The transition from Non-Employer to Employer Status in Low-Income Countries

University Of California-San Diego, La Jolla CA

Investigators

Abstract

The Transition from Non-Employer to Employer Status in Low-Income Countries SBE-SES 0820375: Woodruff The central feature of urban economies in low-income countries is the prevalence of small-scale businesses. Between a quarter and a third of workers are typically self-employed, most often working alone or hiring one or just a few employees. Economic growth depends on job creation by private sector enterprises. This project addresses the barriers to growth among the very large number of very small firms in a low-income country. Scientific evidence on the nature of the barriers is critical to developing policies to stimulate growth. Recent evidence from the United States and Europe indicates that only around one percent of non-employers create jobs (for others)in any given year. Data from a panel of 618 household enterprises gathered by the PI and collaborators suggests similar transition rates from non-employer to employer status in Sri Lanka. Between June 2005 and September 2007, the share of employers in the sample increased by 3 percentage points. However, because the number of non-employers is very large, the non-employers account for a substantial share of new job creation even though only a small percentage of them grow. Identifying the constraints to growth is challenging. In the absence of constraints, firms choose the level of capital, wage labor and manager training so that their marginal product equals the marginal cost. For example, firms will increase their capital stock until the return to capital equals the real interest rate (with risk premium) faced by the firm. Therefore the gap between marginal returns to capital and the market interest rate provides a measure of the extent to which capital constraints bind, preventing growth and perhaps job creation. However, the measurement of the returns to business inputs is complicated by the presence of unobserved characteristics of the owner and firm which affect both input use and output and profitability. For example, more able managers may invest in more capital. The project identifies the returns to capital, wage labor, and management training by randomly altering the price of capital, labor, and business training faced by firms. Altering the price provides exogenous variation at the firm level in the cost of different inputs, enabling identification of the returns to different factors of production, and measurement of the extent to which relaxation of constraints affects the growth of micro-enterprises. The project will provide a detailed and scientific assessment of programs to identify and stimulate high-growth micro-enterprises. Faced with limited budgets for programs aimed at job creation, governments and aid agencies need to focus efforts on those programs and enterprises that are most effective. The project is designed to provide guidance on this issue.