Barriers to Reallocation and Economic Growth: The Effects of Firing Costs

We study how factors that hinder the reallocation of inputs across firms influence aggregate productivity growth. We extend Hopenhayn and Rogerson’s (1993) firm-dynamics model to allow for endogenous innovation. We evaluate the effects of firing taxes on reallocation, innovation, and productivity growth. We find firing taxes can have opposite effects on entrants’ innovation and incumbents’ innovation, and the overall outcome depends on the relative strengths of these forces. In the entrant-driven growth calibration, firing taxes reduce aggregate productivity growth, whereas aggregate productivity growth increases in the incumbent-driven growth calibration. (JEL D24, E23, E24, J23, J24, J62, K31, O31, O47)