Business, Markets and Governmentin the Asia Pacific

Business, Markets and Governmentin the Asia PacificCompetition policy, convergence and pluralism

Edited by Rong-I Wu and Yun-Peng Chu

London and New York

First published 1998by Routledge11 New Fetter Lane, London EC4P 4EE

Simultaneously published in the USA and Canadaby Routledge29 West 35th Street, New York, NY 10001

© 1998 Pacific Trade and Development Conference

All rights reserved. No part of this book may be reprinted orreproduced or utilized in any form or by any electronic, mechanicalor other means, now known or hereafter invented, includingphotocopying or recording, or in any information storage orretrieval system, without permission in writing from the publishers.

British Library Cataloguing in Publication DataA catalogue record for this book is available from the British Library.

Library of Congress Cataloguing in Publication DataA catalogue record for this book has been requested

ISBN 0-415-18302-2 (HB)ISBN 0-415-18303-0 (PB)

This edition published in the Taylor & Francis e-Library, 2002.

ISBN 0-203-02733-7 Master e-book ISBN

ISBN 0-203-20187-6 (Adobe eReader Format)

Contents

List of illustrations viii

1 IntroductionRong-I Wu and Yun-Peng ChuTaiwan Institute of Economic Research, Taipei and the Institute of

Social Science and Philosophy, Academica Sineca, Taipei 1

Part 1: Business and Markets

2 Business networks in East Asia: diversity and evolutionWendy DobsonCentre for International Business, University of Toronto, Toronto 24

3 Markets, competition and restructuring in the 1990sPeter A. PetriBrandeis University, Waltham 48

4 State intervention, ownership and state enterprise reform in ChinaJustin Yifu LinPeking University, Beijing, Hong Kong University of Science & Technology,

Hong Kong and the Australian National University, Canberra 70

Part 2: Competition Policy

5 The evolution of competition policy: lessons from comparative experience

Michael J. TrebilcockUniversity of Toronto, Toronto 86

6 The convergence of competition law within APEC and the CER agreement

Alan Bollard and Kerrin M. VautierNew Zealand Commerce Commission, Wellington 120

7 Competition policy in APEC: principles of harmonisationP. J. LloydUniversity of Melbourne, Melbourne 157

8 Trade and competition policyRong-I Wu and Yun-Peng ChuTaiwan Institute of Economic Research, Taipei and

the Institute of Social Science and Philosophy, Academica Sineca, Taipei 178

9 Competition regulation and policy in ThailandWisarn PupphavesaThailand Development Research Institute Foundation, Bangkok 198

Part 3: Deregulation, Liberalisation and Privatisation

10 Policy approaches to economic deregulation and regulatory reform

Merit E. JanowSchool of International Trade & Public Affairs,

Columbia University, New York 209

11 Telecommunications and privatisation in AsiaJohn Ure and Araya VivorakijUniversity of Hong Kong, Hong Kong 237

12 Japan’s air transport policy at a crossroadUshio Chujoh and Hirotaka Yamauchi Hitotsubashi University, Tokyo 264

13 Power sector reform in Malaysia: privatisation and regulationG. NaiduUniversity of Malaya, Kuala Lumpur 277

vi—Contents

14 Liberalisation and privatisation of the Thai power sector: issues and perspectives

Thiraphong VikitsetNational Institute of Development Administration, Bangkok 300

15 Summary of discussionHeather SmithAustralian National University, Canberra 322

Index 344

Contents—vii

List of Illustrations

FIGURESFigure 2.1 Government intervention and Asian business systems 34Figure 4.1 Domestic gross product (GDP) growth rates and

inflation rates, 1979–95 70Figure 5.1 Welfare effects of monopoly 87Figure 6.1 Taxonomy of international commercial transactions 122Figure 6.2 Indicative mapping of competition laws 125Figure 6.3 Two paths to convergence of competition laws 136Figure 12.1 Comparison of shares in the domestic airline market 270Figure 12.2 Passenger numbers by market type, 1986–94 270Figure 13.1 Electricity supply industry structure in Peninsular

Malaysia, 1995 285Figure 13.2 Regulatory and policy framework for electricity

in Peninsular Malaysia 289Figure 13.3 Possible new industry structure: competitive

framework (operating and trading framework) 299Figure 14.1 Structure of the power sector 301Figure 14.2 Power system before and after privatisation 312

TABLESTable 2.1 Industrial profile of business groups, Korea and Taiwan 31Table 2.2 Industrial profile: 17 ethnic Chinese family groups 32Table 2.3 The electronics industry: sales and procurement by

corporate nationality, Thailand, Malaysia and Taiwan, 1992–93 (shares in cent; shares of intrafirm transactions in parentheses) 39

Table 2.4 Sales and procurement by Japanese MNEs: Thailand and Indonesia, 1993 (shares of intrafirm transactions in parentheses) 41

Table 2.5 Sales and procurement by US MNEs: Thailand and Indonesia, 1993 (shares of intrafirm transactions in parentheses) 42

Table 3.1 Macroeconomic performance 54Table 3.2 Characteristics of competitive systems ranking among

41 economies 55Table 3.3 Labour market regulations 56Table 3.4 Indicators of labour mobility (per cent of total

employment, per annum except as otherwise indicated) 58

Table 3.5 Indicators of capital structure, non-finance companies 60Table 3.6 Specialised transactions in US capital markets

(billions of dollars) 61Table 4.1 Structural change in industrial output, 1978–93 74Table 4.2 Sectoral comparison of growth rates of output value

and total factor productivity, 1980–88 (percentage) 75Table 6.1 Regulation of competition 125Table 6.2 Summary of APEC competition laws 130Table 6.3 Market power thresholds 134Table 6.4 Measures of similarity between country competition

laws (scores in percentage form) 142Table 6.5 Competition laws in Australia and New Zealand, 1996 144Table 8.1 The ratio of foreign direct investment inflows to

gross domestic capital formation in selected APEC economies (percentage) 181

Table 8.2 Foreign direct investment inward stock, 1980, 1985 and 1990 (million US dollars) 182

Table 8.3 Interaction between trade and competition policies on international transaction/investment/business practices 184

Table 8.4 Interaction between trade and competition policies on domestic transaction/investment/business practices 185

Table 8.5 Competition policy in APEC economies: laws and institutions 189

Table 8.6 Merger requirements and tests 190Table 8.7 designation and monitoring of dominant firms and

major conglomerates 191Table 11.1 Telecommunications sector reform and privatisation

Pacific region 241Table 11.2 Quoted telecommunications service companies in the

Asia Pacific in the Asia region, August 1994 242Table 11.3 Asian telecommunications companies: revenue, ranking

and sate ownership 250Table 11.4 Matrix of negative reactions (-) and positive responses (+) 251Table 11.5 Mainline telephones (000s) and cumulative annual

growth rates (CAGR) 256Table 13.1 Peninsular Malaysia: power sector supply and demand

statistics, 1990–95 278Table 13.2 Average consumption per Tenaga customer category 279Table 13.3 Peninsular Malaysia: independent power producers (IPPs) 283Table 13.4 Generation capacity, November 1996 285Table 13.5 Tenaga Nasional Berhad: main financial results,

FY 1992–96 291

List of Illustrations—ix

Table 13.6 Peninsular Malaysia: installed capacity and peak demand, various years 293

Table 14.1 Types of power plant 304Table 14.2 Example of typical power plants in the power development

plan, 1996–2001 304Table 14.3 Marginal costs of service, 1991 (1989 prices) 305Table 14.4 Comparison between tariff rates and marginal costs,

1991–96 305Table 14.5 Contract duration and capacity payments 309Table 14.6 Revision of the IPP power purchase plan (MW) 310Table 14.7 Avoided costs for SPPs (1989 prices) 314

APPENDIXESAppendix 7.1 Bilateral and multilateral indexes of similarity 172Appendix 7.2 The cross-hauling model of oligopoly 173Appendix 11.1 Wireline and wireless (cellular and pcn) operators in South

and Southeast Asian economies and foreign partners 258Appendix 13.1 Peninsular Malaysia’s power sector 298

x List of Illustrations—

1 Introduction

Rong-I Wu and Yun-Peng Chu

The interrelationship between business, markets and government is academicallyintriguing and practically important, particularly in the Asia Pacific region, where awhole spectrum of different economic systems at different stages of development is inevidence. As the fastest growing region in the world, the Asia Pacific is also a naturallaboratory to test the many different hypotheses posed by both economists andpolicy-makers.

One such hypothesis is that of ‘convergence’. For the governance structure in businessand markets, this means convergence to a uniform mode of business operation in auniform type of market. For competition policy, it denotes harmonisation ofcompetition policies across countries. For regulatory reform, it means convergence toa particular mode of government deregulation of the markets and privatisation ofstate enterprises.

A competing and diametrically opposed hypothesis is that of ‘pluralism’. For thegovernance structure, this means the coexistence of different patterns for differenteconomies, or even for different markets and sectors in the same economy. Forcompetition policy, this means that different economies should choose a competitionpolicy that is best for them; in some cases, it could mean the absence of policy. Forregulatory reform, this means the coexistence of different patterns or paths taken bythe authorities, and perhaps desirably, or in some cases inevitably, so.

One hypothesis that lies somewhere between the above two extremes is that of‘gradualism’, which takes the view that institutional changes in the Asia Pacific regionare evolutionary. Certainly, it is obvious that different economies start from differentpoints on the spectrum of economic systems, and at different stages of development.Pluralistic development is only to be expected given these different initial conditionsas well as the different forces at work. Convergence is not precluded, nor is stablepluralism — in some cases, the former can be viewed as a useful concept in analysingevolutionary changes; in other cases, it is the latter that has more explanatory power.What is more interesting is not convergence or stable pluralism in itself but how andwhy institutional reforms occur in different economies.

The chapters presented in this volume do not settle the issue once and for all. It isdoubtful if the issue can ever be settled. But they do shed important light on the matter.

BUSINESS AND MARKETS

On the governance structure in business, Wendy Dobson (Chapter 2) examines EastAsian relationship-based business networks, discusses possible explanatory factors,and suggests how and why the organisational characteristics of these networks mightchange in the future. The chapter first points out that East Asian business systems donot figure prominently in the literature on economic organisation, and thereforeadopts the conceptual framework used in the emerging theory of dynamic firmcapabilities, in which the firm is the unit of analysis.

Dobson surveys the main business systems in Asia — Japanese keiretsu, Koreanchaebol, the Chinese family firm and the Southeast Asian conglomerates — exploringtheir diversity of organisation, production and trade, as well as examining possibleexplanatory factors for this diversity. Japanese keiretsu are characterised by implicitcooperative relationships, both horizontal and vertical, among otherwise independentstand-alone firms. Korean chaebol, accounting for an estimated 70 per cent of theKorean economy by sales/GNP, are centrally-controlled, vertically-integrated clan-controlled business groups which have been given preferential credit treatment by theKorean government. The Chinese family firm is found in most Asian economies andis characterised by smaller size, flexibility, opportunism, paternalistic leadership, highlevels of internal operating efficiency and low levels of organisational complexity. TheSoutheast Asian conglomerate, on the other hand, encompasses ethnic Chinese andindigenous capitalists operating numerous family-owned conglomerates of varyingsizes.

Based on different comparative measures — industrial characteristics, the role of thestate, norms, enforcement mechanisms and legal systems — it is found that thesemajor business systems vary widely in their characteristics and forms of organisation.Dobson discusses how Asian business systems have changed recently, concluding thatfor the future the introduction of market-oriented policies appears to be bringingabout organisational learning from competitors, including, but not limited to,duplicating the characteristics of Western firms. That such learning is not limited toduplication will likely be partially due to institutional inertia, which would tend tofavour established practices and relationships. Opposing such inertia, as East Asiangovernments adopt increasingly open market policies, is international pressure toadopt international rules and procedures with regard to market access to foreignproducers and capital.

Dobson presents data from business surveys conducted in Thailand, Malaysia andTaiwan on international networks in Asia and examines the question of convergencebetween Western and Asian firms as they internationalise. There is evidence

2—Introduction

supporting the theory that when firms locate production abroad, patterns of exchangemay converge, in part because of the impact of locational determinants, such as hostgovernment policies. This conclusion is reached through comparison, by nationalityof the firm, of the production and sales activities of firms located in different Asiancountries.

In concluding, Dobson suggests that the question of ‘convergence’ is overstated andthat in fact optimal industrial organisation may differ both for a single countryduring different stages of development and across countries at a specific point in time.For the Asia Pacific Economic Cooperation (APEC) process and the World TradeOrganisation (WTO), the implications of the analysis are mixed. A suggestedapproach would be for APEC and the WTO to mediate these pressures by creatingworking groups mandated to develop greater understanding of national marketstructures and competition policies.

Although Dobson finds some evidence in support of convergence for internationalinvestment, she is very conscious of the fact that optimal industrial organisation maybe stage-of-development specific or country-specific. More studies are needed.

In contrast, Peter A. Petri’s chapter (Chapter 3) seems eager to endorse a particularmode of business operation which he describes as performing very well in the 1990s— that is, the US model of flexible factor markets and institutions. But he warns thatwhat has been true for the 1990s is no guarantee for the success of the model in thefuture when external factors change.

His study of markets, ‘competition and restructuring in the 1990s’ aims ‘tounderstand how a country’s competitive systems affect its ability to adjust andtransform’. Arguing that different competitive systems vary in their abilities to handledifferent kinds of shocks, Petri posits that the US economy’s out-performance of theJapanese economy and major European economies in the 1990s can be attributed tothe fact that the challenges of this decade have played to the strengths of theAmerican system more than to others.

To better understand these strengths and weaknesses, Petri compares variousindicators of institutional adjustment and market flexibility across the economies ofFrance, Germany, Japan, the United Kingdom and the United States. He concludesthat the United States indeed surpasses these other four economies in thecharacteristics required to best deal with the shocks of the 1990s: factor markets andinstitutional flexibility. However, though the US system has fared well in this decade,Petri warns that the types of shocks which might occur in the next decade could verywell play to the strengths of other systems.

Petri argues that an underlying distinction to be made between various competitivesystems is between unilateral and joint decision-making approaches. The unilateral,or ‘cowboy’ approach is less likely to take into account the implications of individualactor decisions on the rents of other agents. On the other hand, the joint decision-

Introduction—3

making, or ‘family’, approach requires weighing of the objectives of many indicators,even if choices are ultimately made by a single indicator. All competitive systems areargued to involve some weighted combination of these two poles.

The argument is that the economic environment of the 1990s required mechanismswhich allowed existing factor combinations to be dissolved quickly and new ones tobe formed. A system with maximum factor market and institutional flexibilityperformed best under these circumstances. The 1990s was a period of rapidtechnological change and globalisation of production. Important trends included:changes in information and communication technology, coupled with deregulation;shifts towards ‘open standards’ in these sectors, permitting small firms to benefit fromnetwork economies; increased flows of capital and expertise across firms; and theemergence of low-cost producers of high technology.

Petri compares the sample economies in terms of overall economic performance, aswell as a number of indicators of structural flexibility and adjustment. Theseindicators include real GDP growth, unemployment, output per worker andstockmarket capitalisation from the International Monetary Fund (1996) and theInternational Finance Corporation (1996), as well as indicators of labour and capitalmobility and economic incentives from the World Economic Forum (1994). To helpfilter out differences due to levels of development and make it possible to use moredetailed information, the sample of countries does not include all the Asia Pacificregion.

The United States is found to have the highest values for indicators of capital andlabour mobility, as well as the highest overall levels of economic incentives and capitalmarket activity in the mid-1990s. Anecdotal evidence suggest that US capacities forrestructuring, mergers and venture capital make it more flexible in terms ofinstitutional innovation. Petri warns, however, that the US adjustments in the early1990s involving massive lay-offs in the labour market pushed the limits of politicalacceptability. Moreover, given that each system has its strengths and weaknesses, itwould be surprising if the performance rankings of different competitive systems didnot again change in the future.

Justin Yifu Lin’s chapter (Chapter 4) turns attention to a very different type ofeconomy: one which is undergoing institutional change on a gigantic scale — that ofthe People’s Republic of China.

Lin notes the achievements of the Chinese economy since implementing reforms in1979: the average annual growth rate for GDP was 9.8 per cent in the period1979–95; and the average growth rate of real per capita consumption increased from2.2 per cent in the period 1952–78 to 7.4 per cent in the period 1978–94. Despitethese achievements, the reform period has been troubled by recurrence of ‘boom-and-bust’ cycles, which threaten the stability and sustainability of China’s economicgrowth.

4—Introduction

Economists and policy-makers in China are realising that a fundamental cause ofthese cycles has been continued distortions in the macro-policy environment, and inparticular the suppression of interest rates. Marketing reform has been delayedbecause of the inefficiency of most state-owned enterprises (SOEs), as market-levelinterest rates and credit discipline would face massive adjustment in that sector. SOEsstill form the backbone of the Chinese economy and unless the efficiency of theseenterprises can be improved, financial sector reforms cannot be completed.

Lin notes that in research and policy debate in China in the early 1980s, researchersattributed the problems of inefficiency of SOEs to their lack of autonomy andincentives. More recently, many economists have argued that the vagueness ofproperty rights is the major cause of the SOEs’ problems. So far, SOE reforms havecovered both of these aspects, and, as expected, they have resulted in an improvementin productivity. According to World Bank (1992) estimates, the average annualgrowth rate of total factor productivity in the state sector was 2.4 per cent per yearfrom 1980 to 1988. However, despite this, total losses from SOEs increased to RMB45.3 billion, about 14 times the 1985 figure.

Lin argues that the current problems of SOEs originate from the separation ofownership and control, combined with various policy burdens imposed by the state.Because of separation of ownership and control, problems of incentiveincompatibility, information asymmetry, and the disproportionate distribution ofliability between the owners, the state and management arise. Problematic policyburdens include: over-capitalisation, and the unwillingness of the state to allow suchenterprises to go out of business, despite their highly inefficient capital/labour ratio;the serious price distortion for the products of some SOEs; and the huge burden ofretirement pensions and other welfare costs that many SOEs have to bear.

According to Lin, SOE reform involves two primary tasks. One is to create a marketenvironment in which enterprises with all types of ownership arrangements cancompete in a fair environment in which ‘the fittest survives’. Such a marketenvironment would supply a low-cost and efficient mechanism — the profits of anenterprise in comparison to the market average — to monitor enterpriseperformance, thereby reducing informational asymmetries. The other task is toconduct incremental ‘Pareto-improving’ steps to mitigate the effects of, or removecompletely, state policy burdens on SOEs.

One such step would be for extremely capital-intensive SOEs to make explicit statesubsidies, and to fix them at current levels, while allowing a shift in their productionto more competitive products. Another would be to liberalise prices in the case ofindustries producing such tradeable products as coal and petroleum, and, in the caseof SOEs in the large communication and transportation sectors, to eliminateshortages by applying the cost mark-up pricing method to their products and services.A third step would be for the state to relieve all SOEs of the burden of pensions and

Introduction—5

other welfare provisions for aged and retired workers. This would allow SOEs tocompete on a level playing field with non-SOEs, which do not have such a burden.

It seems that although the reforms recommended are generally consistent with theidea of competition enhancement, the specific remedies suggested obviously have astrong ‘local’ flavour: they are based on the specific conditions confronting China’sSOEs.

While there is clearly need for further study, the Chinese experience suggests that‘evolutionary’ and ‘gradual’ change in the structure of governance in businessorganisation delivers results. Even though Chinese reforms have moved at ‘breath-taking’ speed, they have been evolutionary in nature compared with most of theEastern European reforms.

COMPETITION POLICY

In the area of competition policy, convergence versus pluralism versus gradualism isalso a critical question. Some see the trend towards bilateral or multilateralharmonisation of competition policy as a desirable and inevitable one. Othersemphasise that different types of business systems in different economies at differentstages of development may need different competition policies. Others recognise theneed to enhance international cooperation while respecting pluralistic developmentin different economies.

Michael Trebilcock (Chapter 5) provides a foundation for the internationalnegotiation of competition policy issues, in reviewing the evolution of policy in theUnited States, Canada and Europe.

Trebilcock identifies a number of procedural and institutional issues in the design andadministration of domestic competition law regimes, and examines someinternational dimensions of domestic competition laws in light of increasing pressuresto harmonise elements of these laws.

Beginning with a brief discussion of standard economic arguments for and against thebenefits of monopolies, Trebilcock goes on to discuss the history of competition laws.As is evident from his comparison, the United States, Canada and the EuropeanUnion differ in many respects with regard to competition policy and its enforcement.Trebilcock also highlights the major issues currently being discussed under six areas:courts versus commissions, the functions of specialised tribunals, the composition oftribunals and their procedures, the scope of judicial review of tribunal decisions,private enforcement, and per se rules versus rules of reason.

In the last section, Trebilcock clearly identifies the difficulties involved with theinternational dimensions of competition law. Although it is true that harmonisingsystems across national boundaries will have an efficiency-inducing effect, Trebilcockbreaks with views that advocate a long-term goal of a deeply economically integrated

6—Introduction

international system with highly standardised rules of competition. Trebilcock agreesthat harmonisation of domestic laws across countries will very likely serve to reduceadministrative costs to firms operating across national boundaries, facilitate the freemovement of capital, and potentially enable economies of scale in production anddistribution. However, he argues that interest in the European Union model as ageneral paradigm is misguided, since such a model arises out of a particular set ofgeopolitical circumstances. Given the difficulty involved with reaching consensus onthe form of a single, more harmonised system of competition laws in such trilateralcontexts as the North American Free Trade Agreement (NAFTA), prospects for doingso in a multilateral context such as GATT/WTO seem remote.

Consequently, Trebilcock argues that an important distinction to be made in lookingat the issue of harmonisation is positive and negative integration. Positive integrationoutlines which policies countries must adopt, while negative integration maps outwhat policies countries may not adopt. Given the wide range of differing institutionalstructures and conditions across countries, a more modest agenda of adoptingnegative integration as a guiding principle for harmonisation would appear to bemore realistic. Such international treaties as GATT have traditionally emphasisednegative integration policies. Trebilcock goes on to describe how such a guidingprinciple can easily be used to resolve issues of export and import cartels, andcomplaints by foreign companies that the domestic legal environment is stricter thantheir home country’s. (He also argues that such firms should have no choice but toplay by the domestic rules of the game.)

A guiding rule arising from this is that local and foreign firms should be treated nodifferently and should face the same legal environment within a given country. Also,competition laws should not be designed specifically to discriminate against aparticular group or sector. Such guidelines can be used to resolve more difficult casessuch as that of the keiretsu in Japan, which Trebilcock argues do not exist specificallyto make entry into the Japanese market difficult for foreign firms but as a result ofJapan’s development strategy.

Perhaps the more difficult issue is where a firm stands to gain significant marketshare/monopoly power in the world market, or in a market spanning severalcountries, through a transnational merger. In such a case, prosecution, enforcementand compensation could be ranked according to which countries have the largestshare of the merger’s total output.

In conclusion, Trebilcock argues that ‘one world’ or ‘flat earth’ visions of competitionand global organisation are ultimately politically unrealistic and normativelyrepugnant in their implications for political sovereignty and democraticaccountability. Given this, he suggests the following more modest multilateralinitiatives:

• minimising the anti-competitive effects of trade remedy laws;

Introduction—7

• minimising the scope for explicit or implicit discrimination in the formulation orenforcement of domestic competition laws;

• minimising the potential for inter-jurisdictional conflict, and hence risk in transactions affecting supra-national geographic markets through international agreements on choice of law and jurisdiction rules and supranational mechanismsto oversee their application;

• minimising public and private transaction costs in the administration of competition laws through exchange of information among enforcementauthorities; and

• maximising transparency in the administration of domestic competition law regimes and hence minimising the arbitrary and non-accountable exercise of administrative discretion.

The study by Alan Bollard and Kerrin W. Vautier (Chapter 6) is somewhat lesssceptical about greater international cooperation and competition policy. But there,too, it is stated at the outset that their analysis does not start from a presumption thatconvergence of government policies or commercial practices between countries iseasy, clear-cut or necessarily desirable from an international viewpoint.

Bollard and Vautier’s taxonomy of international and domestic business relations issomewhat different but compatible with that employed in the essay by Rong-I Wuand Yun-Peng Chu to be discussed shortly (Chapter 8). Bollard and Vautier pay moreattention to the different types of organisation that affect international verticalarrangements; Wu and Chu pay more attention to the different parties that imposerestrictive trade practices. They have one thing is common though — namely, theassumption that competition policies and trade policies are both involved when itcomes to international business relations.

Bollard and Vautier provide some theoretical justifications for this convergence;however, as they admit, their analysis is very preliminary. Citing research on thewelfare effects of customs unions, they conclude: ‘One might infer … thatcompetition law convergence effects, while usually positive, will not necessarily bemajor nor easily obtained.’

In their discussion of the status of competition law convergence under APEC, Bollardand Vautier provide a very informative summary of APEC competition laws in termsof merger regime, abuse of market power, horizontal agreements, vertical restraints,exemptions, unfair trading and the roles and power of enforcement agencies. Of thecountries surveyed, Canada and the United States have had competition laws for aconsiderable time. Bollard and Vautier note that countries that have modernised theircompetition laws in the last few decades such as New Zealand and Canada haveincorporated some distinctly new concepts, underpinned by new industrialeconomics principles such as contestability theory and transactions cost theory, and

8—Introduction

those have shifted the focus away from older market-share measures of market powertowards newer concepts of dominance.

Japan and the Philippines have competition laws that bear the hallmarks of USinfluence. Mexico and Taiwan adopted competition laws relatively recently and havesince incorporated modern competition policy concepts. China included someelements of competition law in its 1993 Act Against Unfair Competition and plansto include other elements in a future anti-monopoly law. Thailand already has acompetition law covering some forms of anti-competitive behaviour and a draft lawfor new legislation before parliament. Malaysia is currently actively working towardsdeveloping competition laws. Bollard and Vautier note that Mongolia, Vietnam andIndonesia are moving generally in the same direction, in contrast to Singapore, HongKong and Papua New Guinea, which have no general competition laws although theydo have other statutes that impinge on competition.

Bollard and Vautier argue that competition policy objectives have generally provenrelatively durable in most countries: ‘The most common of the objectives are themaintenance of the competitive process or the protection or promotion of effectivecompetition … [o]ther common themes are preventing abuses of economic powerand achieving economic efficiency’. These remarks are consistent with the picturepainted in the aforementioned summary. With respect to the abuse of market power,all eleven countries surveyed have some kind of prohibitive regulations. With respectto horizontal agreements, almost all countries have provisions that either prohibitthem or require that they be authorised. With respect to vertical restraints, includingresale price maintenance (RPM), ties and others, they are regulated in almost allcountries — that is, prohibited, subject to competition tests or requiringauthorisation. With respect to unfair trading, almost all countries outlaw misleadingor deceptive conduct.

There remain important differences, however, with respect to the basic design andtype of enforcement arrangement. Bollard and Vautier show in Figure 6.3 that China,Thailand and Korea rely more on administrative-based enforcement, while theUnited States, Canada, New Zealand, Australia and Mexico rely more on judicially-based enforcement. Also, while competition law in the United States, the Philippines,Thailand and China is more structurally based, that in New Zealand, Mexico, Korea,Canada and Australia is more outcome based. Table 6.3 shows an overall measure ofsimilarity.

As for convergence, Bollard and Vautier draw attention to the following efforts:

• In 1986 the OECD Council recommended that ‘a member country should consider impacts on competition before approving export and import cartels and export limitation agreements; should not encourage them when they are anti-competitive; and should cooperate in each other’s investigation of possible anti-competitive efforts’. In a 1995 update, the OECD recommended that competition enforcement authorities provide government-to-government

Introduction—9

notification when an enforcement action may directly affect the interests of another member country or its nationals; it also recommended the sharing of information including confidential information, positive comity (bringing enforcement actions at the request of another authority), the provision of mutualassistance and investigations (such as one authority using its compulsory powers toobtain information to aid another), and the sharing of investigation costs.

• The European Union handles monopolies and merger control under Article 86 ofthe Treaty of Rome, which requires that member states agree not to abuse positionsof dominance. The European Union has also promulgated rules regulating international merger practice. Cartels and horizontal trade practices are handled under Article 85, which prohibits agreements restricting trade in certain situations.

• NAFTA has achieved very limited harmonisation in competition law and policy. Itaddresses cartels by proscribing anti-competitive business conduct and allows for the designation of a monopoly subject to certain obligations being met. In addition, Article 1501 requires that members adopt or maintain competition lawsand consult and cooperate with each other about enforcement. Article 1504 also seeks to establish a working group to report on competition law and policy and trade law issues.

• In 1991 a US–EU antitrust cooperation agreement was signed which allows one party to ask the other to conduct an antitrust investigation. Another agreement wasreached in 1995 regarding the mutual application of competition laws. In addition,the European Union has opened negotiations with Canada on a draft cooperationagreement and established contacts with Japan and other APEC countries regarding exchange of information.

• In 1994 the United States passed a law permitting US agencies to provide confidential information to foreign antitrust authorities, pursuant to agreements that meet the law’s requirements. The United States now has formal bilateral agreements of cooperation with Australia, Canada and Germany; these are principally defensive in nature and are designed to avoid conflicts arising out of extraterritorial enforcement of US antitrust laws and involve notification of enforcement issues, consultation to resolve differences and the sharing of information. The Australian authority has also been active, and maintains formal and informal agreements with Canada, the United States, Japan and Taiwan.

• The APEC Eminent Persons Group recommended that a policy be based on one of the existing models of international cooperation with respect to competition policy. In 1996 an Australia–Japan Research Centre (1995) report proposed that inorder to ensure that the goal of free and open trade and investment in the Asia Pacific was realised, as laid down in the 1994 Bogor Declaration, there should beagreement on and implementation of region-wide minimum standards for competition. It was suggested that a wide range of standards be harmonised and

10—Introduction

that dumping actions cease among APEC participants — all of which would be handled by competition law.

APEC’s Osaka Action Plan included the words ‘consider developing non-bindingprinciples on competition policy and/or laws in APEC’. Subsequently, the APECCommittee on Trade and Investment (CTI) has discussed a work programme oncompetition policy which includes a possible mechanism for technical assistance withcompetition laws for member economies and encourages cooperation betweenenforcement agencies in investigating and enforcing cases of common interest. So far,however, APEC does not offer a platform on which to harmonise the wording ofcompetition laws. Bollard and Vautier claim that ‘the experience of the CER [CloserEconomic Relations] agreement on free trade between Australia and New Zealandand the European Union suggests that this is never likely to fully occur, exceptamongst economies with a common economic and legal base and enjoying a muchtighter economic union than APEC intends’.

Bollard and Vautier go on to note the following:

Nor would completely harmonised competition laws necessarily be a desirableoutcome. There is not much evidence that lack of harmonised competition law hashindered the very rapid growth in international economic integration by the highgrowth regions … The benefits of convergence may be more marked at later stagesof economic integration. In the meantime, competition laws should continue tomeet the characteristic needs of individual countries … What is desirable is that,while staying in line with the above harmonising principles, each country can learnfrom and copy the experience of the best performers in APEC in designing andenforcing their competition laws.

The CER experience of convergence in competition law is well documented byBollard and Vautier, who point out that the convergence had its origin in the signingof the CER agreement between Australia and New Zealand in 1983, which allowedunimpeded trade in all merchandise goods in 1990. In 1988 the two countries furtheragreed that in the same year, the trans-Tasman anti-dumping measure would beremoved and certain trans-Tasman competition provisions would be introduced intoeach national law. Bollard and Vautier point out that this

reflected a shift in policy priorities from trans-Tasman dumping — with its focuson cross-border price discrimination and material injury to producers — to‘predatory’ trans-Tasman conduct harmful to the competitive process. Thetraditional trade policy language of ‘fairness in trade’ was replaced with thelanguage of competition policy and law — ‘competition, efficiency and consumerwelfare’.

That is, as the two authors note, ‘[p]rice discrimination as such, even if accompaniedby material injury to producers in the importing economy, would no longer suffice asa basis for regulatory intervention’.

Introduction—11

However, as Bollard and Vautier note from Figure 6.4, which chronologically recordsthe process of convergence of competition laws in the two countries, the process ofconvergence ‘even if carried out in highly favourable circumstances, is … slow andpainstaking’. Also, the removal of anti-dumping measures provoked considerableopposition from manufacturers, who envisaged a net reduction in producerprotection.

In addition, there is little evidence so far that the 1990 reform has had significanteffect on business activities. Bollard and Vautier suggest that ‘[t]aking the opinion ofbusiness, officials and enforcement agencies into account, the overall impact of the1990 policy reforms is judged to have been minimal’. They further note that:

even with a considerable degree of statutory harmonisation, business is not assuredof certainty in respect of decision outcomes in the other country; nor could onerealistically assume that it would be, even in its own country. This is especially trueunder a rule of reason approach to competition law …There appears to be limitedbusiness interest in further ‘internationalising’ trans-Tasman competition law.There is also little pressure — on the basis of transaction cost or other arguments— either for further convergence … or for comprehensive integration ofenforcement and judicial procedures.

The views expressed in Lloyd’s chapter (Chapter 7) are generally consistent with thosein Bollard and Vautier’s study. Lloyd first notes that it is the ‘coexistence of globalmarkets with national jurisdictions which causes the search for mechanisms to covercross-border competition problems’. However, he adds later in the analysis that ‘[a]consensus seems to be emerging … that it will not be feasible or desirable at thepresent time to seek a multilateral form of international competition policies’. Hethen points out quite frankly that ‘[a] growing number of authors are recommendinga more gradual approach’.

He also notes that APEC’s 1995 Osaka Action Plan discussed 15 specific areas, ofwhich competition policy was one:

APEC economies will enhance the competition environment in the Asia Pacificregion by introducing or maintaining effective and adequate competition policyand/or laws and associated enforcement policies, ensuring the transparency of theabove, and promoting cooperation among the APEC countries, therebymaximising … the efficient operation of markets, competition among producersand traders, and consumer benefits.

The CTI has since coordinated the development of a ‘collective action plan’ in thisarea. It held two workshops on competition policy and was working towards theestablishment in 1997 of an APEC database on competition policies, laws andregulations. The plan was submitted to the leaders’ meeting in Subic Bay but ‘this wasnot a priority area for delivering immediate actions at the meeting’.

12—Introduction

On the difference in competition policy arrangement, Lloyd notes that, in East Asia,six member countries — Hong Kong, Indonesia, Malaysia, Papua New Guinea,China and Singapore — do not have comprehensive competition policies. For thosewhich do have, the coverage differs greatly. While Bollard and Vautier develop asystem of bilateral comparison between countries, Lloyd, based on their data,develops a system of multilateral comparison and finds that the multilateral index is36 for all samples in the Bollard–Vautier study — which is a rather low figure,indicating little similarity among those APEC countries which do have competitionlaws.

He also points out that the governments of Hong Kong and Singapore havecontended in APEC debates that they are open economies and that open economiesdo not require comprehensive competition policies. This leads him to remark that‘[t]he best competition policy for the APEC countries may be liberalisation of tradeand investment, which makes their markets more contestable’.

Lloyd thinks that the development of international competition policies is likely tobe more difficult than many other areas of international policy. Nevertheless, as ininternational trade negotiations, harmonisation across a number of competitionstandards is likely to bring gains to all participating countries.

The study by Rong-I Wu and Yun-Peng Chu (Chapter 8) shares many of the pointsraised in both the Bollard–Vautier and Lloyd studies but places more emphasis on theinterrelation between trade and competition policies.

Wu and Chu identify 10 different sources of pressure for greater internationalcooperation on trade and competition policies: globalisation, policy awareness(particularly by the United States), the rise of the concept of policy fairness, thepressure for the guarantee of effective access, the spillover effects from the activitiesof multinational corporations, the emergence of new forms of interfirm agreements,the recognition that anti-dumping measures need to be reformed, the danger ofcompetitive exclusionary practices by authorities, and the emergence of the problemof extraterritoriality.

Wu and Chu then use a taxonomy to clearly identify different types of interrelationsbetween trade and competition policies. For restrictive practices imposed by thegovernment, trade policies are good for competition as they remove or reduce suchrestrictions. For restrictive practices imposed by private undertakings, internationalcartels (or abuse of dominant position on an international scale) are not properlyaddressed in either existing trade or competition policy. Transnational mergers aresubject to different reviews, which may impose high transaction costs on business.Anti-dumping is one trade measure that often has adverse effects on competition —a point also raised by Trebilcock. Export and import cartels are permitted under thecompetition laws of many countries but they run counter to free trade. United actionsby domestic firms not properly regulated by domestic competition policies willconstitute a possible barrier to entry by foreign firms.

Introduction—13

Wu and Chu therefore think that substantial benefits can be gained if the countriesinvolved are willing to cooperate on both trade and competition policies — the areaswhere their policies are mutually re-enforcing should be strengthened, while areaswhere their policies are at odds should be reformed.

Wu and Chu recognise, however, that the process involves difficulties:

Although most countries of the world now openly support free and faircompetition, many are more mercantilists than free traders at heart. This will resultin disputes as [different] countries want to open up different areas [in internationalnegotiations] of competition policies to the advantage of their exporters or theirmultinational companies .

The means to resolve differences are, in their view, the same as in all otherinternational negotiations — reconciliation and compromise. The concept ofreciprocity is important. For example, in both bilateral and multilateral agreements,all countries can agree to dismantle their export and import cartels reciprocally.

In contrast to the above studies, which all deal with competition policy from aninternational perspective, the essay by Wisarn Pupphavesa (Chapter 9) deals with theissue from the viewpoint of a single country — Thailand. He first reviews existingmarket law in Thailand, outlining the recent history of market regulation, and givesa detailed description of the Price Control and Anti-Monopoly Act of 1979, whichstill provides the main set of rules regulating market activity. The final section of hisstudy discusses both the shortcomings in the present regulatory environment andimplementation of the Act itself, as well as positive developments in the promotionof free markets.

According to the author, the main thrust of the 1979 Act is that it allows Cabinetministers to declare ‘under control’ merchandise which is suspected of being subjectto unfair price fixing or restrictive business practices. The Act also prohibits collusionto fix prices or cause volatile price fluctuations and outlines a number of practiceswhich are illegal. ‘Control’ can involve a number of factors, such as the ability to fixprices or maximum per unit profit for the relevant product on the part of Cabinet, orto stipulate that producers keep regulators informed about their production,distribution and sales activities of the merchandise. There are currently 22 productswhich are listed as being ‘under control’, most of which are basic consumer goods,intermediate goods or goods which exhibit volatile price increases. The most commoncontrol measure for these goods is the stipulation that prices be displayed.

Pupphavesa notes that the government’s implementation of specific regulationswithin the Act has been uneven and often for purposes other than promotion of faircompetition and prevention of monopolistic practices. One such example has been itsuse as an administrative instrument to maintain price stability, in addition to fiscaland monetary instruments commonly used in macroeconomic management.Pupphavesa also describes how in the case of palm oil the Act’s control measures have

14—Introduction

also been used primarily to protect farmers from smuggling. Furthermore, he arguesthat little effort has been made in the area of anti-monopoly regulation or thepromotion of fair competition, despite high levels of market concentration or smallnumbers of operators in various sectors. Industrial and trade licence issuance has alsobeen used at times to regulate production capacity and supply of goods and services,to the detriment of free market promotion.

Taking a macroeconomic view, Pupphavesa argues that Thailand’s policy ofinvestment promotion is inconsistent with the goal of free market promotion, for anumber of reasons: non-promoted industries are strongly discriminated against;investment promotion sometimes closes out potential entrants; export promotionstipulates that 80–100 per cent of firms’ output must be for export, so domesticconsumers are denied export-quality products; investment promotion also tends to bebiased towards larger and more foreign-affiliated firms; and tax incentives tend toinduce firms to resist restructuring.

Apart from such shortcomings, however, there are some positive trends: both theMinistry of Commerce and the Ministry of Industry are advocating liberalisation,deregulation and decentralisation; the Ministry of Finance has been reforming thetariff structure and unilaterally reducing tariffs in many sectors; the Bank of Thailandand the Ministry of Finance have gradually liberalised the financial sector andincreased competition internally; the state sector is undergoing privatisation andreform; and the Intellectual Property Rights Protection Act has been passed.

Pupphavesa appears to be counting on measures of deregulation and liberalisation toenhance competition in the Thai market. This echoes the view of Lloyd that the bestcompetition policy may sometimes be to dismantle the barriers to entry.

DEREGULATION, LIBERALISATION AND PRIVATISATION

Deregulation, liberalisation and privatisation, sometimes called ‘regulatory reform’,represent another important means of institution-building or institutional reform forthe Asia Pacific economies. Here, too, there is the question of whether differenteconomies are converging on a single path of institutional change or whether they arein fact choosing a variety of ways.

The study by Merit E. Janow (Chapter 10) investigates the background against whichregulatory reforms have taken place as well as how these reforms are related to thecompetition policies discussed above.

Janow notes that regulatory reform is occurring worldwide and that the subjectcontinues to be debated in many countries. Janow observes that the approachesadopted, the sectors chosen for reform and the interplay of social and economicfactors between countries vary significantly, and indeed no single definition ofderegulation captures the full range of policy measures employed across countries.

Introduction—15

Janow attempts to outline and conceptually organise the debate regarding regulatoryreform and competition policy, and to stimulate further discussion.

Janow first outlines the various rationales for regulation and reform, which includethe more traditional arguments of market failure, externalities and informationalasymmetries, as well as arguments for protection of consumers and workers. She thendescribes some of the circumstances which caused traditional rationales for reform tobe increasingly questioned and pressure to be applied towards regulatory reform inthe United States and other Organisation for Economic Cooperation andDevelopment (OECD) countries beginning in the mid-1970s. Janow notes thatregulation has often produced unintended results that were an anathema to achievingthe market efficiency which has been its stated goal; regulated sectors have performedpoorly in comparison to similar sectors in other countries or different sectors in thesame country; labour market problems have at times adversely affected the efficiencyof public sector entities; budgetary considerations have pushed governments toreconsider the regulatory environment to look for cost-saving reforms; technologicalchange has changed the perceived technical feasibility of competition in somemarkets; globalisation of markets has resulted in the loss of control by governmentsover the conduct of private firms, and this has been exacerbated by the arbitrage ofregulatory environments by such firms; international governmental and private sectorpressure has caused some governments, such as Japan’s, to modify domesticregulations; and domestic interest groups in some cases have shifted their dynamicstowards favouring regulatory reforms due to the existence of new marketopportunities which current regulations prevent them from utilising.

Janow also looks at the following institutional features in the translation of reformideas into action as identified by political scientists, economists, lawyers and policy-makers: development of concrete reform proposals rooted in expert empirical analysisby independent research bodies; the existence of significantly institutionallyindependent regulatory agencies which are reform-oriented; a judicial system whichobliges regulators to act openly and transparently, and which provides means forchallenging agency conduct by both public and private litigants; some degree ofoversight by Congressional committees; and the exercise of political leadership byelected leaders.

In considering competition policy against this backdrop, Janow uses US examples ofthe airline and telecommunications industry to press home the point thatderegulation is geared towards promotion of competition, not the removal ofregulated monopolies or cartels. Furthermore, even the best-intentioned regulationsleave uncertainties in implementation and lead to unexpected problems, especially insectors which experience rapid technological change. Given this, generally speaking,fostering competitive market outcomes and competition, when viable, is superior toregulated monopoly. Here, too, we hear echoes of Lloyd’s views.

16—Introduction

Regarding the international dimensions of regulatory reform, it is being increasinglyrecognised, especially with regard to competition policy, that domestic policies canhave a significant impact on the global market. As a result, whether or not suchpolicies are solely a matter of domestic concern has become a matter of increasingdispute. In response to such concerns, several important bilateral antitrustenforcement agreements have been signed, such as between the United States andCanada, and the United States and the European Union, and more sucharrangements are under review. Such proposals have also been referred to the WTO,despite US objections, for it believes that the WTO lacks the experience to addresscompetition policy issues, and that the issue requires further consensus-building athome; substantive law differs sharply even between the United States and Europe insome areas. In any case, as Janow points out, regardless of whether or not competitionpolicy is eventually addressed by the WTO, competition related issues have alreadybecome part of the WTO agenda.

In conclusion, Janow argues for the following priorities in focusing on competitionpolicy:

• there needs to be greater awareness of the distorting potential of private restraints,and more international attention needs to be focused on questions of enforcement;

• increased discussion can be stimulated regarding the degree to which regulatory agencies within countries are independent of the industries that they regulate;

• given the complexity and time needed to institute multilateral enforcement efforts,a two-track approach — whereby bilateral efforts continue to be developed alongwith the larger goal of a multilateral enforcement framework — could be adopted;

• the possibility of the economic policies of countries adversely affecting the abilityof firms to compete in a market needs to be more fully addressed in an inter-national context; and

• it is important, in line with the fact that competition issues are already embeddedin the WTO agenda, that competition elements across sectoral areas are consistentand mutually reinforcing.

The second of these points has particular significance. In many developing countries,prior to reform, the regulatory agencies or public enterprises were often players,coaches and referees all in one. While the goal of deregulation and liberalisation(opening up markets to new entrants) often requires that an agency focus only on itsrole as a referee, in reality adjustment is difficult and at times heavily affected bypolitical factors.

This is well exemplified in the study by John Ure and Araya Vivorakij (Chapter 11)on telecommunications and privatisation in Asia. Ure and Vivorakij note that inmany Asian countries the line separating state from non-state interests is not clear-cutand that the state frequently views local capital formation as an aspect of nation state-

Introduction—17

building, and not infrequently as a way of building local support for the ruling party,military faction or leading family. It is against this background that Ure and Vivorakijanalyse the regulatory reform situation in Asian countries.

Table 11.1 provides an account of the process of deregulation and/or privatisation intelecommunications in 23 Asia Pacific countries. It is clear from the table that mostAsian countries have embarked on telecommunication reforms. Reform has beencarried out in many different ways, though, such as by selling off the shares of thestate-owned telecommunication enterprise (SOTE); operator privatisation — that is,the sale of the SOTE to another private operator; opening the market to newentrants; and outsourcing of the telecommunication business to the private sector.

Of course, there are other ways of mobilising capital for investment intelecommunications besides operator liberalisation, and there are ways to inviteprivate capital. Singapore has achieved an increasingly prosperous economy throughstate-mobilisation of funds and operator reinvestment. China and Vietnam offerother examples of countries using the state to redirect resources and state enterprisesto mobilise capital for telecommunications. But even these countries have sinceliberalised their markets to some degree: Singapore will open its international anddomestic fixed-wireline market to competitive entry by 2000; and China andVietnam have opened their equipment markets to foreign direct investment andallowed joint ventures with foreign companies in network investment.

Ure and Vivorakij argue that the pressure for reform more usually arises from a lackof capital (sometimes as a result of a government fiscal crisis) and managementresources to meet subscriber demand (the Thai electric power case to be discussedbelow being a good example). Also, reforms have been advocated because of theapparent success of radical policy changes in the early 1980s such as the AT&T casein the United States; and OECD countries led by the United States, ‘wereincreasingly determined to force open world markets for trade in services’.

As for the results of privatisation and liberalisation in telecommunications, Ure andVivorakij note that it is too early to assess these at this stage, although there is someevidence that ‘opening the fixed-wireline markets to outside capital investment booststhe absolute level of telephone penetration’.

In conclusion, Ure and Vivorkij state that for Asia, especially for the less developedeconomies,

a state-sponsored ‘consensus’ is often the preferred approach, especially where the… state is centralised and strong; and the protection of existing stakeholders istherefore given high priority. In these economies development is the key issuefacing governments, and the role of telecommunications in development isparamount. Markets rather than consensus policy is the Western model, [the moredeveloped] Asian countries like Japan, South Korea and Singapore attempt to blendthe two.

18—Introduction

So, while they do not necessarily endorse that pattern of reform in the less developedeconomies in Asia, Ure and Vivorakij at least recognise that a different mode of actionis at work there. Also, apparently, the less developed and more developed Asiancountries do have different ways of carrying out such reform.

Different sectors are often endowed with different problems even in the same country,as Ushio Chujoh and Hirotaka Yamauchi’s study (Chapter 12) on air transport policyin Japan illustrates.

Chujoh and Yamauchi first evaluate Japan’s current air transport policy, beginningwith a review of the evolution of policy since the Second World War and continuingwith an examination of the Japanese air transport market structure. The authorsconclude that although significant deregulation has occurred, to the benefit ofconsumers, it is inadequate and incomplete with regard to market entry for bothdomestic and international flights.

Before the mid-1980s, the Japanese airline industry was highly regulated andrestricted, with domestic companies consolidated to the point where, by the 1970s,the market was divided among three domestic carriers — Japan Airlines (JAL), AllNippon Airways (ANA) and Toa Domestic Airways (TDA). This was consistent witha number of Japanese industrial policies at the time, which stressed merger andacquisition of many smaller companies into larger, and more internationallycompetitive, firms.

The collapse of this old air transport regime began with the Interim Agreement of theJapan–US Aviation Treaty of 1985 and the signing of its Memorandum ofUnderstanding. Under this agreement, new cargo and passenger carriers, bothJapanese and American, were allowed to schedule services. Criteria were adoptedwhereby three companies could offer services to routes where the annual number ofpassengers was at least one million, and two companies could provide service toroutes with more than 700,000 passengers annually. Since then, these criteria havebeen relaxed but at a rather slow rate.

In response to criticism that policy changes have been only nominal (with thegovernment’s regulation of fare approval and entry licensing basically remaining thesame as before 1985), the Japanese government adopted a zone-fare system in June1996 that allowed carriers discretion in setting prices within a fixed range. Thissystem is almost identical to that adopted by the European Union before theimplementation of the third package of the common air transport policy in 1993.

In looking at Japan’s present market structure and evaluating current policy, Chujohand Yamauchi draw the following conclusions:

• With regard to domestic markets, although prices have been liberalised, without further deregulation of entry into the market, the current incumbents will have little incentive to significantly change their pricing practices, and so little will

Introduction—19

change. Entry to domestic markets should be opened up even to foreign competitors so as to stimulate innovative marketing and pricing.

• With regard to international markets, there is also little incentive on the part of incumbents to change their practices, despite price liberalisation.

Consequently, although Haneda airport is congested, with limited landing slotcapacity, these slots could be auctioned off as a way to introduce greater marketcompetition. Though difficult and complex to achieve, it would be ideal if Japanparticipated in multilateral international agreements, being the most favourableavenue for liberalisation and development of international air transport markets.Given the time that is required to liberalise international aviation, the Japanesegovernment needs to take the initiative now so as to ensure positive long-termoutcomes for the Japanese air transport industry.

The same kind of call for quicker and more decisive action is echoed in G. Naidu’sdiscussion of power sector reform in Malaysia (Chapter 13). Naidu reviews recentsteps taken by the Malaysian government to liberalise the Malaysian power industry,discusses the strengths and weaknesses of these steps, and offers a tentative evaluationof the success of liberalisation up to the present. Steps towards liberalisation havelargely been instituted in peninsular Malaysia, which is the focus of the chapter.Liberalisation began with the Electricity Supply Act of 1990, which dissolved thestate’s monopoly of the National Electricity Board by corporatising it into the powercompany Tenaga, which has been consequently regulated by the terms of the 1990act. In 1992 Tenaga was further privatised when 25 per cent of its shares were floatedon the main board of the Kuala Lumpur stock exchange. The second component ofliberalisation has involved the fast-track licensing of various independent powerproducers (IPPs), beginning in 1993, followed by further licensing of IPPs through alonger-term process. As a result of such licensing, it was estimated that when most ofthe five first-phase IPPs become fully operational in 1997, they would account for 50per cent of peninsular Malaysia’s energy generating capacity.

However, Tenaga still retains a monopoly in the wires component of power supply,and consequently power purchase agreements (PPAs) exist between Tenaga and IPPs,in compliance with the provisions of the Electricity Supply Act and the MalaysianGrid Code. Under such agreements, Tenaga is obliged to pay a fixed amount whetheror not it takes electricity from the company (‘the take-or-pay, minimum take’provision) or is able to request power on a fully dispatchable basis, subject to the GridCode.

Naidu argues that Tenaga’s performance has generally improved as a result of reform,as indicated by the increase in its annual sales per employee figures since 1992. Themajor contribution of the IPPs is the considerable improvement in power availabilityon the Malaysian peninsula, as well as the large amounts of private investment theyhave attracted into the power sector, thus partially relieving the public sector of thefinancial burden of infrastructure development. Furthermore, improved competition,

20—Introduction

combined with the Grid Code’s merit order criteria — based on variable cost ratherthan average cost of power supply — has ensured that power from the most efficientplants is dispatched first, hence minimising supply costs. The weak point of thissystem is that newer plants are favoured over older ones, and thus Tenaga tends tobear the burden of underutilised capacity in the industry (due to older equipment).Excess capacity is also a problem.

Naidu is also critical of the bidding process for IPP licensing, which he says isinsufficiently open and competitive. Furthermore, ‘take-or-pay, minimum pay’ PPAsare also non-optimal, and in fact only exist in the case of YTL Power. Naidu alsoargues that the government’s decision in 1995 to remove the 1993 tariff adjustmentformula was a serious setback towards development of an efficient power sector.Finally, Naidu claims that, although power transmission offers a natural monopoly,the present system is non-optimal since the grid system is operated by Tenaga, whichis also the network owner. The grid system operator should be an independent orneutral company. There is also no reason that Tenaga should have the nationwidefranchise over distribution. New distribution companies should be licensed to operatelocal networks. New supply companies can also be encouraged to purchase power inbulk from suppliers and sell directly to consumers.

Thailand’s experience is somewhat similar to that of Malaysia in relation to problemsof transparency in pricing regulation, monopsony of purchases from the IPPs, andmonopoly of power transmission, the restructuring of old enterprises and the rate atwhich the market is opened to new entrants. As in the case of telecommunications,how the ‘network’ part — transmission in the case of power and interconnection inthe case of telecommunications; often a natural monopoly — of the services shouldbe managed is the crucial issue.

According to Thiraphong Vikitset (Chapter 14), in Thailand liberalisation andprivatisation in the Thai power sector started in the early 1990s as a response to aneed to reduce foreign debt in the public sector. Major policy decisions in Thailandare made by the Energy Policy Committee (EPC), which was set up in 1986, directlyunder the Cabinet and headed by the Prime Minister. The EPC oversees the threemain power supply authorities — the Electricity Generating Authority of Thailand(EGAT), under the Prime Minister’s office, which is responsible for power generationand transmission for the whole kingdom; the Metropolitan Electricity Authority(MEA), under the Ministry of Interior, which is responsible for distribution of powerto customers in the Bangkok area and the neighbouring provinces of Samut Prakarnand Nonthaburi; and the Provincial Electricity Authority (PEA), also under theMinistry of Interior, which is responsible for power distribution to provincial areasnot served by the MEA (the EGAT also sells power to a few direct customers).

Some of the essential steps that have been or are to be taken include the following:

Introduction—21

• A major power plant has been sold by the EGAT to its newly established subsidiary,which has obtained the status of a private company as government ownership of itsshares is now under 50 per cent.

• The EGAT will be reorganised into six business units and five operative units. Allbusiness units except the transmission system will become commercial companiesand will be privatised. The transmission system and the operative units will retaintheir state enterprise status.

• Private power producers are allowed to generate power and sell their output to theEGAT as well as to customers in their surrounding areas.

• Cabinet approved in principle in 1995 a plan to reorganise the PEA, the businessof which will be allocated to four regional distribution companies as PEA subsidiaries; but implementation has yet to begin. The MEA is also planning reorganisation.

Aside from the transferral of the public sector’s foreign debt, the effects ofprivatisation and liberalisation remain to be evaluated. It is not clear, for one, whethercosts to consumers will be lowered. Competition among the independent powerproducers remains limited as they all supply power to the EGAT at the same officialprice.

CONCLUSION

The studies collected in this volume suggest a number of questions. How much dowe know about the effects of deregulation? How much do we know about the effectsof the competition policies in place, and about the effects of harmonisation (or thelack of it)? How much do we know about the nature of governance structure inbusiness in different economies across spans of time as well as the spectrum ofideology, not to mention culture?

The answer is: ‘too little’. Thus it would be premature to draw conclusions as towhich of the three hypotheses posed at the beginning of this discussion best describesthe relationship between business, markets and government in the Asia Pacific. Morestudies are needed — and badly so. That said, we believe that this volume makes animportant contribution towards fuller understanding of the issues. There is still adistance to be travelled before we reach our goal, but this volume covers somesignificant ground.

Viewed then not from the perspective of conclusions but rather from the testingsconducted along the way, it is still possible to say something about the implicationsof the studies in this volume for the hypotheses raised earlier.

For the governance structure in business and markets, despite some endorsements ofa single kind of system, pluralism is the reality, not only across countries but alsoperhaps within any given country. But that pluralism is anything but stable; rather, it

22—Introduction

is dynamic and evolutionary. Some may be led to believe that all economies aremoving in roughly the same direction of more competition and greater marketorientation, thus giving some support to the hypothesis of an eventual convergence.Others may conclude that important differences will remain, even over the long run.

For competition policy, there is little doubt that harmonisation will prove to be agradual process, whether desirable or not. Some of the world’s fastest growingeconomies have never had a comprehensive competition law as we know it. Othereconomies, particularly the less developed ones, have been slow to adopt competitivelaw. For groups of countries that have succeeded in harmonising competition policies— such as the European Union, and Australia and New Zealand through their CERagreement — there is little evidence that the effects of harmonisation are significant.It may well be then that the APEC approach is the most suitable one: restrain thetemptation to unify competition laws in all member countries straight off and,instead, establish a database first — then compare, then dialogue, then get moreinformation. In the end, if all member countries are able to find a pattern ofharmonisation that appears to present a positive-sum game for all, this is theapproach that will be pursued.

For regulatory reform, things are no doubt moving in roughly the same direction:more private capital, more access to market, less direct controls — be it in China,Japan, Malaysia or Thailand. Convergence theorists may well find something pleasingin this. But, even here, there are some important differences. The ‘consensus’ modeof decision-making that is very much prevalent in Asia is very different from the‘market’ mode employed in the West. There is evidence that the former is stilldominant, at least among the less developed economies. This is not to say that thismode causes under-development but rather that the mode of decision-making that isrealistic and perhaps also optimal can be different for economies at different stages ofdevelopment.

In conclusion, it can be said that while adherents of all three hypotheses set out at thebeginning of this discussion may find something somewhere to their liking, the thirdhypothesis — namely the ‘gradualism’ or evolutionist view — may well offer morethan the other two. More evidence is needed, however, before we know which groupcan make the most convincing claims.

REFERENCES

Australia–Japan Research Centre (AJRC) (1995) Implementing the APEC Bogor Declaration,Canberra: AJRC.

International Finance Corporation (IFC) (1996) Emerging Markets Handbook,Washington DC: IFC.

International Monetary Fund (IMF) (1996) Economic Outlook, Washington DC: IMF.World Bank (1992) Reform in 1990 and the Role of Planning, Washington DC: World Bank.World Economic Forum (1994) World Competitiveness Report, Geneva: World

Economic Forum.

Introduction—23

2 Business networks in East AsiaDiversity and evolution

Wendy Dobson

This chapter examines East Asian relationship-based business networks, factors thatexplain them and how and why their organisational characteristics might change inthe future. These networks are largely identified by their home base — namely, Japan,Korea, Taiwan, Hong Kong and the Southeast Asian economies. The People’sRepublic of China is not included in this analysis. Although the structure ofindustrial ownership has changed dramatically since reforms began in 1979 — fromdominance by state-owned enterprises to greater diversity including privately-ownedventures, joint ventures with foreigners and other forms of collectively-ownedenterprises — relationship-based networks are not yet significant. Explicitcomparison with Western firms is not the purpose here; rather, this chapter providesa comparison of attributes of international networks of both Asian and Westernorigin operating in the region to examine possible patterns of convergence ineconomic organisation as internationalisation occurs. For clarity of analysis, businessnetworks are defined as a subset of the ‘business system’, by which I mean the waysfirms are organised to carry out production and exchange, both within and amongfirms.

The chapter is organised as follows. In the second section, I review alternativeconceptual frameworks within which the significance of and differences among EastAsian business systems can be analysed. In the third section, I survey the mainbusiness systems, explore their diversity of organisation, production and trade, andexamine the implications of changing explanatory factors. In the fourth section, Ipresent some data on international networks in the region and examine the questionof convergence, as both Western and Asian firms internationalise production. In thefinal section, I assess implications of my findings for developing internationally-agreed ‘rules of the road’ in the Asia Pacific Economic Cooperation (APEC) forumand the World Trade Organisation (WTO).

CONCEPTUAL FRAMEWORK

Several conceptual approaches are used in the literature on East Asian businesssystems. The focus of a well-developed body of literature in organisational behaviourand economic sociology describes the organisation of business systems, including the

keiretsu (Gerlach 1987 and 1992; Westney 1996); the chaebol (Hamilton and Biggart1998; Whitley 1994; Sakong 1993); the Chinese family firm (Numazaki 1986;Redding 1990 and 1996); and the Southeast Asian conglomerate (Lim 1996). Otherstudies compare the attributes of these systems (Whitley 1992 and 1994), and someinteresting attempts have been made to identify theoretical frameworks which wouldexplain the diverse characteristics of these business systems (Hamilton and Biggart1988; Biggart and Hamilton 1993). More recently, students of industrialisation havestudied variations in the organisation of networks as a determinant of economicperformance (Gereffi 1996).

East Asian business systems do not figure prominently, however, in the extensivemicroeconomic literature on economic organisation, where the focus is on Westernforms of organisation, including markets, firms and cooperative behaviour (Chandler1977 and 1981; Teece 1980; Williamson 1981 and 1985; Powell 1990). Severalapproaches are possible, depending on the unit of analysis. One is to focus ontransactions; another, on the firm. In neoclassical microeconomic theory, transactionsare the unit of analysis (Chandler 1992). Key assumptions are that managersoperating with common technologies maximise profits in perfectly competitivemarkets on the basis of arm’s-length legal contracts with suppliers and customers.More recent theoretical innovations recognise imperfect competition amongoligopolistic firms in industries that are characterised by high informational andtechnical barriers to entry.

Transaction cost theorists (Coase 1937; Williamson 1975) see firms as organised tominimise the costs of production and transactions. They emphasise asset specificity asa major determinant of whether firms internalise activities within the firm tominimise transactions costs, rather than carrying on such activities through markets.The firm is the unit of analysis in the emerging theory of dynamic firm capabilities.Here, the emphasis is on production rather than exchange (Nelson and Winter 1982;Nelson 1991). The firm’s facilities and skills — namely, its capabilities — determinewhat will be done within the firm and what will be done in the market (Chandler1992). The analytical framework employed by these theorists stresses the firm’sstrategy, structure and core capabilities. The emphasis is on the importance ofcoordinating the firm’s functional activities such as procurement, production,distribution, marketing and research and development (R&D) and its strategicactivities that respond to changes in its environment — such as competitive threatsor government policies — or that require strategic moves into new markets. The firmas an economic organisation is the unit of analysis in this chapter; the businessnetwork, or, more generically, the business system, is defined above. It is assumed thatthe firm is grounded in its home society; while it is affected by many aspects of thatsociety such as geographic location, culture, political stability as well as bycompetitors’ organisational forms developed elsewhere, three critical economicaspects of society influence the firm as an economic organisation: the exercise ofpower by the state; formal rules and laws and informal conventions and norms of

Business networks in East Asia: diversity and evolution—25

economic behaviour, and enforcement of these rules and norms (North 1994;Matthews 1986).1 The next section of this chapter applies this framework to a surveyof Asian business systems.

ASIAN BUSINESS SYSTEMS — A SURVEY

Hamilton (1996) points out some of the pitfalls in analyses that see Asian businesssystems as mirrors of Western ones. There is a tendency to lump Asian systemstogether as homogeneous and different. In reality, Asians are remarkably diverse, asthe analysis in this section will illustrate, and, at the same time, they share similaritieswith the business systems of some European countries. Nevertheless, they can bedistinguished from Western business systems by some key shared characteristics. EastAsian business systems share a respect for status-based relationships which emphasisecooperative business relationships based on family and other informal relationships,as well as ties with the state. Western business systems, in contrast, particularly thosein Anglo-Saxon industrialised countries, share a respect for individualism, contractualrelations and the explicit enforcement of those contractual relations. Businesses in theWest define themselves as legal entities and relate to each other as legal persons withrights and obligations. Businesses in Asia define themselves in terms ofinterrelationships with other businesses and with families and friends, and obligationsare delineated in this way (Hamilton 1996). Although these distinctions should notbe overexaggerated, such stylisations can provide useful analytical insights.

The importance of the state to business systems is evident in prudent macroeconomicpolicies that have contributed to rapid growth and a stable business environment; intrade and investment policies that are relatively open, emphasising exports andavoiding import substitution; and in a willingness to import foreign technology(although not always by direct investment). The impact of the state is very noticeablein forms of government-business cooperation, which has been interventionist inKorea and Japan, and has played a role in influencing the organisation and behaviourof the ethnic Chinese and indigenous capitalists of Southeast Asia. As has been noted,norms of economic behaviour tend to be defined in terms of obligations.Enforcement is also on the basis of obligations. Sanctions for disobedience, such asthe drying up of preferred credit arrangements or ostracism from the group, can beeffective forms of enforcement. As a corollary, however, explicit legal frameworks forbusiness relationships in Asia are seen by many Westerners to be weak.

In this section, I first present stylised summaries of the major characteristics ofdifferent Asian business systems and then analyse selected economic characteristics.

Japanese keiretsu

Japanese keiretsu, both horizontal and vertical, are characterised by implicitcooperative relationships among otherwise independent stand-alone firms. The

26—Business networks in East Asia: diversity and evolution

horizontal keiretsu originated in the reforms associated with the Meiji restoration. TheJapanese government played a major role in that it founded firms in a number ofindustries and then privatised them by selling them to wealthy merchant families ableto buy them. These family-owned firms grew into large holding companies or‘financial cliques’, known as zaibatsu —including such well-known names as Mitsui,Mitsubishi and Sumitomo — that dominated the prewar Japanese economy. Theywere broken up during the American occupation, but subsequently re-emerged askeiretsu in which the family role was largely replaced by professional managers andcooperation was voluntary. Typically, the horizontal keiretsu are comprised of a leadbank, a trading company and one or two major industrial firms. Seven such groupshave dominated the postwar Japanese economy, with activities that reach across mostindustrial areas. Although their share of economic activity is difficult to estimate, dueto the blurred boundaries of the groups, some estimates put their activity at half ofthe Japanese economy measured by assets and sales (Wright 1996).

The objective of the horizontal keiretsu is to spread risk. Interfirm (intragroup)coordination of finance and strategy is key to achieving this goal. Interfirmcommunication occurs at many organisational levels, but most notably among chiefexecutive officers (CEOs) of the companies at the heart of these groups. At regularmeetings, possible strategic cooperation in new product developments, competitivestrategies and government policies are discussed (Wright 1996). At the heart of eachkeiretsu is the lead bank which plays a powerful coordinating role through supportivelong-term financing in return for proprietary access to the strategy and managementof companies in the group. Shareholders, in contrast, provide a small share of fundingand have no say in management decisions. Cross-shareholdings among membercompanies is another attribute which helps reduce the risk of takeovers. Personnelmovements among member companies are also common, contributing to the lifetimeemployment system.

The vertical keiretsu evolved in the postwar business environment, shapedsignificantly by a major labour settlement and increasing technological change. Firstidentified in the auto and electronics industries (namely, Toyota, Matsushita, Hitachiand Toray), but not confined to them, vertical keiretsu link vertically-integratedactivities in an industry within a business group. By allocating various value-addedactivities to different subsidiaries, managers were able to differentiate salary structuresfor different value-added activities in order to control costs and to shift risks withinthe group in ways that were not possible within the parent firm (Westney 1996).

