Effects of Exit on Growth in an Imperfectly Competitive Economy

Abstract

This paper develops a tractable endogenous growth model to investigate the interrelationship between exit of firms and economic growth by integrating Schumpeterian growth and stochastic dynamic industry models. The results are in stark contrast with that of standard Schumpeterian growth theory: while the standard Schumpeterian growth theory implies a positive relationship between the exit and growth rates, this paper shows that there is a negative relationship between them. Based on our prediction, we analyze how an intensified product market competition (PMC) affects exit and growth. The results are as follows. If exit of firms is not introduced into the economy, an intensified PMC raises the growth rate by raising the marginal gain from innovation. However, if exit of firms is introduced into the economy, the positive effect of an intensified PMC on growth is weakened by raising the possibility of firms to exit the market. Therefore, an intensified PMC may reduce the growth rate if it causes too many firms to exit the market. These results are in stark contrasts with that of standard Schumpeterian growth theory.