THE ROLE OF TECHNICAL CHANGE AND

EFFICIENCY IN SHAPING QUALITY OF LIFE:

A CROSS-COUNTRY ANALYSIS
Mayur Agarwal: 22227707012
Mohd. Rahil: 22227707081
Saksham Mehta: 22227707115
Shruti Chopra: 22227707051

ABSTRACT
This paper aims to analyze the influence of productivity growth on the quality of life in diverse
categories of nations. To conduct our research, we utilize data from approximately 100 countries,
which are classified into four income groups. The primary focus of this paper is to measure
technical efficiency using the SFA (Stochastic Frontier Approach) analysis, and subsequently
employ this measurement to compute the overall productivity growth or productivity alteration.
Moreover, our analysis illustrates the manner in which productivity growth impacts the Gross
Domestic Product through changes in technical aspects and improvements in technical efficiency.

INTRODUCTION
This paper aims to investigate the influence of productivity growth on the standard of living across
diverse countries. Our analysis encompasses approximately 100 nations categorized into four
income-based groups. Employing a Stochastic Frontier Approach, we measure Technical Change
and Technical Efficiency, exploring their impact on living standards.
While the concept of "Standard of Living" is often defined as the "degree of wealth and material
comforts available to an individual or community," we acknowledge its subjective nature.
Recognizing the need for a more inclusive perspective, drawing from Amartya Sen's Capability
Approach, we argue against dismissing the conventional definition as insignificant. Economic
means, represented by income or wealth, typically facilitate access to resources essential for a
certain standard of living. Hence, at the national level, we adopt GDP as the metric for living
standards.
In the long run, GDP growth is contingent upon the average productivity of various factors of
production, such as capital and labor. Productivity, defined as the average output per worker,
becomes a focal point of our study. We delve into the capacity of countries to produce and assess
the extent of utilization, considering the productive efficiency of factors of production. This
analysis, in turn, informs our understanding of a country's GDP growth and, consequently, its
standard of living.

LITERATURE REVIEW
On studying the literature, it was found that most studies took a Non-Parametric approach. The
paper by Fare et. al. (1994) computes a Malmquist Productivity Index using activity analysis. They
also break it down further into technical change and efficiency change to make the study more
specific. The results were promising and indicative of the on- the highest in the sample due to
efficiency change and that America had a greater than average productivity growth owing to
technical change, dictating that their study methodology was niche since it aligned with actuality.
This study shall inculcate parts of the methodology of this paper. Shahbinejad et al (2013) in their
paper on applications of SFA and DEA in measuring Agricultural efficiency in MENA countries
also reach a similar conclusion. They looked at total factor productivity growth and its components
in 44 Asian nations from 2000 to 2010. They employed stochastic frontier analysis to do so. They
also divided TFP into technical efficiency change and technical change using the Battese and Coelli
approach. The role of technological change in productivity development was discovered to be
negative in 75% of these economies.

In their study on the causes of falling productivity, JR Norsworthy et al (1979) use a different
approach. The paper's key conclusion was that there are two distinct periods to the slowdown in
labour productivity growth: 1965-73 and 1973-78. The former is mostly explained by a reduction
in R&D spending during the period, whereas the latter is driven by the consequences of lower
capital creation. Given that productivity growth does not follow the same pattern across time, our
research will demonstrate how a slowdown in productivity growth leads to a drop in standard of
living/GDP.

In our paper, we also endeavour to study relationship between Living Standard and Productivity
Growth. The work of MARK VITNER AND AZHAR IQBAL (2013), who hypothesised that a
continuous increase in productivity would result in a greater quality of living, provided the
inspiration for this relationship. 'Productivity growth and an improvement in a country's standard
of living are usually regarded to go hand in hand,' their report claims. 'Productivity growth and an
increase in a country's standard of living are usually regarded to go hand in hand,' according to
their paper. Their statistical analysis shows that the productivity in resurgence era is related with
lower per capita income, employment, and consumer confidence growth rates, and that stronger
productivity gains outperformed advances in real per capita income by a wide margin.

