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Why Is Productivity Procyclical? Why Do We Care?

In: New Developments in Productivity Analysis

  • Susanto Basu
  • John Fernald

Productivity rises in booms and falls in recessions. There are four main explanations for procyclical productivity: (i) procyclical technology shocks, (ii) widespread imperfect competition and increasing returns, (iii) variable utilization of inputs over the cycle, and (iv) resource reallocations. Each of these explanations has important implications for macroeconomic modeling. In this paper, we discuss empirical methods for assessing the importance of these explanations. We provide microfoundations for our preferred approach of estimating a first-order approximation to the production function, using a theoretically motivated proxy for utilization. When we implement this approach, we find that variable utilization and resource reallocations are particularly important in explaining procyclical productivity. We argue that the reallocation effects that we identify are not "biases" - instead, they reflect changes in an economy's ability to produce goods and services for final consumption from given primary inputs of capital and labor. Thus, from a normative viewpoint, reallocations are significant for welfare, and from a positive viewpoint, they constitute potentially important amplification and propagation mechanisms for macroeconomic modeling.

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This chapter was published in:
  • Charles R. Hulten & Edwin R. Dean & Michael J. Harper, 2001. "New Developments in Productivity Analysis," NBER Books, National Bureau of Economic Research, Inc, number hult01-1, May.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 10128.
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