Transcript Baldwin & Wyplosz The Economics of Euroepan Integration
Chapter 6: Market Size and Scale Effects
© Baldwin&Wyplosz The Economics of European Integration 1
Market Size Matters
• European leaders always viewed integration as compensating small size of European nations – Implicit assumption: market size good for economic performance • Facts: integration associated with mergers, acquisitions, etc.
– In Europe and more generally, ‘globalisation’ © Baldwin&Wyplosz The Economics of European Integration 2
Facts
• M&A activity is high in EU • much M&A is mergers within member state – about 55% ‘domestic’ – Remaining 45% split between: • one is non-EU firm (24%), • one firm was located in another EU nation (15%) • counterparty’s nationality was not identified (6%).
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Facts
• Distribution of M&A quite varied – big 4: share M&As much lower than share of the EU GDP.
– I, F, D 36% of the M&As, 59% GDP.
• Except UK – small members have disproportionate share of M&A.
S, 5.3% NL, 6.5% I, 6.2%
M&A activity by nation, 1991-20012
UK, 31.4% F, 13.5% E, 5.0% D, 16.3% B, 2.8% DK, 2.6% EL, 1.1% IRL, 1.7% L, 0.5% A, 2.1% P, 1.2% FIN, 3.9% © Baldwin&Wyplosz The Economics of European Integration 4
Facts
• Why M&A mostly within EU?
• Why UK’s share so large?
– Non harmonised takeovers rules. • some members have very restrictive takeover practices, makes M&As very difficult • others, UK, very liberal rules • lack of harmonisation means restructuring effects very impact by member states.
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Economic Logic Verbally
• liberalisation • de-fragmentation • pro-competitive effect • industrial restructuring (M&A, etc.) • RESULT: fewer, bigger, more efficient firms facing more effective competition from each other. © Baldwin&Wyplosz The Economics of European Integration 6
Economic logic: background
•Monopoly case
Price
Demand Curve
Price
Marginal Revenue Curve
P’ P”
A
Marginal Cost Curve
P*
Demand Curve
B D
Marginal Cost
C
Q’
E
Q’+1
Sales
Q*
Sales
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Economic logic: background
•Duopoly case, example of non-equilibrium
price price Firm 1’s expectation of sales by firm 2, Q 2 Firm 2’s expectation of sales by firm 1, Q 1
p 1 ’
A 1
x 1 ’ Demand Curve (D) Residual Demand Curve firm 1 (RD1) p 2 ’ Residual Marginal Revenue Curve firm 1 (RMR1) MC
Firm 1 sales
Demand Curve (D)
A 2
Residual Demand Curve firm 2 (RD2) MC x 2 ’
Firm 2 sales
Residual Marginal Revenue Curve firm 2 (RMR2) © Baldwin&Wyplosz The Economics of European Integration 8
Economic logic: background
•Duopoly & oligopoly case, equilibrium outcome
price Typical firm’s expectation of the other firm’s sales price Typical firm’s expectation of other the other firms’ sales
p* D RD
A
x* Duopoly RMR MC 2x*
sales
p** D RD’
A
MC RMR’ x** 3x**
sales
Oligopoly © Baldwin&Wyplosz The Economics of European Integration 9
Mark-up (
m
)
m mono
BE-COMP diagram
m duo m ’ BE (break-even) curve COMP curve n=1 n=2 n’
Number
10
Details of COMP curve
Mark-up price
p' m mono
A’
p" m duo
B’
MC Duopoly mark-up D Monopoly mark-up R-D (duopoly)
B A
Marginal cost curve R-MR MR (monopoly) x duo x mono n=1 n=2 COMP curve
Numbe r of firms Typical firm’s sales
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Details of BE curve
euros
p o =m o +MC
price
Home market Demand curve AC>p o
A
AC o =p o p o
B
AC
Sales per firm
C o
Mark-up (i.e., p-MC)
m o
Total sales B
n” n o n’ BE
A Number of firms
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p’
euros
Equilibrium in BE-COMP diagram
Mark-up Price
Home market Demand curve BE
E’
p’
E’
m '
E’
x’ AC MC
Sales per firm
n’ COMP
Number of firms
C’
Total sales
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No-trade-to-free-trade integration
p’ p”
euros E’ E”
AC MC p’ p” p A x’ x”
Sales per firm price
Home market only Demand curve
C
E’ E” A Mark-up
m m ' A
E’ E”
1 BE BE FT
A
COMP n’ n” 2n’
Number of firms
C’ C”
Total sales
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Economic Logic
• Integration: no-trade-to-free-trade: BE curve shifts out (to point 1) • Defragmentation – PRE typical firm has 100% sales at home, 0% abroad; POST: 50-50 – Can’t see in diagram • Pro-competitive effect: – Equilibrium moves from E’ to A: Firms losing money (below BE) – Pro-competitive effect = markup falls – short-run price impact p’ to p A • Industrial Restructuring – A to E” – number of firms, 2n’ to n”. – firms enlarge market shares and output, – More efficient firms, AC falls from p’ to p”, – mark-up rises, – profitability is restored • Result: – bigger, fewer, more efficient firms facing more effective competition • Welfare: gain is “C” © Baldwin&Wyplosz The Economics of European Integration 15
