Determinants of Iran's Total Factor Productivity promotion Hamid Padash

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Determinants of Iran's Total Factor Productivity promotion

Hamid Padash,, Ph.D. of Economics

Faculty of Economics, University of Tehran

Behzad Heydari,, M.A. in Economics

Faculty of Economics, University of Tehran


Our main purpose in this paper is, regard to the planned horizon for Iran's economy productivity according to Vision Document, the Fourth Development plan, and performance of the country in the Third Development plan, to show in the examined years, what factors could explain changes in Total Factor Productivity (TFP). Using ARDL technic, estimation of determinants of TFP shows institutional quality, accumulation of domestic and foreign R&D, human capital, economic openness, physical capital accumulation, investment in ICT, exchange rate, and inflation are factors that explain productivity growth trend in study period.

Key Words: Total Factor Productivity (TFP), determinants of productivity, ARDL method.

  1. Introduction

In traditional growth models, physical factors were considered as basic factor in economic growth of countries. Ricardian growth theory is based on the variable proportions and variation in production factors, such as physical capital and labor cause economic growth but other production factors remain constant. Main important critics to classic economic growth are that the technology is considered constant. In a study (World Bank, 1998) growth rate of many countries is examined. According to the study, physical capital accumulation shows less than 30% of growth rate of countries; more than 70% attributed to factors, directly or indirectly, constitute TFP. Failures of these models in explanation of countries growth lead to emergence of endogenous models. As a result, factors which were considered remain constant, now have distinguished role in explanation of economic growth. TFP beside capital and labor has significant effect on growth. Introducing TFP in analysis of growth has led to the expansion of the literature. As a result, the ways of TFP calculation are evolving.

In this paper, according to production function approach and empirical evidence (econometrics method), we look for variables which determine TFP growth and their effects on Iran economic growth. Structure of the paper is organized as follow: in the next part, we review the literature. At the third part, through empirical studies, we discuss TFP growth variables. At the forth section, the econometric model is specified. At fifth and sixth sections, econometric model is estimated and results are shown. At final, results and discussions are presented.

  1. Literature review

Most of the economists claim that Total Factor Productivity (TFP) explains main part of productivity growth. Based on the fixed ratio factors model of Harrod (1939) and Dumar (1946) and the dual sector model of Lewis (1954), Solow (1957) presented a plain growth model which is considered a turning point in future economic growth theory. Through the model, the neoclassical production model is specified and physical capital, labor and technology affect production level exogenously; therefore, the model is referred to as exogenous model. First estimations of the model for sample developed countries show that residuals are remain unexplained highly. In growth analysis, it is assumed that Solow residual merely refers to TFP.

Failure of neoclassical models in accurate explanation of production growth, open a way for models that focus on analysis of TFP growth sources, which is called endogenous growth models. Proponents of endogenous growth theory claim that physical capital growth itself cannot explain per capita production, and neoclassical growth models have not the ability to recognize factors that explain economic growth. They argue that Solow's residual reacts to endogenous determinants (for instance, endogenous technology and human capital accumulation). Their main discussion considers not only the human capital, but also calls attention to the international trade role. By considering technological changes and technological spillovers through countries, proponents of endogenous growth theory emphasize on the ability to absorb and apply foreign technology.

Considering Cub-Douglas production function, we can persuade above topics algebraic:

In the latter relation, is technical progress rate and are production elasticity of capital stock and labor, respectively.

: Random determinant with dual standard character, and

: Lack of technical efficiency

In latter equation, measures decrease rate in technical efficiency.

Assuming impact of human capital quality and physical capital in economic growth, we can rewrite the above equation as following:

are, respectively, physical capital quality (in form of average life of physical capital) and human capital (in form of amount of schooling years in high school level) at time t. In addition, A is constant and so its Log change is zero.

In latter equation, both of growth rate of random determinant with standard character and growth rate of technical efficiency are zero and omitted from model. With this explanation, the above equation states that percentile change in the level of production is affected by factors like changes in effective units of capital, average period of capital life, effective units of labor, average years of schooling, productivity, and technology (residuals). The second and forth sentences of the latter equation is explained through change in input quality. In the model, the high growth of production can occurs without high growth of capital and this appears when human capital level leads to increase in labor quality. Similarly, high growth of production can be explained without high growth of capital stock, if capital has high quality.

