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Hidden inconsistencies

Personal views of author. Does not represent opinion or position of any institutions to which he is affiliated. Hidden inconsistencies. David Stallibrass. Shanghai | March 2013. Contents. Economics, assumptions, and the law Market shares and equilibrium Collusion and profit maximisation

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Hidden inconsistencies

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  1. Personal views of author. Does not represent opinion or position of any institutions to which he is affiliated. Hidden inconsistencies David Stallibrass Shanghai | March 2013

  2. Contents • Economics, assumptions, and the law • Market shares and equilibrium • Collusion and profit maximisation • Dominance and One Monopoly Profit • Conclusion

  3. Economics, assumptions, and the lawJoke Lawyer: when we find water, who will own it? Economist: Lets just assume we have some water. Engineer: how shall we get water?

  4. Economics, assumptions, and the lawBackground • All economic models require simplifying assumptions • In economic law – such as antitrust – the results of economic models inform the substantive application of the law “Even the most practical man of affairs is usually in the thrall of the ideas of some long-dead economist” JM Keynes

  5. Economics, assumptions, and the lawExample – market shares and mergers

  6. Economics, assumptions, and the lawQuestion in China • Has China imported assumptions from other jurisdictions that are not suitable for the Chinese economy? Assumptions about the European economy Assess? Assumptions about the Chinese economy Inform Imply European Law Chinese Law Based on

  7. Economics, assumptions, and the lawCaveat • Relative concision of Chinese antitrust decisions and guidance • Exercise is necessarily one of speculative explanation • But…throw some light on what might be different about antitrust in China

  8. Contents • Economics, assumptions, and the law • Market shares and equilibrium • Collusion and profit maximisation • Dominance and One Monopoly Profit • Conclusion

  9. Market shares and equilibriumUse of market shares in merger control • MOFCOM relies heavily on market shares • AML Article 27  HHI and market share • Notification form  2 years of market share • Proposal for fast-track (10% combined for horizontal, 20% for vertical) • Cases • All cases mention market share analysis • All but three include market shares • Google – just 1 quarter! • Delphi – “growing market shares” suggests dynamic analysis

  10. Market shares and equilibriumUse of market shares dominance • Less clear how important • AML article 19  presumptions of dominance • QQ / 360  very high market shares consistent across time, no decision yet • Baidu, J&J  market shares not sufficient (though perhaps market not well defined) • Ad-hoc nature means perhaps a little less important

  11. Market shares and equilibriumAssumptions behind market share use • Models of mergers utilize “comparative statics” Model of market before the merger (market shares imply cost, product differentiation, etc)  market shares ≈ market power Model of market after the merger (changes in price, production, output) ∆market shares ≈∆market power Change in market structure Requires equilibrium Assumes quickly move to new equilibrium

  12. Market shares and equilibriumAssumptions behind market share use • No authority relies totally on these models • PCAIDS / ALM experimentation by EU / OFT • But central to determining safe harbours • HHI and safe harbor discussions in the US (1970s and 1980s) still a major driver of thresholds in many jurisdictions • Substantial modern criticism • Market share a “lagging variable” • Requires definition of a market (which doesn’t really exist in reality)

  13. Market shares and equilibriumAssumptions behind market share use • The assumption of equilibrium requires: • The speed of economic change is slower than the speed of firms ability to react to it • In practice: • Change is slow: consumer tastes, regulatory landscape, business opportunities • Reactions are quick: access to capital, low regulation, easy entry

  14. Market shares and equilibriumDo the assumptions hold in China? • Are tastes and business opportunities moving very quickly? • High growth • Very large regional and sectoral variation • Can firms react quickly? • Extensive regulation • Limited and un-even access to capital markets • Conclusion: assumption less likely to hold than in Europe

  15. Market shares and equilibriumSuggestions for Chinese enforcement • Market shares a good proxy for young authorities • Limited resources • Learning • Provides legal clarity • Short-term changes • Ask for three years’ market share • Consider • Adopting GUPPI  doesn’t need market shares

  16. Market shares and equilibriumGUPPI introduction • “First round incentives” of horizontal mergers always to raise price Firm B Profit Cost of production Firm A Profit Firm C Profit Cost of production Cost of production

  17. Market shares and equilibriumGUPPI introduction • “First round incentives” of horizontal mergers always to raise price Firm B • If firm A raises price, loses sales, but makes extra profit on what it does sell. Profit Cost of production Firm A Profit Profit Firm C Profit Cost of production Cost of production Cost of production

