WORKING PAPERS. Global Trends of Multi-Factor Productivity. Jeong Yeon Lee. Economics Series. No. 136, March 2014

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1 WORKING PAPERS E A S T- W E S T C E N T E R WOR K I N G PAP E R S Economics Series No. 136, March 2014 Global Trends of Multi-Factor Productivity Jeong Yeon Lee

2 E A S T- W E S T C E N T E R WOR K I N G PAP E R S Economics Series No. 136, March 2014 Global Trends of Multi-Factor Productivity Jeong Yeon Lee East-West Center Working Papers is an unreviewed and unedited prepublication series reporting on research in progress. The views expressed are those of the author and not necessarily those of the Center. East-West Center Working Papers are circulated for comment and to inform interested colleagues about work in progress at the Center. Dr. Jeong Yeon Lee is a professor of international economics in the Graduate School of International Studies at Yonsei University, Seoul, Korea. Prior to joining the faculty of Yonsei University in 2004, he worked extensively in international organizations and policy institutions, including the World Bank, the Asian Development Bank, and the Korea Institute for International Economic Policy. He has a Ph.D. from the University of Pennsylvania. Working Papers are available online for free at EastWestCenter.org/ewcworkingpapers. To order print copies ($3.00 each plus shipping and handling), contact the Center s Publication Sales Office. The East-West Center promotes better relations and understanding among the people and nations of the United States, Asia, and the Pacific through cooperative study, research, and dialogue. Established by the US Congress in 1960, the Center serves as a resource for information and analysis on critical issues of common concern, bringing people together to exchange views, build expertise, and develop policy options. The Center s 21-acre Honolulu campus, adjacent to the University of Hawai i at Mānoa, is located midway between Asia and the US mainland and features research, residential, and international conference facilities. The Center s Washington, DC, office focuses on preparing the United States for an era of growing Asia Pacific prominence. The Center is an independent, public, nonprofit organization with funding from the US government, and additional support provided by private agencies, individuals, foundations, corporations, and governments in the region. EastWestCenter.org/publications Publication Sales Office East-West Center 1601 East-West Road Honolulu, Hawai i Tel: Fax: EWCBooks@EastWestCenter.org

3 Global Trends of Multi-factor Productivity Jeong Yeon Lee, Abstract Multi-factor productivity (MFP) compares the growth of gross domestic product with the growth of combined capital and labor inputs. The growth rate of MFP assumes theoretical significance because it represents the slope of the steady-state growth path, and hence is a major determinant of the long-term growth trend. This paper offers the balanced panel of the estimated growth rates of MFP for 24 OECD countries over Based on the estimates of MFP growth, a number of notable trends in productivity growth are identified for the entire OECD area as well as three major economies the United States, the Eurozone and Japan within the OECD. Keywords: Economic Growth; Multi-factor Productivity; OECD JEL Classification Codes: O31; O40 Graduate School of International Studies, Yonsei University, 50 Yonsei-ro, Seodaemun-gu, Seoul , Korea. Tel: Fax: address: leejy@yonsei.ac.kr 1

4 1. Introduction The Organization for Economic Co-operation and Development (OECD) has published time series of productivity measures constructed at the level of entire economies since Among the available measures, multi-factor productivity (MFP) compares the growth of gross domestic product (GDP) with the growth of combined capital and labor inputs. As a result, MFP growth represents an improvement in the level of economy-wide efficiency with which capital and labor inputs are used in production. Viewed in this way, the growth rate of MFP is the slope of the steady-state growth path, and hence a major determinant of the longterm growth trend. Therefore, the key role of MFP in long-term economic growth is conceptually clear, but its empirical verification gets somewhat complicated due to the fact that MFP is not something directly observable and thus its growth has to be estimated in an indirect manner. The indirect estimation inevitably involves restrictive assumptions, and the OECD estimates of MFP growth are not free from such limitations as well. However, these estimates hold clear advantages over most other MFP measures for the purpose of international comparisons because a common set of assumptions are behind OECD estimates for all member countries. At least within the OECD area, therefore, the OECD estimates present a sensible indication of relative productivity among member countries. Accordingly, the OECD Productivity database provides MFP measures valuable for international comparisons, but the measures are not available for all member countries and for all years. In this paper I try to fill this gap by constructing a balanced panel of MFP estimates for 24 OECD member countries. The estimates of MFP growth in this panel are 2

