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Economy

The complex case of firms in an oligopoly

Enrique Muñoz-Salido

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In an oligopoly the way in which firms compete is uncertain. Despite there has been a deep researching in this field of the literature it keeps being complex to analyse it.

Broadly speaking, it entails the firms’ target, market’s dynamics and product’s differentiation strategies. Since the oligopolistic theory arose (Bertrand, 1883), it has been evolved with the kinked curve, and complemented by a number of researchers (Anderson, 1984; Bhaskar, 1988; Maskin and Tirole, 1988). Oligopolistic theory suggests a stochastic asymmetry in expected rivals’ responses which is the main factor that sets it as an uncertain theory in Academia and sometimes it was the cause for it to have been discredited by academics (Stigler, 1978; Friedman, 1983). Also this stochastic asymmetry in rivals’ reaction caused the traditional theory modification since it was formulated.

In its traditional formulation the oligopolistic demand curve (Sweezy, 1939; Hall and Hitch, 1939) is kinked at PQ in the kinked demand curve showed below and each firm’s demand curve depends on how competitors react. In this market firms are always trying to develop their products to get their own comparative advantage. By making their product special and genuine they can attract a bigger portion of customers, albeit this fact of differentiate products does not entail a pure strategy equilibria. Following Edgeworth’s first statements, prices will never reach an equilibrium in an oligopoly. For substitutive products he thought a price equilibria didn’t take place in pure strategies and for complementary products he reviewed the concept of Nash equilibrium.

The kinked demand curve

chart2o

In order to set a basic explanation on how this theory works, let X denote a firm in an oligopolistic market. As Begg et al. (2014) discuss, supposing X rises the price, if rivals don’t follow it, the firm will lose a portion of its customers who will buy from the other competitors. Consequently, the firm’s demand curve is elastic above PQ at prices above the current price P. However, if X believes that cutting prices will be followed by its competitors, market shares are unchanged. If firms cut the prices, it will entail extra sales rises due to the industry as a whole will move down the market demand curve.

At point PQ it is shown the kinked demand for these firms, reflecting the effects of a price change. At the output Q, X reaches the inelastic part of its kinked demand curve and marginal revenue is much lower. As from this point demand is less elastic, further output increases require much lower prices to sell this extra output. At Q, X will maximise its profits, but only through following a suitable strategy which fits with the response of its competitors.

Subsequently, regarding to X’s production decisions, it could be considered here the Prisoner’s Dilemma game (Flood and Dresher, 1950). If X, followed by its rivals, increase production the price will be low and each one will make lower profit. Firms can attemp a group strategy in order to establish a collusive monopoly by reducing their production activity, achieving prices increase due to the scant industry output. X can reach to its maximum profit by having the highest output while the others reduce their production in order to get an equilibrium point which let to keep the price at the same level. Nevertheless, as it was held above, X decides prices depending the price it expects its rival to set. If X sets a price above its marginal cost, its competitors automatically will take advantage from it by cutting the prices below it in order to increase their market share. Since firms could anticipate this, it will never set such a price and this will lead until, in Nash equilibrium, firms set prices at marginal cost and split the market between them, forgetting any incentive to getting better market share (Nash, 1950).

The weakness of this theory is that these rivals’ responses are ad hoc and arbitrary as they are not derived from any form of maximising behaviour, and it has been found to be cyclically sensitive so that increases in price were more probable to be followed in booms or inflationary periods while decreases in price were more probable to be followed in recessions or depressions (Bhaskar, Machin and Reid, 1991). The difficult sustainability of the oligopolistic theory has supposed a suitable opportunity for researchers to develop it and makes this theory more rigid since it was formulated, as it was achieved by several contributions despite not reaching to its highest peak. As Vives (1993) stated, Edgeworth’s review of oligopoly theory has been focused on indeterminacy, price dynamics, role of numbers and substitutability of products and Nash equilibrium. Thanks to Edgeworth, the researching on strategic competition has advanced further instead the remaining indeterminacy region in outcomes that has kept reluctant. Thanks to Vives’ further contribution, we know now that pricing is determinate from a static equilibrium approach. Equilibria in pure strategies exist an it has an order structure, non-equilibrium approach is limited and equilibrium outcomes have stability conditions involving oligopoly.

Enrique works in the tech industry, computer software, in the City, London. His interests lie at crossroads of human behavior and software. Enrique is an Oxford Masters graduate, Talentia scholarship.

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Economy

Bangladesh’s Graduation: A Ray of Hope for India’s Garment Industry?

