Total factor productivity

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In economics, total-factor productivity (TFP), also called multi-factor productivity, is usually measured as the ratio of aggregate output (e.g., GDP) to aggregate inputs. [1] Under some simplifying assumptions about the production technology, growth in TFP becomes the portion of growth in output not explained by growth in traditionally measured inputs of labour and capital used in production. [2] TFP is calculated by dividing output by the weighted geometric average of labour and capital input, with the standard weighting of 0.7 for labour and 0.3 for capital. [3] Total factor productivity is a measure of productive efficiency in that it measures how much output can be produced from a certain amount of inputs. It accounts for part of the differences in cross-country per-capita income. [2] For relatively small percentage changes, the rate of TFP growth can be estimated by subtracting growth rates of labor and capital inputs from the growth rate of output. [2]

Contents

Background

Technology growth and efficiency are regarded as two of the biggest sub-sections of total factor productivity, the former possessing "special" inherent features such as positive externalities and non-rivals which enhance its position as a driver of economic growth.[ citation needed ]

Total factor productivity (TFP) is often considered the primary contributor to GDP growth rate. Other contributing factors include labor inputs, human capital, and physical capital. Total factor productivity measures residual growth in total output of a firm, industry or national economy that cannot be explained by the accumulation of traditional inputs such as labor and capital. Since this cannot be measured directly the process of calculating derives TFP as the residual which accounts for effects on total output not caused by inputs.

It has been shown that there is a historical correlation between TFP and energy conversion efficiency. [4] Also, it has been found that integration (among firms for example) has a causal positive impact on total factor productivity. [5]

Calculation

The equation below (in Cobb–Douglas form) is often used to represent total output (Y) as a function of total-factor productivity (A), capital input (K), labour input (L), and the two inputs' respective shares of output (α and β are the share of contribution for K and L respectively). As usual for equations of this form, an increase in either A, K or L will lead to an increase in output.

Estimation and refinements

As a residual, TFP is also dependent on estimates of the other components. [6]

In 2001, William Easterly and Ross Levine estimated that for an average country the TFP accounts for 60 percent of growth of output per worker. [7] : 185 

A 2005 study on human capital attempted to correct for weaknesses in estimations of the labour component of the equation, by refining estimates of the quality of labour. Specifically, years of schooling is often taken as a proxy for the quality of labour (and stock of human capital), which does not account for differences in schooling between countries. Using these re-estimations, the contribution of TFP was substantially lower. [8]

Robert Ayres and Benjamin Warr have found that the model can be improved by using the efficiency of energy conversion, which roughly tracks technological progress. [9] [10]

Critiques

The word "total" suggests all inputs have been measured. Official statisticians tend to use the term "multifactor productivity" (MFP) instead of TFP because some inputs such as energy are usually not included. External costs including attributes of the workforce, public infrastructure such as highways and environmental sustainability costs such as mineral depletion and pollution are not traditionally included. [11] [12] [13] [14]

Growth accounting exercises and total factor productivity are open to the Cambridge critique. Therefore, some economists believe that the method and its results are invalid or need to be carefully interpreted and used along with other alternative approaches. [1]

On the basis of dimensional analysis, TFP has been criticized as lacking meaningful units of measurement. [15] : 96  The units of the quantities in the Cobb–Douglas equation are:[ citation needed ]

In this construction the units of A would not have a simple economic interpretation, and the concept of TFP appears to be a modeling artifact. Official statistics avoid measuring levels, instead constructing unitless growth rates of output and inputs and thus also for the residual.

See also

Related Research Articles

In economics, factors of production, resources, or inputs are what is used in the production process to produce output—that is, goods and services. The utilized amounts of the various inputs determine the quantity of output according to the relationship called the production function. There are four basic resources or factors of production: land, labour, capital and entrepreneur. The factors are also frequently labeled "producer goods or services" to distinguish them from the goods or services purchased by consumers, which are frequently labeled "consumer goods".

Growth accounting is a procedure used in economics to measure the contribution of different factors to economic growth and to indirectly compute the rate of technological progress, measured as a residual, in an economy. Growth accounting decomposes the growth rate of an economy's total output into that which is due to increases in the contributing amount of the factors used—usually the increase in the amount of capital and labor—and that which cannot be accounted for by observable changes in factor utilization. The unexplained part of growth in GDP is then taken to represent increases in productivity or a measure of broadly defined technological progress.

