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ANALYSIS OF PRODUCTIVITY IN HIGHWAY

CONSTRUCTION USING ALTERNATIVE
AVERAGE COST DEFINITIONS

A. P. TALVITIE and CATHARINA SIKOW

Viatck Ltd.. Espoo. Finland

(Received I J September 1991)

Abstract-Productivity in a stale administration has become an important topic in recent years.

In the paper, productivity growth (decline) in highway conslruction 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 economics of scale, both at the project level and at the region level, indicate increasing
returns lo scale. The implications of this and other rcsulrs of the cost function hypotheses testing
lo road construction policy and productivity are discussed. Manipulation of the cost function
makes ir possible 10 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 statisti-
cal accuracy of the estimated cost function. this unexplained component. together with the output
scale componenr. appeared to assume a major significance 10 productivity and averagecost. The
study shows the fundamental importance of the definition of output in productivity and cost
efficiency studies if there are (dis)cconomies 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 cosctffcctivc 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 Ihe results Lo improving the
efficiency and organization of rhe agency are discussed.

INTRODUCTION

Productivity measurement research in highway construction has been rare, compared to

the vast literature in other areas of transportation (e.g. Caves, Christensen and Swanson,
1980; Kim, 1985; Hensher, 1987). In the Nordic countries, where in-house (“own account
work”) by the highway agencies was practiced in a large measure in the two postwar
decades, performance of the highway agency became an important issue. The first pro-
ductivity calculations in highway construction in the Nordic countries date back to the
1960s. Then an index for productivity was expressed in terms of a meter of highway
produced per aggregate inputs used. The intended use of the measure was to compare the
highway regions in constructing highways and to observe the time trend of the measure.
This “highway meter” measure had both quantitative and qualitative shortcomings.
A meter of road in a rough terrain was simply not equivalent to a meter of a wider road
in an urban environment. Similarly, different kinds of roads needed different kinds of
inputs; an aggregate input measure was not easy to define.
In the 1970s. highway construction moved from in-house work to competitive con-
tracting. This shift was joined by even greater emphasis on the efficiency of the highway
agencies. The highway meter measure proved inadequate. Because the pride of the high-
way engineers was at stake, a project was initiated in Finland’s Highway Administration,
subsequently recognized by its Finnish acronym TIEH, to develop a better productivity
index. The index chosen was the Fisher price index. This index served well for nearly 10
years-it is still used for reference-and enabled the agency engineers to develop a good
understanding of the complexity of the issues surrounding productivity measurement.
The Fisher price index, as implemented by TIEH, was deficient because it imposed
several restrictions on the structure of production. First, and perhaps most important, it
did not account for economies of scale but assumed constant returns to scale. Second,
the index assumed only one type of output, or that several outputs were strongly separable
VI(B)26:6-O
461
462 A. P. TALVITIE and C. SIKOW

from each other and from inputs and thus that linear aggregation was possible. Third, it
was not possible to separate the contribution of different inputs on the cost efficiency of
a highway region or over time. Fourth, the price index took no account of the manage-
ment or background variables that may affect the cost of highway construction. Fifth,
the technological change was assumed to be Hicks-neutral. Finally, zeros in the quantity
variables had to be ignored.
The objective of this paper is to analyze the highway construction technology by
using a flexible functional form, the translog cost function and index number theory,
which relaxes the above mentioned apriori restrictions. To appreciate the specific nature
of highway construction technology, a number of key economic constructs need to be
discussed at the outset.

ECONOMIES OF SCALE

Economies of scale are presumed to be important at two levels -the project level
and the regional level. Construction engineers suggest that the economies of scale at the
project level are caused by indivisibility, (dis)economies of management and the weather.
Small projects create indivisibility problems because required laborers, supervisors, con-
trollers and machines are inefficiently employed. The indivisibility of workers can be
alleviated in part by multiple-skill labor training. If several small construction sites are
placed under the same supervision, time traveling between sites leads to inefficient use of
supervisors and controllers.
Indivisibility is also at work with construction equipment. Efficient, high-capacity
machines would be idle in small projects, whereas many small machines are too slow and
in each other’s way. An issue with the machine capability is the ability and skill of the
machine operators. Incompatibility, as well as indivisibility, can be a source of scale
economy. Another dimension to scale economy, and the only one studied thus far (Meyer,
Kain and Wohl, 1965; Keeler and Small, 1977)-with conflicting results-involves the
road width. It is not clear whether a 12-m-wide road is equally expensive to build as a
7-m road, per meter of road width.
Yet a third dimension to scale economy is presented by the speed of construction.
There is a physical upper limit on the speed of construction, but there is no lower limit.
The slow pace of construction consumes money slowly and enables many simultaneously
ongoing projects with a given budget. This style of management may have political
appeal. It keeps the excess laborers working, makes layoffs unnecessary and gives every
town a highway project. But this kind of management also has high interest costs and
may use men and machines suboptimally.
Road width and pace of construction also have user-side effects. Wider roads may
bring user benefits in terms of higher speeds and lower accident costs. Slow construction
causes opportunity losses to users who cannot take advantage of the new road or, during
reconstruction, levy higher user costs due to closed lanes or road roughness.
Project-level scale effects can have economic importance. Optimal choices, which
involve project size, road width and construction time, can yield monetary benefits to a
highway agency and users alike. In two companion studies (RWA, 1986; Talvitie and
Sikow, 1989) these benefits were calculated to range from 11% to 25% of project costs,
depending on the demand volume on the road.
Scale economies at the regional level are equally important. Talvitie and Sikow
(1989) found that economies of scale exist up to 4,000,000 m’ of earthwork. The transpor-
tation agency of a state or country is normally divided into regions that execute the
highway program. Often the agency reduces the work force only by natural attrition, and
restrictions may exist with regard to the relocation of labor. In these cases small highway
region size may present a cost to an agency and place requirements on the programming
of projects to keep the fixed work force employed. If the agency does a large share of
work in house, the problem is compounded. On the other hand, a very large highway
region may exhibit diseconomies of management and high costs.
The relevant issue is optimal region size. A highway region has many other functions
 Analysis of productivity in highway construction 463

besides road construction and rehabilitation. Its size and functions cannot be decided on
narrow interests of efficiency in road construction. However, it may be possible to sepa-
rate road construction from planning and administrative functions to a great degree and
to a lesser degree also from road design.
Another issue pertinent to the organization of highway production is the number of
projects a region plans to carry out with a given budget. What is the optimal number, or
what is the optimal speed of construction for a given budget? Principally, then, the idea
behind optimal region size is to reduce the effect of indivisibilities, allow more efficient
completion of projects, be a positive force in labor training and negotiations and elimi-
nate the need to construct unnecessary projects.

OUTPUT SEPARABILITY

Certain highway construction-related components-design, planning and mainte-

nance-are assumed to be separable from construction. What is not known is whether
different types of highways constitute different outputs and, if so, whether these outputs
are separable from each other. It would be managerially desirable if these existed separa-
bility between different types of output-i.e. motorways, wide roads, narrow roads and
safety or other small “combination” projects. Experience in construction programming
suggests that complete separability cannot be achieved, but the seriousness of nonsepara-
bility is unknown.

