ã 1999 Alexandra Nassopoulos
November 10, 1999

Competition Policy and Mergers in the World Economy

. "Monopoly is a great enemy to good management which can never be universally established but in consequence of that free and universal competition which forces every body to have recourse to it for the sake of self-defense" (Smith, 1776: 63).

Adam Smith found that monopolies were a negative aspect for an economy therefore supporting competition among firms in order to protect one’s firm.

Competition policy affects the nature of firms and policy makers in today’s global economy. Competition policy effects the world economy in many ways and with its increase in importance there must be an international agreement on competition policy. Adam Smith highly regarded competition policy as a means to enhance economic performance. Mergers can provide positive aspects for an economy and competition policy but also provide problems. The merger of aircraft manufacturers shows how mergers directly affect society today.

Competition within economies is the act of competing in the international economy. Competition policy is necessary to regulate competition between firms. It serves as a barrier for misconduct of firms while encompassing antimonopoly

policies which act as guideline against boundaries or barriers. "Competition policy is understood as facilitating corporate takeovers to allow more efficient managers to control productive assets" (Peritz, 1996: 282) The main goal for competition policy is to support effectiveness of the economy as a whole. Smith points out how competition will only benefit both consumers and producers in the end rather than have a monopoly. "It can never hurt either the consumer or the producer on the contrary it must tend to make the retailers both sell cheaper and buy dearer, than if the whole trade was monopolized by one or two persons" (Smith, 1776: 362). Policies aid in providing better utility for consumers and better profits for producers. Without any policies firms could try and monopolize the industry and there would not be restrictions for new producers into the market.

Competition policy effects many parts of the global economy. It impacts actions such as mergers, trade policies, acquisitions and strategic business alliances. Smith examines how trade is related to competition policy when trade is privileged for a few. "Privilege of an incorporated trade restrains the competition in the town where it is established to those who are free of the trade" (Smith, 1776: 135). Some trade policies could affect the process of competition. Today within the international economy trade policy has common characteristics with competition policy in such instances as non-border trade barriers. Although using competition policy as an actual trade policy mechanism in order to increase market access can raise problems. Tharakan and Lloyd point out the fact that using competition policy directly for market access is not a desirable action to take.

Competition is implied from the freedom of economic order and the freedom to compete. Fortman claims that "the exercise of private economic power is controlled by the opportunities enjoyed by other economic subjects to make use of this freedom of enterprise" (Fortman, 1966: 2). Therefore when competition is restricted free enterprise activity is then restricted.

We are living in a world of increased globalization and new technology gains being made everyday. Globalization has been rising through the increase of liberal trade regimes, an increase in direct foreign investment and the lower costs of communication and technology. As a result the need for competition policy has increased within the international setting. "One consequence of the globalization of markets is that the formulation and execution of competition policy is becoming more complex" (Rodriguez et al., 1999: 437). Competition is an extremely important issue for internationally.

As a result of the growing importance of competition policy the World Trade Organization has set up a group to oversee the issue. The WTO has formed a Working Group on Trade and Competition Policy which meets on a regular basis but have made no formal proposals. A complaints procedure has been designed within the WTO to deal with concerns and problems of members relating to competition conditions. Problems have arisen that relate to competition policy further highlight the need for an international standard for competition policy. "There is an increasing realization that action (or non-action) by national competition authorities can often have international spillover effects" (Tharakan, Lloyd, 1998: 999).

Why is it important that there is international competition policy? Domestic competition policy is ineffective in solving problems like that of foreclosure. Presently foreclosure cannot be directly addressed within the WTO. Two articles in GATT refer to goods within international trade. These articles let a member use the dispute settlement agreement to solve a problem regarding damage of benefits through the use of government measures. Yet, this article is only applicable to government measures that foreclose imports not private businesses. The working group on competition policy will be looking at these types of issues. The WTO will attempt to use competition policy as a way to examine public and private dealings that obstruct market entry.

Currently there have been efforts in aiding support between governments to fight against anti-competitive troubles. This is seen through the use of bilateral and multilateral agreements. In 1991 the United States and the European Union established rules regarding international comity and the spread of information about market operations. A second agreement was made in 1998 concerning anti-trust laws. This agreement gave access to the established competition authorities to look into any anti-competitive practices. The Agreement on Basic Telecommunications examines exclusively the prevention of anti-competition. This agreement is only for this particular sector but is an example of a competition agreement. A third example of an international agreement would be the complaints procedure in the WTO which has been previously mentioned.

