Negrete García, Ana Karen
Georg-August-Universität Göttingen & GIGA Hamburg
J.-Prof. Dr. Jann Lay
Doctoral Degree in Economics (Candidate)
[email protected]
Contribution of Mexican Micro and Small Enterprises (MSE)
to economic growth and poverty reduction
Mexico is the fifteenth largest nation and the thirteenth largest economy, but the eighty second in
terms of per capita GDP. It is a middle income country, but still a developing one with rooted
poverty, low productivity and financial problems (Castillo und Cartwright 2011). According to
CONEVAL´s cyphers, about fifty percent of the population has historically lived in extreme
poverty conditions and the inequality Gini coefficient is around 0.5 since 1950. The country also
has significant challenges with respect to infrastructure, human capital and environmental
conditions. According to Growth Theory, technological progress avoids economic stagnation and
generates a positive growth rate in the long run. For instance, the Solow Model (1956)1 shows that
technological progress is precisely the driving force of sustained economic growth because it keeps
the output per worker growing. Thus, given that such progress can be encouraged by investing in
Research and Development (R&D), this activity should be prioritized by countries to ensure their
economic growth in the long run. One implication is that physical investment does generate an
increase in GDP when the level of capital is too low, but it does not generate sustained growth 2.
Despite this, the error of seeing investment and not technological innovation as the factor that
triggers long-term growth is common.
Technological innovations imply an increase in productivity because they expand the
production possibilities frontier (PPF). In other words, they make feasible the production of more
output units with the same amount of inputs, or to increase the quality without increasing the price.
This phenomenon is reflected in lower costs, more competitive prices and increased economic
activity. At the end, what innovations should imply is a higher level of welfare or well being.
According to the World Bank (WB), in 2009 both the OECD and the East Asian countries were
1
Other theoretical models that emphasize the importance of R&D for economic growth are (Romer 1990), (Grossman und Helpman
1993), and (Aghion und Howitt 1992). They define innovation as an endogenous variable that enables cyclical patterns of growth.
Empirical analyses include (Griliches 1992) and (Sylwester 2001).
2
In the late forties the Harrod-Domar model became popular because the theory implied that the disadvantages of developing
countries could be solved if they got some lending to finance capital expenditures. What this model assumed was that the financing
gap, i.e. the difference between the required investment and domestic saving, was limiting economic growth. In 1957, Domar himself
recognized that his model was not applicable to analyze the rate of long-term growth while Solow´s model, which emphasized the
importance of technical progress, indeed was (Easterly 2001).
investing around 2.5% of their GDP in R&D. Meanwhile, the cypher for Mexico was 0.5%, which
is low both in absolute and relative terms. These numbers refer to both, private and public
investment, but when giving a closer look the economic challenge that the country faces becomes
more apparent. According to the Mexican Report of Science and Technology and the Economic
Census, in 2003 just 163 out of 2.9 million Micro, Small and Medium Enterprises (MSME)
reported pursuing activities related to technological innovations.
The problem here is that firms are precisely the basic economic unit of a country. Micro and
Small Enterprises (MSE)3 represent a major feature in the economic landscape of developing
countries. According to (Fajnzylber, Maloney, und Montes-Rojas 2009), microfirm owners and
their workers accounted for approximately 50% of the Latin American labor force during the last
decade. According to INEGI, in Mexico there are about 2.84 million firms and 97% of them are
MSME. As in many developing countries, these businesses are closely related to self-employment
and informality and their size varies little along time. Empirically, informality raises productivity
and efficiency concerns, and a large share of the World’s poor is self-employed. Since MSE
account for a large share of production, income and employment in developing countries, raising
their productivity is considered to be an important development goal across Governments and
International Organizations that aim at instrumenting policies that eliminate the impediments to
their dynamism.
The programs that fight poverty have been financed with State money and with international
development aid. However, countries are generally aiming to go beyond poverty reduction, and
include accelerated growth (and wealth creation). This twin objective without infringing pro-poor
aid conditionalities has created a new college of development (Agbeibor Jr 2006). Because MSME
offer sustainable business solutions that simultaneously fight poverty and accelerate economic
growth, they are now being seen as key determinants in the achievement of these goals. Gaining
insight in the dynamics of these firms might contribute to better policies that provide poor people
real opportunities to thrive by themselves. Moreover, there is some evidence that they might even
generate pro-poor economic growth (Agbeibor Jr 2006).
A stylized fact in this research area is the so called “Missing Middle” that shows the basic
observation that developed countries typically exhibit a lognormal firm size distribution while
developing ones rather present a large share of MSE, a considerable number of large firms and few
middle sized enterprises (Tybout 2000; Ayyagari, Beck, und Demirguc-Kunt 2007). Despite the
optimistic views on MSE, implementing a policy that fosters their growth implies having a larger
share of the population working in these firms. Actually targeting this as an objective for an
economy is rather debatable since more people engaged on them could be either a positive or
3
Microenterprises refer to firms that operate with 10 employees or less.
negative economic sign. For instance, it could mean that markets are working, and people are
finding opportunities to participate in ways that empower and include them. Or, on the contrary, it
could mean that the economy is failing to provide productive jobs and forcing people to refuge in
activities that provide minimal subsistence support (Liedholm 2002).
