Selection à la Banks
| Lasse Lien |
Ideally, the competitive process would select for productivity. It doesn’t actually do that. Presumably it selects for expected profitability, which is close enough — assuming market power isn’t too common. What has the economy been selecting for in the past year or so? The state of low demand means that it’s harder for firms to finance operations and investment, and firms depend more than ever on external capital. For most firms this means the bank. So banks’ credit decisions will to an unusual degree decide who gets to grow and who has to shut down. Simultaneously, banks are cutting back on credit — so which firms will the banks select? Since banks have no upside, they will ration credit on the probability of losses. This is clearly a worse criterion than expected profitability because it involves a degree of risk aversion that cannot be healthy. Presumably new firms, high-debt firms, small firms, and firms with mainly intangible assets can all be selected out (or unduly constrained in their growth), not because they have low productivity or low expected profitability, but because large, established, low-productivity, low-debt, tangible-capital firms represent a somewhat lower credit risk.
Hopefully, the period of bank-driven selection will be short and expected profitability will be restored. The only thing worse, I guess, is selection by lobbying productivity (or scale).