The vast majority of microenterprises have no employees outside the owner’s family. One potential reason is information frictions combined with firing costs, whereby firms are unsure of a worker’s ability and may have legal difficulty firing unproductive workers. Carranza et al. (2019) find that providing workers a way to certify their skills to firms can increase youth employment rates in South Africa, with part of the mechanism being more information for the firms on the applicants’ skills. They find in their setting that risk aversion about hiring a worker with unknown skills is an especially salient concern for microentrepreneurs, who are also least able to afford the fixed cost of setting up a system to assess workers’ skills during the application process. Donovan et al. (2019) find that wages rise more sharply with tenure in developing countries than developed ones. They interpret this pattern as reflecting a selection effect: Firms have imperfect information at the time of hiring, and they shed lower-performing workers as these workers’ low ability becomes apparent to the firm.[1]
Bassi and Nansamba (2019) examine information frictions about workers’ soft skills in the job search and hiring process. They assess applicants’ soft skills and provide the assessment information to applicants and firms in Uganda. They find that doing so increases the low-but-not-lowest skill workers’ likelihood of being hired and also causes low-skill applicants to seek more training. These findings are consistent with both workers and firms having imperfect information about applicants’ skills.
In contrast, de Mel et al. (2019) do not find evidence that points to hiring frictions. They offer (male-owned) microenterprises in Sri Lanka a temporary wage subsidy that covers half the wage for a newly hired employee for six months (34 USD), plus an additional 17 USD for 2 extra months after that. At baseline 81% of firms have no employees.[2] The study finds 24% take-up of the wage subsidy, with 68% of these firms using it for six months or more. About half of the take-up is on the extensive margin: the likelihood of having at least one paid worker increased by 14 percentage points. Most of the hires were known to the business owner (though hiring a family member was not allowed). However, the effect on employment does not extend beyond the subsidy period, suggesting that the intervention was not overcoming a market imperfection but rather just temporarily transferring surplus to participating firms. The treatment increases firm survival by 8 percentage points after two years (from a baseline of 85%), presumably because of the extra surplus the owner received during the wage subsidy period. Conditional on the business still being in operation, treated firms do not have higher profits or sales at the two-year mark.
Alfonsi et al. (2017) highlight another barrier to hiring, which is that an employee’s productivity might be initially low, and a credit-constrained small firm might not be able to bear the initial period of losses during which wages exceed productivity. This study worked with a set of unemployed youth and a set of firms in Uganda. One of the interventions offered firms a wage subsidy to offer on-the-job training to new workers that the researchers matched to the firm. The study also had a treatment arm that instead offered workers vocational training. Many workers in the on-the-job training arm were not successfully matched to a firm and thus never received the training. Thus, from the workers’ perspective, being offered vocational training was most valuable in increasing skills and initial employment. Nonetheless, those in the on-the-job training arm also enjoyed an earnings boost compared to the control group. From the firms’ perspective, being matched to a worker for on-the-job training increased profits, primarily because the trained workers had a longer tenure on the job. Because on-the-job training is not as visible to outside firms as a credentialed vocational course and because it is firm-specific human capital, it offers the benefit of less competition for the workers from other firms. Firms trade off this benefit against the benefit of hiring already-trained workers, who have sector-specific but lack firm-specific skills, and for whom the firm faces more competition. This suggests that a firm with access to credit that can offer training can then keep more of the surplus due to having some monopsonistic power over that worker.
Another potential constraint on hiring is moral hazard. Non-family members may put in less effort and their performance on the job may be difficult to monitor. This issue is prominent in the development economics literature in the context of agriculture (Benjamin, 1992), but is likely also relevant in non-agricultural firms. A recent study by Kelley et al. (2019) offers an interesting case study of how new monitoring technologies can help firms. Privately-run matatus, or minibuses, are the cornerstone of the transportation system in Nairobi, Kenya. Owners of matatus employ drivers to operate the vehicles but are limited in their ability to monitor how much revenue the matatu driver takes in or whether he drives safely; unsafe driving puts passengers at risk and can increase car repair costs from wear-and-tear or accidents.
The intervention in Kelley et al. (2019) is a monitoring device installed in the matatu that tracks the matatu’s distance traveled, location, and vertical motion. The distance data allows the owner to “guesstimate” the number of trips completed and, hence, the amount of fare revenue collected. Data on location and vertical acceleration inform the owner if the driver has taken shortcuts on bumpy dirt roads that damage the vehicle.
Treated drivers engaged in less risky and off-route driving, and repair costs declined by almost a half. In addition, drivers increased their hours worked per day by about 10% and seemed to be less likely to under-report revenue. As a result, the owners’ profits increased. During the initial months, owners reprimanded drivers more often, but over time they also seemed to decrease the target revenue they set for the driver, which suggests that owners learned over time that they had been too distrustful of drivers, who were not shirking as much as they thought. Because drivers reduced the under-reported earnings and worked more hours, it is not clear that they benefited, however. As new technologies are developed, the topic of using technology to monitor employees studied by Kelley et al. (2019) is likely to be an active area of research. More work is needed on not just the efficiency gains from new technologies, but also on the distributional consequences, or how workers and firms share the efficiency gains.
Recap
Only a minority of businesses in developing countries have non-family employees. Studies have investigated various potential barriers to adding employees such as incomplete information about job applicants’ attributes, the need to invest in training new hires, and moral hazard leading to low productivity of hires. These factors do not seem to be the binding constraint on expansion for most firms. However, 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, providing skills training and certification and re-calibrating employment expectations are and will continue to be important topics from the perspective of the workers’ welfare. Finally, there is a gender angle to this topic that, to my knowledge, has not received extensive attention in the literature: being able to hire and delegate certain roles to an employee might be especially valuable to women micro-entrepreneurs because of the competing demands on their time from child care and household responsibilities.
[1] A paper similar in flavor examines how wages vary with age (rather than job tenure), and finds that the age-wage profile is less steep in developing than developed countries (Lagakos et al., 2018).
[2] The study also had two supplementary interventions, a savings account with matched deposits and business training.
