Gross domestic product ; Economic development ; France ; Great Britain ; Germany ; Japan ; Labor supply ; Capital ; Productivity

Brian Motley

English

Research Papers in Economics

FRBSF WEEKLY LETTER
Number 93-05, February 5, 1993
The Sources of the Growth Slowdown
Since the mid-1970s, the growth rate of the U.S.
economy has slowed. Between 1962 and 1974,
real GDP increased at an average annual rate of
3.7 percent, whereas in the following ten years
growth averaged only 2.6 percent. Since 1985
annual growth has slowed further to an average
of only 2 percent, although this partly reflects the
effects of the recent recession.
It is often suggested that this slowing in growth
may be traced to the decline in the private saving
rate since the mid-1970s. Indeed, proposals to
alter the tax system to stimulate private saving
often are justified on the ground that this would
enhance future economic growth. Although the
decline in private saving has been partially offset
by an inflow of foreign saving, ithas also been
coupled with the emergence of a!arge federal
deficit. Together these developments may have
reduced the pace of capital accumulation by
decreasing the supply of investment funds.
Neoclassical economic growth theory (Solow·
1956) argues that the supply of saving in an
economy is a key determinant of the equilibrium
stock of capital and hence influences the pro-
ductivity of its labor force. A permanent decline
in the supply of saving means that the economy
must adjust toward a lower stock of capital per
worker and thus to lower output per worker. Dur-
ing the transition to this new equilibrium, which
may last several decades, output growth will slow.
Although the growth rate will pick up again once
the adjustment is complete, the levels oflabor pro-
ductivity and hence output will be permanently
lower than they would otherwise have been.
Some economists-the proponents of so-called
"endogenous growth theory"-suggest that the
effects of a decrease in the supply of savings may
result not only in temporary slow growth, but
also in a permanent slowdown. These econo-
mists argue that the level of investment affects
the pace of technological progress and the accu-
mulation of knowledge, so that a lower level of
saving and investment slows the rate of technical
change. Hence decreased saving not only re-
duces the quantity of capital that workers have to
work with, but also causes its quality to increase
less rapidly.
An explanation of the growth slowdown along
these lines would carry more weight ifthe accu-
mulation of tangible capital were quantitatively
the principal source of growth in the economy.
However, the explanation would be less convinc-
ing if most growth were due, for example, to ex-
ogenous increases in the quantity or quality of
the labor force.
In this Weekly Letter, I examine the broad
sources of long-run growth between 1962 and
1985 in five industrial countries: the U.s., France,
Germany, Japan, and the United Kingdom. (Inter-
nationally comparable data on stocks of capital
are not available for more recent years; data for
Japan refer only to 1965-1985.) Three facts stand
out. First, GDP growth slowed in all five coun-
tries after the mid-1970s. Second, the relative
contribution of capital accumulation to growth
was smaller and that of labor force growth was
significantly greater in the U.s. than in the other
countries. Third, the contribution of capital ac-
cumulation to growth was less in all countries
after 1975 than before. But the reduced contri-
bution of capital growth has been relatively less
significant in the u.s. than in other countries.
Thus, while it does not appear to be true that
much of the slowdown in U.S. growth has been
associated with a slower pace of capital accu-
mulation, the U.S.is by no means unique among
advanced countries.
Measuring the sources of economic growth
Broadly speaking, increases in an economy's out-
put may be attributed either to growth in the avail-
able supply of factors of production in the form
of labor and capital or to improvements in the ef-
fectiveness with which these resources are used.
The contribution of each factor of production to
the increase in GDP may be measured by its
growth multiplied by its marginal product. If, for
example, the marginal product of a machine is
$15 per hour and that of a worker is $5 per hour,
then employing two more machines with four
more workers for an hour will raise GDP by $50,FRBSF
of which $30 may be attributed to the two added
machines and $20 to the four added workers.
Data are available on the supplies of labor and
capital in most advanced countries, bl,.1t measur-
ing their marginal products is difficult. The usual
approach is to assume that the economy is com-
petitive and exhibits constant returns to scale,
which implies that factors of production are paid
incomes that depend on their marginal products.
With these assumptions, we can use data on
