Factor Substitution, Average Firm Size and Economic Growth

Abstract

ABSTRACT. This paper extends the Lucas (1978, The Bell Journal of Economics 9(2), 508-523) analysis of firm size by taking into account a normalised aggregate CES production function. In a general equilibrium framework it is proved that there is an inverse relation between the elasticity of substitution and average firm size. If interpreted together with the fact that richer countries are characterised by a higher elasticity of substitution, this result can explain why the recent literature finds a positive association between the importance of SMEs in an economy and its stage of development, but seems to fail in finding causality between the two. Both have a common origin: a high value of the elasticity of substitution. This paper also provides a first empirical test of the theory proposed using crosscountry data from both developed and developing countries.KEY WORDS: average firm size, general equilibrium models, neoclassical growth models, CES function.JEL CLASSIFICATION: C65, E13, L11.

The Philosophical Foundations of a Radical Austrian Approach to Entrepreneurship

“…Neoclassical economists, following the path blazed by Leon Walras, are positivists: They assume an objectively "real" world that exists independent of entrepreneurs' Kihlstrom & Laffont (1979), Evans & Jovanovic (1989), Evans & Leighton (1989), Douglas & Shepherd (2000, Bianchi & Henrekson (2005), Aquilina et al (2006) Mostly quantitative/statistical/ variance methods; some qualitative/variance methods Kaish & Gilad (1991), Busenitz (1996), Venkataraman (1997), Zaheer & Zaheer (1997), Ferrier et al (1999, Shane (2000), Shane & Venkataraman (2000), Gaglio & Katz (2001), Demmert & Klein (2003, Gaglio (2004) Mostly quantitative/statistical/ variance methods; some qualitative/variance methods Guth & Ginsberg (1990), Meyer et al (1990Meyer et al ( , 1993, Shane (1996), Tripsas (1997), Venkataraman (1997, Ferrier et al (1999) …”

“…Adopting this approach, entrepreneurship scholars have examined a range of phenomena from firm formation based on risk aversion (Kihlstrom & Laffont, 1979) to entrepreneurial choice under liquidity constraints (Evans & Jovanovic, 1989) to entrepreneurship as a utility-maximizing response (Douglas & Shepherd, 2000). Although scholars still employ neoclassical models to understand entrepreneurship (Aquilina et al, 2006), most usefully at the aggregate level (Bianchi & Henrekson, 2005), these models suffer from a number of serious shortcomings. Among their most significant flaws, from a subjectivist perspective, is that they banish imaginative choice, human action, genuine uncertainty, and market dynamics from explanations of entrepreneurship.…”

“…In their empirical research, neoclassical scholars typically use multivariate regression analysis (Aquilina, Klump, & Pietrobelli, 2006;Douglas & Shepherd, 2002;Evans & Jovanovic, 1989;Evans & Leighton, 1989;Lucas, 1978) to test simple, bivariate relationships concerning such equilibrium phenomena as entrepreneurs' optimal level of start-up capital (Evans & Jovanovic, 1989) and their utility-maximizing decision of whether to be self-employed (Douglas & Shepherd, 2002). This methodological approach limits the scope of neoclassical inquiry to a fairly small domain of problems.…”

Entrepreneurship, economic development and institutions

“…Third, Aquilina et al (2006) have come to the conclusion that a high value of the elasticity of factor substitution not only leads to more per capita capital, but makes it at the same time easier for an individual to become an entrepreneur if the aggregate elasticity of substitution is also negative. In an economy characterized by higher values of the aggregate elasticity of substitution, we should expect a higher level of development, more entrepreneurs and smaller firms.…”

Capital/Labor substitution, capital deepening, and FDI

“…This production function was subsequently used by, among others, Klump and De la Grandville (2000), Klump and Preissler (2000), Miyagiwa and Papageorgiou (2003) and Aquilina, Klump and Pietrobelli (2006).…”