22. Entrepreneurs and Workers

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MIT OpenCourseWare at ocw.mit.edu. PROFESSOR: We’re going to talk
about something we’ve sort of touched on, in many different
contexts, but more head on this time, and that’s
entrepreneurship. And sort of the starting point
of that, I think, there’s a story that somebody once told
me, which, I thought, kind of frames one side of the
debate very well. I was on the plane with a man,
who was clearly sort of a rich, Indian businessman. And he was quizzing me
about what I did. And I said, I study economics
and poor people. And he was very much
of the view. He said, look, you know, there’s
all this stuff about poor people. You guys don’t understand
poor people. They have an entrepreneurial
genius in them. You think I’m a successful
entrepreneur. The way I learned
entrepreneurship was from the poor. So I was kind of saying, yeah,
yeah, yeah, right. Well then he told me a story
that was actually quite compelling. And mostly people– whatever this means, it’s
never clear to me. So I was being slightly
skeptical. But then he told me a story
that was very compelling. So he said that he had
an MBA from the US. I think from Kellogg. And he went back to India
after doing his MBA. And when he arrived in India,
his uncle, who was a businessman in Bombay, said
look, you want to be an entrepreneur. Let me show you what
entrepreneurship is. So basically, they got
in his uncle’s car. The uncle drove him
all the way to the Bombay stock exchange. The Bombay stock exchange, well,
he thought that they would just go inside
the stock exchange. But in fact, he parked his car
in front of the exchange and pointed to four women who were
sitting on the side of the street that goes in front
of the exchange. And he said, you know, can you
figure out what those women’s business model is? So he says, well, I
looked and looked. And they would just get
up, from time to time. They’ll scrape something off the
street, then they’ll come and sit down. And then they’ll be sitting
and talking to each other. It’s early in the morning, like
8:30 in the morning or 9:00 in the morning. Cars were driving by. People were showing up to work
at the stock exchange. But what does it have anything
to do with entrepreneurship? So he kind of tried to come up
with some answer, completely didn’t manage, and finally
told his uncle, look, I have no idea. Why don’t you tell me? His uncle said, these women get
up at 5:30 in the morning. They go to the beach. In the morning, the tide has
receded, so there’s wet sand on the beach. They collect the wet sand and
then they put it in a bag. They come to the
stock exchange. This is one place where
lots of cars go by. And there’s a nice
sidewalk to sit. Before the traffic starts,
they lay the sand out on the street. And then they sit there. And as people drive on the
stand, the heat from the tires dries the sand. So the sand gets heated and
eventually dried by the tires. Once the sand is fully dry, they
scrape off the sand and put it in a bag and take
it back to the slums where they live. Women use this dry sand
as like a scrubber. To clean dishes, you use
this dry sand as a scrubber for that. And so they use this
dry sand to scrub off their dirty dishes. And that’s all dirty– I don’t know, whatever– cook pot and pans. And that’s how these people
make a living. They dry the sand,
and they sell it. So this was his example of how
infinitely creative poor people are. And my reaction to that was,
you know, isn’t that saying much more about how creative
you have to be to make a living if you are poor then
how creative the poor are? So it’s the same proposition,
in a sense. You could say that this
shows that the poor are very creative. Or you could show that the
poor have no business opportunities so they have to
do this completely bizarre thing to make a living. And those are just two sides
of the same coin. And I don’t know. So what I want to talk about
today is a bit on this implicit and often
explicit debate– So before we get there– on whether the poor are
entrepreneurial in some meaningful sense of
the word or not. So let’s start at
the beginning. Who’s an entrepreneur? How do you define
an entrepreneur? AUDIENCE: I guess I would define
an entrepreneur as someone who goes about creating
a new venture that often involves a greater than
average amount of risk. PROFESSOR: So if I am someone
who works for Toyota and designs a slightly different
car, am I an entrepreneur? AUDIENCE: I would say not. PROFESSOR: Why not? It’s risk. I could fail. I would look really, really
stupid to my bosses. AUDIENCE: But it creates
a new venture. I mean, right there, you’re
developing a product inside. PROFESSOR: New venture? So it has to be a new,
separate company. Is that the definition? AUDIENCE: No, but I’d say a
venture not a design, right? PROFESSOR: But I haven’t
got what that means. AUDIENCE: Like a venture in
the sense that it doesn’t necessarily have to be entirely
its own company, but it’s more than just a design. In the sense of a design, but
then you’re not taking into account the other things that
would actually go into making it a car and then
selling that. Like let’s say Toyota decides
to launch a new line, where they’re going to do a new
dealership agreement, new factory, all that, then that
would be a new venture. If I was running that, then I
could be classified, under my definition, as an
entrepreneur. PROFESSOR: OK. So you would– OK, go ahead. No, you should go ahead. AUDIENCE: I think the term, that
we’d have to go into the definition. Besides just creating a new
venture, it would be create a new venture that is, somehow,
innovative and unique in it’s own. So I think, whether not,
necessarily, the business idea or the business strategy of the
product, but maybe even in how the person operates the
company, they can be entrepreneurs in that way. PROFESSOR: So you don’t think
that if I have a set of taxis I’m an entrepreneur? I just bought a set of taxis. I rent them out. AUDIENCE: I would imagine if you
were the person who took the initiative to– PROFESSOR: But this was after
there had been 500,000 taxi companies in the world. If I go tomorrow, quit my job,
and I start a taxi company, I would not be an entrepreneur? AUDIENCE: Well, to some
degree, you could that’s still unique. You’re starting a taxi company,
in a particular city, with a particular
set of drivers. PROFESSOR: But then everything’s
unique. Once I go down that road, I
don’s see how anything. I can’t have a taxi company
which has the same set of drivers as theirs,
everybody else. So this is unique
by definition. Somebody else from
that side, yeah? AUDIENCE: I think someone was
actually saying before that created a normal
amount of risk. But it’s like the financial
risk, as well, absorbing that yourself, as opposed to being
responsible for it underneath an organization. PROFESSOR: Right. I think that’s actually one
key piece of what I would consider the definition. The fact that you a lot
of the risk comes from raising capital. The risk is a significant
