Lecture 9: EU Competition Lecture 9: EU Competition Policy Policy

Based on: Sloman Chapters Based on: Sloman Chapters 6.3 (Monopoly) and 6.3 (Monopoly) and

12.3 (Competition Policy)12.3 (Competition Policy)Swann Swann Chapter 5 p129-148Chapter 5 p129-148

Lecture 9: EU Competition Lecture 9: EU Competition Policy Policy

Based on: Sloman Chapters Based on: Sloman Chapters 6.3 (Monopoly) and 6.3 (Monopoly) and

12.3 (Competition Policy)12.3 (Competition Policy)Swann Swann Chapter 5 p129-148Chapter 5 p129-148

Market Size MattersMarket Size Matters

• European leaders always viewed European leaders always viewed integration as compensating for the small integration as compensating for the small size of European nations:size of European nations:

– implicit assumption: market size good for implicit assumption: market size good for economic performance.economic performance.

• Facts: integration associated with mergers, Facts: integration associated with mergers, acquisitions, etc:acquisitions, etc:

– in Europe and more generally, in Europe and more generally, ‘globalisation’.‘globalisation’.

FactsFacts

• M&A activity is high in EU.M&A activity is high in EU.• Much M&A is mergers within member state:Much M&A is mergers within member state:

– about 55 per cent ‘domestic’about 55 per cent ‘domestic’– remaining 45 per cent split between:remaining 45 per cent split between:

one is non-EU firm (24 per cent), one is non-EU firm (24 per cent), one firm was located in another EU nation one firm was located in another EU nation

(15 per cent)(15 per cent)counterparty’s nationality was not identified counterparty’s nationality was not identified

(6 per cent).(6 per cent).

FactsFacts

• Distribution of M&A quite varied:Distribution of M&A quite varied:– Big-four: I,F,D share M&As much lower than share of the EU GDPBig-four: I,F,D share M&As much lower than share of the EU GDP– I, F, D 36 per cent of the M&As, 59 per cent GDP (except UK)I, F, D 36 per cent of the M&As, 59 per cent GDP (except UK)– small members have disproportionate share of M&A.small members have disproportionate share of M&A.

Source: Baldwin and Wyplosz

FactsFacts

• Why M&A mostly within EU?Why M&A mostly within EU?

• Why UK’s share so large?Why UK’s share so large?

– non harmonised takeovers rules: non harmonised takeovers rules: some members have very restrictive some members have very restrictive

takeover practices, makes M&As very takeover practices, makes M&As very difficultdifficult

others, UK, very liberal rules.others, UK, very liberal rules.

• Lack of harmonisation means restructuring Lack of harmonisation means restructuring effects vary impact by member states.effects vary impact by member states.

Economic Logic VerballyEconomic Logic Verbally

• Liberalisation Liberalisation

• De-fragmentation De-fragmentation

• Pro-competitive effect Pro-competitive effect

• Industrial restructuring (M&A, etc.) Industrial restructuring (M&A, etc.)

• RESULT: fewer, bigger, more efficient firms RESULT: fewer, bigger, more efficient firms facing more effective competition from facing more effective competition from each other .each other .

POLICIES TOWARDSPOLICIES TOWARDSMONOPOLIES AND OLIGOPOLIESMONOPOLIES AND OLIGOPOLIES

• Competition, monopoly and the public interest

• Competition, monopoly and the public interest

The targets of policyabuse of monopoly power

Monopoly and the public interestMonopoly and the public interest

AR = D

£

Q

MCmonopoly

MR

AR = D

£

Q

MCmonopoly

MRQ1

P1

ACmonopoly

AC1

Monopoly and the public interestMonopoly and the public interest

AR = D

£

Q

MCmonopoly

MRQ1

P1

ACmonopoly

AC1

Monopoly and the public interestMonopoly and the public interest

AR = D

£

Q

MCmonopoly

MRQ1

P1

ACmonopoly

AC1

Why do we think Monopoly is bad?Why do we think Monopoly is bad?

