Is Competition Always Good?

CAMBRIDGE – Ask any economist whether competition is always a good thing, and the answer will be a resounding yes. After all, competition powers what the late William Baumol termed the “innovation machine” of the modern market economy.

Through competition, businesses spur each other to increase sales by serving customers better, whether by cutting prices, improving service, or offering innovative products. Innovation has driven the extraordinary improvements in health and quality of life over the past two centuries. And the world will need further creativity to solve pressing challenges such as providing low-carbon energy and transport or developing new vaccines and medicines to tackle the next pandemic or wave of anti-microbial resistance.

Competition is not the only driver of innovation, of course: publicly funded research and government regulation also are essential. But the contest among businesses is how brilliant ideas serving society are diffused at scale. There is ample evidence that strong competition is associated with higher productivity. Less encouragingly, studies also suggest that competition has diminished over time in the United States and other advanced economies.

Yet, among the wider public, “competition” has recently become something of a derogatory term, with some commentators claiming that it has enabled the emergence of dominant players in the digital domain and sectors ranging from food to finance. Adverse consequences include a loss of individual privacy resulting from digital surveillance and rising prices for over-processed foods.

To an economist, this criticism sounds paradoxical: If a market is dominated by a single firm or a small handful of companies, then by definition it is not competitive. So, what explains the newfound aversion to competition among some non-economists?

One likely explanation is that many people take the word “competition” to be a synonym for “business,” and regard pro-competition statements as indicating a market-oriented ideological stance. This interpretation runs through Competition Overdose, a recent book by the legal scholars Ariel Ezrachi of the University of Oxford and Maurice Stucke of the University of Tennessee. For Ezrachi and Stucke, “competition” means a race to the bottom in terms of safety or quality standards, or price gouging, in the interests of increasing corporate profits.

Such an interpretation has some validity. I recently attended a conference hosted by a right-wing think tank at which a free-market Conservative politician began his speech by saying, “Much as my free-market instincts want me to turn a blind eye to monopolies…” Telling this tale makes my economist colleagues roar with laughter, but it reflects a common disconnect between economics and everyday language.

UK Culture Secretary Nadine Dorries also has the pro-business interpretation of competition in mind when she argues that her controversial proposal to privatize the public-service broadcaster Channel 4 will strengthen its ability to compete against global streaming services such as Netflix and Amazon Prime. In fact, Channel 4 – which is publicly owned but commercially funded – is already competing against them very effectively and is profitable.

For Dorries, competition means boosting another large private-sector media firm that might buy Channel 4, such as Disney. But such a tie-up would reduce competition in supplier markets, such as television advertising and independent production. Privatizing Channel 4 is another example of policymakers favoring big global businesses, enabling them to become even more dominant under the rubric of “competition.”

Perhaps economists have simply done a bad job explaining what they mean by competition. But part of the reason for the gap in understanding is highlighted by the proposal to sell Channel 4. When considering a merger or a market with a few dominant players, competition authorities have been reluctant to adjudicate on the basis of business models rather than traditional antitrust criteria such as prices. This stance is becoming untenable.

For example, the winner-take-all nature of digital markets means that dominant firms charging a zero price to consumers can maintain large-scale loss-making operations for many years. This makes it difficult, if not impossible, for start-ups with other business models, such as one based on subscriptions, to grow to sustainable scale.

The same issues arise in the United Kingdom’s retail banking sector. All the high-street banks are trapped in a model of charge-free current accounts, which they must cross-subsidize by overcharging for other services such as overdrafts. UK competition regulators have never plucked up the resolve to insist on a different business model, and no single bank dares to diverge from it.

A similar monoculture is at the heart of the UK authorities’ concerns about price comparison websites, which force all players in markets such as energy and telecoms to offer low headline prices and impose a loyalty penalty on customers who do not switch. Agnosticism about business models results in corporate arms races and competition along a single dimension, and makes economies of scale – a barrier to market entry – essential.

Policymakers must now acknowledge that healthy markets require competition between business models, as well as along traditional dimensions such as price, quality, and innovation. Achieving this will require either more active enforcement or regulatory intervention. Economists such as Kaushik Basu, for example, advocate direct public provision of an alternative business model.

For the past 20 years, competition authorities have presided over increasing concentration in many markets, along with the disappearance of alternative models. Having a public option can help markets to work better and may restore competition’s good name.