Measurementof Total Factor Productivity

inMajor Water Utilities: Melbourne Case Study

ReportNo WSAA 65

September 1993




Indicesof total factor productivity measure the technical efficiency of production byrelating the flow of output to the flow of inputs. If efficiency is increasing,outputs will grow more rapidly than inputs. This study discusses the problemsarising in measurement of total factor productivity for a large water utility,Melbourne Water, and develops a model to measure total factor productivity.




Thoughthe concept is simple, measurement is far from easy since any complexorganisation such as a water utility has many outputs and many inputs. In thisstudy, the following solutions are adopted to this problem.


        All inputs are measured in constant dollars

        All outputs are measured in physical units (megalitres of water etc.)weighted according to cost in a base year


Ifoutputs, so weighted, rise more rapidly than inputs, total factor productivityhas increased.


Thechief problem in measuring inputs is the input of capital. The measure takenhas been based on replacement cost as calculated for rate of return accounting.The main difference from rate of return accounting is that a constant real rateof return of four per cent is assumed. As compared to higher rates, this givescapital a lower weight in the calculations.


Outputsare estimated separately for water supply, sewerage and drainage. Each sectoraloutput indicator includes indicators of flow and indicators of quality. Theindicators are so weighted that in normal circumstances the flow indicatorsdominate output, but if a serious breach of standards occurs the qualityindicators dominate.


Adistinction is made between current operations and the productivity oflong-term capital. Current operations comprise essentially those areas withinthe control of current management; long-term capital comprises a stock ofindustry-specific works accumulated slowly over the past century and more.Productivity in current operations relates all industry outputs, adjusted forquality of maintenance indicators, to current inputs. The productivity oflong-term capital relates all industry outputs, but not maintenance outputs, tothe input of long term capital. Total factor productivity relates all industryoutputs to all inputs.


Comparison with previous studies


Totalfactor productivity in Melbourne Water has been previously estimated in twostudies, one by the Industries Commission and one by Melbourne Water itself.


The inputmeasures used in all studies are similar, though the present study has modifiedthe detailed methodology used to update the capital stock at replacement value.


Mostoutput measures used in previous studies reappear in the present study, but therange of quality indicators taken into account has been broadened. The presentstudy uses constant weights in preference to varying revenue-based weights.Though it is theoretically preferable to use varying weights based on revenue,the relationship between cost and revenue in water utilities is so close thatthis risks confusing outputs and inputs.


Thepresent study is the first to distinguish productivity in current operationsfrom the productivity of long-term capital.




Thestudy agrees with its predecessors that total factor productivity in Melbournehas been increasing at approximately 1.4 per cent a year. Productivity incurrent operations has been increasing at 1.7 per cent a year, but theproductivity of long-lived capital assets has increased more slowly, at 0.8 percent a year.


Productivityin current operations has been calculated with allowance for the maintenance oflong-lived assets. Current productivity growth during the period was reducedbelow potential due to indications that maintenance had been deferred.


Themerger of the MMBW and other authorities to form Melbourne Water during theearly 1990s resulted in a temporary halt to productivity increases. To someextent this reflected the timing of the merger, and to some extent temporaryincreases in inputs associated with the merger. It is expected that growth intotal factor productivity will resume as from 1992-93.


Possible further research


Furtherresearch is warranted to extend the approach to more entities within MelbourneWater, and to improve accuracy.


Extension of thestudy


Ifinputs can be subdivided between water, sewerage and drainage, it will bepossible to develop separate productivity indicators for each sector. (Theoutput indices are already distinguished.)


Ifboth inputs and outputs can be distinguished by region, it will similarly bepossible to develop separate productivity indicators by region.


Improvements inaccuracy


Improvementsin accuracy can be achieved by:


        greater accuracy in measurement of outputs, particularly some of thequality output indicators;


        addition of further quality output indicators to cover aspects not atpresent covered (particularly desirable for maintenance outputs); and


        checking of input indicators. It will be particularly important tofully reconcile the next replacement cost valuation with the last, and to makeappropriate adjustments in the capital input estimates. A reconciliation of thetwo recent valuations could also prove instructive.


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