Productivity

Productivity


Productivity is a measure of the efficiency
of production, that is, of production’s capability to create income, which is measured by the
formula real output value minus real input value.
Productivity can be expressed as a relationship of outputs compared to inputs in economic
processes. In economics it has alternate meanings. For a single input it means the ratio of output
to input. When multiple inputs are considered, such as labor and capital, it means the unaccounted
for level of output compared to the level of inputs. The inverted ratio of input to
output is commonly used at the company level to track individual inputs.
Productivity measures that use one or more inputs or factors, but not all factors, are
called partial productivities. A common example in economics is labor productivity, usually
expressed as output per hour. At the company level, typical partial productivity measures
are such things as worker hours, materials or energy per unit of production.
Productivity is a crucial factor in production performance of firms and nations. Increasing
national productivity can raise living standards because more real income improves people’s
ability to purchase goods and services, enjoy leisure, improve housing and education and
contribute to social and environmental programs. Productivity growth also helps businesses
to be more profitable. Characteristics of production
Economic well-being is created in a production process, meaning all economic activities that
aim directly or indirectly to satisfy human needs. The degree to which the needs are satisfied
is often accepted as a measure of economic well-being.
The satisfaction of needs originates from the use of the commodities which are produced.
The need satisfaction increases when the quality-price-ratio of the commodities improves and more satisfaction
is achieved at less cost. Improving the quality-price-ratio of commodities is to a producer an essential
way to enhance the production performance but this kind of gains distributed to customers
cannot be measured with production data. Economic well-being also increases due to
the growth of incomes that are gained from the growing and more efficient production.
The most important forms of production are market production, public production and production
in households. In order to understand the origin of the economic well-being we must
understand these three processes. All of them have production functions of their own which
interact with each other. Market production is the prime source of economic well-being
and therefore the “primus motor” of the economy. Productivity is in this economic
system the most important feature and an essential source of incomes.
Main processes of a producing company A producing company can be divided into sub-processes
in different ways; yet, the following five are identified as main processes, each with
a logic, objectives, theory and key figures of its own. It is important to examine each
of them individually, yet, as a part of the whole, in order to be able to measure and
understand them. The main processes of a company are as follows: real process.
income distribution process production process.
monetary process. market value process.
Productivity is created in the real process, productivity gains are distributed in the
income distribution process and these two processes constitute the production process.
The production process and its sub-processes, the real process and income distribution process
occur simultaneously, and only the production process is identifiable and measurable by
the traditional accounting practices. The real process and income distribution process
can be identified and measured by extra calculation, and this is why they need to be analysed separately
in order to understand the logic of production performance.
Real process generates the production output from input, and it can be described by means
of the production function. It refers to a series of events in production in which production
inputs of different quality and quantity are combined into products of different quality
and quantity. Products can be physical goods, immaterial services and most often combinations
of both. The characteristics created into the product by the producer imply surplus
value to the consumer, and on the basis of the price this value is shared by the consumer
and the producer in the marketplace. This is the mechanism through which surplus value
originates to the consumer and the producer likewise. It is worth noting that surplus
values to customers cannot be measured from any production data. Instead the surplus value
to a producer can be measured. It can be expressed both in terms of nominal and real values.
The real surplus value to the producer is an outcome of the real process, real income,
and measured proportionally it means productivity. Income distribution process of the production
refers to a series of events in which the unit prices of constant-quality products and
inputs alter causing a change in income distribution among those participating in the exchange.
The magnitude of the change in income distribution is directly proportionate to the change in
prices of the output and inputs and to their quantities. Productivity gains are distributed,
for example, to customers as lower product sales prices or to staff as higher income
pay. Davis has deliberated the phenomenon of productivity,
measurement of productivity, distribution of productivity gains, and how to measure
such gains. He refers to an article suggesting that the measurement of productivity shall
be developed so that it ”will indicate increases or decreases in the productivity of the company
and also the distribution of the ’fruits of production’ among all parties at interest”.
According to Davis, the price system is a mechanism through which productivity gains
are distributed, and besides the business enterprise, receiving parties may consist
of its customers, staff and the suppliers of production inputs. In this article, the
concept of ”distribution of the fruits of production” by Davis is simply referred
to as production income distribution or shorter still as distribution.
The production process consists of the real process and the income distribution process.
A result and a criterion of success of the owner is profitability. The profitability
of production is the share of the real process result the owner has been able to keep to
himself in the income distribution process. Factors describing the production process
are the components of profitability, i.e., returns and costs. They differ from the factors
of the real process in that the components of profitability are given at nominal prices
whereas in the real process the factors are at periodically fixed prices.
