Southern Africa Labour and Development Research Unit

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1 Southern Africa Labour and Development Reearch Unit Entrepreneurhip and the Buine Environment in Africa: An Application to Ethiopia by Zuzana Brixiová and Mthuli Ncube Working Paper Serie Number 146

2 About the Author() and Acknowledgment Zuzana Brixiová: African Development Bank, IZA and Reearch Affiliate, SALDRU, Univerity of Cape Town Mthuli Ncube: Univerity of Oxford Acknowledgement The author thank Emerta Aaminew and Andrea Wörgötter for comment. Special thank go alo to Zorobabel Bicaba for help with the regreion tet. Thi paper i an updated and ubtantially expanded verion of the IZA Dicuion Paper No and the William Davidon Intitute Working Paper No The view expreed are thoe of the author and do not necearily reflect thoe of the African Development Bank. Recommended citation Brixiová, Z., Ncube, M., (2015). Entrepreneurhip and the Buine Environment in Africa: An Application to Ethiopia. A Southern Africa Labour and Development Reearch Unit Working Paper Number 146. Cape Town: SALDRU, Univerity of Cape Town ISBN: Southern Africa Labour and Development Reearch Unit, UCT, 2015 Working Paper can be downloaded in Adobe Acrobat format from Printed copie of Working Paper are available for R20.00 each plu vat and potage charge. Correponding addre: z.brixiova@afdb.org. Order may be directed to: The Adminitrative Officer, SALDRU, Univerity of Cape Town, Private Bag, Rondeboch, 7701, Tel: (021) , ax: (021) , brenda.adam@uct.ac.za

3 Entrepreneurhip and the Buine Environment in Africa: An Application to Ethiopia Zuzana Brixiová and Mthuli Ncube 1 SALDRU Working Paper Number 146 Univerity of Cape Town May 2015 Abtract Policymaker in developing countrie have recognized that productive entrepreneurhip can help eliminate extreme poverty. Thi paper develop a earch model of cotly entrepreneurial tart-up under a contraining buine environment and kill gap, where one of the equilibrium outcome i a low-productivity trap. The model reflect tylized fact from the urban labor market in low income countrie uch a Ethiopia where low rate of productive entrepreneurhip coexit with high output growth in ome ector. Creating an enabling buine environment could help move the economy into the high-productivity equilibrium if the regulatory improvement are ubtantial and other bottleneck uch a kill gap addreed. We tet the role of the buine environment in entrepreneurial ale on data from a recent World Bank urvey of enterprie in Addi Ababa. Key word: Model of tart-up, productivity, multiple equilibria, low income countrie, Africa JEL claification: L26, J24, J48, O17 1 The author thank Emerta Aaminew and Andrea Wörgötter for comment. Special thank go alo to Zorobabel Bicaba for help with the regreion tet. Thi paper i an updated and ubtantially expanded verion of the IZA Dicuion Paper No and the William Davidon Intitute Working Paper No The view expreed are thoe of the author and do not necearily reflect thoe of the African Development Bank. Correponding addre: z.brixiova@afdb.org.

4 1. Introduction Policymaker in low income countrie (LIC) have long recognized the private ector, and productive entrepreneurhip in particular, to be a key part of their agenda to eliminate extreme poverty. 2 Still, contribution of productive entrepreneurhip to growth and employment ha been limited, epecially in LIC where the productive, high value-added type ha been motly miing. One of the reaon ha been lower competitivene in a number of African countrie, temming in part from an overall weaker buine environment and larger human capital gap than in other region. Raiing competitivene through improving the buine environment a well a training and education i thu a top policy priority for the LIC in Africa and other developing region. Thi paper develop a model of cotly entrepreneurial tart-up in an economy with a rigid buine environment, kill gap, and a large informal ector. It contribute to cloing a gap in the entrepreneurhip and development literature, which conit motly of empirical tudie and urvey, but analytical underpinning have been carce. The model extend the framework of Brixiová (2013) and applie it to Ethiopia. It build on Snower (1996) who howed that labor market failure, including imperfect information, lead to uboptimal outcome in developed countrie. Such failure are even more prevalent in LIC where the buine environment i till weak, kill gap prevalent, and the labor market intitution underdeveloped. The paper focue on highly-productive tart-up, a their abence contrain utained growth and job creation in LIC uch a Ethiopia. It develop a model where under a weak buine environment and kill gap the economy can end up in a low-productivity trap, with the informal ector accounting for mot of the private ector output and employment. The model reflect key tylized fact of the labor market in Ethiopia and other LIC. The emphai on firm creation and the informal ector, which characterize LIC, ditinguihe thi framework from Snower (1996) who analyzed vacancie in exiting firm in the formal ector in advanced economie. In um, the model in thi paper focue on tart-up of highly-productive private firm in the formal ector, a their abence contrain utained productivity and job growth in Ethiopia and other LIC. We examine policie that could move the economy into a highly productive equilibrium. Under convex cot of tarting a buine, ubtantial improvement to the buine environment need to be made for a marked impact on firm creation and moving the economy out of the low-productivity trap. urther, improvement in educational attainment of both worker and entrepreneur have a poitive impact on firm performance. We tet the role of the buine environment and entrepreneur education for entrepreneurial performance on recent data from the World Bank Enterprie Survey of Ethiopia. The paper i organized a follow. After thi Introduction, Section 2 give tylized fact on entrepreneurhip and the urban labor market in Ethiopia. Section 3 preent the model and policy analyi. Section 4 tet the reult of the model on data from the World Bank Enterprie Survey of Ethiopia, in particular Addi Ababa in Section 5 conclude. 2 Thi recognition ha been alo reflected in the academic literature. Example of article that view entrepreneurhip a a poible part of olution to poverty include Anderon et al. (2010), Brixiová (2010), Bruton (2010), McKague and Oliver (2012), Bandiera et al. (2013), Bruton et al. (2013) and Tobbia et al. (2013), among other. 2