• • •
State aid (subsidies)
2 immediate questions – “As the number of firms falls, isn’t there a tendency for the remaining firms to collude in order to keep prices high?” – “Since industrial restructuring can be politically painful, isn’t there a danger that governments will try to keep money-losing firms in business via subsidies and other policies?” The answer to both questions is “Yes”. Turn first to the economics of subsidies and EU’s policy © Baldwin&Wyplosz The Economics of European Integration 16
• • •
Economics: restructuring prevention
Consider subsidies that prevent restructuring Specifically, each governments make annual payments to all firms exactly equal to their losses – i.e. all 2n’ firms in Figure 6-9 analysis break even, but not new firms – Economy stays at point A This changes who pays for the inefficiently small firms from consumers to taxpayers.
Mark-up
m ' m A
E’
n’
E”
1 BE
A
BE FT COMP n” 2n’
Number of firms
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• • •
restructuring prevention: size of subsidy
Pre-integration: fixed costs = operating profit = area “
a+b
” Post-integration: operating profit =
b+c
ERGO: Breakeven subsidy =
a-c
– NB: b+c+a-c=a+b
euros Price Mark-up
COMP Demand curve BE FT
E’ E’
p A p’ AC p A
A
MC x’ x A = 2C A /2n’
Sales per firm
a b A A c
C’ C A
Total sales
2n’
Numbe r of firms
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• • • •
restructuring prevention: welfare impact
Change producer surplus = zero (profit is zero pre & post) Change consumer surplus = a+d Subsidy cost = a-c Total impact = d+c
euros Price Mark-up
COMP Demand curve BE FT
E’ E’
p A p’ AC p A
A
MC x’ x A = 2C A /2n’
Sales per firm
a b d A c
C’ C A
Total sales
A
2n’
Numbe r of firms
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• • • • •
Only some subsidise: unfair competition
If Foreign pays ‘break even’ subsidies to its firms All restructuring forced on Home 2n’ moves to n”, but all the exit is by Home firms Unfair Undermines political support for liberalisation © Baldwin&Wyplosz The Economics of European Integration 20
• •
EU policies on ‘State Aids’
1957 Treaty of Rome bans state aid that provides firms with an unfair advantage and thus distorts competition.
EU founders considered this so important that they empowered the Commission with enforcement.
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Anti-competitive behaviour
• • • Collusion is a real concern in Europe – dangers of collusion rise as the number of firms falls Collusion in the BE-COMP diagram – COMP curve is for ‘normal’, non-collusive competition – Firms do not coordinate prices or sales Other extreme is ‘perfect collusion’ – Firms coordinate prices and sales perfectly – Max profit from market is monopoly price & sales – Perfect collusion is where firms charge monopoly price and split the sales among themselves © Baldwin&Wyplosz The Economics of European Integration 22
• •
Economic effects
collusion will not in the end raise firm’s profits to above normal levels. – 2n’ is too high for all firms to break even. – Industrial consolidation proceeds as usual, but only to n B . Point B Zero profits earned by all.
prices higher, p B > p”, smaller firms, higher average cost
Mark-up
m mono p B p”
E” B
n=1 n” n B 2n ’
A
BE FT Perfect collusion Partial collusion COMP
Number of firms
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•
Economic effects
The welfare cost of collusion (versus no collusion) – four-sided area marked by p B , p”, E” and B.
price
p mono Demand curve
Mark-up
m mono p B p”
B E” E” B
C B
Total sales A
BE FT Perfect collusion n=1 n” n B Partial collusion COMP
Number of firms
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• • •
EU Competition Policy
To prevent anti-competitive behavior, EU policy focuses on two main axes: Antitrust and cartels. The Commission tries: – to eliminate behaviours that restrict competition (e.g. price fixing arrangements and cartels) – to eliminate abusive behaviour by firms that have a dominant position Merger control. The Commission seeks: – to block mergers that would create firms that would dominate the market.
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