Returns to Capital in Microenterprises: A pathway out of poverty?

David McKenzie: Small and informal firms account for a large share of employment in developing countries. The rapid expansion of microfinance services is based on the belief that these firms have productive investment opportunities and can enjoy high returns to capital if given the opportunity. However, the opposing view has that microenterprise owners are really subsistence workers, waiting for a wage job. Measuring the return to capital however is complicated by unobserved factors such as entrepreneurial ability and demand shocks, which are likely to be correlated with capital stock. I report on randomized experiments conducted in Sri Lanka and Mexico to overcome this problem. We randomly provided cash and equipment grants to small firms and measuring the increase in profits arising from this exogenous (positive) shock to capital stock. The results show very high returns to capital for microenterprises. We then examine the heterogeneity of treatment effects to explore whether missing credit markets or missing insurance markets are the most likely cause of the high returns. David McKenzie is a Senior Economist in the World Bank’s Development Research Group. His specific areas of research interest include international migration, microenterprises, poverty traps, household responses to aggregate shocks,and the development of econometric methods useful for working with data from developing countries. He was one of the authors of the 2007 World Development Report, and is a co-principal investigator for the Pacific-Island New Zealand Migration Survey, and the Sri Lanka Microenterprise Survey. Motu seminars are free to the public. No registration is required. Simply turn up on the day.