Labor Productivity: Meaning, Effects, How to Calculate and Increase It

What’s it: Labor productivity refers to the output a worker can produce. It applies to a company, industry, or economy. To calculate it, you can compare the quantity output with workers or hours worked.

Calculating labor productivity

Productivity measures the efficiency of workers in performing tasks. The more productive workers are, the more goods and services they produce.

You can calculate labor productivity per unit hour worked or per worker. The formula is as follows:

Labor productivity = Total output / Total workers… (equation 1)

Or

Labor productivity = Total output / Total hours worked … (equation 2)

The use of both depends on the context you are trying to get into. If the companies you studied have different working hour policies, using equation 2 makes more sense.

For example, a worker at company ABC and company XYZ can produce 1 product a day, but with different working hours. In company ABC, the working hours are 6 hours a day, while the company XYZ has 8 hours.

If using equation 1, the productivity of the two companies is the same. Such a conclusion may mislead you.

In this case, you can see the company ABC is more productive. It can produce one product per 6 hours than company XYZ because it requires 8 hours of work. Company ABC may be using newer and more reliable technology than Company XYZ, thus requiring fewer work hours. Therefore, company ABC should have lower labor costs.

Labor productivity in the economy

The concept of productivity also applies to economic aggregate figures. To calculate an economy’s productivity, you can use real GDP as a numerator, representing the monetary value of the economy’s total output at constant prices. Meanwhile, economists usually prefer aggregate hours for the denominator, which is the sum of all workers’ working hours in one year.

Labor productivity = Real GDP / Aggregate hour

Suppose real GDP is $600 billion, and aggregate working hours in the country are 100 billion hours. Labor productivity is $6 per hour worked ($600 billion / 10 billion).

In the following year, real GDP increased to $950 billion, and working hours increased to 150 billion. Labor productivity equals roughly US 6.3 per hour worked. Thus, the labor productivity in the country has increased by about 5.5% = {(6.3 / 6) -1} x 100%.

In general, labor productivity in developed countries tends to be higher than in developing countries. Developed countries are superior in technological advancement and the quality of human resources, making them more productive.

However, suppose you measure productivity growth rates. In that case, developing countries could be higher than in developed countries when the capital stock is increased by the same quantity. That’s because developing countries have lower capital/labor ratios, and so receive more significant benefits when capital is increased.

Why is labor productivity important?

Productivity can be a source of competitive advantage. Labor costs usually cover a large part of the total production cost.

A more productive workforce allows firms to produce more output using the same amount of labor. Or, the company produces the same amount of output but more quickly. Thus, high productivity lowers operating costs. Because of their low costs, firms earn higher profits even when setting the selling price at the industry average.

In the aggregate, productivity boosts economic growth in the short and short term. Long-run output (potential GDP) depends not only on the quantity of labor supply but also on its quality. If it is more productive, the economy can produce more goods and services.

In the short term, increases in productivity push up supply. Higher supply pushes prices down and makes goods and services more affordable to society.

Lower prices also make domestic goods and services more competitive in international markets. It increases exports and encourages real GDP growth.

High productivity allows companies to pay higher wages while still generating high profits. This increases household disposable income, leading to improved living standards and well-being.

How to increase worker productivity?

Three factors influence worker productivity, including investment in human capital, technological innovation, and physical capital availability.

Investment in human capital

Better education and training system improve the quality of human capital. Workers acquire better knowledge and skills.

Keeping the workplace conducive is also suitable for worker morale, which contributes to productivity.

Finally, specialization also increases productivity through the learning curve effect. When working on a specific task, workers will become more skilled over time. Because they are more experienced, they will know how to do assignments faster.

Technological innovation

Technological innovations accelerate workers in completing their tasks. With more sophisticated tools, workers can produce more output than they can with conventional equipment.

More advanced technology enables companies to achieve economies of scale faster and contribute to lower unit costs.

Infrastructure investment

The government plays a critical role in increasing productivity. Investments in infrastructure support business productivity by lowering logistics costs. Tax incentives can encourage businesses to innovate in new technology. Furthermore, by promoting competition, the government also stimulates the market to innovate.

Also, investment in non-physical infrastructures such as education and health is essential to support increased worker productivity.

Increase in physical capital

Physical capital is important for productivity, not only in terms of quantity but also in quality. For example, by purchasing more computers of the same quality, the publishing company can produce more articles. Likewise, as computers’ quality improves, they can produce the same output faster or produce higher output for the same time.