The Economic Efficiency and Productivity of Production Factors and Production Processes
An Article in the Compendium of Market-Based Social-Ecological Economics
Key issues in view of the neoliberal crisis:
How can we guarantee employment and fair income?
How can we protect the environment effectively?
How should we shape the economic globalization?
What should the economic sciences contribute?
What must be the vital tasks of economic policy?
How can we legitimize economic policy democratically?
Table of Contents
It can be seen that the definition of productivity is the key to sustainable globalization: instead of deriving productivity from isolated capital efficiency, it must be socially and ecologically defined, i. e. it must fulfil a social and ecological function. This means that the external costs caused by production processes must be allocated to the production factors without exception in order to find their way into pricing and create incentives to avoid them. A promising requirement to redefine productivity leads from the current neoliberal process of concentration to decentralization, or rather: subsidiarization of economic structure and activity, which involves all citizens as producers (entrepreneurs and employees) and consumers and assigns direct responsibility to them for the human and natural resources of their local and regional environment.
In economic context, the term efficiency is mainly used to describe the economic efficiency of the three factors of production (labour, natural resources and capital).
However, the term can also refer to the economic efficiency of production processes and is then synonymous with the term productivity.
For further details see the following section Productivity.
The three factors of production should be interpreted broadly:
The efficient use of production factors is aimed at
In contrast to the efficiency of the production factors, the efficient (productive) design of production processes in general is about achieving a certain result with the least possible input of resources or achieving the best possible result with given means.
Basically efficiency must be distinguished from effectiveness: Efficiency refers to how economically productive a production factor is deployed or how economically productive a production process is performed. While effectiveness indicates how suitable and operative a factor or process basically is to achieve a desired result. Popularly speaking, you’re efficient when you do things right, and you’re effective when you do the right things. And, obviously, when you do the right things right, you’re both efficient and effective.
By the way, the terms »economical« and »costeffective« are synonymous with the term »efficient«.
Back to the production factors: In determining their efficiency, there may be contradictions and disparities between the micro-economic (business) and macro-economic (national) calculation of accounts, which, as is the case under neoliberal conditions, point to inadequate economic policy regulation and control. For example, when companies are allowed to merge at will and concentrate capital in order to cut jobs and undercut their competitors’ prices, or exploit raw materials at will and turn them into waste. This will increase the business efficiency in purely mathematical terms, but will, at the same time, decrease the actual national efficiency, because labour and natural resources are allocated and utilized inefficiently and could be damaged or even destroyed in the long term.
In other words, when companies maximize their return on investment at the expense of labour and natural resources in an environment of inadequate economic regulation and control, their production processes will provoke negative external effects, i. e. they generate external costs which they themselves do not have to bear but which damage the factors labour and natural resources. The supposed capital efficiency then turns out to be a misallocation of all three production factors caused by the factor capital. A truly efficient utilization of the derived factor capital – including a sustainable return on investment – can only be achieved through the efficient utilization of the original factors labour and natural resources. A capital efficiency independent of the original factors is therefore, by definition, not possible.
In summary, the following applies to business (micro-economic) efficiency: It’s all the higher,
The macro-economic (national) efficiency includes the criteria of the business (micro-economic) efficiency, and beyond that it’s all the higher,
In general, the following applies: With a maximum economic efficiency of the factors labour and natural resources – from which, as already mentioned, the maximum efficiency of the factor capital results, provided that an appropriate economic policy regulation and control is established – an economy achieves the welfare optimum, i. e. the best possible safeguarding of the future. See also the article Sustainable Social Welfare.
Since the macro-economic (national) efficiency is outside the direct interest of both private and public sector players, it must be regulated and controlled by economic policy according to the above-mentioned definition so as not to undermine the future viability of an economy. More concretely this means: Economic policy regulation and control must be designed such that business production processes generate social returns instead of social costs and preferably cause little or no environmental costs, so that the aggregate of all business efficiencies (business accounts) results in the highest possible macro-economic efficiency (national account). In short, economic policy regulation and control must be directed towards the welfare optimum, that is, towards full employment and environmental protection.
