European Competition Policy - uni-jena.deECP/ECP2016_17_Complete.pdfMotta, Massimo (2004):...

European Competition Policy

(Master in Economics)Winter 2016-17

Prof. Dr. Andreas Freytag

Prof. Dr. Michael Fritsch

Tuesday, 10-12 a.m. c.t., Carl-Zeiss-Str. 3, Seminar room 208

Announcement

The exercise course will be held by Moritz Zöllner and Sebastian Spiegel.

Monday, 10 a.m. c.t. , Carl-Zeiss-Str. 3, Seminar room 208.

The written exam will take place on March 1, 2017, 4 p.m., HS 1

Net time one hour

2(c) Freytag/Fritsch, FSU

2016 European Competition Policy Winter 2016 / 17

Outline

I. Introduction: Functions and Characteristics of Competition

II. Models of Competition

a) Perfect competition

b) Contestable markets

c) Market power, duopoly, monopoly

d) Concepts: Harvard School, Chicago School, countervailing power, German digressions

e) Competition and innovation

III. Distortions of Competition

a) Measurement of concentration

b) Mergers & acquisitions

c) Cartels

d) Critical behavior: predatory pricing, price differentiation,bundling, exclusive dealing



IV. Competition Policy

a) Regulation of natural monopolies

b) European competition legislation

c) Other countries’ competition laws

d) Competition and international trade

Assignment:

Andreas Freytag: Sections I, IIa through IId, IIIc and IIId, IVd

Michael Fritsch: Sections IIe, IIIa, IIIb, IVa through IVc.



Basic References

(Suggestions for further reading will be given during class)

Bishop, Simon and Mike Walter (2010): The Economics of EC Competition Law:

Concepts, Application and Measurement. London: Sweet & Maxwell.

Hildebrand, Doris (2009): The Role of Economic Analysis in the EC Competition Rules. 3rd

edition, Alphen aan den Rijn: Kluwer Law International.

Motta, Massimo (2004): Competition Policy, Theory and Practice. Cambridge: Cambridge

University Press.

Neumann, Manfred (2001): Competition Policy. Cheltenham: Edward Elgar.

Tirole, Jean (2000): The Theory of Industrial Organization. Cambridge (MA): MIT Press.

Viscusi, W. Kip, John M. Vernon and Joeseph E. Harrington Jr. (2000): Economics of

Antitrust and Regulation. 3rd ed., Cambridge: MIT Press.

Legal Sources

Act Against Restraints of Competition (GWB) from 1957, 7. amendment from Juli 2005.

Act Against Unfair Competition (UWG) as well as supplementary laws (e.g. copyright law).

Treaty on the Functioning of the European Union (TFEU) as of December 1st 2009;

2010/C 83/01), Articles 101-109, particularly Articles 101, 102 and 107. Merger

Regulation and Group Exemption Regulation of the European Comission.



Basic References in German

Kerber, Wolfgang (2007): ‘Wettbewerbspolitik‘. Vahlens Kompendium der

Wirtschaftstheorie und Wirtschaftspolitik, Bd. 2, 9. Aufl., Munich: Vahlen, 371-434.

Schmidt, Ingo und André Schmidt (2006): Europäische Wettbewerbspolitik und

Beihilfekontrolle – Eine Einführung. 2. überarbeitete und erweiterte Auflage,

München: Vahlen.

Schmidt, Ingo and Justus Haucap (2013): Wettbewerbspolitik und Kartellrecht – Eine

interdisziplinäre Einführung. 10. überarbeitete und aktualisierte Auflage, München:

Oldenbourg.



7

European Competition Library

Some of the source mentioned during the course are available as PDF-file in the

European Competition Library http://www.uiw.uni-jena.de/index.php/sonstiges/eu-competition-library

Access to the innovation library is password protected!

The innovation library should only be used for the purposes of this course!

(c) Freytag/Fritsch, FSU

2015European Competition Policy Winter 2016 / 17

Official Internet-Addresses:

Bundeskartellamt: http://www.bundeskartellamt.de/

Bundesministerium für Wirtschaft

und Technologie: http://www.bmwi.de

European Commission (Competition): http://europa.eu.int/comm/

competition/index_de.html

Federal Trade Commission: http://www.ftc.gov/

Monopolkommission: http://www.monopolkommission.de

OECD: http://oecd.org

Bundesnetzagentur: http://www.regtp.de/

World Trade Organization: http://www.wto.org

Blogs: www.voxeu.org

www.econtalk.org

http://www.ft.com/comment/

columnists/martinwolf

http://gregmankiw.blogspot.com/

www.ecipe.org(c) Freytag/Fritsch, FSU

20168European Competition Policy Winter 2016 / 17

List of Symbols (1)

a Vertical size of the market AC Average costB Horizontal size of the marketC Costc Variable costCR Rate of concentrationDD Demand curveE Cross-price elasticityF Fixed costMR Marginal revenueMC Marginal costP PriceQ Total quantityq Partial quantityR Reaction curve



List of Symbols (2)

s SubsidiesTC Transaction costV Net welfare gain for the economy

ε Price elasticity of demand Π Profitß Own-price effectγ Cross-price effectµ Lerner index

X1 –X7 Points in the graphs



List of Abbreviations

AD-policy Anti-Dumping Policy

ECPR Efficient Component Pricing Rule

EGV Treaty Establishing the European Economic Community

R&D Research and Development

GATT General Agreement on Tariffs and Trade

GVO Block Exemption Regulation

GWB Act Against Restraints of Competition

IAC International Antitrust Code

M&A Mergers & Acquisitions

OECD Organisation for Economic Co-operation and Development

SCP Structure-Conduct-Performance-Paradigm

TKG Telekommunikationsgesetz

TRACLAP Agreement on Trade Related Aspects of Competition Law and

Policy

TFEU Treaty on the Functioning of the European Union

TRAMs Trade-Related Antitrust Measures

UWG The Act Against Unfair Competition

WTO World Trade Organization11



I. Introduction

Competition Policy is part of the economic policy setting in a country. It has to be compatible with the policy setting.

General objectives of economic policy:

� Freedom

� Justice

� Welfare

Therefore, competition is a means, not an end! It is instrumental to meet the objectives.

We will learn that workable competition (i.e. supporting the objectives) does not require a certain pro-competitive attitude but clear and enforceable rule (competition law) � spirit of competition!



What is competition ?

Competition is the attempt of several actors to meet objectives in a sort of “game”.

In the economic sphere, suppliers compete for demand, demanders for the supply (depending on the degree of scarcity), political parties compete for support in elections etc.

� Zero-sum or positive-sum?

� Instruments (strategies):

� price

� quality

� personal relations

� novelties

� anti-competitive behavior, e.g. cartels, M&A etc.

� Role of competition for society



Functions of Competition

� „natural“ function

� peace function--------------------------------------

� allocative function

result oriented, mostly static

� distributive function

� innovative function

process oriented, mostly dynamic, restless capitalism!

� freedom function 14



Policymakers are facing trade-offs

Governments may well strive for additional strategic objectives, e.g.:

� picking winners;

� social reasons;

� enhancing SMEs;

� fostering R&D

� …

Therefore, it cannot always be expected that the government is acting in favor of more welfare enhancing competition.

This is a political economy problem requiring a clear distinction of responsibilities.

In particular, the cartel office should be independent form government.15



Some observations

Competition is benefitting the other market side.

Competition may be fierce and unpleasant for the very market side.

Competition is limiting economic (and political) power.

� Competitors are prone to anti-competitive behavior – permanent problem!

The effectiveness of domestic competition law is restricted by multi-nationalization of firms.

� This requires international agreements wrt competition law.

� However, competition is benefitting from international competitors.



To judge the degree of competitive pressure in a market and to draw policy conclusions, it is sensible to analyze the international or interregional tradability of goods and services respectively.

� Tradables vs. non-tradables (difficult to distinguish in practice)

Examples are:

� Media in Germany, Spain etc. (language barriers, non-tradables)� Retail sector in Germany (tradable or not?)

Tradability is decisive for the contestability of markets. It is dependent on transaction costs and changes over time. It may increase due to deregulation or reductions in transportation or communication costs.

� Service trade in the European single market; increased remarkably since 1992, from non-tradables to tradables



Competition is often distorted in markets where government plays a role either as demander, supplier or regulator. Examples:

• Anti-dumping legislation is often pro-cartel-law;

• telecom markets and market for other utilities often are monopolized and run by parastatal or even state-owned enterprises (SOE);

• German cable cartel 1901 though 1997 (!);

• Monopoly of the Deutsche Post AG until 2007.

• Example for an exception: South African mill cartel 1999-2007

In fact, it is more difficult to find exclusively private distortions than (not necessarily officially intended but) officially backed anti-competitive behavior.

� As a consequence, the European Commission has been assigned the task to control domestic subsidies, since subsidies are distorting competition as well.



II. Models of Competition

a) Perfect Competition

b) Contestable Markets

c) Market Power

d) Concepts and Policy Models

e) Competition and Innovation



In this sections, we first distinguish different market forms and their effects on prices and quantities before we discuss theoretical concepts to organize the competitive process.

� Perfect competition as benchmark (heuristic concept)

� contestable markets;

� natural monopoly,

� duopoly;

� Harvard School;

� Chicago School;

� countervailing power

� German digressions

� the Austrians: competition and innovation



II.a) Model of perfect competition –Assumptions

1. Given resource endowment

2. Constant production technology

3. Constant product program

4. Given and constant preferences

5. Infinite reaction speed / unlimited mobility

6. Formal freedom of choice between alternatives

7. Homogenous goods

8. Atomistic market structure

9. Full market transparency

10. Unlimited divisibility

11. No involuntary exchanges



Model of perfect competition –Crucial results

� In equilibrium, the price equals the marginal costs (i.e. there are no rents).

� Producers are price taker and adjust the quantity accordingly (absence of market power).

� Perfect competition is statically efficient if the conditions are met.

� Deviations from the assumptions of the model of perfect competition lead to welfare losses (technological externalities, indivisibilities, information deficiencies, inflexibility).



p

q

MR

q1q2 q3

p1

p2

p3

X2

X1

X8

X6

DD

X7

X4 X3

X5

MC1=AC1

MC2=AC2

Source: Kerber(2007)

Figure 2.1: Perfect competition vs. monopoly



Model of perfect competition –Critique

Assumptions of the model are unrealistic ("Nirvana" accusation) �implicit threat of ongoing market intervention.

In the presence of subadditivities, an atomistic market structure is no suitable reference standard.

With an infinite speed of reaction there are no possibilities to achieve pioneer profits � insufficient incentive to innovate.

Static character of the approach; dynamics (e.g. economic growth) not explained.

Issue of the “optimum optimorum”.

Issue of the „second best“.



Neglect of the current market structure as relevant for the evaluation of competition processes.

Deviation from traditional paradigms (particular Harvard School: SCP); the market structure does not play a role for the contestability.

Already 30 years before Baumol et al introcuced as “plyopoly” by Fritz Machlup .

Literature:

Baumol, William J. et al. (1988), Constable Markets and the Theory of Industry Structure,

Revised Edition, San Diego et al.: Harcourt Brace Jovanovich.

Machlup, Fritz (1952), The Economics of Sellers‘ Competition, Baltimore: The Johns

Hopkins Press, Parts III and IV.

II.b) Concept of contestable markets –Basics



For the contestability of markets, in theory four conditions are decisive:

� no – private and/or public – barrier to entry (exit)

� sunk costs most important natural barrier to entry

� what are sunk costs?

� homogenous products

� the same technology for all firms

� established firm does not lower its prices at market entry (hit-and-run competition)



Concept of contestable markets –Determinants of the degree of contestability I

The contestability of a market depends inter alia on the irreversible investments, which are the market entry, as they

� represent sunk costs at the market exist (costs of failure).

� open the possibility for ruinous competition.

Total AC

Reversible AC

= short-term bottom price

Irreversible

AC

quantity

AC



� A preferably non-discriminatory access to sales and procurement markets (potential problems: customer retention, time required for the construction of a distribution network, a relatively poor market position for newcomers at procurement markets).

