Firm Dynamics in Developing Countries. A LAC Perspective

Julián Messina* Inter-American Development Bank

World Bank – Government of Peru – Conference

“Promover el Crecimiento a Través de Políticas Efectivas”. Lima, 9-10 July 2015

*The views and interpretations in this presentation are those of the author and should not be attributed to the Inter-American Development Bank.

1

Paper overview

• Lack of contract enforcement prevents owners to obtain manager effort.

– This reduces incentives to innovate.

– Lack of innovation translates into insufficient productivity, which is at the source of firms growth.

– Small firms are not wiped out from the market due to insufficient competition.

• Key mechanism: (Internal) contractual failure prevents firm growth and selection

2

Assessment

• Very nice paper!

• Offers an interesting and plausible mechanism to explain insufficient creative destruction in developing countries.

• Calibration suggests that contract failures can go a long way in explaining differential firm dynamics between India and the US.

3

This Discussion. Outline

1. How relevant the problem in LAC? 2. How relevant this mechanism for LAC? Rule of law and contractual enforcement. Firms’ growth dynamics and market selection. Labor market turnover.

3. How relevant are productivity differentials for firm selection? The missing role of demand.

4. Concluding thoughts.

4

1. HOW RELEVANT IS THIS PROBLEM FOR LAC

5

Fact 1. LAC firms are very small

0%

10%

20%

30%

40%

50%

60%

70%

80%

Perc

ent

Share of firms with no employees in selected countries, 2011

Informal Formal

68.1% 63.1% 62.4%

58.2% 49.8%

45.7% 38.3% 37.1%

29.8% 33.7% 34.2% 38.8%

44.7% 47.9%

43.3% 50.7%

0%

20%

40%

60%

80%

100%

Perc

ent

Distribution of firm size in selected countries, 2011

0 1-5 6-50 50+

Source: Lederman, Messina, Pienknagura and Rigolini. (2014) Latin American Entrepreneurs: Many Firms But Little Innovation. The World Bank . 6

Fact 2. Too many self-employed, and too few employees

Source: Lederman, Messina, Pienknagura and Rigolini. (2014) Latin American Entrepreneurs: Many Firms But Little Innovation. The World Bank .

BOL CHL

COL

CRI

DOM

ECU

GTM

HND

HTI

JAM

MEX

PER

PRY

SLV URY

VEN

0

10

20

30

40

Non

-ag

Ow

n A

ccou

nt (%

)

6 7 8 9 10 11 Log of GDP (PPP) per capita

Nonagriculture, own account

BOL

CHL

COL

CRI

DOM

ECU

GTM

HND

HTI

JAM MEX

PER PRY

SLV

URY

VEN

0

20

40

60

80

100

Non

-ag

Wag

e an

d Sa

larie

d (%

)

6 7 8 9 10 11 Log of GDP (PPP) per capita

Nonagriculture, wage and salaried

7

Fact 3 (i). Little Innovation

0

2

4

6

8

10

12

14

16

Other LAC ECA LAC5 China High Income

R&D

/ M

anuf

actu

ring

Val

ue A

dded

%

Business Enterprise Government Higher Education Private Non-Profit Abroad

R&D Investments

Source: Lederman, Messina, Pienknagura and Rigolini. (2014) Latin American Entrepreneurs: Many Firms But Little Innovation. The World Bank . 8

Fact 3 (ii). Little Innovation Patents

Source: Lederman, Messina, Pienknagura and Rigolini. (2014) Latin American Entrepreneurs: Many Firms But Little Innovation. The World Bank .

1

10

100

1000

10000

Pate

nts p

er 1

mill

ion

peop

le

9

Fact 3 (iii). Little Innovation

0%

20%

40%

60%

80%

100%

Perc

ent

Percentage of Firms that Develop or Introduce a New Product

Source: Lederman, Messina, Pienknagura and Rigolini. (2014) Latin American Entrepreneurs: Many Firms But Little Innovation. The World Bank . 10

2. HOW RELEVANT IS THE MECHANISM IN LAC? RULE OF LAW AND CONTRACTUAL ENFORCEMENT

11

The rule of law in LAC

Source: WDI. The World Bank. Worldwide Governance Indicators.

