Competition Essay

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Competition exists in economic situations whenever two or more actors seek to outperform one another, in pursuit of some commonly identified goal. Markets are the most prominent site of economic competition, employing a price mechanism to connect buyers and sellers, with sellers competing against each other either through cutting prices or through improving the quality of the goods. Markets can experience an absence of competition where monopolies or cartels exist. However, nonmarket forms of economic competition are also significant, especially where technological innovation is concerned, and these are often compatible with monopolistic practices. As a socioeconomic principle, competition is often contrasted with cooperation.

Competitions can be “positive sum,” “zero sum,” or “negative sum.” A positive-sum competition is one in which all parties are better off, in the aggregate, because they are competing against one another. It is one of the founding claims of economic science that markets are positive-sum competitions. This does not mean that some individuals, firms, or communities will not be worse off, but that the net effect of competition is a positive one. A zero-sum competition is one in which the benefits accrued to one party are at the direct and inevitable expense of another party. For example, should two individuals both lay claim to a piece of land, they face a zero-sum competition. A negative-sum competition is one in which all parties are worse off, in the aggregate, because they are competing against one another. Inasmuch as they destroy economic wealth, wars are negative sum competitions. During periods in which economies contract, capitalism becomes a negative-sum competition.

The concept of competition evokes contrasting political, moral, and emotional responses. Where it is celebrated, it is associated with freedom, fairness, and pursuit of quality. This has tended to be the view of free market liberals and conservative political movements, which gathered momentum in many liberal democracies from the 1970s onward, and arose in former communist countries from the 1990s onward. However, it can also be denigrated, being associated with social atomization, disregard for the weak, and absence of collective direction. Socialists and critics of the free market tend to view competition in this way, and argue that it reduces or ignores the capacity of human beings to collaborate. Finally, a realist view of competition regards it as neither good nor bad, but a symptom of human nature. The Darwinian principle of “survival of the fittest” is commonly identified as operating in a free market economy, but in a more limited, less destructive form.

Even if markets and capitalism are positive-sum competitions, the question of how to treat the “losers” is an important political and economic question. This is exacerbated by the fact that the losers tend to cluster in certain areas of industry and geographic locations. The phenomenon of de-industrialization, for instance, which affected developed economies from the 1970s, meant that regions such as the American midwest and northeast Britain were harshly hit by loss of jobs and wealth. These jobs reappeared in low-wage economies such as China and Mexico, and economists would argue that the aggregate effect was a positive one. Yet the damage to the regions that “lost” in this international competition presents a challenge to the logic of free market economics. The concept of regional or national “competitiveness” refers to the capacity of a location to succeed rather than fail in the global economy, often through investing in public resources such as education and infrastructure.

Markets

A market exists where sellers compete against each other for the custom of buyers. Historically, markets have often been created in specific places, such as town squares or trading floors, meaning buyers and sellers meet each other face-to-face. The presence of multiple sellers competing in one place offers the buyer the freedom to choose the best deal. A physically located market has limits around how many buyers and sellers it can attract, which consequently limits the amount of competition and choice involved.

However, with technological advances and more sophisticated market structures, the number of buyers and sellers involved grows. If a customer is seeking to buy a car, and is restricted to the car dealers in a small town, then competition and choice are limited by geography. However, if the buyer is able to travel and to compare prices from dealers over a large region or internationally, then competition and choice increase. The development of electronic media such as the internet means that markets can become fully “virtual” and global, so competition hits unprecedented levels. Web sites such as eBay connect buyers and sellers around the world.

The fact that markets place sellers in competition with one another is central to why economists believe they are efficient. In an ideal marketplace, consumers judge the rival bargains on offer, and select the one that benefits them the most, taking into account both the utility and the price of the product. Sellers that offer good value for money will attract a lot of custom, whereas those that don’t will not. This creates a clear incentive to sellers to cut prices and/or improve quality, which leads them to seek more efficient production techniques, and to shift resources into areas of production that match consumer demand.

