L, WORLD BANK GROUP
Interest Bearing Notes                    OCTOBER 2021
A Finance & Private Sector Development Research Newsletter
What's new on our website
Targeting tax enforcement efforts on larger firms: A necessary distortion?
Some tax administrations focus their enforcement efforts disproportionately on large firms. In a recent
Research & Policy Brief, Pierre Bachas shows that such size-dependent tax enforcement is especially
prevalent in lower-income countries, leading to increasing effective tax rates as firms become larger.
Pierre quantifies the impact of size-dependent tax enforcement for aggregate economic production. The
estimated impact is moderate and thus could be justified for tax authorities with limited resources, given
the revenue gains of enforcement targeted to large firms.
World Bank research
The anatomy of index rebalancings: Evidence from transaction data
Because they entail sudden and large shocks in the demand for affected securities by investors, index
rebalancing events have been studied extensively in financial economics to examine price effects. But
little is known about the actual behavior of the population of investors in response to these events
because high-frequency data on quantities traded by individual investors are typically not available. Using
data covering the universe of transactions on the Colombian Stock Exchange from 2006 to 2017, our
own Alvaro Pedraza, together with Mariana Escobar, Lorenzo Pandolfini, and Tomas Williams,
examine both the price effects of, and investors' behavioral responses to, additions to and deletions from
MSCI Equity Indexes (the most widely tracked international benchmarks for institutional investors in equity
markets). Those price effects are large - inclusion in an international equity index leads to a median
cumulative abnormal return, from the announcement to the implementation date, of 5.5%, driven largely
by increased demand from foreign investors. Most of the trades take place on the effective day of the
index re-composition rather than on its announcement day, and foreign investors' positions in the stock
tend to persist for the next month. Because the authors have data on both quantities and prices from
transactions, the index rebalancing episodes enable them to compute more reliable estimates of the
demand elasticity for stocks than those that rely only on price data. For the median stock in their sample,
a 1 % increase in the quantity demanded of shares (relative to the number of shares outstanding) leads to
an increase in its price of 2.94%, in line with the more inelastic estimates produced in prior studies. The


authors conclude that there is a broad range of foreign investors that have implicit mandates to closely
track the composition of the indexes they follow so that they deviate little from benchmark returns. Hedge
funds and other investors that are supposed to act as arbitrageurs are too small to soften the price
impact. The inelastic demand for stocks is a reflection of these behavioral patterns.
Changing-perceptions of institutions and standard of living in Iraq
Our own Saniya Ansar and Leora Klapper, together with Bledi Celiku and Wael Mansour, use individual-
level nationally representative survey data from Iraq from 2010 to 2019 to study the effects of violent
conflict on two dimensions of inequality: inequality among individuals or households (vertical inequality)
and inequality among regional, ethnic, and other categorical groups (horizontal inequality). To measure
vertical inequality, they use the relative perceptions of women, poorer adults, and adults living in rural
areas; horizontal inequality is measured by comparing perceptions across ethno-religious categories
including Shias, Sunnis, Kurdish Muslims, and Baghdad residents. Overall, Iraqis' confidence in national
institutions, quality of life, and quality of service delivery declined during control of parts of Iraq by the
Islamic State, also known as ISIS (2014-2016), but is slowly picking up in recent years. However, that
general trend masks important heterogeneity. With respect to vertical inequality, poor adults remain more
likely to report being food insecure and to have a more pessimistic outlook about their standard of living.
Regarding horizontal inequality, while assessments of job prospects and the standard of living declined for
all groups (Shias, Sunnis, Kurds, and adults in living in Baghdad) during the period of ISIS control,
improvements on those indicators in the post-ISIS period were more pronounced for Sunnis. A
fundamental concern is that all four of these groups perceived the government to be corrupt, a viewpoint
that was increasingly held before and during the period of ISIS control and only grew stronger in the post-
ISIS period.
