Introducing Competition Policy into Developing Economies: A Summary of Lessons Learned

David SMITH and Su SUN

Perspectives, Vol. 2, No. 4

I. Introduction

With China's economic reform moving further towards a market-based economy, there have been growing discussions in recent years on implementing competition policy. The discussions arise from the concerns that future market reforms will not be effective without dismantling the monopolies that currently exist in many industries. Nor will they be effective without curbing widespread anticompetitive behaviors in the marketplace. Implementing competition policy in a traditionally highly regulated economy like China's is no easy task. To make sound competition policy and implement the policy successfully, it is important to learn from other countries' experiences.

Over the last ten years, many countries throughout the world have begun to employ economic policies based on free markets. These countries have been improving opportunities for better resource allocation within their economies by selling state-owned firms, reducing trade restrictions, reducing economic regulation, eliminating price controls and subsidies, and reducing the role of the government in the economy in general. It is hoped that free markets will be a more efficient way of recognizing consumer sovereignty and directing the limited resources in an economy efficiently to meet the demands of consumers. As part of this policy change, countries generally establish competition policies. A shift toward market-based policies does little to improve economic growth and efficiency if monopolies are allowed to develop in the newly established markets. Private monopolies are no better than public ones. For a market economy to provide efficient use of resources, competitive forces must be able to operate unhindered by monopoly.

Countries interested in establishing new competition policies have the advantage of following others that have gone before. But this does not mean that they should simply copy the earlier models. What is appropriate for one economy might not be for another. Also, a country implementing a competition policy now can learn from the mistakes of their predecessors. In particular, the U.S. model of antitrust, or pro-competition policy, which has a history of over 100 years and is often regarded as a model, does not offer the best approach for other countries.

In this article we will address three of the fundamental issues faced in establishing new competition policies: the statute, the enforcement agency, and the adjudicating body. These views are based on experiences that our firm has had in a number of developing economies.

II. The Statute

New competition policies are typically grounded in a new statute. Even in countries where a competition law already exists, the old laws are generally so far out of step with current economic learning that it is easier to start with a clean slate.

When drafting a new competition law, there is a tendency to use the antitrust laws of the United States as a model. The U.S. laws, first implemented in 1890, have a long tradition. Antitrust enforcement is also generally considered to be more active in the United States than in other countries. There are, however, problems with the U.S. laws that should not be blindly copied. For example, there is widespread agreement among antitrust practitioners that the price discrimination provisions of the Robinson-Patman Act often have the perverse effect of promoting economic inefficiencies. In economies with limited enforcement resources, it may well be advisable to keep the new competition law focused on the behavior that is, competitively speaking, clearly the most harmful to consumers.

Another factor that complicates the simple transfer of U.S. laws to other countries is the different legal systems on which they are based. For example, Civil law, or Roman law, is the foundation of Latin American legal systems, whereas English common law is the basis of the American legal system. The common law system has the advantage of separating the functions of prosecutor and judge. This separation of powers is useful in adjudicating matters regarding competition policy, but it can also be provided in a country with a Civil Law system.

Another issue to be considered when drafting a competition law is when to use a per se standard of illegality, and when to use a rule of reason. A per se standard is one in which it is only necessary to show that an action occurred, not that there was also a significant impact. A rule of reason is an evolving standard requiring not only the existence of monopoly power but also the resulting significant impact on competition. The per se standard can be an efficient way to deal with horizontal restraints of trade such as price fixing or bid rigging. Horizontal restraints reduce competition, but do not usually have any offsetting efficiencies that might occur with, say, a merger. Since the behavior cannot have pro-competitive effects as a justification, it is generally efficient to make the mere existence of these restrictive agreements illegal and not require additional proof of their anticompetitive effects.

