Executive summary

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Research on the dynamics of competition has shown that large amounts of market share are transferred over time from declining to growing firms. The firms that gain market share do so as the result of considerable gains in relative productivity. This reallocative process has been shown to contribute substantially to aggregate productivity growth.

The identity of growing firms and declining firms is difficult to predict ex ante. At the beginning of any time period, there is little difference in the productivity of those who will subsequently gain and those who will subsequently lose market share in the next period. But the former find ways to improve their productivity relative to the latter, and the sudden gain in relative productivity is translated into large gains in market share (Baldwin and Sabourin 2001, 2004; Baldwin and Gellatly 2003). The resulting shift of resources within an industry from less- to more-productive producers accounts for a considerable proportion of overall industry productivity growth—up to 50% in the manufacturing sector (Baldwin and Gu 2006) and around 100% in the retailing sector (Baldwin and Gu 2008).

Complementary research from Canadian business surveys has shown that this sudden emergence of differences in productivity is partly related to differences in the capabilities of firms to innovate and exploit the benefits of advanced technology (Baldwin and Sabourin 2001, 2004; Baldwin, Sabourin and Smith 2003). These emerging differences in productivity create centrifugal forces within the marketplace that increase the market share of those gaining relative productivity and decrease the market share for those with declining relative productivity. Opposing this tendency are centripetal forces within the marketplace that help those losing market share to attenuate their productivity differences relative to rivals that are surging ahead.

Externalities from spillovers contribute to these centripetal forces. Spillovers have long been regarded as an important feature of competitive markets. They involve the unpriced transfers of productive knowledge from some producers—firms that possess special assets, and/or organizational advantages—to rivals. The special knowledge of techniques, technologies, patents and organizational forms that permits some firms to develop an advantage can be transmitted via spillovers to those who fall behind. The magnitude and speed with which this transfer occurs will determine whether those who did not initially discover new techniques or new products survive in the market place.

The importance of these externalities will determine the speed with which populations turn over and renew themselves via entry and exit, and influence the extent to which existing entities can transform themselves in time to save themselves from having to exit. It will determine whether the ecological model of sorting is one where the less productive are rapidly culled or whether there is a type of safety net coming from spillovers that prevents them from falling too far behind the industry leaders. Finally, the speed with which the knowledge of growing firms is transferred to others may affect the incentive of high achievers to innovate and thus overall economic progress. The notion that externalities should be encouraged underlies many industrial policies that are aimed at facilitating the transfer of knowledge to those who are disadvantaged. This goes to the heart of patent laws that offer legal protection for ideas—but only for a prescribed period of time, so that the ideas behind patents can be disseminated as widely as possible.

Research from microeconomic panels has produced a considerable number of studies regarding the sources and types of centrifugal processes at work within the Canadian business sector. These are forces that encourage the competitive separation of more- from less-productive firms. Less effort has been spent examining the nature of the centripetal forces that may potentially mitigate the competitive separation of rival firms. This paper is our first attempt to look at this issue. It focuses on the relationship between the productivity growth of declining plants (possible receivers of spillovers) and that of growing plants (possible senders of spillovers). There are other externalities that are of potential interest, such as those that are transferred to successful plants, for example. But since so much attention has been placed on the process of competitive reallocation that shifts economic resources away from declining to growing firms, an examination of the productivity spillovers that link growers to decliners presents a logical starting point.

This paper uses plant-level data on productivity growth and changes in market share over three periods (1979 to 1984, 1984 to 1990 and 1990 to 1996) to investigate whether plants with declining market shares in each of these periods obtain productivity spillovers from rival producers that are revealed by the market place to be more successful. It examines the extent to which the productivity performance of plants with declining market shares is influenced by (1) their initial proximity to the existing technological frontier, and by (2) contemporaneous productivity changes in rival incumbents that are growing their market share. In doing so, it asks whether the impact of these spillovers is circumscribed by distance.

The paper evaluates these possible sources of spillovers—frontier plants at the beginning of a period and plants which gain market share over a period—because of what they reveal about the types of productive information that struggling plants may be able to assimilate from rivals. Spillovers from the existing frontier are likely to reflect the established best practices of industry leaders; those from market-share gainers involve new sources of productive knowledge that emerge as the frontier is actively being re-established. The spillover model advanced herein incorporates geographic information on the proximity of declining plants to both frontier plants and market-share gainers to test whether productivity spillovers are spatially circumscribed.

The analysis finds that plants losing market share do not obtain productivity spillovers from rivals located at the technological frontier. After mean reversion is taken into account, declining plants that start out further behind the frontier actually exhibit slower, not faster, rates of productivity growth—evidence that knowledge from the old frontier does not spill over to low-efficiency producers. The further a declining plant starts off behind the frontier, the lower its productivity growth is likely to be.

The analysis does find that plants with declining market shares obtain productivity spillovers from rivals gaining market share—plants with a revealed competitive advantage. These are rivals on the right side of the competitive struggle as the dynamics of competition are actively being played out. While declining plants obtain some measure of benefit from these rivals, productivity spillovers from market-share gainers to market-share decliners are spatially circumscribed and qualitatively modest.

At most, these productivity externalities from growing plants increase the rate of productivity growth of declining plants by between 0.18 and 0.34 of a percentage point. This is relatively small compared to the almost 4-percentage-point difference between the median growth rate of growing and declining plants, averaged over the three periods. The externalities measured here then have a relatively minor impact on closing the gap between the more and the less successful. The evolutionary process resembles a contest that quickly rewards the more successful and leaves the less successful to fall further and further behind the leaders.