Technical Efficiency and Its Determinants in the Manufacturing Sector: What We Know and What We Should Know

Abstract

There is a larges literature on technical efficiency (TE) of manufacturing sector firms in developing country contexts, much less so for developing country contexts. Most of empirical research use either data envelopment analysis (DEA) or stochastic frontier analysis (SFA) to estimate TE. Available evidence suggests that TE of firms is low in developing countries, and there is considerable inter-firm heterogeneity in TE. Firm-level TE is correlated with (or influenced by) external factors such as liberalization of trade and foreign direct investment (FDI) and overall economic liberalization, as also by internal factors such as firm size, ownership, whether or not they operate in the formal sector, and use and adoption of ICT. However, there is mixed evidence about the extent to which liberal economic policies and firm characteristics such as size and ownership are associated with higher TE. Future research should focus on the impact of the institutional environment in which firms operate and their managerial capability on firm-level TE.

Appendix

Country	Method	Reference	Empirical finding
Business environment
Cross-country	SFA	[59]	Efficiency distribution for most sectors unaffected by explanatory variables; with weak positive association between high efficiency levels and the expansionary phase of the business cycle.
Cross-country	SFA	[79]	Considerable intercountry and intra-country dispersion in efficiency levels, and inefficiency is mostly associated with managerial experience, infrastructural quality, and competition.
Cross-country	SFA	[60]	Inefficiency is lower in countries that have more sophisticated production processes and higher capacity for innovation.
Cross-country	SFA	[25]	TE improvement is positively associated with infrastructure, political stability, and urbanization. Human capital matters as well; benefits from trade and FDI-driven technology transfer increases a country’s TE only after human capital level reaches a minimum threshold.
Ethiopia	SFA	[24]	TE is low and with high dispersion level. The main reason for low efficiency levels across sectors is shortage in supply of raw materials but low infrastructure quality and unfavorable government rules and regulations play a role as well.
India		[23] and [81]	Infrastructure elasticity for TE is 0.12, on average, and higher for some industries. However, some elements of infrastructure such as power shortage matter much more than others such as transportation quality.
Competition
Indonesia	DEA	[26]	Industry concentration is negatively associated with sector-level TE.
Northern Ireland	SFA	[27]	Average levels of TE is lower in Northern Ireland than in other parts of the UK, in part because there is little churning to facilitate replacement of inefficient firms (which exit) with more efficient firms (that entry). Where entry does take place, the entering firms are not much more efficient than the incumbents.
Economic policies and reforms
Bangladesh		[34]	There was an increase in the overall TE of most industries over time, for both export-promoting and import-substituting industries.

1. (continued)

Country	Method	Reference	Empirical finding
Chile		[32]	There is little evidence of productivity improvement on account of trade liberalization but a greater reduction in protection levels is associated with a larger improvement in the average efficiency level.
China		[33]	Average TE declined in the mid-1980s but has increased since 1992. There is considerable regional variation in TE and inefficiency is impacted by a variety of reforms related to privatization and trade and FDI liberalization, and infrastructure development.
Hungary	SFA	[52]	Inefficiency is higher for firms that are recipient of government subsidy and inefficiency also increases with the level of inefficiency.
India	DEA	[18]	Annual rate of productivity growth is higher in the post-reform period, in part, because of improvement in TE.
India	DEA	[21]	Economic reforms did not change the relative efficiency rankings of the states, and there is no evidence of convergence in the distribution of efficiency subsequent to the reforms.
India	SFA	[20]	Median TE of all but one industry declined between 1989–90 and 2000–01 and that change in TE explains a very small proportion of the change in gross value added.
Malawi	SFA	[22]	Structural changes did not significantly affect the TE of sectors that were relatively efficient before the reforms, but reforms did have a positive impact on firm efficiency in the sector that was inefficient before the reforms.
Malawi	SFA	[13]	Privatization increased industry-level TE but the direct impact of privatization on firm-level TE was negative; efficiency of firms declined following privatization.
Pakistan	SFA & DEA	[19]	TE of most industries increased over time and can possibly be attributed to the reforms that were initiated in the late 1980s, aimed at increasing competition and improving the business environment.
Firm size and formality
Chile		[41]	Micro and small firms are not intrinsically inefficient; there are considerable variations across industries. On average, however, medium firms have higher efficiency levels than micro and small firms. Inter-firm differences in efficiency are explained by factors such as capital intensity.

