Project Research Theme 0: Data, Measurement, and Conceptual Framing, Research Theme 1: Firms, Frictions and Spillovers, and Industrial Policy

Understanding the Role of Informal Firm Clusters for Productivity and Growth

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In developing countries, production is dominated by many small firms and studies typically find that average productivity is low, but productivity dispersion is substantial. These facts have been interpreted as evidence of significant misallocation due to factor market frictions. However, micro-level interventions experimentally reallocating resources or alleviating constraints have rarely led to transformational impacts on firm growth. This raises the question of whether the measured productivity dispersion is truly reflective of misallocation. Two important challenges to answering this question have been the scarcity of firm panels in sub-Saharan Africa and the fact that information on input use is typically available only at the firm level, which can result in substantial measurement error of the productivity estimates. This project seeks to improve the measurement of productivity and misallocation in developing countries by collecting a novel firm panel with detailed product-level information in one of the poorest areas of the world.

The research team will collect a three-wave panel data over two years on 1,000 manufacturing firms in urban Uganda operating in carpentry, metal fabrication, and grain milling. The measurement approach involves three key novelties: (i) product-level assignment of inputs to outputs; (ii) direct measurement of heterogeneity (quality) of inputs and outputs; and (iii) detailed recording of firm-to-firm interactions in informal clusters. Through combining production function estimation with structural modelling techniques, these data allow the team to improve the measurement of productivity dispersion and recover more precise estimates of misallocation, as well as to study the role of informal firm clusters in improving the allocation of resources.

As small firms are the primary source of employment in developing countries, identifying ways to increase their productivity is key to foster poverty alleviation. This project will speak directly to this policy challenge, by conducting counterfactual policy simulations to identify pathways to reduce market frictions and to leverage firm-to-firm relationships for spurring productivity. Through an ongoing relationship between the research team and in-country policymakers, in particular the Private Sector Development Unit of the Ministry of Finance, the project may help to inform industrial policy in Uganda, especially with regards to interventions to improve productivity in firm clusters, such as industrial parks or shared workspaces for SMEs.

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