5 2. The Stylized act Even after departure from the central planning ytem, Ethiopia economy exhibit unique feature. The predominant role of the tate ector in the non-agricultural output, low creation of productive job in the private ector, and high unemployment make it akin to an early-tage tranition economy. At the ame time, Ethiopia i till among the pooret countrie in the world, with: (i) a large informal ector and high hare of agriculture in output and employment; (ii) pervaive labor market friction, including imperfect information; (iii) a contraining buine environment and (iv) relatively low educational attainment. The ection below highlight main tylized fact about the country entrepreneurhip and the urban labor market High Growth, Low Labor Productivity At an average annual growth of 10.6 percent, Ethiopia wa one of the fatet growing countrie in Sub-Saharan Africa (SSA) and globally during However, growth wa driven motly by the modernization of agriculture (which account for 80 percent of employment), commodity boom, public invetment, and with the exception of financial intermediation the expanion of low valueadded ervice (Geiger and Moller, 2013). or the mot part, the performance of the manufacturing ector and high-value added ervice remained ubdued. The tructural compoition of Ethiopia output, reliance of it economic performance on public invetment, and the burden it ha put on it public finance have raied doubt about growth utainability. 4 To achieve high and utained growth, the private ector, including productive entrepreneurhip and the export ector, will need to play a greater role (World Bank, 2014a). Table 1. Labor Productivity in Ethiopia and Selected Countrie (2005) Average Sector with highet prod. Sector with lowet prod. Labor Country Productivity Sector Prod. Sector Prod. (2000 PPP $) South Africa 35,760 pu 91,210 con 10,558 Mauritiu 35,381 pu 137,203 agr 24,795 Nigeria 4,926 min 866,646 cpg 264 Kenya 3,707 pu 73,937 wrt 1,601 Ethiopia 2,287 fireb 76,016 agr 1,329 China 9,518 fireb 105,832 agr 2,594 India 7,700 pu 47,572 agr 2,510 Source: McMillan and Rodrik (2011). Note: agr Agriculture, hunting, foretry and fihing; min Mining and quarrying; man Manufacturing; pu Public utilitie; con Contruction; wrt Wholeale and retail trade, hotel and retaurant; tc Tranport, torage and communication; fireb inance, inurance, real etate and buine ervice; cpg Community, ocial, peronal and government ervice. 3 Thi paper focue on urban labor market. Utilizing data from outhern Ethiopia, Kimhi (2010) how that encouraging rural entrepreneurhip may be favorable for both income growth and ditribution. 4 Public invetment accounted for mot of the growth recorded ince mid-2000, and pecifically for 2/3 in 2011/2012 (IM, 2012, and Geiger and Moller, 2013). 4 Ethiopia purue a public ector-led growth trategy that focue on promoting growth through high public invetment (IM, 2012, page 4). 3

6 Ethiopia productivity level have remained low. Wide productivity gap with Eat Aian economie and ome African frontier market perit (Table 1). The overall low productivity i in part explained by the ectoral ditribution of employment. Agriculture, which ha the lowet productivity level, account for 78 percent of employment (Martin, 2014). 2.2 Limited Private Sector and Entrepreneurial Activity The Ethiopian private ector ha evolved in tage. 5 irt, central planning of the Derg regime during dicouraged private ector activitie. In contrat, the ubequent government favored implementing market reform, to cut red tape and encourage growth of the private ector (Geda and Degefe, 2002). Two decade later, productive entrepreneurhip bloom in ome ector (leather, flower), but i overall limited. SME are typically mall, low-productivity firm, operating in ervice uch a trade. 6 The tate-owned enterprie prevail in the economy, alo becaue key ector uch a banking or telecom are not open to foreign invetment. The Global Entrepreneurhip Monitor 2013 tudy found that Ethiopia ha one of the lowet rate of entrepreneurial activity in SSA, including among the low-income economie. Only 15 percent of the adult (18 to 64) were tarting new firm or running a new buine (le than 3.5 year old) in 2012, compared to the average of 28 percent for countrie in the region. urther, in Ethiopia, 10 percent of adult were running etablihed buinee relative to the regional average of 13 percent. Only 24 percent of adult reported that they intended to create a firm, which i le than half of the region average of 53 percent (Table 2). Thi i conitent with the obervation that about 50 large and medium-ized firm play a key role in the economy (Sutton and Kellow, 2010). Table 2. Entrepreneurial Activity in Selected LIC, 2012 Entrepreneur (% of working age population) Nacent New Etablihed Ethiopia Ghana Malawi Nigeria Uganda Zambia Source: Herrington and Kelley, Note: Since 2010, Ghana ha been claified a a middle income country. Similarly to other LIC, the informal ector account for a large hare percent - of the economy, namely urban employment. The informal ector conit motly of low-productive (e.g., competitive and largely undifferentiated) SME, motly in trade. Some highly productive SME alo operate there, in particular mall-cale manufacturing firm. Thi more dynamic tier, amounting to about 20 percent of the informal ector, alo employ more killed worker. The informal ector in Ethiopia i thu dualitic (World Bank, 2007b). 5 The private ector include all agent in the economy not formally claified a in the public ector that i agent involved in the government, tate-owned enterprie or paratatal, and independent public agencie. 6 The leather indutry i one of the exception. In the early 2000, leather-how indutry ha gained a hare in the dometic market, with it growth being driven by new entrant and expanion of incumbent (Sonobe et al., 2009). 4

