4  Competition policy in New Zealand: a first examination

Given the relative population and income in New Zealand, and its geographic isolation, it is quite likely that there is a significant number of industries where demand within the relevant geographic market is small relative to minimum efficient scale: indeed this is the evidence of Arnold et al (2003). The application of competition law remedies to such industries could significantly magnify these costs. Consider, for example, if the enforcement of merger provisions impedes the ability of the two firms of an industry to merge where demand (as measured by Q*) is 0.66 of minimum efficient scale. Absent a merger, each firm individually would only be able to achieve a scale of 0.33 of minimum efficient scale. As indicated by Table 2 above, depending on the industry, this could impose a significant cost disadvantage on New Zealand producers and consumers.

We note that such inefficiencies could equally arise in other areas of competition policy. For example, consider the case where the competition authority attacks a business practice such as exclusive dealing, tied selling, loyalty rebates or geographic price discrimination under its Abuse of Market Power provisions on the basis that it excludes an equally efficient entrant (ie, with identical cost curves). Or consider a situation where the incumbent firm is required to provide potential entrants with access to its facilities or where conspiracy law prevents two incumbent firms from entering into an agreement where one firm pays its rival for a non-competition (clause whereby the other firm exits this market). If the industry is one where Q* is, for example, 0.66 of minimum efficient scale, the same cost disadvantage could arise.

The most direct policy implication is that much weight should be placed upon the efficiency defence under New Zealand merger and trade practice law. In a seminal article, Williamson (1968) argues that, as a general matter, a horizontal merger could benefit an economy if it allows the firms to achieve “efficiency gains”—ie, a reduction in their per-unit operating costs. The capture of such efficiency gains would reflect real resource savings for the economy. Because efficiency gains allow any given level of output to be produced with fewer inputs (eg, labour and capital), such a merger would free up new resources that could be used in other industries and potentially lower prices to consumers. In essence, the efficiency defence entails permission of mergers and practices that increase the sum of consumers’ and producers’ surpluses.

In open small economies often a relatively high fraction of economic activity in some industries is conducted by foreign firms, and certain of the aggregate benefits may rest with foreign consumers. Furthermore in these economies’ markets firms’ output growth opportunities may lie in exports. Do these issues pose particular concerns for estimating the efficiencies of mergers and practices?

The Commerce Act requires that benefit and detriment (ie, efficiency) calculations be applied to any market that is, under Section 3(1A) of the Act,

A market in New Zealand for goods or services as well as other goods or services that, as a matter of fact and commercial common sense, are substitutable for them.

And Section 4(1) of the Act provides:

This Act extends to the engaging in conduct outside New Zealand by any person resident or carrying on business in New Zealand to the extent that such conduct affects a market in New Zealand.

We note that the Act is defining markets with respect to New Zealand independently of ownership of entities in those markets. The history and implications of this position are reviewed in the Appendix, where it is pointed out that in almost all applications differential treatment of foreign and domestic owners in efficiency analyses would render time-inconsistent policies and actions and inhibit dynamic efficiency.[37] [38]

The calculation of efficiency in a small open economy in industries where a large fraction of output is exported entails applying the efficiency calculation to the domestic market and the efficiencies of firms domiciled in New Zealand. Thus, the efficiency of domestic actions by exporting firms will appear in the calculation as well as the producers’ surplus changes that are anticipated to flow from the effect of these actions on the profitability of exports. In an open trading country, this implies it is very important that producers’ surplus be weighted equally with consumers’ surplus. To ignore or ascribe a lower weight to domestic and/or (potential) export generated producers’ surplus would be to inhibit activity and investment in these industries.[39]

4.1  Assuring efficiency enhancing mergers are not blocked

The principle articulated by Williamson (1968) applies to all industries where a credible efficiency argument can be mounted. Where Q* is small relative to minimum efficient scale, establishing efficiency would require estimating minimum efficient scale and then assessing Q* given a rigorously defined geographic market. As a practical matter, it will be important to assess the curvature of the cost curves as well.[40] As shown in Table 2, some industries have relatively “flat” cost curves (eg, non-rubber shoes in the data from Scherer et al (1975)), and in such industries efficiency arguments would be less substantively important.

Even if a merger increases market power for the merging firms that would enable them to raise price, increased efficiency may still outweigh the welfare loss resulting from the price increase. In Figure 4 it is assumed that a merger creates both market power and efficiencies. This results in lower marginal (and thus average) cost and a higher price / lower output. We can observe three main changes in welfare. First, the restriction of output creates a deadweight loss (area C). Second, the higher price transfers surplus from consumers to producers on the units still sold (area B). And third, the efficiencies lower the costs of producing this output (area D). Antitrust authorities should compare area C and D to determine whether the resulting welfare loss to society is outweighed by the efficiencies created by the merger.

Figure 4 – Efficiencies versus market power [41]

The same principles would apply to non-merger areas such as Abuse of Market Power.[42] Breaking up a firm in an industry with a Q* of, for example, 0.66 could impose significant efficiency losses, depending on the industry.

Although such efficiency analysis will involve markets where most of the consumers are in New Zealand and exports are not significant, as noted earlier, if sales in foreign markets are important, the firms may be able to achieve minimum efficient scale by exporting. Nevertheless, where (potential) exporting is important there may be (potential) domestic market detriments that should be weighed against benefits of mergers and practices that enhance scale related cost savings.