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New Zealand's Productivity Performance - TPRP 08/02

2.  Productivity definitions and measurement

Definitions of productivity

Productivity is about how efficiently a firm or any other organisation can turn its inputs, such as labour and capital, into outputs in the form of goods and services. Producing more goods and services with the same inputs or producing the same quantity of goods and services with less input is an improvement in productivity.

Productivity is the ratio of output to one or more inputs such as labour.

Productivity is typically defined as a ratio of a volume measure of output to a volume measure of input. Beyond this basic concept a range of definition and measurement issues arise. Productivity can be defined in relation to a single input (eg, labour) or to a combination of inputs (eg, labour and capital). The different productivity definitions can be used for different purposes, and each has its own advantages and disadvantages.

Labour productivity

Labour productivity is a central definition of productivity.

Labour productivity is a central definition because:

  • it is a measure of the amount produced for a certain amount of labour effort;
  • it is closely related to individual incomes (ie, wages and salaries) and so living standards; and
  • it can be measured with reasonable reliability.

The simplest measure of labour productivity is output per worker. Increased output per worker could occur if workers produce more in the hours they work or if they work longer hours (eg, by reducing holidays or moving from part-time to full-time employment). The fact that working longer hours also lifts output per worker is a disadvantage of this definition.

Output per hour worked is the main measure of labour productivity we use.

The second measure of labour productivity is output per work hour. Its main advantage is it takes account of variations in the number of hours worked per worker. A disadvantage is that hours worked data tend to be less reliable than employment data. Nevertheless, given average hours worked can and do change, particularly recently, we focus on output per hour worked as the definition of labour productivity.

Labour productivity can change as a result of a change in technology or additional capital. As a result, a limitation of partial productivity measures such as labour productivity is they attribute to one factor of production, in this case labour, changes in efficiency attributable to other factors of production.[1]

Multifactor productivity

It is also important to examine multifactor productivity

Multifactor productivity (MFP) takes into account both labour and capital inputs. It is the part of output growth that cannot be attributed to the growth of labour or capital inputs. MFP reflects such things as business process innovations like supply-chain management techniques or more effective retail store layouts, advancements in technology or almost any other type of improvement in the efficiency of a firm’s operations. When MFP rises, the economy can produce more output with the same quantity of labour and physical capital.

MFP can be equated with technological change if certain conditions are met. For example: firms must behave efficiently and seek to maximise profits; markets must be competitive; and the coverage of inputs must be complete. In practice, these conditions are rarely met so measured MFP will therefore, in addition to technological change, include the combined effects of any model mis-specification and mis-measurement of the variables, including quality change in the inputs. We examine changes in labour quality in Section 4.

Measurement of productivity

Measurement of productivity is difficult in some service and government-dominated industries.

On the measurement side, the ability to gauge productivity varies across the economy. Measurement difficulties are generally greater in the service industries,[2] especially government.[3] For example, in the case of government non-market activities (eg, education, health, administration and defence), services are provided free or at nominal charges. In the national accounting statistics, the output (value added) of these activities is largely measured by inputs, such as the number of employees. Using changes in inputs to measure changes in outputs implicitly assumes zero productivity growth.

The productivity work of Statistics New Zealand (SNZ) is focused on the so-called “measured sector” (see Box 1). The measured sector excludes industries in which outputs are not adequately measured independently of inputs. The latest SNZ estimates are for a measured sector that makes up around 73% of the economy. This version of the measured sector approximates the “business” or “market” sector and hence the firms that are seeking the best mix of resources to exploit market opportunities and earn profits. Australia has a long history of publishing official market sector productivity statistics. Although extending the coverage of the SNZ measured sector to include government non-market activities is useful, there is arguably still a case for retaining measures that focus solely on the business or market sectors.

The measurement of productivity in New Zealand still has some gaps despite recent improvements. Some gaps will be addressed in the near term (eg, wider industry coverage in the measured sector) but others are longer term (eg, productivity by industry, including in education and health, and productivity levels).

