Productivity refers to the ratio between the volume of output and volume of inputs. Inputs here refer to factors of production like land, labor, capital etc. According to definitions, productivity is the residual output that is not explained by the direct contribution of input resources. It refers to goods and services produced in relation to resources used in their production. High productivity indicates that the resources are being used efficiently. If resources are economically the overall production will increase. This also decreases cost of production. It leads to higher production using minimal resources. It is an important critical indicator of economic performance. Residual output is called as Total Factor Productivity (TFP). Increase in productivity benefits the economy by making it possible to start new industrial units and generating more employment opportunities. Higher productivity is necessary for the growth of any nation.
Higher productivity helps in producing quality goods at lower cost. This will lead to lower prices increasing the standard of living. Profit maximization is possible because of higher productivity. This facilitates internal financing of expansion programmes. Factors of production can be used efficiently. This also increases income for workers. Higher productivity determines the standard of living. Lower productivity means low standard of living. GDP measures the total output. So, the total output is equal to the economy. This is the reason why American workers are richer than workers of any other developing nation. For example, let us consider Munro as an economy. He catches his own fish, grows his one vegetables, and makes his own clothes. His production and consumption can be considered as a simple economy. If he is bad at doing these things, he lives poorly. The standard of living of his economy depends on productivity. A country’s standard of living depends on its ability to produce goods and services.
The two variants of productivity are labor productivity and total factor productivity. Labour productivity measures the amount of output per worker. Total factor productivity measures the amount of output per unit of total input. Total factor productivity is total product output divided into index of all inputs like land, labor, capital etc. Output growing faster than inputs is higher productivity. Productivity increases as a result of advancement of technology, invention of new methods, newer processes etc. Increasing returns to scale, larger inputs and production will lead to higher productivity. Even with other factors remaining constant, economies of scale would contribute to productivity. If a product can be produced more efficiently when produced together than apart it creates a different kind of efficiency. It happens in the presence of economies of scope. For example, this happens in the software industry. When consumers buy software to prepare their federal income taxes the CD-ROM usually contains several other modules, including a link to a Web page, government documents, and a tax preparation manual. This shows economies of scope because the different modules can be more inexpensively produced, packaged, and used together than separately. Economics of scope are like the specialization and division of labor that increase productivity as economies become larger and more diversified. Economies of production and scope are also reasons for increasing productivity. Economies of scale and mass production have been important elements of productivity.
There are other factors that determine Robinson Crusoe’s standard of living other than productivity. From the example mentioned above we can call other determinants as physical capital, natural resources, and technological knowledge. These factors have a role in real economy.
Physical capital: physical capital per worker is important as workers will be more productive if they are provided with proper tools. Tools, equipment and structures used in the process of production of goods and services is called physical capital. The processes become easier and simpler with more tools and equipments. A worker with basic tools cannot produce more. Inputs to production are called factors of production. Physical capital is produced factor of production. Capital is an input into the production process that in the past was an output from the production process. Capital is a factor of production that is used to produce all kinds of goods.
Human capital: It includes the knowledge and skills that workers acquire through education, training and experience. The skills and experiences are a result of time spent in schools, programs, colleges, job trainings etc. It is an intangible capital. Like other determinants human capital also contributes to nation’s productivity. Human capital is a produced and completed determinant of productivity. Proper human capital which has effective and efficient workers requires proper educational facilities, teachers and institutions etc. Students are the future workers. They are the human capital that will be used in future production.
Natural Resources: Natural resource is another determinant of productivity. It includes rivers, land, minerals and other resources provided by nature. Natural resources are of two types: renewable sources and non renewable resources. Renewable resources are sources that can be created again or replaced easily. The supply is infinite. Examples include trees, fresh water, solar energy, biomass etc. Non renewable resources are sources that cannot be created again or replaced. The supply is limited. Examples include oil, gas, coal etc. Natural resource disparities are responsible for some of the differences in living standards around the globe. The historical success of USA was driven in the part by the large supply of land well suited for agriculture. Other examples are countries like Kuwait and Saudi Arabia. They are well off because of oil resources. Though natural resources are important, they are not solely responsible for higher productivity. Japan is a good example for this. Despite having low natural resources, it is one of the richest countries in the world. It imports many natural resources from other countries and exports manufactured goods to those countries.
Technological knowledge: Another important determinant of productivity is technological knowledge. It simply means using the best ways to produce goods. Technological advancements have made production process simpler. Once farming required a high input of labor to produce food for the entire population. Now, it has been made possible to produce for the entire population by employing a small proportion of the population. This has allowed labor to focus on other sectors. Technological knowledge has many forms. Common knowledge spreads to everyone after one uses it. For example, Henry Ford introduced production in assembly lines, other carmakers followed it. Rest is proprietary. Only the company that discovers or invents it knows it. Example: Coco Cola recipe. Some inventions are proprietary for short time. They become available to everyone after the patent expires. These forms of are important for the production of goods and services. Important difference between human capital and technology is technological knowledge refers to society’s understanding about how the world works. Human capital refers to the resources expended transmitting this understanding to the labor force.
Let us discuss about other determinants for better understanding of this. Other determinants of productivity are innovation, education, market efficiency and institutional infrastructure.
Innovation: Invention of new technology leads to development of high value added activities and improves the performance of existing economic activities. When we look back at the past we can know that only few countries have created new technology. They have invested heavily in research and development (R&D). Studies have revealed that creation of new technology is associated with higher TFP.
Education: There is a positive relationship between productivity and education. It is evident when we look at developing and developed countries. Studies show that the number of schooling years and completion rate of secondary and tertiary education is important in explaining the improvement of TFP for many countries.
Market efficiency: Studies have shown that market efficiency s related to variation in productivity across countries. Inefficiency in the allocation of human and physical capital is the main explanation for a low income among many countries. Estimates reveal that if capital and labor had been allocated at the same level as USA productivity in India and China could have been 1.6 times and 1.3 times higher than USA respectively.
Institutional infrastructure: Quality of governance that includes political stability, rule of law, the absence of corruption and so on is positively related to TFP and economic growth. Governance works as a channel for geographical endowments, such as temperate locations and proper growing environment for grains, to contribute to the growth of economy. Government size is also related to economic growth. It paves way for well executed government investment.
By studying productivity and its determinants we can understand the importance of productivity to an economy. Productivity ensures higher standard of living. It improves the income of labors and helps in developing the economy of a country. Determinants should be strengthened to increase productivity. Government should invest on infrastructure and education. Resources should be used properly. Higher productivity is essential for all nations.
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