2 Small and distant economies
The characteristics that make a country “small” have been the subject of extensive debate. Kuznets (1963) emphasizes a country’s population and draws a line at 10 million inhabitants. Other authors such as Marcy (1963) and Vakil and Brahmananda (1963) point to a country’s geographic area as well as population, but note that special exceptions are necessary to deal with geographically large countries such as Australia and Canada. A general conclusion drawn in this literature is that none of these variables are decisive (eg, one must take into account a country’s level of development and/or living standard). Vakil and Brahmananda (1963) argue that increases in a country’s size may not be an unmitigated good and there may be an “optimal” country size.[4]
The essential characteristic of small countries is that their firms are limited by the size of their local markets. McLeod (2003) makes the reasonable suggestion that for the consideration of competition law, small economies are defined as those economies that are approaching the minimum size needed to operate a full set of regulatory and competition policies and institutions. This group includes New Zealand, Singapore, Hong Kong, Sweden, Norway, Israel and Ireland. Economies that fall below this threshold, such as the micro states of the South Pacific, are faced by a different set of issues than those of larger economies. The limitation on market size expresses itself in few competing firms and absence of scale of operation.
New Zealand is both small and isolated. While, for competition law, the size of the domestic market is a critical factor, distance from other markets is relevant for cross-border trade and consequently the size and form of the domestic market which, in turn, might reasonably influence reasonable policy settings for competition and trade law. The empirical international economics literature distinguishes between the influence of borders and distance-from-market on trade. While many applications of the gravity model have shown that the volume of trade is materially adversely affected by distance from markets, it is only since the work of McCallum (1995) that the empirical regularity has been established that, given distance, borders also lower trade. McCallum estimates that intra-country cross state (US) and cross province (Canada) trade was some 2200% higher than across the US-Canadian border. Andersen and Van Wincoop (2003) argue that the gravity equations of McCallum are not informed by economic theory and that when the relevant modifications are made the intra-country trade relative to cross border trade falls to 44%.
The distance effects on trade can be attributed to transactions costs, including shipping, timeliness, communication, contractually related costs and weakening cultural ties that affect trade[5] and are associated with distance. Certain of the border effects can be attributed to obvious factors that include different currencies (Rose 2000) and the presence of tariffs and quota trade barriers (Wolf 2000): but other elements of them are more subtle.[6] Border effects arise within as well as between countries. Wolf (2000) for the USA and Combes, Lafourcade and Mayer (2003) for France show that state and regional boundaries affect trade. However, Combes et al explain a significant fraction of the French regional border effects by social networks (measured by employees’ birth places) and by business networks (measured by inter-plant connections). They found that these networks interacted with distance effects on trade by reducing transport costs, and that the effects were present in all industries. The finding of such network effects might have been suggested by the literature on the history of institutions that facilitate trade.[7]
The extent to which a market is small is reasonably assessable. The effects of distance on trade and the interaction of the distance and border factors are much more difficult to assess, and yet they are important in establishing what might be expected of internal and external trade of an isolated economy. The potential vigour of trade affects the definition of relevant markets and concomitantly the extent of competition in them. Despite the width of the Tasman sea, for New Zealand the analysis suggests that open access to trade with its relatively large near neighbour, Australia, is almost certainly extremely important for New Zealand trade per se, and for the competition it potentially poses for the New Zealand domestic market. This is particularly the case given New Zealand’s very small domestic market which, because of the transaction costs and arguably network dislocations implied by distance, suggest a separation of New Zealand’s domestic market from other markets to an extent not experienced by many other countries. However, based on the work of Krishna (2003) that finds for the USA no correlation between trade and welfare arising from either distance or income relating to any of the USA’s trading partners, the extent of the importance of an open trade relationship between New Zealand and any other particular country continues to be an open question. Nevertheless, the implications of low barriers to trade remain and are issues of direct relevance to the specification and application of competition law in New Zealand.
