Adjustment of Inputs and Measurement of Technical Efficiency: A Dynamic Panel Data Analysis

The purpose of this paper is to construct a dynamic stochastic production frontier incorporating the sluggish adjustment of inputs, to measure the speed of adjustment of output, and to compare the technical efficiency estimates from this dynamic model to those from a static model. Assuming that the adjustment speed of all inputs is similar for every production unit, a linear partial adjustment scheme for output characterizes the dynamic frontier. We provide the estimation method for technical efficiency of production units and the speed of adjustment of output for cases when they are time-invariant and when they vary over time. We apply our methods to a panel dataset spanning nine years of data on private manufacturing establishments in Egypt. The dynamic frontiers with time-invariant and time-varying technical efficiency are estimated using the system GMM (generalized method of moments) estimator and the GLS (generalized least squares) estimator with instrumental variables, respectively. The results show that 1) the speed of adjustment of output is significantly lower than unity, 2) the static model overestimates technical efficiency on average, 3) the magnitude of this overestimation varies from 1.5 percentage points to 28.8 percentage points, depending upon the model under consideration, and 4) the dynamic model captures more variation in the time pattern of technical efficiency of a production unit. Further, the ranking of production units based on their technical efficiency measures changes when the lagged adjustment process of inputs is taken into account.