Experiments in industrial policy

Readers of this blog know that I think firms are understudied in development. I’ve said before: the path from $2,000 a head to $10,000 a head in GDP is through industrialization.

But how to spur firm growth? Too many economists are too quick to throw up their hands and say we know nothing or can do nothing. And most of the formal industrial organization research feels completely alien to the issues that concern firms in poor countries.

One of the best sessions I saw at AEA is breaking the trend.

David McKenzie discussed a new experiment that provides temporary wage subsidies to owner-operated microenterprises in Sri Lanka, to hire their first employees and expand. The question: will these temporary subsidies lead to permanent growth and jobs?

Businesses might face fixed costs to hiring their first employee, either because they need time to generate the returns that will make the investment pay off, or because they need to learn how to be a manager. Subsidies might push firms across the cost hump (or reduce the risk of trying), leading to a rise in the level (or even the growth rate) of firm revenues. The results of this experiment are yet to come, but his series of firm experiments with Chris Woodruff and Suresh de Mel is one of my favorite suites of experiments around.

As much as fixed costs matter, the real barrier to firm growth in poor countries could be management. A good manager is partly one with training, experience, and a sense of best practice. A lot of a factory’s success comes down to management as a technology, though. Organizing a production floor, ensuring quality and efficient production: these are less a product of a single manager’s talent and more the product of decades of trial and error in manufacturing plants around the world. The problem: if you are running a firm in India or Mexico or elsewhere, the best practices probably haven’t filtered through.

Two papers looked at bridging the gap. Nick Bloom talked about an experiment (also with coauthors) with large textile firms in India. Some received expert operational consulting for a month. Others just a consulting visit. They found horrendous practices–disorganized factory floors, open garbage, little cleaning, no spare parts, lost tools, and little preventative maintenance—and pushed 38 best practices on their treatment firms. Two thirds of the practices were adopted and the majority seem to have lasted more than the first few months. The firms saw huge improvements in quality and profits.

Antoinette Schoar and coauthors did the same with smaller firms in Mexico (one with 1 to 250 employees). They too received subsidized consulting services, mainly sales, marketing and HR advising for owner managers. Again, sales and profits rose.*

What’s happening here? Why aren’t firms investing in knowledge that provides enormous payback? Several market failures are possible: credit constraints, absence of incentives, behavioral defects (like procrastination), to information that is too messy and inaccessible for non-experts to absorb, even if it’s available.

Even though the mechanism isn’t yet clear, the results suggest a lot of potential for industrial policies that provide short-term subsidies to address start-up costs, technology transfer and human capital. For a serious industrial policy, though, figuring out why the experiments work is probably more important than figuring out how well they work.

All in all, in light of yesterday’s comment on the meaningfulness of development research, all are great examples of the kind of research that matters.

*Sorry–public papers aren’t yet available for most of these presentations.