As a concept, refers to a rivalry among two or more people or groups of people for a given prize; might refer to anything from chess competition to a soccer game as fulfilling the meaning of the verb “to compete.”
Competition is a political and social goal, as well as an economic one, with some possible resulting conflict among these various values. In the political sense, competition refers to a society where individual freedoms fully exist and where democracy is the main founding pillar. In the economic sense, the rivalry is among the firms in a given industry for the goal of maximizing their profits vis-à-vis other firms in an industry. The rivalry in question might also be among the countries to maximize their overall welfare vis-à-vis other countries in the world.
Competition is one of the basic principles of economic theory. The well-known tendency concerning the meaning of competition in economic theory is to consider it as the opposite of monopoly, but this has created confusion in terms of the relationship between economic efficiency and business behavior.
There are a number of scholars who provide significant insights to the concept of competition, such as George Stigler and Paul McNulty. Stigler defines competition in an economic sense as a means of organizing economic activity to achieve a goal. The economic role of competition, according to Stigler, is to discipline the various participants in economic life to provide their goods or services skillfully and cheaply. McNulty points out that competition is a principle so basic to economic reasoning that not even such powerful critics of orthodox theory as Karl Marx and John Maynard Keynes could avoid relying on it without ever clearly specifying what exactly competition is. Both Stigler and McNulty share the same idea that the concept of competition has evolved from the emphasis of Adam Smith in his Wealth of Nations, from rivalry between firms to competition as a situation where there is an absence of effective monopoly power. However, McNulty comments that the concept of competition already existed before Smith, but his emphasis on the issue helped accelerate the evolution of the concept. In the Wealth of Nations, Smith stressed the fact that the actions of the rival firms are the essence of competition. Competition can be present even though there is a monopoly power. According to Stigler, nonocclusive forms of rivalry, for instance, price cutting and product differentiation, are competition for Smith.
Throughout the evolution of the concept of competition, there exists a number of leading economic theories and models that have had significant policy implications. One of the best known of these is the perfect competition model, which is a representation of the optimum, a kind of measuring stick against which all other situations and market structures can be evaluated. It is an exacting concept forming the basis of the most important model of business behavior. The essence of the concept is that the market is entirely impersonal. It exists when there is no monopoly power. In other words, there should be no seller or buyer with price-making power and a significant effect on market results. The absence of price-making ability is highlighted as one of the key features of perfect competition.
The cutthroat pricing contests as the test of market strength between firms are considered a rivalry. The basic assumptions of the perfect competition model were as follows: many number of firms, homogeneous products, free entry and exit to the market in question, perfect flow of information in the market, and the firms make their decisions independent of each other. There were many criticisms of the perfect competition model, such as that it had no connection with real-life phenomena and that it was too abstract. Because of criticisms such as these, other theories and approaches arose.
Another important contributor in the evolution of the competition concept was Edward H. Chamberlin, who merged the concepts of monopoly and competition as the result of the undeniable fact that the business world is more or less a mixture of the two. More specifically, the term “monopolistic competition” is a form of industrial organization in which the elements of competition and monopoly coexist. Chamberlin’s theory of monopolistic competition had two significant results. First, it was an improvement over the simplicity of the older classification of perfect competition. Second, it paved the way for a concept of competition as distinct from the concept of competitive market that is relevant in terms of both economic analysis and economic policy. Chamberlin pointed out the diversity of products in a given market and the similarity of products produced by different industries and developed his theory through the inadequacy arising out of the perfect competition model. Chamberlin’s contribution made it possible to address the problem of defining products and industries, however, the theory was not adequate enough to solve economic problems.
The criticisms about the abstract concept of perfect competition led to other theories and models of competition, such as workable competition. According to this concept, the real-world markets do not have so many firms in a market, therefore, judging them as anticompetitive would not be fair. The workable competition concept had its problems since it made it difficult to clarify which industry was competitive or anticompetitive when used during the policy implementations. Later in the 1960s, the workable competition concept evolved into the effective competition concept by J.M. Clark.
Much of the ambiguity about the meaning of competition arose from the failure to distinguish between competition and market structure. The market structures are monopoly, duopoly, or oligopoly. This classification made it possible to obtain analytical simplicity, and it helped to clear out the confusion between monopoly and competition.
The contributions to the evolution of competition concept are quite extensive. One of the most important conceptual debates concerning competition evolves around the definition of competition with two main approaches: competition as the state of affairs and competition as a process. Neoclassical economists introduced the concept of competition as the state of affairs. And the main contributions of the neoclassical economists were twofold: the perfection of the concept of competition and the idea that competition itself is a market structure. Antoine-Augustin Cournot, William Jevons, and Francis Edgeworth were effective during the evolution of these ideas, yet the merging of the market and competition concepts was the result of the works by J.B. Clark and Frank Knight, which cleared the way for the contemporary perfect competition concept. Stigler, on the other hand, believed that the merging of competition and market concepts was unfortunate since according to him the two needed separate treatment.
