Econometric Estimation of Technical and Environmental Efficiency: An Application to Chemical Industry in and around Mumbai

There is a large concentration of chemical firms around Mumbai, and the Maharashtra Pollution Control Board has been actively monitoring them. However, there is a large variation in the degree of compliance among the firms measured in terms of ratio of standard to effluent quality. The factors responsible for large variations in the compliance to the pollution standards by the firms might be laxity of formal environmental regulation by the government, use of command and control instruments, and the absence of informal regulation by the communities in the neighbourhood of the firms. The objective of this paper is to compute output-oriented technical efficiency and environmental efficiency using the Stochastic Frontier Approach. In this paper we have incorporated the environmental effects in the stochastic frontier approach and have computed environmental efficiency of the firms. The stochastic production frontier approach allows only one (aggregated) output to be modelled. To incorporate environmental efficiency into a description of the production process of chemical industry, the environmentally detrimental variable has to be specified as an input. Biological oxygen demand (BOD) load and chemical oxygen demand (COD) load is modelled as a conventional input in two different Models. The SFA technical efficiency measure is output augmenting and has to be transformed to allow minimisation of the environmentally detrimental input. The panel data of 50 water-polluting small to medium-scale firms for three-year period of 2004–06 was collected in a primary survey of chemical industries around Mumbai. Finally, we have also estimated "shadow prices" of BOD and COD. These "shadow prices" provide a measure of the cost to firms, in terms of foregone real output, of achieving reductions in BOD and COD and are upper bounds to true shadow prices.