Growth and business cycles have traditionally been studied separately, but `opportunity cost' models developed in the
1980s predict that recessions are associated with faster rates of productivity-enhancing activities, which may include labour reallocation, reorganization, implementation of new technologies and/or R&D, training activities, or maintenance and replacement of capital. This approach breaks with the Keynesian views that recessions are undesirable in all respects and that all investment activity is procyclical.

In Discussion Paper No. 709, Research Fellow Gilles Saint-Paul uses data for 22 industrialized countries during 1950-88 to run three sets of tests to determine the response of productivity to business cycles, whether this is stronger in countries whose fluctuations are more transitory, and whether R&D responds to business cycles. He finds that demand innovations very often exert an immediate negative effect on productivity growth, which is stronger when demand fluctuations are more transitory, and explains a small, but non-negligible (10-20%) share of the variance of the Solow residual. He finds no evidence that the volatility of demand shocks affects long-run growth; high- frequency components of fluctuations seem to have a negative effect on long-run growth, while low-frequency components tend to have a positive effect; and there is very little evidence of any pro- or countercyclical behaviour of R&D, but this may simply reflect the poor quality of aggregate R&D data. While these empirical results are at best mixed, Saint-Paul nevertheless concludes that the growth effects emphasized in opportunity cost models may be quantitatively more important than those considered in traditional models.

Productivity Growth and the Structure of the Business Cycle
Gilles Saint-Paul

Discussion Paper No. 709, October 1992 (IM)