Do firms in developing countries grow as they age?

The answer is yes, but not as fast.  In the U.S. for example, we know that new businesses start small, and if they survive, grow fast as they age. An average 40 year old US plant employs over seven times as many workers as the typical plant five years or younger. In a new paper, my co-authors Meghana Ayyagari, Vojislav Maksimovic and I focus on developing countries and look at what happens to firms in the formal sector as they age. We focus on formal firms because informal firms look very different from formal firms in terms of size, productivity and education level of managers and there is little evidence that growth occurs by informal firms eventually becoming large formal establishments. We see that there the average 40 year old plant employs almost five times as many workers as the average plant that is five years or younger.

First we use survey data from 120 developing countries to examine the life cycle of plants (see figure 1).  The upward sloping size-age profile is pervasive in our sample of countries and the results are very robust.   In only less than 10 percent of the countries a plant that is 40 years or older is not at least as big as a plant that is younger than five years old.

Figure 1: Establishment Employment by Age — Sample Estimates in 120 Developing Countries

 Establishment Employment by Age – Sample Estimates in 120 Developing Countries

Second, we look at a developing country, India, more carefully.  Existing research by Hsieh and Klenow (2013) suggests that instead of growing, on average the surviving manufacturing plants in India shrink in size between ages 5 and 35 years. While their study does not look at formal and informal firms separately, in their paper Hsieh and Klenow also mention that these results hold even if they look at only the formal sector firms.  In contrast, when we study the life cycles of Indian plants, we still find that the average 40 year old plant in the formal sector in India is two to four times the size of plants less than five years of age, both when comparing contemporaneously and when comparing older and younger firms within the same cohort (see Figure 2).  It is only when we look at the informal sector (or the full sample firms since it is dominated by informal firms) we see that firms do not grow as they age.  This is consistent with the “dual economy view” where most firms in the informal sector are engaged in subsistence activities and growth occurs through the growth of formal firms.

Psssssst :  Why is bank stock falling?

Figure 2: Firm Size and Age in India — Sample Estimates

 Establishment Employment by Age – Sample Estimates in 120 Developing Countries

Source: ASI Data for following individual census years: 1983/84, 1989/90, 1994/95, 2000/01, 2004/05

So, Indian firms grow as they age as well, but just not as fast as US firms.  Why not? Institutional differences come to mind – differences in legal frameworks, financial institutions, labor and other regulations… But when we try to explain the significant variation in Indian firm life-cycle patterns over time by state-level differences in financial development, we don’t have much success.  This is true even after controlling for differences in labor regulations across states, capital intensity, and firms born before and after major reforms. We are continuing to work on this question, so stay tuned for more.

Further reading:

Ayyagari, Meghana, Asli Demirguc-Kunt and Vojislav Maksimovic, 2013, “Size and Age of Establishments: Evidence from Developing Countries,” World Bank Policy Research Working Paper, No.6718.

Hsieh, Chang-Tai and Peter J. Klenow (2013), “The Lifecycle of plants in India and Mexico,” Quarterly Journal of Economics, forthcoming.

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