What if we told you that if we know a single statistic about a country, we can tell you whether its per capita income is in the top, bottom, or middle of global rankings? And what if we told you that, knowing only that one statistic, we could also guess with considerable accuracy what the country’s overall economy is like and even in what region of the world it is probably located?
There is such a tell-all statistic. It is the percentage of the population that is self-employed. The poorer a nation is, the more of its people are self-employed. In 2016, 6.4 percent of unincorporated Americans were self-employed.1 In Burundi, the share that is self-employed or in family businesses is 89.9 percent. In 2016 the per capita income in Burundi (purchasing power parity) was $800, while it was $57,300 in the United States.2
As a rule, the richest regions are those in which self-employment is lowest, while the poorest are those with the most self-employed inhabitants. Self-employed workers amount to 7 percent of the workforce in North America and 10 percent in the European Union, 22 percent in Latin America and the Caribbean, 36 percent in sub-Saharan Africa, and 41 percent in Southeast Asia.3 The reason, as we noted in chapter 4, is simple: as a rule, the smaller the firm, the lower the productivity level.
Here’s another fun trick. If we know the percentage of self-employment in a country, we can also accurately guess what kinds of things that country exports. High-value-added manufactured goods dominate the exports of countries with low levels of self-employment, while low-value-added commodities such as raw materials and agricultural products and services such as tourism dominate the exports of nations with high levels of self-employment.
According to the World Bank, the poorest countries are Malawi, Burundi, the Central African Republic, and Niger, and their exports are such items as tobacco, uranium and thorium ore, tea, sugar, coffee, cotton, hides, wood, spices, and precious stones. Now let us look at the major exports of the three largest advanced industrial capitalist countries, the United States, Japan, and Germany: machinery, electronic equipment, aircraft, spacecraft, vehicles, oil, medical equipment, iron and steel, plastics, organic chemicals, engines, pumps, and pharmaceuticals. Rich countries export mostly high-value-added manufactured goods. Poor countries export mostly low-value-added commodities, much of them harvested or made by hand using primitive, labor-intensive methods instead of modern machinery.
Specializing in tourism is another guaranteed route to poverty. In 2015, tourism as a percent of total exports was 10.9 percent in the United States, 3 percent in Germany, and 3.5 percent in Japan but 52 percent in Albania, 55.3 percent in Jamaica, 55 percent in Montenegro, and 73.4 percent in the Bahamas.4
There is also a positive correlation between the share of firms that are small and income inequality. Davis and Cobb find that the most equal nation in their sample of fifty-three nations, Denmark, had about one quarter of its workers employed in its largest ten firms. In contrast, in the least equal nation, Colombia, the largest firms employed fewer than 1 percent of workers. Overall there is a negative correlation (−0.47) across nations between income inequality and the share of workers employed in large companies.5
What about new business startups? According to a World Economic Forum report examining the share of startup firms, Uganda is number one, Thailand two, Brazil three, and Cameroon four.6 These countries are hardly economic powerhouses.
What explains this striking correlation among five seemingly unrelated factors: self-employment rates, per capita income, the composition of exports, income inequality, and startup rates? The answer is big business—to be more precise, medium to large to colossal firms in industries characterized by increasing returns to scale. While poor, undeveloped countries are dominated by small famers, producers, and peddlers, often in the informal sector, in the advanced technological nations of North America, Europe, and East Asia big firms are responsible for disproportionate shares of output and employment.
The modern economy is a “bimodal economy,” to use Galbraith’s phrase. It can be divided into industries with constant or diminishing returns, in which the cost of each additional good or service produced is the same as the previous one (think massages), and industries characterized by increasing returns to scale, in which, mainly for technical reasons, the average cost of producing the ten thousandth unit is less than the first (think automobiles). In some digital industries, such as software, the second unit is cheaper than the first by a very large margin because the second one is largely free to produce (it is copied by a computer). Increasing-returns industries tend to be in traded sectors while constant- or diminishing-returns industries such as massage therapy tend to belong to nontraded sectors.
Before the Industrial Revolution, which began in the eighteenth century, the tradable sector was small and negligible, limited to a few luxury items such as spices and silks, which were consumed only by rich elites. Everything else—tools, clothing, food—was made or grown at home or nearby. Industrialization is the process by which more and more goods and services that once were produced locally by human and animal power are produced by machines (including computers) using sources of energy other than human or animal muscle, shifting many of those goods and services from the nontraded sector to the traded sector (whether they are in fact sold abroad or not, they can be). Because the most efficient firms in increasing-returns industries are usually of substantial size, during the process of economic development the number of self-employed workers and mom-and-pop businesses declines, particularly in traded sectors, and the number of wage earners working for medium-sized to large firms expands. So does public sector employment, because rising prosperity permits higher tax revenues with less pain and an expansion of the functions of government.
