Returns to Scale and Productivity

Abstract

Returns to scale is a description of market structures which determines firm behaviour, is important for policy, and underpins macroeconomic models. Generally, returns to scale is an exogenous model parameter. An output-denominated fixed cost in the net output function introduces endogenous returns to scale, which is negatively related to firm size and productivity. This channel is logical given scale economies are the ratio of average to marginal costs. We estimate changing scale economies across the UK economy from 1998 - 2014 using production function estimation methods. As aggregate productivity growth has slowed, economy-wide returns to scale have risen from around 0.7 to 0.8. However, at the firm-level, the relationship between returns to scale and productivity is strongly negative. We reconcile these results in a firm dynamics model with endogenous returns to scale and imperfect competition.

Publication
Currently a Working Paper