Nobody s Business but My Own: Self Employment and Small Enterprise in Economic Development

Transcription

1 July 2006 Nobody s Business bu My Own: Self Employmen and Small Enerprise in Economic Developmen Douglas Gollin * Williams College ABSTRACT In mos poor counries, small firms and self employmen are he dominan forms of business enerprise even in he manufacuring secor. For rich counries, in conras, self-employed people accoun for very small shares of manufacuring employmen and oupu. This paper builds on Lucas (978) o ask wheher srucural changes of his kind are driven by produciviy differences. A model, calibraed o Japanese ime series daa, is shown o mimic key feaures of cross-counry and ime series daa. The resuls suppor he idea ha changes in aggregae produciviy accoun for much of he cross-counry variaion in esablishmen size and self-employmen raes. JEL Classificaions: O (Economic Developmen); L (Producion and Marke Srucure; Size Disribuion of Firms); J23 (Self Employmen) Keywords: Self employmen, small enerprise, firm size disribuion * Auhor s address: Deparmen of Economics, Fernald House, Williams College, Williamsown, MA address: dgollin@williams.edu. Phone: Fax: Early porions of his research were suppored by Naional Science Foundaion Gran NSF/SBR and by he MacArhur Inerdisciplinary Program for Peace and Inernaional Cooperaion a he Universiy of Minnesoa. Subsequen research was conduced while I was a visiing fellow a he Economic Growh Cener, Yale Universiy; I grealy appreciae he recurring hospialiy of he Growh Cener faculy and saff. I am indebed o Tim Kehoe, Ed Presco, Boyan Jovanovic, Jeffrey Campbell, Vincenzo Quadrini, and Cheryl Doss for heir commens and suggesions on early drafs of his manuscrip. A working paper version of his paper, including deails of he calibraion procedure and sensiiviy analysis, is available a: hp://

2 .. Inroducion Small businesses dominae he economic life of mos developing counries. In Accra and Agra, Dhaka and Dakar, family firms and he self employed accoun for he bulk of producion and employmen. This is rue no only in agriculure and he service secor, bu also in manufacuring. From cramped workshops and backyard foundries emerges an asonishing array of manufacured goods: clohing, foowear, poery, meal producs, processed foods, cemen blocks, o name a few. In Ghana, as an illusraion, more han 75 percen of he manufacuring workforce repors being self-employed, and fewer han 5 percen of manufacuring workers are employed in esablishmens wih more han 0 workers (Republic of Ghana 987, 99). In mos rich counries, by conras, small enerprises play a relaively minor role in economic aciviy paricularly in manufacuring. For example, in he Unied Saes, manufacuring esablishmens wih fewer han 5 employees accouned for less han percen of he value added in 997, while firms wih more han 500 employees accouned for almos half he value added (U.S. Census Bureau 2002). These daa are consisen wih a broad range of cross-secion and ime series evidence suggesing ha as counries grow richer, small businesses and own-accoun work play a diminishing economic role. Wha accouns for he differing imporance of small firms and he self employed in rich and poor counries? Can a neoclassical model adequaely capure he relaionship beween economic developmen and he srucure of producion and employmen? Is he small average firm size in poor counries necessarily he oucome of bad policy choices? This paper aemps o shed ligh on such quesions by analyzing a model ha incorporaes esablishmen size explicily. The model, based on he Lucas span-of-conrol framework (978), is explored quaniaively, using parameers drawn from Japanese ime series daa. The calibraed model suggess ha he large differences observed across counries in esablishmen size and employmen srucure can be explained o a surprising exen by differences in produciviy. Alhough disorionary policies such as axes ha There are a grea many small manufacuring esablishmens; he 997 Census of Manufacuring repored ha firms wih o 4 employees represened abou one hird of all esablishmens. Bu hese esablishmens employed only.5 percen of he manufacuring workforce and produced only 0.8 percen of value added.

3 2. repress he growh of larger firms undoubedly play a role in exacerbaing hese effecs, here would be subsanial differences across counries even in he absence of disorions. Moreover, he model suggess ha i is efficien in poor counries for many lower-skilled people o remain self-employed. Secion 2 of his paper briefly summarizes key facs concerning esablishmen size and economic growh, along wih previous lieraure. Secion 3 presens a dynamic general equilibrium model ha is used o address he research quesions. Secion 4 describes he procedure by which he parameers of he model were chosen and he sraegy for using he model o address research quesions. Secion 5 repors some resuls of ineres, and Secion 6 concludes. 2. Background and lieraure As early as he classical economiss, observers have noed ha economic growh is accompanied by a concenraion of producion in ever-larger unis and by a corresponding decline in self employmen and family enerprises. In more recen imes, empirical work by Kuznes (966), among ohers, documened his endency in cross-counry daa. Kuznes suggesed ha one of he principal characerisics of modern economic growh was a series of shifs in he srucure of producion: from small o large firms; from self employmen o wage work; and from unincorporaed enerprises o large corporaions. A number of ypes of daa reinforce his view oday. The Inernaional Labor Organizaion repors naional-level daa on he employmen saus of manufacuring workers for more han 50 counries for he years (ILO 993). Table shows he raio of employers and own-accoun workers (a single caegory in he daa) o all workers, in all counries wih available daa. (For convenience, denoe his as he enrepreneur-workforce raio. ) The daa indicae clearly ha in poor counries, relaively large proporions of he workforce are employers or own-accoun workers. Few people in poor counries work for wages even in he manufacuring secor. 2 Clearly his is 2 For he mos par, his paper will focus on he daa for manufacuring alone, as a way o conrol for differences across counries ha arise due o differences in he secoral composiion of oupu. Furhermore, noe ha he ILO daa combine enrepreneurs and own-accoun workers in a single caegory; i is no possible o disinguish beween he wo. Finally, noe ha he daa implicily rea wo oher caegories of workers, unpaid