As large, more efficient firms gain market share, they provide better opportunities for workers. This is why richer nations also have relatively less self-employment.7 As firm size increases so do incomes for more individuals, many of whom switch from suboptimal “entrepreneurship” to working for wages. This may also explain the recent increase in contingent or gig work since the global recession in Europe and the United States. Much of the focus on the growth of the gig economy has been on the new platforms, such as Uber and Task Rabbit, but it may be that one reason more workers are using work-finding apps to become “1099 workers” (self-employed workers) is because other, higher-quality employment opportunities are lacking.
As a nation industrializes and labor and resources shift from the traditional small firm sectors to the innovative large firm sectors, the country gets richer, because of—and not in spite of—the growth of big business. And the information technology (IT) revolution is enabling a wider variety of service industries to also become increasing-returns-to-scale industries and to become traded. A case in point is banks, which for centuries were mostly local and nontraded. People banked with local banks. Today, with “fintech” and e-banking, banking can be done anywhere in the nation and even across borders. Internet-based banking is like manufacturing, with increasing returns to scale, but even more so, and it enables distance consumption. We see this IT transformation occurring in a host of industries—news, insurance, travel services, retail, law, and several others—where technology is providing increasing returns to scale and making them tradable, just as most of manufacturing has long been. That is why, as we showed in chapter 3, the average nonmanufacturing industry in the United States is seeing increasing average firm size.
Firm Size around the World
American politicians love to talk about American exceptionalism. But the general pattern of American economic development is very similar to that of other advanced industrial nations in Europe and East Asia, characterized by the same coevolution of technological innovation and business on an ever-larger scale. After all, technology tools largely determine firm size, and those tools are available around the globe.
But that’s not to say that other factors don’t impinge. Given the trends in technology, one might expect that, like the United States, other advanced nations would in fact be seeing increased firm size. But while firm size has been increasing in the United States, in some regions it has been shrinking. In Europe, the average firm size declined from seven workers per firm in 2005 to 6.2 in 2013 (see figure 7.1).8 Portugal went from 15.7 workers per firm in 1986 to 9.1 in 2008 and in no sector did firm size increase, while the share of workers who were self-employed increased by a factor of ten.9 Likewise, the share of employment in small firms in China grew from around 22 percent in 2004 to 32 percent in 2009.10
Figure 7.1 Change in Average Firm Size in the United States and the EU-28
What explains firm size changes in a nation? There are two factors: the growth effect and the mix effect. The mix effect refers to changes in the mix of jobs between industries. The growth effect refers to overall trends. In virtually every nation, manufacturing firms are larger than nonmanufacturing firms. So as jobs shift to services, the effect should be to reduce overall average firm size. But the growth effect also plays a role; for example, IT is allowing a range of service firms to gain scale. In countries where firm size is getting smaller, some of this is the result of fewer manufacturing jobs, but much of it appears to be related to the growth effect, whereby average firm size other sectors is not getting larger or are even shrinking.
Why have service firms gotten smaller in some nations but bigger in the United States? Several reasons can be adduced. One may be efforts by nations to “demonopolize” industries that had been nationalized. Another may be policies explicitly favoring small firms while taxing and regulating large firms. In South Korea, for example, the share of output from large firms fell from 72 percent in the early 1970s to around 50 percent in 2006, while the share of employment in small and medium-sized enterprises (SMEs) increased from 80 percent in 2000 to 87 percent by the early 2010s.11 As we will discuss, Korea has enacted a vast array of policies, including explicitly charging its competition authority to create a “competitive environment” for SMEs, that made it harder for large firms to grow.
