(Reprinted from HKCER Letters, Vol. 31, March 1995)
The scope of competition law
Competition law seeks to prevent anti-competitive business practices and developments in industry structure that facilitate these practices. It stops unfair business tactics and abuses of market power to gain excess profits. The rules applied by competition law are not regulations, as some critics claim. On the contrary, they help to minimize government involvement in business. If a government has a clear set of competition rules, it can more easily bat away lobbying by special interest groups for intervention.
Competition law has an interface with a broad range of economic policies affecting competition in local and national markets, including the regulation of transport, power, telecommunications, and other sectors where natural monopolies are likely to occur; international trade; foreign direct investment; intellectual property rights; financial markets; and privatization policies. Thus, a broad range of competition policies play an important role in determining which markets are accessible to firms. These policies can therefore enhance the effectiveness of competition law -- and vice versa. For example, just before the North American Free Trade Agreement (NAFTA) was signed, Mexico updated its competition law to lower internal market barriers and ensure nondiscriminatory treatment of business.
Some argue that deregulation and liberalized trade are sufficient to promote competition. But a high and increasing share of economic activity is related to non-tradable products and services. And competition law is better at addressing situations where:
- International cartels restrict competition with price fixing and geographic market sharing agreements.
- Interfirm contracts tie up scarce raw materials or distribution channels.
- High transport costs or the perishability of products shrink the pool of suppliers.
- Government regulations on product safety, consumer protection, and technical standards, or differences in these regulations or standards, work to restrict competition.
The sequencing of competition law is important. For example, it needs to precede or to be enacted at the same time as privatization programs, to prevent government monopolies from merely being transferred into private monopolies.
The principal objective of competition law should be to maintain and encourage competition in order to promote economic efficiency and consumer welfare. Making economic efficiency the principal objective of competition law supports consistent application of policies and is more likely to limit lobbying by vested interests. This is especially important for countries with limited administrative capacity and weak institutional structures.
In some countries, however, competition law has multiple goals under the rubric of public interest, including fairness, regional development or employment, and pluralism or diffusion of economic power through promotion of small and medium-size businesses. Multiple objectives invite lobbying by different stakeholders in the economy and can lead to inconsistent application of competition law, so that governments end up protecting some firms from competition. That result is at odds with the basic aim of competition law: to protect the competitive process and not the competitors. Trying to balance a wide range of (often conflicting) social, political, and economic concerns is sure to undermine long-term competitiveness, economic growth, and jobs. Instead, different goals are better pursued by different policies.
In recent years, Canada, the European Union, Italy, New Zealand, and the United States have placed more weight on the economic efficiency objective. Several developing countries, including Colombia and Mexico, have done the same. But some countries, notably France, India, the United Kingdom, and some economies in Central and Eastern Europe, pitch competition law toward multiple objectives.
Competition law can be applied in two ways. The first approach is structural, focusing on market share and industry concentration. The second is behavioral, with the focus on combating anti-competitive business practice and pricing policy.
Economic theory suggests that industry structure has an important bearing on firm behavior and performance. Large firms operating in industries with few competitors are more likely to engage in anti-competitive practices. In reality, large firm size does not necessarily confer market power. If there are no barriers to entry, the market will be contested by new competitors every time established firms try to hike prices and cut output to earn excessive profits.
Economies with large domestic markets have little difficulty using the structural approach. The large number of firms in these economies generally ensures vigorous competition. Market share thresholds can be specified to trigger government action to maintain competition. The United States and Canada use such thresholds in the administration of horizontal merger provisions. In countries with small markets, however, the potential risks of misapplying competition law, and the impact on the economy, tend to be greater. These economies tend to be characterized by industries with few firms and high concentration. Applying structural measures to ensure competition may prevent domestic firms from achieving theminimum size needed to compete in international markets. In these circumstances, governments can best alleviate worries about high concentration by removing curbs on foreign trade and investment and lifting regulatory barriers to entry, such as licensing.
The behavioral approach focuses on how firms do business. Some business practice -- such as collusion between competitors to fix prices, to reduce output, to allocate customers, to and share markets -- are clearly anti-competitive and should be per se illegal and subject to heavy fines and penalties. But the effects of such practices as exclusive dealing contracts between sellers and buyers, interfirm cooperation in research and development, and product standards, are less easily decided. These need to be examined case by case, applying a rule of reason approach. Structural arrangements such as mergers and acquisitions and joint ventures should be examined in the same way.
Not only will competition law help to lower costs and prices and increase consumer welfare, it also will foster sound business discipline, culture, and ethics -- especially as state monopolies are being privatized. Promoting such business principles is important in an increasingly integrated world economy where countries can no longer protect their industries without losing profitable opportunities and international competitiveness.
Shyam Khemani is a senior industrial economist in the Private Sector Development Department of the World Bank. The above article is drawn from Public Policy for the Private Sector (December 1994), a publication of the World Bank.