4 3. no rue in rich counries. In he Unied Saes, he enrepreneur-workforce raio for manufacuring was less han In Bangladesh and Nigeria, by conras, he raio was almos Alhough some rich counries, such as Ialy, are known for having vial small business secors, hese are relaively modes ouliers: here is a surprisingly close relaionship beween per capia produc and he enrepreneur-workforce raio. The cross-secion daa hus suppor he idea ha fundamenal differences exis a he esablishmen level beween oday's poor and rich counries. Alhough i is difficul o obain ime series daa ha reflec he same range of income per capia as he cross secion, he experiences of a few rapidly growing counries sugges ha he ime series daa are broadly consisen wih he cross secion. Table 2 shows ime series daa for Japan (ILO 940, 990, 993). Similar daa are available for oher counries. Boh in he ime series and he cross secion, he daa reveal a pronounced negaive relaionship beween real per capia GDP and he enrepreneur-workforce raio. Wha accouns for he profusion of small firms in poor counries? Is i an efficien arrangemen of economic aciviy in counries where produciviy is low? Or is i an archaic (and presumably inefficien) feaure of socieies where he marke has no fully aken roo? Alernaively, is i a response o disorionary policies ha penalize large firms and discourage small ones from expanding? Wihin he developmen lieraure, here is a longsanding recogniion ha small firms are imporan in poor counries. In addiion o Kuznes, Hirschman (958), Rosow (960), Lewis (965), and many of heir conemporaries recognized ha srucural changes in employmen and firm size were a cenral feaure of economic growh. However, as Fafchamps (994) poins ou, hese auhors implicily viewed heerogeneiy of firm size in developing counries as a disequilibrium phenomenon, wih small firms desined o vanish as economies evenually adjused o new echnologies requiring a larger scale of producion. Wihin he more recen lieraure on developmen, a number of auhors have focused on he empirical deerminans of self employmen and he consrains o firm growh. Biggs and Srivasava (996) draw on a number of surveys o characerize manufacuring family laborers and hose no classifiable by saus as employees, raher han employers. In he daa, and in he model economy below, hese individuals are reaed as workers raher han as self employed.

5 4. enerprises in Africa. Liedholm and Mead (999) and Tybou (2000) assess he lieraure on manufacuring firms in developing counries. These papers acknowledge ha small firms are imporan, bu he general view is ha he smalles firms are relaively unproducive and would fade in imporance if marke failures and regulaory obsacles were removed. 3. A model of esablishmen size To accoun for he observed abundance of small firms in poor counries, we need a model in which firm size is defined and in which produciviy levels can vary. Sandard models of neoclassical growh assume consan reurns o scale a he level of he firm. As a resul, hese models do no address quesions of esablishmen size. Wihin he lieraure on indusrial organizaion, here is a subsanial body of heory on he naure of he firm and on firm size. (See, for example, Coase 937, Sigler 968, Alchian and Demsez 972, Williamson 985 and 989, Holmsröm and Tirole 989, and Har and Moore 990.) These models, however, have lile o say abou changes in firm size in he course of economic growh. Kremer (993) offers an explanaion for firm-size differences across counries. In his model, firm size depends on he complexiy of producion processes and he disribuion of skills among workers. In his view, low-skill economies end o have small firms producing goods of low echnological complexiy. 3. Firm size in he Lucas framework An alernaive approach is proposed by Lucas (978), who poins ou ha a disribuion of firm size can be generaed from heerogeneiy in any fixed facor of producion. This model has he virue of allowing for a robus size disribuion of firms wihin a paricular indusry, even when he workers possess essenially equivalen skill levels. The Lucas framework makes i possible o ask quesions abou how various fixed facors may affec he size disribuion of firms in an enire indusry. Some papers using his approach include Evans and Jovanovic (989), Hopenhayn (992), Jovanovic (994), and Lloyd-Ellis and Bernhard (2000). The model ha follows paper draws heavily on he Lucas framework, while embedding i in a dynamic general equilibrium seing ha explicily incorporaes self employmen.

6 5. A lucid explicaion of his framework is offered in Lucas s original paper. In his simple model, labor and capial are wo variable inpus, hired by enrepreneurs. Individuals differ in enrepreneurial abiliy, which Lucas models as a fixed facor, exogenously disribued and inelasically supplied. Individuals can choose beween wo modes of earning a living: eiher hey can work for a wage, w, or hey can manage a firm. If hey become managers, hey forego any wage income and insead receive he rens from operaing a echnology ha displays decreasing reurns o he variable inpus. In equilibrium, all individuals wih enrepreneurial abiliy above some hreshold value will earn more in rens han hey would as wage workers. The equilibrium wage is he one ha clears he labor marke: a ha wage, hose individuals who choose o be enrepreneurs will hire precisely he same amoun of labor as supplied by he individuals who choose wage work over enrepreneurship. In Lucas s model, capial accumulaion will make labor more producive and hus end, all else equal, o increase wages. (I will also increase profis, bu proporionally less.) Thus, wage work will become relaively more profiable. As capial accumulaes, fewer individuals will choose o manage heir own firms, while more choose o work as wage laborers. Thus, here will be progressively fewer firms wih larger numbers of employees. A firm in his model consiss of an enrepreneur, a echnology, and some workers. This may no be a good model for hinking abou indusrial organizaion in an economy wih exensive subconracing, or abou conglomeraes ha consis of many separae producion eniies. Bu i may be a useful way o hink abou plan size, and i seems paricularly useful in hinking abou he small firms ha proliferae in poor counries: ailor shops, carpeners, meal fabricaors, and ohers. Why do some individuals work for hemselves, while ohers run firms wih five, six, or weny employees? Why does he disribuion of firm size differ across economies? 3.2 A model wih self employmen To address hese quesions, his paper considers a se of model economies in which he size disribuion of firms is deermined by a Lucas span-of-conrol framework. All of he model economies are idenical excep in erms of heir exogenously fixed produciviy levels. Each economy grows over ime hrough he accumulaion of capial, bu here is no