� Availability of the best technology (Problem: „learning by doing“-advantages for established).

� No further structural and strategic market barriers.

� No political-administrative market barriers.

� The rate of reaction of (the) established firm (s).

Concept of contestable markets –Determinants of the degree of contestability II



Concept of contestable markets –Competition policy recommendations

� Concentration is only a concern if the market is not or hardly contestable. It is not only the actual market structure that matters but also the potential competition!

� Not justified (objective and subjective) market access restrictions are to be reduced.

� Under certain circumstances, the promotion of the market entry of new providers would be an appropriate strategy for the containment of market power.



Combinations of irreversibility and subadditivity

III

Market with a tendency to

inflexibility

⇒ Possibly problems as of

adaption deficits.

IV

Natural monopoly, protected from

competition

⇒ Usually need for regulation.

I

„Normal“ market

⇒ No intervention required.

II

Natural monopoly, disciplined by

potential competition


low high

high

low

Irre

ve

rsib

ilit

y

Subadditivity



Concept of contestable markets –Critique

Sunk costs are recognized. What causes sunk costs? What is the difference between fixed and sunk costs?

Further conditions are unrealistic:

� homogeneous products rarely observed

� hardly the same technology for all companies

� presumably established supplier will nevertheless lower its prices at market entry (no hit-and-run competition)

What happens when loosening these three conditions? Will markets be more or less contestable?

� Rather more than less (see the Austrians)31



II.c) Market Power

Contents:

� Monopoly

� Cournot Duopoly

� Stackelberg situation

� Monopolistic Competition

� Bertrand Duopoly



Natural Monopoly –

Basics (I)

Average costs decline continuously with increasing production volume (in the relevant area)

Indivisibilities � subadditivity of the cost function

This results in economies of scale (both static and dynamic) and scope:

Economies of scale: C(Q) < C(q1) + C(q2) + ... + C(qn) with

Q = q1 + q2 + ... + qn

Causes:

� Fixed cost degression

� Principle of the least common multiples

� Two-thirds rule

� Law of large numbers and deficient products or substitutes

� Dynamic economies of scale (learning effects)



Natural Monopoly –

Basics (II)

Economies of scope : C(X + Y) < C(X) + C(Y)

Causes:

� Joint production

� Sharing of capacity

� Risk diversification, e.g. in R&D

� Cross-subsidization

Allocation effects of the natural monopoly

Marginal-cost-price-rule causes losses

Monopoly pricing causes dead-weight losses and redistribution from consumers to producers



Figure 2.2: Allocation effects of the natural monopoly

X2

X1

X6

X4

X3

pc

X5

pAC

pMC

C

demand

X5

p

MC

qc qAC qMC q

AC

MC

MR



The DuopolyBasics

The most interesting industrial economic problem from a theoretical and competition political point of view, is the problem of the oligopoly.

Characteristics of the industrial economic analysis:

� Analysis of markets and behavior of firms

� Microeconomic approach

� Concise theoretical derivations

� Drawing on game theory

� Analysis of equilibria

Source: Neumann, Manfred (2001), Competition Policy..., Chapter 2



The Duopoly –The Cournot case

Assumptions:

� two competitors

� homogenous goods and services

� identical cost functions

� linear relationship between the price p and the quantity Q;p = a - bQ, with a and b as variables for vertical and horizontal size of the market

Both firms behave strategically and profit maximizing. The strategic variable is the quantity needed to result in a price.

This stands in contrast to the Bertrand case.



In the first step, both companies set the production capacity and determine the price afterwards.

Thereby, they are dependent on their competitor’s decisions and respond accordingly. Profit maximization is pursued by the choice of output under the constraint of the competitor’s output.

The simultaneous profit maximization of both firms results in the reaction curves according to (1) to (5) and an equilibrium according to (6) to (9).



Cost function of firm 1:

(1)C1 = F1 + c1q1, with F1 = fixed costs and c1 = variable costs

Profit function of firm 1:

(2)Π1 = p(Q)q1 - c1q1 - F1, with p = a - bQ and Q = q1 + q2

(3) Π1 = [a - b(q1 + q2 )]q1 - c1q1 - F1 � max!

(4)dΠ1/dq1 = a - b(q1 + q2 ) - bq1 - c1 = 0

Thereof, the reaction curve is derived:

(5) q1 = R1(q2) = (a-c1)/2b - ½ q2

(5b) q2 = (a - c1)/b - 2q1

�inverse Reaction function (needed for drawing)

Analogously, it is derived for firm 2.

(5c) q2 = R2(q1) = (a-c2)/2b – ½ q1



qiMR

qi*

MC

AC

0

p

DD

Figure 2.3: Individual behavior of firm i

MR=MC

a-bqj

pi*



0 q1

q2

R1

R

2

C

Figure 2.4: Derivation of the reaction curve

a-c1

b

a-c2

2b

a-c1

2b

a-c2

b



In the Cournot case with n suppliers and identical costs F and c, following equilibrium emerges:

(6) q = [a-c]/[b(n+1)]

(7) Q = [n/(n+1)][(a-c)/b]

(8) p = (a-c)/(n+1) + c

(9) Πi = 1/b [(a - c)/(n+1)]² - F = bq² - F

The results are solely dependent on a, b and n as well as on the costs; fixed costs are purely level-changing.



How do the sizes change with increasing number of providers (dn> 0) and with increasing market size (da> 0, db <0)?

dn > 0 � dq < 0

� dQ > 0

� dp < 0

� d Πi < 0

da > 0 � dq > 0

� dQ > 0

� dp > 0

� d Πi > 0

db < 0 � dq > 0

� dQ > 0

� dp = 0

� d Πi > 043



How permanent is an equilibrium?

In the model, the competition ends in an equilibrium; in reality, however:

� demand preferences change;

� there are buyer‘s preferences for single products;

� companies try to reduce costs;

� process and product innovation;

� governments intervene;

� products are inhomogeneous;

� market entries;

� etc.

� Equilibria are difficult to imagine.

Therefore, we use the model as heuristic.44



Different cost functions in the duopoly

1.Assumption: c1 ≠ c2

From (6) one gets (6a) and (6b):

(6a) q1 = [a - c1 - (c1 - c2)]/ 3b

(6b) q2 = [a - c2 + (c1 - c2)]/ 3b

From (9), we move to (9a) and (9b):

(9a) Π1 = 1/b[[a - c1 - (c1 - c2)]/ 3]² - F = 1/b(bq1)² - F = b*q12 - F

(9b) Π2 = 1/b[[a - c2 + (c1 - c2)]/ 3]² - F = 1/b(bq2)² - F = b*q22 - F

European Competition Policy Winter 2016 / 17 45(c) Freytag/Fritsch, FSU

2016

2. Assumption: c1 increases, c2 stays constant;

The increase of c1 is not based on technological developments, but e.g. as of rises in input‘s prices:

Then, by applying the chain rule one gets:

(10a) ∂Π1/∂c1 = -4q1/3 < 0

(10b) ∂Π2/∂c1 = 2q2/3 > 0

Profits of firm 1 decrease, those of firm 2 rise as a result of the marginal cost increase in firm 1 at constant marginal cost in firm 2.

This corresponds to economic intuition.



Process innovation in the duopoly

Distinction in drastic and non-drastic innovations:

An innovation is drastic if it causes the monopoly price of the innovator to be lower than the competitors‘ marginal costs;

� rather unrealistic

An innovation is non-drastic if it simply reduces costs with the result of shifting market shares and profits in favor of the innovator;

� rather realistic

The effect of non-drastic process innovation can be seen analogous to the case of changes in cost of change (with reversed signs).



See e.g. the example of Neumann (2001, S. 53f); there, profits are simulated with different n and given costs.

With increasing n the innovating firm‘s profits are decreasing in absolute terms, but increasing in relative terms.

Therefore, there are sufficient incentives to innovate, a durable collusive equilibrium is not expected.

Conclusion from a dynamic perspective:

Price competition is at the same time always a technological competition through innovation.



Strategic trade policy

Transmission of the strategic considerations to the international division of labor; target is the diversion of rents from abroad to home.

First variation: import tariffs or quota

Assumptions: inhomogeneous goods, segmented markets.

The implementation of import tariffs or quotas enables the home country to snatch rents because of increasing domestic production and thus, increasing profits; see equations (6) to (9).

Sources: Neumann (2001), ..., pp. 54-56;

Krugman, Paul R. and Maurice Obstfeld (1994), International Economics, New York:

Harper Collins, 3. ed., chapter 12 (as well as newer editions).



Second variation: subsidies

Homogeneous goods (pure export goods) are produced with identical costs by two duopolists. The result of the maximization process corresponds to (6) to (9). One of the duopolists obtains a subsidy s.

C1 = c - s; c2 = c

from (6) one gets (11a) and (11b):

(11a) q1 = [a - c + 2s]/ 3b

(11b) q2 = [a - c - s]/ 3b

The amount of the subsidy arises from an optimization calculus:

(12) V (s) = Π1 - q1s



(13) V‘ (s) = [a - c - 4s]/ 9b

(14) s* = [a-c]/ 4

The subsidy increases national welfare even under the consideration of the financing of the subsidy through a lump sum; the welfare maximum is reached at s*.

The total production Q increases.

Consequently, the profit of the two firms under consideration is respectively:

(15a) Π1 =[a-c]²/ 8b

(15b) Π2 =[a-c]²/ 16b



The comparison of (9) and (15a) as well as (15b) shows that the total income Π(1+2) is reduced.

Without subsidy: Π(1+2) = 2[a - c]²/ 9b

With subsidy: Π(1+2) = 3[a - c]²/ 16b

Profit reduction: 2/9 > 3/16

Conclusion:

Strategic trade policy in a duopoly can -in the absence of reaction of foreign countries - lead to an increase of domestic and a reduction of foreign welfare when having a collective profit reduction.

Consumers in a third country (not at home and abroad) in the third country to benefit. Domestic taxpayers lose!



Criticism at the theory of strategic trade policy from a competition policy perspective

� no reaction from abroad assumed; in the case of such a reaction worldwide welfare losses occur (in reality as well as in the model)

� market entry at the home country are difficult because of the subsidy, but not impossible

� Information problem: identification of the sectors to be supported and of s* is difficult

� distribution I: domestic redistribution not considered; consumers/producers; imports/exports; e.g.: Airbus

� distribution II: effects on other (downstream) markets not considered; e.g.: Microchips/PCs in the USA

� distribution III: multinational firms are not considered

� political economy of strategic trade: rent-seeking



Stackelberg’s independence position

Assumption: The duopolists behave no longer symmetrically.

One reason may lie in different cost functions (this is excluded here).

A duopolist (firm 1) includes his competitors‘ reaction to his actions in his operations and acquires the independence position, while the other takes his competitors’ actions as given and acquires the dependence position.



As result in the basic model following (6) to (9), the total quantity is lower (75%), firm 1 behaves like a monopolist, firm 2 produces half of firm 1’s quantity.

Interpretation as sequential decision making:

Independence position is taken by a monopolist; sunk costs as a market entry barrier.

A second provider enters the market and settles for the dependence position in order to even survive in the market.

Thus, the rents are secured for both firms.



Fixed costs versus sunk costs

Fixed costs F play a great role as they lead to decreasing average costs.

In addition, there are sunk costs, which are characterized by the fact that they are lost with the market exit. Examples are:

� Expenditures for business formation

� Networks, e.g. a railway network

� Attending a university lecture

Sunk costs are a real barrier to entry � competition policy need for action.

Fixed and sunk costs are often seen as equal which is not necessarily the case.



Monopolistic competition

“Competition does not only pertain if firms are offering identical products but also if similar products are supplied which are substitutable as seen by the buyers“ (Neumann 2001, S. 58, own highlighting).

The statement is an understatement: competition usually takes place with similar products, there are only few examples for identical products:

� coal

� gasoline

� heating oil

� telephone minutes

But: Around these products, competition with services takes place; non-homogeneous products



The cross-price elasticity of demand is crucial for the ability to substitute:

(16) Ei(pj) = (∂xi/xi) (∂pj/pj)

= (∂xi/∂pj) (pj/ xi)

How does the demand for good i react to a price change of good j?

