Productivity, Profitability and Growth
64 Pages Posted: 14 Jul 2021
Date Written: May 1, 2021
Recent empirical evidence suggests that firm selection and growth are largely demand-driven. We incorporate this feature into a model of endogenous growth in which heterogeneous firms innovate and survive based on profitability, rather than productivity alone. We show analytically that firm-level demand variation impacts aggregate growth by changing firms' incentives to innovate. Estimating our model on U.S. Census firm data, we quantify that 20% of aggregate growth is demand-driven and that the macroeconomic impact of growth policies is fundamentally different compared to a model driven by productivity variation alone. We find empirical support for our model mechanism in firm-level data.
JEL Classification: D21, E24, L1, O31, O33
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