Abstract
This paper critically discusses the most common methodology for decomposing productivity change into inter- and intra-firm effects. It is argued that the methodology can be improved to explicitly take the role of structural transformation into account, and by so doing, a potential source of bias in the results is corrected. This requires the use of a tool from the field of theoretical evolutionary biology: Price’s equation. A review of a sample of studies that apply decomposition analyses shows that the methodology is best suited for studies of the evolution of labour productivity and the reallocation of labour. Based on Danish data for 1992–2010, it is then demonstrated how the results of decomposition analyses can be considerably improved by the explicit inclusion of levels in the selection process. In the specific analysis conducted by the current paper, economic selection among industries is included. It is found that the structural transformation of the economy has a large impact on the results of decomposition studies, not least on the magnitude of the inter-firm selection effect. Structural transformation from capital-intensive and thus high-labour-productivity manufacturing towards labour-intensive and thus low-labour-productivity services entails that the traditional methodology is biased downwards in its measure of economic selection. Finally, it is demonstrated that the length of the interval studied, while often determined by data limitations, has a significant but predictable effect on the results, and it is tentatively demonstrated that economic selection tends to be stronger in the trough of the business cycle.
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Notes
Potentials for widening the definition of evolution when using Price’s equation are discussed in Andersen and Holm (2014).
A process of this nature is, for example, seen in the manufacturing of computers, where the consumer price index shows 80 % deflation in Denmark for the 2000–2013 period.
Schumpeter (1947), pp. 84–85 argued that reallocation of market shares through price cutting is as effective relative to innovation, as “forcing a door” is effective relative to “a bombardment”. Thus, the evolution of the economic system is comparatively indifferent to whether price competition functions. The results of Coad and Teruel (2013) show that changes in the total size of a market far outweigh the effect of competitors’ growth on any given firm.
The use of pre- and post-evolution is not intended to signal that evolution starts and stops. It is intended to distinguish between the population before and after the change in the mean characteristic.
Original Danish name: Firma- og Ressourceområdestatistik.
Danish: General Erhvervsstatistik.
Available from www.statistikbanken.dk
The results reported in the paper all rely on four-digit codes. Results for two- and three-digit codes are available upon request.
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Acknowledgements
This paper is partially based on a chapter from my PhD thesis from 2011, and I am grateful to my supervisors: Esben Sloth Andersen and Christian Richter Østergaard, and to my evaluation committee: Jan Fagerberg, Luigi Marengo and Bart Verspagen for their constructive feedback. I am also indebted to the participants of the 1st IWH ENIC Workshop in Halle, July 2013, to Alex Coad and to two anonymous reviewers for their constructive feedback on the current version. Any remaining errors are entirely my own.
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Holm, J.R. The significance of structural transformation to productivity growth. J Evol Econ 24, 1009–1036 (2014). https://doi.org/10.1007/s00191-014-0380-6
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DOI: https://doi.org/10.1007/s00191-014-0380-6