1. (continued)

Country	Method	Reference	Empirical finding
Cote d’Ivoire	SFA	[56]	TE is low on account of input market imperfections, and larger firms, those operating in the formal sector and those that are part of international networks, are better able to overcome the challenges posed by these imperfections.
Cote d’Ivoire	SFA	[42]	TE is low, on average, but larger firms are more efficient and the lower TE of smaller firms can perhaps be attributed, at least in part, to their informality.
Cote d’Ivoire	SFA	[55]	TE is lower for informal firms than for formal sector firms, mainly on account of the unfavorable business environment within which the former operate.
Ghana	SFA	[14]	Large firms pay more for labor and hence use more capital than would be optimal if they paid the same for labor as the smaller firms.
India	SFA	[8]	Average TE is higher and dispersion of TE is lower in the more modern industries, but firm size is positively associated with TE in only one of the four industries that were examined.
India	SFA	[43]	TE is low among both small and large firms, relative to the medium-sized firms. The inefficiency of large firms can be attributed to low levels of organizational efficiency.
India	SFA	Raj SN (2011)	TE is low among informal sector firms and this can largely be attributed to frictions (or high transactions costs) they experience in the credit and labor markets.
Kenya	SFA	[16]	TE is positively associated with firm size.
Korea	SFA	[61]	TE is positively associated with firm size in every sector examined in the paper.
Philippines	SFA	[82]	TE is positively associated with firm size.
Firm capability
China		[46]	TE is positively related to firm capability as measured by capital intensity and R&D.
China	DEA	[62]	TE is low for SOEs and productivity growth is driven largely by technical progress. Best practice SOEs are significantly different from average SOEs in terms of technology, human capital quality, and managerial capacity.
Ghana	DEA	[44]	Average TE level is high, and TE is positively associated with education and industry experience of managers. The ratio of expatriate managers to total managers is positively associated with TE as well.
India	SFA	[80]	TE is higher for firms that undertake R&D and those that collaborate with foreign partners.

1. (continued)

Country	Method	Reference	Empirical finding
Italy	SFA	[12]	Firms that experience financial constraints (i.e., difficulty in accessing external capital) have an incentive to increase their TE over time.
Italy	DEA	[53]	TE increases with percentage of shares owned by the largest shareholder and is higher for firms that belong to a pyramidal (business) group.
Italy	SFA	[47]	ICT investment by firms is negatively associated with their inefficiency levels.
Mexico	SFA	[57]	Firms that have access to credit from banks, moneylenders, clients, and suppliers have higher TE than firms that are reliant on family, friends, and their own financial resources. TE is highest for firms that have access to bank credit.
Singapore	SFA	[51]	TE is negatively associated with capital intensity. One plausible explanation is that increase in capital intensity has not been accompanied by availability of workers with commensurate skills.
Taiwan	SFA	[45]	Efficiency is positively associated with firm-level investment in training and R&D.
Tunisia	SFA	[48]	TE is low, on average, for Tunisian firms but intensive use of ICT can increase efficiency levels by around 5%.
USA	SFA	[50]	TE is higher for firms whose management is committed to implementing just-in-time purchasing.
Yugoslavia		[49]	TE deteriorates over time, quite possibly on account of poor investment planning and implementation which, in turn, points at poor management and coordination of intermediate input supply.
Multiple factors
China		[63]	On average, TE is lower for SOEs than for privately owned companies, and highest for foreign firms. TE varies positively with firm size and newness of fixed capital assets.
India	SFA	[64]	Efficiency is higher for consumer goods industries than for capital goods and intermediate goods industries. Efficiency is positively associated with factors such as skill and profit, but negatively associated with capital intensity.
Indonesia	SFA	[65]	Efficiency is higher for younger firms than for older firms, for larger firms than for smaller firms, and for domestic firms than for foreign firms.
Indonesia	SFA	[28]	There is considerable inter-firm variation in TE, and TE is positively associated with export orientation and financial integration of firms, as well as on female participation in the workforce.

