Lecture 9: EU Competition Policy Based on: Sloman Chapters 6.3 (Monopoly) and 12.3 (Competition Policy) Swann Chapter 5 p129-148

Market Size Matters European leaders always viewed integration as compensating for the 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’.

Facts M&A activity is high in EU. Much M&A is mergers within member state: about 55 per cent ‘domestic’ remaining 45 per cent split between: one is non-EU firm (24 per cent), one firm was located in another EU nation (15 per cent) counterparty’s nationality was not identified (6 per cent).

Facts Distribution of M&A quite varied: Source: Baldwin and Wyplosz Distribution of M&A quite varied: Big-four: I,F,D share M&As much lower than share of the EU GDP I, F, D 36 per cent of the M&As, 59 per cent GDP (except UK) small members have disproportionate share of M&A.

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 vary impact by member states.

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 .

POLICIES TOWARDS MONOPOLIES AND OLIGOPOLIES Competition, monopoly and the public interest The targets of policy abuse of monopoly power 6

Monopoly and the public interest £ MCmonopoly AR = D MR Q

Monopoly and the public interest £ MCmonopoly ACmonopoly P1 AC1 AR = D MR Q1 Q

Monopoly and the public interest £ MCmonopoly ACmonopoly P1 AC1 AR = D MR Q1 Q

Why do we think Monopoly is bad? £ MCmonopoly ACmonopoly P1 AC1 AR = D MR Q1 Q

If we had perfect competition then P=MC, £ price is lower and quantity is higher MCmonopoly ACmonopoly P1 PPC AC1 AR = D MR Q1 QPC Q

MCperfect competition But what if Perfect competitive firm is small and unable to exploit returns to scale £ MCperfect competition MCmonopoly PPC ACmonopoly PM ACM AR = D MR QPC QM Q

MCperfect competition But what if Perfect competitive firm is small and unable to exploit returns to scale £ MCperfect competition MCmonopoly PPC ACmonopoly PM ACM AR = D MR QPC QM Q

Winecon Example For an alternative presentation of this story see: Perfect Competition and Monopoly Compared If you need to review Monopoly output decisions see: A Monopolist's Revenue

A Duopoly £ AR = D Q MCmonopoly MR Q1 P1 If we have two firms instead of one, Divide up the demand Curve between them £ DD Q MRD QD PD £ DD Q MRD QD PD

PC V Monopoly v Duopoly Under certain conditions Output of Monopoly is ½ of Perfect competition Output of Duopoly Firm is 1/3 of Perfect Competition, Industry output is 2/3 of PC Output of Three firm Oligopoly is ¼ of Perfect Competition, Industry is ¾ of PC Output of Four firm Oligopoly is 1/5 of Perfect Competition, Industry is 4/5 of PC So moving closer to PC all the time.

WinEcon Example This is the link to the full treatment of the Cournot Duopoly Model in WinEcon. This is not absolutely necessary for this module but if you are doing Principles it will provide a useful review of the issues. Cournot's Model of Duopoly

What does EU integration mean Could initially have lots of small firms in each country (High MC) Market integration (larger market) might allow exploitation of increasing returns to scale So might go from 10 in each country to 10 in EU overall. Question: Has monopoly power here risen or not? IN each country? In the EU?

SO If Scale Matters There may also be a trade off between competition (zero supernormal profits) AND Cost savings due to scale effects Firms need to be of some critical size to gain cost benefits SO how big will they be, and how many of them will survive market liberalisation

Increase in variety Suppose 8 countries (UK, FR, GER, It, Sp, & Pol, Sweden, & Slovakia) have one car firm each before market is integrated and this firm dominates home market (due to restrictions). Control their Home market PLUS each controls 1/9 of remaining EU market. What happens after we integrate the EU car market. 1. In each home market go from monopoly high P and ½ PC output) to lower P and 8/9 So all home markets become more competitive But what else?

Fall in costs, price, increase in output and increase in variety available. So consumers gain on all fronts. Not necessarily popular vision of market integation- claim market integration leads to mergers and hence have less than original 8 firms.

Market-Concentrating Merger Literature Big, buys up small and closes it down, x 4 1 2 3 5 6 7 8

What happens to non-merging firms?

Answer: Output and profits rise for all non-merging firms as market becomes more concentrated

Answer: Output and profits rise for all non-merging firms as market becomes more concentrated

Answer: Output and profits rise for all non-merging firms as market becomes more concentrated And after each merger each firm gets bigger - eventually new merger unprofitable

Globalisation / Big EU conglomerate story So here Market Integration results in less firms, lower output and higher prices So need competition policy Block market concentrating mergers Firms will argue that mergers reduce costs rather increase concentration. But regulators are not inclined to believe

Problems with this Globalisation / Big EU conglomerate story Remember all rivals gains from your merger Why buy up rival if everyone else is going to benefit What should I do? Let other firms pay to buy rival – I wait and get the gains – mergers would never happen So must believe that mergers are beneficial to ME - Must be cost synergies

Problems with this Globalisation / Big EU conglomerate story So must believe there are cost savings Either through rationalization Or improved processes. Technology Transfer Mergers

e.g. Technology Transfer Mergers VW purchased Skoda and Seat. VW Sharon/Seat Alhambra and many other VW/Audi/Skoda models identical Honda & Rover- Early 90’s Telecommunications equipment

Technology Transfer Merger with Independent Divisions

Technology Transfer Merger Big, buys up or licenses small, and implements superior technology

Technology Transfer Merger What happens to non-merging firms?

Predator now twice as big, so output and profits of all non-merging firms must shrink.

Predator now twice as big, so output and profits of all non-merging firms must shrink.

Technology Transfer versus Market Concentrating Mergers Now 2 firms with best technology Firms competing against each other (including new divisions) Output rises, prices fall Closer to Perfect competition result Potentially all consumers and society gains But need to believe that technology/management processes are being transferred and that this is the motive for mergers. 6

Competition Policy Concerns So EU is concerned about mergers and possibility of market concentration Concerned about whether mergers really bring cost synergy benefits Collusion is a real concern in Europe: dangers of collusion rise as the number of firms falls. EU is also concerned about ‘state aid’ to protect their own champions, e.g. Rover, Air France

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. Commission also empowered to investigate mergers and allegations of collusion

Anti-Competitive Behaviour perfect collusion: firms coordinate prices and sales perfectly max profit from market is monopoly price and sales perfect collusion is where firms charge monopoly price and split the sales among themselves.

Antitrust and cartels. The Commission tries: 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.

EU Competition Policy Merger control. The Commission seeks: to block mergers that would create firms that would dominate the market.

POLICIES TOWARDS MONOPOLIES AND OLIGOPOLIES EU legislation Article 85: restrictive practices Article 86: monopolies and mergers 1990 merger control measures current approach to merger control assessing EU legislation 6

POLICIES TOWARDS MONOPOLIES AND OLIGOPOLIES UK competition policy the OFT and the Competition Commission restrictive practices policy Chapter 1 prohibition types of anti-competitive behaviour powers of the OFT monopoly policy Chapter 2 prohibition market-share criterion market contestability anti-competitive practices 7

POLICIES TOWARDS MONOPOLIES AND OLIGOPOLIES UK competition policy (cont.) merger policy role of OFT and Competition Commission criteria for judgement Assessment of competition policy focus on behaviour rather than market structure prohibition of certain practices tougher powers to identify secret collusion