Competition, reallocation, and growth: Theory and evidence from Africa

This paper investigates whether economic policy facilitates output growth by exploring the role of competition. We present a growth model with heterogeneous firms in which exposure to competition induces reallocation of market shares from less productive to more productive firms and forces the least productive firms to exit the industry. Confronted by a competition threat, incumbent firms choose either upgrading their products or bribing a policymaker in order to prevent entry by potential competitors. Product upgrading is less profitable than bribing for low-productivity firms but more profitable for high-productivity firms. Reallocation of market shares to more productive firms leads to higher aggregate industry productivity. Testing this prediction of the model using a generalized difference-in-differences approach and production data that cover 23 manufacturing industries and 34 African countries, we found that industries that upgrade more grow disproportionately faster in countries where competition policy is more intensive.