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The Scarring Effect of Recessions

Min Ouyang (minouyang2011@gmail.com)

No 50609, Working Papers from University of California-Irvine, Department of Economics

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.

Keywords: Business cycles; Cleansing effect; Scarring effect; Creative destruction; Learning; Job flows (search for similar items in EconPapers)
JEL-codes: C61 E32 L16 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2005-11
New Economics Papers: this item is included in nep-ent and nep-mac
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Citations: View citations in EconPapers (3)

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https://www.economics.uci.edu/files/docs/workingpapers/2005-06/Ouyang-09.pdf (application/pdf)

Related works:
Journal Article: The scarring effect of recessions (2009) Downloads
Working Paper: The Scarring Effect of Recessions (2005) Downloads
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