“The role of competition in the development of knowledge and economic growth — connecting static competition theory with dynamic growth theory.”

This thess topic explores the link between competition and knowledge, innovation and economic growth. This draws on two areas of economics not often considered together:

1) competition theory — the microeconomic study of the causes and consequences of competition; and
2) growth theory — the macroeconomic study of what drives economic growth

Both of these aeras of study have received considerable attention from economists. In brief, the theory of perfect competition suggests that firms will enter a market until the marginal cost of production equals the price. In this instance, economic (or excess) profits aer zero and the market is pareto optimal. Growth theory has grown into new growth theory, which attempts to explain the driver of long term economic growth — improvements in technological processes (ie innovation).

In exploring the link between these two bodies of knowledge, three additional areas of economics become relevant:

1) Austrian & Schumpeterian economics — which highlights the importance of knowledge in the economic process and the role of comptition in the creation of, and retention of knowledge.
2) evolutionary economics — which stresses the irrelevance of the concept of a stable equilibrium, such as perfect competition, and instead focuses on the economic process.
3) trade economics — while being part of orthodox economic thinking, it is the area of trade economics where the link between competition and growth is being explored most robustly.

Trade policy analysis has long focussed on the allocative efficiency gains that can be achieved through specialisation and trade. However, there has long been a debate about the additinoal existence of ‘dynamic productivity gains’ from trade. One of the possible causes of these dynamic productivity gains is increased competition.

The economic theory required to understand this relationship diverges from both standard competition theory and standard growth theory. Building an integrated theoretical base for this relationship requires traditional competition theory to be supplemented with aspects of Austrian and evolutionary economics so as to describe the competitive process instead of a competitive equilibrium.

The empirical evidence available to show the link between competition and economic growth can be gathered from three sources:

1) case studies — there is plenty of anecdotal evidence to suggest a causal link between competition and higher productivity growth. For example, after the liberalisation of teh sheepmeat market in New Zealand, productivity increased from 1% per annum to 6% per annum and while protection decreased, production and employment from the industry increased.
2) econometric studies — some recent work conducted by Chand from the ANU has provided econometric estimates of the relationship between reduced trade ‘protection’ and productivity growth.
3) modelling inconsistencies — standard trade policy analysis currently excludes any potential dynamic productivity gains from increased competition, and some economists believe that model under-estimates have been caused by this omission.

The questions that this thesis will focus on include:

* Does competition encourage firms to innovate to create a competitive advantage over their rivals, and imitate best-practice production and management practices in order to stay competitive?
* Growth theory suggests that innovation drives economic growth. New Growth theory suggests that R&D drives innovation. What are the free-market incentives that drive firms to invest in R&D and what other factors drive innovation? What role (if any) does competitive pressure play?
* Can ‘dynamic productivity growth’ be incorporated into economic models, and will this improve the findings of such models in trade policy analysis?
* Can the competitive process help explain the rate of fluctuations in economic growth (ie the business cycle)?

The answers to these questions can have some important policy conclusions. If competition is bet understood as an evolutionary process instead of a quest for equilibrium, then competition policy needs to be re-examined (this is already a theme of evolutionary economics as pursued by Prof John Foster and Dr Jason Potts from the UQ economics department). The importance of the competitive process may require difficult trade-offs when policies that encourage R&D conflict with the maintenance of a robust competitive process. Also, the expected impacts of trade liberliations would be significantly different if dynamic productivity gains were significant.

One element of this thesis will be to explore the possibility of introducing dynamic productivity benefits into a trade model, based on econometric estimaets of the relationship between competition and productivity growth. One of the most commonly used models in doing trade policy analysis is the comparative static internatinoal CGE model — GTAP. Other models that could be used include G-cubed (which introduces inter-temporal choices) or partial equilibrium trade and industry models.