Bringing more economic perspectives to competition policy & law

Speakers: 
Mr Rod Sims, Chairman
Conference: 
RBB Economics Conference, Sydney
7 November 2014

ACCC Chairman Rod Sims delivers the keynote address to the RBB Economics Conference in Sydney. The speech makes three vital points. First, the once in 20 year review of competition policy is an opportunity to make a choice about section 46 (misuse of market power) of the Competition and Consumer Act. Second, the Harper Panel’s draft recommendations on extending the Act to cover more government activities is one of its most important proposals. Third, issues around competition advocacy and market studies need to be debated and decided in the context of the competition review.

Transcript: 

Check against delivery

Introduction

My thanks to RBB for inviting me to speak today. This has become my once a year opportunity to speak at a conference organised by economists.

The Competition Policy Review appropriately has a wide Terms of Reference. The Review Panel has done an excellent job in identifying areas for reform that, if implemented, will result in significant improvements in productivity and the living standards of Australians.

Some of the Harper Review Panel’s draft proposals have gained less attention than they deserve.

The Harper Review Panel has proposed reforms to the delivery of human services; cost-reflective road pricing; removing cabotage restrictions on coastal shipping; de-regulating  trading hours recognising that internet trading never stops; and so on. These are important microeconomic reforms.

In a recent speech, Ken Henry linked the important microeconomic reforms during the 1980s and 1990s to mercantilism. Ken reminded us that Adam Smith in 1776 pointed out that the then prevailing mercantilism was completely misguided.

Ken argued that the decisions to reduce tariffs on imported goods, to deregulate the labour market, to reform national competition policy and to reform indirect taxes were motivated, or at least sold to the public, on the basis they will drive exports and hence employment growth.

Mercantilist thinking has on occasion influenced public policy. Some parts of our Competition and Consumer Act 2010 (the Act) are a case in point.

For example, merger authorisations are to be made directly to the Australian Competition Tribunal, which must not grant authorisation unless it is satisfied that the proposed acquisition is likely to result in such a benefit to the public that it should be allowed to occur. The Act specifically provides that the Tribunal must regard a significant increase in the real value of exports and a significant substitution of domestic products for imported goods as benefits to the public.

Mercantilism did play a role in selling some of the early reforms of the Hawke Government. The first microeconomic reform sub-committee of that Government that I can remember, for example, was the Cabinet Sub Committee on Trade Competitiveness.

Where I disagree with Ken, however, is that in my view those in the Governments that introduced these reforms, and those advising them in pushing the microeconomic reform agenda, had a clear goal which was often stated; to remove impediments to competition and the flexible operation of markets in order to improve productivity and in turn the welfare of all Australians.

The microeconomic reforms of the 1980s and 1990s were good policy in their own right, independent of any effect on exports or the balance of trade.

The same can be said for the microeconomic reforms proposed by the Harper Review Panel in their Draft Report. They will enhance productivity and improve the well-being of Australians.

Convincing the public to embrace microeconomic reform can be difficult. I agree with Ken that we need to explain why these reforms are necessary and how they will generate benefits in a clear and intuitive manner.

To me, however, is it so hard to explain the benefits of increased choice?

Continuing my theme of the welfare of all Australians, my focus today will be on some of the competition law aspects of the Competition Policy Review. I will discuss:

  • how this economist finds our current section 46 drafting very strange indeed
  • why I think the Harper Panel’s draft recommendation on extending the CCA to cover more government activities is one of its most important, and
  • the benefits of the ACCC playing a role in competition advocacy and doing market studies.

But first, given that this is an economists’ conference, I want to explain why Adam Smith, again, deserves credit, this time for Immunity Policies. My lawyers have not let me reveal this before.

Adam Smith as the father of immunity policies

We are all aware that Adam Smith said:

“People of the same trade seldom meet together, even for merriment or diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

However, few recall that he then immediately said:

“It is impossible, indeed, to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice.”

Adam Smith, therefore, clearly spelt out the difficulties in detecting and preventing cartels. A couple of hundred years later our good friends at the United States Department of Justice solved this problem when they formulated their first immunity policy for cartel conduct.

I think that those who clearly define a problem, however, should get at least as much credit as those who solve it.