The United States is among a small number of countries that provide criminal penalties for violations of competition law. They can be used as penalties for horizontal restraints of trade, and businessmen sometimes receive prison terms for price fixing or bid rigging. In fact, from 1990 to 1999, inclusive, 132 such individuals were sentenced to prison terms in the United States. In many other countries, criminal penalties are regarded as too severe for violations of these laws. For example, according to a European Commission survey conducted in 1995, among the fifteen European Union member states, only Austria, France and the Netherlands provide criminal penalties for substantive violations of the law regarding restrictive practices and abuses of a dominant position. For a new competition law to be respected and to receive widespread support, it must fit within the norms of its culture. This is especially true with regard to penalties. The choice of penalties needs to be made individually by each country, and to take into account the context of its surroundings. Criminal penalties for violations of competition law may provide a strong deterrent effect, but only if the host country has the will to enforce them. If the penalties are perceived as too strong, they may not be used. In Latin America, criminal penalties theoretically exist in quite a few countries, including Mexico, Brazil, Argentina, Chile, Peru, Bolivia, Dominican Republic, and Guatemala, but they are seldom imposed. Ironically, this could lead to weaker law enforcement than would occur with milder civil penalties. For example, Under Canada's competition law that was in effect before the 1986 revision, anticompetitive mergers were subject to criminal penalties. However, while this earlier law was in place, only one merger was prosecuted and the defendants were acquitted. A compromise that might work for some countries would be to reserve criminal penalties for cases involving repeat offenders.

Even if civil penalties such as fines are used as the only punishment for violations of a competition law, it is important to set the fine amounts correctly. In particular, the probabilities of detection and conviction must be taken into account. The basic principal to apply is that the expected value of the penalty must exceed the expected value of the illegally obtained profit. Since the illegally obtained profit is generally certain if the violation occurs, and the probability of detection and conviction may be rather small, the penalties for those convicted will need to be greater than the value of the illegal gains. For example, there is often a tendency to punish a violator who illegally gained $X with a fine of $X. Given that the probability of detection and conviction is less than 100 percent, a fine of this magnitude is too low to deter this behavior. If the probability of detection and conviction were 50 percent, the fine would need to be greater than $2X to make the expected value of the penalty greater than the expected gain. Fines will typically need to be highest for those behaviors, such as collusive conspiracies, that are concealed. These behaviors are the ones where detection and conviction are least likely. Of course, the exact probability of detection will not be known. Nevertheless, these basic principles can be applied.

Another important issue to consider in a competition statute is merger policy. The vast majority of mergers do not cause competitive harm. Indeed, they may be pro-competitive if they reduce the costs of the merging firms, permitting them to lower prices to consumers. In smaller economies where international trade is extensive, imports can provide an additional layer of competition. Even if the merging parties control a large portion of domestic production, the threat of imports can help maintain competitive pricing.

Nevertheless, a competition statute should be able to block anticompetitive mergers. One of the key provisions for this is a pre-merger notification policy. It is more effective for the enforcement agency to be able to prevent a merger than to undo it. After mergers have been consummated, they can be very difficult to reverse. Time limits can be imposed on the enforcement agency's investigation to prevent unreasonable delays that are burdensome for the merging parties.

Another issue to consider in the competition law is a provision for class actions. Class action lawsuits are common in the United States. Indeed, detractors would say that they are too common. The perceived abuse of class action lawsuits in the United States has made them unpopular in other countries. In the United States, plaintiffs can collect treble damages for antitrust violations. As explained above, when the probability of detection and conviction is less than 100 percent, penalties exceeding single damages are needed to provide an expected penalty that is large enough to deter the anticompetitive behavior. The treble damages do provide a strong incentive for plaintiffs' lawyers to file cases.

One advantage of class action lawsuits is that they can provide a way of enforcing competition laws without using public funds. Entrepreneurial lawyers from the private bar can form classes of consumers allegedly harmed by a particular anticompetitive behavior, and file lawsuits on their behalf.

While the plaintiffs' bar will have strong incentives to file more cases than may be optimal, there are ways of designing a system to avoid the worst abuses. In particular, class action suits could be limited to specific violations, such as horizontal restraints of trade, that are clearly anticompetitive. It would also be important to limit standing strictly to customers. Many opportunities to abuse the system and discourage efficiencies occur when plaintiffs can use the system to sue competitors.

One more important issue to consider in a competition law is ways in which the enforcement agency can be directed toward the state itself. It is important to prevent anticompetitive behavior by private entities in an economy. But many severe competition problems arise due to acts by government agencies or laws. The competition statute should give the enforcement agency the power to influence state-sponsored restrictions on competition, entry, and imports.

III. Enforcement Agency

A country implementing a competition policy needs an enforcement agency with properly trained employees and adequate resources to enforce its new statute. It is also essential that it be politically independent, and operate transparently to avoid charges of corruption.

The proper enforcement of competition policy requires knowledge of both law and economics. Thus, both lawyers and economists should be employed by the enforcement agency. They will need adequate staffs to assist them with their responsibilities. Investigations of competition issues tend to be fact intensive, and the staff will need to be large enough to gather and assess these facts. The employees should be well paid to reduce problems with corruption.