5 based on input and output data from various databases of the OECD, and the panel covers the period The next section briefly reviews how the growth rate of MFP determines the slope of the steady-state growth path and serves as the main determinant of long-term economic growth. Section 3 describes data used in estimation, followed by the report of the balanced panel of MFP estimates. Based on these estimates, Section 4 highlights some notable productivity trends in the OECD area. Section 5 concludes. 2. Multi-factor Productivity and Economic Growth This section illustrates the role of MFP in economic growth using a standard neoclassical framework with a constant, exogenous saving rate that traces back to Solow (1956) and Swan (1956). 1 The aggregate production function is assumed to be described by the Cobb-Douglas function, Y t = A t K t L t 1- (1) where Y is aggregate output, K is aggregate capital, and L is total employment. A>0 is the level of MFP and α is a constant with 0<α<1. A number of assumptions are made for simplicity. First, the economy is closed and there are no government expenditures on goods and services. Hence, aggregate output is either consumed or invested in this economy. Investment is used to create new units of capital which depreciates at the constant rate δ>0. In addition, a constant fraction of aggregate 1 The framework used in this section directly comes from Lee (2009). For a more detailed exposition of the framework, see Barro and Sala-i-Martin (2004). 3

6 output is saved at the rate of s (0 s 1). Given that the amount saved equals the amount invested in a closed economy, the investment rate is also s in this economy. Finally, total employment grows at a constant, exogenous rate of n 0. Eq. (1) can be rewritten in intensive form as y t = A t k t (2) where y Y/L and k K/L The steady state value of k for the given level of MFP, A, is denoted as k, and satisfies the condition sa k = (n+δ) k (3) If k is below k, k is expected to increase over time until it reaches k. The growth rate of k at t along the transition is characterized by k t/k t = sa k t -(1- ) - (n+ δ) (4) It is worth to note that the growth rate of k falls as k increases and it approaches 0 as k approaches k. Using Eq. (3), the growth rate of k at t along the transition can also be expressed as k t/k t = (n+ δ) [( k t ) 1 1] (5) k Subsequently, the economy s growth rate of capital per worker at t depends on the distance between the t period level of capital per worker, k t, and its steady-state level, k. From Eq. (3), k in turn depends crucially on the level of MFP, A. An improvement in MFP 4

7 will raise the steady-state level of capital per worker when the economy s saving rate, depreciation rate, and employment growth rate remain constant. Hence, any changes in MFP are expected to have immediate effects on the growth rate of capital per worker. Figure 1 illustrates the relationship between the economy s MFP and capital growth. Starting from capital per worker in period 0, k 0, with the level of MFP, A 0, the economy s growth rate of capital per worker is measured by ac with the steady-state level of capital per worker, k 0. This positive growth in capital per worker will result in a higher level of capital per worker in a future period 1, say k 1. If the economy s MFP remains the same, then the growth rate of capital per worker in period 1 will be measured by ab with the steady-state level of capital per worker continuing to be k 0. The new growth rate, ab, is lower than period 0 s ac due to diminishing returns to capital. However, if there is an improvement in MFP from period 0 to period 1, the steady-state level of capital per worker will jump to a new level, k 1, under the new level of MFP, A 1. It should be noted that period 1 s growth rate of capital per worker, measured by (ab + bd), can be higher than period 0 s growth rate, ac, with an improvement in MFP even when k 1 is larger than k 0. [Insert Figure 1 Here] In Figure 1, the steady-state level of capital per worker increases from k 0 to k 1 as the level of MFP grows from A 0 to A 1. Subsequently, it is clear that the growth rate of MFP determines the slope of the steady-state growth path. Furthermore, Figure 1 illustrates how a country may resist the gravity of diminishing returns to capital and achieve an accelerating pace of economic growth. MFP growth would shift the country s steady-state position further away and may expand the distance between the current and steady-state levels of capital per 5

8 worker, thereby inducing faster growth even at a higher level of capital per worker. Therefore, MFP growth has not only long run implications for economic growth by altering the long run or steady-state level of capital per worker, but it also has immediate effects on the current pace of economic growth. 3. Multi-factor Productivity: Data and Estimation A sample of 24 countries is chosen from OECD member countries. They include: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Israel, Italy, Japan, Republic of Korea, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, the United Kingdom (UK), and the United States (US). Germany represents unified Germany from 1991 and the whole of Germany before For the years up to 1990, the OECD estimates data for the whole of Germany based on data for West Germany. For each country, multi-factor productivity A is defined as A = Y / [K L (1 ) ] (8) where Y is constant price gross domestic product, K is productive capital stock measured in volume, and L is total hours worked. The coefficient (1 - ) is the share of labor income. Y is GDP adjusted in 2005 prices from the OECD Annual National Accounts database. 2 The variable is converted to an index with 2005 = 1, and reported in Table 1 for 24 sample countries over [Insert Table 1 Here] 2 Data was extracted on Jan 17,

