Total Factor Productivity: A measure of efficiency for managers (Part 1)

Total Factor Productivity (TFP) is an economic term that shows the index of the results of production brought about by improving the efficiency of capital and labor, thanks to the impact of factors. innovating technology, rationalizing production, improving management, improving labor skillse…

This production result can be divided into three parts: capital generated; part created by labor; and the part created by synthetic factors. TFP is calculated by dividing the output by the average of the labor factor and capital inputs, with standard weights of 0.7 for labor and 0.3 for capital. TFP growth rate is calculated by subtracting the growth rate of labor input and capital from output growth. Aggregate factor productivity is a measure of economic efficiency and causes differences in per capita income between countries.

The TFP formula often uses the Cobb-Douglas production function, as follows:

Y = A. f(Kβ Lα )

In which the indexes are:

• Y = Total output
• A = Aggregate factor yield
• K = Capital inputs
• L = Labor input
• β = life of capital contribution, (α = 1- β) = coefficient of contribution of labor

In 2001, William Easterly and Ross Levine estimated that for the average country, the TFP accounted for 60 percent of the growth in output per worker. A 2005 study on human resources also attempted to correct the gaps in the equation for estimating the labor composition of the equation, by refining its labor quality estimates. Specifically, years of schooling are often considered representative of the quality of labor (and human resources), regardless of differences in educational attainment rates across countries. Using these re-estimates, the TFP’s accuracy will improve substantially.

Today, the formula retains the same underlying factors but a lot of ancillary factors have been added to determine aggregate factor productivity. Typically: the increase / decrease in demand for goods (domestic as well as export); Policies to support businesses and industrial promotion; Innovation trend and technology transfer … In particular, technology innovation is a weight worthy of attention because of its ability to reduce input costs, save time, improve labor productivity, improve overall product quality. Changing management technology will also reduce non-value-added activities, reduce waste as well as redundant work that can boost productivity.

Overall, factor productivity (TFP) is often considered the major contributor to GDP growth. For this reason, one of the most common uses of TFP is to measure the remaining growth in a firm’s total output based on industry or sector growth figures, especially under impossible assumptions. It is explained by the accumulation of traditional inputs such as labor and capital. Since this cannot be directly measured, TFP represents the remainder impacting total output.

Productivity and Quality Office