Implications Macroeconomic of Size-Dependent Policies
Nezih Guner, Gustavo Ventura and Xu Yi March 2005
Abstract Government policies that impose restrictions on the size of large establishments or rms, or promote small ones, are widespread across countries. In this paper, we develop a simple framework to systematically study policies of this class. The economies we study are simple growth models with an endogenous size distribution of production units. Production requires a managerial input, and individuals sort themselves into managers and workers. Since managers are heterogeneous in terms of their ability, establishments of dierent sizes coexist in equilibrium. We parameterize the economies so that they are consistent with central properties of the data. Then, we ask: quantitatively, how costly are policies that distort the size of production units? What is the impact of these policies on productivity measures, the equilibrium number of establishments and their size distribution? We nd that these eects are potentially large: policies that reduce average size by 10% lead to reductions in output and output per-establishment up to 4.2% and 13.3% respectively, as well as large increases in the number of establishments (10% or higher). KEYWORDS: Size Distortions, Establishment Size, Productivity Dierences. JEL Classication: O40, L11, D58.
We thank Mark Bils, Lee Branstetter, Jerey Campbell, Jeremy Greenwood, Barry Ickes, Richard Rogerson and seminar participants at University of Southern California, Rochester, Macro Lunch at Wharton, The Cornell-PSU Macro Conference, and the 2004 NBER Summer Institute (Macroeconomics and Productivity). Alejandro Riao provided excellent research assistance. All errors are ours. n Dept. of Economics, The Pennsylvania State University. Corresponding author: Nezih Guner. Address: 619 Kern, University Park, PA 16802-3306. E-mail: [e-mail]
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Introduction
The size of an establishment or a rm is often critically aected by dierent government policies. Several countries implement policies that either restrict the operations of large production units, or subsidize small ones, or try to do both. These policies are widespread across countries and emerge in several forms. In some countries such policies can be extreme. In India, for instance, several products are reserved for small scale rms; simply put, these goods cannot be produced by large rms. The number of reserved products is not negligible, either. As of the late 1980s, production of these reserved items accounted for about 13% of total manufacturing output in India.1 A more widespread practice in many developing countries is the dierential enforcement of taxes and other regulatory policies, as governments often nd taxing or regulating larger units an easier task. These policies are by no means restricted to developing economies. Nearly all countries, poor and rich, provide an array of subsidies to small and medium size units. Labor market regulations in many OECD countries, like dismissal rules, bind only after a certain size. Finally, a number of rich countries, France, Japan, Germany and the U.K., implement policies that regulate the size and operation of establishments in the retail sector. In particular, Japan and France are unique among developed countries as they regulate heavily and at the national level the size of retail shops. In light of the prominence of policies of this type in developing and industrialized economies, we document them in greater detail in the Appendix. In this paper we develop a simple framework to systematically evaluate distortions that depend on establishment or plant size (i.e. size-dependent policies). Our analysis is based on extensions of the well-known Lucas (1978) model. There is a single representative household, which is inhabited by individuals that are heterogenous in terms of their endowment of managerial skills. Production requires three inputs: capital, labor and managerial services. As a result of the underlying heterogeneity, individuals sort themselves between managers and workers. Furthermore, since those who become managers are heterogeneous in terms of their skills, establishments of dierent sizes coexist in equilibrium. We analyze two dierent types of policies: those that restrict production of large establishments and those that
The Indian reservation policy remained essentially unchanged after the economic reforms of the early 1990s. See the Appendix for a discussion.