part of the reason why. If I work for Toyota
there would not be. It could be career
risk for me. But it would not be risk that
is driven by my having to raise capital. So I think you’re making one of
the key points, which is, I think, exactly as you said. Risk is a big piece of it. The next piece of it
is the risk comes from raising capital. I would not say that it has to
be a new product, because I think that’s too narrow
a definition. I mean you could define it. But I think that would mean no
poor people are, essentially, entrepreneurs. But I think raising capital,
the financing side of it. So do you take the risk? And a lot of the risk comes from
owning the asset that’s generating the output. That, I think, is a key part
of being an entrepreneur. The risk comes from putting
money or your own assets on the line. It’s not just that you’re
putting your career or your name on the line. When I write a book, I also
take a risk in that sense. People could say, my god,
what a stupid book. That’s a risk, but I wouldn’t
call myself an entrepreneur. So I think that I want to
emphasize that I think the poor are entrepreneurial. When we talk about somebody who
is an entrepreneur, I’m going to emphasize the fact that
they bear a lot of the risk, from production, and that
risk is closely tied to the ownership of the asset. So it is that they have to
finance the asset and hold on to the risk generated
by that asset. So they could be a farmer. They must have to own
the land and then take the farming risk. Yeah? AUDIENCE: But in the US, don’t
a lot of the people, who we think of as entrepreneurs, they
get venture capital or somebody else to take on
the financial risk. AUDIENCE: But it kind of defers
the financial risk. They’re still taking on
financial risk of their own. PROFESSOR: But first, I think,
nobody gets 100% venture capital funding. Even to get to the venture
capital stage, you typically spend a fair amount of money. And nobody gets 100%
funding even then. And second, in some ways, you
still take financial risk, in the sense that the upside on
the venture capital is precisely your earnings
in the future. So you, basically, dock
your earnings. You are an owner. You have arranged a particular
form of financing, which says that I don’t make any payments
for the time being, on this financing. But it’s exactly like any
other form of financing. I have an obligation
to pay you. That obligation, in venture
capital, is maybe in five years. If the company goes public,
then I will pay you $100 million. That’s a venture capital
contract. It’s still, basically,
a sharing of risk. And I’m taking ownership
of the asset. It’s just a different
contract. Yeah. AUDIENCE: It’s also the
opportunity cost of actually putting all of your energy into
this venture to see it come to fruition, like all the
earnings that you could have earned in that time working
[INAUDIBLE]. PROFESSOR: But that’s a bit
like I could have spent my time consulting or I
could write a book. I mean that’s not
that different. I think the key is that my
earnings are significantly connected to the outcome
of the project. I was just adding to the cost of
what of entrepreneur takes on [INAUDIBLE]. AUDIENCE: I mean, if you wrote
a book that sold 10 million copies or something, then your
future earnings would be significantly. PROFESSOR: Yeah, but mostly, I
think the first order risk, sadly, for me is that people
will just think I’m stupid. I think the risk, in my case. You could imagine everybody has
a small chance of being an entrepreneur, but I think that
mostly, most of my risk has something to do with my ability
to convince other people that I have not lost my
marbles and very little of my risk comes from money. AUDIENCE: Yeah, but at the same
time, there’s some people who are like full-time
authors. And they take out loans. And they write this book. PROFESSOR: Oh, they are
entrepreneurial. I’m not saying they are
not entrepreneurs. I think I am not an
entrepreneur, to first approximation, because my risk
is mostly reputational risk, very little of it is
financial risk. AUDIENCE: Even though you’re
sort of doing a similar thing? PROFESSOR: Yes. My lifetime earnings are,
essentially, with a 99% probability, are unaffected by
this decision, or almost unaffected. So who is and isn’t
an entrepreneur? So we’ve sort of been
talking about that. I’m not, but who is? So clearly, Larry Page and
Sergey Brin are entrepreneurs. Now let’s take something
less obvious. What are other forms of
entrepreneurship, like in the US, less obvious ones then
starting a software company? AUDIENCE: I mean someone who
owns and rents a foodtruck. So PROFESSOR: That’s an
entrepreneur, sure. AUDIENCE: Someone who
starts a laundromat. PROFESSOR: That’s
an entrepreneur. AUDIENCE: So I kind of disagree
with the fact that you’ve got to have some
sort of earnings attached to your venture. I think if somebody starts a
business that focused on community service but is very
unique, entrepreneurial, I think that is still. If it is innovative in some way,
I still think it should be considered as
entrepreneurship. PROFESSOR: I think they say,
sometimes, somebody is a political entrepreneur. But I think that gets the term
to be a little bit too hard to understand. I mean, I think you could make
the case that you’re making. I’m going to sort of resist
that a little bit. Because I think, then,
I don’t know what the limits are anymore. Who’s not a political
entrepreneur? If I go and claim that President
Obama was born in Kenya, am I a political
entrepreneur or not? Is that entrepreneurial? Yes, it’s entrepreneurial. It’s innovative. I feel like that’s making
it too easy. AUDIENCE: So were the people
collecting sand entrepreneurs? PROFESSOR: Sure. They owned this enterprise. Their entire earnings
was subject to that. They had financed whatever
needed to be financed. They had paid for the
plastic bucket. They collected the
sand, the spade. They had paid the bus fare to
get from the beach to the Bombay stock exchange. They had done all
of the financial investment that was involved. It just happens to a small
amount of money. But that doesn’t mean that
they hadn’t done– they had put in 100% of
the capital in there. But another example, just to
not get too stuck on it. Lawyers, for example, most
lawyers are, effectively, entrepreneurs. Because most lawyers actually
have a two-person, three-person partnership. They’re bearing a lot of risk. They pay for the staff. They pay for the office. They pay for the whatever,
the furniture. And so, in that sense, they
would, under this definition, also count. AUDIENCE: I was going to say
you could also say that for doctors as well. PROFESSOR: Doctors the same,
a lot of doctors. I think that’s relevant, because
the typical way– there’s no measurement of
entrepreneurship in the data. Because nobody knows who’s an
entrepreneur, for the same reason as we were having
trouble with it. What is measured in the data
is whether you describe yourself as self-employed. That’s described in the data. So if you look at most
