Productivity is a measure of the efficiency with which a country combines capital and labour to produce more with the same level of factor inputs. We commonly focus on labour productivity measured by output per person employed or output per person hour
A better measure of productivity growth is total factor productivity which takes into account changes in the amount of capital to use and also changes in the size of the labour force.
To give a numerical example, if the size of the capital stock grows by 3% and the employed workforce expands by 2% and output (GDP) increases by 8%, then total factor productivity has increased by 3%.
Factor Inputs (land, labour and capital) + Factor Productivity (efficiency) = Output
Productivity is an important determinant of living standards – it quantifies how an economy uses the resources it has available, by relating the quantity of inputs to output. As the adage goes, productivity isn't everything, but in the long run it's almost everything.
Economic Gains from Higher Productivity
Higher productivity can lead to:
Lower unit costs: These cost savings might be passed onto consumers in lower prices, encouraging higher demand, more output and an increase in employment.
Improved competitiveness and trade performance: Productivity growth and lower unit costs are key determinants of the competitiveness of firms in global markets.
Higher profits: Efficiency gains are a source of larger profits for companies which might be re-invested to support the long term growth of the business.
Higher wages: Businesses can afford higher wages when their workers are more efficient.
Economic growth: If an economy can raise the rate of growth of productivity then the trend growth of national output can pick up.
Productivity improvements mean that labour can be released from one industry and be made available for another – for example, rising efficiency in farming will increase production yields and provide more food either to export or to supply a growing urban population.
If the size of the economy is bigger, higher wages will boost consumption, generate more tax revenue to pay for public goods and perhaps give freedom for tax cuts on people and businesses.
Geoff Riley FRSA has been teaching Economics for nearly thirty years. He has twenty years experience as Head of Economics at leading schools. He writes extensively and is a contributor and presenter on CPD conferences in the UK and overseas.