Module 3 Chapter 5 Competition Policy Young Metcalfe

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Module 3 Chapter 5: Competition Policy Young & Metcalfe Arab Open University - Beirut

Module 3 Chapter 5: Competition Policy Young & Metcalfe Arab Open University - Beirut 1

The Rationale for Competition Policy n. Competition policy is concerned with maintaining competition between

The Rationale for Competition Policy n. Competition policy is concerned with maintaining competition between firms, in order to promote the efficient working of the market. n. Competitive markets typically have a number of inherent advantages such as n The efficient allocation of resources, n The maintenance of consumer choice, n The promotion of technological innovation, and n The autonomy of industrial enterprises. n. But the possible rise of imperfections such as monopoly and pure public goods, call for government intervention. n. There a variety of opinions as to the exact nature of competition and the extent to which state intervention is required. 2

The Nature of the Competitive Process n The Neoclassical View: n Perfect competition provides

The Nature of the Competitive Process n The Neoclassical View: n Perfect competition provides a benchmark against which any form of competition can be judged. It defines an equilibrium position representing an optimal allocation of resources. n Under perfect competition the industry is characterized by zero ‘Super-normal’ profits and free entry and exit in the market. (Super-normal profits are the result of monopoly power). n Market power is an imperfection or deviation from the competitive state. n The role of competition policy is to correct any distortions and restore the market process to its correct competitive path. n Some economists proposed the idea of workable competition. This concept relates more to real-world competition. n An early definition of the term focused on conditions where there are large numbers of sellers of similar products who do not conspire, and where entry is not seriously restricted. 3

The Nature of the Competitive Process n The Austrian School’s View: n The ‘process’

The Nature of the Competitive Process n The Austrian School’s View: n The ‘process’ character of competition is emphasized. Competition is considered to be an ongoing process of entrepreneurial rivalry. The entrepreneurs pursue profits, and this is the driving force of the economy. n Super normal profits are not limited to monopolies. specific competence. Profits reflect superior firm- n Innovation is emphasized in the Austrian approach. Innovations give efficiency gains (Schumpeterian theory). Monopoly power may result in an inefficient use of resources for some time, but profits generated will lead to greater innovation. n Economies of scale in certain markets may lead to concentration of firms thus leading to a form of oligopoly or monopoly. But economies of scale save costs which may be passed on to the consumers. n But without competition policy firms won’t have an incentive to pass the lower costs to consumers, on the contrary they will benefit from super normal profits. 4

The Nature of the Competitive Process n The Radical or Marxian views: n There

The Nature of the Competitive Process n The Radical or Marxian views: n There are two radical views on competition: 1. The notion that market structure has important influence on market performance (similar to neoclassical view). 2. Competition involves competing blocks of capital where different capitals expand compete with each other. n The market system has tendency towards monopoly, where large companies gain market power and become oligopolies. Competition is about market power, as well as economic and political power. 5

The Theoretical Basis of Competition Policy (impediments to competition) n Monopoly: n. Presence of

The Theoretical Basis of Competition Policy (impediments to competition) n Monopoly: n. Presence of a single seller of a given product that has no close substitutes. Entry into the market is blocked. n. There are social costs (welfare losses) resulting from monopoly. Several economists tried to estimate these costs. n. Some estimates found that the cost is trivial, while later estimates found that the costs are very high. The major difference between these estimates is taking into consideration the ability of a monopoly to innovate. n. Note: Costs to maintain monopoly position may include advertising costs. 6

The Theoretical Basis of Competition Policy (impediments to competition) n. Oligopoly: n The notion

The Theoretical Basis of Competition Policy (impediments to competition) n. Oligopoly: n The notion of dominance and dominant positions is important here. Firms with high market shares exert dominance over the market. n The dominant firm acts as the price leader by setting the price for the market and maximizing its own profits. The other producers in the industry are price takers. However, This ‘dominant firm – price leadership’ model has been criticized. n Dominance often involves the idea that a firm can restrict other firms’ choices via strategic behaviour. (advertisements, establishing reputation) n Collusion is outlawed in many countries. The forms of collusion are: (1) Price-setting or (2) an agreement concerning output. Cartel is the most formal form of collusion. n Policy looks at market share as indicator of dominance. 7

The Theoretical Basis of Competition Policy (impediments to competition) n Merger Activity: n Mergers

The Theoretical Basis of Competition Policy (impediments to competition) n Merger Activity: n Mergers are of three types: horizontal, vertical, and conglomerate mergers. n Horizontal mergers involve merging of firms at the same stage of the production process (i. e. mergers of suppliers or of retailers in the same industry). Higher market share and greater power will result, with increased profit margins. n Vertical mergers involve mergers at different stages of the production process (i. e. merger between supplier and manufacturer and distributor). (This might have a negative effect on other distributors because the supplier may limit his supplies to his own distributor) 8

The Theoretical Basis of Competition Policy (impediments to competition) n Merger Activity: (continued…) n.

The Theoretical Basis of Competition Policy (impediments to competition) n Merger Activity: (continued…) n. Conglomerate mergers involve merging of firms across different markets (with no vertical or horizontal relations). This is the most important type of mergers, and the most complex in estimating its welfare costs. n. The case of conglomerate mergers raises the question of firm power since competition policy should include the diffusion of economic power and the protection of economic freedom. Which comes first? n. Austrians might argue that maintaining freedom of economic agents is most important. Radicals might suggest that competition policy should take greater steps to contain the economic power attained by large corporations. 9

Competition policy in different EU countries: UK n The major legislation in the UK

Competition policy in different EU countries: UK n The major legislation in the UK has been the 1973 Fair Trading Act. n This legislation formed The Office of Fair Trading (OFT) which monitors competition. n Monopolies and Mergers Commission (MMC) looks at cases of anti-competitive behaviour. n The definition of a monopoly is a firm holding 25% market share or more. + Two or more firms holding at least 25% of market shares and operate in a way that restrict competition may also be referred to the MMC. n Public interest needs to be preserved by balancing efficiencies (such as scale economies) against the restriction of competition (as caused by the abuse of market power). 10

Competition policy in different EU countries: UK n In 1976, two pieces of UK

Competition policy in different EU countries: UK n In 1976, two pieces of UK legislation were crafted: the Resale Prices Act and the Restrictive Trade Practices Act. They prohibited collusion and price-fixing agreements. n The Competition Act of 1980 prohibited anti- competitive practices like predatory pricing and forcing retailers to stock a whole line of products. n A government statement of policy in April 1993 introduced a new framework to prohibit cartels and to give more power to the Director-General of Fair Trading. Exemptions, exclusions and penalties were defined. 11

Competition policy in different EU countries: Germany n The 1957 Act against Restraint on

Competition policy in different EU countries: Germany n The 1957 Act against Restraint on Competition prohibited agreements or actions that restrain competition. This includes cartel arrangement, price-fixing, exclusive deals and buying arrangements. This act emphasized the market dominance by large corporations. n The act was amended several times, with the last amendment being in 1989. the dominance issue was extended to powerful buyers and sellers and even smaller trading partners. n Anti-trust policy was emphasized, and the law was formulated to protect the interest of small firms. n Activities of small firms are allowed which would be illegal if they were carried out by large firms. n Under German law, conduct which is found severely to restrict competition is generally illegal. 12

Competition policy in different EU countries: France n. The French anti-trust policies constitute one

Competition policy in different EU countries: France n. The French anti-trust policies constitute one of the oldest systems of anti-monopoly legislation in the world (dating back to late 1940 s). n. In 1977, mergers were facing much tougher policy (mergers were encouraged in 1950 s and 1960 s to strengthen French companies). The act provided for the prohibition of mergers and established the Commission de la Concurrence, which investigates anti-trust violations. n. The 1986 amendment replaced the commission by the de la Concurrence (independent from the ministry of economics) the interpretation of the law became the responsibility of the judiciary. Conseil n. This was an important change, which shifted the responsibility of anti-trust enforcement from political judgment to judicial assessment. 13

EU competition policy: The development of competition policy n 1992 witnessed the establishment of

EU competition policy: The development of competition policy n 1992 witnessed the establishment of the Single European Market (SEM). n The EC had to formulate a single competition policy for all its members. Two viewpoints are important, the Anglo-Saxon and the continental approaches to competition policy: n The Anglo-Saxon viewpoint is exemplified by the US and UK. In the US firms are subject to strict inspection and hard compliance regulations. n The continental view is more relaxed accepting social dimensions to competition close links between suppliers and customers. 14