Around the World Small Firms Are Less Productive
This stagnant or even declining firm size in many nations matters because big firms are on average more productive than small firms. One way to estimate this difference is look at their share of employment and GDP. In the early 1990s, out of fourteen OECD nations studied, in all but Spain, small firms’ share of employment exceeded their share of GDP12 In other words, small firms’ workers produced less. In the UK, small firms accounted for two-thirds of jobs but just 30 percent of GDP.13 Workers in very large firms in the UK are more than twice as productive as workers in businesses with one to nine workers.14 Large Finnish firms (more than 1,000 employees) had 13 percent higher total factor productivity than small firms (fewer than fifteen employees), when the type of industry was controlled for.15
Bart van Ark and Erik Monnikhof show that large firms are more productive than small in France, Germany, Japan, the UK, and the United States.16 In Canada, productivity in plants with 100 or fewer employees was 62 per cent of the industry average, but it was 165 percent in plants with 500 or more employees.17 These differences persisted even after other characteristics were controlled for, such as foreign control, export intensity, unionization, and age.18 Even when researchers controlled for industry and age, large firms were still 10.5 percent more productive. One study of Japan found that all of the decline in growth in Japan leading to Japan’s so-called “lost decade” was the result of SMEs not increasing their productivity, something large firms continued to do.19 Indeed, from 1980 to 2000, total factor productivity growth continued to grow for large firms but either stagnated or fell for SMEs. In a combined 18 European nations, firms with 250 or more employees are 80 percent more productive than firms with fewer than ten employees (see figure 7.2).
Figure 7.2 Labor Productivity and Enterprise Size in the European Union, 2014
What about in the developing world? After all, it has become an article of faith in the international development community that multiplying the number of small, even micro, firms will help developing nations escape poverty. But a World Bank study of seventy-six nations found no evidence that SMEs support growth or reduce poverty.20 Another study of ten African nations found that small and large firms created similar numbers of net jobs, but the jobs in larger firms paid persistently higher wages.21 This is because large firms are more productive than small ones.
Large firms in Asia are also more productive than small firms. In India, firms with five to forty-nine workers were just 10 percent as productive as firms with more than 200 workers; productivity for smaller firms in relation to larger firms was 19 percent in Indonesia, 21 percent in the Philippines, 22 percent in South Korea, 42 percent in Thailand, and 46 percent in Malaysia.22 We see the same dynamic in Africa, where larger firms are more productive than smaller ones,23 and in Turkey.24
This explains why a predictable way to determine how rich an economy is is to look at the share of workers in large firms. The larger share of a region’s employment in large firms, the richer it will be. This is also why residents of US states with a higher share of jobs in small businesses have on average lower incomes. In fact, there is a −0.27 correlation between the share of jobs in a state in firms with fewer than twenty employees and the state’s per capita income. For example, per capita income in Montana is just $39,800, with the share of jobs in small firms over 31 percent. Massachusetts enjoys a per capita income of $62,900 and only 16 percent of its jobs are in small firms.25
The same pattern holds true across nations. In general, high-income countries have a much higher share of jobs in big companies.26 Moreover, small business growth appears to be negatively, not positively, related to growth. Scott Shane found that “removing the effect of all other factors that differ between countries, the rate of new firm formation in a particular year has a negative effect on a country’s real per capita GDP in the following year.”27 Moreover, “The countries that have had consistently faster economic growth had declining rates of new firm formation over time from 1975 to 1996.”28 This is why data on new business formation in forty-four countries from 2000 to 2004 show that developing countries have a much higher rate of new business creation than developed countries.29 Higher rates of new firm formation are a sign of poverty, not wealth, because they reflect the paucity of real economic opportunities at firms that are sophisticated and able to be highly productive.
Firm size is also one reason why Canada is poorer than the United States. The smaller average firm size in Canada accounts for approximately 20 percent of the gap in Canada-US sales per employee overall and 48 percent in manufacturing.30 While average firm size in the United States increased, the average size of firms in Canada fell from 17.5 employees in 1984 to 15.3 employees in 1997, with most of the decline coming from large firms getting smaller.31 This decline caused average sales per employee in Canada to fall by $1,700. If the United States had the same firm size distribution as Canada—which, as we will see in chapter 10, the populist left in America desires—US per capita GDP would be $1,800 lower.32 If the United States had the same firm size distribution as Europe, US productivity would be $2,060 lower. That is the small business “tax” these nations pay.
Explaining Firm Size Differences between Nations
Why does this distribution of firm sizes differ so widely between nations? One factor is whether a nation has a greater share of firms that are on average larger, such as manufacturing firms. Nations with more manufacturing firms tend to have higher average firm sizes, all else being equal. Likewise, R&D-intensive industries tend to be larger, and so nations with a larger share will (all else being equal) have larger than average firms.33 But these factors do not appear to play a large role in explaining differences between nations.
