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Theorie und Politik der Europäischen Integration Prof. Dr. Herbert Brücker Lecture 4 Market Size and Scale Effects Trade and Competition Policies Theory.

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Präsentation zum Thema: "Theorie und Politik der Europäischen Integration Prof. Dr. Herbert Brücker Lecture 4 Market Size and Scale Effects Trade and Competition Policies Theory."—  Präsentation transkript:

1 Theorie und Politik der Europäischen Integration Prof. Dr. Herbert Brücker Lecture 4 Market Size and Scale Effects Trade and Competition Policies Theory and Politics of European Integration

2 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Last Lecture Preferential Trade Liberalisation ·The PTA Diagram –Free Trade Equilibrium –MFN Tariff Equilbrium –Unilateral Trade Discrimination –Supply Switches –Welfare Effects ·Empiry: Is Trade Diversion an Issue? ·Welfare Effects of a Customs Union ·Customs Union vs. Free Trade Area ·WTO Rules and Customs Union/Free Trade Areas –Art. 24 WTO

3 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 3 Preferential Trade Liberalisation Uniform MFN Tariff Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Partner Home RoW Border price Border price PaPa P T T P P -T XRXR XPXP XPXP M FREE p* XRXR

4 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 3 Preferential Trade Liberalisation Discriminatory, Unilateral Liberalization Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Partner Home RoW Border price Border price MS PTA 1 PaPa P T T P P P -T XRXR XRXR XPXP XPXP M p*

5 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 3 Preferential Trade Liberalisation Domestic Price and Border Price Changes Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Border price MS PTA P T P P -T XRXR XRXR XPXP XPXP M P

6 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 3 Preferential Trade Liberalisation Domestic Price and Border Price Changes Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Border price MS PTA P T P P -T XRXR XRXR XPXP XPXP M P domestic price falls to P from P

7 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 3 Preferential Trade Liberalisation Domestic Price and Border Price Changes Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Border price MS PTA P T P P -T XRXR XRXR XPXP XPXP M P domestic price falls to P from P Partner-based firms see border price rise, from P-T to P

8 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 3 Preferential Trade Liberalisation Domestic Price and Border Price Changes Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Border price MS PTA P T P P -T XRXR XRXR XPXP XPXP M P domestic price falls to P from P Partner-based firms see border price rise, P-T to P RoW firms see border price fall from P-T to P-T.

9 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 3 Preferential Trade Liberalisation Quantity Changes: Supply Switching Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Border price MS PTA P T P P -T XRXR XRXR XPXP XPXP M P

10 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 3 Preferential Trade Liberalisatio Quantity Changes: Supply Switching Domestic price Home imports MD RoW Exports Partner Exports XS P XS R MS MS MFN M Border price MS PTA P T P P -T XRXR XRXR XPXP XPXP M P RoW exports fall

11 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Today's Lecture - Overview Market Size and Scale Effects EU Competition Policies EU Trade Policies

12 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Today's Reading Market Size and Scale Effects ·Baldwin & Wyplosz (2009) The Economics of European Integration, McGraw-Hill, Ch 6. Competition and State Aid Policies ·Baldwin & Wyplosz (2009) The Economics of European Integration, McGraw-Hill, Ch 14. Trade Policies ·Baldwin & Wyplosz (2009) The Economics of European Integration, McGraw-Hill, Ch 15.

13 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Market Size Matters European leaders always viewed integration as compensating small size of European nations. Implicit assumption: market size good for economic performance. Facts: integration associated with mergers, acquisitions, etc. In Europe and more generally, globalisation.

14 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Sketch of economic logic liberalisation de-fragmentation pro-competitive effect industrial restructuring (M&A, etc.) RESULT: fewer, bigger, more efficient firms facing more effective competition from each other.

15 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Sketch of economic logic liberalisation de-fragmentation pro-competitive effect industrial restructuring (M&A, etc.) RESULT: fewer, bigger, more efficient firms facing more effective competition from each other.

