The majority of enterprises in developing countries have no paid workers. Is this optimal, or the result of frictions in labor markets? We conduct an experiment providing wage subsidies to randomly chosen microenterprises in Sri Lanka. In the presence of frictions, a short-term subsidy could have a lasting impact on employment. We find the subsidy induced firms to hire, but there was no lasting impact on employment, profitability, or sales. Analysis rules out several theoretical mechanisms that could result in sub-optimally low employment. We conclude that labor market frictions are not the reason own-account workers do not become employers.
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