I recently enjoyed reading Due Diligence, David Roodman’s book about the ‘microfinance’ movement in global development. The main conclusion of his book is that microfinance was overhyped, especially in its claimed ability to alleviate poverty, though there are a lot of nuances to this. Microfinance (and the related ‘microcredit’ and ‘microenterprise’) became particularly prominent in the public consciousness after Muhammad Yunus received the Nobel Peace Prize in 2006 for founding the Grameen Bank. The idea that you can kickstart development by loaning small amounts of money to the world’s poor so that they invest it or start businesses is a compelling story; you can see why it attracted the attention that it did.
In chapter three, Roodman traces the movement’s historical foundations. I was surprised to learn that the first person to recognisably engage in modern microfinance was… Jonathan Swift, the author of Gulliver’s Travels.
Swift pioneered a system of ‘loan funds’ that lasted for over a century and, at its apex, provided credit to a fifth of the Irish population. The whole story is surprisingly obscure, even in Ireland.1
The Irish loan funds
Jonathan Swift was the Anglo-Irish Dean of St Patrick’s Cathedral in Dublin, and a public intellectual who wrote about a wide range of social and economic issues. Swift was already famous by the time Gulliver’s Travels was published in 1726, which further boosted his fame across Europe. Gulliver’s Travels is a strange book, which satirises (among other things) the tall tales of travel writing from the time. It’s unsurprising that it has inspired so much literary commentary and analysis in the following 300 years (as well as an extremely stupid Jack Black movie). Three years after Gulliver’s Travels, Swift published A Modest Proposal, a satirical essay which proposes that poor people in Ireland should ease their financial woes by selling their children as food to the British. Meat from the children, he writes, will be “very proper for landlords, who, as they have already devoured most of the parents, seem to have the best title to the children”.
Both through the sales of his books, and his position as Dean, Swift amassed substantial personal wealth – some of which he wanted to use to help the poor. At some point in the 1720s, Swift started a fund with £500 of his own money, and began making interest-free loans sized between £5 and £10 aimed especially at “poor industrious tradesmen”. Swift’s fund had two distinctive features, which made it structurally almost identical to modern microfinance. First, borrowers were expected to make partial repayments on a weekly basis. Second, in order to get a loan from Swift, you had to provide signatures from two people who knew you and attested to your good character. The primary account of these loans comes from a biography written by his godson Thomas Sheridan. Sheridan says that it was a “maxim” for Swift that, due to the co-signing mechanism, “any one known by his neighbours to be an honest, sober, and industrious man, would readily find such security; while the idle and dissolute would by this means be excluded.” The system succeeded: due to the high rates of repayment, Sheridan reports that Swift experienced minimal personal loss of capital. This was the case even though the loans required no collateral. It’s also notable that Swift made use of the court system, prosecuting both borrowers and guarantors if they failed to repay.
By Swift’s time, lending at subsidised interest rates had been established in England as a form of charity, which is probably where he got the idea. That idea is less obvious than it sounds: after centuries of religious hand-wringing about the evils of usury, it was unintuitive that making it easier for people to become indebted could be an effective response to poverty. You can think of Swift as attempting to improve upon the earlier model of a ‘friendly society’, which is a mutual aid group that provides services including loans and insurance. Before the welfare state, friendly societies were a huge deal; in 1905, there were 30,000 separate friendly societies in the UK, with 14 million members.2
Other philanthropically-minded people in Ireland were inspired by Swift’s example. Two years after he died, in 1747, the Dublin Musical Society established a loan fund, in which the proceeds from its performances would be loaned out “upon the same system as Dean Swift”. The credit project came to dominate the Society: by the late 1760s, it was providing loans to more than 5,000 people. Note that these interest-free loans were de facto a subsidy to the poor, given the reality of inflation. The Musical Society scheme eventually fizzled out, but it inspired many similar ventures.
Irish loan funds were opened on a much greater scale after 1823, when Parliament passed the Charitable Loan Societies (Ireland) Act. This allowed funds to charge interest, and it also exempted them from the stamp tax. (You normally needed to pay the stamp tax to make a contract enforceable by a Justice of the Peace, instead of the slower court of quarter sessions.) The new legislation gave the loan funds a big advantage over commercial lenders who hadn’t paid the tax.
One reason why this legislation was passed was that Ireland had suffered a potato famine the year before, and extending credit was seen as one way to help with the recovery. Everybody knows about the Great Famine, which began in 1845; fewer people know about the several earlier (though less deadly) potato famines across Ireland, including in 1822. Some of the loan funds were operated on a charitable basis, while others made a profit. The non-profit model was particularly prevalent in the wave of new funds in the 1820s. A London-based relief fund for the 1822 famine endowed the ‘Reproductive Loan Fund Institution’ with £55,000, which financed 100 new funds – the managers of which were prohibited from obtaining “any salary, allowance, profit or benefit”.
