Firm Size, Finance and Growth

Thorsten BeckAsli Demirguc-KuntLuc LaevenRoss Levine

Motivation

Does finance have distributional effects? Income distribution / poverty (BDL, 2005)

Small (poor) firms do not access financial system, so finance benefits large (rich) firms more

(Greenwood / Jovanovic, 1990)

Financial development lowers fixed costs (transaction & information), so helps small (poor)

(Banerjee / Newman, 1993; Galor / Zeira, 1993)

(How) does finance affect growth?

Policy: (a) Political economy and (b) SMEs

This paper’s goals …

Does financial development boost the growth of small firms more than large firms? Distributional effects Mechanisms through which finance

affects growth Policy

Methodological Strategy Do “small-firm” industries grow faster in countries

with well-developed financial systems? Coase (1937)

Firms optimally internalize some activities, but size enhances coordination costs

Industry’s “natural” firm size depends on that industry’s production technologies

Step 1: Compute each industry’s natural firm size: Share of employment in “small firms.”

Step 2: Test whether industries that are naturally composed of small firms, grow faster in countries with well-developed financial systems.

More on the methodology … We use the U.S. as the benchmark to

compute each industry’s natural firm size

Industry Firm Size = F{Industry & Country} Assume USA has comparatively few distortions Then, role of country traits is small.

Obtain proxy for industry’s natural firm size

(Similar to RZ, who compute industry’s natural tendency to use external finance.)

Related literature

Guiso, et al: Small firms benefit more from regional financial development in Italy Nice. But, we focus across countries

Beck, et al (2005): reported financial obstacles to growth is stronger in small firms in under-developed financial systems Nice. But, based on survey responses

Data

1. Industry growth2. Small firm share3. Financial development

Industry growth

Average annual growth rate of real value added of industry k in country i over the period 1980-1990.

We show the results hold over different sample periods.

Small firm share

Industry k’s share of employment in firms with less than 20 employees in the U.S. (1992 Census, earliest date possible)

Robustness Different firm size cut-offs (5: 500) (1997 Census … correlation of 92%) Concerns about U.S.:

Control for other factors that may invalidate the US as a benchmark.

U.S. markets do not have to be perfect. They have to give a reasonable ranking.

Different benchmark countries

Table 1: Firm size across U.S. industries(A few, select observations)

ISIC Industry name S20 3411 Manufacture of pulp, paper and paperboard 0.14 314 Tobacco manufactures 0.30 353 Petroleum refineries 0.36 311 Food manufacturing 3.82 342 Printing, publishing and allied industries 16.32 390 Other Manufacturing Industries 16.95

331 Manufacture of wood and wood and cork products, except furniture 21.37

Average 5.85

Financial development

Private credit Others

Liquid liabilities Stock market development Legal & accounting systems

,)*( ,

,,

kiik

kii k

kkiiki

FDShareFirmSmall

ShareIndustryCountryGrowth

Methodology

Growth = average annual growth of real value added of industry k in country i, averaged over 1980-90Share = Initial share of industry i in 1980 in total manufacturing FD = Claims of financial institutions on private sector relative to GDP in country i.Small firm share = benchmark share of small firms in industry kOLS and IV, also cluster at industry or country levelSample: 36 industries across 44 countries

Table 3: Financial development, small firm share and growth

OLS OLS IV Share in value added -1.012*** -1.095*** -1.086*** (0.253) (0.253) (0.253) Private Credit * Small firm share 0.409** 0.445** 0.567** (0.172) (0.173) (0.220) Private Credit * External dependence 0.144*** 0.101*** (0.039) (0.037) Observations 1242 1242 1242 R-squared 0.26 0.28 0.27

Financial development, small firm share and growth - economic significance

Small Firm Share: 25th percentile: Spinning 75th percentile: Furniture (lots of small firms)

Private Credit: 25th percentile: India 75th percentile: Canada

Furniture grows 1.4% faster than spinning in Canada than in India

Average growth rate = 3.4%

But, …

Small firm share in the U.S. may be correlated with other industry-specific

traits that interact with country-level

characteristics to explain industry growth

Robustness: industry traits …

Is small firms share a proxy for … External dependence? Intangible assets?

Claessens and Laeven show this with property rights protection

But, we interact it with both property rights and private credit

Good, or bad, growth prospects? Technology factors that firm size in U.S.?

Control for median firm size of the large, listed firms by industry in the U.S. (in a few slides)

Robustness: country traits …

Is financial development a proxy for … Economic development? Schooling?

Human capital may affect natural firm size Size of the market?

Openness to trade Size of the economy

Conclusions

Finance has distributional effects

Small firm industries grow faster (than big firm industries) with better financial development

{BDL: the poor enjoy faster income growth (than the rich) with better financial development.}

Mechanism linking finance and growth: Alleviates constraint on small firm growth

Policy: Political economy & SMEs