AR = D

£

Q

MCmonopoly

MRQ1

P1

ACmonopoly

AC1

PPC

QPC

If we had perfect competition then P=MC,If we had perfect competition then P=MC,

andand quantity is higherquantity is higherprice is lowerprice is lower

AR = D

£

Q

MCmonopoly

MRQM

PM

ACM

MCperfect competition

PPC

QPC

But what if Perfect competitive firm is small and But what if Perfect competitive firm is small and unable to exploit returns to scaleunable to exploit returns to scale

ACmonopoly

AR = D

£

Q

MCmonopoly

MRQM

PM

ACM

MCperfect competition

PPC

QPC

But what if Perfect competitive firm is small and But what if Perfect competitive firm is small and unable to exploit returns to scaleunable to exploit returns to scale

ACmonopoly

Winecon ExampleWinecon Example

• For an alternative presentation of this story For an alternative presentation of this story see:see:

• Perfect Competition and Monopoly Compared

• If you need to review Monopoly output If you need to review Monopoly output decisions see:decisions see:

• A Monopolist's Revenue

£

DD

Q

MRD

QD

PD

A DuopolyA Duopoly

£

AR = DQ

MCmonopoly

MRQ1

P1

£

DD

Q

MRD

QD

PD

If we have two firms instead of

one, Divide up the demand Curve between them

PC V Monopoly v DuopolyPC V Monopoly v Duopoly

• Under certain conditionsUnder certain conditions

• Output of Monopoly is ½ of Perfect Output of Monopoly is ½ of Perfect competitioncompetition

• Output of Duopoly Firm is 1/3 of Perfect Output of Duopoly Firm is 1/3 of Perfect Competition, Industry output is 2/3 of PCCompetition, Industry output is 2/3 of PC

• Output of Three firm Oligopoly is ¼ of Output of Three firm Oligopoly is ¼ of Perfect Competition, Industry is ¾ of PCPerfect Competition, Industry is ¾ of PC

• Output of Four firm Oligopoly is 1/5 of Output of Four firm Oligopoly is 1/5 of Perfect Competition, Industry is 4/5 of PCPerfect Competition, Industry is 4/5 of PC

• So moving closer to PC all the time.So moving closer to PC all the time.

WinEcon ExampleWinEcon Example

• This is the link to the full treatment of the This is the link to the full treatment of the Cournot Duopoly Model in WinEcon. This is Cournot Duopoly Model in WinEcon. This is not absolutely necessary for this module not absolutely necessary for this module but if you are doing Principles it will but if you are doing Principles it will provide a useful review of the issues.provide a useful review of the issues.

• Cournot's Model of Duopoly

What does EU integration meanWhat does EU integration mean

• Could initially have lots of small firms in Could initially have lots of small firms in each country (High MC)each country (High MC)

• Market integration (larger market) might Market integration (larger market) might allow exploitation of increasing returns to allow exploitation of increasing returns to scalescale

• So might go from 10 in each country to 10 So might go from 10 in each country to 10 in EU overall.in EU overall.

• Question: Has monopoly power here risen Question: Has monopoly power here risen or not?or not?

• IN each country?IN each country?• In the EU?In the EU?

SO If Scale MattersSO If Scale Matters

• There may also be a trade off between There may also be a trade off between competition (zero supernormal profits)competition (zero supernormal profits)

• AND Cost savings due to scale effectsAND Cost savings due to scale effects

• Firms need to be of some critical size to Firms need to be of some critical size to gain cost benefitsgain cost benefits

• SO how big will they be, and how many of SO how big will they be, and how many of them will survive market liberalisationthem will survive market liberalisation

Increase in varietyIncrease in variety

• Suppose 8 countries (UK, FR, GER, It, Sp, & Pol, Suppose 8 countries (UK, FR, GER, It, Sp, & Pol, Sweden, & Slovakia) have one car firm each Sweden, & Slovakia) have one car firm each before market is integrated and this firm before market is integrated and this firm dominates home market (due to restrictions).dominates home market (due to restrictions).

