Document(s) 4 of 9

Imagine an open-air market in a developing country — a busy, bustling, lively place. Customers move from one vendor to another, testing the produce, haggling over prices, seeking the best value for their money. The vendors extol the virtues of their produce, offering bargains in an effort to attract more customers. It’s an age-old system based on open competition; vendors who offer the best value do the most business and the customers benefit.

Now imagine a market where all the poultry vendors sell their chickens at the same price, a price that always seems to be a little higher than last week, just like the price of sugar, which has gone up — again! To make matters worse, the bank charges a higher and higher commission to release the money that your family members send from their jobs overseas. Then there’s the bus ride back to the village. There used to be several bus companies. Now there’s only one, and the fare has doubled. But what can the consumer do if there’s no competition?

Competition and the policies that help to underpin it are among the most important elements of modern regulation. Almost every government around the world relies on competition to deliver a more efficient economy and help drive economic growth. Most of those governments are also committed to developing the policy tool kit that lets them harness the process of competition and stop those who might seek to abuse it.

Competition is not necessarily a natural state for many markets. In some, such as gas, water, and electricity markets, the need for major infrastructure impedes competition. But in other services and goods markets, policies that promote competition can be used to encourage fair play among firms, to shed light on otherwise murky pricing and contracting practices, and to open up opportunities for small- and medium-sized enterprises to grow. Competition and the competition policy tool kit can also be used to eliminate corruption and rigged bidding processes and thus maximize the value of public expenditure.

What are competition and competition policy?

Before looking at competition policy, we first need to distinguish it from competition itself. Although this may appear a little contradictory, it is important if we are to identify what each policy area does and what it does not do. It is also important because of language. Many countries have in fact had what are now called competition policies for hundreds, if not thousands, of years. These market-regulating laws and rules were designed to ensure a form of fair play in the marketplace. Market rules have existed for as long as markets and long before what we now call the market economy.

Competition springs from interactions in the marketplace as rivalry between firms over consumers’ or customers’ money drives them to deliver higher quality and lower prices. This process of rivalry then impels each firm to look inward to ensure that it is using all its resources as efficiently as possible. This reduces inefficient use of resources, cutting down waste, and, thereby, reducing costs. Competition is therefore a process, whereas competition policy is largely a curative when that process fails to work.

Competitive markets “Competitive markets are ones in which there are many firms operating; their ability to set prices is limited in that if they charge above the market price, they would lose their customers; information is widely available to producers and consumers; both entry and exit are relatively easy for actors [firms] in the market; externalities are limited; infrastructure is adequate; and contracts can be enforced and property rights protected. When these characteristics apply, economists infer that the market functions well as an institution and permits resources to be used efficiently and welfare [consumer and producer surplus] to be maximized.”— Carlton and Perloff (1999)

The end result of the process of competition is often referred to as “workable competition” (see box on p.4). This is a shorthand phrase to describe the sort of market that we would expect to see with competition — while not perfect — working.

The first modern expressions of what we now call competition law started in North America with the Canadian Combines Act of 1889 and the (US) Sherman Antitrust Act of 1890. These laws resulted from a revolt of the rural and urban poor against the power of what were called the industrial trusts, which controlled large parts of commerce through collusion and abuse of their huge economic power. The laws were also passed to head off more populist and radical responses to an increasingly abusive form of industrial capitalism. The United States still calls its laws antitrust laws and the countries quickest to follow the North American lead were also heavily agricultural economies suffering under the yoke of a small number of very powerful firms.

Structure, conduct, and performance indicators for workable competition Structure The number of traders is at least as large as economies of scale permit.  There are no artificial barriers to entry and mobility.  There are moderate and price-sensitive differences in the quality of the products offered. Conduct Some uncertainty exists as to whether rival firms will try to increase sales and market share by lowering the prices of their products. Firms strive to attain their goals independently, without collusion. There are no unfair, exclusionary, predatory, or coercive tactics. Inefficient suppliers and customers are not shielded permanently. Sales promotion is informative, or at least not misleading. There is no persistent, harmful price discrimination. Performance Firms’ production and distribution operations are efficient and not wasteful of resources. Output levels and product quality (i.e., variety, durability, safety, reliability, etc.) is responsive to consumer demands. Profits are at levels just sufficient to reward investment, efficiency, and innovation. Prices encourage rational choice, guide markets toward equilibrium, and do not intensify cyclical instability. Opportunities for introducing technically superior new products and processes are exploited. Promotional expenses are not excessive. Success accrues to sellers who best serve consumer wants. Adapted from Scherer and Ross (1993).

