Paper to be presented at the DRUID Summer Conference 2004 on

INDUSTRIAL DYNAMICS, INNOVATION AND DEVELOPMENT

Elsinore, Denmark, June 14-16, 2004



TOWARDS A GENERALISED DEFINITION OF COMPETITION

PIER PAOLO SAVIOTTI (*) and JACKIE KRAFFT ()

(*)INRA-SERD, Universit Pierre Mends-France, BP 47, 38040 Grenoble, Cedex 9, France.
Tel: (33-4) 76.82.58.31; Fax: (33-4) 76.82.54.55; E-mail: saviotti@grenoble.inra.fr;
and IDEFI, CNRS UNSA, 250 rue Albert Einstein, 06560 Valbonne, France.
() IDEFI, CNRS UNSA, 250 rue Albert Einstein, 06560 Valbonne, France.
Tel: (33-4) 93 95 41 70 ; Fax : (33-4) 93 65 37 98 ; E-mail: Jackie.Krafft@idefi.cnrs.fr


Abstract
In this paper we propose a conceptual model of competition which is in line with recent
developments in the economics literature. We concentrate mostly on two shortcomings
identified in the past literature, namely on the process critique and on the effect of qualitative
change, that we consider the heir to the product differentiation critique. Furthermore, we
consider that these two shortcomings are not independent, but closely related. For example,
qualitative change destabilizes the system, thus inducing a dynamics of change by which its
own subsequent development is affected.

The conceptual model of competition that we develop in this paper is based on a particular
representation of product technology and of industrial sectors, in terms of product
characteristics. By means of this representation we propose a definition of the intensity of
competition that is in principle applicable empirically and useful for modelling purposes.
Furthermore, we distinguish intra-sector competition from inter-sector competition, we
maintain that these two types of competition interact and that both influence economic
development. A part of our paper is based on the results of a model of economic development
by the creation of new sectors. Finally, our model of competition allows us to discuss the
relationship between competition and growth.

We start our paper by means of a brief summary of the literature on competition and continue
by presenting our conceptual model of competition, its analytical dimension and the
implications it has for economic growth and development.



DRUID 2004/Draft 1/PPS/ 1
TOWARDS A GENERALISED DEFINITION OF COMPETITION

AUTHORS: PIER PAOLO SAVIOTTI
(*)
and JACKIE KRAFFT
()


AFFILIATION :
(*)INRA-SERD, Universit Pierre Mends-France, BP 47, 38040 Grenoble, Cedex 9, France.
Tel: (33-4) 76.82.58.31; Fax: (33-4) 76.82.54.55; E-mail: saviotti@grenoble.inra.fr;
and IDEFI, CNRS UNSA, 250 rue Albert Einstein, 06560 Valbonne, France.

() IDEFI, CNRS UNSA, 250 rue Albert Einstein, 06560 Valbonne, France.
Tel: (33-4) 93 95 41 70 ; Fax : (33-4) 93 65 37 98 ; E-mail: Jackie.Krafft@idefi.cnrs.fr

1) INTRODUCTION

In this paper we propose a conceptual model of competition which is in line with recent
developments in the economics literature. We concentrate mostly on two shortcomings
identified in the past literature, namely on the process critique and on the effect of qualitative
change, that we consider the heir to the product differentiation critique. Furthermore, we
consider that these two shortcomings are not independent, but closely related. For example,
qualitative change destabilizes the system, thus inducing a dynamics of change by which its
own subsequent development is affected.

The conceptual model of competition that we develop in this paper is based on a particular
representation of product technology and of industrial sectors, in terms of product
characteristics. By means of this representation we propose a definition of the intensity of
competition that is in principle applicable empirically and useful for modelling purposes.
Furthermore, we distinguish intra-sector competition from inter-sector competition, we
maintain that these two types of competition interact and that both influence economic
development. A part of our paper is based on the results of a model of economic development
by the creation of new sectors. Finally, our model of competition allows us to discuss the
relationship between competition and growth.

We start our paper by means of a brief summary of the literature on competition and continue
by presenting our conceptual model of competition, its analytical dimension and the
implications it has for economic growth and development.

