Drivers of total factor productivity growth in the EU - the role of firm entry and exit

This section investigates the relationship between business dynamics and total factor productivity growth. Schumpeterian growth models predict a positive association between business dynamics (market entry and exit of firms) and productivity improvements, through the process of innovation and creative destruction. Macro-level data for EU countries over the period 2002-2012 are used to quantitatively assess this relationship, while controlling for other important factors such as distance to the technological frontier, R&D investments, and capacity utilisation. The results provide evidence of a positive relationship between the market entry of new firms and productivity growth. A 1 percentage point increase in the birth rate of new firms is associated with an increase in total factor productivity growth by 0.1 percentage points. This finding is also validated when using alternative specifications of the model. Also some evidence is found for a positive role of market exit in explaining total factor productivity growth. However, the impact of the exit rate is less when the productivity levels of countries are lower, and the econometric estimates are less compelling. The results suggest that policies promoting the entrance of new firms can be conducive to productivity growth, whereas facilitation of market exit (for example, by modernising insolvency legislation) is relevant particularly in countries with relatively high productivity levels.