Illustration by Ingram Pinn

It says a lot about the talents of John Maynard Keynes – and just as much about the shortcomings of modern macroeconomics – that when the financial crisis struck, policymakers instinctively reached not for their fancy models, but for the Keynesian idea of fiscal stimulus. These pages have been filled with eminent thinkers arguing over whether it is time to bring the stimulus to an end.

Perhaps we should turn the question around: if stimulus were to be the solution, what would be the problem? The problem would be that too many of us wanted to save money or pay off debts; that is, we wanted others to pay for our services but weren’t so keen on paying for theirs right now. Simple arithmetic suggests this would leave slack in the economy. In addition, the problem would be that businesses, pessimistic about prospects for recovery, didn’t harness all the spare savings floating around and plough them into new investment projects. The slack would stay slack, possibly for a long time. If that was the problem then government stimulus would be the solution.

And the above paragraph doesn’t seem to be a bad description of the US or UK economy, which suggests the case for stimulus is strong. True, the patience of the bond markets is surely not boundless (and say what you like about kowtowing to the markets, if we’d like them to lend us money we have good reason to care whether they are willing to lend it). And there already is an awful lot of stimulus spending going on right now, so it’s not absurd to suggest we could get by with less as the economy bounces back. I realise that I am sitting on the fence here, but it’s part of my new maxim, which is never to stand in the middle of a fight between Paul Krugman and Niall Ferguson.

Continued at ft.com

I don’t recall it myself, but like most babies born in 1973, I apparently slept face down in my cot. This was the standard advice, made famous by Benjamin Spock in 1948. We now know that for many unlucky families, this well-meaning advice was fatal. According to research published in 2005, putting babies to sleep on their fronts has led to about 60,000 cot deaths.

The story is a favourite of Sir Iain Chalmers, a campaigner for better standards of evidence in medicine and beyond. Because it is possible to do so much unwitting harm in medicine, many medical interventions are now subjected to a randomised controlled trial. Austin Bradford Hill performed the first properly controlled clinical trial in 1948, although he had predecessors, including James Lind, who used a randomised trial to show that citrus fruit prevented scurvy. There’s even a controlled trial in the Bible (Daniel 1:8). Such trials have proved the effectiveness of countless treatments, and the dangers of countless others.

Continued on ft.com

We are sometimes admonished: “Don’t shoot the messenger.” Since there is rarely a logical reason to shoot messengers, such advice should not be needed. But it is, because bad news hurts, and organisations find it difficult to deliver such news to the person in charge.

Andrew Rawnsley’s account of Gordon Brown’s premiership has received attention for its claims that Mr Brown was abusive and physically threatening to his staff, grabbing lapels, stabbing upholstery with his pen and causing his advisers to cower for fear of violence. If true, that is disturbing – but few people will have found it surprising. High-status men sometimes do abuse that status.

I am worried not so much that Mr Brown may be beastly, but that he is cutting himself off from good advice. Mr Rawnsley describes Mr Brown’s fateful decision to pull back from a widely trailed snap election in late 2007. His inner circle waited until he was out of the room before agreeing that such a course would be disastrous. When the prime minister reconvened the meeting, however, this was not conveyed: “No one expressed a clear view. No one wanted responsibility for the decision.”

This is a more significant anecdote than any tale of flying spittle. Any leader needs frank advice, and the biggest obstacle to receiving it is often the leader himself. Even a polite and level-headed boss will be tempted to cut naysayers out of the loop. Knowing this, sensible juniors will avoid expressing criticism or grim tidings if at all possible.

“If you deliver bad news, you’re disempowering yourself,” says Professor David Sims of Cass Business School. “You’re less likely to be listened to in the future.” For some ambitious subordinates, this is a far worse fate than the threat of being thumped.

A new reality television show, Undercover Boss – which has migrated to the US after airing on Britain’s Channel 4 last summer – tries to tap into the dissonance between bosses and front-line staff by filming as a senior executive works incognito in the trenches. It is a delicious premise.

When bosses must don a disguise to learn about how their organisations really work, trouble is in store. One of Friedrich Hayek’s obvious-once-pointed-out observations is that society is full of local knowledge, often of a subtle nature and only fleetingly exploitable. That is one reason why decentralised market processes tend to work well. When a hierarchy has to exist, Hayek’s insight is the reason why bosses should want to receive truthful assessments of what is going on the shop floor (they don’t) and subordinates should be happy to provide them (they aren’t).

What makes matters worse for any organisation is that the same dynamic is taking place at every level. Each middle manager is a fresh obstacle to the flow of truth up a hierarchy of wastebaskets. Sensible managers try to let information flow freely, but many are happy to reinforce the barricades for their own peace of mind.

The results of barriers to communication can be catastrophic. H.R. McMaster’s influential study of decision-making during the Vietnam war, Dereliction of Duty, is packed with examples. The joint chiefs of staff were warned by their chairman, Maxwell Taylor, that Lyndon Johnson did not like “split advice”. Johnson’s defence secretary, Robert McNamara, argued that government would be ineffective if department chiefs were to “express disagreement” with the president. Not disobey, but “express disagreement”. Johnson trusted McNamara implicitly and relied too heavily on the advice of a man he praised as a “can-do fellow”. Isolating himself from dissent, the president made a series of disastrous decisions.

Both the parallels and the contrasts between Vietnam and Iraq are striking. The initial decision to invade Iraq and the appalling prosecution of the war for the first three years were made in an atmosphere in which dissent was made extremely difficult by Donald Rumsfeld and his immediate subordinates at the Pentagon. When the army’s chief of staff, General Eric Shinseki, argued just before the war that many more troops would be necessary, he was rebuked. He retired a few months later. Another general, John Abizaid, was a Middle East expert. He warned that “de-Ba’athification” would backfire and was flatly and repeatedly told that it was official policy. Mr Rumsfeld would not even let his commanders use the word “insurgent”. This Orwellianism made it much harder for army officers to rely on the appropriate doctrine: a counter-insurgency strategy.

The tactics in Iraq were initially corrected from the bottom up. One colonel established stability in the city of Tal Afar only when he engaged in a rebellion against the official strategy. His requests for additional men never made it up the chain of command to the commander in Iraq, General George Casey. He went ahead and turned around Tal Afar anyway. The name of this insurgent colonel? H.R. McMaster, who made such a close study of the top-down dysfunctionality of decision-making in Vietnam.

Most organisations cannot rely on having the equivalent of an H.R. McMaster, who had – literally – a PhD in failures of leadership. So businesses try instead to encourage bottom-up feedback with “360-degree” appraisal processes, “workout” sessions such as those introduced by Jack Welch at General Electric, or anonymous suggestion cards. Older tactics include the court jester and the devil’s advocate.

