Algorithms: The Puppet-master

An algorithm is a step by step method of solving a problem. It is commonly used for data processing, calculation and other related computer and mathematical operations. [Technopedia]

Algorithms are becoming the master of our fates. An algorithm decides the results of our Google search, whether we are entitled to receive a loan, the price of our health insurance, or the likelihood we commit a new crime.

Our behaviour is tracked, predicted and influenced by algorithms.  An algorithm collects, classifies, structures, aggregates and analyses all the information made available to it and takes its decision. The majority of us suffer the consequence of an algorithm’s decision with little or no questioning. We tend to believe that algorithms are fair, right, and unbiased. They are mathematical models after all.

However, algorithms have built in human errors, as well as conscious and unconscious biases. Algorithms can be designed to deliberately deceive regulators (e.g. emissions controls, traffic managements or price-fixing). Or they can become a means of “propaganda.” Lastly, algorithms can become too complicated for humans to understand or unpick (Andrews, 2017).

Hence, automated decisions making can result in: (i) loss of opportunities; (ii) economic loss; (iii) social detriment; and (iv) loss of liberty [here].

How we ensure that algorithms are designed to achieve the greater good, instead of resulting in harmful outcomes is an issue we have yet to find an answer to.

How the algorithm is encoded, how it is trained and managed it is the beginning of the story. Addressing human behaviour is only one part of the problem.  How the algorithm is deployed, managed and governed by corporations is the obvious consequent issue. And last but not least, how the algorithm develops, through machine learning is to be considered (Andrews, 2017).

An algorithm is capable to result in an infringement of consumer protection, privacy and competition rules, among others. The assessment of the societal impact of these new technologies calls for a multidisciplinary approach that brings together economists, lawyers, experts of computer security and artificial intelligence as well as philosophers (here).

[To be continued]

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Is OPEC a (successful) cartel?

The Organization of the Petroleum Exporting Countries (OPEC) was founded in Baghdad in 1960 by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. Nowadays the international organisation counts 14 Members.

OPEC’s mission is:

  • to coordinate and unify the petroleum policies of its Member Countries and
  • ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital for those investing in the petroleum industry.

It seems pretty obvious that OPEC is acting as a cartel. Indeed, the general perception is that OPEC has been able to control the prices and the production of the oil industry. Nonetheless, no competition authority has gone after the organisation so far, to my knowledge. Similarly, I could not find any record of a successful civil law suit.

Is the long, undisturbed life of OPEC only the consequence of politics and pragmatism? Has OPEC been able to continue exist because of faulty rules of procedure or due to the impossibility to apply antitrust legislation to such an international organisation?

But most importantly, has the market finally adjusted itself to prevent OPEC from exercising market power and behave anticompetitively?

Indeed, there are evidence showing that OPEC was never really in control of the market because its Members did not respected the cartel’s decisions [here]. In any case, due to changed conditions of the oil industry, some commentators are arguing that OPEC is no longer able to exercise a decisive influence on the oil’s price.

A successful cartel

A cartel is a group of similar, independent companies which join together to fix prices, to limit production or to share markets or customers between them [here].

Economics tells us that firms have always the incentive to cheat. However, under certain conditions, cooperation can be sustained as the Nash equilibrium.

Sustainable collusion occurs when:

  1. Market players repeatedly interact;
  2. The cheating by one player can be (easily) detected by the other cartellists;
  3. There is a high enough discount factor;
  4. The threat of retaliation is credible; and
  5. Coordination is feasible.

If we simplified to the extreme, likelihood of collusion increases if there are (i) few market players (ii) producing an homogeneous good, (iii) having a similar cost structure, (iv) the spare capacity necessary to retaliate, (v) enjoying a collectively high market share, (vi) in a transparent market (vii) with significant barriers to entry and expansion.

Is OPEC still a successful cartel?

The OPEC’s mission screams to the world that the organisation is acting to distort free competition in the oil industry. No secrecy, no rooms filled with smoke, everything is done under the sun.

Even assuming that the procedural obstacles to start an antitrust case against OPEC can be overcome (e.g. international immunity, cross-border jurisdictions, the need to qualify as an “undertaking” according to EU law), are there the elements to find an antitrust infringements? In other words: is OPEC a successful cartel? Can OPEC really hinder competition in the market?