-2

-1

0

1

2

Rule

of

law in

dex

Rule of Law captures perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence. Estimate gives the country's score on the aggregate indicator, in units of a standard normal distribution, i.e. ranging from approximately -2.5 to 2.5.

12

Contractual uncertainty in LAC

Source: Doing Buisness. The World Bank .

0

200

400

600

800

1000

1200

1400

1600

Tim

e (d

ays)

Time (days)

0

10

20

30

40

50

60

Cos

t (%

of c

laim

)

Cost (% of claim)

Enforcing Contracts in 2013:

13

2. HOW RELEVANT IS THE MECHANISM IN LAC? FIRMS’ GROWTH AND MARKET SELECTION

14

Firm Dynamics in LAC. Growth

0

10

20

30

40

50

60

LAC ECA High Income EAP4N

umbe

r of e

mpl

oyee

s

Average initial size of firm

Average P 10

P 50 P 90

0

2

4

6

8

10

12

14

16

1 to 4 5 to 10 10 to 19 20 to 29 30-39

Rat

io b

etw

een

curr

ent a

nd in

itial

size

Age categories

Average size of firm relative to its initial size

EAP4 ECA

High Income LAC

Source: Lederman, Messina, Pienknagura and Rigolini. (2014) Latin American Entrepreneurs: Many Firms But Little Innovation. The World Bank . 15

Selection in LAC. Entry

Argentina Bolivia

Chile

Colombia

Costa Rica

Guatemala Jamaica

St. Kitts and Nevis

Mexico El Salvador

Uruguay

0

5

10

15

20 En

try D

ensi

ty (%

)

6 7 8 9 10 11 log of GDP per capita

Peru Brazil

Source: Lederman, Messina, Pienknagura and Rigolini. (2014) Latin American Entrepreneurs: Many Firms But Little Innovation. The World Bank . 16

Selection in LAC. Exit (in Colombia)

Source: Eslava and Haltiwanger (2014).

-0.05

0.00

0.05

0.10

0.15

1 2 3 4 5 6 - 10 11 - 15 16-20 21+ra

te

Age Categories

Up-or-out Dynamics in Colombian Manufacturing Establishments

1988-2009

Net growth continuers Destruction from Exit

-0.05

0.00

0.05

0.10

0.15

1 2 3 4 5 6 - 10 11 - 15 16-20

rate

Age Categories

Up-or-out Dynamics in U.S Manufacturing Establishments

1992-2007

Net growth continuers Destruction from Exit

17

2. HOW RELEVANT IS THE MECHANISM IN LAC? LABOR MARKET TURNOVER

18

Fact 1. High Job Creation and Destruction

-30 -20 -10 0 10 20 30

New Zealand (1987-1992) [a]France (1989-1997) [b]

Ecuador (2005-2012) [c]Sweden (1985-1992) [a]

Romania (1994-2000) [d]Denmark (1983-1989) [a]

Finland (1988-1998) [b]Hungary (1992-2001) [b]

OthersLAC

Mexico (1985-2001) [b]Slovenia (1992-2001) [b]Estonia (1995-2001) [b]

OECDPortugal (1983-1998) [b]

Latvia (1996-2002) [b]Netherlands (1994-1995) [d]

Brazil (2007-2012) [c]United States (1988-1997) [b]

Italy (1986-1994) [b]Argentina (2007-2008) [c]Germany (1979-1998) [d]

Canada (1984-1997) [d]

Percentage of employment

Job Creation and Job Destruction Rates

Salidas Destruccion bruta de empleoEntradas Creación bruta de empleo

Source: Adapted from Empleos Para Crecer (2015). IAD.

[a] BID (2004) "Goods jobs wanted: Labor markets in Latin America". [b] Haltiwanger, J.; Scarpetta, S. y Schweiger, H. (2006) "Assessing Job Flows across Countries: The Role of Industry, Firm Size and Regulations", IZA DP No. 2450. [c] estimacion propia en base a Argentina: BADE, OEDE, MTSS; Ecuador: IESS y Brasil: RAIS. [d] Bartelsman, E.; Haltiwanger, J. y Scarpetta, S. (2010) "Measuring and Analyzing Cross-Country Differences in Firm Dynamics", NBER 19

Fact 2. High worker flows, but exits mostly due to layoffs and quits (not firm closures)