Monetary process refers to events related to financing the business. Market value process
refers to a series of events in which investors determine the market value of the company
in the investment markets. Production growth and performance Economic growth is defined as a production
growth of an output of a production process. It is usually expressed as a growth percentage
depicting growth of the real production output. The real output is the real value of products
produced in a production process and when we subtract the real input from the real output
we get the real income. The real output and the real income are generated by the real
process of production from the real inputs. The real process can be described by means
of the production function. The production function is a graphical or mathematical expression
showing the relationship between the inputs used in production and the output achieved.
Both graphical and mathematical expressions are presented and demonstrated. The production
function is a simple description of the mechanism of production growth. Real production growth
consists of two components. These components are a change in production input and a change
in productivity. The figure illustrates a production growth
process. The Value T2 represents the growth in output from Value T1. Each time of measurement
has its own graph of the production function for that time. The output measured at time
2 is greater than the output measured at time one for both of the components of growth:
an increase of inputs and an increase of productivity. The portion of growth caused by the increase
in inputs is shown on line 1 and does not change the relation between inputs and outputs.
The portion of growth caused by an increase in productivity is shown on line 2 with a
steeper slope. So increased productivity represents greater output per unit of input.
In the case of a single production process the output is defined as an economic value
of products and services produced in the process. When we want to examine an entity of many
production processes we have to sum up the value-added created in the single processes.
This is done in order to avoid the double accounting of intermediate inputs. Value-added
is obtained by subtracting the intermediate inputs from the outputs. The most well-known
and used measure of value-added is the GDP. It is widely used as a measure of the economic
growth of nations and industries. Production growth measures the growth of production
output and, therefore, it is only a rough indicator of economic welfare. It does not
reveal anything about the performance of the production process. The performance of production
measures production’s ability to generate income. Because the income from production
is generated in the real process, we call it the real income. Similarly, as the production
function is an expression of the real process, we could also call it “income generated
by the production function”. The real income generation follows the logic
of the production function. Two components can also be distinguished in the income change:
the income growth caused by an increase in production input and the income growth caused
by an increase in productivity. The income growth caused by increased production volume
is determined by moving along the production function graph. The income growth corresponding
to a shift of the production function is generated by the increase in productivity. The change
of real income so signifies a move from the point 1 to the point 2 on the production function.
When we want to maximize the production performance we have to maximize the income generated by
the production function. The production performance can be measured
as an average or an absolute income. Expressing performance both in average and absolute quantities
is helpful for understanding the welfare effects of production. For measurement of the average
production performance, we use the known productivity ratio Real output / Real input.
The absolute income of performance is obtained by subtracting the real input from the real
output as follows: Real income=Real output – Real input
The growth of the real income is the increase of the economic value which can be distributed
between the production stakeholders. With the aid of the production model we can perform
the average and absolute accounting in one calculation. Maximizing production performance
requires using the absolute measure, i.e. the real income and its derivatives as a criterion
of production performance. The differences between the absolute and average
performance measures can be illustrated by the following graph showing marginal and average
productivity. The figure is a traditional expression of average productivity and marginal
productivity. The maximum for production performance is achieved at the volume where marginal productivity
is zero. The maximum for production performance is the maximum of the real incomes. In this
illustrative example the maximum real income is achieved, when the production volume is
7.5. The maximum average productivity is reached when the production volume is 3.0. It is worth
noting that the maximum average productivity is not the same as the maximum of real income.
Figure above is a somewhat exaggerated depiction because the whole production function is shown.
In practice, decisions are made in a limited range of the production functions, but the
principle is still the same; the maximum real income is aimed for. An important conclusion
can be drawn. When we try to maximize the welfare effects of production we have to maximize
real income formation. Maximizing productivity leads to a suboptimum, i.e. to losses of incomes.
Maximizing productivity also leads to the phenomenon called “jobless growth” This refers
to economic growth as a result of productivity growth but without creation of new jobs and
new incomes from them. A practical example illustrates the case.
When a jobless person obtains a job in market production we may assume it is a low productivity
job. As a result average productivity decreases but the real income per capita increases.
