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SMEs, Growth, and Poverty Thorsten Beck, Asli Demirg üç -Kunt, Ross Levine

SMEs, Growth, and Poverty Thorsten Beck, Asli Demirg üç -Kunt, Ross Levine. Discussion by Aart Kraay The World Bank October 14, 2004. What the Paper Does:. Measures of importance of SMEs, and quality of overall business environment (BE) Which matters more for growth: SME or BE?

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SMEs, Growth, and Poverty Thorsten Beck, Asli Demirg üç -Kunt, Ross Levine

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  1. SMEs, Growth, and PovertyThorsten Beck, Asli Demirgüç-Kunt, Ross Levine Discussion by Aart Kraay The World Bank October 14, 2004

  2. What the Paper Does: • Measures of importance of SMEs, and quality of overall business environment (BE) • Which matters more for growth: SME or BE? • Which matters more for changes in inequality: SME or BE?

  3. What I Liked About the Paper: • Paper asks a great question! • Very useful questioning of conventional wisdom • $10 bn is a lot of money to spend without benefit of evidence! • Heroic efforts at cross-country data collection!

  4. What We Need More of: High-quality evidence from micro data on role of firm size …but this is hard to do…and hard to generalize Example 1: Firm Size and Productivity • TFP is Production / Inputs = Q/L • We measure Revenue / Costs = (PxQ)/(WxL) • OK if all firms face same P, W • But they don’t! Market power => Upward bias for large firms Example 2: Firm Size and Job Creation • SME birth creates lots of jobs … but SME death destroys lots of jobs too • To capture this you need a census that credibly tracks entry and exit (including possibly into the informal sector) • This kind of data hard to find in developing countries

  5. What I Didn’t Like: Identification Strategy • Paper rightly is concerned with direction of causation • do SMEs cause growth or does growth create opportunities for SMEs? • does BE spur growth or do perceptions of BE reflect growth? • Lots of possible omitted variables • BE, SME have substantial measurement error All of these problems justify recourse to IV

  6. Identification Strategy, Cont’d • Proposed instruments (ethnic diversity, dummies for LAC, Transition, Africa) are correlated with BE, SME • But it is very hard to believe exclusion restriction required to validate the instruments! • Ethnic diversity matters for growth only through worse BE? • Only reason transition economies grew slowly in 1990s is because they had fewer SMEs? • Africa’s difficult geography and bad institutions don’t matter for growth? • What about all the other endogenous RHS variables (including initial income by construction)? • selective instrumentation does not deliver consistent estimates of any of the coefficients of interest

  7. Taking IV Seriously • Table 4: Business Environment and Growth: • OLS:  = 0.73 • IV:  = 2.72 • Four possible explanations for IV >> OLS • “Perverse” reverse causation • “Peculiar” omitted variables • “Enormous” measurement error in BE • Invalid exclusion restrictions

  8. Taking IV Seriously, Cont’d “Perverse” Reverse Causation • Conventional wisdom (growth raises BE) implies IV < OLS • To justify IV >> OLS need high growth to cause muchworse BE – why might this be? “Peculiar” Omitted Variables • Many likely candidates (e.g. good institutions) raise growth and improve BE, this implies IV < OLS • To justify IV >> OLS need omitted variables that raise growth and lower BE, or vice versa – what could they be?

  9. Taking IV Seriously, Cont’d “Enormous” Measurement Error in BE • Attenuation bias: (OLS) =  VAR(True BE)/VAR(Measured BE) • (IV) = 3 x (OLS) implies variance of measurement error in BE is twice variance of true BE • This means BE measures are virtually uninformative! e.g. suppose observed BE is 1 SD above the mean, best forecast of true BE is that it is only 0.33 SD above mean

  10. Taking IV Seriously, Cont’d Invalid Exclusion Restriction • True model is: Growth =  BE + e BE =  ELF + v • Instrumental variables regression delivers: (IV) =  + (COV(e, ELF)/VAR(ELF))/  • Bias is slope of regression of structural error (e) on the instrument (ELF), scaled by  • Does ELF matter for growth holding constant BE? Quite plausibly (higher inequality, higher social conflict, many other channels)

  11. Summary • Great question very relevant for policy! • Firm-level data will help to get closer to definitive answers on role of SMEs in growth and poverty – but doing this right will be hard • Identification in cross-country (or cross-anything) regressions is hard. Useful to: • take it as seriously as possible • recognize that there is only so much orthogonal and independent variation across countries in the things we care about (so many good things go together across countries!)

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