Is competition regulation an oxymoron?

Competition and markets need rules.

Without a framework of property rights and ‘contracts’, trade cannot operate. Where trade occurs outside a normal ‘legal’ framework, for example in markets for illicit drugs, norms of trust and rules of participation develop that enable trade to work.

Competition regulation, however, goes much further than rules of property rights and contracts. Competition laws deal with the way that firms interact with each other in a market. To a laissez-faire economist, these laws might appear redundant or even harmful. They are not. Indeed, competition regulation was introduced to deal with practical situations where markets did not work properly.

For example, collusion involves competitors agreeing not to compete with each other but to limit the quantity sold and raise the price to their mutual advantage. It is illegal under competition laws in most countries. But the temptations for businesses to collude are strong.

As Adam Smith, the founding father of modern economics, noted in Chapter 10, Book 1 of An Inquiry into the Nature and Causes of the Wealth of Nations:

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

One way to deal with potential collusion would be to prevent competitors meeting or talking with each other. Smith recognised that such laws would be undesirable and unenforceable.

“It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice.”

And competition rules do not prevent “people of the same trade from sometimes assembling together”. But competition laws, such as the cartel provisions in Australia’s Competition and Consumer Act (2010), do make it illegal for competitors to enter a contract, arrangement or understanding not to compete.

While Australia’s anti-collusion laws are relatively recent, they originate in 1870s United States. Railroad owners found competition tough. Establishing a railway involves a large fixed cost and the marginal cost of an extra train is relatively low. So competition led to ‘ruinous’ price wars. To avoid this competition, the railroad owners formed ‘pools’ to divide and share the market.

Unfortunately (for the railroad owners) the ‘pools’ had no legal standing. So some railroad owners cheated and undermined the agreement.

John D Rockefeller, who owned Standard Oil of Ohio, had a better idea. He used the old legal concept of a ‘trust’. Roughly speaking, a trust allows one person (the trustee) to hold and control assets and act on behalf of other parties. By grouping competitive companies into a trust structure, the owners of those businesses could delegate decisions to a single trustee. Needless to say, that trustee did not let the businesses compete but organised the market to maximize profits at the expense of customers.

In 1890, the United States government responded, by passing the Sherman Antitrust Act, which made it illegal for competitors to combine in order to restrain trade. This first competition law has passed on its name to current competition rules, which are often called ‘antitrust’.

By itself, the Sherman Antitrust Act did not stop the problem of business wanting to avoid competition. Indeed, it tended to make it more explicit. If a trust is illegal then one alternative is for one firm to buy all its competitors. So in 1914 the United States passed the Clayton Act, which limited mergers. And s.50 of Australia’s Competition and Consumer Act also bans mergers and other acquisitions that are likely to substantially lessen competition.

Australia’s current competition laws cover a wide range of areas. They cover broad business behaviour, like cartels and mergers. They also cover certain specific behaviour, such as resale price maintenance (RPM), where a wholesaler doesn’t allow retailers to independently set their prices. The laws also have some oddities, such as rules relating to unilateral public ‘signalling’ of strategy by banks (but no other business)!

The current Competition Policy Review, led by Professor Ian Harper, will aim to clean up our competition laws. Straight-forward legal reviews occur about every decade. They are necessary to clear out the detritus that builds up over the years as laws are added and amended in an ad hoc way through the day-to-day political process. For example, the Review will address the banking-specific rules that started in 2012. Either these rules should be extended to all business, if they help markets function, or they should be removed.

A key focus, however, of the current Review needs to be the institutions that enforce our competition laws. The Australian Competition and Consumer Commission (ACCC) is our main competition watchdog. But it has a broad and, in some ways, inconsistent mandate. It is the ‘market referee’ through competition laws. It is a market replacement, for example through its role setting prices for telecommunications, rail, energy and other utilities. It is a market participant, through its role in consumer protection, where it stands in the shoes of the most vulnerable market participants.

These are all important roles. But they involve very different approaches and cultures. Further, this broad mix of roles necessarily limits the degree to which the ACCC can focus on competition regulation. And with the massive changes in markets due to technology – including the internet, mobile devices, digital platforms, and warehousing and tracking logistics – Australia needs a focussed fulltime market referee more than ever.

As a simple example, advances in economics have shown us how seemingly innocuous clauses in business-to-business contracts can have significant anti-competitive effects. The US Department of Justice publically warned businesses about these contracts in 2012. It also ran and won the Apple e-books case. Earlier this year, the Australian Courts heard evidence about the anti-competitive effects of one set of contract clauses in a private action about abuse of market power. But the parties recently settled and so no judgement will be delivered in that case. The ACCC is aware of these issues, but we seem to be lagging the US and Europe.

There are many other examples. Internet sales have brought RPM back to the fore. This law appeared redundant a few years ago. But, as bricks-and-mortar retailers complain to suppliers about on-line competition, those suppliers may try to stop internet discounting. They engage in RPM. There have been a large number of cases, both here and overseas, dealing with this issue and increasing the watchdog’s workload.

Platform markets, something that was rare outside the finance industry a decade ago, are now everywhere. On the internet, competition between competing platforms in search (e.g. Google v Bing), property (realestate.com v domain), cars (carsales.com v tradingpost) and elsewhere are now the norm. Our economic understanding of this competition is progressing rapidly and it can be hard for a competition regulator to keep up. At the same time, markets do not wait, and it is not clear that the ACCC’s decisions, for example in telecommunications or internet platform mergers, have been the right ones.

Australian markets need clear, concise and appropriate competition laws. They help markets work. And anyone who thinks markets will “be just fine” without these laws is ignoring both basic economics and history.

However, Australia also needs a full-time, focussed competition watchdog that applies the law using state-of the-art economics, understanding the ambiguities and subtleties of market interactions. The ACCC does a great job, but the range of inconsistent tasks it deals with hamstrings it. Hopefully the current Competition Policy Review will help restructure our competition institutions, not just the competition laws, to rectify this problem.

Professor King is co-director of the Business Policy Forum at Monash University. He is a former ACCC Commissioner.

 

Additional reading:

On the history of Antitrust, see Mayer, D., D. Warner, G. Siedel and J. Lieberman (2012) The legal environment and government regulation of business, (v1), www.2012books.lardbucket.org (creative commons) available at http://2012books.lardbucket.org/books/the-legal-environment-and-government-regulation-of-business/index.html

For a discussion on issues of competition and contracts see Scott-Morton, F. (2012) “Contracts that reference rivals”, presentation to Georgetown University Law Center, Department of Justice, April, 5 available at http://www.justice.gov/atr/public/speeches/281965.pdf

For more information about the current Competition Policy Review, see http://competitionpolicyreview.gov.au/

For papers by the Monash Business Policy Forum that deal with potential reforms to Australia’s competition laws and its institutions, see http://www.buseco.monash.edu.au/mbpf/papers.html