Entry, Exit, Firm Dynamics, and Aggregate Fluctuations
By Gian Luca Clementi and Dino Palazzo
Abstract
How important are firm entry and exit in shaping aggregate dynamics? We
address this question by characterizing the equilibrium allocation in Hopenhayn
(1992)'s model of equilibrium industry dynamics, amended to allow for
investment and for aggregate fluctuations. We find that entry and exit
propagate the effects of aggregate shocks. In turn, this results in greater
persistence and unconditional variation of aggregate time--series. In the
aftermath of a positive productivity shock, the number of entrants increases.
The new firms are smaller and less productive than the incumbents, as in the
data. As the common productivity component reverts to its unconditional mean,
the new entrants that survive become progressively more productive, keeping
aggregate efficiency higher than in a scenario without entry or exit. We also
find that both the mean and variance of the cross--sectional distribution of
firm--level productivity are counter--cyclical, in spite of the assumption that
innovations to firm--level productivity are i.i.d. and orthogonal to aggregate
shocks. This happens because of selection: the idiosyncratic productivity of
the marginal entrant is lower in expansion than during recessions. Since
idiosyncratic productivity is mean--reverting, mean and variance of the
distribution of productivity growth are pro--cyclical.