Competition, Market Structure & Innovation
Key research questions
New Public Management has been the dominant paradigm in public administration for the past 20-30 years. At its heart is a focus on delivering competitive forces through quasi-markets with the objective of delivering costefficiency and quality improvement. Economic theory makes clear predictions about the effect and process of competition in these cases; competition drives productivity improvements through three mechanisms. Within firms, competition forces managers to increase internal efficiency (x-inefficiency) pushing them closer to their production possibility frontier through organisational changes such as technology adoption, process redesign and improvements in human resource management practices. Competition between firms ensures that more productive organisations increase their market share at the
expense of the less productive, pushing the industry closer to its production possibility frontier. These less
productive firms exit the market and are replaced by more productive firms. And finally, competition drives innovation which leads to increased productivity.
The positive effect of competition on productivity is well established in the literature on the private sector. The evidence from the public sector services is more mixed and comes largely from the healthcare sector (Simpson, 2009). Most empirical studies have focused either on partial output measures, (e.g. mortality rates), or on partial measures of cost-effectiveness (e.g. length of stay). For instance, the most influential study in the US, Kessler and McClellan (2000), found evidence that competition (based upon geographic markets) resulted in lower death rates from heart attacks and lower costs. From the UK, there is some evidence that greater competition was associated with lower costs (Söderlund et al., 1997; Propper 1996) but a decline in quality during the internal market (Propper et. al., 2008). Even if this were accompanied by an increase in productivity it seems unlikely to be a desirable outcome from a welfare perspective. The most recent reforms based upon fixed price reimbursement (Payment by Results) coupled with patient choice of provider supported by detailed information appear to have improved quality (as measured by fewer deaths for heart attack patients) in hospitals facing more competition (Cooper et. al., 2010). Moreover, more competition was associated with shorter lengths of stay, a crude measure of productivity.
Burgess et al. (2005) survey the empirical literature on the effects of competition on schools. There is some evidence from the US that the threat of losing pupils induced by greater competition is associated with an increase in school productivity (e.g. achievement relative to real expenditure per student). Clark (2009) has
exploited a reform to UK schools to investigate the effect of greater school autonomy on performance but finds little evidence that neighbouring schools improved their performance significantly as a result of this increased competition. Overall, therefore, the effect of competition on public service productivity is inconclusive and is dependent upon how productivity is measured.
To make competition effective, the government must create supply side flexibility (e.g. in terms of expansion and contraction of activities, market entry and exit, mergers and take-overs). While the closure of a relatively poorly performing firm in private sector markets may raise the average level of productivity in the industry, this might be less clear cut in the case of public sector organisations if an important mponent of outcome is accessibility. If access to services were not part of the measure of the volume of output then it may potentially be incorrectly inferred that productivity had risen, when it had actually declined. Further, until the threat (i.e. poor providers shutdown or are taken over) or the reward (i.e. expansion) of competition is real the effects on performance may be minimal and therefore hard to detect against a plethora of other policy changes.
Dr. Nikos Chatzistamoulou