Source: Dix-Carneiro, Messina and Ulyssea.(2015).The Dynamics of Formal Employment: Evidence from Brazil. IDB. Mimeo

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

rate

Firm size

Separation rate by firms’ size in Brazil

Separation Firm exit

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

1986-1990 1991-1995 1995-2000 2001-2005 2006-2010

rate

Lustrum

Separation rate by 5 year averages in Brazil

Separation Firm exit

20

Fact 3. Low Duration of Jobs (i)

0

5

10

15

20

25

15-19 20-24 25-29 30-34 35-39 40-44 45-49 50-54 55-59 60-64

Year

s

Age categories

Wage employees’ average spell in their firms by age of the worker. LAC vs. OECD

OECD-24 LAC-14

Source: Empleos Para Crecer (2015). IAD.

21

0

5

10

15

20

25

Year

s

Firm size

Tenure in Brazil by firms’ size

Mean P25 P50 P75 P90

0

2

4

6

8

10

12

14

16

18

Year

s

Lustrum

Tenure in Brazil. 5 year averages

Mean P25 P50 P75 P90

22 Source: Dix-Carneiro, Messina and Ulyssea.(2015).The Dynamics of Formal Employment: Evidence from Brazil. IDB. Mimeo

Fact 3. Low Duration of Formal Jobs (ii)

Fact 4. High flows in and out of unemployment

0%

1%

2%

3%

4%

5%

6%

7%

Portu

gal

Ital

yG

erm

any

Irel

and

Japa

nFr

ance

Uni

ted

Kin

gdom

Spain

OE

CDSw

eden

Nor

way

Aus

tralia

New

Zea

land

Can

ada

Mex

ico

Peru

Ecu

ador

Braz

ilU

nite

d St

ates

LAC

-8Pa

ragu

ayA

rgen

tina

Ven

ezue

laC

olom

bia

Ann

ual P

roba

bilit

y

Probability of moving from employment to unemployment

0%

10%

20%

30%

40%

50%

60%

70%

Ital

yIr

elan

dG

erm

any

Spai

nPo

rtug

alFr

ance

Uni

ted

Kin

gdom

OE

CD

Japa

nA

ustra

liaC

anad

aN

ew Z

eala

ndSw

eden

Nor

way

Col

ombi

aBr

azil

Arg

entin

aPa

ragu

ayE

cuad

orLA

C-8

Peru

Uni

ted

Stat

esV

enez

uela

Mex

ico

Ann

ual P

roba

bilit

y

Probability of moving from unemployment to employment

Source: Empleos Para Crecer (2015). IAD.

23

3. HOW RELEVANT ARE PRODUCTIVITY DIFFERENTIALS FOR FIRM SELECTION?

24

The forces behind firm selection

• In most of the literature, firm selection works through “productivity” differences.

• Productivity here is a proxy for the value of a firm, its competitive edge.

• Firms may grow and gain market share because of technological advances, but also because of demand shifts.

• Up to recently, literature was silent about the relative importance of these two forces.

25

The forces behind firm selection: demand at the forefront

• Recent papers suggest a fundamental role of demand factors for:

– Firms’ growth: Foster, Haltiwanger and Syverson (2012), Pozzi and Schivardi (2015).

– Firm’s exit: Foster, Haltiwanger and Syverson (2008).

– Worker’s reallocation: Carlsson, Messina and Nordstrom-Skans (2014).

• This may be important for the mechanisms outlined in the paper: internal vs. external contractual imperfections.

• Contractual imperfections may hinder specialization across firms

26

4. CONCLUDING THOUGHTS

27

Concluding thoughts (i)

• Contractual imperfections may limit incentives to grow or hinder specialization across firms

• Low productivity-low innovation-low firm growth equilibrium

• Mechanism is sensible, and broad-brush data does not reject its potential importance in LAC

• Other forces may be important (Lederman et al. 2013):

– Quality and type of human capital

– Lack of competition in service sectors

28

Concluding thoughts (ii)

• However, LAC labor markets present tremendous turnover (prima facie, this seems inconsistent with a sclerotic labor market)

– Probably a lot of these worker flows are inefficient (workers not moving from low to high value firms)

– Damaging effects – Low investments in HK

• We need more research and more and better data, in particular on the firms’ side

29

THANK YOU!

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