Furthermore the well-being of the society also grows. This example reveals the difficulty
to interpret the total productivity change correctly. The combination of volume increase
and total productivity decrease leads in this case to the improved performance because we
are on the “diminishing returns” area of the production function. If we are on the
part of “increasing returns” on the production function, the combination of production volume
increase and total productivity increase leads to improved production performance. Unfortunately
we do not know in practice on which part of the production function we are. Therefore
a correct interpretation of a performance change is obtained only by measuring the real
income change. Production models
A production model is a numerical description of the production process and is based on
the prices and the quantities of inputs and outputs. There are two main approaches to
operationalize the concept productivity. We can use mathematical formulae, which are typically
used in macroeconomics or arithmetical models, which are typically used in microeconomics
and management accounting. We do not present the former approach here but refer to the
survey “Growth accounting” by Hulten 2009. We use here arithmetical models because they
are like the models of management accounting, illustrative and easily understood and applied
in practice. Furthermore they are integrated to management accounting, which is a practical
advantage. A major advantage of the arithmetical model is its capability to depict productivity
as a part of production process. Consequently productivity can be understood, measured,
and examined as a part of production process. There are different production models according
to different interests. Here we use a production income model, a production analysis model
and a growth accounting model in order to demonstrate productivity as a phenomenon and
a measureable quantity. Production income model The scale of success run by a going concern
is manifold, and there are no criteria that might be universally applicable to success.
Nevertheless, there is one criterion by which we can generalise the rate of success in production.
This criterion is the ability to produce surplus value. As a criterion of profitability, surplus
value refers to the difference between returns and costs, taking into consideration the costs
of equity in addition to the costs included in the profit and loss statement as usual.
Surplus value indicates that the output has more value than the sacrifice made for it,
in other words, the output value is higher than the value of the used inputs. If the
surplus value is positive, the owner’s profit expectation has been surpassed.
The table presents a surplus value calculation. We call this set of production data a basic
example and we use the data through the article in illustrative production models. The basic
example is a simplified profitability calculation used for illustration and modelling. Even
as reduced, it comprises all phenomena of a real measuring situation and most importantly
the change in the output-input mix between two periods. Hence, the basic example works
as an illustrative “scale model” of production without any features of a real measuring situation
being lost. In practice, there may be hundreds of products and inputs but the logic of measuring
does not differ from that presented in the basic example.
In this context we define the quality requirements for the production data used in productivity
accounting. The most important criterion of good measurement is the homogenous quality
of the measurement object. If the object is not homogenous, then the measurement result
may include changes in both quantity and quality but their respective shares will remain unclear.
In productivity accounting this criterion requires that every item of output and input
must appear in accounting as being homogenous. In other words the inputs and the outputs
are not allowed to be aggregated in measuring and accounting. If they are aggregated, they
are no longer homogenous and hence the measurement results may be biased.
Both the absolute and relative surplus value have been calculated in the example. Absolute
value is the difference of the output and input values and the relative value is their
relation, respectively. The surplus value calculation in the example is at a nominal
price, calculated at the market price of each period. Production analysis model A productivity model is a typical production
analysis model by help of which it is possible to calculate the outcome of the real process,
income distribution process and production process. The starting point is a profitability
calculation using surplus value as a criterion of profitability. The surplus value calculation
is the only valid measure for understanding the connection between profitability and productivity
or understanding the connection between real process and production process. A valid measurement
of total productivity necessitates considering all production inputs, and the surplus value
calculation is the only calculation to conform to the requirement. If we omit an input in
productivity or income accounting, this means that the omitted input can be used unlimitedly
in production without any impact on accounting results.
Accounting and interpreting The process of calculating is best understood
by applying the term ceteris paribus, i.e. “all other things being the same,” stating
that at a time only the impact of one changing factor be introduced to the phenomenon being
examined. Therefore, the calculation can be presented as a process advancing step by step.
First, the impacts of the income distribution process are calculated, and then, the impacts
of the real process on the profitability of the production.
The first step of the calculation is to separate the impacts of the real process and the income
distribution process, respectively, from the change in profitability. This takes place
by simply creating one auxiliary column in which a surplus value calculation is compiled
using the quantities of Period 1 and the prices of Period 2. In the resulting profitability
calculation, Columns 3 and 4 depict the impact of a change in income distribution process
on the profitability and in Columns 4 and 7 the impact of a change in real process on
the profitability. The accounting results are easily interpreted
and understood. We see that the real income has increased by 58.12 units from which 41.12
units come from the increase of productivity growth and the rest 17.00 units come from
the production volume growth. The total increase of real income is distributed to the stakeholders
of production, in this case 39.00 units to the customers and to the suppliers of inputs
and the rest 19.12 units to the owners. Here we can make an important conclusion. The income
change created in a real process is always distributed to the stakeholders as economic
values within the review period. Accordingly the changes in real income and income distribution
are always equal in terms of economic value. Based on the accounted changes of productivity
and production volume values we can explicitly conclude on which part of the production function
the production is. The rules of interpretations are the following:
The production is on the part of “increasing returns” on the production function, when
productivity and production volume increase or
productivity and production volume decrease The production is on the part of “diminishing
returns” on the production function, when productivity decreases and volume increases
or productivity increases and volume decreases.
