Growth Accounting, Total Factor Productivity and Approximation Problem

The paper deals with the approximation problem of standard growth accounting method first introduced by Solow (1957). This method is still used widely by lots of economists and institutions (IMF, national banks and others) for computing the technological or total factor productivity (TFP) dynamics. According to standard growth accounting the TFP growth is a residual, computed simply out of dynamic Cobb-Douglas (original or modified) production function. The purpose of this paper is to show that the usual TFP calculation as a residual is more or less inaccurate and for certain cases can cause slightly biased conclusions. The idea of such weak approximation is based on the nature of differential itself. The growth accounting computes the TFP dynamics accurately only under certain conditions based mainly on assumption of sufficiently small changes in variables.