EFFECT OF INPUTS

Input prices are likely to vary between regions of a country. What is the contribution
of these prices to cost efficiency? This would be important information to a regional
engineer in managing a highway program.

EFFECT OF MANAGEMENT AND OUTPUT CHARACTERISTICS

Construction engineers point to the possible effects of both management and output
attributes on productivity. Managerial decisions about the total volume of work, given
the budget, the number of projects by type, the speed and mode (contract vs own account)
of execution and the allocation of workers to projects have a bearing on costs and
productivity. Construction in urban areas, rehabilitation or reconstruction of an old
road, possibly with minor improvements in alignment, may also have a cost effect.
Two methods of introducing the policy and output attributes into productivity analy-
ses can be used. Hensher (1989) and Obeng (1985) first develop a measure for productiv-
ity-total factor productivity derived from a cost function-and then relate it to the
“background” and policy variables by means of a regression analysis. In the other
method, used in the present study, the background and policy variables are entered
directly into the cost function and their contribution to cost analyzed in the same way as
that of input prices.
The remaining sections of this paper develop an index to measure productivity and
cost efficiency in highway construction and to compare the performance of the regional
highway administrations in Finland.

METHODOLOGY

A review of the productivity measurement literature (Fuss and McFadden, 1978;

Jorgenson and Nishimizu, 1978; Denny, Fuss and May, 1981; Cowing and Stevenson,
1981; Kim, 1985; Hensher, 1987, 1989; Obeng, 1985) shows that the cost function is a
versatile means to measure productivity levels and changes in it. Specifically, the method
involves calculating average cost differences-through time or between regions-and de-
composing them, in the present case, into input, output and management effects and
productivity or trend effects.
464 A. P. TALVITIE and C. SIKOW

It is assumed that highway total cost can be described for each of the regions of
Finland as depending on factor input prices, a list of outputs, management descriptive
variables and a proxy for technological change. Then it can be shown (see appendix for a
brief mathematical exposition) that the change in total cost over time (or between dis-
tricts) depends on the growth rates of these same quantities.
In traditional productivity analyses, output levels have been assumed to depend on
input quantities only. Likewise the firm’s total costs, the dual function, have been ex-
plained by input prices and output levels. Following these traditional definitions, total
factor productivity (TFP) has been defined in the economic literature as the ratio of
aggregated outputs to aggregated inputs and, consequently, in the context of the tradi-
tional definition of the cost function equals the effect of time on the shift of the cost
function, that is, the technical change. This was equally the case with the actual produc-
tivity measure in TIEH.
The difference between the traditional TFP and that being proposed here is that
several management variables are also included that break the trend effect into manage-
ment effect and technological change. This permits an analysis of TFP from two points
of view: the production process, which compares input and output quantity levels and
their changes, and by means of the background variables and the rate of technical change.
A third interpretation is also possible: the background variables can be seen as sources of
variations in the production process, e.g. changes in the level of input factors can be
motivated by technological innovation or a change in the speed of construction can affect
both input use and output levels and thus the productivity of highway construction.
At least two different ways of calculating a measure of average cost efficiency have
appeared in the literature (e.g. Kim, 1985; Henshcr, 1989). The average cost measure is
highly meaningful to engineers and highway program managers, because highway cost
contracting is normally based on unit costs. In the first one, the average cost differential
is explained by differences in factor prices, scale effects, management variables and
technology. This measure places severe restrictions on the underlying production technol-
ogy as it assumes that there is only one output or that the different outputs are homoge-
neous and separable and thus that they can be aggregated. On the other hand, this
measure analyzes the change in average cost in the ideal situation of constant returns to
scale (CRTS). Neither of these assumptions hold in the road construction production
process.
The other measure seen in the transport literature has allowed for heterogeneous or
nonseparable outputs but has not relaxed the assumption of CRTS. In this formulation
average cost differential is also explained by differences in the growth rates of input
prices, scale economies, management variables and technology.
In the present paper, average cost differentials are calculated without setting the
severe restrictions on the underlying production technology found in the above two cases.
The average cost difference is explained by the input price, management and trend/
technical change effects. It differs from the TFP measure by the input price effect only.
Although this version relaxes the assumptions of homogenous outputs and constant re-
turns to scale, it has one severe disadvantage: the average cost measure does not reflect
explicitly the effect the firm gets from producing below (above) the optimum level, where
the average cost curve is above (below) the marginal cost curve and where economies
(diseconomies) of scale prevail.
Using the econometric cost function analysis of highway construction (which is de-
scribed briefly in the appendix), the accuracy of the technological change, which is ob-
tained as the residual or unexplained part of the above index numbers, can be easily
improved. By expressing the residual as the sum of the time derivative taken from the
empirically estimated cost function and a residual, a new factor, the unexplained technical
change, is obtained.
In addition to the derivative of the cost function with respect to time, the cost
elasticities of output and those with respect to management variables are obtained by
estimating empirically a translog cost function. These elasticities are used as weights in
the translog index number together with input cost shares.
 Analysis of productivity in highway construction 465

Translog cost function

The translog function is a flexible mathematical form, as it offers a second-order
approximation to an unknown production function. It is flexible because it places very
few a priori restrictions on the underlying production technology and because it charac-
terizes all the relevant properties of neoclassical production theory: economies of scale,
factor substitution and technological change. Due to the central role of this model, the
main results of that modeling exercise are reviewed briefly before presenting the empirical
results of the translog index number. The model itself is reviewed in the appendix.

The data
Finland’s TIEH, the source of the data in the study, consists of the central adminis-
tration and I3 highway regions. The central administration issues guidelines, prepares
policies, develops standards and handles negotiations and interface with the Ministry of
Transportation and the Parliament. The regions execute the program and policies. The
data consist of the regions’ annual time series data from 1978 to 1990 and a cross-section
of over 100 recently completed highway projects with project duration from I to 4 years.
These data were pooled together for estimation.
Because road construction can be viewed as acquiring, moving, disposing and treat-
ing materials, the volume of this work, measured in cubic meters, is defined as output.
To test for a multiproduct production process, four separate classes according to the
road width (s 6.5 m, 7-8.5 m, r 9 m and “other”) are specified to reflect the possibility
of four different production technologies. The output class labeled “other” includes small
projects for improving traffic safety, bicycle- or walkways, minor road side or rest area
projects and the like. _ -
The input prices include wages, capital service, haulage and material. Wages are
measured as a weighted average wage per hour of the regions’ construction and supervi-
sion labor. The price of capital service as well as that of haulage is a weighted average of
the prices paid for renting the necessary construction machines and equipment. The unit
price of material is obtained by dividing the material cost by the volume of the work.
There are three management variables over which the highway agency, or manage-
ment of a project, is considered to have control. The effects on costs of speed of construc-
tion, measured as cubic meters per number of projects in a given year, and of the
percentage of contract work give valuable information of past decisions and for future
planning. The fixed amount of labor is defined as the third management variable, which,
in the short run, is often beyond the management’s control. Several other variables were
investigated.