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Authors: Ms. Prerana Manral and Mr. Shreyansh Singh*

A report was released by the World Trade Organization (WTO) on May 8th highlighting the implications of graduation of Least Developed Countries (LDCs) on their trade participation. By virtue of their status as LDCs, these countries enjoy access to international support measures such as development financing, preferential market access, technical assistance etc. WTO also obliges LDCs with certain carve outs such as Special and Differential Treatment (S&DT) to increase their participation in global trade.  The LDCs are graduated to developing country status if they meet the threshold levels for at least two of the three indicators i.e. Gross National Income (GNI), Human Assets Index (HAI) and Economic Vulnerability Index (EVI) for two consecutive triennial reviews. Interestingly, in 2018 Bangladesh became the first country to meet the thresholds for all the three indicators and if it meets these thresholds again for the second triennial review in 2021, it will be eligible for graduation in 2024.

In such a scenario, Bangladesh will lose some of the benefits provided to LDCs by developing and developed countries like the preferential market access which presently accords Bangladesh a competitive edge over Indian products. One of the key labor-intensive sectors which contributes significantly to the exports of both Bangladesh and India is garments industry. In 2009, both the countries almost had an equivalent share in the world market, however in 2018 India was left far behind Bangladesh. India’s total garment exports stood at 21 billion USD whereas Bangladesh’s exports were at 40 billion USD in 2018. 

Bangladesh’s garment sector, due to its LDC status, currently enjoys a duty-free access to markets of Europe and other developed countries. Specifically in EU markets, goods from Bangladesh are covered under “Everything But Arms” (EBA) preferential arrangement which provides zero percent duty on all the products except arms and ammunition. On the other hand, India loses out due to 9% average tariff on garments under the Standard GSP scheme of EU. Further, under the SAFTA and APTA Agreements, India also provides similar duty-free market access to LDCs which along with the removal of quantitative restrictions has exponentially increased Bangladesh’s garments exports to India leading to a tough time for the domestic industry even in the internal market.

Source: Authors’ calculation based on data available on World Integrated Trade Solution

The major markets for India and Bangladesh garment exports are the EU, Australia, Canada and Japan. Trade estimates of garment products clearly show that India’s export in terms of value is significantly less than that of Bangladesh. Since 2010, India’s total share of exports grew by 9.4% whereas Bangladesh’s exports skyrocketed by 141% in these markets. The major reasons behind Bangladesh’s exemplary export performance are tariff exemptions and lower wage labor market which provides impetus to narrowly beat its competitors in the international market. The analysis done in the report reveals that 70% of Bangladesh’s overall export is covered under LDC-specific preferences.

At this juncture a possible graduation of Bangladesh will lead to termination of such preferential access granted exclusively to LDCs which may provide an opportunity for Indian exporters to grab a larger share. However, to maximize the gains arising from this development India needs to prepare a robust action-plan. Firstly, low cost inputs such as cheap power, land and raw materials will have far-reaching effects in enhancing the export competitiveness. Secondly, India should focus on mass scale production of garments in order to achieve economies of scale to bring down its cost of production. Presently, the production is limited majorly to small-scale enterprises which lack capital intensive technology. This in turn negatively affects the quality and time of production which are crucial factors in tapping the domestic and international markets. The improvement in these parameters would help Indian exporters to move up the value chain in terms of creating brand value for its superior quality products. Another overdue policy action could be cutting the import duties on high-quality machinery required for better production. In addition to this, a fiscal stimulus is required to boost the ecosystem in wake of Covid-19 pandemic.

Lastly, to offset the preferential access enjoyed by its competitors such as Vietnam, Bangladesh etc. India should identify its partners and strategically negotiate FTAs for lower tariffs and Non-Tariff Measures (NTMs) to obtain better market access for Indian exports. Needless to mention, India will only be able to reap the benefits arising from Bangladesh’s graduation (due in 2024) if it sows the right seeds today. Effectuating such policies especially at a time when corporate taxes are slashed to match that of India’s competitors along will definitely send a positive signal for investment in the sector from the top global garment companies.  

*Authors are Research Fellows at Centre for WTO Studies, Indian Institute for Foreign Trade. Views expressed are personal.

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Economy

Post-Pandemic Economies and Environment

Dr.Abid Rashid Gill

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The cleaner air in cities, the burgeoning biodiversity and dramatic shift to less pollution-intensive lifestyle across the globe indicate the scope of the environmental improvement that can be achieved in just days. This is what we need to adhere to navigate the current pandemics:COVID-19 and environmental degradation. The environmental issues as we know do not seem to wait for a more convenient time, we therefore must deal it and Covid-19 pandemic concurrently. It is a very fatal disease and has incited urgent response all over the world. The governments, businesses and industries have been forced to deal with the pandemic in an unprecedented way.