In the basic example the combination of volume growth and productivity growth reports explicitly
that the production is on the part of “increasing returns” on the production function.
This model demonstration reveals the fundamental character of the phenomenon total productivity.
Total productivity is that part of real income change which is caused by the shift of the
production function. Accordingly any productivity measure is valid and understandable only when
it indicates correctly enough this kind of income change and as a part of real income
change. Another production model also gives details
of the income distribution. Because the accounting techniques of the two models are different,
they give differing, although complementary, analytical information. The accounting results
are, however, identical. We do not present the model here in detail but we only use its
detailed data on income distribution, when the objective functions are formulated in
the next section. Growth accounting model
Growth accounting model is used in economics to account the contribution of different factors
of production to economic growth. The idea of growth accounting is to decompose the growth
rate of economy’s total output into that which is due to increases in the amount of inputs
used and that which cannot be accounted for by observable changes in input utilization.
The unexplained part of growth is then taken to represent increases in productivity.
The growth accounting model is normally expressed in the form of the exponential growth function.
It can also be expressed in the form of the arithmetical model, which way is used here
because it is more descriptive and understandable. The principle of the accounting model is simple.
The weighted growth rates of inputs are subtracted from the weighted growth rates of outputs.
Because the accounting result is obtained by subtracting it is often called a “residual”.
The residual is often defined as the growth rate of output not explained by the share-weighted
growth rates of the inputs. We can use the real process data of the productivity
model in order to show the logic of the growth accounting model and identify possible differences
in relation to the productivity model. When the production data is the same in the model
comparison the differences in the accounting results are only due to accounting models.
We get the following growth accounting from the production data. The growth accounting procedure proceeds as
follows. First is calculated the growth rates for the output and the inputs by dividing
the Period 2 numbers with the Period 1 numbers. Then the weights of inputs are computed as
input shares of the total input. Weighted growth rates are obtained by weighting growth
rates with the weights. The accounting result is obtained by subtracting the weighted growth
rates of the inputs from the growth rate of the output. In this case the accounting result
is 0.015 which implies a productivity growth by 1.5%.
We note that the productivity model reports a 1.4% productivity growth from the same production
data. The difference is caused by the different production volume used in the models. In the
productivity model the input volume is used as a production volume measure giving the
growth rate 1.063. In this case productivity is defined as follows: output volume per one
unit of input volume. In the growth accounting model the output volume is used as a production
volume measure giving the growth rate 1.078. In this case productivity is defined as follows:
input consumption per one unit of output volume. The case can be verified easily with the aid
of productivity model using output as a production volume.
The accounting result of the growth accounting model is expressed as an index number, in
this example 1.015, which depicts the average productivity change. As demonstrated above
we cannot draw correct conclusions based on average productivity numbers. This is due
to the fact that productivity is accounted as an independent variable separated from
the entity it belongs to, i.e. real income formation. Hence, if we compare in a practical
situation two growth accounting results of the same production process we do not know
which one is better in terms of production performance. We have to know separately income
effects of productivity change and production volume change or their combined income effect
in order to understand which one result is better and how much better.
This kind of scientific mistake of wrong analysis level has been recognized and described long
ago.Vygotsky cautions against the risk of separating the issue under review from the
total environment, the entity of which the issue is an essential part. By studying only
this isolated issue we are likely to end up with incorrect conclusions. A practical example
illustrates this warning. Let us assume we are studying the properties of water in putting
out a fire. If we focus the review on small components of the whole, in this case the
elements oxygen and hydrogen, we come to the conclusion that hydrogen is an explosive gas
and oxygen is a catalyst in combustion. Therefore, their compound water could be explosive and
unsuitable for putting out a fire. This incorrect conclusion arises from the fact that the components
have been separated from the entity. Growth accounting based productivity models
were introduced in the 1980s to be used in management accounting but they did not gain
on as management tools. The reason is clear. The production functions are understood and
formulated differently in growth accounting and management accounting. In growth accounting
the production function is formulated as a function OUTPUT=F, which formulation leads
to maximize the average productivity ratio OUTPUT/INPUT. Average productivity has never
been accepted in management accounting as a performance criterion or an objective to
be maximized because it would mean the end of the profitable business. Instead the production
function is formulated as a function INCOME=F(OUTPUT-INPUT) which is to be maximized.