The other striking lesson of Iraq is that a change at the top can work wonders. General David Petraeus, who took command in Iraq in 2007, rightly relied on men such as H.R. McMaster to rewrite strategy. But Gen Petraeus and his boss, Mr Rumsfeld’s successor Robert Gates, had the advantage of not being the men who had made such awful decisions in the first place. Not many leaders can bear to perform their own U-turns.

Click here to view the embedded video.

Spend less time with your children. Don’t underestimate the benefits of a divorce. Never serve dog food at a dinner party. These are some of the unexpected revelations to have emerged from an unlikely combination: happiness, and economists.
You might think that the “dismal science” has done enough damage for now. Economists have hardly emerged from the banking crisis with their reputations enhanced. But forecasting financial meltdown was never going to be easy, so perhaps it is best of economists stick to simpler questions, such as “how can we be happy?”
A growing number of economists have been attempting to answer this question. Not only are the statistical tools of economics surprisingly well-suited to unlock the secrets of happiness, but the research topic is good box office, too… and these are economists we’re talking about.
Some of the results sound as though they come from hippies rather than economists. For instance, economic growth does not seem to make the citizens of a rich country such as the UK any happier. A good job too, considering the current prospects of any economic growth seem slim.
Other discoveries are less intuitive. For instance the economists Andrew Oswald and Nattavudh Powdthavee has discovered that teenagers and the elderly are actually rather happy. “Your late 30s are the most unhappy period of your life,” Oswald cheerfully tells me. Thanks, Professor, from a grateful 35-year-old.
Both these results have been discovered through the simple method of asking people how satisfied they are with their lives, and then cross-referencing what they say with a battery of other data such as health, income, and age. It’s a straightforward approach, but not everyone is convinced that it produces sensible results.
Norbert Schwarz, a psychologist, once conducted an experiment in which he arranged for people to find ten cents – about six pence – by a photocopier just before they filled in his happiness questionnaire. The ones who found themselves pennies richer then claimed to be substantially happier with their lives as a whole. A sunny day had much the same effect.
Partly for this reason, another group of economists comes at the happiness problem in a different way. (No field of economics would be complete without a schism, would it?)
This alternative clan uses the “day reconstruction method”. People would be asked to think about the previous day. What did they do first? (Get up, stumble downstairs for coffee.) How long did it take? How did they feel while they were doing it? And what did they do next?
This method produces a satisfyingly detailed picture of the ebb and flow of happiness and misery throughout the day. One study, conducted by Schwartz, Daniel Kahneman (a Nobel prize winner in economics), and others, interviewed nine hundred working women in Texas. Among the choicer discoveries is that apart from working and commuting, nothing is less enjoyable than childcare. Perhaps we shouldn’t be surprised. Children can be more inspiring in the abstract than in person, and while it is beyond the pale to say you hate spending time with your kids, nobody will blame you if you say they acted like brats yesterday evening.
Indeed, of all the people you might expect to enjoy hanging out with, friends come top, children and spouse bottom. And forget the what the glossy magazines tell you: shopping is a miserable experience, and so is fooling around at home on a computer.
Not every result is a surprise. For instance, having sex is lots of fun. It is also, tragically, the thing that fewest of these women spent any time doing.
Spending time with your boss is no fun. As to the pros and cons of having sex with your boss, economists can only speculate.
I’ve been following the odder corners of economics for years, and have concluded that some of the tips for a happier life come not from this happiness research, but from more unexpected sources. When I go to a restaurant, for instance, I make sure never to alter my choice based on what my dining companions choose. Dan Ariely, an economic psychologist, has discovered that people tend to “fit in” in such situations and end up with a choice they enjoy less.
A less appetising discovery comes from the American Association of Wine Economists, in a new research paper, “Can people distinguish pâté from dog food?”. It turns out that they can: even if puréed to look like duck-liver pâté and served chilled with Carr’s water biscuits, dog food tastes terrible. Alas, a cost-saving idea discredited.
It’s not all silliness, however. Several pieces of economic suggest that divorce is underrated. Andrew Oswald has discovered people who go through divorce find their lives improve. Betsey Stevenson and Justin Wolfers, economists based in the US, found that as individual US states introduced more liberal divorce laws in the 1970s, domestic violence also fell in those particular states, and so did the number of women killed by their husbands.
Meanwhile, some of the economists conducting this research have influence in high places. Lord Layard, the patron saint of happiness economics in the UK, is a Labour life peer. Alan Krueger, an economist who has been working with Kahneman and Schwartz, has been made a senior Treasury official by President Obama. Before his nomination, he was working on a method for producing “happiness accounts” for the United States.
Yet once an economist, always an economist. Some time ago, I spoke to Professor Krueger about his work on happiness. He preferred to speak about “subjective well-being,” he explained to me, because “happiness sounds a bit frivolous.” Oh for goodness sake, Professor. Cheer up.

At least such is the traditional image of the economist; and who is Dear Economist to demur?

He is not, it would be fair to say, as sympathetic as more traditional agony aunts. He is blunt. He is rude. He loves jargon. When confronted with a woman who enjoys the dating game but worries that she might leave it too late to settle down, Dear Economist offers not a shoulder to cry on but a frank explanation of optimal experimentation theory. When a dinner party guest wonders how much to spend on a bottle of wine, Dear Economist ignores the Good Wine Guide and reaches for the Journal of Wine Economics.

But – and this is the crucial question – is the advice any good? In the six years since the Financial Times entrusted me with the awesome responsibility of answering letters to Dear Economist, I have happily donned the persona and issued my instructions. But I have not asked too closely how they were received – until now.

Over the past few weeks, I’ve been writing to some of my correspondents to ask them what they made of my advice, whether they took it and how things worked out. Here, for the first time, are their responses.

. . .

July 2 2005

Dear Economist,
I believe that there is an inexplicable shortage of sex. Given that studies show that women and men enjoy it more than most other activities, and given its intrinsically low cost, it appears that even a crude approximation of a utility-maximising person would probably spend much more time having sex than most. Do you know of any economic discussion of this?
Michael Vassar, New York

Dear Michael,

It is true that there is something puzzling about the lack of sex in the world. Everybody says they enjoy sex, you can do it fairly safely for the price of a condom, and all you need is somebody of the appropriate gender and sexual preference. How difficult can it be?

Economics professor and blogger Tyler Cowen has offered an embarrassment of possible explanations. In the spirit of perfect competition between economic pundits I suggest that you need fewer answers.

