Recent work has highlighted how the lack of reallocation in developing countries hampers their growth. In the US productive firms grow rapidly, creating jobs, while unproductive firms tend to shrink and exit. In developing nations we see far less of this reallocation occurring – productive firms do not grow rapidly and unproductive firms survive for many years. This reduces aggregate growth. Our paper investigates the reasons for this and finds that a major factor appears to be low levels of trust, often called “social capital”, in developing countries. One mechanism for this is that in developing countries entrepreneurs are afraid of employing non-family members in their business as they are concerned that they may not act in the interests of the firm. As a result they struggle to expand as they run out of managerial capital if they grow too large (the size of the firm is determined by the size of the family). We investigate this using a large international dataset on firms, finding strong evidence for a causal impact of trust on firm size and growth.
Aghion, P.; Bloom, N.; Sadun, R.; Van Reenen, J. Multinationals and Growth in Developing Countries (IGC Policy Brief). International Growth Centre (IGC), London, UK (2012) 3 pp.