Output and Input Efficiency of Manufacturing Firms in India: A Case of the Indian Pharmaceutical Sector

Transcription

1 Output and Input Effcency of Manufacturng Frms n Inda: A Case of the Indan Pharmaceutcal Sector Manak Mazumdar, Meenaksh Raeev and Subhash C Ray

2 ISBN , Copyrght Reserved The Insttute for Socal and Economc Change, Bangalore Insttute for Socal and Economc Change (ISEC) s engaged n nterdscplnary research n analytcal and appled areas of the socal scences, encompassng dverse aspects of development. ISEC works wth central, state and local governments as well as nternatonal agences by undertakng systematc studes of resource potental, dentfyng factors nfluencng growth and examnng measures for reducng poverty. The thrust areas of research nclude state and local economc polces, ssues relatng to socologcal and demographc transton, envronmental ssues and fscal, admnstratve and poltcal decentralzaton and governance. It pursues frutful contacts wth other nsttutons and scholars devoted to socal scence research through collaboratve research programmes, semnars, etc. The Workng Paper Seres provdes an opportunty for ISEC faculty, vstng fellows and PhD scholars to dscuss ther deas and research work before publcaton and to get feedback from ther peer group. Papers selected for publcaton n the seres present emprcal analyses and generally deal wth wder ssues of publc polcy at a sectoral, regonal or natonal level. These workng papers undergo revew but typcally do not present fnal research results, and consttute works n progress.

3 OUTPUT AND INPUT EFFICIENCY OF MANUFACTURING FIRMS IN INDIA: A CASE OF THE INDIAN PHARMACEUTICAL SECTOR Manak Mazumdar, Meenaksh Raeev 2 and Subhash C Ray 3 Abstract Ths paper examnes the compettveness of Indan pharmaceutcal frms by computng ther techncal effcency for the perod 99 to 2005 usng the non parametrc approach of data envelopment analyss (DEA). The analyss establshes that even though the output effcency levels of frms reveal a declnng trend, frms have been able to make effcent use of labour and raw materal nputs. An analyss carred out to dentfy the determnants of techncal effcency reveals that n contrast to popular belef, nether R&D and export expendture nor the use of mported technology mprove the techncal effcency of frms. Introducton The Drugs and Pharmaceutcal sector of Inda flourshed under the process patent regme of 970 that regned for more than four decades. The flexble provsons of the Patent Act of 970 helped the Indan frms to mtate patented products of foregn frms, master the technque of reverse engneerng and, n most cases, come out wth even better process technology for the same products. The comparatve advantage of the ndustry was therefore, an outcome of the Patent Act of 970. It favorably nfluenced the Indan producers to create a nche for themselves (Kumar, 2004; Watal, 997; Razada, 2002). However, the Trade Related Aspect of Intellectual Property Rght (TRIPS) n the World Trade Organsaton(WTO) agreement compelled Inda to recognse product patent for a perod of about 20 years. The recognton of product patent n the amended verson of the Patent law passed on st January, 2005, posed a maor challenge and threat to the Indan pharmaceutcal ndustry that had flourshed under the process patent regme of 970. The change n the polcy sparked consderable debate much of whch was centered around the future prospect and fate of Indan pharmaceutcal frms. It s argued by crtcs ( Pharmaceutcal assocatons lke the Inda Drug Manufacturng Assocaton (IDMA) and scholars lke Chaudhur (2004, 2005), Lanouw (997) and Watal (997, 2000) that because of the polcy changes Indan generc frms would be unable to fully explot ther core competences n reverse engneerng and adhere to the age long strategy of mtaton. Consequently, the polcy change mght not be conducve for ts future growth and development, unless the frms re-orent ther strateges and restructure ther modes of operaton n tune wth the changed scenaro. Manak Mazumdar, Ph.D, Fellow Centre For Economc Studes and Polcy (CESP), Insttute for Socal and Economc Change (ISEC) Bangalore Inda, Emal- mmaumder@sec.ac.n,manakecon@gmal.com 2 Meenaksh Raeev, Professor, Centre For Economc Studes and Polcy (CESP), Insttute for Socal and Economc Change (ISEC) Bangalore Inda, Emal- meenaksh@sec.ac.n 3 Subhash C Ray, Professor, Unversty of Connectcut, Storrs CT, USA , Emal- Subhash.ray@uconn.edu

