LECTURE 2 GENERAL PRINCIPLES OF PRODUCTIVITY GROWTH AND MEASUREMENT

Bene ts of producivity growth

Productivity is a crucial factor in production performance of rms and nations. Increasing national productivity can
raise living standards because more real income improves people's ability to purchase goods and services, enjoy
leisure, improve housing and education and contribute to social and environmental programs. Productivity growth also
helps businesses to be more pro table.

An individual's or a socioeconomic class's standard of living is the level of wealth, comfort, material
goods, and necessities available to them in a certain geographic arca, usually a country. The standard of
living includes factors such as income, quality and availability of employment, class disparity, poverty
rate, quality and affordability of housing, hours of work required to purchase necessities, gross domestic
product, in ation rate, amount of leisure time every year, affordable (or free) access to quality
healthcare, quality and availability of education, life expectancy, incidence of disease, cost of goods and
services, infrastructure, national economic growth, economic and political stability, freedom,
environmental quality, climate and safety. The standard of living is closely related to quality of life.

Productivity growth is a crucial source of growth in living standards. Productivity growth means more value is added
in production and this means more income is available to be distributed.

Bene ts derived from higher productivity are as follows:

1. It helps to cut down cost per unit and thereby improve the pro ts.
2. Gains from productivity can be transferred to the consumers in form of lower priced products or better quality
products.
These gains can also be shared with workers or employees by paying them at higher rate.
4. A more productive entrepreneur can have better chances to exploit expert opportunities.
5. It would generate more employment opportunity.
6. Overall productivity re ects the ef ciency of production system.
7. More output is produced with same or less input.
8. The same output is produced with lesser input.
9. More output is produced with more input.
10. The proportional increase in output being more than the proportional increase in input.

At a m or industry level, the bene ts of productivity growth can be distributed in a number of different ways:

1. to the workforce through better wages and conditions;

2. to shareholders and superannuation funds (regular payment made into a fund by an employee towards a future
pension) through increased pro ts and dividend distributions:
3. to customers through lower prices;
4. to the environment through more stringent environmental protection; and
5. to govermments through increases in tax payments (which can be used to fund social and environmental
programs).

Productivity growth is important to the rm because it means that it can meet its (perhaps growing) obligations to
workers, shareholders, and governments (taxes and regulation), and still remain competitive or even improve
its competitiveness in the market place.

Drivers of productivity growth

In the most immediate sense, productivity is determined by the available technology or know-how for converting
resources into outputs, and the way in which resources are organised to produce goods and services.

Historically, productivity has improved through evolution as processes with poor productivity performarnce are
abandoned and newer forms are exploited. Process improvements may include organisational structures (.g.
core functions and supplier relationships), management systems, work arrangements, manufacturing techniques,

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 and changing market structure. A famous example is the assembly line and the process of mass production that appeared

in the decade following commercial introduction of the automobile.

Major sources of productivity growth in cconomic history (Productivity improvingtechnologies)

O Newforms of energy and power

0 Energy ef ciency
o Conversion ofheat to work
Electri cation and the pre-electric transmission of power
o
o Reuse ofheat
Reducing friction
Lighting ef ciency
O Infrastructure
Roads
Ocean shipping and inland waterways
o Railroads
o Motorways
Pipelines
O Mechanisation
o Mechanised agriculture
o Industrial machinery
o Machine tools
o Mining
Mechanised materials handling
o
0 Bulk materialshandling
Palletisation (To stackandpackage (freight, for example) on pallets for ef cient
0 Cranes
O
shipping and handling.)
0 Containerisation
Work practices andprocesses
O
Division oflabour
o
Interchangeable parts
o
Standardisation
o
Modern business management
o Continuous production
Newmaterials, processesand de-materialisation
O
Iron andsteel
o Sodium carbonate(soda ash) and related chemicals
o
Cement
o Paper
o Rubber and plastics
o Optical bre
o Oil and gas
Dematerialisation
Hard materials for(the reduction of total materialandenergys the limitation of its
cutting
environmental impact. This includesreduction of rawmaterials atthe productionstage,
o
of energy and material inputs at the usestage, and ofwaste at thedisposalstage)

D Communications
o Telegraphy
Telephone
o Radio frequency transmission
o Fibre optics
o Communications satellites
o
Facsimile (FAX)
Intemet based communications
.o economics: Public water supply, household gas supply and appliances
O Home
O Automation, process control and servomechanisms (automatic devices that use error-sensing

negative feedback to correct the action of amechanism)

D Computers,semiconductors,dataprocessingand information technology, IT, ICT
etc

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 There is a generalunderstanding of the main determinants or drivers of productivity growth. Certain factors are
critical for determining productivity growth. Five drivers interact to underlie long-term productivity performance:
investment, innovation, skills, enterprise and competition.

