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

How do the adding 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 an unique firm-product data set from the Japanese Census of Manufactures. The data are available annually and are more disaggregated than comparable US 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, Jeong and Kiyotaki (2015) 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 creations for firms with high 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.