Economic Policy Review ISSN 1313 - 0544

European Market or European Union Market Regulation?

28.02.2007
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To begin with, I should point out that the topic I am going to discuss today is a very broad one. It is both covering competition among states and ideologies, and among companies. It also examines how regulation is reflected in the economic activity and tax competition vs. tax harmonization issues in different states. We are going to pay attention to several subjects today. I will start with providing some theoretical background on the EU and its competition ideology. Afterthat I will give an example from a real sector of economy where competition is working – the telecommunication sector. We will continue with estimating the impact of EU competition regulation on the competition in the community. Finally, we will try to explore the liberalization vs. harmonization debate and to assess which is better.

I will start with exposing some conflicting visions of the EU. This is especially important for Bulgaria since the country in one-step in the EU. There are two visions about the EU that are most popular: the European Union as a common economic area against it as a political union. The first vision is supported by the free-marketers. It leads to liberalization and open markets inside and outside the EU. More people believe that the EU is a political union. This vision leads to regulation, centralized harmonization (unification), and geopolitical competition. It makes the competition between the EU and third countries (USA, Canada, etc.) easier but do not assist the competition inside the EU - among countries and companies within the union. When talking about competition we should define the different competition ideologies.

Competition is considered free, perfect or effective. Free competition is the possibility to enter market freely. Free competition is quite realistic and practical concept. It works in the real world showing which plans are wrong, and respectively how to improve or avoid them. Just on the opposite, the perfect competition is an imaginary construction only. It is based on the equilibrium model and does not exist in the real world. The perfect competition idea is based on the thought that if one company does something in the economic area, this particular thing does not affect other actors in the same area. This logic is quite defective since each action in the economy makes an impact no matter how small this impact can be. This hypothesis is not even a good theoretical tool in discussing the real world.

The third and most recently developed perspective about competition is called effective competition. It is closely related to the EU. Effective competition is actual competition. It allows “practical” choice. Effective competition is free competition regulated to become perfect (or at least improved) competition.

Since perfect competition is unattainable, effective competition becomes quite complicated concept. For instance, if someone is offering a particular service and any other company is free to start offering the same service but do not offer it then we have theoretical competition but not effective one. If we look theoretical to effective competition, each competition in the EU especially sectoral competition is based on the idea that we have to introduce effective competition.

Here is the place to elaborate on the natural monopolies argument as well, since they are connected to some extent to what we are discussing. People say that natural monopolies “ought to emerge” when marginal costs are lower than marginal benefits. However, what we see in practice is that in most of the cases we have marginal costs lower than marginal benefits. In this stream of thought we should underline that the natural monopoly is a non-existing phenomenon. The so-called natural monopolies are either an outcome of regulation (because regulation has created them) or choice of consumers (because consumers choose to go to one supermarket instead of other and by doing so create dominant position, which in itself is a market outcome). In most cases, though this is a theory created by dominant companies in order to create territorial privileges, which is completely related to regulation but not to the market process and the market outcome.

It is also important to know more about the “traditional” competition regulation. The three main pillars of official competition regulation are:

· Prohibition to abuse dominant position;

· Prohibition of cartels;

· Regulation of mergers.

Now we have huge discussions in academia about competition regulation, whether it should be ex ante or ex post. The traditional competition laws specify that we have to regulate after the problems emerge. The competing vision is to deal with them and take precautions before the problem is already a fact. It seems that ex ante regulation is a more attractive position, since the problems will be handled in advance.

The traditional competition regulation only describes basic principles and decides ex post on case-by-case basis. New trends in the EU consider this approach as slow, insufficient and not suitable for rapidly changing markets. Moreover, people say that there is a tendency for the companies to develop into natural monopolies, if there is no regulation ex ante. Ex ante regulation is being admired by regulators. But isn’t this approach a market modeling instead of market protection? This will cause some interference in market decisions. In ex ante regulation there is some vision of the market and desire to implement this vision.

