Standing up for competition
Fredrik Erixon and Oscar Guinea / Mar 2019
Margrethe Vestager, the European Commissioner for Competition. Photo: Shutterstock
After the failed rail merger of Alstom and Siemens, there has been a surge of interest in industrial and competition policy in Brussels. The French and German governments have published a powerful manifesto on a new industrial policy. It includes desires to create new ‘European champions’ and, surprisingly, it lays out a series of proposals that take aim of EU competition policy. In their view, the blocking of big-company mergers is a threat to Europe’s economy. Therefore, Berlin and Paris want the European Council to have the power to veto European Commission decisions on competition policy.
France and Germany aren’t alone in this persuasion. There’s been a strong consensus in favour of competition – and guardianship of competition – for decades, but now it’s eroding. It’s naïve, we’re told, to hold up the principle of competition when China is building commercial giants. Manfred Weber, the lead candidate for the European People’s Party in the election to the parliament, took to twitter to give his support – not just for a new industrial policy but for the merger between the two rail companies. Guy Verhofstadt, supposedly a liberal, even penned a long essay about it, claiming that “one of the top items on Europe’s policy agenda should be to create a new legal framework for cultivating European industrial champions”.
This is a misguided view: industrial policy should promote competition, not reduce it. In fact, the whole idea of ‘picking winners’ has been debunked by modern economic history, and reinforcing the market power of firms at the expense of consumers lead just to misery for everyone.
First, promoting some companies over others assumes that politicians know which sectors will become prominent in the future and which company will come on top. Politicians can’t do that. Not even investors and business leaders have that ability: our economic history is littered with examples of corporate collapses and entrepreneurial failures to predict how markets will evolve. What hierarchy of firms that markets will have can only be discovered through a process of competition.
Second, handing out political privileges or enforcing politicians or national governments with the power to decide what mergers should be approved (or not) is a recipe for cronyism. Rather than innovating and taking measured risks – which is what builds our long-term prosperity – firms will be spending their resources on lobbying.
The Franco-German proposal and its supporters have also a misplaced view of what’s actually happened in Europe’s markets: market competition in Europe has been declining for years. Despite an active competition policy, market concentration has gradually increased and, in many markets, the power of a small set of firms have gone up substantially. Take the Spanish banking sector: it went from 62 to 11 banks in the space of 10 years, with rapidly growing market shares from the top five banks that reached 70% in 2018. In Germany, the ten largest firms control 65% of legal and accounting services. Half of the retail market in the Czech Republic is supplied by the ten largest firms. And the biggest telecommunication firms supply almost 90% of the market in each of the member states.
All forms of market concentration aren’t bad for competition, but don’t be surprised that there have been bad consequences for consumers coming hard on the heels of growing market power. Businesses in manufacturing as well as in services have been able to raise their markups, which is the difference between the cost of the product and the price paid by consumers. Tourism, legal and accounting, and advertising show some of the highest margins across countries. Over time, the auto, chemicals, and construction industries have experienced the fastest growth in markups.
So, who is naïve? Europe simply isn’t the Wild West of free competition and open markets. In fact, the way we have structured many of our regulations have reinforced firm power by raising the barriers to entry in many markets. Barriers to entry and exit have become so formidable that they are effectively making it impossible for new competition to happen. This can be seen in the failing rates of firm entry and exit. Moreover, in a new paper, we have shown that many regulatory barriers are responsible for the higher levels of market concentration and market power in Europe.
Undermining competition policy will have long-lasting consequences on innovation. If political lobbying is more profitable than competing through innovation, the economy will suffer. This is already happening and scholars have shown a depressing trend in many countries. For instance, politically connected firms in Italy are more likely to grow in revenue and employment but not in productivity.
The Franco-German manifesto got it wrong: competition should be at the front of any new industrial policy. Instead of promoting European Champions in the belief that scale equals success – no, big isn’t beautiful – Europe should reduce barriers to competition and let its internal market be the real training camp for top performing firms to grow.