Productivity Growth

Productivity is the efficiency with which firms convert inputs such as labor, capital, and materials into outputs. The detailed collection of productivity data over the past few decades has enabled economists to make substantial strides in empirically understanding how this input-output conversion occurs within firms and across time, industries, and countries.

Introduction

Productivity is the efficiency with which firms convert inputs such as labor, capital, and materials into outputs. The detailed collection of production activity data over the past few decades has enabled economists to make substantial strides in empirically understanding how this input-output conversion has occurred within firms and across time, industries and countries.

The first, most puzzling finding is that of substantial and persistent variation in productivity levels and growth rates across firms even within the same industry and during the same time period. A second important observation macroeconomists have made is that aggregate productivity growth is very closely related to cross-country per capita income variation and that the level of productivity dispersion is much higher in some economies than others (Hall and Jones 1999) (Bartelsman, Haltiwanger, and Scarpetta 2013) (Hsieh and Klenow 2009). These findings suggest that certain firm specific features and certain economic/institutional environments foster conditions that enable a more efficient use of resources. Understanding these efficiency-generating conditions is crucial since ultimately, it is these productive firms that are the ones to survive and contribute most to economic growth and that enable increased firm productivity, thereby leading to strong economic development.

The vast majority of research in the productivity literature has focused more generally on the entire distribution of firms, rather than the specific subset of so-called entrepreneurial firms. This is in part because of the newness of the field and data availability. More importantly, however, this is likely because of the difficulty researchers face in defining entrepreneurial firms, which in and of itself is a non-trivial task. Are entrepreneurial firms those that take the greatest risks and yield the greatest growth in productivity, or are they the young new entrants into an industry? It is unclear if these two sets of firms always overlap or if the distinction even needs to be made at this point. The first course of action should be to understand what determines firm productivity, and then once we have a clear sense of these factors, we can then think about how they relate to the different definitions of entrepreneurial firms (be they the young, the most productive, or the most innovative).

Broadly speaking, the literature can be broken down into the study of productivity drivers at the firm/plant level and across firms, industries, and countries. At the firm/plant level, research has shown that management practices, manager experience, firm structure, employee incentive structure, human and physical capital quality, product innovation, and technology adoption affect productivity (Bloom and Van Reenen 2008) (Lazear 2000) (Bandiera, Barankayand, and Rasul 2007) (Bandiera, Barankayand, and Rasul 2009) (Cummins and Violante 2002) (Bertrand and Schoar 2003) (Syverson 2004) (Aw, Roberts, and Xu 2008) (Forbes and Lederman 2010). Across firms, industries, and countries, research has shown that productivity spillovers (the externality of one producer's practices on other producers), regulation, competition both within markets and from international trade and institutional features affect productivity growth (Moretti 2004) (Griffith, Harrison, and Van Reenen 2006) (Foster, Haltiwanger, and Krizan 2001) (Eaton, Jonath, and Kortum 2002) (Melitz 2003) (Hsieh and Klenow 2009) (Ziebarth 2013). While the literature has made some keen steps towards identifying factors that influence productivity, we are still not sure which of these factors matters the most and why only certain firms adopt more efficient practices. If these factors can be institutionally encouraged, we must then direct research towards understanding how to achieve this.

Discussion

Measurement

Before any discussion of productivity can ensue, we must understand how it is measured. The most commonly used measure is called total factor productivity (TFP). This measure does not vary by the intensity with which different firms may use their inputs which makes TFP comparable across firms. As such, higher TFP firms produce more output for a given amount of input than lower TFP firms. A simple way to think of TFP is to think of a basic Cobb-Douglas production function that relates inputs (K=capital, L=labor and M=materials) to outputs (Y) where A is the factor-neutral shifter.

This is a highly simplified description of TFP that is intended to familiarize the reader with a very general sense of how TFP can be empirically estimated. In addition, the econometric concerns that arise from the estimation described above will not be covered here; see Griliches and Mairesse (1998) and Johannes Van Biesbroek (2008) for a discussion of these concerns. Typically using cost-share based TFP is seen as a reasonable start to measuring productivity.

Measurement is a key concern in productivity research since the ultimate goal is to find units of measurement, for both outputs and inputs, that are comparable across firms. Using profits to measure output and labor hours, cost of materials, and cost of capital (imputed rental cost, adjusted for depreciation) to measure inputs is one way to make comparable measurements. There are, however, many variations of measures for both inputs and outputs and the results in many papers in the literature are robust to these different measures.

