Dynamic Efficiency Measurement

A philosophical problem for studies of inefficiency of firms is how to rationalise the inefficiency. Since economists do not have any theory for inefficiency, explaining the results of efficiency analyses are 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: 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.