# **Analytic Framework**

The analytic framework draws upon a new empirical literature that seeks to explain the growth of productivity among firms.<sup>20</sup> In his review of this literature, Syverson (2011) points out that there is broad consensus among researchers about the existence – within narrowly defined industrial sectors – of a pervasive dispersion in productivity levels across firms using the same measured inputs. This within-sector dispersion is much larger than mean productivity differences between sectors. While large in high-income countries, this productivity dispersion across firms in the same sector may be even larger in developing countries.<sup>21</sup> Productivity-level differences across firms also appear to persist over time, suggesting either that firms have persistent (but unobserved) heterogeneous productive capabilities or, alternatively, that their productivity levels may differ as a consequence of their responses to uncertain demand.

The challenge for research is to unpack this productivity “black-box” to explain what drives differences within and between sectors and how firm responses can give rise to different outcomes. Research has focused on employer responses to two broad sets of demand drivers: one from firmspecific productivity attributes and another from competitive pressures affecting numerous firms, such as trade and technological changes (Syverson, 2011). Employer responses to the first set comprise individual firm-level strategies such as the introduction of new management practices (Bloom and van Reenen, 2010), in-service training programs (Dearden, Reed and van Reenen, 2005; Tan and Lopez-Acevedo, 2003) and investing in ICT or new equipment and machinery (Bartel, Ichinowski and Shaw, 2007). These factors are under the control of the firm. Employer responses to the second set of factors focuses on strategies adopted by many firms to align with broad demand shifts affecting production and the structure of whole or multiple sectors, such as trade liberalization (Pavcnik, 2002) or technological change (Bloom, Draca and Van Reenen, 2015). These factors do not directly affect productivity, but the competitive pressures that accompany them may elicit responses from firms (such as those described above) that do. How firms respond can determine their position in the productivity distribution, whether they move up the productivity ladder and grow or fall back and exit.

Taken together, these firm responses to the two demand drivers, together with new firm entry, are thought to be the key drivers of productivity dispersion within and between firms and, more broadly, productivity growth. These two sets of demand drivers also affect skills demand and the

> 20 The earlier productivity research, which relied on aggregate sectoral data, implicitly assumed that firms were homogeneous and experienced the same productivity growth profile as the aggregate sector. The recently available firm-level data indicates that this assumption is untenable. Research using  firm-level panel data points to considerable heterogeneity in productivity among firms even in narrowly defined sectors, and provides insights into how productivity evolves through a dynamic process of new firm entry and growth of more productive firms, and exit of less-productive incumbent firms.

> 21 Measuring within-industry productivity dispersion at the 90th and 10th percentile, Hsieh and Klenow (2009) find productivity differences of 5 to 1 in China and India as compared to 2 to 1 in the U.S.

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