Capacity Strengthening, Firm Formalisation, And Productivity Among Small Enterprises in Nigeria

Abstract

Small and medium-sized enterprises (SMEs) are central to economic growth, employment generation, and innovation in developing economies. However, a large share of SMEs operates informally, restricting their access to finance, formal markets, and institutional support, while simultaneously narrowing the domestic tax base. This study examines the causal impact of SME formalisation on labour productivity and taxable revenue, and analyses how capacity strengthening—through managerial training, human capital development, and capital deepening—supports the transition to formality. Using firm-level data and an Instrumental Variables Generalised Method of Moments (IV-GMM) estimator, the analysis addresses endogeneity concerns arising from reverse causality and selection bias, thereby ensuring robust causal inference. The findings reveal that formalisation significantly enhances firm performance. Formal SMEs exhibit approximately 52% higher output per worker than informal firms, after controlling for firm size, age, sector, access to finance, and urban location. In addition, formalisation expands the taxable base substantially, increasing declared revenue by roughly 75%, underscoring its importance for domestic revenue mobilisation. Capacity-strengthening measures are strongly associated with higher formalisation rates, highlighting the role of managerial competence, skilled labour, and structured investment planning in facilitating compliance. Firm-level characteristics such as larger size, greater capital intensity, stronger human capital, and urban location further reinforce productivity and fiscal gains. Overall, the results demonstrate that formalisation is not merely administrative compliance but a strategic lever for improving firm performance and strengthening fiscal capacity. Integrated policy interventions—combining simplified registration procedures, targeted managerial and technical training, and improved access to finance—can generate complementary effects that simultaneously enhance SME productivity and expand the taxable base.