Markups Dispersion and Firm Entry: Evidence from Ethiopia

This paper examines if and to what extent micro-level distortions affect structural transformation in a developing country by creating entry barriers. We show that while average price-cost margin trigger firm entry, a large dispersion of markups deters new firms from entering the market, thereby disrupting the process of new enterprise creation. We exploit information from the Ethiopian annual census of manufacturing establishments to estimate markups and then dispersion at sector and location-sector wide levels. Results show that higher markups dispersion significantly reduces entry rate into a market even in presence of expected positive average markups. Extension of our framework shows that market distortions caused by markup dispersion are related to a statistically significant drop in aggregate TFP and employment growth. Policies fostering competition on the other hand can reduce entry barriers created by market distortions.