Investment-specific technological progress

Investment-specific technological progress refers to progress that requires investment in new equipment and structures embodying the latest technology in order to realize its benefits. To model the influence of technological change upon production the influence of a technological change upon the specific inputs (i.e. labor and capital) of a production model is assessed in terms of the resulting effect upon the final good of the model (i.e. goods and services).

To realize the benefits of such technological change for production a firm must invest to attain the new technology as a component of production. For example, the advent of the microchip (an important technological improvement in computers) will affect the production of Ford cars only if Ford Motor Co.'s assembly plants invest in computers with microchips (instead of computers with punched cards) and use them in the production of a product, i.e. Mustangs. Investment-specific technological progress requires investing in new production inputs which contain or embody the latest technology. Notice that the term investment can be general: not only must a firm buy the new technology to reap its benefits, but it also must invest in training its workers and managers to be able to use this new technology^[1].

Significance

Identifying investment-specific technological progress within an economy will determine how an individual behaves in reaction to new technology, i.e. whether the individual will invest their savings^[2]. If "investment-specific" technological change is the main source of progress in an industry, then the individual would invest in firms to purchase and develop new capital, as technological improvements result in improvements to the goods available to consume. Firms may also choose to train current employees in the new technology or subsidize the education of new employees in the operation of the new technology. As such technological progress has an impact upon the labour market ^[3].

Technological progress has direct positive impacts upon human welfare. As a result of new technologies producers can produce a greater volume of product at a lower cost. The resulting reduction in prices benefits the consumer, who now can purchase more. ^[4]. Women have been able to break away from the traditional "housewife" role, join the labor-force in greater numbers (Greenwood et al. 2005) and become less economically dependent on men (Greenwood & Guner 2009). Further impacts include a reduction in child labor starting around 1900 ^[5].

 

Figure 1

A simple example: the microwave oven

An example of investment-specific technological progress is the microwave oven. The idea of the microwave came to be by accident: in 1946 an engineer noticed that a candy bar in his pocket had melted while working on something completely unrelated to cooking (Gallawa 2005). The development of this good, from melting the candy bar to the home appliance known today, took time and the investment of resources to make a microwave small and cheap. The first microwave oven cost between 2000 and 3000 dollars and was housed in refrigerator-sized cabinets (Gallawa 2005)! Today, almost any college student can enjoy a 3-minute microwaveable meal in the smallest dorm room. But a microwave's uses do not stop at the dorm room. Many industries have found microwave heating advantageous: it has been used to dry cork, ceramics, paper, leather, and so on (Gallawa 2005). However, for either college students or firms to reap the benefits of quick warming, they must first "invest" in a microwave oven (that "embodies" the technological advance). To realize the benefits of investment-specific technological progress you must first invest in a technology that embodies it.

Measurement

While measuring technological progress is not easy, economists have found indirect ways of estimating it. If "'investment-specific'" technological progress makes producing goods easier, then the price of the goods affected (relative to the price of other goods) should decrease. In particular, "investment-specific" technological advance has affected the prices of two inputs into the production process: equipment and structures. Think of equipment as machines (like computers) and structures as buildings. If there is technological progress in the production (or creation) of these goods, then one would expect the price of them to fall or the value of them to rise relative to older versions of the same good.

Figure 2 (the pink line) shows how the price of new producer durables (such as equipment) in the United States relative to the price of new consumer nondurables (like clothing) has consistently declined over the past fifty years (Gort et al. 1999). To calculate the relative price of producer durables divide the price that firms pay (for the durable inputs of production) by the price that a regular consumer pays (for things like jeans). People use relative prices so they can say how many units of equipment can be bought instead (or in terms) of buying one unit of consumer goods. Figure 3 (the pink line) says that over time, firms have been able to buy more and more units of equipment instead of one unit of consumption, especially when taken into account that the quality of equipment being acquired has increased (a computer today is much faster than a computer five years ago and that should be taken into account when comparing their prices). When changes in quality are not taken into account (which is wrong) it looks like the price of equipment has not decreased as much (see the black line in Figure 2).