In order to help combat anti-competitive practices internationally a multilateral agreement is necessary along with a global competition authority. A multilateral agreement is presently not probable because many countries are lacking sufficient competition laws and institutions. Aside from this fact there remain concerns of a possible loss of national sovereignty. Although this is a justified concern the outcome of an agreement could be more beneficial. Many nations would embrace a multilateral agreement in order to protect interests and restrict other nations from using anti-dumping duties.

It has been suggested to establish a small autonomous international competition policy agency. This agency would incorporate the WTO because its ingrained tradition would act as a good base agency. "The WTO with a large number of members has already established a tradition of multilateral principles such as non-discrimination and national treatment" (Jacquemin et al., 1998: 1182). One problem which may arise is that within a competition agency is located within the WTO it runs the risk of being submerged into trade policy considerations. "While the improvement of competition conditions would go a long way in restraining the use of instruments of contingent protection, in general there is a strong argument that could be made for keeping the competition policy and trade policy separate" (Tharakan, Lloyd, 1998:1000). At the present moment the WTO deals only with actions of national governments not private agents which is what the agency must deal with in order to properly solve anit-compeition problems. Another problem with the WTO is that it does not issue rulings in advance but only after the actual policy has been implemented or an official complaint has been made. It is necessary that these issues be examined before this point to prevent the measures from taking effect.

The agency itself would take on different tasks to enforce competition policy. These tasks could include supporting contracts, supervising competition policy actions between countries and creating competition policy for those countries without it. The group could also make proposals examining effects of anti-competition procedures and how the global community can deal with this problem. Although this type of proposal for a specific competition policy agency is not foreseeable in the near future steps should be taken in that direction. A multilateral agreement is necessary within the international scope to better deal with violations of anti-competitiveness as well as the promotion of competition.

A similar issue relating to competition policy is that of market contestability. Market contestability is when prices rise but barriers are not formed for market entry. "A market is contestable if in the event that prices rise above competitive levels, there is no barrier to entry of new sellers into the market" (Rodriguez et al., 1999: 421). Therefore, as with competition policy the efficiency of the economy is increased. When a producer starts selling at high prices another producer may enter the market offering a lower price. Of course a new seller may not enter the market but it is the threat of the entry that allows for efficiency to operate. Adam Smith discusses how competition occurs through the rise and fall of prices.

"When the quantity of any commodity which is brought to market falls short of effectual demand, all those who are willing to pay the whole value of the rent, wages, and profit, which must be paid in order to bring it thither, cannot be supplied with the quantity which they want" (Smith, 1776:73).

Market contestability does not always lead to enhanced efficiency. One situation in which this may occur is regarding intellectual property rights. They reduce market contestability because of the fact that efficiency is improved over time through the development of new and improved technology. Thus, because of the profit worthy
motivations implicated in generating intellectual property it will not be ended. There are other domains besides intellectual property which could produce problems relating to efficiency and market contestability.

It must be remembered that not all markets are contestable. This could happen when obstacles to a specific market are not overwhelming to start off with. Before entry to the market can be made sunk costs have to be acquired. "Costs are sunk if they are fixed and they are irrecoverable" (Rodriguez et al., 1999: 422). The result of sunk costs can be the natural creation of a monopoly. This poses a problem in allowing for competition within the market further enhancing the need for competition laws and agreements to avoid such problems. Markets can increase contestablility through trade liberalization which further integrates the market.

Mergers of markets allow for efficiency and integration for firms. Mergers can serve as the only way for a small firm to become as efficient as a larger firm because of the integration of markets leading to better profits. In general the desire for a merger is a result of profit and managerial motives which lead to improved effectiveness and productivity. When two firms merge costs are minimized by utilizing the most efficient technology. The most profitable merger would therefore occur between the firm with the most efficient technology and that with the least efficient technology. Although mergers maintain important economic reasons they can also pose problems within the realm of competition policy. Adam Smith noted how a privilege of an incorporated trade can restrict competition from flourishing. "The privilege of an incorporated trade restrains the competition in the town where it is established to those who are free of trade" (Smith,1776:135).

