On the Link Between Cycles and Growth

Min Ouyang

Macro-economic Research

• Macro only: the balance of macro variables at the aggregate level only.– GDP, Aggregate Investment, Aggregate

Consumption; Interest Rate…

• Macro with a micro foundation:– Aggregate– Industry– Individual, firms

An Example: Unemployment

• Macro-only macro:– interest rate and unemployment?

• Macro with a micro foundation:– Job search;– Contracting theory;– Innovation and industry structural change;– Labor-market institutions: minimum-wage law;

unemployment insurance; health insurance.

Macro is Everything!

• Anything interesting is related to macroeconomic thinking and contributes to macroeconomic outcome.

• Macro outcome is the aggregation of individual and firm behaviors.

Current Recession

• Cannot be explained by macro-only macro-economic thinking.

• The collapse of the financial market:– Asymmetric information between lenders and

borrowers;– Re-sale of “lemon” investment packages.

I am…

• A micro-foundation Macroeconomist.– Labor economics;– Industry organization.

My Current Research

• The link between long-run growth and short-run cycles.– Growth economists investigate long-run growth rates

and innovation. They ignore short-run cycles.– Business-cycle economists take long-run growth as

given and examine short-run fluctuations around the growth trend.

– However, the two can be an unified phenomenon. And the causality can go both ways.

Cycles and Growth

From Cycles to Growth

• Growth is driven by activities such as:– Innovation: new technology; new products;– Re-organization;– Reallocation.

• Cycles impact growth through their influence on growth activities:– The cyclicality of innovation;– And the growth consequence of such

cyclicality.

The Cyclicality of R&D

• R&D expenditure provides a measure for innovation input.

• The cyclicality of R&D reflects how short-run cycles influence innovation inputs.

The opportunity-cost View

• Schumpeter (1939)– Firms produce and innovate:– Resource is limited:– When you innovate more, you’ve got to

produce less.– Thus, firms innovate more during recessions

when the return to production is low.

• Reallocation is indeed counter-cyclical. School enrollment is also counter-cyclical.

Aggregate R&D is Pro-cyclical

?

• Does aggregate data really reflect the timing of R&D at the firm level?

• We need micro data, ideally, firm-level data;

• I take a compromise, looking at industry-level data.

An Industry Panel of R&D and Output

• Output by industry: the NBER Manufacturing Productivity Database (1958-2002); output is measured as real value added.

• R&D by industry from the NSF (1958-1998); R&D is deflated by GDP deflator.

Decomposition

N industries, indexed by i

Decomposition of Variances and Co-variance

Pro-cyclical Aggregate R&D

• Dominated by co-movement of R&D and output across different industries.

• The co-movement between R&D and output within industry differs significantly by industry.

• The OC theory should be examined at the micro-level.

The Cyclicality of Industry R&D

Two elements:1. Financial-Market Frictions/Liquidity

constraints;

2. Cyclical Persistence.

Financial-Market Frictions

• Basic Story:– Firms’ ability to finance R&D weakens during

recessions, so that their R&D lowers even if firms desire to raise R&D.

• Data:– Combining my R&D panel with data on

financial indicators from the Quarterly Financial Reports by the Census of Bureau.

– 16-industry panel: R&D, output, and Finance.

Financial-Market Frictions

• Contributes to the cross-industry differences in R&D’s Cyclicality.

• Provides an explanation for Petroleum Refining R&D’s being counter-cyclical.

• But cannot explain all.