Distinction between complements and substitutes.

Competition policy relevant case:

� Complete information is not necessary

� Innovations are recognized

� Competition intensity increases compared to the case of identical goods



The Duopoly –The Bertrand case

Assumptions:

� two competitors

� heterogeneous goods and services

� (non-)identical cost functions

� linear relationship between the price p and the quantity Q;p = a - bQ, with a and b as variables for vertical and horizontal size of the market

Both firms behave strategically and profit maximizing. The strategic variable is the price leading to reactions of quantities.

This stands in contrast to the Cournot case.



Bertrand-equilibrium for heterogeneous products

Distinction in long and short term

Cournot: determination of capacities, long term Bertrand: determination of prices; short term

The duopolists are confronted with following demand curves for heterogeneous goods:

(17a) q1 = α1 - ßp1 + γp2

(17b) q2 = α2 - ßp2 + γp1

with Πi = [p1 - c1]q1 and ß > γ

Thereby, is α positively correlated with demand, ß and γ show own-price effects and cross-price effects.



From these, the response curves of the two competitors are derived (see figure 2.5):

(18a) p2 = - [α1 - c1ß]/ γ + 2ßp1/ γ

(18b) p2 = [α2 - c2ß]/ γ + γp1/ 2ß

In figure 2.7 it is assumed: c1 = c2 and α1 = α2.

The curves rise as the products are imperfect substitutes. If the price for good 1 increases, the demand for good 1 decreases; firm 2 can also raise the price.

Response to changes of ci and αi.



p2

p1

R1

R

2

p*

1

p*

2

ββββ

ββββαααα

222 c+

γγγγ

ββββαααα 11 c+−

0

Figure 2.5: Derivation of the reaction curves



Assessment of models of Market Power

Critique:

� strong dependency on unrealistic assumptions

� results change drastically if assumptions are changed

� limited possibility for policy conclusions due to assumption violations in reality

� lack of dynamic perspectives

� e.g. no reactions of foreign countries in strategic trade policy

� processes of innovation and imitation are ignored

But:

� some real cases could be explained very well with these models, e.g. the Microsoft case (more about this case in the exercise)

� IO-models provide a solid background for the development of advanced (dynamic or more realistic) models



II.d) Concepts and Policy Models

Contents:

� Harvard School

� Chicago School

� Countervailing Power

� German digressions

� the Austrians



Policy Models –Harvard School

� Workable Competition

� Response to the weaknesses of perfect competition, in particular to the unrealistic assumptions.

� Procedure:

� acceptance of incomplete competition

� market structure, market conduct, market performance

� direction of causality: S � C � P (with feedback)

� identification of the market structure leading to the best performance

� several indicators for performance (multigoal-approach)

� The SCP-paradigm leads to market tests of market performance, market conduct and market structure



Institutional framework in the markets

market structure

– concentration of supply

– barriers to entry and exit

– concentration of demand

– market transparency

– heterogeneity of products

– market phase

– economies of scale

and scope

– flexibility

– degree of diversification

– vertical integration

– personal and financial

relations

market conduct

– price strategy

– rebates and conditions

– quantity strategy

– capacities

– quality strategy

– product and process

innovations

– advertisement

– service

– attitude towards

cartels and other

forms of anti-

competitive behavior

market performance

– price level

– technological progress

(innovations)

– profits

– profits versus rents

– adjustment flexibility

– product quality

– product diversity

– efficiency of production

– transaction costs

(advertisement etc.)

– availability of products

Source: Kerber (2007)



The central ideas are:

� the danger of market power of single firms or groups of firms and itsabuse

� incomplete competition

� incomplete knowledge

Market concentration and profits are closely related; structural barriers to entry (Bain) are relevant:

� established firms may have an advance or head start through patents etc. (absolute cost advantage)

� established firms may have an advance or head start through well-known branded products(product differentiation)

� economies of scale

� Are these factors really barriers to entry?67



Policy Models –Chicago School

� Dissatisfaction with Harvard School and its tendency to intervene as well as its unclear and inconsistent objectives:

� efficiency is most important (reduction of dead weight losses matters)

� distribution between consumers and producers not in the focus of the analysis

� M&A may be beneficial; technological progress, transaction costs etc.

� general dislike of barriers to entry

� potential competition � contestable markets

� Normative conclusion: no policy interventions!

� Problem: underestimation of market power, too simple views on markets

68European Competition Policy Winter 2016 / 17(c) Freytag/Fritsch, FSU 2016

Policy Models –Countervailing Power



� If there is only a limited number of (powerful) actors on one market side, countervailing power can solve the problem and prevent anti-competitive behavior

� Equal power (e.g. bilateral monopoly) results in market performance comparable to perfect competition.

� Critique:

� Danger of a vicious circle with permanently increasing power of few actors on markets; reduction of competition;

� markets may not work like this if consumers’ interests are less well organized than producers‘ interests.

Policy Models –German Digressions I

German competition policy models were influenced by the Freiburg School of Economic Policy (Ordo).

The differences to Anglo-Saxon approaches are small, so we can deal with the German specialties briefly. Particularly relevant:

� Hoppmann’s concept of “Freedom to compete” (Wettbewerbsfreiheit)

� Kantzenbach’s concept of optimal intensity of competition

� Hoppman-Kantzenbach controversy



Policy Models –German Digressions II

Concept of freedom to compete (Wettbewerbsfreiheit)

Competiton is not only a means; it serves individual freedom:

� freedom, defined as

� freedom to act

� freedom to chose

is as important.

� Normative fundament, as a by-product other objectives of competition can be met.

� Normative conclusion: no active interventions (see below) but rules to prevent anti-competitive behavior of big players.



Policy Models –German Digressions III

� Another prominent German contribution to the debate is Kantzenbach‘s idea of an optimal intensity of competition (based on workable competition)

� This approach compares potential intensity with effective competition and the kind and degree of market imperfection in order to find an optimal intensity

� This can be calculated for each and every market individually.

� Normative conclusion of Erhard Kantzenbach:

� necessity to intervene into the markets

� polipolies and monopolies are to be changed into wide oligopolies by means of M&A and decentralisation

� justification: monopoly creates dead weight losses, polipolyprevents innovation, and tight oligoply creates too intense and fruitless fights or cartels etc.



Policy Models –German Digressions IV

Critique

� static approach

� interventionistic apporach

� threat of state failure for two reasons:

� enterprises can change market structure strategically

� pretence of knowledge

� relation between market structure and performance is speculative

� disregard of freedom

� Hoppmann-Kantzenbach controversy



The Austrians I

Competition as knowledge creating process (F. A. v. Hayek)

� Competition is a trial and error process, that should in the first place generates new knowledge

� on goods and service markets

� with respect to political decision mechanisms

� There is not be comprehensive and limited knowledge

� It is not possible to provide knowledge centrally



The Austrians II

Competition as a process of creative destruction (J.A. Schumpeter)

� Central to this approach: entrepreneurs

� Introduces new products or methods

� Old products/ methods are not longer necessary

� Old ones are replaced (destructed) by new products

� Process of innovation and imitation is initialized

� Focus on structural change: basis for the explanation of structural changes in the world economyThe possibility for new products and the existence of heterogeneity in products make markets even more contestable!

� In contrast the assumptions in II.b)



The Austrians III

Literature

� Hayek, F. A. v. (1978), Competition as a discovery procedure, In: F.A. v. Hayek (Ed.), New studies in philosophy, politics, economics,and the history of ideas, pp.179-190, Chicago: University of ChicagoPress.

� Schumpeter J. A. (1934), The theory of economic development, Cambridge, MA: Harvard University Press.

� Schumpeter, J. A. (1947), Capitalism, socialism and democracy, 2nd edition, London: George Allen & Unwin.



II.e) Competition and innovation

Main questions:

Is intense competition conducive for the performance of markets with regard to innovation or does high innovative performance of markets require

Large firms ? (Neo-Schumpeter hypothesis I)

Market concentration? (Neo-Schumpeter hypothesis II)

How do large and small firms perform in generation and the marketing of innovations?

Do large firms have an innovative advantage over small firms?

Is a concentrated market more innovative than a market characterized by perfect competition?

(c) Freytag/Fritsch, FSU 2016 European Competition Policy Winter 2016 / 17 77

II.e) Competition and innovation

1. Innovation and firm size

1.1 The Neo-Schumpeter hypothesis I

1.2 Results of empirical analysis of the relationship between innovation and firm size: Stylized facts

1.3 Explanation of the empirical findings: The Cohen-Klepper model

1.4 Radical innovation: The role of new firms

2. Supply-side concentration and innovation

2.1 The Neo-Schumpeter hypothesis II

2.2 Is a concentrated market more innovative than a market characterized by perfect competition?

3. It depends … on the type of market regime: Entrepreneurial and routinized regime

4. Summary of main results

(c) Freytag/Fritsch, FSU 2016 78European Competition Policy Winter 2016 / 17

II.e) Competition and innovation: Literature

Acs, Zoltan J. and David B. Audretsch (1988): Innovation in Large and Small Firms: an Empirical Analysis, American Economic Review, 78, 678-690.

Cohen, Wesley und Steven Klepper (1996): A reprise of size and R&D, Economic Journal, 106, 925-951 (!)

Motta, Massimo (2004): Competition Policy – Theory and Practice, Cambridge: Cambridge University Press, 55-63.

Winter, Sidney G. (1984): Schumpeterian Competition in Alternative Technological Regimes, Journal of Economic Behavior and Organization, 5, 287–320.

Baumol, William J. (2004): Entrepreneurial Enterprises, Large Established Firms and other Components of the Free-Market Growth-Machine, Small Business Economics, 23, 9-21.


Innovation and firm size: The Neo-Schumpeterhypothesis I

Basic statement: The amount of innovative activity increases more than proportional with firm size.

Reasoning:

Cost advantages of large firms in performing R&D (e.g. economies of size / scale, better access of large firms to resources on the labor market or on financial markets).

Large firms may benefit from stochastic economies of scale.

Size advantages in marketing (e.g., due to cost advantages, large marketing organizations may be able to sell large numbers rather shortly after product introduction).

Counter arguments: There may also exist disadvantages of size such as inflexibility, coordination problems, motivational problems of personnel in large organizations, bias against risky projects.


The likelihood of performing R&D increases with firm size.

R&D effort increases monotonously with firm size.

The size-elasticity of R&D effort is about the same in all size classes and has a value equal or smaller one.

The number of innovations per unit of R&D input (= R&D productivity) tends to be larger in small firms than in large firms.

� Do small firms have an innovative advantage over large firms?

Innovation activities in small and large firms: Stylized facts according to Cohen and Klepper (1996)


Cohen and Kleppers’ explanation of lower innovation per R&D input rates of large firms

Basic assumptions:

Innovations are not licensed or sold to other firms in disembodied form due to failure of the market for information and knowledge. � Return of R&D can result exclusively from spreading its benefits over the firm’s own output.

Firms account for ex-ante size of the respective business unit (q) when making their decisions about the amount of R&D to be performed. This implies that they do not expect to grow as a result of their R&D effort.

pc

r

Innovations lead to an increase of the price-cost margin (pc). This increase becomes smaller with a rising level of R&D input (r) (= decreasing marginal productivity of R&D input).

pc (0) = 0; pc’ (r) > 0; pc” (r) < 0.


The basic model of Cohen und Klepper (1996)

Gross return (e) of an innovation (e) is proportional to size (q), i.e.

e = pc(r) · q

What is the profit-maximizing level of R&D?

� Maximize π = pc(r)·q – r !

If pc'(r) = f / r (assuming f = constant), the profit-maximizing R&D effort (r*) results as:

r* = f · q

This means that that the profit-maximizing level of R&D is in a constant proportional relationship with size. Result is in accordance with empirical observation.