The Debate and the Two Main Research Lines
The evidence supporting the view of Micro and Small Enterprises as the engine of growth is in fact
not conclusive. Research findings, in both developed and developing countries, show that job
creation and growth are highly concentrated (Gomez 2008). When studying MSE two main broad
research interests can be identified. First, what constrains prevent informal entrepreneurs reaching
their full potential? Second, how much potential do MSE have to contribute to economic growth,
and employment creation? Research has mainly focused on the constraints that these firms face and
microcredit has gained a major share. However, the relationship between MSE and economic
growth demands further research and my research orientation is precisely this one. As (DemirgücKunt, Beck, und Honohan 2009) state in the World Bank’s Report, there is a lack of systematic
information about the impact that these enterprises have on economic development drivers.
First, the literature branch that focuses on constraints recognizes that successful
entrepreneurship development depends on sound business culture, education, skills and capital
availability, among others (Agbeibor Jr 2006). Regarding capital constraints, studies have found
that there is a relatively big share of microenterprises in developing countries that present high
marginal returns to capital (Fafchamps u. a. 2011; Kremer u. a. 2010; De Mel, McKenzie, und
Woodruff 2008; Mckenzie und Woodruff 2006). This empirical observation indicates constrained
productivity for lack of resources and provides evidence against a pure urban subsistence sector.
However, it has also been found that those initially high marginal returns decline rapidly with
higher capital stocks (Grimm, Krüger, und Lay 2011). Put differently, capital scarcity is indeed a
limitation for MSE, but the observed stagnation may be caused by low productivity and lack of
innovation. (Grimm, Knorringa, und Lay 2012) find evidence on the coexistence between
subsistence-type and potentially successful firms. That is, that MSE have growth potential and they
may indeed be turned into a key determinant of economic growth and poverty reduction.
Second, the literature that aims at understanding better the relationship between these firms
and economic growth, poverty reduction and distributional change is still developing. For instance,
the finding that subsistence-type firms coexist with potentially successful ones (Grimm, Knorringa,
und Lay 2012) is a relevant starting point. From this research line, SME are considered to possibly
play an important role in alleviating poverty and fostering growth. Thus, the implied policies are
more likely to be related with developing their potential as competitive job creators and increasing
their productivity (Agbeibor Jr 2006). Another example is Roxas (2007), who concluded that
MSME may be a precondition for sustainable development because they generate massive
employment, help diversify economic activity, and contribute significantly to local development in
developing economies. All in all, finding empirical evidence on which size category contributes
more to growth, contributory factors to firm graduation, dynamics of different firm sizes, and which
sectors promote pro-poor employment remain as research gaps.
Mexican Micro and Small Enterprises
The importance of MSME is acknowledged in Mexico and there is also scientific research that
provides some evidence on their current state and dynamics. However, a deeper understanding of
their relationship with economic growth requires further exploration. Heino (1999) finds that there
is substantial heterogeneity in the socioeconomic background of borrowers. He also finds liquidity
constraints and that the sources of start-up capital are heterogeneous. The experimental study of
(McKenzie und Woodruff 2008) provides evidence of very high returns in firms that report being
financially constrained. Thus, at least for these ME the high returns at low levels of capital are
caused by credit market imperfections. However, According to data from the National Survey of
Microenterprises (ENAMIN) of INEGI, the major problems that these firms face are not credit
constraints, but rather the market size, low demand and profits, competition and problems with the
authorities.
According to (Mckenzie und Woodruff 2006), Mexican microenterprises show high
marginal returns at low levels of capital and negligible barriers to entry and cots of entry. Thus, ME
owners may not be in a poverty trap, but rather have low saving rates and human capital.
Complementarily, (BenYishay und Pearlman 2010) show that, despite generating high returns to
capital, many microenterprises do not grow. Most microenterprises exhibit only small increases in
capital or labor and show limited upward profit trajectories. Also, the preliminary studies of
Huegerich (2009, 2010) find some evidence that, despite the high marginal returns, the reinvestment
rates are relatively low.
The analysis of (Fajnzylber, Maloney, und Rojas 2006) find that size and time in business
are negatively related to exit and growth. They also conclude that Mexican MEs show dynamic
patterns consistent theoretical literature on firm dynamics thus showing that developing-country
microenterprise should probably be viewed as they are in the advanced countries and thus some
policies might also be applicable on it. The study of Cunningham (2000). show that women and
men are very similar types of entrepreneurs, and thus, aid to entrepreneurs should target “types” of
entrepreneurs rather than gender. (Otero und Pagán 2003) find that the reason for which the owner
started the business is significant in explaining variations in the levels of technical efficiency.
