This paper reviews the recent economics literature on non-agricultural small-scale entrepreneurship (“microentrepreneurship”) in low-income countries. Microenterprises, defined as businesses with zero to four employees, are more prevalent in low-income countries than in high-income countries, and the vast majority have no employees besides the owner (the “microentrepreneur”).
Major themes in the literature include the determinants and consequences of joining the formal sector, the impacts of access to credit and other financial services, the impacts of business training, barriers to hiring, and the degree to which the poor become microentrepreneurs by necessity. The paper devotes special attention to unique issues that arise with female-owned microenterprises, and policy interventions that try to address these issues.
Formalization
Most microenterprises in developing countries are not formally registered with the government. While formalization would give firms greater access to capital and wider markets, the financial costs and red tape involved can be a major deterrent. Several studies have analyzed the impact of interventions that help with the formalization 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 and is therefore quite expensive, though only a small proportion of firms actually want to formalize. Thus, cost-effective interventions need to identify and target those firms who wish to formalize but are discouraged by the associated costs.
Business training
Business training is a widely used intervention 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. However, this literature often suffers from small sample sizes, which make it difficult to detect an effect. Promising interventions focus on the psychological determinants of success such as self-esteem, proactiveness, and aspirations, with add-ons to traditional training that offer mentorship, provide exposure to role models, or strengthen ties among self-employed individuals. This line of research might shed light on 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 impact of greater access to capital and credit. Several studies that offered capital to small businesses find large impacts on profits. Other studies that offered microcredit loans did not find a similarly large effect, 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. In light of this finding, more work is needed to investigate whether grant and loan programs can be redesigned to enable women to invest capital they receive in their businesses.
Other studies examine the impact of access to financial services other than credit. For example, in Kenya, where many people lack access to reliable ways to save, giving zero-interest bank accounts to microentrepreneurs increased savings and investment for women but not men.
Barriers to hiring
One part of the literature investigates why 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. However, these factors do not seem to be the binding constraint on expansion for most firms. For example, less than one-quarter of Sri Lankan microenterprises took advantage of a temporary wage subsidy for new employees, and most firms that did so hired someone whom they knew (hiring a family member was not allowed). As other frictions such as credit constraints are eased, labor market frictions could become increasingly important for understanding business expansion. In addition, given high youth unemployment in many developing countries, the effect of providing skills training and certification and re-calibrating employment expectations will continue to be important topics.
Microentrepreneurship by choice vs necessity
Microentrepreneurs can be categorized into two groups: those who start businesses because they value the perks of self-employment, and those who become microentrepreneurs by necessity. Data on employment transitions in developing countries suggests that self-employment is what many workers do until they find paid employment. There is also evidence that poor employment prospects, such as a low level of education or a prolonged illness, can “push” people into microentrepreneurship.
The other group of microentrepreneurs consists of highly talented individuals who chose entrepreneurship over paid employment, and have the potential to run highly profitable, fast growing firms. 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 microentrepreneurs.
Gender and entrepreneurship
Unlike in developed countries, women run the majority of microenterprises in developing countries. On many indicators, including sales, assets, and profits, female-run microenterprises underperform their male-run counterparts. Part of this gender gap in firm performance can be explained by the unique challenges that women face in running successful businesses, such as commitments at home and difficulties in keeping business and family finances separate. The policy solutions that can address frictions and power imbalances within households will likely need to be more context-specific than current policies.
