Do Crises Catalyze Creative Destruction? Firm Level Evidence From Indonesia

1. Do Crises Catalyze Creative Destruction?Firm Level Evidence From Indonesia Mary Hallward-Driemeier and Bob Rijkers ACES/AEA, January 8, 2012

2. Do crises facilitate or hamper a more efficient allocation of resources? • COMPETING THEORETICAL PARADIGMS: • The “Cleansing” Hypothesis: Crises accelerate the Schumpetarian (1939) process of creative destruction (Caballero and Hammour 1994). • They weed out unproductive firms. • And free up resources for more productive uses • The “Scarring” Hypothesis: Crises obstruct the reallocativeprocess (Barlevy, 2002; Ouyang 2009) • They exacerbate market imperfections (e.g. credit or labor markets) • And destroy potentially productive firms • Implications for appropriate policy response: is there a tradeoff between minimizing short-term impacts and maximizing long-run growth prospects?

3. Related Literature • Empirical evidence Is ambiguous • Not clear whether firm- and job turnover are pro- or countercyclical (Davis and Haltiwanger, 1990, 1992; Caballero and Davis, 1995; Boeri, 1996) • Weak evidence that plant productivity rises during downturns (Griliches and Regev, 1995, Bailey et al. 1998; Davis et al, 1996) • Market imperfections may be particularly pernicious during crises (Bergoeing et al., 2005, Blalock and Gertler, 2006, Gallego and Tessadda, 2009) • Few micro-level studies of the impact of crises on resource allocation • Exceptions, again with ambiguous findings: • Evidence for scarring: Japan’s Banking Crisis (Nishimura et al, 2005) • Evidence for cleansing: Chileduringdebt crisis; Uruguay during the Argentine peso crisis (Tybout and Liu 1995: Casacuberta and Gandelsman: 2009)

4. This Paper • Examines the impact of the East Asian Crisis on manufacturing plant dynamics in Indonesia Complementary analyses • Aggregate productivity decompositions • Contributions due to entry, exit, within-plant adjustment and reallocation between plants • Plant-level regressions of determinants of exit and of employment growth • Examine plant heterogeneity in adjustment patterns • Disentangle the role of productivity and other plant characteristics • Allow for variation in impact over time • Examine role of regulations that varied over time and location • Separate effects of economic crisis and political crisis

5. Testable hypotheses If crises are cleansing: • Aggregate productivity decompositions should show: • Increased contribution of reallocation between firms, and positive correlation between productivity and growth • Relatively larger contributions of entry • Plant-level • Survival: stronger relationship between firm productivity and survival • Growth: productive firms shed proportionately fewer jobs during the crisis and expand faster after the crisis What accounts for the observed patterns? • Plant characteristics: size, sector, need for credit • Policy environment: e.g. labor regulations Is the political crisis more cleansing? Suharto fell in the spring of 2008, but time alone is not enough to distinguish the political crisis. Data can identify those where a Suharto family member has an ownership stake, and/or is on the board (Mobarak and Purbasari, 2008). - Does productivity play a stronger role in connected firms? - Are the general results robust to the exclusion of connected firms?

6. Data • BPS’sIndonesian Annual Manufacturing Census • Covers all manufacturing firms ≥20 employees • Entry: first entry into the survey • Exit: last exit • Sample: 1991-2001 • Detailed information on employment, inputs and outputs, industrial classification and ownership. • Productivity measures: • Real value added per worker • TFP: OLS, Solow residual, Ackerberg Caves and Frazer (2006) • Non-stationarity (and persistence) of series limits the applicability of some estimation procedures, e.g. Arellano-Bond • Political connectedness: • Mobarak and Purbasari (2008) measures of Suharto family ownership and membership on boards • Regulations • Minimum wages, set at the provincial level, World Bank Jakarta Office

7. Plant Entry and Exit Exit rates were higher during the crisis. Peak in 2001 reflects the economic slowdown, but is magnified by splits in provinces where plants were seen to exit and reenter (results robust to excluding 2001)

8. Aggregate Jobs Flows Excess churning and net job destruction during the crisis, 1997-98

9. Decomposing Productivity Growth: Within-Adjustment Dominates FHK Decomposition of the growth of real value added per worker “within” “between” “cross “proportionate entry” “disproportionate entry” “exit” Do see increasing cross and proportionate entry. But negative contribution of exit.