The maintained hypothesis

Hypothesis testing is a central part of model development. The translog mathemati-
cal form is a flexible tool because it allows the testing of several different underlying
production technologies from a nonhomothetic and nonjoint technology to the classical
Cobb-Douglas functional form, in addition to the conventional tests of input substitu-
tion, economies of scale and scope, separability and the nature of technical change.
In most econometric studies, data availability makes disaggregation of variables
impossible. A necessary condition for variable aggregation is separability of the elements
within the aggregate from those outside of it. In other words, separability implies that
marginal rates of transformation between pairs of factors to be aggregated are indepen-
dent of the levels of factors outside that group. Separability is a useful property that
makes multi-phase estimation possible and allows the handling of several variables. Sepa-
rability is also a necessary condition for decentralization and delegation of decision mak-
ing. The derivation and proofs of the parameter restrictions in testing for separability are
given in Denny et al. (1981).
In the maintained hypothesis, input prices are strongly separable from outputs and
management variables, but outputs are not separable from management. This has led
to biased technological change. With respect to factor share equations, the maintained
466 A. P. TALVITIE and C. SIKOW

hypothesis implies that the input cost shares depend only on the prices of other inputs
and trends but not on output levels or management variables.
This means, in practice, that decisions concerning outputs and management can be
made in the highway agency independently of the input market. It would be the concern
of the central administration to ensure competitiveness and free entry in the market for
factors of production. The cost elasticities of output and management variables needed
in calculating the TFP measure and the average cost measure can also be calculated from
the estimated cost function.

Empirical results: the estimated cost function

At the grand sample mean, the multi-product cost elasticity, derived by summing up
the individual cost elasticities, is 0.65, which indicates important economies of scale. The
measure of scale elasticity grows almost linearly with a region’s output volume: at 600,000
annual cubic meters e = 0.3; at 3,000,000 m’ r approaches 0.7. The optimum “firm size”
is about 4,000,OOOm3.
Scope economies measure the possible cost advantage associated with joint produc-
tion in a multi-product context (see Baumol [ 19771 and Baumol, Panzar and Willig [ 19833
for a more thorough discussion). The degree of scope economies for TIEH is -0.41 on
average. This indicates that joint production costs more than specialization to the produc-
tion of one output. One reason for this surprising result is that the regions’ actual product
mixes and the annual number of projects are stipulated by the legislature.
Management has an important bearing on costs. The average cost elasticity of the
speed of construction is -0.28. An increase in the speed of construction would reduce
costs in every highway region. The elasticity of cost with respect to percentage of contract
work is not intuitive: positive and very significant (0.98). The reason for this might be
that the fast increase in the share of contract work has not been followed by a similar
decrease in the regions’ own fixed labor, which has thus had a negative impact on total
cost. An increase of 1% in the fixed labor force raises total costs 0.88% on the average,
whereas the share of labor is only about 35% of the costs. A change in costs with respect
to the fixed amount of labor is thus elastic.
These properties of the cost function suggest that both economies of scale and
management are important in assessing cost efficiency and productivity growth in high-
way construction or in comparing technological advantages of the highway regions.

Empirical results: the translog index number

Tables 1, 2 and 3 show the results obtained by using the different definitions of
average cost (AC), and Fig. 1 plots the development of the different AC curves through-
out the 1980s. The results differ considerably, which shows clearly that assumptions
concerning output aggregation and homogeneity play a crucial role in every efficiency
analysis.
Examining first the AC with homogeneous outputs and CRTS, all years have a
higher level of efficiency or lower level of average cost than the base year, 1980. The
yearly changes are rather insignificant, and the average decrease in the AC is almost
-0.3%. The assumption of homogeneous outputs with constant returns to scale flattens
the differences between different years. This is the more striking when components affect-
ing the change in average cost are analyzed (Table I): scale effect shows huge variations
that do not seem to affect the average cost but are offset by technical change or, more
precisely, by its unexplained portion.
The AC assuming heterogeneous outputs with CRTS shows a declining trend in
efficiency or a steady increase in the average cost index, which is about 22% higher in
1990 than in 1980. The change in AC has been rather steady until 1986, and the latter
part of the 1980s shows a rapid decrease in the efficiency trend.
The AC that allows for heterogeneous outputs and non-CRTS follows quite closely
the AC with heterogeneous outputs with CRTS. The AC has an upward trend, being in
1990 almost 24% higher than in the base year 1980. The biggest difference between the
 Table I. Translog efficiency trend in highway construction, assuming homogeneous outputs and CRTS [equation (4))

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Average cost 100.00 99.66 99.34 99.24 99.78 99.74 98.70 99.66 99.23 99.56 99.10
AC difference from 1980 0.00 -0.34 -0.66 -0.76 -0.22 -0.26 - 1.30 -0.34 -0.77 -0.44 -0.90
AC diff. from previous year 0.00 -0.34 -0.32 -0.11 0.55 -0.04 -1.04 0.97 -0.43 0.33 -0.46
Difference in total cost 0.00 -5.71 2.96 3.60 -1.59 -4.87 13.90 18.62 21.46 34.05 39.43
Scale effect 0.00 -29.96 -63.88 -74.93 - 19.02 - 18.82 - 132.59 - 49.36 -91.66 - 72.08 - 117.86
Scale I (<6.5m) 0.00 -54.41 -40.64 -38.97 -6.31 -6.48 -7.85 -31.38 1.85 29.58 24.26
Scale 2 (7-8.5 m) 0.00 -0.29 2.58 -3.20 0.40 1.45 -11.93 - 11.72 -5.06 -2.22 5.41
Scale3(>9m) 0.00 5.89 2.90 -21.59 0.79 , 12.20 - 53.23 -42.02 -82.60 -115.99 - 137.35
Scale 4 (other) 0.00 21.84 - 28.72 -11.17 - 13.91 -25.99 -59.58 35.76 -5.85 16.55 - IO.18
Factor price difference 0.00 -3.06 2.46 2.41 2.01 1 ::: 6.11
I .49 2.14 2.56 a.37 7.89
Labor 0.00 1.16 2.51 3.73 4.05 5.80 7.42 8.90 10.79
Capital 0.00 -0.45 1.14 1.18 1.35 2.08 2.71 2.22 2.97 4.15 3.95
Haulage 0.00 0.84 1.36 1.69 I .76 2.61 3.33 3.80 3.34 5.46 5.97
Materials 0.00 -4.61 -2.55 -4.19 -5.15 -5.13 - 10.66 -9.68 -11.17 - 10.14 - 12.83
Management difference 0.00 -4.19 -0.37 -5.13 -5.73 -5.09 -11.09 -3.87 - 12.44 -22.78 -33.64
Speed of construction 0.00 -1.74 -1.79 -4.13 -3.89 -3.33 -11.87 -8.43 - 15.27 -22.81 -29.15
Share of contract work 0.00 1.16 4.69 5.48 9.22 10.42 14.62 18.50 20.33 21.46 22.13
Fixed manpower 0.00 -3.61 -3.27 -6.49 -11.06 -12.18 - 13.84 -13.94 - 17.49 -21.43 - 26.63
Technical difference 0.00 34.81 66.50 76.84 27.89 17.03 142.24 69.66 121.98 63.27 109.08
General technical change 0.00 - 10.30 -9.71 -9.86 -9.83 -9.81 - 10.60 - 10.36 - 10.48 - 10.40 - 10.91
Unexplained factor 0.00 45.11 76.20 86.70 37.72 26.84 152.84 80.02 132.46 73.67 119.99
Productivity 0.00 2.72 -3.11 -3.17 -2.23 -5.66 -2.79 -2.48 -3.33 -8.82 -8.78

*Constant returns to scale.

