Front Cover
 Title Page
 Table of Contents
 List of Tables
 Descriptive profile of rural non-farm...
 Determinants of the role of rural...
 Major policy and project issue...
 Back Cover

Title: Rural non-farm employment
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Table of Contents
    Front Cover
        Front Cover 1
        Front Cover 2
    Title Page
        Title Page 1
        Title Page 2
        Page i
        Page ii
        Page iii
        Page iii-a
    Table of Contents
        Page iv
        Page v
    List of Tables
        Page vi
        Page vii
        Page 1
    Descriptive profile of rural non-farm activities
        Page 2
        Page 3
        Page 4
        Page 5
        Page 6
        Page 7
        Page 8
        Page 9
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        Page 12
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        Page 15
        Page 16
        Page 17
        Page 18
        Page 19
        Page 20
        Page 21
    Determinants of the role of rural non-farm activities
        Page 22
        Page 23
        Page 24
        Page 25
        Page 26
        Page 27
        Page 28
        Page 29
        Page 30
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        Page 44
        Page 45
        Page 46
        Page 47
        Page 48
        Page 49
        Page 50
        Page 51
    Major policy and project issues
        Page 52
        Page 53
        Page 54
        Page 55
        Page 56
        Page 57
        Page 58
        Page 59
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        Page 92
        Page 93
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        Page 95
        Page 96
        Page 97
        Page 98
    Back Cover
        Page 99
        Page 100
Full Text

Ilk OW

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Carl K. Eicher and Carl :L:edholm, Co-editors,
. =<***

:. .. The MS
S and: the Ne
S development
S on a wide
I non-farm e
; farmers; a
:;. faculty an
;: :... ...::relsearch a

:: The pa
transl ated
Sand instit
S...and .may re
n ': otific:ati

S.. . ..

* :" .. .. '
' .:. ,. .

... : .. . mm

U Rural Development Paper series is designed to further the
e analysis of rural...development :in Africa, Latiln America, Asia
aar East. The papers will :report research findings onl community:'
t and rural development ini historical perspective :as well .as an
ry rural development programs.. The series.will include paper :
range of topics such .as. alternative rural development strategies;
employmentt and smallTscaTe industry; marketing problems of small
agricultural extension; interrelat:i onships between technology, ..
, and income distributionn; and evaluation of rural development .
While the paperss will convey the. research findi::ngs of MSU
d visiting'schblars, :a few. pape-r will :be published by. re- ..
and policy-makers working with I:MSU scholars on cooperative .
nd action programs in the ..ieid.

pers are aimed at.teachers, researchers, policy-makers, donor
and rural development practitioners. Selected papers will be
into French, Spanish, and.Arab ic. Libraries, individuals,
utions may obtain single. c-ies of the MSU papers free of charge
quest their names be placed on a.mailing list for periodic
ons of published papers by writing to:

MSU Rural Development Papers
Department of Agricultural Economics
206 International Center.
Michigan State University
East Lansing, Michigan 48824

.*t;; .:;.~.:; ;; ..;:. 'lr: ; ;i

i .

:I :

:i: I




Enyinna Chuta**
Carl Liedholm***


*This paper has been developed and published as part of Michigan
State University's Off-Farm Employment Project, which is financed
by the Office of Rural Development and Development Administration,
Development Support Bureau, U. S. Agency for International Devel-
opment. (AID/ta-CA-2)

**International Labour Office (Geneva)
***Professor of Economics, Michigan State University


This paper is one of a series of reports produced by Michigan State

University's Off-Farm Employment Project. The project, which is funded

by the Office of Rural Development and Development Administration,

Development Support Bureau, U. S. Agency for International Development,

has the basic purpose of enhancing the ability of AID missions and host

country institutions to identify and implement programs and policies that

generate off-farm employment and income opportunities benefiting the rural

poor. One of the major components of the project is the generation of

new knowledge relating to rural non-farm activities. In collaboration

with host country institutions and AID missions, detailed field surveys

of small-scale enterprises are currently being conducted in Bangladesh,

Jamaica, Honduras, and Thailand; the results of these studies will be

published in this series. A second component of the project involves the

marshalling and dissemination of existing knowledge of rural non-farm

activities. The present State of the Art paper fits into this project

component. This paper, however, should be viewed as only an initial effort

at disseminating and reviewing the existing knowledge, since a major

monograph, building on the State of the Art paper and the results of the

individual country studies, will subsequently appear in this series along

with several other case studies. Previously completed studies in this

area currently available through the Off-Farm Employment Project include:

1. Carl Liedholm, "Research on Employment in the Rural Non-farm
Sector in Africa," African Rural Employment Paper No. 5,
2. Carl Liedholm and Enyinna Chuta,"The Economics of Rural and
Urban Small-Scale Industries in Sierra Leone," African
Rural Employment Paper No. 14, 1974.

3. Enyinna Chuta, "The Economics of the Gara (Tie-Dye) Cloth
Industry in Sierra Leone," February, African Rural
Economy Working Paper No. 25, 1978.
4. Adewale Mabawonku, "An Economic Evaluation of Apprenticeship
Training in Western Nigerian Small-Scale Industry,"
African Rural Employment Paper No. 17, 1979,
5. Steve Haggblade, J. Defay and Bob Pitman, "Small Manufacturing
and Repair Enterprises in Haiti: Survey Results,"
Michigan State University Rural Development Series,
Working Paper No. 4, 1979.

Copies of these papers as well as additional information on the Off-Farm

Employment Project can be obtained by writing:
Carl Liedholm
Off-Farm Employment Project
Department of Agricultural Economics
Michigan State University
East Lansing, Michigan 48824


Several individuals contributed to the production of this monograph

and their assistance deserves recognition. Herb Kriesel actively partic-

ipated at all stages of the project and played a major role in shaping

the final document. Dennis Anderson, Cliff Barton, Steve Haggblade,

Peter Kilby, and Paul Strassmann read earlier drafts and made detailed

and valuable comments that greatly improved the final manuscript. We

also benefited from the comments of the participants attending Michigan

State University's (May 1979) Off-Farm Employment Conference, where a

preliminary draft of this paper was actively discussed. Useful assistance

was also provided by other members of the Off-Farm Employment Project

including: Jim Boomgard, Yacob Fisseha, Annette Francis, Jim Pease

and Judy Stallmann. Special credit for putting all of this in print

under tight schedule goes to Anne Morris, who produced the final manu-

script in record time.



1. INTRODUCTION . . . . . . . ... . . . 1

2.1 Importance of Rural Non-farm Activities . . . 2
2.1.1 Primary Employment . . . . . . . . 3
2.1.2 Secondary Employment . . . . . . . 5
2.1.3 Importance of Non-farm Income . . . . . . 6
2.2 Sectoral Composition of Rural Non-farm
Activities . . . . . . . . . . 8
2.3 Equity Implications of Rural Non-farm
Activities . . . . . . . . . . 11
2.3.1 Size of Enterprises Engaged in Rural
Non-farm Activities . . . . . . . . 12
2.3.2 Rural Non-farm Earnings and Wages . . . . .. 12
2.3.3 Relation of Non-farm Activities to
the Landless and Near Landless . . . . .. 14
2.4 Growth of Rural Non-farm Activities . . . ... 16

3.1 Demand for Rural Non-farm Activities . . ... 22
3.1.1 Rural Income . . . . . . . .... . 22
3.1.2 Backward and Forward Production Linkages . . .. 24
3.1.3 Foreign and Urban Demand . . . . . . .. 29
3.2 Supply of Rural Non-farm Activities . . . .. 30
3.2.1 Labor Intensity of Rural Non-farm Activities . 31
3.2.2 Labor Productivity ................ 32
3.2.3 Capital Productivity of Rural Non-farm
Activities . . . . . . . ... ........... 35
3.2.4 Alternative Production Techniques in
Rural Non-farm Activities . . . . . .... .39
3.2.5 Economies of Scale in Rural Non-farm
Activities . . . . . . . . . . 43
3.2.6 Profit, Savings, and Reinvestment Rates
of Rural Non-farm Activities . . . . ... 45
3.2.7 Supply of Entrepreneurship . . . . .... 48

4.1 Introduction . . . . . . . .... . 52
4.2 Policies Resulting in Factor Price
Distortions . . . . . . . . ... 54
4.2.1 Interest Rates . . . . . . . . ... .54
4.2.2 Tariffs . . . . . . . . . . . 56
4.2.3 Foreign Exchange . . . . . . . . 58



4.2.4 Other Tax Incentives . . . . . . .... 58
4.2.5 Minimum Wage Regulations . . . . . .... 59
4.3 Policies with Nonprice Supply Effects ...... 60
4.3.1 Development of Infrastructure . . . . .. 60
4.3.2 Industrial Policies . . . . . . . . 61
4.4 Policies Affecting the Demand for
Rural Non-farm Activities . . . . . 62
4.5 Rural Non-farm Enterprise Project
Issues . . . . . . . .. .. . . 64
4.5.1 Introduction . . . . . . . . .. . 64
4.5.2 General Project Issues . . . . . .... 64
4.5.3 Specific Project Issues . . . . . .... 65 Credit Assistance . . . . . . .... 66 Technical Assistance . . . . . . .... 72 Management Assistance . . . . . .... 75 Marketing Assistance . . . . . . .... 76 Common Facilities . . . . . . . ... 78

5. SUMMARY . . . . . . . ... ... .. .79

BIBLIOGRAPHY . . . . . . . . ... .. .. .85



HOUSEHOLD INCOME . . . . . . .











. . . 4

. . . 7

. . . 9

. 15

. . . 18

. . . 33



. . . 55

. . . 57

. . . 67




International donor agencies and the governments of many developing

countries have recently begun to devote increasing attention to the

development of policies and programs for expanding productive employment

and earnings opportunities in the various rural non-farm activities under-

taken in developing countries. This growing interest stems from and

reflects the increased international concern for equity and employment

objectives, and the corresponding reduction of emphasis on the earlier

strategies that had focused primarily on growth and output objectives.

The de-emphasis of growth and output objectives reflects a disillusionment

with the inequitable results of rapid growth in certain countries and

the disappointing results of the attempts to rapidly industrialize by

establishing large-scale, urban-based, capital-intensive industries. In

a number of developing countries, not only was the overall rate of growth

quite low, but employment in the industrial sector failed to keep pace

with population growth and, in some cases, even declined in absolute terms.

Unfortunately, there have been few empirical or analytical studies of

rural non-farm economic activities in developing countries. The excellent

World Bank paper on rural enterprise and non-farm employment (World Bank,

1978a) notes, for example, that "there is little concrete evidence" on

many of the important characteristics of these activities, and Morawetz

(1974, p. 525), in his recent review of the literature, states that

"remarkably little is known about its composition and characteristics."

As a result, those charged with formulating and executing rural non-farm

programs and policies are generally forced, of necessity, to make decisions

"unencumbered by information."

The present paper is an attempt to fill the information lacuna

relating to rural non-farm economic activities in developing countries.

Although the paper, of necessity, concentrates on rural non-farm

activities, one must continually keep in mind that these activities

represent only one facet of the rural development process. The

first section provides a descriptive profile of rural non-farm

activities and sets forth the most important issues relating to their

nature, extent, and composition. The second section examines the deter-

minants of their role in development and focuses on factors influencing

the demand for and supply of these activities. A final section examines

the major policy and program issues relating to rural non-farm activities.


There are several important sets of issues relating to the extent and

nature of rural non-farm activities. These are mainly descriptive issues,

which can usefully serve to provide a foundation for understanding the

role of rural non-farm activities in developing economies. The issue areas

are: 1) the quantitative significance of rural non-farm activities;

2) their sectoral composition; 3) equity implications; and 4) growth


2.1 Importance of Rural Non-farm Activities

One of the first issues to be considered is whether or not non-farm

activities are quantitatively an important component of the rural economy.

Given the paucity of comprehensive income and value added statistics

relating to rural areas of most developing countries, one must, of necessity,

rely primarily on employment data for illumination of this issue. The

importance of non-farm activities as a source of primary employment in

rural areas will be examined first, followed by a consideration of the

importance of these activities in providing secondary or part-time employ-

ment; the relative importance of non-farm income is then discussed.

2.1.1 Primary Employment

The evidence available from national censuses and various regional and

rural surveys indicates that non-farm activities provide an important

source of primary employment in the rural areas of most developing countries.

In the vast majority of the eighteen developing countries where relatively

recent data on the subject are available, one-fifth or more of the rural

labor force is primarily engaged in non-farm activities (table 2.1).

Although the rural non-farm percentage ranged from 14 to 49 percent, in

over three-quarters of the countries the percentage fell between 19 and 28


The figures provide a minimal estimate of the magnitude of primary

employment in rural areas. First, they generally reflect the employment

charactersitics of the rural villages with populations below 5,000; if the

larger rural towns were included, the rural non-farm percentage would

likely be larger.I Second, there are certain measurement errors that

operate to cause systematic undercounting of non-farm activities. In some

African countries rural respondents will claim farming to be their main

See, for example, the evidence cited in the World Bank, 1978a. The
dividing line between "rural" and "urban" is arbitrary, particularly in
census data collected in most countries. They are often framed in terms
of urbanization characteristics rather than minimum size or occupational
structure size and, consequently, settlements of a few thousand are often
classified as "urban." The U.N. definition of "urban" is localities with
20,000 or more inhabitants. This broader definition, which includes small
and medium sized towns, is used in this paper.




Percentage of Rural
Labor Force Primarily
Country Year Coverage Employed in Non-Farm
Sector (%)

Guatemala 1964 All rural 14%
Thailand 1970 All rural 18
Sierra Leone 1976 Male-rural 19
South Korea 1970 All rural 19
Pakistan 1970 Punjab only 19
Nigeria 1966 Male-3 dist. W. State 19
India 1966 All rural 20
Uganda 1967 Four rural villages 20
Afghanistan 1971 Male-Paktia Region 22
Mexico 1970 All-Sinaloa State 23
Colombia 1970 All rural 23
Indonesia 1971 All rural 24
Venezuela 1969 All rural 27
Kenya 1970 All rural 28
Philippines 1971 All rural 28
W. Malaysia 1970 All rural 32
Iran 1972 All rural 33
Taiwan 1966 All rural 49

1. Guatemala: World Bank (1978a)
2. Thailand: Thailand (1973)
3. Sierra Leone: Byerlee, et al.(1977)
4. Korea: Korea (1972)
5. Pakistan: World Bank (1978a)
6. Nigeria: Mueller and Zevering (1970)
7. India: World Bank (1978a)
8. Uganda: Brandt, et al. (1972)
9. Afghanistan: Gerken (1973)

Mexico: World Bank (1978a)
Colombia: World Bank (1978a)
Indonesia: Leiserson (1974)
Venezuela: World Bank (1978a)
Kenya: I.L.O. (1972)
Philippines: I.L.O. (1974)
West Malaysia: World Bank (1978a)
Iran: Dhamija (1976)
Taiwan: Ho (1976)


occupation even if they engage only part-time in this activity. In

addition, women's participation in non-farm activities is often not

counted as employed labor even when these activities result in trans-


2.1.2 Secondary Employment

These primary employment statistics also understate the magnitude

of rural non-farm activities, because they fail to reflect those farmers

who engage in non-farm activities on a part-time or seasonal basis.