16 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Monopolies and duopolies Firms are not price takes Elasticity of demand curve constrains price levels Profit maximum is achieved if prices are chosen in a way that marginal revenues equal marginal costs Duopoly: Price and production depends on expectations on behaviour of competitors Cournot-Nash equilibrium: Optimum is achieved when symmetric firms produce same level of output

17 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Economic logic (background): Monopoly case Sales Price Marginal Cost Marginal Revenue Curve Demand Curve Sales Price Q+1 P Marginal Cost Curve CE D Demand Curve A B Q* Q P* P

18 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Economic logic (background): Monopoly case Sales Price Marginal Cost Marginal Revenue Curve Demand Curve Sales Price Q+1 P Marginal Cost Curve CE D Demand Curve A B Q* Q P* P Extra revenues of one unit: D + E – A. marginal revenue Extra revenues of one unit: D + E – A. marginal revenue

19 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Economic logic (background): Monopoly case Sales Price Marginal Cost Marginal Revenue Curve Demand Curve Sales Price Q+1 P Marginal Cost Curve CE D Demand Curve A B Q* Q P* P Profitmaximum: marginal revenue equals marginal costs.

20 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Duopoly case, example of non-equilbrium Residual Demand Curve firm 2 (RD2) Firm 2s expectation of sales by firm 1, Q 1 Demand Curve (D) MC Residual Marginal Revenue Curve firm 2 (RMR2) x 2 p 2 Firm 2 sales Residual Demand Curve firm 1 (RD1) Firm 1s expectation of sales by firm 2, Q 2 Demand Curve (D) price MC Residual Marginal Revenue Curve firm 1 (RMR1) x 1 p 1 Firm 1 sales A1A1 A2A2 price

21 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Duopoly and oligopoly case, equilbrium outcome RD D MC x** p** sales A price RMR 3x** Oligopoly RD Typical firms expectation of the other firms sales D MC x* p* sales A price RMR 2x* Duopoly Typical firms expectation of other the other firms sales

22 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Bringing this to trade Brander and Krugman (1983) Building on Nash they combine increasing returns to scale, imperfect competition and trade Presentation of theory here in Breakeven- Competition (BE-COMP)-Diagram

23 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Breakeven-Competion (BE-COMP) Diagram Mark-up ( ) COMP curve BE (break-even) curve n mono duo n=1 n=2 Number of firms

24 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Breakeven-Competion (BE-COMP) Diagram Mark-up ( ) COMP curve BE (break-even) curve n mono duo n=1 n=2 Number of firms Markup (µ): Price markup over costs, depends on competition Markup (µ): Price markup over costs, depends on competition

25 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Breakeven-Competion (BE-COMP) Diagram Mark-up ( ) COMP curve BE (break-even) curve n mono duo n=1 n=2 Number of firms Breakeven (BE) curve: With increasing returns to scale only a limited number of firms can survive. Survival depends on markup µ.

26 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Details of COMP curve Marginal cost curve Typical firms sales price p" Monopoly mark-up Duopoly mark-up D R-D (duopoly) x mono x duo MR (monopoly) R-MR MC p' A B A B COMP curve n=1 n=2 mono duo

27 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Details of BE curve: closed economy Sales per firm AC price Total sales CoCo Demand curve Mark-up (i.e., p-MC) o x o = C o /n o MC euros BE nono p o o +MC x= C o /n A B BA popo AC o =p o nn Home market COMP

28 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Outline of BE-COMP Diagram Sales per firm AC price Total sales Demand curve Mark-upeuros x BE 2n x nn E E CC E A 1 E A MC p p pApA ' A p p Home market E E C Average cost curveDemand curve COMP curve

29 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Outline of BE-COMP Diagram Sales per firm AC price Total sales Demand curve Mark-upeuros x BE 2n x nn E E CC E A 1 E A MC p p pApA ' A p p Home market E E C Average cost curve Average cost of representative firm equals price after adjustment of firm number Demand curve COMP curve

30 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Outline of BE-COMP Diagram Sales per firm AC price Total sales Demand curve Mark-upeuros x BE 2n x nn E E CC E A 1 E A MC p p pApA ' A p p Home market E E C Average cost curve Average cost of representative firm equals price after adjustment of firm number Demand curve Competition curve shows combination of mark-up and equilibrium firm number COMP curve

31 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Outline of BE-COMP Diagram Sales per firm AC price Total sales Demand curve Mark-upeuros x BE 2n x nn E E CC E A 1 E A MC p p pApA ' A p p Home market E E C Average cost curve Average cost of representative firm equals price after adjustment of firm number Demand curve Breakeven curve is upward sloping, since sales per firm fall with increasing firm number such that higher mark-up is needed to breakeven COMP curve

32 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Addressing European integration Assume that trade-to-non trade liberalization provides (i) each firm with a market of twice its side and (ii) double the number of firms in each market What happens to markup, equilibrium number of firms, average costs, price and demand?