4 Nevertheless, the reforms n the Drugs and Cosmetcs Act (994 and 2002) as a part of the lberalsaton polcy of 99 also mnmsed the hurdles of regulaton and facltated the smooth functonng of frms n response to market forces. Partcularly, polces lke the abolton of the ndustral lcensng requrements for all varetes of drugs, removng the restrctons on mport of bulk drugs, scrappng the lnkage requrement, lmtng the scope of prce control and the automatc approval for foregn ownershp up to 00 percent wth foregn technology arrangement, allowed frms to mport better qualty raw-materal and technology, ntroduce new product s and processes and face the challenges that mght arse due to recognton of Product Patent. It was also felt that the removal of trade restrctons and recognton of product patent would allow more technologcal collaboraton wth foregn multnatonal enterprses (MNE) whch n turn would have a postve spllover effect on the productvty of the sector. Thus, whle on the one hand the amendment of the patent law was a maor challenge, for the Indan pharmaceutcal frms, on the other hand the removal of domestc regulaton also opened new opportuntes for Indan pharmaceutcal frms. In response to the polcy changes and growng competton there were some changes n the strategc behavour of the frms. We may take for example the case of R&D. When the frst verson of the TRIPS Agreement was enforced n 995 most of the Indan companes were producng low value generc products because of whch the R&D facltes n the ndustry were scanty. However, from 995 onward s there was a dramatc rse n the number of pharmaceutcal frms havng R&D unts and large number of Indan pharmaceutcal frms started nvestng n R&D. Ths was done ether to come out wth nnovatve products or to enter nto technologcal collaboraton wth global pharmaceutcal frms. Therefore R&D s now an mportant parameter of the long term proft maxmsaton exercse of these frms. Apart from R&D related actvtes, a large numbers of Indan frms also started exportng ther products to capture the global market and establsh the network and brand names of the companes. In vew of the changes that are takng place n ths ndustry certan questons pertanng to the future performance of Indan pharmaceutcal frms comes to the fore. Frst, has ncreased competton and the resultng changes n the strateges of the frms helped only a small secton of the frms to perform better and the rest, a large number of small and medum frms, been left behnd n the competton? Or s t true that all frms have geared up adequately to the changng scenaro and are catchng up wth the best? If not, what are the factors that explan the dfferental performance of the frms? Addtonal queres can also be made- how s the adopton of varous strateges reflected n the performance of frms? Such strateges may nclude R&D, modernsaton of plant and machnery to meet the export norms etc. These strateges f adopted, nvolve heavy nvestment n plant and machnery but the returns may not be mmedate. Thus a relevant queston to probe s how such strateges have mpacted the performance of the frms. In ths paper we wsh to examne some of these questons. An approprate way to look nto these questons s through an effcency analyss of the frms (methodology s chalked out n secton 5). It looks nto the producton or the techncal aspects of frms and compares the output producton wth the best performng frms n the sample. More precsely t examnes how best a frm s usng ts nputs to arrve at a 2

5 output level vs-à-vs the frms that produces the same level of output. Alternatvely, one can also ask how effcently a frm s producng output for the same level of nputs vs-à-vs the frms that employ more or less smlar level of nputs. Ths led us to the concept of effcency, n partcular the output and nput effcency of the frms. In effcency analyss t s assumed that even when faced wth a smlar envronment, not all frms may be able to allocate ther resources to carry out ther obectves n the most optmal manner. Ths s reflected n the ndcators lke the gap between the maxmum output producble from ts observed nput bundle defned by the producton fronter constructed wth the nput -output of smlar frms n the sample and the actual output produced by a frm. Such gaps ndcate the level of neffcency faced by a frm. In a sense the above exercse looks at the techncal aspects of a frm and places the performance of a frm n terms of producton as compared to smlar frms n the sample. Thus, there s always a comparson of the frms wth the best performng ones n the sample. After calculatng the effcences we also wsh to dentfy the reasons behnd the neffcent functonng of a frm by dentfyng certan determnants. Revew of Lterature In ths connecton we menton n bref some of the studes that have been carred out to examne the techncal effcency for varous ndustres n Inda. On the bass of the technque used for analyss, studes that have examned the effcency of the Indan manufacturng sector can be broadly classfe d nto two groups a) the parametrc approach to effcency analyss and the b) non-parametrc approach to effcency analyss. The central queston of almost all the papers that have used the fronter analyss was to examne the mpact of globalsaton on effcency of the Indan manufacturng frms. Some of the notable studes that have used the parametrc fronter approach to effcency analyss are by Neog and Ghosh (994), Mtra (999), Krshna and Mtra(998), Kalraan and Bhde (2005), Jayadevan (996), Trved (2000, 2003), Srvastava(2000) and others. Usng a tme varyng fronter producton approach, Neog and Ghosh (994) estmated the nter-temporal movement of the techncal effcency of the manufacturng frms. The study ndcated that there has been a fall n the effce ncy of the frms due to globalsaton. An nqury nto the sources of nter-ndustry effcency varatons shows that skll, labour productvty and proft play sgnfcantly postve role s, whle captal ntensty works aganst general belefs. The frm level panel data of some selected manufacturng ndustry was also employed by Krshna and Mtra (998) to examne the productvty and effcency related ssues. The study could not fnd a strong evdence of the productvty or effcency effect of the reform. Srvastava (2000) examned the effcency of the manufacturng frms for the perods between and He found that the techncal effcency of the Indan manufacturng frms had gone down n the post lberalsaton era. The st udy by Kalraan and Bhde (2005) was the frst of ts knd to use the random coeffcent model developed by Swamy (97) and Swamy and Mehta (977), to estmate the fronter producton functon and the effcency of the Indan manufacturng sector. The study ndcate s that due to lberalsaton, the productvty growth of the manufacturng sector has slowed down whch s manly due to a fall n the techncal effcency of the frms. The mpact of lberalsaton, FDI flow and spll- 3

