Size-Dependent Credit Constraints and High Marginal Returns to Capital

In Simple Words

Imagine a street food vendor who only has enough cash to buy ingredients day-by-day and makes $5 a day; giving them a $100 loan allows them to buy a small refrigerator and purchase ingredients in bulk, instantly doubling their daily earnings.

Research question

Micro and small enterprises in developing countries face binding credit constraints that restrict their capital stock, leading to extraordinarily high marginal returns on small financial injections.

Participants

Microenterprises in Sri Lanka ($100-$200 grants) and medium-sized Indian manufacturing firms ($140,000-$640,000 capital stock).

Study Design

Randomized controlled trial (De Mel et al. grants in Sri Lanka) and quasi-experimental policy evaluation of directed credit expansion (Banerjee & Duflo in India).

Results

$100-$200 cash grants to Sri Lankan microenterprises yielded a 5 percent monthly real return on capital; directed credit expansion to Indian medium-sized firms generated an annual return on loans close to 90 percent.

Takeaway

Expand targeted credit and micro-grant mechanisms for small-scale enterprises where marginal returns on capital injections remain exceptionally high.

Read alongside the research

Plain-English glossary

Original explanations, informed by the references below. Examples are illustrations, not data from the studies above. The research text stays unchanged.

Randomized controlled trial

A study that uses chance, like drawing lots, to decide who receives each option being compared. Researchers compare the groups’ outcomes to estimate the effect of those options.

ExampleA lottery assigns volunteers to a training programme or a comparison group. Researchers then compare their outcomes.

GET-IT glossary · Randomized study ↗Read more about randomized controlled trial →

Related findings

• Microenterprise High Marginal Returns to Capital →Finance & microfinance

  Imagine a street food vendor who lacks twenty dollars to purchase an insulated cooler, forcing them to sell warm drinks at a discount; a small cash grant allows them to buy the cooler and immediately double their profits relative to the tiny investment.

• Informal Credit Market Exclusion →Finance & microfinance

  Imagine trying to run a small grocery shop in a town where banks refuse to offer loans to small vendors, and neighbors or money lenders also do not lend money. The shopkeeper can only buy new shelves or stock if they personally saved cash under their mattress from past sales.

• Baseline Remittance Level Heterogeneity →Finance & microfinance

  Imagine offering a fuel discount voucher to two drivers: one who rarely drives due to high fuel costs, and another who already drives every single day. The driver who rarely drove increases their trips significantly when given the discount, whereas the daily driver makes no additional trips because their driving behavior was already at capacity.

• Capital Compounding in Microenterprises →Finance & microfinance

  Think of two snowballs rolled down a hill: one starts slightly bigger because it was packed with more snow at the top. As both snowballs roll for three full years, the slightly bigger one accumulates dramatically more snow because every extra layer adds even more surface area to pick up new snow.