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Competition

WHY DO WE NEED A COMPETITION POLICY ?

Speech delivered by S. Depypere
Brno Seminar
14/2/1995

These opinions are strictly personal and do not bind the European Commission

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Dear Minister, ladies and gentlemen,

I was asked to speak about the justification for competition policy: "Why do we need it ?"

Even though it is one of my favourite subjects, I will not emphasize the justification in a context of an international dynamic economy but I will give some comments on the role of competition policy in a national environment. As economists like to call it in "a closed economy". Let us look at a few economic situations and verify whether competition surveillance is appropriate.

The basic reference system is that of a market. The essence of the market place is competitive effort of suppliers to make the best offer and of buyers to make the best purchase. This is what Professor Ehlermann referred to : competition means putting in more energy, more effort, more creativity in order to obtain better results. The motivation of the economic agents is probably purely individual but the result is favourable for society. As Adam Smith observed, there is an invisible hand at work to take care of this.

The big question now is the following : is such a wonderful, efficient market a natural phenomenon, is it an equilibrium situation, can we expect it to emerge as a matter of course. The answer is basically yes, but not in a modern society with capital intensive production. An efficient market will only emerge when there are many players, when there are no barriers to entry, when the information flows freely. Looking at these conditions we think of markets for products of agricultural smallholders and these are of course the conditions under which markets have been set up in the first place.

But what happens if we move to an economy that produces complex goods, requiring capital-intensive production methods ? Because of technical and financial considerations two important changes occur: the number of suppliers decreases and the barriers to entry increase. The competitive process can continue to exist but it becomes extremely threatened. Why is that ?

Because the small group of suppliers will aim at influencing both demand and supply conditions.

The case is the most obvious for a pure monopolist. For him demand and supply of the entire market are identical to his own demand and supply. He is likely to see if he cannot draw benefit from this situation. A first possible action will be on demand. For a supplier with many competitors the demand curve is flat and he has to accept the market price that also constitutes his marginal revenue. But for the monopolist, the demand curve has a negative slope. If he sells more the price per unit drops and not only for the last unit but for his entire output. In these circumstances the monopolist can sometimes earn more by selling less.

From microeconomic theory we know that the optimum production for the firm is to be found, at the level for which marginal revenue is equal to its marginal cost. Only now this is at a lower level of production than the one for which market demand and supply are equal. What is the end result ? Less production and higher prices therefore less consumer satisfaction and less welfare creation. The monopolist is said to benefit from a "rent", that is an economic benefit that accrues to him merely because of his position without his needing to make an economic effort to acquire it.

Maybe a small note on the company accounts. Does this rent imply high profits? Maybe, but maybe not. It can also be used to create a lazy production apparatus, uninspired management, a disinterested workforce or the profit can be taken over by the pressure group that protects the monopoly. It is appropriate here to use the vocabulary of thermodynamics. This is a situation of pure increasing entropy. Too little energy flows in the system and the system decays. In terms of global economic performance this is the worst possible situation, consumers are badly served and the suppliers even fail to reap the benefit, they only waste it.

This brings me to a second action viz. on supply conditions. One can expect that the monopolist will not necessarily focus on improving the quality or variety of this supply. He will equally aim at securing his position by regulation. That is on top of the technical and financial barriers to entry he will seek to build legal obstacles. This leads to introducing the supply-side rigidities that can be so detrimental when the economy is faced with shocks.

The danger is that the legal barriers to entry may remain after the technical barriers have disappeared thanks to technological progress or market opening. Telephony is a case in point and energy production may become another one.

On the basis of these considerations we reach the provisional conclusion that there is scope for regulation to avoid abuse of monopoly situations and of dominant positions in general. We need a competition policy to tackle the problem.

After having presented to you the dangers of a monopoly I need to turn to cartels and other forms of restriction of competition. In a way, these reflect respectively the demand and the supply effects of a monopoly but then emulated in a competition context.

