TurnoverBased Productivity Growth

1
Turnover-Based Productivity Growth

• October 31, 2005
• James Tybout
• Pennsylvania State University and NBER

2
Productivity decompositions

• In standard productivity decompositions,
  turnover-based productivity growth (TBPG) occurs
  when
• Unproductive firms exit and more productive firms
  enter.
• Market shares are reallocated from low
  productivity firms to high productivity firms.
• The other source of productivity growth is
  intra-firm productivity growth (IFPG).
• Vintage effects
• Endogenous innovation
• Learning spillovers
• Random shocks

3
TBPG and IFPG are jointly endogenous processes

• Because of vintage effects and endogenous
  innovation, IFPG reacts to turnover.
• TBPG, in turn, reflects the patterns of decay in
  relative productivity among incumbent firms.
• Transition dynamics can be subtle, and time
  horizons can be lengthy.

4
Descriptive analysis of TBPG has its limits

• Sometimes major policy shocks make it possible to
  draw inferences from descriptive statistics
  (e.g., Bartelsman et al, 2004, concerning the
  transition economies).
• But often, it is difficult to assess an
  industrial sectors performance and its relation
  to policy using productivity decompositions and
  reduced-form regressions.
• The alternative structural models of industrial
  evolution.

5
Structural models with TBPG

• Because they are forward-looking models with
  uncertainty and multi-agent optimization,
  industrial evolution models are computationally
  cumbersome.
• The scope for variation in model specification is
  extensive
• Endogenous versus exogenous innovation
• Competitive versus imperfectly competitive market
  structures
• Vintage effects versus homogeneous capital
• Perfect versus imperfect capital markets
• Partial versus general equilibrium
• Open versus closed economy
• But progress is being made, so specific stories
  about TBPG in specific contexts are starting to
  emerge.
• A (non-representative) sampling of developing
  country studies follows.

6
Macro shocks and subsidies for incumbent firms

• Bergoeing, Loayza and Repetto (2004) assume
• Firm-specific vintage capital and exogenous
  productivity shocks
• endogenous turnover
• They explore the effects of production subsidies
  on the speed of recovery from a negative
  aggregate shock.
• The subsidy keeps low-productivity firms active.
  So
• subsidizing incumbents in the aftermath of a
  shock reduces volatility and firm destruction at
  the cost of a long period of stagnation.
• The loss in present value of GDP is a factor of
  1.5 to 2.5, depending upon the magnitude of the
  subsidy (3 or 6).
• Qualitatively, the simulations are consistent
  with cross-country correlations of regulatory
  indices with indices of the severity of
  recessions.

7
Exchange rate volatility and selection

• Pratap and Urrutia (2004) study industrial
  evolution in a context with
• foreign currency financed investment,
• exports,
• potential bankruptcy
• exogenous, idiosyncratic productivity shocks
• Main findings
• Depreciation discourages investment by reducing
  the net worth of firms with dollar-denominated
  debt, and thereby raising borrowing costs.
• This effect can dominate the demand-side effect
  of depreciation

8
Exchange rate volatility, interest volatility and
TBPG

• Bond, Tybout and Utar (2005) assume
• Firms are closely held by risk-averse households
  with heterogeneous wealth.
• Firms profits are determined by their capital
  stocks, productivity shocks, and the exchange
  rate.
• Households choose whether to create (or shut
  down) proprietorships. Those that operate
  proprietorships choose how much to invest in
  them, subject to collateral constraints.

9
Exchange rate volatility, interest volatility and
TBPG

• BTU (2005) estimate profit function and macro
  processes using Colombian data.
• They explore the effects of crisis-prone macro
  environments on TBPG and investment behavior.
• Key effects
• Households with modest wealth less likely to
  operate proprietorships during volatile periods.
• Incumbents with big, poorly performing firms that
  would have exited in a stable environment are
  more inclined to hang on.

10
Simulated Transition to High Volatility

• Initially, volatility increases number of firms,
  relative to the base case

11
Simulated Transition to High Volatility

• The association between size and profitability is
  initially weakened by volatilitybig, poorly
  performing firms are induced to hang around

12
Simulated Transition to High Volatility

• The poorly performing firms that hang on reduce
  size-weighted productivity significantly.

13
Import competition and TBPG

• Erdem and Tybout (2004) examine the effects of
  import competition using an open economy version
  of the Pakes and McGuire (1994) model
• Oligopolistic market structure
• Endogenous investments in innovation
• Vintage capital effects
• Imports are imperfect substitutes for domestic
  varieties
• Quality of imports increases stochastically
• ET (2004) study the effects on TBPG (and welfare)
  of a reduction in the price of imported goods
  accelerated innovation abroad.

14
Reduced Import Prices and efficiency
Average quality of the domestic goods initially
improves relative to imports. Why? The worst
firms/product lines immediately shut down, and
the deterioration due to reduced investment is
gradual.
15
Reduced import prices and innovation
But incentives to innovate are less because
profits are lower (Schumpeter). So firms have
shorter average life expectancies (not shown),
and entry/exit go up.
16
Reduced import prices and producer surplus

• Producers earn less surplus in the new regime
• smaller mark-ups,
• smaller market shares,
• shorter life spans.

17
Accelerated improvement in imported goods
Domestic goods quality improves rapidly because
new firms/product lines embody best
practice. Turnover is more rapid because firms
have more incentive to be new.
18
Accelerated improvement in imported goods
But heightened import competition reduces
producers incentives to invest in innovation
(Schumpeter wins again).
19
Concluding remarks

• Theoretical models provide some interpretations
  for TBPG and IFPG, and their relation to policy.
• But the relationships are subtle, dynamic and
  very dependent upon specific modeling
  assumptions.
• Some findings particular to special contexts have
  begun to emerge, but much remains to be done.

20
Concluding remarks

• Some directions to push in
• Move toward econometric estimation
• Allow for endogenous innovation.
• Model entrants in a more realistic way
• Do a better job of characterizing performance
• Study entry costs more closelywhen are they
  excessive?