THE SOLOW

GROWTH
MODEL
ANITA ROOSMAWARNI (041917037302)
RANTI DARWIN (041917037303)
INTRODUCTION
FACTS ABOUT ECONOMIC GROWTH
IN THIS CHAPTER, WE WILL LEARN…
• the closed economy Solow
model
• how a country’s standard of
living depends on its saving and
population growth rates
• how to use the “Golden Rule”
to find the optimal saving rate
and capital stock

3
Productivity growth slowdown
• standards of living in industrialized
countries have reached level
• average annual growth in output per
person in the United States and
other industrialized countries from
the early 1970s to the mid-1990s
was about a percentage point below
its earlier level

4
Growth miracles
• Hong Kong, Singapore, Taiwan and
South Korea (NIC’s of Asia)
• Very high growth rates  from
developing to developed in a few
decades
• Average income in the NIC’s (for
example) have grown at an average
annual rate of over 5% since 1960

5
Growth disaster
• Sub-Saharan African (Chad, Ghana,
Mozambique) have been extremely poor
• very little growth in recent years
• Income is so low that most of the population
lives on the border of subsistence

• Other countries exhibit more complicated

growth patterns
• Since 1960-1978 real income/person in Africa only
3.2%. In three decades since then, average income
has not increased at all

6
LITERATURE
REVIEW
THE THEORY OF SOLOW MODEL
 ASSUMPTION
 Input - Output
• The Solow model focuses on four variables :
output (Y ), capital (K ), labor (L), and
“knowledge” or the “effectiveness of labor”
(A). At any time, the economy has some
amounts of capital, labor, and knowledge,
and these are combined to produce output.
The production function takes the form
Y(t) = F (K(t ), A(t ) L(t ))

8
 Assumptions Concerning the Production Function
• constant returns to scale (capital & effective labor)
• multiplying both arguments by any nonnegative constant c causes output
to change by the same factor :
• F (cK, cAL) = cF (K, AL) for all c ≥ 0 ………………….(1.2)
• If capital and labor double, the new inputs are used in essentially the
same way as the existing inputs, and so output doubles
• Another input (land, natural resources) are unimportant
• If c = 1/AL in equation (1.2) yields
• F (K/AL, 1) = 1/AL F(K, AL) ……………(1.3)

9
Here K/AL is the amount of capital per unit of effective
labor, and F (K, AL)/AL is Y/AL, output per unit of effective
labor. Define k = K/AL, y = Y/AL, and f (k) = F (k,1). Then we
can rewrite (1.3) as :
y = f (k) ………….(1.4)

10
THE PRODUCTION FUNCTION

Output per
worker, y
f(k)

MPK = f(k +1) – f(k)

1

Note: this production function

exhibits diminishing MPK.

Capital per
worker, k
11
 The National Income Identity
• Y=C+I (remember, no G )
• In “per worker” terms:
y=c+i
where c = C/L and i = I /L

 The Consumption Function

• s = the saving rate,
the fraction of income that is saved
(s is an exogenous parameter)
Note: s is the only lowercase variable that is not equal
to its uppercase version divided by L
• Consumption function: c = (1–s)y
(per worker) 12
 Saving & Investement
• saving (per worker) = y – c

= y – (1–s)y
= sy
• National income identity is y = c + i

Rearrange to get: i = y – c = sy

• Using the results above,

i = sy = sf(k)

13
 Output, Consumption, And Investment

Output per f(k)

worker, y

c1
y1 sf(k)

i1

k1 Capital per
worker, k
14
DEPRECIATION

Depreciation  = the rate of depreciation

per worker, k = the fraction of the capital stock
that wears out each period

k


1

Capital per
worker, k
15
 Capital Accumulation
The basic idea: Investment increases the capital stock, depreciation reduces it.

Change in capital stock= investment – depreciation

k = i – k
Since i = sf(k) , this becomes:
k = s f(k) – k

16
 Steady Steate
k = s f(k) – k
If investment is just enough to cover depreciation
[sf(k) = k ], then capital per worker will remain
constant:
k = 0.

