Teaching Microfinance the "JA" way

I had occasion today to think about how I would start teaching young people about Microfinance, and I thought a fun way to do it would be practical: in the same way that 13 year olds start a business in "Junior Achievement" in middle school, we could have a "JA in the Developing World".

The prototypical business is, of course, the lemonade stand. And in a tropical climate, a lemonade stand should do good business. So, to make things concrete, let's say that there's a street in China where you can set up your lemonade stand, and people will pay 2 Yuan per glass (about 25 cents). All it takes to make a pitcher of lemonade is 2 lemons (3 Yuan each) and 1 cup of sugar (another 3 Yuan). A pitcher has 10 glasses worth of lemonade. So, we run the numbers, and we see we have a profitable business: 9 yuan to make a pitcher of lemonade, and 20 yuan by selling it. Great! Let's get the signs and start making money.

Uhh.... Just one problem.... You only have 2 Yuan! Oh, and by the way, each of your 3 kids needs to eat 1 Yuan worth of food each day or starve.

Hmm... If this were the Silicon Valley, we could get a venture capitalist to invest in our lemonade stand business and buy a share of the company. But it's not. If there were other parts of the US, we could get a bank loan and repay it with our earnings. But it's not. So, it looks like one of your kids will starve today, and the other two will go tomorrow.

You know what? I'm going to do you a BIG favor. I happen to have extra lemons, and some sugar. I'll LOAN it to you, but you have to give it back in the form of lemonade ready for sale. You deserve something for your labor of making the lemonade, and I'm big-hearted and don't want to see your kids starve, so I'll give you 3 Yuan for the finished lemonade. Sure, I can turn around and sell it for 20 Yuan, which is not bad for me:

• 9 Yuan raw materials
  
• 3 Yuan of labor
  
• 8 Yuan profit
  

So of the 11 Yuan of value that "we" created, I get 8 for contributing the capital, and you get 3 for contributing the labor (squeezing lemons for an hour is hard work!)

Hardly seems fair, does it? And yet, what are you going to do about it? Let your kids starve? So, I'll see you tomorrow, and if I'm feeling generous, I'll give you the same deal.

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Pretty bleak, isn't it?

That is the situation faced by many entrepreneurs in the developing world.

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Now, let's re-imagine the scene, but with microcredit.... You have the option of taking a 10 Yuan loan, which must be repaid, 6 Yuan per day, in each of 2 days. (Yes, that's a very steep interest rate, but you know what? You only have 2 Yuan to your name, and no collateral, so you're not a very good credit risk.)

Day 1:

You borrow 10 Yuan, add it to your 2 Yuan, and have 12. You buy the ingredients for lemonade (9 Yuan) bringing your total down to 3. You sell your pitcher of lemonade for 20 Yuan, now wealthy at 23. You feed your kids (3 Yuan), and repay the first payment of your loan (6 Yuan). You have 14 Yuan left at the end of Day 1.

Day 2:

You buy ingredients for another pitcher of lemonade (bringing you down to 5 Yuan). You sell it for 20 Yuan, so you now have 25. You can pay off the second installment of the loan (6 Yuan), feed your kids, and still have the princely sum of 16 Yuan, 14 more than you started with 2 days ago!

Day 3:

A nice pattern emerges: Your daily costs (9 Yuan for materials, 3 Yuan for food) are easily covered by your income (20 Yuan from lemonade sales), leaving you a profit of 8 Yuan per day. Until you suddenly realize, you could make TWO pitchers of lemonade. You only need to feed the kids once, so you make 11 Yuan profit on the second pitcher.... Hmm, maybe you CAN feed the kids a second time. Or think about paying the 2 Yuan daily tuition for school for the older one....

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Hmm, not quite so bleak now, is it? That's the power of microcredit!

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