Measured in terms of firm entry and exit rates, business dynamism in the euro area has weakened markedly over the last twenty years, according to the current Monthly Report. At the same time, aggregate productivity growth has slowed. The authors assume that these developments are interrelated. They note that firm entries and exits are important for the efficient distribution of production factors and thus for productivity – when new firms enter the market, competition intensifies and competitors are under more pressure to innovate. As a result, less profitable firms exit the market and new firms gain access to production resources and sales markets. 

One particular challenge for the analysis lies in the difficult data situation. In addition to conceptual changes in data collection, data gaps hamper analyses of euro area business dynamism. Nevertheless, it can be shown that the declining business dynamism is broad across regions. The picture is also quite uniform at the economic sector level. 

Possible reasons for the slowdown in dynamism: cyclical factors

According to the experts, the rate of firm entries and exits depends on various factors. First, cyclical factors, such as the economic situation: typically, more firms are established in upturns, while more tend to be closed in downturns. The study states that increased uncertainty in times of crisis could also permanently dampen firm entries. This might explain why the firm entry rate in the euro area remained so weak in the years following the global financial and economic crisis and the subsequent European sovereign debt crisis.

Policy responses to macroeconomic developments can likewise have an impact on business dynamism, the authors explain. The German government’s programme to stabilise the economy during the COVID-19 pandemic, for instance, had reduced the probability of firms exiting the market. 

Possible reasons for the slowdown in dynamism: structural factors

According to the study, however, structural as well as cyclical factors are at play, as firm entry and exit rates were declining even before the global financial and economic crisis. 

One possible cause could be demographic change: as a population ages, the supply of labour declines. There is also evidence that innovation and the willingness to take risks tend to diminish as people get older, the Bundesbank’s economists write. Yet these factors play a key role in setting up businesses. A functioning legal system and efficient administration likewise constitute important frameworks for business activity. For example, they point out, insufficient protection of intellectual property, corruption or a high administrative burden have a negative impact on business start-ups. 

The Bundesbank sees a need for reforms in order to stimulate business dynamism

The authors identify potential for reform at the European, but especially at the national level. For example, policy measures aimed at improving the institutional and regulatory frameworks could help to sustainably boost business dynamism and thereby also to strengthen productivity growth. The Bundesbank’s economists further stress the importance of a dynamic business landscape for the digital and the ecological transformation of the European economy: To capitalise on the potential offered by digitalisation, access to sales markets and production resources must be facilitated for innovative start-ups, the study states. The transition to a low-emission economy also calls for a dynamic market environment.