The project empirically analyses the performance and dynamics of urban micro and small enterprises [MSEs] and studies specific risks and constraints that these enterprises face.
The project takes a vulnerability perspective on firm performance and focuses on the lack of productivity improvements and innovation in MSEs. Risks associated with innovation are likely to be a major constraint preventing MSEs from growing and improving productivity, thereby potentially causing income poverty traps for individuals, groups, and, eventually, entire economies. MSEs are the main source of employment in many developing countries, which underscores the importance of better understanding their performance. Against this backdrop, the project investigates the following questions:
- How dynamic are MSEs over time, and which firm and owner characteristics determine firm dynamics? How vulnerable are MSE owners to not earning a living income either permanently or temporarily?
- How do MSEs innovate and adopt technologies and what are the implications for total factor productivity and investment decisions? Can entrepreneurial performance be improved by increasing customer loyalty?
- What is the role of savings for investment and entrepreneurial performance, and to what extent can individual feedback influence saving behaviour?
The first two sets of questions are analysed in the context of the project “Risk, Investment, and Poverty: Dynamics of Micro and Small Firms in Developing Countries”, in a collaborative effort with the University of Göttingen. The third set of questions is analysed in cooperation with the German Institute for Economic Research (DIW Berlin).
Contribution to International Research
Recent empirical work on MSEs has shown that marginal returns to capital stocks in MSEs can be high initially; yet, they also tend to decline rapidly with higher capital stocks. This might indicate capital scarcity driving high marginal returns initially, but evidence from a number of randomised cash transfers suggests that it is not the only factor. We thus consider the role of other major contributors. For one, the stagnation of many MSEs may also be caused by low productivity and the lack of innovation. There is, however, hardly any empirical literature that examines innovation and technology adoption in urban MSEs in low income countries and the project intends to fill this gap. Secondly, one of the main reasons for the lack of innovation and, indeed, any major capital investment may be the risk associated with doing so. While entrepreneurial risk attitudes have received a fair amount of attention in the empirical literature, less is known about the effects of risk on performance. The project offers new perspectives on this issue by analysing entrepreneurs’ vulnerability, which in turn can constitute a major obstacle to investment. Third, part of the reason why retained earnings are not re-invested is simply that entrepreneurs do not manage to save enough. Our project contributes to an improved knowledge of strategies to combat this problem.
Research Design and Methods
We study MSE performance using state-of-the-art micro-econometric methods. This includes in particular differences-in-differences and instrumental variable specifications, as common in the impact evaluation literature. The quantitative analyses are informed by own panel survey data from Uganda. The first wave sampled 450 MSEs and was implemented in 2012. Five consecutive survey rounds were implemented in 2013-2017. During the project, the survey will be extended to a total of seven annual waves with changing foci, but a consistent core questionnaire. While panel data on MSEs is very scarce, our data has another unique feature, as it combines firm surveys with lab-in-the-field experiments on risk and time preferences and overconfidence, as well as randomised experiments on cash transfers, financial literacy, and technology use.
This project builds upon the previous project on “Micro- and Small Enterprises in Developing Countries: Opportunities and Constraints”. 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. 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 investment in MSEs. (3) The role of behavioural constraints is not yet well understood. First results suggest that risk and risk aversion can be important obstacles to capital accumulation.