Product market regulation, business churning and productivity: Evidence from the European Union countries

This paper empirically investigates the effects of product market regulation on business churning (i.e. entry and exit of firms) and their impacts on productivity, using annual data for the period 2000-2014 across individual EU countries and sectors. The paper hypothesises that product market reforms, which reduce entry barriers and increase the degree of competition, can allow new firms to enter the market and compete vis-à-vis incumbent firms. The higher competitive pressures can push competitive incumbent firms to innovate while other less productive and inefficient firms may exit. These possible mechanisms can result in improvements to the average industry-level productivity. By using business demography data (i.e, business churning) at the industry and firm size level, we perform a panel data analysis across European countries and sectors to evaluate the effect of product market regulation on firm churning and their impacts on productivity. In particular, we differentiate between micro (less than 10 employees) and other firms given the substantial degree of heterogeneity among these two size classes both in terms of business churning and productivity growth. The paper finds that reducing product market regulation increases business dynamism (i.e. increases the churn rate) by facilitating firms’ entry and exit which, in turn, boosts sectoral total factor productivity.