According to the experts, this pandemic has provided us with the opportunities to deal with other crises also. We can take a transnational leap towards a sustainable society that produce minimum wastes and emissions. How we deal with current pandemic will also set our environmental trajectory for the centuries to come. The changes in our behaviour that we are experiencing nowadays and some of which may instilus permanently have a far-reaching impact on the environment. Our consumption and travel patron are more responsible: driving less car, attending online meetings rather than taking flights. Equally, it indicates that considerable dent on emissions and wastes products can be made without disturbing too much economic growth.

However, according to International Renewable News Agency (IRENA), for the long-run substantial reduction in the emissions of the toxins, huge and lasting changes are needed in the way how energy is produced and consumed. Though China and India two major growing economies, observed 25% and 30% reduction respectively during the months of lockdown. However, a shift towards low-emission society cannot be accomplished only via individual choices instead it involves reimagining the ways our urbane centres are built and organised, how roads are laid out so that moving without cars become easier, how provisions for walking, cycling and public transport is mad. There is a need for complete overhauling theway we grow, manufacture, trade, consumes and the way we travel.

Cities of Western Europe have been leading this transition by introducing innovative infrastructure projects: Milan has allocated 35 Km street for pedestrians and cyclists; Brussels has created 40km of a new path for cyclists and France has subsided cycling. Also, the Mayor of London started taking measures to build a car and buses free streets and bridges. Similarly, many cities are working on the circular economy where wastes are minimized through reuse and recycling. Following the footsteps of these cities, Pakistan also needs to devise pro-environmental urbane policies and mobility models.

Many studies such asYaron Ogen, 220 and  Dario Caro, 220 indicate a strong link between COVID-19 death rate and an increase in emissions. Especially in North Italy and Spain, the high death rate from COVID-19 is seen to be associated with high air pollution in cities. Curtailing the pollution, therefore, would reduce general health burden and prevent any future pandemic may not prove to be so lethal. It has been learnt from the pandemic that early actions to contain the virus were more effective than trying to deter when the virus has spread. The same is also true for the environmental issues as Prof. Stern of Brentford claimed in 2006 that “countries needed to spend 1% of their GDP to stop greenhouse gases rising to dangerous levels. Failure to do this would lead to damage costing much more, the report warned – at least 5% and perhaps more than 20% of global GDP”.

Eventually, it is time for governments to forge with the private sectors to produce a sustainable economy. After this pandemic is over, the businesses, the industry, and individuals would plead to governments for state support. The governments should have an agenda of a sustainable economy while pouring money into the economy as aid packages. Governments should use this opportunity and must take a long view to utilize the stimulus packages. To an extent, the impact of COVID-19 on the environment is the functions of a kind of fiscal stimulus will be adopted in post-pandemic. Ideally, we should avoid a post-2008-09 financial crisis when fiscal measures of China government boosted the emissions by 6% (World Bank,2020). Rather, a more successful model of South Korea should be borrowed where stimulus package of 2008 included investment in natural conversation, energy efficiency, renewable energies, and sustainable transportations.

The COVID-19 virus is a global issue that requires a global response asall states are sharing data, experiences, equipment, and resources to deal with this pandemic. This same spirit of international collaboration is needed to produce the viable solution of the environmental issues. An inclusive global programme collaborated by rich and poor nations that ensures sustainable production can ensure low-emissions economies across the globe. The post-pandemic economies should be navigated in a way that protects people and planet and avoids any ecological destruction that leads to viral diseases. This pandemic can be taken as a mandate to build a new world from its broken parts.

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Long lockdowns and the status of Indian MSMEs

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Recently, when the Government of India decided to classify institutions as Micro, Small, and Medium Enterprises (MSMEs) they were trying to set up an incentive structure to usher a new era of growth. The incentives announced are in the form of attractive cheap loans, fewer compliance standards, tax benefits, and host of other freebies. The intended scheme wanted to keep growing — from Micro to Small and Small to Medium, and the support system and put the nation on a path of self-sufficiency .

