B-26                              Competition Law Reports                         [Vol. 1

Role of Economics in Competi...
2010]                         Role of Economics in Competition Law                       B-27

In the early days of Compet...
B-28                             Competition Law Reports                          [Vol. 1
strategy to prevent new competit...
2010]                        Role of Economics in Competition Law                     B-29

separate from one another or f...
B-30                                  Competition Law Reports                           [Vol. 1
power in the supply of cel...
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Role Of Economics In Competition Law


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Role Of Economics In Competition Law

  1. 1. B-26 Competition Law Reports [Vol. 1 Role of Economics in Competition Law M. M. Sharma* Author introduces us to the growing role of economics in the competition law assessment in the other jurisdictions. As Competition Law is all about economics and economic behaviour; economic assessment of the important terms frequently used in competition law such as "market definition", "market power" etc. is likely to be made good use by the CCI as the authority commences its role of protecting competition in India. This article would be useful to understand the relevant concepts of economics and how they will be applied in competition assessment in future. Competition law is essentially concerned behave in ways that harm consumers? with the study of markets. The objection Economics attempts to provide answer to of competition law is, inter alia, to ensure these, and other, questions. that there is competition between the Understanding economic helps us to suppliers in any market and that this understand how markets operate, how competition benefits consumers. At the firms will behave in particular markets, day-to-day level, applying Competition and whether their behaviours will result Law involves identifying markets and in competition that benefits consumers. assessing whether or not competition is Economics is also being recognized as working well in those markets. It involves an essential tool to access market power assessing how the actions of firms will and to determine the boundaries of the affect competition and consumers. These market in which such market power is to are economic issues. be analysed. As the Competition Commission of India The determination of the correct relevant (CCI) commences its operations with a market is first step in any assessment of mandate, inter alia, to preserve and competition law which includes in it the promote competition in the markets, a determination of entry barriers in such quick appraisal on the role economic market which may, inter alia, be created analysis is going to play in competition by behaviour of certain firms with market assessment will be just in place. power. The important role of economics Economics involves studying how in competition law is now well- markets work. One of the main questions recognised competition authorities all that economists study is how markets over the world. Competition Law is about allocate goods and services to different economics and economic behaviour, and consumers. They are interested in how it is essential for anyone involved in the consumers fare but there are more or fewer subject–whether as a lawyer, regulator, competitors, when firm merge together or civil servant or in any capacity–to have when firms change their behaviours. They some knowledge of the economic are also interested in why firms behave in concepts concerned. It has been aptly certain ways, such as, under what stated by Brandeis J, “A lawyer who has conditions will firms behave in ways that not studied economics is very apt to benefit consumers; and when they will become a public enemy”. 82 B-26 Jan. 2010 - Mar. 2010
  2. 2. 2010] Role of Economics in Competition Law B-27 In the early days of Competition Law in irrelevant so long as efficiency is both US and Europe, the role of achieved. Chicago school places much economics was insufficiently recognised belief in the ability of the market to correct at a time when the politics of market and achieve efficiency itself without integration were in ascendant; however, interference from government or antitrust the position has changed substantially, law. Chicago School has changed and competition lawyers in EU and US, antitrust thinking profoundly not only now regularly work together in complex in the US but everywhere. It places cases with economists who specialise in vigorous economic analysis at the centre matters such as market definition, the of antitrust. determination of market power and the The allocative efficiency which is the analysis of particular type of business corner stone of Chicago School is based behaviour. It will be interesting to briefly on the concept of total welfare i.e. welfare trace the growth of competition of the producers as well as that of the jurisprudence in US and EU consumers. In a perfect competition the consumer and producer both have equal US Law surplus. Consumer surplus is the In the US, the hallmark of the “Free difference between what the consumer Market Economy”, the Structure- is willing to pay and what he actually Conduct–Performance model was the pays. Producer surplus, on the other first school of economic thought which hand, is the amount of income a producer prevailed in the 1930s. It was also receives in excess of what he would known as the “Harvard School” of require in order to supply a unit of