Is economics helpful when it comes to cartels?

Economics implies that cartels are inherently unstable and so should be short-lived because they price above the Nash equilibrium. However, the evidence is cartels are often long-lived.

When players interact for an infinite number of times, as do firms in real markets, they can escape the short-run Nash equilibrium of the Prisoner Dilemma. In the context of infinite interaction, a collaborative behaviour becomes sustainable depending on the benefits of cheating, the credibility of the punishment’s threat and the discount factor.
“Punishment” refers to the reaction of non-cheating firms to an infringement of the collusive agreement: non-cheaters will move away from the cartel equilibrium towards a more competitive equilibrium, so that the cheater’s profit is reduced. Stability of the cartel is ensured by a punishment mechanism that makes the benefits derived from deviation smaller than the benefits of keeping colluding. An effective punishment mechanism should be strong enough to deter cheating, but also credible. It is in every cartel member’s interest to set the punishment mechanism as high as possible, but credibility follows from each non-cheating firm’s interest to implement it if a breach actually occurs. The punishment mechanism should hurt the cheating firm more than the non-cheating ones; hence, it must correspond to the latter’s profit-maximising behaviour.

Economics’s contribution to anti-cartel enforcement

Ex ante, economics can be used to prevent the formation of cartels by prohibiting mergers that would ease collusion. As tacit and explicit collusion rest on the same economic principles, the criteria used to identify tacit collusion in merger review processes can provide guidance also for the detection of explicit collusion.

Ex post, competition law enforcement can benefit from economic analysis because the latter can provide evidence:

  1. on the plausibility that an industry is/was cartelised, i.e. it can
    a) suggest where to look for a cartel, and
    b) reveal whether, given the characteristics of the market, the cartel
    allegation is credible; and
  2. on the impact that a cartel has had in the market.

Unfortunately economics is unable to establish with certainty whether a market is cartelised: economic models can be employed as screening devices, but further investigation will always be necessary.

Likelihood of collusive behaviours

Economics can help identify markets that are prone to cartelisation and establish whether the cartel allegation is credible given the market’s characteristics. However, economists tend to reject the idea of prosecuting cartels on economic grounds only because patterns of prices under collusion and competition are often similar; moreover, economics cannot distinguish between no collusion and unsuccessful collusion, and it cannot distinguish between tacit and overt collusion.

Structural and behavioural markers represent – complementary – screening tools; they identify suspicious behaviours, but cannot provide hard evidence of collusion. Indeed, they could produce false positives, or negatives, because they cannot distinguish between tacit and express collusion or because market players can evade them. Moreover, not all noncompetitive behaviours infringe competition law.

Estimation of the cartel’s effect on the market

Economics is useful to assess the cartel’s effects on the market. The actual cartel’s impact is of relevance for damages actions, but it can also have a bearing on the size of the fine imposed.

The harm suffered by the direct purchaser of a cartelised product has three elements: (i) the direct effect – the quantity of product purchased multiplied by the increase in price as a result of the cartel; (ii) the output effect – the increase in the purchaser’s selling price that is a likely consequence of its input prices increasing, leads to a reduction in the demand for its products; and (iii) the passing-on effect, which occurs when the direct purchaser raises its selling price in response to the increase in output costs, therefore reducing the harm it suffers

The consequence of a cartel on the market can be estimated by understanding what would have happened absent the wrongful conduct: the claimant’s position during the cartel is compared to the position that he would have been in “but for” the anti competitive behaviour. The difference between the claimant’s profits in the counterfactual world to the one in the cartelised scenario is the amount of compensatory damages due to the claimant. To estimate the counterfactual profit we need to know, or estimate, the following:

  1. the amount of the overcharge;
  2. how much lower would have been the selling price at the lower input costs; and
  3. the level of sales occurred at this lower price.

Direct evidence can be useful to quantify the damage; however, economists have developed different helpful tools to carry out the calculation. Comparator-based methods assume that the counterfactual scenario is representative of the likely non-infringement scenario and that the difference between the infringement data and the data chosen as a comparator is due to the infringement. Cost-based methods estimate the non-infringement price by using some measure of production costs per unit and adding a mark-up for a profit that would have been reasonable in a competitive market. Financial methods compare the counterfactual profitability and the actual profitability of the claimant or the defendant. These approaches can estimate the likely non-infringement scenario but cannot delineate it with certainty and precision.