6 over on the effcency gan of the Indan manufacturng frms was studed by Kathura (2000,2002) and also by Sddharthan and Lal (2004) usng the stochastc fronter approach. A number of studes have also employed the non-parametrc Data Envelopment Analyss (DEA) approach to examne the effcency and productvty of the Indan manufacturng sector. Usng the frm level data and employng the non -parametrc technque of DEA to estmate the effcency of the frms, study by Ray (2002) ndcates that the average effcency of the Indan manufacturng sector had declned between 99 and 996. There was however, some mprovement n the effcency after 996. The study also ndcates that frms wth foregn ownershp or Mult-Natonal Enterprses are sgnfcant n explanng effcency. The non-parametrc approach has also been employed to examne the dynamcs of effcency for the Indan manufacturng sector located n dfferent states by Mukheree and Ray (2005). Utlsng the concept of super-effcency, the study ndcated that there was no change n the rankng of the frms n the post reform perod. Also, no evdence of convergence n the effcency of the frms was notced n the post reform perod. The mpact of the ownershp pattern, partcularly the publc and prvate ownershp, on the effcency was also studed by Rammohan and Ray (2003) for eght dfferent sectors, namely chemcal, electroncs, steel, mneral, non-electrcal, servce, textle and transport, by constructng se parate fronters for each sector. The study ndcated that only for chemcal, ron and steel and textle ndustry the prvate sector s techncal effcency scores were superor; for electroncs and servces, the publc sector s scores are superor and for mnerals, non-electrcal machnery and transport - there was no dfference between the prvate and publc ownershp patterns. As we can make out from the above revew, there are ample numbers of studes examnng the effcency of the manufacturng sector at the nter-ndustry leve l. The mpact of polcy changes however, cannot be assessed adequately by dong an nter-ndustry study, because these studes assume that frms n an ndustry behave alke and therefore the ndustry level characterstcs can be attrbuted to all frms n an ndustry (Sddharthan, 2004). However, wth free market, new frms can enter the market wth advanced technology. Further, the exstng frms can also develop new strateges to cope wth the changng scenaro. Under such crcumstances, the assumpton that all frms n the ndustry are alke s hghly restrctve (Lu and Tybout, 996; Lu 993 and Bartelsman and Doms, 2000). Instead a more n-depth mcro-level study s requred to understand, n a better way, the copng strateges of the frms due to polcy changes. Consequently, a number of studes have also been conducted examnng the effcency at frm level at hgher dgt levels (three dgts or four dgts). Exstng emprcal studes at the ntra-ndustry level can agan be re-classfed nto two groups, vz., parametrc and non-parametrc. The frst group of emprcal works manly apples the parametrc stochastc fronter approach to evaluate the effcency of the frms from dfferent ndustres lke the sugar ndustry (Ferrantno & Ferrer; 995), engneerng ndustry (Goldar et.al. 2004) and textle s (Bhandar and Mat, 2007), and also for frms wth dfferent ownershp patterns (Agarwal, 200). The earlest attempt to examne effcency was however made by Page (984) and Lttle, et al (987), by collectng survey data for frms from ndustres lke shoes, prntng, soap and machne tools. Applyng the parametrc determnstc approach to construct the fronter, the studes dd not fnd any 4

7 sgnfcant dfferences n the effcency of the frms. Snce an overwhelmng proporton of the manufacturng sector s crowded by small frms, a number of studes also examned the effcency of the small scale unts (for e.g, Bhavan, 99 for the metal-product ndustry, Goldar, 985 for soap ndustry Ramaswamy, 994 for machne tools, plastc products and motor-vehcles ndustry). Most of these studes have however, recorded low level of neffcency wth lttle dsperson. The second group of studes employs the non-parametrc fronter technque to compute the effcency. In ths regard, the study by Maumdar (998) evaluates the slack n resource utlsaton by the state -owned enterprses due to soft budget constrant. The dfferences n the techncal effcency for the Indan textle frms were compared by Bhandar and Ray (2008) for dfferent locatons and ownershp patterns by constructng a grand fronter and also locaton and ownershp specfc local fronters nonparametrcally. Concentratng on the Indan pharmaceutcal sector, we found that both the parametrc and the non-parametrc approach for effcency analyss have been used to study effcency for the sector. Usng frm level data for the perod 990 to 200, Chaudhur and Das (2006) estmated the stochastc fronter producton functon to measure the output effcency of the Indan pharmaceutcal sector. The study has shown that the mean effcency scores of the ndu stry had mproved over the sub perod 999 to 200 aganst the sub-perod Further, the study also shows that large szed frms and frms exportng more of ther product n the nternatonal market have reduced ther neffcency. The non -parametrc DEA approach has also been appled by Maumder (994) and Saranga and Phan (2002) to study the output effcency of the Indan pharmaceutcal sector. Maumder (994) studed the capabltes and resource utlsaton of the frms by employng the DEA methodology. The study covers only nne large frms and from 987 to 990. The neffcency levels of the publc sector frms as compared to the prvate players are the man fndngs of the study. From the above revew t s evdent that there are ample numbers of studes examnng the effce ncy of varous ndustres n Inda. However, the relevant effcency related quest ons have not been adequately addressed for the pharmaceutcal sector n Inda. Further, whle measurng effcency earler studes ether used an output orented or an nput orented measure of effcency by mposng a pror assumpton that frms ether maxmse the level of output or mnmse the level of nput use. But optmsng the behavour of a frm requres that a frm maxmses ts level of output and mnmses the nput usage smultaneously. In our study we have, therefore, used a more comprehensve non-parametrc non-radal measure of effcency that smultaneously ncorporates both the potental for the ncrease n the output as well as the reducton n each of the nput s employed by the frms. Ths gves an estmate of nput-specfc neffce nces and the output effcency of the Indan pharmaceutcal frms. The use of ths advanced technque s not common. Only a lmted number of studes have used ths approach (See Ray, 2007). In ths respect the fndngs of the current study are new contrbutons to the lterature. Further, studes that have examned the effcency of Indan pharmaceutcal frms usng DEA have lmted coverage. Our sample covers frms of dfferent szes and over a longer tme perod. The sample sze s a panel of 2492 frms and 5

