It is natural for a developing country to ask: is competition policy necessary given trade liberalisation? This consideration relates to an important theoretical problem: what’s the relation between international trade and competition policy. At the theoretical level, two main concerns are important. First, what is the relation between trade and competition policy; does a liberal international trade largely substitute for a competition policy?
Secondly, what is the relation between trade policy and competition policy; does a strict competition policy aimed at preventing abuses of market dominance conflict with for instance a strategic trade policy aimed at shifting rents in favour of domestic firms?
One of the key sources of benefits from international trade is that international competition constrains the ability of domestic producers to engage in anticompetitive practices, which would otherwise reduce welfare. This idea, known in the industrial organisation literature as the ‘imports-as-competitive-discipline’ hypothesis is not only a theoretical argument, but also supported by strong empirical evidence (see Cadot et al., 2000). Most empirical tests of this hypothesis were based on regressing a measure of profitability, such as price-cost margins, on import penetration and a number of other
factors potentially contributing to industry profitability (see e.g. Roberts and Tybout, 1996).
The conclusion of these empirical studies, mostly carried out at the industry level, is that increased imports tend to be negatively correlated with the profitability of domestic sellers (e.g. Jacquemin and Sapir, 1991; Roberts and Tybout, 1996), particularly when domestic concentration is high (Schmalensee, 1989). The empirical study on the links between import penetration and profitability is the beginning point of any attempt at quantitative assessment of the links between trade and competition policies. If we take increased imports as a proxy for liberal trade policies, this result suggests that liberal trade policies and tight competition policies are, in a loosely defined sense, substitutes (Cadot et al., 2000).
Nevertheless, trade liberalisation may not be sufficient to generate competitive discipline and benefits from trade liberalisation may be dampened in the presence of anticompetitive forces. External liberalisation cannot substitute for a competition policy in case that liberalised foreign trade become subject to domestic monopolistic restrictions.
Higher markups have been observed following trade liberalisation in sectors with high market concentration, low elasticity of demand, and companies abusing their dominant positions (WTO, 1998a, 2000a). For small but extremely open economies like Hong Kong and Singapore, it has been consequently argued that competition discipline was better enforced by trade liberalisation and that competition policy was of far lesser importance to them. This view, however, ignores the aspects of competition we discussed above. In addition, these economies can be the ‘victims’ of foreign anticompetitive practices that originate outside their jurisdiction but which harm competition in their market, such as in the case of international cartels or some M&As (WTO, 2000b).
Several reasons can explain why trade liberalisation may not be sufficient to generate competitive discipline.32 First, imports have no direct competitive effects on non-tradable sectors. The larger the relative size of the non-tradable sectors in the economy, the less significant the ‘imports-as-competitive-discipline’ effect in the country, which depends more on government regulation.33 Secondly, domestic firms may avoid international competition pressures by adopting strategies based on product differentiation and other dimensions of non-price competition. Thirdly, domestic firms may indulge in anticompetitive practices, sometimes with the support of domestic authorities.
The inherent interrelation between trade and competition policies highlights the necessity of a competition policy. Important resistance on the proclaimed ‘globalisation’
process is clearly anticompetitive. Exclusionary restraints on trade and investment by firms or governments hamper the ability of firms to gain access to or to compete in foreign markets. Trade and competition policies can be considered as two approaches to tackling such problems. Trade policy is focused on the actions of governments, while competition policy is principally focused on the behaviour of firms. In this respect, trade and competition policies are designed to look at restraints that stem from different sources. As suggested by the International Competition Policy Advisory Committee (ICPAC) (2000), aspects of these policies’ tools can be mutually supportive, but overlapping policy concerns can lead to different conclusions regarding the effects of a particular restriction. For instance, examination of a vertical distribution practice under US antitrust law might find
32 See Cadot et al. (2000).
33 Hoekman et al. (2001) supported this by showing that, both from a theoretical and empirical perspective, complex entry regulations are more likely to have larger negative effects on competition in large countries, whereas imports restrictions harm more competition in small countries.
that a restriction is efficiency-enhancing and beneficial to consumers, while the same restriction might be regarded from a trade policy perspective as exclusionary and adversely affecting access to markets. Neither trade nor competition policy tools provide complete solutions to the problems that emanate from the mix of government and private restrictions.