The effect of decreasing marginal productivity of R&D input on R&D project of small and large firms

pc‘

r

AB

C

FG

DE

IH

JK

Limit small firm

Limit medium sized firm

Limit large firm


Implications of Cohen and Klepper’s basic model

Higher average productivity of innovation activities in small firms is a consequence of their relatively low level of R&D activity. Lower average productivity of R&D activities in large firms results from decreasing marginal productivity of R&D.

Large firms have an economic advantage over smaller firms because they can realize higher gross returns (e) from a given increase of the price-cost margin (because of e = pc · q).

It may be profitable for large firms to invest in R&D projects that would be not profitable for smaller firms.

�Number and type of R&D projects conducted in an industry not only depend on the level of R&D expenditure but also on the size structure of the firms.


Radical innovation: Completely new type of problem solution� new product, i.e. creation of a new market.

Examples:

- Airplane - Micro-computer

- Internet economy - Biotechnology

- Xerography - Polaroid camera.

Empirical observation: Many radical innovations have been introduced by new firms. Baumol (2004) exaggerates by stating that all of the radical innovations of the 20th century have been introduced by new firms.

Radical innovation: The role of new firms

Innovative entry is a rather important element of market processes !!!


Supply-side concentration and innovation (Neo-Schumpeter Hypothesis II)

Basic statement: Innovation activity increases with concentration at the supply-side of the market.

Reasoning:

Firms with market power may have better opportunities to protect their products against rapid imitation � Longer time periods for realizing extra profits. � Higher profitability of R&D.

Monopolistic profits and the resulting financial resources enable firms to engage in relatively risky projects.

Counter arguments:

Incentives to innovate may be larger with intensive competition than in a monopolistic or oligopolistic setting.

Effective competition is an important stimulus for innovation!


Incentives to innovate in monopoly and under perfect competition

Incentive to innovate:

• perfect competition = ABDE

• 1st degree price differentiation = ABFE

• Monopoly = a + b – c

The lower the price elasticity of demand

• the larger c and

• the smaller b.

Quantity (X)MR

Cold

D

BA

E

P

MC

MR

Demand

MCold

MCnew

F

Cnewc

b

a


2016

European Competition Policy Winter

2016 / 1788

Empirical findings with regard to the relationship between supply-side concentration and innovation

activity

Relationships between supply-side concentration and the level of innovation activity are in most cases rather weak; quite often they cannot be identified at all.

As far as a relationship between supply-side concentration and innovation can be identified it is inversely u-shaped. As supply-side concentration increases innovation activity first rises, reaches a maximum and then decreases again.

At most, only 3 – 4 percent of differences between markets/industries with regard to innovation performance can be explained by respective differences of market structure.


Types of markets: Entrepreneurial (Schumpeter Mark I) and routinized (Schumpeter Mark II) regimes

Schumpeter Mark I-Regime:

High level of innovative opportunities, low level of appropriabilityand cumulativeness at the firm level ⇒ low level of concentration of innovation activity, high entry rates (entrepreneurial regime)

Schumpeter Mark II-Regime:

High level of appropriability and cumulativeness at the firm level ⇒high concentration of innovation activities on a relatively small number of actors (large firms), low entry rates (routinized regime)


Development of the number of suppliers over the product life cycle

Number of firms

‘Routinized’ regime‘Entrepreneurial’ regime

Shake out

Number of firms

Time

Net entry

Number of exits

Number of entries


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Innovation and competition: Main results

Large firms have an innovative advantage over small firms because they can realize higher returns on R&D due to greater volumes!

Most radical innovations are introduced by new firms.

Relationship between market structure and innovation activity is largely negligible.

Innovative advantage of large firms depends on the type of technological regime (≈ stage of the product life cycle).

Innovation activities of large and small firms tends to be in complementary fields.


III. Distortions of competition

a) Measurement of concentration

b) Mergers & acquisitions

c) Cartels

d) Critical behavior: predatory pricing, price differentiation, bundling, exclusive dealing


III.a) Measurement of concentration: Recommended readings

Bishop, Simon and Mike Walter (2010): The Economics of EC Competition Law: Concepts, Application and Measurement. London: Sweet & Maxwell, chapters 3 and 4.

Motta, Massimo (2004): Competition Policy – Theory and Practice, Cambridge: Cambridge University Press, 101-136.


Types of market concentration

Horizontal concentration, i.e. the concentration on the respective market (demand-side and supply-side concentration).

Vertical concentration (integration), i.e. firms are active in upstream or downstream stages of production or markets.

Conglomerate (diagonal) concentration, i.e. firms are active on several markets that are largely unrelated.

Macro concentration or aggregate concentration: The concentration of economic power (e.g., share of the top 100 firms).


Steps in the assessment of concentration

Definition of the relevant market (with respect to products, geography and time).

Choice of the unit for concentration measurement (e.g. establishment, corporate group).

Choice of the characteristic to be used for concentration measurement (e.g., employees, turnover, investment).

Gathering of the relevant data.

Quantitative description of concentration.


Possible criteria for delineating the relevant market I

With regard to products:

Physical and technological characteristics of products (e.g. chemical products, tape recorders, printed books).

Potential substitutes: Goods that serve the same needs (e.g. food, drink, mobility, entertainment); may be measures by cross price elasticities.

Functional substitution: All goods that a well informed customer regards as substitutes given their characteristics, their purpose and their price.

Flexibility in production (supply-side substitution).



A break in the chain of substitution

Area A Area D

Area E

Area C

Area B

Area F

There may exist monopolistic areas within a chain of substitution!

Hypothetical Monopoly Test

The market is correctly defined with regard to products if a lasting

price increase of 5 – 10 percent does not induce any significant

demand shift to other goods that serve as substitutes. If a price

increase does not lead to higher profits because of a shift of

demand toward substitutes, these substitutes have to be included

in the relevant market.


Change in profit (%)

Price increase

(%)

100 4

Relating changes in prices to changes in profit of the hypothetical monopolist

(c) Freytag/Fritsch, FSU 2016 European Competition Policy Winter 2016 / 17

Possible criteria for delineating the relevant markets II

Geographical, e.g.

Neighborhood,

Region (city and hinterland),

National market,

European market,

Global market.

With regard to time, e.g.

Season (e.g. high, low),

Time of the day (e.g., during office hours)

Day of the week (e.g., workdays, weekends)

In crises.


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Measures of horizontal market concentration of firms

Lerner coefficient:

Concentration ratio:

Herfindahl index:

Coefficient of variation:

Lorenz curve and Gini coefficient:

Standard deviation

arithmetic meanV =

P - MC

PL =

CRi = ∑ pi for pi = xi / X with X = ∑ xi (i=1,2,…n)

H = ∑ Pi

2

1

n

5025

75

100%

25

50

100%

75


Trends of supply-side concentration in Germany

Since the beginning of industrialization until the late 1960s/early 1970s: Increasing concentration, until World War II partly promoted by policy.

Since the early 1970s no clear trend. While some industries experienced an increase of concentration it decreased in others.

Current state of supply-side concentration in the manufacturing sector:

In four of the 26 industrial sectors CR10 > 90%.

In five sectors 50% < CR10 < 90%.

In 16 sectors 10% < CR10 < 50%.

In one sector CR10 < 10%.


III.b) Mergers and Acquisitions: Literature

Gugler, Klaus C., Dennis Mueller, B. Burcin Yurtoglu and, Christine Zulehner (2003): The effects of mergers : an international comparison. International Journal of Industrial Organization, 21, 625-653.

Motta, Massimo (2004): Competition Policy – Theory and Practice. Cambridge: Cambridge University Press, 231-243.

Malmendier, Ulrike, Enrico Moretti and Florian S. Peters (2012): Winning by Losing: Evidence on the Long-Run Effects of Mergers. Cambridge (Ma.): National Bureau of Economic Research, NBER Working Paper No. 18024.


Mergers and Acquisitions

Merger = Integration of firms; at least one party loses legal independence.

Acquisition = Takeover of a firm; the acquired firm does not necessarily loose its legal independence.

Mergers and acquisitions are one source of market concentration. They are, therefore, an important starting point of competition policy that tries to avoid market concentration.

Other sources of market concentration

Internal growth (success), and

Market exits.


The difference between horizontal, vertical, and conglomerate mergers


A B JIFE

C HD G LK

Horizontal Vertical Conglomerate

Mergers and Acquisitions in Europe 1985-2016

Source: Institute for Mergers, Acquisitions and Alliances.


0

200

400

600

800

1000

1200

1400

1600

1800

2000

0

2000

4000

6000

8000

10000

12000

14000

16000

18000

20000

Valu

e o

f T

ran

sacti

on

s (

in b

il.

EU

R)

Nu

mb

er

of

Tra

nsacti

on

s

Number of Deals

Economic assessment of mergers and acquisitions: Good or bad?

Generally: The involved parties expect higher profitability from the new larger unit. As far as this higher profitability results from improved competitiveness and productivity (and not from exploitation due to higher market power or restraining competitors)

� Economically desirable!

Particularly hostile takeovers: Hostile takeovers can be regarded a punishment of a relatively bad management by a superior management that expects a higher profit and higher firm value. The possibility of a hostile takeover stimulates the efficiency of the incumbent management. ⇒ desirable!

Possible disadvantage: Mergers and acquisitions may lead to increased market power that creates potentials to exploit exchange partners or to restrain competitors!


Mergers and aquisitions: Williamson’s trade-off-model

Quantity

Marginal cost before merger

Marginal cost after merger

C: Cournot supply after merger

Demand

Marginal revenue

B: P = Marginal cost. Supply before merger

Price

PC

PB

D

E

F

Cost reduction

Deadweight loss

Redistribution of consumer surplus to producer surplus

CEB larger or smaller than DFEPB ?


Critique of Williamson’s trade-off model

Mergers and acquisitions do not necessarily lead to cost reductions. They may also lead to cost increase due to inefficiencies (diseconomies of size).

The model is purely comparative-static in character and particularly disregards the effects on innovation activity.

The model can hardly be practically applied and serve as a decision tool for policy makers.


Chicago School: Let the market decide! Productive mergers will be successful and survive / grow; unproductive merger will lose market share. ⇒ No merger control necessary !

Main motives for mergers and acquisitions

Realizing „economies of scale“.

Realizing „economies of scope“ (synergies).

Faster establishment on new markets („economies of speed“).

Entering a new market without creating additional (excess) capacities.

Diversification of risk (conglomerate mergers).

Possibilities to split-up the firm and profitably re-sell the parts.

Increase of market power

Horizontal mergers: higher market share;

Vertical mergers: securing output markets or input sources;

Conglomerate mergers: greater financial power.

Higher management compensation ?


Methods of evaluating the success of mergers and acquisitions

Following abnormal returns of merged firms before and after the merger. BUT: Do all other firms on the market represent the correct counterfactual development, i.e., performance without the merger?

Malmendier, Moretti and Peters (2012): The counterfactual development is given by the losers in merger bids. ⇒ Compare abnormal returns of mergers with the losers in the merger bids!


Results of empirical studies of the success of mergers and acquisitions based on the development

of abnormal returns

The majority of mergers and acquisitions are not successful! About 40% are a disaster; another 40% are problematic and do not result in higher profitability.

The share of failures is particularly high with regard to pure intra-national mergers. Some studies also find relatively high failure rates for conglomerate mergers.

Firms that engage in mergers and acquisitions relatively often tend to be more successful than firms that have lower levels of experience in this field (learning effects).

Market entry by way of merger and acquisitions tends to be more successful as compared to building up own capacities.

Hostile takeovers tend to be more successful than „mergers of equals“.


Result of comparing abnormal returns of winners with those of losers in merger bids (Malmendier, Moretti and

Peters, 2012)

No significant differences between winners and losers before the merger bid.

In the first few quarters after the merger bid winners show a somewhat better performance.

In the longer run the performance of winners is on average only about 50 percent of the performance of losers.

⇒ Mergers are on average not economically more successful !


Why is the probability of failure with regard to mergers and acquisitions so high?

Uncertainty about the size of synergies is relatively high ex-ante. In most cases the benefits are overestimated !!

Integration of different firm cultures often turns out to be rather problematic !

