# **1 Introduction**

In the quest for explaining the drivers of the observed wide gaps in total factor productivity across countries, a large and growing literature has emerged focusing on cross-country differences in the size distribution of manufacturing firms. A conjecture in part of this literature is that the size distribution of firms in developing countries exhibits a "missing middle" that reflects market frictions and policy distortions that discourage production at an intermediate scale; thereby reducing aggregate productivity. However, the literature evaluating this hypothesis has not yet been conclusive. Tybout (2000) and Tybout (2014) document a lower employment share accounted for by middle-sized firms in low-income countries, while Hsieh and Olken (2014) argue against the missing middle providing an adequate characterization of the firm-level data in these countries.<sup>1</sup> In this paper, we revisit the missing middle hypothesis by exploiting a set of comprehensive firm-level databases from four Sub-Saharan African economies, a region where some of the underlying frictions and distortions are arguably most likely at play (see for example Cirera et al., 2019). One challenge when characterizing the "true" distribution of firms in developing countries is lack of firm-level data covering the informal sector since businesses operating informally often do not appear in official registrar records (Aga et al., 2022). To this end, we compile detailed and comprehensive censuses of establishments including informal producers in four Sub-Saharan African countries, namely Burkina Faso, Cameroon, Ghana, and Rwanda.<sup>2</sup> A unique advantage of these datasets is that they cover all businesses in the non-agriculture sector with a physical location, including both formal and informal (unregistered) firms. Each dataset provides information on the establishment’s registration status with various government agencies and its bookkeeping practices. This information is used to construct comparable definitions of informality across countries and assess the robustness of the results to alternative definitions. A limitation of this data, on the other hand, is the lack of financial information about the establishment, restricting our definition of size to the number of employees and forbidding any measurement of productivity at the firm level.<sup>3</sup> The analysis of the data shows a missing middle in the employment-based size distribution of firms and proceeds to deconstruct it into its potential drivers. The main finding is that the missing middle emerges only under the inclusion of informal establishments in the economy. Restricting the analysis to formal firms leads to a lower average size than in advanced economies but a shape of the size distribution that resembles qualitatively that in the U.S. A first conclusion to be drawn from this result is that imperfect coverage of the informal sector may lead to omittin the missing middle. The second conclusion, to be reinforced below through other elements of the deconstruction, is that the missing middle is informative of the mechanisms through which distortions manifest in the economy. In particular, it points toward distortions that reduce average formal-sector size

> 1 Further details on the specific findings from these authors are provided in section 2.

> 2 The choice of these countries is primarily dictated by the availability of comprehensive firm-level data covering both formal and informal firms.. Furthermore, in this paper, the terms establishment, enterprise, firm, plant, and producer are used interchangeably unless otherwise indicated.

> 3 The data do not allow decomposing formal and informal employment within a formal firm, an intensive margin that was highlighted as important in Ulyssea (2020) and Ulyssea (2018). Notice, however, this distinction does not affect the observation of a missing middle, but may interfere with the inference of it not being present in the size distribution of formal employment.

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