MACROECONOMICS

(ECON 614, Winter 2020-21)

Growth Accounting and Neo-Classical Production

Marco Airaudoa
a Drexel University

Drexel University
Jan. 12, 2021

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Key Facts and Objectives

What drives changes in GDP per capita over time and across
countries?
=) capital accumulation and total factor productivity (de…ned later)
Have countries converged to similar levels of GDP per capita?
=) some did (catching up), some did not (falling down)
How can we explain such behavior?
=) Solow growth model (due to Robert Solow, MIT, Nobel Prize
Winner 1987)
PROs: model is simple and intuitive
CONs: no optimized consumption/savings decision

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Key Facts and Objectives
Key Facts: Real GDP per capita in 1960

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Key Facts and Objectives
Key Facts: Real GDP per capita in 1960

Switzerland the richest: 40 times (!) richer than Tanzania (the

poorest)
Top-25 countries: 20 from OECD, no Asian country
Bottom 25: "only" 19 from Sub-Saharan Africa plus China,
Indonesia, Pakistan, India

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Key Facts and Objectives
Key Facts: Real GDP per capita in 2000

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Key Facts and Objectives
Key Facts: Real GDP per capita in 2000

Luxemburg the richest: 200 times (!) richer than Congo (the poorest)
Top-25 countries: 20 from OECD plus some Asian economies (no
Latin America)
Bottom 25: 23 from Sub-Saharan Africa!

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Key Facts and Objectives
Key Facts: Growth of real GDP per capita vs "recent" levels

Poorer countries have low (even negative) average growth rates since
1960;
Still large di¤erences in income per capita across countries: some
have caught up with the U.S., others have fallen behind.
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A Simple Production Model
Production Function

We will try to explain these trends through a simple model of

production
Suppose
Y = AK α N 1 α

K = capital stock (machineries, buildings, etc...)

N = labor input (workers)
A = total factor productivity (TFP): measures the e¤ectiveness with
which K and N are combined together to give output
0 < α < 1 indexes how important is capital in production

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A Simple Production Model
Production Function: Key features

Constant Returns to Scale: doubling K and N, doubles Y

A (2K )α (2N )1 α
= 2| α 2{z1 }α A (K )α (N )1 α = 2Y
| {z }
2 Y

Positive Marginal Productivity of K and N:

∂Y AK α N 1 α Y
MPK = αAK α 1 N 1 α = α =α >0
∂K K K
∂Y AK αN 1 α Y
MPN = (1 α) AK α N α = (1 α) =α >0
∂N N N
Diminishing Marginal Productivity of K and N:
∂MPK 2
= α (α 1) AK α N1 α
<0
∂K
∂MPN α 1
= α (1 α) AK α N <0
∂N
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A Simple Production Model
Production Function: Capital Input (…xed N)

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A Simple Production Model
Production Function: Labor Input (…xed K)

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A Simple Production Model
Production Function

Assume perfect competition =) large # of identical …rms

Firm maximizes pro…ts:

max Pro…ts = AK α N 1 α
w N
|{z} r
|{z} K
wage rental rate

∂Pro…ts αY rK
= MPK
| {z } r = 0 =) = r =) α =
∂K K Y
α YK

∂Pro…ts (1 α) Y wN
= MPN
| {z } w = 0 =) = w =) 1 α=
∂N N Y
(1 α) YN

rK
α= Y : ratio of capital income to total income, 1/3 in the U.S
wN
1 α= Y : ratio of labor income to total income, 2/3 in the U.S
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A Simple Production Model
GDP per capita( or per person): Cross-country Di¤erences

Let
Yt
yt = = real output per capita (POP stands for population)
POPt
Nt
et = = labor force to population ratio
POPt
Output per capita allows to compare standard of living across
countries
Letting kt = Kt /POPt (capital per capita):
1 α
At Ktα Nt1 α
At Ktα Nt1 α Kt α
Nt
yt = = = At
POPt POPtα POPt1 α POPt POPt
= At ktα et1 α

3 key factors drive yt : TFP At , capital per person kt , and the size of
the labor force et .
Can we use this simple production model to explain data?
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A Simple Production Model
GDP per capita( or per person): Cross-country Di¤erences

Assume α = 1/3, A = 1 and e = 1, and normalize k US = 1.

