On the Cleansing Effect of Recessions and Government Policy: Evidence from Covid-19

Recessions can have a cleansing effect by encouraging the reallocation of resources from lowproductivity firms towards higher-productivity ones. Whether this effect actually occurs is still debated. We contribute to answering this question by providing new evidence. Using a survey of firms matched with administrative data, we trace out the Covid-19 recession’s effects across the productivity distribution. Higher-productivity firms are found to have been more successful at maintaining employment, but there was not a rise in exit amongst lower-productivity firms. In line with the theory that support policies offset the cleansing effect of recessions, highproductivity firms are also found to have been less likely to take up government support.