The classical economists thought of competition as a market process, a force, and a dynamizer of the economy, whereas the neoclassical development of the perfect competition concept was taking it as a market structure. This could be accepted as a sharp break in the evolution of social thought. Actually, classical and neoclassical approaches toward competition are incompatible in a basic sense, reflecting the condition of equilibrium and behavioral patterns leading to it.
It is hardly possible to complete the evolution of competition theory without mentioning the significant contributions of the Austrian school of economists. The Austrians pointed out the limitations of the neoclassical approach. For them, competition is a process that moves the economy to an equilibrium. This follows that the process of exchange, within their terminology catalectics (the science of exchanges), is central to their thinking. Their focus of attention is the entrepreneur or the acting person in a given market. The competitive process is driven by the self-interest of the entrepreneur who has to make choices depending on the limited amount of information he or she has and because of his or her perception of the present and future conditions in the market. The same is true for the others in the market. The Austrian view of competition is based on removing obstacles to competition so that it clears the way for new products, processes, and entry for rival firms.
Apart from the previously mentioned contributions to the concept of competition, though parallel with some of the views already presented, it is worth mentioning two more specific views in the evolution of competitive theory. The first one belongs to Joseph Schumpeter, who points out in “The Process of Creative Destruction” that the reality of the capitalist system demanded a competition arising from a new commodity, new technology, and new sources of supply and that the price competition did not count as such. Second, Frank Knight emphasizes that competition means the existence of many competing units acting independently of each other. This calls for a close conceptual connection between competition, economic rationality, and freedom. Knight also comments that competition actually means the freedom of the individual to deal with any and all other individuals and to select the best terms as judged by him- or herself among those offered.
The increasing usage of game theoretic tools in recent years has also widened the scope of the theory of competition. Structurally, the competition concept includes besides its evolutionary theories the spectrum from monopoly to cartels, to joint-ventures, and to mergers.
It is possible to see a striking contrast between the analytical precision of competition when it is described in terms of market structure and the ambiguity around the idea of competition when it is described in behavioral terms. If the economic competition concept is to be treated in relation to the economic policy, and it is often taken as such, then it is to be associated with the term “compete.” No matter what shape it takes, competition is a concept that has empirical relevance and operational meaning in terms of business behavior.
Competition among the players of any market is attained by the usage of regulatory tools such as competition policy and antitrust laws. The idea is to have efficiently working markets where productive and allocative efficiency are created through antimonopoly policies, and the individual welfare of the consumer is optimized as such. Since the firms will search for ways to maximize their profits, it might be their rational choice to restrain competition between themselves for the attainment of this goal. Then, the regulation of the markets to protect competition that might otherwise be to the detriment of the society and the individual in general becomes a necessity. The important political mission embedded in the competition policy is to avoid the tendency toward totalitarian regimes resulting from possible excessive market power. In essence, competition policy is integral to human nature and to the role of society and the state. Essentially, the liberal view of the state is in tune with the classical model of competition.
The attempts to protect competition and the competitive environment in markets in particular, and the foundations of society in general, led to the passage of laws in the United States that later provided guidance for other countries. One of the most famous of these laws is the Sherman Antitrust Act of 1890, which came into existence as a reaction to the railroad cartels of the time. The act is important for many reasons, the most important being that it institutionalized the protection of competition by state authorities, thus creating a path-breaking regulatory environment that was later to be followed by the Clayton Antitrust Act (1914), the Robinson-Patman Act (1936), and the Celler-Kefauver Act (1950). The European Community (after 1991, the European Union [EU]) later followed the cumulative experience of the United States in the field of competition to establish its own policy and policy tools. There is, however, one important difference between the EU and U.S. competition policies. EU competition policy has the main purpose of attainment of a sound common market, whereas U.S. competition policy addresses a national goal.
The political goal of U.S. competition policy was clearly put forth by President Franklin D. Roosevelt in 1938 when he stated that the liberty of democracy was not safe if the people tolerated the growth of private power to a point where it became stronger than their democratic state itself.
In the regulation and attainment of efficiently and competitively working markets, competition authorities have been influenced by a number of different schools of thought and the paradigms and the theories developed by them as regards the competition policy implementations. The most significant of these are the market power paradigm (Harvard School), the market efficiency paradigm (Chicago School), and the contestability theory. Each of these paradigms or theories has a considerable impact on the evolution of the concept of competition and the competition policy implementations going in parallel with it.
The economic case for competition policy depended on the market power paradigm, which was developed by the Harvard School of economists over a long period. Market power, or in other words the structure-conduct-performance paradigm, has its roots in the neoclassical theory of competition, and it has been the central point of interest in the field of industrial economics. According to this paradigm, the structural factors in the markets such as size distribution of firms and entry barriers have a role in facilitating anticompetitive practices and generating supranormal profits.
There is an apparent determinism—from the structure of the markets to the conduct of the firms in that market toward their performance in the market—in question. The structure in this sense relates to the importance and characteristics of individual markets in an economy. Structure, then, can be identified by market concentration: the extent to which the products are differentiated, the barriers to entry, and the diversification of firms in the market. Conduct refers to the actions of firms and their decision-making processes such as advertising and research and development. Performance is related to the allocative and productive efficiencies on the part of the firm. This paradigm has been attractive for a long time because it has a straightforward chain of reasoning and a relative ease of identifying structural characteristics.