Empirical findings at the firm/plant level

This literature focuses, at a very micro level, on factors that result in productivity differences at the individual firm/plant level. One strain of research finds that high-quality management practices relate systematically to productivity. Bloom and Van Reenen (2007) find that better management practices relate positively to various measures of productivity, including labor productivity, TFP, sales growth, return on capital, Tobin's Q, and firm survival. In addition, they show that firms with better management practices are the ones that face greater market competition and that have external managers (non-family). This finding is especially important when entrepreneurial firms are considered young firms and sometimes confused with small firms, which are also more likely to be family run (see Haltiwanger, Jarmin, and Miranda (2013) for an important discussion on the difference between the entrepreneurial qualities of young versus small firms). Other papers that confirm and solidify the relationship between management practices and productivity include Mas (2008); Bloom and Van Reenen (2010); and Bandiera, Prat, and Sadun (2013). In addition, work by Bertrand and Schoar (2003) shows that effective management (in this case, individual CEOs who move across firms) enter significantly in explaining firms' return on assets. Further management-related work shows that having the appropriate incentive structure (i.e., pay-for-performance) can motivate employees in a way that results in increased firm productivity (Ichniowski, Shaw, and Prennushi (1997); Lazear (2000); Hamilton, Nickerson, and Owan (2003); Bandiera, Barankay, and Rasul (2007) and (2009) to name a few).

In addition, having better quality labor and capital can also increase productivity (Ilmakunnas, Maliranta, and Vainiomäki 2004) (Sakellaris and Wilson 2004). Interestingly, while capital quality seems to matter for productivity across various studies, some studies find that labor skills play a much smaller role in explaining productivity (Galindo-Rueda and Haskel 2005) (Fox and Smeets 2011). Also, the adoption of information technologies and the R&D intensity relate positively to productivity (Doraszelski and Jaumandreu 2013) (Faggio, Salvanes, and Van Reenen 2010). A variety of other factors such as firm structure decisions (factors such as firm decentralization and vertical integration) and innovative capacity on the product margin also result in increased productivity (Brandiera, Prat, and Sadun 2013). Finally, Bertrand and Schoar (2003) show that effective management enters significantly in explaining firms’ return on assets. Specifically, they look at how the managerial talents embedded in effective CEOs translate in terms of financial returns as these CEOs shift from one firm to another. 

Empirical findings across firms/industries and countries

Firms as aggregates can become more productive as individual producers increase their productivity levels and as a result of selection where the most productive firms survive. Industries can become more productive as productivity enhancing practices spill-over from one firm to the rest. Moretti (2004); Griffith, Harrison, and Van Reenen (2006); Bartelsman, Haskel, and Martin (2008); and Keller and Yeaple (2009) among others provide evidence for production-enhancing spillovers to firms that are close geographically and that operate within the same technology space. These spillovers do not necessarily only apply to geographic proximity, but can also extend to firms across borders when there are sufficiently deep relationships (either from ownership of foreign firms or close supplier relations).

A second source of productivity increase comes from enhanced competition. This factor is of particular salience in the context of productivity and entrepreneurship. Competition resulting from intra-firm activity and from international trade is empirically shown to shift market shares towards the more productive producers (Foster, Haltiwanger, and Krizan 2001) (Syverson 2004) (Syverson 2007) (Eaton and Kortum 2002) (Melitz 2003); however, at least one study shows that when the market size is fixed, competition can actually impede productivity enhancements (Vives 2007). In assessing the impact of new (typically) entrepreneurial firms, Holtz-Eakin and Kao (2003) find that an increase in the birth rates of firms leads to higher levels of subsequent productivity (measured by gross state product per worker).

Another factor that can affect aggregate productivity is government regulation. This can be industry specific, protective of employees, or aimed at reducing environmental damage, and can either increase or decrease productivity (Bridgman, Qi, and Schmitz 2009) (Rose and Wolfram 2007) (Nicoletti and Scarpetta 2006).

There are a variety of other factors that also most likely affect productivity not mentioned here, but the factors described above are important ones and should provide a reasonable starting point for anyone new to the literature on productivity.

