In the following article, Joseph Stiglitz argues that power rather than competition is a better starting point for analysing the working of capitalism. People’s rewards depend less on their marginal product than on their power over labour or capital (or lack of it).
As inequality has widened and concerns about it have grown, the competitive school, viewing individual returns in terms of marginal product, has become increasingly unable to explain how the economy works.
Thus the huge bonuses, often of millions of pounds per year, paid to many CEOs and other senior executives, are more a reflection of their power to set their bonuses, rather than of their contribution to their firms’ profitability. And these excessive rewards are not competed away.
Stiglitz examines how changes in technology and economic structure have led to the increase in power. Firms are more able to erect barriers to entry; network economies give advantages to incumbents; many firms, such as banks, are able to lobby governments to protect their market position; and many governments allow powerful vested interests to remain unchecked in the mistaken belief that market forces will provide the brakes on the accumulation and abuse of power. Monopoly profits persist and there is too little competition to erode them. Inequality deepens.
According to Stiglitz, the rationale for laissez-faire disappears if markets are based on entrenched power and exploitation.
Monopoly’s New Era Chazen Global Insights, Columbia Business School, Joseph Stiglitz (13/5/16)
- What are the barriers to entry that allow rewards for senior executives to grow more rapidly than median wages?
- What part have changes in technology played in the increase in inequality?
- How are the rewards to senior executives determined?
- Provide a critique of Stiglitz’ analysis from the perspective of a proponent of laissez-faire.
- If Stiglitz analysis is correct, what policy implications follow from it?
- How might markets which are currently dominated by big business be made more competitive?
- T0 what extent have the developments outlined by Stiglitz been helped or hindered by globalisation?
In April 2015 the European Commission (EC) opened a formal investigation into the behaviour of Google in the market for smartphones and tablets. On the 20th April Google was sent a preliminary judgment (referred to formally as a Statement of Objections) in which it was accused of abusing its dominant market position. The European Commissioner argued that the case was similar to the famous and protracted investigation into the conduct of Microsoft.
In the early 2000s Microsoft had a dominant position in the market for desktop operating systems. It has been estimated that 97% of all computing devices at the time used Microsoft Windows. This market power attracted the attention of the EC who accused the company of using its dominance in the operating systems market to restrict competition in complementary markets for software such internet browsers and media players. This led to a complex legal battle between the two parties.
Windows is proprietory software and computer manufacturers have to pay Microsoft a licence fee to install it on their machines. Before the rulings by the EC, Microsoft could make a licence for Windows conditional on other Microsoft software such as Internet Explorer and Media Player being pre-installed. This is known as bundling and in this case the EC came to the conclusion that it restricted competition. The European Commissioner, Margrethe Vestager recently stated that
“If Microsoft’s media player was already there when you bought a PC, it would be hard to persuade people to even try an alternative, so innovators would be at a big disadvantage”
Microsoft lost most of its competition battles with the EC and had to pay a total of €2.2 billion in various fines. It was also forced to change its conduct. For example, the EC instructed Microsoft to provide its users with a choice of internet browsers.
The marketplace for operating systems has gone through some significant changes since the early 2000s. By 2016 Microsoft’s market share had fallen to 26 per cent. One of the major reasons for this decline has been the increasing popularity of smartphones and tablets.
Google’s Android operating system dominates the mobile market with a market share of over 80 per cent. However, the economics of the Android operating system are very different from those of Windows. Unlike Windows, Android is an example of ‘open-source software’. This means that, rather than having to obtain a licence fee, mobile handset or tablet manufacturers can freely install Android on their devices and are not obliged to pre-install other Google software – both Amazon and Nokia have done this. ,
Another major difference is that it is relatively straightforward for rival firms to develop software that can run on Android. Microsoft was accused of making it very difficult for rival software companies to develop products that would run smoothly on the Windows operating system.
It would appear far easier for rival firms to compete with Google than it ever was with Microsoft when it had a dominant market position. It might therefore seem surprising that the EC has accused Google of abusing its dominant market position.
Rather than any restrictions surrounding the licencing conditions for the operating system the EC’s objections to Google’s behaviour focus on its licencing conditions for other proprietary software products it provides. In particular, the EC has focused on the Google Play Store.
The pre-installation of the Google Play Store is seen as vital to the commercial success of any Android phone. Google Play Store was launched in 2012 and brought three previously separate services together – Android Market, Google Music and Google eBookstore. It is the official app store for all users of a device with an Android operating system. It has been argued that a mobile phone store would not stock an Android phone unless it had Google Play Store pre-installed because it is so highly valued by customers.
