Competition, mergers and antitrust policies © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

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 2006. The Economics of European Integration, 2nd Edition

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%). © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

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. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

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. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Theory: 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 2006. The Economics of European Integration, 2nd Edition

Economic logic: background Monopoly case Demand Curve Price Price Marginal Revenue Curve Marginal Cost Curve Demand Curve P’ P* A P” B D Marginal Cost C E Q’ Q* Q’+1 Sales Sales © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Economic logic: background Duopoly case, example of non-equilibrium price price Firm 1’s expectation of sales by firm 2, Q2 Firm 2’s expectation of sales by firm 1, Q1 p1’ Demand Curve (D) Demand Curve (D) p2’ Residual Demand Curve firm 1 (RD1) Residual Demand Curve firm 2 (RD2) A1 MC A2 MC x1’ Firm 1 sales x2’ Firm 2 sales Residual Marginal Revenue Curve firm 1 (RMR1) Residual Marginal Revenue Curve firm 2 (RMR2) © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

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 D p** RD RD’ A MC A MC RMR RMR’ sales x* 2x* x** sales 3x** Duopoly Oligopoly © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

BE-COMP diagram mmono mduo m’ n’ BE (break-even) curve COMP curve n=1 Mark-up (m) COMP curve BE (break-even) curve m’ n’ mmono mduo n=1 n=2 Number of firms © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Details of COMP curve p' mmono p" mduo D R-D (duopoly) Marginal cost Mark-up price p' mmono A’ p" mduo B’ D Monopoly mark-up Duopoly mark-up COMP curve R-D (duopoly) Marginal cost curve MC B A Number of firms n=1 n=2 R-MR MR (monopoly) Typical firm’s sales xduo xmono © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Details of BE curve BE Home market po=mo+MC Demand curve A AC>po Mark-up (i.e., p-MC) euros price Home market po=mo+MC Demand curve BE A AC>po ACo=po B A po mo B AC<po AC MC n” no n’ Number of firms Sales per firm Co Total sales x”= Co/n” x’= Co/n’ xo= Co/no © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Equilibrium in BE-COMP diagram euros Price Mark-up Home market Demand curve BE E’ E’ p’ p’ m' E’ AC COMP MC n’ Number of firms x’ Sales per firm C’ Total sales © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

No-trade-to-free-trade integration euros price Mark-up Home market only Demand curve BE BEFT E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC COMP MC n’ n” 2n’ Number of firms x’ x” Sales per firm C’ C” Total sales © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

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 pA. 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 2006. The Economics of European Integration, 2nd Edition

Competition & 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”. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

EU’s role Exclusive competency of EU; Commission controls. 2 aspects: mergers & anti-competitive behaviour. Look at justification for putting competition policy at the EU level. Spillovers (negative effects of one Member’s subsidies on other Members’ industry). Need belief in ‘fair play’ if integration is to maintain its political support. Witness recent ‘protectionist’ tendency of Member States to prevent foreign takeovers. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Recall: 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 pA. 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 2006. The Economics of European Integration, 2nd Edition

Competition & 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 2006. The Economics of European Integration, 2nd Edition

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 2006. The Economics of European Integration, 2nd Edition

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 nB. Point B Zero profits earned by all. prices higher, pB> p”, smaller firms, higher average cost. Mark-up BEFT mmono Perfect collusion A B pB E” Partial collusion p” COMP n=1 n” nB 2n’ Number of firms © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Economic effects The welfare cost of collusion (versus no collusion). four-sided area marked by pB, p”, E” and B. price Demand curve Mark-up BEFT pmono mmono Perfect collusion A B B pB E” Partial collusion E” p” COMP n=1 n” nB Number of firms Total sales CB © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

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. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Economics of cartels Suppose price without cartel would be P. Cartel raises price to P’. DCS=-a-b; ‘ripoff’ DPS=+a-c Net welfare = -b-c ; “technical inefficiency” euros Quantity C’ C P’ P AC a b c Demand curve © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

