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The Economics of European Integration 6e  (Chapters 7-13)
 1526847213

Table of contents :
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Citation preview

Chapter

7 Growth effects and factor market integration Chapter Contents 7.1 7. 2 7. 3 7.4

The logic of growth and the facts Medium-term growth effects: induced capital formation Long-term growth effects: faster knowledge creation and absorption

160 164 173

Summary

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· Intro dUCtlOn

and the Eurozone risis started in h EU as a whole and EU growth has been abysmal since the Glloba~~ed to its pre-crisis leve~ for t t eof crises and the up;any 2010 The level of income has only recent Y re . f owth - the unpac .th . thl. anct indi~idual members still have not recovered. This s~~ie of growth that is_ deal~ _wi m s chapter. th1 downs of output during recessions and booms - is n ·t 11 although 'transitory m s case may end · 1 t be trans1 or~ 1 r"1sis t" T· The crisis-linked slowdowns are mostly hke Y O . _ un growth in norma , non-c imes. his . b O ut here 1s long r up being a decade. What we are tal~111g a . . th . th involves an analytic 'change of gears• . f t , f European integration, at is, e impact . act·1v1ties. .. The two previous chapters looked at ' a 11ocat10n ef ec s . o allocated across economic . ·thin nat10ns are . . on the efficiency with which economic resources Wl . h nge leads to a smgle reallocation of ,. h t · gle policy c a • Allocation effects are 'one-off 111 the sense t a a sll1 . different type of econom1c effect - the emphasized a . ff 1 resources. European leaders, however, have ong different from allocat10n e ects; they 11 . th t .s fundamenta y ul growth effect. Growth effects operate 111 a wa1J a 1 . inly capital - are accum ated, hence operate b1J changing the rate at which new factors of productwn - ma the name 'accumulation effects'. . . tegration can change the supp lg of Factor market integration is another channel b1J which_ ~urope;n m EU nation may work in an-y other O productive factors within EU members. Under EU rules, citize~s ani aspect of European integration EU nation. Similar rules guarantee the free mo:ement of capital,:~ in :n given EU member. Or, to put can - in principle - alter the amount of productive factors employ . urces effect from the EU it differently, capital and labour movements can look like an allocat10n-~ -re;~. chapter therefore also perspective, but like an accumulation effect from the national perspective. is studies the economics of factor market integration.

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7.1 The logic of growth and the facts

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The link between European integration and growth rests on the logic of growth. The logic of growt~ 1s sunp e, but widely misunderstood, so before looking at the facts, we briefly present the logic of growth 111 words.

7.1.1 The logic of growth: medium-run and long-run effects

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Economic growth means producing more and more every year. Per capita growth means an annual rise in the output per person. In most western European nations, output per capita rises at between 1 and 3 per cent per year in normal times. How does this happen? If a nation's workers are to produce more goods and services year after year, the economy must provide workers with mor_e 'tools' year after year .. Here 'too~s' is meant in the broadest possible sens_e what economists call capital - and three categones of capital must be distinguished: physical capital (machines, etc.), human capital (skills, training, exper~enc_e, etc.) and knowledge capital (technoloITTJ)Given this necessity, the rate of output growth 1s hitched straight to the rate of physical, human and knowledge capital accumulation. Most capital accumulation is intentional and is called investment. Accordingly, we can say that European integration affects growth mainly via its effect on investment in human capital, physical capital and knowledge capital. The q,ualification 'mainly' is necessary since integration may unintentionally affect accumulation, for instance by speeding the international dissemination of technological progress (this is especially important in central European nations). . Growth effects fall naturally into two categories: medium term and long term. An instance of rnedturn· term effects is 'induced physical capital formation'. For all the r asons documented in the previous chapters, European integration improves the effici nc-y with which productive factors are combined to produce output. As a side effect, this heightened effici nc-y typicall-y makes Europe a better place to invest, so rnore investment occurs. The result is that the initial efficienc-y gains from integration are boosted by induced capital formation. While the above-normal capital formation is occurring, the economies experience a medium-term growth effect. This growth effect is only medium term, since it will eventually peter out; as 5 the amount of capital per worker rises, the gain from investing in each further unit of capital dirnini5 he · 1 Eventually the gain from investing in an extra unit reaches the cost of doing so and the above-norrna capital formation stops. A good example of this is the investment boom that Spain experienced around we time of its accession to the EU.

The logic of growth and the facts Long-term growth effects inv 1 permanent ch ange in the rate of o ve ahpermanent change in the rate of accumulation and thereby a growt . Since th · . . ' returns, long-run growth effects ty . ll e accumulation of physical capital faces diminishing technological progress. pica y refer to th e rate of accumulation of knowledge capital, that is, To summarize the logic of growth ff . -* allocation effect -+ improved eff" . e ects schematically: European integration ( or any other policy) iciency -+ better . t . . skills and/or technolom1 -+ highe tp mves ment climate --+ more mvestment in machines .::n:1 r ou ut per pers U d . ' per person eventually stops at a new hi on. n er medium-run growth effects, the rise in output forever higher. ' gher level. Under long-run growth effects, the rate of growth is

7.1.2 Post-war European growth: the evidence Any informed discussion of E · • · · · . f t W uropean mtegrat10n and economic growth must begm with a fIStful of h overarc mg ac s e first th ·. cover ese facts before setting out a prima facie case that European integration h as, b roa elly speakmg been f · the post-war period. , avourabl e to growth ill

Phases of European growth By his~orical sta~dards, continuous economic growth is a relatively recent phenomenon. Before the Industrial Revolution, which started in Great Britain in the late 1700s European incomes had stagnated for a millennium and a half. As Figure 7.1 shows, at the beginning of th~ first millennium, per capita incomes were hardly above the bare minimum for survival - guesstimated by the great growth scholar Angus Maddison to be $400 per year in 1990 dollars. By the end of year 1000, European incomes had fallen back to the survival minimum. From 1500, Western European incomes climbed extremely slowly. The rising European incomes reflected massive economic and political transformations as feudalism's rural/agrarian focus evolved towards a more urban and market-based economy - a change known as the Commercial Revolution. The Industrial Revolution brought modern growth and incomes skyrocketed. The chart shows that the cumulative income growth between 1900 and 1913 was as large as that won in the five centuries after the turn of the first millennium. Figure 7.1 European incomes, Year 1 to 1913

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8.2.5 The cyclical impact of wage rigidity An important implication of wage rigidity can be seen by consid ring the case of a cyclical downturn

when the wage is fixed at w. We start in Figure 8. 7 from a situation where employment takes place at point B, with involuntary unemployment measured by BC. Now imagine that the economy slows d~~' for reasons explained in Chapter 17. Firms cannot sell all their products. Given that their eq,uipment is in place anyway - their stock of capital cannot be reduced - the marginal product of labour declines a 11 . . by NUTS 3 regions, 2011 -.::::-o-' 0> roroo a, ,_ LL ,_ ·u -:::J>o0~ OJ E ,_ > ..:::. 0 .c c ro ::::, > ~~Q) -LL ~U'-0u::::,~.C0~ 0 ~ro~ Vl ~QJI N ·_ - _ ~ w

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t As far as total national receipts are concerned, Poland is the standout. Poland will . 22 per cent of the total spending, which is more than the combined receipts of th get an aS ounding recipients (Spain and Italy). e next two higher

The many structural funds

For historical reasons, most EU cohesion spending is channelled through three 'funds': tw , tr tur 1 funds' and the 'cohesion fund'. The CAP's second pillar (rural development; see Chapter g fir ~e:'is) ~s run separately but is supposed to be m sync with the Europe 2020 growth strategy. Although there are three funds, they are subsumed in an overall strategy, so the details of the funds are important only for experts.

10.5.3 Proposed reforms for 2021-2027

As part of the long process of policy analysis and reflection, the EU's regional policies are coming under review. The Commission has proposed some changes (European Commission, 2018), but as with the CAP, regional spending is highly political, so the Commission's ideas are unlikely to appear as they were when this edition went to press in 2019. Be that as it may, the changes are mostly evolutionary. According to the proposal the main part of the European Regional Development Fund and Cohesion Fund investments will go to hel~ing firmS mnovate, supporting small and medium businesses, advancing digital technologies, and fostering industrial moderrtlzation. A second set of goals are pre-green. The policies will enhance the speed of shifts towards a low-carbon economy and the fight against climate change.

252

· geograp CHAPTER 10 Location effects, economic

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spects in terms of s upportinfJ poor anct . . k many of the o Id a . d 1 The proposed new Cohes10n Policy eeps t gories of regions: less- e ve oped, transition . . . t k eps the three ca e G lagging regions. Specifically, 1t proposes O e . t· to get most of the money as DP per capita . h ·ons will con mue . · · and more-developed regions. T e poor regi . d H wever all regions will contmue to be eligible 0 will remain the predominant criterio~ for a~ocatmg i~';;;n s~he fight a~ainst unemployment and the need to for spending based on the need for mdust~ial :rans ddif f new criteria such as low education levels 0 adjust to global competition. One novelty lies m the a ion _ , climate change needs, and the reception and integration of ID1grants.

