COST DIFFERENCES AND SURVIVAL IN DECLINING INDUSTRIES - A CASE FOR PICKING WINNERS

In this paper, we examine the relationship between firms' cost structures and the order of exit from declining industries. We distinguish between two fundamental causes of demand decline, namely a shrinkage of the consumer base and a decrease in consumers' willingness to pay. We show that it is not necessarily best to be small and flexible - the order of exit in a market driven outcome depends on the manner in which demand shrinks. We find that from a welfare perspective, the order of exit determined by market forces is not necessarily desirable. However, simple rules for picking 'winners' based on current unit cost, profitability, or productive efficiency do not provide sound guidance for policy. © 1991.