Procyclical productivity : evidence from an emerging economy

Average productivity tends to rise during booms and fall during recessions. This fact is at odds with classical macroeconomic theories which suggest that labor productivity should be countercyclical due to the law of diminishing returns to factors. Theoretical explanations for this puzzle include exogenous changes in production technology, increasing returns to scale, measurement errors due to unobserved input variations, external economies and composition effects at the aggregate level. Surprisingly, aggregate data for the Chilean industry show that productivity is countercyclical. This paper has two objectives. First, we study the cyclical behavior of productivity in 84 sectors of the Chilean industry in the 1979-1997 period. We find that, contrary to the results obtained using aggregate indexes, disaggregated data confirm that on average productivity is unambiguously procyclical. The main reason for this difference is that aggregate data provides a distorted assessment of the cyclical component of productivity due to the marked heterogeneity of behavior between sectors. Second, we examine the determinants of productivity in the Chilean industry using an econometric model that allow us to quantify the relative contribution of the four different explanations of procyclical productivity. The results indicate that technology shocks account for 50% of productivity cycles in the 1979-1997 period, thus supporting the supply shocks hypothesis as the main source of business cycles in Chile. The other 50% of the productivity shocks is explained by important reallocation effects among sectors of different productivity and, more recently, by the presence of increasing returns. Variations in the utilization of capital and labor effort were insignificant.