Competition policy

General principles

    Competition law is one of the most important points of interaction between business,law and economics. Firms need to understand the rationale and practice of competition legislation and rules. Competition law is also important because it

impinges so closely on the welfare of the consumer and the dynamism of the

business sector. Badly framed competition policy will bring relatively few benefits

to the consumer at a high cost to business. These costs include not only the costs

of taking or defending a competition case, but the costs arising when a firm is

uncertain about the applicability of the law to its behaviour.

    While individual countries have their own distinctive competition regimes,

four general principles underlie competition policy:

1. Highly concentrated market structures are more likely to be monopolistic than

less concentrated structures. Competition policy tends to focus on the former.

2. Competition law is applied to a wide range of markets, i.e. to public sector

commercial services and non-profit organisations, as well as to the private

sector.

3. The benefits of competition include direct benefits to the consumer. But its

indirect effects on upstream and downstream markets have also to be taken

into account. An inefficient telecoms industry, for example, affects both the

individual telephone user and also the pattern of comparative advantage,

through raising communication costs.

4. Case-by-case studies are necessary to quantify the net economic benefits and

costs of a monopoly.

5. Care needs to be taken in devising remedies which can include sanctions,

declarations, structural and behavioural actions.

Competition policy – the example of the European Union

    The EU’s competition regime provides a practical illustration of the general

principles of competition policy.

    The principles of the EU’s competition policy are contained in Articles 85 to 94

of the Treaty of Rome. Since the Treaty of Amsterdam came into effect in 1999,

these have been renumbered Articles 81 to 90. To avoid confusion, we use the

post-1999 numbering in this chapter. These articles cover both uncompetitive

behaviour between firms and state aids that affect trade between Member States.

The objective of keeping the EU market open and free from distortion is

addressed by two key articles, Articles 81 and 82 .

    Article 81 prohibits restrictive agreements relating to price, market shares or production controls, unless specifically exempted or licensed. Exemptions can be given by the Commission if the restrictive agreements can be shown to improve efficiency,allow consumers a ‘fair’ share of the resulting benefits, and preserve

some degree of competition. The exemption clause has been frequently and successfully invoked._8 For example, selective and exclusive dealerships for new car sales are permitted by virtue of this clause .

  

    Article 82 addresses the problem of abuse of dominant position. It outlaws unfair

trading practices, unjustified tie-in clauses and similar arrangements. Concepts

such as ‘dominant position’ and ‘market abuse’ have been subjected to different

interpretations. Some indication of the complexity of the issues is given in the

summary of the judgment in the Woodpulp case .

    These articles apply in principle to vertical as well as horizontal agreements

between firms. Vertical restraints are contracts between firms at different

stages of the production chain that specify more detailed commitments on the

parties than simply to exchange a given quantity of goods or services at a given

price per unit. Examples include selective and exclusive dealerships

discussed in Box 7.4, retail price maintenance, service requirements, e.g. undertakings to spend on advertising and after-sales service, and two-part pricing involving a fixed charge and a fixed price per unit. VRs essentially involve

agreements between producers of complementary goods. They are distinguished

from horizontal restraints .HRs relate to agreements between producers at the

same stage of the production chain.

    Competition law tends to take a permissive view of VRs. The reason for this is

that abuse of market power by one producer  damages the producer of the complement .Thus any limit to sales by the manufacturer to exploit monopoly power reduces sales and profits of the dealer, and vice versa in case of use of monopoly power by the dealers. Hence both parties are driven by self-interest to an efficient outcome, very much in the spirit of Adam  Smith, and no intervention by the Competition Authority is needed. In judging VRs, the EU takes a permissive view provided efficiency is in fact achieved. It adds two other criteria: equity – protection of small enterprises; and promotion of market integration – hence any measure preventing ‘parallel’ imports is unfavourably regarded. The more inter-brand competition in the market, the less the danger of a VR being in breach of competition law.

Competition policy,privatisation and regulation

    When competition prevails, firms have limited discretion over price. Profit maximization leads them to equate marginal cost to marginal revenue and, because

price is more or less ‘given’ in a competitive market, price equals marginal revenue.