Data on secondary employment are not generally available for most countries.

The limited evidence indicates that from 10 to 20 percent of the rural

male labor force undertake non-farm work as a secondary occupation. In

Western Nigeria, for example, 20 percent of the rural males engaged in

non-farm work on a part-time basis, while in Sierra Leone, Afghanistan,

and Korea, the figures were 11, 16, and 20 percent, respectively.1

There are significant monthly variations in the amounts of rural

farm and non-farm employment over the agricultural cycle. Farm and non-

farm employment move in opposite directions. There is no period when

non-farm employment disappears and, thus, non-farm employment does compete

with farm employment during periods of the peak agricultural demand. Data

from Nigeria reveal that the peak in non-farm labor use is nine times that

in the slack periods (Norman, 1973). The fluidity of labor between a

number of activities on a seasonal basis is thus a striking feature of

rural areas.

For sources, see table 2.1.

In summary, non-farm activity in rural areas thus appears to provide

a source of employment for from 30 to 50 percent of the rural labor force

in the developing nations, when primary and secondary occupations are

included. Consequently, in terms of employment, non-farm activities are

quantitatively an important component of the rural economy2 that should

not be overlooked in the design of rural development policies or programs.

2.1.3 Importance of Non-farm Income

In view of the magnitude of rural non-farm employment, it is not

surprising that non-farm activities also provide an important source of

income for rural households. Although data on rural incomes are generally

lacking for most countries, the evidence from those countries where

information is available indicates that non-farm earnings account for

over one-fifth of total rural household income (see table 2.2). Indeed in

Sierra Leone, where a detailed rural household survey was recently under-

taken, non-farm income was found to provide 36 percent of rural household

income, while in Taiwan the comparable figure was 43 percent.3

1There is evidence that the figure may be as high as 50 percent in
some countries. Luning (1967), in a survey of rural villages in Northern
Nigeria, reports that 48 percent of the employed males engaged either
full or part-time in rural non-farm activities, while Norman (1973) reports
that, in the same area, 47 percent of male labor time is devoted to these

Several recent historical studies have revealed that non-farm
activities were important, amounting from one-third to two-thirds of
rural occupations, in rural areas of Europe during the 16th and 17th
centuries. See, for example, MacFarland (1977, p. 157) for U.K. and
DeVries (1974) for Holland.

3Moreover, in the Philippines (I.L.O., 1974, p. 504), 37 percent of
the rural households derived their main sources of income from non-farm



Country Year Percentage

Korea 1975 22%

Pakistan (5 villages) 1968 23

Northern Nigeria (3 villages) 1974 28

Sierra Leone 1974 36

Taiwan 1975 43

Japan 1975 70








Korea: Korea (1975)

Pakistan: Kuhnen (1968)

Northern Nigeria: Matlon (1977)

Sierra Leone: Unpublished results of African Rural Employment

Taiwan: Taiwan (1976)

Japan: Japan (1976)

2.2 Sectoral Composition of Rural Non-Farm Activities

Another set of issues revolves around the sectoral composition of

rural non-farm activities. Specifically, what are the types of activities

undertaken within the sector, and which of these are quantitatively the

most important?

There is a wide array of activities being undertaken within the rural

non-farm sector. In terms of the Standard Industrial Classification

categories, the most important components are manufacturing, services,

and commerce activities. This composition is revealed in table 2.3, in

which data are presented on the breakdown of primary employment in rural

areas for selected developing countries. Manufacturing ranges from 22 to

46 percent, commerce ranges from 11 to 35 percent, while services range

from 10 to 50 percent of total rural non-farm employment.1 Other non-farm

activities, such as construction, transport, and utilities, generally

account for less than 25 percent of rural non-farm employment.2

The relative importance of rural, as opposed to urban, manufacturing

may appear somewhat surprising. There is empirical evidence to indicate

that employment in small, rural manufacturing enterprises often exceeds

that in large urban manufacturing firms. In Sierra Leone, 86 percent of

the total manufacturing sector employment and 95 percent of the manufacturing

establishments were located in rural areas (Liedholm and Chuta, 1976).

The percentage of rural manufacturing employment in other countries ranges

1Agricultural processing and marketing activities would be reflected
in these figures; fishing and livestock activities would not.

2The exception is Afghanistan, where transport (particularly camel
driving) is an important rural non-farm activity.



Sierra Phil-
Afghanistan India Indonesia Leone ippines Korea Colombia Malaysia Taiwan
(1970) (1966) (1971) (1975) (1970) (1970) (1970) (1970) (1966)

Manufacturing 46% 39% 29% 40% 34% 30% 33% 22% 27%
Construction 9 14 5 2 11 10 8 5 4
Trade and Commerce 11 14 34 35 15 24 19 22 13
Services 10 24 27 23 30 29 33 41 50
Other 24 9 5 -- 10 7 7 10 6
100% 100% 100% 100% 100% 100% 100% 100% 100%

NOTES: Includes utilities, transport,

and miscellaneous; omits "other and unknown."

Afghanistan: Gerken (1973)
India: World Bank (1978a)
Indonesia: Leiserson (1974)
Sierra Leone: C. Liedholm and E. Chuta (1976)
Philippines: I.L.O. (1974)
Korea: Korea (1972)
Colombia: World Bank (1978a)
Malaysia: World Bank (1978a)
Taiwan: Ho (1976)


from 70 percent in Bangladesh (Bangladesh Institute of Development Studies,

1979), 63 percent in Malaysia (World Bank, 1978b), 57 percent in India (World

Bank, 1978b), to 32 percent in Korea (Korea, 1972). These figures may actu-

ally understate the true magnitude of rural manufacturing activity because

country censuses often fail to pick up the very small rural enterprises.

The Sierra Leone small industry survey found that rural manufacturing

employment had been underestimated in Sierra Leone by almost one-half

(Liedholm and Chuta, 1976). A recent pilot rural industry survey in

Bangladesh indicated that, in one rural district, the number of rural

firms was twenty times greater than indicated by the official statistics

(Ahmed, Chuta, Rahman, 1978).

Within the rural manufacturing component of the rural non-farm sector,

there is a surprising diversity of activities undertaken. The most im-

portant activity in the majority of countries appears to be clothing

production followed by wood working, metal working, and food processing.

Clothing production, for example, accounted for 53 percent of the rural

manufacturing employment in Sierra Leone, 41 percent in Korea, 24 percent

in Taiwan, 32 percent in Western Nigeria, and 52 percent in rural Bangladesh.

Several alternative, sometimes conflicting, classification schemes

have been developed that reflect and highlight the differing forms or

subsectors of activities within the rural non-farm sector. The "informal

sector," a concept popularized by the I.L.O. (1972), refers to activities

that "operate largely outside the system of government benefits and

regulations" and are characterized particularly by ease of entry, small

scale of operation, family ownership, and unregulated and competitive

markets; the "formal sector" activities are essentially the obverse of

these "informal activities."1 Within the manufacturing sector, a distinction

is often made between "artisan activities," where production is completely

under the direction of the owner, and "small factories," where there is

a greater division of labor and the manager, rather than the artisan, is

the central figure (Staley and Morse, 1965, p. 7). A common dividing line

between the two is frequently ten workers. Finally, the World Bank (1978b)

distinguishes "artisan and informal enterprise" from "modern small

enterprise having perhaps ten to fifty workers."1 The available evidence

indicates that the vast majority of the existing rural non-farm enterprises

in developing countries would fall in the "artisan and informal enterprise"


2.3 Equity Implications of Rural Non-farm Activities

The next set of issues focus attention on the equity implications of

rural non-farm activities. Specifically, what is the size of rural non-

farm enterprises, what is the relative income earned by those engaged

in these activities, and finally, what is the relation of rural non-farm

activities to the landless and near landless?

1Steel (1978) recommends a tripartite division between: (1) "casual
and home production," where the marginal product of labor is zero, there
are only family employees, and there are no barriers to entry; (2) the
"intermediate sector," where there are barriers to entry making the marginal
product of labor positive; and (3) the "modern" sector, where there are
severe barriers to entry.

2See below, p.12.

2.3.1 Size of Enterprises Engaged in Rural Non-farm Activities

The size of the enterprises engaging in rural non-farm activities is

an issue of some interest. Variations in size are particularly important

for ascertaining the equity implications of rural non-farm policies or


The available empirical evidence is limited but does indicate that

the vast majority of rural non-farm activities are undertaken by very

small-scale, artisan and informal enterprises. In Sierra Leone, the

average rural industrial firm employed 1.6 workers, and 99 percent of the

firms employed less than 5 individuals (Liedholm and Chuta, 1976). In

rural Jamaica (Davies, Fisseha, Francis, and Kirton, 1979), the average

rural enterprise engaged 1.8 workers. In rural Western Nigeria, an I.L.O.

survey reported that the average industrial firm engaged 2.6 workers (Mueller,

et al., 1970). The results from a similar survey in rural Bangladesh revealed

the average rural enterprise employed 3.8 workers, inclusive of proprietors,

and 84 percent of the enterprises engaged fewer than 6 workers (Bangladesh

Institute of Development Studies, 1979). These findings indicate that

most rural enterprises are of a very small size and thus may be potentially

an important target group for policy makers concerned with the poor.

2.3.2 Rural Non-farm Earnings and Wages

A related issue centers on whether or not the earnings from rural

non-farm occupations or the average incomes of non-farm rural households

"Small-scale" is not a precisely defined concept. There are at
least 50 different definitions used in 75 countries. (See, for example,
Staley and Morse, 1965, and Georgia Tech., 1975). As a working definition
for this paper, "small-scale" is defined to include those establishments
employing less than 50 persons.

are above those in agriculture. This issue is of particular importance

given the increased concern with income distribution, and more specifically,

the widespread interest in identifying the sectoral characteristics of

the rural and urban poor.1

The rather limited amount of available data suggest that, on the

average, the wages and incomes generated by rural non-farm activities

generally exceed those generated by farming. In Sierra Leone, for example,

the income per consumer equivalent for rural non-farm households was $155

while that for farming households was $125.2 In Malaysia, the differential

was even larger, with the income per family member for non-farm households

amounting to $402 and that for land-abundant padi farmers amounting to
$230 (Bell and Hazell, 1976). The lack of detailed data for other areas,

however, makes it difficult to assert with complete confidence that such

differentials necessarily exist in all countries. Moreover, these figures

are averages and mask important variations by season, region, sex, education,

skill level, and type of employer (see, for example, Byerlee, et al., 1976).

There is preliminary evidence to indicate that there is a positive

association between non-farm income sources and income level in some rural

areas. In Northern Nigeria, for example, non-farm income comprised 20

1See for example, Chenery (1974, p. 19).

Data from Africa Rural Employment Study Sierra Leone. The data
include the imputed value of home production that is consumed.

Similar results have been reported from studies in Kenya, Tanzania,
Mexico, Tunisia, and Northeast Brazil. In Kenya, the average earnings
per annum for adult wage workers on small farms was $106 while that for
rural nonagricultural enterprises was $126 (I.L.O., 1972, p. 77). The
average household income of rural nonagricultural households was 53% higher
in Mexico, 41% higher in Tanzania, and 22% higher in Tunisia than the
average incomes of farm households in these countries (Van Ginnekan, 1976,
p. 41). For Brazil, see World Bank (1978) p. 82.

percent of the total household income of the lowest income decile, but

rose to comprise 37 percent of the income of the highest decile (Matlon,

1977, p. 80). Correspondingly, iii Sierra Leone, non-farm income was

28 percent of income in the lowest decile and 37 percent in the highest.1

Although total non-farm income appears to be somewhat concentrated in

the higher income groups in the rural areas, average rural non-farm

earnings are still substantially below earnings in the urban areas. In

both Kenya and Sierra Leone the average rural non-farm earnings are sub-

stantially below the statuatory minimum wage.2 Those engaged in rural

non-farm activities thus are for the most part an important component of

the poor.

2.3.3 Relation of Non-farm Activities to
the Landless and Near Landless

Non-farm activities are particularly important for those rural house-

holds with little or no land. Indeed in countries for which data exist,

there is a clear negative relationship between the importance of non-farm

activity and farm size. As farms become smaller, the share of non-farm

income in total household income becomes larger (see table 2.4). In

Sierra Leone, for example, rural households cultivating more than 15 acres

earned less than 20 percent of their income from non-farm sources, while

those cultivating less than 1 acre earned more than 64 percent from such

Sierra Leone, Rural Employment Study, preliminary results.
In Kenya, the annual earnings from nonagricultural rural wages was $126
while a male subject to the minimum wage would earn $297. In Sierra Leone,
even the small-scale proprietor earned an annual return 13 percent below
that earned by an employee in a large-scale urban enterprise (Liedholm and
Chuta, 1976).



Size Non-farm Income Share Total
of in Total House- Household
Country Holding hold Income Income
(%) ($)

Korea 0.00 1.23 acres 42% $ 495
171 1.24 2.47 acres 19 724
2.48 3.70 acres 10 1015
3.71 4.94 acres 10 1309
4.95+ acres 8 1781

Taiwan (Taichung Region) 0.00 1.19 acres 59 652
197 1.20 2.39 acres 44 764
2.40 3.58 acres 33 1136
3.59 4.40 acres 27 1200
4.41 7.18 acres 40 1811
7.19+ acres 15 1989

Sierra Leone 0.00 1.00 acres 64 587
1.01 5.00 acres 51 404
174 5.01 10.00acres 32 546
10.01 15.00acres 26 770
15.00+ acres 17 927

Northern Nigeria 0.00 2.46 acres 57 479
197 2.47 4.93 acres 31 377
4.94 7.40 acres 26 569
7.41 9.87 acres 15 769
9.88+ acres 24 868

1. Korea: World Bank (1978a)
2. Taiwan: Taiwan (1970)
3. Sierra Leone: Unpublished data from African Rural Employment
4. Northern Nigeria: Matlon (1977)

sources. Clearly non-farm earnings provide a significant portion of

the total income of those rural households with little or no land.

Moreover, these non-farm earnings can be sufficiently large in some

instances to enable landless or near landless rural households to generate

a total household income greater than that of the larger-sized farms.

In Sierra Leone the total income of those rural households with less

than an acre of land was $587, while the income of those households with

1 to 5 acres was $404. A similar pattern was found to exist in Northern

Nigeria.1 Such results call into question the notion that farm size is

consistently an accurate measure of total household income or is con-

sistently a good indicator of who are the rural poor. In much of Africa,

where land is not a primary limiting factor, there does not appear to

be a positive relationship between land holding and total income in

the smallest land holding categories. Such a relationship, however,

may hold in much of Asia, where land does tend to serve as a primary

constraint to income generation.2

2.4 Growth of Rural Non-farm Activities

The final descriptive issue is whether or not rural non-farm activities

and employment decline in importance as development proceeds. More spec-

ifically, do rural non-farm activities decrease as rural incomes rise and

opportunities for trade increase? On this issue, there has been some

divergence of views.