8 the tme span s 5 years (from 99 to 2005). Banker (993) has proved that DEA based estmators are weakly consstent, but wth such a large sample the estmates of effcency are more precse and accurate. Addtonally, n the exstng paper the second stage analyses to dentfy the determnants of effcences consder manly the sze, age and ownershp patterns of the frms. However, our data base allows us to consder a number of other mportant frm specfc factors. Gven ths background, the rest of the paper s structured n the followng manner. Secton 2 outlnes the non-parametrc approach of the DEA methodology to compute the nput and output effcency of the frms. The databases are reported n secton 3. The man fndng from the emprcal analyss s dscussed n secton 4. Secton 5 dentfes the determnants of the effcency scores of the frms through an approprate model and a concludng secton follows thereafter. Non-Parametrc Data Envelopment Analyss (DEA) The producton or techncal effcency of the frms s computed n ths paper by emprcally constructng the fronter or the benchmark technology consderng the nput -output bundles of the best performng frms n the sample usng the non-parametrc technque of DEA. Whle the non-parametrc approach cannot take care of the randomness of the data generatng process, n our study t s stll preferred over the parametrc approach because t does not mpose an explct functonal form on the observed data ponts. Further, f the underlyng functonal form or the producton correspondence s not known mposng sngle functonal form could lead to the problem of msspecfcatons because there s a wde degree of heterogenety n the structure of Indan pharmaceutcal frms v. Further, non-parametrc DEA effcency scores satsfy asymptotc statstcal propertes (Banker, 993). Banker has shown that DEA s ndeed equvalent to the maxmum lkelhood estmaton, when the producton functon s specfed as a non-parametrc monotone and concave functon nstead of a parametrc form. DEA effcency scores are also consstent and converge faster than the estmators from other fronter methods (Grosskoop, 996, Knep et al, 998) for a large sample. DEA s best suted to examne the effcency of frms wth a farly large sample of an unbalanced panel of 2492 frms for 5 years. To construct the fronter, the nput -output set ( X, Y) of the frms n our sample s conceved as the producton possblty set the equaton of whch s gven by T + + N M = {( X, Y ); X R, Y R :X can produce Y} () The dmenson of the nput bundle X n the sample s 4 ) (. The specfc elements of the nput bundle X are labour, raw materal, power and fuel and captal. The study also conceptualses a sngle output, wth ) ( dmenson for the output bundle Y. Addtonally t s also assumed that (a) nputs and outputs are freely dsposable and (b) the producton possblty set s convex (Ray, 2005). Imposng the above assumpton and employng the Debreu-Farell defnton of effcency the nput orented radal measure 6

9 of effcency proposed by Charnes, Cooper, and Rhodes (CCR) (978) and further extended by Banker, Charnes, and Cooper (BCC) (984) of a frm s TE I ( X, Y ) = mn : ( θx, Y ) T θ (2) Smlarly, the correspondng output -orented radal measure of techncal effcency s TE O ( X, Y ) = max φ : ( X, φy ) T φ (3) Both are radal measures because ether all the nputs n the nput bundle are contracted or all the outputs n the output bundle are expanded by the same proporton. The non-radal measure for effcency analyss on the other hand, captures the potental to expand each of the output and contract each of the nputs of the frms separately to get the output specfc effcency and nput specfc effcency of the frms. To measure the nput-specfc effcences we frst defne the nput set assocated wth the technology set T. For the output vector ŷ the nput set V( yˆ ), s set of collecton of all nputs I whch can produce ŷ, the equaton of whch s gven by M V (ŷ) = { I: (I, y) ˆ T, for each ŷ R } (4) + It s assumed that nput sets satsfy the monotoncty and the nestedness property (Varan, 984). Monotoncty property mples that f Iˆ ~ V(ŷ) and I Iˆ ~ then V(ŷ ) I ths follows from the assumpton of the free dsposablty of the nput n the technology set T. The nestedness property follows from the assumpton of free dsposablty of the output n the technology set T and t mples that f Î V(ŷ) and ~ y yˆ, then Î V(y ~ ). Lastly t s also assumed that V( yˆ ) s convex. The nteror ponts of the nput set are ts neffcent ponts whle the boundary ponts are the effcent pont. The soquant s are the boundary pont of V (ŷ) whch s denoted by the followng equaton: IsoV( yˆ) = { I : I V( yˆ) and λ I V(yˆ ) f < } If IsoV( y) λ (5) Iˆ ˆ the nput orented radal measure of techncal effcency Iˆ, yˆ ) ( wll be equal to unty wth the possble presence of nput slacks v. The presence of nput slacks however does not guarantee that the nput specfc techncal effcences wll be equal to unty. Input specfc techncal effcency s equal to unty only f t s an element of the effcent subset of the soquant the equaton of whch s gven by EffV ( yˆ) = { I : I V ( yˆ ) and I V ( yˆ ) f I I} (6) ˆ If I EffV(y) the nput bundle s effcent n Koopman sense (95), there s no way to produce ŷ wth fewer nputs. Clearly, y EffV ( yˆ ) V(ŷ), Iso but the converse s not always true. The 7

10 F & non-radal measure proposed by areand Lovell (978) measures the nput-specfc techncal effcency of the frms relatve to the ponts n the effcent subset of the soquant. In an output -orented measure for techncal effcency the obectve s to produce the maxmum output from a gven quantty of nputs. For ths we frst defne the output set to be the set of all outputs y produced from the nput vector Î denoted by the followng equaton ˆ N ( Iˆ) = { y : ( Iˆ, y) T for each I R } (7) U + Lke the nput set t s also assumed that the output set also satsfes certan propertes. Thus ˆ) ~ f yˆ I( L and f then yˆ I( L). Ths property follows from the free dsposablty of nputs. L ~ Lˆ ˆ) From free dsposablty of output, f yˆ I( L and f ŷ, then I( L. Fnally, the convexty of the technologcal set T also mples that the output set I (L) s also convex. In an analogous manner the boundary pont of the output set s the producton possblty fronter whch s denoted by the followng equaton IsoU ( Iˆ) = { y : y U ( Iˆ) and θ y U (Iˆ ) f > } y~ ˆ y~ ˆ) θ (8) 0 Thus f y IsoU I), the output orented radal measure of the techncal effcency for the ˆ (ˆ output -nput vector ( y 0, I) equals unty because t s not possble to ncrease all the outputs holdng the nputs constant. Ths does not however preclude the possblty to ncrease some components of the output vector 0 y whch s not possble only f the proecton of the output vector s on the effcent subset of the output soquant the equaton of whch s gven by EffU( Iˆ) { y : y U ( Iˆ) and y U ( Iˆ) f y y} = (9) The non-radal measures of the output and nput specfc techncal effcences of the frms are computed wth reference to the effcent subset of the frms. F & areand The earlest attempt to compute the non -radal measure of techncal effcency was made by Lovell (978) takes the followng form n the model: RM Iˆ, yˆ) = whch they also call the Russell measure. The output orented Russell measure = max m y ( where ρ y φr (0) ρ y r subect to λ yr φr yro; r = ( m) [ r = n our model ] 8