Employees are major stakeholders in the vertical keiretsu. At their core is the lead orparent firm, which focuses on high value-added manufacturing, R&D or assembly.Interfirm activities of the group are coordinated by the lead firm which owns themajority of its subsidiaries’ shares and allocates lower value-added activities to them.Thus, the vertical keiretsu organise activities by value-added, forming a verticalnetwork of cooperating firms, among which goods, finance, information and peopleflow (Westney 1996).

Business networks in East Asia: diversity and evolution—27

Korean chaebol

The Korean chaebol resemble the zaibatsu somewhat in that they consist ofindependent firms within business groups which are controlled through familyownership and by cross-shareholdings within the group. Such family ownership andcontrol originated in the postwar business environment, in which government usedthem as instruments of growth and competitiveness by directing them into keyindustrial sectors and providing them with preferential financing and protective tradeand investment policies. South Korean business groups are also rooted in thetransmission and control of family property. Inheritance practices whereby the eldestson receives the main share of communal landholdings has preserved the clan as theprincipal unit of political and economic influence, a unit that was reinforcedbureaucratically by Korean postwar industrial policy. Governments pursued growthobjectives by selecting and financing clan-owned business groups as instruments ofpolicy.

The chaebol dominate the Korean economy — particularly the export sector. The top10 chaebol are estimated to account for 70 per cent of the Korean economy measuredby sales/GNP and compete fiercely with one another for dominance. They arecentrally-controlled, vertically integrated and active in most industrial sectors, thoughconcentrated in the capital-intensive sectors, producing intermediate and final goods.Because of their large size, they are Korea’s main coordinators of production,distribution and capital (Hamilton 1996).

In contrast to the horizontal keiretsu, Korea’s main banks do not achieve interfirm(intragroup) coordination. Instead, the Korean government dominates the financialsystem by ownership and by regulation in order to allocate capital to sectors ofdevelopmental priorities. Interfirm coordination is achieved by families. Chaebolheads have obtained funding from state banks at preferred rates, and it is they whotend to establish firms favoured by development planners and to retain thatownership as the entities grow. Personnel relationships also tend to be family-based(Hamilton 1996).

Chaebol that dominate consumer products — such as Hyundai, Samsung, Daewooand Lucky Goldstar — are also organised in vertical hierarchies, within which goodsand services are obtained. This emphasis on self-sufficiency within the group meansthat chaebol do not cooperate well with firms outside the group, such as small andmedium-sized enterprises (SMEs) or other subcontractors.

Chinese family firm

The Chinese family firm is found in most Asian economies which are hosts to theChinese diaspora in Hong Kong, Taiwan and the ASEAN economies. The Chinesefamily firm is characterised by flexibility, opportunism, paternalistic leadership, highlevels of internal operating efficiency and low levels of organisational complexity.

28—Business networks in East Asia: diversity and evolution

Strategy is the monopoly of the CEO or of a small group; size is biased towardssmallness. Explanations of this behaviour include uncertainty about the political andeconomic environment (that is, markets are imperfect, often rigged), which lead tovolatility and a conviction that one should rely only on those one can trust (East AsiaAnalytic Unit 1995). These characteristics tend to limit such groups to certainindustrial activities, particularly trading, specialised services, retailing and originalequipment manufacturing (Redding 1996).

The origins of the family unit in Taiwan’s industrial structure differs significantlyfrom that in Korea in part because of Chinese inheritance practices and in partbecause of government policy. Partible inheritance practices in China, in which theestate is split equally among sons, contributed to the rise of the small family-basedeconomic unit, which requires voluntary horizontal ties to create a ‘critical mass’ ofresources for investment and the like (Hamilton 1996). This economic unit wasinfluenced by Taiwan’s postwar land reform and by the Kuomintang (KMT)government’s preference that large enterprises should be publicly-owned.

Taiwan’s industrial structure is driven in part by large public sector enterprises whichthe KMT government has used as instruments of its growth and export-oriented tradeand industrial policies. While Taiwan has large private business groups, they do notproduce many export products (although exports are 50 per cent of GDP). Instead,they operate upstream, producing intermediate goods sold domestically, often toSMEs ‘… the fabrics but not the clothes; the plastics but not the toys …’ (Hamilton1996, p. 31).

SMEs are significant players in Taiwan. They form economic alliances with otherTaiwanese businesses, creating diverse cooperative networks; vertical integration israre. Instead, the remarkable diversity of production originates in networks of firmswhich manufacture quantity and quality to the specifications of ‘lead’ firms in thenetwork who create demand for the former’s services. Some of these networks arearm’s-length, others are based on family relationships and friendships, in an extremeentrepreneurial fragmentation characterised by a ratio of approximately one firm forevery eight adults (Hamilton 1996).

Capital for investment comes not from the stock market or the government but fromretained earnings, from the curb market and from guanxi [personal connections]partners. Guanxi ownership is important, since many individual investors are silentpartners in the enterprise (Hamilton 1996). Ownership and control, therefore, residewith heads of households and individuals.

Southeast Asian conglomerates

Business systems in the Southeast Asian economies of Thailand, Malaysia andIndonesia consist of ethnic Chinese and indigenous capitalists operating numerousfamily-owned conglomerates of varying size. Many of the Chinese-owned

Business networks in East Asia: diversity and evolution—29

conglomerates evolved from thousands of small Chinese family firms whichhistorically migrated into the region and began trading businesses. Access tointernational markets, finance and information was relatively straightforward throughregional ethnic Chinese networks. Growth and diversification into manufacturingwas facilitated by participation in government-sponsored import substitutionprogrammes aimed at diversifying the domestic industrial structure. In severalcountries in the region, these ethnic Chinese conglomerates diversify risk and respondto opportunities by diversifying outside their home markets (East Asia AnalyticalUnit 1995). Yet, they have rarely ventured outside the East Asian region successfully,where power relationships and the rules of game are different.

Southeast Asia’s indigenous capitalists are found mainly in Indonesia, Malaysia andThailand and have been promoted by their respective governments in order toprovide a counterweight to the private sector dominance of ethnic Chinese. Theyoriginated in nationalisation of natural resources and agricultural industries in thepost-colonial period. Former indigenous bureaucrat–managers subsequently becomeheads of these organisations when they were privatised, as well as heads of their own(Lim 1996).

Both types of organisations are family-based, relying heavily on personal and politicalconnections. Many of them have expanded horizontally into new industrial sectors,and vertically into other phases of the production and marketing value chain. Thisexpansion is notable in that the objective has been less to capture economies of scalethan to control finance and production through the use of ‘insiders’.2

Industrial characteristics of business systems

As the foregoing survey implies, the organisational characteristics of Asian businesssystems are diverse. Their economic characteristics are similarly diverse, as illustratedby three measures — degree of internationalisation, share of national output andpatterns of exchange.

Internationalisation (the degree to which firms in the group supply intermediateinputs and services required to produce finished products) is highest among theKorean chaebol — something one would expect of groups which dominate theeconomy. Among Korea’s 43 chaebol, more than 17 per cent of the networks’transactions are estimated to be within the group (Hamilton 1996). This ratecompares with one of around 10 per cent in Japan’s horizontal keiretsu (Gerlach 1992,cited in Hamilton 1996) and with one of around 0.02 per cent in Taiwan’s top 96business groups (Hamilton 1996). This comparison underlines the high degree ofvertical integration, and associated impenetrability of the chaebol, and the low degreeof vertical integration found in Taiwan.

This contrast is also apparent in the second measure, a comparison of grouprepresentation in the industrial structure as measured by output shares of business

30—Business networks in East Asia: diversity and evolution

groups. The chaebol dominate most key industries in Korea, whereas suchconcentration does not exist in Taiwan (Table 2.1). Taiwan’s large business groups, incomparison, dominate only the textile industry and to a lesser extent capital-intensiveintermediate goods production including mineral products, transportation and pulpand paper — and the concentration is at lower rates than for their Koreancounterparts. In Japan, many of the holdings of the horizontal keiretsu include thesetraditional industries.

Outside Korea, the ‘new’ export-oriented industries such as auto components andelectronics have attracted the smaller or more flexible entities like Taiwan’s SMEs,joint ventures between family-owned businesses and foreigners in Southeast Asia, andJapan’s vertical keiretsu. More generally, cooperative forms of activity (which includenetworks, strategic alliances and other forms of collaborative activity) have increasedrecently, in part because of the shortening of production cycles and the more rapidtechnological changes (Safarian 1996). The Chinese family firms in Southeast Asia,in contrast are not (yet) heavily represented in these new, more complexmanufacturing industries. They have concentrated in financial services, foodprocessing, natural resource extraction and construction (Table 2.2).

Table 2.1 Industrial profile of business groups, Korea and Taiwan

Business groups’ sharein manufacturing output South Korea (1989) Taiwan (1988)

> 70% Shipbuilding and repair NonePetroleum and coal products

40%–70% Transportation equipment TextilesTextilesElectrical and electronic products

20%–40% Food products Pulp and paper productsBeverages Transportation equipmentChemical materials and plastics Non-metallic mineralRubber products, excl. footwear productsNon-metallic mineral productsBasic metalsMachinery

< 20% Garments and apparel All othersLeather productsLumber and wood productsPulp and paper productsPrinting and publishingChemical productsMetal productsPrecision machineryMiscellaneous industrial products

Source: Hamilton (1996).

Business networks in East Asia: diversity and evolution—31

Table 2.2 Industrial profile: 17 ethnic Chinese family groups

Industry Number of businesses

Finance, insurance, real estate 17Food 11Natural resources 6Infrastructure and transportation 6Hospitality 3Business services 3Electronics and telecommunications 2Autos 1Chemicals 1

Geographical originHong Kong 4Indonesia 3Malaysia 3Taiwan 3Thailand 3Philippines 1

Source: ‘A survey of business in Asia’, The Economist, 9 March 1996.

The third measure is patterns of exchange. Vertically-integrated groups, like those inKorea, are expected to have a significant impact on trade because vertical integrationcreates an incentive for economies of scale in a smaller range of products than wouldoccur in smaller, less integrated groups. Empirical testing of this propositioncomparing product variety in US imports from Korea, Japan and Taiwan indeedshows that Korea’s exports are concentrated in a smaller range of relatively higher-priced final goods than are those from Taiwan, which tends to export a wider varietyof intermediate goods (Feenstra et al. 1996).

In summary, this survey illustrates the diversity of the East Asian business systems.While the chaebol are centralised, family-based and capital-intensive entities whichdominate the economy, Taiwanese business groups, in sharp contrast, are notvertically integrated, nor do they organise the economy. The Taiwanese form oforganisation is horizontally diversified. Chinese family firms tend to be SMEs,paternalistic and tightly controlled, with a characteristic of operating outsideestablished rules and norms where there is considerable uncertainty. In other words,they go where government does not reach. They are capable of entering into looselyorganised production networks which, in Taiwan at least, can manufacture on arelatively large scale. Southeast Asian firms tend to be family-owned conglomerateswhich have taken advantage of the relatively stable political and economicenvironment to grow to large size through diversification of their businesses.

In the next section, I explore the changes underway in aspects of society consistentwith the conceptual framework that are seen to influence the nature and success ofbusiness systems.

32—Business networks in East Asia: diversity and evolution

The role of the state

The impact of the state on business systems varies across the East Asian economiesand through time. In its drive to achieve its goals of rapid economic growth and tocatch up to Japan, the Korean government has played the most interventionist roleoutside of the command economies, actively participating in public and privateproduction and promoting import substitution and export orientation. Economicdecision-making has been highly centralised; the private sector has been controlledmainly through regulation of financial institutions and credit rationing. Thegovernment targeted industries for participation and then made subsidised creditavailable to chaebol to upgrade technological capabilities and to diversify into thesenew industries (Sakong 1993). To encourage scale economies and reduce market risk,market entry by foreigners was restricted.

Japanese keiretsu were influenced differently by the state. Government played a lessinterventionist role as a producer than was the case in Korea but an extensive role ascoordinator of activity and mediator of conflicting interests (Johnson 1982). Whilethe keiretsu were more independent of government, they acquiesced in this informalguidance. Japan also pursued import substitution and export orientation, andrestricted market entry by foreigners.

The Chinese family firm has existed in many countries. The Taiwanese governmenthas played a significant role in influencing its activities. There, the state has ownedand managed enterprises in major import substitution and public service industriesand has exerted strong control over the financial system. Nevertheless, it has alsorelied on market forces and encouraged the private sector, particularly in exportindustries. Taiwan’s postwar land reforms nourished a household-based economicstructure, which became the basis of Taiwan’s horizontal business networks(Hamilton 1996). The Taiwanese government has played less of a coordinating rolethan have the Japanese and Korean governments and has become progressively lessinvolved over time, although it has recently favoured a number of strategic sectors ascandidates for preferential loans and tax treatment.

In Southeast Asia (with the exception of Singapore), governments played a significantdevelopmental role until the late 1970s. Since then, export orientation has beenfacilitated by unilateral trade liberalization and by intergovernmental regionalinitiatives such as the ASEAN Free Trade Area (AFTA) and the Asia Pacific EconomicCooperation (APEC) forum, but significant ‘export protectionism’ still exists (Flattersand Harris 1995; Drysdale and Garnaut 1993). Some restrictions continue to beimposed on direct investment, including local ownership requirements and trade-related performance requirements. Other measures, taken by Malaysia and Indonesia,have encouraged indigenous entrepreneurs as a counterweight to Chinese-ownedgroups.

Hong Kong is at the other extreme to Korea. Industrial, trade and financial policiesare largely laissez-faire. Most land is state-owned, however. A high rate of immigration

Business networks in East Asia: diversity and evolution—33

has been permitted and housing has been subsidised, which has reduced real wagepressures. Small firms have thrived in this environment as the dominant form in mostindustries (Whitley 1994).

In summary, the impact of government on Asian business systems has been diverse.It ranges from negligible intervention in Hong Kong to close cooperation, andextensive intervention in Korea and Japan. While a detailed historical analysis wouldbe necessary to understand the exact role of the state as a determinant of relationship-based business systems, the postwar impact of government intervention implies apositive correlation between the economic dominance of business groups and thestrength of government intervention. This relationship can be arrayed in a simplegraph which relates intervention to the economic attributes of the groups. Korea is atone extreme with heavy government intervention and economic dominance by thechaebol, followed by Japan, Taiwan and the Southeast Asian economies with decliningreliance on intervention and less dominance by business groups, and Hong Kong atthe other end with little government intervention in industry or trade andpredominantly SMEs (Figure 2.1).

Figure 2.1 Government intervention and Asian business systems

34—Business networks in East Asia: diversity and evolution

Business system(size, dominance,capital intensity)

Governmentintervention

Koreanchaebol

Japanese keiretsu

Southeast Asianconglomerate

Chinesefamily firm

light heavy

Norms, enforcement mechanisms and legal systems

The key function of norms, conventions and laws is to promote coordination withinand among economic organisations — how firms cooperate to produce profitably andefficiently. It has been argued that coordination functions are culturally influenced,causing variations in business systems with respect to the kinds of contracts enteredinto within and among firms (whether these are implicit or explicit), and with respectto whether cooperation is monitored or based on trust. As noted above, Asian firmsshare a respect for implicit contracts and trust-based cooperative relationships.

Cooperation depends on intra-organisational relationships. In Asian businesssystems, organisations draw on collective efforts of employees and employers, basedon trust and cooperation. In general, there is a high degree of commitment byindividuals to the firm, accepting its goals and working hard for it, although the focusof commitment may vary from the organisation in Japan to the family in Chinesefirms (Safarian and Dobson 1996).

Cooperation also depends on relationships among firms in the business group.Coordination among firms is motivated by the desire to spread risk, to reducecompetitive uncertainty, to secure access to complementary resources such as know-how, and to reduce the cost of monitoring activities. Coordination may also be asource of diversity among Asian business systems: interaction between families andgovernment is a factor common among the relatively large organisations in Korea,Japan and Southeast Asia. Interaction among families is common to the networks ofsmaller firms in Hong Kong and Taiwan.

Interfirm linkages in East Asia require less formal contracts and external monitoringthan those in industrialised (or other industrialising) countries, as evidence ofJapanese subcontracting and keiretsu relationships suggests. The rapid interactionamong family-owned SMEs in Taiwan is another example. This would also suggestthat the costs of coordination may be lower because concerns for reputation andmutual obligation are higher than among Western firms.

Why might this relative cost calculus exist with respect to cooperation? Oneexplanation is based on cultural factors, such as the inheritance practices describedabove in Korea and Taiwan. Yet similar kinds of informal interfirm collaboration tothat seen in Asia can also be found in very different cultural contexts, such as in Italy,in the Silicon Valley and in Swedish industry and for different reasons (Powell 1990).Other explanatory factors, such as economic and social factors, can be identified. Asone example, worker–management conflict created a crisis in the immediate postwarperiod in Japan. The labour settlement which solved the crisis played a role in the riseof the cooperative relationships in the vertical keiretsu (Westney 1996). Boyer (1992)argues that management–labour conflict, and differences in the relative power of thetwo groups, played a role in the rise of trust relationships which developed both inJapan and Germany.

Business networks in East Asia: diversity and evolution—35

Another explanation is that mechanisms are lacking for reducing mistrust, such asstrong legal systems. Political power has long been concentrated in the hands of rulersor authoritarian states and has often been exercised in arbitrary ways. Formal legalarbitration of disputes or property rights was not available, hence the potential risksand costs of transactions with strangers could be high. Governments, even if theywished to develop a system of commercial law, have been reluctant to exposethemselves to associated pressures to strengthen civil and constitutional law and astrong and independent judiciary.

A related explanation is that relationship-based cooperation is a function of the levelof economic development. In the early stages of industrialisation, factor and productmarkets are fragmented and governments are interventionist; in such anenvironment, information is scarce and considerable uncertainty exists. Much financeis obtained from familiar sources or from retained earnings; employees are known tothe employer; customers are also known; credit is scarce. Trust reduces the costs andrisks of doing business. As development proceeds, markets for inputs and productsbecome less fragmented, and cooperative relationships may be replaced by contractualones (Lim 1996). The issue, then, is not whether trust raises the costs of doingbusiness, but whether it leads to benefits, such as more reliable partners, that are moredifficult to secure through formal mechanisms.

Future evolution of business systems

The final question in this survey of business systems is to ask how Asian businesssystems might change in the future. Despite their diversity, Asian firms share respectfor obligations revolving around the family and cooperation with the state. If theseare functional because of weak legal systems and market fragmentation associatedwith the early stages of industrialisation, what should we expect to see happen tobusiness systems operating in their home environments as economies become moremarket oriented? Will relationship-based business networks evolve in morecontractual and transparent ways?

The most evident change in the East Asian business environments is their increasingmarket orientation. Governments seek to increase productivity growth through accessto foreign technology and to increase the efficiency of domestic producers throughcompetition with foreign producers. To accomplish these goals, governments arederegulating, privatising and allowing greater foreign business presence and moreinternational capital inflows.

Korea’s macroeconomic objective, for example, is associated with a far-reachingreview of the role of government. While Korea has enjoyed major economic successin the postwar period, rising production costs have created substantial pressures torestructure domestic production to higher value-added activities. Pursuit of industryupgrading has exposed some disadvantages of the chaebol. A major obstacle torestructuring has been the lack of technological capability in Korean industry

36—Business networks in East Asia: diversity and evolution

necessary to higher value-added activity. The closed and concentrated nature ofKorean markets has meant that Korean enterprises lacked incentives to acquire ordevelop leading-edge technology (Graham 1996).

In Japan, foreign pressures for market access and successive currency realignmentshave exposed other obstacles to raising efficiency posed by group ties. Market accessfor foreigners is made difficult by internalised relationships in the vertical keiretsu; thecross-shareholdings of the horizontal keiretsu have a downside in cyclical industries inthat indebtedness locks them into high-cost suppliers and employmentconsiderations create obstacles to divesting money losing enterprises. The impact ontraditional economic organisations of these pressures remains to be seen, but it isalready fairly clear that Japan’s business groups rely less and less on policy guidance.

An implicit hypothesis underlying Korean economic reform is that, as state regulationand protection declines, increased competition will create incentives for firms to learnand innovate (Chandler 1992). Thus, while political risks will decline, market riskwill increase from such sources as increased price competition and competition fromthose with superior technology and other proprietary advantages such as marketingand managerial know-how. Learning will have to take place through collaborationwith foreign firms, as has been the case in Southeast Asia, and through more rapidinnovation in Korea, Taiwan and Japan, which have in the past restricted the entry offoreign firms.

As the domestic business environment becomes more market-oriented, declininggovernment activity will reduce government business coordination. The influence oninterfirm coordination is less clear. It could be wrong to conclude that greater market-orientation will create incentives for convergence with the internal organisation ofWestern firms, however. Evolutionary change requires changes in incentive structures;even state intervention or regulation to bring about radical changes in institutionalorganisation by fiat usually requires assent of the affected parties (Matthews 1986).In East Asian economies, the state has traditionally played a strong role in guiding ordirecting industrialisation. As might be expected, vested interests in established waysof doing things have been built up, both in business and in bureaucracy. Theseinterests can slow or block changes in rules and norms that would bring aboutchanges in internal economic organisation.

Such resistance is evident in the diversity of the focus of and experience in theseeconomies with respect to competition policy. Competition policies have beenintroduced in Korea and Taiwan (neither Hong Kong nor Singapore havecompetition policies), but implementation of policy lags behind the nominal powersof enforcement agencies. In Korea, for example, competition law was adopted in1980 and has been amended several times since. The law restricts monopolies andcartels, prohibits price fixing and activities that restrict members’ business activities,and requires review of mergers. Yet its enforcement is subordinated to industrial andtrade policy goals and displays ambivalence about the activities of the chaebol. Only

Business networks in East Asia: diversity and evolution—37

in 1995 did the Korea Fair Trade Commission (KFTC) become an independentagency charged with policy responsibilities for competition and for enforcing anti-monopoly activities (Graham 1996).

In Japan, external bilateral pressures for market access through the StrategicImpediments Initiative and the subsequent ‘framework talks’ have spotlighted similarproblems with the Japan Fair Trade Commission (JFTC). While Japanese antitrustlaw has objectives similar to those in the United States, lagging enforcement has beenthe subject of repeated criticism.

Taiwan’s Fair Trade Law is the most far reaching of the three. The law requires thatmonopolies be monitored and specifies tests of such behaviour; it prohibits abuse ofmonopolistic positions, regulates mergers and prohibits cartels (with certainexceptions specified on efficiency grounds). The law is enforced by the Taiwan FairTrade Commission, which has produced a body of decisions. Even so,implementation is largely by moral suasion, and the economic impact of the law is asyet difficult to determine (Graham 1996).

This brief survey of changes that will influence the evolution of business systemsimplies that the introduction of market-oriented policies will bring aboutorganisational learning from competitors that could include imitation of some of thecharacteristics of Western firms, but not necessarily their duplication, for severalreasons. First, since one rationale for vertically-integrated groups is that they achieveefficient production and distribution in the domestic economy, governments mustweigh the costs and benefits of reducing market power against those of promotinggreater economy-wide efficiency. Second, and related to the preceding rationale, acertain inertia can be expected which favours established practices and relationshipsand reflects the power of vested interests. As East Asian governments permitinternational market forces freer play in domestic economies, however, there will alsobe pressures to adopt international rules of the road with respect to market access forforeign producers and foreign capital; and these pressures may help tip the scalestowards more enforcement.

This analysis applies to the domestic environment and the domestic behaviour offirms. A related question is what happens to business systems when theyinternationalise production by entering other economies. This topic is the subject ofthe next section.

INTERNATIONALISED PRODUCTION NETWORKS

Cooperative production networks are common in East Asia, not only in therelationship-based systems of indigenous firms discussed in the previous section butalso among international firms3 investing, producing and trading in the region. Thefocus in this section shifts to the latter, drawing on empirical evidence from a largerstudy (see Dobson and Chia 1997).

38—Business networks in East Asia: diversity and evolution

To understand the rationale for international production networks, an integratedtheory of trade and direct investment would be helpful. Integrated models, based onthe ‘new’ trade theory (see, for example, Helpman and Krugman 1985) are helpful toexplain trade and foreign direct investment linkages which underly networks. Weassume that firms, regardless of nationality, respond to changing comparative costs inthe home and host economies; that they allocate foreign production in value-addedsegments by ‘slicing up the value chain’ (Krugman 1995) and relocating firms andbusiness segments, as the comparative advantage of a location for investment changes.

Using the ‘segment’ as the unit of analysis, we do not expect that entire industries willrelocate but that industry segments will. Firms in the assembly-based industries, bethey multinationals or international firms of more recent vintage, link these value-added activities into production networks as ways to increase internationalcompetitiveness. Faced with intensifying competition because of such factors asderegulation, falling trade barriers and increasing capital mobility, they seekproduction efficiencies by unbundling value-added activities which were previouslyvertically integrated within a single location or production unit. Locational factors,particularly factor endowments and government policies, are determinants of wherethose activities will be allocated.

Value-added activities with low entry barriers, price sensitivity and standardtechnologies will be located — and relocated — to sites with comparative advantagein, for example, low cost labour or processing plentiful natural resources. Services orproducts that embody recent innovations, or are capital- or technology-intensive withhigh entry barriers, will be allocated to sites with comparative advantage in skilledlabour, low cost communications and infrastructure. Production networks are createdby these cross-border trade linkages, either within a firm or among cooperating firms,since the many intermediate goods in the assembly-based industries that are the focusof this study must be shipped from where they are produced to other locations (withdifferent comparative advantage) where further value is added in the form offinishing, testing, assembly or marketing. This unbundling is facilitated by firm-specific capabilities in microelectronics and information technology to coordinateproduction and trade of the many components to be assembled into the finalproduct.

Table 2.3 The electronics industry: sales and procurement by corporate nationality, Thailand,Malaysia and Taiwan, 1992–93 (shares in per cent; shares of intrafirm transactions in parentheses)

Japanese firms US firmsThailand Malaysia Taiwan Thailand Malaysia Taiwan

SalesLocal 11 0 40 0 1 36economy (17) (-) (2) (0) (100) (-)

Home 19 19 20 24 63 48economy (98) (64) (91) (100) (100) (94)

Business networks in East Asia: diversity and evolution—39

Japanese firms US firmsThailand Malaysia Taiwan Thailand Malaysia Taiwan

Third 71 81 40 76 36 16country (94) (57) (49) (100) (64) (76)

Total 100 100 100 100 100 100(86) (59) (39) (100) (87) (57)

ProcurementLocal 27 29 46 20 9 19economy (19) (0) (-) (100) (13) (0)

Home 56 45 44 25 40 65economy (91) (74) (63) (100) (100) (84)

Third 17 26 10 55 52 16country (52) (28) (17) (100) (64) (49)

Total 100 100 100 100 100 100(64) (41) (29) (100) (74) (63)

Sources: Thai survey results from Ramstetter in Dobson and Chia (1997); Malaysian survey results from Sieh Lee and Yew in Dobson and Chia (1997); Taiwanese survey results from Tu in Dobson and Chia (1997).

Firms’ activities can be linked to economy-wide restructuring in response tolocational determinants which include host governments’ policies. Governments havebeen notably successful in marshalling inputs through industrial upgrading — awillingness to restructure entire industries (and more recently value-added activitieswithin industries) in line with shifting comparative advantage.

The empirical issue is whether patterns of transactions within these internationalnetworks differ by the corporate nationality of the firm. Evidence from the electronicsindustry in three economies at different stages of development is presented in Table2.3.4 Intrafirm transaction patterns of Japanese and US firms resemble each other inways that are clearly suggested in this table. First, sales by both through marketchannels increase (that is, intrafirm transactions decline) as the host economydevelops and matures. Market channels are used more heavily in Taiwan than in theother two host economies. Second, both producers sell more to the local market asthe economy develops and matures; around 40 per cent of sales by both Americanand Japanese firms are to the local market in Taiwan whereas such sales are negligiblein Thailand and Malaysia.

On the procurement side, a similar pattern is evident for Japanese, but it is lesspronounced for US firms. Japanese firms procure nearly half their inputs locally inTaiwan (compared to less than 30 per cent in Thailand and Malaysia), while US firmsfail to show such a pattern for reasons explained below.

40—Business networks in East Asia: diversity and evolution

Few differences by corporate nationality are apparent in trade behaviour. The maindifference is that US industrial electronics firms engage in more intrafirm trade thando Japanese consumer electronics firms (see bottom line of sales and procurementpanels). Why might this be? One of the most plausible explanations is that US firms,in industrial electronics, export more of the components produced in theseeconomies back home and procure more from home — and mostly through intrafirmchannels — in order to protect proprietary advantages and to meet strict qualitystandards. Japanese producers in consumer electronics, in contrast, target localmarkets more heavily and procure from Japanese SMEs which have located in theregion (indeed these Japanese suppliers count as their customers producers of mostother nationalities).

In Tables 2.4 and 2.5, these data are analysed holding corporate nationality constant.Marked differences by industry are apparent. Table 2.4, which presents data forJapanese firms in autos, electronics and textiles and garments (T/G), shows that, inThailand, Japanese electronics producers export most of their output, while Japaneseauto producers export almost nothing because of the local import-substitution policy.Similarly, in Indonesia, most Japanese electronics producers export more than two-thirds of their output while Japanese auto and T/G producer countries export lessthan a third. Procurement data in those tables show slightly less industry variation, inthat Japanese firms in Thailand import more than half of their inputs in both theelectronics and auto industries (and largely through intrafirm channels), althoughlarger shares of auto than electronics parts are procured locally. In Indonesia, most ofthe inputs used by Japanese producers in both the electronics and auto industries areimported from the home economy through intrafirm channels. In T/G, however,inputs are largely procured locally.

Table 2.4 Sales and procurement by Japanese MNEs: Thailand and Indonesia, 1993 (shares ofintrafirm transactions in parentheses)

Thailand IndonesiaElectronics Autos T/G Electronics Autos T/G

SalesLocal 10.8 98.5 na <10 >33 >10economy (16.8) (100.0) (>90) (>67) (<33)

Home 18.6 0.5 na -a -a -a

economy (98.3) (100.0)

Third 70.6 1.0 na >90 <33 <90country (93.8) (100.0) (>90) (>90) (<33)

Total 100.0 100.0 na 100 100 100(86.3) (100.0) (>90) (>33) (<33)

ProcurementLocal 27.2 43.8 na <33 <33 >10economy (18.6) (74.6) (<33) (>33) (<67)

Business networks in East Asia: diversity and evolution—41

Thailand IndonesiaElectronics Autos T/G Electronics Autos T/G

Home 55.6 56.2 na -a -a -a

economy (90.7) (100.0)

Third 17.2 0.0 na >33 >33 <90country (51.5) (0.0) (>67) (>90) (<67)

Total 100.0 100.0 na 100 100 100(64.4) (88.8) (>67) (>33) (<67)

Notes: a Included in third country.na Not available.

Measures in the Thai survey are in per cent shares; in Indonesia shares are measured in intervals — for example, <10 (>90) means that at most 10 per cent of sales by electronics firms were local, of which at least 90 per cent were intrafirm.

Source: Thai survey results from Ramstetter in Dobson and Chia (1997); Indonesian survey results fromPangestu in Dobson and Chia (1997).

Table 2.5 Sales and procurement by US MNEs: Thailand and Indonesia, 1993 (shares ofintrafirm transactions in parentheses)

Thailand IndonesiaElectronics Autos T/G Electronics Autos T/G

SalesLocal 0.0 - - na 100 -economy (0.0) (>90)

Home 23.7 - - na -a -economy (100.0)

Third 76.3 - - na 0 -country (100.0) (0)

Total 100.0 - - na 100 -(100.0) (>90)

ProcurementLocal 20.0 - - na 10–33 -economy (100.0) (67–90)

Home 25.0 - - na -a -economy (100.0)

Third 55.0 - - na 33–90country (100.0) (67–90)

Total 100.0 - - na 100 -(100.0) (67–90)

Notes: a Included in third country. na Not available.‘-’ Denotes US producers not present.

42—Business networks in East Asia: diversity and evolution

Measures in the Thai survey are in per cent shares; in the Indonesian survey, shares are measuredin intervals; US automobile MNEs are not present in Thailand.

Source: Thai survey results from Ramstetter in Dobson and Chia (1997); Indonesian survey results fromPangestu in Dobson and Chia (1997).

A more limited comparison of US producers in Table 2.5 shows a similar dichotomybetween electronics and auto sales (reflecting host government policies), withsomewhat greater similarities in procurement by industry. A more detailedcomparison is not possible because of the absence of US producers from one or moreof the industries in the economies studied.

In summary, the comparative analysis of intrafirm trade in East Asian economies byfirms of different corporate nationality suggests that, when firms locate productionabroad, patterns of exchange may converge, in part because of the impact oflocational determinants, such as host government policies. Production structures,such as the internal procurement practices of the chaebol and keiretsu may bereplicated abroad initially, although here again host government policies requiringlocal sourcing may, over time, reduce the degree of internationalisation.

CONCLUSIONS AND IMPLICATIONS

This chapter’s objective was to explore and apply a common intellectual economicframework to understand Asian business systems — relationship-based networkswhich cooperatively internalise production, exchange and finance and which enforcethese relationships through trust rather than formal monitoring. The firm is the unitof analysis.

This framework was applied to a survey of these business systems and to anexploration of how changing determinants at home and internationalisation ofproduction and exchange abroad might, in turn, change the internal organisation ofthese systems. The survey illustrated the diversity of Asian business systems andexamined alternative explanations for the commonly-shared relationship basis ofthese systems. It was observed that while culture is not a persuasive explanation, otherplausible explanations relate to the absence or weakness of mechanisms for reducingmistrust such as in legal systems and the fragmented markets for such key inputs asfinance and labour which are found in industrialising countries. The interventionistrole of the state, while it does not necessarily explain the origins of business networks,is important to an understanding of variations in economic characteristics (see Tables2.1, 2.2 and Figure 2.1) and in predicting how they might change. While businessgroups have often been the recipients in the past of interventionist industrial andprotectionist trade policies, the environment for these groups is changing asgovernments seek to consolidate the gains from decades of rapid growth byrestructuring, reducing the role of government, and encouraging internationalisationby deregulating, privatising and opening economies to foreign entry.

Business networks in East Asia: diversity and evolution—43

The interesting question is whether cooperative relationships will decline as marketforces play more of a role and governments less of a role. The evidence in this studyis too compressed to be conclusive; nevertheless, several observations are pertinent.First, the conceptual framework implies that if entrepreneurs perceive they could dobetter against competitors by changing their behaviour, or could learn better ways oforganising, they will do so. If they do not think they will do better, they will try toblock change. As Chandler has observed, organisational learning reflects the intensityof competition among organisations; the greater the degree of monopoly power, thesmaller the incentive to learn. Thus, governments interested in encouraging firms tolearn and innovate will foster competition. It does not necessarily follow, however,that an increase in competitive forces and organisational learning will underminecooperative relationships, because values do not change, or because of the inertiarepresented by adaptation/attachment to a different mind set or mental model abouthow things are done.

The second observation relates to this point. The survey of competition policy in thisstudy shows how change can be blocked. While policies have been, or are beingdeveloped in Japan, Korea and Taiwan that should promote competition, restricteconomic power and protect consumers, these policies are either very new or have notbeen enforced. Thus, the impact of new rules is, as yet, restricted because of politicalpressures from vested interests and ambivalence about whether reduced concentrationwill bring net benefits to the economy. Indeed, instead of confronting these issueshead on, a blunter instrument is that of adopting open trade and investment policiesto promote greater competition.

Third, other exogenous forces are pushing governments in the same direction.Western firms which are permitted entry will push for greater transparency inregulation and for a legal framework to settle disputes and protect property rights.Emerging middle-class consumers have similar goals.

Yet, while their home governments wish to see increasingly rapid technologicalchange in key industries, Asian business groups face major challenges as to whetherthey can move to global technological frontiers. It is quite uncertain whether legalreform will be sufficient to reduce mistrust of transacting with parties ‘outside’ thebusiness groups.

These offsetting forces must be taken into account in predicting the future evolutionof relationship-based business systems. The academic debate about ‘convergence’between such groups and the more contractual Western forms of economicorganisation may overstate the issue. Instead, it may be that the optimal industrialorganisation may differ, both for that particular country at different stages of itsdevelopment and among countries at one point in time.

The impact on relationship-based networks of producing abroad has also beenexplored. When firms of different corporate nationality produce in the sameindustries in similar host economies, their patterns of exchange (through sales and

44—Business networks in East Asia: diversity and evolution

procurement transactions) are quite similar. This evidence suggests that locationvariables, particularly host government policies, dominate home country variables asinfluences on exchange and, to a lesser extent, production.

Finally, the implications of this analysis for APEC and WTO negotiations are mixed.Most governments in the region face pressures to sustain decades of rapid growth byencouraging international as well as domestic competition in order to raiseproductivity and facilitate industrial restructuring into higher value-addedproduction. Introduction of market forces, open trade and investment policies, andenforcement of rules to promote competition or ‘contestability’ of domestic markets,will be modified by vested interests and by the trade-off between efficiency andincreased competition for valid reasons identified in this chapter.

As incomes rise in these markets, however, pressures in multilateral and bilateralforums for greater market access by foreigners will increase, as will demands forcontestability. An approach that might be tried in APEC and the WTO to mediatethese pressures is to create working groups mandated to develop greaterunderstanding of national market structures and competition policies — particularlytheir trade implications — and to monitor the enforcement of national policiesamong all members. As this study has illustrated, many questions can be posed —and remain to be answered — in accounting for the diversity of business systems inthe region and predicting their future evolution.

NOTES

I am grateful to Steve Parker, Kohsaka Akira, Yoon Young Kwan, Peter Drysdale, HughPatrick and the editors of this volume, all of whom provided useful comments.1 For the non-economist, it is worth emphasising that the distinctions noted here relate

primarily to the unit of analysis within a market-based framework which is used tounderstand the evolution of modern industrial enterprises.

2 I wish to acknowledge Steve Parker for pointing this out to me.3 The term ‘international’ firm refers to multinational enterprises (MNEs), which locate

parts of their operations in different countries; multi-domestic firms, which replicateoperations in multiple countries; and SMEs, which produce across borders on a smallerscale.

4 The empirical analysis which follows is based mainly on primary data gathered in surveysof 241 firms in the electronics, auto, textiles and garments and chemicals industries ineight East Asian economies (Dobson and Chia 1997). The electronics firms surveyedaccounted for 41 per cent of industry sales in Malaysia, 36 per cent in Taiwan and 76 percent in Thailand.

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Boyer, Robert (1992) ‘How to promote cooperation within conflicting and divided societies:some thoughts about the transition of industrial relations in Europe’, Paper presented atthe conference on ‘Convergence and Divergence in Economic Growth and TechnicalChange’, held in Maastricht.

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Flatters, Frank and Richard G. Harris (1995) ‘Trade and investment: patterns and policyissues in the Asia–Pacific Rim’, in Wendy Dobson and Frank Flatters (eds) Pacific Tradeand Investment, Kingston: Queen’s University.

Feenstra, Robert C., Tsu-Han Yang and Gary G. Hamilton (1996) ‘Business groups andtrade in East Asia: part 2, product variety’, University of California and University ofWashington (mimeo).

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Gerlach, Michael (1987) ‘Business alliances and the strategy of the Japanese firms’, CaliforniaManagement Review (Fall), 30(1), pp.126–42.—— (1992) Alliance Capitalism: The Strategic Organization of Japanese Business, Berkeley:University of California Press.

Graham, Edward M. (1996) ‘Competition policies in the dynamic industrializingeconomies’, APEC Working Papers Series 96–9, Washington DC: Institute forInternational Economies.

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Business networks in East Asia: diversity and evolution—47

3 Markets, competition and restructuring inthe 1990s

Peter A. Petri

The American economy is navigating the economic currents of the 1990s moresuccessfully than its major competitors. It is now in its seventh year of non-inflationary expansion; its unemployment level is low; its profits and stock market arebooming; and its productivity growth, although modest, is higher than at any timesince the early 1970s. In addition, the structure of the US economy seems to berapidly shifting toward information technology and other ‘industries of the future’.Meanwhile, Europe and Japan are recovering slowly from prolonged recessions andshow less evidence of developing new areas of innovation and growth.

This study seeks explanations for these contrasts in the competitive systems of theworld’s major economies. The term ‘competitive system’ is used to cover a range ofpolicies and institutions that affect the flexibility of markets and the productiondecisions of firms and individuals. The study confirms the ‘conventional wisdom’ thatthe US economy, including especially its labour and capital markets, was moreflexible in the 1990s than other economies. But why did this flexibility not producesuperior results in earlier periods? In contrast to much recent writing, this study alsoconsiders the trade-offs involved in the institutions of flexibility. Viewed from thisperspective, the strong recent performance of the US economy is related to specialcharacteristics of the environment of the 1990s and does not necessarily testify to thegeneral superiority of the US competitive system.

Competitive systems vary in their ability to absorb different types of shocks, andthose that occurred in the 1990s played to the strengths of the American system. Thiswas because the shocks of the 1990s required not primarily adjustments within firmsor even within networks of firms but rather shifts in resources among different firms.The institutional characteristics that produced this flexibility, however, can alsoimpede an economy’s ability to generate certain investments and productivityimprovements that are important in technologically more stable periods. This mayexplain why the US economy lagged behind others in the 1980s, when competitionappears to have focused on rapid but essentially incremental innovation.

The subject — the competition of competitive systems — is broad and unwieldy.Nevertheless, the recent thrust towards deregulation in Japan, Europe and, morecautiously, elsewhere in East Asia,1 assumes that an improved regulatory environmentcan bring benefits at the macroeconomic level. To judge whether or under whatcircumstances such results can be expected, it is important to understand theconnections between regulation and aggregate economic performance. In turn, thisrequires research that integrates findings from specialised areas such as finance, laboureconomics and industrial organisation.

For evidence, this study relies on the largest Organisation for Economic Cooperationand Development (OECD) economies — France, Germany, Japan, the UnitedKingdom and the United States. This small sample helps to filter out differences dueto levels of development and makes it possible to use more detailed information. Thefirst section of the chapter develops a conceptual framework for distinguishingnational systems. The next discusses the shocks of the 1990s and the performance ofthe five economies. Subsequent sections examine in detail the factors that underlieeconomic flexibility: labour mobility, capital mobility and management incentives.

ALTERNATIVE COMPETITIVE SYSTEMS

It is easier to ‘know’ that the systems of the United States (and perhaps the UnitedKingdom), Japan and continental Europe differ than to identify the crucial aspects ofthat difference. In addressing related issues, authors have variously focused on the roleof trust (Hirschman 1970; Fukuyama 1995); the importance of ‘insiders’ versus‘outsiders’ in financial decisions (Mayer 1996); the prevalence of networks (Zysman1983 and 1996); and the relative emphasis on collaboration versus competition. Intrade negotiations, particularly those that involve both sides of the Pacific, observersoften contrast legalistic Western and relationship-based Asian values.

These broad characterisations apply to a surprisingly wide range of economicinstitutions. The US financial system, in contrast to those in Europe and Japan,emphasises market finance rather than bank relationships, and investors are relativelydispersed (Berglof 1990). US labour markets, unlike those in Europe and Japan, arecharacterised by job mobility and few long-term obligations between employers andemployees. US management systems, also in contrast to European and Japanesecounterparts, are controlled by equity investors and their boards, provide large,profit-linked incentives for managers, and rely on ‘top-down’ rather than ‘bottom-up’decision-making. Some of these institutional differences are imposed by governmentlaws and regulations while others derive from traditions and history. Convergence isunderway, but the data show that the systems are still quite distinct.

Common to these contrasts is a fundamental distinction between unilateral and jointdecision-making approaches to the coordination of economic activity. Economics haslong been interested in the issue of control, but the recent economics of ‘incompletecontracts’ has called attention to the fact that the allocation of control — who decides

Markets, competition and restructuring in the 1990s—49

what to do in unexpected future states — is an important feature of contracts (Hartand Holmstrom 1987; Holmstrom and Tirole 1989).

In a unilateral control system, which seems to underlie many US institutions, a singleeconomic agent (worker, shareholder, company) makes decisions — and typicallybears financial risks — independently of the other units with which it cooperates.The coordination of units is then managed through more-or-less explicit contractsand transactions. In a joint decision-making system, which seems more descriptive ofEuropean and Japanese institutions, decisions and financial risk are shared bycollaborating units, which then more-or-less cooperatively execute their commonstrategy. This bifurcation is, of course, highly stylised; in fact, there is a great diversityof control arrangements and contracts within each type of system.

The approaches might be caricatured as ‘cowboy’ and ‘family’ styles of economicgovernance. Cowboys used to be hired for one cattle drive at a time; they had clearobjectives — to get the cattle to market alive and in time — and workedindependently. At the other extreme, barring catastrophe, families are committed tolive and work together for long periods. They seldom account for the contributionsand rewards of individual members explicitly, and their decisions require theweighing of individual objectives even if choices are ultimately made by a singleindividual.

The main distinction between these approaches, purposely presented in exaggeratedform, lies in the type of contracts that govern collaboration. Contracts play a centralrole in the analysis of economic institutions (cf. Williamson 1985), especially withrespect to determining the ‘borders’ of the firm. In the present study, contractsgoverning cooperation within firms are also important (Aoki et al. 1990). At theunilateral extreme, contracts need to be relatively complete and parties have fewobligations beyond those in the contract. Except as explicitly provided, capital canleave labour behind without regard to social impact, and workers can leave positionsand compete against their previous employers. Sourcing or marketing ties will besimilarly fluid. But some activities that cannot be specified with complete contracts— and cannot be ‘internalised’ under the control of a single economic agent becausethey require the cooperation of several agents — may not occur in a system that hasno traditions or laws to facilitate joint decision-making. The equilibrium in such asystem will be characterised by relatively weak collaboration as agents attempt tominimise relationship-specific investments. This represents the chief source of marketfailure in unilateral systems.

In a joint decision-making system, partners agree to address new circumstancestogether and therefore do not have to write complete contracts (they do not have toanticipate all future contingencies). Contracts in such a system tend to be confinedto objectives rather than detail. But the partners must be assured, by law or tradition,of the continuity of the joint decision-making unit, even in the face of changes thatmight make it more profitable for one or another partner to ‘go it alone’. The

50—Markets, competition and restructuring in the 1990s

equilibrium in this system involves high specific investments in relationships thatparties then cannot or are reluctant to abandon. The market failure, in this case, isthat some profitable ruptures will not occur.

An important debate in the corporate governance literature addresses these issuesfrom a welfare perspective. One side argues that economic efficiency requiresmanagers to act unilaterally on behalf of capital and to define all other collaborativerelationships (for example, with labour) through explicit contracts (Jensen andMeckling 1976; Reve 1990). The other side counters that perfect contracts cannot bewritten and that the second-best solution requires stakeholders to share in decision-making and in profits (Blair 1995). We return to this debate later but here note thatarguments can be marshalled for both sides. The central problem, however, is thateach system has a ‘blind spot’ and produces market failure under particularcircumstances. The fact that complete contracts cannot always be written means thatthere is no best solution for all circumstances; there are only second-best solutionswhich cannot be ranked independently of circumstances. Indeed, the two types ofsystem may be alternative equilibria — consistent ways of organising economicdecisions and institutions, neither of which consistently dominates the other.

Transition from one type of system to the other is difficult because the institutionsand regulations of each system are highly interdependent (Aoki 1984). Consider, forexample, the case of labour markets and corporate employment policies in Japan.Because employment preservation is an important objective in Japanese firms,markets for skilled, mid-career workers are thin. Weak labour markets, in turn,reinforce firms in their commitment to maintaining employment. If lay-offs havecatastrophic consequences for workers, then loyalty to employees will be a criticalaspect of the reputation of firms. Extreme circumstances aside, firms will be reluctantto adopt flexible employment policies until deeper labour markets make thosepolicies more acceptable. This kind of ‘coordination problem’, which arises from theinterdependence of economic institutions, helps to explain the stability ofcompetitive systems over time.

Although competitive systems are slow to change, they evolve in the long run,presumably in response to underlying economic forces. The unilateral US system, inparticular, developed in the context of America’s extensive, resource-based pattern ofdevelopment. Neither law nor social constraints could effectively bind people or firmsfrom seeking new, profitable markets and leaving existing economic relationshipsbehind. Consequently, it was necessary to develop institutions to facilitatetransactions among strangers and it became less important for economic agents todevelop reputations for loyalty. Given economic and geographic options, there wasprobably also less demand for social protection than elsewhere.

By contrast, population density, borders and language gave rise to relatively fixedeconomic communities in Japan and Europe. Within such communities, reputationsfor loyalty came to be highly valued. Eventually, it appears, these differences were

Markets, competition and restructuring in the 1990s—51

reinforced by policies (Berglof 1990). The United States aggressively promotedcompetition in financial and product markets; for example, restrictions on banking,embodied in the Glass–Stiegel Act, helped to lay the foundations for America’s opencapital markets. Meanwhile, Japan and Europe developed collaborative and network-oriented management systems, and adopted social policies to protect immobilefactors, which as a byproduct sometimes further impeded mobility.

The systems continue to evolve today. In light of the integration and increasingsimilarity of the world’s major economies, the unilateral and joint decision-makingapproaches appear to be converging. In the United States, ‘quality circles’ andbusiness alliances are rapidly gaining favour, while Europe and Japan are movingtowards more competitive, arm’s-length transactions in many previously relationship-based markets. In the case of financial markets (as Table 3.5 will show), quantitativetrends also support this story.

ECONOMIC ENVIRONMENT OF THE 1990S

The 1990s were characterised by rapid changes in technology and the globalisation ofproduction (Oman 1994). These changes were fundamentally microeconomic incharacter but appear to have had macroeconomic effects, including movements in realwages and the distribution of earnings. How different economies coped with theseshocks sheds light on the behaviour of alternative competitive systems. Briefly, thesalient trends included:

• breakthroughs in information and communications technology (often reinforced by deregulation), which create possibilities for new industries and reduce the costsof coordinating economic activity across physically separated workplaces;

• shifts toward ‘open standards’ in several sectors, which permit small firms to benefitfrom network scale economies;

• increased flows of capital and expertise across firms and borders, which sharpen thepressure on firms to distinguish their expertise from those of competitors; and

• the emergence of major new low-cost producers, which encourages the subdivisionof production into smaller steps performed in different countries.

Overall, the trends favoured new industries, new firms and new combinations ofskills. Incremental adjustments were not sufficient to respond to them. In some firms,adjustment required massive retrenchment. In some sectors, established firms couldnot keep pace technologically with new firms having more up-to-date expertise.2 Atthe same time, skill requirements also changed. The demand for the coordinationtasks performed by middle managers sharply diminished, while the need forentrepreneurial and technical skills expanded. For many companies, these trends didnot call for net change in staff but rather for simultaneous lay-offs and new hires. Thetrends also required adjustments in the structure of firms. Outsourcing made it

52—Markets, competition and restructuring in the 1990s

possible to shed activities outside the firm’s core business, which in turn the firmcould strengthen by acquiring companies with complementary technical capabilitiesor markets.

These trends contrasted with the production environment of the 1980s. Firms thenneeded to focus on improving the characteristics of their products, reducing the timerequired for changes and raising productivity. These demands called for moreeffective collaboration among divisions and people inside firms. In the 1990s itbecame more important to bring the right combinations of factors together than toorganise the mechanics of their collaboration. In the 1980s Schumpeter’s ‘creativedestruction’ took place within firms, and in the 1990s across firms. In theterminology of contemporary business consultants, the preoccupation with‘continuous improvement’ gave way to ‘re-engineering’.

Given these changes, it is not surprising that the OECD economies switched placesin relative economic performance. In the 1960s and early 1970s Europe grew robustlyand reduced its income gap with the United States. Japan then led until the late1980s, eventually surpassing (at market exchange rates) incomes in Europe and theUnited States. But in the 1990s the United States again climbed into the lead. Thedata, summarised in Table 3.1, suggest differences in several aspects of performance:

• Growth: The United States experienced a recession in 1990–91 and has since maintained relatively rapid, inflation-free growth. Japan entered a steep and prolonged downturn in 1992 and, despite stimulative fiscal and monetary policies,is only now beginning to mount a recovery. Europe also entered a deep recession around 1991 and is recovering far more slowly than from previous recessions.

• Unemployment: US unemployment rates in late 1996 were at their lowest levels inmore than 20 years. In Europe, unemployment rates climbed into double digits during the recession and, with few exceptions, remain there. Japanese unemployment is still low by Western standards, partly because of measurement differences, but 1996 unemployment was 50 per cent larger than in the 1980s.

• Productivity: Although the measurement of absolute productivity is complex and controversial,3 US productivity growth is higher now than at any time in the pasttwo decades. US productivity growth now falls in the upper end of the five countries analysed, after trailing the group in the 1980s. To be sure, OECD productivity growth remains weak compared to the decades before 1973.

• Restructuring: There are no ready measures of change in industrial structure toward ‘new’ industries but anecdotal evidence suggests that output composition ischanging faster in the United States than elsewhere. The United States leads measures of penetration of computers and telecommunications and is gaining market share in advanced products such as processors and dominates industries such as software. Its major sunset industries — steel and automobiles — have alsoreturned to profitability after prolonged restructuring.

Markets, competition and restructuring in the 1990s—53

• Asset growth: Equity values are routinely used to measure company performance but are a crude indicator of national productivity. Still, the value of US equities more than doubled during the 1990–95 period, an increase twice as large as in thenext best performing major economy. In effect, capital gains (just on the equity oflisted companies) averaged around 10 per cent of US GNP in each year of this period.

Table 3.1 Macroeconomic performance

United UnitedFrance Germany Japan Kingdom States

Real GDP growth (% pa)1978–90 2.5 2.4 4.1 2.4 2.71990–96 1.3 2.1 1.6 1.5 2.1

Unemployment (%)1978–90 8.5 6.4 2.4 8.0 6.91990–96 11.12 8.6 2.7 8.9 6.4

Output per worker (% pa)1978–90 4.1 2.9 4.4 3.5 1.91990–96 3.4 4.0 0.9 3.2 3.2

Stock market capitalisation1990 US$ billion 314 355 2,918 849 3,0591995 US$ billion 522 577 3,667 1,407 6,858% increase 66 63 26 66 124

Sources: International Monetary Fund (1996); The Economist, 28 September 1996; International Finance Corporation (1996).

Was business-cycle timing responsible for these differences in economic performance?From a conventional business-cycle perspective, in 1997 the United States was wellinto a long expansion, while Europe and Japan were just beginning to emerge fromlong recessions and could continue to grow longer. But was this a macroeconomic‘accident’ or a reflection of microeconomic differences? The 1990s were largely freefrom large macroeconomic shocks — like the oil crisis and inflation of the 1970s —that could have affected different OECD countries so asymmetrically andpersistently. Rather, the unusually long business cycles of the 1990s seem to have beentriggered by technological and international developments, or, more precisely, byadaptations to these shocks. Differences in performance seem to reflect thosevariations in microeconomic adjustment that are the focus of this study.

ELEMENTS OF FLEXIBILITY AND ADJUSTMENT

Flexible markets and strong managerial incentives appear to have played an importantrole in the differential performance of the United States and other OECD economies.An overview of these features is presented in Table 3.2, which extracts variables ofinterest from the World Economic Forum’s (1994) World Competitiveness Report.Except for two variables (social security contributions and stock market

54—Markets, competition and restructuring in the 1990s

capitalisation) the indicators present survey results—that is, the opinions ofinternational executives. A high rank (low number in the table) identifies featuresnormally associated with unilateral decision-making styles and a low rank (highnumber in table) identifies those associated with joint decision-making styles.4 Inmost individual characteristics and in all three summary categories (labour mobility,capital mobility and individualistic incentives) the United States ranks ahead of theother economies. These impressions will be examined using objective evidence in thesections below.

Table 3.2 Characteristics of competitive systems ranking among 41 economies

United UnitedFrance Germany Japan Kingdom States

Indicators of labour mobility (ave.) 30 32 24 20 18Flexibility of hiring, firing 31 29 20 6 7High labour turnovera 26 28 36 32 22High work hours per year 27 36 12 20 16Low social security contributionb 36 35 27 23 25

Indicators of capital mobility (ave.) 18 21 20 9 6Production relocated abroad 35 40 32 16 14Progress made in restructuring 11 30 31 8 6Sophistication of financial markets 17 15 16 2 3Venture capital available 6 11 26 4 2Low cost of capital 23 11 9 17 4High stock market capitalisation 13 18 4 5 6

Indicators of economic incentives (ave.) 25 18 24 14 8Little state interference in decisions 27 10 20 6 16Antitrust laws support competition 20 1 19 4 2Extensive financial risk-taking 16 8 1 16 3Sense of entrepreneurship 29 32 34 30 4Sense of risk-taking 37 24 39 15 2Managers free of social constraintsa 21 31 33 10 20

Notes: a The ranking of the variable was reversed from the original report. For example, high labour turnover was judged as a negative indicator of competitiveness in the World Competitiveness Report; here it is viewed as a positive correlate of labour mobility.

b Average ranks of employer’s and employee’s contributions.Source: World Economic Forum (1994).

Labour market flexibility

The most striking difference in performance among OECD economies involvesemployment. Unemployment in the United States has declined to levels commonlyrecognised as ‘NAIRU’ (the non-accelerating inflation rate of unemployment, or fullemployment), while in France and Germany it is in double digits and near postwarhighs. Due to different statistical practices and a high tolerance for underemploymentin Japanese companies, the Japanese unemployment rate is still only 3.5 per cent, butthat too is well above the 2.1–2.5 per cent range of the 1980s.

Markets, competition and restructuring in the 1990s—55

Variations in labour market practices help to shed light on these outcomes (OECD1994b). In the United States and Japan, official policies tend to keep the cost ofemployment relatively low, and government imposes few restrictions on employmentterms, hires or separations. The United Kingdom recently joined this group bydrastically cutting back regulations; its unemployment rate has diminished towardsUS levels. In continental Europe, however, employment remains costly and subject toclose regulation. Related policies include high social insurance taxes, highreplacement incomes for unemployed workers, and rules that limit part-timeemployment, strengthen the role of labour unions, and restrict employment cuts. InJapan, labour market rigidities cannot be blamed on formal restrictions of this type,but flexibility is nevertheless very limited due to deeply-rooted traditions ofemployment maintenance.

These differences are evident in the data. First, unemployment insurance is muchmore attractive in Europe. Benefits in the first few months of unemployment replaceonly 60 per cent of wages in the United States compared to 77 per cent in Germanyand 88 per cent in France. The difference is even larger for long-term unemployed:19 per cent of wages in the United States compared to the 80 per cent range inEurope (OECD 1996). Second, minimum wages are higher and increasing in Europe.While the real minimum wage fell in the United States, it has increased in France —for example, from 40 per cent of average salaries in the early 1970s to more than 50per cent today. The time path is almost parallel to that of the unemployment rate,which increased from 3 per cent to 12 per cent (OECD 1994a, p. 67).

Restrictions on labour markets are also widespread in continental Europe, coveringwork time, vacations, and the contract used to hire employees (see Table 3.3).Regulations prohibit, for example, the French tyre manufacturer Michelin fromoperating its factories for more than five days each week, except for one new, fully-automated plant which received a special exemption. In the larger enterprises ofFrance and Germany, workers are also involved in corporate decisions through boardsand ‘works councils’ and play a legally mandated role in determining lay-offs (BusinessWeek, 8 May 1995, pp. 46–50).

Table 3.3 Labour market regulations

United UnitedFrance Germany Kingdom States

Working time 39 hrs/wk, 37 hrs/wk Not regulated, 46 hrs/wk, maximum 46 maximum 40 although low weeklyhrs/wk, annual hrs/wk averages exist maximum, noovertime strictly in public limits on annualrestricted service overtime

Fixed-term 18-month 18-month Not regulated Not regulatedprotection maximum; maximum;

restricted to restricted to newseasonal work, employees and

56—Markets, competition and restructuring in the 1990s

United UnitedFrance Germany Kingdom States

temporary formerreplacement or apprenticestemporary increasein workload

Employment Reqirement for Strict statutory Steady erosion Employees forprotection government notice periods in the firms with more

authorisation of for all workers; circumstances than 100collective dis- workers can for which employees mustmissals abolished appeal to federal unfair be given 60 daysin 1986, but ‘social labour court and dismissal is notice, butplans’ must be still must be determined authoritiesformulated subject continued in intervene onlyto non-binding employment in cases of‘suggestions’ from until decision is discriminationauthorities made

Minimum wage National statutory Collective Not regulated Nationalminimum wage agreements since the statutoryplus higher sectoral extended to non- wage councils minimum wageagreements which signatory were abolishedare extended by workers by in 1993government tonon- ministerial ordersignatory parties

Employee Works councils are Works councils Not regulated Not regulatedrepresentation required for firms are required for

with more than 50 firms with moreemployees and must than 5include union employees;delegates; workers workers must bemust be represented represented onon joint stock company boardscompany boards

Source: OECD (1994c).

The microeconomic links between interventions and labour mobility are justbeginning to emerge. An important role appears to be played by ‘turbulence’ inlabour markets — hiring and separation at the level of firms and individual workers.Turbulence affects the speed of adjustment and is usually quite high compared tocyclical fluctuations in unemployment. Turbulence contributes to flexibility in twoways: it creates a pool of people available for jobs and it provides a way for companiesto reduce employment through ‘natural’ processes. Several different measures ofturbulence are collected in Table 3.4.

Markets, competition and restructuring in the 1990s—57

Table 3.4 Indicators of labour mobility (per cent of total employment, per annum except asotherwise indicated)

United UnitedFrance Germany Japan Kingdom States

1984–92 1983–90 1988–92 1985–91 1984–91

Net employment change 0.6 1.5 2.1 2.6

Job turnover 27.1 16.5 15.3 23.4Gross job gains 13.9 9.0 8.7 13.0

Openings 7.2 2.5 2.7 8.4Expansions 6.7 6.5 8.6 6.0 4.6

Gross job losses 13.2 7.5 6.6 10.4Closings 7.0 1.9 3.9 7.3Contractions 6.3 5.6 5.3 2.7 3.1

Labour turnover 58.0 62.0 39.1 126.4Hirings 31.6 20.2 64.6Separations 30.4 18.9 61.8

Unemployment flows(Monthly averages for 1993–94)

% of employed 0.4 0.4 0.4 0.6 1.9into unemployment

% of unemployed 3.2 7.6 15.8 7.7 37.5into employment

Employee tenure <1 year 16.8 12.8 9.8 18.6 28.8(1991, % of all employees)

Notes: Labour turnover data are for France: 1990–91, for Germany: 1985–90 and for the United States:1979–83.

Source: OECD (1994c, 1996).

Job turnover measures the sum of job creation and destruction that result from thechanging employment levels of individual companies.5 There are no systematicdifferences in this measure across countries, suggesting that international differencesin turbulence are due to other sources. Labour turnover, however, does vary a greatdeal across economies. This index measures the sum of individual hires andseparations. It is 2–5 times as large as job turnover; individuals apparently oftenchange jobs without changes in their firm’s employment level. The US labour marketis roughly twice as turbulent by this measure as continental European markets.Consequently, roughly twice as many US workers have less than one year of jobtenure than European workers. Unemployment flows also differ internationally: many

58—Markets, competition and restructuring in the 1990s

more people enter unemployment in the United States than in other OECD countriesand they also tend to leave much more rapidly.

Thus, differences in the flexibility of labour markets cannot be explained by differentmacroeconomic conditions, which would presumably effect primarily company-levelemployment changes. Rather, workers are simply less likely to leave existing jobs inEurope or Japan than in the United States. And when they do change jobs, they areless likely to pass through formal markets for the unemployed. In other words, USlabour markets seem to involve frequent, arm’s-length transactions, while theirEuropean and Japanese counterparts involve less mobility and appear to be basedmore on relationships than formal markets.

Capital market flexibility

The environment of the 1990s required capital to shift rapidly across industries, andespecially across different types of firms. For example, there were major realignmentswithin the US computer sector: giants like Digital Equipment, Apple and even IBMshrank and reoriented their activities, while upstarts like Microsoft, Cisco Systemsand Dell dramatically expanded their share. Capital markets played a central role insuch shifts by exerting pressure on declining firms, providing a market forrecombining businesses through mergers, and offering finance and extraordinaryrewards to new ventures.

The case of General Dynamics (GD), a major defence contractor, illustrates themicroeconomics of these resource transfers.6 Facing major cutbacks in defencespending, GD brought in new management in 1991 to refocus its business strategy.The new CEO, William A. Anders, a former astronaut, decided to avoiddiversification into new lines of business (an approach often followed by decliningfirms) and instead chose to concentrate on the company’s strengths. He undertook anaggressive divestiture program but also continued to acquire businesses in core fields.By 1993 GD had reduced employment from 98,000 to 27,000 (about one-thirdthrough lay-offs and the rest through the sales of business units), achievedprofitability and increased its share values by US$4.5 billion, for a total return of 553per cent. A careful study of stockmarket reactions to the company’s decisionsattributes two-thirds of these gains to management strategy (Dial and Murphy 1995).About half of GD’s equity was returned to shareholders as dividends and buy-backs.These funds presumably found their way into sectors offering superior returns.

These adjustments took place with the help of capital markets that differ substantiallyfrom those in Europe and Japan (see Table 3.5). GD was relatively free to act becauseUS and UK debt–equity ratios are usually well below those in continental Europe andJapan, and debt consists more of bonds than bank borrowings. Ownership of equityis far more dispersed; of larger public companies, only 9 per cent have a singleshareholder with 50 per cent of more shares in the United States, and only 2 per centin the United Kingdom, compared to 55 per cent in France and 66 per cent in

Markets, competition and restructuring in the 1990s—59

Germany. Japan is an intermediate case; its companies are not dominated by a singleshareholder but often by a small group of owners, usually including the company’smain bank and other related companies. Due to such linkages, the financial activitiesof non-financial firms are much more important in Europe and Japan, as indicatedby the larger share of financial assets in total assets.

Table 3.5 Indicators of capital structure, non-finance companies

United UnitedFrance Germany Japan Kingdom States

Ownership concentration% of large public firms where:Largest owner owns > 50% 55 66 5 2 9Largest owner owns < 10% 9 2 25 84 52

Debt–equityShort and long-term liabilitiesover equity

1994 1.58 1.52 3.97 0.46 1.071986 2.01 1.63 4.22 0.44 0.68

Bank debt–debtBanks credits–total liabilities 0.25 0.39 0.10 0.09

Financial assetsAs share of total assets

1994 0.59 0.55 0.53 0.40 0.351986 0.55 0.48 0.58 0.38 0.29

Sources: Berglof (1990); OECD (1995).

In the transaction-oriented context of US and UK finance, a great variety ofspecialised institutions have emerged for handling operations such as those used byGD in its restructuring. Pressure from equity markets helps to identify sub-parperformers, forcing management change and restructuring. Mergers and acquisitionmarkets allow firms to reassemble assets in new combinations, and sophisticatedventure capital markets ensure that capital released from declining sectors is wellutilised in new areas. By contrast, in bank-dominated financial markets there is muchless opportunity for such specialised institutions to emerge. Given their commitmentto long-standing relationships, owners tend to work through problems withmanagement rather than force dramatic change. Companies are less likely to sellcomponent businesses, and new companies, with no established relationships, find itdifficult to obtain finance.

The features behind the flexibility of the US system — institutions for restructuring,mergers and acquisitions, and venture capital — are analysed in detail below. Indexesof the importance of related transactions are provided in Table 3.6.

