A new decomposition approach to growth accounting: derivation of the formula and its application to prewar Japan

How can an economy grow in the early stages of economic development in the absence of total factor productivity growth, as has been allegedly the case in fast-growing East Asian economies? This paper advances the hypothesis that capital deepening associated with transformation of industrial structure can sustain growth for a long period without causing a decline in the rate of returns to capital. To examine our hypothesis, we develop a new decomposition formula for growth accounting that highlights such capital deepening. The formula is applied to data from prewar Japan, to assess the significance of industrial transformation in economic growth.