THE EFFECTS OF FIRMS’ ENTRY CARLOS CARREIRA AND PAULINO TEIXEIRA FACULTY OF ECONOMICS AND GEMF, UNIVERSITY OF COIMBRA Does Schumpeterian Creative Destruction Lead to Higher Productivity?

O VERVIEW Introduction: motivation and main purpose Background literature Methodological issues Results: entry and exit pattern in the Portuguese manufacturing sector and the direct and indirect effects of entry on productivity growth. Concluding remarks.

M OTIVATION A number of authors has carried out decomposition exercises of aggregate productivity growth to examine the contribution of new firms.  After the pioneering works of Baily et al. (1992) and Griliches and Regev (1995), Baldwin and Gu (2006), Carreira and Teixeira (2008), Disney et al. (2003), and Foster et al. (2001) inter al.

M OTIVATION In these studies, however, there is the risk of underestimation of the entry effect on industry productivity growth as the decomposition fails to account for the entry effect on the overall competitive pressure.  Aghion et al. (2009) and Falck et al. (forthcoming) showed that industries with a high entry rate are the ones in which incumbents have an increasing pressure to improve their performance.

M AIN P URPOSE In this paper we analyse the effects of entry on industry productivity growth. Our key hypothesis is that firm entry generates direct and indirect productivity effects:  The direct effect is related to the introduction of innovative products and technologies by new, high-productivity firms.  The indirect effect is related to  the crowding-out of low-productivity firms by new competitors  the increased incentive of established firms to innovate in order to escape the pressure.

B ACKGROUND L ITERATURE Theoretical framework:  Schumpeterian theory.  Aghion et al. (2009) Schumpeterian growth model.  It predicts that by increasing the entry threat the incumbents in the neighbourhood of the technology frontier will tend to be more innovative just to preclude entry of new competitors.  Melitz (2003) model [based on Hopenhayn (1992)].  It claims that firm entry forces the least productive firms to exit which induces inter-firm market share reallocation towards the more productive firms.

B ACKGROUND L ITERATURE Empirical decomposition exercises of aggregate productivity growth:  They are not entirely conclusive on the direct impact of entry.  Bailey et al. (1992) and Griliches and Regev (1995) claim that the direct contribution of entrants is relatively small.  A OECD (2001) cross-country study suggests that whenever the net entry (entry minus exit) contribution is positive and sizeable, exits explain most of this impact.  Baldwin and Gu (2006), Disney et al. (2003) and Foster et al. (2001) show that entry makes a substantial contribution.

M ETHODOLOGICAL ISSUES Direct effect  Aggregate productivity growth decomposition  terms: within covariance entry exit Indirect effect (competitive effect) over incumbents  Entry effect on incumbents’ productivity level   Increasing entry threat effect on incumbents’ producti. growth 

M ETHODOLOGICAL ISSUES We use an unbalanced panel of Portuguese manufacturing firms covering the period Productivity (firm-level; measured in log form )  Labour productivity   Total factor productivity  Factor elasticity parameters (  ) were estimated from the (log) Cobb-Douglas production function: 

A NNUAL E NTRY AND E XIT R ATES (%) Year Entry rateExit rate Unweighted WeightedUnweightedWeighted Average Notes: The reported entry and exit rates are calculated as the ratio of entering and exiting firms, respectively, to the total number of firms in year t-1.

E MPLOYMENT AND O UTPUT S HARES (%) Year Entry shareExit share L Y L Y Average Notes: The reported employment and output shares of entrants and exits are calculated as the ratio of the total output/employment of entrants and exits to the total output/employment of all firms in the market in each year. L and Y denote employment and output, respectively.

C REATION AND D ESTRUCTION R ATES Year Creation rate (%) Share due to entrants Destruction rate (%) Share due to exits L Y L Y L Y L Y Average Notes: The reported creation and destruction rates are calculated as a percentage of the average output (employment) in years t and t-1. L and Y denote employment and output, respectively.

P RODUCTIVITY G ROWTH D ECOMPOSITION Year Productivity growth WithinCovarianceNet entryEntryExit a) ΔlnTFP Average b) ΔlnLP Average

P RODUCTIVITY L EVEL R EGRESSIONS (I NCUMBENTS ) Variables(2) TFP(4) LP Constant 0.519*** (0. 760) 8.248*** (0.144) Entry rate 0.007* (0.004) 0.016** (0.007) Herfindahl Index 0.032*** (0.011) 0.061** (0.025) Industry size (0.062) (0.107) Export intensity (0.030)-0.143*** (0.052) Industry growth-0.154*** (0.061) (0.091) Technological regime 1.337*** (0.090) 0.319* (0.167) GDP growth (0.023) (0.046) Unemployment-0.072*** (0.017)-0.216*** (0.029) Industry dummiesYes N. of observations Wald test ***610.28*** Notes: Random-effects GLS regression. Variables are in logarithmic form. Robust standard errors. ***, **, and * denote statistical significance at the.01,.05, and.10 levels, respectively.

P RODUCTIVITY G ROWTH R EGRESSIONS (I NCUMBENTS ) Variables(1) ΔlnTFP(2) ΔlnLP Constant-0.187*** (0.059)-0.322*** (0.111) Net entry rate 0.257** (0.110) 0.437** (0.206) ΔHerfindahl Index (0.026) (0.050) ΔExport intensity-0.267*** (0.056)-0.279*** (0.105) Industry growth-0.562*** (0.083) (0.156) Technological regime 0.059*** (0.019) 0.070** (0.036) GDP growth (0.041) (0.076) Unemployment 0.097*** (0.018) 0.094*** (0.034) Year dummiesYes Num. of observations Log likelihood LR-test163.76***64.32*** Notes: Random-effects ML regression. Variables are in logarithmic form. Robust standard errors. ***, **, and * denote statistical significance at the.01,.05, and.10 levels, respectively.

C ONCLUSIONS We found that in spite of the strong entry flow, the direct effect of entry on the aggregate productivity growth decomposition is small, a result that can be explained by the fact that in the year of entry the new firms tend to exhibit lower productivity than incumbents. The contribution of net entry effect to productivity growth is more visible as low-productivity firms are excluded from the market and replaced by new and more productive firms.

C ONCLUSIONS New firms were able to generate increased competition on incumbents, who have responded with an increase in productivity in order to survive. Thus, entering firms do matter in terms of industry productivity growth. As regards to policy implications, the research calls for a promotion of an environment more favourable to raised firms mobility (namely, entry on the markets) in order to increase the economic growth.

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