Growth Accounting

Professor Xiaodong Zhu

February 15, 2023

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 700
70000

7000
1950
1951
1952
1953
1954
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1958
1959
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1962
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1966
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1968
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Brazil
1974
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China
1978
1979
1980
1981

India
1982
1983
1984
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1987

Indonesia
Per Capita GDP in 2011 US Dollar

1988
1989
1990
1991
USA
1992
1993
1994
1995
1996
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1998
1999
2000
2001
2002
China’s growth in modern period

2003
2004
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2013
2014
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 The growth question

“Is there some action a government of India could take

that would lead the Indian economy to grow like
Indonesia’s or Egybt’s? If so, what exactly? If not, what
is it about the ’nature of India’ that makes it so? The
consequences for human welfare involved in questions like
these are simply staggering: Once we start to think about
them, it is hard to think about anything else.”

Robert E. Lucas Jr. (1988, p.5)

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 China’s growth miracle

• China was one of the poorest economies in the world in 1953

• Despite government-led efforts of industrialization and

investments in heavy industries between 1953 and 1978, China
was still one of the poorest economies in the world in 1978

• Since 1978, however, China has experienced four decades of

rapid growth of per capita GDP

• What are the drivers of China’s growth since 1978?

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 What drives China’s growth since 1978?

There are three widely held views about China’s growth

• Data problem: growth rates have been consistently over stated

• State capitalism: growth has been driven by high rates of

investment, especially state sector investment

• International trade and surplus labour: growth has been driven

by export expansion fueled by aboundant cheap labour

These are myths, not facts

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Myth: Official GDP data have exaggerated China’s growth

• Li Ke Qiang (2007): Electricity, rail cargo shipments and bank

loans are more reliable indices than GDP
• These may be true at local levels, but the National Bureau of
Statistics (NBS) makes careful adjustments to the data
reported by the local governments. Example: Industrial GDP
• Industrial firms report to the NBS both value-added and
income items (labour compensation, profits, depreciation, and
net production taxes)
• There is an accounting identity: value-added=sum of the four
income items

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 Annual Suvey of Industry
• The main data source for estimating industrial GDP in China,
covers all SOEs and above scale POEs in the industrial sector

Reported value-added=sum of the four income items?

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 Over reporting value-added by firms

Reported value-added is around 30% higher than the sum of the

four income items
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Myth: Official GDP data have exaggerated China’s growth
• Li Ke Qiang (2007): Electricity, rail cargo shipments and bank
loans are more reliable indices than GDP
• These may be true at local levels, but the National Bureau of
Statistics (NBS) makes careful adjustments to the data
reported by the local governments. Example: Industrial GDP
• Industrial firms report to the NBS both value-added and
income items (labour compensation, profits, depreciation, and
net production taxes)
• There is an accounting identity: value-added=sum of the four
income items
• Reported value-added has been systematically been 30%
higher than the sum of the income items
• Probably at the request of the local governments who want to
report higher local GDP
• NBS uses the sum of the income items instead of the reported
value-added in calculating GDP in industry

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No systematic bias found in NBS GDP growth rates

• Carsten Holz (HKUST, 2013) “The quality of China’s GDP

statistics”
• Few anomalies in the official statistics
• Nakamura, Steinson and Liu (2016) “Are Chinese growth and
inflation too smooth? Evidence from Engle curves”
• Using household consumption expenditure data to infer
household income: higher income implies lower food share in
consumption expenditures
• Their inferred income series is more volatile than the official
GDP series, but the average growth rates of the two series are
very close

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No systematic bias found in NBS GDP growth rates

• John Fernald, Isreal Malkin and Mark Spiegel (Federal Reserve

Bank of San Francisco, 2013) “On the reliability of Chinese
output figures”
• GDP by the NBS and Li index track each other remarkably well

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 Myth: China’s growth is driven by investment

• Modern growth requires investment in capital, so growth is

always associated with investment
• Investment driven growth: growth is driven by increasing the
rate of investment (as % of GDP) rather than improving
productivity
• Many people believe China’s growth has been driven largely by
increasing the rate of investment, especially the investment in
the state sector

This is again a myth

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 Investment rates in China
Nominal and Real Investment Rates in China
0.5

0.45

0.4

0.35

0.3

0.25

0.2

0.15
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
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2010
2011
2012
Nominal Investment Rate Real Investment Rate

• Nominal investment rate = nominal capital formation/nominal GDP

• Real investment rate = real capital formation/real GDP = nominal
investment rate/PI
• PI = price index of capital / price index of GDP
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 Investment driven growth?

• The rise of the nominal investment rate before 1990 was due
to the rising cost of investment
• the real investment rate was actually declining during that
period
• The real rate of investment has been increasing steadily since
1990
• Can the steady increases in the investment rate drive sustained
GDP growth without productivity improvement?