7 6. echnological progress wihin any economy. Each economy hus converges o a Solow-ype seady sae. Much of he analysis ha follows compares seady saes across economies. Wihin each economy, here is a single secor producing a composie good ha can be consumed or used as capial. People in he model economy differ ex ane only in heir enrepreneurial abiliy. Because self employmen is an imporan feaure in he daa, I add his as an explici alernaive o he Lucas framework. Thus, in each period, people can choose among hree alernaive forms of employmen: wage work, self employmen, and full-ime enrepreneurship. Workers receive he marke wage, w, while full-ime enrepreneurs receive he rens from operaing a firm. The self-employed divide heir ime beween physical producion and oher enrepreneurial aciviies needed for operaion of an esablishmen. They receive some enrepreneurial rens as well as a reurn o labor effor. Individuals make heir employmen decisions in such a way as o maximize earnings. (They are indifferen, in erms of uiliy, beween he hree uses of heir ime). The inuiion of he Lucas model holds in hese economies. Those individuals wih he highes enrepreneurial abiliy will become full-ime managers, while hose wih he lowes levels will work for wages. People wih inermediae levels of abiliy can spli he difference. Self employmen allows hem essenially o be par-ime workers and par-ime managers. The opporuniy cos of foregone labor is lower han for full-ime managers, bu he size of heir firms is limied in a way ha makes his opion unaracive for he mos highly skilled managers. Formally, in each model economy, here is a measure one of infiniely-lived people, indexed on he inerval [0, ] by enrepreneurial abiliy, x. There is a disribuion (x) over { } skill ypes. Preferences are defined over lifeime consumpion sreams c ( x) = 0 by: U = ( ( )) β u c x () =0 In addiion o skills, individuals are endowed wih one uni of labor in each ime period, which is supplied inelasically; and wih k 0 unis of iniial capial. For simpliciy, boh iniial capial and he skill disribuion are aken as idenical across all economies.

8 7. A each dae, a single good is produced; his can be consumed or saved as capial o be used in he nex ime period. Producion can ake place in wo ypes of esablishmens: hose operaed by full-ime enrepreneurs and hose operaed by he self-employed. In eiher ype of esablishmen, an individual s enrepreneurial abiliy, x, deermines he oupu aained from given levels of capial and labor. Thus, he enrepreneur s choices of n and k depend on her level of enrepreneurial abiliy, x. Opimal esablishmen size hus varies across individual enrepreneurs. The wo ypes of esablishmens differ in wo respecs. Firs, he self-employed face a size resricion on heir firms: hey may use no more han α unis of labor inpu, where 0 α. This reflecs he ime consrain faced by he self-employed. Second, selfemployed enrepreneurs have an advanage in managerial efficiency, relaive o full-ime enrepreneurs. This reflecs he subsanial incenive advanage ha he self-employed face wih respec o labor supervision. Specifically, his advanage is represened by a scalar erm ASE ha eners muliplicaively ino he managerial echnology. An individual of ype x who is a full-ime manager of a firm wih n workers and k unis of capial in counry i produces oupu: where f is consan reurns o scale, increasing, and concave in each argumen, and where 0 < θ <. The parameer θ reflecs he fac ha producion displays decreasing reurns o scale in capial and labor, due o he fixed facor (enrepreneurial abiliy). An individual of ype x who is self-employed produces oupu according o he producion funcion: [ f ( n,k) ] θ y = xai, (2) [ f ( n k) ] θ y = xase Ai, (3) where f and θ are he same as above and 0 n α. As noed above, he parameer A SE is an indicaor of produciviy in esablishmens operaed by he self-employed, relaive o

9 8. produciviy in esablishmens operaed by full-ime enrepreneurs. Noe ha as invarian across counries. ASE is modeled 3.3 Occupaional choice An individual in his economy chooses he ype of employmen ha will maximize income. The reurns from wage work are simply w, which he individual akes as given. All individuals are homogeneous as wage workers; differences in enrepreneurial abiliy do no aler labor produciviy. The individual compares his wage wih poenial earnings from self employmen or full-ime managemen, which are deermined as follows. The reurns from self-employmen consis of enrepreneurial rens as well as he marke value of he ime available for labor. Thus, a self-employed individual earns π SE ( x ), where his income includes reurns o labor as well as rens: π SE θ ( x) = { } xa A [ f ( n, k )] r k + w ( α n ) max, (4) n k SE s.. i k 0 n α < Noe ha he self employed forego( α ) unis of ime o manage heir enerprise; of he remaining α unis, hey may hire ou any labor ha is no used in heir own enerprises. This reflecs he fac ha many self employed people operae heir own businesses on a par-ime 0 basis, while also hiring ou labor o oher enerprises. An individual who operaes a firm as a full-ime manager will receive only he enrepreneurial rens. These individuals use heir enire ime endowmen o manage firms and hus receive no wage income. Thus, a full-ime manager wih abiliy level x earns income of: 3.4 Consumer s problem θ ( x) = { n k} xai [ f ( n k )] w n r k FT π max,, (5) s.. n, k 0 Having chosen an employmen opion o maximize income, he individual faces a sraighforward problem in allocaing his income o consumpion and o savings.

