PROBLEM AND METHODOLOGY

2.1 Introduction :

This chapter on problem and methodology of the study is categorized into

various sections. Section 2.2 provides the Statement of the problem. The
objectives of the study is presented in Section 2.3. Description of the study area
is given in Section 2.4. Mention is made of the methodology of the study in
Section 2.5 which includes the theoretical framework of the study in Section
2.5.1. Section 2.5.2 relates to computation of growth rates for time-series data.
The Stochastic frontier production function for Technical efficiency using
time-series data is presented in Section 2.5.3. In Section 2.5.4 the Stochastic
frontier production function for Technical efficiency using panel data is given.
The Malmquist productivity index for panel data is mentioned in Section 2.5.5.
The various limitations of the study are listed in Section 2.6.

2.2 Statement of the Problem :

The first comprehensive economic reform policy statement was formulated for
India in July 1991, in the form of industrial and trade sector liberalization. The
economic reforms of the 1990’s which strengthened the process of
liberalization, privatization and globalization in the country have brought new
opportunities and challenges before food processors through a competitive
market environment. To meet the emerging demand for processed food
products, it is imperative to capture the huge and exponentially growing food
market in India, by adopting sophisticated technology in food processing for
competitive success and survival. An analysis of productivity and efficiency
changes in the food processing industry in India during pre-liberalization and
post-liberalization periods is essential.

As the major economic reforms in the country took place during the 1990’s, a
comparison of productivity and resource-use efficiency between the pre- and
  15

post-reform periods across the food processing sector provides practical

insights on technical and managerial issues for policy makers, food processors
and researchers in the changing market environment. Thus, measuring
Technical Efficiency (TE) in the food processing sector in India is important to
understand the resource-use efficiency for the various Sub-segments as well as
the various States / Union Territories of India.

2.3 Objectives of the Study :

The major objectives of this study are :

(1) To compare the structural composition and growth of various sub-

segments within the food processing industry in India using time-series
data at all India level during the pre- and post-liberalization period.

(2) To compare the Technical Efficiency (TE) of major inputs used in the
food processing industry in India across major commodity segments
over time.

(3) To study the performance of States / Union Territories in the food

processing sector in India, computing TE by estimating Frontier
Production Function using Panel data.

2.4 Description of the Study Area :

Secondary data was chosen for this study on Food Processing Industry in India.
Both time-series data and panel data have been used, which was compiled from
the Annual Survey of Industries (ASI), published by the Central Statistical
Organization (CSO), Ministry of Statistics and Program Implementation,
Government of India. Both time-series data for sub-sectors of food
manufacturing units and panel data for various States / Union Territories of
sub-sectors of food manufacturing units have been used in this study. All units
with 10 or more workers operating with the aid of power and units having 20 or
  16

more workers operating without the aid of power were covered under the ASI
database.

Time-series data on input and output related to registered / organized food

manufacturing units for the period from 1973-1974 to 2007-2008, for a period
of 35 years has been used for the study. It is to be noted that since ASI data
(census data) representing sub-sectors of all food manufacturing industries is
used, it is expected that differences in firm performance are largely explained
by industry in which they operate.

Panel data for the period from 1998-2008, for a period of 10 years pertaining to
the various States and Union Territories of India on food manufacturing units
has also been used in this study. The scope of the ASI was extended to all
registered manufacturing establishments in the country, except the States of
Arunachal Pradesh, Mizoram and Sikkim and the Union Territory of
Lakshadweep for the survey.

The time-series data and panel data used in this study include the output
variable Gross Value of Output along with input variables such as Material
consumed, Fuel consumed, Cost of Capital and Cost of Labor. The definition
of these and other variables used in the study is given below:

Definition of Variables Used in the Study :

(1) Gross Value of Output : Gross Output is defined as the ex-factory

value of products and by-products manufactured during the accounting
year.

(2) Cost of Capital : User’s cost of capital which is a sum of depreciation,

interest payment and rent is used to estimate the capital use in food
processing industry.
  17

(3) Cost of Labor : The ASI provides two categories of labor Employment
in the food processing industry – employees and workers. Cost of Labor
is the sum of Wages and salaries and PF and other benefits.