  18. Market shares and equilibriumGUPPI introduction • “First round incentives” of horizontal mergers always to raise price Firm B • In this instance, it will not raise it’s price. Profit Increased profit < value of lost sales Cost of production Firm A Profit Profit Firm C Profit Cost of production Cost of production Cost of production

  19. Market shares and equilibriumGUPPI introduction • “First round incentives” of horizontal mergers always to raise price Firm B • Some of those sales go to competitors, who make extra profit Profit Cost of production Firm A Profit Profit Firm C Profit Cost of production Cost of production Cost of production

  20. Market shares and equilibriumGUPPI introduction • “First round incentives” of horizontal mergers always to raise price Firm B • If Firm A owned firm C then it would count firm C’s profit when it thought about raising it’s price Profit Cost of production Firm A Profit Profit Firm C Profit Cost of production Cost of production Cost of production

  21. Market shares and equilibriumGUPPI introduction • “First round incentives” of horizontal mergers always to raise price Firm B • In this case, it would raise it’s price Profit Increased profit of firm A and B > value of lost sales to firm A Cost of production Firm A Profit Profit Firm C Profit Cost of production Cost of production Cost of production

  22. Market shares and equilibriumGUPPI calculation • The real drivers of horizontal unilateral effects are not market share or market definition, but diversion ratio’s and profit margins. • A has a stronger incentive to raise prices if it either A loses a lot of customers to C when it raises it’s price, or C has very high profits Firm A Profit Profit Firm C Profit Cost of production Cost of production Cost of production

  23. Market shares and equilibriumGUPPI calculation • Two things we need to know for UPP • UPPA = Diversion RatioAC x Unit profitC • Maybe a lot easier than market definition! Diversion ratio (units diverted to Firm C as proportion of units lost by Firm A) Firm A Profit of Firm C Profit Profit Firm C Profit Cost of production Cost of production Cost of production

  24. Market shares and equilibriumGUPPI calculation • GUPPI puts that in context • GUPPIA = UPPIA / PriceA • In US, if < 5% then safe harbor. > 10% raises concerns Firm A Price of Firm A Profit Profit Firm C Profit Cost of production Cost of production Cost of production

  25. Market shares and equilibriumSummary • PRC enforcement (especially in mergers) very market share focused • May not be appropriate given nature of PRC economy • Could consider more direct ways of establishing competitive harm from mergers

  26. Contents • Economics, assumptions, and the law • Market shares and equilibrium • Collusion and profit maximisation • Dominance and One Monopoly Profit • Conclusion

  27. Collusion and profit maximisationPRC approach to collusion • Merger control • Co-ordinated effects commonly mentioned: the belief that the merger will increase the likelihood of collusion • Novartis / Alcon, HDD, Potash • All foreign firms. Nexus of competition often outside of China • Administrative enforcement • Unilever pricing intention case • Foreign and domestic firms, competing in China

  28. Collusion and profit maximisationAssumptions behind collusion analysis • Primary assumption: firms only collude if it is in their unilateral incentive to do so • Expected gains from collusion > expected cost • Collusion likely sustainable where • Firms are symmetric • Market is stable • Goods are homogenous • Collusion almost always harmful • Raises price and lowers quantity compared to non-collusion

  29. Collusion and profit maximisationDo the assumptions hold in China? • No strong evidence. But: • Large number of family owned firms • Theory that Chinese business sometimes more focussed on win-win than win-lose • Theory that Chinese businessmen sometimes care more about winning than maximising profit • Substantial state intervention • Trade associations may sustain collusion where otherwise it would fail • Etc. • Perhaps they hold less

  30. Collusion and profit maximisationImplications for enforcement • Enforcement – perhaps correct to be more concerned • If features of market suggest collusion more likely • No evidence that increased Chinese concern is linked to characteristics of Chinese business • In mergers, all firms were foreign, and nexus of business largely outside China • In administrative enforcement, then increased concern may be acceptable

  31. Collusion and profit maximisationImplications for enforcement • There may be situations where cartel enforcement would be welfare reducing • Current “Chinese equilibrium” sustains cartel with large number of firms (quantity high, price medium, output high, employment high) • Busting the cartel leads to standard competition • If market is highly competitive, then inefficient firms will leave the market until remaining firms re-enter tacit collusion • This new collusion may involve lower production than previous • Welfare effects may be ambiguous •  Further research required

  32. Contents • Economics, assumptions, and the law • Market shares and equilibrium • Collusion and profit maximisation • Dominance and One Monopoly Profit • Conclusion

