Economics Letters 114 (2012) 91–93

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Economics Letters
journal homepage: www.elsevier.com/locate/ecolet

Variable factor shares, measurement and growth accounting

Hernando Zuleta ∗
American University in Bulgaria and Universidad del Rosario, Balkanski Academic Center, 54 Alexander Stambolinsky St. Blagoevgrad 2700, Bulgaria

article info abstract

Article history: Recent evidence shows that factor shares are not constant. Consequently, growth accounting exercises
Received 14 September 2010 rely on a false assumption and a measurement problem arises. We propose an empirical methodology to
Received in revised form solve the measurement issue and estimate TFP growth.
2 September 2011
© 2011 Elsevier B.V. All rights reserved.
Accepted 22 September 2011
Available online 1 October 2011

JEL classification:
O11
O30
O41

Keywords:
Factor shares
Production function
Measurement

1. Introduction of substitution between factors is different from one; (iii) an

The idea that labor income share is roughly constant, namely,
the Cobb–Douglas–Kaldor paradigm,1 produced important conse-
quences in the area of economic growth. Almost all the literature
on growth accounting assumes that the elasticity of output with
respect to capital is constant and concludes that the major part of
economic growth is explained by growth in TFP (see Easterly and
Levine, 2002; Solow, 1957 or Young, 1995 among others).
Empirical work shows that the Cobb–Douglas–Kaldor paradigm
is not supported by the data. Kahn and Lim (1998) provide evidence
that the shares of equipment, production workers and non-
production workers have clear trends. Blanchard (1997) observes
that the share of labor decreases in continental Europe after the
80’s and suggests that the reason for such a decline may be
technological bias. Other authors calculate the income share of
reproducible (human and physical capital) and not reproducible
factors and argue that the latter is positively correlated with the
income level (see Krueger, 1999, Caselli and Feyrer, 2007, Zuleta,
2008a, Sturgill, 2009 and Zuleta et al., 2010).
The variability of factor shares can be explained by different
phenomena: (i) changes in the bargaining power of different
agents,2 (ii) an aggregate production function where the elasticity
∗ Tel.: +359 73 888 235.
E-mail address: hernando.zuleta@gmail.com.
1 See Cobb and Douglas (1928) and Kaldor (1961).
2 According to this line of research, the decrease in labor shares is due to a
decrease in the bargaining power of workers generated by the institutional setting
(see Bentolila and Saint-Paul, 2003, Giammarrioli et al., 2002, Berthold et al., 2002
and Bental and Demougin, 2010 among others).
increase in the relative size of the sectors where factor shares are
different from the average or (iv) biased technological change.3 Of
course, in the first case the functional distribution of income has no
relation with aggregate output so, if this is the correct explanation,
then there are no measurement problems. However, if any of the
other explanations is correct then any change in the functional
distribution of income is a result of a fundamental change that also
affects aggregate output. 4
Changes in the factor shares have different effects on output
depending on the factor abundance of the economy. If the income
share of abundant factors is growing then the effect of this change
on the income level is positive but if the share of abundant factors
decreases the effect of the change is negative.
To illustrate the importance of correct measures for the factors
consider the simplest Cobb–Douglas technology with two factors:
K and L. Output per worker, y = Y /L, can be expressed as a function
of capital per worker k = K /L : y = Akα .
Now, suppose that there is an increase in the share of capital.
The effect of the change in factor shares on income per worker
depends on the relative abundance of capital,
∂y
= Akα ln k.
∂α
3 In the last decades some authors revisited the theory of biased innovations and
challenged the Cobb–Douglas–Kaldor paradigm (see Zeira, 1998, 2005, Seater, 2005,
Peretto and Seater, 2006 and Zuleta, 2008b among others).
4 According to Aghion and Howitt (2000) the attempt to attribute changes in
human capital and raw labor shares to deunionization fails on the basis of time
considerations.

0165-1765/$ – see front matter © 2011 Elsevier B.V. All rights reserved.
doi:10.1016/j.econlet.2011.09.026
92 H. Zuleta / Economics Letters 114 (2012) 91–93

Table 1
A numerical exercise on the effect of changes in the capital share.
Capital stock per worker 1975 GDP per Change in Effect on income Percentage effect on GDP per
(constant prices 1985)a worker 1975 capital shareb worker 1975 (%)
(constant
prices 2000)a
Thousands (A) Ten (C) (D) Thousands Ten thousands Thousands Ten thousands
thousands (B) (ln(A) ∗ C ∗ D) (ln(B) ∗ C ∗ D) (E/C) (G) (F/C) (H)
(E) (F)

Australia 28.5 2.9 39 915.7 0.08 10 700.5 3347.7 27 8

Belgium 27.0 2.7 43 250.1 0.05 7 127.2 2147.8 16 5
Denmark 24.7 2.5 34 590.9 0.04 4 434.2 1248.3 13 4
Finland 28.9 2.9 32 293.3 0.10 10 865.2 3429.4 34 11
France 24.2 2.4 40 230.7 0.03 3 847.8 1068.7 10 3
Germany 36.9 3.7 38 315.2 0.05 6 912.5 2501.3 18 7
Ireland 13.9 1.4 30 533.0 0.17 13 676.4 1724.6 45 6
Italy 21.5 2.2 38 370.3 0.10 11 777.0 2941.9 31 8
Norway 38.9 3.9 46 667.9 0.11 18 797.6 6977.3 40 15
Sweden 25.6 2.6 37 406.9 0.02 2 426.2 703.6 6 2
United kingdom 14.6 1.5 33 511.3 0.10 8 988.6 1272.3 27 4
United states 26.1 2.6 48 774.3 0.02 3 182.3 936.2 7 2
a
Source: Penn world data tables.
b
Source: United Nations Data Set. The data was taken from Finnoff and Jayadev (2006). They used the United Nations dataset to construct the data on labor shares.

