Total Factor Productivity
AdvancedTotal factor productivity is the part of economic output growth that cannot be explained by increases in labour and capital, reflecting how efficiently these inputs are used, through factors such as technology, innovation and better management.
An economy can grow by adding more workers, more machinery and more buildings. But it can also grow by using the same inputs more effectively. Total factor productivity, often shortened to TFP, captures this second source of growth.
Economists estimate TFP by measuring output growth and subtracting the contributions of growth in labour and capital. What remains, sometimes called the Solow residual after economist Robert Solow, is attributed to improvements in efficiency and technology.
For example, if an economy grows by 3% in a year, and growth in labour and capital together explains 2 percentage points, TFP growth accounts for the remaining 1 percentage point.
TFP growth is considered the main driver of long-term increases in living standards, since there are limits to how much labour and capital can be added. Sources include technological innovation, education, better organisation, competition and efficient institutions. Because it is measured as a residual, TFP also absorbs measurement errors.
For worked examples and full lessons, visit notesbysara.org.