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Department of Economics, Stockholm University Research Papers in Economics, Department of Economics, Stockholm University

No 2010:13:
Is the psychology of high profits favorable to industrial renewal? Experimental evidence for the theory of transformation pressure and Schumpeterian economics

Lennart Erixon () and Louise Johannesson

Abstract: The theory of transformation pressure sheds light on the importance of negative driving forces for economic growth and the countercyclical movement in innovations and productivity growth. The theory suggests that firms have a status-quo bias in periods of increasing profits leading to lower productivity growth. Firm agents are governed by changes in current profits through historical relativism, the peak-end rule and overconfidence. They will first abandon a status-quo bias after an actual decline in profits though both under- and overreaction is possible. On the other hand Schumpeterian economics stress that firm renewal is speeded up during recoveries, e.g. by psychological reasons. The two contradicting hypotheses were tested by a role play where a group of university students in economics completed a questionnaire acting as managers for an established company. The students had the opportunity to choose between different growth strategies and define the underlying psychological mechanism. The questionnaire also provided room for rational considerations. The role play confirmed the theory of transformation pressure more than Schumpeterian economics but primarily that the students expected that they would have reacted rationally as managers.

Keywords: Transformation pressure; Schumpeterian economics; peak-end rule; historical relativism; productivity growth; overconfidence; bounded rationality; the business cycle; heuristic decision rules; role play; (follow links to similar papers)

JEL-Codes: C23; C99; D21; D92; E32; (follow links to similar papers)

71 pages, June 24, 2010

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