2. COMPETITION IN RETROSPECT.

The evolution of the concept of competition in the literature has never been based on a
continued improvement process. Rather, this evolution has been characterized by some
important ruptures, some neglects of important contributions, and even some retreats and
regressions. The static nature of competition has been criticised by early authors such as
Hayek (1937) or Schumpeter (1912, 1942), and has motivated alternative investigations into
the process of competition in terms of discovery or selection procedures. The effect of
product differentiation on competition led to the creation of theories of imperfect competition
by Chamberlin (1933) and Robinson (1933). However, on the one hand, the 'process' critique
did not take into account the effect of product differentiation and, on the other hand, the
'differentiation' critique still considered competition as a state of affairs. More recently, other
authors such as McNulty (1968), Kirzner (1973), and Richardson (1975) contributed to clarify
that it is necessary to move from a notion of competition which essentially relates to a theory
DRUID 2004/Draft 1/PPS/ 2
of economic equilibrium towards a new concept of competition which is based on a theory of
economic evolution. This distinction is considered as crucial since, in the first case,
competition has a key role to play in the balancing of supply and demand in particular
markets, while, in the second case, competition contributes to structural and technological
development. Within this distinction, commentators suggested also that competition is
essentially a market behaviour and not a market structure.

The positive outcome of these long debates and controversies on competition is that we have
come today to a rather consensual definition of competition, quite close to the everyday
meaning of the term
1
. Competition is taken to mean that range of actions aimed at ensuring
the realization of the choices of a given firm while restraining at the same time the sphere of
actions of its rivals. Competition is a process of rivalry between firms which takes the form of
contests within existing markets (intra-industry competition), and the form of potential entry
into new areas (inter-industry competition). Competition includes rivalry in terms of price, but
also in terms of altered or improved techniques of production or products, and in terms of the
provision of information to consumers about products. All these forms of rivalry have
consequences for the level and rate of growth/decline of production and standards/variety of
consumption, and for the evolution of the structures of markets themselves which are
increasingly shaped by new forms of organizations in which customers, suppliers, partners
and even competitors are involved (Krafft, 2000).

The negative counterpart, quite paradoxically, is that it is still difficult to know in what ways
competition can promote economic development, and how more or less competition favours
or hinders economic growth. In a recent article, Blaug (2001, p. 37) asks whether competition
is such a good thing and reconsiders the usual distinction static versus dynamic efficiency.
He notes that In the end-state of conception of equilibrium, the focus of attention is on the
nature of the equilibrium state in which the contest between transacting agents is finally
resolved; if there is recognition of change at all, it is change in the sense of a new equilibrium
of endogenous variables in response to an altered set of exogenous variables; but comparative
statics is still an end-state conception of economics. However, in the process conception of
competition, what is in the foreground of analysis is not the existence of equilibrium, but
rather the stability of that equilibrium state. How do markets adjust when one equilibrium is
displaced by another and at what speed will these markets converge to a new equilibrium?.
According to Vickers (1995, p. 1), Despite the widespread view, which has considerable
empirical support, that competition is important for productive efficiency, it is not so obvious
why. Competition seems very well in practice, but it is not so clear how it works in theory.
In what follows we argue that there is a major reason for this. The reason is that, in most of
the analyses of competition which were developed from the 1970s to the 2000s, the main
focus was to show that competition is not simply related to the number of companies (market
structure). However the question of how the interactions between firms within a given
industry (intra-industry) and among different industries (inter-industry) are modified over
time was not systematically investigated.


