The Impacts of Demand and Productivity Shocks on Product Dynamics: Evidence From Japanese Product and Firm Level Data

How do the addition of new products and the dropping of old products by incumbent firms interact with aggregate economic activities over the business cycle? This paper empirically examines the effects of demand and supply shocks on product dynamics by constructing a unique firm-product data set from the Japanese Census of Manufactures. The data are available annually and are more disaggregated than comparable U.S. data, showing that product adding and dropping by incumbent firms contributes to fluctuations of aggregate shipments much more than firm entry and exit. Extending the Dekle et al. [(2015). Dynamics of firms and trade in general equilibrium. USC-INET Research Paper No. 15-12] model, we regress the gross adding rate of new products of individual firms on aggregate shocks to find that shocks that increase foreign demand have positive effects on the gross adding rate of new products. The expansionary foreign demand shocks also increase the gross dropping rate, implying creative destruction. We also find that liquidity facilitates gross product creation for firms with high total factor productivity (TFP). Our empirical results shed light on the propagation mechanism of aggregate shocks on the business cycle through intangible capital accumulation of individual firms in the medium run.