This occurs at one value of k, denoted k*,

called the steady state capital stock

17
 Investment
and k
depreciation
sf(k)

k* Capital per
worker, k
18
Moving Toward The Steady State

Investment
and k
depreciation
sf(k)

k
investment

depreciation

k1 k* Capital per
worker, k
19
Moving Toward The Steady State

Investment
and k
depreciation
sf(k)

Summary:
As long as k < k*, investment will
exceed depreciation,
and k will continue to grow toward k*.

k3 k* Capital per
worker, k
20
An Increase In The Saving Rate
An increase in the saving rate raises investment… causing k to grow toward a new
steady state:

Investment
and k
depreciation s2 f(k)

s1 f(k)

k
k 1* k 2*
21
Prediction:
• Higher s  higher k*.
• And since y = f(k) , higher k*  higher y* .
• Thus, the Solow model predicts that
countries with higher rates of saving and
investment will have higher levels of
capital and income per worker in the
long run.

22
The Golden Rule
• Different values of s lead to different
steady states.
How do we know which is the “best”
steady state?

• The “best” steady state has the

highest possible consumption per
person: c* = (1–s) f(k*).

23
• An increase in s
• leads to higher k* and y*, which
raises c*
• reduces consumption’s share of
income (1–s), which lowers c*.
• So, how do we find the s and k* that
maximize c*?

24
The Golden Rule Capital Stock

k gold 
*
the Golden Rule level of capital, the steady state value
of k that maximizes consumption.

To find it, first express c* in terms of k*:

c* = y*  i*
in the steady
= f (k*)  i*
state:i* = k*
= f (k*)  k* because k = 0.

25
The Golden Rule Capital Stock

steady state
output and
depreciation k*

f(k*)
Then, graph f(k*) and
k*, look for the point
where the gap between
them is biggest. c gold
*

i gold
*
  k gold
*

y gold
*
 f (k gold
*
) k gold
*
steady-state
capital per
worker, k*
26
The Golden Rule Capital Stock

k*
c* = f(k*)  k*
is biggest where the slope f(k*)
of the production function
equals the slope of the
depreciation line:
c gold
*

k gold
*
steady-state
capital per
worker, k*
27
The Transition To The Golden Rule Steady State

 The economy does NOT have a tendency to move toward the

Golden Rule steady state
 Achieving the Golden Rule requires that policymakers adjust s
 This adjustment leads to a new steady state with higher
consumption
 But what happens to consumption during the transition to the
Golden Rule?

28
Starting With Too Much Capital

If k *  k gold
*

y
then increasing c*
requires a fall in s.
c
In the transition to the
Golden Rule, consumption i
is higher at all points in
time.
t0 time

29
Starting With Too Little Capital

If k *  k gold
*

y
then increasing c* requires an
c
increase in s.
Future generations enjoy higher
consumption, but the current
one experiences an initial drop i
in consumption.
t0 time

30
Population Growth

Assume that the population (and labor force)

grow at rate n. (n is exogenous.)

EX: Suppose L = 1,000 in year 1 and the

population is growing at 2% per year (n = 0.02).
Then L = nL = 0.021,000 = 20,
so L = 1,020 in year 2.

31
Break-even Investment

( + n)k = break-even investment,

the amount of investment necessary
to keep k constant.
Break-even investment includes:
 k to replace capital as it wears out
n k to equip new workers with capital
(Otherwise, k would fall as the existing capital stock would be
spread more thinly over a larger population of workers.)

32
The Equation Of Motion For k
With population growth,
the equation of motion for k is

k = s f(k)  ( + n) k

actual
break-even
investment
investment

33
The Impact Of Population Growth

Investment,
break-even (  + n2 )
k
investment ( +n1)
An increase in n k
causes an sf(k)
increase in break-
even investment,

leading to a lower
steady-state level
of k.

k 2* k1* Capital per

worker, k

34
Prediction:

Higher n  lower k*.

And since y = f(k) ,
lower k*  lower y*.
Thus, the Solow model predicts that countries with
higher population growth rates will have lower levels
of capital and income per worker in the long run.

35
The Golden Rule With Population Growth

To find the Golden Rule capital stock,

express c* in terms of k*:
c* = y*  i*
= f (k* )  ( + n) k*
In the Golden
c* is maximized when Rule steady state,
MPK =  + n the marginal product
of capital net of
or equivalently, depreciation equals
MPK   = n the population
growth rate.

36
Summary

1. The Solow growth model shows that, in the long run, a country’s standard of living
depends :
 positively on its saving rate
 negatively on its population growth rate
2. An increase in the saving rate leads to
 higher output in the long run
 faster growth temporarily
 but not faster steady state growth.

