HAS PRODUCTION MANAGEMENT IMPROVED SINCE 1984?

DAVID G. BIVIN
The growth rate of GDP stabilized around 1984. and improvements in production
management have been cited as a possible cause. This article examines this rationale
with two-digit SIC manufacturing data. The empirical questions are whether there is
evidence of structural change in industry output aroutid 1984 and, if so, did output
track demand more closely following the change? The results indicate that only
two industries exhibited structural change in the 1982-86 period. There is
evidence that output has tracked demand more closely in recent years, but this is
hecause demand shocks have become less persistent. {JEL C15, D21, E22)
Kim and Nelson (1999) and others have
recently presented evidence of a dramatic de-
cline in the volatility oi' real gross domestic
product (GDP). When the data are plotted,
the break date is easily identified as 1984.
Kim and Nelson conclude that the enhanced
stability is broadly based. But statistical anal-
ysis by McConnell and Perez-Quiros (2000;
hereafter MPQ) points to reductions in inven-
tory volatility in the durables sector as the
source of the newfound stability. Although in-
ventory investment is a very small component
of GDP, changes in inventory investment are
one of the most volatile components of changes
in GDP. Ramey and West (1999) calculate that
declines in inventory investment typically ac-
count for 49"/. of reductions in U.S. GDP dur-
ing recessions. Inventories in the durables
sector are substantially more volatile than in
the nondurables sector, and thus inventory in-
vestment in this sector is more Hkely to contrib-
ute to macroeconomic instability.
The 1984 break date is intriguing because it
coincides with the rising popularity of new
production management techniques, such as
Just-in-Time (JIT).' Hall (1983) describes
JIT as an emphasis on "producing exactly
what is needed and conveying it to where it
is needed precisely when required." He cites
several components to the successful imple-
Bivin: Associate Professor, Indiana University-Purdue
University Indianapolis, 425 University Boulevard,
Indianapolis, IN 46202. Phone 1-317-997-6528. Fax
1-317-274-0097, E-mail dbivin@iupui.edu
I. A widely ciled guide to the benefits of JIT, Zero
Inventories, by Robert W. Hall, was published in 1983.
Hirseh (1996) cites 1982 as the year in which JIT became
prominent.
mentation of JIT, but one of the major com-
ponents is flexible production implying rapid
response and the ability to profitably produce
only what is immediately required. In this
ideal environment, no unfilled orders or fin-
ished goods are accumulated, and whatever
raw materials and work-in-process must be ac-
cumulated are quickly processed. More gener-
ally, the more flexible and well-coordinated
the production process, the more quickly out-
put can respond to a demand shock."
The questions addressed here are as follows:
1. Is there evidence of structural change in
output?
2. Did the structural change (if any) occur
around 1984?
3. Did output track demand more closely
following the structural change?
The answers to all three questions must be
yes to support the contention that improved
production management is responsible for the
2. Production may also take place prior to the arrival
of a demand shock, especially among firms that produce to
stock. When faced with increasing marginal costs of pro-
duction, the firm has an incentive to produce additional
output prior to an expected increase in demand as a means
of smoothing production. Although smoothing is not ev-
ident in the data (Blinder 1986), the incentive to smooth is
an indication of a lack of production flexibilily and thus
violates JIT.
ABBREVIATIONS
GDP: Gross Domestic Product
JIT: Just-in-Time
MPQ: McConnell iind Perez-Quiros (2000)
SBIC: Schwarz Bayesian Infonnation Criterion
671
Economic Inquiry
(ISSN 0095-2583)
Vol. 44, No. 4, October 2006. 671-688
doi:10.I093/ei/cbj038
Advance Access publication March 22, 2006
2006 Western Economic Association Intemational
672 ECONOMIC INQUIRY
Stabilization of GDP. The analysis is carried
out at the industry level to identify those in-
dustries that satisfy the criteria. The quality
of production management is measured as the
difterence between the log of output and the
log of new orders, both measured monthly.
New orders represent demand and are equiv-
alent to sales among firms that hold no unfilled
orders. If the firm achieves the ideal efficiency,
then output is identical to demand. More gen-
erally, effieiency is refiected in the time re-
quired for the firm to return inventories and
unfilled orders to their target values following
a shock to demand or output. An increase
in efficiency implies a more rapid output
response to demand shocks so that any differ-
ences between output and demand are re-
solved more rapidly.
Structural change is identified with tests for
structural change with unknown break dates
developed by Andrews (1993) and Andrews
and Ploberger (1994). Following Herrera
and Pesavento's (2004) industry-level analysis,
the tests allow for multiple breaks. Their tests
for stability are conducted on univariate auto-
regressive models of sales and inventories by
stages of fabrication. Here, the growth rate
of output or the difference between the log
of output and the log of new orders is the de-
pendent variable allowing for a direct observa-
tion of structural change in the variable of
interest. In addition, the models are richer
in that variables such as new orders and raw
materials are included on the right-hand side
to determine the sensitivity of the break date
to potential sources of any change in output
behavior.
Several studies in addition to Herrera and
Pesavento's (2004) have examined industry-
level data for evidence of structural change
that might indicate improvements in pro-
duction management. See Irvine and Schuh
(2005) and McCarthy and Zakrajsek (2005).
Rossana (1998) examines cointegrating vec-
tors among stocks by stages of fabrication,
output, and sales for the nondurables indus-
tries and uncovers evidence of structural
change associated with the productivity slow-
down in the early 1970s and the change in Fed
operating procedures in the early 1980s. But
he reports no structural change associated
with improved production management in
the mid-1980s.
This article also builds on cointegrating
relationships within production, specifically
the long-term equality between output and de-
mand. To implement the methodology, real
new orders are constructed for those industries
that produce to order. The Bureau of Eco-
nomic Analysis provides data on real sales
but not on real new orders. Thus much of
the previous work has been confined to the rel-
atively few industries that produce solely to
stock or have used real sales as the measure
of industry demand. The former approach
does not account for output volatility in the
durables sector even though output in this
sector is far less stable than in the nondura-
bles sector.^ The latter approach is problem-
atic because sales lag demand in industries
that produce to order.
This study differs from MPQ in its empha-
sis on the contemporaneous correlation be-
tween output and demand rather than the
stability of output. There is a tendency to as-
sociate the quality of production management
with the stability of output. But West (1989)
has noted that demand is more volatile than
output among industries that accumulate un-
filled orders. Thus output may need to become
more volatile if it is to track demand more
closely.
Stock and Watson (2002) have emphasized
that changes in the dynamic properties of a
model may refiect changes in underlying dy-
namics or in the variances and covariances
ofthe shocks. Throughout this article, changes
in the dynamics of the model are emphasized
as an indication of improved production man-
agement. Although improvements to produc-
tion may also appear in the form of smaller
independent shocks to output, any reduction
in the scale ofthe shocks could also reflect an-
other source of enhanced stability, such as im-
proved monetary policy or smaller aggregate
shocks to the economy.''
