On the benefit of switching towards financing SMEs rather than micro businesses

Published in Faedrelandsvennen 12 july 2018

Strømme Foundation changes its strategy from a focus on microcredit to a focus on financing small and mediums sized companies, in line with what my own research and experience indicates to be a better path towards prosperous economic development. I concur with this move and look forward to seeing the results from this change, and encourage more organizations and investors to follow this path. This is not to say that microfinance is not helping poor people. Someone said to me: “These microloans do help a little especially when it comes to women who can send their kids to school. Put a metal roof with monies earned from the small businesses they setup.” I completely agree, but by focusing on small and medium sized companies, we can help create even more jobs through scaling businesses led by competent managers. It is simply difficult to scale a small microentrepreneur with very limited personal capacity to lead a larger business. I simply suggest that there are other means which we also need to explore. Financing of SME´s has until recently been a forgotten area of focus, and more and more investors are shifting towards this group as well for more impact.

For Norwegian version, see this link: 2018-07-12_Faedrelandsvennen

For English transaltion, see this link: Strømme Foundation puts microfinance on the shelf.

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Engstrom & McKelvie in International Small Business Journal (ISBJ), “Financial literacy, role models, and micro-enterprise performance in the informal economy”

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Tidningen entré skriver om min mikrofinansforskning samt MTI Investment — investerar i växande små och medelstora företag i Östra Afrika

I senaste numret av entré skriver journalisten Maria Linde om min avhandling samt om vårt jobb med MTI Investment AS – det nordiska investmentbolaget som investerar i växande små och medelstora företag i Östra Afrika.

För att ladda ner delen som har med min forskning att göra klicka här:

Pontus Engström_entre-nr-4-2016

För att ladda ner hela tidningen, klicka här:

http://www.esbri.se/pdf/entre/4_2016.pdf

A research mention in “Vårt Land”

The Norwegian newspaper Vårt Land writes in the Monday issue (October 17, 2016 p. 8-9) about my research in an article with the title “Therefore microfinance is not that effective” (Derfor er mikrofinans lite effektivt). While my findings do find that microfinance does add extra income to an individual´s business, it also shows that size can act as a counterbalancing factor such that income actually is reduced with increased sized. The economies of scale are in other words negative in the early phase of the firm. My research also points to the fact that growth in sales or assets does not seem to be related to taking on microloans. This is not controversial. What is obvious and perhaps more relevant from my research is that the level of financial literacy among poor microentrepreneurs is VERY low, and then one should take into account that the clients I surveyed were not the poorest of the poor, but merely poor. Little research is still however done in this area, and much more is needed. There is even research pointing towards the odd fact that those with more education actually do worse. This

Little research is still however done in this area, and much more is needed. There is even research finding in some informal economies that those with more education actually do worse (Honig, 1998). This is counterintuitive, and much more research is needed here. I am currently working on a paper which looks at the role of Financial Literacy, Role Models and how these two concepts affect firm performance in the informal economy. Research in the left tail of human capital among the poorest individuals on the planet is still in its infancy, but over time we will eventually learn how to effectively lift the human capital and sustain individuals in an improved economic state. The practical example of MTI Investments, and other pioneering firms, financing small and medium-sized firms, may be leading the way in this regard, where more investments are allocated towards small and medium sized firms, rather than mostly microenterprises today.

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My PhD story

Here I present my story, connecting the dots of my academic life. I began thinking about pursuing a PhD in 1991, when I was an undergraduate student at Slippery Rock University (SRU) in Pennsylvania, USA, on a Sweden–America Foundation scholarship.

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Freshman International student class (1991). Dr Engstrom in the upper right corner. An unforgettable time and unforgettable friends. Thanks.

Several informal talks with one of my undergraduate professors helped me weigh the pros and cons of an MBA versus a PhD. Being a bit ambivalent about the decision and wanting to keep both doors open, I elected to go for a bachelor of science degree in economics. Upon graduating summa cum laude in 1994, I was still ambivalent, so I returned to Sweden, where I took a job assisting Professor Lars Oxelheim at the Research Institute of Industrial Economics (IFN, then known as IUI) in writing a book about the deregulation of the Nordic financial markets and its effect on Nordic interest rates as compared to a global interest rate (Oxelheim, 1996). Professor Oxelheim and I also discussed me potentially pursuing a PhD, but back then I did not know what research focus I was interested in, nor did I realize that embarking on a PhD is one of the more entrepreneurial ventures in which a person can engage.

