# **1. Introduction**

One of the most stylized facts in firm and industry evolution is that growth rates decrease as size and age increase. Dunne, Roberts, Samuelson (1989), Evans (1987a, 1987b) and numerous other studies have provided evidence on these regularities. Studies like Jovanovic (1982), Cooley and Quadrini (2001), Klette and Kortum (2004), Klepper and Thompson (2007) construct structural models that can explain these regularities. Basically, diminishing returns to scale or bounded efficiency can explain the negative relation between size and growth. Similarly, diminishing returns to learning can explain the inverse relation between growth and age. Jovanovic (1982) argues that firms learn their efficiency levels over time. Least efficient firms exit and more efficient firms adjust their scale of operations through learning. Hence small and young firms grow faster because they are in the initial process of uncovering their efficiency levels.

In this study, we investigate employment growth of firms in Turkey with an emphasis on small and medium size enterprises (SMEs). SMEs in Turkey play a crucial role in economic development. They account for 76.7 percent of employment, almost 40 percent of investments, 26.5 percent of total value added and 25 percent of bank credit. Moreover, a healthy SME sector is important to increase the resilience of the economy to economic shocks. Hence it is important to understand whether SMEs face any obstacles in their evolution and how does a better investment climate (IC) contribute to their expansion.

There are numerous factors that can affect firm growth. The levels of technology and human capital, the development level of the country, or the environment in which the firms operate are very crucial for growth. Especially for the developing countries where infrastructure, financial, or regulatory services don’t function smoothly, firms can be discouraged to grow. SMEs that may lack the capacity to cope with these distortions could be severely affected. Beck, Demirguc‐Kunt, and Maksimovic (2005) show that financial, legal, and corruption related problems distort firm growth. They also show that whether these factors affect growth depends on firm size and among all firms, small firms are the most constrained group. In a more recent study Aterido, Hallward‐Driemier, and Pages (2009), analyze how investment climate affects firm growth using a wide set of objective measures for obstacles. They show that poor investment climate hurts firm growth and the amount of distortion varies by firm size.

Using detailed firm level data from the recent Enterprise Survey<sup>3</sup> , we first analyze whether the stylized fact on the relation between growth, size, and age holds for Turkish firms. Analysis shows that there are some irregularities on firm growth rates. Medium size firms are the least growing group of firms in the economy. Then, we investigate whether the investment climate plays any role in affecting growth. Analysis shows that better access to finance significantly increases growth of firms. However, interaction of the IC variables with the firm size shows that the IC variables don’t have any differentiating effect on the growth rates of firms at different size groups.

The Enterprise survey was conducted in 28 other countries in the Eastern Europe and Central Asia (ECA) region in the same time period it was conducted in Turkey. This allows us to compare firm

> 3 See www.enterprisesurveys.org for the detailed description of the data and methodology used in sampling. The full dataset is available on this website.

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