antitrust analysis. As per this school output. The total welfare is achieved of thought, the structure of the market where consumer surplus equals determines the firm conduct and that producer surplus and allocative conduct determines market efficiency is achieved in a state of total performance, for example, profitability, welfare. It is also sometimes called efficiency, technical progress and “social welfare” by the economists. growth. This school believed that Understandably, even the determination market structure dictated performance of the consumer or the producer surplus of firms and therefore, antitrust law would require an economic analysis. should be concerned with structural More recently, there has been a remedy rather than behavioural rapprochement of different schools of remedy. The focus of attention was thought and some extreme Chicago ideas therefore, on concentrated industries have been tempered. There is a general where barriers for entries were recognition that economics may give widespread. This school of thought indications of what questions to ask but remained popular till the 1960s and it does not always yield definite answers. led to an extremely interventionist In Modern Industrial Organization antitrust enforcement policy in the US. theory or new industrial economics, The change came in the form of “Chicago which is presently being debated upon, School” of thought which produced stresses the effect that the strategic revolution in antitrust thinking in the US. conduct of firms can have in different The fundamental Chicago view is that market situations. It considers that firms pursuit of efficiency, by which it meant may indulge in strategic entry deterrence, allocative efficiency as defined by the for example. So the belief that predatory market, should be the sole goal of pricing is rarely rational conduct, as per antitrust. In the Chicago school the the Chicago school, is replaced with the identity of the winners or losers is idea that it can be adopted as a rational Jan. 2010 - Mar. 2010 83
  3. 3. B-28 Competition Law Reports [Vol. 1 strategy to prevent new competitors policy which is based on sound entering the market. We have entered a economics and which has the protection less doctrinaire age, in which there is of consumer interest as its primary more reliance on the “rule of reason” concern”. analysis, as witnessed in the decision of The economic approach stressed by the US Supreme Court in the . as laid Monti has moulded the competition law down in the case of Leegin Creative Leather in Europe whereby, the focus is on Products, Inc. v. PSKS, Inc., 551 U.S. 877 “consumers” as the direct beneficiaries (2007), in which the Court overruled the of the application of competition laws. 97 years old “Per Se” rule laid down in In EC law, the achievement of efficiency Dr. Miles Medical Co. v. John D. Park & has to leave a room for other Sons Co. 220 U.S. 373 (1911). considerations and cannot be said to be the sole goal of EC competition policy, European Law because competition is considered as a The EC Law stresses upon “effective part of the overall scheme of community competition” in which the emphasis is policies and has to interact with them. on the “effect” of competition on Thus, there is a clear distinction between “consumer welfare”. Competition Policy the US law and the European law on the has been included in the list of main objective of competition policy but community activities set out in Article 3 in both jurisdictions there is equal of the Treaty of Rome, which came into reliance on economic analysis in force on 1 st January, 1958. The Competition Law. competition policy has played an important role as an instrument of single Having discussed, the Competition Law European market integration and is in two major jurisdictions, which have absolutely crucial for the European by and large, influenced the Union. Competition policy is still seen jurisprudence of Competition Law in as an instrument for the single common other jurisdictions, including Canada, market goal, particularly after the Australia, Japan and South Africa, and enlargement of the European Union on which recognise the role that economic 1st May, 2004. However, achievement of analysis plays in Competition Law, I will efficiency is also considered important now discuss the practical use of in European competition policy. economics in competition assessment. Particularly, after the appointment of an “Market definition”–Market definition economist, Mario Monti, as is an essential tool to identify and define Commissioner responsible for the boundaries of competition between competition in 1999, the promotion of firms. The legal test for market definition efficiency was declared to be the master was laid in the Continental Can Co. Inc. value. Monti emphasized that “the goal (1973) as “where goods or services can of competition policy, in all its aspects, be regarded as interchangeable, they are is to protect consumer welfare by within the same product market”. In this maintaining a high degree of competition case, it was the Commission’s failure to in the common market. Competition define the relevant product market that should lead to lower prices, a wider caused the ECJ to quash. The Commission choice of goods, and technological had held that Continental Can and its innovation, all in the interest of the subsidiary SLW had a dominant position consumer”. Monti also spoke of the goal in three different product markets–cans on both sides of the Atlantic being “to for meat, cans for fish and metal tops– ensure effective competition between without giving a satisfactory enterprises, by conducting a competition explanation of why these markets were 84 Jan. 2010 - Mar. 2010