 

In conclusion, even though economic cannot provide hard core evidence of collusion, it is a useful tool to detect cartels and understand their effects in the market. However, the quality of the answers economics can provide is only as good as the data available and as appropriate as the approach chosen.

When the market definition/market share approach does not work to assess market power

Traditionally, competition authorities start their assessment by identifying the competitive scene, i.e. the relevant market, which includes the firm’s product and potential substitutes. They then calculate market shares to decide whether the firm(s) under scrutiny has enough market power to benefit from the adoption of an anticompetitive strategy. 

However, when market shares are not a strong indication of market power, market definition is least useful. Difficulties arise in products differentiated markets since market boundaries are problematic to draw; as well as in bidding markets, in markets with networks, and in highly dynamic and innovative market. This is so because competition might be “for the market” rather than “in the market.” Moreover, when market concentration has no strong links to the economic theory by which competition would allegedly be harmed, market definition is also of limited help.

From an economic point of view, the assessment of market power does not always require the identification of the relevant market. Economists prefer to focus on the level of competition in the market and to gather and assess evidence in the way that best sheds light on the competition question at hand. To better serve the purpose of competition law analysis, economists have developed techniques that allow the direct assessment of market power, some of which are discussed below.

Direct evidence of the effects of a firm’s behaviour might better answer the question at hand. Indeed, sometimes it might be enough to establish that the firm’s price is too high compared to its marginal cost, or that its economies of scales are so great that no one can replicate them, and hence compete effectively. Past events in the market, such as recent mergers, the entry, expansion or exit of market players and their effects on prices, are likely to be very informative regarding the potential competitive effects of future occurrences in the market.

Alternatively, market power can be assessed directly by calculating the Lerner Index, which predicts the price-marginal cost margin and reveals the firm’s ability to raise prices above short-run marginal costs. However, in many industries the competitive price is not equal to short-run marginal costs. Moreover, the Lerner Index is not applicable to firms producing multiple products – the majority – and it assumes that the firm is competing according to a static short-run non-cooperative Nash equilibrium – but this will often not be the case.

Another way to identify market power is to observe the way firms and industries react to variation in marginal costs. This can be done, for example, by focusing on the residual demand estimation, which measures the ability of a firm to raise prices by reducing output after taking into account the demand responses of buyers and the supply responses of its competitors. The residual demand curve is the horizontal difference between the market demand curve and the total supply of all other firms. 

As the exercise of market power follows from demand inelasticity, a firm holds market power and can increase prices when buyers do not have good demand substitutes. If demand is not highly elastic, the exercise of market power can be directly observed by looking at the competitive price or competitive industry output. If costs have not changed, the most plausible explanation for any observed variation in the market price is that the demand elasticity has altered while firms were exercising market power.

A fourth technique to assess directly market power relies on the assumption that firms may behave differently when cooperating than when they compete. If data regarding multiple types of behaviours is available, econometricians will assess whether the specific shift in prices can be better explained by two types of behaviours rather than one.

Lastly, the effects that a merger can have in a market can be directly assessed by focusing on consequent price changes rather than increases in market shares. Merger simulations and pricing pressure tests are more suited to assess deals in products differentiated markets than the market definition/market shares approach.

Merger simulation directly calculates how much the price will increase post-merger by first modelling the nature of competition in the pre-merger scene and then combining this data to predict the post-merger scenario. Merger models can play an important role in the assessment of the effects post-merger marginal cost reductions have on prices, but they cannot represent the only basis for a competition authority’s final decision, as they omit important parts of the competitive effects analysis, such as entry, buyer power, product repositioning and changes in the mode of competition post-merger. 

When closeness of competition is the central issue, market shares are not necessarily indicative, while diversion rations directly assess the issue. Diversion rations calculate the percentage of lost volumes that are captured by another product following a unilateral price increase. If combined with margin data, diversion ratio can perform so-called price-pressure tests, which can assess the change in pricing incentives post-merger – and, at instances, the magnitude of the price change. The firm’s net incentive to raise prices after the merger is identified by comparing its incentive to increase prices due to lost competition against the opposing incentive to decrease prices due to cost savings.

In conclusion, depending on the type of behaviour under scrutiny and the available data, it is not always necessary or useful to delineate the relevant market to establish if a firm is able to exercise market power. The choice towards one or the other method should be dictated by the structure of the industry under scrutiny and the legal question at hand, rather than by the certainty that market definition is the best tool available.

