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Students Zone - Answers to End of Chapter Questions

CHAPTER 10 INDUSTRY POLICY AND COMPETITION POLICY

1. The Lisbon Agenda, or the Lisbon strategy, aims to establish the European Union as the most competitive economy in the world by 2010. What are the chances of this becoming reality? How do you think that either EU IP or CP could help in achieving these goals for the European Union?

Answer

Students should refer to relevant EU websites for up to date statements about the Lisbon Agenda and developments with it. Also press releases from the EU Competition Office will be helpful.

Cynicism should be avoided in answering a question like this, but it may be difficult not to be sceptical with reference to the hopes and ideals of the Lisbon Agenda. The EU still lags behind the USA and other countries, like Korea for example, in terms of international competitiveness. However there may be agreement, in principle at least, that IP and CP could and should contribute to improving European competitiveness. After all increasing competitiveness is the rationale of CP! So IP and CP could help. The problem as to whether IP and CP will help is complicated by political differences between member states. The European Union may be seen by some as a union more in name than in practice when we see the reluctance of many member states to give up their policies of support for domestic companies through state aid and public procurement procedures.

2. Both Lynch and Ferguson have approaches to classifying IP. Describe both UK and EU IP using both of their models.

Answer

Both Lynch and Ferguson and Ferguson do, indeed, have suggestions as to how IP may be classified or categorised. Lynch`s approach is the simpler, or some might say more limited, with its two extremes of Laissez-Faire and Dirigisme. (See ch 10 p. 284). In Lynch’s terms IP in both the UK and EU would be seen as predominantly Laissez-Faire, with some exceptions. Lynch points out that most countries have a mixture of both approaches.

According to the Ferguson and Ferguson taxonomy EU and UK IP would both be called supportive and broadly neutral, rather than Laissez-Faire, as there are certainly some interventionist elements in both (see page 285, and also the statements under heading ‘IP in the European Union’ p 286).

3. Argue the case that state aid is an unwarranted distortion of free markets and therefore should be totally outlawed in the European Union. How likely do you think it is that state aid will, one day, be totally banned in the European Union? Explain carefully.

Answer

There could be agreement that, strictly speaking, state aid is ‘a distortion of free markets’. This is almost a truism - true by definition. The purpose of state aid is to give firms some sort of assistance, or advantage, compared to rival firms either at home or abroad. Whether state aid is ‘unwarranted’ distortion is another matter. If there are arguments about its desirability so there may be arguments as to whether it should be banned. Points made in favour of state aid have a good deal in common with the defence of protectionism, especially the infant industry ideas. The political desires of many member states and regional authorities, to continue to use state aid, are important factors to consider when viewing the future of state aid. The wish to promote and sustain local or national firms, and employment providers, whether ‘champions’ or not, is strong. It seems very unlikely that sate aid will be totally banned in the EU. Even if there were to be a ban on state aid as such there would surely be other means by which some firms would continue to receive support, simply be renaming the support or providing for it with money from the cohesion and regional budgets.

4. Public procurement accounts for about 15-20 per cent of EU GDP. It is currently not conducted in very open and competitive markets. First, outline some arguments why public procurement should be more open and competitive, and show how businesses might gain. Then second, discuss what the main issues are in trying to make it more transparent.

Answer

Public procurement, of itself, is neither contentious nor controversial. It is simply the process whereby governments, both local and national, award contracts for the supply of goods and services to businesses. Where the controversy arises is when such contracts are awarded on a discriminatory basis, either by giving favourable terms to domestic firms or by restricting the access to such contracts, or both. Such behaviour can easily be declared to be a distortion of free markets and against the principles of the single market.

If public procurement were to be conducted in a more open way than it is at present then firms in ‘other countries’ would benefit from the extra opportunities to do business. Furthermore home based firms could also gain, in the long run if not the short run, from the exposure to more vigorous competition, on which efficient and effective business depends. The main difficulties in making public procurement more transparent in its operation are primarily political. As long as both governments and firms within a country or region are keen to cooperate in the ‘rigging’ of public contracts then it will remain difficult if not impossible to eliminate the practice.

5. It is sometimes said that business people know their own business best, and therefore there should be no interference at all by such bodies as the CP authorities. Defend and support this position.

Answer

To ‘defend and support’ the point of view expressed in the question a number of points could be made. It could be argued that CP practitioners around the world are almost always, and by necessity, public officials. They are typically civil servants, lawyers or seconded academics, and just occasionally from the world of commerce. Thus they are, to a greater or lesser extent, largely ignorant of how business works and how it works best. On this basis it might be argued that civil servants and lawyers are just about the last people who should be dictating to private enterprise how they should run their businesses. The discipline of the market place, and the force of public opinion should be relied upon to promote efficient and effective firms, and CP is either unnecessary and or a dysfunctional waste of time and effort.

