Economic growth and the rise of large firms

Economic growth and the rise of large firms

The disparity in the size distribution of business firms between rich and poor countries has long been a subject of interest among economists. Recent research by Zhang Chen has shed light on how this disparity evolves with economic development, both within countries over time and across different nations. Chen's study, which will be published in Econometrica, explores the systematic thickening of the right tail of the firm size distribution as economies grow.

To understand this phenomenon, Chen develops a simple idea search model that incorporates both endogenous growth and an endogenous firm size distribution. This model provides a framework for analyzing how economic development affects the size of firms and the overall structure of the economy. The economy in the model features an asymptotic balanced growth path, meaning that it eventually stabilizes and grows at a constant rate.

Along the transition to this balanced growth path, Chen's model shows that Gibrat's law holds at each date. Gibrat's law, which states that the growth rate of firms is constant on average, is a well-established empirical observation in economics. However, the model also demonstrates that the right tail of the firm size distribution becomes monotonically thicker over time. This means that as the economy develops, there is a growing proportion of very large firms relative to smaller ones.

Ultimately, the firm size distribution in Chen's model converges to Zipf's distribution. Zipf's law, which posits that the frequency of an item is inversely proportional to its rank in a distribution list, is often used to describe the size distribution of cities, income, and other economic phenomena. The convergence to Zipf's distribution suggests that the economy becomes more unequal in terms of firm sizes as it develops, with a small number of large firms dominating the market.

Chen's research also has important implications for policy. The model indicates that policies that favor large firms can improve welfare due to the externality associated with idea search. In other words, large firms tend to invest more in research and development, which can spill over to smaller firms and stimulate overall economic growth. This suggests that policymakers should consider the role of large firms in driving innovation and productivity, and potentially support measures that encourage their growth.

Furthermore, Chen extends the results obtained in the simple model to a general class of idea search models. Under common functional form assumptions, this model stands out as the only one within the class that is consistent with both Gibrat's law and a thickening right tail. This makes it a valuable tool for understanding the complex interplay between economic growth, firm size distribution, and policy interventions.

In conclusion, Chen's study highlights the intriguing relationship between economic growth and the size distribution of firms. As economies develop, the proportion of large firms tends to increase, leading to a more unequal distribution of economic power. While this may have negative consequences for competition and social welfare, it also underscores the importance of large firms in driving innovation and economic progress. As such, understanding this dynamic is crucial for crafting effective economic policies that balance these competing priorities.