9 In the absence of directly observable flows of capital services, the flow of capital services is widely assumed to be proportional to the productive stock at the end of the previous period. 3 The productive capital stock for each type of asset is constructed using the perpetual inventory method. The construction begins with a time series of investment expenditure, and this investment expenditure series is deflated using producer price indices of investment goods to obtain constant-quality volume measures of vintage investment. Retirement patterns and age-efficiency patterns are also defined to account for, respectively, discarded assets and the loss of productive capacity of aging capital goods. The resulting productive capital stocks of different types of asset are weighted by their relative productivity in production to estimate a country s overall productive capital stock. 4 K is the overall productive capital stock from the OECD Economic Outlook database. 5 The OECD Economic Outlook database has gaps in data for the productive capital stock of Germany ( ), Greece ( ), and Ireland ( ) over the study period of Subsequently, those missing observations were filled in by assuming the perpetual inventory model with a constant scrapping rate. To determine the constant scrapping rate for each of the three countries, annual scrapping rates were estimated using constant price non-residential fixed capital formation for the years in which data on productive capital stock are available, and then each country s first five-year average was calculated. The resulting scrapping rate was respectively (Germany), (Greece), and (Ireland). Table 2 converts the productive capital stocks of 24 countries to indices with 2005 = 1. 3 For example, see Schreyer (2003), p For a more formal presentation of the construction, see OECD (2001), Annex 4. 5 Data was extracted from OECD Economic Outlook No. 92 on May 20, The OECD also provides other types of internationally comparable capital stock data. Schreyer, et al. (2011) discusses the issues associated with different types of capital stock data available at the OECD. 7

10 [Insert Table 2 Here] L is total hours actually worked from the OECD Productivity database. The measure covers total employment comprising wage and salary earners as well as the self-employed (including contributing family members), and it is corrected for paid holidays, sick leave and annual leave. 6 During , there are missing values of L for Austria ( ) and Portugal (1985) that were filled in using the estimated growth rate of L. To estimate the growth rate of total hours worked (L), it was assumed to be the sum of the growth rates of total employment measured by the number of persons (TE) and average hours worked per person (AH). While the OECD Productivity database provides data on TE for all years during , data on AH at the level of the total economy is not available from the OECD for Austria ( ) and Portugal (1985). In estimation, therefore, the growth rates of AH for manufacturing wage earners in Austria and AH for total employees in Portugal were used instead. These data on AH were from ILO (International Labour Office) LABORSTA Internet. Table 3 presents the values of L that have been converted to indices with 2005 = 1. [Insert Table 3 Here] Based on Eq. (8), the multi-factor productivity index with 2005 = 1 was calculated using the values of Y, K and L reported in Tables 1 through 3. The coefficient (1 - ) is the average share of labor income from (Table 4). 7 The calculated MFP indices are reported in Table 5. Finally, Table 6 presents the balanced panel of the growth rates of MFP for 24 OECD countries over See OECD (2001), Chapter 4 for details. OECD (2003) provides a summary of various issues associated with the measurement of total hours worked. 7 Data on the share of labor income was extracted from OECD.Stat (Unit labour Costs Annual Indicators) on May 24,

11 [Insert Table 4 Here] [Insert Table 5 Here] [Insert Table 6 Here] 4. Productivity Growth Trends in OECD Based on the estimates of MFP growth rates presented in the previous section, this section outlines some notable productivity growth trends in the OECD area over the past 25 years. We start with dividing our study period into five sub-periods, each halfdecade-long, and calculating the average growth rates of MFP for each sub-period. The results, reported in Table 7, clearly show erratic variation in the pace of OECD-wide productivity growth over time. For example, OECD countries as a whole were found to achieve the highest pace of MFP growth in the second half of the 1990s, but this strong productivity growth sharply decelerated cut by more than 40 percent in the subsequent sub-period. In fact, productivity slowdown was extensive all over the OECD area during ; Iceland, Israel, Japan and Sweden were the only countries in our sample of 24 countries that didn t experience a slowdown in MFP growth in this sub-period. [Insert Table 7 Here] The pace of OECD productivity growth that had already become visibly sluggish during was found to slow even further down in the following sub-period. The average growth rate in fact came to be negative representing productivity deterioration in many countries during It is very likely that this sharp slowdown was at least partly due to cyclical effects since the period includes the worldwide great recession following the 9

