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John Fingleton speaking at the European Competition Day 2014 in Rome.

Competition and growth in Europe

On 10 October 2014, John Fingleton spoke at the European Competition Day in Rome. These are notes of his speech.

I would like to thank the Autorità Garante della Concorrenza e del Mercato for inviting me to speak at the European Competition Day as part of the Italian Presidency of the EU. The European Competition Day provides an excellent opportunity to look at the wider economic context and implications of competition policy.

I had the great pleasure of speaking at the previous Italian European Competition Day on the 9th December 2003. The topic then was “Liberalisation, Competition and Economic Growth”. The topic today, “Competition and Growth: Theoretical and Regulatory Frameworks” is similar, but the context could not be more different.

Europe is confronting the most serious problem with economic growth that we have known for generations. For developed countries, productivity growth is essential for economic growth. As Paul Krugman said, “Productivity isn’t everything, but in the long run it is almost everything”. [1] Competition has a central role to play in driving productivity growth. Today I will talk about what the links between competition and productivity growth imply for the reform of competition policy in Europe.

My conclusion is that we are not always putting our reform efforts into the correct areas. David Ricardo, the 19th Century British Economist, drew a distinction between the intensive and extensive margin. Increases on the intensive margin consist of getting more output from land which is already being used. Increases on the extensive margin consist of getting output from land that was not previously utilised. I worry that we put too much emphasis on small refinements of the existing system – the intensive margin – rather than examining bolder policies such as those undertaken in the years around 2003, or the even bolder ones when the competition rules of the Treaty of Rome were written.

What does theory tell us?

The link between competition and productivity involves incentive effects, selection effects and innovation effects. [2]

  • Competition gives firms incentives to cut prices, and more importantly, to cut costs. By cutting prices and costs, and increasing the quality of their products, firms can win business from their competitors and grow. In competitive markets, companies are generally better managed, use their inputs more efficiently, and offer better price, range, quality and service to meet consumers’ needs.
  • Selection effects arise when less efficient firms fail and are replaced by more efficient ones. Ease of entry and expansion for new players is key for this to happen.
  • Innovation effects arise when a new or innovative product or service is brought to the market, often in a way that disrupts existing markets. It is most common in research and development intensive industries such as pharmaceuticals, engineering and technology.

The cost of the lack of competition is not only measured in terms of high prices for consumers. Firms that do not face competition are generally less efficient. They have higher costs and are often less responsive to their customers. They produce less with more. They are unproductive.

Further, in order to prevent competition undermining their cosy existences, they are also more likely to engage in wasteful “rent-seeking” and lobbying behaviour. The impact of low competition in one sector can affect the whole economy through misallocation of resources. For example, sectors with weak competition often pay wages well above the market rate, resulting in a mis-allocation of talent that can persist for a generation. It can mean that the brightest graduates become pharmacists, lobbyists, and bankers, all occupations that add relatively little economic value compared to research scientists, engineers, and entrepreneurs.

Policy to improve competition should be expected to lead to greater productivity growth, especially over time. Policies can be split into two types:

  • policies that increase price rivalry among existing firms such as prohibitions of cartels and anticompetitive mergers, or improved consumer switching; and
  • policies that remove barriers to entry, expansion and exit, such as the prohibition of exclusionary abuse of dominance, or removing regulations that inhibit entry.

What is the evidence?

The aviation sector provides many examples of how competition drives productivity growth to the benefit of consumers and the economy.

  • The liberalisation of airline routes in the EU that started in the late 1980s contributed – between 1992 and 2002 – to an increase in flight frequency of 78% and a reduction in the lowest non-sale fare by 66%. Liberalisation enabled low-cost carriers with a new business model to enter, forcing incumbent (usually state owed) carriers to adapt or, in some cases, leave the market. In this way, it was not only those who flew on low-cost airlines who benefited; airfares across the sector fell. This is an example of how removing barriers to entry can increase competition, illustrating both the incentive and selection effects.
  • In February 2007, the UK Office of Fair Trading initiated consumer enforcement action against thirteen airlines for quoting unavoidable costs, such as taxes and surcharges, separately from the base fare on their websites and in advertisements. These costs were added to the price at a late stage in the booking process and, as a result, the actual price paid by consumers could be significantly higher than the headline price. The OFT action ensured that all compulsory costs were included in headline prices of flights, facilitating consumer choice and increasing market contestability. A later independent evaluation suggested this had annual benefits of £131m. [3] This is an example of how incentive effects can have large positive impact.
  • In May 2006, the OFT initiated an inquiry into UK airports as a result of which, in March 2009, the UK Competition Commission required British Airports Authority (BAA) to sell two of its London airports (out of Heathrow, Gatwick and Stansted) and one of its Scottish airports (either Glasgow or Edinburgh). As a result, there has been keen competition between airports in the United Kingdom, with clear improvements in service. They are also actively competing for runway expansion. This is an example of how creating competition where previously there was a monopoly can result in improved incentives. It shows the importance of introducing competition alongside the privatisation of state-owned monopolies (BAA had been privatised as a monopoly), reducing the potential gains from competition.

