Microentrepreneurs and their money: three anomalies Joint with Dean Karlan and Sendhil Mullainathan March 16, 2007

Motivation Microfinance has grown extremely fast Yet we know little about the production side – the uses of money  What are the investments that are profitable enough to pay off MFIs?  Investment environment? Implications for MFIs Design of loan products Other financial products High-impact non-financial interventions

Anomaly # 1: borrowing persistence A typical urban working poor profile  Has a small vegetable vending business  Daily working capital cycle  Borrows Rs in the morning and repays Rs at the end of the business day  Has been in this cycle for 10 years

Why is this an anomaly? Return from not borrowing is 10% overnight! Working capital outlays small enough to be ‘saved up’ in a few months  Power of compounding Why do we observe this persistence of high- cost borrowing?

Possible explanations Mismeasuring ‘true cost’ of the loan  Desire to keep relationship with money lender Access to savings devices Intra-household savings conflicts Mis-construal of compounding  Do not understand how much they’re losing

Current work Give cash to get people out of debt trap Ask whether they fall back  Would rule out pure consumption constraints (i.e. could not cut back on consumption to finance getting out of trap) Test efficacy of financial planning and savings interventions to prevent fall-back

Anomaly # 2: too few joint production ventures Typical investment opportunity  2 types of cows: Rs and Rs  Rs cow yields Rs. 500/flush month  Rs. 10,000 cow yields Rs. 1200/flush month  So 10,000Rs. cow earns 20% higher rate of return Why do joint liability group clients consistently choose lower return cows?

Why is this an anomaly? Costs of cooperation do not deter from joint borrowing Group solidarity hypothesis would predict more joint production What are the implied limits to monitoring?  Note: the cow production function is especially simple Could alternate days in taking care of the cow Input feeding should be easy to monitor in small groups

Possible explanations Joint production more expensive than joint liability Joint liability is an added tax, but cheaper than alternative Risk diversification

Current work Individual vs joint liability borrowing, Philippines (Gine and Karlan, 2006)

Anomaly # 3: role of non-financial market failures What is going on in other markets that MFI clients are part of? Labor? Labor Asset rental? Asset rental

Why is this an anomaly? How much are MFI investments sustained by these failures? ‘Unwitting entrepreneurs’? Is credit the best intervention?

Possible explanations Labor market failures  (Emran, Morshed and Stiglitz, 2006) High business risks and depreciation

Planned work Evaluate MFI interventions in secondary markets  Daycare  Asset rental  Financing SMEs that employ MFI clients

Thank you

Buffalo cost6000 Daily revenue24 Monthly revenue720 Annual revenue5760 Annual feed cost2400 Net profits3360 Capital costs (25%)1500 Net profits after capital costs 1860 Labor2700

Daily pushcart rental rate 30 Annual rental cost10950 Cost to purchase2000 Annual rent to cost ratio 5.475