Finance, Firm Size, and Growth
Thorsten Beck, Asli Demirguc-Kunt, Luc Laeven and Ross Levine*
June 7, 2006
Abstract: This paper provides empirical evidence that financial development boosts the growth of small firms more than large firms and hence provides information on conflicting theoretical predictions about the distributional effects of financial development. Using cross-industry, cross-country data, the results are consistent with the view that financial development exerts a disproportionately positive effect on small firms. These results have implications for understanding the political economy of financial sector reform.
Keywords: Firm Size; Financial Development; Economic Growth JEL Classification: G2, L11, L25, O1
* Beck, Demirgüç-Kunt: World Bank; Laeven: International Monetary Fund and CEPR; Levine: Brown University and NBER. Corresponding author: Ross Levine, Department of Economics, Brown University, Providence, Rhode Island, 02912, Email: Ross_Levine@brown.edu. We would like to thank Maria Carkovic, Stijn Claessens, Bill Easterly, Alan Gelb, Krishna Kumar, Michael Lemmon, Karl Lins, Alan Winters and seminar participants at the World Bank, University of Minnesota, New York University, University of North Carolina, the University of Stockholm, Tufts University, and the University of Utah for helpful comments, and Ying Lin for excellent research assistance. We also thank Lori Bowan at the U.S. Census Bureau for help with the U.S. Economic Census data on firm size distribution. This paper was partly written while the third author was at the World Bank. This paper’s findings, interpretations, and conclusions are entirely those of the authors and do not necessarily represent the views of the International Monetary Fund, the World Bank, their Executive Directors, or the countries they represent.
Introduction Although research shows that financial development accelerates aggregate economic
growth (Levine, 2006), economists have devoted few resources to resolving conflicting theoretical predictions about the distributional effects of financial development. Some theories imply that financial development disproportionately helps small firms. If smaller firms find it more difficult to access financial services due to greater information and transaction costs, then financial development that ameliorates these frictions will exert an especially positive impact on smaller firms (Galor and Zeira, 1993; Aghion and Bolton, 1997)). In contrast, if fixed costs prevent small firms from accessing financial services, then financial development will disproportionately help larger firms (Greenwood and Jovanovic, 1990; Haber et al., 2003). Besides assessing theoretical disputes, political economy and public policy considerations motivate our study of the cross-firm distributional effects of financial development. If financial development affects small firms differently from large ones, then firms might disagree about the desirability of financial reforms. Even if financial development helps all firms, one set of firms might oppose financial reforms that diminish the group’s comparative power, which is consistent with influential work on the political economy of financial policies such as Kroszner and Stratmann (1998), Kroszner and Strahan (1999), Rajan and Zingales (2003), Pagano and Volpin (2005), and Perotti and von Thadden (2006). Rather than analyzing political lobbying by firms of different sizes, we examine whether financial development has cross-firm distributional effects. In addition, the World Bank pours about $2 billion per year toward subsidizing small firms, which further motivates our examination of the cross-firm distributional effects of financial development.
We examine whether industries that have a larger share of small firms for technological reasons grow faster in economies with well-developed financial systems. As formulated by Coase (1937), firms should internalize some...
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