Jovanovic and MacDonald (1994) propose a model that is consistent with the observed shakeout of firms as product markets mature. They postulate that at the beginning firms all use a common technology, but over time a new technology emerges which offers low unit costs but higher level of output per firm. The transition to the new technology involves a shakeout of first generation firms, and the survival of a smaller number of firms which employ the new largerscale technology. Klepper (1996) combines a stochastic growth process for firms who enter by developing some new products, with the idea that each firm spends some fixed amount to lower its unit costs. Assuming some imperfection in capital markets and inertia in sales, larger firms will invest more on fixed costs for product innovation, and over time tend to displace smaller firms generating the shakeout.

The presence of high turbulence in most markets is consistent with the _active learning model_ developed by Ericson and Pakes (1995).<sup>4</sup> In their model, a firm explores its economic environment actively and invests to enhance its profitability under competitive pressure from both within and outside the industry. Its potential and actual profitability changes over time in response to the stochastic outcomes of the firm’s own investment, and those of other actors in the same market. The firm grows if successful, shrinks or exits if unsuccessful.

Vintage models of technological change also offer possible explanations for the observed regularities in firm dynamics and performance. These models stress that new technology is often embodied in new capital which often requires a retooling process in existing plants (see _e.g_ . Solow, 1960; Cooper, Haltiwanger and Power, 1997). Related to this idea are models ( _e.g_ . Caballero and Hammour, 1994; Mortensen and Pissarides, 1994; Campbell, 1997) that emphasize the potential role of entry and exit: if new technology can be better harnessed by new firms, productivity growth will be dependent upon the entry of new units of production that displace outpaced establishments. Moreover, the existence of sunk costs implies that new firms using the “state-of-the-art” production technology coexist with older and less productive firms generating the observed heterogeneity.

In this paper, we look at harmonized firm-level data for several industrial, transition and developing countries to seek confirmation of the statistical regularities highlighted in previous studies and to assess the possible sources of firm heterogeneity exploiting cross sectoral and well as cross-country variations. As such, this is the first paper, to our knowledge, to exploit a crosscountry sample beyond industrialized countries.

# **_The Role of Market Structure and Institutions_**

It is tempting at first glance to hypothesize that countries -- and/or sectors -- where the creative destructive process is distorted in some manner will have less churning and lower productivity levels and productivity growth rates. Indeed, it is not hard to take extreme versions of the models discussed in the prior section and generate just this prediction. That is, making entry and exit (and adjustment more generally) prohibitively costly via distorted market structure and institutions will lead to a reduced pace of churning and lower productivity (see, e.g., Davis and Haltiwanger, 1999 for the illustration of this prediction in a calibration exercise using an extreme example where all reallocation is shutdown). Taken literally, this prediction can be tested by examining the variation by country, sector and year in our harmonized data and relating

> 4. Various empirical papers have attempted to identify passive and active learning processes. For example, using US data, Pakes and Ericson (1998) claim that manufacturing firms are more consistent with the active learning model whilst retailing firms are more consistent with the passive learning model.

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