60—Markets, competition and restructuring in the 1990s

Table 3.6 Specialised transactions in US capital markets (billions of dollars)

Leveraged Mergers Initial public Reference:buy-outs acquisitions offerings GPCF

1980 34.8 1.4 4771981 3.1 69.5 3.1 5321982 3.5 60.7 1.3 5191983 4.5 52.7 12.4 5521984 18.8 126.1 3.6 6481985 19.6 146.0 6.3 6901986 46.4 205.8 17.7 7091987 35.6 178.3 17.0 7231988 58.3 271.2 5.4 7771989 76.1 310.6 6.0 7991990 17.9 201.1 4.5 7931991 7.5 141.5 16.3 7371992 8.1 124.6 23.4 7881993 10.1 174.1 34.2 8821994 7.8 410.5 22.9 9551995 29.0 1,028

Sources: Business Week, 18 December 1995; Pritchard (1994); Mergers and Acquisitions, 1995.

Restructuring

Efficiency requires companies to return capital to shareholders (through dividendsand stock repurchases) when higher returns are available elsewhere, but managers ofcourse prefer to retain assets under their control. Financial markets help to addressthis ‘agency problem’. In the mid-1980s, leveraged buy-outs (LBOs) emerged as aruthless but effective mechanism for withdrawing capital from underperformingfirms by forcing them, in effect, to change managers and to buy back equity withdebt.7 Almost 10 per cent of US corporate assets changed hands in the LBO boom(Kaplan and Stein 1993), raising share prices and return expectations throughout theeconomy.

LBOs took many forms, but their predominant effect was to increase leverage andpressure on management, and consequently to refocus corporate activity on corebusinesses through asset sales (Seth and Easterwood 1993). Risky and widelycriticised, LBOs failed to last as an important tool in corporate restructuring but theyestablished a model for ‘unlocking’ share value. In the 1980s, the capitalisation of theUS bond market doubled relative to the US stockmarket. Even companies thatperformed poorly financially as a result of debt (a case that became increasinglyfrequent in the late 1980s) often improved their economic performance. Kaplan andStein (1993) report, for example, that Federated Department Stores, acquired in1988 in a notorious deal that led to the collapse of the company, wound up profitablein the long run — after bankruptcy helped to bring in effective management.

Markets, competition and restructuring in the 1990s—61

While market monitoring of corporate performance appears to have sharpened withthe LBO wave of the 1980s, it is nevertheless difficult to establish empirically thatLBOs improved corporate performance. Some studies do find positive effects (Palepu1990; Smith 1990), but others do not (see references in the discussion of mergersbelow). To be sure, there is an important methodological issue: if the role of LBOs isto shift capital from inefficient to distant efficient activities, they do not need toimprove the performance of ‘disciplined’ companies; all that is required for efficiencygains is that they shrink.

Mergers

Facilitating new combinations of productive assets is a second important function ofcapital markets. In light of recent technological breakthroughs, for example, manycompanies are now attempting to integrate technology, service and productionactivities in fields as diverse as medical imaging equipment and aircraft engine repairs(Smart 1996). Deregulation is also driving a wave of rationalisations in thecommunications and entertainment industries.

Merger markets in the United States and the United Kingdom provide more activesupport for such operations than their counterparts in continental Europe and Japan.Mergers amounted to 41 per cent of gross capital formation in the United Kingdomand 40 per cent in the United States, compared to less than 2 per cent in Germanyand 5 per cent in France (Geroski and Vlassopoulos 1990). US and UK mergermarkets were not constrained by the interlocking interests of relationship-basedfinance, and both countries relaxed their antitrust policies in the 1980s. LBOsdiminished towards the end of the 1980s, but an even larger merger boom is nowunderway in the United States, with transactions reaching half of gross capitalformation. The wave is driven by strategic responses to innovation and deregulation.In banking, for example, mergers are intended to exploit eased geographic andproduct regulations as well as technological breakthroughs in processing andcustomer service.

Active merger markets presumably contribute to productivity, but these benefits arealso difficult to measure. A classic study of mergers between 1950 and 1976 found nosubstantial improvement in the operating characteristics of merged companies(Ravenscraft and Sherer 1987), and recent studies of banking mergers also failed tofind unusual profits.8 Others such as Healy et al. (1992) are more positive. To be sure,the counterfactual is again difficult to establish; mergers may have prevented declinesin performance without generating excess returns. Today’s strategic mergers seem tomake sense and are taking place under more demanding and watchful capital marketsbut their benefits remain to be verified.

62—Markets, competition and restructuring in the 1990s

Venture capital

Getting money to new firms is the third critical function of a financial system.America’s distinctive venture capital industry excels in this area. One importantcomponent of the industry consists of venture capital firms, which finance and oftenhelp to manage young companies. The other is the public Initial Public Offering(IPO) market, which finances the ‘exit’ of venture capital firms. Even foreigncompanies often come to the United States to take advantage of this two-step system(Laidlaw 1991). The venture capital market is not large — US$3–4 billion, plusUS$10–20 billion invested by wealthy individuals according to Farrell (1995) — butit has a remarkable record of success. It works in tandem with deep US markets for‘small cap’ equities, which guarantee the quick and profitable sale of successful newventures. The venture capital firms, in turn, quickly recycle their expertise; their ruleof thumb is to sell investments within 5–7 years (Gompers 1995).

As Table 3.6 shows, US IPOs have grown spectacularly. They have been alsoremarkably profitable: Standard & Poor’s new-issue index increased 538 per centbetween 1990 and 1995. Some IPOs, such as Netscape, represent major nationalmedia events and make their entrepreneurs wealthy overnight. NASDAQ, the over-the-counter small-capitalisation stockmarket, serves as the focal point for companiesthat trade and monitor the securities of small issues. The information developed bythis network, in turn, helps to attract institutional funding for the new issue market.European capital markets are far behind; the UK’s ‘Alternative Investment Market’ isthe most established but is still small; France just started a ‘Nouveau Marche’, andcomparable German and Italian markets are still only in the planning stage (BusinessWeek, 26 February 1996, p. 41).

Managerial incentives

The transaction-based financial system of the United States, while effective atorchestrating large changes in corporate direction, provides little ongoing monitoringof performance compared to the relationship-based systems of continental Europeand Japan. This increases conflicts of interest between owners and managers andintroduces a general ‘agency cost’ burden on business. The LBOs of the 1980s offereda dramatic disciplining device, but they were too costly and too infrequent to providea satisfactory tool for management oversight. Since the 1980s attention has shiftedfrom external discipline to compensation strategies. Companies have increased therole of stock options and stock-price-based bonuses in executive compensation,seeking to align manager and owner interests.

The case of GD is again instructive. Early in the restructuring plan, CEO Anderspromised 25 top executives bonuses equal to 100 per cent of salary if the stock pricemoved from US$25 to US$35, and a further 200 per cent for each additional increaseof 10 points. Anders argued that the scheme would focus attention on share valuesand create a sense of ‘partnership’ among managers. GD shares reached the first two

Markets, competition and restructuring in the 1990s—63

bonus levels in two years. Bonus payments amounted to only 6 per cent of the sharevalue created (Dial and Murphy 1996) but nevertheless triggered a firestorm ofcriticism in the national press. The company was, in effect, rewarding managers withhuge bonuses for lay-offs. The incentive system was replaced with a more opaquescheme, although one still tied to share values.9

In the venture capital context, uncertainty about the viability of projects (even thosehand-picked by venture capitalists have a 15 per cent failure rate) produces evengreater possibilities for agency conflicts between managers and investors. In manycountries these problems limit financing to ‘angel capital’ from relatives. The venturecapital industry has addressed these problems with a range of solutions (Sahlman1994). Venture capital deals often include: phased disbursement of capital, based onperformance; intense monitoring by an experienced investor; and an unusualmanagement pay-off structure that gives the venture capitalist disproportionatecontrol over assets in case of failure. The potential gains on successful ventures arelarge enough to yield high returns to venture capital funds (as much as 30–50 percent per year) and to entrepreneurs. In 1995 the heads of two new companies becamebillionaires and entrepreneurial companies now routinely attract the best talent fromAmerica’s business schools (Farrell 1995). This system of incentives helps to explainwhy larger companies cannot keep up with new companies in areas of rapidtechnological change.10

In sum, the monitoring weakness of transaction-based markets has been addressedrecently with major changes in compensation arrangements that tend to align theinterests of managers and investors. These changes have attracted much socialcriticism, but they seem to have succeeded in reducing agency costs withoutimpairing the scale of adjustments. For better or worse, joint decision-makingsystems do not appear to be producing the ‘mirror image’ adaptations — that is,institutional mechanisms that would accelerate restructuring or innovation whilepreserving the advantages of continuous monitoring. Rather, such systems seem to beunder pressure to transform into transaction-based models.

SHAREHOLDERS AND STAKEHOLDERS

This chapter has highlighted the benefits of unilateral decision-making for economicadjustment in the 1990s. The distributional implications of flexibility have been lesspositive. Unilateral decision-making systems allow ‘lucky’ factors — those favouredby regulatory and technological trends — to move to fields with high returns, leaving‘unlucky’ stakeholders behind with inferior returns. At worst, unilateral decisionsallow managers to reward shareholders by breaking implicit contracts (Shleifer andSummers 1988). Injured stakeholders may include employees, owners of fixed-income securities, public tax collection, and suppliers and customers who are forcedto renegotiate implicit or explicit contracts. Income differentials are correlated withobserved flexibility; US returns to capital are historically high in the 1990s, and wage

64—Markets, competition and restructuring in the 1990s

differentials — the ratio of the average wage of the ninth decile of workers to the wageof the first decile — have increased by about one-third in the United States and by20 per cent in the United Kingdom since the 1980s, while remaining constant orfalling slightly in the less flexible economies of France, Germany and Japan (OECD1996).

Whether or not the interests of stakeholders should be taken into account incorporate decisions has been debated on grounds of both efficiency and equity. Theefficiency argument for the unilateral model is stated in plain language by GD’s CEOAnders:

I do not see that we have a special obligation to our employees. This is an issue ofexcess human capacity that had to leave the defense industry. We trained our peopleto have specific skills and paid for that training. Then we paid for their skills. Whatare we to do when those skills are no longer needed? … The loss of jobs at GD isactually better for America if we redeploy those assets appropriately. We have donemore than any other defense contractor in creating new jobs by putting $3.4 billionback into investments — by letting shareholders redeploy those resources in newindustries for new products (as quoted by Dial and Murphy 1995, p. 303).

In other words, the interests of society are best served when the sole responsibility ofmanagers is to represent shareholders. To accomplish this, it may even be necessary attimes to hire specialist ‘corporate killers’— executives from the outside who have norelation to stakeholders and are experienced in managing restructuring through lay-offs and asset sales.

An efficiency argument for the joint decision-making model has been based onincomplete contract theory. Suppose that efficient production requires workers tomake firm-specific investments, and workers make this investment only if they arepromised higher wages over their career with a company. Although such wagestructures are widely observed, they are not written into explicit contracts, because itis too difficult to define the future circumstances in which the agreement could bebroken. An alternative to such a contract is for companies to develop reputations asloyal employers, as appears to be the practice in Japan. But the proponents ofstakeholder rights argue that reputations cannot be credibly maintained given freemarkets for corporate control. Therefore, they seek legislation to guaranteestakeholders a role in corporate decision-making.

The deeper problem, as we have seen, is that incomplete contracts force second-bestsolutions, which will not be appropriate in all (unforeseen) circumstances. The choicebetween systems is complicated by their longevity. It is difficult to change systems,and yet the choice affects an economy’s performance under distant, unpredictableshocks.

The social consequences of flexibility have also generated a debate on equity. Even inthe United States, the adjustments of the 1990s clearly challenged the limits of the

Markets, competition and restructuring in the 1990s—65

political acceptability of unilateral decision-making. Much criticism of the corporatelay-offs of the early 1990s focused on the argument that companies, in effect, brokeimplicit contracts for long-term employment. In the airline and other industries,wage and employment cuts (in some cases by explicitly breaking contracts throughthe mechanism of bankruptcy) were important in the performance gains achieved bymanagement. Frequently, the lay-offs of the early 1990s targeted middle management— articulate people who had not faced similar challenges in the past. At one point,The New York Times predicted a popular reaction:

Corporations and financiers must recognize that they cannot forever placate theanxiety of white-collar Americans by saying they are casualties of a righteous effortto squeeze out the last penny of profit for shareholders. American historydemonstrates few patterns more clearly than that in which flamboyant corporatecallousness leads to government regulation (The New York Times, Editorial, 10March 1996).

Nevertheless, the rapid growth of employment subsequent to the lay-offs of the early1990s has muted these criticisms, and the elections of 1996 demonstrated that thepublic’s assessment of economic restructuring was overwhelmingly positive.

CONCLUSIONS

The transformations of the 1990s, driven by new technologies and types of economicchange, required more radical shifts in resources than other recent episodes ofeconomic change. America’s unilateral decision-making system appears to have fit therequirements of this period more than competitive systems based on the pluralisticgovernance principles of Japan and continental Europe. Labour and capital marketsresponded most flexibly in the United States, with Japan and the United Kingdomfalling somewhere in between the United States and continental Europe. As a result,significant differentials have emerged among these countries in returns to capital aswell as employment.

The features of the US system that facilitated adjustment included an open labourmarket, unconstrained by regulations on wages and mobility, a large anddecentralised open capital market which developed new techniques for financingrestructuring, business combinations, and entrepreneurial innovation, and effectivenew modes of management compensation. But the flexibility of this system comes ata cost in equity and efficiency: factors of production are less willing to makerelationship-specific investments in a highly mobile economy. This makes it moredifficult for companies to undertake tasks that require close coordination ofstrategies, either within firms or between them. US manufacturing fell behindJapanese manufacturing for this reason in the 1970s and 1980s.

The contrast of these major global competitive systems, then, is ultimately abouttrade-offs: between flexibility and relationship-specific investments, between growth

66—Markets, competition and restructuring in the 1990s

and equity. The question is, have these trade-offs changed permanently in the 1990s?Has the pattern of volatile, disjointed changes in technology, and global competition,become a permanent feature of the world economy? If so, the case for apredominantly unilateral model is not just limited to the circumstances of recentyears but represents a general recipe for economic success. Countries like Japan orFrance will have to go beyond ‘just’ eliminating excessive regulations11 and undertaketo transform their basic economic institutions. The interdependent character of theseinstitutions, as we have seen, suggests that the transition will be difficult.

But one cannot conclude yet that economic trends will permanently favour unilateraldecision-making. For one thing, the negative social consequences of the unilateralsystem have yet to be addressed successfully. For another, the contrast between the1980s and the 1990s demonstrates that it is easier to see in retrospect whatinstitutions fit their time than it is to pick the winning institutions of the future. Itwould be surprising indeed if the performance rankings of different competitivesystems remained long in the patterns we observe today.

NOTES

1 Developments in this region are outlined in Alexander and Petri (1996).2 The software industry provides an extreme example: aside from the ubiquitous Microsoft,

the lives of firms were often coterminous with the lifecycle of the (single) product theyinvented.

3 Recent US statistics have shown large productivity gains, but the Bureau of EconomicAnalysis has recently adopted a new indicator — a chain-weighted index of constant-price output — that reduces the magnitude of gains. The previous fixed-weighted indexexaggerated the impact of productivity change in the computer industry by valuing the‘real’ contribution of large increases in processing power with the prices of processingpower at the beginning of the measurement period — 1987. The statistics produced bythe new index still show improvement, but on a more modest scale (Oliner and Wascher1995).

4 Table 3.2 here seeks to reflect the unilateral–joint dichotomy, rather than the WorldCompetitiveness Report’s, ranking of competitiveness. In general, the report regardsindicators of unilateral decision-making as correlated with competitiveness. However, fortwo variables (marked with asterisks) the ranking was reversed from the publishedranking, because in those cases the report associated joint decision-making withcompetitiveness.

5 To find job turnover, one first calculates firm-level changes in the number of employeesbetween the beginning and end of a measurement period. Absolute values of thesechanges are then added. Thus, job turnover is the sum of the net employment changes ofcontracting or closing firms plus the sum of net employment changes of expanding andopening firms. Job turnover is often reported in terms of four components: jobs added bynew and expanding firms, and jobs destroyed by contracting and closing firms.

6 The discussion of the General Dynamics case is based on a fascinating paper by Dial andMurphy (1995) that offers an exhaustive history and rigorous analysis of the company’sperformance over 1991–93.

7 Even companies that were not taken over felt the effects. For example, Phillips Petroleumprevented a takeover in 1985, but raised dividends, bought back shares, and sold US$2billion in assets (Pritchard 1994).

Markets, competition and restructuring in the 1990s—67

8 A ‘megastudy’ of 39 research studies on bank mergers undertaken in the 1980s concludesthat mergers do not seem to have lowered costs, improved operating performance or evenraised market valuation, once effects are summed over acquiring and target companies(Rhoades 1994).

9 One of those responsible for the firestorm, a Prudential Bache analyst who recommendedselling GD shares through much of the company’s recovery, was eventually fired for hisinaccurate reading of GD’s strategy.

10 Some large companies are experimenting with internal venture-capital models. ThermoElectron, a diversified high technology company, has restructured itself as a venture-capital incubator and offers managers shares in new units. Once sufficiently mature, unitsare ‘spun off ’ for public sale, with Thermo Electron retaining substantial ownership.

11 The case for joint decision-making is not inconsistent with deregulation now underwayin Europe and Japan. Much of the inflexibility of these economies, one presumes, hasnothing to do with the institutions that facilitate joint decision-making.

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Alexander, Barbara and Peter A. Petri (1996) ‘The regulatory transition in East Asia’, Reportfor the Economic Development Institute of the World Bank.

Aoki, Masahiko (1984) The Economic Analysis of the Japanese Firm, Amsterdam: North-Holland.

Aoki, Masahiko, Bo Gustaffson and Oliver E. Williamson (eds) (1990) The Firm as a Nexusof Treaties, London: Sage Publications.

Berglof, Erik (1990) ‘Finance and the political structure of the firm?’, in Masahiko Aoki, BoGustaffson and Oliver E. Williamson (eds) The Firm as a Nexus of Treaties, London: SagePublications, pp. 237–62.

Blair, Margaret M. (1995) Ownership and Control: Rethinking Corporate Governance for theTwenty-First Century, Washington DC: Brookings Institution.

Dial, Jay and Kevin J. Murphy (1995) ‘Incentives, downsizing and value creation at generaldynamics’, Journal of Financial Economics (March), pp. 261–314.

Farrell, Christopher (1995) ‘The boom in IPOs’, Business Week, 18 December, pp. 46–52.Fukuyama, Francis (1995) Trust: The Social Virtues and the Creation of Prosperity, New York:

The Free Press.Geroski, P. and A. Vlassopoulos ((1990) ‘European merger activity: a response to 1992’, in

Centre for Business Strategy (ed.) Continental Mergers are Different, London: LondonBusiness School, pp. 22–46.

Gompers, Paul A. (1995) ‘Optimal investment, monitoring, and the staging of venturecapital’, Journal of Finance 50(5) (December), pp. 1461–90.

Hart, Oliver and Bengt Holmstrom (1987) ‘The theory of contracts’, in Truman E. Bewley(ed.) Advances in Economic Theory: Fifth World Congress, New York: Cambridge UniversityPress.

Healy, Paul M., Krishna G. Palepu and Richard S. Ruback (1992) ‘Does corporateperformance improve after merger?’, Journal of Financial Economics 31, pp. 135–75.

Hirschman, Albert O. (1970) Exit, Voice and Loyalty, Cambridge, MA: Harvard UniversityPress.

Holmstrom, Bengt and Jean Tirole (1989) ‘The theory of the firm’, in R. Schmalensee andR. Willig (eds) Handbook of Industrial Organisation, Amsterdam: North-Holland.

International Finance Corporation (IFC) (1996a) Emerging Markets Handbook, WashingtonDC: IFC.—— (IFC) (1996b) Emerging Stock Markets Factbook, Washington DC: IFC.

International Monetary Fund (IMF) (1996) Economic Outlook, Washington DC: IMF.Jensen, Michael and William H. Meckling (1976) ‘Theory of the firm: managerial behavior,

agency costs and ownership structure’, Journal of Financial Economics 3, pp. 305–60.

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Kaplan, Steven N. and Jeremy C. Stein (1993) ‘The evolution of buyout pricing andfinancial structure in the 1980s’, Quarterly Journal of Economics 23, pp. 313–57.

Laidlaw, Ken (1991) ‘Entrepreneurial firms looking to the bigger, bolder US for finance’, TheFinancial Post, 30 November, p. U6.

Mayer, Colin (1996) ‘Corporate governance, competition and performance’, EconomicsDepartment Working Papers No. 164, Paris OECD.

Mergers and Aquisitions (1995) ‘LBO Signposts’, Mergers and Aquisitions,November/December, p.47.

OECD (1994a) Etudes Economiques de L’OCDE 1994–95: France, Paris: OECD.—— (1994b) The OECD Jobs Study: Evidence and Explanations (July), Paris: OECD.—— (1994c) Employment Outlook (July), Paris: OECD.—— (1995) Financial Statistics, Paris: OECD.—— (1996) Employment Outlook, July, OECD: Paris.

Oliner, Stephen D. and William L. Wascher (1995) ‘Is a productivity revolution underway inthe United States?’, Challenge (November–December), pp. 18–30.

Oman, Charles (1994) Globalisation and Regionalisation: The Challenge for DevelopingCountries, Paris: OECD.

Palepu, Krishna G. (1990) ‘Consequences of leveraged buyouts’, Journal of FinancialEconomics 27, pp. 247–62.

Pritchard, Bill (1994) ‘Finance capital as an engine of restructuring: the 1980s merger wave’,Journal of Australian Political Economy 33, pp. 1–20.

Ravenscraft, D. J. and F. M. Sherer (1987) Mergers, Sell-Offs, and Economic Efficiency,Washington DC: The Brookings Institution.

Reve, Torger (1990) ‘The firm as a nexus of internal and external contracts’, in MasahikoAoki, Bo Gustaffson and Oliver E. Williamson (eds) The Firm as a Nexus of Treaties,London: Sage Publications, pp. 133–61.

Rhoades, Stephen A. (1994) ‘A summary of merger performance studies in banking,1980–93, and an assessment of the “operating performance” and “event study”methodologies’, Staff Study No. 167, Board of Governors of the Federal Reserve System,Washington DC.

Sahlman, William A. (1994) ‘Insights from the venture capital model of project governance’,Business Economics 29(3) (July), pp. 35–8.

Seth, Anjou and John Easterwood (1993) ‘Strategic redirection in large managementbuyouts: the evidence from post-buyout restructuring activity’, Strategic ManagementJournal 14, pp. 251–73.

Shleifer, Andrei and Larry H. Summers (1988) ‘Breach of trust in hostile takeovers’, in A. J.Auerbach (ed.) Corporate Takeovers: Causes and Consequences, Chicago: University ofChicago Press.

Smart, Tim (1996) ‘Jack Welch’s encore’, Business Week, 28 October, pp. 42–50.Smith, Abbie (1990) ‘Corporate ownership structure and performance: the case of

management buyouts’, Journal of Financial Economics 27, pp. 143–64.Williamson, Oliver E. (1985) The Economic Institutions of Capitalism, New York: The Free

Press.World Economic Forum (1994) World Competitiveness Report, Geneva: World Economic

Forum.Zysman, John (1983) Governments, Markets and Growth, Ithaca: Cornell University Press.—— (1996) ‘Beyond the myth of the ‘global’ economy: enduring national foundations and

emerging regional realities’, Berkeley: BRIE.

Markets, competition and restructuring in the 1990s—69

4 State intervention, ownership and state enterprise reform in China

Justin Yifu Lin

Since the commencement of economic reforms in 1979, China has moved away fromtraditional central planning and has become the fastest growing economy in theworld. GDP averaged 9.8 per cent annually in the period 1979–95. Along with rapideconomic growth, the living conditions of ordinary people have improvedsubstantially. The average growth rate of real per capita consumption rose from 2.2per cent in 1952–78 to 7.4 per cent in 1978–94. Despite such achievements,however, the Chinese economy in the reform period has been troubled by therecurrence of a ‘boom-and-bust’ cycle that has threatened the stability andsustainability of China’s economic growth (see Figure 4.1).

Figure 4.1 Domestic gross product (GDP) growth rates and inflation rates, 1979–95

1979 1981 1983 1985 1987 1989 1991 1993 19950

5

10

15

20

25

0

100

200

300

400

500

GDP growth rate GDP inflation rate GDP index

State intervention, ownership and state enterprise reform in China—71

China’s traditional economic system comprised a set of three internally consistentinstitutional arrangements: a price-distorted macro-policy environment, with its lowinterest rates, overvalued exchange rates, and low prices for raw materials and livingnecessities; a planned resource allocation mechanism; and an autonomy-deprivedmicro-management institution comprising the state-owned enterprise (SOE) systemand the collective farming system. The above institutional arrangements weredesigned to facilitate the pursuit of a heavy-industry-oriented development strategyin a capital-scarce economy (Lin et al. 1996a and 1996b). Under the traditionalsystem, economic efficiency was poor due to misallocation of resources and thesuppression of incentives. China’s reforms commenced with the micro-managementinstitution, the decollectivisation of the farming system and the delegation of someautonomy to SOEs followed by gradual relaxation of the planned resource allocationmechanism and liberalised prices, exchange rates and so on. During the period oftransition, reform of the macro-policy environment lagged behind that of the micro-management institution and the resource allocation mechanism.

Below market-clearing interest rates have stimulated enterprises to obtain more creditfor investment than money supply permitted. Before the commencement of reform,excess demand for credit to finance investments was suppressed by directmanagement of investment and restrictive credit rationing, with money supply andinflation being under the state’s control. Since 1979, whenever the centralgovernment’s direct control of investment and credit rationing has been relaxed, therehas been an investment rush and an expansion in credit. Because the expansion incredit during investment rushes has not been supported by an increase in savings, thebank has had to finance the credit expansion by creating additional high-powermoney. On the other hand, the investment rush has led to investment-led growth anda bottleneck in transportation, energy and the supply of construction materials.Therefore, the high growth rate fuelled by credit expansion and the money supply hasinevitably resulted in a high inflation rate. The government is reluctant to increaseinterest rates as a way of checking the thrust of investment and high inflation becausethe implicit subsidies from its low interest rate policy are necessary to the survival ofmany large and medium-sized SOEs. The government has therefore had to resort totraditional means of centralised rationing of credits and direct control of investmentprojects. The pressure of inflation has been reduced but slower growth has followed.To stimulate growth, the government has relaxed investment and credit control,leading to another round in the ‘boom-and-bust’ cycle. The cyclic pattern of growthand inflation described above has occurred three times since 1984 (see Figure 4.1).

After experiencing several such cycles, more and more economists and policy-makersin China have realised that the only way out is to deepen reform of the macro-policyenvironment — that is, to liberalise the remaining distortions in the macro-policyenvironment, especially the suppression of interest rates. Scarcity of capital will surelylead to a jump in interest rates when financial suppression is removed.1 Given the lowmanagement efficiency, most SOEs are unable to meet the market-level interest rates

72—State intervention, ownership and state enterprise reform in China

and will not be able to survive if interest rate control is liberalised.2 Although thegovernment understood the importance of financial reform to the stability ofeconomic growth and made marketisation of interest rates and commercialisation ofthe banking system major goals of a mini-package of reforms in 1994, reform waspostponed because of concern about survival of the SOEs (Lin 1995). Unless theefficiency of the SOEs can be improved, it will be impossible to complete reform ofthe financial sector.

Most researchers in China in the early 1980s attributed the SOEs’ problems to a lackof both autonomy and incentives. Reform measures therefore focused on increasingthese. Many economists have suggested that vagueness in the delineation of propertyrights is the major cause of the SOEs’ problems and that the SOE reforms wereadapted to take this factor into account.

In this chapter, I argue that the SOEs’ problems of incentive incompatibility,information asymmetry and liability disproportionality between the owner — that is,the state and the managers — originate from the separation of ownership and control.Managerial discretion may become a serious problem, the solution to which is tomake the incentives between the owner and manager compatible. This in turndepends on the existence of a simple, low-cost indicator of managerial performanceto alleviate information asymmetry problems and an effective corporate governancestructure to mitigate possible opportunistic behaviour arising from the limitedliability of managers. An enterprise’s profit level in a fair, competitive productprovides an adequate indicator of managerial performance. Fair market competitionis therefore a precondition for an effective enterprise system. Effective corporategovernance is specific to an enterprise, and depends on market competition, the legalenvironment, enterprise size, the source of capital, the ability of the owner, level oftechnology, and so on. Chinese SOEs shoulder many policy-determined burdens,which means that the their profit levels do not provide a sufficient indicator ofmanagerial performance. The key to reform of China’s SOEs, therefore, is toeliminate these burdens and thereby enable them to compete fairly with otherenterprises in the market.

This chapter is organised as follows. The next section reviews the achievements andproblems of China’s SOEs during the course of reform; the third section discusses theunderlying reasons for the problems that have arisen for the SOEs during the reformprocess; the conditions for successful reform of the SOEs are presented in the fourthsection; the fifth section lists the policy-determined burdens being shouldered by theSOEs; the sixth section suggests a ‘Pareto-improvement’ approach to rid the SOEs ofthose burdens; and the final section offers some concluding remarks.

State intervention, ownership and state enterprise reform in China—73

CONFLICT BETWEEN PRODUCTIVITY IMPROVEMENT ANDDECLINING PROFIT RATES

In the pre-reform era, the SOEs played a central role in China’s economy, especiallyin the industrial sector. In 1978 the output value of China’s state-owned industrialenterprises accounted for 80.8 per cent of the total industrial output value in China,while the number of state-owned industrial enterprises accounted for 24 per cent. Atthat time, SOE managers had no autonomy in deciding what to produce, where toinvest, whom to hire, and how much to pay workers. As a result, SOE managementwas unable to improve production and to motivate workers and hence efficiency wasvery low. Symptoms of the SOEs’ problems included the ‘Iron Rice Bowl’ (securedjobs) and the ‘Large Canteen Meal’ (egalitarian wage rates). After the death ofChairman Mao and the return to power of pragmatic veteran leaders like DengXiaoping, the Chinese government initiated a series of reforms in late 1978 aimed atimproving the efficiency of the economic system. Since then, reform of the SOEs hasformed the central plank of China’s overall reform package.

In the process of reform, the SOEs were given more power to make decisions abouttheir own production, sales and investments and were allowed to retain a portion oftheir profits, which they were then able to use for worker welfare programmes andbonuses, for example, and for other development-related purposes, such as upgradingof equipment or investments in new facilities.

Along with managerial decentralisation, new institutional arrangements wereintroduced to regulate the SOEs’ managerial behaviour. A profit-retention systemwhereby managers took full responsibility for profits and losses was tested in someSOEs in 1981. Under this system, a profit quota was set for the profit-making SOEs.Any profit that exceeded the quota was retained by the enterprises in total or inpredetermined portions. If the quota was not reached, the enterprises were requiredto make up the difference from their own funds. Similarly, a loss quota was set forthose SOEs running losses. The losses exceeding the quota were no longer covered bythe state budgets and the reduced losses were retained in full or in part by the SOEs.In addition to the profit-retention system, the state began a new experiment in 1981in which the old practice of submitting all profits made by the SOEs to the state waschanged to one where the SOEs were obliged to pay the state taxes and charges forfixed and working capital. In 1983 the charges paid by both large and medium-sizedSOEs were combined into an income tax. In 1985 the SOEs’ capital investment setupwas changed from one of interest-free state appropriations to bank loans accompaniedby interest charges.

The reforms allowed the SOEs to sell their output on the market at market pricesafter fulfilling their plan obligations and to use the retained profits for investment, inaddition to welfare programmes and bonuses, as mentioned above. This gave theSOEs greater incentive to achieve enhanced profits, technical progress and productinnovation, and their production decisions became more sensitive to market

74—State intervention, ownership and state enterprise reform in China

conditions. Driven by market signals and profit motivation the SOEs invested part oftheir retained profits in industries that had been suppressed by traditionaldevelopment strategy, resulting in improved resource allocation. The improvementsin incentives and resource allocation resulted in a new stream of resources, which,together with the output increase from farming system reform, formed the materialbasis for China’s gradual, incremental reforms (Lin et al. 1996a and 1996b).

As the enterprises were allowed to sell part of their output in the market at marketprices, the enterprise reforms also resulted in the formation of a ‘dual-track’ systemfor resource allocation and prices. Under this system, the market began to play a rolein resource allocation alongside the plan allocation mechanism. The focus of reformthus moved from the micro-management institution to the resource allocationmechanism and price systems. In 1987 the dual-track system was applied to 40 percent of all production materials, accounting for 75 per cent of total transactions inthese materials. To increase the SOEs’ autonomy further, the categories of industrialproducts directly controlled by the State Planning Commission were reduced frommore than 120 in 1979 to about 60 in 1992. In the same period the categories ofmaterials distributed exclusively by the state dropped from 126 to 26, while thecategories of commodities purchased by the Ministry of Commerce fell from 188 to23. The proportion of all commodities produced under planning control anddistributed with plan prices fell below 30 per cent by 1992. In addition, the factormarkets underwent development and the sources of SOE financing becamediversified. On the foreign exchange market, the dual-track system was replaced by aunified, managed floating system in 1994.

The emergence of the market track provided an opportunity for the rise of township-and-village enterprises (TVEs), joint ventures and other non-SOEs, whosedevelopment before the reform process was suppressed because of the lack of accessto inputs and output markets. Without state subsidies and protection, the survival ofthe non-SOEs depends on their ability to compete in the market, and hence they areadaptable in the market and have flexible management. Their entry into the marketbrought pressure to bear on the SOEs. With the enlargement of the non-state sectorand the shrinkage of the state sector in terms of output share (see Table 4.1), theSOEs became subject to mounting competition.

Table 4.1 Structural change in industrial output, 1978–93 (billion yuan RMB; percentage)

Total State enterprises’ Collective enterprises’ Other enterprises’output value output value (%) output value (%) output value (%)

1978 423.700 328.918 77.6 94.782 22.4 0.000 0.01985 971.747 630.212 64.9 311.719 32.1 29.716 3.01990 2,392.436 1,306.375 54.6 852.237 35.6 233.786 9.81993 5,269.199 2,272.467 43.1 2,021.321 38.4 975.411 18.5

Note: Industrial output value includes the TVEs on and below the village level. Source: State Statistical Bureau (1992, p. 406; 1994, p. 375).

State intervention, ownership and state enterprise reform in China—75

Under the traditional economic system, the SOEs’ micro-management institutionhad two main drawbacks — lack of autonomy and lack of incentives. Thesedrawbacks were mitigated after 17 years of reform. Government intervention inmicro-management was gradually reduced and the SOEs gained more autonomy. Theincrease in managerial autonomy led to greater incentives for SOEs. As expected, thereform resulted in improved productivity among SOEs. According to World Bank(1992) estimates, the average annual growth rate of total factor productivity in thestate sector was 2.4 per cent between 1980 and 1988 (and rising) (see Table 4.2).

Table 4.2 Sectoral comparison of growth rates of output value and total factor productivity,1980–88 (percentage)

1980–88 1980–84 1984–88

State sectorTotal output value 8.94 6.77 10.22Total factor productivity 2.40 1.80 3.01

Collective sectorTotal output value 16.94 14.03 19.96Total factor productivity 4.63 3.45 5.86

Source: World Bank (1992).

From a social perspective, the increase in total factor productivity among the SOEspoints to the success of the reforms. The government, however, is dissatisfied with theSOEs’ level of profits and their contribution to state revenue, on two counts.

First, the number of SOEs running at a loss has been rising, as have the lossesthemselves. In 1993 total losses from state-owned industrial enterprises amounted toRMB45.3 billion, which was about 14 times higher than in 1985. The loss–revenueratio was 0.78 per cent in 1986, 0.74 per cent in 1987, 0.79 per cent in 1988, 1.46per cent in 1989 and 1990, 2.45 per cent in 1991, and 2.08 per cent in 1992. In1992 the ratios for the collective-owned industrial enterprises and for otherownership-type enterprises were only 0.39 per cent and 1.44 per cent, respectively.Due to the range and amount of losses sustained in the state sector, governmentsubsidies to the SOEs also swelled, jumping 37 per cent between 1986 and 1992.

Second, the SOEs’ contribution to government revenue has been declining. The ratioof profit plus tax over sales revenue for the SOEs dropped from 25.57 per cent in1980 to 11.65 per cent in 1992, while the ratio of profit plus tax over total outputvalue dropped from 24.23 per cent to 11.38 per cent.

The reform measures that were implemented increased the SOEs’ managerialautonomy and allowed them to retain profits and increased their incentives andproductivity. However, the state, as the owner of the SOEs, did not benefit from thesereforms. It is imperative, therefore, that reforms be formulated that make it possible

76—State intervention, ownership and state enterprise reform in China

to protect the state’s rights while increasing the incentives of the SOE managers. Inorder to do so, it is vital to understand why there is a disparity between increasedproductivity and declining profitability among the SOEs.

INSTITUTIONAL INCOMPATIBILITY AND SOE REFORM

State ownership of enterprises has been an indispensable part of China’s traditionaleconomic system. Both state ownership and China’s traditional economic system areproducts of its heavy-industry-oriented development strategy. To develop capital-intensive heavy industry in a capital-scarce, under-developed economy, interest rates,foreign exchange rates, wage rates and prices of energy, raw materials and livingnecessities were artificially suppressed so as to mobilise resources and lower the costsof capital formation in heavy industries. The above distortions formed China’s macro-policy environment and led to overall economic shortages. Planning andadministrative measures became indispensable in guaranteeing the allocation of scarceresources to the priority sectors. The institution of state ownership was adopted toensure that the enterprises would follow the state’s plans and that the surpluses theSOEs created in the distorted macro-policy environment would be used according tothe state’s strategic goals. The government was then able to assign compulsory tasksto the SOEs and exercise direct control of the enterprises’ revenues and surpluses.3

The SOEs are owned by the state and run by the managers and workers, and thisseparation of ownership and control leads to three common problems. The first isincompatibility between incentives, with the owners and managers having differentgoals. The owner will want to get the largest possible return from his/her investment,while the manager will want to maximise his/her personal income and welfare. Themanager will thereby seek to engage in opportunistic behaviour that benefits him/herat the expense of the owner. The second problem is that of information asymmetry.The owner is not involved in the production process and does not have directinformation about material requirements, actual expenditures, revenues, and so on.This information asymmetry may result in opportunistic behaviour. In the case ofSOEs, managers may require more inventory, use more inputs, and reduce the profitssubmitted to the state by overstating costs and/or under-reporting revenues. The thirdproblem is one of disproportional liability. The punishment that the owner canimpose on a manager of a failed enterprise is disproportional to the value of theenterprise. Therefore, the manager may develop over-risky projects. If a projectsucceeds, the manager may reap very high rewards, but if it fails, the enterprise maybecome bankrupt. If so, the manager’s loss will be disproportional to the owner’s loss.

The conflict of interest between owners and managers has existed ever since theappearance of the modern corporation, especially joint stock companies, in whichownership and control were separated (Berle and Means 1932). In any economy, thesuccess of an enterprise depends on its ability to cope with information asymmetry,disproportional liability and incompatibility between incentives. In a mature market

State intervention, ownership and state enterprise reform in China—77

economy, there are a number of institutions that lower the costs both for monitoringa manager’s behaviour and for punishing/rewarding a bad/good manager, so that amanager will have an incentive to act in the interests of his/her owner. It is crucialthat there be a fair, level playing field for competition in product and factor markets,and that there are no entry barriers — that is, that enterprises are free to enter andexit. Such conditions will give rise to the notion of industrial average profits, with theprofit level of an enterprise depending solely on its competitiveness. By comparingthe actual profits of an enterprise with average industrial profits, one can easily inferhow efficiently an enterprise is being managed. Evaluation of a manager’s competenceand behaviour becomes simple with this information.

Second, there is a competitive market for managers. A manager’s promotion andcompensation depend on how he/she operates the enterprise, and, indirectly, howhe/she serves his/her owner’s interests. A profitable enterprise means the owner of theenterprises gains, with remuneration of the enterprise’s manager increasing throughmanagerial market competition. On the contrary, an unprofitable enterprise meansthat the owner loses and the manager will be demoted or fired. The manager’s loss ofhis/her job signals his/her poor ability or lack of personal integrity. In a competitivemanagerial market, he/she may be unable to find a good job again. The coexistenceof competition in the product market and the managerial market makes managers’incentives more compatible with those of owners.4

Furthermore, to prevent opportunistic behaviour by managers due to disproportionalliability, the enterprise also needs to adopt an effective internal governance structurethat evaluates the manager’s initiatives and monitors their implementation. Effectivecorporate governance is specific to each different enterprise, depending on its size, itssource of capital, the ability of its owner, its technology, the legal environment thatexists, and so on. The so-called ‘modern corporate institution’ does not refer to anyspecific form of corporate governance structure, such as the joint stock system or theholdings system. In fact, in the developed market economies, there is more than onetype of modern corporation system. Many different types of corporate governancestructures come into being through a long process of institutional and organisationalinnovation. The evaluation of a manager’s initiatives and monitoring of his/herimplementation of these depend directly and indirectly on the information obtainedfrom competitive markets. Therefore, the institutional foundation for an effectiveenterprise system is the competitive market.5

Clearly, in a mature market economy, the assessment of a manager’s performance, andreward and punishment, all result from market competition. This is the essentialcondition for the success of modern corporate institutions in a mature marketeconomy. Without the aforementioned competitive market institutions in a plannedeconomy, the lack of managerial autonomy among SOEs provides them with anefficient institutional arrangement from the viewpoint of protecting the state’sproperty and securing the state’s objectives. Hence, the SOEs’ governance structure inthe pre-reform period constituted an endogenous institutional arrangement, the

78—State intervention, ownership and state enterprise reform in China

specific arrangements being conditioned by distortions in the macro-policyenvironment and the planned, administratively-controlled, resource allocationmechanism. After reform, the SOEs obtained a substantial degree of autonomy.However, markets were still underdeveloped, and conditions for competition wereimperfect and unfair. The SOEs still continue to incur many policy-induced losses (asdiscussed later). Under such conditions, an SOE’s profit level cannot be used tomeasure managerial performance in the enterprise. Because of the lack of a simple,sufficient indicator of managerial efficiency and behaviour, managerial discretion thusbecomes an unavoidable problem. It becomes rational for SOEs managers to improvethe SOE’s productivity and, at the same time, to embezzle state property and profits.This may explain the paradoxical coexistence of productivity increases andprofitability declines during the process of managerial decentralisation.

CONDITIONS FOR SUCCESSFUL SOE REFORM

A popular view in China is that the key to successful SOE reform is to change theSOEs’ property-right arrangements or their ownership structure, with privatisationbeing the most frequently suggested means. However, the potential of this isquestionable.

Private ownership is neither a sufficient nor a necessary condition for an efficiententerprise. There are plenty of cases of inefficient private enterprises. Moreover, aneconomy with private ownership as its micro-foundation will often fail too. Forinstance, private ownership is prevalent in India and in Latin American countries.However, in those countries economic efficiency is quite low, rent-seeking iscommon, and economic development has not been successful. Therefore, privateownership is not a sufficient condition for a successful enterprise institution and forrapid economic development. On the contrary, cases of successful, non-privateenterprises are not difficult to find, such as the state-owned Singapore Airlines,Korea’s state-owned Pohang Iron and Steel Company, US plywood industrycooperatives, and so on. Needless to say, in rural China, a large number ofcollectively-owned TVEs outperform not only the SOEs but also private enterprises.In fact, the TVEs have been the most important force behind China’s dynamicgrowth since the implementation of reform. Therefore, private ownership is neither anecessary condition nor a sufficient condition for enterprise efficiency. If aneconomic entity has the freedom to choose an alternative form of ownership, then allexisting types of ownership arrangements in the economy are efficient. Thus, onecannot assume ex ante that state ownership constitutes an inefficient ownershiparrangement.

In fact, the dilemma between improving productivity and deteriorating profitabilityarises because SOE reform to date has not solved or mitigated the problem ofinformation asymmetry. Economic reform has resulted in the emergence of variouskinds of non-state-owned enterprises (non-SOEs) —including TVEs, joint ventures,

State intervention, ownership and state enterprise reform in China—79

and so on. And market competition has appeared. Nevertheless, the SOEs still haveto bear many policy-determined burdens, which causes unfair competition betweenSOEs and non-SOEs. Under such conditions, the profit level of an SOE is unable toserve as a sufficient indicator of managerial efficiency. Since the informationasymmetry problem has not been overcome, managerial decentralisation hasincreased the possibility of opportunistic behaviour by managers. In particular, withthe existence of a dual-track price system, it has been very easy for SOEs to under-report revenue and over-report costs without being detected. As a result, there hasbeen a decline in both SOE taxes that should have been paid to the state and the SOEprofits that should have been shared with the state, even though managerialdecentralisation improved SOE productivity. Moreover, because the unfairness of theexisting market competition has been induced by policy, whenever an SOE incurslosses, its manager can blame it all on policy and have the government cover its lossesthrough explicit or implicit subsidies. Thus the SOE’s budget becomes soft. Due tosoft budgetary constraints, an SOE manager may not be under much pressure toimprove management. He/she may also pursue some extremely risky projects, or evenengage in direct asset-stripping — plundering state property to line his/her ownpockets. Therefore, successful SOE reform is dependent on creating fair marketcompetition first of all so that an SOE’s profit can serve as a sufficient indicator ofmanagerial performance and thus mitigate the information asymmetry problem.With sufficient information from the market, the state and the SOEs will be able toformulate internal governance to motivate the managers on the one hand and checkopportunistic behaviour due to disproportional liability on the other.

Clearly, the primary task in China’s SOE reform is not to transplant a specific type of‘modern corporation system’ into the economy. It is also impractical to designate apriori a specific type of enterprise institution for all SOEs in China. The essential stepin China’s SOE reform is to create a market environment in which enterprises havingall kinds of ownership arrangements can compete with each other in a fairenvironment that allows for ‘survival of the fittest’. The primary task in SOE reformis to then eliminate the existing policy-determined burdens for SOEs and create alevel playing field.

UNFAIR COMPETITION AND SOFT BUDGETARY CONSTRAINTS

Since the beginning of economic reform, the emergence and growth of the non-statesector has posed a big challenge to the SOEs. Managerial decentralisation hasincreased the linkage between the rewards of SOE employees and the efficiency oftheir enterprises and has induced the SOEs to improve levels of management andefficiency. However, for reasons discussed below, the SOEs still bear many policy-determined burdens and thus an SOE’s profit or loss levels are not a sufficientindicator of managerial efficiency. The existence of policy-determined burdens givesthe SOEs an excuse to continue with soft budgetary constraints. These burdens,

80—State intervention, ownership and state enterprise reform in China

which led to unfair competition between the SOEs and the non-SOEs, can begrouped into three major categories as follows.

First, the capital-intensity of some SOEs is too high, and they will not be able tosurvive without implicit or explicit subsidies. Capital is still very scarce in the Chineseeconomy. The heavy-industry-oriented development strategy produced an extremelybiased industrial structure. A substantial number of SOEs, especially large-sized ones,have an extremely high capital intensity that is incompatible with China’s endowmentstructure of abundant labour and scarce capital. Compared with a labour-intensiveindustry, a capital-intensive industry exhibits a longer gestation period with respectto construction and a longer production cycle, and requires more working capital andmore funds for technical innovation. Hence a capital-intensive industry bears highercapital costs.

This problem existed before reform. The SOEs were set up to meet the state’s strategicgoals. Before reform, the SOEs were able to obtain free appropriations for investmentand working capital from the state. When the SOEs were granted autonomy after thecommencement of reform, especially after the policy for investment funding changedfrom one of appropriations to one of loans in 1983, the SOEs started to be chargedinterest. SOE products in the capital-intensive industries in general are competingwith products produced in more capital-abundant, advanced countries where interestcosts are low. When the SOEs are confronted by international competition and incurlosses, they blame interest charges for their failures. They press the state to recognisetheir losses as a legacy of change in its funding policies and demand that the stateprovide subsidies to cover their losses. Because it is state policy that accounts for SOEproduction in capital-intensive industries and the existence of the SOEs is viewed asessential to economic development, the state is unable to resist such demands.

Second, the prices of some SOE products are still seriously distorted. In the macro-policy environment associated with the traditional development strategy, the prices ofenergy, raw materials and other inputs for heavy industry were kept low. After 17years of reform, the prices of most products have been liberalised. However, the pricesof energy, raw materials and the like are controlled and remain much lower thanmarket equilibrium levels. Since the inputs of most sectors in the economy arecomprised of the above products and services, an increase in prices exerts awidespread cost-push effect. The state is reluctant to liberalise or raise these pricesbecause of the potential negative impacts on other industries. As a result, theseindustries are subject to an unfavourable price structure. Their prices often cannotcover their costs, and since the losses of these industries are policy-induced, the statehas to accept responsibility and cover these losses — even though some or most ofthese losses derive from inefficient operations rather than from the policiesthemselves. It is estimated that about half of the state subsidies paid to SOEs are usedto cover SOE losses in industries subject to price controls (Zhou et al. 1994, p. 37).

State intervention, ownership and state enterprise reform in China—81

Third, the SOEs bear the heavy burden of managing retirement pensions and othersocial welfare costs. During the pre-reform period, the traditional developmentstrategy distorted the macroeconomic policy environment in order to promoteconstruction of heavy industries. One of the macro-policies that was adopted centredon low nominal wages with in-kind benefits for SOE employees. Under the low-wagepolicy, an SOE was responsible for its workers’ medical care, retirement pension,housing, and other needs. Other things being equal, an enterprise would earn fewerprofits the more retired personnel and other social welfare expenditures it was obligedto support. This did not pose any problem before economic reform because all SOErevenues were remitted to the state and the state covered all SOE expenditures.However, after economic reform began and the SOEs obtained a certain degree ofautonomy, the different burden of retirement pensions and social welfare expenditurebetween the SOEs and non-SOEs became a major source of unfair competition. Inshort, the longer an SOE had been established, the heavier its financial burden was.

Many large and medium-sized SOEs were set up shortly after, or even before, theCommunist takeover. The proportion of retired and aged SOE employees issubstantial and their retirement pension and social welfare expenditures constitute avery heavy burden. National statistics show that the security and welfare expenses forretired SOE employees increased from RMB4.01 billion in 1980 to RMB56.32billion in 1992 (mainly through retirement pensions, medical reimbursements andliving subsidies). While this is not to say that all the losses sustained by the SOEs werecaused by these employee obligations, it is true that the non-SOEs, which were set upafter the commencement of economic reform, do not have similar obligations —which again contributes to unfair competition between the SOEs and the non-SOEs.

The existence of such conditions makes it hard to distinguish between losses arisingfrom policy legacies and those deriving from mismanagement. An SOE’s profit levelsdo not reflect its managerial efficiency. Give such a situation, the costs of monitoringSOEs by the state will be very high. In a profit-making SOE, a manager could behavein an opportunistic way but this would go undetected by the state since no objectivereference exists to determine profit rates. In a loss-making SOE, a manager could usepolicy-induced losses to cover up operational losses arising from poor management,managerial indiscretion and so on, and press the state to compensate for such losses.The state is vulnerable to this kind of pressure because it is unable to ask the SOEsto assume responsibility for policy-induced losses. The policy-determined burdensthat exist are the major cause of soft budgetary constraints, and these in turn reducethe incentives for SOE managers to become more efficient. Even if managerialefficiency is improved, the gains are easily siphoned away and the state may not beable to benefit from enhanced efficiency. The conflict between increased productivityand declining profitability among the SOEs since the commencement of reform is agood example of this.

82—State intervention, ownership and state enterprise reform in China

THE ‘PARETO IMPROVEMENT’ APPROACH TO SOE REFORM

The success of China’s reforms so far can be attributed to the states’ implementationof a gradual, incremental ‘Pareto improvement’ approach (Lin 1996a, 1996b). Thatis, in the process of reform, the government avoided hurting, to the maximum extentpossible, the vested-interested groups, and relied on the allocation of newly-createdresources to adjust the structure of interests among various social groups. Similarly, inthe case of the SOEs, the government avoided dramatically adjusting the intereststructure and destabilising the SOEs, which would have accompanied the reallocationof the SOEs’ existing capital stock, by granting the SOEs more autonomy andallowing them to allocate part of their newly-created resources to more profitablesectors. The stability of the SOEs prevented the sudden erosion of the tax base,massive lay-offs and the J-curve GDP growth pattern which accompanied the ‘big-bang’ reforms in Eastern Europe and the former Soviet Union. The final success ofthe SOE reforms depends on the creation of an environment to promote faircompetition so that the SOEs’ budget constraints can be hardened and the incentivesbetween the state and SOE managers and workers can be made compatible. Duringthe process, the reform measures should adhere to the principle of ‘Paretoimprovement’, or at least ‘Kaldor improvement’, in order to maintain social stability,as discussed in the following.

Firstly, most SOEs with extreme capital intensity in production, such as those in theheavy-machine-building industry, may not be able to survive in a competitive marketenvironment as their technology and products are inconsistent with China’scomparative advantages. The state needs to retain its existing level of subsidies to keepthese SOEs going. The state would do well to turn its explicit and implicit subsidiesinto one explicit subsidy and fix the total subsidy at the existing level. Meanwhile, theSOEs should be given the freedom to shift their production to products that are morecompetitive in the market. The above subsidy arrangement would allow the SOEs toat least survive at current welfare levels if they maintain their current lines ofproduction. Generally, these SOEs have the best-trained engineers and workers. Inother words, they have a comparative advantage in terms of human capital. If they aregiven the freedom to shift their production lines, it is expected that they would beable to find a niche in the market where they have competitive advantages. Bygradually shifting their production capacity to more competitive products, their levelsof profitability would rise. The state would then be able to monitor the efficiency oftheir operations according to their profit level, calculated as revenues+subsidy–costsof operation. The state would also be able to benefit from their increased efficiencythrough the increased tax revenue it would derive.

Secondly, the price formation mechanism for those SOEs with suppressed pricesshould be changed. For SOEs in the coal and petroleum industries, for example, theprices of their products should be liberalised and allowed to rise to international levelsso that their products are competitive with imported products. SOEs in the largecommunication and transportation sectors have natural monopolies and their

State intervention, ownership and state enterprise reform in China—83

products and services are non-tradeable. To eliminate the shortage in these industries,the state needs to apply the cost-mark-up pricing method to their products andservices. If the state were to rid itself of the burden of managing millions of SOEs andconcentrate on managing a few large enterprises in the infrastructure sector, theproblems arising from information asymmetry could be alleviated, and the statewould be able to design a better framework for regulation to improve the incentivesand efficiency of these SOEs.

Thirdly, the state should relieve all SOEs of the burden of pensions and other welfareprovisions for aged and retired workers. The additional surplus that was extractedthrough the low-wage policy that existed before the reforms was remitted to the statecoffers and used for the state’s investment funds. To create an environment in whichSOEs can compete fairly with non-SOEs, the state should take full responsibility forpensions and welfare provisions for those SOE employees who were hired before thereforms. In the case of current SOE employees, the state should be responsible for theproportion of years that they were hired before the commencement of reforms.

CONCLUDING REMARKS

SOEs form the backbone of the Chinese economy and have been the focus of China’seconomic reforms since 1979. In the early stages of China’s reforms, most researchersattributed the SOEs’ poor performance to a lack of incentives and autonomy. As aresult, the reform measures focused on increasing these. Recently, many economistshave suggested that vagueness in the delineation of property rights is the major causeof the SOEs’ declining profits. The stockholding system was believed to hold asolution to the problem. However, this system cannot be applied to unprofitableSOEs, and most SOEs that adopted it still face problems of declining profits and evenan erosion of state property.

In this chapter, I have argued that the SOE’s problems originate from the separationof ownership and control. This separation gives rise to such problems as incentiveincompatibility, information asymmetry, and disproportional liability between SOEmanagers and the state. As a consequence, moral hazard may become a seriousproblem for SOEs. The separation of ownership and control and its associatedproblems are common to all large enterprises. The solution to the problem ofmanagerial discretion is to make the incentives between the owner and the managerscompatible; and this depends, first of all, on the existence of a low-cost, sufficientindicator of managerial performance. An enterprise’s profit levels in a fair,competitive market provide a sufficient indicator of the performance of the managerof the enterprise. Competition on a level playing field constitutes the most importantinstitutional arrangement for solving problems arising from incentive incompatibilityin a market economy. With profit providing a sufficient indicator of performance, thesuccess of an enterprise will also require effective internal governance that prevents

84—State intervention, ownership and state enterprise reform in China

any indulgence in over-risky projects and other opportunistic behaviour that mayarise from limited liability of managers.

Before the commencement of reform in China, as prices were distorted, enterpriseswere required to assume many policy-determined burdens, and competition wasrepressed. An SOE’s profits were therefore unable to provide an indicator ofmanagerial performance. To mitigate the problem of managerial discretion in such anenvironment, SOE managers were deprived of autonomy. But since managerialautonomy is necessary for the efficient operation of an enterprise, during the reformprocess, SOE managers were given increasingly more autonomy. After reform,competition began to emerge. However, this competition is unfair because the SOEsstill face many policy-determined burdens, which means that an SOE’s profit levelsdo not provide a sufficient indicator of its manager’s performance. These burdens alsosoften the SOEs’ budgetary constraints. The key to China’s SOE reform, therefore, isto eliminate these policy-determined burdens and to enable the SOEs to competewith other enterprises in the market on a level playing field. In that way, an SOE’sprofit levels will serve as a sufficient indicator of managerial performance such thatthe information asymmetry problem can be overcome. With sufficient informationavailable about an SOE’s managerial performance, it will be possible to overcome theincentive incompatibility problem by designing a compensation scheme that links amanager’s rewards with his/her performance. Furthermore, given sufficientinformation, it will be possible to create effective internal governance to check otheropportunistic behaviour that may arise from limited liability of managers.

While the discussion in this chapter focuses on SOE reforms in China, it should alsobe useful in relation to SOE reforms in other economies. SOEs in other economiesare generally inefficient and require government subsidies to survive. This is becausemost of them bear policy-determined burdens, and thus their profit levels do notprovide a sufficient indicator of managerial efficiency. These policy burdens also makefor soft budgetary constraints. As in China, the managers of these SOEs are under nopressure to improve their efficiency and, in turn, their governments find it hard toimpose discipline on the SOEs. The key for successful SOE reform in othereconomies then is also to eliminate policy-determined burdens so that profit levelscan be used to assess managerial performance, as shown by the experience of NewZealand (World Bank 1996, p. 50).

NOTES

1 In 1994–95 the market interest rate was about 25 per cent and the official interest ratewas about 12 per cent.

2 In 1994 bank loans to state-owned industrial enterprises totalled RMB2,610 billion. Themarket interest rate and the official bank interest rate differed by about 10 per cent.Implicit subsidies amounted to RMB261 billion. However, total after-tax profits wereonly 83 billion yuan (State Statistical Bureau 1995, pp. 394–5).

State intervention, ownership and state enterprise reform in China—85

3 For further discussion of China’s heavy-industry-oriented development strategy, theformation of the traditional economic system, and the resulting economic performance,see Lin et al. (1996a).

4 The existence of product market competition is more important than that of managerialmarket competition. If the latter does not exist, other institutional arrangements, such asJapan’s main bank system, may evolve to compensate for this.

5 For stockholding corporations, a competitive stock market is also indispensable for theefficiency of enterprise if there is a well-functioning legal system; the shareholding is fullydiversified and insider trading is prohibited; and the volume of the stockmarket is largeenough such that an individual shareholder is unable to manipulate the stock price.Under the aforementioned conditions, the stock price can truly reflect a corporation’sexpected earnings, and changes in the stock price will basically reflect the performance ofthe corporation.

REFERENCES

Berle, Adolf A. and Gardiner C. Means (1932) The Modern Corporation and Private Property,reprinted (1991) by Transaction Publishers, New Brunswick.

Du, Haiyan et al. (1990) ‘Self sovereignty, market structure, and incentive system of SOEs’,Economic Research l.

Groves, T., Y. Hong, J. McMillan and B. Naughton (1994) ‘Autonomy and incentives inChinese state enterprises’, Quarterly Journal of Economics 109(1) (February), pp.183–209.

Lin, Justin Yifu (1995) ‘Can China’s mini-bang succeed?’, Contemporary Economic Policy 13(January).

Lin, Justin Yifu, Fang Cai and Zhou Li (1996a) The China Miracle: Development Strategy andEconomic Reform, Hong Kong: Chinese University Press.—— (1996b) ‘The lessons of China’s transition to a market economy’, Cato Journal16(2) (Fall).

Liu, Zunyi and Yingyi Qian (1994) ‘Suggestions on financial restructuring of China’s bankand enterprise’, Reform 6.

Qi, Ming (1995) ‘Is there an once-for-all solution to the huge bad debt of the state sector’,Economic Highlights 1.

State Statistical Bureau (various years) Statistical Yearbook of China, Beijing: China StatisticalPress.

World Bank (1992) Reform in 1990 and the Role of Planning, Washington DC: World Bank.—— (1996) World Development Report 1996: From Plan to Market, New York: OxfordUniversity Press.

Zhou, Xiaochuan, Lin Wang, Meng Xiao and Wenquan Yin (1994) Enterprise Reform: ModelChoice and Course Design, Beijing: Economic Publisher of China.

5 The evolution of competition policyLessons from comparative experience

Michael J. Trebilcock

This chapter has two central purposes: first, to reflect on what we have learned fromone hundred years of domestic antitrust experience in selected Western industrialisedeconomies; and, second, to explore some of the international dimensions ofantitrust/competition policy in the light of globalisation of markets and consequentpressures for harmonisation of many domestic policies, including competition policy.The second section of this chapter sets out the basic economic function ofcompetition laws in addressing the problem of monopoly or market power in itsvarious manifestations. The third section provides brief overviews of the evolution ofcompetition laws in the United States, Canada and the European Union. The fourthsection identifies a number of important procedural and institutional issues in thedesign and administration of domestic competition law regimes that are highlightedby the comparative experience. The final section examines various internationaldimensions of domestic competition laws.

THE BASIC ECONOMIC FUNCTION OF COMPETITION LAWS

It is useful at the outset to review briefly the underlying economic theory on thewelfare implications of monopoly. The concept of ‘market power’ or ‘monopolypower’ — these terms will be used interchangeably — drives most aspects of moderncompetition laws. Whether one is concerned with a single firm monopoly,competitors colluding with a view to acting as if they were a monopoly, a firm seekingto predate on existing or potential rivals in order to exclude them from the market,or a merger that may lead to a dominant position, in every case the focus is on thesocial welfare implications of excessive market power. In economic terms, marketpower basically means the ability to increase prices above (or reduce non-pricedimensions of competition below) competitive levels by a non-trivial amount for anextended period of time. In order to establish whether any of the foregoingarrangements involve excessive market power, it is obviously necessary to define oneor more relevant product and geographic markets in which the firms in question arealleged to be exercising market power — an exercise that is central and problematicin most antitrust cases (see Landes and Posner 1991, p. 937).

The evolution of competition policy: lessons from comparative experience—87

The traditional economic analysis of monopoly has a structural and static focus. Itexamines the welfare implications of a firm being a monopolist. Although most lawsrelating to monopolisation or abuse of dominant position deal with conduct entailedin attempting to acquire, defend or enlarge a monopoly position, the static analysisprovides the foundation for legal concerns that have a more dynamic or conduct-oriented focus. Thus, I begin with this conventional static analysis, which is shown inFigure 5.1.

Figure 5.1 Welfare effects of monopoly

In a ‘perfectly competitive’ market, firms would price at PC (where the marginal costcurve intersects the industry demand curve) and would produce QC of output. Asidefrom transitory effects, there are no ‘economic profits’ to be made. The monopolist,in contrast, will maximise its profits by restricting output to QM — the point atwhich its marginal cost and marginal revenue curves intersect.1 It therefore prices atPM.

As can be observed from the figure, there are several undesirable consequences ofmonopoly relative to a competitive market. First, quantity is lower (by QC–QM).Second, price is higher (by PM–PC). Third, consumers on the demand curve betweenPC and PM are priced out of the market even though the resource costs entailed inserving them (as represented by MC1) are lower than the prices that they are willingto pay. Compelling them to reallocate their expenditures to less preferred forms ofconsumption creates the so-called ‘dead-weight-loss’ triangle designated as DWL in

MCMC

1

2

Q

QM MR QC

D

P

PM

PC

DWL

88—The evolution of competition policy: lessons from comparative experience

the diagram (allocative in efficiency). Fourth, consumers who remain in the market(namely, those consumers on the demand curve above PM) are required to transferpart of the ‘consumer surplus’ that they would have realised under competitiveconditions (with price at PC) to the monopolist (as reflected in the hatchedrectangle). Although such wealth transfers in themselves have purely distributionaleffects and are not a misallocation of resources, political opposition to monopoliesoften focuses on this factor. Moreover, it may often be the case that the lure ofmonopoly profits will induce socially wasteful investments in rent-seeking activities,rendering at least part of the rectangle indirectly an additional measure of resourcemisallocation (see Posner 1976, p. 12). Finally, some lines of objection to monopolyare non-economic in nature, such as populist concerns that large concentrations ofeconomic power carry the potential for undue political influence.3

The model of monopoly depicted in the diagram assumes a single monopoly price.However, a monopolist may be able to do even better than this if it is able to pricediscriminate by raising the price to highly inelastic customers on the demand curveabove PM and/or lowering the price to more elastic customers on the demand curvebetween PM and PC. At the limit, a perfectly discriminating monopolist wouldcharge every consumer on the demand curve his or her reservation price andappropriate the entire consumer surplus under the demand curve and above PC.While this strategy would exacerbate the wealth transfer implications of monopolynoted above, it would also raise the monopolist’s output to the competitive level (QC)by ensuring that all consumers prepared to pay more than the resource costs ofproducing a unit of output are in fact served, thus eliminating the dead-weight-losstriangle (or allocative inefficiency). In the real world, however, perfect pricediscrimination is almost never feasible because it would entail a monopolist havingboth perfect information about each customer’s reservation price (namely, elasticityof demand) and the ability to prevent arbitrage between low price and high pricepurchasers. Thus, one is more likely to observe attempts to segment customers intoseveral broad groups (such as business and leisure travellers, and adult and childrencinema-goers), who are charged different prices reflecting general differences in theirelasticities of demand. In such cases it is not possible, as a matter of a priori analysis,to deduce whether total industry output is likely to rise or fall relative to the singlemonopoly price scenario.4

There is an important additional implication of monopoly to be noted from thediagram. Suppose that in moving from a competitive to a monopolised industry themonopolist is able to reduce its cost of production from MC1 to MC2 throughvarious economies of scale and/or scope, thus releasing resources for more productiveuse elsewhere in the economy. Two opposing welfare (as opposed to distributional)effects result. The negative welfare (namely, misallocation) implications of the dead-weight-loss associated with monopoly remain, but there are now also productiveefficiency gains from the savings in resources. As Williamson demonstrated in aseminal article with respect to mergers, depending on the elasticity of demand (and

The evolution of competition policy: lessons from comparative experience—89

therefore the size of the dead-weight-loss triangle), if monopoly results in a reductionin average costs in the order of 5–10 per cent, the merger must give rise to priceincreases in excess of 20 per cent (with an elasticity of 0.2) and in excess of 40 percent (with an elasticity of 0.05) for the net allocative effects to be negative (seeWilliamson 1968, p. 18.). This raises difficult questions as to whether some form ofefficiency defence should be available to firms achieving monopoly power.5

It should be noted that some analysts worry about the opposite phenomenon.Undisciplined by competition, a monopolist may be able to enjoy ‘the quiet life’,which, through excessive management perks and general organisational slack, resultsin its costs rising above, or rates of innovation falling below, the level that wouldprevail in a competitive market (‘X or dynamic inefficiency’). Other commentatorsdiscount this possibility by arguing that even monopolists (or their shareholders) havean incentive to maximise rather than dissipate monopoly rents (although this may notbe as likely in the case of state-owned monopolies, where monitoring incentives areoften weak).