2.1. IN THE 1970S: THE MYTH OF AN INCREASING CONCENTRATION
The fundamental contributions provided by Hayek and Schumpeter on the process of
competition remained neglected for a long time. The Harvard School, and the SCP paradigm,
occupied the centre scene, and it is only in the 1960s and 1970s that things started to change.
The emergence of the Chicago School, as well as the early developments on the theory of

1
See entries on competition in the Palgrave: Stigler (1987); Clifton (1987); Roberts (1987); Mc Nulty (1987).
DRUID 2004/Draft 1/PPS/ 3
barriers to entry, provided a new vision of competition, namely more behavioural and less
structuralist. Authors such as Telser (1964), Benham (1972), Demsetz (1973), Posner
(1977), Bork (1978), Brozen (1982) developed a series of new propositions which were in
strong opposition to the Harvard School. Empirical studies on industry time-series showed
that market forces seemed to prevent by themselves the existence of dominant firms or
monopolistic competition. There was no obvious causality between small number markets and
the lack of competition, and no observable tendency to concentration over the long run. The
myth of an increasing concentration was thus significantly weakened and progressively
replaced by a new body of analysis. For the main authors of the Chicago School, a
concentrated industry is not necessarily a non-competitive industry. In fact, large, efficient
firms come to dominate the industry since they outperform their inefficient competitors.
Moreover, entry in most industries is relatively easy and, in most cases, barriers to entry do
not deter entry. In this context, market power of incumbent firms has to be evaluated with
respect to effective competition, but also potential competition. Finally, since economic
systems are recurrently faced with major changes, monopolies and oligopolies cannot be
considered as permanent forms of industry. Rather, they emerge in a transitory manner to
secure the appropriation of gains related to innovation, but are naturally conducted to
disappear over time.


2.2. IN THE 1980S: POTENTIAL COMPETITION AND CONTESTABILITY
The theory of contestable markets developed by Baumol, Panzar and Willig (1982)
contributed also to refining the relation (or the absence of relation) between competition and
market structures. In this perspective, the notion of potential competition played a key role.
This theory advocates that competition is not necessarily connected to the number of market
participants. In fact, a market is contestable (and thus competitive) when a) entry in this
market is free, which means that new entrants come to be perfectly adapted both to the
techniques of production and quality of products which are offered in this market, and when
b) exit is also free, which means that new entrants can immediately exit without costs. A
contestable market can thus exist, and approximates the optimum, since potential competitors
are able to enter the market, obtain a profit when prices are superior to marginal costs, and
exit when prices decrease either naturally with declining profit opportunities or strategically
with increasing price competition from the incumbents. Contestability, supported by the hit
and run assumption, provides firms with the adequate incentives to adopt a competitive
behaviour, and guarantees that prices will not remain over marginal costs in the long run.
Contestability stresses that industry structure is intrinsically endogenously determined, with
the prevailing strategies in terms of prices, production, and marketing. This involves an
important departure from traditional conclusions, in which market structures were essentially
exogenously determined. Monopoly and oligopoly structures are part of a natural process of
competition which results from the interaction between, on the one hand, the incumbents and,
on the other hand, the potential competitors which create new profit opportunities, introduce a
qualitative change within the existing market structure, and import novelties from other
industries. In addition, this process of competition is favourable to consumers, who benefit of
a larger and diversified spectrum of offers.

2.3. IN THE 1990S: INCENTIVES AND COMPETITIVE BEHAVIOUR
The theory of contestable markets was significantly complemented by the emergence of the
New Industrial Economics. Contestability theory essentially provided new developments
about the relation between market structure and technological efficiency. In this framework,
technological efficiency was determined by the analysis of the production functions of
DRUID 2004/Draft 1/PPS/ 4
different players (incumbents, effective entrants and potential entrants) and the prevalent
market structure was supposed to reflect and to adapt to this efficiency. Nevertheless, in
the real world players do not necessarily behave as this model suggests. In other words, the
examination of the production side of the problem does not provide a definite analysis of how
players behave effectively. These types of behaviour are, in most cases, related to complex
patterns of incentives which may involve a gap between what firms do and what they should
do. In the mid-1980s, thus, the New Industrial Economics emerged as a major framework and
it soon imposed another vision of competition. Competition was now analysed through the
characteristics of different markets where strategic interactions prevail, and where a large
spectrum of (conflicting) incentives drive these market behaviours. Using the apparatus of
game theory, this approach is able to describe a complete range of market strategies, from
agreements between firms that could be either explicit or tacit, to excessive pricing, price
discrimination, predatory pricing, patent races, and vertical restraints that can deter entry or
impose foreclosure (Phlips, 1995; Baumol, 2001; Evans and Schmalensee, 2001; Lewis and
Yildirim, 2002).