This relationship is also found in an even more extreme form in
Japan. Disposable income per capital in 1974, in index form, is 111 for
farms of 0.1 0.5 ha., 99 for 0.5 1 ha., 89 for 1 1.5 ha., 88 for
1.5 2.0 ha., and 94 for 2.0 ha. See Kato and Izumida (1977, p. 3).

See Korea and Taiwan, for example, in table 2.4.

The issue was sparked by the 1969 paper, "A Model of an Agrarian

Economy with Non-Agricultural Activities," (1969) by Stephen Hymer and

Stephen Resnick. In this paper, they develop a model of the rural economy

in which rural non-farm activities, denoted as Z goods, are hypothesized

to decline as rural incomes rise and opportunities for trade increase.

Resnick, in a subsequent article (1970), provided empirical evidence for

the contention by tracing the decline of rural industry in Burma, Philippines,

and Thailand from 1870 to 1938. Comprehensive time series data were not

available, however, and Resnick, of necessity, was forced to rely on frag-

ments of evidence from various sources. Consequently, the results of

the study, while interesting, cannot be considered conclusive.

The empirical evidence available for more recent periods would in-

dicate that rural non-farm activity and employment recently have been

increasing, rather than decreasing, with development. Table 2.5 presents

the figures from ten countries for which aggregate time series data exist.

In all cases, the rates of rural non-farm employment growth were positive,

ranging from 3.2 percent per year in Korea to 9.4 percent per year in

Taiwan.1 These results, while not conclusive, would indicate that rural

non-farm activities and employment have been increasing in absolute terms

over time in developing countries.

There is evidence to indicate that, in most areas, non-farm employ-

ment has been growing more rapidly than farm employment. Dennis Anderson,

using secondary I.L.O. data, has shown that the rural labor force increased

Two qualifications should be noted. The growth of non-farm employ-
ment in rural towns which are rapidly growing centers of such employment -
is omitted. On the other hand, part of the "recorded" increase in rural
non-farm employment may be monetization of activities previously undertaken
in the household.



Rural Non-farm Non-farm Share of
Employment Growth Rural Labor Force (%)
Country Period Rate (per year) Initial End
(%) Period Period

Taiwan 1955-66 9.4% 30% 49%
Kenya 1969-74 8.8 NA NA
Philippines 1961-71 8.5 NA NA
(Gapan area)
Mexico 1960-70 5.6 14 23
Indonesia 1961-71 5.5 17 24
Iran 1956-72 4.8 20 33
India 1953-60 4.0 NA NA
Afghanistan 1964-71 3.9 NA NA
Korea 1960-74 3.2 18 19


Taiwan: Ho (1976)
Kenya: Steele (1976)
Philippines: Gibb (1974)
Mexico: Mexico (1978a)
Indonesia: Leiserson (1974)
Iran: Dhamija (1976)
India: India (1965)
Afghanistan: Gerken (1973)
Korea: Korea (1976)

faster between 1959 and 19701 than the agricultural labor force in all

regions except Latin America. In addition, the specific country data

presented in table 2.5 reveal that over time the percentage of the rural

labor force engaged in non-farm work has risen. Finally there is some

cross-sectional evidence that there is a positive association between

the share of the rural labor force engaged in non-farm work and the level
of per capital income. These results indicate that rural non-farm

activities, rather than decreasing, are becoming a more important source

of employment in rural areas.

Although the available evidence indicates that aggregate employment

and output in rural non-farm activities have been increasing, an important,

related issue is: What has been the growth performance of the individual

types of rural non-farm activities? There are many heterogeneous kinds

of activities covered by the rural non-farm umbrella and some of these

activities might be expected to have declined while others might be

expected to have increased over time.

Unfortunately, much of the available information is antecdotal or

episodic. Comprehensive time series data for particular types of rural

non-farm activities are generally not available, although some information

on specific manufacturing activities do exist for some countries such as

the Philippines (Gibb, 1974; Anderson, 1979), Sierra Leone (Liedholm and

Chuta, 1976), and Haiti (Haggblade, et al., 1979). Among the major types

World Bank (1978a). In Latin America from 1960-70, the agricultural
labor force increased 0.8 percent per year while the rural labor force in-
creased 0.6 percent per year. (These results are based on preliminary
figures from the I.L.O. and must be interpreted with some caution.)

The non-farm data in table 2.1 were regressed against levels of per
capital income yielding the following result: Percent of rural labor force
in non-farm activities = -.12 + 4.06 log per capital income. R = .2, F = 4.

of existing activities the available evidence indicates that tailoring,

dress making, furniture making, baking, and rice milling have continued

to grow in importance even after large-scale, domestic factory production

of these commodities has begun. Shoe production, leather production, and

pottery appear to have generally declined in importance.1 A mixed record
appears with blacksmithing, and spinning and weaving. It should be noted

that the kinds of activities undertaken by some of the important artisan

groups have been evolving. In some countries, for example, rural black-

smiths, who previously were primarily engaged in the production or servicing

of hand tools, now also produce or service animal-drawn or mechanized farm

equipment, and irrigation equipment (Liedholm and Chuta, 1976; Child and

Kaneda, 1975). Moreover, several newer types of artisan activities, such

as bicycle, auto, and electrical repair activities have grown particularly

rapidly in recent years. These newer activities reflect the increased

service-oriented nature of many artisan activities as the level of income

and urban factory production increase. In addition, certain types of craft-

oriented artisan activities designed for the international market, such as

gara (tie-dye) cloth in Sierra Leone (Liedholm and Chuta, 1976) and wood

carving in Haiti (Haggblade, et al., 1979) have also been growing rapidly

in certain countries. Finally, a few "modern" factory activities, some of

which have emerged from smaller enterprises, such as metal working factories

in India (Berna, 1960) and cement block production and essential oils

Additional evidence on the decline of these particular activities is
found for India (Prasad, 1963), Ethiopia (Karsten, 1972), and Burma (Resnick,

2Spinning and weaving has declined in the Philippines and Sierra Leone,
but has increased, since Independence, in India.

(luxury perfume) production in rural Haiti (Haggblade, et al., 1979),

have also begun to increase in importance.1

These differential growth patterns are important to recognize in

the design of programs and policies for the rural non-farm area. Govern-

mental policies, particularly with respect to large, modern industries

and agriculture, influence growth patterns of individual activities

within each country.2 Although some of the existing rural non-farm

activities will evolve and new activities will emerge, the sheer magnitude

of these existing informal artisan activities in most countries indicates

that any major transformation will take many years to complete. Stewart

(1977) has estimated that it will take several decades before the "formal"

sector will begin to absorb even the additions to the labor force in most

developing countries. Consequently, attention must continue to be directed

towards enhancing many of the types of activities represented in the

existing structure of rural non-farm enterprise, even if, in the longer

run, many of them will eventually decline in importance or disappear.

For an excellent listing of the types of "modern" small enterprises,
both urban and rural, likely to increase in importance, see Staley and
Morse (1965, p. 97ff). Locational, process and market influences are

In India hand loom production declined from 1901-1948 under
colonial rule (Prasad, 1963; table 14), but increased after Independence
with government encouragement.

3Investments in most "informal" rural non-farm enterprises, for
example, would be fully amortized within a ten to twenty year time


Both the future and existing patterns of rural non-farm activities

are determined by a set of factors influencing the demand for and supply

of these economic activities. These demand and supply issues will be

examined in the next section.

3.1 Demand for Rural Non-farm Activities

There are three principal sources of demand for the products and

services of rural non-farm activities that should be considered. The

primary source is the demand generated from the incomes of rural consumers.

A second source of demand arises from the backward and forward production

linkages with the agricultural and large-scale industrial sectors. The

final, important source of demand is provided by the urban and foreign or

export sector. The issues relating to each of these demand sources will

now be examined.

3.1.1 Rural Income

A central issue is whether or not the demand for rural non-farm

activities should be expected to increase as rural incomes increase.

There have been some divergent views expressed on this particular matter.

Hymer and Resnick (1969) have argued that rural non-farm goods and

services, "Z goods," are "inferior" goods and thus the demand for these

goods will decline as rural incomes rise. Pack, in his review (1977) of

the report of the 1972 I.L.O. mission to Kenya, also contends that

increasing the incomes of the poor may have, at best, only a limited

effect on the demand for the goods and services of the "informal sector,"

which includes rural non-farm activities. Neither Hymer and Resnick, nor

Pack, present any empirical evidence to support this view and Pack himself

admits, "relatively little is known about the magnitudes involved."

Mellor (1976), Liedholm and Chuta (1976) and various I.L.O. Employ-

ment Missions (1972), (1974), have contended that there is a strong,

positive relationship between rural income and the demand for rural non-

farm activities. The available evidence, though limited, tends to

support this view. Virtually all the standard analyses of rural

household expenditure surveys undertaken in such diverse countries

as India (Mellor, 1976), Kenya (Massell, 1969), and Uganda (Massell and

Parnes, 1969), indicate that the income elasticity of demand by rural

households for nonfood consumption items is positive and, in most cases

exceeds unity, and that these activities account for an increasing pro-

portion of a rural household's budget as its income rises.

Although these analyses are indicative, they are not conclusive,

because they fail to differentiate between those nonfood consumption items

produced in the rural areas and those produced in urban areas or imported.

King and Byerlee's (1978) pioneering rural expenditure survey in Sierra

Leone, however, does differentiate activities by origin or location and

reveals that the rural expenditure elasticity for rurally-produced non-farm

consumption activities is 1.4 (i.e., indicating that an increase of rural

incomes of ten percent raises the expenditure for rural non-farm goods

and services by fourteen percent). Studies by Leurquin in Ruanda-Urundi

(1960, p. 313) and Gibb in the Gapan area of the Philippines (1974) also

indirectly indicate that an increasing share of income is allocated to

rural non-farm activities as income rises. Consequently, these few studies

reveal that rural non-farm goods are not "inferior" (i.e., possess an

expenditure elasticity below zero), and rather than being viewed as an

over-riding constraint, the demand induced from increasing incomes should

be viewed as a strong force for the growth of rural non-farm activities

in developing countries.1 Clearly, further research is needed to verify

these relationships in other countries and the magnitude of the elas-

ticities for individual rural non-farm activities.

3.1.2 Backward and Forward Production Linkages

A second major demand issue centers on the nature and extent of the

production linkages between rural non-farm activities and other sectors

of the economy, particularly the agricultural and large-scale industrial

sectors. Specifically, there are the "forward" linkages from the rural non-

farm sector, where rural non-farm outputs serve as inputs to other sectors,

and the "backward" linkages from the rural non-farm sector, where this

sector provides a demand for the output of other sectors. There are diverg-

ing opinions and varying empirical evidence on the production linkage issue.

In this section, the rural non-farm sector's linkages with the agricultural

sector will be examined first, followed by a discussion of its linkages

with large-scale industry.

A. 0. Hirschman, in his classic book, The Strategy of Economic Develop-

ment (1958), contends, without detailed empirical evidence, that the linkages

between agriculture and other sectors are quite weak. Yet, Mellor (1976),

argues that linkages with agriculture are, or could be, potentially quite

significant; indeed these agricultural linkages are an essential ingredient

in Mellor's "rural-led strategy of development."

The composition and magnitude of these effects depends importantly on
the pattern of agricultural growth. See below (p. 62) as well as Mellor
(1976), and Johnston and Kilby (1975) for further discussions of these effects.

The empirical evidence on rural non-farm linkages with agriculture

tends to be somewhat limited. The vast majority of the input-output studies

fail to include any explicit rural non-farm activities, and thus they mask

or understate the rural non-farm linkages with agriculture.1 The few

input-output studies that specifically include rural non-farm activities,

however, indicate the "forward" and "backward" production linkages from

this sector to agriculture are often quite important. Such results are

found in input-output studies of India (Krishna, 1973; Falcon, 1967); of

the Muda River Area of Malaysia (Bell and Hazell, 1976); of the Philippines

(I.L.O., 1974) and of Sierra Leone (Byerlee, et al., 1977). Additional

support for the strength of these "production linkages" is also found in

several detailed industrial case studies undertaken in these and other


With respect to the "forward linkages" from rural non-farm activities

to agriculture, the empirical studies indicate that rurally produced

agricultural inputs are particularly important where traditional "inter-

mediate" agricultural technologies are utilized. Johnston and Kilby's

(1975) analysis of farm equipment in India, Pakistan, and Taiwan stresses

that traditional tools are most often made by rural artisans, while improved

implements, and irrigation pumps and motors are likely to be fabricated

by light engineering workshops located in rural towns.2

IThe rural non-farm activities are either omitted, often for lack of
data, or are lumped together with agriculture or "modern" large-scale
industrial activities.

Tractors, combines, and other large items with high performance
characteristics, as well as fertilizers, tend to be produced abroad or
in urban areas. Consequently, the nature of the agricultural technology
adopted has important effects on rural non-farm linkages (see below,
p. 64 for a further discussion).

Karsten's study of rural blacksmiths in Ethiopia (1972) and Liedholm

and Chuta's analysis of rural artisans in Sierra Leone (1976) provide

further support for the crucial role played by rural artisans in providing

inputs for traditional agriculture in Africa. Liedholm and Chuta note

that approximately one dollar of rural blacksmithing output, particularly

in the form of hoes, knives, and axes, is demanded for every one hundred

dollars of agricultural output. Moreover, both Child and Kaneda's (1975)

analysis of diesel tubewell production in Pakistan and Cartillier's (1975)

study of electric tubewell manufacturing in India point out the extensive

growth of these light engineering activities in those rural areas where

improved agricultural practices have been adopted.

With respect to the "backward" linkages from rural non-farm activities

to agriculture, the weight of the empirical evidence suggests that these

are quite significant. Most of the studies focus on the linkages between

rural agricultural processing and the agricultural sector, although rural

transport and rural marketing activities are also potentially important

backward linkages. Krishna's (1973) input-output study of India indicates

that such activities as the processing of gur, tobacco, sugar, cashew nuts,

and flour have among the highest intersectoral linkages. Unfortunately,

the location and size of these activities is not specified. Falcon's (1967)

study of agricultural-industrial inter-relationships in Pakistan, however,

reveals that crop flows to small-scale processing activities, the majority

of which are rural, are more than five times the flow to urban, large-

scale processing.

Indeed the strength of this "backward" linkage from rural non-farm

processing to agricultural production depends crucially on the choice and

location of the processing technology involved. Although there is some

indication that a range or mix of technologies will sometimes be optimal,

most of the case studies of processing indicate that small-scale, rurally-

based processing activities generally are economically efficient in

developing countries.1 Studies of rice processing in Indonesia (Timmer,

1975) and Sierra Leone (Spencer, 1976) reveal the significant links between

small, rural rice mills or hand-pounding and rice production. Similar

results for palm oil processing in Nigeria are reported by Miller (1965).

In summary, these various empirical studies indicate the importance of

backward and forward linkages of the rural non-farm sector with agriculture

and point to the need for future researchers to incorporate explicitly rural

non-farm activities when analyzing sectoral interactions.

The empirical evidence on the production linkages between rural non-

farm activities and large-scale industry is also somewhat sparse. Only

a few of the input-output studies, as noted previously, explicitly include

rural non-farm activities, and case studies in this area are very limited.

