A New European Competition Policy for Growth Driven by Profitable Investments. The European Commission's Policy In Light of the Modern Economic Growth Theories

Abstract

1. Although market dominance is not illegal in the European Union, European Commission’s doctrine regards exercise of market power as economically inefficient. Its economic policy is meant to push markets towards perfect competition, but ignores that investments required for dynamic efficiency are financed by the profits they create.

Although under the European law market power is not illegal by itself, the economic doctrine of the Commission considers, however, that the exercise of market power, i.e. charging supra-competitive prices, lead to inefficient market outcomes. The economic policy of the European Union is a competition policy which aims to make markets tend towards a perfectly competitive frame, where profit margins are eliminated and prices tend towards marginal costs. The Commission monitors and controls market structures to ensure that competition drives growth by selecting the most efficient companies and sectors. The Commission regards competition as the major driver of competitiveness and growth provided it is supported by competition policy which makes markets efficient under the criteria of a static economic analysis. Its purpose is to raise competition intensity in the intermediate markets to allow producers of final goods to benefit from lower input price to improve their efficiency. In addition, it aims at promoting the mobility of factors of production, transferring them from the less efficient to the most efficient and productive sectors.

The Commission argues that under the guidance of competition authorities, competition leads to cost efficiency, raises the amount of resources available to leading sectors and at the same time promotes investment through the “escape from competition” effect.

This doctrine has, however, important shortcomings. It ignores the fact that lower profits can hamper investment and that companies with negative expectations on profitability will not invest. The European Commission is unclear about whether competition should be seen as a process or a steady state. When politically advocating its competition policy, the European Commission depicts competition as an evolutionary dynamic that promotes efficiency, investment and innovation. However, when actually implementing its policy, the European Commission aims to make markets tend towards a steady state of maximum level of static competitive intensity (with no technological progress) by eliminating market power and ensuring the most perfect competitive frame possible. The pursuit of the maximum level of static competitive intensity might then deter investment, which is the driver of dynamic efficiency, and eventually economic growth.

2. The European competition authorities’ policy is to prevent exercise of market power whereas the purpose of US competition authorities is to maintain undertakings’ incentives to invest in order to gain market power.

The European Commission intervenes ex-ante through policies promoting market entry in order to prevent the formation of a market power likely to be exercised and relies on antitrust action to remove it ex-post. In their practical approach, the competition authorities ban mergers that bring market power arguing that intermediate and final consumers would face higher prices and lower innovation. They approve consolidations provided merged companies commit to transfer productive assets to direct competitors. They consider that temporary rents from investment and innovation efforts distort competition because they grant dominant positions and thus have to be tackled by the enactment of competition law. As the practical approach of competition authorities is to reach the maximum level of static competitive intensity, (where prices equal marginal production costs), their focus is on the upward price pressures that mergers would trigger in the short term.

The European competition authorities do not spontaneously consider the positive effects on investment and efficiency that could stem from a merger. They are sceptical about the arguments put forward by companies in support of these effects. Therefore, when evaluating mergers, the authorities do not consider the value that corporate investment in quality and quantity (stemming from higher expected profitability) can bring to the consumer. The same reasoning is applied to the analysis of abuse of dominant position. The appraisal of market dominance and of the exercise of market power by the European authorities might hamper the incentives of private companies to invest and innovate. The US competition authorities apply a different antitrust policy with regards to maintaining a competitive market structure. Contrary to the European competition authorities they do not consider that the dominant firm is liable for the competitive market structure or responsible for maintaining its competitors on the market. They give priority to returns on investment and incentives to invest over forcing companies to share their assets with their competitors to preserve static competition. They thus favour the growth of market players (hence to market power) over maintaining a perfectly competitive market structure.

The US competition authorities and policymakers consider market power in the form of mark-ups over competitive prices both a condition for returns on prior investment and a condition of future investments. As a result, they are more likely to foster incentives to invest and innovate, as investors do not necessarily expect both their assets and their returns to be transferred to competitors.

In Europe, the willingness of competition authorities to eliminate profit margins, to limit capital intensity favored by mergers, and to ban large companies from acquiring competitive advantages can deprive these companies of prospects which motivate their investments, as expectations regarding profitability become negative. This has an overall deterrent effect on investment and innovation, and in turn undermines economic growth in the European Union.

3. The European Commission acknowledges investment as a driver of macroeconomic growth undermined by poor profitability but ignores this point concerning the provision of intermediary goods by high technology industries in the internal market.

The European Commission acknowledges that the European Union’s macroeconomic weaknesses, although worsened by the financial crisis, have structural causes. The European Union has slower productivity growth than the United States, especially in high-tech sectors, and a weaker industrial sector. According to the Commission, Europe has been losing competitiveness because of high labour costs and companies’ difficulties in specialising in fast growing sectors, exporting their goods and services, and accessing sources of funding.