When it comes to Article 101 TFEU, the anticompetitive conduct must have an appreciable effect on the EU market. Hence, even in case of infringement by object, the undertaking should be allowed to prove that its conduct had no such appreciable effect on the market.

The debate on “restriction by object” and “restriction by effect” is far from being settled. I will limit myself in stating that any cartel that does not enjoy a significant market power would be shooting itself in the foot by trying to restrict competition. [The “by object/effect” issue is excellently discussed here, specifically in relation to OPEC].

OPEC’s Members own 3/4 of the world’s oil reserve. They produce 40% of the global demand and  their exports represent about 60% of international traded oil.

The numbers above seem to hint that OPEC has some substantive market. However, many have started to doubt that OPEC can still effectively control oil’s price. Indeed, OPEC seemed unable to prevent the 2008 price race, despite the fact it increased its production quotas to the highest level in history.

In the past few years few events have contributed to erode OPEC’s power. The development of substitutes of oil products play now a competitive constraint on OPEC’s ability to increase prices. If the cost of a barrel goes too high, the switch to other energy sources will become more convenient, attracting further investments; shale oil prices are constraining OPEC’s ability/willingness to increase prices, for example [here]. Non-OPEC countries also influence OPEC’s strategy. Russia is now the biggest oil producer, as well as the number 1 energy producer [here]. Russia, as much as Saudi Arabia, depends on oil exports for a great  portion of their budget revenues. The two countries put energy issues at the heart of their foreign policy and use oil (and in Russia’s case, natural gas) as tools to achieve political objectives [here]. Russia’s increased production kept under control OPEC’s behaviour, even in the face of a high demand [here].

Other factors that influence the sustainability of the OPEC’s cartel are the differences in production costs of the OPEC’s members, the different weight that oil’s revenues play in their national economy, and their different policy’s objectives [here].

Moreover, a sustainable cartel needs a credible retaliation mechanisms. While Saudi Arabia, the biggest oil supplier, usually keeps at hand more than 1.5 – 2 million barrels per day of spare capacity for market management [here], the rest of the Members have little room to increase production [here].

If OPEC has no influence on oil’s price, what does?

Normally, prices drop when supply and demand increase and vice versa. But in the oil world, demand and supply are only part of the equation. Elements of geopolitics, environmental concerns as well as the oil’s status as the preferred source of energy complicate the picture [here].

The production costs per barrel depend on technological progress and the characteristics of the resource stock [here], which are independent from OPEC.

In the long-run the two factors that drive oil price are: the global demand and the future supply. The former is directly linked to the constant population growth and the increasing need for oil of emerging countries. The latter is highly uncertain to remain stable given that supplier countries manage their reserve more and more independently from the needs of third parties. There is no concrete reason for them to respond to the needs of importing countries and establish a low price [here]. So even in the absence of OPEC the price is very unlikely to go below costs of production.

Zietlov argued that factors that play a greater influence on the oil’s price than OPEC’s market power are:  the steady increasing of global demand, the temporary supply constraints, the US dollar exchange rate, and the growing importance of resource pragmatism and nationalism.

 

The oil industry might be a perfect example of the need to trust the market to eventually adjust itself. Similarly, the oil’s industry provides an example of how market shares are not always indicative of real market power.

However, if now the market seems to have adjusted to a level playing field, it could also go back to a less competitive scenario. For example, things might change if Russia decides to formally join the organisation, so bounding itself to abide OPEC’s decision and increasing OPEC’s spare capacity, necessary to retaliate [here].

P.s.: In the EU, the Commission would have the option to go after OPEC also for infringement of article 102 TFEU. However, from the above I conclude that in spite of the high market shares, OPEC is not able to behave independently of the other market players, hence its Members should not be found to enjoy collective dominance.

Open Standards to Boost the Internet of Things

The Internet of Things (IoT) integrates the physical world into a computer-based system to allow objects to collect and exchange data. This inter-networking should bring improved efficiency, accuracy and economic benefits. However, many of the benefits of the IoT will occur only as a result of a widespread approach, sharing of data across the value chain and novel services. The adoption of widely accepted standards is the tool to achieve effective and efficient interoperability. The exclusion of all technologies but one might have an adverse effect on competition. Building the IoT on open standards could be the way to maintain a level playing field and promote innovation.

