Reaching up and reaching out: The impact of competition on firms’ productivity and export decisions

• Author: Kate Hynes,Eric E. O. Opoku,Isabel K. M. Yan
• DOI: http://doi.org/10.1111/1468-0106.12287
• Published date: 01 February 2020
• Date: 01 February 2020

ORIGINAL MANUSCRIPT

Reaching up and reaching out: The impact of

competition on firms’productivity and export

decisions

Eric E. O. Opoku

1

| Isabel K. M. Yan

1

| Kate Hynes

2

1

Department of Economics and Finance,

City University of Hong Kong, Kowloon Tong,

Hong Kong

2

School of Economics, University College,

Dublin, Ireland

Correspondence

Isabel K M Yan, Department of Economics and

Finance, City University of Hong Kong, 83 Tat

Chee Avenue, Kowloon Tong, Hong Kong.

Email: efyan@cityu.edu.hk

Funding information

Strategic Research Grant (SRG) of the City

University of Hong Kong (Project No. 7008144)

Abstract

Using firm-level data from 139 countries, this paper inves-

tigates the effect of competition in both the domestic and

foreign markets on firm productivity and export decisions.

Applying a sample selection endogenous treatment

(SSET) Poisson model that tackles both the issue of

endogenous sample selection and endogenous treatment at

the same time, we document robust evidence that strong

competition in the domestic market propels firms to be

more productive, and decreasing domestic competition

increases firms’propensity to export. However, firms’

export intensity (i.e. how much they export) is not directly

influenced by competition in the domestic market. More-

over, lower competition in the foreign market increases

the propensity of domestic firms to export, enlarging the

set of exporting firms to include firms with relatively

smaller export amounts.

1|INTRODUCTION

Competition greatly affects firms’performance. In the face of competition firms tend to react differ-

ently. Some may downsize, others may exit the market and then some firms may adopt survival tac-

tics to remain in business. Over the past couple of decades, countries have become more and more

integrated and this has intensified competition among them.

1

The existence of trade agreements

between countries and countries’affiliation to international bodies such as the World Trade Organiza-

tion (WTO) have contributed to eliminating entry barriers and, thus, enhanced competition. Chen,

Imbs, and Scott (2009) for example, stress how openness influences competition. The emergence of

China in the manufacturing sector has contributed remarkably to the rise in global competition

(Abraham & Van Hove, 2011).

2

Received: 9 October 2017 Revised: 13 August 2018 Accepted: 1 October 2018

DOI: 10.1111/1468-0106.12287

Pac Econ Rev. 2020;25:69–101. wileyonlinelibrary.com/journal/paer © 2018 John Wiley & Sons Australia, Ltd 69

It has been well documented that competition in market economies results in the survival of the

most efficient firms, whereas the inefficient firms die out, resulting in the relocation of scarce

resources from the less efficient firms to the most efficient firms (Kilinç, 2014; Poschke, 2010). In

effect, competition drives prices down until they equal the marginal cost. As a result, competition is

argued to be the bedrock of firm efficiency and innovation.

Competition can positively impact firms, especially if it improves firms’total factor productivity

growth (Nickell, 1996). Ahn (2002) stresses that the benefits of competition can be widely expressed

in terms of both productive and dynamic efficiency, which, in a nutshell, can be seen as productivity

growth through innovations. The benefit of productive efficiency originates from innovations that

stimulate productivity such as the introduction of new and improved techniques of production. As

this is achieved, fruitful innovations will ultimately cause the level and growth rate of productivity to

appreciate, thus achieving “dynamic efficiency”gains.

One of the key strategies opened to firms in their quest to sell more, to be more productive and to

expand their horizons is proceeding to the international market through exporting. In entering the

export market, one of the most important considerations is the level of product market competition

(Melitz, 2003). In this sense, the level of competition prevailing in the foreign market can determine

whether a domestic firm enters or not. The foreign market consists of a large number of firms, all

competing for a share of the market. With the perceived intense foreign competition, it has been

largely argued that to survive, a firm’s assessment of its capacity in the form of productivity and com-

petitiveness is important (Bernard, Bradford, Redding, & Schott, 2007; Melitz, 2003; Rodríguez &

Rodríguez, 2005).