 Table 2. Translog efficiency trend in highway construction allowing for heterogeneous outputs but assuming CRTS* [q (S)]

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Average cost 100.00 90.26 99.90 97.98 98.20 97.17 100.47 110.96 110.79 123.45 122.66
AC difference from 1980 0.00 -9.74 -0.10 -2.02 -1.gO -2.83 0.47 10.96 10.79 23.45 22.66
Factor price difference 0.00 -3.06 2.46 2.41 2.01 s.40 1.49 2.14 2.56 8.37 7.89
Labor 0.00 1.16 2.51 3.73 4.05 583 6.11 5.80 7.42 8.90 10.79
Capital 0.00 -0.45 1.14 1.18 1.35 2.08 2.71 2.22 2.97 4.15 3.95
Haulage 0.84 1.36 I .69 I .76 2.61 3.33 3.80 3.34 546 5.97
Matcriafs 8:: -4.61 -2.55 -4.19 -5.15 -5.13 - 10.66 -9.68 -11.17 - 10.14 - 12.83
Productivity 0.00 -6.69 -2.56 -4.43 -3.81 -8.23 -1.02 8.82 8.24 15.08 14.78
Speed of construction 0.00 - 1.74 -1.79 -4.13 -3.89 -3.33 -11.87 -8.43 - 1527 -22.81 -29.15
Fixed manpower 0.00 -3.61 -3.27 -6.49 -11.06 - 12.18 - 13.84 - 13.94 - 17.49 -21.43 - 26.63
Share of contract work 0.00 1.16 4.69 5.48 9.22 10.42 14.62 18.50 20.33 21.46 22.13
Sum I 0.00 -4.19 -0.37 -5.13 -5.73 -5.09 -11.09 -3.87 - 12.44 -22.78 -33.64
Scale I(<65 m) 0.00 - 10.31 -7.07 -6.88 - 1.01 - 1.01 -1.22 -520 0.30 5.07 4.36
Scale 2 (7-9 m) 0.00 -0.21 1.85 -2.28 0.29 1.06 - 8.28 -8.57 -3.46 -1.44 3.23
!Scale3(>9m) 0.00 1.15 0.58 -4.70 0.16 2.41 - 13.78 -9.53 - 24.02 -42.36 - 59.43
scale 4 (other) 0.00 3.62 -5.16 -1.90 -2.15 -3.93 -9.78 3.90 -0.76 2.15 - 1.39
Sum 2 0.00 -5.74 -9.80 - 15.76 -2.71 -1.46 -33.06 - 19.39 -27.94 - 36.58 - 53.22
Technological difference 0.00 3.25 7.61 16.46 4.63 -1.68 43.14 32.08 48.62 74.44 101.64
General technical change -9.72 - 10.30 -9.71 -9.86 -9.83 -9.81 - 10.60 - 10.36 - 10.48 - 10.40 - 10.91
Unexplained factor 9.72 13.55 17.32 26.32 14.47 8.13 53.74 42.44 59.09 84.84 112.55

*Constant returns to scale.

 Table 3. Translog efficiency trend in highway construction allowing for heterogeneous outputs and non-CRTS* [eq (6)l

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Average cost 100.00 92.16 99.28 97.82 97.34 94.53 102.09 110.85 111.54 122.78 124.62
AC difference from 1980 0.00 -7.84 - 0.72 -2.18 -2.66 -5.47 2.09 10.85 11.54 22.78 24.62
AC diff. from previous year -7.84 7.73 -1.47 -0.49 -2.88 7.99 8.58 0.63 10.07 1.50
Total cost differena 8:: -5.71 2.% 3.60 -1.59 -4.87 13.90 18.62 21.46 34.05 39.43
Aggregate output 0.00 2.13 3.69 5.79 1.07 0.60 11.81 7.78 9.92 11.28 14.80
Output 1 (c 6.5 m) 0.00 3.82 2.66 2.53 0.40 0.41 0.44 2.08 -0.11 -1.56 -1.21
Output 2 (7-8.5 m) 0.00 0.08 -0.70 0.84 -0.12 -0.44 2.96 3.44 I .23 0.44 -0.90
Output 3 (>9 m) 0.00 - 0.43 -0.22 1.73 -0.06 -0.98 4.92 3.82 8.53 13.06 16.53
Output 4 (other) 0.00 -1.34 1.94 0.70 0.g5 1.60 3.49 - 1.57 0.27 -0.66 0.39
Factor price difference 0.00 -3.06 2.46 2.41 2.01 5.40 1.49 2.14 2.56 8.37 7.89
Labor 0.00 1.16 2.51 3.73 4.05 5.83 6.11 5.80 7.42 8.90 10.79
Capital 0.00 -0.45 1.14 1.18 1.35 2.08 2.71 2.22 2.97 4.15 3.95
Haulage 0.00 0.84 1.36 1.69 1.76 2.61 3.33 3.80 3.34 5.46 5.97
Materials 0.00 -4.61 -2.55 -4.19 -5.15 -5.13 - 10.66 - 9.68 -11.17 - 10.14 - 12.83
Productivity 0.00 -4.79 -3.18 -4.59 -4.67 - 10.87 0.60 8.71 8.98 14.40 16.74
Change in input quantities 0.00 -2.66 0.51 1.20 -3.60 - 10.27 12.41 16.48 18.90 25.68 31.54
Change in output quantities 0.00 2.13 3.69 5.79 1.07 0.60 11.81 7.78 9.92 11.28 14.80
Management difference 0.00 -4.19 -0.37 -5.13 -5.73 -5.09 -11.09 -3.87 - 12.44 - 22.78 -33.64
Speed of construction 0.00 -1.74 -1.79 -4.13 -3.89 - 3.33 -11.87 - 8.43 - 15.27 -22.81 -29.15
Share of contract work 0.00 1.16 4.69 5.48 9.22 10.42 14.62 18.50 20.33 21.46 22.13
Fixed manpower 0.00 -3.61 -3.27 - 6.49 -11.06 -12.18 - 13.84 - 13.94 - 17.49 -21.43 - 26.63
Technical difference 0.00 -0.60 -2.81 0.55 1.06 -5.78 11.69 12.58 21.42 37.18 SO.38
General technical change -9.72 - 10.30 -9.71 -9.86 -9.83 -9.81 - 10.60 - 10.36 - 10.48 - 10.40 - 10.91
Unexplained factor 9.72 9.70 6.90 10.41 10.90 4.03 22.29 22.94 31.90 47.58 61.29

*Constant returns to scale.