(4) Raw material : Raw material is the major input used in food processing,
basically constituting raw agricultural produce of respective food unit,
like spices, edible oils, fruit and vegetables, chemicals, ice and packing
materials, and so on.

(5) Energy Used : Values / costs of different types of energy ; mainly

includes electricity, diesel and petrol used in food processing units.

(6) Factory : Factory is one that is registered under the Factories Act, 1948
and refers to any premises, whereon ten or more workers are working in
a manufacturing process being carried on with the aid of power (or)
whereon twenty or more workers are working in a manufacturing
process being carried on without the aid of power.

(7) Fixed Capital : Fixed Capital represents the depreciated value of fixed
assets owned by the factory which includes land, buildings plant &
machinery, furniture and fixtures, transport equipment, water system and
roadways and other fixed assets such as hospitals and schools used for
the benefit of the factory personnel.

(8) Physical Working Capital : It is the total inventories comprising of raw

materials and components, fuels and lubricants, spares, stores and
others, semi-finished goods and finished goods.

(9) Working Capital : It is the sum total of the physical working capital
and the cash deposits in hand and at bank and the net balance receivable.

(10) Productive Capital : It is the total of fixed capital and working capital.
Productive Capital = Fixed Capital + Working Capital.
  18

(11) Invested Capital : It is the total of fixed capital and physical working
capital. Invested Capital = Fixed Capital + Physical Working
Capital.

(12) Outstanding Loans : It represents all loans, whether short-term or long-

term, interest bearing or not, outstanding according to the books of the
factory.

(13) Workers : Workers include all persons employed directly (or through
any agency) whether for wages or not and engaged in any manufacturing
process or connected with it. Labor engaged is also included.

(14) Employees : Employees include all workers and persons receiving

wages and holding clerical or supervisory or managerial positions
engaged in administrative office, as well as watch and ward staff.

Employees = Workers + Administrative & Watch and Ward Staff.

The number of workers or employees is an average number obtained by

dividing man days worked by the number of days the factory had
worked during the reference year.

Number of Workers

(or) Employees = Man days worked / Number of days the factory

had worked.

(15) Total Persons Engaged : This includes the employees and all working
proprietors and their family members actively engaged in the work of
the factory, even without any pay and the unpaid members of the co-
operative societies who worked for the factory in any direct and
productive capacity.
  19

(16) Wages and Salaries : These include all remuneration in monetary

terms, including direct wages and salary, remuneration for the period not
worked (leave period allowances payable, compensation for
unemployment and so on), bonuses and ex-gratia payment paid, both at
regular and less frequent intervals. Wages are expressed in terms of
gross value, before deduction for fines, damages, taxes, provident fund,
ESI contribution and so on.

(17) Total Emoluments : It is the sum of wages and salaries, employers’

contribution as provident fund and other funds and workmen and staff
welfare expenses.

Total emoluments = Wages and Salaries + Employers’

contribution as Provident Fund and other
funds + Workmen and Staff Welfare expenses.

(18) Total Input : It comprises total value of fuels and materials consumed.

Total Input = Fuels Consumed + Materials Consumed.

(19) Total Output : It comprises total ex-factory value of products and by-
products manufactured as well as addition in stock of semi-finished
goods and own construction.

(20) Depreciation : It is consumption of fixed capital due to wear and tear

and obsolescence and is taken as provided by the factory owner or is
estimated on the basis of cost of installation and working life of the
fixed assets.

(21) Net Value Added : It is arrived at by deducting total input and

depreciation from total output.

Net Value Added = Total Output - Total Input - Depreciation.

  20

(22) Gross Value Added = Total Output - Total Input (or)

Net Value Added + Depreciation.

The time-series data used in this study for the period from 1973-1974 to
2007-2008 would enable a comparison of the performance of the food industry
sub-sectors, through the inclusion of the fairly long-term effects of the
pre-liberalization and post-liberalization period. It would also facilitate the
assessment of the structural changes in the food processing industry during the
study period. As the major economic reforms in the country took place during
the 1990’s, a comparison of productivity and efficiency between pre-reform
and post-reform periods across the food processing sector would provide a
practical insight into technical and managerial issues in the changing market
environment.

