Technical efficiency, scale effect, and trade liberalization: evidence from the Nepalese manufacturing sector

This paper investigates the impact of trade liberalization and scale of operation on technical efficiency of the Nepalese manufacturing sector after the 1992 economic liberalization. The study utilizes industry panel data and analyses the relationship using stochastic frontier analysis. We find that the manufacturing sector of Nepal is highly inefficient. Technical progress is found initially, however after 1996/97, technical regress dominates each period. Sectoral efficiency, on average, is estimated around 28.7% of potential value added whereas inefficiency is as high as 146%. The scale of operation, as expected, is highly significant in explaining industry efficiency. Trade liberalization, on the other hand, is not a significant determinant though its estimated coefficient carries the expected sign. Along with advocating industry size, the ‘scale effect’ also represents embodied-technology effect that comes with imported inputs. The results show that foreign technology contained in imported raw material inputs is an important source of efficiency improvement for the Nepalese manufacturing sector.