7 2.3 Contraining Buine Environment The lack of an enabling buine environment that i intitution and policie that affect firm entry, urvival, growth and exit have contributed to the uppreed private ector. A Lopez-Garcia (2009) note, the two main barrier to firm creation tend to be the adminitrative burden related to tarting a buine and acce to finance, while the government interference and taxe impact the expected profit and firm urvival. Thee are alo the main barrier in Ethiopia. 7 Table 3. Indicator of Starting a Buine: Ethiopia and Other African LIC Average Ethiopia EAC Rwanda Madagacar Rank (out of 184) Procedure (#) Time (day) Cot (% of income per capita) Min. Capital (% of income per capita) Source: Author calculation baed on World Bank Doing Buine The firm creation in Ethiopia ha been impeded by weaknee in the buine environment (Table 3). In the latet, 2015, World Bank Doing Buine report, Ethiopia ranked overall a #132 out of 189 countrie, a decline from #97 in Starting a Buine i challenging (ranking i #168), motly due to high tart-up cot and required minimum capital. It cot 89.3 percent of income per capita and require paid-in minimum capital of percent of income per capita to open a firm in Ethiopia. Subtantial regional difference prevail. or example, minimum capital required to tart a buine in Addi Ababa amount to 10 time GNI per capita. Another area of doing buine that would benefit for trengthening i regitering property, which i key for enuring formal property right, including land adminitration. It in turn impact formation of collateral and acce to finance. In 2015, Ethiopia ranked a number 104 out of 189 countrie (World Bank, 2014b). 2.4 High Unemployment, Skill Shortage and Mimatche The low entrepreneurial rate contribute to high unemployment, epecially in urban Ethiopia (igure 1), a the exit rate from the unemployment pool to the private ector have been low. A poible contributing factor to the low entrepreneurial rate and apiration i the overall low level of education, a the ucce rate and utainability of early-tage entrepreneur are poitively correlated with their educational attainment. The level of education, and entrepreneurial education, in Ethiopia i lagging other low income countrie in SSA (Table 4). Beide kill hortage, the labor market ha been alo characterized by mimatche between kill upplied by the educational ytem and thoe demanded by the private ector, a evidenced by high urban unemployment rate of young people with high chool and higher education (igure 1). 7 Thi paper conider the acce to finance a part of the broader buine environment. 8 The World Bank Doing Buine indicator, while widely ued, have received criticim a a meaure that would guide government reform prioritie. or example, Arrunada (2007) point out that the indicator focu only on cot on regulatory intitution and do not adequately capture the benefit including information they generate. 5

8 Moreover, 1/5 of vacancie in the early 2000 remained unfilled, due to the lack of killed worker or their unwillingne to relocate from the urban to the rural area (World Bank 2007a). igure 1. Total and Youth Unemployment Rate by Urban Center, youth unemployment rate (% of relevant L) Correl. Coef. = 0.82 Addi Ababa unemployment rate (% of L) Source: Central tatitical office and author calculation. 1/ Urban center have above 2000 inhabitant. Table 4. Entrepreneurial Education and Training in Ethiopia and Selected LIC ETH SSA av. GHA MLW NIG UGA ZAM Primary and econdary education: encourage creativity, elf-ufficiency and initiative give adequate attention to entrepreneurhip and new firm creation Univeritie provide good and adequate preparation for tarting up and growing new firm Buine and management education provide good and adequate preparation for tarting up and growing new firm Vocational and profeional education provide good and adequate preparation for tarting up and growing new firm Source: Herrington and Kelley (2013). Note: Anwer are expert opinion from urvey conducted by the Global Entrepreneurhip Monitor, meaured on an increaing cale from 0 (lowet core) to 5 (highet core). Note: Since 2010, Ghana ha been claified a a middle income country. 6

9 The kill hortage have been amplified by an ineffective matching proce where due to the lack of functioning labor market office killed worker are not aware of vacancie. In turn, employer poting the vacancie may not know about available killed worker. The employment exchange are rarely ued, a job eeker earch through relative, top by at work ite, or tart their own enterprie. In addition to job carcity, the declining vacancy-to-unemployment ratio poted by agencie may reflect the reduced trut of firm in agencie ervice (Denu et al, 2005). 3. The Model and Policy Analyi Thi ection develop a model illutrating the role of an enabling buine environment and kill for timulating productive entrepreneurhip. The model build on Brixiová (2013) and Snower (1996). It include the informal ector that contain both the elf-employed worker and low-productive firm, reflecting the ector dual nature. 9 Key friction in the model are cotly earch of entrepreneur for productive buine opportunitie and inefficiencie in matching earching entrepreneur and killed worker. The model illutrate how in thi framework (i) low-income economie uch a Ethiopia could end up in a low-productivity equilibrium and (ii) reform in the buine environment can help move the economy into a high productivity equilibrium. 3.1 The Environment The population i normalized to one. There are two type of agent, entrepreneur and worker, with population hare m and 1 m, repectively. They live for one period, are endowed with one unit of time and w amount of conumption good, and have preference, E(c), where c denote conumption good and E the expectation agent form at the beginning of the period. 10 Entrepreneur At the beginning of the period, entrepreneur earch for opportunitie to open productive firm in 2 the private ector. Thi earch cot them γ 1x + γ 2 x / 2, γ 1, γ 2 > 0, unit of the conumption good and reult in the probability x of finding a buine opportunity with productivity per worker z. They can turn a buine opportunity into a highly-productive firm by hiring n killed worker. Denoting m p a number of entrepreneur earching for killed worker, the matching of the aggregate killed vacancie, V = m n, with killed worker, N, follow: p h = Amin[ N ; V ] = Amin[ N ; m n p ] (1) where h i the total number of matche and A denote matching efficiency. Entrepreneur with a N high-productivity buine opportunity find killed worker with probability ρ = Amin[,1]. 11 V In (1) A < 1 to reflect imperfection in the matching proce. Thee can include tranportation 9 Brixiová and Égert (2012) examined the role of the buine environment in tranition economie. 10 Thi approach, where entrepreneur have rik-neutral preference, draw on Blanchflower and Owald (1998). 11 A Snower (1996) point out, when firm are imperfectly informed about the availability of killed worker, even kill that are ueful to all firm are not general ince not all firm have acce to thee worker. Such kill are alo not pecific ince more than one firm uually ha acce to a killed worker. 7

