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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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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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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; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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