• Control their Home market PLUS each controls Control their Home market PLUS each controls 1/9 of 1/9 of remainingremaining EU market. EU market.

• What happens after we integrate the EU car What happens after we integrate the EU car market.market.

• 1. In each home market go from monopoly high P 1. In each home market go from monopoly high P and ½ PC output) to lower P and 8/9and ½ PC output) to lower P and 8/9

• So all home markets become more competitiveSo all home markets become more competitive• But what else?But what else?

• Fall in costs, price, increase in output and Fall in costs, price, increase in output and increase in variety availableincrease in variety available..

• So consumers gain on all fronts.So consumers gain on all fronts.

• Not necessarily popular vision of market Not necessarily popular vision of market integation- claim market integration leads integation- claim market integration leads to mergers and hence have less than to mergers and hence have less than original 8 firms. original 8 firms.

Market-Concentrating Merger LiteratureMarket-Concentrating Merger Literature

x

Big, buys up small and closes it down, Big, buys up small and closes it down,

1 2 3 4

86 75

What happens to non-merging firms?

Answer: Output and profits rise for all non-merging firms as market becomes more

concentrated

Answer: Output and profits rise for all non-merging firms as market becomes more

concentrated

Answer: Output and profits rise for all non-merging firms as market becomes more

concentrated

And after each merger each firm gets bigger - eventually new merger unprofitable

Globalisation / Big EU conglomerate

storySo here Market Integration results in less firms, lower output and higher prices

So need competition policy

Block market concentrating mergers

Firms will argue that mergers reduce costs rather increase concentration.

But regulators are not inclined to believe

Problems with this Globalisation / Big EU conglomerate storyRemember all rivals gains from your

merger

Why buy up rival if everyone else is going to benefit

What should I do?

Let other firms pay to buy rival – I wait and get the gains – mergers would never happen

So must believe that mergers are beneficial to ME - Must be cost synergies

Problems with this Globalisation / Big EU conglomerate

storySo must believe there are cost savings

Either through rationalization

Or improved processes.

Technology Transfer Mergers

e.g. Technology Transfer Mergers

VW purchased Skoda and Seat.

VW Sharon/Seat Alhambraand many other VW/Audi/Skoda models identical

Honda & Rover- Early 90’s

Telecommunications equipment

Technology Transfer MergerTechnology Transfer Mergerwith Independent Divisionswith Independent Divisions

Technology Transfer Merger Technology Transfer Merger Big, buys up or licenses small, and Big, buys up or licenses small, and

implements superior technologyimplements superior technology

Technology Transfer MergerTechnology Transfer Merger What happens to non-merging firms?What happens to non-merging firms?

Predator now twice as big, so output and Predator now twice as big, so output and profits of all non-merging firms must profits of all non-merging firms must

shrink. shrink.

Predator now twice as big, so output and Predator now twice as big, so output and profits of all non-merging firms must profits of all non-merging firms must

shrink. shrink.

Technology Transfer versus Market Technology Transfer versus Market Concentrating MergersConcentrating Mergers

• Now 2 firms with best technology

• Firms competing against each other (including new divisions) Output rises, prices fall

• Closer to Perfect competition result

• Potentially all consumers and society gains

• But need to believe that technology/management processes are being transferred and that this is the motive for mergers.

• Now 2 firms with best technology

• Firms competing against each other (including new divisions) Output rises, prices fall

• Closer to Perfect competition result

• Potentially all consumers and society gains

• But need to believe that technology/management processes are being transferred and that this is the motive for mergers.

Competition Policy ConcernsCompetition Policy Concerns

• So EU is concerned about mergers and So EU is concerned about mergers and possibility of market concentrationpossibility of market concentration

• Concerned about whether mergers really Concerned about whether mergers really bring cost synergy benefits bring cost synergy benefits

• Collusion is a real concern in Europe:Collusion is a real concern in Europe:

– dangers of collusion rise as the number dangers of collusion rise as the number of firms falls.of firms falls.

