Many basic economic theories with perfectly functioning markets do not predict the existence of the vast number of microenterprises readily observed across the world. We put forward a model that illuminates why financial and managerial capital constraints may impede experimentation, and thus limit learning about the profitability of alternative firm sizes. The model shows how lack of information about one’s own type, but willingness to experiment to learn one’s type, may lead to short-run negative expected returns to investments on average, with some outliers succeeding. To test the model we put forward first a motivating experiment from Ghana, and second a small meta-analysis of other experiments. In the Ghana experiment, we provide inputs to microenterprises, specifically financial capital (a cash grant) and managerial capital (consulting services), to catalyze adoption of investments and practices aimed towards enterprise growth. We find that entrepreneurs invest the cash, and take the advice, but both lead to lower profits on average. In the long run, they revert back to their prior scale of operations. The small meta analysis includes results from 18 other experiments in which either capital or managerial capital were relaxed, and find mixed support for this theory.
This paper studies the causal impact of credit constraints on exporting firms. We exploit a natural experiment provided by two policy changes in India, first in 1998 which made small-scale firms eligible for subsidized direct credit, and a subsequent reversal in policy in 2000 wherein some of these firms lost their eligibility. Using firms that were not affected by these policy changes (in each case) as our control group, we find that expansion of subsidized credit increased the rate of growth of bank borrowing by about 20 percent and export earnings by around 22 percent. Interestingly, the subsequent policy reversal in 2000 had no impact on the rate of growth of bank borrowing and on export earnings.
This paper documents a widely overlooked dimension of relationship lending: the personal interaction between the borrower and the lender reduces the willingness of the borrower to engage in moral hazard and default on the loan officer. We conduct a randomized experiment with small business borrowers of the largest commercial bank in India to test the impact of three different levels of interactions between the borrower and the bank. Borrowers who are regularly called either by a single assigned relationship manager or by one manager randomly selected from a small team of managers shows much better repayment behavior and greater satisfaction with the bank services than borrowers who either receive no follow up or only receive follow up calls from the bank when they are delinquent. The results are economically and statistically significant: borrowers who receive the more intensive treatment see a large reduction in the number of late payment spells and delinquencies.
What capital is missing in developing countries? We put forward “managerial capital”, which is distinct from human capital, as a key missing form of capital in developing countries. And it has also been curiously missing in the research on growth and development. We argue in this paper that lack of managerial capital has broad implications for firm growth as well as the effectiveness of other input actors. A large literature in development economics aims to understand the impediments to firm growth, particularly small and medium enterprises. Standard growth theories have explored the importance of input factors such as capital and labor in the production function of firms and countries.