It is crucial that the price of a good is allowed to fluctuate (sometimes in the course of a single deal, such as where “haggling” occurs) or else the competitive process stalls and efficiency is not maximized. It is equally crucial that buyers exercise freedom to select the seller who best serves their interests, or else the same problem arises. Where market competition and consumer choice are present, this ought to drive efficiencies throughout the rest of the economy, including into nonmarket spheres such as firms.

A common criticism of economics is that real-world markets are never as competitive as the model suggests. While there may be some markets, such as stock markets, in which prices are constantly changing, with buyers determining where resources are diverted to, there are a large number of markets that do not operate in this fashion. First, sellers may be bound by some informal, psychological, or cultural norms to maintain similar prices. If three tomato salesmen are in a marketplace, and all succeed in finding customers, there is little incentive for any of them to improve their deal to customers. This type of cooperation develops further if the sellers are socially acquainted with one another. Second, buyers often lack the time or the inclination to compare deals and select their preferred one, but buy the same product or brand repeatedly. Advertising and branding exist to build relationships between buyers and sellers, so that consumers do not choose every product as a one-off transaction, and sellers are not constantly operating in a situation of price competition.

Market Power

The significance of the price mechanism is that, in a competitive market, no single seller can control the price of a product. However, as competition reduces, either in quantity or in intensity, the possibility for a seller to control the price of a product arises. Where a seller—or group of sellers—is able to set the price regardless of consumer demand, this is an instance of market power. Market power is one of the four types of “market failure” identified in the tradition of welfare economics, the other three being “information asymmetries,” “externalities,” and “public goods.” These tend to provide the justification for some sort of regulatory intervention.

Markets have a tendency to reduce the quantity of competition contained within them. This is for the simple reason that inefficient firms selling unappealing products will tend to go out of business, whereas efficient firms selling popular products will grow larger. Where markets contain a small number of sellers, they form what is known as an oligopoly. Where all competition is eliminated, the surviving seller has what is known as a monopoly.

Antitrust laws (also known as competition laws) exist to protect competition in the face of oligopolies and monopolies. However, a sharp distinction is now drawn between protecting competition and protecting competitors. The first piece of antitrust legislation ever created was the 1890 Sherman Act in the United States. From the 1940s until the early 1980s, antitrust law in the United States was regularly used to prevent firms from becoming too large, and to protect smaller firms from being squeezed out of markets. Oligopoly and monopoly were viewed as undesirable in and of themselves, and smaller competitors therefore had to be defended by the state.

Since the 1980s, and the influx of Industrial Organization economics into antitrust policy, policy makers have viewed their role as protecting competition, not protecting competitors. Antitrust authorities now perceive that the presence of competitors in a market is not an automatic indicator of efficiency, and the absence of competitors not an automatic sign of inefficiency. The efficiency or otherwise of an industrial structure becomes a matter for empirical economic analysis. So long as firms are not acting deliberately to exclude potential competitors—for instance, via a cartel—then very large market shares are entirely permissible; indeed, they can be viewed as a sign of efficiency, and therefore beneficial to consumers.

European antitrust authorities have followed a similar path. Although cartels and monopolies were tolerated in many central European countries through the first half of the 20th century, competition authorities emerged in many European nations in the years following World War II. The German economic school of Ordo-Liberalism provided the intellectual foundations for German competition policy. Ordo-Liberalism treats competition as not only a means of achieving efficient economic outcomes, but as an important basis for political freedoms. The legal defense of competitive markets therefore takes on a distinctly ethical and political dimension.

Since the 1980s, the European Commission has become a more active force in European competition policy. Since the late 1990s, it has gradually converged with the American model of employing Industrial Organization economics to defend competition, not competitors. European policy makers use the term “dominance” rather than “market power,” and view it as their role to prevent “abuse of dominance,” rather than prevent dominance as such.

Anxiety regarding market power has tended to focus on large industrial producers, while political and historical factors also play a role. During periods when the free market is viewed as socially damaging, benign monopolists have been viewed favorably, and almost become an arm of government. When the free market is more in favor, large producers tend to be viewed with greater suspicion, except where they are competing in large, competitive markets. It is worth noting that buyers can also attain market power, where they create “buyers cartels” to fix the maximum price of a product.