Section I motivates the empirical analysis
through a linear-quadratic model that in-
cludes both raw materials and finished goods.
The model is similar to that of Humphreys
3. The nondurdbles sector is primarily production to
stock, and the durables sector is primarily production lo or-
der. Over the 1984-99 period, the standard deviation ofthe
annualized growth rate of output in the nondurables sector
was 15.8% compared to 26.97o for Ihe durables sector.
4. For a description and evidence of some of these
other sources of aggregate enhanced stability, see Kim
and Nelson (1999). Clarida. Gaii and Gertier (2(M)0).
Blanchard and Simon (2001), Ramey and Vine (2001).
Stock and Walson (2002), Ahmed et al. (2004). and
Kim et al. (2003).
BIVIN: PRODUCTION MANAGEMENT SINCE 1984 673
et al. (2001). The transition from the theoret-
ical model to the estimating model is described
in section II. Section III describes the data.
Section IV implements the tests for structural
change with an unknown break date. The
complete model is developed by progressively
adding explanatory variables to the right-
hand side of the equation as a means of deter-
mining the source of any structural change.
For instance, an important question is
whether the break in output volatility is due
to a change in the behavior of demand or
to changes in the way in which output re-
sponds to demand. The latter may reflect im-
provements in production management and
the former does not. Section V examines the
output response to demand shocks to deter-
mine whether output management has im-
proved since the structural break.
I. THE MODEL
Tn this section, a simple linear-quadratic
model is developed to illustrate how the adop-
tion of JIT increases the coherence between
output and demand. The purpose is to demon-
strate how the cost structure influences the re-
lationship between output and demand. Let
Q, demand in period /,
Xt output in period /,
D, = materials deliveries in period /,
F, = level of net fiinished goods inventories
on hand at the end of period r.
Ml level of raw materials inventories on
hand at the end of period /,
V, per unit raw materials purchase cost.
Demand and material costs are treated as
exogenous and random. Both variables are
defined as random walks:
firm is governed by the following inventory
investment identities:
where ef and e| are mean-zero random vari-
ables. (Constants are omitted for simplicity.
The random walk simplifies the presentation
because it allows us to replace current and fu-
ture expected values of Q, and V, with Q,_^
and K,_.|, respectively. Moreover, it is consis-
tent with the data although demand exhibits
drift, which is excluded here for convenience.
The evolution of stocks and flows within the
(la) F,-
(lb) M, - ^ D, - X,
where the second equality in (lb) is obtained
by substituting for X, from (la). Net finished
goods in (la) encompasses production to
stock {Ft > 0) and production to order
(F, < 0). In the latter case, net finished goods
is interpreted as unfilled orders. It will never be
optimal to simultaneously carry finished
goods and unfilled orders in the model. The
change in raw materials is equal to deliveries
of new materials minus materials used up in
production. Although it is technologically fea-
sible to order materials, process them, and sell
the final product in a single period, the cost
function contains stockout avoidance motives
that make production lags economical. The
unit of measurement for materials is such that
one unit of materials is required for each unit
of output.
To take advantage of certainty equivalence,
the cost functions are quadratic in the decision
variables. Linear terms are largely excluded
for the sake of convenience. The cost function
in period / is
(2) COST, = 0.5 a 0.5
f 4- V,D,
where ay, QD-, ^> Pi and ^ are non-negative. In-
creasing marginal costs are attached to output
to reflect the fact that some of the resources
used in production are fixed. The inventory
cost functions reflect the combined influence
of carrying costs (which rise as inventories
rise) and stockout avoidance costs (which fall
as inventories rise). The slope of the marginal
cost function for both stocks is set to /) because
there is no benefit to distinguishing between
the two. The stockout avoidance parameters
are p for finished goods and tj) for raw mate-
rials. JIT is associated with inventory minimi-
zation, so it is standard to assume that the
implementation of JIT is reflected in smaller
values of p and <[).
In period 0, the firm maximizes the ex-
pected value of its discounted profit over an
674 ECONOMIC INQUIRY
infinite horizon. The revenue function is not
specified, but it is assumed that revenue is in-
dependent ofthe stocks of finished goods and
raw materials. This allows us to focus on costs.
Thanks to certainty equivalence, maximizing
the expected value of profit is equivalent to
maximizing the function under certainty with
future demand and costs by their expected val-
ues. Output and deliveries are eliminated from
(2) by substituting from the inventory invest-
ment identities in (la) and (lb):
(3)
The objective function is maximized with re-
spect to F, and M,:
(4)
max
where 0 < ?^ < 1 is the discount factor. The
first-order conditions are
(5a) EidXl/dF,)
(5b) E{dn/dM,)
The stocks fiuctuate around their steady-state
values, and thus the steady-state solutions are
an indicator of the average level of stocks.
Set F,=Ft and M, = M^ for ail /, where the
0 subscripts indicate expected long-run targets
conditional on information available at the
beginning of period 0. Substituting these
expressions into (5a) and (5b) and solving:
(6a)
(6b)
The steady-state solutions are smaller than
their target values because ofthe marginal cost
of obtaining, maintaining, and processing the
materials. Thus,/^* declines as f^_|,a;\-, anda/j
rise and M^ declines as K_i and a^ rise.
Increases in b move the steady-state stocks
closer to the targets because the marginal pen-
alty for deviations from the target stocks rises.
Increases in Q_\ need not result in increases in
F* or A/o- However., it is evident that reduc-
tions in p cause Ft to fall and reductions in
{{) cause MQ to fall. This is the intuitive proxy
for JIT policies.
The focus here is on the flexibility of output
refiected by how closely output tracks de-
mand. For instance, suppose that there is
a positive one-unit shock to demand. The
random-walk assumption implies that the
shock is expected to be permanent. As output
becomes more flexible, it rises by one unit
more quickly. Because finished goods inven-
tory investment is the difference between out-
put and demand, the more quickly output
adjusts to demand shocks, the less transitory
inventory disinvestment. In the medium term,
output must typically rise above demand to re-
store finished goods to their optimal level. As
output becomes more flexible, less overshoot-
ing is required.^
The notion of flexibility readily translates
into the decision rules of the model. Those fa-
miliar with the solution to models such as that
developed here, are aware that the decision
rule for finished goods and raw materials
5, One aspect of flexibility that is not addressed here is
the lag between the order and delivery of raw materials.
Throughout, it is assumed thai orders placed at the begin-
ning of the period can be processed and sold by the end of
the period.