37
Summary

3. If the economy has more capital than the Golden Rule level, then reducing saving will
increase consumption at all points in time, making all generations better off. If the
economy has less capital than the Golden Rule level, then increasing saving will increase
consumption for future generations, but reduce consumption for the present
generation.

38
STRENGTHS AND WEAKNESSES OF THE SOLOW MODEL

• It focuses on investment and capital, while the

STRENGTHS much more important factor of TFP is still
unexplained.
• It provides a theory that determines • It does not explain why different countries have
how rich a country is in the long run. different investment and productivity rates.
• The principle of transition dynamics • The model does not provide a theory of
allows for an understanding of sustained long-run economic growth.
differences in growth rates across
WEAKNESSES
countries.

39
LITERATURE
REVIEW
JOURNAL REVIEW
 Aggregate Productivity and the Allocation of Resources Over the Business Cycle
J By: SophieOsotimehin
O Journal : Review of Economic Dynamics

U
R The Nexus Between Financial Integration and Real Economy: Solow Growth Model Concept
N By : Md. Saifur Rahmana,⁎, Farihana Shaharib
Journal : Research in International Business and Finance
A
L
Is China's e-governance sustainable? Testing Solow IT productivity paradox in China's context
By : Shiyi Chen ⁎, Zhen Xie

R Journal : Technological Forecasting & Social Change

E
V Processing trade, tariff reductions and firm productivity: evidence from chinese firms

I By : Miaojie Yu
Journal : The Economic Journal
E
W
Solow Residuals Without Capital Stocks
By : Michael C. Burda , Battista Severgnini
Journal : Journal of Development Economics
41
 The Solow model in the empirics of growth and trade
J By : Erich Gundlach

O Journal : Oxford Review of Economic Policy

U
R Endogenous Growth, Convexity Of Damage And Climate Risk: How Nordhaus’ Framework SupportsDeep Cuts In Carbon EmissionS
By : Simon Dietz and Nicholas Stern
N Journal : The Economic Journal

A
L Georgescu-Roegen Versus Solow/Stiglitz: Back to a controversy
By :Marc Germain
Journal: Ecological Economics
R
E Knowledge spillovers, innovation and growth
V By :Philippe Aghion and Xavier Jaravel
Journal: The Economic Journal
I
E
W
The sources of growth in a technologically Progressive economy: the united states, 1899–1941
By : Gerben Bakker, Nicholas Crafts and Pieter Woltjer
Journal : The Economic Journal

42
 Aggregate Productivity and the Allocation of Resources Over the
Business Cycle

By: SophieOsotimehin
Journal : Review of Economic Dynamics

This paper proposes a novel decomposition of aggregate productivity to evaluate

the role of allocative efficiency for the cyclical dynamics of aggregate
productivity. The decomposition, which is derived from the aggregation of
heterogeneous firm-level production functions, accounts for changes in allocative
efficiency, as well as for changes in entry and exit. This approach thereby extends
Solow’s (1957) growth accounting exercise to a framework with firm
heterogeneity and frictions in the allocation of resources across firms.

43
 Data Description

The dataset collected annually by the French tax administration and combined
with survey data in the INSEE unified system for business statistics (SUSE).

Estimation Method
Firm-level and sectoral TFP

44
 The General Framework
Consider an economy with Ssectors. In sector s, firm iproduces a differentiated
good using a Cobb–Douglas technology,

where Yit denotes firm’s i value added, Kit its capital, Lit its labor, and Ait its TFP in
period t. To simplify notations, sector subscripts sare omitted on firm-specific
variables.

45
 The Nexus Between Financial Integration and Real Economy:
Solow Growth Model Concept

By : Md. Saifur Rahmana, Farihana Shaharib

Journal : Research in International Business and Finance

This paper aims to investigate the nexus between financial integration and the
real economy in ASEAN +3 economies based on the concept of Solow-Growth
Model. The equity indices as a proxy for financial markets are collected from
each ASEAN + 3 members and are segmented between two periods; before
and after the financial cooperation agreement period. The finding presents
several outcomes;
1) No cointegration nexus is found in the system during the preagreement
periods;
2) The markets are found cointegrated during the post-agreement period,
3) Financial integration is found to influence the real sectors of ASEAN +3
economies. Finally, this study offers policy implications to improve
financial integration for stabilizing the real economy.
46
The theory of Solow-Growth Model can be applied in this regards.
According to this theory, capital accumulation improves the economic
growth and overall real economy. The intraregional capital allocation
and regional capital accumulation improve the regional investment and
productivity. The interesting concept of this theory has not been
explored empirically in the earlier study. Therefore, based on the
concept of Solow-Growth Model, this study explores the nexus
between financial integration and the real economy in ASEAN +3
economies.

