1  Introduction

Productivity measures are required in several areas of economic analysis. These range from exchange rate determination to examining the (proximate) sources of economic growth. A variety of methods are available to the productivity analyst in calculating productivity estimates, with the choice of method partly dependent on the objectives of the analysis. This paper provides an introduction to measuring productivity using the index number method. Consideration is given to this approach owing to the use of index numbers in constructing economic aggregates (such as GDP and the Consumers’ Price Index) and because index number techniques are used by statistical agencies that publish official productivity measures. Readers interested in alternative approaches to productivity measurement should see Mawson, Carlaw and McLellan (2003).

There are two main approaches to choosing an index number formula: the economic and axiomatic approaches. The former approach bases the choice of index formula on a producer’s underlying production technology, and therefore has theoretical microeconomic underpinnings. The axiomatic approach bases the choice of index formula on desirable properties that indexes should exhibit. Once the index formula is chosen, consideration then needs to be given as to whether the productivity index should be chained to reduce substitution bias associated with fixed weight indexes.

Good measures of outputs and inputs are needed in forming reliable productivity measures. This paper gives special attention to measuring physical capital and quality-adjusted labour inputs, as measuring these inputs present particular challenges for productivity analysts.[1] Measuring physical capital inputs requires the construction of productive capital stocks from data on past investments and the formation of rental prices for different asset types. This is achieved using an integrated framework in which the loss in the productive capacity of an asset is linked to economic depreciation and its rental price (or user cost of capital). The measurement of quality-adjusted labour inputs requires rich information on labour market earnings and worker characteristics.

The remainder of the paper is organised as follows. Section 2 discusses the index number approach to measuring productivity and choice of index number formula. Included in this section are numerical examples, based on hypothetical price and quantity data, illustrating the construction of productivity indices using various index formulae. Section 3 outlines the rationale and procedure for chaining fixed weight indices, illustrating this procedure with a simple numerical example. Measurement of capital inputs using an integrated framework that links the loss in productive capacity of an asset with economic depreciation and its rental price is discussed in Section 4. The measurement of quality-adjusted labour inputs is canvassed in Section 5. Section 6 provides a brief summary.