5.1 Theoretical underpinnings of anti-competitive behaviour
5.1.1 Anti-competitive behaviour from an economics approach
This section discusses the theoretical foundations used to identify anti-competitive behaviour of firms in the market. It argues that the market conduct of state monopolies is no different from that of other firms, because they are based on the same theoretical underpinnings that influence the competition policy of any country. Hence, competition law can be applied to the market conduct of state monopolies.
The section begins with the preliminary questions: what market behaviour fall within the scope of competition law and why they are concerned with competition law?
157 It is accepted that firms in the market usually strive to maximize their profits.1 Guided by profit maximisation, a firm‟s conduct is aimed at achieving a higher position in the market and attaining more advantages than competitors and the desire of most firms is to attain a dominant position.2 There are a number of concerns about such conduct of firms in so far as it may impact on competition.3 First, there is collusion between firms to restrict the market entry of other competitors or to fix prices.4 Such conduct could alter existing market structure, impact on the allocation of resources and cause inefficiency in the market. Under normal circumstances a competitive market structure will allocate resources in such a way as to „produce the goods and services which consumers value most highly and are prepared to pay for and the use of resources is limited at the lowest possible cost‟.5 Second, some conduct could result in an increase in market power or result in a substantial lessening of competition.6 Furthermore, the attainment of market dominance makes it possible for the firm (firms) to abuse this position to affect competition. Third, mergers and acquisitions entail the potential to directly alter market structure7 and they serve the desire to create market power or to exploit more from the firm‟s existing market power.8
As concluded by Martyn Taylor, there should be two types of regulation by means of
1 Michael Trebilcock and Edward Iacobucci, „Privatization and Accountability‟ (2003) 116 (5) Harvard Law Review 1424; Herbert J Hovenkamp, „Antitrust Policy after Chicago‟ (1985) 84 (2) Michigan Law Review 226-229. See also „firm objective‟ and „profit maximization‟ in John Black, Nigar Hashimzade and Gareth Myles, A Dictionary of Economics (Online) (Oxford University Press, 2009).
2 „A dominant position is a position of economic strength enjoyed by an undertaking which enables it to prevent effective competition being maintained in the relevant market by affording it the power to behave to an appreciable extent independently of its competitors, its customers and ultimately of the consumers‟.
See „dominant position‟ in Peter Cane and Joanne Conaghan, The New Oxford Companion to Law (Oxford University Press, 2008).
3 Rhonda L Smith, Competition Law and Policy- Theoretical Underpinnings
<http://www.regulationbodyofknowledge.org/documents/011.pdf>.
4 „Collusion refers to covert arrangements between firms to agree pricing policies or general market behaviour, or both. For example, firms could agree to split up a market such that each firm promises to stay within a particular sector, leaving it free to pursue its own strategies without fear of competition from other members of the colluding group. When such agreements are made formal they are called cartels‟. See
„collusion‟ in Peter Moles and Nicholas Terry, The Handbook of International Financial Terms (Oxford University Press, 1997).
5 Smith, above n 3.
6 Ibid. Market power is referred to as a situation where a firm (or group of firms acting jointly) has discretion in its decision making because it is free from constraints imposed by competition.
7 Smith, above n 3.
8 John F Stewart, Robert S Harris and Willard T Carleton, „The Role of Market Structure in Merger Behaviour (1984) 32 (3) Journal of Industrial Economics 296-297.
158 competition law. The first is „behavioural regulation‟ which refers to the regulation of behaviour of market participants. It is important to prevent firms from seeking market power individually and collectively in the form of engaging in anti-competitive behaviour. The second one is „structural regulation‟, which refers to the prevention of firms from merging with other firms in order to increase their market power excessively.