The Big Data Challenge

Big Data is the fuel of the digital economy. It is the large amounts of different types of data produced at high speed from multiple sources, requiring new and more powerful processors and algorithms to process and to analyse.

Big Data can enhance economic growth and be helpful in various sectors. For example, by making information transparent, or by helping to create new services and products or  to better tailor existing ones.

However, Big Data also creates concerns. When it constitutes personal information, i.e. when it can personally identify an individual or single them out as an individual, it can be used as a currency, becoming the quid pro quo for online offerings which are presented or perceived as being ‘free.’  Moreover, even though we have not analysed the impact of free services on the digital economy yet, we have already understood that power can be achieved through the control over great volumes of data on service users. Refusal of access to personal information and opaque or misleading privacy policies can result in the abuse of a dominant position and in harm to consumer. This may justify a new concept of consumer harm for competition enforcement in digital markets.

Big Data touches on areas that are of interest for data and consumer protection, as well as for competition law. Competition regulation aims to achieve an efficient allocation of marketing resources and ensure consumer welfare. Consumer protection rules’ goal is to prevent the use of  misleading claims about products and services. Data Protection regulates how collected data can be used. In the end, the three areas of law share common goals: the promotion of growth and innovation and the enhancement of the welfare of individual consumers.

A new investigation on Big Data

At the end of May the Italian Competition (& Consumer Protection) Authority joined the team of enforcers which has opened their own investigation on Big Data. However, the Italian investigation will look at the issue with new eyes as the competition regulator has joined forces with the Data Protection Authority and the Communications Authority to carry out the exercise.

The three Italian regulators  will assess if and when access to Big Data might constitute an entry barrier or if Big Data can facilitate the adoption of anticompetitive behaviours that could possibly hinder development and technological progress. To get their answer, the three authorities will analyse the impact that online platforms and the associated algorithms have on the competitive dynamics of digital markets, on data protection, on the ability of consumers to choose, and on the promotion of information pluralism. They also aim to verify the effect that information aggregation and that access to Big Data obtained through non negotiated forms of user profiling have on the digital ecosystem [For more information see the press release here].

 

The Digital Clearing House

It seems a widely accepted fact that to respond to the digital challenge, enforcers need to come together.  Last year, the European Data Protection Supervisor (EDPS) proposed to set up the Digital Clearing House (DCH) to bring together, in a voluntary network, privacy, competition and consumer protection authorities willing to share information and to discuss how to better enforce the rules [here].

The DCH had its first meeting just the day before the three Italian regulators launched their investigation. Participants included regulators with responsibilities for various aspects of the digitised economy from around the world. Participants expressed their concerns on information and power disparities between individuals and the service providers whom they rely on. Their discussions touched on common short and longer term issues, such as fake news and voter manipulation, data portability, as well as the emergence of attention markets and the opacity of algorithms which determine how personal data are collected and used. Regulators have identified four areas of overlap or possible gaps in the current legal framework:

  1. unfair or harmful terms and conditions for digital platforms;
  2. security considerations for connected things and apps;
  3. the ‘fake news’ phenomenon; and
  4. the longer term impact of big tech sector mergers.

The next meeting of the DCH will take place in the fall.

For Further Background

 

Economics and Competition Law

Economics is the study of how society decides what, how and for whom to produce.”

Begg, Fischer and Dornbusch

A lawyer who has not studied economics…is very apt to become a public enemy.

Justice Brandeis (1916)

To abandon economic theory is to abandon the possibility of rational
antitrust law.

Judge Robert Bork (1978)

 


It is undoubted that economics has come to play a crucial role in competition law assessments.

This might represents a natural evolution of the area, as competition policy rests on the economic idea that it is appropriate to limit the exercise of market power in the interest of economic efficiency and welfare. And economics goals are at the heart of modern competition law regimes, i.e. society/consumer welfare.

At the most fundamental level economics is concerned with the implication of a rational choice, hence it is an essential tool for figuring out the effects of legal rules.

Economics studies how markets work, how they allocates goods and services to different consumers. Competition law is concerned with how markets work; its general objective is to ensure that there is competition between market players, and that this competition benefits consumers.

Economics can help understand how markets operate, how firms (will) behave, and whether their behaviour will eventually benefit consumers; it helps answering questions that are central to competition law cases.