The "forward" production linkages from rural non-farm enterprises

to large-scale industry, where these enterprises provide intermediate or

capital goods to large-scale industry, are most frequently discussed in

terms of subcontracting relationships (see World Bank 1978b). Such sub-

contracting arrangements have been particularly important in Japan, where

approximately 60 percent of all small-scale units are subcontractors to

large firms (Vepa, 1971; Paine, 1971). There is little evidence on the

1See below (p. 35) for a more detailed examination of production

location of these subcontracting enterprises, however, and it is difficult

to specify how much of these subcontracting activities are undertaken by

small, rural enterprises. Subcontracting to small enterprises does not

appear to be as extensive outside of Japan, although the empirical evidence

is admittedly very sketchy. In India, for example, subcontracting repre-

sents about 1 percent of the total product of small-scale industry (Vepa,

1971). In Africa and Latin America, subcontracting and the "forward"

linkages from small, rural non-farm enterprises to large enterprises are

minimal (Liedholm and Chuta, 1976; Pack, 1978; UNIDO, 1969).2

Indeed the "backward" production linkage from small-scale, rural,

non-farm activities to large-scale industry appears more extensive than

the "forward" linkage. Even in Japan output flows from large to small

enterprises are almost three times as much as that from small to large

enterprises (Hoselitz, 1968). Several examples of small, rural non-farm

enterprises purchasing their intermediate inputs from larger firms are

cited by Pack (1977) for Kenya, Child and Kaneda (1975) for Pakistan,

and Liedholm and Chuta (1978) for Sierra Leone.3 In summary, the nature

and extent of these production linkages from rural, non-farm activities

There is also subcontracting undertaken for foreign firms for com-
ponent production or assembly. These relationships are found extensively
in Hong Kong, Taiwan, Mexico, Singapore, and a few other areas; most of
their subcontractors are urban based (see Watanabe, 1976). Some foreign
initiated rural subcontracting does exist, however, in a few developing
countries such as Haiti, but these relationships have not been studied.

2See below, p. 64 for a discussion of the policy issues relating to
the promotion of subcontracting activities.

3These backward linkages may have fewer indirect employment effects
than the forward linkages (see Pack, 1977).

have not been extensively examined, and additional, detailed studies

of these intersectoral linkages are clearly required.

3.1.3 Foreign and Urban Demand

The final important demand issue centers on the nature and magnitude

of the foreign and urban demand for the products of rural non-farm

enterprises.1 The lack of detailed data on the location of productive

activities in most countries makes it difficult to derive any definitive

conclusion on this issue.

The available evidence does indicate that rural non-farm products

do enter into international markets and that, for some activities, the

international market is a major component of the total market. In Iran,

handicrafts, including carpets, is the largest export item after oil

and 60 percent of the handicraft activity is undertaken in rural areas

(Dhamija, 1976). In India, handicraft and handloom commodities account

for approximately 6 percent of the country's value of exports (Government

of India, 1965). Finally, evidence from Sierra Leone indicates that

approximately one-fifth of the total production of the rural gara (tie-dye)

industry is exported (Liedholm and Chuta, 1976).

The evidence also supports the view that the international market

is or is potentially an important component of demand for rural non-farm

activities. The only detailed study in this area has been undertaken by

Huddle and Ho (1972), who examined the international demand for eighty-

one different "culturally-oriented" products. Specifically, their study

reveals that the overall income elasticity of demand exceeds one in high

The actual and potential demand of government for rural small enter-
prise goods and services (e.g., school uniforms) should also be considered.

income countries for products such as wood carvings, brassware, and

earthenware. Thus the overall demand for these products should be

expected to increase importantly as income in high-income countries

increases. More detailed studies focusing on the location of these

production activities would be useful in determining whether or not

there are differences in the elasticities of demand between rurally-

produced, "culturally-oriented" commodities. Little is known of the

factors determining the proportion of the total market captured by each

individual country. Such studies are important for designing effective

programs and policies enabling developing countries to take full ad-

vantage of this important market.1

3.2 Supply of Rural Non-farm Activities

Supply factors also play crucial roles in determining both the

current and future nature, extent, and composition of rural non-farm

activities. The important supply issues relate primarily to the efficiency

with which rural non-farm enterprises utilize their economic resources,

both in static and dynamic terms. The key static efficiency issues

center on the existing labor intensity, capital productivity, factor

substitutability, and economies of scale in rural non-farm activities;

the dynamic issues relate primarily to the potential for the expansion

of capital and entrepreneurship in these activities.

Policies such as those designed to improve the rural infrastructure
and the marketing system may be crucial for fully exploiting this inter-
national market. See below, p. 60 for further discussion of these policy

3.2.1 Labor Intensity of Rural Non-farm Activities

One important supply issue is whether or not rural non-farm activities

are more labor-intensive than other segments of the economy. Since in

most developing countries, capital and foreign exchange are relatively

scarce, and labor, particularly unskilled, is relatively abundant, those

activities and techniques of production that are more labor-intensive would

generate the largest amount of employment per unit of scarce factor and

thus appear to represent activities or technologies most "appropriate" to

their factor endowments.

The evidence available indicates that existing rural non-farm activities

are generally more labor-intensive than other segments of the economy. Most

of the studies utilize the capital-labor ratio or its reciprocal to measure

labor intensity and this labor intensity measure must be interpreted with
caution. Moreover, the majority of these studies have either examined

specific processes within industries or compared large and small enterprises

and thus generally have not specifically compared rural non-farm activities

with other activities. Since the great bulk of rural non-farm enterprises

are very small and utilize certain types of processes, it is possible to

impute cautiously from the results of these more general studies.

There have been studies involving at least nine countries comparing

the labor-capital ratio, or its reciprocal, of large- and small-scale

enterprises. In every country, the smaller scale enterprise group

possess a higher labor-capital ratio (or lower capital-per-worker ratio)

1See White (1978), and Morawetz (1974) for a general discussion.

Such factors as excess capacity, heterogeneity of capital and labor,
stock versus flow problems, and use of market prices have been mentioned
(see Bhalla, 1975).

than the larger scale enterprise group, with the labor intensity of

small firms ranging from four to fifteen times higher than the large

firms (see table 3.1).

Although these studies reveal that smaller enterprises are more

labor-intensive than larger enterprises, they do not differentiate

between rural and urban enterprises and thus do not conclusively verify

whether rural non-farm activities are themselves more labor-intensive.

There is one exception that sheds some light on the issue. The Sierra

Leone small enterprise survey (Liedholm and Chuta, 1976) does differ-

entiate by location and indicates that the small-scale, rural enterprises

in Sierra Leone are at least twice as labor-intensive.1 Although

additional studies in this area are needed, the analysis points to the

relative labor intensity of rural non-farm activities.

3.2.2 Labor Productivity

A second supply issue centers on how the labor productivity of

rural non-farm activities compares with labor productivity in other

segments of the economy. The relevance of this issue, however, is

perhaps as important as the conclusions derived from the various

empirical studies.

During the 1950s and 1960s several international study groups and
productivity missions equated "efficiency" with labor productivity;

The differences were statistically significant.

2See, for example, the I.L.O. report cited in Kilby (1962).


Country' Size of Enterprise 1-10 workers 11-50 workers 50+ workers

Fixed Capital Per Worker ($)
Japan (1966) $ 934 $1040 b $4333
(30-49) (1000+)
India (1965) 278 557 2450
("small") ("medium") ("large")
Malaysia (1968) 521 997 2671
(20-29) (500+)
Philippines (1970) 1020 2850 8000
("small") ("medium") ("large")
Sierra Leone (1974) 158 225 1175
Kenya (1960) 772 986 3108
(15-19) (100+)
Ghana (1970) 1372 3724 6468
(10-29) (100+)
Latin America
Mexico (1970) 3700 9500 14,500
("small") ("medium") ("large")
Colombia 3000 --- 13,400

Japan: Okhawa and Tajima (1976)
India: World Bank (1978b)
Malaysia: Okhawa and Tajima (1976)
Philippines: World Bank (1978b)
Sierra Leone: Liedholm and Chuta (19i
Kenya: I.L.O. (1972)
Ghana: Steel (1977)
Mexico: World Bank (1978b)
Colombia: World Bank (1978b)

aFixed capital per worker ($)
bNumbers in brackets refer to
size distribution when
they differ from heading


consequently, enterprises with high average labor productivities were

considered the most "efficient."1 The efficacy of this view has rightly

been questioned by many observers (see White, 1978). Although the

level of labor and managerial skills do affect the labor productivity

measure, the amount of capital with which each employee works is a

crucially important determinant of labor productivity. A low labor

productivity figure for a rural non-farm establishment may be a reflec-

tion, as White notes, "of the efficient combination of labor with low

levels of capital in developing countries" (White, 1978, p. 30). The

average productivity of labor thus would not appear to be a very useful

efficiency criterion, particularly if labor is not viewed as the binding,

scarce resource constraint.2

The available empirical evidence generally indicates that the average

productivity of labor is lower in small-scale enterprises than in the

larger scale enterprises (see the results of the studies listed in table

3.1). The results from Sierra Leone (Byerlee, et al., 1979) indicate

that small, rural, non-farm enterprises have somewhat lower labor pro-

ductivities than do their larger scale counterparts in urban areas.

Such findings are not surprising in light of the results presented in the

previous section that the larger enterprises possess greater amounts

of capital per worker.

1In a dynamic framework, the World Bank (1978a) argues that, "gains
in labor productivity are essential." The crucial issue is, however, how
the increase in output (the numerator) is to be maximized given the scarce
resource constraints.
If any labor measure is to be used, it would be the marginal rather
than the average product of labor. Specifically, the value of the marginal
product would be equated to the wage in any efficiency measure. Skilled
labor or managerial labor might be a scarce resource in certain industries.

3.2.3 Capital Productivity of Rural Non-farm Activities

A third supply issue revolves around whether or not rural non-farm

enterprises use the scarce factor, capital, as efficiently as do other

enterprises or activities. There have been divergent opinions expressed

on this issue.

Several international groups and individuals, including Nicholas

Kaldor, argued during the 1960s that small-scale, labor-intensive

activities would use not only more labor, but also more of the scarce
factor, capital, than their larger scale counterparts. Hence they

argued that these small-scale, labor-intensive activities would possess

lower output-capital ratios and would be consequently less efficient

than the larger, more capital-intensive enterprises. There could be a

conflict between the objectives of maximizing output and employment if

such a condition exists. (See Baer and Herve, 1966; Morawetz, 1974). During

the 1970s several sources (World Bank, 1978a; World Bank, 1978b; Pack, 1974;

Liedholm and Chuta, 1976; Marsden, 1969) have argued that small-scale

labor-intensive enterprises might also be more efficient in the utilization

of capital (i.e., possess higher output-capital ratios) than their more

capital-intensive counterparts. There need not be a trade-off in such a

case between output and employment objectives.

The available empirical evidence relating to the capital productivity

of rural, non-farm activities, while indicative, is not conclusive. Most

of the studies compare either large and small enterprises or processes

within activities and thus do not explicitly focus on rural, non-farm

1See, for example, Robinson (1965), Barber (1969), I.L.O. Report in
Kilby (1962) and I.L.O. (1961).

activities. There are also measurement problems, particularly for the

smallest enterprises, as well as several conceptual problems relating

to the comparison of large and small enterprises. Thus any aggregate

comparison must be interpreted with extreme caution.

The majority of the empirical evidence does appear to provide some

support for Marsden's (1969) contention that "the smaller enterprises,

with a lower level of investment per worker, tend to achieve a higher

productivity of capital than do larger, more capital-intensive enter-

prises." An examination of table 3.2, where the relationship between

the output-capital ratios and size of establishment in the nine countries

where sufficiently detailed results are available, reveals that in only

one country, India, does the overall capital productivity of the largest

enterprises appear to exceed that in the small enterprise. India may

not even be an exception since several other studies (see World Bank,

1978b and Shetty, 1963) found that the capital productivity of larger

enterprises in India is lower than that found in smaller Indian firms.2

1Data from the smallest enterprises (i.e., one through nine worker
category) are very unreliable since the majority do not keep books and
memory recall is limited (see below, p. 50). Aggregate data comparing
large and small enterprises mask the differences in capital productivity
between individual lines of activity. The appropriate, but less readily
available, comparison is between firms producing the same product with
the same degree of vertical integration (White, 1978). See below, p. 42
for size comparison by roughly comparable product groups. Finally,
the most desirable comparison between small and large enterprises would
involve the marginal rather than the average product of capital, but
unfortunately, such data are generally not available; thus average
products must serve as rough proxies. A related issue in a dynamic
or investment framework is how rapidly the marginal productivity of
capital declines with additional capital invested in rural small enter-

See also the debate and exchange on this issue in India between
Mehta (1969) and Sandesara (1966, 1969).



Country Size of Enterprise 1-10 workers 11-50 workers 50+ workers

Value Added Per Unit of Fixed Capital
Japan (1966) 1.55 3.32 b 1.50
(30-49) (500-999)
India (1953) 0.10 0.47 0.73
(1-19) (20-49) (500-999)
Pakistan (1960) 1.16 0.37 0.28
(20-49) (100+)
Malaysia (1968) 2.01 1.32 1.02
(20-29) (100-199)
Philippines (1960) 0.96 0.98 1.11
(5-19) (20-49) (500+)
Sierra Leone (1974) 3.20 1.50 0.72
Ghana (1976) 0.60 0.30 0.60
Kenya (1972) 5.60 2.60 1.10
(0-4) (20-29) (100+)
Latin America
Mexico (1965) 1.34 0.64 0.61
(1-5) (16-25) (500+)

Japan: Okhawa and Tajima (1976)
India: Okhawa and Tajima (1976)
Pakistan: Ranis (1961)
Malaysia: Okhawa and Tajima (1976)
Philippines: Okhawa and Tajima (1976)
Sierra Leone: Liedholm and Chuta (1976
Ghana: Steel (1977)
Mexico: Okhawa and Tajima (1976)

value added per unit of
fixed capital
bNumbers in brackets refer to
size distribution when they
differ from heading
CRefers to distribution
1) activities only


Since the majority of rural non-farm enterprises fall into the

smallest size category (i.e., one through nine) the relative capital

productivity of this size enterprise group is of particular interest.

Several sources (World Bank, 1978b; Okhawa and Tajima, 1976) have con-

tended that the capital productivity of the "very smallest enterprise group"

(i.e., one through nine) might be lower than the next largest small-

scale size category (i.e., ten to fifty). An examination of table 3.2

reveals that such a result appears to hold only for Japan and perhaps

India; thus the capital productivity of the smallest size enterprise,

where most of the rural non-farm enterprises are found, generally compares

favorably with that of the larger-sized enterprises.
Direct evidence on the relative capital productivity of rural non-

farm activities is available only in the Sierra Leone industry study

(Liedholm and Chuta, 1976). This survey indicates that the output-capital

ratios for rural non-farm enterprises are markedly higher than those of

their urban, small-scale counterparts. These various results, while

certainly not conclusive, thus do tend to indicate that rural non-farm

enterprises generally are not only more labor-intensive, but also may

generate more output per unit of capital than their larger scale counter-

parts; thus there may not be any output-employment trade-off, at least

in a static sense. More detailed case studies of rural non-farm enter-

prises are required before more conclusive judgements can be made.