The IoT can build applications for smart transport, health, education, manufacturing and other sectors. It may support more responsive business models thanks to a more granular and frequent data collection that will allow firms to better assess their customers’ needs. Allowing the IoT to live up to our expectations might entail a shift in our approach to governance. If a blanket approach might not be the best solution, it is also true that no one single company, or government, can solve the issue.

The debate on whether there is the need for IoT specific regulation is ongoing and far from being settled. Some consider that the IoT world can be efficiently and effectively governed by current horizontal legislation, such as privacy, safety, environmental and competition rules. However, as a successful IoT environment demands that different devices interact, it is crucial to enable those products to communicate between each other. Hence, it seems impossible to avoid the adoption of a regulatory framework that will allow for interoperability.

Standardisation is critical in establishing a Single Market for IoT. Standards allow complementary or component products from different manufacturers to be combined or used together. They increase consumer choice, convenience and reduce costs of production. They eliminate fragmentation and will enable the emergence of the IoT ecosystem boosting innovation and reinforcing competition.

The endorsement of a particular standard is done at the expense of potentially competing technologies. However, competition in network markets is likely to result in standardisation anyway, as long term coexistence is unlikely given that a small initial advantage is apt to influence consumer expectations regarding the adoption of a specific standard. In markets with network effects, such as the IoT one, the product’s value increases the higher the number of adopters. Consequently, the network’s value increases to future adopters. Consumer expectations are often self-fulfilling and an early lead will turn in a competitive advantage difficult to overcome.

The IoT is expected to improve many aspects of our daily lives. It will influence all major economic sectors, from health to education, from transport to manufacturing. Given the total interconnection between all IoT technology, network effects will strongly influence the competitive features of the market. It seems of excruciating importance to assure that the IoT’s potential is not locked in the hands of few dominant market players.

Amazon, Apple, Google, as well as other companies already offer integrated solutions. SSOs are already working on developing standardised software layers. However, the Garten report predicts that there will not be a dominant ecosystem of platform until 2018.

Many of the existing platforms are based on a proprietary model that locks consumers into specific interface standards. Open standards seem to be preferable to proprietary solutions as they have a positive effects as regard to large scale deployment, widespread adoption and lock-in prevention. Open standards would appear to present a perfect mix of flexible multi-stakeholder arrangements. They ensure an adequate balance between the need to foster private sector innovation and the need to avoid technological lock-in or gridlock. Through the application of the principles of openness, broad consensus, transparency, availability and market-driven adoption, consortia are more likely to develop inclusive technology that more strongly adheres to the principles that are at the basis of some of the best technological innovations of our time, including the free and open Internet. With truly open specifications in place, the pathway to standardisation may also become a more smooth one.

So far the digital ecosystem has proved to be a stimulating and innovative environment, continuously delivering new inventions capable of disrupting our daily routine. For the sake of a successful, competitive and fair IoT market, it is about time for the digital world to deliver a business model that moves away from IP revenues-based models and shift to models that generate income through the delivery of innovative complementary products.

***

Dolmans, M., Standards for Standards, paper for the Joint DOJ/FTC hearings on Competition and Intellectual Property Law and Policy in the Knowledge-Based Economy, Washington DC, 22 May 2002, s4.1(a), available at: http://www.ftc.gov/opp/intellect/020522dolmans.pdf.

Dolmans, M., A Tale of Two Tragedies – A Plea for Open Standards, (2010) available at: http://www.ifosslr.org/ifosslr/article/view/46.

Glander, M., Open Standards, Policy Aspects and Legal Requirements, European Competition Journal Vol.6, Iss. 3, 2010.

Ghosh, R.A., An Economic Basis for Open Standards, (2005), p. 4 available at:
https://www.intgovforum.org/Substantive_1st_IGF/openstandards-IGF.pdf.

Kim, D., Lee, H., and Kwakc, J., Standards as a driving force that influences emerging technological trajectories in the converging world of the Internet and things: An investigation of the M2M/IoT patent network, Research Policy Volume 46, Issue 7, September 2017, pp. 1234-1254.

Regulation (EU) n. 1025/2012 of the European Parliament and of the Council of 25 October 2012 on European standardisation

Organisation for Economic Co-operation and Development, The Internet of Things: seizing the benefits and addressing the challenges, Background report for Ministerial Panel 2.2., Working Party on Communication Infrastructures and Services Policy, 2016, p. 12, available at: http://www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=DSTI/ICCP/CISP(2015)3/FINAL&docLanguage=En.