countries, one of the employment categories
is self-employed. And that number, which includes
lawyers, doctors, consultants, many other such
people, and not just laundromat owners and Google
owners, but lots of other people, that category turns
out to be about 12% of the population. So 12% of the population,
under a very generous definition of entrepreneur,
which is self-employed, are entrepreneurs. That’s for the OECD. The OECD is like all the rich
countries in the world. In the rich countries, roughly
12% of the population would call themselves self-employed. That number is much
higher among the poor in poor countries. And I’m going to show
you some numbers. So here’s some numbers. So self-employed in agriculture,
rural population, you can see that, in many
countries, over 75 to even 100%, nearly, are self-employed
in agriculture. Take Panama or Pakistan, like
70% of these people are self-employed in agriculture. Meaning that they, basically,
exactly using the equivalent definition to the one that’s
used in the OECD, which is that they describe themselves
as self-employed. Meaning that, typically, they
are putting up the capital, usually the land and the inputs,
and they’re getting the returns. So they are risk taking. And they’re betting a lot of
risk, and they own the assets that are generating that risk. So that’s a number
that’s high. As you will see, that number
is, in a sense, an underestimate of how
many people are self-employed overall. So this is just in
agriculture. This is how many people who
have somebody who’s self-employed in
non-agricultural work. In Brazil, rural Brazil,
60-something-percent are self-employed in
non-agricultural work. So who are these people? They’re like somebody who
provides any services, a barber, carpenters, somebody
who builds, a bricklayer. Instead of a working as a part
of a company, most of these people just work as
single-person enterprises. So bricklayers are
bricklayers. They have a brick laying
company, which is themselves. And they, typically, will do the
brick laying for somebody. In many ways, this is another. So if you have to take the
fraction of people who are self-employed, either in
agricultural or not, or somebody in their family is
self-employed in either agriculture or outside
agriculture, that’s and even higher fraction. That’s like 70% of most poor
people have somebody in the family who is self-employed. So this is a combination of
these two sets of numbers. And some of them are both. Some of them have one family
member who is self-employed in agriculture, one family member
who is self-employed outside agriculture. But even if you take
the average, it’s quite a high number. So most poor people, in our
definition, are at least self-employed. Well, why is this? Yeah? AUDIENCE: What would we consider
sharecroppers, who have to bear a lot
of the risk? PROFESSOR: I think, here, they
are considered self-employed. But that’s a good question. I don’t know the answer to
whether they should be or not. So why should we think
there is anything interesting about this? Why would it be at all
surprising if a lot of poor people were entrepreneurs? Why would it be even worth
commenting on? AUDIENCE: I don’t understand
the question? PROFESSOR: I said that 12% of
the people in rich countries are entrepreneurs. Maybe 70% of the poor, in poor
countries, are entrepreneurs. Is that something that
has anything interesting about that fact? And there I want to get you
to these two questions. Is it the case that the poor
have specific advantages being an entrepreneur? Do they have specific
disadvantages in being entrepreneurs? So let’s start with
the disadvantages. Is that clear? AUDIENCE: The risk is higher,
because the overall capital they have is less. PROFESSOR: So risk is at least
relatively higher, because they have– I don’t know where this came
from, but I kind of know where it should go. So one thing that’s
clear is that entrepreneurship is risky. If you’re at the margin of not
having enough money for something really essential,
then the same risk hurts you more. Because you’re really
in danger of something awful happening. Like you couldn’t pay for your
mother’s hospital stay if your business collapses. So the risk is much
more important. We talked about this
some few weeks ago. Other reasons, other
disadvantages? AUDIENCE: It’s harder
to raise capital. PROFESSOR: Sure. It’s harder to raise capital. If you don’t have a bank
account, if you don’t have assets that you can pledge, if
you don’t have contact among financials, it’s harder to
raise capital, surely. Yeah? AUDIENCE: You have to rely on
your business more, because it’s harder for you to get a
steady paying job at some other company. PROFESSOR: Is that a
disadvantage or an advantage? AUDIENCE: I think it’s a
disadvantage, because then you bear a lot of the risk
of the business. PROFESSOR: I see. So you may not have skills
that you would get you an alternative job, so if your
business fails, then it really hurts you. I see. Yeah. AUDIENCE: Particularly, if
you’re really poor, in a rural area or a slum, it’s really
hard to get the resources. I mean, I feel like in America
today, we have a whole lot of resources to encourage
entrepreneurship and help entrepreneurs. I would imagine, based on what
I’ve read, that that really doesn’t exist. PROFESSOR: So you may not have
the know-how to be an entrepreneur. You may not know what market
opportunities are available, because you’re not that well
connected to the media. You may not know, even, what the
best prices are for what you will buy and the best prices
are for what you will sell, where to sell, all the
information that you need. Presumably, that’s correlated
with being educated. And so if you are poor in a
poor country, you are less likely to have all
that information. AUDIENCE: This is something
that applies to all entreprenuers. But I think it would affect the
poor more, specifically. I was thinking about the
benefits you get from working for a corporation. Sometimes you get health
care, things like that. And so being an entrepreneur
is like taking a risk with respect to that. And then for the poor, depending
on where they live, or what atmosphere is around,
it might disproportionately affect them. PROFESSOR: Yeah, that’s also
possible that there’s some additional benefits to
having a steady job. That’s particularly important
if you have no other source of support. Yeah? AUDIENCE: On the advantages
side, couldn’t you say– PROFESSOR: Let’s do
the disadvantages. Hold that. AUDIENCE: Wouldn’t your
income not be regular. It would be really uncertain. PROFESSOR: Yeah. So that’s related to, I think,
the first point that was made. AUDIENCE: Chances are,
you’re not going to have an original idea. You’re going to be copying what
other people are doing. PROFESSOR: Yeah. But why would it be less true
of the poor than the rich. AUDIENCE: The rich might have
access to educational resources that will allow them
to come up with better ideas. AUDIENCE: You could also make
the converse argument that since the rich have access to
