Productivity and the welfare of nations

Abstract

We show that the welfare of a representative consumer can be related to observable aggregate data. To a first order, the change in welfare is summarized by (the present value of) the Solow productivity residual and by the growth rate of the capital stock per capita. We also show that productivity and the capital stock suffice to calculate differences in welfare across countries, with both variables computed as log level deviations from a reference country. These results hold for arbitrary production technology, regardless of the degree of product market competition, and apply to open economies as well if TFP is constructed using absorption rather than GDP as the measure of output. They require that TFP be constructed using prices and quantities as perceived by consumers. Thus, factor shares need to be calculated using after-tax wages and rental rates, and will typically sum to less than one. We apply these results to calculate welfare gaps and growth rates in a sample of developed countries for which high-quality TFP and capital data are available. We find that under realistic scenarios the United Kingdom and Spain had the highest growth rates of welfare over our sample period of 1985-2005, but the United States had the highest level of welfare.