The U.s. And The World Economy

Policy Alternatives For New Realities

John Yochelson

• Publisher: Routledge
• Year: 2019
• Topic: Politics & International Relations
• eBook ISBN:
  9781000306552
• Subtopic: International Relations
• Index: Politics & International Relations

The structure of the world economy has changed dramatically in recent years, reflecting a redefinition of U.S. interests in light of increasing foreign penetration in U.S. markets, global pressures for protectionist policies, the emergence of the newly industrializing countries, and the vulnerabilities of the international financial system. This collection of essays addresses these and other developments facing policymakers in business, government, and labor. The authors discuss policy challenges in international trade, technological competition, exchange-rate disequilibrium, Third World debt, and the role of the private sector.

Business Cycles, Macroeconomic Policy, and U.S. Industrial Performance

by Gordon Richards

In recent years there has been an emerging debate as to the relative roles of cyclical and structural factors in the performance of the U.S. economy over the last two decades. In structural interpretations, the economy is theorized to have undergone a series of adverse longer-term changes, producing a secular deterioration in industrial performance during the 1970s. Some versions of this thesis call for various forms of industrial or structural adjustment policy to reverse this deterioration. Conversely, in cyclical interpretations, the central role of business cycles implies that the determinants of economic performance have been concerned primarily with macroeconomic policy The implication is that the appropriate policy instruments for bringing the economy back to its long-term growth trajectory are not industrial policies aimed at structural adjustment but traditional stabilization tools.

To some extent, the preferability of cyclical or structural interpretations depends on the choice of the dependent variable. Cyclical interpretations have tended to emphasize movements in total economic activity and have modeled developments in individual sectors primarily as a function of variations in the GNP and aggregate demand. Structural interpretations, on the other hand, have emphasized factors such as changes in the output mix, a secular decline in productivity growth and international competitiveness, decreases in capital inputs, slower gains in R&D spending, and a deterioration in the quality of microeconomic decision making. Both cyclical and structural interpretations have acknowledged some role for exogenous disturbances. The energy shocks caused by the increases in OPEC oil prices had a pronounced impact on the economy, both because they led to restrictive monetary policies that threw the economy into recession and because changes in relative factor prices had adverse effects on the productive structure. A second disturbance to the economy had to do with the massive growth in the labor force during the 1970s. The resulting increase in the natural rate of unemployment appears to have contributed to the destabilizing course of macroeconomic policy.

This paper is primarily concerned with macroeconomic policy and the business cycle, and the analysis is at the aggregate rather than the sectoral level. Although structural arguments are subordinated, this does not imply that secular forces were entirely absent or did not account for some aspects of economic performance. Nevertheless, structural factors are dealt with here insofar as they influenced macroeconomic policy and, indirectly, cyclical swings.

The basic thesis is that increased cyclical volatility in the 1970s and early 1980s is attributable to destabilizing macroeconomic policies. Structural factors such as the OPEC shocks and the explosion in the labor force were partially responsible, however, for the conduct of demand management. The greater magnitude of recessions since the mid-1970s resulted from the combination of the OPEC shocks and the restrictive reaction of macroeconomic policy. The booms of the early and the late 1970s were achieved through the prolongation of reflationary policies until the latter stages of recoveries and these policies were in part an effort to achieve full employment in the face of unprecedented growth in the labor force. The result was that demand management exhibited a procyclical bias that exacerbated cyclical movements in output and inflation.

Although structural factors help explain business cycles, they do not provide a complete picture. Macroeconomic policy did not merely respond to oil price increases and labor force growth but was dictated independently by political factors. An understanding of the economy's performance during the 1970s therefore requires not merely an acknowledgement of policy responses to exogenous disturbances but also an explanation of political determinants of macroeconomic decision making.

The major portion of this paper reviews in some detail cyclical developments during the 1970s. First, however, is an examination of the cyclical versus structural debate. The final section examines the causes of macroeconomic instability and provides some preliminary policy recommendations.

Cyclical versus Structural Interpretations

The decision to emphasize macroeconomic policy and the business cycle as determinants of economic performance cannot be made a priori. Instead, a review of major developments in the economy during the 1970s is necessary at the outset to assess the relative strengths and weaknesses of cyclical and structural interpretations. The indicators surveyed here include benchmark measures of aggregate economic activity—industrial production and capital investment—along with productivity, R&D spending, international trade, and employment. Even where there is evidence of a role for structural factors, cyclical variations explain a significant component of the behavior of these indicators. To be sure, there is an unambiguous role for structural factors such as the increase in relative energy prices and the demographic explosion in the work force during the 1970s. But these developments are of interest at least as much for their influence on macroeconomic policy as for their independent effects on the productive structure. In this sense, they can be viewed as indirect determinants of the business cycle.

Industrial Growth and Investment

In comparing the aggregate performance of the economy during the 1970s to the previous decade, there is no evidence of structural decline in real GNP growth or industrial production. Instead, what is particularly striking about the period from the 1970s onward is that slower average growth was attributable largely to the greater depth and frequency of the downturns in the business cycle. Table 1 gives the annual growth rates of real GNP, industrial production, and manufacturing output for the period 1962 to 1983. During the 1960s, the economy underwent approximately eight years of continuous growth, interrupted by only one minor slowdown in 1967. Beyond this point, however, there is evidence of considerably greater business cycle volatility. During the periods of expansion, the growth rates of real GNP, industrial production, and manufacturing output all achieved levels comparable to or greater than those experienced during the 1960s. There is, therefore, no basis for positing a secular decline in manufacturing or long-term "deindustrialization." Instead, the lower average growth rate from the 1970s onward reflects the severe contractions in output during the major recessionary periods, 1974 to 1975 and 1980 to 1982.