2. How to solve the problem?

2.1. Assuming away factor augmenting technological change

Consider a production function with only two factors, constant

returns to scale, decreasing marginal productivity of factors and all
the standard assumptions:
Yt = At F (φK Kt , φL Lt ) (1)
where Y is total income, K is physical capital, and L is raw labor.
Now, given that factor shares vary, the relative abundance of
factors becomes very important and, for this reason, it is necessary
Fig. 1. The effect of an increase in the capital share.
to have correct measures of capital and labor. The parameters φK
and φL play this role. If φK Kt ≥ φL Lt then the economy is capital
Therefore, if k > 1 then the effect is positive and if k < 1 the abundant.
effect is negative. Fig. 1 illustrates this fact. Differentiating Eq. (1),
In general, any change in the share of capital has an effect on 1Yt

1At 1Kt 1Lt

φK Kt

income. The size of this effect depends on both the capital labor = + αt + (1 − αt ) + 1αt ln (2)
Yt At Kt Lt φ L Lt
ratio and the income per worker. In Table 1 we provide a numerical
exercise that illustrates both the possible size of this effect and the where αt is the elasticity of output with respect to capital and
importance of the units used to measure the capital labor ratio for (1 − αt ) is the elasticity of output with respect to labor.
a set of OECD countries. The first two columns (A and B) present Now define
the capital per worker in 1975 measured in thousands and ten 1Yt 1 Kt 1Lt
 
thousands of dollars respectively (constant 1985 prices). The third St = − αt + (1 − αt ) . (3)
Yt Kt Lt
column (C) presents the GDP per worker in 1975 (constant 2005
prices). The fourth column (D) presents the change in capital share The variable S in Eq. (3) is the Solow residual. Now, from Eqs. (2)
between 1975 and 2000. Columns (E) and (F) show the effect that and (3) it follows that the Solow residual is not only TFP growth, it
the change in the capital share would have on the income level, also includes biased technological change:
1y = y ln k1α . In column (E) we compute the effect measuring 1At

φK Kt

the capital labor ratio in thousands of dollars and in column (F) we St = + 1αt ln . (4)
At φ L Lt
measure it in ten thousands of dollars. Finally, the last two columns
present these changes as a percentage of GDP per worker in 1975. Define S̃t = St − 1αt ln (Kt /Lt ), so Eq. (4) can be rewritten
The first thing to note is that when we measure the capital labor
1At φK
 
ratio in thousands the effect of the change in capital share is higher S̃t = + 1αt ln . (5)
than 10% of GDP per worker for 10 of the 12 countries. Second, At φL
when we measure the capital labor ratio in ten thousands, the size We can estimate the following equation:
of the effect is reduced substantially (for Ireland the difference is
close to 40%). Therefore, this numerical exercise suggests that (i) S̃t = C0 + C1 1αt + ρt (6)
the size of the effect of an increase in the capital share can be  
1At φK
significant in economic terms and (ii) the units we use to measure where At
= C0 + ρt and C1 = ln φL
.
the stock of capital affect in a significant way the estimation of the Therefore, this methodology allows us to identify the correct
effect. measures of factors per worker φK /φL and the growth rate of TFP.
 H. Zuleta / Economics Letters 114 (2012) 91–93 93

Finally, from Eq. (1) we get: Note, however that in this case the ratio φK /φL may change
with time. In order to apply this methodology with constant units
φK Kt φK Kt
1−αt −αt
of measurement we need to choose a period t = v such that
 
Yt Yt
At φK = and At φL = . (7)
Kt φ L Lt Lt φ L Lt D1,v = D2,v = 1 and ln (φK /φL ) = C1 − ln (1 + C2 ).
In the same way we have to introduce the following restriction:
Therefore, knowing the correct measures of factors per worker,
C1 − ln (1 + C2 ) + ln 1 + C2 D2,t
 
we can also identify the level of TFP multiplied by the correct
measure of labor (and capital) for every t.
D1,t = .
C1

2.2. What if there is labor augmenting or capital augmenting 3. Conclusions

technological change?
The approach described above has three main advantages over
If there is factor augmenting technological change then Eq. (2) the standard growth accounting methodology. First, it takes into
becomes account the variability of factor shares. Second, it is also a way to
solve the problem of measurement. Finally, it helps to understand
1Yt 1At 1AKt 1ALt 1Kt

= + αt + (1 − αt ) + αt the possible effects that changes in factor shares have on aggregate
Yt At AKt ALt Kt output.
Applications of this methodology should take into account that
1Lt φK ,t Kt
 
+ (1 − αt ) + 1αt ln (2A) the correct units of measurement can be different from country to
Lt φL,t Lt country. Additionally, in the short run factor shares may fluctuate
1AKt 1ALt for reasons unrelated to the elasticity of output with respect to
where and are, respectively, capital and labor augment-
AK t ALt factors so the growth rates should be computed for time periods
ing technological change. of at least 5 years.
Eqs. (4) and (5) become
Acknowledgments
1At 1AKt 1ALt φK ,t Kt
  
St = + αt + (1 − αt ) + 1αt ln (4A)
At AKt ALt φL,t Lt I am grateful to Peter Howitt and one anonymous referee for
comments and suggestions. The usual caveat applies.
φK ,0 1AKt 1ALt 1At 1ALt
   
S̃t = 1αt ln 1+ − + + References
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