# **Section 1: Why Do Management Capabilities Matter?**

The persistence in productivity differences between firms, within the same industry, is striking and puzzling. For example, labor productivity for plants in the 90<sup>th</sup> percentile, within narrowly defined four-digit US manufacturing industries, is four times as high as plants in the 10<sup>th</sup> percentile. Likewise, the difference in Total Factor Productivity (TFP) is twice as high, when controlling for other factors (Syverson, 2011). These differences persist over time and are robust to controlling for plant-specific prices in homogeneous goods industries. Such TFP heterogeneity is not an artifact of the US data; it is also evident in several other countries. It is well-known that variations in productivity trump any other source of heterogeneity in firm performance: in the United States, firms in the 90th percentile of the productivity distribution produce twice as much with the same set of inputs as firms in the 10th percentile, whereas in China and India this gap is 5:1 (Hsieh and Klenow 2009). Often such within-industry productivity differentials are attributed to “hard” technological innovations, as embodied in patents or in adoption of advanced equipment. Bloom et al. (2016a) provide an alternative explanation, which is also the focus of this paper, that is, productivity differences reflect variations in management practices.

Bloom et al. (2016a) propose that some forms of management practices are like “technology”, in the sense that they raise firm productivity. Bloom and co-authors have significantly advanced the empirical foundations for measuring management practices across firms and countries, which has allowed core theories in many fields such as international trade, labor economics, industrial organization and macroeconomics to incorporate firm heterogeneity as a central component. While a frontier topic globally, there exists little evidence on managerial practices of firms in Croatia and the relationship between management and productivity. Nevertheless, there is some evidence on management in countries from the Europe and Central Asia region, where Bloom et al. (2011) find a strong association between managerial practices and firm performance.<sup>1</sup> To quantify the importance of management for the performance of firms in Croatia, and particularly in Eastern Croatia, we conducted a survey on firm capabilities in Croatia, which includes the following modules: (i) Working Time, Employed Personnel and Remunerations; (ii) Training; (iii) Business Capabilities and Entrepreneurship; (iv) Government Programs and Funding; (v) Global Production Chains; (vi) Science, Technology and Innovation and (vii) Access to Finance.

This study analyzes the outcomes for Eastern Croatia along several dimensions of firm performance, including not only labor productivity, total factor productivity (TFP) and profits, but also outcomes relating to average skill intensity, training, innovation and technology adoption. These outcomes are evaluated with management capabilities being the centerpiece, that is, we associate all the measures of firm performance with the adoption of structured management practices.

How are structured management practices measured? The survey module on Business Capabilities and Entrepreneurship includes 15 core questions of the US Census Management and Organizational Practices Survey <u>(MOPS) main module. The survey was deliberately designed to replicate the US Census MOPS to maximize</u> comparability with the United States as well as other countries where this survey has been conducted (e.g., the United Kingdom, Canada, the Russian Federation and Mexico). We exploit the survey data on 585 small and medium enterprises (SMEs) in the manufacturing and services sectors. Of these 585 firms, 145 firms are from Eastern Croatia. The survey was conducted from January 2019 to June 2019. The FINA database provides the sample frame for this survey, where the sample was stratified by region and sector.<sup>2</sup> Firms were randomly sampled and interviewed face to face. Firm responses to questions on managerial practices are aggregated into a single management score,

> 1 In 2008 and 2009, the European Bank for Reconstruction and Development (EBRD) in cooperation with the World Bank (WB) conducted a new survey, the EBRD-WB Management, Organization and Innovation (MOI) survey.

> 2 The Financial Agency (Fina) is the leading Croatian provider of financial data services. The database comprises of all tax registered firms in Croatia.

2