1. Competition, mergers and antitrust policies
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

2. Market Size Matters
European leaders always viewed integration as compensating small size of European nations.
Implicit assumption: market size good for economic performance.
Facts: integration associated with mergers, acquisitions, etc.
In Europe and more generally, ‘globalisation.’
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

3. Facts M&A activity is high in EU.
much M&A is mergers within member state.
about 55% ‘domestic.’
Remaining 45% split between:
one is non-EU firm (24%),
one firm was located in another EU nation (15%),
counterparty’s nationality was not identified (6%).
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

4. Facts Distribution of M&A quite varied:
Big 4: share M&As much lower than share of the EU GDP.
I, F, D 36% of the M&As, 59% GDP.
Except UK.
Small members have disproportionate share of M&A.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

5. Facts Why M&A mostly within EU? Why UK’s share so large?
Non harmonised takeovers rules.
some members have very restrictive takeover practices, makes M&As very difficult.
others, UK, very liberal rules.
Lack of harmonisation means restructuring effects very impact by member states.
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6. Theory: Economic Logic Verbally
liberalisation 
de-fragmentation 
pro-competitive effect 
industrial restructuring (M&A, etc.)
RESULT: fewer, bigger, more efficient firms facing more effective competition from each other.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

7. Economic logic: background
Monopoly case
Demand
Curve
Price
Price
Marginal Revenue
Curve
Marginal
Cost Curve
Demand
Curve P’ P* A P” B D
Marginal
Cost C E Q’ Q*
Q’+1
Sales
Sales
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

8. Economic logic: background
Duopoly case, example of non-equilibrium
price
price
Firm 1’s expectation of sales by firm 2, Q2
Firm 2’s expectation of sales by firm 1, Q1
p1’
Demand
Curve (D)
Demand
Curve (D)
p2’
Residual Demand
Curve firm 1 (RD1)
Residual Demand
Curve firm 2 (RD2) A1 MC A2 MC
x1’
Firm 1 sales
x2’
Firm 2 sales
Residual Marginal Revenue
Curve firm 1 (RMR1)
Residual Marginal Revenue
Curve firm 2 (RMR2)
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

9. Economic logic: background
Duopoly & oligopoly case, equilibrium outcome
price
Typical firm’s expectation of the other firm’s sales
price
Typical firm’s expectation of other the other firms’ sales p* D D
p** RD
RD’ A MC A MC
RMR
RMR’
sales x*
2x*
x**
sales
3x**
Duopoly
Oligopoly
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

10. BE-COMP diagram mmono mduo m’ n’ BE (break-even) curve COMP curve n=1
Mark-up (m)
COMP
curve
BE (break-even) curve m’ n’
mmono
mduo
n=1
n=2
Number of firms
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

11. Details of COMP curve p' mmono p" mduo D R-D (duopoly) Marginal cost
Mark-up
price p'
mmono A’
p"
mduo B’ D
Monopoly
mark-up
Duopoly
mark-up
COMP
curve
R-D (duopoly)
Marginal cost
curve MC B A
Number of firms
n=1
n=2
R-MR
MR (monopoly)
Typical firm’s sales
xduo
xmono
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12. Details of BE curve BE Home market po=mo+MC Demand curve A AC>po
Mark-up
(i.e., p-MC)
euros
price
Home market
po=mo+MC
Demand curve BE A
AC>po
ACo=po B A po mo B
AC<po AC MC n” no n’
Number of firms
Sales
per firm Co
Total
sales
x”= Co/n”
x’= Co/n’
xo= Co/no
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

13. Equilibrium in BE-COMP diagram
euros
Price
Mark-up
Home market
Demand curve BE E’ E’ p’ p’ m' E’ AC
COMP MC n’
Number of firms x’
Sales
per firm C’
Total
sales
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

14. No-trade-to-free-trade integration
euros
price
Mark-up
Home market only
Demand curve BE
BEFT E’ E’ E’ 1 p’ p’ m' C E” E” E” p” p” A mA A pA AC
COMP MC n’ n”
2n’
Number of firms x’ x”
Sales
per firm C’ C”
Total
sales
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

15. Economic Logic
Integration: no-trade-to-free-trade: BE curve shifts out (to point 1).
Defragmentation:
PRE typical firm has 100% sales at home, 0% abroad; POST: ,
Can’t see in diagram.
Pro-competitive effect:
Equilibrium moves from E’ to A: Firms losing money (below BE).
Pro-competitive effect = markup falls.
short-run price impact p’ to pA.
Industrial Restructuring:
A to E”,
number of firms, 2n’ to n”.
firms enlarge market shares and output,
More efficient firms, AC falls from p’ to p”,
mark-up rises,
profitability is restored.
Result:
bigger, fewer, more efficient firms facing more effective competition.
Welfare: gain is “C”.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