2.4. IN THE 2000S: INDUSTRIAL DYNAMICS AND QUALITATIVE CHANGE
New developments on Industrial Dynamics are related to the need for an operational concept
of competition that can include the following features of industrial evolution (Klepper, 1997).
Industries, like biological organisms, face different stages during their lifetime, and these
stages imply modifications in their characteristics. The first stage begins with the introduction
of a new product on the market, either by the inventor or the first producer, and this period
corresponds to the emergence of a new industry. At that time, the size of the market is
narrowly defined, and there is a high uncertainty on the future growth of this market. The
product is like a prototype without any clear definition of applications and, further, of
potential demand. This first stage ends with the emergence of new producers (new entrants).
The length of this period depends on the size of the market just after the introduction of the
product, on the number of potential entrants and on their ability to copy product innovation.
The second stage is characterized by an increase in the number of incumbent producers.
Output growth is high and the final design of the product is now available. In the third stage,
net entry is around zero. Product innovation is decreasing and is replaced by process
innovation. This stage ends with the decline of gross entry rate. The fourth stage involves a
negative net entry. The fifth stage reflects the maturity of the market in which a number of
incumbent firms exit from the industry: the shakeout occurs.

These developments further involve the following elements. Firstly, firms seek a selective
rather than a uniform expansion, tending to specialize in a more closely similar group of
activities and coming to rely on sales and purchases from other businesses. Secondly, firms do
not react at an identical speed, and react on the basis of different (and incomplete) sets of
information, as well as different incentives over time. Thirdly, qualitative change seems to be
a key element in the analysis of the process of competition, and this element has long been
left out of existing analytical frameworks.

3) ON THE NATURE OF COMPETITION.

The concept of competition we develop here is compatible with the developments in the
literature described in section 2. As pointed out in the introduction, we intend to combine the
process and qualitative change critiques of competition, the latter being the heir of the product
differentiation critique. Furthermore, we intend not only to frame the problem at a conceptual
DRUID 2004/Draft 1/PPS/ 5
level, but to provide a definition of competition which is both analytically and empirically
useful. Our treatment of competition is going to be essentially based on three aspects:
competition as an interaction, competition and qualitative change, competition as a process.
That firms interact means that the behaviour of each firm is not independent of the behaviour
of other comparable firms. Firms interact because they compete for customers, in a way
extremely similar to the one by which biological species compete for resources (Maynard
Smith, 1974). Let us observe here that in atomistic competition the behaviour of each firm is
independent of that of other firms. Competition here arises because the number of customers
is not enough to keep all the firms in business. If the number of customers were at all times
more than enough to absorb all the output of all incumbent firms there would be no
interaction and no competition: each firm would behave individually quite simply because it
would not need to take into account the behaviour of other firms. Thus, the existence of
competition as interaction depends on the 'resource' that firms are competing for. Even if such
scarcity were not there initially it would be inevitably created by the evolution of the
economic system. If at given time the output of incumbent firms were inferior to present
demand, and even admitting that these firms were interested or willing to expand their output,
other firms would enter to exploit the existing capacity gap. Thus, the scarcity of the 'resource'
competed for would be created even if it had not been there initially.

These considerations indicate already the link of competition as interaction with the other two
aspects of the problem, competition and qualitative change and competition as a process.
First, firms compete for customers by means of their outputs, be they products or services.
The intensity of competition is then proportional to the similarity of firms' outputs, or
equivalently, inversely proportional to the heterogeneity of their potential customers. Firms
making shoes do not compete with firms making photographic cameras. In fact, if customers
were homogeneous there would be no sense in differentiating outputs. Again, let us remark
here that in atomistic competition firms' outputs are identical. A range of possible situations
exist varying from a)firms producing identical outputs, to b)firms producing completely
different outputs, passing through a series of intermediate situations in which the degree of
similarity of firms' outputs varies form one to zero. Of course, this means simply that
competition implies substitutability. Thus competition is intimately linked to qualitative
change, which modifies firms' outputs. Second, competition is part of a process and is
intrinsically dynamic. In particular, a situation in which there is no competition would
intrinsically unstable because it would induce competition by the entry of new firms. Both of
these aspects are going to be analysed in the following paragraphs.

