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PRODUCTIVITY
 

 

by Valentino Piana (2001)

     
 
 

Contents


 
 
1. Significance
 
 
2. Computation
 
 
3. Determinants
 
 
4. Impact on other variables
 
 
5. Long-term trends
 
 
6. Business cycle behaviour
 
 
7. Data
 
 
8. Formal models
 
  9. How to increase productivity  
 
10. Related essays
 
 

Bulgarian translation of this page!

 
 
A 2011 empirical application quoting this paper (pp. 19-24)
 
 
 
 

Significance

Physical productivity
is the quantity of output produced by one unit of production input in a unit of time. For example, a certain equipment can produce 10 tons of output per hour.

Economic productivity is the value of output obtained with one unit of input. For example, if a worker produces in an hour an output of 2 units, whose price is 10$ each, then his productivity is 20$.
It is clear that both technological and market elements (as output quantities and prices, respectively) interacts to determine economic productivity.

Computation

Average economic productivity is computed by dividing output value and (time/physical) units of input. If the production process uses only one factor (e.g. labour) this procedure gives the productivity of that factor, in this case labour productivity.

When more than one input is used, for each factor it is possible to compute by the same procedure its productivity, called in this case "partial".

"Total factor productivity" is the attempt to construct a productivity measure for an aggregation of factors. The meaningfulness of such an aggregation requires additional hypotheses, thus it is not assured in a general framework.

Determinants

Technology determines the maximal physical quantity of output that can be reached as well as the number and the quality of inputs required. Adopted technology is in turn an economic choice, taken upon both economic and technological reasons. The spectrum of concurrent technologies that can be chosen is influenced by available innovations and adopter's compatibilities. Reversibility of this choice is often low because of high switch costs.

Technological change is fast only in some industries, whereas in many others it is much more gradual.
In any case, the diffusion of worse technology than that presently in use is a marginal and irrilevant phenomenon. Technology always improves. Physical productivity, too.
Economic productivity will depend also on pricing and demand. If consumers require less products than potentially producible, plants will not work at full productive capacity. Thus economic productivity can well fall, as with decreasing demand and prices.

On an individual scale, physical productivity depends on the difficulty of the task, the skills of the worker and its learning curve (the number of times he already performed the task and how he was guided by good "teachers / masters"). For example, think at an unskilled buyer assembling an IKEA piece of furniture for the first time: he will be looking for avoiding mistakes more than optimising the time to work. If he purchased a second piece, he will be much more productive (i.e. will need less time to assembly it). After a few pieces his productivity will level off with no further large improvements.

On a macroeconomic level, labour productivity, i.e. GDP per worker, depends on the corrisponding dynamics of the two aggregates (GDP and employment). Productivity will rise if GDP increases faster than employment.

A decoupling of labour market and macroeconomic policies can lead to higher employment without GDP growth, leading to a lower productivity.

A high degree of productive capacity utilization is conducive to high productivity of labour and capital.

A prolonged structural increase in productivity is the result of many factors, among which the following:

1. capital accumulation through investments;
2. the long-lasting process of diffusion of new technologies (often imported from abroad), which in turn can be accelerated by a pro-diffusion tax;
3. domestic innovative efforts;
4. imitations of organizational and technological modes of production from world-class practises;
5. enhanced division of work across the supply chain in the different stages of production and distribution, coupled with effective coordination mechanism, including by prices, contracts, formal and informal agreements, communication, trust, reputation, etc.;
6. the development of physical infrastructure, including efficient transport, energy, telecommunication networks;
7. a sound social infrastructure, including effective public institutions, NGOs, business and social networks, etc.
8. higher levels of education and competencies;
9. a higher involvement and motivation of workers in the production processes.

At firm level, firms' incentives increase workers productivity through a stimulating environment and the removal of obstacles to their effective work.

In a broader perspective, an increase of productivity is due to a squeeze in waste of resources, to narrower limits of irrational processes of production and governance, to an effective link between market and social needs.


Impact on other variables

Higher productivity first impacts usually on profits; then, with lags and without automatic mechanisms, on wages. Firms can afford to pay them without losing market shares but it's on workers the effort to organize and get pay increases.

If production costs do not overshoot that productivity increase, unit cost of production will be lower, opening the possibility of price fall or stability. In this vein, higher productivity is conducive to lower inflation.

The higher profits due to high productivity generate the cash flow, foster trustworthiness for loans and equity investors, as well as the reason for larger investments. If they entails economies of scale and are matched by a growing demand, and these dynamics take place in a sufficienty large share of the economy, an important supply-side based mechanism of GDP growth is put into motion.

International competitiveness will increase by the same chain of reasons, boosting exports by a combination of lower prices and better quality. This in turn should improve the trade balance, reducing the need for aid and providing currency to pay back the possible debt cumulated towards foreign entities.

If the increase of GDP is slower than the increase in productivity, a fall in employment will take place (as a matter of definition!).

If a firm dismisses workers after having invested in new machines, technological unemployment will take place.

If on the contrary the improved production can be sold at higher prices or produced with less wasted materials and energy, output value added can rise and one can obtain even an increase in employment.

Employment in machine-producer industries will rise in both situations.

Higher productivity in the public sector reduces the time and improves the quality of response to society demands, possibly increasing the consensus politicians enjoy. Instead, much of political debate between lower taxes and higher welfare protection leads to reciprocal dissatisfaction because of the appaling low productivity of public services.

