erc/metu
INTERNATIONAL CONFERENCE IN ECONOMICS  IV
September 13-16, 2000, Ankara

Scale Economies, Scope Economies, and Looking Beyond the Test of Market-Power and Efficient-Structure Hypotheses – Empirical Evidences on Taiwnese Banking Market

Peiyi Yu (University of Birmingham, UK)

Abstract

The study aims to investigate the economies of scale, economies of scope and the profit-structure relationship of the Taiwanese banking system. During the period of study, 1985 to 1997, a number of regulatory changes were made that permitted a major expansion of the number of operating banks. These developments offer the potential for a pre- and post-analysis of the changes and an assessment of their impact on the banking sector.

We discuss the overall economies of scale and product-specific economies of scale in section I. Scale economies are very important for bank managers and for regulators. If overall scale diseconomies exist, then mergers or increasing branch numbers should be discouraged. Then, we examine the product-specific economies of scale for the Taiwanese banking industry. Overall, we discover that overall economies of scale and product-specific economies of scale actually exist in Taiwanese banking industry. However, there are two ways for banks to obtain the benefit of scale economies: (1) to achieve overall economies of scale by increasing branch number by itself or (2) to increase its size by merger. To deal with the question which of the two ways is more suitable, we examine the economies of scope and expansion path subadditivity in section II. We find out that overall economies of scope existed before the financial reforms, but vanished thereafter. Furthermore, since expansion path subadditivity is a more appropriate method than traditional scope economy measures for examining the cost structure of banking markets, we apply expansion path subadditivity to measure the relative efficiency of large and small banks and consider both scale and scope economies simultaneously.

Overall, the Taiwanese banking industry can be considered as a natural monopoly. Combined with the empirical results from section I and II, we can conclude the current wave of merger observed elsewhere is also suitable for Taiwan.

In the section I and section II, a pooled-time series approach is used to estimate a hybrid translog cost function system. This approach differs from that of previous studies which use a single year to investigate economies of scale. Then, we employ the seemingly unrelated regression estimation (SUR) technique, which is particularly useful with large panel data sets to estimate several equations simultaneously. In the section III, instead of using the market-power (MP) and efficient-structure (ES) hypotheses for explanations of the observed variation in bank profitability, we use the tests performed by regressing profits against measures of concentration, market share, X-efficiency and allocation inefficiency, scale efficiency and real growth of deposits market. Rather than imposing predetermined distributions on the X-efficiencies and random error, we apply the “distribution-free” method on the same banking data. Our results are estimated by GMM procedures and suggest that research may benefit from looking beyond the current version of the ES and MP hypotheses for explanations of the observed variation in bank profitability.

Economic Research Center
Middle East Technical University
06531 Ankara Turkey
Phone: + 90 312 210 3044, 210 2003
Fax: +90 312 210 1244
e-mail: metuerc@metu.edu.tr