1 - Introduction
When the Single Market Program (SMP) was implemented in 1992, there were hopes that it would bring increased competition, meaning more productive and innovative companies, and lower prices for consumers. The SMP was therefore targeting improvement in both allocative efficiency and productive efficiency.
Estimating the evolution of price cost margins (PCMs, ) basically provides an estimate of change in allocative efficiency, as it measures a change in the difference between the actual price set by firms (P) and the standard of perfect competition where firms should price at marginal cost (c). Deviation from perfect competition has clear welfare implications because it leads to lower output, higher prices, and lower welfare (i.e. the sum of the consumer surplus and of the producer surplus).
Has the Single Market Program influenced firms’ pricing behaviour in UK manufacturing? Has it forced the introduction of a tougher price competition in the spirit of Sutton (1991)? Can we talk of a “switch of regime”? In this paper we try to answer these questions by estimating the dynamics of price cost margins in the UK manufacturing.
To our knowledge, this paper is the first to estimate PCMs in UK manufacturing using firm level data following the methodology of Roeger (1995). By focusing on the firm as the unit of analysis, we are able to capture the evolution of the average PCM in a given subset. We devote a particular attention to the explanation of the change in intra-industry average PCM.
There is a small literature that has estimated the importance of market power in the UK. Using sector level data, Small (1997) estimated the level of PCMs in 16 industries in manufacturing and services over the period 1968-1991. He found evidence of large markups in most industries, especially in services. He also found pro-cyclical markups.
Other papers have tackled the issue using firms’ profit margin and accounting margins to check for the presence of market power (Machin and Van Reenen, 1993; Haskel, Martin and Small, 1995). A more recent exercise by Griffith (2001) looked more particularly at the effect of the SMP on the Lerner index. Using the ARD dataset, she found that the Lerner index had declined more in sensitive industries than in the non sensitive industries.
Our analysis is complementary to hers in the sense that we use a different methodology that assumes that marginal costs are unobservable and indirectly estimates the deviation from perfect competition by observing the way firms adapt their input demand to changes in output.
Some papers have looked at the effect of the SMP in other European countries: Italy (Botasso and Sembenelli, 2001), Spain (Siotis, 2002) and Belgium (Warzynski, 2002), as well as the European Commission (1999), using sector-level data. The main finding is that PCM seem to have declined mostly in large countries, where PCMs were higher before 1992, but stayed relatively constant in small countries.
We find that price cost margins declined by 25% after 1990, controlling for cyclical effects, falling from 0.14 to 0.10 on average. This is an extremely large figure and we discuss whether this dramatic evolution can be attributed to the SMP. We also describe the heterogeneity of the evolution across sectors and discuss extensions to this work.
Section 2 details the methodology that we follow. Section 3 describes our dataset. Section 4 presents and discusses our results and section 5 concludes.