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encourage production by small ones. We also extend our framework to a two sector model, and introduce restrictions on the size of establishments in one of the sectors. In this case, we interpret one of the sectors as the retail sector and identify the other with the rest of the economy, and calibrate the model to the U.S. retail and non-retail sectors. In each scenario, we ask: quantitatively, how costly are policies that distort the size of production units? What is the impact of these policies on productivity? How do these policies aect the size distribution of establishments? Several observations make the study of size-dependent policies of special interest. First, large establishments account for a disproportionate fraction of output and employment. In the case of the United States, an economy for which the policies we study are largely absent, establishments with more than 100 workers correspond to 2.6% of the total number of establishments but account for 44.9% of total employment.2 This concentration of employment in large plants holds for the economy as a whole, for the manufacturing sector, as well as for the dierent sectors in the service area. Thus, it is natural to conjecture that policies that restrict the size of establishments are costly in terms of output and will impact productivity measures. In particular, it is an open question the extent to which policies of this sort contribute to rationalize the large observed dierences in productivity across countries documented by Klenow and Rodriguez-Clare (1997) and Hall and Jones (1999), among others. Second, restrictions on size in the retail sector might be of special importance. In the rst place, there is evidence of substantial productivity growth in services, and in the retail sector in particular. According to Basu, Fernald, Oulton, and Srinivasan (2003), productivity growth in wholesale and retail trade between 1995 and 2000 was the second highest among all sectors in the U.S., second only to information technology producing sectors. In the second place, the experience of the heavily regulated Japanese retail sector is particularly illustrative. Japanese retailing is characterized by (i) a relative large number of stores percapita, (ii) a large concentration of employment and hours worked in small establishments, and (iii) low productivity. The rst fact is documented by Flath (2003), among others, who reports that there are about 11.2 stores per 1000 population in Japan, while the same number is 6.1 in U.S. For the second fact, we note that while retail establishments with
Source: our calculations using tabulated data from the U.S. Economic Census (1997). Available at http://www.census.gov/epcd/www/ec97stat.htm.
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more than 100 workers accounted for 32% of employment in the sector in the United States in 1997, they accounted for just 12% of retail employment in Japan in 2001.3 Similarly, according to McKinsey Global Institute (2000), the share of traditional mom-and-pop stores in total hours worked in retailing is about 55% in Japan and 19% in the U.S. For the last fact, McKinsey Global Institute (2000) and Baily and Solow (2001) document that output per-worker in merchandise retailing in Japan was about half of the level in the U.S. in 2000 at common prices. To put this gure in perspective, aggregate output per-worker in Japan was about 70% of the U.S. in 2000. Finally, the size distribution of establishments diers signicantly across countries and available evidence suggests a central role for policy dierences.4 Tybout (2000) summarizes evidence that shows a drastic contrast between size distributions of manufacturing plants in developing and industrial countries. In developing countries the size distribution of establishments shows a concentration of employment in small and large establishments with a missing middle group. This stands in contrast to the case of industrialized countries in which the share of total employment rises with size. Perhaps more interestingly, size distributions dier sharply even among countries of comparable levels of development. Dierences among the U.S., the E.U. and Japan are striking: small and medium size establishments plays a signicant role in Japan, but are much less signicant in the U.S. with the E.U. being somewhere in the middle (European Commission (1996)). Surprisingly, the dierences within the E.U. are also large. While small establishments account for the bulk of employment in Italy, larger establishments play a more important role in other countries, like Sweden and the U.K.5 Davis and Henrekson (1999) and Henrekson and Johansson (1999) argue that the economic policy environment plays a key role in the prevalence of large establishments in Sweden. They point out, among other things, the role of labor regulations that aect all establishments in Sweden but only the larger ones in other countries, like Italy.
Sources: U.S. Economic Census (1997) and Japans 2001 Enterprise and Establishment Census, which is available at http://www.stat.go.jp/english/data/jigyou/index.htm. 4 Although we focus on the role of policy dierences in this paper, there are obviously several factors that contribute to the cross country dierences in size distribution, and these factors go well beyond the dierences in government policies see Kumar, Rajan, and Zingales (1999) for a recent review. 5 Establishments with 1 to 9 and more than 250 workers accounted for 45.8% and 21.5% of employment in Italy in 1991, while the same numbers were 29.2% and 44.5% in Sweden in 1992, and 15.4 and 50.2% in U.K. in 1993 European Commission (1996).
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Our strategy to draw quantitative implications from size-dependent policies is to rst use observations from the U.S. economy to calibrate the model economies we study. More specically, we restrict the model parameters in order to reprod...
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