10 9. Denoe he individual's maximum income from employmen in a given period as: { } SE FT ( x) max w, π ( x) π ( x) π =, (6) m ( x) The individual's decision rules can be represened by marker funcions. Le = if he individual earns maximum income from full-ime managemen, and le m ( x) = 0 oherwise. Similarly, le s ( x) self-employmen, and le s ( x) = 0 oherwise. = if he individual earns maximum income from The problem of a consumer wih enrepreneurial abiliy x can be wrien as: max { c, n, m, s } =0 s + c (x), k s (x) 0 β u(c (x)) s.. c (x) + k (x) ( + r - δ )k (x) + π (x) (7) s where s k denoes he capial supplied by he consumer (in conras wih capial demanded by a paricular enrepreneur). d k, which denoes 3.5 Equilibrium An equilibrium for his economy consiss of sequences: s d { c ( x), n ( x), k ( x), k ( x), w, r, y ( x), m ( x), s ( x) } [ 0,] 0 x = such ha: (i) The consumer's problem is solved for all individuals x [0,]. (ii) All esablishmens are maximizing profis, aking prices as given. (iii) The usual feasibiliy and marke clearing condiions are saisfied, for all. The marke-clearing condiion for he goods marke is given in Equaion (8), which holds ha consumpion plus invesmen mus no exceed he sum of producion from he self-employed and from esablishmens operaed by full-ime enrepreneurs.

11 c 0 s θ ( x) d ( x) + k ( x) d ( x) m ( x) xa [ f ( n ( x), k ( x) )] d ( x) s θ s ( x) x A A [ f ( n ( x), k ( x) )] d ( x) + ( δ ) k ( x) d ( x) SE 0 i + 0 i On he righ-hand side of Equaion (8), he firs erm gives he oupu of all firms operaed by full-ime enrepreneurs, while he second erm gives he oupu of he selfemployed. Marke-clearing in he wage labor marke is given in Equaion (9). This condiion 0 m ( x) n ( x) d ( x) ( m ( x) )( s ( x) ) d ( x) + s ( x) ( α n ( x) ) d ( x) requires ha he demand for wage labor by full-ime enrepreneurs mus no exceed he supply. In paricular, he lef-hand side of Equaion (9) is he oal amoun of labor used by full-ime enrepreneurs. The firs erm on he righ-hand side is he measure of pure wage laborers, and he second erm gives he supply of wage labor from he self-employed. Finally, he marke for capial services clears when: 0 + (9) 0 0 (8) The srucure of he model immediaely implies ha people's work choices, m ( x) and s ( x), will be (weakly) monoonic in x. In oher words, a each dae, here will be wo cuoff levels of enrepreneurial abiliy z and z 2 [ 0], such ha everyone wih a skill level below z will work, and everyone wih a skill level above z 2 will be a full-ime manager, while individuals wih inermediae levels of enrepreneurial abiliy (i.e., x [ z z 2 ] s ( x) d ( x) k ( x) d ( x), ) will be self-employed. For some parameer values, here may be no self-employed people in he economy. 4. Quaniaive Experimen To compue soluions for he model, funcional forms mus be specified and parameer values assigned. For simpliciy, his paper akes u c) log( c) echnology, i uses he sandard CES form f ( n k) γ n ρ + ( γ ) 0 d k (0) 0 ( =. For he producion [ ] ρ ρ, = k. Finally, he

12 . disribuion for enrepreneurial abiliy, (x), is aken o be a symmeric bell shape, which is modeled as a bea disribuion, wih parameers a = b = 8. The model parameers are chosen o mach key feaures of Japanese ime series daa. During he 20 h cenury, Japan s economy has grown a a remarkable rae, and is srucural ransformaion has included sriking changes in firm size and he srucure of employmen. In 930, for example, almos one-hird of Japanese workers were self-employed or full-ime enrepreneurs, including 29. percen of manufacuring workers. By 992, only 8.6 percen of manufacuring workers were self-employed. Thus, Japan s experience over ime mirrors he phenomenon observed in comparisons of rich and poor counries oday. Parameer values are chosen so ha he model economy will mach Japan s income, capial sock, facor shares, and self employmen levels a wo momens in ime (930 and 992). Deails are provided in Gollin (2002b). Oupu from he calibraed model is hen compared wih daa on he Japanese economy. To he exen ha he calibraion succeeds in replicaing key feaures of he Japanese daa, i encourages us o use he model as a ool for considering he cross-counry daa as well as ime series daa from oher counries. Mos of he parameer values are sraighforward. Using sandard approaches, i is possible o arrive a a value of for he depreciaion rae and for he discoun rae, wih an implied seady-sae value for r of An imporan parameer in he model is θ, which gives he reurns o scale associaed wih he CES producion funcion. In he model, he fracion ( - θ) represens he share of oupu reained as rens by enrepreneurs. I is essenially impossible o find macro daa ha disinguish effecively beween enrepreneurial rens and reurns o capial, for any economy. There is subsanial evidence, however, ha capial and labor shares are relaively consan boh across counries and over ime, wih labor shares around 0.65 o 0.70 and capial shares are around 0.20 o 0.25 in many observaions. These figures sugges ha enrepreneurial reurns could be in he neighborhood of 0.0 of oupu, which corresponds o a value of θ = This is he value used in he calibraion. Modes changes in he value of θ have lile impac on he qualiaive resuls of he model. Two addiional parameers of ineres relae o he producion funcion. The parameer γ is he CES share parameers, and ρ is relaed o he elasiciy of subsiuion

