1. Entry Regulation and Intersectoral Reallocation Antonio Ciccone and Elias Papaioannou UPF Dartmouth College NBER Summer Institute – Macroeconomics and Productivity July 2008

2. 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

3. 3 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

4. 4 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

5. 5 Presentation Overview 1.Theoretical model 1.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

6. 6 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

7. 7 V(n,i)V(n,i) A(V,n,i)A(V,n,i) 0 Technology Shocks and Varieties Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Introduction – Model – Estimation – Empirical Results – Conclusion

8. 8 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

9. 9 Profit Maximization Employment and Varieties z(v,n,i)z(v,n,i) 0V Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Introduction – Model – Estimation – Empirical Results – Conclusion

10. 10 V z(v,n,i)z(v,n,i) 0V(n,i)V(n,i) Zero-Profit Variety Range z 0 ni Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Introduction – Model – Estimation – Empirical Results – Conclusion

11. 11 Adjustment to Global Sectoral Shocks Shocks to technology (A ni ) 3 components: 1.country level (ρ n ) 2.industry level (σ i ) 3.country industry level (u ni ) Key role for industry adjustment Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Introduction – Model – Estimation – Empirical Results – Conclusion

12. 12 Frictionless Intersectoral Adjustment Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Introduction – Model – Estimation – Empirical Results – Conclusion

13. 13 0 Adjustment with Country-Industry Specific Entry Restrictions Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Introduction – Model – Estimation – Empirical Results – Conclusion

14. 14 Extensive Margin OnlyIntensive & Extensive Margin Industry Employment Growth Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Introduction – Model – Estimation – Empirical Results – Conclusion

15. 15 0 Industry Shock Employment Growth Economy with less restricted entry Economy 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

16. 16 Adjustment with Country-Specific Entry Restrictions Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Introduction – Model – Estimation – Empirical Results – Conclusion

17. 17 Industry Employment Growth and Global Shocks Quadratic approximation in  and Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Introduction – Model – Estimation – Empirical Results – Conclusion

18. 18 Model Estimating Equation 1 Industry frictionless global employment growth Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Model Estimating Equation 2 Introduction – Model – Estimation – Empirical Results – Conclusion

19. 19 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

20. 20 2 Proxy Measures of Frictionless Employment Growth 1.US Employment Growth (US-EMPGR i ) 2.Global Frictionless Employment Growth (G-EMPGR i ) Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Introduction – Model – Estimation – Empirical Results – Conclusion

21. 21 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

22. 22 Preliminary evidence: Model prediction of negative relationship between frictionless employment growth and the marginal industry effect of entry delays 0 US-EMPGR i or G-EMPGR i ii Frictionless employment growth Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Introduction – Model – Estimation – Empirical Results – Conclusion

23. 23 Marginal Effect of Entry Delays and Frictionless Employment Growth in the 1980s Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation Introduction – Model – Estimation – Empirical Results – Conclusion

24. 24 Marginal Effect of Entry Delays and Frictionless Employment Growth in the 1990s Introduction – Model – Estimation – Empirical Results – Conclusion

25. 25 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. Introduction – Model – Estimation – Empirical Results – Conclusion Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation 1 st Stage Figures

26. 26 IV Estimates – Combining the two proxy measures of frictionless employment reallocation Ciccone Papaioannou: Entry Regulation and Intersectoral Reallocation 1 st Stage FiguresIntroduction – Model – Estimation – Empirical Results – Conclusion

27. 27 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

28. 28 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