An important point to emphasise from this brief review of the basic economics ofmonopoly is that economic concerns over the effects of monopoly (or market power)focus primarily on its adverse effects on consumers. Competition policy is thusprimarily concerned with protecting consumer welfare, not with preserving some givenstate of competition or number of competitors. Conceived of as consumer protectionlegislation, competition laws should not be encumbered with other policy objectivessuch as protecting small businesses or industrial policy concerns such as promoting‘national champions’. This view of the purposes of competition policy has now wonwide acceptance amongst antitrust scholars and enforcement authorities in theUnited States, Canada and the European Union (while recognising that this stillleaves room for much debate as to the effects on consumer welfare of particularpractices in particular cases). This has been an important advance over earlier andwidely divergent understandings as to the purposes of competition policy.

THE HISTORY OF ANTITRUST LAWS

The United States6

In the latter half of the nineteenth century, the economy in the United States becamenational in scope7. Territorial expansion westward had driven the development ofextensive railways and, eventually, communication systems, which in turn providedthe means for interregional trade. These and other innovations, such as thedevelopment of sophisticated capital markets, allowed firms to expand beyond theconstraints of their immediate markets, and soon big businesses were a major force inthe US economy. This development, however, was the source of discontent in manyquarters, particularly among consumers, small businessmen and farmers (Dunlop,McQueen and Trebilcock 1987, p. 16). Dissatisfaction was particularly directed

90—The evolution of competition policy: lessons from comparative experience

towards the increasing prominence of the use of trusts, whereby stocks of competingcompanies were transferred to trustees, who proceeded to manage the industry inquestion. The elimination of competition entailed by these trusts became increasinglyunpopular, and one view is that the Sherman Act of 1890 (26 Stat. 209) was enactedby the United States Congress in partial response to this pressure. This Act was passedby a margin of 242–0 in the House, with 85 abstentions (Kovaleff 1990), whichsupports contentions such as Letwin’s that, ‘[t]he Sherman Act was passed in responseto public demand’ (Letwin 1965, p. 15).

A more cynical view is that the Act was the result of political ‘horse-trading’. Threemonths after its passing, Senator John Sherman, who, as the name indicates,promoted the Sherman Act, sponsored a bill popularly known as the ‘CampaignContributors’ Tariff Bill’, but known more formally as the ‘McKinley Tariff ’ (seeTrebilcock 1991, p. 31). This sequence of events has led some commentators tointerpret ‘these two pieces of legislation as a political logrolling exercise’,8 wherebythe Sherman Act assuaged small business and farmers, while the McKinley Tariffprotected big business.

Whatever its motivation, the Act became law in 1890. Its substantive provisions areremarkably brief:

Section 1: Every contract, combination in the form of a trust or otherwise, orconspiracy, in restraint of trade or commerce among the several States, or withforeign nations, is hereby declared to be illegal ...

Section 2: Every person who shall monopolize, or attempt to monopolize, orcombine or conspire with any other person or persons, to monopolize any part ofthe trade or commerce among the several States, or with foreign nations, shall bedeemed guilty of a felony ...

The Sherman Act in large part embodied tenets of the common law; indeed, Shermanhimself stated that the Act ‘does not announce a new principle of law, but applies oldand well-recognised principles of the common law’.9 With its passing, however,enforcement became a governmental matter as well as a private matter. Thegovernment was given responsibility for taking action against anticompetitivebehaviour, but this was shared with private plaintiffs who were permitted to launchsuits if they had suffered damages as the result of this behaviour. To encourage suchactions, the Act provided for treble damage awards in successful suits.

The reaction of economists to the Act was almost uniformly negative. In what was aprecursor to the more recent emergence of the ‘Chicago School’,10 many economistsat the time believed that the restrictions on combinations would simply eliminateeconomies of scale. At an important meeting of economists, the Chicago TrustConference, the consensus was that high concentration levels, which the Sherman Actwas designed to discourage, were the result of ‘natural industrial evolution’ and were

The evolution of competition policy: lessons from comparative experience—91

therefore efficient — a sort of Darwinian theory of natural economic evolution (seeHatfield 1899, p. 1).

Despite this general lack of enthusiasm for enforcing antitrust law, there were somesignificant developments in the early years of the Sherman Act. For example, theUnited States Supreme Court held in 1897 in United States v. Joint TrafficAssociation ([1987]171 US 505) that some horizontal arrangements, such as price-fixing, were per se illegal; that is, they may be condemned without the court engagingin a full-blown rule-of-reason inquiry. In Dr. Miles Medical Co. v. John D. Park &Sons Co. ([1911]220 US 373) The United States Supreme Court extended this strictrule to some vertical arrangements, holding resale price maintenance to be per seillegal. Later other vertical arrangements, such as tying and exclusive dealing, werealso deemed to be per se illegal.11

On balance, however, despite the Sherman Act’s invitation to introduce significantchanges to antitrust policy, ‘enforcement was spotty until the presidencies ofTheodore Roosevelt and [William] Taft’ (Kovaleff 1990, p. 4). The 1912 Presidentialelection was fought largely on the antitrust issue.

The Clayton Act of 1914 (38 Stat. 730) emerged from this political debate. Draftedto complement the Sherman Act, the Clayton Act broadened the scope of antitrustpolicy by making certain mergers, price discrimination, tying and exclusive dealingcontracts, and interlocking directorates (whereby competing companies had commonboard members) unlawful if they ‘substantially lessened competition’. At the sametime, the Federal Trade Commission Act (38 Stat. 717) was passed, which establishedthe Federal Trade Commission (FTC). The Act’s only substantive provision, Section5, states: ‘Unfair methods of competition in or affecting commerce, and unfair ordeceptive acts or practices in or affecting commerce, are hereby declared unlawful.’Like the Clayton Act, no criminal sanctions were attached; the FTC was limited toissuing prospective decrees.

The FTC’s responsibility for antitrust was, and is, shared with the Department ofJustice (DOJ). While any overlap in the jurisdictions of the FTC and the DOJ wasostensibly limited to joint enforcement of the Clayton Act, in practice there is alsosignificant overlap in enforcing the Sherman Act, with the exception of criminalinvestigations, which have remained under the domain of the DOJ, given thatviolations of this Act are generally considered to be unfair within the meaning of theFTC Act.

As a result of these legislative changes, antitrust enforcement entered its first wave ofvigorous activity. Economists, however, remained sceptical of this interference withthe workings of the free market. As summarised by Hovenkamp (1985, p. 220)‘[d]uring this period, roughly 1890–1930, American economists developed a set oftheories that found consumer benefits in concentration and large firms probably to agreater extent than did any economic model until the rise of the Chicago School’.

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This view perhaps contributed to the short life span of the first wave of enforcement.Rather than expanding the scope of antitrust law, soon legislative additions to theSherman Act narrowed its application. For example, the Webb–Pomerene Act of1918 (40 Stat. 516) exempted export cartels from the ambit of antitrust law, and theMerchant Marine Act of 1920 (41 Stat. 988) did the same for marine insurance.

This weakening of antitrust law continued into the Great Depression, when theNational Recovery Administration encouraged cartels as a means of supportinghigher prices. However, shortly after the National Industrial Recovery Act wasdeclared unconstitutional in 1935, the Administration brought Thurman Arnold andothers committed to revamping antitrust policy to the Department of Justice.12 Thisspawned another wave of antitrust activity, which included the passage of theRobinson–Patman Act (15 USCA) in 1936, which outlawed price discrimination.

While the Second World War ended this renewed vigour, this lapse was onlytemporary. Following the work of Arnold and other antitrust activists in the late1930s and early 1940s, the ‘workable competition’ theory of J. M. Clark emerged.This theory worked from the premise that perfectly competitive markets wereunlikely to occur due to product differentiation, but antitrust policy could be used topromote the highest levels of competition possible. The turning of the tide wasevident in 1950, when merger law was strengthened by the Celler–Kefauver Act (64Stat. 1125), which closed various loopholes13 in the Clayton Act with respect tomergers.

The influence of the ‘workable competition’ theory was supplemented by theemergence of the ‘structure–conduct–performance’ school in the late 1950s. Led byHarvard economist Joe Bain, this school held that economies of scale were generallynot substantial, that barriers to entry to markets were often high, and thatanticompetitive behaviour began at relatively low levels of industry concentraiton (seeHovenkamp 1985). Bain concluded from such findings that antitrust law should bevigorously enforced. This played a significant role in bringing about the most spiritedperiod of antitrust activity in US history. In the 1960s and early 1970s, possiblyanticompetitive behaviour was pursued with unprecedented zeal. For example, inBrown Shoe Co. v. United States ([1962] 370 US 294) the United States SupremeCourt blocked a merger that would have created a firm with 4.5 per cent of the USshoe production market, and 2.3 per cent of the shoe retail market. Such remarkabledecisions led Justice Stewart in dissent in United States v. Von’s Grocery Co. to write:‘[t]he sole consistency I can find is that in litigation under s.7 [of the Clayton Act],the Government always wins’ ([1966] 384 US 253, p. 301).

More recently, however, antitrust policy in the United States reversed this trend yetagain. Policy has been greatly influenced by ‘Chicago School’ economists, whocriticised the tendency of antitrust policy in the United States to protect smallbusiness at the expense of economic efficiencies associated with size. They argued thatthe purpose of antitrust law should be to maximise efficiency; other goals of social

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policy should be pursued, if at all, through other instruments. As a result of thisefficiency-oriented analysis, corporate concentration and mergers leading to highlevels of concentration were viewed as likely to reflect, or to be likely to realise,superior efficiencies, while many vertical and some horizontal arrangements that hadbeen condemned in the past were viewed by the Chicago School as sociallydesirable.14 The antitrust policies of Presidents Reagan and Bush were influenced bythis economic thinking, and enforcement of the antitrust laws dropped, except inrespect of horizontal cartels (Whish 1993, p. 18).

Thus US antitrust policy has undergone significant swings over its century-longexistence. Recent exclusionary or market foreclosure theories, such as ‘raising rivals’costs,15 may indicate the return to a greater suspicion of anticompetitive behaviour.There is thus reason to expect debates over the appropriate scope and application ofUS antitrust policy to continue well into the next century (Demsetz 1992, p. 207).

Canada

Canada16 was the first jurisdiction in the world to adopt an antitrust statute, with theenactment of the federal Anti-Combines Act in 188917 — one year before theenactment of the US Sherman Act (26 Stat. 209 [1890]). As is true in the UnitedStates with the Sherman Act, there is some debate over the motivations of itsproponents. While some claim that the Act was the result of public dissatisfactionwith large combines, others argue that it was largely designed to ease political pressureresulting from the erection of large tariff barriers in the National Policy of 1879,which was adopted by the same Conservative government. Conservative N. ClarkeWallace championed the bill as a ‘terror to evil-doers’, but historian Michael Blisscharacterises this statement as fraudulent political posturing, designed partly tocontinue to enhance Wallace’s popular reputation as the enemy of combines, andalmost certainly also as part of a calculated Conservative manoeuvre to deflectcriticism from the combine-creating effects of the protective tariff (Bliss 1973, p.182).

The initial focus of the Act was on combinations amongst horizontal competitors —principally price fixing and market allocation arrangements — which were madesubject to criminal sanctions.18 In 1910 the Act was amended to extend thesesanctions to mergers or monopolies where these operated or were likely to operate tothe public detriment.19 In the mid-1930s, following recommendations of the RoyalCommission on Price Spreads (1935), which was concerned about so-called‘destructive competition’ in many sectors during the Great Depression, pricediscrimination and predatory pricing were added to the list of criminal offences. In1952, following the recommendations of the MacQuarrie Committee (1952), whichwas set up to investigate inflationary pressures in the postwar boom (now prices werethought to be too high rather than too low), resale price maintenance was added as acriminal offence,20 and the Restrictive Trade Practices Commission (RTPC) was set

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up to conduct inquiries into possible offences and recommend prosecutorial actionwhere appropriate.21 At the same time, the Director of Investigation and Research ofthe Competition Policy Bureau was created as a specialised enforcement officer.22 Thisremained the structure of Canadian competition law for more than two decadesthereafter.

In part because of constitutional concerns as to the ability of the federal governmentto enact competition laws other than pursuant to the exercise of its criminal lawjurisdiction, all these laws were criminal in nature and were enforced throughcriminal prosecutions in the ordinary criminal courts. Over the first 80 years ofCanadian competition law, prosecutorial attention was focused principally on theconspiracy provisions, and, since 1952, also on the resale price maintenanceprovisions. Almost no prosecutions were brought under the price discrimination andpredatory pricing provisions, and very few were brought with respect to mergers ormonopolisations, and even fewer succeeded. It should also be noted that there was noprovision for any civil right of action for breach of any of these provisions. Thus, incontrast to US antitrust law, and more recently EC competition law, administrativereview of competitive practices (in the United States by the Federal TradeCommission; in the European Community by the European Commission), and civilrights of action (such as the treble damage action in the United States for violation ofthe Sherman Act) (Clayton Act, 15 United States C.s15 [1988]), were essentiallyabsent from the Canadian competition law domain.

In 1967 the federal government asked the Economic Council of Canada to undertakea fundamental review of Canadian competition law and recommend proposals forreform. In its Interim Report on Competition Policy, issued in 1969, the EconomicCouncil of Canada (1969) called for a sweeping reformulation of Canadiancompetition laws, with sharply reduced reliance on criminal sanctions,correspondingly increased reliance on expert economic review, and a significant rolefor private rights of action. In 1971 the federal government introduced a bill thatsought to implement most of the Economic Council’s recommendations,23 but thisbill attracted a storm of criticism from both the business and legal communities, andwas withdrawn from parliament. The federal government then decided to proceedwith reform in two stages. In 1976, a set of ‘stage one’ reforms was enacted thatextended the scope of the Act from goods to services, tightened up aspects of theconspiracy provisions, made bid rigging a per se offence, provided for a single damageright of action for violation of the criminal provisions in the Act,24 and introduced aset of reviewable vertical practices — namely, refusal to supply, exclusive dealing,market restrictions, tied selling, and consignment selling — that were subject to rule-of-reason review by the Restrictive Trade Practices Commission at the instance of thedirector and in appropriate cases to cease and desist orders (S.C. 1974–45–76, c.76).However, the central issues of controversy — that is, how to deal with mergers andmonopolies — were postponed for further consideration. Finally, after a number offalse starts, in 1986 the new Competition Act (the ‘stage two’ amendments) was

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adopted by parliament. This Act abolished the Restrictive Trade PracticesCommission and replaced it with the new Competition Tribunal (S.C. 1986, s.3), amixed body comprising federal court judges and non-judicial experts, vesting in thetribunal extensive review powers with respect to mergers and monopolisation (calledin the Act ‘abuse of dominant position’) (S.C. 1986, s.46) on application for relief bythe Director of Investigation and Research. These activities were removed from thecriminal law. The tribunal also assumed the RTPC’s review functions with respect tovertical practices. The civil damage right of action introduced in the ‘stage one’amendments in 1976 relates only to breaches of the criminal prohibitions in thestatute (with or without a prior criminal conviction), and not to any of the reviewablepractices.25 Private parties, beyond complaining to the director, have no direct accessto the tribunal, although in the event of the director initiating proceedings before thetribunal, private parties may be granted standing by the tribunal in the ensuingproceedings.

This process of historical evolution of Canada’s competition laws has, in effect,resulted in a two-track process of review of competitive practices: the first is thecriminal law track where the federal attorney-general can bring prosecutions in thecriminal courts for breach of the criminal prohibitions in the Act. The second is theadministrative review track that entails the initiation of proceedings before the newCompetition Tribunal by the director. A third and less practically important track alsoexists in that there is now a possibility of private rights of action being brought in thecivil courts for breach of the criminal prohibitions in the Act, but to date this righthad been very sparingly exercised (partly because of constitutional doubts, onlyrecently resolved, as to the validity of the provision).26

The European Union 27

On 18 April 1951 France, Germany, Italy, the Netherlands, Belgium andLuxembourg became signatories to the Treaty of Paris, creating the European Coaland Steel Community.28 This marked the beginning of pan-European competitionpolicy. Of the current member states of the European Union, only Britain andGermany had comprehensive competition laws, although even these only originatedin the immediate postwar period. The purpose of the Treaty of Paris was to establisha ‘common market’ in the coal and steel markets in order to enhance ‘economicexpansion, growth of employment and a rising standard of living in the MemberStates’.29 This agreement called for the abolition of perceived impediments to thisobjective, including tariff and non-tariff barriers to trade. Furthermore, Article 4 ofthe treaty called for the removal of restrictive practices ‘which tend toward the sharingor exploiting of markets’.30

The concern about competition arose for several reasons. One was simply that theindustries covered by the treaty were plainly not competitive in the postwar years, andUS experience convinced many that pursuing competitive markets through

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competition policy would promote economic efficiency. This was not, however, thesole reason for competition policy. The abolition of restrictive practices was alsodesigned to prevent incumbent firms in each of the member states from dividing upthe ‘common market’ by country, which would circumvent the very purpose of thetreaty. That is, competition policy was seen as a tool to further the integration of themember states.

This motivation continued to influence European attitudes towards competition lawand was incorporated into the Treaty of Rome, which was signed on 27 March 1957.31

This treaty, which grew out of the successes of the Treaty of Paris, was intended, interalia, to integrate the entire economies of the member states, not simply certainsectors. It was recognised during preliminary discussions that competition policywould be a valuable tool for achieving this objective. An initial report on theprospects for a new treaty ‘the Spaak Report’, stated:

the Treaty will have to provide means of ensuring that monopoly situations orpractices do not stand in the way of the fundamental objectives of the CommonMarket. To this end it will be necessary to prevent:

A division of markets by agreement between enterprises, since this would betantamount to re-establishing the compartmentalisation of the market (Spaak1993, p. 25).

Thus Articles 85 and 86 were included in the Treaty of Rome. Article 85(1) prohibitsas incompatible with the ‘common market’, ‘all agreements between undertakings,decisions by associations of undertakings and concerted practices which may affecttrade between Member States and which have as their object or effect the prevention,restriction or distortion of competition within the common market ...’

Article 86 was directed at firms with a dominant position. It provides ‘[a]ny abuse byone or more undertakings of a dominant position within the common market or ina substantial part of it shall be prohibited as incompatible with the common marketin so far as it may affect trade between member states’.

These articles, and the establishment by the treaty of a Directorate of the EuropeanCommission, which was responsible for enforcing competition policy (hereinafter‘DG IV’) were intended to promote both efficiency and the integration of Europe asan end in itself. To this latter end, the European Community’s jurisdiction extendsonly to transactions or practices with a ‘Community dimension’, purely localtransactions or practices being governed by the domestic competition laws of themember states.

However, the treaty failed to establish an effective competition policy until theapproval of Council Regulation no. 1732 by the European Council on 6 February1962.33 This regulation set out various procedural rules for implementing Articles 85and 86 of the treaty, such as complaint procedures and rules for notifying theEuropean Commission of agreements undertaken. This had profound effects on EC

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competition policy. Prior to the passage of Regulation 17, DG IV had investigatedonly 33 cases and had not issued a formal decision on any case (Goyder 1993, p. 46).As Holley (1993, p. 670) put it, ‘It was in 1962 that the practice of EEC competitionlaw began, upon the issuance of Council Regulation No. 17.’

Over the next several years, EC competition law began to take shape. While startingslowly, the number of DG IV decisions increased annually. To illustrate, in 1972 theCommission issued its First Report on Competition Policy, covering the period1962–71, which listed 51 cases decided under Article 85, of which 19 were decidedin 1971 (cited in Holley 1993, p. 672). Furthermore, all three Article 86 cases listedwere decided in 1971. As Holley (1993) states: ‘[t]he acceleration was obvious’.

The next major development in EC competition law was the development of blockexemptions. Rather than devoting resources to reviewing all arrangements on a case-by-case basis, the Commission opted to exempt certain classes of arrangements fromcompetition scrutiny. Notifications of arrangements pursuant to Regulation 17 hadbecome a deluge, and block exemptions were seen as a means to reduce excessiveadministrative costs. Thus on 2 March 1965 Regulation 19/65 was adopted, whichgave the Commission the power to establish these block exemptions. TheCommission subsequently issued block exemptions with respect to exclusive dealingagreements,34 exclusive distribution agreements,35 and other types of agreements.Other arrangements are exempt from Article 85 scrutiny if they fail to meet theCommission’s de minimis threshold,36 are granted a negative clearance underRegulation 17 indicating the Commission’s approval of the arrangement, or qualifyfor an exemption under Article 85(3). Article 85(3) exempts an agreement thatcontributes to improving the production or distribution of goods or to promotingtechnical or economic progress, while allowing customers a fair share of the resultingbenefit.

Early European cases centred on agreements amongst competitors; merger policy didnot begin to evolve until the 1970s. In the first case where merger policy became anissue, Continental Can Co. (O.J. L7/25 [1972]), the Commission invoked Article 86to block a merger that, in its view, would have strengthened a dominant position.While the European Court of Justice annulled this decision on its facts, it approvedthe use of Article 86 to prevent some anticompetitive mergers.37 This begandiscussions and debate about EC merger policy, which resulted in the passage of the1989 Merger Regulation.38 This regulation outlined EC merger policy with respect toboth procedure and substance, and merger reviews have subsequently increased toabout 50 cases a year, in contrast with one case in 1973 (see Kleeman 1991, p. 624).

EC competition policy and law has thus changed dramatically in a relatively shorttime. As Holley (1993, p. 674) states:

[a]n annual review of United States antitrust law shows a complex but slowprogression resulting mainly from a multitude of court cases, with legislation byand large affecting only the fringes, more like the movement of a glacier. The image

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produced by an annual review of EEC competition law is more like that of anavalanche, where the flow of new legislation is all important and the central roleplayed by the Commission allows important changes often with little or no notice.

PROCEDURAL AND INSTITUTIONAL ISSUES

In addition to debates over substantive policy issues, a number of procedural andinstitutional issues have been central in debates over competition policy reforms inthe United States, Canada, the European Union and elsewhere.

Courts versus commissions

For most of the history of Canada’s competition laws, the adjudicatory function withrespect to most substantive issues has been vested in all-purpose criminal courts, withthe investigatory and enforcement functions initially vested in general lawenforcement agencies and since 1952 in the office of the Director of Investigation andResearch of the Federal Competition Policy Bureau. With the 1986 amendments tothe legislation, the adjudicatory function with respect to mergers, abuse of dominantposition and vertical restraints has been removed from the criminal law and from all-purpose criminal courts and vested in the Competition Tribunal, an administrativetribunal with civil review powers. Conspiracies, bidrigging, price discrimination,predatory pricing and resale price maintenance remain criminal offences thatcontinue to be adjudicated in all-purpose criminal courts.

The considerations that bear on the choice between criminal and civil sanctions andbetween generalist courts and specialised tribunals are complex (see Dunlop,McQueen and Trebilcock 1987, pp. 69–71). However, a tenable division of labourmay entail general criminal courts imposing criminal sanctions in the case of purecartels under a per se illegality rule, and general civil courts awarding damages inprivate actions in the same context. In all other cases, rule of reason review by aspecialised tribunal would seem preferable to such review by all-purpose courts (seeWarner and Trebilcock 1993, p. 679).

The functions of a specialised tribunal

Assuming that a decision is made to assign a significant role to a specialised tribunalin the administration of a country’s competition laws, these are still importantdecisions to be made as to what functions are to be assigned to the tribunal. TheEuropean Commission has been described as acting as policeman, prosecutor, judgeand jury (Whish 1993, p. 264), given the broad investigatory, rule-making,enforcement, adjudicatory and sanctioning power with which it is vested. The USFederal Trade Commission exhibits many of these same characteristics. I believe thatthis fusion of functions, at least in the present policy context, would not sit well withmany Canadians.

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First, Articles 85 and 86 of the Treaty of Rome are bare-bones framework legislation,the substantive content of which has been left to the Commission and, by virtue ofthe appellate process, the European Court of Justice, for elaboration by means ofregulations, notices and adjudications. By way of contrast, the current legislativeframework in Canada is much more detailed, and much less of the policy articulationfunction is delegated to the enforcement and adjudicatory authorities.

Second, the enforcement function in Canada has been sharply separated from theadjudicatory function — the Competition Policy Bureau in the federal Departmentof Industry is charged with investigatory and enforcement responsibilities, while(depending on the substantive issue) either the general courts or the CompetitionTribunal are charged with adjudicatory responsibilities. In the case of theCompetition Tribunal, no rule-making, investigatory or research functions orresources have been assigned to it. Its functions are purely to adjudicate such disputeswith private parties as the director chooses to remit for review by the tribunal. Thisdivision of functions is felt to minimise the risk of compromising the objectivity ofadjudicative determinations.

Third, the choice between a ‘law enforcement’ model and an ‘administrative review’model of competition law administration (Stikeman, Elliott, Barristers and Solicitors1996) may be important, especially if the administrative review function is locatedwithin the bureaucratic apparatus of government and lacks political distance andindependence from government, risking politicisation of an agency’s decisions.

The composition and procedures of a tribunal

Even if the above issues have been resolved, questions will remain as to thecomposition of the tribunal. As has been noted earlier, the Canadian CompetitionTribunal comprises four all-purpose Federal Trial Court judges (who sit part-time ontribunal matters) and up to eight non-judicial members. The composition of theCanadian Competition Tribunal obviously reflects a compromise between the viewsof those who wished to see all competition law matters left in the general courts andthose who saw advantages to broad jurisdiction over these matters being vested in aspecialised, expert tribunal. How well the compromise has worked is debatable.However, it bears noting that the composition of any tribunal will send signals toprospective parties appearing before it as to what kinds of arguments and evidence itis likely to be receptive to. Will it conceive its functions in a relatively narrow,formalistic, legalistic sense, or will it conceive its functions more broadly as entailingdetailed economic analysis of contested issues brought before it?

After ten years of operation of the new merger provisions, only two contested mergershave so far been heard by the tribunal.39 Each case took over a year from the date ofthe director’s application to the tribunal to the issuance of the tribunal’s decision andentailed many hearing days and the participation of numerous lawyers and experts.Whether such a formalised adjudicative process is warranted is highly debatable and

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stands in sharp contrast to the European Commission merger review process (seeCampbell, Janisch and Trebilcock 1996). The extreme formality of the tribunalprocess has, somewhat perversely, led parties to favour the extreme informality of thefederal Competition Policy Bureau’s decision-making processes, with most cases beingsettled within the bureau. Apart from raising important due process, transparency,and public accountability issues, this has also not been conducive to the elaborationof a clarifying body of public jurisprudence by the tribunal.

The scope of judicial review of tribunal decisions

Both the European Commission and the Canadian Competition Tribunal are subjectto quite expansive powers of judicial review, in the former case by the EuropeanCourt of Justice (and now the Court of First Instance) and in the latter case by theFederal Court of Appeal and ultimately the Supreme Court of Canada. Article 173(1)of the Treaty of Rome provides that the Commission may be challenged on groundsof ‘lack of competence, infringement of an essential procedural requirement,infringement of this treaty or of any rule of law relating to its application, or misuseof powers’. The most common grounds of appeal are failure to give a fair hearing,failure to articulate properly the reasoning behind its decisions, and failure to base adecision on adequate evidence (Whish 1993, p. 262). In the case of the CanadianCompetition Tribunal, decisions may be appealed on matters of law, matters of lawand fact, and matters of fact with leave of the Federal Court of Appeal.

At least two general issues are raised by such broad grounds of appeal. First, it is notclear what comparative advantage general appellate courts possess over a specialisedtribunal in matters of substantive policy, while recognising the appropriateness ofrights of appeal on matters of due process and jurisdiction. Broad rights of appeal onsubstantive issues seem significantly to undermine the rationale for removing theseissues from all-purpose courts in the first instance and vesting them in an experttribunal. Second, private parties who might otherwise be willing to contemplatechallenging the position of the enforcement authorities (the Director of Investigationand Research under the Canadian Competition Act) have to contemplate not onlythe costs, delays and uncertainty of a hearing before the tribunal but also the costs,delays and uncertainty of a subsequent appeal process in the courts. This prospectsubstantially and perhaps inappropriately strengthens the director’s hand in informalnegotiations with the parties.

Private enforcement

The Treaty of Rome does not explicitly confer private rights of action on aggrievedparties, such as rivals or consumers, in respect of violations of the competition lawprovisions of the treaty, but domestic legal systems are at liberty to recognise suchrights, as the British courts have done (that is, rights to injunctive or compensatoryrelief for violations).40 In Canada, the Competition Act confers a right on aggrieved

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parties to sue in the civil courts for single damage compensation in respect of conductthat constitutes a violation of the Act (whether or not there has been a priorconviction). However, this only applies to conduct that constitutes a criminal offenceunder the Act, and not to mergers, abuse of dominant position or vertical restraints,which are subject to civil review on a rule-of-reason basis by the tribunal. Moreover,only the director can trigger proceedings before the tribunal. For example, a privateparty cannot challenge a merger to which the director does not object, and force areview by the tribunal, although in the event of the director precipitating a review,private parties may be given standing in proceedings before the tribunal. The EC andCanadian positions stand in strong contrast to the US experience, where the privatetreble-damage remedy for most antitrust violations has been a prominent feature ofthe US enforcement process, accounting for about 70 to 90 per cent of allenforcement actions.

Clearly, as the US experience demonstrates, the vigour of a country’s competitionlaws will be in part determined by the expansiveness of rights of private enforcementthat it recognises. There are arguments to be made on both sides of the issue (seeRoach and Trebilcock, 1997). Private rights of action provide a check on the integrity,assiduousness and competence of public enforcement authorities. On the other hand,as ongoing US debates over the case for detrebling the damage remedy suggest (seeBreit and Elzinga 1985, p. 405; Easterbrook 1985, p. 445; Hovenkamp 1988, p.233), if one takes a restrained view of the appropriate role for competition laws in agovernment’s economic policy-making functions, private rights of action carry thepotential for strategic behaviour by competitors, suppliers and distributors throughthe dislocation and harassment of often benign private business activities. TheCanadian position reflects a much more cautious view of the role of privateenforcement. Even the single damage remedy introduced in the 1975 amendmentshas rarely been invoked. Proposals are currently under discussion to provide privateparties with direct access to the tribunal in respect of reviewable practices (see Roachand Trebilcock, 1997).

Per se rules versus rules of reason

Per se rules, particularly per se rules of illegality, such as the absurd structural rulesonce governing mergers in the United States that have rightly been derided by criticsof decisions such as that of the US Supreme Court in ‘Von’s Grocery’, and the rulesof near per se illegality that have hitherto applied to many kinds of vertical restraintsin the United States, have fallen into disrepute in most current antitrust scholarship.The most prominent exception to this view is the continuing widespreadendorsement of a per se prohibition of so-called ‘naked’ cartels (see, for example,Posner 1976, p. 39; Bork 1978, p. 263). In other contexts, rules of reason areincreasingly favoured, entailing case-by-case analysis and balancing of competingeconomic theories, evidence and effects. However, rules of reason do not comewithout costs, in terms of straining the adjudicative competence of courts or

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tribunals, protracting hearings, generating increased transaction costs, and subjectingparties to many transactions to high levels of uncertainty. The fact that per se ruleshave been ill-advisedly chosen in the past does not necessarily discredit the concept.Further thought is required as to whether per se rules might be resurrected in a newform, with a particular focus on per se rules of legality. For example, conglomeratemergers with no substantial horizontal elements and vertical mergers in mostindustries might be exempted altogether; horizontal mergers below some sizethreshold might also be automatically exempted. With regard to vertical restraints,various sub-categories meeting well-specified criteria might be exempted altogether.Alternatively, rather than automatic exemptions, strong legal presumptions alongthese lines could be adopted.42 While bright-line rules always entail the vice of beingunder or over-inclusive (or both), it is arguable that these error costs may be morethan compensated by savings in transaction and uncertainty costs as well as error costsin case-by-case adjudication under complex and ill-defined rule of reason standards.

The block exemption process under Article 85(3) of the Treaty of Rome exhibits someof these characteristics, but the negotiation of these exemptions has itself entailedsubstantial costs, delays and uncertainties. Ideally, appropriate rules of per se legalityshould be enshrined in the competition policy legislation itself; as a second-best,enforcement guidelines should be promulgated by enforcement agencies to this end.With the adoption of a per se prohibition on naked cartels, and per se rules of legalityfor conglomerate, vertical and smaller horizontal mergers, and for many kinds ofvertical restraints, the target zone of contentious antitrust enforcement would belargely confined to large horizontal mergers and to some classes of vertical practices.Here, unfortunately, neither economic theory nor any set of legal principles is likelyto yield high levels of determinacy or predictability in adjudication. In Lindblom’s(1959, p. 79) phrase, ‘muddling through’ with an appropriate sense of modesty andcaution reflecting how little we know about the dynamics of industrial organisationmay define our aspirational limits.

INTERNATIONAL DIMENSIONS OF COMPETITION LAW 43

The foregoing review of the evolution of antitrust (or competition) laws in the UnitedStates, Canada and the European Union reveals significant substantive, institutionaland procedural differences. A comparative review of competition laws in otherjurisdictions would reveal even more striking differences (American Bar AssociationAntitrust Section 1991; OECD Committee on Competition Law and Policy 1994;Hawk 1996; Bollard and Vautier, Chapter 6, this volume). These differences ordivergences in domestic antitrust or competition laws have led to increasing calls forharmonisation or integration. According to Ostry (1993), ‘The new arena forinternational policy cooperation is moving beyond the border, to domestic policies.The basic reason for this shift lies in changes in the extent and nature of theinternational linkages among countries which have produced a new type of friction I

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have called “system friction”.’ Ostry (1993, p. 261) argues that a globalising world hasa low tolerance for system divergence.

In this section of the chapter I ask how domestic competition policies (or theirabsence, or ineffective enforcement of them) may improperly constrain internationaltrade and investment. It is now widely argued that as firms attempt to improve ormaintain their competitive position in an increasingly more open economicenvironment, they may take actions aimed at effectively locking competing importsor foreign investors out of their domestic market. A dominant firm or a colludinggroup may engage in predatory behaviour, such as price cutting, to fend off the effortsof a foreign rival trying to get access to its market. Some forms of pricediscrimination, such as loyalty bonuses, rebates and discounts accorded to localpurchasers may deter them from dealing with foreign firms. A group of firms mayengage in horizontal exclusionary behaviour by collectively practising predatorypricing or by collectively boycotting distributors who deal with foreign firms seekingto gain access or suppliers who deal with foreign firms trying to establish a presence.The operation of trade associations may also be anticompetitive if they provide aforum to organise industry cartels with exclusionary effects on foreign competitors orif they are used to discriminate against foreign-controlled domestic companies bylimiting their rights to participate in association activities, including access to productor service certification regimes, thus impairing their competitiveness. Verticalrestraints may also be a vehicle to impede market access and presence. If incumbentmanufacturers have tied up all retailers through exclusive dealing arrangements orthrough full vertical integration, a foreign entrant will have to overcome barrierscreated by the larger amount of capital required and risks entailed in setting up itsown distribution network. Alternatively, a producer which controls all distributionoutlets may charge foreign rivals a higher price in order to allow access to the market,thus limiting their competitiveness. Global rationalisation through mergers andacquisitions can promote oligopoly and oligopsony. Strategic alliances, which arebecoming increasingly common in high technology sectors where R&D costs areenormous, may be efficiency enhancing but may also provide a vehicle to segmentmarkets or to achieve a dominant position (see Zampetti and Sauvé 1995, pp. 19–20;Fox and Ordover 1995, p. 5). Firms given protected home market positions may beable to use their supracompetitive profits to engage in ‘strategic’ (predatory) dumpingin export markets. Alternatively, monopolies or mergers leading to dominantpositions may be permitted by domestic antitrust authorities if most of their outputis sold in foreign markets where rents can be realised by supracompetitive prices at theexpense of reductions in foreign consumer welfare; similarly in the case of exportcartels or domestic cartels that sell most of their output in foreign markets.

In considering future reform strategies, I find the ‘system frictions’ thesis advanced byOstry unhelpful as an analytical guide. In a world of nation–states, system frictionsare everywhere. If the whole world spoke the same language, there would be fewersystem frictions (for instance, in facilitating foreign investment). If everybody in the

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world drove on the same side of the road, there would again be fewer system frictions(for example, in exporting automobiles). If preferences and priorities regardingeducation and credentialling policies, labour policies, environmental policies,culture, health care, law and order and the rule of law, property rights, and almostevery other area of domestic policy-making one could identify were the same theworld over, there would be fewer system frictions. However, in her otherwisemagisterial Handler Lecture on the evolution of competition policy, Fox (1993)speaks repeatedly of her vision of ‘one world’ and the inspiration afforded to the restof the world in this context by the evolution of the European Union.

This general captivation with the EU model seems to me to be seriously misguided.In few, if any, other parts of the world do the special geo-political circumstanceswhich led to the evolution of the European Union exist, and the prospects forcreating the supranational institutions which have been central to the integrationproject of the European Union are close to non-existent. In a trilateral context, withthe prospect of a number of other Latin American countries joining the NorthAmerican Free Trade Agreement (NAFTA) over the next decade, deep economicintegration of the kind that has been pursued in Europe would entail either assigninga hegemonic role to the United States, which would be unacceptable to most, if notall, of the other member states, or adopting supranational federalising institutions,with a more egalitarian distribution of political influence, which would be almostcertainly unacceptable to the United States (recalling the fate of the InternationalTrade Organisation [ITO] over 40 years ago) (see Howse and Trebilcock 1995). In amulticultural context such as the General Agreement on Tariffs and Trade(GATT)/World Trade Organisation (WTO), agreement amongst the more than 100member states on both the substance and enforcement of domestic competition lawswould seem remote.

In my view, it is difficult to approach the case for harmonising domestic competitionlaws in a substantially different way from that of harmonising any number of otherdomestic laws or policies that may create ‘system frictions’. In thinking aboutharmonisation issues generally, and competition policy issues specifically, in either atrilateral or multilateral context, it is useful to bear in mind the distinction oftendrawn in the economic integration literature between negative and positiveintegration (see, for example, Pelkmans 1986; and Pinder 1968, p. 88). Negativeintegration essentially tells countries what policies they may not adopt, while positiveintegration tells countries which policies they must adopt. It is obviously true thatharmonised domestic laws and policies are likely to reduce the administrative(compliance) costs of firms operating across a wide range of jurisdictions, whichwould have to undertake compliance with only one set of rules. In this respect,harmonisation can facilitate freer movement of goods, services and capital. Second,differential or distinctive regulatory requirements can constitute a barrier to entry toa foreign market, where a foreign producer is required to adapt its products todistinctive requirements of the importing jurisdiction. Third, common regulatory

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standards across a range of jurisdictions may enable economies of scale in productionand distribution to be realised. However, as Leebron (1996a, p. 41; 1996b) suggests,‘if the optimal policies for national populations do differ, then harmonisation requiresthat some measure of local welfare be sacrificed’. These welfare losses are unlikely tobe completely captured in measured income estimates. It is true that in manycontexts, domestic policies may not reflect the true preferences of a majority of thepopulation, perhaps because the government is undemocratic or even predatory. Inother cases, policy differences may largely reflect the contingencies of history and nolonger reflect current social objectives or at least the most appropriate means ofrealising them (but rather simply policy inertia). In these cases, policy harmonisationcarries few, if any, costs, and potentially significant benefits. But in a wide range ofother cases, Leebron’s observation presumably holds true. Indeed, many pro-free tradeeconomists, who have generally supported harmonisation efforts within the EuropeanUnion and elsewhere, have at least implicitly recognised this in their rejection of fairtrade and related harmonisation claims in the labour and environmental areas (Howseand Trebilcock 1996, p. 61).

Fox herself, in a recent paper with Ordover (Fox and Ordover 1995), recognises theseconsiderations in identifying as ‘the aspiration and guiding light world welfare,appropriate sovereignty, and national autonomy’ or ‘the one-world-with-appropriate-autonomy vision, but rather like Ostry’s ‘system friction’ thesis, this ‘guiding light’provides very little purchase in itself (like the elusive concept of ‘subsidiarity’ in theEuropean Union), on how to strike the appropriate balance. In other recent papers,(1995a, pp. 181–3; 1995b), Fox spells out in more detail this more cautious vision— what she describes as a ‘targeted constitutional’ approach, in contrast to a‘comprehensive’ approach, on the one hand, or a ‘minimalist’ approach, on the other.

These considerations warrant a cautious approach to proposals for radicalharmonisation of domestic laws and policies, including competition policies. Inadopting this more cautious approach, I return to the negative and positiveintegration distinction noted above. International trade treaties such as the GATThave traditionally emphasised negative integration — namely what kinds of policiescountries may not adopt — and, in particular, have prohibited the adoption ofdomestic policies that either explicitly or implicitly discriminate either betweenforeign trading powers (the most-favoured-nation principle) or that discriminatebetween domestic producers and foreign producers (the national treatmentprinciple), at least beyond certain clearly identified exceptions such as bound tariffsand health and safety and related exceptions set out under Article XX of the GATT,and national security exceptions set out in Article XXI of the GATT.

In developing a more modest agenda for reconciling domestic competition policiesand international trade policies, this approach enables us to develop a useful purchaseon a number of problems. First, exemption from, or non-enforcement of,competition laws for export or import cartels are clearly discriminatory in that theyexplicitly treat either domestic producers or domestic consumers differently from

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foreign producers or foreign consumers.44 While dispensation for export or importcartels may enhance national income (at least in the case of export cartels) in the shortrun, they are myopic in that they encourage a downward spiral or beggar-thy-neighbour dynamic through reciprocal measures that in the long run reduce bothnational and global welfare (much as with reciprocal tariffs) (see Fox and Ordover1995, p. 15; Wolff 1995). These are easy cases. These dispensations should beremoved and appropriate procedural mechanisms adopted for ensuring non-discriminatory enforcement of anti-collusion laws. With respect to these proceduralmechanisms, Fox has developed some useful proposals. She suggests that the homenation where the internal market conduct has occurred should have the primary rightto take enforcement measures. A harmed nation may request a home nation to takeenforcement action against an apparent violation, and the home nation should beobliged to give sympathetic regard to this request. If recourse cannot be had throughaction by home nation authorities or otherwise in home nation courts, the harmednation should be entitled to assert enforcement jurisdiction over the subject matter ofthe controversy, but at the option of the defendant the court should apply thesubstantive principles of the defendant nation’s law (Fox 1995a, p. 34; 1995b, p.182). Assertion of jurisdiction by the harmed nation will, of course, be of little valueif the injurers maintain no presence in the form of personnel or assets in the harmedcountry’s territory. Thus, an additional step would be to build on the Chapter 19binational panel experience under the Canada–US Free Trade Agreement andNAFTA, relating to the application of domestic trade remedy laws (see Mercury1995, p. 525), by providing a WTO or NAFTA panel procedure whereby aggrievedforeign parties (states or firms) could complain to a supranational panel in caseswhere it is alleged that member states are not faithfully interpreting or enforcing theirown domestic competition laws in a non-discriminatory manner.

There also appear to me to be easy cases at the other end of the spectrum. Foreignproducers trading into the US market who collude to fix prices in the US marketshould not be permitted to complain of the relatively stringent US price fixing laws,on the grounds that in their home jurisdiction price fixing laws are lax or non-existent. Thus, I see no objection to the United States asserting jurisdiction in suchcases, as the majority of the United States Supreme Court held in Hartford FireInsurance Co. v. California (1993).45 In Hartford, where United States insurers werealleged to have conspired with UK re-insurers to curtail the availability of certainforms of liability insurance coverage in the US market, to have treated local insurersas subject to domestic price fixing laws while exempting foreign re-insurers ongrounds of extraterritoriality would have entailed discrimination in favour of foreignfirms relative to domestic firms. On the other hand, to the extent that domesticinsurers were able to claim the insurance exemption under the McCarran–FergusonAct from United States antitrust laws, then to hold the foreign re-insurers liablewould have entailed discrimination against them relative to domestic insurers.

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Conversely, US producers trading into or investing in jurisdictions with lax or non-existent anti-collusion laws (that, for instance, may affect the price or supply ofinputs) equally have no basis for complaint, provided that these policies are appliedin a non-discriminatory manner. This observation would extend to permissiveprovisions on joint research and production ventures, research consortia and otherforms of strategic alliances, provided again that the provisions are not framed orapplied in a discriminatory manner. I am thus sceptical of the case for the UnitedStates asserting jurisdiction against Pilkington Glass46 in a recent law suit, allegingrestrictive distribution arrangements impeding effective market access by UScompetitors to other markets around the world.47 Equally, US or other producerstrading into or operating in the European market have no basis for complaint becausethe abuse of dominant position provisions of Article 86 of the Treaty of Rome areapplied somewhat more stringently than the monopolisation provisions in Section 2of the Sherman Act. Similarly, if the European Union should choose to take accountof industrial policy considerations, and not only consumer welfare considerations, inthe administration of its merger law, or conversely some other country should applyits merger law in a more populist fashion designed to prevent concentrations ofeconomic power, foreign firms operating in these markets, notwithstanding sharpdifferences from competition laws obtaining in their home market, should accept thelocal rules of the game (whether perceived to be well conceived or not), provided thatthese rules are applied in a non-discriminatory fashion to both domestic and foreignfirms. Again, if one country chooses to create or maintain state-owned or sanctionedmonopolies in some sectors, foreign producers should have no right of complaintabout being excluded from these markets, given that other domestic producers facesimilar exclusion, although discrimination by such monopolies in sales or purchasingdecisions against foreign firms would be objectionable (as both GATT and NAFTApresently provide) (see Campbell, Rowley and Trebilcock 1995, p. 167).

Other cases are admittedly more difficult. One controversial case relates to therelatively quiescent state of Japanese competition law as it applies to both vertical andhorizontal keiretsu. Vertical production and distribution keiretsu and other exclusivedealing arrangements are alleged to prevent foreign firms from gaining ready accessto Japanese manufacturing, retail and distribution networks. Horizontal keiretsu,because of the prominent role played by lead banks and because of cross-shareholdings, are alleged to prevent foreign investors from readily acquiring Japanesefirms as a means of lower cost and more efficient entry into the Japanese market thangreenfield entry. Data indicate a dramatically lower level of foreign investment stockin Japan than most other industrialised economies, and notwithstanding the majorgrowth in foreign direct investment flows in the 1980s, dramatically lower levels ofinflows into Japan (see Ostry 1995, p. 31). It is true, of course, that Japanesecompetition laws on these matters are facially neutral as between the ability ofdomestic and foreign firms to challenge these arrangements, although one should notbe so naive as to terminate the analysis there. If, as in the case of import cartels, theevidence disclosed discrimination in the application and enforcement of these laws

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depending on whether the complainant was a domestic firm or a foreign firm, thiswould constitute a form of discrimination for my purposes. Moreover, even if thelaws were both framed and enforced in a neutral fashion, one would still want to ask— as many GATT decisions under Article III (National Treatment) and Article XX(exceptions to GATT obligations) have done — whether these laws are a form ofdisguised protectionism or discrimination. This question is not always easilyanswered, because it may be the case that Japanese competition laws do have adisparate impact on foreign exporters or investors relative to domestic producers.However, this is equally true (as I have argued above) of different language laws,driving laws, and the like, so that mere demonstration of disparate impact is notsufficient unless disparate impact is also indicative of a disguised attempt atdiscrimination. In the case of the Japanese keiretsu, given the central role that theyhave traditionally played in corporate governance and organisational structures inJapan (see Gerlach 1992a, 1992b; Gilson and Roe 1992). It is difficult to believe thatthe primary purpose for their adoption has been to differentially disadvantage foreignproducers, even though that may be a consequence. An ironic feature of current USconcerns over Japanese vertical arrangements and lack of antitrust scrutiny of them isthat much recent thinking amongst US antitrust scholars (reflected increasingly inUS case law) has rejected sinister (anticompetitive) explanations of vertical restraintsand views many such restraints as benign (efficiency-enhancing) (see, for example,Mathewson and Winter 1992). In applying the Article XX exceptions to GATT,which may not be invoked where they would constitute a means of arbitrary orunjustifiable discrimination or a disguised restriction on international trade, GATTdispute resolution panels have often applied a least-trade-restrictive means test byasking whether the measures in question are the least-trade-restrictive means available(relative to other available domestic policy instruments) of achieving a country’slegitimate policy objectives. A similar test might usefully be applied to privaterestrictions: Is a private restriction the least-trade-restrictive means available ofrealising its proponents claimed efficiency justifications?

Even if private restrictions meet this test, and thus are not discriminatory in terms ofthe ‘national treatment principle’, more fundamental objections to such restrictions,and indeed other domestic policies of foreign countries, such as the maintenance ofstate-owned or sanctioned monopolies in given sectors, invoke instead a notion ofreciprocity. Here the argument is made that even if these restrictions or policies satisfythe ‘national treatment principle’, if one country has adopted much more liberalpolicies in these respects while another country has adopted much more restrictivepolicies — for example, if the United States has adopted much more assertiveantitrust policies on vertical restraints and has privatised and/or deregulated state-owned or sanctioned monopolies, while Japan has adopted much more permissivepolicies on vertical restraints and allows much greater scope for state-owned orsanctioned monopolies — Japanese firms have much more favourable access to USmarkets, both as exporters and investors, than US exporters and investors with respectto Japanese markets. This claim may well be true. It is also true that the notion of

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reciprocity has long played a central role in international trade policy — for example,in tariff negotiations under the GATT and various regional trading arrangements.However, if this broad notion of reciprocity, or functional equality of access, were tobecome the normative touchstone rather than the ‘national treatment principle’ inaddressing divergences in domestic competition and related policies, the ability ofcountries to maintain any diversity or distinctiveness in a whole range of domesticpolicies would largely be forfeited, with serious implications for notions of politicalsovereignty. Countries which have chosen unilaterally to adopt more assertivedomestic antitrust policies, for example with respect to vertical restrictions, or havechosen to privatise and/or deregulate state-owned or sanctioned monopolies, havepresumably done so for what were conceived to be good domestic reasons, takingfully into account the implications for foreign trade and investment inter alia. Thatother countries have chosen to pursue different policies in this respect, provided thatthey are non-discriminatory, should provide no basis for complaint by the firstcountry, otherwise the latter would be in a position to ‘export’ its domestic policiesto every foreign market in which it has present or prospective trade or investmentinterests, dramatically expanding notions of extraterritoriality beyond any scopehitherto considered defensible. This is not, of course, to foreclose the possibility ofinternational negotiations over such policies (by way of analogy with tariffnegotiations); rather, it is to argue for a highly restrained role for unilateral action byone country with respect to another country’s domestic policies, or indeed agreementson modifications to these policies extracted under threat of unilateral action.

Another problematic case is transnational mergers (see Campbell and Trebilcock1992, p. 5; 1993; 1996; and Whish and Wood 1994). Some cases are easier thanothers. If two firms which are based in country A but sell most of their output incountry B, merge and acquire a dominant position in country B’s market, monopolyrents will be realised in country A but consumer welfare losses will be sustainedprimarily in country B. This may induce the competition authorities in country A toapprove the merger. In my view, this is a form of disguised discrimination againstconsumers in country B, if the competition authorities in country A would havereached a different and adverse conclusion if all the affected producers and consumershad been located within their own jurisdiction. In other words, this is to discriminateagainst consumers in country B and, as with export cartels or tariffs, is myopic in thelonger run (see Fox and Ordover 1995, p. 39). Thus, in my view, competitionauthorities in country B are entitled to object to this merger, as the Federal TradeCommission did in the Institut Merieux/Connaught case (1990),48 despite beingwidely criticised for doing so. This kind of case is not conceptually different from theexport cartel case, except that the discrimination is implicit.

Other cases are not so straightforward. One such example is the widely discusseddecision of the European Commission49 prohibiting the acquisition of de Havilland,a Canadian-based commuter aircraft producer (owned by an American firm, Boeing)by a European joint venture, ATR (whose parents were, respectively, owned by the

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French and Italian governments) on the grounds that the merger would give themerged entity excessive market power in the European (and global) market (withATR being the leading producer of commuter aircraft in the EU and global markets),despite the fact that the merger was not opposed by the Canadian competitionauthorities. On a charitable view of the facts, I assume that the Canadian competitionauthorities had approved the merger pursuant to the efficiencies defence underSection 96 of the Canadian Competition Act (a provision unique to Canadiancompetition law), despite some enhanced ability of the merged entity to raise pricesin its output markets (primarily outside of Canada), and not simply because of adesire to save Canadian jobs or to appropriate monopoly rents from foreigners. In thiscase, we may have a genuine problem of inter-jurisdictional conflict. That is to say,assuming the Canadian authorities would have made the same decision if all of themerged entities’ output had been sold in the Canadian market, it would no longer bepossible to impute discrimination against foreign customers; rather, the source of theconflicting determinations would genuinely reside in differences in the domesticcompetition law regimes applied to the transaction. Conversely, of course, one wouldwant to be reassured that the EU competition authorities would have reached thesame decision had the acquired firm been located not in Canada but in the EuropeanUnion, and the claimed efficiency gains from the merger would have been fullyrealised within the European Union and not Canada.50 Given any reasonableunderstanding of the ‘effects’ test for asserting extraterritorial jurisdiction, bothjurisdictions could legitimately lay claim to jurisdiction in this case, and, on the factsassumed, neither could be shown to have discriminated either against foreignproducers or foreign consumers. The European Union could claim that the consumerwelfare test that it applied enjoys wide currency in other countries’ competition lawregimes (in particular, in the United States) and in much respected academicliterature. On the other hand, the Canadian authorities could reasonably claim thatthe total welfare test applied by them, while perhaps less justiciable and morespeculative, actually accords better with pure economic theory (see Campbell andRowley 1993). Short of a meta-choice, presumably through international agreement,by affected jurisdictions between these two welfare tests in this class of case, such casesof inter-jurisdictional conflict are not easily resolved. In making such a meta-choice,on balance the consumer welfare test is probably to be preferred, in part because itreflects the predominant test applied in US and EU competition law and in partbecause it is more straightforwardly reflective of the consumer (rather than theproducer) protection rationale for competition law (Campbell and Rowley 1993, pp.13, 14).

Another difficult case is one where two firms merge and the relevant geographicmarket is either the global market (for example, if Airbus and Boeing were to merge)or at least a regional market (such as North America). Here, in principle evenapplying a consumer and not a total welfare test, in the first case every competitionauthority in the world could legitimately assert jurisdiction, invoking a reasonableinterpretation of the ‘effects’ test, and in the second case every competition authority

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within the regional market could properly assert jurisdiction. In some cases, themerger may be able to be addressed by requiring divestiture of subsidiaries or assetsin particular sub-markets within the regional market, but in other cases the entiremarket may be served by single companies. It may be possible to envisage negotiatingan international agreement by which a lead jurisdiction is designated by reference toa ‘primary effects’ test, perhaps operationalised by identifying the market where thelargest percentage of the merged entity’s output is likely to be sold (see Campbell andTrebilcock 1996). In a trilateral context, this will mostly be the United States, andthis will also often be the case in global markets, given the size of the US economy.In addition, one might need to contemplate the creation of a supranational authorityin which jurisdiction is vested to determine the lead jurisdiction in the event ofdisputes over whether the relevant market is supranational or where the largestproportion of the merged entity’s output is likely to be sold (Campbell and Trebilcock1996). It should be emphasised that in these last two examples the problem is notnecessarily a problem of discrimination but rather a problem of conflict of laws wherea choice of law (and forum) rule is required in order to resolve the potential for inter-jurisdictional conflict. It should also be acknowledged that these problems of inter-jurisdictional conflict would obviously be drastically reduced or eliminated if allcountries could agree on a common set of competition laws and credibly commit toa consistent enforcement policy, but for reasons noted above this would forfeit thevalue of policy diversity for both purely domestic and supranational transactionswhile agreement on a choice of law and forum rule would much more narrowly targetthe area of required agreement on the latter class of cases only.

Beyond these difficult substantive issues, a range of procedural harmonisationmeasures are much more likely to be resolved in that they appear to representpositive-sum strategies for most countries and their constituents. In this respect, theAmerican Bar Association’s NAFTA Task Force offers a number of extremely usefulsuggestions for enhancing cooperation among domestic competition authorities, andthus minimising duplicate investigative efforts (public transaction costs) (see alsoCampbell, Roode and Rowley 1995), and for minimising the direct transaction costsfaced by private parties in meeting divergent information requirements and decisiontimetables under existing domestic competition law regimes (see NAFTA Task ForceReport, Chapters 4 and 5; and Baker et al., 1997). Bilateral agreements between theUnited States and the European Union, the United States and Canada, and NewZealand and Australia already go some distance towards providing for inter-agencycooperation in competition law enforcement (see Trebilcock 1991).

In contrast to ‘one world’ (or ‘flat earth’) visions of competition as a global organisingeconomic principle, ‘system frictions’ or inappropriate EU analogies applied to themultilateral or trilateral context, which are politically quite unrealistic and indeed atthe limit normatively repugnant in their implications for political sovereignty anddemocratic accountability (concerns that are increasingly manifest even in Europeover the more ambitious integration proposals), a series of more modest multilateral

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or trilateral initiatives might usefully be contemplated. These initiatives would focuson several distinct problems:

• minimising the scope for explicit or implicit discrimination in the formulation orenforcement of domestic competition laws;

• minimising the potential for inter-jurisdictional conflict and hence risk and uncertainty in transactions affecting supranational geographic markets through international agreements on choice of law and forum rules and supranational mechanisms to oversee their application;

• minimising public and private transaction costs in the administration of competition laws through harmonised information requirements, decision timetables, and exchange of information and cooperation amongst enforcement authorities; and

• maximising transparency in the administration of domestic competition law regimes and hence minimising the arbitrary and non-accountable exercise of administrative discretion (and unpredictability).

To advance these objectives, member states of the WTO (or NAFTA) should agree toensure that their domestic competition laws adopt prohibitions against both exportand import cartels and adopt complementary procedural mechanisms to ensureeffective enforcement. With respect to merger law as this might impact oninternational mergers, various forms of procedural harmonisation might becontemplated pertaining to information requirements, decision timetables, andinformation sharing among competition authorities. With respect to substantiveharmonisation, member states with merger laws might commit themselves, in theinterests of transparency, to publishing a set of non-binding merger enforcementguidelines that indicate how these merger laws are likely to be enforced with respectto a common checklist of issues that the guidelines would be required to address (butwithout a commitment to a common position on these issues). In the case oftransnational mergers impacting on supranational geographic markets, internationalnegotiations need to be contemplated over choice of law and forum rules such as a‘primary effects’ test designed to identify a lead jurisdiction for evaluating suchmergers with a possible role for a supranational authority to resolve disputed issues ofjurisprudence. With respect to the contentious issue of vertical foreclosure of effectiveaccess to foreign markets, controversy here is likely to be particularly intense givenwidely differing industrial organisation and antitrust traditions in different countries,and substantial theoretical controversies as to the appropriate form that laws shouldtake with respect to vertical restrictions.51 In this area, it is difficult to contemplateready multilateral consensus on an appropriate set of legal norms. Perhaps the mostthat might be hoped for is that member countries would agree that, as a baseline,vertical restrictions should be included in domestic competition laws as reviewablepractices without sectoral or similar exemptions but without any commoncommitment to the legal norms governing the review process.52 Again, as with merger

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review, it may be possible to reach agreement on a commitment for each memberstate to publish a set of non-binding vertical restraint enforcement guidelines thataddress a common checklist of issues. One might go further by providing a WTO orNAFTA panel procedure whereby aggrieved foreign parties (states or firms) couldcomplain to a supranational panel in cases where it is alleged that member states arenot faithfully interpreting or enforcing their own domestic competition laws in a non-discriminatory manner. In the meantime, it may be useful for the Organisation forEconomic Cooperation and Development (OECD) Competition Law and PolicyCommittee to convene a group of internationally recognised apolitical competitionlaw experts to work on a non-binding model competition code53 that, over time, mayexert an exemplary or exhortatory influence over the evolution of domesticcompetition law regimes (rather like the US Restatements) (Phillips 1994, p. 327).54

This might usefully build on the report by the OECD Committee on CompetitionLaw and Policy, Interim Report on Convergence of Competition Policies (see Phillips1994).

Beyond these competition policy innovations, we should return to the historicalorigins of the tension between competition law and international trade policy inNorth America that consigned the former to a deep second-best policy role andattend to the remaining protectionist elements in international trade policy,particularly trade remedy regimes such as antidumping and countervailing dutyregimes (residual elements of the ‘political fraud’ that characterised the initialenactment of competition laws in North America), and set seriously about the task ofexorcising these elements of mercantilism that constrain the operation ofinternational competitive forces far more than do any aspect of current domesticcompetition policy regimes.55 Because trade remedy laws apply pricing constraints toforeign firms that do not apply to domestic firms, they are inherently discriminatory.In this respect, the outlines of a political deal may be discernible: in return for less-developed countries (LDCs) and newly-industrialised countries (NICs) adoptingbasic competition law measures of the kind outlined above, industrialised countrieswould agree to substantial curtailment of their trade remedy laws and somesupranational oversight in their application — a deal which Mexico in effect acceptedunder NAFTA.56 More radical proposals would entail the complete repeal ofantidumping laws and their replacement with non-discriminatory harmonised cross-border predatory pricing laws, along the lines of the regime adopted by Australia andNew Zealand in 1990 under the Closer Economic Relations (CER) agreement (seeWarner 1992, p. 791; Trebilcock 1991; Trebilcock and Boddez 1995). This distinctiverole for harmonised competition laws surely warrants a high priority.

NOTES

1 The monopolist restricts output to the point where the marginal cost and marginalrevenue curves intersect because, assuming it is able to charge only a single price forwhatever output it produces (that is, that it cannot discriminate between price-sensitiveand price-insensitive customers), lowering the price below PM in the diagram in order to

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capture further sales means foregoing some of the profits on all sales up to that point.(This assumption is relaxed below.)

2 The extent to which the monopolist is able to price above PC is a function of theelasticity of demand which it faces — the more inelastic the demand at the competitiveprice, the greater the capacity to increase price above this level without losing largenumbers of profitable sales.

3 However, it is not clear how these concerns can be rendered justiciable undercompetition law, and it seems likely that other public policies can better addressinequalities of political influence (see Dunlop, McQueen and Trebilcock 1987, pp.67–8).

4 To return to the diagram, if the monopolist were to raise the price for inelastic customerson the demand curve above PM and then set a separate price for more elastic customerson the demand curve below PM and above PC (that is, set two prices), sales to theinelastic customers are likely to decline, while sales to the more elastic customers arelikely to increase, with the net effect on output being unclear as a matter of logic(although in most cases it is likely to be positive).

5 I do not consider here the case of so-called ‘natural monopoly’, where scale effects are solarge that for a single firm in an industry average total costs are falling in the region oftotal industry demand. Here some form of price regulation is more appropriate than acompetition policy response, although it should be noted that in recent years industriesor segments of industries traditionally viewed as natural monopolies — such astelecommunications, transportation, electricity and gas — are now widely viewed ascontestable, leading to deregulation, privatisation and the application of competitionpolicy to their contestable elements.

6 For an overview of the evolution of US antitrust policy, see Peters (1996).7 For an outline of the economic history of the United States leading up to the Sherman

Act, see Dunlop, McQueen and Trebilcock (1987, pp. 8–18). Also see Chandler (1977).8 See Trebilcock (1991, p. 32), describing the views of Di Lorenzo (1985).9 21 Cong. Rec. 2456 (1890). For a discussion of these common law origins, see

Trebilcock (1986).10 For more on this, see the discussion below.11 In Times–Picayune Pub. Co. v. United States, [1953] 345 US (594, the US Supreme

Court held some tying arrangements (whereby the purchase of one good is conditionalon the purchase of a different good) to be per se illegal, and in Standard Oil Co. ofCalifornia v. United States (Standard Stations), 337 US 293 (later overruled by TampaElectric Co. v. Nashville Coal Co. [1961] 365 US 320), the court held exclusive dealingarrangements to be illegal if they represented a significant dollar volume of commerce ina market.

12 For a statement of Arnold’s interventionist views, see Arnold (1937).13 For example, the Clayton Act merger provision (s.7) only applied to acquisition of stock,

not assets; the amendment removed this loophole.14 See, for example, Bork's (1978, pp. 270–4) discussion of United States v. Sealy, Inc.

[1967] 338 US 350. See, more generally, Goldschmid, Mann and Weston (1974). 15 See Salop and Scheffman (1983, p. 267) and Krattenmaker and Salop (1986, p. 209).

According to this theory, many practices of dominant firms, such as bidding up the priceof scarce inputs, are pursued to maintain their dominant positions by raising their rivals'costs. See also Ware (1994, p. 9).

16 For an overview of the evolution of Canadian competition policy, see Doern (1996).17 S.C. 1889, c.41. For discussion of the origins of the Act, see Baggaley (1991), Bliss

(1991, p. 239) and Benidickson (1993, p. 799). 18 For a discussion of the early years of Canadian competition policy, see Benidickson

(1993) and Gorecki and Stanbury (1991, p. 53).

The evolution of competition policy: lessons from comparative experience—115

19 Combines Investigation Act of 1910, S.C.1910, c.9.20 S.C.1951 (2nd Sess.), c.30, s.1. For a discussion of the origins of the resale price

maintenance provisions, see Hunter (1991, p. 177).21 Combines Investigation Act, R.S.C.1952, c.314.22 Combines Investigation Act, R.S.C.1952, c.314.23 Competition Act, Bill C-256.24 S.C.1986, c.26. For a discussion of the process that led to the passage of the Act, see

Clark (1991, p. 227).25 Combines Investigation Act, R.S.C.1970, c.C-23, s.31.1.26 The constitutionality of the provision was upheld by the Supreme Court of Canada in

General Motors of Canada, Ltd v City National Leasing [1989] 58 D.L.R. (4th) 255.27 For an overview of the evolution of EU competition policy, see Wilks and McGowan

(1996).28 Treaty Establishing the European Coal and Steel Community (1951).29 Article 1 of the Treaty of Paris, cited in Goyder (1993, p. 18).30 Article 4 of the Treaty of Paris, cited in Goyder (1993, p. 18).31 Treaty Establishing the European Economic Community, 25 March 1957, 298 U.N.T.S.

3 (1958).32 Council Regulation No.17/62, 13 J.O. 204 (1962) [hereinafter Regulation 17].33 The regulation became effective on 13 March 1962.34 Commission Regulation No. 67/67 of 22 March 1967, O.J. (1967) No. 57 at 849.35 Commission Regulation No. 1983/83 of 22 June 1983, O.J. Legislation (1983) No.

L173 at p. 1.36 According to the notice on Minor Agreements of 1970 (amended in 1977 and 1986),

this threshold is not met if the parties to an arrangement together combine for less than5 per cent of total supply and where the aggregate annual turnover of the parties doesnot exceed 200 million ECU. See Korah (1990, pp. 43–4).

37 Europemballage Corp. & Continental Can Co. v. Commission [1973] 12 C.M.L.R. 199.38 Council Regulation No. 4064/89, amended by O.J. L 257/14 (1990).39 Director of Investigation and Research v. Hillsdown Holdings (1992) 41 C.P.R. (2d)

289; Director of Investigation and Research v. Southam (1992) 43 C.P.R. (3d) 161; seeBodrug and Goldman (1993).

40 Garden Cottage Foods Ltd. v. Milk Marketing Board [1984] A.C. 130 (H.L.).41 United States v. Von's Grocery Co. (1906) 384 United States 270.42 See Easterbrook (1984, p. 1) and comments thereon by Markovitis (1984 p. 41).43 The following section of the chapter is derived from Trebilcock (1996, p. 71).44 For a useful comparative review of the evolution and effects of these exemptions, see

American Bar Association Antitrust Section (1991), Chs 3 and 4.45 1162 ATRR 30. For extensive discussions of this case, see Fox (1995b) and Dam (1993,

p. 289). 46 United States v. Pilkington plc, and Pilkington Holdings Inc. (IV No. 94-345 JVC CD

Ariz. 1994.)47 Both the US Foreign Trade Antitrust Improvements Act of 1982 and the recently

released Antitrust Enforcement Guidelines for International Operations of the USDepartment of Justice and Federal Trade Commission (April 1995) contemplatesubstantial US extra-territorial jurisdiction over foreign restrictions on outbound UStrade.