10.6 Empirical evidence

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. of econoffilC ac 1v1 y: r egiona1 po ·cy The chapter has stressed three main determinants of the Iocat ion . . . d agglomeration). We now consider the and two purely economic determinants ( comparative advantage an importance of these three forces. • h · To evaluate the determinants of industrial location in the EU, researchers try to exp1am ow regwna1and national shares of various types of manufacturing vary with regional and national characteri~tics, where _it is useful to divide the national characteristics into three broad groups: relative labour supplies, econmmc geography features and policies affecting industrial location. For instance, the theor1:1 section explained wh1:1 we should expect nations that have a relatively high share of the EU's skilled labour also to have a relativel1:1 high share of the EU's manufacturing sectors that are relatively intensive in their use of skilled labour. The same link should be expected for relative endowments of other t1:1pes of labour - low-skilled and medium-skilled workers - and sectors that use these tl}pes of labour intensivel1:1 as well as regional endowments of agricultural land and industries that use agricultural inputs intensivellJ. The theory section also explained that the spatial allocation of demand affects the location of industry since sectors where firms tend to concentrate production in a single location (i.e. those marked by important economies of scale) will tend to favour locations that are near large markets. This so-called demand linkage (firms want to be near th~ deman~ for_their go?ds) is complemented by so-called supply linkage_ that is, firms in se~tors that ~e lots o~ mtermediate mputs will te~d to favour locations with concentrations of their suppliers. Finally, poli~lJ can dire~tly encourage the ~ocation of particular tl}pes of sector in particular locations, and this effect can either amplify or dampen the rmpact of factor endowments and e • geograp h y f a ctors . . . . conormc on the location of mdustry. Although the research m this area is limited_ mainln • t k of da ta on the • • l:1 owmg o a 1ac location of manufacturing and regional labour endowments - the results so f ar suggest that all three f ac tors . . matter. Interestingly, 1t seems that labour endowments have become more· rta . . . ti·on . . . . lillpo nt m deterrmrung loca as European econormc mtegration has become tighter. One of the two aggl . ly . . . omeration forces - namely supp linkages - seems to be gettmg stronger, while the demand linkage is gettin k . 2010 Given that EU regional policy has been operating at a significant lev;l:~~ e~ (see Red~g, ~~sults on the impact of policy are even more tenuous. The best studn in thi . Y s~ce the nud-19BOs,_ 1 t 1 . . . . l::1 s area 1s still Midelfart-Knarv1k e a· (20 02) smce 1t uses a direct measure of cohes10n polic1:1 spending. It finds . . .. antl!J affected the geographical location of industries. In particular these autho t~at EU pohc9 has signific ding did affect the location of high-skilled intensive industries. ' rs fmd that E structural spen

Recent studies The collection of and availability of daLa has improved . . n a big increase in the number of empirical sLudic, F . ~a~slvely m tll last 15 years and the result has bee Pienkowski and Berkowitz (2015) Syi--•Jlesi·zi·. s. or a,n mtegraL d urv y of the empirical evidence, see • •L .. ng acrnss sLt r 11 · da positive but small effect of structural funds d. le ies, , 11s survey finds that most studies foun t 1119 marked for the poorest regions The surve spten on regional growth, with the size of the effect rnos . · Y no ·es 11owever that f negative effect on the regions. Only some of the; . , a ew s t u ct·1es found zero effect, or even . a but the ones that do tend to encourag f e sLudies draw conclusions for the path of future poliCY, e a ocus on the spendin O f th A key limitation to these empirical t d. g · e poorest regions. 8 data available to researchers w t u ies has been the lack of recent data. Until 2015, the onl!J empirical evidence. you can ch ekn f up to only 2oo5. The newly released data should produce new · ec or new eviden ce on t h e Commission's website: http://ec.europa. eu/ reg1onal_policy/en/policy/evaluations/.

Q References and further reading

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10. 7 Summary Europe's economic activity is hi hl · · . . . T . . g Y concentrated geographically at the nat10nal level as well as withm nat10ns. his 1s a problem for soc· 1 h · · d· h , , · hi h · ia co es10n smce peop1e locate mt e core enJoy g er mcomes nd a lower :111employm~nt rates. European integration seems to have led to a narrowing of income eq,uality across nat~ons, but an mcrease in ineq,uality within nations. Nevertheless, European integration has been accompa rued ~y only. mo~est relocation of industry among nations, but the little movement we have seen h as be~n m th e direction of manufacturing activities having become more geographically dispersed, not less, while most European nations have become more specialized on a sector-by-sector basis. The chapter presented two main theories that could account for these facts. The first - the comparative a?vantage framework - explains why nations have become more specialized while at the same time income differen ces have narrowed. The second - based on the so-called new economic geography - focuses on a gg_lomeration forces that account for the way in which tighter economic integration can foster the clustermg of economic activities within nations. The chapter also presented the main outlines of the EU's regional policy. The goal of this policy is to h elp to disperse economic activity to less-favoured regions. Most of the money is spent on so-called convergence regions that typically have per capita incomes that are less than 75 per cent of the EU average. The EU spends about a third of its budget on these policies.

,,, Self-assessment questions 1 Draw a diagram with the extensions to the agglomeration diagram suggested in Box 10.2.

2 Download the European Commission's proposal for reforming structural spending and compare it to the principles of the system in place up to the end of 2006. 3 The educational level in all EU nations is rising. How would this affect the spatial allocation of production in the Heckscher-Ohlin framework?

References and further reading . . f . t· .ti . th E u · ,· man (2004) 'The spatial distribution o econormc ac ivi es m e uropean ruon , m 0 Combes, P.-P. a H. vFerThi e (eds.) Handbook of Regional and Urban Economics. 4. Cities and Geography, J.V. Henderson and J.- · ss ' References

nd

2845 909 Elsevier Amsterdam. ' . .' ) Seventh Report on Economic, Social and Territorial Cohesion, http://ec.europa.eu/ . ti . . n/information/cohes10n-repor . regional_pohcy/e . l Develo'Ylment and Cohesion Beyond 2020: The New Framework at a Glance, . . (2018) R egwna r European Comm1ssion . . n/ ·t /beta-political/files/budget-may2018-new-framework-glanc _en.pelf. u/comrrnss10 si es . . https://ec.europa.e . b00 k 201 8 Eurostat Luxembourg, https://ec.europa.eu/eurostat/statisticsEurostat (2018) Eurostat Regional Y~ar ' b 'k . . h /Eurostat regional_year oo . . explamed/mdex.p p . ·f th balance of competences betwe n the United Kingdom and the t (2014) 'Review o e Her Majesty's Governme~ . , en civilservice.gov.uk/. European Union: cohesion pohcy' g · SJ R dding and A.J. Venables (2002) 'Delocation and . K H H G Overman, . . e . / bli t· / Midelfart-Knarvik, .- ·, · · . ·ustified?', hUp://ec.europa.eu/economy_fmance pu ca ions European integration: is structural spending J European Comnnss1on ( 2017

publication11136_en.pdf. . yment clusters: nearness matters within and across Europe's 2001) 'Reg10nal unemp1o Overman, H. and D. Puga ( . . 17 (34): 115-47. national borders', Economic :olicy, 'Econometric assessments of Cohesion Policy growth effects: how t~ make . 'kowski , J • and P. Berkowitz (2015) DG Reg10, . Re~. nional Working Paper 02/2015, http://ec.europa.eu/regional_ P 1en olic makers?', them more relevant for P y 2015 02_econ_assess.pdf. . . . . ography' Journal of Regional Science, 50(1). 297-311. Policy/sources/docgener/work/ .. f ew econoIDIC ge ' Redding, S. (2010) 'The empmcs O n

h and regional policy CHAPTER 10 Location effects, economic geograp y

Further reading: the aficionado's corner

. h 1 ation of economic activity in the EU, see: ming changes ID t e oc C . For a more extensive discussion of the facts conce . t tion Patterns in Europe, ahiers de B iilh t M and R Traeger (2003) An Account of Geographic Concen r~ Politinue (DEEP), Universite de Lausanne r ar ' . . d'E etrie et d'Econorme ...,, ' Recherches Economiq,ues du Departement co~om www.hec.unil.ch/deep/publications-english/e-cahiers.htm. , . , . the EU. This contains a large number of maps showing Each year, the Commission produces a report on cohesion ID in agriculture, industry and services. It also things such as unemployment, declining population, a~d share of the ec~nomy ployment and income distribution. See: presents a large number of indicators of social cohesion, s~ch as you~ ~:i:sion. http://ec.europa.eu/regional_policy/ European Commission (2001) Second Report on Econorruc and Social sources/docoffic/official/reports/contentpdf_en.htm. For an advanced treatment of the new economic geography, see Part I of: . . nd Baldwin, R., R. Forslid, P. Martin, G. Ottaviano and F. Robert-Nicoud (2003) Economic Geography a Public Policy, Princeton University Press, Princeton, NJ.

Useful websites The European Parliament's factsheets provide a wealth of information on EU regional policy. See: http://www.europarl. europa.eu/aboutparliament/en/displayFtu.html?ftuld=theme5.html. The Commission department devoted to regional policy (DG Regio) has an extensive website that provides masses of data and several highly readable explanations of EU policy in the area. There is a lso a very handy facility to display regional data on maps. See http://ec.europa.eu/regional_policy/index_en.cfm.

Chapter

11 EU competition and state aid policy Chapter Contents 11.1 11. 2 11.3

The economics of anti-competitive behaviour and state aid EU competition policy Summary

256 269 273

CHAPTER 11 EU competition and state aid policy

Introduction

.

, cial market econom9. It 1s what turns th Competition among firms is the heart and soul of E~~pe s so h h tendenc1::1 to bre k d e profit motive into a socially beneficial urge. Competition, howev~r, aAsd as Sa ·th wrote· 'P al own. . 1776 masterpiece . . Th e u, am IDI • eop e of the 1 In his on market economics yyea lth oif 1uatwns v ' • ' • d di sion but the conversat10n ends in same trade seldom meet together even for merriment an ver , . . . a . . . .' . · ri·ces' Policies that prevent this sort of consprracy agarnst the public, or rn some contrivance to raise P · . . collusion among firms encourage rivalry among firms. This is generally a good thin g: When firms are struggling with one another to offer better goods and advantageous prices, consumers wrn. Deeper European economic integration - together with more general tr~ nds such a~ WTO trade liberalization and globalization - has put European manufacturing and service sector frrms under a great deal of pressure. As discussed in Chapter 6, the long-run outcome of_ t~s h~ightened com?etitive pressure is typically a reshaped industry marked by fewer, bigger, more efficient f1:rms engaged m more effective competition among ·themselves. However, in the short and medium run frrrns may be tempted to collude in order to avoid or postpone industrial restructuring, and Member State governments may be tempted to provide subsidies that delay the necessary but painful restructuring. The founders of the European Union understood that pressures to collude and subsidize would arise in the course of economic integration since they had seen this sort of behaviour between the two world wars. They also understood that anticipation of such unfair practices could reduce political support for economic integration in all nations. The point is that one nation may be reluctant to let market forces discipline its firms if it believes other nations will not. The competition must thus be seen as being fair across nations if EU members are to be happy with deeper economic integration. To guard against these pressures, broad prohibitions were written into the Treaty of Rome on private and public policies that distort competition. Despite all the reforms and treaty changes, these basic strictures have been kept at the core of EU policy ever since. Treaty writers over the last seven decades have felt that enforcing fair play in the internal market was so important that EU competition policy req,uired special institutional arrangements - arrangements that would ensure that political expediency would not hinder the maintenance of a level playing field. To this end, the Treaty grants the European Commission the sole power (exclusive competence in EU jargon; see Chapter 2) to regulate the EU's competition policy. When it comes to competition matters, the Commission's decisions can be overturned by the EU Court but they are not subject to approval by the Council (i.e. what was called the Council of Ministers before the Lisbon Treaty) or the European Parliament. Of course, the Commission is not a 'Lone Ranger' in such matters. It continu~u~ly consults ~th Member States, especially via their respective competition authorities, but the Commission has the fma~ word ?n whether mergers are allowed, whether particular business practices are allowed, and whether aid provided by Member States to firms is allowed. We can say that competition policy is one area where the Member States have truly transferred substantial sovereignty to a supranational level. The Lisbon Treaty confirmed the special position of competition policy and the control of state aid. This ~hapter open~ ?Y providing an introduction to the economics of anti-competitive practices by private firms and subsidies by governments. It then proceeds to discuss the EU's actual policies.

