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The Scarring Effect of Recessions

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Author Info
Min Ouyang () (Department of Economics, University of California-Irvine)

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Abstract

Recessions often coincide with intensified restructuring. The conventional Schumpeterian view argues that recessions promote allocative efficiency by driving out less productive firms and freeing resources for more productive uses. This paper proposes that the conventional cleansing effect is offset by a scarring effect. Recessions impede the development of potentially superior firms, which might put innovations to better uses, but which are destroyed during their infancy, and never realize their potential. A model of industry dynamics that combines Schumpeterian creative destruction with firm learning is developed to capture both the cleansing and scarring effects. Calibrating the model with data from the U.S. manufacturing sector demonstrates that the scarring effect is likely to dominate the cleansing effect, and accounts for the procyclicality of average labor productivity, a phenomenon at odds with conventional cleansing models.

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Publisher Info
Paper provided by University of California-Irvine, Department of Economics in its series Working Papers with number 050609.

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Length: 40 pages
Date of creation: Nov 2005
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Handle: RePEc:irv:wpaper:050609

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Postal: Irvine, CA 92697-3125
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Keywords: Business cycles Cleansing effect Scarring effect Creative destruction Learning Job flows

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Find related papers by JEL classification:
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
L16 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Industrial Organization and Macroeconomics; Macroeconomic Industrial Structure
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Carlos Carreira & Paulino Teixeira, 2007. "Internal and External Restructuring over the Cycle: A Firm-Based Analysis of Gross Flows and Productivity Growth in Portugal," GEMF Working Papers 2007-01, GEMF - Faculdade de Economia, Universidade de Coimbra. [Downloadable!]
  2. Min Ouyang, 2006. "Plant Life Cycle and Aggregate Employment Dynamics," Working Papers 050632, University of California-Irvine, Department of Economics. [Downloadable!]
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