The Role of Competition in a Market Economy

Competition Law Associates Windhoek, March 2014 1

Industrial Organization and Competition Policy

 Industrial Organization is a field of economics that studies the strategic behavior of firms, their interaction and the structure of markets  Competition Policy is the study of policy options for promoting healthy competition in the market place  Competition Law is the legislated expression of those competition policy choices that a government has adopted.

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The Gale of Creative Destruction

 Joseph Schumpeter used this term in his 1942 book “Capitalism, Socialism and Democracy” to describe the process of competition  Competitive markets in continual process of transformation  Entry, innovation and entrepreneurship are essential to sustainable economic growth  Winners and Losers 3

The Role of Competition Authorities

To protect the process of competition in order to:  Promote the efficiency and adaptability of the economy  Facilitate the opportunity for business to participate in world markets  Ensure that SME ’ s have an equitable opportunity to participate in the market  Provide consumers with competitive prices and product choices 4

Functions, Powers and Duties of Competition Authorities

 S.16

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Competition Not an End in Itself

 Economic Benefits – efficient resource allocation, growth, innovation  Consumer Welfare Effects – lower prices, better quality, greater choice  Governance – less need for government intervention, reduced regulation 6

Economic Benefits

 In 1889, a year before the Sherman Act, Canada passed into law an “ Act for the Suppression of Combinations, Formed in Restraint of Trade ”  The framers understood what is still true today: healthy competition encourages “ large aggregations of capital ”  It is this capital, these investments that result in economic growth and job creation  The forces of competition lead to the innovation, economic transformation and renewal that Schumpeter pointed out were necessary to sustain growth  The pressure of competition creates the need which is the “ mother of invention ” and innovation.

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Efficiency

 Economists speak of dynamic efficiency and static efficiency the latter includes allocative and productive efficiency  Allocative efficiency is macro. Competition forces competitors to make efficient choices resulting in the efficient allocation of resources across the economy.

 Productive efficiency is micro. Competition forces firms to save resources in the production process  Dynamic efficiency – competition encourages innovation and invention which results in increases in productivity and overall welfare 8

Welfare Effects

 Adam Smith stated that the ultimate purpose of all production was consumption and without the latter, the former has no purpose  As such efficiency in production should only be an intermediate goal  Allocative efficiency achieved through competition results in lower prices, better quality and more choice  Allocative efficiency tends to be more egalitarian at the macro level (across the economy) 9

Governance

 Competition law enforcement is the lightest form of government regulation or intervention in the market  Allows competitors to freely make choices unless they violate the law – reduces regulatory oversight  The cost of administering competition law is far below that of regulatory oversight  The cost of collecting, administering and distributing excess rents is likely to be far above the cost savings foregone by prohibiting a monopoly  Firms try to limit competition by pressuring government to impose costly trade restrictions or regulation 10

Market Definition

 When analyzing anti-trust cases, competition authorities are called upon to define the relevant markets  This consists of Product and Geographic markets  Although tools used in the analysis and relevant evidence may apply to both it is critical that these exercises are treated separately  Product market analysis must always be done first 11

Relevant Product Market

 Hypothetical monopolist  Critical loss analysis  Own price elasticity of demand  Price cross elasticity of demand  End use of the product  Technical or physical characteristics of the product  Switching costs 12

Relevant Geographic Market

 Hypothetical Monopolist test  Actual shipping patterns, imports, exports  Transportation modes and costs  Frequency of shipments, inventories  Natural and artificial barriers (rivers, borders)  Currency exchange rates 13

Market Power

 Ability to impose a small but significant non-transitory increase in price that cannot be defeated by competitors or customers  We call this the SSNIP test  1- 2 year measurement period  Price is used as a proxy for service terms and quality 14

Three Main Areas of Concern

 Conspiracy and Bid rigging – considered to be the most egregious competition offense because it is intended to eliminate competitiion  Mergers – the formation of market power through the acquisition of assets or shares  Abuse of Dominance – a firm with market power engages in anti-competitive acts to lessen competition or eliminate competitors 15

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Conspiracy and Bid-rigging

Cartel, formal or informal group of independent businesses whose concerted goal is to lessen or prevent competition among its participants.

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

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

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

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Conspiracy and Bid-Rigging

 Cartels are harmful because typically they result in higher prices for consumers and reduce the incentive for companies to cut costs and be innovative.

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

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

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Merger

 Acquisition or establishment, direct or indirect, by one or more enterprises (i) whether by purchase of shares or assets, lease of assets, amalgamation or combination or otherwise, (ii) of control (S.42) over the whole or a part of the business of an immediate competitor, supplier, consumer or other enterprise; 18

Market Share & Concentration

 Safe harbour: combined market share (unilateral measure) or turnover or assets of target below certain amounts  CR4 below certain level (interdependent measure)  High market share necessary but not sufficient condition to establish that the merger would result in the creation of market power  Market share calculated on basis of dollar revenue, unit volume or capacity  Herfindahl-Hirschman Index (HHI) 19

Economic Factors Affecting Competition

 Foreign competition  Failing Firm  Availability of Substitutes  Entry  Competition remaining in the market  Removal of an effective competitor  Change and innovation  Life cycle of market – expanding, declining 20

Efficiency / Welfare Trade Off

 Canada - Efficiency Defence in the law  U.S. - Price Standard  E.U. – Consumer Surplus Standard  U.K. – Public Interest override by Minister of Trade and Industry  Namibia – trade off between detrimental effects of a lessening of competition and other potential economic benefits or benefits to the public S.47

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Abuse of Dominance

 A person or persons with market power have engaged in abusive or anti-competitive conduct  The conduct may be a single act, a single act repeated and/or a series of different acts  Such conduct has an anti-competitive purpose or effect which is exclusionary, disciplinary or predatory 22

Evidence of Abuse of Dominance

Usually readily available corporate documents:  Exclusive contracts, payments for exclusivity  Long term contracts or restrictions in contracts  Correspondence revealing discriminatory, exclusionary or predatory practices  Strategic documents, documents prepared for senior management or the Board of Directors usually reveal if strategies are anti-competitive 23