53999 FPD IMPACT FEBRUARY 2009 The Lessons from DECRG-FP Impact Evaluations ISSUE 1 Introducing the FPD Impact Series. This new series is intended to share the findings of impact evaluations in the areas of finance and private sector development that researchers in DECRG-FP have been involved in, and to draw out their lessons for operational staff and policymakers. Rigorous evaluations of FPD policies are relatively rare compared to other sectors such as health and education, and there is often a perception that many FPD projects do not lend themselves to serious evaluation. Our hope going forward is to showcase examples where assessment has been possible, and to enhance operational interest in evaluations of upcoming projects. Which Microenterprises have High Returns to Capital? David McKenzie Small and informal firms are the source of and US$200 were given to randomly selected employment for half or more of the labor subsets of microenterprises in each country. force in most developing countries. A central We can then compare the profits of firms question for policymakers is whether these which were randomly chosen to receive this firms hold the potential for income growth additional capital to the profits of similar for their owners, or whether they merely firms which did not receive this additional represent a source of subsistence income for capital. low-productivity individuals unable to find alternative work. The rapid increase in High returns for the average development funding being channeled to microenterprise microfinance organizations is based on belief We find: that these firms can earn high returns to Real returns to capital of 5.7 percent capital if given the opportunity ­ while critics per month in Sri Lanka, substantially argue that attention should instead be directed higher than the market interest rate. towards creation of wage jobs to pull people Real returns to capital of 20 to 33 out of subsistence self-employment. percent per month amongst small Assessing the extent to which a lack of retail firms in Mexico, much higher capital is a constraint on business profitability than market interest rates. is complicated by the fact that firms which The higher return in Mexico than Sri Lanka is have more capital stock or greater access to likely the result of (a) the Mexican sample credit are likely to also differ in many other containing only men, while the Sri Lanka ways from firms with less capital stock. The sample has both men and women; (b) the higher profits earned by firms with more Mexican sample being relatively poorer and capital may therefore simply reflect that more credit-constrained than the Sri Lankans; owners of firms with more capital have better and (c) Market interest rates being much entrepreneurial skills than those with less higher in Mexico than Sri Lanka. capital, or that they have increased their capital investments in response to growing Which firms have the highest returns and demand for their products. why? In Sri Lanka, returns to capital are higher for Randomizing capital entrepreneurs who are more severely capital Two recent randomized experiments in constrained - those with higher ability and low Sri Lanka and Mexico provide a way to wealth. Returns do not vary with risk aversion resolve this problem, and credibly identify the or uncertainty, suggesting it is not the case return to capital. Grants of between US$100 that firms choose not to undertake high return investments because they involve too The highest returns to capital are found for much risk. poor, urban, male microenterprise owners A provocative finding in the Sri Lanka with high ability (as measured by education or study is that while the average male-owned a digit span recall test). This group has not enterprise has very high returns to capital, on been the typical target of microfinance. There average female-owned enterprises saw no gain is a serious need for innovative new products in profit from the grants. A future impact which can direct finance to these individuals. note will discuss our research into the reasons behind these gender differentials. 4. Conditionality of Cash Transfers to Returns are highest in Mexico for firms that Business Owners might not matter say finance is a constraint to their business The experiments gave unrestricted cash grants growth and lower for firms that have to some of the treated microenterprises, and previously had formal loans or supplier credit, grants in the form of materials or equipment again consistent with credit market for the business to the other. We find no imperfections restricting firms from taking difference in the share of the grant ending up productive investment opportunities. in the business, suggesting that cash transfers might be a more cost-effective mechanism for Policy implications delivering capital to business owners than 1. Many microenterprises have the ability grants tied to having them spent on the to pay the high interest rates needed for business. microfinance to be self-sustaining. High returns to capital imply that the average 5. Grants or Loans? microenterprise has the ability to pay the high The results show that one-time grants can interest rates charged by some microfinance raise the incomes of poor businesses by a organizations, such as Compartamos, the largest significant amount, with the incomes of the pure micro-lender in Mexico, which charges treated group still higher than the control an average annual interest rate of 105%. The three years later in Sri Lanka. Many of these high returns suggest it is not the cost of microenterprise owners do not qualify for capital, but access, that is the issue. loans offered by existing microlenders, and it is not clear how many of them would take a 2. Marginal investments have high returns loan at market rates. An important policy ­ microenterprises aren't in poverty traps. question for future work is thus whether An influential class of models of poverty traps grants or loans are a better mechanism for rely on the assumption that there are non- raising the incomes of poor business owners. convexities in production. That is, if you start too small, you will remain trapped in Want to know if you are having an subsistence forever because the only impact? profitable investment projects require a big DECRG-FP researchers are always looking lumpy investment. Our results suggest high for opportunities to work with colleagues in returns from relatively small amounts. Firms the Bank and IFC to evaluate FPD projects. If can therefore start small and grow. you would like to ask our experts for advice or collaborate on evaluation strategies for 3. Microfinance is not targeting the upcoming projects, please contact us care of microenterpreneurs with the highest the FPD Impact editor, David McKenzie returns. (dmckenzie@worldbank.org). For further reading see: De Mel, Suresh, David McKenzie and Christopher Woodruff (2008) "Returns to capital: Results from a randomized experiment", Quarterly Journal of Economics, 123(4): 1329-72, 2008. McKenzie, David and Christopher Woodruff (2008) "Experimental Evidence on Returns to Capital and Access to Finance in Mexico", World Bank Economic Review, 22(3): 457-82.