by Vinayak Maheswaran

Created on: July 29, 2011

I will focus solely on long growth and the effect of Total Factor Productivity (TFP) on economic growth in this piece of writing.

It has been long established that TFP and TFP growth are prerequisites for returns to capital, factors accumulation and growth. In this article, we briefly explore what are then the determinants of TFP.

The first order determinant of TFP is technological discoveries that make existing capital and labor more productive. For example, think about the invention of the compass. Without the compass, 10 sailors and a ship are capable of producing only a limited amount of shipping services as they will get lost very easily. When the compass is created, the same 10 sailors and the same ship are going to be able to produce much more shipping services.

More recently think of the invention of the Google search algorithm. Technological innovations are a very important driver of TFP growth in developed economies (like the US). For example, when looking at the estimates of the contribution of information technology to labor productivity (note that labor productivity is different from total factor productivity) in the US it can be seen that labor productivity grew a little more than 1.5% per year because of information technology in the years 1996-2002. To give you a reference on the magnitude of those numbers, the increase in labor productivity is larger than the one that the steam engine brought in UK during the industrial revolution.

How about in developing countries?

Developing countries should have an advantage over developed countries as they should be able to import more advanced technology from more advanced countries. Indeed, in looking at statistics we see that countries that reached a certain income level

(2000 1990US$) late in the current century were able to double their income at a much faster rate than countries that reached the same level the previous century. The US, for example reached the level in 1860 but it took more than 40 years to double that level as improvements in productivity were obtained only through technological discoveries. Taiwan instead was able to double the income from 2000 to 4000 in less than 10 years because it was able to increase productivity by adopting better technology that were already around. Yet we have seem that in many cases TFP in developing countries is much lower than in developed countries and most importantly it fails to grow.

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