Exit and entry of firms are fundamental elements behind the structural changes in different industries. To investigate forces underlying the establishment of new firms and closing down firms is very important, both for understanding industrial change, and from an economic policy point of view. The importance of industrial dynamics and firm entry and exit has been recognised since the early 20th century. Perhaps the most influential contributions in this area are made by Schumpeter (1942) who discussed the concept of creative destruction“. According to Schumpeter the most important form of competition comes from the new commodity, new technology, the new source of supply, the new form of organisation.“ (Schumpeter, 1942 p. 84-85).
The creative destruction approach clearly emphasizes the competition aspects of industrial dynamics. In contrast to the competition approach, theories of agglomeration suggest there are important interrelationships between firms that influence new firm formation and exit of firms. One also has to consider the demand side effects of new firm formation and firms that close down. These two types of theories instead suggest that there might be cumulative effects of firm entry and exit. Both of these forces can be expected to be working at the same time. The question is which force is the most important? Do previous entry cause exits or do entry stimulate new firm formation? What are the interrelationship between entry and exit? These are questions that we intend to answer in this paper.
The result of earlier empirical work on entry and exit differs substantially between different studies depending on industries, countries and time periods studied and methodology used. It is therefore important to take time specific and industry specific effects into account in the empirical analysis. The time specific effect makes it possible to control for differences in the level of entry and exit rates over the business cycle.
An investigation with Swedish data of the relationship on the relationship between entry and exit of firms is not yet available and would be of interest for both researches who want to know more about industrial change and for politicians who try to stimulate entry and keep exit rates at a low level. Methodologically the paper contributes to the existing literature on firm entry and exit by using the tools offered by recent developments in panel data econometrics (especially methods of dynamic panel data).
The paper is organised as follows: The theoretical framework is presented in section two. In particular the two major competing forces determining the relationship between entry and exit are expanded upon; multiplier effect versus competitive effect. Section three presents an overview of previous studies on the relationship between entry and exit of firms. In section four the data and variables included in the study are presented. Section five presents the econometric tools used, focusing on methods for dynamic panel data estimation. The empirical results are presented in section six. Finally conclusions and suggestions for future research are presented.
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Interdependencies in the Dynamics of Firm Entry and Exit
