Policy interventions in non-agricultural small-scale enterprises shed light on what matters for firm growth and profitability
Microenterprises, defined as businesses with up to four employees, are much more prevalent in developing countries than in developed countries, and the vast majority have no employees besides the owner (i.e. the ‘microentrepreneur’). Given the importance of microenterprises in developing country economies, numerous policy interventions have tried to increase their profitability and growth rates via various channels, including access to credit, business training, and reducing barriers to hiring.
In addition, unlike in developed countries, the majority of microenterprises in developing countries are run by women (Klapper and Parker 2011). Across many indicators – including sales, assets, and profits – these female-run microenterprises underperform their male-run counterparts (Bruhn 2009, Nix et al. 2015, Hardy and Kagy 2018). To explain this gender gap in firm performance, some interventions have focused on understanding and addressing the unique challenges that women face in running successful businesses. In this column I review the lessons learned from the various policy interventions aimed at microenterprises, and areas for future research.
Most microenterprises in developing countries are not formally registered with the government. While formalisation would give firms greater access to capital and wider markets, the financial costs and red tape involved can be a major deterrent (de Soto 1989, 2000). Several studies have analysed the impact of interventions that help with the formalisation process, such as covering registration fees, information provision, and cash incentives to register. The most effective type of assistance involves close interactions with the firms – for example, conveying information in person via trained staff – and is therefore relatively expensive (de Andrade et al. 2013, de Mel et al. 2013, Benhassine et al. 2018). Given the additional tax liability and regulatory scrutiny, only a small proportion of informal sector firms actually want to formalise. Thus, cost-effective interventions need to identify and target firms who wish to formalise but are discouraged from doing so by the associated costs.
Business training: Mixed evidence and promising interventions
Business training is a widely used tool to help microentrepreneurs in developing countries. The evidence on its impacts is mixed, with many studies failing to find significant impacts on revenues or profits (Karlan and Valdivia 2011, Drexler et al. 2014, Fiala 2018, Lafortune et al. 2018). In other contexts, studies have found that business training does increase long-term profits, survival, and/or growth (Blattman et al. 2016, McKenzie and Puerto 2017). In some cases, the null result can be explained by small sample sizes, which make it difficult to detect an effect (McKenzie and Woodruff 2014). Promising interventions focus on the psychological determinants of success, such as self-esteem and proactiveness, with add-ons to traditional training that offer mentorship, provide exposure to role models, or strengthen ties among self-employed individuals (Brooks et al. 2018, Campos et al. 2017, Field et al. 2016). This line of research might help explain the gender profit gap, given that in many societies, women expect fewer career opportunities than men.
Returns to capital and access to credit
Many studies have looked at the impacts of greater access to capital in the form of cash grants, loans, or in-kind transfers. Several studies that offered capital to small businesses have found large impacts on profits (McKenzie and Woodruff 2008, Blattman et al. 2014, Fiala 2018). Other studies that offered microcredit loans did not find a similarly large effect (Angelucci et al. 2015, Banerjee et al. 2015), possibly because the firms targeted in the cash grant studies tended to be larger and more established than the typical firms receiving microcredit loans. In addition, the term structure and other requirements of microcredit loans may discourage the sort of long-term investments that grant recipients undertook.
A stark pattern across several studies is that grants often improve business outcomes exclusively for male-run businesses. Recent work identifies one important reason: money given to female entrepreneurs is often not invested in their businesses, whether by their choice or not (Bernhardt et al. 2017, Friedson-Ridenour and Pierotti 2019). Thus, more work is needed to investigate whether grant and loan programmes can be redesigned to enable women to invest capital they receive in their businesses.
Barriers to hiring
Most microenterprises do not hire non-family employees. Potential barriers to hiring include incomplete information about non-family job applicants’ attributes, the need to invest in training new hires, and moral hazard leading to low productivity of non-family hires. There is evidence that monitoring technologies make non-family employees more careful on the job and less likely to under-report revenue, thereby increasing owners’ profits (Kelley et al. 2019). However, hiring frictions do not seem to be the binding constraint on expansion of most firms. For example, less than one-quarter of Sri Lankan microenterprises took advantage of a temporary wage subsidy for new employees, and though hiring a family member was not allowed, most firms that did so hired someone whom they knew (de Mel et al. 2019). As other frictions such as credit constraints are eased, labour market frictions could become increasingly important for understanding microenterprise expansion.
Microentrepreneurship by choice versus necessity
In the majority of cases, people become microentrepreneurs by necessity. Data on employment transitions in developing countries suggest that self-employment is something many workers engage in until they find paid employment (Donovan et al. 2019). There is also evidence that poor employment prospects, such as a low education level or a prolonged illness, can ‘push’ people into microentrepreneurship (Adhvaryu and Nyshadham 2017).
However, a subset of microentrepreneurs are highly talented individuals who chose entrepreneurship over paid employment, and have the potential to run highly profitable, fast-growing firms (Falco and Haywood 2016, Blattman and Dercon 2018). In many cases, their firm’s growth is limited by policy-fixable constraints, such as imperfect capital markets. Higher social and financial returns could be achieved by targeted lending to these types of microentrepreneurs.
Gender and entrepreneurship
Part of the gender gap in firm performance can be explained by challenges specific to women microentrepreneurs, such as commitments at home and difficulties in keeping business and family finances separate. For example, a sizable portion of grants given to female microentrepreneurs are spent on household expenses (Fafchamps et al. 2014), and a considerable proportion of women have to bring small children to work, which affects their management operations and ultimately lowers business profits (Delecourt and Fitzpatrick 2019). The family pressure to share income can decrease the likelihood of investing in one’s business (de Mel et al. 2009, Jakiela and Ozier 2016) and could partly explain why policy interventions targeted at women have often not had the desired effect. Policy solutions that can address frictions and power imbalances within households will therefore need to be more context-specific and subtle than current policies.
Highlights and wrapping up
Studying the effects of policy interventions targeted at microenterprises has shed some light on a couple of effective ways to support their growth, such as in-person assistance with formalisation procedures and financial aid in the form of grants. These interventions also highlighted the particular challenges that women-run microenterprises face, which partly explains the gender gap in firm performance. For example, in many societies, women have more modest expectations about career opportunities than men, and interventions that change these expectations by offering mentorship and access to role models have had promising results. Also, besides running a business, women microentrepreneurs typically have childcare commitments and manage the family’s finances, so the capital they receive is likely to be shared with family rather than invested in their business. A challenge for future interventions is finding appropriate ways to address the social and cultural norms of how power, roles, and responsibilities are distributed within households.
Author’s note: This column is based on a PEDL study. The author would like to thank Eileen Tipoe for her assistance in writing the column.
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