The Stochastic (or econometric) Frontier Production Function model is used in

this study for time-series data of the food-processing industry at all India level.
This facilitates an empirical study to compute commodity specific TE values
for the food processing industry in India.

The panel data on various States / Union Territories for the period from 1998 to
2008 on various sub-sectors of the food industry, would provide for measuring
the degree of variation across States with respect to the growth indicators such
as mean values of variables. State-wise mean values of technical efficiencies
would help identify the most efficient States in this industry in India, which
would provide for policy implications.

This study also applies the output-oriented Malmquist DEA method based on
panel data of 31 States / Union Territories of India in the ten year period 1998-
2008 for estimating the Total Factor Productivity (TFP) change in the food
processing industry in India. It further decomposes the TFP change in the
disaggregated food processing sector into technical and efficiency changes, in
  21

order to identify which States / Union Territories have expanded the production
frontier between periods. It is worth mentioning that the study uses both the
Stochastic Frontier Production Function model which is a parametric approach
as well as the output-oriented Malmquist DEA method which is a non-
parametric approach to the panel data.

2.5 Methodology of the Study :

In this study the Annual Growth Rates (AGR) and Compound Annual Growth
Rates (CAGR) are computed using time-series data, in order to compare the
performance of the various sub-sectors of the food processing industry in India
during the pre-liberalisation, liberalisation and post-liberalisation periods.

The Stochastic Frontier Production Function (parametric approach) is applied

to the time-series data of various sub-segments of the food processing industry
in India, which facilitates the computation of commodity specific TE values for
the sub-segments.

Panel data on 31 States / Union Territories on various sub-sectors of the food

industry is used to measure the extent of variation in mean TE across the States
/ UT’s in India. The application of the Stochastic Frontier Production Function
model facilitates identification of the most efficient States / UT’s in the food
processing industry in India, in comparison with the all India level TE.

This study also applies the output-oriented Malmquist DEA (non-parametric

approach) method based on the panel data for estimating the Total Factor
Productivity change in the food processing industry in India. The Malmquist
approach identifies the ‘ best-practice ’ States / UT’s in every period, which
gives an efficient production frontier and measures each State / UT’s output
relative to the frontier. The following sections give a detailed account of the
methodology of the study.
  22

2.5.1 Theoretical Framework :

Productivity is one important component of the monitoring, analysis and

supervision of firm performance. The term productivity was probably first
mentioned by the French mathematician Quesnay in an article in 1766
(Sumanth 1998). In 1950, the Organization for European Economic
Cooperation (OEEC), one of the oldest organizations espousing productivity
enhancement, particularly in Europe, issued a formal definition :

Productivity is the quotient obtained by dividing output by one of the factors of

production. In this way it is possible to speak of the productivity of capital,
labour, raw materials or fuel, according to whether output is being considered
in relation to capital, labour, raw materials or fuel.

The performance of a firm, converting inputs into outputs, can be defined in

many ways. One possible measure of performance is a productivity ratio. By
defining the productivity of a firm as the ratio of outputs that it produces to the
inputs used, the larger values of this ratio are associated with better
performance. Productivity is a relative concept and can be measured over time.
The present study compares the productivity of the various sub-segments of the
food industry in India over time (1973-2008) and also across various States /
Union Territories of India (1998-2008).

Changes in productivity are of great importance at all levels-national, state,

industry, firm and individual. At national and state level, productivity is a
major element of economic growth and progress. At the industrial level,
above-average productivity growth leads to relative decline in costs and prices.
This increases the competitiveness of firms in progressive industries, which
consequently tend to grow faster than average. At firm level, productivity is
fundamental to profitability and survival. On the whole, improved productivity
is essential to eliminate hunger, disease and poverty.
  23

2.5.2 Computation of Growth Rates (Time-series data) :

The efficiency of production is extremely important for output growth. Using

existing resources in the best possible manner would yield the highest possible
output for the given technological constraints.

