Scandinavian Working Papers in Economics

Working Papers,
National Institute of Economic Research

No 91: Is Rising Returns to Scale a Figment of Poor Data?

Sten Hansen and Tomas Lindström ()
Additional contact information
Sten Hansen: Ministry of Finance, SE-103 33 Stockholm, Sweden
Tomas Lindström: National Institute of Economic Research, Postal: National Institute of Economic Research, P.O. Box 3116, SE-103 62 Stockholm, Sweden

Abstract: While using detailed firm-level data from the private business sector, this study identifies two empirical puzzles: (i) returns-to-scale (RTS) parameter estimates rise at higher levels of data aggregation, and (ii) estimates from the firm level suggest decreasing returns to scale. The analysis shows that, although consistent with rising estimates, the Basu-Fernald (1997) aggregation-bias effect does not drive this result. Rather, rising and too low returns-to-scale estimates probably reflect a mixture of random errors in factor inputs. It turns out, in fact, that a 7.5-10 percent error in labor (hours worked) can explain both puzzles.

Keywords: Business cycles; Data aggregation; External economies; Factor hoarding; Firm-level data; Monte Carlo simulation; Random errors; Returns to scale

JEL-codes: D24; L60

38 pages, May 1, 2004

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