National and international mergers pose different scenarios within the world economy. Profitability of national mergers can be observed through functions of market shares and the total number of firms involved. If the country has very few firms which are inefficient than a merger may not be a good alternative for increasing profits. It could be profitable but it could also leave the firms worse off. A national merger will be beneficial to the world when terms of trade effects are minor. The national competition authorities are then predisposed in denying globally advantageous mergers. International mergers will never be approved if they are not advantageous globally. Therefore, the system tends to be biased against the mergers that do benefit globally.

Tariffs influence domestic and international mergers in different ways. A national merger is discouraged by tariffs. At the same time this tariff is protecting its firms domestically. "Tariff reductions by the home country make its less efficient firms more attractive as merger partners to more efficient firms, both domestic and foreign" (Falvey, 1998: 1067). An international merger is enhanced by the tariff when a domestic firm and a foreign firm merge. This results as well with the merger of two foreign firms.

The profits of mergers can be observed through market power. The shareholders of the acquired firms and acquiring firms gain through the merger. Through the combination of wealth effects the firm values are combined which shows a considerable enhancement. "This increase in stock-market value of the merging firms may represent either value creation or wealth transfers from other stakeholders of the firm" (Kim, Singal, 1993:549). Support of the increase in market power is observed through the price changes of airline mergers. When the merger is completed the gains in efficiency begin. These efficiency gains compensate for the consequence of the increase in market power. With the conclusion an airline merger the firm then raises the fares which still remain below industry level. Then the rival firms will match these prices so that pricing for both firms turns out relatively equal. "The joint effect of market power and efficiency gains due to mergers has similar pricing implications for both merging and rival firms" (Kim, Singal, 1993:567). This leads to the conclusion that cooperation is apparent between airlines in pricing fares.

Under certain circumstances mergers can be unprofitable. When identical firms merge this results in no profit and the emergence of anti-competitive nature. This results because the number of firms is reduced while the price is increased. The positive aspect to this is that the product will be more cost-effective. Trade liberalization is a second factor which reduces profitability of mergers.

Mergers must follow certain criteria in order to be considered. These criteria include the efficiency gains, the net transfers, the consumption on losses and the lost profits from the terminated products. The Antitrust Division of the United States Department of Justice serves to thwart the concentration of markets and to evaluate mergers. The Antitrust doctrine has changed within the eighties in order for firms to prove that the merger will promote an increase in efficiency. Before the eighties mergers would be blocked completely to even if it verified that efficiencies would be gained. As a result of an increase in mergers in the early eighties a guideline was established in 1982 which defined the beginning of a relevant market. Guidelines and authority to oversee merges is necessary to promote the best interest of everyone within the global market.

Mergers have caused international conflict denoting the need for international competition policy. A conflict emerged between the United States and Europe over the $14 billion merger between two U.S commercial aircraft companies, Boeing and McDonnell-Douglas. Europe maintains Boeings most significant rival, Airbus. Both the United States and Europe were allowed to review the merger under the Mergers Regulation Act of 1989. Both parties reached different conclusions regarding the global efficiency of the firm. Europe wanted to block the merger because it would be expanding the stance of Boeing in respects to its own firm, Airbus.

The United States naturally accepted the merger arguments of efficiency even though concentration would be increased within the market. The aircraft market was already significantly concentrated at this point. The United States did speculate if the reason for Europe’s concern was merely out of defense of their own industry. Europe proposed a deal to let the merger continue. They wanted Boeing to accept certain conditions including ending relationships a specific number of airlines. Europe did not want Boeing to become a monopoly and leave them behind in technology and profit gains. As we can see problems did arise because of the two different competition authorities examining the same situation. As in this example they arrived at different conclusions and were faced with a large workload. The better way to approach this problem would be to have a global review board which would provide a more effective assessment.

Mergers, in particular airline mergers, can in fact promote competition. Many positive outcomes can occur from the mergers of airlines including increased profits and improved productivity. They are able to increase technology and use more practical equipment. Although any surplus of aircraft has not shown to be rid of after a merger. In past mergers the extra carriers have been used for the development of new air routes. The consolidation can lead to more opportunities to use aircraft. In the long run the competition for aircraft will increase through the airline mergers. Positive benefits result for airlines in purchasing aircraft enhancing the desire to purchase more. "Carriers buying new aircraft will be in a better position in a difficult economic climate than airlines that do not modernize their fleets" (Ott, 1986:32).

