Big Constraints to Small Firms' Growth? Business Environment and Employment Growth across Firms

An issue of particular relevance for economic growth is how the development of markets and institutions influences the growth of firms. This issue is even more important in developing countries, where markets and institutional infrastructure are less developed. A related concern is whether an adverse business environment affects the efficiency and the dynamism of the business sector. This study uses firm-level data on more than 56,000 enterprises in 85 developing countries and five high-income economies to assess the effects of the broader business environment on employment growth by firms, focusing on differences across firm size. This study is related to two strands of literature. First it relates to recent studies (Hsieh and Klenow 2009; Restuccia and Rogerson 2008) that show that there is considerable resource misallocation across firms, which is driven by firm-specific distortions. While these studies are silent about the nature of the distortions, they show that such distortions lead to substantial aggregate productivity losses and that differences in the degree of distortions would explain a significant portion of why India and China exhibit lower manufacturing productivity than the United States. This study examines differences in business environment across firm size, and there-fore it helps to provide a better understanding of which dimensions of the business environment matter and of the heterogeneity of distortions across firms. © 2011 by The University of Chicago.