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Macroeconomics and Microeconom~cs
of Innovation: The Role
of the Technological Environment
. .. . .
ANN F. FRIEDLAENDER
If America is to continue to grow and thrive, the answer to the
question of how productivity growth and technical change take place
is crucial. The answer can perhaps only be obtained by using analytic
frameworks that confine and synthesize the insights of technologists,
. , .
engineers, ana economists.
As an economist who has worked with engineers and technologists for
many years, I am struck by the fundamental lack of communication that
exists between them in discussing the sources and nature of innovation and
productivity growth. This anses, I believe, because of basic differences in
the way each group visualizes the production process and the nature of
innovation. Since each group brings a very different perspective to the prob-
lem, increased communication should lead to a richer analytic framework
and a deeper understanding of the sources and nature of technological change.
OVERVIEW
A brief description of the approach of each group will indicate some of
the ways in which a greater synthesis of the two approaches could increase
our understanding of technical change and productivity growth.
While something of a cancature, it is probably fair to state that economists
view the production function as an abstraction, a "black box" if you will,
that permits the transformation of certain inputs (labor, capital, materials,
and so forth) into different outputs; Hey have little, if any, interest in the
inner workings of that black box. Thus, to economists, the production func-
327
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328
ANN F. FRIEDLAENDER
tion is merely that a general functional expression relating outputs to inputs;
they have little regard for the specific functional fonn or how the specific
technology employed may affect either the functional form or the parameters
of the production function. Indeed, it is only within the past decade that
economists have generally realized that the specific functional form used to
describe technology may impose severe restrictions on its assumed nature
(e.g., the unitary elasticity of substitution associated with the Cobb-Douglas
production function) and have adopted so-called flexible functional foes in
analyzing production relationships and productivity growth.
In contrast, engineers and technologists have little interest in the abstract
"production function" as such; instead, they are interested in describing the
actual technical relationships that permit the translation of specific amounts
of labor, machines, and materials into widgets or other commodities. Thus,
engineering production functions tend to be very detailed and to focus on
He technical environment in which production takes place. Consequently,
although relative input prices drive the allocation of inputs within the context
of the economists' production or cost functions, Hey tend to be ignored in
engineering production functions. Conversely, while He technological en-
vironment tends to drive engineering production functions, it is often ignored
in economic production functions. Thus, by focusing on He technological
environment, engineers and technologists can provide economists with im-
portant insights Hat could enrich the economists' framework and analytic
models.
IMPORTANCE OF THE TECHNOLOGICAL ENVIRONMENT
A few examples will illustrate the kinds of things that I am refemng to.
Consider the question of productivity grown in the automobile industry. In
recent years, there has been considerable concern about the level of pro-
duciivity in the American automobile industry relative to that in Japan. In
particular, the concern has focused on two organizational differences between
He two countnes: the use of "quality-control circles" in the organization of
Japanese labor and He use of "just-in-time" inventories in the Japanese
production process. The use of the former presumably makes labor more
productive, and the use of the latter pennits considerable savings on capital
that is tied up in inventories.
Suppose American producers adopted both of these innovations tomorrow
and that ~ years hence an econome~ician attempted to measure productivity
growth in the U.S. automobile industry. What would be He likely outcome
of this econometric investigation? To see this, consider how each innovation
would appear within the context of the abstract production function. Since
the introduction of the quality-control circles would presumably permit more
output for given amounts of labor and increase the marginal product of labor
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ROLE OF TECHNOLOGIC~ E~IRONME~ IN ECONOMICS OF INNOVATION 329
relative to that of capital, it would show up as a labor-saving innovation. In
contrast, since the introduction of just-in-time inventories would lead to lower
capital requirements, it would show up as a capital-saving innovation. On
balance, depending on the relative magnitude of these effects, one would
observe increased productivity growth and technical change that could be
described as labor saving, neutral, or capital saving. Clearly, however, the
ex post aggregate characterization of technological change in any of these
terms is not particularly enlightening, since it does not indicate how this
technical change came about and what specific innovations contributed to it.
What is useful is the knowledge of the specific innovations that led to the
change, or, how the workings inside the "black box" were altered. While
this Is something that a few economists attempt to unravel, in general too
much attention is paid to the aggregate concepts rather than to the techno-
logical environment that created the changes.
As another examples consider industries such as transportation or com-
munications, in which the configuration and utilization of the network can
have a significant impact on productive relationships and technical change.