470 A. P. TALVITIE and C. SIKOW

-15 1 I I I I I I 1 I 1 I I

1980 1901 1902 1983 1984 7985 1906 1987 1980 1989 1990

Fig. I. Average cost (AC) measures (deviation from 100); 0 = AC with homogeneous outputs and CRTS
(constant returns to scale) [eqn (4)j. +- = AC with heterogeneous outputs and CRTS [eqn (S)]. 0 = AC with
he:erogencous outputs and non-CRTS [qn (a)].

two average cost measures seems to occur before 1986, the AC assuming CRTS showing
slightly less positive development than that allowing for non-CRTS.
More interesting in the preceding results is the information concerning the reasons
for changes in the average cost efficiency. Changes in factor prices and management
variables are the same for the three definitions, and thus their effects on average cost are
analyzed first. Although the input price effect has been relatively small, it is seen that
only the price of materials-chiefly, the price of oil-has declined and that the price of
labor has shown the greatest and steadiest increase. The prices of capital and haulage
inputs have shown more moderate increases. In sum, the input prices have pushed the
construction costs up by almost 8% since 1980. This small overall impact seems to imply
rather rigid real input prices.
The total effect of the three management variables-speed of construction, percent-
age of contract work and amount of fixed labor-has been positive throughout the
decade, decreasing the average cost by almost -33% in 1990 compared to 1980. The
effect of speed of construction, as well as that of the amount of the fixed labor, has had
a substantial and positive effect on cost. This outcome agrees with the management
policy of building a few projects fast, and it states clearly that the reduction of TIEH’s
own permanent construction work force has been efficient. This positive result has been
somewhat offset by a negative impact of the share of contract work, which was expected
as the cost elasticity of the variable was already against intuition.
All the practical evidence, however, speaks for the positive effects of increasing the
share of contract work. In another study (RWA, 1986). the total advantage of contracting
was calculated to be atmost 30,000,OOOmarks (7,SOO,OOOUS%) in 1989. As contracting is
based on strict competition, it should have a decreasing impact on average cost. It seems
that the variable acts as a proxy to another, unknown phenomenon.
The measure for “pure” technical change, derived from the empirically estimated
translog cost function, shows that there has been a steady and positive development’in
the highway construction technology through the 1980s. decreasing the AC Ievel about
10% p.a. However, the unexplained portion of the index number measure is very large,
 Analysis of productivityin highwayconstruction 471

causing average cost to increase, and it fluctuates strongly in each model version. This
indicates that it is unlikely that the residual is strictly of technical origin but derives from
managerial, environmental and institutional sources and from the definition of output.
To check for these, several output characteristics were tested in the estimation of the cost
function-percentage of urban construction, percentage of reconstruction/rehabilitation,
etc., but their effect was not statistically significant. It is evident that more research is
needed to clarify this point.
Another plausible source for the growth of the unexplained portion of technical
change is the definition of output. This interpretation is suggested by the results in Table
4 and Fig. 2, which contains the 1990 comparative performance of the highway regions.
Substantial efficiency disadvantages, both average cost and productivity differences, are
recorded precisely in those regions where several (urban) motorway projects had been
started in the last two years (regions 1, 2 and 4). On one hand, economies of scale are
provided by the ongoing projects but, on the other hand, productivity or technical prog-
ress is hindered by the preliminary or completion works on the sites where much labor is
consumed but only little earth is moved.
The different total factor productivity measures are plotted in Fig. 3. Assuming
homogeneous outputs and CRTS, the development of the TFP is very positive throughout
the decade, the productivity in 1990 being almost 9% better than in 1980. The develop-
ment of the TFP is very different when the assumption of homogeneous outputs is
relaxed. Allowing for heterogeneous outputs but assuming CRTS, the development of
the TFP is positive until 1985 and negative since then; the TFP has worsened almost
- 15% from 1980 to 1990. When the assumption of CRTS is further relaxed, TFP shows
a steeper declining trend, being - 17% worse in 1990 compared to 1980.
The sources for the evolution of productivity seem to vary according to which model
specification is selected. Assuming homogeneous outputs and CRTS, the positive trend
comes from important economies of scale that offset the negative impact of technological
change. Allowing for heterogeneous outputs but assuming CRTS, the scale benefits are
not enough to compensate for the negative impact of technical change. Allowing for
heterogeneous outputs and non-CRTS, the unfavorable development of technology seems
to be due to negative technical change or to the quantities of inputs increasing faster than
the quantities of outputs.
The most significant difference in addition to the variations in average cost comes
from the output or scale effect, as expected. When homogeneous outputs and CRTS are
assumed (Table I), there are huge but unsteady scale economies throughout the 198Os,
reaching a maximum in 1986 (- 133%). However, the economies of scale are offset by
an opposite effect in the unexplained portion of technical change. This implies that
assumptions of homogeneous and thus aggregative outputs having constant returns to
scale cannot be maintained in highway construction technology.
When analyzing Tables 2 and 3, it has to be kept in mind that Table 2 presents scale
effects, whereas Table 3 shows differences in output quantities. Thus a negative figure in
Table 2 implies decreasing average cost due to scale benefits, whereas it has the opposite
meaning in Table 3, where a negative figure implies smaller output quantities or an
increase in average cost. These two models give quite similar results. It seems that the
output weights that scale the cost elasticities to sum to unity do not worsen the results
noticeably.

“Technological gap”
Figure 1 shows clearly that until 1985 the three AC measures differed only slightly,
whereas since 1986 the difference between the average cost measure, assuming homoge-
neous outputs and CRTS and the two other curves, has become larger every year. This
difference is called “technological gap.”
The curve assuming homogeneous outputs and CRTS shows how the performance
of TIEH has developed with the prevailing technology and without taking the increasing
economies of scale into account. On the other hand, when the assumption of homoge-
neous outputs and CRTS is relaxed, the true economic performance of TIEH is obtained
 Table 4. Translog efficiency comparison between districts in 1990 AC*. allowing for heterogeneous outputs and non-CRTSt [eqn (6)]