The name of the game is to maximize income, not to maximize productivity.
Objective functions An efficient way to improve the understanding
of production performance is to formulate different objective functions according to
the objectives of the different interest groups. Formulating the objective function necessitates
defining the variable to be maximized. After that other variables are considered as constraints.
The most familiar objective function is profit maximization which is also included in this
case. Profit maximization is an objective function that stems from the owner’s interest
and all other variables are constraints in relation to maximizing of profits. The procedure for formulating objective functions
The procedure for formulating different objective functions, in terms of the production model,
is introduced next. In the income formation from production the following objective functions
can be identified: Maximizing the real income
Maximizing the producer income Maximizing the owner income.
These cases are illustrated using the numbers from the basic example. The following symbols
are used in the presentation: The equal sign signifies the starting point of the computation
or the result of computing and the plus or minus sign signifies a variable that is to
be added or subtracted from the function. A producer means here the producer community,
i.e. labour force, society and owners. Objective function formulations can be expressed
in a single calculation which concisely illustrates the logic of the income generation, the income
distribution and the variables to be maximized. The calculation resembles an income statement
starting with the income generation and ending with the income distribution. The income generation
and the distribution are always in balance so that their amounts are equal. In this case
it is 58.12 units. The income which has been generated in the real process is distributed
to the stakeholders during the same period. There are three variables which can be maximized.
They are the real income, the producer income and the owner income. Producer income and
owner income are practical quantities because they are addable quantities and they can be
computed quite easily. Real income is normally not an addable quantity and in many cases
it is difficult to calculate. The dual approach for the formulation
Here we have to add that the change of real income can also be computed from the changes
in income distribution. We have to identify the unit price changes of outputs and inputs
and calculate their profit impacts. The change of real income is the sum of these profit
impacts and the change of owner income. This approach is called the dual approach because
the framework is seen in terms of prices instead of quantities.
The dual approach has been recognized in growth accounting for long but its interpretation
has remained unclear. The following question has remained unanswered: “Quantity based
estimates of the residual are interpreted as a shift in the production function, but
what is the interpretation of the price-based growth estimates?”. We have demonstrated
above that the real income change is achieved by quantitative changes in production and
the income distribution change to the stakeholders is its dual. In this case the duality means
that the same accounting result is obtained by accounting the change of the total income
generation and by accounting the change of the total income distribution.
National Productivity “Productivity isn’t everything, but in the
long run it is almost everything. A country’s ability to improve its standard of living
over time depends almost entirely on its ability to raise its output per worker.” [Read challenges
to the “output per worker” metric in “Validity” section below.]
In order to measure productivity of a nation or an industry, it is necessary to operationalize
the same concept of productivity as in a production unit or a company, yet, the object of modelling
is substantially wider and the information more aggregate. The calculations of productivity
of a nation or an industry are based on the time series of the SNA, System of National
Accounts. National accounting is a system based on the recommendations of the UN to
measure total production and total income of a nation and how they are used.
Productivity is considered a key source of economic growth and competitiveness and, as
such, is basic statistical information for many international comparisons and country
performance assessments. There are different measures of productivity and the choice among
them depends either on the purpose of the productivity measurement and/or data availability.
One of the most widely used measures of productivity is Gross Domestic Product per hour worked.
Another productivity measure is so called multi factor productivity also known as total
factor productivity. It measures the residual growth that cannot be explained by the rate
of change in the services of labour, capital and intermediate outputs, and is often interpreted
as the contribution to economic growth made by factors such as technical and organisational
innovation. Productivity measures are key indicators of
economic performance and there is strong interest in comparing them internationally. The OECD
publishes an annual Compendium of Productivity Indicators that includes both labor and multi-factor
measures of productivity. Several statistical offices publish productivity accounting handbooks
and manuals with detailed accounting instructions and definitions. For example the following:
Measuring Productivity – OECD Manual Office for National Statistics Productivity
handbook Bureau of Labor Statistics, Productivity Statistics
Labor productivity Labor productivity is the value of goods and
services produced in a period of time, divided by the hours of labor used to produce them.
In other words labor productivity measures output produced per unit of labor, usually
reported as output per hour worked or output per employed person.