What is a cartel ? Our dictionary tells us that a cartel is an association or an agreement between independent entrepreneurs to do away partially or entirely with competition. One particular kind of cartel is generally accepted to be essentially detrimental namely the so-called "hard-core cartel", i.e. a "horizontal" agreement between undertakings at the same level of supply which aims at particularly dangerous restrictions of competition such as price-fixing, market-sharing or limitation of production. In fact it can be compared to a monopoly created by a small group of suppliers (or buyers). Its aim is to reduce competition for the benefit of the group members. If it is well organised it can be as efficient for its members as an individual monopoly. Exactly the same analysis about the effect of restricting supply and increasing prices can be used. So the creation of a "hard-core cartel" is by its very nature similar to an abuse of a monopoly situation. It usually has no positive effects whatsoever for society and it should be forbidden per se, because of its very nature. One needs a competition law to make this clear and a competition policy to enforce the law. Enforcement is of critical importance. The possible benefit for the participants in cartel can be so high that a credible force of deterrence is necessary.

On the other hand there are agreements between direct competitors or between suppliers and commercial buyers (i.e. so-called vertical agreements) that have the effect to partially do away with competition but that also have beneficial effects. The effect of competition distortion must then be weighed against these positive effects. This problem arises for instance frequently in the context of the vertical agreements. The limits on competition are brought about through clauses on exclusivity, restricted use of the products, etc. In fact what vertical agreements produce is a mixture of supply-side rigidities and incentives. Part of the clauses can be really beneficial, e.g. by providing legal security for the parties which will allow them to undertake supplementary activities and accept supplementary risk. But on the other hand some clauses may have mainly negative effects excluding possible innovation and creativity. This makes it a difficult subject, necessitating tailor-made analysis. Again we find the need for the guidance offered by a clear and transparent competition policy. When enforcing competition in these relations one hopes to strike the right balance admitting clauses that will produce more incentive than rigidity and prohibiting the others. This becomes "High Tech" competition technology.

In the EU competition system this problem is dealt with through the so-called group exemptions. These are regulations laying down for specific types of agreements which clauses and conditions are acceptable and which are not.

It is always important to set time limits so as to reassess the issues regularly.

Time lacks to discuss the economics of special rights and of mergers. Suffice it to say that the issues are similar to those raised by monopolies and dominant positions. So I will skip these subjects but I should not conclude without touching upon the issue of state aid monitoring.

The economic analysis of aid brings us to the supply-side again. The aid we are interested in, aims at favouring the production of certain goods or the production by certain enterprises. So we are not talking of aid to certain consumers like old-age or low-income persons.

Certain types of aid can have the particularly damaging effect of leading to a bad allocation of resources - producers making the wrong investments or producing the wrong quantity of goods - and of discouraging other producers. The latter is the case when competitors become disappointed and leave the arena.

On the other hand certain aid can remedy market failures and in the case of externalities there are clear arguments to favour an aid policy. What is the problem ? In certain situations, companies will "underinvest" in particular assets because they themselves cannot reap the benefit from the investment, alternatively because the cost of the underinvestment is borne by someone else anyway. Economists talk of positive and negative externalities. A clear example is a smoke filter in a chimney. The negative externality of the production - the smoke - falls on the others anyway. An alternative way of looking at the same problem is to say that the positive effect from an investment in a smoke filter would accrue to others than the company. What needs to be done is to "internalise the externalities" that means taking such measures that the company will take account of the external effects during its own decision process. The authorities can do so by imposing regulation or by giving aid or by combining both.

Again we need a competition policy permitting a skilful monitoring of aid schemes. We need to avoid damaging schemes such as aid covering part of the variable cost of production which is very discouraging for competition while allowing other aid schemes such as for environment protection, R&D, regional development.

A prerequisite for an efficient monitoring is to create transparency this is to know which aid schemes exist and under which conditions they are intended to be given.

A further word on the efficiency of competition control. Recent economic theory shows that the efficiency of policies depends critically on the credibility of the enforcing authority. This appears to be true for all public actions - even in very technical matters such as tax collection, monetary policy and competition policy.

Therefore we reach the final conclusion : in a market economy there is a threat of abuse in various situations. Such abuses are very detrimental for society. The way to avoid them or seek remedies is to establish a competition policy and to enforce it credibly.

Competition policy must not only be applied, it must also be expected to be applied. If we succeed in doing this we produce a Public Good which is welfare enhancing for the benefit of society at large.



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