THE ROLE OF TOTAL FACTOR PRODUCTIVITY AS A SOURCE OF ECONOMIC GROWTH

IN SRI LANAKA 1990-2008.

Ravindra Deyshappriya N.P

Entrepreneurship & Management Degree Program, Uva Wellassa University
ravipdn@yahoo.com
ravindra@uwu.ac.lk

ABSTRACT
Over the last two decades the determinants of economic growth have attracted
increasing attention in both theoretical and applied researches. Even though
the underlying process economic performance is inadequately conceptualized
and poorly understood, something, which can be partly attributed to the lack
of generalized or unifying theory. Therefore a long time economists thought
that growth in physical inputs was the most crucial factor in explaining
economic growth. However, following the seminal work of Solow (1956),
there was wide recognition that physical inputs explained only a fraction of
the growth in output in most economies. Furthermore it has been observed
that there is a hidden part in the economic growth which is not explained by
factor accumulation and named it as “Total Factor Productivity” (TFP).
Therefore in growth accounting research works it is worth to take contribution
of TFP to economic growth in to account.

This paper attempts to identify the source of economic growth of Sri Lanka
during the period of 1990 – 2008 with special references to the contribution of
Total Factor Productivity (TFP). OLS method has been employed to estimate
the Cobb – Douglas production function empirically to quantify the TFP for
the sample period and evaluate the contribution of factors of production to
economic growth. In the Sri Lankan context, physical capital is the key
determinant of economic growth and the contribution of TFP is significantly
low. Furthermore the study stresses that human capital, openness of the
economy, exchange rate and investment on infrastructures are the prominent
factors of Sri Lanka TFP growth and however political instability adversely
affect to TFP. Ultimately, the study strongly recommends adapting the efficient
policies to increase the TFP in order to sustain a steady economic growth in
the future together with the accumulation of physical capital.

Keywords: Total Factor Productivity, Cobb – Douglas production function,

OLS method
1. INTRODUCTION across the countries. In fact total factor
productivity (TFP) is typically referred as
“something else” which contributes to the
Economic growth is an instrument
differences of economic growth across the
which can be used to achieve the economic
countries.( Khatiwada and Sharma – 2002)
development of any country in order to achieve
According to the empirical studies in the recent
the social well being of the citizen. Therefore the
literature, TFP growth accounts for higher
term of “Economic Growth” is one of the
proportion of economic growth in some
frequently used words in the glossary of
countries and on the other hand capital
economics. Since, the most of the current
accumulation is the key component of economic
researchers try to work out their research works
growth in some countries.(Mankiw et.al. 1992)
in the field of economic growth. According to
Furthermore it has been observed that TFP
the literature most of the global research studies
growth accounts for about half of the output
on economic growth have tried to compile the
growth in OECD countries, even if capital
most comprehensive assessments of economic
accumulation was the key component of the
growth in developing and transition economies
growth miracle in East Asian economies.
rather than focusing on the developed countries
(Josephson and Schon 2002) Although there are
(Khatiwada and Sharma – 2002) More
few contradictory ideas about TFP plays a major
specifically, they have tried to examine the
role in economic growth in some countries.
source of aggregate growth, role of market in
influencing growth, performance of Even if the empirical research on TFP is not
microeconomic agents and the role of political much common in the context of Sri Lanka, but
economy in the growth process. IMF working paper has emphasized the
contribution of TFP on economic growth of Sri
In the past, the global research studies
Lanka. This paper has used the growth
on source of economic growth had mainly
accounting framework to assess Sri Lanka’s
focused on the relationship between economic
sources of growth, especially by employing
growth and factor accumulation. With the
Cobb- Douglas production function including
improvement of the technology, it has been
human capital. It has found that while labor was
realized that there is a hidden part of the
the dominant factor contributing to growth in the
economic growth, which is not explained by the
1980s, labor’s contribution declined over time
factor accumulation. Therefore the current
and was overtaken, to a large extent, by TFP and,
problem of understanding the source of
to a lower extent, by physical and human capital
economic growth is not just understanding the
accumulation. Moreover, study stressed that
process by which an economy raises its rate of
productivity of physical capital slowed down in
factor accumulation, but “something else” which
recent years, largely due to neglect and fast
explains the differences in economic growth
depreciation as a result of the political conflict After investigating the literature it is apparent
and wars. (Duma. N 2007) that various theoretical models have been
successfully estimated empirically. However
Therefore, this paper attempts to examine the
Cobb – Dogulas production function is the most
above situation in the context of Sri Lanka by
commonly used theoretical model in the
analyzing the effect of TFP on economic growth
literature. Following natural logarithmic
and other sources of economic growth as well.
transformation of Cobb – Dogulas function has
been utilized for IMF working paper in the
context of Niger. (Nachega and Fontaine –
2. OBJECTIVES OF THE STUDY.
2006).

