Thursday, May 22, 2008

Why Competition can sometimes be BAD for Social Welfare


We find that: (a) the main sources of knowledge are competitors; suppliers; and plants that belong to the same business group ; (b) these three flows together account for about 50% of TFP growth; (c) the main "free" information flow spillover is from competitors; and (d) multinational presence contributes to this spillover.

Sometimes, innovation can be very expensive and costly. New processes sometimes take a lot of trial and error to get right: for instance, the "just-in-time shipping" Boeing uses right now is quite troublesome, and their new airliner has had its release date set back significantly. Several times.

So, if I am a business, I'm not going to innovate unless I am damn sure I can lower costs significantly. Enough so that I can get a competitive advantage. But, my competitors are going to gain from my hard work! Because of this effect, it is quite possible that we are missing out on some major innovations.

What innovations are we likely missing out on? The most expensive kinds that are most likely to reap the big rewards: if Starbucks suddenly spends $1 billion on developing some new production process, it may IMMEDIATELY get stolen by local coffee shops as employees shift around. So, the risk of such innovations is too high: Starbucks is going to stick to cheaper innovations instead.

There are other ways competition can be bad, too. For instance, reducing my price makes consumers richer, since the overall price level will be lower. However, this means that it will increase the demand of my competitors. After all, if two goods are substitutes, it means I am going to consume BOTH of them to some extent...if Nestle lowers the price of their chocolate, I am going to use some of the savings to finance my addiction to dark chocolate M&Ms. That's a losing proposition for Nestle.

Of course, this doesn't mean competition is BAD. It just means that, sometimes, it doesn't work perfectly.

No comments: