Why are Plant Deaths Countercyclical: Reallocation Timing or Fragility?
43 Pages Posted: 13 Dec 2006
Date Written: September 2006
Because plant deaths destroy specific capital with large local economic impacts and potentially important macroeconomic effects, understanding the causes of deaths and, in particular, why they are concentrated in cyclical downturns, is important. The reallocation-timing hypothesis posits that plants suffering adverse permanent demand/productivity shocks delay shutdowns until cyclical downturns when plant capacity is less valuable, while the fragility hypothesis posits that shutdowns occur in downturns because the option value of maintaining the plant through weak demand periods is too low. I show that the effect that a plant's specific capital has on the timing of plant deaths differs across these two hypotheses and then use this insight to test the hypotheses' relative importance. I find that fragility is the dominant cause of the countercyclical behavior of plant deaths. This suggests that the endogenous destruction of capital is likely an important amplification and propagation mechanism for cyclical shocks and that stabilization policies have the benefit of reduced capital destruction.
Keywords: Plant deaths, business cycle
JEL Classification: E20, E22, E23
Suggested Citation: Suggested Citation