y t = a + bt + ak t
As mentioned in the introduction
information, the main objective of this study is to Where the lowercase variables, y and k denote
fulfill the research gap which has been observed the natural logarithms of output and physical
in the introduction part. Therefore I tried to capital in per capita terms respectively. In
explain the sources of economic growth in Sri addition to that empirical research work on
Lanka during the period of 1990 – 2008 with Swedish manufacturing industry (Josephson and
special reference to the contribution of TFP on Schon – 2002) has calculated the total factor
economic growth of Sri Lanka. More productivity by using following method.
specifically, the main objectives of this study
Y = f ( La C 1−a )
are;
TFP = dY − a.dL −(1 − a ). dC
1. Identification of sources of
Where Y- Value added and C – capital Stock and
economic growth and examining the
L – Labor in working hours
empirical relationship between TFP and
economic growth in Sri Lanka during the Furthermore “Country Study Report; Nepal” has
period of 1990 – 2008. revealed in detail the significant of Cobb –
2. Examining the relationship between Douglas production function for analyzing the
economic growth, political instability and source of growth and calculating the TFP.
policy changes. (Khatiwada and Sharma – 2002). In their study
3. Identification of determinant of the conventional Cobb-Douglas production
Total Factor Productivity.(TFP) function with the assumption of constant returns
to scale has been used as follows.

3. METHODOLOGY Y = AK α L1−α

3.1 IDENTIFICATION OF THEORETICAL

MODELS Where, Y = real GDP

A = Total Factor Productivity (TFP)

 K = Capital utilized Cobb – Douglas production function in
the same way utilized in “Nepal: Country Study
L = Labor
Report” (Khatiwada and Sharma – 2002) to
α = Output Elasticity of Capital
achieve my research objectives. Therefore to
1- α = Output Elasticity of Labor accomplish the first objective, following function
has been employed with the help of OLS
methods.
Log transformation of above Cobb-Douglas
log( Y / L ) = A +α log( K / L) + u ..(1)
production function is applied to estimate Cobb-
Douglas function empirically by using OLS According to the second objective mentioned
method. above, two dummy variables have been
introduced to measure the effect of political
Y = AK α L1−α u
log Y = A + α log K + (1 − α) log L + u instability (during the war period) and policy
changes on economic growth. Especially under
Subtracting log L from both sides,
the policy changes, it is concerned that the
log Y − log L = A +α log K + (1 −α) log L − log L +
changes
u in exchange rate policy; from manage
log Y − log L = A +α log K + log L −α log L − log floating
L + u exchange rate system to floating

exchange rate system in 2001. Therefore,

Rearranging the above equation, the following
following equation has been estimated to take
equation was empirically estimated.
the above mentioned situation into account.

log( Y / L ) = A + α log( K / L ) + u

In fact, Total Factor Productivity (TFP) log( Y / L) = A + α log( K / L) + D1 + D 2 + u.....( 2)

means the growth in output which is not
explained by the growth in factor accumulation.
D1 = =1 War period
Therefore following equation has to be utilized
= 0 Otherwise
to
TFP = log Y − α log K − (1 − α) log L
measure the total factor productivity. = 1 Floating Exchange Rate

