Policy Recommendations on Regulatory Reform

Competition Consumers and Regulatory Reform

Competitive and Dynamic Markets: Integrating OECD’s Competition Principles into Regulatory Reform

David Parker
OECD Secretariat

Materials

1997 OECD Policy Recommendations on Regulatory Reform

1. Adopt at the political level broad programmes of regulatory reform that establish clear objectives and frameworks for implementation.

2. Review regulations systematically to ensure that they continue to meet their intended objectives efficiently and effectively.

3. Ensure that regulations and regulatory processes are transparent, non-discriminatory and efficiently applied.

4. Review and strengthen where necessary the scope, effectiveness and enforcement of competition policy.

• Eliminate sectoral gaps in coverage of competition law, unless evidence suggests that compelling public interests cannot be served in better ways.
• Enforce competition law vigorously where collusive behaviour, abuse of dominant position, or anticompetitive mergers risk frustrating reform.
• Provide competition authorities with the authority and capacity to advocate reform.

5. Reform economic regulations in all sectors to stimulate competition, and eliminate them except where clear evidence demonstrates that they are the best way to serve broad public interests.

6. Eliminate unnecessary regulatory barriers to trade and investment by enhancing implementation of international agreements and strengthening international principles.

7. Identify important linkages with other policy objectives and develop policies to achieve those objectives in ways that support reform.

Competition policy is central to regulatory reform. Its principles and analysis provide a benchmark for assessing the quality of economic and social regulations. It motivates the application of laws that protect competition, which must be applied vigorously as regulatory reform stimulates structural change so that private market abuses do not reverse the benefits of reform. A complement to enforcement is advocacy, the promotion of competitive, market principles in policy and regulatory processes. Effective competition policy is important to stimulating innovation and production while keeping price increases in check. It can thus help eliminate some of the bottlenecks to achieving growth without inflation, which include weak price competition and insufficient entry and innovation.

Competition policy is increasingly being integrated into the general policy framework for regulation in many countries. This includes de-monopolisation and privatisation programs that are designed to create more competitive structural conditions in network industries. It also includes a broad range of “framework regulation” in many different sectors which affect competition.

box 1: competition policy’s roles in regulatory reform

In addition to the threshold, general issue, which is whether regulatory policy is consistent with the conception and purpose of competition policy, there are four particular ways in which competition policy and regulatory problems interact:

• Regulation can contradict competition policy. Regulations may have encouraged, or even required, conduct or conditions that would otherwise be in violation of the competition law. For example, regulations may have permitted price co-ordination, prevented advertising or other avenues of competition, or required territorial market division. Other examples include laws banning sales below costs, which purport to promote competition but are often interpreted in anti-competitive ways, and the very broad category of regulations that restrict competition more than is necessary to achieve the regulatory goals. When such regulations are changed or removed, firms affected must change their habits and expectations.
• Regulation can replace competition policy. Especially where monopoly has appeared inevitable, regulation may try to control market power directly, by setting prices and controlling entry and access. Changes in technology and other institutions may lead to reconsideration of the basic premise in support of regulation, that competition policy and institutions would be inadequate to the task of preventing monopoly and the exercise of market power.
• Regulation can reproduce competition policy. Regulators may have tried to prevent co-ordination or abuse in an industry, just as competition policy does. For example, regulations may set standards of fair competition or tendering rules to ensure competitive bidding. Different regulators may apply different standards, though, and changes in regulatory institutions may reveal that seemingly duplicate policies may have led to different outcomes.
• Regulation can use competition policy methods. Instruments to achieve regulatory objectives can be designed to take advantage of market incentives and competitive dynamics. Co-ordination may be necessary, to ensure that these instruments work as intended in the context of competition law requirements.

box 2: The competition policy toolkit

General competition laws usually address the problems of monopoly power in three formal settings: relationships and agreements among otherwise independent firms, actions by a single firm, and structural combinations of independent firms. The first category, agreements, is often subdivided for analytic purposes into two groups: “horizontal” agreements among firms that do the same things, and “vertical” agreements among firms at different stages of production or distribution. The second category is termed “monopolisation” in some laws, and “abuse of dominant position” in others; the legal systems that use different labels have developed somewhat different approaches to the problem of single-firm economic power. The third category, often called “mergers” or “concentrations,” usually includes other kinds of structural combination, such as share or asset acquisitions, joint ventures, cross-shareholdings and interlocking directorates.