33 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies No-trade-to-free-trade integration Sales per firm AC price Total sales Demand curve Mark-upeuros x BE 2n x nn E E CC E A 1 E A MC p p pApA ' A p p Home market E E C Average cost curve After integration, each firm has (i) second market of same size and (ii) twice the number of competitors

34 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies No-trade-to-free-trade integration Sales per firm AC price Total sales Demand curve Mark-upeuros x BE 2n x nn E E CC E A 1 E A MC p p pApA ' A p p Home market E E C Average cost curve Competition effect: number of firms is 2n, such that mark- up declines to A at given firm number.

35 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies No-trade-to-free-trade integration Sales per firm AC price Total sales Demand curve Mark-upeuros x BE 2n x nn E E CC E A 1 E A MC p p pApA ' A p p Home market E E C Average cost curve Market size effect: BE curve shifts to outward to the right. At given number of firms (point 1) we have no equilibrium).

36 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies No-trade-to-free-trade integration Sales per firm AC price Total sales Demand curve Mark-upeuros x BE 2n x nn E E CC E A 1 E A MC p p pApA ' A p p Home market E E C Average cost curve Smaller mark-up and higher competition reduces prices to p A. Below breakeven point for given number of firms. Industrial restructuring results in E equilibrium number of firms.

37 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies No-trade-to-free-trade integration Sales per firm AC price Total sales Demand curve Mark-upeuros x BE 2n x nn E E CC E A 1 E A MC p p pApA ' A p p Home market E E C Average cost curve Since each firm has a larger market in new equilibrium, average costs decline. Efficiency gain.

38 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies No-trade-to-free-trade integration Sales per firm AC price Total sales Demand curve Mark-upeuros x BE 2n x nn E E CC E A 1 E A MC p p pApA ' A p p Home market E E C Average cost curve Welfare gain: C. Consumer benefit from (i) lower prices, (ii) higher consumption.

39 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Economic logic Integration: no-trade-to-free-trade: BE curve shifts out (to point 1). (Larger market effect) Defragmentation: PRE typical firm has 100% sales at home, 0% abroad; POST: 50-50, Cant see in diagram. Pro-competitive effect: Equilibrium moves from E to A: Firms losing money (below BE). Pro-competitive effect = markup falls. short-run price impact p to p A.

40 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Economic logic (cont.) Industrial Restructuring: A to E, number of firms, 2n to n. firms enlarge market shares and output, More efficient firms, AC falls from p to p, mark-up rises, profitability is restored. Result: bigger, fewer, more efficient firms facing more effective competition. Welfare: gain is C.

41 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Facts M&A activity is high in EU. much M&A is mergers within one member state about 55% domestic; remaining 45% split between: ·one is non-EU firm (24%), ·one firm was located in another EU nation (15%), ·counterpartys nationality was not identified (6%). ·Empirical evidence: Single Market Programme reduced Price- Cost Margins by 4 per cent on average. ·High variance: ·- 15 per cent in office equipment sector ·-0.1 per cent in brewing

42 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Facts Distribution of M&A quite varied: Big 4: share M&As much lower than share of the EU GDP. I, F, D 36% of the M&As, 59% GDP. ·Except UK. Small members have disproportionate high share of M&A. This picture fits pretty well into theoretical expectations: Small countries suffer more from fragmentation of markets such that pressure for industrial restructuring is higher compared to countries with a larger market share

43 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Facts

44 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Facts Why M&A mostly within EU? Why UKs share so large? Non harmonised takeovers rules. ·some members have very restrictive takeover practices, makes M&As very difficult. ·others, UK, very liberal rules. Lack of harmonisation means restructuring effects very impact by member states.

45 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EU Competition and State Aid Policy

46 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 5 Preferential Trade Liberalisation Competition and subsidies Two immediate questions: As the number of firms falls, isnt there a tendency for the remaining firms to collude in order to keep prices high? Since industrial restructuring can be politically painful, isnt there a danger that governments will try to keep money-losing firms in business via subsidies and other policies? The answer to both questions is Yes. See Chapter 14, 3 rd Edition.

