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The Small Stories that Explain Big Trends

Firm-level data yields new insights into the underpinnings of macroeconomic dynamics

If you want to understand how the macroeconomy will respond to a new policy, you need to first understand, at the microeconomic level, how decision makers in the economy would behave under those policies, according to Ufuk Akcigit.

The University of Chicago economist recently co-organized a Becker Friedman Institute conference, “Firm Dynamics and the Aggregate Economy,” that sought to deepen understanding about what drives firm behavior and productivity under different market policies and conditions. Akcigit said that economists and policymakers are often puzzled about why some policies are not very effective or why others generate results opposite of what was expected. “As a result, it is very crucial to understand the microlevel firms,” he said.

This kind of firm-level analysis has been building for several decades as researchers have gained greater access to company-level production data, explained conference co-organizer Chad Syverson of the University of Chicago Booth School of Business. What has become clear to Syverson and his colleagues is that “a lot of aggregate phenomena are best understood by drilling down, seeing the processes that go on at the microlevel, and figuring out how those all add up across companies and over time to make the macroeconomic movements that we observe.”

Syverson noted especially the significance of how frequently firms enter and exit within an industry over time. This “churn” may not be evident to most observers, but a massive amount is likely going on within US industry at any one time. For example, if there are 100 firms in an industry, it is likely that 50 of those are companies were not in existence ten years ago, having replaced another 50 that went out of business. New, more efficient companies come in and replace older companies.

“It turns out that this churn isn’t just noise,” explains Syverson. “We know from lots of evidence that churning itself moves an industry forward. It is kind of a Darwinian process that happens over time, and the industry as a whole becomes more productive.” The conference helped advance understanding of these phenomena, exploring possible reasons for why this churning has slowed in recent years.

A second, important aspect of the conference was to understand better why firm dynamics differ so much across countries. There is a particularly marked difference in the growth rate in developed countries, such as that of US firms, where businesses need to grow rapidly to in order to succeed, compared to the growth rate of developing countries, where firms don’t grow nearly as quickly. The markets in developing countries work in fundamentally different ways that are just beginning to be understood. “We need to understand those so we can understand better how to remedy the problems,” observes Akcigit.

The conference convened some of the most influential leaders in the field of firm dynamics—including Hugo Hopehayn of the University of California, Los Angeles; Boyan Jovanovic of New York University; and John Haltiwanger of University of Maryland—together with scholars who have worked at length on very similar issues. The sessions presented a broad span of new papers and the latest thinking in firm dynamics, with a special emphasis on the US and China.

A brief synopsis of the new papers presented at the forum, which was held at the Quadrangle Club Library, follows below. Ali Hortaçsu and Nicholas Bloom also served as co-organizers.

  • Russell Cooper analyzed the effects of new policies in China that introduced job protection measures. He focused on the impact of a requirement to increase severance pay and on credit market liberalization, the areas where effects were most pronounced. Cooper found that increased severance pay increased average employment, while credit market liberalization reduced employment. He also emphasized the special considerations he felt China analysis requires versus other nations: the importance of their state sector and of trade. Jeff Campbell discussed the paper.
  • Esteban Rossi-Hansberg looked at gaining insight in to what drives the differences among the organizational characteristics of firms in Portugal. He specifically examined the relationship between expansion due to increase in product demand and the drive to retain and grow the firm’s knowledge and talent. Firms add layers of management to accommodate quantity-based productivity growth and to increase market knowledge and problem-solving skills; however, this also shifts the cost structure notably. He added that this puts pressure on revenues because firms lower prices as their ability to generate larger quantities rises. He concludes, in part, that the ability to reorganize is essential to firm growth, and this could be one aspect holding back firms in developing countries. Ananth Seshadri, University of Wisconsin-Madison, commented on the paper.
  • Gian Luca Clementi adapted a firm dynamics model to more fully examine the relationship between firm size and equity returns. He looked specifically at investment rates and excess equity returns. Felipe Saffie discussed his work.
  • Hugo Hopenhayn responded to a growing literature on the misallocation of firm resources and the resulting negative effects on firm and aggregate productivity (total factor productivity, or TF). Recent literature explores the question of how detrimental these distortions are across firms, time, and countries. Hopehayn’s work tries to to identify the sources of the largest distortions and begin to determine which types of misallocations are the most damaging to productivity. He concludes that the concentration of the distortions has the most detrimental effects. Richard Rogerson discussed his work.
  • Jing Cai studied how forming networks of business relationships influenced firm growth in developing countries. Cai held a series of regular business meetings for young Chinese managers and compared performance of the firms where the managers worked with that of managers who did not participate. She found many positive outcomes to the increased business relationships, most notably a positive impact on firm performance. For firms with managers taking part in the meetings, firm sales increased of 7.7 percentage points; she also found increases in productivity, employment, and overall number of business partners. Samuel Kortum remarked on the paper.
  • John Haltiwanger investigated why business dynamics, or the churning of businesses through launch, growth, decline, and exit, has slowed significantly in the US’s high tech sector since 2000. His results showed that during the 1980s and 1990s, firms were able to respond quickly to productivity shocks, but that has declined substantially since 2000. Although much of the decline remains unexplained, Haltiwanger found evidence that globalization is reducing the responsiveness of young firms. Ben Jones discussed his paper.
  • Boyan Jovanovic developed a modified model of firm reputation to investigate how investment in a firm’s reputation can affect aggregate outcomes. He argues that a firm’s discount factor, or their expectation of a future return for their investment in their reputation today, is cyclical and dependent on the pace of booms and recessions. Dimitris Papanikolaou offered remarks.   

—Jennifer Roche