Therefore it is vital for Android smartphone and tablet manufacturers to obtain a licence for the Play Store. The conditions for obtaining a licence are outlined in the Mobile Application Distribution Agreement. This specifies that a number of other Google apps must also be pre-installed on the device in order for a licence to be granted for the Play Store. These apps include Gmail, Google Chrome, Google Drive, Google Hangouts, Google Maps, Google Search and YouTube. The manufacturer is free to install any other non-google apps.
The EC has specifically objected to the condition that Google Search has to be installed and set as the default search engine. It is concerned that this that will make it very difficult for other search services to compete with Google because (1) manufacturers will have limited incentives to pre-install any competing search engines and (2) consumers will have less incentive to download competing search engines.
The EC has also expressed concerns that the pre-installation of Google Chrome as the mobile browser will also have a negative impact on competition and innovation in this market.
Companies are given 12 weeks to respond after they have received a preliminary judgment. If they do not accept the objections, then the EC will take several months to come to a final ruling and suggest some appropriate remedies. In this case, the most likely remedy is the removal of the licence conditions for the Google Play Store. If Google appeals the ECs decision to the General Court of the EU, it could take years until a final judgment is made.
Murad Ahmed, the European Technology Correspondent at the Financial Times commented that
“One lesson Google might want to learn from Microsoft’s example is while it fights the EU watchdog it is not overtaken by a less distracted competitor.”
Europe v Google: how Android became a battleground The Guardian (20/4/16)
EU accuses Google of using Android to skew market against rivals The Guardian (20/4/16)
Google faces EU charge over Android ‘abuse of dominance’ BBC News (20/4/16)
Google hit with EU competition charges for ‘abusing’ dominant position with Android Independent (20/4/16)
Everything you need to know about Google and its EU battle The Telegraph (20/4/16)
- Draw a diagram to compare and contrast the price and quantity in a competitive market with a situation where a firm has market dominance. Clearly state any assumptions you have made in the analysis.
- What factors does the EC consider when judging if a firm has a dominant position in the market?
- This blog has focused on one aspect of Google’s behaviour/conduct that has raised concerns with the EC. What other elements of Google’s conduct has the European Commission objected to?
- Explain the difference between pure and mixed bundling.
- What impact does bundling have on consumer welfare?
On 13th October 2015 the management team of SABMiller (the second largest brewing business in the world) agreed in principle to a $108 billion takeover offer from AB-InBev (the largest brewing business in the world). When the announcement was made it was clear that the global nature of the businesses involved meant that the deal would have to be cleared by numerous competition authorities from all over the world. This blog focuses on the latest developments in the European Union.
The relevant legislation in Europe that addresses Mergers and Acquisitions (M&As) is the Merger Regulation that came into force on the 1st May 2004. This legislation gives the European Commission (EC) the power to investigate M&As that are said to have an ‘EU dimension’ as they exceed certain turnover thresholds.
Businesses involved in an M&A that meet the ‘EU dimension’ are obliged to pre-notify the EC and obtain clearance before going ahead with the deal. AB-InBev formally notified the European Authorities of its intention to acquire SABMiller on 30th March 2016.
Once official notification has been received, the EC launches a Phase 1 investigation which usually has to be completed in 25 working days. The investigation focuses on whether the M&A would:
“significantly impede effective competition, in the internal market or in a substantial part of it, in particular as a result of the creation or strengthening of a dominant market position” (Article 2(2) and (3))
This is often referred to as the ‘SIEC’ test. In addition to worries that an M&A may create or strengthen ‘single-firm dominance’, the ‘SIEC’ test is also used to test for ‘collective dominance’. Collective dominance is the possibility that the M&A might make either formal or tacit collusion more likely.
The European Competition has expressed concerns that the acquisition of SABMiller by AB-InBev might significantly impede effective competition in the premium lager market. Unconditional clearance of the deal would result in the same business owning many of the best-selling premium lager brands in Europe, including Stella Artois, Beck’s, Budweiser, Corona, Peroni and Grolsh.
As part of the Phase 1 investigation, the management of the businesses involved with the M&A can have ‘State of Play meetings’ with officials from the EC. At these meetings EC staff can raise any competition concerns they have with the deal and the businesses can respond by offering to take specific actions that they hope will address any issues. The most common action is a commitment to sell of some of the assets of the newly merged business.
