The Alleviation of Competition
Let us take a moment to consider what might cause competition to break out within a seemingly stable social structure of accumulation. After a prolonged period of lax competition, profits begin to suffer, despite the absence of strong competition. Business begins to take on more and more staff. Lower level workers begin to wrest some concessions from their employers. In effect, then, the measures used to protect the profit rate from competitive pressure eventually allow x-inefficiencies to eat away at profits.
As profits from productive activities sag, firms and investors will try to maintain their profit rate through speculative activity. While speculation might help to shore up profits for an individual investor or firm, speculation in itself does nothing to make an economy more productive.
To make matters worse, speculation consumes considerable resources that could have otherwise been used for productive purposes. Admittedly, this tendency can work to the benefit of the profit rate, especially if speculators are consuming products that are subject to increasing returns -- say, for example, computer software. Finally, speculative pressure takes a toll on the profits of productive firms to the extent that speculation bids up the prices of rents and raw materials.
At first, the negative effects of speculation may go unnoticed since speculative profits can create an economic euphoria. Investors begin to overestimate the probable profit of their ventures rates since they become increasingly insensitive to risk. During such heady times, foolhardy investments will become commonplace. Finally, speculators will also inflate the stock and bond markets. The high price for financial assets will drag down the rate of profit in finance.
These conditions put the monetary authorities in a bind. If they continue to allow the speculative excesses to continue, the economy will become increasingly distorted. If they decide to bite the bullet and rein in speculation by tightening the money markets, competitive pressures will ratchet up. Prices, especially prices for stocks, bonds and raw materials will become cheaper, while unemployment will soar. More often than not, this process, if left unchecked, will result in a severe recession, or even a depression -- especially if the speculation has been prolonged.
In the wake of the depression, the public will search out culprits: ghoulish monetary authorities, greedy speculators, or foolish management practices. In truth, all will play a role, but the stage was set by the prior lack of competitive pressures. A recession or depression will increase the level of competition.
Typically the human costs of a depression are heavy. Even in the automobile industry, where prices fell relatively little during the Great Depression, employment fell sharply. Such are the demands of a market economy.
Once the consequences of a competitive environment are felt by those who are accustomed to a more privileged position in the economy, the authorities shrink from allowing the competitive process to run its full course. Typically, they will step in with a looser monetary policy or expanded government spending -- often on the military. With competition blunted again, the process will repeat itself.
Economists of a more libertarian persuasion will insist that the blame belongs with those who attempted to blunt the effect of competition in the first place. Alas, in the absence of these measures, an economic downturn would just as certainly occur, and perhaps with even more severity. Unfortunately, these downturns are far more savage than the libertarians acknowledge. The Ambiguity of Competition
So far, I have followed the standard practice of economics in using the term, "competition," in an admittedly loose manner. On the crudest level, industries are said to be either competitive or non-competitive. For most economists, if competition is not rigorous enough, the fault must lie with government policies or collusion among corporations. In the absence of such interference with the market, strong competition will supposedly be the natural state of affairs. I agree with this conclusion, except that I maintain that under a regime of strong competition, crises will be the norm.
Specialists in industrial organization do have quantitative indices of the degree of competition. Typically, they look at the share of an industry held by the four largest firms. While this measure, known as a concentration ratio, appears to be objective or even scientific, many economists dismiss its relevance for several reasons.
In the first place, economists are hard pressed for an exact definition of an effective market. What is the market for a newspaper? Does my small town newspaper compete against the ”Wall Street Journal• or the ”New York Times•? What about our free weekly newspaper? I could argue that the newspaper also competes with television, magazines, and even bowling, depending on how we understand the activity of reading a paper.
In addition, while many economists accept that high concentration ratios do exist, they dismiss any concern with that indicator. According to this school of thought, markets have merely determined the most effective outcome. High concentration ratios may be nothing more than evidence of the previous competitive success of the leading firms in the industry. The few remaining firms may just be so efficient that most of their rivals were too inefficient to survive. Lessening the powers of these successful companies would merely hobble the most efficient firms in the industry. Consequently, they argue that we should do nothing to tamper with the result.
Still others accept that the dominant firms might not necessarily have achieved their position as a result of prior efficiencies. Mergers or acquisitions might have eliminated some of the potentially most efficient firms. Even so, we should accept the high concentration because only the large firms are capable of mustering the forces required to achieve efficiency.
Although all parties in these debates differ in almost every other respect, we do find one constant theme: the presumption that the more competition the better society will be. As Lester Telser, an exceptional economist who has taken the time to analyze the foundations of economic theory, wisely observed, "It is hard for many economists to accept the proposition that competition may be excessive because the received theory regards competition as always good, the more the better" (Telser 1987, pp. 6-7).
To allow that too much competition can be destructive does not mean than competition serves no good purpose at all. In the absence of competitive pressures, few firms would be likely to exert themselves to strive for much efficiency -- let alone maximum efficiency. Not many economists would disagree with the contention of Hicks, that, in the absence of strong competitive pressures, those who run business will satisfy themselves with what Hicks called, the 'quiet life'. In effect, with a relatively stable social structure of accumulation, business will mostly settle back and run on automatic pilot. Of course, business will, as always, look for profitable situations, but just not too hard.
At such times, the competitive system might have a few 400 hitters, but only because most of the competition is so lax. Mark Egnal tells two stories that illustrate the nature of lax competition. In 1956, Bethlehem Steel Corporation, the nation's second largest steel producer employed eleven of the eighteen best-paid executives in the U.S. Every vice president had his own dining room with linen tablecloths and full waiter service. Each Bethlehem plant had its own golf course, and the company employed three individuals whose only job was playing golf with clients (Egnal 1996, p. 163).
Egnal also reports that Pete Estes (who was soon to be appointed president of General Motors) turned thumbs down on a proposal in the early 1970s to introduce front-wheel-drive cars. He confided to a colleague: "When I was at Oldsmobile, there was something I learned that I've never forgotten. There was an old guy there who was an engineer. and he had been at GM a long time and he gave me some advice. He told me, whatever you do, don't let GM do it first" (Egnal 1996, p. 165; citing Halberstam 1986, p. 23). We may have some evidence of modest improvements under such conditions, but, continuing with Gould's baseball metaphor, we will not see many home runs -- at least in terms of major breakthroughs in productivity.
In sum, we have seen that firms require some sort of stress in order to prod them to be more efficient or even to pursue technical change energetically. Unfortunately, I cannot conceive of any rule that could apply in all, or even most cases.
Egnal's two stories are a case in point. Pete Estes reaction indicates a concern with a tradition, albeit a benighted tradition. Rewards of the nature of the perks of the Betheleham executives should encourage long-term planning and strategic thinking, since the flow of benefits would stop if the vice presidents under-performed or the company failed, as John Legge has reminded me. The present system of salaries and share options but no perks has removed the long term incentive.
In short, too much stress causes waste and great human losses; too little stress also causes waste and inefficiency. No economist to my knowledge has seriously addressed this question.
The closest I can come to a general proposition comes from an influential survey of the research on the state of industrial organization. The authors concluded that "a market structure intermediate between monopoly and perfect competition would promote the highest rate of inventive activity" (Kamien and Schwartz 1975, p. 32). So, we are left nothing more satisfying than an appeal to what we will later call, "the Goldilocks principle." Keeping Competition at Bay
Martin Neil Baily, a member of President Clinton's Council of Economic Advisors at the time, wrote:
##Vigorous global competition against the best-practice companies not only spurs allocative efficiency, it can also force structural change in industries and encourage the adoption of more efficient product and process designs .... This conclusion represents a subtle departure from the standard view of competition. [Baily 1995, p. 308]
Baily's supposed 'subtle departure' cries out for some explanation. If firms are always searching for the best business practices, why should the recent entry of foreign firms make this search significantly more effective? Baily seems to have stumbled on to a phenomenon that most economists have missed -- that competitive pressures are variable.
Although business and government leaders eagerly pay lip service to their devotion to the principles of competition, in truth they go to great lengths to blunt competitive forces. These worthies rely on a number of tricks to keep competition at bay. Government regulations and tariffs protect domestic markets; government looks favorably on business cooperation and mergers; and finally, governments engage in stimulative monetary and fiscal policies. We normally do not consider expansionary monetary and fiscal policies to be anti-competitive, but additional buying power certainly does take some of the sting out of competition.
Even so, business, if economists' presumption about economic behavior were true, should still energetically seek out any means to increase profits. Such does not seem to be the case. Where competitive pressures are light, business does indeed seem to prefer the 'quiet life' to the frenetic quest for maximum profits.
At the same time, as I mentioned before, the economists are perfectly correct in believing that vigorous competition is the normal state of affairs -- at least in the absence of measures, customs or institutions that curtail competition. Where efforts to weaken competition are not present -- whether collusion among firms, artificial stimulation of the economy or protection through tariffs, quotas or regulation -- competitive forces will take on a momentum of their own. Prices will approach marginal costs, threatening to throw virtually all high fixed cost producers into bankruptcy.
