Drivers of Regional Efficiency Differentials in Italy: Technical Inefficiency or Allocative Distortions?

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  • Drivers of Regional Efficiency Differentialsin Italy: Technical Inefficiency or

    Allocative Distortions?


    ABSTRACT This paper estimates regional economic efficiency differentials at the firm level

    for the Italian manufacturing sector in the period 19982003. We implement an input distance-

    function approach providing measures of both technical inefficiency and allocative distortions in

    the choice of input mixes. Our results confirm the substantial technical efficiency gap suffered by

    firms located in Southern regions, thus providing empirical support for the structural and tech-

    nological gap interpretation of Italian dualism. On the other hand, the allocative distortions in the

    use of inputs show less-remarkable regional differences. In terms of policy, our results suggest the

    need for a reallocation of public resources for development policies from business incentives to

    public investment.


    T he dualistic structure of the Italian economythe so-called Mezzogiorno1

    and the rest of the countryis probably unique among the countries of theEuropean Union. Public intervention for the economic and social development ofSouthern Italian regions dates back to the 1950s, since when there has beenimplementation of both demand- and supply-oriented policies.2 However, theItalian Mezzogiorno still lags behind the rest of Italy.

    It has been acknowledged that demand-linked regional policies since the 1980shave not produced positive results, and supply-side-based interpretations of Italys

    Fabrizio Erbetta is an assistant professor in the Department of Management and Territorial

    Studies, The University of Eastern Piedmont, Via Perrone 18, Novara, I-28100, Italy. He is a research

    associate at the Ceris-CNR (Institute for Economic Research on Firms and Growth) and HERMES

    (Higher Education and Research on Mobility Regulation and the Economics of local services), Via

    Real Collegio 30, Moncalieri (TO), I-10024. His e-mail address is:

    Carmelo Petraglia (corresponding author) is an assistant professor in the Department of Economics,

    The University of Naples Federico II, Complesso Universitario di Monte SantAngelo, Via Cinthia,

    80126, Naples, Italy. His e-mail address is: We thank Graziano Abrate,

    Ciro Avitabile, Matteo Ferraris, Giovanni Fraquelli, and Adriano Giannola for useful discussion. We

    are indebted with three anonymous referees whose comments significantly helped to improve the paper.

    Usual disclaimers apply.

    Growth and ChangeVol. 42 No. 3 (September 2011), pp. 351375

    Submitted July 2010; revised February 2011; accepted March 2011. 2011 Wiley Periodicals, Inc

  • dualism have gained credibility and promoted public policies in the shape of bothincentives to private capital accumulation and public investment. The emphasisput on either incentives to private investment or public investment policies crudelyreflects the two alternative supply-side explanations for Italys dual economicstructure, i.e., it reflects the market-oriented and the structural and technologi-cal gap views (Destefanis 2001).

    According to the market-oriented view, market failures in the efficient alloca-tion of resources are more severe in the Mezzogiorno than in the Northern Italianregions. In this view, allocative inefficiency is regarded as the main source ofperformance differentials between Southern and Northern firms. Hence, firmsneed well-designed incentives in order for local resources to be employed mosteffectively and efficiently, in the presence of soft external public intervention.On the other hand, those scholars who adhere to the view of a structural andtechnological gap emphasise the role played by the structural poverty of theMezzogiorno economy producing a less-favourable environment (e.g., transportand communications, education, and public order), which considerably reducesthe technological possibilities of local firms. Indeed, given the uncertainty of theeconomic system, many Southern entrepreneurs may be reluctant to undertakeinvestment programmes aimed at improving technology and at enhancing theiroperating scale. At the same time, there are few incentives for workers to improvetheir skills or to benefit from learning opportunities (Cenci and Scarlato 2002).The combined effect of these factors is likely to hamper technical efficiency.Hence, public investment is crucial for improving environmental conditions andreducing uncertainty.

    Because of the complexity of the problem in terms of both the number ofvariables involved in the analysis and its historical persistence, it would be mis-leading to lean toward one or other of the explanations referred to above. However,in terms of the implications for policy, it is clear that empirical support for theseviews would help in the design and implementation of effective policies thatwould enhance productivity in the Mezzogiorno economy.

