Total Factor Productivity is an important concept in
economics. It connotes the fact that factors other than capital and labour
contribute to the output of an economic system. Total Factor Productivity (TFP)
is the portion of output not explained by the amounts of inputs used in
production. As such, its level is determined by the amount of inputs used in
production, and by how efficiently and intensely the inputs are utilized in
production. TFP growth is usually measured by the Solow Residual. An equation
of Cobb-Douglas form is used to explain total output as a function of total
factor productivity and the capital and labour productivity. While some
economists believe that TFP is a key driver of economic growth, others believe
that it is subject to annual variations and suffers from imperfect
measurements.
The Conference Board in its Productivity Brief 2015
suggests that TFP growth is the result of a combination of improvements in
efficiency (meaning, fewer inputs are needed for a given output) as well as
technology and innovation (meaning, more output is achieved from a given
input). It considers financial capital in terms of machinery, equipment and
structures. It considers human capital in terms of skills and management
competencies. Adding technology and innovation to this capital combination, it
expects increase in output per worker hour. If jobs expand together with higher
productivity there would be a growth in total output. The data presented by The
Conference Board present a declining or flat growth situation in TFP, across
the developed markets as well as emerging markets. It concludes that unless
productivity growth picks up, key indicators of economic health would not pick
up, affecting societal welfare.
Macro or
micro?
National economic management is in the hands of policy
makers in the Governments. They typically attempt to draw up policies at macro
level that stimulate and attract national and international investments and
support expansion of micro-level industrial, business and economic activity.
Industries and businesses do require policy stimulation and support but
probably there is a lot that can happen at micro level itself through higher
productivity. The trickle-down effect of policy stimulation and bottom-up
impact of productivity improvement would be synergistic. In fact, without the
latter (of productivity improvement) inflow of capital arising from policy
stimulation would cause further exacerbation in productivity scenario. Without
productivity drivers in the economy flow of capital, even if stimulated by
policy framework, could eventually ebb. The linkages between macro and micro
are as important as discrete macro and micro improvements. This is particularly
important for India given the legacy of socialist policies, inevitability of
mixed economy and importance of domestic and foreign investments.
Industry gets organized in public sector (or
Government owned sector), private sector (or citizens, individually or
collectively, and in joint sector (Government and people ownership). There is
also the concept of public-private partnership. Although all of these are
organizational entities, they are considered to vary significantly in respect
of productivity practices, which are in turn linked to management approaches.
The common view is that public sector is sought to be influenced by the
Governments while private sector seeks to influence the Governments. The
former, it is felt in some quarters, is a convenient instrument for economic
stimulation and job creation while, likewise in some quarters, the latter is arraigned
as an opportunistic instrument for market capitalization and rent seeking. The
joint sector and public-private partnerships are stuck in the middle, often
gridlocked with ownership differences. The polemical perceptions should not be
allowed to influence a genuine focus on total factor productivity which is
essential for any organization (and economy), regardless of organizational nature
or ownership (or economic policies).
Pan-organizational
Within the limits of what is humanly possible and
within the perspectives of work-life balance, the greater the output that is
achieved from certain inputs, productivity movement is supported. This, in
turn, helps economic growth. This is applicable for all organizations. The
totality with which a policy issue is considered and the speed with which the
policy thought is converted into executive action defines productivity of
national governance. The comprehensiveness with all inputs are aggregated and
the competitiveness with which the aggregate is converted into a product or
service for the customer defines the productivity of industrial management. The
productivity of governance is impacted by certain democratic structures and
processes, be it in US and Japan or India and China. The productivity of
industry may be impacted by policy framework but is largely within
organizational control.
Unfortunately, over the last several years, productivity
as a concept is overshadowed by competitiveness. Individual and system
productivities are considered to be of lower significance than businesses
competitiveness; and competitiveness is defined in terms of either product
differentiation or cost leadership. The emergence of concepts of
competitiveness is welcome but the dilution of focus on productivity is not so
helpful. Productivity has a strong connotation of intrinsic efficiency
improvement in an absolute sense while competitiveness has a connotation of
getting better of another in a relative manner. While the concept of
competitiveness may be helpful at an overall business level, organizational
management has to continue to be focused on productivity. There have, of
course, been criticisms of productivity that it lacks a business perspective
and could lead to sub-optimization of the total system even if the sub-systems
are productive. One can safely premise, however, that without productivity
there cannot be competitiveness.