more stuff, they’re more likely to copy other ideas. PROFESSOR: Good. AUDIENCE: But that would also
mean they might not be as likely to make a lot of money. So those would be the bad,
rich entrepreneurs. AUDIENCE: Not necessarily. Microsoft copied Apple’s
architecture [INAUDIBLE]. AUDIENCE: Well, that’s
a different story. AUDIENCE: I mean this was
already said before. But just thinking about like,
if you’re poor, you’re going to have to use– an entrepreneur, let’s say you
had some savings or you had family that was helping
support you. You have support system that has
some sort of capital, even if it’s not that much. But when you’re poor, you have
to use everything that you have to put into
that business. And that takes away from just
living, even things like that. PROFESSOR: So the risk is
higher, and your ability to self-finance is lower. Anything else? Yeah? AUDIENCE: You could say, if
other people copied your idea, it would hurt you more, because
then they’d just increase the supply and decrease
your overall– PROFESSOR: But why would
it be any different from anybody else? If I’m rich and you copy my
idea, that still hurts me. It is not clear, especially in
the sense if the poor use ideas that are particularly– they’ve already copied
from somebody. They’re less hurt by copying. Yeah? AUDIENCE: Perhaps, if you
think about the social infrastructure, people are
more able to copy ideas, because of the lack of legal
support or an ability to check or to enforce that people are
not copying your ideas. PROFESSOR: Right, so you might
thing that they have less access to lawyers
and things like. They may not understand
the law well. So they may not be able to use
the legal system to protect themselves as effectively. What’s another thing that helps
an entrepreneurs other than money and ideas? What’s the third thing that? AUDIENCE: Sort of broadly
speaking, a social safety net. In the sense that, let’s say,
in American, you’re entrepreneur and you absolutely
fail, there’s still a social safety net that you
could at least rely upon. And that doesn’t
exist in poor– PROFESSOR: Right. That’s true of poor countries,
but not necessarily more of poor people. That’s a point about
poor countries, less about poor people. One other thing that I think
matters a lot is contacts. I think that, if you know
somebody, if your uncle is the CEO of a company, they
may be more willing to give you a try. If you’re starting up, you’re
making widgets, somebody has to buy them. It’s much easier if you know
somebody than if you don’t. I mean, why would anybody
trust you? So you often get your first
breaks by having some connection to somebody else,
who will do the buying. And I think that’s a very big
piece of what makes it very difficult for the poor to be
effective entrepreneurs is that they actually don’t
know anybody. And so it’s much harder
for them to break in with a products. So I think contacts are a
very big piece of it. The other part of it is that it
might be that, in order to be in business, for example– take the venture capital
example. Typically, the way a lot of
start-ups work is that you know that you’re going to
lose money for a while. Because you have to build
a reputation. And the way you build a
reputation is by going to someone and saying, look, you’re
buying from him for $5. I’ll sell it to you for $3. And you know you lose money at
$3, but you’re willing to lose money for a while, because that
way he’ll see that you’re really good at doing it. And then, maybe, you could
charge $4 and get the market. So a lot of way new businesses
start is by actually undercutting other businesses
and losing money. So if you can’t lose money,
effectively– so if you’re poor and you can’t
afford to lose money, it’s often very difficult
to enter a new product. Because part of the way you
enter the new product is by actually selling
it very cheap. And it’s very difficult to
sell it very cheap if you can’t afford to lose money. So those are all the
disadvantages. Are there advantages? So I don’t know how many of you
know, but there’s a very famous book called The Fortune
at the Bottom of the Pyramid. If you’ve read that book, it
makes the case that there’s actually lots of entrepreneurial
opportunities for the poor. And that, in some sense, they
might have an advantage. What are potential advantages? Yeah? AUDIENCE: Because you have
access to a unique market that the rich don’t even know
about, like the women who sell sand. PROFESSOR: So they might know
about things which are underserved. So maybe the way capitalism has
developed, it’s better at serving the demands of
the middle classes. The poor might demand certain
products which are not supplied by the market. So at this point, it might be
easier to find a new product to supply if you know
what the poor want . That’s one of the cases
that’s being made. We’ll see to what extent
that’s true. Any others? You were going to mention
something? AUDIENCE: Maybe it’s easier to
make use of some resources than it would be if you were a
richer person trying to start a [INAUDIBLE]. Like, for example, the women
with the sand, they can go to the beach and dig up some
sand and carry it away. No one’s going to say
anything to them. But if someone was trying to do
this on larger scale, then there would be issues. PROFESSOR: That’s
exactly right. So it may well be that, if I’m
the person who comes and– imagine that I’m rich. Let’s say, I can either take
a job or I can be an entrepreneur. To compensate me for my job, I
would need to be able to do the business at a particular
scale. Imagine I’m in the business of
sorting through garbage and finding things which
are sellable. Just doing that, physically, if
I started to use that much garbage, I’ll need
a lot of space. Whereas a poor person may be
able to cover her daily wage, which is very low, by just
sorting through the garbage she finds in the neighborhood
or something. Another advantage of being poor
might be that you may be less considered or less easily
monitored, so you may be able to bend the rules more
effectively. So you might be able to make
products, which somebody else would not want to do, because
it would too easy to scrutinize. So you may be involved in– I’m not saying illegal products,
but you might use techniques which are possibly
less hygienic or something. So if I setup a big factory
dyeing garments, that pollutes the water supply. And the city will
shut me down. If I have a very small operation
inside my house, dyeing garments, nobody
will notice. And I could use the city’s water
supply and pollute it. This doesn’t mean that I’m
doing a good thing. But it means that it might
be easier for me to be an entrepreneur, the producing
and dyeing garments than somebody who’s richer than me. So there’s some potential
advantages. Still, I think my sense is that
everybody would think that, basically, it’s easier
for the rich to be entrepreneurs than the poor. So that’s on balance. And we’ll look at this
a little bit, in the data, in a bit. So then why are the poor
