As the economic integration of Europe continues, it is likely that increasing international competitive pressures will be felt by firms in European industries. It follows that the extent of economies of scale remaining to be exploited in countries with relatively mature industries could be a critical factor in determining the ability of firms to succeed in this new environment. (1) This article explores the existence of scale economies as well as the substitution relationships among the various inputs in the Italian motor vehicle industry. The presence of economies of scale is a particularly significant issue when motor vehicle manufacturing is a growth industry in a number of countries, such as Spain, Portugal, Turkey, and Algeria, within or adjacent to the European Union (see Associazone Nazionale Fra Industrie Automobilistiche, 1996, pp. 52-53, 268-75; Wells and Rawlinson, 1994, p. 3; Business Week, 1996, 1997; Wall Street Journal, 1997). It is also of some importance in the Daimler-Chrysler merger as well as other mergers that may occur in the wake of that union (for example, see Wall Street Journal, 1998, and Business Week, 1998).
The automotive sector constitutes a substantial part of the EU economy, making up approximately 10% of total manufacturing output. Moreover, in 1991, this sector accounted for a trade surplus for the former European Community of approximately 22 billion European currency units (ECUs, or euros, now), but automobiles accounted for only about 2 billion ECUs of the total (Wells and Rawlinson, 1994, p. 1). In Italy in 1995, transport vehicles accounted for approximately 6.2% of value added at market prices in manufacturing, about 4.1% of industrial value added, and 1.3% of total value added (Istituto Nazionale di Statistica, 1997b, p. 46). In 1994, nearly 60% of the value added of transport vehicles was attributable to motor vehicles and tractor-trailers; however, motor vehicles and tractor-trailers made up approximately 70% of the value of output of the transport vehicle sector (Istituto Nazionale di Statistica, 1997a, p. 606). In 1995, the transport equipment industry accounted for about 10.5% of Italy's imports and approximately 10% of exports, and it accumulated a trade surplus of 2,774 billion lire (Istituto Nazionale di Statistica, 1997a, p. 405). (2)
The automobile industry in Italy is a particularly interesting one to study because, to a substantial extent, it centers around one company, Fiat, and the majority of sales are Fiat Group makes. For example, in 1988, 59.9% of the vehicles sold and approximately 99.2% of the automobiles produced in Italy were made by Fiat, Alfa Romeo, Lancia, Autobianchi, or Ferrari, all part of that company (see Associzione Nazionale Fra Industrie Automobilistiche, 1996, pp. 80, 99; Financial World, 1989). Moreover, Fiat recently ranked fifth among Western European automobile manufacturers, where, in addition to Fiat, the major producers include the VW Group, the PSA Group (Peugeot and Citroen), Ford, GM/Opel, Renault, Mercedes, Rover Group, BMW, Volvo, and Japanese manufacturers. Nevertheless, Fiat is finding the new European environment challenging, and, in the absence of Italian government intervention, the ability to increase its production volume in the presence of scale economies may be critical to its survival (see Fin ancial Times, 2002a; Wall Street Journal, 2002; Unsal and Richard, 1994, pp. 14-15; World Business, 1996).
II. THE TRANSLOG COST FUNCTION
An industry-level transcendental logarithmic (translog) cost function was used to investigate prospects for economies of scale in the Italian motor vehicle industry. The results enable one to draw inferences regarding the presence of scale economies in the industry and to advance a tentative conclusion regarding the behavior of unit costs, ceteris paribus, as industry output changes in the future. Besides providing information on scale economies, this cost function allows calculation of input direct and cross-price elasticities so the responsiveness of input demand to price changes as well as the relationships among the various inputs in the productive process can be explored (see Christensen et al. …