13 2. beween capial and labor. The calibraion is quie sensiive o he value of ρ; Lucas s original paper (978) showed ha capial accumulaion would resul in a declining fracion of enrepreneurs if and only if he elasiciy of subsiuion was less han uniy. For his paper, γ and ρ are drawn from aggregae observaions for Japan in he 930s and 980s, using he firs-order condiion ha: γ γ rk wn = K N ρ, which given wo daes yields wo equaions in wo unknowns. The soluion values for he parameers are ρ = and γ = This value for ρ implies an elasiciy of subsiuion beween capial and labor of σ = 0.695, well wihin he range considered plausible by many economiss. There are wo final parameers in he model: he ime limi on self-employmen labor, α, and he managerial efficiency advanage of he self employed, A SE. The laer of hese is no idenified separaely from he aggregae produciviy parameer A. 3 Thus, I mus calibrae he wo parameers simulaneously wih my normalizaion of A. In keeping wih he approach ha I seek o use for he cross-secion analysis, I model he Japanese economies in 930 and 992 as represening he seady saes of wo separae model economies wih differing levels of oal facor produciviy. I normalize A so ha he oupu of he model economy is measured in housands of real 985 inernaional dollars. Japan s oupu per capia in 930 was $,539, which implies a value for A in his economy of.034. Japan s oupu per capia in 992 was 9.8 imes higher, in real erms, han is oupu per capia in 930. To aain his magniude of difference in oupu per capia in he model economy, I need o se A for he second economy a a value of The wo parameers are, however, separaely idenified, as hey have slighly differen effecs in he model. Since α essenially places a limi on he ime worked by a self-employed person, i can be inerpreed as reflecing he opporuniy cos of self employmen in erms of los labor income. This becomes a relaively more imporan effec as wage raes rise in he economy. Thus, lowering he value of α, holding everyhing else consan, is likely o decrease he araciveness of self employmen in all economies bu relaively more so in economies wih high wage raes (i.e., high values of A i ). By conras, A SE shifs he advanage of self employmen equally across all economies. The wo insrumens are hus sufficien o mach he daa. 4 This seems o imply a TFP growh rae of abou 2.8 percen annually, which is broadly speaking consisen wih Maddison s esimaes of Japan s long-run TFP growh. Noe, however, ha my approach here reas he wo economies as represening separae seady saes, raher han a single economy in which

14 3. Given hese values for A, in addiion o he parameer values above, I calibrae α and A SE o mach he observed raes of enrepreneurship in Japanese manufacuring in 930 and 992. The relevan facs are ha in 930, he fracion of employers and own-accoun workers in he manufacuring workforce was In 992, he fracion was To mach he daa, I find implied an implied value α of and a value for A SE of.3. To provide some inerpreaion of hese numbers, he real-world inerpreaion is ha self employed people use only fory percen of heir work ime o perform physical producion aciviies (e.g., sewing, hammering, ec.) bu are abou one-hird more producive in erms of TFP han firms of comparable size operaed by full-ime managers. Alhough here is no obvious es of hese parameers, hey boh appear o fall wihin plausible ranges. 5 Table 3 summarizes he parameer values used in he quaniaive experimens described below. 5. Resuls By consrucion, he calibraed model economy exacly replicaes he enrepreneurworkforce raios for he Japanese manufacuring secor in 930 and Perhaps more surprising, he model economy also reproduces several oher feaures of he Japanese ime series daa, including facor shares. For example, he employee compensaion shares of GDP in he model economy are close o hose observed in he daa. In 930, he employee compensaion share for he model economy was , while he daa give a figure of For 992, he model economy gives , while he daa show The model economy does no offer insighs ino he ransiional dynamics of he Japanese economy a subjec of considerable ineres in he lieraure, saring wih King and Rebelo (993), Hayashi (989), and Chrisiano (989), and coninuing hrough Parene growh is occurring a an observed and undersood exogenous rae. As a resul, he resuls canno direcly be likened o a single economy wih exogenous TFP growh of 2.8 percen. 5 This is consisen wih a number of observaions suggesing ha he produciviy of small and micro firms is higher han ha of larger firms (e.g., Liedholm 993) or a leas comparable (e.g., Tybou 2000). 6 To be precise, by he calibraed model economy, I mean he enire cross secion of model economies, which differ in produciviy levels. By focusing on his cross secion, I absrac from he ransiion behaviour of each individual economy. This approach differs also from one in which produciviy growh is exogenous and anicipaed.