The impact of competition on the firm and its activities has attracted much attention among

researchers and policy-makers. This is the case as the level of competition can determine the survival

of the firms (Lee, Lee, & Baek, 2017), and the economy as a whole. Despite the increase in interest

in this area, cross-country analysis is particularly lacking. Due to data availability, the majority of

studies have concentrated on the analysis of advanced economies and have typically conducted

single-country analysis (Amato & Amato, 2001; Baghdasaryan & La Cour, 2013; Buccirossi, Ciari,

Duso, Spagnolo, & Vitale, 2013; Nickell, 1996; Nickell, Nicolitsas, & Dryden, 1997; Tang & Wang,

2005). As a result, studies on developing countries are scarce. More importantly, a consensus has not

be reached on the effect of competition on productivity and other activities of the firm, either theoret-

ically or empirically (Aghion, Bloom, Blundell, Griffith, & Howitt, 2005; Schmitz, 2005; Schmut-

zler, 2009; Syverson, 2004; Vives, 2008), and this calls for further and detailed investigations,

especially with larger sample sizes. In our paper, we attempt to fill this gap in the literature by investi-

gating a larger number of countries (a larger number of firms for that matter) across different regions

to examine the impact of competition in both the domestic and foreign markets on firms’productivity

and exporting decisions.

The contribution of the present study to the literature is manifold. First, we utilize firm-level data

for a larger number of countries (139 countries with approximately 68 000 firms) between 2006 and

2016. To the best of our knowledge this is the largest number of countries empirically analysed with

respect to the impact of competition on firms. The large sample size is deemed important as with this

we can make constructive conclusions about the global effect of competition.

Second, we make a distinction between domestic and foreign competition. As a proxy for domes-

tic competition, we use a concentration measure, the Herfindahl index, which is widely used in the

published literature (Baghdasaryan & La Cour, 2013; Cherchye & Verriest, 2015; Valta, 2012; Xu,

2012). For foreign competition, although not explored as widely as domestic competition, a handful

of the existing studies have used proxies such as import penetration, tariffs, the number of foreign

70 OPOKU ET AL.

competitors in the domestic market and subjective responses of respondents’assessment of foreign

competition (Baghdasaryan & La Cour, 2013; Gorodnichenko, Svejnar, & Terrell, 2010; Kostevc,

2009). However, measures such as import penetration and the number of foreign competitors in the

domestic market do not capture foreign competition prevailing in the foreign market. Regarding

exports we believe that competition prevalent in the foreign market is more important than foreign

competition in the domestic market. The propensity and intensity of exports can be influenced by the

prevailing market conditions in the foreign country. Understanding competition in international mar-

kets is more important for local firms that are considering exporting abroad as it will help them devise

more informed entry strategies. What products to export and how much to export will be dictated by

the prevailing market conditions (of which competition is a major part) in international markets. We

argue that multinational (foreign-owned) firms located in the domestic market should be captured as

part of domestic competition.

As domestic and foreign markets may be of different size and have different market structure

(e.g. monopolistic competition vs oligopoly/monopoly), domestic firms that have little room to sur-

vive in the domestic market due to small domestic market size or low domestic market power may

choose to sell to the foreign market. As long as the profit margin is sufficient to cover the cost of

exporting, firms will export to the foreign market. As the degree of foreign competition in the foreign

market (where the exporting firms are selling to) directly affects the firms’profitability and chance of

survival, it is important to study the impact of foreign competition in the foreign market on domestic

firms. Studies that support the view that domestic firms aspiring to export have to keenly take into

consideration the competition existing in the countries they want to export to include Cateora and

Ghauri (2000) and Darling and Seristö (2004).

Some studies have touched on the effect of foreign competition on domestic exporting firms’

innovation and market share, including Darling and Seristö (2004) and Cavusgil (1984). As main-

tained by Darling and Seristö (2004), stronger foreign competition in the foreign market will necessi-

tate domestic exporting firms being more innovative by formulating new products, services and

processes to meet the demand of the customers in foreign markets. Cavusgil (1984) similarly argues

that competition in the foreign market propels domestic firms to design products that meet the spe-

cific needs of foreign customers and to commit financial and managerial resources to foreign market

research for product innovation. Domestic firms wanting to export will, therefore, have to improve

their innovativeness to penetrate and survive in foreign markets. The market size of the firms in the

foreign market depends on the successfulness of the firms there.

In our measure of domestic competition, we consider all firms operating in the domestic econ-

omy, and this includes foreign-owned firms as well. Considering foreign competition in international

markets will help provide insights to local firms and governments, especially in developing econo-

mies, on how to enhance and sustain their export patterns. Our two measures of foreign competition

show the degree of competition that domestic firms may potentially face in international markets.

The subjective measure has limitations and is likely to be biased as different firms will have different

opinions based on their subjective experiences. Given that the literature does not provide a smoking

gun proxy that can capture competition in the foreign market, we construct two proxies based on a

concentration measure, the Herfindahl index. Our measures of foreign competition show the degree

of competition that domestic firms may potentially face as they enter foreign markets. These mea-

surements are discussed in Section 3. Our measurement of competition in the foreign market is in

sharp contrast with most of the existing studies that have captured foreign competition as they con-

sider foreign competition prevalent in the domestic market. We therefore contribute to the literature

by capturing the impact of foreign competition in the foreign market.

OPOKU ET AL.71