The Analytics of Industrial Restructuring

This Note surveys theoretical research on troubled industries — on how interindustry adjustments take place, and on the rationales for government intervention to ease the transition. The author considers incentives in the decision to leave an industry. For example, in an industry with excess capacity and declining demand, theory shows that larger firms tend to bear a disproportionately large share of the burden of adjustment. Much of the adjustment that actually takes place in any market economy is successfully mediated by the market. Low prices are in themselves a signal to firms to cut back on their capacities. The author also presents possible reasons that the price systems may not produce fully optimal adjustments. These reasons include market frictions, especially in the labor market. Such distortions provide a basis for government intervention, although whether intervention is in fact warranted depends also on its costs.