Returns to Physical Capital in Ethiopia: Comparative Analysis of Formal and Informal Firms

Abstract

Summary This paper investigates returns to capital in the formal and informal sectors in Ethiopia using parametric and semi-parametric regression techniques. Results show that there is a higher annual median return to capital in the informal sector (52–140%) than the formal sector (15–21%). However, informal firms might benefit from working formally as their capital stock gets larger. Marginal returns in the informal sector increase with: firm size, access to reliable markets, market uncertainty, and owners’ labor supply. On the other hand, marginal returns to capital and overall profitability decrease with capital stock, contrary to the poverty trap hypothesis.