What Baily observed was the effect of a watershed moment when an economy, which was relatively protected from competition, suddenly began to felt the effect of competition from abroad -- the unraveling of the regime of x-inefficiency that Harvey Leibenstein had discovered. One leading text book on industrial organization had already pointed out evidence that strong import competition seems to blunt x-inefficiencies (Scherer and Ross 1990, p. 670). Of course, other factors were at work in influencing the economy, but I think that the delayed recognition of this shift marked the gulf between Baily's assertion and what he called, 'the standard view of competition'.
Baily's description of the effect of the introduction of a heightened degree of foreign competition bringing an end to a period of the 'quiet life' is comparable to an asteroid setting off a rapid evolutionary burst within the theory of punctuated equilibrium. The threat of imports from foreign producers forces domestic producers to embark on a series of defensive innovations in a belated effort to prevent imports (Wood 1995, p. 159).
As we have mentioned before, economics departs from the story of punctuated equilibrium in one important respect: catastrophes in economics do not necessarily depend on some external event. Economic forces themselves generate catastrophes on their own. Of course, if we think of the solar system as a whole, rather than life on earth, then the events that might otherwise seem external, such as an asteroid crashing into earth, may be internal to the system. The Goldilocks Principle of Competition
Now let us return to the cherished idea of most economists believe that competition is unequivocally good -- although some individuals may be hurt in the process. Keep in mind that competition is most intense during deep depressions. In fact, I am convinced that a depression is nothing else but an intensification of competition, while prosperity usually indicates a slackening of competitive pressures.
If more competition were always desirable, we should welcome depressions and rue their end. Of course, depressions are tragic events that take an immense toll on society. Yet some sort of oversight is necessary in any economy. In this sense, depressions do serve a useful purpose a market economy, in the sense that they create pressures that coerce firms into finding new and better ways of doing business -- including the creation of new social structures of accumulation.
Indeed, business responds to an outbreak of strong competitive pressures with a frantic search for efficiencies, but often apparently to no avail -- at least in the short-run. The absence of an immediate pay-off is to be expected for two reasons.
First, people often behave irrationally under stress. Indeed, many, but certainly not all, firms will make bad choices as they set off under duress to explore uncharted waters.
An even more important force is at work. Most of the firms and many of the workers are experiencing financial distress causing markets to shrink at an alarming pace. For most firms, the rewards from successful innovations will have to wait until the return of a period of general prosperity.
A good many of the firms -- even those firms that seem to be making the right decision in the midst of a depression -- will not survive long enough to enjoy the fruits of their efforts. When competitive pressures become too intense, as they do during such times, they create mass economic extinctions, liquidating alike both efficient and inefficient firms -- although an objective standard for determining which firms are efficient or inefficient at any moment is admittedly wanting.
At such times, survival of the fittest is certainly not operative. Like Gould's lungfish, a firm that may be tottering at the edge of extinction today might be ideally suited for the economic conditions that loom at the horizon. In any case, I have strong doubts that competitive forces are very selective once the full force of a depression is underway.
Only later, once the competitive pressures let up, will we see the benefits from the competitive struggle. Then, as the depression gives way to a stronger economy, the first fruits of the depression era struggles will begin to appear. At that point, we will see business beginning to apply new technologies and to market new products. Such times resemble the flourishing periods following the mass extinctions that the paleontologists describe.
We might be tempted to think of an optimal level of competition -- an intensity that would neither force the economy into depression nor let business become too lax. In reality, the appropriate level of competition will vary according to economic conditions. Immediately following a depression, business enterprises will be taut -- or following the fashionable expression of recent times, lean and mean. Strong competitive pressures will serve little purpose at that moment. Later, as the recovery begins to age, an increasingly strong competitive pressure might become appropriate.
Such considerations never arise in mainstream economic literature. Few economists ever consider the possibility that competition can become too intense, although a handful of economists have recently developed theoretical models to indicate that excessive competition is likely to be the norm in an unregulated market (Stiglitz 1981; Suzumura and Kiyono 1987; Suzumura 1995; and Vickers 1995). This analysis has had virtually no impact on the thinking of economists in general.
Instead, most economists also assume that, in the absence of collusion or protection by the government, competition can never become either too feeble or too strong. Like Goldilocks's porridge, the extent of competition will never be too hot or too cold.
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Michael Perelman Economics Department California State University michael at ecst.csuchico.edu Chico, CA 95929 530-898-5321 fax 530-898-5901