The work of Moses Abramovitz (1986) highlights a key idea that there is usually an inverse relation
between productivity growth rates and productivity levels, which intuitively makes sense. This
article demonstrates that variations in productivity levels among countries generate a great
possibility for level convergence in the future, given that countries have a "social competence"
sufficient to absorb more modern technology. This idea, as well as the convergence of production
levels it implies, is backed up by a century of experience in a group of currently industrialised
countries. However, the rate of convergence differed from period to period.

To quantify technological efficiency in public education, Chakraborty et al. (1998) used both
stochastic and non-stochastic production function approaches. The stochastic specification uses
half normal and exponential distributions to assess technical efficiency. To disentangle the impacts
of fixed inputs on the measure of technical efficiency, the non-stochastic specification employs
two-stage Data Envelopment Analysis (DEA). The empirical research reveals significant
differences in efficiency between school districts.

Christopher Cornwell et al. (1998) compared non-frontier and frontier techniques, placed standard
non- frontier specification within their frontier model, and derived differing productivity change
estimates. The results of their frontier approach revealed that average productivity growth was
around 0.3 percent during the period, with efficiency change rising and dropping. The typical non-
frontier model, on the other hand, produced a negative estimate of productivity change for the
industry as a whole, and the likelihood ratio test also rejected this specification. Our research not
only examines the factors that influence productivity growth, but it also establishes a link between
productivity growth and GDP- based standard of life. Mark Vitner et al. (2013), who hypothesised
that a continuous increase in productivity would lead to a greater quality of living, provided the
inspiration for this relationship. 'Productivity growth and an increase in a country's standard of
living are usually regarded to go hand in hand,' their report claims.

DATA
(https://databank.worldbank.org/databases).

The Development Data Group of the World Bank manages statistical and data activities as well as
maintaining a number of macro, financial, and sector databases. The group is guided by
professional standards in the gathering, compilation, and dissemination of data, and works closely
with the Bank's regions and Global Practices to ensure that all data users may have trust in the
quality and integrity of the data produced. Much of the data comes from member countries'
statistical systems, and the quality of global statistics is influenced by how effectively these
national systems work.

The World Bank works with developing nations to help them enhance their national statistical
systems' capacity, efficiency, and effectiveness.
The results for the period 1990 to 2015 are used in the paper. Because input force data for years
other than 1990-2015 was not easily available, our research was limited to this shorter timeframe.
We have 96 countries in our initiative. These have been chosen to cover the entire analysis.
Because we used such a vast number of nations, we are limited in our ability to identify some
characteristics that influence technological efficiency in all of them. As a result, we primarily
considered two factors: net FDI inflows (current US$) and working population (Aged between 15-
64 years).
We could only acquire input data for Labor Force due to data availability limits.

Gross Domestic Product (GDP) is our output.

The important variable taken into consideration from the data are:
1- Time Period
2- Country coverage
3- Factors affecting technical efficiency (z)
4- Input Series
5- Output Series

METHODOLOGY
We used Stochastic Frontier Analysis to estimate technological efficiency. The notion
behind the stochastic production frontier proposed by Aigner et al. (1977) and Meeusen and van
den Broeck (1977) is that deviations from the production "frontier" may not be totally under the
control of the firm in question. It's a parametric method that employs industry-standard production
function methodology. The method understands that the production function indicates the
theoretically maximum possible output level for a given output level.

The equations below represent the general stochastic production frontier model, where y is the
vector of quantities produced vector of parameters describing production technology.

y=f(t,x,β).exp(v).exp(-u), u≥0

lnyi= xi’β+vi-ui

uit= f(zit)

Ui ~ N.(µ,σ)

Different error components are represented by the v and u terms (vectors). The first is measurement
errors, statistical noise, and random fluctuation of the frontier between firms, whereas the second
is a downward deviation from the production frontier, i.e. technical inefficiency. ui is greater than
zero, but vi can be any value. Vi is commonly considered to have a symmetric distribution, such
as the normal distribution.