Such regulation is commonly applied because the potential for anti-competitive conduct exist in all markets.9 Therefore, despite differences in detail between countries, anti- competitive conduct is commonly regulated according to these three categories: (i) collusion in the forms of contracts, arrangements and understandings between competitors; for example, market sharing, price setting, etc; (ii) making use of market power either in the form of unilateral or collective conducts; and (iii) altering market structure by means of merger or acquisition.10 This categorisation is common in competition jurisdiction, of which good examples can be found in the EU, US and Australia.11
The next question is how a firm‟s conduct is explained and when it can be considered as harmful to competition. These questions can be answered by observing the theoretical underpinnings of various countries‟ competition policies. The conceptual framework for the consideration of the conduct of firms and their regulation by a competition law can be derived from two sources:
9 This preposition is made in most of the major textbooks on competition law, for example, Edward M Graham and J David Richardson (eds), Global Competition Policy (Institute for International Economics, 1997); G Bruce Doern and Stephen Wilks, Comparative Competition Policy: National Institutions in A Global Market (Oxford University Press, reprinted 2001); Richard A Posner, Antitrust Law (University of Chicago Press, 2nd, ed, 2001); Gorgio Monti, EC Competition Law (Cambridge University Press, 2007);
Alison Jones and Brenda Sufrin, EC Competition Law: Text, Cases and Materials (Oxford University Press, 3rd ed, 2008); Martyn Taylor, International Competition Law: A New Dimension for the WTO (Cambridge University Press, 2006); Barry J Rodger and Angus MacCulloch, Competition Law in the EC and UK (Routledge-Cavendish, 4th ed, 2009); S G Corones, Competition Law in Australia (Thomson Reuters, 5th ed, 2010); Maher M Dabbah, International and Comparative Competition Law (Cambridge, 2010); Lee McGowan, The Antitrust Revolution in Europe: Exploring the European Commission’s Cartel Policy (Edward Elgar Publishing, 2010).
10 Taylor, above n 9; Smith, above n 3. See also Corones, above n 9, 11; Monti, above n 9, 2; Rodger and MacCulloch, above n 9; 2-3; Dabbah, above n 9, 13-14, 32-35.
11 The practice of EU competition law offers a good example. The aim of the European Competition Law stated in Article 3(1) (g) of the EU Treaty is to condemn anti-competitive behaviour in order to ensure that competition in the internal market is not distorted. European competition rules encompass prohibitions and remedies to three types of anti-competitive behaviour: (i) entering into agreements restrictive of competition (e.g. price fixing cartels); (ii) harmful behaviour to the competitive process by dominant firms; and (iii) mergers that may harm competition. See Monti, above n 9, 2.
159 (i) The argument over the market conduct of firms. Although theories of economics explaining the conduct of firms are different,12 most of them employ the same method; that is, to place it in relation to two other factors: market structure and market performance. The triangular correlation among the three factors is the key principle of the „Structure–Conduct–Performance‟ paradigm (hereinafter referred to as the SCP paradigm).13 Explanations for the identification and regulation of anti-competitive conduct are inferred from the impacts of such conduct over other elements of the SCP paradigm.
(ii) The attainment of market power of a firm in the market. In this regard, the market conduct of firms is motivated by the desire to achieve individual or collective market power.
5.1.1.1 The Structure–Conduct–Performance paradigm14
The SCP paradigm suggests that how firms conduct themselves in the market can be inferred by observing the structure of a market, while the conduct of firms can be used to
12 For example, Harvard School with the SCP paradigm; Chicago School; Market Structure of Industrial Organisation of F M Scherer…See, e.g. Monti, Van den Bergh and Camesasca, Rhonda Smith.
13 The SCP paradigm was introduced by E Mason in the 1930s and further expanded by his colleagues such as J S Bain in the 1950s. See Jones and Sufrin, above n 9; Paul R Ferguson and Glenys J Ferguson, Industrial Economics: Issues and Perspectives (Newyork University Press, 2nd ed, 1998).
14 For a summary of this paradigm, see Frederic M Scherer, Industrial Market Structure and Economic Performance (Rand McNally, 1970) ch 1; Paul and Glenys Ferguson, above n 13, 16; Leonard W Weiss,
„The Structure-Conduct-Performance Paradigm and Antitrust‟ (1979) 127 (4) University of Pennsylvania Law Review 1104-1140.
The core theory of the Harvard School called the Structure – Conduct – Performance paradigm (SCP) was developed by Edward Mason in the 1930s and 1940s. See E S Mason, „Price and Production Policies of Large Scale Enterprises‟ (1939) 29 American Economic Review 61; E S Mason, „The Current State of the Monopoly Problem in the United States‟ (1949) 62 Harvard Law Review 1265; Roger van den Bergh and Peter D Camesasca, European Competition Law and Economics: A Comparative Perspective (Intersentia, 2001), 68.
This theory later became prominent in the 1950s and 1960s. See Monti, above n 9, 57. It was the articulation of the basic perceptions of industrial organisation theory and used to explain the relationship among three variables and to describe the direction of causality from structure to conduct to performance.
See Bergh and Camesasca, 55-67.
The SCP paradigm was tested and further developed by the works of the Harvard School economists e.g.
