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Dynamic Efficiency Measurement

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Abstract

A philosophical problem for studies of inefficiency of firms is how to rationalise inefficiency. Since economics do not have any theory for inefficiency, explaining the results of efficiency analyses is notoriously more difficult than carrying out the estimations. The literature points to measures of inputs and management as not including quality dimensions as a reason for measured efficiency differences, indicating that more work needs to be done on data collection. Strategic behaviour in game situations between owners and management and between management and labour may also show up as inefficiencies. Another reason is technology differences. The frontier production function is the key to information on best practice technology. Estimation of efficiency is usually done for units observed during the same time period; thus, in this respect, the measures are static. Interpretations of dynamic efficiency measurement are offered. The vintage model of substitutability between inputs including capital before investment, but no substitution possibilities after investment, and ex post production possibilities characterised by fixed input coefficients, can rationalise inefficiency due to technology differences. Key elements in understanding structural change are the entering of capacity embodying new technology and exiting of capacity no longer able to yield positive quasi-rent. Three crucial production function concepts are identified as follows: the ex ante micro-unit production function as relevant when investing in new capacity, the ex post micro-production function, and the short-run industry production function giving the production possibilities at the industry level. Productivity measurement, taking these types of production functions into consideration, leads to different interpretations of productivity change than traditional approaches not being clear about which production function concept is used.

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Notes

  1. 1.

    Cost of adjustment is introduced in Sengupta (1995, 1996). However, it is not so easy to understand how the dynamics of his analyses actually work, cf. comments in Nemoto and Goto (2003, p. 192).

  2. 2.

    The basis of the modelling except the specific adaptation of the DEA model has much in common with the approach in Rubin (1973).

  3. 3.

    If deviation form an optimal path is called waste, confer Stigler (1976, p. 576): “…waste is not a useful economic concept. Waste is error within the framework of modern economic analysis, and it will not become a useful concept until we have a theory of error.”

  4. 4.

    As expressed in Rothschild (1971, p. 605), “Much of the current interest in cost of adjustment functions stems from their ability to provide a rigorous theoretical justification for the use of distributed lags in econometric studies of investment behavior.”

  5. 5.

    As to the Penrose effect of the importance of constrained management resources, Slater (1980, p. 521) remarks that there is no recognition in economists’ models of the role of the management; management has no role to play which bears upon the firm’s performance.

  6. 6.

    In practice merit order is based on costs, therefore the theoretical merit order based on quasi-rent will only be relevant if input prices are equal.

  7. 7.

    In Førsund and Hjalmarsson (1979), introducing this measure, it was called the gross scale efficiency.

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Author information

Authors and Affiliations

  1. Department of Economics, University of Oslo, Oslo, Norway

    Finn R. Førsund

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  1. Finn R. Førsund
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Correspondence to Finn R. Førsund .

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Editors and Affiliations

  1. Department of Economics, University of Connecticut, Storrs, USA

    Subhash C. Ray

  2. Department of Economics, State University of New York, Binghamton, New York, USA

    Subal C. Kumbhakar

  3. Department of Economics, University of Delhi, Delhi, India

    Pami Dua

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Førsund, F.R. (2015). Dynamic Efficiency Measurement. In: Ray, S., Kumbhakar, S., Dua, P. (eds) Benchmarking for Performance Evaluation. Springer, New Delhi. https://doi.org/10.1007/978-81-322-2253-8_4

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