Market Structure, Productivity and Scale in European Business Services

Abstract

Labour productivity in the business-services industry tends to lag behind the rest of the economy. The present chapter investigates whether or not labour productivity in European business services is affected by unexploited economies of scale. In addition, it analyses whether the incidence of scale suboptimality is related to characteristics of the market or to national regulation characteristics. The econometric analysis is based on a production function model in combination with a distance-to-the-frontier model. A main result is that we find evidence for the existence of increasing returns to scale in business-services firms. Throughout the EU, firms with fewer than 20 persons have a significantly lower average level of labour productivity than the rest of the business-services industry. We find two explanatory factors for the level of scale inefficiency. The first is the level of policy-caused firm-entry costs; higher start-up costs for new firms go along with more scale inefficiency for business-services firms. Secondly, we find evidence that business-services markets tend to be segmented by firm size: firms tend to compete predominantly with other firms of similar size. Scale-related inefficiencies may to some extent be compensated by more competition within a firm’s own size segment. If a firm operates in a more “crowded” segment this has a significant and positive impact on its labour productivity. We derive some policy implications from our findings.