To restore competitiveness, productivity and growth in the Union, the Commission recommends strengthening high productivity industries and companies exposed to international competition. It posits that raising the share of the manufacturing sector in the aggregate added value should raise productivity gains in the global economy. The policy of the European Union consists in fostering transfers of inputs from the non-tradable sector (mainly services) to the tradable sector (industry). Structural reforms are thus designed to reduce labour costs through tax shifts and to decrease the prices of intermediate inputs in market services (sheltered from international competition) through stronger competitive pressure. The Commissions posits that exporting industrial companies would then be able to restore their profit margins and therefore the investment capacities needed to bring technological progress to the internal market. The Commission thereby recognises both the need for profit margins to finance current corporate investment and the need for sufficient expected returns to commit to new investments.

However, it still enforces the ban on the exercise of market power as the essential component of its competition policy, relying on the “escape-competition effect” to foster investment when competition is intense. The Commission thereby ignores that investment in market services can be slowed down due to negative expectations on revenues and profit margins which will limit the capacity of companies to finance themselves. The Commission suggests that increased competition in the banking sector might raise the credit supply and overcome the shortage of internal resources, but, by doing so, the Commission seems to confuse financing issues and profitability issues. For the Commission, internal resources to finance investment will not come from competitive advantages (as fair reward from investment) but from lower input costs due to increased competitive pressure.

4. Economic growth results from improved productivity due to investments incorporating technical progress in the production system. Investments decisions by market players are subject to expected profits and cannot be achieved when competition intensity exceeds its optimal threshold. A growth-supportive competition policy should adjust competitive intensities to maximise the contribution investments in each industry to maximise the contribution investments in each industry provide to productivity and growth.

The European competition authorities advocate monitoring markets to ensure that an evolutionary process leads companies to invest and innovate. But in the Commission’s doctrine, technological progress is regarded as exogenous to the market. The European doctrine focuses on static efficiency, making prices converge towards marginal costs, thereby eliminating mark-ups over steady state competitive prices. By doing so, it rejects the endogenous drivers of dynamic efficiency.

Endogenous growth theory has shown that technological progress is not brought to the market, but is instead created by the market. It is the result of private investment decisions. It stems from the accumulation of knowledge and capital goods by private companies. Mark-ups over competitive prices are both the result of past investment and the precondition for future investment. Private investors are willing to bear the cost of investment provided they are granted temporary rents to reward their capital expenditure. Investments cannot be made without a prospect of profit. Internal resources can provide critical contribution to the financing of future investment. A certain degree of imperfect competition is thus needed to foster accumulation of fixed capital (which incorporates technological progress).

A competition policy pushing markets towards perfect competition is thus likely to hamper investment and growth. This is why the pursuit of “perfect” markets might not be the soundest policy choice when the objective is to promote growth through private investment.

Provisions to remove structural entry barriers and price-cost margins removes at the same time both the incentives and the internal resources needed to invest. Recent empirical studies have evidenced that competition might harm investment and innovation above an optimal threshold. Thus, when competition exceeds it, it is unlikely that proceeding with a competition policy that unconditionally attempts to eliminate all abilities to exercising market power remains the most suitable choice to promote investment and growth.

In Europe competition policy is applied uniformly irrespective of the specific rate of technological progress of industries. This practice is not consistent with the fact that corporate investment that embodies technological evolution is endogenous to market competition. Private investment can only be sustained over time, let alone increased, provided sufficient levels of cash flow are forecasted to justify capital expenditure. This requires sufficient expected profits and mark-ups over competitive prices. Some sectors, including services markets, are highly capital-intensive and evolve rapidly with technological change. These sectors accumulate fixed capital which incorporates the technological progress and contribute to the growth of productivity. They do need sufficient profitability to fund their current investments and to consider future investments as well. Under the European Commission’s doctrine that aims to maximise static competitive intensity, such sectors will hardly be fully efficient and provide a full contribution to economic growth through the accumulation of technological progress.

The intensity of use of new technologies matters more for economic growth than the timing of their emergence. Thus a competition policy conducive to growth needs to attach at least as much importance to corporate investments in fixed capital goods that embody the new technologies as it does to investments in the creation of new technologies (i.e. R&D activities).

As private incentives to invest are endogenous to the market structure, the intensity of investment needed to improve competitiveness could only be reached and maintained if capital-intensive industries restore their profit margins. The framework of analysis and the implementation rules of European competition policy need to be updated. The European economic policy could usefully update its views on the aims and practical implementation of its competition policy. It could do so by taking account of the specific industrial and financial constraints of companies that provide technological progress through the investments. Their expenditures on fixed capital need sufficient self-financing capacities and thus mark-ups over competitive prices.  

Keywords: Macroeconomic Policy, Antitrust Issues and Policies, Regulation and Industrial Policy, Competition Policy, Technological Change, Endogenous Growth

JEL Classification: E60, L40, L50, O30, O40