One factor in national firm size appears to be population size and the size of market access. A larger population means larger markets, so more firms are able to achieve economies of scale using mass production technologies. Indeed, there is a positive 0.45 correlation between the population of twenty-nine OECD nations34 and the share of jobs in firms with more 250 workers and a negative 0.2 correlation between population size and share of jobs in firms with fewer than 51 workers. Likewise, better access to foreign markets through trade agreements and other market opening measures should enable greater firm size, as would improvements in transportation networks and communication networks. If firms can reach more markets through better physical transportation or through information transfer on broadband networks, they will likely be larger.
Higher per capita income also plays a role. Higher incomes not only increase market size, they make it more likely a person will want to be a wage worker rather than a subsistence entrepreneur. Many studies have found this relationship. Examining the period of 1900–1970, Robert E. Lucas, Jr., found a strong positive relation in the United States between average firm size and GNP per capita.35 Likewise, in a study of more than thirty countries, Markus Poschke found that richer nations have more large firms and fewer small firms.36 Rich nations also have relatively more managerial jobs.37 In short, as nations get richer, their firm size generally increases, as was the case in most East Asian economies over the last forty years, including Indonesia, Japan, South Korea, and Thailand.38 Small firms are more prevalent in poor countries in part because poor countries provide smaller markets for needed economies of scale. So having a large share of small firms should not be seen as a sign of success, something that policy makers should build on. Rather, it should be seen as a sign of underdevelopment. A high level of self-employment in a country means there are not enough good full-time jobs, so many people are forced to obtain low incomes by working for themselves.
Culture also plays a role. In his book Trust: The Social Values and the Creation of Prosperity, Francis Fukayama argues that strong family ties are bad for the formation of larger firms because they make it harder for individuals to trust non-family members. For example, the large number of small firms in Southern Italy stems in part from a culture in which family is trusted but outsiders are not. This may be why numerous studies have found that nations with a population that showed higher levels of trust of non-family members had a statistically significant greater share of economic output in larger firms.39 Higher levels of trust also let managers delegate to a broader range of individuals with greater assurance that they will act in the interests of the firm.40
The regulatory and legal climate also plays a role. Several studies have found that nations with stronger property rights, including intellectual property rights, have larger firms.41 The argument is that “an efficient legal system eases management’s ability to use critical resources other than physical assets as sources of power, which leads to the establishment of firms of larger size. It also protects outside investors better and allows larger firms to be financed.”42 This is also true at the subnational level. For example, Mexican states with more effective legal systems have larger firms because states with better legal systems reduce the risk firm owners face, leading them to increase investment.43 Nations with better-developed financial markets also have larger firms. One study found that firms in industries more dependent on outside financing are larger in nations where financial markets are more developed.44
Policies to Keep Businesses Small
A major reason firms are smaller in some nations is that governments actively want small firms and have a broad array of policies that tilt toward smaller firms, including weaker regulatory requirements, tax preferences, and subsidies. When policy rewards smallness and penalizes bigness, smallness is the result.
In most nations, governments exempt small businesses from regulation or subject them to lesser requirements. The European Commission’s official policy is to size discriminate, stating: “Being SME-friendly should become mainstream policy. To achieve this, the ‘Think Small First’ principle should be irreversibly anchored in policy making from regulation to public service.”45 In France a number of regulatory requirements apply only to businesses with fifty or more employees. In Portugal, firms with fewer than workers have access to workers whose wages are subsidized by public funds and who receive priority for worker training subsidies. Also, the more workers, the higher the fines are for violations of labor law. The exemptions for small firms are even stronger in many developing nations. For example, in Brazil, most of the labor inspections are focused on large, formal firms, not on small informal firms.46
Many countries also protect small-scale mom-and-pop stores through barriers to entry, zoning laws, and restrictions on the size of stores. For example, Argentina has an array of policies to favor small, less-productive grocery stores.47 Larger firms are forced to “donate” food to neighborhood associations and face price controls and import limits. Regulations limit the size of stores and the maximum number of stores any one firm can operate in an area. Some regions even require hardship pay increases for working in large stores.
Worried that French consumers will buy too many books on Amazon.com and reduce sales at small bookstores, France’s minister of culture has described Amazon.com’s free shipping of online orders as “a strategy of dumping.”48 And a bill recently unanimously approved by France’s lower house of Parliament would effectively force online booksellers to sell at higher prices than brick-and-mortar stores by banning any seller from applying discounts to the cover prices of books that are shipped to readers. The McKinsey Global Institute has found the same kind of small retailer protections in Brazil.49 In Japan, laws limiting the entry of large supermarkets and providing incentives for small retailers to stay in business explain the country’s high share of low-productivity family retailers.
