Benefits of Product Market
Competition
National Training Workshop on Competition Policy
and Law
Gerald Gregory
(CUTS Fellow)
Summary





Competition ensures allocative efficiency so the right
goods are produced in the right quantity at the right
price, at any one point in time
Competition ensures productive efficiency at the firm
and industry level and so maximises the level of
productivity in an economy
Competition can be a driver of innovation which leads
to productivity growth over time
Increases in productivity lead to higher output from the
same input, so it is the most direct route to inflation
free economic growth and higher standards of living
Therefore sound competition policy is essential to
economic development
Allocative efficiency




When competition is restricted, 'monopoly' prices are
significantly above marginal cost
Consumers willing to pay above marginal cost but
below monopoly price are not supplied leading to loss
of welfare associated with a sub-optimal allocation of
resources
Competition drives price down towards marginal cost
so these consumers are supplied leading to an
increase in welfare
Competition maximises welfare by ensuring allocative
efficiency – the right goods are produced in the right
quantity at the right price at any one point in time
Consumer Benefits





As well as increases to total welfare through increased
allocative efficiency, competition benefits consumers by
lowering prices (which transfers surplus from producers to
consumers)
The UK Office of Fair Trading measures the consumer
benefits of its interventions annually and finds that its
interventions have saved on average £409m per year in
the period 2006-2009
In the same period the average annual expenditure of
interventions (mergers, competition law enforcement,
market investigations) was £53m
So the consumer benefit-cost ratio of the UK competition
authority is 8:1
Wider benefits could be even larger given the deterrence
effect of competition law enforcement dynamic welfare
gains from new products
Productive efficiency – firm level
Within monopoly firms managers have little incentive
to be cost efficient in production
 This managerial slack is removed by competition as it
creates incentives to maximise productive efficiency:
- There is greater opportunity for owners to compare
and monitor managerial performance
- Cost-reducing improvements in productivity could
generate a larger increase in revenue in a competitive
environment
- A higher probability of bankruptcy forces managers to
work harder to avoid bankruptcy

Productive efficiency – industry level




Competition brings about a Darwinian process of
'survival of the fittest' where only the strong survive
Less efficient firms are weeded out from more efficient
firms with labour and capital being reallocated from
shrinking/exiting firms to entering/growing firms
These changes to composition in an industry due to
firm dynamics raise productive efficiency across the
industry
The reallocation of labour and capital between firms is
essential to the process and so well functioning labour
and capital markets are very important
Innovation


'Breaking new ground' through process and product
innovations leads to productivity growth
But there are differing theories on whether competition
promotes innovation:
- Schumpeter (1942) argued competition is not good for
innovation; if firms make no private gain post-innovation
because it is competed away they will have no incentive to
undertake R&D (also large firms have more internal
financing)
- Arrow (1956) suggested that the greater pre-innovation
rents the lower the net gain resulting from innovation; firms
facing competition might be expected to have stronger
incentives to undertake R&D
Innovation (continued)

Aghion, Harris, Howitt and Vickers (2000) found an
inverted-U relationship between product market
competition and innovation
- At low levels of competition innovation is low due to lack of
incentive (Arrow effect)
- At medium levels of competition as firms try to escape
competition by innovating
- At high levels of competition innovation is reduced as the
potential gains are reduced by the high number of potential
imitators (Schumpeter effect)

Other studies have found a more definite positive
relationship between competition and innovation
Evidence competition enhances
productivity




There is a strong evidence base backing the theory
that competition enhances productivity
Nickell (1996) looked at a sample of 676 UK firms over
1975-86 that competition and found competition was
associated with higher productivity growth rates
Disney et al (2000) looked at 143,000 UK firms and
found competition was associated with higher
productivity levels as well as higher growth rates
There is also a significant amount of evidence to
suggest international competition drives domestic
productivity growth
Evidence interventions enhance
productivity




A 2004 study by the Centre for Competition Policy,
University of east Anglia assessed the benefits from
competition using illustrative cases in the UK
The breaking of a price-fixing cartel in the replica
football kit market by the OFT led to price reductions of
15%
The ending of Resale Price Maintenance on books led
to price decreases and increases in productivity
The liberalisation of European air routes by the
European Commission facilitated the emergence of an
entirely new business model in the form of low cost
airlines
Evidence competition drives
economic growth




If evidence suggests competition positively affects
productivity at the firm and industry level then a
positive relationship between competition and
aggregate economic growth can be assumed
However, only a few studies have attempted to test
this because of measurement difficulties
Dutz and Hayri (1999) found their index of procompetitive policy had a positive effect on the growth
rate of GDP per capita in a cross-section of countries
Some studies find evidence that competition resulting
from openness to trade positively impacts on
economic growth
Recap






Competition improves allocative efficiency and while
bringing about consumer benefits
Competition reduces 'slack' so that firms are as
efficient as possible
Selection through 'survival of the fittest' ensures
industry level efficiency
Competition generally promotes innovation which
leads to productivity growth
As competition leads to productivity growth, it is a
driver of economic growth and living standards
Policy makers must ensure a sound competition
regime is in operation as part of any development
strategy
Thank you for your attention!
geraldgregory@hotmail.co.uk