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Does public sector inefficiency constrain firm productivity? Evidence from Italian provinces

International Tax and Public Finance volume 27, pages 1019–1049 (2020)Cite this article

Abstract

This paper studies the effect of public sector efficiency on firm productivity using data from more than 400,000 Italian firms. Exploiting the large heterogeneity in the efficiency of the public sector across Italy’s provinces and the intrinsic variation in the dependence of industries on the government, we find that public sector inefficiency significantly reduces the productivity of private sector firms. The results suggest that raising public sector efficiency could yield large economic benefits: If the efficiency in all provinces reached the frontier, output per employee for the average firm would increase by 9%.

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Notes

  1. In the same vein, Rajkumar and Swaroop (2008) show that more public spending on education and health care translates into better education and health outcomes only in countries with high bureaucratic quality and low corruption levels.

  2. Contrary to previous studies—such as Knack and Keefer (1995), Hall and Jones (1999), Dollar and Kraay (2003), and Rodrik et al. (2004)—which rely on International Country Risk Guide or World Bank broad quality of governance indicators, Evans and Rauch (1999) develop an index of bureaucratic quality for 35 countries and show that it correlates positively with long-run growth.

  3. Acemoglu and Dell (2010), Gennaioli et al. (2014), and Breinlich et al. (2014) document the relevance of differences in productivity and growth across regions within countries.

  4. Most notably, Rodríguez-Pose and Di-Cataldo (2015) and Ganau and Rodríguez-Pose (2019) study the relationship between firm performance and regional quality of governance indicators in Europe. These indicators are computed from survey data, reporting the assessments of “experts,” entrepreneurs, and common citizens (Charron et al. 2014).

  5. In the case of Italy, Giacomelli and Tonello (2018) computed an objective measure of government performance by making phone calls to Italian municipal offices under the pretense of being entrepreneurs wanting to start a business in the municipality.

  6. Similar indicators at the subnational level have been computed for a few other countries: see Balaguer-Coll et al. (2007) for Spain; Borge et al. (2008) for Norway; and Revelli (2009) for the UK.

  7. Needless to say, in the real world rivalry and excludability are a matter of degree more than a zero/one feature. Furthermore, in many cases the effects of different services cannot be disentangled (e.g., Miguel and Kremer (2004) and Jayachandran and Lleras-Muney (2009) show that healthcare improvements improve school outcomes).

  8. Starting from a production function \( y_{ij} = A_{ij} h_{ij}^{1 - \alpha } k_{ij}^{\alpha } \left( {\frac{{\varepsilon_{j} G}}{n}} \right)^{\alpha } = A_{ij} h_{ij} \left( {\frac{{k_{ij} }}{{h_{ij} }}} \right)^{\alpha } \left( {\frac{{\varepsilon_{j} G}}{n}} \right)^{\alpha } \) in which k is physical capital and h is human capital, if the two kinds of inputs can be transformed into each other on a one-to-one basis, it must be that \( MPK_{ij} = MPH_{ij} \) so that \( \frac{{k_{ij} }}{{h_{ij} }} \) = \( \frac{1 - \alpha }{\alpha } \) and \( y_{ij} = A_{ij} h_{ij} \left( {\frac{1 - \alpha }{\alpha }} \right)^{\alpha } \left( {\frac{{\varepsilon_{j} G}}{n}} \right)^{\alpha } \), which is very similar to the production function discussed in this section (Barro and Sala-i-Martin 2004).

  9. Also in this case, we require that the budget of each local government is balanced.

  10. For nationwide public goods, \( \frac{{\partial MPL_{ij} }}{{\partial \varepsilon_{j} }} \) is increasing with α, provided β is sufficiently small.

  11. In Italy, a province is an administrative unit between municipalities and regions. Italy is divided into roughly 20 regions, 100 provinces, and 8,100 municipalities.

  12. Regional disparity in per capita GDP is much more pronounced, with real per capita GDP in the north almost double that of the south of Italy. This is largely explained by differences in employment and labor force participation rates. Productivity differentials, as measured by gross value added per euro spent on employees, in national accounts data are of similar magnitude to the ones we uncover in the firm-level data.

  13. A large literature has documented that large firms are more productive (e.g., Idson and Oi 1999).

  14. The standard errors of the estimated coefficients are slightly smaller with clustering at the level of the province and slightly larger with two-way clustering at the level of the province and two-digit industry code. These alternative methods of clustering do not affect the statistical significance of the findings discussed in the paper.

  15. For a full description of the methodology, data, and estimation strategy, see Giordano and Tommasino (2013). They compute PSE measures using both deterministic and stochastic parametric techniques. These alternative methodologies deliver indicators of provincial government efficiency that are very similar to the baseline used in our study.

