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Competition in a Dual Economy
By Joseph Bowring
PRINCETON UNIVERSITY PRESSCopyright © 1986 Princeton University Press
All rights reserved.
Firms, Industries, and Competition
The theory presented in this study is in the broad tradition of economic analysis, which has attempted to come to terms with the role and significance of the very large corporation in our economy. This tradition includes the neoclassical models of oligopoly and monopoly; models of imperfect competition and oligopoly behavior; models of workable competition, limit pricing, and contestable markets; Marxist models of monopoly; managerial models of the large corporation; Galbraith's related theory of the "planning sector"; and dual economy analyses. What ties this tradition together from the perspective of the present study is a common concern with how, if at all, the rise of large corporations has affected the way in which competition takes place and thus economic performance at the firm, industry, or macroeconomic level. Each of these theories or models is at least in part a theory of competition. They each address the question (if sometimes only implicitly): How do large firms compete and how do the systematic results of that competition compare with the results under atomistic competition where there are assumed to be no significant, persistent heterogeneities in the universe of firms? This tradition may be characterized generally as suggesting that insofar as the existence of large firms has any effect on competition, competition is reduced by their presence. Further, industries dominated by large corporations are thought to be unusual for that reason and to represent more or less isolated islands of oligopoly in the stream of competition.
This broad tradition of analysis can be usefully separated into three strands, each of which encompasses a substantial amount of diversity: the formal neoclassical models of oligopoly and monopoly; the industrial organization tradition which attempts to address the institutional realities of competition from the neoclassical perspective; and the dual economy approach which suggests that firms and/or industries can be grouped into two broad categories for analyzing competition.
The present study attempts to define the dual economy approach more precisely than it has been to date, to formulate a derivative set of testable hypotheses, and to subject them to empirical testing. While it is within the dual economy tradition, the theory presented here will be termed the core–periphery theory. Throughout the book the core–periphery theory is contrasted primarily with the industrial organization tradition, which is defined more precisely in chapter four, and both core–periphery and industrial organization analyses are contrasted with the neoclassical model of competition.
The theory of core and periphery is consistent with and builds upon both developments in the study of industrial dualism, the dual economy tradition, and developments within the field of industrial organization. Though initial developments in the analysis of dualism focussed on firms and industries, the principal focus of recent interest has been the derivative structure of labor markets, termed labor market segmentation. Common to empirical studies of industrial and labor market dualism has been the conception of the industry as the unit of analysis. That is, it is assumed that the most important differences separating the two principal sectors of the U.S. economy are based on industry characteristics.
Some authors writing from the dualism perspective have suggested that the sectoral distinction should focus on individual firms. This position is consistent with the core–periphery argument made here that there are important distinctions between firms in a single industry and that the heterogeneous internal structure of industries makes them inappropriately aggregated for analyses of firm performance. There may, for example, be firms with periphery characteristics in industries which are classified as core industries because they are dominated by core firms. This second, firm-specific part of the dualism literature has not previously been subjected to empirical testing for broad sectors of the economy. In the case of the labor market segmentation literature this is principally a result of the lack of labor market data at the firm level.
The core–periphery analysis also builds on the relatively new development within the field of industrial organization of a more sophisticated approach to the study of industry structure and performance. The literature of strategic groups suggests that industries are too complex structurally to usefully study as units and that more detailed examination reveals that there exist within industries clusters of firms with common attributes, termed strategic groups.
These attributes derive in part from the different strategies chosen by firms as a means to the common goal of profit maximization. The attributes which may distinguish strategic groups within an industry include: the nature of production technology; the degree of product differentiation, vertical integration, and diversification; and the nature of formal organization and control systems.
These important distinctions between groups of firms within industries are also associated with differences in performance. Again, the important conclusion of this literature is that a focus on industry characteristics alone is not an adequate guide either theoretically or empirically to an analysis of the performance of firms in an industry.
This book will focus on the firm-based theory of dualism, which is consistent with the convergence of these developments in the study of industrial structure on the importance of intraindustry, interfirm distinctions. However, while the core–periphery theory draws on these elements of the tradition of analysis identified above, it breaks with various aspects of that tradition in several important respects.