47
 Data
The data series and source used in this study are provided in the following

48
 Estimated Models

The study employs Cointegration test proposed by Johansen and Juselius (1990) to
examine the financial integration. This method is more applicable in the case
where the variables involved in the model are not covariance stationary in the
level but they are stationary in the first differences. There are several steps that
must be performed in order to examine the existence of cointegration among the
indicators. First, test the order of the integration of each index in the model. In this
study, therefore, the stationarity of each series was tested using the Augmented
Dickey and Fuller (1979) (ADF) unit root test as the following :

49
 Is China's E-governance Sustainable? Testing Solow IT Productivity
Paradox In China's Context

By : Shiyi Chen ⁎, Zhen Xie

Journal : Technological Forecasting & Social Change

The role of technology in economic development and productivity change has

always been an important issue, and it is also a debated topic that whether the
ICT (information and communication technology) succeeded in promoting the
productivity or not, thus proposing a famous notion of “Solow paradox”.

The empirical results also show that the ICT has a negative impact on the
regional productivity in China, while for the east region, the negative impact
can be basically ignored, while the central and the west region are negatively
affected. This result may indicate that with a higher development level, the
current period negative impact of ICT on productivity will be lessened and
maybe converted to positive impact in the future.
50
Methodology

For recent studies in the measurement of productivity and efficiency,

the DEA (data envelopment analysis) method has been widely used,
this approach was first proposed by Farrell, and gained its popularity
after Charnes and Cooper's work (Charnes et al., 1978), This method
basically uses linear programming to form an efficient convex
production frontier, the classic DEA include CCR (Charnes et al., 1978)
and BCC (Banker et al., 1984) model.

51
Slacks-Based Measure (SBM) Model

52
Total Factor Productivity Growth Analysis

53
 Processing Trade, Tariff Reductions And Firm Productivity:
Evidence From Chinese Firms

By : Miaojie Yu
Journal : The Economic Journal
This article explores how reductions in tariffs on imported inputs and final
goods affect the of large Chinese trading firms, with the special tariff treatment
that processing firms on imported inputs. Firm-level input and output tariffs
are constructed. Both types of tariff reductions have positive impacts on
productivity that are weaker as firms’ share of processing imports grows. The
impact of input tariff reductions on productivity improvement, overall, is
weaker than that of output tariff reductions, although the opposite is true for
non-processing firms only. Both tariff reductions are found to contribute at
least 14.5% to economy-wide productivity growth
54
 Data

To investigate the impact of trade liberalisation on firm productivity, I rely on the

following three disaggregated, large panel data sets: tariff data, firm-level
production data and product-level trade data.

55
 Methodology

Three alternative approaches to measure firm TFP:

(i) labour productivity;
(ii) the Levinsohn–Petrin (2003) TFP; and
(iii) the Blundell and Bond (1998) system-GMM TFP.

Given that the system-GMM TFP has an additional advantage in controlling

for the role of lagged firm productivity to avoid possible serial correlation in
the TFP estimation (Fernandes, 2007), I use it as the main measure of firm
TFP

56
 Total Factor Productifity (TFC)

The augmented Olley and Pakes (1996) approach to construct measures of

Chinese firm-level TFP following Amiti and Konings (2007). Assuming a Cobb–
Douglas production function, the usual estimation equation is as follows:

refer to firm i’s output, materials, capital and labour in

industry j in year t, respectively.

57
 Solow Residuals Without Capital Stocks

By : Michael C. Burda , Battista Severgnini

Journal of Development Economics

We use synthetic data generated by a prototypical stochastic growth

model to assess the accuracy of the Solow residual (Solow, 1957) as a
measure of total factor productivity (TFP) growth when the capitalstock in
use is measured with error. We propose two alternative measurements
based on current investment expenditures: one eliminates the capital
stock by direct substitution, while the other employs generalized
differences of detrended data and the Malmquist index. In short samples,
these measures can exhibit consistently lower root mean squared errors
than the Solow–Törnqvist counterpart. Capital measurement problems
are particularly severe for economies still far from their steady state. This
drawback of the Solow residual is thus most acute in applications in which
its accuracy is most highly valued. As an application, we compute and
compare TFP growth measures for developing countries in the Heston–
Summers dataset. 58
 Methodology

