DP16205 Productivity, Profitability and Growth

Author(s): Marek Ignaszak, Petr Sedlacek
Publication Date: May 2021
Keyword(s): demand, Firm Heterogeneity, growth, Innovation, R&D, selection
JEL(s): D21, E24, L1, O31, O33
Programme Areas: Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16205

Recent empirical evidence suggests that firm selection and growth are largely demand-driven. We incorporate this feature into a model of endogenous growth in which heterogeneous firms innovate and survive based on profitability, rather than productivity alone. We show analytically that firm-level demand variation impacts aggregate growth by changing firms' incentives to innovate. Estimating our model on U.S. Census firm data, we quantify that 20% of aggregate growth is demand-driven and that the macroeconomic impact of growth policies is fundamentally different compared to a model driven by productivity variation alone. We find empirical support for our model mechanism in firm-level data.