Canadian COMPETITION LAW

August 23, 2010

By Derek Ireland

There are some useful parallels between the competition policy and law experience of Canada and the competition policy and law challenges now being faced by smaller developing and transition economies as well as other developing countries with small and fragmented markets that have recently adopted and started to enforce a modern competition law.  Canada compared with our closest neighbour the United States has a small market and developed its modern industrial base and fully opened its market to foreign trade and investment much later than our much larger neighbour.  Canada passed its first competition statute in 1889 which is one year earlier than the Sherman Act in the United States, but enforcement of the Canadian law was limited for nearly one hundred years.  Canada in many ways had to “start from scratch” when the Canadian Competition Bureau began enforcement of the modern Competition Act of 1986.

As a member of the G8, Canada has a much larger gross domestic product and more competition law experience than many developing countries that have recently adopted a modern competition law.  However, developing and transition economies will be facing many of the same challenges at this stage of their development in order accelerate their country’s development and transition from e.g. a more resource based to a more diversified, modern and knowledge based industrial and services economy.

Therefore Canada’s experience in designing and enforcing competition policy and law in a comparatively small economy with a large and more experienced neighbour, the United States, is relevant and helpful to many developing countries at their current stage of competition policy and law enforcement and economic development.

Expanding on the above, Canada’s competition law experience, and the growing literature on competition policy and law in smaller developed and developing economies[1] and other developing economies with small relevant markets for competition law enforcement indicate that special approaches and different priorities and emphases are required for competition law design and enforcement in smaller developing economies and other developing countries with small fragmented markets.  This is because of the inherent tensions between: (i) small highly concentrated markets that can accommodate only one or a few efficient suppliers operating at minimum efficient viable scale that is profitable to the suppliers; (ii) the high risk that suppliers with no or few competitors and little threat of entry will collude and/or abuse their dominant position and therefore charge high prices, provide low quality products, and hurt competition, consumers and the competitiveness of the national economy; and (iii) the limited resources and experience available to the competition authorities of many developing countries when compared with their substantial and often unfamiliar competition policy and law challenges.

In short, the competitive effects/efficiencies trade-off of Williamson (1968) will be particularly challenging and complex and will occur with comparatively greater frequency in smaller developing economies and many other developing countries with limited merger review resources and experience.[2]

Because of these tensions, new and inexperienced competition authorities with limited resources will often be under pressure from businesses and their government and media supporters to approve a competitively questionable merger or non-merger horizontal agreement or to allow a competitively questionable dominant position to continue with no detailed investigation and remedy.

This inherent tension essentially captures the challenges faced by the Canadian government and business community in the mid-1980s before the Canadian Competition Act was modernized in 1986 and the Free Trade Agreement was signed with the United States in 1989.  The Canadian experience and the small economy literature since then provides a number of implications and insights that may be important to administering the new competition policy and law in smaller developing economies and other developing countries with smaller markets that have recently introduced a modern competition law.

While few suppliers and high levels of market concentration can provide a strong presumption of anticompetitive conduct and effects when investigating mergers, dominant positions, non-merger horizontal arrangements and other competition law cases, this in our view simply means that greater emphasis in merger review and other competition law cases must be given to business conduct in the relevant market, actual or the threat of entry, positive as well as adverse competitive effects including innovation effects, static and dynamic efficiencies, superior competitive performance, and other short-term and more dynamic longer-term considerations that could offset any adverse competitive effects to competition and consumers in small highly concentrated markets.

Particular emphasis should be placed on the growing theoretical and empirical research that single-firm dominance with a competitive fringe, duopolies and three-firm oligopoly markets can provide reasonably competitive outcomes as long as at least some of these conditions are being satisfied: (i) pro-competitive business conduct and intense inter-firm rivalry in the current market; (ii) external and domestic reforms and an open national and/or regional economy; (iii) limited technological, government imposed and company created barriers to entry, resulting in favorable entry conditions for both domestic and foreign companies; (iv) readily available close product substitutes supplied by non-merging companies that are the second choices of customers and final consumers in the pre-merger market; (v) or are supplied by the competitive fringe and preferred by some consumers when a dominant position is being investigated; (vi) creation of a highly vigorous and effective maverick producer as a result of a merger, or the existence of an aggressive alternative supplier to the dominant company for an abuse of dominance case; (vii) horizontal and non-horizontal mergers that generate static and dynamic efficiencies, innovation effects, and a superior competitive performer that shares the benefits from these efficiencies with business customers and final consumers; (viii) a dominant player that is a superior competitive performer that “earned” its dominant position through providing higher quality products, low “quality-adjusted” prices and better service to business customers and final consumers[3]; (ix) reallocation of production after a merger in favour of more efficient lower-cost suppliers that could be either the merged entity or a non-merging competitor; (x) innovation, entrepreneurship and an emerging pro-competition culture in the industry, relevant market and economy; (xi) procompetitive small business sector and government programs to support small business development; and (xii) strong business customers with countervailing buyer power and well informed and demanding final consumers.

