Competition, concentration and value-added

5Until the 2000s, American markets were more competitive than European markets, with lower prices and often lower margins. These trends were then reversed, with a sharp increase in profit margins in the United States, but not in Europe (see Figure 1). This evolution of margins can be compared with the evolution of concentration over the last fifteen years: increasing sharply in the United States, it is relatively stable in Europe. Measuring concentration in Europe (i.e. 28 Member States in which the degree of concentration may vary by sector) is a more complicated exercise than in the United States, but all available studies conclude that the increase is significantly higher in the United States than in the European Union. [1] Moreover, for the United States, this result remains valid when the digital giants (GAFAM) are excluded. On the other hand, margins are stable or declining when the analysis is limited to sectors subject to international competition.

1

Profit margins in the United States and the European Union, 1992-2015

Profit margins in the United States and the European Union, 1992-2015

Reading: Profit rate for the non-agricultural business sector, excluding the real estate sector. The black series is first aggregated in the European Union (EU) countries, within industries, by weighting production in EU countries, and then in EU industries by weighting by gross industrial production. The grey series uses American industrial weights to eliminate compositional effects.

2

Evolution of concentration levels in the United States and the European Union, 2000-2015

Evolution of concentration levels in the United States and the European Union, 2000-2015

Reading: Absolute changes in the concentration ratio of the eight largest firms (CR8) in all sectors, weighted by real gross output, from 2000 onwards. The US CR8s are based on Compustat’s consolidated financial data. European Union (EU) figures are also based on Compustat data and non-consolidated financial data from ORBIS. The country series treat each country as an independent market. The aggregate series consider the EU as a single market. See Philippon T. (2019): “Les marchés européens sont-ils devenus plus concurrentiels que les marchés américains ?”, Focus du CAE, no 31-2019, May.

6Finding 1. In the United States, there is a significant increase in concentration in many sectors and a distortion of value-added sharing in favor of profits. This is not the case in Europe.

Competition, price and purchasing power

7Competition policy in favor of consumers should translate into lower prices. To test this idea, we compare the evolution of prices in relation to the unit cost of labor between Europe and the United States. This exercise carried out in the ten main countries of the European Union and the United States shows that over the 2000-2015 period, prices increased by 15% more in the United States than in Europe, but wages only increased by 7%. The price/wage margin fell by around 8% in Europe compared to the United States. For a worker with a median salary, this represents an 8% increase in purchasing power. [2]

8In addition, price decreases in Europe are often the result of economic policy measures with pro-competitive effects. For example, following the granting of a fourth license to Free in France in 2011, prices fell by 40% in less than a year. Prices for telecommunications services, which were higher in France than in the United States until 2011, have become and remain lower (see Figure 3). These results are consistent with the report of the European telecoms regulator which shows that in the three countries (Germany, Austria, and Ireland) where the number of operators has increased from four to three, prices have increased. [3]

3

Telecommunications price index in France and the United States, 2005-2014

Telecommunications price index in France and the United States, 2005-2014

Competition, investment, and productivity

9A (too) strict competition policy could weigh on corporate profits to the point of limiting investment or innovation. This theoretical argument is valid but its empirical relevance seems limited. The comparative developments in the United States and Europe in concentration, profits, share prices and investment for the five most rapidly concentrated industries in the United States are very telling from this point of view. Concentration, operating margins, and share prices have increased in the United States at the same time as investments, including intangible investments and R&D, have declined. Conversely, concentration has decreased in Europe and investments have remained (relatively) stable, despite lower profits and lower share prices. [4] If the concentration in the United States is a sign of a lack of competition, this is exactly what the theory would predict.

10Finding 2. Investment and productivity in Europe have not been negatively affected by lower industrial concentration compared to the United States.

11More generally, recent work analyzing the impact of competition policy (concentration, barriers to entry, etc.) on the differential of productivity between the United States and the European Union shows that in industries where competition is more intense in Europe, we observe a similar, or even slightly higher, productivity level than in the United States. [5]

12In the end, nothing suggests that Europe implements an “excessively” rigorous competition policy, in the sense that it would hinder development, even if at the same time the United States seems to have become too lax. Profit increases in the United States have been used to increase dividends and share buybacks but not investment or R&D. In addition, recent research shows that the decline in competitive intensity has been favored by increased spending on lobbying regulators and policies. [6] Competition policy in Europe, on the other hand, is showing signs of success with lower prices and at least equivalent productivity. The relative weakness of innovation in Europe has many causes, but competition policy is probably not one of them. To explain the export performance of European companies, it is rather the articulation with trade policy that must be questioned.