The relationship between competition and trade policies is complex because they regularly have contrary objectives. As Levinsohn (1996) noted, whereas competition policy aims to curb the market dominance of domestic producers, strategic trade policy attempts to encourage its emergence in order to shift rents away from foreigners. In the presence of the pressure from import-competing interests, reduced trade barriers may lead governments to search for alternative instruments of protection. Grounded in the observation that the reductions in tariff barriers negotiated in multilateral rounds of trade liberalisation have led to the spread of less transparent non-tariff impediments and to growing use of contingent protection, one might expect a selective relaxation of competition rules to be used strategically to provide favourable treatment to domestic producers (Fox and Ordover, 1997). Richardson’s study (1996) suggested that the number of firms is higher in the constrained (free trade) equilibrium than in the unconstrained (tariff-ridden) one, which is contrary to the fears expressed earlier. Horn and Levinsohn’s study (1998) reached a similar conclusion that trade liberalisation would lead to a tightening of domestic competition policy by a welfare maximising government. Starting from a position where the export subsidy is set at its optimal level, they demonstrated that a small reduction in this subsidy, taken as a proxy for trade liberalisation, induces a tightening of domestic competition policy. The political economic approach to trade and competition policies recognises that such policies are subject to lobbying pressures from both domestic and foreign entities. This approach to the determination of trade policy, sometimes referred to as the influence-driven approach was introduced by Grossman and Helpman (1994), based on developments in the principal-agent theory of Bernheim and Whinston (1986).
The relationship between competition policy and the multilateral trading system has been subject to much debate in academic literature and international organisations. In 2001, the future of a multilateral framework for competition within the WTO was discussed during the Doha Ministerial Conference. All member governments signing the Doha declaration recognised for the very first time that there is a valid case for the WTO to negotiate and conclude a Multilateral Agreement on Trade and Competition (see Subsection 8.2.3 for a detailed discussion). The negotiation of a multilateral agreement on competition in the WTO may underpin the impressive progress that has been made in trade liberalisation over the past few decades. Before the Doha Ministerial Conference, even the principle of having such an agreement within the WTO was controversial. On the one hand, there is wide acknowledgement that competition policy and trade liberalisation share common objectives of the promotion of economic efficiency and consumer welfare, and the lack of effective competition policies can harm gains from trade liberalisation (WTO, 1997; UNCTAD, 1997a; OECD, 2001). On the other hand, there have also been arguments against an expanded involvement of the WTO in the area of competition policy.34
The relationship between competition policy and the multilateral trading system is not a concern exclusive for developed countries. Although the debate on this issue was originally stimulated by developed countries’ perceptions that anticompetitive practices
34 See Anderson and Holmes (2002).
impede foreign market entry, it has been recognised that anticompetitive behaviour also impacts directly on the welfare and development of developing countries (UNCTAD, 1997a; Jenny, 2001; Hoekman and Holmes, 1999; and Levenstein and Suslow, 2001). It has been argued that international agreements can play a vital role in enabling developing countries to implement effective competition policy, by promoting cooperation in institution building and by providing a tool for overcoming domestic constituencies (Jenny, 2001; Garcia-Bercero and Amarasinha, 2001; and Birdsall and Lawrence, 1999).35
Within the WTO regime, in addition to the issue of the TRIPs Agreement, another consideration that highlights the necessity of competition policy with concerns to developing countries is the Agreement on Trade Related Investment Measures (TRIMs).
TRIMs refer to restrictions attached by host countries to the activities of MNCs. It is acknowledged that TRIMs distort trade flows and are therefore inconsistent with the principles of the WTO. The removal of a TRIM can affect trade flows and such removal is the intention of the TRIMs Agreement in the Uruguay Round Agreement. The TRIMs Agreement imposed new prohibitions on the use of TRIMs, with transition periods for developing countries. The abolition of TRIMs reduces host government’s bargaining power and accordingly reduces the potential gains from FDI for the host economy (Morrissey, 2000). The principal problem facing developing countries is that their legal systems, in particular their capability to implement competition policy and regulate MNCs without TRIMs, are limited. Measures to strengthen their capability to implement effective domestic competition policy are essential (Lloyd, 1998; Morrissey and Rai, 1995). For developing countries without competition policy, establishment and effective implementation of such a policy is crucial.