Change of classification criteria

In fact, the businesses are  classified as Micro, Small, or Medium depending on the kind of investments they were making in plant and machinery and  if we made investments of up to 5 Crore, then we are as a Small enterprise. But what happens when business is booming and there’s an incentive for us  to invest and expand. Well, without government intervention, we’d have lapped up this opportunity no questions asked. But now, we have to consider the downside. Because, as our transition from being Small to Medium, we’ll forego a few benefits. Benefits that  might not want to cede. Here likes the dilemma because when we  try and deceive the government into thinking we  are a Small enterprise when in fact we are not and we will  have to do is to keep making the investments we  need, but figure out ways to hide the investments on our  accounting books. That means the government will now have to spend additional resources in physically verifying your claims. In effect, the incentives that were designed to help MSMEs grow and become self-sufficient have now turned “perverse”. A move that was meant to promote investment and foster growth is now yielding terrible unintended consequences stifling all progress.

Scheme of the Government

So they began working on a proposal to change the classification criteria. They figured that total revenues would be a good metric since claims regarding revenue can easily be verified with the GST Sales data filed at the Goods and Service Tax portal. More importantly, entrepreneurs won’t have to worry about making new investments since the benefits are no longer tied to this metric. But the industry body representing MSEMs is not happy with this development. They lobbied and urged the government to keep the classification criteria intact but  when the government finally charged ahead and introduced turnover as an additional criterion. They even expanded the investment limit to ensure MSMEs don’t graduate out of benefits too soon. However, MSMEs in the service sector (IT and stuff) will also be classified along the same lines as their manufacturing counterparts. So no step-motherly treatment for the people in the service industry either. Besides the classification, the government also wants to get the big guns interested in the space. They want Venture Capitalists to walk in and buy ownership in promising upstarts. The plan is simple. Put together a mother fund with 10,000 crores from the government. And then disburse the funds from the mother entity to smaller daughter funds in a piecemeal fashion and try and get other investors on-board these smaller funds. If all goes well, the 10,000 crores from the government should attract an additional 40,000 crores from outside investors (PE/VCs) and this should give MSMEs some much-needed funding support. They are calling it the Fund of Funds.

However, in the present status of pandemic banks don’t want to offer another lifeline by extending new loans considering their own precarious situation. And they most certainly cannot contain the problem; since we are likely to see a spike in defaults owing to the fact that most MSMEs have shut shop completely since the lockdown. And if MSMEs can’t restart operations and fail en masse, we will have a systemic problem on our hands. So a government intervention was inevitable. And the finance minister finally announced 3 lakh crore worth of collateral—free loans for businesses, including MSMEs in a bid to plug the funding gap. If we are in a business with a loan burden on your hands, banks will now extend new loans of up to 20% of the total loan outstanding so that we  can restart operations. Now, we’ll have 4 years to repay this loan. Repayment obligations won’t kick in until the end of the first year. The government will stand as our guarantor in case we  default and they will compensate the banks in full interest and principal. So technically, banks should be more willing to lend to these institutions now.

Growing importance of agriculture

 Around 51 lakh people migrated to agriculture last year and this should be seen positively. In fact, we should actively pursue this endeavour and focus on making farming economically viable. Indian Agriculture, on an aggregate level,  has been unprofitable for a good while now. Monsoons are erratic. Irrigation infrastructure still needs work. Warehousing and storage problems still persist. The middlemen skim most of the profit and many farmers work with land parcels so tiny that they can almost never leverage benefits of scale. Meaning we have a small proportion of landowners who run an extremely profitable enterprise while a good chunk of the agrarian population  still live below the poverty line. The point is — there’s been very little incentive for people to continue and work the farmland. And as a consequence, many people migrated from rural hinterlands to urban centres en masse.

But now in the pandemic and long lockdown the  migration patterns have reversed.  There’s now more incentive for India’s labour population to return to agriculture. It’s become prosperous again. First, it is likely that employment did not actually increase in agriculture, but the sector merely absorbed the excess labour as it had no other place to go to. Farmers did not actually call out for more labour. But, family labour landed up in farms when they had no other place to go to. The real estate and construction sector, which is usually a provider of employment to low-skilled farm labourers who try to move out of the labour surplus farmlands, shed 4.6 million jobs between January-April 2018 and January-April 2019. This failure of the construction industry to absorb farm surplus labour is, possibly, the biggest reason why there is an increase in employment under agriculture. A family farm always has scope to absorb some unpaid labour although such additions may not increase any production or profit. There is always an extra patch of the farms to tend to or the need to take the cattle to graze a little farther. Farm work can be spread thinly over available labour and keep everyone “employed” when there is no alternate work available to them.And right now, with the lockdown in place, we are seeing it happen again. People are moving back to agriculture en masse because they have nowhere else to go. The only difference—it’s happening at a scale that almost seems unreal. This migration also has some very real policy implications.

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