Accounting for cross-country output differences: A sectoral CES perspective

Conventional development accounting attributes the enormous variation in output per worker across countries to differences in production factors and productivity. Our paper contributes to this literature along three important lines. First, we tackle the simplifying assumption of an aggregate Cobb-Douglas production function by estimating more flexible constant elasticity of substitution (CES) production functions in a tradable market sector and five subsectors across 38 countries. Our results suggest that physical and human capital are gross complements in production in all sectors, indicating that production factors play a larger role in explaining cross-country output differences than previously thought. Second, we find that differences in output per worker largely stem from the efficiency with which countries employ human capital. Third, we highlight the importance of sector-level analyses by showing that productivity differences play a smaller role in construction, distribution services, and financial and business services than in manufacturing and personal services.