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 An accounting framework
• GDP is a function of production inputs, capital and labor, and
a variable called TFP–total factor productivity

Yt = At Ktα (ht Lt )1−α = Ktα (Lt × Et )1−α

• Here, Kt is the aggregate physical capital stock, ht is the

average level of human capital (labor quality), Lt is the
aggregate employment (labor quantity),
1
Et = At1−α ht

• and At is the TFP, which measures how efficiently the capital

and labor inputs are used in producing GDP. Its level depends
on
• Technology used
• Efficiency of resource allocation

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 Growth accounting
An accounting framework
• GDP is a function of (capital and labor) inputs and a term
called TFP–total factor productivity
Yt = At Ktα (ht Lt )1−α

ln (Yt ) = ln (At ) + αln(Kt ) + (1 − α)ln (Lt )

For any variable, xt , define gx = 4ln (xt ) = ln (xt+1 ) − ln (xt ),
then,

gY = gA + αgK + (1 − α) (gh + gL )
TFP A is difficult to measure directly, but output, capital stock and
labour input can be measured. Infer TFP growth from the equation
above

gA = gY − αgK − (1 − α) (gL + gh )
Here, 1 − α = labor income share, which is around 2/3 in the US 15 / 30
 Growth accounting for US

gY gK gHL gTFP 1−α

1950-2014 3.11 3.03 1.91 0.83 0.67
1950-1973 3.95 3.82 2.42 1.07 0.67
1973-1993 2.81 2.81 2.10 0.48 0.67
1993-2007 3.19 2.92 1.64 1.13 0.67
2007-2014 1.01 1.27 0.28 0.40 0.67

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 East Asian miracles?

In the mid-90s, the World Bank issued a report entitled “Eastern

Asian Miracles”
• Miracles created by “market friendly government policy”

Around the same time, some careful data work by Alwyn Young and
a popular writing by Paul Krugman in Foreign Affairs magazine:
• There was no Asian Miracle

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 Growth accounting for four East Asian economies

Estimates by Alwyn Young:

gY gK gHL gTFP 1−α

Hong Kong (66-91) 7.3 8.0 3.2 2.3 0.63
Korea (66-90) 10.3 13.7 6.4 1.7 0.70
Singapore (66-90) 8.7 11.5 5.7 0.2 0.51
Taiwan (66-90) 9.4 12.3 4.9 2.6 0.74

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Average growth rates in China

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 Simple growth decomposition

In China, α = 1 − α = 0.5
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Technological progress as the only driver of long-run growth

K = k (L × E ) , Y = f (k) (L × E )

• In the long-run,

K = k ∗ (L × E ) , Y = f (k ∗ ) (L × E )

• So both capital stock and GDP grow at the same rate n + g ,

the population growth rate plus the rate of technological
progress
• Even without increase in the investment rate s, capital stock
grows with labour input and labour efficiency
• Capital stock per worker and GDP per worker grow at the rate
g
• Long-run growth is driven by technological progress only

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 Influence of saving/investment rate

• An increase in the investment rate s will lead to temporary growth and a

permanently higher income level
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 Real investment rates in China

Nominal and Real Investment Rates in China

0.5

0.45

0.4

0.35

0.3

0.25

0.2

0.15
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Nominal Investment Rate Real Investment Rate

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China growth decomposition: 1990-2013

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 Bias of standard growth decomposition

• Even if there is no increase in investment rate (s), the capital

stock would still grow as long as there there is population
growth or TFP growth.

• How much of the capital stock growth is due to increases in

investment rate and how much of the capital stock growth is
due to TFP growth?

• We next use a simulation method to answer the question.

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 Decomposition based on simulation

• Consider the following dynamic system of equations:

Yt = At (Kt )α (ht Lt )1−α

Kt+1 = (1 − δ)Kt + st Yt
When we use the data on TFP At and real investment rate st ,
the GDP (Yt ) and capital stock (Kt ) series are the same as in
the data.
• We consider two alternative counter-factual simulations:
• (1) Holding the investment rate at its 1990 level between 1990
and 2013
• (2) Holding the TFP at its 1990 level between 1990 and 2013

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(1) Growth constribution of investment rate increase

Holding the investment rate at its 1990 level: for

t = 1991, ..., 2013,

Yt = At (Kt )α (ht Lt )1−α

Kt+1 = (1 − δ)Kt + s1990 Yt

The simulated capital stock and GDP series imply the following
growth rates are:
• gY = 8.19, gK = 6.47
• investment rate increase contributed to 1.97 (10.16 − 8.19)
out of 10.16 percentage points GDP growth, or 0.19% of the
GDP growth

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 (2) Growth constribution of TFP growth

Holding the TFP at its 1990 level: for t = 1991, ..., 2013,

Yt = A1990 (Kt )α (ht Lt )1−α

Kt+1 = (1 − δ)Kt + st Yt
The simulated capital stock and GDP series imply the following
growth rates are:
• gY = 3.92, gK = 5.90
• TFP growth contributed to 6.24 (10.16 − 3.92) out of 10.16
percentage points GDP growth, or 0.61% of the GDP growth

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 0
2
4
6
8

-2
10
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14
16
1979
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1988
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1995
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1997

GDP growth
1998
1999
2000
2001
2002

TFP growth
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Growth of GDP and TFP in China

2015
40 years of GDP Growth and TFP Growth in China

2016
2017
2018
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 Has China’s growth been driven by investment?

Answer: No!

• The Chinese government often used investment driven policy

to stimulate growth, especially when growth slows down.
• However, the strategy has not been effective, rapid growth has
invariably driven by rapid TFP growth

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