We need just two complementary theories, one to explain the all-night-long sex that couples aren’t having as much of as they should; and the other to explain the casual sex that strangers should be having with each other, and aren’t.

For couples, it’s surely a case of diminishing returns. Just because the average utility of sex is high, doesn’t mean that the marginal utility of more sex is also high. I enjoy sex but I am no longer a teenager and, to be blunt, it takes me days to reload. For strangers, the risk of rejection, violence or social condemnation seems very high. In groups where these risks are lower (gay men, students, hippies) my theory predicts that more sex should be going on.

There is a simpler explanation, though: everybody is having constant, guilt-free sex. They just haven’t told the economists.

Michael Vassar responds:
Your response was far more fun than asking a sex columnist why people don’t have enough money would be, but possibly grabs the low-hanging fruit while leaving a substantial proportion of the effect unexplained. That’s the disciplinary standard though. Economists are prone to looking at the direction of an effect and mostly ignoring its magnitude, rather than proposing experiments to measure that magnitude. I’m happy with just the existence of such a column anyway.

. . .

December 17 2005

Dear Economist,
I recently noted that I only really fancy my girlfriend after I’ve had a few drinks. Is this relationship worth pursuing?
David Pigeon, London

Dear David,

I know how you feel: I only fancy chips with mayonnaise. Sadly for my waistline, my relationship with chips has not suffered. You are saying that like chips and mayonnaise, alcohol and your girlfriend are complementary goods. I am not sure this is a problem.

It might be a problem if your predicament were unusual. It is not. Many people have found that alcohol has aphrodisiac qualities.

Of course, it is easy to drink more alcohol than is good for you, but there should be no need for worry. The government advises that the average man should drink no more than three to four “units” of alcohol. Since the typical British couple claims to make love every three days or so, you should be able to lubricate yourself appropriately without putting too much strain on your liver.

It seems to me that there is one cause for concern: your girlfriend must never suspect that you need to don the beer goggles to find her appealing. Drinking is commonplace in our culture, so you shouldn’t find it hard to camouflage the limits of your infatuation. Just don’t do anything stupid, such as discussing it in the pages of a national newspaper.

David Pigeon replies:
I followed your advice in the knowledge that I had one of the finest economic brains in the country at my side to steer me through the relationship. However, you omitted to advise that the beneficial effect of alcohol in enhancing sexual charms diminishes over time. I soon found that I required ever greater quantities in order to maintain interest and this took considerable toll on both my health and my pocket. I also encountered situations where no alcohol was available but had little explanation for my refusal of my partner’s advances.

Nevertheless, all was for the best. We split up, but I’m now with a wonderful partner who I think I love, but who irritates and annoys me when she gets drunk. Any advice?

. . .

June 17 2006

Dear Economist,
Why do most of us iron our clothes, when we are untidy in so many other ways?
Judith Oliver, Singapore

Dear Judith,

There is an obvious difference between an immaculate shirt and an immaculate sitting room: you get to enjoy the aesthetic benefits of tidying your living space, but not – unless you spend a lot of time in front of the mirror – the aesthetic benefits of your own clothes.

After all, how many of you can honestly say you haven’t sailed through the day, only to discover that you have spinach between your teeth and you forgot to brush your hair? The horror is apparent to everyone but you.

So why do we care more about other people’s enjoyment of our tidiness than our own? It is not a matter of selflessness: we try to make a good visual impression because it will bring us wealth, status and, we hope, a bit of sex, too.

But a second question arises: why are we judged on appearances? It might be intrinsically satisfying to have a well-dressed boyfriend, but there is nothing fundamentally less productive about a scruffy accountant. Evidently, the tie is important because employers believe it is correlated with diligence and talent.

If this is true, we would expect to see the largest premium on snappy dressing in professions where there are few other effective ways to evaluate performance. Estate agents and management consultants are sharply dressed in the absence of more convincing guides to their competence.

In professions where talent is more obvious, this façade is not needed. That is why when I scan the Financial Times office, neatly pressed shirts and blouses are hard to find.

Judith Oliver replies:
I’ve been trying to picture Robin Lane Fox, my favourite FT columnist, in an un-ironed shirt, whether in a garden or in an Oxford tutorial. And it has been difficult. I thought of writing to ask him but I’m afraid he might think it a dreadful impertinence. Luckily, I have no doubt about his vast knowledge and talents.

. . .

August 11 2007

Dear Economist,
I have just joined a dating website in the hope of finding true love. Friends of mine have started dating someone they met online, only for a “better offer” to arise on the website. If this happens, what should I do?
Duncan, London

Dear Duncan,

Internet dating allows more offers to be considered, so the tried-and-tested rules of thumb may no longer be appropriate. It might seem natural simply to consider how many offers you must sample until you are likely to meet “Ms Right”. That would be naive. You must instead balance the benefits of choice against the effect your flightiness may have on your targets.

These decisions are much like those faced by a company choosing the optimal number of suppliers. Dealing with more suppliers allows the company to choose the cheapest and best. But having too many makes suppliers insecure and unwilling to invest in the relationship.

Your ideal choice depends on what you want. Fun and frolics are ideally obtained by keeping options open, perhaps even switching to the spot market. But if you want your partner to have your babies, support you while you write your novel or share the cost of buying a home, you will need to reassure her that you do not have other competitors waiting in the wings.

In some industries it is common to sign contracts with two suppliers – enough competition to keep each on its toes, but enough commitment to inspire big investment in the relationship. In your case that would be a wife and a long-term mistress. Perhaps the tried-and-tested rules of thumb work after all.

Duncan replies:
I was very grateful for your advice. I am delighted to report that I am now happily married, and so is my mistress.

. . .

November 3 2007

Dear Economist,
I am in doubt whether it is worth changing school for my last year of A-levels. I would be living in a much better place (Cambridge, whereas I am now in Dover) and getting more tuition. I am likely to have better accommodation, more freedom and will meet people with diverse interests. But is it worth the risk of not getting into university or getting lower grades on my A-levels? Please help me to solve this dilemma.
GP, Dover

Dear GP,

Let us run through this supposed dilemma again. You are considering a move to a place that appears to be better in every dimension, including the academic one. Yet you are hesitant because of a perceived risk.

I am tempted to suggest you consult a shrink rather than an economist. Fortunately, so-called behavioural economists combine the best qualities of economist and psychologist. And any behavioural economist would quickly diagnose that you are a victim of the “endowment effect”.

The endowment effect is an irrational preference to keep what you have – better the devil you know and all that.