10 bottleneck or imperfect information where killed worker do not know about available vacancie and earching entrepreneur about earching worker. Labor market meaure that raie the matching efficiency include information diemination and, more generally, job earch upport, etablihment of a national job databae, and increaed quality of labor market placement office. Tranport infratructure and upply of affordable houing are alo important, a they help overcome regional mimatche by linking job and worker from different location. After finding a highly-productive buine opportunity and killed worker, entrepreneur pay tartup cot c (e.g. licening fee, etc.) and produce output according to (2). The output depend on the productivity level, z > 0, and the quality of the buine environment in the formal ector, β, 0 β irm in the formal ector pay profit tax τ and earn after-tax profit: π = ( 1 τ )( β z n w n c) (2) Where w i the wage of killed worker (in the formal ector), determined through bargaining. Entrepreneur who do not find highly-productive opportunitie or killed worker open lowproductivity firm in the informal ector, with productivity per worker of z u. The entrepreneur I productivity i further lowered by the buine climate factor in the informal ector β where I 0 < β < β < The entrepreneur employ unkilled worker, nu, where 0 < n u < n, that i firm in the informal ector are maller. Entrepreneur in the informal ector do not pay taxe, but are ubjected to tax monitoring and full confication for tax evaion. Their profit amount to: π u I = ( 1 φ)( β zunu wu n u ) (3) w u where i the wage of an unkilled worker in a low-productivity, informal firm, which equal the income, b, of the elf-employed in the informal ector, and φ i the probability that the firm tax evaion i detected by the tax authority. In um, z > zu > b > 0 are productivity level in highproductivity firm (in the formal ector), low-productivity firm (in the informal ector), and elfemployed, repectively. Worker When acquiring kill demanded in the highly productive private firm, worker incur cot, 2 k( q) = qq / 2 whereq > 0 i the cot parameter. Their effort reult in probability q of obtaining V kill 14 and probability x = Amin[,1] of finding a job in a highly productive firm. Worker who N do not obtain killed job work in the informal ector, either a elf-employed or in a low-productive firm. In both cae they earn income b <. w 12 More generally, β reflect quality of formal intitution. Amoro (2009) how empirically that difference in intitutional quality help explain difference in entrepreneurhip acro countrie. 13 Dethier at al. (2011) obervethat not only can better buine environment caue firm to be more efficient, but that alo that inherently more efficient firm chooe better buine environment. 14 x (and q) are between 0 and 1. Depite their effort, worker (entrepreneur) occaionally fail to acquire kill (find buine opportunitie). 8

11 While the market for unkilled worker i perfectly competitive, wage for the killed worker are et through decentralized bargaining between the killed worker and the productive private firm. If bargaining doe not lead to an agreement, the worker would receive income from elf-employment in the informal ector, b. The outcome of decentralized bargaining depend on the relative trength of the killed worker and the firm, α : w = α( b z π ) + (1 α b (4) u ) The wage gap between killed and unkilled job amount to α ( b z π b). The Labor Market Clearing Condition The characterization of the environment i completed by the labor market equilibrium condition. Denoting m u a the hare of entrepreneur running low-productivity firm and employ the unkilled worker, the market clearing condition for the entrepreneur i: m = m u + m p (5) Denoting n to be the total number of killed labor employed in the formal private ector, n u = munu the total unkilled labor in the informal ector, and a the total number of elfemployed in the informal ector, the labor market equilibrium condition for worker i: ni u 1 µ = n + n + n (6) u i 3.2 Multiple Equilibria An equilibrium in thi economy i defined a an allocation of entrepreneur and worker and wage rate uch that: (i) each entrepreneur chooe the effort x put into earch for buine opportunitie; (ii) each worker chooe effort q put into acquiring kill; (iii) wage rate i et through Nah bargaining a in (4); and (iv) labor market clearance condition are met. 15 In equilibrium, the marginal cot of entrepreneur earch for a buine opportunity equal the net profit a in Equation (7). Similarly, the worker marginal cot of acquiring kill equal the expected difference between a killed wage and alternative income, given by (8): 16 (1 m) q γ 1 + γ 2 x = ρ( π π u ) = Amin ;1 ( π π u ) mxn (7) mxn q q = x ( w b) = Amin ;1 ( w wu ) (1 ) q m (8) 15 It i traightforward to how that depending on the parameter, the model either ha (i) a unique lowproductivity equilibrium where worker and entrepreneur exert zero effort or (ii) one low productivity and one high productivity equilibrium with poitive effort by worker and entrepreneur. 16 In (7) and (8), the number of killed vacancie i V = mxn, where m p = mx i the hare of entrepreneur with productive buine opportunitie. Similarly, the hare of killed worker earching i N = ( 1 m)q. 9