Agreements may permit the group of firms acting together to achieve some of the attributes of monopoly, of raising prices, limiting output, and preventing entry or innovation. The most troublesome horizontal agreements are those that prevent rivalry about the fundamental dynamics of market competition, price and output. Most contemporary competition laws treat naked agreements to fix prices, limit output, rig bids, or divide markets very harshly. To enforce such agreements, competitors may also agree on tactics to prevent new competition or to discipline firms that do not go along; thus, the laws also try to prevent and punish boycotts. Horizontal co-operation on other issues, such as product standards, research, and quality, may also affect competition, but whether the effect is positive or negative can depend on market conditions. Thus, most laws deal with these other kinds of agreement by assessing a larger range of possible benefits and harms, or by trying to design more detailed rules to identify and exempt beneficial conduct.

Vertical agreements try to control aspects of distribution. The reasons for concern are the same—that the agreements might lead to increased prices, lower quantity (or poorer quality), or prevention of entry and innovation. Because the competitive effects of vertical agreements can be more complex than those of horizontal agreements, the legal treatment of different kinds of vertical agreements varies even more than for horizontal agreements. One basic type of agreement is resale price maintenance: vertical agreements can control minimum, or maximum, prices. In some settings, the result can be to curb market abuses by distributors. In others, though, it can be to duplicate or enforce a horizontal cartel. Agreements granting exclusive dealing rights or territories can encourage greater effort to sell the supplier’s product, or they can protect distributors from competition or prevent entry by other suppliers. Depending on the circumstances, agreements about product combinations, such as requiring distributors to carry full lines or tying different products together, can either facilitate or discourage introduction of new products. Franchising often involves a complex of vertical agreements with potential competitive significance: a franchise agreement may contain provisions about competition within geographic territories, about exclusive dealing for supplies, and about rights to intellectual property such as trademarks.

Abuse of dominance or monopolisation are categories that are concerned principally with the conduct and circumstances of individual firms. A true monopoly, which faces no competition or threat of competition, will charge higher prices and produce less or lower quality output; it may also be less likely to introduce more efficient methods or innovative products. Laws against monopolisation are typically aimed at exclusionary tactics by which firms might try to obtain or protect monopoly positions. Laws against abuse of dominance address the same issues, and may also try to address the actual exercise of market power. For example under some abuse of dominance systems, charging unreasonably high prices can be a violation of the law.

Merger control tries to prevent the creation, through acquisitions or other structural combinations, of undertakings that will have the incentive and ability to exercise market power. In some cases, the test of legality is derived from the laws about dominance or restraints; in others, there is a separate test phrased in terms of likely effect on competition generally. The analytic process applied typically calls for characterising the products that compete, the firms that might offer competition, and the relative shares and strategic importance of those firms with respect to the product markets. An important factor is the likelihood of new entry and the existence of effective barriers to new entry. Most systems apply some form of market share test, either to guide further investigation or as a presumption about legality. Mergers in unusually concentrated markets, or that create firms with unusually high market shares, are thought more likely to affect competition. And most systems specify procedures for pre-notification to enforcement authorities in advance of larger, more important transactions, and special processes for expedited investigation, so problems can be identified and resolved before the restructuring is actually undertaken.

EXAMPLES OF INTEGRATION ISSUES

Competition Principles Applied to Structural Reform Issues

• Pro-competitive Restructuring of Public Industries: This is now fairly common place, involving the horizontal and vertical separation of former government monopolies to create from the start a competitive structure in a newly private industry. Examples: Electricity and Gas Reform

• A Role for Competition Law in Privatisation Sales?: When a public industry is split up for sale to achieve a competitive structure a common issue is to avoid all or most of the assets being purchased by one or a few purchasers which would reduce the level of post privatisation competition. Two ways to deal with this: prior rules or application of the concentration provisions of the competition law. Example: Australian asset sales.

• The Role of Competition Law After Privatisation or Reform: Private anti-competitive behaviour can undo the intended competition effects of reforms if it is not prevented.

1. New areas of application. Example: Medical profession and application of law to self regulation
2. Post privatisation collusion. Example: Market sharing
3. Undoing mistakes: Example: Abuse of dominance

• The International Dimension: Global cartels and the OECD Recommendation on “Hard Core Cartels”.

II. The OECD Anti-Cartel Recommendation and Program

The OECD’s anti-cartel Recommendation was issued in 1998. The Recommendation defined “hard core” cartels as anticompetitive agreements by competitors to fix prices, restrict output, submit collusive tenders, or divide or share markets. The Recommendation condemns such cartels as the most egregious violations of competition law, noting that by raising prices and restricting supply they make goods and services completely unavailable to some purchasers and unnecessarily expensive for others. It urges OECD countries to improve the effectiveness of their anti-cartel programs, calling particular attention to the adequacy of their investigation tools, their sanctions, and their ability to engage in international co-operation. It also invites implementation by non-Member countries.