The ratio of observed output to potential output (provided by the frontier) represents the level of
technical efficiency (TE).

This implies that level of technical efficiency is captured by exp(-ui) Production Function Used
Other methods for estimating production functions include Ordinary Least Squares production
function estimation and Deterministic production function estimation. Due to the constraints of the
other two production frontiers, the stochastic frontier was utilized

1. Deterministic production frontier

All errors are presumed to be attributable to technical inefficiency in this model, with no
consideration for noise, i.e. vi

Consider the following simple specification:

ln yi= □xi □ □ui for firms i= 1,2,...N

xi's are in logs and include a constant

ui is a non-negative random variable. Therefore ln yi

2. Ordinary Least Squares(OLS)

In contrast to deterministic production frontier , this model assumes all the errors due to noise term
only.

The model specification is:

qi = β0 + β1xi + vi
if we use OLS, the intercept term will be biased downwards as it ignores the term ui i.e. technical
inefficiency.

If we correct the OLS estimate by adding the maximum likelihood estimate of ui, we get a
deterministic model, but the difficulty now is that this estimate can be an outlier at times. The
Stochastic frontier is kept under the deterministic one by the existence of the noise term, i.e. vi. As
a result, SFA appears to be a superior fit for the data.
Functional form used :
A number of different functional forms are used in the literature to model production functions:
● Cobb-Douglas (linear logs of outputs and inputs)
● Quadratic (in inputs)
● Normalised quadratic
● Translog function

We looked at several various sorts of production functions before settling on one that was most
suited to our needs. The logarithmic transformation of the Cobb Douglas is the most popular
production function employed in empirical estimations of frontier models, owing to its simplicity.

The following are the various production functions that were considered:
1) Production function of Cobb Douglas
2) Full trans-log production function

We utilised these three factors to reject any production function:

Sign of coefficients.
Allen elasticity of substitution (AES), which measures the percentage change in factor proportions
due to a change in marginal rate of technical substitution. The production function with constant
AES or having a a-priori about AES is not a flexible production function.
The more the log likelihood estimate is, the better is the fit of the function.

The issue with the Cobb Douglas production function that arises in our study is that the sign of the
coefficient is correct, but we already know that the AES of this production function is unitary,
implying that it is not a flexible production function. The log likelihood estimate increased when
we employed the full Translog production function, indicating a significantly better fit.
Functional form of translog production model in SFA:

Where;
Yit= Output in the i-th country in the t-th period
Xit = input variables in the i-th country in the t-th period
β0. βi, βii-the unknown parameter to be estimated.
v = independently and identically distributed random error having normal distribution with mean
0 and variance σ^2
u = downward deviation from the production frontier ie, Technical Inefficiency. It is measured as
ratio of observed output to the corresponding SFA output. It takes a value between 0 and 1.

Our Specification:

Full trans log production function (Time varying fixed effects model)

Ln(GDP)= βo+ β1 Ln(L) + β2 Ln(k) + β3t+ β4 (Ln(L))² + β5 (Ln(K))² +β6t² + β7 Ln(L)Ln(K)+

β8tLn(L) + f9 tLn(K) + Σ(i=1 to n) βj Countryi + v-u

GDP = Gross Domestic Product

L = Labour
K= Capital
T= Time
We've used about 100 countries and have created n-1 dummies to represent them.
Our main research focuses on measuring technical efficiency using the SFA analysis and using the
same to calculate total factor productivity growth/productivity change.

Technical Change (TC) and Technical Efficiency Change (TEC) are two
components of total factor productivity growth. Technically, we calculate TC and TEC, the
product of which is TFP growth.
The following formulae can be used to calculate TEC and TC once the parameters have been
estimated.