Competition policy: controlling distortions linked to the exploitation of market power

14Competition policy is justified by the fact that fully competitive markets ensure the best allocation of resources and benefits in terms of price, quality, and innovation for consumers. In particular, the proper competitive functioning of markets makes inefficient or technologically outdated firms disappear, attracting capital and jobs to more efficient sectors and technologies; this dynamic effect, often forgotten by those who see competition as just a means of lowering prices, is key for innovation and its diffusion in economy. However, the presence of externalities (e.g. environmental or R&D-related) or strategic corporate behavior (cartels, abuse of dominant position) sometimes prevents these virtuous mechanisms from operating. For various reasons, prices are no longer good signals for decisions. In such cases, competition policy is responsible for correcting imperfections in corporate behavior that impede the proper functioning of markets. [8]

15This competition policy is one of the pillars of European integration and the single market. Its legal principles are contained in texts of different levels of the hierarchy: treaties, regulations, and guidelines. Its implementation is an exclusive competence of the Commission [9] (through its Directorate-General for Competition), which operates mainly in three areas: the detection and repression of cartels, abuses of dominant positions and merger control.

16While action against cartels and abuses of dominant position takes place ex-post, once the potentially illegal conduct has been observed, merger control takes place ex-ante (see Box 1). This is what brings this aspect of competition policy closer to sectoral regulation, which also defines a priori the rules under which companies in regulated sectors (telecommunications, energy, etc.) can operate. While competition policy in Europe has been stricter in its implementation than in the United States (see above), the Commission’s rejection of mergers is extremely scarce, while unconditional acceptance constitutes the vast majority of cases. Over the period from January 2010 to December 2018, among the 2,980 merger transactions notified to the Commission, 2,704 were accepted unconditionally (90.7%), including 1,949 (65.4%) in Phase 1, and 156 transactions were conditionally approved. Among these accepted mergers, some have given rise to very large European champions, such as the mergers between Luxottica and Essilor in eyewear and between Lafarge and Holcim in cement, to quote only two examples. Moreover, merger control has not deterred merger operations since, only 56 of those 2 980 operations were withdrawn in Phase 1 and 9 in Phase 2. These withdrawals cannot be attributed to the severity of the Commission’s criteria. Finally, only 7 transactions were refused by the Commission (2 of which involved American companies). While the preservation of competition sometimes imposes asset transfers to companies, merger control does not appear to be an obstacle to the emergence of large European companies.

17Moreover, whatever the complexity and extent of the competition concern raised by the Commission in a merger, there are usually solutions through the establishment of “remedies” discussed between the parties and the Commission (see Box 1). However, while many national authorities accept “behavioral” commitments (whereby companies commit to implement, or not implement, particular behaviors), this is not the case for the Commission, which over time and under the strict control of the European Court of Justice, has increasingly limited the commitments it accepts to “structural” remedies: companies must agree to sell particular assets (establishment, production line, subsidiary company…). However, if the implementation of such commitments is less difficult for the Commission to monitor, they have the disadvantage of not being reversible, while behavioral commitments can always be adapted if new events change the competitive functioning of the market. In France, the competition authority has reduced the behavioral commitments made by the Canal+ Group when it merged with TPS and then when it acquired Direct 8 and Direct Star channels, to take into account the arrival of audiovisual content platforms such as Netflix and Amazon. [10] It would be appropriate to allow for easier and more frequent application of these behavioral measures, in particular by amending (at least) the Commission’s communication on remedies admissible under Council Regulation (EC) 139/2004 and Regulation (EC) 802/2004.

18Recommendation 1. Facilitate the application of behavioral measures in commitments undertaken by companies to adapt to postmerger market developments.

