The bigger the better: Using lotteries to identify the allocative efficiency effects of firm size

  • Governments around the world provide economic incentives to small and medium-sized enterprises (SMEs). SMEs are typically favoured in tax and regulatory policy and are often targeted in public procurement and business development programmes. Such policies are based on the belief that SMEs need help to grow out of inefficiently small sizes.
  • Public procurement spending, in particular, provides a promising instrument for policymakers to direct resources to targeted sectors of developing economies. The positive demand shocks induced by public procurement could potentially facilitate firm growth and efficiency gains.
  • After a significant overhaul in Ecuador’s public procurement legislation in 2009, public contracts for certain kinds of smaller construction projects are allocated to competing firms through a lottery system.
  • The findings in this study suggest that random lottery winnings lead to substantial increases in firm scale in the short run and expansion is achieved by employing more inputs.
  • Further, while the estimated effects on firm scale are large, there is no crowd-out of sales to non-lottery activities. However, this growth is not sustained in the long-run. Viewed through the lens of a theoretical model, this finding suggests that firms in the study face distortions that become increasingly cumbersome as they grow