In the case of inadequate or not properly focused economic policy, as is the case under the current neoliberal doctrine, a tendency towards capital dominance and return on investment emerges at the expense of labour and natural resources. This is a development that is not only macro-economically inefficient, but also in terms of business activities in the long term, because it disconnects the development of wages and purchasing power from productivity growth, thereby weakening or even interrupting economic cycles and thus ultimately harming the capital owners as well. The dominance of the factor capital to the detriment of labour and natural resources is always a sure indication of capitalist excesses of the market economy (for more details see the article Excesses of Capitalism).
3.1 General Definition
Productivity is, as already mentioned, a measure of the economic efficiency of production processes. Data on productivity can refer to a national economy, a sector of the economy, an industry, an individual company or a single product. In any case, productivity data denotes the extent of the contribution of production factors (as input) to produce a certain output of goods or services within a certain period, usually one year. The purpose of productivity calculations is to compare different periods of production to determine growth rates and to compare competing regions and countries.
The three factors of production are included in the productivity calculation with the sum of their total prices. Each total price of a factor is the product of the number of units of measure used and the price of a unit of measure. The production result is included in the productivity calculation with the total price to be achieved for the produced quantity. If possible, calculations are performed using current market prices, otherwise costs are used. Productivity can also be shown as a quotient of the total price of the output (counter) and the total price of the input (nominator). The higher the output price is in relation to the input price, the higher the value of the quotient and the higher the productivity. A quotient less than 1 means negative productivity, a quotient greater than 1 means positive productivity.
For further understanding, it should be noted that productivity can basically be calculated only in the interaction of all three production factors.
Although a single production factor can be used more or less efficiently and thus contribute more or less to productivity, an isolated calculation of its efficiency and thus its contribution to productivity is not possible. Only the relative efficiency of a single factor can be determined provided identical conditions of all three factors are given in the comparison of production processes of competing products.
3.2 Labor Productivity
In practice, overall productivity is often simply stated as output of goods or services per hour worked and is then referred to as labor productivity. This calculation basis is practical because it shows the output of a certain number of products at a certain delivery price per costs of a productive working hour and enables comparisons to be made within similarly structured companies in an industry segment. Such comparisons are suitable to identify potentials for increasing efficiency in the use of all three factors. At the same time, the calculation basis is problematic because it gives the impression that productivity is determined by labor only, when in fact it is just as well impacted by capital and natural resources.
3.3 Capital Productivity / Resource Productivity
Similarly, a capital productivity can also be shown as the market price of the output of goods or services per market price of a capital unit, or analogously a resource productivity. The latter is common in agriculture and is, without including any price or costs, simply accounted as yield per hectare of arable land, making it suitable for cross-country comparisons.
3.4 Marginal Productivity
The marginal productivity indicates the productive effect of the last unit of a production factor used. For entrepreneurial practice, this means that the costs of using an additional unit of one factor (the marginal cost) are only worthwhile if they are lower than the additional revenue generated by it (the marginal return). Generally speaking, the productivity of a production cannot be increased unrestrictedly by adding one unit of one factor while leaving the use of the other two factors unchanged; and furthermore, the efficiency of production processes can be maximised by allowing entrepreneurs to balance the use of all three production factors – conditional scarcity and limitation assumed – in such a way as to achieve the greatest possible production yield at the lowest factor cost. With a simple example, in which the physical capital and raw materials remain unchanged, the impact of the labour input can be explained: If a suboptimal number of employees is employed, the production yield can be increased by hiring new employees up to the optimum. Over and above the optimum, the labour costs of the next new employee will reduce the additional yield, further new hires will then be even more inefficient, because their costs will initially only consume the additional yield gained until they ultimately lead to a declining overall production yield.
As will be shown below, a calculation of productivity covering all actual prices and costs has not yet been enforced politically. That is to say that both the prices of the productive factors (input) and the prices of the production result (output) are so far still being distorted by externalised social and environmental costs as well as by government subsidies and are therefore underestimated and generally set too low. As a result, false positive micro-economic (business) and subsequently false positive macro-economic productivities are reported, which in reality are negative, so that the damage to productive factors caused by economic activity remains hidden and the destructive process cannot be countered politically.
3.5 Micro-Economic/Business Productivity
In business administration, the calculation of productivity always refers to a specific company. In their calculation, companies only include the output which they can sell on the market, and only the input for whose costs they must pay directly. For example, state-subsidised raw materials or subsidised labour costs (such as for 400 euro jobs in Germany) are not taken into account for the input as well as externalised costs such as environmental and health burdens remain unconsidered for the output, at least insofar as they do not have to be included by legal obligations. Subsidies such as externalized costs represent a relief for companies and a burden for the overall economy.