Within the industrial organization literature the usual view of interfirm competition and the industrial structure accords the firm and the industry equal importance in the analysis. This approach views industries as composed of firms which are qualitatively identical although they may vary along any of several dimensions, principally size or output; the firm is uniquely a member of its industry and is in a sense defined by its industry membership. Higher firm profits, in this view, are associated with efficiency or a lower position on the industry cost curve. Group dynamics like collusion may or may not play an additional role within particular industries. In this sense the industry is the unit of analysis while firms give the industry internal structure and provide the mechanism for working out the imperatives of industry technology mediated by the individual characteristics of the firms.
The theory of core and periphery takes the firm as the unit of analysis. This implies that, while industry location is important and some aspects of firms' market power can only be defined relative to an industry, there are significant firm attributes which are independent of particular industry membership. In the theory of core and periphery, salient firm attributes serve to organize firms into two large groups regardless of specific industry membership. Rather than being essentially undifferentiated, firms can be classified into two broad, qualitatively different groups, core and periphery on the basis of differences in size and joint market share, which in turn imply differences in competitive behavior, performance, and market power.
Core firms, which exist as the result of an historical process that has proceeded over the last century, are thus defined to be large relative to all firms in the economy, and to possess significant joint market share in one or more industries, which together result in market power. Periphery firms are all those which do not meet the twin criteria for core membership. Thus, large firms without significant market power and small firms with and without market power are all members of the periphery. Within the simple two-group classification, there may be firms in transition from core to periphery and from periphery to core. Large firms without significant market share may be in this transitional group, as may be profitable, rapidly growing small firms, but in both cases such firms are included by default in the periphery category. Some such firms may ultimately join the core group. Large firms with significant market share in shrinking markets may also be in this transition group although they are currently included by definition in the core group.
Core and periphery firms by this definition frequently coexist within individual industries; and within industries, as in the economy as a whole, core and periphery firms constitute groups with distinct patterns of behavior and performance. Periphery firms are not necessarily "mom and pop" operations nor are they necessarily family-dominated entrepreneurial-style firms. Many periphery firms are relatively large in the universe of all corporations and many have traditional managerial corporate structures. Thus the core–periphery distinction is not equivalent to either the large–small distinction or the owner–managerial control distinction.
Within the industrial organization tradition, firms with significant market power represent isolated outposts noteworthy for that reason, but they have no direct part in the formation of the normal rate of return which results from a generalized competitive process among the majority of firms. Interindustry capital flows are not systematically treated in the industrial organization approach. The majority of industries do not represent outposts of oligopoly power. Competition serves to regulate the profit rates of all firms across all such industries, it is assumed, but details of a plausible institutional mechanism to accomplish that regulation on a sufficient scale are left unspecified. For oligopoly-dominated industries it is frequently assumed that potential entry constitutes a limit on firm profit rates, although the model provides no general explanation of the sources of the new investment, actual or potential.
In the core–periphery view, while core firms are not individually isolated, the competitive dynamic which involves core firms is itself isolated from the competitive dynamic among periphery firms. Thus, rather than small groups of noncompeting firms surrounded by a generalized process of competition, the core–periphery hypothesis is that there are two generalized competitive processes or regimes, one in which only core firms participate and one in which predominantly periphery firms participate.
Further, it is hypothesized that these two distinct competitive regimes have characteristics quite different than those imputed, explicitly or implicitly, in the traditional view. The hypothesis is that active core firm competition, particularly on an interindustry basis, results in the formation of a relatively homogeneous group profit rate when compared with periphery firm competition, which is hypothesized to be largely intraindustry and which produces only a weak tendency toward the formation of a group profit rate; there is a stronger tendency toward an equal rate of profit within the core than within the periphery.
Core firms tend not to engage in active price competition within their home industries. Rather, they adopt a form of behavior which recognizes the mutual interdependence of their pricing decisions, termed corespective behavior, which is consistent with maintaining relatively high profits among the core group in an industry. Core firm investments in new industries, or diversification, provide a profitable outlet for the reinvestment of earnings not always available in the home industry, and create significant interindustry capital flows. It is hypothesized that these capital flows and the associated direct and potential competition between core firms, frequently with different home industries, contribute to the formation of a core rate of profit.
