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Demand or productivity: What determines firm growth?

  • Andrea Pozzi

    (EIEF)

  • Fabiano Schivardi

    (University of Cagliari, CEPR and EIEF)

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 Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1211.

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Length: 57 pages
Date of creation: 2012
Date of revision: Oct 2012
Handle: RePEc:eie:wpaper:1211
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