Comparative Evaluation of Common Measures of Total Factor Productivity: Evidence From South Asia
Author | MUHAMMAD ILYAS AND UZMA RIAZ |
Abstract. Total factor productivity (TFP) growth is described as the unexplained part of economic growth which captures the effects of economies of scale, foreign direct investment, education expenditures, technological growth, and so on. Three methods are commonly used to measure TFP growth: growth accounting, index number and econometric method. The objectives of this study is to measure and compare the trends of TFP growth estimated through the above mentioned three methods in South Asia for the sample period 1990-2013. The results indicate that the trends of TFP growth during the sample period in the selected panel remained cyclical but the overall average growth rate of TFP remained positive. Moreover, the econometric method produced consistent trends of TFP growth relative to those produced through growth accounting and index number methods.
Keywords: Total Factor Productivity Growth, Growth Accounting, Divisia-Tornqvist-Index of TFP, Econometric Method of TFP, Growth in South Asia
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INTRODUCTION
South Asian countries have experienced remarkable differences in growth rates of real GDP. Some countries have been enjoying quite high growth rates of real GDP, whereas others have been facing low growth rates that are insufficient to fulfill the needs of a growing population. But, the overall growth rate of real GDP has been lower than its potential. These countries have realized an average real GDP growth rate of 5.23 percent per year during the period 1981 to 2013. Furthermore, after remaining relatively less volatile till 2000, growth rates of real GDP of South Asian countries have tended to be more volatile afterward.
Figure 1 represents the average growth trends of real GDP of South Asian economies. Differences in real GDP growth rates exist not only across countries but also across the time period as shown by Figure 1 and such differences invite a careful investigation. Although in economics an abundant literature on economic growth is available, this issue is still important and current.
Theorists have established various economic models that explain the mechanisms of long-term output growth rates. But, the relative importance of the factors of output growth rates is still disputed. In general, theorists of growth models can be grouped into two main categories: accumulationists and revisionists. Accumulationists believe that output growth is mainly the result of capital accumulation. Conversely, revisionists relate output growth with total factor productivity (TFP) growth. Harrod (1939) and Domar (1946) explained the mechanism of long-term output growth under the assumption of fixed proportions of factors. Unlike these models, Solow (1956) assumed that labor and capital, to a large extent, are substitutable (but not perfectly substitutable) with each other and presented a simple model of economic growth. According to him, physical capital, labor and exogenously determined technology are the sources of output growth.
Using neoclassical growth model he observed the model does not explain a large proportion of output growth. The unexplained proportion of output growth is known as TFP growth or Solow residual. Since Solow (1956), a large number of researchers have conducted studies to identify the factors of output growth. Nonetheless, the idea of TFP growth is still important because besides measuring output growth and cross-country growth differences it determines economic fluctuations and business cycle frequencies (Comin and Gertler, 2006). Studies of TFP growth investigate the reasons for lackluster, volatile and slow output growth. Being a multifaceted mechanism the output growth involves many factors besides capital accumulations and technology. The combined impact of these factors remains behind the concept of TFP, very succinctly brought forth by Solow (1957).
TFP captures the effects of technical growth, human and physical capital growths, research and development expenditures, economies of scale, government policies, international trade policies, remittances, and so on. Actual reason for the continual importance of TFP is the scarcity of factors of production. Due to the unavailability of new factors of production, especially in economically developed countries, long-term sustainable output growth is almost impossible through factor accumulations. Alternatively, long-term output growth can be sustained by putting the existing factors of production to more productive and efficient use that necessitates TFP growth.
A review of previous studies indicates various methods of measuring the TFP growth rate in an economy: growth accounting method, index number method, and econometric method. Each method is characterized by certain advantages and disadvantages as will be discussed in detail in methodology section. Current study intends to measure TFP growth rates in South Asian countries using all the three commonly used methods and to identify a method that produces more consistent TFP growth rates. Another objective of this study is to observe that what has happened to the trends of TFP growth in South Asian economies during the sample period.
Rest of the study is organized as follows: Section 2 reviews the relevant empirical studies of TFP growth. Section 3 discusses the methodology and data. Section 4 presents the trends of TFP growth. Section 5 draws conclusions from the study.
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REVIEW OF LITERATURE
The theoretical and empirical literature on the measurement and testing of TFPG has emerged very swiftly and it has gained much importance. As a result, a sufficient literature has been formed on the subject. Han (2003) has rightly stated that “Since Solow (1957), the number of studies attempting to calculate TFP growth for various economies have been too numerous to count”. Despite ample literature is available on the subject matter, Jorgenson and Griliches (1967), Jorgenson et al. (1987) and Jorgenson and Stiroh (2000) argued that traditional measures of TFP growth overestimate it.
Cororaton et al. (1995) measured TFP employing two commonly used approaches: growth accounting approach and stochastic frontier production function. For their study they used the data of 25 large-scale manufacturing industries of the Philippines and selected the sample period of 1956 to 1992. They observed that TFP had a negative sign in the case of the Philippines. Moreover, the number of industries with negative TFP was increasing over time during the period of study.
Chen (1997) examined the studies of TFP as a source of growth in East Asian countries. He argued that the importance of technological change in economic growth depends largely on how TFP is defined and measured. He argued that the conclusion drawn by Young (1992, 1994) and Krugman (1994) that factor accumulation is the main source of economic growth was based largely on the assumption that all technological change is TFP.
Rosegrant and Evenson (1995) computed TFP indices for 271 districts covering 13 states of India for the period 1956 to 1987. Their results showed that significant TFP growth in the Indian crops sector was generated by investments, in research and extension services, marketing, and irrigation. TFP growth contributed roughly 1.1 percent growth per year to crop production in India.
Sabir et al. (2003) determined the effect of macroeconomic reforms on TFP growth in Pakistan during the period 1973 to 2002. They used the data on GDP and on the sectoral output of agriculture, manufacturing and services sector of Pakistan. They estimated TFP growth through the growth accounting approach and index number approach separately. The findings of their study revealed that macroeconomic reforms introduced in the late 1980s put a negative pressure on TFP in the economy as a whole and on TFP in the manufacturing and services sectors. Nevertheless, due to these...
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