From Boom to Bust and Back Again: A dynamic analysis of IT services

Aggregate shocks in demand such as the burst of the 2001 dot-com bubble affect firms’ behavior and, therefore, the market structure. This paper proposes a fully dynamic oligopoly model to evaluate the impact of aggregate demand shocks on entry and exit costs as well as on investment and labor adjustment costs in IT services. The empirical application builds on an eight year panel dataset that includes every IT service firm in Sweden. The paper finds higher fixed investment and labor adjustment costs for software but lower for operational services after the dot-com bust. The entry costs for software were six times lower than for operational services, which might explain the large number of entrants in software. Entrants are found less productive than incumbents and net exit contributed the most to productivity growth in the IT services after the dot-com bust. For policy makers, the changes in cost structure give key information about industry dynamics and its impact on high-skilled jobs.<p>