An Introduction to Competition Law

Piet Jan Slot, Martin Farley

• Publisher: Hart Publishing
• Year: 2017
• ISBN:
  9781782250135
• Edition: 2
• Topic: Law
• Subtopic: Antitrust
• Index: Law

This book is intended to serve as a first acquaintance with competition law. It aims to reach a broad range of readers: students, teachers in further and higher education, officials and practising lawyers who are not usually faced with competition law issues in their working lives. This second edition has been fully updated in the light of the latest developments, and covers both EU and UK competition law along with an introduction to the EU rules on State Aid. It provides insight into the combined system of EU and UK competition law, providing a broad range of examples for the three main subjects – the prohibition of cartels, the prohibition of the abuse of a position of dominance and the supervision of concentrations (ie mergers and acquisitions). Those examples are drawn from European and UK practice. These greatly enhance the exposition of the general principles, taking into account recent legislative and judicial developments.

1

Introduction to Competition Law

1.1The Economic Background to Competition Law

Competition law is, in many ways, the night-watchman of a market economy. In a market economy, the important decisions about production and consumption (ie supply and demand) are taken through the market. Producers and consumers decide, on the basis of prices, whether or not to produce (supply) and/or whether the answer is to consume (demand). The goal of competition law is to ensure that the market functions optimally: ie to let competition do its good work. According to economists, an optimal operation of the market leads to greater welfare. This happens in three ways.

First, a well-functioning market leads to productive efficiency. The ‘products’ (which can be goods or services) are produced at as low a cost as possible. To achieve a certain quality, no more materials are used in production than is absolutely necessary. Companies are forced to look for better production methods so that the product can be produced at lower costs. If they do not do this, they are punished immediately by competition from their competitors.

Secondly, the proper operation of the market leads to allocative efficiency. Allocative efficiency is promoted by putting the available resources of production to work where they contribute most to consumer preferences. Production responds optimally to demand. Market power stands in the way of achieving allocative efficiency. Imagine that there is a monopoly over the production of blue pens, while producers of red pens compete strongly among themselves. Consumers generally prefer the blue pens. However, because the producer of blue pens holds a monopoly and charges a (higher) monopoly price, a number of consumers switch over to red pens. Through this shift in demand, more productive resources must be engaged in the production of red pens to satisfy the increased demand. From the point of view of social welfare (ie consumer preference), this is not optimal. If the price of blue pens were to fall, then the use of those productive resources would shift to the production of blue pens. In this way there is an improvement in allocative efficiency, because production is more in accordance with the preferences of the consumers.

Thirdly, the operation of the market leads to dynamic efficiency. Competition drives companies to be innovative and strive to create new products. Without this push, industry would continue to produce old fashioned and less useful models. The achievement of dynamic efficiency was also an important driving force for the UK government when introducing the Competition Act 1998, and the more recent reforms of the Enterprise Act 2002.¹

In the European Union (the EU), competition law has the further goal of promoting the functioning of the internal market. For this reason, close attention is paid to ensuring that the commercial world does not conclude or maintain agreements that restrict the free movement of imports and exports to and from other EU Member States. This objective has played an important role, particularly in the early days of the development of the internal market. The creation and development of the internal market has in no small part been due to the application of competition law.

This book discusses the meaning of competition law for the healthy functioning of the market. First of all, therefore, we will consider the function(s) of competition law. Thereafter, a number of economic concepts and background matters will be introduced and explained. A full treatment of these matters is beyond the scope of this introductory book. However, the reader who aims at a higher level of understanding of economics and wants to practice competition is well advised to familiarise him- or herself more thoroughly with this discipline.

1.2The Function(s) of Competition Law

Although the function of competition law has already implicitly been touched upon in the preceding section, it is perhaps useful to dwell upon this question for a moment. Antitrust law in the US (competition law in European terms) was developed in a period where trusts (ie, cartels) threatened from all sides to bring the American economy under their control. A cartoon from the 1890s illustrated this by depicting the most notorious cartels and monopolies as a giant octopus that held Uncle Sam in its all-embracing grip. Antitrust law—which seeks to break the trusts (ie, cartels)—was, therefore, also intended above all as a political message that the government recognised the damaging nature of the trusts and wanted to call a halt to them. It was thus a question of control and the redistribution of power and wealth. In other words, antitrust law was a strongly populist instrument. Behind this there was also a more economic–political objective, namely to guarantee the operation of the market mechanism. In a famous decision of the US Supreme Court, Socony-Vacuum Oil,² it was made clear that a price cartel that had been set up to combat ruinous competition simply could not be allowed to stand. The case concerned a price-fixing cartel that had been set up by small manufacturers in an attempt to stabilise oil prices in the face of the economic crisis of the 1930s. Despite the desperate situation faced by the companies concerned, the Supreme Court remained of the view that American antitrust law did not exist to protect the small competitor. It was about the protection of the competitive process. This judgment illustrates strikingly the conflict between the objectives of competition law. The current US antitrust law is increasingly directed at protecting the interests of the consumer and carries with it heavy sanctions. For example, prison sentences can be imposed upon individual offenders and claimants can bring so-called ‘treble damages actions’ against undertakings that have breached the antitrust rules. These sanctions ensure that American antitrust law carries important political and social baggage.

