As his doctoral dissertation advisor at Vanderbilt University's Department of Economics, I feel persuaded to correct my illustrious student on that issue as well as those who fondly excerpt his statement as if to laud him for saying that and by default conveying the impression that, at least for poverty alleviation, the economics taught in universities is of little practical relevance. The reality is that the Grameen Bank model is based entirely on standard economic theory. The statement excerpted above reminds one of the well-known dichotomy between what entrepreneurs are found to be doing (endeavoring to equate marginal cost to marginal revenue to maximize profits) and what many of them say they do, namely, that they do not even know what marginal revenue and marginal cost mean, much less than equating the two marginal measures.

Theory of Prices

A golden rule of economic development is that for a nation as for a family, raising a value product lower than the cost of production is immiserizing. Producer subsidies are a way of accepting lower value production than its cost. Little wonder that the South Asian countries which have used subsidies extensively to alleviate poverty, are still among the poorest in the world. The Grameen Bank bade good-bye to that tradition. It has been charging roughly 15% real rate of interest, or 10% to 12% higher than the open-market real rate of interest, though the Grameen rate is only a fraction of the moneylender's rate. That practice is entirely consistent with the stated theory of development, in as much as the Grameen Bank's costs of disbursing and collecting its loans through weekly trips to rural areas by its employees on foot or bicycle are relatively high. Its clients, mostly poor women, must produce a value that covers at least the cost of credit, in addition to making their labor more productive. Thus, the Bank has immaculately harnessed the pricing principle of economic growth.

Theory of Risk

Entrepreneurs are those who assume risks. To the extent they can, however, entrepreneurs try to minimize risk for a given objective. Banks minimize their risk by requiring collaterals against their loans. Group lending is another form of risk insurance, which has existed in the Indian subcontinent for centuries. Credit co-operatives are designed to help low-income households to save and obtain credit without stringent collaterals practiced by banks. These and similar other forms of small credit are alternative ways of risk assurance. What Muhammad Yunus did was to use an updated version of risk assurance through a group-lending and co-signing method. Thus, it is not that Yunus turned the risk-assurance theory upside down or entirely ignored it. He adroitly designed a co-signing form of finely tuned, intelligently structured, practical method of risk assurance for lending to poor women. That is not inconsistent with the theory of risk assurance in economic textbooks.

A Banking Principle

Banks make money by lending at higher rates of interest relative to the borrowing and deposit rates. In free markets, rates of interest will be determined by the demand and supply of funds. When a government imposes price restrictions on banks, such as requiring them to advance credit at below-market rates of interest--as is the prevalent policy in South Asian countries in general to secure credit for public enterprises and chosen target groups in the name of promoting investment or reducing poverty--the banks' capacity and incentive to attain efficiency is compromised. The Grameen Bank started and has remained as a private bank and has fortunately not been subjected to the country's populist or dirigistic policies. As a private bank, it was able to follow the pricing rule discussed above. Had, for instance, it been required to advance credit at below-market rates of interest, as in the case of the nationalized and most commercial banks, the Grameen Bank would apparently not have met any of its objectives.

Basic Economic Premise

Intuitively, Yunus believed that the poor are basically honest in repaying their debts irrespective of collateral. At the same time he must also have assumed (though implicitly) that the poor, too, are maximizers, that they work hard to maximize their incomes, and that they will ordinarily use the petty money for the purpose for which it was loaned to advance their economic well-being or self-interest. The fact that over 98% of them could repay their loans is evidence confirming that behavior. Isn't that the basic economic premise?

Theory of Innovation

To the extent Muhammad Yunus has developed this concept from a scratch, or reorganized the historical group-lending model of the sub-continent, or conceived a modified form of the once well-established credit co-operatives in Bengal, he is an innovator. The textbooks of graduate economics are full of the role of innovators and imitators.

Theory of Poverty

The most important contribution that Muhammad Yunus has made to practical economic theory lies in a successful experiment of the right theory of poverty alleviation, namely reducing poverty not through subsidization but through income-generation capacities. In the South Asian world, where Yunus has carried out this unique experiment on a massive scale, poverty alleviation policies have consisted predominantly of (producer and consumer) subsidies to poor families.

Contrary to the general impression, subsidies, whether in the form of lower prices or income transfers-given to other than the handicapped and similar unfortunate individuals/families-scarcely reduce poverty. Rather they sustain poverty and may perpetuate it. They introduce dependency. Instead of augmenting their income-generating capacities and providing incentives/pressures to work, subsidies put the recipients on crutches. The South-Asian advocates of subsidies to the poor have confused egalitarianism with poverty eradication. An effective long-term remedy against poverty is to empower the poor to earn their incomes. Among the most effective ways to attain that objective are enabling: (a) the children of poor families to get quality education and (b) the adults of those families to improve their earning capacities. Earning capacities of adults are built up by vocational training and microcredit at a rate of interest that covers its cost, rather than subsidized credit. These are normative policies implicated by positive economics.

Needless to say Vanderbilt University is proud of having taught economics to this student who has put what he learnt at Vanderbilt into practice on such a vast scale. In recognition of that, Vanderbilt University has awarded the first "Most Outstanding Alumnus Award" to Dr. Muhammad Yunus.

The author is a Professor of Economics, Emeritus, Vanderbilt University, Nashville, Tennessee. He was in the thesis advisory committee while Dr. Yunus was doing his Ph. D. at Vanderbilt.