19Regarding State aid, the Commission’s competence derives from the need to harmonize the conditions of competition between the Member States: it is, therefore, a European specificity. As in previous areas, one of the objectives of State aid control is to ensure that it does not distort the market. In addition, there is a related but fundamental objective: the achievement of the single “internal market”, in which the conditions of competition are equivalent throughout the Union. This excludes the possibility for a Member State to subsidize its companies in a way that distorts competition in the internal market.

20The implementation of competition policy has evolved considerably since the mid-2000s, from an initially more legal approach to recently a more economic implementation. In the antitrust field, the cumbersome and administrative ex-ante notification of agreements has given way to ex-post control (Regulation 1/2003). Similarly, merger control has confirmed the abandonment of the test of “creation or strengthening of a dominant position” in favor of the economic test of “a substantial reduction of competition” resulting from the operation (Regulation 139/2004). With regard to abuse of dominant position, the Commission has adopted, after many debates at European level, its Communication on abuse of dominant position which takes the same path in favor of a more economic approach. [11] Finally, State aid control is also moving towards a more economic approach. On the one hand, since the aid is derogatory from the normal functioning of market economies, it must be justified by an identified market failure for which public intervention is necessary; while on the other hand, the subsidy must just compensate what is necessary to overcome the failure in question, without giving the company receiving it, beyond this compensation, any advantage that is likely to distort competition.

European trade policy: defending the European Union’s offensive and defensive interests

21The Union’s trade policy is also an exclusive competence of the European Commission, which negotiates free trade agreements with the various regions of the world on behalf of the Member States under the aegis of the WTO, which defines a multilateral framework for international trade. It is the body that possesses the trade defense instruments to remedy unfair practices like anti-dumping duties and countervailing measures to subsidies. [12] However, their final implementation is subject to examination by the Committee on Trade Defense Instruments, composed of representatives of the Member States, which may oppose the Commission’s recommendations by a qualified majority. Anti-dumping proceedings are based on complaints from European companies about “abnormally low” prices charged by foreign competitors on the European market. The difficulty lies in assessing the “normal” price that would prevail in the absence of dumping, as a low price may reveal lower costs and not necessarily foreclosure behaviors by competitors. The Commission’s investigation must, therefore, provide evidence that these prices are indeed linked to dumping and that European companies are harmed. If such evidence is provided, the Commission may apply anti-dumping duties to the products in question to compensate for the difference due to this practice. At the end of 2018, 94 anti-dumping measures were in force (27 of which were extended to third countries to avoid circumvention), two-thirds of which concerned China. [13]

22In terms of countervailing measures, additional customs duties may be applied to imported products that benefit from prohibited or detrimental subsidies in their country of origin. However, while the procedure is similar to anti-dumping, the demonstration of the existence of subsidies is sometimes difficult and the establishment of “injury” or “serious prejudice” (under the terms of Article 5 of the WTO Subsidies Agreement) even more challenging. The WTO requires its members to notify subsidies granted to companies, giving priority to a complete provision of information every two years. Otherwise, the Commission must investigate the cases submitted in order to demonstrate the existence of subsidies. At the end of 2018, 12 countervailing measures were in force (one extended), half of which concerned China. [14]

23But unlike competition investigations, where it has the capacity to investigate companies under its jurisdiction, the Commission cannot do the same for subsidization practices to companies operating from sovereign states. To access relevant information, the Commission must ask the States and companies concerned to cooperate, and in the event of refusal, make estimates from available (and sometimes limited) sources. Moreover, the European trade policy is mainly organized around the negotiation of trade agreements and relatively little around their monitoring, so that non-compliance with commitments by states that have signed agreements with the European Union is insufficiently detected and corrected by appropriate measures.

24In addition, the European Commission operates under the supervision of the European Court of Justice and in compliance with WTO rules. This has an important consequence: both have a restrictive definition of what constitutes a subsidy (or State aid within the meaning of European competition policy). Aid granted from direct State resources shall be considered to a subsidy. Aid that takes more indirect forms, such as access to a resource (natural resource or production factor) at a preferential price or the use of a loan at a subsidized rate by a public bank, is difficult to qualify and quantify.

25European trade defense instruments were modernized in June 2018 to give the Commission the capacity to act more efficiently. Among other amendments, the Commission can take up the matter ex-officio and is no longer limited to practices denounced by the companies. If it discovers practices other than those initially denounced (dumping or subsidies), it can impose duties. However, it is still too early to know whether these changes will be sufficient and effective.

