Reforming European competition policy

Abstract

Operating a complex competition policy, the EU intends to ensure undistorted competition within the Single Market. Today, with competition being increasingly necessary for Europe in order to combat the challenges of globalisation, the global crisis has shed light on some of the existing weaknesses in the system, especially regarding consumer welfare. In this article, the author brings to light the importance of implementing an economic approach to competition policy. This approach offers more consumer protection as well as giving businesses the opportunity to freely choose the most profitable commercial practices available to them.

The need to reform European competition policy

Europe needs to boost its competitiveness to deal with the future challenges of the world economy, both to remain effective in the market and to take advantage of–-instead of incurring losses due to–-the entrance of emerging countries into the market.

Furthermore, Europe needs to close a substantial productivity gap between itself and the United States. According to some analysts, the United States–-the country in which the recent economic crisis originated–-will most probably recover faster than any country in Europe. The reason for this assertion is that the economic structure of the US, which is overall quite competitive and flexible, will allow for a relatively fast recovery, while the overly rigid, protected and, in many sectors, non-competitive European economy will encounter more difficulties.

A process leading to a more competitive Europe will necessarily involve two sides of the same coin. On one hand, it will mean enacting sound economic policy measures which directly aim at increasing the efficiency of the economy. This will mainly be the responsibility of EU policymakers and individual Member States, which are in charge of the implementation of proper structural, fiscal and monetary policies and reforms. On the other hand, it will entail setting out proper rules and procedures that aim at removing all possible hindrances to the efficient functioning of economic activity. This task, which has been delegated to the European Commission at the EU level and to national competition authorities at the Member State level, is exactly within the scope of competition policy.

To be more specific, large firms and corporations usually have the capability to affect, through their business practices, relevant aspects of the market in which they operate, such as prices, the quality and variety of products, investment and levels of innovation. Under some circumstances, the rationale of profit maximisation that guides these firms may lead them to use their market power to the detriment of the functioning of the market. The precise scope of competition policy is to identify and ban such anti-competitive behaviour.

Competition policy thus consists in overseeing the correct functioning of the market, and the correct functioning of the market is in turn an important tool for promoting economic growth and social well-being. Furthermore, many of the most common macroeconomic policies, both fiscal and monetary, will be largely ineffective if applied to a market system that does not function well in terms of its general competitive conditions. A careful and efficient competition policy is, thus, of the utmost importance for making macroeconomic policy work.

What is more, in our time we are experiencing a lack of confidence in the capability of free competition in the market to guide the economy towards a broad and satisfactory level of social well-being. In the wake of a looming recession worldwide, many EU countries are, in fact, being lured more and more into adopting protectionist instead of liberal policies. It is a future challenge for policymakers and for EU institutions to restore confidence in the market system as a tool for achieving social and economic well-being. This challenge will not be won unless institutions are able to put conditions in place that will restore the proper functioning of the market. An effective competition policy constitutes an important step in this direction.

However, the current organisation of competition policy in Europe is largely unsatisfactory in many respects. Cases against anti-competitive behaviour tend to last too long, cost an enormous amount of public resources to run and do not provide for standards consistent across jurisdictions and across similar competition cases, thus failing to signal to firms the best practices (the less anti-competitive ones) to follow. As a consequence, the current administration of competition policy in Europe may not provide firms with the right guidance and incentives for behaving competitively in the market.

A main reason for this is the fact that currently the administration of competition policy is seen more as a legal exercise than as a deep investigation of the economic consequences of the various business practices implemented by corporations. In other words, the current focus of competition authorities is more on the commercial form that business practices take than on their true economic consequences. It is no surprise, then, that competition policy in Europe not only may fail to induce and support more efficient economic activity, but may also be perceived as–-and indeed constitutes–-a further hindrance to the efficient functioning of markets. As an upshot of this state of affairs, a broad reform of the principles governing competition policy in Europe is being currently debated at the EU level. In particular, an approach to competition policy that is more economically based has been sketched and suggested in recent influential papers (see, for example, [5,8], and has started to be taken into consideration by European institutions. ¹

1

See for example the proposed reforms of Articles 81 and 82 of the Treaty of Rome and of merger control in the communications from the European Commission [2,3] and the European Council [4], respectively.

The debate is ongoing and should become broader and more widespread, especially after the decision of the European Commission in December 2008 to adopt this economic approach in addressing the reform of Article 82 of the Treaty of Rome. ²

2

The debate is heated. See Lang [6], who tries to defend the current juridical approach to competition policy. An answer to his arguments can be found in Gual et al. [5], who also provide for addressing concrete competition cases. With different arguments, a defence of a more economically sound approach to competition policy can be found in Martin [7].

In this paper, I take a position in favour of the economic approach to competition policy and elaborate on it. The following section describes the approach and contrasts it–-under several different rubrics–-with the approach currently followed by authorities in Europe. The third section briefly introduces some more features of the economic approach; the fourth and final section presents some conclusions. A much broader and more complete analysis of the economic approach to competition policy can be found in Calciano [1].

