World Development Report 2024: The Middle-Income Trap

Governments can also discipline incumbents through targeted interventions. In countries where competition laws are in place (typically rules against abuse of dominance and anticompetitive agreements, as well as merger controls), competition authorities monitor, discourage, and punish anticompetitive behavior by firms and prevent mergers that could harm competition.

According to the World Bank Anti-Cartel Enforcement Database, competition authorities in 34 middle-income countries sanctioned 406 cartels from 2017 to 2022. These cartels cover a diverse set of markets, including manufacturing, construction, wholesale and retail trade, and transportation and storage. In middle-income countries in Latin America, elimination of anticompetitive practices has increased innovation and productivity (box 7.5).

For competition rules to be effective, threats of enforcement must be credible. A few middle-income countries (such as Brazil, Egypt, Mexico, and South Africa) have successfully decided cases about cartels and abuse of dominance involving digital platforms, as per the Global Digital Antitrust Database. And yet the staffing and budget limits of competition authorities in many middle-income countries reduce their capacity to act (figure 7.11). According to another sample, in those countries more than two-thirds of competition authorities have annual budgets of less than US$5 million, while the average number of staff per million inhabitants in high-income countries is more than 70 percent higher than in middle-income countries. Upper-middle-income countries, in particular, should invest in building independent and accountable competition authorities that are adequately funded and staffed.

Box 7.5 Tackling anticompetitive practices increases incumbents’ innovation incentives

Economic cartels are prevalent across various economies affecting many markets. Unlike other forms of anticompetitive practices, such as abuses of dominance in which efficiencies could counterbalance some of the negative effects, cartels in middle-income countries constitute the most harmful anticompetitive practices. Failure to address cartel activity limits productivity growth.aAnticompetitive agreements weaken efficiency incentives, and the presence of cartels can cut the growth of labor productivity by as much as 20–30 percentage points when compared with that for industries without cartels.b Evidence from a 40-year-old cartel in the United States suggests that sectoral output declined by 22 percent over the counterfactual.

Cartels also harm export competitiveness by raising the cost of inputs, with negative implications for the development of both domestic and international value chains, thereby diminishing the benefits of trade liberalization. Among countries in the Pacific Alliance (which have the lowest trade barriers in Latin America), at least 67 cartels operate in tradable sectors, and one-third of them have been in place for more than five years.c

Cartels and abuse of dominance have been associated with lower wages in Mexico and lower incumbent productivity or innovation efforts in Chile, Colombia, and Uruguay. In Mexico, after antitrust sanctions were put in place wages grew by 1.4 percentage points a year and productivity rose by 2.4 percentage points a year.dIn Colombia, following sanctions on a sugar cartel and a separate intervention to sanction abuse of dominance, sales and value added in the affected market increased, while markups fell (figure B7.5.1). Furthermore, the leading firms increased efforts to raise productivity as they dealt with growing competition in the market after price-fixing behavior was curtailed (figure B7.5.2).e

Competition authorities should also have the power to advocate the elimination of regulatory restrictions of competition that can ultimately facilitate anticompetitive practices. Competition laws that do not exclude certain firms (such as businesses of the state) or specific sectors are also essential.

The challenges with competition are even more pronounced in partially contestable markets and natural monopolies. For example, to ensure efficient pricing, controls are needed for final services and products in the case of natural monopolies and only for essential inputs in the case of partially contestable markets. By contrast, price controls can completely undermine market signals in competitive markets.

As economies (or sectors) move closer to the technology frontier, competition agencies will need to consider a possible trade-off between innovation incentives and market power. When market power reduces the incentive to innovate, firms may resort to anticompetitive behavior, necessitating the intervention of antitrust policies. Here, competition and innovation policies will have to be coordinated to achieve the optimal outcomes for innovation. Again, for the sake of coordination, competition authorities must have adequate independence, budget, capacity, and technical sophistication.

For upper-middle-income countries shifting to innovation, a special concern should be the containment of killer acquisitions—that is, when incumbents acquire innovative firms specifically to kill future competing products and technologies. Not all acquisitions are deadly: many young entrepreneurs try deliberately to be acquired by an incumbent, producing complementary innovations that an incumbent can scale up. Antitrust agencies must use a risk-based approach to carefully examine the effects of risky acquisitions on corporate innovation and future competition.

Even if competition authorities use counterfactuals to anticipate the potential effects of a deal, building such scenarios in rapidly evolving markets such as digital ones may result in errors. Thus distinguishing good concentration from bad is hard. In these instances, a dynamic, forward-looking perspective is essential, building on credible data. Authorities should consider the future potential of the acquired firms, recognizing the possibility that these start-ups will grow rapidly and become tomorrow’s superstar firms.

While strengthening competition authorities and regulatory institutions to discipline incumbent firms, a government should also use fiscal policy and support coalition building to make elites contestable. A society’s wealthiest members often use their social and political power to slow creation and preserve the systems that benefit them. Meanwhile, wealth is frequently inherited or acquired through rent-seeking, which does not create and add value to the economy. Instead, it manipulates the social and political conditions of economic activity to distribute wealth upward.

By adopting a progressive income taxation system, countries can compress the after-tax income distribution, reduce inequality, and promote social mobility. Tax rates that are too high, however, can dampen incentives to undertake high-return, high-risk innovation activities. For example, in response to higher income taxes, innovators or entrepreneurs can reduce their efforts, evade taxes, or migrate to lower-tax localities. Inventors prefer to locate in the same places as other inventors in their specific domain.

Countries can use inheritance or estate taxes to reduce wealth inequality while financing social protection programs. Progressive inheritance taxes can motivate charitable giving by allowing tax deductions for donations by wealthy individuals—and others—just as progressive income taxes often do. Charitable giving has gained momentum in some middle-income countries, including the BRICs (Brazil, Russia, India, China). And yet in terms of gifts per donor, Asia and Latin America rank the lowest (about US$200,000).

Overall, policy makers in middle-income countries, like those in advanced economies, must strike a fine balance in disciplining economic elites without getting rid of the geese that could lay the golden eggs. What is critical is finding the optimal tax rate that will balance disincentive effects with steps to lower inequality. Governments can also offset some of the disincentive effects of progressive taxation by supporting an enabling innovation environment, with universities, high-quality infrastructure, urban amenities, and direct incentives for innovation (R&D subsidies).