Two better ways to improve outcomes of small businesses (in Togo and Nigeria)

Two recent and excellent studies offer some important insights into how best to help improve the outcomes of small business owners in developing countries. Both studies evaluate programs motivated by the perception that the traditional way business skills training programs operate could be improved. (For more on this idea, read McKenzie and Woodruff (2013).)

The first study compares two programs, implemented in Togo, against each other (and a comparison group). The “traditional training” simply teaches participants lessons in accounting, management, financial decision making, and marketing. The second training included insights from psychology and aims to not only teach business skills but also to instill a mindset of self-starting behavior and encouraging personal initiative. This strategy behind this second training program acknowledges that simply being trained with the necessary business skills is not sufficient in spurring high-growth small business growth. Entrepreneurship takes a particular penchant for risk, a market opportunity, and a little bit of luck — all things that are typically tough to come by in many developing countries. The impact evaluation of these programs, published in the journal Science, found that the psychology-based training program produced better outcomes compared to the traditional training program. Here a link to the World Bank write up of the study and the abstract of the full study:

Standard business training programs aim to boost the incomes of the millions of self-employed business owners in developing countries by teaching basic financial and marketing practices, yet the impacts of such programs are mixed. We tested whether a psychology-based personal initiative training approach, which teaches a proactive mindset and focuses on entrepreneurial behaviors, could have more success. A randomized controlled trial in Togo assigned microenterprise owners to a control group (n = 500), a leading business training program (n = 500), or a personal initiative training program (n = 500). Four follow-up surveys tracked outcomes for firms over 2 years and showed that personal initiative training increased firm profits by 30%, compared with a statistically insignificant 11% for traditional training. The training is cost-effective, paying for itself within 1 year.

In the second study, after a brief business skills training session, an organization in Nigeria funded a large-scale business plan competition. The winners of the competition, which included over 1,000 business owners from over 24,000 applicants, received a grant of about $50,000 on average. This study aims to answer the very basic but also provocative question, “what would happen if we just gave all the money used to organize and implement business training programs directly to entrepreneurs instead?”

Perhaps unsurprisingly, since I’m blogging about this study, the business plan contribution lead to very positive outcomes. Not only did firms that received a grant show more resiliency to economic ups and downs, but they also significantly expanded employment. A jaw-dropping stat comes from the American Economic Association write up: “Experimental winners were about twenty percentage points more likely to have ten or more workers than their counterparts — a result that is especially significant in Nigeria, where 99.6 percent of companies have fewer than ten employees”. Here is a link to the study, recently published in the American Economic Review, and the abstract:

Almost all firms in developing countries have fewer than ten workers, with a modal size of one. Are there potential high-growth entrepreneurs, and can public policy help identify them and facilitate their growth? A large-scale national business plan competition in Nigeria provides evidence on these questions. Random assignment of US$34 million in grants provided each winner with approximately US$50,000. Surveys tracking applicants over five years show that winning leads to greater firm entry, more survival, higher profits and sales, and higher employment, including increases of over 20 percentage points in the likelihood of a firm having ten or more workers.

Not only are these studies well-executed, but they provide accessible lessons for lots of people working hard to improve outcomes of small businesses around the world. The first study shows that there are potentially huge gains to be realized from experimenting and iterating with the content of business skills training curriculum. The second study shows that reimagining how governments and development donors spend money on small business development can also lead to much needed benefits.

Both of these lessons are important considering that these programs tend to be relatively expensive. For example from 2002 to 2012, the World Bank invested $9 billion dollars across 93 business skills training programs around the world. These studies imply this money could have been spent much better. The good news is we can learn from these studies and do better in the future.

Entrepreneurs Who Don’t Aspire to Grow Their Business

In David McKenzie’s most recent Weekly Links, he posted a link to an interview with Erik Hurst, who is an economist at the University of Chicago’s Booth School of Business. The interview spanned a wide range of topics including Erik’s work on income inequality, the decline of the US manufacturing industry, college attendance, and (what Erik calls) endogenous gentrification. The whole interview is fascinating to read, but I’d like to highlight one part of the interview that I find particularly interesting.

Question: Many people have an image of the typical entrepreneur in their head and it often includes a significant taste for risk and large long-term aspirations. What does your work on entrepreneurship suggest about that profile?

Erik Hurst: Most small businesses are plumbers and dry cleaners and local shopkeepers and house painters. These are great and important occupations, but empirically essentially none of them grow. They start small and stay small well into their life cycle. A plumber often starts out by himself and then hires just one or two people. And when you ask them if they want to be big over time, they say no. That’s not their ambition. This is important because a lot of our models assume businesses want to grow. Thinking most small businesses are like Google is not even close to being accurate. They are a tiny fraction.

My work with Ben Pugsley has been emphasizing the importance of nonpecuniary benefits to small-business formation. Because when you ask small-business people what their favorite part of their job is, it’s not making a lot of money. They do earn an income and they’re very happy with it, but they get even more satisfaction from being their own boss and having flexibility and all of those other nonpecuniary benefits that come with being the median entrepreneur in the United States.

