On the macroeconomics of firm entry and exit

Abstract

This thesis straddles two seemingly quite distinct fields within macroeconomics, namely endogenous growth and business cycle theory. The unifying element of the thesis is the fundamental role played by firm entry and exit in each chapter. In the longrun, I find that if entering firms imitate incumbents, firm turnover promotes growth by removing inefficient firms and replacing them by more productive ones. In the shortrun, fluctuations in the number of firms lead to movements in sectoral relative prices. In particular, pro-cyclical net entry leads to a fall in the price of investment in terms of consumption goods during booms; those relative price movements may be delayed if it takes time to set up a firm. The first chapter deals with the long-run effects of firm turnover. I set up a dynamic general equilibrium model with firm-specific productivity shocks. Those firms whose productivity has fallen too low exit, and entrants’ expected productivity is a function of current average productivity. Because of the resulting selection and imitation process (similar in some ways to the concept of natural selection), aggregate productivity in the economy grows endogenously. When calibrated to U.S. data, the model suggests that around one-fifth of productivity growth is due to such a selection effect. The following two chapters deal with the short-run effects of net firm entry within a framework of imperfect competition. I argue that the counter-cyclical fluctuations in the price of investment in terms of consumption goods which are observed for the U.S. are due to pro-cyclical competitive pressure through variations in the number of firms. The idea is that, since investment is much more variable than consumption, competition will be more variable in the investment sector, thereby pushing down prices more strongly in the latter sector during expansions.