The Financing of Ideas and the Great Deviation

IMF Working Papers, July 31, 2017

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The Financing of Ideas and the Great Deviation

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Bibliographic details

• Authors: Daniel Garcia-Macia
• Published: July 31, 2017
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781484311134.001

Summary of the paper

• Research question: Why did the Great Recession lead to such a slow recovery?
• Core mechanism: Heterogeneous firms invest in physical and intangible capital and can default on their debt; intangible assets are harder to seize by creditors in default, leading to higher financing costs for intangible capital.
• Crisis amplification: In a financial crisis, default is more likely and aggregate risk bears a higher premium, exacerbating the financing cost differential and causing a fall in intangible investment that amplifies the crisis.
• Persistence channel: Gradual intangible spillovers to other firms contribute to the persistence of the downturn.
• Empirical focus: Panel data on Spanish manufacturing firms are used to estimate the model matching firm-level moments regarding intangibles and financing.
• Comparative result: A standard model without endogenous intangible investment would miss more than half of the GDP fall observed in Spanish manufacturing during the Great Recession.

Model and mechanisms

• Firm heterogeneity:
  • Firms invest in physical and intangible capital.
  • Firms can default on debt; in default intangible assets are harder to seize.
• Financing cost differential:
  • Intangible capital faces higher financing costs relative to physical capital.
  • The differential increases during financial crises due to elevated default risk and higher aggregate risk premia.
• Amplification and persistence:
  • Fall in intangible investment amplifies the initial shock.
  • Slow spillovers of intangible capital across firms prolong the recovery.

Empirical estimation and validation

• Data: Panel data on Spanish manufacturing firms (details in the working paper).
• Estimation objective: Match firm-level moments related to intangibles and financing.
• Fit: The estimated model captures the extent and components of the Great Recession in Spanish manufacturing.

Policy implications and recommendations

• Targeted transfers:
  • A policy of transfers conditional on firm age could speed up the recovery.
  • Rationale: Young firms tend to be more financially constrained, particularly with respect to intangible investment.
• Less effective alternatives:
  • Conditioning transfers on firm size appears to be less effective.
  • Subsidizing credit (as in current E.U. policy) appears to be less effective.

Content in this bundle

• The Financing of Ideas and the Great Deviation, WP/17/176, July 2017
  • The Financing of Ideas and the Great Deviation, WP/17/176, July 2017 (Markdown version)
  • The Financing of Ideas and the Great Deviation, WP/17/176, July 2017 (PDF)