The regulation of entry and aggregate productivity

The aim of this paper is to contribute to explaining differences in aggregate productivity between similar, industrialized countries such as the US and European Union (EU) member states. By introducing shifts in administrative entry cost and a firm technology adoption decision in a model of heterogeneous firms close to Hopenhayn (1992), it matches the following facts: higher entry cost is associated with (1) both lower labor and total factor productivity, (2) more capital-intensive production, and (3) lower firm turnover. Compared to previous studies of reallocation intensity and aggregate productivity, endogenizing capital intensity through technology choice leads to stronger results; higher equilibrium capital intensity acts as an entry barrier to new firms, and protects low-productivity incumbents. Notably, the very small differences in the administrative cost of entry as documented by Djankov, La Porta, Lopez-de-Silanes and Shleifer (2002) suffice to explain 10 to 20% of differences in TFP and the capital-output ratio between Europe and the US. To obtain this, both heterogeneity of firms and allowing for technology choice are crucial.