Firm size and productivity

One of the most interesting areas of recent research is that which explores the reasons for the wide differentials in establishment-level productivity within a country as well as cross-country aggregate productivity. Poorer countries have been characterised by lower establishment level productivity which translates into lower aggregate productivity.

In a new working paper, Pedro Bento and Diego Restuccia uses data of manufacturing establishments from across 12 countries and finds a "clear positive relationship between aggregate productivity and average establishment size". They write,

We calibrate a benchmark economy to US data and show that reasonable variations in the extent of correlated distortions have substantial negative effects on establishment size, establishment-level productivity, and aggregate output per capita. In order to provide a quantitative assessment of this channel in explaining productivity differences across countries, we first document evidence from cross-country micro data for the elasticity between distortions (wedges) and establishment productivity, using establishment-level data from the World Bank's Enterprise Surveys.

We show that the elasticity of distortions with respect to productivity in the micro data is strongly negatively related with both average establishment size and GDP per capita across 53 countries... Compared to the calibrated U.S. benchmark economy, increasing correlated distortions to 0.56 (the elasticity between wedges and establishment productivity found for India) generates a reduction in establishment size to 3.4 workers versus the 22 workers in the US economy (a 6-fold difference), and a similar reduction in establishment-level productivity. 

Their sample finds the income elasticity of establishment size to be 0.26 - a one percentage increase in income is associated with an increase in establishment size by 0.26 percentage. This climbs to 0.33 when small countries with population less than half a million are eliminated. 

Industrial policies pursued by governments have largely been confined to fiscal concessions, cheap credit, and subsidised inputs. An encouraging development in recent years has been the increasing salience of policies to prune regulatory and transactional thickets that improve the ease of doing business. Another area that demands immediate attention is informality and small firm size. An industrial policy that seeks to help firms start formal and encourage informal firms turn formal, and then create the conditions for even 10-20% of them to grow in size, has the potential to unlock large gains.