26To accomplish the goal of better protection, a screening mechanism for foreign investment was introduced in March 2019. It provides the Union with a cooperation mechanism for controlling the purchase of domestic companies by foreign ones when security or public order are potentially threatened. This mechanism coordinates institutional structures and organizes information and evaluation sharing, with the Commission being able to issue an advisory opinion. In this sense, it is an important institutional innovation. It is the result of growing doubts about the European Union’s ability to defend its interests through a completely open investment regime, since State interests and sovereignty issues are becoming increasingly important in acquisition projects. However, its limitations are obvious. In particular, it does not create any obligation other than information and it is only intended to protect security and public order, even though it explicitly provides for the context and circumstances of the investment to be taken into account, including the possible control of the investor by a State. [15]

27Finding 3. Anti-dumping and anti-subsidy controls are long and complex to implement. In response, Europe is developing defense instruments, including investment screening.

Risk of abuse of a dominant position in a foreign market

29The asymmetry in the implementation of competition policy, highlighted above with regard to the United States, also exists with regards to China, albeit for different reasons. Competition policy in China is in the process of being developed, and while there have been significant structural reforms in recent years, it remains subject to industrial policy decisions (see Box 2). In sectors where the Chinese authorities favor export capacity, competition on the domestic market is not always an objective, as the authorities often seek to promote (and often constitute) one or more national champions, even if this means creating a dominant position on their market.

30This asymmetry in the application of competition policy creates the risk that European companies may face competitors who can rely on a dominant position in their national market. With regard to the risk of distortion of competition that this entails, it should be stressed that the competence of European competition policy extends to all cases with effects on the European market, whether they involve mergers and acquisitions or abuses of a dominant position. A proposed merger between foreign companies that could distort competition on the European market may, therefore, be the subject of a request for a remedy or blocking by the Commission, as in the case of the 2001 prohibition of the merger between Honeywell and General Electric. The case has never before arisen for Chinese companies, but the same control would then apply, and European competition policy would have the means to enforce its decisions, for example, by not recognizing the newly formed entity under European law, thus preventing it from carrying out any economic activity in Europe.

31Where the company already enjoys a dominant position on its market, the European rules for the prevention of abuse of a dominant position apply. Various recent procedures have shown that this policy is binding on companies, both European and non-European. However, three main questions remain to be asked, namely excessive delays of procedures, the case of killer acquisitions and competition on third markets.

Industrial subsidies

50The use of industrial subsidies and instruments to remedy their adverse effects (countervailing measures, i.e. anti-subsidy duties) are governed by the corresponding WTO agreement. In practice, this framework is currently unsatisfactory. Its rules are too restrictive in their definition and too demanding in the evidence they require. In particular, a subsidy can only be characterized when a financial contribution by the government or a public entity can be identified (excluding income or price support), and the WTO Dispute Settlement Appellate Body has interpreted that an entity must “possess, exercise or be vested with government authority” to be considered public. [23] However, this case only covers part of the practices. In the Chinese case, the protean nature of subsidies, often in the form of privileged access to capital and various inputs, through a multitude of channels and structures, goes well beyond this framework. [24] This problem is aggravated by the lack of transparency of many WTO members. Indeed, notification requirements are often not well respected, when they are not simply ignored. [25] Witness of the tensions induced by the implementation of these obligations, the counter-notifications made five times since 2011 by the United States, concerning nearly 500 Chinese subsidy measures that, according to the United Sates, should have been notified and but had not been notified. [26]

51Only two types of company- or industry-specific subsidies are prohibited by the WTO Agreement on Subsidies and Countervailing Measures (SCM): the ones that are contingent upon export performance or upon the use of domestic over imported goods. The others are only enforceable if it is possible to establish the existence of “injury” or “serious prejudice”, which is often very difficult. Given the necessarily limited investigative powers of the Commission, this makes it difficult to restore the balance between companies operating from countries that do not respect the same rules. However, the duration of the examination procedures prior to the implementation of compensatory measures is often too long in relation to the life of the business.

