The Determinants of Total Factor Productivity Growth: Evidence from Panel Data Analysis

Abstract

Productivity growth over the past six decades have been recognised as a major source of economic growth for many countries. And with increasing globalization efforts across all regions, the emphasis on improving productivity and competitiveness of domestic industries has then become the forefront of many government policies. The main purpose of this research is therefore to analyze what factors affect the growth of Total Factor Productivity (TFP) across different income grouped countries and identify possible policy implications based on the relevant findings. A special focus is made on how the quality of governance, as a determinant of productivity, affects TFP growth using specific governance indicators. This aspect of the research is deemed necessary as though the quality of governance is generally expected to have a positive impact on economic growth and development, there is very limited explanation and evidence as to how specific indicators of governance quality will affect TFP growth. The research will therefore bridge the gap in knowledge by explaining how the quality of governance affects the growth of total factor productivity. In order to achieve the research objective, the study investigates three specific questions: 1. Whether the indicators used for the quality of governance significantly impact productivity growth across the income groups; 2. Which of the determinants affect productivity growth the most among high income countries and lower income groups; and lastly, 3. Does FDI, human capital, R&D, and the indicators for the quality of governance have greater impact on productivity growth in lower income or high income countries. Using Pooled OLS and Fixed Effects regression analysis, this study analyzes the determinants of Total Factor Productivity (TFP) growth for 35 countries across different income groups for the period 2002 to 2014. The main results reveal that Government Effectiveness, Rule of Law, FDI, and Trade Openness, all had statistically significant effect on the growth of Total Factor Productivity. In regards to the sample of High Income countries, the evidence suggests that Government Effectiveness and R&D negatively impacts growth in Total Factor Productivity, whereas Trade Openness and FDI showing positive impact. Whereas, in Lower Income, R&D impacts productivity growth positively, whilst Human Capital has a negative impact. An additional and unique finding of the research, was that Government Effectiveness and Rule of Law, both being used as proxies to measure the effect of the Quality of Governance on productivity growth, had totally opposite impact. Specifically, Government Effectiveness was negatively related to productivity growth across all samples, whereas Rule of Law was positive.