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Customer Driven Establishment Dynamics and Allocative Efficiency

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  • Allen Tran

    (UCLA)

Abstract

A common result from models of misallocation is that allocative efficiency is reflected in the correlation between size and productivity. But establishments start small which raises the question: how does the distribution of size have to evolve over the lifecycle to achieve allocative efficiency? Simply put, it must be that more productive establishments grow faster at the expense of less productive establishments. As evidence of this selection mechanism, I use establishment level data to construct cohorts of entrants and show that the spread of growth between fast and slow growing establishments is positively associated with higher exit rates. But unlike typical models that feature selection, I show that neither increases in input costs nor greater volatility are the force behind selection. To reconcile these facts, I present a model where the degree to which customers are willing to match with establishments who produce low quality goods introduces a new margin that affects selection. In the model, 60 per cent of changes in the intensity of selection come from changes in demand side behavior. To assess this new margin of selection, I recalibrate a parameter which controls the degree to which establishments can crowd out others for customers to match the slower fanning out in the evolution of the size distribution in Chile relative to the US. The model suggests that going from the US to Chile in this dimension would result in a 44 per cent loss in welfare.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 115.

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Date of creation: 2013
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Handle: RePEc:red:sed013:115

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  1. Ron S Jarmin & Javier Miranda, 2002. "The Longitudinal Business Database," Working Papers 02-17, Center for Economic Studies, U.S. Census Bureau.
  2. Emin M. Dinlersoz & Mehmet Yorukoglu, 2012. "Information and Industry Dynamics," American Economic Review, American Economic Association, vol. 102(2), pages 884-913, April.
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  7. Pablo D. Fajgelbaum, 2013. "Labor Market Frictions, Firm Growth, and International Trade," NBER Working Papers 19492, National Bureau of Economic Research, Inc.
  8. Satkartar K. Kinney & Jerome P. Reiter & Arnold P. Reznek & Javier Miranda & Ron S. Jarmin & John M. Abowd, 2011. "Towards Unrestricted Public Use Business Microdata: The Synthetic Longitudinal Business Database," Working Papers 11-04, Center for Economic Studies, U.S. Census Bureau.
  9. Erzo G.J. Luttmer, 2007. "On the Mechanics of Firm Growth," Working Papers 2007-4, University of Minnesota, Department of Economics, revised 10 2007.
  10. Fishman, Arthur & Rob, Rafael, 2003. "Consumer inertia, firm growth and industry dynamics," Journal of Economic Theory, Elsevier, vol. 109(1), pages 24-38, March.
  11. Leena Rudanko & Francois Gourio, 2011. "Customer capital and the business cycle," 2011 Meeting Papers 120, Society for Economic Dynamics.
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