Alternatively, altering these conditions in a pro-competitive direction can indicate the kinds of remedies that need to be applied to allow a questionable horizontal or non-horizontal merger to proceed or to allow a company with a dominant position to continue to operate without a structural or behavioural remedy.  Many smaller and other developing countries will place special emphasis on trade, investment, business licensing, corporate governance, bankruptcy and related business development reforms that will facilitate import and export expansion, entry by more efficient domestic and foreign companies, and exit by less efficient suppliers and that will make highly concentrated markets more “contestable”.[4]

Satisfaction of at least some of these conditions can mean that single-firm dominant positions with a competitive fringe, duopolies and three firm oligopolies can result in reasonably contestable markets and reasonably competitive outcomes for business customers and final consumers especially when e.g. one or more of the remaining suppliers after a horizontal merger are vigorous and effective competitors.

As a consequence, rigid rules based on market concentration and power should be avoided; and the competition agency should apply a fact intensive, case specific rule of reason and dynamic approach to all of its enforcement cases — with the important exception of naked cartels where something approaching a per se approach is required.

Some of the more important implications for smaller developing economies and other developing countries with smaller markets are as follows.  The substantial lessening and prevention of competition test should be applied to all competition law cases except for explicit naked cartels.

Reasonable market competition and contestability should be the benchmark that is employed, not the perfect competition model of many anonymous buyers and sellers of the standard microeconomics textbook.  Otherwise, there is a major danger that the very scarce resources and expertise of competition authorities in developing countries will be misallocated to merger and other cases where the risk of harm to competition and consumers is very limited.

Compared with larger economies and relevant markets, competition in smaller economies and markets will more often be for the market rather than within the market.  Competition for the market will be important to both merger review, where the merging companies intend to “win” the market” through merger and acquisition, and for abuse of dominance cases where the major supplier is attempting to win the market through exclusionary practices, entry deterrence and other competitive and/or anticompetitive conduct and strategies.[5]

The two major issues for competition authorities when investigating “winner-take-all” markets are: (i) whether the winner of the competition for the market that is ultimately decided by merger or corporate strategy is a vigorous and effective competitor that wins on merit rather than through political and bureaucratic connections, successful rent seeking and anticompetitive entry deterrence strategies and related unilateral conduct; and (ii) whether the market, industry, and economy is sufficiently open and “contestable” after the merger to ensure that the post-merger winner remains vigorous and effective as a consequence of the threat of entry in the near term and of actual entry and competition within the market in the longer term as the market expands and technological conditions and opportunities change.

For the smaller and other developing countries experiencing high growth and dynamic technological and institutional change, competition within the market could replace for the market in a relatively few years as along as entry barriers are low and the policy and investment environments support business entry and competition.

Competition authorities in smaller developing economies and other developing countries with smaller and more fragmented markets must be very careful in selecting and implementing structural and behavioral remedies that are intended to fix a competitively questionable merger or dominant position.  Smaller and other developing countries often have few or no buyers for the company assets to be divested.  More generally, any remedy should be assessed critically to ensure that it is feasible and implementable and that the remedy will not undermine the ability of the merged entity or dominant company to be efficient and competitive and to serve their business customers and final consumers.

As emphasized above, entry conditions and barriers are particularly important to merger review and other competition law cases in smaller developing economies and relevant markets.[6]  For smaller countries and markets, actual entry or the threat of entry through uncommitted or low cost committed entry is especially needed to provide reasonably competitive markets and to discipline the pricing and other decisions of incumbents in highly concentrated markets.