The experience at IFN led to my next job as a researcher at the Boston Consulting Group (BCG), where I specialized in corporate valuations and a corporate performance framework known as Cash Flow Return On Investment (CFROI), developed by HOLT Value Associates (Madden, 1999). The experience at BCG motivated me to take a master of science degree in economics and finance from the Stockholm School of Economics (SSE). This was one of the best career decisions I have made and gave me many valuable contacts with whom I still interact today. In 1998 and 1999, after graduating, I tried starting a couple of businesses. One was an online database for financial analysis services called MIG (Management Information Group) and the other a business promoting stand-up comedians and speakers, called IGNITE Infotainment Professionals. Both firms had high-flying visions (seen in the pluralistic nature of the names) but made meager progress. Despite the tough times, the experience was enjoyable, and I learned more about business in these two years than any school could have taught me. Specifically, I learned that perseverance, along with a strong personal conviction, is important, but that luck is probably also part of the equation. The experience and knowledge gained through these years are also shown throughout this dissertation.

In 2005, having spent five years as a financial advisor on global equities at Credit Suisse, I became a portfolio manager at DNB Asset Management, responsible for global cyclical firms (materials, transportation, automobiles, and commercial services). However, in 2008, this work came to a sharp halt with the collapse of Lehman Brothers and the layoff of many in the financial industry, including those of us at DNB. I discussed with Professor Carl Fey starting a PhD, but I still felt ambivalence about the prospect. I had previously written an academic paper with Professor Fey and Professor Ingmar Björkman based in my master thesis at SSE. The article is today cited 49 times according to Google Scholar (Fey, Engström, & Björkman, 1999). However, I did not pursue the opportunity, as this was not an area of interest close to my heart, and I therefore again missed how incredibly entrepreneurial it is to undertake a PhD.

Instead, I worked for three years as chief financial officer at the Swedish Mission Covenant Church, which not only gave me a better understanding of civil society and organizations based on the popular movements from the late 1800s and early 1900s but also a lot of experience in managing people, creating control systems, and managing a budget process and different type of assets, such as properties and foundations. The job involved a lot of responsibility and creativity, but it was also very entrepreneurial. It gave me a good glimpse at how small businesses are run and governed, since the church was involved in several small and large businesses.

One of the investments the church had made was a small footnote on the balance sheet, Oikocredit, that was not earning any interest for the church. As the financial assets I was responsible for were a guarantee for the future pensions of several employees, I was keen to ensure the assets were managed in the best possible way. Not getting a return on investment was unsatisfactory to me. I therefore investigated Oikocredit and visited an annual general meeting in 2011 in Dar es Salaam, Tanzania, where I learned about microfinance. I observed how controversial the idea of paying investors a market interest rate was; some owners there argued frantically that this was morally wrong. In 2011, the interest investors could receive from lending money to Oikocredit was at most 2%. In a scenario where inflation is running at 3%, I as an investor would lose 1% by investing in microfinance. The argument against a higher return to investors was that there was also a return to society, a social return, upon which investors should look favorably. The return was not close enough to the cost of capital required by the pension fund, which was the foundation of the church assets, and thus microfinance did not seem as a good investment to me at the time. Now, with global interest rates at record low levels, many investors are turning towards microfinance as an alternative asset class, in hopes better returns.

The experience in Tanzania sparked my interest in this controversial topic, and I immediately contacted Professor Lars Oxelheim again, with whom I had kept in touch with over the years. The decision to contact Professor Lars Oxelheim was also inspired by my friend Klas Palm, who had just initiated his PhD studies on innovation and quality management related issues. My research interest then was how interest rates are affected by the increased rate of return required by investors. My hypothesis was that the interest rate would not change to the end user, as the local market sets the interest rate. What I therefore wanted to research was the degree to which the microfinance investment vehicles like Oikocredit, which operate between the investors and the local microfinance banks, could absorb a higher required rate from investors, and whether this would pressure them to become more efficient in order to preserve a low interest rate. Little did I know that my topic would be completely different a year later.