(Barceló, Angulo, und Campos 2011) found that, firms that have employees present higher survival
rates relative to self employees of firms respective. (BenYishay und Pearlman 2010) find that
higher rates of property crime are associated with significantly lower probability that an enterprise
will be formally registered or plan to expand in the next 12 months. (Woodruff und Zenteno 2007)
find that investment in ME is positively associated with migration rates and migration is also
associated to greater use of unpaid labor in enterprises owned by females. Lastly, entrepreneurs
born in high migration regions in Mexico have higher earnings.
According to data from the ENOE survey, informal microenterprises employ about 28% of
the active labor population. The estimations may vary slightly among studies because of the usage
of direct or indirect methods to measure informality (Ciencia u. a. 2005), but all of them show that
informality is a major feature in the economic panorama. Informality has actually been widely
studied for the Mexican case. (Barceló, Angulo, und Campos 2011) found that informal
microenterprise have greater growth in and a longer life expectancy. The results also show a
tendency by entrepreneurs to select an informal business model as a profitable way of doing
business. Di Giannatale, Ramírez-Abarca, und Smith (2013) analyze impact of formality over net
profits, levels of capital and labor and find that informal ME employ higher levels of labor and
physical capital but do not earn higher profits.
Our Current Research
In a preliminary study (Negrete García 2011) I focused on constraints to innovation faced by
Mexican firms. It was found that, due to financial market imperfections, corporate firms generally
do not use resources from the financial market to finance R&D projects and prefer to rather utilize
production revenues. In terms of policy, it implies that the development of the financial market
could potentially contribute to foster the existence of venture-backed firms, which would enable
small firms to have real opportunities to survive and to compete in the production of technological
innovations.
(Almeda und Baysic-Pobre 2012) show that the majority of the micro and small enterprises
in Latin America do not grow or graduate to the next scale. (Liedholm und Mead 1998) show that it
is possible to draw patterns of growth about the small share of firms that achieve graduation. Also,
(Grimm, Knorringa, und Lay 2012) find empirical evidence on the coexistence between
subsistence-type and potentially successful firms. These findings, together with the already exposed
MSE literature set a starting point for my doctoral project (Negrete García). The study aims at a
better understanding of these firms´ dynamics, as well as the relationship between their performance
with economic growth, poverty reduction and distributional change. In other words, to make an
empirical scientific contribution on their potential role as key determinants of growth and
development.
For the paper that we are currently working on, we have Mexico as a case study and are
addressing the missing middle phenomenon. Our research focuses on firm graduation and considers
labor and capital. We apply a decomposition method as econometric tool and a dataset that exploits
the longitudinal nature of the Mexican Family Life Survey (MxFLS) and matches it with both, the
National Survey of Microenterprises (ENAMIN) and the National Survey on Employment (ENOE),
which are important sources of ME information in Mexico. Further exploring the causes and the
effects of the change or stagnation of these firms in certain size is relevant to assess distinctions
between survivalist firms and those with productive potential. Given the nature of the data, a better
understanding of job´s creation and welfare implications is possible both at the household and
national level. Additionally, this study further differentiates from others in that it takes a dual
perspective by taking into account micro and macro perspectives.
Conclusions
Having in mind the aim of lowering poverty in Mexico, we seek economic growth. By seeking
economic growth we all here are aware that innovation and R&D are of major importance. Under
these premises, I just presented you how such aims have everything to do with supporting our
national firms. Which happen to be primarily Micro and Small Enterprises. As I explained, their
performance is tightly intertwined with growth and development. The specific channels through
which MSME contribute to these phenomena and their dynamics are currently part of the research
agenda. However, a better understanding in this direction might also provide clues on how to
improve their overall productivity, innovation activities and their incorporation into the global
markets. As an example, in some economies, like the American, innovation rate is higher in small
firms than in large firms conditional on the industry. The study of Almeda and Baysic-Pobre (2012)
explained that the high rate of innovation among them may be the result of a better exploitation of
SMEs on university-based research than large enterprises. However, this is not true in Mexico.
There is still much to be learned and researched. Just as I started my exposition, we have to
recognize that Mexico is facing huge challenges. For the specific case of the support of MSE there
are already some efforts at the academic and governmental level. For instance, CONACYT, SHCP
and SE already destine resources to foster them with programs, orientation or subsidies. They also
have some initiatives such as ProMéxico and BANCOMEXT. However, there is still much to do for
our people and our economy. We are here to sum efforts and show some of the little advances that
we have made in that direction, hoping that they will contribute at least a bit to a brighter future.
Hope your research has an echo on our reality and help in the design of programs and plans that are
stable and ideally supported by long term policies.
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