These results by themselves do not provide a sufficient condition for
additional investment in rural non-farm enterprises. Analytically, data on
the marginal productivity of capital as well as information on how rapidly
the marginal productivity would decline with additional capital are required.
Other potentially scarce resources, such as skilled labor, management, and
foreign exchange, should ideally be included in a measure of total scarce
factor productivity rather than simply capital productivity; these inputs
should be examined at their social prices (see, Morawetz, 1974).

3.2.4 Alternative Production Techniques
in Rural Non-farm Activities

Another important issue is whether or not there is an array of

efficient alternative processes in use or available for the types of

non-farm activities undertaken in rural areas. This issue has significant

policy relevance because it provides an indication of whether changes or

distortions in factor prices have any effect on the optimal production

technique or factor proportions. An examination of the efficiency of

alternative processes within individual industries, rather than the

broadly defined aggregates such as large versus small-scale establishments,

is central to resolving the output-employment trade-off issue.

A central theme among engineers and even some economists, particularly

during the 1950s and 1960s, was that few, if any, efficient alternatives

to the capital-intensive processes of the developed countries existed.1

This contention has been strongly attacked in recent years by a wide

array of individuals and organizations.2

The accumulated, empirical evidence supports the view that a wide,

although not unlimited, number of alternative processes exist within most

lines of manufacturing activities. One of the empirical approaches has

been to measure, by means of econometric estimation procedures, the

elasticity of substitution between capital and labor in a number of

activities. These studies have been carried out in at least 25 developing

See sources mentioned in footnote one on the preceding page, as well
as Francis Stewart (1972) and Eckhaus (1955).
2See White (1978) and Morawetz (1972) for a listing of these views.

See ibid. for a good summary of the evidence.

countries and the vast majority find that estimates of the elasticity

of substitution are positive and tend to bunch between values of 0.5

and 1.2. Although these studies indicate that efficient factor substi-

tution is possible, they all suffer from several methological difficulties.

Consequently, these results must be interpreted with some degree of caution.

A second empirical approach has been to delineate, through individual

case studies, the main production techniques and processes in a given line

of activity. The factor-intensity and efficiency of both existing and

potential techniques are then examined. There have been detailed studies

of only a few products or processes. The results from these studies con-

sistently indicate that factor substitution is possible and the difference

in factor ratios can be quite substantial (White, 1978, p. 34). Unfor-

tunately, many of the case studies do not directly include rural non-farm

processes or products.

The evidence from the limited number of case studies explicitly in-

volving rural non-farm products or processes does indicate that there is

factor or process choice within many lines of rural non-farm activity.

In the various case studies of Sierra Leone rural and urban manufacturing

there were at least five clothing processes, six bread processes, five

gara (tie-dye) processes, three metal-working processes, and five rice

milling processes delineated, all of which possessed different factor

1Morawetz (1974), Gaude (1975), and O'Herlihy (1972).

proportions. Similar results have been reported elsewhere by Bhalla

(1965) and Timmer (1972).2

The few case studies involving rural non-farm activities have re-

vealed that rural non-farm processes are generally both more labor-

intensive and more productive per unit of capital than their larger,

often urban-based counterparts in the same industry. Studies in

Indonesia (Timmer, 1972) and Sierra Leone for rice processing (see table

3.3), indicate that both traditional handpounding and small, rural rice

mills were more labor-intensive and generated more output per unit of
capital than the larger scale mills. For cloth production, several

studies of spinning and weaving in India (Sen, 1968; Bhalla, 1964, Raj,

1957) indicate that the output-capital ratios for traditional hand loom

spinning and weaving activities, the majority of which are rural, are

higher than those for factory production. Similar results are found

for clothing production in Sierra Leone (see table 3.3). Finally, for

bread production, rural bakers using traditional, mud ovens are found to

be more labor-intensive and more productive with capital than the larger,

urban-based bakers (see table 3.3). Similar results are found indirectly

See Chuta (1978), Liedholm and Chuta (1976), and Spencer, et al., (1976).
Although there is evidence that several differing techniques and
processes are being used within many lines of rural non-farm activity, the
range of choice is undoubtedly far from complete. There is thus scope for
the development of new processes or products, particularly those that in-
crease overall factor productivity or will be, at least, more labor-intensive.
For an excellent, recent review of the evidence on technical progress, and
research and development in developing countries, see White, 1978. See also
Marsden (1971), and Strassmann (1968).

In India Bhalla (1965) found that handpounding possessed a lower
output-capital ratio (capital productivity) than machine-milled rice.
Small mills, however, possessed higher output-capital ratios than did
the large mills.


Labor-Capital Ratio Output-
Activity/Country (man-hours per $ Capital
of capital) Ratio

A. Rice Milling
1. Sierra Leone
Rural handpounding 638.00 40.90
Rural small-steel-roller mill 1.25 1.80
Urban large rice mill 0.12 1.20
2. Indonesia
Rural handpounding NA NA
Small rice mill 0.14a 2.60
Large rice mill 0.02a 0.80
3. India
Rural handpounding 1.70a 1.20
Small rice mill 0.04a 2.20
Large rice mill 0.04a 1.90
B. Spinning and Weaving
1. India Spinning
Rural, traditional cotton spinning 4.70a 0.15
Factory spinning 0.02a 0.11
2. India Weaving
Rural fly-shuttle hand-loom NA 4.50
Automated power loom NA 0.30
C. Clothing Sierra Leone
Rural tailor, small-scale non- 16.60 8.30
electric sewing machine
Urban tailor, small-scale electric 4.30 2.60
sewing machine
Urban clothing factory, large-scale 2.20 1.70
D. Bread-making Sierra Leone
Rural baker, small-scale, 38.00 19.00
traditional oven
Urban baker, small-scale, 5.30 3.20
multiple-deck oven
Urban baker, large-scale, 2.60 2.60
tunnel oven

Rice milling: Sierra Leone: Spencer, et al. (1976); Indonesia: Timmer (1972);
India: Bhalla (1965).
Spinning and weaving: India-spinning: Bhalla (1964); India-weaving: Sen (1968).
Clothing: Byerlee, et al. (1979).
Baking: Chuta (1979)
NOTE: aNumber of workers per $100 of capital stock

for sugar processing in India (Baron, 1975). These studies, while

certainly not conclusive, do indicate in several lines of activity at

least there are rural small-scale processes that generate more employ-

ment and output per unit of capital than their larger scale, urban-

based counterparts; consequently, in these cases, employment-output

conflict would appear to vanish.1

3.2.5 Economies of Scale in Rural Non-farm Activities

A related issue is the extent of the economies of scale in the

existing or potential lines of activity engaged in by rural non-farm

enterprises. This issue is important in determining whether scale

economies are so predominant that policies to emphasize small, rural

activities might result in a loss in economic efficiency or in a rapid

elimination of rural enterprises as markets expand.

The empirical evidence on this issue, though limited, indicates

that the importance of the scale factor varies importantly by type of

industry or activity. There are certain lines of activity where scale

effects appear to be important such as in chemicals, petroleum refining,

and brewing, where surface areas and volume relations become dominant

features, or metal finishing where the setting-up costs of a production

run become important (White, 1978; Scherer, 1970). There are only a

limited number of empirical studies that have verified the existence of

significant scale economies in developing countries. For metal

These findings must be interpreted with some caution since they
are subject to many of the same measurement and conceptual problems
described in the previous subsection. In addition, Kilby (1964) and
Stewart (1977) have argued that even within the same industry there are
important differences in product quality and that these quality differences
are related to the size and capital intensity of the enterprise. It is not
clear, however, that these quality differences are sufficiently large to
vitiate the results.

machinery (Boon, 1976) in Mexico, and cement block manufacture (Stewart,

1976) in Kenya, recent empirical studies have shown that "there are

appreciable economies of scale and that capital-intensive methods are

necessary to capture these economies."

Several other studies have indicated a number of lines of activity

where scale economies do not appear to be significant. In Sierra Leone

results of production function analyses revealed that there was no

evidence of economies of scale in cloth making, wood working, metal

working, and baking (Liedholm and Chuta, 1976). Similar results were

found in India for textiles (Murti and Sastry, 1957) and in Pakistan

for textiles, light engineering, plastics, and leather (Ranis, 1962).

A similar finding was reported for machine goods production in Pakistan

(Child and Kaneda, 1972). Finally, Pack (1974), using world-wide

cross-section data, found no evidence of significant scale economies in

the bicycle, wheat milling, tire, and woolen yarn textile industries. Thus

the limited available evidence indicates that economies of scale do not

appear to be significant in a wide range of activities where rural non-

farm enterprises are involved.

The results of these various empirical studies indicate that many

small rural non-farm enterprises are relatively efficient in their

utilization of existing resources.2 It is also important to ascertain

whether these activities are efficient in a dynamic sense.

See also Pack and Todaro (1969) for a general discussion of scale
economies in the capital goods industry in developing countries.

These findings do not suggest that these rural non-farm activities
are permanently superior to large, urban-based activities or that they
merit support to the exclusion of urban-based, larger scale activities.
Certain types of activity may be better served by large-scale enterprises.
Moreover, both small and large enterprises can and do co-exist and often
serve different markets.

3.2.6 Profit, Savings, and Reinvestment Rates of
Rural Non-farm Activities

An important dynamic efficiency issue centers on the relative profit,

savings, and reinvestment rates of rural non-farm activities. This

capital growth issue is significant for policy because it sheds light

on the economy's growth rate and whether or not there might be output-

employment conflicts over time.1 Galenson and Leibenstein (1955) and

Sen (1968), argue that even though efficient, small-scale, labor-intensive

activities or processes might exist, large capital-intensive activities

or processes should be chosen because they generate the most savings

and reinvestment and, consequently, generate the most rapid growth of

output and employment over time. This outcome occurs, they argue,

because such activities or processes produce the highest returns (profits)

to capital and capital owners have higher savings and reinvestment rates

than do workers. If these contentions are true, then rural non-farm

activities, which tend to be small and labor-intensive, would appear to

provide less growth support for the economy than others.

There are three empirical components bearing on this capital growth

issue that must be examined. The first relates to the relative savings

propensities from profit and employment income; the second relates to

the relative rate of profit per unit of capital generated by rural non-

farm activities as opposed to those generated by others; the last relates

to the relative savings and reinvestment propensities of these activities.

1Power (1962) used the following formulation to relate the components
of growth: (Y/K)(S/Y) = S/K. This criterion was used to judge the con-
tribution of small and large units.

For some of these components, the empirical evidence is available and

indicative, but for others it is limited and not conclusive.

The empirical evidence on the savings propensities from employment

and profit sources is perhaps the strongest. Studies by Houthackker (1961),

Williamson (1968), as well as others reviewed by Mikesell and Zinser (1973),

do tend to support Galenson and Leibenstein's contention that savings out

of labor income is low while that out of profits tends to be high.

The evidence relating to the returns to capital or profit rates

is much more limited, but is also somewhat indicative. Accurate data on

profit rates of small, rural non-farm enterprises are very difficult to

collect and, consequently, there are only a few studies that can shed

light in this area. Nevertheless these few studies indicate that the

profit rates of small, rural non-farm enterprises are substantial. Child

(1973) found that the median gross profit rate for his sample of rural

industries in rural Kenya was approximately 75 percent. Liedholm and

Chuta (1976) report that the average "economic profit" of rural small-

scale enterprises in Sierra Leone ranged from 20 percent for tailoring

to about 200 percent for gara (tie-dyeing). Finally, Huddle (1977)

reported that the financial profit rates generated by a sample of rural

artisans in Colombia exceeded 150 percent. In all these instances, the

rates of return to capital were markedly higher than rates of return

generated by their larger scale, capital-intensive, urban-based counterparts.2

1The opportunity cost of the proprietor's and family's labor has been

There is evidence from urban-based surveys, such as those undertaken
for Karachi (Ranis, 1961) and Delhi (Dhar, 1961), that small-scale, labor-
intensive enterprises generate a higher rate of return to capital than their
large-scale, capital-intensive counterparts.

Thus Galenson and Leibenstein's contention that the profit rates of

capital-intensive enterprises would exceed those of the smaller, labor-

intensive enterprises does not appear to be supported by the limited

empirical evidence to date. Clearly more studies of the profitability

of small, rural enterprises are needed.

Finally, the evidence relating to the savings and reinvestment

propensities of various enterprises is the most scanty and least reliable

of the empirical components. The only empirical studies of the savings

propensities of small enterprises have been of urban enterprises (Ranis,

1961; Dhar, 1958), and the quality of their savings and reinvestment data

for the smallest enterprises was admittedly very poor. Both authors

concluded that "the percentage of total profits which the small scales

are capable or willing to save (i.e., one-half to two-thirds) is not

significantly smaller than that in other scales" (Ranis, 1961, p. 20).

For the small, rural-based enterprises, the majority of which are family

owned activities, the profits from the enterprise often become mixed with

savings and expenditures from other household activities; thus it becomes

very difficult to isolate the savings and reinvestment rates for those

small rural enterprises that are merely a component of a more complex

rural household. Huddle, in a recent study of Colombian artisans (1977),

however, did find that the average savings propensity of the smallest,

self-employed artisan household was 16 percent, a rate double that of

the general population. There is evidence that a large part of the

initial capital and reinvested capital from small, rural enterprises is

derived from savings. For rural non-farm enterprises in Sierra Leone

(Liedholm and Chuta, 1976) 60 percent of the initial capital came from

agriculture or business, while over 90 percent of the expansion capital

came from reinvested profits. These few limited studies indicate that

rural non-farm enterprises may have a savings and reinvestment potential

that is not markedly below that of their larger counterparts. Clearly

more detailed and careful surveys are needed in this area. In summary,

the empirical evidence does not provide support for Galenson and Leibenstein's

contention that the profit, savings, and reinvestment rates of the kinds

of activities that are undertaken by rural non-farm enterprises will

necessarily result in less output and employment for the economy over time.2

3.2.7 Supply of Entrepreneurship

Another dynamic efficiency issue centers on how responsive the supply

of entrepreneurship3 in rural non-farm activities is to changing conditions

over time. This issue is of importance for policy because it provides an

indication of the nature and extent of any constraints to an expansion

of entrepreneurial supply and the efficacy of various policies and programs

designed to overcome them.

Similar results on the importance of self-financing are reported for
small-scale urban enterprises in India (Singh, 1963; Berna, 1960) and for
small and medium size urban enterprises in Nigeria (Harris, 1970).

Data on the rate of growth of individual rural enterprises are
generally lacking and thus the total relationship between profits, savings,
reinvestment, and firm growth cannot be easily examined. Results from
Haiti (Haggblade, et al., 1979) indicate that the average net rate of equip-
ment investment by individual small-scale enterprises was 6 percent per year
between 1974 and 1978. Moreover, the previously described rapid growth of
rural small-scale enterprise employment in general is also somewhat indica-
tive; even if the growth occurs primarily via the establishment of new,
small-scale enterprises, it could be argued that the savings is being used
to establish new, small enterprises rather than to expand existing ones.