48 No. 891-0098 Fed.Reg.1614. Also see commentary by Owen and Parisi (1991, p. 11). 49 Aerospatiale-Alenia/de Havilland, Commission Decision 91/619 of 5 December 1991, 1

CEC at 2,034 (1992).50 See Fox and Ordover (1995) for a similar approach on pp. 39, 41 and 46.

116—The evolution of competition policy: lessons from comparative experience

51 See OECD Committee on Competition Law and Policy (1994) for a useful review ofmajor commonalities and differences in OECD member countries’ competition laws.

52 For a similar proposal, see Sharma, Thomson and Christie (1994).53 See Phillips (1994, p. 327) for an initial statement of consensus views. 54 This evolutionary approach to international harmonisation of competition is also

advocated by Petersmann (1994, pp. 276, 277). A more sceptical view of whether there isany problem of significance is taken by Palmeter (1994, p. 417). Palmeter notes that,according to research by Finger and Fung (1994, p. 379), in only one of the 82 Section301 cases concluded in the United States between 1975 and 1992 was an affirmativedetermination based on anticompetitive provisions in a foreign country’s laws and in onlytwo other cases were competition issues even raised. Palmeter (1994, p. 421) concludesthat ‘whatever might be limiting import competition in various national markets, therecord suggests it is not likely to be lack of competition policy’.

55 See Trebilcock and Boddez (1995, p. 1). See Palmeter (1994, p. 422) for a similar view,although he regards this proposal as ‘highly meritorious’ but for the present andforeseeable future as ‘highly utopian’ (p. 418). See also American Bar AssociationAntitrust Section (1994) and Fox and Ordover (1995, p. 32) for similarly temperedpositions.

56 The three parties agreed under Article 1501 of NAFTA to maintain effective competitionlaws. Chapter 19 of NAFTA makes permanent the binational panel review process fordomestic antidumping and countervailing duty determinations initially adopted on atemporary basis under the Canada–United States Free Trade Agreement.

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Baker, Donald, Neil Campbell, Michael Reynolds and William Rowley (1997) ‘Global forumon competition and trade policy — report on harmonization of internationalcompetition law enforcement’, in, William S. Comanor, Akira Goto and LeonardoWaverman (eds) Competition Policy in the Global Economy: Modalities for Co-operation,London: Routledge.

Benidickson, J. (1993) ‘The combines problem in Canadian legal thought, 1867–1920’U.T.Law Journal 43.

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Bodrug, John and Calvin Goldman (1993) ‘The Hillsdown and Southam Decisions: the firstround of contested mergers under the Competition Act’, McGill Law Journal 38.

Bork, R. (1978) The Antitrust Paradox, New York: Basic Books.Breit, William and Kenneth G. Elzinga (1985) ‘Private antitrust enforcement: the new

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Campbell, Neil and William Rowley (1993) ‘Industrial policy, efficiencies and the publicinterest — the prospects for harmonization of international merger rules’, McMillanBinch, Toronto, October.

Campbell, Neil, Hudson Janisch and Michael Trebilcock (1996) ‘Rethinking the role of theCompetition Tribunal’, Paper presented at the conference of the Canadian BarAssociation Competition Law Section, 27 and 28 September.

Campbell, Neil, Jeffrey Roode and William Rowley (1995) ‘The proper framework forcooperation among national antitrust agencies’, Paper presented at Roundtable onCompetition Policy Reform, University of Toronto, 8 December.

Campbell, Neil, William Rowley and Michael Trebilcock (1995), ‘The role of monopoly lawin the international trading system’, International Trade Law and Regulation 1.

Chandler, A. Jr. (1977) The Visible Hand: The Managerial Revolution in American Business,Cambridge MA: Harvard University Press.

Clark, I. (1991) ‘Legislative reform and the policy process: the case of the competition act’,in S. Khemani and W. Stanbury (eds) Canadian Competition Law and Policy at theCentenary, Halifax: Institute for Research on Public Policy.

Dam, Kenneth (1993) ‘Extraterritoriality in an age of globalization: The Hartford Case’, TheSupreme Court Review.

Demsetz, H. (1992) ‘How many cheers for antitrust’s 100 years?’, Economic Inquiry 30.Di Lorenzo, T. (1985) ‘The origins of antitrust: an interest group perspective’, International

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Policy, Oxford: Clarendon Press.Dunlop, B., D. McQueen and M. Trebilcock (1987) Canadian Competition Policy, Toronto:

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—— (1985) ‘Detrebling antitrust damages’, Journal of Law and Economics 28.Economic Council of Canada (1969) Interim Report on Competition Policy, Ottawa: Queen’s

Printer.Finger, J. M. and K. C. Fung (1994) ‘Can competition policy control S. 301?’,

Aussenwirtschaft 49.Fox, Eleanor (1993) ‘Antitrust trade and the twenty-first century: rounding the circle’, The

Record of the Association of the Bar of the City of New York.—— (1995a) ‘Competition law and the next agenda for the WTO’, in OECD NewDimensions of Market Access in a Globalizing World Economy, Paris: OECD.—— (1995b) ‘Jurisdiction and conflicts in the global economy: crafting a systemsinterface’ (mimeo), NYU Law School, 3 March.

Fox, Eleanor and Janusz Ordover (1995) ‘The harmonization of competition and trade law’,World Competition 19.

Gerlach, Michael (1992a) The Keiretsu: A Primer, New York: The Japan Society.—— (1992b) Alliance Capitalism: The Social Organization of Japanese Business.

Gilson, Ronald and Mark Roe (1992) ‘Understanding the Japanese keiretsu: overlaps betweencorporate governance and industrial organization’, Columbia University Law School,Working Paper No. 83, 14 September.

Goldschmid, H., H. M. Mann and J. F. Weston (eds) (1974) Industrial Concentration: TheNew Learning, Boston: Little, Brown & Co.

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Gorecki, P. and W. Stanbury (1991) ‘The administration of and enforcement of competitionpolicy in Canada, 1889 to 1952’, in S. Khemani and W. Stanbury (eds) CanadianCompetition Law and Policy at the Centenary, Halifax: Institute for Research on PublicPolicy.

Goyder, D.G. (1993) EC Competition Law (2nd edn), Oxford: Clarendon Press.Hatfield, H. (1899) ‘The Chicago Trust Conference’, Journal of Political Economy 8.Hawk, Barry (1996) Antitrust and Market Access, Paris: OECD.Holley, D. (1993) ‘EEC competition practice: a thirty-year retrospective’, Fordham

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Hunter, T. (1991) ‘History of price maintenance in Canada’, in S. Khemani and W. Stanbury(eds) Canadian Competition Law and Policy at the Centenary, Halifax: Institute forResearch on Public Policy.

Kleeman, Dietrich (1991) ‘First year of enforcement under the EEC merger regulation: aCommission view’, Fordham Corporate Law Institute, New York.

Korah, V. (1990) EEC Competition Law and Practice (4th edn), Oxford: ESC Publishing.Kovaleff, T. (1990) ‘Preface’, Antitrust Bulletin 35.Krattenmaker T. and S. Salop (1986) ‘Anti-competitive exclusion: raising rivals’ costs to

achieve power over price’, Yale Law Journal 96.Landes, W. and R. Posner (1991) ‘Market power in antitrust cases’, Harvard Law Review 94.Leebron, David W. (1996a) ‘Lying down with Procrustes: an analysis of harmonization

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Mathewson, Frank and Ralph Winter (1992) ‘The law and economics of vertical restraints’,in F. Mathewson, M. Trebilcock and M. Walker (eds) The Law and Economics ofCompetition Policy, Vancouver: Fraser Institute.

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Ostry, Sylvia (1993) ‘Beyond the border: the new international policy trend’, in H.Kantzenbach, E. Scharrer and L. Waverman (eds) Competition Policy in an InterdependentWorld Economy, Baden-Baden: Nomos Verlagsgesellschaft.—— (1995) ‘Challenges for the trading system’, in OECD New Dimensions of MarketAccess in a Globalizing World Economy, Paris: OECD.

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6 The convergence of competition law within APEC and the CER agreement

Alan Bollard and Kerrin M. Vautier

PRINCIPLES OF CONVERGENCE OF COMPETITION LAWS

A theoretical model of international convergence

This chapter does not start from any presumption that the convergence ofgovernment policies or commercial practices between countries is an easy, clear-cut ornecessarily desirable trend from an international viewpoint.1 The welfare implicationsof policy convergence may be indeterminate in general terms, and need to bedemonstrated in particular cases. This section sets up a framework to demonstrate thevarious classes of international commercial transactions. In turn, this allows us toanalyse the costs of differential treatment of these transactions, and thus to analysewhat convergence of competition law between countries might involve and whateffects it might have.

This is initially done by using a transaction cost minimising framework. In itssimplified form, this is illustrated by a model in which production firm x in countryA trades with firm y in country B where the ultimate consumers reside. This situationis represented in Figure 6.1. There are three broad classes of commercial transactionsof interest to us (and most other arrangements may be represented in these terms).

• International vertical relations: It is useful to think of the vertical relationship between firms x and y as potentially having a number of different forms. The mosttraditional is an interfirm trading relationship where x exports to y. At the other end of the spectrum is an overseas direct investment relationship, where capital moves instead of goods and services and the transaction is done inhouse. In that case, x may be a parent company which invests in subsidiary y. In between these extremes there are a wide range of contractual options, sometimes known as ‘newforeign direct investment’. In Figure 6.1 this is illustrated by a joint venture or licensing agreement between two partners, x and y. These relations are traditionally

The convergence of competition law within APEC and the CER agreement—121

governed by international agreements on trade and international aspects of domestic competition law.

• Horizontal relationships dealing in foreign goods: In Figure 6.1, firm y in country B faces another competitor, z, who is supplying the local market. These relationships between y and z may take on a number of different forms. First, theymay be friendly relationships, such as agreements to operate in particular ways (forexample, market sharing or distribution agreements). Such agreements may be formal (such as joint ventures), or implicit (for instance, price leadership). They may be legal (joint ventures, say) or illegal (such as price fixing). They may hurt consumers by increasing margins, decreasing choice or service, and/or they may improve the efficiency of production. Sometimes, interfirm agreements are not considered to offer the necessary integration, and an outright merger takes place. Second, these may be hostile relationships, ranging from healthy competition through to price wars, predatory behaviour or exclusionary deals such as boycotts.Again, these practices may be legal or illegal, and their welfare effects will differ, depending on the circumstances. These transactions are governed by domestic competition laws.

• Domestic/international consumer relations: The third type of transactional relationship in Figure 6.1 relates to the sale of imports or local goods and servicesby firm y to customers in country B. The terms of sale in these transactions are governed by pre-sales and post-sales consumer law, often known as fair trading legislation. This differs significantly between countries.

This taxonomy is somewhat similar to that developed by Wu (1994), where he splitspractices into those involving international cross-border transactions and domestictransactions that have cross-border effects on the one hand and whether or not thepractice is initiated by government or a private party on the other. Internationalcartels, transnational mergers and antidumping measures fall into the internationalcategory while export and import cartels and domestic industry actions to preventforeign entry fall into the domestic category.

The focus of this chapter is the impact that competition law has on internationaltransactions. Competition law relates narrowly to those statutes that cover firms’commercial transactions in the market, as described below.2 In contrast, competitionpolicy is here broadly defined as including all aspects of government policy affectingthe scope for competition between firms and the prevention of inefficient privaterestraints on trade.3

It needs to be noted that competition law is only one of the classes of business lawand regulation that affect international commercial transactions. Other aspects ofinternational commercial policy include securities law, intellectual propertyprotection, international capital controls and international trade policy. Alsoimportant are the range of domestic policies that impinge indirectly (and sometimesunintentionally) on international transactions. It is important to take a holistic view

122—The convergence of competition law within APEC and the CER agreement

of these policies and their overall interaction. Note, however, that this chapter focusessolely on competition law, although of course it is frequently difficult to isolate thelatter’s effects from other related regulation and policy.

Figure 6.1 Taxonomy of international commercial transactions

The competition regulation regimes in any two countries impact on their cross-border transactions. Doing business in another country inevitably involvesuncertainties about how to organise commercial transactions and, in some cases,certainties that there will be unequal treatment of different operators — usually (but

COUNTRY A

Firm x

Partner x

Parent x

COUNTRY B

Localcompetitor z

Agent y

JVpartner y

Subsidiary y

Customers

The convergence of competition law within APEC and the CER agreement—123

not always) a perception by the foreigner that the domestic competitor will receivesome preferential treatment.

Uncertainties about the rules of the game impact on the cost of doing internationalbusiness, with the danger that mutually profitable trades may not occur and domesticconsumers may not get access to the best range of foreign goods at lowest prices. Itcan also impact on the optimal organisational forms for doing business: for example,firms may be forced into joint venture arrangements with local partners whose realrole is nothing more than to smooth the way into the local market, supply contactsor keep the local government happy.

However, it should be noted that while uncertainty about competition outcomes maycause transaction costs, this may not necessarily be reduced by convergence ofcompetition law.

Fox (1991) notes that, as well as these transaction cost issues impinging on privatefirms, there are also welfare questions, in particular the issue of internationalexternalities: the problem of firms engaging in activities that impose external costs onplayers in other countries for which they do not have to pay. One example could bea legalised export cartel, though in practice it would be unlikely to enjoy dominancein regional markets unless it was an internationally coordinated one such as theOrganisation of Petroleum Exporting Countries (OPEC). Another example could bea domestic cartel that controlled imports or local distribution systems, though in thatcase most of the detrimental effects would be felt by the home country.

These are principally arguments for encouraging countries to establish workablecompetition laws and to enforce them, rather than being arguments for competitionlaw convergence itself.

The remainder of this section analyses the effects on international commercialtransactions of competition law convergence between countries. Any such analysisrequires some assumptions. We assume as a counterfactual that firms would continueto trade in an environment of existing but divergent national competition polices. Wealso make the crucial assumption that the competition law in one trading partner isreasonably ‘well designed’, and that competition law in the other country convergestowards this better designed environment.4 Initially, we also assume there are nocomplicating third-country effects.

Competition law convergence is not usually directly addressed in the theoreticalliterature, but general results can be deduced from the established literature oninternational organisation forms and the literature on customs unions. The followingobservations follow from this:

• International producer effects: As in Figure 6.1 above, competition law convergence is likely to mean that the costs of transferring goods and capital will decrease and hence at the margin the volume of bilateral trade will likely increase.

124—The convergence of competition law within APEC and the CER agreement

This implies increased production and possibly increased producer surplus by both foreign firm x and local partner y to their mutual benefit.

• Domestic producer effects: Somewhat akin to trade diversion in customs union theory, if the convergence process induces more trade, then some of it may displacethird-country imports, but some may also displace the production of (presumablyhigher cost) domestic producer z. Assuming again that convergence is towards a well-designed standard, then firm z may no longer be able to use restrictive practices to block the foreign competitor, or else it may find that the newly converged competition law provides a better environment for it to do business. Firm z may, therefore, oppose the convergence process, but this process is not necessarily against its own interests.

• Domestic consumer effects: The impact of competition law convergence on consumers is more likely to be unambiguously positive for several reasons. First, effective competition by foreigners with local companies heightens the competitiveenvironment that the latter operate within, as well as providing a wider range of competing products. In addition, convergence of consumer law to a higher standard means that the consumer has the information necessary to make rationalcomparisons of the utility from these international goods and services. Assuming the convergence is also accompanied by agreements between regulators, these authorities are likely to be able to deal with the extraterritorial enforcement issuesmore satisfactorily.

• Overall welfare effects: The static effects above suggest that competition law convergence is likely to have a positive impact on domestic consumers, foreign producers, and domestic companies dealing with them, but it has indeterminate and possibly negative effects on competing domestic producers.

This analysis is very limited: it ignores the assumptions listed above; it is partial andstatic in scope; and it ignores general equilibrium effects that might impinge onexchange rates and local prices. Externalities from one country’s competition rules (orlack of them) can impinge adversely on another country’s producers or consumers.The analysis also ignores dynamic effects such as the need to maintaincompetitiveness and any counterfactual assumption that a high-cost local producercould expect to remain in business indefinitely. In practice, the latter may be able torestructure and compete effectively or diversify into other operations withoutthrowing its resources into unemployment, thus reducing the negative impacts.

In practice, the welfare effects of customs unions are hard to measure and generallyturn out to be relatively small. One might infer from this the likelihood thatcompetition law convergence effects, while usually positive, will not necessarily bemajor or easily obtained. This welfare analysis also allows the economist to start tothink about the complex political economy of reform: who bears the costs and whogains, and hence who has an incentive to oppose or support a harmonisation process.

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126—The convergence of competition law within APEC and the CER agreement

Types of international competition regulation

The categorisation in Table 6.1 shows the instruments and enforcement mechanismsused to regulate international competition under traditional systems and newcompetition policy systems.

As a generalisation, the traditional instruments used to regulate competition are older,and have arisen in an evolutionary way, generally in order to attain other objectives.Some of these other objectives are economic but they may include social andnationalistic outcomes, and typically are less market-oriented, more proscriptive, andfocus on distributional as well as efficiency outcomes. Traditional enforcementmechanisms reflect their eclectic and evolutionary origins. Some are based on tradepolicy instruments, and some are ad hoc responses to particular situations. The designand effectiveness of competition law instruments today, therefore, depends onwhether they stem from an older era, or whether they have been custom-designed tofit into a deregulated liberalised environment.

The core of modern competition regulation is a competition statute incorporatingsome of the following instruments:

• Merger regime: Almost all competition law regimes cover merger and acquisition with specific provisions. Most important is a merger threshold, beyond which themerged entity is proscribed. The threshold may be some measure based on a lessening of competition or on market dominance, or on monopolisation. There may also be scope for the merged entity to claim offsetting benefits (including efficiences). In some regimes it is compulsory to notify intended mergers, while inother cases there is voluntary pre-notification. A regulatory authority may offer clearances or authorisations, or else legality may have to be tested in a court.

• Abuse of market power: In most regimes, firms with a large amount of market power have special conditions imposed on their conduct. The threshold at which these conditions apply could be a substantial degree of market power or a dominant position. Some competition law regimes use the concept of joint dominance, judging the power of several players together. The provisions may cover all trading practices or they may be restricted to certain classes of goods, certain locations of trades, or certain classes of owner. Exemptions for governmenttrading, international operations such as aviation and shipping, agricultural marketing and labour practices are relatively common. A major issue is whether acompetition regime has a special essential facilities access path and how this is designed. These and other provisions may be enforced by a special industry regulator in key utility industries.

• Restrictive trade practices: Competition laws contain provisions that cover a wide range of trade practices, some of which may be said to be restrictive. These are generally either ‘collusive’ in nature, involving several operators acting in unison (for example, market-sharing agreements) or ‘exclusive’ where a player is held from

The convergence of competition law within APEC and the CER agreement—127

operating in a market (for instance, boycotts). The law usually imposes some type of lessening of competition threshold. Horizontal practices between firms in a market (such as pricing or market-sharing arrangements) attract most attention. However, there are also a wide range of vertical trade practices (for instance, resaleprice maintenance, exclusive dealing arrangements, ties and forcing) that may be covered. As well as a set of general principles, most regimes name some specific practices as either per se illegal or presumed to be so unless authorised. These generally include practices that are unambiguously detrimental to welfare, such as price fixing, but they may also catch more common and welfare-ambiguous practices such as price discrimination, resale price maintenance and exclusive dealing arrangements.

• Unfair trading provisions: This area governs the terms of sale and service between traders and consumers. Sometimes it is integrated into general competition policy;in other cases it is handled by separate law. It covers pre-sale terms and may sometimes also extend to post-sales. Coverage may be related only to certain classesof goods or it may be more generally to all goods and services traded. The customers who gain protection may be limited to personal consumers or the coverage may extend to include business customers. The more prescriptive consumer protection laws include requirements that the trader must satisfy, whereas the less prescriptive fair trading laws merely outlaw misleading or deceptive information to allow the consumer to make a rational judgment — the ‘caveat emptor’ approach. There may be specific information and safety regulationsthat relate to particular products. Intellectual property concerns are frequently handled under ‘passing off ’ provisions of fair trading laws. Note that conceptuallythere may be important differences between consumer law and competition law, although they both cover transactions between sellers and buyers. These differencesmay present themselves in the language of the law, in standards of behaviour, in statutory objectives, and in enforcement approach.

• The regulator: Just as there are many types of competition law, so too there are many approaches to the design of competition regulators. There may be one or more regulatory bodies with limited or broad coverage. A principal question is whether or not general competition agencies exist alongside specialist industry regulators. They may be situated in the judicial arm of the government’s operationswith statutory independence, or they may reside more in the political or administrative arms of government. Most enforce the law and carry out public education, while some also have adjudication, review, arbitration or policy roles. Their powers, sanctions, penalties and remedies differ considerably depending in part on whether there are private rights of action.

128—The convergence of competition law within APEC and the CER agreement

Techniques of convergence

Just how easy and desirable it is for competition laws to converge depends on anumber of issues, including the underlying similarity of the background economicenvironments of the countries involved, the underlying similarity of existingcompetition law, the goals of competition law in each country, and the mechanismsof convergence used.

Economies with similar cultural backgrounds, economic experiences, tradingstructures, business histories, legal and property rights environments andderegulatory experiences find it easier to achieve convergence in competition laws.Those economies that start with similar competition laws find further convergenceeasier. An obvious example is Australia and New Zealand, where the New Zealandcompetition statute was based largely on the Australian statute and has proved anamenable base for further convergence following further economic integration. Ingeneral, similarly endowed countries will find convergence easier, although in suchcases the incremental benefit from this may be relatively lower.

To what extent will competition among competition laws bring convergence withoutintervention? Will governments gravitate towards an optimal competition lawregime? Vautier (1993) argues that for a number of reasons competition laws indifferent countries are unlikely to evolve naturally to become globally optimal. Shealso points out the risk that strong countries could use their dominance to imposecoercive provisions on others. Just as there is no Gresham’s Law of competition policy,neither is there Darwinian survival of the fittest.

Convergence may occur in several ways:

• Unilateral convergence occurs when one country (usually the non-dominant trading partner) moves its competition laws towards those of its partners (althoughthe other country may give lip service to the ideal as well). Under this approach thefirst country may decide to copy parts or all of the other country’s competition lawor enforcement structure, and it may encourage its own regulatory bodies to adoptthe latter’s legal precedent as its own.

• A second bilateral process of convergence occurs when two countries agree to coordinate their approach to competition, implying that the regimes of both will change. Here they could either adopt a common but brand new regime, or they could adopt the regime of a third party, or they could agree to submit to a higherauthority.

• A third approach is truly multilateral and accompanies some broader regional integration. To date EU competition law provides the only example of this.

In practice, there are many practical cooperation measures that could be taken. Theseinclude:

• information sharing and cooperation agreements between regulatory agencies;

The convergence of competition law within APEC and the CER agreement—129

• operational and coordination agreements between agencies;

• agreements regarding mutual extensions of jurisdictions;

• assertions of extra-territoriality without agreement;

• agreements on the treatment of certain practices, such as dumping complaints;

• agreement about broad principles of desirable competition policy goals;

• agreement on broad instruments to be used in achieving competition policy goals;

• agreement regarding particular mechanisms of competition law;

• convergence towards partial harmonisation of competition law; and

• identical law and policy.

Fox (1991) notes that the variety of competition standards now being appliedindependently by individual states, and needing to be complied with byinternationally mobile traders, has become a major issue. Lloyd (see Chapter 7, thisvolume) cites the example of the Gillette–Wilkinson merger, which was subject to theregulation of the different competition law jurisdictions, each with different tests andrequirements.

The process of international convergence of competition law may be compared withthe domestic convergence of law. Surprising as it may seem, in reality most countries’internal competition laws are not fully consistent, in that they treat certain sectors,industries or locations differently. For example, only interstate practices may becovered in federal countries, and there may be exemptions by type of enterprise (suchas government trading operations, cooperatives, trusts, charities and localauthorities), and different treatment of international activities (especiallyinternational shipping, aviation and export cartels).

Australia has recently been through a process of partial internal harmonisationresulting from the 1993 Hilmer Report. Like Australia, Canada has also struggled toharmonise its many aspects of law between provinces. In Europe, internalharmonisation is the role of the European Union, which reviews all cases that haveimpacts across the borders of member countries.

CONVERGENCE OF COMPETITION LAWS WITHIN APEC

A survey of competition laws

This section focuses on the competition laws in the Asia Pacific EconomicCooperation (APEC) member countries and analyses their similarities and futureconvergence. Table 6.2 summarises the main elements of each country’s competitionlaws, based on an unpublished 1994 survey undertaken by the New Zealandgovernment for APEC. The various countries’ laws inevitably differ in a number ofways.

130—The convergence of competition law within APEC and the CER agreement

Table 6.2 Summary of APEC competition laws

a) Merger regime

Public benefitThreshold exemption Notification

Australia Substantial lessening of competition Yes VoluntaryCanada Substantial lessening of competition Yes Size limitChina - - -Chinese Taipei Market share 2>1/3 or - Size limit

1>1/4 or sales levelJapan Substantial restraint of competition Size limit

or unfair trade practicesKorea Restricting substantial competition - Size limitMexico Impending competition and market - Wage limit

participationNew Zealand Dominance Yes VoluntaryPhilippines - - -Thailand Creating a monopoly - Certain firmsUnited States Substantial lessening of Size limit

competition or creating momoply

b) Abuse of market power

Threshold Prohibition

Australia Substantial degree of market power Prevent entry/competitive behaviourCanada Dominance Preventing or lessening of competitionChina - Predatory practices illegalChinese Taipei Dominant enterprises (defined by Prevent competition, maintain prices

market share) abuse positionJapan Monopolisation Unreasonable restraint of tradeKorea Market dominance (designated by Determine prices, control sales,

market share) interfere with othersMexico Substantial market power Eliminate competitors, impede entry,

obtain advantageNew Zealand Dominance Restrict/deter entry/competitionPhilippines Monopolisation Restrain fee competition

c) Horizontal agreements

Otherrestrictive

General prohibition Price fixing Boycotts agreements

Australia Substantial lessening Illegal Authorisable Illegalof competition

Canada Prevent or lesson Illegal Illegal Illegalcompetition unduly

China - - - -Chinese Taipei Concerned actions Authorisable Authorisable AuthorisableJapan Monopolisation or Illegal Illegal Illegal

unreasonable restraintof trade

The convergence of competition law within APEC and the CER agreement—131

Otherrestrictive

General prohibition Price fixing Boycotts agreements

Korea Restriction of substantial Competition test Competition test Competition testcompetition

Mexico Diminish, impair or Illegal Competition test Illegalprevent competition

New Zealand Substantial lessening Authorisable Authorisable Illegalof competition

Philippines Restraint of trade to - - -prevent fee competition

Thailand Specified anticompetitive Illegal by some Illegal by some Illegal by someactivities by controlled firms firms firmsfirms

United States Monopolisation or Illegal - Illegalrestraints to trade

d) Vertical restraints

RPM Ties, etc. Other restrictions

Australia Illegal Competition test AuthorisableCanada Illegal Competition test Competition testChina - Illegal -Chinese Taipei Authorisable Reasonableness test Reasonableness testJapan Illegal Competition test Competition testKorea Authorisable Reasonableness test Competition testMexico Competition test Competition test Competition testNew Zealand Authorisable Competition test Competition testPhilippines - - -Thailand - Illegal by some firms Illegal by some firmsUnited States Prohibited Competition test -

e) Juristictions: exceptions

Government Intellectual Labour

Specified cartels Specified industries agencies property markets

Australia Export cartels Shipping, telecoms State agencies Exempt except Included

exempt misuse of power

Canada Export cartels Underwriting (in part) Not exempt Partial exemption Exempt

amateur sport

China - - - -

Chinese Taipei Import, export, Public utilities, Exempt for Exempt if Exempt

rationalisation and communications and period reasonable

depression cartels transport etc exercise

(authorisable)

Japan Import, export, Specific exemptions, Exempt Exempt

rationalisation and mainly agriculture,

depression cartels finance, transportation,

(authorisable) wholesaling

132—The convergence of competition law within APEC and the CER agreement

Government Intellectual Labour Specified cartels Specified industries agencies property markets

Korea Rationalisation and Industries other than Partial exemption Exempt -

depression cartels specified list

(authorisable)

Mexico Specified exporters Specified strategic Exempt in IP deemed not Unions deemed

sectors strategic sectors a monopoly not monopolies

New Zealand Export cartels Shipping, Not exempt Exempt except Exempt

notifiable pharmaceuticals misuse of -

dominance

Philippines - - - No exemption -

Thailand - - Exempt - -

United States Export cartels Aspects of agriculture, Largely exempt - Workers can act

partially exempt communications, collectively

energy, transport,

0.insurance

f ) Unfair trading

Prohibitor

Australia Misleading/deceptive conductCanada Misleading/deceptiveconductChina False/misleading informationChinese Taipei Misleading claimsJapan Misleading representationsKorea False/misleading representationsMexico –New Zealand Misleading/deceptive conductPhilippines Untrue, deceptive, misleading advertisingThailand –United States Unfair/deceptive Acts

g ) Roles, enforcement, powers

Competition agencies Courts Private actions Sanctions

Australia Enforce, authorise, Determine Available Fines, injunctions,education contraventions divestiture,

appeals damagesCanada Enforce, review, Determine Available Fines, prison, prohibition

educate contraventions orders, injunctions,appeals damages, divest

China – – – FinesChinese Taipei Enforce, promulgate – Available Fines, prison, injunctions,

rules triple damagesJapan Enforce Appeals Available Fines, prison, injunctions

cessation orders, damages

The convergence of competition law within APEC and the CER agreement—133

Competition agencies Courts Private actions Sanctions

Korea Enforce, authorise make rules policy Appeals Not available Fines, restitution orders,

injunctionsMexico Enforce, authorise, Appeals Limited availability Fines, injunctions,

education divestiture, damagesNew Zealand Enforce, authorise, Determine Available Fines, injunctions,

education contraventions, divestiture, damages,appeals court orders

Philippines Enforce Criminal Not available Fines, prisonjurisdiction

Thailand Make orders Impose penalties Not available Fines, prisonUnited States Enforce, make rules, Determine Available Fines, prison, restitution

policy contraventions, orders, injunctions,appeals divestiture, court orders,

triple damages

The most venerable origins of competition policy come from traditional China. Liu(1995) records a number of examples, including Article 33 of the miscellaneousprovisions of the Tang Code enacted in 737 AD, which prohibited any person who isselling or buying goods from forcibly creating a barrier to entry in the marketplace,fixing the prices of goods they would buy or sell, or misrepresenting the prices of suchgoods.

Some Western competition law is well established: Canada and the United Statesenacted competition legislation towards the end of the last century. The two countriesalso have a long history of competition cooperation (Addy 1995). Prior to that,private restraints impeding commercial rights were mainly handled under thecommon law or general legal system. Most Organisation for Economic Cooperationand Development (OECD) countries have for many years applied elements ofcompetition law under headings such as unfair profiteering but have not had amodern comprehensive competition law until the last few decades. Those countriesthat have modernised their competition laws in the last few decades, such as NewZealand and Canada, have incorporated some distinctly new concepts underpinnedby new industrial economics principles such as contestability theory and transactionscost theory, which leads the focus away from older market-share measures of marketpower towards newer concepts of dominance.

Some East Asian countries such as Japan and the Philippines have competition lawsthat bear the hallmark of US influence, though they also retain some distinct aspectsof their own.5 APEC countries such as Mexico and Chinese Taipei that have adoptedcompetition laws relatively recently have taken the opportunity to incorporatemodern competition policy concepts. In recent years many countries have seriouslyconsidered the introduction of broad-based antitrust laws for the first time; theseinclude China, Mongolia, Vietnam, Thailand, Malaysia and Indonesia.

134—The convergence of competition law within APEC and the CER agreement

China has included some elements of competition law in its 1993 Act Against UnfairCompetition and plans to include others in a future antimonopoly law. Thailandalready has a competition law covering some forms of anticompetitive behaviour andhas a draft law for new legislation before parliament; Malaysia is currently activelyworking towards developing competition laws.

Korea, Thailand and, to some extent, Japan have adopted competition laws thatincorporate some aspects of their broader industry policies, such as exemptingauthorised rationalisation and depression cartels, with exemptions for some ‘strategic’sectors. Economies such as Singapore, Hong Kong and Papua New Guinea have nogeneral competition law although they do have other statutes impinging oncompetition.

Some countries with federal structures such as the United States and Australia havedevolved some of the competition regulatory powers away from federal authority tostate governments. Most countries designate a single named body as their specialistcompetition authority. The degree of administrative and operational autonomy ofthese bodies differs considerably, as do their powers and their jurisdictions. In somecases — for example, New Zealand — they enjoy near-blanket jurisdiction, whilesome (such as the United States) are split by industry sectors, some (like Australia) aresubject to limited powers over certain state activities, and others operate alongside aregime of utility and industry-specific specialist regulators.

Table 6.3 Market power thresholds

Some legal thresholds used in competition law

Economic description of Market structure Market behaviour the market approach approach

Perfect competitionWorkable competition Low market sharesImperfect competition Impeding competition

Substantial lessening of competition

Oligopoly High market shares Substantial degree of market powerMarket dominance

Monopoly Monopolisation Absolute controlTypical measures of market Market shares Lerner indexespower Concentration ratios Profitability measures

Other behavioural HH indexes measures

While competition law changes from time to time, competition policy objectives havebeen relatively durable in most countries. The most common of the objectives are themaintenance of the competitive process or the protection or promotion of effective

The convergence of competition law within APEC and the CER agreement—135

competition. Other common themes are preventing abuses of economic power andachieving economic efficiency. In addition to these primary objectives, somecountries’ competition laws have supplementary objectives such as protecting smallbusiness or broader economic aims. These countries may face particular difficulty inachieving multiple objectives (OECD 1993).

Most countries have two market power thresholds that are specified in theircompetition laws: one is the threshold above which merger is prohibited or subjectedto special conditions, and the other is the threshold above which certain firm or inter-firm behaviour is prohibited or is subjected to special conditions. These thresholds areeither defined in traditional forms such as a particular maximum market share for aleading firm, or they are defined in market behaviour terms — for example, alessening of competition. The exact terms vary considerably.

Table 6.3 illustrates some of the legal thresholds used in APEC competition law andshows how they rank. In particular, the more traditional market structure measuresrelating to market shares contrast with the newer market behaviour approachesrelating to competition outcomes.

Competition laws also differ on whether to establish clear rules of contravention, orinstead to lay down behavioural outcome standards. The former (‘per se rules’) aremore frequently the result of an administratively regulated system and are morecapable of setting out clear rules for businesses to follow without requiring complexlegal interpretation. The latter (‘rules of reason’) more frequently require a court oradjudicator to interpret on a case-by-case basis, and the business must followprecedent and exercise its own legal judgement. The latter is more capable ofdelivering a welfare-enhancing route through the conflicting objectives of efficiencyand fairness for any particular practice, while the former offers lower transactioncosts.

Thus, a trade practice such as a tie, which in theory is indeterminate in its welfareeffects, might be treated as per se illegal, or else it might be considered legal butsubject to some competition test. Horizontal collusion practices like price fixing aremore frequently thought to be welfare-damaging, and more often are illegal, whilevertical practices such as exclusive dealing arrangements are more often subject tosome test of competition.

As can be seen from these arguments, there are many different ways of classifyingcompetition laws. In order to illustrate some broad patterns and to provide a way ofclustering similar types of competition laws, Figure 6.2 uses two major underlyingcharacteristics of design and enforcement as a basis for classification — ‘structure-based’ and ‘outcome-based’. In the former, the focus is on market-share typethresholds for merger, with per se rules defining illegal trade practices. In the latter,practices are judged not on the size of the market players but on their competitiveoutcomes — ‘outcome-based’ law is characterised by behavioural thresholds formerger and rules of reason regarding trade practices.

136—The convergence of competition law within APEC and the CER agreement

Figure 6.2 Indicative mapping of competition laws

The enforcement of competition law is defined in the figure as being more or less‘administrative’ or ‘judicially-based’. This may be enforcement by the administrativearm of government (usually a government department or agency) or by the judicialarm of government (a court or specialist quasi-judicial body). The former is likely tohave more oversight by the political arm of government and the latter is more likelyto enjoy political autonomy. The former implies a government monopoly onenforcement. The latter is more likely to admit private legal actions. Exemptions tothe law are more likely in the former than in the latter.

Figure 6.2 provides an indicative mapping of APEC competition laws based on thesespectra of design and enforcement. Interestingly, it shows two broad clusters of laws,one that is designed around market structure and enforced by administrative bodies,and another that is designed around competition outcomes and enforced by thejudiciary. Furthermore (with a few outliers) the mapping appears to delineate

• United States • Canada • New Zealand

• Australia

• Mexico

• Japan

• Korea

Chinese Taipei •

• Philippines

• Thailand

• China

Administrative-basedenforcement

Judicially-basedenforcement

Structurally-baseddesign

Outcome-baseddesign

The convergence of competition law within APEC and the CER agreement—137

between Western laws (above the axis) and Eastern laws (below the axis) and alsobetween older legal regimes (left-hand side) and newer regimes (right-hand side).

Convergence to date

Harmonisation of policy objectives

The move towards internationalising competition policies has been a postwarphenomenon. Vautier (1993) documents the earlier attempts to link tradeliberalisation and competition policy through the General Agreement on Tariffs andTrade (GATT), the United Nations Conference on Trade and Development(UNCTAD) and by the 1980s through the OECD. In 1986 the OECD Councilrecommended a series of policy principles to strengthen competition in national andinternational markets. These included the application of trade policy measuresaffecting competition, and procedures to minimise conflicts between trade andcompetition policies. In particular, they recommended that ‘a member countryshould consider impacts on competition before approving export and import cartelsand export limitations agreements; should not encourage them when they are anti-competitive; and should co-operate in each other’s investigations of possible anti-competitive efforts’ (OECD 1988).

Recently, the OECD Competition Law and Policy Committee has begun working toproduce a revision of the 1986 recommendation on cooperation among enforcementagencies. A recent study on international mergers found that rules governingconfidential information were the single greatest procedural obstacle to increasedcooperation. The study also sought to learn from the examples of other lawenforcement officials on international cooperation in the fields of tax, securities andcrime.

In 1995 the OECD updated its recommendations, setting out principles for thecoordination of investigations (recommending that competition enforcementauthorities provide government-to-government notification when an enforcementaction may directly affect the interests of another member country or its nationals),the sharing of information including confidential information, positive comity(bringing enforcement actions at the request of another authority), the provision ofmutual assistance and investigations (such as one authority using its compulsorypowers to obtain information to aid another), and the sharing of costs ofinvestigations.

There has also been some pressure through the OECD from trade officials who feelthere has been inadequate enforcement of national competition laws, an argument infavour of bringing competition policy into the World Trade Organisation (WTO) atsome stage (Phillips 1995). Further discussions of the interaction between trade andcompetition policy is likely to enter the WTO arena. In the 1990s the Pacific

138—The convergence of competition law within APEC and the CER agreement

Economic Cooperation Council (PECC) has also taken up the issue, outlining a ‘new’trade agenda with reference to trade and competition policy links in the Pacific region(Feketekuty 1993).

Harmonisation and free trade agreements

The most experience in the harmonisation of competition law and policy to datecomes from the record of the European Union, the North American Free TradeAgreement (NAFTA) and the Closer Economic Relations (CER) agreement betweenAustralia and New Zealand. The CER experience is examined in detail in the secondhalf of this chapter.

The European Union handles monopolies and merger control under Article 86 of theTreaty of Rome, which requires that member states agree to no abuses of a dominantposition. It has also promulgated rules regulating international merger practice.Cartels and horizontal trade practices are handled under Article 85, which prohibitsagreements restricting trade in certain situations.

NAFTA is at this stage far less harmonised in its competition law and policy; itaddresses cartels by proscribing anticompetitive business conduct, and allows for thedesignation of a monopoly subject to certain obligations being met (Wu 1994).Article 1501 of the NAFTA Act provides that the signatories shall adopt or maintaincompetition laws and shall consult and cooperate with each other about enforcement.Article 1504 establishes a working group to report on competition law and policy andtrade law issues.

In 1991 a US–EU antitrust cooperation agreement was signed. This allowed oneparty to ask the other to conduct an antitrust investigation. The European Union andthe United States reached agreement in 1995 regarding the mutual application oftheir competition laws. Biennial high level meetings are held between the EuropeanCommission and US Antitrust Authorities. The European Union has openednegotiations with Canada on a draft bilateral cooperation agreement in the area ofcompetition. There are also annual bilateral meetings between the DirectorateGeneral IV of the European Union and the Japan Fair Trade Commission, and therehave been approaches by the European Union to other APEC countries regarding theexchange of information.

Inter-agency regulatory agreements

These and other bilateral expressions of cooperative intent rely on inter-agencyregulatory agreements and ultimately on closer working relationships.

In 1995 the Federal Trade Commission and the US Department of Justice jointlyissued ‘anti-trust enforcement guidelines for international operations’, emphasisingtheir commitment to cooperate with foreign competition authorities. In addition, in

The convergence of competition law within APEC and the CER agreement—139

1994 the United States passed the International Anti-Trust Enforcement AssistanceAct, permitting US agencies to provide confidential information to foreign antitrustauthorities, pursuant to agreements that meet the Act’s requirements.

The United States now has formal bilateral cooperation agreements with Australia,Canada and Germany. These agreements are principally defensive, designed to avoidconflicts arising out of the extraterritorial enforcement of US antitrust law. Theyinvolve notifying enforcement issues, consulting to resolve differences, and sharinginformation.

The Australian Trade Practices Commission (now the Australian Consumer andCompetition Commission) has also been active in pursing inter-agency agreements.It maintains formal and informal arrangements with several other agencies in theregion including Canada, United States, Japan and Chinese Taipei. The TradePractices Commission/New Zealand Commerce Commission Agreement is discussedbelow.

Harmonisation under APEC

Wu (1994) notes that the APEC Eminent Persons Group recommended in 1993 thatAPEC consider adopting a policy based on one of the existing models of internationalcooperation on competition policy, principally because it was felt that tradeliberalisation needed the support of an effective competition policy. In the BogorDeclaration of 1994, APEC members committed themselves to the long-term goal offree and open trade in investment in the Asia Pacific region at the latest by 2010 forindustrialised countries and by 2020 for developing countries. The memberspromised to pursue this goal by continuing to reduce barriers to trade and investmentin a GATT-consistent manner. In itself this does not necessarily commit members toliberalise on a non-discriminatory or most-favoured-nation basis.

The Bogor Declaration does, however, foresee the APEC region heading towards thedismantling of all impediments to all international economic transactions within theregion, including trade, investment and other international economic transactions.Such impediments would include divergent domestic policies (including competitionpolicy) and would take place through continued liberalisation of internationaleconomic transactions, facilitation of trade and investment, technical cooperation toshare information and expertise, and economic policy coordination to reduceuncertainties.

An Australia–Japan Research Centre (1995) report proposes that this process includeagreement on and implementation of region-wide minimum standards forcompetition. The only specific measures the report suggested were the harmonisationof a wide range of standards and the cessation of dumping actions among APECparticipants, which would be handled by competition law. APEC’s Osaka Action Plan

140—The convergence of competition law within APEC and the CER agreement

includes a recommendation to: ‘consider developing non-binding principles oncompetition policy and/or laws in APEC’.

Others — such as Fels (1995) and Han (1995) — have argued for an APECcooperation agreement to help inter-agency cooperation. Varney (1995) emphasisesthere is already a large amount of antitrust cooperation among some APEC countriesand suggests an initial role for APEC as a clearing house, helping member companiesto keep abreast of competition cooperation. Given the variations in economies andlegal systems within APEC in the region, Varney argues that APEC probably shouldnot try to coordinate or mandate any wider competition role. She sees cooperation aspresenting the best first step rather than moving immediately towards convergence,due to substantive differences between countries and systems.

The APEC Committee on Trade and Investment has discussed a work programme oncompetition policy which includes a possible mechanism for technical assistance to beprovided to member economies on competition laws and encourages cooperationbetween enforcement agencies in relation to the investigation and enforcement ofcases of common interest.

What APEC does not offer at this stage is any platform on which to harmonise thewording of competition laws. Indeed, the experience of the CER agreement and theEuropean Union is that this is never likely to fully occur, except amongst economieswith a common economic and legal base and enjoying a much tighter economic unionthan APEC intends.

Nor would completely harmonised competition law necessarily be a desirableoutcome. There is not much evidence that lack of harmonised competition law hashindered the very rapid growth in international economic integration by the highgrowth East Asian economies, at least in its early stages. For example, in many of thehigh growth regions such as the Pearl River–Coastal South China region and theJahore growth triangle, the participating economies have not had anything likeharmonised competition law, if indeed any competition law at all. Liu (1995) notessome major differences between the competition laws of China and Chinese Taipeidespite common cultural and institutional strands. He concludes that it cannot beassumed that competition laws are yet important features in these economies.

The benefits of convergence may be more marked at later stages of economicintegration. In the meantime, competition laws should continue to meet thecharacteristic needs of individual countries and they need to be continually evolvingwith new trading practices. What is desirable is that while staying in line with theabove harmonising principles, each country can learn from and copy the experiencesof the best performers in APEC in designing and enforcing their competition laws.

The convergence of competition law within APEC and the CER agreement—141

Similarities among APEC competition laws

To measure how similar each country’s competition law is to each other, and hencehow practical further convergence might be, we have constructed a simpleconvergence index in Table 6.4 (based on the information in Table 6.2). Thecharacteristics of each country’s competition law are assessed with regard to theirtreatment of mergers, dominant firm behaviour, horizontal agreements, verticalrestraints and unfair trading. In addition, the judicial and enforcement characteristicsare assessed. For each of these seven categories, the competition law similaritiesbetween each country-pair are assessed, and then assigned a mark, which is higher thecloser the two laws are together.

A number of major qualifications need to be noted immediately. Table 6.4 is based on1994 survey returns and is not completely up-to-date. In addition, the survey did notachieve complete coverage, and it is subject to different interpretations of varyingcountry practices, and indeed different linguistic translations of particular thresholdsand contraventions. The assessment of country-pair similarities is inevitably sketchyand somewhat subjective. Further, Table 6.4 focuses only on stated competition lawand assumes that the law is interpreted and enforced as stated. Divergence betweenwritten law and actual practice, such as uneven or inadequate enforcement (forwhatever reason), is common in some APEC countries, but it is not adjusted for inthis measure.

Several other countries are currently designing or contemplating competition laws butthese are not yet at the stage that they can be included in the table. Note that theinformation is restricted to relatively narrow interpretations of competition law anddoes not allow conclusions about wider aspects of competition policy. Note also thatthis table does not provide a measure of liberalisation, no matter how tempting it maybe to read this into it. The overall convergence index is actually a measure of closenessto the APEC norm, not a measure of reform or liberality. As a result of all thesequalifications, no more than generalising conclusions should be drawn from thesedata.

These conclusions suggest that while there may be some commonality in competitionobjectives amongst APEC countries as a whole, these objectives are currentlyaddressed by quite different forms of competition law. Examination of country-pairsin the data suggests there are limited patterns of similarity, as follows:

• The Australia–New Zealand nexus is the strongest. Australia and New Zealand arethe only two countries whose competition laws could really be said to be synchronised. They are rated in Table 6.4 at 77 per cent. This relatively convergedpairing is the subject of a case study in the second part of this chapter.

• With the addition of Canada, there is a three-country grouping that shows strong similarities based around a British legal system.

Tabl

e 6.

4M

easu

res

of s

imila

rity

bet

wee

n co

untr

y co

mpe

titi

on la

ws

(sco

res i

n pe

rcen

tage

form

)

Chi

nese

New

Uni

ted

Ove

rall

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tral

iaC

anad

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hina

Taip

eiJa

pan

Kor

eaM

exic

oZ

eala

ndPh

ilipp

ines

Tha

iland

Stat

esin

dex

Aus

tral

ia0

42C

anad

a67

043

Chi

na17

170

19C

hine

se-

Taip

ei41

4617

038

Japa

n41

4717

470

42K

orea

4344

1753

540

41M

exic

o47

5017

3141

410

37N

ew Z

eala

nd77

7017

5353

5659

047

Phili

ppin

es20

2029

2131

3114

230

25T

haila

nd17

1621

2629

2723

1423

023

Uni

ted

Stat

es51

5317

4361

4647

4736

290

43

Not

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he s

core

s in

thi

s ta

ble

are

calc

ulat

ed f

rom

the

des

crip

tion

in T

able

6.2

of

each

cou

ntry

’s co

mpe

titi

on la

w in

rel

atio

n to

the

22

com

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for

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imila

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bet

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here

is s

ome

subj

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in t

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mea

sure

s.O

vera

ll in

dex:

The

set

of

scor

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or e

ach

coun

try

is a

vera

ged

to g

ive

this

cou

ntry

’s ov

eral

l con

verg

ence

mea

sure

. It

coul

d be

inte

rpre

ted

as a

n un

wei

ghte

d in

dex

of t

hecl

osen

ess

of e

ach

coun

try

to s

ome

hypo

thet

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APE

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orm

. The

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her

the

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som

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sts

appl

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som

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ffer

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lega

l wor

ding

;3

indi

cate

s sa

me

prin

cipl

es o

f la

w, s

light

ly d

iffe

rent

tes

ts u

sed;

2 in

dica

tes

sam

e pr

inci

ples

of

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y, d

iffe

rent

law

s ap

plie

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indi

cate

s no

or

only

slig

ht s

imila

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in p

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nd0

indi

cate

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law

or

polic

y in

use

.

The convergence of competition law within APEC and the CER agreement—143

• The US–Japan pairing, at least on paper, looks relatively strong scoring 61 per cent.The competition principles laid down in Japan after the Second World War clearlydrew on US law. Despite this, there are significant differences in the way the two countries interpret and use their competition laws.

• There is a grouping of countries with relatively new competition laws — Mexico, New Zealand, Canada, Korea and Chinese Taipei. All have laws enacted within thelast decade or so, and they all share some modernising principles. They score similarity ratios of 40–60 per cent or more.

• There is a grouping of East Asian ‘tigers’ whose laws record similarities in the 40–60per cent range. This includes Japan, Korea and Chinese Taipei. In these cases the similarities probably stem from certain underlying similarities in the countries’ industry policies.

• The competition laws of the OECD developed country grouping within APEC show some general similarities amongst themselves, more so than amongst the fastgrowing East Asian countries.

• The competition laws of the NAFTA grouping of the United States, Canada and Mexico also show some similarities, but they could not be said to be highly harmonised in the CER sense.

• China, Thailand and Philippines stand out as having individualised or partial regulation of competition that has relatively little in common with other countriesin the region. Much of the ASEAN region still has no formal competition law anduntil recently has shown little interest in harmonisation on this theme.

CONVERGENCE OF COMPETITION LAWS WITHIN THE CERAGREEMENT

Trans-Tasman integration

In 1983 New Zealand and Australia signed the CER agreement, a free tradearrangement which allowed in 1990 unimpeded trade in all merchandise goodsbetween the two countries (but not all services). This agreement both reflected andcontributed to growing trans-Tasman economic integration in trade (especiallymanufacturing products), investment and, to a more limited extent, services trade andlabour movement.

Pursuant to a 1988 Memorandum of Understanding on the harmonisation of businesslaws, Australia and New Zealand undertook to consult one another over changes totheir regimes with a view to appropriate harmonisation. Competition law has beenthe main focus in practice.

144—The convergence of competition law within APEC and the CER agreement

As part of the 1988 CER Review, the two governments also agreed that, when freetrade was accomplished in 1990, the trans-Tasman anti-dumping remedy would beremoved and certain trans-Tasman competition provisions would be introduced intoeach national law. By international standards, this represented a rare step towardsintegrating instruments of trade policy and competition policy. It reflected a shift inpolicy priorities from trans-Tasman dumping — with its focus on cross-border pricediscrimination and material injury to producers — to ‘predatory’ trans-Tasmanconduct harmful to the competitive process. The traditional trade policy language of‘fairness in trade’ was replaced with the language of competition policy and law —‘competition, efficiency and consumer welfare’.

The trans-Tasman competition provisions were driven more by the pricediscrimination issue than by any broader policy objective to apply a competitionstandard to all forms of conduct affecting all trans-Tasman trade (including trade inservices). A broad-based trans-Tasman competition law was neither the mainachievement nor the main objective of the 1990 amendments. Such a shift in policywould have required a much more comprehensive approach to the application ofcompetition law to trans-Tasman trade. It would, for example, have requiredextension to contracts and arrangements which substantially lessen competition inmarkets within Australia and New Zealand.

In 1990 both countries also amended their laws relating to the enforcement of ordersand judgments to allow their courts to sit in each other’s jurisdictions in respect ofcompetition law cases arising from the trans-Tasman competition provisions.

As shown by the measures of competition law similarity (Table 6.4), Australia andNew Zealand are the two APEC economies that have made the most progress towardscompetition law convergence; this has been part of a more general process ofconvergence of the two economies. We now turn to discussion of the competitionlaws of each country (see Table 6.5), which illustrate the complexity of this policy areain practice. We then set out features of the main provisions and where differences inthreshold, prohibition and procedure still exist and look at the implications for trans-Tasman corporate operations.

Table 6.5 Competition laws in Australia and New Zealand, 1996

Australia New Zealand

IntroductionThe statute Trade Practices Act 1974 and Commerce Act 1986 and

amendments amendmentsObjective Enhance welfare of Australians through Promotion of competition in

promotion of competition and fair trading markets inNew Zealand

MergersThreshold Substantial lessening of competition DominanceProhibition Acquiring or strengthening Acquiring or strengtheningAuthorisable? If public benefits outweigh detriments If public benefits outweigh

detriment (must have regardto efficiency)

The convergence of competition law within APEC and the CER agreement—145

Australia New Zealand

Procedure Voluntary application for authorisation Voluntary application for clearance, authorisation

Market powerThreshold Substantial degree of power DominanceProhibition Preventing entry Restricting entry

Preventing/deterring competitive conduct Preventing/deterring competitive conduct

Eliminating or damaging competitor Eliminating any personAuthorisable? No No

Vertical arrangementsThreshold Substantial lessening of competition, Substantial lessening of

exclusionary arrangements competition, exclusionary arrangements

Prohibition Contracts, arrangements, understandings Contracts, arrangements, understandings

Authorisable? If resulting public benefit If resulting public benefitSpecial provisions: Presumed illegal Presumed illegal, but

authorisable–RPM–Price discrimination Some illegal Substantial lessening of,

competition test, authorisable–Third line forcing Presumed illegal Substantial lessening of

competition test, authorisable–Exclusive dealing, Subject to competition test Substantial lessening of

ties, etc. competition test, authorisableHorizontal agreements Substantial lessening of competition Substantial lessening of

competitionThreshold Contracts, arrangements understandings Contracts, arrangements,

understandingsProhibition If resulting public benefit If resulting public benefitAuthorisable? Presumed illegal Presumed illegal but

authorisableSpecial provisions: Presumed illegal Substantial lessening of

competition test, authorisable

Price fixingBoycotts, other

market arrangements

Price controlLegislation Prices Surveillance Act Part IV, Commerce ActProcedure Price surveillance Price control (currently

unused)Consumer rights

Legislation Part V, Trade Practices Act Fair Trading ActProhibition Misleading/deceptive conduct Misleading/deceptive conduct

False representations False representationsCertain practices Certain practicesUnconscionable conduct

Requirements Certain product safety Certain product safety and consumer and consumerinformation requirements information requirements

146—The convergence of competition law within APEC and the CER agreement

Australia New Zealand

EnforcementCompetition agencies Australian Competition and Consumer New Zealand Commerce

Commission CommissionNational Competition CouncilAustel (transitional)

Role Enforcement, authorisation, adjudication Enforcement, authorisation,adjudication

Appeals re. agencies Australian Competition Tribunal High Court (+ lay members)Contraventions Federal Court High Court (+ lay members)

determined byPrivate action Available AvailableSanctions, penalties Fines, injunctions, damages, divestitures, Fines, injunctions, damages,

court orders, enforceable undertakings divestitures, court orders,enforceable undertakings

Jurisdiction/exemptionsOverseas activities Yes Yes, if NZ market is

of citizens affectedDomestic activities Yes Yes, if NZ market is

of foreigners affectedActivities beyond Yes, if it affects Australian market Yes, if NZ market is

borders affectedExport cartels Some exempted Some exemptedSpecific industries International shipping, International shipping and

telecommunications, some state activities civil aviation, and stateexempted pharmaceuticals largely

exemptedIntellectual property Exempt unless misuse of market power Generally exemptLabour markets Exempt Generally exempt

Competition law in Australia

Australia’s principal competition law is the Trade Practices Act 1974. In addition,each State and Territory has competition legislation governing intra-state trade andthe conduct of non-incorporated bodies.7

Australia has had competition laws from the beginning of this century. The influenceof the US Sherman Act is apparent in its first competition statute, the AustralianIndustries Preservation Act 1906, which adopted a prohibition approach aimed atmonopolies and restraint of trade or commerce.

The Trade Practices Act 1965 generally adopted a prescriptive approach tocompetition law, more akin to the UK Restrictive Trade Practices Act 1956 than toUS law. A major criticism of the 1965 Act was that it was inefficient; its proceduresslow and costly; and that, pending any restraining order, examinable agreements orpractices remained in operation.

The convergence of competition law within APEC and the CER agreement—147

The Trade Practices Act 1974 returned to a prohibition approach. It coveredcontracts, arrangements and understandings in restraint of trade or commerce;monopolisation; exclusive dealing; resale price maintenance; price discrimination;mergers; and a range of consumer protection provisions.

The Trade Practices Commission was established to administer and enforce the Act,and the Trade Practices Tribunal (including lay assessors) was retained to hear appealsfrom the commission; jurisdiction in respect of offences was vested in the IndustrialCourt. For the first time, rights of action became available to private parties. A regimefor examination of public benefits arising from otherwise prohibited trade practiceswas also established, allowing the commission to authorise such practices to becontinued.

The first substantive amendments to the 1974 Act followed the Swanson Report.8

These saw:

• the concept of a restraint on trade replaced with a prohibition against contracts, arrangements or understandings which substantially lessen competition in a market;

• a narrowing of the scope of control on mergers to focus on transactions which ledto the acquisition or extension of control or dominance of substantial markets; and

• procedural changes including the abolition of clearance procedures for trade practices and mergers, leaving parties to assess their own risk of the possibility of court action.

A second set of major amendments involved:

• a narrowing in the merger prohibition to situations where a single firm would dominate a market;

• a change in the monopolisation provision so that it applied to corporations with asubstantial degree of power in a market (instead of a position of substantial control); and

• removal of a requirement of direct evidence of an intention to damage a competitor— such intention could now be inferred from conduct.

Further amendments in 1992:

• changed the merger prohibition to situations where the transaction would substantially lessen competition in a market;

• introduced mandatory pre-notification for certain mergers;

• increased penalties;

• empowered the Trade Practices Commission to obtain in court enforceable undertakings in settling trade practice matters; and

148—The convergence of competition law within APEC and the CER agreement

• extended the consumer protection prohibition on ‘unconscionable conduct’ to commercial transactions.

The next and most recent (1996) amendments to the Trade Practices Act were thoseflowing from the Hilmer Report of 1993, which followed an independent inquiryinto national competition policy. Its key findings and recommendations were:

• universal application of the Trade Practices Act — that is, including to States;

• review and reform of anticompetitive structures of public utilities;

• introduction of appropriate regulation of natural monopolies, especially in regardto conditions of access to natural monopoly facilities;

• continued prices surveillance in a modified and more limited form;

• review and reform of anticompetitive regulation; and

• review and reform of unfair practices of government business enterprises to improve competitive neutrality.

The Hilmer Committee also recommended changes in institutional arrangements:the creation of a National Competition Council charged with broad oversight ofcompetition policy and assisting the Commonwealth and State governments incompetition policy development and implementation; and reformation of the TradePractices Commission as the Australian Competition and Consumer Commissionincorporating the Prices Surveillance Authority (which provides oversight of pricechanges for some goods and services) and having responsibility for ‘access issues’. Acomplex set of processes now applies to third-party access issues involving certainfacilities.

In addition, a separate price discrimination provision (applicable to domesticcommerce) was removed and resale price maintenance (RPM) became authorisable.

While most of these changes further harmonised the national competition laws ofAustralia and New Zealand, the detailed access regime was a significant departure inthat New Zealand relies on general competition law to govern access to essentialservices.

Competition law in New Zealand

New Zealand has adopted a broad-based approach to competition policy.Competition law, which finds its expression in the Commerce Act 1986, has been animportant part of this. It represented new rules of the game for New Zealandbusinesses facing an open competitive economy, guiding the behaviour of firms thathad recently been exposed to market forces by the removal of import protection, pricecontrol and other regulations. The implication was that such firms should movetowards efficient competitive operation or else exit.

The convergence of competition law within APEC and the CER agreement—149

The Act’s objective was ‘to promote competition in markets within New Zealand’. Itwas designed to regulate business acquisitions in accordance with a marketdominance test; to impose special restrictions on the behaviour of dominant firms;and to prevent agreements between firms that substantially lessen competition.Business acquisitions and anticompetitive contracts could however be authorised ifthey were likely to result in a benefit to the public which would outweigh anydetriment resulting from increased dominance or (in the case of trade practices) thesubstantial lessening of competition.

The Commerce Act also provides for price controls although none are currently inplace. Unlike Australia, a separate statute — the Fair Trading Act 1986 — coversconsumer protection issues.

The Commerce Commission was established as a combined regulatory and quasi-judicial authority to administer the Act. There are no comparable industry-specificstatutory regulatory authorities and the Commerce Commission has broad sectoralpowers including coverage of all utilities. Its decisions may be appealed to the HighCourt (assisted by lay members) and then to the Court of Appeal. Private rights ofaction are available for most contraventions and may be appealed as far as the PrivyCouncil in London. The commission is an independent statutory authority but thegovernment can publicly direct it to ‘have regard to’ its economic policies.

While the Commerce Act 1986 looked to the United States for its underlying micro-economic principles, it relied heavily on the Australian Trade Practices Act 1974 forits statutory framework. The Australian approach was broad enough to incorporateNew Zealand requirements for the regulation of a liberalised Western economywithin the Westminster judicial system tradition, which New Zealand could draw onfor institutional design and legal precedent (although this has not been limited toAustralian precedent). The evolving closer economic relations between the countriesalso gave some impetus for harmonising the two national competition laws. Whilebroadly harmonised, the substantive provisions differ in several significant ways,notably in respect of the competition thresholds for business acquisitions and use ofmarket power, and the extent to which types of conduct are specifically prohibited.Institutional arrangements are similar.

From 1990 the Commerce Commission was required to include in any public benefitassessment any efficiencies resulting from the conduct under examination. Mergerpre-notification became voluntary and resale price maintenance became authorisable.In 1996 the jurisdiction of the business acquisition regime was extended to covertransactions overseas if they affect a market within New Zealand.

Amendments in 1990 to both the New Zealand and Australian Acts — the ‘trans-Tasman competition provisions’ — established the concept of a trans-Tasman marketin respect of proscribed conduct by powerful firms.

150—The convergence of competition law within APEC and the CER agreement

In 1994 the Trade Practices Commission and the Commerce Commission reached aninter-agency agreement to share information that will:

• facilitate effective application of their respective competition laws;

• avoid unnecessary duplication;

• facilitate the coordination of investigations;

• promote a better market understanding of enforcement activities; and

• keep each other informed of developments.

Convergence of competition laws

Figure 6.3 illustrates the twisting and sometimes tortuous paths towards convergenceof competition law followed by the two countries. A qualification that must be madeis that the direction and magnitude of change consequent on each statutory orregulatory change is clearly a matter of subjective judgment. Despite this, Figure 6.3illustrates that convergence, even if carried out in highly favourable circumstances, isa slow and painstaking process. It also shows that New Zealand has made stronger,more consistent and earlier moves to convergence than has Australia.

As illustrated earlier in the chapter, the two country’s acts are very similar in terms ofstatutory language, scope and procedure. But, as a result of retaining legislativediscretion, some noticeable areas of divergence remain — such as a different marketpower threshold for the abuse of market power prohibitions (including the trans-Tasman competition provisions), and, from 1992, a different competition standardfor business acquisitions.

The CER context has clearly been relevant to the convergence process. From theoutset, the member states envisaged, albeit in a limited way, that working towardsharmonisation (in the sense of conformity not uniformity) was part of the jointagenda. For a start, New Zealand’s overhauled competition legislation, the CommerceAct 1986, was very much influenced by the overall structure and language ofAustralia’s pre-existing Trade Practices Act 1974.

The trans-Tasman competition provisions introduced in 1990 were simply an extra-territorial extension of their pre-existing parent provisions which prohibit the use ofa dominant position (or, in Australia’s case, the use of a substantial degree of marketpower) for the purpose of restricting and/or preventing entry or competitive conduct.They were a useful but limited extension, by means of market definition andjurisdiction, of the parent provision in each country’s national competition law.

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152—The convergence of competition law within APEC and the CER agreement

Effects on Trans-Tasman corporate operations 9

The question posed in this section is, broadly: what has competition law convergencemeant in terms of trans-Tasman corporate operations?

Business generally accepted that competition law harmonisation (the terminology ofthe CER agreement) was properly on the CER agenda, although the rationale for thiswas never clearly or rigorously argued by policy-makers. Rather, there was anunderlying policy assumption that statutory convergence would be good for businessin the context of a free trade area and an integrating single market. In turn, this wastaken to mean that the costs of transacting business in the two economies would belowered.

At the same time, there seems to be broad acceptance for retaining an element ofregulatory independence in Australia and New Zealand; the perceived advantage ofthis seems to outweigh any transaction and/or compliance costs that may beassociated with divergence. Further, there has not been a strong call by business for acommon judicial system or for a transnational appeal authority.

As far as the specific 1990 trans-Tasman reforms were concerned, the policy rationaleseemed to rest in part on an assertion that the CER economies were sufficientlyintegrated to qualify for ‘single market’ status; and in part on a desire to remove therisk that the trans-Tasman antidumping remedy might be used as a protective devicewhile the general level of industry protection was falling. Even so, introduction of thetrans-Tasman competition provisions suggested that opportunities were likely toremain for both Australian and New Zealand-based firms to price discriminate forpredatory purposes, as well as to engage in non-price predatory conduct. Focusing onthis type of conduct rather than the form of price discrimination that can triggerantidumping activity had the effect of turning attention to competition andconsumer-welfare impacts of business conduct as distinct from impacts on producersalone. At the time, this policy shift provoked considerable opposition frommanufacturers who envisaged a net reduction in producer protection. Butcompetition was now the requisite benchmark for trans-Tasman business. Pricediscrimination as such, even if accompanied by material injury to producers in theimporting economy, would no longer suffice as a basis for regulatory intervention.

Thus the trans-Tasman competition provisions were not — and were not intended tobe — a direct substitute for the trans-Tasman antidumping remedy; their scoping andobjectives were different. In fact, they did not add substantively to the competitionremedies already available. Furthermore, they were limited by the fact that ‘impactmarkets’ excluded markets exclusively for services. Thus the design of the trans-Tasman competition provisions was influenced more by the traditional scope ofantidumping law being confined to goods than by what justifiably could have been amore comprehensive approach to competition regulation.

