April 22, 2013

Production as Privilege: Thoughts on Competition

I started writing a post about mercantilism, but I realized I needed to do a bit more thinking about competition first. The last post on this blog was talking specifically about the effect of competition on how people consume, but this is looking more generally at the nature of competition within market. This post is part of a series called Production as Privilege, looking at the way that production relates to the distribution of wealth.

Conceptual Tool #11: Understanding Competition

Competition is a fundamental concept of economics but it is usually restricted to a simplistic market framework of buyers and sellers, or game theoretical choices and payoffs. Let's think a bit harder about what competition is: what we are competing for, who is doing the competing, what are we competing with, etc...

To start with, here are two basics we should be able to agree on:

Competition requires at least two entities. Usually these are firms or individuals, but we can also think about competition between other aggregations: classes, industries, cities or countries.

Competition must be for something that is limited in some way. In economics these are somewhat unhelpfully known as "rivalrous" goods. The point is that they can run out, and each competitor can't have as much as it wants. We don't have to compete for air unless we are underwater.

There are several ways in which we think about competition that are misleading.

First of all, we tend to think about it in static terms, with competitors gunning for a set quantity of stuff. This is rarely true: competitors are often chasing after expanding or contracting amounts of stuff--where "stuff" can be anything from wind-generating capacity to customers who want to purchase typewriters. People have recognized this dynamic element of competition and it gets reflected in business strategies like "blue ocean" strategy.

Once we recognize the dynamic nature of competition, it becomes clear that competition has a probabilistic component as well. We often compete to optimize our returns in the future, and such returns necessarily involve uncertainty. We compete for uncertain outcomes when we buy raffle tickets that might win us a new TV, or when we create export-processing zones that we hope will attract foreign investment.

The third thing we often fail to recognize, and this is perhaps the most interesting point I'm making, is the way that competitors' own actions can shape the availability of what they are competing for. That is, competitors may be competing for pieces of the pie, but the pie may expand or contract based on the actions of the competitors. This is because the fungibility of money converts many different types of competition into competition for value, and we produce value in order to exchange it for other value. This is not a trivial point: it is the crux of Adam Smith's (and all modern free trade supporters') argument against mercantilism (see here) and for the productive power of self-interest.

Fourth, we also forget that much of competition is for things that are artificially scarce. Certainly most newer digital products are kept artificially scarce through copyrights and other legal protections. What's less commonly understood is that compound interest on loans creates scarcity as well, by asking people to pay back more than their original amount. Some bankruptcies are thus actually required because not everyone can win. (Although it's also true that new loans can be created; so I'm not sure I fully understand the implications here.)

Finally, while economics is well acquainted with problematic economies of scale and network effects, the extent to which there is free entry into markets and truly open competition is often overstated. Mass retail markets are dominated, perhaps by definition, by massive economies of scale. Many primary and non-consumer markets are basically oligopolistic--one rationale for deregulated trade is that national-level oligopolies will be replaced by more efficient international competition. And digital markets have entirely different economies of scale than the world has ever seen, where the tools of production and maintaining scarcity take almost any form we can imagine. Here is a fun TEDx talk highlighting network effects and describing the way we misunderstand them when thinking about economics.

When we put all these ideas together we get a picture of competition that doesn't look much like the basic perfect competition/monopolistic competition/oligopoly/monopoly models. Instead there is a dynamic ecosystem of not only firms and workers, but also financers and consumer preferences, and an infinite variety of markets that defy easy classification. Economists know this, of course--they just don't know a precise, mathematical way to think about it.


  1. Re: your 4th point on interests, isn't the idea that as long as there is economic growth, everyone can win? But the game changes when growth stops?

    Fun TED talk, especially the part on the monopoly of economists.

  2. Regardless of "actual" economic activity (and growth), there is a quantifiable amount of money that gets created through loans (via fractional reserve lending) and then destroyed by loan payments. If "growth" means willingness of bankers to loan funds, then the current debts may be paid back but only by further borrowing. But if this borrowing is on better or equal terms then perhaps it's sustainable?