Total Factor Productivity Growth And Its Importance In An Essay.

What is the total factor productivity growth and why is it important?

Definition of Total Factor Productivity

Total Factor Productivity (TFP) is referred to as that portion of the output, which is unexplainable when it comes to the inputs that are used in the production. This level has to be decided upon how efficiently and effectively the inputs in the production are utilized. TFP plays a very important role in the economic growth, economic fluctuations and for determining the per capita income differences (Chun 2016). With the evolving of the total factor productivity there would be a long-run economic growth in a country. The derivation of total TFP growth involves three main improvements, first being change in the use of input factors and allow for change in the utilization of input factors (macroeconomics 2017). Secondly, use an approach to change TFP to macro level from the industry level. Thirdly, an open economic characteristic has to be taken into consideration by providing a key role to terms-of-trade shocks.

Total factor productivity is the ratio of aggregate output to aggregate input. This can be also be expressed in the ratio of output quantity index to the input quantity index. In other words, it is a method of measuring the efficiency of all the inputs in the production process (Peyrache 2014).

Efficiency is the ability to produce something without causing any wastage of time, materials and energy. On the other hand, productivity includes both labour and capital is the rate at which goods are produced or the work is being completed.

Productivity is basically a basis to measure the efficiency of production. It is generally referred when something is produced, in how much time and when something needs to be produced. Quality and wastage is not a more important factor than quantity. Economic well-being is the most important characteristic of production. Its main aim is to satisfy the human need whether directly or indirectly. The need for satisfaction comes from the commodities which are produced and this need will increase when the quality and price ratio will improve (et al. 2014). Productivity can also be viewed by the industry as a view to examine the trends in the wage level, labour growth and technical improvements. Since capital and labour both are scarce resource so it is important to maximize their impact in the modern business. Productivity enhances through technology advances like computers, improvement in the logistics or the supply chain management and an increase in the skill levels (Mallaby et al. 2016).

Difference between efficiency and productivity

Effectiveness is the time, cost and effort used to fulfill the task. It is also a ratio of output to input. Therefore, it is usually expressed in a percentage and 100% would be the ideal percentage in most of the cases. It is all about doing the things right (Mallaby et al. 2016). The process of selecting the objects for the process is as important as the quality of that process because it helps in avoiding mistakes and errors. It is based on the present thinking and not the result of any future innovation.

Efficiency is the performance indicator of the organization whereas productivity measures the output expected from the given input. Efficiency is used to measure the waste in the system whereas production measures the output produced from one unit of input. Efficiency is how much one produces the given resources in the given amount of time and production is the amount of time one spends on a particular task (Gillingham, Kenneth, and Palmer 2014). Efficiency depends entirely on quality on the other productivity depends solely upon production.

According to Paul Krugman (2016) productivity measures how effectively production units such as the labour and the capital are being used in the economy in order to produce the given level of output. It can be considered as a key source for economic growth and competitiveness. Productivity growth constitutes an important element for making a framework for productive capacity of economics (Paul 2017). It also helps the analysts to determine the capacity utilized which allows one to forecast economic growth. Apart from this, production also helps in assessing demand and the inflationary pressures. There are different measures of productivity and the choice between them depends upon the availability of data. One of the widely used measures of productivity is Gross Domestic Product. This measure would help to capture the labour inputs better than output.

The importance of TFP for sustainable development is as follows:

Emerging market along with developing economies has experienced a exceptional growth in the recent times. Improvement in the growth performance has facilitated better policy, increase in trade and financial integration and favorable external conditions (International Monetary Fund 2017).

For low-income countries in order to increase their production there should be rapid accumulation of capital, continuous labour shifts and diffusion of technology in labour-intensive sectors. Income convergence and sustainable growth will require greater flexibility in resource shifting, reduce resource misallocation within the sectors and apply more knowledge and skill-intensive production techniques. Apart from this, economic institutes should be strengthened, reducing the trade barriers, reformation of the banking and agricultural sector and also improving the infrastructure and basic education needs in order to increase the productivity.

Paul Krugman’s theory

In case of upper-middle income countries focus should be on capital market is required and also developing more competitive and flexible product and labour markets, developing more skilled labour force and investing more and more in development of new technologies(International Monetary Fund 2017).

Structural reforms are required to achieve sustainable growth and to foster higher income levels. For sustaining the long-run growth performance companies require changes in the economic structure and new growth model. For productivity growth, long term prospects and improvement in the standard of living of the people is important.

The factors, which affect the total factor productivity, are:

• Technological progress
• Level of labour force (human force)
• Imported inputs cost (oil)
• Weather (bumper crops, droughts)
• The institutional, economic and legal environment

 The vanishing of the productivity growth had a great mystery behind it because it appeared as if there has been a resurgence of productivity in the 1990s and the labour productivity grew at the rate of 2.2% while the total factor productivity grew at the rate of 1.7% per year. A decade old practice of reengineering, corporate restructuring and downsizing had finally borne its fruit and led to a great productivity in 1990s along with boom investment information technologies. The switch in 1995 from fixed-weight system of measuring GDP to chain-weight method led to a drastic change in the productivity. Accordingly, there was a growth in the labour productivity at the rate of 1.4% per year and the total factor productivity grew at the rate of 0.9% per year.

Table 1: Difference in the per-capita growth rate of various countries:

(Source: World Economic And Social Survey 2013

The three main factors, which lead to economic growth, include:

• Increase in labour inputs like workers or hours worked
• Accumulation of capital stock
• Advancement in technology.

Progress in technology is the main reason for the long-run growth. According to the law of diminishing return, by holding the input factors constantly the additional output that can be obtained by adding one additional unit of labour or capital will gradually decline. As a result of which country cannot maintain its long-run growth by accumulating more of capital or labour.

For every country, the per capita output growth is first broken down into respective contributions from labour inputs, capital stock and technological advancements. Next the sample collected is being divided into two periods that is before and after the financial crisis (Economic growth 2017). This will help us to check if the drivers of growth relates to the economic performance of the country especially on or after recession ( Leigh, Green and Blakely,2016). Finally the gross domestic product growth against the average contribution to output growth of labour, capital and TFP are plotted.

Sustainable development- the importance and example of TFP

The reason behind the failure of sustainable development would be rise in food, financial crisis and breeching of planetary boundaries made it clear that if the current strategies prevail it will not help in achieving sustainable development. In case of certain important areas development is falling and targets are being missed, and there is lot of disparities within and between the countries. Recession has led to increase in unemployment worldwide and the decline of poverty (World economic and social survey 2013). Increase in the food prices has led to an increase in the production of the bio fuels and a rise in the energy prices. Factors like extreme weather conditions and increase in speculative activities have posed various threats. Lastly, it has been indicated that due to environmental degradation the world has been facing sustainability challenges. A global future agenda are required to take steps for addressing the sustainability challenges and a change can be facilitated at global, national and local level.

Conclusion

Natural resources and economic growth are important factors of sustainable development. It is not important for a country to produce or own natural resources because there are many problems associated with the production and the ownership of natural resources. These include currency appreciation from export of natural resources, which causes the various segments of the economy to become uncompetitive in the global market, and the nonrenewable natural resources may limit growth unless there is a more efficient use of resources. An increase in the labour force participation rate would raise the per capita GDP apart from this it also effects the country’s sustainable rate of economic growth. There should also be a positive relationship between investment in the physical stock and growth. Technological growth will affect both physical and human capital. Growth will mainly arise from the enhancement of human capital through improvement in technology and a more efficient production. Investments and saving model will also have a great affect on economic growth.

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