What’s the difference between Labor Productivity and Total Factor Productivity?

Productivity is a measure of economic efficiency that shows how effectively economic inputs are converted into goods and services. In simple terms, productivity goes up when we make more goods and services (output) with fewer resources.^[1] In the long run, increased productivity leads to economic growth and a higher standard of living. The Bureau of Labor Statistics (BLS) has a program dedicated to measuring two types of productivity for the U.S. economy: labor productivity and total factor productivity. What can these different measurements tell us?

Labor productivity

Labor productivity measures how efficiently hours worked are used in production. That is, how much can be produced without adding more worker hours. When this measure rises, it means that the economy has become more efficient in terms of the amount of labor required to produce goods and services, also referred to as output.

As an example, imagine a company, Alice’s Earthworks, that digs trenches. They employ ten people full-time that manually dig a mile of trench a day. A second company, Bob’s Digging, has only two employees and a machine that digs trenches, such as an excavator. They also dig a mile of trench a day. These companies have identical output – a mile of trench dug, but Bob’s company uses less labor than Alice’s does. In fact, Bob’s Digging uses one-fifth of the labor that Alice’s Earthworks does (2 people compared to 10 people). This means that Bob’s Digging’s labor productivity is five times that of Alice’s Earthworks. In other words, Bob’s company uses labor five times as efficiently.

You might see a problem with this example. Bob’s Digging seems more efficient because they have an excavator, but excavators come at a cost. The equipment and other assets that go into production are called capital. Capital might be equipment like Bob’s excavator, but it can also be buildings, vehicles, software, or other investments a company makes to increase the efficiency of its workers. Capital often makes hours worked more efficient.

Total factor productivity

When we are accounting for capital or other inputs in addition to labor, we are measuring total factor productivity (TFP). TFP measures the efficiency of labor, capital, and other countable inputs. TFP tells us how much can be produced without adding more inputs – the “secret sauce” of how a business is run.^[2]

Need an example? Let’s think back to Alice and Bob. Remember that they have the same output – a mile a day – but Bob is using his labor five times as efficiently as Alice because he has an excavator. Once we account for the cost of Bob’s excavator (which costs the same as eight more employees), Alice and Bob are equally efficient. They invest the same amount of combined inputs, and they get the same amount of output—a mile of trench dug. Their total factor productivity is equal. Now let’s add a third company, Carlos’s Ditches. Carlos’s company digs a mile and a half a day with two employees and an excavator. From the outside, Carlos’s company looks a lot like Bob’s. He has the same amount of labor and the same amount of capital, but Carlos is getting more out of these same inputs. Carlos’s company is clearly more productive than Bob’s because they dig more trench with the same resources. However, it’s difficult to put our finger on why. This difference in overall efficiency is what we capture when we measure total factor productivity (TFP).

TFP measures how efficiently all inputs combined (not a single input like labor) are used in production. Some of these inputs are easy things to count: capital, labor, raw materials…but other things are tougher to observe and count. What if Carlos’s company has really talented management or is better at scheduling? What if they have better skills at using the excavators or train their workers more effectively? Their increased education, experience, and skills will make their hours worked more effective. These hard-to-count inputs still show up in their total factor productivity, even after the measurable inputs (like hours worked and excavators) have been accounted for.

Why have multiple measures?

Why do we need two measures of productivity? Why isn’t one enough, or better than the other? Well, they serve different purposes. Labor productivity and total factor productivity are distinct metrics used to assess economic production. If the country were a person, then measuring labor productivity would be like checking their pulse, blood pressure, and temperature; measuring total factor productivity would be like giving them a full-body internal scan.

Labor productivity focuses specifically on the output per hour worked, measuring how effectively businesses employ their workforce. Labor productivity gives us a good top-line measure of the economy that's easy to understand. When labor productivity is rising, we're getting more reward out of each hour someone works. However, as we learned above, that might be caused by better tools and equipment, more skilled laborers, or better organization.

Total factor productivity examines the causes of that growth. TFP considers the overall efficiency of all inputs, including labor and capital. TFP captures the broader picture by assessing the output in relation to all inputs. It offers a more comprehensive measure of productivity and captures advancements in technology and overall production efficiency beyond labor contributions. This is where we separate the factors that might contribute to growth. Is an industry growing because it is investing in better equipment? Are its workers becoming more educated and more effective at their jobs? Or is it something else?

How these measures are used

Productivity data helps to provide a better understanding of how the economy is doing. The BLS was directed by Congress in June 1940 “to make continuing studies of productivity and labor costs in the manufacturing, mining, transportation, distribution, and other industries.” Labor productivity measures started during WWII to capture the effects of the changing workforce on output. Total factor productivity measurement began at BLS in 1983 to capture the impact of equipment and other capital on labor productivity.

The Federal Reserve treats productivity as a measure of overall economic growth and examines labor productivity as one factor when setting interest rates.^[3] The Organization for Economic Co-operation and Development (OECD) uses both labor productivity and total factor productivity as internationally comparable indicators of economic growth and competitiveness.^[4] The World Bank seeks to track productivity as it works to increase the productivity of less-developed countries, believing that increased productivity is a driver of human welfare. ^[5] Productivity can also be used for setting prices for services over long periods of time. The US Department of Health and Human Services uses TFP calculations to adjust Medicare benefits over time.^[6] These are just a few of the ways that productivity measurements are used.

In our examples, we compared companies to one another. However, the focus at BLS is on productivity measures for entire industries or sectors of the economy as well as states and regions. Productivity is best measured as changes over time, because changes in production processes and decisions to use more labor versus capital or other inputs take time to filter into production. Remember, productivity growth means we’re using our resources more efficiently, so there’s a bigger pie of rewards to draw from and lifestyle can improve. Recall that Alice, Bob, and Carlos have the same costs, but Carlos is producing more output, which can translate to higher wages for his workers and higher profits. Since 1947, labor productivity growth has increased just over two percent per year.^[7] This has meant huge advances in the way we live.

For more information check out our productivity homepage and data page. And feel free to contact us.

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Last Modified Date: January 13, 2025