Economic Issue of the Day
Philippine Institute for Development Studies S u r i a n s a m g a Pa g -a a ral Pangkaunlaran ng Pilipinas
Vo l . V I N o . 7 ( O c t o b e r 2 0 0 6 )
Productivity: putting the use of resources at their best
P
roductivity defines the relationship between output and factor inputs where output can be any goods or services produced while inputs refer to labor and/or capital. Algebraically, productivity is the ratio of output to factor inputs used. Labor input can be measured in terms of work hours or number of employed individuals while capital input can be quantified in terms of the value of machinery and equipment or infrastructure in place. In any firm or industry, productivity is a concept that measures the efficiency with which inputs are transformed into valuable output in a production process. Similarly, it can be defined as the combination of efficiency and effectiveness of a production process that aims to maximize output while minimizing the use of inputs. At the economy-wide level, productivity is the overall measure of how well a country manages or uses its resources to produce goods and services. In both cases, improving productivity involves changing how things are done by investing in new machinery and technology, and by advancing the knowledge of the labor force through education and training.
Productivity measures Productivity can be expressed either through partial factor productivity (PFP) or total factor productivity (TFP). Partial factor productivity associates output to one factor input—either capital or labor. When output is related to capital input, say in terms of machine hours or amount of money invested, this is a measure of capital productivity. On the other hand, when output is associated to labor input, say the volume of output produced for every hour of work or the value of output
_____________________ 1
Based on growth accounting approach. Nevertheless, it should be noted that this approach has been heavily criticized due to some methodological problems which, according to Felipe and McCombie (2006), may give misleading estimates of technical change (efficiency).
produced for every employed individual, this is referred to as labor productivity. Both measures indicate the efficient utilization of either factor input in producing the output. Between the two, labor productivity is the more popular partial measure of productivity. Total factor productivity, meanwhile, considers both factors of production and reflects the efficiency with which capital and labor inputs are used. Between the two measures, TFP is considered the better measure of productivity as it accounts for the contribution of changes in the quantity and quality of combined inputs to changes in output 1 and is more comprehensive. It is however more difficult to estimate. The difficulty lies in the existence of various approaches in estimating TFP and of some underlying complexities in valuing capital stock. The measurement of TFP requires a method for aggregating all factor inputs into one index.
Implications of productivity estimates Using the growth accounting approach, TFP estimates can be obtained by getting the difference between the growth in output and growth in factor inputs. A difference equal to zero means all the growth in output is accounted for by the growth in factor inputs. On the contrary, a difference not equal to zero means there is a portion of output growth that is not fully explained by the growth in factor inputs. This suggests that there could be other factors affecting output growth which are not explicitly accounted. These factors may include, but are not limited to, education and capability building of the labor force; efficient public sector; economies of scale; research and development; externalities, spillover effects, and diffusion of technology; and innovation. They can serve as productivity enhancers or stumbling blocks depending on how they are managed. TFP estimates indicate the efficiency (or inefficiency) of resource utilization. High TFP growth is desirable as it implies that more outputs are generated given a certain amount of inputs. At the aggregate level, it shows
Economic Issue of the Day
PRODUCTIVITY
Vo l . V I N o . 7 ( O c t o b e r 2 0 0 6 )
a nation’s capability to use to the fullest its human and physical capital to achieve economic growth.
Table 1. TFP estimation growth accounting approach
Growth in Output, %
Estimating TFP To illustrate the estimation of TFP, suppose the average growth of output over a ten-year period is 6.5 percent and the growth in capital and labor is 5 percent and 3 percent, respectively. Assume that the share of capital to total output is 40 percent and the share of labor to output is 60 percent. Using this information, TFP estimates can be derived by applying the simple operation shown in Table 1. The result indicates that the contribution of TFP to output growth is positive. As an indicator of efficiency, a positive value is desirable as this shows that other “factors” of production like improved quality of labor force; usage of high-tech equipment and machinery; and investment in research and development were utilized to improve output. On the other hand, a negative TFP estimate suggests that the same factors mentioned were underutilized or ill-absorbed. Labor productivity, the simpler measure of factor efficiency, can be expressed in terms of physical or monetary values. Consider a small-scale pottery industry. A physical measure of labor productivity is the number of pots produced per worker. The corresponding monetary measure is the value of pots produced per hour worked. In this sense, labor productivity is the ratio of output to labor input. Labor productivity estimates may be assessed over time where a higher estimate indicates a more efficient way in which labor input was utilized in the production through the years. Similarly, labor productivity estimates may be compared across sectors where a higher estimate suggests that a sector is more productive than other sectors. It should be noted though that efficiency encompasses more than the mere number of workers and may include the quality of machinery and equipment used, labor practices, and management style.
Significance of productivity
Less:
Less:
6.5
(Share of capital) x Growth of capital
40% 5%
2.0
(Share of labor) x Growth of labor
60% 3%
1.8
TFP growth
2.7
competitiveness and revenues. Take, for instance, two firms, firm A and firm B, with the same level of output. Firm A however utilizes lesser input than firm B. Thus, firm A is more productive. With lesser usage of input, it is expected that firm A will have a lower cost of production and can charge a lower price for its products. Consequently, it is likely to have a larger market share and higher revenues. Firm B, on the other hand, will have to improve its productivity to compete well with firm A and can set up productivity-enhancing measures like skills training for its employees, investment in equipment and machineries, reorganization, re-orientation of production process, and/or investment in research and development. Improving productivity is essential in attaining global competitiveness with the end goal of achieving sustained economic growth. ❋
References Cororaton, Caesar and Janet Cuenca. 2001. Estimates of total factor productivity in the Philippines. PIDS Discussion Paper No. 200102. Makati City: Philippine Institute for Development Studies. Felipe, Jesus and John McCombie. 2006. The tyranny of the identity: growth accounting revisited. International Review of Applied Economics 20 (3):283-299. Sicat, Gerardo. 2003. Macroeconomics. Economics (New Edition) Vol 2. Anvil Publishing, Inc.
Productivity is an important tool in evaluating and monitoring the performance of firms, industries, and countries. It determines
The Economic Issue of the Day is one of a series of PIDS efforts to help in enlightening the public and other interested parties on the concepts behind certain economic issues. This dissemination outlet aims to define and explain, in simple and easy-to-understand terms, basic concepts as they relate to current and everyday economics-related matters. This Issue was written by Janet S. Cuenca, research specialist at the Institute. She acknowledges the comments of Dr. Aniceto C. Orbeta Jr., senior research fellow, and Ms. Ma. Teresa Dueñas-Caparas, research associate, both at the Institute. The views expressed are those of the author and do not necessarily reflect those of PIDS. ❋ Philippine Institute for Development Studies NEDA sa Makati Building, 106 Amorsolo Street, Legaspi Village, Makati City Telephone Nos: (63-2) 8924059 and (63-2) 8935705 Fax Nos: (632) 8939589 and (63-2) 8161091 URL: http://www.pids.gov.ph