entrepreneurs? That’s the question
that comes back. If we say it’s easier for the
rich to be entrepreneurs, but the rich are less likely to be
entrepreneurs than the poor, then we have a kind
of a puzzle. Why are the poor
entrepreneurs? What is it that? So one view of this is sort
of Muhammad Yunus’s view. Muhammad Yunus is the guy who
started Grameen Bank. And he’s on record saying that
the poor are natural born entrepreneurs. So there’s one view, which is
to say that something about the poor, which, by being
poor, they learn to be entrepreneurial. They can’t really survive on
anything else, so they become like these women we were talking
about. they become very clever at finding
opportunities. They are natural
entrepreneurs. That’s one way to think about it
is that, when you are poor, you’re just better at thinking
about opportunities. Now, one way we can kind of
address this is by looking at the businesses of the poor. What do you know about
these businesses? So these are people who
are under $1 a day. And if you take the business of
people, who live under $1 a day, I think the striking fact
is that, in most countries for which we have data, let’s say,
10%, so the average number of employees in a business
is 0.15. It’s one in seven businesses
have an employee, a paid employee. They took two countries where
it’s different, but even in those countries, they don’t
have one employee. They have 0.6 employees. So these are very small
businesses. The first thing to note is that
the businesses of the poor are kind of very, very
small businesses. This includes your unpaid
employees, which is like your son or your wife or
you, yourself. And that number is
just over one. So the average number of
employees is just over one, meaning that it’s you plus
somebody who works, maybe, part of the time. Or alternatively, it’s you and
no one or you plus one person, but not much more than that,
so very few employees. Second, what fraction of the
businesses own a vehicle? Just to measure some other
measure of the size of the business, it’s only a vehicle. And Pakistan is the
one country where many people own cycles. They might be delivering stuff,
but then, all the other countries, it’s really,
really small, like 5%. If you look at an even more
obvious question, what fraction own machines,
any machine? The answer is not
100% even there. 60% in the Ivory Coast
own any machine. What’s the average machine
that they own? They own a weighing scale or
sort of a piece of metal for digging something, but
no more than that. So it’s really like these
businesses have no assets whatsoever. So the first point about the
businesses of the poor, they are very small, by all
of these measures. They have no employees, no
machines, no vehicles. The second, related point, I
wanted to make is that the fact that they don’t have any
machines is telling you something quite important, which
is that these are not very sophisticated businesses. You’re not surprised
to hear that. But it is very, very clear that
the average business has very little skill involved. And to be honest, there’s
not a lot of diversity. If we look at the top five
businesses, they are things like tailoring, a small corner
store, selling snacks on the street, embroidering or
stitching clothes and selling them as a retail sale, not a
tailor, but someone who retail sells garments. And I think the last one is– I forget– carpentry, I think. It’s like none of these
businesses, except, I think, carpentry, possibly, require
huge amounts of skill. So they tend to be very low
skilled businesses. And this is most businesses. So these are not people
who are creating very original ideas. Indeed, the usual problem that
people write about is most people, in the same
neighborhood, have the same business. They’re also selling snacks. They’re all delivering loads. They’re all tailors, rather
than a lot of innovation. There’s no evidence that they’re
very creative in what business they go into. On the other hand, many, many
people own multiple businesses. That’s the other very,
very common fact. This is the fraction of
people who get incomes from multiple sectors. So that’s like somebody who was
has farming business but also has income from, let’s say,
he does some bricklaying on the side. That’s somebody who has
multiple sources. And the striking fact
is how common it is. In most countries, it’s close to
50% of the population have income from multiple sources. So in other words, they’re not
putting all their time, available time, into
their own business. Why would they not do that? If you have a business, in
your family, why aren’t putting all of your
effort into it? Why would we observe this fact,
that most people, many people, have multiple business
or multiple occupations? AUDIENCE: It might be
comparable, then, to [INAUDIBLE]. PROFESSOR: Right. So, for example, you might
be only able to sell one kind of snack. And people might want snacks
only, maybe, in the evening or something. In the morning, you
go to work. There’s no demand for snacks. Or you might sell breakfast,
and you can only sell breakfast till 10:00 AM. After that, breakfast is over. And so you have to find
something to do. So one thing could be there’s a
natural capacity constraint. There’s not much demand
for the product. And so you can do it for two
hours a day but not for eight hours a day. Yeah? AUDIENCE: There might be
seasonal variations. You might be able to a certain
type of business only during certain times of the
year, [INAUDIBLE]. PROFESSOR: Absolutely. So agriculture is one classic
business, where you can work a few months of the year, but the
then the rest of the time, you don’t have irrigation. There’s nothing to do. So you work on something else. Yeah? AUDIENCE: You might diversify
your portfolio as part of [INAUDIBLE]. PROFESSOR: Right. So you may bear less risk by
having multiple businesses. Yeah? AUDIENCE: It might be the return
for business is so low, that even if you invested more
time and energy into it, it wouldn’t be worth it. PROFESSOR: But why don’t you
take the one which is the highest return and put all
your time into it? AUDIENCE: Maybe I don’t
want to [INAUDIBLE]. PROFESSOR: Why? AUDIENCE: Because even if that
was the highest return, [INAUDIBLE]. PROFESSOR: But why would you
ever start a second, even lower return business? If there’s one business that
has the highest return, why won’t you put all your eggs
into that basket? AUDIENCE: Diversity. PROFESSOR: Yeah, so that’s what
she said, which is that want to diversify risk. What other reason could
you imagine? AUDIENCE: It could also be
that you might have one business that’s really
profitable, let’s say, you’re selling something in the morning
for breakfast, but it might be the time– PROFESSOR: Right, that’s,
I think, also someone brought up. AUDIENCE: I think there are like
some businesses which are like needlepoint, which
physically hurt you if you do it too much. People like become blind. PROFESSOR: Right, so maybe, just
you don’t want to do it for too long? Another obvious reason. AUDIENCE: Didn’t they say in the
