Undercover Economist

March 30, 2012 10:03 pm

Capital ways to survive the worst

The results of an experiment in Sri Lanka show the impact of financing on small businesses in communities shattered by natural disasters

In 2004, two economists, Chris Woodruff and David McKenzie, applied for funding from the National Science Foundation to do some research in Mexico. The idea was to draw inspiration from medical research and conduct a randomised controlled trial to find out whether small businesses could benefit from more access to capital. The NSF liked the idea, Woodruff recalls, but in the end turned down the funding request.

Then something truly awful happened – the Boxing Day tsunami, which devastated the coast of the Indian Ocean and killed well over 200,000 people. In Sri Lanka, more than 30,000 people were killed and many more left homeless. Small business owners found their stock, their equipment and their premises destroyed.

Against this backdrop, Julia Lane, an officer at the National Science Foundation, contacted McKenzie and Woodruff. She had liked the original research proposal and she had money to spend researching the aftermath of natural disasters. She even knew a local economics lecturer, Suresh De Mel, who might be able to get the research going in what was surely a challenging environment. A few weeks later the three researchers were in Sri Lanka testing out the first surveys.

The experiment itself looked at different kinds of businesses in different situations. All the businesses selected were tiny. Some had suffered huge losses. Others had avoided direct damage but were located in shattered coastal communities. Others were a few miles inland, unaffected by the tragedy on the shoreline. The typical (median) business had about $270 worth of capital, and the researchers were handing out grants of 10,000 rupees (about $100) or 20,000 rupees. These grants were sometimes paid in cash and sometimes made by accompanying business owners to market to make purchases on their behalf.

The results, recently published in articles in Science and the Economic Journal, tell a subtle story of recovery and of the difference access to capital can make. The broad story is this: businesses that suffered direct damage took a couple of years to catch up with those that had merely suffered indirect disruption; and businesses that received grants derived huge benefits from them – about 10 per cent return every month.

Beyond these averages, though, lurk stark differences. Damaged retail businesses enjoyed huge monthly returns when given grants. Unaffected businesses of any sort enjoyed healthy returns to capital – more than 7 per cent a month, suggesting that Sri Lankan small businesses are typically starved of capital.

But manufacturing businesses in affected areas, whether or not they had themselves been damaged, seemed to be able to do nothing useful with the money. One explanation is that they needed more capital to get manufacturing off the ground, but those receiving $200 seemed to do no better than those receiving $100. So a more plausible hypothesis is that each manufacturer was suffering from the disruption of supply chains.

In the coir industry, for example, there’s a long supply chain from the coconut harvest to processors to manufacturers of mats, brushes and other products. Each entrepreneur must deal with the damage to his suppliers and customers, and each entrepreneur may fear that others will simply give up and spend their grant money elsewhere. In such circumstances, says Woodruff, co-ordination and business advice may be critical.

The lesson I draw for other disaster hit areas, from Port-au-Prince in Haiti to Sendai in Japan, is that any industry based on a complex network of local firms is vulnerable. And something we already knew: recovery is dependent on the availability of loans or grants. When disaster has destroyed every physical asset of your business, capital counts.

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