The Role of Competition in a Market Economy

Competition Law AssociatesWindhoek, March 2014

1

Industrial Organization and Competition Policy

Industrial Organization is a field of economics that studies the strategic behavior of firms, their interaction and the structure of markets

Competition Policy is the study of policy options for promoting healthy competition in the market place

Competition Law is the legislated expression of those competition policy choices that a government has adopted.

2

The Gale of Creative DestructionJoseph Schumpeter used this term in his 1942 book

“Capitalism, Socialism and Democracy” to describe the process of competition

Competitive markets in continual process of transformation

Entry, innovation and entrepreneurship are essential to sustainable economic growth

Winners and Losers

3

The Role of Competition Authorities

To protect the process of competition in order to:

Promote the efficiency and adaptability of the economy

Facilitate the opportunity for business to participate in world markets

Ensure that SME’s have an equitable opportunity to participate in the market

Provide consumers with competitive prices and product choices

4

Functions, Powers and Duties of Competition Authorities

S.16

5

Competition Not an End in Itself

Economic Benefits – efficient resource allocation, growth, innovation

Consumer Welfare Effects – lower prices, better quality, greater choice

Governance – less need for government intervention, reduced regulation

6

Economic Benefits In 1889, a year before the Sherman Act, Canada passed

into law an “Act for the Suppression of Combinations, Formed in Restraint of Trade”

The framers understood what is still true today: healthy competition encourages “large aggregations of capital”

It is this capital, these investments that result in economic growth and job creation

The forces of competition lead to the innovation, economic transformation and renewal that Schumpeter pointed out were necessary to sustain growth

The pressure of competition creates the need which is the “mother of invention” and innovation.

7

EfficiencyEconomists speak of dynamic efficiency and static efficiency

the latter includes allocative and productive efficiency

Allocative efficiency is macro. Competition forces competitors to make efficient choices resulting in the efficient allocation of resources across the economy.

Productive efficiency is micro. Competition forces firms to save resources in the production process

Dynamic efficiency – competition encourages innovation and invention which results in increases in productivity and overall welfare

8

Welfare EffectsAdam Smith stated that the ultimate purpose of all

production was consumption and without the latter, the former has no purpose

As such efficiency in production should only be an intermediate goal

Allocative efficiency achieved through competition results in lower prices, better quality and more choice

Allocative efficiency tends to be more egalitarian at the macro level (across the economy)

9

GovernanceCompetition law enforcement is the lightest form of

government regulation or intervention in the market

Allows competitors to freely make choices unless they violate the law – reduces regulatory oversight

The cost of administering competition law is far below that of regulatory oversight

The cost of collecting, administering and distributing excess rents is likely to be far above the cost savings foregone by prohibiting a monopoly

Firms try to limit competition by pressuring government to impose costly trade restrictions or regulation

10

Market DefinitionWhen analyzing anti-trust cases, competition

authorities are called upon to define the relevant markets

This consists of Product and Geographic markets

Although tools used in the analysis and relevant evidence may apply to both it is critical that these exercises are treated separately

Product market analysis must always be done first

11

Relevant Product MarketHypothetical monopolist

Critical loss analysis

Own price elasticity of demand

Price cross elasticity of demand

End use of the product

Technical or physical characteristics of the product

Switching costs

12

Relevant Geographic MarketHypothetical Monopolist test

Actual shipping patterns, imports, exports

Transportation modes and costs

Frequency of shipments, inventories

Natural and artificial barriers (rivers, borders)

Currency exchange rates

13

Market PowerAbility to impose a small but significant non-transitory

increase in price that cannot be defeated by competitors or customers

We call this the SSNIP test

1- 2 year measurement period

Price is used as a proxy for service terms and quality

14

Three Main Areas of ConcernConspiracy and Bid rigging – considered to be the most

egregious competition offense because it is intended to eliminate competitiion

Mergers – the formation of market power through the acquisition of assets or shares

Abuse of Dominance – a firm with market power engages in anti-competitive acts to lessen competition or eliminate competitors

15

Conspiracy and Bid-riggingCartel, formal or informal group of independent

businesses whose concerted goal is to lessen or prevent competition among its participants.

Typically, cartel members enter into a covert agreement to engage in one or more anti-competitive activities, such as to fix prices, allocate markets or customers, limit production or supply, or rig bids.

Conspiracy can be international, national or regional in scope, with various degrees of formality and secrecy.

Can be a loose oral arrangement or a highly structured set of membership rules established by a trade association and elaborately enforced.

16

Conspiracy and Bid-RiggingCartels are harmful because typically they result in

higher prices for consumers and reduce the incentive for companies to cut costs and be innovative.

Cartel behaviour is unlawful under the competition laws of most countries.

Bid-rigging occurs when two or more bidders, in response to a call for tenders, agree that one person will refrain from bidding, withdraw a submitted bid, or to agree among themselves on bids submitted.

17

MergerAcquisition or establishment, direct or indirect, by one

or more enterprises (i) whether by purchase of shares or assets, lease of assets, amalgamation or combination or otherwise,

(ii) of control (S.42) over the whole or a part of the business of an immediate competitor, supplier, consumer or other enterprise;

18

Market Share & ConcentrationSafe harbour: combined market share (unilateral

measure) or turnover or assets of target below certain amounts

CR4 below certain level (interdependent measure)

High market share necessary but not sufficient condition to establish that the merger would result in the creation of market power

Market share calculated on basis of dollar revenue, unit volume or capacity

Herfindahl-Hirschman Index (HHI)

19

Economic Factors Affecting Competition

Foreign competition

Failing Firm

Availability of Substitutes

Entry

Competition remaining in the market

Removal of an effective competitor

Change and innovation

Life cycle of market – expanding, declining

20

Efficiency / Welfare Trade OffCanada - Efficiency Defence in the law

U.S. - Price Standard

E.U. – Consumer Surplus Standard

U.K. – Public Interest override by Minister of Trade and Industry

Namibia – trade off between detrimental effects of a lessening of competition and other potential economic benefits or benefits to the public S.47

21

Abuse of DominanceA person or persons with market power have

engaged in abusive or anti-competitive conduct

The conduct may be a single act, a single act repeated and/or a series of different acts

Such conduct has an anti-competitive purpose or effect which is exclusionary, disciplinary or predatory

22

Evidence of Abuse of DominanceUsually readily available corporate documents:

Exclusive contracts, payments for exclusivity

Long term contracts or restrictions in contracts

Correspondence revealing discriminatory, exclusionary or predatory practices

Strategic documents, documents prepared for senior management or the Board of Directors usually reveal if strategies are anti-competitive

23