1, Investment is in physical capital- machinery, equipment and buildings. The more capital workers have
at their disposal, generally the better they are able to do their jobs, producing more and better quality output.

2. Innovation is the successful exploitation of new ideas. New ideas can take the form of new
technologies, new products or new corporate structures and ways of working. Speeding up the diffusion of
innovations can boost productivity.

3. Skillş are de ned as the quantity and quality of labour of different types available in an economy.
Skills complement physical capital, and are needed to take advantage of investment in new technologies
and organisational structures.
4. Enterprise is de ned as the seizing of new business opportunities by both start-ups and existing ms.
New enterprises compete with existing fms by new ideas and technologies increasing competition.
Entrepreneurs are able to combine factors of production and new technologies forcing existing rms to
adapt or exit the market.

5. Competition improves productivity by creating incentives to innovate and ensures that resources are
allocated to the most e cient rms. It also forces existing rms to organise work more effectively through
imitations of organisational structures and technology.

The list can be made more detailed, showing quite a variety of factors which can affect productivity, both positively and
negatively. These include:
1. capital investments in production 13. quality of management
2. capital investments in technology 14. legislative and regulatory environment
3. capital investments in equipment 15. general levels of education
4. capital investments in facilities 16. social environment
5. economies of scale 17. economic climate
6. workforce knowledge and skill resulting from 18. markets
training and experience 19 change
7. technological changes 20. people
8. work methods 21. rewards
9. procedures 22. infomation
10. systems 23. technology
11. quality ofproducts 24. geographic factors
12. quality of processes

The rst 12 factors are highly controllable at the company or project level. Numbers 13 and 14 are marginally
controllable, at best. Numbers i5,16, 17 are controllable only at the national level, and 24 is uncontrollable.

output
productivity =
input

There are two major ways to increase productivity: increase the numerator (output) or decrease the denominator
(input).

Of course, a similar effect would be seen if both input and output increased, but output increased faster than input; or if
'input and output decreased, but input decreased faster than output.

Organisations have many options for use of this formula: labour productivity, machine productivity, capital
productivity, energy productivity, and so on. A productivity ratio may be computed for a single operation, a
department, a facility, an organisation, or even an entire country.

Organisations can monitor productivity for strategic reasons such as corporate planning, organisation improvement, or
comparison to competitors. It can also be used for tactical reasons such as project control or controlling performance to
budget.

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 Productivity is usually expressed in one of three forms: partial factor productivity, multifactor productivity, and total
productivity.

PARTIAL-FACTOR PRODUCTIVITY

The standard de nition of productivity is actually what is known as a partial factor measure of productivity, in the sense
that it only considersa Ssingle input in the ratio. The formula then for partial-factor productivity would be the
ratio of total output to a single input.

Managers generally utilise partial productivity measures because the data is readily available. Partial factor
productivity measures are easier to relate to speci c processes. Labour-based hours (generally, readily available
information) is a frequently used input variable in the equation. When this is the case, it would seem that
productivity could be increased by substituting machinery for labour. However, that may not necessarily be a wise
decision. Labour-based measures do not include mechanisation and automation in the input; thus when automation
replaces labour, misinterpretation may occur.

Other partial factor measure options could appear as output/labour, output/machine, output/capital, or outputenergy.
Terms applied to some other partial factor measures include capital productivity (using machine hours or units
of money invested), energy productivity (using kilowatt hours).

MULTIFACTOR PRODUCTIVITY

A multifactor productivity measure utilises more than a single factor, for example, both labour and capital. Hence,
multifactor productivity is the ratio of total output to a subset of inputs:

A subset of inputs might consist of only labour and materials or it could include capital.

Obviously, the different factors must be measured in the same units, for example money units or standard hours.

TOTAL FACTOR PRODUCTIVITY

A broader gauge of productivity, total factor productivity is measured by combining the effects of all the resources used
in the production of goods andservices (labour, capital, raw material, energy, etc.) and dividing it into the output.

Total output must be expressed in the same unit of measure and total input must be expressed in the same unit of
measure. However, total output and total input need not be expressed in the same unit of measure.

Total productivity ratios re ect simultaneous changes in outputs and inputs. As such, total productivity ratios provide
the most inclusive type of index for measuring productivity and may be preferred in making comparisons of
productivity. However, they do not show the interaction between each input and output separately and are thus too
broad to be used as a tool for improving speci c areas.

Total Factor Productivity is a measure favoured by the Japanese, whereas labour productivity is the measure favoured
by the United States.

