An Accounting Method for Economic Growth

Abstract

As Chari et al. (2007) indicate, many growth theories explaining frictions in real economies are equivalent to a competitive economy, with some exogenous taxes. Using this idea, I developed an accounting method for identifying fundamental causes of economic growth. A two-sector neoclassical growth model with taxes is used as a prototype economy, and its equilibrium conditions define wedges. These wedges endogenously determine the long run growth rate, which is exogenous and not correlated with any other variables in a one-sector growth model. Furthermore, the importance of wedges in explaining the long-run growth rate can be evaluated through the use of a prototype economy. Applying this method to fifty countries reveals that, among seven wedges, two wedges that are respectively associated with the production function and the Euler equation for human capital are important in explaining economic growth.