Production Efficiency

The most striking thing about modern industry is that it requires so much and accomplishes so little. Modern industry seems to be inefficient to a degree that surpasses one's ordinary powers of imagination. Its inefficiency therefore remains unnoticed.

This jarring passage is from E.F. Schumacher's Small is Beautiful.1

Schumacher's defends this statement by noting that the world's most advanced industrial economy, the United States, uses enormous quantities of resources for relatively unimpressive human results:

An industrial system which uses forty per cent of the world's primary resources to supply less than six per cent of the world's population could be called efficient only if it obtained strikingly successful results in terms of human happiness, well-being, culture, peace, and harmony. I do not need to dwell on the fact that the American system fails to do this.2

One can debate the degree to which the United States is successful in human terms, but Schumacher's main point is indisputable: the efficiency of industry must be measured, at least in part, by its human results in relation to the inputs it requires.

To be analytically useful, however, his sweeping claims must be converted into well-defined statements. The issue here is not the efficiency of "an industrial system", but of production itself, and specifically the production of a final output.

Similarly, the human results cannot include the non-economic issues of happiness and peace, but must focus on health exclusively.

Finally, the production stage of a final output cannot be held accountable for inefficiencies elsewhere in the output life cycle.

A factory, for example, cannot be blamed if the social act of distribution channels the bulk of its outputs to those who have already reached satiation.

With these caveats clearly stated, we can proceed.

To identify the restricted responsibilities of the economy’s production phase, ENL uses the concept of potential gains. This is the difference between a final output's potential value (PV) and the input cost (IC) incurred during its production, at the quantity specified by the allocation decision:

Potential gains = PV - IC

Effectual value is absent here because this is beyond the purview of production activities.

Similarly, the input cost used in this context is not the life-cycle input cost, which is too broad to attribute entirely to production, but the input cost incurred during the production phase itself. This excludes the natural cost and labor cost associated with resource extraction, consumption, maintenance, and disposal.

Finally, potential value refers to delivered potential value, which is what remains after the output loss caused by transportation to the sphere of consumption has been subtracted. The reference here is to the first “leak” in the pipeline of effectual value.

With this definition in place, it can be stated that a production process should strive to maximize the potential gains of its output while minimizing the quantity of its required inputs.

Production efficiency (Ep) measures the degree to which this is successful, and is thus defined as the ratio between potential gains and input quantity (Qi). That is:

Ep = Potential gains/Input quantity

Ep =(PV-IC)/Qi

For generality, input quantity can refer to a single input, such as hours of software programming, or to a combination of inputs, such as days of construction labor plus the use of a backhoe.

Input quantity is the correct denominator here because a decrease in production resources is in most cases conducive to greater overall health.

If input quantity is reduced for a specific production process, a promising choice opens up for those making allocation decisions: they can leave the input quantity unchanged, thereby increasing output quantity, or they can reduce input quantity and redirect the unused inputs to the production of different outputs.

If neither option will increase health, the inputs can be left unused. For natural resources this could mean a reduction in environmental damage, while for labor it could mean a welcome shortening of the work-day.

Because the definition of production efficiency includes potential value, the measure can be applied either to a final output or to a sequence of production stages that results in a final output. If the analyst wants to judge the production of any other part of the output life cycle, potential value is not available and production efficiency cannot be determined.

To use an earlier example, the production of jet fuel results in an intermediate output that is required for the utilization of airplanes. The potential value resides in the airplane, however, and not in the fuel it utilizes. In all such cases, production can be judged only by input cost and by labor productivity.

There is an important dimensional difference between allocation efficiency and production efficiency. Allocation efficiency is a pure number expressed as a percentage, which means that all such efficiencies are commensurable. Production efficiency, however, is a ratio of mixed dimensions: health divided by the quantity of an input or input mix.

This means that production efficiencies are incommensurable unless the input mix is substantially the same.

It is possible, for example, to compare the production efficiencies of several three-worker construction crews if they all use nail guns and electric saws. However, it is impossible to compare production efficiencies between such a crew and one that uses six workers but avoids automated tools.

This incommensurability is unfortunate, but it is inevitable for a logic that dispenses with the money measure and focuses instead on the concrete realities of humankind and nature. This problem also arises when dealing with an economy’s total outputs.

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