Comments on: Experimental Evidence on Returns to Capital and Access to Finance in Mexico by R. Cull, D. McKenzie, and C. Woodruff Matthias Schündeln Harvard University 1

Returns to capital and access to finance yes no returns to capital? low investment high 2

Returns to capital: approaches production function estimation dynamic structural approaches (Schündeln 2006) exogenous variation in access to credit or capital natural experiments that vary credit access (e.g. Banerjee and Duflo 2004) random allocation of capital (this paper; de Mel, McKenzie, Woodruff 2006) 3

This paper’s findings returns to capital: 20-50% per month for “constrained firms”: almost 100% per month implied returns are huge are these reasonable numbers? authors compare to market interest rates one Mexican micro-lender charges 105% annually other estimates from the literature: McKenzie and Woodruff (2006), Mexico: 10-15% per month de Mel, McKenzie and Woodruff (2006), Sri Lanka: 5-7% per month Udry and Anagol (2006), Ghana agriculture: 50-250% annually Schündeln (2006), Ghana, manufacturing: 30-80% annually 4

Concern: externalities sample of retail businesses from small geographic units: strategic interaction? negative externalities of additional capital? this may lead to overestimation of treatment effect treatment group profits treatment effect (over-) estimated treatment effect “control” group (with externalities) control group (no externalities) pre treatment post treatment time 5

Concern: uncertainty – an example pre-treatment profits (at median): 3000 pesos with 50% monthly return, the expected profit of re-investing all of these 3000 pesos is 1500 pesos assume: profits = 4000 or profits= - 1000 with equal probability p=0.5 => consumption either 7000 or 2000 risk-free outside option that gives 10% monthly return => consumption: 3300 constant relative risk aversion: NOT investing in risky project maximizes single period utility if γ >1.65 6

Concern: why no reinvestment? puzzle: if returns are high, why not reinvesting? behavioral issues, e.g. mental accounting? profits may be framed as belonging to income thus favoring consumption treatments may be framed as belonging into another category that favors investment are entrepreneurs prompted about investing before? 7

Private returns vs. social returns externalities? (see earlier discussion) with easier access to capital, we would see more entry and different types of entering entrepreneurs; equilibrium effects? => social return unclear, even with large private returns 8

How to identify constrained firms? study asks entrepreneurs whether financing is a constraint 64% say financing is a constraint 36% say financing NOT a constraint frequently studies ask similar subjective questions about financing Question: is this information useful? 9

Identifying constrained firms (1) this study firms that claim “financing is a constraint”: strong effect of treatment firms that say “finance is NOT a constraint”: no effect 10

Identifying constrained firms (2) using manufacturing surveys from Ghana, 1991-1999, I estimate production functions and calculate returns to capital from estimates: firms that say “credit biggest problem”: annual returns approximately 55% returns of firms that do NOT mention “credit”: annual returns approximately 30% 11

Identifying constrained firms (3) in current work, I use productivity estimates to control for investment opportunities and test for financing constraints via investment-cash flow sensitivities I show that using productivity estimates instead of Q remedies the problems that have been raised about Fazzari et al. (1988) firms that say “credit biggest problem”: strong investment-cash flow sensitivity firms that do NOT mention “credit”: insignificant investment-cash flow sensitivity 12

Summary: how to identify constrained firms? several pieces of suggestive evidence that subjective information can be useful study sample of firms: “credit a problem” “credit NOT a problem” returns to capital (monthly) Cull et al. 2007 100% not significant returns to capital (annual) Schündeln 2006 ~55% ~30% investment-cash flow sensitivities significant 13

Conclusion very nice study together with a related study on Sri Lanka (de Mel, McKenzie, Woodruff) this research program significantly adds to our knowledge of micro-enterprises results suggest large returns to capital, i.e. productive investment opportunities side product: suggestive evidence that self-assessed level of financing constraints contains useful information 14

Other concerns/questions measurement of profits do entrepreneurs take into account the treatment amounts? long run vs. short run effects? cash vs. inventory/equipment transfer? heterogeneity of effects: small vs. large businesses? 15