book that a lot of people don’t like running their own
businesses, and so they don’t want to put time into it. PROFESSOR: But why would you
do three different ones? I’m Asking a simpler question
than the one you’re answering, which is people seem to do
two or three different occupations. Why would do two or
three rather than? Say I want to work
eight hours. Why wouldn’t I put all
eight hours into one? We’ve gone through a bunch
of reasons for that. AUDIENCE: Is that the marginal
returns decline, especially for this type of a business? PROFESSOR: So it could be that
the marginal returns on the extra piece of effort is low. Another possibility that
I think is even more straightforward. Maybe some businesses
require capital and others less capital. So you have a certain
amount of capital. You put into the capital
intensive business. And then use still don’t
have some time left. So you work in the other one. For example, to do needlepoint,
you’ll have to buy fabric first. And you can only afford fabric
that covers half your day. And you buy fabric for
half your day. You work half your day
on needlepoint. The rest of the half of your
day, you have to find something else to do. So it may just be that you don’t
have enough capital to make it possible to spend your
whole day working on it. So in any case, we do see this
evidence that people don’t seem to be excessively
committed to any single business. That has the cost, obviously,
that they’re not getting a lot of benefits from
specialization. They’re not learning or
improving very fast, because they’re doing many, many
things at the same. What is striking about this
picture is says, in even rural households, a lot of them have
a non-agricultural business. So they’ll actually, if you look
at how many people have a non-agricultural business, like
about a third of them have a non-agricultural
business, even if they’re rural. So these are people who
live in rural areas. They do farming as one of their
businesses, probably. But they also have a second
business, which is non-agricultural. And that’s sort of striking. We think of, often, rural areas
in developing countries as farmers kind of living
in isolation. In fact, most of these
people are in a second business as well. So the next fact about
businesses of the poor is that these businesses are
very fragile. So if you look at Mexico, in
85% of the people, the poor didn’t have a business
in 2002. 15% had a business. By 2005, out of those 15%, only
6% still had a business. So 60% of all businesses
just closed. So the they’re also going
in and out of business all the time. On the other hand, many other
people started new businesses. And you look at the fraction
of the people who retained their existing labor force. They’re just 1.8%. So most people either grow their
business or shrink it or shut it down. So businesses are very,
very fragile. It’s not that you set up a
business and it lasts forever. It’s quite a high
risk outcome. And this is sort of the answer
to the question, do the poor feel entrepreneurial? And this is a survey we’ve done
in many countries, now. We always find the say answer. You ask people, you have a
child, what occupation do you hope for your child to be? And we ask it two ways. One, we ask them, what
occupation do you hope for your child? Then you might worry if
you ask that question. They might be conditioning
on their condition. And so they’d look, you know,
my child he’ll never be able to do the right kind of
business, because he doesn’t have enough money
or something. So we asked them, if you won a
lottery and you would invest in something, what occupation
would your child want to be in? It doesn’t make a difference. They always give you the same
answer, which is that they don’t want to be in business. The answer is very,
very clear. 18% want them to be a private
firm employee, 41% to be a non-teaching government
job, and 34% to be a government teacher. So that’s 93% don’t want them
to be an entrepreneur. So basically, the poor don’t
like the idea, at least, of their children being
entrepreneurs. And it’s consistent with
everything else we see, which is that they don’t seem to
invest all their time in a single business. Even if they have a business,
they’ll put only a part of their time into it. We saw, earlier, that they don’t
try very hard to save their way out of debt. We saw that when we looked at
the fruit vendors, that they were not saving a lot and tried
to get out of debt. So it seems like they don’t seem
to be hugely committed to growing their business. There’s no evidence. And we see the businesses
don’t grow. Many of them shrink
or shut down. Very few of them actually
add an employee. At best, these business
are always small. They stay small or
they shutdown. They rarely grow. So there is no evidence that the
poor are actually dynamic entrepreneurs, in the sense
that they are looking for opportunities to grow their
business all the time. Now, that doesn’t mean that
there are not a million dynamic entrepreneurs
among the poor. One should not confuse the
statement that the average poor person is not a dynamic
entrepreneur with the statement that there
are no dynamic entrepreneurs among the poor. There may be exactly the same
fraction of dynamic entrepreneurs among the poor
as there are among MIT students, for all I know. It’s just most people are
not cut out to dynamic entrepreneurs. And the poor, maybe, just
like everybody else, they don’t like risk. They don’t like the idea of
worrying about all of the problems that running
business has. They like a steady job. And then a few people really
like being an entrepreneur. I don’t know that this makes
them any different from anybody else. It just says that they’re not. You see a huge
over-representation of the poor among entrepreneurs. That doesn’t mean that this is
what the poor want to be. It’s not that they’re
entrepreneurial in some natural sense. They’re not that they want
to be an entrepreneur. They’re an entrepreneur for some
other reason we’ll come to in a minute. None of this evidence seems to
suggest that they’re dying to be entrepreneurs and to
grow their businesses. That doesn’t mean that there
aren’t some who are. There’s this story that you saw
in the microfinance movie of some woman who started
as hair collector. Remember this person? And she’s now a hair tycoon. And they exist, people like
that, everywhere in the world. I’m even willing to believe
that there are as many genuinely entrepreneurial people
among the poor as there are among anybody else. But that’s a very different
sentence from saying that most poor people have businesses
because they’re entrepreneurial. Because they’re so massively
overrepresented. They’re really unlikely people
to be entrepreneurs. So if they are entrepreneurs,
it’s not because they want to be. This is all consistent with the
fact that, if you look at these businesses, they’re
not really attractive economically. So one place where we have
detailed data, we could actually calculate how much
