Yardstick Competition and Spatial Interdependence of Cost Efficiency in Local Governments : Development and Application of an Interpretable Spatial Inefficiency Stochastic Frontier Model

We develop a new spatial inefficiency stochastic frontier model. Our spatial inefficiency stochastic frontier model meets the following conditions: (a) It can detect not only positive, but also negative spatial autocorrelation of inefficiency; (b)The inefficiency follows a truncated normal distribution; and (c) It can distinguish whether the detected spatial autocorrelation is caused by an influence from one’s own inefficiency on the surrounding inefficiency (true spatial spillovers) or by a lack of spatially dependent determinants of inefficiency (spurious spatial spillovers).Furthermore, we use our proposed model to verify whether there is a spatial interdependence of cost inefficiency in Japanese local governments. Our results support that yardstick competition between Japanese local governments is present. It implies that the disclosure of information on local government activities may lead to better efficiency