shrinking firms) than most continental European countries (Figure 3). Across countries, high-growth firms (HGFs) make a disproportionate contribution to employment growth: HGFs account only for between 3.6 and 6.4% of all surviving firms, yet they account for between 25.5% (Austria) to 64% (UK) of all jobs created by surviving firms. However, non-HGFs still account for between 1/3 and 3⁄4 of job creation (and the underlying reallocation and innovation), highlighting the need to consider the full growth distribution when designing policies to foster desirable reallocation and innovation.

This and related studies highlight the importance for reallocation and innovation of: (1) flexible product market (entry and competition) regulations, with less stringent regulations in manufacturing industries associated with higher allocative efficiency, and reforms in services markets regulations having stronger effects on resource allocation when labor and credit markets are more responsive (Andrews and Cingano 2012) (2) flexible labor market regulations, lowering the costs of downward adjustment, spurring greater risk taking, faster job reallocation and increasing productivity growth in R&D intensive and labor-intensive sectors, with firms less willing to expand their workforce or enter into new markets if they cannot reduce their workforce later if their reallocation and innovation decisions prove unsuccessful (Andrews and Criscuolo 2013, and Bartelsman et al. 2010 and 2013)<sup>55</sup> (3) more developed financial markets, regulations that encourage banking competition and an efficient judicial system that enforces contracts on the growth distribution of firms, boosting the growth of the best performing firms and speeding up the contraction of underperforming firms in industries highly dependent on external finance (Dutz et al. 2012a)<sup>56</sup> (4) bankruptcy laws that are not excessively stringent, as they impose high exit costs in the event of business failure and therefore may make entrepreneurs less willing to experiment with risky technologies; with more debtor-friendly bankruptcy codes being associated with more rapid technological diffusion, enabling countries to catch-up with the technological frontier (Westmore 2013).<sup>57</sup> Importantly, R&D fiscal incentives may have the unintended consequence of protecting incumbents and slowing down the reallocation of resources towards more innovative entrants. Fiscal incentives for R&D, a market-based tool intended to support R&D activities that otherwise would not have taken place by reducing the marginal cost to firms of R&D activities, are increasingly being used in developing countries (including Brazil, Chile, China, India, Poland, Russia, and Turkey), in addition to being widely used in 55 Bartelsman et al. (2010) describe how firing costs reduce the incentive for firms to attempt adopting risky technology, impeding flexibility to be able to reorganize operations to best fit the technology (firms that turn out to be unsuccessful in adopting new risky technologies need to be able to avoid deep losses, otherwise the incentive for adoption is lost). More generally, any regulation that becomes more burdensome at some size threshold is shown by Bartelsman et al. (2013) to generate significant welfare losses from misallocation.

56 Based on an econometric analysis of over 26,000 manufacturing enterprises across 71 countries, Dutz et al. (2012a) find that countries with a more competitive business environment (measured by Doing Business variables interpreted as reflecting access to key essential business services, especially access to credit and to registering property) are associated with more innovation and more inclusive-type job creation. Access to information (Internet use) and formal job training are much more important to the employment growth of young enterprises than they are to other categories of enterprises.

57 The direction of the link between bankruptcy regimes and innovation is less clear-cut and varies according to the capital intensity and the dependence on external finance of the industry, as loose bankruptcy regulation with weaker creditor rights also attenuates the creditors’ insurance effect and thereby increases the cost of raising external finance. For a review of recent empirical evidence, see Andrews and Criscuolo (2013).

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