New Ideas in Business Growth

My colleague Bilal Zia and I organized a conference on New Ideas in Business Growth: Financial Literacy, Firm Dynamics and Entrepreneurial Environment that took place at the World Bank last Wednesday. The conference brought together researchers and policy makers in the area of private sector development to share new findings about the types of policy interventions that are effective at promoting business growth. We decided to focus the discussion on three topics that have recently received increased attention from both a research and a policy angle: 1) business and financial literacy training 2) the business environment and 3) corporate governance and firm dynamics. The selection of these three topics also raised a larger question in my mind—should the research community spend so much of its effort on microenterprises, when larger firms may have much higher growth potential? That’s a question I’ll return to at the end of the post.

In recent years, many governments, international institutions, and NGOs around the world have been providing business and financial literacy training for entrepreneurs. However, so far, we know relatively little about the impact of this training on business performance and growth. In an effort to contribute to filling this knowledge gap, Bilal and I conducted a randomized control trial in Bosnia-Herzegovina, where we collaborated with a microfinance institution and an NGO to provide business and financial literacy training to young entrepreneurs.

It turns out that many other researchers had similar interests and intentions, and the conference features five other papers studying the impact of different types of business and financial literacy interventions, for the most part through randomized control trials, in different countries: Canada, the Dominican Republic, Mexico, Pakistan, and Sri Lanka. Most of these papers (including ours) find that training improves financial literacy and business practices. For example, our paper shows that the training improved our measure of business and financial knowledge by 27%, for entrepreneurs who had below median business and financial knowledge at baseline. Also, the percentage of entrepreneurs mixing business and household expenses dropped from 65% in the control group to 44% in the treatment group. The effects on business performance and growth tend to be weaker in some of the papers, or perhaps just harder to detect since these outcomes are very noisy and might take a longer time to change. A challenge in this emerging literature will be to reconcile the findings from different studies and to determine why results differ, given that they vary in several respects, including the content of the training, delivery mechanism, and target group.

The second theme discussed in the conference was the impact of reforms of entry regulation on business creation and firm formalization. According to the World Bank’s Doing Business reports, entry regulation is one of the areas of regulation that has seen the largest number of reforms during the past few years. A new paper by my colleagues Inessa Love and Leora Klapper takes advantage of this large number of reforms to examine the impact of entry reforms on formal firm creation across countries and years. Their findings suggest that the size of the reform is very important, i.e. regulation needs to be reduced by at least 40-50% to have a meaningful impact on formal firm creation.

Portugal is one of the countries that implemented a very large entry reform. The conference also included a paper that studies the effects of the reform in Portugal on firm creation using a very rich matched employer-employee dataset. The results of this paper support earlier findings of a study I conducted for Mexico that a simplification in entry procedures can lead to more firm creation. However, as in Mexico, this appears to be due to employees setting up new firms instead of informal firms formalizing. Since the study for Portugal has more detailed data than I was able to obtain for Mexico, the authors are also able to show that most of the newly created firms post-reform are “marginal”, i.e. less productive and less likely to survive than firms that registered under the more complicated regime.

Another paper featured in the conference—this one by my colleague David McKenzie and co-authors—uses a randomized control trial in Sri Lanka to go deeper into examining why informal firms are not registering. They find that reducing the initial costs of registration does not entice firms to register, but paying firms relatively large amounts of cash does, suggesting that informal firms worry about the ongoing cost of formalization, such as profit and labor taxes.

The final session of the conference focused on the role of corporate governance in determining firm productivity and growth. Features of corporate governance are often difficult to measure and difficult to vary exogenously in order to study their impact on firm performance. However, two papers in this conference were able to work closely with firms to overcome data and identification issues. One of the papers uses a confidential firm dataset detailing bribes paid to the firm’s buyers to document that corruption within firms (even private firms) is common. The paper also provides some evidence that this can lead to inefficiencies in transactions between firms. The second paper worked closely with a bank in Colombia to change work incentives provided to loan officers. These incentives led to improved time management, less stress, and better individual performance among loan officers. Finally, this session also included a paper that examines how firm dynamics influence productivity growth overall, drawing a link from individual firm growth to aggregate productivity in the economy.

We also invited two academics, Abhijit Banerjee and Antoinette Schoar, both from the Massachusetts Institute of Technology, and two practitioners, Marilou Uy and Monika Weber-Fahr, both from the World Bank Group, for a panel discussion. Asli chaired the session. The panelists had a lively discussion on several issues, ranging from why we need to do impact evaluations to measure the effectiveness of different interventions to whether directed lending programs can improve firm growth.

However, as I mentioned at the beginning of the post, there was one overarching question that ran through all of the topics: Is the recent research and policy focus on microenterprises warranted, or should we be spending more of our time looking at interventions targeted at larger “high growth” firms instead? Arguments in favor of focusing on microenterprises included that they provide employment and income to many low-income households around the world, so that focusing on these firms can lead to poverty alleviation and that providing business training may be an efficient way of redistributing income. The main counterargument was that, unlike median or large sized firms, microenterprises do not contribute a large share to productivity or output growth. Finally, the panelists expressed concern that it may be politically and morally difficult to support programs that provide more resources to firms or individuals that are already relatively well-off compared to microenterprise owners.

I think that the focus on microenterprises is warranted: I actually see it as one way of promoting growth among larger firms. Raising the incomes of micro-entrepreneurs may increase consumption demand, allowing larger firms to grow and create employment. However, at the end of the day, we probably need a mix of policies targeted at microenterprises and at larger enterprises. And particularly in the area of large firm growth, we need more research on which interventions work and which don’t. Stay tuned for more interesting findings on this topic...