Technical Change (TC)

The geometric mean of exponentials of two partial derivations of the production function with
regard to time is computed as the technological change index for a country between periods t and
t+1.
TC(t,t+1) = Geometric Mean { TC(t) , TC(t+1) } Where TC(t) =
TC > 1 means an upward shift in the production frontier and technological progress
TC < 1 represents a downward shift in the production frontier and technological regress and TC =
1 means that the frontier remains unchanged

There are 3 types of technical change:

1. Capital-deepening technical progress:

If the MRSL K increases along a line with a fixed K/L ratio, technical progress is capital-deepening
(or capital-using). This means that technological progress raises capital's marginal product faster
than labor's marginal product.

2. Labor-deepening technical progress:

If the MRSL increases along a radius through the origin (with a constant K/L ratio), technical
advancement is labor-deepening. This means that technological advancement raises the MPL
quicker than the MPK.

3. Neutral-technical progress:
Technical progress is neutral if it increases the marginal product of both factors by the same
percentage, so that the MRSL K (along any radius) remains constant

We chose Neutral technological advancement for our research since we don't want our research to
be skewed by any factor, and there is neutrality in technical change according to Harrod and Hick's
definitions. Furthermore, because our research spans the globe, there may be differences between
countries; but, on average, we assume it to be neutral.

Technical Efficiency Change (TEC)

The efficiency change index for a country is the ratio of the observed technical efficiency in time
period t+1 to that in time t,

TEC (t,t+1) = TE (t+1) / TE (t)

TEC > 1 means that the producer moved towards the production frontier, i.e., became more
efficient,
TEC < 1 represents a movement away of the frontier and
TEC = 1 means that the position of the producer in relation to the production frontier remained
unchanged

Total Factor Productivity Change (TFPC)

We can now compute TFPC using the following formulae because Total factor productivity may
be split into technical change and technical efficiency change.

TFPC(t,t+1) = TC (t,t+1) * TEC (t,t+1)

= {TC(t) *TC(t+1)}0.5 * {TE (t+1)/TE (t)}
RESULTS AND DISCUSSION
The methodology discussed above was then applied to approximately 100 countries
using data on their current GDP levels and on two inputs i.e. total labor force and
Gross fixed capital formation. Two factors affecting technical efficiency were also
included i.e. Net inflows of FDI and Working population (Aged between 15-64 years).
A time varying fixed effect stochastic frontier approach has been used to estimate the
production function. We have 96 countries, so 95 dummies were created for each
country to capture the specific traits of each country with country Albania as the base
country

Empirical production function-

Ln(GDP) = 0.111204 Ln(K) + 0.1724681 Ln(L) + 0.0014647 t + 0.0095483[Ln( L)]^2
+ 0.0046456[Ln(K)]^2 + 0.0067432Ln(L) Ln(K) + 0.0000632 t*Ln
vi ui

The term ui denotes technical inefficiency and as it was be observed the parameter of mu
(u) is 0.3275184 and is significant. This implies that the value of u is little far from zero which
means that there is some scope for improvement in technical efficiency. Thus the efficiency
estimate for most of the observations will be close to 1 which is validated by the fact that mean
efficiency is 0.850003. Apart from technical efficiency term, our explanatory variables i.e. gross
domestic fixed capital formation and Total labor force are statistically significant, which implies
that our inputs exert some influence on Gross domestic product of a certain country. Other
explanatory variables include dummies for all the countries. It was found that some countries are
statistically significant and have positive coefficient i.e. there are some country fixed effects which
influence Gross Domestic Product over time. While some countries had negative and statistically
insignificant coefficients such as Bulgaria, Brazil, El Salvador, Guinea-Bissau, Malawi. The
following form for ui has been considered :

uit = f (zit)
Here z is a vector for factors affecting technical inefficiency which includes net inflows of FDI
and Total working population (aged 15-64 years). It was observed that increasing net inflows of
FDI has a significantly positive impact on the technical efficiency (shown by negative impact on
technical inefficiency) and this is in line with our a-priori. While, Working population (Aged 15-
64 years) has a negative impact on technical efficiency (shown by positive impact on technical
inefficiency), which is a surprising result and this does not match our a-priori. This can be possibly
explained by the fact that in some sectors we have disguised unemployment i.e. more people are
working than required which is leading to lower efficiency.