I could give many other examples such as taxi markets, international telephone calls, energy, where the removal of entry barriers and consumer switching costs has resulted in clear productivity growth.

What are the implications for European competition policy?

The framework in the EU has many of the key elements of an effective competition regime. In common with most other jurisdictions, it has effective prohibitions against anti-competitive agreements, abuse of dominance, and anticompetitive mergers. The European Competition Network, whereby these laws are jointly enforced by the European Commission and the Competition Authorities of the Member States is unique, and works well. Unusually, and importantly, the EU also has a prohibition on anti-competitive state aid and anti-competitive state regulation. The EU has been exemplary in refining and reforming its functions to make them more effective over time.

This framework has delivered substantial benefits to consumers and businesses across the EU, in part because of the broad range of complementary tools available to the Commission. Taking the benefits of airline competition as an example, the initial liberalisation package was not fully effective, because national governments began to subsidise national carriers who could not compete, substantially blunting incentive and selection effects. However, from 2001, the Commission began to enforce state aid law more effectively, with the result that flag carriers could no longer be propped up by their national governments, and were forced to become far more efficient. In addition, the Commission used its abuse of dominance feature to prevent incumbent airlines from blocking entrants, and examined numerous joint venture and merger agreements in the sector, prohibiting those whose purpose was to soften the competitive pressure of liberalisation. [4]

While there are many things that could be done to improve the framework, I believe that there are three important areas where policy needs to develop.

Prohibitions on anticompetitive regulation

First, the prohibitions on anticompetitive (state) regulation and state subsidies are enforced only by the European Commission. There are numerous disproportionate restrictions of competition at national, local and city levels which are too small and widespread to be capable of being tackled by the European Commission. For example, it is likely that many cities across Europe impose excessive regulation on taxis resulting in cost and detriment for local residents, businesses and tourists. This is perhaps most easily seen in the difficulties that new business models like Uber have had in securing regulatory approval. In recent months, Uber has faced obstacles in Paris, Brussels, across Germany and even faced an attempt to restrict it in London. Because of the fragmentation of regulation across the EU, and the local level that regulations are enacted, European Competition policy cannot drive competition in taxi markets as it did in airlines.

One solution to this would be to empower national competition authorities of the Member States to enforce Articles 106 (regulation) and 107 (state aid). There is a precedent for this: in 2003, the EU empowered the national competition authorities to enforce Articles 101 (agreements) and 102 (abuse of dominance). This has been hugely successful. [5]

State restrictions on competition are often the most pervasive and the most difficult to remove because they are backed by powerful vested interests. Removing them can have huge benefits, as the airlines example shows. In the case of taxi markets, it would in addition send a powerful signal that the EU favours innovation and efficient new technology over traditional vested interest. Entrusting European powers to state competition agencies would go some way to redress the imbalance.

Dynamic focus

Second, the focus of existing competition enforcement needs to be challenged. Both economic theory and evidence show that competition drives productivity effects as a dynamic process. [6] For this reason, policy should focus on improving market dynamics, stimulating price rivalry, reducing switching costs, and tackling entry barriers. Much of current policy does this, but there are some concerns.

  • Too often, competition authorities are concerned with market structure instead of market dynamics. For example, in the UK, the competition agencies have recently ordered the break up of two companies (one in cement, one in private hospitals) using a highly structural analysis. UK politicians have called for market share caps and further restructuring in the energy and banking markets, both of which are currently subject to investigation by the CMA.
  • Too many agencies are focussed on bargaining disputes in the supply chain that have little impact on consumers or economic growth. The UK Government has created a specialist adjudicator for supply chain concerns in the grocery sector, and it is difficult to see how this will do anything other than possibly decrease industry efficiency and increase prices for consumers. Consumer-facing companies that face intense competition will always put pressure on their suppliers to offer better value, higher quality, and more reliable delivery. This is simply the competitive process at work, and in all but the most extreme cases it should not be the role of competition agencies to intervene.
  • Competition authorities should be cautious about relying heavily on evidence from competitors. Vigorous competition that is good for consumers is usually a challenge for competitors. In mergers in particular, the level of complaints by competitors is likely to correlate with consumer benefit and productivity increases. Competition authorities should prioritise their cases around the impact they have on consumers and economic growth, either directly because of the impact on the market in question or indirectly because of any deterrence effect that they may have across the economy.
  • The prohibition of cartels in Europe has improved over the past decade or so. But there is a risk of us developing a fetish around numbers of cases and high fines. The legal community clearly stands to benefit from this and is a powerful voice in the debate. Here, competition authorities and governments should focus on what is good for consumers and economic growth, and filter out vested interests. The performance of competition authorities should not be measured by case numbers or achieved levels of fines. Instead the focus should be on measuring the real effect on consumers and economic growth (as has been attempted in the UK for the past decade). While the focus on cartels is good, it should not be at the expense of other areas of enforcement that may perhaps be less lucrative to the wider competition law community.