Strengths of economy-wide measures of productivity include consistency with real Gross Domestic Product (GDP), real GDP per capita, and forecasts of real GDP.[4] Economy-wide measures are generally better suited to international comparisons since the definition of the measured sector is not uniform across countries and the measured sector series are only available for a small number of countries. Economy-wide measures are also typically more up-to-date (being quarterly and sourced from current series) and provide information on productivity levels (not just growth rates as with the measured sector data).

We focus on the measured sector productivity data but also consider economy-wide measures.

On balance, we think analysis should generally focus on the measured sector, although it is important to consider economy-wide measures. A focus on measured sector productivity is not to deny the importance of public sector productivity (including linkages between the sectors, say from public sector capital). However, there are substantive measurement issues with public sector productivity and it can therefore be appropriate to focus on a broader set of measures to assess public sector performance.[5]

 

Box 1: Statistics New Zealand work on productivity measurement

The quality of productivity data has improved in recent years and further improvements are planned. Statistics New Zealand (SNZ) received funding from the Growth and Innovation Framework in 2003 to develop official productivity statistics for New Zealand, building on initial work by Diewert and Lawrence (1999) and Black, Guy and McLellan (2003).

The releases from SNZ cover productivity growth in the measured sector of the economy. The latest version of the measured sector, which made up 73% of the economy in the March 2004 year, excludes industries in which outputs are not adequately measured independently from inputs, namely: property services (6% of nominal GDP in 2004); ownership of owner-occupied dwellings (7%); government administration and defence (4%); education services (4%); and health and community services (5%).

The SNZ productivity statistics comprise index series for labour productivity, capital productivity and MFP. These series identify productivity growth rates but not absolute levels of productivity. The SNZ productivity statistics are consistent with Organisation for Economic Co-operation and Development (OECD) guidelines. SNZ productivity data are annual and cover March years, with a publication lag of almost one year.

Real GDP (production) is used as the output measure. Labour input is based on hours paid for all employed persons (paid employees and the self-employed) in the measured sector. It is derived as a composite of firm surveys and household surveys. Capital input is based on the flow of capital services generated by capital stocks, which are themselves developed using the Perpetual Inventory Method (PIM) for 24 asset types within seven asset classes (eg, intangible assets; buildings; plant, machinery and equipment; transport equipment). These are supplemented by estimates for three other assets: livestock, exotic timber grown for felling, and land used for agriculture and forestry.

The first release of official productivity data by SNZ in March 2006 covered the 1988-2005 period. The second release in March 2007 covered the 1988-2006 period and was updated for an erratum in May 2007. As part of the third release, in October 2007, SNZ provided a longer time series back to 1978 and examined productivity growth between cyclical peaks. The peaks are determined by comparing annual MFP growth with a trend estimate. The peak deviations between the two series are used as the main indicator of growth-cycle peaks.

In March 2008, SNZ released productivity data for 1978-2007 and the measured sector was expanded to include business services and personal and other community services (both from 1996 onward). A series covering the previous definition of measured sector (ie, excluding business services and personal and other community services) was published to provide a link to previously-released data and enable a direct comparison with Australia. The Australian Bureau of Statistics (ABS) use the term “market sector”, which makes up about two thirds of the Australian economy.

An experimental quality-adjusted labour productivity series will be released by SNZ later in 2008, and the measured sector will be expanded to about 80% of nominal GDP in the near future by including property services. No date has been set for industry-level productivity data.

Notes

  • [1]The theory and evidence on investment and productivity will be covered in more detail in one of the five driver papers.
  • [2]In this paper, “industry” refers to an area of activity such as “mining”, “manufacturing” or “government administration and defence”. A “sector” refers to a particular group of industries (eg, “measured” and “non-measured”) or refers to the sector of ownership (ie, “private” and “public”). Claus and Li (2003) compare New Zealand’s production structure (albeit in the mid-1990s) to that in other developed countries.
  • [3]In the context of Gross Domestic Product (GDP) and productivity measures, “government” refers to goods and services but not transfer payments. The government’s direct role in GDP is therefore less than indicated by the amount of government spending (which includes transfer payments) recorded in the financial statements of the government prepared by the Treasury.
  • [4]Throughout this note GDP and GDP per capita will refer to real GDP and real GDP per capita respectively, unless otherwise stated.
  • [5]See Douglas (2006).
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