So we have even more to thank Adam Smith for. This is, of course, very important in the constant battle between economists and lawyers for ownership of the soul of competition policy and law.

One economist’s perspective of section 46 of the Act

One part of the Review Panel’s work that has probably gained more attention than may be warranted is section 46 of the Act. That is not to say that misuse of market power or abuse of dominance laws are not important. They are.

Firms with new ideas and technologies and the drive to meet the changing needs of consumers are a constant threat to firms with market power. These firms are important drivers of productivity growth in their own right. The threat they pose also encourages incumbent firms to continually do better.

Misuse of market power laws must prevent firms with substantial market power from using that power to stifle competition and innovation. They must also, of course, allow firms with market power to compete on their merits, including using the advantages that come with their scale and experience. The balance can be a difficult one.

From this economist’s view, and as someone who has advised some of Australia’s top companies on commercial strategy for nearly 20 years, Australia’s current section 46 seems extremely odd, for three reasons.

First, the focus in section 46 is on competitors rather than competition. The provision outlaws a corporation that has a substantial degree of market power from taking advantage of that power for the purpose of, among other things, eliminating or substantially damaging a competitor.

Yet this is exactly what vigorous competition does. Firms that make a better offer to consumers and win sales necessarily hurt or damage their competitors.

I have recently been asked whether the current increases in production by BHP and Rio are a misuse of market power. Surely their behaviour is damaging their competitors.

When I answered this question I instinctively used a substantial lessening of competition (SLC) framework to explain why in the circumstances, it was not a misuse of market power. This makes intuitive sense.

To explain that it was not a misuse of market power because there was no “taking advantage” is both hard to explain, and it implies an acceptance of a problem when there is none.

I am in this position very often. As another example, I am often told that when a supermarket opens in a new geographic area, that the existing shops will be substantially damaged. I am then asked: what is the ACCC going to do about it?

Of course, there is no SLC in this case, although there may be harm to individual competitors in the market.

In explaining why they think the Harper Panel’s recommendations on section 46 will damage competition the Australian National Retailers Association last week said:

Competition can be bruising, any change to competition law should be directed towards protecting the competitive process rather than individual competitors”

We completely agree: indeed, this is the ACCC’s argument as to why section 46 needs to change.

The second problem is with the taking advantage element of the provision. As we all know the take advantage element is supposed to provide the filter for distinguishing between pro-competitive conduct and anti-competitive conduct. But it does this in a curious and confusing way.

A common approach to assessing whether a firm has taken advantage of its substantial market power is to ask: would a firm behave in the same manner in the absence of such power? Answering this question requires a court to predict the behaviour of a hypothetical firm in a hypothetical market.

Unsurprisingly, the courts struggle with this hypothetical analysis.

Worse, it fails to understand that the same action taken by a firm with and without market power can have different intent and consequences. For example, we are not worried about exclusive dealing or mergers by firms with a small market share.

Take advantage seems a flawed and illogical filter.

Third, section 46 is only concerned with the purpose of the conduct, not its effect.

Business leaders often say to me: “Rod, at my company we do not set out to break the law.” I can accept that.

But the test for misleading and deceptive conduct, for example, does not include intent.

Companies simply strive to maximise profits and sometimes cross important lines. This can happen with misleading and deceptive conduct, agreements that SLC and, surely, with a misuse of market power.

I have heard concerns from many leaders in the business community about an effect of SLC test. It seems to me those concerns are based on a misunderstanding.

Some business leaders have said that, for example, when they innovate, actively compete on price or enter a new geographic market, and the result is that they succeed and most others fail, they fear their outcomes will have the effect of SLC.

This confuses the outcome with how you get there. To be held to have substantially lessened competition you have to do something anti-competitive; pro-competitive behaviour, whatever the outcome, cannot be held to SLC.

As we have said, the ACCC sees anti-competitive behaviour as essentially exclusionary; it must affect the process of competition itself.

New innovation, aggressive discounting (provided it is not below cost for a sustained period), and new market entry, are all pro-competitive and, in our view, cannot have the effect of SLC.

Pricing below cost for a sustained period, purchasing all available inputs to production beyond your own needs, refusing to supply, high levels of price rebates only if minimum purchase levels are reached, can all be anti-competitive. Such actions would only likely trigger the ACCC’s interest if they are exclusionary. The facts would then be examined to determine if there was the purpose or effect of SLC.