We can define qualitative change as the mergence of new entities emerge within the economic
system, possible new entities being new objects (product or services), new activities (the
production processes required to produce the new objects), and new actors (the new firms and
all the other institutions required for the new products and services to diffuse and to acquire
economic weight) (Saviotti, 1996; Saviotti,Pyka, 2004a). In what follows we will concentrate
on the new products and services. In order to take into account the influence of the nature of
outputs on competition in presence of qualitative change we need suitable descriptors or
representations of firms' outputs and of their changes in the course of time. This will allow us
to determine the similarity of firms' outputs. Leaving aside for the moment the details of this
representation, we can expect competition to be affected by qualitative change in the
following ways:

DRUID 2004/Draft 1/PPS/ 6
(i) the output of any incumbent firm is likely to change in the course of time, either
by differentiating products in the same industry or by starting to produce products
in one or more new industrial sectors.
(ii) Completely new types of outputs can be created and produced by new firms. These
new types of outputs will change in the course of time for each of the firms that
started to produce them. The intensity of competition will be affected by how
similar, or different, firms outputs become in the course of time: increasing
similarity will lead to increasing intensity of competition and the reverse.
(iii) A number of combinations of the previous trends can be conceived.

It can be seen right away that the previous trends and any combination of them can provide
opportunities for both growing or falling intensity of competition in the course of time.
(a) when a firm innovates and differentiates its outputs with respect to those of its
competitors it reduces the intensity of com to which it is subject and gains a
degree of local and temporary monopoly. The monopoly is local because, as
we will see later, the innovation places the firm in a unique position in
characteristics space, where at the time of the introduction of the innovation
there are no competitors. However, such monopoly is limited because the
outputs of other firms can be if not in the same position at least in the
neighbourhood. The monopoly is temporary because id the innovation is
successful sooner or later some competitors will imitate.
(b) when after an innovation has been introduced other firms imitate and enter the
industry, the intensity of competition gradually rises up to a maximum.
(c) When, as it happens in an industry life cycle, there is a shake out and the
number of firms in the industry falls, the intensity of competition decreases.

Without getting into further details we can realize that the process of economic development
will not be accompanied by a unidirectional change in the intensity of competition. That is,
the overall intensity of competition of an economic system will neither rise continuously nor
fall continuously. On the contrary, we can expect within each sector alternating periods of
growth and fall of intensity of competition. We will discuss later the impact that this variable
intensity of competition can have on economic efficiency.

From the previous considerations it follows that competition cannot be conceived as a state of
affairs. The economic system is not static. Its composition changes in the course of time in
ways that both influence competition and are influenced by it. The intensity of competition at
a given time is a determinant of the future economic behaviour of the system. The intensity of
competition existing in an economic system at a time t determines the development path of
the system in the following period. For example, when the first entrepreneur creates an
innovation and establishes a firm to exploit it, the situation of temporary monopoly acts as an
inducement for other firms (imitators) to enter. However, the development path thus created
induces subsequent changes in the intensity of competition. Summarising, competition is both
a determinant and a consequence of the dynamic process of economic development.
Alternatively, and without excluding exogenous shocks to the system, we can say that
competition is a component of an endogenous process of economic development

Qualitative change is one of the most important sources of dynamism of the economic system.
Without qualitative change the only possible source of dynamism would be constituted by the
growing efficiency with which a constant set of outputs can be produced. It is very doubtful
that an economic system could develop in these circumstances, and in any case its
DRUID 2004/Draft 1/PPS/ 7
development would not resemble the one we can observe. We can consider that economic
development is created by the two distinguishable but complementary trends towards (i)
growing efficiency and (ii) growing variety (Saviotti, 1996), or, in other words, by efficiency
and creativity. The combination of these two trends provides opportunities for both rising and
falling intensity of competition, with growing efficiency tending to raise the intensity of
competition and growing variety tending to reduce it.

