Raising Galveston Incomes
by David Stanowski
15 August 2008
The previous article, The Galveston Economy: Diagnosis and Cure, made the case that the Galveston economy suffers from a variety of ills due to the mis-allocation of available capital, and the inability to raise sufficient capital. It argued that industries with major capital investments, like the Port, have the potential to pay above-average wages, as is the case for enterprises that employ people with superior skills.
This article will turn its attention to a grassroots method to use the leverage offered by capital to raise incomes by providing financing to those who have skills that they could use to increase their income, but lack the capital to do so. Some historians think that this practice may date back hundreds of years, but in more recent times it seems to have begun in Bangladesh, in 1974. Since then it has helped millions of people in the Third World, so it may even have a chance in Galveston!
In 1974, Professor Muhammad Yunus, a Bangladeshi economist from Chittagong University, led his students on a field trip to a poor village. They interviewed a woman who made bamboo stools, and learnt that she had to borrow the equivalent of 15p to buy raw bamboo for each stool made. After repaying the middleman, sometimes at rates as high as 10% a week, she was left with a penny profit margin. Had she been able to borrow at more advantageous rates, she would have been able to amass an economic cushion and raise herself above subsistence level.
Realizing that there must be something terribly wrong with the economics he was teaching, Yunus took matters into his own hands, and from his own pocket lent the equivalent of $17 to 42 basket-weavers. He found that it was possible with this tiny amount not only to help them survive, but also to create the spark of personal initiative and enterprise necessary to pull themselves out of poverty.
Against the advice of banks and government, Yunus carried on giving out 'micro-loans', and in 1983 formed the Grameen Bank, meaning 'village bank' founded on principles of trust and solidarity. In Bangladesh today, Grameen has 1,084 branches, with 12,500 staff serving 2.1 million borrowers in 37,000 villages. On any working day Grameen collects an average of $1.5 million in weekly installments. Of the borrowers, 94% are women and over 98% of the loans are paid back, a recovery rate higher than any other banking system. Grameen methods are applied in projects in 58 countries, including the US, Canada, France, The Netherlands and Norway.
What Professor Yunus discovered was that many of the poor already had a variety of skills that they could exploit to make a living through self employment, but without the access to conventional financial institutions, they were financing their businesses through loan sharks. This made the cost of capital so prohibitive that it never offered the leverage they needed to increase their income and wealth. If someone was willing to offer them loans at "market rates", the whole situation could turn around!
In 2006, Professor Yunus and Grameen Bank were awarded the Nobel Peace prize for their efforts to create economic and social development from below through their pioneering work in the field of micro loans, or micro finance!
If you give a man a fish, he will have a single meal. However, if you loan him the money to buy a fishing pole, he will eat for the rest of his life.
Is the Grameen model the best approach in a place like Galveston?
There are two basic ways to inject capital into the economy; equity and debt financing. A local program could offer capital in the form of equity financing, but this approach does not lend itself well to the types of businesses it will target. Those who offer equity financing are usually known as venture capitalists. They nearly always require at least 51-55% ownership in a business, and they are looking for substantial appreciation in the value of the company as the way to make their investment payoff.
It would make little sense for a VC firm to invest in a one-man business that has little chance to appreciate substantially in value, and what owner would want to permanently give up a majority of the profits in return for equity financing? Even a non-profit VC institution would want to sell out as soon as possible to recapture their capital, so such equity financing would really look more like a no-interest loan. Therefore, it would seem that Galveston would be best served by using debt financing for a micro finance program, too.
Obviously, the key issue in the business of loaning low-income people money is repayment. If they were doing well with their finances, they wouldn't need a loan. However, remember that these loans are only made to allow them to build a small business; not for consumption.
In the Third World, some of the micro-lenders only loan money to members of a group, so that if one member starts missing their payments, the group applies peer pressure to try to make them perform. This is a practice that would probably not work well on the Island.
A better approach might be to have a loan committee that screens applicants based on their character. Is the committee convinced that if they loan this person money, he or she will actually use it to try to start a business, and not to throw a big party?
Some U.S.-based micro finance institutions (MFIs) also require that applicants take a short business-basics course that covers concepts like: Financial Management, Marketing, Forecasting, Cash Flow, Pricing, and Business Planning. The Plan Fund, in Dallas, charges $35 for its 2-day course that qualifies graduates to receive business loans.
Another method often used by MFIs is to collect interest on a weekly basis to make sure that borrowers are budgeting their repayments properly.
Even though most Third World MFIs report repayment rates in excess of 90%, they still insist on charging interest rates in the 16-20% range. Since many of these MFIs have become large institutions with a lot of overhead, they say that they need to charge these rates to offset the high cost of servicing small loans. This practice would not have to be employed in a Galveston MFI, if it was kept small and nibble and was run primarily by a volunteer staff.
Most MFIs raise the capital for their lending programs from large foundations, but new efforts to do small-scale fund raising are using Internet sites such as Kiva, MicroPlace, AccionUSA, and Prosper to allow individual donors to contribute amounts as low as $25 to a general fund, or to earmark their donations to specific businesses featured on the web site.
The Galveston Founders Party would like to set up a 501c(3) as a Micro Finance Institution. This MFI would make arrangements to have Galveston College develop a business-basics course for their use. Class graduates would be eligible to apply for loans where they would present a business plan and character references. Interest rates would be kept as low as possible, and payments would be collected weekly.
Fund raising would be done at Foundations and directly with individuals over the Internet. Even though money is transferred to borrowers as loans, and not gifts, when loans are repaid, they would not be returned to the donors; the funds would be used for more lending.
How would this work?
1. One of my neighbors is a very good handyman, but he doesn't have the capital to expand his business. Since he doesn't have enough cash income to even buy a telephone, his business is limited to the neighbors who have heard about his service, and who walk over to his apartment, and knock on the door.
With a loan of as little $200, he could get a phone and some business cards, and increase the territory that he can serve. As his business builds, and he pays back the original loan, he could apply for another larger loan to get a vehicle which would allow his business to cover the whole City.
2. Someone else I know is trying to expand a small publication. With a loan of $2,000 +, he could lease commercial space, buy equipment, hire 2-3 part time employees, and increase his advertising revenue.
3. Want to cut hair in your home? Get the required licenses and apply for a small loan to buy equipment, and finance some basic advertising.
4. Want to start a lawn-mowing business, but you don't have $500 for equipment? You need a micro loan!
As a non-profit MFI with low overhead, a lot of seed money could be invested at the very grassroots level of the local economy where it would have a lot of leverage to change people's financial circumstances dramatically. Obviously, some businesses would fail, and some or all of the money lent to them would be lost, but many would succeed and raise the income of their owners, AND the income for the whole City! As those businesses expand, the successful owners will turn to their friends to find employees, and the process will spread through the neighborhoods.
Micro finance is truly a way to bring capitalism to those who have no capital! It provides start-up money to low-income people and gives them a chance to become productively self-employed, which demonstrates that individual initiative and capital formation are the most important components of upward mobility. Unleashing the creativity and energy of each individual is the way to grow the economy.
Looking for volunteers:
The Galveston Founders Party is looking for someone to take over this project and run with it. If you are interested contact me at:
firstname.lastname@example.org or 409-621-2099.
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