16. Competition & Subsidies
2 immediate questions:
“As the number of firms falls, isn’t there a tendency for the remaining firms to collude in order to keep prices high?”
“Since industrial restructuring can be politically painful, isn’t there a danger that governments will try to keep money-losing firms in business via subsidies and other policies?”
The answer to both questions is “Yes”.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

17. EU’s role Exclusive competency of EU; Commission controls.
2 aspects: mergers & anti-competitive behaviour.
Look at justification for putting competition policy at the EU level.
Spillovers (negative effects of one Member’s subsidies on other Members’ industry).
Need belief in ‘fair play’ if integration is to maintain its political support.
Witness recent ‘protectionist’ tendency of Member States to prevent foreign takeovers.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

18. Recall: Economic Logic
Integration: no-trade-to-free-trade: BE curve shifts out (to point 1).
Defragmentation:
PRE typical firm has 100% sales at home, 0% abroad; POST:
Can’t see in diagram.
Pro-competitive effect:
Equilibrium moves from E’ to A: Firms losing money (below BE),
Pro-competitive effect = markup falls,
short-run price impact p’ to pA.
Industrial Restructuring”
A to E”,
number of firms, 2n’ to n”,
firms enlarge market shares and output,
More efficient firms, AC falls from p’ to p”,
mark-up rises,
profitability is restored.
Result:
bigger, fewer, more efficient firms facing more effective competition.
Welfare: gain is “C”.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

19. Competition & State aid (subsidies)
2 immediate questions
“As the number of firms falls, isn’t there a tendency for the remaining firms to collude in order to keep prices high?”
“Since industrial restructuring can be politically painful, isn’t there a danger that governments will try to keep money-losing firms in business via subsidies and other policies?”
The answer to both questions is “Yes”.
Turn first to the economics of subsidies and EU’s policy
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

20. Anti-competitive behaviour
Collusion is a real concern in Europe.
dangers of collusion rise as the number of firms falls.
Collusion in the BE-COMP diagram.
COMP curve is for ‘normal’, non-collusive competition
Firms do not coordinate prices or sales.
Other extreme is ‘perfect collusion’.
Firms coordinate prices and sales perfectly.
Max profit from market is monopoly price & sales.
Perfect collusion is where firms charge monopoly price and split the sales among themselves.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

21. Economic effects
Collusion will not in the end raise firm’s profits to above-normal levels.
2n’ is too high for all firms to break even.
Industrial consolidation proceeds as usual, but only to nB. Point B Zero profits earned by all.
prices higher, pB> p”, smaller firms, higher average cost.
Mark-up
BEFT
mmono
Perfect
collusion A B pB E”
Partial
collusion p”
COMP
n=1 n” nB
2n’
Number of firms
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

22. Economic effects The welfare cost of collusion (versus no collusion).
four-sided area marked by pB, p”, E” and B.
price
Demand curve
Mark-up
BEFT
pmono
mmono
Perfect
collusion A B B pB E”
Partial
collusion E” p”
COMP
n=1 n” nB
Number of firms
Total
sales CB
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

23. EU Competition Policy
To prevent anti-competitive behavior, EU policy focuses on two main axes:
Antitrust and cartels. The Commission tries:
to eliminate behaviours that restrict competition (e.g. price-fixing arrangements and cartels),
to eliminate abusive behaviour by firms that have a dominant position.
Merger control. The Commission seeks:
to block mergers that would create firms that would dominate the market.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

24. Economics of cartels Suppose price without cartel would be P.
Cartel raises price to P’.
DCS=-a-b; ‘ripoff’
DPS=+a-c
Net welfare = -b-c ; “technical inefficiency”
euros
Quantity C’ C P’ P AC a b c
Demand curve
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

25. The vitamin cartels (Box 11‑1)
In 2001, Commission fined 8 companies for vitamins cartels
vitamins A, E, B1, B2, B5, B6, C, D3, Biotin, Folic acid, Beta Carotene and carotinoids
The European vitamins market is worth almost a billion euros a year.
The firms fixed prices, allocated sales quotas, agreed on and implemented price increases and issued price announcements in according to agreed procedures.
They set up a mechanism to monitor and enforce their agreements and participated in regular meetings to implement their plans.
Formal structure with senior managers to ensure the functioning of the cartels: the exchange of sales values, volumes of sales and pricing information on a quarterly or monthly basis at regular meetings, and the preparation, agreement and implementation and monitoring of an annual "budget" followed by the adjustment of actual sales achieved so as to comply with the quotas allocated.
Hoffman-La Roche of Switzerland (cartel ringleader) received the largest fine (462m euros); BASF and Merck (Germany), Aventis SA (France), Solvay Pharmaceuticals (the Netherlands), Daiichi Pharmaceutical, Esai and Takeda Chemical Industries (Japan).
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