For instance the vertical integration in any sphere. Someone has the vision that the providers of the network should be separated from the providers of the service. Thus, they model the market so that to impede vertical integration. The market modeling is just the opposite of competition since it prohibits market process and impedes the choice between bad and good through the market.

On the other side isn’t it natural to end with market modeling if you start with traditional competition law? If the competition is regulated ex post then there will be ending the market as such. The debate on ex ante – ex post regulation will be clarified by taking a specific example with the telecommunication industry, since it is a frontier industry, and it has been developing rapidly in the last couple of years.

The telecommunication is a very specific industry with respectively specific regulations. It shows some main trends. The most important feature of the telecommunication industry is that it is a symbol of the failure of the natural monopolies doctrine. Recent surveys show that people consider the telecommunications as an intensely competitive market.

The telecommunication sector is very dynamic. New technologies, new companies, and new demands are emerging every day. The specifics of the industry lead to formation of big players that are by definition dominant actors and have significant market power, and it is quite unrealistic to expect small players in the telecommunication market. As we have already mentioned the regulations in the telecommunication sector are quite specific.

In the European commission, we have special directorate for telecommunication and in each member state, there are special agencies occupying themselves with telecommunication industry issues only. The regulations in the telecommunication industry aim to introduce effective competition. Regulators inescapably find most players as having “significant market power” or holding dominant position. Thus, regulation is becoming more “flexible” in order to catch up with the rapidly developing market conditions.

If we think about the regulators who favor effective competition, we will see that they are the same people who were defending natural monopolies 5 or 10 years ago. This is not a complete change of direction though. These people still favor the same ideology because effective competition is compatible with natural monopolies argument but not with competition. The same regulators, who ensured monopoly rights, now regulate to implement effective competition. The visible outcomes of regulation are quite attractive and commission tries to sell these visible outcomes. There are many providers in the telecommunication sector, which is a sure sign for practical choice. The prices (of broadband, roaming, etc.) are lower in the short run because of the regulation. In addition, consumers have more rights, i.e. to leave the provider and to save the number.

There are some invisible outcomes as well. There are disincentives to invest for example. If the prices of the broadband are regulated, nobody has the incentive to invest since he is not going to receive the profit he expects from this investment. Losses will be incurred by the investor, but profits will be expropriated. In the long run this invisible outcome increase prices. Another thing is the establishment of a regulatory jungle. Companies in Lithuania are punished for not bargaining with customers while prices are regulated!

Not the market but the regulation is a jungle and it is quite complicated to understand this jungle. Another invisible outcome is the technological non-neutrality. And of course we have natural orientation to the signals of the regulator, not the consumers, and a slow adaptation to new conditions. All of these is an example of the deepening of the goal to achieve effective competition not free competition. If this bad trend is not changed, we will end with this in all sectors.

Now, let us return to the broader issues of competition and regulation and the participation of the government in these processes. Government affects competition through 5 basic channels:

• Regulation;

• Taxation - especially when there is no flat taxation;

• Public ownership and discrimination of private ownership;

• Public procurement;

• Intergovernmental harmonization, and here we must quote the French president saying, “Companies, not governments have to compete”. Of course, it sounds very nice at first glance, but after profound investigation of the question we are able to see that this is the main trend defended by regulators who want to limit competition just to the companies and leave governments regulate, i.e. the taxation issues.

If one looks at the governments, the EU and the private companies and which actor is allowed what in private competition it is quite clear that EU allows distortions of competition in every sector (standards, zoning, etc.). If someone wants to introduce some new standards, which will be beneficial to him, but not to his competitor s/he can just go to the EU commission or his regional municipality and propose the new standard. Competition can be distorted by government (not by private actors), and the involvement is always legal when done by the public actor. Only some state support is prohibited, but overall EU aggregates rather than diminishes state support. EU does not allow private agreements on the same issues where public (government) agreements are allowed.