Most nations require large firms to pay higher taxes. In Mexico, from 1998 until 2013, firms with sales below 2 million pesos (about $125,000 in 2008) paid a flat tax of about 2 percent of their sales and were exempt from payroll income and value-added taxes. Firms above the 2 million pesos threshold were subject to a 15 percent value-added tax, a 38 percent income tax, and a 35 percent payroll tax.50 In Indonesia, firms above a certain size are required to pay 10 percent value-added tax. In South Korea, small companies pay a 10 percent corporate tax while large ones pay a 22 percent tax.
Many nations have special tax incentives that either apply only to small business or are more generous for them. In South Korea, only small firms are eligible for a 5 percent tax credit for expenditures on industrial or advanced office equipment. The UK provides a new enterprise tax allowance but only to small firms. In Canada, small firms are eligible for an R&D credit 75 percent greater than that for large firms. China has recently introduced an additional round of special tax cuts for small businesses, including a tax rebate scheme for small businesses.51
In most nations, small businesses also benefit from subsidized loans, direct grants, lower fees for government services, and set-asides for obtaining government contracts. South Korea requires banks to lend to small firms, resulting in an overabundance of debt. In 2012, 78 percent of bank lending went to SMEs, compared to about 25 percent in the United States.52 In addition, public financial institutions such as the Korea Finance Corporation and the Small and Median Business Corporation provide loans directly to SMEs. Only 21 percent of loans made to SMEs were not guaranteed or collateralized by government.53 The government also operates 1,300 SME programs and forty-seven support measures covering taxes, marketing, and employment.
Many governments simply give small businesses cash. While the European Commission restricts state aid to business, it exempts many small firms.54 European governments can give direct aid to small fishers, farmers, coal-mining companies, shipbuilders, steel companies, and synthetic fiber firms, but not to large ones. The European Commission wants to reduce “competition-distorting handouts to national champions, and instead support measures which contribute to boosting growth and creating jobs.”55 This means they want to give money to small business. This is one reason why in France, “There are over 250 different grants and subsidies … available to individuals for starting up a personal enterprise or small business.”56
Many nations prop up small firms because they do not want to suffer the economic disruption coming from job loss and because policy makers do not trust the market to create jobs. So they in essence enable inefficient small companies to continue to be inefficient. But this simply keeps more productive firms from gaining market share. Korea is a classic case in point. Because of deep societal aversion to employment disruption, the Korean government perpetuates an array of policies to limit firms from going out of business. The 2012 Global Innovation Index ranks Korea 120th in the cost of redundancy of dismissal of employees.57 The government promotes a range of domestic policies to shelter small firms from competition. Its National Commission on Corporate Partnership is charged with “designating suitable industries for SMEs.”58 For example, it ruled that medium-sized restaurant companies cannot open new stores within 150 meters from small eateries that earn less than 48 million won ($42,800) in annual revenue.
The situation in South Korea demonstrates how size discrimination limits growth. SMEs account for 87 percent of jobs, compared to just 44.4 percent in the US.59 The lavish benefits and regulatory exemptions SMEs enjoy mean that few firms want to grow. Of the millions of SMEs in South Korea in 2002, only a paltry 696 had graduated from SME status by 2012. And their labor productivity in manufacturing is less than a third that of large companies and 45 percent in services. Massive government favoritism toward small firms lowers labor productivity below what it would be if workers were distributed randomly between low, medium, and highly productive firms. In contrast, in the United States the actual distribution raises productivity by 50 percent over what it would be if less productive firms had the same market share.60
The consequences of a tilted playing field are similar in many nations. In France, firms with fifty or more employees face substantially more regulation than firms with fewer than fifty. An NBER study by Luis Garicano, Claire LeLarge, and John Van Reenen finds that as a result, many French firms intentionally stay under the magic fifty-worker threshold, and that this lowers French GDP by as much as 5 percent of GDP, with workers bearing most of the cost.61 A related cause of this lower growth is that by reducing wages, these regulations encourage “too many agents with low managerial ability to become small entrepreneurs rather than working as employees for more productive entrepreneurs.”62
In Portugal, the expansion of discriminatory regulations meant that the average firm size declined by almost 50 percent from 1986 to 2009, and because these firms are less productive than larger firms, growth stagnated.63 Likewise, studies show that small firm preferences keep firms small in India,64 Italy,65 and Japan.66
These policies not only keep more efficient larger firms from gaining market share, they stifle the growth of small businesses into large ones, since they are loathe to lose their cushy preferences. This hurts growth by diverting output from more productive larger firms to less productive smaller ones. This is why one study found that “policies that reduce the average size of establishments by 20% lead to reductions in output and output per establishment up to 8.1% and 25.6% respectively, as well as large increases in the number of establishments (23.5%).”67
These small firm preferences are even extensive in many developing nations and even more damaging given their already low levels of per capita income. India is emblematic. Post-independence Indian economic policy was heavily influenced by “small is beautiful” thinking. Embracing this mentality, coupled with pressures from unions for featherbedding and protections against productivity improvements, India’s government passed laws limiting the size of certain enterprises, in the quixotic pursuit of job creation. In the 1970s, Prime Minister Indira Gandhi reserved approximately 800 industries for the small-scale sector. Investment in plant and machinery in any individual unit producing these items could not exceed $250,000.68 For example, pencil makers could grow no larger than fifty employees, which resulted in India having one of the world’s most inefficient pencil industries. As Gurcharan Das writes, “Thus, large Indian firms were barred from making products of daily use such as pencils, boot polish, candles, shoes, garments, and toys—all the products that had helped East Asia and China create millions of jobs. Even after 1991, Indian governments were afraid to touch this holy cow.”69 One result of this tragic legacy is that by 2005, while 52 percent of China’s manufacturing workers were employed by large firms, just 10.5 percent of India’s were.
