For a detailed explanation of the dynamics of the long wave, see the paper on A Systems Thinking Perspective on Manufacturing & Trade Policy,

From the Holm Mortgage Finance Report, 2/18/05, By Jon Holm

A PICTURE IS WORTH 1,000 WORDS, or so they say. The Long Wave graph (see below) took us many years to produce (we will explain why later on). It was like trying to re-invent the wheel, but we finally did it. In 1992, Professor John Sterman of MIT wrote an article titled, "Tne Long Wave Decline and the Politics of Depression." The article dealt with the discovery that Professor Jay Forrester and others at MIT made in the ‘70s when applying their new technique of systems thinking to the economy as a whole. Their computer model produced the Long Wave. Then they had to explain how it happened.

This is quite different from the research that Russian economist Kondratief did back in the early 1920s when he produced his theory of the long wave (or K-wave) which many since then have hijacked to try to predict the stock market and other such unrelated things. For this reason, many contemporary economists shy away from the theory because it has been tainted by the get-rich-quick schemers. It is unfortunate that the MIT researchers chose to use the term "Long Wave" to describe their findings. A more appropriate name would probably increase its popularity today and separate this remarkable academic work from the K-wave stock market timers. This is unfortunate because MIT’s Long Wave explains why we aren’t seeing more job growth in this recovery. Sterman’s article reveals how this newly discovered cyclical phenomenon operates; it does not attempt to predict future trends.

We do know that MIT’s Long Wave exists. We know how it behaves and why. What we don’t know is exactly when trends will change, but we can logically conclude that after a long decline in economic activity, the trend will reverse. We can see from the graph that we are not in an economic uptrend. Based on the Long Wave theory as produced by Sterman and others, we know we are in the trough of the Long Wave–the period after a long decline but before a new uptrend has started.

The problem we all face now is one of being in the trough and not knowing when the new Long Wave uptrend will begin. Our guess is that we will find ourselves in the new uptrend through hindsight. As we continue to update the graph, at some point we will see that the line is advancing upward. But we know for certain that such an uptrend is in the future–still many years away.

The graph, as mentioned earlier, was a work-in-progress project for us. The original graph was presented in Sterman’s article in 1992 but included the data only through then. The basis of the data and calculation method were revealed in the article, but there was no formula presented that would allow one to re-create the graph, not to mention extending the graph to the present day. Through trial and error, we just recently managed to "break the code" so to speak.

Sterman’s data was based on GNP, the measure of economic growth that everyone used back then. But now we all use GDP. By applying the methodology that MIT used to create their graph, we used GDP to create our updated graph and extend it through 2002. There are slight differences when comparing the two, but the overall result is amazing.

What we can see from the graph is that the peak of the Long Wave began in the early 70s. Not only did economic activity reach its peak and begin to decline but so did average real hourly wages. Intuition told us that the long boom of the ‘90s that ended with the bursting of the dot.com bubble was a period of strong economic activity, but was it the beginning of a new uptrend?

The graph clearly indicates that it was a false start. Indeed, it was a bubble that quickly reversed and probably led to conditions that will keep us stuck in the trough for longer than we would like to be. With the huge budget deficits hanging over the economy and much of our resources going into the war, is it any wonder that we are not producing strong job growth? Add in the exporting of jobs to the equation and it is easy to see why we will not be in an uptrend for some time.

What does the graph tell us? Based on the findings of MIT, the uptrend of the Long Wave began after WWII ended. During that war-time economy there was rationing of goods and a scarcity of consumer products such a cars. After the war, the pent up demand generated the building of much infrastructure and capital investment to produce durable goods. Since it takes a long time to bring capital investment on line, the economy grew robustly until the 70s when supply caught up with demand and enough factors of production were created. Since that time we have not needed all that capacity, and the decline in the Long Wave is mostly the result of excess capacity. Add in the boom in computer technology and communications in the 90s, and we can see why we are suffering from an even greater glut of capacity.

When looking at the graph, some may wonder why there is no label for the Y-axis. This graph shows the relativity of where we are rather than assigning it an absolute number. We can clearly see that 1973 was the peak of the Long Wave. The sharp decline from ‘73 to ‘75 indicates a recession, but the magnitude or difference between the two points in time is not important; it only tells us that economic activity contracted. What the points on the graph show is the difference between real GDP growth for that year and the average annual long-term growth trend since about 1800.

Apparently, the economy grows on its own at a rate of about 3.4% a year, based on technology advances and the growth in population. It compounds on its own. If it grows more than 3.4%, it must be due to factors that are identifiable and vice-versa. For example, the period from 1979 through 1982 illustrates the efforts of the Fed to squeeze inflation out of the economy. The Fed-induced recession halted economic activity, even though GDP grew 2.5% in 1981. However, that 2.5% growth was below the normal 3.4% growth, so the graph indicates a decline. It does not necessarily indicate that GDP growth was negative, only that it was below its normal rate of 3.4%.

Essentially, the graph illustrates the history of GDP growth over time, stripped of its 3.4% normal compounded growth rate. So when we hear the analysts crowing about how the economy grew 3.1% we know that we left money on the table for some reason. And when the experts predict that the economy should grow about 3% to 3.5% in 2005, we know we are still stuck in the trough of the Long Wave because that is basically no growth at all.

The Long Wave. This graph is derived by subtracting out a long-term trend of exponential growth of the economy of 3.4%, primarily due to population growth