Virtues of Bad Times

A very interesting paper “Virtues of Bad Times Revisited” was presented by its author, Min Ouyang, this week in our Macro-Intl seminar.

Its about recessions and whether they are good or bad in terms of productivity. An old idea, credited to Schumpeter, says that recessions are good because they free resources to more productive uses. This is a ‘cleansing’ effect of recessions, sort of how you get more productive when all the old crap laying around your room gets ushered to the nearest recycling bin.

The problem is that the cleansing story doesn’t really agree with the data. First, she cites that those firms that ‘die’ during a downturn aren’t necesarily the least productive firms. Second, assume that firms learn to be more productive as time goes by. If so, then the following fact would mean that the dynamic effects of recessions are hurtful to productivity — the firms that die during recessions are young firms. These firms don’t have a chance to learn what their true productivity. This is what she calls a ’scarring’ effect.

The paper continues to model the above phenomenon, and the exact details are interesting.

But i have a problem with this paper. Firm productivity, and the learning of one’s intrinsic ability, comes from somewhere. In her paper, she briefly mentions three sources of uncertainty regarding intrinsic productivity: unobserved managerial skill, unknown demand for product, unpredictable profitability of certain locations. But in a recession, while firms may die, these sources of productivity do not.

So when the recession ends, these same factors are still in play, so scarring need not happen. To be specific, lets say its managerial talent that is important. Then, when a recession hits, its still possible for this talent to bloom elsewhere (another industry), and so there is no loss — its merely re-allocated.

To retain scarring, you have to assume idiosyncratic productivity that is industry and time dependent. So, lets say I am a manager for a software firm gets laid off because my firm ‘dies’ in the recession of ‘07. I get another job, in another industry, or — gasp! — get into Economics Grad School. I earn some human capital in my new industry, but my inate talents in software engineering never get used again because my built abilities aren’t transferable to software engineering. Depending on your viewpoint on human capital, these are either natural assumptions or onerous.

Plan for the Lit Review

Deadline for the Lit Review is coming up soon. i’ve been thinking about how to attack it. i want to present a research program in the form of a lit review. Roughly (very), here is my view of my ‘research program’ thus far:

I. The Border Effect
I want to summarize the vast literature now on the border effect. Recent papers i’ve read/seen here are Lipsey and Swendenborg (NBER 13239, July 2007) “Explaining Product Price Differences Across Countries”
Gorodnichenko and Tesar “Border Effect or Country Effect” mimeo Aug 2006
Bergin and Glick “Global Price Dispersion: Are Prices Converging or Diverging” mimeo Sept 2006
Anderson and Van Wincoop “Trade Costs” Journal of Economic Literature Sept 2004

What i want to say: The Border Effect is confounded by the distribution of prices. From Bergin and Glick, there is a U-shaped pattern in price dispersion. they suggest oil, but i want to suggest industry dynamics instead.
Lipsey adn Swedenborg. They seek to explain price diversion as well. they find, similar to Gordornichenko and Tesar that the country fixed effects are very important (other than income per cap). so there is something happening at the country level. i think its industry dynamics, interacting w domestic demand side.

II. Multiproduct Firms
There are lots of stuff here. Mostly by Bernard and jensen, schott and kortum. Brambilla and weinstein too. Outline the empirical results

III. Trade and Firm Productivity
A. Begin with the theory, say melitz (2003)
B. Empirical — Bernard and jensen (1999), with the newest Trefler (2007).
C. Connect Multiproduct Firms and Firm productivity theory and empirics from A and B.

i think part I can be cut, if the choice is between a tight review of lit and an exploration of my ideas. i think i can write another document detailing what i want to do. But for the purposes of this exercise, i think i can come up w a decent review on II and III.

There is also a IV:
IV: Product Cycles and development
Industry structure has something to say about economic development and macro phenomena. the range of industries a firm can enter is wider is developed countries. this is an extension of the product cycles/quality ladder literature that is out there, but here the ladder is vertical AND horizontal. Macro phenomena, the business cycle and prices (linking back to part I, which is the border effect and price setting), can be linked with multiproduct firm, industry dynamics and reactions to shocks, national price setting etc.

yeah, in the midst of writing this, i’ll probably focus on II and III to come up with a more structured review of lit. develop my ideas in I and IV next week to show to some classmates and advisors. One baby step at a time…

Product Creation and Destruction, More Empirical Evidence from Market Research Data

More empirical evidence on product creation and destruction from Christian Broda and David Weinstein (BW).

They have an impressive dataset from AC Nielsen (which, my professor asked Prof Weinstein about, and she said it costs alot of money), which is a demographically balanced sample of households in 23 US cities. This data covers 40% of all expenditure in the CPI.

What are their findings?

1) Multi-product firms are the norm. The average firm sells 8 different UPCs (Universal Product Codes). The distribution of UPCs is skewed, with a large number of firms having small number of products.

2) The vast majority of product creation and destruction occurs within the firm. Over the last 4 years, 82% of product creation is done within firms, 87% for product destruction. ‘Creation’ is the ratio of value of new UPCs to Total Value. Destruction is the ratio of value of disappearing UPCs to total value.

Also,40% of household expenditures are in goods that were created in the last 4 years, 20% are in goods that disappear in the next 4. In BW, this is products in terms of UPCs, so it includes packaging and size as well. This is the most disaggregated data i have seen in an economics paper.

3) Product Creation is Strongly Pro-Cyclical — that is, it positively co-varies with aggregate measures of consumption. Consider the graph below:

In the recession of 2001, sales dropped and so did new product creation. In another graph, they document that destruction is  weakly counter-cyclical. During the same recession, destruction rose.