1990 District no. I 2: 4 5 6 7 8 9 10 I1 12 13 14

Average cost 156.42 142.76 139.09 66.44 60.75 44.03 56.66 94.73 110.26 5.91 99.97 66.84 98.34
Difference from 100 56.42 42.76 39.09 -33.56 - 39.25 -55.97 -43.34 -5.27 10.26 -94.09 -0.03 -33.16 -1.66
Total cost difference 92.14 41.98 59.13 -53.52 -51.21 - 100.60 - 16.51 - 0.05 8.17 -111.72 -28.06 -65.13 -1.14
Difference in agg. output 36.33 5.22 20.05 - 19.96 -II.% -44.64 26.83 5.21 -2.09 - 17.62 -28.03 -31.97 0.51
Output l(c6.5 m) 0.00 1.97 0.00 -4.63 -0.38 -1.05 2.80 0.00 -4.28 -1.20 0.00 9.81 4.07
Output 2 (7-9 m) 8.05 6.58 0.06 -8.90 -7.88 -11.21 L 8.41 6.47 15.10 -17.17 7.04 - 15.25 4.81
Output 3 (>9 m) 24.39 -3.24 16.90 -6.72 -7.32 -32.04 14.88 0.09 - 12.56 0.00 - 34.88 -27.53 -8.31
Output 4 (other) 3.89 -0.09 3.09 0.28 3.62 -0.34 0.73 -1.35 -0.34 0.75 -0.19 1.00 -0.05
Factor price difference 9.32 8.87 - 22.45 -2.40 - 17.64 -6.97 - 17.85 1.74 -4.15 5.92 -9.64 8.98 5.34
Labor -4.71 1.50 6.33 -0.21 3.83 -4.79 4.86 -0.52 -4.68 0.80 - 1.62 -5.42 8.78
Capital 3.49 -0.26 -3.66 -2.28 -3.28 -5.12 -2.68 0.79 -3.52 -4.12 0.03 0.96 4.01
2
N Haulage 4.51 -3.38 -3.33 -1.71 -5.20 1.20 - 1.76 - 2.05 -4.44 -5.79 -2.59 1.24 -0.18
Materials 6.03 11.00 -21.79 1.80 - 12.99 I .74 - 18.27 3.53 8.50 15.04’ -5.46 12.20 -7.34
hlanagement difference 71.38 20.08 46.42 - 22.49 -11.09 - 36.85 1.22 -2.12 14.20 -61.07 -29.75 - 50.47 24.29
Speed of construcGon 15.88 I .86 2.61 -2.04 -0.63 0.29 11.27 -0.05 8.64 3.41 0.58 -0.94 -0.70
Share of contract work -3.50 1.51 9.32 -0.17 4.70 - 10.10 2.07 3.23 -6.24 -7.26 1.47 - 17.88 -5.73
Fixed manpower 59.01 16.71 34.42 - 20.28 - 15.17 - 27.03 - 12.12 -5.30 II.79 -57.21 -31.80 -31.65 30.71
Technical difference -24.29 13.82 15.12 -8.67 - 10.52 - 12.15 - 26.71 -4.89 0.20 -38.94 39.35 8.33 -31.28
General technical change -5.66 -5.22 - 10.32 -6.53 -8.70 -6.59 -9.79 -6.05 -5.07 -4.74 -7.20 -4.68 -8.28
Unexplained factor - 18.63 19.04 25.44 -2.14 -1.82 -5.56 - 16.92 1.16 5.27 - 34.20 46.55 13.01 -23.01
Productivity 47.09 33.89 61.54 -31.16 -21.61 -49.00 -25.49 -7.01 14.40 - 100.01 9.60 -42.14 -6.99
Diff. in input quantities 83.42 39.12 81.58 -51.12 -33.57 -93.64 1.34 -1.80 12.32 -117.63 - 18.43 -74.11 -6.48
Diff. in output quantities 36.33 5.22 20.05 - 19.96 -11.96 -44.64 26.83 5.21 -2.09 - 17.62 -28.03 -31.97 0.51

*Average cost.
tconstant returns to scale.
$For historical reasons, there is no district number 3.
 Analysis of productivity in highway construction

60

so
40

30

20

10

-10

-20

-30

-40

-50

-60

-70

-80

-90

- 100
-110 1 I I 1 ,
OIU 04H
1 OQM 08Ku dv 110 14L
OT OSKy 07 K 09 s ‘II P 13 n

Avenge cost I P&u&vity Technical diff. I

Fig. 2. Translog efficiency comparison between districts in 1990 AC (average cost), allowing for heterogeneous
outputs and non-CRTS (constant returns IO scale).

16

16

14

12

10

-2

-4

._
ISRO 1981 1982 1903 1984 1905 1906 1907 7988 1989 1990

Fig. 3. Total factor productivity (VP) indexes (deviation from 100); 0 = TPP with homogeneous outputs
and CRTS (constant returns to scale), + = TFP with heterogeneous outputs and CRTS, 0 = TFP with
heterogeneous outputs and non-CRTS.
474 A. P. TALVlTtE and C. SlKOW

when the technological aspects, especially scale economies, are accounted for. The gap
between these curves shows that it has not been possible to benefit from the technological
possibilities in road construction.
In other words, TIEH has not been able to reach the optimum output level because its
marginal cost curve is about the average cost curve due to increasing scale economies. When
the average cost is analyzed, ignoring the scale economies, the development seems good
because the average cost is steadily decreasing. But in economic terms, output ought to have
been increased until the optimum is reached where marginal cost equals average cost.
There are certainly several reasons for the steadily increasing technological gap. It is
quite possible that when the road construction monies began an upward trend after
several strict years, the production technology was not adapted to take into account the
economies of scale effect or the advantages of smooth and rapid construction and the
possibilities offered by contracting. The size and the growing trend of the unexplained
technical change indicate that the reason for TIEH’s worsening performance is due
more to other factors than the traditional input prices or even the chosen management
variables.
Although the share of contract work increased steadily throughout the 1980s. three
years (1986, 1987 and 1989) witnessed an increase in the absolute amount of in-house
monies and a steep decline in efficiency (AC with heterogeneous outputs and non-CRTS:
8, 8 and lo%, with respect to the previous year). It seems evident that the share of
contract work variable does not wholly catch the complex effects of the shifting from
in-house work to bidding and competitive markets and that it acts as a proxy for an
unknown factor. As the efficiency index decreases with increases in in-house work, it
would be interesting to use it as a variable. Other important factors to test for would be
the average size of a contract, indicating the roles of different contracting policies-
several small and partial vs global contracts-on regions’ efficiency performances.
When the distribution of the construction monies is analyzed further, it can be
noticed that the increasing trend in the overall monies is accompanied by an increase in
the level of fixed or joint costs (management, office work, etc.). This is a clear sign of
the difficulties in adopting the production technology to take into account the economies
of scale. One of the reasons for this is the average project size and the speed of construc-
tion, which have remained the same.
A shift in the production function could be one of the explanations behind the sharp
decrease in efficiency since 1986. Since then the project composition has changed, with
more emphasis being placed on investments in main roads instead of on technologically
“easier” local roads. Higher quality standards and a more sophisticated technology are
bound to increase average cost at the expense of efficiency. The considerable efficiency
differences between construction regions might be due partly to differences in production
technology: the three big southern regions (1, 2 and 4) have invested in increasing their
highway capacity, both motorways and complex urban projects, whereas the small dis-
tricts have more gravel road construction.