There is strong pressure on the management as soon as the intentions for a merger/acquisition become public because

The attention of additional bidders may be drawn to the firms that is to be acquired � price increases.

Uncertainty about firm ownership and the future management may impede the course of business.

Positive effects of an acquisition (e.g. synergies) are often already included in the price � Price of acquired firm tends to be too high!.


III.b) Mergers and Acquisitions: Summary of main points

Merger activity has considerably increased over the last decades; a main reason is maybe globalization and market integration.

An important motive for many mergers is quick access to a new market.

Most mergers are not economically successful ! Support for the position of the Chicago School?

Management of mergers is a rather difficult task.


III.c) Cartels

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies, much less to render them necessary.

A regulation which obliges all those of the same trade in a particular town to enter their names and places of abode in a public register, facilitates such assemblies. It connects individuals who might otherwise never be known to one another, and gives every man of the trade a direction where to find every other man of it.”

Smith, Adam (1776), The Wealth of Nations, Books I-III, Harmondsworth, Middlesex:

Penguin Classics, Reprint 1986, pp. 232f.


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Transaction costs are not welcome. A welfare economics perspective suggest to reduce them. Examples:

� Publication of product tests (e.g., “Stiftung Warentest”) increases market transparency;

� Advertisement reduces (increases?) information cost

� Warranties reduce search costs;

� Liability law reduces (increases?) transaction costs;

� Rule of law reduces negotiation costs and leads to a reduction of insecurity.

It would be optimal to reduce transaction costs and anti-competitive potentials at the same time.


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Transaction costs and collusion

Transaction costs may however not only influence the choice between different market forms and the decision to acquire firms and merge with other firms, but also the tendency towards collusive behavior.

Again: markets vs. hierarchy!

Solution with the lowest transaction costs is chosen.

The question of whether or not to form a cartel may follow a similar calculus:

If [profits minus legal costs minus transaction costs] exceed the returns of legal behavior, then a cartel is attractive.


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Transaction costs and their impact on the firm in competition

However, transaction costs may be beneficial as they reduce the potential for collusion.

Cartel law, M&A-control, and regulation reduce collusion:

� Cartels require discipline, i.e. high transaction costs exist, punishments (in case of disclosure can be interpreted as transaction costs);

� mergers have the potential of abuse of market power; control increases transaction costs, trade-off with losses;

� Regulation increases opportunity costs of abuse of market power; however: costs of regulation.


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Transaction costs and cartels

Strategies to restrict competition

Source: Schmidt (2001)

Negotiation strategy

horizontal

vertical

coordination

cartels

vertical price fixture

vertical price

recommendation

licensing

Hindrance strategyde jure

de facto

boycott

price differentiation and

discrimination

exclusivity and bundling

Concentration strategy

external

internal

horizontal

vertical

conglomerate (diagonal):

- market widening

- Market linking

- Market diversification

Please check

how these

strategies are

affected by

transaction costs.


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� regarding the value added chain

� horizontal

� vertical

� diagonal

� regarding the cause

� negotiations, e.g. cartels

� hindrance, e.g. bundling

� concentration, e.g. M&A

Can be combined !


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Ways of restricting competition

Cartels and coordination

� Contract or other form of agreement between

� legally independent firms serving the same market aiming at

� constraining competitive options for the other side of the market.

Coordination does not require official contracts; self-enforcing contracts are necessary: e.g. moon phase rules, basing-point pricing

The economic consequences of both forms of collusion are similar

� We focus upon cartels.(c) Freytag/Fritsch, FSU

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Negotiation strategies

� Price cartel

� Quantity cartel

� Import cartel

� Export cartel

� Conditions cartel

� Production cartel

� Type cartel

� Norm cartel

� Rationalization cartel

� R&D cooperation


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Forms of cartels

� Market structure (SCP)

� Conditions of symmetry

� Utilization of capacities � high elasticity of supply

� Low price elasticity of demand

� Low income elasticity of demand

� Obligation to form a cartel

� external force

� internal force

� Formation due to governmental decision (public cartel).


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Determinants of cartel formation

� Reduced static and dynamic efficiency

� Performance-linked wage distribution not guaranteed

� Compliance with innovation function undetermined� strategic alliances in R&D; � are they distorting competition?

� Reduced flexibility of adaptation of enterprises

� Decrease of transaction cost decreased, particularly by means of standardization cartels

� problem of standardization; path-depedence; network externalities; pretence of knowledge


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Potential welfare effects of cartels

III.d) Critical behavior: predatory pricing, price differentiation, bundling, exclusive dealing

Vertical restraints of competition (resale price maintenance as well as recommended retail prices)

Characteristics of such vertical agreements. They are a contract or decision among

� legally autonomous enterprises in upstream or downstream stage of production with the objective to

� limit the competition-related freedom of action and decision of the other side of the market

With resale price maintenance agreements the competition at the downstream stage of production is restricted; Example book trade � elimination of price competition

Recommended retail prices less strictly handled.


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Effects of price maintenance agreements

Potential advantages:

� reduction of information cost due to higher level of transparency

� increase of planning reliability

� better advice due to elimination of price competition

Potential disadvantages:

� elimination of price competition leads to excessive prices

� growing risk of horizontal competition restrictions at the stage of production


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Hindrance strategies

Boycott and refusal of delivery

A distributor or customer is disposed not to supply other enterprises or not to buy any of their products.

Objectives:

� price-influencing (� distributor)

� restriction of distribution channels (� customer)� automobile industry

This strategy can only be valuated along with other strategies impeding competition.


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Price differentiation and price discrimination

Price differentiation per se is not problematic from the point of view of competition.

However, in combination with the market power, the possibilities to exploit price discriminations to restrain competition increase; it has do be distinguished between market power on the supply side and demand side.

Examples:

� flights (no market power)

� energy (market power on the supply side)

� supplier to the automobile industry (market power on the demand side)


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Price discrimination arises on the market of:

� the discriminating enterprise (first line) or

� the favored or discriminated enterprise (second line) or

� on third markets (third or fourth line)

Assessment criteria are

� individual protection

� institutional protection

There might arise trade-offs.

� Remark: price differentiation on international markets = Dumping!?


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Exclusivity and Bundling

Types:

� condition of exclusivity to distributors and customers

� exclusive distribution ties (personal, spatial)� automobile industry

� restriction on use

� informal bundling arrangements

� dto. without formal contracts


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Evaluation of the strategies impeding competition from a political perspective

Pro

� transaction cost saving

� service for technically complex devices

� extensive distribution, luxury etc.; retailer can be found easier

� rather usual on the market

Contra

� developing of market power

� artificial market entry barriers

� corresponds to vertical integration

� restriction of price competition(c) Freytag/Fritsch, FSU

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Governments as causes of distortions

Not only do enterprises impede competition, but also public authorities, partly on purpose, partly unintensional, namely if other political objectives (not analyzed here) are aimed for.

Analytically it can be distinguished between direct distortions or policy measures, which contribute directly, if not invite to distortions by private persons.

Practically this differentiation is more difficult, as the same regulation/selective support can have direct or indirect effects.

There is distortion between different sectors and within individual sectors.


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Intersectoral distortions

� Tariffs in favor of a sector

� market entry barriers

� public provision

Intrasectoral distortions

� import quotas

� subsidies

� market entry barriers (e.g. taxi business)

� public provision (e.g. radio broadcasting )

� guaranteed monopoly status (e.g. Deutsche Post AG)

� ministerial permission (for M&A)


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Measures of competition policy with a potential character of competition restriction

� areas of exception

� ministerial permission

� exceptions on the ban of cartels

� resale price maintenance

These measures are not implemented to distort competition, but to be able to react on certain competitive situations flexibly.

However, at times there is a direct distorting effect, e.g. in the case of the ministerial permission and the resale price maintenance, and a indirect distorting effect, e.g. in the energy sector (cable cartel).


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Restricting competition in economic policy

� Handicrafts regulation (discriminates between Meister and Gesellen)

� regulation of the labor market (may result in insider-outsider-problems; market power of bargaining parties)

� tax law (discriminates partly between form of ownership of enterprises)

� subsidies (discriminate between sectors and individual enterprises within a sector)

� sector-specific regulations (monopoly status of Deutsche Post AG discriminates against alternative supplier)

� Interstate Broadcasting Treaty (disadvantages of private supplier compared to public law institutions)

� technology funding (discriminates between enterprises)


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International trade and competition

� Tariffs I (discriminate between residents and foreigners, but not between different foreign suppliers; discriminate as well between import competition and exporters)

� Tariffs II (can be interpreted as abuse of a dominant market position; optimum tariff argument)

� export subsidies (unfair competition practices)

� import quotas and VER (discriminate between different foreign suppliers)

� anti-dumping policy (discriminates between different foreign suppliers and serves as driver of cartelization)

� public procurement procedure (discriminates between residents and foreigners)

� regional discrimination (discriminates between enterprises from member states and third countries)


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Development policy and competition

� development aid with tying of aid (discriminates between residents and foreigners

� exceptions to GATT in favor of developing counties (discriminates between residents and foreigners)

All specified politics have in common, that they disadvantage consumers in favor of producers and that they constrain competition in general:

� Institutional protection missed and

� Individual freedom reduced!


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Conclusions

Positive analysis: state interventions have regularly a restrictive effect on competition.

Particularly the problems caused by foreign economic policy are serious; beggar-thy-neighbour!

Normative claim: Therefore a control of the measure‘s proportionality assessment (objective-mean) is necessary.

Between residents and foreigners shall not be discriminated.

Conclusion: However, restrictive effects on competition of economic policy can never be totally excluded.


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Digression from Institutional Economics:Factor specificity

Another important aspect relevant for competition is factor specificity.

This implies that factors of production are highly specialized, so that they have difficulties to be of use in different assignment. The factor income would be much lower. These factor specificities include the following:

� Specificity of location;

� … of capital;

� … of human capital;

� … of dedication;

� … of branding;

� temporary specificity


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Fundamental transformation

Factor specifity changes the market structure indirectly.

Example downstream market: producers of automotive parts have invested specifically, from his perspective, a monopsonic market has evolved.

� Hold up!

After the specific investment the other market side has a special incentive to re-negotiate prices and conditions in order to skim the market (transaction costs specific quasi rent).

Conclusion:

Anticipation � underinvestment � vertical Integration, missing the economic optimum.(c) Freytag/Fritsch, FSU

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2016 / 17142

IV. Competition Policy

a) Regulation of natural monopoly

b) European competition legislation

c) Other countries’ competition laws

d) Competition and international trade


IV.a) Regulation of natural monopolies: Recommended readings

Viscusi, W. Kip, John M. Vernon and Joseph E. Harrington (2005): Economics of Regulation and Antitrust, 4th edition, Cambridge (MA): MIT-Press.

Fritsch, Michael (2011): Marktversagen und Wirtschaftspolitik, 8. Auflage, 187-216 (in German).

Textbooks in the field of “Industrial Economics“, “Industrial Organization” such as

Martin, Stephen (2010): Industrial Organization in Context, Oxford University Press.

Carlton, Dennis W. and Jeffrey M. Perloff (2005): Modern Industrial Organization, Boston (Mass): Pearson/Addison Wesley.


Combinations of irreversibility and subadditivity

III

Market with a tendency to

inflexibility

⇒ Possibly problems as of

adaption deficits.

IV

Natural monopoly, protected from

competition

⇒ Usually need for regulation.

I

„Regular“ market


II

Natural monopoly, disciplined by

potential competition


low high

high

low

Irre

ve

rsib

ilit

y

Subadditivity


Subadditivity and irreversibility in different industries

Industry Stage of production

Subadditivity Irreversibility

Electricity / gas Production

Distribution

No

Yes

Low

High

Letters / parcels Transport

Delivery

Questionable

Yes

Questionable

Low

Railroad Railway network

Freight- and passenger

transportation

Yes

No

High

Low

Telephone Local network

Wide area network

Terminal equipment

Yes

No

No

High

No

Low

Cable TV Program

Distribution

No

Yes

Low

High


Objections against the deregulation of market entry in case of natural monopolies

Market entry in case of natural monopolies leads to a multiplication of costs and ruinous competition !

