The returns to scale effect in labour productivity growth

Labour productivity is defined as output per unit of labour input. Economists acknowledge that technical progress as well as growth in capital inputs increases labour productivity. However, little attention has been paid to the fact that changes in labour input alone could also impact labour productivity. Since this effect disappears for the constant returns to scale short-run production frontier, we call it the returns to scale effect. We decompose the growth in labour productivity into two components: 1) the joint effect of technical progress and capital input growth, and 2) the returns to scale effect. We propose theoretical measures for these two components and show that they coincide with the index number formulae consisting of prices and quantities of inputs and outputs. We then apply the results of our decomposition to U.S. industry data for 1987–2007. It is acknowledged that labour productivity in the services industries grows much more slowly than in the goods industries. We conclude that the returns to scale effect can explain a large part of the gap in labour productivity growth between the two industry groups.