revenues these businesses were making, calculate profits. Now a key part of the
profit calculation– remember, almost none of these
firms have employees. So you have to evaluate the
time spent by the owner in running the business. Somehow, how do you
price that? So you price that
at minimum wage. These businesses lose money. So if I went out and worked at
minimum wage, I would make more money than if I did this
business and spent all the time I’m spending
in the business. Now, I’m not necessarily
working as hard in the business as I would be working
in other things. But it isn’t the case that
I’m making lots of money. I think this is a pattern that
people have noticed. Now, here’s a puzzle. I just said they don’t
make a lot of money. They’re not very profitable,
these business. Before, I’ve also told
you that they pay very high interest. So they must be generating
an extra $1. They must be generating
at least that much. So if I’m paying 60% interest,
$1 must be generating more than $0.60. If I’m investing $1 and then
paying 60% interest, that $1 must be generating
more than $0.60. How do those two facts
fit with each other? I said, A, they’re not
very profitable. B, the marginal $1 must be
making a high return, because otherwise they wouldn’t be
investing their marginal $1. You won’t borrow money at 60%
unless you can cover 60%. So we know that they’re
making lots of money. Yeah? AUDIENCE: This talked a
lot about in the book. But basically, there’s two
different types of return. One is marginal returns,
[INAUDIBLE] where an extra $1 spent,
what’s their return. The other’s the total return. For a lot of these businesses,
there is a point, early on, with this very high, marginal
return, and then it really levels off. So that’s what you run into,
where it’s possible that, if you have a very small
business, like the example in the book. Let’s say you have a shop, but
you really can’t put anything on the shelves. If you spend an extra $20, you
can actually have some candy on the shelves, then that
will produce very high marginal returns. But if you spend $300 and have
a lot of inventory, you might have to hire another employee. There’s risk of stuff spoiling, et cetera, et cetera. PROFESSOR: So I think that’s
absolutely right. But I was making an even simpler
point, here, which is that think of that business. The person who set up a shop. You invest your time
into the shop. And you invest the space. You invest the shelves. You invest the inventory. Then you start selling. So in particular, your time
is a fixed investment. Because you have now decided
that instead of working outside, I’m going to
stay in the shop. So you need to cover. To become profitable, you need
to cover your own daily wage. Let’s say you make $2 a day. Then even if you made a total
of $2 a day by selling, you would have just covered
your wage. Then you recover your
inventory, your capital cost, et cetera. So unless you operate at a high
enough scale, you’re not going to cover your time. And so one of the problems
is these people are often operating at a very
small scale. So they rarely manage
to cover their cost. But then why don’t these
people just grow their businesses? Maybe if they’re not making a
lot of money, because they have to cover their fixed cost,
then why not just keep investing till you make
a lot of money. Your marginal returns are high,
so you could invest more and make more money. And then the answer is, your
marginal are high, but not high for a very wide range. So they start falling
fast as well. So this is the picture
that is in the book. And it’s worth, probably,
understanding that picture. So that picture, it tells a
story of two technologies. There’s one technology which is
gives you a high return but quickly flattens off. And if that was the only
technology in the world, then we would not observe
any large funds. Because that’s a technology
which stops becoming profitable after a point,
very quickly. But there’s another technology,
which starts way to the right of that. And that technology is only
profitable if you invest. So what that curve says
is that there is two technologies. Production from technology two
is lower than production for technology one until you cross
a particular point. So you need to make enough
investment to make that profitable. So you’re going to buy a machine
which produces a lot of garments. But if you can’t buy the cloth
that goes with the machine, there’s no point in buying
the machine. You’re going to lose money for
sure, because you have nothing to use the machine with. Garments need a machine
and they need cloth. And you have only money for the
machine, then you should not buy the machine. You should buy the machine
only if you can buy the machine and buy the cloth. So there that are more
profitable technologies and less profitable technologies. But the disadvantage of the
more profitable technology turns out to be that you need
to invest enough in them to make money. So the problem is that the poor
are caught between a kind of a rock and a hard place,
which is that they can’t really get up to the
level at which they would make real money. Because that technology is just
too expensive for them. They don’t have that
much money. The technology that they can
access has very fast diminishing returns. So that one also is not
worth growing a lot. So that’s the sense in which
they’re between a rock and a hard place. They can’t grow the technology
fast enough. The one that they have,
they can’t grow. And the one that can grow,
they can’t have. And that’s what this
picture is about. If this is what the world looks
like, then the poor are stuck at a point, like M, and
the rich are stuck at point like that second
ball up there. So the poor are stuck, because
the technology that has growth is not available to them. And the one that’s available
to them does not have growth in it. So there’s no point in their
putting a lot of effort into growing their technology,
because they’re really not going to make a lot of
money either way. That would explain why they
don’t really want to be entrepreneurs, because they know
that they’re never going to get very far in
this process. So then that leaves us with
the last slide, well, actually, one slide
that suggests that this picture is right. There was this experiment in Sri
Lanka, where people were given, randomly, either $250
or $500 for investing. And this was just a gift. The World Bank, basically, did
this experiment, where it went to people and said,
here’s $250. These were all small
businessmen. Use it in your business or
do something with it. And some people, they
offered $500. It’s kind of nice experiment
to do, because you can find out what’s the effect on getting
money on people’s investment. And strikingly, if you
give $250, you get high marginal returns. So these people who get $250,
they invest $250, and they make about 60% a year on that. So that’s pretty good returns. On the other hand, if you give
them $500, they don’t invest the second $250. They just use it for repairing
their home. So they don’t believe that the
