Information Technology and Returns to Scale

Abstract

Relying on a novel dataset on hardware and software investments in the universe of French firms, we document a robust within-industry correlation between firm size and the intensity of IT demand. To explain this fact, we argue that the relative marginal product of IT inputs may rise with firm scale, since IT helps firms deal with organizational limits to scale. We propose a general equilibrium model of industry dynamics that features nonhomothetic production functions compatible with this mechanism. Estimating this production function, we identify the nonhomotheticity of IT demand and find an elasticity of substitution between IT and non- IT inputs that falls below unity. Under the estimated model parameters, the cross-sectional predictions of the model match the observed relationship of firm size with IT intensity (positive) and labor share (negative). In addition, in response to the fall in the relative price of IT inputs in post-1990 France, the model explains about half of both the observed rise in market concentration and the market reallocations toward low-labor-share firms.