The amount of resources made available for enforcing the competition law is key. It is quite possible to have everything else in place, but have a weak competition policy because of inadequate enforcement resources. The amount of resources needed will depend on the size of the economy and the amount of anticompetitive activity. For example, if the economy has a number of long-established cartels, a strong initial enforcement effort may be required to unseat them.

Even with a fairly generous budget, a new enforcement agency will need to set priorities for its enforcement goals. A good way to start this process is to focus first on horizontal restraints of trade, especially cases of price fixing and bid rigging. In these cases, large benefits can often be obtained for consumers by breaking up the cartels and introducing competition.

In countries with new competition policies, there is often a tendency to focus on complex vertical relationships, perhaps because of complaints about these matters filed by competitors. These cases need to be assessed early to determine the likelihood of competitive harm, and how many resources would be used in the investigations. In this way long, expensive, and complicated investigations with minimal benefits can be avoided. In countries where competition policies have not been in force, another especially important task of new enforcement agencies is educating the public. To educate the general public, the enforcement agency should have a broad policy of spreading information on its activities and goals. The agency can be more helpful to consumers if they understand what the agency can do for them, and how they can file complaints with the agency. It is also important for the enforcement agency to clarify its intentions to the companies that will be affected by its policies. Toward this goal, the agency might want to issue merger guidelines to signal its enforcement intentions. The better their understanding of the enforcement agency's policies, the more efficiently companies will be able to deal with them. This is not to say, however, that the merger guidelines existing in other countries, perhaps the United States, should be copied. For example, an important part of a new enforcement agency's guidelines would be the market share and market concentration standards by which it will evaluate mergers. The standards in the U.S. merger guidelines, which were written for a large economy, might not be appropriate for a smaller economy heavily involved in international trade.

Another way in which the enforcement agency could educate the country on the benefits of competition, and its role in enforcing competition is to give the agency the authority to advocate competition before the legislative body and in regulatory hearings. Also, the agency could be given the authority to go one step further and bring cases before the adjudicating body and have it issue countervening orders when other government agencies have regulations or practices that violate the national competition policy.

When staffing the enforcement agency, it will be important to consider the backgrounds of the potential employees. Under old government policies, one Latin American country had a price control agency responsible for monitoring prices for fairness. Under the new competition policy, these employees were to lose their jobs. The suggestion was made that they could be hired by the new competition enforcement agency, but this would have required these employees to pursue goals 180 degrees from those that they had been seeking for many years. Under circumstances like these, it is especially important to resist political pressures and staff the enforcement agency with properly trained employees.

IV. Adjudicating Body

When establishing a new competition policy it is generally best not to rely on existing courts for enforcement. The current judges will typically not have the experience or expertise needed to deal with the esoteric issues raised in these proceedings.

Ideally, the new adjudicating body would consist of a panel of experts who specialize in competitive matters. Both lawyers and economists should sit on this panel. They should be adequately compensated, operate in open sessions to the extent practical, and write opinions that can be publicly evaluated to ensure transparency.

Some countries may already have specialized adjudicating bodies for other purposes. If so, they can be used as models for the competition court. For example, Argentina had a tax court made up of specialists who dealt only with tax issues. This court was used as a model for the newly formed competition court in that country.

Each member of the panel will need a staff, preferably consisting of both lawyers and economists. Adequate resources should be allocated for this competition court. The necessary amount will vary from country to country, depending on a variety of factors.

V. Summary and Conclusion

As countries move toward market-based policies, it is important for them to have effective competition policy. The cornerstones of competition policy include a statute, enforcement agency, and adjudicating body. Although there are basic principles that are useful to follow when designing new competition policy, the specific context of each economy should be taken into account when preparing a policy. Simply copying an approach used elsewhere will not guarantee effectiveness.

Establishing this basic framework is the first step in implementing competition policy. Once it is in place, adequate funding and appropriate enforcement choices are essential to protect the competitive forces on which a market economy is based.

The lessons we have learned from helping some developing countries implement their competition policies, as well as the antitrust laws and policies of the United States and other mature market economies, are useful references for designing an effective competition policy for China. The successful implementation of such a policy will prove crucial to the success of China's ongoing market reform.

(David Smith is a Vice President and Su Sun is a Senior Economist at Economists Incorporated, an economic and litigation consulting firm based in Washington DC.)