The growth rates indicating the performance of the various sub-segments of the
food processing industry in India during 1973-2008 have been computed. This
enables a comparison of productivity and efficiency between pre- and post-
reform periods across the food processing sector in India.

Productivity measurement is usually conducted from two perspectives – the

level of productivity and trends in productivity. The productivity ratio refers to
the productivity level at a given point in time expressed as output units
delivered per unit of input resources expended. The Trend is defined by
looking at productivity development over time.

Partial productivity measures indicate the ratio of output to a single input.

These include labour productivity, materials productivity, capital productivity
and fuel productivity which represent single inputs such as labour, materials,
capital and fuel or some other input. The advantage of partial productivity
measures is that they are much easier to understand and to measure.

Productivity trend provides information on the causes of changes in

productivity, that is, whether they are attributable to the input or the output
dimension. In order to compute the annual growth rates (AGR), the linear
regression model,

ln Yt = β1 + β2t + Ut

where the parameters β1 and β2 are linear, is used, wherein the regressand is
the logarithm of Y and the regressor is time. In such semi-log model or log-lin
model, the slope coefficient measures the constant proportional or relative
  24

change in Y for a given absolute change in the value of the regressor (the
variable t), that is,

relative change in regressand

β2 =
absolute change in regressor

If the relative change in Y is multiplied by 100, β2 (at a point in time) will then
give the percentage change or the growth rate in Y for an absolute change in X,
the regressor, known as the semielasticity of Y with respect to X.

The Compound Annual Rate of Growth (CAGR), is calculated by taking the

antilog of the estimated β2 and subtracting 1 from it and multiplying the
difference by 100. Thus, CAGR (over a period of time) is given by,

{ [ antilog β2 ] - 1 } × 100

The measurement dimensions mentioned above have different uses.

Productivity level data can be useful in determining budget requirements and
identifying opportunities for improvement by comparing an entity’s
productivity levels with that of other entities delivering the same or similar
services. Productivity trend data can be useful in identifying opportunities for
improvement by comparing current productivity with that of previous periods
and thereby monitoring productivity improvement.

2.5.3 Stochastic Frontier Production Function and Technical Efficiency

(Time-series data) :

The Stochastic (or econometric) Frontier Production Function model is used in

this study for time-series data of the agro-processing industry at all India level.
The technical efficiency of various sub-segments of food processing industry in
India is investigated and their performance is compared using Cobb Douglas
stochastic production function. In the stochastic frontier production function
  25

approach, an efficient production unit such as a firm is said to operate on the

production frontier while inefficient firms are those operating below the
production frontier. The frontier production function is defined as the
maximum feasible or potential output that can be produced by a firm, given
level of inputs and technology.

The efficiency of a production unit can be measured either with respect to its
normatively desired performance or with respect to the performance of another
production unit. Thus, measures of efficiency are essentially computed by
comparing observed performance with some specified standard notion of
performance. The ‘ production frontier ’ serves as one such standard in the case
of TE. Production frontier indicates the minimum inputs required to produce
any given level of output for a firm operating with full efficiency. The level of
technical efficiency is measured by the distance a particular firm is from the
production frontier. A firm that sits on the production frontier is said to be
technically efficient. The actual output is less than the potential output for a
production unit which is inefficient.

Thus, the ratio of the actual output and the potential output can be considered
as a measure of the technical efficiency of the production unit.

actual output
TE =
potential output (constant)

Technical efficiency is a measure of how well the decision-making units use

their inputs in generating outputs. It leads to an investigation of the relationship
between the usage of various inputs and the outputs, particularly in the
processed food sector in India.

In the present Indian context, the level and structure of the food processing
industry reflects that processed food production is mainly constrained due to
lack of production augmenting technologies. To meet the emerging challenges,
  26

the need is to bring efficiency to the production process, either through

maximizing the output or minimizing the cost. Thus, technology is the key to
improvement in the growth and efficiency of the food processing industry.

This study evaluates the performance of the various sub-segments of the food
processing industry in India, in terms of efficiency change over the period from
1973-2008, in order to analyse pre-liberalisation, liberalisation and post-
liberalization periods. Thus, the study hypothesizes the following :

There is a positive and significant relationship between factor intensity

and technical efficiency in the food processing industry in India.