Although there are numerous definitions of entrepreneurship, a common
theme is that the entrepreneur is a key decision maker. As such, the entre-
preneur can be treated as a factor of production where performance is
determined by supply factors (Harris, 1970).

There are contrasting views concerning the responsiveness of the

supply of entrepreneurship over time. Economists such as Harris (1970),

Papanek (1971), and Leibenstein (1969) argue that the supply of entre-

preneurship is responsive and that any deficiencies are either transient

or due to market or policy imperfections. Indeed a recent review article

by Leff (1979) argues that it is a "slack variable" and not a crucial

constraint to development. Kilby (1971), as well as those stressing

the importance of either psychological (e.g., Hagen, 1962; McClelland,

1961) or sociological (e.g., Weber, 1930; Cochran, 1965) theories of

entrepreneurial supply are much more pessimistic about the entrepreneurial

supply responsiveness. The relative importance of the determinants of

entrepreneurial supply and success, such as ethnicity, status, education

(both formal and non-formal), are central to the validation of these


Unfortunately, there have been very few detailed studies of rural

entrepreneurs that focus on the determinants of entrepreneurial supply

in developing countries (see Broehl, 1978 for India, and Liedholm and

Chuta, 1976 for Sierra Leone). Most of the studies examine enterpre-

neurship in somewhat larger, urban-based firms and thus their findings

are only of limited usefulness.2

A common finding of all of these studies is that there are generally

serious deficiencies in the entrepreneur's managerial and technical

He does not include the management function in his analysis, however,
and focuses on the innovation and risk-taking functions.
2See, for example, those in India of Berna (1960), Singh (1963),
Gadgil (1959), and Lamb (1955); Kilby (1971) and Harris (1970) in Nigeria;
Marris and Somerset (1973) in Kenya; Carroll (1965) in the Philippines; and
Cochran (1959) in Puerto Rico.

performance in most countries (see Kilby, 1971 for a listing and review).

A crucial question then is whether or not the provision of training

would enable this supply constraint to be overcome. Kilby (1971) and

Cochran (1959) argue, however, that these marginal shortcomings are

"enduring impediments rooted in sociological variables" that cannot be

overcome by training, while Harris (1967) and others argue that appropriate

training would be sufficient to expand entrepreneurship.

The empirical evidence on this issue is somewhat mixed. With respect

to formal education, for example, Kilby (1965), Harris (1970), and Liedholm

and Chuta (1976) have found little or no evidence that formal education

and entrepreneurial success are related. One explanation for this finding

is that nonformal education may be a more relevant form of education than

the formal kind for smaller rural enterprises. In most rural areas the

apprenticeship system is the primary vehicle for providing technical

training; indeed in Sierra Leone 90 percent of the proprietors had

previously served as apprentices. Other nonformal methods of training

are also available in rural areas. One aspect of this training that

appears crucial is record keeping, a skill that can be imparted by non-
formal methods. Yet, most rural entrepreneurs do not keep any records.

The Sierra Leone study (Liedholm and Chuta, 1976), indicates that those

rural enterprises that maintain even a rudimentary set of books are more

successful (i.e., generate more profits) than those that do not. This

same study also reveals that another nonformal type of education, number

of years of on-the-job "experience", is also a significant determinant

of a rural enterprise's success.

In Sierra Leone, only 17% of the proprietors kept any books; in
rural Bangladesh only 6% kept books (Bangladesh Institute of Development
Studies, 1979), while in Jamaica only 11% of the rural proprietors kept
any records (Davis, Fisseha, Francis, and Kirton, 1979).

The nature of the managerial and technical constraint on the

entrepreneurial supply, however, may vary by the type of expansion

envisaged. The supply of entrepreneurial services can be enlarged

either through an expansion of existing enterprises or through a pro-

liferation of new enterprises. There is some evidence that there may

be some deterioration in managerial performance as very small enter-

prises expand (Harris, 1970; Kilby, 1969; Marris and Sommerset, 1972).

Harris points out, "When the business expands beyond the point that the

owner can control everything himself, serious problems are encountered.

The ability to delegate responsibility and authority while still keeping

control, is generally lacking." The type of training required for over-

coming these difficulties might thus be somewhat different than that

required for ensuring the proliferation of new firms. In the latter case,

the existing apprenticeship system, the training ground for new entre-

preneurs in most countries, may play a more crucial role.

With respect to the other socioeconomic variables that might be

expected to affect the supply of rural entrepreneurship, there is little

empirical evidence. The few existing studies generally have not been

able to verify that sociological factors, such as caste, ethnicity, and

parent's occupation, are important determinants of entrepreneurial supply

(see Harris, 1970; Nafziger, 1971). Many of these socio-cultural variables

are interrelated with economic ones, and indeed interact with them.

Consequently, the individual effects cannot be easily measured.

Moreover, the various economic and socio-cultural determinants

of entrepreneurial supply most likely vary from country to country.

Thus detailed studies of entrepreneurial success would be useful

before designing policies and programs for rural non-farm enterprises.

The major policy and program issues will now be examined.


4.1 Introduction

The foregoing analyses and other studies have established that the

rural non-farm sector is much more important than has been generally

recognized and, given even a neutral economic environment, the sector

could contribute much more to employment, equity, and output objectives.

Unfortunately, the economic policies of most developing countries are

generally biased in favor of large, mostly urban, capital-intensive

activities. The direct or indirect consequences of many of these policies

generally have been strongly negative for the non-farm sector, and

specific policies pertaining to the sector have been given little

explicit consideration.

An analysis of the policy environment within which rural non-farm

activities operate is consequently an important ingredient in the formu-

lation of specific projects and programs. Such an analysis would reveal

the degree to which the existing policies affect the viability of various

rural non-farm projects as well as indicate the potential efficacy of

various policy changes. Indeed, changes in existing policies might even

reduce or remove the need for specific projects in this area.

This policy analysis, however, must take account of not only

economic, but political considerations as well. The government's real

attitude toward rural non-farm activities is often difficult to ascertain

and frequently its position is not clear-cut or self-evident. The government

may assert strong support for rural non-farm activities in its Plan,

yet allocate few resources to this area, and may, in fact, be pursuing

a set of policies and programs for large-scale enterprises that have

a strong negative impact on the rural non-farm sector.

Since the national governments frequently consist of or represent

those individuals who benefit from the existing structure of the economy,

they may be reluctant to institute new policies and programs that might

adversely affect their interests. If these individuals are benefiting

from existing policies and programs favoring large-scale enterprises

they may be unwilling to institute even "neutral" policies for rural non-

farm enterprises whenever these are perceived to have potentially

deleterious effects on larger scale enterprises. Moreover, small rural

non-farm enterprises are widely dispersed and politically are frequently

neither well organized nor effectively represented. Presenting govern-

ments with an analysis of the effects of various policy and program

changes on existing interests, including a determination of the dis-

tribution of costs and benefits, is important to permit judgements as

to the government's willingness and ability to institute any policy


In this portion of the paper, specific issues will be raised with

respect to the major policy variables that influence non-farm activities.

Policies causing input price distortions will be discussed first, followed

by a brief discussion of the major nonprice distortions. A brief dis-

cussion of policy variables which influence demand for the sector's

output will conclude this section. Following this discussion of policy

issues, questions will be raised with respect to the major types of

projects designed to affect rural non-farm enterprises.

4.2 Policies Resulting in Factor Price Distortions

Distortions of input prices often originate from unsuspected

sources and, as emphasized in the earlier section, have very significant,

pervasive effects on rural non-farm activities. Five of the major sources

of price distortion will be discussed interest rates, tariff rates,

foreign exchange rates, fiscal policies, and minimum wages.

4.2.1 Interest Rates

In most developing countries, two distinct capital markets exist -

the "formal" and the "informal." Banks and similar institutions con-
stitute the formal market while money lenders, raw material suppliers,

and purchasers constitute the bulk of the informal market. Interest

rates vary widely between the two. For eight countries shown in table

4.1, official interest rates, where government imposed ceilings

generally exist, ranged from 9 to 24 percent, while the "nonofficial"

rates ranged from 29 to over 200 percent. Particularly under inflationary

conditions, the formal real rates become very low, sometimes negative.

Thus, not surprisingly, the banks have tended to lend only to the es-

tablished, large-scale firms, which may appear to the banks to involve

lower risks and lending costs. Most of the recipients are urban based

and they have tended to become more capital-intensive than would have

been the case at the "opportunity costs" of capital. For the rural non-

farm activities, an important question is: To what extent has the frag-

mented capital market resulted in depressed enterprise creation, capital

formation, employment generation, and labor productivity?



Nonofficial Official
Country Rate of Interest Rate of Interest
(%) (%)

Thailand 29% 9.0%

Korea 35-60 17.5

Afghanistan 33 ---

Gambia, Sudan, 50-100 10-12
and Sierra Leone

Colombia 36-60 24.0

Haiti 40-240 12-15

1. Thailand: Ingle, et al. (1973)
2. Korea: Morrow and White (1973)
3. Afghanistan: Norvell (1973)
4. Gambia, Sudan: United Nations, F.A.O. (1963)
Sierra Leone: Bank of Sierra Leone (1969)
5. Colombia: Kochav, et al. (1974)
6. Haiti: Haggblade, Defay, Pitman (1979)

An important related issue is the extent to which the government-

imposed ceiling on "formal" interest rates contributes to the gap

between the demand for and supply of credit for rural non-farm enterprises

at a given time in a country.1 An artificially depressed rate of interest

can be expected to reduce credit availability in rural areas as compared

to what would prevail if the rates were equated with "opportunity costs."

4.2.2 Tariffs

The import duty structure can be an important source of differential

treatment for the urban large-scale over the rural small-scale enterprise.

For most developing countries, import duties are lowest for heavy capital

goods and become progressively higher through intermediate and consumer

durable goods categories (see table 4.2). Yet, many items classified as

intermediate or consumer goods in tariff schedules are capital goods

for rural small-scale firms. In Sierra Leone the sewing machine, an

important capital item for tailoring firms, was classified as a luxury

consumer good and taxed accordingly (Liedholm and Chuta, 1976).

Further escalating the distortion in capital cost is the frequent

practice of granting concessions or even total waiver of import duties

on capital goods or raw materials for specified periods as an inducement

for industrial development. In some cases, small firms may technically

qualify for similar concessions, but may be unaware of this opportunity

or, even when aware, they may find the process so complicated and time

See below, p. 66, for a more detailed discussion of credit programs.



Group Ghana Pakistan Brazil
1966 1965/66 1964

I. Capital goods:
Machinery and



II. Intermediate goods:
1. For industries
capital goods
a. Unprocessed
b. Processed
2. For industries
consumer goods
a. Unprocessed
b. Processed

III. Consumer durables

IV. Consumer nondurables
1. Essentials
2. Semi-luxuries
3. Luxuries





Ghana: Steel (1972, p. 219)
Pakistan: Lewis (1970, p. 68)
Brazil: Bell (1971, p. 47)



consuming that it is not economic for them to exercise the option. In

many other cases, small firms do not even qualify.

4.2.3 Foreign Exchange

Many developing countries institutionally maintain a high price

for foreign exchange but grant concessionary rates to large firms.

Small firms are deprived of comparable advantages since they usually

do not qualify for concessional rates. Even if there are no concessions

the large firms usually import relatively more equipment and inputs

and therefore benefit more than the small ones. The consequence is

to encourage greater capital intensity among urban large-scale industries

and a less than optimum use of capital among rural non-farm industries.

Under conditions of rationed foreign exchange, the larger firms are more

likely to have access to these scarce resources than the small firms.

4.2.4 Other Tax Incentives

Several countries employ tax incentives to encourage industrial

development. These incentives have differed with respect to timing

and coverage. Qualifying firms have been eligible for such incentives

as: (1) tax holiday periods, (2) accelerated depreciation and invest-

ment allowances, and (3) exemptions from some import duties, as discussed

above. These incentives provide an advantage to those enterprises able

to qualify.

Many of these fiscal incentives have had pronounced differential

effects as between large and small rural non-farm firms. Income

Tariffs can also bring direct benefits to rural non-farm enterprises
when they are placed on commodities that the small enterprises produce.
These may benefit large, local enterprises as well.

tax exemptions in many countries are only made available to enterprises

above a certain minimum investment or employment threshold. In those

countries with no minimum requirements, the qualifying procedures are often

so sophisticated and time consuming that they discourage small entrepre-

neurs. On the other hand, smaller enterprises, particularly those at

the lower end of the size spectrum, often do not pay any income taxes

due either to explicit size exemptions or to a tax administration that

is ineffective in reaching the smallest firms.

There is also an array of indirect taxes that may discriminate

against smaller enterprises. Sales and excise taxes, which apply at

all stages in the production process fall more heavily on smaller

enterprises, which usually must pay taxes on each input, than on the

larger, vertically-integrated enterprises (World Bank, 1973). Such

taxes as licensing and municipal fees and stamp taxes tend to be re-

gressive in nature.

4.2.5 Minimum Wage Regulations

Minimum wages, often initiated to achieve socially sound objectives,

often apply only to larger enterprises in urban areas of developing

countries. Where they are applicable country-wide, they are often not

enforced as effectively among the smaller-scale, rural non-farm

activities. Minimum wages in most developing countries have tended to

cause greater capital intensity in urban areas and a greater rural-

to-urban migration. The latter may be the consequences of potential

migrants' perception rather than actual urban employment opportunities

and thus exacerbate the (perhaps partially revolving) urban unemployment

problem. For the rural areas, the overall direct effect has been

a possible reduction in the number of potential entrepreneurs (Berg,

1966, p. 201) and a deterrent to development of a permanent skilled

rural labor force (Weeks, 1971; Berg, 1966; Isaac, 1963).

4.3 Policies With Nonprice Supply Effects

Some policies employed by developing country governments have effects

on rural non-farm activities other than through input prices. These may

originate from unexpected sources and can range from very general to

rather specific influences. These are discussed under two categories -

infrastructure and industrial policies.

4.3.1 Development of Infrastructure

Policies designed to develop the infrastructure of a developing

economy could indirectly affect the performance of rural non-farm

enterprises. The provision or expansion of electricity, water, or roads

would appear to benefit these enterprises (World Bank, 1978a). These

same amenities also benefit their larger scale urban-based counterparts,

which may now be able to enter markets previously dominated by rural

non-farm enterprises. Indeed, one differential advantage possessed by

rural non-farm enterprises may be that they do not require large amounts

of potentially costly infrastructure.

If clear-cut advantages of expanded infrastructure are indicated,

two guidelines are relevant: (1) the substantive nature and/or sophis-

tication of the installation or service, and (2) the scale or rate of

installation of the service. In the case of electricity, for example,

the initial installations may be small on-premise generating units

for key enterprises; next there could be larger generators serving

several enterprises, followed by phasing up to community or area-wide

service from a single generator. An important overall objective is

the compatability between the infrastructure contemplated and the

enterprise clientele to be serviced, if there is to be balance between

social costs and benefits. It is also important to make sure that

rural non-farm enterprises are not discriminated against in their

access to the infrastructure once it has become available.

