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Trade distortion and protectionism

Do you need competition policy when you have free trade?

Published 10 January 2019

Domestic competition policies versus free trade – what are the pros and cons? For over two decades, governments have discussed whether and how to develop common approaches to national competition policies.

Increased competition might not be an unqualified good.

Freedom to trade across borders is integral to economic development and growth, but it also generally increases competition. Cross-border competition sometimes raises questions by policymakers about whether firms operating in their market are doing so fairly.

When might governments scrutinize the competitive environment? In an industry sector that is globally concentrated, a handful of exporting firms could form “export cartels,” coordinate a common export price, or agree to divvy up export markets among themselves. International mergers and acquisitions could consolidate companies or assets through financial transactions in such a way that the resulting entity might enjoy a new dominant market position or significantly increased share in the market.

There are limits to the long arm of the law.

Anti-competitive practices or market structures decrease choice and often increase prices to consumers. Domestic competition policies aim to regulate such practices to promote inter-firm rivalry and equitable opportunities to compete in the marketplace. They are oriented toward fostering the most efficient use of resources and increasing the incentives to innovate, both of which result in lower prices, better quality, and more choice for consumers.

But domestic competition policies have limitations when it comes to cross-border transactions. They cannot be used to prevent anti-competitive effects of export cartels formed in other countries or mergers and acquisitions initiated in other countries, unless it can be shown that harm was caused in the home market.

This is the main argument behind attempts to create an international competition agreement or some level of cooperation among governments on their approaches to competition policies and their enforcement.

Does competition promote or stifle development?

For over two decades in international forums, governments have discussed whether and how to develop common approaches to national competition policies. Economically developed countries tend to have strong competition policies and broadly support the creation of international disciplines, though they may disagree on the specifics.

Developing countries have expressed more mixed views about signing on to an international agreement. On the one hand, developing country governments often express vulnerability as they are unable to affect cartels or mergers organized abroad but may nonetheless face higher prices as an importing country. They may be reluctant to take on international commitments, however, given their relative lack of experience and resources to create and effectively enforce competition laws.

On the other hand, many developing countries either run monopolies or have large stakes in state-sanctioned monopolies in sectors they believe are key to economic development, and therefore wish to avoid adopting international disciplines lest it constrain their own policy choices at home.

Limited monopolies in institutional environments that otherwise promote freedom and respect rule of law, may not be an inherently bad policy choice, but they can be particularly harmful in countries that have high levels of corruption. The institutions of the monopoly will support policies that benefit the government over the consumer, reducing consumer welfare through artificially increased prices, lower quality goods, and stunted competition.

Has competition policy been included in trade agreements?

Yes, with mixed results.

Members of the World Trade Organization (WTO) generally agree that effective competition policies help reinforce the benefits of trade liberalization and market-based reforms, ensuring they flow through to the firms and consumers of each member.

Around half of WTO members have competition laws, including about 50 developing countries. In 1996, trade ministers meeting at the first WTO Ministerial Conference agreed to create a working group to study the interaction between trade and competition policies to decide whether to put the issue on the global negotiating agenda.

The working group ferreted out the potential for members to develop disciplines on core issues of transparency, non-discrimination, procedural fairness, and voluntary cooperation particularly around the regulation of so-called “hardcore” international cartel. However, WTO members ultimately decided in 2004 to drop competition policy from consideration as part of the Doha Development Round of negotiations.

Where competition policy issues have been addressed in some bilateral agreements and regional trade agreements such as NAFTA (and its eventual replacement, the U.S.-Mexico-Canada Agreement), the commitments typically focus on information-sharing and cooperation in cases affecting competition in the markets of the parties to the agreement while maintaining differences among domestic competition laws as they pertain to regulating and enforcing specific market activities.

Of course, if we had real free trade, we might not need competition laws.

Proponents of coordinated competition policies argue they are an effective and necessary tool to promote competition among nations. But competition policies themselves can create trade barriers. As long as governments maintain competition policies, it could be useful to agree that national authorities will not use them to serve protectionist aims or allow restrictive practices that undermine the benefits of liberalization.

Of course, if trade were truly free, policymakers could spend less time worrying about competition provisions because we wouldn’t need them.

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Gabriella Beaumont-Smith is Policy Analyst in Macroeconomics at The Heritage Foundation specializing in international trade and agriculture. She holds a Master's in Economics from George Mason University and is a graduate of the Mercatus MA Fellow Program.

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