The what, why and how

Productivity growth is an indicator of a nation's success in 
harnessing its resources to produce more output, generate
more income and lift the living standards of its citizens

What is productivity?

  • At the level of a national economy, or broad industry sector, productivity is defined and measured as the ratio of outputs produced to inputs used.
  • Outputs and inputs are measured as quantities (rather than in dollar terms).
  • Productivity is therefore the rate at which producers transform quantities of inputs into quantities of outputs.
  • Productivity measures are (ideally) indicators of the efficiency of production. 'Ideally' because there can be qualifications on productivity measures as indicators of production efficiency (see Interpretation of productivity measures).                                                                          
Why does productivity matter?
  • Productivity is not the end game, to be pursued at all costs. Productivity must serve a 'higher purpose'.
  • Productivity serves the higher purpose of improving general living standards, often indicated by average income or GDP per capita. 
  • Productivity growth means a nation's resources (production inputs) are used to produce more output. That also means resources are used to generate more income, which in turn raises income per capita. 
  • Productivity growth matters because it is the most important source of growth in general living standards over the long term. Essentially, without productivity growth, a nation shows no economic development and its citizens do not have the additional wherewithal and opportunity to enrich their lives with greater material wealth, social capital and environmental sustainability.
  • There are other sources of improvement in living standards -- a higher rate of employment or a favourable shift in the terms of trade (the ratio of export prices to import prices). But these sources have ceilings (the rate of employment can only go so high) and are volatile (the history of the terms of trade shows that what goes up, comes down sooner or later).
  • If the rate of employment or the terms of trade rise, they can be a greater fillip to living standards than productivity. But it will only be in the short to medium term.
  • Productivity is the major source of sustained improvement in living standards over the long term.
  • Over the past 40 years or so, productivity growth has accounted for nearly ALL of the improvement in Australians' per capita incomes.

How does productivity improvement come about? 
  • Productivity improvement happens at the level of firms. Innovation is the way in which firms improve their production efficiency.
  • Innovation means firms do something different (introduce a new or better-quality product) or do things in a different way (introduce more-sophisticated machinery or better inventory management practices). 
  • Innovation is doing something that is new to the firm. It can be uptake of existing technology. It does not have to be an invention or something that is new to the world.
  • Innovation means firms get more or higher-value outputs from their use of inputs. Or they can produce their products in less input-intensive ways. Either way, innovation raises the ratio of outputs to inputs -- that is, productivity.
  • Productivity improvements can also come about through 'firm dynamics' -- the entry or rapid growth of more-productive firms and the slow growth or demise of less-productive firms.
  • Through these two mechanisms, the average productivity of the industry in which the firms operate can rise. 
  • The allocation of resources (that is, production inputs) to more-productive firms is therefore a potential source of productivity improvement -- in addition to improvements in production efficiency within firms.
See also 'How can governments influence productivity growth?'