Using the above coefficients we computed the trends in productivity change, technical efficiency
change, and technical change for the overall period of study.
The above table 1 and 2 shows technical change and technical efficiency change for
four regions which is averaged across countries. Since due to large number of
countries and years we have shown it over a gap of five years. Total factor
productivity growth is the multiplication of TC and TEC which is shown in table 3
and figure 1. The major difference in TFPC across four regions was observed from
year 1991 to 1994. On the onset of year 1994, it was observed that productivity
growth for low income countries started rising sharply and in 1995 it was observed
to be highest. In the same time period productivity growth was also rising among
other three regions but their rise was less than low income countries. In further years,
fluctuations were observed among all the four regions and over the entire time span
of our study, it was observed that productivity growth for low income countries
fluctuated more than other regions specifically high income countries. In year 2006,
productivity growth was observed to be highest for lower middle income countries.
From year 2007 there is a decline in productivity growth for all the four regions which
can be attributed to global financial crisis. From year 2009 and 2010, it started
recovering from fall in productivity growth as it can be seen from the figure that
TFPC is rising for all the four regions. Around 2008-09 also there is sharp fall in the
rate in all 4 categories, so this shows as recession hits an economy the productivity
growth rate also falls.

In low income and low middle-income countries there is larger fluctuations in the
productivity growth rate in some years it is below 1 too as compared to upper and
upper middle-income countries.

The above table shows that there is a significant difference between high and low
income countries specifically in year 1991 and for year 2000, high income countries
like Macao SAR, China ; Norway; Saudi Arabia are far better than low income
countries.

Since, our main focus in this paper lies on finding how productivity growth affects standard
of living
i.e. its impact on per-capita GDP. For this we performed regression between Current
per-capita GDP (dependent variable) and productivity growth (explanatory variable)
and found a positive impact. This implies that increasing productivity growth
increases per-capita GDP of any country. This result is significant given the fact that
p value of productivity growth is close to zero.
VISUALIZATIONS

Intra-region comparison

Through all these graphs we can observe that there is lot of fluctuation in both inter
and intra region and these graphs along with the upper one validates the relationship
that we have established through estimation also that as productivity growth
increases standard of living of a country also improves over time which is measured
by GDP improvement used a proxy for it.

CONCLUSION
In conclusion, the evaluation of "standard of living" traditionally centers around the availability of
fundamental necessities such as adequate food, clothing, and housing. However, a more
comprehensive assessment includes various indicators such as healthcare, life expectancy, income
distribution, and educational standards. Over time, with economic development, there is a
noticeable and substantial increase in people's standard of living, evident in the dynamic changes
observed in GDP.

Our analysis has illuminated the significant impact of productivity growth on Gross Domestic
Product (GDP) through shifts in technical change and efficiency, a relationship that has
demonstrated statistical significance. While our examination has primarily focused on two key
inputs—Total Labor Force and Gross Domestic Fixed Capital Formation—future research could
expand the scope by incorporating additional variables like total energy consumption to assess
potential variations in results.

It's noteworthy that the inclusion of more factors influencing technical efficiency, beyond the two
considered—net inflows of Foreign Direct Investment (FDI) and total working population—could
bolster the robustness of our findings. Despite these considerations, our results lead to a definitive
conclusion: the Gross Domestic Product of any country is intricately linked to total factor
productivity growth, and in turn, GDP significantly shapes the standard of living in that country.

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APPENDIX

Results for COBB-DOUGLAS Production function