Public subsidies, TFP and Efficiency : a tale of complex relationships

The paper analyses the causal effect of capital subsidies on firms' efficiency and productivity by exploiting the conditions for a local random experiment created by Law 488/92 (henceforth L488), which has been an important policy instrument for reducing territorial disparities in Italy. The presence of sharp discontinuities in the L488 rankings used for allocating subsidies to projects allows us to use a regression discontinuity design (henceforth RDD). We show that a suitable decomposition of TFP can be applied to a large sample of subsidized firms for a relevant period of time, allowing to evaluate either the roles of technical progress and technical efficiency change, or scale and allocative efficiency change as determinants of granted firms' long-term growth. The stochastic frontier model used in this study assumes that technical inefficiency evolves over time, enabling to decompose productivity changes into the change in technical efficiency (i.e., measuring the movement of an economy towards, or away from, the production frontier), and technical progress (measuring shifts of the frontier over time). Moreover, because a flexible technology is used, the SFA allows to evaluate the presence of scale efficiency, as well as the additional measurement of changes in allocative efficiency (i.e., the Bauer-Kumbhakar decomposition; Bauer, 1990; Kumbhakar, 2000; Kumbhakar and Lovell, 2000; Brummer et al., 2002). Unlike the previous literature, we estimate the effects of the subsidies after 5 years from the subsidized investment. The results show that , after four years, the impact of public subsidies on TFP and efficiency is positive and statistically significant.