Paper prepared for the World Bank conference on Access to Finance RETURNS TO CAPITAL IN MICROENTERPRISES: EVIDENCE FROM A FIELD EXPERIMENT Christopher Woodruff, UCSD (With Bob Cull and David McKenzie) Paper prepared for the World Bank conference on Access to Finance March 15-16, 2007

The project We estimate returns to capital for a set of very small household enterprises. No paid employees, capital of less than $US 1000 (~two-thirds of the income distribution in Mexico)

Returns to capital in microenterprises --Why do we care? Large portion of urban labor market is self-employed. About one-quarter in Mexico What is the potential for growth of these enterprises? Financial market imperfections can result in large inefficiencies, underinvestment

Why might returns be high or low? Low returns: Several influential theory papers posit some minimum scale of investment / non-convex production sets (Banerjee and Newman 1993; Aghion and Bolton 1997) High returns: Capital constraints Risk / uncertainty

Evidence on returns to capital in enterprises Among others: Banerjee and Duflo 2003 (74%-100%) Bigsten et al (30%) Udry and Anogol 2006 (60%-250%) De Mel, McKenzie and Woodruff 2007 (60%) McKenzie and Woodruff 2006 (10%/month)

Returns from ENAMIN data

What is wrong with existing evidence? Some from cross section: Worry about conflating ability and capital investment Some from loan programs: Measure only for the self-selected sample that applies for credit McKenzie and Woodruff suggests that returns are high in the broad sample of firms, yet take up rates for loan programs are low

The Experiment Randomized experiment where we provide grants to enterprises to create exogenous variation in capital stock Selected 207 retail firms in Leon, Guanajuato Sample drawn from block-to-block survey of households in selected UPMs Surveyed first in November 2005, then quarterly through November 2006 (5 waves)

Capital shock After the first and third round of the survey, randomly selected firms were given capital shock ~$140, in cash or equipment 33% of mean baseline capital stock, 50% of mean monthly earnings Use grants rather than loans because we want to measure the full spectrum of firms

What part of the population?

Random Assignment to treatment

Attrition something to address

Returns to capital

Returns to capital

Attrition: Lower Lee bounds

Heterogeneity of returns

High returns to MFIs making small loans

Conclusions Use random shocks to capital stock to estimate returns to capital Data noisy, but suggest monthly returns in the 20%-35% range Returns in the constrained firms These returns are even higher than the returns we find from cross-sectional OLS data (attenuation?)