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Measuring technical and allocative efficiencies for banks in the transition countries using the Fourier flexible cost function

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Abstract

The transition economies are known to have quite different market structures from the market economies. State-owned banks accounts for a major part of the financial sector in East European countries before the transition period. Since the input prices of the sector are frequently under the control of those governments, the misallocated resources may incur the loss of economic efficiency. This paper attempts to gauge the technical and allocative efficiency using unbalanced panel data of 340 banks from 14 transition countries under the framework of the Fourier flexible shadow cost function. Accommodating technical and allocative efficiencies simultaneously, as suggested by Atkinson and Cornwell (Int Econ Rev 35:231–243, 1994a) and Kumbhakar and Wang (J Econom 134:317–340, 2006a), avoids potential specification errors and leads to consistent parameter estimates. The average total cost savings resulting from greater technical and allocative efficiency are around 28.31 and 7.13%, respectively. Foreign-owned banks are found to be the most economically efficient. The enforcement of financial liberalization does gradually improve upon the sample banks’ technical efficiency. The allocative inefficiency arises from over capitalization and excess funds. Scale diseconomies appear to prevail in the sample states with a few exceptions.

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Notes

  1. New private banks are the banks that were established by private entrepreneurs after 1989, while older banks are the banks that were privatized before 1989.

  2. Due to the serious problem of data missing on the personnel costs in Bulgaria between 1993 and 1998, we exclude the country completely.

  3. Ownership characteristics are identified according to whether the holding of a bank’s shares is in excess of 50% by the specific owners.

  4. As data on the number of employees are either missing or unavailable for many sample banks, the price of labor is defined as the ratio of personnel expenses to total assets. In other words, the item of total assets is used as a proxy to the number of employees. Altunbas et al. (2000, 2001), Weill (2004), Fries and Taci (2005), and others utilize the same definition.

  5. We respectively re-parameterize H 2/H 1 and H 3/H 1 using the three ownership dummies. The estimation results show that the AI parameters of both capital and funds are less than unity, but only the former reaches statistical significance. This indicates that banks in transition countries are inclined to over-utilize input capital regardless of ownership types. We next divide the entire sample period into two sub-periods, i.e., 1994–1998 and 1999–2004, to investigate whether the AI parameters change over time. The coefficient estimates of the dummy variable are found to be insignificant, meaning that the allocative inefficiency is neither getting worse nor better across the two sub-periods.

  6. We also estimate the FF cost functions under the assumption of achieving allocative efficiency, but the results are not shown to save space. Generally speaking, the parameter estimates are quite different from the ones shown in Table 7 and much less number of those estimates attains the 10% significance level. Recall that the failure of modeling both TI and AI is apt to result in biased parameter estimates.

  7. It is important to note that the average potential percent cost reduction is 32.68% for the translog model using the same data. Such a difference in cost reduction can be attributed to the superiority of the FF function which fits the data more closely than the translog function.

  8. We also estimates the potential percent cost savings under the assumption of achieving allocative efficiency. The average TE scores equal 83.30%. Compared with Table 8, the model of ignoring AI leads to biased parameter estimates, consistent with the finding of Kumbhakar and Wang (2006a), which in turn leads to an overestimation of the TE measures. In addition, the calculated average scale economies measure is slightly greater than unity, implying the prevalence of economies of scale.

  9. Bauer et al. (1998) argue that measuring efficiency by acceptable approaches should yield efficiencies which are fairly stable over time, and regulatory policies targeted specifically at either very efficient or very inefficient firms should still hit their marks after normal policy and implementation lags. Our FF cost function appears to produce reasonably stable TE scores over time.

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Authors and Affiliations

  1. National Chengchi University, Taipei City, Taiwan

    Tai-Hsin Huang & Kuan-Chen Chen

  2. National Taiwan University, Taipei City, Taiwan

    Chung-Hua Shen

  3. Chung Yuan Christian University, Chung Li, Taiwan

    Shen-Ju Tseng

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  1. Tai-Hsin Huang
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  2. Chung-Hua Shen
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Correspondence to Tai-Hsin Huang.

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Huang, TH., Shen, CH., Chen, KC. et al. Measuring technical and allocative efficiencies for banks in the transition countries using the Fourier flexible cost function. J Prod Anal 35, 143–157 (2011). https://doi.org/10.1007/s11123-010-0181-3

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