Total factor productivity

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Total-factor productivity (TFP) addresses any effects in total output not caused by inputs or productivity. For example, a year with unusually good weather will tend to have higher output, because bad weather hinders agricultural output. A variable like weather does not directly relate to unit inputs or productivity, so weather is considered a total-factor productivity variable.

The equation below (in Cobb-Douglas form) represents total output (Y) as a function of total-factor productivity (A), capital input (K), labor input (L), and the two inputs' respective shares of output.

$Y = A \times K^\alpha \times L^{1-\alpha}$

Technology Growth and Efficiency are regarded as two of the biggest sub-sections of Total Factor Productivity, the former possessing "special" inherent features such as positive externalities and non-rivalness which enhance its position as a driver of economic growth.

Total Factor Productivity is often seen as the real driver of growth within an economy and studies reveal that whilst labour and investment are important contributors, Total Factor Productivity may account for up to as much as 60% of growth within economies.

Growth accounting exercises and Total Factor Productivity are open to the Cambridge Critique. Therefore, some economists believe that the method and its results are invalid.

As a residual, TFP is also dependent on estimates of the other components. A 2005 study^[1] on human capital attempted to correct for weaknesses in estimations of the labour component of the equation, by refining estimates of the quality of labour. Specifically, years of schooling is often taken as a proxy for the quality of labour (and stock of human capital), which does not account for differences in schooling between countries. Using these re-estimations, the contribution of TFP was substantially lower.