  33. Dominance and One Monopoly ProfitPRC approach to Leveraging • Merger control appears open to the idea of a dominant firm “leveraging” market power from one market into another • CocaCola • WalMart • Shenhua • Decisions are short and not much detail is given

  34. Dominance and One Monopoly ProfitLeveraging theory • Before merger, Firm 1 is dominant in Market A Market B Market A Firm 3 Firm 1 Producers Firm 4 Firm 5 Firm 6 Firm 2 Firm 7 Consumer Consumers

  35. Dominance and One Monopoly ProfitLeveraging theory • Firm 1 buys firm 3 in market B Market B Market A Firm 3 Firm 1 Producers Firm 4 Firm 5 Firm 6 Firm 2 Firm 7 Consumer Consumers

  36. Dominance and One Monopoly ProfitLeveraging theory • Firm 1 bundles the two goods together… Market B Market A Firm 3 Firm 1 Producers Firm 4 Firm 5 Firm 6 Firm 2 Firm 7 Consumer Consumers

  37. Dominance and One Monopoly ProfitLeveraging theory • Forcing other firms out of the market Market B Market A Firm 3 Firm 1 Producers Firm 2 Firm 7 Consumer Consumers

  38. Dominance and One Monopoly ProfitLeveraging theory • But the Chicago school (1970s, 1980s) says this is wrong: • Before the merger, Firm 1 already charging “monopoly price” • Forcing customers to buy the good of Firm 3 when previously they didn’t want to is the same as lowering the price of the good of Firm 1 • This would be unprofitable, since they are already charging the profit maximising price for the good of Firm 1 •  Firm 1 has only “one monopoly profit” which it has already extracted – it can not extract it again! • Post-chicago modifies this, but Chicago school still starting point for most analysis

  39. Dominance and One Monopoly ProfitApplication in other jurisdictions • EU comparison • DGCOMP, ‘EU non-horizontal guidelines’, 2008: "it is acknowledged that conglomerate mergers in the majority of circumstances will not lead to any competition problems.“ • CFI (Tetra Lavell): “Since the effects of a conglomerate-type merger are generally considered to be neutral, or even beneficial, for competition on the markets concerned, ... the proof of anti-competitive conglomerate effects of such a merger calls for a precise examination, supported by convincing evidence, of the circumstances which allegedly produce those effects.” • Pure leveraging theory of harm is not credible • Other arguments necessary: Raising rivals costs, Increased ability and incentive to foreclose, Increased ability and incentive to predate, etc.

  40. Dominance and One Monopoly ProfitKey assumption behind Chicago School • All firms are profit maximising • Even dominant firms

  41. Dominance and One Monopoly ProfitDoes the assumption hold in China? • Substantial intervention of state into management of firms • Large firms  SOE’s • Medium and small firms  Local development plans • Different firm objective • Sustain status quo? • Sense of civic responsibility? • OMP may not hold

  42. Dominance and One Monopoly ProfitImplications for enforcement • Leveraging theories of harm may be more plausible in China • Monopoly profit not yet extracted in Market A, so may try and extract some in Market B through bundling / tying • Power of government intervention may force firms to accept the bundle, despite not wanting to do so • But unclear whether merger cases are compatible with this • Do not appear to be firms with substantial state involvement

  43. Contents • Economics, assumptions, and the law • Market shares and equilibrium • Collusion and profit maximisation • Dominance and One Monopoly Profit • Conclusion

  44. ConclusionProblem of identification • PRC decisions are short • Hard to know why they were made • Hard to know what assumptions underpinned analysis • Makes it hard for external observers to understand • Lawyers less able to advise firms • Firms less able to self-police • Government less able to benefit from advice and support of academia

  45. ConclusionMixed sensitivity to different assumptions • PRC enforcement appears to have a strong focus on market shares • Not consistent with analysis of economic differences • PRC enforcement appears to be more concerned about collusion • Generally consistent with analysis of economic differences, but unclear in particular cases • PRC enforcement appears to be more concerned about leveraging market power • Generally consistent with analysis of economic differences, but unclear in particular cases

  46. ConclusionFurther work • RPM in China – a two headed dragon • Practical analysis of GUPPI vs. Market Shares in PRC merger control • Modelling of “Chinese collusion equilibrium” • “Chicago in Shanghai”: how the Chicago school applies to Chinese antitrust

  47. Contact details • economics@davidstallibrass.com • PRC Tel: (+86) 186 1307 4004 • www.davidstallibrass.com

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