Is constant returns-to-scale a restrictive assumption for sector-level empirical macroeconomics? The case of Europe

ABSTRACT

Assuming constant returns-to-scale is commonly agreed for empirical macroeconomic studies when countries are of interest. Recently, an increasing number of works have started to look at sectors building on the same assumption. In this letter, we question the reliability of this assumption for 10 European sectors for the period 1995–2014, for different production factor combinations. We make use of a simple sample-based nonparametric test that does not require any assumptions for any aspect of the production process. Our results suggest that, in general, this assumption is rather acceptable and that the specification with only capital and labour is the best in this case.

KEYWORDS:

• Macroeconomics
• sectors
• returns-to-scale
• nonparametric
• Europe

JEL CLASSIFICATION:

• E00
• C60

Acknowledgements

We thank the Editor David Peel and the anonymous referee for their comments that have improved the article substantially.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ In practice, it is enough to evaluate (i.e. when assuming non-increasing returns-to-scale) and compare to . If they are equal, decreasing returns-to-scale is acceptable. Otherwise, increasing returns-to-scale should be chosen. The linear program to obtain the estimators is obtained by a slight modification of (LP-VRS): (C-5)′ to .

² The countries are Austria, Belgium, Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Italy, Luxembourg, Netherlands, Norway, Poland, Slovakia, Slovenia, Spain and Sweden. The sectors are agriculture, mining, manufacturing, electricity, gas and water, construction, wholesale, transport, public administration, education and health.

Additional information

Funding

This work was supported by the National Natural Science Foundation of China under Grant No. 71750110539.