BIVIN; PRODUCTION MANAGEMENT SINCE 1984 675
are expressed as linear functions of lagged
stocks and expected current and future values
of the forcing variables. The presence of lag-
ged stocks reflect a lack of complete flexi-
bility. As output becomes more flexible, the
influence of lagged stocks diminishes. Like-
wise, the time horizon effectively contracts
because the profltability of responding in
the current period to anticipated future move-
ments in demand becomes smaller, Complete
flexibility means that lagged values of the
stocks and future expected values of new
orders become irrelevant.^
The solution to the model is contained in an
appendix available from the author and is also
described in West (1995). The decision rules
require the solution to the following difference
equation (derived in the appendix):
(7)
where L is the lag operator and 7XL) ^ (1 -
XL-^)i\ - L) = - -H (1 + A,) - XL-\ The
presence of 7^{L) implies that L""^ and L^ both
appear in the model, and thus there are four
roots that satisfy (7). The solution is such that
two of the roots are convergent and two are
divergent. Denote the convergent roots as 6|
and 01. Planned finished goods and raw mate-
rials in period 0 is^
(8a)
(8b) E{MQ) = mM-i + K2M.2
6. Expected raw material prices will still be relevant
because flexibility does not nullify the incentive to accu-
tnulate raw materials prior to expected price increases.
7. The decision rules seem to suggest that finished
goods and raw materials evolve independently except
Tor their reliance on the same forcing variables. This is a re-
flection of the assumption, inherent in the derivation, that
past .stocks have evolved in an optimal manner. Thus the
past behavior of raw materials is reflected in the past be-
havior of finished goods. It is evident from the first-order
condition on finished goods, however, that its behavior
does depend on lagged stocks of raw materials. See Craig
Burnside, "Dynamic Optimization" (www.ccon.jhu.cdti/
People/Lubik/616_05/bumside.pci) for a derivation that
makes the dependence apparent. His approach is more
diflicult to implement and offers tittle additional benefit
for my purposes.
where TT] 9| -I- 62, ^2 -6162- Convergence
requires that 7i| -^ 7t2 be less than 1.
The solution to (7) is significant because the
roots reflect the flexibility of output. The sum
of Tt] and 7t2 measures the speed with which in-
ventory disequilibria are resolved. As rtj 4- 1x2
declines, the speed of adjustment rises indicat-
ing that output has become more flexible.
From (8), we may infer that output is com-
pletely flexible when TII -I- 7t2 = 0 so that Fo =
fo' independent of F..| and F^i- ^n this case,
the model is no longer dynamic. From (7). it
can be seen that this solution emerges when
the coefficients on T^(L) and 7"(L) are both 0,
and this requires that (axlb) and (ai)/b) equal 0.
In this case, r(L) 1. Setting ax and af, to
0 eliminates the increasing marginal costs of
output and deliveries that discourage rapid
adjustments of these flow. From (6a) and
(6b), when ax = ai, = 0, the steady-state so-
lutions in (6a) and (6b) become
The steady-state solutions differ from their
target values only because of the incentive
to economize on the purchase cost of raw
materials. Conversely, as b approaches infin-
ity, the marginal penalty for deviations from
the target stocks rises and the firm uses output
and deliveries to maintain inventories at their
target stocks regardless of their marginal costs
(as long as they are finite). If b approaches in-
finity, this incentive disappears as well due to
the infinite cost of departures from the target
stocks.
The expression in (8a) can be written in
terms of the difference between output and
new orders by noting that
(9)
= TCi [F-i - F-2) + TC2(F_2 - F_3
The term FoF*\is a linear function of
the shocks to demand and materials costs
676 ECONOMIC INQUIRY
and may be interpreted as a stationary ran-
dom error. Convergence implies that (9) is a
relationship between stationary variables.
Put differently, output and new orders are
cointegrated when new orders obey a random
walk. Equation (9) is the basis for the estima-
tions undertaken next.
To appreciate the influence of the cost fac-
tors in determining the rate at which output
converges with demand, suppose that ao 0.
It is shown in the appendix that (9) becomes
(10)
that this does not mean that the volatility of
output declines as n approaches 0. In fact,
output is least volatile when n: = 1 because,
from(lO), (A'o) = X^i.
This conclusion contradicts the standard
view that JIT is responsible for output stabili-
zation. The apparent source of the contradic-
tion is the view that JIT leads to better
inventory control and thus smaller deviations
of inventories from their target value. Al-
though this may be true, the inventory disequi-
libria occur only because of the inflexibility
of output and deUveries. But this inflexibility
implies lessnot morevolatility.'
where Zj = (1 ~ Tz){Ft - Fl^
V[a2 - 4X1)/2X, and a = (1 +
average lag is
, 7i = ( o t -
)- The
j=0
= {\-n)
-1
which is clearly an increasing function of n.
Also note that
- So)
and thus the volatility of XQ ^o declines as TI:
approaches 0.^
The value of n depends on (blax). As
b declines or ax rises, the ratio becomes
smaller, a becomes smaller and n rises, ap-
proaching I. When fl^ 0 or /) <, TC 0
and Xo - EiQo) implying perfect flexibility and
a one-period average lag. Thus a firm that
plans production as if it were facing either
or both of these values will set output equal
to expected current demand. It is worth noting
8. The derivation assumes serial independence of the
shocks and homoskedasticity. Because F* - /^* i is a linear
function of the shocks, homoskedasticity ensures the cur-
rent variance of the shock can be used for all time periods.
II. IMPLEMENTING THE MODEL
Ideally the structural relationships modeled
in the previous section would be estimated di-
rectly and the estimates of the parameters un-
covered. It is likely, however, that real-world
production exhibits substantially more dy-
namic interaction than the model developed
here. For instance, with the monthly data
employed here, there may be no industries
in which materials can be ordered, delivered,
processed, and sold within the same period.
Likewise, the data-generating processes for
demand and materials costs are likely to re-
quire more lags than the simple random walks
assumed in the prior section.
To account for these uncertainties in the
specification, the estimations are carried out
in a nonstructural VAR framework that
allows for cointegration between output and
sales as implied by (9). The initial model is
a univariate VAR in the growth rate of output.
These results are evaluated and then the
growth rate of demand is added to the model
along with the cointegrating restriction. Fi-
nally, the growth rates of raw materials and
raw materials costs are added. Although
raw materials do not appear in the decision
rule for finished goods in (8a), intuition sug-
gests that excess raw materials in the prior
9. For two contradictory interpretations, see Kahn
et al. (2002) and Bivin (2005). The former focuses on
ihe use of technology to obtain better forecasts of sales.
