What is productivity? Definition and meaning
Productivity refers to the rate of output per unit of labor, capital or equipment (input). It can be measured in a number of different ways. The productivity of a factory could be measured according to how long it takes to produce a specific good, while in the services sector, where units of goods do not exist or are more difficult to define, the measurement may be based on how much revenue each worker generates, divided by his or her salary.
In a factory, you can measure it by dividing the total output by the number of workers. Imagine a table factory that employs 100 people producing 2000 tables per day. The productivity of each employee is:
2000 (tables) ÷ 100 (workers) = 20 tables per worker per day
Productivity is expressed as output divided by input.
If productivity can be increased from 20 to 30 tables per day, without increasing costs, the factory has improved efficiency – it will have lower unit costs. The lower unit costs will generate higher profits.
Although productivity and efficiency are often cited together, they do not have the same meaning. While productivity focuses on getting the maximum production per worker or unit of machine per minute, hour, day, or week, etc., efficiency looks more at eliminating waste and maximizing quality.
Factors that determine productivity
It is the result of several factors, including the quality of machines available, workers’ skills, speed of delivery, and effective management.
A company can usually improve productivity by investing in better equipment, training its staff, and improving the management of workers.
Although the company will be initially spending money in the short term if it aims to boost productivity, over the long term it will be worth it when production per unit of input per day rises.
Productivity can be expressed as the ratio of output to inputs used in the process of production – output per unit of *input.
* Input is something that is put into a system or expended in its operation to achieve output, such as power to drive a machine, the machines themselves, and the workers.
These data, from the US Bureau of Labor Statistics, include the revised first-quarter 2016 measures – % change from previous quarter, at annual rate (Q to Q) and from same quarter a year earlier (Y to Y).
Output value minus input value
The value of outputs minus the value of inputs is a measure of the income that is generated in the production process. It is a measure of the production process’ total efficiency, and as such the objective to be maximized in the production process.
Partial productivities are measurements that use one or more factors (inputs) of production, but not all factors. Labor productivity, which is generally expressed as output per hour, is a common example in economics. At the company level, typical partial productivity levels include energy per unit of production, as well as worker hours and materials.
The approach in macroeconomics (branch of economics concerned with large-scale or general economic factors) is quite different. The macroeconomist wants to examine an entity of several production processes, and the output is calculated by summing up the value-added created in the single processes.
It is important when summing up all the factors that there is no doubling up of intermediate inputs. Value-added is obtained by subtracting the intermediate inputs from total outputs. The most widely-used measure of value-added is the gross domestic product (GDP). It is commonly used to measure the economic growth of industries and whole countries. GDP is the income available for paying labor compensation, capital costs, taxes and profits.
For a single input this means the ratio of value-added output to input. When multiple inputs are considered, such as capital and labor, it means the unaccounted-for level of output compared to the level of inputs. In macroeconomics, this measure is called TFP (Total Factor Productivity) or MFP (Multi Factor Productivity).
This graph by the UK Office for National Statistics shows contributions to growth of the whole British economy, output per hour. Seasonally Adjusted, Cumulative quarterly changes, quarter 1 2008 to quarter 1 2016. (Image: adapted from ones.gov.uk)
Productivity is what matters
It is what really matters when looking at the production performance of nations and companies. When productivity rises so do living standards, because a greater level of real income improves individuals’ ability to buy goods and services, enjoy leisure, improve education and housing, and contribute to social and environmental programs.
As far as businesses are concerned, increased productivity helps them become more profitable.
According to the Financial Times’ ft.com/lexicon, productivity is:
“How much is produced per unit of input. There are various kinds of productivity depending on the input, and various ways to calculate it. Labour productivity, for instance, can be calculated per worker, per hour worked, etc. Capital productivity is similar to calculating a return from an investment.”
Why is productivity important?
Productivity gains are crucial for an economy, because they allow people to achieve more with less. Two vital resources in the production process are scarce – labor and capital. Therefore, maximizing their impact will always be a core concern of businesses.
Economists measure and track productivity because it provides an important clue to predicting future GDP growth levels.
When the media report on the productivity measure of a nation, they are invariably talking about the ratio of GDP to total hours worked across the whole country during a specific period. In the United States, this measure is produced by the Bureau of Labor statistics every quarter (three months).
The UK’s Office for National Statistics reports on a range of measures, including output per job, output per worker, output per hour for the whole economy and a range of businesses, the public sector, and international comparisons across the G7 nations.
Adam Smith (1723-1790) was a Scottish pioneer of political economy and a moral philosopher. He is cited as the ‘father of modern economics’. In several of his works he talked about productivity, and how the division of labor was crucial in getting more production out of limited inputs. (Image: adamsmith.org)
Labor productivity and costs
According to the US Bureau of Labor Statistics, labor productivity “relates to output to the labor hours used in the production of that output.”
Two Bureau of Labor Statistics programs produce LPC (labor productivity and costs) measures for sectors of the United States’ economy:
– The Major Sector Productivity program: published annually and quarterly, includes measures of output per hour and unit labor costs for the US business, non-farm business, and manufacturing sectors. These are the figures that the national media most commonly refer to.
– The Industry Productivity program publishes annual measures of production per hour and unit labor costs for US industries.
The Multifactor Productivity homepage contains output related to a combined set of inputs, which are produced for major sectors and industries.
Regarding how it is measured, the US Bureau of Labor Statistics says:
“Productivity is measured by comparing the amount of goods and services produced with the inputs which were used in production. Labor productivity is the ratio of the output of goods and services to the labor hours devoted to the production of that output.”
What are unit labor costs?
We calculate unit labor costs by dividing total labor compensation by real output, or by dividing hourly compensation by productivity. In other words:
Unit Labor Costs = Total Labor Compensation ÷ Real Output
Unit Labor Cost = Hourly compensation ÷ productivity = [total labor compensation ÷ hours] ÷ [output / hours]
Therefore, increases in productivity reduce unit labor costs while compensation increases raise them. If both of them move equally, unit labor costs remain the same.
Video – What is productivity?
In this New Zealand Productivity Commission video, Paul Conway, Director of Economics and Research, provides an overview of why it matters so much.