It is to be noted that TE is strictly > 0 and < or = 1. TE = 1, implies that the

industry is on the best practice frontier, whereas, TE < 1 indicates that the
industry is below the frontier or technically inefficient.

The efficiency of a firm / production unit can be measured in terms of

allocation efficiency (indicating the ability of the firm to use inputs in optimal
proportions, given their respective prices) and technical efficiency. Technical
efficiency change (catch-up) measures the change in efficiency between current
(t) and next (t+1) periods, while the technical change (innovation) captures the
shift in frontier technology. More specifically, technical change includes new
production processes called process innovation and the discovery of new
products called product innovation. With process innovation, firms figure out
more efficient ways of making existing products, allowing output to grow at a
faster rate than the growth of economic inputs. The cost of production declines
over time with process innovations or new ways of making things.

Technical efficiency change, on the other hand, can make use of existing labor,
capital and other economic inputs to produce more of the same product. An
example is increase in skill or learning by doing. As producers gain experience
in production, they become more and more efficient at it. Labor finds new
  27

ways of doing things so that relatively minor modifications to plant and

procedures can contribute to higher levels of productivity.

Hence, the empirical strategy consists of estimating the Stochastic Frontier

Production Function, thereby measuring commodity specific TE values and
estimating input-output relationship in processed food production in India.

Model Specification (Time-series data) :

The Stochastic Frontier production model was originally developed to handle

cross-sectional data, although today the model has been improved to account
for panel data. Battese and Coelli (1995) proposed a Stochastic Frontier
production function, which has firm effects assumed to be distributed as a
truncated normal random variable in which inefficiency effects are directly
influenced by a number of variables. Given the objectives the Cobb-Douglas
production function and the Stochastic Frontier, the model specification for the
time-series data is as follows :

ln Yt = βo + β1 ln (M) + β2 ln (F) + β3 ln (C) + β4 ln (L) + Vt - Ut

where :

ln Yt denotes Natural Logarithm of Gross Value of Output

βo constant

βi ’s unknown parameters to be estimated

M Expenditure on Materials

F Expenditure on Fuel

C Cost of Capital

L Cost of Labour

Vt symmetric component of the error term

  28

Ut non-negative random variable which is under the control of the

DMU

i = 1,2,3,4

t time period

Technical Efficiency (TE) of an individual firm is defined as the ratio of

observed output to the corresponding frontier output conditioned on the level of
inputs used by the firm and is estimated from the composed error term. TE is
therefore defined as the amount by which the level of production by the firm is
less than the frontier output. Technical Efficiency is strictly > 0. TE = 1 implies
that the production unit is on the best practice frontier, whereas, TE < 1 means
that the production unit is below the frontier or technically inefficient.

TE is obtained from the error term et. The et is an error term made up of two
components : Vt is a random error having a zero mean as (o ; σv2) which is
associated with random factors such as measurement errors in production
which the producer does not have control over. Ut is a non-negative random
variable associated with firm-specific factors which leads to the ith firm not
attaining maximum efficiency of production. Ut is associated with the technical
inefficiency of the firm and ranges between zero and one.

The time variable is introduced in the model to study how technical efficiency
in the Indian food processing industry has evolved over time. Thus, in the
above model the time variable comprises of values from 1 to 35 pertaining to
the corresponding 35 year period from 1973-2008.

It is worth mentioning here that there has been a data gap in terms of the
variables used in computing Cost of Capital and Cost of Labour using time
series data for a six year period from 1973-1978. In computing cost of capital
there is a data gap in the case of the variables Rent Paid and Interest Paid in the
ASI data frame for the six year period from 1973-1978. In computing cost of
  29

labour there is a data gap in the case of the variable PF and other benefits in the
ASI data frame for the six year period from 1973-1978. Hence this data gap
has been accounted for in the time-series study.

