6  Preliminary life cycle dynamics

Section 4 discussed the contribution from firm entry and exit to industry labour productivity growth. As noted in that section, the entry and exit components of the FHK and GR decompositions measure the contribution from entering and exiting firms for the first and last years of their lives respectively. For entering firms, this means that firms that survive beyond one year are classified as continuing firms in subsequent years. Therefore, although most entering firms make a negative contribution to industry labour productivity growth in the first year of their lives, because their entry level of labour productivity is lower than the average level of labour productivity for the industry, at a later point in their life cycle they may begin to make positive contributions to industry labour productivity growth.

To provide some insight into labour productivity dynamics of entering firms, Figure 6 shows the evolution for cohorts of entering firms between 1995 and 1999 conditional on survival in 2003.[10] The average labour productivity of each cohort is indexed at 100 for the year of entry for ease of comparison.

Figure 6 – Growth of entering firms

Figure 6 indicates growth in the average labour productivity of a cohort of entering firms is usually quite strong in the second year. With the exception of the 1999 cohort where average labour productivity declines by around 14% (which may be owing to the recession of the late 1990’s), the average labour productivity growth of the other cohorts range between 11% and 16%. This will add to the within component of both the GR and FHK decompositions. The contribution to the between component of both the GR and FHK decompositions from entering cohorts in the second year is likely to be negative, even if firms experience an increase in labour input shares, because most entering firms have lower labour productivity than the industry average. It is therefore not clear whether entering firms in general will make positive or negative contributions to labour productivity growth in their second year of life. Conditional on survival the average annual labour productivity growth for each cohort of firms to 2003 is: 6% for the 1995 cohort; 11% for the 1996 cohort; 9% for the 1997 cohort; 12% for the 1998 cohort; and 3% for the 1999 cohort. Furthermore, the average labour input share for each cohort also tends to increase over time.

The opposite pattern to that seen for entering firms can be seen in the evolution of labour productivity for firms as they approach the year that exit occurs. Figure 7 shows the evolution of labour productivity for the 1995 population of firms that exit between 1999 and 2003. The average labour productivity for the cohort of exiting firms is indexed at 100 in the year that exit occurs. Figure 7 shows that cohorts of exiting firms from the population of firms in 1995 generally experience static or declining labour productivity as they approach the year that they exit. The average labour input share of each cohort also declines through time by approximately 4% per annum.

One interesting observation is that most cohorts of exiting firms experience a slight improvement (or a reduction in the rate of decline) in labour productivity over the year immediately prior to their exit. This could be due to a number of factors such as shedding labour, running down inventories or acquiring new capital in an effort to remain in operation.

Figure 7 – Growth of exiting firms, 1995 population of firms