International Think-Tank on Innovation and Competition
On the European Approach to Competition Policy
October 5th, 2005
Recently on the Financial Times, a prestigious economist, John Kay criticized the opinion of Commissioner Kroes on the way to improve the European competition policy (“European monopoly laws are already fair and stringent”, Financial Times, October 4th, 2005, p. 15). Kroes’ approach essentially focuses on abuses of dominant positions which harm consumers and evaluates them through rigorous economic analysis. We support this approach and do not even see what else should policy focus on other than enhancing consumer welfare and ensuring an efficient allocation of productive resources. Whether this new approach is more in line with American practice, as Kay claims, is not that important; what matters is that it represents a step forward to fill the gap in competitiveness between Europe and US, especially in the dynamic and innovative markets of the New Economy.
According to Mrs Kroes’ recent speech, a good policy should punish abusive actions which ultimately induce increases in prices or reduce product quality, which is what harms consumers, and be neutral toward practices making consumers better off. Mr Kay must have the opposite opinion since he hopes to resist to such a policy, otherwise “actions would be permitted if, on balance, they contribute to the welfare of consumers”. We find hard to understand why such actions could ever be abusive! Now, it is not always easy to verify the effects on consumers of a given practice; nevertheless, this is not a reason to give up, as Mr Kay seems to propose, but it may be a good reason to strengthen economic analysis case by case, as Mrs Kroes prefers.
Occasionally, antitrust policy has been naively biased against dominant firms and in defense of their competitors. Mrs Kroes has correctly suggested a more balanced approach: when market leaders adopt aggressive pricing strategies, competitors should not be protected if these strategies ultimately benefit consumers. Competition is free when firms, dominant or not, are free to supply better products at lower prices, and clearly what protects the right of any firm to compete aggressively does not protect its competitors. But things don’t work this way in the world of Mr Kay: according to his view, “a distinction is sometimes made between protecting competition and protecting competitors, but there is not conflict”. If this was the case, antitrust authorities should simply shadow the desires of the competitors of market leaders. We are not sure this would properly defend consumers, but this does not appear the priority of Mr Kay.
A recent EU Report written by a group of experts (“An Economic Analysis to Article 82” by J. Gual, M. Hellwig, A. Perrot, M. Polo, P. Rey, K. Schmidt and R. Stenbacka) has shown that most actions can have both efficiency enhancing and foreclosure effects, but sound economic theory and data analysis can provide accurate accounts of the net effects for consumers: this is what we really need in antitrust cases. Moreover recent economic research has shed a new light on this issue. The general principle is that dominant firms may behave in an anti-competitive (accommodating) way in markets with barriers to entry, while they always behave in a pro-competitive (aggressive) way whenever entry in the market is free. In this second case, dominant firms produce more, invest more to reduce costs or improve product quality, engage in more informative advertising, innovate more and so on: this allows them to increase their market shares, reduce prices and gain from a reduction in the average costs of production, but it also disciplines the competitors and keeps market prices at a low level, with unambiguous benefits for the consumers.
Some factors make leaders even more aggressive and tend to increase their market share (eventually until other firms exit): these are scale economies, network effects and learning by doing in dynamic contexts, product homogeneity and rapid technological development, all factors typical of the markets in the New Economy. The consequence is that markets with high concentration due to the presence of a dominant firm are perfectly consistent with efficiency. This has drastic consequences for the competition policy: while the old approach to abuses of dominant positions needed to verify dominance through structural indicators and the existence of a certain abusive behaviour, a correct approach would just need to verify the existence of harm to consumers, which is exactly the thesis of Commissioner Kroes. Even the cited Report correctly points out that “the case law tradition of having separate assessments of dominance and of abusiveness of behaviour simplifies procedures, but this simplification involves a loss of precision in the implementation of the legal norm. The structural indicators which traditionally serve as proxies for ‘dominance’ provide an appropriate measure of power in some markets, but not in others”, as indeed in the New Economy.
Moreover, in line with the recent research, the same Report clarifies that “in an effects-based, non-dirigiste approach the analysis of competitive harms naturally focuses on keeping the competitive process open and avoiding the exclusion of actual or potential rivals from the market”. Another implication is that aggressive pricing by the leaders can have a predatory role under barriers to entry, but not under free entry (even if this leads to exit of some competitors). The same holds for other strategies which typically have exclusionary motivations under barriers to entry, like dumping (in presence of learning by doing and network effects) or bundling and tying strategies. As long as entry of firms in the market is free, the adoption of these strategies by a dominant firm ends up beneficial to consumers - while this is not the case in presence of other barriers to entry.
Finally, notice that, as Commissioner Kroes has pointed out, what matters for competition policy is not only welfare of current consumers but also that of future ones. The EU Report provides a simple example on excessive pricing: “One response to the problem might be for the competition authority to intervene, citing excessive pricing by a monopolist as an infraction of the abuse-of-dominance prohibition in Article 82 of the Treaty. Another response might be to leave the matter alone, hoping that the profits that the monopolist earns will spur innovation or imitation and entry into the market, so that, eventually, the problem will be solved by competition.” Sometimes, this second approach can have superior results in defending the welfare of consumers.
In conclusion, all what Mrs Kroes has correctly noticed is that a good policy requires a good diagnosis. Mr Kay has a rigid and formal way to define abuses of dominant position: in his words, “what you do, rather than what you were thinking, establishes abuse”. According to the new approach supported by Mrs Kroes and by many distinguished economists, the negative effects on consumers establish abuse. We believe that this “effect-based approach” can promote competition in a more effective way.