To point out the implications of this, let me discuss the way in which the
introduction of network variables can enhance our understanding of produc-
tive relationships and technical change. First, consider a "typical" economic
production function that relates output (ton-miles, passenger-miles, message
units, or some disaggregated version thereof) to generalized inputs (labor,
capital, materials, and so forth). It should be clear that both the configuration
and utilization of the network will have a significant impact on the way in
which inputs are transformed into outputs. Suppose, for example, that Grin
A utilizes a network composed of a limited number of comdors, each of
which is between major urban centers and thus has high density of usage.
In contrast, firm B utilizes a "hub-and-spoke" network, with a central core
that services a hinterland. Finally, firm C utilizes a network composed of a
large number of corridors linking small urban areas without ~ hub-and-spoke
network. One can readily imagine a situation in which each find utilizes the
same amount of each input, but produces very different levels of output and,
~us, has very different implied levels of productivity. Although the econ-
omist may simply retort Flat this is a problem of aggregation, the problem
is really deeper than that, because the configuration and utilization of the
network add a dimension that make the Free production processes funda-
mentally different, regardless of the specification of Output. Thus again, what
is going, on inside the "black box" adds fundamental insights to our under-
standing of the production process. (For a full discussion of these and related
points, see Chiang et al., 1984.)
As a final example, let me describe a recent study I have undertaken on
Me trucking industry (Friedlaender and Bruce, 1985) to try to explain its
productivity growth in the period prior to deregulation (1975 to 19791. In
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330 . ANN F. FENDER
this particular study, costs were estimated as a function of input prices
(capital, labor, fuel, and so forth), output levels (ton-miles), shipment char-
actenstics (average load, average length of haul, shipment size, and so foray,
and a time trend. Thus, in addition to Me usual arguments in the cost function
(output, input pnces, and a time trend to capture productivity growth), the
study included variables to reflect the technological environment or the way
in which inputs were transformed into outputs. In this connection, it was
interesting to note that virtually all of the productivity growth and technical
change could be attributed to the technological factors considered rather than
to He various inputs or to the scale of output. While the measures of the
technological environment used in this study were admittedly crude, their
statistical significance clearly indicates that what often drives productivity is
the way in which inputs are utilized and the way in which output is configured.
Although changes in the technological environment could have been labeled
capital- or labor-saving innovations, we are surely better off knowing that
what was really driving productivity growth was the way in which shipments
were distnbllted over the network. Ideally, both for purposes of policy and
for purposes of understanding technical change, we would like to know the
specific organizational or logistical changes that were made and how they
could be expected to affect productivity so that all firms could be encouraged
to undermlce them. ~
To summarize my basic point, I believe that a much richer analytic frame-
work is possible if economists would attempt to incorporate the fundamental
insight of engineers and technologists- that the organizational and techno-
logical environment can have a major impact on productivity and technical
change. While abstractions relating to the elasticities of substitution, returns
to scale, and neutral or nonneutral technical change are useful, they are that
much more meaningful if the interactions between input utilization and the
technological environment are recognized and taken into account.
COMMENTS ON CHAFERS BY JORGENSON AND MANSFIELD
I am disappointed to note that in their discussions in this volume, which
deal with microeconomic issues related to technical change and productivity
grown, Dale W. Jorgenson and Edwin Mansfield largely ignore the potential
insights of technologists and engineers with respect to innovation and pro-
ductivity growth.
Let me begin with Jorgenson's chapter, which analyzes the sources of
productivity grown in the American economy in the postwar period. As is
true in most analyses of this type, Jorgenson employs a neoclassical frame-
work, which assumes that firms operate in perfectly competitive input and
output markets and that they utilize an aggregate production function that
transforms aggregate inputs (capital, labor, electrical energy, and nonelec-
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ROLE OF TECHNOLOGICAL ENVIRONMENT IN ECONOMICS OF INNOVATION 331
trical energy) into an aggregate output. Recognizing the importance of sec-
toral differences, Jorgenson utilizes a disaggregated sectoral analysis and
estimates a price frontier, adjusted for productivity growth, for 35 industnes.
Not surprisingly, he finds that patterns of productivity growth are not uniform,
but vain widely among industries; no more than ~ of the industries exhibited
common patterns of productivity growth.
