Economic Sophistication and Reallocation of Small Firms in Brazil

While studies have analyzed the sectoral reallocation of micro and small enterprises (MSEs), the literature often overlooks their influence on regional productive structures. This study addresses the critical role of MSEs in economic sophistication within a developing country context. Utilizing panel data from Brazil’s industrial sector, we employ econometric models, including Fixed Effects (FE) and the Driscoll-Kraay (DK) estimator, to analyze 558 microregions from 2003 to 2015. The impact of within-sector dynamics on productive sophistication, measured by economic complexity, is examined. Robustness tests are conducted using instrumental variable models, such as Limited Information Maximum Likelihood (LIML), Two-Stage Least Squares (2SLS), and Generalized Method of Moments with Continuously Updating Estimates (GMM-CUE). Our findings demonstrate that a higher intensity of firm reallocation between micro and small size categories, measured by a within-sector turbulence index, has a positive and statistically significant impact on regional productive sophistication. This underscores the importance of policies aimed at fostering a dynamic business environment that facilitates market selection and resource reallocation.