Informality, Ethnicity and Productivity: Evidence from Small Manufacturers in Kenya

A rapidly increasing share of firms in Kenya consists of not only small but also informal establishments. This paper investigates the role of ethnicity and other factors in the choice of formality status at start-up. Differences in productivity, investment and growth across the formality and ethnicity divide are also investigated. The results show that while African-owned firms are more likely to start informally, enterprises owned by either professionals or persons who are older are less likely to start informally. African informal firms are more efficient than African formal firms are, but both categories are less efficient than Asian-owned formal firms are. We conclude that ethnicity is important in explaining choice of formality status, while the network implications of ethnicity account for the differences in firm productivity, investment and growth prospects. It is possible to mainstream informal enterprises by reducing cost related to business registration. However, additional analysis is needed to unpack the ethnic variable en route to developing policy interventions for improving the performance of small scale manufacturing in Kenya.