Back to Basics: Total Factor Productivity

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Total factor productivity (TFP) measures an economy’s ability to generate income from inputs—“to do more with less.”
Inputs considered are primarily labor (the workforce) and capital (land, machinery, and infrastructure).
Countries cited with some of the world’s highest TFP: The Netherlands, Norway, Switzerland, and the US.
Recent IMF research shows that TFP growth has slowed around the world since the global financial crisis, and in low-income developing countries it "has come to a virtual standstill in recent years."

Long-run improvements in living standards must come from growth in TFP because living standards are measured as income per person and capital investments have diminishing returns.
Robert Solow’s 1957 paper demonstrated that sustained growth in income per person requires TFP advancement.
TFP improvements allow maintenance or increases in living standards while conserving natural resources, including the climate and biosphere.
Cross-country income disparities are largely explained by TFP: 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 recent estimate attributes more than 66 percent of cross-country income disparities to differences in TFP.

Statistically, TFP is measured as a residual—the portion of national income not attributed to labor and capital—described as a “measure of our ignorance.”
Economists have identified at least three variables closely related to higher TFP:
- Workforce productivity: more years of schooling, better quality of education and training, and better workforce health raise the value generated per hour of work.
- Resource allocation: allocative efficiency—where the most productive firms attract the bulk of labor and capital—raises overall productivity; allocative inefficiency (resources stuck in unproductive firms) drags down TFP.
- International trade: trade promotes specialization, economies of scale, and competition that favors productive firms, raising TFP.

Partial blueprint to close the TFP gap with richer countries includes:
- Mobilizing financing to improve public provision of human services (education, health).
- Removing taxes and subsidies that distort markets.
- Lowering barriers to fair competition between firms.
- Opening up to international trade.
Economic studies suggest these measures could close some of the TFP gap, but a large part of the gap remains unexplained.

Further TFP gains from workforce productivity, allocative efficiency, and trade openness are limited because advanced economies operate close to the frontier in these areas.
The most likely source of sustained TFP growth in advanced economies is innovation in technology, production processes, and product variety, though evidence suggests the impact of such innovation has slowed in recent decades.
Recommended policy priorities:
- “Do no harm”: avoid policy mistakes that reduce market competition or introduce costly trade protectionism.
- Craft regulations to harness productivity benefits from green technology, information and communications technology, and artificial intelligence.
- Tackle barriers restricting opportunities for women and minorities to contribute their talents across sectors.

TFP is central to long-run living standards and to reconciling economic growth with resource constraints.
Closing TFP gaps requires country-specific strategies: human capital and market reforms for developing economies; competition, innovation-friendly regulation, and inclusion for advanced economies.
If future improvements in wellbeing (for example, more leisure time) occur, TFP growth is likely to be the major contributing factor rather than individual-level productivity advice.

F&D Magazine — ROBERT ZYMEK, September 2024.

Back to Basics: Total Factor Productivity
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CHAPTER 3 SLOWDOWN IN gLObaL MEDIUM-TERM gROWTH: WHaT WILL IT TaKE TO TURN THE TIDE?
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