10. Firm Survival: Econometric Strategy Discrete-time logistic survival model (Cox, 1972) “Proportional Hazards” Our strategy: Interact explanatory variables over time to examine how the determinants of survival vary over time: Competing Hypotheses Crises have no differential impact on creative destruction (in the short-run) Crises accelerate creative destruction (in the short-run) Crises attenuate creative destruction (in the short-run)

11. The crisis attenuated the link between productivity and exit

12. Results are robust Robustness tests passed but not presented: • Additional controls (in years for which they are available): self-reported constraints, training, R&D intensity, foster parent company, education, minimum wages. • Using lagged productivity as a proxy for true productivity • Including anomalous observations • Excluding outliers

13. Are Credit Constraints Driving the Attenuation Effect? • Hypothesis: Firms that are credit constrained or face greater needs for financing should be disproportionately hurt (exit more, face greater attenuation effect) • Cannot measure financial constraints directly • Across sectors: use measure of financial dependence • Use Rajan-Zingales (1998) measure of dependence on external credit, Braun (2003) measure of asset tangibility • Within sectors: exploit information on the composition of investment financing. • Compare: firms that financed investment with loans versus financed by other means • With depreciation, those with loans could be disproportionately hurt rather than protected by having credit. If productive firms received loans in dollars and then exited during the crisis, this could account for the attenuation. But results hold excluding them. • Result: Changing credit conditions amplified exit, those in sectors with greater need for financing experienced higher rates of exit. • But do not account for the observed attenuation • Attenuation result remains even including financial dependence • And protective role of productivity is actually higher during the crisis in sectors with greater financial dependence – consistent with the cleansing hypothesis. • Attenuation was strongest for firms that lacked access to credit to start with.

14. Firms in sectors more dependent on external finance were more likely to exit… yet the attenuation effect was weakest in these sectors

15. Labor market rigidities? • Labor markets were relatively flexible during Suharto • Minimum wages set at provincial level • MW were rising steadily during the 1990s • Results: • Interaction terms of plant productivity and provincial minimum wage is >1; more productive firms are more likely to exit when MW are high – and this is more pronounced during the crisis • Including MW also reduces the overall attenuation results.

16. Labor market regulations are partial explanation

17. Political crisis was more cleansing Connected firms were far more likely to exit post-Suharto, but less so for productive firms.

18. Employment Growth Estimating Equation NB: testing strategy is analogous to that for the survival model Competing Hypotheses Crises has no differential impact on the reallocative efficiency of employment growth Crises improves the reallocative efficiency of employment growth Crises weakens the reallocative efficiency of employment growth

19. The association between employment growth and productivity weakened over time and did not recover post-crisis

20. Conclusions • The crisis was excessively punishing in the short-run • Excess job losses • Attenuation of the link between productivity, survival and growth • Although some improvement in relative productivity of entrants • Changing credit market conditions amplified exit, but do not fully account for the observed attenuation. • Attenuation was strongest amongst firms that lack access to credit to start with • Political crisis exhibited more cleansing • Post-Suharto, previously connected firms were more likely to exit, but more productive ones were more likely to survive • Reallocation dynamics were not permanently scarred • The link between productivity and survival is restored post-crisis • Yet, the link between productivity and employment growth remains weaker than it had been pre-crisis • Perhaps because of more stringent labor market regulation?

21. Broader Lessons from Indonesia • Indonesia of interest as a large ‘tiger cub’. But are these likely to be relevant elsewhere? • Crisis was marked by large fall in demand and tightening of credit markets • The extent of the depreciation is significant. • Crisis are more prevalent in developing countries, although current situation shows lessons can be relevant for a larger set of countries • Shock was particularly large • But not unprecedented – or unmatched. • Cleansing hypothesis may be more easily rejected if there are large market frictions • Labor markets were fairly flexible under Suharto, although regulations were tightened after his fall