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However, looking at the linear relationship between competition and productivity can tell us about the relative strength of these two effects. For example, if the linear relationship is positive, it suggests that the Escape competition effect dominates. Pricing Power in South African Industry Empirical analysis appears suggests that there is a positive relationship between competitiveness and productivity in the South African context. Aghion, Braun and Fedderke (2006) measure the extent of competitiveness in an industry on the basis of pricing power – specifically, two proxies of the Lerner index. The first proxy measures the differential between value added and the total wage bill as a proportion of gross output. The second proxy is the difference between output and both the wage and capital costs. Using these two measures, the authors find that pricing power in South Africa is greater than in other countries and has not declined over time. This finding is confirmed using cross-national data at both the firm and industry levels. The firm level analysis uses data from listed firms in 60 countries over 1980-2004, and suggests that South African firms 24
exhibit profitability levels that are approximately 50 percent higher, when profitability is measured using the Net Income/Sales ratio or the Price/Earnings Ratio. The industry level analysis is based on the TIPS dataset, and suggests that the aggregate mark-up for the manufacturing sector is 54 percent (when mark-ups are estimated on the basis of the approach of Hall (1990) and Roeger (1995)). The evidence also suggests that mark-ups have increased over this period. As shown in Table 4.1, markups have increased for 16 of the 3-digit manufacturing sectors. Table 4.1 Summary of recent mark-up behavior in manufacturing Source: Aghion, Braun and Fedderke, 2006 Pricing Power and Productivity Growth Empirical evidence also suggests that a reduction in pricing power would boost productivity growth in South Africa. For example, when growth in labor productivity is regressed on the lagged average mark-up, the estimated coefficients are negative and statistically significant, for data at the firm and industry level, and for specifications using cross-country data, as well as South African alone. Table 4.2 presents estimates using firm-level data. The coefficients imply that a 10 percent increase in the margin above the mean mark-up of .12 for South Africa would raise productivity by 2.4 percent. This is fairly substantial given that the median productivity growth rate for South African firms is 1.8 percent. 25
Table 4.2 Margins and Growth: Firm-Level Evidence Source: Aghion, Braun and Fedderke, 2006 The positive coefficients on the squared terms above confirm that the relationship between the price-cost margin and productivity is U-shaped, which is consistent with the theoretical framework outlined above. However, the linear relationship is negative, which is consistent with the idea that the escape competition effect predominates.