In Simple Words
If buying an extra Rs 1,000 worth of carpentry tools allows a woodworker to earn an extra Rs 110 every month forever, the tools pay for themselves quickly. However, if the lender demands immediate weekly installments that exceed initial cash flows, the woodworker can never buy the tools in the first place.
Women borrowing through VFS in Kolkata
- Repayment starts after two weeks
- Reference business capital
- Repayment starts after two months
- About Rs.23,600 more business capital
Nearly three-year trial result; capped, unadjusted capital estimate. Returns and income-versus-portfolio mechanisms require additional assumptions. Default also rose.
See source →Research question
Micro-entrepreneurs in developing economies remain trapped in low-income equilibria because credit market rigidities prevent them from accumulating the capital stock necessary to exploit extremely high marginal returns to capital.
Participants
N = 766 urban microenterprises in Kolkata, India surveyed nearly 3 years post-disbursement.
Study Design
Instrumental Variables (IV) linear regression of profits on total capital stock, instrumented by random assignment to a grace period contract and controlling for labor hours.
Results
Estimated monthly return on business capital was 11.0% in the top-coded sample (95% CI: 2.4%–19.7%) and 13.0% in the full sample (95% CI: 1.0%–26.0%), generating an Rs 23,594 to Rs 28,770 increase in long-run business capital stock (an 81.0% increase over control).
Takeaway
Structure loan duration and capital sizing using instrumental variable return estimates to ensure borrowers can achieve self-sustaining capital compounding.