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Hoping to Win, Expected to Lose: Theory and Lessons on Micro Enterprise Development

  • Dean Karlan

    ()

    (Economics Department, Yale University)

  • Ryan Knight

    ()

    (School of Management, Yale University)

  • Christopher Udry

    ()

    (Economics Department, Yale University)

Registered author(s):

    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.

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    File URL: http://www.econ.yale.edu/growth_pdf/cdp1014.pdf
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    Paper provided by Economic Growth Center, Yale University in its series Working Papers with number 1014.

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    Length: 54 pages
    Date of creation: Aug 2012
    Date of revision:
    Handle: RePEc:egc:wpaper:1014
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    1. Dean Karlan & Martin Valdivia, 2007. "Teaching Entrepreneurship: Impact of Business Training on Microfinance Clients and Institutions," Working Papers 107, Center for Global Development.
    2. Karlan, Dean S. & Osei, Robert & Osei-Akoto, Isaac & Udry, Christopher, 2012. "Agricultural Decisions after Relaxing Credit and Risk Constraints," CEPR Discussion Papers 9173, C.E.P.R. Discussion Papers.
    3. Christopher Udry & Santosh Anagol, 2006. "The Return to Capital in Ghana," American Economic Review, American Economic Association, vol. 96(2), pages 388-393, May.
    4. de Mel, Suresh & McKenzie, David J. & Woodruff, Christopher, 2009. "Measuring microenterprise profits: Must we ask how the sausage is made?," Journal of Development Economics, Elsevier, vol. 88(1), pages 19-31, January.
    5. Christopher Udry & Santosh Anagol, 2006. "The Return to Capital in Ghana," Working Papers 932, Economic Growth Center, Yale University.
    6. Shawn Cole & Thomas Sampson & Bilal Zia, 2011. "Prices or Knowledge? What Drives Demand for Financial Services in Emerging Markets?," Journal of Finance, American Finance Association, vol. 66(6), pages 1933-1967, December.
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