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The Scarring Effect of Recessions

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  • Min Ouyang

    ()
    (Department of Economics, University of California-Irvine)

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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Bibliographic 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
Date of revision:
Handle: RePEc:irv:wpaper:050609

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Keywords: Business cycles; Cleansing effect; Scarring effect; Creative destruction; Learning; Job flows;

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Cited by:
  1. Can Tian, 2012. "Riskiness Choice and Endogenous Productivity Dispersion over the Business Cycle," PIER Working Paper Archive 12-025, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  2. Lucia Foster & Cheryl Grim & John Haltiwanger, 2013. "Reallocation In The Great Recession: Cleansing Or Not?," Working Papers, Center for Economic Studies, U.S. Census Bureau 13-42, Center for Economic Studies, U.S. Census Bureau.
  3. Dimitris Christopoulos & Miguel León-Ledesma, 2009. "Efficiency and frontier technology in the aftermath of recessions: international evidence," Studies in Economics, Department of Economics, University of Kent 0922, Department of Economics, University of Kent.
  4. Marcela Eslava & Arturo Galindo & Marc Hofstetter & Alejandro Izquierdo, 2010. "Scarring Recessions and Credit Constraints: Evidence from Colombian Firm Dynamics," DOCUMENTOS CEDE, UNIVERSIDAD DE LOS ANDES-CEDE 007711, UNIVERSIDAD DE LOS ANDES-CEDE.
  5. Fackler, Daniel & Schnabel, Claus & Wagner, Joachim, 2012. "Establishment Exits in Germany: The Role of Size and Age," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century, Verein für Socialpolitik / German Economic Association 62025, Verein für Socialpolitik / German Economic Association.
  6. Carlos Carreira & Paulino Teixeira, 2008. "Internal and external restructuring over the cycle: a firm-based analysis of gross flows and productivity growth in Portugal," Journal of Productivity Analysis, Springer, Springer, vol. 29(3), pages 211-220, June.
  7. Yi-Chen Lin & Tai-Hsin Huang, 2012. "Creative destruction over the business cycle: a stochastic frontier analysis," Journal of Productivity Analysis, Springer, Springer, vol. 38(3), pages 285-302, December.
  8. Min Ouyang, 2006. "Plant Life Cycle and Aggregate Employment Dynamics," Working Papers, University of California-Irvine, Department of Economics 050632, University of California-Irvine, Department of Economics.
  9. Sophie Osotimehin & Francesco Pappada, . "Credit frictions and the cleansing effect of recessions," Virginia Economics Online Papers 403, University of Virginia, Department of Economics.
  10. Carly Petracco & Helena Schweiger, 2012. "The impact of armed conflict on firms’ performance and perceptions," Working Papers, European Bank for Reconstruction and Development, Office of the Chief Economist 152, European Bank for Reconstruction and Development, Office of the Chief Economist.
  11. Sophie Osotimehin, 2013. "Aggregate productivity and the allocation of resources over the business cycle," Virginia Economics Online Papers 404, University of Virginia, Department of Economics.
  12. Tian, Can, 2011. "Technology choice and endogenous productivity dispersion over the business cycles," MPRA Paper 34480, University Library of Munich, Germany, revised 02 Nov 2011.
  13. Chiara Criscuolo & Peter N. Gal & Carlo Menon, 2014. "The Dynamics of Employment Growth: New Evidence from 18 Countries," CEP Discussion Papers, Centre for Economic Performance, LSE dp1274, Centre for Economic Performance, LSE.

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