Analysis of productivity in highway construction using alternative average cost definitions

Productivity in a state administration has become an important topic in recent years. In the paper, productivity growth (decline) in highway construction over time and comparisons between different regions of a highway agency are made. The cost function is used to analyze the road construction process. The explanatory variables are the factor prices, the output levels and several factors over which the management of the highway agency has control. The hypotheses concerning economies of scale, both at the project level and at the region level, indicate increasing returns to scale. The implications of this and other results of the cost function hypotheses testing to road construction policy and productivity are discussed. Manipulation of the cost function makes it possible to compare productivity growth (decline) and average cost differences between regions or between points of time. In addition, the sources of productivity growth and unit cost difference can be traced to a pure regional effect, an input price effect, an output scale effect, a management effect, technical change and an unexplained component. In spite of the high statistical accuracy of the estimated cost function, this unexplained component, together with the output scale component, appeared to assume a major significance to productivity and average cost. The study shows the fundamental importance of the definition of output in productivity and cost efficiency studies if there are (dis)economies of scale. It is shown, in particular, that if economies of scale are present and they are not taken advantage of in the production, a ‘technological gap’ develops. This means that the agency may appear to be performing in a cost-effective manner when it could, in fact, be performing much better. The method is applied and demonstrated using data from the Finnish Highway Administration. The implications of the results to improving the efficiency and organization of the agency are discussed.