By Fabrice Collard and Omar Licandro
This paper embeds firm dynamics into the Neoclassical model and provides a simple framework to solve for the transitional dynamics of economies moving towards more selection. As in the Neoclassical model, markets are perfectly competitive, there is only one good and two production factors (capital and labor). At equilibrium, aggregate technology is Neoclassical, but the average quality of capital and the depreciation rate are both endogenous and positively related to selection. At steady state, output per capita and welfare both raise with selection. However, the selection process generates transitional welfare losses that may reduce in around 60% long term (consumption equivalent) welfare gains. The same property is shown to be true in a standard general equilibrium model with entry and fixed production costs.
This is a really neat paper with an interesting solution and an interesting result. However, it assumes perfect competition as selection becomes stronger. I wonder how welfare results would change as markets likely become less competitive in such a case.
The main point of the paper is to show that selection entails high transitional costs due to destruction even in economies that are perfectly competitive (with more selection been Pareto improving). We benefit from a modelling design allowing the use of standard techniques to solve the dynamic problem of an economy with heterogeneous firms. This model design may be extended to economies with imperfect competition which will allow us to answer your concern. For example, we have in our agenda to analyse the transition of the Melitz (Econometrica, 2003) model from the perspective of the sufficient statistics approach suggested by Arkolakis, Costinot and Rodriguez-Clare (AER, 2012). I hope we will be able to tell you more soon.
Thanks for mentioning the paper.
We hope the paper will help better tackle the transition of selection in models of firm dynamics. We make indeed a specific assumption, but while the price today is not that high, it helps delivering lots of insights regarding the transition and the welfare properties associated with selection.