DP7990 | Solow Residuals without Capital Stocks

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Using synthetic data generated by a prototypical stochastic growth model, we explore the quantitative extent of measurement error of the Solow residual (Solow 1957) as a measure of total factor productivity (TFP) growth when the capital stock is measured with error and when capacity utilization and depreciation are endogenous. We propose two alternative measurements of TFP growth which do not require capital stocks: one measure eliminates the capital stock by direct substitution, while the other is based on generalized diff erences of detrended data and the Malmquist index. The root mean squared errors of these alternatives are as low as one third of those for the Solow-Tornqvist residual. Our comparative evaluations on artificial data indicate that measurement problems are severe, in particular for economies still far from their steady state. This drawback of the Solow residual is thus most acute in applications in which its accuracy is most highly valued. As an application, we compute and compare TFP growth estimates using data from the new and old German federal states.