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2009 AEC-On Determinants of SMEs in Ethiopia Which Incentives Matter


Since coming to power in 1991, the Ethiopian government has strived to create an environment that supports entrepreneurship. Almost 20 years later, however, the highly productive small and medium-sized enterprise (SME) sector remains limited. This paper develops a simple theoretical model of SME start ups with frictions in the business climate and the labor market that characterize the Ethiopian institutional landscape. It finds that subsidizing entrepreneurs’ search may encourage start-ups, but it needs to be accompanied by improvements to the business environment and functioning of the labor market. Wage subsidies would be less effective in stimulating SMEs, but they could encourage firms to move from the informal to the formal sector. Since unclear property rights constitute potentially the most severe form of taxation, reforming them is key.

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