Competitive Convergence in the World Economy

 In principle, a firm’s competitive advantage manifests itself in a return on investors' capital that is higher than the opportunity cost of the firm’s capital. Deviations of returns from the cost of capital are a signal for competitive entry, or for exit, while the sustainability of deviations and the speed of convergence indicate the strength of competitive forces.

 The research issues are:

• What is the nature and strength of the competitive forces in the modern world economy?
• Is the world becoming more competitive due to deregulation, IT, and globalisation?
• Does the strength of competitive convergence wax and wane around the business cycle?
• Is there evidence of different speeds of convergence in different sectors and different countries that has implications for the degree of competition?

  Financial markets are interested in the process of competitive convergence. An equity analyst building a valuation model that, typically, requires projections of cash flows to some horizon. The conventional modelling assumption is that the firm will learn a rate of profitability which is above (or below) the competitive norm during the horizon period, but which converges to the competitive norm thereafter. So you want to know what factors determine the speed of convergence and the likelihood of convergence:

• How long you should expect convergence to take,
• The likelihood of convergence,
• What, in any particular context, profitability converges to,
• Whether and why these things are different in different sectors and different countries.

The methodological approach is to use to study convergence in returns using large datasets on company balance sheets that are available for a number of developed economies. In particular we have access to data on quoted companies since 1949 for the UK and 1950 for the US.