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Abstract

This paper critically investigates standard total factor productivity (TFP) measurement in the public sector, where output information is often incomplete or distorted. The analysis reveals fundamental paradoxes under three common output measurement conventions. When cost-based value added is used as the aggregate output, measured TFP may paradoxically decline as a result of genuine productivity-enhancing changes such as technical progress and improved allocative and scale efficiencies, as well as reductions in real input prices. We show that the same problems carry over to the situation where the aggregate output is constructed as the cost-share weighted index of outputs. In the case of distorted output prices, measured TFP may move independently of any productivity changes and instead reflect shifts in pricing mechanisms. Using empirical illustrations from the United Kingdom and Finland, we demonstrate that such distortions are not merely theoretical but are embedded in widely used public productivity statistics. We argue that public sector TFP measurement requires a shift away from cost-based aggregation of outputs and toward non-market valuation methods grounded in economic theory.