12 and w pecified in Equation (4). Equation (7) and (8) can be obtained by olving entrepreneur and worker problem (Annex I), together with the labor market clearing condition (5) and (6). In (7), γ + γ x 0 denote the marginal cot of entrepreneurial earch. 1 2 The equilibria form at the interection of the entrepreneur earch curve a in (7) and worker training curve given by (8) and (4). The ytem decribed by (4), (7) and (8) can lead to two equilibria: (i) a low-productivity equilibrium, where entrepreneur exhort limited effort to tart firm and (ii) a high-productivity equilibrium with higher effort by entrepreneur. Low Productivity Equilibrium The firt equilibrium i the low productivity trap, where under a hortage of private firm, i.e. µ xn < ( 1 µ ) q the buine environment (i.e. tax rate, tart up cot, earch cot) i uch that π π u γ 1 / A. Equation (7) how that in uch environment where difference between in profit between running high and low productivity firm i mall, entrepreneur will not earch for highly productive buine opportunitie, i.e. x = 0. Equation (8) in turn how that worker will not acquire kill i.e. q = 0. The economy will thu conit only of low-productive firm and unkilled worker, both operating in the informal ector. 17 A Snower (1996) emphaized for the cae of developed countrie, when the economy i in a low-productivity equilibrium (or low-kill, bad-job trap ), the need for public timulu rie markedly relative to other equilibrium cae. High Productivity Equilibrium The econd, high productivity equilibrium, i above the low productivity trap and comprie both poitive entrepreneurial earch and worker learning effort (x, q>0). A pre-condition for reaching thi equilibrium i a buine environment conducive enough o that profit in the highly productive private firm employing killed worker ufficiently higher than thoe in productive firm with unkilled worker, i.e. π π u > 0. In thi equilibrium, the economy conit of both high productivity private firm in the formal ector, low productivity firm in the informal ector a well a elf-employed worker in the informal ector. 3.3 Policy Analyi In thi ection, we relate the key parameter of our model to evidence on the buine environment in Ethiopia and other low income countrie. A Ncube (2005) undercore, the type of education and the environment that individual are expoed to are critical for their entrepreneurial aptitude. In the Ethiopian public univeritie, entrepreneurhip i till in it early phae of development and concentrated motly in buine chool and agricultural college. Entrepreneurhip promotion center are alo carce. The country thu need to integrate entrepreneurhip in the curricula while etablihing center of entrepreneurial excellence (Gerba, 2012). 17 The econd cae i when the hare of killed worker i below that or ame a the hare of killed vacancie, u i.e. ( 1 µ ) q µxn. When w w = b, that i b u + b π z, unkilled worker will not have incentive to obtain training. The abence of the killed worker will remove incentive for entrepreneur to earch for buine opportunitie requiring killed worker. 10

13 During a tart-up phae, each entrepreneur earche for a buine opportunity. After a uitable opportunity i identified, the entrepreneur need to turn it into productive firm. At thi tage, they can be hampered by cumberome regitering and licening procedure, tringent hiring regulation, and the lack of killed worker, among other factor. The ability of the legal framework to protect property right i equally important, a it influence the expected profit and hence effort that entrepreneur put into earch. The entrepreneur alo conider the tate of the financial infratructure uch a development of capital market, control of corruption, and effectivene of the government during their tart-up phae (Ncube, 2005). Improving the Buine Environment Thi ection undercore the impact of improved buine environment on (i) entrepreneur earch for highly-productive buine opportunitie; and (ii) worker effort to acquire kill. It follow from (4), (7) and (8) that in the cae of hortage of killed vacancie, ( 1 µ ) q < µxn, a better buine environment (e.g. higher β and lower γ ) will encourage entrepreneur to intenify their earch effort (x) for productive buine opportunitie. Thi in turn, will incentivize unkilled worker to acquire kill. 18 A more intene earch by entrepreneur due to improved buine environment and the ubequent additional learning effort by worker will reult in a higher number of productive firm, increaed output, and additional productive employment. Reforming Property Right Unclear property right, which imply a poibility of expropriation (where β = 0 ), are an important component of the buine climate in many low income countrie. Denoting probability of expropriation a ψ, the efficiency coefficient in the production function change to β = ( 1 ψ ) β + ψ 0. Entrepreneur are more likely end up running low productivity firm in the informal ector, a the expected profit in the formal ector i reduced by the poibility of expropriation. The revere alo hold if improvement to property right are ufficiently large, entrepreneur who will increae their earch effort and more likely end up in the formal ector. Given two negative externalitie (earching and learning) that characterize the low-productivity trap, izeable intervention both on the ide of buine environment (generating labor demand) and training (improving quality of labor upply) are needed. The non-linearity in the earching and learning are key for prioritizing intervention. Specifically, policie hould firt target the mot ignificant contraint to the creation of productive firm. In ector or communitie with hortage of productive firm, policie hould focu on better buine environment to encourage entrepreneurial earch. In (ome high-tech) ector characterized by kill hortage, intervention encouraging training hould be prioritized. Since the binding contraint may be changing over time, complementary, and well-equenced, policie would be mot effective. π 18 π π More formally, from (2) > 0 and, < 0. rom (7) the entrepreneurial earch effort x β τ γ x x x become x = A( π π u ) / γ killed job are carce. Hence > 0 and, < 0. rom (8) then β γ τ q > 0. x 11

