Does competition reduce costs?

"Although the allocative efficiency benefits of competition are a tenet of microeconomic theory, the relation between competition and technical efficiency is less clear. Neoclassical models of profit-maximization subsume static cost-minimizing behavior regardless of market competitiveness, but traditional cost-of-service regulation may mitigate incentives for cost-minimization, and agency models of managerial behavior suggest possible scope for competition to influence cost-reducing effort choices.This paper explores the empirical effects of competition on technical efficiency in the context of electricity industry restructuring. Restructuring programs adopted by many U.S. states made utilities residual claimants to cost savings and increased their exposure to competitive markets. Using data on annual generating plant-level input demand, we find that municipally-owned plants, whose owners were for the most part unaffected by restructuring, experienced the smallest efficiency gains over the past decade, while investor-owned utility plants in restructured states significantly reduced their nonfuel operating expenses and employment. The analysis also highlights the substantive importance of treating the simultaneity of input and output decisions, which we do through an instrumental variables approach"--National Bureau of Economic Research web site.