    With this in mind, we evaluate the productivity gap between Southern firms andthose located in the rest of the country by estimating sector-specific input distancefunctions. This approach will allow us to distinguish regional differentials relatedto technical inefficiency, from those due to allocative distortions in the choice ofinput mixes. We interpret the presence of the former as supporting the structuraland technological gap view and the latter as supporting the market-oriented view.

    The paper is structured as follows: The second section briefly reviews thealternative supply-side views of Italian dualism and introduces the main featuresof recent development policies for the Italian Mezzogiorno. The third section


  • discusses methodological aspects of the input distance function, and the fourthsection presents the data set and the model. The empirical specification is providedin the fifth section, and the sixth section summarises the results. The mainconclusions are presented in the last section of the paper.

    Regional Development Policies and Supply-side Interpretations ofItalian Dualism

    Development policies for the Italian Mezzogiorno. During the 1980s, Italianregional policies were based on measures aimed at stimulating the demand side ofthe economy by means of fiscal subsidies to firms and income support for house-holds and job creation measures in the public sector. These policies were based onthe idea of endogenous development: Supporting local demand was expected tocreate local supply and boost local industrial activities. This strategy failed,however, because of the strong economic dependence of the Mezzogiorno onNorthern regions. Supporting local demand, far from stimulating local supply, ledto increased imports from the North, which crowded out local industrial activities(Del Monte and Giannola 1997). Following this policy failure, supply-side inter-pretations of Italian dualism gained credibility in the late 1990s, promoting aswitch to policies based on both incentives for private investment and productivepublic expenditure.

    Since the late 1990s, a new strategy of public intervention has been adopted inan attempt to reconcile policy-making confidence in the capabilities of less-developed areas to attain endogenous development, with calls for extensiveexternal intervention aimed at improving the local, social, and economiccontext. The declared ultimate aim of this strategy was the creation of the condi-tions required for a self-sustaining development process through improvements tothe socio-economic and institutional context of the area. A distinguishing featureof this new policy of public intervention is a bottom-up strategy in which bothplanning and implementation processes are extensively decentralised to regionaladministrations.3

    Development policies are designed to improve market competition for labour,goods, and financial capital; communications; training of human resources andinnovation opportunities; social infrastructures; internal relations; externalitiesfrom agglomerations of entrepreneurial activities; and accessibility to natural andcultural resources (Barca 2003, 2006). The main instruments employed to achievethese ambitious goals fall into two categories: incentives for private investmentand the provision of public goods via public investment. From a policy-makingpoint of view, support for business should be temporary and should foster capitalaccumulation (and thus local employment and income) in less-developed areas to


  • enable the takeoff of local-growth processes. Local growth will only be enabled ifsupport for local private investment is balanced by public investment aimed atimproving the context of backward regions in terms of the endowment of publicgoods to match conditions in the leading regions (Ministero dello SviluppoEconomico 2006).4 However, despite this declared strategy of balanced interven-tion, data on public spending (Table 1) show that the Mezzogiorno has not ben-efited from better provision of material and immaterial infrastructures comparedwith the rest of the country. On the other hand, per capita expenses relative tospending on industry and services, which is related mainly to business incentives,show the greatest differential between the two macro-regions.5 Although theprovision of business incentives could be seen as an attempt to allocate resourcesto Southern firms by supporting their competitiveness and survival, it is debatablewhether this strategy will succeed without sustained efforts to make the techno-logical and institutional setting more attractive.


