Most traditional explanations for the decreasing aggregate output volatility - so-called "Great Moderation" - fail to accommodate, or even directly contradict, another aspect of empirical data: the average sales volatility for publicly-traded US firms has been increasing during the same period. The paper aims to reconcile the opposite trends of firm-level and aggregate volatilities. I argue that the rise of organization capital, or firm-specific intangible capital, is the origin of the volatility divergence. Firms in the modern economy have been investing heavily in intangible and organizational assets, such as R&D, management processes, intellectual property, software, and brand name - the "soft" capitals that distinguish a firm from the sum of its physical properties. Most intangible assets are firm-specific, inseparable from the company that originally produced them, and difficult to trade on outside market. Investing in these organization-specific capitals insulates a firm from market-wide shocks, but introduces higher firm-specific risk that does not equally affect its peers. When value creation is increasingly relying on organization capital, the impact of idiosyncratic risk factor rises, while that of general risk factor declines. The former elevates firm-level volatility; the latter reduces aggregate volatility, mainly through weakening the positive co-movements among firms. Therefore, the decrease in aggregate output volatility is not because of less turbulent macro environment, but a result of more heterogeneity among production units. In this sense, the Great Moderation is rather a story of "Great Dissolution". It may indicate greater economic uncertainty faced by individual agents, instead of less. My empirical investigation found that, consistent with the paper's hypotheses, firm-level volatility increases with organizational investment, but general factors' impact on firm performance and a firm's correlation with others decrease with organizational investment. Simulations of the general equilibrium model featuring organization capital investment are capable of replicating the volatility trends at both aggregate and firm level for the past two decades.
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number
13701.
Find related papers by JEL classification: D21 - Microeconomics - - Production and Organizations - - - Firm Behavior E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data E23 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Production D24 - Microeconomics - - Production and Organizations - - - Production; Capital and Total Factor Productivity; Capacity
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