The impact of ethnic fractionalisation on labor productivity: Does firm size matter?

Ethnic fractionalisation has both positive and negative consequences. We contend that the positive effects of skill complementarity in the production process apply to large firms. Because small businesses rely more on public goods and have less access to institutions, the negative effects of lower quality public goods and higher transaction costs have a greater impact on them. Consistent with this viewpoint, we find that larger firm size significantly mitigates the negative impact of higher ethnic fractionalisation on the level and growth rate of labor productivity in manufacturing firms across 84 developing countries. Evidence on the potential mechanisms is provided.