For further details see the article Economic Externalities.
The following is a schematic representation of a calculation of the productivity achieved in a production plant in a fiscal year:
|Operating expenses (input)||Euro|
|Revenues of the output||Euro|
|Revenue end products||713.000|
|Revenue customer service||16.400|
|Total revenues||729.400||Net annual income: revenues minus expenses||60.900|
As is customary today, the balance sheet shown does not include any external costs, so that the productivity of the company is shown as positive as the net annual income suggests; accordingly, the ratio (quotient) of revenues/expenses (output/input) of 1.09 is above 1 and thus in the positive range. The ratio can be used for comparisons within an industry.
If externalised social and environmental costs were taken into account, the productivity of the fictitious company would certainly be negative.
Regardless of the externalised costs not currently taken into account, companies can bridge periods of negative productivity with loans (periods in which they accumulate losses). This is usually the case during the start-up phase of companies. In later phases, longer periods of negative productivity can lead to insolvency with the risk for owners and creditors to lose their invested capital or parts thereof.
3.6 Macro-Economic/National Productivity
To put it straight: So far, no economic area has bothered to truthfully determine its business, public and private balance sheets, and because the macro-economic (national) balance sheet is the aggregate of the individual balance sheets mentioned, all the balance sheets and productivities published today are clearly nothing but window dressing.
However, an exact mathematical calculation of economic balance sheets and productivities in euros and cents is not possible because the early and more so the delayed consequences of economic activities, especially regarding ecological and social damages (costs), can only be roughly quantified. Therefore, suitable estimation methods for the quantification and monetization of externalized costs must be developed and continuously reviewed and adjusted based on experience.
The development of estimation methods is imperative in view of the debts accumulated by economic activities towards the biosphere and mankind since the beginning of industrialisation alone. The increase of the anthropogenic mountain of debt has to be slowed down at first, then stopped completely, and finally moved into a phase of debt repayment, i.e. to remove damages to the biosphere by technical measures and to avoid social and health impairments by means of political measures. In addition I recommend the article Factors of Production.
The existing base of accumulated debts (damage) to the biosphere and the accumulated debts to human society must logically be excluded when determining the current productivity of entrepreneurial, public and private economic activities, that is, it must be tackled as a parallel task. In other words, the determination of current productivities can only be based on the new, additional damage to the biosphere and society. The courage not to shy away from negative productivity values, i.e. to face the facts, is crucial in determining true productivity, because only then have effective political countermeasures a chance. The current eyewash must be combated politically in order to put an end to it once and for all – for the good of all of us!
Productivity is the decisive, economic policy indicator for securing the future of the biosphere and human society!
The German Federal Statistical Office is also making no effort to create a realistic basis of calculations and estimates for determining the productivity of the German economy. Instead, the Office does the usual eyewash by publishing a so-called labor productivity based on German real or nominal Gross Domestic Product (GDP).
As the name suggests, GDP shows only the production, i.e. the output of goods and services in a period, usually one year, minus advance services and imports in market prices. In contrast, the Federal Office does not have the data on the deployment (inputs) of the two factors natural resources and labour that are indispensable for calculating economic productivity. In other words, the Federal Office is not in a position to make statements on actual economic productivity because it lacks the data for the denominator of the output/input quotient.
Back to GDP: In real GDP, market prices are related to a previous reference year to exclude inflationary and deflationary distortions. For example, real GDP is suitable for comparing different annual figures and determining growth rates of economic production. The nominal GDP per capita of a certain year (GDP divided by the number of national inhabitants) is suitable to compare the performance and material wealth of different national economies as a snapshot – as already mentioned, the damages of the factors natural resources and labour are not taken into account in the performance and wealth thus reported!
Example based on nominal German GDP in 2016:
Nominal GDP was EUR 3.134 trillion, the number of people in employment was 43.595 million and a total of 59.444 billion working hours were performed. The so-called labour productivity per person employed is calculated from the ratio of GDP and number of persons employed: 71,889 euro per person employed. The so-called labor productivity per working hour is calculated from the ratio of GDP and number of working hours: 52.72 euros per working hour.