Long-term trends

Productivity has grown in the long run in almost all countries in the world. In rich countries, GDP soared mainly through productivity increase. Countries with a low productivity increase are among the poorest of the planet.

Wide productivity differentials in the world are the main explanation of dispersion of per-capita income.

Business cycle behaviour

Economic productivity usually shows a pro-cyclical behaviour, while at the same time it is necessary to distinguish smaller sub-phases and wider multiplicity of paths than in the case of other variables.

Just after high peaks, GDP slowing dynamics is not immediately matched by employment. Productivity per worker falls.

As far as recession takes momentum, firms begin to dismiss workers in attempt of reducing losses. This move should increase productivity again, but dismissed workers reduce their consumption and GDP contract further. The net effect on productivity depends on the speed and strength of the two factor.

When recovery begins, once more employment is lagging, thus there is a drastic improvement in productivity and productive capacity utilization. These developments positively impact on profits and on the willingness of firms to invest.

Depending on institutional incentives, firms can opt for an unbalanced mix of the following strategies:
1. to better exploit existent employment and massively use overhead, so that per-worker productivity rises dramatically,
2. to enlarge employment proportionally to output, keeping productivity stable,
3. to invest in labour-saving machinery, with a lagged increase of productivity and, potentially, a negative impact on employment.

Depending on the aggregated effect of these decentralized choices, productivity will more or less increase with GDP rise.

At peaks, productivity is much higher than in troughs.

Data

Productivity in 99 countries (1950-2012)
Industry-level data
Data for all theUS variables in IS-LM model
EU data for all the variables in IS-LM model (Germany, France, Italy, Spain, UK, Switzerland and other 13 European countries)
Total factor productivity growth in Japan

Formal models

An interactive map of how the economy works according to a basic macroeconomic scheme: the IS-LM model

How to increase productivity

You can increase the internal productivity of 1. production processes, 2. of the decision-making and governance processes as well 3. the external-to-the-firm productivity of the environment in which it operates.

In the first field, there are several opposed trajectories that allows for increasing productivity, intertwining micro and macro levels.

Physical productivity of a production process can rely on faster and bigger machines, performing simplified and repetitive tasks strictly matching the requirements (inputs-outputs) of further machines (assembly line). Typically this method of increasing the number of products obtained per hour corresponds to repetitive tasks performed by low-skilled labour, whose low wages (possibly due to a weak trade union, legal setting easing firing and high unemployment) lead to high economic productivity (which, however, will depend on the price of product sold - if it is low because of low quality and in order to address large segments of low-income television-dependent consumers, only very large, stable and predictable sales can generate enough total margins to justify the high capital investment in machines, which in turn requires television large-scale advertising: economies of scale and barriers to entry are established - possibly leading to oligopoly without new entrants). This mechanism works "well" (leaving for the moment aside the social pain, worker - and consumer - alienation and many other negative effects it involves) if GDP growth provides the macroeconomic conditions for market expansion (increase of production, increase of productivity, lower price, higher demand, increase of sold production) but it enters in tough difficulties in case of GDP stagnation and market saturation (due to the cumulative bundle at households and their low level of income leading to postponement of repurchasing). International competition (e.g. from very big countries where internal market allows for reaping economies of scale) can shift domestic demand towards imports (leakage).

An opposite way to raise productivity is creativity. A creative person can generate high value products in short time - an extremely high productivity largely irreproducible by machine. This is not only the case of people like Picasso (who stated "I don't seek, I find"), whose production has a skyrocketed value, but more in general of a society where everybody is well educated and trained in what's his and her inclinations and talents can lead to excellent and intriguing results. High labour skill - possibly in connection with all-purposes machines like computers - generate high productivity. The economic productivities of such processes is enhanced by a market which recognizes and pays for quality and innovativeness and a business / network organisation and routines that allows for such creativity to flourish (instead of being repressed).

In between these two extremes, you would find, on the one hand, "mass customerization" and the exploitation of product platforms (crossing standard components and differentiating details) to get "economies of scope", and, on the other hand, craftsmanship where individual human creativity, skills and styles generate highly differentiated goods and services.

In the second field, many decision-making processes are dysfunctional, with hiatus between stated goals and implementation, the on-going re-definition of goals and tools, with the adoption of partial solutions which generate bottlenecks and disadvantages on other performance indicators, etc. Raising productivity in this field would involve changing governance routines (e.g. the timing, the number and the disciplines of people involved since the very beginning on the decision, the qualification of people involved in the implementation, etc) as well as modifying the shape of the network that actually takes decisions. "Smart decisions" instead of "stupid" ones would raise group and individual productivity. Please note that in bureacracy and office work, many production processes are at the same time decision-making processes (e.g. the concession of a "permit to build" is a task for the Municipality office but at the same time is a decision changing the landscape).

In the third field, higher productivity is obtained in a country by improving infrastructure, connections, availability of supply chain services, the urban and rural spatial organization, the source, the use and the business model of energy, as we are proposing in specific fields. Less niches of privilege and higher remuneration of quality are horizontal goals for policies to raise productivity.

Related essays

High-Tech Start-Ups and Industry Dynamics in Silicon Valley

Does Schumpeterian Creative Destruction Lead to Higher Productivity? Evidence on Entry and Exit in Portuguese Manufacturing

Productivity, Factor Accumulation and Social Networks: Theory and Evidence

Productivity analysis of cassava production in an African country

 

 
 
 
 
Key concepts
  Industrial dynamics  
  World trade  
  Business cycles  
  Labour market  
 
     
 
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