Published on Let's Talk Development

Product market competition, regulation and inclusive growth

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It is hard to overemphasize the role of productivity growth in reducing poverty and raising living standards.  Sustained productivity increases have made possible the unprecedented rise in prosperity over the last two centuries.  Recent evidence suggests that productivity growth has been on the decline around the world for the last decade, with a few exceptions.  Understanding whether this is correct, and, if so, what explains it and what can be done, are now priorities for economists and policymakers. 

The recent 1st joint IMF-OECD-World Bank Conference on Structural Reforms focused on productivity through the lens of competition, product market regulation, and innovation.  This choice of an angle reflects the concern that relentless technological advances are resulting in more capital- and knowledge-intensive production that is diminishing competition.  This discourages new entrants, may support less innovative and less productive incumbents, and results in large costs to economic activity, households, and companies. 
The “puzzles”
The keynote speakers Philippe Aghion, Ufuk Akcigit, and Jan de Loecker framed the discussion of slowing productivity growth by articulating several “puzzles.” These include waning economic dynamism (slower rates of firm entry and exit), weaker reallocation of resources to more efficient uses, and increased concentration and mark-ups across industries in advanced economies.  Productivity growth has not only slowed, but it has diverged between the leaders at the top and the “laggards,” the 90 percent of firms at the bottom.  The share of employment by young firms has decreased sharply while, in the aggregate, the share of labor in national income has declined.  And while expenditures on R&D have not declined, patents by new firms are down: the share of patents held by the top 1 percent of the firms in the US has increased by 10 percentage points in ten years. 
Akcigit’s Shumpeterian model helps explain these stylized facts.  Incumbents innovate to improve their mark-ups and followers innovate to catch up with the leader.  New firms may enter industries only if they hope to bring down the incumbents. For the incumbents, increased mark-ups provide the financial cushion to innovate and the competition cushion against new entrants.  This model has variations and some of them do not distinguish between innovation due to incumbents improving their products or new firms entering the industry and moving aside incumbents.  In reality, this difference in innovation drivers matters substantially for policy recommendations.
Industry concentration, competition, and implications
Many of the presenters pointed to increased concentration in numerous industries in the US and some other countries.  While “big is not always bad” as Alejandra Palacios from the Mexican competition authority COFECE noted, higher concentration and mark-ups suggest the potential increase in market power. In Mexico, this market power led to overpricing by 98 percent on average in 12 markets.  The implications are large: households pay an additional 16 percent of household expenditures on average and those in the lowest decile about 31 percent.  Graciela Murciego and Martha Licetti presented evidence that in developing countries, regardless of definitions, markets are typically concentrated.  For example, in 4 out of 5 African countries, a single firm accounts for more than 80 percent of domestic air travel, while 3 companies linked to the government control the GSM market in Vietnam. 
Such concentration and market power can emerge in several ways.  One is through innovation by the most productive firms.  Ana Cusolito presented work that uses plant level data to demonstrate a positive relationship between plant-level mark-ups and productivity.  The paper demonstrates a negate impact of competition on innovation and productivity, with the relationship the strongest for firms farther away from the technological frontier.    
Another way of acquiring market power is through anti-competitive mergers.  This path is not possible without an omission by policymakers.  The lessons from the EU are clear: strengthen competition policy and anti-trust rules but be careful, as higher market share and concentration may be the result of increased competition and not lack of competition.  Geert-Jan Koopman from the European Commission also noted that while Europe in general is different in terms of concentration and market power from the US, the competition authorities need to be vigilant.  Concentration has been broadly stable in Europe and profit margins have increased by less, in part due to EU state aid control.  For example, four airlines exited the airline industry in the EU because of state aid.  There remain many more carriers in the EU than in the US, some with higher cost per km, so more consolidation would boost productivity while preserving competition. 
This cautionary point was emphasized by Anton Korinek from UVA in his presentation on superstar firms.  Digitization is the main force behind this phenomenon.  Information differs from other inputs into production as it is non-rival but excludable, thus it generates monopoly power.  Part of that power is needed to produce, as such output cannot be produced in a competitive market (as the marginal costs are very low).  A free market economy suffers will suffer, as a result, from insufficient digital innovation and inefficiently low output.  The policy remedy according to Korinek is to use public investment to finance innovation and basic research.  (Public intervention is not the only path: there is plenty venture capitalists can do within the appropriate enabling environment.) 
Intangibles and productivity
Most of the literature focuses on tangible assets as factors of production.  Romain Duval from the IMF presented a paper on intangible investment, regulation and monetary policy.  Intangible investment is becoming more important for growth, but intangibles usually cannot be pledged as collateral.  In industries with stronger competition, firms find it hard to finance investment through retained earnings.  As a result, investment in intangibles would tank in a crisis if monetary policy does not provide a cushion of liquidity to banks through counter-cyclical policy not to reduce lending.  (Venture capital financing is also an important avenue to support new and innovative firms.)    
Economic distortions and productivity
Jan de Loecker provided a broader background on the evidence that market power is due to misallocations.  In his keynote address, he posited that factors preventing an optimal allocation of resources across firms are either “primitives” (technology, preferences, or nature) or “policy-variant” (policies and institutions). The Hsieh-Klenow approach has dominated the literature, despite increasing criticism about some of its conclusions.  If the world behaves differently from the model, typically “macro” people will say that the world is misallocated and “micro” people will say that there is market power.  There could be other factors for sure.  In the aggregate, it matters which mechanism is at play, as aggregate data fails to give a mechanism of how things work in the world – and, therefore, what policy interventions may be needed. 
Building on this foundation, Paulo Correa presented a paper that identifies and quantifies the impact of economic distortions on productivity using data from World Bank’s Enterprise Surveys.  The analysis is careful to note that the presence of dispersions in estimates of firm-level TFP need not be the result of distortions.  The study suggests that red tape has a strong negative impact on productivity and that young firms gain more from access to high-skilled workers than other firms.   
Graciela Murciego and Martha Licetti discussed ways to define the relevant markets, measure properly market shares and market power in practice, and design appropriate policies to regulate product markets to foster competitive market outcomes.  To help assess the extent of competition and the potential regulatory measures, the OECD and the World Bank have partnered, along with the IADB, to develop just-published product market regulation (PMR) indicators for 16 LAC countries, supplementing the measures the OECD has published for OECD countries since 2008.  Complementing these efforts, the World Bank continues systematizing implementation challenges on the ground, through the Annual Competition Advocacy Contest together with the International Competition Network and developing additional databases that will help assess status of competition law enforcement and implementation gaps. 


Ivailo Izvorski

Chief Economist, Europe and Central Asia region

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