But, if on the one hand economics has helped clarify some of the debated issues, on the other hand it might have brought also some non-sense. Why? “[a]lthough economic theory is indispensable to our task, clear-cut answers are often impossible. The complexities of economic life may outrun theoretical tools and empirical knowledge. We often will remain uncertain about the economic results of the particular practice or market structure under examination. Nor can we always predict the consequences of prohibiting some particular behavior. Thus, we shall time and again meet this question: How far must we search for economic truth in a particular case when the economic facts may be obscure at best, when the relevant economic understanding may be controversial or indefinite, and when the statute does not give us a clear-cut value choice?” ( P. Areeda, L. Kaplow and A. Edlin, Antitrust Analysis, Problems, Text and Cases, Aspen
Publishers, 6th Edition, 2004, p. 105)

Glossary of Industrial Organisation Economics and Competition Law – OECD

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Italian Annual Competition Law Bill: the NeverEnding Story

Article 47 of Law n. 99/2009 obliges the Italian Government to submit to the Parliament, a competition law bill to stimulate competition in the Italian market. The bill should be submitted on a yearly basis, taking into account the Annual report that the Italian Competition Authority submits every summer to the Parliament.

In February 2015, the Council of Ministers adopted, for the first time, a draft of the competition law bill…which still awaits for the Parliament’s approval.

The Government’s draft was not as bold as expected (and announced), and received a rather cold welcome by the Italians. For example, the provision favouring Uber and similar services disappeared. The provision extending to para-pharmacies the ability to sell Class C medicines (i.e. those not reimbursed by the National Health System) suffered a similar faith. The only actual pro-competitive article seemed to be the one that takes away, from Poste Italiane, the monopoly  for the notification of fines and other judicial documents.

The Lower Chamber of the Parliament approved the bill in September 2015. Since then, the bill has been sitting in the Senate.

In these two years, the bill was not really improved. If anything its content was watered down, as recognised by the President of the Italian competition Authority as well as the European Commission.

The Senate’s plenary is scheduled to vote on the draft in April. The Press reports that, now, the Government intends to impose the “vote of confidence” to ensure a smooth and short debate of the bill. However, few issues remains unresolved. Once the Senate will finally adopt the text, the latter will be sent back to the Lower Chamber for the final approval.

The text approved by the Senate’s Committee contains 74 articles, introducing new rules for TMT and TV operators, the financial services, postal, energy, tourism, transport sectors, as well as for lawyers and notaries. During the discussion at the Senate’s committees level, the two rapporteurs introduced an article changing the mergers’ notification thresholds. It was announced that the Government intends to introduce a “defensive” measure against hostile takeovers, to ensure total transparency in investment strategies in Italian companies.

After more than 800 days the Senate approved the bill on 3 May 2017. The text, which now contains 74 articles, now awaits the final approval by the Lower Chamber.

The content of the drafted bill in pills:

INSURANCE: New rules on discounts for cars’ insurance policies to reward the virtuosity of consumers.

ENERGY: Liberalization of retail energy market (in July 2019). New rules to enhance consumer protection. New provisions to simplify renewable energy production and to encourage small electricity distribution companies.

MOBILE TELEPHONE, ELECTRONIC COMMUNICATIONS AND AUDIOVISUAL MEDIA: rules to increase transparency of mobile contracts and make easier for customers to switch operator. However, operators may impose the payment of the costs incurred by the company to end the contract.

ENVIRONMENT: Stronger rules to allow producers’ access to the packaging market, new minimum quality standards for the treatment of electrical and electronic equipment’s waste, and procedural simplifications concerning ferrous and non-ferrous metal waste.

BANK SERVICES: new provisions to protect competition and transparency in the financial leasing sector.

PROFESSIONAL SERVICES: changes for notaries, regulated professions (e.g. engineers and lawyers) and pharmacies.

TRANSPORT: within a year the Government has to approve new rules for non-scheduled public car services (Taxi).

[To To be continued]

Italian Competition Law Bill – The NeverEnding Story on Storify.

Aside

An Introduction to EU Competition Law*

As freak legislation, the antitrust laws stand alone. Nobody knows what it is they forbid.”

Isabel Paterson


  WHAT IS COMPETITION POLICY?

Competition policy deals with the organisation of domestic market economics. It aims to allocate resources in the most efficient way.

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Aside

Dive into Competition Law

THE ORIGINS AND AIMS OF COMPETITION POLICY

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.”

 A. Smith, Wealth of Nations 

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