Declining Dynamism, Increasing Markups and Missing Growth: The Role of the Labor Force

Abstract

A growing body of empirical research highlights substantial changes in the US economy during the last three decades. Business dynamism is declining, market power seems to be on the rise, and aggregate productivity growth is sluggish. We show analytically that a decline in the rate of growth of the labor force implies all of these features in a frontier model of firm dynamics. The reason is that a decline in labor force growth reduces the long-run entry rate but keeps expansion incentives of incumbent firms unchanged. This implies that lower labor force growth reduces creative destruction, increases average firm size and raises market power. We calibrate the model to data on employment and sales for the universe of firms in the U.S. Census. We find that the empirically observed decline in the rate of labor growth since the 1980s can account for the decline in entry and the increase in firm size, generates quantitatively significant and welfare-relevant changes in markups, but plays a minimal role in explaining the decline in aggregate productivity growth.