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 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.

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 eocnomy, 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 the quality of response to society demands, possibly increasing the consensus politician enjoy.

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 (1950-2000)
Industry-level US data
Data for all the 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

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