11 λ I I ; =(n) [=4 n our paper] (0a) N = N λ = and λ = 0; = ( N) Wth multple outputs, f output slacks exsts at the optmal soluton of a radal DEA model, the non-radal Russell measure falls below the radal BCC model. Ths s because the radal proecton s always a feasble pont for the non-radal measure and hence the value of non-radal techncal effcency never exceeds the radal effcency measure. The analogous nput -orented non-radal measure of techncal effcency s RM λ I ( Iˆ, yˆ) = ρi where ρi = mn θ () n subect to yr yro; r = ( m) λ I θ I ; =(n) (a) N = N λ = and λ = 0; = ( N) Analogous to the output orented techncal measure the optmal proectons of the observed nput bundle Î takes place n the effcent subset of the soquant of the output ŷ. Output and Input Effcences: The PRS model None of the non-radal measures presented above consder the output orented and nput orented slacks smultaneously; snce, these are ether output orented or nput -orented measures, ether the nput slacks or the output slacks are gnored. The non-radal measure by Cooper and Pastor (995) and extended by Pastor, Ruz, and Srvent (999) however takes care of both the output and nputs slacks smultaneously and s therefore more comprehensve measure of effcency. Pastor, Ruz, and Srvent (999) utlses the concept of the famlar Pareto-Koopman crtera to devse the method of effcency measurement. Accordng to the Pareto-Koopman crtera, an nput -output combnaton s not consdered as effcent f t volates the followng postulates: ) It s possble to ncrease at least one output n the output bundle ŷ wthout reducng any other output and wthout ncreasng any other nput bundle Î ; or 9

12 ) It s possble to reduce at least one nput n the nput bundle Î wthout ncreasng any other nput and wthout reducng any output n the bundle ŷ. Clearly, unless ( I y) ˆ, ˆ RM y ˆ, ˆ = RM I ( Iˆ, yˆ ) =, at least one of the neffcency postulates are volated and ( I y) bundle s not Pareto-Koopman effce nt. An Input -output bundle s Pareto-Koopman effcent only when the followng condtons hold: Iˆ ˆ and () yˆ EffU( I ˆ ) () EffV( y) In the parlance of economc theory suppose that wth reference to EffU (xˆ ), the potental amount of r th output that frm t can produce s y r * whch s obvously hgher than the actual output produced from the same nputs I. (y r *) s the expanded output (vrtual) of the frm on the effcent subset t y and t y / y r * s the techncal neffcency of the frm for the r th output. Suppose φ r be the value of the factor by whch the r th output s scaled up nto the effcent subset of the frm then y* = effcency (TE) for the r th output of the frm = reducton for the th nput by the frm s say I *, r φr. Smlarly, correspondng to the (yˆ φ ) * t y and the techncal EffV the potental θ = I / I s the nput neffcency for the th nput. A non-radal measure Pareto-Koopman measure of techncal effcency for the nput -output par ( I y) s computed as: ˆ, ˆ Γ= θ n mn m r φ r (θ L + θ K + θ E + θrw ) mn 4 φ (2) subect to λ y φ yo (Output) (3) λ L L θ (Labor) (4) L 0 λ K θ K K 0 (Captal) (5) λ E E θ (Energy) (6) E 0 0

13 λ RW RW θ RW 0 (Raw -Materal) (7) N = λ = and λ N = 0; = ( N) Note that the effcent nput -output proecton I * Thus,, ŷ) * * ( L, y ) satsfes * I I ˆ * = λ and y = λ * y yˆ (8) (I ˆ s Pareto-Koopman effcent, ff φ * = for each output r and r θ for each nput, mplyng that Γ =. The Pareto-Koopman effcency measure s a global effcency measure (GEM) and s the product of two factors 2 component (GEMIN) and the second factor γ and γ. The frst factor γ = θ n γ = m φ 2 r r * = s the nput orented s the output orented component (GEMOUT). Thus, whchγ = γ γ 2. The obectve functon Γ n ths mathematcal programmng problem s a non-lnear problem. Followng Charnes and Cooper (968), the form of normalsaton used by PRS to transform ths fractonal functonal programmng problem n to a LP problem restrcted the technology set n the model by non-ncreasng returns to scale, whch s unnecessarly restrctve. Applyng the frst order Taylor seres for Γ at Γ = θ functon as ( θ * = and φ * r = r r, Ray (2007) has shown that t s possble to lneralse the obectve Γ = + θ φr and retan the VRS assumpton. n m Thus solvng the lnear programmng problem: Γ = + n m θ φ (9) r r subect to the same set of constrants llustrated above and substtutng the optmal * *, φ r ) value Γ * = n m r θ φ * * r the effcency measure for s (I, ŷ) s arrved at. In ths regard t s worth mentonng here that the dual of the above programmng has some nterestng nterpretaton. Ray and Jeon (2007) have shown that the dual of ˆ * Γ can be nterpreted as the

