Growth accountingGrowth accountingRecall:Recall:

YYtt = A = Att K Ktt L Ltt (1-(1-))

Take logs:Take logs:log Ylog Ytt = log A = log Att + + log K log Ktt + (1- + (1-) log L) log Ltt

Also true for t-1:Also true for t-1:log Ylog Yt-1t-1 = log A = log At-1t-1 + + log K log Kt-1t-1 + (1- + (1-) log L) log Lt-t-

11

Growth accountingGrowth accounting (log Y(log Yt t - log Y- log Yt-1t-1) ) = (log A= (log Att - log A - log At-1t-1) )

+ + (log K (log Ktt -log K -log Kt-1t-1) ) + (1-+ (1-)(log L)(log Ltt - - log Llog Lt-1t-1))

%% Y Ytt = % = % A Att + + % % K Ktt + (1- + (1-)%)% L Ltt

Rearrange to get:Rearrange to get:%% A Att = % = % Y Ytt - - % % K Ktt - (1- - (1-)%)% L Ltt

Growth accountingGrowth accountingWe have data on Y, K and LWe have data on Y, K and L

(1-(1-= labour’s share of income= labour’s share of income= wL/Y= wL/Y 0.6 (on average)0.6 (on average)

Thus Thus 0.4 0.4A is the “Solow” residualA is the “Solow” residual

Labour inputLabour input Labour input measured by total Labour input measured by total

hours worked (L)hours worked (L)

L = average workweek L = average workweek employmentemployment

Ireland, Hours worked per employee in the business sector

Source: EcoWin

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06

N/A

1500

1600

1700

1800

1900

2000

2100

2200

Basic growth accountingBasic growth accounting

YY Y*Y* KK Labor inputLabor input Labor input*Labor input* TFTFPP

TFP*TFP*

WWWW EmplEmpl..

WWWW Empl.Empl.

19601960-73-73

4.34.3 4.64.6 0.70.7 -0.5-0.5 0.10.1 -0.5-0.5 -0.2-0.2 4.34.3 4.84.8

19731973-95-95

4.14.1 4.64.6 2.72.7 -0.6-0.6 0.80.8 -0.6-0.6 0.80.8 3.23.2 3.73.7

19731973-80-80

4.64.6 4.64.6 3.03.0 -1.1-1.1 1.11.1 -1.1-1.1 0.70.7 3.63.6 4.04.0

19801980-95-95

3.93.9 4.64.6 2.52.5 -0.4-0.4 0.70.7 -0.4-0.4 0.80.8 3.03.0 3.63.6

19951995-00-00

9.49.4 10.210.2 4.94.9 -1.6-1.6 5.65.6 -1.6-1.6 6.16.1 5.25.2 5.65.6

* Business sector

Main points:Main points: Ireland’s TFP growth slowed between Ireland’s TFP growth slowed between

1973-1995, but picked up post-19951973-1995, but picked up post-1995 Investment also picked up post-1995Investment also picked up post-1995 Especially impressive boom in Especially impressive boom in

employmentemployment Probably even bigger contribution from Probably even bigger contribution from

labour input if labour quality adjusted.labour input if labour quality adjusted.

Labour demandLabour demand Competitive wages (w/A) Competitive wages (w/A) Foreign multinationals using Ireland as Foreign multinationals using Ireland as

an export platforman export platform EU internal marketEU internal market Low corporation taxLow corporation tax Highly educated, English-speaking Highly educated, English-speaking

workforceworkforce Flexible labour marketsFlexible labour markets IDA policy; agglomeration effectsIDA policy; agglomeration effects

Expanding services sectorsExpanding services sectors Boom in construction industryBoom in construction industry

Labour supplyLabour supply Natural demographic effectsNatural demographic effects

Figures 1, 2 & 3 in Fitz Gerald (2004)Figures 1, 2 & 3 in Fitz Gerald (2004) Low dependency ratioLow dependency ratio Total fertility rate = 2! (EU average = Total fertility rate = 2! (EU average =

1.5)1.5) Participation ratesParticipation rates MigrationMigration

Ireland, Labour force participation rate

Source: EcoWin

60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06

N/A

61

62

63

64

65

66

67

68

69

70

71

72

Labour supplyLabour supplyNational Competitiveness Council, National Competitiveness Council,

Annual Competitiveness Report 2005Annual Competitiveness Report 2005 http://www.forfas.ie/ncc/reports/ncc_http://www.forfas.ie/ncc/reports/ncc_

annual_05/ch03/ch03_01.htmlannual_05/ch03/ch03_01.html

Central Statistic OfficeCentral Statistic Office http://http://www.cso.iewww.cso.ie

Wedge accountingWedge accounting Ahearne, Kydland, Wynne, (2005) Ahearne, Kydland, Wynne, (2005)

“Ireland’s Great Depression” “Ireland’s Great Depression” Ireland experienced a great Ireland experienced a great

depression in the 1980sdepression in the 1980s Study the contribution of different Study the contribution of different

wedges to the downturn and wedges to the downturn and subsequent recoverysubsequent recovery

Model economyModel economy Computer model of the Irish economyComputer model of the Irish economy Explicitly model behaviour of agentsExplicitly model behaviour of agents Households make choices about how Households make choices about how

much to consume/save and how much much to consume/save and how much to workto work

Firms maximize profitsFirms maximize profits Agents are forward lookingAgents are forward looking

““Wedge” accountingWedge” accounting Basic idea:Basic idea:

Examine movements in wedges or Examine movements in wedges or distortions to account for cyclical distortions to account for cyclical episodesepisodes

Applications:Applications: Accounting for the (US) Great Accounting for the (US) Great

DepressionDepression Accounting for 1990-91 (US) recessionAccounting for 1990-91 (US) recession

DefinitionsDefinitions Efficiency wedgeEfficiency wedge

Essentially TFPEssentially TFP Labor wedgeLabor wedge

Distorts (intratemporal) labor-consumption Distorts (intratemporal) labor-consumption decisiondecision

Investment wedgeInvestment wedge Distorts (intertemporal) investment Distorts (intertemporal) investment

decisiondecision Government consumption wedgeGovernment consumption wedge

Efficiency wedge

A

B

Nonmarket activity

Consumption

Labor wedge

A

B

Nonmarket activity

Consumption

Capital wedge

A

B

Current Consumption

FutureConsumption

Government consumption wedge

• Unproductive government spending• Resource constraint

Yt =Ct + It + Gt + Xt - Mt

ResultsResults Efficiency wedge by itself does a good job Efficiency wedge by itself does a good job

accounting for downturn and recovery, accounting for downturn and recovery, though predicts an earlier recoverythough predicts an earlier recovery

Labour wedge predicts an even more Labour wedge predicts an even more severe downturn, but no recoverysevere downturn, but no recovery

Investment and government wedges Investment and government wedges cannot account for downturn and cannot account for downturn and recoveryrecovery

Convergence or Regional Convergence or Regional Boom?Boom?

Barry (2002)Barry (2002) Rapid growth in 1990s was a regional Rapid growth in 1990s was a regional

boom boom Region Region very open labour markets very open labour markets If good shock hits region If good shock hits region boom boom

Ireland’s case: FDIIreland’s case: FDI Bad shocks can lead to a reversal! Bad shocks can lead to a reversal!