This reduces the unanticipated shocks to demand that
by assumption are absorbed by inventories. Thus inven-
tory fluctuations about the target stock are reduced and
smaller output respotises are required. Bivin models the
adoption of JIT as a technology that allows the firm to
reduce the scale of shocks to output. These smaller shocks
directly reduce the volatility of output.
BTVfN; PRODUCTION MANAGEMENT SINCE 1984 67?
period should cause output to rise in the cur-
rent period as a means of distributing the ex-
cess stocks across stages of fabrication. The
absence of raw materials in the decision rule
for finished goods is explained in note 7.
Let .Vf and q, denote the log of output and
the log of demand, respectively. Assuming
that both variables are unit root processes,
it follows that
(II) y,=x,- q,
is stationary and represents a cointegrating
relationship.
The estimating model follows naturally
from a specification that incorporates the sta-
tionarity of >-,. We begin with a two-equation
system in which x, and q, are expressed as dis-
tributed lags on themselves:
(12)
where Z, [q, x,]' , OQ is a 2 x 1 vector of con-
stants, and O, (y = 1,2, . . . , y) is a 2 X 2 matrix
of coefficients on the lagged values of the
endogenous variables. The 2 x 1 vector V,
contains the random error terms. These are
serially independent but may be contempora-
neously correlated.
The stationarity of _v, implies the following
error-correction form of (12):
(13)
j=\
where (3 [P^ P^^]' is a 2 x 1 vector of error-
correction coefficients and ^P/ (y 1,2, . . . ,
J I) is a 2 X 2 matrix of coefficients derived
from the OyS. Once the lag lengths are deter-
mined, the equations in (13) can be estimated
with ordinary least squares. Two assumptions
enable this approach. The first is that the coin-
tegrating vector is known to be [-1, I] and
thus %j and p^ are immediately identified,
The second is that the constant term in both
regressions is 0. The constant in (13) compli-
cates the estimation because the uncon-
strained estimates need not imply that Ax,
Ac/, in the long run. A straightforward means
of ehminating this difficulty is to express the
growth rates of demand and output as devia-
tions from their means so that the constants
disappear from the regression. To ensure that
the growth rate of output and demand have
the same mean, they are expressed as devia-
tions from their common mean, calculated
as the simple average ofthe mean growth rates
over the period.
The error-correction model in (13) can be
converted to a standard trivariate vector auto-
regression in A^,, ^Xt, and y, by appending
an additional estimating equation that esti-
mates y, as a function of the 7 - 1 lags of
A^;. A.V,. and i,. This extension introduces
additional lags of;', into (13) but the added
lags do not enhance the explanatory power
of that model for the growth rates of demand
or output because of the following linear
dependence:
(14)
y, =
Lagging this expression indicates that y,_2 =
y,-] + A.V/.j A^,_i and because the three
variables on the right-hand side of this ex-
pression are already in the VAR. the inclu-
sion of i',_2 introduces a linear dependence
into the model and no additional explanatory
power. Obviously, the same will also be true
for longer lags of v,. An implication of this
dependence is that there are no shocks to y,
that are independent of the shocks to A.v,
or A^,. Thus the estimates in (13) are equiv-
alent to those from a trivariate VAR with >>,
as the third variable. Expressing the model in
this way is helpful for describing the dynamic
properties of the ability of output to track
demand.
The final model is a five-variable VAR in
stationary variables including., in addition to
Ax,, Af/,. and y,, the growth rates of raw mate-
rials inventories (Ani,) and the real cost of raw
materials (Av,). Shocks to costs and stocks
help account for deviations of output from
new orders that would otherwise be attributed
to dynamic adjustments. When necessary, the
constant will be omitted from the regressions
for reasons noted earlier, ln these cases, these
variables are expressed as a deviation from
their mean over the respective sample.
Ill, DATA
The Bureau of Economic Analysis provides
monthly data on real sales and inventories by
stage of fabrication spanning the period from
January 1959 through July 1999. The data are
provided for each of the 20 two-digit SIC
678 ECONOMIC INQUIRY
FIGURE 1
The Values ot yi for Durables and Nondurables
0. 1-
0 -
-0.05-
-0.1-
. 11
NTfi'i yy
manufacturing industries as well as total
manufacturing, durables manufacturing, and
nondurables manufacturing. The data are
only available on a seasonally adjusted basis.
The inventory data are multiplied by an ad-
justment factor to insure that they are deflated
on the same basis as sales (West, 1983).
Measured output at the industry level dif-
fers conceptually from GDP in that GDP is
a value- added concept while industry output
also includes the value of raw materials con-
tained in the output. By the same token, inter-
mediate production appears in GDP. whereas
industry output includes only finished prod-
ucts. Thus GDP includes investment in raw
materials and work-in-process as well as fin-
ished goods. Final sales in the national income
accounts are equivalent to industry sales, but
there is no national income accounts counter-
part to new orders.
The focus on the relationship between out-
put and demand is an innovation of this study.
Typically, sales are treated as the forcing vari-
able but this is problematic because the sale of
a product must occur after its production.
When firms produce to order, new orders (rep-
resenting demand), typically leads sales and is
the more appropriate forcing variable.
Sales and new orders are identical in those
industries that produce to stock and thus un-
filled orders are nonzero only among those in-
dustries that produce to order. Unfortunately,
the Bureau of Economic Analysis does not
provide data on rea! new orders for these in-
dustries. The Bureau of the Census provides
monthly, seasonally adjusted, nominal ratios
of unfilled orders to sales for many industries.
The real series is created under the assumption
that the nominal ratio of unfilled orders to
sales is equal to the real ratio. Multiplying
these ratios by real sales yields real unfilled
orders. Real new orders are then defined as
the sum of real sales and the change in real un-
filled orders.'**
Plots of >', for durables and nondurables are
contained in Figure I. The standard deviation
of V, in the durables sector is more than six
times larger than for nondurables. This reflects
the longer production lags in the durables sec-
tor that make it more difficult for output to
track demand over a month's time. Both series
are apparently stationary around 0 although
the durables series deviates from 0 for long
10. West (1989) employs this assumption to construct
real new orders and points out that it is valid as long as
unfilled orders are valued at current prices. Apparently
this h the common practice. Here, as elsewhere, the non-
durables sector is treated as production-to-stock even
though some of the industries in this sector produce to
order. Unfilled orders data are not available lor six of
the 20 two-digit industries that produce to order and they
are excluded from the analysis.
BIVIN: PRODUCTION MANAGEMENT SINCE 1984
679
periods of time, especially prior to 1984. The
diagram suggests that y, in the durables sector
stabilized in the early to mid-1980s. Formal
tests for the stationarity of _v, reject the presence
of a unit root for durables, nondurables, and
the remaining industries as well."
Table 1 presents data on the volatility of >',
using January 1984 as the break date. Each of
the standard deviations is constructed under
the assumption that the population mean is 0.
