Quantifying the impact of market failures that prevent parents and schools from reaching their desired educational goals is central to our understanding of the sector. Using an experimental design, we examine how alleviating one such market failure—access to finance—affects school profitability, enrollment and test scores. Specifically, we randomly assigned 851 private schools across 266 villages in rural Pakistan to one of two types of financial treatments: (i) `High Intensity’, where all private schools in the village received an unconditional grant of \$500 each and (ii) `Low’ intensity where one private schools is randomly chosen to receive the grant. In the low intensity treatment, revenues increased substantially due to higher enrollments, but there was no increase in test scores or fees. In the high intensity treatment, revenues increased both due to greater enrollment and increased fees that accompanied higher test scores. While the returns exceeded market interest rates in both cases, because higher quality was obtained through greater remuneration for teachers—a variable, rather than a fixed cost—the private returns were lower in the high intensity arm.
This difference between high and low intensity arms follows from the underlying market structure. In an oligopoly setting with capacity constraints and vertical differentiated firms, financing a single school, allows the treated school to expand capacity without triggering price competition. When all schools receive financing, simultaneous capacity increases in all schools leads to severe price competition, thereby increasing the incentives for quality enhancements. While private returns are higher when only a single school receives financing, our results are consistent with a greater social impact when all schools receive financing as the wider set of market participants `crowds-in’ higher quality provision.

Written with Asim Khwaja (Harvard University), Selcuk Ozyurt (Sabanci University) and Niharika Singh (Harvard University)