Academic journal article Journal of Economic Development

Limited Re-Entry and Business Cycles

Academic journal article Journal of Economic Development

Limited Re-Entry and Business Cycles

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1. INTRODUCTION

Given the well-documented heterogeneity among both plants and firms,1 a number of recent papers have explicitly modeled the entry and exit of plants or firms for the purpose of studying macroeconomic dynamics.2 In the literature, exit has typically been modeled as a permanent decision whereby it is not possible for the exiting plant or firm to "re-enter" in the future. This paper, however, relaxes this assumption by assuming that the exit decision is not permanent, but an exiting producer still has a "limited" ability to re-enter. By constructing a model of firm dynamics augmented to allow for re-entry, this paper studies the consequences of "limited re-entry" for the aggregate economy. The model, reasonably calibrated, indicates that "limited re-entry" has made output both more volatile and persistent, and has contributed to the slow recovery following the 2007-09 recession.

Building on Hopenhayn (1992), I assume that the economy is populated by a continuum of perfectly competitive producers, where labor is the only input in a decreasing returns-to-scale production function. Each producer can be interpreted as consisting of an "entrepreneur" and some amount of labor. Entrepreneurs are heterogeneous in terms of their idiosyncratic productivity, which is stochastic and represents the management skills of entrepreneurs. Because entrepreneurs must pay fixed costs in order to operate, only those entrepreneurs with a sufficiently high idiosyncratic productivity will operate and enter. As in Lee and Mukoyama (2013) and Clementi and Palazzo (2014), I augment Hopenhayn (1992) with an aggregate technology shock. The key difference, however, is that I assume that exit is not necessarily permanent for entrepreneurs. Specifically, I assume that exiting entrepreneurs can become potential entrants, enabling them to possibly "re-enter" in the future.

Next, I calibrate the model so that the ability of exiting producers to re-enter is limited. Specifically, I make two key assumptions. First, I calibrate the model so that exiting producers have a low probability that they will be able to re-enter within one year. This assumption can be justified by the observation that it would be difficult for an entrepreneur to quickly re-hire skilled labor or re-acquire the necessary physical capital if market conditions were to improve. Second, the model is calibrated so that the probability a potential entrant enters in any particular period is low. A low entry probability will ensure that the magnitude of fluctuations in entry rates is roughly consistent with the data. Moreover, it implies that it is relatively difficult for entrepreneurs to turn an "idea" into a new business.

Then, I construct an aggregate technology shock by setting the sequence of shocks so that the model-predicted fluctuations in output match those seen in the data. This requires that the equilibrium of the model be solved to back out the sequence of technology shocks. After feeding this sequence of shocks back into the model, it does well accounting for the dynamics of observed entry and exit rates. This is consistent with the results of Macnamara (2015). Specifically, it matches the empirical observation that entry rates are procyclical and exit rates are countercyclical. It does particularly well accounting for the fall in entry and the increase in exit during the 2007-09 recession.

As noted earlier, the benchmark economy was calibrated so that only a small fraction of exiting entrepreneurs re-enter within one year. To evaluate the economic impact of this assumption, I consider an alternative calibration in which exiting entrepreneurs can re-enter more easily. Specifically, I re-calibrate the model so that exiting entrepreneurs not only have a high probability of eventually being able to re-enter, but also that re-entry happens quickly. I then feed into the model the exact same technology shock measured using the benchmark economy. …

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