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The Scarring Effect of Recessions

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  • Min Ouyang

    ()
    (Economics University of Maryland at College Park)

Abstract

This paper explores the role that recessions play in resource allocation. The conventional cleansing view, advanced by Schumpeter in 1934, argues that recessions promote more efficient resource allocation by driving out less productive units and freeing up resources for better uses. However, empirical evidence is at odds with this view: average labor productivity is procyclical, and jobs created during recessions tend to be short-lived. This paper posits an additional "scarring" effect: recessions "scar" the economy by killing off "potentially good firms". By adding learning to a vintage model, I show that as a recession arrives and persists, the reduced profitability limits the scope of learning, makes labor less concentrated on good firms, and thus pulls down average productivity. Calibrating my model using data on job flows from the U.S. manufacturing sector, I find that the scarring effect is likely to dominate the conventional cleansing effect, and can account for the observed pro-cyclical average labor productivity

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 205.

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Date of creation: 11 Nov 2005
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Handle: RePEc:sce:scecf5:205

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Keywords: Business Cycles; Cleansing Effect; Scarring Effect; Creative Destruction; Learning; Job Flows;

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Cited by:
  1. Daniel Fackler & Claus Schnabel & Joachim Wagner, 2013. "Establishment exits in Germany: the role of size and age," Small Business Economics, Springer, vol. 41(3), pages 683-700, October.
  2. 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, vol. 29(3), pages 211-220, June.
  3. 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.
  4. Min Ouyang, 2006. "Plant Life Cycle and Aggregate Employment Dynamics," Working Papers 050632, University of California-Irvine, Department of Economics.
  5. Marcela Eslava & Arturo Galindo & Marc Hofstetter & Alejandro Izquierdo, 2010. "Scarring Recessions and Credit Constraints: Evidence from Colombian Firm Dynamics," DOCUMENTOS CEDE 007711, UNIVERSIDAD DE LOS ANDES-CEDE.
  6. Lucia Foster & Cheryl Grim & John Haltiwanger, 2013. "Reallocation In The Great Recession: Cleansing Or Not?," Working Papers 13-42, Center for Economic Studies, U.S. Census Bureau.
  7. Yi-Chen Lin & Tai-Hsin Huang, 2012. "Creative destruction over the business cycle: a stochastic frontier analysis," Journal of Productivity Analysis, Springer, vol. 38(3), pages 285-302, December.
  8. Dimitris Christopoulos & Miguel León-Ledesma, 2009. "Efficiency and frontier technology in the aftermath of recessions: international evidence," Studies in Economics 0922, Department of Economics, University of Kent.
  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. 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.
  11. Carly Petracco & Helena Schweiger, 2012. "The impact of armed conflict on firms’ performance and perceptions," Working Papers 152, European Bank for Reconstruction and Development, Office of the Chief Economist.
  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.

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