Calculations based on GDP are additionally distorted because the goods and services that have to be produced and provided to limit environmental damage and, for example, to care for the unemployed, are added to economic output erroneously and increase it.
3.7 Initiatives to Replace the Gross Domestic Product
There are a whole series of initiatives worldwide to replace or supplement GDP. No one succeeds in quantifying (monetizing) both the adjusted, effective output and the input, so none of the initiatives can succeed in determining productivity as the decisive indicator.
For clarification, I will take the Initiative of the European Commission called “Beyond GDP”, which is supported by the EU institutions and whose results are published by the EU Statistical Office eurostat. In the following I refer to the eurostat report of November 2017: “Sustainable development in the European Union – 2017 monitoring report of the progress towards the SDGs in an EU context”.
It should be emphasised that the initiative of the EU Commission refers to the input side only for which it makes incomplete and predominantly qualitative assessments (which is at least a first step towards a future-oriented approach), while it does not cover the output side. Therefore, the data is not sufficient to calculate productivity.
SDG stands for Sustainable Development Goals, i.e. the defined goals for sustainable development in the EU. There are 17 SDGs with a total of 100 individual indicators. The Monitoring Report 2017 presents the direction of the short-term and long-term development of the past 5 and 15 years respectively. The SDGs were originally agreed in 2015 as part of the 2030 Agenda for Sustainable Development of the United Nations, in which the EU played a major role. Since then, the EU, like its member states, has seen itself as the spearhead of implementation, also ostensibly in accordance with the principle of subsidiarity enshrined in the EU Treaties.
Excerpts from the 2017 monitoring report: The EU claims to have made significant progress on 5 SDGs: SDG 7: Affordable and clean energy; SDG 12: Responsible consumption and production behaviour; SDG 15: Land-based flora and fauna; SDG 11: Sustainable development of cities and communities; SDG 3: Good health and well-being.
Moderate progress is claimed for 8 SDGs: SDG 4: High quality education; SDG 17: Partnership in target tracking; SDG 9: Industry, infrastructure and innovation; SDG 5: Gender equality; SDG 8: Humane working conditions and economic growth; SDG 1: No poverty; SDG 2: Zero hunger; SDG 10: Reducing inequalities.
For 4 SDGs the development direction cannot be determined due to insufficient data: SDG 6: Clean water and sanitation; SDG 13: Climate protection; SDG 14: Underwater life; SDG 16: Peace, justice and strong institutions.
Details can be found in the following publications:
Sustainable Development Goals – Overview
Monitoring Report: Sustainable Development in the EU – 2017
Critical evaluation of the EU initiative: The initiative is a first step in the right direction, namely to roughly capture the ecological, economic and social development qualitatively and as far as possible also quantitatively by means of appropriate indicators and to use the data for political countermeasures (possibly later also as the input parameter for the determination of productivity).
It should be criticised that the initiative does not set any priorities for the indicators. Hard indicators, such as the degradation of natural resources and labour, should take precedence over those that only measure the subordinate quality of life. And the most important indicator is also missing: population density, including the subsequent repurposing and destruction of natural and agricultural land. Only if the ecologically compatible population density for each settlement area (for each EU member state) has been determined beforehand can a politically controlled, long-term adjustment take place. As long as the EU regards the adjustment of population density as a taboo issue, its initiative is not expected to lead to any breakthrough in sustainable welfare development. As shown in the following article, Germany’s current population density already exceeds the ecologically acceptable level by more than a factor of 3: Demography and Retirement Provision.
3.8 Genuine Productivity Gains
A number of key principles must be observed in the countermeasures to be defined politically: Genuine macro-economic productivity gains can only be achieved when all business, public and private activities cause no or the lowest possible social and ecological costs, or, in the distant future, even generate social and ecological returns, i.e. eliminate previously caused damages.
Productivity increases result when the productive factors labour, natural resources and capital are used more efficiently and production processes are designed more optimally, for example
The notable feature of economic productivity is, after all, that it can be continuously enhanced without limit. Until now, mankind has never been deterred from producing as many high-quality products as possible with the least amount of work and resources in aiming to create space and time for its social and cultural needs that go beyond the purely existential. Therefore, no objection can be made against high productivity and the desire to constantly increase it.