2.5.4 Stochastic Frontier Production Function and Technical Efficiency

(Panel Data):

This study also attempts to estimate the technical efficiency – a measure of

how well inputs are being used towards producing output – using panel data of
about 31 States / Union Territories in the Indian food processing industry from
1998-2008. The Stochastic Frontier Production Model in which technical
efficiency effects are assumed to be a function of industry-specific variables
and time is estimated using Panel data. The Stochastic Frontier Model which is
a parametric approach is applied to a sample of Indian food industry firms, in
order to provide empirical evidence on the sources of technical efficiency in the
food manufacturing sector.

This study also evaluates the performance of various States / Union Territories
of the food processing industry in India in terms of Total Factor Productivity
(TFP) and efficiency change over the period of 1998-2008. Using the output-
oriented Malmquist Productivity Index, that is a non-parametric approach, this
study decomposes the TFP change in the disaggregated food processing sector
into technical and efficiency changes.

Model Specification (Panel data) :

The model specification for the panel data is as follows :

ln Yit = βot + βit ln (M) + βit ln (F) + βit ln (C) + βit ln (L) + Vit - Uit
  30

where :

ln Yit denotes Natural Logarithm of Gross value of Output

βot constant

βit ’s unknown parameters to be estimated

M Expenditure on Materials

F Expenditure on Fuel

C Cost of Capital

L Cost of Labor

Vit symmetric component of the error term

Uit non-negative random variable which is under the control of the

DMU

i = 1,2,3,…………….,31 (State / Union Territory)

t = 1998,1999,………….2008 (time period)

2.5.5 The Malmquist Productivity Index :

Malmquist Productivity Index is an index number enabling evaluation of

efficiency change over time. It is measured as the product of catch-up or
recovery and frontier-shift or innovation terms, both coming from the DEA
technologies. In 1953, Sten Malmquist, a Swedish economist and Statistician,
published in Trabajos de Estadistica (Malmquist 1953) a quantity index for use
in consumption analysis. Later, Caves, Christensen and Diewert (1982) adapted
Malmquist’s idea for production analysis and they named their productivity
change indices after Sten Malmquist.

The Malmquist index is defined as the ratio of two output distance functions.
This index measures the TFP change of a decision-making unit (DMU),
between two data points (for example, those of a particular State in two
  31

adjacent time periods) by calculating the ratio of the distances of each data
point relative to a common technology. The input-output variables used in this
study include Cost of capital, Cost of labor, Materials consumed, Fuel
consumed and Gross value of output.

This study applies the output-oriented Malmquist DEA method based on a

panel data of 31 States / Union Territories of India in the ten year period 1998-
2008 for estimating the Total Factor Productivity change in the food processing
industry in India. This study represents a departure from existing studies in that
it considers the entire States / UT’s as the producing units.

According to Lovell et al (1996), the Malmquist index has some advantages

relative to other productivity indices. For example, it does not require input
prices or output prices, which makes it particularly useful in situations where
prices are misrepresented or non-existent. The Malmquist index does not
require the profit maximization or cost minimization assumption. This makes it
useful in situations where the objectives of producers differ, are unknown or
not achieved.

The Malmquist TFP index method has a major advantage of allowing the
decomposition of TFP (Fare et al, 1989) into efficiency change and technical
change. The value of this decomposition is that it provides insight into the
sources of productivity change. When applied to panel data, as in the present
study, this approach can also identify the innovator States / Union territories
over time. The Malmquist approach does not require the assumption of
efficient production, but instead identifies the ‘ best practice ’ States / UT’s in
every period, which gives an efficient production frontier and measures each
State / UT’s output relative to the frontier.

Productivity indices explain the role of index figures in measuring growth in

output (output-oriented approach) that are net of input growth. One way to
  32

measure a change in productivity is to see how much more output has been
produced, using a given input level and the present state of technology, relative
to what could be produced under a given reference technology using the same
input level. An alternative is to measure the change in productivity by
examining the reduction in input use, which is feasible given the need to
produce a given level of output under a reference technology. These two
approaches are referred to as the output-oriented and input-oriented measures
of change in productivity (Coelli, 1998). This study concentrates on the output-
oriented Malmquist productivity index.