The Solow residual and the capital measurement problem

The Solow residual after a half-century: a brief review

Solow (1957) considered a standard neoclassical production function Yt =

F(At, Kt, Nt) expressing output (Yt) in period t as a constant returns function
of a homogeneous physical capital stock (Kt), employment (Nt) and the level
of total factor productivity (At). He defined TFP growth as

the difference of the observable growth rate of output and a weighted

average of the growth of the two inputs, where αt and 1 − αt are local
output elasticities of capital and labor; a dot denotes the time derivative
(e.g.A˙ ¼ dA=dt).

59
 Methodology

The Solow residual after a half-century: a brief review

In practice, the Solow decomposition generally measures TFP growth (αt) in
discrete time as (Barro, 1999; Barro and Sala-i-Martin, 2003):

where Kt denotes capital at the beginning of period t.When factor markets are
competitive, output elasticities of capital and labor correspond to aggregate
factor income shares, which are constant in the case of the Cobb–Douglas
production function; for most technologies which allow for factor substitution
60
 The Solow Model In The Empirics Of Growth And Trade

By : Erich Gundlach
Journal : Oxford Review of Economic Policy

Translated to a cross-country context, the Solow model (Solow, 1956)

predicts that international differences in steady-state output per person
are due to international differences in technology for a constant capital–
output ratio. However, most of the empirical growth literature that refers
to the Solow model has employed a specification where steady-state
differences in output per person are due to international differences in the
capital–output ratio for a constant level of technology.

61
My empirical results show that the former specification can summarize the
data quite well by using a measure of institutional technology and treating
the capital–output ratio as part of the regression constant. This
reinterpretation of the cross-country Solow model provides an implication
for empirical studies of international trade. Harrod-neutral technology
differences, as presumed by the Solow model, can explain why countries
have different factor intensities and may end up in different cones of
specialization.

62
 Methodology

The Solow residual after a half-century: a brief review

In practice, the Solow decomposition generally measures TFP growth (αt) in
discrete time as (Barro, 1999; Barro and Sala-i-Martin, 2003):

where Kt denotes capital at the beginning of period t. When factor markets

are competitive, output elasticities of capital and labor correspond to
aggregate factor income shares, which are constant in the case of the Cobb–
Douglas production function; for most technologies which allow for factor
substitution
63
 Alternative empirical implementations

There is no question that there are different possibilities to derive empirical

specifications from the Solow model. A Cobb–Douglas production function
with Harrod-neutral technology is an obvious possibility to begin with.
Abstracting from all detail and focusing on the simplest case with just two
factors of production, we have

where Y is output, K is capital, A is technology, and L is labour. Since K is an

endogenous variable, this equation has to be rearranged to allow for an
unbiased estimate of the production elasticity.
64
Dividing by L with Y/L = y and K/L = k, taking logs, and rearranging terms so
as to have the capital–output ratio on the right-hand side gives

with ε as an error term. A standard textbook exercise based on the expression for the
steady-state capital intensity shows that the marginal product of capital (MPK) equals
MPK = α(n + g + δ)/sk, where n is the rate of labour-force growth, g is the rate of
technological change, δ is the depreciation rate, and sk is the share of saving in GDP.

65
 Alternative Empirical Implementations

Since the share of saving can be approximated by the share of investment in

GDP (I/GDP)) and α equals the marginal product of capital times the
capital–output ratio, it follows that equation
(2) can be rewritten as:

which is the specification employed by MRW to estimate the Solow

textbook model in a cross-country context.

66
 Endogenous Growth, Convexity Of Damage And Climate Risk: How
Nordhaus’ Framework Supports Deep Cuts In Carbon EmissionS

By : Simon Dietz and Nicholas Stern

Journal : The Economic Journal

To slow or not to slow’ (Nordhaus, 1991) was the first economic appraisal of
greenhouse gas emissions abatement and founded a large literature on a
topic of worldwide importance. We offer our assessment of the original
article and trace its legacy, in particular Nordhaus’s later series of ‘DICE’
models. From this work, many have drawn the conclusion that an efficient
global emissions abatement policy comprises modest and modestly
increasing controls.
67
We use DICE itself to provide an initial illustration that, if the analysis is
extended to take more strongly into account three essential elements of the
climate problem – the endogeneity of growth, the convexity of damage and
climate risk – optimal policy comprises strong controls.