Instability of natural monopolies and under-supply as a result of ‘cream-skimming’ behavior !


Is there a danger of cost multiplication and cutthroat competition in case of decreasing average costs?

No sunk cost High sunk cost

Is there a danger of cost multiplication in case of entry ? No Yes

May entry induce ruinouscompetition ? No Yes

Incentives for non-innovative market entry ? Normal Relatively low

Will entry lead to multiplication of costs and cutthroat competition? No No


Instability of a natural monopoly as a result of ‘cream skimming’ behavior

XH X0 XM

ACH

ACM

P0

ACP

0 Quantity (X)

Demand

Average cost (AC)


Arguments in favor and against entry regulation in case of an instable natural monopoly

In favor of entry regulation:

Securing full supply / Prevention of ‘cream skimming’.

Against entry regulation:

In many cases the cost function can not be determined with sufficient exactness.

The monopolist may try to exploit the customers – Regulation may be necessary.

Monopolist has only weak incentives to be efficient (in a static and in a dynamic sense).

The monopoly problem often only of a temporary nature – Legal entry barriers tend to be long-term effective and are difficult to abolish (in case that they are no longer justified).

Problems of under-supply can be solved in other ways (e.g., compulsory area-wide supply).


Alternative policy responses to problems of natural monopoly

Measures aiming to improve the contestability of markets (abolishing unjustified barriers to entry, stimulation of market entry).

Regulation of natural monopolies.

Measures aiming to prevent the emergence of high market concentration

Prevention of cartels and coordinated market behavior.

Prevention of a misuse of market power.

Merger control.


Alternative ways of regulating natural monopolies

Restricting the activities of the monopolist to the monopolistic bottleneck (essential facility).

Price regulation.

Auctioning a monopoly position for a limited time.

Creating countervailing power.

Regulation of the output quality and of business conduct (e.g. obligation to contract).


Examples for a monopolistic bottleneck and upstream / downstream steps of value-added

Value-added step Economic sector

Railway Electricity / gas Telephone

Upstream Railway vehicles, control

technology

Generation Telecommuni-cation

equipment

Monopolistic bottleneck

Railway network

Distribution network

Local area network

Downstream Transport services

Marketing Telecommuni-cation

services

European Competition Policy Winter 2016 /

17 153

(c) Freytag/Fritsch, FSU 2016

Arguments in favor and against restricting the activities of a monopolist to the essential facility

In favor of a restriction

Monopolistic profits enable firms to adopt „predatory pricing“.

A monopolist that is also a supplier on downstream markets may have an incentive to discriminate against the competitors on that market with regard to the use of the essential facility.

This could be done by means of the prices charged to downstream competitors for using for the essential facility or by non-price measures (e.g. unnecessary restrictive conditions for the use of the essential facility, allocation of unattractive slots).

Against restriction

Restriction of economic activity to the essential facility may lead to a loss of economies of scope.


Alternative methods of price regulation for natural monopolies

Cost-oriented methods

Obligation to marginal cost-pricing and public transfers for covering the respective deficit.

Pareto-optimal quantity of supply and covering the deficit by means of price differentiation.

Obligation to cost-effective prices: Average cost-pricing and Ramsey pricing.

Obligation to non-discriminating prices for the monopolistic bottleneck.

Regulation of profits.

Price cap regulation.

Equity-oriented price regulation (e.g. nation-wide equal prices for mail and telecommunication services).


Obligation to marginal cost-pricing and public transfers for covering the respective deficit

Concept:

The regulated firms has to take prices according to marginal costs; the state compensates for the deficit that emerges from such a pricing behavior.

� Price and quantity are pareto-optimal.

Problems:

Determining marginal costs. Short-term, mid-term or long-term marginal costs? Problems of determining marginal costs in multi- product firms.

Only weak incentives for the regulated firms to be economically efficient.

Who pays for the deficit?


Pareto-optimal quantity of supply and covering the deficit by means of price differentiation

Concept:

The regulated firm is allowed to apply price differentiation in order to cover the deficit.

�Quantity of supply tends to be pareto-optimal.

Problems:

Not the first-best solution because a marginal condition for a welfare optimum (equal prices for everybody) is not fulfilled.

Price differentiation must be possible (requires an effective prevention of re-sale).

There is a danger that the monopolist is absorbing more consumer surplus than is necessary for covering the deficit. ⇒ Price-control may be necessary.



Obligation to cost-effective prices: Average cost-pricing and Ramsey pricing

Concept:

Supply at cost-effective prices (average cost-pricing or Ramsey prices). ⇒ Policy is not aiming to attain a firs-best optimum.

Advantage:

Determining average costs is much easier than determining marginal costs.

Problems:

Ramsey-Prices very difficult to calculate.

Price controls may be necessary in order to limit excess profits.



Welfare losses of cost-effective prices if average costs are decreasing

The higher the price elasticity of demand the larger the welfare loss if prices are set above marginal costs (e.g. according to average costs).

B´DC < A´EC.

Averagecosts (AC)

Marginal costs (MC)

Quantity (X)

ACMC

N

N'

E

DF

C

A B

PG

AC

AC'

MCP

P

A‘

B‘


Obligation to non-discriminating prices for the monopolistic bottleneck

Relevance:

In case that the owner of a monopolistic bottleneck is allowed to supply on downstream markets.

Concept:

Prevent the extension of monopoly power to downstream markets by discriminating competitors with regard to the usage of the bottleneck resource.

Problems:

The problem of determining the non-discriminating price is unsolved.

The owner of the bottleneck may apply other methods of discrimination that are not based on prices.


Profit regulation

Concept:

The price of the monopoly firm should result in appropriate returns to the capital invested.

Problems:

Requires information about the value of the capital and the profits necessary.

Creates an incentive to capital-intensive production. ⇒Misallocation of resources.

What is an appropriate return capital? How to account for entrepreneurial risk?



Price cap regulation

Concept:

The regulation authority sets an upper limit for price increases (price cap). This price cap is oriented at the inflation rate and the average productivity growth in the respective industry. ⇒ Higher incentives to be dynamically efficient than with cost-oriented regulation.

Problems:

Determination of the average productivity increase. [There may be no other firm (or only some very few) because of a monopoly.]

There is an incentive to increase profits by reducing the quality of output.


Equity-oriented price regulation: equal prices nation-wide

Concept

Motivated by considerations of ‘justice’ politicians require from monopolies to set the same prices nation-wide even though the costs differ considerable across regions. Examples: Costs for a telephone extension, costs of mail services.)

Problems

Leads to misallocation if the costs of provision differ across regions.

Better: Subsidize those persons or regions that are in need.


Auction of a monopoly position for a limited time

Concept:

Competition for a monopoly position. The highest bid wins the auction. Time limitation secures dynamic efficiency.

Advantages:

The most efficient bidder will succeed.

The organizer of the auction is absorbing large parts of the monopoly rent and can distribute it.

Problems:

Regulation of prices, quality, and of business conduct (e.g. obligation to contract) may be necessary.

The auction procedure may not be well working.

The incumbent suppliers may have a competitive advantage (higher efficiency due to learning by doing) over other bidders in the following auctions.


Alternative policy responses to problems of natural monopoly: Summary and conclusions

The different methods of price regulation can not solve the problem completely.

Regulation is not a fully adequate substitute for competition !

Policy should limit the activities of the monopolist to the monopolistic bottleneck in order to avoid any disturbance of competition on upstream and downstream markets.

The time-limited auction of a monopoly position can be a good approximation of the optimum.

Regulation of prices and profits only if a time-limited auction is not possible.


IV.b) European Competition Legislation

1. Development of Competition Policy in Germany and in the EU

2. Legal basis and main actors of Competition Policy in Germany and in the EU

3. Main regulations of Competition Policy in the EU

3.1 Agreements, decisions, and concerted behavior

3.2 Abuse of market power

3.3 Mergers and acquisitions

3.4 Control of State aid


IV.b) European competition legislation: Recommended readings

Treaty on the Functioning of the European Union (2010/C 83/01, TFEU), Articles 101-113, particularly Articles 101, 102, and 107.

Bishop, Simon and Mike Walker (2010): The Economics of EC Competition Law: Concepts, Application and Measurement. London: Sweet & Maxwell, Chapters 5 and 6.

Hildebrand, Doris (2009): The Role of Economic Analysis in the EC Competition Rules, 3rd edition, Alphen aan den Rijn: Kluwer Law International, 7-93.

Motta, Massimo (2004), Competition Policy, Theory and Practice, Cambridge: Cambridge University Press, 1-38, 270-292.

Schmidt, Ingo and André Schmidt (2006): EuropäischeWettbewerbspolitik und Beihilfekontrolle – Eine Einführung, 2. überarbeitete und erweiterte Auflage.


Competition Policy in Germany

Main actors

Federal Ministry of Economics and Technology.

Federal Cartel Office (independent agency assigned to the Federal Ministry of Economics and Technology).

Monopoly Commission (since 1973).

Courts: District Court of North-Rhine Westphalia (“Oberlan-desgericht Nordrhein-West-falen”)

Federal High Court of Justice (“Bundesgerichtshof”, BGH).

Main legal sources

Law against restraints of competition (“Gesetz gegenWettbewerbsbeschränkungen”, (GWB) of 1957, 8th novel as of June 2013.

Fair Trade Law (“Gesetz gegenunlauteren Wettbewerb”, UWG) and othe laws such as Copyright Law).


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2016 / 17168

European Competition Policy

Main actors

European Parliament

Council of Ministers of the European Union.

European Commission (General Directorate Competition).

European Court of Justice.

Main legal sources

Articles 101 – 113 of the Treaty on the Functioning of the European Union (TFEU), particularly Articles 101, 102, and 107.

Regulations and guidelines of the European Commission (e.g., merger guidelines).


2016


2016 / 17169

Objectives of European Competition Policy

Create a common internal market including all Member States of the EU.

Secure an open market economy with free and undistorted competition.

Strengthening competitiveness of the European Union.

Growth and welfare !!!

The EU Competition Policy intervenes only if the trade between Member States is distorted by certain practices. Anticompetitive practices that affect only competition within a Member State are subject to national competition law.

EU Competition Policy applies also to firms not located in the territory of the EU. The critical point is that they influence the directions of trade within the EU.


European Competition Policy: Main fields of activity

Prohibition of anticompetitive horizontal and vertical agreements (cartels, restraints, etc.). [Art. 101]

Prohibition of an abuse of a dominant market position (e.g. exploitative behavior). [Art. 102]

Merger control. [Art. 102]

Promotion of trade between Member States by abolishing unnecessary regulation (e.g., freedom of establishment and services, EU services directive). [Art. 106]

Control of state aids in order to prevent a distortion of competition within the Common Market. [Art. 107, 108]


Industries where EU Competition Policy does not fully apply

General exemption: Agriculture.

Special regulations apply for

Railways, road haulage, transport by sea.

Air traffic,

Insurances.


Article 101 (1) of the TFEU: Anticompetitive agreements, decisions and concerted behavior

Prohibits „all agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition within the internal market, and in particular those which:

(a) directly or indirectly fix purchase or selling prices or any other trading conditions;

(b) limit or control production, markets, technical development, or investment;

(c) share markets or sources of supply;

(d) apply dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage;

(e) make the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts.


Article 101 (1) TFEU: Interpretations

Agreement, recommendation of an association and concerted practice.

Appreciability: Enforcement practice of the Commission and judgements by European Courts require that the restriction according to Art. 101 (1) must be ‘appreciable.’ This requires a definition of the relevant market and an assessment of the size and the market share of the parties involved.

Object or effect on competition within the internal market: The critical factor here is that the directions of trade is affected. It is not necessary that trade between Member States is factually distorted but the agreement, decision or concerted practice must be capable of having that effect.


Article 101 (2, 3) TFEU

(2) “Any agreements or decisions prohibited pursuant to this Article shall be automatically void.”

