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GU ECON 102 - Competitive Pressure

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Federal Reserve Bank of Minneapolis Quarterly ReviewSpring 2003, Vol. 27, No. 2, pp. 9–23Competitive Pressure and Labor Productivity:W orld Iron Ore Markets in the 1980sJosé E. Galdón-Sánchez James A. Schmitz, Jr.Associate Professor Senior EconomistDepartment of Economics Research DepartmentUniversidad Pública de Navarra Federal Reserve Bank of MinneapolisPamplona, Spain and Adjunct Professor of Economicsand Visiting Research Fellow University of MinnesotaDepartment of EconomicsPrinceton UniversityAbstractDoes the extent of competitive pressure industries face influence their produc-tivity? We study a natural experiment conducted in the iron ore industry as aresult of the collapse in world steel production in the early 1980s. For iron oreproducers, whose only market is the steel industry, this collapse was an ex-ogenous shock. The drop in steel production differed dramatically by region: itfell by about a third in the Atlantic Basin but only very little in the PacificBasin. Given that the cost of transporting iron ore is very high relative to itsmine value, Atlantic iron ore producers faced a much greater increase in com-petitive pressure than did Pacific iron ore producers. In response to the crisis,most Atlantic iron ore producers doubled their labor productivity; Pacific ironore producers experienced few productivity gains. This article originally ap-peared in the American Economic Review. © American Economic Association.The views expr essed herein ar e those of the authors and not necessarily those of the FederalReserve Bank of Minneapolis or the Federal Reserve System.Does the extent of competitive pressure industries face in-fluence their productivity? While a widespread view saysthat competitive pressure does influence productivity , andsome theoretical reasons to expect gains exist, the amountof evidence to support this view is not overwhelming.1Evidence has been sought, for example, in the impact ofeconomic liberalization policies, such as deregulation, pri-vatization, and tariff reductions, on productivity. Thesepolicies are thought to increase competitive pressure onindustries and, hence, to lead to productivity gains.2Butthe evidence that they increase productivity is not over-powering. This lack of evidence may well stem from is-sues such as policy endogeneity. Here we study a situationakin to a natural experiment in which competitive pressurewas brought upon producers by a shrinking market fortheir product. In particular, we examine the increased com-petitive pressure iron ore producers faced in the early1980s following the collapse of world steel production.We show that a striking relationship exists between theincrease in competitive pressure iron ore mines faced inthe early 1980s and their subsequent labor productivitygains in the 1980s. In countries where mines faced littleincrease in competitive pressure, productivity changed lit-tle over the 1980s; in countries where mines faced dra-matic increases, productivity gains ranged from 50 to 100percent, rates that were unprecedented.We say that the collapse of world steel production ledto an incr ease in competitive pressure at a mine if becauseof the collapse the likelihood that the mine would closeover , say, the next decade, increased. The increase in com-petitive pressure a mine faced depended on a number offactors, but two were paramount: the mine’s location andthe mine’s production costs.Location was paramount because the costs of shippingiron ore are high relative to the ore’ s value at the mine.(T ransport costs often amount to 50 percent and more ofdelivered prices.) The steel production collapse in the ear-ly 1980s was almost entirely concentrated in the AtlanticBasin. Because iron ore mines in Atlantic Basin countries(Brazil, Canada, France, South Africa, Sweden, and theUnited States) were located in the region of the steel col-lapse, they faced, everything else equal, a greater increasein competitive pressure than mines in Pacific Basin coun-tries (Australia and India).3Production costs were, obviously , also paramount in de-termining the increase in competitive pressure a minefaced. The production costs of mines in Atlantic Basincountries (with one exception) greatly exceeded the pro-duction costs of mines in Pacific Basin countries. Hence,on both counts, the Atlantic Basin mines faced a greaterincrease in competitive pressure than the Pacific Basinmines.Regarding production costs, the exception was Brazil:its mines had the lowest production costs in the world. Aswe demonstrate below , the Brazilian mines were likethose in the Pacific Basin countries in that they faced littleincrease in competitive pressure.Among those mines that faced little or no increase incompetitive pressure, Australian and Brazilian mines hadno productivity gains in the 1980s (and few in the preced-ing decade either); Indian mines had modest productivitygains, about 29 percent in the 1980s (55 percent in thepreceding decade). Among mines that faced a dramatic in-crease in competitive pressure, Canadian, Swedish, andU.S. mines had productivity gains approaching 100 per-cent in the 1980s (whereas each had no productivity gainin the preceding decade); South African mines had sub-stantial gains, about 50 percent in the 1980s; and Frenchmines had no productivity gains and by the end of the1980s were (essentially) out of the business. France dem-onstrates that not all industries that face a dramatic in-crease in competitive pressure will increase productivity.(See discussion below.)As we mentioned, evidence for the influence of com-petitive pressure on productivity is often sought in eco-nomic liberalization episodes. But studying these experi-ences presents a number of difficulties. First, a change inpolicy may not increase competition. For example, somegovernment-owned businesses are subject to the samecompetitive pressure as their private counterparts; hence,privatization need not increase competitive pressure. (See,for example, Caves and Christensen 1980.) Second, thereis the issue of policy endogeneity. Privatization choicesand tariff choices are made in the political forum. It’s oftenhard, then, to argue that tariff reductions are akin to ex-ogenous shocks (or random treatments). Perhaps industriesthat are expected to have significant productivity declinesare the ones that lose political support and suffer thegreatest tariff reductions. In that case, reductions in tariffsmight be correlated with productivity


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GU ECON 102 - Competitive Pressure

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