Consistent with aggregate results, the stan-
dard deviations for the durables industries
are virtually all larger than the standard devi-
ations for the nondurables industries. A com-
parison ofthe standard deviations for the first
and second periods indicates a shift toward
stability in 11 of the 16 industries. The ex-
ceptions are transportation, instruments, to-
bacco, chemicals, and petroleum. Thus three
of the six two-digit nondurables industries
do not exhibit a shift toward stability.
IV. STRUCTURAL CHANGE IN OUTPUT
The empirical model is a five-variable VAR,
but the variable of interest is the growth rate of
output. Thus specification issues such as lag
length and break dates are defined solely in
terms ofthe performance ofthe AA", equation.
The remaining equations in the VAR come
into play in section V, where the stability ef-
fects of any structural changes are evaluated.
In this section, structural break dates in out-
11. Tests for structural change with unknown break
date arc conducted next, and one cannot be certain a priori
whether the data are unil rools over the relevant samples
without extensive testing. The conclusions on stationarity
are based on tests over the entire sample, the 1959-8.1 and
1984-99 subsamples and consecutive five-year subperiods
commencing in 1959. The logs of output and demand are
tested against Ihc alternative hypothesis ofa linear trend.
The null hypothesis ofa unit root cannot be rejected for
either variable for any industry over the entire sample or
either of the larger subsamples. Rejections are sporadic
at the 5% level for the five-year samples. For y,, the null
hypothesis ofa unit root is always rejected for the over-
all sample and for the 1959-83 period. For the 1984-99
period, the null ofa unit root is not rejected for the trans-
portation industry when the alternative hypothesis is no
constant and no trend. The level of significance is only
11%, close to the 5% level employed for the remaining
data. Moreover, some ofthe products produced in trans-
portation, such as aircraft, ships, and railroad equipment,
are subject to very long production lags that could result in
long delays between demand shocks and the resulting out-
put response. This long delay could disguise any cointe-
graiion between demand and output. For the five-year
tests on the stationarity of >' noncointegration is rejected
only sporadically.
TABLE 1
Standard Deviation of _v,
Industry
Manufacturing
Durables
Stone, clay, and glass
Primary metals
Fabricated metals
Industrial machinery
Electronics
Transportation
Instruments
Nondurables
Food
Tobacco
Apparel
Chemicals
Petroleum
Rubber
1959-99
0.019
0,036
0.027
0.076
0.043
0.056
0,045
0.099
0.071
0.005
0,009
0.031
0.019
0.012
0.015
0.015
195-3
0.021
0.040
0.028
0.091
0.050
0,066
0.048
0,092
0,071
0,006
0.010
0.021
0.019
0.012
0.014
0.018
1984-99
0.014
0.027
0.025
0.041
0.027
0.037
0.039
O.ltO
0,071
0.005
0.006
0,043
0.018
0.013
0.017
0.009
1,
Ratio
0.651
0.664
0.865
0.445
0.536
0.564
0.821
1,193
1.008
0.878
0.638
2,058
0.955
1.080
1.276
0.493
Notes: The SDs arc constructed assuming that the
ptopulation mean is 0. "Ratio" refers to the ratio of the
standard deviation of ^', during the 1984-99 period to
the standard deviation of >*, dudng the 1959-83,
put are identified. If a break contributes to
enhanced aggregate stability, then it should
occur around 1984 and output should exhibit
greater stability following the break.
The model of interest is
(15)
7=1
u,
Note the lag lengths for the four right-hand-
side variables are all J. This is consistent with
the VAR framework and also simplifies the
search for the optimal model. The value of
J is chosen through the Schwarz Bayesian
Information Criterion (SBIC). The constant
is retained for the time being for reasons to
be explained.
The existence of a break date is assessed
through the exponential lest developed in
Andrews (1993) and Andrews and Ploberger
(1994). The date of the structural break is
identified as the date that maximizes the
Wald statistic for structural change. The sig-
nificance of the break date is assessed using
680
ECONOMIC INQUIRY
the approximation developed by Hansen
(1997). The critical significance level is 5%.
Following the recommendation of Andrews
and others, 15% ofthe observations at the be-
ginning and the end ofthe sample are excluded
as potential break dates.' '
Multiple break dates are possible as Rossana's
(1998) results discussed in the introduction
indicate. Bai (1997) demonstrates that when
the model is estimated over the entire sample,
the existence of multiple break dates reduces
the power of the test for a single break date.
He recommends testing for break dates in the
two samples separated by the estimated break
date regardless of its significance. If both tests
yield insignificant results, then the original
date is the only relevant one assuming it is
significant. If one or both secondary dates
are significant, the initial date is "refined"
as described by Bai. This procedure can be
continued indefinitely, but here the methodol-
ogy is limited to allow a maximum of three
break dates. For each stage of the test, the
sample changes. The optimal lag lengths are
redefined in each case using the SBIC criteria.
The model is estimated in stages. In the first
stage, the growth rate of output is estimated as
a univariate autoregressive model. Ofthe mod-
els estimated here, this is the most similar to that
estimated by MPQ in that the model is simply
exploring the possibility of structural change
12. The 15% criterion can only be applied when ihe
number of parameters being estimated is less than 15%
of the observations in the subsampie, ln some cases, this
condition either was not satistied or left very few degrees of
freedom. In tbese cases, the 15% criterion was replaced
with a criterion that specified a smaller proportion of el-
igible dates. The following condition was employed: If the
number of parameters to be estimated was greater than
10% of the sample size, then 25% of the observations at
each end of ihe sample were omitted as potential break
dates; if the number of parameters to be estimated was
greater iban 20% oflhe sampie size, then 35% of the obser-
vations were omitted al each end ofthe sample; if the num-
ber of parameters lo be estimated was greater ihan 30% of
Ihe sample size, Ihen 45% of the observations at each end
of the sample were omitted. The goal is to avoid conduct-
ing the lest over samples in which the degrees of freedom is
less than 15% ofthe sample size,
13, For instance, if a significant break date appears in
both the first and second subsamples, then the sample
bounded by these dales is tested for a significant break
date and, if one appears, it replaces the original estimated
date, and there are three break dates in the sample. If a sig-
nificant break appears in the second subsample but not in
the lirsl. then the original break date is refined over ihe
sample ihat begins wilh the first observation in the data
set and terminates with ihe second subsampie break date.
The procedure is analogous when a significant break date
appears in the first subsample but not the second.
but is not capable of attributing structural
change to any particular cause. This model
includes a constant but does not allow for the
cointegrating relationship between output and
demand. Only the parameters <^Q, <^\, -, <^j
in (15) are estimated; the remaining coefficients
are set to 0. The null hypothesis is that all ofthe
parameters are constant over the entire sample.
