Productivity Growth

   Businesses achieve efficiency gains-more output with the same amount of input-when they devise better ways of organizing and using the equipment they own and the people they employ. Efficiency gains include both process innovations, which increase productivity by reducing the capital or labor needed to produce a unit of output, and product innovations, which increase productivity by increasing the value of output. For example, when Henry Ford began mass-producing Model T's, the Model T itself was a product innovation, while the moving assembly line was a process innovation. The combination of improved process and product allowed the Ford Motor Company to reduce its production costs and become more competitive.

   A more recent example of process improvements that led to direct efficiency gains may also be helpful in illustrating this concept. Managers at a 3M tapemanufacturing plant increased productivity by reorganizing part of their production process. By moving machines such as glue coaters and tape slitters closer to the packing equipment and robotic transporters, 3M substantially increased labor productivity at its plant. The reorganization reduced the need to move output around the plant, and cut the length of the production cycle. In addition, with all the packing supplies located in one place, managers could see when they had more than they needed and could cut costs by reducing excess inventories of supplies. This improvement is an efficiency gain because the plant produced more output without increasing capital or labor. This example is typical of the innovative process: companies purchase and install new machines-from computers to conveyor belts-but it takes time and further innovation to learn how to take full advantage of the new machines.

   Entrepreneurship (developing new ways of doing business and making risky investments to implement them) and competition partially determine the degree to which innovation contributes to labor productivity. If a business comes up with a new product or a new way of organizing production and spends the resources to try it out, and if the new way improves on the old, the business ends up with a higher level of profit and an incentive to expand. Innovation by one business is likely to have little direct effect on a nation's productivity growth, but competition forces other businesses to either come up with innovations of their own or to cede market share. When this happens, capital investment and labor flow to businesses with better methods of production, and productivity increases as a result.

   Entrepreneurship occurs on both small and large scales; many large multinationals spend large sums on research and development in order to innovate and expand, but individual entrepreneurs who operate on a small scale may also innovate. The entry and growth of new businesses, combined with the exit of older, less productive businesses, has been found to be responsible for a substantial share of efficiency growth.