Competition policy aims to ensure that market practices and strategies do not reduce consumer welfare. Industrial policy, meanwhile, aims at securing framework conditions that are favourable to industrial competitiveness, and deals with (sector-specific) production rules as well as the direction of public funds and tax measures. But, how should competition policy and industrial policy interact? Is industrial policy contradicting the aims of competition policy by promoting specific industrial interests? By: Georgios Petropoulos Date: July 15, 2019 Topic: Innovation & Competition Policy Bruno Le Maire, the French minister of the economy and finance, in his recent talk at Bruegel, referred to the necessity to make technological
Georgios Petropoulos considers the following as important: competition policy, European macroeconomics, European Union, finance, industrial policy, innovation, Innovation & Competition Policy, tax
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Competition policy aims to ensure that market practices and strategies do not reduce consumer welfare. Industrial policy, meanwhile, aims at securing framework conditions that are favourable to industrial competitiveness, and deals with (sector-specific) production rules as well as the direction of public funds and tax measures. But, how should competition policy and industrial policy interact? Is industrial policy contradicting the aims of competition policy by promoting specific industrial interests?
By: Georgios Petropoulos Date: July 15, 2019 Topic: Innovation & Competition Policy
Bruno Le Maire, the French minister of the economy and finance, in his recent talk at Bruegel, referred to the necessity to make technological sovereignty one of the top priorities of Europe through the effective use of EU industrial and competition policies.
Competition policy’s objective is not to protect market competition, but to ensure that market practices and strategies do not reduce consumer welfare. If restricting competition to some moderate extent proves necessary in order to achieve some benefits which especially make consumers better-off (or at least not worse-off), then such a practice is desired and accepted.
Industrial policy i) aims at securing framework conditions that are favourable to industrial competitiveness, incentivising private investments across sectors and firms (horizontal industrial policy); ii) deals with (sector-specific) production rules as well as the direction of public funds and tax measures, which generate further incentives for private investments to the benefit of specific technologies, sectors or even firms (vertical industrial policy).
But how should competition policy and industrial policy interact? Is industrial policy contradicting the aims of competition policy by promoting specific industrial interests?
In this text I argue that, for building a successful economic model, these two policy instruments should be viewed and implemented as complements rather than as substitutes. Competition should be considered the basis which is effectively protected and promoted by the implementation of competition policy rules. Effective competition policy removes market-entry barriers imposed by incumbents. This can lead to increased innovation incentives for entrants who want to improve their market position and increase their customer basis. However, it also increases the incentives of the incumbents to innovate and protect their market share from their competitors. Innovation leads to better-quality products and services which are offered at a competitive price, thus increasing both consumer and producer welfare.
However, even in a competitive environment, there might be market imperfections that impose constraints on investments in innovation and growth. Then, there is a need for industrial policies that can remove these constraints and motivate investments. Such impediments may arise due to capital-market imperfections and credit constraints, administrative burden, or complicated labour or tax rules. Well targeted industrial policies can provide, for example, tax incentives for innovating firms, re-design the rules to reduce the administrative burden for innovators, and relax credit constraints by protecting intangible assets. Constraints may also limit the reallocation of firms towards new, growth-enhancing sectors (e.g. ICT, nanotechnology, biotechnology). If markets are competitive, state intervention can be more effective in providing some assistance to firms to enter and scale up in these sectors.
While competition provides increased incentives to firms to innovate, industrial policies can help by improving their capacity to undertake growth-inducing investments. A successful model of industrial development clearly needs both: competition as the basis, and carefully designed industrial policies on the top of that, without violating competition rules.
The efficacy of industrial policies highly depends on how competitive markets are. Industrial policies are more likely to be successful when they are implemented in markets of some optimal degree of competition. Aghion et al. (2015) use data from China and find that the more competitive the sector that receives state aid, the more positive the effects of state subsidies to that sector on total factor productivity, its growth and product innovation. By contrast, for sectors with low degree of competition, the effects are negative.
An important criterion for this complementarity model to be successful is that (vertical) industrial policies should not provide selective advantages to specific firms. In fact, sector-wide industrial policies that apply to many firms without discrimination are expected to work better at inducing sustainable growth.
Indeed, picking a specific firm as the champion of the sector, instead of letting the market’s competitive process decide which firm will emerge as the leader, can be ineffective since i) the government cannot assess the chances of commercial success better than the market (it may pick a winner that is not the most efficient); ii) the government’s selection process may involve the risk of capture and rent-seeking, especially when the selection process is not transparent and the rules of selection are not clear.
With the deepening of globalisation, more and more firms from other jurisdictions enter and compete in the EU single market. While in principle this is good news – because it means increased market competition, lower prices and more efficient production – the industrial policies of other jurisdictions towards specific firms that compete in the EU market can potentially distort competition when they are excessive. How can the EU deal with such cases, since EU competition policy law – which ensures a level playing field – does not apply in other jurisdictions?
In the recent Alstom-Siemens merger debate some member states proposed to bend competition policy rules, in order to create a European champion that can effectively compete with Chinese state-owned or -supported potential entrants in the EU rail market. In addition to the two reasons mentioned above, such a proposal is unlikely to work because:
- Competition shapes incentives for investment. By reducing competition, we may have adverse effects on private investments by firms. So, industrial policies may be ineffective.
- Industrial policies are decided by governments. So, by adjusting competition rules to the industrial policy in place, market transparency will be reduced while uncertainty over the politically dependent market rules will increase. This is not the ideal framework to promote (long-run) investments.
- A politically dependent competition policy could also lead to escalated tensions with other jurisdictions, as market competition can more easily be perceived as an instrument of retaliation, harming the operation of EU firms abroad.
- The impact on consumers is more likely to be negative by increasing concentration, prices, inequality and lack of transparency.
So, it is not a wise move to deviate from the ‘competition as basis’ model, where competition policy is politically independent and applies without discrimination to all market participants, irrespective of their origin. This is especially true in the case of merger control, since the EU has only blocked mergers in a few exceptional cases where the potential social harm has been clearly illustrated.
A better strategy will be to investigate how we can make sure that foreign governments will respect EU rules. As Petropoulos and Wolff (2019) explain, efforts should be devoted to the development of a platform for an international collaboration that can help the EU to react in the case of distortionary subsidies. The WTO could potentially play such a role through the agreement of its members on subsidies and countervailing measures. However, even in the best case, this can only be a partial solution to the problem since, so far, for various reasons, the WTO agreement has not been so effective.
Another avenue can be the endorsement of bilateral dialogue with countries whose industrial policies raise the suspicion of distortion of competition in the EU market. The EU has already put such an open dialogue in place with China. Particular emphasis should be given to the translation of this dialogue into specific binding agreements that will decrease the possibility of market-distortionary state-aid strategies. Participating in the EU single market should not only incorporate benefits but also the obligation to be in line with the EU (competition) rules.
The EU may also consider implementing some form of entry regulation of foreign corporations that receive distortionary state support. Its design, as such, should discourage market distortions. The EU competition policy, and in particular the EU merger control, can be in line with such entry restrictions, since their motive is to remove competition distortions that are harmful for consumers. Yet, it is and must be clearly restricted to well-defined concerns, to prevent it becoming just a simple tool for protectionism. It is thus not suited as a general state-aid control mechanism. In order to be more effective, monitoring mechanisms that facilitate better shared knowledge of such cases among EU member states should be put in place. In any case, it is very important to increase corporate transparency requirements on all firms that want to enter our markets.