while concentrating employment in small-sized businesses through the proliferation of an informal sector rather than through a reallocation from the middle to the bottom of the formal sector’s size distribution.

A second step in the deconstruction of the missing middle is to assess whether it is observable in the size distribution of entrants. A plausible conjecture regarding firm demographics in developing countries is that it is characterized by little growth and turnover of firms, a feature that would motivate the missing middle to emerge at entry. Our evidence refutes this conjecture, as it shows a size distribution of entrants where the employment share of the largest firms is significantly lower than in the whole economy’s distribution. Rather, our data shows the growth of the right tail and a depletion of the middle as an outcome of growth and churning in the formal sector over the course of the life cycle. Inspecting the size distribution of firms across various cohorts, we find that the formal firm size distribution reallocates employment from the bottom to the top of the distribution as the cohort ages, whereas the informal firm size distribution remains rather stable. The missing middle, then, is an outcome of stagnant informal businesses and growing formal producers conditional on survival.<sup>4</sup> The last two steps in the deconstruction involve assessing the role of state and foreign-owned enterprises in accounting for the employment share at the top. Also motivated by the conjecture of little growth and turnover of firms in less developed countries, a plausible explanation for the employment concentration among large firms may be attributed to state and foreign-owned enterprises. Able to circumvent domestic distortions hampering firm growth, these enterprises stand out as prominent large employers in the economy. The data, however, attributes a weak role to this channel. Even conditioning on domestic and private firms, a missing middle emerges in the data.

Another key component in the deconstruction of the missing middle is the role of entry barriers and productivity-dependent idiosyncratic distortions in explaining the missing middle and its driving forces. To this end, the paper extends a standard model of firm dynamics and feeds it with calibrated values of entry barriers and idiosyncratic distortions using the Ghana’s census of manufacturing firms covering the universe of formal establishments. The calibration strategy of distortions follows the approach in Fattal-Jaef (2022). The productivity-elasticity of idiosyncratic distortions is calibrated as the regression coefficient from projecting between _logTFPR_ and _logTFPQ_ , defined as in Hsieh and Klenow (2009), and the entry barrier is inferred residually so that the distorted economy’s average formal firm size replicates the Ghanaian economy.

Equipped with these estimates of the distortions, a model of firm dynamics with endogenous informality is proposed to characterize their implications for the firm-size distribution and aggregate outcomes. The model treats formal and informal goods as imperfect substitutes. Consumers confront a nested constant elasticity of substitution demand system combining baskets of formal and informal varieties. There is endogenous entry to the formal and informal sectors. Upon entry, formal producers are endowed with an endogenous innovation technology that shapes growth over their life cycle. The informal sector’s productivity evolves exogenously. Both supply and demand side forces interact in shaping the economy’s response to the distortions. When these are introduced,

> 4 The inference on the life-cycle properties of the firm-size distribution is limited by the cross-sectional nature of the data, which do not allow disentangling the role of firm growth from the role of survival in explaining the rise of the right tail

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