MACRO: Scalable Expertise; Professor Venky Venkateswaran (New York University)

Abstract

We develop and test a theory of firm size and scope centered on the scalability of a firm’s expertise, i.e. the extent to which its knowledge can be applied across multiple units (products, markets, or locations). In the model, heterogeneous firms choose scope along with the level and scalability of its expertise. A central mechanism of the model is the two-way feedback between scope and scalability, which amplifies the firm’s response to changes in demand in a heterogeneous fashion. Firms whose expertise is more scalable have endogenously higher returns to scale, i.e. exhibit stronger responses to the same changes in demand. This also implies that when scalability and size are positively correlated, a rise in industry demand can increase concentration. Despite its parsimony, the model generates a rich set of testable predictions about which firms respond more to common shocks and the margins along which they adjust. We provide support for these predictions using data on multi-product and multi- establishment firms across several different contexts. We show that, in line with the theory, firms with higher size and scope exhibit stronger responses to demand changes. We also construct a novel measure of firm-level scalability using detailed product characteristics and use it to perform deeper and more direct tests of the theory. Finally, we show that innovations by scalable firms tend to diffuse more quickly to other firms, suggesting that changes in scalability can have larger effects on productivity beyond the firm.

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