WHAT DETERMINES THE GROWTH OF SMALL AND MEDIUM SCALE INDUSTRIES: ADYNAMIC PANEL STUDY Evidence from Northern Part of Ethiopia (Tigray Region)

Abstract

This study examines what determines the growth of small and medium sized firms (SMEs) in Ethiopian manufacturing industry particularly in Northern part of the country. The study uses dynamic panel data and System GMM estimation to control for the effect of unobserved heterogeneity and endogeneity in the firm growth-size relationship. The study attempted to address the potential problem of endogeneity and unobserved firm’s heterogeneity using System GMM. It also addresses the statistical concerns in growth-size models such as sample selection bias and regression fallacy using OLS. The empirical results show that size is inversely related to firm growth, implying that smaller firms grow faster than larger firms. The growth and size relationship is robust irrespective of the change in firm size and age coverage as well use alternative growth model and regression to the mean. Thus, Gibrat’s Law is decisively refuted. Both the labor productivity and skill affect firm’s employment and out-put growth with robust level of significance, and thus entails skill engenders efficiency and it eventually brings productivity. Capital influences growth rate positive when it is working capital, and negative while fixed capital. The negative relationship between capital deepening and growth rate suggest that either the SMEs substitutes capital for labor or produces under capacity in terms of employment and added value growth model respectively. The two growth models, employment and added value, brings the same results except slight magnitude differences. Hence, firms are higher elastic for out-put growth than employment growth for their size and availability of liquid asset. From policy perspective, Government’s policy making efforts in combating the poverty, the unemployment and stimulating income generation should be reinforced by promotion of firms which grow faster (small firms) as those will contribute more to employment generation and added value.