Microfinance — the provision of small, group loans to poor people in poor countries — is, depending on whom you ask, either the latest way for western capitalists to exploit third world laborers or the miracle cure that will allow the world’s poorest citizens to successfully run their own business and thereby work their way out of poverty. The government of Andhra Pradesh, the Indian state where I spent the better part of last summer, clearly agrees with the former view. In 2007, after a spate of farmer suicides, the government nearly wiped out the state’s entire microfinance industry by making repayment of microfinance loans illegal. Many of the development organizations that support microfinance, on the other hand, clearly believe that microfinance has significant potential. I met many people who sincerely believed that their microfinance efforts represented their best contribution in the fight against global poverty. However, by over-selling the benefits of microfinance, these organizations risk leaving other important problems unaddressed.

I tend to be more skeptical — while microfinance is clearly beneficial to poor countries, these benefits are neither as large nor of the form that many of microfinance’s proponents claim. First, I do not accept the implicit premise that small businesses represent the way out of deprivation for the majority of the world’s poorest citizens. Second, microfinance lending is structured in a way that is of little use to people who wish to start new and innovative businesses.

In Andhra Pradesh, small, family-owned shops are a dime a dozen: Drive down any major road, and you’ll probably see at least one every hundred yards. During my time in India, none of the small-business owners whom I met earned an income significantly higher than comparable daily laborers. Economic studies done in this part of India have shown that the average owner-operator of one of these businesses earns less than the minimum wage. Most of these small business owners are running small businesses because they have no alternatives, not because they are somehow more entrepreneurial than the citizens of developed countries.

If given the choice, many small business owners would rather be working in a stable, wage-paying job than running their own business. The owner-operator of a small business bears a tremendous amount of risk — a wage-earning employee, on the other hand, has significantly greater security in regards to future income and employment. There is considerable empirical evidence that this greater stability improves the lives not only of the workers themselves but also of their children. For instance, one study in Mexico showed that women who moved from running a small business to working in a sweatshop began to better feed their children, thereby largely eliminating the height difference between those children and healthy children. Like it or not, the soulless multinationals who established sweatshops in Singapore and call centers in India are doing something that most poor small business owners can never do for themselves — create consistent employment that is the first step on the ladder out of poverty. Research by Tuck School of Business professor Rafael La Porta has shown that more developed economies have a smaller proportion of the population who are self-employed or work for small businesses.

Even if small businesses were a feasible route out of poverty, microfinance is unsuited to properly support these endeavors. Traditional loans to the poor — uncollateralized, with flexible repayment schedules — are very risky and time-consuming from the lender’s perspective. Microfinance loans, in contrast, are completely inflexible — the repayment dates are fixed, and defaults are rare because an entire group of borrowers is usually responsible for the repayment of every individual’s loan. This rigidity is not well suited to entrepreneurship, which, by definition, is risky and uncertain. One cannot reasonably start a new business with loans that demand quick and complete repayment.

That being said, there is considerable evidence that microfinance loans help poor families ride out hard times without falling into destitution — economists call this “consumption smoothing.” In this regard, microfinance is often invaluable. But it is wrong to think that microfinance is a panacea for eliminating global poverty. This simplistic kind of thinking obfuscates other immense economic problems that poor countries face. Given how fortunate all of us at Dartmouth are, we owe the world’s poorest citizens more than sloppy thinking.