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Competition, the economist’s fetish

Competition, the economist’s fetish

Two broad definitions of competition pervade economic and managerial literature: competition as a process of rivalry and competition as an end-state (or equilibrium) of rivalry between interacting agents (1). The first can be traced back to classical economists such as Adam Smith, who understood competition as a property of a relationship between economic actors (2). Smith’s notion of competition has been described as “rivalry in race – a race to get limited supplies or get rid of excess supplies (3). This definition, which envisions competition in terms of individual rivalry, is often considered as being closer to the “common sense” understanding of competition as it is frequently conveyed in business discourse (4).

 

A second theoretical development of competition began to emerge with the advent of marginalism and perfect competition theory in the mid-nineteenth century (5). This conception has since endured to become part of neoclassical economic theory. Competition in the neoclassical sense is often understood as a “state” or “situation" (6). While classical economists such as Smith saw competition as a particular characteristic of the interaction between actors, neoclassical economists would define competition as a static property attributed to an aggregation of individual actors (7). A market is termed “competitive” when no single actor has the power to significantly influence the demand or supply of a good to his own advantage. 

 

Competition is accordingly seen as the opposite of collusion and monopoly (8), terms which neoclassical economists generally do not clearly differentiate from cooperation. This stands in contrast to many earlier economists such as Smith (9), for whom “neither competition nor monopoly was a matter of the number of sellers in a market; monopoly did not mean a single seller but a situation of less than perfect factor mobility and hence inelastic supply; and the opposite of competition, was not monopoly, but co-operation” (10).

 

A relevant question for strategic management concerns the normative evaluation of competition, that is to say how one may answer the question: “is competition a good thing?” Proponents of the end-state definition often see competition as an inherent characteristic of markets. But markets, it should be noted, are able to function properly thanks to an amalgam of institutions: the recognition and respect of private property, the proper enforcement of contracts, free and consensual exchange (11). An economic system cannot be called a market unless people follow these rules of the game. It is only because these rules are being followed that a competitive equilibrium emerges as self-interested individuals seek to satisfy their preferences.

 

According to mainstream economists, a state of unhampered or “perfect” market competition is, ceteris paribus, a state of Pareto efficiency, where no individual can be made better off without making someone else worse off. Insofar as Pareto efficiency is good, so is competition. Perfect competition is thus valued because it is seen as the only possible state in which resources are allocated efficiently (12). However, both theory and empirical evidence indicate that when the ideal conditions for perfect competition cannot be realized, the best way to increase economic efficiency is not necessarily to bring the market “as close as possible” to a state of perfect competition. In cases where several imperfections exist, fixing a specific market imperfection could just as much decrease the efficiency of the system (13). 

 

This suggests that it can be preferable to evaluate the different factors affecting competition and examine whether they can lead to positive social consequences in their specific empirical context. Determining if a given form of competition delivers a positive outcome requires, first, that we pay closer attention to the particular details of the process in which agents are engaged, and second, that we establish what a “positive” outcome is; in other words, that we clearly differentiate and justify both the means and ends of the competitive practice.

 

Unlike end-state competition, competition as a process is not limited to markets (14); many social practices, such as leisure sports and courting, also count as "competition" despite the fact that they are not necessarily based on any formal economic exchange. To say that agents are “competing” means that they are vying for a desired resource which cannot be divided; in other words, they are engaged in an interaction which produces winners and losers. The fact that some will – or may – have a more beneficial outcome than others creates an incentive for agents to continuously invest efforts in their attempt to obtain this exclusive outcome.

 

The benefits of competition have nothing to do with its intrinsic merits; they are to be found in the fact that competition forces agents into a constant escalation of effort (15). Carefully designed competitive processes can thereby produce collective benefits which outweigh the losses of losers, creating “positive system effects”(16). The virtues of competition are thus to be found in the rules that structure the competitive practice and their capacity to properly constrain the actions of players. Both the way we consciously design the institutions that constrain individual behaviour, and the ability of individuals to respect these rules, are potentially subject to normative evaluation – that is, on whether individual behaviour matches collective expectations. 

 

The process of competition is thus collectively beneficial “when players exercise restraint in the strategies that they employ, when they confine their adversarial behavior to certain specific contexts, and when they refrain from allowing moral lapses on the part of other competitors to transform the entire contest into a race to the bottom” (17).

 

While it may have its benefits and drawbacks, competition is perhaps best understood when defined in opposition to cooperation. I will therefore shed some light on this alternative process in my next article, which exposes some of the ways cooperation has been conceptualized in previous literature.

 


Notes

[1] Blaug (2001).

[2] According to Trapido (2007), Smith understood the intensity of competition as something that depended on (1) the degree to which the actors strive for the same third party resource, and (2) the degree to which they do it independently.

[3] Vickers (1995: 4).