The convergence of competition law within APEC and the CER agreement—153

Responses to a 1996 business survey in Australia and New Zealand (Vautier andLloyd 1997) were mostly either neutral towards the impact on trans-Tasman businessactivity of the 1990 reforms or were positively disposed towards the shift in policyfocus. Current research shows that, in a practical sense, over the six years since theirinception, the trans-Tasman competition provisions have not been significant. Apartfrom an unsuccessful interlocutory injunction application in Australia, there havebeen no court cases mounted by private litigants nor prosecution actions mounted bythe two enforcement agencies. Taking the opinion of business, officials andenforcement agencies into account, the overall impact of the 1990 policy reforms isjudged to have been minimal.

One explanation for the reasonably smooth transition from a trans-Tasman anti-dumping regime to the new trans-Tasman competition provisions was undoubtedlythe pre-existing and broadly harmonised competition laws; the general level offamiliarity in the business sector with this regulatory framework; and the general levelof confidence in the autonomy of the competition agencies and in their ability tocooperate on enforcement matters.

International, even bilateral, convergence of competition law is a complex area. Thus,even with a considerable degree of statutory harmonisation, as in the case of Australiaand New Zealand, business is not assured of certainty in respect of decision outcomesin the other country; nor could one realistically assume that it would be, even in itsown country. This is especially true under a rule of reason approach to competitionlaw.

There appears to be limited business interest in further ‘internationalising’ trans-Tasman competition law (although some jurisdictional gaps remain). There is alsolittle pressure — on the basis of transaction cost or other arguments — either forfurther convergence between the competition laws of each country, or forcomprehensive integration of enforcement and judicial procedures.

Survey of Australian and New Zealand businesses

At a more specific level, some preliminary results from the 1996 business survey areof interest.

Business firms in Australia and New Zealand were asked to identify any trans-Tasmancompetition problems. Just over 80 per cent of the 108 respondents said that, since1990, they had encountered no problem or dispute with unfair or anti-competitiveconduct by their trans-Tasman competitors.

The small number of problematic ‘pricing tactics’ cited included three references tolower intermediate goods pricing or secondary dumping. Half of the New Zealandrespondents who indicated a trans-Tasman competition problem specified Australiangovernment actions (for example, special industry assistance) rather than businessconduct as the source of that problem.

154—The convergence of competition law within APEC and the CER agreement

Residual concerns about suspected trans-Tasman ‘dumping’ clearly remain. But it isworth noting that trans-Tasman price discrimination issues have not been pursuedunder the available trans-Tasman competition law remedy. Indeed, only seven firmshad ever considered using the competition law remedy to challenge in the courts whatthey considered anti-competitive trans-Tasman business conduct. These firms hadalso identified what they regarded as a trans-Tasman competition problem, includingtying price/delivery, differential pricing, exclusive dealing, and an industry-specificaccess issue. Six of these firms decided not to proceed with court action.

The most noticeable feature of the business responses relating to interaction withthird countries was the extent to which they cited problems for business (and, inparticular, for competitiveness) associated with government actions or inactions(including tariffs, non-tariff barriers and industry assistance). The scope of perceivedcompetition problems was thus broad; once again, problems were not confined to thesort of business conduct usually covered by competition law. It was evident thatbusiness respondents did not tend to distinguish between problems of competitionpolicy and other issues of competitiveness in international trade (such as access tointermediate inputs on equal terms, or dumping). Both problem sources wereperceived to affect the ability of business to compete. This was a much moreimportant point from their perspective than trying to determine the dividing linebetween a competition policy matter and a trade policy matter; and it served tohighlight an important interaction between competition policy and internationaltrade policy: both are linked in a positive way with the opening of markets,competition within them, and attitudes to the competitive process.

New Zealand responses certainly suggested that some government assisted and/orprotected domestic positions are still held in Australia. These are perceived asallowing unfair cross-subsidy across the Tasman, and beyond. On the other hand,business respondents in the Australian sample in effect gave the New Zealandgovernment a clean slate. This appears consistent with New Zealand’s policy shift toreliance upon tariffs for industry assistance, and probably also reflects the greaterextent to which New Zealand has deregulated and removed artificial impediments tomarket access and competition.

It would not be correct to conclude that anti-competitive business conduct — thesubject of competition law — was high on the list of business respondents’competition concerns (either in the CER context or in respect of third countries).Indeed, very little reference was made by them to business conduct in the form ofrestrictive trade practices — either in respect of trans-Tasman markets (where there isa relatively high degree of economic integration) or in respect of third countries(where there is a growing level of trade and economic interaction). There may havebeen a number of reasons for this. For example, relative to other market influences atpresent, such practices were not regarded as significant; respondents were not awareof the existence or the actual or potential effect upon competition of restrictive tradepractices; or such practices are not prevalent.

The convergence of competition law within APEC and the CER agreement—155

Overall, a feature of the business responses was that they appeared to reinforce abroad approach to competition policy. This is consistent with an important findingof this chapter: while convergence of competition laws may be an important elementin the process of regional economic integration, there is little to suggest thatconvergence as such should represent a stand-alone policy goal, especially in view ofeconomic welfare implications that are not unambiguously positive. If, however,convergence is to be part of regional economic cooperation, it would be one of manyconsiderations relevant to effective competition policies. Positive welfare effects aremost likely to derive from well-designed competition law and effective enforcement,as well as from use of other competition policy instruments affecting regulation ofmarkets.

NOTES

This chapter represents our personal views. We wish to thank Pamela Campbell, John Feil,Geoff Connor, Kihwan Kim, Larry Qiu and Peter Lloyd for suggestions, assistance and ideas.1 This chapter focuses on the concept of convergence which we see as the process of moving

towards some ultimate state of harmonisation. It is the journey that interests us here,rather than any particular destination.

2 The APEC Committee for Trade and Investment (Singapore, 1996) defines competitionlaw as ‘laws that prohibit anti-competitive conduct and market structures that areconducive to anti-competitive conduct. Competition law recognises that even if othermarket liberation policies support competition, it may be possible for firms to harm thecompetitive process.’

3 This definition was used by the APEC Conference on Competition Law and Policy(Auckland, 1995).

4 A well-designed competition law might be characterised as being relatively: transparent,predictable (with respect to outcomes), non-distortionary, accommodating of a diversityof business forms, non-proscriptive of specific practices (except where the practice isunambiguously welfare damaging), non-prescriptive (except where this minimisestransaction costs compared with a rule of reason approach).

5 For a history of this, see Kurita (1995).6 Lloyd (Chapter 7, this volume) provides an interesting mathematical representation of

this and earlier measures.7 For the most part these mimic the federal legislation. The jurisdiction of the Trade

Practices Act 1974 was extended to a variety of areas which were formally excluded fromits application by the Trade Practices Amendment Act 1995. Most notably, this extendedthe Act’s application to the trading activities of State governments and to non-incorporated traders such as lawyers and other professionals. Given the very significantinvolvement of State governments in areas such as energy supply, ports, primary producetrade and a broad range of other businesses, the previous lack of jurisdiction was asignificant barrier to the operation of an effective trade practices regime in Australia.

8 Trade Practices Act Review Committee, Report to the Minister for Business andConsumer Affairs, August 1976.

9 This section of the chapter is drawn from work-in-progress on Australia’s and NewZealand’s recent experience with trade and competition policy in the context of the CERagreement. This work is part of a joint research programme, involving Kerrin M. Vautierand Professor Peter J. Lloyd; it is being supported by the Institute of Policy Studies,

156—The convergence of competition law within APEC and the CER agreement

Victoria University of Wellington, the APEC Study Centre at the University of Aucklandand the University of Melbourne.

REFERENCES

Addy, G. N. (1995) ‘International harmonisation and enforcement co-operation: theCanadian experience’, in C. K. Wang, C. J. Cheng and L. S. Liu (eds) InternationalHarmonisation of Competition Laws, Dordrecht: Martinus Nijhoff.

Australia–Japan Research Centre (1995) Implementing the APEC Bogor Declaration, Canberra:Australia–Japan Research Centre.

Bollard, A. E. (1994) ‘The role of antitrust in a small open economy: the Commerce Act inNew Zealand’, Review of Industrial Organisation 9, pp. 671–94.

Chia Siow Yue and Lee Tsao Yuan (1993) ‘Sub regional economic zones: a new motive forcein Asia Pacific development’, in F. Bergsten and M. Noland (eds) Pacific Dynamism in theInternational Economic System, Washington DC: Institute for International Economics.

Feketekuty, G. (1993) ‘New trade related issues: competition liberalisation’ in Gili Yen (ed.)New Directions in Trade Liberalisation and Investment Cooperation, Chinese Taipei: PacificEconomic Cooperation Council, pp. 172–6.

Fels, A. (1995) ‘Co-operation between enforcement agencies’, Paper presented at the APECConference on Competition Policy and Law, Auckland.

Fox, E. M. (1991) ‘Harmonisation of law and procedures in a globalised world: why, whatand how’, Anti-Trust Law Journal 60, pp. 593–8.

Han Jung Kil (1995) ‘The direction of the development of international co-operationmechanism on competition law and policy in the APEC region’, Paper presented at theAPEC Conference on Competition Policy and Law, Auckland.

Kurita, M. (1995) ‘Recent developments of competition policy in Japan and the implicationsfor international harmonisation of competition laws’, in C. K. Wang, C. J. Cheng and L.S. Liu (eds) International Harmonisation of Competition Laws, Dordrecht: MartinusNijhoff.

Liu, L. S. (1995) ‘Efficiency, fairness, adversary and moralsuasion: a tale of two Chinesecompetition laws’, in C. K. Wang, C. J. Cheng and L. S. Liu (eds) InternationalHarmonisation of Competition Laws, Dordrecht: Martinus Nijhoff.

OECD Committee on Competition Law and Policy (1993) ‘Objectives of CompetitionPolicy”, DAFE/CLP (92)2, Paris: OECD.

Phillips, B. J. (1995) ‘Co-operation among OECD enforcement agencies’, APEC Conferenceon Competition Policy and Law, Auckland.

Varney, C. (1995) ‘Co-operation between enforcement agencies: building on past experience’,Paper presented at the APEC Conference on Competition Policy and Law, Auckland.

Vautier, K. M. (1993) ‘New trade related issues: competition trade policy and competitionpolicy’, in Gili Yen (ed.) New Directions in Trade Liberalisation and Investment Co-operation, Singapore: Pacific Economic Cooperation Council, pp. 146–71. —and P.J. Loyd (1997) International Trade and Competition policy: CER, APEC and theWTO, Institute of Policy Studies.

Wu, Rong-I (1994) ‘On possible areas of co-operation on competition policy’, Paperpresented at the Sixth APEG Eminent Persons Group meeting, 30–31 May 1994, HongKong.

7 Competition policy in APECPrinciples of harmonisation

P. J. Lloyd

The international dimensions of competition policy have become a ‘new issue’ ininternational economic policy in recent years.1 The proximate cause of this growingconcern is an increasing frequency of disputes among governments or producers overalleged anticompetitive behaviour that involves two or more nations. In the WorldTrade Organisation (WTO), the primary concern is that anticompetitive behaviourby producer agents may restrict international trade in goods and services and reducethe benefits of the General Agreement on Tariffs and Trade (GATT) liberalisation ofgovernment barriers to this trade. In the Organisation for Economic Cooperation andDevelopment (OECD), the concern is with the growing problems of nationalcompetition authorities in administering their national competition laws. There is,however, an underlying reason for these concerns — namely, the increasinglyinternational nature of competition which has resulted from the reduction in borderbarriers to international trade in goods, services and capital. This trend is likely tocontinue. Consequently, the international dimensions of competition policy arecertain to become more prominent in the international forums.

The Asia Pacific Economic Cooperation (APEC) debate on competition policiesreflects this wider concern. Competition policy is one of the 15 specific areasdesignated in the 1995 Osaka Action Plan. The focus in these plans is on thedevelopment of national competition policies in all member countries andcooperation among members.

The second section of this chapter discusses the nature of the new issues incompetition policy. The third section reviews the APEC work programme and thefourth section outlines the diversity among APEC countries in their nationalcompetition policies. The fifth section examines how these diverse national policiesmight be harmonised and the sixth section considers whether harmonisation isdesirable. Some conclusions are presented in the final section.

THE INTERNATIONAL DIMENSION OF COMPETITION POLICY

Globalisation has raised new issues of competition policy. Many markets which werepreviously segmented are now imperfectly accessible. Foreign producers have become

158 Competition policy in APEC: principles of harmonisation

less tolerant of behaviour which they see as anticompetitive and as posing a threat totheir access to foreign markets, either through direct exporting or through theestablishment of foreign affiliates. As the perception of these barriers to competing inforeign markets has increased, private producers and governments, acting as theagents of producers, have sought ways of reducing anticompetitive behaviour in othercountries.

Increasingly in the OECD, and now the WTO, the notion of the internationalcontestability of markets is being used as a framework for analysing issues ofinternational trade and competition.2 This use of the notion of contestability hasbeen adopted from industrial organisation theory. A contestable market requires theabsence of restrictions, in the public or private sector, on entry and investment as wellas access to the markets of the products. In the case of those services which involve acommercial presence or the movement of natural persons, market access can only beachieved by market presence and this requires free movement of capital and persons.

The fundamental difficulty in developing cross-border competition policies to makemarkets more contestable is that competition policies are based on nationalcompetition laws.3 There has been no multilateral organisation and no substantialmultilateral rules relating to cross-border competition. While the WTO containssome international law relating to some areas of competition, the coverage is stillextremely limited. In particular, the WTO is confined to regulating the activities ofgovernments, not private producers. It is not an adjudicating body for actionsinvolving competition polices; it has no powers of investigation and no fines orremedies can be imposed on governments, let alone private agents, and privatepersons cannot bring actions.4

National laws differ in the extent to which they cover conduct beyond their nationalborders, but in all cases the ability to pursue actions in other countries is limited.Countries may base the jurisdiction on the doctrines of territoriality, or nationality oreffects. Under the principle of territoriality a state may exercise its jurisdiction overall persons (including corporations), whether local or foreign, within its territory.This prevents the reach of its laws beyond its jurisdiction unless the government canpersuade the governments of other countries to take actions in their territories tosupport the actions of the competition authorities of the home government. Theprinciple of nationality allows a state to exercise its jurisdiction within its territoryover its nationals who reside abroad. This extends the jurisdiction to a subset ofpersons residing outside the home country. Under the effects doctrine, a state claimsthe right to take actions against persons outside its jurisdiction for conduct which haseffects within its borders. This extends the jurisdiction to the subset of personsresiding outside the home country whose actions affect residents of the home country.

The most prevalent doctrine is territoriality. Some countries extend the reach of theircompetition laws to their citizens resident in other countries. A few, most notably the

Competition policy in APEC: principles of harmonisation—159

United States and in some respects the European Union and Canada, apply the effectsdoctrine.5

It is this coexistence of global markets with national jurisdictions which causes thesearch for mechanisms to cover cross-border competition problems. Thesemechanisms range from an extension of national powers through bilateral agreementsbased on cooperation among nations at one end of the spectrum of powers to thedevelopment of an international competition law administered by a multilateralauthority at the other. The options will not be reviewed here.6

A consensus seems to be emerging, in some countries at least, that it will not befeasible or desirable at the present time to seek a multilateral form of internationalcompetition policies. The Chairman of the US Federal Trade Commission hasrecently stated that a world antitrust code ‘is not going to happen in the near future’(Pitofsky 1996). Another US author states his beliefs even more strongly:

The opinion of this author is that it is highly unlikely that countries will agree inmy own lifetime to the creation of an EU-like mechanism in the domain ofcompetition policy at the level of the WTO, i.e. one where an agency along thelines of DG [Directorate General] IV [of the European Union] is given powers toimplement and enforce competition applicable to all WTO member nations(Graham 1995, p. 112).

A growing number of authors are recommending a more gradual approach.7 Lookingforward to the debate at the Singapore Ministerial Meeting of the WTO, theEuropean Union commissioned a group of independent experts to consider the roleof competition policy in the WTO. The report of this group (European Union 1996)preferred a gradual building-block approach, recommending the development ofnational competition policies in all countries, a core of common principles andcooperation under bilateral agreements and through the OECD recommendations. Asimilar view has been put forward in Australia (see Productivity Commission 1996;and Lloyd 1996). In Canada, Crampton and Witterick (1996) have advocated a two-track approach, one track being bilateral cooperation and the development of a set ofminimum standards, and the other being international dispute settlement. Bliss(1996) reaches similar conclusions.

A gradual approach is usually associated with a preference for plurilateral (non-binding) agreements rather than multilateral (binding) agreements. A plurilateralagreement may be a stepping stone to an eventual multilateral agreement.

In this environment, the harmonisation of national laws is an important componentof the gradualist options. This term encompasses the development of national policiesin countries which have none and the development of a core of common principlesor minimum standards, but there are many options within harmonisation.

160 Competition policy in APEC: principles of harmonisation

THE APEC WORK PROGRAMME ON COMPETITION POLICIES

At the Osaka meeting in December 1995, the APEC economic leaders adopted anAction Plan. The plan included action in 15 specific areas, of which ‘competitionpolicy’ was one. The objective of the plan in this area read:

APEC economies will enhance the competitive environment in the Asia–Pacificregion by introducing or maintaining effective and adequate competition policyand/or laws and associated enforcement policies, ensuring the transparency of theabove, and promoting cooperation among the APEC countries, therebymaximizing, inter alia, the efficient operation of markets, competition amongproducers and traders, and consumer benefits (APEC 1995, p. 19).

The guidelines called upon the member countries to review their competitionpolicies, to implement technical assistance in regard to policy development amongthem as appropriate and to establish appropriate cooperation arrangements amongthe APEC economies with regard to competition policies.

Under the Action Plan, members are to develop both ‘collective action plans’ andindividual country ‘action plans’ for this area, as with other areas. The collectiveaction plan will encourage cooperation among the competition authorities of APECeconomies with regard to information exchange, notification and consultation andexamination of the interrelationships between competition policies and laws andother policies related to trade and investment. It provides for the development of atraining programme in the area. Perhaps of most importance in the long run, it asksmembers to consider developing non-binding principles on competition policy andlaws in APEC.

The APEC Committee on Trade and Investment (CTI) has coordinated thedevelopment of the collective action plans in this area. To carry out this function, itheld two workshops on competition policy and was working towards theestablishment in 1997 of an APEC database on competition policies, laws andregulations. The CTI meeting in February 1996 agreed to merge the work areas ofcompetition policies and deregulation in the APEC countries but the collective actionplans for the two areas would be separate. The workshop noted the central role ofcompetition policy in enhancing economic efficiency and observed that theglobalisation of business is creating new challenges for competition policy. Thecollective action plan which incorporates these developments was presented to theLeaders’ Meeting in Subic Bay but this was not a priority area for deliveringimmediate actions at the meeting. A decision was made to hold a further workshopon competition policy and deregulation in 1997 with a view to continuing theexchange of ideas and policy dialogue in these areas.

Thus the outcome of this process to date has been to establish a dialogue amongmembers on competition policies and laws. The emphasis on cooperation and the

Competition policy in APEC: principles of harmonisation—161

consideration of a set of non-binding principles may lead to the harmonisation ofcompetition policies in the APEC region on a plurilateral basis.

APEC DIVERSITY IN COMPETITION LAWS

Before examining inter-country differences in competition policy, it is necessary todefine these competition policies. There is some difficulty in defining the scope ofthese policies. A broad definition would encompass all government policies whichaffect competition in markets. However, this is open-ended and too broad as manygovernment policies which are not addressed at competition in markets do affectcompetition incidentally in some industries; such policies include, importrestrictions, foreign investment regulations and industrial policies. More narrowly,one can define competition policies as those which are intended to promote freecompetition among producers. These policies plainly include antitrust law andexclude government policies such as privatisation, foreign investment regulation andregulation or deregulation. (Some commentators express this difference by referringto competition law as distinct from competition policy in the broad sense.) There aregrey areas such as subsidies or state aid and consumer protection which are regardedas part of competition policy in some countries but not in others.

A narrow definition is preferable as it contains the scope of the discussion and makesagreement among countries more achievable. For the same reasons, it would be better,at least in the early stages, to omit grey areas.

APEC has adopted the narrower definition with the addition of consideration of thelinks between competition policies on the one hand and other policies related to tradeand investment. The CTI meeting in February 1996 agreed to merge the work areasof competition policies and deregulation in the APEC countries.

As part of the preparation for the CTI work programme, the New Zealand officialsconducted a survey of the competition policies of APEC member countries in 1994.8

There is great diversity among the APEC countries in terms of their nationalcompetition policies, much greater in fact than in their policies with respect tointernational trade in goods and services or foreign investment. In East Asia at thepresent time, six member countries — Hong Kong, Indonesia, Malaysia, Papua NewGuinea, the People’s Republic of China and Singapore — do not have comprehensivecompetition policies. All have some policies which can be regarded as elements of acompetition policy. For those countries which do have comprehensive competitionpolicies, the coverage of these policies differs greatly.

The difficulty in the description of these competition policies is that they are multi-dimensional. One dimension or element is the specific rules which apply tooutcomes. In the case of competition policies, these are types of horizontal or verticalrestraints or mergers — price fixing, bid rigging, market sharing, retail pricemaintenance, and so on. Another element is remedies. Other elements are the

162 Competition policy in APEC: principles of harmonisation

territorial application of the rules and the extent of private actions. Yet other elementsare the objectives of competition policy, the principles and the methods of analysis ofcompetition policies.

Enforcement of policies is as important as the substance of the policies. Lack ofenforcement is one of the major causes of disputes between countries in the area ofcompetition policies, such as the Kodak–Fuji dispute, for instance. Some have alsosuggested a form of dispute settlement for this area.

The tabulation of national competition policies done for APEC by the New Zealandgovernment classifies the competition policies of the APEC countries according totypes of horizontal and vertical restraints, sanctions ‘enforcement, remedies andpenalties’ and ‘international application’.

In Chapter 6 of this volume, Bollard and Vautier have taken seven aspects of elementsof competition policies from these tables and tabulated the results. From thisinformation, they have constructed a novel index of similarity of the competitionpolicies of a pair of countries. This index has a maximum value of 100 (or 1 if eachelement is scored on the interval from 0 to +1). Hence, it measures the extent towhich two countries have adopted the same competition policy rules in theircompetition law. For a pair of countries, an increase in this index over time representsconvergence.

There are 11 APEC countries which have comprehensive competition policies and Bollard and Vautier have considered seven elements of competition law. These pair-wise indexes differ greatly. They range from a low of 14 for NewZealand–Thailand and Mexico–Philippines, indicating little similarity between thesepairs of countries in their competition policies, to a high of 77 for Australia–NewZealand, indicating a close similarity for this pair.

One can construct a multilateral index of the similarity of competition policiesamong a group of countries by averaging the bilateral indexes (see Appendix 7.1). Amultilateral index can be used to measure similarity across a set of countries such asAPEC. An increase in the multilateral index over time would represent multilateralconvergence of competition policies. For the countries in Bollard and Vautier’ssample, the multilateral index is 36, which is a rather low figure, indicating littlesimilarity among those APEC countries which do have competition policies.

Tabulations of elements of competition law can be interpreted in different ways.Levinsohn (1966, p. 331) partitions the competition policies of nations into fivegroups according to the degree of liberality. These range from the lax or laissez-faire(such as Singapore and Hong Kong) to the most strict, with no or few exemptionsand with per se prohibitions in all markets. In between these extremes are the groupsof countries which apply the rule of reason to some or all markets. One group appliesthe rule of reason to domestic but not to export markets, a second group applies it toboth domestic and export markets; and a third group applies strict per se rules to

Competition policy in APEC: principles of harmonisation—163

domestic but not to export markets. This is a useful but rough categorisation whichemphasises the distinctions between the rule of reason and strict rules and betweenexport and domestic markets.

There are examples of these types in the Asia Pacific region. At the most lax extremelie Singapore and Hong Kong and other countries with no comprehensivecompetition policy. At the strictest end of the spectrum generally is the United States.In between, Japan is an example of a country which enforces a fairly strict policy indomestic markets but is lax in export markets.

HARMONISATION — WHAT IS IT?

The notion of harmonisation is vague. ‘Harmonization can be loosely defined asmaking the regulatory requirements or government policies of different jurisdictionsidentical, or at least similar’ (Leebron 1996, p. 43). That is, harmonisation isconvergence of requirements or policies. Harmonisation of domestic policies acrosscountries has been debated in several areas of policy as an adjunct of internationaltrade liberalisation.9 These areas include all of the ‘new issues’ in the WTO —environmental standards, labour standards and competition policies — and taxpolicies (see Bhagwati and Hudec 1996). The literature on the harmonisation ofcompetition policies is sparse.

In some policy areas, the notion of harmonisation is straightforward as there is onlyone object to be harmonised and this object has a parameter or value which can belocated on a single dimensional continuum. This applies, for example, toharmonisation of the tariff rate for some tariff item or to the excise tax rate for someexcisable commodity. For a group of countries, each country has a single parameterwhich might be harmonised among them, as in a Common External Tariff or acommon schedule of excise tax rates. In all such cases, there will be debate about thelevel at which the rates should be harmonised but the concept of harmonisation isunambiguous.

In the area of competition policy, there are examples of elements which can bemeasured on a line. Where there is discretion, competition tests may apply, such astests of dominance or market power and merger thresholds. These concepts are, inprinciple at least, measurable on a continuum. Tests of dominance use market sharesor concentration ratios which lie on an interval of the real line (from zero to one).Merger thresholds are in value terms (zero to infinity).

Most elements of competition policy, however, cannot be portrayed on a line orcontinuum. Some restraints are binary variables; for example, either there is pricefixing or collusion or exclusion or whatever, or there is not. A country may have acompetition policy in regard to some restraint or it may not. Some authorities applythe rule of reason whereas other authorities prohibit them per se. For some restraints,there are exemptions for some industries or enterprises (such as state-owned

164 Competition policy in APEC: principles of harmonisation

enterprises or exporters or intra-state traders). All such elements can be regarded as abinary variable which takes on two values — one if some property holds and zero ifit does not.

Where the elements are binary variables, harmonisation takes the form of allcountries agreeing to one of the two alternatives. For example, they might all agree tohave competition policies relating to price fixing and to ban the practice per se or tomake it authorisable. Or, they might all agree on common objectives of competitionpolicies (such as efficiency in the allocation of resources) – that is, to include ratherthan to exclude a list of objectives. Or they might agree on common principles (suchas national treatment, non-discrimination, transparency and the rule of law). Or theymight agree on common methods of analysis (such as market definition and analysisand the identification and analysis of entry barriers). Or they might agree oncommon enforcement procedures. This type of harmonisation might be calledqualitative harmonisation as distinct from the harmonisation of, say, tariff rates,which might be called quantitative harmonisation. Harmonisation of competitionpolicies is predominantly qualitative harmonisation.

For any one element, the most extreme form of multilateral harmonisation would befor all APEC countries to agree to adopt the same values, either qualitative (0 or 1)or values on some line interval. Complete convergence across countries would beachieved if all agreed to adopt the same standard for all elements — that is, a singleuniform law among all nations. This could be achieved in several ways. All countriescould agree to adopt a uniform law. Alternatively, the establishment of a multilateralcompetition authority would result in a single uniform law among all nations.Another possibility which has been discussed in the literature on harmonisation ofcompetition policies is the development of some ‘model’, a composite of the laws ofseveral countries perhaps. All of these forms of multilateral harmonisation areextremely unlikely, given the diversity of policies and views among countries. Partialconvergence could be achieved by uniformity among a subset of countries oruniformity among a subset of elements of competition policy.

There are so many elements of competition policy that even partial harmonisationcould not, at least initially, address all of them. Hence harmonisation will inevitablybe restricted to a limited number of elements. This form of harmonisation ofcompetition policies is known as ‘minimum standards’ (or what might be called weakqualitative harmonisation). It may be achievable and is the most likely form.

There are two aspects to minimum standards. First, there is the choice of the set ofelements which is to be included. They might be restricted to a small set, a ‘core’.10

Second, there is the choice of standard for each element which is included.

In relation to the choice of elements of competition policy to be included, discussionsof harmonisation of competition policy tend to produce lists of items which arebelieved to be more important or more easily implemented. For example, Cramptonand Witterick (1996, p. 5) single out five restraints as forming the core of any

Competition policy in APEC: principles of harmonisation—165

competition policy: these are exclusionary behaviour by dominant firms, price fixing,bid rigging, market allocations and boycotts of distributors carrying products offoreign or other low-cost suppliers. Crampton and Witterick call these ‘the mostegregious of private anticompetitive restraints’. One can add objectives, principles orinstruments/remedies or jurisdictions to the list of selected items.

In relation to the choice of common standards for each element of competition policywhich is included in the set, such standards may already exist in one membergovernment. It is extremely unlikely that any single country’s policies would bechosen given the diversity of views among APEC countries. Alternatively, a standardcould be a composite or model standard.

For any set of elements and any chosen standard for each element, the competitionpolicies of a group of countries will become harmonised as the countries adopt theseminimum standards. (The Index of Similarity developed in Appendix 7.1 has thedesired properties that it will increase as partial convergence occurs and will reachunity with uniformity of policies.)

There is a danger that harmonisation could result in a lowering of efficiency throughthe adoption of the lowest common denominator by all countries. This problem hasarisen with environmental standards and tax rates, in what has been called the ‘raceto the bottom’ — see Bhagwati and Hudec (1996, Chs 10–11). In the context ofharmonisation of competition policies where most standards are binary variables, theobjections of some countries could result in the omission of some aspects ofcompetition policy from the core, but it is unlikely to result in those countries whichalready have policies in these areas following the example of those which do not.

In principle, the choice of standards should be that which maximises the gains fromharmonisation. This requires an understanding of the benefits and costs ofharmonisation.

THE BENEFITS AND COSTS OF HARMONISATION

Harmonisation is not an end in itself. Harmonisation of competition policies isgenerally believed to have two primary benefits.

The first benefit is a reduction in transactions costs, including uncertainty. This refersspecifically to the compliance and enforcement costs associated with doing businessacross jurisdictions. Leebron (1996, p. 53) notes that the elimination of these costsdoes not require uniformity of policies. Rather, this can be achieved instead bydeciding which jurisdiction the policies and laws apply to.

The second benefit relates to an increase in the efficiency of markets. This should beinterpreted as Pareto-efficiency in the world economy and as such it includesimprovements in efficiency due to improvements in the allocation of productionamong producers and commodities and improvements in the allocation of aggregate

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world production among consumers. The ultimate concern is with the welfare ofconsumers or users, though this includes income effects as well as price effects.

The size of the benefits from harmonisation will depend on the pattern ofharmonisation and, in particular, the standards or levels which are chosen. If the beststandards are adopted for any element, it would seem that the region will gain fromharmonisation since this implies the replacement of inferior competition standards bysuperior standards. But what is the ‘best’? Is the standard which is best from the pointof view of one country also the best from the point of view of other countries and theworld?

The ‘best’ policy depends upon the effects of the choice on market efficiency sinceany harmonised standards will eliminate the costs of doing business acrossjurisdictions with different policies — the costs of disharmony.

An issue here is whether there is a single best choice for every element of competitionpolicy. Principles of economic behaviour and analysis are universal — that is, thesame principles apply to all countries. Certain restraints may be universallycondemned as unquestionably harmful in all markets in all countries: for example,price fixing and bid rigging. These should be prohibited per se in all countries underthe harmonised standard. In cases where the rule of reason applies, the sameprinciples should be used to analyse each case. This implies that if the samecircumstances arose with respect to actions in two (or more) countries, the samecompetition policy decisions would be taken, but it also allows the circumstances ofthe individual country markets to be taken into account where they differ. For otherrestraints, however, it may be necessary to have some variation among countries inbest choices to allow for local conditions and differences in legal or regulatorysophistication.

In some cases the question of the best choice is uncertain because the benefits andcosts may be distributed so that one or more countries will gain and one or more willlose from the adoption of a harmonised standard. Is ‘best’ defined from the point ofview of the world? This choice would be analogous to the national interest provisionat the level of competition policy decisions by a national competition authority. Thisworld view has been advocated by Crampton and Witterick (1996) and Fox andOrdover (1995), subject to preservation of some national autonomy in the latter case.

We need to analyse possible cases of cross-country harmonisation, using economicmodels of the industries concerned. A large literature has emerged in the last ten yearswhich models international trade in markets that are imperfectly competitive. Thisdraws heavily on recent developments in the theory of industrial organisation. A basicproblem with the literature from the point of view of considering the effects ofharmonisation of national competition policies is that the outcome in any market ishighly sensitive to the particular specification of the model. It makes a greatdifference as to whether the products traded are homogeneous or differentiated,whether there are constant or decreasing unit costs and whether the oligopolies are

Competition policy in APEC: principles of harmonisation—167

Cournot or Bertrand competitors, and so on. There is a second body of literature inwhich models with imperfectly competitive markets have been used to analyse theeffects of trade policies such as the introduction of tariffs or export subsidies. This isthe so-called ‘new trade theory’.11

However, the models in industrial organisation and new trade theory have rarely beenused to analyse the interaction of trade and competition policy or the effects of thecross-country harmonisation of competition policies. To find how the adoption of aharmonised standard would affect competition and decisions by competitionauthorities, it is useful to consider some examples.

Example 1: export cartels

Several countries which are members of APEC exempt export cartels from theircompetition policies. They include Australia and New Zealand, Canada, the UnitedStates, Japan, Korea and Taiwan (Productivity Commission 1996, Table 3.1). Othercountries exempt state trading authorities which operate export cartels. These state-owned traders are probably the purest examples of export cartels. They are commonin developing and transition economies but there are also important examples inAustralia, New Zealand and Canada.

The economic analysis of this case is straightforward. Export cartels increase the pricein world markets of the commodities controlled by the cartel. They have, therefore,a terms of trade effect. There is a standard theorem of international economics whichshows that an improvement in the terms of trade increases the welfare of theexporting country and lowers that of the importing country. Moreover, the combinedworld market gains from the removal of the price discrimination in the market. Thus,harmonisation of competition standards which included agreement for allparticipating countries to remove the exemption from national competition laws forall export cartels will yield world gains.

Export cartels may have further effects on the degree of competition in domesticmarkets and may distort the allocation of investment funds. It seems likely thatstrengthening competition laws to eliminate these cartels would yield further benefitsif such effects are present.

Example 2: price fixing

Levinsohn (1996, pp. 345–50) provides one of the few examples of the analysis of theharmonisation of competition policies of two countries. It relates to actual orpotential cartels operating in the home market of one of two countries. The twocountries produce a homogeneous product under constant returns to scaleconditions. One country has a lax competition policy permitting a domestic cartelwhich raises the domestic price and the other has a strict policy outlawing a cartel.

168 Competition policy in APEC: principles of harmonisation

In choosing the harmonisation standard, there is a conflict between the interests ofproducers and consumers within each country. However, both producer interests andconsumer interest coincide across countries; what is good for producers in onecountry is good for producers in the other country, and the same holds forconsumers. Essentially, a tolerant competition policy which permits cartelisation inone country has effects which spill over into the other country, benefiting itsproducers and harming its consumers.

The outcome of harmonisation depends on whether the harmonisation adopts thestandards of the lax country or those of the strict country. To assess the change inwelfare in each country, the welfare of the producer and consumer groups areweighted equally. Under the adoption of the standards of the strict country, thecountry with the lax standards may gain or lose and the country with the strictstandard gains and the world gains. The possibility that the country with the laxstandards may gain contrasts with the result of Example 1, in which there is a clearconflict of interest between the exporting and importing countries. Under theadoption of the standards of the lax country, the country with the strict policy loses,the country with the lax standard gains, and the world loses.

Hence, the choice of standard clearly matters. The main lesson from this example isthat harmonisation should be towards the standards of the country which has themore pro-competitive policy. This follows the intuition of basic economics, asLevinsohn noted.

Example 3: mergers

The cross-hauling model of oligopoly can be used to illustrate merger policy. Thismodel is a generalisation of the Levinsohn model. It has been widely used in theanalysis of trade with imperfect competition and has been used in discussions ofcross-country harmonisation of competition policies (see Bliss 1996; and Richardson1996). It assumes that there is only one good produced by the industry and there aretwo (or more) countries. There are a fixed number of producers in each country, andproducers of each country sell in each other’s markets. There are economies of scaledue to fixed costs and constant marginal costs. Competition in the world markets isCournot. The model is described in Appendix 7.2.

The competition policy of governments is now introduced through merger controlswhich allow the governments of each country to determine the number of domesticfirms.12 If one country adopts a tougher competition policy which increases thenumber of domestic firms, the world market price falls. For this country exportsincrease and imports fall as the share of this country’s domestic producers increases inboth countries (Bliss 1996). Aggregate country profits fall in the home country andin the foreign country. Thus, as in the Levinsohn model, there is a conflict betweenthe interests of producers and consumers, and producer and consumer interestscoincide across countries. Lowering barriers to international trade increases the

Competition policy in APEC: principles of harmonisation—169

interpenetration of national markets and increases the importance of competitionpolicies.

To model harmonisation of merger policies, we may suppose that countries differ interms of the toughness of their merger polices, perhaps because they give a differentweighting to producer interests vis-à-vis consumer interests. If the country with theless tough merger policy standards adopts those of the other, the number of firms willincrease in this country and in the world markets. Consumers will gain and theproducers will lose in both countries, as in the Levinsohn model. Both countries gainif we weight the welfare of consumer and producer groups equally. The country whichtightens its merger policies and increases the number of its domestic firms actuallygains more as the decrease in the profit margins of its firms is partially offset by theaddition of profits of the extra firm or firms. The world as a whole gains.

Thus, such harmonisation is beneficial. And, again, the beneficial harmonisation isthe one which adopts the standards of the more pro-competitive country. The race isto the top, not to the bottom. One should note, however, that if the welfare functionsof the countries are weighted solely or heavily towards the producer interests, theopposite conclusions hold; the countries would harmonise downwards and the worldas a whole, including the consumer interests, would lose (see Appendix 7.2).

These results may generalise further to other imperfectly competitive markets, thoughexperience with models of imperfect competition and international trade shows thatit may be possible to find combinations of assumptions which yield perverse resultsin which a more pro-competitive policy is harmful.

WHAT SHOULD BE INCLUDED IN THE CORE?

The examples of minimum standards in the previous section related to horizontalprice restraints which are commonly regarded as core problems.

An advantage of the minimum standards approach is that it is flexible. It can beginwith a modest coverage and extend the coverage as countries exchange informationand experiences.

One problem in achieving effective harmonisation is that elements of competitionpolicy interact. For example, in the oligopoly models considered in the previoussection, it was assumed that entry into the industry is blocked. Indeed, the lack ofentry into the market is the source of market power of the oligopolists and thefundamental aspect of competition policy in this example. A government might forcemarket access and increase the number of producers. Competition policies requireconsistency among the elements.

Consistency in turn requires common methods of analysis. If the competitionauthorities have different views of the nature of competition, harmonisation of otherelements will be ineffective. This element seems crucial to effective harmonisation.

170 Competition policy in APEC: principles of harmonisation

Similarly, if the competition authorities have different objectives, harmonisation maybe ineffective. Examples 2 and 3 in the previous section showed that differentoutcomes will arise if countries differ in the weightings they attach to producer andconsumer interests. The same problems arise if some countries have competitionpolicies which seek to develop small and medium-sized enterprises or to promoteexports.

Another element which might be included in the minimum set is competition policyenforcement. Fox and Ordover (1995) suggest that countries could allow residents ofnations which are affected adversely by cartels in other countries to have access to theenforcement procedures of the countries in which the cartels are located, and that thecompetition authorities of all countries take account of the harm caused by cartelsoutside the territory of the cartel. In the example above, this would allow theconsumers in other countries to take action to terminate the cartel, provided thecompetition law of the cartel’s home country permitted this action. Thus it requiresprior harmonisation of the law. If the source of the anticompetitive behaviour is laxenforcement rather than the absence of law, this is the solution.

It may not be desirable to harmonise some elements of competition policies. Forexample, the thresholds for mergers are in terms of units of the local currencies andthey depend in part on the size distribution of firms in the national economy. Thelack of harmonisation of these thresholds is, however, consistent with a single view ofthe competition process and harmonised competition policies.

An important aspect of the desirability of harmonisation is raised by the cases ofHong Kong and Singapore. It was noted in the previous section that these countrieshave no comprehensive competition policies. The governments of these two countrieshave contended in APEC debates that they are open economies and that openeconomies do not require comprehensive competition polices. Openness means ‘notariff, no quantitative restrictions on foreign goods and no capital flow restrictions onforeign investment’ (Hong Kong government 1996, p. 9). This applies to markets forservices as well as goods.

The removal of barriers to trade in goods and services, together with the applicationof the GATT principles of most-favoured-nation and national treatment, means thatall producers compete on a level playing field. There are no government-imposedbarriers to entry or exit. In this environment, the role of the government is to providelegal and regulatory infrastructure that underpins free and fair markets and toencourage enterprise through small government and low and stable taxation. TheHong Kong government recognises that there are circumstances where freecompetition may not be practicable: they list those where a very high level ofinvestment is required, where there is a need for prudential supervision, and wherethere is a need to protect the long-term interest of consumers.

In essence, the governments of Hong Kong and Singapore argue that a policy of openmarkets makes markets contestable (with limited exceptions) and therefore makes a

Competition policy in APEC: principles of harmonisation—171

comprehensive competition policy redundant. They have a competition policy; it isto open their economies to all flows of goods and services and capital.

This point has been recognised before at the level of the world economy. Lloyd andSampson (1995, p. 701) argue that the best policy the WTO might adopt towardscompetition is not to develop a competition policy within the WTO to complementits trade policies but merely to continue to move towards free international trade ingoods and services. This argument applies equally to an individual country withrespect to its unilateral trade policy. And it applies to the APEC region as a whole.The best competition policy for the APEC countries may be liberalisation of tradeand investment, which makes their markets more contestable.

The same applies to other policies which affect competition in industries such asprivatisation and deregulation. Privatisation and deregulation will increasecompetition in the industries which are privatised and deregulated. Conversely, agovernment which chooses to maintain a public monopoly in some industry — say,in telecommunications — will not require a competition policy for the industry. Sucha policy exempts the industry concerned from normal competition policy rules.

All of these are examples of the interrelationships between competition policies of acountry on the one hand and, on the other, the policies towards trade in goods andservices and foreign investment that it adopts. They show that the competitionpolicies that are required to make markets contestable for a country depend onpolicies with respect to the country’s trade and foreign investment, privatisation andderegulation and other policies that affect competition in markets.

This conditionality does not, however, rule out harmonisation in the form ofminimum standards. Open economies may still have residual competition problemsdue, for example, to vertical restraints and exclusive dealerships.

Information is lacking about the nature of competition in world markets and how ithas been affected by these structural changes in the world economy. This should bean urgent priority for future research.

As regards the political feasibility of harmonisation of competition policies, even if aworld view is adopted for the purpose of harmonisation, there is still the difficultythat countries which stand to lose from the adoption of a particular harmonisedstandard will oppose its adoption. (This applies to the export cartel example abovebut not to the oligopoly example.) In this respect, international competition policiesresemble international negotiations which have reduced trade barriers. Reductions intrade barriers is a positive sum gain in which ordinarily all nations can expect to gain:reducing a country’s tariff and non-tariff barriers increases the welfare of the homecountry as well as that of the exporting countries.13 However, governments frequentlyweight producer interests more heavily than consumer interests and see somereductions as ‘concessions’ which are necessary to achieve gains in other areas. Ininternational competition policies, there is no general proposition or expectation that

172 Competition policy in APEC: principles of harmonisation

all nations will gain from the harmonisation of individual competition policystandards and this problem will be exacerbated if governments weigh producerinterests more heavily. The development of international competition policies is likelyto be more difficult than many other areas of international policy. Nevertheless, as ininternational trade negotiations, harmonisation across a number of competitionstandards is likely to bring gain to all countries participating in the harmonisation;what they lose on the swing they would more than gain on the roundabout.

APPENDIX 7.1: BILATERAL AND MULTILATERAL INDICES OFSIMILARITY

In the text of their study, Bollard and Vautier (Chapter 6) construct a bilateral indexof the similarity of the competition policies of any pair of countries. This appendixgeneralises their bilateral index to a multilateral index of the similarity of competitionpolicies among a number of countries.

Suppose that there are m countries whose competition policies we wish to compareand n elements of competition policies in each country. There are s = mC2 = m!/2!(m– 2)! = m(m – 1)/2 pairs of countries; for example, if there are 11 countries (as insample used by Bollard and Vautier), s = 11.10/2 = 55.

Take any pair of countries, say countries h and j. Let be the measure of similarityfor the ith element of the index. If element i is a binary variable, it will take a valueof 0 or 1. If element i is a continuous variable, it can lie anywhere on theclosed interval [0,1]. Hence, for all i. The Bilateral Index of Similarity issimply

(A1.1)

This index can accommodate both binary and non-binary variables. It weights theelements equally. It lies on the unit interval. 1 represents identical policies betweenthe two countries. An increase in this index over time represents convergence of thepolicies of the two countries.

The Multilateral Index of Similarity averages the value of the index of similarity forany element across all pairs of countries and then calculates the unweighted averageacross all elements:

(A1.2)

where

E s Ei

s

ihj= 1

1/ Σ

S n E

i

n

i==

11

/ Σ

hj

i

n

ihj

S En==

11

/ Σ

ihjE e[0 1, ]

ihjE

Competition policy in APEC: principles of harmonisation—173

is the average value of for all pairs of countries. This index lies on the unitinterval. 1 represents identical policies among the m countries. Moreover, changingthe order of summation,

That is, the Multilateral Index is also the unweighted average of the bilateral indicesfor all pairs of countries. An increase in this index represents a convergence of policiesamong the countries.

If a minimum set of standards is agreed upon by a set of countries, one can calculatean index of the extent to which the countries conform to this standard:

(A1.3)

where measures the similarity or degree ofconformity of country h to the agreed standard for element i. C lies on the unitinterval. An increase in this index represents convergence towards the agreedstandards.

APPENDIX 7.2: THE CROSS-HAULING MODEL OF OLIGOPOLY

Suppose there are two countries, indexed by i=A,B. In each country there are initiallya fixed number of producers, though not necessarily the same number in eachcountry, nA and nB. There are nT = nA + nB firms in the world market. The product ishomogeneous and there are identical inverse demand functions in each country:

(A2.1)

where xi is the aggregate demand in country I. All firms have identical cost functions:

(A2.2)

where F is fixed costs and c is the constant marginal cost of producing yf. Each firm

is a Cournot competitor — that is, it maximises profits, given the outputs of all otherfirms in countries A and B. Suppose that international trade has been freed in thismarket. Consequently, there is one market price, p. Hence, there is an inverse demandfunction for the world:

(A2.3) p x xA B= − ( ) +α β1 2/ ( )

f nT= , ,1 K C F cyf f= +

i A B= ,p xi i= −α β

ih

D C nm

i

n

h

m

ih

D== =

11 1

/ Σ Σ

S s

shj

S= 11

/ Σ

E ihj

174 Competition policy in APEC: principles of harmonisation

The equilibrium is a symmetric one in which all firms are identical. Each of the firmsmaximises profits by choosing its output, given the outputs of the other firms. Thesolution for y

fis

(A2.4)

For convenient reference, the terms involving nT are collected in square brackets.Substituting (A2.4) in (A2.3), the price which clears the world market is

(A2.5)

The profits of the firm are

(A2.6)

Each firm sells on both the home and the foreign market — that is, there is cross-hauling.

Total profits of firms in countries A and B are

(A2.7)

Total profits in both countries combined are

(A2.8)

Thus, the total global profits are divided between the countries in proportion to theirshare of the total number of firms in the world market.

Consumer surplus in country i is

(A2.9)

Total consumer surplus in countries A and B combined is

(A2.10)

Because of identical demand conditions, this is double that of either country. Totalwelfare in each country is the sum of consumer surplus and profits:

(A2.11)

Global welfare is the sum of the total welfare in both countries:

(A2.12)W n n n c n FA B T T T T+ = + + ⋅ − −{[ ( ) /( ) ] ( ) / }2 1 2 2α β

i A B= ,W n n n c n Fi i T T i= + + ⋅ − −{[( ) /( ) ] ( ) / }4 1 22 2 2α β

CS n n cA B T T+ = + ⋅ −[ /( ) ] ( ) /2 2 21 α β

i A B= , = + ⋅ −[ /( ) ] ( ) /n n cT T2 2 21 2α β CS p xi i= −( ) /α 2

P n n c n FA B T T T+ = + ⋅ − −{[ /( ) ] ( ) / }2 1 2 2α β

i A B= , P n n c n Fi i T i= + ⋅ − −[ /( ) ] ( ) /2 1 2 2α β

= + ⋅ − −[ /( ) ] ( ) /2 1 2 2n c FT α βP py F cyf f f= − +( )

p n c nT T= + +[( ) /( )]α 1

f nT= , ,1 K f Ty n c= + −[ /( )]( ) /2 1 α β

Competition policy in APEC: principles of harmonisation—175

To model harmonisation of competition policies, suppose that each country controlsthe number of domestic firms in the country. One country adopts a more lax mergerstandard than the other in that it allows a smaller number of firms in relation to thesize of the market. It was these merger standards which determined that the initialnumber of firms be nA and nB, respectively.

Now, the two countries decide to harmonise their merger policies. Suppose thecountry with the lax standards adopts the standards of the other country. It willincrease its number of firms (by disallowing some mergers). The total number offirms in the industry worldwide increases and the market price falls (from EquationA2.5). Equations A1.7 and A1.9 are decreasing and increasing in nT respectively for i= A and B. Hence, consumers gain and producers lose in both countries from theincrease in the number of competitors. The expression in the curly bracket inEquation (A2.11) is increasing in nT and Wi is increasing in nT too for (ni/nT) < 3/4,provided F is not large. That is, this country gains from an increase in the number offirms in the country. The other country loses. If the country which increases thenumber of firms has (ni/nT) > 3/4, this country loses and the other gains, providedthe economies of scale are not too large. The world gains from harmonisation, againprovided the economies of scale are not too large.

The symmetry of the model can be relaxed, the countries could be of different size,the firms could have different production functions and tariff barriers to tradebetween countries can be introduced, without changing the qualitative conclusions.

NOTES

I wish to acknowledge the comments and suggestions made on an earlier draft of this chapterby Alan Bollard, Paul Crampton, Kin Kihwan, Martin Richardson and Kerrin Vautier.1 The international dimensions of competition policy do not constitute an entirely new

area. Issues of harmonisation of domestic policies, including what is now calledcompetition policy, were first raised by international trade economists in the early stagesof the GATT liberalisation of world trade. See Johnson, Wonnacott and Shibata (1968).

2 See Sauvé (forthcoming) and Zampetti and Sauvé (1996), who discuss contestability inrelation to competition policy.

3 Here I overlook the law which is emerging in regional trading arrangements such as theEuropean Union and the Closer Economic Relations (CER) agreement between Australiaand New Zealand. This is setting important precedents but the geographic coverage islimited to the members.

4 See Hoekman and Mavroidis (1993) and Lloyd and Sampson (1995) for a review of thepowers of the WTO in relation to competition policies.

5 See the Productivity Commission (1996) and the New Zealand government (1996) forsome discussion of the application of these principles in the major OECD or Asia Pacificcountries respectively.

6 Many options are discussed in OECD (1995).7 Harry Johnson reached this conclusion in 1968: ‘Harmonization in this area however,

raises some exceedingly complex issues in both economic theory and legal practice, andconsideration of the possible need for it would probably most wisely be deferred untilexperience of free trade has provided evidence on the question’ (Johnson 1968, p.433).

176 Competition policy in APEC: principles of harmonisation

8 Other less detailed surveys of the competition policies in APEC countries have beenprepared by Waverman and Wu (1995), Green (1996) and the Productivity Commission(1996, Table 3.1). Boner and Krueger (1990) review the competition laws of the majorindustrialised countries.

9 The same issues have arisen with regional freeing of trade. For an early treatment of taxharmonisation in this context, see Shoup (1967).

10 In the debate as to whether labour standards should be added to the WTO, there hasbeen much discussion of a ‘core’ of especially important labour standards.

11 For a recent survey of this, see Brander (1995).12 If all firms in one country merge, we have a single seller that operates like the cartel in

Levinsohn (1996) except for the presence of fixed costs in the cross-hauling model.13 There are two exceptions to this rule. First, there may be large terms of trade effects in

countries which have considerable market power. It is generally believed that terms oftrade effects will not be large for most countries. Second, there may be perverse effectswhen economies of scale and imperfect competition are features of a market. ‘New tradetheory’ has produced examples of countries which gain from the imposition of someborder restrictions, especially export subsidies which shift profits, but even in these casesthe world as whole gains from trade liberalisation. Moreover, in oligopolistic markets,some models predict additional gains following trade liberalisation arising from anincrease in the degree of competition.

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8 Trade and competition policy

Rong-I Wu and Yun-Peng Chu

The general principle behind trade and competition policies should be the same —namely, fair competition. There may be more emphasis on free competition for tradepolicies but the difference is more apparent than real. Encouragement of freer tradeis designed to open up markets by removing barriers to entry so that producers fromdifferent nations can compete. In that sense, trade policy should form an integral partof a general policy aimed at fair competition.

In reality, trade and competition policies have been kept separate. And, in this way,the negotiating parties, sometimes after rounds and rounds of negotiations, come toforget the true principles that they are meant to abide by. For example, antidumpingis supposed to provide a measure against price predation, but over the yearsantidumping regulations have developed into such an extensive network of rules andcases that the original purpose has often been lost. People tend to observe some fixedrules: for example, that dumping is established if the foreign price falls below thedomestic price by a given percentage and if the complainant has been truly injured.But that is not good economics: it is a long way from cutting prices to stopping pricepredation. In the end, instead of encouraging fairer trade, antidumping measures canbe used by domestic producers as shields against legitimate foreign competition.

The time has come for a review of the practices of both policies. This chapter providesa taxonomy that clearly defines their borders and where they overlap. This taxonomyshows where the two policies provide support for each other and where they do not.The first case represents a virtuous alliance which should be strengthened; while thelatter runs contrary to the goals of both policies and needs to be corrected.

In the second section more reasons are given to explain the necessity of reviewing thelinkage between trade and competition policies. The third section explains why thereis now considerable pressure for a competition policy agenda. The fourth sectionpresents a taxonomy of the two set of policies. The fifth section deals with theimportance of international cooperation on competition policy, with special emphasison initiatives under the Asia Pacific Economic Cooperation (APEC) banner. Finally,the sixth section provides some concluding remarks.

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LINKAGE BETWEEN TRADE AND COMPETITION POLICIES

The importance of the linkage between trade and competition policy has been wellrecognised (Wu and Chu 1994). The linkage is all the more important as trade andinvestment among nations becomes more liberalised. While competition is a dynamicforce of change, it may also be a force for industry concentration. Winners willexpand and are likely to use all means at their disposal to consolidate their patches ofturf. Trade liberalisation without safeguards for fair competition is in danger ofcausing greater concentration in some industries and less competition in the end.This would mean the eventual erosion of world trade for these industries whichwould run contrary to the original aims of General Agreement on Tariffs and Trade(GATT) negotiations for freer trade. Consequently, the maintenance of competitionshould not only supplement the new world trade order; it should form a part of thecore, providing as it does a key to the long-term health of that new order.

Current trade issues are in general more concerned with the interests of nationalproducers than with those of consumers. By ensuring a competitive environmentwhere producers interact according to fair rules and where the interests of consumersare adequately taken care of, the new world trade order will be better balanced. Manyallegations against the abuses by transnational enterprises can meanwhile be resolvedor clarified; as a result, the lack of confidence, justifiable or not, among theseenterprises is more likely to be replaced by other more positive sentiments.

In discussing trade issues such as ‘dumping’ or other forms of ‘unfair trade practices’,attention has traditionally focused on national interests, but in the narrow sense. Themere shift of focus from trade to competition policy represents a healthy movementtowards enhancement of national interests as part of the enhancement of global orcollective interests. The removal of tariffs and other barriers is one step; theredefinition of trade as transactions subject to competition rules would represent agiant step forward.

Increasingly, what were once considered to be purely domestic policies — policiessuch as patent laws, the setting of standards for high tech products, governmentprocurement, trade-related investment measures (TRIMs) and subsidies — are all onthe international negotiations agenda.

Pressure exists to also place domestic competition law policy on the agenda. TheOrganisation for Economic Cooperation and Development (OECD) has stated that‘International cooperation in competition policy is high on the agenda of the currentdebate on strengthening the rules of the game for economic relations’ (OECD 1992).Peter Sutherland, the former Director-General of GATT, has stated that competitionpolicy should be on the agenda for future multilateral discussions of harmonisation.

The recently signed GATT/World Trade Organisation (WTO) undertakings do notexplicitly address competition policy although several sections are clearly related.Thus some scholars see the TRIMs agreement as having clear competition policy

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consequences since these measures were introduced to affect the business practices ofmultinational corporations (MNCs). It has been suggested that domestic competitionlaw will be necessary in the aftermath of the disappearance of TRIMs. The trade-related intellectual property provisions (TRIPs) section of the GATT/WTOagreements provides for consultation between governments where there is reason tobelieve that licensing practices or conditions pertaining to intellectual property rightsconstitute an abuse of these rights and have an adverse effect on competition.

Other sections of the agreements — on the new subsidies codes (the traffic lights),the revised antidumping agreement (which some see as a backwards step) — are allconsistent with reducing trade and investment barriers to foreign firms.

Still, there is no coherent understanding of the role of competition law and policy inthe GATT/WTO agreement. Hoeckman and Mavroidis (1994), among others,suggest that GATT Article XXIII:1 (b) on ‘nullification and impairment’ of benefitscould be used to bring a complaint to GATT dispute resolution aboutanticompetitive practice. In addition, the dispute resolution process in the WTO islikely to be open to a complaint brought forward on some aspect of domesticanticompetitive behaviour. However, rather than being dragged, without analysis andwithout discussion, into some form of ‘top down’ finding of the merits or demerits ofa particular business practice, it is wise to begin analysing the international aspects ofdomestic competition policy.

While these reasons are relevant for global cooperation on competition policy, theyare particularly important to the Asia Pacific region. In the region, trade andinvestment boomed during the past two to three decades, as it was enjoying higheconomic growth rates unseen in the other parts of the world. Many existingmultinationals in industrialised nations have moved into the region, as hasmultinational business among the newly-industrialising nations. There is real needfor a set of codes for international competition for this part of the world.

Nations may also need to provide mutual assistance not only in investigatingrestrictive trade practices but also in taking remedial action. Since sovereignty will bean issue here, it will not be easy to conclude agreements over the short term, but stepsshould still be undertaken to achieve this, based on the principle of reciprocity andcooperation.

Bilateral and trilateral cooperation on competition policy has already started amongAsia Pacific countries. Australia and New Zealand have harmonised their competitionlaws and policies as part of their Closer Economic Relations (CER) agreement; theNorth American Free Trade Agreement (NAFTA) has some provisions regardingcooperation on competition; and the APEC Eminent Persons Group (EPG) hasrecommended that APEC ‘consider adopting a policy based on the existing models ofinternational cooperation on competition policy’ (APEC 1993, p. 43,Recommendation 6).

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When mapping out the report, the EPG undertook intensive discussions on thesubject. In particular, there were concerns over the growing use of antidumpingmeasures. That led the EPG to recommend in its second report that ‘APEC create atask force on anti-dumping and restrictive business practices, to address anti-dumping practices and the impact of national anti-trust laws on international tradewith eventual expansion into the broader aspects of competition policy’ (APEC1994a, p. 21). This recommendation has been well received by the APEC MinisterialMeeting. Competition policy was also very much on the agenda of the APECCommittee on Trade and Investment (CTI). A CTI recommendation in a 1994report to include competition policy in the APEC work programme has beenapproved by APEC ministers (APEC 1994b).

PRESSURES FOR A COMPETITION POLICY AGENDA

There are various pressures to include competition policy on the multilateral agendaanalysis. The GATT/WTO agreement was not delivered from the skies but was theendogenous outcome of a set of negotiations; similarly, the forces pushing for freetrade in APEC by 2010/2020 are likewise endogenous. These pressures have beenadmirably described elsewhere, so here we will simply provide a brief sketch of them.

• Globalisation — The rapid rates of growth of trade and foreign direct investmentrelative to GNP in the last 15 years integrate national economies much more deeply so that policies that were once irrelevant or simply of nuisance value are now important (see Tables 8.1 and 8.2).

Table 8.1 The ratio of foreign direct investment inflows to gross domestic capital formation inselected APEC economies (percentage)

1971–75 1976–80 1981–85 1986–91

Australia 4.0 4.6 4.6 9.5Canada 3.6 1.7 -0.7 3.7China 0 0.08 0.9 3.7Hong Kong 5.9 4.2 6.9 12.1Indonesia 4.6 2.4 1.0 2.4Japan 0.1 0.05 0.1 0.1Malaysia 15.2 11.9 10.8 9.7Mexico 3.5 3.6 2.7 7.0New Zealand 4.8 6.1 4.9 8.6Philippines 1.0 0.9 0.7 5.7Republic of Korea 1.9 0.4 0.5 1.1Singapore 15.0 16.6 17.4 29.4Chinese Taipei 1.4 1.3 1.5 3.5Thailand 3.0 1.5 3.1 6.3United States 0.9 2.0 3.0 5.6

Source: Waverman and Wu (1994).

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Table 8.2 Foreign direct investment inward stock, 1980, 1985 and 1990 (million US dollars)

1980 1985 1990

Australia 13,173 25,049 74,451a

Canada 670d 3,444 10,648b

China 51,651 62,416 108,023Hong Kong 1,729 3,520 11,685b

Indonesia 10,274 24,971 38,883Japan 2,979 6,397 18,432Malaysia 6,076 8,510 10,117c

Mexico 8,459 14,629 30,310New Zealand 2,363 2,043 3,242b

Philippines 1,225 1,302 1,568b

Republic of Korea 1,140 1,806 3,956c

Singapore 6,203 13,016 26,780b

Chinese Taipei 2,405 2,930 6,801c

Thailand 1,981 1,999 5,536b

United States 83,046 184,615 403,735

Notes: a 1991.b 1989.c 1988.d 1981.

Source: Waverman and Wu (1994).

• Policy awareness — Economies that were once less involved in world trade, such asthe United States, are now deep in trade. One may argue that the US views of theorigins of its trade deficit are misplaced but now other countries’ trade, investmentand domestic policies form breakfast-table topics in policy corridors.

• Policy fairness — The concept of what is ‘reciprocal is fair’ and what is ‘level (as in a playing field) is fair’ has taken root and will not be done away with. Therefore,countries can no longer use the excuse ‘it is purely domestic’ when they choose notto discuss the impacts of regulatory, purchasing or competition policy regimes.

• Effective access — Along with ‘globalisation’, ‘awareness’ and ‘fairness’ has come the recognition that the end of the process must involve effective access; that truenational treatment requires the opening of markets. The speed of opening and theimpediments to the large MNCs while domestic economies prepare for competition are clearly topics for discussion.

• Spillovers — As the activities of MNCs grow in importance and start to cross manyborders, the spillover effects from domestic policies such as competition policy willbecome greater. Examples are given below, but a simple case is a proposed mergerwhich, given the multilateral nature of the corporations involved, requires the approval and consent of many antitrust authorities. Three ideas are key here. First,any antitrust authority acting alone can end the merger even if it has benefits in theother jurisdictions. Second, there is a fear that others will compete in the directionof the lowest common regime in order to acquire foot-loose investment. Third, a

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regime without any antitrust law is not at the table — it is, at best, a victim, not aparticipant.

• New forms of interfirm agreements — New and evolving patterns of interfirm behaviour, collaboration and alliances are emerging, making effective analysis of interfirm behaviour difficult (see Bureau of Competition Policy, Canada 1985). Thus, enforcement by a single national antitrust authority may be constrained as many of the new forms of behaviour cross borders.

• Dumping — Ninety-five per cent of observers would likely agree that antidumpingpractices as commonly employed are basically, although not exclusively, protectionist, and that they raise domestic prices and lower welfare (see Council ofEconomic Advisors 1994). In addition, antidumping is inconsistent with free tradeand violates principles of national treatment (Waverman 1994). Ninety-five per cent of observers also agree that replacing antidumping by competition policyprocedures would be superior. To do this, however, requires some overall competition policy in each country which addresses predatory practices.

• Strategic dumping — Strategic dumping essentially involves subsidising exports through high home prices sustained by collusive price behaviour and a protected home market. Views that strategic dumping exists are growing and thus must be dealt with through rational analysis and discussion.

• Competitive exclusionary practices — Danger exists that without competition policy convergence, nations will act unilaterally to defend what they consider to betheir strategic interests. For example, the European Commission has complained that recent US legislation (in this case the National Cooperative Production Act of1993, which extended permissive antitrust treatment to the production end of R&D collaborations) was conditioning the principle of national treatment so as toassist US firms (European Commission 1994).

• Extra-territoriality — National governments are unilaterally extending the reach oftheir laws, including that of antitrust laws. Thus, in 1991 the US Federal Trade Commission concluded a consent decree with Institut Merieux of France which purchased Connaught Laboratories of Canada, neither having production facilitiesin the United States, and without informing the Canadian counterpart agency. In1994 the US Department of Justice concluded a consent decree with Pilkington (UK), a decree which stated that Pilkington’s restrictive business practices affectedthe ability of US firms to export technology to build turnkey glass plants overseas.No impact on welfare in the United States is discussed. All these raise serious issuesabout sovereignty that need to be attended to in multilateral negotiations on competition policy. Thus, nations cannot escape competition law by simply avoiding having one.

All this is by way of saying that domestic competition policy is on the multilateralagenda.

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A TAXONOMY OF TRADE AND COMPETITION POLICY

Tables 8.3 and 8.4 present a useful classification of the issues involved in the linkagebetween trade and competition policy according to the nature of activity involved(that is, international or domestic with cross-border effects) and according to theparty imposing the barrier (namely, government or private undertakings). Since theaim of competition policy is to regulate the anticompetitive conduct of private and(to some extent) public enterprises in order to ensure effective competition, it maysometimes conflict with trade policies which have different goals. The followingdiscussion examines these barriers to competition imposed by government and byprivate undertakings respectively.

Table 8.3 Interaction between trade and competition policies on internationaltransaction/investment/business practices

Party imposing barriers to competition

Government Private undertakings

Nature of activities involved Situation Examples Situation Examples

International (cross- 1. Competition Reduction in 1. Many restrictive International border) transaction/ laws usually tariff, non-tariff business practices cartels,investment/business exempt barriers and are currently not abuse of dominantpractices government subsidies properly regulated position

activities Some countriesresort to extra-territorialapplication of competition lawsbut this may causeinternational conflicts.Cooperation inpolicies is needed

2. Trade 2. Some of the Transnational negotiations can restrictive business mergerslead to freer practices arecompetition currently regulated

across countries,leading to conflictsand unduly highrisks borne bybusiness

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Nature of activities involved Situation Examples Situation Examples

3. Some cases are Antidumping handled under measurestrade agreements,which, however,may have adverseeffects oncompetition. The system needs to bereviewed

Table 8.4 Interaction between trade and competition policies on domestic transaction/investment/business practices

Party imposing barriers to competition

Government Private undertakings

Nature of activities involved Situation Examples Situation Examples

Domestic 1. Competition 1. Many competition Export and import transaction/invest- laws usually laws allow practices cartelsment/business exempt that do not restrict practices that government domestic trade buthave cross- activities may restrict border effects international trade.

