Working Paper 2009-8
Abstract: There are large differences in income per capita across countries. Growth accounting finds that a large part of the differences comes from the differences in total factor productivity (TFP). This paper explores whether barrier to entry is an important factor for the cross-country differences in TFP. The paper develops a new model to link entry barriers and technology adoption. In the model, higher barriers to entry effectively reduce entry threat, and lower entry threat leads to adoption of less productive technologies. The paper demonstrates that technology adopted in the economy with entry threats is at least as good as the technology adopted in the economy without entry threats. Moreover, the paper presents numerical simulations that suggest entry barriers could be a quantitatively important reason for cross-country differences in TFP and are more harmful to productivity in the countries with monopolists facing inelastic demand.
JEL classification: 011, 043
Key words: entry barriers, technology adoption, total factor productivity
Why does output per capita vary so much across countries? This is one of the most important questions in economics. According to the Penn World Tables, GDP per capita in the U.S. is more than 30 times larger than GDP per capita in the poorest ten percent of countries in the world. A large body of research works have found that differences in TFP is the quantitatively most important factor for the cross-country differences in GDP per capita. (1) This raises the question of why poor countries do not use better technologies.
This paper proposes a theory of TFP differences based on cross-country differences in the barriers to setting up a new business. The theory is supported by strong empirical evidence. For example, Djankov et. al. (2002) analyze the data on the regulatory cost of setting up a new business in 85 countries, and find a negative correlation between GDP per capita and the ratio of entry cost to GDP per capita. Nicoletti and Scarpetta (2003) and (2006) find that entry barrier is negatively related to TFP in OECD countries. Moreover, Lewis (2004) provides industry evidence that product market regulation negatively affects productivity in both rich and poor countries.
Motivated by these empirical works, this paper studies how entry barriers affect technology adoption. The model developed in this paper builds on the monopolistic competition framework with a final good sector and many intermediate goods industries. In each industry, there is an incumbent and a potential entrant. Both of these two firms make their technology choice based on adoption costs and compete with each other in Bertrand fashion. This industry structure is related to Aghion et. al (2006). However, Aghion et. al (2006) investigates how entry barriers affect the incumbent firm's technology choice in rich countries. To analyze the large differences in TFP between rich and poor countries, this paper deviates from Aghion et. al (2006) mainly in two ways. First, the available technology set is continuous, and second, entrants do not operate at the technology frontier without cost. As a result, the model can generate the negative relationship between entry barriers and technology adoption, and countries with higher entry barriers are characterized by the use of less advanced technologies and lower TFP.
Four findings emerge from the model. The first one is that the lack of competition leads to adoption of less productive technologies. In particular, the paper demonstrates that the technology adopted in the economy with entry threats is at least as good as the technology adopted in the economy without entry threats. The second finding is that higher entry barriers lead to adoption of less productive technologies. The third finding is that the effect of entry barriers on technology adoption is characterized by threshold effects. …