14 3.4 Illutrative Numerical Solution To illutrate the impact of policie uch a improved functioning of the labor market, A, and a better buine environment, β, a well a lower cot of earch for buine, γ, and reduced profit tax τ, thi ection provide a numerical example. The baeline parameter are et in Table 5; thee value were et to yield the hare of informal ector employment in total employment of 50 percent and of formal ector firm in total firm of 29 percent. 19 Table 5. Baeline Parameter Parameter A m φ q γ I β β α n b nu z z τ u Value The indicative elaticity of informal ector employment to change in each of the buine environment variable ( A, τ, γ, β ) i calculated by changing value of thee variable by 20 percent and computing the new informal employment rate: Table 6. Elaticitie of Key Outcome w.r.t. Change in the Buine Environment Variable New value New hare of formal firm New hare of informal employment Elaticity of informal and unkilled employment to 20 % change in variable % of total % change A τ γ β The reult in Table 6 confirm that improvement in the buine climate would raie number of highly-productive firm and high-killed/high-wage employment. In the example, the 20 percent improvement would lower low-killed/low-wage employment in the informal ector by 27 percent, with a correponding increae in employment in the formal ector. Another effective way of raiing productive, formal ector employment are improvement in the labor market functioning, including through proviion of information and reducing cot of job earch. A Table 6 illutrate, reduced cot of entrepreneurial earch would increae number of highly productive firm and killed employment (in either formal or informal ector). 19 Parameter are choen to match the limited available information. or example, the wage of unkilled worker in the informal ector amount to percent of the wage of the killed worker, and the wage gap between killed worker in the formal and informal ector. 2005, i 30 percent. 12

15 4. Empirical Evidence from Ethiopia Thi ection preent empirical reult from the World Bank Enterprie Survey of the urban Ethiopia (namely Addi Ababa in 2011). 20 It examine entrepreneurial performance baed on the actual and perceived buine environment a well a peronal characteritic uch a education. Key feature of micro- and mall enterprie The empirical analyi utilize the 2011 World Bank Enterprie Survey of Ethiopia, pecifically information on 150 enterprie in the manufacturing and ervice in Addi Ababa. or practical purpoe we identify entrepreneurhip with 117 micro (le than 5 employee) and mall (5 19 employee) enterprie. The ret are the medium (20 99 employee) and large (100 or more employee) enterprie. Thi ub-ection examine the difference in mean between thee two group of enterprie in term of performance, characteritic of the owner(), and characteritic of the enterprie (having a licene, an outtanding loan or financial tatement inpected by an auditor, among other). Reult are reported in Table 7. irt, difference in mean in peronal characteritic of owner and manager of micro and mall firm (with le than 20 employee) and medium and large firm (20+ employee) are preented. While that hare of women owner in micro/mall enterprie i lower than in large firm, the revere hold for the hare of women manager. Table 1 alo reveal that top manager in micromall firm have lower level of human capital both in term of education and year of experience than their counterpart in medium and large firm. Regarding the buine environment, the micro and mall enterprie encounter greater challenge w.r.t. power outage or finding time for innovative idea, but are under le control from tax or financial audit than larger enterprie. inally, medium and large enterprie markedly outperform mall and micro one in term of annual ale, while difference in labor and other cot are le pronounced. Kernel denity etimate of entrepreneurial ale The part below preent the kernel denity etimate of the probability denity etimate of probability denity function of (log of) annual ale for entrepreneurial firm (defined a micro and mall enterprie with le than 20 employee MSE). They examine if the buine environment impact poitively entrepreneurial performance, meaured by average annual ale. 20 The 2011 World Bank Enterprie Survey of Ethiopia conit of 150 enterprie in the manufacturing and ervice ector in Addi Ababa, of which 117 enterprie were micro (le than 5 employee) and mall (5 19 employee) enterprie and 33 medium (20 99 employee) and large (100 or more employee) enterprie. or empirical purpoe of thi paper entrepreneurhip i repreented by micro and mall firm, i.e. firm with le than 20 employee. 13

16 Table 7. Difference between micro/mall and other enterprie in Addi Ababa All enterprie Variable Micro/mall Medium/large SE and tat. ign employee 20+ employee (in % of enterprie, unle otherwie indicated) Peronal characteritic of owner() Gender (female) *** Nationality (Ethiopian) *** Peronal characteritic of top manager Experience in the ector (year) Education (higher) * Gender (female) ** Buine environment Monthly power outage (#) ** Applied for phone line * Time for new idea * Inpected by tax official *** Audited fin. tatement *** Outcome and cot Annual ale (Birr) 2,816,588 7,858,134 5,041,546* Annual labor cot (Birr) 122, , ** Source: Author calculation baed on the data of the 2012 World Bank Enterprie Survey of Ethiopia. Note: *, **, *** denote 10%, 5%, and 1% ignificance level, repectively. igure 2 preent reult for the ale ditribution by MSE with le than 20 employee according to the enterprie characteritic. igure 2a how that almot the entire probability denity function hift to the right for MSE operating under a government contract relative to thoe without uch contract. At higher ale range, regitered firm outperformed unregitered one (igure 2b). igure 2c and 2d examine the internal operating environment of the micro and mall firm. Enterprie which experienced power outage poted lower annual ale than firm without outage throughout mot of the ale range except the very low and high annual ale range (igure 2c). However, none of the entrepreneur reported that they have not experienced power outage reported very high ale, uggeting that other factor impact ale of the bet performing firm. 21 In contrat, firm with a webite achieved higher ale than firm without webite throughout the entire ale range (igure 2d). Thi can be in part due to ector difference (dicued below). Enterprie characteritic uch a education of the top manager or acce to loan alo impact performance. irm where the top manager had higher education outperformed firm with le educated manager for mot of the ale range, except the highet ale. irm where owner did not ue peronal loan for buine recorded higher ale than thoe that did (igure 2e and 2f). 21 An alternative explanation could be that firm with higher ale conume more electricity and hence are more likely experience power hortage. The iue can be examined in further reearch. 14

17 igure 2. Obtacle to operation, MSE characteritic and etimate of ale in Addi Ababa igure 2a. Type of contract Kernel denity etimate, by contract Denity logale kernel = epanechnikov, bandwidth = Under government contract Without government contract igure 2b. Regitration Kernel denity etimate of ale Denity logale kernel = epanechnikov, bandwidth = irm i regitered irm i not regitered 15

