Understanding aggregate fluctuations: the importance of building from microeconomic evidence.

• Author: Haltiwanger, John C.

In recent research using longitudinal establishment-level data, a pervasive finding is that idiosyncratic factors dominate the distribution of growth rates of output, employment, investment, and productivity across establishments. Seemingly similar plants within the same industry exhibit behave quite differently in terms of real activity at cyclical and longer-run frequencies. Even in the fastest-growing industries, a significant fraction of establishments decline substantially; similarly, a large fraction of establishments in the slowest-growing industries grow dramatically. During severe recessions virtually all industries decline, but within each industry a substantial fraction of establishments grow. Likewise, during robust recoveries, a substantial fraction of establishments contract. Simply put, the underlying gross microeconomic changes in activity dwarf the net changes that we observe in published aggregates.

The tremendous observed within-sector heterogeneity raises a variety of questions for our understanding and measurement of key macro aggregates. Much of macroeconomic research and our measurement of aggregates is predicated on the view that building macro aggregates from industry-level data is sufficient for understanding the behavior of the macro economy. The implicit argument is that, at least at the detailed industry level, the assumption of a representative firm or establishment is reasonable.

The finding of tremendous within-industry heterogeneity is not by itself sufficient to justify abandoning this useful assumption. There is undoubtedly considerable canceling out of the impact of idiosyncratic shocks (for example, taste, cost, and technology) that underlie the heterogeneous fortunes across individual producers. Evidence from recent establishment-level studies of employment, investment, and productivity growth, however, suggests that this canceling out is far from complete. It is becoming increasingly apparent that changes in the key macro aggregates at cyclical and secular frequencies are best understood by tracking the evolution of the cross-sectional distribution of activity and changes at the micro level.

A number of different factors are potentially important in this context. The observed heterogeneity in output, employment, and investment growth rates within sectors implies a large, continuous pace of reallocation of real activity across production sites. Such reallocation inherently involves substantial frictions. One obvious and important friction is that it is time- and resource-consuming for workers (and for other inputs) to reallocate across production sites. High- and low-frequency changes in key macro aggregates are likely associated with the interaction of these frictions and the pace of reallocation. The level of unemployment, as well as the growth rate of aggregate measures of real activity (for example, real output or productivity), will reflect the efficiency of the economy in accommodating the pace of reallocation. Changes in institutions, regulation, the pace of technological change, and the sectoral mix of activity all may alter the intensity of reallocative activity and the economy's ability to accommodate the reallocation.

Relatedly, it is important to...