Entry and Productivity Growth: Evidence from Microlevel Panel Data

GAICIL Insights

Domestic champions often lobby against foreign entrants.¹ This paper, using UK evidence from the 1980s, suggests the entrants may have helped them. Entry and Productivity Growth: Evidence from Microlevel Panel Data, by Philippe Aghion, Richard Blundell, Rachel Griffith, Peter Howitt and Susanne Prantl, exploits UK policy reforms that opened the economy during the 1980s, with panel data on British establishments, to ask how new firms' entry affects incumbents' productivity.

The central finding: more entry, measured by a higher share of industry employment in foreign firms, led to faster total factor productivity growth of domestic incumbent firms and thus faster aggregate productivity growth. Entry spurred incumbents to improve. The newcomer raised the house's game.

The result is robust. The EU Single Market Program as a major policy reform, together with information on the technological situation abroad, controls for the endogeneity of foreign entry. Cross-industry and time-series variation in these instruments separates the entry effect from other factors.

Innovation is the interpretation. Entry spurs incumbent growth by inducing those close to the technological frontier to innovate to escape entry. Facing more efficient entrants, frontier incumbents invest in innovation to stay ahead. The threat works because the capable can answer it.

Alternatives get careful scrutiny. Selection, with entrants driving out poorly performing incumbents, might drive the aggregate effect, yet results are robust to allowing each establishment its own permanent level of productivity growth, possibly correlated with entry, so selection does not explain all the variation. Another possibility is that entrants demonstrate new methods and goods to incumbents, whose superior methods spill over. Competition and teaching may work together.

Where does this leave AI? Artificial intelligence entrants, startups and firms entering from other sectors or countries, can pose a competitive threat to incumbents. Such entry can spur incumbents near the frontier to innovate, raising their productivity. Openness to AI-driven entry may benefit the economy by pushing incumbents to improve. A protected incumbent may be a slower incumbent.

Escape entry is the engine. Incumbents near the frontier can respond to entry threats by innovating. In AI, the threat of entrants with superior technology can drive established firms to adopt AI and improve products. Keeping markets contestable sustains the pressure. An incumbent that never fears entry never needs to hurry.

Foreign entry is the notable channel. Entry is measured by foreign firms' employment share. International openness brings firms with advanced technologies and practices. For AI, openness to foreign investment and firms can bring frontier technology and competitive pressure, benefiting domestic incumbents and the economy. Restricting foreign AI firms may protect domestic incumbents from exactly the pressure that would improve them.

Spillovers complete the picture. Entrants may demonstrate methods incumbents adopt. AI-enabled entrants can show incumbents how AI applies in practice, speeding diffusion. Learning effects complement competitive pressure in raising productivity. The rival's product is also a free demonstration.

The reform-based design strengthens the evidence. Using the opening of the UK economy and the EU Single Market Program as variation provides credible evidence on entry effects. Similar natural experiments could illuminate AI-driven entry.

On policy, entry raises incumbent productivity, especially near the frontier. Reducing entry barriers, including for foreign firms, strengthens competition and innovation. As AI creates new entry opportunities, open, contestable markets help economies capture productivity gains.

Pulled together, entry is a powerful driver of productivity growth. Foreign entry into the United Kingdom led to faster productivity growth among domestic incumbents, individually and in aggregate. As AI enables new entrants to challenge established firms, openness to entry will help competitive pressure spur innovation and productivity across the economy.

A question worth carrying into AI openness debates, with the caveat that the evidence comes from 1980s Britain: if foreign entry pushed frontier incumbents to innovate then, what pressure would domestic AI firms lose if foreign rivals were kept out?