Vii. Productivity And Firm Dynamics: Evidence From Microdata - Review

OECD Economic Outlook, June, 2001

Introduction and summary

Chapters in the two previous issues of the OECD Economic Outlook (Nos. 67 and 68) discussed growth patterns in the OECD countries at the macroeconomic and sectoral levels. But growth of output and productivity takes place in individual firms, whose behaviour and decisions are influenced not only by market forces but also by policies and institutions. Understanding the underlying forces generating differences in performance at the firm level thus helps to formulate growth-oriented policies.

There is by now a sizeable body of evidence on firm performance, but international comparisons have been difficult to make. This chapter reports evidence on productivity growth and firm dynamics [1] for ten countries (United States, Germany, France, Italy, United Kingdom, Canada, Denmark, Finland, Netherlands and Portugal) on the basis of a common analytical framework and, to the extent possible, harmonised data. [2]

The main conclusions of this analysis are the following:

A large fraction of aggregate labour productivity growth is driven by what happens in each individual firm, while shifts in market shares from incumbents in decline to those who are growing seem to play only a modest role.

Labour productivity growth is also boosted by the exit of low productivity units, especially in mature industries. In other industries -- in particular those experiencing rapid technological changes (e.g. ICT-related industries) -- the entry of new units is important in fostering overall productivity growth.

Within-firm growth makes a relatively smaller contribution to multifactor productivity growth -- a proxy for overall efficiency in the production process -- than it does to labour productivity. This suggests that incumbents often raise labour productivity by increasing capital intensity and/or shedding labour. By contrast, new firms provide a relatively larger contribution to multifactor productivity, possibly because they enter the market with a more "efficient" mix of capital and labour and likely new technologies.

- A large number of firms enter and exit most markets every year. The early years are the most difficult for entrants: 20 to 40 per cent of entering firms do not survive the first two years. Young firms that fail are often very small, while those surviving tend to be larger and experience further increases in the initial years.

The chapter is divided into four separate sections. The first section discusses the contribution of firm-level data to the analysis of productivity growth in OECD countries. The second section presents evidence on the importance for aggregate productivity dynamics of developments within individual firms as well as entry and exit of firms in markets. A decomposition of productivity growth is performed for manufacturing and for some service sectors and refers to estimates of both labour and multi-factor productivity. The third section characterises entry and exit of firms across industries and countries and sheds some light on post-entry growth. Lastly, a short final section offers some preliminary policy considerations.

The role of firm-level data for the. analysis of productivity dynamics

Analysis of micro data points to a marked heterogeneity in the distribution of output, employment, investment and productivity growth across firms and establishments. [3] Even in expanding industries, many firms experience substantial decline, and in contracting industries it is not uncommon to find rapidly expanding units. Likewise, business-cycle upturns and downturns do not necessarily involve a synclironised movement of all, or even most, firms or establishments.

There are a number of possible explanations for this. Heterogeneity may reflect certain conditions in the product market, e.g. product differentiation, which can, at least partially, be related to regulatory and institutional conditions. At the same time, uncertainty about market conditions and profitability may lead firms to make different choices concerning technologies, goods and production facilities. [4] This process of "experimentation", in turn, is associated with high entry rates but also high failure rates, especially amongst relatively young firms, and more generally widens differences in outcomes. Finally, it has been argued that new technologies are often embodied in new capital, which, however, requires a retooling or remodelling process in existing plants adopting these technologies, as well as changing work practices in some cases. Insofar as new firms do not have to go through this process, they may better harness new technologies and growth will then tend to be associated with new entrants wh o displace obsolescent establishments, and this process of "creative destruction" contributes to the observed heterogeneity in firms' performance.

Policy orientations to enhance growth may depend crucially on how growth is generated at the level of individual firms. Importantly, the expansion or contraction of existing units or the creation and failure of firms impose costs on all those involved (e.g. entrepreneurs, workers, financing institutions). The magnitude of these costs is influenced by institutional and regulatory settings in the product and labour markets, such as administrative regulations on start-ups, bankruptcy laws and regulations affecting the reallocation of labour and capital across firms and sectors. Identifying policy barriers that increase adjustment costs at the level of the individual firm is thus an important role for firm-level analysis. More generally, knowledge of the determinants of heterogeneity across firms, and how they are affected by policy interventions, may contribute to the understanding of how the aggregate economy evolves and reacts to exogenous shocks.