total factor productivity
/ TFP, tee-eff-pee /
Suppose a country adds 10 percent more workers and 10 percent more machines but its output jumps by 20 percent. Where did the extra growth come from, the part not explained by simply having more inputs? Economists call that leftover piece total factor productivity. It is the efficiency with which an economy turns all its inputs together, labour and capital, into output, and it captures the magic of doing more with the same.
Total factor productivity, or TFP, is the part of output growth that cannot be accounted for by growth in measured inputs like labour hours and capital. Because it is found by subtracting the contributions of labour and capital from total growth, it is also called the Solow residual, after Robert Solow who pioneered this growth accounting. A TFP gain means the same workers and the same machines produce more, thanks to better technology, smarter organisation, improved management, stronger institutions, or simply better ideas about how to combine resources. If output grows 20 percent while inputs explain only 12 percent of that, the remaining 8 percent is attributed to rising TFP.
TFP matters because, over the long haul, it is the main reason rich countries are rich. You can grow for a while by piling on more capital, but diminishing returns eventually slow that down; lasting growth in income per person comes mostly from rising TFP, that is, from technological progress and better ways of doing things. The honest caveat is that TFP is a residual, a measure of our ignorance as much as our knowledge. It is whatever is left after we account for everything we can measure, so calling it technology is partly a label for the things we do not fully understand.
Two factories have identical machines and equal numbers of equally skilled workers, yet one produces 30 percent more cars. The difference, not explained by inputs, is higher total factor productivity, perhaps from better management, layout or processes.
TFP is the growth left over after counting labour and capital.
TFP is a residual, calculated as what is left after measured inputs are subtracted. It therefore bundles together genuine technical progress with measurement errors, so it should be read as an estimate, not a precise reading of pure technology.