Heterogeneous Distributions of Firms Sustained by Innovation Dynamics – a model with an empirical application

This paper develops a framework to appreciate the observed heterogeneity of firm size distributions and the entry and exit of products and firms associated with it. It is based on a model where new products are introduced by innovating firms in a quasi-temporal setting of monopolistic competition. The rate at which a firm innovates, according to a firm-specific Poisson process, is assumed to be influenced by the firm’s past experience and cumulated knowledge assets. The model assigns a fundamental role to entrepreneurship of existing and potential firms. The empirical analysis is based on detailed firm-level export data, which describes firm size in terms of products and markets, and firm dynamics in terms of changes in the supply pattern (varieties and markets) of existing firms in combination with entry/exit of firms. The empirical results are consistent with the model. First, the modeled innovation process imply a persistent distribution of heterogeneous firms. Second, the invariant size distribution of firms is associated with significant micro-dynamics, where firms continuously add and subtract varieties from their product mix, and new firms may enter while some exit. Third, an econometric analysis where firms’ introduction of new varieties is explained by firm attributes provides support for the assumption of a firm-specific and state-dependent stochastic innovation process.