Chapter 5 Competition in transition. Competition in Transition b b Major features: 1. Liberalisation of prices and trade 2. Macroeconomic stabilisation

Chapter 5Chapter 5

Competition in Competition in transitiontransition

Competition in TransitionCompetition in Transition

Major features:• 1. Liberalisation of prices and trade • 2. Macroeconomic stabilisation policies • 3. Privatisation and new firms leading to the creation

of a large private sector• Increasing competition or competitive pressure

What was the impact of increased competitive pressure? • Firm sales, productivity, innovation...

Complementary of privatisation and competition

Centrally Planned Centrally Planned EconomyEconomy

Decisions made by central planners not market forces:• location, scale, integration of production defined• output quantities and types set by plan and sales guaranteed• prices and wages controlled

Objectives of the Central Plan firms different from those of the Market-oriented firms in that the Plan:

• Maximises output and employment, not profits• Does not minimise losses government always bails out the loss-

making firms (soft budget constraints)• Does not aim to improve goods’ quality. That required greater

coordination to deal with a greater number of brands and prices. market structure: very large firms and very few small

firms; no competition and build-in inefficiency

Transition ProcessTransition Process

Early 1990s: liberalisation of prices, trade, and labour market Large changes expected to happen:• reallocation of resources (via demand and supply):

– firms closing down and employees moving firms

• firm restructuring: – new plants, new or upgraded products, training of

employees, different organisation (different decision structure and working incentives)

Transition: natural experiment to test theory of competition and impact on firm performance.

Why is competition Why is competition important?important?

External factors impacting on firm performance:• Competition (product and input markets)

– More competition increases the bankruptcy risks increases managers’ efforts reduce costs, improve quality, launch new products.

• Ownership is associated with the risk of bankruptcy – But: lack of competition may reduce the bankruptcy risk so

need to have both• Soft budget constraints (various forms)

– reduce the impact of competition for state owned firms• Investment environment:

– macroeconomic environment, policy stability, taxation, infrastructure, legal system, law enforcement, access to loans.

Why is competition Why is competition necessary?necessary?

Competition (or market contestability) leads to:• 1) Efficiency:

– through harder budget constraints, increasing managers efforts, cost minimisation and profit maximisation increases welfare

• 2) Innovation: – incentive to surpass competitors by introducing new products

or improving product quality

• 3) Managers turnover: – improve decision making process and production techniques

• 4) Market selection: – entry/ expansion of small efficient and exit of inefficient firms

Some important Some important definitionsdefinitions

Perfect competition:• large number of small

firms • free entry and exit• price takers: buyers and

sellers decisions have no effect on market price

Monopolist: • one seller (or potential

seller of good Monoposonist:

• one buyer or potential buyer of good

Market contestability or potential competition• when few firms exist in

the market but• there is free entry (equal

access to technology and information) or exit,

• there is a threat to incumbent firms: new firms may enter and they may exit

importance of competition policy

Competition and Technical Competition and Technical EfficiencyEfficiency

Labour: L

Production: y = f(L)

A

LoL1

yo

y1

The Production Function

With competition-more production with same input-reduce production but reduce input

Competition and Allocative Competition and Allocative EfficiencyEfficiency

DemandMR

MC

y

P

ycym

pc

pm

Comparison between competition and monopoly

With competition-prices are lower = MC-quantities are higher

Shows importance to demonopolise or ensure market contestability.

