Competition and productivity

The Competition and Markets Authority (CMA) in the U.K. has produced a report (pdf) which looks at the the theoretical and empirical evidence on the relationship between competition and productivity. The report states that,

The evidence reviewed here addresses two separate but related questions: first, does stronger competition between firms lead to higher levels of productivity; and second, does competition policy and enforcement lead to stronger competition and hence higher productivity?

There is a strong body of empirical evidence showing that competition can drive greater productivity. Within-country studies demonstrate a positive relationship between strength of competition and productivity growth across sectors. Similarly, cross-country studies suggest that countries with lower levels of product market regulation, enabling stronger competition, tend to have higher levels of productivity growth.

There is also an extensive literature examining the impact on productivity of changes in competition over time, including as a result of deregulation. These studies show generally strong positive effects on productivity in sectors where deregulation has occurred, including transport and utilities.

There are three main mechanisms via which competition drives productivity. First, within individual firms managers are forced to become more efficient when facing competition from other firms. Secondly, competition means that the more productive firms increase their market share at the expense of those firms that are less efficient. The low productivity firms may, in the end, be forced out of the market having been replaced by more productive firms. Thirdly, and perhaps most importantly, competition drives firms to innovate, coming up with new products and processes which can lead to step-changes in efficiency.

These ideas kinda seems obvious when you see them but they are often forgotten when people talk about the advantages of deregulation and increased competition in markets.