Do crises catalyze creative destruction ? firm-level evidence from Indonesia

 WPS5869 Policy Research Working Paper 5869 Do Crises Catalyze Creative Destruction? Firm-level Evidence from Indonesia Mary Hallward-Driemeier Bob Rijkers The World Bank Development Research Group and Development Economics Vice Presidency November 2011 Policy Research Working Paper 5869 Abstract Using Indonesian manufacturing census data (1991– survival was stronger in provinces with comparatively 2001), this paper rejects the hypothesis that the East lower reductions in minimum wages, but not due Asian crisis unequivocally improved the reallocative to reduced entry, changing loan conditions, or process. The correlation between productivity and firms connected to the Suharto regime suffering employment growth did not strengthen and the crisis disproportionately. On the bright side, firms that entered induced the exit of relatively productive firms. The during the crisis were relatively more productive, which attenuation of the relationship between productivity and helped mitigate the reduction in aggregate productivity. This paper is a product of the Development Research Group and the Development Economics Vice Presidency. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The author may be contacted at mhallward@worldbank.org. The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent. Produced by the Research Support Team  Do Crises Catalyze Creative Destruction? Firm-level Evidence from Indonesia Mary Hallward-Driemeier* Bob Rijkers** Key words: Financial crisis, creative destruction, firm survival, productivity decompositions, capital market imperfections JEL Codes: G01, O47, J21, D22 * Office of the Chief Economist, World Bank. ** Development Research Group, World Bank. We would like to thank Andrew Waxman for assistance in the preparation of the dataset and paper, and Ana Fernandes, Fitria Fitrani, Leo Iacovone, Kai Kaiser, Alex Korns, David Newhouse, Rifa Rufiadi and William Wallace for their assistance in obtaining the data and in discussing the policy environment in Indonesia. We are also indebted to Mushfiq Mobaraq and Denni Purbasari for generously sharing their data on political connectedness. We also thank seminar participants at the IZA/World Bank Conference on Economic Development, the World Bank Economists’ Forum, a World Bank Macroeconomics and Growth seminar, the 2010 NEUDC conference at MIT, Eric Bartelsman, John Giles, Pierella Paci, Luis Serven, and two anonymous referees for their useful comments. Jagadeesh Sivadasan kindly shared the code used to implement the Ackerberg Caves Frazer procedure. The views expressed here are those of the authors and do not necessarily represent the views of the World Bank, its Executive Board or member countries. Correspondence can be sent to Mary Hallward- Driemeier, mhallward@worldbank.org. 1. Introduction While crises are periods of intensified adjustment, firm-level evidence on the impact of crises on resource allocation is limited. Moreover, their impact is theoretically uncertain. The idea that crises may accelerate the Schumpetarian (1939) process of creative destruction by “cleansing