In our culture we seem to want to subsidize small businesses because it’s the American dream. I think that could be fine, if you believe that there’s a friction out there preventing some small businesses from starting or growing. But you might want to target that friction directly as opposed to targeting all small businesses generically. Ben and I have a recent paper in which we show in a simple model that if you subsidize all small businesses, in a world with nonpecuniary benefits being the big driver of small-business entry, the policy is highly regressive. Why? High-wealth people are already small-business owners because they can afford the nonpecuniary benefits that come with owning a small business. So in that world, we’re basically just transferring money to high-wealth people when we subsidize small businesses overall, and that’s something we need to consider.

Excellent points, I think. I’ve been having discussions with some colleagues of mine about similar issues in developing countries. A lot of very popular international development policies aim to support entrepreneurship in developing countries (i.e. microcredit, business skills training, etc.). Unfortunately many of these programs often fail to pave a smooth and wide road out of poverty for the average household. One reason to explain this failure is that it seems many assume that everyone who owns a business is an entrepreneur who is risk-loving and aspires to grow and expand their business beyond it’s current level. This assumption breaks down in many developing countries (in similar ways to how Erik describes the breakdown in the US).

This has lead my colleagues and I to conclude that we many need a different word for, and a method for identifying, an “entrepreneur who doesn’t aspire to grow their business”. This sort of semantic and empirical innovation would have several interrelated benefits.

First, it would help policymakers better target certain policies and programs to individuals who would actually benefit from the program. Instead of rolling out a micro-loan product or a business skills training program to the population in general (which may lead to either diluted average effects or regressive benefits – as discussed above) programs could target specific individuals who actually aspire to grow and expand their business. Including everyone else will be wasteful because even if all the necessary external constraints are lifted (i.e. credit, skills, insurance, access to markets, etc.), these individuals may still not grow their business because they do not desire to do so.

Second, this innovation would also help empirical development economists who run experiments to estimate the impacts and cost-effectiveness of policies and programs. If it were possible to correctly diagnose development interventions that aim to support entrepreneurship and administer them only to those who are risk-loving and aspire to grow their business then, statistical tests would be much more accurate. As Bruce Wydick explains in a recent blog post on Diagnosis and Development Impact:

Suppose that a is the average treatment effect of an intervention on the properly diagnosed, e is the externality of the intervention to all others in the treatment group (with no externality to the control), and d is the percent of the treatment group that is diagnosed correctly.  In this case, the ITT is just the weighted average of these effects between the properly diagnosed and others (the misdiagnosed) and is ad + e(1 – d).  To estimate the ITT with 95% confidence and 80% power, the condition must hold that ad + e(1 – d) = 2.8SE , or that the percent correctly diagnosed must be equal to d = 2.8SE – e / a – e   (where 2.8 is the sum of corresponding z-scores of 1.96 and 0.84 and SE  is the standard error.)  Assuming a > e, first differentiation shows this yields a negative relationship between d and e; analysis of the second derivative shows the relationship to be concave, as shown in the figure [in this link].  This yields a continuous set of statistical power contours that illustrate the trade-off in ITT estimations between correct diagnosis and the strength of externalities within the pool of subjects exposed to the intervention.  Statistically speaking, the result is quite similar to the loss in statistical power one experiences with a treatment that is targeted at treatment group, but where very few people actually take up the treatment.

So, I’d say we need to think of a term for “entrepreneurs who don’t aspire to grow their business”. That is the first hurdle to jump. The second is to find ways to effectively diagnose risk aptitude and aspirations (or better yet hope for business growth). Some ideas come to mind – methods for estimating risk preferences are well established and I have a working paper currently out for review that makes some initial steps in validating a method for quantifying measures of hope and aspirations – but these methods need to be further investigated and tested.

HT: David McKenzie

Links I Like [6.14]

There was lots to like in the past month. The Economist highlighted some recent studies on the impact of microfinance. The consensus is still: it works, except when it doesn’t.
Cass Sunstein (of Nudge fame) wrote an essay on Albert Hirschman’s thoery of the “hiding hand”. This essay will be the introduction of a new edition of Hirschman’s essential Development Programs Observed.
There have been many excellent blog posts recently about the SAOS study on Fairtrade. (Fair-trade has never worked. Why is everyone so excited now?, Million Dollar Question: Does Fairtrade Work?, and What is Fair to Expect of Fairtrade?)
Arvind Subramanian, a Senior Fellow at the Center for Global Development, created an extensive reading list for understanding economic development.
Finally, Owen Barder (of “Development Drums” podcast fame), wrote an excellent blog piece on Google and the Trolley Problem. Basically, that philosophical hypothetical about a speeding trolley and the choice to do nothing and let five people die or take action and kill one person is no longer hypothetical.

All of these links I like, but there are three links I LOVE:

1. Why You Should Root for Nigeria (or Brazil, Mexico, or Ghana
Development economist, Dean Karlan made a quick and dirty formula for who you should root for in the World Cup if you hold strongly to utilitarian principles and global happiness.

2. Sinister Tips for Mission Trips
Bruce Wydick (the guy who did the evaluation on Compassion International’s child sponsorship program) has written a marvelous piece about summer mission trips in the style of C.S. Lewis’s Screwtape Letters. It is a great mix of satire and utmost sincerity. If only every development economist wrote like this…

3. Please Do Not Teach This Woman to Fish
Daniel Altman, professor of economics at New York University, wrote a harsh but clearheaded plea for all those who work with small-scale entrepreneurs in developing countries to rethink their strategy.

Finally, the picture of the month – from 40 Maps that Explain the Middle East I really enjoy these nighttime space images. Check out the light lining the Nile River!