Chamberlin and Robinson, Bain and Clark. This paradigm was challenged by the Chicago School theorists, principally in relation to the price theory. The SCP paradigm prevailed in the theory of industrial
organisation, but it has become less widely applied today due to the emergence of theories arguing about other determinants of market conduct beyond market structure alone. See Taylor, above n 9, 78-79.
160 evaluate the market‟s economic performance.15 This sub-section concludes that the interpretation of the SCP paradigm can be employed to explain how state monopolies‟
behaviour in the market has an impact on competition and thus that competition rules can apply to state monopolies, as they do to every other firm.
This is summarised as below:16
Market structure refers to the characteristics of a given product market within which firms operate. Among these, the number of firms and their size are the principal ones.
Market structure is an indirect causal determinant of the extent of competition in a particular market.17
Conduct is defined as the way in which the firms behave. It includes criteria that firms use to set prices (e.g. collusion, independently or on the basis of consumer demand). It also includes how they decide on advertising and research and development expenditure.
Market conduct is the direct causal determinant of the extent of competition in a particular market and it is influenced by market structure.18
Performance is described as the measure of business conduct which determines whether the firms enhance economic welfare. Performance refers to the results of a given structure-conduct pattern and the economic performance of a firm is measured based on its productive, allocative and dynamic efficiency.19 Performance is also measured by other criteria such as, but not limited to, efficiency and technical progressiveness, employment of human resources, equitable distribution of income.20
The SCP paradigm is used as the groundwork for the consideration of anti-competitive conduct in competition law. It is concluded from the SCP paradigm that market structure determines conduct and this in turn determines performance. As a result of a firm‟s anti-
15 Corones, above n 9, 28-32; Monti, above n 9, 57-59; Bergh and Camesasca, above n 14, 24-26; Paul and Glenys Ferguson, above n 13, 16-17.
16 Monti, above n 9, 57. See also Taylor, above n 9, 79; Corones, above n 9, 28; Bergh and Camesasca, above n 14, 24.
17 Taylor, above n 9, 79.
18 Ibid. Corones, above n 9, 28.
19 For further discussion about economic efficiency, see Corones, above n 9, 25-26; Taylor, above n 9, 12- 13, Maher M Dabbah, above n 9, 23-25.
20 Monti, above n 9, 57; Corones, above n 9, 28.
161 competitive conduct, there will be an increase in the firm‟s market power and consequently a substantial lessening of competition.21 The two following analyses are also drawn from a study of the SCP paradigm to further demonstrate this conclusion.
From the structural approach, it is widely believed that a market with many buyers and many sellers is good for guaranteeing the welfare of consumers.22 Chicago School economists argue that a monopolist in a market with easy market entry will not raise prices due to the fear of losing its dominant position to other competitors.23 Nevertheless, without challenging the above arguments of the Chicago approach, it can be inferred that the ability to raise prices will be restricted by the entry into the market of competitors, unless this is constrained by entry barriers. The more existing and perhaps potential competitors there are in a particular market, the more difficult it is to raise prices. Firms tend to collude therefore in order to restrict entry into the market. One practice used to frustrate competition is predatory pricing, because it excludes from the market or weakens the competitive strength of competitors.24 The SCP paradigm identifies predatory pricing as anti-competitive behaviour because it affects market structure by reducing the numbers of competitors and leads to increased concentration.25
It can also be inferred from the relationship between the three elements in the SCP paradigm that merger and acquisition conducts cause changes in market structure and this later impacts on economic performance, or economic efficiency.26 A high concentration in the market will limit the participation of new competitors and reduce rivals among them, while allowing firms after concentration to attain market power for profit maximisation through their pricing policy. A high level of concentration therefore increases significantly the possibility of anti-competitive conduct and this is likely in turn
21 Ibid; Corones, above n 9, 28; Smith, above n 3.
22 Monti, above n 9, 4.
23 Ibid.
24 Monti, above n 9, 57.
25 Ibid 62.
26 Jones and Sufrin, above n 9.
162 to cause poor performance, such as the restriction of output or higher prices.27
There are also two competing hypotheses in the SCP paradigm with regard to market concentration.28 The first one, called „structure performance hypothesis‟, states that the degree of market concentration is inversely related to the degree of competition and that this is a direct relationship between them, because market concentration encourages firms to collude. It explains why firms in more concentrated industries will earn higher profits than those in less concentrated ones.29 It is then inferred that firms are motivated by the pursuit of profits to undertake mergers and acquisitions, thus distorting market structure and lessening competition.