CONCLUSIONS

The paper has investigated the implications on cost efficiency and TFP of alternative
specifications of average cost. Particular consideration was given to definitions of output.
The problem with the definition of output is not so much the cubic meters but the period
of the measurement. It would be useful in future studies to estimate the cost function
with data on a project basis instead of the yearly basis so as to eliminate the project-phase
problem and permit a better definition of many variables. Problems caused by the near
zero elements in the output vector can be handled by the Box-Cox transformation (see
Harmatuck, 1981). Aggregation of the cubic meters by road width classes could be re-
placed by road width to account for the multi-product nature of highway construction.
The effect of the rigidity of the quantity of own labor force should also be checked by
estimating a short-run cost function with one fixed input (see Caves, Christensen, Trethe-
way and Windle, 1986).
 Analysis of productivity in highway construction 475

Output characteristics, attitudes toward contract size and the practice of bidding-
including methods vs end product specification contracting-should be incorporated into
the model. The key is understanding the contracting and construction processes and the
effects of institutional arrangements on them so that appropriate data can be collected.
Often understanding comes -as in the present case- in interpreting the results. It is too
late for data collection, but it is not often that one is praised by the field personnel when
asking them to gather data.
The multi-product nature of the highway agency is likely to prevail. It may be
possible to achieve an equally good statistical fit by using only one aggregate output and
region-specific dummy variables. But this choice would ascribe to regional differences
those effects that actually are the result of management’s actions to compose the output
vector in a particular way. In the present research it was opted to forgo a consistent
output aggregate and gain the insight to highway production process by increased compli-
cation, a conscious choice.
In brief the results showed that improved model specification is desirable. Not unlike
other econometric models, too much of the explanation is in the unexplained, unobserved
factors. One way for improved model specification is through discussions with experi-
enced engineers and bureaucrats in a nonstructured forum where all kinds of thoughts
and feelings, positive and negative, are permitted. Concerns regarding data quality can
be addressed at the same time. Improved understanding is also needed in defining output,
especially in urban areas, and how different governmental rules, budget constraints,
management procedures and design specifications affect experimentation, development
and employment of new techniques or materials.
A seemingly fruitful way to address these issues would be with disaggregate, project-
specific data. With project-specific data; variables describing timing, design, technology,
materials, contract type, output, etc., can be more easily defined, and questions not
analyzable with aggregate data can be addressed. The use of aggregate data cannot,
however, be abandoned. A most useful property of the present model is the information
it gives on the structure of the organization, scale and scope economies and the multi-
product nature of highway construction.
The research reported in this paper has been useful to the sponsoring agency in
several ways. First, it gives quantitative information on the agency’s highway construction
program. The value of this rich information is proved by experience because it has served
a useful -although often disputed -information base for discussions and for effecting
change.
Second, the results significantly affected the structuring of the highway regions’
output vector. Very early it became apparent that excess laborers and the slow speed of
construction with many ongoing projects were detrimental to the highway regions’ effi-
ciency in using their scarce monies. Economies of scale and scope got added meaning and
relevance.
Third, the value of competition in the market was clarified; new and novel means of
competing suppliers of equipment, materials and haulers against each other were tried;
even the government regulations became affected. Fourth, and this is of great interest,
the importance of management and institutional arrangements on costs was clearly dem-
onstrated and will impact the administration’s future organization. Fifth, the complex
issues of technical change and output characteristics are very important and require much
more research.
It may seem odd to conclude that the measurement of productivity is not impor-
tant - the study of it is. It is important to ensure that free competition- free entry to
market and freedom to use factors of production the best way-exists in the market.
That ensured, the market takes care of productivity automatically, provided the institu-
tions that are the market makers are not preventing the development and employment of
efficient technologies.
An analysis of these issues for trying to understand relationships between productiv-
ity, efficiency and institutional structure is greatly assisted by econometric estimation of
the cost function. The focus of the analysis, however, must be shifted away from the
476 A. P. TALVIT~E and C. Slrow

traditional price orientation on transaction costs: what is the management environment;

why is one organization better than another; what is the role of the management, what of
technology, what of the managers themselves?
Finally, the model is not an automaton: it does not tell what should be done and
what course should be followed. But it does compel the manager and the administrator
to think and direct attention to issues and problems that might have been ignored or
neglected in the past.

REFERENCES

Baumol W. J. (1977) On the proper cost tests for natural monopoly in a multiproduct industry. Am. Econ.
Rev., 67. 809-822.
Baumol W. J.. Panzar J. C. and Willig R. D. (1982) ConfesrobleMarkets and the Theoryof Indusfry Swucture.
Harcourt Brace Jovanovich, New York.
Caves D., Christensen L. and Swanson J. (1980) Productivity in U.S. railroads: 1951-1974. Be//J. Econ.. 1,
166-181.
Caves D. W.. Christensen L. R., Tretheway M. W. and Windle R. J. (1986) Network effects and the measure-
ment of returns to scale and density for U.S. railroads. In A. F. Daughety (Ed.), Anulyficul Sfudies in
Transport Economics, Cambridge University Press, Cambridge, pp. 97-120.
Cowing T. G. and Stevenson R. E., Eds. (1981) Productivity Measurement in Regulated Industries. Academic
Press, New York.
Denny M., Fuss M. and May J. D. (1981) Intertemporal changes in regional productivity in Canadian manufac-
turing. Gun. J. Econ.. XIV. 390-408.
Diewert D. E. (1976) Exact and superlative index numbers. J. Economefrics, 4. 146-155.
Fuss M. and McFadden D.. Eds. (1978) Production Economics: A Dual Approach to Theory and Applications.
North Holland, Amsterdam.
Harmatuck D. J. (1981) A motor carrier joint cost function; a flexible functional form with activity prices. J.
Tffmsp. Econ. PO/., 15(2), 135-153.
Hensher D. A. (1987) Productive efficiency and ownership of urban bus services. Trunsportution, 14,209-225.
Hensher D. A. (1989) foral factor productivity of public transit services: Australia 1980-1987. Proceedings of
rhe Fi/rh World Conjerence on Transporf Reseurch. Vol. 111, Yokohama, Japan, pp. 817-28.
Jorgenson D. W. and Nishimizu M. (1978) U.S. and Japanese economic growth 1952-1974; an international
comparison. Am. Econ. J.. 88.707-726.
Keeler T. E. and Small K. (1977) Optimal peak-load pricing, investment, and service levels in urban expressways,
J. Pot. Econ.. 85, l-25.
Kim Moshe (198S)Total factor productivity in bus transport. J. Transp. Econ. PO/., 19, 173-183.
Meyer J., Kain J. and Wohl M. (1965) The Urbun TrrmJsportalion Problem. Harvard University Press, Cam-
bridge, MA.
Obeng K. (1985) Bus transit cost productivity and factor substitution. J. Trunsp. Econ. Pal, 19. 183-203.
RWA/Projektikonsultit (1986) Optimal Duration and Implementation of Highway Projects, Helsinki (in
Finnish).
Talvitie A. and Sikow C. (1989) Econometric analysis of highway construction technology. Proceedings o/the
Fifrh World Conyerence on Trunsporr Reseurch. Vol. Ill. Yokohama, Japan, pp. B69-84.

