The indexes themselves could be formulated as, e.g. logeiui1t0.5 u2t2ti1 log
0.5 t 2
log 2t log,
i 1,2, n.
38 In this formulation, the second-order eects and the cross eect between t and
log are assumed to be identical in each of the n eciency indexes. In 38, the expression ui1u2t log
indicates } multiplied by 100 } by how many per cent the eciency of factor i increases from period t to period t1, and the
expression ti1t2 log t denotes by how many per cent the eciency
index increases, if the production level is increased by 1. Other formulations might prove equally useful, and other exogenous factors in addition to time,
t }
such as machine eciency, squared time dierences in the capital stock representing internal costs of installingremoving capital equipment, mean age
of the capital stock capturing vintage-eects, eduction levelhuman capital, fuel-eciency, climate, land, infrastructure, public RD, etc. } may enter the
eciency indexes as well.
Fortunately, it turns out that eciency indexes of the form 38 render any stripped down exible cost function exible in t and , as shown below for
more details and a numerical example, the reader is referred to Thomsen, 1998, Appendix B. Consider a stripped down long-run translog cost function,
logCHa0log
A logP0.5 logPB logP where A is a n]1 vec- tor of parameters summing to unity, and B is a n]n symmetric matrix of
parameters with rows and columns summing to zero. Consider also the standard long-run translog cost function: logCHa0A logPattay log
0.5 logPB logPBt logPtBy logP log
0.5a tt
t 2btyt log0.5ayy
log
2, where at, ay, att, bty and ayy are scalars, and Bt and By are n]1 vectors
of parameters summing to zero see Christensen et al., 1971,1973, or Diewert and Wales, 1987, p. 46. Now, let X1, X2, W1, W2 and U be n]1 vectors of the
eciency parameters of 38 i.e. with identical elements of the three vectors X2, W2 and U. It can be shown see Thomsen, 1998, Appendix B, for more
details that augmenting the stripped down translog with eciency indexes of the form 38 results in the standard translog, with the following relationships
between the 2n3 free parameters of at, ay, att, bty, ayy, Bt and By on the one
hand, and the 2n3 free parameters of X1, X2, W1, W2 and U on the other:
atX1A, ay1W1A, BtBX1, ByBW1, attX2AX1BX1, ayyW2AW1BW1, btyUAW1BX1. These relationships yield
a completely new way of interpreting the translog trend- and scale-parameters, since these can be directly translated into eciency parameters, and vice versa.
And since the stripped down translog can mimic the factor price substitution of any other stripped down exible cost function to a second-order degree, it
follows that eciency indexes of the form 38 render any stripped down exible cost function fully exible in t and .
14 T. Thomsen
Journal of Econometrics 97 2000 1}23
10 Regarding scale-eects, the quadratic formulation of the -eects in 39 or in the more restricted 38 is exible enough to make possible the presence of U-shaped long-run average costs,
ACHCH . With ti1t1, ti2t2, and i, the scale-eects are of the so-called
`Nerlove- Ringstada type cf. Zellner and Ryu, 1998.
11 This is the normal case. However, if the substitution is very large, the use of factor i itself might even rise, if it gets more ecient. This would be the case if the own-price elasticity of factor i is below
1. Besides, a rise in the eciency of factor i rises the use of those of the other factors that are complementary to i negative cross-price elasticities.
In spite of 38 being fully exible, one could, however, relax the restriction that the second-order eects are identical for the dierent indexes. Thus, a more
general formulation would be the following: logeiui1t0.5 ui2t2ti1 log
0.5 t i2
log 2it log,
i 1,2, n.
39 Here, if ui1u1, ui2u2, and i i.e., the ui1s the ui2s, and the is
are identical, technological change is Hicks-neutral unbiased. If ui1ui2 i0, except the ui1-, ui2-, and i-parameters of the labour eciency index,
technological change is Harrod neutral labour augmenting. And if ui1ui2 i0, except the ui1-, ui2-, and i-parameters of the capital eciency index,
technological change is Solow neutral capital augmenting. If ti1t1, ti2t2, and i, the production function is homothetic
unbiased scale eects. Specically, if ti1t1, ti20, and i0, the pro- duction function is homogenous of degree 11t1. The restriction
ti1ti2i0 implies constant returns to scale.10 Regarding the eciency index approach, it is nally worth mentioning that
the way these eciency indexes inuence the long-run demands can be decom- posed using the following simple relationship:
R logXHIE R log e, 40
where XH is a n]1 vector of the long-run factor levels, I is a n]n identity matrix, E
is a n]n matrix of long-run partial price elasticities, and e is a n]1 vector of
eciency indexes. From this relationship, it is seen that if there is no factor substitution E0, an increase in the eciency of factor i by 1 simply causes
a corresponding decrease in the use of factor i itself by 1. If there is non-zero factor substitution, the use of factor i would fall by less than 1, and this is
`useda to reduce the levels of one or more of the other factors as well.
11 If the formulation 39 is used, the trend- and scale-eects can be decomposed into
R logXHRtIEX1X2tU log
, and
R logXHR logIEW1W2 log Uti,
where X1, X2, W1, W2 and U are n]1 vectors of the eciency parameters of
39, and i is a vector of ones.