  16. Main sources are the Ministries of Health, Education, and Interior, INValSI (the national institute responsible for evaluating the Italian educational system), Consiglio Superiore della Magistratura (the magistrates’ governing body), and the Government’s Environmental Protection Agency.

  17. In 2012, more than 99.9 percent of businesses employed fewer than 50 people. These businesses accounted for 70 percent of value added and 54 percent of overall employment in Italy.

  18. The sample size is reduced by almost 50 percent if we were to focus on the ratio of output or gross value added per worker. The attrition is significantly higher among smaller and younger firms.

  19. More specifically, we estimate: \( Y_{i} = \beta *GovEff_{p} + \gamma X_{i} + \alpha_{s} + \varepsilon_{i} \).

  20. The drag on productivity from the inefficient provision of public goods adds to the disadvantages faced by firms in relatively inefficient regions. Limited geographical differentiation in nominal public sector wages and downward private sector wage rigidity due to competition with the public sector and a centralized wage bargaining system prevent firms from adjusting wages to fully accommodate the lower labor productivity.

  21. Besides reducing the productivity of existing firms, public sector inefficiency has also been shown to exert a negative effect on firm entry (see Amici et al. 2016) for evidence based on Italian municipalities).

  22. We take the sector’s dependence on external finance from Tong and Wei (2011), which build in turn on the methodology first developed by Rajan and Zingales (1998). Specifically, financial dependence of a sector is constructed as the difference in the capital expenditures of the sector and its cash flow as a share of its total capital expenditures in the 1990–2006 period in the US. Financial development at the province level is proxied by the log of outstanding credit per capita.

  23. Since higher public sector efficiency may increase firms’ willingness to invest and hence their stock of capital, greater capital intensity could be one channel through which strengthening public sector efficiency could improve firm outcomes. Hence, our baseline specification does not control for firm’s capital intensity.

  24. The findings are virtually unchanged if we use the input–output table from Italy to calculate the share of output sold to the private sector. The correlation between these sectoral measures of government dependence when computed with German and Italian data is 0.98.

  25. The correlation between the Pellegrino and Zingales (2019) measure of government dependence and the share of output sold to the government is about 0.25. However, the measure based on input–output tables exhibits much wider variation across sectors (the percent of output sold to the government has a median of 0 across sectors, mean of 5, and a standard variation of 17). As reported in Table 3, Panel B, the mean of the Pellegrino and Zingales (2019) measure of government efficiency is 0.65 with a standard deviation of 0.07. A one standard deviation increase in GovDep*GovEff measure is associated with about 6 percent higher output per euro spent on worker. In comparison, a one standard deviation increase in the same measure using the Pellegrino and Zingales (2019) government dependence is associated with 18 percent higher output per euro spent on worker.

  26. For comparability with the subsequent robustness check, we perform this exercise using 2010 firm-level data.

  27. In particular, we estimate: \( Y_{it} = \beta *GovEff_{rt} *GovDep_{s} + \delta *GovEff_{rt} + \alpha_{t} + \alpha_{i} + \varepsilon_{it} \) where αt are year fixed effects, while αi are firm fixed effects, which subsume the sector and province fixed effects in Eq. 1.

  28. This method of resampling implicitly assumes that firms in ORBIS within a specific industry and industry class size cell are representative of the true population within that cell. However, we cannot correct for potential selection bias from differential propensity of reporting by firms based on other characteristics (e.g., profitability, age, etc.) and our findings should be interpreted in light of this analytical shortcoming.

  29. Capital intensity is defined as capital compensation as a share of sectoral value added, while skill intensity is the number of hours worked by high-skilled workers as a share of total hours worked. Both variables are obtained from the 2013 release of the Socio Economic Accounts of the World Input–Output Database at the two-digit sectoral level.

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Acknowledgements

The views expressed in the article are those of the authors and do not involve the responsibility of the Bank of Italy or the IMF. We thank Giacomo Caracciolo and Domenico Depalo for their useful comments.

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Authors and Affiliations

  1. Bank of Italy, Rome, Italy

    Raffaela Giordano & Pietro Tommasino

  2. IMF, Washington, USA

    Sergi Lanau & Petia Topalova

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  1. Raffaela Giordano
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  2. Sergi Lanau
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  3. Pietro Tommasino
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Correspondence to Pietro Tommasino.

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Giordano, R., Lanau, S., Tommasino, P. et al. Does public sector inefficiency constrain firm productivity? Evidence from Italian provinces. Int Tax Public Finance 27, 1019–1049 (2020). https://doi.org/10.1007/s10797-020-09600-x

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Keywords

  • Public sector efficiency
  • Firm productivity
  • Regional development
  • Quality of government

JEL Classification

  • H40
  • H70