    South Centre-North

    2000 2001 2002 2003 2000 2001 2002 2003

    Environment 46.1 53.4 43.6 39.3 46.2 46.4 53.2 62.5Energy 80.9 59 74.3 85.3 103.9 112 135.7 119.1Cultural

    services32.7 36.2 24 29.1 48.6 46.1 46 54.1

    Education 80.2 91.7 102.7 103.3 86.2 97.5 112.4 120.4Industry and

    services202.8 299.3 333.2 275.9 100.1 111.8 159.4 155.9

    Public health 30.3 41.8 34.1 35.9 56.3 55.2 56.7 60.2Transport

    networks214.7 254.9 221.2 234.9 243.6 292.6 327.6 374.1

    Public orderand lawenforcement

    16.5 22.5 27.2 19.4 18.8 21.6 34.4 33.4

    Note: Although reported data refer to the period 20002003, similar evidence isavailable for most recent years.Source: Own elaboration of Conti pubblici territoriali, Dipartimento per lepolitiche di sviluppo.


  • Supply-side interpretations of the Italian dualism. As already argued, pri-oritising either well-designed incentives or public-investment policies reflects thetwo different supply-side interpretations of Italian dualism: the market-orientedand the structural and technological gap views. The key point for market-orientedscholars is the higher extent to which Southern firms fail to allocate availableproductive resources efficiently. There are many examples of this. Asymmetricinformation between the two sides of the labour market due to uncertainty aboutthe workers real skills on the one hand, and the opportunities for career advance-ment offered by the firms on the other, results in a mismatch between the twogroups of agents in this market and leads to inefficient allocation of the workforce(Cenci and Scarlato 2002). In addition, credit market imperfections can lead toincorrect evaluation of investment projects, resulting either in under-investment orin firms being forced to use their own resources to finance investment. Hence,performance differences across Italian regions are mainly seen as stemming fromhigher input allocative inefficiency in the South and, in this view, well-designedincentives for firms should produce an efficient exploitation of resources.

    Figure 1 illustrates this point. Assuming a simple technology uses two inputs(xi and xj, whose respective prices are wi and wj) to produce one output, the inputcombinations at the boundary of the feasible input requirement set, BB, aretechnically efficient because it is not possible simultaneously to reduce further theuse of all inputs. However, the units at the boundary are not equivalent in terms oftheir allocative efficiency. According to Schmidt and Lovells (1979) definition, a



  • producer is allocatively efficient if it succeeds in allocating inputs in such a waythat the marginal rate of technical substitution equates the input price ratio. InFigure 1, while the input combination of unit F ensures cost minimisation, unit E,although technically efficient, does not, as it shows excessive use of input j withrespect to input i, given the market input prices. This distortion in input demandlevels disappears at the input shadow price ratio wsi/wsj. This means that, for firmmanagers deciding about input demand, the relevant relative prices diverge tosome extent from actual (market) prices. This divergence may be due to a numberof environmental factors that make the objective of cost minimisation unafford-able. The divergence between the shadow price ratio and the market price ratioprovides a direct measure of the allocative distortion embedded in a given inputmix.6 When the allocative distortion is such that some inputs are systematicallyfavoured over others, there is a need for proper business incentives aimed atstimulating adjustments to the input demand decisions that are consistent with themarket price set.

    Adherents to the structural and technological gap view (e.g., Costabile 1996)emphasise the role played by the structural poverty of the Mezzogiorno economyin terms of its less-favourable environmental conditions. According to this view,technical efficiency can be regarded as the main source of regional differences inperformance. As Figure 1 shows, the input mix of unit D is allocatively efficient,but the input levels are technically inefficient. Therefore, public policies should beaddressed mainly to removing, or at least mitigating, those factors that system-atically foster the overuse of inputs. In this case, an integrated system of publicinterventions (including, e.g., improved communication and transportation infra-structures, establishment of high-quality education systems, and enforcement ofpublic order) may be regarded as more suited to creating the conditions for privateinvestment in less-developed areas to be more productive.

    Modelling Technical Inefficiencies and Allocative DistortionsEconomic efficiency involves technical and allocative components (Farrell

    1957). In general terms, technical efficiency reflects the managers capacity tominimise input utilisation and to reduce waste, while the concept of allocativeefficiency is based on the ability to define a cost-minimising input mix, givenmarket factor prices. The approach used to derive estimates of technical efficiencyand allocative distortions is the input distance function. Furthermore, becausetechnology ca...


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