How to price public sector productivity

21 Mar 17

Productivity in the public sector has a significant effect on the economy, directly and indirectly. This can prove difficult to measure – not impossible 

 

Productivity in the public sector has a significant effect on the economy, directly and indirectly. This can prove difficult to measure – not impossible

Photo: Alamy

 

Public sector productivity matters. Efforts to boost the productivity of the entire economy will be hamstrung unless the performance of the 20% of it for which public services account also improves. But this does not mean the challenges in raising public sector productivity are the same as those in the private sector. There are significant differences.

One of these is measurement. Stock responses to the idea of measuring productivity in the public sector include claims that it is too hard or something about these services means it is impossible. This view is outdated. Following the work of the late Sir Anthony Atkinson and others, the Office for National Statistics has carried out valuable activity on measuring public sector productivity for over a decade. Lessons have been learned. 

Conceptually, a key problem is the lack of market-clearing prices in the public sector. Given the variety of outputs produced in an economy, productivity measures require an approach that combines these diverse outputs into a single index. In the private sector, prices can be used to combine outputs, as they are assumed to be a good indicator of consumers’ valuation of (willingness to pay for) them.

In contrast, public services lack or at best poorly reflect prices as they are provided free or are subsidised. Therefore, prices cannot be used as proxies for the value of services and some other way is required to combine diverse outputs into a single index – a weighting schedule. Sometimes, cost weights are used but these reflect the value placed on the service by the producer and imply that higher costs equal higher quality.

The difficulty does not stop there. The quality of a product or service may vary over time as it is refined and developed, or as the producers’ operating environment changes. Yet adjusting estimates of public sector productivity for quality changes is complex. A good example of this is the ONS’s work on education productivity. Quality adjustments make a substantial difference to measured productivity; they account for around 90% of the annual growth rate in education sector productivity from 1997 to 2011. A change in practices such as the number of students sitting non-GCSE exams can have a non-trivial impact on estimates and mean the ONS has to revise its approach.

This is all before we account for institutional factors – such as parliamentary accountability for inputs, competition and consumer choice – which may mean public services require a different approach to measuring productivity.

This may be difficult but is not impossible. Consider the Office for Budget Responsibility’s work on the long-term fiscal outlook. This shows that not only will demand for key public services increase but also that growth in the total labour force is expected to slow. The implication is that the public sector’s operating environment will become both more demanding and more input constrained, so there will be a greater need to boost productivity.

This can be a good thing. An increase in public sector productivity would allow more public services to be provided at the same cost – or alternatively, to provide the same level of public services at a lower cost. Faster productivity growth can bend down fiscal cost curves and provide future governments with fiscal headroom. 

The effects goes well beyond these direct measures. Productivity growth in the private sector relies on a healthy, well-educated population, whose efforts depend on good physical and social infrastructure. Given this, it is reasonable to maximise services provided for a certain level of inputs. A concern with productivity is a feature of strong public services. 

  • Patrick Nolan
    Patrick Nolan

    principal adviser at the Productivity Commission, New Zealand. Formerly chief economist at the Reform think-tank.

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