SOME CHALLENGES OF PRODUCTIVITY MEASURES/MEASUREMENT

It has been said that the challenge of productivity has become a challenge of measurement. Productivity is dif cult to
measure and can only be measured indirectly, that is, by measuring other variables and then calculating productivity
from them. This dif culty in measurement stems from the fact that inputs and outputs are not only dif cult to de ne but
are also dif cult to quantify.

The ways in which input and output are measured can provide different productivity measures. Disadvantages
of productivity measures have been the distortion of the measure by xed expensesand also the inability of productivity
measures to consider quality changes (e.g., output per hour might increase, but it may cause the defect rate to
skyrocket), It is easier to conceive of outputs as tangible units such as number of items produced, but other factors such
as quality should be considered.

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 Experts have cited a need for a measurement program that gives an cqual weight to quality as well as productivity.
If
ouality is included in the ratio, output may have to be de ned as something like the number of defect-free units of
Droduction or the number of units which meet customer expectations or requirements.

PRODUCTIVITY INDEX

Since productivity is a relative measure, for it to be meaningful or useful it must be compared to something.
For example, businesses can compare their productivity values to that of similar ms, other departments within the
same m, or against past productivity data for the same m or department (or even one machine). This allows rms to
measure productivity improvement over time, or measure the impact of certain decisions such as the introduction on new
processes, equipment, and worker motivation techniques.

In order to have a value for comparison purposes, organisations compute their productivity index.

A productivity indexX is the ratio of productivity measured in some time period to the productivity measured in a
baseperiod.

For example, if the base period's productivity is calculated to be 1.75 and the following period's productivițy is
calculated to 1.93, the resulting productivity index would be 1.93/1.75 = 1.10. This would indicate that the
m's productivity had increased 10 percent.

If the following period's productivity measurement fell to 1.66 the productivity index of 1.66/1.75 = 0.95 it would
indicate that the organisation's productivity has fallen to 95 percent of the productivity of the base period. By tracking
productivity indexes over time, managers can evaluate the success, or lack thereof, of projects and decisions.

Productivity may bemeasuredeither on agregate basis or on individual basis, which are called
total and partial measure.

Total productivityIndex/measure =Total output/ Total input

= Totalprocuction ofgoodsandservices
Labourtmaterial+capital+Energy+management

Partial productivity indices, depending upon factors used, it measuresthe ef ciency of individual

factor ofproduction.

Labourprodđuctivity
Index/Measure=Qutputin unit
Man hours worked
Management productivity Index/Measure = Output
Total cost ofmanagement

Machine productivity Index/Measure = Total output

Machine hours worked

Land productivity Index/Measure Totaloutput

Area of Landused

PartialMeasure =Output or Output or Qutput or Output

Labour Capital Materials Energy

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 PROBLEMS:
Example-1 Units of a currency (N)
The input and output data for an industry given in the tabíe. Find out various productivity
measureslike total, multifactor and partial measure.

Outputand Inpatprodnctiondata in

Qutout
1. Finished units 10,000
2. Work inprogress 2,500
3. Dividends 1,000
4. Bonds
5. Other income

Input
1. Human 3,000
2. Material 153
3. Capital 10,000
4. Energy 540
S. Other Expenses 1,500
Solution:
Totalmeasure= Total Output =13.500 =0.89
Total Input 15.193
Multi factormeasure= TotalOutput = 13,500=4.28
Human+Material 3,153
Multi factormeasure= Finished units= 10,000=3.17
Human+Material 3,153
PartialMeasurej = Total Output = 13.500 =25
Energy 540
PartialMeasure,= Finished units =10.000 =18.52
Energy 540

Example 2
Block manufacturing company has provided the following data:
2015 2020

Output() 22,000,000 35,000,000

Inputs ():
Labour 1,000,000 1,500,000
Materials 8,000,000 12,000,000
Equipment depreciation 7,000 10,000
Other 20,000 48,000

Compare the productivity indices for total productivity, partial productivity for labour and materials, and multifactor productivity for
materials and equipment for the years indicated above.
Total Productivity index:
2019 22,000,000/(1,000,000 + 8,000,000 + 7,000 + 20,000) 2.43

2020 35,000,00/(1,500,000 + 12,000,000 + 10,000 + 48,000) = 2.58

2.58/2.43 = 1.06 increase in productivity

Labour:
2019 22,000,000/1,000,000 =22

2020 35,000,000/ 1,500,000= 23

23/22 = 1.05 increase

Materials:

2019 22,000,000/ 8,000,000 = 2.75

2020 35,000,000/12,000,000 = 2,92

2.92/2.75 = 1.06 increase 6

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 ltiactor productivity ( materialsandequipment):
22,000,000/(8,000,000 +7,000) = 2.74
019
2020 35,000,000/(12,000,000 + 10,000) = 2.91

291/2.74 = 106 increase in productivity

Note: For multifactor and partial measues it is not necessary to use total output as numerator.
Often, it is describe to create measures that represent productivity as it relates to some particular
output ofinterest.