EU competition policy: Some History n The central feature of EU policy is the

EU competition policy: Some History n The central feature of EU policy is the belief in the static and dynamic benefits of competition. n Competition policy evolved from the founding guidelines established in the Treaty of Rome in the 1950 s. n The treaty established the commission as the authority in all matters of competition policy, with DG IV being established as the appropriate branch of the commission n Two major articles of the Treaty of Rome are Article 85 (dealing with anti-competitive practices) and Article 86 (dealing with dominant market practices and their abuse). 15

EU competition policy: Article 85 n Price-fixing, price discrimination, agreements to predetermine market shares,

EU competition policy: Article 85 n Price-fixing, price discrimination, agreements to predetermine market shares, any controls on production, investment, were declared void. n Agreements that are permitted are the ones promoting efficiency in production and distribution, promoting technical progress, or providing consumers with benefits. n So it was on a case by case basis. The DG IV had to build the appropriate body of law. n The commission was given substantial power to investigate, supported by national authorities. n Firms with less than 5% market share were exempt from article 85 n Violation of Article 85 results in fines. 16

EU competition policy: Article 86 n Article 86 prohibits the abuse of a dominant

EU competition policy: Article 86 n Article 86 prohibits the abuse of a dominant position in a single market, so far as the abuse may affect trade between member states. n It would cover, for example, restrictions on supply or technical development and unfair pricing. Unlike Article 85 there is no provision for granting an exemption, but like 85 violations are penalized with fines. (Tetra Pak, 75 million fine). n This Article did not provide clear guidance on mergers and acquisitions, therefore, the European Commission Merger Regulation was introduced in 1990. 17

EU competition policy: EC Merger Regulation n The merger regulation which came into force

EU competition policy: EC Merger Regulation n The merger regulation which came into force in September 1990, outlines the procedure for assessing whether cross-member State mergers create a dominant position. n Authority to judge was also given to the DG IV, which has established a merger task force. n A merger falls within the regulation’s scope if it passes 3 tests: n. The aggregate worldwide turnover of all the undertakings involved must exceed 5 billion. n. The aggregate EU turnover of each of at least two of the firms involved must exceed 250 million. n. Finally the regulation does not apply if each of the firms involved has two-thirds of its EU turnover within one member state. 18

Overview n The openness of markets to entry by new firms, new products, and

Overview n The openness of markets to entry by new firms, new products, and new methods of production is a central feature of a competitive environment. n A policy to reduce entry barriers, deregulate markets, and stimulate innovation through technology policy is recognized as a pro-competition policy. n One should keep in mind that in some cases monopoly power should be allowed for the sake of innovation. n Pharmaceutical companies need sufficient market power (like patent protection) in order to develop beneficial products. n Note: you should be able to differentiate between profits arising from market power and profits arising from superior competence. 19

Module 3 Chapter 6: International Competition Policy Alan Sykes Arab Open University - Beirut

Module 3 Chapter 6: International Competition Policy Alan Sykes Arab Open University - Beirut 20

National antitrust policy with international trade n Global welfare concerns should be considered when

National antitrust policy with international trade n Global welfare concerns should be considered when a nation formulates a policy. An open economy is now present in most countries, where goods and services are traded internationally. n So does the argument against monopoly still hold in an open economy? n If global welfare is the criterion, then the analysis does not change. n But if national welfare is the criterion, their view of monopoly may change dramatically. n From the national perspective, monopoly is far more harmful when the monopolist is a foreigner (US vs. OPEC) 21

National antitrust policy with international trade n While if the monopolist is domestic and

National antitrust policy with international trade n While if the monopolist is domestic and the consumers are foreign. Then from the national perspective the increase in profit to the monopolist is a national gain, and the harm to consumers is of no concern. n Some national governments might make decisions that promote the national interest at the expense of the global interest. (Webb-Pomerane act; permits cartels that operate in export markets) n Thus, we can imagine a international agreement committing its members to pursue global welfare rather than national welfare. 22

Legal obligations n Here are few suggestions for such an agreement: n Nations should

Legal obligations n Here are few suggestions for such an agreement: n Nations should not discriminate in their competition policy rules or enforcement actions according to the nationality of producers or consumers affected by them. n Foreign nationals and domestic nationals should be treated in the same way, and given the same rights. n In order to detect deviations from the agreement, transparency is required: n Publication of decisions, accompanied by a statement of reason. n Due process requirements: all parties be given notice of proceedings and an opportunity to be heard. n Finally a dispute resolution system is needed, such as the WTO 23