14 shadow cost per unt of shadow revenue at the optmal nput-output bundle for a frm. In other word s n the absence of market prce for the nputs and outputs the obectve of mnmsng * Γ closely corresponds to the maxmsaton of the shadow proft for the frms that n turn, gves the proft effcency for the frms. It s to be noted here that ths LP s a more generalzed optmsaton problem wth the same set of constrants, but wth the obectve functon mn βrφ (20) r r Ω = αθ r r ro (2) subect to λ y φ y ; r = ( m) λ I θ I ; ( n) (2a) = N = λ = and λ N = 0; = ( N) n m If α = and βr = r, we get the usual Pareto-Koopman problem. If, on the other hand we set β r = 0 r, we get the usual nput-orented Russell measure. Addtonally f we set, α = α, we get the usual nput-orented radal DEA problem. Smlarly, the restrcton α = 0 leads to the output orented Russell measure. Further, wth the restrcton β r = β r, we get the usual output orented radal DEA problem. Data Sources and Modelng Fronters Over Tme To examne the effcency of the pharmaceutcal companes, frm level nformaton was consdered from 99 to 2005 v. The number of frms n the sample vares from 70 to 289 over the years and n total there s an unbalanced panel of 2492 frms for 5 years. The frms consdered n the study together account for about 80 percent of the total output and 87 percent of the nput usage for the sector for almost all the years. Thus the sample of frms consdered n the study can be vewed as representatve of the sector. The relevant data necessary for the computaton was collected from the fnancal balance sheets of the companes provded by the prowess data source of the Centre for Montorng of Indan Enterprses. The study conceptualses a -output, 4-nput producton technology. The output n the model s the value of total output ( y ) defned as the total sales of the frms plus the change n the stock of output measured n terms of the openng stock mnus the closng stock n output. The nputs n the model are () labour (l) (measured n terms of wages and salares for the workers) () materal nputs (rw) (measured n terms of 2

15 the companes expendture for raw materal), () energy nput (pf) measured s terms of the expendture for power and fuel and (v) captal (k) s the book value for plant and machnery and buldng. To brng the varables n real terms each varable was approprately deflated. The value of output was deflated by the prce ndex for the drug and the pharmaceutcal sector collected from the Reserve Bank of Inda (RBI) monthly bulletns. The expendture for workers was deflated by the Consumer Prce Index (CPI) for manual and the non-manual workers, expendture for fuel and power was deflated wth the prce ndex for fuel, power lghts and lubrcants collected from the RBI bulletns to arrve at the real fgure, the company expendture for raw materal was deflated by the average prce ndex for chemcal and chemcal products from the (Annual Survey of Industry, ASI) data base. The captal stock was avalable as book value for plant and machnery, therefore the Perpetual Inventory Method (PIM) by Balakrshnan et al (2000) s used to deflate the value of captal wth 2003 as the benchmark year. To measure effcency one needed to account for the avalablty of technology and construct fronters at dfferent pont n tmes. In DEA lterature (Tulkens and Vanden Eeckaut, 995) three forms of fronters were dstngushed vz., ) the contemporaneous fronter ) the sequental fronter and ) the ntertemporal fronter. For any gven year say t, the contemporaneous fronter was constructed by consderng only the data pont of the t th year. On the other hand to construct the sequental fronter for the t th year t was assumed that the data ponts and the technology of the prevous years {(t -), (t -2) } are feasble but technology for the future years {(t+), (t+2) } were not avalable. For nter-temporal fronter however, all data ponts are consdered to construct the fronter. In other words, to calculate the nte-temporal fronter for t th year t was assumed that the data ponts and the technology of the prevous years {(t-), (t-2) } as well as the future years {(t+), (t+2) } were avalable. In the lterature the three types of fronters were conceptualsed keepng n mnd the possble techncal progress (regress) n the model (Tulkens and Vanden Eeckaut, 995). Wth techncal progress the producton possblty set and the fronter shfts out; however, ths mportant component of the change could not be captured n the contemporaneous fronter because the benchmark kept changng from year to year. In other words, t was assumed that at each pont n tme the reference set was completely dfferent. Thus, the effcency of the frms computed for dfferent years were not comparable and hence could not be used to understand whether or not the performance of the frms had mproved durng the span of the study perod. In the ntertemporal fronter, a sngle fronter was constructed for all the years and, therefore, t assumed away any techncal progress or regress and no shft n fronter were consdered. The sequental fronter some sort of dependence was assumed between the producton possblty sets that allowed for outward shft of the fronter. It thus allowed for enlarged producton possblty set over the years assumng mplctly no techncal regress. We used the sequental fronter because t was assumed that for the sample years the sector mght have experenced technologcal progress because of greater nvolvement n R&D, mport of captal goods and nvestments n modern plant and machnery etc. 3

16 Emprcal Fndngs Comparng Effcency of Pharmaceutcal frms: In our emprcal analyss, the Pastor, Ruz, and Srvent (999) model (see equaton 2 and 9), that allows for the smultaneous ncrease n the output that a frm produces and also reduces the nputs that t employs, was employed to get the output and nput effcency scores of a frm. Snce a sngle output four nput technology was conceved for the pharmaceutcal frms effcency scores were avalable for () raw - materal, () power and fuel () labour (v) captal (v) and output. Table provdes the average effcency scores obtaned for the frms n the sample for each year. Table : Input and output specfc effcency of the pharmaceutcal sector ( ) () Year (2) Output Effcency φ (3) Materal Effcency θ RM (4) Power and Fuel Effcency θ E (5) Labor Effcency θ L (6)Captal Effcency θ K Consder frst the case of output effcency of a frm. The frst column n table depcts the value of φ (see equaton 2 and 9) that represents the unrealsed potental ncrease n the output of a frm that could be acheved wthout employng any addtonal nput s. More precsely n 99 the average effcency attaned by the frms n the sample was 8 percent. Further, there was a fall n the average effcency for the sector. Smlar conclusons have been arrved at by earler studes (see Ray, 2002; Mukheree and Ray, 2004 ; Ray, 2004; Srvastava, 200; and Parameshwaran, 200) for the Indan manufacturng sector. Consstent fall n the mean output effcency for the sector also mples that compared to the output produced by the fronter frms the producton le vel of the neffcent frms have been fallng over the years. In the context of our study we also found that from 995 onwards there was a fall n the average levelof 4