52The best response to this would be a reform of the WTO Agreement on Subsidies. The Commission’s proposals to this end are welcome, as they aim in particular to “improve transparency and notification of subsidies”, better clarify commitments concerning state-owned enterprises and make constraints on the most distortive types of subsidies more effective. [27] In particular, the creation of a rebuttable presumption that non-notified subsidies would be detrimental to partners and therefore susceptible to compensatory actions would be a powerful lever to change the nature of incentives in this area.

53Recommendation 6. Make subsidies a priority subject in WTO reform negotiations, in order to strengthen transparency obligations and facilitate the adoption of countervailing measures when partner’s subsidies are harmful.

54Such reform must remain the priority objective: the establishment of multilateral rules to limit distortions linked to subsidies is the solution most in line with European values and interests. But given the extreme difficulty in substantially changing WTO rules, it is necessary to prepare a “plan B” in case of failure, making it possible to defend European interests and, as a result, to improve the Union’s ability to negotiate constructive reform. The reform of trade defense instruments and the reform of the methodology for determining anti-dumping duties, which recently entered into force, are the first step in this direction. These instruments must now be used reactively as soon as justified, in accordance with our international commitments. In particular, the most appropriate response to partners’ industrial subsidies is the implementation of countervailing measures. Although we have highlighted the limitations of the current WTO agreements, full use must be made of the existing rules and the flexibility allowed by the recent reform of trade defense instruments where industrial subsidies or unfair competitive practices harm European industries. [28]

55The foreign direct investment must also be taken into account because it is another subject on which State strategies can distort competitive logic. In this case, we have recalled above that the European Union has just adopted a system for screening foreign direct investment when it represents a potential threat to security or public order. On a purely economic level, any restrictions in this respect must be handled with caution, as they can easily be diverted to protect sectoral interests from the competition without valid justification, and can have an impact on incentives to invest. However, concerns about public funding (to avoid distortions related to subsidies) and the preservation of competition (to counter killer acquisitions) could also be addressed more systematically.

56Recommendation 7. Reactively use trade defense instruments when industrial subsidies or unfair trade practices harm European industries. Address more systematically concerns related to public financing and the preservation of competition in the screening of foreign direct investment

State aid can be used for an active European response

57Without entering into the complex debate on European industrial policy, the question arises as to whether the Union’s response should take a more active form. In this respect, competition policy is often seen as a constraint due to the discipline it imposes on the State aid. In this respect, the main criticism of industrial policy is that public authorities are poorly qualified to select the companies benefiting from their actions (picking winners). This is because information on the performance of companies is often scarce and potential candidates have an interest in concealing information on their costs in order to distort public decision-making to their benefit. In the European context, moreover, State aid carries the risk of non-cooperative strategies by the Member States. This explains the strict framework applied in Europe, which may give rise to fears that public investments will not be implemented even though they would be socially beneficial.

58However, the modernization of the State aid rules has provided a framework to address these disadvantages, as it promotes the implementation of projects that are difficult to finance because of the technological or financial risks they present, even though they allow significant challenges to be met. This legal framework, known as Important Projects of Common European Interest (IPCEI), makes it possible to grant significant amounts of aid to large industrial projects. The eligibility criteria attached to them ensure that they avoid the shortcomings mentioned above by requiring them to target an entire sector and not individual companies that would be chosen ex-ante, and by ensuring that the benefits are not limited to a single Member State. These criteria prevent the aid in question from reducing the strength of intra-European competition, which could prove counterproductive. Provided they are respected, therefore, there is nothing to prevent Member States and/ or the European institutions from implementing ambitious initiatives to guide economic activity through a combination of investments in technology and infrastructure, in particular, such as those motivated by the need to address the challenges of climate change adaptation. The alignment of national interests can certainly be a limitation in some cases. Poland was thus rather reluctant at first to the ongoing development of a Franco-German IPCEI on electric batteries, as it hosts a Korean battery plant on its territory. In this field as in others, adapting to the challenges of competition challenges Europe to achieve cohesion.

59In the current context of a decline in multilateralism, Europe must arm itself to defend its economic interests. It is less on the side of its competition policy, given the benefits for European consumers, than in the articulation with trade policy that it must look for ways to better enforce the rules and defend its interests.