Entry and exit in the 2008–2013 Portuguese economic crisis

Recessions are conventionally considered as times in which low-productivity firms are driven out of the market at a relatively accelerated pace and resources freed to more productive uses as a result. But recessions that are closely associated with financial crises can reduce efficiency in resource reallocation through reduced bank lending to profitable projects. Banks may also forbear bad debtors, delaying the process of firm death in an effort to protect their own balance sheets, thereby hindering one of the key mechanisms through which productivity growth does its job. We study the hypothesis that when financial markets are seriously distorted, reallocation may be driven by financial constraints rather than by micro foundations such as productivity, demand, and cost structure. This hypothesis is therefore a strong candidate to explain the unusually anaemic economic growth in most advanced economies in the aftermath of the Great Recession despite extensive monetary easing policies.

The 2008–2013 Portuguese crisis, for its nature and length, offers a quite natural experiment. We found quite expectedly a strong exit flow of firms during the crisis and an increase in job destruction. But a non-negligible fraction of high-productivity firms (some of which are very large) have actually shut down, an indication of a major market selection failure. Although we confirm that low-productivity firms have a lower probability of survival, credit market conditions play a strong role in firm exit, especially in the case of large firms. High external funding dependence during the crisis is also found to be adversarial to employment creation.

These are important results for policy makers: in deep recessions, very harsh credit market conditions entail the risk of throwing out the promising baby with the bath water, thus impairing the post-crisis recovery.

Click here to go to the paper by Carlos Carreira and Paulino Teixeira.