The other, called „efficient structure hypothesis‟, argues that the performance of a firm is positively related to its efficiency. Whenever firms in a low cost structure increase profits by reducing prices and expanding market share, this causes increased market concentration.30 It is inferred from this hypothesis that firms are motivated by the desire to enhance their efficiency to pursue market concentration. In both theories there is obviously a link between market concentration and the conduct of firms. The concern is that such market concentration will cause a change in market structure which reduces the number of firms and concentrates market share to some firms, enabling them to undertake pricing policies. As a result, economic performance is restricted.
27 The concern about mergers and acquisition causing distortion to competition was once the central point of antitrust law and the incorporation of SCP analysis of the legality of horizontal mergers under section 7 of the Clayton Act by the US Supreme Court was formally used in the US v Philadelphia National Bank. See United States v Philadelphia National Bank 374 US 321(1963). Besides, the SCP paradigm influence was found in the Department of Justice Merger Guidelines adopted in 1968 for the implementation of merger control. It was considered that the conduct of the individual firms in the market tends to be controlled by the structure of that market; hence the focus of the Department‟s merger policy was market structure. See Monti, above n 9, 60.
28 Seanicaa Edwards, Albert J Allen and Saleem Shaik, Market Structure Conduct Performance (SCP) Hypothesis Revisited using Stochastic Frontier Efficiency Analysis (2006), 1-2
<http://www.docstoc.com/docs/10381823/Market-Structure-Conduct-Performance-(SCP)-Hypothesis- Revisited-using-Stochastic-Frontier-Efficiency-Analysis>.
29 Ibid.
30 Ibid.
163 5.1.1.2 Market power as the motivation for anti-competitive behaviour of
firms
This sub-section argues that competitive behaviour of firms is also motivated by the desire to achieve market power. This argument relies extensively on the writing of Martyn Taylor, who believes that market power is the desire of firms, even though an increased market power may cause distortion to competition.31 The target of achieving market power is considered the cause of anti-competitive conduct of firms. This in turn is a cause of market failures resulting from imperfect competition. Market failure refers to
„a situation in which markets left to themselves do not efficiently organise the production or allocation of goods and services to consumers in a way that achieves the highest total social welfare‟.32
Having market power will clearly enable a firm to enjoy many benefits, including the ability to impose monopoly prices and to eliminate potential competitors or launch barriers for competition. It is therefore concluded that the desire for market power is also a significant motivation for state monopolies to conduct anti-competitive behaviour.
The motivation of firms in colluding with others is also explained as a means to attain market power.33 Since a monopoly in the market is hard to accomplish34 because of the number of firms normally operating in the market, firms seek cooperation among themselves. Such cooperation is useful for coordinating their business activities, achieving their commercial objectives and reducing competition between them. By cooperating, firms may be able to enhance their market power, allowing them to engage in the same kind of conduct that a firm having significant market power alone can do,
31 As concluded by Martyn Taylor, the necessity of regulating against market power is clear, because increased market power will give market participants an increased ability to influence market prices to maximise profits, thus harming market efficiency. They will also be less subject to competitive constraints imposed by other competitors. See Taylor, above n 9.
32 Corones, above n 9, 19. Due to various market imperfections, perfect competition cannot be achievable in the real world. For that reason, the best outcome envisaged (in the „Pareto Optimal‟) sense cannot be attained. The idea of a completely efficient market is rarely, if ever, observed in practice. The greater the impact of competition becomes, the more chance there is for market failure. See Clifford Winston, Government Failure versus Market Failure – Microeconomics Policy Research and Government Performance (2006) <http://reg-markets.org/admin/authorpdfs/redirect-
safely.php?fname=../pdffiles/php3v.pdf>.
33 Taylor, above n 9, 89.
34 Ibid.
164 such as monopoly pricing.35 Collaboration among firms may be seen at two levels. At a lower degree, cooperation among firms is in the forms of agreements, arrangements, understandings and concerted practices. At a higher level, such cooperation can become complete where cooperative conduct is then internalised within a single legal entity (merger).36
However, not all cooperative forms among firms should be considered as harmful to competition. Some of them increase net welfare and cooperative activity may enable firms to achieve economics of scope and scale, leading to a reduction in their production costs and increased productive efficiency.37 But the consequence to competition brought about by the concerted conduct of firms must be taken seriously into account.38
In sum, anti-competitive conduct of firms in the market that is subject to the regulation of competition law can be grouped into three types: (i) the use of market power of firms having individual market power; (ii) concerted behaviour of firms in order to achieve collective market power; and (iii) merger of firms to enhance their structural market power.39 Arguments for the anti-competitive nature of such types of conduct are derived from theories of economics that are principally found in the SCP paradigm, as briefly discussed above.