Multifactor productivity (MFP) is measured as a ratio of output per unit of labour and capital factor inputs to production. Businesses use labour and capital inputs to varying degrees of intensity depending on prevailing economic conditions. The intensity of use of inputs to production, measured against a possible maximum capacity, is defined as utilisation.
One of the key assumptions underlying productivity estimation is that the utilisation rate of the factor inputs in the production process are constant, and do not take into account technological change. This assumption is applied because changes in the utilisation of factor inputs are typically unobservable. To deal with this assumption, the ABS recommends analysing MFP averages over growth cycles. By reducing the impact of changes in utilisation, MFP growth cycle averages align more closely with their conceptual definition of technology change.
In the short run, utilisation rates of labour and capital can vary due to a range of factors, including changes in the economic cycle or economic shocks. For example, in cyclical downturns, businesses may retain skilled labour even though there is reduced economic activity. This helps businesses to reduce future costs around recruitment and training when economic activity recovers. Capital inputs are often fixed in the short term, and reducing capital utilisation may be the only option for many businesses in response to temporary shocks, such as lower demand for goods and services.
This article examines the extent to which the assumption of constant utilisation rates may have distorted productivity measures over the last two decades, by stress testing a selection of productivity assumptions, especially in relation to capital.