Credit market frictions and the allocation of resources over the business cycle

In a seminal paper, Davis and Haltiwanger (1990) demonstrated that recessions are associated with increased job reallocation. The conventional view has interpreted this as evidence of "cleansing": less productive jobs are destroyed in recessions, and resources are reallocated to more productive uses. This paper argues instead that in the presence of credit market frictions, reallocation might go the other way, directing resources from more efficient to less efficient uses. This will occur if more efficient production arrangements are also more vulnerable to credit constraints. I show that this pattern arises endogenously in an equilibrium model, and offer some evidence that firms with higher output per worker tend to borrow more, suggesting they are more vulnerable to credit constrains. (C) 2003 Elsevier B.V. All rights reserved.