01.16.09
Industrial Restructuring, Financial Instability, and the Dynamics of the Postwar U.S. Economy
Industrial Restructuring, Financial Instability, and the Dynamics of the Postwar U.S. Economy
ABSTRACT: The transition from a manufacturing to a service economy has opened new frontiers of economic opportunity, but it has also been associated with a great deal of volatility in financial markets, job layoffs, and social stress. When this transition is complete will we find the overall health of the U.S. economy has improved or declined?
This study is an empirical investigation into the combined effect that financial instability and industrial restructuring have had on postwar economic growth and recessions. The purpose is to shed light on the more fundamental question of whether recent innovations in financial markets are positive for the economy as a whole.
During the postwar period there was a perceptible shift in the approach taken to study the dynamics of the economy, corresponding to a consensus that the economy had stabilized since the crisis of the Great Depression. The movement was away from an inductive method, in which data analysis interacts with formal theory development, toward a deductive approach in which econometrics was called upon to confirm pre-established theories regarding macroeconomic equilibrium.
The emergence of increasing market volatility in recent decades, and new insights into the nature of complexity gained from the study of chaos, have cast doubt on the usefulness of this approach, and a new type of analysis is called for, one that can better accommodate complexity in the modeling of economic dynamics. The book begins with an examination of these methodological issues. A brief history of economic thought relating to business cycles serves as a reminder of the contributions made by researchers who relied on an empirical approach to pull us out of the Great Depression.
Changes in the industrial structure of the economy over the postwar period are then examined to reveal some of the factors responsible for secular changes in employment, wages, productivity, and profitability. Input-output data of interindustry transactions and income distribution is related to NIPA flows of GDP sectors to account for dramatic changes in economic structure. The decline of manufacturing and the rise of service industries is associated with secular changes in the pattern of personal consumption, employment, wages, and productivity, and the impact of these changes on the distribution of income across industries and between profits and wages is examined.
To explain the cyclical nature of investment and output, Institutional theory regarding financial instability is examined in depth and related to investment behavior. An empirical model of this behavior is constructed by linking capital flows (corporate profits, commercial credit, stock prices, and bond yields) to fluctuations of investment and GDP with a nonlinear accelerator, in which the stability conditions of the characteristic equation are evaluated using historical values for the multiplier and accelerator. The effect of changing flows of credit and finance on capital spending simulates the learning and decision processes of investors as they react to conditions in financial markets.
The resulting nonlinear model accurately predicts historical investment and output cycles, and yields stability conditions for different historical periods. The confirmation of a relationship between these stability conditions and postwar economic recessions makes it possible to forecast the timing and severity of recessions, given the current state of financial markets. It is also possible to evaluate various adjustment policies for their effectiveness at optimizing macroeconomic growth and avoiding future recessions.
The model was developed in the sincere hope that it might someday be used for the purpose of avoiding or at least mitigating the devastating economic impacts of financial crises. If we learn from history, future generations need not suffer from the vagaries of an economy that seems beyond control.
