## The Financing of Ideas and the Great Deviation

_IMF Working Papers, July 31, 2017_

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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

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### 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.

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## Content in this bundle

- **The Financing of Ideas and the Great Deviation, WP/17/176, July 2017**
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_Source: https://www.imf.org/en/publications/wp/issues/2017/07/31/the-financing-of-ideas-and-the-great-deviation-45031_