[4] An observation which was first made by Friedrich Hayek (1949) and then echoed by Milton Friedman, for whom “competition has two different meanings. In ordinary discourse, competition means personal rivalry [...] in the economic world, competition means almost the opposite.” (Friedman, 1962: 119)

[5] According to Blaug, “only in 1838, in Cournot’s Mathematical Principles of the Theory of Wealth was the process conception of competition totally displaced by the end-state conception of market-clearing equilibria.” (Blaug, 2001: 38) The author provides an excellent account of the historical development of perfect competition theory.

[6] Vickers (1995).

[7] In his Soziologie (1908), Georg Simmel also made an interesting distinction between conflict and competition. Simmel “considered conflict to be a social relation in the sense that parties to conflict not only take one another into account but also orient their actions to one another. He conceived of competition as the indirect and diffuse (hence asocial) influences among actors that arise from their joint striving for the same limited outcomes.” (Hannan and Caroll, 1991: 27)

[8] See McNulty (1968), pp. 639-640.

[9] Adam Smith, David Ricardo, Karl Marx, Thorstein Veblen, as well as most Austrian economists viewed competition as “a dynamic process of rivalry and contention, not a market structure.” (Baskoy, 2003)

[10] Blaug (2001: 38).

[11] North (1991).

[12] Hausman (2007: 242).

[13] I here draw upon Lipsey and Lancaster’s (1956) theory of the second-best. The authors’ conclusion has “the important negative corollary that there is no a priori way to judge as between various situations in which some of the Paretian optimum conditions are fulfilled while others are not. Specifically, it is not true that a situation in which more, but not all, of the optimum conditions are fulfilled is necessarily, or is even likely to be, superior to a situation in which fewer are fulfilled. It follows, therefore, that in a situation in which there exist many constraints which prevent the fulfillment of the Paretian optimum conditions, the removal of any one constraint may affect welfare or efficiency by raising it, by lowering it, or by leaving it unchanged.” (Lipsey and Lancaster, 1956: 11-12)

[14] It is not uncommon for strategic management scholars to exclusively focus on microeconomic or market-based concepts of competition (Barney, 1986).

[15] Heath (2001).

[16] Martin (2013).

[17] Heath (2007: 367).

 

 

References

BARNEY, Jay B. (1986). “Types of Competition and the Theory of Strategy: Toward an Integrative Framework”, The Academy of Management Review, Vol. 11, No. 4, pp. 781-800.

BASKOY, Tuna (2003). “Thorstein Veblen’s Theory of Business Competition”, Journal of Economic Issues, Vol. 37, No. 4, pp. 1121-1137.

BLAUG, Mark (2001). “Is Competition Such a Good Thing? Static Efficiency versus Dynamic Efficiency”, Review of Industrial Organization, Vol. 19, No. 1, pp. 37-48.

DEUTSCH, Morton (2006). The Handbook of Conflict Resolution. Second edition. John Wiley & Sons.

FRIEDMAN, Milton (1962). Capitalism and Freedom. University of Chicago Press.

HANNAN, Michael T. and Glenn R. CARROLL (1991). Dynamics of Organizational Populations: Density, Legitimation and Competition. New York: Oxford University Press.

HAUSMAN, Daniel M. (2007). The Philosophy of Economics: An Anthology. Cambridge University Press.

HAYEK, Friedriech A. (1949). “The Meaning of Competition”, in Individualism and Economic Order, London: Routledge.

HEATH, Joseph (2001). The Efficient Society. Penguin Books.

HEATH, Joseph (2007). “An Adversarial Ethic for Business: or When Sun-Tzu Met the Stakeholder”, Journal of Business Ethics, Vol. 72, No. 4, pp. 359-374.

LIPSEY, Richard and Kelvin LANCASTER (1956). “The General Theory of the Second Best”, The Review of Economic Studies, Vol. 24, No. 1, pp. 11-32.

MARTIN, Dominic (2013). “The Contained-Rivalry Requirement and a ‘Triple Feature’ Program for Business Ethics”, Journal of Business Ethics, Vol. 115, Issue 1, pp. 167-182.

MCNULTY, Paul J. (1968). “Economic Theory and the Meaning of Competition”, The Quarterly Journal of Economics, Vol. 82, No. 4, pp. 639-656.

NORTH, Douglass (1991). “Institutions”, The Journal of Economic Perspectives, Vol. 5, No. 1, pp. 97-112.

TRAPIDO, Denis (2007). “Competitive Embeddedness and the Emergence of Interfirm Cooperation”, Social Forces, Vol. 86, No. 1, pp. 165-191.

VICKERS, John (1995). “Concepts of Competition”, Oxford Economic Papers, Vol. 47, No. 1, pp. 1-23.

 

Photos :

Triptych, by Dave W. [Source].

Rings in a Tree, by FastCo [Source].

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