12 global financial crisis of Against this backdrop, it is worth to take note of the productivity trend in Korea because the country managed to accelerate the average growth rate of MFP during in contrast with most other OECD countries, thereby keeping up its productivity growth at a much higher level vis-à-vis other OECD countries. The productivity growth trend for three major economies the United States, the Eurozone, and Japan is presented in Figure 2. The Eurozone includes: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Portugal, and Spain. The growth rate of MFP in the Eurozone is constructed using a real GDP weighted average of MFP growth rates in 11 member countries. The trend for the Eurozone is shown for our entire study period of even though the euro was officially introduced only in [Insert Figure 2 Here] Figure 2 indicates that productivity growth in the United States was relatively weak, often trailing behind that of the Eurozone and Japan, until it accelerated to a much higher pace during the second half of the 1990s that also coincided with the period of exploding Information and Communication Technology (ICT) investment. As this investment boom collapsed in 2000, MFP growth in the United States somewhat slowed down compared with the robust growth in the previous boom period. Nonetheless, U.S. productivity growth remained to be relatively strong and consistently outpace productivity growth in the Eurozone and Japan at least until Turning to the Eurozone, it is clear from Figure 2 that the common currency area has been generally lagging behind the United States as well as Japan in promoting productivity growth since its start in Prior to the official launching of the Eurozone, however, its 10

13 current member countries as a whole managed to consistently reap a relatively high pace of MFP growth, surpassing the U.S. rate of MFP growth in most years throughout the late 1980s and the 1990s. It should be noted that Eurozone countries carried out structural reform to meet the euro convergence criteria in the areas of budget deficit, public debt, inflation and interest rates. Those reform measures were likely to help potential member countries to improve their multi-factor productivity during their preparation to join the Eurozone. Finally, Figure 2 illustrates that Japan followed a much more erratic path of productivity growth than the United States and the Eurozone. After showing particularly strong growth in the second half of the 1980s, Japan s MFP growth began to sharply slow down as the country suffered the bursting of the asset bubble and subsequently entered the so-called lost decade. Throughout the 1990s, Japan s MFP growth was found to be close to virtual stagnation on average, and consistently behind productivity growth in the U.S. and the Eurozone. However, there was a brief recovery of productivity growth in the country over the period with Japan s MFP growth rate consistently higher than that of the Eurozone during the time. Following the global financial crisis of , a sharp downturn followed by a sharp rebound in productivity growth was common for all three major economies as shown in Figure 2, but Japan s path exhibited far greater variation than the paths taken by the other two economies. 5. Concluding Remarks This paper offers the balanced panel of the estimates of annual MFP growth rates for 24 OECD countries over These estimates are expected to supplement the OECD estimates of MFP growth that are available in the OECD Productivity database but often have 11

14 missing observations. For the purpose of international comparisons, the estimates presented in this paper hold clear advantages over most other estimates involving a single country or a small number of countries. Since a common set of assumptions are behind the estimates for all 24 countries, the growth rates of MFP estimated in this study provide a sensible indication of relative productivity among the 24 countries considered. Based on the estimates of MFP growth, a number of notable trends in productivity growth have been identified for the entire OECD area as well as three major economies the United States, the Eurozone and Japan within the area. These trends are also shown to be accompanied by some meaningful economic developments. Their examples include the rise and collapse of the ICT investment boom, the launching of the Eurozone, and the great recession following the global financial crisis of The formal analysis of a link between these developments and productivity growth can be a topic for further study. 12

15 References Barro, R. J. and Sala-i-Martin, X. (2004), Economic Growth (Cambridge, MA: MIT Press). Lee, J. Y. (2009), Korean economy : A growth theory perspective, Journal of International and Area Studies, 16:1, pp OECD (2001), Measuring Productivity: OECD Manual, Paris. OECD (2003), Measuring hours worked in OECD countries, Note by the Secretariat, DSTI/EAS/IND/SWP(2003)10, November 3, Paris. Schreyer, P. (2003), Capital stocks, capital services and multi-factor productivity measures, OECD Economic Studies, 37, 2003/2, pp Schreyer, P., Dupont, J., Koh, S.-H. and Webb, C. (2011), Capital stock data at the OECD Status and outlook, June, OECD. Solow, R A contribution to the theory of economic growth. Quarterly Journal of Economics, 70, February, pp Swan, T Economic growth and capital accumulation. Economic Record, 32, November, pp

16 Table 1. Gross Domestic Product (in 2005 prices, 2005 = 1) AUS AUT BEL CAN DEN FIN FRA DEU GRE ISL IRL ISR ITA JPN KOR NLD NZL NOR PRT ESP SWE CHE GBR USA Note: AUS, Australia; AUT, Austria; BEL, Belgium; CAN, Canada; DEN, Denmark; FIN, Finland; FRA, France; DEU, Germany; GRE, Greece; ISL, Iceland; IRL, Ireland; ISR, Israel; ITA, Italy; JPN, Japan; KOR, Korea; NLD, Netherlands; NZL, New Zealand, NOR, Norway; PRT, Portugal; ESP, Spain; SWE, Sweden; CHE, Switzerland; GBR, United Kingdom; USA, United States. 14

