Do Entry Costs Provide an Empirical Basis for Poverty Traps? Evidence from Mexican Microenterprises

This paper explores the possibility of non-divisible start-up costs preventing entry to self-employment or resulting in low returns from entering with small amounts of capital.

The paper examines the empirical relevance of the assumptions that minimum start-up costs are high relative to entrepreneurs’ wealth, and that returns to capital are low at low investment levels. Findings suggest that:

• Median investment levels of new firms in some sectors are very low, less than US $100 in construction and personal services;
• Marginal return to capital invested in these sectors is quite high for low levels of invested capital;
• Returns to capital are above 15 percent a month for investment levels below US $200, substantial for investment levels below US$1000, and more moderate for investment levels above US$1000;
• Inclusion of the ability controls does not result in a marked change in the estimated return to capital, although measures of entrepreneurs’ ability and firm earnings are positively correlated.

Finally, access to startup capital does not determine the ultimate size of the enterprise. Entrepreneurs without startup capital can pull themselves up by their bootstraps by reinvesting their profits.