I believe it is also worth mentioning that about a year prior to me beginning at the University of Agder, I became friends with the beat artist Michael Bowen and his family, who had moved from Hawaii to Sweden (Collin, 2006). On a few occasions, I played the saxophone while Michael spoke or painted. It was inspirational to meet with Michael, who was very positive and encouraging of my talents. Tragically, Michael passed away in 2009. However, his memories live on and are, in fact, scattered all over the University of Agder. He has more than 100 art objects installed at the university and the nearby Kristiansand Cathedral School. I have obtained permission from his widow Isabel Paoli-Bowen to use his paintings as article separators in this thesis. Michael was a pioneer in combining music and painting (art), known as performance art, and building on these ideas, I would like to emphasize the long-standing relationship between research and art, and the inspiration both music and art are to my endeavors.

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Art and research go hand in hand at the University of Agder.

After my first year of PhD studies, during which I learned about current and historic research and methods and interacted with many students and faculty, my interest had turned to how microfinance impacts the microentrepreneurs. I had experienced being an entrepreneur previously, and the topic of microfinance and the microentrepreneurs seemed a lot more interesting than doing research on the sensitivity of interest rates. “Come on,” as my supervisor Trond Randøy would say. I also had access to unique data, since one of my supervisors, Professor Roy Mersland, had helped build a leading microfinance institution in Ecuador (Banco D-Micro). I am especially grateful to Carolina and Hans Martin Espegren, for a successful collaboration in gathering data in Ecuador. We spent several weeks collecting and analyzing the data together, but we also had fun visiting the coast, surfing, cooking dinner together, or going for an evening run.

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The old town of Guayaquil. We walked the 450 some stairs to the top where the view was magnificent. Worth noting is that we walked in a safe zone, such that there were armed guards with bulistic safety vests securing for a safe passage to the top and back. Barrio Las Peñas in Guayaquil, Ecuador.
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Soccer game between Barcelona and Quito (capital). Barcelona won 1-0. Barcelona is Ecuador´s most successful football team and has won the series A 14 times. The team was founded 1925 by a Spanish immigrant who namned the club after his home city, Barcelona.
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Panama Hats are actually from Ecuador and the small town of Montecristi makes the orginal ones. This store had the best quality hats.
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Me and Hans Martin Espegreen in from of a gigantic and very old so called Ceibo. This tree allegedly gathered visitors from the far east and many other religious visitors for prayers. Not sure about the validity of these claims, but it sure was a gigantic and beautiful tree.
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Me and Isaak
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Maria, Isak, Carolina, Hannah, Pontus
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Maria, Isak, Carolina, Hannah, Pontus
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At Chirije Bahia de Caraquez.

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Future star actor (for real) Isak Holmen Sørensen – The small museum of Chirije holds evidence of old american civilizations, perhaps even with visitors from China and the far east, suggesting that Asian discoverers may have discovered the americas long before Columbus and the Vikings…

I would also like to express my gratitude to my supervisors. First of all, a big thank you to my main supervisor, Professor Trond Randøy. Working together with Professor Randøy has been truly enjoyable from the start, and I am grateful for not only the professional collaborations, but also for the personal friendship we have built over the years, including a few jazz jam sessions, hikes in the mountains, canoeing around Kristiansand, international research conferences, and entrepreneurial ventures in Tanzania. An indirect result and spin-off from this PhD endeavor is the creation of MTI Investment AS (www.mti-investment.com), a venture capital firm investing in the growth of eastern Africa. In MTI, all of my previous undertakings and experiences are combined and maximized, and every person with whom I have ever worked is connected somehow with this business.

One of Professor Randøy’s previous PhD students, Professor Roy Mersland, was my second supervisor. He became a professor within five years of obtaining his PhD. I am grateful for having met Professor Mersland and seen the dedication, passion, and focus with which he carries out all work. Professor Mersland was instrumental in getting me access to Banco D-Miro data, which form the skeleton of my PhD. My third supervisor is Dr. Leif Atle Beisland. Dr. Beisland and I had many discussions about performance measurement that were instrumental in focusing the thesis on return on assets. I would also like to express a special thank you to Professor Oxelheim who has followed my academic progress and with whom I have written several debate articles with during these three years (Engström & Oxelheim, 2013a, 2013b, 2014). Professor Oxelheim has an inner energy and passion for research that is truly inspirational. Just like my supervisors did, I wrote this thesis during numerous flights, on various airport buses and trains, sometimes in a hotel room in a foreign country such as in Tanzania, sometimes in the office in Kristiansand, and sometimes in the office at the Stockholm School of Economics (SSE), with which I was affiliated during the last year of my thesis.

