Productivity and efficiency: Do we need a bridge?

Abstract

The paper focuses on comparing two popular approaches to estimating firm production technology: the proxy-variable method and the stochastic frontier (SF) analysis approach. We show that although the economic interpretations of productivity and efficiency are not the same, the difference between them is not fundamental and even trivial as far as the estimation techniques are concerned when the same structural framework is assumed. By showing the connection and comparing the difference between these two methods, this paper is aimed at building a bridge to connect these two strands of literature. In addition, we provide the SF audience with a new estimation method, i.e., the modified proxy-variable method, with its advantages in handling the endogeneity issue, along with a new way to estimate technical inefficiency. We examine their finite sample performance using Monte Carlo simulations. In the empirical section, we compare the proposed estimator with the conventional MLE SF estimator using Chinese manufacturing firms in the computer and peripheral sector over the period 1998 to 2007. We find that the estimates from our method are more reasonable in explaining the production behavior of these firms, and firms’ technical inefficiency levels are highly persistent over time.