17 the output effcency of the frms. Snce 995 was the year when the Government of Inda nsttuted a number of polces to nfuse competton for the sector, we found that contrary to the popular percepton, gradual lberalsaton and hgher competton had an adverse effect on the general effcency level of the sector and the gap between t he effcent and neffcent frms had rsen over tme. Three dstnct possbltes mght arse n ths context. Frst, snce we were usng a sequental fronter for the panel data, n the ntal years the degrees of freedom were less and therefore ths mght have artfcally caused a number of observatons to have a measured effcency of one. That n turn could be reflected n a hgher average effcency value for the sector for the ntal years. Secondly, the form of producton fronter constructed for the sector ncorporated the possbltes of technologcal progress; n other words, an outward shft n the fronter was possble for the subsequent years. Ths mples that f there was technologcal progress for ths sector leadng to an outward shft n the producton fronter, for the neffcent frm the dstance from the fronter was ncreasng even though ther performance may not have declned n an absolute sense of the term. Ths could happen f the effcent frms become more effcent over the study perod pullng the fronter outward. Fnally, t could so happen that the neffcences of the frms that le below the fronter worsen n absolute terms. We next tred to understand the characterstcs of the neffcent frms v. Frst, t was observed that most of the neffcent frms were also small szed frms; t also appears that there was a sgnfcant negatve correlaton between the sze of the frm and ts effcency. Almost all the frms wth an neffcency score of less than.45 we re tny frms wth a very small scale of operaton; whereas most of the large and medum szed frms were ether effcent or moderately effcent. The tny and the smaller unts accounts for about 45 percent of the unts but contrbute less than 7 percent of the total value of output produced n the sector. Thus the overall neffcency for the sector can be attrbuted manly to the neffcent small szed frms. In the next step we compared the effcent small frms wth the neffcent ones. Compared to ts peers wth an average turnover (or revenue per unt of the labour employed) between.5 to 2.4, the overall turnover for the neffcent small frms were abysmally low at around.74 to about.87. Whle the performance of the effcent small frms (measured n terms of revenue earned per unt of the labour employed) had mproved over the study perod, not much mprovement was also notced for the neffcent small frms. We also compared the average turnover of the effcent large and medum frms wt h the neffcent ones. We also fnd that the effcent medum and large szed frms had the hghest rato of output to labour (almost 2.5 to 4.2) n the sample and the rato was rsng over the years. Compared to ts peers the neffcent frms (large an d medum) had an average turnover of around.8 to 2.7. The performance of the large and medum szed frms had also mproved over the years (n an absolute sense) even though the mprovement was not suffcent to catch up wth the rse n the average turnover of ts peers. Ths ndcates that possbly the sector mght have experenced techncal progress due to the effcent fronter frms. Ths n turn mght have led to an outward shft n the fronter, resultng n a rse n the output dstance between the neffcent and the effcent frms. A cross comparson of the revenue earned between effcent small and large frms also ndcates that a possble fronter shft was much more pronounced at hgher levels of output. 5

18 To provde some tentatve explanatons as to why most of the tny unts were neffcent we have examned ts capacty utlsaton rato, the workng to fxed captal rato and the product mx. It was notced that the capacty utlsaton rato of the tny neffcent unts was consderably low and stood at around 2 to about 24 percent. In contrast, capacty utlsaton rato ncreased from 24 per-cents to about 80 percent wth the rse n the sze of the frms. The peers of the tny neffcent frms had capacty utlsaton rato of about 60 percent. It was also notced that the workng to fxed captal rato was only.35 for the neffcent small unts whereas t was about.36 for ts peers and reached as hgh as 3.4 for the large szed frms. The low value of workng to fxed captal for the tny unts possbly ndcated the nablty of tny unts to secure suffcent funds to meet ther credt requrements. The nadequate avalablty of workng captal may hamper the smooth functonng of the producton process and lead to hgh capacty utlzaton rato and neffcency for tny szed frms. The product mx of the tny frms clearly ndcates that most of them produced low -value products and hence the return was also low whch was reflected n the low level of neffcency. The poor performance of small Indan pharmaceutcal frms was also revealed by the study of Pradhan and Sahu (2008). The study brought out the fact that the lack of expertse, tranng and fnance for technologcal up-gradaton and adopton of good manufacturng practces (GMP) by small enterprses to meet global qualty standards; lmted exposure and expertse on Intellectual Property Rghts (IPR) ssues; lmted adopton of nformaton technology (IT) technques n producton and processes; low or neglgble R&D expendture whch affects the ablty of small Enterprses to offer nnovatve solutons; and the nablty of Small enterprses to access fnance on easy terms for mport of captal goods were the man reasons for poor performance of small enterprses n the Indan pharmaceutcal sector. Input Effcency Movng now to the nput-wse measure of neffcences, columns 3 to 6 n table summarses the value of θ,s whch represents the maxmum possble contracton on an average n the use of a partcular nput that a frm employs wthout reducng the output or the employment of other remanng nputs. The average nput -wse measures n neffcences reveal certan nterestng features for the ndustry. It was notced that even t hough the output effcency revealed a declnng trend, the frms on an average were able to make effcent use of labour, materal and captal. The average effcency scores for labour, raw materal and captal fluctuated around the mean value of.90,.85 and.63, respectvely, over the years. On the other hand, over the years, the mean effcency for power and fuel s only.40. What could be the possble reasons for effcent use of raw materal and labour and neffcent use of power-fuel by Indan pharmaceutcal frms? Raw materal s a factor of producton whch can be used n approprate quantty f the ndustry does not suffer bottlenecks n supply of raw materal and has good backward lnkages wth the raw-materal ndustry. Inda has a well developed chemcal ndustry (Kaul, 2007), whch provdes raw materals to the pharmaceutcal ndustry. The bulk drug ndustry n Inda procures raw materals, processes t and produces the essental component, the actve pharmaceutcal ngredent (API), of the medcne for the formulaton 6