A typical experiment designed to reveal the effect would give participants a small gift for participating in the experiment. Later, the participants would be invited to swap the gift for an alternative. No matter what the original gift was, or what the alternative is, people, irrationally, are reluctant to make the swap.

Your attachment to substandard lodgings and scant tuition in Dover is clearly irrational. Move to Cambridge at once. You may be wrong, of course, but a risk of error is no excuse for inaction.

GP responds:
I am very thankful for your advice as it has helped me to achieve one of my academic goals. I have followed it: I left my old college in Dover last January and went to a sixth-form college in Cambridge. This was all to get into the University of Cambridge, which had rejected me. I was lacking the courage to go for a change, but your logical explanation of the situation was decisive.

At the end of it all, not only did I make lots of new friends and do well in my exams, but I managed to get into Cambridge – to read economics – on my second attempt! I am now preparing for my first year.

Again, thank you very much for your influence.

. . .

June 14 2008

Dear Economist,
I am about to be married, and have no doubts about the relationship. But there is one nagging worry: my fiancé co-owns a condo overlooking the Pacific Ocean near San Francisco – with an ex-girlfriend, who lives next door to it. She is not in a position to buy him out of his investment, and although they rent it out, the mortgage is steep. I believe the condo is an investment specific to the former relationship and would like it divested – but the housing market is a shambles.
Mary

Dear Mary,

While I sympathise with your problem, I must correct you.

A relationship-specific investment is one that is worth more within a relationship than outside it, such as a set of wedding photos. The condo is not relationship-specific, just unprofitable and illiquid. The condo can therefore be disposed of without destroying value – but not, it seems, by either side buying the other side out.

If your fiancé sold his share to a stranger, he’d sell at a loss. But, in truth, the loss has already happened; his reluctance to sell suggests he’s pig-headed as well as an incompetent investor.

So I recommend that you buy out your fiancé’s share, at a fire-sale price. Subsequent negotiations about the condo would then be between you and the ex. Should your marriage work out, you can share the profits with your fiancé. And if not, at least you will have prearranged some compensation.

Mary admits that she had not taken my advice, and invites her fiancé (still not married?) to respond.

He writes:
My stake in the flat is essentially a free call option. My renters’ payments cover the mortgage payments, and the asset has already lost its value. Upside awaits. What I didn’t take into account were the externalities: an indignant fiancée, a difficult ex and an illiquid market. My biggest regret is not securitising those risks, representing them as assets and selling them to the major US banks.

First published in FT Magazine, 8 August 2009

Not very long ago, Americans were terrible savers. In 2007, the average person put aside 60 cents of every $100, or .6% per paycheck. However, the current economic downturn has shocked us into depositing more at the bank. As of February, the personal savings rate was more than 4%. That’s a big improvement, but it’s still half of 1980s levels, when Americans routinely socked away 10% of their paychecks. Why is saving so hard? And how can we be smarter savers?

Behavioral economists—researchers who mix psychology and economics—have uncovered three reasons why people find it so difficult to save. The first is temptation: Although we often later regret it, we just can’t resist spending. The second is lack of understanding: Our brains can’t quite grasp the profitability of saving. The third is optimism: We believe that everything will work out, even if we don’t save.

Fortunately, researchers have found solutions to these problems. Temptation can be countered if you make saving as much fun as spending. This isn’t such a stretch. Neuroeconomist Ben Seymour of University College, London, sits in front of a brain scanner and watches what happens in our heads when we think about financial decisions. He found that imagining a future purchase is almost as good as getting it. For example, when we daydream about buying a new car, our brains respond in much the same way as when we actually make the purchase.

We can harness this buzz to our benefit by discarding vague ideas of “saving for a rainy day” and focusing instead on particular items we need or want. “Saving is much easier when it’s for something specific,” Seymour says. Reinforce this connection in your mind by opening a different savings account devoted to each of your goals: one for a new car, one for a vacation, one for a child’s college tuition fees.

Or try this effective technique: Remind yourself to save whenever your paycheck comes. Write messages in your calendar or set up your computer or e-mail program to give you periodic prompts. Dean Karlan, an economist at Yale, has tested this method in experiments in countries such as the Philippines and Bolivia. He discovered that even low-income bank customers managed to deposit some of their wages when they were nudged to do so by regular text messages. “That beats the argument that people just don’t have the money,” Karlan explains.

Researchers Jonathan Zinman of Dartmouth College and Victor Stango of the University of California, Davis, have discovered another reason that we don’t save:  We forget about the power of compound interest—how, say, $10,000 invested at a 5% interest rate will almost triple in 20 years.

“Almost everyone severely underestimates how much interest they can earn on their savings,” Zinman says. The same cognitive glitch applies to how we think about debt. Millions of Americans pay interest rates of 20% or more on their credit-card balances, and these high rates will make even a modest amount quickly balloon. Never under-estimate how much debt costs and how much your savings can grow.

Richard Thaler, a professor and behavioral economist at the University of Chicago, is convinced that there’s just one way to save. “Having an amount automatically deducted from your paycheck is the only thing that succeeds,” he says. “If we have to decide with every paycheck how much we should put aside, the answer is often zero.”

However, all of this research on better ways to save does not shed light on why such large numbers of Americans were steady savers in the past and why so many gave up on the practice. Economists Ulrike Malmendier of the University of California, Berkeley, and Stefan Nagel of Stanford believe that our attitudes toward risk are strongly shaped by the economic conditions we experienced when we were teenagers or young adults.

Over the last two decades, stock prices rose strongly and downturns were relatively gentle. As a result, those who grew up during this period became optimistic about future investments and willingly took big risks. Older investors, shaken by the poorly performing stock market of the 1970s, acted with much more caution.

Thanks to the present financial turmoil, today’s teenagers will probably have much less trouble saving when they hit adulthood. They’ll have seen firsthand that saving is not about using your money to invest and make a killing on stocks or real estate; it’s about putting some of your money safely aside in an uncertain world. That’s a lesson we should all start to learn.

Many economists think corruption is a rational response to irrational incentives. The World Bank’s “Doing Business” database lists 40 countries, from Iraq to Ethiopia, in which legally acquiring the necessary permissions to export a single standard cargo container takes more than one month. The more difficult it is to do something legally, the larger the temptation to do it illegally. Small wonder that in developing countries, few people make more money than customs officials.

If perverse incentives create corruption, that suggests a simple solution to an age-old problem. Hence for the last decade or so the mantra of aid agencies has been “institutions matter”—even if it is not clear what humanitarians are supposed to do with this insight.

