A reader points me to this letter from Milford Bateman about the impact of microfinance.

first, a serious shortage of funds for small and medium-sized enterprises, which is deeply damaging because SMEs have by far the most sustainable growth and development potential. Second, thanks to microfinance there has been an accelerated proliferation of informal-sector microenterprises in Serbia over 2004-08, so the country is now chock-full of traders, kiosks, shops, street-traders and subsistence farms. The base of the economy is quite simply being destroyed.

I guess the question is whether the rise of tiny informal businesses comes at the expense of the formal economy, as Bateman claims, or whether it represents a net addition to economic activity. Conceivably, microfinance could “crowd in” rather than crowd out the formal economic sector. If it is the latter, then indeed it requires second thoughts.

UPDATE: Rafael La Porta and Andrei Shleifer find neither crowding out nor crowding in.

growth comes from the creation of the highly productive formal firms. Informal firms keep millions of people alive, but disappear over time.