18 igure 2c. Power outage Kernel denity etimate of ale Denity logale kernel = epanechnikov, bandwidth = Experiencing power outage Not experiencing power outage igure 2d. Webite Kernel denity etimate of ale Denity logale kernel = epanechnikov, bandwidth = Enterprie with webite Enterprie without webite 16

19 igure 2e. Education of manager Kernel denity etimate, by education of manager Denity logale kernel = epanechnikov, bandwidth = Univerity education Le than univerity education igure 2f. Peronal loan financing Kernel denity etimate of ale Denity logale Peronal loan outtanding are currently ued for buine No peronal loan outtanding are currently ued for buine kernel = epanechnikov, bandwidth = Source: Author calculation baed on the World Bank Enterprie Survey of Ethiopia (Addi Ababa, 2011). Note: Enterprie with le than 20 employee are included in the graph. 17

20 igure 3. Perceived obtacle to operation and etimate of ale in Addi Ababa igure 3a. Tax adminitration Kernel denity etimate of ale Denity logale kernel = epanechnikov, bandwidth = Tax adminitration i an obtacle Tax adminitration i not an obtacle igure 3b. Acce to land Kernel denity etimate of ale Denity logale kernel = epanechnikov, bandwidth = Acce to land i an obtacle Acce to land i not an obtacle 18

21 igure 3c. Acce to finance Kernel denity etimate of ale Denity logale kernel = epanechnikov, bandwidth = Acce to finance i an obtacle Acce to finance i not an obtacle igure 3d. Acce to electricity Kernel denity etimate of ale Denity logale kernel = epanechnikov, bandwidth = Electricity i an obtacle Electricity i not an obtacle 19

22 igure 3e. Obtaining licene Kernel denity etimate of ale Denity logale kernel = epanechnikov, bandwidth = Getting licene i an obtacle Getting licene i not an obtacle igure 3f. Tax rate Kernel denity etimate of ale Denity logale kernel = epanechnikov, bandwidth = Tax rate i an obtacle Tax rate i not an obtacle Source: Author calculation baed on the World Bank Enterprie Survey of Ethiopia (Addi Ababa, 2011). Note: Only enterprie with le than 20 employee are included in the graph. Among variou buine environment impediment, more than one out of firm reported the acce to finance to be the mot eriou obtacle to their operation, followed by tax rate (one out five firm) a well a the availability of electricity and barrier to trade (almot one out of ten firm). igure 3 how the aociation between perception of MSE on obtacle and the actual ale. 20

23 irm that perceived factor in the buine environment uch a acce to land, electricity, finance and tax adminitration a an impediment to their operation typically poted lower ale than thoe who did not perceive uch obtacle (igure 3a 3d). The important exception are the highet ale range where firm noted obtacle but poted highet ale regardle. Other factor in the buine environment thu eem to be driving the bet performer. urther, obtaining the buine licene matter only at the very high ale range; in the lower range the ale are almot identical between firm that perceived getting licene a a challenge operation and thoe who did not (igure 3e). inally, and perhap not urpriingly, MSE that viewed tax rate a an obtacle to operation reached higher ale through mot of the ale range except it highet end (igure 3f). Reult of the OLS regreion etimation Thi ection tet if the enterprie characteritic or the buine environment remain ignificant for firm performance (e.g., ale) in a multivariate OLS regreion. The baeline model link the log of ale to characteritic of the firm uch a the year when the firm regitered, number of it employee, education of it worker and the top manager, gender of the manager, whether the firm work under the government contract and whether peronal loan of the owner are ued to fund buine. Sale are alo linked with the actual and perceived buine environment, uch a frequency of power outage, availability of credit. A one of the robutne check, we alo looked at the role of corruption, telecommunication and the combination of the two. The finding are that ale performance of micro and mall enterprie i poitively related to the ize of the firm (number of employee) and the level of education of it worker. or thee variable, the coefficient etimate are poitive and tatitically ignificant in the baeline model and the verion which tet whether corruption and inadequate telecommunication are perceived a an obtacle, weighted and un-weighted etimate (Table 8). Among the buine environment factor, ale are negatively aociated with the limited upply of credit and power outage. The ale performance i alo poitively correlated with the higher education of the owner (Table 8, Column 1 and 3). However, ince the ampling deign wa tratified, un-weighted etimate can be biaed, while the unbiaed etimate were not tatitically ignificant. 22 Coefficient for government contract are negative and tatitically ignificant under the weighted etimate (Column 2 and 4), pointing to negative aociation between thee contract and firm performance. irm that perceived both corruption and the lack of telecommunication ervice a an obtacle to operation reported lower ale than firm that perceived either only one or none of thee factor a an obtacle (Table 8). According to a recent World Bank report, telecommunication i a ector particularly challenged by corruption, due to the lack of accountability and it monopolization by the Ethiopian Telecommunication Corporation (Plummer, 2012). In Ethiopia, thee obervation bode for further improvement in the buine environment, epecially the infratructure (electricity) and acce to credit. Tackling the corruption in the telecommunication could alo facilitate entrepreneurial productivity. Other element and broader reform to create an enabling entrepreneurhip condition alo need to be in place. Thee include macroeconomic and political tability, acce to credit, and an educational ytem that would intill 22 The trata ued in the ample encompa three dimenion: region of the etablihment, indutry creener ector, creener ize. See Under tratified random ampling, un-weighted etimate are biaed unle ample ize are proportional to the ize of each tratum. Column 2 and 4 of Table 8 account for thi ampling iue by weighting individual obervation by the invere of the weight, accounting for the fact that the different enterprie have different chance of being included in the ample. 21