Any commitments must be made no later than 20 days following the formal notification of the merger and they result in the time frame for the Phase 1 investigation being extended from 25 to 35 working days.
On the 8th April, AB-InBev made a commitment to the EC to sell the SABMiller brands Peroni, Grolsch and Meantime as a potential remedy for their competition concerns. A price of €2.55 billion for the deal was agreed with Asahi – the largest Japanese brewery. The sale of the brands is subject to the acquisition of SABMiller by AB-InBev being completed. Following this commitment, the EC extended the deadline for the Phase 1 investigation to May 24th.
It appears that at subsequent State of Play meetings EC officials expressed concerns that this commitment was not enough to address fully their worries over the impact of the acquisition on competition.
On April 27th (just inside the 20-working-day deadline) AB-InBev made an extended package of commitments to the European Union authorities to try to remedy their continued concerns. The commitments now include the sale of the SABMiller breweries in Eastern Europe (Poland, Hungary, Romania, the Czech Republic and Slovakia). Part of this sale would also include the Pilsner Urquell brand – a best-selling beer in the Czech Republic – and the Drecher brand – a best-selling beer in Hungary.
If the EC decides that the deal still raises concerns and could significantly impede effective competition in the single market, then the acquisition will be referred for a Phase 2 investigation. Phase 2 investigations are far more detailed than at Phase 1 and place far greater burdens on the parties involved. They also take much longer. The initial deadline for completion is 90 working days, but this can be extended to 125 working days in certain circumstances. Taking holidays into account they could last for 6 to 7 months before coming to a final decision.
This may help to explain why AB-InBev is willing to sell off nearly all of SABMiller’s European assets in the hope of obtaining clearance for a deal at the end of the Phase 1 investigation. The company aims to finalise the takeover in autumn of this year and is therefore very keen to avoid any regulatory delay created by a more detailed Phase 2 investigation.
Its willingness to sell off the European assets also confirms AB InBev’s main motive for its acquisition of SABMiller – to gain access to new and growing markets in Africa and Latin America.
It will be interesting to see the outcome of the Phase 1 investigation on May 24th.
AB InBev accepts Asahi offer for Peroni and Grolsch Independent (19/4/16)
Asahi laps up Peroni and Grolsch to smoothe AB InBev’s SABMiller deal The Telegraph (19/4/16)
Peroni and Grolsch sold as AB Inbev and SABMiller deal nears The Guardian (19/4/16)
AB InBev offers more SAB Europe assets to win EU deal approval Reuters (29/4/16)
Peroni and Grolsch brands sold by AB InBev to Asahi BBC News (19/4/16)
- What threshold criteria have to be met in order for a merger to be classed as having a European dimension?
- Discuss the different types of decision that can be made by the European Commission at the end of a Phase 1 investigation.
- Compare the notification system used by the European Commission with the one used by the UK competition authorities.
- Discuss some of the market conditions that would make either formal or tacit collusion more likely.
- Discuss some factors that might make it in the interests of society for an M&A to go ahead?
- To what extent does the evidence suggest that M&As have delivered the benefits predicted by the managers of the businesses involved?
Tax avoidance has been in the news since the publication of the Panama papers, which show the use of offshore tax havens by rich individuals and companies, partly for tax avoidance, partly for money laundering and other criminal activities – some by corrupt politicians and their associates – and partly to take advantage of lower regulation of financial dealing.
There are many tax havens around the world, including Switzerland, Hong Kong, British overseas territories (such as the British Virgin Islands, the Cayman Islands and Bermuda), Jersey, Singapore and certain US states (such as Arizona, Delaware, Nevada and Wyoming).
Here we focus on tax avoidance. This is the management of tax affairs by individuals or firms so as to avoid or minimise the payment of taxes. Tax avoidance is legal, unlike tax evasion, which is the practice of not declaring taxable income.
In a statement from the White House, directly after the publication of the Panama papers, President Obama spoke about the huge international scale of tax evasion and tax avoidance:
“A lot of it is legal, but that’s exactly the problem. It’s not that [people are] breaking the laws, it’s that the laws are so poorly designed that they allow people, if they’ve got enough lawyers and enough accountants, to wiggle out of responsibilities that ordinary citizens are having to abide by.
Here in the United States, there are loopholes that only wealthy individuals and powerful corporations have access to. They have access to offshore accounts, and they are gaming the system. Middle-class families are not in the same position to do this. In fact, a lot of these loopholes come at the expense of middle-class families, because that lost revenue has to be made up somewhere. Alternatively, it means that we’re not investing as much as we should in schools, in making college more affordable, in putting people back to work rebuilding our roads, our bridges, our infrastructure, creating more opportunities for our children.”