11.1 The economics of anti-competitive behaviour and state aid Before turning to how the European Commission regulates comp titian and state aid it is important to understand the economics that lead private firms Lo engage in anti-competitive beha~iour and what the ef~ects of this are on ~he broader _economy. This is Lhe task w turn to first. Here, we study basic issue; usmg the framework mtroduced m Chapter 6. The discussion here assumes readers have mastered th BE-COMP diagram, which is explained at length in Chapter 6.

11.1.1 Allowing collusion in the BE-COMPframework the EU's Single Market becomes less fragmented, firms experience greater competition which forces them to re struc~~ _in a way that l?wers their c?sts. Freq,uently, such adjustments i.Iw~lve waves 0: mergers and acq,msitwns. An alternative, however, 1s for the firms to collude i.11 order to avoid or _2ostpon

As

The economics of anti-competitive behaviou r and state aid

257

. f th h ·ce between perishing industrial restructuring. Or, to put it more directly, in many sectors firms ace e c 01 les or engaging in anti-competitive behaviour; some firms choose the latter. See Box 11.1 for some examp · -

,s~lm.1

Cartels in car parts

In 2017, the European Commission fined five car safety eq,uipment suppliers €34 million after finding them guilty of running cartels for seatbelts, airbags and steering wheels supplied to Japanese auto manufacturers located in Europe. The EU competition policy Commissioner, Margreth~ Ve stager, commented: 'Seatbelts and airbags protect lives every day and are essential in all cars m th e EU. The five suppliers fined today colluded to maximize their profits from the sale of ~hese co~ponents. This may have raised the costs of these car parts for a number of manufacturers selling cars m Europ~, potentially affecting consumers. We do not accept cartels that affect the European consumers, even if the cartel is organized outside Europe.' . The 201 7 fine was part of a series of cartel cases where the Commission fined supp~ers of automotive bearings, wire harnesses in cars flexible foam used in car seats, parking heaters m cars and trucks, air conditioning and engine coollilg systems, and lighting systems. The total fines imposed for all of these amounted to €1.6 billion. Interested readers can find details of the latest convictions on http://ec.europa.eu/competition/ cartels/cases/ cases.html

Theory While firms reacting to competitive pressure by price-fixing may be understandable, doing so is illegal under EU law and economically harmful for Europe as a whole. In a nutshell, allowing collusion among firms can result in too many , too small firms that must charge high prices to compensate for their lack of efficiency. The high prices result in lower demand and production. Thus protecting existing firms can end up reducing the overall level of industrial production. One very clear real-world example was seen in telecoms services. Before liberalization, each European nation had its own monopoly provider; services were expensive since firms were small and as a result consumers did not spend much on telecoms. Since liberalization, competition has forced a massive industrial restructuring, a massive increase in the size of firms and a massive reduction in the price of services. The result has been a boom in the amount of telecoms services produced and consumed in Europe. We illustrate this general point with an extended version of the BE-COMP framework from Chapter 6 _

The BE-COMP diagram Reviewing it briefly, the BE-COMP diagram, shown in Figure 11.1, has three panels: The middle panel shows the de~and curve_ facing the sector in a typical nation (the diagram assumes that there are two identical nat10ns; the middle panel shows the demand curve for one of them _ the Home market) . This panel is used for keeping track of consumer surplus and th connection between price and industry-wide production (which must eq,ual consumption). For .,rample, in the closedeconomy case, the long-run price is P'. This means that total consumption must eq,ual C'. This in turn means that total production must be C'. 2 The left-hand panel shows the averag~ and marginal cost curve for a typical firm (all firms are identical). The diagram assumes that frrms enter or e it until all pure profit is eliminated that i until price eq,uals average ~ost. This panel is us d to keep track of the typical firm's size, ;, and i: efficiency, as measured by its average cost (lower average cost means higher efficiency). The lon _ run eq,uilibrium firm size is deduced from the long-run eq,uilibrium price since we know that g profits are zero in the long run, so the long-run price must eq,ual the average cost of the typical f~~ The average cost curve, AC, thus tells us how large the typical firm must be to have an .. . . . average cost eq,ual to the long-run eq,uilibnum pnce. For example, if the long-run price is P', the ty pica · 1 f"1rm size . . must be x ' to ensure that pnce eq,uals average cost.

CHAPTER 11 EU competition and state aid policy

258

f

·onshi s between the mark-up and the munber of d that we denote it with the Greek letter µ firms. Recall that the mark-up is ~rice ~us margmal c~~; curve shows the eq,uilibriurn combination~ pronounced 'mu'. The number off~_ 18 denoted n. The re firms corresponds to more competition and of µ and n assuming normal competition; as expected, mo . • as the number of firms ns · k ) is upward sloprng srnce, es, thus a lower mark-up. The BE (brea -even curve_ in order to cover their fixed costs. the sales per firm fall and so firms would need a higher mark-up .. .

3 The right-hand panel shows two eq,uilibnum rel~ti

Figure 11.1 Analysis of economic integration without collusion or subsidies Euros

Price

Mark-up

Home market

Demand curve

P'

E'

E'

------------P' ------------------ ----------µ I

E11

---- --- -- -p

p 11

I I

PA -------------------:

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11

f

I II - - - - - - - - - - - - - - - - - - - -:-

Sales per firm



II

- - --- ---

µ

I

II

I I

A +- -------µA

-------------------~-! ~--1

I

I

I

C'C

n' n

11

2n' Number of firms

11

Total sales

The eq,uilibrium in the three panels i?entifies the eq,uilibrium number of firms, n, mark-up, µ, price, p ) firm size ) x I and total output/consumpt10n,• C. • As in Chapter 6, we model European integration as a no-trade-to-free-trade liberalization between two identical nations. The eq,uilibrium with no trade is marked by E'; the one with free trade between the two identical nations is markedE'. There are two immediate and very obvious effects from the no-tradeto-free-trade liberalization:

Market size: post-integration, each firm has access to a second market of the same size. 2 Degree of competition: post-integration, each firm faces twice the number of competitors. The market-size effect shifts the BE curve to the right, specifically out to the point marked 'l' (see Chapter 6 for a detailed explanation). The competition aspect is the simpl st to illustrate in the diagram, Figure 11. 1. Immediately upon opening the markets, that is, b fore the industry has had time to adjust, the number of firms is 2n'. Thus the typical firm will lower its mark-up in each market to point A - assuming, of course, that firms do not collude (recall that the COMP curve shows the mark-up under normal competition: • The extra competition forces mark-ups down to point A, and this pushes prices down to PA- At this combination of sales per firm and mark-up, all firms begin to lose money (i.e. A is below the relevant break-even line, BEFT). This 'profit pressure' forces industrial reorganization (mergers, acq,uisitions a nd bankruptcies) =, which gradually reduces the number of firms to the new long-run eq,uilibrium number, n". Note that after this long-run 'industry shake-out', firms are bigger and more efficient (the left-hand panel shows that x has increased to x" and average cost has decreased to P';; they are also facing rn~re effective competition than before the liberalization (the right-hand panel shows that the price-cost margWS drop to µ'').

The econom· f · ics o anti-competitive behaviour and state aid

To summarize in words, deeper E . . req,uires the industry to consolid t uropean ll1tegratwn boosts the degree of competition and this in tum e so as to . . consohdat10n . . involves the exit of some firms aTh . better exp101·t sea1e econormes. Naturally, this market integration has resulted 111 .' e classic examples are telecoms, airlines, banking and autos, where . a wave of mergers The key po111t as far as competition r . · generally be accompanied by a 1 _ po 1~Y ~s concerned is that deeper European integration will ong run reduct10n 111 the number of firms. This is important for two reasons: • First, it means that Europe m t b not collude. us e even more vigilant to ensure that the fewer bigger firms do • Second, it means that firm or delay the• d t . s may be tempted to engage in anti-competitive practices in order to avoid m us nal restructuring.

",7~ turn not to showing what anti-competitive practices look like in the BE-COMP diagram. Box 11.2 provi es a rea example of how five firms conspired to raise the price of ocean transport. ~'(If>

' Box 11.2

Collusion in the oceanic transport sector

In February 2018, the European Commission decided to fine five maritime car carriers for colluding to keep prices high. The Chilean carrier CSAV1 Japanese carriers 'K' Line MOL and NYK and the Norwegian/Swedish carrier WWL-EUKOR were found guilt1:) of having participated in the c~rtel and fined a total of €395 million. The anti-competitive behaviour lasted for six years and during this time, the five carriers raised prices for oceanic transport of new cars, trucks and other large vehicles on various routes between Europe and other continents. The investigation revealed that the carriers' sales managers met at one another's offices in ' bars, restaurants or other social gatherings and were in contact over the phone on a regular basis. They coordinated prices, allocated customers and exchanged commercially sensitive information about elements of the price, such as charges and surcharges added to prices to offset currency or oil price fluctuations. The carriers agreed to maintain the status q,uo in the market and to respect one another's traditional business on certain routes or with certain customers, by q,uoting artificially high prices or not q,uoting at all in tenders issued bl:J vehicle manufacturers.