X-Inefficiency or X-Inefficiency or managerial slackmanagerial slack

Monopoly power has perverse effects on the supply side:• monopolist produces at at a higher cost: pays little attention to

cost-cutting strategies• objectives other than profit maximisation and soft budget

constraints little monitoring of employees and production

MC1

MC0

y

P

ycym

pc

pm

The ratchet effectThe ratchet effect

Under central planning managers• were given a plan of production • but also bonuses rewarding them for

overfulfilling it • they would only slightly overfulfill the

planned production because bonuses would increase today and decrease tomorrow

wrong incentives Competition is to create a new

structure of incentives

Competition and market selection: entry and exit of SMEs

Market selection: • firm entry, survival and exit

Desirable selection and expansion: • efficient firms enter• inefficient firms exit• efficient firms expand productivity and

employment • exit or employment contraction is expected

in state-owned enterprises (SOEs)

Exit and exit barriersExit and exit barriers

Exit is a normal process of a market economy

Exit of inefficient firms and contraction of less efficient firms is to be expected with reforms

Exit barriers in transition• Legal/regulatory bankruptcy rules (bankruptcy

law) and its (low or slow) enforcement • Soft budget constraints that save inefficient

firms and potential exiting firms (they also become a barrier to entry)

Entry and entry barriers

New entry important• New goods and services, • Changes the balance between sectors• Innovation: new tech. and managerial techniques• Evidence suggests job creation is located in new

firms Entry barriers:

• natural barriers: economies of scale, patents, access to a technology structure of the particular market

• “strategic” barriers: strategic actions taken by incumbent firms to deter entry

Barriers to start-ups in transition countries

Uneven playing field between SOEs and start-ups• Licensing taxes and regulation; • Legal institutional norms (e.g. capricious actions by

public officials, corruption and lobbying groups); • Anti-Competitive practices by incumbents (SBCs,

collusion, favoured access to utilities or essential business);

• Macro-stabilisation (e.g. inflation); • Access to financing; • Access to infrastructure (e.g. distribution means,

utilities)

Measures of competitionMeasures of competition

Domestic competition• product market

– number of competitors– market concentration measures

– firm’s market share, HHI and CR

– ratio of the growth of output price to growth of input prices

– qualitative measures and managers’ perceptions

• inputs market– number of employers locally– market concentration measures using

employment

importsortsoutput

imports

nconsumptiodomestic

importsIP

exp

Foreign competition: imports may act as disciplinary tool (cheaper or better quality)

– import penetration ratios:

Concentration measuresConcentration measures

4

1

4i

imsCR : ratio ionconcentrat

100Y

ymsi i

i :share market firm

N

iimsHHI

1

2

: ionconcentratof Index Hirshman-Herfindahl

Measures of firm Measures of firm performanceperformance

Number of new products or upgraded products

Sales growth Profitability Price cost margins Technical efficiency: productivity

measured as total factor productivity Allocative efficiency: Solow residuals

Empirical evidenceEmpirical evidence

Evidence shows that competition (domestic and foreign) has positive impact on performance.

Studies:• Earle and Estrin (1995, 1998)-Russia; Konings (1997)-

Bulgaria, Romania and Hungary; Jones, Klinedinst and Rock (1998)-Bulgaria, Anderson, Lee and Murrell (1999)-Mongolia; EBRD Transition report (1999); Earle and Brown (2000)-Russia; Angelucci, Estrin, Konings and Zolkieski (2001)-Romania, Poland and Bulgaria, Konings

Studies used survey data, cross-sectional data, panel data

EBRD Transition report EBRD Transition report (1999)(1999)

Business Environment and Enterprise Performance Survey together with the world bank

Groups of countries:• Central Europe and Baltic countries• South-Eastern Europe• Central CIS• CIS periphery

Look at statistical association between variables

EBRD Transition report EBRD Transition report (1999)(1999)

Find that: • number of innovations increasing with number of

competitors • sales growth increasing in the number of competitors• when foreign competition is present sales growth is

higher suggesting that foreign competition is important

• exit barriers impact negatively on desirable contraction

• entry barriers impact negatively on desirable expansion

• not enough competition rules implemented

Konings (1997)Konings (1997)

300 firms (SOEs, privatised, new private firms) 300 firms (SOEs, privatised, new private firms) interviewed on ownership and competitioninterviewed on ownership and competition