47 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EU Competition Policy Exclusive competency of EU; Commission controls. 2 aspects: mergers & anti-competitive behaviour. Economic integration yields less firms, higher concentration but more cross-border competition Creates incentives to collude and undertake anti- competitive measures Look at justification for putting competition policy at the EU level

48 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Anti-competitive behaviour Collusion is a real concern in Europe. dangers of collusion rise as the number of firms falls. Collusion in the BE-COMP diagram COMP curve is for normal, non-collusive competition Firms do not coordinate prices or sales Other extreme is perfect collusion Firms coordinate prices and sales perfectly Max profit from market is monopoly price & sales Perfect collusion is where firms charge monopoly price and split the sales among themselves

49 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Economic effects Number of firms Mark-up COMP BE FT E nBnB mono B n=1n A 2n B Consider two cases: Perfect collusion: Firms set prices to monopoly level and divide profits equally. Price increases. Markup increases. More firms enter market. Eventually, zero profit condition restored, i.e. price equals average costs. nPnP

50 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Economic effects Number of firms Mark-up COMP BE FT E nBnB mono B n=1n A 2n B Partial collusion Less opportunities to cheat 2n is too high for all firms to break even. Industrial consolidation proceeds as usual, but only to n B. Zero profits earned by all at point B. Prices higher, p B > p, smaller firms, higher average cost.

51 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Economic effects (cont.) price Total sales Demand curve Number of firms Mark-up COMP BE FT pBpB Perfect collusion Partial collusion E nBnB mono B n=1n p mono E p B CBCB A The welfare cost of collusion (versus no collusion) four- sided area marked by p B, p, E and B.

52 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EU Competition Policy To prevent anti-competitive behavior, EU policy focuses on two main axes: Antitrust and cartels. The Commission tries: to eliminate behaviours that restrict competition (e.g. price-fixing arrangements and cartels) to eliminate abusive behaviour by firms that have a dominant position Merger control. The Commission seeks: to block mergers that would create firms that would dominate the market.

53 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Economics of cartels euros Quantity CC P P = AC a b Demand curve Suppose price without cartel would be P. Cartel raises price to P. Consumers lose: -a-b; ripoff-effect Producers gain: a. Net loss: b. technical inefficiency

54 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies The vitamin cartels (Box 11 1) In 2001, Commission fined 8 companies for their participation in cartels that eliminated competition in the vitamin sector (vitamins A, E, B1, B2, B5, B6, C, D3, Biotin, Folic acid, Beta Carotene and carotinoids) for more than ten years. The European vitamins market is worth almost 1 billion euros a year. The firms fixed prices, allocated sales quotas, agreed on and implemented price increases and issued price announcements in according to agreed procedures. EU can fine firms up to 10 % of total annual sales.

55 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies The vitamin cartels (Box 11 1) (cont.) They also set up a mechanism to monitor and enforce their agreements and participated in regular meetings to implement their plans. This included the establishment of formal structure and hierarchy of different levels of management, often with overlapping membership at the most senior levels to ensure the functioning of the cartels, the exchange of sales values, volumes of sales and pricing information on a quarterly or monthly basis at regular meetings, and the preparation, agreement and implementation and monitoring of an annual "budget" followed by the adjustment of actual sales achieved so as to comply with the quotas allocated. Hoffman-La Roche of Switzerland received the largest fine (462m euros) for being the cartel ringleader, which also included BASF and Merck (Germany), Aventis SA (France), Solvay Pharmaceuticals (the Netherlands), Daiichi Pharmaceutical, Esai and Takeda Chemical Industries (Japan).

56 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Exclusive territories More common anti- competitive practice is exclusive territories Nintendo example; high prices in Germany vs UK. Prevent arbitrage within the EU (illegal). European Commission fined Nintendo and the 7 distributors 168 million euros. euros Quantity P Germany P UK D Germany D UK MC MR Germany MR UK

57 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Exclusive territories German demand curve steeper, i.e. higher willingness to pay (lower price elasticity) UK has flatter demand curve (e.g. more opportunties to substitute, higher price elasticity) Profits are maximized where marginal revenue and marginal costs curve intersect This implies requesting higher price in DE relative to UK euros Quantity P Germany P UK D Germany D UK MC MR Germany MR UK

58 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Abuse of dominant position Firms that are lucky or possess excellent products can establish very strong positions in their market. Not a problem, per se position may reflect superior products and/or efficiency e.g. Googles triumph However dominance may tempt firm to extract extra profits from suppliers or customers Or arrange the market to shield itself from future competitors. E.g. hiding the programm code. Illegal under EU law abuse of dominant position. e.g. Microsoft with media software charge high price of Word, etc. where the competition has been driven out of biz (WordPerfect, etc.), but give for free all software where there is still competition.

