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From Citizendium, the Citizens' Compendium
The purpose of competition policy is to regulate those business practices that restrict competition, and to limit the ability of firms to combine in such a way as to enable them to restrict competition.
Although there had been legislation about competition in Elizabethan England, modern competition policy had its origin in United States antitrust legislation of the late nineteenth century. Its introduction outside the United States began in Europe after the second world war, and it has since spread to most developed countries. Its initial development was generally influenced by early antitrust practice, but subsequent intellectual and legal developments have brought about significant modifications.
There are uncertainties about the likely impact of competition policy upon the practice of business that arise from the fact that its operation requires the exercise of a considerable degree of expert judgement. Its legislative framework normally provides no more than a broad indication of the intentions of the policy makers who devised it, and it delegates to the authorities which it appoints, a wide range of discretion in their performance of the task of giving practical effect to those intentions. Also, its rationale is in some respects incomplete, leaving scope for a range of interpretations.
This article is concerned only with underlying principles and common regulatory practices. There are separate articles about the operation of EU competition policy and about the operation of Antitrust policy in the United States. References to specific regulatory practices in this article relate to their adoption by both the United States and the European Union.
It is generally accepted that the purpose of competition policy is to improve economic welfare (although it can be argued that the founders of United States antitrust law were mainly motivated by a wish to limit the power of big business ). Its basis is a set of propositions that were put forward by economists in the nineteenth century. Those propositions are founded, however, on a highly simplified model of the economy, and even within that model, they are subject to important qualifications. (As is noted in the article on competition such qualifications arise from the existence of externalities and from the theory of the second best). However, subject to an occasional need to allow for those qualifications, there is a strong presumption that a reduction in barriers to competition will result in an improvement in the form of economic efficiency that is known to economists as allocative efficiency. Competition policy is not usually concerned only with the promotion of competition, however. In the pursuit of economic welfare, account may also to be taken of its effects upon productive efficiency.
Thus competition theory provides the intellectual foundation for competition policy but it does not provide all that is needed to build a serviceable structure upon that foundation. It does not lead to unequivocal prescriptions except where competition is the only question at issue - and even then the questions of externalities and of ‘the second-best’ may introduce qualifications. Where the issue of gains in productive efficiency also arises, other branches of economic theory must be called in aid. The difficulties which then arise stem not so much from the limitations of the available theory, as from the fact that quantification is then needed in order to draw up a balance between losses of allocative efficiency and gains of productive efficiency. The information requirements for that purpose tend to be demanding, and commercial accounting systems are seldom capable of providing the necessary inputs. In practical terms, therefore, the economic rationale for competition policy is incomplete and its implementation depends partly upon judgement rather than entirely upon analysis.
Definition by form or by effect
The first requirement of a regulatory system is a definition of the business practices which fall within its scope. A practice may be defined for that purpose either in terms of its form, or in terms of its effect. An example of the application of a form-based or per se definition would be the prohibition of exclusive dealing (the practice of making it a condition of supply that a retailer does not deal with other suppliers). A form-based definition of that sort has the merit of letting all concerned know exactly where they stand. It also simplifies regulation by excluding all considerations other than the evidence concerning the existence of the practice. However, it invites the use of devices which meet the letter of the law but evade its intent. A loyalty rebate could, in the example, be used to obtain the equivalent of exclusive dealing without breaching the form-based prohibition of that practice. An attempt to amend the form-based rules to prevent companies from evading the intent of the policy may result in an unending contest between the drafters of legislation and the company lawyers. A prohibition of practices which have the effect of exclusive dealing could not be evaded in that way, and that alternative has the merit of directly attacking the real problem. On the other hand, the use of an effects-based prohibition introduces an element of judgement into the implementation of policy, which may reduce its certainty. The circumstances under which a quantity discount would be deemed to have the prohibited effect might, in the example, be unclear. In the longer term, however, many such uncertainties might be expected to be resolved by the establishment of precedents.
Regulation of structure or behaviour
Regulators have a choice between regulating business conduct in order to prevent its abuse and regulating industry structure in order to limit the capacity for abuse. The effectiveness of conduct regulation is, however, limited by the need for a detailed understanding of the circumstances of each case. The regulation of industry structure may thus appear preferable, but other factors such as the advantages of large-scale operation may count against it. Regulatory systems that are concerned exclusively with the promotion of competition are likely to implement that objective mainly by stringent control upon mergers and by the breaking up of existing monopolies. Where more weight is given to the promotion of productive efficiency, account is likely to be taken of the benefits of mergers and of the costs of disruption.
The determination of market power
The term market power refers to the ability of a firm to exercise some degree of choice concerning what prices to charge for its products. It is conceptually a measure of how far its situation departs from the ideal of perfect competition in which every firm is a price-taker, and it is a measure of a firm's ability to impose an economic loss upon the community by distorting consumer choice. (See the article on competition). It is the basis upon which regulatory jurisdiction is usually defined and it has a strong influence upon the treatment of business practices that fall within its scope.