The competitive regime of core firms is inaccessible to routine access by periphery firms as a result principally of size-related barriers to entry. It is argued that core firms' investments contribute to their market power within individual industries by raising new entry barriers as well as by contributing directly to profitability. Periphery firms, limited by lower profits, are generally isolated in single industries and in the periphery sectors of single industries and tend not to engage in interindustry competition. As a result, periphery firm profit rates tend to be more heterogeneous than core firm profit rates.
Thus the core–periphery hypothesis is that periphery firms tend to be isolated in individual industries by a combination of exit and entry barriers, while it is core firms that engage in more active interindustry competition. Such competition, however, does not carry with it the normative connotations of neoclassical competition; there is no presumption that society receives the benefits of core firm competition. In the core–periphery model there is a bifurcated process of competition which results in the formation of two distinct rates of profit rather than a single normal rate of return, which is the usual outcome.
The size, joint market share, and resultant market power of core firms, together with the absence of active price competition among core firms within individual industries means that the outcome of the core firm competitive process is quite different from that among periphery firms. It is hypothesized that a principal result of the dual competitive process is that core firms earn profit rates that are systematically and significantly higher on average than those of the periphery group.
Further, it is hypothesized that the market power of core firms allows them to earn not only higher profit rates than periphery firms but also profit rates which are significantly less risky than those earned by periphery firms. The profit-maximizing strategies of core firms simultaneously produce profits that are higher and less risky than those of periphery firms. The structural advantages of core firms, which permit higher profits, also provide lower risk. The hypothesis is that the bifurcated competitive process produces two distinct relationships between risk and return; while there is an intragroup tradeoff between risk and return for both core and periphery firms, core firms enjoy superior performance on both risk and return measures when compared to periphery firms.
This study defines the core–periphery theory more precisely than previous efforts to address industrial dualism. In addition, this study examines in detail the industrial organization literature, which is where much relevant theoretical and empirical work appears, for consistency with the core–periphery theory. Finally, a set of independent empirical tests of the theory are performed on a data set constructed for this purpose.
Chapter two presents the theory of core and periphery as a theory of competition and develops the theory in terms of firm goals, the structure of industries, and interindustry capital flows. The chapter also presents a set of derivative, empirically testable hypotheses. Chapter three reviews historical evidence on the evolution of the industrial structure, patterns of diversification, trends in aggregate and industrial concentration, and the stability in the ranks of very large firms, and demonstrates the general consistency of this evidence with the theory of core and periphery.
Chapter four reviews other perspectives on competition, principally those embodied in the literature of industrial organization and in the somewhat more scanty dual economy literature. Chapter five reviews the empirical industrial organization literature in areas relevant to this study. Results on profitability and size; profitability and concentration; more complex relations between profitability, absolute firm size, relative firm size, and industry concentration; and profitability and various measures of risk, are shown to be consistent with the empirical hypotheses generated by the core–periphery theory. Chapter six presents the empirical results from tests of the hypotheses of this study as well as details of the data set and empirical methodology.
Excerpted from Competition in a Dual Economy by Joseph Bowring. Copyright © 1986 Princeton University Press. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
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Table of Contents
- FrontMatter, pg. i
- Contents, pg. v
- List of Tables, pg. vii
- Acknowledgment, pg. ix
- Chapter One. Firms, Industries, and Competition, pg. 1
- Chapter Two. Core and Periphery Competition, pg. 11
- Chapter Three. The Development of Core and Periphery, pg. 48
- Chapter Four. Theories of Industry Structure and Competition, pg. 79
- Chapter Five. Empirical Propositions on Industry Structure and Performance, pg. 104
- Chapter Six. Empirical Tests of the Core-Periphery Hypotheses, pg. 151
- Chapter Seven. Conclusion, pg. 181
- Bibliography, pg. 193
- Index, pg. 205