Financing Constraints, Radical versus Incremental Innovation, and Aggregate Productivity

By Andrea Caggese

I provide new empirical evidence on a negative relation between financial frictions and productivity growth over firms’ life cycle. I show that a model of firm dynamics with incremental innovation cannot explain such evidence. However also including radical innovation, which is very risky but potentially very productive, allows for joint replication of several stylized facts about the dynamics of young and old firms and of the differences in productivity growth in industries with different degrees of financing frictions. These frictions matter because they act as a barrier to entry that reduces competition and the risk taking of young firms.

After the last recessions, many people have called for adding frictions in the financial sector and for reducing risk-taking. This paper seems to be advocating the exact opposite if we want to raise the productivity growth rate, which has indeed been lagging recently. Should the pendulum swing back now?


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