<span class="mw-page-title-main">Agricultural productivity</span> Quotient between production and productive factors

Agricultural productivity is measured as the ratio of agricultural outputs to inputs. While individual products are usually measured by weight, which is known as crop yield, varying products make measuring overall agricultural output difficult. Therefore, agricultural productivity is usually measured as the market value of the final output. This productivity can be compared to many different types of inputs such as labour or land. Such comparisons are called partial measures of productivity.

Capital intensity is the amount of fixed or real capital present in relation to other factors of production, especially labor. At the level of either a production process or the aggregate economy, it may be estimated by the capital to labor ratio, such as from the points along a capital/labor isoquant.

Efficiency is the often measurable ability to avoid making mistakes or wasting materials, energy, efforts, money, and time while performing a task. In a more general sense, it is the ability to do things well, successfully, and without waste.

<span class="mw-page-title-main">Cobb–Douglas production function</span> Macroeconomic formula that describes productivity

In economics and econometrics, the Cobb–Douglas production function is a particular functional form of the production function, widely used to represent the technological relationship between the amounts of two or more inputs and the amount of output that can be produced by those inputs. The Cobb–Douglas form is developed and tested against statistical evidence by Charles Cobb and Paul Douglas between 1927 and 1947; according to Douglas, the functional form itself was developed earlier by Philip Wicksteed.

<span class="mw-page-title-main">Production function</span> Used to define marginal product and to distinguish allocative efficiency

In economics, a production function gives the technological relation between quantities of physical inputs and quantities of output of goods. The production function is one of the key concepts of mainstream neoclassical theories, used to define marginal product and to distinguish allocative efficiency, a key focus of economics. One important purpose of the production function is to address allocative efficiency in the use of factor inputs in production and the resulting distribution of income to those factors, while abstracting away from the technological problems of achieving technical efficiency, as an engineer or professional manager might understand it.

Productivity is the efficiency of production of goods or services expressed by some measure. Measurements of productivity are often expressed as a ratio of an aggregate output to a single input or an aggregate input used in a production process, i.e. output per unit of input, typically over a specific period of time. The most common example is the (aggregate) labour productivity measure, one example of which is GDP per worker. There are many different definitions of productivity and the choice among them depends on the purpose of the productivity measurement and data availability. The key source of difference between various productivity measures is also usually related to how the outputs and the inputs are aggregated to obtain such a ratio-type measure of productivity.

<span class="mw-page-title-main">Diminishing returns</span> Economic theory

In economics, diminishing returns are the decrease in marginal (incremental) output of a production process as the amount of a single factor of production is incrementally increased, holding all other factors of production equal. The law of diminishing returns states that in productive processes, increasing a factor of production by one unit, while holding all other production factors constant, will at some point return a lower unit of output per incremental unit of input. The law of diminishing returns does not cause a decrease in overall production capabilities, rather it defines a point on a production curve whereby producing an additional unit of output will result in a loss and is known as negative returns. Under diminishing returns, output remains positive, but productivity and efficiency decrease.

In economics, the concept of returns to scale arises in the context of a firm's production function. It explains the long-run linkage of increase in output (production) relative to associated increases in the inputs.

The Solow residual is a number describing empirical productivity growth in an economy from year to year and decade to decade. Robert Solow, the Nobel Memorial Prize in Economic Sciences-winning economist, defined rising productivity as rising output with constant capital and labor input. It is a "residual" because it is the part of growth that is not accounted for by measures of capital accumulation or increased labor input. Increased physical throughput – i.e. environmental resources – is specifically excluded from the calculation; thus some portion of the residual can be ascribed to increased physical throughput. The example used is for the intracapital substitution of aluminium fixtures for steel during which the inputs do not alter. This differs in almost every other economic circumstance in which there are many other variables. The Solow residual is procyclical and measures of it are now called the rate of growth of multifactor productivity or total factor productivity, though Solow (1957) did not use these terms.

The Solow–Swan model or exogenous growth model is an economic model of long-run economic growth. It attempts to explain long-run economic growth by looking at capital accumulation, labor or population growth, and increases in productivity largely driven by technological progress. At its core, it is an aggregate production function, often specified to be of Cobb–Douglas type, which enables the model "to make contact with microeconomics". The model was developed independently by Robert Solow and Trevor Swan in 1956, and superseded the Keynesian Harrod–Domar model.

<span class="mw-page-title-main">Productive efficiency</span> When one must decrease production of one good to increase another in an economy

In microeconomic theory, productive efficiency is a situation in which the economy or an economic system operating within the constraints of current industrial technology cannot increase production of one good without sacrificing production of another good. In simple terms, the concept is illustrated on a production possibility frontier (PPF), where all points on the curve are points of productive efficiency. An equilibrium may be productively efficient without being allocatively efficient — i.e. it may result in a distribution of goods where social welfare is not maximized.