Break dates that are significant at the 5%
level are illustrated in Table 2. Dates that oc-
cur in the 1982-86 period may indicate that
the industry played some role in the stabiliza-
tion of GDP in 1984. These dates are high-
lighted in bold. The results support the MPQ
claim of a structural break in 1984, Break dates
in the relevant 1982-86 periods were uncovered
for total manufacturing, durables, and non-
durables. The three break dates for total manu-
facturing between August 1979 and May 1986
suggest a gradual adoption or perhaps the
effects oi aggregation over industries. In addi-
tion, four ofthe seven two-digit durables indus-
tries exhibited a break in the 1982-86 period, as
did one of the nondurables industries. There
were two durables industries and two nondura-
bles industries in which no structural change
oeeurred over the sample. This is surprising
given the 40-year span of the sample.
The next model includes the growth rate of
demand on the right-hand side along with the
growth rate of output to create a bivariate sys-
tem; >'f-i is included in the model as well. Be-
cause the break dates are not known, the
constant is retained to allow for a change in
the means of Aq, and Ax, across samples. In
addition to the parameters estimated in the
univariate autoregressive model, this estima-
tion includes 8/ through 5y and 3.v The null
hypothesis is again that all of the parameters
are constant over the sample.
If some of the break dates noted in Table 2
disappear when demand is included in the
model, it suggests that the structural changes
in output are a reflection of structural changes
in demand rather than the adoption of im-
proved production management techniques.
Table 3 contains the results. The significant
breaks in 1983 and 1984 that appeared in
the univariate model for total manufacturing
and durables disappear when the growth
rate of demand is added to the model.'"* The
14. For both industries, a break date was Ktimated
in December 1983, but ihe significance levels were around
30%,
BIVIN: PRODUCTION MANAGEMENT SINCE 1984
TABLE 2
Test for Structural Change in Ax, with Unknown Break Dates: Univariate Model
Industry
Manufacturing
Durables
Stone, clay, and glass
Primary metals
Fabricated metals
Industrial machinery
Electronics
Transportation
Instruments
Nondurables
Food
Tobacco
Apparel
Chemicals
Petroleum
Rubber
First Estimated
Break Date
August 1979
March 19S0
August 1971
December 1979
May 1984
May 1984
February 1990
May 1979
February 1966
February 1992
March 1984
October 1967
Second Estimated
Break Date
December 1983
August 1984
October 1985
March 1986
August 1993
December 1982
December 1997
September 1980
Third I'^itimated
Break Date
May 1986
August 1995
1
Note.t: The dates listed are those for which there was evidence of a break date using the Andrews and Ploberger
exponential test and a signifiaince level of 5%. Break dates occurring in the 1982-86 period are highlighted in bold.
significant date for structural change in these
sectors is now March 1991a date that coin-
cides perfectly with the trough of the 1990-91
business cycle. This same date marks struc-
tural change for the primary metals industry
and there is a break date for the instruments
industry in the prior month. Among the
two-digit durables industries, only industrial
TABLE 3
Test for Structural Change in Ax, with Unknown Break Dates: Cointegration Model
with A.Y, and Aq,
Industr)'
First Estimated
Break Date
Second Estimated
Break Date
Third F^stimated
Break Date
Manufacturing
Durables
Stone, clay, and glass
Primary metals
Fabricated metals
Industrial machinery
Electronics
Transportation
Instruments
Nondurables
Food
Tobacco
Apparel
Chemicals
Petroleum
Rubber
March 1991
March 1991
July 1968
December 1971
August 1981
June 1989
August 1978
January 1993
May 1982
January 1972
June 1979
February 1991
March 1982
March 1991
April 1982
October 1997
February 1984
January 1997
March 1998
Notcr The dates listed are those for which there was evident^ of a break date using the Andrews and Ploberger
exponential test and a significance level of 5%, Break dates occurring in the 1982-86 period are highlighted in bold.
682 ECONOMIC INQUIRY
TABLE 4
Test for Structural Change in Ax, with Unknown Break Dates: Cointegration Model with
Ax,, Aq,, AVf, and Am,
IndtLstry
Manufacturing
Durables
Stone, clay, and glass
Primary metals
Fabricated metals
Industrial machinery
Electronics
Transportation
Instruments
Nondurables
Food
Tobacco
Apparel
Chemicals
Petroleum
Rubber
First Estimated
Break Date
March 1991
Augtist 1991
July 1968
July 1980
March 1991
December 1989
December 1983
September 1974
June 1972
February 1980
February 1998
Second Estimated
Break Date
Febniary 1994
April 1998
December 1997
July 1979
May 1984
Third Estimated
Break Date
October 1996
April 1995
Notes: The dates listed are those for which there was evidence of a break date using the Andrews and Ploberger
exponential test and a significance level of 5%. Break dates occurring in the 1982-86 period are highlighted in bold.
machinery exhibited a break date in the 1982-
86 period. There is still a significant break for
nondurables in 1982. and apparel and petro-
leum in the nondurables sector exhibit break
dates in the 1982-86 period as well.
The final question is whether the break
dates are sensitive to the inclusion of material
costs and the growth rate of raw materials.
Even if firms have adopted improved pro-
duction management techniques, shocks to
these variables are likely to account for
short-run deviations of output from demand.
Thus their presence is important to ensure a
properly specified model, even in the absence
of structural change. Moreover, improve-
ments in production management should alter
the responses of output to shocks to raw mate-
rials and material costs. For instance, one of
the goals of JIT is inventory minimization,
and this suggests that positive shocks to raw
materials will elicit a more rapid output re-
sponse following the adoption of the JIT pro-
duction strategy. For this model, all of the
parameters in (15) are estimated, and the null
hypothesis is that they are all constant.
The significant break dates are shown in
Table 4. Only instruments and petroleum
contain a break date in the 1982-86 period.
Now there is no evident structural change in
manufacturing or in nondurables. Durables
still exhibits a structural change in 1991. In
fact, 9 of the 18 significant break dates take
place in 1991 or later. Because the sample ends
in 1999, this raises the concern that some of
these results reflect too small samples and
may, in fact, be spurious.
V. HAS PRODUCTION BECOME
MORE FLEXIBLE?
Having uncovered the structural shifts
documented in Table 4, the question remains
as to the nature of the shifts, that is, whether
production management has improved since
the date of the shift. A variety of criteria
may be used to identify improvements in pro-
duction management. The criteria employed
here emphasize flexibility: Production man-
agement improves when output responds
more quickly to exogenous demand shocks.
The more rapidly the growth rate of output
responds to an independent shock to demand,
the more rapidly y, returns to 0,
The vector autoregression described at the
end of section I is fully implemented here.
