EU Industrial Policy EU Competition Policy

EU Industrial Policy EU Competition Policy EU Integration and the European Business Environ Management Centre Kings College London Shannon Mudd, Ph.D.

Outline • Competition Policy • Industrial Policy • Ryanair and the EU

Government vs. Market Effort to affect allocations across regions Regional Policy Effort to affect allocations across sectors Industrial Policy Competition Policy Ensure member states’ policies do not adversely affect competition

Competition Policy • “The main purpose of competition policy is…protecting the market mechanism…by i) promoting competitive market structures and ii) policing anti-competitive behavior.” El-Agraa (2001) • in US terms, “anti-trust” policy, named after efforts to curb powers of railroad, oil and banking “trusts” at turn of 20th century. (Sherman Act of 1890) • Anti-trust provisions were included in original European Coal and Steel Community Treaty of 1954 but not in the EC treaty

Competition Policy • The EU does this by • enforcing prohibitions against • anti-competitive agreements • anti-competitive behavior of firm(s) large enough to harm competition • vetting mergers and acquisitions • to see if likely to result in non-competitive market structure • But these do not differ from national competition policies

Competition Policy • The EU differs in three important characteristics • aims to promote and protect market integration w/in EU • Some conflict w/ economic efficiency considerations, e.g. neg view of vertical agreements w/ territorial effects • addresses market distortions of member state policies • implemented in multi-level political system, i.e., EU and member states • Movement to decentralize decisions

Competition Policy • “Perfect competition” exists only as an ideal. Then what practices, situations lead to restrictions of competition that merit intervention? • Practices: vertical restraints, pricing below cost, effects of M&A on mkt structure, mkt concentration (#firms or relative size), etc. • Role of competition policy it to substitute for competitive pressure. • focus on market structures (Harvard School)or on efficient outcomes (Chicago School)? EU looks at both

Competition Policy • Article 81(1) prohibits collusive agreements (market sharing, price fixing, discrimination) • 81(2) rules them illegal. • 81(3) provides for exemptions awarded only by commission (movement for devolution) • Article 82 focuses on anti-competitive behavior (predatory pricing, tying, discrimination). But asymmetric – applies only to firms with market power. • i) define market • ii) establish firm(s) dominance, • iii) demonstrate abuse

Competition Policy: M&A • While articles 81 and 82 examine infringement ex post., EU takes ex ante control of M&A activity (Council Regulation 17) • All M&A activity above a certain threshold must pass through system of pre-notification • Allows EU to examine and provides firms with legal certainty • Q: merger likely to create or strengthen dominant market position? • Key: how is market defined? If wide – more likely to be approved.

Competition Policy: State Aid • Article 86 provides rules concerning state-owned enterprises • Articles 87-89 rules on restrictions of effective competition from state aid (any level) favoring some companies over others • State aid includes subsidies, tax advantages, favorable loan terms, credit guarantees, sale or lease of goods and real estate below mkt prices, etc. • Exceptions of acceptable state aid: i) aid considered compatible with the internal market (social aid to consumers, disaster relief) and ii) aid cleared by the Commission

Enforcement:Clearances, Exemptions and Informal Solutions • Firms want certainty (clearance) that agreements are not automatically void creating potential liability. And, only through notification is it possible to obtain exemption. • Regulation resulted in huge number of notifications of agreements – too many to handle • Few individual exemptions (no time limit on response), Instead 90% informal: • comfort letters (mostly de minimis –i.e., too small) • block exemptions (white list and black lists)

Competition Policy: Directions • Notification of agreements provided consistency in Competition Policy across EU • decisions used in proceedings in national courts • spontaneous harmonization of national rules • Movement to rationalize EU role by streamlining block exemption process and devolving decisions to national govts. • Will allow EU to focus on new problems of recently liberalized markets, oligopolistic markets (game theory!) and markets that extend beyond the EU • EU competition policy has focused more and more on state aid

Defining Industrial Policy • “all acts and policies of the state to alter the allocation of resources between sectors • Micro/Micro – firm specific • Micro – industry specific • Macro – general industry • Excludes “horizontal” policies which do not discriminate among economic activities (fiscal, monetary, competition, regional, social, labor, environ, etc) • Generally require some selectivity bad record of “picking winners” • Contradictory – both sunset and sunrise sectors

Defining Industrial Policy • Practically – subsidies or protection (most studies are rooted in trade) • Evolution over 40 years • 1960-70’s – role for gov’t in correcting mkt failures; response to recession in 1970’s & early 80’s; creation of super firms to compete w/ US giants. • 1990’s – less convinced of effectiveness of gov’t intervention. Recognition that gov’t policy is also costly • IP “should promote adaption to industrial change in an open and competitive environment” Martin Bangermann, Commissioner for Industry 1989-1999 • Yergin, The Commanding Heights

Industrial Policy – Why? • Market Failure • Environment, knowledge (R&D) • Infant Industry • Scale or learning efficiencies. Do subsidies end? • Strategic industrial policy • Strategic trade policy, comp. adv. can be shaped, (financing w/ scale, first mover, infra-structure) • Industrial agglomeration • Next Silicon Valley (Holy Grail) vs. cathedrals in desert • Large firms/small firms? Mysterious! • Domestic distortions • E.g., expensive social welfare program affects hiring • R&D support – at what stage?

Industrial Policy - problems • Picking winners – who does it if not market? • If all member states have IP, will their be overprovision? • Rent-seeking behavior

Industrial Policy in the EU • No common EU Industrial Policy as in Ag, Transport, Regional policy • Focus is on preventing member state aid from distorting competition • Articles 87-89 • 87(1) broadly prohibits state aid “which distorts… competition by favoring certain undertakings or production of certain goods” • 87(3) then grants considerable leeway listing areas of possible exemption • Important projects of common European interest, certain economic activities, certain economic areas (shipyards mentioned), culture and heritage conservation • 88 allows constant review of state systems of aid • 89 empowers Commission to develop regulations

EU History • Historical development of decisions • Objections (El-Agraa Tbl 13.1) • Open conflict between DG III(industrial affairs) and DG IV (Competition) • Steel, Fibres and “temp crisis cartels” as orderly out;reduction of over-capacity to improve competitiveness; not “survival of fittest”! • “Negative Policy” - permitted subsidies of “sectors in difficulty” under close supervision • Highly criticized

EU History • Historical development of decisions • With single market, became more important to prevent state aid from distorting competition, • Positive Policy (1998): group exemptions for i) Horizontal aid including, SME, R&D, environmental protection employment and training, ii) regional aid iii) de minimis aid • Decrease in state aid (El-Agraa Tbl 13.2)

Table: State Aid as a percentage of GDP 1981-6 1986-8 1988-90 1990-2 1992-4 1994-6 1995-7 1997-9 Austria Belgium Denmark Finland France Germany Greece Ireland Italy Lux Netherlnd Portugal Spain Sweden UK EU avg 4.1 1.3 2.7 2.5 2.5 5.3 5.7 6 1.5 1.8 3 3.2 1 2 2.5 4.5 2.7 3.1 4 1.3 1.5 2.7 1.1 2.2 2.8 1.1 2.1 2.5 3.1 1.9 2.8 3.9 1.1 2 1.8 1.2 2.1 2.3 1 1.8 2.4 2.2 1.5 2.8 3.9 0.9 1.4 1.3 0.6 1.9 1.7 1.1 1.4 2.5 1.3 1 2.1 2.4 0.7 1 1.1 0.4 1.6 0.6 1.3 1 0.5 1.1 1.9 1.2 0.8 2 1 0.7 0.9 1.2 0.8 0.5 1.3 1.3 1.6 1.1 2.2 1.5 1.7 1.6 1.1 1.8 0.9 0.8 1.7 1.4 1 0.7 1.4 1.2 1.4 1.1 1.7 1.4 1.4 1.2 1.4 1.3 1.3 0.9 1.6 1.2 0.8 0.6 1.2 Source: EU Commission, Surveys of State Aid in the European Union (1st to 9th surveys) Updated from El-Agraa (2001), Table 10.2

source:Ninth Survey of State Aid in the EU

State aid to manufacturing by objectives (%) 1981-6 1986-8 1990-2 1992-4 1995-7 1997-9 Horizontal Obj Of which R&D Of which R&R Regional Objectives Sectoral Objectives 22 4 14 63 40 9 34 26 38 10 50 12 30 7 53 17 32 5 59 9 37 3 56 7 Source: EU Commission, Surveys of State Aid in the EU (1st to 9th surveys) Updated from El-Agraa (2001), Table 10.3

