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Competition and the law – economically sound, or theoretically patchy?


Stephanie Gale

By

October 12th, 2013


When assessing a firm’s market power, do judges yield to the wisdom of economic experts? Stephanie Gale unravels the principles of Australian competition law.


If you look across today’s media, discussion about the level of modern competition appears to be everywhere. Headed by Coles and Woolworths, Australians are slowly seeing numerous facets of their everyday lives taken over by the large conglomerates – petrol, insurance, let alone the (decreasing number of) brands that can be physically purchased when heading to the supermarket.

An interesting question for consideration, at least in my view, is how our legal and enforcement systems actually deal with changes in competition, and how ‘economic’ their motives behind their decisions really are. How does the judiciary impose law onto what would otherwise be the free market – and, for those of us with a piqued interest in the subject, where do economic advisers fit in?

Competition law in Australia – the system

The state of competition in Australia is primarily based around the Competition and Consumer Act 2010. As this country is a majority free-market economy, it should not be entirely surprising that the main objective of the legislation is to ‘promote competition amongst firms’ – it’s at least a good start. Whilst most of the statute itself is focused around consumer law (making competition, in a sense, its slightly-forgotten cousin), the law centres itself more on what companies are not allowed to do by way of prohibition, instead of providing only a few methods for expansion and growth.

The standard for these prohibitions – centring around mergers, cartels, predatory pricing and your usual ‘economic nasties’ – is that they will block or undo conduct where it ‘substantially lessens competition’. What this actually means is where the ‘economic’ side of the law makes its debut appearance. The most authoritative Australian cases (if anyone is interested, and has a lot of time on their hands, check out QCMA) effectively mandate the determination of market power in a sector or for a product – i.e. what is the current state of competition, what is the change that is occurring (the hypothetical merger), and does it change that state?

Interestingly, QCMA focuses primarily on the fundamental economic principles of elasticity and substitution: if a firm is to give less, in terms of service or supply, and charge more, would there be much of a reaction from consumers? Fairly straightforward – at least to those of us who know a thing or two about economics. Where I found the test intriguing was through its inclusion of ‘supply substitution’. We are all aware of the idea that, for example, if the price of tea goes up, a certain amount of consumers will switch their purchasing preference to coffee (I wouldn’t, but I suppose I’m just inelastic). The courts have moved to place a large emphasis on the importance of suppliers being able to quickly, and relatively cheaply, move their production capabilities over to a new product if the price were to increase – in effect taking advantage of inelastic demand.

The five other ‘main’ elements of economics the law takes into account in market definition are as follows:

  • How many firms are in the market, and what is their market share?
  • Are there barriers to entry?
  • To what extent do products within the market differ?
  • Does vertical integration exist between functions, e.g. suppliers are also retailers?
  • Are there arrangements amongst firms, e.g. agreements not to compete?

There have recently been arguments concerning issues that arise where there are in fact firms within a market that are considered too efficient – a company that is excellent at its function is likely to drive out competitors, thereby changing the structure of the market without undertaking some kind of ‘prohibited’ arrangement. Another criticism also involves the age-old economic concept of game theory – the law fails to consider the fact that firms tend to act (at least in modern competitive markets) based on what competitors either are or may be doing; should we be including an element of economic strategy in considerations of market structure? What do you think?

The role of economic expertise and the judiciary

Something that a number of you may have realised, however, is that most judges don’t have an economics degree. Many are not aware of the finer points of market definition, whilst ideas of substitution tests are often impractical due to evidential issues; it can often be hard to put parameters on something which is intuitive in nature. This is where economic/industry experts are said to pull their weight. They are likely to be called to the stand, with a whole bunch of statistics (what a surprise…), to give their views on what a market is, and is not.