Implementing the Anti-Cartel Recommendation – the Good News

The OECD’s recent report on the implementation of the anti-cartel Recommendation concludes that it served as a catalyst for an impressive amount of legislative reform and of law enforcement action. New and stronger competition laws were enacted (Denmark, Netherlands, UK), as were updated substantive rules (Korea), new investigation tools (which in Canada include wiretapping and protections for whistle-blowers), and more stringent sanctions (which in Germany include criminal penalties). Nine OECD countries now have criminal penalties for such cartels, and the competition authority in Sweden has recently recommended this approach. Moreover, old statutory exemptions were repealed (most notably in Japan and Korea). In New Zealand, a study of optimal sanctions for cartels led to willingness by courts to impose larger fines and a legislative proposal for increased maximums.

In actual cases, to the extent such work can be disclosed, there were many “firsts.” The French authority made its first criminal referrals (and got its first convictions) for cartel activity. The UK brought its first international cartel case. The US obtained criminal convictions and record fines in several global cartel cases, and record fines were also imposed elsewhere, including Canadaand Norway. Ireland declared cartels “public enemy no. 1,” and until recently all of its civil and criminal cases involved price fixing. Spain condemned cartels illustrating how local cartel activity can have international effects by raising the input prices of producers that compete in international markets. Overall, OECD members’ recent actions against price fixing and other such cartels have halted billions of dollars in secret overcharges to individual consumers and business purchasers.

The Bad News

The same cases that successfully halted these massive overcharges have a dark side, however, in that their most important lesson is that such cartels are much more prevalent and harmful to the global economy than previously believed. The OECD was not able to estimate cartels’ global impact, and precise quantification would be never be possible, but to begin calling attention to this lesson, the report explains that in the United States alone, ten recently condemned internationalcartels:

• cost individuals and businesses many hundreds of millions of dollarsannually;
• affected over $10 billion in US commerce, with overcharges of over $1 billion;
• caused even more harmful economic waste estimated at over $1 billion.

To calculate the global harm of all cartels, these striking numbers would need to be increased by the harm these ten cartels had outside the US, plus the harm by (a) the many other successfully challenged international cartels, (b) the many more successfully challenged domestic cartels (many with international effects), and (c) the much larger number of undiscovered and unproven international and domestic cartels. No such calculation is possible, but cartels clearly are a major -- and until now invisible -- drain on the world’s economy.

Moreover, OECD members had relatively little success in achieving the more effective co-operation that the Recommendation recognises as vital in attacking cartels, because in order for anti-cartel co-operation to be significantly more effective, the competition authorities would need to be released from the statutory bans most countries have on sharing information with foreign agencies. Clearly, confidential business information must be protected from improper disclosure or use, but the record is clear that such information can be protected and shared among law enforcement agencies. Many agencies in other fields are authorised to gather and exchange confidential information with foreign agencies in appropriate circumstances, but nearly all competition authorities lack that that authority. Moreover, most OECD countries currently ban exchanges of much information that is in no way confidential. For example:

• Most authorities are prevented from sharing any non-public information acquired in a law enforcement investigation, even if it is not confidential.
• Due to vagueness or over-breadth, laws intended to protect confidential business information often restrict access to information that is not confidential.
• When investigations disclose illegal conduct in another country, authorities are often barred from alerting the relevant authority even by a “tip” that reveals no confidential information.

The Phase II Anti-Cartel Program’s Relationship to Developing Countries

Given these problems, the report calls for, and OECD Ministers have endorsed, an intensified 3-year anti-cartel program that will address five topics of urgent concern to OECD competition authorities:

• the extent of cartels’ overcharges and other harm;
• the real world impact of restrictions on international co-operation in cartel cases;
• optimal co-operation in cartel cases;
• optimal investigation tools for cartel cases; and
• optimal sanctions in cartel cases.

Study of the first two topics is needed to gather information to help overcome the knowledge gap and obtain needed reform. On the last three topics, the CLP will seek to identify best practice options that advance members’ common goal while allowing for individual differences.

Moreover, this program is to be complemented by further – and new kinds – of outreach to non-member countries. As outlined in the report, the program is intended primarily to reduce cartels’ multi-billion dollar drain on the global economy, and it deals only with issues the OECD will study and report on to help members devise more effective anti-cartel programs. But these reports will also be relevant, available, and beneficial to non-member countries, and OECD members would benefit if non-members in fact took advantage of the current momentum and recent lessons to increase their effectiveness in halting cartels. The details of the Recommendation and report can be communicated through traditional, capacity-building outreach in which the OECD shares its findings and provides assistance in developing policies that help developing and transition countries find appropriate ways of adapting those findings to their particular situations. Developing a mutually beneficial broader consensus against cartels, however, requires not only enhanced capacity, but also the kind of common understanding and trust that OECD meetings have been able to produce among its members. Taking outreach to the next level, this work on the anti-cartel program build can start to build that kind of understanding and trust, and encourage non-members to adopt and implement pro-competition laws and policies because of a belief in their benefits, rather than for other, less enduring reasons.