Simon Johnson MIT Sloan Comments on Credit Constraints as a Barrier to the Entry and Post-Entry Growth of Firms Simon Johnson MIT Sloan

Summary Assessment Growth is largely about entry Confirm earlier results Availability of external finance constrains entry Nature of constraint and effect varies systematically across firms Most novel here: Size of firms may matter in this regard

A (Potential) Debate The Finance View The Property Rights View Access to credit has a first-order effect on ability to become an entrepreneur (and therefore growth) The Property Rights View Only potential entrepreneurs who perceive their property rights to be secure will make investments

An Econometric Problem If you do not control for property rights (instrumented) then the finance variables may actually be picking up broader institutional effects Not a problem if you can instrument convincingly for finance variables But this is hard Is there plausible evidence that property rights matter for entry and post-entry growth of firms? See work by John McMillan

The main finding Effect of credit constraint depends on size of firms Relaxing this constraint helps small firms more than large firms “it may even discourage entry by [large firms]” (p. 2)

Question #1 What exactly is “entry by large firms”? Is this entry, as in start-up? Or entry into the database? How does the database handle Entry by foreign companies Mergers and acquisitions This entire measurement issue needs to be at least 1/3 of the paper By the way, how big were Microsoft or Intel or Google or Whole Foods when they first started up?!

Question #2 Rajan and Zingales (1998): breakthrough paper for methodology of studying financial development Why 1,000+ papers using this method, and almost no work checking if nonUS financial dependence of sectors is really similar/correlated with the US? Exception: Subramanian et al (India) 1980s vs. 1990s: why such differences? R&Z + AJ: robustly, financial development matters for composition of output (types of sectors) but NOT for GDP per capita AJM: may matter for vertical integration, when contracting costs are high (CAUTION: new result)

Question #3 Djankov et al; Doing Business Indicators have been a breakthrough for quantifying and focusing on barriers to entry But just putting these in a regression (not instrumented) may not tell us very much Likely correlated with broader institutions Probably there is some form of “seesaw” effect: If you push down on one end (lower some cost for new entrants to become large firms) then the other end will pop up (some other costs/barriers emerge)

Question #4 If you have a potentially endogenous rhs variable or other issues is it [still] just OK to find a possibly more exogenous variable as an instrument? Don’t we need more theory and evidence (also from outside the regression framework being used) to support the exclusion restriction? There is a great deal of confusion over the “other channels” issue, but this is a potentially important point What are the deep determinants (of growth) and how are the effects of these manifest?

The Limits to Knowledge (Today) What are the robust facts? Financial development matters For the composition of output: agreed For GDP per capita: contested Legal origin matters for financial development: probably For GDP per capita: no What are the implications for Entry? Composition vs. level of output?! Property rights & security of investment cannot safely be omitted from the regression

Policy Implications We need rules, not discretion, for: Updating our stock of useful knowledge based on new research Apply the same rules across different kinds of research (but you can’t randomize everything!) Sometimes the new findings are sufficiently convincing and important that we should change our views Resist fashion, if you can (hence the need for rules) Emphasize robustness, replication, and data revisions First, do no harm Agreed, but what if you are in a crisis?