|POLICY RESEARCH WORKING PAPER 1999

# Summ.rary findings

A long tradition sees the smail firm sector as a holding pattern for workers queuing for jobs in the formal sector of a segmented labor market. An alternative "entrepreneurial" view suggests that many workers prefer self-employment to salaried jobs. These competing views can be resolved if the sector is heterogenous.

Using factor and cluster analysis, Cunningham and Maloney generate a typology of the sector by taking advantage of a Mexican data set on micro-firms that offers information on a broad range of small firm characteristics. The methodology permits divisions to emerge from the data without the a priori imposition of a theoretical structure.

The data break into several distinct groups, broadly characterized as highly profitable and dynamic young firms, older firms that have stabilized at a small size, and young firms that act as an employer of last resort. Those in the last group, comprised of older entrepreneurs with low levels of education, are the most likely to cite that they started their firms because they were unable to find a salaried job.

In general most of the firm owners in all groups stated that they chose self-employment over formal sector employrment in order to be independent, collect higher earnings, or follow family tradition. These survey responses are supported by the finding that income distribution adjusted for human capital is composed of two subdistributions, with the "underperforming" distribution comprising only 14 percent of the sample.

The factor analysis also implies that firm owner characteristics and firm size or profitability may not be correlated. For example, young workers who we might think are forced into the small firm sector due to inability to enter the formal job market do not necessarily earn less or have less capital than older entrepreneurs. Furthermore, a distribution of the earnings residual factor shows that very few firms, regardless of the firm owner's age, are earning below their expected profits.

The data suggest that the small size of informal firms may not necessarily result from limited access to financial institutions or a desire to evade labor or tax laws. Instead, the firms simply may be in the beginning stages of a growth process or owners may prefer to remain small.

This paper is a product of the Poverty Reduction and Economic Management Sector Unit, Latin America and the Caribbean Region. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contactTania Gomez, room 18-102, telephone 202-473-2127, fax 202-522-2119, Internet address tgomez@worldbank.org. William Maloney may he contacted at wmaloney@worldbank.org. October 1998. (42 pages) _The Policy Research Working Paper Series dissemiinates the findings of work in progress to necourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than folly polished. The papers carry the names of the authors and should he cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent._ Produced by the Policy Research Dissemination Center