There is a popular alternative view that says corrupt countries are corrupt not because the incentives are perverse but because they’re stuffed full of crooks, born and bred. In this view, corruption is cultural, and poor countries are poor because their citizens are dishonest (or lazy, or fools).

Into this controversy strode two economists, Raymond Fisman of Columbia and Edward Miguel of Berkeley, with a 2006 research paper that was brilliant and trivial in roughly equal measure. Fisman and Miguel realized that to test the two theories about corruption, you would ideally need to pluck people from all over the world, place them into a community whose laws they could ignore with impunity, then see who cheated and who was honest.

Impossible? Not at all. The United Nations in Manhattan kindly provided guinea pigs for just such an experiment. Diplomatic immunity meant that parking tickets issued to diplomats could not be enforced. The decision to park legally or not, therefore, was a matter of each person’s conscience…

Fisman and Miguel found that countries with endemic corruption at home, as measured by the anti-corruption organization Transparency International, were represented by habitual illegal parkers. Chad and Bangladesh, so often near the top of “perceptions of corruption” rankings, produced more than 2,500 violations between them from 1997 to 2005. Squeaky clean Scandinavians, on the other hand, committed only 12 unpaid parking violations, and most of those involved a single criminal mastermind from Finland. On the face of it, this evidence supports the view that poor countries are corrupt because they’re full of corrupt people.

Yet incentives clearly matter, too. In 2002, after decades of playing cat and mouse with the United Nations, New York City won much greater power to punish deadbeat diplomats. (The former New York senator and new secretary of state, Hillary Clinton, gets some of the credit for this change. Let’s hope the world’s diplomats don’t hold it against the State Department moving forward.) The city began to tow cars and the State Department deducted fines from the relevant foreign aid budgets. Almost overnight, unpaid violations fell dramatically.

This is sparkling stuff, and the story is enjoyably retold in Fisman and Miguel’s slim new volume, Economic Gangsters: Corruption, Violence, and the Poverty of Nations. I recommend the book wholeheartedly; it is engaging and confidently written, and it describes research of genuine interest. Yet while the parking ticket study exemplifies the authors’ ingenuity, it also illuminates their limitations. I cannot be the only person to have admired the original research paper, only to put it down, reflect for a moment, and furrow my brow. We learn something about diplomats, but have we really learned something about economic development? I am still trying to make up my mind.

The other chapters employ a similar approach, taking a clever research paper by Fisman, Miguel, or both, and writing it up with an emphasis on storytelling rather than academics. Economic Gangsters tackles two big “institutional” problems of development economics—corruption and violence—through a series of vignettes based on research studying the value of political connections, smuggling between China and Hong Kong, the links between rainfall and civil war, witch killings in Africa, and rebuilding Vietnam after “the American war.”

The book is bracketed by introductory and concluding chapters that loosely tie the story together and argue that the big debates about foreign aid and economic development cannot be resolved without careful empirical detective work such as that offered in Economic Gangsters. Summarizing one development controversy, for example, they conclude “both views are reasonable, but for now they’re just theories. What we really need are better real-world answers. That’s where our research and this book comes in.” Such a claim is slightly misleading: While it’s true that careful empirical work is needed to resolve these debates, and while it’s true that Fisman and Miguel have done careful empirical work, it is not the kind of work that is likely to resolve the big controversies.

The Princeton economist Alan Krueger recently highlighted what he calls “tectonic economics”—research that studies seismic shifts in society. Steven Levitt and John Donahue’s infamous research on abortion and crime is the canonical example. Levitt and Donahue concluded that the legalization of abortion had reduced crime rates almost two decades later, presumably by reducing the number of unwanted children. This shift is “tectonic” indeed: a sudden and wrenching legal change that seemed to produce significant consequences many years later.

According to Krueger, those who pursue tectonic economics do so “because of frustration that the randomized and natural experiments often give us a compelling answer but to a narrow question.”
Fisman and Miguel, like all economists, try for both compelling answers and big questions. But when forced to choose between precision and scope, they choose precision every time.

That is not necessarily the wrong approach, but it is instructive to compare the young authors with two giants of the field, the charismatic Jeffrey Sachs (surely the world’s most famous development economist) and Daron Acemoglu, winner of the rarer-than-the-Nobel John Bates Clark medal, given every other year to an outstanding economist under age 40. (The American Economic Association apparently has decided that the Clark medal is too scarce. In the future it will be awarded every year.) Sachs and Acemoglu approach the question of whether institutions matter in very different ways.

A decade ago, Sachs and two colleagues published research arguing that poor countries are poor in part because of their geographical disadvantages. Tropical climes encourage malaria; poor soil cannot be replenished without expensive fertilizer; potential markets are far away. And tropical, landlocked countries certainly do tend to be poor. Acemoglu took a different view, blaming institutions, not geography, for underdevelopment. The United States was once a developing country too, remote from potential markets. Now it is the market from which everyone else’s isolation is measured. Remote Australia and New Zealand are prosperous too. Disease is not a geographical constant but something rich countries can fight; mortality rates in the disease-ridden American cities of the 19th century, for example, were appalling. Something happened to change that, and it clearly wasn’t geography.

Acemoglu (with his colleagues Simon Johnson and James Robinson) does not deny that virulent illnesses have made their mark on economic growth. His contention is that they did so centuries ago. Tropical diseases, especially malaria and yellow fever, were so deadly to colonial settlers that the British authorities, under the auspices of the Beauchamp Committee in 1795, decided that Gambia and Southwest Africa were too dangerous even as a dumping ground for convicts. (They were transported to Australia instead.) In a Scottish-led expedition across Africa in the early 19th century, every single European died. Overall, 40 percent to 50 percent of European settlers in Africa passed away within 12 months of arriving.

For locals, these diseases were less dangerous. Acemoglu observes that local troops serving in the British army in India suffered mortality rates similar to those of British troops serving in Britain. But for British troops in India, death rates were five to 10 times greater.

In short, Europeans preferred to settle in the safer climes of what would eventually become Australia, Canada, New Zealand, and the United States. The Pilgrim fathers, for example, planned to travel to Guyana, on the northern borders of Brazil, before deciding that New England would be a wiser choice.

With colonists giving up on tropical territory, European colonial powers decided instead to establish highly exploitative institutions there, calculated to bring as many precious metals, ivory tusks, and slaves as they could in the shortest time possible. The settler-based colonies—New Zealand, Canada, the United States, Australia—eventually became independent, with decent political institutions designed to respect private property and uphold the law. When the tropical economies became independent, their new political systems continued to suck out every cent of short-term gain and funnel it to the men in charge. Since political and economic systems are hard to change, the systems these former colonies have today bear a strong familial resemblance to the systems they had at independence. There are no prizes for guessing which institutions promote economic growth and which encourage corruption and violence.

