Karl Marx seems to be the poster boy of late in the economics world with his critiques of capitalism penned in the 1800s. To maintain the illusion that this burningpants correspondent is hip (so far no Che t-shirts though), we will play along.

If we could surmise his criticisms they would be a ready army of unemployed; falling profit rates; cyclical business crises; increasing misery amongst the proletariat; and industry consolidation into fewer hands.

The last point here provides a nice little deviation into CoreData’s latest paper, Measuring the Efficiency of Australia’s Depository Institutions.  This paper seeks to capture the economic efficiency of Australia’s ADIs via a simple to understand metric – X-efficiency. How this ties in with Marxian analysis will become evident soon.

On reading the paper, it is tempting to conclude that, on average, the big four banks are more X-efficient than both building societies and credit unions. However, our modelling reveals that institution type does not appear to have a direct bearing on efficiency scores.

Rather, the size of the institution has a greater impact. This is evident in the chart below, where it appears that the large institutions exhibit, on average, greater cost efficiencies. What’s the explanation? Scale economies of course!

To achieve the scale, ADIs appear to need at least $1 billion in assets. To a large extent this does support some calls for ever greater consolidation amongst ADIs and Marx’s thesis that in a capitalist economy, productive capital is inexorably concentrated in fewer and fewer hands since it is more efficient.

So, does this mean that the industry should run amok with consolidations everywhere? Sorry Marx, you may be wrong here. Two factors suggest this.

Firstly, at the very largest scales, there is some evidence that there are diseconomies of scale.

In our paper, we find, for example, that ANZ has an average efficiency score of 79%, which basically means the bank is producing its products at a cost that is approximately 21% greater than is necessary.

Both Westpac and Commonwealth Bank exhibit lower efficiency scores (low seventies) compared to ANZ and National Australia Bank. Are they getting too big to manage well? In contrast, a few of the larger building societies score in the high seventies and low eighties.

Secondly, we find that there is a slight negative correlation between market concentration as measured by a Herfindahl-Hirschman Index and X-efficiency.

The key message? Economies of scale do matter in this industry but to a point. If ADIs seek to merge purely for the market size that is all well and good. However, from a societal perspective (attain efficiencies and reducing waste) it probably should only be advocated a certain point. Marx might just have been right.