4.3.2 Industrial Policies

Many policies designed primarily with reference to large-scale

urban firms are also made applicable to small firms, but often work

a relative hardship on the latter. Simple licenses or permits to engage

in business may be so exacting in requirements or so formidable admin-

istratively as to constitute virtual barriers to entry for small firms.

On the other hand, some countries, such as India, have taken positive

measures by reserving certain business activities for the rural non-farm

or small-scale sector. Such actions pose an issue as to whether they

may bring over-corrections and raise barriers to development of other


Conditions of employment and product standards specified by govern-

ment can be obstacles for the small firms if the measures do not take

into account sufficiently the realities facing such firms. These

regulations can have both positive and negative impacts on consumers

as well as on the firm and its workers. Meritorious are those which

realistically safeguard the health and safety of workers and the

consuming public.

Quantity controls of different kinds also can have relative or

absolute negative effects on rural non-farm activities. Examples are

import quotas on raw materials, such as special cloth for small textile

producers. In any general quota program, the large-scale firms are

usually more likely to be accomodated than are the small ones.

4.4 Policies Affecting the Demand for Rural Non-farm Activities

The analyses in the earlier sections of this paper have revealed

that the primary demand for most rural non-farm goods and services

stems from the agricultural sector and that this demand is transmitted

through both income and production linkages. Since the available

evidence indicates that the rural households' income elasticity of

demand for rural non-farm goods is positive and agriculture generates

the largest share of rural income, policies designed to increase agri-

cultural output and/or income have an important indirect effect on the

demand for rural non-farm activities. Consequently, pricing policies

that improve the terms of trade between agricultural and the large-

scale urban sector or specific investment programs and policies designed

to increase, directly or indirectly, agricultural production and income

can generate an increased demand for a wide array of rural non-farm goods

and services.

The nature and composition of these agricultural policies and pro-

grams, however, should also be considered, since they can have important,

differential effects on the demand for rural non-farm activities. There

Demand is also crucially affected by specific marketing projects,
such as government purchasing programs or export marketing schemes.
These and others are described below on p. 76.

is some evidence that the higher income rural households have a somewhat

lower income elasticity of demand for rural non-farm activities than do

the lower income households, the majority of which are small-scale

farmers (see King and Byerlee, 1978). Moreover, as noted previously,

the agricultural inputs such as tractors and fertilizers used by large-

scale, high income farmers are less likely to be produced in rural

localities than are those inputs used by the small-scale farmers (see

Johnston and Kilby, 1975). Consequently, policies and programs designed

to benefit a larger number of small-scale, low income farmers are likely

to generate a larger demand for rural non-farm activities and services

than those designed to benefit a few, larger scale farmers. These

differential effects on rural non-farm activities must be recognized

when designing agricultural policies.

Government policies also can affect the demand for rural non-farm

activities that arise from production linkages with large-scale industry.

Sub-contracting is the most frequently discussed industrial linkage (see

p. 27). Properly designed, such policies can provide relatively stable

demand for certain products at prices which will not adversely affect

the profitability of rural enterprises or the quality of the work environ-

ment. Unfortunately, some policies of developing countries have had a

deleterious effect on sub-contracting. The system of "cascading" sales

tax, for example, whereby taxes apply to all stages of activities relating

The small scale farmers are also more likley to use primarily the
smaller, rurally-based agricultural processing establishments, while the
large-scale farmers might be expected to make more use of the larger scale,
urban-based processing plants.

to any one product discourage sub-contracting and encourages vertical

integration into single, capital-intensive units. Some of the previously

mentioned factor price distortions also tend to reduce the incentive

for large scale units to sub-contract with small, non-farm units.

4.5 Rural Non-farm Enterprise Project Issues

4.5.1 Introduction

In most developing countries, important issues relating to those

existing or potential projects that directly influence rural non-farm

enterprises also need careful examination. Some of the issues are of

a general nature while others are project specific, but all are important

for consideration in the process of designing, implementing, and

evaluating rural non-farm enterprise projects.

4.5.2 General Project Issues

One of the major general issues confronting designers of projects

for rural non-farm enterprises is: How does one identify the intended

project beneficiaries? The descriptive profile presented earlier in

this paper has revealed that, although most of those engaged in rural

non-farm activities are relatively poor, the enterprises themselves are

heterogeneous and widely dispersed geographically. Since it may be

impossible with a single project or set of projects to address the

needs of all rural non-farm enterprises, it will usually be necessary

to develop some criteria for more sharply delineating the project

beneficiaries. Geography, enterprise size, or enterprise types are

some elements that might be incorporated into the formulation of

1Specific programs and projects designed to facilitate sub-contracting
such as information dissemination, quality control, management training, are
described in Staley and Morse, 1965, chapter 9. The minimum wage policy
might tend to encourage sub-contracting while capital subsidization and
other policies would tend to discourage it.

these criteria. It would be useful to identify the types of rural

non-farm activities and the specific enterprises within them that

possess the greatest potential for expanding employment, output and income

in the rural areas. Such information, however, is not generally available

and some in-depth surveys may need to be undertaken in the early stages

of project preparation.

A related general issue confronting designers of rural non-farm

enterprise projects is: How does one decide the types of direct assistance

to be provided? A crucial element involves the identification of the

types of constraints facing the rural enterprises. Only after these

constraints have been identified, can the type and nature of direct

assistance be ascertained. Otherwise, inappropriate interventions may

be proposed.

A final general issue is: How does one establish an effective

monitoring and evaluation system for these projects? Some useful ex-

post evaluations of rural non-farm projects have been undertaken (see Kilby,

1979). Yet, a crucial element that is frequently missing is adequate

benchmark data from which performance can be measured. Once again,

the need for detailed surveys in the project preparation stages becomes


4.5.3 Specific Project Issues

Various types of direct assistance have been utilized in developing

countries to promote rural non-farm enterprise. Although there does

not appear to be any standard way of classifying the various kinds of

direct assistance (see, for example, World Bank, 1978a, 1978b; Staley and

Morse, 1965), a listing of the types of direct intervention would include

the provision of credit, technical/production, management, and marketing

assistance and common facilities (usually industrial estates). The

form which each type of assistance takes and its associated delivery

channels are presented in table 4.3. The major issues that relate to

each of these types of direct assistance for rural non-farm enterprises

will now be examined. Credit Assistance

There are several issues related to the design of credit projects

for rural non-farm enterprises. These issues can be usefully grouped

into those that center on the rural non-farm enterprises' demand for

credit and those that relate to the supply of credit to these enterprises.

One important demand issue is: What is the extent of the effective

demand for credit by rural non-farm enterprises? Some evidence would

appear to indicate that this demand is quite sizable. Rural non-farm

entrepreneurs, for example, when asked directly to identfiy their

greatest assistance needs and greatest perceived bottleneck, will usually

list credit and capital first (Liedholm and Chuta, 1976; Schatz, 1977;

Haggblade, et al., 1979). There is evidence that for many types of rural

non-farm enterprises, the rates of return on existing capital are quite

substantial (see above, p. 46). These high rates of return indicate

that the potential demand for credit could be quite large.

Yet, other evidence indicates that the rural non-farm enterprises'

demand for credit may be somewhat less extensive than indicated above.

Detailed analyses of entrepreneurs undertaken in Sierra Leone (Liedholm

and Chuta, 1976) and Kenya (Harper, 1978) revealed that, although lack

of credit was perceived to be the crucial bottleneck, some other problems,



Type of
Assistance Form Delivery Channel


-Loans in cash and/or kind
for fixed assets and/or
working capital





-Advice on processes, design
of products, tools, equipment,
machines, quality control,
plant layout

-Production planning
-Inventory control
-Capital budgets, etc.
-Personnel management
-Entrepreneurship development

-Advice on packaging,
merchandising, product demand
-Raw material procurement
-Maintain emporia sales and
displays at home and abroad
-Serve as collection centers
-Buy on consignment basis
-Undertake export service
-Offer credit insurance

-Engineering Workshops
-Electricity and water

-Commercial Banks
-Specialized Banks
-Finance Corporations
-Extension Agents
-Credit Schemes
-Loan Boards
-Private Voluntary Agencies
-Informal Channels

-Vocational Training Institutes
-Trade Centers
-Extension on-the-spot, at
Development Centers or
through mobile workshops
-Appropriate technology units
-Local entrepreneurs

-Vocational Training Institutes
-Management Development
-Extension on-the-spot, at
the Industrial Development
Centers, through mobile
-Formal and informal meetings

-Extension Services
-Trading Corporations
-Credit and Export Schemes
-Customer Service Centers
-Handicraft Centers
-Display Centers

-Industrial Estates, Areas
or sites
-Workshop complexes

such as inadequate management or raw material procurement difficulties,

proved, in actuality, to be the crucial basic constraints facing these

enterprises. Unless these other difficulties are recognized and dealt

with, the simple provision of credit could, at a minimum, be wasteful

and could actually prove to have a deleterious effect on the rural non-

farm enterprises. Several studies have indicated that at least some

of the demand for finance is met through self-financing or through

the informal credit market. Recent evidence from Sierra Leone (Liedholm

and Chuta, 1976), Ghana (Steel, 1977), Bangladesh (Ahmed, et al., 1978),

and Haiti (Haggblade, et al., 1979) reveal that personal and family savings

accounted for over 80 percent of the funds used for establishing rural

non-farm enterprises, while about 90 percent of the funds used for ex-

pansion were reinvested profits. Are these self-financing and informal

credit sources sufficient to satisfy the major capital needs of these

enterprises? One might argue that rural non-farm enterprises are

simply forced to use these sources because they are denied access to

the apparently lower cost, "formal" credit markets. Clearly, more

studies are needed to ascertain the magnitude of the rural non-farm

enterprises' effective demand for credit.

Another demand issue relates to the composition of this credit

demand from rural non-farm enterprises. In particular, is the credit

demand primarily for fixed or for working capital? The composition of

the credit demand does appear to vary somewhat depending on the size and

1This is a supply issue, which will be examined below. Although
the interest rate in the formal market may be low, the borrowing costs
may be high due to high transactions costs. The complicated procedures
and long processing time required by these institutions may make the
"transactions" costs very high if not prohibitive, particularly for
those enterprises needing working capital quickly.

type of rural non-farm enterprise. For the smallest enterprises, which

account for the bulk of the rural non-farm sector, the primary credit

demand appears to be for working capital (see Haggblade, et al., 1979).

It is important to ascertain how much of the credit demand is simply a

manifestation of some other problem such as a raw material shortage,

inadequate management or a lack of demand.

One important supply issue centers on what is the appropriate

delivery channel for providing financial services to rural non-farm

enterprises? In most developing countries, formal credit institutions

such as commercial banks, specialized small enterprise banks, specialized

divisions of development banks, credit unions, cooperative and worker

banks have typically been used to channel funds to rural non-farm enter-

prises. Although such devices as rediscounting facilities, guarantees,

and earmarked funds are frequently introduced to entice these "formal"

institutions into expanding their lending to rural non-farm enterprises,

it is not yet clear that these have been successful in significantly

expanding the amount of formal credit available to these enterprises,

particularly the smaller ones.1

Indeed, the vast majority of these rural non-farm enterprises have
never even applied for funds from formal credit institutions. Thus,

alternative institutional mechanisms to the formal ones might also need

to be considered. Informal financial institutions such as money lenders,

input suppliers, purchasers and rotating credit societies, provide most

For a review of alternative institutional arrangements, see Kochav,
et al., 1974.

21n Haiti, 94 percent had never applied (Haggblade, et al., 1979),
while in Sierra Leone, the figure was 96 percent (Liedholm and Chuta, 1976).

of the institutional credit to rural non-farm enterprises. Studies

of these institutions might reveal how these formal and informal

financial institutions are linked and how the informal institutions

might be better integrated into the formal credit system. Finally,

consideration might also be given to establishing new intermediary

institutions, possibly linked with private voluntary organizations,

which might, in turn, link into the formal financial system. Clearly,

no single delivery system has emerged as a solution for providing credit

to the wide array of rural non-farm enterprises.

Another related supply issue centers on the costs and risks associated

with lending to rural non-farm enterprises. It is argued that, owing to

the geographical dispersion and vast number of rural non-farm enterprise-

borrowers, the administrative costs of lending to this group are signif-

icantly higher than lending to large-scale borrowers. Another allegation

which is often made against lending to rural non-farm enterprises is

that, due to the vulnerability of these firms to adverse economic con-

ditions, failure rates are high and therefore the incidence of default

is higher compared to large firms (World Bank 1978b). Furthermore,

the risk factor in lending to rural non-farm enterprises is compounded

by the fact that these firms possess very little collateral and the actual

losses of principal could be fairly high.

These contentions, while valid in some cases, need to be tempered

somewhat. There is evidence in some countries that the default rates

In the Philippines, it was estimated that the administrative costs
incurred by two lending institutions for small-scale loans were 3 percent,
for a given value of lending, while those for large-scale loans were 0.5

among small farmers and small businessmen are lower than among larger

borrowers (Steel, 1976, p. 182; Meyer, 1978). Moreover, alternative

procedures for reducing risks and administrative costs can perhaps be

developed. Instead of relying only on collateral, which many rural

non-farm enterprises may lack, the underlying economic viability and

cash flow potential of the borrowers can be emphasized. Also, loan

repayment schedules can be designed to fit the nature of the different

rural non-farm enterprises. The appraisal and supervision of the loans

for rural non-farm enterprises could be standardized and streamlined.

In addition, managerial, technical and other assistance could be pro-

Vided both borrowers and lenders. Finally, if loans are made at rates

which even approximate the opportunity cost of capital, the financial

institutions could probably cover any higher costs associated with

lending to rural non-farm enterprises.

A final issue that relates both to the demand for and the supply

of credit is: What should be the interest rate for small-scale enterprise

credit projects? In many countries, and within some donor agencies,

there is a feeling that rural non-farm enterprises should receive credit

at a rate below the opportunity cost of capital. It is argued that these

enterprises generally are owned by the poor and that they are already

operating in a policy environment that discriminates against them. More-

over, they contend, if large-scale enterprises already receive subsidized

interest rates, then it would be unfair, and politically unwise, to charge

higher interest rates to rural non-farm enterprises.

A related issue is whether or not the credit and noncredit assistance
should be separated or provided by the same institution.

There are persuasive arguments for an interest rate that closely

approximates the opportunity cost of capital. First, a subsidized

interest rate may encourage rural non-farm enterprise to adopt tech-

nologies that are too capital-intensive. Secondly, most studies (see

Liedholm and Chuta, 1976; Haggblade, et al., 1979) indicate that the

viable rural non-farm enterprises are able and willing to pay higher

interest rates than currently exist in the formal market, especially

if the only alternative is the informal money lender's very high rate.