Perfect collusion The COMP curve in Figure 11. l assumes that firms do not collude. Both before and after the integration, we assumed that firms engaged in 'normal' competition in th e sense that each firm decided on how much to sell, taking as given other firms' sales. In other words, each firm decided its output without coordination among firms. This assumption of 'normal' competition is q,uite reasonable for many industri , but it is not the most profitable behaviour for firms. If firms were allowed to collude, they could rai e profits by reducing the amount they sell and raising prices. We consider some real-world exampl s in the policy section below (Section 11.2), but interested readers may wish to go to ~t~:// .europa.e~competitio~antitrust/cases/ for details 011 the latest cases in which the European Comm1ss10n has caught firms colludmg. There are many, many forms of collusion in the world. _Th first form we con~ider is the simplest to study. Instead of assuming no collusion on output, we consider the extreme opposite of perfect collusion on output. . . . . If all firms could perfectly coordinate th err sales, t~at 1s, if they could act as if they were a single firm, they would limit total sales to the monopoly level. This would allow them to char~e the monopoly price and to earn the greatest possible profit from the market. After ~ll, the monopoly pnce-sale~ combina~ion l·s , b y d ef'1111·t·1011, th e co mbm· ation that extracts the greatest profit from the market. In the diagram , this is

. . an d state aid policy CHAPTER 11 EU compet1t1on

d to one firm (n -_ I) . The res ulting price is the monopolu m which correspon s f sales among the colluding shown by the mark-up, µ ' . ·a p the monopoly level1 o st each firm w ould like to • pm to div1 e u gm· a co , . pnce, shown as j, llusion is finding a way h higher than mar f" s manage the collusion by f hard part o is .cothat' because the price is s~ mule, c we assume that the rrmd m· the BE-COMP diagram . TheThe problem things simp illustrate rrms. . can be . t a lln" since it assumes that the sell a little more than its share. To - keep s This type o f behaviour . ds honzon allocating an eq,ual share to all firm . . Figure 11.2. This line exten umber of firms. 'th the 'perfect collusion' line shown m k µm regardless of then :ark-up always eq,uals the monopoly mar -up, ' Figure 11.2 Perfect collusion Home market Euros

Price

Mark-up

Demand curve

Em

---- ---------------µ

m

Perfect co llusion

I

I I

I I I I

: P" ---- ~-I

:

I I

:

£"

-------- j-I ---- I ----------

AC

1 I

I I

I I

:

:

I

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,,

-,--MC----+----f--+--\~---~n~=~1--n~"-;2~n~'-~N~u~m~b;er

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xm x" Sales per firm

cm

C"

of firms

Total sales

. did harge the monopoly mark-up, then the maximum number of firms that could break even c This would involve new entry - an outcome that we rarely observed after Ii'beralization. . If all firms b • t '2' shownposs, y P?bmili.ty jg that all 2n" firms would without .any new Another . stay in business, . . firms entering;. this( is· sho'"!: eE . t A'. Note that, at this point, all firms are makmg pure profits owing to the collusion smc pbom the AC curve in the left-hand panel and it is above the BEF'f curve in the right-hand panel). 18 a This ove collusion is good for finns ' prof'its, bu t 1·t 1s . ba d f or society . . the p erf as a whole. Companng . ect . collusion outcome to the long-run outcome without collusion (eq,uilibrium, E'), we see that the pnce JS higher and consumption and production are lower. Moreover, since firms are sma1Jer (since overall produ~tion with collusion, the output of each firm must be smaller), averag costs are higher, so the industryisislower less efficient.

18

~

Partial collusion Perfect collusion is difficult to mainlain sin ·e the gains from 'cheating' on other colluders are q,uite high. To reduce the incentive to cheat, the actual degree of collusion may be milder than perfect colluswn. This sort of partial collusion restricts sales of all firms but not all the way back to the monopoly level, so mark-up is lower than the monopoly mark-up but higher than the COMP mark-up. With the mark-up lower, the it is easier to sustain the collusion since the benefits from cheating are not q_uite as large. . f But how much low_er Would the mark-up be llnder Partial collusion? As it tums out, an understanding advanced IS needed to formalize this notion of Partial collusion', so we do not address it here 0 depic e mecononucs 11 .3. et al., 1995, for an advanced treatment). F rtun t exphc1t1y (seegure Mas-Coiell th b • •ct can be easily · t d · Fi

o

a e1y,

e

as1c 1 ea

The economics of anti-competitive behaviour and state aid

Figure 11.3 Partial collusion a d f ·1 . n ai ed industrial restructuring Home market

Euros

Price

Mark-up

Demand curve

Em --r-------------p mcollusion pPC

P" collusion

AC

: I

I

r-----;...;-.__ _

MC----t-----+----i._;_-~_ ___.1____;__ _ _!_.J:__:__ _ __ n" \ 2n' Number : n=1 nPC of firms I Sales cm / C" Total sales per firm cPC I I

xm\ x" xPc

The curve labelled 'partial collusion' shows a level of collusion where the mark-up is somewhere between the m~n~poly mark-up and the ~o-collusion mark-up shown by the COMP curve. We do not specify exactly where 1t lies between the two as 1t does not change the q,ualitative analysis. All we need to assume is that the partial collusion curve lies between the COMP curve and the perfect collusion curve as shown in the diagram. If the 2n' firms all engaged in this partial collusion, then the mark-up would be shown by point A". This mark-up is higher than the long-run eq,uilibrium mark-up without collusion (µ''), so we see that this partial collusion offsets, to some extent, the increase in competition induced by integration. (Recall from Chapter 6 that the size of the mark-up is an indicator of the degree of competition.) Note, however, that although this mark-up is higher than under normal competition, it is not high enough for all the firms to break even. We can see this from the fact that point A" is below the break-even curve (BEFT). What this means is that, even with partial collusion, some firms will exit the market. In the long run, the number of firms adjusts to restore zero pure profits, and this is where the partial competition curve and the break-even curve intersect, namely at pointEPc_ Point EPC is the long-run eq,uilibrium since with nPc firms the mark-up would be mPc and, with this mark-up, npc firms would all break even. As before, we can read off all the important aspects from the diagram. The level of consumption in the Home market (which is half of total consumption since Foreign is assumed to be identical) is cPC. Since supply eq,uals demand in eq,uilibrium, we know that cPc is also the total production in each nation. As usual, the eq,uilibrium price also tells us the eq,uilibrium efficiency, that is, the typical firm's average cost. Using the average cost curve, we also know that the size of the typical firm is _xYC. . . . . .. . Now we study the economic implicat~ons o:, such collus1~n, comp~nng 1t to the _long-run eq,uilibnum with normal competition, that is, eq,uilibnum E ... T~ summarize t_he pnce ~nd q,u~~t1t~ ch~nges, we ~ote that, compare d to the normal competition eq,uilibnum, the partial collusion frrms . . eq,uilibnum mvolves . . that are smaller, less efficient and more numerous. The mark-up 1s higher along with the pnce, so consumption and total production are lower.

CHAPTER 11 EU competition and state aid policy

Long-run economic costs of collusion

The first point is that collusion will not in the end raise firms' profits to above-nor~al levels. E~en allowing for the way that partial collusion raises prices above P', the initial number of firms after liberalization

namely 2n', is too high for all of them to break even. Industrial consolidation proceeds as usual, but instead of the zero-profit level being reached when the number of firms has dropped to n", the process halts at nPc_ As noted above, this is where pure profits - which started at zero in the pre-integration long-run eq,uilibrium

described in Figure 11.1 - are returned to zero. In other words, the higher prices do not result in higher long-run profits. They merely allow more small, inefficient firms to remain in the market. The welfare cost of the collusion is measured by the four-sided area marked by pP 0 , P", E" and B. This is just the consumer surplus loss~ but since there is no change in pure profits (it is zero in the long run with or without collusion), the change ill consumer surplus is the full welfare effect. To sum_mari~e, collusion prevents the full benefits of restructuring from occurring. By keeping ~oo many firms ill the market, anti-competitive behaviour thwarts part of the industry's adjustment that 1s the key to the gains from integration. Having presented a general analysis that suggests why deeper European integration and competition problems ~end to go hand in hand, we turn now to considering four types of anti-competitive practices in more detail. We start with cartels.

11.1.2 Anti-competitive behaviour Firm~ like ~o ~ake money· Comp~tition hinders this, so some firms try to limit competition. One age-old way of dorng t~s 1~ to form a cartel with other firms in the industry. For example, one of the best-known cartels the Orgamzation of the Petroleum Exporting Countries (OPEC) h b · . . · ' of crude oil since the early 1970s. ' as een controlling the mtemational pnce

Horizontal anti-competitive practices: cartels and exclusive territories The truck cartel is a European example (see Box 11 3) A p· of cartels are rather straightforward (see Chapter 4 if ·y · s ~gure ll.4 shows, the economic effects The diagram depicts the impact of the price-raising effectsoufnee a refresher on this sort of economics). o a cartel.

Figure 11.4 Economic analysis of cartels

Euros

Demand curve

C'

C

Quantity

The economics of anti-competitive behaviour and state aid

,,.r,

Box U,..3

The truck cartel

- ~ ;•~~

In September 2017, the European Commission wound up a long-running case against five companies who colluded in the European market for trucks for 14 years starting in 1997 - five years after the completion of the Single Market. The EU Commissioner for Competition, Margrethe Vestager, explained: 'Today's decision marks the end of our investigation into a very long lasting cartel-14 years. This cartel affected very substantial numbers of road hauliers in Europe, since Scania and the other truck manufacturers in the cartel produce more than 9 out of every 10 medium and heavy trucks sold in Europe. These trucks account for around three q,uarters of inland transport of goods in Europe and play a vital role in the European economy . Instead of colluding on pricing, the truck manufacturers should have been competing against each other - also on environmental improvements.' The Commission's investigation found that the companies _ MAN, DAF, Daimler, Iveco, Volvo/ Renault and Scania - coordinated prices as well as the introduction of emission technologies for medium and heavy trucks to comply with the increasingly strict European emissions standards. The companies managed the collusion via meetings held at senior manager level, sometimes at the margins of trade fairs or other events. This was complemented by phone conversations. From 2004 onwards, the cartel was organized via the truck producers' German subsidiaries, with participants generaUy exchanging information electronically. Source: This box is based on information from DG Competition's website at http://ec.europa.eu/competition/cartels/cases/ cases.html

