Determinants of a Firm’s Productivity Growth

likely to benefit government in higher taxes. And as Perham (n.d.) pointed out, increased taxes allow the government to fund more social programs such as education, health and other social infrastructures which in turn improve people’s wellbeing, and sustained and inclusive prosperity of society.

Last and often forgotten, productivity growth in firms reduces economic waste as well as environmental waste. Most firms’ inputs such as energy, minerals or timber are derived from the environment where sources are sometimes irreplaceable, or take a long time to replace, and there are climatic and other environmental repercussions to this. In most cases, the argument of environment protection comes at embedded social cost that usually traditional firms escape from paying. However, taken from the view of productivity growth, the fact that the firm can pursue more output out of the same environmental goods positively contributes to society. The European Commission analysed economic opportunity of “efficient” use of bio inputs and best practice processes in food and drink manufacturing, fabricated metal products, and the hospitality and food services sectors (European Commission, 2013). The report found that each of these sectors, in the same order, could have an annual efficiency benefit in the following ranges: Euro 64-118, 44-82, and 18-43 billion which translates to an average turnover growth of Euro 424,000 (11 percent), 164,000 (17 percent) and 27.5 (10 percent) respectively. It is important to note that the discussion is not to avoid using bio input, rather than a process tied to productivity growth benefits by using them while striving to attain the highest possible value.

inquiry we can understand the bigger picture on the determinants of productivity growth in a country.

For the sake of a simple explanation the firm can be defined as a type of an organization which uses inputs such as labour and capital, which can be fixed capital, such as machinery, and /or intermediary capital – usually raw materials – to profitably convert them into sellable goods and services.

Although this description of a firm is straightforward, usually the firm’s operations are rather more complex, and in the course of achieving this goal, it will interact with several actors who will affect its productivity growth.

One view of assessing the determinants of the firm’s productivity is through the firm processing flow diagram as shown in figure 4.5. Figure 4.5 portrays the target of reducing units of input while increasing output units, which is technical efficiency; doing the same in terms of value, which is productive efficiency; again changing the output mix to the most valuable output, which is allocative efficiency; and reiterating the process to improve the system over time, which is dynamic efficiency.

Figure 0-5 - Firms value creation process, and the interacting environment

In so doing, the firm interacts with three subsystems which define its ability to increase productivity. As shown in figure 4.5, these subsystems include the firm’s internal systems, the firm’s external environment, and inputs.

Two assumptions are important to note. First, it is assumed that output of the firm is unrestricted and it is largely dependent on the firm, hence dependent of the firm’s ability to produce given the other three subsystems.

Second, in figure 4.5 there is a dotted arrow pointing downward that indicates loss in input that is not converted to the final output. While in reality the production process includes loss of inputs, such as the wasted timber that was not used or unutilized capacity such as a machine which was not turned on when it had to be. These losses are not explicitly quantified in the quest of productivity growth. Rather they are manifest in the overall productivity growth. In fact, it is assumed that for the firm to enhance productivity it will try to identify the sources of the resource waste and turn them into output generation. Therefore, the following discussion proposes the determinants of productivity growth, based on the three subsystems identified in figure 4.5.

Input

Firm creation usually reflects availability of assets or accessibility to essential inputs for the firm to operate profitably. These include the fundamental elements of the firm such as endowment of natural resources, cheap labour for assembly industries or highly skilled labour for financial, high technology or higher education industries. In most instances, countries tend to develop industries which exploit their endowed inputs. For example, discovery of cheap extractable oil fields in Saudi Arabia allows companies operating in that field to become more productive than their counterparts in less extractable fields, other things being constant. This explains the concentration of oil companies in Saudi Arabia and Nigeria, but also the increasing influx of manufacturing companies in Vietnam, Myanmar and Bangladesh. The ability of firms and countries to tap into cheap and abundantly available inputs, and thus actually to reduce their input units and cost to produce practically the same or more units of output allows them to improve productivity.

Internal system

The main function of the firm lies in its ability to convert resources to sellable products and services. The ability of the firm to do so is dependent on the firm’s technology and innovativeness. For the firm to enhance its productivity, what is needed is more than just good technologies, but also better processes and organization to streamline the production activities and resources to reduce waste and increase output in units and value. A popular example is adoption of information and communication technologies to enhance firms’ and countries’ productivity growth.

External system

Apart from endowment of input, and its internal ability to produce output, the firm’s ability to increase productivity depends on the enabling environment around it. The most influential determinant in the external environment is the role of public policy, which will be discussed in section 4.6.

Apart from government policy other components include the economic hard infrastructure such as reliable availability of electricity, transportation and the Internet; also business enabling services such as advanced financial institutions and financial services, access to capital markets, and availability of quality advisory services. Improvement in the external systems does not guarantee direct enhancement of productivity for the firms that can access these benefits, but rather enables the firm’s ability to capture value as the environment changes. This is an important point to make because the main distinction between the firm’s internal system and external one is who is in control of changing these systems. Almost always, countries which have advanced economic infrastructure and pro-productivity policies tend to have economies with highest productivity, and those which improve their firms’

external environment the fastest, tend to benefit from higher productivity growth.