Industrial Evolution in Crisis-Prone Economies

Joint with: Eric Bond and Hâle Utar

Balance of payments crises and banking crises are commonplace in developing countries. Often they feed off one another, creating dramatic swings in the real exchange rate, real interest rates, and expectations about regime sustainability. We quantify the effects of these crises on industrial sector productivity distributions, size distributions and borrowing patterns. To do so, we first develop an industrial evolution model in which capital market imperfections link firms’ ability to borrow and the wealth of their owners. Then we fit our model to firmlevel

panel data and macro data from Colombia that span the debt-crisis period of the 1980s. Finally, using the estimated parameters, we simulate industrial evolution patterns under

alternative assumptions about the stochastic processes for exchange rates and interest rates. Among other things, we find that increases in macroeconomic volatility reduce average productivity through selection effects. These effects are particularly dramatic in the immediate

aftermath of a shift from a stable regime to a volatile regime because heightened uncertainty creates greater incentives for large, poorly-performing firms to delay exit in the hope that things will improve. We also find that improvements in the efficiency of loan contract

enforcement lead to more borrowing, larger firms, more entrepreneurship among households with modest wealth, and a more egalitarian distribution of income.

For more information, contact Stephen Yeaple.