How does productivity relate to economic growth

To analyze the sources of economic growth, it is useful to think about a production function , which is the process of turning economic inputs like labor, machinery, and raw materials into outputs like goods and services used by consumers. A microeconomic production function describes the inputs and outputs of a firm, or perhaps an industry. In macroeconomics, the connection from inputs to outputs for the entire economy is called an aggregate production function.

Economists construct different production functions depending on the focus of their studies. Figure 6. In the first production function, shown in Figure 6. The inputs in this example are workforce, human capital, physical capital, and technology. We discuss these inputs further in the module, Components of Economic Growth.

Aggregate Production Functions An aggregate production function shows what goes into producing the output for an overall economy. Because it is calculated on a per-person basis, the labor input is already figured into the other factors and does not need to be listed separately. For example, if the percentage of the population who holds jobs in an economy increases, GDP per capita will increase but the productivity of individual workers may not be affected.

Over the long term, the only way that GDP per capita can grow continually is if the productivity of the average worker rises or if there are complementary increases in capital. A common measure of U. This measure excludes government workers, because their output is not sold in the market and so their productivity is hard to measure.

It is interpreted as the contribution to economic growth made by managerial, technological, strategic, and financial innovations. Also known as multi-factor productivity MFP , this measure of economic performance compares the number of goods and services produced to the number of combined inputs used to produce those goods and services.

Inputs can include labor, capital, energy, materials, and purchased services. When productivity fails to grow significantly, it limits potential gains in wages, corporate profits, and living standards. Investment in an economy is equal to the level of savings because investment has to be financed from savings.

Low savings rates can lead to lower investment rates and lower growth rates for labor productivity and real wages. This is why it is feared that the low savings rate in the U. Since the global financial crisis, growth in labor productivity has been weak.

In the U. This has been blamed on the declining quality of labor, diminishing returns from technological innovation, and the global debt overhang , which has led to increased taxation. That, in turn, has led to suppressed demand and capital expenditure. In , global growth productivity fell about 0.

A big question is what role quantitative easing and zero interest rate policies ZIRP have played in encouraging consumption at the expense of saving and investment. Companies have been spending money on short-term investments and share buybacks, rather than investing in long-term capital. One solution, besides better education, training, and research, is to promote capital investment. And the best way to do that, economists say, is to reform corporate taxation, which should increase investment in manufacturing.

More recently, there have been some signs that the economic crisis and lockdown have actually boosted productivity growth. Since companies from just about every single industry—from restaurants and factories to financial institutions and retail stores—are leaning on technology more than ever, workers are being allowed to focus on "higher-value" tasks. The work-from-home model, for instance, is becoming a permanent setup for businesses around the world. Productivity is largely determined by the technologies available and management's willingness and know-how to make process improvements.

The calculation for productivity is straightforward: divide the outputs by a company by the inputs used to produce that output. The most regularly used input is labor hours, while the output can be measured in units produced or sales.

Sales can also be used as a measure of output. Auto manufacturing giant Toyota offers a prime example of high-end productivity in real life. The company has very humble beginnings but has grown to become one of the largest and most productive car manufacturers in the world. TPS includes a few of the following principles:. In , Toyota had to recall roughly 9 million cars due to pedal entrapment and accelerator issues.

Straying away from its foundational TPS principles were widely blamed for the recalls. Since then, management has refocused on its foundational TPS philosophy. Of course, a real-world look at productivity wouldn't be complete without talking about Amazon, the world's largest online marketplace. What is labor productivity? What is multifactor productivity? What is unit labor cost? Why does productivity change? Why is productivity important? The third factor that determines labor productivity is economies of scale.

Recall that economies of scale are the cost advantages that industries obtain due to size. Read more about economies of scale in Cost and Industry Structure. Consider again the case of the fictional Canadian worker who could produce 10 loaves of bread in an hour. If this difference in productivity was due only to economies of scale, it could be that Canadian workers had access to a large industrial-size oven while the U. To analyze the sources of economic growth, it is useful to think about a production function , which is the process of turning economic inputs like labor, machinery, and raw materials into outputs like goods and services used by consumers.

A microeconomic production function describes the inputs and outputs of a firm, or perhaps an industry. In macroeconomics, the connection from inputs to outputs for the entire economy is called an aggregate production function.

Economists construct different production functions depending on the focus of their studies. Figure 1 presents two examples of aggregate production functions. In the first production function, shown in Figure 1 a , the output is GDP. The inputs in this example are workforce, human capital, physical capital, and technology. We discuss these inputs further in the module, Components of Economic Growth. For example, if the percentage of the population who holds jobs in an economy increases, GDP per capita will increase but the productivity of individual workers may not be affected.

Over the long term, the only way that GDP per capita can grow continually is if the productivity of the average worker rises or if there are complementary increases in capital. A common measure of U. This measure excludes government workers, because their output is not sold in the market and so their productivity is hard to measure. It also excludes farming, which accounts for only a relatively small share of the U.

Figure 2 shows an index of output per hour, with as the base year when the index equals The index equaled about in In , the index equaled 50, which shows that workers have more than doubled their productivity since then. According to the Department of Labor, U. In fact, the rate of productivity measured by the change in output per hour worked averaged 3. Figure 3 shows average annual rates of productivity growth averaged over time since In recent years a controversy has been brewing among economists about the resurgence of U.

The most optimistic proponents argue that it would generate higher average productivity growth for decades to come. The pessimists, on the other hand, argue that even five or ten years of stronger productivity growth does not prove that higher productivity will last for the long term.