New research explains why businesses in developing economies remain smaller and grow more slowly than their counterparts in advanced economies – pointing to regulatory hurdles, credit constraints, and measurement challenges as key culprits.
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Why are businesses in developing economies so much smaller than their counterparts elsewhere, and why do so many of them stay that way? In a new review, Marcela Eslava discusses what is known – and what remains a black box – about this puzzle, from regulatory hurdles and credit access to the surprising role that better data has played in reshaping the debate.
The scale of the difference is striking. According to Eslava, a worker in a developing economy is three times more likely than one in an advanced economy to be running or employed in a very small business, with self-employment representing the most extreme version of this pattern.
Some firms in developing economies do grow to be as large as major corporations elsewhere, but the odds of any individual entrepreneur reaching that scale are much lower than in richer economies.
Why growth is sluggish and firms hit walls
Firms in developing economies face both slower growth generally and specific barriers that can halt growth altogether. Limited and expensive access to credit, alongside more frequent and intense regulatory burdens, compound with a shallower pool of entrepreneurial talent and technology access to hold businesses back.
"It's more sluggish in general, and it's partly more sluggish because they hit those walls."
Even firms with strong productivity face an environment that makes both investing in further improvements and capitalising on them significantly harder than in advanced economies.
Why quality and market access matter more than cost efficiency
One of the review's more striking findings is that cost efficiency, while necessary, is far less important to a firm's ultimate success than quality and market access – a pattern that holds in both developing and developed economies alike.
"Cost efficiency is a precondition, but it won't make you the best firm in the world. However, if you do have the best product, if you do have the best way to get to the hearts of consumers, then that's what's going to make you really successful."
Eslava warns that an overemphasis on cost-cutting, particularly around labour, can be short-sighted both for firms and for the wider economy, since workers bear the cost of that narrow focus.
How regulation and labour costs distort firm growth
Distortions vary enormously by country, but labour market regulation is a recurring theme. Eslava points to Honduras, where up to 70% of workers earn below the minimum wage, illustrating how poorly calibrated policy can be to economic reality, while in other countries non-wage labour costs can nearly double the cost of employing someone.
"The crucial feature for governments to understand is that the package of regulations that firms face may end up being a true hurdle for how you translate your efforts to become more productive into actually hiring more workers."
She stresses that there are no easy answers: policies designed to help small firms, such as preferential tax treatment, can inadvertently penalise growth by raising the cost of becoming larger.
What stops firms from exporting
Exporting success is rarer in developing economies, partly because fewer firms reach the productivity threshold required, and partly because of weaker government capacity around customs processes and limited market knowledge among entrepreneurs.
"The mindset to not only export but to grow is one of the lacking parts."
Eslava notes that e-commerce platforms have lowered some of these barriers over the past 15 years, though she cautions that easier routes to export may not deliver the same productivity and growth benefits as more traditional, effortful market entry.
How researchers have improved their ability to count small firms
A particularly revealing part of the conversation concerns measurement. Older data appeared to show firms in developing economies were larger on average – a finding now understood to reflect the fact that only large, registered firms were visible to statisticians, while micro and informal businesses went uncounted.
"The firms that were showing up in the numbers... were the very exclusive selected class of the firms that were already large in these economies."
Improvements in business censuses and, crucially, household and employment surveys – which capture self-employed individuals and micro-enterprise workers who never appear in firm-level registries – have given researchers a much fuller picture of the true size distribution of firms.
What drives informality and micro-enterprise
Informality and micro-entrepreneurship, while closely linked, are driven by a mix of factors: personal preference for flexibility and autonomy, lower underlying productivity, and the practical incentive to avoid the costs and regulatory burdens associated with formal growth.
"All of those things that make it costly to grow are incentives to stay smaller, and in many cases, smaller means micro. And a way to not only make that less heavy but just sidestep it completely is to stay informal."
Understanding this mix matters for policy, since interventions aimed at one driver may do little to address the others. Despite significant advances, much about these dynamics remains unexplained by current models, and researchers continue working to isolate the effects of specific regulatory hurdles from the broader package of constraints firms face.
Reference
Eslava, M (2026), "Firm size and dynamics in less-developed economies," Annual Review of Economics, 18.