1. (continued)

Country	Method	Reference	Empirical finding
Indonesia	SFA	[66]	Larger firms are more efficient than smaller firms, and private firms are, by and large, more efficient than the public sector firms. The Asian crisis had a negative impact on the growth rate of TE across all sectors examined in the analysis.
Nepal	SFA	[35]	Efficiency is positively associated with firm size and negatively with capital intensity. It is also adversely affected by high levels of protection.
Pakistan	DEA	[11]	Efficiency is higher for newer firms, those that are managed by entrepreneurs with at least primary education, and those that are involved in subcontracting.
Thailand	SFA	[67]	TE varies inversely with firm size and is generally higher for firms in urban areas. State ownership is associated with declining TE over time, perhaps because the more efficient firms are privatized.
Thailand	SFA	[68]	TE is influenced by a number of factors such as firm size, firm age, access to skilled labor, ownership, and location.
Turkey	SFA	[69]	TE is higher for larger firms and those located in the metropolitan areas or their hinterlands. On average, TE is also higher for private enterprises than for public sector enterprises, but this is mostly relevant for the post-1982 period.
Turkey	SFA	[70]	There are considerable inter-sectoral differences in efficiency, and efficiency is influenced by a number of factors such as legal status of firms, firm size, forms of contracting, and location.
UK	SFA	[6]	Market concentration has a curvilinear relationship with efficiency. Higher export and import intensity are associated with higher spreads of efficiency within industries. Capital intensity is negatively associated with efficiency, possibly because large sunk costs make it difficult for firms to alter their behavior as demand etc. change.
Vietnam	SFA	[83]	TE is similar, on average, for state- and private-owned domestic firms, but is lower for foreign-invested sectors. TE also increases with greater compliance with the labor code, and export orientation of firms.
Ownership and organizational form
Brazil		[7]	TE of foreign firms not significantly different from that of domestic firms but the former enjoys greater returns to scale and has greater elasticities of substitution.

1. (continued)

Country	Method	Reference	Empirical finding
China		[15]	Within the public sector, TE is highest for relatively large TVEs and lowest for SOEs; COEs are less efficient than TVEs but more efficiency than SOEs.
India	DEA	[71]	Cooperative firms are more efficient than their counterparts but the result is influenced by the choice of the sample.
Northern Ireland	SFA	[54]	TE of Northern Irish firms increased over time. The positive impact of foreign ownership on TE, however, decreased over time, and the largest increases in TE were observed among domestically Northern Irish firms.
Trade and FDI
China		[29]	TE is positively associated with export orientation and FDI intensity of industries, even though it is also associated by factors such as firm size and capital intensity. There is also regional variation in TE.
Cross-country	SFA	[30]	Efficiency gains from exporting are large and are largest for new entrants to exporting. This is driven by both learning by exporting and self-selection of the most efficient firms into exporting.
India		[31]	Trade liberalization was positively associated with productivity in four out of the six industries examined.
Indonesia	SFA & DEA	[39]	Foreign firms are more efficient than domestic firms, and the former may increase the inefficiency of the latter. In particular, FDI may have negative impact on TE changes of domestic competitors and positive impact on TE changes of domestic suppliers.
Spain	SFA	[38]	Trade liberalization was negatively associated with efficiency, in part, on account of the lack of flexibility on the part of the firms to adjust to the resultant change in the environment in which they operate.
Taiwan	SFA	[36]	TEs of manufacturing firms are positively associated with their OFDI activities.
UK	SFA	[37]	TE is positively associated with the extent of foreign ownership in the domestic industry, but the spillover effect is only significant for industries of above-average regional concentration.