1. 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

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

3. 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

4. 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: % annually
Schündeln (2006), Ghana, manufacturing: 30-80% annually 4

5. 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

6. 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 = or profits= with equal probability p=0.5
=> consumption either 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

7. 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

8. 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

9. 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

10. 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

11. Identifying constrained firms (2)
using manufacturing surveys from Ghana, , 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

12. 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

13. 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

14. 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

15. 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