Starting from the early 1970s, the Chicago School of economists developed the market efficiency paradigm as a criticism of the market power paradigm of the Harvard economists. According to the adherents of this paradigm, monopolization or high market concentration cannot be blamed on its own as anticompetitive and one has to understand how these monopolies come into existence. For instance, firms might achieve a cost reduction that results in an increase in their profits, and when that does not negatively affect the resource and income distribution, it is not fair to punish these types of firms. The efficiency of the firm and the market power or higher profits they sustain in this way should not be considered as anticompetitive. The outcome of the development of the market efficiency paradigm, or in other words the alternative paradigm, is that competition policy implementations became less rigid in parallel with the basic idea of this paradigm that market power is not in itself anticompetitive per se in the beginning of the 1980s.
In the 1980s, the contestability theory also came into existence. This theory stressed the fact that a particular market structure is not necessarily equivalent to a particular type of performance. The theory was built around the contestable market idea and was focused on several aspects of market entry. The conditions of this theory hold for three conditions. First, entry is free and there are no limits. Second, the entrant can establish him- or herself in the market before an existing firm can give any response. Third, entry is reversible. This means that exit from the market is perfectly free. The contestable market theory also attracts criticisms as regards real-world phenomena. The arguments point out that it leaves little room for competition policy since in a contestable market no firm has absolute market power.
With the globalization trend and the gradual opening of world markets, and the transfer of production factors from one country into another, the concept of competition becomes more and more important in international trade. Firms that operate in a global context and transnational mergers, joint-ventures, and takeovers create a concern for national competition authorities as to how to regulate these issues. Therefore, there is an ongoing trend of cooperation among the competition authorities all over the world. The best-known example of this type of cooperation is between the United States and the EU. These efforts are now leading to the establishment of an international competition authority to oversee the global markets.
The discussion of competition and the creation of cohesion between trade and competition policies has been on the agenda of relevant international organizations, such as the Organization for Economic Cooperation and Development (OECD), for the past decade. This discussion relates to the definition of the common and differing aspects of competition and trade policies for defining future policy options. The idea behind these attempts is to create an optimum interaction environment for the two policies and policy instruments. Competition policy and trade policy are complementary in the sense that they are both procompetitive and proconsumer oriented. The underlying rationale is that both competition policy and trade policy address the issue of elimination of barriers to and distortions of the markets. Both of the policies aim to increase general efficiency and welfare. The present policy question is: How can these two policies be used effectively for the attainment of their main goals? The answer lies in the economic rationale behind the integrated usage of trade and competition policies.
Adam Smith articulated the economic rationale of the competition-integrated approach to trade. He pointed out that trade liberalization is necessary for sustaining the economic benefits of market competition. The opening up of national markets to global competition is the pillar of trade and investment liberalization. There are both static and dynamic gains associated with free competition in this sense. Static gains are those that improve the allocation of resources, by the exclusion of discriminatory measures that are disrupting competition. Dynamic gains result from the positive effects of competition on the efficiency of the production process. This type of competitive gains introduces the incumbent firms with the new production technology. Thus, a technology transfer occurs, which enhances the general welfare of the host country. Competition-integrated trade policy implementation might also bring about the economic benefits through democratic regulatory reforms triggered by international interactions.
Competition policy and competition law should be thought of as distinct from one another. Competition policy pertains to both the private behavior of firms and government policy, whereas antitrust rules pertain only to the behavior of firms. Competition policy has a broader context, which comprises a number of measures and instruments used by the governments that define the competitive conditions on a national scale. Competition law has started to become a focal point for trade-policy officials. This is partially initiated by export interest groups who are pointing to the anticompetitive practices that prevent them from selling goods and services in foreign markets. This concern also includes the transnational mergers and acquisitions among big companies. Competition policy already exists in the WTO by way of trade policy, subsidies, intellectual property rights, and so on. The WTO agreements such as the Trade-Related Investments Measures, the Trade-Related Aspects of Intellectual Property Rights, and the General Agreement on Tariffs and Trade also contain substantial provisions concerning competition. Still, whether these provisions are implemented or not, the restrictive business practices on services are not definitive. The members are now free to act on their own initiative about these issues.
An important question for the WTO is whether national competition regulations have an effect on trade or not. In 1996, the WTO (like the OECD) created a working group to examine the relationship between trade and competition policies. There is no consensus as yet whether the competition policies should be integrated into a world trading system or not.
The advocates of the international competition authority in the WTO have as their main focus the issue of market access. There are a number of groups with different agendas and arguments, such as developed country views as opposed to developing country or less-developed country views. The EU and the United States are investigating the possibility of using competition policy as an export promotion device, as they are not actually interested in exposing their firms to international competition disciplines. The main focus of the 1990s was on the cross border mergers in terms of interaction of international trade and competition policies. Now, the main question that remains is how strategic interest should use the regulatory framework of competition in sustaining free trade in the international context.
Esra LaGro
See also: Cartels; European Union; Marx, Karl; Smith, Adam; World Bank; World Trade Organization.
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