D2 =
= 0 Manage Floating Exchange Rate
3.2 EMPIRICAL MODELS

It is obvious that throughout the literature, Cobb- After estimating the TFP by using the above
Douglas production function has been commonly production function, the study attempts to
applied to fill the methodology part of research examine the determinant of the TFP in Sri Lanka
task on economic growth as it is the more during 1990 – 2008. According to the recent
realistic production function. Therefore, I literature, several factors which can be affected
to total factor productivity have been found. By
considering those factors, following equation has
been empirically tested with the aim of achieving
the final objective of this study.
TFP = α1 + α2 ER + α3Op + α4 IOI
+ α5 LR + α6 D1 + u....( 3)
Where TFP means total factor productivity,
which can be calculated from the estimated
Cobb-Douglas production function. According to
the above equation exchange rate
Openness of the economy (OP), investment on
infrastructure (IOI) and literacy rate (LR) have
been taken into account as the determinant of
total factor productivity. In addition to these,
Dummy variable (D1) was also included to
measure the effect of political instability on the
total factor productivity.
Especially above production function was used
to calculate the TFP for the period of 1990 –
2008. According to the regression statistics
overall function and all the coefficients are
significant at 1% level and the independent
variables explain approximately 82% of total
variation of dependent variable. Therefore the
estimated function is appropriate enough to
calculate the TFP.
(ER), 4.2 CALCULATING THE MEAN
CONTRIBUTION OF INPUTS AND TFP TO
REAL GDP GROWTH.
Following table clearly summarizes the mean
contribution of inputs and TFP to real GDP
growth during the sample period. Furthermore
sample period has been divided in to two sub
periods, 1990 – 2000 and 2001 – 2008
respectively. Accordingly following table helps

4. DATA ANALYSIS AND FINDINGS to identify the source of growth in Sri Lanka
1990 – 2008.

4.1 ESTIMATION OF PRODUCTION Table 01: Mean contribution of inputs and

FUNCTION TFP to real GDP

As discussed under methodology section, present Sample Growth Contri. Contri. Contri.
Period Rate of of K to of L to of TFP
study has estimated following empirical Real GDP GDP to GDP
GDP
production function by regressing real GDP on
90-00 5.114 13.354 1.246 0.355
labor and capital. Furthermore this function was 01-08 6.327 62.051 1.4180 -0.110
used to observe the sources of growth and 90-08 5.654 34.997 1.322 0.148

contribution of the TFP in order to achieve the Source: Self calculation

first objective. According to the table, it is obvious that growth

of real GDP in Sri Lanka is basically depends on
Log (Y / L) = 5.495 *** + 0.1805 ***
Log ( K / L)
accumulation of physical capital and TFP does
2
R = 0.8156 Prob > F = 0.0000 not contribute much to the country’s economic
*** - Significant at 1% level growth. Especially contribution of physical
capital has dramatically increased during the
period of 2001-2008, approximately it is 5 times
high compared to the previous period. However 4.3 ESTIMATION OF PRODUCTION
the contribution of labor to the economic growth FUNCTION WITH DUMMY VARIABLES
remained the same during the both considered
periods and it shows that labor is not a major
Two dummy variables have been added to the
contributor of economic growth. Although mean
above estimated production function to take into
contribution of labor is quite high compared to
account the effect of political instability and
the contribution of TFP. According to the above
adaptation of floating exchange rate policy.
table, it is apparent that contribution of TFP is at
the very poor level compared to the capital and
labor, especially it has recorded negative
Log (Y / L) = 4.44 *** + 0.357 *** Log ( K / L)
contribution (-0.110) also during the period of
− 0.546 *** D1 − 0.516 *** D2
2001-2008 and contribution of TFP has not
exceeded even 0.5% during the considered R2 = 0.97 Prob > F = 0.0000
periods. Following graph also shows the mean
*** - Significant at 1% level
contribution of each factor and TFP to economic
growth of Sri Lanka.
The estimated equation shows that all
coefficients statistically significant at 1% level
and all explanatory variables jointly explain the
97% of the variation of dependent variable
Log(Y/L). The main significant of estimating
above production function is, the calculating
TFP. In addition to that it can be used to
accomplish the second objective of the study by
considering two dummy variables. The
coefficient of D1 reflects that during the war
Figure 01: Mean contribution of inputs and period growth of real GDP is lower by 0.546 per
TFP to real GDP cent compared to the non war period. This
adverse impact of civil war has been stressed by
Not only Sri Lanka, most of the developing
the recent researcher also. (Duma 2007)
countries and rarely some developed countries
Similarly the coefficient of D2 implies that
also currently maintain a negative growth rate of
adopting a floating exchange rate negatively
TFP, according empirical research works Sub-
affects to the growth of real GDP. More
Saharan countries ( Razafimahafa 2002),
specifically due to implementing of floating
Malaysia (Jajri 2005) and Niger ( Nachega &
exchange rate growth of real GDP in Sri Lanka
Fontaine 2006) are giving negative contribution
has decreased by 0.52% compared to the period
to the economic growth of these countries.
of adopting manage floating exchange rate
policy.
By fulfilling the second objective, above
estimated function clearly shows that both
political instability and adopting a floating
exchange rate policy have adversely affected to
the Sri Lanka economic growth during the period
of 1990 – 2008.
relationship between human capital and TFP.
However investment on infrastructure does not
significantly link with TFP during the considered
period but moving to the global context it has a
significant effect for sub-Saharan economies
((Razafimahefa 2002). Furthermore it has been
observed that during the war period TFP was
lower by averagely 0.13 compared to the non
war period.

