High Entry Costs Reduce Productivity

It is common sense that if it costs a lot to start a new business, few businesses will start up. How high entry costs affect the productivity of existing firms is less obvious.

A new paper , by Levan Barseghyan at Cornell, looks at the effect of high entry costs on productivity and output. The main finding: "an increase in entry costs by 80% of income per capita, which is one half of their standard deviation in my sample, is estimated to decrease total factor productivity and output per worker by 22% and 29%, respectively." The analysis is done for over 100 countries.

The effect is quite large. It suggests that if Burkina Faso were to eliminate all entry costs (currently equal to 82.6% of income per capita, workers would be a third more productive. Why is that?

Three reasons. First, a lot of currently underemployed public officials will enter business. This finding is corroborated by Miriam Bruhn's paper on entry reform in Mexico.

Second, existing businesses will face stiffer competition and a need to be more productive. Bruhn, for example, finds that "competition from new entrants lowered prices by 1 percent and decreased the income of incumbent businesses by 3.5 percent."

Third, many informal businesses become formal and expand their operations. A recent paper by David Kaplan and others finds this to be the case. As informality in Burkina Faso is estimated at over 65% of business activity and 95% of the workforce, this effect may be the largest yet.