Fewer but Better: Sudden Stops, Firm Entry, and Financial Selection

Abstract

We incorporate endogenous technical change into a real business cycle small open economy framework to study the productivity costs of sudden stops. In this economy, productivity growth is determined by the entry of new firms and the expansion decisions of incumbent firms. New firms are created after the implementation of business ideas, yet the quality of ideas is heterogeneous and good ideas are scarce. Selection of the most promising ideas gives rise to a trade-off between mass (quantity) and composition (quality) in the entrant cohort. Chilean plant-level data from the sudden stop triggered by the Russian sovereign default in 1998 confirm the main mechanism of the model, as firms born during the credit shortage are fewer, but better. The quantitative analysis shows that four years after the crisis, 12.5% of the output deviation from trend is due to permanent productivity losses. Distortions in the entry margin account for 40% of the loss, and the remainder is due to distortion in the expansion decisions of incumbents.

Credit Supply and Productivity Growth

“…On the one hand, lack of resources may spur productivity growth, if it forces firms to innovate to survive (Field, 2003), 3 while abundance might aggravate agency problems and stifle managers' efforts (Jensen, 1986). Furthermore, firms may be more likely to invest first in the most profitable business opportunities: as credit constraints become slacker, the marginal project may be less productive (Ates & Saffie, 2016). On the other hand, credit availability may have positive effects on firm productivity by supporting productivity-enhancing strategies.…”

Endogenous Growth and Household Leverage

“…Guerron-Quintana and Jinnai (2015) use an endogenous growth model with financial frictions to argue that a financial shock reduced the economy's trend growth rate in the aftermath of the Great Recession. Ates and Saffie (2016) combine an endogenous growth model with a small open economy Real Business Cycle model to show that sudden stops to incoming capital can cause a large permanent income loss.…”

Born in Hard Times: Startups Selection and Intangible Capital During the Financial Crisis

“…1 Introduction 1 Credit markets shape aggregate productivity both in the short run (Ates and Saffie, 2016;Sedláček and Sterk, 2017) and the long run (Midrigan and Xu, 2014;Buera and Moll, 2015) by affecting entrepreneurs' ability to fund their ventures. Whilst the literature has extensively studied the roles played by investment and selection in firm total factor productivity as transmission mechanisms for financial shocks (Kiyotaki and Moore, 1997;Moll, 2014), technological adoption might provide an additional substantive channel (Araujo et al, 2019).…”