Does firm exit promote innovation and thus growth?

This study investigates the roles of firm destruction (exit ratios) and creation (entry ratios) in innovation and economic growth. Although destruction is often seen as a byproduct of innovative activities, its relationship with productivity and growth remains unclear. To disentangle these dynamics, a vector error correction model is employed to analyze the effects of exit and entry ratios on production, innovation, and growth. Using time-series data from the US and Canada, the empirical results indicate that exit ratios have a positive influence on the growth rate through the “innovation channel,” augmenting total factor productivity (TFP). Conversely, entry ratios positively impact the growth rate through the “production channel,” enhancing gross domestic product (GDP). Despite their positive effects on growth, entry ratios are negatively associated with TFP, while exit ratios negatively affect GDP. These findings underscore the distinct mechanisms through which exit and entry ratios contribute to growth.