Estimation of Technical and Allocative Inefficiency Using Fourier Flexible Cost Frontiers for Taiwan's Banking Industry

We construct a Fourier flexible functional form which can globally approximate the unknown true function, taking into account both technical inefficiency and allocative inefficiency components to avoid possible specification error. Empirical results suggest that technical inefficiency alone raises a bank's cost about 12 per cent on average, that allocative inefficiency alone raises an average bank's cost 15.8 per cent, and that the cost rises due to allocative inefficiency decrease over time. Translog evidence on economic efficiency suggests a much higher cost savings when achieving both technical and allocative efficiency than does the Fourier flexible function.