Suboptimal Capacity and its determinants in Canadian Manufacturing Industries

Abstract

THE extent of suboptimal capacity, that is, the of industry output produced in suboptimal plants (SUBQ hereafter) is a very important aspect of market performance, particularly for a small country like Canada. However, only a very few studies have attempted to estimate SUBQ and investigate its causes. These studies have considered the influence of some of the traditional elements of market structure on SUBQ. Weiss' (1964) preliminary study tried to demonstrate that the survivor technique could be used to obtain reasonably acceptable estimates of SUBQ. But, he did not investigate its causes beyond showing that it was negatively related to concentration. Eastman and Stykolt (1967, ch. 3) estimated SUBQ in 16 Canadian industries from their engineering estimates of minimum efficient scale (MES). They hypothesized the percentage entry barrier, the capital requirement entry barrier, the degree of product differentiation and industry growth rate as its determinants, and found the effect barrier to be important. They also found the capital requirement barrier to be significantly correlated with SUBQ, though it turned out to be insignificant in the multiple regressions due to its collinearity with the effect barrier. Their study is an important initial contribution and remains the only work relating to Canada so far; but, it is difficult to generalise their findings due to the small size of their sample. Duetsch (1973) again used the survivor technique to estimate SUBQ in about 100 U.S. industries and found it to be significantly dependent upon concentration, effect entry barrier and industry growth. More recently, Weiss (1976) has made some new estimates of MES (based on interviews and questionnaires) and SUBQ for 16 U.S. industries. He considered and found concentration ratio, industry size relative to MES, steepness of average cost curve and geographic market size as the important determinants of SUBQ. However, as will be clear from what follows, all these studies have ignored many other important factors that may be expected to influence SUBQ. Finally, Scherer et al. (1975, ch. 3) have attempted to explain the ratio of actual average plant size of the largest plants accounting for half of industry output to their engineering estimates of MES in 12 industries across 6 nations. Although it is hard to interpret this ratio as a measure of inefficiency arising from the prevalence of suboptimal capacity, some of their hypotheses and discussions throw a good deal of light on the determinants of SUBQ. This brief survey of the literature clearly indicates that there is a need for further research in this area. In addition to the traditional elements of market structure mentioned above, the role of international trade and foreign direct investment in influencing domestic market performance has recently been brought out,' and it must be considered in any study of market performance. Besides, factors like market size which determine the extent of plant specialization should also be taken into account in a study pertaining to suboptimal capacity. All these factors seem to be particularly relevant for a small and open economy like Canada's, where the extent of foreign ownership of industries is also quite substantial. The purpose of this paper is to specify a model of suboptimal capacity by taking into consideration these factors as well and to test their significance in an empirical estimation of the model on the basis of data from a fairly large sample of Canadian manufacturing industries. As far as the task of estimating SUBQ is concerned, it depends on estimating MES first. The comparative merits and demerits of the survivor, statistical and engineering techniques of estimatReceived for publication May 1, 1978. Revision accepted for publication November 28, 1978. * Panjab University. The author is indebted to M. A. Fuss, T. A. Wilson, L. Waverman and two anonymous referees for their valuable comments and suggestions. I See Caves (1974a, 1974c). Eastman and Stykolt (1967) also emphasised the role of international trade in this context, but they did not explicitly test the relevant hypotheses in their model of suboptimal capacity.