Face-Saving and the Business Cycle
By Arnold Kling
From a new paper by Steven R. Grenadier, Andrey Malenko, and Ilya A. Strabulaev.
When decision makers face the unappealing task of revealing unsuccessful outcomes that impact their reputations, delay may be their first instinct.1 Delay becomes even more enticing if they can wait for industry-wide downturns in order to hide individual failings and instead “blend in with the crowd,” by liquidating their projects strategically when many other projects have to be terminated.
This sort of just-so story, if you can buy it, would help the PSST model. One of the problems with PSST is explaining why there is a sudden imbalance between expanding and contracting sectors. I tend to suspect that there are reasons to cancel projects at the same time that other firms are canceling projects. Moreover, since so many Garett Jones workers are engaged in projects, this would cause a rise in unemployment.
The idea of the paper is that firms accumulate bad projects during a boom. They hold onto them in order to–as I would put it–save face. When someone signals the end of a boom (for example, by coming to Congress with hurried legislation to bail out banks), it becomes ok to kill off the bad projects.