Testing classic theories of migration in the lab
Despite the substantial financial benefits of migration, only 3.3% of the world's population live outside their
country of origin. The literature has tried to understand constraints by incorporating liquidity shortages,
risk and uncertainty, imperfect information, and destination choice in economic decision models. In this
paper, our own David McKenzie, along with Catia Batista, use incentivized lab experiments to test how
potential migrants trade off different location attributes and use this to distinguish between competing
migration theories. Working with samples in Portugal and Kenya, the study randomly assigns observed
and unobserved skill levels, as well as endowments. Further, the study varies factors such as
unemployment risk, liquidity constraints, and information. The results show that adding real-world
constraints of risk, liquidity, and information substantially lowers migration rates and makes selection less
negative. The authors also test the popular assumption regarding independence of irrelevant alternatives
and find that it holds for most people when migration decisions involve wages, costs, and liquidity
constraints. However, the assumption starts to break down when risk and incomplete information are
added to the mix. These findings demonstrate the need to move beyond classical theories to explain
patterns observed in global migration.
Our eclectic guide to recent research of interest


Big loans to small businesses: Predicting winners and losers in an entrepreneurial lending
experiment
Gharad Bryan, Dean Karlan, and Adam Osman designed and implemented an experiment with the
Alexandria Business Association (ABA), a large Egyptian lender, to understand whether giving larger
loans to some firms could benefit the lender and clients. ABA selected 1,004 approved borrowers for a
larger loan. These borrowers were randomly allocated to treatment group and a control group. Treatment
borrowers were offered loans four times larger than their previous loans. Control borrowers were offered
loans that were two times larger (for fairness reasons). Administrative data show that all borrowers
eventually repaid their loan, but treatment borrowers were more likely to make a late payment than control
borrowers. These delays were not excessively costly for ABA since it earned more in late fees than it lost
in foregone lending revenue. ABA decided to scale-up the program after the completion of the
experiment. To measure the effects on borrowers' firms, the authors conducted two follow-up surveys, 20
and 30 months after disbursement of the loans. The larger loans had no effect on firms' profits on
average. The authors then use machine learning and psychometric data, collected at baseline, to classify
borrowers into "top performers" and "poor performers", based on their predicted treatment effects. This
analysis reveals significant heterogeneity in the effect of larger loans: being allocated to the treatment
group increased profits by 55% for top performers, but it reduced profits by 52% for poor performers,
perhaps because the latter made risky and poorly thought-out investments.
Closing the profit gender gap
Female-led businesses often report earning less than half the profits of their male counterparts, even
when operating in similar sectors. Catia Batista, Sandra Sequeira, and Pedro C. Vicente study two
potential explanations for this gender profit gap: limited access to savings accounts and lack of financial
management skills. The authors conducted a field experiment with 1,270 formal microentrepreneurs in
urban markets in Mozambique. The microentrepreneurs were stratified by gender and randomly allocated
to a control group or one of three treatment groups. To help microentrepreneurs accumulate capital, the
first treatment group received access to a mobile money account that paid a promotional 5-percent
interest rate each month for the first three months (and no interest thereafter). The second treatment
group was invited to a 4-hour financial management training session. The third treatment group was
offered the combination of both mobile money accounts and training. Follow-up survey data was collected
12 months and 6 years after the intervention. The results show that the mobile money and combined
treatments significantly increased profits for female-led businesses, but not for male-led businesses,
suggesting that access to mobile money accounts can help close the profit gender gap. Training alone
had no significant effect on profits.
Loan officers impede graduation from microfinance: Strategic disclosure in a large microfinance
institution
In a new working paper, Natalia Rigol and Benjamin Roth study the determinants of an important puzzle
in microfinance - borrowers do not graduate to larger and more flexible loans. Using observational and
experimental data from a large microfinance lender in Chile, the authors find that loan officer
compensation contracts are an important impediment to loan size graduation. Specifically, loan officers


are rewarded for the size and performance of their portfolio and, therefore, are disincentivized to graduate
their best clients. After confirming this observation in the data, the authors experimentally study the effects
of changing the loan officer contract structure. Once the implicit penalty is removed, the authors find that
graduated borrowers who are endorsed by loan officers are 34% more profitable for the lender compared
to those endorsed before. A simple calculation suggests that this strategic behavior of loan officers is
costly, in the range of $4.8-29.2 billion in social value from forgone borrower graduations in microfinance
worldwide.
