Innovative Growth Accounting

Abstract

Solow (1956) famously decomposed output growth into contributions from capital, labor, and productivity. Mankiw, Romer, and Weil (1992) further decomposed productivity into human capital versus residual productivity. We take this residual productivity, routinely calculated by the US Bureau of Labor Statistics (BLS), as our starting point. We attribute productivity growth to innovation and ask: What form does the innovation take, and which firms do most of the innovation? Innovation can take the form of a stream of new varieties that are not close substitutes for any existing varieties (Romer 1990). Alternatively, growth could be driven by creative destruction of existing products as in Aghion and Howitt (1992). Examples include Walmart stores driving out mom-and-pop stores or Amazon stealing business from physical stores. Yet another possibility is that growth takes the form of existing producers improving their own products (e.g., successive generations of Apple iPhones or new car models). Even conditional on the form of innovation, growth could be led by entrants and young firms (e.g., Uber or Netflix) or by older and larger firms (e.g., Intel or Starbucks). Figure 1 shows US productivity growth has been lackluster in recent decades, except for a decade-long surge from the mid-1990s through the mid-2000s. At the same time, as shown in figure 2, plant and firm entry rates have fallen and reallocation of labor across incumbent firms has slowed—a phenomenon coined “declining business dynamism” by papers such as Decker et al. (2014). Large, established superstar firms have captured a bigger share of markets. Is this declining dynamism and rising