The decomposition of cost efficiency: An empirical application of the shadow cost function model to Dutch general hospitals

This paper investigates the performance of the Dutch general hospital industry by a parametric method. In general, the parametric approaches find more difficulties in distinguishing between technical and allocative efficiencies than DEA. Only recently a class of models is developed based on shadow prices which have possibilities to distinguish between technical and allocative efficiency. However, these models cause some serious computational problems. This paper recommends an approach to overcome these problems by using an iterative two-stage estimation procedure. The estimation is conducted on a panel data set of Dutch general hospitals. Estimation shows that this method is effective. The parameter estimates are plausible, reliable and satisfy all theoretical requirements. In particular we find some reliable estimates for the individual hospitals' shadow prices. According to these shadow prices hospitals should reallocate their resources in favor of material supplies at the cost of other personnel and nursing personnel. The mean technical efficiency is about 86%, whereas the allocative efficiency is about 92%. The outcomes also show that technical progress is very small. Economies of scale are present only for small hospitals.