OECD’s definition Labour productivity is a revealing indicator
of several economic indicators as it offers a dynamic measure of economic growth, competitiveness,
and living standards within an economy. It is the measure of labour productivity which
helps explain the principal economic foundations that are necessary for both economic growth
and social development. Although the ratio used to calculate labour
productivity provides a measure of the efficiency with which inputs are used in an economy to
produce goods and services, it can be measured in various ways. Labour productivity is equal
to the ratio between a volume measure of output and a measure of input use.
labour productivity=volume measure of output / measure of labor input use
The volume measure of output reflects the goods and services produced by the workforce.
Numerator of the ratio of labour productivity, the volume measure of output is measured either
by gross domestic product or gross value added. Although these two different measures can
both be used as output measures, there is normally a strong correlation between the
two. The measure of input use reflects the time,
effort and skills of the workforce. Denominator of the ratio of labour productivity, the input
measure is the most important factor that influences the measure of labour productivity.
Labour input is measured either by the total number of hours worked of all persons employed
or total employment. There are both advantages and disadvantages
associated with the different input measures that are used in the calculation of labour
productivity. It is generally accepted that the total number of hours worked is the most
appropriate measure of labour input because a simple headcount of employed persons can
hide changes in average hours worked, caused by the evolution of part-time work or the
effect of variations in overtime, absence from work or shifts in normal hours. However,
the quality of hours-worked estimates is not always clear. In particular, statistical establishment
and household surveys are difficult to use because of their varying quality of hours-worked
estimates and their varying degree of international comparability.
In contrast, total employment is easier to measure than the total number of hours worked.
However, total employment is less recommended as a measure of labour productivity because
it neither reflects changes in the average work time per employee nor changes in multiple
job holdings and the role of self-employed persons.
Validity Validity is a characteristic of the measure
which is used in measuring. Validity implies how exact information the used measure can
generate from the phenomenon. We need to understand the phenomenon, the measure and the possible
difference between them. Often when we aim at simplicity and understandability in measuring,
we have to lower the requirements for validity. For this reason it is important to evaluate
the validity of the measurements used, case by case. Good measuring presupposes that those
responsible for measuring are familiar with the validity of the measurements and also
keep users informed of the validity. The Gross Domestic Product is a technical
quantity of national accounts that measures the value-added generated by a nation. Value
added is equivalent to output less outside purchases. According to OECD, Gross Domestic
Product per capita measures economic activity or income per person and is one of the core
indicators of economic performance. GDP per capita is a rough measure of average living
standards or economic well-being. GDP is, for this purpose, only a very rough
measure. Maximizing GDP, in principal, also allows maximizing capital usage. For this
reason GDP is systematically biased in favour of capital intensive production at the expense
of knowledge and labour-intensive production. The use of capital in the GDP-measure is considered
to be as valuable as the production’s ability to pay taxes, profits and labor compensation.
The bias of the GDP is actually the difference between the GDP and the producer income.
Another labour productivity measure, output per worker, is often seen as a proper measure
of labour productivity as here: “Productivity isn’t everything, but in the long run it is
almost everything. A country’s ability to improve its standard of living over time depends
almost entirely on its ability to raise its output per worker.“ This measure is, however,
more problematic than the GDP or even invalid because this measure allows maximizing all
supplied inputs, i.e. materials, services, energy and capital at the expense of producer
income. Multifactor productivity The multifactor productivity model is an application
of the growth accounting model depicted above. Multifactor productivity is the ratio of the
real value of output to the combined input of labor and capital. Multi-factor productivity
is also known as total factor productivity and it measures the residual growth that cannot
be explained by the rate of change in the services of labour, capital and intermediate
outputs, and is often interpreted as the contribution to economic growth made by factors such as
technical and organisational innovation.. Historically there is a correlation of TPF
with energy conversion efficiency. Accounting procedure
Multifactor productivity is the name given to the Solow residual in the BLS productivity
program, replacing the term “total factor productivity” used in the earlier literature,
and both terms continue in use. The MFP measure can be compactly introduced with an accounting
procedure in the following calculation. We can use the fixed price values of the real
process in the productivity model above to show the accounting procedure. Fixed price
values of the real process depict commensurate volumes of the outputs and inputs. When we
subtract from the output so called intermediate inputs we obtain the value-added. Value-added
is used as an output in MFP measure. The principle is to compare the growth of the value-added
to the growth of labour and capital input. The formula of the MFP growth is as follows:
change of MFP=change of output minus change of labour input x cost share
of labour minus change of capital input x cost share
of capital As an accounting result the MFP growth is
1.119-0.546-0.541=0.032 or 3.2%. It is somewhat unclear what phenomenon is
measured with this measure. There are many explanations. One explanation is derived from
the fact, that MFP is an average measure of some phenomenon. Then is traced the original
phenomenon which can be presented in the form of the following formula: Value-Added minus
Total Input, i.e. Labor and Capital. We come to a conclusion, that the original phenomenon
is production profitability and the MFP is a rough average measure of production profitability
change. According to the definition above “MFP is
often interpreted as the contribution to economic growth made by factors such as technical and
organisational innovation” . The most famous description is that of Solow’s: ”I am
using the phrase ’technical change’ as a shorthand expression for any kind of shift
in the production function. Thus slowdowns, speed ups, improvements in the education of
the labor force and all sorts of things will appear as ’technical change’ ”. Yet
another opinion: In practice, TFP is a measure of our ignorance, as Abramovitz put it, precisely
because it is a residual. This ignorance covers many components, some wanted, others unwanted.
