Total Factor Productivity Growth and Structural Change in Transition Economies El-hadj Bah Arizona State University and University of Auckland Josef C. Brada Arizona State University and Macedonian Academy of Sciences and Arts

Bah-BradaTFP in New EU Members2 Closing pcy Differences Between Old and New Members Growth accounting literature (Solow (1957), Prescott (1998) and Hall and Jones (1999), etc.) stresses: –Changes in total factor productivity (TFP) account for the largest part of economic growth. –International differences in TFP account for the bulk of international differences in pcy.

Bah-BradaTFP in New EU Members3 Income/Productivity Convergence Source: EU

Bah-BradaTFP in New EU Members4 Contributions to “potential” growth (period average) of: Labor Hours CapitalTFP Change EU EU Source: EU

Bah-BradaTFP in New EU Members5 Income/Productivity Convergence is Accompanied by Structural Change Kuznets (1966) – pervasive pattern of structural change accompanying economic development. Over-industrialization, over-“agrarianism” and neglect of service sector under Communism (Gregory, 1970; Ofer, 1976) due to ideology and “common sense”.

Bah-BradaTFP in New EU Members6 Agriculture’s Share of Employment Country Czech Rep Estonia Hungary Poland Slovakia Slovenia New EU rich EU countries Source: EU

Bah-BradaTFP in New EU Members7 Industry’s Share of Employment Country Czech Rep Estonia Hungary Poland Slovakia Slovenia new EU rich EU countries

Bah-BradaTFP in New EU Members8 Market Services’ Share of Employment Country Czech Rep Estonia Hungary Poland Slovakia Slovenia new EU rich EU countries

Bah-BradaTFP in New EU Members9 Why worry? Can TFP growth continue? What are the effects of structural change on TFP growth?

Bah-BradaTFP in New EU Members10 Barriers to Continued TFP Growth in New Members Reforms cease – better institutions yield higher TFP. Outward opening slows – globalization and FDI inflows raise TFP. Granick - Prescott effects wear off. EE has a poor record of TFP growth.

Bah-BradaTFP in New EU Members11 EE’s record of TFP Slowdown in Soviet TFP growth noted in 1960s (Kaplan, 1968). We were confused by Weitzman (1970) and Easterly and Fischer (1995). Studies of EE economies used variety of models & statistical techniques but all came to the same conclusion. By the early 1980s, only source of growth was “extensive” – TFP was zero. If determinants of the level of TFP are slow to change, current TFP growth may be temporary

Bah-BradaTFP in New EU Members12 Structural Change Is the structural change we have seen in EE a source of positive change in TFP? Development literature (e.g.,Herrendorf and Valentinyi (2006); Hsieh and Klenow (2007); Bah(2008)) suggest that TFP levels differ among sectors.

Bah-BradaTFP in New EU Members13 Why Not Apply Growth Accounting to Transition Economies ? Sectoral Data Not Available. Even Aggregate Capital Stocks Suffer from Major Defects (Campos and Coricelli (2002)). –Large but unmeasured depreciation and abandonment –Moral depreciation – large changes in pattern of production and in technology Estimates of TFP depend critically on “revisions” of “official” data (Izumov and Vahaly (2006, 2008))

Bah-BradaTFP in New EU Members14 This Paper Builds a dynamic 3 sector (Agriculture, Industry, Services) model Calibrates the model using US data Calculates Austrian sectoral TFP using Austrian sectoral labor allocation Compares Austrian TFPs to those of transition economies

Bah-BradaTFP in New EU Members15 The Model Key features for labor reallocation across sectors: – Non-homothetic preferences and agricultural TFP growth drive labor out of agriculture –TFP growth differential and elasticity of substitution between industrial and services output drive labor reallocation in those 2 sectors. Closed economy

Bah-BradaTFP in New EU Members16 Preferences Household lives forever, supplies labor to 3 sectors, earns income. Utility

Bah-BradaTFP in New EU Members17 Technologies Agriculture uses only labor and land (L=1), and is only used for consumption. With N A the agricultural labor, where

Bah-BradaTFP in New EU Members18 Technologies Industrial output can be consumed or invested. where The law of motion of the aggregate capital stock (K) in the economy is given by: where δ is the depreciation rate.

Bah-BradaTFP in New EU Members19 Services Services are only consumed. where

Bah-BradaTFP in New EU Members20 Solving the Model A competitive equilibrium is a set of allocations and prices such that: (i) Taking prices as given, the household maximizes lifetime utility subject to its budget constraint (ii) Taking prices as given, the representative firm in each sector maximizes profits (iii) Markets clear Equivalent to a social planner’s (SP) problem

Bah-BradaTFP in New EU Members21 SP Model Choose

Bah-BradaTFP in New EU Members22 Calibration to US Data A a = 1 in 1950 A m = 1 in 1950 A s =1 in 1950 Ã a = 0.24 α = 0.70 (T) β = δ = 0.05 ε = (U) γ m = (T) γ s = (T) λ = 0.01 (U) Θ = 0.03 (U)

Bah-BradaTFP in New EU Members23 Apply Model and Calibrated Values to Austria and New EU Members Austria as a comparator Per Capita Incomes as % of EU-15 Average Country Austria Czech Republic Estonia Latvia Lithuania Hungary Poland Slovak Republic Slovenia (source: EU)

Bah-BradaTFP in New EU Members24 Intuition for Solution At a heuristic level, given the calibrated preference parameters: Employment in agriculture determines agricultural TFP. Relative employment between industry and services determines relative TFP between them. Aggregate GDP per capita determines the levels of TFP in industry and services.

Bah-BradaTFP in New EU Members25 Austria

Bah-BradaTFP in New EU Members26 Bulgaria

Bah-BradaTFP in New EU Members27 Czech Republic

Bah-BradaTFP in New EU Members28 Estonia

Bah-BradaTFP in New EU Members29 Hungary

Bah-BradaTFP in New EU Members30 Latvia

Bah-BradaTFP in New EU Members31 Lithuania

Bah-BradaTFP in New EU Members32 Poland

Bah-BradaTFP in New EU Members33 Slovak Republic

Bah-BradaTFP in New EU Members34 Slovenia

Bah-BradaTFP in New EU Members35 AG TFP vs Austria

Bah-BradaTFP in New EU Members36 IND TFP vs Austria

Bah-BradaTFP in New EU Members37 SERVICES TFP vs Austria

Bah-BradaTFP in New EU Members38 Rankings of Sectoral TFPs Relative to the US Country Ranking Bulgaria IND>SER>AGR Czech Republic AGR>IND>SER Estonia AGR>IND>SER Hungary AGR>IND>SER Latvia IND>AGR>SER Lithuania IND>SER>AGR Poland IND>SER>AGR Slovak Republic AGR>IND>SER Slovenia IND>SER>AGR

Bah-BradaTFP in New EU Members39 Loss of GDP per capita due to structural transformation (as % of 1995 GDP per capita) Country % Loss Austria 1.28 Bulgaria 0.95 Czech Republic 2.29 Estonia 3.83 Hungary 2.31 Latvia 4.47 Lithuania 6.55 Poland 2.74 Slovak Republic 4.44 Slovenia 3.16

Bah-BradaTFP in New EU Members40 Policy Implications Sectoral differences are important –In some countries catch up is hampered by poor performance in one or more sectors –Structural change not a major drag Specific policy measures depend on how we believe TFP is determined Research question: Is sectoral TFP performance linked to nature of reforms such as privatization, governance, regulation, etc. ?

Bah-BradaTFP in New EU Members41 Thank you.