To repeat, to SLC there must first be behaviour that could be seen as anti-competitive. There cannot be an SLC through competition on is merits.

 This is not just the ACCC’s view, it is also that of the courts. For example, an agreement by two small companies to collaborate on innovation to take on larger rivals would be seen as pro-competitive by the courts, applying section 45 as it is now, even if the effect of the behaviour was that they eventually became dominant.

With this once in 20 years review of competition policy and law we have a choice.

We can either stay with a known, but flawed law which currently has limited utility, causes many unnecessary arguments, and could be used to prevent pro-competitive behaviour, or we can seek to pursue the objective of the Act, to enhance “the welfare of Australians” by, as other key sections of the CCA do, focussing on the purpose or effect of SLC.

 It cannot help “the welfare of Australians” to focus on the damage to an individual competitor; to spend countless hours determining whether a smaller company could have done the same thing, as if that matters; and to disregard the actual effect of the behaviour.

I wonder whether we have all invested so much in the flawed logic of Section 46 that we no longer see the wood for the trees.

We can use the Harper Review to pose some broader and overdue questions about the logic and utility of section 46, as indeed the Harper Panel itself had done.

Role of governments in competition

The Hilmer review 20 years ago extended the reach of the CCA to cover government business enterprises. This was a big step.

The Harper Panel is also recommending a big step, which can have a profound effect.

The  draft report includes a discussion on Government procurement activities, and notes there are many circumstances in which the Crown participates in markets, sometimes with a substantial presence, but may not necessarily ‘carry on a business’ for the purposes of the CCA.

This is contrasted with other jurisdictions, such as New Zealand, where “the Crown is subject to almost all the same penalties as private sector organisations, including third party damages and other court orders”.

The Harper Panel concludes that “through its commercial transactions entered into with market participants, the Crown….has the potential to harm competition”, and therefore recommends that the “Crown should be subject to the competition law insofar as it undertakes activity in trade or commerce”.

This is a logical extension of the NCP reforms undertaken to date, as the Harper Panel recognises. The same reasoning is, of course, also relevant to other issues raised by the ACCC in its submission to the Harper Panel, and which are acknowledged elsewhere in the Draft Report.

In particular, the actions taken by governments in the course of operating and/or privatising major infrastructure or other assets can have profound and long-term effects on competition. These ultimately flow on to consumers in the form of higher prices or reduced levels of quality or innovation.

The Harper Panel’s recommendation on the Crown being subject to competition law when it undertakes activity in trade or commerce may also apply to such actions.

The ACCC is aware of several examples of governments privatising assets with provisions that are likely to have the purpose or effect of restricting competition. Our submission, and the Panel’s draft report, highlighted the example of the Commonwealth privatising Sydney Airport, and bundling into the sale the right of first refusal to operate a second airport.

Clearly the structure of such transactions can also have material impacts on competition in significant markets upstream and downstream. Equally clearly, these transactions have a strongly commercial flavour to them.

When these issues arise, it is common for governments to argue, often quite legitimately, that they have good reasons for acting in ways that may inhibit competition. For example, the development of major new infrastructure facilities might mean a government has to invest considerable time, expense and inconvenience in building new roads to deal with increased traffic.

However, it seems that the spirit of the Harper Panel’s recommendations strongly supports a view that the manner in which such issues are dealt with matters.

Including anti-competitive provisions in contracts that are hidden from public view is not the appropriate way for governments to engineer particular policy outcomes.

The ACCC’s initial submission to the Harper Panel noted that governments have an explicit power under section 51(1) of the Act to legislate that certain conduct is exempt from the application of Part IV. Legislative processes would be preferable to not having anti-competitive actions caught by the Act.

They make public the cost to competition from the government’s policy decisions, and invite scrutiny as to whether restrictions on competition are in fact the best way to achieve the desired policy goal.

The ACCC has recommended, though, that any such exemptions be strictly time limited and, if they remain in the public interest, legislated again.

An alternative approach, and one that would apply if the government action falls within the scope of the Act, is for governments to seek authorisation of the conduct on public benefit grounds under Part VII of the Act.