Tax avoidance, whether in tax havens, or through exploiting loopholes in the tax system may be legal. But is it fair?
Various principles of a tax system can be identified. These include:
||People in the same situation should be treated equally. For example, people earning the same level of income and with the same personal circumstances (e.g. number and type of dependants, size of mortgage, etc.) should pay the same level of income tax.
||Taxes should be ‘fairly’ apportioned between rich and poor. The rich should pay proportionately more taxes than the poor.
||Equity between recipients of government services
||Under the ‘benefit principle’, it is argued that those who receive the most benefits from government expenditure ought to pay the most in taxes. For example, it can be argued that roads should be paid for from fuel tax.
||Difficulty of evasion and possibly of avoidance
||If it is desirable to have a given tax, people should not be able to escape paying.
||Taxes alter market signals: taxes on goods and services alter market prices; taxes on income alter wages. They should not do this in an undesirable direction.
||Convenience to the taxpayer
||Taxes should be certain and clearly understood by taxpayers so that they can calculate their tax liabilities. The method of payment should be straightforward.
||Convenience to the government
||Tax rates should be simple to adjust and as cheap to collect as possible.
||Minimal disincentive effects
||Taxes may discourage people from working longer or harder, from saving, from investing or from taking initiative. It is desirable that these disincentives should be kept to a minimum.
Of course, not all these requirements can be met at the same time. One of the most serious conflicts is between vertical equity and the need to keep disincentives to a minimum. The more steeply the rich are taxed, it is argued, the more serious are the disincentive effects on them likely to be (see the blog post from 2012, The 50p income tax rate and the Laffer curve). Another is between vertical equity and equity between recipients of services. Some of the people most in need of government support are the poorest and hence pay the least taxes.
The crucial question is what is regarded as ‘fair’. What is vertically equitable? According to the second article below, people’s preferred tax rates depend on how information is presented. If information is presented on how much tax is paid by the rich, people generally feel that the rich pay too much. If, however, information is presented on how much income people are left with after paying tax, people feel that the rich still have too much and ought to pay more tax.
The majority of people in the UK feel that tax avoidance, although legal, is morally wrong. According to the results of an HMRC survey in 2015, “the majority (63%) of respondents felt that the use of tax avoidance schemes was widespread. However, the majority (61%) also responded that it was never acceptable to use a tax avoidance scheme. The most frequent reason given as to why it was unacceptable was that ‘it is unfair on others who pay their taxes’.”
In making judgements about the fairness of tax, people generally have inaccurate knowledge about the distribution of income, believing that it is more equal than it really is, and about the progressiveness of the tax system, believing that it is more progressive than it really is. Despite this, they want post-tax income distribution to be more equal.
What is more, although people generally disapprove of tax avoidance, it is the system that allows the avoidance of taxes that they want changing. As long as it is possible to avoid taxes, such as giving gifts to children to avoid inheritance tax (as long as the gift is made more than seven years before the person’s death), most people see no reason why they should not do so themselves.
The following articles look at tax avoidance and people’s attitudes towards it. They are all drawn from The Conversation, “an independent source of news and views, sourced from the academic and research community and delivered direct to the public.”.
Explainer: what are ‘tax havens’? The Conversation, Tommaso Faccio (5/4/16)
When it comes to tax, how do we decide what’s fair? The Conversation, Stian Reimers (8/4/16)
Six things a tax haven expert learned from the Panama Papers The Conversation, Ronen Palan (6/4/16)
The Panama Papers The International Consortium of Investigative Journalists
Exploring public attitudes to tax avoidance in 2015: HM Revenue and Customs Research Report 401 HMRC, Preena Shah (February 2016)
2010 to 2015 government policy: tax evasion and avoidance HMRC/HM Treasury (8/5/15)
- Distinguish between tax avoidance and tax evasion.
- Give some examples of tax avoidance.
- Look through the various principles of a tax system and identify any conflicts.
- What problems are there in having a highly progressive tax system?
- What is a ‘shell company’? How can it be used to avoid and evade taxes?
- What are bearer shares and bonds? Why were they abolished in the UK in 2015?
- What legitimate reasons may there be for a company or individual using a tax haven?
- To what extent might increased transparency in tax affairs discourage individuals and companies from engaging in aggressive tax avoidance?
