Journal article: Small firms, structural change and labor productivity growth in Africa: Evidence from Tanzania


by PIM

Africa’s impressive economic performance over the past two decades has been accompanied by a proliferation of small firms, many of which operate in the informal sector. Researchers at the African Development Bank estimate that the informal sector accounts for approximately 55 percent of the gross domestic product (GDP) in Africa south of the Sahara and 80 percent of its employment. This finding is potentially alarming because firms in the informal sector are widely viewed as unproductive employers of last resort.

With their new paper Small firms, structural change and labor productivity growth in Africa: Evidence from Tanzania (World Development, May 2018), Xinshen Diao, Josaphat Kweka, and Margaret McMillan aim is to contribute to the understanding of the role that small firms play in a rapidly growing, but still poor, African economy.

Mama Nalepo in her shop in the local market of Mamura village in Arusha, Tanzania. Photo: UN Women/Deepika Nath

Focusing on Tanzania, the authors find that at 4.1 percent per year, labor productivity in the country grew more rapidly between 2002 and 2012 than at any other time in recent history. They also show that employment growth kept up with population growth at roughly 2.5 percent per year. The bulk of this employment growth, almost 90 percent, has occurred in the nonagricultural sector. However, more than 80 percent of employment growth in the nonagricultural sector is accounted for by largely informal enterprises. The authors conclude that because employment growth in the informal sector has been much more rapid than employment growth in the formal sector - and there is no indication that this is likely to change any time soon - more attention needs to be paid to firms in the informal sector.

The authors use Tanzania’s first nationally representative survey of micro-, small-, and medium-sized enterprises (MSMEs) to explore the nature of these businesses and their contribution to economywide labor productivity growth. These firms operate primarily in the manufacturing and trade services sectors and are distributed across regions roughly in proportion to population density. Roughly half of MSME business owners would not quit their businesses for a full-time salaried position.

Diao et al. estimate that MSMEs contributed roughly one percentage point to economywide labor productivity growth in Tanzania between 2002 and 2012. A small subset of firms with above average labor productivity accounted for the bulk of this growth. The authors hypothesize that these small yet highly productive MSMEs are most likely to contribute to future growth and identify the following readily observable characteristics of high potential MSMEs: they are more likely to keep written accounts in a ledger, and the owners of firms in the in-between sector are more likely to save money in a formal bank account. The authors argue that these characteristics could be used for targeting financial and other services.


Diao, Xinshen; Kweka, Josaphat; and McMillan, Margaret S. 2018. Small firms, structural change and labor productivity growth in Africa: Evidence from Tanzania. World Development 105 (May 2018): 400-415.

This work was undertaken as part of the CGIAR Research Program on Policies, Institutions, and Markets (PIM) under research flagship Economywide Factors Affecting Agricultural Growth and Rural Transformation. The authors thank the International Growth Centre and PIM for financial support.