Schumpeterian Restructuring by P. Francois and H. Lloyd-Ellis

1. Schumpeterian Restructuringby P. Francois and H. Lloyd-Ellis Discussion

2. “Searching for the Invisible Man”(Economics Focus, March 11) Economics rediscovers the entrepreneur: “The French, according to George Bush, have no word for them, economic theory has surprisingly little room for them, and it is a mystery why anyone would choose to be one.”

3. Objective of the paper • Develop a theory of restructuring and innovation that explains cyclical behavior of employment (job creation and destruction) real wages and productivity • Endogenous growth model where: - business cycle fluctuations are endogenous; - workers’ wages endogenously resolve incentive problems

4. New evidence on job flows / wages • Traditional view: cyclical movements mainly reflect fluctuations in job destruction; • Recent evidence: when correctly measured, job creation is more variable than job destruction (Shimer (2005) and Hall (2005)) • Wages: real wages are mildly procyclical

5. Model • Schumpeterian model builds on Grossman-Helpman (1991) • Francois and Lloyd-Ellis (2003) show that when implementation of innovation can be delayed, an equilibrium with endogenous cycles exists exhibiting: - booms following clustered implementation of previous innovations; - slow-downs and downturns during which labor is allocated to innovation instead of production

6. Additional Ingredients • Two types of complementary labor: managers and production workers • Managers allocate their time between supervision of workers to or innovation • During the cycle: - when managers allocate their time away from production to innovation, the demand for workers falls, and aggregate rate of job destruction rises - when managers decide to implement new innovation, demand for workers rises Note: Schumpeterian framework allows to have entry and exit of firms, thus distinguishing adjustments to the labor force on the extensive and the intensive margins

7. Additional Ingredients (2) • Managers’ incentives are well aligned with those of shareholders (“reputation concern”) • Efficiency wage for workers: - exert effort: wage w, “normal” rate of job loss m - shirk: wage w, but rate of job loss m+q qinfinity perfect monitoring, no incentive problem

8. Implications for production structure • Efficiency wage implies that a production firm with an obsolete technology at the time of innovation knows with certainty that it will shut down at the next round of new technology implementation  cannot provide incentive to workers  firm taken over by successful innovator • Take-over (“restructuring”) is a credible signal that an innovation has taken place • Successful innovator produces at large scale, with price set by competitive fringe of “entrepreneurial” firms (one manager producing at previous technology)  output price decoupled from production wages

9. Employment flows • At the beginning of a recession, job creation falls on the intensive margin as aggregate demand falls (managers move into entrepreneurship) • Plants close down as new innovation takes place (job destruction on the extensive margin) – large scale production is taken over by successful innovators (“restructuring”).

10. Procyclicality of wages • Effects of efficiency wages: - procyclical: with higher hiring rate, threat of being fired has lower incentive effect - countercyclical: when rate of job destruction (m) is higher, the punishment component (q) becomes relatively smaller with declining employment, the marginal cost of effort is lower tomorrow than today

11. Questions • Is managerial effort perfectly contractible and are incentives always aligned with those of shareholders? - managers’ objectives differ from profit maximization - managerial decisions have effects on firm policies (Bertrand and Schoar, 2003) • alternative model in which managerial effort in production is non-observable & no efficiency wage for workers. Would this generate result on employment flows? • The introduction notes recent discussion of impact of labor market frictions on growth Future step: how do labor market institutions affect restructuring? What would be the effects of policies “preventing” plants to close down (at least until implementation of new innovation)? • It would be nice to discuss the evidence of countercyclicality of innovation and procyclicality/clustering of implementation of innovation

12. Look at production worker wages. But managerial wages are decoupled from the cycle.  What do we know about relative cyclical characteristics of wages of skilled (managers) and unskilled workers? Model predicts that firms close down (and are being taken-over) before becoming bankrupt, i.e. as soon as innovation takes place, but before its implementation. Is there supportive evidence? The price charged by the producer is decoupled from production wages, but how is this price set after innovation but before its implementation? What is the role of the exogenous component of job destruction? Some surprisingfeatures of the model