Market selection and scale inefficiency – A new methodology applied to EU business services

The paper proposes a new way of analysing the efficiency of dynamic market selection, based on the persistence of scale economies. The new methodology is used to investigate the causes of stagnating productivity growth in EU business services. The persistence of scale-related inefficiencies is used as an indicator for the effectiveness of market selection.We use a DEA method to construct the productivity frontier by sub-sector and size class, for business services in 13 EU countries. From this we derive scale economies and their development over time. Our results indicate malfunctioning competitive selection. Between 1999 and 2005 we observe a persistence of scale diseconomies, with scale efficiency falling rather than growing over time. In panel regressions we find the distance to the productivity frontier (within and between size classes) to be significantly explained by regulatory policies that hamper entry and exit dynamics and labour adjustment, and by a lack of import penetration and domestic start-ups.The results suggest that policy reform and more market openness may have positive productivity effects. This holds for business services itself, but also wider, because of business services’ large role in intermediary production inputs.

► Business services in the EU experiences a virtual productivity growth stagnation.
► The paper analyses competitive market selection, based on the persistence of scale-related inefficiencies.
► The paper uses data envelopment analysis to analyse the incidence of scale efficiency and X-efficiency in 8 sub-sectors of business services, 5 size classes, 13 EU countries, 1999–2005.
► We find persistence and even deterioration of scale inefficiencies, which indicates poor competitive selection in this industry.
► Regulatory obstacles and low import penetration explain the the persistence of scale-related inefficiencies.