3 measures of competition:3 measures of competition:• number of rivals (short run competition)number of rivals (short run competition)• expected change in price due to competitionexpected change in price due to competition• expected change in number of competitorsexpected change in number of competitors

competition has increased in all but in competition has increased in all but in Romania< Hungary and SloveniaRomania< Hungary and Slovenia

competition has positive effect on firm competition has positive effect on firm productivity in Hungary and Slovenia (LR) and productivity in Hungary and Slovenia (LR) and Romania (SR) Romania (SR)

Brown and Earle (2000)Brown and Earle (2000)

Panel of data from 1992-98 concerning 14,961 firms covering 75% of all industrial employment

Look at medium and large Russian firms (+100 employees) and their productivity.

Productivity measured as: total factor productivity Analyse association between several factors and

productivity Measure time path of the effects of competition:

slope dummies Measure intensity dimension of competition Firm individual effects: random effects


Comprehensive and disaggregated information that allows to study the impact of• regional and national competition in the 1) product and 2)

labour markets (Russia is large country with important local markets for output and inputs)

• foreign competition through imports• participation in external markets or exports (international

markets screen firms: tough standards• transportation infrastructure: difficulties of transportion

hinder competition and generate market power and is barrier to entry

• macroeconomic environment: recession and boom


What is in X, that is, the list of factors determining productivity?• National and regional product market concentration: HHI and

CR2• Mixtures of the national and regional with weights = % of

consumer goods in firm output and measure of transportation• Import penetration ratios• Local labour market concentration: HHI using employment• Transportation infrastructure quality• Ownership: state (fed., reg. and loc), mixed, private and foreign)• Initial conditions: military, profits, exports, size, ind. and reg.

growth • Real output growth • Industry dummies, Year dummies

Possible biasesPossible biases

1) Selection bias: • only look at efficiency of firms in the survey so

run a probit model for survival 2) Endogeneity:

• not a problem because transition changes structure exogenously

• but use instrumental variables (initial year of 92) 3) Other bias:

• privatised firms more efficiency or privatisation took place in more competitive markets: do as point 2.


Results:• Survival equation

– domestic and foreign competition decrease prob. Survival– transport has negative effect– private and foreign firms more likely to exit– exports, size, profits, and growth have positive effect– no plants is positively and subsidiary is negatively

associated

• Productivity – domestic and foreign competition: positively associated – private ownership: private firm outperform state firms – initial profits: positive impact; military: negative, exports:

ambig. – ind. and reg. growth: positively

Angelucci, Estrin, Konings Angelucci, Estrin, Konings and Zolkiewski (2001)and Zolkiewski (2001)

Use a panel of firms in manufacturing for 3 countries: • Bulgaria (1997-98), Romania (1997-98) and Poland

(1994-1998) - good for comparing countries 1500 firms in Bulgaria, 2047 firms in

Romania, 17,570 firms in Poland Data from Amadeus and Polish statistical

office Studies the impact of ownership and

competition on firm productivity controlling for firm unobserved heterogeneity


Back to the equations:• Inputs: capital and only one measure of labour • X includes:

– product market concentration: HHIat sector level – import penetration ratios– ownership: state, private and foreign– interaction terms between competition and ownership

– allows us to check on the complementarity between privatisation and competition.

– Industry dummies, Year dummies

• Use OLS, Fixed effects and random effects


Results:• Ownership:

– Private domestic firms outperform state firms in Bulgaria, Romania and Poland. Private foreign firms outperform private domestic firms in Bulgaria and Poland but not in Romania.

• Domestic competition leads to – higher productivity in Poland (association reinforced for

foreign owned firms) and in Romania. In Bulgaria the effect of competitive pressure is found to be dependent on the ownership structure of the firm: a positive association is found for private firms only.

– Suggests complementarity of competition and privatisation


Results (cont.)• Foreign competition:

– positively associated with firm performance in Poland (association found to be reinforced for foreign owned firms) but negatively associated with firm performance in Romania and in Bulgaria (though not significant for this country).