Students could try to rebut this argument as outlined.

6. Given the evidence that suggests most, or nearly all, mergers have a negative effect on business performance, do you think that all mergers should be banned? Why or why not? Explain carefully and give some recent examples of where a merger has been banned and where it has not, and why.

Answer

The ‘given’ in the question could be challenged. Yes, there is much evidence that shareholder wealth (in terms of share values and dividends) is often negatively influenced, at least in the short run, following mergers. But such negative results, if they occur, may have many explanations. One important consideration is whether the merger is ‘friendly’ or ‘hostile’; by mutual agreement or unwanted takeover.

In the UK in the 1960s it was active government policy to encourage certain mergers, in some cases providing funds to facilitate reorganisation and restructuring of merged firms. The classic case for such mergers, then and now, is on the basis of rationalisation and the elimination of duplication of activities (especially in research And development), as well as general ideas of economies of scale. Further arguments that ‘synergy’ may provide gains may also be put forward.

It is, therefore, probably difficult to make a clear case for the outright prohibition of mergers. Indeed the current position in the UK and EU seems in practice to be rather the opposite: the general presumption being that mergers should be allowed to proceed unless there are clear public interest reasons to prevent them.

Students should refer to recent examples in UK and EU of mergers that have been both allowed and prohibited and should argue the merits of these cases.

7. What are the theoretical grounds for expecting monopolistic market structures to lean to poor economic performance? How does this relate to reality?

Answer

The basic theoretical grounds for the condemnation of monopoly are illustrated in figure 10.1. This theory may be challenged on various grounds, not least the ideas relating to dynamic technical progress associated in particular with Schumpeter and Galbraith. Even if the deadweight loss can be ‘proved’ this is ‘comparative static’s’ analysis (that is comparing two theoretical positions at different points in time), it can be argued. Reality is not about comparative statics. Much more important they, and many others, argue is how business performs over time. And over time big business is typically much more innovative and creative than small firms.

A counter argument would suggest that ‘in reality’ many big firms actively inhibit competition and progress, for example by buying up new ideas and patents, to prevent them being used by rivals, or similarly by buying scarce resources to prevent them being used by competitors. An example of the latter could be current allegations levelled at, and vigorously rebutted by, Tesco that they buy land suitable for retail development to prevent it falling into the hands of competitors as much as for their wish to build on it themselves. Similarly there are suspicions that Shaun Wright-Phillips, an excellent footballer, was bought by Chelsea Football Club to prevent other clubs having him. A player of international quality, he rarely gets a game for Chelsea!

8. It is sometimes argued that in modern economies, in which multinational corporations and globalisation are now the norm, the attempts to control big business behaviour by CP authorities are doomed to fail. Discuss this point of view.

Answer

It is often difficult, but not impossible, for national CP authorities to challenge or dictate terms to powerful global firms. However it can be done. Recent rulings by the EU CP authorities with respect to Microsoft are a case in point. Or, alternatively, the occasional high profile case where the authorities challenge a large global firm may be seen as the exceptions to prove the general rule that CP is typically virtually powerless against global firms. Here the Cowling and Sugden argument, relating to denial of market access, may be relevant. (See ch 8 p 181).

Within countries, and especially within a large grouping of economies like the EU, CP authorities clearly can and do have the force of the law and their governments behind them. The extent to which governments wish to support the CP practitioners is a matter of political will. CP activities are ‘doomed to fail’ is surely too strong and too negative a position to sustain.

9. Following on from question 8, consider the argument that CP is no more than pretence, or an attempt to persuade the public that they are protected from the power of monopolies and cartels. Is this a sound argument? State your case carefully.

Answer

As suggested in the answer to Q1 above, cynicism should be avoided even if a sceptical or critical view is taken. The present author has some personal knowledge and experience relating to the proposition that ‘CP is a pretence’, having once worked as a CP analyst. Of course it is the case that the balance of power between the CP authorities and some big firms is tilted in favour of the firms. When IBM were engaged in a long running case with the US anti-trust authorities in the 1970s and 1980s they employed hundreds of top lawyers and economists to argue their case. The anti-trust authorities were both out-numbered and out-resourced. In the end some compromise outcomes were agreed.

However to suggest that the whole panoply of CP rules and regulations in the UK, the EU and elsewhere is some sort of sham is not a point of view to accept.

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