Competition policy and financial crises : lessons learned and way forward

Abstract

The financial crisis originating in the USA quickly spread to the rest of the world with confidence receding, interbank lending rarefied and a serious credit crunch. Financial institutions throughout the world got into trouble, and over time the crisis in the financial markets has caused wide-spread financial difficulties across the world. Iceland is one of the countries hardest hit by the crisis, but most of the other Nordic countries have experienced and anticipate further economic downturns as well, although presumably at a lesser scale. In their semi-annual meeting in Helsinki in March 2009, the Directors General of the Nordic competition authorities discussed the financial crisis, its economic impact on the real economy as well as how the crisis had affected the respective Nordic competition authorities. The Directors General unanimously agreed and stressed the importance of not weakening competition policy in times of crisis. At the same time, and as evidenced by history, this view has and will expectedly be challenged further as the crisis evolves. Thus, the Directors General acknowledged the need to substantiate why continued, vigorous competition enforcement is important to come strengthened out of the crisis. This is the background for this report. The report consists of six different parts. The first part (chapter 2) contains a review of how the crisis has affected the economies of the Nordic countries, and the respective measures imposed to counteract the effects. Chapter 3 presents EU Commission policy and Commission measures related to the crisis. Chapter 4 takes a historical perspective on previous crisis, and briefly review the lessons learned from a competition point of view. The report also contains a review of the experience on the connection between competition, productivity and economic growth (chapter 5), before presenting how competition policy has been challenged so far during the crisis in the Nordic countries. Here, the Icelandic experience is particularly relevant and important. The report concludes with specific recommendations on competition policy in times of crisis in chapter 7. A brief summery of the different part of the report is presented below. Chapter 2 – The current financial crisis and the economic perspectives in each of the Nordic countries The current global crisis has profoundly affected the availability and cost of credit to the world’s households and businesses. Being basically a crisis in trust this credit crunch has impacted all Nordic countries by a quick and deep contraction of the economies. Stock prices are down between 50 per cent and 90 per cent since the peak in early 2007. Except for Greenland, GDP growth has fallen sharply in 2008, and will continue to do so in 2009. Unemployment rates have risen and will first start to level in 2010. Inflation remains low, however, but a real fear of deflation still exists. Initiatives to remedy the effects of the crisis include expansive fiscal policy measures and tax cuts, credit packages for households and industries as well as bank rescue packages. Iceland’s situation is particularly urgent and complicated, as outlined in chapter 2.7. Chapter 3 – EU Commission – policy and measures related to the current financial crisis The European Commission has, along with the member states, launched a number of efforts to remedy the effects of the financial crisis. Its European Economic Recovery Plan, aims at stimulating demand and confidence and secure long term competitiveness. It proposes a set of actions to support the real economy by countercyclical macroeconomic responses, some of which include State aid. The imminent need to unblock bank lending and encourage investment were met by the adoption of “Temporary Framework” in December 2008. This framework includes measures which allow Member States to mitigate or remedy the effect of the credit crunch on the real economy in minimally distortive way. The subsequent implementation of financial aid schemes was widespread, and by May 2009 the Commission had authorized nearly 40 measures in 16 Member States within the framework. Chapter 4 – Experiences from previous financial crises In times of crises competition law becomes particularly important. In earlier crises, proposals have come forward calling for weaker competition laws. In order to be able to assess the rationale of such a standpoint, it is helpful to look at experiences and evidence from earlier economic setbacks, recessions or depressions. Lessons can be learned from the Norwegian banking crisis of the 1920s, the Great Depression and how it was dealt with in United States and by the Nordic countries, as well as the Scandinavian/ Nordic banking crisis of the 1990s. Research has shown that weakening competition laws as a tool to combat economic difficulties may have the opposite effect and works to prolong the crisis. It is important to keep this in mind when governments take actions in order to limit the negative effects of the current crisis. Chapter 5 – The benefits of competition Economic theory supports the view that competition is desirable because it increases the welfare of consumers and contributes to efficiency in economic activity. Competition is rivalry between individual firms. Rivalry ensures that only the most efficient and innovative firms are in the market. Competition is an ongoing process that works through utilization of company resources, entry and exit in the market and innovation. It is difficult to quantify how much an efficient competition affects productivity and the economy more generally, but a number of extensive studies have found that stronger competition is associated with higher productivity. In the same way that it is clear that competition in business has a positive impact, it has also been established that competition restrictions may cause great damage to the public and the economy. Chapter 6 – Challenges to competition policy The current economic crisis poses several challenges to competition policy. When it comes to merger control, competition authorities may envisage an increased reference to the failing firm defence. The crisis can also affect the notion of what are legitimate responses to the downturn. Firms may disregard the illegality of cartels and see a cartel agreement as the best way to reduce overcapacity and reduce uncertainty. As substantial parts of the fiscal stimulus are channeled subject to public procurement, it might be needed to further underline the risk or propensity of cartel formation among participants in tenders. The rise in bankruptcies in various industries has led and will lead to concentration that in already concentrated markets may distort competition. Firms’ restricted access to credit may imply increased barriers to entry. We will see an increased pressure for state aid and other government interventions that may distort competition. Public measures that imply a restriction or distortion to competition might be proposed and be more politically acceptable in times of crisis. Chapter 7 – Summary, conclusions and recommendations The report concludes with a number of recommendations. First of all, the report emphasizes the importance of continued, vigorous competition enforcement and to stand firm on competition policy also in times of global economic crisis. It is well documented that competition contributes to economic growth and increases welfare. This is supported by historical evidence, which clearly indicates that actions that restrict competition actually prolong the economic difficulties and postpone recovery. Consequently, measures implemented to deal with the crisis must not distort or weaken competition; for instance by reducing the companies’ ability or incentives to compete, or by raising barriers to entry. Experience shows that measures imposed often are irreversible in nature (e.g. forced mergers) or tend to become permanent. Thus, temporary measures and government involvement must be truly temporary and include a clear exit strategy. Even though the crisis does not alter the rationale for competition policy as such, it alters the economic realities in which competition policy works. Some industries will become more concentrated. The failing firm defense might be invoked to an increasing extent, it might be more tempting to collude or abuse a dominant situation. The competition authorities will not tolerate any attempts to use the crisis as an excuse for a more lax attitude towards competition law. Mergers and acquisitions will be assessed according to the normal criteria for assessment, but the competition authorities will also act expediently and allocate the necessary resources to the assessment, for instance when necessary to secure continued operations and to avoid unnecessary loss of workplaces. An important part of the fiscal stimulus packages imposed in the Nordic countries will be directed towards public construction projects. The report underlines the importance of effective competition and low barriers to entry in local, regional and state procurement. This applies even if urgency procurement procedures are used. Checklists to aid in detecting illegal cooperation and bid rigging are available. As the crisis has evolved, the Nordic competition authorities have witnessed and still expect an increased pressure for state aid and other government interventions that may distort competition. As a final point, the report stresses the importance of state aid complying with EU/EEA rules and guidelines. Furthermore, protectionist measures must be avoided as this will only prolong the crisis.