Growth Model and Macroeconomic Projections

The PWBMsim is calibrated to reflect U.S. demographic and economic characteristics in an extremely detailed manner. All of the important conditioning information is employed in the development of each individual and family attribute and the result is extensively validated over the historical simulation from 1996-2015. The goal of developing such a detailed microsimulation is to aggregate population attributes to make historical validations and projections of macro-economic variables such as GDP, the capital stock, labor force, productivity, economic growth, and so on. However, to be comprehensive and to maintain the consistency of estimates over time, all population attributes must be integrated under a coherent and internally consistent framework. That framework is provided by the standard-form Solow growth model.

The Solow growth model is a widely-used work-horse for organizing economic activity: using economic inputs (capital, labor, and productive technology) to produce outputs (goods and services for consumption and investment) and to determine the distribution of the value of total output across the inputs – providers of labor and capital services.

The PWBMsim microsimulation provides the inputs of labor and capital services. Labor services are derived from the population’s characteristics: Labor force participation by individuals with a variety of productive attributes -- the same ones simulated. Capital services are derived from a model of capital accumulation at the micro level calibrated to data from the Federal Reserve's Survey of Consumer Finances, including foreign sourced capital inflows into the United States.

Total economic output is the result of capital and labor inputs modeled as a "production function." This function describes how the quantity of labor and capital available to the economy are tranformed into consumable and investible output of goods and services. The transformation is governed by two key parameters: The output elasticities of capital and labor and a technological growth parameter. The output elasticity of capital dictates the rate of conversion of capital per worker into output per worker. This elasticity is assumed to be 0.35. The technological growth parameter dictates by how much extra output is produced each year relative to the amount that would result from available inputs, with the extra output resulting from technological improvements. These two parameters are estimated from macro-economic data on labor services (hours worked and the efficiency of employed workers), capital services (an index of productive capital defined over the collection of existing commercial and residential buildings, structures, equipment, computer hardware and software, etc, weighed by their productive service generating capacities), and total value of the nation's output of goods and services.

Labor and capital output elasticities also determine the contributions of the two inputs to total production, thus pinning down the rates at which the two are compensated. In particular, these compensation rates are used to govern and allocate returns to labor services provided by workers in PWBMsim. Technological growth combined with growth in the national population, employment and capital stocks govern growth of GDP, capital and labor returns, worker wage and non-wage compensation, tax bases, and government revenues from taxes levied on labor and capital income, payroll taxes, corporate taxes, and indirect and other taxes. The Solow growth model framework described briefly here is elaborated in Appendix 6.