Returns to Capital in Microenterprises: Evidence from a Field Experiment

This paper uses a randomized field experiment to identify the marginal return to capital for all firms, irrespective of whether or not they choose to apply for credit at market interest rates. The paper also examines the heterogeneity of returns in order to test why firms may have marginal returns well above the market interest rate. The authors:

• Survey microenterprises in Sri Lanka and provide small grants to a randomly selected subset of firms;
• Measure the increase in profits arising from the exogenous (positive) shock to capital stock;
• Use two different sizes of treatment to test whether returns are linear, increasing, or decreasing;
• Set out a model to investigate the causes of high returns to capital;
• Consider theories of imperfect credit markets and imperfect insurance markets.

The authors find that:

• The average real return to capital is substantially higher than the market interest rate;
• Returns vary with entrepreneurial ability and with measures of other sources of cash within the household;
• Returns do not vary with risk aversion or uncertainty;
• Returns are flat or decreasing;
• Marginal returns are highest for entrepreneurs with more ability and with fewer other workers in the household.

The authors conclude that:

• The reason for high returns to capital is missing credit markets;
• The household internal capital market is a binding constraint;
• There will be demand for loans from microlenders, even at high interest rates.