Further evidence supporting a cyclical interpretation of industrial performance is provided in econometric tests by Robert Lawrence (1984). When the index of industrial production is regressed on the GNP, not only is a very high percentage of the variance explained, but the equation closely replicates the actual behavior of industrial output during the 1970s. In other words, the growth rate of industrial pro

TABLE 1 Domestic Economic Indicators, 1962-1983 (Annual Percent Change)

duction is explained largely by aggregate economic activity, and there is no evidence of a decline in manufacturing relative to total GNP.¹

Essentially the same pattern applies to capital formation. Table 1 provides data on gross and net domestic private investment for the period 1962 to 1983. As with industrial production, capital investment shows much greater evidence of cyclical volatility than of secular stagnation. During the recoveries of the 1970s, the growth rates of both gross and net domestic investment averaged above those of the 1960s. The acceleration in the growth rate of net fixed investment during the late 1970s is particularly marked. The speed of expansion of investment during the recovery periods, however, was at least partially as compensatory—a response in some sense to contractions in investment produced by downturns in the business cycle in conjunction with the energy shocks and increases in the user cost of capital. What occurred in the capital sector was an increase in the magnitude of business cycle fluctuations; the depth of the recessionary downturn tends to explain the strength of the ensuing rebounds. Year-to-year movements in capital spending were more jagged than in previous periods, particularly the 1960s; but no structural decline was in evidence.

Productivity

Although the performance of industrial production and capital investment appears to have been dominated by cyclical rather than structural factors, in certain other areas, notably productivity, there is evidence that adverse secular forces also were at work during the 1970s. Since the mid-1970s, a marked deterioration in the rate of productivity growth occurred in the United States and throughout the industrial countries. Productivity growth rates initially slackened in late 1973 and declined sharply in 1974. Thereafter, productivity growth underwent a cyclical recovery in 1975-1978, although it did not attain the growth rates experienced during previous expansionary periods. In the United States, productivity growth was well below trend during the later stages of the 1975-1979 recovery. Beginning in 1979, productivity growth again became negative. A normal cyclical recovery in productivity growth, comparable to the earlier recovery in 1976, occurred in 1982, however.

The causes of the productivity decline have been examined in numerous econometric studies.² The contribution of cyclical factors is readily apparent. Productivity initially underwent a mild slowdown during the late 1960s, notwithstanding continuous economic expansion, in part because of high rates of labor utilization. Partly as a result, the productivity decline during the 1969-1970 recession was more acute than during the recessionary periods of the late 1950s, despite the fact that these previous downturns were deeper. (See table 2.) The sharpest fall in productivity, however, took place during the recession of 1974-1975, when output per hour was depressed both by cyclical losses and by the energy shock. Econometric analysis of the world productivity slowdown at this time by Michael Bruno (1982) confirms that this phenomenon is explained largely by the combination of the energy shock and the contraction in output associated with the restrictive macroeconomic reaction.

TABLE 2 Postwar Recessions

To a substantial degree, the same process was repeated after the second OPEC shock in 1979-1980. This time, the world economy was moving less rapidly, while the feed-through of energy prices into domestic inflation rates was more gradual, producing a slower decline into recession. In part because of the slower pace of the contraction, labor markets adjusted more rapidly relative to the fall in demand, with the result that the recession brought smaller declines in productivity and greater increases in unemployment than in 1974-1975. By comparison, the speed of decline in the recession of the mid-1970s was so rapid that employment fell only with substantial lags causing a sharp initial decline in the output-labor ratio. The recession of 1980-1982 was considerably longer than that of 1974-1975, however; and the cyclical decline in productivity at this time lasted for a period of roughly three years.

The contribution of cylical factors to the slowdown in productivity during the intervening recovery in 1975-1979 is less clear, but underutilization of capacity appears to have played some role in other countries, The recovery of 1975-1979 was unusually slow in all of the industrial countries except the United States, where the looser stance of monetary policy enabled restoration of normal postwar growth rates in real GNP and a full recovery in capacity utilization. Nevertheless, while the U.S. economy had converged to full capacity by 1978, Canada, Japan, and Western Europe contined to experience substantial slack. The role of underutilization of capacity has been confirmed as an explanation for slower productivity growth in Canada and Western Europe (Helliwell, 1983; Lindbeck, 1983) but is largely irrelevant for the United States. Noncyclical factors therefore must account for some of the productivity decline.

The rise in oil costs is estimated to have accounted for as much as one-third of the cyclically-adjusted productivity slowdown in the United States since 1973. In addition to their direct impact on factor inputs of energy, the OPEC shocks had a secondary depressing effect on productivity through the capital-labor ratio and the output mix. The price increases raised the relative cost of capital inputs. At the same time, they encouraged shifts in the sectoral composition of output from energy-intensive manufacturing industries, which typically exhibit high productivity growth, to non-energy-intensive services w...

Table of contents

• Cover
• Half Title
• About the Book
• Title
• Copyright
• Contents
• About the Authors
• Foreword
• Acknowledgments
• Trade Policy and Trade Negotiations in the 1980s
• Outlook for U.S. Economic Diplomacy: Europe and the Pacific Basin
• The Linkage between International Trade and Financial Policy
• The United States and the New Technological Competition
• Business Cycles, Macroeconomic Policy, and U.S. Industrial Performance
• Quadrangular Forum Working Groups