15 4. and Presco (994), Gilchris and Williams (2004), and ohers. These papers focus aenion on he behavior of facor prices and shares during he course of Japan s rapid growh, wih an implici argumen ha ransiional dynamics alone canno accoun for he observed paerns of he daa. The curren paper does no provide insigh ino hese quesions, because i focuses on a cross secion of seady-sae equilibria, raher han on pure ransiional dynamics. Essenially by consrucion, his model economy yields consan raes of reurn o capial. I does, however, provide some insigh ino observed facor shares. Insead of comparing he model o Japan s ime series, hen, i is perhaps more informaive o compare i wih oher cross-secion and ime series observaions. The following paragraphs repor several differen comparisons. Firs, enrepreneur-workforce raios from he model economy are compared o ime series daa for hree groups of counries: rapidly growing economies in Eas and Souheas Asia, OECD counries, and he world s poor counries. Second, enrepreneur-workforce raios from he model are compared o cross-secion daa for all counries wih available daa. Third, he enrepreneur-workforce raios from he model are compared o pooled cross-secion and ime series daa from all available observaions. Nex, similar comparisons are made using facor shares from he model economy and from a number of acual economies. In all hese cases, he model economy offers a good represenaion of he daa. 5. Enrepreneur-workforce raios The model economy is designed o illuminae he relaionship beween growh and he srucure of employmen. Thus, i is useful o see how well i succeeds in characerizing he changes observed in a number of rapidly growing economies. Figure shows ime series daa for he enrepreneur-workforce raio for he model economy and a number of Eas and Souheas Asian economies ha experienced rapid growh in he period since he Second World War. The resuls are sriking. The model economy appears o display roughly he same paern as he daa for Thailand and Malaysia, and i parallels he daa for Korea. Across his se of counries and over ime, here appears o be a relaively uniform rend in he enrepreneur-workforce raio, and he model economy displays a similar rend. The model s

16 5. predicions are oo high, almos uniformly, bu he shape of he graph corresponds well o he daa. Does he model perform equally well in maching enrepreneur-workforce raios from rich counries? For OECD counries in general, he model generally overpredics he share of enrepreneurs in he workforce for hese counries, alhough i maches he daa reasonably well for Denmark and Ialy. In general, he model predics ha he fracion of enrepreneurs should remain fairly fla for counries wih per capia income in excess of $5,000. This corresponds o ime series observaions for mos rich counries. For poor counries, he model also does a reasonably good job of maching he daa. Consider nex he panel creaed by pooling all available ime series and cross secion daa, as shown in Figure 2. Here, he model s fi is sufficienly good ha he prediced values of he model yield an R-squared value of 0.58 wih respec o he acual values, compared o an R-squared value of for a polynomial regression of he daa on a consan erm, real per capia GDP, is inverse, is square, and is cube. Alhough he model slighly underpredics he fracion of enrepreneurs in he workforce in poor counries and overpredics he fracion in rich counries, he model succeeds in capuring he general shape and paern of he daa. 5.2 Facor shares To some exen, he model has been consruced o mach he daa on enrepreneurworkforce raios. I is ineresing hen o compare is predicions in anoher dimension: wih cross-secion and ime series daa on facor shares. In he Unied Saes and mos oher rich counries, he wage share of oupu is ofen found o be beween 0.65 and 0.75, wih he capial share generally compued as he residual. The wage share has shown remarkably lile variaion over ime. Across counries, however, employee compensaion as a share of oupu is subsanially lower in poor counries. This is occasionally inerpreed as implying ha labor shares are lower in poor counries han in rich counries, bu in fac employee compensaion is only a parial measure of labor income. Par of he income of he self-employed also should be viewed as labor income and included in calculaions of he labor share. Gollin

17 6. (2002a) argues ha he apparen dispariies in labor shares are relaed o differences across counries in he imporance of self employmen and he corresponding differences in he share of naional income accruing o business proprieors. The model presened here helps o accoun for he observed paerns of facor shares. Figure 3 shows employee compensaion shares of naional income across counries and compares daa wih he oupu of he model. The model does a reasonably good job of maching he daa. Mos of he observaions from acual economies are relaively close o he pah prediced for he model economies. The model slighly overpredics he employee compensaion share, paricularly for rich counries, bu i shows ha changes in produciviy alone can generae subsanial changes in he share of employee compensaion in oupu. As wih he enrepreneur-workforce daa, i is sriking ha he model predics relaively fla employee compensaion shares for rich counries. This is consisen wih he ime series daa for curren rich counries, which show lile rend over ime in he employee compensaion share. A he same ime, he model predics a rapid increase in he employee compensaion share for poor counries. Thus, he model s predicions are consisen wih boh cross-secion and ime series daa on facor shares. I is imporan o noe ha he behavior of he employee compensaion share is no direcly deermined by he fracion of employees in he economy, since i also depends on wage raes. Thus, he employee compensaion share is independen of he daa repored above on he fracion of enrepreneurs in he workforce. Sill anoher variable of ineres in he model economy is he fracion of oupu accruing o he owners of sole proprieorships as operaing surplus. Operaing surplus is defined as value added less ne indirec axes, less employee compensaion, less gross fixed capial formaion. For acual economies, he operaing surplus of privae unincorporaed enerprises (OSPUE) is ofen repored in he naional income and produc accouns. For he model economy, here is no caegory of business esablishmens ha direcly corresponds o privae unincorporaed enerprises. However, i is reasonable o assume ha he esablishmens operaed by self-employed people are boh privae and unincorporaed. Figure 4 shows he operaing surplus of self-employed people in he model economy, as a share of oal produc. The line represening he model economy is conrased wih daa