• EU is also concerned about ‘state aid’ to EU is also concerned about ‘state aid’ to protect their own champions, e.g. Rover, protect their own champions, e.g. Rover, Air FranceAir France

EU policies on ‘State Aids’EU policies on ‘State Aids’

• 1957 Treaty of Rome bans state aid that 1957 Treaty of Rome bans state aid that provides firms with an unfair advantage provides firms with an unfair advantage and thus distorts competition.and thus distorts competition.

• EU founders considered this so important EU founders considered this so important that they empowered the Commission with that they empowered the Commission with enforcement.enforcement.

• Commission also empowered to Commission also empowered to investigate mergers and allegations of investigate mergers and allegations of collusioncollusion

Anti-Competitive BehaviourAnti-Competitive Behaviour

• perfect collusion:perfect collusion:

– firms coordinate prices and sales firms coordinate prices and sales perfectlyperfectly

– max profit from market is monopoly price max profit from market is monopoly price and salesand sales

– perfect collusion is where firms charge perfect collusion is where firms charge monopoly price and split the sales monopoly price and split the sales among themselves.among themselves.

EU Competition PolicyEU Competition Policy

• To prevent anti-competitive behavior, EU To prevent anti-competitive behavior, EU policy focuses on two main axes.policy focuses on two main axes.

• Antitrust and cartels. The Commission Antitrust and cartels. The Commission tries:tries:– to eliminate behaviours that restrict to eliminate behaviours that restrict

competition (e.g. price-fixing competition (e.g. price-fixing arrangements and cartels) arrangements and cartels)

– to eliminate abusive behaviour by firms to eliminate abusive behaviour by firms that have a dominant position.that have a dominant position.

EU Competition PolicyEU Competition Policy

• Merger control. The Commission seeks:Merger control. The Commission seeks:

– to block mergers that would create firms to block mergers that would create firms that would dominate the market.that would dominate the market.

POLICIES TOWARDSPOLICIES TOWARDSMONOPOLIES AND OLIGOPOLIESMONOPOLIES AND OLIGOPOLIES

• EU legislation

– Article 85: restrictive practices

– Article 86: monopolies and mergers

– 1990 merger control measures

current approach to merger control

– assessing EU legislation

• EU legislation

– Article 85: restrictive practices

– Article 86: monopolies and mergers

– 1990 merger control measures

current approach to merger control

– assessing EU legislation

POLICIES TOWARDSPOLICIES TOWARDSMONOPOLIES AND OLIGOPOLIESMONOPOLIES AND OLIGOPOLIES

• UK competition policy– the OFT and the Competition Commission

– restrictive practices policyChapter 1 prohibitiontypes of anti-competitive behaviourpowers of the OFT

– monopoly policyChapter 2 prohibitionmarket-share criterionmarket contestabilityanti-competitive practices

• UK competition policy– the OFT and the Competition Commission

– restrictive practices policyChapter 1 prohibitiontypes of anti-competitive behaviourpowers of the OFT

– monopoly policyChapter 2 prohibitionmarket-share criterionmarket contestabilityanti-competitive practices

POLICIES TOWARDSPOLICIES TOWARDSMONOPOLIES AND OLIGOPOLIESMONOPOLIES AND OLIGOPOLIES

• UK competition policy (cont.)

– merger policyrole of OFT and Competition Commission

criteria for judgement

• Assessment of competition policy

– focus on behaviour rather than market structure

– prohibition of certain practices

– tougher powers to identify secret collusion

• UK competition policy (cont.)

– merger policyrole of OFT and Competition Commission

criteria for judgement

• Assessment of competition policy

– focus on behaviour rather than market structure

– prohibition of certain practices

– tougher powers to identify secret collusion