Summarising this section, we can say that competition is an interaction, that the intensity of
such an interaction depends on the similarity of firms' outputs, that firms' outputs are modified
in the course of time by qualitative change, that the dynamics of qualitative change gives rise
to a process in which competition is both a determinant and a consequence of economic
development. In the following section we provide a more analytic treatment of all the
previous concepts.

3.1) THE INTENSITY OF COMPETITION.
The starting point of an operational definition of competition is a representation of outputs
(products and services) in characteristics space. This is a modified version of Lancaster's
approach, as developed by Saviotti, Metcalfe (1984). In this framework each product is
represented by two sets of characteristics, one describing the internal structure of the product
(technical characteristics) and the second the services performed for the users (service
characteristics). This representation can find a theoretical justification both in terms of
Herbert Simon's (1969) ideas and based on a complex systems approach (Frenken, 2001).
This representation gives us the possibility to represent all heterogeneous, multicharacteristics
firms' outputs in a characteristics space. In particular, we will mostly use a representation in
service space, because it is in this space that demand is formed and that selection and
competition take place. Thus, two technologies occupying different dimensions in technical
characteristics space, might supply similar services and thus compete. The product models of
different firms can be expected to differ for at least the level of services supplied, and will
thus be represented by different points in service characteristics space. The output of a set of
firms producing an heterogeneous multicharacteristics product will thus be a cloud of points,
each point corresponding to a product model. An industrial sector will be the set of firms
producing a common but differentiated product. An industrial sector will thus be represented
by a population of firms and by a population of product models. The latter population will be
analysed more often in this paper because outputs influence competition in a most direct way.
It is outputs that are selected by consumers and users, and this selection process determines
differential firm survival. Of course, firms' activities are a determinant of firms' outputs. For
example, the knowledge base (KB) of a firm determines the nature of its outputs, that is of the
Revealed Technological Performance (RTP) that the firm can produce at a later time.
Schematically:

KB (t
1
) RTP (t
2
) (t
2
> t
1
)

Thus, when consumers and users select given product models they directly select an RTP and
indirectly select the corresponding KB. In this paper we will concentrate exclusively on RTP,
as represented by product models' characteristics. In this framework the intensity of
competition between the products of two firms will be directly proportional to their similarity,
or inversely proportional to their distance (Fig. 2).

DRUID 2004/Draft 1/PPS/ 8
Y
2
Y
1
P
1
P
2


Fig. 2. Representation of two product populations (P
1
and P
2
), corresponding to two
industrial sectors, in service characteristics space.

Competition as experienced by any producer will be constituted by two components, intra-
sector or intra-industry competition, and inter-sector- or inter- industry competition. We can
expect the intensity of intra-industry competition to be directly proportional to the density of
the population of products in service characteristics space. The denser the population, the
more similar product models are and the more products that can be considered close
substitutes there are within the population. Inter industry competition can be expected to be
inversely proportional to the distance between two different and separable populations of
products in service characteristics space. The overall intensity of competition must be
determined not only by the number of firms, as it would have been the case in the SCP
approach, but also by intra- and inter- industry competition. As a consequence, the intensity
of competition as experienced by any producer in a sector i will be function of three variables:

(1) IC
i
= f[N
i
,
i
, D
y
(i,j)]

Where N
i
is the number of firms in sector i,
i
is the density of products/services in service
characteristics space and D
y
(i,j) is the distance between the product populations
corresponding to two different sectors. The form of IC
i
is left implicit in Eq. 1, but it can be
made explicit and used to calculate actual values and time paths of intensity of competition
(Saviotti, Pyka, 2004a).

Having established this general representation of products and of competition let us go back
to the process aspect of competition by considering competition as an interaction. When firms
interact the result is likely to change the state of all of them. In other words, any system
constituted by a number of interacting firms is likely to be intrinsically unstable and to lead to
a dynamics in which the subsequent states of the interacting firms change until the system
reaches a state of rest. Competition as an interaction then works by creating a potential,
characterized for example by a high intensity of competition, which drives the system to
subsequently lower values of intensity of competition. This does not mean that the intensity of
competition IC
i
will tend to fall at all times, but only that there is a tendency internal to sector
i, that is manifesting itself to the extent that sector i is isolated, towards the reduction of IC
i
.
DRUID 2004/Draft 1/PPS/ 9
This internal tendency can be compensated by other factors leading to a more complicated
time path for IC
i
. In particular, the overall IC in any sector will depend on the contributions of
intra- and inter- sector IC. In particular, if the sector is not isolated, inter-industry competition
will be superimposed on intra-industry competition.