However, for smaller countries, entry and the threat of entry will more often come from foreign sources in particular suppliers and potential entrants in a larger perhaps more industrialized and developed country such as the United States in the case of Canada and Mexico, Australia in the case of New Zealand, India for Sri Lanka and Bangladesh, China for Viet Nam and Mongolia, Brazil vis a vis its smaller Mercosur partners and associates such as Uruguay and Paraguay, and South Africa and its smaller and less developed neighbours in Southern Africa.

This of course requires low tariff, direct investment and other formal and informal barriers between the small economy and the larger neighbouring country, usually through a regional free trade or similar commercial agreement.  This situation requires as well the establishment of formal and informal agreements of cooperation and mutual support with neighbouring large and small countries in order to assess cross-border merger transactions and other competition law cases with transborder implications in a cost-effective manner.[7]

For similar reasons, for larger developing countries such as China, India, Russia, Brazil and Indonesia with small, fragmented and highly localized and differentiated markets, entry and the threat of entry will more often involve suppliers and potential entrants in neighbouring regions in the same country.  This requires that national governments place a priority on the reduction and removal of government and enterprise imposed internal trade barriers and “administrative monopolies” that restrict flows of goods, services, investment and human capital between provinces, states, regions and municipalities within the national economy.[8]

Companies based in the larger neighbours of smaller developing economies can enter the smaller market in various ways including through imports, greenfield investment or merger and acquisition.  As a consequence, compared with larger countries, merger review in smaller developing economies will more often need to address foreign-to-local transactions.  Such mergers can often bring improved technology, management and market access to smaller economies; and typically do not substantially lessen competition in the small economy’s domestic market in the short run, since only one of the merging companies has a significant commercial presence in the small economy before the merger.

At the same time, some of these foreign-to-local mergers could pre-empt and prevent future competition through eliminating a potentially vigorous and effective domestic competitor from the local and global markets.  Competition authorities in smaller economies therefore should have the mandate and resources to review mergers where only one of the merging parties has a significant commercial presence in the smaller country.

Competition law enforcement in smaller economies and developing economies with smaller more fragmented markets also needs to give special attention to the production technology that is employed and to the resulting technology based entry barriers in the relevant market and industry.  Merging companies and defendants in abuse of dominance and monopolization cases often argue that mergers and market dominance are needed to achieve economies of scale and scope, learning curve effects, and related efficiencies.

This situation continues to be true for some industries especially the more capital intensive sectors.  However, there is growing evidence that, in many industries, minimum efficient scale can be achieved at low production volumes; and constant costs and returns to scale are found across a wide range of quantities supplied, in contrast to the semi-circular supply curves presumed in traditional microeconomic theory textbooks.  The result is that economies of scale and scope in some industries can be achieved at comparatively low production volumes.

There is growing evidence as well that smaller companies can compensate for their lower production volumes through greater flexibility and adaptability, less bureaucracy and overhead costs, better corporate governance, and the ability to better meet the needs of customers and final consumers.

Another implication from the Canadian experience and the small economy literature is that smaller countries have smaller more closely knit business communities with only a few major companies.  These companies often are members of diversified enterprise and business groups and networks, and have close relations with their national and local governments.  This situation increases the risks of regulatory capture and of tacit collusion and explicit cartels that at times are protected by government.

At the same time, the government and businesses in smaller economies can benefit from much lower information asymmetries and related information and transaction costs between businesses and the competition and other government agencies.  For example, the remaining competitors, potential entrants and business customers in small concentrated markets in small developing economies and other developing countries are more likely to know what the merged entity and other competitors are doing and are likely to do, and therefore are better positioned to respond in a pro-competitive manner through product repositioning, imitating the efficiencies of the merged entity, or some other pro-competitive corporate strategy.

As long as the appropriate competition culture is emerging and the competition agency has conducted the necessary business, government and public education and voluntary compliance programs, adverse competitive conduct and effects after a merger or the establishment of a dominant position or collusive arrangement are more likely to come to the attention of the competition agency and other government ministries and officials and to result in complaints from business customers, suppliers, consumers associations, politicians  and other groups, when relevant markets are smaller and more fragmented with relatively few competitors and other market and supply chain participants.

