Effects of competition on profit margins from a Post Keynesian perspective

The interdependence of competition and profit margins is one of the most important features of industrial economics. According to mainstream economics, intense market competition results in smaller profit margins. Long-term profits are contingent on competition and market imperfections; perfect competition presumably reduces profits to zero in the long run (excluding normal profits allocated to managerial compensation). This relationship between competition and profit margins is also an important theme in Post Keynesian economics. From Joan Robinson's Economics of Imperfect Competition to Kalecki's analyses of the degree of monopoly, Post Keynesian economists have long been interested in this aspect of economic theory. There is however no unified Post Keynesian view of competition and its effect on profit margins, and we can, from a historical perspective, identify two main strands of Post Keynesian thought, each relying on a specific theory to determine profit margins. Based on the ‘imperfect competition and degree of monopoly principle,' the first branch considers that profit margins are the result of market structure (market imperfections). In this view, as in the theory of monopoly capitalism (see Moudud, Bina, and Mason 2013), profit margins thus positively correlate with competition imperfections and degree of monopoly. Rooted in the ‘investment financing tradition,' including the works of Alfred Eichner and Adrian Wood, the second branch makes a direct connection between profit margins and internal financing requirements for investment. We consider this second view to clearly represent Fred Lee's economic thinking (see, for example, Lee 2013b). A comparison of the two Post Keynesian branches shows that the first position closely resembles what later became the mainstream view on the relation between competition and profit margins (notably with the emergence of the so-called structure-conduct- paradigm in the 1960s and 1970s, which remains an influential theoretical framework for industry-competition policies). Stated succinctly, in this theory, the tougher the competition, the smaller the profit margins. Nevertheless, empirical testing of this theory poses certain difficulties. In fact, many empirical studies fail to validate the direct link between the degree of competition (regardless of the chosen criterion) and profit margins. Such studies often report weak or even paradoxical results, be it at the sectoral or macroeconomic level. These unexpected results can, however, be explained from the ‘investment-financing' theory of profit margins. Based on the theories of Alfred Eichner (1973, 1976) and Adrian Wood (1975), this second branch offers an explanation for why profit margins are independent of the degree of competition in the market. In conjunction with his two-curve diagram, Adrian Wood's analysis (developed in his 1975 book, A Theory of Profits) enables us to show why competition does not affect the determination of profit margins. Therefore, the second strand's main contribution is its emphasis on the fundamental role of internal financing in capitalist economies, which is the missing link in industrial economics.