Timeline of competition laws 1889 — Canadian Combines Act passed (Canada) 1890 — Sherman Antitrust Act passed (United States) 1911 — Standard Oil and American Tobacco Co. split up using the Sherman Act 1914 — Clayton Antitrust Act passed (United States) 1915 — Federal Trade Commission formed (United States) 1957 — Treaty of Rome established (European Economic Community) 1976 — Hart-Scott-Rodino Antitrust Improvement Act (United States) investigated mergers for antitrust activities 1980 — United Nations Conference on Trade and Development (UNCTAD) adopted a set of policies to tackle restrictive business practices 1982 —American Telephone & Telegraph (United States) split up because of an antitrust suit filed in 1974

The origins of modern competition law were, thus, a response toabuse by firms. However, they were also framed by the need toensure that the economy used its resources as efficiently as itcould. Monopolies were seen as wasteful and as closing offopportunities for rival firms to sell their wares. The desire forefficiency and to promote entry and innovation have underpinnedmuch of the efforts to inject more competition intoeconomies ever since.

The proliferation of modern competition law only really occurredafter World War II. Although, previously, many countries hadsome market-regulating rules (most European countries have hadsuch laws since the Middle Ages), they tended to be biased infavour of the largest and most powerful firms and guilds andagainst the consumer and smaller players. One of the reasons forthe increase in competition policy after World War II was the role that anticompetitive practices played in the run-up to the waritself. In both Germany and Japan, cartels were forced on theeconomy as part of war preparations. In the immediate aftermathof the war, the occupying powers broke up these cartels and wrotecompetition laws in both Japan and Germany. However, it wasnot until the formation of the European Economic Communitythat we really saw modern competition law take root in Europe.

The object of competition law is generally twofold: first, to ensurethat anticompetitive behaviour and agreements are restricted withthe object of, second, ensuring that normal market dynamicsoccur. Thus, competition policy is largely intended to cure abusesin the marketplace (cartels and barriers to rivalry) or to ensurethat future abuses do not occur (by blocking mergers).

To complicate matters, competition policy includes things likeadvocacy and coordination with government departments that gobeyond competition law. Competition law is the adoption oflegislation to prohibit anticompetitive conduct by the privatesector that reduces competition in markets. Competition law andpolicy are part of a tool kit that all governments need and mostuse to deal with the modern world economy. Other measuresinclude trade, investment, and general government policies thataffect competition within an industry or market. Some industries,particularly those that used to be run by the state or are “naturalmonopolies,” have sector-specific regulation (i.e., a specificregulator keeps them in check and generally tries to introducecompetition into the market gradually).

Competition law is used to address three main situations:

• Anticompetitive agreements, where two or more firms agreeamong themselves to fix prices, limit production, divide marketsup geographically, or rig bids when tendering for governmentcontracts.
• Abuses of dominance or exclusionary behaviour, whereone firm is so powerful it can act without thinking about itsrivals or can act to exclude its rivals. Abuses of dominance orexclusionary behaviour can include predatory pricing (pricingbelow cost to drive competitors out of a market and then raisingprices once they have gone), tying up distribution networksto exclude competitors from the market (not allowing distributorsto carry competitors’ products), and denying competitorsaccess to essential facilities (stopping a shipping companylanding goods at a dock).
• Merger-control regulation, where firms that want to mergeare reviewed to ensure that their deal is not likely to reducecompetition significantly. Merger-control regulation is aimedat ensuring that mergers do not lead to too much market concentration,which may lead to abusive behaviour. This type oflaw is unusual in that it is pre-emptive — economists wouldsay ex ante — an authority can block a merger before it happens.Anticompetitive agreements and abuse of dominancecontrols are reactive (ex post) in that the events have alreadyoccurred.

Natural monopoly Some industries have phenomenally high entry costs. For example, it isunlikely that a firm entering the market would build a new underground railwayline, road system, or gas pipeline alongside an existing one, and fewindustries or countries would want to bear the costs, financial and social, ofhaving two subways or pipelines. Once a firm has invested in facilities, itenjoys lower and lower marginal costs. It is thus said to have a degree ofnatural monopoly over some elements of its business. Such industries tendto be closely regulated to stop them from abusing their monopoly power by,for example, limiting access of rivals to an essential facility (like a pipelineor a port).

As we shall see, national competition laws differ in scope and coverage. For example, several developing countries, including Peru and Jamaica, do not have merger control. Its relevance is questioned particularly for small economies where concentration is argued to be necessary to achieve economies of scale and competitiveness, both in domestic and export markets.

Why has competition policy become a controversial issue?

The last few decades have seen a surge in the process known as globalization. This term describes a number of trends. Among these are a growth in cross-border trade and commerce, an increase in the importance of private capital, an increase in foreign direct investment by multinational corporations, and deregulation or liberalization of previously state-owned or -controlled sectors. Competition has thus reached into a larger number of areas and countries than ever before, and the practices that can stifle that competition have become more visible, particularly where government monopoly has been replaced by private monopoly.