Productivity
matrix
Productivity is all about efficiency and
effectiveness. The concept itself needs to be deployed efficiently and
effectively for the concept to deliver results in today’s scenario. True and
authentic productivity analysis becomes possible when it is viewed as a matrix
of value chain management and total factor deployment. A worker being
productive on a manufacturing line in terms of components produced in a given
unit of time would not help in the system productivity if the product is not
packaged well or is not transported safely and delivered on time. Managing the
value chain on an end to end basis would be of no avail if factors of
productivity in each constituent are not taken into account to develop
effective input-output metrics. Some firms view this need (if at all they
recognize the concept) as more relevant for integrated companies which control
all activities of the value chain. Firms also consider outsourced activities to
be adequately measured in terms of productivity just through their cost
competitiveness.
The fact, however, is that productivity matrix is
relevant for all activities and for all firms. A highly research oriented
innovation-dependent firm as well as an operations oriented
manufacturing-driven firm would benefit by the concept of productivity matrix. In
the former, at a gross level, more inputs may seem to lead to better output
because the probability of an innovative discovery would improve with more work
streams. However, in each work stream experimental productivity is vital. On
the other hand, in repetitive work environment smooth flow, seamless
coordination and freedom from defects support productivity. Productivity does
not mean error-proof activities; rather it means discovering the cause of
errors and enhancing output. Measurement systems for finished products ensure
product quality but they would not assure zero defects. Understanding the
output profile, in terms of quality and productivity, of the material supplier
would, on the other hand, ensure productivity. Quality and productivity are
interrelated. High quality leads to high productivity while just a rate of
production without quality assurance would lead to poor final output.
Matrix
measurement
Total factor productivity would work only if inputs
and outputs at each stage of the value chain are fully understood and measured.
There are more inputs than labour, capital and technology as commonly
understand; nor are all the inputs linear and variable. Usually the three
common inputs of labour, plant & machinery and technology are expressed in
common financial terms and used as denominator. It is possible to granulate the
inputs into sub-classifications such as direct labour, indirect labour,
permanent employees, contract employees, energy, other utilities, land,
building, equipment, direct materials, indirect materials, long term capital,
short term capital, investments in R&D and so on. The granulation becomes
relevant to compare and contrast productivity measurements across industries,
firms and time. Adjustment for parity helps managements understand true
operational productivity.
There are other process related variables as well,
which impact productivity. In governance, the discussion and decision making
structures (for example, ministerial versus bureaucratic or individual versus
committee) impact productivity. On a shop floor, the feeder systems for
materials and components (centralized versus decentralized versus delivered on
spot or taken from store) determine the level of productivity. In a research
laboratory, the access to global intellectual property databases and the availability
of patent evaluation and patenting infrastructure determine the level of
productivity. With respect to human capital the processes adopted and time
invested for writing down operating procedures and training people in them
determine the level of productivity. While all these are doubtless captured in
financials, gross indexes convey little direction for improvement.
Organizing
for TFP
Most productivity departments in firms are confined to
shop floor as industrial engineering or productivity improvement departments.
More recently operational excellence has come up as a more contemporary
nomenclature. Yet, a preoccupation with manufacturing remains the unchanged
focus. As discussed in this blog post, productivity is a much more
comprehensive concept covering the total value chain with multiple factors in
each stage of the matrix. A total factor productivity department needs larger
organizational appreciation and leadership commitment. Economists are rightly
intrigued to capture what is not covered in total factor productivity; it is
time that industrialists, businessmen and administrators begin to get intrigued
about and interested in what is yet to be covered for measurement of total
productivity.
Posted by Dr CB Rao on June 27, 2015
1 comment:
I never read this type of article before. I appreciate you for the article you have written. Thanks.
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