For a long time, when there is talk of productivity it always means labor productivity. This is the measure of the output that an hour of labor produces. Multi-factor productivity is more comprehensive than labor productivity.
Whereas labor productivity tends to focus on manufacturing (easier to quantify) rather than services, multi-factor productivity on the other hand takes the computation several levels up.
As one of the economic indicators, productivity is basically a measure of how efficiently an economy transforms its labor, capital, and raw materials into goods and services.
Conventional productivity measurement
In a car manufacturing plant, productivity measurement is straightforward. One is a physical measure where the total number of cars made in a period of time is divided by the number of worker-hours spent in producing them.
The other way is a monetary measure. It is the total dollar value of cars produced in a given period of time divided by the total number of worker-hours needed to assemble them.
KLEMS
In labor productivity, the equation is simply output divided by input (O/I).
On the other hand, multi-factor productivity growth is the rate of output growth relative to the growth of all production inputs labor, energy, materials, and services.
In the equation Multifactor Productivity=Output/(KLEMS), K is the capital services, L is labor services, E is for energy, M stands for materials and S refers to the purchased services.
The equation is a complicated index number. The purpose is to arrive at a figure of the change in output relative to the change in all the inputs. Theoretically, the number is more comprehensive, but it is also difficult to calculate.
The old assembly plant
A first-hand comparison between labor productivity and multifactor productivity is illustrated by the economist Jack Triplett during a panel discussion sponsored by the National Association of Business Economists.
In his anecdote, Mr. Triplett recounted visiting an old but still workable assembly plant three stories high. The workers followed the old routine of bringing in the materials in the first floor, doing the sub-assembly at the second floor and the final assembly at the top floor.
Over the years, the machines assembled got bigger and bigger and they were difficult to bring down from the top floor. Somebody finally suggested reversing everything: bring the materials to the top floor, do the sub-assembly at the second floor and the final assembly in the first floor.
It had a big positive effect on productivity. They were able to produce more with the same number of workers. Mr. Triplett did not comment much on the change of multifactor productivity because of KLEMS.
He did mention though that the guy who did the suggestion is an S in KLEMS. If the man was a consultant and was paid for it, it will show up as an S in the equation and would show no increase in the multifactor productivity output.
On the other hand, if the idea was from a bright worker and was not paid, then there is no input recorded. In conventional accounting, that would register well as an increase in the multifactor productivity side.
Mr. Triplett continued that the multifactor productivity measure is often preferred now over that of conventional labor productivity because it is a measure of technological change as well.