Abstract: Small and informal firms account for a large share of employment in developing countries. The rapid expansion of microfinance services is based on the belief that these firms have productive investment opportunities and can enjoy high returns to capital if given the opportunity. However, measuring the return to capital is complicated by unobserved factors such as entrepreneurial ability and demand shocks, which are likely to be correlated with capital stock. The authors use a randomized experiment to overcome this problem and to measure the return to capital for the average microenterprise in their sample, regardless of whether they apply for credit. They accomplish this by providing cash and equipment grants to small firms in Sri Lanka, and measuring the increase in profits arising from this exogenous (positive) shock to capital stock. After controlling for possible spillover effects, the authors find the average real return to capital to be 5.7 percent a month, substantially higher than the market interest rate. They then examine the heterogeneity of treatment effects to explore whether missing credit markets or missing insurance markets are the most likely cause of the high returns. Returns are found to vary with entrepreneurial ability and with measures of other sources of cash within the household, but not to vary with risk aversion or uncertainty.

Small and informal firms account for a large share of employment in developing countries. The rapid expansion of microfinance services is based on the belief that these firms have productive investment opportunities and can enjoy high returns to capital if given the opportunity. However, measuring the return to capital is complicated by unobserved factors such as entrepreneurial ability and demand shocks, which are likely to be correlated with capital stock. The authors use a randomized experiment to overcome this problem and to measure the return to capital for the average microenterprise in their sample, regardless of whether they apply for credit. They accomplish this by providing cash and equipment grants to small firms in Sri Lanka, and measuring the increase in profits arising from this exogenous (positive) shock to capital stock. After controlling for possible spillover effects, the authors find the average real return to capital to be 5.7 percent a month, substantially higher than the market interest rate. They then examine the heterogeneity of treatment effects to explore whether missing credit markets or missing insurance markets are the most likely cause of the high returns. Returns are found to vary with entrepreneurial ability and with measures of other sources of cash within the household, but not to vary with risk aversion or uncertainty.

The second issue in a new series, Global Financial Development Report 2014 takes a step back and re-examines financial inclusion from the perspective of new global datasets and new evidence. It builds on a critical mass of new research and operational work produced by World Bank Group staff as well as outside researchers and contributors.

For policymakers, economics is a useful tool in the development and evaluation of public policy. And like many sciences, economics is evolving to become more interdisciplinary in its approach. Today, economic theory is often used in conjunction with insights gleaned from psychology and sociology to create a more inclusive, real-world approach to implementing public policy. In this book, five award-winning economists tackle a diverse range of topics and show how applied economics has evolved to give policymakers a more nuanced approach to policy development. The award-winning economists included in this volume are Erica Field, Nancy Folbre, Avner Grief, David M. Kreps, and Michael J. Piore, and the topics they discuss include microfinance, human capital, societal institutions, worker motivation, and workplace regulation.

Studies of African economic development frequently focus on the daunting challenges the continent faces. From recurrent crises to ethnic conflicts and long-standing corruption, a raft of deep-rooted problems has led many to regard the continent as facing many hurdles to raise living standards. Yet Africa has made considerable progress in the past decade, with a GDP growth rate exceeding five percent in some regions. The African Successes series looks at recent improvements in living standards and other measures of development in many African countries with an eye toward identifying what shaped them and the extent to which lessons learned are transferable and can guide policy in other nations and at the international level. The third volume in the series, African Successes: Modernization and Development looks at the rise in private production in spite of difficult institutional and physical environments. The volume emphasizes the ways that technologies, including mobile phones, have made growth in some areas especially dynamic.

At roughly 4 percent per year, labor productivity in Tanzania has grown more rapidly over the past 14 years than at any other time in recent history. Employment growth has also been strong, keeping up with population growth at roughly 2.5 percent per year; the bulk of employment growth (90 percent) has been in the nonagricultural sector. However, the vast majority of this nonagricultural employment growth has occurred in informal sector. Using Tanzania’s first nationally representative survey of micro-, small-, and medium-sized enterprises, this paper shows that firms in the informal sector contributed roughly half a percentage point to economywide labor productivity growth in Tanzania between 2002 and 2012. However, virtually all of the labor productivity growth contributed by informal firms came from a small subset of firms called the “in-between firms.” This paper considers attributes of the in-between firms that could be used for targeting financial and business services to firms with the potential to grow. This paper finds two salient characteristics of in-between firms that might lend themselves to targeting—their owners are more likely to keep written accounts and more likely to keep their savings in formal bank accounts.

Abstract: Is the vast army of the self-employed in low income countries a source of employment generation? This paper uses data from surveys in Sri Lanka to compare the characteristics of own account workers (non-employers) with wage workers and with owners of larger firms. The authors use a rich set of measures of background, ability, and attitudes, including lottery experiments measuring risk attitudes. Consistent with the International Labor Organization's views of the self employed (represented by Tokman), the analysis finds that two-thirds to three-quarters of the own account workers have characteristics which are more like wage workers than larger firm owners. This suggests the majority of the own account workers are unlikely to become employers. Using a two and a half year panel of enterprises, the authors show that the minority of own account workers who are more like larger firm owners are more likely to expand by adding paid employees. The results suggest that finance is not the sole constraint to growth of microenterprises, and provides an explanation for the low rates of growth of enterprises supported by microlending.