There are two contrasting views of the growth potential of microenterprises. One view is that small firms in the informal sector are a source of dynamism unburdened by the excessive regulations and other barriers to growth imposed on the formal sector. The informal sector can provide a testing ground for potential entrepreneurs, who try their luck at a small scale and don’t engage in formal institutions until they gain experience and learn about their ability. In the alternative view, the informal sector consists mainly of subsistence and low-productivity firms, which exploit the cost advantage from informality and discourage the growth of larger, more efficient formal firms. In practice it is an empirical question as to which view best describes the majority of firms operating in this sector. Our work will provide new data intended to help address this question at a microeconomic level, conditional on the given institutional and regulatory environments facing firms in the countries studied. Specific questions to be addressed include:
a) Are there high returns to capital among microenterprises? Is there an efficiency case for providing additional credit to this sector?
b) What are the ability characteristics of owners of microenterprise firms? How important is ability in determining the profitability of these small firms?
Returns to capital will be measured by means of randomized experiments in Sri Lanka and Mexico. In each country some firms are randomly given treatments of capital stock or cash for their business, while control groups receive nothing. The treatment will be used to generate an exogenous source of variation in capital stock, allowing the returns to capital in these microenterprises to be measured. Quarterly panel data on earnings and investment will also enable study of the dynamics of these firms. Detailed questions on the characteristics of firm owners will provide a richer understanding of the extent to which these small business owners are truly entrepreneurs.
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