The differential effects of competitive funding on the production frontier and the efficiency of universities

• How does third-party funding affect university efficiency and production frontier?
• We exploit university-level panel data in 8 European countries between 1994 and 2006.
• A stochastic frontier estimates the differential impact on frontier and efficiency.
• International Public funds decrease the production frontier but decrease efficiency.
• Tuition fees increase the production frontier but decrease efficiency.

European governments increasingly employ competitive university funding to improve performance in higher education. The framework that is developed in this paper suggests a donor-specific trade-off between fostering best performing universities and increasing university efficiency when introducing competitive funding in the university sector. We test this assertion based on a university-level panel dataset across eight European countries from 1994–2006. Estimating a simultaneous two-stage Stochastic Frontier Approach, we find that international public funds decrease the productivity of the best performing universities, which suggests a non-negligible effect because of the administrative burden induced by competitive funding. However, the competition for international public funds also disciplines universities as evidenced by a positive impact on efficiency. Conversely, tuition fees enhance the productivity of the best performing universities but increase the spread of universities with lower productivity, which suggests a strong sorting effect.