Abstract
This paper studies the joint evolution of aggregate productivity and welfare in Spain and Italy between 1970 and 2010. Using a growth-accounting framework for open and distorted economies with input-output linkages, I construct aggregate TFP measures that correct biases in conventional Solow residuals. Once distortions are taken into account, the productivity decline in Spain begins seven years later and is roughly half as large as the traditional Solow residual suggests. To identify the sources of this decline, I develop a novel decomposition of aggregate TFP growth that separates the contributions of technical efficiency, factor reallocation, and changes in domestic and foreign intermediate linkages. I find that Spain’s TFP decline is driven entirely by the reallocation of capital and labor toward low-productivity service sectors, whereas in Italy the decline is driven mainly by deteriorating technical efficiency. Aggregate welfare nevertheless continued to rise in both countries, sustained by factor accumulation and technological progress at home and abroad, revealing a systematic TFP-welfare disconnect.