The economic approach to competition policy

The principal aspect of the economic approach is that it establishes a consumer welfare standard as the main criterion for evaluating competition cases. A consumer welfare standard prescribes that a certain business conduct, implemented by a certain firm, be considered as anti-competitive and banned by competition authorities if and only if it harms consumer welfare. ³

3

There is some controversy in the economic literature about using consumer welfare or total welfare (consumers plus producers) as the right measure of welfare. This issue is beyond the scope of this paper. We acknowledge, however, that we would favour consumer welfare as far as competition policy is concerned.

A first important feature of the economic approach is that with a consumer welfare standard as a guiding criterion, competition policy can be systematically grounded in sound economic analysis. In fact, economic theory allows one to evaluate how an industry, or the economy as a whole, performs in terms of the satisfaction of consumer needs. This does not mean that economics provides for easy and empirically usable measures of consumer welfare, as likewise it does not provide for empirical measures of competition. Nevertheless, an important part of economics is devoted to studying conditions under which practices in the market will injure the welfare of consumers. Therefore, and if we decide to follow an economic approach, it is these practices that must be sanctioned by a competition authority and not others. Against this backdrop, economic theory can certainly help to distinguish the business practices which lead to higher levels of consumer welfare from those that may instead harm consumers.

The goal of competition policy, with a consumer welfare standard as a guide, is neither to protect competition per se, nor to protect competitors in general. On the contrary, its main goal is to protect the well-being of consumers. The economic approach suggests that the criterion that competition authorities should use in assessing whether a certain business practice is anti-competitive or not consists in asking the following question: does the business practice harm consumer welfare or not? This is the sole fundamental question that each competition authority must always bear in mind.

Unfortunately, the use of a consumer welfare standard is not the current practice in the exercise of competition policy in Europe. This does not mean that consumer welfare is not taken into consideration in concrete competition cases. On the contrary, it is. But the whole body of current competition policy is instead organised by case-law analysis of the various business practices of firms. In such a framework, consumer welfare is only one of the various issues that may be brought to the attention of the courts. In the economic approach, however, consumer welfare is the exclusive organising principle in the design and implementation of competition policy.

Let us elaborate on this point in more detail. The current case-law approach to competition policy in practice translates into a ‘checklist’ approach. With such an approach, potentially anti-competitive behaviour is classified according to a list of categories of conduct, such as predatory pricing, various forms of discrimination, targeted rebates, tying, bundling, exclusionary contracts and market foreclosure, to give only some common examples.

With such a list in hand, competition authorities verify (1) whether a firm is dominant or not in its market, ⁴ and (2) whether the firm has adopted some of the practices on the checklist. If the answer to both questions is affirmative, the firm is fined and forbidden to continue the practices. If the answer to one of these questions is negative, the competition case is dismissed.

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If a firm is non-dominant in its market (for example, if it is small), the view is that it can do only minor competitive harm. This is also the view taken by the European Court of Justice in the so-called de minimis doctrine, according to which those firms that are small in size or that have a small share of the market are generally cleared of allegations of anti-competitive practices.

The main issue with the checklist approach is, of course, in the use itself of a checklist. The problem is that different commercial practices can serve the same anti-competitive purpose. For example, predatory pricing can take the form of offering lower prices to competitors’ customers (price discrimination), or the form of fidelity rebates that are in fact tailored to the specific needs of competitors’ customers. The predator can also engage in tying and bundling of products, whenever competitors’ customers are particularly interested in the products in question. To continue, a firm that wants to dominate a market may explicitly refuse to deal with other firms, or may also establish non-written exclusive-dealing arrangements.

However, under the checklist approach all the aforementioned practices are considered distinct practices and are treated separately. This discrimination of practices according only to their commercial form has at least three unfortunate consequences.

1. 1.

   The practices receive different treatment according to different case-law traditions, different jurisdictions and even different national legal standards, with some practices possibly enjoying a relatively more permissive attitude than others, in spite of the fact that they serve the same anti-competitive purpose. This fact makes competition policy less predictable, with the consequent damage to the normal business activity of firms.

2. 2.

   A company that has been caught using a certain practice may well shift to a second, different practice that entails the same anti-competitive effect and that differs from the first only in terms of legal details and features (this has been the case, for example, in the Michelin saga). With the checklist approach, a new competition case has to be opened against this firm, which may then shift again to a third practice serving the same purpose just as well. Therefore, and as a result of using a checklist approach, competition cases usually tend to last longer and absorb a greater amount of public resources. Furthermore, the checklist used by competition authorities will never be complete; new anti-competitive practices can always be invented and implemented by firms.

3. 3.

   We now come to the third and perhaps most negative consequence of using a checklist approach. If a firm can pursue the same anti-competitive purpose by using a variety of different business practices which are treated and sanctioned differently, this allows the firm to choose which practice to follow in order to minimise the risk of being caught and, eventually, to receive the lowest possible fine. Thus, a checklist approach allows firms to arbitrage among different practices and among different jurisdictions to pick the practice that entails the lowest risk of being judged by a court. In other words, the checklist approach has the consequence of signalling to firms what the ‘best way’ to violate competition rules is, given the anti-competitive effect that a firm wants to pursue.