17 Table 2. Productive Capital Stock (in volume, 2005 = 1) AUS AUT BEL CAN DEN FIN FRA DEU GRE ISL IRL ISR ITA JPN KOR NLD NZL NOR PRT ESP SWE CHE GBR USA Note: AUS, Australia; AUT, Austria; BEL, Belgium; CAN, Canada; DEN, Denmark; FIN, Finland; FRA, France; DEU, Germany; GRE, Greece; ISL, Iceland; IRL, Ireland; ISR, Israel; ITA, Italy; JPN, Japan; KOR, Korea; NLD, Netherlands; NZL, New Zealand, NOR, Norway; PRT, Portugal; ESP, Spain; SWE, Sweden; CHE, Switzerland; GBR, United Kingdom; USA, United States. 15

18 Table 3. Total Hours Actually Worked (in annual hours, 2005 = 1) AUS AUT BEL CAN DEN FIN FRA DEU GRE ISL IRL ISR ITA JPN KOR NLD NZL NOR PRT ESP SWE CHE GBR USA Note: AUS, Australia; AUT, Austria; BEL, Belgium; CAN, Canada; DEN, Denmark; FIN, Finland; FRA, France; DEU, Germany; GRE, Greece; ISL, Iceland; IRL, Ireland; ISR, Israel; ITA, Italy; JPN, Japan; KOR, Korea; NLD, Netherlands; NZL, New Zealand, NOR, Norway; PRT, Portugal; ESP, Spain; SWE, Sweden; CHE, Switzerland; GBR, United Kingdom; USA, United States. 16

19 Table 4. Average Share of Labor Income ( ) AUS AUT BEL CAN DEN FIN FRA DEU GRE ISL IRL ISR ITA JPN KOR NLD NZL NOR PRT ESP SWE CHE GBR USA Note: AUS, Australia; AUT, Austria; BEL, Belgium; CAN, Canada; DEN, Denmark; FIN, Finland; FRA, France; DEU, Germany; GRE, Greece; ISL, Iceland; IRL, Ireland; ISR, Israel; ITA, Italy; JPN, Japan; KOR, Korea; NLD, Netherlands; NZL, New Zealand, NOR, Norway; PRT, Portugal; ESP, Spain; SWE, Sweden; CHE, Switzerland; GBR, United Kingdom; USA, United States. 17

20 Table 5. Multi-factor Productivity (2005 = 1) AUS AUT BEL CAN DEN FIN FRA DEU GRE ISL IRL ISR ITA JPN KOR NLD NZL NOR PRT ESP SWE CHE GBR USA Note: AUS, Australia; AUT, Austria; BEL, Belgium; CAN, Canada; DEN, Denmark; FIN, Finland; FRA, France; DEU, Germany; GRE, Greece; ISL, Iceland; IRL, Ireland; ISR, Israel; ITA, Italy; JPN, Japan; KOR, Korea; NLD, Netherlands; NZL, New Zealand, NOR, Norway; PRT, Portugal; ESP, Spain; SWE, Sweden; CHE, Switzerland; GBR, United Kingdom; USA, United States. 18

21 Table 6. Growth Rate of Multi-factor Productivity (in percent) AUS AUT BEL CAN DEN FIN FRA DEU GRE ISL IRL ISR ITA JPN KOR NLD NZL NOR PRT ESP SWE CHE GBR USA Note: AUS, Australia; AUT, Austria; BEL, Belgium; CAN, Canada; DEN, Denmark; FIN, Finland; FRA, France; DEU, Germany; GRE, Greece; ISL, Iceland; IRL, Ireland; ISR, Israel; ITA, Italy; JPN, Japan; KOR, Korea; NLD, Netherlands; NZL, New Zealand, NOR, Norway; PRT, Portugal; ESP, Spain; SWE, Sweden; CHE, Switzerland; GBR, United Kingdom; USA, United States. 19

22 Table 7. Growth Rate of Multi-factor Productivity: Sub-period Average (in percent) Australia Austria Belgium Canada Denmark Finland France Germany Greece Iceland Ireland Israel Italy Japan Korea Netherlands New Zealand Norway Portugal Spain Sweden Switzerland United Kingdom United States Average

23 Source: Lee (2009), Figure 1 21

24 Figure US Japan Euro* * Real GDP weighted average of MFP growth rates of Eurozone countries. 22