Efficiency Analysis and the Insights that the Right Tools Can Deliver

Efficiency Analysis and the Insights that the Right Tools Can Deliver

Stochastic Frontier Analysis

The authors behind A Practitioner’s Guide to Stochastic Frontier Analysis Using STATA take you inside a powerful new tool and important analytical method.


Worldwide, given the limited resources available, efficiency improvement is often regarded as one of the most important goals behind many social and economic policies and reforms. Examples are numerous. For instance, opening up of markets to competition, the removal of trade barriers, and the privatization of state enterprises are all motivated, at least in part, by the potential for efficiency improvements. At a high level, many policies are well understood by economists, but when you consider the details and the specifics of individual industries within the economies, things are less clear.

For instance, why do some firms achieve greater efficiency gains than others? What are the determinants of the efficiency gain? Has privatization generally “worked” or is it the opening of the market to competition, rather than privatization per se, that has resulted in efficiency improvements? Has regulation or, for that matter, deregulation been successful? And, at an industry level, are some reforms more successful than others?

Similar questions arise with respect to different forms of corporate ownership and the public-private interfaces within an economy. For instance, when we consider publicly owned corporations, public private partnerships, not-for-profit companies, family owned firms, private companies, or the recent influx of private equity investment, which forms of ownership turn out to be the most effective, and does this depend on the sector? Public-private partnership are frequently used in many parts of the world, but is such an approach really the most cost effective route in all cases?

At a micro-level, within businesses, there are numerous critical questions that would benefit from the insights available from rigorous analysis. For example, a key strategic question may be whether or not a take-over or merger with a current competitor makes sense. Although there are multiple reasons for considering takeovers, one of the key questions to answer is whether it will result in cost efficiency improvements and/or cost savings through economies of scale and scope. A business may be interested in knowing whether a profit-sharing scheme would help boost employees’ incentives and increase.

Stochastic frontier analysis (SFA) is a powerful tool that can be used to investigate all the above issues (and more). However, everyday applications of SFA has been somewhat limited to the expert practitioner or academic and often we have seen policy decisions being made based on incorrect insights due to the use of inferior tools. As such, we spent close to a decade developing the coding together with a step-by-step guide in order to make it relatively straightforward to carry out the complex computations necessary to both estimate and interpret SFA models. A Practitioner’s Guide to Stochastic Frontier Analysis Using STATA is the result.

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