Distortions in Firm Selection During Recessions: A Comparison Across European Countries

Recent evidence documents the weakness of market selection based on productivity differentials and the absence of cleansing during recessions. This paper argues that a possible explanation lies in the role of competitive rents, i.e., market advantages due to idiosyncrasies of the firm’s demand. Competitive rents allow firms to sustain profit independently of their internal efficiency, creating a selection advantage. During an economic recession, this advantage increases because competitive rents operate as a resilience factor. The process of firm selection can thus be distorted with relatively inefficient firms that manage to survive. These predictions are tested on a sample of French, Italian, and Spanish manufacturing firms, looking at the selection that took place during the Great Recession. Ceteris paribus, firms with competitive rents are less likely to exit than firms without competitive rents. This effect is stronger in countries more severely impacted by the downturn. The implications of these results for policy interventions to sustain aggregate productivity growth are discussed.