Does manager education play a role in the productivity of informal firms in developing economies? Evidence from firm‐level surveys

• Published date: 01 May 2022
• Author: Mohammad Amin,Asif M. Islam
• Date: 01 May 2022
• DOI: http://doi.org/10.1111/rode.12864

962 

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     wileyonlinelibrary.com/journal/rode  Rev Dev Econ. 2022;26:962–984.

© 2022 John Wiley & Sons Ltd

Received: 3 August 2021 

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  Revised: 22 December 2021 

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  Accepted: 13 January 2022

DOI: 10.1111/rode.12864  

REGULAR ARTICLE

Does manager education play a role in the

productivity of informal firms in developing

economies? Evidence from firm- level surveys

MohammadAmin1,2

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Asif M.Islam3

1Enterprise Analysis Unit, World Bank 

Country Office in Kuala Lumpur, Kuala 

Lumpur, Malaysia

2Enterprise Analysis Unit, World Bank 

Country Office, Washington, District of 

Columbia, USA

3Office of the Chief Economist, Middle 

East and North Africa Region, World 

Bank, Washington, District of Columbia, 

USA

Correspondence

Mohammad Amin, Enterprise Analysis 

Unit, World Bank Country Office in 

Kuala Lumpur, Malaysia and Washington 

DC, USA.

Email: mamin@worldbank.org

Abstract

The informal  sector is  dominant in  developing econo-

mies, and the vast majority of the  poor rely on it. There 

is much to learn about informal firms— the “businesses 

of  the  poor”— as little  is  known  about  the  drivers  of 

their  performance.  The  present  paper  attempts  to  fill 

this gap in the literature by analyzing how labor produc-

tivity of informal firms in developing countries depends 

on  the  level  of  education  of  the  manager  or  the  main 

decision- maker of the firm. Using survey data  for 3,854 

informal or unregistered firms in 18 countries in Africa, 

Asia, and Latin America, we find that labor productivity 

is 28% to  33% higher when the  manager has secondary 

or higher education  versus only  primary education  or 

no education.  The  finding is  robust to  various robust-

ness checks  including parametric and semi- parametric 

specifications  and  confirmed  using  instrumental  vari-

ables estimation.

KEYWORDS

Africa, education, informal, labor productivity, manager

JEL CLASSIFICATION

O17; L26; L21; J24

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963

AMIN and ISLAM

1

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INTRODUCTION

Addressing the informal sector is  a challenge for governments. Policy- makers continue to grap-

ple with the sector's importance in providing livelihoods for millions of  people, coupled with its 

low productivity relative to  the formal sector. While the low productivity of  the informal sector 

has been  a long- standing concern,  policy efforts  to improve productivity  have been hampered 

by a limited understanding  of the productivity drivers in  the sector. The present study  attempts 

to fill  this gap in  the literature by  analyzing the role of education  of the  firm's main decision- 

maker (henceforth,  manager) in  affecting the  labor productivity  of informal  firms. Firm- level 

survey data on informal firms in 18 developing countries collected by the World Bank confirm a 

large positive impact  of higher manager  education on firms’ labor productivity. A  conservative 

estimate is that labor productivity  increases by 28% when the manager has secondary or higher 

education versus no or primary education. The positive relationship is robust to various controls, 

alternative estimation methods, and it holds for various subsamples of informal firms.

Available estimates suggest that in developing countries, the informal sector accounts for about 

one- third of gross domestic product (GDP) and  70% of employment (Loayza,2016; Ohnsorge & 

Yu,2021). The sector has also grown over the last few decades, defying expectations that it would 

fade away with economic development. Situations where  countries are running out of industri-

alization opportunities (premature deindustrialization) may  shift workers towards the informal 

sector (Rodrik,2016). Furthermore,  the formal sector may be  unable to absorb a growing work 

force due to rising populations, as  evident in developing economies, leaving the informal sector 

as the only option. Finally, the informal sector may be the sector of choice for those seeking more 

flexible arrangements (Maloney,2004). Thus, while reducing informality is important within the 

context of improving social protection and safety nets for workers, the informal sector is unlikely 

to decline substantially anytime soon. Therefore, policies aiming to improve the informal sector 

are likely to be pertinent. Thus, we believe that our findings are relevant for academic as well as 

policy- related reasons.

While there are exceptions, the literature linking labor productivity with education is  largely 

focused  on  the  formal  sector, and  on  worker  education  rather  than  manager  education  (see 

Bartelsman  &  Doms, 2000;  Nichter  &  Goldmark, 2009;  Rosholm  et  al.,  2007;  Zhang, 2017). 

Nevertheless, important insights can be gleaned  from this body  of work that  may explain why 

and how manager  education may affect labor productivity. These insights and explanations are 

discussed in  Section2. Having said  that, the need  to empirically verify the  manager education 

and labor productivity relationship for the informal sector remains. The reason for this is that the 

formal and informal sectors are very different, and what benefits the formal sector may not ben-

efit the informal sector. For instance, educated managers may be better at managing labor issues, 

but this may be of little  value to most informal  firms that operate with either no employees  or 

very few employees. Focusing on the informal sector, La Porta and Shleifer (2008, 2014) point out 

there is a quite a gap  between the education of managers in informal  versus formal firms. They 

argue that this gap is what makes formal  firms far more productive. Note that the study focuses 

on contrasting the formal and informal sectors, and hence it is silent on how manager education 

affects productivity of firmswithinthe informal sector. Jones (2001) explores the relationship be-

tween education and productivity for both informal and formal firms, but focuses only on worker 

education in Ghana.

This study contributes to the literature in the several ways. First,  it investigates the relation-

ship between manager education and labor productivity for informal firms, a hitherto neglected 

but important issue in  development economics. We provide several layers of robustness  for our