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Development accounting with wedges: the experience of six European countries

  • Istvan Konya EMAIL logo
Published/Copyright: June 19, 2013
The B.E. Journal of Macroeconomics
From the journal The B.E. Journal of Macroeconomics Volume 13 Issue 1

Abstract

The paper interprets the growth experience of three Western European countries (France, Germany and the UK) and three Central-Eastern European economies (the Czech Republic, Hungary, and Poland) through the lens of the neoclassical growth model. It combines the methodologies of Development Accounting (Caselli, F. 2005. “Accounting for Cross-Country Income Differences.” In Handbook of Economic Growth, Chapter 9, 679–741.) and Business Cycle Accounting (Chari, V. V., P. J. Kehoe, and E. R. McGrattan. 2007. “Business Cycle Accounting.” Econometrica 75 (3): 781–836.) to calculate distortions – “wedges” – in production efficiency, and in the labor and capital markets. The exercise sheds light on the extent and evolution of factor market distortions between 1996 and 2009. The main result of the paper is that capital and labor market distortions do not explain income differences across the two country groups, but are important to understand income differences within groups. In addition, observed labor and capital taxes are related to the measured wedges, but significant unexplained components remain. Reducing labor and capital market distortions would lead to significant output gains in all countries.

Keywords: business cycle accounting; capital and labor markets; development accounting; distortions; European economies; JEL codes: E13; O11; O47
Corresponding author: Istvan Konya, Magyar Nemzeti Bank and Central European University, 1054 Budapest, Szabadsag ter 8-9, Hungary, Tel.: +36-1-4282600/1526, e-mail: ;
  1. 1

    Important earlier contributions documenting the importance of TFP in explaining large cross-country differences are Klenow and Rodríguez-Clare (1997) and Hall and Jones (1999).

  2. 2

    In the second equation, assume that Then the consumption terms drop out. This assumption would be satisfied, for example, in a log-linear approximation.

  3. 3

    Similarly, in a small open economy the borrowing wedge summarizes all distortions affecting consumption. The measurement of the borrowing wedge is completely analogous to the measurement of the investment wedge discussed below, and it is left for the interested reader.

  4. 4
  5. 5
  6. 6
  7. 7

    Justification for these values and further details are given in Caselli (2005: p. 7).

  8. 8
  9. 9
  10. 10

    The investment series go back to 1970 for Poland and Hungary and Germany, and to 1950 for France and the UK. For the Czech Republic investment data starts from 1990.

  11. 11

    The third category, household investment, is thus higher in the WE countries.

  12. 12

    A quick look at the growth accounting data from the Total Economy Database (http://www.conference-board.org/data/economydatabase/) reveals the same sharp TFP slowdown for France in the 2000s.

  13. 13

    Given the log-log specification of the utility function, the welfare increase 1+μ is defined as: 1+μ=(c′/c)·[(1–h′)/(1–h)]χ, where variables with a prime indicate the new steady state values after the reduction in the wedge(s).

  14. 14

    Results for the labor wedge under particular values for this parameter are available from the author upon request.

  15. 15

    In fact in the baseline case the implicit assumption was that all output decrease was due to employment and productivity.

I would like to thank Péter Benczúr, Fabio Canova, Refet Gürkaynak and Katrin Rabitsch for helpful comments. All remaining errors are mine.

Appendix

A Tax rate derivations

B Steady state

The steady state conditions:

The effect of capital and labor wedges:

  • Reducing the labor wedge:

  • Reducing the investment wedge

  • Eliminating both the investment and labor wedges:

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Published Online: 2013-06-19
Published in Print: 2013-01-01

©2013 by Walter de Gruyter Berlin Boston

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https://doi.org/10.1515/bejm-2012-0153
Keywords for this article
business cycle accounting; capital and labor markets; development accounting; distortions; European economies; JEL codes: E13; O11; O47

Articles in the same Issue

  1. Masthead
  2. Masthead
  3. Advances
  4. How have global shocks impacted the real effective exchange rates of individual euro area countries since the euro’s creation?
  5. Employment by age, education, and economic growth: effects of fiscal policy composition in general equilibrium
  6. Overeducation and skill-biased technical change
  7. Strategic wage bargaining, labor market volatility, and persistence
  8. Households’ uncertainty about Medicare policy
  9. Contributions
  10. Deconstructing shocks and persistence in OECD real exchange rates1)
  11. A contribution to the empirics of welfare growth
  12. Development accounting with wedges: the experience of six European countries
  13. Implementation cycles, growth and the labor market
  14. International technology adoption, R&D, and productivity growth
  15. Bequest taxes, donations, and house prices
  16. Business cycle accounting of the BRIC economies
  17. Privately optimal severance pay
  18. Small business loan guarantees as insurance against aggregate risks
  19. Output growth and unexpected government expenditures
  20. International business cycles and remittance flows
  21. Effects of productivity shocks on hours worked: UK evidence
  22. A prior predictive analysis of the effects of Loss Aversion/Narrow Framing in a macroeconomic model for asset pricing
  23. Exchange rate pass-through and fiscal multipliers
  24. Credit demand, credit supply, and economic activity
  25. Distortions, structural transformation and the Europe-US income gap
  26. Monetary policy shocks and real commodity prices
  27. Topics
  28. News-driven international business cycles
  29. Business cycle dynamics across the US states
  30. Required reserves as a credit policy tool
  31. The macroeconomic effects of the 35-h workweek regulation in France
  32. Productivity and resource misallocation in Latin America1)
  33. Information and communication technologies over the business cycle
  34. In search of lost time: the neoclassical synthesis
  35. Divorce laws and divorce rate in the US
  36. Is the “Great Recession” really so different from the past?
  37. Monetary business cycle accounting for Sweden
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