Policy makers in Europe have been concerned that lack of product market competition
have led productivity to lag behind the US. Theoretical models are ambiguous about the
direction of the effect that product market competition should have on productivity. On
the one hand increasing competition lowers firm’s profits and thus reduces incentives to
exert effort (the Schumpeterian effect), on the other hand it reduces agency costs (or
increases the risk of bankruptcy ) thus increasing incentives to exert effort. This paper
uses panel data on UK establishments over the period 1980-1996 to investigate the
relationship between product market competition and productivity levels and growth
rates. The introduction of the European Union Single Market Programme (SMP) is used
as an instrument for the change in product market competition. The SMP was ex ante
expected to affect competition in some industries but not others. It is shown that the
Lerner Index fell in the affected industries after the SMP by more than in the nonaffected.
The results suggest that the increase in product market competition brought
about by SMP led to an increase in overall levels of efficiency and growth rates. The
sample of firms is then split into those with a principal-agent set up and those without.
The increase in efficiency occurred in principal-agent type firms, and not in those where
managerial control and ownership were more closely related. These results suggest that
product market competition can play an important role in reducing agency costs and may
explain some of the poor performance of European economies