A firm's market share; is generally taken to provide an a priori measure of its market power, but account is also taken of the availability of substitutes, of the ease by which other firms could enter the market and, if necessary, of the countervailing power of buyers in the market. Its calculation depends upon a specification of a product classification and of the geographical extent of the market in which it is traded, and most competition authorities publish guidelines for such calculations.
The control of mergers
For the purpose of competition policy, a merger is deemed to have occurred when one firm acquires a sufficient holding in the shares of another to give it a substantial degree of control. A majority holding is not deemed to be necessary for that purpose and holdings of 20 per cent and lower have sometimes been deemed sufficient. The definition encompasses both agreed and contested mergers.
A merger between former competitors is termed a horizontal merger, whereas a merger between a firm and one of its suppliers is termed a vertical merger.
Although the purpose of merger control is to limit the acquisition of market power, the regulatory authorities do not intervene unless a notional threshold is exceeded. The threshold that is adopted relates both to the market share that is required and to the increase in, and resulting level of, industrial concentration that results. (Concentration can be measured by calculating the total of the market shares held by the three or four leading firms, but the regulatory authorities use the more sophisticated Herfindahl Index which is a obtained by summing the squares of the market shares of the suppliers of a product). The acquisition of a market share of greater than 40 per cent is normally prohibited, but regulatory authorities have often intervened when lower market shares have been acquired if the merger results in an increase in concentration in a highly concentrated markets. Occasionally, however, the theory of the second best is deemed to justify the approval of mergers that substantially increase both market share and concentration. For example, a merger between the second- and the third- largest firms in a market may serve to restrain the exercise of market power by the market leader. Most regulatory authorities issue guidelines to reduce the uncertainty facing businessmen contemplating mergers. Nevertheless, there is often a substantial degree of uncertainty as to whether a proposed merger will trigger a regulatory response.
In assessing the acceptability of a merger from the standpoint of the public interest, the regulatory authorities often have to strike a balance between the expected losses of allocative efficiency resulting from its reduction of competition, and any expected gains in productive efficiency resulting from economies of scale. The likelihood of acceptance is reduced by existence of barriers to entry, (such as network effects, regulatory barriers or the need for a large amount of capital investment or promotional expenditure.) Conversely the authorities are likely to be more tolerant of mergers affecting a product market that is easy to enter.
The merger of a firm with one of its suppliers might enable it to manipulate an "upstream" market to the detriment of is competitors, and it is similarly possible that a "downstream" acquisition of sales outlets might be used to restrict competition. Neither possibility is, however likely unless the acquiring firm already enjoys substantial market power. The regulatory authorities have been reluctant to prohibit vertical mergers except in the comparatively rare cases in which there is clear evidence of the prospects of abuse.
The regulation of business practices
Overt price-fixing agreements are illegal, and secret agreements, if detected, are likely to attract deterrent penalties. The regulatory authorities may also infer an intention to fix prices from the practice of exchanging price lists, even if that intention is not explicitly stated. However, most authorities produce guidelines listing a wide range circumstances under which they are likely to regard exchanges of price information as unobjectionable. Parallel pricing (which is the practice of adjusting prices in line with the wishes of a competitor) is also prohibited, but its symptoms are usually difficult to distinguish from competitive behaviour, and do not usually prompt regulatory action in the absence of corroborative evidence.
Predatory pricing is the illegal practice of pricing below cost in order to eliminate a competitor. Whether a particular practice is likely to be prohibited by a regulatory authority may depend upon the definition of cost adopted for the purpose by that authority. However, failure to cover average variable cost is generally taken to indicate predatory intent.
Restrictions imposed by suppliers upon distributors that have been deemed by the regulatory authorities to have potentially adverse effects upon competition have included:
- Resale price maintenance (the stipulation of fixed or minimum prices);
- Price discrimination (the charging of prices differences among distributors that are unrelated to costs)
- Exclusive dealing (the requirement that a distributor must not sell a competitor's products);
- Full-line forcing (the requirement that a distributor buys the full range of the suppliers' products);
- Tie-in Sales (the requirement that in order to deal in one of the supplier's products, the distributor must also accept another); and,
- Selective distribution (the imposition of criteria that limit the outlets permitted to sell a product).
Of those restrictions, resale price maintenance is unconditionally prohibited, but the prohibition of the others usually depends upon establishing that, if they have any adverse effects upon competition, they are not outweighed by other advantages to the consumer. The authorities normal follow the ancillary constraints doctrine which deems a restraint not to be anti-competitive if it does not have the purpose of restricting competition, and if it is necessary for the success of a beneficial transaction.