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Why Competition Policy matters for Growth?

Mariniello, M., (2014), “Why Competition Policy matters for Growth?”, Bruegel, 18 Φεβρουαρίου.

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.

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