The diagram shows the situation for a particular market, says DRAM, where the price without the cartel would be P. This initial price is shown as being eq,ual to average costs (AC), which indicates zero profits even before the cartel; the analysis follows through even if the initial price were above AC, but this way makes it easier to see the effects. When the cartel raises the price to P' by reducing the volume of sales to C', consumer surplus is reduced by area a + b. The cartel's profit rises by area b. This analysis illustrates the two main problems with cartels: the rip-off effect and the inefficiency effect. First, the fact that they allow firms to profit at the expense of customers is considered by most people (and by EU law) to be unfair- a rip-off, to put it colloq,uially . Second, the gain to firms is less than the loss to consumers, so the cartel is inefficient from a purely technical point of view. Specifically, the net economic loss is area b. While few Europeans know or care about the efficiency loss, almost all would believe that the rip-off effect is something their governments should do something about. Another rather common way of restricting competition is for firms to agree upon so-called exclusive territories. For example, one company would agree to sell only in its local market in exchange for a similar promise by its foreign competitors. One example of this can be found in the market for video games. Nintendo and seven of its official distributors in Europe teamed up in the 1990s to boost profits by dividing up Europe's markets and charging higher prices in those areas wh re consumers had a higher ability to pay. Under this practice, distributors had to prevent games b ing shipped from their territory to that of another EU market where prices were higher. Independent ustomers who allowed such sales among territories were punished by being given smaller shipm nt ne t time or cut off altogether. In this way, these companies managed to maintain big pri differences for play consoles and games in various EU markets (e.g. Britons enjoy d prices that w re 65 per cent cheaper than those faced by the Germans and Dutch). The European Commission fined Nintendo and the seven distributors 168 million euros. Thinking more broadly, it is clear that such practices offset all the goals of European integration, which is exactly why the Treaty of Rome prohibited such behaviour. Figure 11.5 shows a situation whereby a firm would like to charge different prices in the German and UK markets.

CHAPTER 11 EU competition and state aid policy

.c analysis of exclusive territories Figure 11.5 Econoffil

Euros

pD '

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The diagram shows the two demand curves; the German demand curve DD is steeper th~n the British demand curve nuK_ The steepness of a demand curve reflects a 'willingness to pay' since 1t te~ us how much consumption of Nintendo products would drop for a given price increase. The German curv~ IS drawn as steeper to reflect the fact that Germans have fewer options when it comes to consumer electrorocs and games ( owing to the smaller number of people who speak German versus English worldwide, and to widespread restrictions on retail outlets in Germany). In economics jargon, German demand is more inelastic, that is, more unresponsive to price. In this situation, Nintendo would maximize profits by selling the q,uantities in Germany and Britain that correspond to the ~ter~ections of the marginal revenue c~~es (MRD and MRUK) and marginal cost cur:es (~C); see Chapter 6 if this reasoning is unfamiliar. The q,uantit1es are not shown explicitly, but the resultmg pnces are marked as pD and pUK_ In an integrated market, independent firms, often called 'traders', could arbitrage the price gap by buying Nintendo goods in the UK and shipping them to Germany. Such shipments _ which are known ~s 'parallel trade' - would lower Nintendo's profits and those of its official distributors. To preserve thell' profits, Nintendo and its distributors attempted, illegally, to prevent such trade.

Bullies in the market: abuse of dominant position Business leaders and stock markets often evaluate a company's performanc bas don the growth of its market share, so many firms aim to conq,uer the market. Firms that are lucky or possess excellent produ_cts can succeed in establishing very strong positions in their markets. Thi is not a problem if the position reflects superior products and/or efficiency - Google's triumph in th marl t for search engines could be one example. However, once a firm has a dominanL position, it may b tempted to use it to extract extra profits from its suppliers or customers, or ii may aLtempt to arrange th market so as to shield itself fro~ future competitors. According to EU law, such practices, known technically as 'abuse of dominant position ' are illegal. The _classic example of this ~s Microsoft. Most computer users are happy that Microsoft has standardize~ the basics of personal computmg around the world - especially those that move between nations or us more than one machine on .a regular b as1s. · In oth er words, computer operating . systems are sub'ect to. .. ~ network externalities. That is, computer operating system software becomes more valuable to each useI as more people use it.

The economics of anti-competitive behaviour and state aid

To und ersta~d how and why network externalities work, just think about why the English language has sprea~ so wi~ely ~nd co~tinues to do so; more and more people learn it since so many people speak it. Just as with English, rndu stnes characterized by network externalities tend to be marked by a dominant firm, or a handful of firms. In the_ca~e of M~crosoft, which has dominated the operating system software market for decades, the q,uest10n is how it came to dominate applications with products such as Word and Excel. Although it has nev~r been proven in court, many observers believe that the company used freq,uent updates of its operatmg system to induce users to drop competing applications (as recently as ten years ago, Microsoft had real competition from rival products such as WordPerfect and Lotus). The details of Win~ow~ updates are available to engineers updating Microsoft applications but not to those updating rival applicat10~s, so ne:W versions of rival applications often had glitches caused by incompatibilities with the lates_t vers10n of Wmdows. Even if a user preferred the other applications, incompatibilities with successive verswns of DOS a nd Windows meant it was easier to switch to Microsoft's applications than it was to deal with the glitc~es. _M~reover, when competing firms came up with innovative programs, Microsoft typically r~spon~ed with similar programs and gave them away for free. Today, for example, Microsoft charges a high pnce for Word, where it no longer has any real competitors, but it charges a zero price on software where it has significant rivals, such as media readers and web browsers. A similar set of issues arose with respect to Google's dominant position in search services. See Box 11.4 for details.

F

11.4

The Google case

In March 2013, Google was alerted by the Commission that it was under investigation for business

practices that potentially violate EU anti-trust rules prohibiting the abuse of a dominant position. These included: (1) displaying Google's own specialized web search services more prominently than those of competing companies; (2) using (without consent) other companies' original content; (3) obliging website publishers to obtain most of their online search advertisements from Google; and (4) restricting the transferability of online search advertising campaigns to rival search advertising platforms. In February 2014, Google was made to change its practice in response to a Commission antitrust investigation. Specifically, Google guaranteed that the services of three rivals would be promoted along with its own specialized search services. Commission Vice President in charge of competition policy, Joaq,uin Almunia, said:

My mission is to protect competit~on to the benefit of consumers, not competitors. I believe that the new proposal obtained from Google after long and difficult talks can now address the Commission's concerns. Without preventing Google from improving its ow n serv ices, it prov ides users with real choice between competing serv ice p resented in a comparable way; it is then up to them to choose the best alternati ve. This w ay, both Google and its ~ivals _will be able _and encouraged to innovate and improve their offerings. Turning th_is_ propos~l _into a legally binding obligation for Google w ould ensure that competitive conditions are both restored quickly and maintained over the nex t years. The investigation actually began in November 2010 following more than a doz n formal complaints about Google's business practices.

11.1.3 Merger control

.

.

.

In many European industries, the number of firms 1s fallmg _as they mer_ge or b~y one an?ther out. This sort of concentration of market power is a natural outcome _of European mtegrat1on, as Figure 11.1 showed, but it may also produce cartel-like conditions. The basic trade-off can be illustrated with the so-called Williamson diagram in Figure 11. 6.

CHAPTER 11 EU competition and state aid policy

. . k t ower vs. efficiency gains Figure 11.6 Basic econonucs of mergers. mar e P

Euros Demand curve

p ' l - - - - - -\--- - - - -

C'

C

Quantity

Consider a merger that allows the merged firms to charge a higher price, but which also allows them to lower average cost by eliminating redundant capacities in marketing, accounting, sales representatives, and so on. The price rise is shown in the diagram by the increase in price from P to P' (the diagram assumes that the market was in long-run eq,uilibrium at P = AC to start with). The efficiency gain is shown by the drop in average cost from AC to AC'. The gain to the firm's profitability is strongly positive. Before, P = AC meant there were no profits. After, profit is the area a + c. The merger is bad for consumers, since the price hike implies a loss of consumer surplus eq,ual to the area a+ b. The overall gain to society, taking profits and consumer surplus together, is the area c - b since area a is merely a transfer from consumers to firms. There is a point here that is important for understanding the EU's new rules on mergers. Notice that if entry and exit in the indust~y are unr~stricted, ~nd the remaining firms do not collude, then the Ion~run outcome of this merger will be to dnve the pnce down to the lower average costs, P" = A C'. This 1 essentially what happens when the eq,uilibrium shifts from E' to E" in Figure 11. 1. In this case, the mergerwith-efficiency gain is always positive and eq,ual to area c + d + e since the consumer surplus gain from the lower long-run price, P", is not offset by any loss of producer surplus; profits were zero to tart with (P' = AC') and to end with (P" = AC'): Since entry and exit in most EU industries are fairly unrestricte?, there is a presumption that mergers will generally be of the type that boosts efficiency and passes on this efficiency to consumers. Note that our treatment of co~petition her_e is highly simplified. The impa t of m rgers on pricing and costs can be extremely complicated and highly dependent on the natm of th industry. Examples of such reasoning can be found in the Commission's analysis of actual m rger cases on its website: http://ec.europa.eu/competition/mergers/cases/.

11.1.4 State aid The Figure 11.1 logic linki~g integration and industrial restructming presumes that profit-losing firJtlS would eventually leave the industry - that they would be bought out by another firm, merged with oth~f firm~ ?r, in r~re cases, go bankrupt. All _three of these exi~ strategies may involve important job Ioss~s 111 spec1f1c locat10ns, or at the very least an important reorganization that may req,uire workers to change Jobs. Since job losses and relocations are painful, govenunents freq,uently seek to prevent them. For example, if the firm is government owned, trade unions may force the government to continue to shore up the

The economics of anti-competitive behaviour and state aid

money-losing enterprise. If it is privately owned, the government may provide subsidies through direct grants or through long-term loans that may not be repaid. He_re'. we look a_t the long-run economics of such subsidies - called 'state aid' in EU jargon - under two distmct scenanos. The first is where all governments provide such support. The second is where only one does.

