How does institutional quality affect the efficiency of local government? An assessment of Italian municipalities

Abstract This study investigates the role of institutional quality in the cost efficiency of social services provided by local governments in Italy. Using a newly developed panel stochastic frontier approach, we address the issue of endogeneity, which can lead to biased estimates in efficiency analyses. By analysing a large dataset of social services expenditures in Italian municipalities from 2015 to 2018, we assess the impact of provincial institutional quality, measured by the Institutional Quality Index (IQI), on cost efficiency. Our findings reveal that low institutional quality negatively affects cost efficiency, but this effect is only fully captured when endogeneity is taken into account. Specifically, we find that three pillars of the IQI - control of corruption, rule of law, and regulatory quality - are critical determinants of cost efficiency in social service provision. These results underscore the importance of strengthening institutional quality to ensure fair, efficient, and effective delivery of social services, contributing to better governance and social well-being.