The measurement of the ability to earn of an industry 41

As discussed above, an industry’s ability to earn is characterised by its profitability. Profits can be considered as a measure that incorporates both price and quality aspects of competitiveness, since they capture information about both the price-cost margins as well as the customers’ appraisal of the products sold.²¹ Tharakan et al. (1989) argue that profits are a forward-looking indicator of economic performance since investments concentrate in sectors that are profitable (Tharakan et al. 1989: 41). An industry with a high profitability also has good competitive potential, which implies that it is able to improve its competitive position in the future (Viaene, Gellynck 1998: 149). An unprofi-table industry fails in the long run; hence, the sustainability of profitability is what matters. Hence, profits not only show the actual competitiveness per-formance, but are also linked to competitiveness potential.

Compared to the large number of indicators of the ability to sell, economic literature is relatively poorer in terms of measures of an industry’s ability to earn. Nevertheless, a few indicators can be found. Tharakan et al. (1989), for example, use gross profits as a direct measure of profitability. The authors econometrically estimate gross profits as a share of the turnover of 77 industries

21 One can argue that the more customers appreciate a product because of some non-price attribute it incorporates, the more they are willing to pay for that product, hence, ensuring higher profits to the seller of the product.

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in Belgium over 6 years on independent variables reflecting the determinants of comparative advantage based on factor proportions theory (Heckscher-Ohlin-Samuelson (HOS)) (capital and labour intensity), indicators neglected in the classical HOS theory, such as economies of scale and the degree of con-centration of production, tariffs and non-tariff barriers to trade, and the degree of openness in the economy.²²

Martin et al. (1991), on the other hand, suggest value added as a proper, though indirect measure of profits for an agribusiness industry that buys raw materials, processes them and resells them in different forms. The authors suggest using value added relative to the number of workers, sales, expenditure on wages, or the number of establishments in this industry, for a comparison with the same industries in other countries (Martin et al. 1991: 1456). Their approach is supported by Abbott and Bredahl (1994: 16), who argue that value added counts as the returns to those entities who are directly concerned with competitiveness – labour, capital and the government. In terms of a national economy, the profitability of an industry not only depends on the pure profits it generates, but also on the employment and income the industry generates for the domestic economy. Hence, measures of value added should be preferred to measures of pure profits in the assessment of the competitiveness of an industry.

As an alternative proxy for the profitability of an industry, but related to value added, is the price-cost margin. Ezeala-Harrisson (1999) relates price-cost margins (or mark-ups) directly to the competitive advantage of an industry, claiming that the industry can be considered as internationally competitive if and when the firms belonging to the industry maintain a positive growth rate of aggregate competitive advantage, which itself refers to the relative advantage that a country’s industries have regarding their ability to operate profitably within a competitive environment. Hence, the level of price-cost margin itself does not indicate competitiveness, what matters is its dynamics over time.

There are two main definitions of price-cost margins (PCM) often used in the literature (European Commission 1996; Schmalensee 1989; Sleuwaegen, Yamawaki 1988):

(7) 1 = ,

(8) 2 = ,

where VA denotes value added, LC stands for labour costs and S refers to sales.

22 As an alternative to profits, the authors also use the Balassa index of RCA as a measure of competitiveness, however, they recognise that trade regressions reflect distorted patterns of trade, whereas profit regressions show the patterns of competitiveness “more or less as the market reveals it” (Tharakan et al. 1989: 56). The reason for this is that the subsidies paid by the government distort the foreign trade figures in the RCA index, but profits reflect the fact that domestic competition cancels out the subsidy effect.

While the first indicator has been often used to study the link between pro-fitability and concentration, the latter is more in conformity with the theoretical concept of profit-sales-ratio.

Yet, in the industrial organisation (IO) literature and in the theory of eco-nomic integration, price-cost margin is considered an indicator of market struc-ture and efficiency. A fall in price-cost margins as a result of competitive pres-sure indicates a loss in the market power of firms within the industry and consequently, an increase in their efficiency, which itself can be associated with competitiveness. Thus, as regards competitiveness, price-cost margins can give ambiguous signals. On the one hand, increased margins indicate higher profitability and hence, higher income for the industry. On the other hand, a rise in price margins can be a sign of a decline in efficiency within the industry, which can result in a loss in long-run profitability. This significantly compli-cates the interpretation of the results, but gives important insights into the matter of competitiveness. Nevertheless, from the short-term perspective of the industry, however, a rise in price margins refers to higher profitability, and hence, an increase in its competitiveness over time.

Profitability is directly related to the performance of an industry both in domestic and foreign markets, irrespective of changes in market size, and is, therefore, free of the problems that are characteristic to market share indicators.

Buckley et al. (1988) even argue that profitability could be “the single most important measure of competitive success” and “long-run profitability is essential for survival”. However, a bare indicator of profitability does not allow us to distinguish between competitiveness in the export and domestic markets, and thus, needs to be used in combination with indicators of the ability to sell.

The measurement of an industry’s profitability, however, poses some problems. First, firms within an industry may be willing to undergo a short-run loss in profits in order to achieve a long-run growth. Second, profitability at industry level does not show the distribution of profitable and unprofitable firms within the industry. For example, an industry can consist of one very large profitable company and a large number of unprofitable micro-companies, and due to the dominance of the profitable firm, the summed profitability of the industry might be positive. However, it is not clear whether this kind of industry can be considered profitable from the macroeconomic perspective.

Third, Hazledine (1994) points out the ambiguity of the results when com-bining indicators of profitability and ability to sell. He asks whether an industry with high profits but low market share is less competitive than an industry with low profits but high market share.

Fourth, according to industrial organisation (IO) theory, as mentioned be-fore, profitability in a mature industry is rather a sign of market power, and higher profits are related to economic inefficiency. Therefore, profitability should not be seen as an objective, but as a constraint, in so far as profits should sustain the activities of the firm or the industry (Hazledine 1994: 242–243).

Finally, as in the case of the indicators of the ability to sell, different indicators

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of profitability can give different results, making the interpretation of the results rather difficult.

The studies conducted on the competitiveness of an industry often do not measure competitiveness based on its defined notion, but rather based on the different (individual) factors behind competitiveness. This practice, however, is misleading, as it does not directly measure the actual competitiveness, but rather the potential for competitiveness. The next section aims to identify factors that determine the competitiveness of industries, and given the aim of this study, the main focus is on the determinants of competitiveness – and the role of regional economic integration within this framework – in the food processing industry.

1.2. The determinants of the international

competitiveness of an industry and the role of regional economic integration

1.2.1. The determinants of the competitiveness of an industry