However, economies can only be sure not to consume their national wealth, but rather increase it with growing productivity, under the conditions of qualitative growth and progress.
Qualitative growth requires that the cycles of non-renewable and renewable resources are tightly closed, renewable energies increasingly used, and the products produced improved regarding their use and disposal, that is, that they become both more efficient and effective. In the theoretical but desirable state of fully closed cycles of non-renewable and renewable resources and the exclusive use of renewable energies, the quantity of resources deployed for a production process or a product no longer has any influence on factor efficiency and productivity of processes because no more external costs are caused, always provided that all resources required in an economy can be allocated.
Generally speaking, this is a desirable state in which social conditions within an economy are continuously improved by economic activities, and the condition of the environment stabilized at a high level of quality. In this state, human economic activity is practically freed from its original sin of social and ecological exploitation.
3.9 Neoliberal Apparent Productivity
Contrary to the above-mentioned desirable conditions, when determining productivity under the prevailing neoliberal circumstances, it should be noted that most economic activities, as mentioned, cause negative external effects (external costs) such as health impairment or environmental damage, the prices of which are usually not attributed to the production factors and thus erroneously increase the reported total productivity. Under neoliberal conditions, the negative external effects emanating from economic activities have, as a result of declining economic policy control, reached a hitherto unknown magnitude of existential threat to mankind and nature, both in the social sphere – with underemployment, mass unemployment and poverty – and in the ecological sphere – with the exploitation of resources, climate change, species extinction and the threat to the food chain. For further details I recommend the articles Economic Externalities, Economic Pricing and Full Employment.
Since the factor labour causes the highest costs for most productions, it is evident to replace labour with machines, i. e. to automate and rationalize the production processes. With declining economic governance and, as is the case in the current neoliberal economic system, the loss of jobs through automation and rationalization is proving to be an effective way of increasing company productivity, as companies do not have to fear higher labour costs or a reduction in working hours. However, this further widens the gap between increasing apparent business productivities and stagnating or declining real wages, so that purchasing power decreases and, sooner or later, depending on the proportion of export business, will backfire on producers in the form of declining domestic sales. In other words, if wages and working hours are not adapted to productive progress, the dynamics of economic cycles will diminish, because the supply meets a declining demand.
If wages are not raised or weekly working hours are not reduced with increasing productivity, for example as a result of automation, this is always an alarm signal that points to poor economic governance and the decline of social welfare. Countermeasures by means of stepping up export production only have a temporary effect and ultimately lead to extreme unequal distribution and social division. The current development in Germany is an outstanding example of the extreme export bias and its consequences under the prevailing neoliberal conditions.
For the national productivity, the necessity of recording external costs can be demonstrated most vividly using the factor labour as an example: Not only all wages and other remuneration – as the prices for labour – that provide a decent livelihood, must be included in the calculation, but also all state transfer payments that serve to safeguard the livelihood of precarious employees and the unemployed. Transfer payments are the costs incurred – in economic terms – for the damage to the factor labour by precarious employment relationships and unemployment. The higher the percentage of transfer payments of the total price of labour is, and thus also of the total income of the potential working population, the more the labour market is damaged and the greater are the social imbalances, and: the greater is the negative impact on overall economic productivity. In fact, the recording of costs must even be pursued in the future, because social imbalances and distortions entail medium- and long-term follow-up costs – for example through psychosomatic illnesses and drug abuse of the people concerned, through disadvantages for the adolescent generation and through an increase in crime.
When business costs are continuously externalized, the production processes will inexorably move towards their natural end: with social orders dissolving, non-renewable resources dwindling and renewable resources being destroyed. The answer to the frequently asked question of why malnutrition and poverty are propagating worldwide, whilst economic productivities are apparently rising at the same time, is in the short term answered by the fact that systemic unequal distribution is mounting, but in the long term even more profoundly by the systemic distortion of productivity, namely apparent productivity, and the resulting destruction of assets, which sooner or later will backfire on the whole of human society. A fairer distribution of the allegedly neoliberal »wealth«, as is often demanded under the heading »There is enough for all«, does therefore not hold as a sustained solution for combating malnutrition and poverty and for securing the future.