I also would like to thank all the faculty members at the University of Agder, in particular Professor Otto Andersen, Dr. Bjørn-Tore Flåten, Dr. Rotem Shneor, Professor Andreas Falkenberg, Professor Joyce Falkenberg, Andre Tofteland, Anne Line Omsland, Dr. Burak Tunca, Dr. Daniel Göller, Daudi Pascal Ndaki, Diana Trydal, Professor Ellen Nyhus, Erik Arntsen, Geir Haaland, Gro Anita Homme, Professor Emeritus Harald Knudsen, Professor Ilan Alon, Irfan Irfan, Professor Jan-Inge Jensen, Dr. Kjetil Andersson, Dr. Kristin Dale, Kristina Walker Pedersen, Bandula Galhena, Amila Sirisena, Harald Stokkeland, Lisa Whitehead, Dr. Naima Saeed, Dr. Neema Mori, Dr. Gibson Munisi, Nertila Stringa, Professor Stein Kristiansen, Dr. Stina Torjesen, Stina Øyna, Stine Bårdsen, Unni Henriksen, Inger-Lise Myrvold, and Målfrid Tangedal.

In addition to the above-mentioned individuals, I also owe a thank you to many of the faculty members and PhD students from other schools, such as Professor Dale Duhan, Professor Arent Greve, Professor Terje Moen, Professor Yaakob Weber, Professor Kirsten Foss, Dr. Gry Alsos, Professor Tommy Clausen, Professor Johan Wiklund, Professor Karl Wennberg, Professor Carin Holmquist, Professor Sara Carter, Professor Hans Lundström, Dr. Espen Isaksen, Dr. Marianne Steinmo, Dr. Maj Munkefjord, Dr. Sølvi Solvoll, Marianne Arntzen-Nortquist, Marit Breivik Meyer, Karin Wigger, Oxana Bulanova, Nhien Nguyen, Thomas Lauvås, Siri Jakobsen, Are Jensen, Dr. Terese Strand, Nedim Effendic, Dr. Nadav Rotemberg Shir, Beldina Owalla, Kajsa Asplund, and Professor Alex McKelvie.

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Bodø at midnight

Apart from academia I am also grateful to the Norwegian Alliance Microfinance and their CEO Andreas Andersen for allowing me to work with Banco D-Miro in Ecuador. At Banco D-Miro, I am thankful to all the support and help from the CEO Carlos Viteri and the marketing director John Pacheco in creating the survey instrument and in motivating and instructing the local call center. I am also grateful to Johnny Villavicencio and colleagues for helping me in retrieving longitudinal (historic) data from the Banco D-Miro database. When in Ecuador, I was also fortunate to get to know many wonderful people from the local Alliance Mission group, including Hans Martin and Caroline Espegren, Isak Holmen Sørensen, Maria Andreassen, Rebeckka Andreassen Garcia, Daniel Garcia, Maria Andreassen, Ingunn Skutlaberg Valbø, Bjørnar Valbø, Rita Franco, Lily Macias Ramos, and many more. Gathering data without this group of individuals around would simply not have been the same experience. Thank you all.

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Last but not least, I would like to thank my close friends and family for supporting me every step of the way. I wish I could thank my aunt Kajsa Tunér, who is not with us anymore, but she definitely was an influence, and I still to this day remember when she earned her PhD in 1986 when I was 15 years old (Tunér, 1986). The same must also be said about some other important people who are no longer with us, like my grandparents on both my mother’s and father’s sides. My brother Johan Engström has been an inspiration in his hard work to become a radiologist, and also my sister Hedvig Engström Jakobsson, who earned her PhD in 2011 (Engström Jakobsson, 2011). I would like to thank my mother Margareta Dehle for always being very supportive and for helping my family in so many ways. A special thank you is directed to my two daughters Ella and Kajsa who, who during these three years, have had to speak to their father on Skype and Facetime far too many times. A special welcome and thank you to my newborn adorable daughter Leona, who was born in the very last phase of my PhD, a phase when I also lost my dear and greatly missed father, Per Engström, who had been a surgeon. This dissertation is therefore made in memory of my father and dedicated to my three children.

