Factor demand flexibility in the primary aluminium industry: Evidence from stagnating and expanding regions

The purpose of the paper is to analyse and compare short-run factor demand responses to price changes in the primary aluminium industry in Western Europe and the Africa–Middle East (AME) region. We outline a Translog variable cost function model, which is estimated employing a panel data set at the individual smelter level over the time period 1990–2003. The empirical results show evidence of limited – but far from insignificant – price-induced factor demand responses in the short-run. Overall aluminium smelters in the AME-region show evidence of higher estimated short-run own- and cross-price elasticities than their competitors in Western Europe, at least when it comes to labour and electricity demand. One important reason for this result is the greater number of pot lines with slightly different technologies at each smelter as well as the more intense use of the Prebake technology in the AME-region making retrofits in existing plants less costly than in Western Europe. The results also suggest that in both regions the demand for electricity has over time become less sensitive to short-run price changes, while the labour and material demand responses to price changes have increased but only in the AME-region. The liberalisation of the Western European electricity markets in combination with the rigid labour markets in this part of the world suggest that the shift in production capacity from the western world to the AME-region as well as China may continue.

► We analyse short-run factor demand responses to price changes in the primary aluminium industry.
► The study compares price responses in Western Europe and the Africa–Middle East (AME) region.
► The analysis relies on a panel data set at the smelter level over the time period 1990–2003.
► Aluminium smelters in the AME-region respond more strongly to higher input prices.
► This is particularly evident in the cases of labour and electricity demand.