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Innovation, Productivity and Welfare Marcel Timmer Groningen Growth and Development Centre University of Groningen Presentation for the 2008 World Congress on NAEP Measures for Nations 1 Motivation Imagine a small open economy with two sectors: Stagnant services sector (producing for domestic demand) Dynamic Telecommunication equipment manufacturing (mainly for export) Do workers gain in welfare when productivity growth is high in telecom? Innovation can have two counteracting effects on welfare Improve productivity Declining terms-of-trade 2 This paper Trace the contributions of individual sectors to overall real income growth Productivity growth in a sector will contribute positively, but part of gains might spillover to foreigners. This will depend on share of exports and on terms-of-trade (price exports over price imports). Use two approaches: GDP function approach (Kohli, Diewert) Production possibility approach (Gollop) Empirical application to Finnish economy 3 Real Production versus Real expenditure Figure 1: Measures of Real GDP q2 P1 C P2 P3 D U B' A 0 B P1 P3 P2 q1 4 Decomposing real GDP growth GDP (net output) function : Kohli (1990); Diewert and Morrison (1986). Follow Kohli (2004) ( P F , P X , P M , L, K , t ) max P F F P X X P M M : ( F , X , M , L, K , t ) Tt F , X ,M ln Q ln Y v X ln P X v M ln P M v L ln L v K ln K ln A v X ln P X v M ln P M Q (real income) is nominal GDP divided by price of domestic expenditure, while Y is nominal GDP with X and M deflated seperately (real production). NB Prices of exports and imports relative to price dom exp 5 Prices and Real GDP in Finland 1.5 Index (1995 =1 ) 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 PX PI PF X Q 6 Sectoral contributions Breakdown aggregates into sectoral contributions (in the spirit, but not equal to Diewert, 2008): Define aggregate technical change (A) and Export prices as Tornqvist volume aggregation of sectors ln A PjL L j PjK K j Y P Y j ln P X j PjX X j PX X ln A j ln PjX 7 PjF PjX PjY Data Need value added, labour, capital and MFP (technical change) by industry EU KLEMS database (www.euklems.com) Need export values and prices by industry Not available. Use Input-output table to divide industry output into X and F (from Eurostat IO-database) Assume price of industry output is the same for all uses. PjF PjX PjY 8 Finland, Contribution to real income (%-points), 1995-2004 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 2000-2004 1995-2000 Capital MFP non P export non Labour P import MFP ICT P export ICT 9 Alternative approach Net output approach ignores role of intermediate inputs. Technical change only affects K and L. Following Gollop (1982), our model of an open economy is set up by defining sectoral production possibility frontiers for each sector j as follows: h j F j1 , F j 2 .., F jn , E j1 , E j 2 .., E jn , M j1 , M j 2 .., M jn g j L j , K j , X 1 j , X 2 j ,.., X nj , M 1 j , M 2 j ,.., M nj , t 10 Sectoral frontiers F E X w ln F w ln E w ij ij ji ln X ji ij ij i i i v jL ln L j v jK ln K j vijX ln X ij vijM ln M ij ln A j i wijF v L j PijF Fij PjY Y j Pi L L j Y j P Yj i F E X w w w ij ij ji 1 i i i v Lj v Kj vijX vijM 1 i i 11 Aggregation P Y Y PjL L j PjK K j PijM M ij j i ln Y w jY wijF ln Fij wijE ln Eij j i i L K M w v j ln L j v j ln K j vij ln M ij ln A j j i Y j wYj PjY Y j PY Y 12 Decomposition of growth in real expenditure F v jL ln L j v jK ln K j 1 ln F F w jY M E v ln M ln A w ln E ij ij j ij ij w j i i Advantages above GDP approach: More general definition of technology Industry deliveries to real expenditure rather than to real income Role of prices? 13 Concluding remarks Advantages of production possibilities frontier approach above GDP approach: More general definition of technology Industry deliveries to real expenditure rather than to real income Innovation gains can spill over internationally Decomposition is silent on causality: Why do export and import prices change? 14