References:

Collin, L. (2006, November 7). Det bor en beatnik i staden. Svenska Dagladet. Stockholm.

Engström Jakobsson, H. (2011). Molecular characterization of the dynamics and development of the human microbiota.

Engström, P. (2016). The Role of Finance and Microentrepreneurship in the Informal Economy. University of Agder. Doctoral Dissertation 132.

Engström, P., & Oxelheim, L. (2013a, May 19). Sverige bör gå i bräschen för nordisk mikrofinans. Dagens Nyheter, p. 6.

Engström, P., & Oxelheim, L. (2013b, June 19). Bruk NIB til mikrolån. Dagens Næringsliv, pp. 40–41.

Engström, P., & Oxelheim, L. (2014, July 18). Nya grepp krävs för att främja företagande. Svenska Dagladet, p. 6. Stockholm. Retrieved from http://www.svd.se/nya-grepp-kravs-for-att-framja-foretagande_3750486

Fey, C., Engström, P., & Björkman, I. (1999). Effective human resource management practices for foreign firms in Russia. Organizational Dynamics, 28(2), 69–80.

Madden, B. J. (1999). CFROI valuation. Butterworth-Heinemann.

Oxelheim, L. (1996). Financial markets in transition: globalization, investment and economic growth. JSTOR.

Tunér, K. (1986). Studies on beta-lactamase producing anaerobic bacteria in recurrent tonsillitis and peritonsillitis.

 

Sri Lanka – are all clients of a microbank entrepreneurs?

I recently had the opportunity to spend some time in Sri Lanka with practitioners with Strømme Foundation and other leading microfinance researchers from around the world. The photo below is from University of Ruhuna.

Microfinance Research Team

We spent several days discussing various research problems, in addition to making a field visit to a microbank providing group loans to women.

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When approaching the microbank the women greeted us with some leaves. I did not know what I was expected to do with these leaves so I took one, and continued into the room. A colleague then told me I was not supposed to take the leaf… Ok… I should have made a short worship and passed the leaf back….oh well..then I was told one could actually eat the leaf, so me and a colleague tried that. Then I was told that the leaf can make you feel a little “tipsy”…but don´t swallow it…because it is hot like cayenne…too late….cough…very spicy….

The microbank we visited work differently from the one I have previously met in Ecuador. They worked only with women – typically the poorest of the poor, with little entrepreneurial skills, in comparison with the people I met in Ecuador who we may call the entrepreneurial poor and were both men and women. The husbands of these women were often doing other labor work, and if this microbank had not provided a loan and help with their business, these women would likely also be doing poorly paid labour work, providing a fraction of what these businesses made. So for these women, taking a loan to do these businesses provides more income to them. However, when asked who came up with these business ideas, it was obvious that these opportunities were not discovered by these women, but rather suggested by the microbank´s credit officer. In fact, taking on this business project entailed very little risk to the women, as the resale of the bricks was guaranteed. Hence, are these women entrepreneurs, or self-employed?

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This form of microfinance helps women make slightly more money than they would have earned given the availability of other jobs. They are still among the poor, but not at the lowest level. It improves their standard of living, but in some cases they built a new brick house, but continued to use their old houses which they were more used to. Obviously, we had too little time to really understand all that is going on here, and many have actually already studied this form of microfinance. This form of microfinance does reduce poverty and improves social security, but it is questionable whether it eradicates poverty and whether it has any major effects on economic development. It does offer a higher likelihood for poverty eradication to happen. It is important as there is no distribution of wealth in Sri Lanka, as it is in for instance Sweden. It is a reminder of how important it is with a social safety net, providing basic education and health care, but also some form of wealth distribution to allow people a certain basic standard of living.

