A Technique for Obtaining Improved Proxy Estimates of Minimum Optimal Scale

Abstract

IN the field of industrial organization, the concept of of is of fundamental importance. Large minimum optimum scale (MOS)1 and significant unit cost reduction up to MOS size together suggest the possibility of high industry concentration and significant barriers to entry.2 However, a recent paper in this REVIEW (Caves, Shirazi and Porter (1975)) has pointed to the severe difficulties encountered by students of industrial organization in empirical analyses of these relationships. The chief problem is that objective measures of MOS (i.e., engineering estimates)3 and of the cost disadvantage of suboptimal scale production are available for only a small minority of all U.S. manufacturing industries at, say, the 4-digit level. Since there are more than 400 such industries, it is most unlikely that there ever will be much change in this situation. This means that in large-scale cross section statistical analyses various proxies for scale economy influences must be used. This is also the case in other fields of economics in which the influence of industrial organization has been recently felt-in the investigation of sectoral patterns of direct foreign investment and the commodity composition of international trade, for example. Unfortunately, little has been achieved in terms of the development of reliable proxies for scale economies or minimum optimal scale. This relative poverty in the data seriously jeopardizes the empirical analyses undertaken in all the above-mentioned fields. The present paper is a first step at overcoming this deficiency: it offers a critical analysis of the proxies currently in vogue, and it suggests an alternative technique for generating estimates of MOS that appear to be substantially superior to them.