Markups, Firm Scale, and Distorted Economic Growth

We study the dynamic consequences of markups for long-run economic growth in a general equilibrium theory of firm-driven endogenous technological change. In this environment, differentiated firms engage in monopolistic competition, charge heterogeneous markups and make forward-looking investments in R&D to improve their process efficiency. Markups constrain the scale at which these firms operate and therefore distort their incentives to make sunk investments in R&D. With dispersion in markups, both the aggregate and cross-firm allocations of such investments are thus inefficient. Using firm-level administrative data from France to discipline our model, we find that transfers inducing firms to operate at the efficient scale increase the long-run growth rate of total-factor productivity by 1.2 percentage points. Nearly 75% of this faster productivity growth can be achieved by simply reallocating R&D resources across firms, revealing that it is the dispersion in markups, rather than their average level, that is more distortionary to economic growth.