18 7. on OSPUE for a sample of acual economies. The model economy generally undersaes he observed levels of OSPUE/GDP. Ineresingly, however, he model seems o capure he approximae levels and curvaure of he daa. 6. Conclusions and Implicaions Previous heories of developmen have largely absraced from quesions of esablishmen size, despie subsanial evidence ha average esablishmen size and paricularly he level of self-employmen changes dramaically as economies grow. This paper suggess ha a model wih explici reamen of esablishmen size and selfemploymen can reproduce a number of disparae feaures of he daa. No only can such a model mimic he daa on enrepreneur-workforce raios across a wide range of counries, bu he model also performs well in explaining cross-counry observaions of facor shares and oher naional income accouning saisics. The model economies do no, of course, fi he daa perfecly. This is no surprising, given ha he model economies absrac alogeher from policies ha affec firm size and self-employmen raes. The imporance of such policies is addressed in Gollin (2003). Bu given ha a model wihou disorionary policies accouns for abou wo-hirds of he variaion in he cross-secion daa (as measured by an R-squared of 0.673), i appears ha produciviy differences across counries may accoun for much of he observed heerogeneiy in firm size and self-employmen raes. This is no o sugges, however, ha policies are unimporan. For example, Table shows ha Bolivia, wih a real per capia GDP of $,72, had an enrepreneur-workforce raio almos double ha of he Philippines, a counry wih essenially he same level of real per capia GDP. Policies and regulaion may play an imporan par in accouning for such differences (as in de Soo, 989). Noneheless, he model reminds us ha we need no invoke policy disorions o accoun for he broad prevalence of self employmen in poor counries. Even in he absence of disorions, counries like Bolivia and he Philippines should be expeced o have higher levels of self employmen and more small firms han would be found in rich counries.

19 8. This insigh has imporan implicaions for developmen policies aimed a small enerprises and he informal secor. Policies aimed a favoring large firms over small ones in poor counries, in he ineress of promoing efficiency or modernizaion, are likely o be misguided. Indeed, any effors o aler he prevailing size disribuion of firms should be appraised criically. There may be value in programs ha redress missing markes or remove disorions, such as micro-credi schemes or liberalizaion of laws ha inhibi he formaion and expansion of firms. Bu in he poores counries, i is unreasonable o imagine ha such policies will make he informal secor disappear or lead o huge reducions in selfemploymen raes. Moreover, disorions aimed a alering he size disribuion of firms may be cosly, in erms of aggregae oupu, for poor counries. REFERENCES Alchian, A. and H. Demsez Producion, informaion coss, and economic organizaion. American Economic Review 62: Biggs, Tyler and Pradeep Srivasava Srucural aspecs of manufacuring in sub- Saharan Africa: Findings from a seven-counry enerprise survey. World Bank Discussion Papers: Africa Technical Deparmen Series, No Washingon, DC: The World Bank. Chrisiano, Lawrence J Undersanding Japan s savings rae: The reconsrucion hypohesis. Federal Reserve Bank of Minneapolis Quarerly Review (Spring) Coase, R The naure of he firm. Economica 4: De Soo, Hernando The oher pah: The invisible revoluion in he Third World. New York: Harper and Row. Evans, David and Boyan Jovanovic An esimaed model of enrepreneurial choice under liquidiy consrains. Journal of Poliical Economy 97 (4): Fafchamps, Marcel Indusrial srucure and microenerprises in Africa. Journal of Developing Areas 29 (Ocober): -30. Gilchris, Simon and John C. Williams Transiion dynamics in vinage capial models: Explaining he poswar cach-up of Germany and Japan. NBER Working Paper No Gollin, Douglas. 2002a. Geing income shares righ. Journal of Poliical Economy 0(2), Gollin, Douglas. 2002b. Nobody s business bu my own. Working Paper, Williams College Deparmen of Economics. Gollin, Douglas Do axes on large firms impede growh? Working Paper, Williams College Deparmen of Economics.

20 Har, O. and J. Moore Propery righs and he heory of he firm. Journal of Poliical Economy 98 (December): Hayashi, Fumio Is Japan s savings rae high? Federal Reserve Bank of Minneapolis Quarerly Review (Spring): 3-9. Hirschman, Alber O The sraegy of economic developmen. New Haven: Yale Universiy Press. Holmsröm, B. and J. Tirole The heory of he firm. In Handbook of indusrial organizaion, eds. R. Schmalansee and R. Willig. Amserdam: Norh-Holland. Hopenhayn, Hugo Enry, exi, and firm dynamics in long-run equilibrium. Economerica 60: Inernaional Labour Office Year book of labour saisics. Geneva: Inernaional Labour Organisaion. Inernaional Labour Office Year book of labour saisics rerospecive ediion on populaion censuses, Geneva: Inernaional Labour Organisaion. Inernaional Labour Office Year-book of Labour Saisics 940. Geneva: Inernaional Labour Office. Jovanovic, Boyan Firm formaion wih heerogeneous managemen and labor skills. Small Business Economics 6: King, Rober G. and Sergio T. Rebelo Transiional dynamics and economic growh in he neoclassical model. American Economic Review 83(4) Kremer, Michael The O-ring heory of economic developmen. Quarerly Journal of Economics 08(3): Kuznes, Simon Modern economic growh: Rae, srucure, and spread. New Haven: Yale Universiy Press. Lewis, W. Arhur Theory of economic growh. New York: Harper Torchbooks. Liedholm, Carl Pages in Agriculural ransformaion in Africa: Proceedings of he seminar on Agriculural Tranformaion in Africa held in Balimore, Maryland, May 27-29, 992, ed. David Seckler. Arlingon, VA: Winrock Inernaional Insiue for Agriculural Developmen. Liedholm, Carl and Donald C. Mead Small enerprises and economic developmen. New York: Rouledge Publishing Co. Lloyd-Ellis, Huw and Dan Bernhard "Enerprise, inequaliy and economic developmen." Review of Economic Sudies 67, Lucas, Rober E. Jr On he size disribuion of business firms. Bell Journal of Economics 9 (2): Maddison, Angus. 99. Dynamic forces in capialis developmen: A long-run comparaive view. Oxford: Oxford Universiy Press. Organisaion for Economic Co-Operaion and Developmen (OECD) Naional Accouns, : Main Aggregaes Volume I. Paris: OECD Saisics Direcorae. Republic of Ghana. 99. Ghana indusrial census 987: Phase II repor, background and resuls. Accra, Ghana: Saisical Service. Republic of Ghana Populaion census of Ghana 984: Demographic and economic characerisics, oal counry. Accra, Ghana: Saisical Service. 9.