(3) “The provisions of paragraph I may, however, be declared inapplicable” if an agreement, decision of associations, or concerted practice “contributes to improving the production or distribution of goods or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit, and which does not:

(a) impose on the undertakings concerned restrictions which are not indispensable to the attainment of these objectives;

(b) afford such undertakings the possibility of eliminating competition in respect of a substantial part of the products in question”.


Article 101 (3) TFEU: Interpretations and general practice

In order to qualify for an exemption under Article 101 (3) the net effect of the agreement must be positive.

For undertakings seeking an exemption under Article 101 (3) it is necessary to produce documentary evidence, that an exemption in justified. ⇒ Burden of proof to establish the net benefit of an agreement is on the parties.

No ex-ante control of agreements (⇒ no obligation to notify the authorities) but ex-post evaluation. ⇒ Problem of limited predictability of legal decisions.

The Commission issues more detailed criteria for exemptions of agreements under Article 101 (3) in order to improve the predictability of legal decisions. The Commission also issues guidelines for good practice.


Criteria for exemptions according to Article 101 (3) TFEU: Vertical agreements

Preconditions

� Agreements must not contain ‚hardcore restrictions‘ (e.g. resale price fixing, allocation of market or customers, limitation of output or sale) and

� The market share of the suppliers must be below 30 percent.

� Possible block exemptions (legal restrictions / agreements):

Agreements concerning exclusive dealing (exclusive purchasing, sole distribution).

Tying and bundling (e.g. franchising)


Criteria for exemptions according to Article 101 (3) TFEU: horizontal agreements

Agreements about common R&D ⇒ Sum of market shares should be ≤ 25%.

Agreement concerning specialization of production (division of labor) ⇒ Sum of market shares should be ≤ 20%.

Common procurement ⇒Market power is assumed to be not

excessive if the sum of market shares is ≤ 15%.

Marketing cooperation ⇒ Sum of market shares should be ≤ 15%.

Agreements about norms and standards with regard to technological and qualitative standards of products and production methods.

Agreements concerning the protection of the environment.


Article 102 of the TFEU: Abuse of a dominant market position

“Any abuse by one or more undertakings of a dominant position within the internal market or in a substantial part of it shall be prohibited as incompatible with the internal market in so far as it may affect trade between Member States.

Such abuse may, in particular, consist in:

(a) directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions;

(b) limiting production, markets or technical development to the prejudice of consumers;

(c) applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage;

(d) making the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts.”


Definition of „dominant market position“ in EU Competition Policy

Undertakings are in a dominant position when they have the power to behave independently without taking into account to any substantial extent, their competitors, purchasers, and suppliers. It is not necessary for the undertaking to have total dominance such as would deprive all other market participants of their commercial freedom, as long as it is strong enough in general terms to devise its own strategy as it wishes.

Requires the definition of the relevant market.

Main criteria applied:

Market share and market share of competitors,

Financial power,

Technological advance, intellectual property rights

Entry barriers and potential competition,

Structure of the opposite market side, dependence of customers.


What can be regarded exploitative behavior according to Article 102 (a) TFEU?

Four main cases:

To charge unfairly high prices from customers,

To extort unfairly low prices from suppliers,

To impose unfair trade terms and conditions of sale on purchasers or on suppliers, which they would not accept in case of effective competition.

Predatory (ruinous) pricing (?)


Basic problems of price controls in order to impede exploitative pricing

General problem: What is the correct price?

If the hypothetical reference price is too high, exploitation is accepted .

If the hypothetical reference price is too low, firms may be forced to make losses or exit.

Critique:

Attempts to determine a hypothetical market result are not in accordance with the character of competition as a discovery procedure (pretence of knowledge). [Are price controls compatible with a market economy ?]

Such a policy tries to cure symptoms. It would be better to eliminate the reasons for exploitative behavior (e.g. market power or inadequate regulation).


Methods for determining the hypothetical price under competition

Cost control: Does the price considerably exceed average costs?

Problem: Data may not be available. Problems of calculating costs for single product in large multi-product firms.

Profit control: Is the price cost margin of the dominant firm considerably higher than the price cost margin of firms that are subject to considerable competition?

Problem: Reliable information may not be available, particularly in case of multi-product firms.

Compare with prices of the respective good under conditions of effective competition, particularly with prices in other regions/countries.

Problem: Comparable markets may not exist.


Article 102 (b) TFEU: Limiting production, markets of technical development to the prejudice of consumers

Possible negative effects: May lead to prices significantly above costs (Cournot behavior).

Examples:

Discontinuance of production of spare parts for a product that is no longer in supply.

Restrictions of markets or of customers supplied by distributors or to cut-off supplies to certain purchasers.

Restrictive use of intellectual property rights by a dominant firm may limit access to the use or development of a new technology-

Only few decisions by the Commission or the Court with respect to Art. 102 (b).


Article 102 (c) applying dissimilar condition to equivalent transactions

Subject of regulation: Discrimination between different trading partners (customers or suppliers) in the terms and conditions of trading, with the result that some are disadvantaged.

Possible negative effects:

Exploitation of customers by price differentiation.

Distortion of competition if some customers are advantaged over their competitors.

Critical issue: Are transactions alike? Does not require identical prices and conditions throughout the Community but differences should be tolerable and justifiable. Price discrimination not generally regarded to be abusive.

Discrimination should not be used as part of a policy of dividing markets. [May also fall under Art. 102 (a) and (b).]


Article 102 (d) TFEU: Tying

Subject of regulation: A dominant firm makes the conclusion of a contract with a non-dominant firm subject to acceptance by the other party of supplementary obligations which have no connection with the subject of such contract. Presupposes two different products rather than a combination of different components in a single product. [May also be critical with regards to Art. 101 (3).]

Negative effects of tying:

Reduces the degrees of freedom for the tied partner.

Extends the market strength of the dominant firm from the market of the tying product to the market of the tied product.

Possible justification of tying: Secure the functioning of the tying product and the reputation of the dominant firm (e.g. franchise agreements).


Abuses not directly covered by the examples in Article 102 (a)-(d) TFEU

Subject of regulation:

Refusal to supply or of access to a resource

Dependence of customers (i.e., in terms of alternative suppliers) important. Particularly critical if the good is a monopolistic bottleneck. Sudden withdrawal of supplies may also be critical. Refusal to supply requires an ‘objective justification’ to be acceptable.

Predatory pricing (pricing that aims at elimination or seriously weakening of a competitor), such as

Selective price-cutting,

Unprofitable or barely profitable price levels (dumping),

Pricing aimed at a specific competitor.

Exclusionary rebate schemes (e.g., fidelity rebates) that do not reflect costs and aim at tying customers.


Different causes of market concentration and possible policy reactions

Internal growth of firms � Limit further growth, dissolution.

Problems:

Misallocation of resources,

Reduced incentives to be successful and grow,

Political feasibility.

Market exit � State subsidies to prevent exit

Problems:

Misallocation of resources,

Reduced incentives to be economically efficient.

Mergers and acquisitions (external growth) � Merger control

Problem:

Assessing the positive (greater static or dynamic efficiency) and the negative consequences (increased market power and maybe political influence).


Merger Control in EU Competition Policy

� Merger Control was initially not intended.

Policy is legally based on Art. 102 TFEU as an abuse of a dominant market position. The policy wants to prohibit mergers that constitute or strengthen a dominant market position.

First proposal of the Commission for a Merger Regulation in the year 1973.

EU Merger Regulation (4064/89) adopted in 1989.

Method: Strict ex-ante control.


EU-Merger Regulation [139/2004]: Thresholds and criteria (Art. 1)

Worldwide turnover of all enterprises involved >

5 Bn. Euro?

and

Community-wide turnover of at least two of the

involved enterprises > 250 Mio. Euro?

More than 2/3 of the

community-wide turnover

in one Member State

only?

Merger is of importance for the Common

Market � Application of EU Merger Regulation.

Yes

Competition Law of the

respective Member State

should be applied.

Yes


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EU Merger Control [139/2004]: Criteria for the appriasal of mergers (Art. 2)

A merger will be declared not compatible with the Common Market if it would significantly impede effective competition in the Common Market or in a substantial part of it, particular as a result of the creation or strengthening of a dominant position. “In making this appraisal, the Commission shall take into account

(a) the need to maintain and develop effective competition within the common market in view of, among other things, the structure of all the markets concerned and the actual or potential competition from undertakings located either within or outwith the Community;

(b) the market position of the undertakings concerned and their economic and financial power, the alternatives available to suppliers and users, their access to supplies or markets, any legal or other barriers to entry, supply and demand trends for the relevant goods and services, the interests of the intermediate and ultimate consumers, and the development of technical and economic progress provided that it is to consumers' advantage and does not form an obstacle to competition”.


Article 106 of the TFEU: Public enterprises

“1. In the case of public undertakings and undertakings to which

Member States grant special or exclusive rights, Member

States shall neither enact nor maintain in force any measure

contrary to the rules contained in the Treaties, in particular to

those rules provided for in Article 18 and Articles 101 to 109.

2. Undertakings entrusted with the operation of services of

general economic interest or having the character of a revenue-

producing monopoly shall be subject to the rules contained in

the Treaties, in particular to the rules on competition, in so far

as the application of such rules does not obstruct the

performance, in law or in fact, of the particular tasks assigned to

them. The development of trade must not be affected to such

an extent as would be contrary to the interests of the Union”.


Article 107:State aid

1. Save as otherwise provided in the Treaties, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market.

2. The following shall be compatible with the internal market:

(a) aid having a social character, granted to individual consumers, provided that such aid is granted without discrimination related to the origin of the products concerned;

(b) aid to make good the damage caused by natural disasters or exceptional occurrences;

(c) aid granted to the economy of certain areas of the Federal Republic of Germany affected by the division of Germany, in so far as such aid is required in order to compensate for the economic disadvantages caused by that division. …”.


Article 107:State aid (continued)

“3. The following may be considered to be compatible with the internal market:

(a) aid to promote the economic development of areas where the standard of living is abnormally low or where there is serious underemployment, and of the regions referred to in Article 349, in view of their structural, economic and social situation;

(b) aid to promote the execution of an important project of common European interest or to remedy a serious disturbance in the economy of a Member. …

(c) aid to facilitate the development of certain economic activities or of certain economic areas, where such aid does not adversely affect trading conditions to an extent contrary to the common interest;

(d) aid to promote culture and heritage conservation …;

(e) such other categories of aid as may be specified by decision of the Council on a proposal from the Commission”.


Competition Policy in the USA

Main actors:

Antitrust Division of the U.S.

Department of Justice (exclusively

responsible for application of the

Sherman Act).

Federal Trade Commission

(exclusively responsible for unfair

competition practices according to

Sec. 5 Federal Trade Commission

Act).

Regulatory Commissions (special

rules for certain industries).

District Courts or Administrative

Law Judge, Court of Appeals,

Federal Supreme Court.

Legal basis:

Sherman Act (1890)

Clayton Act (1914)

Federal Trade Commission Act

(1914)

Further laws:

� Robinson-Patman Act (1936):

Prohibits discrimination

� Hart-Scott-Rodino

Improvements Act (1976):

Requires ex-ante registration

of large mergers.


2016


2016 / 17195

Competition Policy in the USA: Sherman Act (1890)

Prohibits horizontal and vertical agreements, concerted behavior, and mergers that monopolize, or attempt to monopolize the market as far as these behaviors are „unreasonable“.

Is mainly based on „rule of reason“. Some kinds of behavior are regarded as “unreasonable” per-se (e.g., price agreements).

Provides the possibility to split up dominant firms.

First Competition Law of a modern State. ‚Anti-Rockefeller Law‘. Main objective: Control of economic power.


Competition Policy in the USA: Clayton Act (1914)

Prohibits

Price discrimination (independent of the market power of the discriminating firm),

Tie-ins and exclusive dealings,

Mergers,

as far as they lead to a considerable reduction of the intensity of competition or may tend to create a monopoly.

Prohibits interlocking directorships of companies that compete in the same market.

Supplements the Sherman-Act. Objective: Prevent attempts of monopolization already in its early stages.


Competition Policy in the USA: Federal Trade Commission Act (1914)

Legal foundation of the Federal Trade Commission.

