What is the Impact of Increased Business Competition?

IMF Working Papers, December 13, 2019

Source details

Research objective: Study the macroeconomic effect and underlying firm-level transmission channels of a reduction in business entry costs.
Empirical strategy: Use a natural experiment — a reform in Portugal that reduced entry time and costs — exploiting the staggered implementation of the policy across Portuguese municipalities.
Data focus: Firms' entry, exit, and employment decisions.

Entry and employment effects:
- The reform increased local entry by 25% per year in its first four years of implementation.
- The reform increased local employment by 4.8% per year in its first four years of implementation.
Source of employment gains:
- Around 60% of the increase in employment came from incumbent firms expanding their size.
- Most of the incumbent expansion occurred among the most productive firms.
Heterogeneity:
- The response across incumbent firms was heterogeneous, with the most productive firms driving the bulk of expansion.

Standard models:
- Standard models of firm dynamics that assume a constant elasticity of substitution are inconsistent with the observed expansionary and heterogeneous response across incumbent firms.
Alternative model:
- A model with heterogeneous firms and variable markups can account for the facts: the most productive firms face a lower demand elasticity and expand their employment in response to increased entry.

Subjects: Demand elasticity, Economic theory, Employment, Labor, Labor demand, Labor supply, Production, Productivity
Keywords: Demand elasticity, Employment, Europe, firms drive, idiosyncratic productivity, incumbents firm, Labor demand, Labor supply, math display, municipality Count firm, pre-existing firm, price level, Productivity, productivity distribution, WP