Friday, December 2, 2011

Sutton and I on firm-size (he's probably right...)

I've been on the LSE podcasts once again, this time listening to John Sutton talking about industrial capabilities in an International Growth Centre Talk. It's interesting stuff but that is perhaps also a slight confirmation bias story....

For one of my PhD thesis papers, I tried to uncover a firm growth threshold effect from some Mozambican firm-level data. The idea was that small firms grow to a certain small size, below the government tax radar, or they start off considerably larger where they can handle being on the radar and dealing in some way with taxes, regulations, bureaucracy etc. It's related to the missing middle story, where the huge micro sector manages to escape, while the small "large" sector manages to get either incentives and benefits, or has political/government contacts, and in any case has enough scale to make certain compliance costs appear relatively very small.  Anyway, partly due to a tiny sample size, and partly perhaps because my underlying theory wasn't quite full-proof, I had a bit too many firms jumping the threshold to really make it a genuine threshold (at least, that's what the anonymous referee said when I submitted to a journal). 

Anyway, Sutton says the same story in terms of size, but has a different explanation - management capabilites. What he says also confirms what I saw in interviews in Mozambique so I have to stand aside, take my hat off and all the rest. As he points out in his talk, the lack of growth from micro to any reasonable size is indicative of a lack of ability to manage a medium large firms (particularly in the kind of conditions which I refer to above - so actually, we're not really saying different things in a way). But what is more, medium firms tend to emerge from existing medium firms, even if this is in other sectors. So, citing cases from Ethiopia and Tanzania, he talks about how trading firms gained insights into markets, prices, supply-chains etc etc before then entering totally different fields, including manufacturing. 

He also mentions the issue of large multi-product firms which can diversify risk through various products, thus offsetting losses in some areas while learning takes place in terms of how to improve standards or productivity in other areas. So the big multi-sector firms one sometimes comes across may not be so bad - an argument also made by Ha-Joon Chang in yet another LSE lecture, of course talking of the chaebol...

This is all well and good, and quite inspiring even if the idea is pretty simple. In fact, when I was discussing firm thresholds someone pointed out to me that even in a developed economy, it's very different to manage 3, 4 or 5 people, than 15. So perhaps in any country there is a threshold when you go from being a "successful entrepreneur" to a "successful company", and where the skills are very different. And while this is likely to remain true for a developing country, where markets are dispersed, consumption of anything beyond basic goods are low, and the bureaucratic burdens are high, the skills to be a successful, medium-sized, formal firms are likely to be very different from being small, or running the local subsidiary of a multi-national. Does that mean we need more management consultants in development? (yes!)

So, I like the idea.

BUT. That said, Sutton moves on to discuss "what needs to be done" and this leads him to suggest the need to look for "doable" policy issues to remedy to allow some of these firms that have the capabilities to thrive. A little along the lines of Rodrik's search for the "binding contraint",  he suggests that the diagnostics of what is required for a good business environment are relatively easy, but doing something about them is not. So, choose some which are "doable" and then "just do them".

This is a little unsatisfactory. Rather than a "just do it", this is where I was waiting for Prof. Sutton to say, "ask the question, why has it not been done already". He talks about land titling as an easy win, for example. But surely the question is, "who gains from the current land titling system?". Why has nobody sorted it out before? since many of these things have been discussed for a long time. It may indeed be, as he says, lack of capacity, but when someone mentions that along with "lack of political will", there is a need to ask the question where the political will does lie, and why. Maybe then you can actually work out what is doable.

In the meantime, the firms which are willing to take the risk will be learning capabilities to get around the current system instead of improving their business itself. So I think it's a great point about firm capabilities. It made me think I should resurrect that thresholds model some day... 

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