4.4 ANALYZING THE DETERMINANT OF

5. CONCLUSION.
TFP

Even if currently TFP does not contribute much

As mentioned in the background of this study, it
to the economic growth of Sri Lanka, it is wise
is evident that total factor productivity plays a
to identify the determinants of TFP when we are
major role in economic growth in some countries
going to adapt alternative policies to improve the
while factor accumulation is accounting for some
TFP. Therefore following function has been
other countries. After analyzing the data from
estimated econometrically for the sample time
1990 – 2008, it has been observed that the
period.
growth of output in Sri Lanka mainly depends on
capital accumulation and labor force but TFP
does not have significant effect on the Sri
TFP = 3.6 *** − 0.0017 ***
ER + 0.008 ** OP
Lanka’s growth process. Furthermore, political
+ 0.004 IOI + 0.02 * LR − 0.13 *** D1 + u
instability in the country during the war period
R2 = 0.8834 Prob > F = 0.0000 and changes in exchange rate policy also
adversely affected to Sri Lankan economic
*** - Significant at 1% level
growth rate during the sample period. In addition
** - Significant at 5%v level
to these results, this paper concluded that
* - Significant at 10% level openness of the economy, human capital,
investment on infrastructure are positively
According to the regression equation Openness,
related with total factor productivity while
Investment on Infrastructures and Literacy rate
exchange rate and political instability slow down
positively related with TFP while Exchange rate
the growth rate of total factor productivity.
negatively. Most of the empirical research works
(Razafimahefa 2002), (Jari 2002), (Nachega &
Fontaine 2006) have revealed the positive
According to the current situation in Sri
relationship between openness and again
Lanka, capital accumulation is the key
(Razafimahefa 2002) has found the positive e
component of economic growth, even if most of
the developed countries maintain a higher level
of economic growth by getting the contribution
of TFP. TFP has helped to achieve a higher level
of economic growth and increase
productivity of the other production factors as
well. Therefore as a developing country, if the
country can increase the TFP, it is not much
difficult task to be a developed country by
achieving the higher level of economic growth
joining with the capital accumulation as other
Josephson, C. & Schon, L. (2002). Determinant
of total factor productivity and phases in
economic growth; Swedish manufacturing
industry 1950-1994. Congress of the
International Economic History Association.
Khatiwada, Y.R, & Sharma, S.K. (2002) Nepal:
the
Country Study Report. Institute for Integrated
Development Studies, Nepal.
Mankiw, G. et. Al (1992). A contribution to the
empirics of economic growth. Quarterly
Journals of Economics, 107(2), 407-37.
Nachega, J.C. & Fontaine, T. (2006). Economic
Growth and Total Factor Productivity in Niger.
IMF Working Paper, WP/06/208.

developed countries. Therefore, infrastructures Razafimahefa. I.F. (2002). Determinant of total

and human capital development, and appropriate
exchange rate policy are strongly recommended
under a stable political situation to achieve a
higher level of economic growth by increasing
TFP.
factor productivity; the case of Sub-Saharan
African economies. Kobe university japan.
Solow, R.M. (1957). Technical Changes and the
Aggregate Production Function. The Review of
Economics and Statistics, vol 39aug.

This paper mainly addresses the contribution of

TFP, labor and capital for economic growth, but
on the other hand factor such as human capital
also affects the economic growth vastly.
Similarly TFP also can be influenced by the
factors which are not touched by this study.
Therefore these limitations are highlighted and
left to the future researchers by providing a
better pathway to empirical research on
economic growth.

REFERENCES
Duma. N. (2007). Sri Lanka’s sources of growth.
IMF working paper. WP/07/225. Asia and
pacific department.

Jajri. I. (2007). Determinant of total factor

productivity in Malaysia. Journal of economic
corporation. University of Malaya.