The 1980s saw the beginning of a wave of governments selling off — in full or partly — their utility, transport, telecoms, and sometimes health sectors to private firms or investors. The wave was triggered in the early 1980s by political and economic shifts in key developed countries, like the United States and the United Kingdom, that favoured private over state control of assets. The wave moved to large parts of the world, as a condition on loans from international financial institutions and as a wider shift toward private capital, hastened by the end of the Cold War and dissolution of the Soviet Union. A useful database of cases can be found on the Public Services International website (PSIRU n.d.).

This process of restructuring, triggered by greater exposure to globalization, has generally increased competition in domestic markets by dismantling the protective border barriers and restrictive investment rules that prevailed in the postwar years and by creating a domestic environment that facilitates foreign investment and trade. In the early 1980s, developing countries had started liberalizing their economies under International Monetary Fund–World Bank structural adjustment programs, which imposed these conditions for debt rescheduling. In 1994, trade liberalization was accelerated by the successful negotiation of the General Agreement on Tariffs and Trade, under which industrialized countries lowered tariffs considerably, particularly those on non-agricultural goods.

Competition law, in its role as curative to market ills, grew in prominence because countries feared losing the possible gains from liberalization to anticompetitive agreements or practices. During the 1990s, there was also increasing concern over the cross-border impact of international cartels. A number of enormously powerful and important international cartels were uncovered during this time and their impact on developing countries became more apparent.

Cartels Cartels involve firms agreeing among themselves to limit production, divide markets, and fix prices. Of 40 cases of privately operated cartels prosecuted in the United States and Europe in the 1990s, 24 had lasted more than 4 years. The total annual worldwide turnover of just 20 of these cartels exceeded US$30 billion. There are three types of cartels: private international cartels, state-exempted export cartels, and state-organized cartels. Big international cartels are most common in intermediate (input) markets. The most damaging cartels existed in the vitamins, lysine, and graphite electrodes markets.

The link between trade and competition policies was explored several times, including during the Doha Round of World Trade Organization (WTO) negotiations, as one of what were called the “Singapore issues.” Although the trade–competition link was never moved into the negotiations agenda itself, it is addressed in many regional trade agreements (RTAs).

Singapore issues The first ministerial conference (the WTO’s highest level decision-making body) took place in Singapore in 1996. At that meeting, a number of “trade-related” issues were raised by member states. These included the links between trade and competition policy and between trade and investment policy. The Working Group on Competition Policy enjoyed significant progress in sharing experiences in competition law among members (WTO 2001, 2003). But opposition to adding competition to the negotiations agenda gradually increased. Along with two other proposed items, the topic of competition was set aside from WTO deliberations after the Cancun Ministerial Conference of 2003.

In addition to improving efficiency and bringing new challenges to incumbent firms, competition can have other benefits that are politically contentious. As evidenced in the WTO, many interests are ranged against the introduction of effective competition policies. Anticompetitive behaviour entails a transfer of resources from consumers to the producers involved. In developing countries, the poorest are often effectively paying a tax to the richest. The intended benefits of trade reform, in terms of lower prices for consumers, are only forced through from the docks to the doorstep if liberalization is accompanied by competition policies. Competition law can also play a significant role in exposing government contract and deregulation processes and limiting “sweetheart” deals behind closed doors.

Challenges in introducing competition law

Competition policy can be an effective tool in reducing corruption, ensuring that consumers gain from liberalization and trade reform, and limiting the power of the largest corporations nationally, regionally, and globally. Thus, it is no surprise that it has many powerful enemies. The difficulty of overcoming entrenched opponents is often compounded by the fact that developing countries simply copy large parts of their laws and policies from developed countries without necessarily adapting them to local conditions. There are also significant challenges to setting up the right institutions to handle competition law and policy.

In developed countries, current laws have evolved significantly over time and are enforced by well-funded and -supported public bodies, whose key staff move in and out of the public sector and a well-resourced, private-sector legal and economics community. IDRC-funded research projects on competition law have been trying to address some of the problems that arise when developing countries adopt these policies in a “one size fits all” approach. Some of the key issues raised in that research point to the need to ensure that

• Actions against anticompetitive practices affecting development goals are given priority;
• Fines are a serious deterrent to infringement;
• The competition authority is properly funded;
• Merger policy is appropriate to the size and stage of development of the economy; and
• Dominance measures are appropriate to the size and stage of the economy.

In developing countries, competition law and policy face many challenges. Among the key ones are ensuring political and societal support, enforcing the laws with limited resources, and dealing with cross-border enforcement problems.

