Blog Post

Why competition policy matters for growth?

Economic literature suggests that competition can have broad economic effects in three areas: the total amount of economic wealth available in the market at a given point of time, companies’ productive process, and their incentives to innovate or improve the quality of their products.

By: Date: February 18, 2014 Topic: Innovation & Competition Policy

See also event ‘Competition policy enforcement as a driver for growth

Economic literature suggests that competition can have broad economic effects in three areas: the total amount of economic wealth available in the market at a given point of time, companies’ productive process, and their incentives to innovate or improve the quality of their products.

In the first area, any transaction creates some value. An increase in prices resulting from a reduction of competition in the market, however, does not automatically translate into a one-to-one shift of value from the buyer to the seller. Unless consumer demand is perfectly inelastic (that is: purchasing habits do not vary with price), some of the value that was enjoyed previously by the buyers disappears and does not translate into higher profits. This happens because a number of transactions no longer take place, because some buyers drop out of the market. This deadweight loss is inversely correlated with the degree of competition in the market. By triggering a misallocation of resources, lack of competition may therefore imply a smaller cake to be divided between sellers and buyers (Tirole, 1988). In other words, from a static perspective, lower levels of competitions are associated with lower levels of aggregate wealth, everything else being equal.

Competition also affects companies’ productivity. Two main effects are identified in the literature. First, competition raises managers’ incentives to out-perform competitors and, therefore, is often associated with higher levels of total factor productivity (Van Reenen, 2011). Second, competition operates a Darwinian selection: only the most efficient firms survive high competitive pressure. Therefore, when competition is healthy, production is rationalised naturally because of the churn of inefficient firms leaving the market and efficient firms entering and prospering in it (see, for instance, Disney et al, 2003). Competition has ambiguous effects on companies’ incentives to innovate. While actual competition increases R&D because innovation offers an opportunity to escape competition and achieve higher post-innovation profits, the prospect of future competition might indicate smaller post-innovation rents and, therefore, reduce incentives to innovate in the first place (Shumpeter, 1939). This dichotomy has been identified in the data and described as the “inverse-U” relationship between competition and innovation (Aghion et al, 2002). This explains why competition policy cannot be used as an instrument to fight market power per se: a degree of market power can sometimes be the necessary price to pay to achieve higher overall welfare levels.

Correct implementation of competition policy would take those short-term and long-term effects into account, ensuring that customers would access products or services at competitive prices without dumping incentives to innovate. Most scholars agree that this is best achieved by antitrust authorities preserving market competition and not defending competitors (Motta, 2004).

Likewise, many economists tend to be skeptical about the effectiveness of policies designed to create or nourish national champions, while developing economies, such as China, are often blamed for their pro-domestic industry subsidisation policy. National-champions policies are based on the assumption that governments are better equipped than markets to select the most efficient companies. Industrial policy is however often captured by vested interests, and rent-seeking politicians are unlikely to out-perform markets in the process of selecting companies that maximise social welfare (Persson and Tabellini, 2000). On the other hand, economic patriotism, the other main potential explanation for national-champions policies, has little backing in the empirical literature. There is no case for favouring companies on the basis of their nationality, on the assumption that domestic companies would be more beneficial to the domestic economy. Studies on several sectors in different countries generally show a positive impact on productivity and no significant impact on employment following foreign takeovers (see OECD, 2009, for an overview, or Bernand and Jensen, 2007, for the US).  Moreover, foreign direct investment is frequently associated with significant positive spillover effects on domestic firms’ productivity (for example, see Wei and Liu, 2006, for a study on the benefits of FDI for China’s manufacturing sector).

References

Aghion, P., Blundell, R., Griffith, R., Howitt, P., Prantl, S. (2009). The effects of entry on incumbent innovation and productivity. The Review of Economics and Statistics, 91(1), 20-32.

Bernard, A. B., Jensen, J. B. (2007). Firm structure, multinationals, and manufacturing plant deaths. The Review of Economics and Statistics, 89(2), 193-204.

Disney, R., Haskel, J., Heden, Y. (2003). Restructuring and productivity growth in UK manufacturing. The Economic Journal, 113(489), 666-694.

Motta, M. (2004). Competition policy: theory and practice. Cambridge University Press.

OECD (2009). Employment and industrial relations – 2008 Annual Report on the OECD Guidelines for Multinational Enterprises.

Persson, T., Tabellini, G. (2004). Constitutional rules and fiscal policy outcomes. American Economic Review, 25-45.

Schumpeter, J. A. (1939). Business cycles (Vol. 1, pp. 161-74). New York: McGraw-Hill.

Tirole, J. (1988). The Theory of Industrial Organization. MIT Press Books, Ed. 1, Vol. 1.

Van Reenen, J. (2011). Big ideas: How competition improves management and productivity. CentrePiece – The Magazine for Economic Performance 340, Centre for Economic Performance, LSE.

