Entry Regulation and Intersectoral Reallocation

Antonio Ciccone and Elias Papaioannou

UPF Dartmouth College

NBER Summer Institute – Macroeconomics and Productivity

July 2008

2

Motivation: Entry Restrictions and Productivity

How do entry restrictions affect intersectoral factor reallocation when open economies are hit by global industry shocks?

- Multi-sector world equilibrium model where countries put upper bound on entry of new varieties.

- Implies that in response to global sectoral shocks there is less factor reallocation in economies with tighter restrictions compared to frictionless benchmark.

- Test this prediction in 1980s and 1990s using 2 proxies for frictionless benchmark reallocation.

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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Existing Theoretical Literature

Entry costs economic efficiency - Technology adoption (e.g. Parente and Prescott, 1994)

- Industry efficiency (e.g. Hopenhayn, 1992)

- Product variety (e.g. Dixit and Stiglitz, 1978)

- Market power (e.g. Stigler, 1971).

- Entrepreneurship and employment (e.g. Pissarides et al., 2001)

Focus here

- Interaction between entry restrictions/delays and economic shocks

- Examine link: entry restrictions/delays intersectoral factor reallocation

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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Empirical Literature on Entry Regulation

- Measurement of entry costs and delays

De Soto (1989); Djankov, La Porta, Lopez-de-Silanes, and Shleifer (2002); World Bank (Doing Business Around the World); OECD (Regulation Database)

- Entry regulation and entrepreneurship/growth

Fisman and Sarria-Allende (2004); Klapper, Laeven and Rajan (2006); Nicoletti and Scarpetta (2001, 2002, 2006); Alesina, et al. (2005); Bertrand and Kramraz (2002); Bruhn (2007); Aghion, et al. (2008); Yakovlev and Zhuravskaya (2007); Ardagna and Lusardi (2008).

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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Presentation Overview

1. Theoretical model1. Set-up

2. Equilibrium analysis

3. Global industry shocks and country-level entry restrictions

2. Estimation Issues and Data

3. Empirical Results 1. Preliminary Results

2. Empirical Analysis

4. Conclusion

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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Set-Up, Preferences, and Technology

- Continuum of countries and sectors (each mass=1).- Each sector is made up of freely traded varieties, differentiated by country of

origin.- Range of available varieties is endogenous.- Symmetric Cobb-Douglas preferences across industries (equal expenditure

shares across industries).- Symmetric Constant-Elasticity-of Substitution within industries (substitution

elasticity = > 1). - Labor only production factor- To produce q of a variety, firms need z=q/A production workers and 1 overhead

worker.- There is heterogeneity in productivity A across countries, sectors, and varieties.

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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V(n,i)

A(V,n,i)

0

Vni ni niA A V

0 ( 1) 1

Technology Shocks and Varieties

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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Market Structure and Equilibrium

- Each firm produces a distinct variety and sets price to maximize profits.

- Goods markets clear internationally.

- Wages adjust to clear national labor markets. Labor supply is inelastic and constant in time.

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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( 1)1( )Vni n ni i niz Yw A P V

Profit Maximization Employment and Varieties

z(v,n,i)

0 V

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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V

z(v,n,i)

0 V(n,i)

Zero-Profit Variety Range

z0ni

11

( 1) ( 1)( )ni ni i nV A P Y w

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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Adjustment to Global Sectoral Shocks

Shocks to technology (Ani)

3 components:

1. country level (ρn)

2. industry level (σi)

3. country industry level (uni)

ln ln ( )ni i n i ni ni nA P u

Key role for industry adjustment

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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Frictionless Intersectoral Adjustment

ln ( ) ln ln

( ln | )

f ii ni

f ii i

Industry frictionless employment growth:

L Y w

Labor Market Clearing:

E L

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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0

ln niV

nin

n

/ ln lnn ni nY w

Adjustment with Country-Industry Specific Entry Restrictions

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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ln niL

niExtensive Margin Only Intensive & Extensive Margin

Industry Employment Growth

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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0

Industry Shock

Em

plo

ymen

t G

row

thEconomy with less restricted entryEconomy with more restricted entry

C zone B zone A zone

Industry Shocks and Employment Growth

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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ln niV

nin

Adjustment with Country-Specific Entry Restrictions

n

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

n

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Industry Employment Growth and Global Shocks

( ln | , ) ln ( | )ni i n i ni n uE L L u dF

Quadratic approximation in and

( ln | , )ni i n n i i nE L

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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Model Estimating Equation 1

ln ( ln )+fni n i n i niEMP ED L

Industry frictionless global employment growth

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Model Estimating Equation 2

ln

ln

ni n i i n ni

fi i

EMP ED v

L

Introduction – Model – Estimation – Empirical Results – Conclusion

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Proxies for Frictionless Employment Reallocation in Response to Global Shocks

1. Benchmark-country approach: use data from a country with low levels of entry regulation, where employment growth is unlikely to reflect frictions in product (or labor or capital) markets (Rajan and Zingales, 1998). Idiosyncrasies of benchmark country introduces measurement error. ME does not necessarily take the “classical form.”