19 companes. Inda also has a vbrant bulk-drug ndustry that produces almost all varetes of API requred for synthessng the formulaton or the fnal medcne for consumpton. Wth good lnkages wth the rawmateral ndustry t was expected that the Indan frms would be able to synthesse the raw materal effcently. In ths regard we also calculated the rato of stock to annual consumpton of raw materal. We found that the rato was steadly fallng from a value of about.6 to about.2 for the study years. It rose margnally to about.22 n 2005 for whch the raw-materal neffcency was also the hghest. Noteworthy to menton here that there was no sgnfcant dfference n the value of the rato for frms of dfferent szes ndcatng possble effcent use of raw -materal for almost all types of frms. Labour was another factor of producton that showed hgh effcency. Perhaps after lberalsaton, the frms have greater flexblty n utlsng the labour n conuncton wth other factors of producton to meet the demand for output. It became possble to hre and fre labour comparatvely more easly than before v. Ths may account for effcent use of labour by the ndustry. In ths regard t s worth mentonng here that the annual average real wage rate of employees (n Rs.) has gradually rsen over the year from Rs to about Rs. 2,000 over the years. If we assume that hgher wage rate s monotoncally related to the qualty of labour we can nfer that the sector s employng more and more hgh qualty labour. Another mportant factor of producton s captal. The effcency fgures for captal revealed that t was neffcently used compared to labour and raw materal whereas ts effcency was much hgher compared to the use of power and fuel. On the whole t can be argued that frms were moderately effcent n usng captal. It must be remembered that returns from captal generally flow over a perod of tme; hence t may not be possble for a frm to fully utlse the captal stock n the year t s nstalled. In Inda most of the frms nvested heavly n plant and machnery to adhere to the new rules n the recently amended Drugs and Cosmetc Act whch mght have lead to a rse n unused captal stock x. Underutlsaton of captal stock can also arse f frms are slow n applyng and adaptng new technology or when n lean a perod the demand for the product s low. Ac cumulaton of underutlzed captal stock can be checked by plottng the growth rate of captal stock and the growth rate of output aganst tme. Fgure (Appendx A), reveals that for most of the years the growth rate of the captal stock n ths sector was hgher than the growth rate of output, whch mples the presence of underutlzed captal stock. The Capacty Utlzaton Rato has also reduced from about.80 percent to about.60 percent for the sector durng the study perod. Thus whatever neffce ncy was notced for the stock of captal was manly due to ts underutlzaton. We also observe d that power and fuel was utlsed n the pharmaceutcal sector to generate energy for the dstllaton process. The energy consumpton note of the frms (that s avalable n the balance sheet of the companes) revealed that frms (manly the large frms) that had undertaken ntatves to conserve energy n the producton process by replacng the old technology wth modern ones were the effcent ones. The rest of the frms stll used technology that consumed more energy per unt of the output generated and ncurred energy wastage (that also leads to hgh level of energy neffcency for the sector). It s note - worthy that the consumpton of power and fuel ncreased for the sector from about 4.5 per cent to about 8 per cent of the total cost of producton from 995 to However, for large frms (effcent and the 7

20 neffcent frms) the share of power and fuel consumpton n the total expendture remaned constant at around 2 per cent. For tny, small and medum frms the share of power and fuel consumpton was around 4 to 5 per cent leadng to fuel usage neffcency. Determnants of Effcency After estmatng the effcency levels, t was of nterest to examne the factors that determne the effcency of the frms. Snce the effce ncy scores are bounded between 0 and, one way to examne the determnants of effcency s to use a Tobt model (Ray 99; McCarty and Yasawarng 993; Lovell et al 994; Duncombe et al 997). We used a random effect Tobt model to dentfy the determnants of the effcency scores of the frms. Instead of usng a random effect model, a fxed effect model cannot be used because estmatng the unobserved frm specfc effect ( v ) along wth β, s creates the ncdental parameter problem (Wooldrdge, 2002), whch leads to nconsstent estmate of the β,s x. The problem arses when the number of parameters partcularly the v,s ncreases as, N for a fxed T. The model s specfed as z = x β + µ + v * t t t (22) where represents the th frm =() N; subscrpt t denotes tme x, (n our model t spans from 99 to 2005). The analyss was done for two sets of effcency scores namely, output effcency and tot al nput effcency x separately. To explan the varaton n the effcency scores of the frms we selected a number of explanatory varables. The explanatory varables can be broadly classfed n to three groups (A) Frm s Structural Varables and (B) Frm Specfc Strategy Varables and (C) Polcy related Varable. Structural Varables The structure of a frm s determned largely by ts sze, technologcal parameters, product mx, and ownershp pattern and also by geographcal locaton (Caves and Barton, 990; Caves, 992). We took each of these factors nto consderaton. From the theoretcal vewpont the relatonshp between the sze of frm and ts effcency was not clear (Audrestch, 999). On t he one hand t can be hypothessed that large sze frms wll be more effcent because the presence of threshold lmt n producton, scale economes, mperfecton n captal market and market power may favourably nfluence the sze factor (Kumar, 2003). However, beyond a certan lmt, hgher market power may also plague the frm wth X-neffcency (Lebensten, 976) whch may lead to lower effcency. The output share of a frm n the total ndustry (Kwoka, 978) was taken as a proxy for ts sze. To capture the possble non-lneraltes between the output effcency and the sze of the frms we also ncluded the sze of a frm and ts square n the regresson analyss. 8