Public Policy Sources #37:
Empirical growth accounting: what do the data tell us?

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Productivity is the cornerstone of real economic growth: productivity growth distinguishes wealthy economies from poor economies. Economist Robert Solow first noted this fact in the late 1950s. Applying the tools of growth accounting, Solow (1957) found that the growth rate of total factor productivity accounted for a large portion of American economic growth since the Second World War. More recent estimates by Edward Denison (1985) and Dale Jorgenson (1990) confirm this fact, although the importance of total factor productivity in more recent studies is somewhat smaller as the more recent studies use better measures of "effective" labour and capital inputs (i.e. they incorporate quality improvement in their measures of input supplies). Some of the key findings from Denison (1985) and Jorgenson (1990) are displayed in table 1.

Table 1: Sources of American economic growth (average annual growth rates, in percent)

Growth in the United States

The data in table 1 reveal a few important "stylized facts" regarding American economic growth. One is that productivity growth accounts for a fairly significant portion of total output growth over the sample period. According to Denison, the average annual growth rate of real GDP for the United States from 1929 to 1982 was 2.92 percent. Denison estimates that 1.02 percent--approximately one-third--of this growth was due to improvements in total factor productivity. Output growth during the post-war period from 1947 to 1985 occurred at an average annual rate of 3.28 percent. According to Jorgenson, 0.71 percent--slightly less than one-quarter--of this growth rate can be attributed to total factor productivity growth. The differences between Jorgenson's and Denison's estimates are due to two main factors--different sample periods and different ways of measuring the quality of the capital stock and the labour force. The basic message is clear: total factor productivity growth is an essential ingredient for sustained growth in real incomes. Total factor productivity growth accounts for approximately one-quarter to one-third of the increase in American output since World War II. America would be a much poorer country if there were no total factor productivity growth. Hence, "working smarter" definitely pays.

Another stylized fact highlighted by the table 1 is that total factor productivity growth does not appear to be constant over the post-war period. Table 1 shows that total factor productivity declined from an annual average growth rate of 1.53 percent from 1947 to 1973 to -0.27 percent from 1973 to 1982. Jorgenson estimates that from 1973 to 1979, total factor productivity grew at an annual rate of -0.67 percent. This sharp reduction in productivity growth is dubbed the "productivity slow-down." Economists worry about developments like this because a slow-down in productivity growth implies lower material living standards in the long run. Hence, the "productivity slow-down" has been the subject of significant economic research. I will return to this topic later.

Growth in Canada

The Canadian experience mirrors the American in a number of respects. According to Nason's back-of-the-envelope calculations, Canadian real output grew at an average annual rate of 3.1 percent from 1960 to 1985 (Nason 1994). He attributes 0.81 percent of this annual growth rate to total factor productivity growth, 0.96 percent to growth of the capital stock, and 1.33 percent to increases in the stock of labour (which reflects increasing participation in the labour force by women). According to these numbers, total factor productivity growth is responsible for about one-quarter of total output growth in Canada since 1960. Canada would be much poorer today in the absence of total factor productivity growth--it is only by "working harder" and "working smarter" that Canada has been able to attain its current living standard. Like the United States, Canada also experienced a "productivity slow-down" during the 1970s though, unlike most other industrialized countries, Canada's total factor productivity growth rate did not recover during the 1980s and 1990s (see below, page 18). Nason (1994) estimates that total factor productivity growth was positive for only three years from 1975 to 1985 period. Imagine how much higher Canadian output would be today if productivity had not slowed during the 1970s and 1980s.

International evidence

The international evidence reveals similar trends in total factor productivity growth. Among most industrialized nations, total factor productivity growth accounts for a significant portion of total output growth. This suggests that productivity is important for improvements in material living standards over the long term. Moreover, during the 1970s, productivity growth rates declined significantly in most of these countries. Table 2 displays total factor productivity growth rates since 1960 in the countries of the Group of Seven (G-7). The productivity slow-down appears to be an international phenomenon. There has been some recovery in total factor productivity growth rates during the 1980s and 1990s but, by and large, total factor productivity growth rates have not been restored to their immediate post-war levels.

Table 2: Total factor productivity growth in the G-7 countries (average annual growth rates, in percent)

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