The contrast between the Sachs/Acemoglu disagreement and the Fisman-Miguel approach is striking. Famous “tectonic” results, such as Levitt’s findings on abortion and crime or Acemoglu’s study of institutions and settler mortality, are fiercely contested by other researchers. That is not surprising: They are inherently open to challenge because of thescope of the question and the need for sophisticated statistical techniques and careful interpretation of raw data. Nobody is arguing about the statistical analysis performed in the parking ticket paper.

Instead, economists debate whether the behavior of diplomats tells us anything about what we really want to know—that is, how to fight corruption. Fisman and Miguel have their own bottom line: The parking ticket paper shows that “corrupt behavior is deeply engrained in culture and no small matter to root out.” That’s plausible but surely not proven.

It would be unfair to suggest that Fisman and Miguel are bonsai economists, producing beautiful miniature studies and little else. Their grander ambitions are most obvious in Chapters 5 and 6, in which they lay out evidence that drought or excessive rainfall leads first to famine, then to civil war and to other, more surprising forms of violence, such as witch killings. They convincingly argue that collapses in rural incomes helped trigger violence in Darfur, Chad, and Rwanda.

They then lay out the case for Miguel’s brainchild, “Rapid Conflict Prevention Support.” RCPS is foreign aid targeted at employing young men—the most likely to take up arms in times of famine—and providing food to rural families, which are the most likely to kill off helpless old grandmothers and aunts when food is short. RCPS is humanitarian aid, but it aims at prevention rather than cure. Whenever rainfall patterns indicate that famine is ahead, donors send money to head off violence before it starts. And because rainfall cannot be controlled, dictators cannot manipulate it to win a larger flow of foreign aid. Fisman and Miguel believe that Botswana’s long record of strong economic growth has been safeguarded by a domestic drought relief program. The idea may or may not be workable on an international scale, but it certainly does not lack ambition.

Overall, though, Fisman and Miguel’s research shines a spotlight rather than a floodlight on development problems. Perhaps they’re right to do so. Not everyone can be Daron Acemoglu or Steven Levitt, and it is surely better to answer a small question well than to answer a big question poorly.

Taking baby steps is not just a research strategy; it’s a development strategy too. The aid skeptic William Easterly has complained that government bureaucracies would rather tackle a large nebulous problem than a small specific problem. Aid agencies’ missions have thus crept from things that can be achieved and measured to things that cannot. Easterly dislikes the utopian rhetoric of Jeffrey Sachs and argues that development is better left to local, bottom-up, improvisational efforts that can be rigorously evaluated or (even better) subjected to a market test.

In their final chapter, Fisman and Miguel implicitly endorse Easterly’s incrementalist view. They gently chide Sachs’ hugely ambitious Millennium Village Project—an effort that funds clinics, schools, new agricultural techniques, and other simultaneous investments in “model villages”—because it has not been set up to allow random evaluations. They advocate the use of randomized trials for small aid projects all over the world. Though this last chapter wanders away from the questions of corruption with which the book started, it is worth reading.

Such evaluation efforts, like the book itself, are necessarily piecemeal. Because a randomized trial offers compelling evidence on what works but not why it works, the lessons from such evaluations tend to be hard to transport to a different context. It is all very frustrating for big-picture aid evangelists, and it isn’t much better for those readers who prefer books that offer grand concepts. Economic Gangsters contains none. Whether looking at corruption, smuggling, or outright violence, it is a fractured vision of a fractured world—and all the better for that.

First published in Reason

Bob Annibale’s corner office, high up in one of London’s few real skyscrapers, overlooks the Thames and the Millennium Dome from one window, Greenwich Park and the Royal Observatory from another. It is the kind of enviable perch you’d expect Citigroup’s senior treasury risk manager to enjoy. But that is the job Annibale left three years ago; now he is Citi’s “global director of microfinance”…

Microfinance, the system of providing tiny loans and savings accounts to the poor, seems an unlikely and somewhat ironic candidate for Citigroup’s attention. It was because banks weren’t interested in serving the poor that the pioneers of microfinance saw a gap to be filled, back in the 1970s.

The most celebrated microfinance institution, the Grameen Bank, was born in Bangladesh in 1976 after Muhammad Yunus, a young economics professor, found that craftswomen were struggling to deal with the high costs of borrowing in order to buy raw materials. Village moneylenders charged up to 10 per cent interest per day. At such rates, a debt of a single cent would balloon to the size of the US economy in just over a year.

Yunus began lending – originally, less than a dollar each to a group of 42 families – and found that the poor were capable of investing the money, lifting themselves out of poverty and paying back the loans with near-perfect reliability. “All people are entrepreneurs,” he proclaimed.

From small beginnings, a global microfinance movement has developed, with perhaps $25bn of loans outstanding and 125m to 150m customers. It has been blessed by the United Nations, which declared 2005 the International Year of Microcredit, and by the Nobel committee, which awarded the Nobel Peace Prize to Yunus and Grameen Bank in 2006.

Now multinational banks at last see microfinance as a profit opportunity. “Colleagues asked me if was giving up a business role,” says Annibale, who became Citi’s first microfinance chief in 2005. “I’d say, ‘No, I’m taking up a new one’.” He plans to make money for Citigroup by providing technology, advice and investment banking services to microfinance lenders. His division has so far been unaffected by this year’s market turmoil.

The Citigroups of the world are not the only commercial players to get involved in what was once a purely philanthropic endeavour. Sequoia Capital, the venture capital fund that backed Google, Apple and Cisco, has taken an $11m stake in SKS Microfinance, a large Indian lender. Private equity groups such as Helios Capital are making similar moves. Pierre Omidyar, founder of eBay, gave $100m to Tufts University in 2005 with the stipulation that the donation be used to create a fund seeking its returns only through investments in microfinance. The fund’s director, Tryfan Evans, recently predicted that it would be fully invested by the end of this year.

Most surprising and controversial are those microfinance institutions that have been transformed from charities to profitable companies through hugely successful initial public offerings. The most notorious, Mexico’s Compartamos (“Let’s Share”), used a $6m investment to turn itself into a billion-dollar company in less than a decade, expanding rapidly while charging very high rates to borrowers. What was once an idealistic movement is now a fast-growing industry – one that is rapidly losing its innocence.

