Firms in low and middle income countries tend to disproportionately be small in size compared to firms in high income countries, driven by high rates of self-employment. What explains this empirical fact? The paper discusses existing evidence and promising paths for future research. We begin by summarising existing work investigating the role of capital constraints as a primary explanation. We then discuss theories beyond credit constraints, such as monitoring costs and demand structure, that could lead to small firm sizes. Finally, we suggest directions for future work that expands on the rich literature studying the effects of interventions that aim to reduce barriers to firm growth. We identify frictions in managerial labour markets as another interesting direction for research focused on barriers to growth among SMEs. However, we also suggest research directions that examine the possibility that micro-entrepreneurship may be an optimal response to frictions that may not directly affect SMEs, but make finding wage labour more difficult.
Pathfinding Paper • Research Theme 1: Firms, Frictions and Spillovers, and Industrial Policy, Research Theme 2: Labour, Home Production, and Structural Transformation at the Level of the Household