Zolkiewski (2001)Zolkiewski (2001)

Uses the data from Polish statistical office on all Polish firms

Estimates the production frontier X includes:

• ownership• market concentration proxying domestic

competition• Import penetration ratios as a proxy for

foreign competition

Zolkiewski (2001)Zolkiewski (2001)

Results• Labour = most import factor of production Polish

manufacturing reveals decreasing returns to scale. • Private firms, especially foreign owned (but

coefficient estimates were similar), outperform SOEs in Poland.

• Foreign competition increases firm efficiency although may be negative for private domestic firms.

• Wide variation of firm efficiency• Small firms are more efficient than medium and

large firms in Poland

Konings, Van Cayseele and Konings, Van Cayseele and Warzynski (2001b) - Warzynski (2001b) - TransitionTransition

Panel of data: +3,000 manufacturing firms with +100 employees = large representative set taken from Amadeus data set.

2 countries: Bulgaria (2047) and Romania (1701)

look at firms’ market power: check if market power has indeed decreased • analyse price behaviour of firms (price cost

margins) and its determinants – domestic and foreign competition (trade liberalisation) – firm ownership (private domestic, private foreign - fdi -

and state)

Konings, Van Cayseele Konings, Van Cayseele and Warzynski (2001b) - and Warzynski (2001b) - TransitionTransition

Market concentration declining in Bulgaria and Romania and import penetration rising

Argument: trade liberalisation should increase competition and thus decrease price cost margins but some evidence that MNEs implemented in sectors with high market power and receive support from state - Test that in the transition context

Roeger’s (1995) method = no need to deflate


Estimate price cost margins (PCMs) for all the 2-digit industries• first with all years pooled together • for different sectors• using panel data regressions

Results:• Bulgaria:

– import penetration decreases PCMs– high concentration leads to high PCMs– private domestic and private foreign have higher PCMs– foreign firms have the highest PCMs


Results:• Romania:

– import penetration increases PCMs– high concentration does not lead to high PCMs– private domestic and private foreign have higher PCMs

• Conclusions:– PCMs around 20% very similar to the West– private firms increasing market power. State giving

benefits to private foreign– not enought demonopolisation and privatisation not a

good substitute to competition– trade not a disciplinary tool: case if imports do not

compete with domestic production

Konings, Van Cayseele Konings, Van Cayseele and Warzynski (2001a) and Warzynski (2001a)

PCMs of around 20% Import penetration ratios increase

market power for the Netherlands and not significant for Belgium

Policy priorities IPolicy priorities I

Results from study: • Privatisation appears to have the desired

effect so should proceed – but impact decrease with market concentration.

• Competition has desired effects. Privatisation alone not a good substitute for competition. They are complementary.

– So must ensure there is competitive pressure. – More attention should be put on demonopolisation.

• More attention should also be put on trade liberalisation since it reduces market power in highly concentrated markets.

Policy priorities IIPolicy priorities II

Competition policy: • Law and institutions:

– significant efforts made to have both and coherent and integrated with EU law.

– Competition institutions had fruitful activity – but concerns about implementation of fines and

public assistance and law enforcement in general– concerns also about independence of institutions

• removal barriers to exit and entry:– bankruptcy law, anti-trust law and monotoring of

collusive behaviour (mergers and cartels) at local and national level, together with fine implementation

– financial discipline and harder budget constraints– more information to SMEs– competition in the telecommunications and

transportation sectors

Policy priorities IIIPolicy priorities III

Trade policy: • removal of tariffs and non-tariff barriers:

foreign competition is of major importance• international agreements• foreign direct investment

Financial and banking sector in general• development of financial (as well as non-

financial) services suitable to SMEs

general institutional and legal frameworks • protection of property rights• clarification and simplification of licensing

and taxation• law enforcement

Documents

Chapter 5 Competition in transition. Competition in Transition b b Major features: 1. Liberalisation of prices and trade 2. Macroeconomic stabilisation