Table Of ContentM.I.T. LIBRARIES - DEWEY
Digitized by the Internet Archive
in 2011 with funding from
Boston Library Consortium Member Libraries
http://www.archive.org/details/improperchurnsocOOcaba
wcvvty
1
531
4415
working paper
department
economics
of
IMPROPER CHURN: SOCIAL COSTSAND
MACROECONOMIC CONSEQUENCES
massachusetts
institute of
technology
50 memorial drive
Cambridge, mass. 02139
WORKING PAPER
DEPARTMENT
OF ECONOMICS
IMPROPER CHURN: SOCIAL COSTSAND
MACROECONOMIC CONSEQUENCES
Ricardo Caballero
MuhammadHammour
98-11 July, 1998
MASSACHUSETTS
OF
INSTITUTE
TECHNOLOGY
50 MEMORIAL DRIVE
CAMBRIDGE, MASS. 02142
SEP 1 6 1998
LIBRARIES
Improper Churn:
Social Costs and Macroeconomic
Consequences
Ricardo J. Caballero Mohamad L. Hammour*
July 23, 1998
Abstract
This paper assembles elements that are essential in forming an integral picture
of the way a "churning" economy functions, and of the disruptions caused by
transactional difficulties in labor and financial markets. We couch our analysis
in a stochastic equilibrium model anchored with US evidence on gross factor
flows and on rents in worker and firm income. We develop a social accounting
framework to measure the costs of transactional impediments. We calculate the
average social loss associated with structural unemployment and low productivity
—
due to technological "sclerosis" and a "scrambling" ofproductivity rankings in
entry and exit decisions. We also estimate the loss from arecession. An additional
forty percent to the traditional unemployment cost is due to reduced productivity,
and is determined by the recession's cumulative effect on the economy's churn
rate. Although a recessionary shock increases the economy's "turbulence" at
impact, semi-structural VAR evidence from US manufacturing indicates that,
—
cumulatively, it results in a "chill" which is costly in an economy that suffers
from sclerosis.
1 Motivation and Summary
A main theme ofrecent—research in macroeconomics is the nature and impli-
cations ofthe "churn" the massive process ofon-going factor reallocation
•Respectively: MIT and NBER; Capital Guidance. We are ">rery grateful to Fernando
Broner, Christian Frois, Roberto Neut, Roberto Rigobon and Vanya Rosenblat for excel-
lent research assistance. We thank Robert Gordon, John Haltiwanger and Glenn Hub-
bard for providing us with data and references; as well as Daron Acemoglu, Steven Davis,
Robert Hall, Guido Kuersteiner, Jaume Ventura, and seminar participants at Columbia,
MIT, the Minneapolis Fed, Stanford, UCSD, Virginia, the AFSE meetings, the NBER
Summer Institute, andtheNBEREF&G meetingsfor theircomments. Ricardo Caballero
thanks the NSF for financial support.
through which the economy's productive structure adjusts to innovations
and shifting economic circumstances.1 Beyond being an object of study by
itself, this underlying churn view of the economy seems indispensable in
addressing questions as central as: What determines the rate of unemploy-
ment? What is the macroeconomic impact of transactional impediments in
factor markets? How do these impediments affect the efficient use of pro-
duction opportunities? What is the cost of recessions? This paper is an
attempt at assembling elements that seem essential in forming an integral
view of the way a churning economy functions, and allow us to address such
questions meaningfully. We couch our framework in a stochastic equilibrium
model that we quantify and use to explore data.
To be concrete, consider the traditional question of the "cost of reces-
sions." What are the costs of possible maladjustment to an adverse aggre-
gate shock? Suppose we compute "social welfare" as the present value of
aggregate consumption discounted at rate p. The welfare effect of malad-
justment can then be generally written as
(Vh - c) / \H(t) - H(t)\ e-ptdt -Vd \D{t) - D(t)\ e~ptdt + S. (1)
H
(t) and D(t) denote the path ofgross creation and destruction in response
to the shock; while H(t) and D(t) denote the path of those variables absent
the shock. Vh and Vd denote appropriately defined social values of jobs
on the creation and destruction margins; and c is the cost of creating a
job. S denotes a residual term that reflects a compositional effect of the
shock on the productivities of units created and destroyed.2 Expression (1)
gives the welfare effect as the sum of the social value of creating a unit
times the cumulative response of creation, the social loss from destroying
a unit times the cumulative response of destruction, and the compositional
term. Naturally, in an efficient equilibrium, the social values of creating or
destroying a marginal unit are zero (Vh — c = Vd = 0), and the welfare
cost ofmaladjustment is therefore zero. It is because of eventual distortions
that make those social values non-zero, combined with the precise response
of gross flows, that such a social cost arises.
An aspect of the maladjustment cost of recessions can be gleaned from
1For recent studies that emphasize the role of gross factor flows in macroeconomic
analysis, see, e.g., Davis and Haltiwanger (1990, 1992), Blanchard and Diamond (1990),
Mortensen and Pissarides (1994, 1998), Caballero and Hammour (1994, 1996a), Cole and
Rogerson (1996), Ramey and Watson (1997), Den Haan, Ramey and Watson (1997),
Campbell and Fisher (1996), Merz (1996). For a thorough analysis and description of
microeconomic and aggregatedataonjob flows, seeDavis, Haltiwanger and Schuh (1996).
2Those quantities are given precise definitions in section 4.3. See footnote 42.
