Evaluating the efficiency of municipalities in the presence of unobserved heterogeneity

The paper applies some of the latest advances of probabilistic approach to account directly for unobserved heterogeneity in the estimation of efficiency measures of performance for a sample of 154 Spanish municipalities over the period 2005-2012. Specifically, we develop time-dependent nonparametric conditional measures considering unobserved factors like local government strategies or institutional arrangements that might affect local governments performance. Moreover, we apply a second-stage approach to estimate measures of pure or managerial efficiency, which are an approximation of the unexplained part of the conditional measures after removing the effect of those latent factors. The empirical results suggest that the dynamic effect of those unobserved conditions play an important role as influencing efficiency distribution and the production set. Likewise, we identify that this influence has been more emphatic towards the core of the economic and financial crisis period. In terms of policy implications, our empirical findings suggest that Spanish municipalities could not cope and adapt their administration strategies properly and in time with the ongoing volatile crisis environment.