Wei, Y., Liu, X. (2006). Productivity spillovers from R&D, exports and FDI in China’s manufacturing sector. Journal of international business studies, 37(4), 544-557.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article Download PDF More on this topic More by this author

Policy Contribution

Are European firms falling behind in the global corporate research race?

The author looks at how concentrated corporate R&D is in Europe, compared with sales and employment. The US and China are more likely to produce new R&D leaders that take over some of the top positions from incumbent R&D leaders. How is the EU coping with technology shifts and creating the next generation of new leading firms?

By: Reinhilde Veugelers Topic: Innovation & Competition Policy Date: April 12, 2018
Read article More on this topic

Blog Post

Do wide-reaching reform programmes foster growth?

With growth gathering momentum in the eurozone, some have claimed this is the proof that structural reforms implemented during the crisis are working, re-opening the long-standing debate on the extent to which reforms contribute to fostering long-term growth. This column employs a novel empirical approach – a modified version of the Synthetic Control Method – to estimate the impact of large reform waves implemented in the past 40 years worldwide.

By: Alessio Terzi and Pasquale Marco Marrazzo Topic: European Macroeconomics & Governance Date: March 28, 2018
Read article More on this topic More by this author

Opinion

Greece must capitalise on its growth momentum

Better-than-expected growth performance reflects the underlying positive changes in the Greek economy – but net investment is in fact negative, while Greece has various institutional weaknesses. Further improvements must be made regarding Greece’s attractiveness to foreign direct investment. A new (at least precautionary) financial assistance programme would improve trust in continued reforms and also address eventual public debt financing difficulties.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: March 26, 2018
Read article

Opinion

Chinese banks’ improved asset quality cannot hide other phantoms

The recent improvement in asset quality cannot mask other growing concerns in China’s banking sector. Beyond liquidity concerns, other structural issues such as low profitability and insufficient generation of organic capital, are emerging.

By: Alicia García-Herrero and Gary Ng Topic: Finance & Financial Regulation, Global Economics & Governance Date: December 20, 2017
Read article More on this topic More by this author

Blog Post

Optimistic UK business confidence indicators predict smooth Brexit

UK business confidence indicators hardly fell after the Brexit vote in 2016 and have been increasing steadily since. The most likely reason is an expectation of smooth Brexit deal, especially for industry, while there is more uncertainty for services.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: December 19, 2017
Read article More on this topic More by this author

Blog Post

Moroccan job market issues, and labour trends in the Middle East and North Africa

Morocco is an interesting case of structural labour market disequilibrium despite respectable growth, and illustrates the issues facing the region’s oil-importer countries

By: Uri Dadush Topic: Global Economics & Governance Date: December 7, 2017
Read about event

Past Event

Past Event

Zombie firms and weak productivity: what role for policy?

At this event, we will have the chance to discuss the final findings of OECD's project on Exit Policies and Productivity Growth, which started at the end of 2015.

Speakers: Carlo Altomonte, Dan Andrews, Giuseppe Nicoletti and Reinhilde Veugelers Topic: Finance & Financial Regulation, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: December 6, 2017
Read about event More on this topic

Past Event

Past Event

Antitrust Concerns in Digital Markets

Following our past events on the topic of antitrust concerns in zero price markets and on big data, digital platforms and market competition, this November we are hosting an event on antitrust concerns in the digital markets.

Speakers: Svend Albaek, Cristina Caffarra, Justus Haucap, Jorge Padilla and Georgios Petropoulos Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 29, 2017
Read about event More on this topic

Past Event

Past Event

Mergers and innovation

At this closed-door, off-the-record event we will discuss the impact that mergers have on innovation.

Speakers: Justus Haucap, Carles Esteva Mosso, Jorge Padilla and Reinhilde Veugelers Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 29, 2017
Read about event

Past Event

Past Event

Sustainable growth in transition countries

This event will feature a presentation of the EBRD Transition Report 2017-18.

Speakers: Jonathan Charles, Zsolt Darvas, Sergei Guriev, Debora Revoltella and Lucio Vinhas de Souza Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 28, 2017
Read article Download PDF

Policy Contribution

European Parliament

How should the European Central Bank ‘normalise’ its monetary policy?

During the crisis, the ECB resorted to a number of unconventional monetary tools. This paper discusses how to phase out these policies and what the ‘new normal’ in monetary policy should look like.

By: Grégory Claeys and Maria Demertzis Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: November 23, 2017
Read about event More on this topic

Past Event

Past Event

Growth, productivity and social progress in Europe

On 26 October, Bruegel is organizing an interactive brainstorming seminar on Growth, Productivity and Social Progress in Europe. This is a closed-door, high-level workshop for a selected number of experts in the field.

Speakers: André Sapir Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: October 26, 2017
Load more posts