Big Is Good
I recently came across a research paper by Abiodun Egbetokun that purportedly investigates a topic of great interest to me: the evolution of large firms in an economy. While I have reservations regarding the paper, its subject deserves attention and has important implications for economic development.
It is a consensus among development scholars that low-income countries are poor because productivity by workers and businesses is low. One of the reasons for low productivity is that low-income countries are dominated by ‘’informal’’ small firms that struggle to grow, create jobs, and be profitable.
In another recent study that looks at the patterns of industrialisation in some African economies and their struggles, with productivity and employment — the problem of firm size did show up in the data. Here are the authors comparing Ethiopia and Vietnam:
Ethiopia is the second most-populous country in Africa. Its government has pursued an aggressive industrialization strategy, which largely revolves around attracting investment in labor-intensive manufacturing for export. As of 2021, Ethiopia’s strategy mirrors to a large degree the strategy pursued by Vietnam; as noted earlier, both countries have been heavily influenced by China’s use of special economic zones…….
Of course, there are also some striking differences. The most notable is the sheer size of the formal manufacturing sector in Vietnam relative to Ethiopia. An 8 percent increase in formal sector manufacturing in Vietnam adds an additional 520,000 jobs while an 8 percent increase in formal sector manufacturing in Ethiopia adds around 28,000 jobs. If employment in Ethiopia’s manufacturing sector continues to grow at 8 percent per year, it will take Ethiopia 38 years to catch up to the level of employment seen in Vietnam today. Part of this difference has to do with the fact that Vietnam had a much larger industrial base when it embarked on its strategy of export-led manufacturing development…….
A striking difference between Ethiopia and Vietnam is the rapid expansion of foreign firms in Vietnam’s manufacturing sector. In 1990, at the onset of Vietnam’s reforms, there were less than 1,000 workers employed in foreign-owned firms. Between 1990 and 2000, employment in foreign-owned manufacturing enterprises grew at an annual average rate of 47.3 percent (General Statistics Office 2006).
Employment growth in domestic private and state-owned enterprises paled in comparison at 3 percent and 2 percent respectively. Although employment growth in foreign-owned enterprises slowed down after 2000, it remains the dominant source of employment growth in Vietnam’s manufacturing sector. Between 2000 and 2017, annual employment growth in foreign-owned manufacturing enterprises averaged close to 14 percent; employment growth in domestic private firms averaged 4 percent while it was −6 percent in state-owned enterprises. By 2017, the share of manufacturing employment in foreign-owned enterprises exceeded 60 percent in Vietnam……
A unique feature of many of the foreign firms in Vietnam is their sheer size. For example, in 2017, there were 756 foreign-owned firms in Vietnam with more than 1,000 employees; in Ethiopia, this number is only 21. Moreover, there were 125 foreign firms with more than 5,000 employees in Vietnam while there are no firms of this size in Ethiopia’s manufacturing sector. This difference does not apply only to foreign firms, although the “huge” firms are more prevalent among foreign-owned enterprises and in the labor-intensive sectors of apparel and footwear. We call this the case of the missing huge firms.
The importance of big firms regarding development and industrialisation is still a contested fact to some people, despite very good evidence for it. The Nigerian technology startup industry is an excellent example of a typical counterargument. The startup industry has seen incredible growth, and foreign investment has created a booming international market for local software developers. This success has caused many to argue for political incentives for the startup model across other sectors such as transportation, energy, and agriculture. However, Ricardo Hausmann cautioned against this kind of thinking ten years ago:
The software industry is unique, because it has unusually low barriers to entry and ready access to a huge market through the Internet. A start-up is typically just a group of kids with a good idea and programming skills. All they need is time to write the code. Incubators provide them with space, legal advice, and contacts with potential clients and investors.
But consider a steel, automobile, or fertilizer plant — or a tourist resort, a hospital, or a bank. These are much more complex organizations that must start at a much larger scale, require much more upfront investment, and need to assemble a more heterogeneous team of skilled professionals. This is not something at which a young college dropout is bound to excel, because he lacks the experience, the organization, and the access to capital that these ventures require
And, compared to software development, these activities also require more infrastructure, logistics, regulation, certifications, supply chains, and a host of other business services — all of which demand coordination with public and private entities. Most important, these activities are most likely to be central to economic growth in developing and emerging countries
As large businesses are integral to many industries, both in terms of functioning and success, it is essential to understand how they come to be. This was the topic that caught my eye when I found Egbetokun’s research paper. As there is often political resistance to the entry of foreign firms, it is of particular importance to understand how big firms can emerge locally. The first noteworthy result from his paper is that large firms are simply those that have managed to stay in business for a long time.
One main finding discussed in the paper is that larger firms tend to be older firms. Hence one of the ways firms can grow big is by managing to simply stay in business. The author writes:
Of the 106 firms, only three were started between 2000 and 2005; the rest being at least 25 years old. On average, the older firms are larger (Figure 1). The apparent correlation between age and size conforms with the hypothesis that firms grow as they age, one which finds support in the existing literature. From a policy standpoint, therefore, it seems logical to pursue firm survival since older firms tend to exhibit higher growth over time. In a resource-constrained environment like Nigeria, the modal firm is born small even if it has growth aspirations. Such firms need to survive long enough to accumulate the capabilities required to operationalise their growth aspirations.
Reading this reminded me of another good paper by David McKenzie of the World Bank about the death of small firms in developing countries. His survey found that about half of small firms at any particular time in the cohort of countries he studied are likely to die every six years. He also found that ‘’the common reason for firm death is that less profitable and less productive firms end up making losses and closing’’. This suggests that policymakers must be careful before pursuing interventions that create distortions that keep unproductive firms alive.
Another noteworthy thing from Egbetokun’s paper is that large firms in Nigeria are located in or around Export Processing Zones (EPZs). The gospel of exports will already be familiar to readers of this blog. The benefits of an export-led development strategy cannot be overstated. But alas, Nigeria has been sleeping on this. Most of our EPZs have poor connecting infrastructure, and the trade policy implementation is only slightly less onerous than the rest of the country. The bias against foreign firms is also counterproductive. Specific policies that facilitate technology transfer and humane labour laws can be used to manage relations with foreign firms.
But it would be foolish to think we can do it all by ourselves. As silly as waiting for one man before we can refine crude oil into petrol.