Schumpeterian entrepreneurs are typically those people who make dramatic innovations, by combining resources, and create something new. One such entrepreneur can create 1000s of copy-cat entrepreneurs and 10.000s of employment opportunities. In economic development, we don´t want a large population of entrepreneurs, below 10% is roughly a good sign, not 40-50%.

Asking the microbank, we are told that there are a few clients who had been able to grow and employ more people, up to 20 employees, but this is very uncommon. However, the majority of small businesses stay small, and the form of support they receive thus become more as a form of social security. Other businesses could include small scale agriculture. The question is how these small, essentially self-employed, businesses, can become entrepreneurial ventures propelling these groups out of poverty.

Below is a short video, giving a flavor of the visit to Sri Lanka. Can highly recommend a visit.

 

Jambo (hello)! A field trip to Tanzania

Just ended an interesting two-week field trip to Tanzania. Me and the one eyed professor Trond, named so after a lost battle with his contact lens in the flight over, have been travelling around the Tanzanian country side, together with our Tanzanian colleague Dr. Neema Moori.

Bumpy road
Bumpy road

Like three explorers we have travelled on bumpy “roads” in a 4wd jeep meeting many small businesses around Tanzania and also presented and discussed research at the University of Dar Business School, the leading business school in Tanzania, on micro entrepreneurship and microfinance.

University of Dar es Salam Business School
University of Dar es Salaam Business School

Driving on the left hand side was an experience. When we changed from driving on the left hand side to the right during a weekend in the 1960s, the Swedes allegedly first started with busses and trucks on day one, and on day two allowed cars to switch side (a Norwegian joke..…)..  In Dar es Salam we experienced some of this when driving in the “mixed lane” in the middle…

Stockholm 1967 or Dar es Salaam mixed lane 2014?
Stockholm 1967 or Dar es Salaam mixed lane 2014?

We have met many innovative entrepreneurs, discussing gold mining operations and suggested alternative methods instead of their dangerous usage of mercury and cyanide, seen farming, visited a dairy production, a security business, a honey business, a power plant in Burundi, solar-power companies, coffee and fruit juice operations, construction companies and much more.

Young men seeking gold in the small Tanzanian mines.
Young men seeking gold in the small Tanzanian mines.
500 chicken
500 chicken

We also met Statoil and learnt about the current status and plans for the country. They have found gas 100 km out in the sea outside the Tanzania coastline. Drilling for gas in depths of 2000 meters is new to Statoil and the transportation of the gas once recovered is not the easiest thing. One of the biggest obstacles to Statoil is getting the bureaucratic permits and reaping any revenues from the drilling lies years ahead, but the government of Tanzania is already busy setting up a “welfare fund”.

In terms of the small businesses, there is no shortage of ideas and opportunities and the future of Tanzania is promising, although some major challenges and risks are ahead, such as road infrastructure, schooling, health and housing, and of course access to finance and an efficient government. A day at a pig and poultry farm was encouraging with environmentally friendly production methods, and good treatment of the animals, but we smelled like pigs back at the hotel afterwards….

Small baby pigs at a farm start-up
Small baby pigs at a farm start-up

Over the weekend we took a small, Indiana Jones inspired, plane to Stone Town, Zanzibar, see blog. When sitting just behind the pilots we noticed how the co-pilot fell asleep and awoke when we landed…. The other pilot was a short fellow who had to stand up while landing the plane, quite the scene, but we landed safely. Tanzania and not the least Zanzibar is blessed with some amazing shorelines and beautiful scenery. Islam is the dominant religion at Zanzibar, whereas Tanzania is more mixed between Islam and Christianity.

Beach at Zanzibar
Beach at Zanzibar

While travelling we were pulled over 4 times by different cops for various reasons, such as crossing the double-lines in the middle of the road, which of course we had not done. All this was part of the daily revenue generation strategy by the police force. The revenues from the first 150 pulled over go to the government, while the rest go to the police force… If they stopped you, it was better to pay the 20 dollars than to spend 30 minutes discussing with them, which they knew. But they were very nice, typically dressed in white.

Victoria lake, stone structures, near Mwanza
Victoria lake, stone structures, near Mwanza

Today, coming home to celebrate my “insanely great” first born and oldest daughter Ella, turning 13 years old. <3<3<3<3

Asante sana (thank you)!