Now that the break dates are known, it is rea-
sonable to assume that the means of the en-
dogenous variables are constant within the
BIVTN: PRODUCTION MANAGEMENT SINCE 1984 683
TABLE 5
Sample Break Dates
Industry
Durables
Stone, clay, and glass
Industrial machinery
Electronics
Transportation
Instruments
Start Date
April 1959
April 1959
April 1959
May 1959
April 1959
April 1959
First Period
End Date
March 1990
Sept. 1990
July 1979
March 1990
Dec, 1988
Dec. 1982
Second
Start Date
April 1992
Oct. 1992
Sept. 1981
April 1992
Jan. 1991
Jan. 1985
Period
End Date
July 1999
July 1999
July 1999
April 1997
Dec. 1996
July 1999
samples and therefore to represent these var-
iables as deviations from their means. Thus
constants are omitted from the regressions.
Some of the industries are omitted because
there were no significant break dates. Others
are omitted because their break dates fall
too near to the beginning or the end of the
sample to be of practical interest. Finally,
a few industries are omitted because the break
dates are too close together to yield reliable
estimates. To allow for gradual adjustments
prior to or following the break dates. 12 obser-
vations on both sides of the break dates are
dropped. The sample dates are contained in
Table 5. The ending dates for the first sample
range from 1979 to 1990, and the start dates
for the second sample range from 1981 to
1992. This broad range of dates casts doubt
on a common source of structural change.
The first question is whether _v, stabilized af-
ter the structural change and, if so, whether
the stabilization is due to improved dynamics
or smaller shocks. The tests conducted in the
previous section are predicated on the assump-
tion that improved production management
appears in the fonn of more stable dynamics.
Stock and Watson (2002) illustrate how cross-
sample changes in volatility can be partitioned
into a contribution due to smaller shocks and
a contribution due to changes in dynamics.
Let Z, [A(/,,, Av,, Am,, A.x,, y,]' and let U,
denote a 5 x 1 vector of serially independent
random error terms. Then the system of equa-
tions may be written as
U,
k=l
polynomial in L. The moving average fonn
of this system is ,
(16)
j=0
where Cy is a 5 x 5 matrix containing the mov-
ing average coefficients for lag /. From this
expression, it folJows that the variance of Z, is
(17)
j=0
where T/^ is a 5 x 5 matrix of coefficients,
L is the lag operator, and '^{L) is a matrix
where St/ = VAR(f/,). The estimates of the Cs
and of Z(j are unique to each sample period.
Denote the first subsample (second sub-
sample) with the superscript 1 (2) and de-
note the variances of y, calculated with these
coefficient matrices and residual variance-
covariance matrices as Var ( j , | c' , l | , ) for
the first sample and Var(_V/lC^. 2^) for the
second sample. Hereafter, the first-sample
variance will be standardized to I.
The contribution of improved dynamics to
cross-sample changes in the variance of v, can
be extracted by constructing the counterfac-
tual second-period variance ofy, under the as-
sumption that the variance-covariance matrix
of the shocks in the second sample did not
change from the first sample. In other words,
compare Var(>', | C^. i j , ) with V-AT(y, \ C' , i j / ).
If changing dynamies stabilized y,, the ratio
of the first term to the second will be smaller
than 1.
Table 6 contains the results, expressed as
ratios of standard deviations. The first column
is the ratio of the actual standard deviations.
Of the industries considered, output tracked
demand more closely in the second sample
than in the first, except for transportation.
ECONOMIC INQUIRY
TABLE 6
Decomposing the Second-Period SD of y,
Industry Vl'
Durables
Stone, clay.
and glass
Industrial
machinery
Electronics
Transportation
[nstrumenls
^ARo-, c^I;|,)|
0.609
0.784
0.728
0.939
1.199
0.994
VIVARO', C^El,)l
0.802
1.085
0.787
0.901
1.058
0.940
Nole: The entries are expressed as ratios to
TTiere is a very slight reduction for instru-
ments, but the volatility of y, fell by almost
40% for durables manufacturing. The second
column maintains a constant variance of the
shocks across samples. Now all of the ratios
are less than one except for transportation
and stone, clay, and glass, which experienced
a 5-lOyo increase in volatility due to changes
in dynamics. Improved dynamics account for
reductions in the standard deviation of y, of
20yo and 21% in the durables and industrial
machinery sectors. Electronics and instru-
ments both stabilized as well, but the reduc-
tions are less than 10%) in both cases.
The question remains as to whether these
reductions in volatility refiect greater output
fiexibility. Although output has tracked de-
mand more closely in recent years for some
industries, the reason may simply be that
demand has become easier to track, perhaps
because demand shocks are smaller or decay
more rapidly.
One measure of output flexibility is the con-
temporaneous response of the growth rate of
output to a one-unit independent shock to de-
mand. Ideally, this number will be 1, indicat-
ing that the demand shock is fully absorbed by
the output shock in the period in which it
occurs. This statistic is essentially the corre-
lation coefficient between the residuals from
the demand equation and the residuals from
the output equation and is denoted as p,'^
Another measure is the estimate of p,.' ^he
error-correction coefficient for output. This
15. Specifically, p = cov(uA,.Ui,)/var(MA^) and the
correlation coefficient iscov(ua,,H^)/7(var(M4,)var(u4,).
The measures are precisely equal when the variance of
ihe demand shocks and the variance of the output shocks
are equal.
describes the output response to a one-unit im-
balance between log output and log demand in
the preceding period. Two versions of this sta-
tistic are considered here. The first is simply
the estimate of p.^ and the second is the esti-
mate of pj(/{l - p^). The latter is the propor-
tion of the imbalance eliminated by output
after accounting for the portion eliminated
by demand. If both demand and output adjust
to eliminate a portion of the response and y,
adjusts monotonically, then p^ > 0 > p^ >
(p,, - 1) and - 1 < p.^( I - Prf) < P.V < 0. Values
closer to 1 indicate improved production
flexibility.
The results are contained in Table 7.
Improvements in production flexibility are
reflected in larger values of p. However, p
declined in five of the six industries. Appar-
ently demand shocks elicited a smaller con-
temporaneous output response in the second
sample than in the first. This may reflect less
production flexibility, but it could also occur
if demand shocks were viewed as more transi-
tory in the second sample than in the first.