Alliances provide a direct alternative to mergers without the added difficulties. "Given the higher international surveillance on prospective mergers alliances are a soft solution to the establishment of joint operations, intelligently bypassing the finer grid of mergers and acquisitions regulations" (Flores, 1998:1107). An alliance can serve as an easier option to join operations of two firms than a merger. An important motive for an alliance is the increased efficiency is provides. Through the alliance operating performance is improved and costs are reduced by less efficient firms. "When establishing an alliance, airlines try to gain scale in these supporting activities, to enlarge their scope, or to optimize them somehow through a joint operation" (Flores, 1998: 100). It also allows for more coverage geographically providing more opportunities for better revenue.

Alliance do have problems which result from its instability. It must be remembered that an alliance is a second best option. Generally it has not been shown to meet the requirements for survival while its loose structure leads to its inability to deal with competition problems. Many alliances take place during periods of transition for firms leading to an eventual diminishing of the alliance.

When markets merge or consolidate the risk of forming a monopoly is always present. The United States was concerned during the Boeing merger that there would be no interest in the merger because of its monopolistic tendencies. Access can be denied for distribution channels of products. When this access is denied then new products are not able to be marketed well and the firm is left at a disadvantage. "Existing patterns of mergers which sometimes deny access to the distribution channels necessary for the marketing of the new products, place certain firms with a competitive product at a disadvantage" (Tharakan, Lloyd, 1998: 1001). Adam Smith has examined the inequalities from the Policy of Europe which "occasions a very important inequality in the whole of the advantages and disadvantages of different employment by restraining the competition in some employment to a smaller number" (Smith, 1776:135). A result of the inequalities of wages and profits competition is unable to flourish.

Competition policy is becoming an increasingly important issue within the global economy. The world is becoming a smaller and more efficient place placing demands on firms for providing equal competition. This allows products to have equal capability of succeeding in the market. As Smith notes even when competition might cause problems for a firm initially in the end consumers and producers are never hurt. "Their competition might ruin some of themselves; but to take care of this is the business of the parties concerned, and it may safely be trusted to their discretion" (Smith, 1776: 362).

Competition policy must be present so that barriers are eliminated and markets remain open and free for anyone to enter. When violations against competition are made there must be a mechanism to investigate these problems. This will allow the market to remain free of anti-competitive practices. The international market needs to be kept in a state of competition which be to the benefit of the firms and the consumers. As consumers we can be assured to receive the best products for the best prices.

There is a need for multilateral agreements regarding competition policy because of the increasing globalization. It is necessary to have a single body for making claims on misbehavior and to promote ways to enhance competition policy. Domestic authorities will not be sufficient enough with the larger international ties and easier communication around the world.

The integration of firms through mergers allows for less efficient firms to improve their efficiency. Smaller firms are given the chance to compete with larger firms who are more efficient. Competition problems can arise when two large firms merge and create a monopoly. This is in direct violation of competition policy but it can also help firms to compete better. A solution lies within a global authority to oversee and approve mergers. This authority will then have the opportunity to examine the positive and negative effects on the entire global economy. Without this authority it becomes difficult to prevent a monopoly from emerging. As we saw with the Boeing case the United States authorities and the European authorities conflicted in their results of the case. A neutral third party is then necessary to avoid this problem.

It is important that the WTO is making small steps to include competition policy within their authority. The WTO is an important tool for setting forth guidelines and standards for nations to follow. Hopefully the WTO can provide a full multilateral agreement regarding competition policy which would aid nations in enhancing policy and preventing firms from practicing anti-competitiveness. Yet, it is essential that private firms be incorporated in this not just national govenrments. The future looks to bring an even further integration of world economies demanding a global agreement on competition policy in order to promote greater efficiency and productivity in the global economy.

Bibliography

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Falvey, Rod. 1998. "Mergers in Open Economies. The World Economy Volume 21 Number 8, pages 1061-1073.

Flores, Renato G. 1998. "Competition Policy and Trade in Servies: The Airlines’ Global Alliances." The World Economy Volume 21 Number 8, pages 1095-1109.

Graham, Edward. "Approaches to Competition Policy" In Rodriguez, Mendoza., Low and Kotchwar. 1999. Trade Rules in the Making. Washington DC: The Brookings Institute Press.

Jacquemin, Lloyd, Tharakan and Waelbroeck. 1998. "Competition Policy in an International Setting: The Way Ahead." The World Economy Volume 21 Number 8, pages 1179-1183.

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