Cost efficiency of Slovenian water distribution utilities: an application of stochastic frontier methods

This study estimates cost inefficiency and economies of scale of Slovenian water distribution utilities over the 1997-2003 period by employing several different stochastic frontier methods. The results indicate that significant cost inefficiencies are present in the utilities. An introduction of incentive-based price regulation scheme might help resolve this problem. However, the inefficiency scores obtained from different cost frontier models are not found to be robust. The levels of inefficiency estimates as well as the rankings depend on the econometric specification of the model. The established lack of robustness can be at least partly explained by different ability of the models to separate unobserved heterogeneity from inefficiency. Newly proposed true fixed effects model (Greene, J Econom 126:269-303, 2005; J Prod Anal 23(1):7-32, 2005) appears to perform better than the conventional panel data models with respect to distinguishing between unobserved heterogeneity and inefficiency. On the other hand, different models produce fairly robust results with respect to estimates of economies of output density, customer density and economies of scale. The optimal size of a company is found to closely corresponds to the sample median. Economies of scale are found in small-sized utilities, while large companies exhibit diseconomies of scale.