In Discussion Paper No. 1221, Craig Burnside, Martin Eichenbaum and Research Fellow Sergio Rebelo study the implications of procyclical capital utilization rates for cyclical movements in labour productivity and the degree of returns to scale. They pose five questions first, is the phenomenon of near or actual short-run increasing returns to labour an artefact of the failure accurately to measure capital utilization rates?; second, is there a significant role for capital services in aggregate and industry level production technologies?; third, is there evidence against the hypothesis of constant returns to scale?; fourth, is there evidence against the notion that the residuals of their estimated production functions represent technology shocks?; and fifth, how does correcting for cyclical variations in capital services affect the statistical properties of estimated aggregate technology shocks?

The estimated coefficients of the model are consistent with a set of orthogonality conditions that candidate measures of technology shocks ought to satisfy. The implications of the authors' results are: first, that models that depend on large, increasing returns to scale as a source of large propagation effects are inconsistent with the data because there is virtually no evidence that suggests important deviations from constant returns to scale in manufacturing industry; second, that existing real business cycle models, which depend on large, volatile aggregate technology shocks and which predict a high correlation between the growth rate of output and aggregate technology shocks, are empirically implausible; and third, that the results support models that emphasize cyclical movements in capital utilization rates as an important determinant of movements in conventional measures of total factor and labour productivity.

Capital Utilization and Returns to Scale
Craig Burnside, Martin Eichenbaum and Sergio Rebelo

Discussion Paper No. 1221, August 1995 (IM)