These should bemodified inaccordance with thenational treatment principle under GATT;international cooperation is needed

2. Trade negotiations Deregulation of 2. Different contents United actions bycan lead to freer the domestic and enforcement rules domestic firms notcompetition market of competition laws properly regulated

in different countries will block the may constitute a entry of foreignsource of ‘unfair’ or other domestictreatment. firms to certainInternational marketscooperation isnecessary toward theestablishment of a setof basic rules

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Barriers to competition imposed by governments

When barriers are directly or indirectly imposed by governments, through tariffs,non-tariff barriers, subsidies or restriction on foreign investment, competition lawsare usually not applicable. This includes international transaction/investment/business practices, which are comprised of all international trade and directinvestment in foreign countries, as well as business practices such as horizontal orvertical restraints involving companies from more than one country (hereafterreferred to as ‘ITIB’). Also included are other kinds of activities such as domestictransaction/investment/business practices with cross-border effects (hereafter referredto as ‘DTIAB’).

This includes regulations, state monopolies, special privileges, licensing and the like.The government itself, as an entity making and carrying out public policy decisions,is typically exempt from competition law. Exclusive right to entry and some otherprivileges granted to public or private undertakings (written into laws by thelegislature) are usually beyond the reach of competitive laws and their enforcementagencies.

In these cases, trade agreements, to the extent they lower barriers to entry, are usefulin improving the environment for competition. Here, the goal of trade policies issimilar to that of competition policy. For ITIB, actions include the reduction of tariffrates and non-tariff barriers. For DTIAB, actions include deregulation or the removalof barriers to entry into domestic industries, which previously might not have beenopen to any new entrant, domestic or foreign.

In these cases, the optimal policy is to let the trade talks — both bilateral ormultilateral — continue, and to let the barriers to entry be further reduced. Theresult would be freer and fairer trade and investment and a better environment forcompetition at the same time. Therefore, this will facilitate the growth of trade andinvestment in the negotiating countries and in the world market as well.

Private dealings in ITIB that impede competition

With regard to private dealings in ITIB, international cooperation in competition isdefinitely called for, in at least three areas.

Whereas trade agreements have removed or lowered many of the barriers to entryimposed by governments and private enterprises, important private restrictions tocompetition may remain unregulated, thus undermining efforts towards freer andfairer trade. For example, a transnational company with substantial market powermay impose territorial restraints along country lines on its dealers in order to enforceprice discrimination. Another company which also has market power may coerce itscustomers into buying its products exclusively by threatening adverse allocation intimes of shortage.

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In cases like these, the victims are usually able to file a complaint with a governmentagency or bring the case to court, if the country in which they reside has acompetition law. But what happens if a foreign entity is found guilty? Is the countryin question willing to apply its laws to that foreign entity? If so, does it have thecapability to do so? Extra-territoriality is the issue here. This often involves thequestion of national sovereignty, which can lead to international conflicts or friction.Consequently, international or regional cooperation is needed. Under the CERagreement, the problem is eliminated as both competition laws and their enforcementhave been harmonised between Australia and New Zealand. In the EuropeanCommunity, the problem is taken care of by the European Commission, whichreviews all cases that involve cross-border effects on member countries

Of the restrictive business practices that are currently regulated, some are regulateddifferently across countries, which can lead to high uncertainty and costs being borneby business. Mergers, usually cross-country mergers of a size above some minimumstandard, have to seek approval from all the authorities involved — each of which hasa de facto veto power. This can create confusion and uncertainty. Internationalcooperation is needed to reduce the transaction costs.

When trade talks do deal with abuses by private undertakings across countries,sometimes the process itself may in the end harm competition. Dumping is the mostimportant case in question. In many trade agreements, antidumping duties can beimposed as long as the foreign supplier is selling at a price below its home level, andby so doing causing injuries to a domestic competitor. But it may be that the foreignsupplier is simply participating in legitimate price competition. This often happenswhen a new and better technology is introduced and production costs consequentlydecline by a significant amount. This will increase competition and benefitconsumers. The adoption of antidumping measures will in this case evidentlyinterfere with international competition. A domestic supplier may be using theantidumping procedure as a shield from foreign competition instead of as a remedyfor hostile and illegitimate price predation.

Here, more international cooperation is also needed. One possible way of cooperatingis to bring issues of competition to trade negotiations, and to modify antidumpingagreements accordingly. The WTO, as noted earlier, is doing just that. Another pathis to substitute antidumping measures with the enforcement of competition laws thatare designed to handle price predation across borders. However, this requiresagreement among the contracting parties.

Private dealings in DTIAB that impede competition

For private dealings in DTIAB, competition policies are usually directly applicablewhile trade policies are usually not. Thus, the burden is on the former to maintain anenvironment favourable to free competition. Here there are also two possible areas foreconomic cooperation.

188 Trade and competition policy

Competition laws may be a barrier to international competition if they give a greenlight for domestic firms to engage in arrangements that do not restrict domestic, butwill restrict international, competition. In the competition laws of many countries,for example, export or import cartels are either approvable under or exempt fromcompetition laws. This is a violation of the principle of national treatment underGATT. We know that export or import cartels are not always anticompetitive;however, countries need to get together to review their respective laws and to revisethem if necessary, given that all other countries in the group are willing to do thesame.

Competition laws may also be a source of ‘unfair competition’ when the laws andtheir enforcement are different across countries, or when they are completely absentin others. Countries that have a stringent set of laws and a record of vigorousenforcement may argue that their businesses are subject to more regulationdomestically than are their counterparts in other countries, and may describe thesituation as ‘unfair’. How serious the situation really is is hard to assess. The first stepfor cooperation could be simply information gathering: to understand the nature ofcompetition laws and their enforcement in different countries, and to make aninventory of the cases that occur, for example.

Since competition policies will be included on the agenda in the post-UruguayRound trade talks under the WTO, it is all the more important to understand theinteraction between trade and competition policies and how the global market can bemade more open or less open as a result of negotiations with respect to competitionpolicies. Agreements which would lower the barriers to trade imposed bygovernments should be strengthened. Agreements which may unduly hurtcompetition should be modified. Restrictive business practices in the global marketshould be effectively regulated through international cooperation on competitionpolicies. Domestic competition laws should not give special permission to practicesthat affect the foreign but not the domestic market. The nature of competition lawsand their enforcement in different countries should not be a source of unfaircompetition in the international market.

WHY IS INTERNATIONAL COOPERATION ON COMPETITION POLICY NEEDED?

We define competition law and policy to be the set of laws, regulations andinstitutions which control restrictive business practices, including domestic cartelsand horizontal restraints among competitors; dominant firm behaviour ormonopolisation; anticompetitive mergers; and other restrictive business practices.

Surveys of competition policy in the APEC region have been undertaken by, forexample, the APEC CIT (APEC 1994b). From these reports, it seems that manyAPEC countries — including Hong Kong, Indonesia, Malaysia, the Philippines,Singapore and Thailand — do not yet have a competition policy. Most of these

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countries have legislation to prevent misleading advertising, and to provide for pricecontrol where necessary, but they do not have a body of legislation which addressesanticompetitive practices in their various guises, and which is backed by a separatelarge independent enforcement apparatus.

Among the APEC economies which do have competition laws and policy, the processand the substance of the law differ quite significantly. Tables 8.5, 8.6 and 8.7document some of these differences.

Table 8.5 Competition policy in APEC economies: laws and institutions

Geographic Covers Administrative limitation government enforcement

Main legislation (if any) enterprises agencies

Australia Trade Practices Act, Restricted to Noa Trade Practices1974; Prices Surveillance interstate and Commission,Act, 1983 territorial activities Prices Surveillance

Authority

Canada Competition Yes Director of Act, 1986 Investigation

and Research,Bureau ofCompetitionPolicy

China Law Against Yesb AdministrativeImproper DepartmentCompetition, for Industrial1993 and Commercial

Affairs

Japan Anti-Monopoly Yes Fair Trade and Fair Trade CommissionLaw, 1947

Mexico Federal Law and Yes Federal Economic CompetitionCompetition, Commission1993

New Zealand Commerce Act, Commerce 1986; Fair CommissionTrading Act,1986

Republic of Monopoly Commission forKorea Regulation No Fair Trade

and Fair TradeAct, 1980

190 Trade and competition policy

Geographic Covers Administrative limitation government enforcement

Main legislation (if any) enterprises agencies

Chinese Taipei Fair Trade Law, Yesc Fair Trade 1991 Commission

United States Sherman Act, 1890 Restricted to trade No Department of Clayton Act, 1914 between states and Justice,Federal Trade international trade Federal Trade Commission CommissionAct, 1918Webb–PomereneAct, 1918Robinson–PatmanAct, 1936Celler–Kefauver Act, 1956Hart–Scott–RodinoAntitrust ImprovementAct, 1976

Notes: a Proposed reforms will extend application of the Act to businesses established understate government authority and to government enterprises.

b While this applies to state-owned enterprises, it appears not to apply to the business activities of state agencies.

c State-owned companies were granted a temporary four-year exemption, however. Source: Waverman and Wu (1994).

Table 8.6 Merger requirements and tests

Assessed mainly in terms ofcompetitive impact (C) or

Pre-merger notice required against broader criteria (B)

Australia N BCanada Y BChina na naJapan Y BMexico Y BNew Zealand N BRepublic of Korea Y BChinese Taipei Y BUnited States Y C

Notes: N = no, Y = yes, na = not applicable.

Source: Waverman and Wu (1994).

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Table 8.7 Designation and monitoring of dominant firms and major conglomerates

Designation of dominant Designation of major firms conglomerates

Australia N NCanada N NChina na naJapan N NMexico N NNew Zealand N NRepublic of Korea Y YChinese Taipei Y NUnited States N N

Notes: N = no, Y = yes, na = not applicable.

Source: Industry Canada (1995).

Competition policy and APEC

Three major themes could be on the agenda for discussion in the APEC region:

• Are domestic competition polices a hindrance to growth?

• What minimum set of competition laws and policies is required to fulfil the goal of free trade in APEC by 2010/2020?

• What convergence, if any, is required in APEC in the process and the substance ofcompetition law and policy?

Note that we define competition law and policy broadly. It is insufficient in our viewto promulgate some laws without ensuring effective enforcement. Effectiveenforcement requires an independent agency, with a significant budget, and anagency which is able not only to examine if the law is being observed but also to actas a spokesman for competition policy within the government by examining existingand new laws, regulations, privatisation processes and so on for their impact oncompetition policy. Enforcement means the ability to impose punitive fines anddamages; enforcement refers to a public process with reasons and decisions, not awarning administered in private. For competition policy to be more than a ‘papertiger’ requires effective enforcement and remedies.

A set of guidelines for competition policy in APEC

However, it is not necessary to have a set of harmonised competition policies acrossthe Asia Pacific. They are not needed and are likely to be counterproductive. Thereason is simple. Economists disagree as to some of the essential fundamentalprinciples of industrial organisation, such as the question of when vertical restraintsare competitive or anticompetitive. Also, are R&D alliances welfare enhancing or

192 Trade and competition policy

welfare reducing? The divergence in theory suggests that harmonising competitionpolicy to some tight standard is impossible and not beneficial — a ‘competition ofcompetition policies’ is still required. Also, some elements of competition policyreflect essential domestic ways of operating an economy. The best example of this ismerger law — the Anglo-Saxon model of corporate governance stresses the need forhostile takeovers to ensure managerial efficiency, while the German–Japanese modelstresses long-term alliances and frowns on hostile takeovers. To many, competitionpolicy is going too far if the basic corporate governance of a nation has to be alteredto some other model.

Yet, as we have stressed above, domestic anticompetitive abuses can have clearinternational ramifications — they can be barriers to trade and investment. Moreover,the spillover effects also discussed above require some closer harmonisation.

Merger policy has long differed across countries. However, a merger today can involveoperations spanning a host of countries, thus involving applications to competitionauthorities in many jurisdictions at the regional, national and subnational level (forexample, Siemens and GEC referred their bid for Plessey separately to the British,German, French and Italian governments, in addition to the European Commission).Each authority utilises differing laws, differing thresholds, differing informationrequests and so on. Mergers and acquisitions are the main instrument of foreigndirect investment today. Any authority acting in isolation can terminate the merger,including individual US states (in the United States private parties also have standingto challenge mergers). International mergers thus face mounting transactions costsand uncertainty. The use of extra-territoriality also adds uncertainty as foreignjurisdictions mount actions even when no production units exist in that jurisdiction.

Countries can no longer ‘avoid’ competition policies if firms domiciled there are freeto contravene antitrust laws in other jurisdictions. The extension of domesticcompetition law through extra-territoriality is not without its reasons as any countrymust be able to protect itself against companies or other anticompetitive behaviourlaunched from outside the country. However, extra-territoriality can mean abuse ofanother country’s jurisdiction and laws. The principle of ‘comity’, to take anothersovereign’s interests into account, is genuine but difficult to make enforceable andconcrete. The United States and the European Union have been particularlyaggressive in extra-territorial applications of domestic competition law. The recentlyannounced consent accord between Pilkington (UK) and the US Department ofJustice signals a new extension of the extra-territorial application of antitrust law tothe arena of patents and trade secrets.

These clashes between domestic competition policies and inter-linkages with trade,investment and technology policy can only grow as multinationals expand throughforeign direct investment and as countries in the Asia Pacific region liberalise tradeand investment. In addition, as stressed here and elsewhere, a whole new set ofhorizontal arrangements among multinationals is expanding — joint ventures,

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strategic alliances, research consortia and production consortia. Many of these newventures are driven by the needs of innovation and technology transfer. If clashesbetween domestic competition law increase friction and transactions costs, foreigndirect investment could be reduced.

Finally, as competition is introduced into traditional ‘public utilities’, the tensionbetween competition policy and regulation increases. As foreign direct investmentinto public utilities is also increasing, the interplay between competition policy andregulation becomes a trade and investment issue.

In view of the above development, it is our opinion that the issue for the PacificEconomic Cooperation Council (PECC) and APEC is to define:

• the minimum set of substantive competition policy issues that a domestic policy should include;

• a means of procedural harmonisation, so that information requiring notice periodsand so on can be set within some reasonable set of limits; and

• a dispute resolution mechanism.

Recommendations

According to the above analysis, international and regional cooperation on trade andcompetition is required. Our view is that policy can proceed in the following areas.

• With respect to the control of restrictive business practices across borders:

— to review existing cases, paying special attention to cases of cross-border abuseof dominant position and cartelisation;

— to study the possibility of establishing principles dealing with the extra-territorial application of competition law;

— to study the possibility of establishing principles on cooperation on such matters as consultation, assistance in investigation and in remedial actions; and

— to study the possibility of establishing principles on the review procedure and the approval criteria for cross-border mergers.

• With respect to trade policies that may have adverse effects on competition:

— to review current trade measures which may have adverse effects on competition, paying special attention to the issue of antidumping; and

— to study the possibility of making recommendations to deal with trade issues, with a view to modifying trade measures that are judged to have had adverse effects on competition, or substituting these measures with cooperation on competition policies.

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• With respect to the possible impact on the international market of competition laws:

— to review the clauses and the enforcement of the competition laws to see if theyallow practices that do not restrict domestic but that may restrict internationaltrade, paying special attention to export and import cartels; and

— to study the possibility of reaching an agreement on modifying existing laws orenforcement practices to remedy such biases reciprocally.

• With respect to whether the lack of the competition law or that of its adequate enforcement constitutes a case of unfair trade:

— to review existing cases based on the above allegation;

— to collect information on competition laws and their enforcement; and

— to undertake a comparative study of this information and to make recommendations.

Solely as the basis for discussion, we would also suggest the following as the minimumset of competition policy substantive requirements:

• Horizontal practices/bid rigging/cartel behaviour — some law is required here in each country in a free trade area, where:

— the industry has an important share in world exports (and thus can raise the world price) or in exports to a particular country — otherwise there is no spillover to outside markets (except see below);

— a country to which exports flow alleges that strategic dumping is taking place,in this case the complainant must show that other practices limit imports; and

— where horizontal practices are combined with vertical restraints.

• Vertical restraints could be viewed as legal unless:

— controls exist over some scarce factor not available to exporters (for instance, strategic locations for retail establishments);

— the vertical practice is not available to foreign firms, for whatever reason; and

— the restraints are used in an industry where market power is high.

• Monopolisation or abuse of a dominant position—a large market share (say 50 percent or more) which is combined with specific conduct that restricts competitionby others should be examined for legality;

• That anti-dumping remedies be withdrawn in favour of competition policy controls;

• That an independent agency be created with an adequate budget;

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• Substantive fines, penalties and other means of ensuring compliance;

• A process of appeal to the court system;

• The right to act as advocate for competition within government.

• For process harmonisation, we would urge:

— annual meetings of competition policy authorities;

— studies of process differences; and

— proposals for process harmonisation.

• Dispute resolution.

Disputes will always occur and will be of several kinds. First will be complaints thatdomestic policy was not adhered to, nor enforced. One of the first dispute panels setup under the WTO to judge the Venezuelan claim that US standards for cleanergasoline discriminate against imports will be a test as to whether the disputeresolution mechanism will work well or whether APEC will need a NAFTA-stylemechanism. A second set of disputes will occur where multiple countries havejurisdiction and one has to sort out whether one jurisdiction will take the lead on howsubstantive differences between regimes can be accommodated at least cost.

CONCLUDING REMARKS

The Fair Trade Commission of Japan stated in its 1994 Antimonopoly ActGuidebook:

In a free economic community, the general principle is that firms and consumersengage in economic activities at their own discretion. Each firm produces andcompetes with others to have consumers buy its products. On the other hand,consumers try to choose products of the highest quality and lowest price.Production and consumption are linked to one another through the system ofcompetition, a system in which firms compete with one another in price, qualityand service for consumer purchases. Desirable results are thus achieved for thesociety as a whole, including ensuring an abundance of reasonably priced goods andservices and the realisation of viable development of economic activities.

We take it that in our context, a ‘free economic community’ refers to the APEC FreeTrade Area of 2010/2020. In order to obtain the true goals of free trade — productiveefficiency and consumer welfare — each country in APEC should be required topromulgate an effective, enforceable minimum set of competition policies; that theprocess of competition policy be harmonised somewhat; and that an effective disputeresolution mechanism be implemented.

An agreement will not come about automatically. Although most countries of theworld now openly support free and fair competition, many are more mercantilists

196 Trade and competition policy

than free traders at heart. This will result in disputes as countries at different stagesof economic development and with different patterns of comparative advantage wantto open up different areas of competition policies to the advantage of their exportersor their MNCs. For example, less-developed countries may want to put emphasis onthe critical review of antidumping measures, and on regulating cross-border abuses ofdominant MNCs, sometimes by vertical restraints along country lines and sometimesby illegitimate use of intellectual property rights. The more industrialised countriesare more concerned with removing barriers to entry to certain local markets that areclosed to competition under collusive behaviour by local producers, and with morestringent enforcement of intellectual property rights.

When these do occur, the way to resolve differences is just like that in all internationalnegotiations: reconciliation and compromise. Countries can first work on the areathat almost all parties agree to — for example, the reciprocal revision of competitionlaws that allow import or export cartels. They can then move on to areas where manydifferences in opinions exist. Then, again by observing reciprocity, maybe someagreement can be reached. Because it is not an easy process, the recommendationsgiven above are quite mild and exploratory in nature. They are firm in their basicdirection but flexible as to the actual process of enactment and enforcement.

One point of importance is that in many countries competition policy specialists arefar outnumbered by those familiar with trade policies. Sometimes the lack of accurateknowledge can lead to misunderstandings and undue conservatism. Internationalbodies such as the WTO and APEC can provide a great service to all membercountries if they establish study centres for the education and training of specialistsin competition policies.

Our hope is that this discussion will aid in the process.

NOTE

Parts of this study were adapted from papers by Wu and Chu (1994) and Waverman and Wu(1994) presented, respectively, at the Second Conference on Pacific Basin Business,Economics and Finance (Chinese University of Hong Kong) and the PECC Trade PolicyForum (Taipei). The authors would like to thank participants at these conferences and alsothe PAFTAD conference for helpful comments and suggestions.

REFERENCES

APEC (1993) A Vision for APEC: Towards an Asia Pacific Economic Community, Report of theEminent Persons Group to APEC Ministers, October, Singapore: APEC.

APEC (1994a) Achieving the APEC Vision — Free and Open Trade in the Asia Pacific, SecondReport of the Eminent Persons Group, August, Singapore: APEC.

APEC (1994b), Report to Ministers, Prepared by the Committee on Trade and Investment,Singapore: APEC.

Bureau of Competition Policy, Canada (1985) Draft Guidelines on Strategic Alliances.Council of Economic Advisors (1994) Report to the President, USA.

Trade and competition policy—197

European Commission (1994)‘Report on US barriers to trade and investment’, April,Brussels: European Commission.

Hoeckman, Bernard M. and Petros C. Mavroidis, (1994) ‘Competition, competition policyand the GATT’, World Economy 17(2), pp. 121–50.

Industry Canada (1995) ‘Foreign direct investment and market framework policies’, Paperpresented to the APEC Economic Committee, Ottawa: Industry Canada.

OECD (1992) Competition Policy in OECD Countries, 1989–1990, Paris: OECD.Waverman, Leonard (1994) ‘Measuring Industry Specific Protection: Antidumping in the

United States: Comment’, Brookings Paper on Economic Activity 32, pp. 111–14.Waverman, Leonard and Rong-I Wu (1994) ‘Trade and Competition Policy in APEC’, Paper

presented at the PECC Trade Policy Forum, April, Taipei.Wu, Rong-I and Yun-Peng Chu (1994) ‘International cooperation on competition policy:

issues, existing models and prospects for the future’, Paper presented to the SecondConference on Pacific Basin Business, Economics and Finance, May, Hong Kong.

9 Competition regulation and policy in Thailand

Wisarn Pupphavesa

Thailand has been a free market economy since the establishment of the Kingdom ofSukothai in the 13th century. A stone inscription in the Thai language attributed toKing Ramkhamhaeng the Great reads, in relation to the economic system of thatperiod, that: ‘Those who want to trade elephants can do so while others who want totrade horses can do so as well.’ This statement is taken to mean that it was the King’spolicy to promote a system of free enterprise within the kingdom.

Free enterprise has remained at the heart of the Thai economy to the present day,despite the fact that national economic development policies over the last fourdecades have resulted in various restrictions and created state monopolies in somesectors. These exceptions have been based on the theory that state monopolies willproduce dynamic growth effects and favourable externalities.

The change in emphasis in industrialisation policy in the 1980s from importsubstitution to an export orientation exposed Thai producers to competition in worldmarkets and prepared them to appreciate and be ready for competition in the homemarket. Export industries began to recognise the disadvantages of a restricted homemarket with respect to product development and the costs of protected upstreaminputs. Moreover, the obligations accepted under the Uruguay Round agreements toopen up the home market and to meet the challenges of even greater competition inthe world market triggered awareness of the need to revitalise competition in thehome market and, as part of that process, to revise the nation’s inadequate andoutdated competition rules and regulations.

Thailand is currently engaged in revising existing laws and enacting new legislationrelating to competition applicable to both domestic and external entities in order topromote and ensure fair and open competition internally as well as externally.Although this process has been ongoing for some time, no prior study has yet beenundertaken of this subject. It is therefore timely to review the nature and status ofexisting competition regulations and their role in the Thai economy and economicpolicy. The next section of this chapter describes existing competition law and its rolein regulation of the Thai economy. The third and final section of the chapter

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addresses competition policy in Thailand and its relationship to overall economicpolicy.

EXISTING COMPETITION LAW

The first law relating to competition in the modern Thai economy, known as theExcess Profit Prevention Act, was enacted in 1947 and amended in 1964 by theExcess Profit Prevention Act II. That Act empowered government authorities to actagainst profiteering and specified the scope of regulatory actions that could be taken.Specifically, the authorities were empowered to designate merchandise subject toregulation and then to control production, distribution and movement of themerchandise; determine prices; ration or set conditions for purchase or sale; restrictthe possession or use of the merchandise; and, if necessary, take over production orsale of the merchandise. To enforce the Act, the authorities could seize merchandisein the hands of an offender or punish him with fines and jail terms.

The Excess Profit Prevention Act II was, in turn, found to be inadequate, and wasreplaced by a completely new act, the Price Control and Anti-Monopoly Act of 1979,which remains in force at the present time.

The 1979 Act was intended to eliminate certain loopholes found in the previous actsin order to provide better consumer protection against rapid price increases. The actalso seeks to prevent monopolisation and restrictive business practices, and it putsnew controls on mergers and price-fixing cartels. Moreover, in contrast to theprevious legislation, which applied only to merchandise, the 1979 Act covers bothmerchandise and services.

The 1979 Act established a Central Committee on Price Control and Anti-Monopoly, with jurisdiction over the national economy and Bangkok, along withprovincial committees on price control and anti-monopoly with jurisdiction for eachof the provinces. The Central Committee is comprised of the Minister of Commerceas chairman; the Permanent Secretary of Commerce as vice-chairman; the Director-General of the Internal Trade Department as Secretary; and four to eightdistinguished members appointed by the Cabinet of Ministers, as least half of whommust be from the private sector. An office within the Internal Trade Departmentserves as the administrative arm of the Central Committee and coordinates betweenthe Central Committee and the various provincial committees. The Director-Generalof the Internal Trade Department serves as ex-officio Secretary-General of the officeof the Central Committee.

The provincial committees, which act under the guidance or instructions of theCentral Committee, consist of the provincial governor as chairman, the provincialcommerce officer as secretary and five to nine distinguished members appointed bythe provincial governor. Each provincial committee has an administrative officeheaded by the respective provincial commerce officer.

200 Competition regulation and policy in Thailand

The 1979 Act gives authority to the Central Committee subject to the approval of theCabinet Ministers to declare particular merchandise ‘under control’ and then to takeany of the following actions:

• to fix the minimum purchase price or maximum selling price, or to freeze prices ata certain level;

• to fix the maximum profit margin per unit of the merchandise under control;

• to order that the merchandise price be revealed and displayed with the merchandise;

• to devise rules, regulations, measures, procedures, and conditions for the producersor distributors of the ‘under control’ merchandise to follow in their production, distribution, import into and out of the kingdom, buying, selling or stocking;

• to declare the geographical area and time-frame for which the ‘control’ applies;

• to require that the relevant parties tell the authorities where the merchandise is stocked, in what quantities, the cost of production, expenses, production processesand distribution channels;

• to order that inventory be kept or increased in specific geographical areas and specific warehouses;

• to prohibit or permit movement of the merchandise out of or into the area undercontrol;

• to order the operators to improve their efficiency in production, distribution, buying, selling, or stock-keeping, including reduction or elimination of certain excessive expenses;

• to order rationing in buying and selling of the ‘under control’ merchandise or specify the conditions for buying and selling of the merchandise;

• to order that the merchandise be sold according to approved quantity and price, including restriction of sales to specific government agencies or individual personsas determined by the Central Committee;

• to prohibit selling, giving, using, moving or transforming the merchandise in excess of the approved quantity;

• to order that the Secretary-General or authorised officials take charge of production, transportation, buying, selling and stocking of the merchandise undercontrol; and

• to devise measures to prevent stock-piling or possession of the ‘under control’ merchandise in excess of the approved quantity.

In exercising its authority, the Central Committee is required to review the economicsituation and take into account reasonable costs and expenses, appropriate profits,

Competition regulation and policy in Thailand—201

and the impact of control measures on investment and future expansion of domesticproductive capacity.

The 1979 Act also prohibits collusion to fix prices at abnormally low or high levelsor to cause violent price fluctuations. Moreover, the Act prohibits hoarding orinventory accumulations in excess of quantities allowed by the Central Committee,keeping merchandise in places other than those reported to the Central Committee,refraining from normal sales of merchandise or outright refusal to sell, as well asdelaying deliveries without reasonable justification.

In addition to declaring merchandise ‘under control’, the Central Committee hasauthority to declare lines of business activity ‘under control’ if it appears thatmonopolistic behaviour or restrictive business practices are present. Operators ofenterprises in ‘under control’ businesses must report sales prices to the CentralCommittee, which has authority to determine prices if it finds the reported pricesinappropriate or if no report is made. Operators in an ‘under control’ business areprohibited from merging or forming cartels that would result in monopoly orrestrictive business practices. In particular, they are prohibited from engaging in thefollowing acts:

• jointly appointing an exclusive distribution agent for the whole kingdom;

• agreeing to fixed prices;

• dividing and allocating markets among them geographically or by target grouping;

• dividing and allocating suppliers among them so that they can avoid competitive buying;

• fixing or suppressing prices for their purchases or restricting the amount of their purchases;

• restricting production, buying or selling to create excess demand;

• agreeing on certain conditions for buying and selling;

• degrading product quality while maintaining or raising the price;

• merging their businesses or integrating their management or policy direction; and

• making an agreement to take over or control the market.

The Act also prohibits any operator in an ‘under control’ business from deliberatelycreating excess demand through reduction of supply or through damage orobstruction to other operations that results in their bankruptcy or exit and thuslessens competition in the market. Similarly, any agreement or conditions imposed byan operator on a customer that restricts the latter’s production, purchases or sales, orthat constrains their opportunities to buy or obtain credit from competitors, is alsoprohibited by the Act.

202 Competition regulation and policy in Thailand

Violations of the Act are subject to penalties ranging from fines of 1,000 to 20,000baht and/or imprisonment for up to seven years. If the violators are a foreigners, theywill be expelled from the Kingdom of Thailand for certain kinds of violations.

There are currently 22 types of merchandise listed as ‘under control’. Included arestaple food items such as pork, sugar, milk, processed food, animal and vegetable oils,and instant coffee, as well as other basic consumer goods such as detergents,pharmaceutical products and student uniforms. Also included are several basicintermediate goods, such as fertilisers, pesticides, animal feed, iron rods, fuel oil andgas, formic acid and calcium carbide. In addition, there are certain other goods thatare included because they have exhibited volatile price increases or for other reasons:motor vehicles, auto parts and components, audio and video tapes and compact discs,and machines used in the audio and video tape recording industry.

A requirement for the attachment of price tags is the most common control measure,applicable to 18 of the 22 types of merchandise ‘under control’. Other controlmeasures are applicable to only a few items. For example, price ceilings are applicableonly to pork, sugar and cooking gas. Retail price reports are required only for fuel oiland gas items. Stock and warehouse reports are required for new passenger andcommercial cars, crude palm oil and iron rods.

Prior reports of price setting or changes are required for cooking oil, detergent, ironrods, motorcycles, passenger and commercial cars, fertiliser and pesticides. Forstudent uniforms, animal feed, pharmaceutical products and milk, price changereports may be made after the changes go into effect. Prohibition of possession isimposed on refined or semi-refined palm oil, while prohibition of price changes isimposed only on instant coffee. For some items, such as live pigs, formic acid,calcium carbide, and machines used in the audio and video recording industries, thecorresponding control measures are yet to be declared.

It is interesting to note that the Act has been implemented mainly as anadministrative instrument to maintain price stability, in addition to fiscal andmonetary instruments commonly used in macroeconomic management to promotefair competition and prevent monopoly practices. Although control of prices is notan appropriate measure to solve inflation problems, it can be useful in the short termas a temporary curb on inflation spirals caused by panic and dynamic inflationaryexpectations. It is also considered a necessary instrument for the control of inflationin an economy like Thailand’s where, in spite of the competitive environment,producers and sellers tend to take advantage of consumers by raising their prices inconcert, leaving consumers little or no ability to choose low price suppliers. Dynamicinflationary expectations and panic purchases on the part of consumers, together withrelatively low price elasticity of demand for basic consumer goods, also make itpossible for producers and sellers to raise prices without fear of losing customers, thusmagnifying the initial price increase caused by a shock or structural problem.

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The price control measures implemented so far have not been particularly restrictive.The price-tag attachment measure, for example, serves to provide necessaryinformation to consumers to enhance consumer sovereignty and promote faircompetition. In fact, price information should be available to consumers for a muchwider range of products than those under control. Several other measures are usedmainly as price monitoring devices.

It is noteworthy that the Act has also been used to serve purposes other than thedesignated ones. For example, in the case of palm oil, the control measures are beingused to protect palm-oil farmers against smuggling. Another interesting example isthe machines used in audio and video recording industries, which are put undercontrol in part to provide government officials with an instrument to cope with theproblem of violations of intellectual property rights; for these areas, the controlmeasures mentioned above are not quite relevant and hence have not yet beendeclared as applicable measures. Presumably, new measures will have to be devised forsuch purposes; however, such misuse of the Act is not advisable.

On the other hand, there has been little effort to implement the provisions of the1974 Act concerned with monopoly regulation and promotion of fair competition.So far, there have been two cases cited as efforts made against restrictive businesspractices. One involved ice producers in Bangkok and neighbouring provinces whowere attempting to establish a price-fixing cartel in 1980. The Central Committeeexamined the facts and found positive evidence of anticompetitive activity. TheCentral Committee then declared the ice production in that area ‘under control’ andset a price ceiling for the product. The cartel attempt was abandoned, and the controlwas lifted in 1982. Another case involved 10 plywood producers who, in 1986,jointly planned to establish a distribution centre that would require plywood retailersto pay a fee to the distribution centre. The Central Committee advised the group todrop such a plan to avoid being put ‘under control’. The plywood producers acceptedthe advice.

So far there has been little if any analytical research and study on firm behaviour,restrictive business practices, or the role of government policy and regulation inpromoting a competitive business environment. No attention has been paid topossible monopolies and restrictive business practices, even though there appeared tobe a high degree of market concentration in various sectors, such as cement, glass,sugar, oil refinery, petrochemicals, iron and steel, and animal feed. There is alsogrowing horizontal and vertical integration, as well as cross shareholding and jointventures between big corporations and even between rival firms. In short,competition regulation is still weak and lacks analytical and investigative support.Official attention has focused incorrectly on changes (increases) in prices, which arenot a good indicator of monopoly or restrictive business practices. On the other hand,inadequate attention has been paid to whether the prices are at competitive levels —which is a much better test for monopolies and restrictive business practices.

204 Competition regulation and policy in Thailand

Instead of focusing on expanding competition, government authorities have shownconsiderable concern over the potential for excess capacity and over-competition,leading to a waste of scarce capital resources and business failures. Thus, industrialand trade licences and permits sometimes have been used to regulate productioncapacity and the supply of goods and services. There was for some period of time aban on capacity increase and/or new entry in certain industries, such as textiles andautomobile assembly. Investment promotion was for some time ended in certainindustries or granted with the condition that no promotion privileges would be givento other applicants for a period of time. No new entry in commercial banking hasbeen allowed for decades. Moreover, Thai exporters have been subjected to exportquota restrictions in products such as garments and tapioca as a result of protectionistmeasures in developed countries.

Certain state enterprises compete with private firms but enjoy monopoly rights toservice certain state needs. An example is the Express Transport Organisation (ETO),which services the Bangkok Port. This not only allows the ETO to profit from unfaircompetition, it also costs Thai exporters some degree of competitiveness in the worldmarket due to ETO’s inefficiency. Similarly, the inefficiency of the TelephoneOrganisation and the Communication Authority of Thailand, which respectivelymonopolise internal and external telecommunication services in Thailand, have costThai producers and exporters some degree of competitiveness in the world market.

Labour rights in Thailand meet International Labour Organisation (ILO) standards.Employment of labour in Thailand is governed by Revolutionary Decree No. 103 andsubsequent decrees issued by the Ministry of Interior under the Labour Relations Actof 1975 (No. 1) and of 1991 (No. 2), by the State Enterprise Employee Relations Actof 1991, and by the Labour Court Establishment Act of 1979. There are alsonumerous decrees under these acts. State enterprise employees have been excludedfrom the Labour Relations Act by the State Enterprise Employee Relations Act of1991 to prevent them from striking. Strikes were used often in the past for politicalmotives rather than to solve genuine labour problems, and they caused both severepolitical instability and economic losses. Such work stoppages were often undertakenby employees of major state enterprises, such as the Electricity Generation Authorityof Thailand and the Port Authority of Thailand. They were also accompanied bythreats to cut off utilities or block the use of public infrastructure facilities.

Labour in private enterprises has been accorded the right to organise and the right tostrike. They have also been able to negotiate wages and benefits annually, andsometimes they have been able to review and adjust wages twice a year. The minimumwage has been rising quite rapidly and has risen faster than the marginal productvalue of labour. Female and child labour are also well protected by the laws, althoughthere might be a few cases of illegal child labour found in the informal sectorproducing low-quality products. In the past, some labour might have voluntarilyaccepted wages below the minimum wage, due to surplus labour conditions.Nowadays, however, Thailand has begun to experience labour shortages at various

Competition regulation and policy in Thailand—205

skill levels and to lose its comparative advantage in labour-intensive industries. As faras labour standards are concerned, therefore, Thai producers are subject to faircompetition with international producers.

Overall, competition regulation plays an important role in maintaining price stabilityand protecting consumers from hyper-inflation and unreasonably high prices.However, its role in ensuring and promoting fair competition and eliminating andpreventing monopoly and restrictive business practices is still limited andovershadowed by other regulations and considerations which often neglect the issueof fair competition.

COMPETITION POLICY AND ITS ROLE IN THE OVERALL ECONOMICPOLICY OF THAILAND

Slowly but surely, Thailand is moving towards more open markets and towardsgreater respect for consumer sovereignty. This progress is taking place in a supply-constrained developing economy with a growth-oriented paternalistic government.While there continues to be strong public support for growth-oriented industrialpolicies, the paternalistic role of government has lost ground drastically. Thegovernment has become less of a director and more of a facilitator in microeconomicpolicy. The private sector, with increasingly more qualified personnel educated at thebest universities, is relatively stronger and often leads the way rather than followinggovernment policy. There is also increasing pressure from the private sector for equaleconomic opportunities and free competition.

However, at least until recently, competition policy has taken a back seat toindustrialisation and investment promotion policies. Fair competition, equalopportunities and consumer welfare were often overlooked or neglected in the courseof import-substitution industrialisation.

While macroeconomic policy has been clearly set and effectively implemented by afew relevant authorities — namely, the Bank of Thailand, the National Economicand Social Development Board, the Budget Bureau and the Ministry of Finance —microeconomic policies and sectoral policies have often been unclear, inconsistentand uncoordinated. Policies for the agricultural sector fall mainly under the Ministryof Agriculture. The Ministry of Industry is in charge of industrial policies. While theMinistry of Commerce is responsible for internal and external trade policies coveringthe whole range of merchandise and services, the Ministry of Finance controls fiscaland tax policies affecting both production and trade for agricultural and industrialproducts. The Board of Investments, however, through its investment promotionpolicies, may impose import surcharges or grant exemptions or reductions on varioustaxes to selected enterprises and activities. It is quite common to observe theseagencies implementing policies and measures that would result in limitingcompetition, prohibiting entry, and protecting or providing privileges and advantagesto selected enterprises.

206 Competition regulation and policy in Thailand

Investment promotion is egregious in its inconsistency with competition policy aswell as for the fact that it generally overrules the latter. First, by granting promotionalprivileges and incentives to selected applicants, the government discriminates againstnon-promoted enterprises. Clearly, investment promotion would be lessanticompetitive if the incentives were made generally applicable on a sectoral basisinstead of on a firm-specific basis.

Second, investment promotion has sometimes been accorded to one or a few firms,and then closed to all other interested parties for some lengthy period to avoid excesscapacity. As a result, new entry has effectively been prevented. If the investmentpromotion policy did not put emphasis on the domestic market, there would be noreason to worry about an excess capacity problem.

Third, when investment promotion policy became more export oriented,promotional incentives were conditioned by export performance — namely, 80 to100 per cent of output had to be for export. Such a requirement was, in effect,allocating the domestic market to existing enterprises and at the same time denyingdomestic consumers the freedom to choose export-quality products. However, theexport requirement is being phased out due to Thailand’s commitment under thetrade-related investment measures (TRIMs) agreement of the World TradeOrganisation (WTO).

Fourth, since relatively large firms and foreign affiliates were more keen to seekinvestment promotion, the resulting unequal opportunities and unfair competitiontended to favour large and foreign-affiliated enterprises.

Fifth, the major incentives provided to promoted enterprises have been exemptionsand reductions in income taxes and business and sales taxes, as well as exemptions onimport duties for capital machinery, equipment, and intermediate and raw materialinputs. The income tax exemption or reduction is allowed for 3–11 years withaccumulated losses deductible for three additional years. This incentive feature acts toinduce firms to resist restructuring and therefore is inconsistent with the policy topromote competition and improve industrial competitiveness. Moreover, import dutyexemptions for raw materials and intermediate inputs, coupled with deductableaccumulated loss provisions, encourage transfer pricing practices by foreign affiliates,particularly those involved in intrafirm trade. Therefore, a competition bias hasdeveloped that favours foreign multinational enterprises.

As far as development and industrial policy are concerned, the Ministry of Industryhas advocated liberalisation, deregulation and decentralisation. Approval andpermission are no longer required for industrial activities of small and medium-sizefirms which have no significant environmental impact, although those with somesmall impact on the environment are required to inform the authorities aftercommencing operations. Only those relatively large-scale projects which havesubstantial environmental impacts are required to obtain approval from theauthorities before beginning operations. Regulation of new establishments and

Competition regulation and policy in Thailand—207

renewal of industrial permits are also delegated to local and regional authorities,instead of being centralised in the Department of Industry in Bangkok. Control overentry to avoid excess capacity and over-competition has also been lifted. Where thereare still regulated prices, as in the case of the petrochemical industry, internationalprices plus a certain margin have been adopted to replace the cost-plus-marginmethod.

The Ministry of Commerce is also advocating liberalisation of both internal andexternal trade and is in the process of drafting a trade competition act to replace thePrice Control and Anti-Monopoly Act of 1979. The new Act aims to improve uponthe provisions concerning antimonopoly and restrictive business practices. TheMinistry has also issued a Decree on Criteria and Procedures for the Imposition ofSurcharges Against Dumping and Subsidies. However, trade liberalisation is still byand large in the hands of the Ministry of Finance, which decides tariff barriers.

Nevertheless, the Ministry of Finance has been reforming the tariff structure andmaking unilateral tariff reductions in one sector after another. The overall target is tosimplify the tariff structure into six different rates ranging from 0 to 30 per cent.Consumer goods would get a maximum 30 per cent rate, intermediate goods wouldbe subject to lower rates (around 10–15 per cent), while capital goods and rawmaterials would face 5 per cent or lower tariff rates. The new structure promises to bemuch more liberal than Thailand’s WTO commitments would require.

The Bank of Thailand and the Ministry of Finance have also gradually liberalised thefinancial sector and have increased competition internally in preparation for furtherliberalisation and opening-up to competition from foreign banks and financecompanies.

Privatisation and reform of state enterprises is also in progress. Thai AirwaysInternational is now listed on the Thai stock exchange. Reform and reorganisation ofthe Communication Authority for Thailand and the Telephone Organisation ofThailand, along with amendment of relevant laws and regulations, are underdiscussion and consideration. Various new services and capacity expansion of thesetwo state enterprise have already been open to private participation in the form ofsubcontracting and build–transfer–operate (BTO) contracts. There is increasingcompetition among close substitute services in the telecommunications and postalservices sectors.

The Intellectual Property Rights Protection Act has been passed and became effectivein early 1997. The computer software industry felt the impact immediately withunpirated software enjoying a substantial upward shift in demand. Users now have tobear much higher costs for software and therefore try to economise on softwareinvestment. Local software consultants may discover a growing market as users lookto keep software costs down.

208 Competition regulation and policy in Thailand

Overall, the policy direction is clearly towards open and fair competition, andcompetition policy and law will have a greater role in the Thai economy. However,there remain significant problems in regulating restrictive business practices, due toinadequate understanding and analytical capability regarding the behaviour andpractices of business firms.

10 Policy approaches to economic deregulation and regulatory reform

Merit E. Janow

Regulatory reform is now a worldwide trend. Over the last 20 years, a number of onceheavily regulated sectors, especially of Organisation for Economic Cooperation andDevelopment (OECD) economies, have experienced considerable economicderegulation and regulatory reform. This subject remains the focus of continuingdebate in a number of countries — including developed, developing and newly —industrialising economies.1 The sectors chosen for regulatory reform or deregulation,the approaches employed by policy-makers, and the interplay of political, social andeconomic factors, vary significantly. There is also no single definition of deregulationthat captures the full range of policy measures employed across countries.2

Generally, it can be said that most jurisdictions that have undertaken extensivereforms have done so out of a recognition that traditional assumptions regarding theneed for regulation (for example, market failure and externalities) have failed torecognise or anticipate other factors (for instance, technological change andregulatory failures) that have come to challenge such traditional rationales. Only in afew instances has economic deregulation resulted in the elimination of regulatoryoversight of a previously regulated industry. Typically, it is also a protracted andselective process.3 This complexity makes generalisations difficult.

Efforts at regulatory reform tend to represent an interest in a greater role for market-based competition and ‘improved efficiencies of policies that intervene in decisionsabout market entry, the production methods, production attributes, and transactionsarrangement between suppliers and customers’ (Noll 1996).

In a number of jurisdictions, including the United States, the goal of injecting agreater role for market-based competition has been seen as necessitating an increasedrole for competition or antitrust policy. But, here again, this observation is not justlimited to advanced industrial economies. Since 1980 many developing countries,economies in transition and many formerly communist or socialist nations haveenacted new antimonopoly laws or bolstered existing laws and policies to facilitate thetransition from planning to markets (see Kovacic 1995).

210 Policy approaches to economic deregulation and regulatory reform

In many transitional economies, market-oriented reforms have a tenuous foothold inpublic policy. In these environments, experts note that the contribution of antitrustor consumer protection laws can include: an institutional voice within thegovernment for the promotion of markets and opposition to state efforts to distortmarket processes; an instrument for attacking government policies that impede thedevelopment of markets; and an instrument to help ensure that the state intervenesonly to correct genuine market failures (Kovacic 1995). Competition and consumerprotection authorities might, for example, be given a role in reviewing the decisionsof other government ministries with respect to such matters as the issuance of licencesor the privatisation of state-owned firms. A further function that these laws canprovide is, of course, to address private efforts to undermine markets. Competitionlaws and policies can ‘establish institutions that provide actual and symbolic assuranceto the public and their elected officials that the move to a market system does notleave citizens at the mercy of market failures’ (Kovacic 1995). In many environments,the alternative to antimonopoly or consumer protection legislation ‘may be far moreintrusive forms of government intervention, including direct price controls, broadlimits on entry, and continued widespread public ownership of business enterprises’failures’ (Kovacic 1995).

As explained in more detail below, it is also no longer the case that focused attentionon the market effects of particular regulatory schemes nor the role for competitionpolicies are solely matters for domestic economic policy. Increasingly, firms andgovernments have come to focus on the market access and trade-distortingconsequences of regulatory policies and private business practices. The globalisationof markets, technological advances and the reduction of governmental barriers fromnumerous multilateral and bilateral trade negotiations have all combined to shiftinternational trade policy attention to internal practices exercised by firms andgovernments that impact upon what has been called the ‘contestability’ of markets,with the recognised corollary proposition that trade liberalisation can bothcomplement and reinforce regulatory reform (see Graham and Lawrence 1996).

This chapter is therefore organised in the following manner. First, it offers someobservations on traditional rationales for regulation and then identifies a number offactors that have driven or influenced deregulation or reform of previously regulatedmarkets. Second, it discusses the links between regulation, deregulation andcompetition policy, drawing largely, but not exclusively, from the US experience,while overlaying implications for competition policy more generally. And, finally, itidentifies some dimensions of regulatory reform, economic deregulation andcompetition policy that have become matters of international attention by both tradeand competition communities and offers perspectives on the challenges associatedwith resolving conflicts at the international level.

This study is both brief and general in nature and designed to stimulate discussion ofregulatory reform and competition policy in the Asia Pacific region.

Policy approaches to economic deregulation and regulatory reform—211

RATIONALES FOR REGULATION AND REFORM

Market failure: Traditional theory of economic regulation argues that regulationserves the public interest by correcting some form of market failure. An often-citedexample of market failure is natural monopolies, where it was assumed that consumerwelfare would not be maximised by allowing firms to pursue profit-maximisingstrategies in markets that were not structurally competitive.4 A traditional assumptionhas been that the market cannot efficiently support more than one firm. At variouspoints in time, the energy, utilities and communications sectors have all been seen asnatural monopolies.

Other forms of market failure: Regulation has also be seen as justified undercircumstances where competitive solutions exist but are seen as inefficient because ofexternalities (such as air or water pollution), inadequate information (for instance, asafety problem in a consumer product), public goods (a lighthouse, say) or theproblem of the commons (such as over-use of shared natural resources). In each ofthese cases the production or consumption of the product has effects that go beyondthe entities that are directly involved in the production or consumption of theproduct (OECD 1992, p. 12). Over time, the remedies for these types of marketfailure have also differed.5

One general rationale for regulation has been that it ‘provides protection forconsumers or workers’ (MacAvoy 1992, p. 1).6 Observers of US business history arguethat New Deal regulations in the US transportation (railroad, trucking and airlines),communication (telephone and telegraph), energy (electric and gas) and financialsectors were all designed to in some sense stabilise competition through governmentcontrol of price, profitability, entry and restructuring (Victor 1994, p. 1). Suchcontrol was believed to be necessary to keep a tight lid on monopolies such as utilitiesand to deal with complex competitive problems (as in the case of railroads) for thepublic good. Much of the economic regulation introduced in the first quarter of thecentury in the United States was designed to curb the market power of firms and toprotect consumers from monopoly power. A customary way of doing this was tocreate a regulatory agency endowed with wide powers to establish price ceilings in linewith the costs of production and distribution (MacAvoy 1992).

New Deal legislation gave federal agencies far greater powers than earlier legislation.7

The main objectives of economic regulation in these industries included high quality,wide availability of service, secure contractual arrangements, and stable prices.Legislators also wanted to ensure that all consumers could obtain services, even if itmeant that certain customer prices are set low to ensure service, subsidised bycustomers who pay more. The oversight agencies then had to protect the regulatedfirms from competitive entry that might erode the higher prices charged to otherconsumers in order to provide returns to cover the below-cost pricing to high-endcustomers (MacAvoy 1992, p. 12).

212 Policy approaches to economic deregulation and regulatory reform

MacAvoy argues that much of the US regulation was put in place to have stabilisingeffects along these lines. He argues that the implication of stability was as follows:

… companies licensed for service would offer prices that on average over a decadewould be no more than sufficient to cover the average total (variable and capital)costs of service for all classes of consumers. With both averaging over time and overclasses, regulation would then have one of two effects. It would either reducemonopolistic prices or require that excess revenues from continued monopolisticprices to some customers in some periods be used to subsidise services at pricesbelow costs to other customers at other periods (MacAvoy 1992, p. 12).

By the mid-1970s traditional justifications for regulation increasingly came underattack in the United States and in other OECD countries. Some of the theoreticalbases for this attack are described in brief in the following section of this chapter, buthere let us identify a number of different and non-exclusive circumstances that haveinfluenced the drive towards regulatory reform. Eight such circumstances are worthbrief mention.

First, regulatory reform has arguably been introduced in a number of jurisdictionswhen regulators had no choice but to undertake reform measures. There is a naturaldisinclination of regulators to unilaterally relinquish their controls over economicactivity. And, even aside from regulatory resistance, in most policy environmentsregulation has fallen behind market developments. Regulatory changes tend to beintroduced after market-based developments have made regulation more costly andless beneficial and these developments could not be ignored. The factors discussedbelow all have bearing on this first general observation.

The OECD suggests that in many countries, interventions, once intended to correctmarket failures, have produced adverse and often unintended consequences for theachievement of efficient market outcomes. Since regulation often was designed toserve a variety of public interest concerns unrelated to economic efficiency, suchregulation in numerous instances distorted the market price mechanisms and led touneconomic activities and outcomes. Excessive costs, high prices, pricing rules thatmade administrative sense but not economic sense, vagueness of regulatory objectivesand difficulties of precisely determining a ‘socially optimal output level has producedinimical to the efficient management of the industries concerned’ (OECD 1992, p.17). Such inefficiencies have all been identified as important motives for deregulationand regulatory reform.8

For example, critics of regulation in the United States have argued that the growth ofregulation in the United States brought on a variety of ills such as ‘high cost;ineffectiveness and waste, procedural unfairness, complexity and delay;unresponsiveness to democratic control; and the inherent unpredictability of the endresult’ (Breyer 1982).9 Overall, imperfect procedures probably have ‘preventedregulation from working in the interests of consumers, by reducing production across

Policy approaches to economic deregulation and regulatory reform—213

the regulated industries and thereby reducing the rate of growth of the economy’(MacAvoy 1992, p. 4).

A second and related motivation for deregulation and reform has been the perceptionthat regulated sectors have performed poorly. Comparisons with deregulated sectorsin other countries, or between regulated and deregulated regions within countries,have accentuated this recognition. Regulation itself has been identified ascontributing if not producing such poor performance — for example, by skewingincentive structures through low salaries; allowing political interference in decision-making; imposing constraints on diversification; and limiting public and regulatedenterprises from introducing new technologies or management methods.10

Third, the OECD notes that labour market problems have also had significant effectson the movement towards regulatory reform. The performance of public sectorentities deteriorated as union pressures brought pay increases in excess of productivityimprovements. In the United Kingdom, for example, the OECD notes that supportto public sector entities became a disguised employment subsidy with adverseconsequences for the specific sector and the overall health of the economy as a whole(OECD 1992).

A fourth factor exerting a strong influence on deregulation and regulatory reform hasbeen budgetary. Regulatory reform in the form of privatisation can provide a directcash infusion to public coffers, and other forms of regulatory reform can bringsubstantial cost savings. Both the United Kingdom and Japan are often cited ascountries where this motivation featured prominently in the privatisations that tookplace. In the UK context, the instruments chosen to implement privatisation haveincluded transfer of share ownership from public to private sectors, subcontractingand curtailment of statutory monopoly powers (Harbury 1990, p. 268). In Japan, abudgetary rationale appears to have also played a part in the decision to privatiseNippon Telegraph and Telephone (NTT). Government debt in Japan had grownfrom 9.2 per cent of GNP in 1974 to 41.2 per cent in 1982 (Haley 1989, p. 134). In1982 the Ad Hoc Commission on Administrative Reform proposed that NTT bereorganised into private companies to raise capital to reduce debt. Reminiscent of thefirst point made above, the commission also argued that the time had come for Japanto allow more competition in telecommunications, if only because it had no choice ifit wanted to keep up with developments in international markets.11

A fifth and related factor that has undermined regulation and driven reform istechnological change itself. This phenomena has been especially evident in servicesectors — for example, in financial and telecommunication services —where somecombination of growth in market size and technological change increased thetechnical feasibility of competition. Technology can also be an enabling factor,moving industries to more competitive markets because technological systems are inplace or can be introduced — for instance, to take advantage of billings andinvoicing.12

214 Policy approaches to economic deregulation and regulatory reform

A sixth factor that has driven regulatory reform has been the globalisation of markets,which has in turn resulted in some loss of control by governments over the conductof private enterprises. This tendency has been exacerbated by the arbitrage ofregulatory environments by private firms. Some analysts see this loss of control asresulting in pressure on national systems for competitive deregulation or regulatoryreform. This tendency has been very pronounced in the Asia Pacific region, forexample, where recent years have witnessed important modifications in investmentregimes as policy-makers have tried to attract additional foreign investment. Manyexperts from the region argue that market-driven competition has placed greaterpressures on countries in the region to liberalise than multilateral trade negotiations.13

A seventh factor that has influenced regulatory reform is international governmentaland private sector pressure. This has taken many specific and general forms. Forexample, the recently concluded World Trade Organisation (WTO) basictelecommunication services agreement implicates not only market access butfundamental issues of regulatory oversight and design. Multilateral lendinginstitutions have also played a role in seeking reforms as well as keeping them inplace. In Japan’s case, for example, multilateral and bilateral trade pressure has innumerous sectors obliged government officials to modify domestic regulations thathave had intended and unintended consequences for foreign and new marketentrants.14 Again, in the telecommunications sector, NTT’s procurement practices,standards established by the Ministry of Posts and Telecommunications (MPT) or itsaffiliated industry associations, certification and testing procedures, MPTs regulationof mobile communications such as cellular telephone and third party radio, have allbeen sources of bilateral US–Japan trade friction and much deregulation occurred asa result of that external pressure.

An eighth, highly complex factor that has influenced regulatory reform has been someshift in domestic interest group dynamics in favour of reform. In some jurisdictions,regulatory reform has been possible because affected interests have tolerated or evenurged regulatory reform because there was a dissipation of rents associated withpreviously existing regulatory frameworks. In this vein, Kahn (1990) notes forexample that airline deregulation in the United States owed a ‘great deal to theunhappiness of United Airlines with the Civil Aeronautics Board’s systematic denialto it of the ability to enter new markets or desert old ones’. Similarly, he argues thatcompetitive encroachments on the formerly protected markets of the electric and gasutilities arose because of the desire of ‘large industrial customers to take advantage ofemerging opportunities to make bulk purchases at bargain rates in the field and fromoutside suppliers with excess capacity’.

In other instances, regulatory reform has occurred because new entrants (bothdomestic and international) have pushed the reform process forward. Partialderegulation of Japan’s Large Scale Retail Store Law may be an example of the latter,where domestic large stores pressed for reform. Reform has also produced its own new

Policy approaches to economic deregulation and regulatory reform—215

vested interests, including market entrants that entered a market after changes weremade.

This brief reference to interest group dynamics does not, of course, illuminate theinstitutional features that have been important in translating the idea of reform intoaction.

There is no single (or simple) set of institutional features across countries thatexplains why regulatory reform has or has not occurred. Much depends on thepolitical economy of the country in which deregulation or regulatory reform hasoccurred as well as the sector in question.

In the United States, a number of political scientists, economists, lawyers and policy-makers have identified the following institutional features as important features in thetranslation of reform ideas into action: first, the development of concrete reformproposals that were firmly rooted in empirical analysis undertaken by experts atindependent universities or think-tanks; second, the existence of regulatory agencieswith a significant degree of institutional independence, included by virtue of theirappointed chairs, who were in some instances themselves reform-minded; third, ajudicial system that obliged regulators to act in an open, transparent manner andprovided means for challenging agency conduct by both public and private litigants;15

fourth, varying degrees of involvement by Congressional oversight committees,dependent in part on the activism and priorities of the Committee chairperson; and,fifth, the exercise of political leadership by elected leaders (Derthwick and Quirck1985).

This same mix of factors will obviously not exist or interact in the same manner acrosscountries.16 It is useful in forums such as this for experts to further consider theinstitutional features that are needed to move a reform process forward. In looking atdebates surrounding regulatory reform that are occurring in a number of developingas well as developed economies, even if there is a significant degree of domesticconsensus that further reform should be introduced, institutional mechanisms areoften not fully in place that can identify and then implement a reform programme.

It is also important to note that recent history also suggests that the abolition of directeconomic regulation is not synonymous with laissez-faire. Kahn (1990), for example,argues that the US record is quite the contrary. Regulatory reform ‘may call forgovernment interventions no less vigorous than direct regulation itself, butfundamentally different in character and intent’. Some political scientists havesuggested that the regulatory reforms that have occurred particularly since the mid-1970s represent not deregulation but some combination of liberalisation and re-regulation (see Vogel 1996). Thus, the factors driving deregulation and theapproaches taken in the reform process, as well as the economic and marketconsequences of regulatory reform and deregulation, vary greatly by country andsector.

216 Policy approaches to economic deregulation and regulatory reform

This complexity notwithstanding, the preponderance of the economic assessments ofeconomic deregulation and regulatory reform have been positive. In the UnitedStates, for example, studies have shown that the welfare gains from the deregulationof seven sectors over the 1970s and 1980s (in airlines, railroads, rail freight,telecommunications, cable vision, stock-brokering and natural gas) were betweenUS$33 billion and US$43 billion a year (at 1990 prices) (see Winston 1993). InAustralia, deregulation is said to have reduced prices by some 20 per cent (see Noll1996).17 Recent studies by Japan’s Economic Planning Agency (EPA) argue that eventhe limited deregulation that occurred in Japan between 1990 and 1995 contributed0.5 per cent annually to GDP growth. Looking ahead, economic reform could raiseGDP by 0.9 per cent annually between 1998 and 2003 (see Nihon Keizai Shimbun,various articles, April and June 1997). In telecommunications, by some estimates, theaverage prices for telephone services has fallen by 63 per cent in the United Kingdomand some 41 per cent in Japan (OECD 1997).

THE NEXUS BETWEEN COMPETITION POLICY AND REGULATORYREFORM

Competition or antitrust enforcement has in a number of jurisdictions been used intandem with economic deregulation and regulatory reform. Perhaps for this reason,it is still common to hear the view that competition policy is simply another form ofregulation that is to be avoided in an period of deregulation and regulatory reform.To characterise competition policy as simply another form of regulation is tomisconstrue the fundamental goals and instruments of competition policy.

As numerous US experts have noted, competition policy enforcement seeks to createor maintain a competitive marketplace rather than to replicate the results ofcompetition and correct for defects in competitive markets. Thus, while bothregulation and antitrust aim to achieve similar economic objectives, regulation seeksto obtain the benefits of competition typically via an administrative body that createsrules that determine the regulated firms’ prices, entry and other areas of conduct,while in theory ‘spurring those firms toward innovation and efficiency’ (Breyer 1982).

Antitrust or competition laws, in contrast, act ‘negatively’,

through a few highly general provisions prohibiting certain forms of conduct. Theydo not affirmatively order firms to behave in specified ways; for the most part theytell private firms what not to do … Only rarely do the antitrust enforcementagencies create the detailed web of affirmative legal obligations that characterisesclassical regulation (Breyer 1982, p. 157).

In the US context, a general principle that captures this dynamic between the role ofcompetition policies and the role of regulation has been advanced, albeit ratherstarkly, by Hovenkamp (1994, p. 649) when he states:

Policy approaches to economic deregulation and regulatory reform—217

the less the regulatory regime interferes with the workings of the market, the moreroom for antitrust. Intervention under the antitrust laws is generally appropriatewith respect to market decisions that (a) are actually or potentially anticompetitive;and (b) are made according to the discretion of private firms without effectiveagency supervision.

By implication, and in practice, as industries move ‘from price regulation to pricecompetition, the antitrust notions of collusion, boycott and predatory pricing picksup where agency price regulation left off ’ (Hovenkamp 1994, p. 649).

But this does not mean that firms subject to extensive regulation are necessarily freefrom competition policy scrutiny.18 Even in those areas where a firm is subject toextensive regulation, the analytical question applied when examining the conduct ofa regulated firm is not whether the industry or firm in question is regulated but ratherwhether or not the conduct exercised by firms in that regulated industry wasinstigated by a regulatory agency, approved after a full review of the merits, orstemmed from unsupervised conduct of a firm. In this way, antitrust or competitionhas been seen as an important function of government oversight even with respect tofirms operating in heavily regulated areas.19

In US cases, key questions that courts ask include:

• whether the conduct was within the jurisdiction of the oversight agency;

• whether it was actually presented to the agency for review;

• whether the agency appropriately reviewed potential anticompetitive consequences;

• whether application of the antitrust law in this particular instance would create inconsistent mandates or would frustrate the operation of the regulatory process;

and

• whether the agency has special expertise not generally available to antitrust tribunals to evaluate a particular claim (Hovenkamp 1994, p. 654).

But antitrust laws are premised on the assumption that a ‘workably competitivemarketplace’ will achieve more efficient allocation of resources, greater productefficiency, and increased innovation than government regulation. It seeks to achievethese ends by removing private impediments to competition (Breyer 1982, p. 158).As Breyer argues,

where this assumption holds true, antitrust would ordinarily seem the appropriateform for government intervention to take. Where the assumption fails, one findsthe demand for other modes of governmental intervention, such as classicalregulation. Viewed in this way, regulation is an alternative to antitrust, necessarywhen antitrust cannot successfully maintain a workably competitive marketplace or

218 Policy approaches to economic deregulation and regulatory reform

when such a marketplace is inadequate due to some other serious defect (Breyer1982, p. 158).

The complex question then becomes whether the market defect stems from defects inthe competitive process or some other feature. Much of the deregulation thatoccurred in the United States in the late 1970s and 1980s stemmed from a theoreticaland empirically-based perspective held by reformers that a number of regulatedmarkets were in fact ‘workably competitive’. Indeed, studies began to call intoquestion traditional assumptions about natural monopoly as a rationale for economicregulation. The well-known theoretical foundation for this assessment is based incontestable market theory.

In some instances, early theories of ‘excessive competition’ as a rationale for regulationwere, in the words of one expert, shown to be ‘an empty vessel’ (Noll 1996). Studiessuggested that countries that allowed more competitive entry and relaxation ofregulations ‘had lower prices and more productive industries’ (Noll 1996). Airlinederegulation is often cited as a case in point. As one analyst notes, ‘since there wereno strong entry barriers and no sources of scale economy, there was no obvious reasonto impose price restrictions or to continue regulatory restrictions on entry’ (see Perle1996).

This argument was also advanced with respect to the telecommunications sector.Reformers became convinced that both telephone equipment and long distancecommunications service could become workably competitive and could supportseveral competing firms. However, the situation in telecommunications has beenvastly more complex since there were prospects for competition in portions of theindustry while other portions were viewed to be more natural monopolies.20

Such distinctions derived from the structure of individual markets, and regulatoryregimes produced obvious complexity in the process of deregulation itself. Forexample, in airlines the entire structure of regulation was vested in the CivilAeronautics Board (CAB). Between 1938 and 1978, not a single major trunk carrierwas permitted to enter the industry — despite some 79 applications during thatperiod. And, similarly, inefficient carriers were not permitted to go out of businessbut were kept afloat by enforcement of rates based on the average costs of the industry(see Hardaway 1991). When the decision was made to deregulate, the regulatoryagency, CAB, was eliminated without affecting supervision over safety standardswhich were the responsibility of a separate agency — the Federal AviationAdministration (FAA).

In telecommunications, however, reform was implemented initially through thecourts and the Federal Communications Commission (FCC), in contrast to thederegulation of airlines where Congress was the institution that implementedderegulation. In addition, in telecommunication deregulation, some services werederegulated with continued regulation of others, involving numerous agencies andongoing conflicts between regulatory agencies and antitrust courts.21 It was only in

Policy approaches to economic deregulation and regulatory reform—219

1996 that Congress passed a comprehensive Telecommunications Competition andDeregulation Act.

Most US analysts of airline and telecommunications deregulation argue that it has,on balance, provided substantial benefits to American businesses and consumers. Inthe airline sector, although comfort and service quality may have declined,deregulation produced vigorous price competition and an expansion of capacity.There have also been structural changes in the industry.

But it is also important to note that the process and consequences of deregulation arenot straightforward. Competition problems have existed both before and afterderegulation.

Proponents of deregulation in airlines did not rest their arguments on expectations ofdeconcentration; rather, they argued that potential and actual competition would‘force prices down and increase traveler choice, irrespective of whether the industrybecame more, or less concentrated’. Some analysts also point to certain regulatoryoversight features of the airline sector that may not have properly ensured competitiveindustry structures.

