Total Factor Productivity

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The primary components that help determine labor productivity had already been identified. Capital deepening, labor quality, and total factor productivity are the elements that had been used in many of past applied productivity work.

In capital deepening, workers are found to be more productive when they have more or better physical capital with which to work. Growth in labor productivity is proportional to the growth in capital per hour worked.

Labor quality means productivity gains are also dependent towards the quality of workers: more skills mean higher marginal products. Labor quality is defined as the growth in labor input per hour worked.

Total factor productivity is a catch-all term that captures the impact of technological change as well as the increasing returns to scale, omitted variables, reallocations, and any remaining measurement errors.

Capital deepening

This is an indicator that shows the increase in the amount of services from the physical capital presently available to each worker. As corporations and firms invest and purchase new equipment and structures, the workforce becomes better equipped.

Consequently, they are able to produce more. Productivity growth rises proportionally with capital deepening. However, there had been some questions addressed in different manners by the experts regarding capital services.

One is how to treat individual assets which are rapidly changing over time. The other is how to correctly group these different types of capital into a single number. These questions are central to the accuracy of measuring capital as a factor in productivity.

Labor quality

This factor captures the increase and the quality of labor inputs from the ever-evolving and changing mix of workers. As the workforce evolves, workers with different skills are employed at different rates.

This change in composition directly affects how much output can be produced from a given amount of worker hours.

An example would be as follows: As relative wages change, firms substitute between different types of workers. This in turn changes the average productivity of the workforce. This composition effect is often referred to as a change in labor quality.

Estimates of labor hours are relatively easy to compute by simply adding up the hours worked of all types of workers. From there, growth rate can be extracted. In this calculation, all types of workers are essentially treated the same and receive identical weights.

More difficult is the construction of an estimate of the aggregate labor that accounts for the changing composition of workers. Instead of simply summing up the hours, estimates use weights that are equal to marginal products.

Total factor productivity

Also known as the Solow residual (in honour of Nobel laureate Robert Solow), total factor productivity represents the ability to produce more output from the same input.

However, it is often seen as a measure of technological change. TFP also reflects additional factors like economies of scale, resources allocations, measurement errors, and also as growth in disembodied technology.

TFP is calculated as a residual and a catch-all term that captures the impact of all growth factors not explicitly measured by economists. Unmeasured inputs and the inaccurately measured capital and labor inputs affect the measured TFP residual.

All in all, these are the factors presented that determine the labor productivity in general. As had been noted, these traditional factors had been in use for other applied productivity work.