The dynamic advantage of competition

We design and conduct a series of cross-section regression tests to determine the relationship between competition and national competitiveness. We find that an increase in domestic competition, even in countries with open markets, is associated with improved national competitiveness. Combining our study with existing work, we find that at all levels of inquiry (the nation, the industry and the firm); competition is correlated with competitiveness.

Inspired in part by Porter (1990), we develop three original theories to explain the positive association between domestic rivalry and competitiveness. First, extending Fudenberg and Tirole (1983), we develop a model in which production is characterised by learning-by-doing and spillovers which flow more rapidly domestically than internationally. Using calibrated comparative statics, we demonstrate that increasing domestic competition improves domestic firms' cost competitiveness and national welfare. We modify our basic model to show that increasing domestic competition is as effective as Brander and Spencer subsidies in garnering international oligopoly rents. Second, we argue that the stock market compares corporate performance to determine the degree of managerial myopia. With an original model, we demonstrate that such comparative performance evaluation is more likely to be effective if firms are domestic rivals. Finally, we create an original model to show how differentiated competitors encourage the creation of industry-specific human capital by spreading the earnings risks of graduates. We show that the avoiding human capital hold-up may provide an incentive to firms to license their products, and we solve for the optimal licence fees.

We conclude by noting the primary implications: strict anti-trust enforcement, with a guarded preference for foreign acquirers over domestic ones. (D190,161)