Study: Competition and productivity growth

A main source of productivity growth in most manufacturing industries is the competitive process that shifts market share towards plants that are more productive, a new research report shows.

During the past three decades, the competitive process that shifts market share from one producer to another accounted for more than half of overall growth in labour productivity in the manufacturing sector.

The study examined industrial competition and productivity growth in Canadian manufacturing between 1973 and 1997.

Higher productivity, as measured by production per hour worked, occurs when output increases faster than hours worked. In general, productivity growth helps improve prosperity and standards of living.

The paper found that the reallocation of market share has a considerable impact on growth of productivity, whether it comes from the entry and exit of firms, or gains and losses in existing firms.

For example, between 1988 and 1997, the reallocation of output across plants contributed positively to productivity growth in all 22 manufacturing industries studied. Reallocation was responsible for more than one-half of productivity growth in 13 of these 22 industries.

Dynamic competitive markets provide the foundation for economic prosperity. Productivity growth comes not so much from productivity growth in long-established incumbents, but from their replacement by new more dynamic competitors who gain market share. Renewal is key to productivity growth.

The report also found that the pace of market-share reallocation increased in the 1990s. This occurred as the Canadian manufacturing sector was restructured in response to the changes brought about by the Free Trade Agreement with the United States and the North American Free Trade Agreement.

Two main sources of productivity growth

There are two main sources of aggregate productivity growth: growth that occurs within plants and growth that occurs because of the reallocation of outputs across individual plants from the less to the more productive.

The reallocation of outputs and restructuring takes several forms. At the margin, some firms enter and displace firms that are less productive, many of which exit the market. Within the population of incumbent firms, market share is shifted from those who are less to those who are more productive.

There is large-scale and ongoing reallocation of outputs across individual producers. On average, 37% of market share in an industry was transferred from plants that either contracted or closed, to new plants or plants that expanded between 1988 and 1997.

The continuing plants that increased market share acquired an additional 16 percentage points in market share over the period. The plants that entered captured 21 percentage points. The continuing plants that lost market share lost a total of 21 percentage points, while the plants that closed relinquished 16.

The pace of market-share turnover increased in the 1990s. Shifts in market share averaged 3.61 percentage points a year between 1979 and 1988, and 4.11 percentage points a year between 1988 and 1997.

The competitive process that shifts market share among plants from the less productive to the more productive is an important source of aggregate productivity growth. Between 1988 and 1997, 53% of aggregate productivity growth was the result of the reallocation of outputs towards more productive plants. Between 1979 and 1988, reallocation contributed 55%.

The reallocation effect that came from continuing plants was more important than the impact arising from the displacement of plants that closed by new plants. Competition among incumbents contributed most to the reallocation effect.

Of the 53% contribution from the output reallocation between 1988 and 1997, 39 percentage points came from reallocation within continuing plants. The remaining 14 percentage points were came from entry and closure.

Market share changes endemic to almost all industries

Market-share changes are endemic to almost all industries. In industries with a large number of producers such as clothing, furniture and fixtures and leather and allied products, about half of market share was transferred from plants that either contracted or closed to new plants, or plants that expanded between 1988 and 1997.

Shifts in market share were also substantial in two high-technology industries: electrical and electronic products, and industrial machinery. The intense competition in those two industries shifted nearly half of the market share across plants between 1988 and 1997.

The reallocation of output across plants made a positive, large contribution to productivity growth in all 22 industries of the manufacturing sector in the 1990s. Again, in those industries with a relatively large number of competitors, such as leather and allied, non-metallic mineral, clothing and textile products, almost all productivity growth came from market share reallocation.

In industries where economies of scale were more important and where there were fewer competitors, such as transportation equipment, refined petroleum, chemicals, primary metal and pulp and paper, within-plant productivity growth accounted for a larger proportion of total productivity growth. However, even in these industries, market-share turnover made an important contribution to overall productivity growth.

The competitive process that caused more productive plants to gain market share from the less productive ones was also an important driver of rapid productivity growth in the high-tech manufacturing sector during the 1990s, the report found.

The research paper Industrial Competition, Shifts in Market Share and Productivity Growth, no. 21 (11F0027MIE2004021, free) is now available online. From the Our products and services page, under Browse our Internet publications, choose Free, then National accounts.

Additional information on related papers that describe the importance of turnover and competition can be found at our economic analysis site (/english/studies/eaupdate/dynamics.htm).

For more information, or to enquire about the concepts, methods or data quality of this release, contact John Baldwin (613-951-8588) or Wulong Gu (613-951-0754), Micro-economic Analysis Division.