From here onwards the analysis of the dynamics of competition is based on the results of a
model of economic development by the creation of new sectors in which competition plays an
essential role (Saviotti, Pyka, 2004a, 2004b). We can begin analysing the process when an
entrepreneur creates a niche by introducing an innovation in the hope of achieving a
temporary monopoly. When the entrepreneur introduces an innovation he/she creates an
adjustment gap, a potential market that is initially empty since there is no production capacity
to satisfy this potential demand. The size of the adjustment gap acts as an inducement for
entry. Imitative entry gradually reduces the degree of temporary monopoly and raises IC
within the sector, up to the point where the sector does not attract any more entry and may
even encourage exit. Exit is here induced by increasing IC
i
. In absence of interactions with
other sectors or of the creation of new sectors, subsequent development would proceed by
reducing the number of firms in the sector until a configuration of rest is achieved, usually an
oligopoly or a monopoly. However, such a development path would make the system
unstable unless new sectors were created (Saviotti, 1996; Saviotti, Pyka, 2004a, 2004b).
Economic development then proceeds by means of the creation of further niches, at least
some of which will subsequently become new sectors. Within this model of economic
development there is a competition based life cycle, characterised by the interplay of the
tendency of entrepreneurs to achieve a temporary monopoly, followed by imitative entry that
raises IC
i
, and finally by the 'saturation' of the sector leading to a reduction in the intra-sector
IC
i
. The cycle starts all over again as other entrepreneurs create new niches. The results of the
model referred to above show that while there is an intrinsic tendency towards the long run
fall of IC
i
within the sector, this can be compensated by inter-sector IC, that keeps IC
i
at a
high level all the times (Fig. 3).
Fig. 3. Evolution of the intensity of competition in different sectors.

The development path of each sector can be recast in terms of competition as a form of
interaction. To the extent that consumers' preferences are differentiated the market is not
homogeneous, but it is separated into a number of niches. Each niche is sufficiently small to
be considered internally homogeneous, so that all consumers present within it are assumed to
have equal preferences. According to niche theory as used in biology (Roughgarden 1996;
May, 1974), only one species can survive in a niche. Thus we can expect the niche created by
an entrepreneur either to saturate and not to be able to support a large number of producers, in
the limit only one, or to grow into a fully fledged market, containing an increasing number of
niches. We can expect the intensity of competition IC
i
to increase first and then to fall within
DRUID 2004/Draft 1/PPS/ 10
each niche, while the overall intensity of competition is kept high by inter-industry
competition.

3.2) COMPETITION, EFFICIENCY AND GROWTH.
It is often implicitly assumed that the more competition there is in an economic system, the
more efficient the system will be and the higher its growth rate. According to our paper that is
not always the case. As we saw in the previous section, the creation of a niche which will
become a new sector is induced by the expectation that the first entrepreneur will enjoy a
temporary monopoly. The creation of the new sector is at least favoured by a very low (zero
at the beginning) intensity of competition. Subsequent imitative entry is induced by the
success of the innovation created by the first entrepreneur and by the still low intensity of
competition. The inducement to further entry falls gradually as the intensity of competition
rises. In other words, in the part of the industry life cycle preceding the shake-out we can
expect the rate of creation of new niches and the rate of entry into a sector to increase the
lower is the intensity of competition. We can infer from the previous considerations that if the
intensity of competition were very high always and everywhere in the economic system,
including in newly formed niches, the rate of creation of new sectors would be lower than it
actually is. To the extent that economic development is created by the emergence of new
sectors (Saviotti, Pyka, 2004a, 2004b) we can expect rates of economic growth to be unevenly
affected by competition: in certain phases of economic development and in particular
positions in output space a rise in the intensity of competition can raise rates of growth while
in others it can lower rates of growth. In other words, the absence of islands of temporary
monopoly in a sea of competition could actually slow down the rate of economic growth.

