Are Technology Improvements Contractionary?

This 2006 American Economic Review paper (circulated as NBER Working Paper 10592, June 2004) asks a question its own abstract answers in one word – “Yes” – are technology improvements contractionary? The authors construct a “purified” measure of aggregate technology change that corrects the standard Solow residual for varying utilization of capital and labor, non-constant returns to scale, imperfect competition, and aggregation effects, building on the production-function methodology of Basu and Fernald (1997) and Basu and Kimball (1997) – an identification strategy that relies on entirely different assumptions from, and is explicitly offered as a complement to, Galí’s (1999) long-run-restriction structural VAR approach to the same question. Using this measure on postwar U.S. data, the paper’s central finding is that when technology improves, input use (hours, utilization, and especially non-residential investment) falls sharply on impact while output barely moves, and only with a lag of one to several years do inputs, investment, and output recover and then rise strongly – a short-run contraction followed by a long-run expansion. The authors show this pattern is “clearly inconsistent with standard parameterizations of real-business-cycle models,” which predict inputs and output rise immediately after a technology improvement, but is qualitatively consistent with sticky-price models, in which a positive technology shock that is not immediately offset by expansionary monetary policy reduces firms’ demand for labor and capital in the short run even as it raises full-employment output. The paper argues this amounts to a “robust stylized fact” because four methodologically distinct approaches – their own production-function measure, Galí’s SVAR, estimated structural DSGE models, and Shea’s (1998) patent/R&D-based technology proxy – all independently reach the same short-run-contraction conclusion.

John Fernald | Macro Paper Warehouse

Are Technology Improvements Contractionary?