This situation makes the threat of abuse of dominance or anticompetitive agreement cases after a questionable merger more credible.  In addition, when a merger to monopoly or near monopoly is needed to achieve economies of scale and scope and other efficiencies, a formal regulatory regime to monitor and control product price and quality may not be needed, or will be relatively easy and inexpensive to administer.

Finally, as implied in a previous point, competition law enforcement in smaller developing economies would especially benefit from the enactment and enforcement of all provisions and sections of the competition law in a proactive, flexible, and complementary manner, and from the consistent application of similar competition law standards and enforcement practices across all sections, including merger review, abuse of dominance, anticompetitive agreements, monopolization and/or vertical restraints (depending on how the competition law is structured).

This for example would allow the competition authorities to clear a questionable merger in a highly concentrated small economy market with full knowledge from both sides that the non-merger provisions can and will be enforced if the merger results in adverse coordinated and/or unilateral conduct and effects that are harming competition, consumers and the competitiveness of the national economy.

The above provides only a very preliminary discussion of the insights from the Canadian experience and small economy literature that may be relevant and helpful to merger review, abuse of dominance and other competition law cases when the competition authorities of a smaller developing economy or other developing economies with smaller markets are enforcing a new or amended competition law.

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[1]  Associated in particular with the research of Michel S, Gal.  See e.g. Michal S. Gal: “Size Does Matter: The Effects of Market Size on Optimal Competition Policy” Southern California Law Review Vol. 74: 1437-1478 2001; and Competition Policy in Small Market Economies Harvard University Press 2003.

[2] See Oliver E. Williamson Oliver E. “Economies as an Anti-Trust Defense: The Welfare Trade-Offs”, American Economic Review 58, pp. 18-36 1968.

[3] See for example Dennis W. Carlton “Using Economics to Improve Antitrust Policy” Handler Lecture, December 9 2003 (Forthcoming: Columbia Business Law Review).

[4] William J. Baumol “Contestable Markets: An Uprising in the Theory of Industry Structure” The American Economic Review Vol. 72 No. 1, March 1982, pp. 1-15 1982.

[5] See e.g. Toshiaki Takigawa “A Comparative Analysis of U.S. EU, and Japanese Microsoft Cases: How to Regulate Exclusionary Conduct by a Dominant Firm in a Network Industry” The Antitrust Bulletin Vol. 50, No.2/Summer 2005, pages 237-266 2005; Gregory J. Werden “Network Effects and Conditions of Entry: Lessons from the Microsoft Case” Antitrust Law Journal 69(1) 2001; David T. Scheffman and Richard S. Higgins “20 Years of Raising Rivals Costs: History, Assessment and Future” George Mason Law Review, Vol. 12:2, pp. 371-387 2003; and Derek Ireland, Derek “Intellectual Property Rights and Competition Policy in the Knowledge-Based Economy: Compatible or Colliding Policy Regimes” Chapter 13 of Bruce Doern ed. Innovation, Science, Environment: Canadian Policies and Performance, 2007-2008, McGill-Queens U. Press 2007.

[6] See for example R. Singleton “Competition policy for developing countries: a long run, entry-based approach”, Contemporary Economic Policy 15 (2) 1-10 1997.

[7] See e.g. A. Vindelyn Smith-Hillman “Market Power, Competition Policy and Developing Economies: Divergent Conditions within African and Caribbean Countries” Journal of Economic Studies 34(2): 120-135 2007; and Taimoon Stewart, Julian Clarke and Susan Joekes Competition Law in Action: Experience from Developing Countries Ottawa Canada: International Development Research Centre (IDRC) 2007.

[8] See e.g. William Blumenthal “Challenges in Implementing the Competition Act” in Dr. Madhav Mehra Editor Competition Law: An Instrument for Inclusive Growth New Delhi: International Academy of Law pp. 57-70 2009; Eleanor Fox “An Anti-Monopoly Law For China–Scaling the Walls of Government Restraints” Antitrust Law Journal Vol. 75 p. 173 2008; and Bruce M. Owen, Su Sun and Wentong Zheng “China’s Competition Policy Reforms: The Anti-Monopoly Law and Beyond” Antitrust Law Journal Vol. 75 Antitrust p. 231 2008.

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