Protection of effective competition.

Protection of enterprises against unfair competition practices.

Supplements the Sherman-Act. Contains comprehensive general clause that prohibits “unfair methods of competition and unfair or deceptive acts or practices”, that affect the terms and conditins of trading.


Main differences between Competition Policy in the EU and in the USA (I)

Discrimination

USA: Generally prohibited.

EU: Prohibited for enterprises with a dominant market position.

Possibility of a demerger of monopoly firms

USA: Yes.

EU: No.

Prohibition exploitative behavior

USA: No.

EU: Yes.

Possibility of private litigations for damage

USA: Up to treble damage.

EU: No.


IV. d) Competition and international trade

Competition takes place increasingly globally. Firms in one country affect the competition in other countries.

Main questions:

� Is there a need for international coordination?

� What is the relevant market?

� Is the theoretical basis sufficient?


Competition and international trade -Introductory remarks (I)

Before discussing the global organization of competition, there are some fundamental questions.

What does international coordination of competition policy mean?

There are three approaches:

1) Level of coordination

� target level

� conceptional level

� instrumental level


2) Case by case reconcilement vs. reconcilement on principle

� regulatory policy vs. process policy

� rule binding vs. discretion

� supply-side policy vs. demand-side policy

3) Institutional basis vs. loose arrangements

� Global organization of competition

� By-product of other frames (G8, WTO, OECD)

Generally anything is conceivable. To better clarify these questions clearly, it is necessary to draw upon theoretical frameworks.

Source: Donges, Juergen B. and Andreas Freytag (2009), Allgemeine Wirtschaftspolitik, 3. ed., Stuttgart: Lucius & Lucius, chapter VII.


When does international coordination of competition policy theoretically make sense?

As long as competition policy and other policy areas are applied in a way that they distort competition, it does not make sense.

It does make sense if the behavior of private individuals in country A affects the welfare of private individuals in other countries.

� Spillovers

and if there is clarity about the economically reasonable answer on competition policy at the same time

� Low uncertainty


This is principally applied for all policy areas, in which there is a need of coordination with regard to economic policy:

� global environmental policy

� international monetary policy

� international crime combat

� security policy

� development policy

� education policy

� etc.

International policy coordination is not justified in all cases. On the basis of figure 4.1 reveals the authorization to coordination can be identified.


Figure 4.1: Guideline for global competition policy

Source: Klodt, Henning (1999), Internationale Politikkoordination, Leitlinien für den globalen Wettbewerbspolitiker, Kiel.

strong spillovers

high degree of

uncertainty


Please assign the following examples to the appropriate 4 quadrants of figure 4.1:

� Supply of telecommunication services until the end of the 1980s in Europe

� German cable cartel 1901-1997

� Anti-dumping policy and cartelization

� Merger of Edeka / Tengelmann

� Merger of Boeing / McDonnell Douglas 1996/97

� Subsidies for the Airbus since 1974

Obviously, not all cases relevant for competition policy are also a case for international policy coordination.


Role of the international tradability of goods

Goods, which are internationally non-tradable, do not require international coordination of competition policy – national competences are sufficient.

Internationally tradable goods have to be observed more critically; spillovers may be possible.

The borderline between non-tradable and tradable goods is fluent and changes permanently,

� transaction costs


Role of contestability of markets

On contestable markets there is no need for coordination in particular.

However, rules or test schedules to analyze the cases and to determine the form of coordination should exist. Rules themselves are already a form of coordination.

Conclusions from the theoretical considerations:

� There is need of coordination with regard to rules; there is mainly a collective need of omission.


Political economy considerations

Governments may use international rule binding to cancel specific regulations, protection measures or other restrictions of competition:

� dirty work hypothesis

� direct effect

Both can have strong disciplining effects:

� liberalization of telecommunication

� MFN principle

Problems of coordination are the presumption of knowledge and the cementing of structures.


Types of international competition policy

Basically there are seven types of international coordination of competition policy:

� mutual recognition of the effects doctrine

� mutual recognition of the territoriality principle

� mutual consideration of interests (negative comity)

� mutual request of administrative assistance (positive comity)

� international leading cartel authority (Lead Jurisdiction Model)

� international harmonization of the anti-trust law

� establishment of a world cartel authority (under the WTO or differently organized)


Mutual recognition of the effects doctrine (I)

The effects doctrine implies that the country, in which the restriction of competition takes effects, makes use of the competition law against the foreign initiator.

1. Unilateral application

� Example USA, Germany until 1999

The problem of the unilateral application is the asymmetry of countries: Rule of Law vs. Right of the strongest!

Besides that, a worsening of the negotiation atmosphere may come up.


Mutual recognition of the effects doctrine (II)

2. Mutual agreement: Example: US-EU Agreement

Advantages:

� decrease of transaction cost

� competition of competition systems

� no long-lasting negotiations

Disadvantages:

� race to the bottom is possible

� possibility of excessive interpretations to protect domestic enterprises � trade policy!


Mutual recognition of the territoriality principle

The competition distorting measure has to take effect on the domestic market and had to emerge from the home country.

Relevant is the economic activity on the domestic market - the measure may also emerge from the parent company abroad.

1. Unilateral application

� Example: United Kingdom

2. Mutual recognition

Advantages and disadvantages are similar to those of the effects doctrine.


Mutual consideration of interests (negative comity)

The competition authority of the acting country is consulted by the country of effect ; its interests are taken into consideration.

Advantages:

� avoidance of dual actions

� ex-ante coordination of actions

� improvement of the atmosphere

� no ex-ante harmonization necessary

Disadvantage:

� politically difficult to enforce


Mutual request of administrative assistance (positive comity) (I)

The competition authority of the acting country is asked to initiate adequate competition policy measures by the country of effect .

A priori it is not explicitly clarified, whose competition law applies.

Advantages:

� avoidance of dual actions

� ex-ante coordination of actions

� improvement of the atmosphere

� no ex-ante harmonization necessary


Mutual request of administrative assistance (positive comity) (II)

Disadvantages:

� high level of information demand

� confidentiality/secrecy is affected

� race to the bottom is possible (but unlikely)

Example:

Closer Economic Relations Trade Agreement between New Zealand and Australia; there are obligations to

� complete the competition law

� Waiver of AD-measures

� cooperate once the competition law is applied


International leading cartel authority (-ies) (Lead Jurisdiction Model)

An international panel or a forum of competition authorities appoints case by case one or few national authorities, which carry out the procedure.

Advantages:

� decrease of transaction cost

� contradictory decisions can be avoided

Disadvantages:

� politically difficult to enforce

� divergent interests


International harmonization of the anti-trust law

Agreement on a consistent competition law or rather on minimum standards; either multilateral or plurilateral.

Advantages:

� agreement on standards = improvement on a global level

� behavior of the State will be put on the test � from a politico-economic point of view rather a disadvantage

Disadvantages:

� minimum standard = too low standard?

� competition of policies eliminated

� Possible overtaxing of numerous governments


Establishment of world cartel authority (under the WTO or differently organized)

Global competition cases are examined by a world cartel authority.

The renouncement of national sovereignty is an advantage and disadvantage at the same time.

Advantage: Protection and industrial policy is not possible any longer

Disadvantage: low acceptance, particularly in the USA!

A world cartel authority may only be established in conjunction with a world anti-trust law (international harmonization).


Specific proposals for a global organization of competition

Draft International Antitrust Code (IAC, Fikentscher and Heinemann)

� There is no unitary law. Starting point is the national anti-trust law,

� however, there are relatively high minimum standards,

� domestic and foreign citizen are treated equally with respect to the competition policy. This is in accordance with Article III of GATT,

� the area of application is limited to cross-border issues,

� the rules are to be transferred to national law. To enforce the rules two institutions are established: an international anti-trust authority as well as the International Antitrust Panel.


The cases, in which the IAC comes into effect, are similar to those in the German anti-trust law:

� Horizontal and vertical limitations to competition (cartels, price fixing, exclusivity contracts/agreements); foreign trade cartels are prohibited,

� control of mergers,

� abuse of dominant market positions.


Advantages:

� there are just minimum standards

� limitation of beggar-thy-neighbor

� increase of legal certainty

Disadvantages:

� agreement on minimum standards is difficult

� acceptance of both supranational institutions is questionable

� political implementation is difficult

� massive effort; experience suggests the chances that this proposal is successful are currently small

Conclusion: Problems of implementation ought to excel its advantages.


TRAMs (I)

Propositions for the coordination of competition policy within the world trade order are numerous, e.g. TRAMs (IIE) and TRACLAP (critics: Hindley).

Concerning TRAMs:

� subsidiary companies of foreign companies are treated as domestics; additionally an agreement on the protection of investment is necessary

� international control of cartels and other anti-competitive agreements

� complete registration of anti-competitive practices, which lead to consultations between members

� notification of M & As is obligatory

� TRAMs plus: possible registration of safeguard clauses like AD-measures


TRAMs (II)

Critique:

� TRAMs is a proposition related to reality without

� ex-ante harmonization and

� new institutions,

� but also without

� a far-reaching elimination of safeguard clauses concerning trade policy (at least optional),

� the consideration of other areas of politics as well as

� the tightening of the anti-trust law.

� Under consideration of the political enforceability, the TRAMs is dominating the IAC.


Reduction of trade barriers and increase of global contestability of markets: no special competition policy

Globalization of competition only makes sense, if it is not undermined by other politics or by the application of the domestic competition law itself. In addition the weaknesses of other propositions have to be considered:

� Requirement of harmonization and individual state sovereignty

� Obviously, role of propositions are put forward on the WTO-level (Singapore issues = EU-issues)

� Potential welfare enhancements by systems competition is given up?

Therefore it is necessary to focus on the most essential areas:

� national government

� international trade policy (particularly on AD-policy)

� subsidies

� exceptions of the competition law(c) Freytag/Fritsch, FSU 2016 European Competition Policy Winter 2016 / 17 225

Domestic competition barriers (non-tradeble goods) are eliminated by domestic competition policy. The elimination of distortions of the state (as it is hoped!) increases the contestability of markets.

Some time later there may arise additional need for regulatory.

Advantage:

This proposition may be introduced unilateral, so that the national welfare can be increased without discriminating others

� “unilateral globalization“, “globalization from below“.


Literature (selection)

Fikentscher, Wolfgang and Frank Heinemann (1994), ‘Der "Draft International Antitrust Code"

- Initiative für ein Weltkartellrecht im Rahmen des GATT‘, Wirtschaft und Wettbewerb, 44, 97-

107.

Freytag, Andreas and Ralf Zimmermann (1998), ‘Muß die internationale Handelsordnung um

eine Wettbewerbsordnung ergänzt werden?‘, RabelsZ, 62, 38-58.

Graham, Edward M. and J. David Richardson (1997), Competition Policy for the Global

Economy, Washington D.C.: Institute for International Economics.

Hindley, Brian (1996), ‘Competiton Law and the WTO: Alternative Structures for Agreement‘,

Jagdish Bhagwati and Robert E. Hudec (Eds.), Fair Trade and Harmonisation - Prerequisites

for Free Trade , Vol. 2: Legal Analysis, Cambridge/Mass. and London: MIT Press.

International Competition Network: http://www.internationalcompetitionnetwork.org/index.html.

Klodt, Henning (1995), ‘Internationale Regeln für den Wettbewerb‘, Wirtschaftsdienst, 556-61.

Marsden, Philip (2003), A Competition Policy for the WTO, London: Cameron May.

Meessen, Karl M. (1998), ‘Souveränität im Wettbewerb der Systeme‘, Volkmar Götz, Peter

Selmer and Rüdiger Wolfrum (Eds.), Liber amicorum Günter Jaenicke - Zum 85. Geburtstag,

Berlin, Heidelberg und New York: Springer Verlag.

Messerlin, Patrick A. (1994), ‘Should Antidumping Rules Be Replaced by National or

International Competition Rules‘, Außenwirtschaft, 49, 351-73.

Monopolkommission (1998), Marktöffung umfassend verwirklichen, Hauptgutachten XII

1996/1997, Baden-Baden: Nomos.


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