Environmental efficiency measurement with heterogeneous input quality: A nonparametric analysis of U.S. power plants

While there is an abundant theoretical and empirical literature on environmental efficiency measurement, the impacts of heterogeneous input quality on environmental efficiency remain unexplored. Failing to control for this heterogeneity may lead to performance measurement errors, i.e., fuel quality differences are confused with technical inefficiency. In this paper, we account for this problem by proposing a Materials Balance production model that accommodates heterogeneous material flow coefficients and thereby allows for heterogeneity in input quality. Based on this model, a decomposition of environmental efficiency is proposed which disentangles the contributions of fuel quality differences and technical inefficiency. We implement our approach using nonparametric methods to evaluate and decompose environmental efficiencies using panel data on U.S. coal-fired power plants. Our results show that most of the potential to improve environmental efficiency is due to fuel quality differences and that environmental regulations have had an adverse impact on fuel quality.