Recently (Google ‘Arnotts competition case’ if you want to read further) the courts have decided that you cannot have an expert determining the answer to what they have termed a legal question – has this company broken the law? Depending on how you frame it, this could easily become an economic question: is there sufficient market power held by this company to distort the market (unfairly) in its favour? Surely, in this latter situation, an economic expert’s opinion would be paramount, rather than the opinion of relatively uninformed legal decision-makers? Without wanting to take anything away from the judiciary (I would dearly love to join their ranks, one day), it hardly seems enough to merely listen to a lecture on economic principle from an expert, and leaving a court to apply it all by itself.

Hopefully, that’s cleared up some of your minds as to how competition law works in Australia on a basic level, including its (in some ways limited) application of economic principle. There are some decent concepts the court considers, however the main question is whether it really should be the courts that are considering them in depth? Do you have another solution?

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

  • Yannis Goutzamanis

    Hey Steph,
    Nice article. I am definitely keen to study competition law soon!

    I was thinking of a potential solution to the problem of judges not having sufficient economic or econometric skills or knowledge to deal with some complex questions about whether a particular M&A transaction will hinder competition, etc. My solution is this. An economic advisor (perhaps sourced from a private economics consulting firm or high level academic staff at a university) is hired by the court and they are to be independent, with a duty first and foremost to the court. Their role would be to assist the judge in answering these complex questions and perhaps conducting some modelling.

    The first argument against my proposal is that it requires extra funding to the judiciary. My answer to this is as follows. Each party have their own expert witnesses to produce modelling favourable to their side. For example, ACCC staff may perhaps use assumptions that produce an outcome where the transaction appears to be in breach of competition law and the other party will hire persons from an economics consulting firm who use different assumptions and techniques to produce a different outcome. Let’s assume each party’s expert witness costs $Y. If the court had it’s own economic advisor to produce modelling without the intrinsic bias of the expert witnesses they could mandate that each party does not bring expert witnesses to produce modelling. The court then passes on this cost in court costs. Now instead of 2 biased economic experts producing modelling totalling $2Y the cost is only $Y.

    The objection to this proposal would not be economic but rather legal. The traditional objection would be that such an approach is more inquisitorial rather than adversarial. However, I do not see this as a problem if it leads to a better and more informed outcome. In my view, there is no harm in having an open-mind and borrowing aspects of other legal systems that work well. Conversely, there is harm in a legal system having its head buried in the sand and refusing to consider proposals or reforms which do not conform with our traditional ‘adversarial’ approach.

    I would like to hear what you think of my proposed solution. Cheers.

  • Stephanie Gale

    Hi Yannis,

    I have to admit, I like your solution – I think however, you’ve picked up its main pitfall (if that’s really the right name for it), in that it is based on inquisitorial principles rather than Australia’s generally adversarial approach. You’re right in noting that this is a potentially backwards way for our courts to operate; I’d probably say that as we evolve, our markets are changing even faster (let’s face it, otherwise things like the global financial crisis wouldn’t have happened so seriously, so quickly), and so the approach is going to eventually have to take in some kind of international element to define the outer bounds of the market… I’m not entirely sure our judges are up to doing this, at least not yet.

    The other possible issue with the approach, however, is the general cost issue. Whilst the cost would be generally lower (which given our current legal funding issues, is excellent), at the end of the day, it’s far easier for the courts to burden the parties with the bill from the outset, rather than paying for something and chasing them for it afterwards. If you otherwise moved for a system where the expert didn’t appear if the parties didn’t pay first, you could say it defeats the point of seeking out an expert at all, as you’re losing the benefit of something that’s meant to help the court come to a better judgment. As weak as it sounds (particularly given the potential upside of an independent expert), administration is probably the biggest hurdle to jump.

    Also, I’d note the old chestnut – put seven economists in a room, and you’ll get eight different opinions!

  • Yannis Goutzamanis

    Yes I agree with all that.

    On the old chestnut I would say that in complex cases you can attain similar divergence in the opinion of judges, as you are well aware. Without detracting from the capabilities of the judiciary, which we would both agree are immense, I would say that it is perhaps better to have diverging opinions on economists on what are fundamentally complex economic questions.

    Cheers.

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