Firm types and jobs creation in developing countries

Hassen Arouri, Caroline Freund, Antonio Nucifora, Bob Rijkers 03 July 2015

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Firms create jobs. And encouraging businesses to take root in developing countries has been a long-held means to creating more. But which firms create the most jobs in developing countries? The jury is out, which is unfortunate because the answer to this question has important policy implications for how to tackle unemployment. Weak job creation could reflect distortions inhibiting the growth of productive firms (Hsieh and Klenow 2009, Hsieh and Klenow 2014, Bartelsman et al. 2013), or be due to demand constraints, with productivity a potentially even more important determinant of growth and survival. Moreover, limited job creation may be driven by stagnation among incumbent firms, insufficient entry, and/or excessive exit (Davis et al. 1996). Understanding which of these margins matters most and who creates jobs can guide the design of policies that promote private sector development. Small and medium enterprise promotion programmes, for instance, are predicated on the notion that small firms create the most jobs.

Age matters more than size

Recent literature using firm level data from developed countries implies that the ability of high productivity firms to grow quickly is critical to job creation. Haltiwanger et al. (2013) and Criscuolo (2014) show that the US and other OECD countries exhibit an up-or-out dynamic, where the most productive entrants expand and the weakest ones are driven out of business; as a result it is the young and fast growing firms and also the large firms that create the most jobs.  Put differently, age matters more than size.

Patterns could be different in developing countries, where firms are smaller on average and the industrial sector is a growing share of income. Using a unique dataset containing information on all registered firms, including the self-employed, our new paper (Rijkers et al. 2014) dissects private sector job creation patterns in Tunisia — a country with high and persistent unemployment — focusing especially on the contributions of small and medium enterprises, which account for the bulk of all employment.

We argue that weak aggregate job creation was the result of insufficient dynamism, manifested in a lack of upward mobility and stagnation amongst incumbents, and market imperfections preventing the best firms from growing. While entry of small firms was an important engine of job creation, the post-entry job performance of such firms was inferior to that of larger firms. 

Our first observation is that between 1994 and 2010, the Tunisian firm-size distribution has remained severely skewed towards small-scale employment. Net job creation was predominantly driven by jump start self-employment (firms of one year of age employing one worker), as is demonstrated in Figure 1 which depicts total net job creation by firm size and age over the period 1996-2010, showing that startup of one-person firms was an important contributor to aggregate job creation. The figure furthermore shows that job creation is concentrated amongst young firms.

Figure 1. Net employment creation by firm age and size 1996-2010 (Green=Growth, Red=Reduction)

Second, the post-entry performance of small firms is feeble, and job creation is impeded by a lack of upward mobility. While small firms on average tend to create more jobs than larger firms, as is demonstrated in Figure 2, which depicts the coefficients of regressions of job creation on firm-size (the blue dotted line), this relationship is due to the fact that small firms tend to be younger; once firm age is conditioned on (the red line) small firms create fewer jobs than large firms. In other words, as in the United States and other OECD economies, small firms create more jobs because they are young (as is shown in Figure 3), not because they are small per se.  What is distinctive about business dynamics in Tunisia is that even small firms that manage to stay in business don’t create more jobs than large firms (Figure 4). This contrasts sharply with the experience of developed countries, which are characterised by an ‘up-or-out’ dynamic, with small firms being more likely to die than large firms, but also more likely to grow conditional on surviving.

Figure 2. Net job creation by firm size: All firms 1997-2010

Figure 3. Net job creation by firm age: All firms 1997-2010

Figure 4. Net job creation by firm size: Continuing firms 1997-2010

Last but not least, these patterns seem to be driven by deficiencies in the allocative process. While both profitability and productivity are positively associated with net job creation, this correlation is very weak. The best firms have difficulties expanding and gaining market share, and firm productivity does not rise rapidly with firm age, suggesting markets don’t select the best firms, but instead impede them from creating jobs. At the same time inefficient producers are able to continue operating, as somehow they manage to protect their market share.

Firm dynamics in developing countries

The results from Tunisia dovetail with the work on firm dynamics in developing countries and labour dynamics in developed countries.  Hsieh and Klenow (2009; 2014) show that the failure of high-productivity firms to grow large over time results in sizable losses in aggregate productivity growth in developing countries relative to developed countries.  Bartelsman et al. (2013) estimate the covariance between productivity and size in narrowly defined industries, in a group European countries and the US.  They find that allocative efficiency is stronger in countries with higher aggregate productivity.  Moreover, the covariance between size and productivity was near zero (or negative) at transition in Eastern Europe and has since increased, i.e. allocative efficiency has improved sharply.  Thus, weak firm dynamics in developing countries go a long way in explaining their relatively worse productivity performance. Turning to jobs, the fast-growing high-productivity firms that support aggregate productivity growth are also a major source of job creation in developed countries (Haltiwanger et al. 2013, and Criscuolo 2014). In countries like Tunisia, with significant unemployment, it is thus no surprise that allocative inefficiencies help explain the failure to create jobs.

The binding constraint to job creation in Tunisia is the lack of a business climate that fosters the expansion of the most productive firms. Policies such as regulatory barriers on firm entry and expansion and on hiring and firing workers, cumbersome bankruptcy procedures, and a defunct financial sector, all undermine competitive pressures and hamper the efficient allocation of resources. As a result, programmes to finance new and existing small or medium sized enterprises are ill-equipped to address unemployment because these firms rarely grow. Job creation in Tunisia functions like a nursery shielded from the sun – no matter how many seeds are planted there will be few blossoms unless barriers are removed.

References          

Bartelsman, E, J Haltiwanger, and S Scarpetta (2013), “Cross-Country Differences in Productivity: The Role of Allocation and Selection”, The American Economic Review 103: 305-334.

Criscuolo, C, P Gal, and C Menon (2014), “DynEmp: New cross-country evidence on the role of young firms in job creation, growth, and innovation”, VoxEU.

Davis, S, J Haltiwanger, and S Schuh (1996), Job Creation and Destruction, Cambridge, USA: MIT Press.

Haltiwanger, J, R Jarmin, and J Miranda (2013), “Who Creates Jobs?”, Review of Economics and Statistics 95 (2): 347-361.

Hsieh, C-T and P Klenow (2009), “Misallocation and Manufacturing TFP in China and India”, Quarterly Journal of Economics 124(4): 1403-48.

Hsieh, C-T, and P Klenow (2014), “The lifecycle of plants in India and Mexico”,  Quarterly Journal of Economics 129 (3): 1035–1084.

Rijkers, B, H Arouri, C Freund, and A Nucifora (2014), “Which Firms Create the Most Jobs? Evidence From Tunisia”, Labour Economics 31: 84-102.

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Topics:  Development

Tags:  Tunisia, firms, “SME”

Chief Engineer and Director of the business register and economic surveys, Tunisian National Institute of Statistics

Director, Trade, Regional Integration and Investment Climate, World Bank

Lead Economist for Brazil, World Bank

Senior Economist in the Trade and International Integration Unit of the Development Research Group, World Bank

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