The economic approach, by contrast, ensures that different business practices are treated consistently. Specifically, two different business practices harming the welfare of consumers in a comparable way are to be treated similarly, independently of their commercial and legal forms. When this is done, the three negative consequences considered above with respect to the current checklist approach disappear and, at the same time, new, desirable features emerge. Let us consider how this can be the case.

1. 1.

   With the economic approach the predictability of competition policy will increase, because the policy would be based on a common, sound and unifying principle known to all market actors: the protection of consumer welfare. Firms need clear, predictable rules to carry out their economic activity.

2. 2.

   With the economic approach there will be no need to continuously expand the checklist with new anti-competitive practices, because the only thing that matters is the consequence of the practice for consumer welfare, not the commercial form of the practice itself. An enormous variety of potentially anti-competitive conducts will be grouped into much broader classes according to the effect that they have on consumer welfare, as suggested by economic theory. Competition policy will, in this respect, be simplified and run more rationally and more effectively, saving public resources, reducing the duration of competition cases and above all having a much clearer concern for the protection of consumers.

3. 3.

   Finally, and even more importantly, if competition policy follows the economic approach, firms will be led by the structure of competition policy itself to choose the practices that least harm consumer welfare and not choose those that are simply more difficult to detect due to their commercial form. An economic approach to competition policy will signal to firms the best practices in terms of lowering the probability of damaging consumer welfare, and will give firms the right incentives to adopt those practices.

To summarise, the consumer welfare standard would establish a common foundation for assessing the potential harmfulness of an enormous variety of business practices which are, at present, judged on the basis of their legal differences instead of on the basis of their similar economic consequences for the well-being of consumers. In so doing, the economic approach would make competition policy more predictable, more consistent and better organised. Above all it would put the protection of consumers definitively and legally at the centre of attention, giving the right incentives to firms to be responsive to consumer needs in their search for economic efficiency and profits.

Some other features of the economic approach

If competition policy is reformed according to the economic approach, competition authorities will give more attention to the general economic context in which a business practice occurs. In fact, a given business practice may harm consumers in a specific economic context, while in a different economic context the same practice may be beneficial to them. In the first case, the business practice should be sanctioned, whereas in the second case it should be allowed.

This observation makes clear that a main feature of the economic approach is not to prevent the authorities from discriminating among the business practices of firms. On the contrary, authorities must discriminate, but this should be based on the right economic principles and always with the concern of consumer welfare in mind.

Consider, for example, the relationship between market power and incentives for firms to innovate. This relationship is not straightforward. The economic literature points out that the impact of market power on innovation depends on the market context at stake. Furthermore, a firm will never produce innovation if it is not sure that it will be able to appropriate the revenues from the innovation, or in other words, if it cannot exert some market power on the use of the innovation.

An innovative firm may try to gain this market power in a variety of ways. For instance, it may patent the innovation whenever this is allowed and thus receive exclusive rights for its use. Or it may refuse to sell the new technology it has invented to competitors. Or again, it may establish exclusive contracts and relations to provide the new technology only to a restricted number of other market participants.

The last two practices are exclusionary and anti-competitive in nature and would be grounds for sanction by a court under a strict checklist approach. However, under an economic approach, these practices may be allowed if the market context suggests that the practices are strictly needed for the firm to appropriate the revenues from its innovative activity; for example if a proper law on patents is not available in the industry under consideration.

In general terms, under the economic approach firms will be free to choose the most profitable practice under the sole constraint that it does not harm the welfare of consumers. No other obstacle will be put in the way of the business strategies of firms. This will promote economic efficiency and growth to the benefit of consumers.

Another advantage of the economic approach is that it would help to keep the lobbying process in balance. Large companies are generally better organised and acquainted with competition cases than consumers, and hence competition decisions may tend in some cases to be influenced by corporations and bigger companies, through the normal lobbying process, more than by simple consumers.

Against this backdrop, adopting an economic approach may help to balance this difference in access to the lobbying process by different stakeholders. As a matter of fact, consumer welfare has been established as the main criterion for the enforcement of competition policy, it will be the general responsibility of policymakers and a statutory responsibility of competition authorities to take the interests of consumers systematically into account.

As a result, the economic approach to competition policy would help to keep the lobbying processes in balance by making competition authorities more responsive to consumers’ needs when confronted with the lobbying pressure of firms and corporations.

Conclusions

This paper has supported an economic approach to European competition policy, in the belief that such an approach would ameliorate the design of current European competition policy in many respects.

The economic approach puts the protection of consumers definitively at the centre of attention, and gives the right incentives to firms to be responsive to consumer needs in their search for economic efficiency and profits. In the economic approach to competition policy, firms’ business practices will not be judged on the basis of their commercial form, but only on the basis of their effect on consumer welfare. Firms will be free to choose the most profitable commercial practice under the sole constraint that it does not harm the welfare of consumers. No other obstacle will be put in the way of the business activity of firms. This will foster economic efficiency and growth to the benefit of consumers.

Furthermore, by adopting the economic approach, competition policy will be reorganised and simplified and will be run more effectively, absorbing a smaller amount of public resources, keeping the lobbying process more balanced and providing for more predictable and consistent competition rules.