EU-wide subsidies: thwarting the main source of gains Start by suppos~g. th at both governments provide subsidies that prevent restructuring. To be concrete, we make th e additi?nal, more specific assumption that governments make annual payments to all firms exact~y eq,u~l to their losses. Under this policy, all 2n' firms in the Figure 11.1 analysis will stay in business, but, ~mce frr~s are ~ot making extraordinary profits, no new firms will enter. The economy, in short, remam~ a~ pomt A owmg to the anti-restructuring subsidies. . An msightf~ way ~o think about this subsidy policy is as a swap in who pays for the inefficiently small firms. ~~fore 1:11-tegration, prices were high, so consumers paid for the inefficiency. After liberalization, competitwn dnves down the price but this comes at the cost of extra pay-outs from the national treasuries, so now the taxpayers bear the burden of the industry's inefficiency. Moreover, since all the firms stay in business, integration is prevented from curing the main problem, that is, the too-many-too-small firms problem. Firms continue to be inefficient since they continue to operate at too small a scale. As a conseq,uence, the subsidies prevent the overall improvement in industry efficiency that was the source of most of the gains discussed in Chapter 6. Do nations gain from this liberalize-and-subsidize scheme? As it turns out, both nations do gain overall, even counting the cost of the subsidies. We shall show this with a diagram, but before turning to the detailed reasoning, it is instructive to explain the deep reason for this result. Imperfect competition is inefficient since it leads prices to exceed marginal costs. Recalling from Chapter 4 that the consumer price is a measure of marginal utility, the fact that price exceeds marginal cost implies that the gain to consumers from an extra unit would exceed the resource cost of providing the unit. In short, society tends to gain from an expansion of output when price exceeds marginal cost. Because of this, policies that increase output tend to improve welfare. In the jargon of public economics, the subsidy is a 'second-best' policy since it reduces the negative effects of market-power distortion, even if it does not solve the root of the problem. Note, however, that this reasoning is very partial. This sort of 'reactive' subsidy turns out to be a very bad idea in the long run. The subsidies are paid to prevent firms from adapting to changed circumstances. While the government may occasionally improve things by preventing change, a culture of reactive interventionism typically results in a stagnant economy. Staying competitive req,uires industries to change _ to adapt to new technologies, to new com~etitor~ and to new opportunities. When firms get used to the idea that their governments will keep them m busmess no matter what, the incentive to inno ate and adapt is greatly weakened. Firms with this sort of mindset will soon find themselves far behind the international competition.

Welfare effects of the liberalize-and-subsidize policy To explain the welfare effects of the liberalize-and-subsidize policy, we refer to Figur 11.7. The policy we consider freezes the economy at point A in the right-hand and middle panels (thi point A corresponds exactly to point A in Figure 11.1). We know that the price falls from p: top and onsump~on rises from C' to cA-. Since the number of firms has not changed but total sales m ach mark t (which must eq,ual total consumption in each market) have increased, we know th~t th. al__ of ea h f~·m have increased somewhat, from x' to :xf, as shown in the left-hand pan l. At Un pomt, f1rm ar losmg money, but the government offsets this with a subsidy. How bi will the subsidy be? The easiest way Lo make this omparison is to adopt a roundabout approach. -J!rrst consider the total size of operating profit that the whole Home industry needs to cover all fixed costs bef~re the liberalization. The answer is already in the middle panel. Before the liberalization, the industry broke even by selling a total of C' un~ts at price p'. The oper_ating profit o~ this was _the area A+ B • th "ddl panel of the diagram, that 1s, the gap between pnce and margmal cost trmes the m e rm e . , . f" • B c (the new pnce-cost · units ld Aft th liberalization, the mdustry s operatmg pro 1t 1s area + gap, so . er e . f" • h c · pA _ MC, times the new sales, d) . The drop in operatmg pro 1t 1s t us area mmus area A. The subsidy we

CHAPTER 11 EU competition and state aid policy

. · d-subsidize policy Figure 11. 7 Welfare analysis of a liberalize-an

Mark-up Price

Euros

P' ___________________ .., 1 I I I

I

AC

I

,o

A

pA ---- ~,------------- p ------IIA

I I 11 11 1 - - - - +-+-- - - - 11

,,

A I ______________ ,__ _

: I

B IC I MC----.!.---------~-,

of firms

11 11 11

x't XA

=

Sales 2CA / 2n ' per firm

2n' Number

C'

cA

Total sales

are considering would have to exactly offset the loss, so the subsidy would eq,ual area A - C. With these facts established, we turn to the welfare calculation. . r part of the welfare calculation is simple. Consumers see a lower pnce so consumer The consurne 'd hi h uals s lus rises bl) the area +A+ D. To see the overall welfare effect, we subtract_t~e s:1bs1 ~' w ~ eq; . A~C. The net welfare effect is A+ D - (A- C), which eq,uals D + C. W~ know this 1s ngh~ smce t~ a~ea IS the gap between price and margin~l cost summed over ~11th~ extra urnts consumed. Notice that this IS the classic gain from partially redressing a market power distortion.

Only some subsidize: unfair competition .

.

Th vernments of EU Member States differ over how much theIJ can or want to subsidize loss-making f~oYet, when only some governments subsidi~e th~ir fir~s, the outcome of the restructuring ~1~y_be 'unfair' in the sense that it gets forced upon the frrms in nations that do not subsidize, or stop subs1dizn:g before the others. The real problem with this is that it may create the impression that European econonuc integration gives an unfair advantage to som~ nation~' firms. . To examine this problem more closely while keeping the reasoning as tangible and simple as possible, we continue with the Figure 11.1 example of two nations engaged in an extreme no-trade-to-free-trade integration. The integration moves each identical economy from point E' to point A. t A, all firms in bo~ nations are losing money . Now suppose that restructuring takes, saIJ, fiv y ar in th sense that, ~tei that time, the number of firms has adjusted from 2n' to n". In our simple ampl , th re is no way of telliM which of the surviving firms will be Home firms and which will b For ign firm . ymmetry suggests ~~t half the remaining firms would be Foreign, but nothing in th o ampl n ur s that this is the case. This is where subsidies can make a big difference. To be concrete, suppose that prior Lo Lho libcralizaLion th r - w r 10 firms in Home and 10 in Foreign, and that after restructuring there will be 12 firms in total. F\uth rmore, suppose that Home provid~s ~ five-year subsidy to all of its 10 firms, wiLh tho siz of th subsidy being large enough to offset the liberaliZa~o~ induced losses. The Foreign government, by contrast, is assumed to pursue a laissez-faire policy, that IS, it allows the market to decide which firms should survive - either because it believes in the market or because it cannot afford the subsidies. In this situation, it is clear that 8 of the 10 Foreign firms will go out of business, while a~ ~O firm~ will survi:e. At the end of the five-year period, the Home government no longer needS to subsidize its frrms since the exit of eight Foreign firms restores the industry to profitability.

~om:

EU competition policy

From a purely economic perspective the F . . . in our example brings nothing t . ' oreign nation nught have been the winner since having firms . 's sub s1dies . . were merely o nat10nal welfare (firms earn zero prof.1t m . t h e b est of cases). The Home nat10n . . a waste of taxpay ' Tw First, this sort of conclusion sho th . ers money. o comments are relevant at this stage. For example, we did not conside twhs at our srmple example is actually too simplistic in many ways. . rth e cost of workers h avmg · t o swi·tch JO · b sand possibly . . unemployed for some trme. Second it sho . . bemg ' ws at econonucs 1s only part of the picture.

The politics. .of state aid disciplines·• /'II play on Iy I., th e rues t . I are ,a,r

From a political perspective, this sort 0 . .. . business groups in Forei natio ~ ~arr compe~t10n would be mtolerable. Indeed, if trade unions and the whole integration gn . ns anticipated that this would be the outcome, they might very well block exercise. To avoid thi . . . . . strict rules forbi.ddm· h . s sort of resistance to liberalizat10n, the EU establishes very g sue unfarr c ft· . on state aid is the fact th . ompe 1 ion. In this sense, one of the most important effects of discipline at it allows governments to proceed with painful and politically difficult reforms.

11.2 EU competition policy

/~

Having .laid out the basic 1ogic · Of co11us1on . and subsidies we turn now to considering actual EU policy that constrams such. actions b · t · ' practices) and governments (subsidies). . Y pnva e actors (anti-competitive EU competition rules are I · d t · h · · of the European Umon · . . . . a1 ou m t e Treaty of the Funct10nmg and the rmp_l~men~g legislat10n. The main provisions discipline anti-competitive practices and abusive dominant positwns m the ~arket. The Treaty also sets rules on subsidies, or 'state aid' as the Commission calls it. Generally state aids are prohibited unless sanctioned by the Commission.

11.2.1 Institutions: the power of the European Commission The founders of the EU were fully aware that integrating Europe's markets would result in restructuring and that this would produce incentives for private and public actors to resist consolidation. This is very clear, for example, in the 1956 Spaak Report, which was the economic blueprint for the Treaty of Rome (Rapport des chefs de delegation aux ministres des affaires etrangeres, Bruxelles, 21 April 1956). Moreover, they feared that the perception that some nations might 'cheat' in an effort to shift the burden of consolidation onto others would, in itself, make deeper European integration politically impossible. To ensure that the prevailing attitude was 'I will reform since the rules are fair' instead of 'I cannot reform since other nations will cheat', the Treaty of Rome prohibited any action that prevents, restricts or distorts competition in the common market. Importantly, the Treaty puts the supranational Commission in charge of enforcing these strictures. Just as European leaders decided to forgo their control over monetary policy (by making central banks independent) since they knew in advance that short-r~. politic_s wo_uld lead to bad long-run policy, the Treaty of Rome grants a great deal of powe~ on c~~pet1t10~ policy directly to the European Commission. The idea was that the politicians in the Council of Ministers might not be able to resist the short-run pressure of special-interest groups opposed to the consol~d_ation t~at ~s necessary to obta~ the ~ong-run gains_ fr?m European economic integration. In fact, competit10n policy 1s probably the area m which the Conumss1on has the greatest unilateral power. . . .. Th Commission has considerable powers to mvestigate suspected abuses of EU competition law, in 1 ~ th · ht to force companies to hand over documents. Most famously, the Commission has cu g e ng · · h. h th d' f 11 'd ·ct ' the right to make on-site inspections witho~t pnor warnmg, w 1c e m ia o ten ca awn ra1 s . ·th urt d the Commission can even mspect the homes of company persmmel. W1 a co or er, .. . .. I d thi b · · · · ti' . • h the power to prohibit anti-compet1t1ve activities. t oes s y 1ssumg mJunc ons The COffiffilSSlOn as . . f' f' f d guilty · f' T b k these demands, the Commission has the nght to impose mes on rrms oun agamst. rrms. .o. ac upd t The fines vary according to the seventy • o f the ant·1-competitive practi'ces, of anti-competitive con uc . . . . . • . nt of the offending firm's worldwide turnover. When 1t comes to subsidies, with a maxrmurn of 10 per ce . . . . . . • • h th power to force firms to repay subsidies 1t deems to be illicit. th e Coffiffi1ss10n as e

