Verdoorn’s law

2 April, 2017 at 11:25 | Posted in Economics | 2 Comments

In the standard mainstream economic analysis a demand expansion may very well raise measured productivity in the short run. But in the long run, expansionary demand policy measures cannot lead to sustained higher productivity and output levels.

verdoornIn some non-standard heterodox analyses, however, labour productivity growth is often described as a function of output growth. The rate of technical progress varies directly with the rate of growth according to Verdoorn’s law. Growth and productivity is in this view highly demand-determined, not only in the short run but also in the long run.

Given that Verdoorn’s law is operative, expansionary economic policies actually may lead to increases in productivity and growth. Living in a world permeated by genuine Keynes-type uncertainty, we can, of course, not with any greater precision forecast how great those effects would be.

60274818So, the nodal point is — has Verdoorn’s Law been validated or not in empirical studies?

There have been hundreds of studies that have tried to answer that question, and as could be imagined, the answers differ. The law has been investigated with different econometric methods (time-series, IV, OLS, ECM, cointegration, etc.). The statistical and econometric problems are enormous (especially when it comes to the question on the direction of causality). Given this, however, most studies on the country level do confirm that the Verdoorn law holds.

Conclusion: demand policy measures can have both short and long run effects.

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2 Comments »

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  1. This suggests an exponential growth relationship if both rate of growth and the amount of it are directly related. But as we well know there are other factors which also apply and change this limited theory. We need to look at all of the Big Picture to properly appreciate what other factors apply and in particular how much speculation in land values is constraining the prosperity of a developing region.

    • Verdoorn’s law just changes the standard mainstream economic analysis from precisely wrong to vaguely wrong. We need to consider more complete factors: relative labor productivity to labor compensation, and relative labor cost to payroll number in labor force.
      .
      This precisely right equation can be derived as shown below from macro accounting data. This equation reflects the economic reality. It is not in exponential growth relationship.
      .
      GDP=relative_labor_productivity *relative_labor_compensation*payroll


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