- What light does/can behavioural economics shed on people’s perceptions of fairness?
- How might the use of absolute amounts or percentages influence people’s thinking about the fairness of a tax system? What implications does this have for politicians in framing tax policy?
- In the principal–agent problem, where the principals are the tax authorities and the agents are taxpayers, why does asymmetric information arise and why is it a problem? How do the tax authorities seek to reduce this problem?
When people think about healthcare in the UK they tend to associate it with the NHS. However, there is a £5 billion private healthcare market. Concerns have been expressed about the lack of effective competition in this sector and it has been investigated by the competition authorities over a 5-year period.
Approximately 4 million people in the UK have a private medical insurance policy. The majority of these are paid for by employers, although some people pay directly. Four companies dominate the health insurance market (AXA PPP, Bupa, Pru Health and Aviva) with a combined market share of over 90%.
Health insurance companies purchase healthcare services for their policy holders from private hospitals. The majority of private hospitals in the UK are owned by the following businesses – BMI, HCA, Nuffield, Ramsey and Spire. Some concerns have been expressed about the lack of competition between private hospitals in some areas of the country.
After its initial analysis into the sector, the Office of Fair Trading (OFT) referred the case to the Competition Commission (CC) in April 2012 to carry out a full market investigation. This process was then taken over by the Competition and Markets Authority (CMA) when it replaced the OFT and CC. The final report was published on April 2nd 2014.
One specific region that was identified in this report as having a lack of effective competition was central London for patients with health insurance. In particular it was concluded that:
||The market in central London was heavily concentrated and HCA had a dominant market position – its aggregated share of admissions across 16 specialities (e.g. Oncology, Cardiology, Neurology, Dermatology etc.) was 45% to 55%.
||There were significant barriers to entry including substantial sunk costs. A particular issue for a new entrant or existing business was the problem of securing suitable sites in central London to build new hospitals and in obtaining planning permission. It was pointed out in the report that the market structure in central London had changed very little in the previous 10 years despite a rapidly growing demand for private healthcare.
|| HCA was charging insured patients higher prices for similar treatments than its leading rival – The London Clinic. HCA was also found to be making returns that were in excess of the cost of capital.
One of the key recommendations of the report was that HCA should be forced to sell–off one or two of the hospitals that it owned in central London to increase the level of competition.
Unsurprisingly HCA was very unhappy with the decision and applied to the Competition Appeal Tribunal (CAT) for a review of the case. During this review, economists working for HCA found errors with the analysis carried out by the CMA into the pricing of health services for insured customers.
In January 2015 the CAT concluded that the findings and recommendations of the report on insured patients in central London should be overturned and the CMA should reconsider the case. In November 2015 the CMA announced that having reviewed the case it had come to a similar set of conclusions: i.e. there was a lack of effective competition and HCA should be forced to sell off two of its hospitals in London.
HCA still claimed that the pricing analysis was incorrect because it did not fully take into account that HCA treated patients with more complex conditions than TLC and that was why their prices were higher.
On March 22nd 2016 the CMA announced that it had reversed its ruling and HCA would no longer be expected to sell off any of its hospitals. The reason given for this change in recommendation was the appearance of new entrants into the market. For example, Cleveland Clinic a US-based private healthcare provider has purchased a long-term lease on a property in Belgravia, central London. It plans to convert the office space into a private hospital with 2015 beds.
A spokesperson for Bupa commented that:
“The CMA has confirmed again that there isn’t enough competition in central London, with HCA dominating the private hospital market and charging higher prices. We ask the CMA to act now to address this gap.”
It will be interesting to see the impact these new entrants have on the market in the future.
London develops as a global healthcare hub Financial Times Gill Plimmer (31/01/16)
Competition watchdog reverses ruling on private hospitals Financial Times Gill Plimmer, (22/03/16)
CMA’s private healthcare provisional decision on remedies CMA 22/03/16
Competition problems provisionally found in private healthcare CMA 10/11/15
CMA welcomes Court of Appeal verdict in private healthcare case CMA 21/05/15
- Define sunk costs using some real-world examples.
- Why might the existence of sunk costs create a barrier to entry?
- Draw a diagram to illustrate why a profit-maximising business with significant market power might charge higher prices than one in a very competitive environment.
- What is the cost of capital? Explain why returns that are greater than the cost of capital might be evidence that a firm is making excessive profits.
- Draw a diagram to illustrate the impact of new entrants in a market.