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Previous articleNext article FreeCommentCharles EngelCharles EngelUniversity of Wisconsin and NBER Search for more articles by this author PDFPDF PLUSFull Text Add to favoritesDownload CitationTrack CitationsPermissionsReprints Share onFacebookTwitterLinked InRedditEmailQR Code SectionsMoreThis very interesting paper by Gianmarco Ottaviano explores the dynamics of firm behavior over the business cycle in a model with firm entry and exit. The paper has a number of precise predictions, and raises challenges for modeling macroeconomies.My aim in these brief comments is simply to draw links to the literature. I will not give a comprehensive review—this is certainly not my area of expertise—but I do want to indicate different literatures to which this paper belongs. In the introductory comments, Ottaviano links the paper to models of creative destruction, to models of search, and to macroeconomic models with imperfect competition. There are other literatures that, I think, are even more closely related.One really fascinating aspect of the analysis in this paper is that it raises questions about what macroeconomists mean by aggregate total factor productivity (TFP). Even if we could measure TFP at the firm level, it is not clear what the right way is to aggregate firm TFP to get a measure of economy-wide TFP. Aggregate statistics suggest a close link between TFP fluctuations and the business cycle, and of course there has been a long ongoing debate about the meaning of that link. That is, does measured TFP capture actual exogenous changes in productivity, or is there labor hoarding, and so forth, that leads to endogenous movement in TFP?In this paper, exogenous shocks to labor productivity drive the business cycle. However, the implications for economy-wide TFP are not so clear. In the model, an increase in the productivity level of all firms draws less productive firms into production. Average productivity, as measured by the simple average of productivity over all firms in the economy, is influenced not only by the increase in productivity of firms that are initially producing, but also by the entry of firms with lower productivity. In the first place, there is an empirical literature that has investigated how productivity of individual firms varies over the business cycle, and how this relates to aggregate productivity. Bartelsman and Doms (2000) surveys some of the earlier work on this topic. An important recent contribution is Foster, Haltiwanger, and Syverson (2008), which emphasizes that productivity is not the only factor that determines entry and firm survival and provides a measure of the roles of productivity and demand. The recent paper of Bartelsman, Halitwanger, and Scarpetta (2009) investigates the differing behavior of firm productivity and employment across countries.Macro theorists have investigated the role of firm entry and exit over the business cycle. In a sense, this paper is closing a circle. Its antecedents are Melitz and the papers that have stemmed from Melitz’s seminal work on firm productivity and trade. Melitz’s work, in turn, heavily draws on Hopenhayn’s (1992) model of firm dynamics. Hopenhayn’s work has spawned a related macroeconomic literature. Notably, Hopenhayn and Rogerson (1993) apply the Hopenhayn model to firm dynamics in a business-cycle setting. There is a large literature following on these papers. Ghironi and Melitz (2005), of course, is a well-known open-economy macroeconomic model that considers the role of firm entry and exit.The question of how to measure productivity when there is entry and exit is not a new one. Jaimovich and Floettotto (2008) build a model in which aggregated TFP fluctuates both because of fluctuations in firm-level TFP and because of effects coming from entry and exit. They suggest a method for decomposing measured TFP into these two components, though as Ottaviano notes, their model does not allow for heterogeneity in productivity.Finally, the paper is related to the burgeoning recent literature on resource allocation and its implications for aggregate productivity. Hsieh and Klenow (2009) show how resource misallocation can lower measured total factor productivity, and calculate that misallocation severely reduced TFP in China and India. Restuccia and Rogerson (2008) calibrate a growth model with heterogenous firms to US data and calibrate the degree to which resource misallocation hinders growth. In a similar vein, Buera and Shin (2010) assess the costs of misallocation in the context of a model with financial frictions. My comments here consist of nothing more than a reading list. Ottaviano has developed an interesting model, but the open question is whether it accurately describes firm dynamics over the business cycle. How does this model’s predictions compare to competing models? That assessment will require serious empirical work. A starting point is to place this model in the context of the existing empirical and theoretical body of work on macroeconomic models with firm dynamics.NotesFor acknowledgments, sources of research support, and disclosure of the author’s material financial relationships, if any, please see http: // www.nber.org / chapters / c12502.ack.ReferencesBartelsman, Eric J., and Mark Doms. 2000. “Understanding Productivity: Lessons from Longitudinal Microdata.” Journal of Economic Literature 38:569–94.First citation in articleGoogle ScholarBartelsman, Eric J., John Haltiwanger, and Stefano Scarpetta. 2009. “Cross-Country Differences in Productivity: The Role of Allocation and Selection.” NBER Working Paper no. 15490. Cambridge, MA: National Bureau of Economic Research, November.First citation in articleGoogle ScholarBuera, Francisco J., and Yongseok Shin. 2010. “Financial Frictions and the Persistence of History: A Quantitative Exploration.” NBER Working Paper no. 16400. 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