The long-term effects of industrial policies in Korea
Industrial policies have been frequently used by countries of all ideological stripes, but their long-term
causal effects remain underexamined. Jaedo Choi and Andrei Levchenko examine the effects of one of
the most prominent industrial policies ever pursued by a country: The Heavy and Chemical Industry (HCI)
Drive implemented in South Korea in 1973-1979, which subsidized access to foreign credit for firms in
selected industries and regions. HCI was implemented for military purposes and was unanticipated,
resulting in large variation across industries and regions, all features that facilitate identification of the
causal effects. The authors find that the long-term effects of the HCI Drive were substantial - an increase
in the sales growth of subsidized firms of 8.5 percentage points for the subsequent three decades. They
propose that the key drivers of this large impact were learning by doing and relaxation of financial
constraints. Using a counterfactual analysis, they estimate that the HCI Drive raised South Korea's overall
welfare by 22-31 %.
Bureaucracy and development
Two opposite views shape our understanding of bureaucracy and development. One considers
bureaucrats as ineffective, either prone to industry capture or "grabbing hands" simply out for themselves.
The other view, most prominently held by Max Weber, considers bureaucrats as professionals specialized
in providing public goods integral to development-think, for example, of the East Asian development
states. Timothy Besley, Robin Burgess, Adnan Khan, and Guo Xu take stock of a vast theoretical and
empirical literature on bureaucracy and development to identify what makes for an effective bureaucracy
and the critical ingredients of state capacity. The authors provide stylized facts about the quality of
bureaucracy, such as its persistence and its strong link with the level and growth of income. They argue
that whether bureaucracy promotes development depends on interactions (i) between different levels of
bureaucracy, (ii) between government departments, (iii) between citizens, politicians, and bureaucrats and
(iv) between bureaucrats, firms, and NGOs. While the analysis and conclusions are nuanced, the authors
appear to give more weight to the second view, or at least the conditions for the second view to hold.
Their coverage is very thorough, including theoretical takes on bureaucrats from both the principle-agent
and the multi-task perspectives, and key empirical insights from contemporary research that uses
administrative data and field experiments. For those interested in how bureaucracy facilitates/hinders
development, this is a must read.
Upcoming events and miscellanea
2022 University of Oklahoma Energy and Climate Finance Research Conference


The University of Oklahoma's (OU) Price College Center for Financial Studies is organizing the fourth OU
Energy and Climate Finance Research Conference, to be held on the OU campus in Norman, Oklahoma
on April 22-23, 2022. About 12 papers will be accepted for presentation in plenary sessions over a day
and a half. After the conference, participants will be invited to visit an energy facility in Oklahoma. The
conference is co-sponsored by the Review of Financial Studies (RFS). At the authors' option, papers
submitted to the conference will, in addition, be considered for publication at the RFS free of charge. The
deadline for submissions is November 30, 2021.
9th Annual Conference on Financial Market Regulation (CFMR 2022).
The SEC's Division of Economic and Risk Analysis (DERA), Lehigh University's Center for Financial
Services (CFS), the University of Maryland's Center for Financial Policy (CFP), and CFA Institute will
jointly host the CFMR 2022 in the afternoon on Thursday, May 5 and all day on Friday, May 6, 2022 at the
SEC Headquarters in Washington, DC. The goal of the conference is to bring together participants for an
exchange of views on topics of relevance to the SEC. Two papers will be selected in each of four broad
topic areas: corporate finance, market microstructure, financial intermediation, and asset management.
The deadline for paper submissions is November 18, 2021 with a submission fee of $40.
Happy reading!
Your editors Miriam Bruhn (mbruhn@worldbank.org), Bob Cull (rcull@worldbank.org), Colin Xu
(Ixul @worldbank.org), and Bilal Zia (bzia@worldbank.org)
IBN is a product of the Finance and Private Sector Development Team in the World Bank's Development Research
Group. Our working papers and descriptions of research projects in progress can be found, along with a list of
forthcoming seminars and conferences, on our web page
Please send comments, suggestions (such as your own or others' interesting research)
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