Growth accounting is a methodology that was first introduced by American economist Robert Solow. This methodology is commonly used by economists to measure the role various factors play in economic growth. It can also be used to analyze future long-term growth patterns based on a number of changes in the global economic environment. Thus, it has become an important tool in economic analysis and has helped identify what production strategies help increase economic growth.
Growth accounting essentially breaks down an economy’s entire output into three variables — changes in capital, labor, and total productivity. Two of these components, capital and labor, directly control observable factors of growth or decline in an economy under the rules of the growth accounting model. Total factor productivity, on the other hand, is not directly observable. Thus, other techniques, which will be explained later, must be used to account for the total factor productivity.
The mathematics involved in growth accounting is based on proportions of growth. If the proportional growth rates of capital, labor, and total economic output are known, then the growth accounting equation is able to calculate the rate of the growth of total factor productivity. This is an extremely important function of growth accounting, because total factor productivity is unobservable and needs to be calculated mathematically.
Any parts of the Gross Domestic Product (GDP) that are the result of the unobservable aspect of total factor productivity are called Solow residuals. These residuals can be attributed to technological progress that leads to increases in productivity. Technology in growth accounting is not limited to machinery but also includes labor organization, government regulation, and literacy levels. Thus, technological progress is very loosely defined, which allows for the inclusion of multiple factors economists would normally not take into account. In addition, with technological progress, manufacturers and producers are able to get more output with the same amount of input, which leads to much higher levels of productivity.
Growth accounting is a technique that has been applied to virtually every economy in the world. By applying this method, we are able to make observations on how governments can stimulate growth through domestic policy changes. The most common observation is the fact that not all economic growth can be accounted for by changes in capital, population, labor force, and other directly observable factors. Thus, loosely defined technological advances do, in fact, increase productivity levels. These increases eventually result in economic growth on a national level.