Developing Country Perspective

Competition can have desirable effects on growth and development, but does this conclusion also apply to developing countries? Is the focus of competition policy on allocative efficiency and consumer welfare consistent with the goal of development?

Laffont (1998) argued that because developing countries are so far from the ideal

‘first-best world of economists’, it is not always the case that competition should be

29 See Aghion and Howitt (1997) for an overview.

encouraged in these countries. According to this ‘second best’ theory of welfare economics, in case that any one of the theoretical assumptions required cannot be met, restricted rather than free competition may be a superior choice. The unfettered competition may not be appropriate for a developing economy and too much competition can be as harmful as too little (Singh, 1999).

In developing countries, market-supporting institutions are weak, corporate governance regimes are not well functioning, and information asymmetries and contract enforcement problems are usually significant. Competition can act as a substitute for some institutions in the areas where institutional arrangements were deterred. There is evidence that competition can substitute for an effective bankruptcy system because it exerts pressure on inefficient firms to go into liquidation. There is evidence that competition can substitute for strong shareholder control in firms in raising productivity growth. There is also evidence that competition can change the nature of labour market institutions.³⁰ In the institutional environment in developing countries, agency problems are likely to be more severe.

Depending on the degree of agency problems, the same increase in competition may have a different impact on R&D and economic development. Competition may have a particularly favourable impact on R&D, productivity and growth when firms face important agency costs, as it is likely to be the case in developing economies. In such a situation in developing countries, according to Rey (1998), the main impact of competition would be to induce firms to behave more closely to profit maximisation. Competition has many more merits: it acts as a disciplining device, creating incentives that ensure that resources are more productively deployed, costs are reduced and profits are increased. This new perspective of analysis not only highlighted the necessity of competition policy for developing countries but have also implications for the design of competition policy in developing countries.

There are many potential restrictions to competition. In developing countries the main institutional obstacle to domestic competition may be government restrictions on market entry. Soft budget constraints and preferential treatment of state-owned enterprises are among other major restrictions on competition. Due in part to institutional obstacles to competition, even in the tradable sector, international competition may not lead to competitive domestic market. Excessive government regulation also facilitates corruption and lead to adverse distributional consequences by inducing workers and firms to escape into the informal market. Like in developed countries, private institutions can also cause restrictions to competition in developing countries. For example, the monopolisation of domestic distribution channels can mean that even when a good can be imported freely, there still may not be effective competition in the domestic market. In developing countries the transaction costs of collusion are lower because of the weakness of legislation and the inefficiency of monitoring system. Hence firms have lower implicit risk aversion and little to lose from colluding. Therefore, measures to prevent collusions and abuses of dominant positions are required.

Although horizontal constraints remain the main feature that hampers competition in developing countries, vertical restraints may also require monitoring. According to Cook (2001), there are several reasons. First, there is limited inter-brand competition in low-income countries so that vertical agreements can easily lead to forms of monopolistic collusion. Secondly, given the scale of firms in low-income countries, the scope to establish their own distribution channels or create new investment is lacking. Thirdly,

30 See e.g. World Bank (2002).

governments in developing countries may actually support restrictions on distribution and, therefore, vertical arrangements are viewed as anticompetitive. In developing countries, vertical restraints within firms may impede competition but may also increase the level of competition. They may contribute to an increase in the supply of goods and services and improve product quality. It is necessary to establish the difference between agreements among competitors that are designed to restrict competition and vertical restraints that are designed to increase efficiency (Rodriguez and Williams, 1996). Caution must be exercised because not all agreements among competitors are inefficient (Graham and Richardson, 1997).

As to the importance of competition in developing countries, Singh (1999) suggested that there should be a concept of ‘optimal degree of competition’, based on the studies of experience of Japan and South Korea. To promote a long-term and sustained growth of productivity, there should be a related concept of ‘optimal combination of competition and cooperation’ between firms, and there also should be a recognition of the concept of

‘simulated competition’, which involves contests among those seeking state support and which can be as powerful as real market competition. How can competition be introduced or reinforced in developing economies? A simple emulation of the competition policies of developed countries is inappropriate. One of the key elements in the promotion of competition in developing countries is to remove government restrictions on market entry.

A major discrepancy between competition issues in developing and developed countries relates to the source of anticompetitive restrictions. In developing countries, dominant firms often result from the direct action of governments’ industrial policy (Khemani and Dutz, 1995). As a result, dominant firms in developing countries may be inefficient, with the protection of market entry barriers. It is extremely harmful to the competition process that regulations are introduced to protect domestic firms, usually state-owned, from efficient entrants. Competition can be effectively injected into the economy by forcing firms to participate in competitive markets. This may mean relaxing government regulation, opening up domestic markets and forcing domestic firms into markets. Participation in international export markets may constitute an effective transmission mechanism for injecting competition in domestic markets and forcing domestic firm participate in market competition. According to the World Bank (2002), in developing countries, the policy priority should be to ensure both free market entry and exposure to international competition. However, in some specific industries in the particular context of emerging markets and transition economies, it is inappropriate to fully open domestic markets to new entrants and imports. Much more sophistication is needed with regard both to the institutional contextual characteristics and to technological industrial traits. Singh (1999)’s concept of ‘optimal degree of competition’ may provide a case for a more careful treatment to the relationship between competition and development.

Competition can also be promoted or protected by introducing or reinforcing competition policy and its implementation. In the short run, a well-implemented competition policy may protect and promote competition, accordingly ensure that allocative efficiency is achieved and consumer welfare is maximised. In the long run, in combination with other policy instruments, competition policy may help to stimulate technological progress and promote economic growth. However it is difficult to assess the competition effects in a developing country where market imperfections are manifold. Too much competition may sometimes be as harmful as too little. Furthermore, as mentioned above, the institutional contexts and technological traits of various industries are quite different in developing countries. Therefore, no uniform answer is applicable to different questions – the effects of international trade, inward FDI and government intervention

should all be considered when specific decisions on competition issues are being made.