Total Factor Productivity

Program Major Batch Group Members

Subject Lecturer

: Magister Manajemen : Business Management (Eksekutif Muda) : 15B :2 : Adeline Chitranegara Budi Kurnia Christian Putra Nugroho Ervina Gani Hary Nugroho Pieter Alexander De Haan : Economics for Business : Paul Oppusunggu, MM.

TOTAL FACTOR PRODUCTIVITY Extraction of Total Factor Productivity elements: institutions, rent seeking, and financial institutions; from the text book, Miles and Scott's Macroeconomics – Understanding the Wealth of Nations, with additional references.

BOOK REFERENCE 1. Miles, D. and A. Scott, Macroeconomics – Understanding the Wealth of Nations, John Wiley & Sons, England, 2005. 2. Lambsdorff, Johann Graf, The Institutional Economics of Corruption & Reform: Theory, Evidence and Policy, 2007. 3. Lipsey, Richard G, Economics, Harper Collins, USA, 1993.

TOTAL FACTOR PRODUCTIVITY (TFP) TFP is the measure of efficiency on how all production inputs is utilized. It reflects a huge range of influences on both economics and socio-cultural. Here we will only have a look on a few factors that might influence a level of TFP. FIRST, THE IMPORTANCE OF INSTITUTIONS… The term “Institutions” does not limit to a government building, instead the term extends to a wide range of implicit and explicit social behaviors that might influence the economy; hence, it is also called the “rules of the game” in society. An economy that has high quality Institutions will produce higher levels of GDP per capita; and government plays an important role in the growth of GDP. Thus, government institutions need to provide the framework for its market economy which is given by such things as: well-defined property rights security, security and enforcement of contracts, law and order and the basic rights of individual to do anything they like with his or her sound money. What kind of indicators that we use to measure a quality of government institutions? The World Bank has developed six indicators to measure institutions' quality across countries: 1. Voice and accountability 2. Political stability and lack of violence 3. Government effectiveness 4. Regulation quality 5. Rule of law 6. Corruption In cases of a country with abundant natural resources, the Institutions may have poor quality, as it usually would only raise revenue from selling raw materials, which then would lead to rent seeking and corruption to flourish. Such condition is known as the “Natural Resource Curse,” where the Institution is doing no value-added activities to raise either its revenue or its economic growth; hence, zero productivity. MOVING ON TO… RENT SEEKING AND CORRUPTION In order to have a high level of TFP, value-added activities must be encouraged and acted upon. Rent-Seeking is exactly the contrary of that activity. Rent-Seekers are individuals that earn their money by taking the value added someone else has produced. Rent Seeking can lower economic growth; as a result of how Rent Seeking would kill the sources of economic growth: innovation and output creation. Rent Seeking can be done in three ways:

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1. It absorbs labor that could be potentially productive in entrepreneurships 2. Rent seekers act as a tax and decrease the supply of entrepreneurs 3. If rent seeking is rewarded high, the most talented people become rent seekers and entrepreneurs' quality gets suffered Corruption is a form of Rent Seeking activities presents in many countries and in some cases, corruption could help boost the economy if it helps to oil the wheels of trade. Despite that fact, corruption adversely affects TFP and the level of output in an economy. Another form of Rent Seeking is lobbying, a form of rent-seeking activities done by rent-seekers to obtain prospects rents. While, lobbying is commonly pursued between two parties or more with the same interest in self-enrichment and increase rent’s size; corruption is commonly described as the more monopolistic form of rent-seeking. Moreover, corruption has worse welfare implication than alternate rent seeking activities. Studies showed that the least corrupt economies are richer than most corrupt. This is due to the lack of trust to public institution caused by corrupt economies; whereas trust, between contractual partners, is an indispensable part of successful economy. This is known as Social Capital. Societies with high social capital have higher value added activities. Thus, Institutions must encourage individuals to earn their income through engaging in Entrepreneurships rather than any Rent Seeking activities. LAST BUT NOT LEAST… FINANCIAL INSTITUTIONS Another form of Institutions that has a huge influence on TFP is Financial Institutions. The lack of adequate, trustworthy and trusted system of financial institutions is often a barrier to development. When banks and other financial institutions do not function effectively, the link between private savings and investment may be broken, making it difficult to raise fund for investment. Or when banks cannot count on their deposits being left in the banking system, they can not engage in the kind of long-term loans that are needed to finance investment. In relation to Social Capital, developing countries must create financial institutions as well as develop enough stability and reliability so people will trust their savings to the banking or financial institutions. Countries with well develop financial systems saw faster growth in GDP per capita and capital and also saw higher levels of TFP.

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