Preview of the Great Lakes economy looking north and south

Abstract

Introduction In the above epigraph the managers are attempting to identify, in a particular context, the firms which are doing the best job of accomplishing the company objectives. Such firms are known as the best practice firms. Economists typically make similar inquiries concerning the production process. They address the issue by theoretically defining the best practice firm, empirically identifying it, determining its resource utilization, and then evaluating how others compare to it. More generally, economists, like the new CEO, are concerned with productive efficiency. Because of changes taking place in the banking industry, the importance of efficiency has increased substantially. As geographic and product deregulation occurs, the resulting increase in competition should place banks in a situation where their success will depend on their ability to adapt and operate efficiently in the new environment. Banks unable to do so will have difficulty surviving. Most studies of bank efficiency have concentrated on cost advantages resulting from the scale of production. In fact, this is probably one of the most researched topics in banking.' There are, however, other aspects of efficiency which students of the industry have just begun to evaluate. For example, do the producers of banking services effectively combine their productive inputs? Once employed, do they use the inputs effectively? If not, how inefficient are they? What allows them to continue to do this and stay in business? Given its importance in the deregulated environment, it is imperative that the various aspects of bank efficiency be understood and empirically analyzed. In this article we discuss the concept of efficiency in production, define its various aspects and the means to measure it, and review the relevant literature concerning inefficiency in the banking industry. Our major conclusion is that there appears to be significant inefficiency in banking. Inefficiency resulting from operating at an inappropriate scale of operation is probably in the range of 10-20 percent of costs. However, by emphasizing the role of scale, researchers have essentially overlooked a major portion of bank inefficiency. The evidence suggests that inefficiencies resulting