The original MFP model involves several assumptions: that there is a stable functional relation
between inputs and output at the economy-wide level of aggregation, that this function has
neoclassical smoothness and curvature properties, that inputs are paid the value of their marginal
product, that the function exhibits constant returns to scale, and that technical change
has the Hicks’n neutral form. However no instructions have been given how these assumptions
should be taken into account in practical situations when the accounting results are
interpreted. Hence it remains unclear how much is measured the real world and how much
the assumptions made. Validity
In order to evaluate validity of any measure we need to understand the phenomenon, the
measure and the possible difference between them. In the case of MFP we cannot make this
evaluation in a traditional way because the phenomenon intended to measure is somewhat
unclear. Instead we can identify the differences between MFP model and total productivity model.
As seen from the accounting results the MFP model and the total productivity model report
differing accounting results from the same production data. MFP-model reports a productivity
change of 3.2% which is more than double compared to the result of the total productivity model,
the change of 1.4%. The difference between the models can be explained with the modifications
made to the MFP model. In the MFP model the Value Added is used as
an output instead of Total Output. Value added is also used as a measure of production volume
instead of input volume. As a result of these modifications production volume change in
the MFP model is 1.119 instead of 1.078 in the total productivity model.
The real income which is the measure of production performance is totally eliminated in the MFP
model. Actually real income is replaced in the MFP model with the capital usage by making
the following assumption: Real income=Capital usage. The reason of this modification is
not known nor argued but for sure it will weaken the validity of the measure.
It is clear that due to these modifications the models report differing accounting results
from the same production data. Importance of national productivity growth Productivity growth is a crucial source of
growth in living standards. Productivity growth means more value is added in production and
this means more income is available to be distributed.
At a firm or industry level, the benefits of productivity growth can be distributed
in a number of different ways: to the workforce through better wages and
conditions; to shareholders and superannuation funds through
increased profits and dividend distributions; to customers through lower prices;
to the environment through more stringent environmental protection; and
to governments through increases in tax payments. Productivity growth is important to the firm
because it means that it can meet its obligations to workers, shareholders, and governments,
and still remain competitive or even improve its competitiveness in the market place.
There are essentially two ways to promote growth in output:
bring additional inputs into production; or increase productivity.
Adding more inputs will not increase the income earned per unit of input. In fact, it is likely
to mean lower average wages and lower rates of profit.
But, when there is productivity growth, even the existing commitment of resources generates
more output and income. Income generated per unit of input increases. Additional resources
are also attracted into production and can be profitably employed.
At the national level, productivity growth raises living standards because more real
income improves people’s ability to purchase goods and services, enjoy leisure, improve
housing and education and contribute to social and environmental programs. Over long periods
of time, small differences in rates of productivity growth compound, like interest in a bank account,
and can make an enormous difference to a society’s prosperity. Nothing contributes more to reduction
of poverty, to increases in leisure, and to the country’s ability to finance education,
public health, environment and the arts’. Sources of productivity growth
The most famous description of the productivity sources is that of Solow’s: ”I am using
the phrase ’technical change’ as a shorthand expression for any kind of shift in the production
function. Thus slowdowns, speed ups, improvements in the education of the labor force and all
sorts of things will appear as ’technical change’ ” Since then more specific descriptions
of productivity sources have emerged referring to investment, innovations, skills, enterprise
and competition. Drivers of productivity growth
There is a general understanding of the main determinants – or “drivers” – of
productivity growth. Certain factors are critical for determining productivity growth. The Office
for National Statistics identifies five drivers that interact to underlie long-term productivity
performance: investment, innovation, skills, enterprise and competition.
