Competition: What Is It All About? (First of two parts)

Philippine Institute for Development Studies June 2001

Economic I ssue of the Day

Volume II Number 1

Competition: What Is It All About?

(First of two parts)

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ompetition policy is a "fashionable" topic these days as we witness many developing countries and economies in transition legislate their competition laws. But what exactly is competition law and policy and why does a country need it? Is trade liberalization not enough to ensure competition? Would competition not lead to cutthroat rivalry that eventually results in the death of domestic firms and domination by large firms?

Before one answers these questions, however, one first needs to understand the concept of competition which is explained in the sidebar.

It is important to recognize that high levels of market concentration as well as the presence of monopolies (a type of industrial structure where there is only one large firm) or oligopolies (where there are a few large firms) are not necessarily detrimental to competition. Large firms may achieve a dominant position in the market through legitimate ways like innovation, superior production or distribution methods, or greater entrepreneurial skills. For as long as markets remain contestable wherein entry into a market is easy, one can expect large firms in an oligopolistic environment to act independently or monopolies to behave in a competitive manner.

One may ask: how can there be competitive prices if there is only one firm or only a few firms in the market? The answer is that if entry is easy and costless, the potential threat from imports or domestic competitors will make the incumbent firms behave competitively. For instance, as soon as one firm or a group of firms attempts to increase prices or lower quality from the competitive levels, a new firm can come in to serve the market, thereby driving prices back to competitive levels.

Barriers to competition Competition, however, can be lessened significantly by structural characteristics, restrictive business practices, and government regulatory policies, examples of which are shown in Box 1. These act as barriers to entry. Economies of scale is an example of a structural barrier . When there are increasing returns to scale, there is a minimum size that firms have to attain if they are to have their average cost as low as possible. If the minimum efficient scale is so large that only one firm can serve the entire market, there will be a monopoly as in the cases of public utilities like the distribution of water, electricity, and piped gas.

Cartel arrangements and mergers that limit competition, meanwhile, are examples of behavioral characteristics or restrictive business practices whereas anti-dumping and investment licensing, among others, are regulatory barriers .

What is competition?

Competition is seen as a process that allows a sufficient number of producers in the same market or industry to independently offer different ways to satisfy consumer demands.

Since competition is often equated with rivalry, it pressures firms to become efficient and offer a wider choice of products and services to consumers at lower prices. A competitive economy enables individuals to exercise economic freedom wherein consumers are able to choose what they value most and entrepreneurs to choose where they want to invest. The competition process allows consumers and producers to make their choices, free of any price fixing conspiracies and monopolistic bullying. As such, consumer welfare increases, resulting in dynamic efficiency through innovation and technological change.

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Economic Issue of the Day June 2001

COMPETITION

Volume II Number 1

The Economic Issue of the Day is one of a series of PIDS efforts to help in enlightening the public and other interested parties on the concepts behind certain economic issues. This dissemination outlet aims to define and explain, in simple and easy-tounderstand terms, basic economic concepts as they relate to current and everyday economicsrelated matters.

This Issue was written by Ms. Rafaelita A.M. Aldaba, Research Associate at the Institute.

The views expressed are those of the author(s) and do not necessarily reflect those of PIDS.

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Box 1: Structural, behavioral, and regulatory barriers to entry Structural: barriers due solely to conditions outside the control of market participants p Sunk costs – costs that a firm cannot avoid by withdrawing from the market; they are a sort of entry fee p Absolute cost advantage – access to natural resource or human resources p Economies of scale – unit cost of production falls with increasing output p Large capital requirements p Network industries – firms that are competitors share some critical facility like transportation and telecommunications Behavioral: represent abuse of dominant position where “relatively large” firms engage in anticompetitive conduct or restrictive business practices by preventing entry or forcing exit of competitors through various kinds of monopolistic conduct p Excess capacity p Product differentiation and advertising p Horizontal restraints – cartels or collusion (price-fixing agreements, market sharing territorial arrangements, bid rigging), price discrimination p Vertical restraints – resale price maintenance, exclusive dealing p Foreclosure and exclusion p Tactics to increase rivals’ costs Regulatory: barriers imposed by government policies p Special permits, license to operate p Regulations influencing the use of some inputs p Tariffs, quotas, and other nontariff barriers p Anti-dumping and countervailing duties p Discriminatory export practices p Exclusionary lists p Ownership restrictions Source: A Framework for the Design and Implementation of Competition Law and Policy, the World Bank and the Organisation for Economic Co-operation and Development, 1998.

Market power and abuse of dominance

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The presence of barriers to entry impedes competition and allows firms to acquire and exercise market power. Market power in turn enables firms, unilaterally (in the case of a monopoly) or in collusion with others (as in cartels), to profitably raise prices and maintain these over a significant period of time without competitive response by other existing or potential firms. Market power gives rise to reduced output, higher prices and poorer quality products which harm consumers and other producers. Thus, economic welfare is adversely affected.

For instance, with cartels and collusion, the economic freedom of consumers and potential rivals is taken away. Cartels make consumers believe that what they see are independent offers. By raising prices and restricting supply, however, they deliberately create artificial shortages, resulting in goods and services becoming completely unavailable to some buyers and unnecessarily expensive for others. These output restrictions cause inefficiency, reduce productivity, result in economic and social harm, and hinder development.

Large firms may further take advantage of their market power by abusing their dominant position or monopolization. They may suppress competition by restricting or foreclosing the entry of smaller rivals through, for example, the increase of the competitors’ costs of entering a market or the charging of predatory prices which harms the competitive process. k