wage and nonwage incomes to estimate the mar-
ginal products of labor and capital, and therefore
measure each factor's contribution to the econ-
omy's growth rate by multiplying its growth rate
by the share of the total national income that
accrues to it. In most countries, the shares of
national income received by labor and capital
have been relatively stable over time.
Sources of Economic Growth
in Industrial Countries
JA
8.64
1962-1974 1975-1985
• - Labor I - Capital I - Productivity
Percent
10
8
6
4
2
o
-2
The combined contributions of labor and capital
do not account for all of measured GOP growth.
The remainder represents the contribution of ad-
vances in technology and education that add to
the productivity ofeither labor or capital. This
contribution is described either as "multifactor
productivity" or, less formally, as the "Solow re-
sidual:' after Robert Solow who developed this
technique (Solow 1957). In the data shown in the
chart discussed below, the effects of changes
in average hours of work are included in multi-
factor productivity, but these are relatively small.
However, because it is calculated as a residual,
multifactor productivity also includes errors of
measurement both in the stocks of labor and
capital and their marginal products (the inputs
to production) and in GOP (the output).
Why has growth slowed?
The chart compares the average growth rates of
real GOP in the five countries in 1962-1974 and
1975-1985. Growth slowed in all five countries,
suggesting that the u.s. slowdown was not due to
factors unique to the U.S. Indeed, the slowing was
relatively less severe in the u.s. with average
annual growth decreasing from 3.74 to 2.63 per-
cent. As a result, there was some convergence
between national growth rates, and the u.S.
ranking improved from fourth to second among
the five countries. Only Japan experienced
stronger average growth between 1975 and 1985.
The chart also shows the sources of growth
between 1962 and 1985. These measures were
constructed from data on national product, em-
ployment, and the capital stock (OECO 1983,
1987). In all countries except the U.S., growth in
the supply of labor made only a negligible con-
tribution to economic growth. Indeed, in the
three European countries, the labor supply actu-
ally made a negative contribution between 1975
and 1985. In the U.S., bycontrast, about one-
third of the growth in output was attributable to
increases in the supply of labor. Moreover, the
contribution of labor to economic growth was
about the same in the earlier and later periods.
Employment growth contributed 1.2 percentage
points to GOP growth between 1962 and 1974 and
1.1 percentage points between 1975 and 1985.
Thus, the slowdown in GOP growth in the later
period was not due to slower growth in the con-
tribution of labor.
Growth in the stock of capital played a larger
role in economic growth abroad than in the U.S.
In Japan, for example, real GOP growth averaged
6.6 percent annually over the whole period, and
growth in the stock of capital contributed 4.7 per-
centage points. In all four foreign countries, capi-
tal growth was responsible for more than half the
total growth, compared to only 45 percent in
the u.s. Growth in multifactor productivity was a
relatively more important contributor to growth .
in the three European countries than in either the
U.S. or Japan. However, economists frequently
refer to multifactor productivity as "the measure
of our ignorance:' since it refers to that portion of
overall growth that is not "explained" by growth
in the supplies of labor and capital. Hence, it isdifficult to draw conclusions from differences in
the contribution ofthis factor, especially since
any errors in the calculations show up here.
In all five countries, only a minor part of the
slowing in growth after the mid-1970s was due to
slower growth in employment. The largest effect
was in France, where slower growth in labor in-
put during the 1975-1985 period cut 0.4 percent-
age point off annual GOP growth. In all countries, .
the largest source of the slowdown was reduced
growth in capital. Reflecting the larger contri-
bution of capital to growth in foreign economies,
it also played a greater role in the slowdown in
those countries. In Japan, for example, the con-
tribution of capital to growth declined from
6.4 percentage points in 1965-1974 to 3.1 per-
centage points in 1975-1985. Slower capital
growth was less of a factor in the U.s., with its
contribution decreasing from 1.7 percentage
points to 1.2 percentage points.
Conclusions
What should we conclude from this brief look at
the sources of growth in the u.s. and abroad? ,
First, the high productivity and steady growth of
the U.S. work force have played a major role in
economic growth. This is an interesting finding
in an era where the popular media often deride
u.s. workers, comparing them unfavorably with
