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Growth accounting

Growth accounting. Recall: Y t = A t K t a L t (1- a ) Take logs: log Y t = log A t + a log K t + (1- a ) log L t Also true for t-1: log Y t-1 = log A t-1 + a log K t-1 + (1- a ) log L t-1. Growth accounting. (log Y t - log Y t-1 ) = (log A t - log A t-1 )

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Growth accounting

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  1. Growth accounting Recall: Yt = At Kta Lt(1-a) Take logs: log Yt = log At + a log Kt + (1-a) log Lt Also true for t-1: log Yt-1 = log At-1 + a log Kt-1 + (1-a) log Lt-1

  2. Growth accounting (log Yt - log Yt-1) = (log At - log At-1) + a (log Kt -log Kt-1) + (1-a)(log Lt - log Lt-1) % Yt = % At + a% Kt + (1-a)% Lt Rearrange to get: % At = % Yt - a% Kt - (1-a)% Lt

  3. Growth accounting We have data on Y, K and L (1-a) = labour’s share of income = wL/Y  0.6 (on average) Thus a 0.4 A is the “Solow” residual

  4. Labour input • Labour input measured by total hours worked (L) • L = average workweek  employment

  5. * Business sector

  6. Main points: • Ireland’s TFP growth slowed between 1973-1995, but picked up post-1995 • Investment also picked up post-1995 • Especially impressive boom in employment • Probably even bigger contribution from labour input if labour quality adjusted.

  7. Labour demand • Competitive wages (w/A) • Foreign multinationals using Ireland as an export platform • EU internal market • Low corporation tax • Highly educated, English-speaking workforce • Flexible labour markets • IDA policy; agglomeration effects • Expanding services sectors • Boom in construction industry

  8. Labour supply • Natural demographic effects • Figures 1, 2 & 3 in Fitz Gerald (2004) • Low dependency ratio • Total fertility rate = 2! (EU average = 1.5) • Participation rates • Migration

  9. Labour supply National Competitiveness Council, Annual Competitiveness Report 2005 • http://www.forfas.ie/ncc/reports/ncc_annual_05/ch03/ch03_01.html Central Statistic Office • http://www.cso.ie

  10. Wedge accounting • Ahearne, Kydland, Wynne, (2005) “Ireland’s Great Depression” • Ireland experienced a great depression in the 1980s • Study the contribution of different wedges to the downturn and subsequent recovery

  11. Model economy • Computer model of the Irish economy • Explicitly model behaviour of agents • Households make choices about how much to consume/save and how much to work • Firms maximize profits • Agents are forward looking

  12. “Wedge” accounting • Basic idea: • Examine movements in wedges or distortions to account for cyclical episodes • Applications: • Accounting for the (US) Great Depression • Accounting for 1990-91 (US) recession

  13. Definitions • Efficiency wedge • Essentially TFP • Labor wedge • Distorts (intratemporal) labor-consumption decision • Investment wedge • Distorts (intertemporal) investment decision • Government consumption wedge

  14. Consumption A B Nonmarket activity Efficiency wedge

  15. Consumption A B Nonmarket activity Labor wedge

  16. Future Consumption A B Current Consumption Capital wedge

  17. Government consumption wedge • Unproductive government spending • Resource constraint Yt =Ct + It + Gt + Xt - Mt

  18. Results • Efficiency wedge by itself does a good job accounting for downturn and recovery, though predicts an earlier recovery • Labour wedge predicts an even more severe downturn, but no recovery • Investment and government wedges cannot account for downturn and recovery

  19. Convergence or Regional Boom? • Barry (2002) • Rapid growth in 1990s was a regional boom • Region  very open labour markets • If good shock hits region  boom • Ireland’s case: FDI • Bad shocks can lead to a reversal!

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