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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 shortrun 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 industrylevel 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 (19581998); 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.