IMF MDSx Mod 1 Videos

Supply and Productivity

This material was extracted from the International Monetary Fund's online course entitled Macroeconomic Diagnostics MDSx. To take the entire course, you must register for an account (free) on www.edx.org.

1. Introduction to Supply and Productivity Module

In this module, you will learn how to assess the supply side drivers of growth. It features some simple tools that help explain why a country is growing — or not growing. The tools can serve as a cross–check on other growth forecasts generated in other ways.

2. The Production Function Approach

A fundamental tool for economists, a production function illustrates an economy’s supply constraint in terms of two factor inputs, namely capital and labor. Total factor productivity serves to summarize how efficiently inputs are transformed to outputs. Marginal products of both capital and employment are positive but diminishing.

3. Investment and the Capital Stock

Most countries do not publish an estimate of the capital stock. The perpetual inventory method provides a rough estimate thereof based on some initial stock of capital, gross investment flows over time, and an assumption on the depreciation rate. So long as investment in any period exceeds the volume of depreciation, the capital stock will grow.

4. Investment and the Capital Stock in Excel

As a first step in your growth diagnostics, we will implement the perpetual inventory method. On screen, we show the case of “Country X.”

5. The Labor Force and Employment

Commonly used measures pertaining to the labor force and employment are introduced. The labor force is the working age population times the labor force participation rate. Employment equals the labor force times the employment rate.

6. The Labor Force and Employment in Excel

As a second step in your growth diagnostic, we will obtain a measure of employment. On the screen, we show the case of “Country X.”

7. Total Factor Productivity

The total factor productivity term reflects both technological and structural policies under the control of a country’s authorities. The past century has seen rates of growth of both output and GDP that were unprecedented in history. Some economists doubt that such rapid growth rates will prevail into the future. Instead, the potential role of productivity enhancing reforms may now be more important than ever.

8. The Cobb-Douglas Production Function

Here we develop a specific case of the production function that allows us to put in numbers. The Cobb-Douglas production function is widely used because it satisfies some of the theoretical properties discussed earlier. Also, this function has some data-based evidence in support of it.

9. The Growth Decomposition Approach

By adopting a Cobb-Douglas form and putting data to it, we are able to illustrate the supply side drivers of growth, element-by-element, in a simple way. In the Cobb Douglas function, each factor of production is assigned a growth elasticity. Each factor’s contribution to growth equals that factor’s growth rate times its growth elasticity.

10. The Growth Decomposition Approach in Excel

This exercise is perhaps the centerpiece of the country growth diagnostic. The supply side drivers of growth are calculated in contribution terms, element-by-element. On screen, you will see the technique implemented for “Country X.”

11. Growth of Capital Stock - A Closer Look

By using an alternative perspective, we see that the capital stock can grow more either if the investment to GDP ratio rises, or GDP itself rises, thus providing more resources to invest with. One way to boost GDP is through higher TFP . Thus, higher TFP – perhaps reflecting better structural policies – can have an indirect effect on GDP by boosting capital growth. However, such a beneficial effect does not take place immediately, but only on a gradual basis.

12. Capital Stock Growth with Excel

As an alternative perspective on the growth process, we measure gross investment as a ratio to the previous year’s capital stock. If that ratio exceeds the depreciation rate, the capital stock will grow. On screen, “Country X” is shown.

13. Per Capita Approach

The concept of a country's standard of living is hard to define. Even so, output per worker is a reasonable approximation to this concept. We can easily rework the growth decomposition to show growth of output per worker depending on both total factor productivity growth and growth of the capital to labor ratio. Positive movement in either means more output per worker – and potentially a higher standard of living for each worker.

14. Per Capita Approach in Excel

We now review the data in a new, more handy table. In this way, we can see how GDP growth behaved differently and had different drivers during different periods. At the same time, we do note the importance of TFP for growth. Finally, we recast the growth decomposition in per–capita terms — the metric that gives us a better guide as to the improvement in the standard of living for a country’s citizens.

15. Growth Decomposition: Looking Forward (Excel)

Analysts often make forecasts about how much a country will grow. No one, of course, has a crystal ball. However, the growth decomposition can provide a handy check on such forecasts. If the forecast for growth is more optimistic, we may ask the analyst to explain their results in terms of factors of production.

16. Summarizing What We Have Learned

In this module we have learned a useful tool to understand why the economy grew at the rate that it did. The tool is simple. But it is widely used by economists, and it helps them discipline their discussions about a country’s supply constraint and why it grew or did not grow.

17. A Rough Reality Check

Discussion with Gustavo Stisman and Evan Tanner which gives a broader perspective on why we do the growth decomposition exercise -- a rough reality check on other forecasts.

18. Diagnostica Assessment

A brief review of the results regarding the case study used in the MDSx course -- the country named "Diagnostica."

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