What Is Growth Accounting?
Growth accounting is a quantitative tool used to breakdown how specific factors contribute to economic growth. It was introduced in 1957 by Robert Solow. Growth accounting focuses on three primary factors, which include: the labor market, capital, and technology.
Understanding Growth Accounting
The concept of growth accounting was introduced by Robert Solow in 1957. Solow was an American economist and a Professor Emeritus at the Massachusetts Institute of Technology. His concept has also been referred to as the Solow residual.
Solow provided economists with a tool for quantitatively breaking down gross domestic product (GDP), the primary economic growth statistic. With the growth accounting model, Solow brought technological advancement onto the stage as a GDP contributor. Prior to 1957, economists had mainly focused on the impacts of labor and capital investments.
- Growth accounting breaks down the contribution of factors to total GDP growth.
- Growth accounting was introduced by Robert Solow in 1957.
- The growth accounting equation primarily looks at three factors: labor, capital, and technology.
The Growth Accounting Equation
The growth accounting equation is a weighted average of the growth rates of the factors involved. Solow’s economic growth accounting model looks at three factors: labor market growth, capital investment, and technology. Capital investment is often the key component obtained from statistical data releases. Solow also introduced technological progress as a third factor to explain the residual gap.
To calculate the growth accounting equation, economists must obtain the key data points as outlined below:
- GDP: annual growth and annual GDP
- Labor: annual growth and annual contribution
- Capital: annual growth and annual contribution
The growth accounting equation is as follows:
GDP Growth = Capital Growth*(Weight of Capital Contribution) + Labor Growth*(Weight of Labor Contribution) + Technological Progress
Labor growth accounts for the remainder of inputs after capital or vice versa depending on the data used. Technological progress is the residual growth. Without technological progress, the equation wouldn’t balance. With technological progress, the equation shows how technology is influencing production.
Growth Accounting Factors
While the growth accounting equation can seem somewhat simple, identifying the data factors and calculating it can be tedious. The Conference Board (CB) can help, providing an annual breakdown of economic growth accounting by region.
Below is a look at the growth accounting factors along with one-year data results for 2018.
GDP: Annual GDP is reported by the Bureau of Economic Analysis. In 2018, GDP was $20,500.6 billion. In 2018, the GDP growth rate was 2.90%.
Capital: Adding capital to the economy should, among other things, increase productivity. Capital investment is of key importance to the growth accounting equation because it can easily be obtained from the Bureau of Economic Analysis’ GDP reporting. In 2018, capital investment was $3,652.2 billion for a capital contribution of 17.82%. Capital investment grew from $3,246.0 billion in 2017 for a growth rate of 13%.
Labor: Labor looks at the number of people employed to identify a growth rate. Typically, more workers will generate more economic goods and services.
In 2018, the U.S. labor market of full-time workers grew from 125.97 million to 128.57 million or 2.06%. Its weight is identified by subtracting the capital weight, considering that capital and labor are the only two factors. In 2018, labor would have had a weight of 82.18%.
Technology: In the growth accounting equation, technology is a third residual factor. Cutting edge technology can bring many benefits, including facilitating greater output with the same stock of capital goods.
Using 2018 as an example, Solow’s growth accounting model can be calculated as:
2.90% = 13%*(17.82%) + 2.06%*(82.18%) + Technological Progress
The technology factor turns out to be -1.11% in 2018.
The Conference Board uses a two-year average with some slightly different data pulls.
Growth accounting is generally used by economists as one way to break down the percentage of a country’s economic growth coming from key factors. Solow’s economic growth accounting model looks at three key factors which provide a simplified view.
The Bureau of Economic Analysis also provides contribution values using a similar methodology to Solow in its regular GDP reports but with more factors. In 2018, the BEA showed the following contributions to GDP growth: