Abstract
• Uses a panel data stochastic frontier model with firm fixed effects and inefficiency. • Address endogeneity of inputs using economic behavior. • Models persistent allocative inefficiency. • Address incidental parameter problem. • Compute cost of technical and allocative inefficiency. In this paper, we consider a state-of-the-art panel stochastic production frontier model and estimate it using a system that includes both technical and allocative inefficiency. The system consists of the optimal input choice rule (the first-order conditions (FOCs)) under cost minimization together with the production function. The FOCs are used to take care of endogeneity of inputs. Allocative inefficiency is modeled as non-fulfillment of the FOCs. We use distributional assumptions on the noise and inefficiency components and estimate the model parameters using the maximum likelihood method. In estimating technical and allocative inefficiency components and costs therefrom we control for fixed firm-effects in each equation of the system. We also correct for the incidental parameter bias by using the half-panel jackknife estimator.
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