Why Do Firms in Developing Countries Have Low Productivity?

In summary, we find evidence that firms in developing countries are often badly managed, which substantially reduces their productivity. This appears particularly important in larger firms (100+ employees), which are operationally complex so that effective coordination and motivation require formalized management practices. We also find that financial constraints are a binding factor for growth, notably in smaller firms. In larger firms, which often appear to have already overcome financing constraints, another growth constraint arises in the inability of firms to successfully decentralize decision making. In developing countries owners tend to make almost all major management decisions because of fears of expropriation by their managers. But, because the owners’ time is limited, they have the capacity to make decisions for firms only up to a certain size. Thus, without delegating decision-making these firms find that growth becomes unprofitable, or even impossible, because decisions are constrained by their owners’ time. This suggests that the results of Eric Bartelsman, John Haltiwanger and Stefano Scarpetta (2009) and Chang-Tai Hsieh and Peter Klenow (2009) — that productive firms in developing countries like India and China do not expand as rapidly — due to a mix of financial factors (particularly for smaller firms) and organizational factors (particularly for larger firms).