The World Economic Forum Global Competitiveness Report for 2009-2010 will be out in September. Widely watched by analysts, it has a bearing on inward investment. The focus of the report is on ?how nations and businesses manage the totality of their competencies to achieve greater prosperity?. Against the background of the crisis, with many economies in deeper disarray, India has every reason to rise from its current position half way down the league table.
A competitive firm is one that can match others in its sector in competition variables. In a fairly open economy with intense competition, domestically competitive firms are potentially internationally competitive. An economy with a good number of such firms is itself internationally competitive. Furthermore, if competition is intense, resources are reallocated more efficiently and the growth potential of the economy is higher. Clearly the intensity of competition conditions the firms and the economy for internationally competitiveness. On this count, India should rise in the top leagues in a few years.
A key message that students take home from Econ101 is that in a competitive environment, all companies earn the same rate of return. However naive, this is a useful starting point in the analysis of competition. By this reckoning, the charts summarise how the intensity of competition has evolved in India. They plot selected percentiles of the annual cross sectional distribution of profitability, between 1989 and 2007, across public, listed and unlisted companies. The plotted lines represent the time series of various percentiles of annual cross sections, not of specific firms (individual firms may move up or down the distribution from one year to the next). The same data is rearranged in the second chart in terms of differences between percentiles: the 5th and the 95th; the 10th and the 90th and so on.
There was a marked rise in the dispersion of profitability throughout the mid-nineties. The pattern holds true at the disaggregated level for many important individual sectors. The profitability dispersion was stable at a relatively low level through the early nineties, and appears to be stable at a high level through the noughties. The rise in the spread of the distribution from mid to late nineties was driven by the left (bottom) tail of the distribution, as the poorest performers forayed deep into negative profitability. The economic environment in this period was not favourable to industry. There was a short recession in 1996 and some longer lasting slowdowns over this period. The Asian economic crisis soured the external economic environment, and the industrial growth rate dropped. But when the bottom end recovered after 2002, the best performers clambered up into ever higher reaches of the profitability distribution than before. Profitability dispersion did not fall.
Does this observed pattern mean that competition intensity declined in the second half of the nineties, and has been low since then? A truer characterisation of competition is that competitive forces (rivalrous strategies deployed by firms, including entry that targets high profit niches) work over time to whittle away above normal profits enjoyed by any firm. It is dynamics that matter in understanding the intensity of competition?does above or below normal profitability persist, or is it drained off relatively quickly? Further, it is naive to expect all firms to converge to a common normal rate of profitability. Each firm has its own normal rate of profitability: a sustainable profitability rate determined by the firm?s specific command over (and efficient use of) resources?knowledge and organisational capital, apart from physical, financial, human and other types of capital. So we can only expect competition to evaporate away (over the short run) the transient abnormal profitability enjoyed by any company. The rate at which this happens is a useful summary measure of the intensity of competition.
Together with Neng Jiang and others, I have been examining the extent to which deviations from normal profitability tend to be corrected among both developed and emerging markets, with particular focus on Indian and Chinese firms. Controlling for relevant factors, we found that in India, over the 1991-95 period, on average, a 1% deviation from normal profitability was corrected by 0.2 percentage points within one year. This rate of correction (reversion back to the normal) went up to 0.5 percentage points in the period 1995-1999, and further to 0.65 percentage points in the 2000-2007 period.
Reversion from above normal end was always higher than reversion from below normal end; firms on the wrong side of normal profitability have tended to persist more. Reversion from the top end increased significantly between the early nineties and the mid-nineties, and then again between the mid-nineties and the noughties. Reversion from the bottom end did not change much between the first phase and the second, but increased significantly from the second phase to the third. Overall, evidence is that the intensity of competition has grown to be higher in India than in many developed economies.
But is the increased dispersion of profitability consistent with the evidence for increased intensity of competition? The explanation lies in a collateral aspect of liberalisation and integration into the world economy?the attendant increase in the volatility of business environment. Shocks and disturbances of many different types (macroeconomic, sectoral and technological, and individual firm specific) have grown more numerous and have been transmitted to firms with less cushioning than before. Even as firms began to revert at faster rates to normal profitability, idiosyncratic shocks began to hit them more, and harder. The result is a more dispersed distribution of profitability. One implication of this, among others, is that we need more sophisticated approaches to judging firm performance.
?The author is reader in economics at Judge Business School, University of Cambridge, and a fellow of Corpus Christi College