CHAPTER 11 EU competition and state aid policy

. . ,s d ec1s1 • ·ons are not subject to approval by the . . C rmss10n Unlike most other areas in which it acts, the om se is through the European Court. This is . t The only recour f Council of Ministers or the European Parliamen . . t t ensure a better outcome or all. an area in which Member States truly did pool their sovereign y o

11.2.2 EU law on anti-competitive behaviour

. T ty of Rome and has not been changed . f" t 1 .d out rn the rea . EU law on anti-competitive practices was rrs ai . most recently in the Lisbon Treaty) . b . of the art1c1es, . . substantially ( apart from occasional renum errng t that we merely hint at actual pollen. . •· · · · rtant to no e ~ Here we review the mam prov1s1ons, but it is impo E pean Court and one m ust master the ' . · · of the uro EU competition policy has been subJect to many deciswns . e prohibited and why. Moreover d h"ch practices ar ' 1 details of these cases in order to fully ~-derst~n w. . th t firms can more easily determine the Commission publishes its own administrative ~de!rnes s:rmi:ed by the Commission. whether a particular agreement they are c?nt_emplatmg will be P (as the Treaty of Rome was re-labelled Article 101 of the Treaty on the Funct10nmg of th e EU, TFEU . t distort competition unless . . . practices · tha t Prevent ' .restnc dor rth reading in its 'entirety by the Lisbon Treaty) outnght forbids the Commission grants an exemption. This article is clearly wntten an wo (see Box 11.5). ..

Box 11.5

Article 101 (Article 81 pre-Lisbon; Article 85 in the original

-.~

T~q

The following shall be prohibited as incompatible with the common market: all a~reeme~ts between undertakings, decisions by associations of undertakings and concerted practices w~ch may affect trade between Member States and which have as their object or effect the p reven~on, restriction or distortion of competition within the common market, and in particular those which: (a) directly or indirectly fix purchase or selling prices or any other trading conditions; (b) limit or control production, markets, technical development, or investment; (c) share markets or sources of supply; (d) apply dissimilar conditions to eq,uivalent transactions with other trading parties, thereby

placing them at a competitive disadvantage; (e) make the conclusion of contracts subject to acceptance by the other parties of supplementary

obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts. 2 Any agreements or decisions prohibited pursuant to this Article shall be automatically void. 3 The provisions of paragraph 1 may, however, be declared inapplicable in the case of: • any agreement or category of agreements between undertakings; • any decision or category of decisions by associations of undertakings; • any concerted practice or category of concerted practices, which ontributes to improving the production or distribution of goods or to promoting technical or anomic progress, while allowing consumers a fair share of the resulting benefit, and whi h do s not: (a) impose on the undertakings concerned restri tions whi h ar

attainment of these objectives;

not indispensable to the

(b) afford such undertakings the possibilily of eliminating comp titian in respect of a substantial

part of the products in q,uestion.

Typ~~ally, the restriction~ in Article 101 are classified as preventing horizontal or vertic~l ~~­ competitive agreements. Horizontal agreements are arrangements, like cartels and exclusive terntofl~ ' upon competitors selling similar goods. Vertical agreements are arrangements between a firm and its

EU competition poli cy

tr suppliers or diS ibutors (e.g. agreements by retailers to charge not less than a certain price, and tie-in arrange~ents whereby ?00 ds ar~ only supplied if the vendor agrees to purchase other products). st The frr ~art of ~icle 101 is so categorical that it rules out an enormous range of normal business practi~es'. which can ID fact_be good for the European economy. The final part therefore allows the Comrmssw~ t~ gra nt exei:nptions to agreements where the benefits outweigh the anti-competitive effects. The Comrmsswn does th is for individual agreements notified to the Commission for exemption, but it also has ~stablish ed the p olicy of 'block exemptions' that grant permission to broad types of agreements. These exist for technology transfer and for R&D agreements. Political pressure has also forced the Commission to gran_t a block exemption to the anti-competitive practices in the distribution of motor vehicle_s. The second maJor set of policies _ restrictions on the abuse of a dominant position - are found ID Article 102 of the TFEU (see Box 11.6). A dominant position usually depends upon a firm's market share. Abuse is a gen eral t erm but it includes refusal to supply, unfair prices and conditions, predatory pricing, loyalty rebates, exclusiv e dealing req,uirements and abuse of intellectual property rights.

Box 11.6

Article 102 (formerly Article 82 pre-Lisbon; 86 in original TEC)

Any abuse by one or more undertakings of a dominant position within the common market ~r in a substantial part of it shall be prohibited as incompatible with the common market insofar as it may affect trade between Member States. Such abuse may, in particular, consist in: (a) directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions; (b) limiting production, markets or technical development to the prejudice of consumers; (c) applying dissimilar conditions to eq,uivalent transactions with other trading parties, thereby placing them at a competitive disadvantage; (d) making the conclusion of contracts subject to acceptance by _the other parties of supplei:nent~ry . • obligat10ns w hi c h , by their nature or according to commercial usage, have no connection with the subject of such contracts.

11 2 3 Control of mergers

. .

· · . ot address the control of mergers. The Commission, however, saw some control The Treaty of Rome did n k . competition vibrant. The issue was controversial among members. of mergers as essential to eer;nx controlling and others thought such control should be at the national, Some doubted that mer_gers ~ee ed merger policy as an important plank in their industrial policy and not a not EU, level. Some n~ti?ns vie;~ed that state aid and rules on 'abuse of dominant position' were re pected. concern of the Comrmsswn ?ro ctr· ·n the 1980s to complete the Single Market, and 'European Union th This reluctance shifted d~r-mg e . iv: ~0 and has been amended occasionally since. 9 Merger Regulation' came mto force m db itself but rather is one pillar in a merg r control difice that also st The Merger Regulation does not anf h y izontal mergers and on best practic in m rg r investigations, O includes guidelines on the assess~~nt Tho: Merger Regulation defin s anti- ompetitive behaviour. as: and reforms within the Com~iss~o_n. tl ·mpede effectiv comp tit.ion, in th common market or ma 'A concentration which would signiflcan y it· or strengthening of a dominant position, shall be declared . . . ul by the crea 10n · . . ~ubstantial part of 1t, m partic ar et., Under the rul s, merg rs that me~t the ~el vant cr~t~na do not h~ve incompatible with the common ma~k h e presumed to be compatible with competition. For details, to be notified to the Commission smce t ey ar see Commission (2010). . t ole to national competition authorities and courts under · a prommen kr which facilitates coordmat1on · · among EU and nat10na · 1 The current rules also give the so-called European Competition Net7i°; describes the decisions taken by the Commission on two . . a nd courts · Box . competition authont1es particular mergers.

CHAPTER 11 EU competition and state aid policy

Box 11. 7 Two examples of merger decisions

'(

· d e of consolidation and, as part of this The European pharmaceutical sector has expen~nce a wav uro ean Commission, the Sanofi anct two mega-mergers were brought to the atte~t10n. of the E p .ssion determined that both would Synthelabo link-up and the Pfizer and Pharmacia fus10n. The Comnu dru Th C . . . th choice of some gs. e omrmss1on funit lessen competition in certain market segments by mg e uld b f ' · d b Ii d that the mergers co e use ul however, recognized the need for efficiency gains an e eve diti. Th f " · . . allowed the mergers subiect to con ons. e• mns were The outcome was that the Comm1ss10n J • •• · • competitors · req,urred to transfer some of their products to therr so as to redress potential anti-competitive . / . t·b· t· hypnotics and sedatives. effects. For example Sanofi/Synthelabo sold off certain an i 10 ics, . . . · ' · · merger between To t a !Fina and Elf Anmtame which were Another case involved a mainly domestic '-1, • ' · players in · the French petroleum sector. The Commiss10n · · d e termined that their m erger would the main · 1 have allowed them to push up costs for independent petro s t a t·10n op erators (e. ·g · supermarkets) . Fr and the combined company would have operated around 60 per cent of the ser:1 ce sta_tw~s on ench motorways. The combined firms would also have been the leading suppher of liq,u~d petrol~~ gas. The European Commission believed that this level of market power would be anti-comp~titive and agreed to the merger only on the condition that TotalFina/Elf sell off a large proportion of these operations to competitors. For example, it sold 70 motorway service stations in France to competitors.

11.2.4 EU policies on state aid The EU's founders realized that the entire European project would be endangered if EU members felt that other members were taking unfair advantage of the economic integration. To prevent this, the 195,.. Treaty of Rome bans state aid that provides firms with an unfair advantage and thus distorts competiti n Importantly, the EU founders considered this prohibition to be so important that they actually empowered e supranational European Commission to be in charge of enforcing the prohibition. Indeed, the Co · n has the power to force the repayment of illegal state aid, even though the Commission normally has no .,..y over members' individual tax and spending policies. The Treaty prohibits state aid that distorts competition in the EU, and it defines state aid in very bro d terms. It can, for instance, take the form of ?rants, interest relief, tax relief, state guarantee or holding. or the provision by the state of goods and services on preferential terms. Some state aid however is allowed according to the Treaty since subsidies, when used correctly, are an essential instrn~ent in the toolkit of good governance. The permitted exceptions include social policy aid, natural disaster aid and econontlc development aid to underdeveloped ~re~s. More generally, state aid that is in the g n ral int rest of the E_U is permitted. For exa~ple, t~e ~offiffilssion has a~so adopted a number of bloc- .,.. mption rule that e~-plalil which sorts of state aid are indisputable. These mclude aid to small and m dium iz d nt rprises, aid for training and aid for employment. More information can be found on th DG ornp titian website. --

Box 11.8

State aid and the global crisis

>-

The glo~a~ crisis th~t started ~n the USA in 2008 spread rapidly to Europ . EU policymakers responded by prov~ding massive state aid to banks to prevent the financial shock from creating a second Great Depres~1on.. All these measures had to be approved by the Commission under its state aid poliCY· ~ the ~rrst five ye~rs of the crisis, the Commission authorized more than 400 state-aid measures to the fmancial sector. Aid used for recapitalization and asset relief measures amounted to almost 600 billion