Although more banks began opening in Ireland following financial liberalisations in the 1820s, they remained largely institutions for the rich. In his economic history of Ireland, Cormac Ó Gráda describes Irish banking during this time as dealing almost exclusively with the richest third of the population. When banks attempted to enter the market for small loans to the poor, they often lacked the local knowledge and community enforcement mechanisms that distinguished the loan funds. Several pejorative terms attest to the low reputation of Irish moneylenders at the time, being called ‘mealmongers’ or ‘gombeenmen’ (the latter evolved into the modern Irishism of gombeen man, i.e. somebody corrupt).
Additional loan fund legislation was passed in 1836 and 1838. These bills established the Loan Fund Board, which collected information about the loan funds and disseminated knowledge about best practices. It also gave depositors more information about creditworthiness, making them more likely to invest. The number of loan funds spiked after the creation of the Board.
At its peak, these funds were making loans to over a fifth of households in Ireland – a much higher fraction than commercial banks. In the early 1840s, there were twice as many loan funds as there were bank branches. Essentially the only difference between these loan funds and the Swift system is that borrowers were paying interest. Since large deposits will, naturally enough, make up the majority of the total, the loan funds were still a relatively small fraction of total deposits by value: from the 1830s to 1840s, loan funds increased from 2% to 5% of the level of total bank deposits.3
The charitable reading of the government’s treatment of loan funds is that they were helping the poor to help themselves. Until 1838, Ireland had no equivalent of England’s Poor Laws, which went back to Elizabethan times. The upper and middle classes bristled at the level of tax increases that would have been required to create even a minimal welfare state.
Another way in which loan funds were modern was their then-revolutionary practice of lending to women. A fifth of borrowers from loan funds were women, most of whom were unmarried. A high rate of lending directly to women is one of the most notable characteristics of microfinance; 97% of borrowers from Grameen Bank are women. Although a fifth is far from gender parity, it was certainly an improvement on traditional banking in this regard.
The decline of the funds
After peaking in 1843, the Irish loan funds began a precipitous decline. One reason was the Great Famine, which followed the potato blight of 1845. Repayment rates tanked, and many of the one million people who emigrated in the wake of the famine did so while still indebted. Another reason was new legislation: in 1843, the Loan Societies Act lowered the caps on the funds’ interest rates from 13.6% to 8.8%.
Irish parliamentarians and those familiar with the loan funds system were almost unanimous in their opposition to the legislation. Irish newspapers were also generally against the change; the Freeman’s Journal wrote that “We do not conceive that the borrowers will be much benefited, but we think deposits will be limited in number by the operation of reduction [in the interest rate]”.4 The Act may not have passed if there had been a proper parliamentary debate, but it was rushed through as a form of ‘housekeeping’ and fewer than 40 MPs even showed up to vote on it.
The interest rate cap was probably not motivated by a desire to prevent usury, or indeed by any of the usual arguments for price controls. Banks and other moneylenders were still allowed to charge far more than 9% interest. It was more likely motivated by the growing political influence of banks, which had been surprised by the levels of competition they faced from loan funds in the market for small and medium-sized deposits. The single individual who defended the Act in parliament, John Young, was a director of the Bank of Ireland.
It’s a particularly dark irony of history that the legislation which devastated one of the main financial services for the Irish poor was passed two years before the Great Famine. The 1843 bill is a stark contrast to the earlier legislation, all of which were aimed at encouraging Irish loan funds.5
The number of loan funds in Ireland fell from a high of around 300 in 1843 to 50 by 1916. The final official report on the loan funds was released in 1914. It painted a bleak picture of a small amount of inherited capital, with apathetic managers and committee members. The weekly repayments had become payments once per month or even less often.
The resilience of the loan funds was impressive: they provided credit to the poor for more than a century, during a period of frequent macroeconomic instability and emigration. A perennial dilemma for the funds was adverse selection: since there was no collateral required, those seeking a loan were in some ways negatively selected. Due to weak record-keeping and bureaucracy, even just administering the funds was challenging. Court records describe cases sometimes being thrown out because it couldn’t be proven whether the borrower was the same person who signed the contract.
The legacy of Irish microfinance
Were the Irish loan funds effective at reducing poverty? There were certainly reports of the many lives uplifted by the funds: Sheridan wrote “I have been well assured from different quarters, that many families in Dublin, now living in great credit, owed the foundation of their fortunes, to the sums first borrowed from [Jonathan Swift].” A report to the Loan Fund Board in the 1840s describes the effect which microcredit had on a village in Cork:
Farmers by a command of money at a reasonable rate of interest… can purchase the best seed for the land. The fishermen living along the coast do not lose the chance of fish from want of boats and fishing gear, and the tradesmen are no longer idle from want of material to work with.
