What is new in the research on Firms, Trade, and Development?

Firms affect poverty and economic growth in low- and middle-income countries (LMICs) not only through their output but also because of their role as employers. For example, manufacturing firms affect the economy both through the products they produce and because they provide wages and other services for employees.

Working for a firm can often generate higher incomes than achievable through a microenterprise or agricultural production. This role of firms as employers is important for LMIC households with limited resources, since their time may be the primary – if not only – asset to generate earnings, especially for non-agricultural households. And moving workers from agriculture to firms can have broad economy-wide benefits as the key to structural transformation.

Understanding labor market outcomes, including firms’ role as employers and the determinants of labor supply and productivity, has important implications for both the livelihoods of low-income people and economic growth. These topics will be at center of discussions at the Firms, Trade, and Development Conference 2024, co-hosted by the Economic Growth Center and the International Growth Centre at Yale University on October 24 and 25, with a live Zoom simulcast.

Looking at some of the exciting research that will be presented at the conference, four key insights emerged. In my discussion below, I provide links to the presenters’ websites and to working paper versions that are available online. Some drafts may be preliminary and change before conference presentations.

Firm choices influence the work environment and the incentives that workers face, with important implications for worker productivity.

Firms can make important investments that shape the work environment to improve worker productivity. Maulik Jagnani (Tufts University) and coauthors study how labor productivity responds to the installment of air purifiers in garment manufacturing firms in Dhaka, Bangladesh, where indoor air pollution is far beyond the World Health Organization’s safe limit. By comparing output from workers at firms that are randomly assigned to receive air purifiers with those that are not, they show that improvements to air quality from air purifiers improve productivity by 10%.

Deivy Houeix (MIT) emphasizes how digital technologies increase the ability of firms to monitor their employees’ effort. Studying the taxi industry in Senegal, he finds that randomized access to a digital payment technology, which allows taxi owners to observe driver behavior more easily, increases worker effort by almost 30% and changes contracts. But many of the poorest drivers choose not to adopt this technology unless visibility is curtailed.

Decisions by individual firms and workers that affect labor supply and productivity can affect others in meaningful ways, called externalities. In the absence of policy interventions, when firms and workers do not incorporate the effects of their actions on others in decision-making, markets can fail to maximize efficiency.

Yogita Shamdasani (National University of Singapore) and coauthors illustrate how habits shape labor supply. Specifically, individuals who work more – due to random exposure to work bonuses – increase future labor supply. Similarly, workers who encounter circumstances that lead them to exit the labor force, such as funerals, reduce subsequent labor supply. It follows that individual firms do not capture the full benefit of providing employment opportunities. Current work opportunities increase future labor supply, which also benefits other firms, generating a positive labor-supply externality. Therefore, the levels of work and wages resulting from individual short-term decision-making may be lower than what would maximize long-run economic gains.

Studying food delivery workers in urban China, Yulu Tang (Dartmouth) quantifies two important externalities of geographic clustering. First, productive knowledge transfers are concentrated among workers from identical hometowns – a positive externality. Second, congestion from workers simultaneously increasing labor supply in response to adverse hometown events, such as floods, reduces wages during this time of need – a negative externality. As workers do not individually consider these positive and negative externalities when choosing their work location, clustering of workers can be suboptimal.

The business environment can also directly affect workers and labor productivity. Due to challenges in identifying far-away trading partners, limited information about other firms, and other factors, many LMIC firms only sell locally. Even though firms might sell only locally, they often need a full “unit” of labor (or capital) to make even one sale, as highlighted by Tilman Graff (Harvard University) and coauthors. For example, a retail shop always needs at least one worker, even for stores that are mostly empty. This “integer problem” (i.e., that some decisions require a full next unit) can leave resources, including labor, underutilized, adversely impacting productivity.

Wei Qian (Haverford College) and coauthors illustrate that geographic integration of economic activity affects labor supply and productivity. On the one hand, improved integration enables firms to expand and access new demand. However, increased competition can close firms, restraining movement from low-productivity subsistence agriculture. On the other hand, increased access to agricultural products for consumption from elsewhere can release labor from the agricultural sector, increasing non-agricultural employment. Empirical analysis of major highway constructions in India and China shows that both forces matter. In India, where the agricultural share was relatively low, the first channel dominates, while the opposite occurs in China.

Workers’ characteristics, both in terms of their assets and knowledge (i.e., both physical and human capital), can affect the performance of the firms they work for. In LMICs, where firms may face challenges in acquiring their own assets or training workers, these worker features might be especially important.

Jiayue Zhang (Brown University) and coauthors highlight that many LMIC workers bring productive machinery (“capital”) to work: some garment workers bring sewing machines and some carpentry workers bring wood planers. When some workers are randomly assigned to receive capital from a cash transfer, worker productivity increases. Suggestive evidence highlights that productivity improvements may reflect firms responding to the capital by increasing revenue-sharing. Then, workers increase effort because of the improved alignment of incentives. It follows that firms could benefit by helping workers access capital, such as dedicating some of a worker’s compensation to it. And, because of overall productivity gains, the firm and worker could both gain if the firm subsidizes access to capital.

Finally, how does low-skilled immigration from a high-income country to a LMIC affect firm productivity? Daniel Osuna-Gomez and a coauthor study the effects of US deportees to Mexico on firm behavior. They find that firms in areas with more deportees benefit relative to comparison firms: they report higher survival rates and average revenue. Firm benefits increase in the US tenure of the deportees point towards the benefits of knowledge and financial cross-border transfers from workers to firms.

I propose four key takeaways:

1. Policymakers should consider targeting barriers that limit firms’ adoption of technology and practices that improve productivity. Such barriers may include limited knowledge of the existence of certain technologies and practices, or their benefits, as well as financial or other implementation barriers that firms face.
2. Policy design should mitigate externalities. For example, when habit formation has large labor supply effects, wage and work subsidies could counteract suboptimally low levels of work. Similarly, providing access to insurance can help workers respond to negative events without causing congestion externalities.
3. While geographic integration can spur economic growth through many channels, it also redistributes productive resources and opportunities. Policies can help those adversely affected by integration gain access to resources to offset losses.
4. As firm and worker productivity can depend upon many features of the employer-employee relationship and match, policymakers should evaluate how to best support firms and workers to access assets and knowledge that improve productivity.

This article was published in collaboration with the International Growth Centre (IGC) to set the scene for Firms, Trade, and Development 2024. The cover image shows garment factory workers in Dhaka, Bangladesh, March 2023. Photo by Nazmul Islam.