Trends in State Aid • For state aid to manufacturing: • Sectoral (aid to industries) falling across the board replaced by horizontal objectives and regional aid • Regional Aid risen from 14% (1981-86) to more than 50% • R&D stable around 10% • Beware ad hoc aid! (micro-micro, i.e., to individual firms, but considered horizontal?) • EU data hides great variation across member states in direction of aid and persistent violators.

Ryanair and Competition Policy • Ryanair – pioneer European discount airline based out of Ireland. Low prices, no frills, open seating • Focus on routes from major to secondary airports. Business model - wring out rebates and incentives from these secondary airports (20% of airports owned by govts) • Prior to profit warning, Europe’s largest airline by market capitalization • Discount airlines 15% of European mkt (less than in US mkt)

Ryanair and Competition Policy • Ryanair and Charleroi Airport • Depressed mining town 37mi from Brussels, • pre 1997 – fewer than 0.2 mil passengers/yr • 2003 – more than 1.8 mil passengers • Ryanair negotiated concessions with regional gov’t in Wallonia, 95% owner of Charleroi • €15mil since 2001 • Discounts on landing (50%), handling fees (90%); one-off funds for staff, marketing of new routes, office space and hotel accommodations • Approximately 90% of cost over a 15 year period. • Competitors angry at size and that must pay full • Ryanair counters Charleroi would never have become competitive alt to Brussels w/o their pioneering

Ryanair and Competition Policy • Complaint to Commission by Brussels airport • Judgement • Consistent EU stance - state aid is anti-competitive; must pay €4.5mil back (1/3) • Transport Commissioner de Palacio • Agreements viable if aimed at regional dev’t, transparent and don’t favor one over another • Future aid will be limited to 50% of airline costs for marketing new routes max 5 years • Walloon economy minister to join appeal • 3,400 jobs depend; considering across the board reduction of fees; may privatize in order to escape EU regulations on state aid

Ryanair and Competition Policy • Reaction • Michael O’Leary, Ryanair Chief Executive • Ruling was “unfair, bizarre, wrong, backward-looking, anti-competitive, and very damaging.” • European Commission was “an evil empire” • “Disaster” for low cost airline industry • Association of European Airlines welcomed decision • So did EasyJet!

Ryanair and Competition Policy • Reaction • Le Derniere Heure (Belgium tabloid) • Called ruling “finally rather measured.” The Commission’s main gripe, it said, was that the Wallonian regional gov’t had offered a “preferential tariff… there was no transparency, and no equal opportunities for other airlines.”

Ryanair and Competition Policy • Reaction • Irish Independent • “will do the opposite of what it is supposed to do: ensure competition and low prices.” • Compares subsidies of landing fees to subsidized mobile phones – make money on other services. • Illogical - Whether pricing policy is anti-competitive depends on ownership?? Isn’t airport considered infrastructure like roads which don’t recover full cost? • Concludes Commission likes competition among firms, but not among states (like tax competition). “The Wallonia gov’t is competing for tax base (employment) by offering cut price access to infrastructure.”

Ryanair and Competition Policy • Reaction • Financial Times • Charleroi whose main tourist attractions include “some castles and 63 coal slag heaps” would never have attracted Ryanair w/o offering incentives. The EC “accepts that”, Lex noted, “but it also recognises that a line has to be drawn somewhere to prevent distortions to market competition.” The incentives “would have been legal,” if Charleroi “could achieve a fair return over a reasonable time – as a private operator would.” That was impossible, the EC judged, “given the degree of Ryanair’s incentives.

EU Industrial Policy EU Competition Policy