1'

Summary

euros or almost 5 per cent of EU GDP . almost twice as large As the c . . h ' a nd aid for guarantees and other forms of liq,uidity support was · ns1s as calm d h • The Commission duln d . e , muc of the aid has been repaid. 1:1 a opted six 'C · • , . . . regarding what type of aid would be all ornrnumcati~ns providing ~dance for Member States Member States to underpin f . o~e_d a nd how it would be momtored. The goal was to allow manc1al stab11it11 whi·1 · • • • di . .. banks and across nations Fin . . . 1:1 e mm1m1zmg stort10ns of compet1t10n between st systems and helps banks · .dancial abihty avoids major negative spillovers across EU banking . prov1 e loans to the real economy When applymg the rules to indi .d · criteria and takes a t f vi ual cases, the Commission looks beyond its usual industry-level 0 long-term viabilit t~e. macroeconomic environment. Key points for the Commission are the bank-specific risk~t~kin e ;~si~zed ban~s and whether the need for support arose from the crisis or be restructured. g. his is an ongomg challenge as large parts of the EU financial sector must

c~~:

Source: This box is based mainl on d · · · ·ct html Y ata from http://ec.europa.eu/competition/state aid/scoreboard/financial_econorruc_cnsis_ a1 :en. -

A contentious example: airlines in trouble The Commission is freq,uently in the headlines regarding its decisions on state aid since these often produce loud protests from firms and/or workers who benefited from any state aid that the DG Competition judges to be illegal. An excellent example concerns the airline industry - an industry in which there are clearl11 too many firms in existence and the tendency to subsidize is strong. Many European airlines are the national 'flag carrier' and as such are often considered a symbol of national pride. Consolidation of the European airline industry has been on the cards for years, but the problem was exacerbated b11 the terrorist attacks of 11 September 2001. The ensuing reduction in air travel caused great damage to airlines all around the world and led to calls for massive state aid. To prevent these subsidies from being used as an excuse to put off restructuring, the Commission restricted subsidies to cover only the 'exceptional losses' incurred when transatlantic routes were shut down immediatel1J after 11 September. To date, the Commission has managed to resist the desire of several Member State governments to support their national airlines to the same extent that the US Government has supported US airlines.

11.3 Summary

Three main points have been made in this chapter: . . pact of European integration has been to face individual European firm with . . . 0 ne very o b v10us 1m . , , ket This produces a cham react10n that leads to fewer, bigger, more efficient a bigger home mar . .. . . . firms that face more effective compet1t10n from one _another. The attendant mdus~·1al ~-e_ tructurmg . IT painful since it often results m layoffs and the closure of m ff1c1ent plants. 11 1 is freq,uentl11 po icaftlJ attempt to offset this political pain by providing 'stat aid' to their national ~overnments vefl:J_do enb viewed as unfair and the perception of unfairn s thr atens to undermine firms. Such state a1 can e . . . . , . t • integration. To avmd these probl ms, th founde1 of the EU established EU members 1~t_ereds tmt aid that distorts competition. The Commission is charged with enforcing rules that proh1b1te s a e these rules. . . . •t· t· d EU . . lso seek to avoid restructuring by engaging m anti-compet1 1ve prac ices, an 2 Pnvate firms ma11 a s integration proceeds and the number of firms falls, the temptation for rules prohibit this. Moreover, a firms to collude may increase. .. . t · t rules on anti-competitive practices. It also screens mergers to ensure 3 To avoid this, the EU hafsf_s_nc Again the Commission is charged with enforcing these rules. that they will enhance e iciency · '

CH APTER 11 EU competition and state aid policy

,'1;

Self-assessment questions

i

Suppose that liberalization occurs as in Figure 11.1 and the result is a pro-competitive effect but instead of merging or restructuring, all firms are bought by their national governments t~ allow the firms to continue operating. What will be the impact of this on prices and government revenues? Now that the governments are the owners, will they have an incentive to continue with liberalization? Can you imagine why this might favour firms located in nations with big, rich governments? 2 Look up a recent state aid case on the Commission's website (http://ec.europa.eu/competition/ state_aid/register/) and explain the economic and legal reasoning behind the Commission's decision, using the diagrams in this chapter. 3 Look up a recent anti-trust case (Article 81) on the Commission's website (http://ec.europa.eu/ competition/antitrust/cases/index.html) and explain the economic and legal reasoning behind the Commission's decision, using the diagrams in this chapter. 4 Using a diagram similar to Figure 11.2, show what the welfare effects would be following a switch from normal competition to perfect collusion. Be sure to address the change in consumer surplus and pure profits.

References and further reading

References Commission (2010) 'EU competition law: rules applicable to merger control, situation as at 1 A ril 2010' DG Competition, ec.europa.eu/competition/mergers/legislation/legislation.html. p ' Mas-Colell, A., M. Whinston and J.R. Green (1995) Microeconomic Theory , Oxford umvers1 · ·ty p ress, New v:.1ork.

Further reading: the aficionado's corner Bannerman, E. (2002) The Future of EU Competition Policy, Centre for European Reform.

For a very accessible introduction to EU competition policy, see: Neven, D., P. Seabright and M. Nutall (1996) Fishing for Minnows, CEPR, London. Every interested reader should at least skim through the Commission audio • 1 . . . p - 11 . . n/ . visua material on Competit10n o11c::1 (http://ec.europa.eu/compet1t10 consumers1mdex_en.html). It is well executed a d hi hl . n g Y accessible.

Useful website The DG Competition website has several highly accessible accounts of EU c titi . . . ompe on policy and mformation on recent cases; see http://ec.europa.eu/dgs/competition/index_en.htm.

Chapter

12 EU trade policy Chapter Contents 12 .1 12. 2 12.3 12.4 12.5

Pattern of trade and tariffs: facts EU institutions for trade polic"y EU trade policy: broad goals and means EU trade policy: existing arrangements Summary

276

280 283 283 284

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CHAPTER 12 EU trade policy

Introduction C t"ng EU28 exports both within the EU and to The European Union is the world's biggest trader by far. o~ 12017 That is a great deal more than China · accounte d f or 33L.__--,--~ ~~ ~ EU28 exports EU28 imports Source: Based on data from WTO online trad

t ti ti d b e s a s cs ata ase.

w hole (although Britain naturally trades more with North Atlantic economies than the average EU member), so its departure will not fundamentally change the EU trade pattern (Figure 12.2). The figures show that the EU27 accounted for about 50 to 60 per cent of Britain's imports and exports in 2016. The rest of UK exports and imports went to Asia, the Americas and the non-EU nations in Europe like Switzerland and Norway.

Figure 12.2 Britain's imports and exports by partner UK Trade Partners

(%)

100 90

80 Oceania Africa ~ Non-EU Europe Ill] Americas mAsia

[email protected]

70 60 50 40 30 20

~

ISl EU28

10

0 J _ ~~ ~---,-~~.,..____--, Imports Exports

Source: Based on data from The

P-nk Book www.ons.gov.uk.

12.1.1 Differences among

i

'

Member States

olic a contentious issu is the fact that the various Member States One of the things that makes EU trade p y mbers are landlocked and surrounded blJ other EU members, me · or La tin Amenca. · It is · have q,uite different trade patterns . Some or culturall11 close to Africa, North Amenc_a while others are geographically ~nd/ rtance of various trade partners var~es q,wte a lot across the EU27. . . th efore that the impo d Af . while Asia is a more rmportant partner for members not surpnsmg, er ' . Latin America an nca, th The Iberians trade more wi B ·tain Denmark and Poland. such as n , with eas1J access to the sea,

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CHAPTER 12 EU trade policy

12.1.2 Composition of the EU's external trade

f th rest of the world? As Figure 12.3 shows the rt t d import rom ethe diagram are: ' O What sorts of goods does the EU expo an . . f , The roam pomts rom ds answer is 'mainly manufacture d goo • t f EU exports with about 40 per cent of all exports • Manufactured goods account for almost 90 per cen being machinery and transport eq,uipment. b uf t d t on imports go to uy man ac ure goods • On the import side, about two out of every three euros spen · · th e EU's trade · • Other types of goods play a relatively minor part m

°

'

Figure 12.3 Composition of EU27 imports and exports, aggregate trade

(%) 100 90 80 70 60 50

What the EU28 Imports and Exports, 2017

El Machinery and transport ~ Other manuf' d goods !iJ Chemicals 1ml Fuels ~ Raw materials

40 30 20

ISi Food, drinks and tobacco

10

0

-+--~....,,,__,._,.__,,_.___-----.--~~~----,

Exports

Imports

Source:: Based on data from Eurostat online database.

Which EU members trade the most with the UK? The likelihood that Britain will leave the EU in 2019 - and that this change will most likely be disrupth·e makes it important to understand the bilateral relationships between the UK and the nations who stay in the EU. As we saw in Chapter 3, the decision-making process depends upon the attitudes of individual members. So which EU members care most about exports to and imports from the UK? The UK is one of the larger economies in the EU28, but it is not dominant by any means, 0 the importance of the UK market to individual EU members is fairly small, as Table 12.1 shows. The a rag figure for the EU27 as a whole is 7 per cent - which is far smaller than the UK's export depend n on th E market (about 45 per cent). While this seems like an unfair comparison (the UK is only on ountry and the E is 27), the reality is that the EU acts as one when it comes to trade policy in it i ustoms muon, As mentioned in Chapter 3, the decisions for trade policy are taken by th 27 a ting a n . , The nation with the highest dependence on the UK is Ir land. Thi i naturn.1 gi n the geography (UK IS a big nation, very close to Ireland), the common languag and long hi t ri al ti (Ireland as basically a colony of Britain up until the early 1900s). On the oth r nd of th sp trum, th Balkrui. nations care veTY little about the UK market.

12.1.3 The EU's Common External Tariff (CET) The EU has been an active participant in the 60-year-long seq,uence of gilobail tairiff-cuttmg talks known as GA'IT Rounds or, since 1995, WTO Rounds. As a result the EU's tariffs are ~rte low for most goods that were bargained over in these Rounds. Since agricultur;l tariffs were not indude