68
 Endogenous Growth

In standard DICE, the production function is:

69
 A Model Of Capital Damage, And Knowledge Proportional To The
Capital Stock

Our first growth model incorporates knowledge spillovers via the capital stock in
the tradition of Arrow (1962), Romer (1986) and others. We combine this
formulation with a partitioning of the damage multiplier between output and
capital. The production function becomes

where DY now denotes the damage that directly reduce annual output

70
 Georgescu-Roegen Versus Solow/Stiglitz: Back to a Controversy

By :Marc Germain
Journal: Ecological Economics

Within the framework of an optimal growth model with a non

renewable resource, this paper seeks to answer the question of
whether a production function that ignores the constraints of physics
on the production process (such as the Cobb-Douglas) can generate a
good medium-term approximation of the trajectory of the economy
obtained with a “true” production function, which takes these
constraints into account.

71
Two functions that respect these constraints are considered: (i) the CES
function and (ii) a function called ATF, designed specifically for the
purposes of this paper and which has the property of being closer to the
Cobb-Douglas than is the CES.

The approximation generated by the Cobb-Douglas can be rough, at least

for some variables. When the “true” production function is the CES, this is
explained by two effects: (i) the difference in technologies and (ii) the fact
that the Cobb-Douglas totally changes the long-term path of the economy
compared to that induced by the CES. In the case of the ATF, only the
second effect acts.
72
If accuracy is a concern, then whatever the “true” function the obtained
results do not argue in favour of a positive answer to the above question.
The Cobb-Douglas is only acceptable when the constraints of physics act
weakly, which unfortunately is not always empirically verified (especially
in the case of energy). If accuracy is not the first concern, then the answer
seems positive, to the extent that the medium term paths generated by
the Cobb-Douglas and the “true” function have a similar shape and the
orders of magnitude are preserved.

73
 The CES and Cobb-Douglas Production Functions

In the context of this model, the CES production function is written:

α and ρ are two parameters verifying 0<α<1 and ρ ≥−1. ρ determines the elasticity
of substitution ν between capital and resource according to the relationship

74
75
 Knowledge Spillovers, Innovation And Growth

By :Philippe Aghion and Xavier Jaravel

Journal: The Economic Journal

Cohen and Levinthal (1989) introduced the notion of absorptive capacity

and demonstrated that knowledge spillovers can induce
complementarities in R&D efforts. We show that this idea has rich
implications when analysing important aspects of the growth process
such as cross-country convergence and divergence, the international co-
ordination of climate change policies, and the role of openness in the
production of ideas. We also show that the notion of absorptive capacity
sets an agenda for new empirical and theoretical analyses of the role of
R&D spillovers in innovation and growth.
76
77
78
The Sources Of Growth In A Technologically Progressive Economy:
The United States, 1899–1941

By : Gerben Bakker, Nicholas Crafts and Pieter Woltjer

Journal : The Economic Journal

We develop new aggregate total factor productivity (TFP) growth

estimates for the USA between 1899 and 1941, and sectoral
estimates at the most disaggregated level so far, 38 industries.We
include hard-to-measure services, and a refined measure of sectoral
labour quality growth.

79
The resulting data set supersedes Kendrick (1961), showing TFP growth lower
than previously thought, broadly based across industries, and strongly variant
intertemporally. The four ‘great inventions’ that Gordon (2016) highlighted
were important but less dominant in TFP growth than their predecessors in the
British industrial revolution. The findings also make it unlikely the 1930s had the
twentieth century’s highest TFP growth.

80
 Data and Methods

The definitive study on American productivity growth at the industry level

for the first half of the twentieth century is still Kendrick (1961). Kendrick’s
TFP growth concept (A) is based on real value-added growth (Y) minus the
factorshare weighted sum of capital (K) and labour input (L) growth rates:

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where hats indicate growth rates in natural logarithms and α is the capital
compensation share in value added. For the PDE and the five main
sectors, labour inputs are based on person-hours weighted by average
hourly earnings to capture labour quality increases that result from
workers’ movement between differently paid occupations and industries.
Within subsectors, however, labour quality is assumed to remain
unchanged. Kendrick reports TFP growth rates by sector and subsector but
does not provide nominal value-added estimates.

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