The driving force behind the mounting apparent productivity of the neoliberal system is the striving for expansion of entrepreneurial players, that is flourishing wildly in the neoliberal political vacuum and has found its doctrinaire glorification as a growth paradigm. The oversized production capacity, which is being built up under the constant striving for expansion and the pressure of global competition, is met by declining demand due to the general saturation of the typical neoliberal markets for goods and services in the developed industrialized countries. Demand is further declining due to falling employment as well as stagnating wages and public investment. Global players are trying to counteract the imbalance with innovation and export initiatives, thus aggravating the situation. At the same time, new emerging economies are swamping the export markets and raise the global supply, while the purchasing power in importing industrialized countries continues to go down. In this vicious circle, there is finally only one way to cope with the cost pressure in global competition: the exploitation of social and natural resources. Companies are taking brisk advantage of this option – with political toleration and support – and so the neoliberal house of cards made up of apparent productivity and profits is piled up ever higher, until it will eventually collapse under its own weight.
The extreme neoliberal development exemplifies that the definition of productivity is the key to a sustainable globalization: Instead of deriving productivity from isolated capital efficiency only, it must be socially and ecologically defined, that is, it must fulfil a social and ecological function. That can be achieved by adding the external costs caused by the production processes to the production factors without exception. Thereby the external costs find their way into pricing and create incentives to avoid them. A promising way to redefine productivity leads from the current neoliberal process of concentration of economic capital and power to a process of decentralization, or, more precisely, to a subsidiarization of economic structure and activity, which gets all citizens involved in economic life and directly assigns the responsibility for the human and natural resources of their local and regional environment to them.
First of all, economic and political insight is required to understand that there can be no abstract productivity that is detached from social and ecological responsibility, that productivity can only be thought of in the context of a humane expediency: namely, to make life consistently more bearable and pleasant. »The economy must serve the people, and not vice versa«, is, not without reason, a well-known truism. This also means that economic cycles must be designed and managed where people live their lives: locally, regionally and nationally. This explains the fact that genuine economic productivity generally increases with the degree of de-centrality or, better still, with the degree of subsidiarity of the production structure, because subsidiarity promotes the involvement, self-determination and responsibility of all economic players. Subsidiarity means qualified decentralization and represents a hierarchy of production technology: That is, the demand for capital and technology increases towards the upper levels and the intensity of labour decreases accordingly, resulting in comprehensive economic diversity at the lower, labour-intensive levels, complemented by demanding, capital-intensive productions at selected central locations (see also the articles Economic Subsidiarity and Scale Economies and Productivity).
Undivided local responsibility is the starting point for real productivity and real added value and the guarantee that the productive population places progress at the service of their fellow humans and their natural environment. The decentralized responsibility naturally includes the decisive condition that costs may not be transferred (externalized) without mutual consent from home locations of economic activity to foreign locations. Therefore, with decentralization or subsidiarity as such, an »automatic« inherent barrier against arbitrary relocation (externalization) of economic costs is already being created. In addition to this inherence, however, legal and fiscal measures are required which, in accordance with the »polluter pays principle«, create obligations and incentives to avoid external costs caused by economic processes to the greatest extent possible based on state-of-the-art technology. Costs initially considered unavoidable must be included (internalized) in the business balance sheets and national accounts in order to document and combat them.
The small-scale economic cycles within subsidiary structures ensure that economic players can directly perceive the consequences of their activities and can be motivated for mutual commitment and community spirit. Thus, social progress is induced, supplemented by measures that allow dependent employees to participate appropriately in the fruits of their labour. Their participation can be secured, for example, by reducing weekly working hours and raising wages at the same time as productivity grows, supplemented by a proportionate return on investment, all regulated by labour law and collective bargaining laws. This combination of measures gurantees that the number of jobs required for full employment is maintained in the course of technological progress, that labour demand and supply can be very flexibly adapted, that all employees can contribute to progress and the development of a better world, and that economic cycles are kept going by a constantly optimal distribution of income, thus ensuring optimal welfare.
Intact decentralized economic cycles that interact across all levels of production are indispensable as a foundation for a sustainable, post-neoliberal economic globalization
The practical building of domestic subsidiary economic structures under the conditions of the neoliberal globalisation as an initial measure on the road to a post-neoliberal economic order is described in the article Building Subsidiary Economic Structures.
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