Other elds for the measurement of partial measures of productivity are:

Business Productivity Measure

Restaurant Customers (Meals) per labour hour
Retail Store Sales per square foot
Uility plant Kilowatts per ton of coal
Paper mill Tons ofpaperper cord of wood

PRODUCTIVITY AT THE NATIONAL LEVEL

Productivity is one of the basic variables goveming economic production activity and may be the most important. It is
the fundarmental controllable factor in wealth production. Since other economic variables depend on it, increasing
productivity tends to have a bene cial multiplying effect on other economic variables. This is generally true at every level
zof economic aggregation.

Improving productivity is of national importance because, for a society to increase its standard of living, it must rst
increase productivity.

Overall productivity for individual countries is calculated by dividing output, as measured by GDP or GNP, by the
country's total population.

Gross domestic product (GDP) is the monetary value of all the nished goods and services produced within a
country's borders in a speci c time period. Though GDP is usually calculated on an annual basis, it can be
calculated on a quarterly basis as well. GDP includes all private and public consumption, government outlays,
investments, private inventories, paid-in construction costs and the foreign balance of trade (exports are added,
imports are subtracted).

Gross National Product. GNP is the total value of all nal goods and services produced within a nation in a
particular year, plus income earned by its citizens (including income of those located abroad), minus income of non-
residents located in that country. Basically, GNP measures the value of goods and services that the country's citizens
produced regardless of their location. GNP is one measure of the economic condition of a country, under the assumption
that a higher GNP leads to a higher quality of living, all other things being equal.

1. GDP, or Gross Domestic Product is calculated either by measuring all income earned within a country, or by
measuring all expenditures within the country, which should approximately be the same.
2. GNP, or Gross National Product uses GDP, but adds income from foreign sources, less income paid to foreign
citizens and entities.
Both represent an attempt to measure the total economic output of a nation during a given period (usually one year),
and serve as barometers to measure both the level and direction of a country's economic activity.
GNP can be either higher or lower than GDP, depending on whether or nota country has a positive or negative result
from net foreign in ows and outgo.

Thus, productivity is measured as the monitory value per capita outputs. An increase in this measure of productivity means
that each person in the country, on average, produced more goods and services. Also if productivity increases, then pro ts
increase. The resulting pro ts can then be used to pay for wage increases (inherent in in ation) without having to raise
prices. In this way, productivity gains actually help curb in ation.

Productivity is considered basic statistical information for many international comparisons and country performance
assessments and there is strong interest in comparing them internationaly.

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 roductivity paradox

One of
. nfthe coreissues for economists in thepastdecadeshasbeentheproductivityslowdownthatbeganin theearly
19705s.

Eyen after accounting for factors such as the oil price shocks, most researchers nd that there is an unexplained
residual drop in productivity as compared with the rst half of the post-war period. The sharp drop in productivity
roughly coincided with the rapid increase in the use of IT. Although recent productivity growth has rebounded
somewhat, especially in manufacturing, the overall negative corelation between economy-wide productivity and the
advent of computers is behind many of the arguments that IT has not helped producivity or even that IT investments
havebeen counter-productive

The paradox has been de ned as a perceived "discrepancy betweenmeasures of investment in information technology
andmeasures of output at the national level".

There are four probable causes for this paradox.

1.
Mis-measurement: the gains are real, but our curent measuresmiss
them:;

2. Redistribution: there are private gains, but they come at the expense of other rms and individuals, leaving
little
3. Time lags: the gains take a long time to show
up; and
4. Mismanagement:
A
there are no gainsbecauseof the unusual dif culties in managing IT or information
itself.

STUDY QUESTIONS

1. Brie y explain the following:

a. Process improvement
b. Standard of livingAiving standard
2. What are the bene ts of higher productivity/productivity growth at the level of:
a. economy
b. industry
rm/organisation
3. What are the main factors that have major bearing on productivity?
4. Enumerate major sources of productivity growth in economic history
s. Differentiate between Partial Factor Productivity, Multifactor Productivity and Total Productivity.
6. Explain how the above can be measured giving appropriate examples
7. What are the main challenges associated with measuring productivity.
8. Explain what productivity index is.
9. Explain how the following can be calculated
a. Total Productivity index
b. Land Productivity index
c. Labour productivity index
d. Management Productivity index
e. Machine Productivity index
f. Partial Productivity index
10. Describe and explain Productivity Paradox.
11. Explain how productivity is measured at the National level and what is its importance/signi cance

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