Domar aggregation is an approach to aggregating growth measures associated with industries to make larger sector or national aggregate growth rates. The issue comes up in the context of national accounts and multifactor productivity (MFP) statistics.

The Malmquist Index (MI) is a bilateral index that can be used to compare the production technology of two economies. It is named after Professor Sten Malmquist, on whose ideas it is based. It is also called the Malmquist Productivity Index.

Stochastic frontier analysis (SFA) is a method of economic modeling. It has its starting point in the stochastic production frontier models simultaneously introduced by Aigner, Lovell and Schmidt (1977) and Meeusen and Van den Broeck (1977).

Production is the process of combining various inputs, both material and immaterial in order to create output. Ideally this output will be a good or service which has value and contributes to the utility of individuals. The area of economics that focuses on production is called production theory, and it is closely related to the consumption theory of economics.

Productivity in economics is usually measured as the ratio of what is produced to what is used in producing it. Productivity is closely related to the measure of production efficiency. A productivity model is a measurement method which is used in practice for measuring productivity. A productivity model must be able to compute Output / Input when there are many different outputs and inputs.

In the technological theory of social production, the growth of output, measured in money units, is related to achievements in technological consumption of labour and energy. This theory is based on concepts of classical political economy and neo-classical economics and appears to be a generalisation of the known economic models, such as the neo-classical model of economic growth and input-output model.

References

  1. 1 2 Sickles, R., & Zelenyuk, V. (2019). Measurement of Productivity and Efficiency: Theory and Practice. Cambridge: Cambridge University Press. doi:10.1017/9781139565981
  2. 1 2 3 Comin, Diego (August 2006). "Total Factor Productivity∗" (PDF).
  3. ↑ Robert J. Gordon (29 August 2017). The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War. Princeton University Press. ISBN   978-1-4008-8895-5.
  4. ↑ Ayres, R. U.; Ayres, L. W.; Warr, B. (2002). "Exergy, Power and Work in the U. S. Economy 1900-1998, Insead's Center For the Management of Environmental Resources, 2002/52/EPS/CMER" (PDF).{{cite journal}}: Cite journal requires |journal= (help)
  5. ↑ Natividad, G. (2014). "Integration and Productivity: Satellite-Tracked Evidence". Management Science. 60 (7): 1698–1718. doi:10.1287/mnsc.2013.1833.
  6. ↑ Zelenyuk (2014). "Testing Significance of Contributions in Growth Accounting, with Application to Testing ICT Impact on Labour Productivity of Developed Countries". International Journal of Business and Economics. 13 (2): 115–126.
  7. ↑ Easterly, W.; Levine, R. (2001). "It's Not Factor Accumulation: Stylized Facts and Growth Models" (PDF).{{cite journal}}: Cite journal requires |journal= (help)
  8. ↑ "Human Capital and the Wealth of Nations" (PDF). May 2006. Archived from the original (PDF) on 29 August 2006. Retrieved 2 November 2006.
  9. ↑ Ayres, Robert U.; Warr, Benjamin (2004). "Accounting for Growth: The Role of Physical Work" (PDF).{{cite journal}}: Cite journal requires |journal= (help)
  10. ↑ Ayres, Robert U.; Warr, Benjamin (2006). "Economic growth, technological progress and energy use in the U.S. over the last century: Identifying common trends and structural change in macroeconomic time series, INSEAD".{{cite journal}}: Cite journal requires |journal= (help)
  11. ↑ Robert Shackleton. 2013. Total Factor Productivity Growth in Historical Perspective. CBO Working Paper 2013–01. page 1, footnote 1
  12. ↑ Total factor productivity. OECD Productivity Manual: A Guide to the Measurement of Industry-Level and Aggregate Productivity Growth, Annex 1 – Glossary of Statistical Terms. OECD: Paris. 2001
  13. ↑ Frequently Asked Questions, U.S. Bureau of Labour Statistics
  14. ↑ W.E. Diewert and A.O. Nakamura. 2007. The measurement of productivity for nations. Chapter 66 of Handbook of Econometrics, volume 6A, edited by J.J. Heckman, and E.E. Leamer. p. 4514
  15. ↑ William Barnett II (2007). "Dimensions and Economics: Some Problems" (PDF). Quarterly Journal of Austrian Economics . 7 (1).

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