The remaining columns contain the error-
correction coefficients. The values of p should
still be negative in the second period, but
larger in absolute value. Again, there are
very few case in which output became more
flexible by these measures. Industrial machin-
ery and transportation are the only examples
in which the second-sample error-correction
coefficients increased in absolute value.'"^
Apparently, the enhanced flexibility is not
evident in the contemporaneous or one month
lagged response of output to a shock to the
growth rate of demand. An explanation for
this behavior can be found in Figure 2, which
illustrates the impulse responses to demand
shocks for the durables sector. For both sam-
ples, the initial shock to the growth rate of de-
mand is set to the standard deviation of the
residuals from the first sample. The behavior
of _V, is represented in the first panel. The sec-
ond and third panels illustrate the demand and
output responses in the first and second sam-
ples, respectively. Output and demand are
level data derived from the simulated growth
16. The positive estimate of p, in the second period for
instruments indicates ihat the output response to the im-
balance actually made the imbalance worse. For electron-
ics in the second period, p, < 0 but pj > 1 and thus the
adjusted error-correction coefficient is positive (0.224). ln
this case, the growth rate of demand is very "flexible" and,
as a result, y, oscillates around 0.
BIVIN: PRODUCTION MANAGEMENT SINCE 1984 685
TABLE 7
Short-Run Output Flexibihty
Industry
Durables
Stone, elay, and glass
Industrial machinery
Electronics
Transportation
Instruments
Contemporaneous Output
Respoase to an Independent
Demand Shock (p)
First Period Second Period
0.403 0.302
0.580 0.505
0.221 0.264
0.265 0.194
0.281 0.226
0.128 0.123
Error-Correction
CoefBcient on
Output p .
First Period Second Period
-0.165* -0.095
-0.205 -0.124*
-0.124* -0.299*
-0.252* -0.065
-0.060 -0.071
-0.081* 0.213
Adjusted Error-Correction
Coefficient on
Output (P
First Period
-0.180*
-0.703*
-0.133*
-0.219*
-0.124*
-0.124*
Al - M
Second Period
-0. 154
-0.133*
-0.326*
0.224
-0.179
0.170
Significant at the 5% level (one-tailed test).
*Significant at the 1% level (one-tailed test).
rates using the inverse transformation; for in-
stance, Q, = Qr_iCXp{Aq,) for demand.
From the first panel, it is apparent that y,
converges more rapidly in the second sample
than in thefirst.'^Thusoutput has tracked de-
mand more closely in recent years. The second
and third panels suggest that the reason for
this is that demand shocks have become less
persistent. In both samples, there is a large
gap between demand and output in the period
of the shock. In the first sample, the gap is
eliminated by gradual declines in demand
and gradual increases in output. About 50%
of the long-run error correction is due to de-
mand adjustments and 50% to output adjust-
ments. In the second sample, however, about
100% of the long-run error correction is due to
declines in demand. It is interesting that even
though the initial output response to a demand
shock is smaller in the second sample than
in the first, very little output adjustment is
required in the periods following the shock
because demand eliminates so much of the
gap. Thus output arrives at its new long-run
equilibrium in the period of the shock and de-
mand reaches the new long-run equilibrium
in the period following the shock although
it deviates in the following period.
These results are somewhat muddled be-
cause of the intermingling of output and de-
mand dynamics. To avoid this difficulty, an
additional simulation is carried out in which
demand suddenly rises by 10% and then
17. The differences, however, are not significant when
parameter uncertainty and random shocks are taken into
accoutit.
remains permanently at thai higher value.
This is accomplished by imposing a sequence
of residuals on the growth rate of demand
equation that ensure that the growth rate
of demand is 0 following the initial shock.
These shocks are then distributed among
the remaining variables using the Cholesky
decomposition. Because demand is constant,
the error correction is carried out entirely
through output adjustments. The question
is how long do these adjustments take? This
question is addressed by constructing the
average lag of >,."*
The average lags in months are shown in
the first two columns of Table 8. The last
two columns contain the results of the oppo-
site experiment in which output is subject to
a permanent shift and the adjustment is un-
dertaken by demand. If demand has become
more flexible in recent years, then the average
lags should decline from the first column to
the second.
The average lag for output fell in recent
years only for industrial machinery and elec-
tronics where the declines are almost five
months and two months, respectively. Neither
of these industries exhibited a break in the
1982-86 period, although there is a break for
industrial machinery in 1980. For durables,
stone, clay, and glass, and transportation,
there are slight increases, on the order of
18. The average lag is defined as E / o f E / o
The measure is only meaningful if thci's maintain lhe same
sign throughout the adjustment to the steady state. For ail
of the industries considered here and for both subsamples,
y, is negative at every point in time. Put diflerently, output
never rises above demand in the simulations,
686 ECONOMIC INQUIRY
FIGURE 2
Responses of Demand, Output, and y, to a Demand Shock for the Durables Industry
0.005
-0.03
First Sample
Second Sample
1.04
1.03-
1.02-
1.0J -
Demand
OLItpUt
1.04
L03-
1.02-
1.01-
Second Sample
Demand
Output
two weeks at the most. For instruments, the
lag almost doubles from less than 10 months
to almost 18 months.
Clearly the evidence in favor of greater pro-
duction flexibility is weak at best. The evidence
in favor of more flexible demand is more
promising. The average lag fell in four indus-
tries and rose in only two. For durables the lag
fell from almost 15 months to less than
3 months. There was a similar dramatic im-
provement for electronics. Apparently, the
more stable behavior of y, in recent years is
primarily due to declines in the persistence
of demand.
BIVIN: PRODUCTION MANAGEMENT SINCE 1984 687
TABLE 8
Average Lags of y^
Industry
Durables
Stone, clay, and glass
Industrial machinery
Electronics
Transportation
Instruments
Output
First Period
4.601
1.277
8.103
5.350
5.078
9.450
Shock
Second Period
5.006
L500
3.261
3.549
5.245
17.943
Demand Siiock
First Period
14.873
1.382
14.873
17.649
1.514
3.013
Second Period
2.947
0.511
18.896
1.467
1.479
3.392
VI. SUM^MRY AND CONCLUSIONS
The conclusion that output experienced
an exogenous stabilization in 1984 is not well
supported by industry-level manufacturing
data. When the growth rate of output is
modeled as a univariate process, both total
manufacturing and durables exhibit structural
change in 1984, but once demand is admitted
into the model, the break dates for these
sectors shift to 1991. When materials costs
and raw materials are added to the model,
the break date for manufacturing disappears
entirely. The significant break dates are widely
scattered over the sample, but only the dates
for instruments and petroleum fall in the
1982-84 period. Surprisingly, total manu-
facturing did not exhibit a significant break
during the 1959-99 period.
Among the selected industries that ex-
hibited structural breaks in output in the late
1970s through the early 1990s, output typ-
ically tracked demand more closely following
the break. More stable dynamics are partially
responsible for this improvement. The en-
hanced stability is most evident for durables
where the volatility of v, declined by almost
40yo. However, further tests and simulations
do not support the view that output has be-
come more responsive to demand shocks in
the very short run. It appears, instead, that
the improvements are more a reflection of less
persistent demand.
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