The nonparametric productivity approach yields insight that a parametric

approach or production-function approach cannot. For example, with the
nonparametric approach one can estimate technical efficiency for each State /
UT in each period under alternative assumptions about returns to scale
(constant or variable). The States / UT’s which advance the technological
frontier between time periods can also be identified. Discovering which States /
UT’s expanded the production frontier is useful information that can in turn be
used to improve understanding of various economic policies.

Definition of Malmquist Index : The Malmquist Index (MI) is an index

number used to identify productivity differences between two firms or one firm
over two-time periods. To estimate technical efficiency changes and
technological changes over the period in question we use a decomposed
Malmquist productivity index based on ratios of output distance functions.

The output-based Malmquist productivity index between time periods t and

(t+1) can be decomposed into two components, as :

Dt+1 (yt+1, xt+1) Dt (yt, xt) Dt (yt+1, xt+1) 1/2

Mt, t+1(yt, yt+1,xt,xt+1) = x

Dt (yt,xt) Dt+1(yt,xt) Dt+1 (yt+1, xt+1)
  33

where the notation D represents the distance function and the value of M is the
Malmquist productivity index. A value of M greater than one (M>1) denotes
productivity growth, while a value less than one (M<1) indicates productivity
decline, and M=1 indicates no productivity change.

The first component of MI, the catch-up effect C is also termed as efficiency
change (EFFCH), which is measured by the ratio of the efficiency of (yt+1, xt+1)
with respect to period t+1 technological frontier and the efficiency of (yt, xt)
with respect to period t frontier.

Dt+1 (yt+1, xt+1)

C =
Dt (yt,x t)

When C > 1, it indicates progress in the relative efficiency from period t to t+1,
while C = 1 and C < 1 indicate no change and regress in efficiency,
respectively. The catch-up effect C can be further decomposed into its pure
efficiency change (PECH) and scale efficiency change (SECH) components.
The PECH is relative to the variable returns to scale (VRS) frontier and is
given by :

D tv1 (yt,xt)

D tv (yt,xt)

whereas the SECH component is actually the geometric mean of two scale
efficiency measures given by :

t+1 t+1 t+1 t+1

D tv1 (y , x ) / D ct 1 (y , x ) D tv (yt+1, xt+1) / D ct (yt+1, xt+1) 1/2

x
t t t t
D t 1
v
t 1
(y , x ) / D (y , x )
c D tv (yt, xt) / D ct (yt, xt)
  34

The first is relative to the period t+1 technology and the second is relative to
period t technology. The subscripts v and c relate to the VRS and CRS
(constant returns to scale) technologies, respectively.

The second component of MI is the frontier shift (innovation) effect or

technological change. It is taken into account in order to fully evaluate the
productivity change since the catch-up effect is determined by the efficiencies
being measured by the distances from the respective frontiers.

The frontier shift effect is given by the formula :

Dt (yt, xt) Dt (yt+1, xt+1) 1/2

F = x
t+1 t t
D (y , x ) Dt+1 (yt+1, xt+1)

The frontier-shift effect has in turn two components. The first component is the
frontier-shift effect at (yt, xt) evaluated as the ratio of the efficiency of (yt+1,
xt+1) with respect to period t and t+1 frontiers, respectively. Hence, frontier-
shift effect is defined by the geometric mean of the two components. The
frontier-shift effect F > 1 indicates progress in the frontier technology around
the DMU from period t to t+1, while F = 1 and F < 1 indicate the status quo
and regress in the frontier technology, respectively.

The product of the catch-up effect C and frontier-shift effect F is the Malmquist
Index (MI) which is given by the formula :

Dt+1 (yt+1, xt+1) Dt (yt, xt) Dt (yt+1, xt+1) 1/2

MI = x
Dt (yt, xt) Dt+1 (yt, xt) Dt+1 (yt+1, xt+1)

Calculation of Malmquist index for adjacent periods includes four different

distance functions, namely, Dt (yt, xt), Dt (yt+1, xt+1), Dt+1 (yt, xt) and Dt+1 (yt+1,
xt+1). The above expression gives an interpretation of the geometric means of
the two efficiency ratios : The first being the efficiency change measured by
  35

period t technology and the other the efficiency change measured by period t+1
technology.