But ultimately, bad data quality and the lack of experimentation mean that it’s almost impossible to isolate a causal effect of the funds. Even today, with multinational organisations that keep extensive records, the same considerations mean that it’s extremely difficult to determine the effects of microfinance (Roodman again: “On the limited high-quality evidence so far available, the average impact of microcredit on poverty is about zero”).6
Aidan Hollis and Arthur Sweetman wrote a relatively positive history of the loan funds, which is well worth a read. Borrowing can help people escape a poverty trap, but poor people might also take on unsustainably high levels of debt, and there are also questions about what the enforcement mechanism is for repayment. As with any microcredit, how these net out is an empirical question. Hollis and Sweetman see certain features of the funds, such as being highly locally devolved and requiring signatures to attest to the borrower’s good character, as largely solving the problems inherent in encouraging the poor to take on more debt.
There is a long history of pushing for credit expansion as a way to jumpstart prosperity. The government of British India began encouraging what would now be called microfinance through an act from 1904, following a recommendation from the Indian Famine Commission. After the enabling legislation was passed, non-profit financial institutions owned by their members (credit cooperatives) began to open across India and issue small loans. The presence of credit cooperatives was one of the reasons why Bengal was the location of the modern resurgence in microfinance beginning in the 1970s. Horace Plunkett had attempted to introduce credit cooperatives to Ireland (which were, like their Indian counterparts, inspired by the ‘Raiffeisen’ model in Germany), but they never took off.
It’s tempting to think that the problem with extending credit to those in poverty is that there will be high rates of default. But this is not so, according to Banerjee and Duflo’s classic paper The Economic Lives of the Poor. In the poorest countries, the rates of loan repayment are surprisingly high – in large part because there are informal social networks and enforcement mechanisms to make people pay. It’s easier to refuse to repay your loans to an impersonal institution than to people in your village. Generally, one of the most striking features of microfinance is that the rates of repayment are sky high (suspiciously so!).
Is there reason to think that today’s microfinance is historically connected with the earlier Irish microfinance? Roodman thinks that the earlier microfinance efforts did affect the modern ones: “The ideas within [microfinance] are ancient, and their modern embodiments descend directly from older successes.”7 Microcredit is a sufficiently obvious idea that it will recur throughout history; it also has several other predecessors. But Jonathan Swift’s scheme is the earliest clear parallel I’m aware of. If only he had lived to see the invention of Substack, I’m certain he would’ve had his own grants program.
Tyler Cowen and Alex Tabarrok noted the Jonathan Swift connection with microfinance on their blog many years ago. You can also listen to Tyler interview Jonathan “GPT” Swift.
Due Diligence, Kindle edition, location 1114.
Hollis and Sweetman, pp. 300–304.
Hollis and Sweetman, p. 303.
Not all the reasons for the decline in the Irish loan funds are sinister. For example, increasing urbanisation was unfavourable to loan funds, which extensively relied on personal contacts for repayment.
Due Diligence, Kindle edition, location 3231.
Due Diligence, Kindle edition, location 947.
Great article as always Sam, thanks for this
I found this an extremely interesting article. This is not least since, coincidentally, I am writing a short section on the Irish loan funds in the 2nd completely updated edition of my 2010 book “Why Didn’t Microfinance Work?’ due out early next year with Bloomsbury.
Let me make two observations related to what I wrote. I challenge the very common idea that the loan funds were the forerunners of the modern microfinance movement. First, you did not mention the radical politics of Swift and how he saw the loan funds as a way of helping the poor for sure, but also as a backdoor way of advancing his staunch anti-capitalist/anti-English/anti-Imperialist views. There are many reasons why the loan funds would promote such goals - promoting self-sufficiency meant not buying from the hated English; targeting support at good businesses and turning away poor prospects and directing them to other social programs, thus saving hapless individuals from their likely fate, showed the correct (non-capitalist) way to do business; validating the general concept of not-for-profit enterprise as opposed to capitalist for-profit enterprise; and so on. Since Swift’s ideological position and goals are the exact opposite of those individual capitalist goals (see Hayek, Friedman, etc) that gave life to the modern microfinance movement in Latin America in the 1960s under USAID tutelage, I find it really hard to agree with those that claim Swift’s loan funds are the first microfinance institutions. Apart from some obvious operational similarities, their respective goals were a million miles apart.
Second, Hollis and Sweetman’s work is very interesting, but also in a way that you did not refer to. They precisely pinpoint the fall of the loan funds to 1843, which is the year when the nascent financial elites likely bribed Irish government regulators to pass regulations that forced the loan funds to drop their social mission, cooperative format, commercialise and become for-profit financial businesses but in a way that they could not compete with the private commercial banks just getting started. The end of the loan funds was made inevitable. Many soon began to lose clients, some were taken over by greedy entrepreneurs and turned into their own money-making machines, and so on. My point here is that his destructive conversion episode is very similar indeed to what happened to begin to destroy the modern microfinance movement and effectively led to its fall from grace. This is to say that the microfinance industry was also forced, from the 1990s onwards, to commercialise and become a for-profit business and to drop all remnants of its original social mission. The result of this transition is now all around us: the largest microfinance institutions now rake in Wall Street-style profits from their reckless lending activities in the global south, while the evidence that microfinance is having a quite destructive impact on the global poor overall is now, in my opinion, beyond a doubt.
I’d value any comments/corrections!