Integrating consumer policy

Third, Europe needs to improve its consumer policy and join it up with its competition policy. Many of the biggest barriers to competition come from problems on the demand side of the market where consumers cannot easily compare prices or switch. For example, experience of competition in airlines shows how improving consumer choice can have a large positive impact on competition, and how the use of a range of complementary instruments can be necessary to achieve effective competition. Consumer enforcement is currently not something the European Commission pays much attention to. More importantly, what competencies there are in this area were fragmented in the second Barroso Commisison and will continue to be so in the Junker Commission. Improvements in co-ordinating consumer protection and competition enforcement would not just be good for economic growth, but might also help to build public support for the single market.

This is particularly important in fast moving online markets where novel issues arise and disjointed policy can have a significant negative impact on competition and growth. For example, many consumer-facing businesses now collect enormous amounts of data on their customers and, with the aid of technology, use behavioural economics and other marketing techniques to engage in sophisticated yield management – charging higher prices to consumers less likely to switch and focussing low price offers at the most active consumes. To demonstrate the importance of this, consider the speculation on October 7, 2014 around Dunnhumby, the Tesco-owned operation responsible for using Clubcard and other data for intelligent pricing strategies. [7] A value of £2bn was mooted, representing nearly 15% of the value of the entire business. [8]

This price discrimination may be good for consumers overall. However, many competition authorities lack the tools necessary to assess this. There are also political risks for competition authorities. When such price discrimination tends to be progressive (as with airlines), politicians don’t care. But when it is regressive (as it was with energy in the UK in 2008), it undermines politicians’ confidence in competition and markets, and can lead to political intervention that harms the market process. [9]

The new EU Competition Commissioner, Margarethe Vestager, has talked about the need for competition authorities to understand personal data. Many agencies lack expertise in this area. More importantly, without consumer enforcement powers, they lack the instruments to address many of the problems that may arise. The fragmentation of consumer policy across the new Commission may make this difficult. It would be unfortunate if the result was intervention to stop competition instead of intervention to make it more effective.

The current discussion about reforms to EU competition policy are worthwhile and should be pursued. But they feel like increases on the intensive margin: tweaks to make the existing system work better. If competition policy in Europe wishes to play a key role in driving growth, it needs to change and face up to these challenges. We need to break new ground.

[1] Paul Krugman (1994). The Age of Diminishing Expectations. MIT Press.
[2] See Chad Syverson, ‘What Determines Productivity?’ (2011) 49 Journal of Economic Literature 326-365 for a more detailed account.
[3] See http://londoneconomics.co.uk/wp-content/uploads/2011/09/32-Evaluation-of-a-sample-of-OFTs-consumer-enforcement-cases.pdf
[4] See http://ec.europa.eu/competition/sectors/transport/reports/ for policy reports supporting the EU competition policy regarding air transport; http://ec.europa.eu/competition/consultations/2013_aviation_guidelines/index_en.html for current draft guidelines on application of state aid to airports and airlines; and http://ec.europa.eu/competition/mergers/cases/decisions/M5747_20100714_20310_802534_EN.pdf for a non-opposition merger decision showing the level of detail of analysis even for non-interventions by the Commission on airline mergers.
[5] Wils, Wouter P. J., Ten Years of Regulation 1/2003 – A Retrospective (June 4, 2013). Journal of European Competition Law and Practice (2013 Forthcoming); presentation at the conference ’10 Years of Regulation 1/2003′ (Mannheim Centre for Competition and Innovation, 7 June 2013). Available at SSRN: http://ssrn.com/abstract=2274013.
[6] See Paul Klemperer Alfred Marshall lecture for a good description in relation to auctions (http://www.nuff.ox.ac.uk/users/klemperer/usingandabusing.pdf), and Sidak & Teece Favoring Dynamic Competition, Journal of Competition Law & Economics 2010 for a more general view.
[7] See http://www.bloomberg.com/news/2014-10-07/tesco-gains-most-in-six-months-on-speculation-of-dunnhumby-sale.html
[8] See http://www.ft.com/cms/s/0/da0ae8d6-4de6-11e4-adfe-00144feab7de.html#axzz3GgZRadHV
[9] See submission to the CMA from Stephen Littlechild et. al. (https://assets.digital.cabinet-office.gov.uk/media/53e38996e5274a261f000001/Stephen_Littlechild_et_al_submission_to_CMA_7_Aug_2014.pdf)