## Back to Basics — Total Factor Productivity

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**Canonical URL:** [Back to Basics — Total Factor Productivity](https://www.imf.org/-/media/files/publications/fandd/article/2024/09/b2b-productivity.pdf)

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### Why TFP matters
- Total factor productivity (TFP) measures an economy’s ability to generate income from inputs—primarily labor and capital—and captures the part of income growth not explained by these inputs.
- TFP growth is required for sustained increases in income per person because investments in capital have diminishing returns; TFP advancement “is the only source of sustained growth in income per person,” as Robert Solow showed in a 1957 paper.
- TFP improvements allow maintenance or increases in living standards while conserving natural resources and the environment.

### Current trends and disparities
- Recent IMF research shows that TFP growth has slowed around the world since the global financial crisis; in low-income developing countries it has “come to a virtual standstill in recent years.”
- Countries with some of the world’s highest TFP include The Netherlands, Norway, Switzerland, and the US; these countries are also among the richest.
- Cross-country income disparities are large: controlling for national prices, the average person’s income in South Sudan was estimated to be less than 1 percent of the average person’s in the United States in 2023.
- A large share of cross-country income differences—“more than 66 percent by one recent estimate”—is explained by differences in TFP.

### Major drivers of TFP (factors economists have identified)
- Workforce productivity
  - Higher average years of schooling, better quality of education and training, and better workforce health raise TFP by increasing value added per hour worked.
- Resource allocation (allocative efficiency)
  - When labor and capital flow to the most productive firms within sectors, overall TFP is higher; when resources are stuck in relatively unproductive firms, an economy is “allocatively inefficient” and TFP is depressed.
- International trade
  - Trade promotes specialization, economies of scale, and selection of productive firms, thereby supporting higher TFP.

### Policy implications and prescriptions
- For emerging market and developing economies (catch-up agenda)
  - Mobilize financing to improve public provision of human services (education and health).
  - Remove taxes and subsidies that distort markets and contribute to resource misallocation.
  - Lower barriers to fair competition between firms.
  - Open up to international trade to exploit comparative advantage and scale economies.
  - These measures “could close some of the TFP gap between rich and poor countries,” though a large part of the gap remains unexplained.
- For advanced economies (frontier innovation agenda)
  - Avoid policy mistakes that reduce market competition or revert to trade protectionism, which can stifle entry and innovation.
  - Craft regulations that enable productivity gains from green technology, information and communications technology, and artificial intelligence.
  - Tackle remaining barriers that prevent women and minorities from participating fully across sectors to expand the talent pool and innovative potential.
  - Recognize that frontier economies are already near the limits of gains from workforce productivity, allocative efficiency, and trade openness; sustained TFP growth will depend primarily on innovation in technology, production processes, and product variety.
- General policy principle
  - “Do no harm” by preserving competition and open markets while actively enabling adoption and diffusion of new technologies and inclusivity.

### Key statistics and references from the text
- “more than 66 percent” — share of cross-country income disparities explained by TFP in one estimate.
- “less than 1 percent” — South Sudan average person’s income as a share of the United States average in 2023.
- “1957” — year of Robert Solow’s seminal paper demonstrating TFP’s role in long-run income per person growth.

*Source: b2b-productivity (SEPTEMBER 2024, F&D)*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2024/09/b2b-productivity.pdf_