  4. 4. 2010] Role of Economics in Competition Law B-29 separate from one another or from the These two landmark cases illustrate the market for cans and containers generally. importance of economic analysis in The ECJ in effect insistent that, the determination of the correct relevant Commission should define the relevant market. Thus, emerged the economic product market and support its definition concepts of “demand side in a reasoned decision. For the purpose substitutability” and “supply side of delimiting the market, the ECJ in this substitutability” and the “Small but case enjoined the Commission to Significant Non-transitory Increase in investigate–“those characteristics of the Price” (SSNIP) test to determine both the products by virtue of which they are demand or supply side substitutability. particularly apt to satisfy an inelastic The SSNIP test was first deployed by the need and are only to limited extent Department of Justice and the Federal interchangeable with other products. Trade Commission under US Similarly, in United Brands v. competition law while analysing Commission (1978), where the Applicant horizontal mergers [Horizontal Merger was arguing that bananas were in the Guidelines (issued in 1992 and revised same market as other fruit, the ECJ said in 1997)]. As per this test “a market is the that this issue dependent on whether narrowest set of products for which a banana could be: “singled out by such hypothetical monopolist producing all special features distinguishing it from the products in that set would find setting other fruits that it is only to a limited a 5 per cent or 10 per cent margin above extent interchangeable with them and competitive price level as profitable”. is only exposed to their competition in This is also known as Hypothetical a way that is hardly perceptible”. In this Monopolist Test. This test has been used case, United Brands had successfully extensively by the European Commission convinced the Commission that banana in the Commission Notice on the was included in the common market of Definition of the Relevant Market for the “fruits” and their market share in the Purposes of Community Competition fruit market was not large and Law [1998]4 CMLR 177. therefore, it was not a dominant player. However, the SSNIP test which was The ECJ relying upon economic devised in the US in the context of merger analysis to determine the degree of cases has its limitation in the form of substitution or interchangeability of what came to be popularly known as the banana with other fruits and held that Cellophane Fallacy. This limitation of the because of the special characteristics SSNIP test came to be noticed for the first of banana, on which two kinds of time in the US in the case of United States people, either small children or too old v. El du Pont de Nemour and Co.351 US persons, without teeth, heavily 377 (1956). In this case, the US Supreme depend, banana cannot be included in Court committed an error by including the common market of “fruits” and that cellophane, which constituted less than the banana market was a market 20 per cent of all flexible packaging sufficiently distinct from other fresh materials in the US, as a part of the wider fruit markets. In the market for a market of flexible packaging materials by particular variety of banana viz., holding that cellophane was Chiquita banana, United Brands was interchangeable with numerous other having a market share of more than 40 materials and was a part of the market per cent. The fallacy in decision of the for flexible packaging materials and European Commission in the United competition from other packaging Brands case is, therefore, popularly materials in that market prevented known as the toothless fallacy. DuPont from exercising any monopoly Jan. 2010 - Mar. 2010 85
  5. 5. B-30 Competition Law Reports [Vol. 1 power in the supply of cellophane. The applied in an incorrect market then even Appellant, Du Pont in this case produced a monopolist who may be charging the almost 75 per cent of the cellophane sold monopoly price may be able to get in the US and since cellophane being a irrelevant products included in the set of separate packaging material which products for determining the SSNIP could only be used for packaging meat thereby, failing the test. Thus, SSNIP test and other edible products, it was, in fact is useful only when the competitive price a separate product which ought not to of the product is correctly determined have been included in the market of all which presupposes the correct flexible packaging materials. The error determination of the relevant product thus, committed by the US Supreme Court market without committing a cellophane whereby, a monopolist over cellophane fallacy. was held not to have misused its market Since all the abovementioned techniques power in the correct relevant product or test are required economic analysis market came to be known as the and the above mentioned tests have Cellophane Fallacy. become possible only through The effect of cellophane fallacy on the economics, the importance of economics SSNIP test is that if the market is not in market definition need no further correctly defined and the SSNIP test is emphasis. Copyright © M.M. Sharma * The author is “Head-Competition Law & Policy” at Vaish Associates, Advocates, New Delhi and an alumni of Kings College London. Views are personal. He can be contacted at e-mail: mmsharma@vaishlaw.com 86 Jan. 2010 - Mar. 2010