Does competition stimulate innovation and productivity in Dutch retail trade?

1. Does competition stimulate innovation and productivity in Dutch retail trade? Henry van der Wiel CPB Netherlands Bureau for Economic Policy Analysis & CentER OECD Workshop on Productivity Analysis and Measurement, Bern, 16-18 October 2006

2. Outline • Introduction/background • Relation competition and innovation • 2 research questions • Model for innovation and productivity • Data and empirical results • Concluding remarks

3. Background (I) • Dutch retail trade on its return? • Missed strong productivity growth of US since mid 1990s • Gradually losing its strong position in EU since end of 1980s Labour productivity (per hours worked) relative to EU-average (EU=100), 1979-2002 Source: GGDC,2005

4. Background (II):lack of competition and innovation? • General belief that competition may stimulate productivity => static efficiency • lower price margins • efficient production (less X-inefficiencies) • Likewise, innovation enhances productivity (growth) => dynamic efficiency • Dutch policy measures in 1990s focussed on more competition • New Competition Act in 1998 • Regulatory reforms in retail trade => longer opening hours (1996)

5. Competition and innovation:negative or positive? • Negative relationship: • Standard IO literature and most (early) endogenous growth models • Schumpeter model: competition reduces monopoly rents and thus the expected pay off from innovation • Positive relationship: mostly based on empirics • Paper of Nickell (1996): competition is good for innovation • New development => inverted U-shaped curve • Combining both theoretical ideas • Empirically supported by Aghion et al. (2005, QJE) for UK

6. Competition and innovation: inverted U-curve? • Inverted U: composition effect • Weak competition: • industry is relatively often in a level state => • increase in competition stimulates innovation by the "escape" effect • Intense competition: • industry is often unlevelled=> • increase in competition reduces innovation because there is little incentive for laggards to catch up

7. Two questions • Did competition affect innovation in Dutch retail trade? • Did competition and innovation contribute to productivity growth in this industry? • Conclusion: more competition in Dutch retail trade stimulates both innovation and productivity growth

8. Outline • Introduction/background • Relation competition and innovation • 2 research questions • Model for innovation and productivity • Data and empirical results • Concluding remarks

9. Basic idea of CIP-model • Assume no feedback from P to C or from I to C Competition (C) Static efficiency InvertedU-curve? Productivity (P) Innovation(I) Dynamic efficiency

10. CIP-model • Presentation only focuses on results for innovation and productivity • Skip model for explaining competition (in paper!), but not how to measure competition • See also Creusen, Minne and Van der Wiel, 2006, in De Economist, September

11. How to measure competition • We introduce a new measure, relative profits measure (RPM): • based on intuition that in a more competitive market, firms are punished more harshly for being inefficient • Firms differ in efficiency in terms of marginal costs (or productivity level). • Cost advantages lead up to higher profits • We estimate for an industry the following elasticity: percentage increase in profits due to a 1 percent increase in efficiency

12. Cons traditional measures competition • Conventional ways of measuring competition (concentration (H) and price cost margin (PCM)) are not robust from a theoretical point of view • Problem with H is that more aggressive conduct forces inefficient firms out of the market thereby increasing concentration • It incorrectly suggests that competition is reduced • As conduct becomes more aggressive, market share is reallocated from inefficient firms (with low PCM) to efficient firms (with high PCM) which tends to raise industry wide PCM • It incorrectly suggests that competition is reduced

13. Innovation: model • Explanation of innovation: inn = α0 + α1 RPM + α2RPM 2 +βms with inn log innovation rate (firm level) RPM competition indicator (5-digit industry level) ms log market share (firm level) • Expectations • If inverted U: α1 > 0 and α2< 0 • Scale effect: β > 0

14. Productivity growth: model • Simple Cobb Douglas function: • Split TFP-growth in contribution of competition and innovation • Explanation of labour productivity growth: Δp = γ0+ γ1ΔRPM + γ2INN-1+ γ3 (Δk - Δl) + γ4 Δl ───────┬──────── TFP-growth with Δp labour productivity growth (firm level) (Δk - Δl) capital intensity (firm level) Δl labour (economies of scale, firm level)

15. Outline • Introduction/background • Relation competition and innovation • 2 research questions • Model for innovation and productivity • Data and empirical results • Concluding remarks

16. Data and method • Firm-level data • Two sources of Statistics Netherlands • CIS-innovation surveys: 1996,1998 and 2000 • Annual surveys ‘Production Census’:1993-2002 • Matched both sources • Number of observations ≈1150 • Regression methods: • Innovation based on TOBIT I-method • Innovation outlays left censored: no innovation in 75% of firms • Productivity based on OLS

17. Innovation results (I) No inverted U-relation !!

18. Innovation results (II):simplified model

19. Productivity growth results

20. Concluding remarks • No inverted U-relationship in Dutch retail trade! • positive relation between competition and innovation • Both competition and innovation have a positive impact on productivity growth • So more competition in Dutch retail trade may stimulate productivity growth • in the short term by reductions in X-inefficiency • in the longer term by innovation