24 entrepreneurial attitude from early on. A hown in the model and empirical evidence, education program for entrepreneur and worker, together with improvement in the infratructure, credit and upport for entrepreneurial earch, are likely to timulate entrepreneurial tart-up. Table 8. irm performance and the buine environment in Addi Ababa (1) (2) (3) (4) Variable Year of formal regitration ** *** ** ** (0.0301) (0.0194) (0.0295) (0.0209) Number Of full-time employee 0.202** 0.441*** 0.174** 0.419*** (0.0855) (0.102) (0.0842) (0.117) Share by the larget owner() ( ) (0.0123) ( ) ( ) Experiencing power outage * * ** ** (0.554) (0.733) (0.606) (0.984) Univerity education-larget owner 1.199** ** (0.545) (1.332) (0.524) (1.455) Education a obtacle ** 0.645** (0.344) (0.239) (0.424) (0.255) Educated full time worker ** *** *** *** ( ) ( ) ( ) ( ) Top manager i female (=1) * * (0.718) (0.405) (0.744) (0.617) Outtanding peronal loan * 1.313** 0.745*** (0.600) (0.247) (0.598) (0.213) Supply of credit * *** ** *** (0.0190) (0.0144) (0.0187) (0.0160) Government contract * ** (0.598) (0.523) (0.595) (0.345) Corruption a an obtacle (0.761) (1.034) Telecommunication a an obtacle (0.675) (0.863) Corruption* telec ** * (1.095) (1.249) Contant 155.8** 127.3*** 162.8*** 112.4** (60.98) (39.40) (59.77) (42.62) Obervation R-quare Weight No Median cell weight No Normality tet (adj. Chi 2) Multicollinearity (Mean VI) Specification tet : p-value Predicted(Log(Sale)) [Predicted(Log(Sale))] Median cell weight Source: Author calculation baed on the World Bank Enterprie Survey of Ethiopia (Addi Ababa, 2011). Note: Enterprie with le than 20 employee are included in the graph. Note: VI tand for variance inflation factor. Robut tandard error in parenthee. *** p<0.01, ** p<0.05, * p<0.1 22

25 5. Concluion Thi paper firt preented everal tylized fact about Ethiopia growth, undercoring that the impreive rate may not be utainable unle the future growth i more broad-baed and private ector-led. High-value added entrepreneurhip in particular could play a greater role in raiing the economy output and productivity. Utilizing the World Bank Doing Buine Report, Global Entrepreneurhip Monitor Report and the World Bank 2011 Enterprie Survey of Ethiopia, among other ource, the paper alo documented ome of the main obtacle that Ethiopian entrepreneur face, epecially at the tart-up tage. Reflecting thee fact, we developed a model of entrepreneurial tart-up where an equilibrium outcome could be a low-kill, low-productivity trap. We howed that an improved buine environment could foter creation of high-productivity private firm, leading to increaed aggregate output and employment, provided that the improvement in the buine environment are ufficiently large and other key gap addreed. In Ethiopia, firm that perceived their buine environment to be without buine environment obtacle (land, credit, tax adminitration and electricity) outperformed their counterpart expoed to uch obtacle throughout mot of the ale range, except for the highet one. Thi indicate that factor other than the buine environment alone impact the firm performance and hould be tudied further. Higher education among worker and firm ize were alo found to impact poitively firm ale performance, while the preence of government contract would diminih it. In um, the empirical analyi illutrated the role of the buine environment, in particular infratructure/acce to electricity, acce to credit and reducing corruption in telecommunication ector, for fotering productive entrepreneurhip. Many African countrie would benefit from addreing the remaining obtacle to private ector activitie, uch a high cot of tarting a buine, weak property right, burdenome profit tax rate, untable tax regime, and limited acce to finance. In the cae of high-tech SME, kill hortage among entrepreneur and worker may need to be tackled to foter innovation and high value-added activitie. Stronger intitution, including buine ervice provider and thoe channeling information about buine and funding opportunitie would alo encourage productive entrepreneurhip. Thee and other contraint to entrepreneurhip in variou African region, countrie, and ector could be a topic for further reearch. 23

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28 outhern africa labour and development reearch unit The Southern Africa Labour and Development Reearch Unit (SALDRU) conduct reearch directed at improving the well-being of South Africa poor. It wa etablihed in Over the next two decade the unit reearch played a central role in documenting the human cot of apartheid. Key project from thi period included the arm Labour Conference (1976), the Economic of Health Care Conference (1978), and the Second Carnegie Enquiry into Poverty and Development in South Africa ( ). At the urging of the African National Congre, from SALDRU and the World Bank coordinated the Project for Statitic on Living Standard and Development (PSLSD). Thi project provide baeline data for the implementation of pot-apartheid ocio-economic policie through South Africa firt non-racial national ample urvey. In the pot-apartheid period, SALDRU ha continued to gather data and conduct reearch directed at informing and aeing anti-poverty policy. In line with it hitorical contribution, SALDRU reearcher continue to conduct reearch detailing changing pattern of well-being in South Africa and aeing the impact of government policy on the poor. Current reearch work fall into the following reearch theme: pot-apartheid poverty; employment and migration dynamic; family upport tructure in an era of rapid ocial change; public work and public infratructure programme, financial trategie of the poor; common property reource and the poor. Key urvey project include the Langeberg Integrated amily Survey (1999), the Khayelitha/Mitchell Plain Survey (2000), the ongoing Cape Area Panel Study (2001-) and the inancial Diarie Project. Level 3, School of Economic Building, Middle Campu, Univerity of Cape Town Private Bag, Rondeboch 7701, Cape Town, South Africa Tel: +27 (0) ax: +27 (0) Web: