[An updated version of this article can be found at Competition in the 2nd edition.]
"Competition," wrote Samuel Johnson, "is the act of endeavoring to gain what another endeavors to gain at the same time." We are all familiar with competition—from childhood games, from sporting contests, from trying to get ahead in our jobs. But our firsthand familiarity does not tell us how vitally important competition is to the study of economic life. Competition for scarce resources is the core concept around which all modern economics is built.
Adam Smith saw that competition would lead not to chaos, but to a spontaneous and productive social order. His insight gave birth to economics as a science. Economists have spent two centuries divining the myriad ways in which competition works its influences. What John Stuart Mill said in 1848 is still true today: "Only through the principle of competition has political economy any pretension to the character of a science."
The effects of competition permeate economic life. Prices, wages, methods of production, which products are produced and in what quantities, the size and organization of business firms, the distribution of resources, and people's incomes all result from competitive processes.
Consider market prices for consumer goods. The baker has on hand a stock of bread, a valuable good for which consumers are willing to compete by offering the baker a price. The baker wants to get the highest price possible, but he is constrained. If he sets his price too high, customers will not buy all that the baker has to sell. They will buy from another baker, or they will buy pizza or potatoes instead. So the baker sets a price that he thinks will "clear the market." That price is determined by the willingness of customers to compete for his product, and by the willingness of rivals to compete for his customers. In this way, competition determines the prices of houses and hair-cuts, beach chairs and Bibles, and the million-and-one other goods and services that we consumers desire.
An identical process occurs with producer goods. USX has on hand a supply of steel, for which automobile companies, appliance makers, and equipment manufacturers are willing to compete. The firm wants to get as much revenue as it can, taking into account the willingness of its customers to pay and the threat of lower offers from its rivals. The customers want to pay as little as possible, taking into account that rival customers may outbid them. This two-sided competition will again set a price that "clears the market."
The market-clearing price represents the lowest price that buyers of steel must pay, and the highest price that sellers of steel can receive, each without being outbid by rivals. This competitive process fixes the rates of all productive resources—from the prices of steel and semiconductors to the wages of busboys and brain surgeons.
At the same time that competitive bidding fixes prices in the market, it also determines incomes and allocates goods. The low wages earned by the busboy give him a relatively low income with which to go into the market and purchase consumer goods. The high wages earned by the doctor give him a relatively high income with which to purchase goods. Naturally, the doctor will be able to buy a larger share of consumer goods than will the preacher or busboy.
Purchases by consumers act as a kind of silent auction in which those who buy commodities bid them away from those who do not. If we could assemble gigantic snapshots of all the food in all the refrigerators in America, or all the furniture in all the rooms, or all cars in all the garages, we would see how competitive bidding allocates consumer goods.
The same kind of allocation occurs with producer goods. Automobile makers want steel for engines and auto bodies. Appliance manufacturers want it for washers, dryers, and refrigerators. Construction firms want it for reinforcement bars. Businessmen in all these industries compete for steel by placing orders to the manufacturers. Their purchases channel steel into its various uses in the economy. And what is true for steel is true for all resources used in production.
Competition acts as both stick and carrot in economic life. If the worker does not keep his hands to the machine, his employer will replace him. If the employer does not treat his employee as well as other employers would, the employee quits and goes somewhere else. If the manufacturer does not run his shop efficiently, his customers will go where they can find better service at the same price or equal service at a lower price. All of us, as producers, are subject to replacement by those who are able and willing to do the job better or cheaper.
On the other side, if we do our jobs well, we are more likely to be rewarded. The successful manufacturer draws in more customers and increases his revenues. The productive worker moves up to higher wages and more responsibility. The incentives created by competition—or not created because of the lack of it—reveal themselves in the attitudes and activities of producers. Compare the listless indifference of the postal worker to the speed and efficiency of the United Parcel Service driver. Look at the shoddy workmanship in Eastern European goods as compared to their Western European counterparts. Now that firms in the two parts of Germany can openly compete, the Wartburg and Trabant have lost out to Opel and Volkswagen. Because producers are freer to compete by offering better products, and employees freer to compete by working harder, competent work is better rewarded in market economies than in planned or bureaucratic ones.
The carrot of successful market competition takes the form of profits. By introducing new goods, new technology, or new forms of organization, or by finding new markets or new sources of raw material, entrepreneurs can earn profits. The lure of profits inspires alertness, creativity, judgment, and risk taking. Similarly, workers who perform better will, all other things being equal, get bigger raises and more promotions.
The pursuit of profits, in the two hundred years since the industrial revolution, has unleashed what economist Joseph Schumpeter called a "gale of creative destruction." The horse and wagon have been replaced by the railroad, the automobile, and the airplane. The open-hearth fire has yielded to the electric stove and microwave oven. The wash-board and clothesline have bowed to the washer and dryer. Novocaine and other modern drugs kill the pain that was formerly endured or drowned in whiskey. The telephone wire and the electromagnetic wave transmit news that previously traveled by ship or pony.
The competitive process that has wrought these enormous changes is governed by rules that, taken collectively, we call the market economy or the system of private property. This system recognizes the right of each person to use his property as he sees fit, and to keep the fruits of his labor. This leaves the worker free to pursue the occupations for which he thinks himself best suited. It leaves the entrepreneur free to explore new forms of production.
Many critics of capitalism and market economies contend that competition is one of the central evils of the system—that the pursuit of higher profits or higher wages pits people against one another, works to reduce cooperation within society, and makes some people better off only at the expense of others who are made worse off. Competition, however, is not the creation or even a by-product of a capitalist or market system. Competition exists everywhere in nature, and in all economic systems.
The difference in social systems is not the presence or absence of competition. Instead, one difference is the type of competition different systems unleash. For example, the rivalry to become a central planner in the Soviet Union was just as great as the rivalry to become a captain of industry in the United States. To succeed in becoming a planner, one must excel in bureaucratic politics; to succeed in becoming an entrepreneur, one must excel in productive efficiency.
Despite its importance to modern economic life, competition is not the be-all and end-all of economic activity. The modern market economy is as much a system of cooperation as it is a system of competition. Within the family and within the firm, between the customer and the supplier, we cooperate to achieve our ends. This cooperation is as vital as competition to a productive economy.
To a humane social order, the kind of competition matters far more than the amount. Competition that takes the form of violence and plunder destroys wealth; competition that takes the form of trying to be more productive creates wealth. One consequence of property, as the idea has been developed by Western philosophers and jurists over the past three centuries, has been to reduce plunder and to increase production. The result, while far from perfect, has been an economy that is more creative, and more humane, than any other system yet devised.
Jack High is a professor of economics at George Mason University. He was Newcomen Fellow at Harvard University's Graduate School of Business Administration for the 1990-91 term and is acting editor of Business History Review for 1993-94.
Dennis, Kenneth G. Competition in the History of Economic Thought. 1977.
DiLorenzo, Thomas, and Jack High. "Antitrust and Competition, Historically Considered." Economic Inquiry 26 (July 1988): 423-35.
Hayek, Friedrich A. "The Meaning of Competition." In Hayek. Individualism and Economic Order. 1984.
Hayek, Friedrich A. "Competition as a Discovery Procedure." In Hayek. New Studies in Philosophy, Politics, and Economics. 1978.
McNulty, Paul. "A Note on the History of Perfect Competition." Journal of Political Economy 75 (August 1967): 395-99.
Schumpeter, Joseph. Capitalism, Socialism, and Democracy. 1942.
Stigler, George. "Perfect Competition, Historically Contemplated." Journal of Political Economy 65 (February 1957): 1-17.
Related Material on Econlib:
Of Competition and Custom, Book II, Chapter 4 of Principles of Political Economy, by John Stuart Mill. See par. II.4.2. for quote "Only through the principle of competition...".