Opportunity Costs, Productive Arbitrage, and Medium-Term Economic Growth Forecasting

Abstract

The paper proposes a novel theory-based approach to economic growth prediction. In the economy populated with economically independent decision-makers, the information about their individual preferences, available technologies, and resource constraints is embedded in decision-makers' opportunity costs. By relating opportunity costs over available alternatives to individual's choices, it is possible to make inference about agent's aggregate behavior in the macroeconomy. Conceptually, the information about the measurable structure of the economy can be used to predict aggregate economic activity, and, hence, economic growth. The paper develops practical procedures for measuring opportunity costs of goods produced and goods demanded. It is theoretically shown that the difference between the two, or the opportunity cost differential, is the primary cause for a productive arbitrage -- an expansion of production, and hence, economic growth. An applied model of medium-term economic growth is developed using input-output and econometric techniques. It is shown that the opportunity costs differentials computed from mid-2000s and early-2000s input-output tables explain more than three-quarters of the variation of the growth rates for the ten-year period for a cross-section of 40 nations. In contrast, the applied model suggests that the sovereign debt has neither positive nor negative effects on midterm economic growth rates.