Firm entry and aggregate efficiency growth: an optimal dynamic: program of entry and R&D investment.

• Author: Raies, Asma
• Position: Report

1. Introduction:

   On the empirical level, the issue of the relative contribution of firms entry to aggregate productivity growth is still an object of controversies. Indeed, this contribution varies from one study to another, depending on the measurement of aggregate productivity, the time horizon over which changes occur, the business cycle, as well as on the country or industry under investigation. For example, Baily et al. (1992) and Griliches and Regev (1995), found that firm entry and exit had a small contribution to aggregate productivity growth for US manufacturing and Israeli industries respectively. According to Foster et al. (1998), the contribution of net entry to aggregate growth depends on the horizon over which the changes are measured. When high frequency data are used, the contribution of entry and exit to productivity growth is low, but with intermediate (a 5-year time horizon) or long run (a 10-year time horizon) data, the contribution of net entry is large. Martin and Jaumandreu (2004) find that entry has a positive and significant effect on Spanish aggregate productivity growth with a stronger impact in the period before Spanish integration in the EU. Scarpetta et al. (2002) analysed several OECD countries and found that the entry and exit contributed to between 20% to 40% of aggregate productivity growth. There were significant differences in the contributions of entry to aggregate productivity growth between Europe and the US. In the former, the entry of firms has a positive contribution to growth, but the effect is small, whereas in the latter, firm entry has a negative contribution to growth. Differences were also found in terms of the importance of the contribution to aggregate productivity growth across manufacturing sectors. In high technology sectors, the entry of new firms has a larger than average contribution to total growth. The results also differ according to whether aggregate productivity is measured by TFP or labour productivity, with a net entry having a strong contribution to TFP growth. Brandt (2004), using a new data set covering nine EU countries suggests that high rates of firm entry coincide with rapid productivity, especially in the ICT related services sectors and in some business services industries, while in the more mature manufacturing industries, expenditure on formal R&D seems to be more important as a determinant of productivity growth. According to Baldwin and Wulong (2006), firm entry explains 70 % of the aggregate labour productivity growth of the Canadian manufacturing sector over the period 1979-1999. Both Toshiyuki and Kazuyuki (2005) and ITO Keiko (2011), using Japanese firm-level data respectively over the periods 1992-2002 and 2000-2007, found that the entry tends to be negatively associated with the productivity growth both in the manufacturing and the service sectors.

   It comes out from these empirical divergences that the effects of entry liberalizing policies are still unresolved too. Indeed, Srivastava (1996) shows that the rate of TFP growth increased after deregulation in India in 1985. However, more recently, Aghion, Burgess, Redding and Zilibotti (2005), provide evidence that deregulating entry in India in 1985 and 1991 has had an ambiguous effect. Nicoletti and Scarpetta (2003) and Alesina et al. (2003) found a negative effect of regulation reforms on productivity growth in OECD countries. This result is confirmed in Brandt (2004) for European Union. However, Griffith and Harrison (2004) show different impacts of entry liberalization on economic rent, R&D and growth rates of labour productivity and of TFP in the European Union over the period 1985-2000 as well as separately for the manufacturing and services sectors. The results obtained by Cincera and Galgau (2005), using 352 digits sectors for 9 OECD countries suggest that the coefficient on regulation is allowed to differ across sectors with the sign and significance varying across sectors and countries. The result that product market reforms in different countries led to different experiences leads to the question of whether it is possible to impose a common structure across EU different countries.