Better still is that the anti-competitive restrictions are not imposed at all. In many cases policy goals can be achieved without closing off the prospect of competition.

Competition advocacy and market studies

Competition advocacy and market studies are closely linked. It is important that these issues are debated and decided in the context of our first comprehensive review of competition policy in 20 years.

The issues of competition advocacy and market studies raise many important questions, for example:

  • How pro competition does Australia want to be?
  • Do we need a new institution for these tasks or should we use what we have?
  • Do we wish to align with overseas practice in those areas?
  • Do we wish the ACCC to be, in competition and consumer matters, primarily an enforcement agency, or to have a broader toolkit, to quote the object of the CCA: “to enhance the welfare of Australians through the promotion of competition and fair trading and provision for consumer protection”?

Let me illustrate.

Advocacy

As well as participating in commercial activity, there is a great deal done by all levels of Government that has an impact on competition and consumers.  For example, Governments make planning decisions about where commercial premises can operate, they set rules about the hours shops can be open, they grant licences to explore for minerals and they make rules about how particular commercial activities should be conducted.  While the role of government in these instances is to act on behalf of the broader public interest, these decisions can also have an impact on competition.  Such anticompetitive outcomes may not otherwise be a breach of the CCA.

This problem is addressed in many countries by giving competition agencies an ‘advocacy’ function which empowers agencies to address public restrictions on competition.  Advocacy usually involves the promotion of a competitive environment by examining markets, seeking to understand barriers to competition and then proposing ways to remove those barriers.  From time to time this role has been performed in Australia in a limited way by the National Competition Council, the Productivity Commission, the ACCC and some state agencies such as IPART, the Essential Services Commission and the Queensland Competition Authority.

The draft Harper panel report suggests this may be a function of a proposed new agency. Internationally, competition review of such government and administrative regulation is usually a core responsibility for competition agencies.

An even more formal competition advocacy function has been conferred on many overseas competition agencies.  For example, in Korea, the Korean Fair Trade Commission has a specific power to assess government regulation and then recommend anticompetitive rules be amended or set aside.  In Italy the Italian Competition Authority has time set aside twice a year in the Parliamentary schedule to propose legislation to repeal competition restrictions in Italian law.

The ACCC supports establishing a stronger framework in Australia to facilitate scrutiny of restrictions on competition.  Restrictions should be both in the public interest and have objectives which can only be achieved by maintaining them. Legislation and regulation which restricts competition when appropriate could also be subject to sunset provisions, as I have just mentioned.

The Panel’s draft report, in its recommendations regarding competition institutions, expresses the view that “the ACCC should not undertake competition policy advocacy…as this may compromise stakeholder perceptions of impartiality”. However, the lines between competition enforcement, economic regulation and competition advocacy are at times grey.

We consider they may best be navigated by an agency, such as the ACCC, with well developed expertise in dealing with competition issues at a practical level.

Ultimately it will be a decision for the Federal Government to determine what is the most effective model for Australia.

Market studies

The International Competition Network (ICN) makes the point that market studies have a long history. Since the early 20th century in the United States, and in Japan, since 1947.  At least 40 competition authorities use market studies as part of their portfolio of tools.

The ICN also notes that:

“Market studies are generally performed for one of two reasons: either as a lead-in to enforcement action when anticompetitive behaviour is suspected in a sector but competition authorities do not know the exact nature and source of the competition problem; or as a lead-in for competition advocacy, where no violation of competition laws is suspected but it appears that the market is not functioning well for consumers. This may be due to public restrictions on competition or inefficient market equilibria. In such cases a market study can identify the root causes of any dampening of competition and formulate appropriate remedies. These can include recommendations to government or other decision makers for regulatory or policy change, or encouraging market participants to take voluntary action to stimulate competition.”

In these circumstances, I do not think the idea of the ACCC having a market study power is particularly radical. As I have said, many overseas competition regulators have this ability, and having a broader toolkit can take the focus away from relying on enforcement.

Such a role could be helpful to both businesses and governments in allowing markets to work better, without committing them to action. Indeed, they may make clear that no particular action is needed, and that markets are in fact working effectively.

To conclude, we have many debates before us now. Sound economics, as always, can make a valuable contribution to addressing them.

Thank you for your time today.