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A Simple Production Model
GDP per capita on a Common Production Function

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A Simple Production Model
GDP per capita: Cross-country Di¤erences

Few observations
1 Despite large variation in capital per person, model predicts smaller
variation in GDP per person across countries with respect to to what
observed
Ex: Burundi’s observed GDP per person is 1% of US; predicted is
18% of US.
India’s observed GDP per person is 8% of US; predicted is 39% of US
2 Model systematically predicts that countries should be richer than
they actually are
Ex: Japan and Switzerland should be richer than the US
3 Model predicts that poor countries should have higher MPK: hence
we should observe more investments in poor countries (not the case in
reality)
What are we doing wrong?
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A Simple Production Model
Inferring TFP

Let’s focus on the role of TFP: it is a catch-all e¤ect measuring how

well a country transforms inputs into output
Problem: TFP not directly observable
Reverse engineering: we assume the model is "correct" and use it to
infer country-speci…c TFP (we keep et = 1)
Take a generic country i (i =US, Japan, India, et...)
1/3
yti = Ait kti
yti GDP p.c. observed in country i
=) Ait = 1/3
=
kti GDP p.c. predicted by model for country i

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A Simple Production Model
Cross-country Di¤erences in TFP

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A Simple Production Model
Country-speci…c Production Functions

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A Simple Production Model
Some Growth Accounting

Capital per worker and TFP are key to understand di¤erences in

income per capita across countries
Which one matters more?
Take Burundi vs the U.S.
if they had same TFP, Burundi would have 1/6 (18%) of US income
per capita
in reality, Burundi has only 1/100 (1%) of US income per capita
TFP accounts for about 5/6 (82%) of the observed di¤erence
Even more insightful: compare top-5 richest countries to bottom-5
poorest
0 11/3
y rich Arich B
Bk
rich C
C Arich
= =) = 18
y poor Apoor @|k poor
{z }
A Apoor
| {z }
108 216
| {z }
6
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A Simple Production Model
TFP Di¤erences: Drivers?

Human capital: workers in di¤erent countries possess di¤erent

amounts of human capital
EX: avg yrs of education is 13 in US, 4 in poor country
Returns to education could be extremely high in poor countries!
Technology: rich and poor countries produce with di¤erent
technologies
Managerial / organizational capital: …rms in di¤erent countries use
di¤erent processes to organize production
Infrastructure: countries vary in the extent and quality of their
transportation links, power grids, etc.
Institutions: the extent of rule of law, regulation, taxation, corruption,
etc. varies across countries (risk of expropriation, military coup,
dictatorships, . . . )

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A Simple Production Model
More Growth Accounting

Let’s go back to Yt = At Ktα Nt1 α

Then: 0 1α 0 11 α

Yt At BB Kt C
C B N C
B t C
= B C B C
Yt 1 At 1 @ Kt 1 A @ Nt 1 A
| {z } | {z } | {z } | {z }
1 +g Y 1 +g A 1 +g K 1 +g N

Take ln of both sides recalling the following rules

ln (xy ) = ln x + ln y ln x b = b ln x ln (1 + x ) x (for x small)

Then
gY = gA + αgK + (1 α) gN

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A Simple Production Model
More Growth Accounting

In U.S. for period 1982-2011

gY = gA + αgK + (1 α) gN =) gA = 1.06% (per year)

|{z} |{z} | {z }
3.23% 1.18% 0.99%

In U.S. for period 1973-1982

gY = gA + αgK + (1 α) gN =) gA = 0.27% (per year)

|{z} |{z} | {z }
1.55% 0.69% 1.13%

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