Tracing the Dynamics of Competition: Evidence from Company Profits

By Cuaresma, Jesus Crespo; Gschwandtner, Adelina | Economic Inquiry, April 2008 | Go to article overview

Tracing the Dynamics of Competition: Evidence from Company Profits


Cuaresma, Jesus Crespo, Gschwandtner, Adelina, Economic Inquiry


I. INTRODUCTION

Since the seminal contributions of Mueller (1977, 1986), there is a fruitful and steadily growing literature aimed at investigating empirically the persistence of company profits. While the competitive environment hypothesis predicts that profit differentials across firms should disappear in the long run, the empirical evidence tends to give little support to this theory. Several studies analyze the question of competition within the frame of profit persistence across different economies, industries, and time periods.

Mueller (1990) presented a comprehensive international comparison of profit dynamics. In his study, the dynamics of company profits were analyzed and compared for seven developed economies--United States, United Kingdom, Japan, France, Germany, Sweden, and Canada--during the 1960s-1980s. The main finding of this study was that in all these seven developed economies, a high degree of profit persistence was found. The percentage of companies with persistent long-run profit rates was much higher than one would expect to be in a competitive environment. Kambahampati (1995) analyzed and compared the profits differentials in 42 Indian industries over the period 1970-1985 and showed that competition is less intense in fast-growing, concentrated industries. Glen, Lee, and Singh (2001) analyzed and compared the dynamics of competitive forces in seven emerging markets--India, Malaysia, South Korea, Brazil, Mexico, Jordan, and Zimbabwe--during the 1980s and early 1990s and concluded that the intensity of competition is, if anything, greater in emerging countries than in advanced countries. Odagiri and Maruyama (2002) analyzed the intensity of competition in Japan during the period 1964--1997 and still found a considerable degree of profit persistence. Yurtoglu (2004) analyzed the persistence of firm-level profitability for the largest 172 manufacturing firms in Turkey during the period 1985--1998 and concluded that the intensity of competition in Turkey is no less than in developed countries. Gschwandtner (2005) analyzed the differences in profit persistence between surviving and exiting firms in the United States for the second half of the twentieth century.

The empirical literature on profit persistence uses two different but interrelated definitions of persistence of profits. The persistence measure related to long-run deviations from normal profits is given by the unconditional expectation of the stochastic process that profit rates are assumed to follow (usually an autoregressive process). Short-run persistence (which corresponds to the context in which "persistence" is usually used in time series analysis), on the other hand, is given by the size of the autoregressive parameter in the dynamic representation of the profit rate. If the time series span a long period of time, considering persistence (whichever its definition) constant might be very restrictive since the degree of overall competition in the economy or the sector under study may be expected to change over time. There is evidence, for example, that competition increased in the United States after the opening to international competition in the 1960s, and structural breaks of this kind could have taken place also afterward. Recently, Gschwandtner (2004), using data for U.S. companies in the period 1950--1999, found evidence of significantly different profit dynamics when dividing the sample into different subperiods.

According to the Chamberlinian hypothesis (see, e.g., Scherer [1980] and Kessides [1990]), in an industry of small size, firms are bound to accept their mutual strategic interdependence and therefore maintain oligopolistic discipline. Fluctuations in industry size, therefore, would lead to changing profit persistence in time. The empirical literature dealing with profit persistence has also found other variables to be robust determinants of differences in profit persistence across firms and in the time dimension. …

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