Table 16 shows the regression results using this generated variable as a control for the stringency of current labor regulations. Medium size firms are the least growing firms relative to micro firms. Interestingly, the coefficient of this IC variable is positive and significant. This could mean that firms that grow faster complain more about labor regulations. The second column in the table includes interaction terms with size classes. The coefficient of labor regulation loses significance and the interaction terms are not significant as well<sup>14</sup> .

To provide further support to the significance of access to finance for firm growth, we used principal component method. First we determined the principles of the IC variables that measure access to finance. The first regression uses six of the seven IC variables that are related to access to finance in Table 11. The excluded variable is the use of collateral. Collateral variable is included in the second estimation<sup>15</sup> . Since very few firms answered the question for collateral usage, the sample size in the second regression is much smaller. The principal component analysis allows me explain the overall effects of variables representing access to finance. In the regressions, we only included the first component. Higher ranked components didn’t have significant coefficients. In both regressions, access to finance contributes positively to growth and medium size firms grow significantly less than micro and large firms.

# **7. Policy Evaluation and Conclusion**

In this study, we analyze how firms evolve in Turkey. A well established fact on firm evolution is that the growth rate decreases in size and age. Analyzing a recent firm level dataset from Enterprise Surveys, we show that the growth rate decreases in a non‐monotonic way in Turkey as size increases. Comparison of evolution of Turkish firms with several comparator countries in the ECA region shows growth rates of SMEs are significantly lower in Turkey than the firms at the same size group in comparator countries. One possible explanation for why SMEs grow less goes in line with the discussions of missing middle hypothesis. There are several studies which discuss this issue such as Gauthier and Gersovitz (1997), Sleuwaegen and Goedhuys (2002), and Van Biesebroeck (2005). They argue that existing policies and regulations can be more distortive to SMEs than micro and large firms. As a result, these firms might have difficulties evolving into larger firms.

From a policy perspective, development of efficient institutions that improve functioning of markets is crucial for firm growth. Reforms that focus on improving opportunities and incentives for SMEs to grow can be productive for these firms to catch up with their counterparts in other countries in the region. It is important to implement policies that promote economic activity by these groups of firms. The analysis performed in this study shows that among all measures of investment climate increased access to finance stands out as an important contributor of firm growth. The firms that finance their investments through external sources and that have a line of credit or a loan from a financial institution grow faster in Turkey. This finding is robust to alternative definitions of firm growth and when the analysis is performed with the panel data alleviating the endogeneity problem. This strong

> 14 I perform the same analysis using 3 size groups as an alternative. The results are quite similar.

> 15 For all variables but collateral, higher values should lead to higher growth. To be consistent with this definition, I multiplied collateral variable with ‐1 and then included in the principal component analysis.

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