The Measurement of Environmental Economic Inefficiency with Pollution-generating Technologies

This study introduces the measurement of environmental inefficiency from an economic perspective that integrates, in addition to marketed good outputs, the negative environmental externalities associated with bad outputs. We develop our proposal using the latest by- production models that consider two separate and parallel technologies: a standard technology generating good outputs, and a polluting technology for the by-production of bad outputs (Murty et al., 2012). While research into environmental inefficiency incorporating undesirable or bad outputs from a technological perspective is well established, no attempts have been made to extend it to the economic sphere. Our model defines an economic inefficiency measure that accounts for suboptimal behavior in the form of foregone private revenue and social cost excess (environmental damage). We show that economic inefficiency can be consistently decomposed according to technical and allocative criteria, considering the two separate technologies and market prices, respectively. We illustrate the empirical implementation of our approach on a set of established and complementary models using a dataset on agriculture at the level of US states.