On the Ills of Adjustment

Ricardo J. Caballero, Mohamad L. Hammour

NBER Working Paper No. 5198
Issued in July 1995
NBER Program(s):   EFG

We analyze market impediments to the process of structural adjustment. We focus on incomplete-contract inefficiencies in the transactions between workers and firms that render the quasi-rents from 'specific' investment appropriable. During adjustment, the result is a depressed rate of creation of the new productive structure and excessive destruction of the old one, leading to an employment crisis. Moreover, appropriability weakens the incentives for extensive restructuring and results in a 'sclerotic' productive structure. An adequate managed- adjustment program combines vigorous creation incentives in the expanding sector with measures to support employment in the contracting one. In contrast, the common prescription of gradualism does not act as an effective 'synchronizer' of creation and destruction, for it can only reduce destruction by also reducing an already depressed creation rate.

(468 K)

Published: Journal of Development Economics, vol. 51, no. 1, October 1996 pp. 161

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