South Asia Watch on Trade, Economics & Environment (SAWTEE)

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Efficiency defense in competition law
Published: The Kathmandu Post, 26 November 2004
By: Ratnakar Adhikari

Since the third self-imposed deadline for enacting competition law (by Paush end 2061) is fast approaching, it is necessary for all the stakeholders to engage in an informed discussion to ensure that the deadline is not missed this time. At the same time, the discussion should also aim at convincing certain sections of our society which are averse to the idea of enacting such a law because of the sheer ignorance of its benefits. In this article, I shall discuss one such issue that would probably ally the fears of a particular sector, which is yet to be convinced of the need for a competition law. One of the fundamental objectives of competition law is to ensure efficient use of resources through vigorous competition among the business enterprises. For relatively small open economy like Nepal characterised by high concentration in many sectors, firms are definitely not operating at minimum efficient scale. This causes efficiency issues to be particularly important. It is, therefore, important for us to learn from the practices elsewhere in this connection.

There may be instances in which apparent restrictions of competition can mean more efficient resource use. Such restrictions can be broadly classified into two categories – pro-competitive and anti-competitive. The first category of restrictions includes a merger between two small competitors to make themselves more effective rival to a larger rival; and a joint venture between two potential competitors to develop a new product. A merger between two private diaries to counter the market power of Dairy Development Corporation and a merger between two bottlers of mineral water to produce distilled water for medical use are two hypothetical examples that could be cited here. The second category of restrictions includes two competitors merging to take advantage of economies of scale thus making better use of resources, but charging higher price to the consumer because of the market power they are able to enjoy post-merger. Some other real life examples of restrictions falling into this category are: a) two potential competitors entering into a joint venture to develop a new product to eliminate duplication of research and development (R&D) and avoid the cost of racing to be the first in the market, resulting in delay in the introduction of new product/process in the market; and b) two multi-product competitors agreeing to specialise production with each supplying the needs of the other, providing each other with the opportunity to know each other’s cost thereby leading to less price competition. Some countries have either a statutory or an administrative provision for an efficiency exception or defense. The European Union (EU) allows for the exemption of anticompetitive agreements that also bring about economic benefits. As per their rules, some collusive behaviors restricting competition in a non minor way may be exempted because of sufficient beneficial effects. However, four conditions should be met. First, the agreement must contribute to the improvement of the production or distribution of goods or promote technical or economic progress. Second, it must allow ultimate buyers a fair share of the resulting benefits. Third, the restriction must be necessary for the attainment of the objective. Fourth, the firms concerned must be unable to eliminate competition with respect to a substantial part of the product in question.

The trade-off of expected efficiencies against expected anticompetitive effects is universally recognised as difficult. Therefore, extra care should be taken to ensure that the efficiency gains outweigh the costs to the consumers as well as to the society at large. For example, even if a merger between two competitors results in cost reduction and the cost is passed on to the consumers, competition authority will have to see whether the costs saving are equitably shared by the new company and the consumers and whether the market power of the incumbent company would actually be reduced. Further, it should also look at the redistributive impact. An example of such redistributive impact that follows from the second hypothetical example is whether poor consumers are able to benefit from the access to new product.

R&D cooperation is another area, which is increasingly being accepted by competition regimes around the world as a means to enhance efficiency, outweighing the possible anticompetitive effect. For example, Canadian Competition Act provides a defense for R&D joint ventures involving a specific program of research that would not otherwise take place. Agreements among competitors with respect to cooperation in R&D are exempt from the criminal conspiracy provisions of the Act unless they lessen competition unduly with respect to prices, output, markets, customers, or channels of distribution. Similarly, the US courts are required under National Cooperative Research and Production Act to judge joint research and production arrangement on a rule-of-reason basis.

There is considerable amount of support for joint R&D at the conceptual as well as empirical levels. Cooperative R&D can be viewed as a means of simultaneously internalising the externalities created by significant R&D spillovers - hence improving the incentive problem and providing a more efficient sharing of information among firms. Some studies have used a model to study the impact of R&D spillovers on a firm’s optimal R&D investment. In comparing the symmetric cooperative and non-cooperative solutions, they find that large spillovers lead to higher R&D expenditures and production levels under the cooperative scenario. Clearly, this behavior is superior from a social welfare point of view. However, contrasting with these potential advantages of cooperative R&D, effects leading to a harmful reduction of competition must also be considered. One danger is that cooperative R&D could be a way for a dominant firm to avoid competition through innovation, by co-opting potentially very innovative rivals and by controlling and slowing down the innovation race. A second situation involves an extended collusion between partners, resulting from their action in R&D and creating common policies at the product stage (competitive level).

The point I am trying to make in this column is that cooperation among companies should be allowed, even if they have minor deleterious impact on competition. After all, the competition law we have been talking about all these years should be anchored on development dimension. Normally, as an advocate of consumers’ interests, I could have mentioned that consumers’ interest is supreme and therefore consumer welfare should be the touchstone to measure the success or failure of the competition law. But I am not doing that because there is more to development than consumer welfare despite the fact that consumers are the raison d’etre of all the economic activities. Finally, in order to conduct sophisticated analyses mentioned above, it is necessary for the competition authority to be a powerful, independent and impartial. They should not only be provided with adequate resources but also be allowed to generate resources from elsewhere. Moreover, the authority should be able to assure those who are still opposed to the enactment of competition law that genuinely efficiency enhancing actions will not be curtailed just because of the enforcement of a competition law.

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