Vulnerability as a Determinant of Entrepreneurial Choice: Evidence from Poor Microentrepreneurs in Peru

Microenteprises are increasingly recognized as major generators of income and employment in the developing world. Recent surveys suggest, however, that the sector is plagued by low productivity, leading some to claim that reducing impediments to microenterprise productivity is necessary to reduce urban poverty. Given mixed evidence that the only impediments are lack of credit and entrepreneurial skill, I propose vulnerability, defined as the inability to smooth consumption across negative shocks, as an additional barrier to highly productive enterprises. Since high yield projects likely carry more risk than low yield projects, I argue households choose high yield enterprises over low yield alternatives only if they are able to manage higher levels of risk. I define a simple theoretical model showing that vulnerability leads households to dedicate fewer resources to high yield/high risk enterprises. Using data on urban microentrepreneurs in Lima, Peru I find empirical corroboration of this prediction, suggesting that vulnerability helps drive enterprise choice and may explain a portion of low productivity in the microenterprise sector. Finally I show that households with microfinance dedicate more resources to high yield/high risk projects, implying there may be a link between enterprise choice and microfinance use. ________________________________ * I am indebted to Monique Cohen, formerly of the AIMS project and currently of Microfinance Opportunities, who provided me with the data and put me in contact with Elizabeth Dunn, the primary researcher for the AIMS project in Peru. I am also grateful to Roger Betancourt for numerous rounds of feedback and good advice, and to John Wallis, Rodrigo Soares, Christopher McKelvey and seminar participants at the University of Maryland for invaluable comments. E-mail contact: [email protected]