It is noted that MI consists of four terms : Dt (yt, xt) and Dt+1 (yt+1, xt+1) in the
main diagonal relate to the measurements within the same time period, while
Dt (yt+1, xt+1) and Dt+1 (yt, xt) in the off-diagonal account for inter temporal
comparisons. MI > 1 indicates progress in the multi-factor productivity of the
DMU from period t to t+1, while MI = 1 and MI < 1 indicate the status quo and
decay in the multi-factor productivity, respectively.

In the above equation the term outside the brackets (EFFCH) is a ratio of two
distance functions, which measures the change in the output-oriented measure
of the technical efficiency between period t and t+1. The square root term
(TECHCH) is a measure of the technical change in the production technology.
It is an indicator of the distance covered by the efficient frontier from one
period to another and thus a measure of technological improvements between
the periods. The term (EFFCH) is greater than, equal to or less than one if the
processor is moving closer to, unchanging or diverging from the production
frontier. The square root term (TECHCH) is greater than, equal to or less than
one when the technological best practice is improving, unchanged or
deteriorating respectively.

The analysis in this study is carried out with the output – oriented approach of
DEA – Malmquist to put greater weight on the expansion of output from a
given amount of inputs. Therefore, TFP index is a ratio of the weighted
aggregate output to weighted aggregate input. Input and output quantities of the
food sector are the set of data used to construct a piece-wise frontier over the
data points. Efficiency measures are then calculated relative to this frontier that
represents an efficient technology.
  36

The Malmquist index approach is used to examine inter-state industrial

efficiency and productivity. When applied to panel data as in the present study,
this approach can also identify the innovator States / Union Territories over
time. The Malmquist approach does not require the assumption of efficient
production, but instead identifies the ‘best practice’ States / Union Territories
in every period, which gives an efficient production frontier and measures each
State / UT’s output relative to the frontier.

The study also facilitates an assessment of the sources of productivity gains or

losses by comparing the values of Efficiency Change (TE) and Technology
Change (TC). If TE > TC, then productivity gains are largely the result of
improvements in efficiency. Whereas if TE < TC, productivity gains are
primarily the result of technological progress. TE and TC are defined as
follows :

Dt+1 (yt+1, xt+1)

TE =
Dt (yt, xt)

Dt (yt, xt) Dt (yt+1, xt+1) 1/2

TC = x
Dt+1 (yt, xt) Dt+1 (yt+1, xt+1)

There are many different methods that could be used to measure the distance
function, which makes up the Malmquist productivity index. In the empirical
part of this study, Malmquist TFP index and efficiency scores have been
obtained by using Data Envelopment Analysis Program (DEAP) software
(version 2.1) developed by Coelli (1996). This is presented and explained in
detail in Chapter Five on ‘Productivity and Resource-use Efficiency in Food
Processing Industry in India’.
  37

2.6 Limitations of the Study :

(1) Gaps in the time-series data pertaining to sub-sectors of the food

processing industry in India.

(2) The geographical coverage of the Annual Survey of Industries during

the time period of study is extended to the entire country except the
States of Arunachal Pradesh, Mizoram and Sikkim and Union Territory
of Lakshadweep for the surveys.

(3) The firm level efficiency concept has been applied to industry level data
and State level data and that we use data aggregated across sub –
segments and States / Union Territories.

The results can be interpreted as indicative aggregative efficiency

measures of all firms within the sub – segments and States. Such
aggregate – level studies can greatly complement firm – level studies in
the construction of practical policy directions for strengthening and
accelerating the growth of various sub – segments of the food processing
industry.

(4) Frontier functions assume that all inputs have been taken into
consideration. However, in this study as well as others, it is possible to
raise questions about whether all inputs have actually been accounted
for, since firms that are apparently inefficient may just use less of certain
unmeasured inputs.

Although this study has tried to adjust for data quality, data limitations
inevitably hamper the analysis. However, it is believed that the findings
presented here represent the true productivity trends.

The next chapter provides details of the Survey of relevant literature including
empirical studies on the food processing industry.