Dynamic Competition

The arena of economic competition is never entirely fixed and stable. Where new products and services are being created and sold, they will often create entirely new markets in the process, and destroy previous ones. This process of competing through innovation and the creation of new markets is known as dynamic competition. It is contrasted with the “static competition” that takes place in a stable market, and is closely associated with the ideas of Austrian economist Joseph Schumpeter.

The driving force of dynamic competition is the entrepreneur who helps bridge the gap between technological innovation and buyers. Where a stable market involves several sellers competing to sell similar products, the entrepreneur offers a new product, and therefore initially has no competitors. If this new product somehow renders an existing one obsolete, then the market for that obsolete product is destroyed. This process of “creative destruction” is a different way of understanding the competitive process. Rather than view markets as the organizing frameworks of competition, markets become viewed as internal to competition. Competition becomes a constant remaking of the competitive arena itself.

There are at least two significant implications of this. First, it leads to a very different way of viewing monopolies. In a dynamically competitive environment, monopolies are both inevitable and desirable. The seller who succeeds through dynamic competition has, in all likelihood, taken some substantial risks. Unlike the seller in a stable market who simply reproduces what they (and their competitors) have been doing in the past, the creator of a new product has no certainty that their product will find a market of buyers at all. In order to take this gamble, they need the incentive of a big payoff at the other end. Where their new product succeeds in attracting demand, they will have a monopoly position, which they can exploit as a reward for the gamble. The venture capital industry exists to fuel dynamic competition, and gives an indication of the stakes involved. Venture capitalists expect only a small minority of the businesses they invest in to succeed, but they also expect the rewards to be very large when success does occur.

In many circumstances, however, the monopoly is not sustainable for very long, which damages the incentives to make risky investments. This introduces a role for intellectual property rights such as patents. A patent is a legally entrenched right to exclusive use of a scientific or technological innovation, for a time limited period. Intellectual property rights, and patents in particular, exist precisely to nurture innovation and dynamic competition. The individual or firm who makes the effort and takes the risk to produce something new is rewarded with a monopoly, not just in the very short term (what might be called “first mover advantage”) but in the medium to long term. This allows them to recoup their investment, before the innovation is released for use by their competitors some years later. Patents are especially important in industries such as pharmaceuticals, in which a large amount of research and development is involved, and a large number of unsuccessful products developed.

This leads to the second significant issue, namely time horizons. As its name suggests, dynamic competition takes place over a period of time, but disputes arise over what are the most appropriate time horizons with which to view it. It is debatable how long an innovator should be permitted to have exclusive rights to their intellectual property. In the realm of competition policy, it is debatable whether (or for how long) an innovator should be permitted to exclude competitors through other nonlegal means.

Those who take a very long-term view argue that monopolies are never permanent, and some new innovation will eventually emerge to destroy the monopolist’s power. But those who take a more short-term view would argue that allowing a single seller to have exclusive right to an innovation is still a form of market power, and thus inhibits consumer rights. On balance, antitrust authorities tend to have more sympathy with the latter view. U.S. merger guidelines, for instance, state that monopolistic practices are acceptable only if a new competitor is likely to arrive within two years. The notion that a newcomer will eventually arrive, while true, is not considered a sufficient basis to tolerate market power in the short and medium term.

Bibliography:

  1. Robert Bork, The Antitrust Paradox: A Policy at War With Itself (Macmillan, 1978);
  2. David Gerber, Law and Competition in Twentieth Century Europe: Protecting Prometheus (Clarendon, 1998);
  3. Frank Knight, Risk Uncertainty & Profit (Kelly & Millman, 1921);
  4. Frank Knight, The Ethics of Competition and Other Essays (Chicago University Press, 1935);
  5. Joseph Schumpeter, Capitalism, Socialism & Democracy (Routledge, 1976);
  6. Hans Thorelli, The Federal Anti-trust Policy: Origination of an American Tradition ( Allen & Unwin, 1955);
  7. Harrison White, Markets from Networks: Socioeconomic Models of Production (Princeton University Press, 2002).

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