second $500 are going to grow their business that much more. They believe that there’s
diminishing returns. That’s why they don’t
invest it. So basically, the poor seem to
be acting as if they also believe exactly that picture,
that they have high returns on the first $250 but not
on the second $250. Yeah? AUDIENCE: So [INAUDIBLE] they just save up enough money
or take a loan out so that you can achieve or you can jump
the curve and buy the technology. PROFESSOR: Absolutely. AUDIENCE: So it’s like,
technically, giving loans to small businesses should work. PROFESSOR: Well, it depends
on how big the loan is. I think the problem is that
the jump is not at $500. The jump is at $10,000. So none of the loans they are
being offered allow them to make that jump. That’s the problem. AUDIENCE: And they’re
still too small to go to a normal bank? PROFESSOR: Yeah. that then brings us to the final
question, which is, if this is all not such
a great deal, why are they in business? Yeah, go ahead. AUDIENCE: Because
they have to be. PROFESSOR: Yeah. One is that they have to be. There’s a vicious cycle, here. Suppose no one can create a
business that’s big enough to hire employees. Then I can never be
an employee in somebody else’s firm. What else can I do? I can start my own business,
which can’t hire anybody. So if nobody is creating
businesses which have employees, then, in a
sense, I’m stuck. I can’t get a job, because
nobody else is creating those jobs. But if nobody else is creating
those jobs, then I can’t really work for anybody else. But I still have to earn a
living, so I go and find my own thing to do. So I think the primary reason
why you have a lot of entrepreneurs is because no
entrepreneur is big enough to hire the others. So everybody’s an
entrepreneur, a mini-entrepreneur. Nobody gets to the scale where
they can hire others. And therefore, everybody’s
kind of stuck. So if I start a business that
hires 10 people, then that stops 9 other people from
being an entrepreneur. That’s one reason. A second reason has to
do with flexibility. I think a lot of poor
people don’t have access to social services. So if I have to have childcare,
pay for childcare, I’m never going to able to
afford my business, because childcare is too expensive. So if I have to go out and get
a job, which is 9-to-5, and I have to work all
the time, who’s going to provide childcare? So often, they choose businesses
which are designed to work well with childcare. Like I took a snack
making business. Why? Because I can do it at home. I make the snacks at home. And then I go out to
sell for two hours. At that time, I take
my child with me. And then I bring
the child back. And that way, I don’t ever
have to deal with the childcare issue. So flexibility is
a second one. The third and most
worrying one– and microcredit makes me
worry about this most– is whether or not a lot of men
are very enthusiastic for the wives to work even harder. So they feel that, you know,
I’m working at a job. I would like my wife
to work harder. And the way they get their wives
to work harder is by making them start a business. So I don’t know whether
microcredit is necessarily wonderful for all
of these women. I think that, historically, men
have found it difficult to understand that women, even
though they don’t go out to work, actually have to work. They have like cooking
and cleaning dishes and washing up. They’re all hard work. And if you think that that’s a
problem in the US, now, then you can imagine in a lot of
developing countries, it’s even more of a problem. So it may well be that a lot of
men are under the illusion that their wives are idle. And that they are very willing,
therefore, to start a business for them, so they can
work a little harder and add to the family pie. So I don’t know how much of
these businesses are a result of that, rather than any desire
to start a business. Comments, questions? So just to close this whole
thing, I think the key policy question, that we don’t know the
answer to, is how to not get more businesses,
but more businesses that hire other people. That’s the key policy
question we haven’t managed to solve yet. And it’s an absolutely central
policy question for most developing countries to figure
out how to get not micro-businesses but
small businesses. And this is often called the
missing middle problem. In many countries, in poor
countries, you’ll find that there are many micro-businesses
and some large businesses, but not
enough middle-sized businesses. So that’s the policy problem
that many, many countries are wrestling with. And it’s one that, I think,
we haven’t yet got a very good handle on. But it’s something to think
about is how to generate those jobs. Yeah? AUDIENCE: So specifically in
developed countries, then, what provides the capital for
the middle businesses? PROFESSOR: So for one,
the state does a lot. Like in the US, for example,
there’s a Community Reinvestment Act, which means
that banks are required to provide a certain fraction of
their loans to the community where they are raising
the savings. So the CRA forces them, then,
to finance local businesses. And so there is a lot of
intervention, even in a country as uninterventionist
as the US, to help small businesses set up. This CRA is a very
good example. The Small Business
Administration is huge in the US, by the way. And they provide all kinds of
help to small businesses, including capital, including
guarantees. They give a lot of
loan guarantees. Even the US, which is one
of the world’s least interventionist countries,
tends to be very interventionist when it comes to
promoting small businesses. That’s probably the direction
that policy needs to go in developing countries. But it’s something we
know less about. OK. Thank you.

Author Since: Mar 11, 2019

  1. How the hell do you get into MIT then get into a really interesting class where you don't even have to think very hard and the material should be of your chosen career interest, but then you decide to play video games on your 4 inch iPhone screen.

  2. You are not entrepreneur if you have no idea what you are doing. It has to have some plan to it calculations , sense.
    For instance women with sand i doubt they came up with it or ran numbers to see is it really best thing for them to do.
    They just saw some woman do it and copied it without thinking much.
    Someone that owns farm. Its more like caste job than having your own business. Its not something he thinks about or something he chose to do. If his dad was baker and had small local bakery. He would be baker too.

    Self employed,yea. Entrepreneur no.

  3. there are these loooong breaks of silence when the students are just minding their own business on their own devices and the Prof. is revisiting his life decisions that led him to this moment!

  4. Genuinely great learning…. trying to teach from the real world problem and Case studies…. very sad to see the students are browsing in the class…… anyway that is so called MIT….

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