Economies of scale is so interesting issue to deal due to they contribute to achieve efficient uses of resources. I propose a model under this type of economies, this model is developed under diseconomies of scale for each firm but as soon they agglomerate, then they reach economies of scale. The test for this model was through Basic Plastic industry in Colombia and results were those expected, as firms agglomerate they faces a lower Average Cost (lower average price per kg of basic plastic), in quantitative terms as agglomeration index increases in 1.0%, then total cost faces a reduction of 0.04% (ceteris paribus). Of course, if the number of firms exceeds the optimum number, these firms will face financial losses, for instance Bogotá is around her equilibrium point in this industry (the optimum number is about 49), one can say if there are huge number of firms, then the economies of scale is lost and the problem of congestion appears. Under this thought policy makers have to set up strategies to generate efficient conglomerates to take advantages of Free Trade Agreements and work hard to make room in Bogotá due to high concentration of firms that let get them financial losses.
Author: Humberto Bernal,
Economist,
e-mail: zhumber@gmail.com
Twitter: Humberto_Bernal
Economies of Scale are an important issue to deal under Free trade Agreements (FTAs) to be competitive. Economic models that work on this issue are varied, for instance Bernal (2013) work on this type of models where there is a common good as Basic Plastic. The result of this model is the agglomeration lets achieving economies of scale (in rigorous words External Economies of Scale). This model was tested through Colombia basic Plastic production between 1995 to 2011 with 307 firms in this sector. The data is annual and the total observation were 1,621, it means a unbalanced Panel Model. This note summarizes the main result of this work.
Although Colombia faces hard times due to internal war conflict, there is room to produce added value goods such as Basic Plastics. Production of this good was doing by 119 firms in 2011 where most of them were located in Bogotá, Medellín and Cali as figure 1 shows. Firms that produce this type of basic plastics show a degree of agglomeration that let them to get economies of scale. There are indexes that measure the grade of agglomeration, for instance GINI coefficient according to locations went from 0.597 in 1995 to 0.628 in 2011 for these type of firms in Colombia. I proposed an index where the degree of agglomeration is calculated through taking into account the place (municipality) where firms produce (the formula is shown in the working paper attached).
Figure 1. Number* of firms that produce basic plastic in Colombia by municipality in 2011
*Total number of firms: 119.
Source: Bureau of Statistics (Superintendencia de Sociedades) and own calculations Stata 12.1.
This index is showed for two municipalities in figure 2, Cartagena and Bogotá. Cartagena’s index showed an increase in the last years, this dynamic can be explained by proximity to Mamonal refinery, the high crude oil production in Colombia; the annual production went from 193,199 thousand of barrels in 2006 to 334,068 thousand of barrels in 2011, it meant an annual average growth rate of 11.6% between 2006 and 2011 and finally the low number of agglomerated firms that could let getting high profits that took attention to other firms; the number of firms in Cartagena went to 3 in 2006 to 6 in 2011.
Figure 2. Agglomeration index in Cartagena and Bogotá (1995-2011)
The Bogotá’s agglomeration index showed a decline in the last years, this decline trend can be explained by the high number of firms in Bogotá, they went from 55 in 2006 to 48 in 2011, as is pointed in the mathematical model (in the working paper attached), as the number of agglomerated firms increased, then the profits decline, moreover if there are lot of agglomerated firms, then profits can be negative. The Cartagena’s agglomeration index showed a band between 0.02 and 0.07 while Bogotá’s agglomeration index showed a band between 0.35 to 0.51.
Two typical cases are the firms Alico S.A. located in Medellín and Tromoplas located in Bogotá, figure 3 shows the negative slope on Cartesian plane, it means these firms took advantages of agglomeration effect, therefore they face lower costs than producing far way without any contact with other firms.
Figure 3. Total cost and agglomeration index relation
(natural logarithm)
Source: Bureau of Statistics (Superintendencia de Sociedades) and own calculations Stata 12.1.
Finally, the big conclusions from this work are: through agglomeration index [0, 1], 307 firms and a period from 1995 to 2011 that means 1,621 observation, an unbalanced Fixed Effect model was taking into account to test this theoretical model. The Basic Plastic production in Colombia is so close to a homogeneous good, this sector is competitive in price and shows high concentration of production in cities such as Bogotá, Medellín and Cali. The results were those expected, as agglomeration index increases in 1.0%, then total cost for each firm shows a decline in 0.040%. The Fixed Effect model was controlled by production and inputs’ prices.
This work can be interesting to take advantages in global market in these days of global competition through Free Trade Agreements. Police makers can work on setting up locations to generate efficient agglomeration to achieve economies of scale, for instance locations for textile and cloth industry in Colombia.
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