   To explain and justify such inconclusive current empirical evidence (1), the endogenous technological change literature provides a coherent and attractive framework for modelling efficiency growth at the aggregate level. Nevertheless, the effect of entry on the aggregate efficiency growth is still theoretically unresolved. That is by intensifying competition, the entry of new firms may either enhance or discourage the R&D activity of incumbent firms. Consequently, the growth rate of aggregate efficiency may either increase or decrease. Indeed, Aghion et al. (2006) provide one of the most recent models on the impact of firm entry or the threat of entry on incumbent firms' incentives to innovate, which in turn affects aggregate productivity growth. Firm entry or the threat of entry produces two effects on incumbents' incentives to innovate. On the one hand, there is an escape entry effect or an encouragement effect according to which, an increase in the threat of entry of new firms will increase the incentives to innovate in sectors that are close to the technological frontier because firms close to the frontier know that they can escape entry by new firms through innovation. On the other hand, there is also a discouragement effect of entry according to which, an increase in the threat of entry may discourage innovation in sectors that are initially far below their current technological frontier. In this case, firms know that they are too far away from the frontier to win against a new entrant and they decrease innovation since the increase in the threat of entry leads to a decrease in the expected payoff from investing in R&D. The study shows too that liberalization (as measured by an increase in the threat of entry) encourages innovation in industries that are close to the frontier and discourages innovation in industries that are far from it. Productivity, output, and profits, should thus be higher in industries and firms that are initially more advanced. In the second part of the paper, the authors support empirically these evidences, using micro-level data for productivity growth and patenting activity for UK firms over the 1987-1993 period and from the liberalization experience in India over the 1990-1997 period. However Aghion et al. (2006)'s result is contrasted by some others empirical studies. For example, Scarpetta et al. (2002) found that tight product market regulations have a direct negative effect on productivity regardless of their position relative to the technology frontier. This negative effect is larger the further a country is from the technological frontier. This result is confirmed once again by Nicoletti and Scarpetta (2003) who show significant links between product market policies and productivity performance, with entry liberalisation leading to productivity gains in all of the OECD countries regardless of their position relative to the technology frontier. In addition, Bettina (2006) provides an endogenous growth model where entrants offer higher quality products than existing ones. This assumption implies a positive effect of entry (and of liberalizing entry policies) on the economic growth rate. This result is contrasted by empirical ones which found a negative effect of liberalizing entry on productivity growth. Grossmann and Steger (2008) conclude that if the incumbent firms do not benefit from entrants' R&D (absence of spillovers), the negative discouragement effect outweighs the encouragement one. If, on the contrary, technological spillovers exist, the net effect of entry becomes ambiguous. This theoretical result can't interpret empirical ones since technological spillovers exist in reality. Carreira, C. and Teixeira, P. (2008) provide a neo-Schumpeterian model to discuss how the mechanisms of entry and exit contribute to industry productivity growth in two alternative technological regimes. Their evolutionary approach assumes that individual firms learn about technology through a variety of sources (learning by doing, by using, by searching and learning from advances in science and technology and from inter-industry spillovers). The numerical simulations show that the industry-level productivity growth is higher in the entrepreneurial regime (where the improvements in the technological knowledge are mainly due to the new firms) than in the routinized regime (where such improvements are mostly associated with the established firms). More recently, Acemoglu, D and Cao, D (2010) find, despite the Schumpeterian character of their model, a strictly negative relationship between the rate of firm entry and the rate of aggregate productivity growth. This reflects the importance of the productivity growth by incumbents and the dominance of the discouragement effect. The resulting lower productivity growth by incumbents outweighs the higher growth due to entry. This result is contrasted by Murao and Nirei (2011) who develop an endogenous productivity growth model with heterogeneous innovation efficiency across firms. They show that a reduction in the entry cost decreases the equilibrium rent for innovators, and thus reduces the incentive for R&D with a stronger effect for high innovative types than low innovative types. Thus, the reduced entry cost may have a negative impact not only on the average R&D investments but also on the reallocation of market share from the low-innovative firms to the high innovative firm. By estimating the model on Japanese manufacturing firm level panel data over the period 2001-2004, they found the reduced entry cost greatly enhanced the positive entry effect, which outweighs the other two negative effects on the aggregate productivity growth.

   All studies cited above are silent and represent a radical departure from the...