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Demand or productivity: What determines firm growth?

  • Pozzi, Andrea
  • Schivardi, Fabiano

We disentangle the contribution of unobserved heterogeneity in idiosyncratic demand and productivity to firm growth. We use a model of monopolistic competition with Cobb-Douglas production and a dataset of Italian manufacturing firms containing unique information on firm-level prices to reach three main conclusions. First, demand shocks are at least as important as productivity shocks for firm growth. Second, firms respond to shocks less than a frictionless model would predict, suggesting the existence of adjustment frictions. Finally, the degree of under-response is much larger for TFP shocks. This implies the existence of frictions with differential effects according to the nature of the shock, unlike the typical frictions studied by the literature on factor misallocation. We consider hurdles to firm reorganization as one such friction and show that they hamper firms' responses to TFP shocks but not to demand shocks.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9184.

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Date of creation: Oct 2012
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Handle: RePEc:cpr:ceprdp:9184
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