On the Timing and Efficiency of Creative Destruction

Ricardo J. Caballero, Mohamad L. Hammour

NBER Working Paper No. 4768
Issued in June 1994
NBER Program(s):   EFG

This paper analyzes the timing, pace and efficiency of the on- going job reallocation that results from product and process innovation. There are strong reasons why an efficient economy ought to concentrate both job creation and destruction during cyclical downturns, when the opportunity cost of reallocation is lowest. Malfunctioning labor markets can disrupt this synchronized pattern and decouple creation and destruction. Moreover, irrespective of whether workers are too strong or too weak, labor market inefficiencies generally lead to technological 'sclerosis,' characterized by excessively slow renovation. Government incentives to production may alleviate high unemployment in this economy, but at the cost of exacerbating sclerosis. Creation incentives, on the contrary, increase the pace of reallocation. We show how an optimal combination of both types of policies can restore economic efficiency.

(665 K)

Published: Quarterly Journal of Economics, Vol. 446, no. 3 (August 1996): 805-852.

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