Bus transit technical efficiency using latent class stochastic indirect production frontier

Using an Indirect Production Frontier (IPF), this article examines technical inefficiency within a latent class framework while simultaneously accounting for allocative distortions from operating and capital subsidies. It identifies two latent classes of US public transit systems, one characterized by economies of scale with 16.61% technical inefficiency and the other by diseconomies of scale with 14.16% technical inefficiency. It decomposes technical inefficiency among some of its sources and finds that the incentive tier of federal operating subsidies, regulations regarding years of vehicle use, subsidy-induced allocative distortion from labour overuse relative to capital negatively influence technical inefficiency in all transit systems. For the Latent Class 1 transit systems, the sources of lower technical inefficiency are operating speed, purchased transportation and years-of-vehicle-use regulation. For the Latent Class 2 transit systems, these sources are subsidy-induced capital-labour allocative distortion and the incentive tier component of the federal formula grant.