Explaining Declining Business Dynamism: A Monetary Growth-Theoretic Approach

This study offers a monetary growth theory that can explain the declining business dynamism observed over the past few decades in some developed countries by developing a new R&D-based growth model; the main departure from existing models is the introduction of an entry cost after innovation and an endogenous survival investment that is subject to a cash-in-advance constraint. Due to this, in our model, the entry/exit rates and firm age distribution are all endogenous. The core finding is that, theoretically, the nature of business dynamism at the macro level essentially depends on nominal factors. Specifically, lower inflation leads to declining business dynamism, characterized by lower entry and exit rates and a maturity bias in the firm age distribution, if the entry cost is sufficiently high. Empirically, we also find supportive evidence that, among a set of European countries, firm entry/exit rates are higher in countries with higher inflation rates. Then, calibrating the model to the E.U. economy, we verify that lower inflation leads to declining business dynamism under empirically plausible values of entry, exit, and inflation rates.