Firm size and productivity gaps in the EU
Small mid-caps could benefit from more proportionate regulation that facilitates the scale-up of Europe’s productive sector, an idea which the Draghi report stressed in order to regain global competitiveness.
The European Commission proposed in May the definition of a new business category based on size, the so-called «small mid-caps». These firms, with between 250 and 750 employees and an annual turnover ranging from 50 to 150 million euros, are in the transition phase between medium and large enterprises. The aim is to allow them to benefit from more proportionate regulation that facilitates the scale-up of Europe’s productive sector, an idea which the Draghi report stressed in order to regain global competitiveness. The smaller average firm size of is particularly pronounced in certain EU countries, such as Greece, Italy, Portugal and Spain. In this article, we focus on how this distinctive feature may relate to productivity disparities, with which firm size is positevely correlated.
The positive association between size and productivity
Differences in productivity between countries can be either due to divergences in the general efficiency conditions of an economy, such as the institutional or legal framework, or related to productive structures with different characteristics, whether at the sectoral or corporate level.1 Through a simple statistical decomposition analysis, we can approximate the contribution of each of these elements to the differences in productivity between individual European countries and the EU as a whole (see first chart).2 For example, within the four major economies, Germany and France show a similar profile: their productivity per person employed3 exceeds the European average thanks to a higher concentration of larger firms than in the rest of the EU, and this is a factor associated with higher productivity (see second chart).4
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See, among other references: E.J. Bartelsman and M. Doms (2000), «Understanding productivity: Lessons from longitudinal microdata»; M.J. Melitz (2003), «The impact of trade on intra-industry reallocations and aggregate industry productivity», and D. Restuccia and R. Rogerson (2017), «The causes and costs of misallocation».
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A country’s productivity can be expressed as the average productivity in each sector-firm size pair weighted by the number of employees in that pair. Thus, the productivity gap between two countries can be broken down into the contribution of the differences in: (i) the percentage of employment by firm size within a sector, (ii) the percentage of employment by sector and (iii) the productivity level for each sector-firm size pair. The full formulation can be found in chapter 7.2 of P. Bauer et al.(2020), «Productivity in Europe: Trends and drivers in a service-based economy».
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According to the Eurostat definition, the number of persons employed in a company includes employees, owners and partners who work in the business, as well as unpaid family members working in the business.
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The debate on causality between firm size and productivity remains open and references in both directions can be found. For instance, the study by E. Moral-Benito (2016), «Growing by learning: firm-level evidence on the size-productivity nexus» argues for Spain that low productivity growth is behind the fact that the distribution is skewed towards smaller businesses and not vice versa.
On the other hand, this factor has a negative contribution in Spain and, especially, in Italy. In the case of Spain, the sectoral composition of the economy is also unfavourable, while in Italy the greater relative weight of smaller (and thus less productive) businesses is offset by general productivity levels that exceed those of the EU as a whole. Among other Member States, Portugal and Greece stand out, as all three of these components – sectoral structure, firm size and overall efficiency – make a significant contribution to explaining their notably lower productivity relative to the European average.
Large and manufacturing firms as key drivers of innovation
A standard measure of firm size is the ratio between the number of persons employed and the total number of companies. However, this metric introduces a considerable bias when there is a significant presence of self-employed workers or micro-enterprises in the productive sector, skewing the focus towards the lower end of the distribution. An alternative approach, which is also consistent with the productivity decomposition analysis discussed above, is to calculate the average size weighted by the percentage of persons employed in each category, as this brings us closer to the economy’s actual productive capacity. As an example, if an economy has 100 companies with one worker and one company of 100 workers, the first measure would give us an average size of 1.98 and the second, of 50.5; a substantial difference.
For the countries analysed above, France has the highest weighed average firm size, with 750 persons employed, followed at some distance by Germany with 530 and Spain with 400. The figure is below 300 in Italy and Portugal, while Greece ranks last, with less than 150 (see third chart). There are also significant differences by sector, with administrative and ancillary services, transport and logistics, and information and communication services showing a notably higher figure than average. At the other end of the spectrum, firm size is generally smaller in construction, hospitality and professional and technical activities.5 In terms of the cross-country dispersion within sectors, the biggest differences are found in the manufacturing and transport services sectors, with Germany and France showing an average firm size that is more than double those of the other Member States in question. In these cases, it seems that the larger size of these economies make it possible to exploit the importance of scale in the two sectors.
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Regarding the differences in average firm size by sector, see G. Berlingieri, S. Calligaris and C. Criscuolo (2018). «The productivity-wage premium: Does size still matter in a service economy?», AEA Papers and Proceedings.
In the case of manufacturing, beyond the positive association between size and productivity we demonstrated earlier, the divergence in firm size also has implications for innovation and technological progress for the economy as a whole. This is because the percentage of value added that firms spend on research and development varies substantially according to their size, with the greatest jumps occurring between the micro-enterprise and small business segments, as well as between the medium and large segments (see fourth chart). For the EU as a whole, large firms are responsible for two thirds of all R&D spending, with around 80% of funding coming from the business sector itself and with manufacturing being the top investing sector (60% in the EU and over 80% in Germany).
In search of the right tools for scaling up
The positive association between firm size and productivity gives support to the goal of reducing the regulatory burden, as proposed by the European Commission in May, in order to facilitate the scale-up in the productive sector, by softening the differential impact of regulations depending on the size of the company.6 Beyond this element, and in the light of the stark differences that persist between Member States, as well as for the EU as a whole with respect to the US, this step should be supplemented with an additional battery of measures at the national and EU level. One of the key factors identified as influencing the distribution of companies by size is the role of the institutional framework, with judicial and government efficiency being a particularly favourable factor for boosting firm size, and even more so in the case of innovative and capital-intensive activities.7 In this regard, countries with a greater relative weight of small businesses score lower in indicators related to aspects such as regulatory quality and the protection of property rights.8 On the other hand, at the EU level, following the path laid out by the Letta and Draghi reports, one of the top priorities highlighted in the Competitiveness Compass presented by the Commission in January is to pursue further integration of the single market, including capital markets.9 Removing the obstacles that encourage their fragmentation would favour cross-border activity among European companies and facilitate a jump in scale that is crucial in order for some sectors to compete globally. Behind this element is also the ongoing debate in the EU regarding a possible revision of competition rules, in which the political discussion will seek a difficult balance between efficiency and well-being.
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See N. Guner, G. Ventura and Y. Xu (2008). «Macroeconomic implications of size-dependent policies», Review of Economic Dynamics, volume 11, chapter 4.
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See K.B. Kumar, R.G. Rajan and L. Zingales (1999). «What determines firm size?», NBR, Working Paper 7208.
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P. Bauer et al. (2020), «Productivity in Europe: Trends and drivers in a service-based economy», includes, in chapter 7.2, an analysis with multiple institutional variables and different definitions of firm size.
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See the Focus «A shift in the EU’s political priorities» in the MR04/2025.