Finance & PSD Impact JANUARY 2017 The Lessons from DECFP Impact Evaluations ISSUE 38 Our latest note examines whether labor market imperfections stop microenterprises from growing, using an experiment that provided wage subsidies to small firms to help them hire workers Are labor market imperfections the reason so few microenterprises hire workers? An experiment in Sri Lanka suggests they are not. Suresh de Mel, David McKenzie and Christoper Woodruff The majority of enterprises in many by men, only 11 percent had any paid developing countries have no paid workers. workers to begin with, and they averaged Previous work providing capital grants to US$130 per month in profits. Additional microenterprises has found long-term groups were given the wage subsidies impacts on firm profitability and survival, but together with business training or a savings that capital alone was insufficient to get these intervention to determine whether firms hiring workers. complementary interventions were needed Do labor market frictions prevent for firms to realize the benefits of wage more of these firm-owners from hiring subsidies. workers? In the presence of training costs, The study began in 2008 with a search and supervision costs, regulatory baseline survey, and then tracked the firms distortions, and other frictions, firm owners through 12 survey rounds through 2014, with the ability to grow may not hire workers, enabling us to measure the dynamics of even when doing so would be profitable in adjustment over a period of four years after the long-term. As a result, their firm size the subsidy ended. would be inefficiently small. Results Wage Subsidies to Microenterprises  Figure 1 shows the key result. 24% of We provided a temporary wage firms take the subsidy to hire a worker, subsidy to owners of microenterprises in Sri resulting in an increase in employment Lanka to encourage them to hire a new during the subsidy period. However, once worker. The subsidy was for approximately the subsidy ends, firms fire some half the cost of an unskilled worker, and workers, others quit, and there is no long- lasted six months, with an additional two term employment impact. months of subsidy at half this amount. If firms are constrained from hiring Figure 1. Dynamics of Adjustment to workers because it takes time to train them to Wage Subsidy become productive, or because it is costly to Proportion with a Paid Worker search for and identify good workers, or if it .4 takes firm owners time to learn their own Proportion with a paid worker entrepreneurial ability, then this short-term .3 subsidy could lead to long-term increases in firm employment. .2 Data and Experimental Design We work with a control group of 286 .1 2 4 6 8 10 12 microenterprises and wage subsidy treatment Survey Round group of 250 microenterprises in three urban Wage Subsidy Group Control Group areas of Sri Lanka. These firms were all run Do you have a project you want evaluated? DECRG-FP researchers are always looking for opportunities to work with colleagues in the Bank and IFC. If you would like to ask our experts for advice or to collaborate on an evaluation, contact us care of the Impact editor, David McKenzie (dmckenzie@worldbank.org)  The new firms induced to hire workers because of the subsidy are smaller and To what extent do these results generalize to less profitable than the firms in the other settings? We suspect that many control group that hire workers. The characteristics of this labor market hold in subsidy does appear to have provided most urban areas in developing countries. these firms with additional funds, which Workers remain unregistered and hiring is helps them survive: we find the subsidy generally unregulated. The work performed increases the likelihood of still running a by employees in small enterprises involves firm four years later by 5.8 percentage relatively more brawn and less creative points. energy. Employees are hired from local areas  We find no significant impacts of the and there is usually a low degree of subsidy on firm profitability and sales. separation between employer and employee The return to the additional labor appears before hiring. However, we do note that similar in magnitude to the subsidy generalized trust appears higher in Sri Lanka offered, suggesting additional workers than many other developing countries, bring no more value to the firm than their perhaps lowering one potential difficulty in unsubsidized labor cost. hiring a worker.  The effect is no larger when business training or a savings intervention are If capital grants and wage subsidies don’t provided, suggesting the lack of impact is cause firms to hire, what will? Our results not due to the lack of complementary are consistent with a Lucas (1978) model of skills. firm size, in which firms are small because  Detailed survey questions suggest that the productivity of the firms and firm owners can fill vacancies reasonably entrepreneurial ability of the owners is low. quickly, that it usually takes only a month This suggests four directions for policy: (i) to get the worker up to speed in the new from a social protection viewpoint, noting role, and that lack of access to capital that relieving capital constraints may increase does not seem to be the reason few firms the incomes of these owners, even if they are hiring. don’t go on to hire others; (ii) working towards ways to better identify the subset of Policy Implications firm owners who may have more capacity to Taken together, our results suggest grow; (iii) developing better ways of building that the labor market functions with modest entrepreneurial capacity given the mixed frictions for these firms, with hiring frictions results from business training; and (iv) not the main constraint to firm growth. This continuing with policies to help develop the then raises two issues for policy: growth of larger firms which can eventually hire these owners as wage workers. For further reading see: Suresh de Mel, David McKenzie, and Christopher Woodruff. (2016) “Labor Drops: Experimental Evidence on the Return to Additional Labor in Microenterprises.” World Bank Policy Research Working Paper no. 7924 Recent impact notes are available on our website: http://econ.worldbank.org/programs/finance/impact