The discussion of productivity in entrepreneurship has largely been sidestepped, because understanding the various factors that affect productivity within firms and across firms should give us a better sense of what makes highly entrepreneurial, innovative, and presumably productive firms. We can then go further to look at how young firms are affected by and affect this environment. As such, discussing entrepreneurial productivity in isolation seems less useful than understanding the factors that affect productivity, which can then guide us to uncovering what it means for firms to be truly entrepreneurial.

Future Research

  • We have to think very carefully about what productivity means and how it can be measured as our economy becomes more technologically driven. What do companies such as Google, Facebook, Instagram, Wikipedia, and the multitude of technology firms in Silicon Valley produce and how would one measure their output and inputs? Do revenue based output measures make sense here, especially when what the consumer demands (the search engine for example) is different than how the firm raises revenues (advertising)?
  • How can we measure the output of small and young firms when misreporting issues are endemic?
  • Is capital allocated appropriately? Do new businesses have access to financial capital and is access to this capital what drives productivity? Does financial capital relate to productivity differently for young firms versus more mature firms?
  • What type of market structures facilitate the entry of new, productive firms which will in turn increase competition? What type of government regulation may encourage this (or alternatively deter it)?

Data Sources

References

Aw, Bee Yan, Mark J. Roberts, and Daniel Yi Xu. 2008. "R&D investments, exporting, and the evolution of firm productivity." The American Economic Review 98(2): 451-456. doi:10.1257/aer.98.2.451

Balasubramanian, Natarajan, and Jagadeesh Sivadasan. 2011. "What happens when firms patent? New evidence from U.S. Economic Census data." The Review of Economics and Statistics 93(1): 126-146. doi:10.1162/rest_a_00058

Bandiera, Oriana, Iwan Barankay, and Imran Rasul. 2007. "Incentives for managers and inequality among workers: evidence from a firm-level experiment." The Quarterly Journal of Economics 122(2): 729-773. doi:10.1162/qjec.122.2.729

Bandiera, Oriana, Iwan Barankay, and Imran Rasul. 2009. "Social connections and incentives in the workplace: Evidence from personnel data." Econometrica 77(4): 1047-1094. doi:10.3982/ecta6496

Bartelsman, Eric J., John C. Haltiwanger, and Stefano Scarpetta. 2013. "Cross-country differences in productivity: the role of allocation and selection." American Economic Review 103(1):305-344. doi:10.1257/aer.103.1.305

Bartelsman, Eric J., Jonathan Haskel, and Ralf Martin. 2008. "Distance to Which Frontier? Evidence on Productivity Convergence from International Firm-Level Data." Centre for Economic Policy Research (CEPR) Discussion Paper 7032.

Bertrand, Marianne, and Antoinette Schoar. 2003. "Managing with style: The effect of managers on firm policies." The Quarterly Journal of Economics 118(4): 1169-1208. doi:10.1162/003355303322552775

Bloom, Nicholas, and John Van Reenen. 2007. "Measuring and explaining management practices across firms and countries." The Quarterly Journal of Economics 122(4): 1351-1408. doi:10.1162/qjec.2007.122.4.1351

Bloom, Nicholas, and John Van Reenen. 2010. "Why do management practices differ across firms and countries?" The Journal of Economic Perspectives 24(1): 203-224. doi:10.1257/jep.24.1.203

Bridgman, Benjamin, Shi Qi, and James A. Schmitz. 2009. "The economic performance of cartels: evidence from the New Deal US sugar manufacturing cartel, 1934-74." Federal Reserve Bank of Minneapolis Staff Report 437.

Cummins, Jason G., and Giovanni L. Violante. 2002. "Investment-specific technical change in the United States (1947–2000): Measurement and macroeconomic consequences." Review of Economic Dynamics 5(2): 243-284. doi:10.1006/redy.2002.0168

Doraszelski, Ulrich, and Jordi Jaumandreu. 2013. "R&D and Productivity: Estimating Endogenous Productivity." The Review of Economic Studies 80(4): 1338-1383. doi:10.1093/restud/rdt011

Eaton, Jonathan, and Samuel Kortum. 2002. "Technology, Geography, and Trade." Econometrica 70(5): 1741-1779. doi:10.1111/1468-0262.00352

Faggio, Giulia, Kjell G. Salvanes, and John Van Reenen. 2010. "The evolution of inequality in productivity and wages: panel data evidence." Industrial and Corporate Change 19(6): 1919-1951. doi:10.1093/icc/dtq058

Forbes, Silke J., and Mara Lederman. 2010. "Does vertical integration affect firm performance? Evidence from the airline industry." The RAND Journal of Economics 41(4): 765-790. doi:10.1111/j.1756-2171.2010.00120.x

Foster, Lucia, John C. Haltiwanger, and Cornell John Krizan. 2001. "Aggregate Productivity Growth: Lessons from Microeconomic Evidence." New Developments in Productivity Analysis. Chicago: University of Chicago Press/NBER, 303-372.