For instance, if companies want to agree on some standards, this will be called cartel agreement and respectively prohibited by the EU law. For the same outcome to be achieved these companies should go to the government and then the outcome will be legal. Thus, what appears is when two companies want to agree and not force the same agreement on others this will be considered illegal, and on the other side when the government forces this standard on everybody it is legal.

States as such are monopolies and the EU as such is a cartel of states. Another thing is that EU funding directly distort competition. In Lithuania, for example some big factories received funding from the EU, which would never have happened before. When we take the government against the private companies, we will see a rather negative picture of the government.

If we capture a specific example with Lithuania we will see that the only difference is that now the country has joined the cartel. Lithuania is the only state in EU that prohibits anticompetitive actions of governments: government and municipalities (but not parliament) are not allowed to take any decision that may hamper competition. Competition Council may issue compulsory rulings concerning these decisions. This was quite used before joining the EU, but what we have in practice now is ignoring of these provisions. The EU Competition DG does not force national Competition Council to implement it. The implementation of other provisions is treated as an essential even though the Treaty and the Regulation do not require it.

Moreover, non-competitive public purchase from public companies (municipality has the same provider of garbage collection and now has an offer from private company) had been treated as illegal, but now it is legal because of EU practices. Overall, competition ideology and the theory the EU is using is fake, and as such, it is not working effectively.

So should we have harmonization or liberalization in the European Union? To start answering this question we should emphasize that harmonization and liberalization are two different concepts and we cannot use them interchangeably. Harmonization means unification.

There are numerous regulations and every behavior has a specific course of exercising it. Liberalization on the other hand is freedom and acknowledgement of the right to be different. EU is more interested in the first concept than in the second. It is obvious in sectors such as telecommunication, services, taxation. The services directive gives plenty of regulations.

Despite the concrete statement in the Treaty of Rome, that freedom of services is essential, the services directive leaves no freedom and no liberal market. It just aims to harmonize. In case of taxation, on the other hand, it is interesting how the same people introduce competition ideology and simultaneously favor the harmonization.

For instance, Balkenstein who is known as the father of the services directive and for his liberalizing efforts also strives to introduce tax harmonization. And what Commission is trying to achieve now is summarized in two basic efforts: 1) to harmonize taxes and 2) to implement global access to information. Both of these aspects do not help business and competition.

Harmonization of the tax base will lead to limit of competition among countries regarding taxation, and the global access to information will lead to sharing of information about taxes in different countries, which looks innocent but in fact will lead to drastic reduction of tax competition. And speaking about harmonization, the initiative for harmonization in the corporate tax-base is undertaken with the sole aim to achieve harmonization of tariffs.

One other aspect of the debate harmonization vs. liberalization is that liberalization can actually lead to decentralized harmonization. A good example for this will be the spillover effect of the flat tax. Flat tax disease in Europe started from Baltic States. It happened partially because it was initiative by government that was not opposed, and partially because of the hyperinflation. The mergers and the progressive taxation became quite important after some years of hyperinflation.

People liked the flat taxation and some other countries looking at the experience of the Baltic states understood it is quite reasonable to have flat tax. They began copying the example or in other words started practical harmonization. Therefore, if we open the markets and introduce liberalization it will be followed by harmonization, which is to say to change your own practices according to the best practices in the EU, not to force others to change according to officially accepted practices, which might not be the best ones.

Thus, harmonization is a very good trend and our efforts are against forced or centralized harmonization (unification), not against harmonization per se, since when you have possibility to choose and harmonize according to your own choice this is a positive trend, which we do not oppose. And my proposals here are first related to competition in general and only afterwards as a result to taxation. In my view, we should abolish ex ante competition regulation. We should also abolish sector specific competition regulation and limit regulation in general since it always distorts competition. Private agreements, which are now illegal because of cartel, dominant position and merger regulation, should be allowed as well. And competition between both companies and governments should be liberated.

Broadly, my conclusion is that we have to choose European market, not European Union Market Regulation!

 



[1] The presentation was prepared for the Conference on capitalism and happiness in the EU, organized by IME on 25th of November, 2006 in Sofia