59 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Merger control Initially P=AC. Merger implies lower AC to AC, but raises the price to P. CS=-a-b; ripoff PS=+a+c Net welfare = -b+c ; ambiguous, efficiency defence Laissez-faire (in US and increasingly in EU); if free entry then eventually P driven down to AC. Overall gains as in BE-COMP diagram. euros Quantity CC P P=AC a b c Demand curve AC Williamson diagram

60 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies State aid economics Look at two cases: Restructuring prevention. Unfair competition.

61 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Restructuring prevention Consider subsidies that prevent restructuring Specifically, each governments make annual payments to all firms exactly equal to their losses i.e. all 2n firms in Figure 6-9 analysis break even, but not new firms Economy stays at point A This changes who pays for the inefficiently small firms from consumers to taxpayers. Number of firms Mark-up COMP BE FT BE 2nnn E A 1 E ' A

62 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Restructuring prevention: size of benefit Pre-integration: fixed costs = operating profit = area a+b Post-integration: operating profit = b+c ERGO: Breakeven subsidy = a-c Net Benefit: b+c+a-c=a+b Sales per firm AC Price Total sales Demand curve Numbe r of firms Mark-upeuros x COMP BE FT 2n p CCACA pApA x A = 2C A /2n pApA a bc E A A A MC E

63 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Restructuring prevention: welfare impact Sales per firm AC Price Total sales Demand curve Numbe r of firms Mark-upeuros x COMP BE FT 2n p CCACA pApA x A = 2C A /2n pApA a bc E A A A MC E d Change producer surplus = zero (profit is zero pre & post) Change consumer surplus = a+d Subsidy cost = a-c (producers loss) Total impact = a+d – (a-c)= d+c

64 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Does it make sense to subsidize? Static welfare gains resulting from inefficiency of imperfect competition, i.e. differences between average and marginal costs Higher production = higher welfare under increasing returns to scale However, subsidizing loss-making enterprizes creates dynamic losses -> reduced innovation and technological progress

65 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Only some subsidise: unfair competition If Foreign pays break even subsidies to its firms All restructuring forced on Home 2n moves to n, but all the exit is by Home firms Unfair Undermines political support for liberalisation

66 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EU policies on State Aids 1957 Treaty of Rome bans state aid that provides firms with an unfair advantage and thus distorts competition. EU founders considered this so important that they empowered the Commission with enforcement.

67 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EU Trade Policies

68 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Trade: Facts Two-thirds of EU25 exports are to other EU25 nations. More than 90% of this is actually among the EU15 trade (10 new Member States are fairly small economically). Add all other European nations, three-fourth of Europes trade is within Europe. North America and Asia are the EU25s main markets outside Europe, each accounts less than one-tenth of EU exports. Africa, Latin America and the Middle East are not very important. The pattern on the import side is very similar Rounding off, three-fourth of EU imports are from Europe, with the fourth quarter split into two more or less even groups of nations – Asia, and all other nations. Trade with non- European nations is balanced.

69 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Facts: Patterns of Trade

70 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Facts: Differences across Member States: non-EU trade

71 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Composition of imports and exports, aggregate trade Manufactured goods 90% of total exports (half of all exports being machinery and transport equipment). Import side, two-thirds on manufactured goods. EU-25 is a big importer of fuel (18 % of imports). Only 6% food and agriculture. Other types of goods play a relatively minor part in the EUs trade.

72 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Composition of imports and exports, aggregate trade

73 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EU External Trade Policy: Institutions and trade in goods Recall: Customs Union requires common trade policy Trade policy among the first pillar since Rome Treaty European Commission has the right to set tariffs and negotiate on trade issues at WTO EC Trade Commissioner negotiates, has a mandate assigned by the council of ministers Council has final say

74 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EU Trade Policies: other areas World trade negotiations involve far more than trade in goods. Trade-related intellectual property rights (TRIPs) Trade-related investment measures (TRIMs), Service trade Technical Barriers to Trade (TBTs), trade facilitation, etc. Treaty of Rome only gave Commission power over trade in goods Treaty of Nice (& Amsterdam) extended Commissions authority to some aspects of Services trade and TRIPs, & made QMV the rule in Council on such matters.

