Paper presented to the 2nd World Congress of Environmental and Resource Economists Marriott Hotel, Monterey, California 24 to 27 June 2002 ✪ Greg Murtough, David Appels and Anna Matysek work for the Productivity Commission, which is the Australian Government’s principal review and advisory body on microeconomic policy and regulation. Knox Lovell is Professor of Economics & Terry Chair of Economics at the University of Georgia. ★ The views expressed in this paper are those of the authors and do not necessarily reflect those of the Productivity Commission. The authors wish to thank Dr Tim Coelli (Centre for Efficiency and Productivity Analysis, University of New England), Dr Harry Schaap (Electricity Supply Association of Australia), Jo Evans (Australian Greenhouse Office), and Dr John Pezzey (Centre for Resource and Environmental Studies, Australian National University) for their helpful comments on drafts of this paper. Why Greenhouse Gas Emissions Matter When Estimating Productivity Growth: An Application to Australian Electricity Generation Greg Murtough ✪ , David Appels ✪ , Anna Matysek ✪ and C.A. Knox Lovell Productivity Commission ★ and University of Georgia Locked Bag 2, Collins St East PO, Melbourne VIC 8003, Australia Conventional productivity estimates reward firms for producing more goods from their inputs but not for creating fewer undesirable environmental externalities. This paper extends the techniques of production frontier analysis to quantify how conventional estimates of productivity growth are biased by the omission of environmental externalities. We develop two alternative approaches and compare them in an analysis of greenhouse gas emissions from Australian electricity generation. Our results indicate that the bias in conventional productivity growth estimates can be large and the direction of this bias varies between firms and over time. Thus, it is not possible to say that conventional productivity growth estimates are consistently above or below true productivity growth. Nevertheless, productivity growth does tend to be under-estimated when a utility’s emission intensity falls and over-estimated when emission intensity grows. JEL Codes: C61 (Optimization Techniques; Programming Models; Dynamic Analysis), D24 (Production; Capital and Total Factor Productivity; Capacity), Q25 (Renewable Resources and Conservation; Environmental Management: Water; Air; Climate), Q41 (Energy: Demand and Supply)