The commercialisation of microfinance has sparked a fierce debate between profit advocates such as Carlos Danel and Carlos Labarthe, the founders of Compartamos, and traditionalists such as Yunus, who see microfinance lenders like Compartamos as indistinguishable from the moneylenders he set out to replace in 1976. Between these two poles lie the majority of microfinance practitioners, eager to gain access to capital and commercial expertise but concerned that competitive market forces may not help the poorest.

Commercialisation is a huge opportunity to lift people out of poverty. Despite the credit crisis, most of us take for granted the ability to save, to borrow for emergencies or to buy assets, to move money around and to insure ourselves. But several billion people lack these basic, life-improving services. The microfinance industry today serves fewer than one in 10 of them. Few people believe microfinance can grow quickly enough without adopting a more commercial model.

It is not just that commercialisation would provide plentiful access to foreign capital – although that is likely – but also that expertise from commercial players might allow microfinance lenders to move beyond simple loans. If lenders could take deposits, they should easily be able to fund their own loans: many poor people are would-be savers who lack a safe place to put their money. But as the credit crisis has made clear, deposit-taking is a difficult business requiring regulatory supervision even in rich countries. Commercial expertise is therefore indispensable for a deposit-taking bank.

Yet this is also a dangerous moment. Microfinance harnesses market forces to bring basic financial services to the poor, but many microfinance institutions do much more than that. Using donor funds or reinvested profits, coupled with their reach into remote villages, they provide subsidised education and healthcare. There is a risk that commercial logic could threaten these subsidised services by repelling donors or poaching the best customers. There is also the risk that competition misfires, leaving the poor paying higher rates rather than lower ones.

More than 500 years before the birth of modern microfinance, Franciscan monks in Perugia, Italy, developed their own method of social finance. They would lend money to the poor in times of crisis; as collateral, they would hold some precious item and charge a fee for its safekeeping to cover their operating costs. The idea was endorsed by the Pope and widely emulated. The monks called the fund a “Monte di Pieta”, a Fund of Mercy. Today, we would call it a pawnshop.

This cautionary tale – told by Larry Reed of the Boulder Institute of Microfinance – resonates in a social movement that is sharply divided over commercialisation.

The crisis was provoked by Compartamos’s initial public offering in April last year. Compartamos was founded in 1990 as a non-profit organisation, but after a decade converted itself into a profit-making company, with investors including Acción International, which is part-funded by the United States Agency for International Development (USAid) and the International Finance Corporation, which is the World Bank’s private sector lending arm. (Disclosure: I used to work for the IFC.)

Many microfinance schemes have a profit-making structure, including Grameen Bank; what was unusual with Compartamos was how profitable it turned out to be. The initial investments of about $6m, between 1998 and 2000, were worth about $1.5bn at the time of the public offering in 2007. That valuation was justified by a combination of fast growth and high interest rates. Just how high is not quite clear – to their discredit, it is rare for microfinance lenders to report such things – but a report from the Consultative Group to Assist the Poor, an independent microfinance think-tank housed by the World Bank, estimated that Compartamos charged interest rates of more than 100 per cent APR (annual percentage rate), after tax.

That is not as usurious as it might seem. Most microfinance lenders charge rates that would make credit-card companies blush – often more than 30 per cent a year – because small, short-term loans are costly: a loan of $50, borrowed at an annual interest rate of more than 50 per cent and repaid over four months, will produce less than $5 in interest repayments. That isn’t much to cover overheads. Yet Compartamos was so profitable that it could have lowered rates without jeopardising its expansion. It chose not to.

Yunus’s response to that was little short of an excommunication. He declared himself “shocked” by the public offering. In a documentary on US public television, he described his attitude to the profit motive in microfinance. “You [profit-focused microfinance practitioners] are on the moneylender’s side. Because your aim is the moneylender’s aim. Your thinking is the moneylender’s thinking. So I don’t want to associate with you, I want to battle with you and to fight you.”

Compartamos itself was silent on the subject for a long time, eventually producing a response that defended its motives, beliefs and mission more than a year after the public offering. The language of the battle had been defined: a lexicon of mission and motives, them and us, good and evil. “Yunus is concerned that his legacy, even the language of microcredit, is being appropriated,” says Jonathan Morduch, a microfinance expert at New York University. “But the rest of the world doesn’t care and shouldn’t care.”

There is nothing intrinsically sinful about pawnbroking or intrinsically virtuous about microloans: what matters is the effect on the clients. And to our discredit, we don’t really know what that effect is. There have been only two serious cost-benefit analyses – and they’ve produced a split decision as to whether, given the subsidies involved, microfinance delivered value for donor dollars.

Dean Karlan, a microfinance economist at Yale, is frustrated by this lack of serious research into what works. He also thinks Yunus’s talk of “the moneylender’s thinking” is unhelpful. “If you’re trying to make the world a better place but you’re not, that’s bad. If you’re trying to make profits and don’t care about people, but make them better off anyway, that’s good,” he says.

So, can you lift people out of poverty by lending money to them at 100 per cent APR? Karlan, with Jonathan Zinman of Dartmouth College, is behind one of the few pieces of research to hint at an answer.

In South Africa in late 2004, Karlan and Zinman persuaded an anonymous consumer finance company that we’ll call “ZaFinCo” to participate in an experiment. Ordinarily, almost half of its borrowers would have been turned away as a bad credit risk. But for two months, ZaFinCo loan officers were instructed to identify applicants who had narrowly failed to pass credit checks. From this pool of near-customers, a computer selected almost half and requested that branch managers reconsider and offer a loan anyway.

This procedure emulated the randomised trials of new medicines – after all, a more typical, non-random comparison of borrowers versus non-borrowers would not be able to tell whether borrowers were doing well because they had access to loans, or because they were confident, entrepreneurial people.

Karlan and Zinman wanted to know what value there might be in expanding access to credit. ZaFinCo was no dewy-eyed social business, but a hard-nosed, profit-minded company, charging 11.75 per cent per month on a four-month loan, or 200 per cent APR, much more than Compartamos was generally judged to have been charging.

Despite the high rates, the results were astonishing. “We expected to see some good effects and some bad,” explained Karlan, who checked in with the experiment’s participants six to 12 months after they had filed their initial loan applications. “But we basically only saw good effects.”

Most strikingly, those “treated” by the experiment – that is, those for whom the computer requested a second chance at a loan – were much more likely to have kept their jobs than the control group. They were also much less likely to have dropped below the poverty line or to have gone hungry. All these outcomes were recorded well after the loan had been taken out and (usually) repaid, so this was not measuring a temporary debt-funded binge.