75 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Contingent protection WTO allows members to raise tariffs to: Counter unfair trade practices, e.g. Antidumping measures, e.g. penalty tariffs Countervailing duties, e.g. voluntary agreements of price-undertakings ·Firms charge higher prices, but EU loses tariff revenue Provide temporary protection safeguards Widely applied by US and EU The various WTO articles on these require a procedure; in EU the Commission is in charge of these procedures, but the final decision is subject to QMV approval of the Council.

76 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EU External Trade Policy: MFN Tariffs MFN tariff structure reflects comparative advantage of EU industries Low tariffs in manufacturing ·Exception: textiles and clothing High in food and agriculture, especially diary products Interest groups matter

77 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EUs MFN tariff structure (Common External Tariff – CET)

78 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EU External Trade Policy: Preferential Agreements EU has special deals with 139 nations; often more than one per partner. Each can be very complex...

79 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EU External Trade Policy

80 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Preferential agreements: logic Hub and Spoke System EU is a regional hub in hub and spoke system of trade deals ·Morocco is a typical case: 71% of exports to EU, but only 1% of EU imports from Morocco ·Asymmetry gives EU high leverage in dealing with these nations

81 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EU External Trade Policy: European circle European-Mediterranean area: West, Central and Eastern Europe = Single market in industrial goods; ·EU + EEA + Swiss bilateral agreements Euro-Mediterranean Association Agreements: ·Morocco, Algeria, Tunisia, Egypt, Israel, the Palestinian Authority, Lebanon, Jordon, Syria and Turkey. ·Asymmetric (EU cuts its tariffs faster) FTAs in manufactures, by ·Turkey unilaterally in Customs Union in manufactures.

82 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies EU External Trade Policy: European circle (cont.) European-Mediterranean area (cont.): Asymmetric dependence (e.g. 70% of Moroccos exports to EU, but <1% of EU to Morocco) EFTAs FTA union with EU; EFTAns mimic EU to avoid discrimination against EFTA-based exporters.

83 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Former Soviet Republics & Western Balkans Partnership and Cooperation Agreements (PCAs). These are GSP+ (GSP=Generalised System of Preference). Russia, Ukraine, Georgia, Belarus, Armenia, Azerbaijan, Kazakhstan, Kyrgyzstan, Moldova and Uzbekistan. Asymmetric tariff reduction without requiring PCA partners lowering theirs. Stabilisation and Association Agreements (SAAs). Former Yugoslavian states. Croatia has started membership; others likely to follow.

84 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Preferential arrangements with former colonies Colonial preferences conflicted with Common External Tariff EU made exception for these nations to avoid imposing new tariffs; signed unilateral PTAs ·Yaoundé Convention and Arusha Agreement When UK joined 1974 exceptions extended to many Commonwealth nations. ·ACP nations (Africa, Caribbean & Pacific); the new agreement = Lomé Convention. ·Duty-free but subject to quota for sensitive items (sugar, banana, etc.)

85 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Preferential arrangements with former colonies These didnt help the ACP nations much c.f. Asian success without tariff preferences When Lomé Convention renewed in 2000, the EU and the ACP nations agreed to modernise the deal Cotonou Agreement; eventually reciprocal free trade stepwise reduction of tariffs on ACP nation side general outline of principles details fixed in bilateral Economic Partnership Agreements (EPAs)

86 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Generalised System of Preferences (GSP) 1971 GATT provision allows tariff preferences. EU grants GSP to almost all poor nations. General GSP. Super-GSP more generous on market access. Everything but Arms (EBA) for least developed nations.

87 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Generalised System of Preferences (GSP) (cont.) On paper, EBA grants zero-tariff access all goods, except arms and munitions. Goods in which these nations are most competitive are in fact excluded from the deal. Tariffs on bananas, rice and sugar – products where these poor nations could easily expand their EU sales – are to come down only in the future. Moreover, even though all tariffs on these items will be gone by 2009, the exports quantities are limited by bilateral quotas. 49 nations qualify for EBA in principle in 2005.

88 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Non-regional FTA Mexico, Chile, and South Africa, done. Ongoing with Mercosur and the Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates).

89 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies Finally, non-preferential trade Only 6 main nations: US, CAN, JAP, AUS, AT, KOR But about 1/3rd of EU imports are not granted some sort of preferential treatment

90 Prof. Dr. Herbert Brücker Lehrstuhl für Volkswirtschaftslehre, insbesondere Integration Europäischer Arbeitsmärkte Universität Bamberg | | Theory and Politics of European IntegrationLecture 7 Trade and Competition Policies NEXT LECTURE December 12, 2013


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