What is Labour Productivity?

Newspapers, and in particular economists frequently talk about labour productivity. Especially when commenting the current state of the economy, labour productivity is of central concern. This post will explain the concept of labour productivity and highlight its importance in the context of business cycle analysis.

The Concept of Labour Productivity

Economists define labour productivity, sometimes referred to as workforce productivity, as real economic output per labour hour. That is, labour productivity is the ratio of the amount of goods and services produced over the amount of labour input used to produce these goods (see Equation (1)). The system of national accounts (SNA) defines labour productivity as the ratio of real Gross Domestic Product (GDP) over labour input. That is, total hours worked.

(1)  \text{Labour Productivity} = \frac{\text{produced goods and services}}{\text{labour input (hours)}}

Usually, economists are less concerned about the level of labour productivity but much more interested in the changes of labour productivity over time. The reason being that labour productivity growth is a central indicator for economic growth. Growth in labour productivity is calculated by the change in economic output per labour hour over a defined period.

Note that, labor productivity is not the same as employee productivity. Employee productivity refers to a single worker’s output, while labour productivity refers to productivity of an economy as a whole.

Why is Labour Productivity Important?

As already mentioned, productivity growth is considered to be an important indicator for economic growth since an increase in labour productivity is directly linked to an increase consumption. The economic intuition reads as follows: An increase in labour productivity implies that more goods and services are being produced for the same amount of work. In order words, for the same work more goods are being produced. Hence, an increase in labour productivity leads to an increase in output that allows to consume more goods and services without working more. Everyone is better off.

How Can We Increase Labour Productivity?

Obviously, the question every policy maker asks is: How can we influence labour productivity? Generally, there exists various factors that are able to change labour productivity. These factors can thereby influence either the amount of goods produced or the total amount of labour used in the production process. That is, these factors can either change the nominator or the denominator of Equation (1). Economically speaking, changes in labour productivity can occur because of changes in the capital that is used in the production process (human or physical capital) or due to technological change.

More specifically, one can achieve an increase in labour productivity by

  • An increase in capital intensity. That is, use more capital per worker/hours worked
  • An increase in human capital. That is, increase workers education/skills
  • Technological progress. That is, engage in research and development in order to render the production process more efficient

While these points are rather theoretical, there are some very concrete measures policy makers can take in order to improve labour productivity:

  • Provide Vocational Training. That is, provide the opportunity for employees to improve their education and skills in order to become more efficient.
  • Create Tax Incentives. Provide tax incentives in form of tax breaks or tax exemptions for specific investment projects, i.e. investment projects involving energy efficient equipment or involving a new superiour technology.
  • Favour Replacement Investment. In a similar fashion, incentivise the replacement of old and inefficient capital stock by new and more efficient capital. Furthermore, favour an increase of the capital stock as a whole, which will, given a standard production function, increase production given the same labour input.
  • Decrease Market Regulations. A decrease in market regulations can increase firm entries and exits. According to economic theory, a decrease in market regulations causes firms with a higher productivity to enter the market. These higher productive firms entering the market will put less productive firms out of the market. Overall labour productivity increases.
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