Vertical mergers are not necessarily competition law friendly

The vertical integration of producers of complementary products or services results in no loss of direct competition as they operate at different levels of the supply chain. On the one hand, vertical mergers are likely to produce efficiency gains because they give rise to a direct incentive to reduce prices and/or improve quality. On the other hand, they can create market power, either by coordinated or unilateral effects, which may result in detriment to consumers. Competitive and anticompetitive effects of a vertical merger arise from the same source: the creation of cost asymmetries between the integrated firm and its rivals. Whether the deal will result in detriment to consumers, it depends on whether it will be greater the market power increase or the reduction in cost of the integrated firm.

Substitution vs. complementarity

Horizontal mergers involve producers of substitute products and are likely to cause anticompetitive effects because substitute products have a positive cross-price elasticity: if product A’s price increases, the demand of product B will rise as some customers will switch to the latter. Because post-merger some of the lost sales are internalised, a horizontal merger creates an incentive to raise prices.
Conversely, the relationship between complementary products is characterised by a negative cross-price elasticity: the sales of both products will increase following the reduction of either’s price. If producers of complementary products merge, this beneficial effect is internalised providing an additional incentive to lower prices. This externality effect is not restricted to prices: any improvements of quality, promotion or distribution will produce a positive effect. Because the integrated firm will act to maximise profits across the two lawyers of the chain, prices will decrease and output will rise. Vertical mergers are presumed to be pro-competitive; indeed, the main rational behind a vertical merger is the achievement of efficiencies rather than the increase of market power. However, in limited circumstances the cost asymmetries produced by the integration can result in the foreclosure of competitors and eventually lead to higher prices. The competition concerns created by vertical mergers are similar to those put forward in abuse of dominance cases: the integrated firm might have the ability to foreclose rivals in downstream and/or upstream markets, might act to raise rivals’ costs or weaken their offering by bundling, discriminating or refusing to supply.

Anti-competitive effects of vertical mergers

Efficiencies can create cost asymmetries between the merged firm and its non-integrated rivals, which can eventually lead to an increase of the integrated firm’s market power as a result of:
(i) the loss of attractiveness as a substitute of rivals’ products, either because they are of lower quality, more expensive or because competitors are excluded from the market or prevented entry (unilateral effect); or
(ii) the increased likelihood of coordinated conduct (coordinated effects).

The change of incentives and constraints following the vertical integration can rise rivals’ costs (input foreclosure) or reduce their revenues (customer foreclosure). Moreover, vertical integration can make it easier for firms to coordinate or evade regulatory obligations.

Input foreclosure
To engage in anticompetitive input foreclosure, a firm needs to have the ability and the incentive to foreclose and its behaviour must result in detriment to consumers.
The merged entity will be able to engage in input foreclosure only if it controls an important input to downstream rivals. If it will either stop supplying competing downstream firms or will do so at a higher price, the cost of downstream rivals may be negatively affected and, as a consequence, their prices will increase. The restriction could also prevent a new entry, and hence the vertically integrated firm will preserve significant market power upstream. The downstream prices will either increase or fall, depending on whether dominates the cost or the market power effect of integration. In conclusion, the overall effect on consumers is ambiguous.

However, engaging in a foreclosure strategy involves a profit sacrifice, i.e. the lost margins on the sales of products to downstream competitors that are not made post-merger. Only if the benefits outweigh the costs, the integrated firms will have the incentives to engage in foreclosure. The empirical analysis assessing the trade-off between costs and benefits involves, inter alia, the assessment of upstream and downstream margins as well as the propensity of consumers to switch and the reaction of competitors.

If, as a result of the foreclosure, rivals’ price increases, costumers will switch to the integrated firm’s product: the greater the switching rate, the greater the benefits will be since the merged entity will earn both the wholesale and the retail margin on those additional sales. However, the merger will harm consumers and, hence will be considered anticompetitive, only if it allows for a price increase possible given the reduced competition.

The merger will not cause anticompetitive effects unless the competing upstream firms are capacity-constrained, or less efficient, or if branding is important since, in these cases, the downstream firms may find it difficult to obtain equivalent input at pre-merger price. Competition concerns are unlikely to arise also if the upstream product represents only a small proportion of the overall retail price because, in these instances, even a substantive price increase would be unlikely to affect the final price. Similarly, the greater is the incentive for the downstream firms to absorb the price increase, the less effective will be a foreclosure strategy.