The important question is that which of the factor accumulation or TFP growth has the main role in growth? In analyzing US growth, Solow (1956) stated that residuals and accumulation of nonproduction factors except production factors, explain large part of production growth. Easterly & Levine (2001) and King & Levine (1994) found that residuals explain large part of differences between countries, respect to the income and economic growth. On the other hand, King & Lau (1996) stated that accumulation of production factors is an essential element for explanation of differences. Jorgensen & Griliches (1967) evaluated TFP growth rate as difference between rate of change in real production and rate of input growth. Using this definition, we can calculate change in TFP as following:

Through estimation of technical efficiency for OECD countries, Coop (1999) found that accumulation of production factors explain large part of production growth, and in this way, they separated production growth to components like changes in inputs, efficiency, and technology. Their results showed high share of accumulation of production factors in growth. Technological changes have the second position in explanation of production growth, and ultimately economic efficiency growth has a low share in stimulating economic growth.

  1. Empirical Evidence

In the theoretical literature, issues such as productivity and its role in explanation of growth, sources of productivity growth in different countries, accumulation and growth of production factors, and evaluating productivity growth are under concern. In the same way, the empirical studies have been expanded to explain TFP role. Beyer & Vegara (2002) follow up the productivity and growth topic for Chile economy over the period of 1980-2000. They insisted on the institutions and economic policies applied by governments in the process of economic growth. Moreover, they argued that, after experiencing more than 7 percent growth rate for 15 years, Chile economy encounter below 3 percent growth rate in latter 5 years. Estrada & Lopez-Salido (2001) showed for Spain economy that in 1980-1995 labor productivity increased by 3.3 percent, however, after adjustment of growth of labor cost and substitution of capital for labor, TFP growth- including added value- was 2.5 percent. Jorgenson et al. (2003) studied important productivity factors in US for the period of 1995-2003. Their study showed that despite of negative economic shocks, productivity growth rate has accelerated in recent years. They predicted that private productivity of US would increase to 2.6 percent, in future decade, which is a significant increase related to the 2.2 percent predicted in 2002. Hu & Khan (1997) investigated China growth and suggested that china's rapid growth is resulted from capital accumulation and sustainable productivity improvement in Reform period.

Senhadji (1999) studied growth sources and causes of different production factor productivity growth rates. He found a negative correlation between physical capital and TFP growth. In the study capital stock has been driving force of Asia economic growth. Initial conditions of countries considerably explain their TFP, and improvement in macroeconomics indices such as inflation rate, real exchange rate, public consumption, and foreign debts can result in higher TFP. According to the study, Political and social stability and totally, improvement in institutions quality affect TFP growth positively.

Coe et al. (2008) investigated effects of R&D investments in the industrial countries on the developing countries. According to their study, trade with industrial countries causes production factor productivity improvement in the developing countries; the more openness of a country, the more marginal advantage of R&D of the industrial countries.

We mention some of important studies but there are other works. The most important determinants in TFP productivity are shown in Table 1.

Table1. Determinants of the TFP growth (according to empirical studies)

Determinants of TFP

effect on TFP


Institutional quality


Senhadji (1999), Beyer & Vegara (2002), Hu & Khan (1997)

Inflation rate


Senhadji (1999), Hu & Khan (1997), Gordon (2005), Freeman & Erger (2007), and Gillman & Nakov (2002)

Real exchange rate


Senhadji (1999), Hu & Khan (1997), Schnatz et al. (2003) and Aghion (2006)

Foreign debt


Senhadji (1999),

Physical capital stock


Senhadji (1999), Easterly & Levine (2001), Coop (1999), Jorgenson et al. (2003), King & Lau (1996), Jorgensen & Griliches (1967)

Education and human capital


Easterly & Levine (2001), Coop (1999), Estrada & Lopez-Salido (2001), King & Lau (1996), Jorgensen & Griliches (1967)

R&D capital stock in the developing countries


Coe et al. (2008),

Ratio of total export to GDP


Hu & Khan (1997), Jorgenson et al. (2003),



Hu & Khan (1997), Beyer & Vegara (2002) ,

IT quality


Jorgenson et al. (2003), Beyer & Vegara (2002),
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