Measurement of the Total Factor Productivity in Major Water Utilities: Melbourne Case Study

This report was produced for the Urban Water Research Association of Australia, a now discontinued research program.

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Report no. UWRAA 65

September 1993

Synopsis

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

Methodology

Though the concept is simple, measurement is far from easy since any complex organisation such as a water utility has many outputs and many inputs. In this study, 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

If outputs, so weighted, rise more rapidly than inputs, total factor productivity has increased.

The chief problem in measuring inputs is the input of capital. The measure taken has 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 rate of return of four per cent is assumed. As compared to higher rates, this gives capital a lower weight in the calculations.

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

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

Comparison with previous studies

Total factor productivity in Melbourne Water has been previously estimated in two studies, one by the Industries Commission and one by Melbourne Water itself.

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

Most output measures used in previous studies reappear in the present study, but the range of quality indicators taken into account has been broadened. The present study 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 that this risks confusing outputs and inputs.

The present study is the first to distinguish productivity in current operations from the productivity of long-term capital.

Results

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

Productivity in current operations has been calculated with allowance for the maintenance of long-lived assets. Current productivity growth during the period was reduced below potential due to indications that maintenance had been deferred.

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

Possible further research

Further research is warranted to extend the approach to more entities within Melbourne Water, and to improve accuracy.

Extension of the study

If inputs can be subdivided between water, sewerage and drainage, it will be possible to develop separate productivity indicators for each sector. (The output indices are already distinguished.)

If both inputs and outputs can be distinguished by region, it will similarly be possible to develop separate productivity indicators by region.

Improvements inaccuracy

Improvements in accuracy can be achieved by:

· greater accuracy in measurement of outputs, particularly some of the quality output indicators;

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

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

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