Achieving Scale Collectively

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This paper argues that rental market interactions allow small firms to increase their effective scale and mechanize production, even when each individual firm would be too small to invest in expensive machines. We conduct a novel survey of manufacturing firms in Uganda, which uncovers an active rental market for large machines between small firms in informal clusters. We then build an equilibrium model of firm behavior and estimate it with our data. Our results show that the rental market is quantitatively important for mechanization and productivity since it provides a workaround for other market imperfections that keep firms small. We also show that the rental market shapes the effectiveness of policies to foster mechanization, such as subsidies to purchase machines.