Investment is in physical capital — machinery, equipment and buildings. The more capital
workers have at their disposal, generally the better they are able to do their jobs,
producing more and better quality output. Innovation is the successful exploitation
of new ideas. New ideas can take the form of new technologies, new products or new corporate
structures and ways of working. Such innovations can boost productivity, for example as better
equipment works faster and more efficiently, or better organisation increases motivation
at work. Skills are defined as the quantity and quality
of labour of different types available in an economy. Skills complement physical capital,
and are needed to take advantage of investment in new technologies and organisational structures.
Enterprise is defined as the seizing of new business opportunities by both start-ups and
existing firms. New enterprises compete with existing firms by new ideas and technologies
increasing competition. Entrepreneurs are able to combine factors of production and
new technologies forcing existing firms to adapt or exit the market.
Competition improves productivity by creating incentives to innovate and ensures that resources
are allocated to the most efficient firms. It also forces existing firms to organise
work more effectively through imitations of organisational structures and technology.
Other drivers of productivity growth include effective supervision and job satisfaction.
Having an effective or knowledgeable supervisor has an easier time motivating their employees
to produce more in quantity and quality. An employee who has an effective supervisor,
motivating them to be more productive is likely to experience a new level of job satisfaction
thereby becoming a driver of productivity itself.
Productivity improving technologies In the most immediate sense, productivity
is determined by: the available technology or know-how for converting
resources into outputs desired in an economy; and
the way in which resources are organised in firms and industries to produce goods and
services. Average productivity can improve as firms
move toward the best available technology; plants and firms with poor productivity performance
cease operation; and as new technologies become available. Firms can change organisational
structures, management systems and work arrangements to take the best advantage of new technologies
and changing market opportunities. A nation’s average productivity level can also be affected
by the movement of resources from low-productivity to high-productivity industries and activities.
with increase pressure from the international or National productivity growth stems from
a complex interaction of factors. As just outlined, some of the most important immediate
factors include technological change, organisational change, industry restructuring and resource
reallocation, as well as economies of scale and scope. Over time, other factors such as
research and development and innovative effort, the development of human capital through education,
and incentives from stronger competition promote the search for productivity improvements and
the ability to achieve them. Ultimately, many policy, institutional and cultural factors
determine a nation’s success in improving productivity.
Productivity articles with a special focus The purpose of this main article is to describe
the theory of productivity and to make the concept of productivity a measureable quantity.
Other interesting aspects of productivity are presented in the articles with a special
focus to productivity. Productivity in practice Productivity is one of the main concerns of
business management and engineering. Practically all companies have established procedures
for collecting, analyzing and reporting the necessary data. Typically the accounting department
has overall responsibility for collecting and organizing and storing the data, but some
data normally originates in the various departments. Productivity paradox Despite the proliferation of computers, productivity
growth was relatively slow from the 1970s through the early 1990s. Although several
possible cause for the slowdown have been proposed there is no consensus. The matter
is subject to a continuing debate that has grown beyond questioning whether just computers
can significantly increase productivity to whether the potential to increase productivity
is becoming exhausted. Partial productivity Measurement of partial productivity refers
to the measurement solutions which do not meet the requirements of total productivity
measurement, yet, being practicable as indicators of total productivity. In practice, measurement
in production means measures of partial productivity. In that case, the objects of measurement are
components of total productivity, and interpreted correctly, these components are indicative
of productivity development. The term of partial productivity illustrates well the fact that
total productivity is only measured partially – or approximately. In a way, measurements are
defective but, by understanding the logic of total productivity, it is possible to interpret
correctly the results of partial productivity and to benefit from them in practical situations.
See also Productivity model
Production Production, costs, and pricing
Production theory basics Production possibility frontier
Production function Computer-aided manufacturing
Productive and unproductive labour Productive forces
Productivity improving technologies Division of labour
Mass production Assembly line
Second Industrial Revolution Industrial Revolution
Footnotes References External links
Field, Alexander J.. “Productivity”. In David R. Henderson. Concise Encyclopedia of Economics.
Indianapolis: Library of Economics and Liberty. ISBN 978-0865976658. OCLC 237794267. 
Productivity and Costs – Bureau of Labor Statistics United States Department of Labor:
contains international comparisons of productivity rates, historical and present
Productivity Statistics – Organisation for Economic Co-operation and Development
Greenspan Speech OECD estimates of labour productivity levels

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