The Role of Efficiency as an Explanation of International Income Differences

Why are some countries richer than others? If, as some recent work has suggested, the answer lies not in differences in physical and human capital accumulation but in differences in productivity, this merely shifts the question to: why are some countries more productive than others? This paper investigates differences in productive efficiency as an explanation of international income difference using stochastic frontier analysis. We find that human capital and geography are important in explaining differences in productive inefficiency in a panel of 82 countries over the period 1960-87. We also investigate the effects of government policy, as measured by its fiscal stance, on a subset of OECD countries over a shorter period. We find that increases in the budget surplus are associated with lower levels of productive efficiency in the economy as a whole.