Potential Growth

and Prospects
Joji Ide
International Monetary Fund

Plan of the Presentation

Section 1: Estimating potential growth
Section 2: Determinants of total factor productivity (TFP),
empirical investigation
Section 3: Investment and employment, cross country
comparison
Section 4: Reform scenario that would raise potential growth
2

Methods of Estimating Potential Growth

Simple filtering approach

Decompose output into cycle and trend components
Production function approach

Look explicitly at the supply side of the economy
Multivariate timetime-series model approach

Decompose output into transitory and permanent
components

Advantages and Disadvantages

of the Different Methods
HP filter

Production
function

Structural VAR

Advantages

Disadvantages

Only require GDP as an

input

Suffer from the end-of

sample problem

Require a lot of data such

Allow analysts to identify as capital stock, which is
not publicly available in
the sources of growth
many countries
Allow the data to
determine the strength
of the relationship
among variables

Give no insight why

potential growth has
changed over the years
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Estimation Methodology:
Production Function

Potential growth: Weighted sum of growth in potential

labor and capital input combined with trend growth in total
factor productivity (TFP)
Y * = L * +(1 )K * +TFP(trend)

Capital: Capital stock is estimated by the perpetual inventory

method
Labor: Population aged 15 years or over, labor force,
employment, and mean hours worked are used

Estimation Methodology:
Multivariate Time Series Model

A bivariate vector autoregression (VAR) is estimated,

following Blanchard and Quah (1989)
Key restriction: only supply disturbances have an effect on
output over time (no lunglung-run effect of demand
disturbances on output)
Two variables (quarterly data on GDP growth and
unemployment rate ) are used

All three approaches indicate that potential

growth has increased since the late 1990s
Potential Growth: Philippines
(In percent)

Potential Growth: Developing Asia 1/

(In percent)

Source: IMF staff estimates. 1/ The HP filtering approach is used.

The contribution of TFP has increased over

the years in line with other ASEAN countries
Potential Growth: Contribution
(In percent)

Contribution of TFP to Output Growth

(In percent)

Indonesia
Source: IMF staff estimates.

Malaysia Philippines Thailand

Plan of the Presentation

Section 1: Estimating potential growth
Section 2: Determinants of total factor productivity
(TFP), empirical investigation
Section 3: Investment and employment, cross country
comparison
Section 4: Reform scenario that would raise potential growth
9

Cross Country Panel Regressions:

Specification, Data, and Methodology

Regression equation:
TFP it =c i + * Ini it + * Inf it+ * Open it + * Gov it + * Sch it + * FDI it + * Sec it +u it

Convergence
factor (initial per
capital GDP)

Economic policy variables

(Inflation, Openness, Governance, Average schooling
years, FDI to GDP ratio, and Agriculture sector share)

Data: A panel dataset of 52 countries (non(non-overlapping 5

year averages over the period of 19811981-2005) is used
Methodology: Cross country fixed effects model is applied
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All variables have expected signs, and

many of them are statistically significant
TFP Growth, Fixed Effects, Panel Regressions
TFP growth
Initial per capita GDP (ln)

-3.98
(-5.79)***

-4.05
(-5.88)***

-4.76
(-6.18)***

Inflation rate (percent)

-0.001
(-1.76)*

-0.001
(-1.67)*

-0.001
(-1.67)*

Openness (percent of GDP)

0.02
(1.87)*

0.02
(2.03)**

0.01
(0.97)

Governance (rating)

0.05
(3.26)**

0.05
(2.94)**

0.03
(1.98)**

Secondary schooling year (year)

1.07
(3.07)**

0.97
(2.78)**

0.77
(2.20)**

Foreign direct investment (percent of GDP)

0.08
1.54

0.09
(1.76)*

Agriculture sector share (percent of GDP)

-0.14
(-2.50)**

Number of observations
2

Adj. R

255
0.35

251
0.36

245
0.37

Note: T-statistics are in parenthesis: ***, **, and * indicate significance at 1, 5 and 10 percent.
Source: IMF staff estimates.
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Plan of the Presentation

Section 1: Estimating potential growth
Section 2: Determinants of total factor productivity (TFP),
empirical investigation
Section 3: Investment and employment, cross country
comparison
Section 4: Reform scenario that would raise potential growth
12

Both public and private investment

has been anemic over the years
Investment
(In percent of GDP, 2000-09 (average))

Capital-to-Output and Investment-toOutput Ratio

(Relative to steady-state level in 2008)

Sources: WEO database; Pen World Tables; and IMF staff calculations.

13

Fiscal slippages need to be revised, and the

business climate needs to be improved
Link between Government
Revenue and Public Investment 1/

Ease of Doing Business (Ranking out of

183 countries by category)

Sources: WEO database; and World Bank, Doing Business Survey (2010). 1/ 2000-09 average.

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Growth has created jobs,

but unemployment rate remains high
Employment
(1995=100)

Unemployment Rate 1/
(In percent)

Source: CEIC Data Company Ltd.

1/ National definitions may vary. 2/ The definition was revised in 2005.

15

In fact, the historical relationship between

growth and unemployment rate appears weak
Okuns Law: Malaysia

Source: CEIC Data Company Ltd.

Okuns Law: Philippines

Okuns Law: Thailand

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Plan of the Presentation

Section 1: Estimating potential growth
Section 2: Determinants of total factor productivity (TFP),
empirical investigation
Section 3: Investment, cross country comparison
Section 4: Reform scenario that would raise potential
growth
17

Potential growth could be raised further

by strengthening all three pillars

TFP: An increase in human capital, a further transition from

agriculture, and an improvement in governance would be helpful
Investment: Fiscal reforms and improvements in the investment
environment would raise the investment rate
Employment: Promoting labor market flexibility and active labor
market measures such as job training would be helpful
Potential growth (percent)

2000-09
(average)

2015
(baseline)

2015
(reform)

4.6

5.0

7.0

Contribution of TFP (percent)

2.0

2.1

3.0

Contribution of capital (percent)

1.0

1.4

2.0

Contribution of labor (percent)

1.6

1.6

2.0

15.0

16.4

19.5

Memorandum item
Investment rate (in percent of GDP)
Source: IMF staff estimates.

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Thank you!

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