Productivity (Economics) - Explained
What is Productivity?
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Table of ContentsWhat is Productivity in Economics?How is Productivity Used in Economics?Labor ProductivityThe Solow Residual and Multi-Factor ProductivityProductivity Growth, Savings and InvestmentAcademic Research on Economic Productivity
What is Productivity in Economics?
In economics, productivity calculates output per unit of input, like capital, labor, or any other resource and is usually calculated for the economy as one, as a gross domestic product (GDP) ratio to hours worked. Labor productivity might be further divided by sector to evaluate trends in wage levels, technological improvement, and labor growth. Shareholder returns and corporate profits have a direct link to productivity growth. At the corporate level, where productivity reflects how effective a company's production process is, it is derived by measuring the number of units produced in relation to employee labor hours or by measuring the net sales of a company in relation to employee labor hours.
How is Productivity Used in Economics?
Productivity is a major source of competitiveness and economic growth. The ability of a company to improve its standard of living is dependent almost totally on its ability to raise its output per worker, i.e., producing more goods and services for certain hours of work. Economists utilize productivity growth to model economies productive capacity and know their capacity utilization rates. This, in turn, is used for the forecast of business cycles and prediction of future GDP growth levels. Also, production capacity and use are utilized for accessing demand, as well as inflationary pressures.
Labor productivity published by the Bureau of Labor Statistics is the most commonly reported measure of productivity. This is dependent on the GDP ratio to total hours worked in the economy. Labor productivity growth arises from an increased capital amount available to each worker (capital deepening), technological improvements (multi-factor productivity growth), and the workforces experience and education (labor composition). However, productivity isnt necessarily an indicator of an economys health at a specific time. For instance, during the United States 2009 recession, output, as well as, hours worked were falling while productivity was rising. This was because hours worked were dropping faster than output. Because productivity gains can happen in recessions, as well as, in expansions, as seen in the late 1990s, one has to consider the economic context when analyzing productivity data.
The Solow Residual and Multi-Factor Productivity
Many factors exist which can affect a countrys productivity, like innovation, investment in plant and equipment, improvements in supply chain logistics, enterprise, and competition. The Solow residual, which is also known as total factor productivity, calculates the portion of an economys output growth which cant be ascribed to the accumulation of labor and capital. Its interpreted as the contribution to economic growth made by technological, managerial, financial, and strategic innovations. Also referred to as multi-factor productivity (MFP), this measure of economic performance carries out a comparison of the number of goods and services produced to combined input numbers used in the production of the goods and services. Inputs can include capital, energy, purchased services, labor, and materials.
Productivity Growth, Savings and Investment
When productivity refuses to grow significantly, it limits potential gains in corporate profits, wages, and living standards. Investment in an economy equals the savings level because investment must be financed from saving. Low savings rates can result in lower growth rates and lower investment rates for labor productivity, as well as, real wages. That is why its feared that the United States low savings rate could affect productivity growth adversely in the future. Since the global financial crisis, there has been a collapse of labor productivity growth in all advanced economies. Its one of the major reasons GDP growth has been so slow since then. In the U.S., labor productivity growth dropped to a 2.2& annualized rate between 2007 and 2017, compared to at a 2.5% average in almost all economic recoveries since 1948. This has been blamed on labors declining quality, diminishing returns from the global debt overhang and technological innovation, which has resulted in increased taxation, which has in return suppressed capital expenditure and demand. A major question is what role zero interest rate policies (ZIRP) and quantitative easing have played in encouraging consumption at the detriment of saving and investment. Companies have been spending money on both share buybacks and short-term investments, as against investing in long-term capital. One solution, asides training, research, and better education, is promoting capital investment. According to economists, the best way to do that would be reforming corporate taxation, which should increase manufacturing investment. This is the goal of the tax reform plan of President Trump.
Academic Research on Economic Productivity