21 Rosow, W. W The sages of economic growh. Cambridge: Cambridge Universiy Press. Sigler, G The Organizaion of indusry. Homewood, Ill.: Irwin. Tybou, James Manufacuring firms in developing counries: How well do hey do, and why? Journal of Economic Lieraure 38(), -44. Unied Naions Saisical Office Naional income saisics of various counries, Lake Success, New York: Saisical Office of he Unied Naions. Unied Naions Naional accouns saisics: Main aggregaes and deailed ables, 988. Pars I and II. New York: Unied Naions Publishing Division. U.S. Census Bureau Economic Census. Manufacuring Subjec Series. Table -4. U.S. Deparmen of Commerce, Bureau of Economic Analysis Naional income and produc accouns, : Saisical ables. Washingon, D.C.: U.S. Deparmen of Commerce. U.S. Deparmen of Commerce, Bureau of Economic Analysis Naional income and produc accouns, : Saisical ables. Washingon, DC: U.S. Governmen Prining Office. Williamson, O The economic insiuions of capialism: Firms, markes, relaional conracing. New York: The Free Press. Williamson, O Transacion cos economics. In Handbook of indusrial organizaion, eds. R. Schmalansee and R. Willig. Amserdam: Norh-Holland. 20.

22 2. Table : Proporion of workforce consising of enrepreneurs, own-accoun workers, and unpaid family laborers: manufacuring secor and enire economy. Counries are ordered by real GDP per capia. Counry GDP per Capia Manuf. Secor Toal Labor Force Counry GDP per Capia Manuf. Secor Toal Labor Force Cenral Af. Rep Uruguay Nigeria Malaysia Honduras Mexico Pakisan Greece Bangladesh Venezuela Philippines Korea, Rep Bolivia Porugal Egyp Ireland El Salvador Spain Peru Israel Morocco New Zealand Paraguay Finland Boswana Singapore Sri Lanka Ialy Guaemala U. K Ecuador Ausria Souh Africa Neherlands Tunisia Belgium Panama France Colombia Sweden Cosa Rica Denmark Iran Ausralia Turkey Germany, W Poland Japan Brazil Norway Thailand Canada Syria Hong Kong Hungary U.S.A Chile Source: Daa on real GDP per capia are aken from he Penn World Tables, Mark 5.6. Figures are given in consan dollar erms, using 985 as a base year, and following a Chain Index. Daa on labor force srucure are aken from Inernaional Labor Organizaion Yearbook, 993.

23 22. Table 2: Employers and own accoun workers as share of manufacuring workforce in Japan. Year Real per capia GDP Enrepreneurs as share of manufacuring workforce Source: ILO Yearbooks of Labour Saisics, various years; PWT v. 5.6; and Maddison (99).

24 23. Table 3: Parameer values for quaniaive experimen. Parameer Value Descripion β Discoun facor δ Depreciaion rae θ 0.90 Exponen on g enrepreneur s share = 0.0 γ Labor coefficien in f ρ Exponen on f σ = (x) β (8, 8) Disribuion of enrepreneurial abiliy α Upper bound on labor inpu of he self-employed A SE.3 Managerial produciviy advanage of he selfemployed

25 Figure : Employers and own-accoun workers as share of manufacuring workforce, six Eas Asian economies and model economy. 0.8 Share of workforce Model Korea Malaysia Philippines Singapore Thailand Real per capia GDP ($,000)

26 Figure 2: Enrepreneurs and own accoun workers as share of oal workforce: panel daa and model economy Acual economies Model Share of workforce Real per capia GDP ($ 000)

27 0.70 Figure 3: Employee compensaion as a share of oal produc, model economy and acual economies Employee compensaion / GDP GDP per capia ($ 000) Acual economies Model economy Source: Daa on employee compensaion shares in acual economies are aken from Unied Naions, Naional Accouns Saisics: Main Aggregaes and Deailed Tables, 992, Pars I and II(New York: Unied Naions Publishing Division, 994). Daa on real per capia GDP are from Penn World Tables v. 5.6 for 990 or appropriae year. Daa on model economy are aken from model oupu.

28 Figure 4: Operaing surplus of privae unincorporaed enerprises for acual economies compared wih mixed income of he self-employed for he model economy Acual economies Model economy Share of oal produc Real per capia GDP ($ 000) Source: Daa on operaing surplus of privae unincorporaed enerprises are aken from Unied Naions, Naional Accouns Saisics: Main Aggregaes and Deailed Tables, 990, Pars I and II (New York: Unied Naions Publishing Division, 992). Daa on model economy are aken from model oupu. Mixed income of he self-employed includes labor income, capial income, and enrepreneurial rens accruing o he self-employed. Daa on real GDP per capia are from Penn World Tables, v. 5.6, for he appropriae year.