2  The concept of productivity

This section discusses conceptual issues surrounding productivity. Subsection 2.1 outlines the concept of productivity, including the distinction between partial productivity measures, such as labour and capital productivity, and total factor productivity (TFP). Because TFP is often (erroneously) seen as a measure of technological change, Section 2.2 outlines several reasons why TFP cannot be equated with technological progress.

2.1  What is meant by “Productivity”?

When economists refer to productivity, at the broadest level they are referring to an economy’s ability to convert inputs into outputs. Productivity is a relative concept with comparisons either being made across time or between different production units.[2] For example, if it is possible to produce more output in period 2, when using the same amount of inputs that were used in period 1, then productivity is said to have improved. In other words, productivity is higher in the second period compared to the first.

Different types of input measure give rise to different productivity measures. For example, labour productivity measures involve dividing total output by some measure that reflects the amount of labour used in production. The total number of worker hours is one such measure, although some studies have used total numbers employed.[3] Capital productivity is measured by dividing total output by a measure reflecting the total amount of physical capital used in the production process.

Productivity measures, such as labour productivity and capital productivity, that only relate to one class of inputs are known as partial productivity measures. Caution needs to be applied when using partial productivity measures as changes in input proportions can influence these measures.

A simple substitution of capital for labour within the input mix of a firm or industry can also raise average labour productivity. This means that movements in the average labour productivity statistics do not always represent true changes in the underlying productivity of labour….

Dixon, 1990: 6

The level of TFP can be measured by dividing total output by total inputs. Total inputs are often an aggregation of only physical capital and labour, and may overlook inputs such as land.[4] When all inputs in the production process are accounted for, TFP growth can be thought of as the amount of growth in real output that is not explained by the growth in inputs. This is why Abramovitz (1956) described the TFP residual as a ‘measure of our ignorance’.

As TFP levels are sensitive to the units of measurement of inputs and outputs, they are rarely of primary interest. Rather, the measurement of TFP growth is of primary interest. Hence, it is common to use the notation “TFP” to refer to growth rather than levels, and this is the convention adopted in this paper.