26. Exclusive territories
More common anti-competitive practice is ‘exclusive territories’.
Nintendo example; high prices in Germany vs UK.
Germany’s inelastic demand meant Nintendo wanted to charge a higher price than in UK.
Normally Single Market limits this sort of price discrimination (arbitrage by firms).
Nintendo implemented a system that prevented arbitrage within the EU (illegal).
European Commission fined Nintendo and the 7 distributors 168 million euros.
euros
Quantity
PGermany
PUK
DGermany
DUK MC
MRGermany
MRUK
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

27. Abuse of dominant position
Firms that are lucky or possess excellent products can establish very strong positions in their market.
Not a problem, per se:
position may reflect superior products and/or efficiency,
e.g. Google’s triumph.
However dominance may tempt firm to extract extra profits from suppliers or customers.
Or arrange the market to shield itself from future competitors.
Illegal under EU law ‘abuse of dominant position.’
e.g. Microsoft with media software:
Charge high price of Word, etc. where the competition has been driven out of biz (WordPerfect, etc.), but give for free all software where there is still competition.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

28. Merger control Initially P=AC.
Merger implies lower AC to AC’, but raises the price to P’.
DCS=-a-b; ‘ripoff’.
DPS=+a+c.
Net welfare = -b+c ; ambiguous, ‘efficiency defence’.
Laissez-faire (in US and increasingly in EU); if free entry then eventually P driven down to AC’.
As in BE-COMP diagram.
euros
Quantity C’ C P’
P=AC a b c
Demand curve
AC’
Williamson diagram
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29. State aid economics Look at two cases: Restructuring prevention.
Unfair competition.
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30. Restructuring prevention
Consider subsidies that prevent restructuring.
Specifically, each government makes annual payments to all firms exactly equal to their losses:
i.e. all 2n’ firms in Figure 6-9 analysis break even, but not new firms.
Economy stays at point A.
This changes who pays for the inefficiently small firms from consumers to taxpayers.
Mark-up BE
BEFT E’ 1 m' E” mA A
COMP n’ n”
2n’
Number of firms
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

31. restructuring prevention: size of subsidy
Pre-integration:
fixed costs = operating profit = area “a+b”.
Post-integration: operating profit = b+c.
ERGO: Breakeven subsidy = a-c .
NB: b+c+a-c=a+b.
euros
Price
Mark-up
COMP
Demand curve
BEFT E’ E’ p’ a AC A A pA pA A b c MC
2n’
Number of firms
Sales
per firm
Total
sales x’ C’ CA
xA= 2CA/2n’
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

32. restructuring prevention: welfare impact
Change producer surplus = zero (profit is zero pre & post).
Change consumer surplus = a+d.
Subsidy cost = a-c.
Total impact = d+c.
euros
Price
Mark-up
COMP
Demand curve
BEFT E’ E’ p’ a AC d A A pA pA A b c MC
2n’
Number of firms
Sales
per firm
Total
sales x’ C’ CA
xA= 2CA/2n’
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

33. Only some subsidise: unfair competition
If Foreign pays ‘break even’ subsidies to its firms,
All restructuring forced on Home,
2n’ moves to n”, but all the exit is by Home firms.
Unfair.
Undermines political support for liberalisation.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

34. EU policies on ‘State Aids’
1957 Treaty of Rome bans state aid that provides firms with an unfair advantage and thus distorts competition.
EU founders considered this so important that they empowered the Commission with enforcement.
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35. © Baldwin & Wyplosz 2006. The Economics of European Integration, 2nd Edition

36. Microsoft case Chronology
Source: European Commission & Financial Times
Chronology
1998: Complaint from Sun Microsystems. Microsoft was refusing it information necessary to interoperate with Microsoft’s dominant PC operating system
2000: The Commission sent Microsoft a Statement of Objections.
2001: The Commission sent a second Statement of Objections.
2003: A third Statement was sent.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

37. Microsoft case
Microsoft reacted to each Statement and requested an Oral Hearing (2003)
2004: “The decision” (by the Commission)
Microsoft abused its dominant position
in the PC operating system
Refusing to supply competitors information.
Then, Microsoft has to disclose information in 120 days
Harming competition through the tying of its separate Windows Media Player
Then, Microsoft has to provide (in 90 days) a version of Windows without Windows Media Player.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

38. Microsoft case
In June 2004, Microsoft lodged an action for annulment of the Decision.
Why ? Microsoft would suffer from serious and irreparable damage:
Harm its intellectual property rights
Interfere with its commercial freedom
Alter market conditions.
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition

39. Microsoft case
The Court of First Instance delivered its judgement on September The Commission was right
Microsoft has to pay a fine: 497 million €
Microsoft reaction:
. Allow access to interoperability information
. Information will cost € one-off fee rather than a percentage of revenues
Failing to comply with 2004 decisions, the European Commission fined Microsoft a record € 899 m (2008)
© Baldwin & Wyplosz The Economics of European Integration, 2nd Edition