The vitamin cartels (Box 11‑1) In 2001, Commission fined 8 companies for vitamins cartels vitamins A, E, B1, B2, B5, B6, C, D3, Biotin, Folic acid, Beta Carotene and carotinoids The European vitamins market is worth almost a billion euros a year. The firms fixed prices, allocated sales quotas, agreed on and implemented price increases and issued price announcements in according to agreed procedures. They set up a mechanism to monitor and enforce their agreements and participated in regular meetings to implement their plans. Formal structure with senior managers to ensure the functioning of the cartels: the exchange of sales values, volumes of sales and pricing information on a quarterly or monthly basis at regular meetings, and the preparation, agreement and implementation and monitoring of an annual "budget" followed by the adjustment of actual sales achieved so as to comply with the quotas allocated. Hoffman-La Roche of Switzerland (cartel ringleader) received the largest fine (462m euros); BASF and Merck (Germany), Aventis SA (France), Solvay Pharmaceuticals (the Netherlands), Daiichi Pharmaceutical, Esai and Takeda Chemical Industries (Japan). © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Exclusive territories More common anti-competitive practice is ‘exclusive territories’. Nintendo example; high prices in Germany vs UK. Germany’s inelastic demand meant Nintendo wanted to charge a higher price than in UK. Normally Single Market limits this sort of price discrimination (arbitrage by firms). Nintendo implemented a system that prevented arbitrage within the EU (illegal). European Commission fined Nintendo and the 7 distributors 168 million euros. euros Quantity PGermany PUK DGermany DUK MC MRGermany MRUK © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Abuse of dominant position Firms that are lucky or possess excellent products can establish very strong positions in their market. Not a problem, per se: position may reflect superior products and/or efficiency, e.g. Google’s triumph. However dominance may tempt firm to extract extra profits from suppliers or customers. Or arrange the market to shield itself from future competitors. Illegal under EU law ‘abuse of dominant position.’ e.g. Microsoft with media software: Charge high price of Word, etc. where the competition has been driven out of biz (WordPerfect, etc.), but give for free all software where there is still competition. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Merger control Initially P=AC. Merger implies lower AC to AC’, but raises the price to P’. DCS=-a-b; ‘ripoff’. DPS=+a+c. Net welfare = -b+c ; ambiguous, ‘efficiency defence’. Laissez-faire (in US and increasingly in EU); if free entry then eventually P driven down to AC’. As in BE-COMP diagram. euros Quantity C’ C P’ P=AC a b c Demand curve AC’ Williamson diagram © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

State aid economics Look at two cases: Restructuring prevention. Unfair competition. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Restructuring prevention Consider subsidies that prevent restructuring. Specifically, each government makes 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 BE BEFT E’ 1 m' E” mA A COMP n’ n” 2n’ Number of firms © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

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 BEFT E’ E’ p’ a AC A A pA pA A b c MC 2n’ Number of firms Sales per firm Total sales x’ C’ CA xA= 2CA/2n’ © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

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 BEFT E’ E’ p’ a AC d A A pA pA A b c MC 2n’ Number of firms Sales per firm Total sales x’ C’ CA xA= 2CA/2n’ © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

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 2006. The Economics of European Integration, 2nd Edition

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. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

© Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Microsoft case Chronology Source: European Commission & Financial Times Chronology 1998: Complaint from Sun Microsystems. Microsoft was refusing it information necessary to interoperate with Microsoft’s dominant PC operating system 2000: The Commission sent Microsoft a Statement of Objections. 2001: The Commission sent a second Statement of Objections. 2003: A third Statement was sent. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Microsoft case Microsoft reacted to each Statement and requested an Oral Hearing (2003) 2004: “The decision” (by the Commission) Microsoft abused its dominant position in the PC operating system Refusing to supply competitors information. Then, Microsoft has to disclose information in 120 days Harming competition through the tying of its separate Windows Media Player Then, Microsoft has to provide (in 90 days) a version of Windows without Windows Media Player. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Microsoft case In June 2004, Microsoft lodged an action for annulment of the Decision. Why ? Microsoft would suffer from serious and irreparable damage: Harm its intellectual property rights Interfere with its commercial freedom Alter market conditions. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

Microsoft case The Court of First Instance delivered its judgement on September 2007...The Commission was right Microsoft has to pay a fine: 497 million € Microsoft reaction: . Allow access to interoperability information . Information will cost € 10.000 one-off fee rather than a percentage of revenues Failing to comply with 2004 decisions, the European Commission fined Microsoft a record € 899 m (2008) © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition