1. Firm Size, Finance and Growth Thorsten Beck Asli Demirguc-Kunt Luc Laeven Ross Levine

2. 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

3. 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

4. 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.

5. 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.)

6. 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

7. Data 1. Industry growth 2. Small firm share 3. Financial development

8. 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.

9. 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

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

11. Financial development  Private credit  Others Liquid liabilities Stock market development Legal & accounting systems

12. Methodology Growth = average annual growth of real value added of industry k in country i, averaged over 1980-90 Share = 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 k OLS and IV, also cluster at industry or country level Sample: 36 industries across 44 countries

13. Table 3: Financial development, small firm share and growth

14. Financial development, small firm share and growth - economic significance  Small Firm Share: 25 th percentile: Spinning 75 th percentile: Furniture (lots of small firms)  Private Credit: 25 th percentile: India 75 th percentile: Canada  Furniture grows 1.4% faster than spinning in Canada than in India  Average growth rate = 3.4%

15. 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

16. 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)

17. 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

18. Table 4: Controlling for Additional Industry and Country Characteristics

19. Table 5: Alternative measures of firm size distribution

20. Alternative small firm data Measured in 1997, not 1992 Different benchmark country Median size of listed firms by industry in U.S. to test whether SFS proxies for U.S. specific industry factors

21. Table 7: Alternative indicators of financial development

22. Alternative dependent variable

23. 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