Competition in transition

1
Chapter 5

• Competition in transition

2
Competition 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

3
Centrally Planned Economy

• 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

4
Transition 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.

5
Why is competition 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.

6
Why is competition 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

7
Some important definitions

• 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

8
Competition and Technical Efficiency
Production y f(L)
The Production Function
y1
With competition -more production with same
input -reduce production but reduce input
A
yo
Labour L
Lo
L1
9
Competition and Allocative Efficiency
Comparison between competition and monopoly
With competition -prices are lower
MC -quantities are higher
Shows importance to demonopolise or ensure
market contestability.
Demand
MR
10
X-Inefficiency or managerial 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

11
The 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

12
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)

13
Exit 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)

14
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

15
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)

16
Measures of competition

• Domestic competition
• product market
• number of competitors
• market concentration measures
• firms 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

17

• Foreign competition imports may act as
  disciplinary tool (cheaper or better quality)
• import penetration ratios

18
Concentration measures
19
Measures of firm performance

• 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

20
Empirical 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

21
EBRD Transition report (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

22
EBRD Transition report (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

23
Konings (1997)

• 300 firms (SOEs, privatised, new private firms)
  interviewed on ownership and competition
• 3 measures of competition
• number of rivals (short run competition)
• expected change in price due to competition
• expected change in number of competitors
• competition has increased in all but in Romanialt
  Hungary and Slovenia
• competition has positive effect on firm
  productivity in Hungary and Slovenia (LR) and
  Romania (SR)

24
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

25
Brown and Earle (2000)

• 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

26
Brown and Earle (2000)

• 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

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Possible 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.

28
Brown and Earle (2000)

• 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

29
Angelucci, Estrin, Konings 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

30
Angelucci, Estrin, Konings and Zolkiewski (2001)

• 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

31
Angelucci, Estrin, Konings and Zolkiewski (2001)

• 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

32
Angelucci, Estrin, Konings and Zolkiewski (2001)

• 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).

33
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

34
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

35
Konings, Van Cayseele and Warzynski (2001b) -
Transition

• 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)

36
Konings, Van Cayseele and Warzynski (2001b) -
Transition

• 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
• Roegers (1995) method no need to deflate

37
Konings, Van Cayseele and Warzynski (2001b) -
Transition

• 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

38
Konings, Van Cayseele and Warzynski (2001b) -
Transition

• 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

39
Konings, Van Cayseele and Warzynski (2001a)

• PCMs of around 20
• Import penetration ratios increase market power
  for the Netherlands and not significant for
  Belgium

40
Policy 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.

41
Policy 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

42

• 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

43
Policy 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

44

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