Development Accounting

Researchers have made much progress in the past 25 years in accounting for the proximate determinants of income levels: physical capital, human capital, and Total Factor Productivity (TFP). But we still know little about why these factors vary. We argue that TFP exerts a powerful influence on output not only directly, but also indirectly, through its effect on physical and human capital accumulation. We discuss why TFP varies across countries, highlighting misallocation of inputs across firms and industries as a key determinant.