Fox, Jeremy T., and Valérie Smeets. 2011. "Does input quality drive measured differences in firm productivity?" International Economic Review 52(4): 961-989. doi:10.1111/j.1468-2354.2011.00656.x

Galindo-Rueda, Fernando, and Jonathan Haskel. 2005. "Skills, workforce characteristics and firm-level productivity: evidence from the matched ABI/employer skills survey." IZA Discussion Paper No. 1542.

Griffith, Rachel, Rupert Harrison, and John Van Reenen. 2006. "How special is the special relationship? Using the impact of US R&D spillovers on UK firms as a test of technology sourcing." American Economic Review 96(5):1859-1875. doi:10.1257/aer.96.5.1859

Hall, Robert, and Charles Jones. 1999. "Why do some countries produce so much more output per worker than others?" The Quarterly Journal of Economics 114(1): 83-116. doi:10.1162/003355399555954

Haltiwanger, John, Ron S. Jarmin, and Javier Miranda, Javier. 2013 "Who creates jobs? Small versus large versus young." Review of Economics and Statistics 95(2): 347-361. doi:10.1162/rest_a_00288

Hamilton, Barton H., Jack A. Nickerson, and Hideo Owan. 2003. "Team incentives and worker heterogeneity: An empirical analysis of the impact of teams on productivity and participation." Journal of Political Economy 111(3): 465-497. doi:10.1086/374182

Holtz-Eakin, Douglas, and Chihwa Kao. 2003. "Entrepreneurship and economic growth: the proof is in the productivity." Syracuse University Center for Policy Research. Working Paper No. 50. doi:10.2139/ssrn.1809885

Hsieh, Chang-Tai, and Peter J. Klenow. 2009. "Misallocation and manufacturing TFP in China and India." The Quarterly Journal of Economics 124(4): 1403-1448. doi:10.1162/qjec.2009.124.4.1403

Ilmakunnas, Pekka, Mika Maliranta, and Jari Vainiomäki. 2004. "The roles of employer and employee characteristics for plant productivity." Journal of Productivity Analysis 21(3): 249-276. doi:10.1023/b:prod.0000022093.59352.5e

Keller, Wolfgang, and Stephen R. Yeaple. 2009. "Multinational enterprises, international trade, and productivity growth: firm-level evidence from the United States." The Review of Economics and Statistics 91(4): 821-831. doi:10.1162/rest.91.4.821

Melitz, Marc J. 2003. "The impact of trade on intra-industry reallocations and aggregate industry productivity." Econometrica 71(6): 1695-1725. doi:10.1111/1468-0262.00467

Moretti, Enrico. 2004. "Workers' education, spillovers, and productivity: Evidence from plant-level production functions." The American Economic Review 94(3): 656-690. doi:10.1257/0002828041464623

Nicoletti, Giuseppe, and Stefano Scarpetta. 2006. "Regulation and Economic Performance: Product Market Reforms and Productivity in the OECD." Institutions, Development, and Economic Growth. Cambridge, Mass.: MIT Press, 81-120. doi:10.1787/726517007575

Sakellaris, Plutarchos, and Daniel J. Wilson. 2004. "Quantifying embodied technological change." Review of Economic Dynamics 7(1): 1-26. doi:10.1016/S1094-2025(03)00052-8

Syverson, Chad. 2004. "Product substitutability and productivity dispersion." Review of Economics and Statistics 86(2): 534-550. doi:10.1162/003465304323031094

Van Biesebroeck, Johannes. 2008. "The sensitivity of productivity estimates: revisiting three important debates." Journal of Business & Economic Statistics 26(3): 311-328. doi:10.1198/073500107000000089

Ziebarth, Nicolas L. 2013. "Are China and India backward? Evidence from the 19th century U.S. Census of Manufactures." Review of Economic Dynamics 16(1): 86–99. doi:10.1016/j.red.2012.09.003

 Page last updated 14 November 2016