EQUIPMENT AND STRUCTURES CAPITAL: ACCOUNTING FOR INCOME DIFFERENCES

I. INTRODUCTION Cross-country differences in income per worker are enormous. The ratio of 90th to 10th percentile in the world income distribution is over 20 (Penn World Tables [PWT] version 6.3, see Heston, Summers, and Aten 2009). The literature on income differences points to the importance of differences in stocks of physical capital across countries. It is well known that rich countries have much larger stocks of physical capital than poor countries. The capital-output ratio in the country at the 90th percentile of the world income distribution is over three times the capital-output ratio in the 10th percentile country. The 90-10 ratio of capital-per worker is also large, at nearly 75. In fact, the cross-country dispersion in physical capital is more than the dispersion in income per worker (see Figure 1). Little is known about the composition of physical capital across countries. Most of the literature treats physical capital as a homogeneous good. International dollar values of all types of capital goods are summed up to arrive at the aggregate capital stock of a country, with prices acting as weights. Even if the relative valuations of various types of capital are captured by the prices, their relative contributions to output, and hence the contribution of capital composition, are not accounted for by the prices. Such an aggregation also assumes that the various types of capital are perfect substitutes of one another, which is clearly not the case. Using the U.S. data on manufacturing, Sato (1967) estimates the elasticity of substitution between equipment and structures and finds that the two kinds of capital are far from being perfect substitutes. In this article, I present purchasing power parity (PPP) measures of the stocks of equipment capital and structures capital for 119 countries, and demonstrate that the composition of capital is systematically related with the income per worker. To construct the stocks of equipment and structures capital, I use data on the PPP investment levels for equipment and structures during 1950-2004, and employ the perpetual inventory method. Equipment corresponds to fabricated metal products, electrical and nonelectrical machinery, transport equipment, communication equipment, office machinery, and professional and scientific equipment. Structures comprise both residential and nonresidential buildings. The cross-country dispersion in equipment capital is much larger than the dispersion in structures capital and aggregate capital. The equipment capital-output ratio is a factor of about 7 between rich and poor countries, while the structures capital-output ratio is a factor of 3, and the aggregate capital-output ratio is a factor of 3.3. The composition of capital is systematically related with the income levels. On average, equipment is 21% of the total capital stock in rich countries and 8% in poor countries. The dispersion in equipment capital has also increased over time, while the dispersion in structures has declined. This systematic variation of heterogeneous capital with incomes is potentially significant for the income differences across countries, as also previously noted by Caselli (2005). [FIGURE 1 OMITTED] The success of factors in accounting for income differences is determined by the way we model and measure factors across countries. In the absence of measures of heterogeneous capital, standard development accounting exercises have attributed a large fraction of the income differences to unknown total factor productivity (TFP) differences. In this article, I conduct development accounting with equipment and structures capital to determine the significance of capital composition for the income differences. For development accounting, I consider both Cobb-Douglas and constant elasticity of substitution (CES) specifications to aggregate equipment and structures within a Cobb-Douglas production function. (1) In my sample of 119 countries for the year 2004, the log variance in income per worker is 1. …