The previous considerations require further analysis, but they already have intriguing
implications. The policies used during the periods when competition favours economic
development are unlikely to work during the periods in which competition hinders economic
development. Thus, it is very important to be able to identify the role played by competition
in different phases of economic development and in different subsets of output space.


4) SUMMARY AND CONCLUSIONS.

The concept of competition evolved considerably in the economics literature. In the first half
of the XXth century the importance of product differentiation and of imperfect competition on
the one hand and of the dynamic nature of competition on the other hand were recognised.
While the dominance of the SCP (Structure, Conduct, Performance) paradigm regularly
reoriented the debates towards a static interpretation of competition, important alternative
developments in the literature brought back both the dynamic nature of competition and the
influence of variables other than the number of firms on the intensity of competition. Both
product differentiation and the strategic interactions between firms are additional variables
that affect competition.

We consider that the view of competition we propose in this paper is compatible with existing
trends in the literature. We start by considering competition as a form of interaction amongst
firms, which compete for a 'resource' constituted by their potential customers. Firms compete
by offering outputs that are selected by their customers. The intensity of this interaction is
proportional to the similarity of firms' outputs. Starting from this premise we develop a
representation of firms' outputs based on product characteristics. This representation leads to a
definition of intensity of competition which includes not only the number of firms but also a
DRUID 2004/Draft 1/PPS/ 11
measure of the degree of firms' outputs within a sector and in different sectors. In this way we
introduce a distinction between intra-sector competition and inter-sector competition. The
overall intensity of competition experience by a firm in a particular sector is the combination
of intra- and inter- sector intensity of competition. The definition of the intensity of
competition we propose is in principle empirically applicable and useful for modelling
purposes. In this paper we quote some results from a model of economic development by the
creation of new sectors incorporating this definition of the intensity of competition.

This particular framework has the following advantages: (i) it provides a unique model
encompassing both Classical and Schumpeterian competition as two extremes of a range,
within which one can find the types of competition present in economic systems, and (ii) it
provides a potentially operational definition of the intensity of competition, provided that the
required data on output characteristics are available.

The framework developed here stresses the influence of qualitative change and of its dynamic
aspects. In particular, it combines the effects of qualitative change with a process approach.
Competition is dynamic because its intensity in a given state of the system determines the
subsequent evolution of the system. In turn, the next state of the system induces changes in
the intensity of competition. The process continues until the system comes to a state of rest.
Thus, the first entrepreneur creates a niche induced by the expectation of a temporary
monopoly. If the innovation introduced by the entrepreneur is successful imitative entry
follows, thus raising the intensity of competition and reducing further inducement to entry.
Qualitative change plays a central role in creating and sustaining this process: first by creating
the innovation that leads to the new sector, and, second, by determining the subsequent
evolution of the sector by means of the changes introduced during the life cycle of the
innovation.

Our concept of competition is closely related to Schumpeter's work, both because innovation,
creating qualitative change, is a form of disequilibrium, and because it is a form of creative
destruction, from which some economic actors benefit while others may be destroyed from it.
Our concept of competition is compatible with Schumpeter's work, but extends it by
providing an explicit account of the effects of product differentiation within an industry and
of inter-industry competition, thus incorporating market contestability within a Schumpeterian
framework.

Our concept of competition allows us to analyse in a different way the relationship between
competition, efficiency and growth. By referring to the results of a model of economic
development by the creation of new sectors, we show that the role of competition can vary
depending on the situation, and in particular on the phase of the industry life cycle. For
example, a new sector is created by an entrepreneur induced by the expectation of a
temporary monopoly. Thus, the process of creation of new sectors benefits from the absence
or from a very low intensity of competition. Conversely, once a new sector is created and
stabilised it is quite likely that competition favours the subsequent development of it. Our
analysis of this problem is preliminary, but it has some important policy implications.



DRUID 2004/Draft 1/PPS/ 12
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