Competition law in the EU, however, was mainly directed at achieving the objectives of the common market, which later became known as the ‘internal market’. The function of the promotion of competition was an active part of these objectives. The same is true of the protection of the consumer.³ Various EU block exemption Regulations have the goal of promoting research and development: this happens by exempting agreements in this field from the prohibition on cartels. This also takes place through encouraging the development of patents. These developments can be seen as a form of industrial policy in which legislators and enforcement agencies recognise that a certain degree of cooperation between competitors can, in certain circumstances, be beneficial for the market—and consumers—as a whole.⁴

In this connection, it is important to note that competition law does not strive to achieve moral goals, nor does it carry any moral baggage other than the promotion of competition. Whenever, for example, a particular undertaking builds up a large market share through a very efficient production process and very effective commercial policy, that position is not in itself prohibited. On the other hand, such praiseworthy market behaviour does not have the consequence that the company is somehow freed from the stricter competition rules that apply to undertakings that hold a position of dominance on the market. Here, again, the issue is the protection of competition and not the protection of successful market behaviour.

1.3The Market

1.3.1Economic Theory Distinguishes Between Various Market Forms

Economic theory distinguishes between a number of market forms. First, there is the market with full or ‘perfect’ competition. In this market, there is an infinite number of producers and, as a result of this, no single producer is in a position to influence the price. Similarly, there is an unlimited number of consumers/buyers, who are just as unable to influence the price. The product is homogeneous, so that no single buyer has a slight preference for one type of the product over another. Buyers and sellers have full information at their disposal concerning prices and the sort of goods that will be offered, so that both will buy and sell at the current price. Also, buyers and sellers neither ask nor offer any deviation from the standard quality of the product. There are also low barriers to entry for the producers. The classic example of a market that approaches this model is that of the market for grain in the United States. This market has a very large number of farmers who grow the grain and many purchasers. Furthermore, the grain is all of the same quality. Although the model of perfect competition is hardly ever encountered in practice, it performs an important exemplary function in competition law. In this model, undertakings produce at the point where their marginal costs⁵ are equal to the price. That means that the consumer pays the lowest possible price for the product. This price is an equilibrium price because it places the producer in a position to produce in an economically responsible manner. In this situation of equilibrium, no profit is made, apart from a reasonable allowance for the factors of production involved. Furthermore, there are no other forces to ensure that new producers will enter the market. The results of this model are used to explain its normative effects upon competition law. Thus, in the application of competition law the authorities strive to ensure the largest possible number of sellers of products. It also explains why agreements between producers concerning prices and market sharing are undesirable. Such practices keep the price artificially above the equilibrium level.

This market form, however, is only partly of relevance in the daily practice of competition law. The American economist JM Clark, in his article ‘Towards a Concept of Workable Competition’, made an important contribution to the further development of the theory of market forms.⁶ Clark concluded that perfect competition does not exist in practice. In his view, there are always circumstances which ensure that the market does not function perfectly (so-called ‘market imperfections’). Thus, producers and consumers are far from having full information at their disposal. The product is also rarely homogeneous, so that different prices can apply to different qualities. Often there are also barriers to entry for producers. These imperfections have important consequences. For Clark, the issue was thus to create the conditions in which the market would be, and would remain, workable. As a result, certain restrictions upon competition could be accepted in order to realise other goals, such as a good product or a good service. This concept of workable competition has also been followed in EU and UK competition law, and is even enshrined in the relevant legislation Article 101(3) TFEU and section 9(1) of the Competition Act 1998 (see Chapter 3.5 below). Thus, the Court of Justice of the European Union (ECJ, or ‘the Court’) in its Metro I judgment⁷ held that the issue was one of ‘effective’ competition—that is, the measure of competition that is necessary to comply with the basic demands of the EU Treaty and to achieve its objectives. On the basis of this starting point, the ECJ accepted a certain restriction of price competition, since this could lead to an increase in competition with regard to factors other than price.

A second market form is that of monopoly. In this market form, there is only one producer that puts the relevant product on to the market. Through this, this producer is in a position to demand a price for the product that is far above the equilibrium price (ie, the marginal costs) as there is no competition to constrain its behaviour. The consumer pays much more for this product than would be possible under perfect competition. The extra income that the consumer spends in this way cannot be used to purchase other products. In such a market, allocative inefficiency occurs. Indirectly, the existence of a monopoly can also lead to productive inefficiency. But then we must accept that—due to the absence of competitive pressures—costs will be higher than where competition is present. Alongside this, the pressure for product innovation can also fade: the absence of such pressure can lead to a reduced level of dynamic efficiency. This model of monopoly also has great normative value for competition law. As we will discuss in Chapter 4, those with dominant positions are subjected to stricter rules than undertakings with a lesser degree of market power. The same considerations also form the basis of merger control, with the creation or strengthening of a dominant position being a specific example of the type of significant impediment to competition that can result in the prohibition of a merger under the EU Merger Regulation: on this, see Chapter 5.

The mirror image of a monopoly is a monopsony. In this situation, there is only one buyer. This position gives the buyer the possibility to dictate the conditions of purchase. From a competition point of view, this situation is just as undesirable as a monopoly. An example of a monopsony was the position of the Spanish State telephone company, prior to the liberalisation of the telecoms market. Telefonica was the only company that bought telecoms equipment on the Spanish market. When two large producers of this equipment decided to merge, a dominant position on the equipment market would have been created and the question was whether this dominant position would distort competition. The European Commission (which had to decide whether or not to approve the merger) took the view that, due to the existence of only one buyer of such equipment, the merger in fact would not do so.⁸

A third market form is that of oligopoly. In this model there is only a limited number of sellers or producers. This provides them with the possibility of influencing market conditions. This possibility is increased still further if this small group of producers conspires to impose their conditions upon the market. In oligopolistic markets the competition authorities must therefore be particularly vigilant. An understanding of the nature of oligopolistic markets is of especial relevance in the contexts of: the notion of concerted practices (see Chapter 3.2.2.3); the concept of collective dominance (see Chapter 4.2.13); and the merger field, when assessing coordinated effects and the likely structure of the market subsequent to the proposed merger (see Chapter 5...