This seems mysterious. How can a loan at 200 per cent APR help people to stay out of poverty? One answer is that most people turned down for a 200 per cent APR loan would be able to get one at 300, 500 or over 1,000 per cent from an informal moneylender. More important is that these loans were not used to start businesses but to help people keep jobs that they already had. If a smart new blouse or a spare part for the family moped is what it takes to stay in work, then who is to say that an expensive loan isn’t a wise investment?

Karlan is the first to warn against extrapolating too much from a single experiment. “This is the last thing in the world that I would use to develop policy,” he warns. “You’ve got to replicate.” The trouble is that the replication just isn’t happening. For all the optimism about microfinance – and the ZaFinCo experiment only encourages that optimism – it is striking how much we do not know about when it works, and why.

This matters because non-commercial microfinance projects often depend on donor subsidies. And while microfinance has a good reputation among development professionals, that doesn’t mean guaranteed access to those subsidies. More credible evaluation would help preserve the programmes that deserve to be preserved.

Already, solidly held beliefs about microfinance have been shaken. The “group liability” system, in which a group of borrowers guarantee one another’s loans, is still supposed by many to be the secret behind Grameen Bank’s low default rates. But a randomised trial in the Philippines conducted by Karlan and a World Bank economist, Xavier Gine, found that group liability was discouraging new customers without improving repayment rates. Grameen itself quietly dropped group liability some time ago.

Another sacred cow of microfinance is that women make best use of the money – the Grameen Bank says 97 per cent of its borrowers are women. But another randomised trial, conducted in Sri Lanka by a team of researchers including David McKenzie of the World Bank, found that male borrowers seemed to make a far higher return on their capital. As with the ZaFinCo study, it’s just one experiment in one country.

Yet it raises a worrying question: for how long will donors fund microfinance projects with so little compelling evidence about exactly what kinds of project really work?

While many non-profit microfinance institutions depend on donor subsidies to cover overheads, reduce interest rates, or provide parallel schemes, some use profits from the best customers to cross-subsidise other operations. These parallel schemes can be vast. BRAC, a Bangladeshi microfinance organisation often called the world’s largest NGO, provides primary education, mobile libraries, legal aid and healthcare, all on an astonishing scale. But what is the future for such programmes in the face of commercial competition? Cross-subsidies are rarely sustainable in a competitive market: commercially minded banks will simply lure the best customers – usually those borrowing the largest sums, and with the best credit records – by offering them better rates.

The trouble is that the world cannot rely on commercial operations alone; they will miss far too many people. ZaFinCo’s clients were ideal customers for a commercial lender: they were city-dwellers and therefore cheap to reach; they were poor enough to want loans but rich enough that the loans were profitably chunky. A peasant farmer in Sudan ticks none of those boxes: living in the middle of nowhere, he is expensive to reach and so poor that he can afford only tiny loans. Nor does he have job that a ZaFinCo-style loan can help preserve or any business prospects either. Then there are the destitute, the disabled, the elderly and the orphans. Such people cannot repay loans at a rate that would cover costs. Heavy subsidies or outright grants would be needed. “All people are entrepreneurs,” says Muhammad Yunus. If only he were right.

At least commercialisation seems likely to help those borrowers who can be served on commercial terms. After all, if even a 200 per cent APR loan can help moderately poor customers, surely anything goes as long as the market expands? Sadly, the truth is not so easy. The ZaFinCo study showed not that loans at 200 per cent are good for everybody, merely that they are good for the people who choose to apply for them – in other words, that ZaFinCo’s borrowers knew what was good for them. Most people will only be helped by loans at lower rates. Competition should bring down those rates, of course, and one of the strongest defences of Compartamos is that its success is attracting competitors with exactly that effect.

Healthy competition is a better protector of consumer interests than good intentions. The trouble is transparency. Competition works when customers know what they’re paying and what they’re paying for – which is why lenders in the US have been required for the past 40 years to disclose their interest rates in a standardised format. Few microfinance institutions do the same thing, and the results can be baffling. “You have a borrower comparing two institutions across the street from each other, and she can’t tell which has the cheaper product,” complains Chuck Waterfield, the founder of a non-profit called Microfinance Transparency.

The lack of a standardised format for reporting loan costs makes it hard to compare what lenders are offering. One common practice is to charge “flat interest”, meaning that interest is calculated on the initial loan amount, rather than the declining balance as the loan is gradually repaid. The apparently small tweak almost doubles the effective rate.

It is, in any case, misleading to think that the only aim should be to provide, sustainably, as many cheap loans as possible. That would be the impression gained from Muhammad Yunus, who always emphasises “microcredit” rather than “microfinance”. But there is more to finance than credit: even the Grameen Bank has moved away from pure microcredit to provide a wider range of financial services. In fact, if you did not have the ability to save or to insure yourself, for example, you would be forced to rely on loans to handle emergencies.

“There is lots of evidence suggesting that poor people would rather save, turning small amounts into a lump sum, rather than borrow a lump sum and then pay it back,” explains Elizabeth Littlefield, the head of the CGAP microfinance think-tank. “But the only way you can offer a safe place to save money is if you have sound, government- licensed, well-governed institutions. And that is what commercialisation really means.”

As microfinance institutions move into deposit-taking, the stakes become higher. Governments almost always impose arduous regulations on deposit-taking institutions, and understandably so: just imagine what will happen if the manager of a microbank in Peru or Pakistan or Nigeria decides to use his customers’ deposits to fund his retirement. Yet governments, especially in the world’s poorest countries, are not known for their ability to draft the kind of light-touch regulation that will allow a fledgling microbanking industry to spread its wings.

Ironically, if microfinance institutions can find ways to provide savings accounts to the very poor – despite sceptical regulators, a difficult business environment and tiny transactions – they will not need much of the foreign capital commercialisation is supposed to provide. Most poor households are savers, or would like to be. Many poor countries are savers. All that is needed to raise the capital for making fresh microcredit loans is a successful deposit-taking bank for the poor.

The future of microfinance, we must hope, will be one in which the poor enjoy the financial services that surround the rest of us. For the poorest, subsidies will still be necessary, and the industry is running out of excuses as to why rigorous trials are still so rare. But Yunus and his fellow pioneers have shown that many poor people can be served profitably by commercial organisations.

Making that vision a more widespread reality will require less finger-pointing, and more thought about how competition really works. The sector’s problems are beginning to look more like those of the retail banking industry in developed markets: accessing wholesale capital, protecting consumers, safeguarding deposits and making competition work for customers. The credit crisis has reminded us that these are not trivial problems – but beyond doubt, they are symptoms of success.