Secular Stagnation of Total Factor Productivity

Abstract

Italy’s economic crisis – arguably – poses the greatest challenge to the future of European economic and monetary integration, not just because of the relative size of the Italian economy or because Italy has been a founding member of the European Union and its forerunner. A more important reason is the country’s pre-crisis economic stagnation which had started long before the 2008 Global Financial Crisis and which had put Italy in a relatively disadvantageous position when the crisis happened. To investigate this secular stagnation of economic growth in the Italian case, this study looks into potential output growth as determined by the growth in Total Factor Productivity, or TFP growth. This report first scrutinizes the concept of TFP growth and shows that it can be defined in three ways: (i) as a “residual”, following Solow’s work; (ii) as weighted average factor productivity growth; and (iii) and as weighted average factor payment growth. We utilize “shift-share” analysis to dissemble labor productivity growth into two components: “within-“ and “between-sector” labor productivity growth. Last, we construct economic model of secular stagnation of TFP growth in the Italian economy. We use all three definitions and show that that aggregate Italian TFP growth has been stagnating since the country’s peak growth in 1973. Our findings show that Italian economy has been suffering predominantly by the secular stagnation in its within-sector labor productivity. By analyzing the evidence on the country’s long-run real wage between dynamic and stagnant sectors, we find that real wage growth rates have been declining across the board as well. Thus, we find no support for Italy of the “cost disease” that Baumol predicted, i.e. the rise in the relative price of the services, the sector that is stagnant in terms of productivity growth. Using 2SLS regression analysis, our economic model shows that real wage growth and final demand growth can partly define the phenomenon of secular stagnation of TFP growth in the Italian economy.