2. Global estimation approach: estimate global employment reallocation in a frictionless economy using data on all countries and accounting for the fact that in countries with high barriers to entry (or other institutional frictions) employment reallocation might not reflect industry shocks (Ciccone and Papaioannou, 2006). Does not reflect idiosyncrasies of any country. Must be treated as a generated regressor. (Consistency of estimates under quite weak conditions. Valid standard errors somewhat more complicated. See Wooldridge 2002.)

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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2 Proxy Measures of Frictionless Employment Growth

1. US Employment Growth (US-EMPGRi)

2. Global Frictionless Employment Growth (G-EMPGRi )

ni n i i n ni

i i

EMPGR ED

G EMPGR

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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Data

1. Country-Industry Level (from UNIDO)- Log change in employment (in the eighties and nineties). - 55-45 countries; 27-28 manufacturing industries (more than 1,000 obs.)

2. Country-Level- Entry restriction indicators from Djankov, La Porta, Lopez-de-Silanes and

Shleifer (2002); focus on time to start business (model emphasis on delays)- Other controls (labor market regulation, financial development, income)

3. Industry-level- US Employment growth- Global employment reallocation in a frictionless economy - Other industry measures (external finance dependence, sales growth, etc).

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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Preliminary evidence:Model prediction of negative relationship between frictionless

employment growth and the marginal industry effect of entry delays

ni n i i nEMPGR ED

0 US-EMPGRi or G-EMPGRi

i

Frictionless employment growth

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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Marginal Effect of Entry Delays and Frictionless Employment Growth in the 1980s

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

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coeff. (s.e): -0.2065 (0.0234)

-.01

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ffect

of

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try D

ela

ys in

the

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-.06 -.04 -.02 0 .02 .04Frictionless employment growth in the 1980s

R-squared: 0.762

Introduction – Model – Estimation – Empirical Results – Conclusion

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coeff. (s.e.): -0.1754 (0.404)

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ffect

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-.15 -.1 -.05 0 .05Frictionless Employment Growth in 1990s

R-squared: 0.656

Marginal Effect of Entry Delays and Frictionless Employment Growth in the 1990s

Introduction – Model – Estimation – Empirical Results – Conclusion

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Estimation

1. LS using US industry employment growth to proxy frictionless reallocation

2. LS using estimated global (non-US) frictionless industry employment growth.

3. IV using estimated global (non-US) frictionless industry employment growth as an “instrument” for actual US employment growth.

,n i n i i nEMPGR G-EMPGR ED

Introduction – Model – Estimation – Empirical Results – Conclusion

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

, ,n i n i i US nEMPGR EMPGR ED

, ,

,

n i n i i US n

i US i

EMPGR EMPGR ED

EMPGR a bG-EMPGR

1st Stage Figures

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IV Estimates – Combining the two proxy measures of frictionless employment reallocation

(1) (2) (3) (4) (5) (6)

Administrative Entry Delay X -0.3781 -0.3534 -0.3536 -0.5901 -0.5799 -0.4989Frictionless Employment Reallocation (0.0623) (0.0720) (0.0661) (0.1019) (0.1105) (0.1204)[ED X US-EMPGR ] 0.00 0.00 0.00 0.00 0.00 0.00

Labor Market Regulation X 0.0013 -0.0003Frictionless Employment Reallocation (0.0040) (0.0054)[LMR X US-EMPGR ] 0.76 0.96

Financial Underdevelopment X -0.0156 -0.0149Frictionless Employment Reallocation (0.0034) (0.0042)[FIN-UND X US-EMPGR ] 0.00 0.00

Observations 1428 1386 1349 1001 981 975Countries 55 53 52 43 42 42Industry Fixed-Effects Yes Yes Yes Yes Yes YesCountry Fixed-Effects Yes Yes Yes Yes Yes Yes

Employment Growth 1980s Employment Growth 1990s

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

1st Stage Figures Introduction – Model – Estimation – Empirical Results – Conclusion

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Sensitivity Analysis-Robustness Checks

1. Differential effect of financial development for external finance dependent sectors (Rajan and Zingales, 1998) and sectors with good opportunities (Fisman and Love, 2007).

2. Positive effect of schooling level and schooling accumulation in spurring growth of skill-intensive sectors.

3. Controlling for income.

4. Alternative measures of entry restrictions.

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion

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Conclusion

Potential effect of entry restrictions on intersectoral factor reallocation?

- Slow down the entry of new varieties and therefore intersectoral factor reallocation towards expanding industries.

Do entry restrictions matter for intersectoral reallocation empirically?

- Yes; countries where new businesses can be incorporated more quickly see faster employment growth in globally expanding industries.

Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation

Introduction – Model – Estimation – Empirical Results – Conclusion