Though these “permit raj” policies have largely been abandoned, India still seeks to protect its fragile small business flowers from big business. In India, various regulations on manufacturers kick in at various firm size levels, depending on the type of regulation, such as health, social security, and labor protection. The Industrial Disputes Act, which significantly limits the ability of firms to lay off workers, applies only to companies employing 100 or more workers, which must get permission from the government to lay off workers and give twenty-one days’ notice if they are going to change leave, wages, and hours.70 Likewise, the Indian government prohibited Wal-Mart from selling directly to consumers; it could only sell to retailers, which then resold their purchases to customers. If you want to buy a set of sheets or some socks for your child, you don’t go to Wal-Mart; you go to your local corner shop, which resells to you what it bought from Wal-Mart, at a markup. The study found that Indian states with more flexible labor market regulations have a higher share of employment in large firms.71
Most developing nations have made the same mistakes. One study found that large firms in Pakistan, South Korea, Ghana, and Sierra Leone had costs of between 10 and 26 percent more than small firms because of tax policy differences, while costs for large firms in Ghana, Sierra Leone, Tunisia, and Brazil were 20 to 27 percent higher because of labor regulations.72 These distortions reduced GDP by between 6 and 18 percent. Hsieh and Kienow found that in India and China, small manufacturers have a significantly larger share of the market than they would if the goal was to maximize productivity.73 They argue, “It is harder for a more productive firm to grow but also easier for a less productive firm to survive in India than in the United States.”74
Moreover, in the developing world large numbers of small firms are not subject to regulatory and tax obligations because they operate in the informal economy (what could be more accurately termed the illegal economy). For example, in Brazil most of the labor inspections are focused on large formal firms, not small informal firms.75 As the World Bank writes, informality provides “unfair advantage to noncompliant firms, thereby distorting the allocation of resources.”76 Luis Videgaray Caso, Mexico’s Secretary of Finance and Public Credit, writes, “The informal workforce reduces productivity and thereby diminishes economic growth.”77 The McKinsey Global Institute found: “One reason for Mexico’s weak productivity growth overall is that more than half of non-agricultural workers are employed in the informal sector; indeed, informality is growing due to the high regulatory cost of establishing a formal business and lax enforcement.”78 Informality is a drag on growth, not a progressive force.79
The international development community has not helped matters by latching on to fads such as supporting microbusinesses and the informal economy. For example, the European Commission writes: “In many developing countries, the expansion of the private sector, notably micro-, small- and medium-sized enterprises, is a powerful engine of economic growth and the main source of job creation.”80 Under Goal 8 of the UN Sustainable Development Knowledge Platform to encourage sustainable growth, one of the means is to “encourage the formalization and growth of micro, small, and medium-sized enterprises.”81 And the World Bank “promotes small and medium-sized enterprise (SME) growth through both systemic and targeted interventions.”82 The irony of these policies is that they are resulting in the exact opposite of their intention: the holding back of development. The result of this fixation on small business has been slower productivity and per-capita income growth.83
The lesson should be clear. If the goal is to advance global development, particularly in low-income nations, the focus should be on size neutrality at minimum. Ill-advised national policies to prop up, subsidize, or protect small firms in the name of job creation or social inclusion work against achieving the long-term goals of economic development and improved living standards.