foreign workers. Second, the accumulation of
capital has contributed less to recent GOP
growth in the U.s. than in other countries, but
the slowing in capital's contribution to growth
since 1975 has been more dramatic abroad. The
lower level of investment relative to GOP in the
U.s. may reflect the larger stock of capital per
worker that has already been accumulated in the,
U.s. The fact that the U.S. did not suffer the dev-
astation of capital that occurred in World War II
probably explains both the larger contribution of
capital to growth in foreign countries prior to
1975 and the sharper slowdown since then.
The slowing in growth associated with reduced
capital formation since the mid-1970s has been
less severe in the U.s. than in other countries.
This suggests that the high rates of growth and
capital formation that other countries experi-
enced in the immediate post-war period repre-
sented a catching up process, as these countries
made up for the low investment (and actual cap-
ital destruction) during the war years. Since 1974,
the cross-country differences in both investment
rates and GOP growth have been significantly
less, which may mean that countries are closer
to their long-run equilibria.
The benefits from raising the capital-labor ratio
by increased saving do vary between countries.
Most economists argue that increases in the stock
of capital relative to labor produce diminishing
returns, which implies that increases in saving
may be less productive in countries where the
stock of capital already is substantial. Also, al-
though a larger stock of capital makes it possible
to produce more output per worker, not all of this
added product is available to raise living stan-
dards. This is because a larger stock of capital
also means that a bigger share of current output
must be devoted to maintaining and replacing
worn-out capital and so is not available for con-
sumption. Nonetheless, it seems dear that even
for countries like the u.s. that have already ac-
cumulated a large capital stock, further increases
it) the capital-labor ratio would payoff in the
form of higher consumption for future genera-
tions. But this does require more saving by the
present generation. Higher future living standards
are not a free lunch!
Brian Motley
Senior Economist
References
GECD. Various issues. National Accounts, Volume 1,
Principal Aggregates. Paris.
GECD. 1983, 1987. Flows and Stocks of Fixed Capital,
1955-80, Flows and Stocks of Fixed Capital,
1960-85. Paris.
Solow, Robert M. 1956. "A Contribution to the Theory
of Economic Growth:' Quarterly Journal of Eco-
nomics pp. 65-94.
___.1957. "Technical Change and the Aggregate
Production Function." Review of Economics and
Statistics pp. 312-320.
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Index to Recent Issues of FRBSF Weekly Letter
DATE NUMBER TITLE AUTHOR
7/24
8/7
8/21
9/4
9/11
9/18
9/25
10/2
10/9
10/16
10/23
10130
11/6
11/13
11/20
11/27
12/4
12/11
12/25
1/1
1/8
1/22
1/29
92-27
92-28
92-29
92-30
92-31
92-32
92-33
92-34
92-35
92-36
92-37
92-38
92-39
92-40
92-41
92-42
92-43
92-44
92-45
93-01
93-02
93-03
93-04
First Quarter Results: Good News, Bad News
Are Big U.s. Banks Big Enough?
What's Happening to Southern California?
Money, Credit, and M2
Pegging, Floating, and Price Stability: Lessons from Taiwan
Budget Rules and MonetaryUnion in Europe
The Slow Recovery
Ejido Reform and the NAFTA
The Dollar: Short-Run Volatility and Long-Run Adjustment
The European Currency Crisis
Southern California Banking Blues
Would a New Monetary Aggregate Improve Policy?
Interest Rate Risk and Bank Capital Standards
NAFTA and u.s. Banking
A Note ofCaution on Early Bank Closure
Where's the Recovery?
Diamonds and Water: A Paradox Revisited
Sluggish Money Growth: Japan's Recent Experience
Labor Market Structure and Monetary Policy
An Alternative Strategy for Monetary Policy
The Recession, the Recovery, and the Productivity Slowdown
U.S. Banking Turnaround
Competitive Forces and Profit Persistence in Banking
Trenholme/Neuberger
Furlong
Sherwood-Call
Judd/Trehan
Moreno
Glick/Hutchison
Throop
Schmidt/Gruben
Throop
Glick/Hutchison
Zimmerman
Motley
Neuberger
Laderman/Moreno
Levonian
Cromwell/Trenholme
Schmidt
Moreno/Kim
Huh
Motley/Judd
Cogley
Zimmerman
Levonian
The FRBSF Weekly Letter appears on an abbreviated schedule in June, July, August, and December.

974-2246, Fax (415) 974-3341.~ t%\ 'S)jU! ueaqAos 41!M ''I'' IC!1 Jaded palOAOaJ uo palUljd Oi':Lt>6 \I) 'O)SPUl?J::IUl?S ZOLL xog 'O'd O)SPUOJ:J UOS JO ~U08 aAJaSa~ IOJapa:J ~uaw~Jodaa 4)JOaSa8 Index to Recent Issues of FRBSF Weekly Letter

A Contribution to the Theory of Economic Growth:'

Flows and Stocks of Fixed Capital, 1955-80, Flows and Stocks of Fixed Capital,

The sources of the growth slowdown

http://www.frbsf.org/publications/economics/letter/1993/el93-05.pdf

The sources of the growth slowdown

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