 

Figure 2

Measuring the price of structures is more complicated than measuring the price of equipment, but economists have again been able to get an idea of how much progress there has been in structures (such as buildings). One approach is that if newer buildings were constructed or designed using newer technologies then they should be worth more than older buildings (because they embody the new technology (Gort et al. 1999). In particular, they should rent for more. As Figure 3 shows, this is true. Renting a square foot in a new building is much more expensive than renting a square foot in a building forty years old. So it must be the case that you are paying for a nicer, more functional and maybe even safer building.

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Figure 3

Figures 2 and 3 suggest that investment-specific technological change is operating in the US. The annual rate of technological progress in equipment and structures has been estimated to be about 3.2% and 1%, respectively (Gort et al. 1999) (Greenwood et al. 1997).

Conclusion

In the second section it was mentioned that "investment-specific" technological change is important since it will affect production (both in quality and size). An important question then is, just how much "bang for your buck" do you get with "investment-specific" technological change? The answer is quite astounding; economists have found that 37% of growth in United States output (production) is due to technological progress in equipment and 15% is due to technological progress in structures (Gort et al. 1999) (Greenwood et al. 1997). All in all, more than half (37% + 15% = 52%) of the growth of the United States economy is due to "investment-specific" technological change (Gort et al. 1999) (Greenwood et al. 1997).

References

• Gallawa, J. Carlton (2005), Who Invented Microwaves.
• Gort, Michael; Greenwood, Jeremy; Rupert, Peter (March 1, 1999), "How Much of Economic Growth is Fueled by Investment-Specific Technological Change?", Economic Commentary, Federal Reserve Bank of Cleveland.
• Greenwood, Jeremy; Guner, Nezih (2009), "Marriage and Divorce since World War II: Analyzing the Role of Technological Progress on the Formation of Households" (PDF), NBER Macroeconomics Annual 2008, 23: 231–276, doi:10.1086/593087.
• Greenwood, Jeremy; Hercowitz, Zvi; Krusell, Per (1997), "Long-Run Implications of Investment-Specific Technological Change", American Economic Review, 87 (3): 342–362.
• Greenwood, Jeremy; Jovanovic, Boyan (2001), "Accounting for Growth", in Charles R. Hulten, Edwin R. Dean & Michael J. Harper (ed.), New Developments in Productivity Analysis, Chicago: University of Chicago Press.
• Greenwood, Jeremy; Seshadri, Ananth; Yorukoglu, Mehmet (2005), "Engines of Liberation", Review of Economic Studies, 72 (1): 109–133, doi:10.1111/0034-6527.00326.
• Lebergott, Stanley (1964), Manpower in Economic growth: The American Record since 1800, New York: McGraw-Hill Company.

1. Greenwood, Jeremy; Jovanovic, Boyan (2001). New developments in productivity analysis - Accounting for Growth. Hulten, Charles R., Dean, Edwin., Harper, Michael J., Conference on Research in Income and Wealth. Chicago: University of Chicago Press. ISBN 0-226-36064-4. OCLC 290503961.
2. Gort, Michael; Greenwood, Jeremy; Rupert, Peter (March 1, 1999). "How Much of Economic Growth is Fueled by Investment-Specific Technological Change?". Economic Commentary. Federal Reserve Bank of Cleveland: 1.
3. Krusell, Per (1998), "Investment-Specific R and D and the Decline in the Relative Price of Capital", Journal of Economic Growth, 3 (2): 131–141, doi:10.1023/a:1009701518509
4. Greenwood, Jeremy; Vandenbroucke, Guillaume (2006), "Hours Worked: Long-Run Trends", in Lawrence E. Blume, Steven N. Durlauf (ed.), The New Palgrave Dictionary of Economics (2nd ed.), London: Palgrave Macmillan
5. Greenwood, Jeremy; Seshadri, Ananth (2005), "Technological Progress and Economic Transformation", in Philippe Aghion and Steven N. Durlauf (ed.), Handbook of Economic Growth, Amsterdam: Elsevier North-Holland.