IB Economics SL 3.1.1 National income accounting Question Bank

Study the extract below and answer the questions that follow.
Micro-credit conflict of interest

(1) The idea of giving small loans to poor people, especially women, was hailed as the key to achieving economic development for even the poorest citizens. Muhammad Yunus, the economist who pioneered the practice by lending small amounts to basket weavers in Bangladesh, won a Nobel Peace Prize in 2006.

(2) The practice has grown so popular, helping establish small businesses such as tailors and hairdressers, that some are now concerned over the direction it has taken. Attracted by the prospect of profits from even the smallest of loans, some banks now dominate micro-credit, with some charging interest rates of over 100 %.

(3) The key question facing the industry remains how much money investors should make from lending to poor people, mostly women, often at hidden interest rates. "Micro-credit should be seen as an opportunity to help people out of poverty, not as an opportunity to make money out of poor people," Yunus said. "Interest rates should be 10 to 15 % above the cost of raising the money and anything beyond that is exploitation. Most micro-credit lenders would fail this test."

(4) How much interest and profit are acceptable and what constitutes exploitation? The interest rates that draw the most concern include those in Nigeria and Mexico, where the demand for small loans from a large population cannot be met by existing lenders. One Mexican lender charges an annual rate of 125 %. The average in Mexico is about 70 %, compared with a global average of about 37 % in interest and fees.
5 There is debate over whether micro-credit loans actually lift people out of poverty. Some researchers conclude that not every poor person is an entrepreneur in waiting but the loans do help relieve some of the worst aspects of poverty.

(6) The micro-credit industry has outgrown its charitable beginning. Despite a promise to put the money back into development, analysts say the high interest rates and healthy profits of the largest micro-credit institutions pushed up interest rates across Mexico.

Using a circular flow diagram, explain how micro-credit increases economic activity in a developing economy.