It is admittedly useful to know that 8 of the 35 industries exhibited a pattern
of productivity growth in which increases in the prices of capital, labor,
electrical energy, and nonelectrical energy retard productivity growth and in
which a rise in the price of materials stimulates productivity growth. More-
over, it is also useful to know that 20 of the 35 industries exhibited a pattern
of capital-using productivity growth. Nevertheless, it would be even more
useful to know why those industries exhibited different patterns of growth
and what determined the magnitude of the stimulating or inhibiting effects
of input price changes on productivity growth. Without such knowledge,
neither businessmen nor policymakers have any real guides concerning ap-
propriate actions they could take to increase productivity growth in particular
industries and in the nation as a whole; nor do they know whether past
relationships between input prices and productivity growth can be expected
to continue in the future.
To continue with this theme, the following ~ industries exhibited a common
pattern in which price increases in all inputs (with the exception of materials)
inhibited productivity growth: tobacco, textiles, apparel, lumber and wood,
printing and publishing, fabricated metals, motor vehicles, and transporta-
tion In contrast, the following S industries exhibited the same pattern of
productivity growth, with the exception that increases in the cost of capital
stimulated rather than retarded productivity growth: rubber; leather; instru-
ments; gas utilities; and finance, insurance, and real estate. These lists of
industries immediately bring the following questions to mind: (1) What was
there in the technological environment in the 8 industries that led them to
exhibit a common pattern of productivity growth? (2) What was there in the
technological environment of the 5 industries that led Rem to exhibit a
common pattern of productivity grown? (3) What was there in the techno-
logical environment of the 13 industries that led them to exhibit common
patterns of productivity growth, with the exception of capital? (4) And fi-
nally, to what extent were these similarities and differences due to the nature
of the output, the nature of the inputs, or the technological environment in
which production took place? Thus, Jorgenson seems to skirt the basic ques-
tion of why productivity growth is stimulated in some industries by rises in
certain input prices and why it is inhibited by similar price increases in other
industries. Whether the answers to these questions can be found in the analy-
ses of engineers and technologists is unclear, but it would be interesting to
get their insights into this problem.
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332
ANN F. FRIEDLAENDEl?
My comments on Manshleld's discussion echo this theme, although perhaps
in a somewhat gentler voice, since Mansfield does attempt to focus on the
following specific factors that affect innovation and productivity growth:
(1) the level and nature of expenditures on R&D and basic research; (2) the
role of imitation costs, imitation times, patents, bamers to entry, and in-
dustnal concentration; and (3) the diffusion of innovation and technology
transfer. Thus, instead of focusing on the aggregate production function,
Mansfield focuses on issues that relate to the productive and technological
environment.
Nevertheless, one wishes that Mansfield and his fellow economists had
gone further. If, for example, labor and capital productivity are positively
affected by the level of R&D expenditures, one would like to know how this
process takes place. Is it the existence of R&D expenditures, per se, that
stimulates labor arid capital productivity, or are R&D expenditures trans-
fonned into specific innovations that make labor or capital more productive?
Similarly, why does basic research stimulate total factor productivity inde-
pendent of the level of R&D expenditures? As Mansfield points out, the
question is whether this reflects a tendency for basic research findings to be
exploited more fully by finns and industries that were responsible for it,
whether it reflects a tendency for applied R&D expenditures to be more
effective when earned out in conjunction with some basic research; or whether
basic research is merely serving as a proxy for long-tenn R&D.
Again, we are left with many tantalizing questions, but little analysis to
answer them. Thus, I would like to close by encouraging economists to think
more seriously about and confront the issues posed by the disassembly of
the black-box production function. While such a disassembly would certainly
reduce He elegance of economic analysis and limit the generality of the
models employed, it should also provide greater insights into the question
of how productivity growth and technical change take place. If America
is to continue to grow and thrive, Me answer to this question is crucial. In
this regard, I suspect it can only be obtained by using analytic frameworks
that combine and synthesize the insights of technologists, engineers, and
economists.
REFERENCES
Chiang, Wang, Judy S. Friedlaender. and Ann F. Friedlaender. 1984. Output aggregation, network
effects. and the remeasurement of ~uclcing technology. Review of Economics and Statistics 66(May):267-
277.
Friedlacnder, Ann F., and Sharon Schur Bruce. 1985. Augmentation effects and technical change
in the regulated trucking industry, 197~1979. In Studies in Transportation Economics. Andrew
Daughety, ed. New York: Cambridge University Press (Forthcoming).
Representative terms from entire chapter:
technological environment