Also, competition forces firms to minimise costs and to search relentlessly for new

and better ways of doing things. Competition encourages innovation. For these

reasons, maintaining a market structure that is open to competition is of the

utmost importance to an efficient economy.

    Our first task in this chapter is to assess the case for competition and to define

the characteristics of a market that encourages competition.

    Our second task is to analyse competition policy. Competition policy refers to

the rules governing the conduct of firms in a market. Without well-developed

and effective competition rules, the market system will not function properly. Yet

a competition regime has to balance the need for active competition on the

domestic market with the equally pressing need to allow firms to attain a

minimum efficient scale and be able to match international competition. On

occasion, it may make sense to tolerate, even encourage, high concentration

ratios in the domestic market. The extension of competition policy to deal with

state aids to industry, and particularly support for state-owned enterprises, is also

examined. We illustrate these issues with examples from the competition policy

of the EU.

    Third, the move to privatisation is analysed. Starting in the 1980s in the UK and

New Zealand, privatisation programmes have been implemented throughout the

world economy. ‘New consensus’ thinking goes far to explaining the rapid spread

of these privatisation programmes. They have been motivated by the desire to

introduce competition where it was absent as well as assisting governments to

improve their financial situation.

    The degree of popular enthusiasm for competition has waxed and waned.

Proponents of competitive market structures are now in the ascendant. In order

to understand why, we must understand the origin of this pro-competitive viewpoint.

It is not necessarily pro-business, though it has coincided with a strongly

pro-business trend in other areas of economic policy. Most businesses feel under

 threat from competition. They are more likely to believe that their problems

derive from excess competition rather than an insufficiency of competition. They

argue for space and time to adjust to the pace of technological advance and to

build up competitive advantage. Getting the balance right between sectoral

strength and optimal competitive pressure is vitally important for economic

performance.

The case for competition

    Competition policy is based on a belief in the economic benefits of competition.

The starting assumption is that market forces are the most effective means of

ensuring efficiency in the allocation of resources, of adapting to change and,

ultimately, of maximising consumer welfare. A much-quoted passage from the

European Commission’s first report on competition policy reflects this basic philosophy:

  

    Competition is the best stimulant of economic activity since it guarantees the widest possible freedom of action to all. An active competition policy ... makes it easier for the demand and supply structures continually to adjust to technological development.Through the interplay of decentralised decision-making machinery, competition enables enterprises continually to improve their efficiency, which is the sine qua non for a steady improvement in living standards and employment prospects within the countries of the Community. From this point of view, competition policy is an essential means for satisfying to a great extent the individual and collective needs of our society.

    Competition has several major advantages over monopoly .First,it provides static benefits through elimination of deadweight losses illustrated in Figure 6.2. This figure shows how competition can lead to more output at a lower price – and it accords with the practical experience of falling prices and higher sales volumes that followed the introduction of competition to formerly monopolized industries ranging from air transport to telecoms. Estimates of the importance of this static effect vary widely, but some have reached as high as 1 per cent of GDP._2 Second, competition brings dynamic benefits:

- It makes organisations internally more efficient by sharpening incentives to

avoid slackness.

-It allows the more efficient organisations to prosper at the expense of the

inefficient .

- It improves dynamic efficiency by stimulating innovation.

The above arguments emphasise efficiency. Equity is another important consideration in competition policy. Governments enforce competition policy in order

to protect weaker companies against the abuse by monopolies of their dominant

market position. Support for the free market presupposes ‘fair’ trading rules and a

level playing field. Defining ‘fairness’ is not, of course, always easy. Moreover,

the dictates of fairness, efficiency and competition sometimes pull in different

directions. Efficiency may require a more concentrated industrial structure than a

government concerned with equity might want to tolerate. Somehow, consistent

rules must be formulated which encourage competition and allow business a

reasonable degree of certainty, but have enough flexibility to deal with cases

where market power may be necessary on technical grounds.