Higher interest rates may also serve to increase the rate of savings

in rural areas. Finally, the economic viability of the lending insti-

tution is seriously compromised if the interest rate is unduly sub-

sidized. Yet, although strong arguments exist for interest rates closely

approximating the opportunity cost of capital, political, social, and

economic realities may necessitate some degree of interest rate sub-

sidization for rural non-farm enterprise projects. Technical Assistance

Several major issues need to be considered while designing technical

assistance for rural non-farm enterprises. First, it is important to

ascertain the magnitude of the demand for technical assistance. There

is some evidence to indicate that entrepreneurs are not aware of their

.need for technical assistance and the benefits they may derive from it

(see Liedholm and Chuta, 1976; Harper, 1978). Consequently, case studies

may be needed to identify the amounts and required forms of technical

assistance, particularly since assistance needs will likely vary by the

size and type of enterprise.

A second general issue which deserves careful consideration is:

What are the most cost-effective institutional mechanisms, if any, for

delivering technical assistance to rural non-farm enterprises? One

important channel that has been utilized in some developing countries

such as Kenya (Harper, 1978), Ghana, and India is a rural industry

extension service. Unfortunately, there are no systematic analyses

of the experiences with or the effectiveness of this approach. An

important issue which needs careful consideration is: What quality

of personnel should be utilized for delivering these services to rural

non-farm enterprises? Is there a place for both generalists and

specialists in view of the heterogeneity of rural non-farm enterprises

and the complex range of technical operations they face? Another

related issue is whether these services should be offered free, at some

token fee, or at economic costs to be paid by the rural non-farm entre-

preneurs. If extension services should be delivered free to rural

non-farm enterprises, who should underwrite the necessary costs and

for how long? A final issue is whether this active outreach approach

is as cost effective as a more centralized assistance approach, in which

clients would approach a centrally located institute for assistance.

The Rural Industrial Centers in Kenya (see Livingston, 1977) and the

Industrial Development Centers in Nigeria (see Hawbaker and Turner, 1972)

are examples of the more centralized approach to the delivery of assistance.

Vocational training institutes also have been relied upon for

delivering technical assistance, particularly to unemployed youth in

developing countries. For some already employed personnel, vocational

training has been utilized for developing alternative job opportunities

or enhancing capabilities in existing lines of activity. But, unfor-

tunately, the progress of clientele has not been ascertained and overall

effectiveness of vocational training has not been determined.

An already existing institutional mechanism is the apprenticeship

system, and an important issue is whether or not it can be effectively

utilized for transferring technical skills to existing and potential

rural non-farm enterprises. The available empirical evidence reveals

that in most developing countries, the apprenticeship system is the

primary vehicle for skill formation in rural non-farm industry (Liedholm

and Chuta, 1976; Steel, 1977; Haggblade, et al., 1979). Recently,

Mabawonku's study (1979) revealed that with respect to both private and

social rates of return in employment, apprentice training compares

quite favorably with government trade and vocational school programs.

Yet, the apprenticeship system, which is an important channel for skill

formation in rural non-farm industry, is often overlooked by donor

agencies and host governments of developing countries when designing

technical assistance programs.

Another related issue is the degree to which technical assistance

delivery institutions should be separated from the regular governmental

machinery. There would appear to be some advantages associated with

utilizing semi-public organizations or even private sector approaches;

confidence among entrepreneurs would likely be higher and qualified

staff could perhaps be more easily recruited and retained. At the same

time it is unlikely that, in practice, donor agencies can remain com-

pletely detached from the existing governmental technical assistance


Finally, there is the question of whether there are effectively

staffed in-country research institutions to address relevant researchable

problems of small rural non-farm enterprises. Are the institutions

linked to comparable research centers in the world and, within the

country, are there effective links with personnel handling information

dissemination and technical advisory services? Management Assistance

An important issue which should be addressed while designing a

rural non-farm project is to ascertain whether or not there is a demand

for management assistance. Indeed, most rural non-farm enterprises

scarcely recognize that lack of management capacity could pose a serious

problem. Yet, previous studies of rural non-farm enterprises have

revealed that managerial competence is a key determinant of business

success (Harris, 1967; Liedholm and Chuta, 1976; Steel, 1977). It is,

therefore, crucial to ascertain not just what are the perceived, but

also the actual needs in this area.

Another related issue which must be considered is what forms of

management skills these rural non-farm enterprises really need; these

needs will likely vary somewhat depending on the size and nature of the

enterprises. Most rural non-farm entrepreneurs use simple technologies

and possess little or no educational background. Consequently, it may

be important to design management assistance to enable rural non-farm

entrepreneurs to be able to distinguish between personal and business

transactions, evaluate resources (especially their labor input) at their

appropriate opportunity costs, understand effective inventory plans,

adjust their businesses to viable sizes, and adopt methods of pro-

duction that utilize local resources.

A third issue which deserves careful consideration is what delivery

mechanism, if any, will be cost-effective in carrying out management

assistance projects for rural non-farm enterprises. This issue, which

raises other questions relating to the appropriate use of an apprentice-

ship system, extension services and other institutional mechanisms,

has already been discussed under issues relating to technical assistance. Marketing Assistance

The design of marketing assistance for rural non-farm enterprises

raises several issues. First, it is important to ascertain what existing

or new sources of domestic demand are available and how these could be

further stimulated or developed. Many of these sources and programs

have been discussed previously. In addition, the governments themselves

have frequently developed programs to purchase the products of rural

non-farm enterprises, but sales to governments have been hampered by

cumbersome purchase procedures and unrealistic quality standards

(Schatz, 1977,p. 199). A relevant issue is whether official procedures

should be streamlined and excessively high quality requirements waived

to facilitate the purchase of rural non-farm enterprise products by

government departments and the public?1

Large-scale enterprises frequently use packaging or promotional
devices to create product "quality" differentials. Some of these "quality
differentials" may be specious and can have a deleterious effect on rural
non-farm enterprises operating in these same industries. The Kenyan soap
industry (Langdon, 1975) and the Egyptian carpet industry (El Karanshawy,
1975) provide illustrative examples.

A second issue that is relevant for designing marketing assistance

relates to the external demand for the products of rural non-farm

enterprises. In particular, a key issue is how one develops and delivers

information to rural enterprises on the details of both the existing and

new product demand in foreign markets as well as information on product

handling and financial transactions. In addition, since products of

rural non-farm enterprises must be competitive in foreign markets, a

related issue is how one ensures at least minimum product quality.

Thirdly, there is the issue of whether there exists an accessible,

cost-effective, institutional support which can enable rural non-farm

enterprises to purchase raw materials and produce for and effectively

reach the export markets. In most countries this institutional support

is urban based. Decentralization of such facilities to service the needs

of rural non-farm enterprises becomes crucial.

With respect to raw material purchase, evidence from some developing

countries such as Haiti and Bangladesh (Haggblade, et al., 1979; Ahmed,

et al., 1978) reveals that the lack of raw materials constitutes

a major constraint in rural non-farm enterprise. An important issue

which deserves careful attention is what forms of delivery channels

will be cost-effective in providing raw materials to rural non-farm

enterprises? Some developing countries' governments have relied on the

formation of rural cooperatives or producer associations for bulk purchasing

of inputs in order to lower costs of production. However, evidence from

some developing countries reveals that rural cooperatives have often failed

due to personal rivalry, lack of effective leadership and management

problems (Shetty, 1963, pp. 184-185). In other countries, such as Honduras,

the government operates a raw materials bank so that scarce intermediate

inputs can be provided to rural non-farm enterprises; administrative

procedures for distributing inputs often become quite cumbersome. Common Facilities

In many developing countries, the most popular type of assistance

used in providing common facilities for rural non-farm enterprises is

industrial estates. In some developing countries, industrial estates

have been utilized for decentralizing industry toward small rural towns

and villages (Dhar and Lydall, 1961, p. 36). An important issue which

arises is whether estates located in rural areas where basic infra-

structural facilities are lacking can be cost-effective. Experience from

India, reveals that there are relatively few economic justifications

for establishing estates in rural areas (Kochav, et al,. 1974, p. 33).


Rural non-farm activities in developing countries have begun to

receive increased attention from international assistance agencies and

the governments of developing countries. This growing interest has

paralleled the increased international concern for equity and employment

objectives and the realization that expanded rural non-farm activities

might contribute to both growth and improved equity within countries.

Unfortunately, there have been relatively few empirical studies of these

activities. Consequently, those charged with formulating and executing

programs and policies to expand productive rural non-farm employment

and earning opportunities have been generally forced, of necessity, to

make decisions "unencumbered by information." In order to fill that

void, this paper has attempted to assemble and interpret the currently

existing data concerning rural non-farm activities. The major issues

relating to these activities have been considered in the body of the

paper and are summarized briefly below.

A first major issue concerns the overall importance and composition

of rural non-farm activities. The available evidence indicates that

rural non-farm activities are quantitatively very important with from

30 to 50 percent of the rural labor force in most developing countries

either primarily or secondarily engaged in some form of rural non-farm

activity. Currently, the rural non-farm sector encompasses a wide

variety of activities, although manufacturing, commerce, and services

generally predominate. Manufacturing appears to be particularly significant;

in fact, employment in rural manufacturing often exceeds that in urban

manufacturing establishments.

Related to the issue of the current importance of rural non-farm

activities is the question of how rural non-farm activities have evolved

as development proceeds. Hymer and Resnick, for example, hypothesize

that these activities have declined and will continue to do so as rural

incomes rise and opportunities for trade increase. Although some

specific types of rural non-farm activities appear to have declined

over the recent past, the empirical evidence indicates that, overall,

rural non-farm activities and employment have been increasing in most

developing countries.

Several important issues, which have additional implications for

the future growth of the sector, relate to the nature of the demand for

the goods and services produced by rural non-farm activities. One crucial

issue, on which there has been a divergence of opinion, is whether or

not the demand for these activities increases as rural incomes increase.

Hymer and Resnick have argued that rural non-farm activities are "inferior,"

which means that the demand for them would be expected to decline as

rural incomes rise. Mellor, Liedholm and Chuta, and various I.L.O.

Missions, on the other hand, have contended that there is a strong,

positive relationship between income and the demand for these activities.

The few empirical studies of rural demand, particularly that of King

and Byerlee, support the latter position.

Another demand-related issue is whether or not there are strong

backward and forward linkages between rural non-farm activities and

other sectors of the economy, particularly agriculture. Hirschman has

contended that linkages between agriculture and other sectors are quite

weak, while others, such as Mellor and Johnston and Kilby, have argued

that the linkages between rural non-farm activities and agriculture, in

particular, are or could be potentially very strong. The available

empirical evidence indicates that these linkages are quite important. The

rural non-farm sector is influenced by the pattern of agricultural growth,

but, also, the rural non-farm sector can influence the course and rate of

agricultural development. The evidence on linkages with large-scale

industry is sparse but the evidence available indicates that they are

somewhat limited. Finally, there is some empirical and analytical evidence

that the international market is an important component of demand for

certain types of rural non-farm products.

With respect to supply, one important issue is whether or not

rural non-farm activities are more labor-intensive and thus generate

more employment per unit of capital than other non-farm components of

the economy. The available empirical evidence is generally quite con-

sistent in indicating that small-scale, rural enterprises are more labor-

intensive than their larger-scale counterparts.

A key related issue is whether or not these same labor-intensive

rural non-farm enterprises use the scarce factor, capital, more efficiently

than other larger-scale enterprises. Several international groups and

individuals, including Nicholas Kaldor, have argued that the capital

productivity (i.e., the output-capital ratio) of small, rural enterprises

is lower than that of their larger-scale counterparts. Marsden, Liedholm

and Chuta and others have contended that the reverse situation holds.

The available aggregate country data are generally not of high enough

quality to provide a conclusive answer to these conflicting views,

although there are many instances where the small, rural non-farm

enterprises appear to possess the higher capital productivity. When

rural non-farm and urban large-scale enterprises within the same narrowly-

defined industry are compared, there is evidence, in several industries,

that the rural non-farm enterprises are not only more labor-intensive,

but also more productive per unit of scarce capital than their larger-

scale counterparts. Consequently, in these cases, there need not be a

trade-off between output and employment objectives, at least in a static


These findings are reinforced by evidence on profitability, which

indicates that profit rates in many rural non-farm enterprises are also

higher than those in urban, larger-scale firms. Moreover, in a dynamic

context, there is no empirical evidence to support Galenson and

Leibenstein's contention that the profit, savings, and reinvestment

rates of small-scale or rural non-farm enterprises are necessarily lower

than those of the large, capital-intensive enterprises.

Although static and dynamic efficiency considerations are of great

importance to policymakers, the equity implications of rural non-farm

activities also are attracting increased attention. The limited evidence

shows that, on the average, the income of rural non-farm households

is somewhat higher than that of farming households, but is substantially

below urban incomes. Rural non-farm activities are generally undertaken

by very small-scale, artisan and informal enterprises, which employ on

the average, fewer than five individuals. These activities are partic-

ularly important for those rural households with little or no land.

Given the great potential of rural non-farm activities for increased

employment, increased income, and favorably affecting income distribution,

many governments are showing increasing interest in assisting rural

non-farm enterprises. Governments can assist these enterprises by

general policy measures, which affect the environment in which rural

non-farm enterprises operate, and by providing direct project assistance.

Several major policy options are available to those governments

interested in influencing rural non-farm activities. However, great

care must be exercised in policy selections as many government actions,

seemingly unrelated to rural non-farm activities, can have inadvertently

adverse effects on them. For example, policies that result in input

price distortions have significant, though often unintended, negative

effects on rural non-farm activities. In most developing countries,

interest rates, tariff rates, foreign exchange rates, and tax policies

have been designed to benefit large-scale enterprises and consequently

are generally biased against the small, rural non-farm enterprise.

Government policies with respect to the infrastructure, industry, and

agriculture also have important indirect effects on the expansion of

rural non-farm employment and income opportunities. Because of the

strong linkages between agricultural and rural non-farm activities,

agricultural policies and programs, in particular, have a strong

influence on rural non-farm activities.

The major types of direct assistance projects used to promote

rural non-farm activities include a broad spectrum of interventions:

the provision of credit, technical, management, and marketing assistance

and common facilities (usually industrial estates). A crucial element

in determining which form of direct intervention is most appropriate

is the identification of the key constraint or constraints facing the

rural enterprise. Rural entrepreneurs, when asked to identify their

primary constraint, will usually state that it is a lack of credit.

Yet, in-depth analyses frequently reveal that other underlying constraints

are more crucial. Such analyses are important for identifying both

the types and forms of assistance that are most needed.

Another key project issue that deserves careful consideration relates

to the supply of this assistance. What are the most cost effective

mechanisms for delivering this assistance? Should existing institutions

be used or should new ones be established? Should these be separated

from the existing governmental structure? Should several forms of

assistance be provided by the same institution? Because rural non-farm

enterprises are so heterogeneous and conditions vary so markedly from

country to country, there are no single answers to these questions;

rather, the appropriate institutional arrangements will depend importantly

on the country and the nature of the non-farm enterprises that are to

receive this assistance.

Although rural non-farm activities represent only one facet of the

rural development process, their importance in this process is becoming

increasingly recognized. With judicious governmental policies and

carefully formulated direct assistance measures, the already sizable

contribution of rural non-farm activities to this process can be sig-

nificantly enhanced.


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