APPENDIX

The rranslog index

It is assumed that the highway production process can be described by a cost function of the following
form:

C = g(W,, Q,.
4. T, Q).

where C ( = EWJ,) is the total cost of production, W, a vector of input prices, X, a vector of input quantities,
Q, a vector of outputs, M, a vector of management variables, T the binary time variable or a proxy for
technology and D, a vector of dummy variables to specify geographic regions.
Total differentiation of the logarithm of the cost function with respect to time yields (see Diewert [I9761
for a more thorough discussion).

dInE a In g d In W, +z:alngdlnQ,+EdIng dInM,+

dT aIn a In Q, dT a In M, dT

A change in total cost is explained by the growth rates of input prices. output levels, the differences in
management variables, the shifts in the cost function and the regional effect.
In infertemporal comparisons the regional effect ((13 In g/a D,)IdD,/dT]) becomes zero. Likewise, in
calculating efficiency differences between highway regions in a given year, the time effect (b In g/aT) is zero.
In the following the derivation of the different intertemporal efficiency measures is shown: the derivation of
the cross-efficiency measures is straightforward.
Perfect competition is assumed to prevail in factor markets; thus, using Shephard’s lemma, the cost-
minimizing input levels, s,. can be derived:
 Analysis of productivity in highway construction 4n

& - &WI _--- ac WI a In c

c aw, c =a
By denoting the inverse of the scale economics or the cost elasticity of outputs as l
, = b In C/d In Q, and the
cost elasticity of the management variables as m, = a ln C/d ln M.. qn (2) can be simplified:

dIn& d In W, + &d ln Q, + Lm d In Mb a In g
ti-+-$
dT ’ dT ’ dT dT

From the above equation, the effect of time on the change in total cost is calculated as the residual or
unexplained total cost difference as follows:

-I--
a In g d In C =d In W, &d ln Q, _ Cm d In ML
w
aT dT ‘dT_ I dT tdT’

Total factor productivity

Total factor productivity (TFP) has been defined in the economic literature as the ratio of change in
aggregated outputs to change in aggregated inputs. Using the cost function of the present study, the TFP
becomes

1
_ Cm d In Mb a In g &d In W,
kdT+- (6)
at 1 IdT-

_ EmdInMI --d
+a 1=& In9, &jd = -TFP.
‘--ii7 ar ’ dT ’ dT

The TFP measure differs from the time effect only by the management variables effect. Equation (6)
enables analysis of the changes in TFP from two different angles: the production process. which compares
input and output quantity levels and their changes, and the background variables, i.e. the differences in the
management factors and the rate of technical change. A third interpretation is also possible: the background
variables can be seen as the sources of variations in the production process, e.g. changes in the level of input
factors can be motivated by a technological innovation, or a change in the speed of construction can affect
both input USCand output levels and thus the productivity development of highway construction.

Average cost differential

There have been at least two different ways of calculating a measure of average cost efficiency in the
literature (e.g. Kim, 1985; Hcnshcr, 1989). In the first one, the average cost measure is obtained by subtracting
L(d In Q, / dT) from both sides:

+ Ed ln QI=I
d In C
AC r -
df dT

Dd In W, d In Q, + Cm d In M, a In g
+ C(e, - I) by+-.
’ dT dT dT

This measure places severe restrictions on the underlying production technology: there is only one output or the
different outputs are homogeneous and separable and thus they can be aggregated, and constant returns 10
scale are assumed.
The other measure seen in the transport literature has allowed for heterogeneous or nonseparable outputs
but has not relaxed the assumption of constant returns to scale:

AC=--
d In C r: e, d ln Q,
dT b, dT =

Bd In W,
,dT + je, - +-I[” t>] + Em,? + +.

In this paper, average cost differentials are calculated without setting these severe restrictions on the underlying
production technology:

d In C
AC=-- Led -_
dT ’ dT

Dd In W, + Lm d In M, a In g
tdT+-.
’ dT dT

Unexplained technical change

Using the econometrically estimated cost function, the accuracy of the technological change, which is
obtained as the residual or unexplained part of the above index numbers, can be easily improved. By expressing
the residual as the sum of the time derivaiivc taken from the empirically estimated cost function and a residual
la(S) 26:6-E
478 A. P. TALVIT~E and C. SIKOW

(z). a new factor, the unexplained technical change, is obtained. Equation (9) can be written in the following
form:

-_
d In C &d ‘n QI = (10)
dT ’ df

&d In W, + ~:m d In MI a In g
ky+-+t.
’ dT aT

Translog cost function

The translog function is a flexible mathematical form, a second-order approximation of an unknown
production function. It is flexible because it places very few u priori restrictions on the underlying production
technology and because it characterizes all the relevant properties of neoclassical production theory: economies
of scale, factor substitution and technological change.
Using the notation defined above, the translog cost function has the following general form:

In C = g (In W,, In Q,. In M,. In 7. D,)

= % + 61, In W, + Eb, In Q, + EC, In hfk

+ f(EEd, In W, In W, + LEe, In Q, In Q, + EEJ,, In M, In M,) (‘1)

+ EEg,, In Wt In Q, + EEh,, In W, In M, + EEm,~ In Q, In M,

+ nr In T + fn,(ln 77’ + Ep,r In W, In T + U,D, + t.

The symmetry conditions (d, = d,,. e, = e,, and/,, = /,) and the homogeneity restrictions (Ea, = I and E,d,, =
Es” = Ekh,k = Ep,r = OVi) are imposed.
The input cost-share equations, obtained by Shephard’s lemma, are

s, = u, + Cd, In W, + &g, In Q, + Eh,, In M, + p,r In T. (12)

The translog total cost function [eqn (I I)] was estimated jointly with the cost-share equations [equation (12)j
less one using Zcllner’s seemingly unrelated regression technique.

The maintained hypothesis

A necessary condition for variable aggregation is separability of the elements within the aggregate from
those outside of it. Separability implies that marginal rates of transformation between pairs of factors to be
aggregated are independent of the levels of factors outside that group, or mathematically

auax
a MRTg = 0, where MRT, = 2. (13)
ax, auax,
In the maintained hypothesis. obtained through statistical hypothesis testing, input prices are strongly
separable from outputs and management variables, but outputs are not separable from management. The cost
function is reduced to the form

In C = f (In W,) + g (In Q,. In M,) =

u. + CO, In W, + Cb, In Q, + Cc, In M, + (14)

i(EZd, In W, In W, + EEe,, In Q, In Q, + E&J,, In ML In M,) +

EEm,, In Q, In M, + nr In T + in rr (In r)* + Ep,r In W, In T + c.

The maintained hypothesis implies that the input cost shares depend only on the prices of other inputs and
trends but not on output levels or management variables:

s, = u, + Ed,, In tV, + p,r In 7. (1%

The cost elasticities of output and management variables, respectively. are

a In c
Q,= -a InQj = b, + Ee, In Q, + Cm,, In M,

a In C
m, = - = q + Elk:/,,In M, + Em,, In Q,.
a In M,