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Demand or Productivity: What Determines Firm Growth?

  • Andrea Pozzi

    (Einaudi Institute for Economics and Finance)

  • Fabiano Schivardi

    (University of Cagliari, Einaudi Institute for Economics and Finance, CEPR and LdA)

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 Centro Studi Luca d'Agliano, University of Milano in its series Development Working Papers with number 344.

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Length: 58
Date of creation: 13 Nov 2012
Date of revision: 13 Nov 2012
Handle: RePEc:csl:devewp:344
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