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Growth accounting
Growth accounting is a procedure used in economics to measure the contribution of different
factors to economic growth and to indirectly compute the rate of technological progress, measured
as a residual, in an economy. This methodology was introduced by Robert Solow in 1957.[1]
Growth accounting decomposes the growth rate of economy's total output into that which is due to
increases in the amount of factors usedusually the increase in the amount of capital and labor
and that which cannot be accounted for by observable changes in factor utilization. The unexplained
part of growth in GDP is then taken to represent increases in productivity (getting more output with
the same amounts of inputs) or a measure of broadly defined technological progress.
The technique has been applied to virtually every economy in the world and a common finding is that
observed levels of economic growth cannot be explained simply by changes in the stock of capital in
the economy or population and labor force growth rates. Hence, technological progress plays a key
role in the economic growth of nations, or the lack of it.[2]


Decomposing increase in output into that due to technology and that due to increase in capital (click to enlarge)

As an abstract example consider an economy whose total output (GDP) grows at 3% per year. Over
the same period its capital stock grows at 6% per year and its labor force by 1%. The contribution of
the growth rate of capital to output is equal to that growth rate weighted by the share of capital in
total output and the contribution of labor is given by the growth rate of labor weighted by labor's
share in income. If capital's share in output is 13, then labor's share is 23 (assuming these are the
only two factors of production). This means that the portion of growth in output which is due to
changes in factors is .06(13)+.01(23)=.027 or 2.7%. This means that there is still 0.3% of the
growth in output that cannot be accounted for. This remainder is the increase in the productivity of
factors that happened over the period, or the measure of technological progress during this time.

Technical derivation[edit]
The total output of an economy is modeled as being produced by various factors of production, with
capital and labor being the primary ones in modern economies (although land and natural resources
can also be included). This is usually captured by an aggregate production function:

where Y is total output, K is the stock of capital in the economy, L is the labor force (or population)
and A is a "catch all" factor for technology, role of institutions and other relevant forces which
measures how productively capital and labor are used in production.
Standard assumptions on the form of the function F(.) is that it is increasing in K, L, A (if you
increase productivity or you increase the amount of factors used you get more output) and that it
is homogeneous of degree one, or in other words that there are constant returns to scale (which
means that if you double both K and L you get double the output). The assumption of constant
returns to scale facilitates the assumption of perfect competition which in turn implies that factors get