What Is Productivity and How to Measure It

What Is Productivity?

Productivity is a measure of performance that compares the output of a product with the input, or resources, required to produce it. The input may be labor, equipment, or money.

The U.S. government focuses on labor productivity. Economic productivity is calculated as a ratio of gross domestic product (GDP) to hours worked. Labor productivity is analyzed by sector to identify trends in job growth, wages, and technological advances.

In the business world, productivity is a measure of the efficiency of a company's production process, It is calculated by measuring the number of units of a product produced relative to labor hours or by measuring net sales relative to labor hours. Corporate profits and shareholder returns are directly linked to productivity growth.

Understanding Productivity

Economists see productivity as the key source of economic growth and competitiveness, whether it is being measured in a business, an industry, or a nation.

A country’s ability to improve its standard of living depends on its ability to raise its output per worker. This does not necessarily mean that every worker works harder. It means that some combination of improvements in equipment, the production process, and the work environment enables workers overall to increase their production.

Economists use productivity growth to model the productive capacity of economies and determine their capacity utilization rates. This, in turn, is used to forecast business cycles and predict future levels of GDP growth.

In addition, production capacity and utilization are used to assess demand and inflationary pressures.

4 Types of Productivity Measures

Labor Productivity

The most commonly reported productivity measure is labor productivity published by the Bureau of Labor Statistics. This is based on the ratio of GDP to total hours worked in the economy. Labor productivity growth comes from increases in the amount of capital available to each worker (called capital deepening), the education and experience of the workforce (labor composition), and improvements in technology (multi-factor productivity growth).

However, productivity is not necessarily a reliable indicator of the health of an economy at a given point in time. For example, during the 2009 recession in the United States, output and hours worked were both falling while productivity was growing. That is, hours worked were falling faster than output.

Gains in productivity can occur both in recessions and in expansions—as it did in the late 1990s—so one needs to take economic context into account when analyzing productivity data.

Total Factor Productivity

Many factors impact a country’s productivity. Investment in plant and equipment, innovation, improvements in supply chain logistics, education, enterprise, and competition all effect productivity.

The Solow residual, which is usually referred to as total factor productivity, measures the portion of an economy’s output growth that cannot be attributed to the accumulation of capital and labor.

It is interpreted as the contribution to economic growth made by managerial, technological, strategic, and financial innovations.

Also known as multi-factor productivity (MFP), this measure of economic performance compares the number of goods and services produced to the number of combined inputs used to produce those goods and services. Inputs can include labor, capital, energy, materials, and purchased services.

Capital Productivity

Capital as a productivity measure looks at how efficiently physical capital is being used to create goods or services. Physical capital includes tangible items such as office equipment, labor materials, warehouse supplies, and transportation equipment.

Capital productivity is calculated by subtracting liabilities from physical capital. You then divide the sales number by the difference. A higher capital productivity number shows that physical capital is being used efficiently in the creation of goods and services while a lower capital productivity number shows the opposite.

Material Productivity

Productivity by materials measures output compared to the amount of materials consumed. Materials consumed can be heat, fuel, or chemicals used in the process of creating a product or service.

It analyzes the output generated per unit of material consumed.

Productivity and Investment

When productivity fails to grow significantly, gains in wages, corporate profits, and living standards are limited.

Investment in an economy is equal to the level of savings because investments are financed from savings. Low savings rates can lead to lower investment rates and lower growth rates for labor productivity and real wages. When savings rates in the U.S. are low, it is viewed as harming productivity growth in the future.

A big question is what role quantitative easing and zero interest rate policies (ZIRP) have played in encouraging consumption at the expense of saving and investment. For instance, during periods of lax monetary policy where credit is accessible and affordable, consumers are more likely to incur debt and decrease their savings in pursuit of mortgages, loans, and other major purchases.

It is only when monetary policy is tightened and rates rise that the economy encourages saving and ultimately future investment.

Companies can choose to spend money on short-term investments and share buybacks rather than investing in long-term capital. Some economists call for corporate tax reform to better incentivize investment in manufacturing, infrastructure, or long-term assets.

Work-at-Home Productivity

In the wake of the COVID-19 pandemic, some economists believe that workers have been focusing more on "higher-value" tasks that rely on technology, mobility, and scalability.

As more businesses shift away from strictly on-premises operations, alternative infrastructure investments are needed to handle a hybrid or fully remote entity.

How to Calculate Productivity

The calculation for productivity is straightforward: divide the outputs of a company by the inputs used to produce that output. The most regularly used input is labor hours, while the output can be measured in units produced or sales.

For instance, if a factory produced 10,000 widgets last month while being billed for 5,000 hours for labor, productivity would be two widgets per hour (10,000 / 5,000).

Sales can also be used as a measure of output. In the same factory, let's say 10,000 widgets translate into $1 million in sales. Divide the $1 million figure by 5,000 labor hours to get the productivity number: $200 in sales for each hour of labor.

Real-World Example

Auto manufacturing giant Toyota offers a prime example of high-end productivity in real life. The company had very humble beginnings but has grown to become one of the largest and most productive car manufacturers in the world. Its Toyota Production System (TPS) is one of the main reasons for that.

TPS includes a few of the following principles:

• An environment of constant learning and improvement
• Standardizing systems for consistent quality
• The elimination (not just reduction) of waste

By enacting TPS practices in its manufacturing every day, Toyota ensures the company is continually improving and operating at a high standard while resources are not being lost.

The Bottom Line

The concept of productivity is simple: at a given level of input, there is a given level of output. More productive societies and processes will yield more output at the same level of input.

Whether it is viewed from an economic standpoint, a company standpoint, or a personal standpoint, being able to measure and track productivity is crucial to long-term success.