Customer foreclosure
If before the merger the downstream firm was a significant market player, and following the integration it stops purchasing from upstream rivals, the latter’s average costs of supply might increase because of the reduction in sales. If customer foreclosure results in exit (from higher average costs) or reduced competitive vigour (from increased marginal costs), the competitive constraints that upstream competitors exert on the upstream division of the integrated firm will be reduced, leading to greater market power upstream and higher input prices. It is a concern only when the vertical merger involves a firm that is an important customer that enjoys significant market power in the downstream market, i.e. it has the ability to foreclose.

Only in certain instances consumers are harmed. There are competition concerns, only if, by denying access, the wholesale price to non-integrated downstream firms increases leading to reduced competition downstream and hence higher retail margins. Competition concerns may also arise when the integrated firm is successfully winning sales from its upstream competitors and the upstream market is characterised by significant economies of scale, since customer foreclosure can lead to higher input prices. In general, customer foreclosure is anticompetitive only if there is a significant customer in the downstream market with large market share, the input suppliers are subject to significant economies of scale, and the upstream firms are not able to expand sales to other downstream firms.

Enhanced likelihood of collusion
Vertical mergers can make it easier for firms to engage in tacit or express collusion since it might facilitate the exchange of pricing and other competitively sensitive information in either the input or output market, or it can eliminate a disruptive buyer or enhance market transparency. The greater the benefit of the downstream division from raising the costs of its rivals, the greater the incentive for the integrated firm to coordinate pricing upstream. However, the coordinated effects are likely to be significant only if either the upstream or the downstream market is conducive to coordination.

Evading price regulation
If the upstream market is regulated, but the downstream market is not, by integrating, the upstream monopolist can realise its monopoly profit in the downstream market. This is possible by either discriminating other downstream players or engaging in cost misallocation. At the same time, a downstream monopolist active in a regulated market could integrate and use transfer pricing to evade its regulatory constraint and earn the monopolist profit upstream. If the integrated firm engages in discrimination, it will disadvantage its downstream rivals by reducing the quality of the input or raising competitors’ costs. This relaxes the competitive constraints played by downstream competitors and hence, the integrated firm will be able to increase prices. If the regulated price upstream is cost-based, the integrated firm will have the incentive to have its downstream costs attributed to its upstream division so that it relaxes the price constraints in the upstream market and increases its profits downstream. As it occurs with cost misallocation, the market power and profits are realised by the unregulated entity. These strategies are of concern because they result in greater exercise of market power and produce inefficiencies.

Pro-competitive effects of vertical mergers

Vertical integration enhances coordination between the upstream and downstream firms. The most evident positive effect of vertical integration is that the merged entity will no longer pay a wholesale price that includes a mark-up over marginal cost: it will transfer the input internally at only marginal cost. Hence, vertical integration solves the problem of double marginalisation and can allow for an immediate price reduction.
Efficiency gains are not limited to costs and price reductions; they also include improvements in quality, increased variety, and innovation leading to new products.

From an empirical point of view, those efficiencies are found to outweigh possible anticompetitive effects in most contexts. However, in limited circumstances, vertical mergers can indirectly generate anticompetitive concerns as a result of changes in constraints and incentives.

***

Bishop, S. and Walker, M., The economics of EC competition law: concepts, application and measurement, University Edition, Sweet and Maxwell, 2010.

Church, J., The Impact of Vertical and Conglomerate Mergers on Competition, European Commission, 2006, available at: http://bookshop.europa.eu/en/the-impact-of-vertical-and-conglomerate-mergers-on-competition-pbKD7105158/.

Church, J., Vertical Mergers, in Issues in Competition Law and Policy, Vol. 2, p. 1455, ABA Section of Antitrust Law, 2008, available at SSRN: https://ssrn.com/abstract=1280505.

Gunnar, N., Jenkins, H., and Kavanagh, J., Economics for Competition Lawyers, Oxford University Press, 2016.

RBB, The efficiency-enhancing effects of non-horizontal mergers, 2005, available at: http://ec.europa.eu/DocsRoom/documents/3667/attachments/1/translations/en/renditions/native.

Rosengren, E.S., and Meehan, J.W., Antitrust policy and vertical mergers, in New England Economic Review, 1995, pp. 27-38.

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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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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