Micro- and Small Enterprises in Developing Countries: Opportunities and Constraints

Dr. Lena Giesbert
German Ministry for Economic Cooperation and Development (BMZ)

Prof. Holger Görg, Ph.D., Kiel Institute for the World Economy

Prof. Dr. Michael Grimm, University of Passau



Research Questions
It is a well-documented fact that MSEs account for a large share of production, income and employmentin urban areas of low-income countries (LICs). Against this background the project investigates the following questions:

  • What is the role of behavioral factors, specifically risk aversion, time preferences, and overconfidence in determining MSE growth?
  • Can savings devices mitigate the effects of high discount rates and/or self-control problems on savings and investment decisions in MSEs? Can savings accounts serve as commitment devices?
  • How do MSEs innovate and adopt technologies and which are the implications for total factor productivity and investment decisions?

Contribution to International Research
An active recent empirical literature has considerably improved the understanding of the microeconomics of urban small-scale activities, which constitute the main source of livelihood of most the world’s urban poor. Yet, the empirical puzzle of high marginal returns to capital at low capital stocks in MSEs remains largely unresolved. In particular the role of own savings, or rather the lack of it, is not well understood. It is, for example, still unclear which features of specific savings devices are most effective in addressingdifferent constraints to save. In addition, neither the determinants of productivity in MSEs nor the role of (perceived) firm productivity for investment decisions has been thoroughly analysed. Saving and investmentdecisions strongly depend on behavioural factors such as attitudes towards risks, overconfidence, and locus of control. We investigate the relative relevance of these behavioural constraints for firm performance. Finally, it is particular uncomforting that most of the above findings rely on the empirical analysis of short-term relationships due to the lack of long-term panel data of MSEs.

Research Design and Methods
We study MSE behaviour using state-of-the-art microeconometric methods. This includes in particular differences-in-differences and instrumental variable specifications, as common in the impact evaluation literature. The quantitative analyses will be informed by own survey data from Sri Lanka and Uganda. In both countries, a first survey was conducted in 2012 and a second wave was fielded in 2013. Funding for a third wave in both countries is being sought. While panel data on MSEs is very scarce, our data has another unique feature, as it combines firm surveys with lab experiments on risk and time preferences, and, in 2013, on overconfidence. The similar survey designs will allow for cross-country comparisons.

Preliminary Results
Three main insights have emerged from our research to date: (1) The typical informal MSE should not be considered a subsistence enterprise. This is evident from the very high marginal returns to capital that can be earned in these enterprises. The fact that relatively rich economies, for example, Peru, still exhibit high shares of informal employment places a big question mark behind those entrepreneurial activitiesthat are perceived as comprising the subsistence sector. It can hardly be argued that 70 per cent of Peru’s labour force pursue subsistence activities. Rather, an important share of MSEs, even in poor economies, for example in the Sahel zone, can be considered "constrained gazelles". (2) High returns in microenterprises remain unexploited due to a number of economic, institutional, and social constraints. While credit constraints are found to be a key constraint for MSEs, specific sectors are heavily constrained by access to public utilities. In addition, forced solidarity, i.e. social constraints, can also partly explain the lack of investmentin MSEs. (3) These altered perspectives on the informal sector have important policy implications.From a policy perspective, these findings may accordingly be taken as an argument for providing households with credit, savings devices, and insurance. Savings devices and insurance would also enable households to insure themselves against business and non-business risks, thus channeling savings into productive investment instead of withholding liquidity for insurance purposes.