2.1.2.1What is Productivity?

The concept of productivity is generally well-understood, but there is no unique way to define and measure it. In general, it refers to the ratio of output to input(s) used in the production function of any good or service. Historically, as noted by Norsworthy and Jang (1992), productivity was expressed such as bushels of wheat per acre in agriculture. In Europe, as craftsmen became more numerous, output per worker, per day or per week became common measures of productivity. In the United States, because natural resources were relatively abundant, labor productivity or the marginal product of labor was considered more important.

Unfortunately, there is no single definition of productivity because it involves a complex set of issues. The Bureau of Labor Statistics, the reference source for productivity measures in the United States, defines two distinct measures of productivity: labor productivity and total factor productivity (TFP).

Labor productivity relates output to the labor time used to generate that output. In other words, it is the ratio of output to labor input (hours worked). It is the most commonly used measure of productivity because labor is the dominant cost of production in the economy, and it is also the major part of value added in most industries.

Total factor productivity, which is also called multifactor productivity, refers to the relationship between output and the combined inputs of labor, capital and intermediate purchases. It is a broader measure of productivity because it includes all purchased inputs. It does not measure the efficiency of labor only but of all of the inputs that enter the production process. When output is measured as value-added, only capital and labor inputs are considered, and all intermediate inputs are netted out. When output is measured as gross output, then the associated inputs are the factors of production (labor, capital...) and purchased intermediate products (materials, supplies, energy, and other services consumed in the production process). Multifactor productivity has been called “the residual” because it is the change in output that could not be explained by the change in inputs with constant productivity. Because firms are interested in the least-cost combination of inputs, total factor productivity is the concept of most interest for establishments, companies and industries.