Ensuring support

Competition policy and law fall victim to the classic problem of reformers everywhere: those who do well under the existing rules will oppose change much more strongly than those who might gain from change. What is already a difficult task is further complicated by the fact that competition policies and laws are complex instruments with uncertain outcomes. The problems faced in all countries — and made more difficult in developing countries — include getting the law before legislative bodies, getting that law through legislative bodies, then ensuring that the authority charged with the task of enforcement has the resources needed to carry out the job. All stages require political and public support, and advocacy efforts should focus on gaining such support.

Living with scarcity

Lack of resources is a huge obstacle to successful implementation of competition law. The required resources are not just financial, but include institutional capacity, particularly skilled human resources, and wider societal capacity to engage with the reform process. Any country introducing a competition law will need judges and lawyers trained in competition law as well as skilled staff able to identify anticompetitive behaviour. Outside the immediate legal system, a country will also need journalists, consumer groups, and other non-governmental organizations (NGOs) who understand the law and its benefits and who can act as watchdogs.

Dealing with cross-border anticompetitive conduct

One of the greatest challenges facing enforcement agencies in developing countries is cross-border anticompetitive activity. Although cross-border activity has always been part of the world economy, increasing globalization has triggered an increasingly linked series of anticompetitive agreements. International cartels stretch across national borders and are seemingly invulnerable to the laws of a single country, even countries as powerful as the United States or entities such as the European Union.

In 1997 for example, according to a well-known study, developing countries imported US$81.1 billion in goods from industries that had seen a price-fixing conspiracy during the 1990s. These imports represented 6.7% of imports and 1.2% of gross domestic product (GDP) in developing countries. For the poorest developing countries, they represented an even larger proportion of trade — 8.8% of imports (Levenstein and Suslow 2001).

Competition authorities in industrialized countries, particularly the United States and those of the European Union, have been increasingly successful in uncovering and prosecuting international cartels. “Leniency programs” and increasing cooperation between large authorities were largely responsible for the successes. Many of the cartels that have been uncovered — such as the vitamin cartel (involving vitamins and all foods containing vitamin additives) and the lysine cartel (animal feed) — had a significant impact on the cost of basic foods in developing countries.

What is a leniency program? Leniency programs are designed to reward the first cartel member who “blows the whistle” on fellow conspirators. Whoever tips off an agency and provides evidence of cartel activity will see their fine reduced or eliminated. For leniency programs to work, the competition authority must have a reputation for rigour and aggressive enforcement.

Developing countries face a number of problems in combating international cartels. For example, there is a lack of cooperation between developing- and developed-country authorities, and among developing-country authorities. Perversely, foreign firms may also be protected by the confidentiality laws of the country in which they have their home base. Of a more basic nature, developing countries may not wish to take on some of the largest corporations in the world for fear of retaliation. Some of these issues are being increasingly addressed in bilateral and regional trade negotiations (Figure 1) and have been included more generally in two sets of international guidelines — those of the United Nations Conference on Trade and Development (UNCTAD) and the Organisation for Economic Co-operation and Development (OECD).

Figure 1. Proportion of regional trade agreements (RTAs) with provisions related to competition law (Cernat 2005)

UNCTAD’s set of mutually agreed equitable principles and rules for the control of restrictive business practices (UNCTAD 2000), or “the Set” as it is known, was negotiated during the 1970s and adopted in 1980 by the United Nations General Assembly. The non-enforceable objectives of the Set are to ensure that

• Restrictive business practices do not impede realization of the benefits of trade liberalization;
• Competition is protected in the market and concentration of capital and economic power are controlled;
• Social welfare is protected; and
• Disadvantages to trade and development resulting from restrictive business practices are eliminated.

The Set has been used by many developing countries as a guide to writing their own national laws.  In any case, the rules are not binding on United Nations’ member states.

Similarly, the OECD countries agreed on guidelines for multinational enterprises (OECD 2000a). These were first adopted in 1976, and revised in 2000, as part of The OECD Declaration and Decisions on International Investment and Multinational Enterprises (OECD 2000b). The guidelines include a competition section, which requires multinational enterprises to refrain from anticompetitive behaviour and to comply with all local competition laws. In 1998, the voluntary guidelines were supplemented by the Recommendation of the Council Concerning Effective Action Against Hard Core Cartels (OECD 1998), inspired by the increasing awareness of the existence of cartels and in recognition of the success of the United States Department of Justice’s prosecution of international cartels.

During the late 1990s, discussions of the WTO’s Working Group on the Interaction between Trade and Competition Policy led to a realization that most developing countries were uninformed about competition law and policy (WTO 2001, 2003). National efforts to improve understanding were given technical assistance by the WTO, UNCTAD, and the World Bank. The sum of all these efforts has been a vigorous debate about the kind of multilateral agreement that might be needed to enable developing countries to tackle egregious practices from abroad. However, this debate has cooled of late with the withdrawal of the WTO as a venue for a possible agreement.

Document(s) 4 of 9