GovWire

Scale economies describe how much costs respond to producing more output. When scale economies rise, for example due to new technologies such as cloud computing or software, this allows businesses to grow more quickly, and we expect to see productivity growth.

We find that scale economies have risen in the UK, but at the same time productivity growth has stagnated. This puzzle has a variety of plausible explanations, but we focus on the role of competition and market power.

Rising scale economies mean less productive businesses cannot compete. But when firms have greater market power, this relationship is weaker. Being able to set higher price markups over costs allows less productive businesses to stay profitable.

We show empirically that higher scale economies coexist with rising markups in the UK and can account for the slowdown in productivity growth since the 2007 to 2008 Financial Crisis.