For example, Breyer (1987) has argued that special scrutiny of airline mergers may bewarranted because generalisations do not necessarily reflect special circumstances ofderegulated carriers. This view finds more recent expression in statements by thethen-Assistant Attorney General for Antitrust that the authority vested in theDepartment of Transportation (DOT) to review mergers ‘did not reflect the broadexpertise in competition analysis that the Department of Justice brings to mergerreview. Thus, DOT approved mergers over the opposition of the Department ofJustice — mergers that unfortunately resulted in anticompetitive concentration atspecific hubs and higher prices to consumers’.22

Vertical foreclosure has been a recurring source of dispute in the telecommunicationssector.23 Under US antitrust doctrine, vertical foreclosure involves the use of marketpower in one market to acquire advantage in a vertically-related market to sustainsupercompetitive prices or exclude competitors. Typical forms of vertical foreclosureinclude refusals to deal or exclusionary pricing. The subject of vertical integration andits potential effects on competition is itself a very complex area with much dividedexpert option whether vertical integration is benign from a competition perspectiveand justified by efficiency gains and interest in minimising transaction costs, orwhether it produces anticompetitive consequences — for example, by securing themonopoly position of the monopolist and by forestalling entry by other firms.24

Looking back on US experiences with deregulation, a number of experts who werethemselves advocates of reform have argued that although the basic logic ofderegulation properly emphasises the role for antitrust enforcement as a replacementto regulatory efforts to provide economic protection for the public in workably

220 Policy approaches to economic deregulation and regulatory reform

competitive markets, reformers may have failed to fully anticipate the full range ofmarket risks associated with deregulation (see Kahn 1990; Breyer 1987).25

More recently, the Chairman of the Federal Trade Commission (FTC), RobertPitofsky, argued that the risks included: a tendency for participants in a newlyderegulated environment to seek to extend anticompetitive coordination into thenewly deregulated environment; the incomplete nature of the transition out ofregulation that can produce regulatory problems where some players are regulatedand some are not with the unregulated free to raise or cut prices in pursuit of variouscompetitive strategies; and the need for continuing regulation during a transitionperiod in some instances because certain policy goals can be handled comfortably ina regulatory regime but are not congenial to antitrust enforcement.26

Given the complexity of factors identified above and the brevity of this discussion, itwould be foolhardy to offer but a few modest observations from this recent record.First, it is broadly recognised that economic deregulation and regulatory reform hasproduced concrete economic gains to consumer welfare broadly defined. But, at thesame time, few policy issues are ever settled. Even the best intentioned of regulationsleave uncertainties in implementation and lead to unexpected problems, especially insectors subject to significant technological and market-based changes.27 Second, theglobalisation of trade and investment is itself requiring continuing adjustments inregulatory systems and also necessitating increased consultation and discussion.Third, antitrust or competition policy enforcement has been an important policyinstrument for fostering competitive market outcomes and competition, and if viable,it is superior to regulated monopoly.28 And, fourth, the regulatory reform processraises many complex issues including the danger that new market entrants, includingforeign firms, could be thwarted in their entry efforts by the reform methodsintroduced in the name of reform.

INTERNATIONAL DIMENSIONS

The preceding discussion has identified a number of concepts and factors that havedriven regulatory reform and economic deregulation and discussed the potential rolefor competition or antitrust policies in fostering competitive markets. This sectionfocuses on international policy dimensions of these same issues.

As suggested in the introduction to this chapter, regulation and competition policyare both increasingly the subject of international attention. The reduction of formalbarriers to trade at the border has shifted attention to the market-distorting effects ofprivate and government restraints.

International bodies, such as the OECD and to some extent the WTO, amongothers, are focusing their attention on prospects for harmonisation of regulatorysystems and improvements in regulatory processes to ensure greater transparency,accountability and attention to international market consequences of regulatory

Policy approaches to economic deregulation and regulatory reform—221

practices. Over time, we can expect that much additional international attention willcontinue to focus on problems arising from regulatory heterogeneity or divergence.From an international perspective, the basic costs of this divergence are limitations onthe economies of scale and entry costs that can constitute high fixed costs forpotential market entrants (see Leebron 1996). Regulatory divergence also posestransparency problems that can undermine a trade regime. This has given rise togrowing interest in identifying regulatory features with international marketconsequences.

In the area of private restraints, it is widely recognised that national competitionpolicies must become even more aware of the impact of global competition, butaddressing competition policy internationally is sensitive and complicated. Let usbriefly review some evidence that points to the need for greater cooperation as well assome of the policy challenges to such cooperation.

First, business is increasingly transnational in character, obliging multi-jurisdictionalreview of mergers, often with mismatches in reporting requirements, review periods,and so on. According to the US FTC, for example, as much as one-quarter of thetransactions now notified under the Hart Scott Rodino Improvements Act of 1976involve foreign parties.29 Thus, there could be considerable benefits from cooperationbetween competition authorities, both for government officials and affected businessinterests.

Second, evidence has shown that anticompetitive or collusive business practices arenot just a domestic concern. There have been cases where two or more foreign firmshave colluded to share the domestic market of a given country.30 There have also beencases where firms in several jurisdictions have entered into reciprocal agreements notto compete in each other’s markets.31 Allegations continue to be made that there areinternational cartels in certain industries of a classic nature (where the purpose isprice fixing, division and allocation of markets and joint restraints on output anddelivery on a global basis) — for example, in the steel sector.32 In late 1996 the ArcherDaniels Midland Co. agreed to plead guilty and to pay a US$100 million criminalfine — the largest criminal antitrust fine ever — for its role in two internationalcartels to fix prices and eliminate competition and allocate sales in the lysine marketsworldwide.33

Third, even jurisdictions with established competition laws and enforcementtraditions differ markedly in their approaches.34 And, of course, many developingeconomies are still in the early days of introducing laws and polices aimed atmaintaining and encouraging competition in an economy. In this sense, althoughtransnational competition policy issues are increasing, international harmonisation ofsubstantive law remains a distant prospect. One area of possible exception to thisgeneral observation may be in the area of hardcore cartels. Horizontal agreementsamong competitors that reduce competition, foreclose opportunities for new marketentrants and intend to restrict output and fix or raise prices have been a central

222 Policy approaches to economic deregulation and regulatory reform

concern of competition laws in most jurisdictions that have such laws. The area ofhard-core cartel enforcement may be one area of substantive law where there is likelyto be substantial agreement among competition authorities that such cartels have noredeeming competitive attributes.

Fourth, appropriate policy responses to perceived differences in competition policyenforcement are themselves a matter of international dispute. Inadequate ordiscriminatory enforcement of competition laws has risen to the level of internationaltrade disputes on several occasions, notably between the United States and Japan.Such tension has been especially difficult to resolve when the disputes have involvedvertical restraints where the economic effects of such restraints remain subject toconsiderable disagreement among policy and academic experts.

Bilaterally, the United States and Japan have experienced numerous trade disputes inrecent years that have centred around allegedly anticompetitive and discriminatoryconduct exercised by private firms. As a result, numerous bilateral trade agreementshave contained a competition feature, usually taking the form of affirmativestatements by the government of Japan that it will vigorously enforce itsAntimonopoly Act, and occasionally resulting in commitments to proactivelyencourage greater import penetration of competitive foreign goods and services.35 Thestill-unresolved dispute between the United States and Japan regarding barriers tosales of consumer photographic film centres around alleged government as well asprivate restraints.

And, fifth, a further source of international tension has emanated from government-authorised restraints (such as competition policy exemptions) as well as approaches toregulation itself that are perceived as tolerating or encouraging anticompetitiveconduct.

Given this heterogeneity of experience as well as substantive orientation, it is notsurprising that there is, as yet, little consensus at an international level whetheranticompetitive practices are properly matters to be addressed solely by nationalauthorities or whether expanded bilateral, regional or multilateral disciplines shouldbe developed (see Janow 1996). Yet, in recent years a number of proposals havesurfaced by expert and policy groups and the subject remains a topic of intensediscussion.

In the United States, antitrust officials have undertaken a variety of incrementalmeasures. US officials have sought to address some dimensions of internationalanticompetitive conduct through changes in domestic enforcement priorities.36 And,during the first term of the Clinton Administration, the Justice Departmentdeveloped new international antitrust guidelines which, among other features,outlined circumstances under which action would be undertaken in light of domesticenforcement priorities.37 In addition, several important bilateral antitrust cooperationagreements have been entered into — notably between the United States and Canadaand the United States and the European Union. In 1994 legislation was passed to

Policy approaches to economic deregulation and regulatory reform—223

permit antitrust enforcement officials to enter into agreements with foreigngovernments for both criminal and civil antitrust violations and to share confidentialinformation with foreign competition authorities under certain circumstances.38

There have also been several high profile cases where US and foreign competitionauthorities have cooperated on particular investigations.39

The last several years have also brought some important developments multilaterally.Various European leaders have been forceful advocates of bringing competition policyinto the WTO.40 In 1996 proposals surfaced from the European Union as well asfrom Japan to include some competition policy discussions within the context of theWTO.41 The EU proposal envisaged at least four different dimensions of competitionissues that could be addressed within the WTO framework. Specifically, it argued thatthe WTO could be used to:

• oblige WTO members to develop domestic competition structures, such as to develop competition laws and enforcement agencies;

• identify core common principles and work towards their adoption at internationallevel — especially with regard to hard-core cartel conduct;

• encourage greater cooperation among competition authorities; and

• identify what procedural and substantive elements could be made subject to WTOdispute settlement processes.

The EU proposal argued for the creation of a new WTO working group to exploreprospects for integrating a new instrument in the WTO to address anticompetitivecommercial practices with an international dimension. It proposed that the groupthen report to the 1998 WTO Ministerial on the feasibility of conductingnegotiations to develop a framework of rules on competition in the WTO. Japan’sproposal called for a thorough review of the links between trade and competitionpolicy. It appeared to be primarily directed at reviewing (and, by implication,challenging) antidumping duties.

In the run up to the December 1996 WTO Ministerial held in Singapore, US tradeand competition officials were indicating more concern than interest in having theissue of competition policy addressed within the WTO.42 A number of differentreasons are often referenced by US officials — for instance, that the WTO lacksexperience in this area; that the issue requires more vetting at home; that substantivelaw differs sharply even between the United States and Europe in some areas; and thatefforts must be made to guard against a lowest common denominator outcome in thedevelopment of competition policy rules by the WTO. US private sector advisorygroups also cautioned against moving too fast down the road to multilateralisediscussions on competition policy.43

Despite such concerns, at the Ministerial Conference in Singapore, it was agreed thatthe WTO would set up an informal working group to consider competition

224 Policy approaches to economic deregulation and regulatory reform

questions. A joint statement by Ambassador Barshefsky and Sir Leon Brittan madeplain that the establishment of this working group ‘will not affect domesticantidumping standards and provisions’; and, further, that the mere fact that aworking group was to be established does not mean that the contracting parties to theWTO have agreed that negotiations will occur in this area.44

As of this writing, since the working group on competition policy is still in its infancy,an important point upon which to reflect is that those discussions occur against abackdrop where selective competition-related issues have already become part of theWTO agenda. In this sense, the WTO consultations are occurring in an environmentwhere competition issues have already become embedded into existing multilateralrules. A few examples are illustrative:

• The agreement on basic telecommunications services obliges countries to liberalisemarket access and national treatment restrictions and to implement regulatory principles that are to guide domestic regulatory practices. The principles reflect a recognition that telecommunications remains a heavily regulated sector and in many jurisdictions regulatory authorities are not independent of telecom providers.And, since domestic suppliers are usually dominant suppliers, whether private or public entities, if they are left free to make decisions about how to treat other suppliers such entities would be capable of thwarting the market access and national treatment commitments made by governments. The principles are designed to support competition in the telecommunications sector through competitive safeguards that would prevent major suppliers from engaging in anticompetitive practices;45 through undertakings to provide transparent and nondiscriminatory interconnection with essential telecommunications facilities; through transparent and publicly available licensing criteria; and by requiring thatdomestic regulatory authorities are independent from and not accountable to anysupplier of basic telecommunications services, among other features.

• Moreover, the General Agreement on Trade in Services (GATS) contains a number of provisions designed to deal with anticompetitive practices exercised bydomestic service providers.46 The GATS agreement contains two broad and potentially far-reaching provisions aimed at addressing those commercial practicesof service providers that could adversely impact competition in a market. Specifically, Article VIII provides that monopoly service suppliers must not act ina fashion inconsistent with most-favoured-nation obligations under the GATS agreement or their scheduled commitments (see Article VIII [1] of the GATS agreement). Similarly, where a domestic monopolist is competing in the supply ofa service over which it does not have monopoly rights, the GATS agreement obligesWTO member governments to ensure that such firms do not abuse their monopoly positions in respect of that market where they do not hold a monopolyposition (see Trebilcock and Howse 1995). Under Article VIII, the Council for Trade in Services is identified as the forum whereby a WTO member has the rightto request specific information concerning the conduct of a monopoly service

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supplier if so requested and further obliges WTO members to notify the council ifit intends to extend additional monopoly rights. Article VIII also applies to formalor informal authorisations of a small number of service suppliers that ‘substantiallyprevents competition among those suppliers in its territory’ (see Article VIII 5(b) of the GATS agreement). In Article IX on Business Practices, the GATS agreementrecognises that in addition to monopolistic conduct as identified in Article VIII, other business practices of service suppliers may restrict competition and trade inservices. The GATS agreement does not specify the conduct that can give rise to such concerns. However, it requires mandatory consultations regarding alleged restrictive business practices if requested by another WTO member government.

• The trade-related investment measures (TRIMs) agreement provides that no laterthan five years after its entry into force, ‘the Council for Trade in Goods shall consider whether it should be complemented with provisions on investment policyand competition policy’ (see Article 9). And, already, some developing countries have signalled their discomfort with the Multilateral Agreement on Investment (MAI) investment negotiations occurring within the context of the OECD for failing to take into consideration the concerns of developing countries, especially in the area of restrictive business practices.

• The trade-related intellectual property provisions (TRIPs) accord includes provisions to control anticompetitive practices in contractual licences.

Further, while the WTO rules now contain some competition-related features, theWTO is not the only, or even the predominant, venue for consultation oncompetition issues. International consultation on competition issues has long beenunderway in the OECD context, which now has an active programme of substantivediscussions between trade and competition policy officials.

In addition, there are two regional settings where formalised cooperation on antitrusthas already proven possible — in the European Union and the Closer EconomicRelations (CER) agreement between Australia and New Zealand. An informal processof consultations has recently been initiated within the Asia Pacific EconomicCooperation (APEC) context, which includes both developing and developedeconomies. Overall, APEC has produced no binding agreements in any area underdiscussion, including in the area of competition policy. There is, however, anincreasingly active dialogue on competition issues among officials and experts fromthe region. Moreover, some APEC members have urged that APEC develop a set ofnon-binding competition principles that could be enhanced over time. This reflectsan approach that APEC economies have applied in other areas — for example, in thedevelopment of non-binding investment principles. For reasons that I have elaboratedupon elsewhere, I believe that while regional discussions on competition laws andnorms can be useful, it would be quite problematic if APEC were to develop a set ofweak non-binding competition principles that merely reflected what countries findpolitically acceptable. There are significant problems with an approach that seeks to

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develop competition norms that reflect an exchange of concessions rather than anapproach that is well grounded in empirical evidence as well as theory.47

In sum, while it may be some years before countries will agree on what national andinternational measures are necessary to coordinate or enhance competition laws andpolicies, such issues are now an important challenge and opportunity facinginternational economic policy.

CONCLUDING OBSERVATIONS

Regulatory reform and economic deregulation is a continuing and worldwide trend.The factors driving reform and the approaches taken will vary depending on thesector in question and the political and economic context in which such reform iscontemplated. The introduction of reforms is likely to occasion continuing policyadjustments — through regulatory and other means. And, with the globalisation ofmarkets, regulators have been and will continue to be challenged to remain mindfulnot only of the domestic but now the international consequences of regulatoryschemes. Even regulatory activity that does not have any explicitly discriminatorycharacter can be a matter of concern to the international trading system since it canpotentially undermine market access commitments.

For countries just starting down the road of deregulation and regulatory reform, USand other country experiences with regulatory reform and economic deregulation canprovide a source of useful lessons. Increased privatisation and deregulation provideincreased opportunities for countries to improve efficiencies. For high-growthdeveloping economies, this is also likely to provide increased opportunities for foreigninvestment. But increased foreign investment is likely to also require morepredictable, transparent and rational regulatory systems, which is itself a majorchallenge in many jurisdictions.

The further integration of the global economy and the now-obvious economic gainsfrom fostering increasingly open markets has the companion feature that fewregulatory decisions are matters only of domestic concern. This economic reality isitself requiring adjustments, and there is a need for more detailed examination ofissues such as regulatory transparency, accountability, national treatment and non-discrimination more generally.

This is not meant to suggest that there is a single model available for replication butrather that the growth of international trade and investment is likely to requirecontinuing adjustments in regulatory systems and increased consultation onapproaches taken to regulation and its reform. Expanded international cooperationand consultation could result in better understanding of the economic consequencesof regulatory reform as well the positive linkages between regulatory reform and othereconomic objectives such as increased foreign investment and access to technology.These features are especially important for developing economies and economies in

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transition. Greater international consultation on regulatory matters can also serve toreduce or ameliorate trade frictions arising from differences in regulatory regimes.

In this complex mix, competition policy has been an important policy tool employedin some jurisdictions not only to address private anticompetitive practices but also toensure that regulatory reform as well as the conduct of firms in regulated industryfurthers competition. For developing countries and economies in transition, theintroduction of competition laws and norms is an important measure to strengthenmarket forces. The design and implementation of competition laws, along with themix of enforcement priorities and instruments will need, of course, to reflect thetechnical capacity as well as the institutional capabilities and endowments of thegiven political economy.48 As this discussion has sought to amplify, the role forcompetition policy in deregulating markets is rarely straightforward, and evencountries with well-established competition policy regimes are modifying andmodernising their competition laws and policies in light of global economic trendsand new learning.

Further international consultation on competition policy and its role in regulatoryreform is both necessary and useful. While this author agrees with the view that theWTO does not currently have the competence to deal with substantive competitionlaw and indeed should not seek to develop a comprehensive global competition code,there are some aspects of the problem that could benefit from substantialconsideration at the international level at this early stage.

Many industrialised economies have competition laws in place and many othercountries are now introducing such laws and policies. Although these laws haveimportant points of difference between them, many international frictions havearisen because of the perceived lack of effective enforcement of those laws and, insome instances, discriminatory enforcement patterns. Thus, at a minimum, as I haveargued elsewhere (Janow 1997), there appear to be at least six dimensions to the issueof competition policy that could usefully receive priority international attention.

First, there is considerable room for developing a heightened awareness of the market-distorting potential of private restraints and bringing more international attention tobear on the question of enforcement. This could build upon efforts underway at theOECD and might usefully link those efforts with the informal effort at the WTO.

Second, it is evident that not all competition enforcement agencies nor regulatoryagencies are fully independent agencies within their own government structures.There is considerable room for international discussions of the structural andanalytical features that regulatory and competition enforcement agencies need toestablish within their own jurisdictions.

Third, recent years have witnessed increased cooperation between some enforcementagencies. This author is of the view that given the political and economic sensitivityof the issue of competition policy, multilateral enforcement efforts are unlikely to

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proceed more quickly or more efficaciously than are bilateral cooperation initiativesbetween enforcement agencies. This does not mean that multilateral efforts must waituntil bilateral initiatives have fully matured; it suggests, however, that a multi-trackapproach is needed.

Fourth, the shear volume of transactions subject to international regulatory andcompetition policy review suggests that improved coordination even of proceduralaspects of multi-jurisdictional merger review could reduce transaction costs andimprove information flows.

Fifth, there is also a broad spectrum of government actions that can negatively impacton the ability of firms to compete in a market — for example: exceptions tocompetition laws; industrial policies; and government procurement practices. Theseimportant and difficult areas need to be more fully addressed in an internationalcontext because they have been and are likely to continue to be sources ofinternational economic and trade tension in the future.

And, sixth, the WTO working group on competition could, and hopefully will, playa role in advancing the agenda outlined above. It could, for example, offer aconstructive medium-term vision for future international cooperation, whether at theWTO or through other international mechanisms. If history is a guide, WTOdiscussions are more likely to be fruitful if the participants focus on those aspects ofcompetition policy that are trade-related and thus appropriately the subject of WTOconsideration rather than focusing on issues of substantive legal harmonisation whichare likely to be divisive subjects. Resolving differences in substantive law are also notself-evidently necessary. At a minimum, since competition issues are alreadyembedded in the WTO agenda, it will be important to ensure that competition policyapproaches across sectoral areas are consistent and mutually reinforcing.

NOTES

1 In the October 1996 elections in Japan, although candidates offered or debated fewconcrete policy proposals, the goals of further deregulation and administrative reformwere identified as a top priority by every one of Japan’s political parties. In South Korea,the 1993 New Economic Plan outlined a programme to reform the overall economicsystem, stressing greater participation of the private sector, fiscal reform, reform of thefinancial sector and relaxation of administrative control, among other measures. Morerecently, a report issued by an advisory group to the Prime Minister echoed this call forfurther regulatory reform, including the use of competition policy, as a much neededinitiative to enhance Korea's international competitiveness, to eradicate corruption andto bring Korea into greater conformity with international standards, among otherreasons. See Globalisation Committee (1996)

2 A now classic definition of economic deregulation was advanced by Stigler (1971) —namely, the state's withdrawal of its legal powers to direct the economic conduct of non-governmental bodies. Stigler’s definition can encompass a very broad range of actionsincluding the removal or reform of regulations on market entry and exit, output, servicesand prices. Reform can mean ‘deregulation, privatisation combined with the creation of aregulatory authority, or more targeted and focused regulation that makes greater use of

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economic incentives, economic policy analysis, and policy coordination among agencies’see Noll (1996).

3 Economic deregulation has triggered debate in many countries as to the responsiveness,or lack of it, of economic regulations and deregulatory measures to social policy concernssuch as health, safety, pollution control, employment and quality of life. Many debateson economic deregulation and regulatory reform ultimately turn on whether the analystbelieves that an efficiency-based rationale for economic deregulation applies in a giveninstance, and, if so, if it is sufficiently sensitive to broader social policy concerns.Although that assessment is important, this study does not attempt to assess the costsand benefits of economic deregulation on a sectoral or national basis.

4 As discussed herein, technological change, market-based pressures, and the evolution ofregulatory schemes have all come to challenge traditional notions of natural monopolies.

5 For example, in the case of information asymmetries, remedies typically include variousincreased disclosure requirements. Finding the right instrument to correct the perceivedfailure has not been a straightforward process in most jurisdictions. Also, disclosure (withthe associated transparency and accountability) has proved an elusive objective in manycountries.

6 MacAvoy (1992) argues that in trucking rates and airline fares, for example, regulationwas seen as necessary because rates varied widely from monopolistic to competitive levels.And, in regulating retail gas, electricity and telephone companies, state and federallegislatures argued that cost-based prices were necessary so that local monopolies couldnot set high and discriminatory prices. The underlying assessments of businessconditions, of course, varied. In airlines, for example, the early justification for regulationstemmed from arguments about ‘excess competition’. In communications, in contrast,the underlying argument was often ‘natural monopoly’.

7 Examples include the passage of the Civil Aeronautics Act and the Natural Gas Act in1938.

8 Regulation has been justified in the name of market failure, which is itself not a staticconcept. As the OECD (1992, p. 20) points out, changes in technologies and marketconditions have led to rethinking of the nature and extent of market failure.

9 MacAvoy (1992) identifies two main ‘culprits’ as causing serious regulatory problems inthe United States. The first of these, he argues, is the tendency of regulation throughlegislation to serve too many and too diverse interest groups, thereby producingdistortions in the regulatory process and in pricing and structure. The second culprit isthe limited managerial competence to be found in the regulatory agencies. He also notesthat approaches to regulation that may have made sense under one set of marketconditions often proved to make far less or no sense under different conditions. Forexample, MacAvoy points to the use of ceilings on prices in line with previous periodcosts of service. He argues that ‘these worked well when industry demands increased andcosts decreased each year from larger scale. But when inflation was accompanied byrecession, so that costs increased rapidly, this same method had quite the opposite effect.Prices lagged behind costs so long as costs increased continuously. The operatingpractices of the agencies by themselves generated adverse price and production behavior’(MacAvoy 1992, p. 4).

10 Writing about Europe in the 1960s, a leading advocate of industrial policy, Jean JacquesServan-Schrieber, argued that government intervention was essential to survive thecompetitive onslaught of American enterprise. Many European and American economistsnow argue that France and other European nations pursued this policy with littlediscernible success: ‘National champions insulated from competition seldom, if ever,become world class competitors.’ See ‘Remarks’ by Dr Frederic Jenny, Professor ofEconomics, Chairman of the OECD Competition Law and Policy Committee at the17–18 March 1997 Meeting on Competition Policy in a Global Economy, New Delhi,

230 Policy approaches to economic deregulation and regulatory reform

citing approvingly the works of US economist F. M. Scherer. The traditional regulatoryfailure rationale for further economic deregulation and regulatory reform, which we haveseen in the United States and elsewhere, is also clearly part of the debate in Japan. Norhas this debate been limited to the telecommunications area. Even MITI commented inits 1995 white paper that: ‘in order to reduce the domestic/external price gap we mustcorrect the gap, in productivity which is brought about by anticompetitive and inefficientregulations and trading practices’ (MITI 1995, p. 146).

11 The commission recommended the privatisation of Japan National Railways, NTT andthe Japan Monopoly Corporation as necessary cost-saving reforms. Analysts ofprivatisation argue that when the act of selling a public enterprise is seen as primarily ameans of budget-balancing, there is a corresponding tendency to make the resultingentity a monopoly with few constraints placed upon it, requiring further adjustments,and a heightened role for competition policy attention. See Roger Noll, ‘Comments’before the Columbia University Conference on Economic Deregulation and CompetitionPolicy in the Asia–Pacific Region, March 1997.

12 See ‘Remarks’ by Dr George Yarrow at the Columbia University Conference onEconomic Deregulation and Competition Policy in the Asia–Pacific Region, March1997.

13 This argument has been advanced at various times by important economists associatedwith the Pacific Trade and Development (PAFTAD) process, such as Professors RossGarnaut, Peter Drysdale and Mari Pangestu.

14 In some of the sectoral disputes between the United States and Japan, the United Statessought remedial steps in the form of deregulatory actions by the Japanese government —notable examples include telecommunications and standards, licensing and certificationrelated agreements. More commonly, the US government sought to remove what it sawas discriminatory or anticompetitive biases in Japan's regulatory arrangements and theintroduction of measures to increase administrative transparency, accountability, fairnessand market access.

15 In the US context, the Administrative Procedures Act (APA) has long been identified asproviding such features. In its early days, a main feature of the APA was its requirementthat regulated companies have recourse to due process through judicial review of agencyaction. Over time, the scope of this review has broadened to examine whether agencydecisions are reasonable in light of the goals of the statute. In the 1970s the APA came tobe used by activists as a sword to ensure that their interests in agency decision-makingwere given fair representation. And, in the 1980s, the APA was used to challenge theelimination of entire programmes of agencies.

16 Analysts often do not agree on the relative importance of factors in influencing thereform process even within a given nation. In the United Kingdom, for example, Sir AlanWalters, former personal economic adviser to Prime Minister Thatcher, has argued thatthe two principal motives for economic deregulation, and in particular the extensiveprivatisation programmes of the Thatcher government, include: the desire to reduce thepoliticisation of economic decision-making, particularly in state-run companies; and thedesire to increase net wealth through improvements in economic efficiency of enterprises.Oxford Professors Raymond Vickers and George Yarrow, on the other hand, argue thatthe momentum of privatisation policies was initially influenced by dissatisfaction withthe performance of publicly-owned industries, later by short-term budgetaryconsiderations, and finally by share ownership and distributional objectives. Thedistributional objective — namely, gaining political advantage by means of transfers ofwealth — was far more important in a latter period of privatisation, such as between1987 and 1993. Sir Ian MacGregor, a key figure in privatisation in the United Kingdom,stresses that privatisation was driven by ideology, coupled with a growing recognition of

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privatisation’s collateral advantages — namely, the populist notion of widening shareownership. See MacAvoy et al. (1989).

17 Also, there have been numerous sectoral studies on the effects of deregulation. One studyof privatisation in the Chilean and Mexican telecommunications sectors found economy-wide benefits for Telmex of some 50 per cent and 155 per cent for Chile Telecom.Efficiency gains have also been identified for British telecom after privatisation. See Galalet al. (1994).

18 In most countries there remain areas where the role of competition or antitrust law islimited or non-existent — for example, in the United States. The ‘state action doctrine’immunises some private action that is taken pursuant to articulated state governmentpolicies and that is actively supervised by the state. For this doctrine to apply, theimmunised conduct must be the product of deliberate state intervention and not merelythe product of an agreement among private parties. According to one expert, theEuropean Union has largely rejected such a state action doctrine because competitionpolicy maintains a ‘constitutional’ status in the European Union, in contrast to alegislative status in the United States. See Committee on Competition Law and Policy(1995). There are other areas in most jurisdictions where regulatory statutes expresslyexempt firms from antitrust liability. In the United States, numerous industries benefitfrom express exemptions to antitrust laws. For example, agricultural cooperatives aregranted an exemption under the Clayton Act, which permits producers to agree witheach other to set price and output — but still the Supreme Court has held thatagreements between producers and non-producers are not exempt. Also, theMcCarran–Ferguson Act creates an exemption for what has been defined as the ‘businessof insurance’. When an insurance company in engaged in many diverse activities, courtsthen determine whether or not that activity falls within the ambit of ‘the business ofinsurance’. The McCarran antitrust exemption still does not apply to boycott, coercionor intimation. See Hovenkamp (1994, pp. 662–7).

19 As Hovenkamp (1994, p. 653) states: ‘The mere fact that the underlying regime is“pervasive” should not be considered dispositive. If the private conduct being challengedwas neither compelled nor approved by the regulatory body, then any claim of antitrustimmunity is greatly weakened … in such cases the court will generally deny theimmunity unless application of the antitrust laws would create a “clear repugnancy”between the regulatory statute at issue and federal antitrust policy.’

20 For this reason, as one analyst notes, ‘in telecommunications the initial pressure tointroduce competition occurred in customer premises equipment and in intercity servicerather than in network access’ (Perle 1996, p. 25). It has been argued by many scholars inthe telecommunications field that the nature of the market has changed dramaticallywith the advancement of technology so that the local telecommunications market is nolonger a natural monopoly. Commonly cited reasons for such views are the increasingalternatives to traditional local access exchange (such as cellular communications), thepotential competitive strength of cable providers, and the appeal of small providers ofbypassing the local exchange carrier to get to the large commercial customers. And, morespecifically, satellites, cellular service, land microwave networks and expanded fibre opticsare capable of allowing direct competition in transmission of local calls. See Nowicki(1996).

21 There are numerous other differences between airline and telecommunicationsderegulation in the United States. Stephen Breyer notes, for example, that intelecommunications the arguments that telecommunications could not support severalcompetitors were stronger than in airlines, the income effects probably favoured thebusiness community while airline deregulation probably favoured the consumer, and, inairlines, Congress had found serious problems with the way the CAB regulated airlines

232 Policy approaches to economic deregulation and regulatory reform

but did not find comparable problems with telephone service regulation. See Breyer(1987) and Noll (1995).

22 ‘Remarks’ by Anne Bingamen, Assistant Attorney-General for Antitrust, ‘Injectingcompetition into regulated industries and utilities’, Address before the Public Utility,Communications and Transportation Law Section, American Bar Association, 20 April.

23 These go back as far as the early 1910s, with AT&T’s integration into manufacturingand its refusal to interconnect local exchange carriers to its long distance network. Thisdispute was resolved by the so-called Kingsbury Agreement. See US v. AT&T 1 Decreesand Judgements in Civil Federal Antitrust Cases 554 (D.C. Ore. 1914) and Noll (1995).

24 Such problems are not limited to the US experiences with deregulation. The OECDpoints to the UK experience with deregulation of express coach services as illustrating theproblems of incumbency and the failure of liberalisation to reduce the market power ofthe major publicly-owned carrier. In the words of the OECD, ‘the incumbent, NationalExpress strengthened its position by using the marketing advantages of its establishednational network, combined with exclusive or dominant access to city centre terminals.Together with an aggressive pricing strategy, this enabled the company to resist newentrants. This dominance was subsequently tacked by a programme of fragmenting thebusiness into regional operating companies.’ See OECD (1992, p. 12).

25 Stephen Breyer’s article points to the following types of risks: first, that general antitrustpolicy will overlook the special features of particular industries; second, a general policyrisk whereby, in the process of deregulation, policy-makers will protect competitorsinstead of protecting competition; third, that regulatory policy will fail in treatingregulated segments of otherwise deregulated industries; and, fourth, that antitrust policymay find it hard to prevent anticompetitive bottlenecks in partially deregulated industries(see Breyer 1987).

26 See ‘Prepared remarks’ by Robert Pitofsky (Chairman Federal Trade Commission),‘Competition policy in communications industries: new antitrust approaches’, GlasserLegal Works Seminar on Competitive Policy in Communications Industries: NewAntitrust Approaches, 10 March 1997, Washington DC.

27 This observation was also noted by Noll (1995) in his assessment of the role for antitrustpolicy in telecommunications.

28 Although beyond the scope of this discussion, for LDCs or countries with limitedexperience with competition policies, the sequencing of regulatory reform measures andcompetition policy instruments can be very important.

29 See ‘Remarks’ by Christine A. Varney, Commissioner, US Federal Trade Commissionbefore the Fordham Corporate Law Institute Conference, New York, 17 October 1996.The FTC has recently held extensive hearings on the changes in the competitiveenvironment that may require adjustments in antitrust and consumer protectionenforcement. These hearings examined questions such as: whether antitrust’s traditionalapproach to defining a relevant market and measuring market power fully accounts forglobal competition; whether antitrust analysis can improve its ability to assess thelikelihood of entry by foreign firms into particular markets; and how antitrust canmaximise the likelihood of realising beneficial efficiencies and minimise the likelihood ofinjuring consumers from an increase in market power when agencies review mergers,joint ventures or network type operations that have apparent efficiencies, among othermatters. See the FTC Internet web-site at ‘http://www.ftc.gov’.

30 For example, Sumitomo Chemical Canada and Chemagro Ltd. (parent Bayer AG ofGermany) were fined over US$900,000 for participating in a foreign-directed conspiracyto clandestinely divide market share for chemical insecticides in Canada in 1987 and1988. An investigation was initiated after a voluntary disclosure by a third party, AbbottLaboratories Ltd. See Antitrust and Trade Regulation Report (1993, p. 691).

31 See US v. Diebold Inc. and Chubb & Sons, Ltd. Cr. No. 76-49 (N.D. Ohio 1976).

Policy approaches to economic deregulation and regulatory reform—233

32 See, for example, the discussion by Wolf (1995). There are also allegations thatgovernments had a hand in the formation of a global production reduction programmein the aluminium sector that may have evolved into a cartel. See ‘Foiled competition:don’t call it a cartel, but world aluminum has forged a new order’, Wall Street Journal, 9June 1994; ‘Cartel well smell and rhyme quite well, but aluminum isn’t oil’, AmericanMetal Market, 20 June 1994; ‘Soda makers rip aluminum producers’, American MetalMarket, 27 February 1995.

33 In this case, Korean and Japanese companies were also implicated in the lysineconspiracy. The felony charges against Archer Daniels Midland Co. include: agreement tocharge lysine and citric acid prices at certain levels and to increase those pricesaccordingly; agreement to allocate among the corporate conspirators the volume of lysineand citric acid to be sold by each, participation in meetings and conversations for thepurpose of monitoring and enforcing adherence to the agreed upon prices and salesvolumes. See Press Release, Antitrust Department, 15 October 1996.

34 Treatment of vertical restraints is a particularly controversial area but differences are evensubstantial between the United States and the European Union in the area ofmonopolisation or abuse of dominance. In analysing a case, both US and EU law requirethat there be a finding of market power in relation to a defined market. For the UnitedStates and the European Union, market share is a common proxy or first screen.However, there are significant differences as to the level of shares that can be consideredproblematic — high shares are required in the United States whereas lower levels couldsuffice in the European Union. And, in the European Union, concerns about singlemarket integration, protection of competitors, and the viability of smaller businesses haveat times been of more central concern to EU authorities than have concerns abouteconomic efficiency, which has increasingly come to guide US antitrust doctrine in thearea of monopolisation or attempts to monopolise.

35 The latter approach has been particularly controversial, with little agreement between theUnited States and Japan as to the market effects of the practices identified andconsiderable divergence of opinion as to the appropriate role of governments inpunishing, deterring or influencing the private conduct identified by the United States asproblematic.

36 This refers to the decision late in the Bush Administration by the Justice Department topursue antitrust enforcement actions against conduct abroad that affects US exportcommerce. This reflects a shift from policies under the Reagan administration whichlimited enforcement priorities to cases where only US consumers were harmed.

37 These guidelines declare that agencies do and will cooperate with foreign authorities inthe enforcement of competition policy and that US agencies will consider internationalcomity issues when deciding whether or not to pursue a matter and they will seek theassistance of foreign authorities in dealing with the matter. See US Department of Justiceand Federal Trade Commission (1995).

38 This is embodied in the International Antitrust Enforcement Assistance Act (IAEAA).The United States entered into its first cooperation agreement under the IAEAA withAustralia in April 1997.

39 Examples include the joint investigation and enforcement action taken against Microsoftin 1994; the joint Canada–US criminal prosecution involving thermal fax paper; and theCanadian government’s assistance to the Justice Department in connection with itssuccessful criminal investigation of price fixing involving plastic dinnerware.

40 Sir Leon Brittan, for example, advocated the internationalisation of competition policyinto the WTO in a major speech at Davos in 1992.

41 The European Union has adopted a paper written on this subject by Sir Leon Brittan andCommissioner Van Miert. Japan also tabled a non-paper on this subject in the run-up tothe Singapore Ministerial.

234 Policy approaches to economic deregulation and regulatory reform

42 See, for example, the remarks of Acting US Trade Representative Ambassador CharleneBarshefsky, who stated in public testimony that ‘We consider the issue of competition tobe important … However, the broader issue of competition is not ripe for any kind ofnegotiation in the WTO to establish a comprehensive new framework of rules. This is anextremely complicated and multifaceted issue, which encompasses a broad range ofquestions relating to both private company and governmental actions … the fact of thematter is that an extraordinary amount of work and study remains to be done in thisarea.’ See Statement of Ambassador Charlene Barshefsky before the Subcommittee onTrade of the Committee on Ways and Means, US House of Representatives, 11September 1996. Not long afterward, the Acting Assistant Attorney-General for Antitrustargued that while the United States has not ‘ruled out the possibility of a role for theWTO’ in the area of competition policy, it has ‘urged a cautious approach’. See ‘Remarks’by Acting Assistant Attorney-General for Antitrust Joel I. Klein, ‘A note of caution withrespect to a WTO agenda on competition policy’, The Royal Institute of InternationalAffairs, London, 18 November 1996.

43 See, for example, a report by USTR’s most senior advisory group, the ACTPN, whichargued that ‘there has not yet been sufficient domestic discussion and analysis of thesehard issues within the government or private sector. Without such analysis andestablishment of objectives and desired outcomes, US participation in any internationaleffort would be premature.’ See ACTPN (1996).

44 See Statement on Competition Policy in the World Trade Organisation by CharleneBarshefsky, Acting United States Trade Representative and Sir Leon Brittan, VicePresident of the European Commission Responsible for Trade Policy, 13 December 1996.

45 Identified anticompetitive practices included cross-subsidisation, using informationobtained from competitors with anticompetitive results and ‘not making available toother suppliers on a timely basis technical information about essential facilities andcommercially relevant information which are necessary for them to provide services’. SeeFinal Draft of WTO Telecom Regulatory Principles, 30 April 1996.

46 The GATS agreement ‘is designed to reduce or eliminate governmental measures thatprevent services from being freely provided across national borders or that discriminateagainst locally-established service firms with foreign ownership’. See Statement ofAdministrative Action, H.R. Doc., No. 103-316, 103d Cong., 2d. Sess. 297.

47 A number of the Asian member economies of APEC have urged that APEC developvarious non-binding principles that can be enhanced over time. In 1994 APEC Ministersagreed on a set of non-binding investment principles. As it turned out, the APEC non-binding investment principles were not only weak but in some respects were weaker thanthe investment commitments already agreed to in the context of the Uruguay RoundTRIMs. As currently drafted, they accord no degree of meaningful legal protection toinvestors from arbitrary and capricious actions of governments. Some have argued,however, that they should be viewed as reflecting an initial and early effort to buildconsensus on a complex and divisive issue, and that they have served to inaugurate aprocess of building consensus within the region on steps necessary towards even widerinvestment liberalisation. This is a form of a ‘ratcheting up’ argument. The same logic isnow being applied in the area of competition policy. For a more detailed discussion ofthis point, see Janow (1996/97).

48 For further discussion of the role of competition policy for developing economies as wellas arguments about the appropriate priorities and sequencing of competitioninstruments, see Khemani and Dutz (1996) and Frischtak and Pittman (forthcoming).

Policy approaches to economic deregulation and regulatory reform—235

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Kahn, Alfred (1990) ‘Deregulation: looking backward and looking forward’, Yale Journal onRegulation 7 (Summer), p. 325.

Khemani, R. Shyam and Mark A. Dutz (1996) ‘Instruments of competition policy and theirrelevance for economic development’, World Bank, Private Sector Development,Occasional Paper No. 26 (June).

Kovacic, William E. (1995) ‘Cultural conceptions of competition: designing andimplementing competition and consumer protection reforms in transitional economies’,DePaul Literary Review 44, p. 1197 (Summer).

Leebron, David W. (1996) ‘Mutual recognition: structure, problems and prospects’, Paperprepared for the OECD Trade Committee Symposium on ‘Regulatory Reform andInternational Market Openness’, 9–10 July, Paris.

MacAvoy, Paul W. (1992) Industry Regulation and the Performance of the American Economy,New York: W.W. Norton & Co.

MacAvoy, Paul, W. T. Stanbury, George Yarrow and Richard Zeckhauser (eds) (1989)Privatisation and State-Owned Enterprises, Boston: Kluwer Academic Publishers.

236 Policy approaches to economic deregulation and regulatory reform

MITI (Ministry of International Trade and Industry) (1995) Tsusho Hakusho [White Paper],Tokyo: MITI.

Noll, Roger (1995) ‘The role of antitrust in telecommunications’, Antitrust Bulletin (Fall).—— (1996) ‘Regulatory reform as international policy’, Paper prepared for the OECDTrade Committee Symposium on ‘Regulatory Reform and International MarketOpenness’, 9–10 July, Paris.

Nowicki, Elizabeth (1996) ‘Competition in the local telecommunications market: legislate orlitigate?’, Harvard Journal of Law and Technology 9, p. 353 (Summer).

OECD (1992) Regulatory Reform, Privatisation and Competition Policy, Paris: OECD.—— (1997) OECD Report on Regulatory Reform, Paris: OECD

Perle, Lewis J. (1996) ‘Regulatory restructuring in the United States’, National EconomicResearch Associates, Inc., in International Comparison of Privatisation and Deregulationamong the USA, the UK and Japan, Keizai Bunseki [Economic Analysis], EconomicResearch Institute of Japan’s Economic Planning Agency, Tokyo (January).

Stigler, George (1971) ‘The theory of economic regulation’, Bell Journal of Economics(Spring).

Trebilcock, Michael J. and Robert Howse (1995) The Regulation of International Trade,London: Routledge.

US Department of Justice and Federal Trade Commission (1995) Antitrust EnforcementGuidelines for International Operations (April), reprinted in Trade Reg. Prt. 4 (CCH) 13,107; also ‘http://www.doj.gov’.

Vietor, Richard H. K. (1994) ‘Contrived competition: economic regulation and deregulation,1920s–1980s’, Business History 36(4) (October).

Vogel, Steven K. (1996) Freer Markets, More Rules, Ithaca: Cornell University Press.Winston, Clifford (1993) ‘Economic deregulation: days of reckoning for microeconomists’,

Journal of Economic Literature XXXI (September), pp. 1263–89.Wolf, Alan Wm. (1995) ‘The problems of market access in the global economy: trade and

competition policy’, in OECD New Dimensions of Market Access in a Globalising WorldEconomy, Paris: OECD.

11 Telecommunications and privatisationin Asia

John Ure and Araya Vivorakij

DEREGULATION, PRIVATISATION AND LIBERALISATION

From the outset, the terms deregulation, privatisation and liberalisation, whichabound in any discussion of the telecommunications sector, require some definition.By deregulation we mean the unwriting of rules or regulations which have thepractical effect of restricting entry to the industry. This most frequently starts withthe deregulation of customer premises equipment (CPE) markets. Domestic pressurefor such deregulation comes from user groups — usually the large corporate users —who want the right to attach to their telephone lines any compatible equipment, frombasic telephone sets to fax machines to private automatic branch exchange (PABX) tonetworked computers. Domestic pressure also comes from CPE vendors who areanxious to see the market grow, especially if they do not already enjoy a privilegedsupplier relationship with the dominant telecommunications company; from newoperators wanting to break the monopoly power over terminal equipment exercisedby the dominant telecommunications company; and from ministers, economists andindustry regulators who want to promote competitive markets. Overseas pressurecomes from bilateral and multilateral trade negotiations that seek to lower non-tariffbarriers (NTBs) to trade and open market access. The regulation of CPE standardsand testing procedures has been, in some cases, an effective weapon of protectionists.A recent example of deregulation in Hong Kong arose when the regular, the director-general of the Office of the Telecommunications Authority (OFTA), determined that,subject to network technical compatibility, no cellular telephone operator has theright to deny subscription service to customers who have bought their handsets fromanother supplier. This move is designed to force greater price competition on thehandset market.

Deregulation clearly implies liberalisation, and this loose definition also includes theremoval of exclusive rights from monopolies. But because these privileges are oftenenshrined in property rights — such as exclusive licences and franchises — theirremoval is legally difficult. More often, however, exclusivities are enshrined in

238 Telecommunications and privatisation in Asia

legislation which traditionally has built upon the Post, Telegraph and Telephone(PTT) administrations model. These were, for historical reasons, departments ofstate, usually under the policy control of a ministry whose jurisdiction covers postsand telecommunications; — sometimes in conjunction with other policy areas, suchas ‘energy’ (Malaysia) or ‘tourism’ (Indonesia) or ‘transport’ (Philippines). The firststep towards deregulation, therefore, required the investiture of a corporate statusupon the state-run organisation so that subsequent legislation could deal with it on acommercial basis — hence the creation of state-owned telecommunicationsenterprises (SOTEs). Step number two then occurs — partial privatisation; partialbecause SOTEs are often the largest entities on the corporate landscape and quiteindigestible on stockmarkets if sold off in their entirety. Also, governments arereluctant to lose total control over them, seeing them as cash-cows, as national assets,as strategic industries. Even in the most developed industrial nations governments arerarely totally ready to surrender their power over SOTEs, preferring to hold back a‘golden share’ which gives them the right of veto over future share ownership. Forexample, the New Zealand government owns a ‘kiwi share’ despite having a policy ofwhat must be, at least in formal terms, the most ‘liberal’ telecommunications regimein the world — there is no specific telecommunications regulator, although the sectoris covered under general competition law.

By definition, privatisation involves the transfer of share ownership to the privatesector, but the real question is whether it also involves a shift towards a market-focused management and how this is reconciled with the social and other inheritedobligations of the SOTE. For example, the SOTEs in developing economies haveobligations to provide service to uneconomic rural areas, and they inherit a bloatedworkforce employed on civil service conditions and terms of employment. Theseissues cut across numerous policy considerations, ranging from reforms of the stateapparatus, including the separation of powers between policy-makers, regulators andSOTE operators, to macroeconomic and social policy questions such as theredeployment of labour, industrial policy, service and tariff cross-subsidisation, thepromotion of competition within the industry, trade negotiations and the opening ofmarkets. At the root of the privatisation issue, then, is the question of how far thetransfer of share ownership also involves the transfer of control and managerialdirection, and, when it does, how far, if at all, that is to be reconciled with stateinterests, however these may be defined.

Liberalisation is a policy objective of many governments and regulators. In the idealworld of economists, it is often seen as a good in itself, but as a policy objective thereare many, many other influences and pressures promoting its merits. Liberalisationessentially refers to the removal of barriers to market entry and, as all textbooks willdictate, this also implies the removal of barriers to exit. The latter may be achievedthrough an act of omission by governments more used to intervention and subsidy,or through constructed regulatory policies, such as the right of assignment of licencesand a liberal attitude to joint venture partnerships and foreign direct investment in

Telecommunications and privatisation in Asia—239

the industry which enables firms in financial trouble to spread their risk or cut theirlosses. More critical, however, are the rules, regulations and procedures governing thebehaviour of the dominant telecommunications company towards the new entrants.Issues such as interconnection, predatory pricing, structural and separationsaccounting to prevent hidden cross-subsidies, discriminatory pricing, tie-inagreements and so forth are the nuts and bolts of regulation in thetelecommunications industry. And built on top of all this is the licensing regime,which sets the terms and conditions on entry. The most liberal, a class licensingregime which allows licencees to choose which services they offer within the class ofservices covered by the licence, is liberal in the sense that anyone may apply for onefor a very small fee. Hong Kong is on the verge of taking such a step if the regulatoryrecommendations are accepted into law. Most Asian states are far from this, havingonly recently emerged from the PTT era.

In light of these distinctions, this chapter uses the term privatisation in the broadestcontext to refer to the process through which private capital is brought into the publicswitched telecommunications network (PSTN) and is likely to lead to an extensionof private sector management and control over part or all of the PSTN, includingprivatisation in the form of a private network by-pass of the PSTN. This broader,looser conceptualisation of privatisation overlaps with the concept of liberalisation —for example, the issuing of competing PSTN licences, which allows private operatorsto win public network traffic — although it is possible to have either one without theother.

Asian economies each had their own reasons for choosing to reform their state andindustrial policies. Some, such as Burma (Myanmar) and North Korea, have made nosignificant changes and remain locked in policies of autarky. Others, such asSingapore, Hong Kong and the tiny Portuguese colony of Macau, base their entireisland-economies upon being open ports and international hubs for communicationsand trade. Their telecommunications reforms reflect this openness. Between thesetwo ends of the spectrum stand societies which differ widely in their state ideologies,social and ethnic make-up, cultures and religions, and levels of development. Butwhat they share in common is a relative lack of independent institutions of civilsociety. This stands in contrast to most highly developed Western societies andcultures, and it undermines the notion that privatisation implies a clearly defined linebetween the state and the private sector as it does in the West.

In their very different ways, the lines of distinction between the role of the state andthe productive, commercial and cultural life in Asian societies tend to be lessformalised than those in the West, and therefore the exercise of state prerogatives, theadministration of laws and the allocation of resources can often appear arbitrary.Policy-making and the exercise of policy administration — such as the decision toissue licences to new telecommunications operators, the choice of how many licencesand the choice of who they should be awarded to — are frequently opaque, lackingin transparency even to the point where it remains unclear which government agency

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is responsible for what, and where and when and how a particular decision was made,or indeed if a decision was made at all. Nor is it entirely unusual for commercialagreements reached by the outgoing minister of one government to be rescinded bythe incoming minister of another, or for those agreements to be overturned after alegal challenge. This adds political risk to telecommunications investment, whichmay already carry substantial commercial risk.

The role of family or military or political or religious ties is usually very strong inAsian societies, accentuated by the relative lack of independent civil institutionsthrough which social matters can be debated. This heightens the potential role of thestate as the arbiter of social issues, where private interests lobby directly those whohold power, not as an action complementary to their public bids but as an actionwhich substitutes for public declarations of interest. In the case where the state itselfbecomes a terrain of conflict and struggle between competing social and ideologicalgroups, policy-making becomes paralysed. In his study of telecommunications inLatin America and Asia, Petrazzini (1995) argues that reforms were more likely tosucceed in cases where the relative autonomy of the state was high, where it wasrelatively insulated from political pressure, and where power within the stateapparatus was highly concentrated, than in cases where political power was moreevenly contested and administrative power diffused. He contrasts the success of theprivatisation of Telekom Malaysia with the failure of Thailand to reform theTelephone Organisation of Thailand (TOT) despite years of debate within the Thaistate.

Under these circumstances it makes far better sense to discuss the issue ofprivatisation as a series of policy approaches which encourage private sector capitalbut which leave the lines of demarcation between public and private sectormanagement and control of networks and services unclearly, or pragmatically,defined. Examples range from the efforts in Thailand to keep ownership of joint-venture assets within the hands of the SOTE, to controls that the Singaporegovernment exerts over nominally private companies — although companies inwhich the government may indirectly own shares — to self-censor if, for example,they are handling information coming into Singapore, including over the Internet, orto promote particular technologies, such as videotex or adopt certain technologies,such as electronic data interchange (EDI).

Asian economies are developing economies, their societies undergoing radicaltransformation, and overseeing them are Asian governments very much in the processof state-building. Privatisation, under these circumstances, is a policy-instrumentwhich can serve many different purposes and different interests — and therefore takesa variety of different forms. Thus the approach adopted here acknowledges commonfactors at work (see below) but sees privatisation as less of an act of transfer and moreof a partial process of restructuring the relationship between state and private capital;1

and emphasises the need to explore that variety of forms to explain differencesbetween Asian economies and the reform process. This study confines itself to the

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task of providing an overview of privatisation developments in Asiatelecommunications and conceptualising a model which can provide a means bywhich to conduct country studies in greater depth.

PRIVATISATION IN ASIA

In many countries in Asia, privatising the SOTE is seen as one of the important stepsin telecommunications sector reform. Privatisation also forms the core of reform inother sectors and regions of the world. The amount of privatisation in all sectors ofdeveloping countries has significantly increased about eightfold from less than 100cases in 1988 to almost 800 cases in 1993. Privatisation of infrastructure — includingtelecommunications, energy, water and transportation — accounted for the largestshare of total privatisation in the developing countries, with sales volume peaking atUS$29 billion in 1992 and falling slightly to US$24.4 billion in 1993 (InternationalFinance Corporation 1995). Asia accounted for only a minimum share in total salesvolume as compared with other regions such as Latin America and the Caribbean, forreform and privatisation of telecommunications in Asia has been slower and of morelimited scope (see Smith and Staple 1994). However, as Table 11.1 indicates, fewAsian countries have not embarked on telecommunications reform.

Table 11.1 Telecommunications sector reform and privatisation in the Asia Pacific region

Japan Partial privatisation of PSTN in the 1980s; domestic market liberalised; 3 international carriers; cable TV-telephony planned.

Four DragonsHong Kong Four private PSTN operators since 1995; 4 cellular operators and 7

licences; international non-voice traffic liberalised.Singapore Partial privatisation 1993; a second cellular licence awarded;

liberalisation of international carrier by 2000 announced.South Korea Value-added network services (VANS) liberalised from 1985; two

international carriers; third international and domestic carriers to be licenced; cellular competition from 1996; partial privatisation of PSTN planned.

Taiwan Liberalisation reform agreed 1996; cellular licences to be awarded; partial privatisation of PSTN planned.

Southeast AsiaIndonesia Partial privatisation 1994, 1995; liberalisation on a SOTE joint-

operating scheme (KOS) basis 1996.Malaysia Partial privatisation of PSTN 1990; liberalisation of VANS.Philippines Liberalisation of private PSTN 1994 and VANS.Thailand BTO schemes 1990; privatisation under policy review.

South AsiaBangladesh Partial liberalisation of rural PSTN.India Partial privatisation of international carrier; liberalisation in cellular

1995 and in local PSTN 1996.

242 Telecommunications and privatisation in Asia

Table 11.1 continued

Pakistan Partial privatisation 1994.Sri Lanka Partial privatisation 1992.

China and Indo-ChinaChina State-controlled local competition since 1994.Vietnam Business cooperation contracts with foreign companies.Burma No reform to date.Cambodia State joint venture concessions to foreign companies.Laos State joint venture concessions to foreign companies.

Pacific IslandsAustralia Liberalisation in 1992.Fiji Public offering planned for PSTN. International carrier is 49 per cent

joint venture with Cable & Wireless.New Zealand Liberalisation in 1990.Solomon Islands Cable & Wireless 51 per cent joint venture.Vanuatu France Cable et Radio 49 per cent joint venture.

Prior to 1988, when the shares of Hongkong Telecom were sold on the Hong Kong,New York and Pacific stock exchanges, the only traded Asian telecommunicationsstocks in East and Southeast Asia were those of Philippines Long Distance Telephone(PLDT).2 For a thorough discussion of IPO procedures and methods of placing aninitial value upon the shares of a SOTE, see the analysis of the IPO of NipponTelegraph and Telephone (NTT) in Japan in Takano (1992). By mid-1994, as Table11.2 shows, the number of listed Asian telecommunications companies had risen to27, with Japan Telecom and PT Indosat (Indonesia) being added later in the year, andPT Telkom (Indonesia), Philtel (Philippines) and TACS (the Thai cellular operatingcompany of Ucom, which has listed on the Singapore exchange), being added during1995. Additional listings planned for 1996 included Smartone (Hong Kong), and, inThailand, Jasmine Overseas and Shinawatra International.

Table 11.2 Quoted telecommunications service companies in the Asia Pacific region, August 1994

Company Country Year listed

Hongkong Telecom Hong Kong 1988Champion Technology Hong Kong 1992Star Paging Hong Kong 1991ABC Communications Hong Kong 1991Philippines Long Distance Telephone Philippines naPhiltel Philippines naGlobe Telecom Philippines naEasycall Philippines 1991Time Engineering Malaysia naTechnology Resources Industries Malaysia naTelecom New Zealand New Zealand 1991

Telecommunications and privatisation in Asia—243

Company Country Year listed

Telekom Malaysia Malaysia 1991Singapore Telecom Singapore 1993TelecomAsia Thailand 1993Shinawatra International Thailand 1991Advance Info Services Thailand 1991United Communications Thailand 1993Loxley Thailand 1993Thai Telephone and Telegraph Thailand 1994Jasmine Overseas Thailand 1994Samart Thailand 1994Shinawatra Satellite Thailand 1994Korea Telecom Korea 1994Korea Mobile Telecom Korea 1992DACOM Korea 1992Videsh Sanchar Nigam Limited India 1992Mahanagar Telephone Nigam Limited India 1992

Note: na = not available.Source: Harrington (1995).

This leap in numbers represents not only ‘privatisation’ in the narrow sense of theselling off parts of SOTEs but also the use of a generous definition of privatisation asopening the market to private operators. Only one-third of the listed companies inTable 11.2 represent SOTEs, with many non-listed private operators having alsogained licences to operate in Asian markets in recent years.

In the most straightforward case, privatisation is the sell-off of shares of the SOTE toprivate investors, which is usually one of two types. The first of these is shareholderprivatisation through an initial share offering (IPO), leading to a stock exchangelisting — which approach was adopted by Telekom Malaysia in l991 and SingaporeTelecom in 1993 when they listed around 18 per cent and 10 per cent of their shares,respectively. Similarly, PT Indosat (Indonesia) in 1994 and PT Telkom (Indonesia) in1995, launched IPOs of around 25 per cent and 20 per cent respectively of theirshares on the New York, London and Jakarta stock exchanges to raise US$1 billionand US$1.68 billion of private investment. In all these cases only a fraction of totalshares were on offer.3

The second type is operator privatisation, involving the sale, normally through asealed-bid auction, of the SOTE to one or more private telecommunicationsoperators, usually international carriers or substantial national operators with deeppockets and a wealth of managerial and technological experience. For example, in1990 New Zealand Telecom was auctioned to Bell Atlantic (United States) andAmeritech (United States) for NZ$4.25 billion.

Market liberalisation also works as a form of privatisation by opening the market tonew entrants backed by private capital, although in principle the new entrant couldbe another state-owned entity as is the case in China and Vietnam.4 In 1991 the

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Australian government, having merged Telecom Australia and OverseasTelecommunications Corporation (OTC) into Telstra, then created a duopoly byawarding a second carrier licence to Optus Communications, a consortium consistingof Bell South (United States), Cable & Wireless (United Kingdom) and four localpartners. As part of the deal the government sold to Optus Australia the debt-burdened satellite, Aussat, for $800 million. In both Australia and New Zealand thesesteps were seen as the first towards further market liberalisation.

A related form of privatisation through market entry is the outsourcing oftelecommunications business to the private sector. Pressure from two principalsources gives rise to this development. In the case of a privatised company operatingin a liberalised market there exists an imperative of competition to drive costs to aminimum and shareholder value to a maximum. Telecommunications companies inall liberalised markets have sought ways to outsource business considered vital to theiroperations but inessential to their commercial competitive advantage — such as theducting of telephone cables and the building of new exchanges/central offices,building and office security, and certain non-strategic data management functions.

In the case of an SOTE in a developing economy, the pressure more usually arisesfrom a lack of capital and management resources to meet subscriber demand. In 1990in Thailand, two SOTEs — the Telephone Organisation of Thailand (TOT) and theCommunications Authority of Thailand (CAT), which are responsible for domesticand international telecommunications respectively, broke new ground when theybegan a series of build–transfer–operate (BTO) agreements with private sectorcompanies, such as Charoen Pokphand, Loxley, Samart, Shinawatra and others.Under the BTO arrangement the private sector builds the network and transfersownership to the TOT or the CAT — or the Posts and Telegraph Department (PTD)in two of the three very small apperture terminal (VSAT) cases — but continues torun the network on a revenue-sharing basis for the period of the franchise. The BTOhas been used in Thailand to steer around the problem that the telecommunicationslaws, which date to the 1950s and l970s, require services to be state controlled. Fixed-wire and wireless services are now extensively offered on a BTO basis. In Indonesia,PT Telkom adopted a similar approach in 1989 when Pola Basi Hasil (PBH) revenue-sharing agreements were reached with nine private sector companies to build fixed-wire local loops. In this case both ownership and operation were transferred to PTTelkom, although line maintenance was subcontracted to the PBH partners.

There is another reason for outsourcing. It is a common requirement in developingcountries such as Malaysia and Indonesia that a SOTE, subject to corporatisation andprivatisation, guarantee the employment and the pension rights of staff as a means ofsoftening labour union opposition. One means used to guarantee employment butshift excess staff off the books of the operating company is to set up subsidiary orauxiliary companies to undertake outsourcing. In Asia this approach was first adoptedby Nippon Telegraph and Telephone (NTT) in Japan following corporatisation in1985 and the beginnings of privatisation in 1986. Even so, by 1990 NTT had cut

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back its 1984 workforce of 310,000 by 50,000 (Takano 1992). In the case ofIndonesia today, the foreign companies being invited to participate in the JointOperating Scheme (KOS) in different regions of the country are required to employPT Telkom staff.

PRIVATISATION AS A DEVELOPMENT ISSUE IN ASIA

Privatisation is now widely promoted as a way to tap into a wider pool of investiblefunds — though corporatisation alone usually ensures access to major capital markets— and as a milestone on the route towards a greater responsiveness to the market andto customer needs. Privatisation is seen as a stepping-stone towards, if not the actualachievement of, competition in facilities and services. And in the world’s pooresteconomies, even the thorniest of problems, such as the goal of a universal basictelephone service, are now seen as being eased rather than exacerbated by privatisation(see Smith and Staple 1994)

These perceptions have been espoused in a stream of papers, publications and reportsfrom the World Bank and its affiliate, the International Finance Corporation (IFC),in the APEC Telecoms Working Group forums, in the General Agreement on Tariffsand Trade (GATT) and General Agreement on Trade in Services (GATS) and WorldTrade Organisation (WTO) debates, in International Telecommunications Union(ITU) forums, as well as in an uncountable number of internationaltelecommunications and information technology trade conferences. And,increasingly, they are being accepted across Asia. Among the reasons, three areoutstanding.

First, a shift in perceptions was triggered by the apparent success of radical policychanges in the early 1980s which notably included the antitrust divestiture of AT&Tin the United States, and in Britain privatisation of Cable & Wireless and BritishTelecom. These policy shifts provided both templates for other governments,including Japan,5 and strong practical and ideological arguments for the process. Onthe practical side was the sale of state assets, the run-down of state liabilities and thepromotion of local stockmarkets; on the ideological side was the commitment tomarkets in opposition to state ownership and control.

Second, the Organisation for Economic Cooperation and Development (OECD)countries, led by the United States, were increasingly determined to force open worldmarkets for trade in services, and in consequence brought considerable pressure tobear on the more advanced developing economies, especially in Asia. These pressurescame both directly through trade negotiations and political contact, and indirectlythrough the recommendations of multilateral lending and aid agencies, and otherinternational bodies, including those listed above.

Third, despite the fact that the debt crisis of the early 1980s generally affected Asialess than other parts of the world, such as Latin America and Eastern Europe —

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although there were notable exceptions, such as the Philippines — many Asiangovernments (Malaysia, for example) did feel the impact of a fiscal crisis as worldtrade threatened to collapse. Fiscal tightening in South Korea and Taiwan in the later1980s and early 1990s arose for similar balance-of-trade and payments reasons. Thesepressures, which derived from the growing integration of the world production, tradeand financial systems, affected alike the more export-oriented economies foundmostly in Southeast and East Asia, and the more closed or protected economiesconcentrated on the Indian sub-continent of southern Asia and Indo-China. Underthese circumstances of fiscal uncertainty, privatisation became an increasinglyattractive option, quite independently of any intrinsic merits or relevance to theindustries concerned. In India, for example, the programme of privatisationannounced in 1991 by Prime Minister P. V. Narasimha Rao departed radically fromthe policies of all post-Independence governments in India.

In Vietnam, where the Communist Party and government remain staunchly statist,the Stalinist constitution of 1980 was replaced with a new constitution in 1992, theguiding principle of which is ‘oi moi’ or economic renovation through innovation,laying the groundwork for a greater role for private, including foreign, capital.Foreign investment has also been encouraged by China, although in the area oftelecommunications this remains restricted to equipment manufacture and does notextend to network ownership or operation. In the early 1990s China’s open-doorpolicy, initiated by Deng Xiaoping after 1978, was given significant impetus by thedeclaration of a socialist market economy involving state enterprise reforms,including partial privatisation.

The aims of privatisation differ as widely as the variety of forms. At one radicalextreme there stands an ideological commitment to minimise the role of the state asa direct agency of production, distribution, exchange and of redistribution.Undoubtedly, the privatisation program of the Thatcher government in Britain after1979 was conducted in this spirit, and it is interesting to note that Mrs Thatcher’sfirst act of privatisation was to sell a SOTE — namely, Cable & Wireless.6 NewZealand and Chile have been the most radical in the Asia Pacific region, the latterstrongly ideologically motivated.

At the other end of the spectrum is the view that telecommunications is a securityissue and a national asset that must not fall into foreign hands. But even in this casethere is pragmatic recognition of the need to tap into a wider pool of capital for thedevelopment of the network. China, for example, has encouraged the use ofbuild–transfer–lease arrangements in telecommunications. Local state enterprise, andin at least two cases overseas capital,7 has been permitted to ‘invest’ in building fixed-wire and wireless networks either by leasing equipment to the provincialtelecommunications authorities (PTAs) or by building and transferring networks tothe PTA and then leasing them back on a local joint-venture operating and revenue-sharing basis.

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Behind such pragmatism lies a recognition of the changing role oftelecommunications within modern economies. The technological transformation ofthe industry over the past decade has changed its entire relationship to the productiveeconomy, making it central to economic and industrial development. With the worldmarket encroaching upon every society, the developing countries of Asia know fullwell how strategic a modern telecommunications network is for their survival in acompetitive global economy. The broad principles of these radical changes werealready evident to industry specialists by the early 1980s, although policy-makerswere then more likely to be aware of the role computers and micro-processors weredue to play in the transformation of industry than of the role of telecommunications.From the early 1980s, and in some cases earlier, the newly-industrialising economies(NIEs) of Asia — especially the ‘four dragon’ economies of Hong Kong, Singapore,South Korea and Taiwan, but also a second tier including China, India, Malaysia,Pakistan and Thailand — were developing policy initiatives to encourage theadoption and diffusion of the new technologies.8

With the recognition growing across Asian economies of the need to placetelecommunications development on the fast track, there were two courses of actionopen to governments. The first was to commit more public funds to investmentwithin the industry. The problem with this option was threefold. First, the fiscal crisiswhich hit many states in the early to mid-1980s was triggered by a recession in globaltrading and the world debt crisis. This was certainly the factor behind the Malaysiangovernment’s 1983 plan for the privatisation of telecommunications (see Petrazzini1995, p. 146).9 Second, governments in developing countries have tended to view thetelecommunications sector as a source of scarce foreign exchange, andtelecommunications has been a net contributor, not a net recipient, of funds. InIndonesia and Taiwan, for example, as much as 60 per cent of annualtelecommunications revenue has gone to the treasury during periods of fiscaltightening. Third, a state bureaucracy is not well adjusted to the management of asector which is subject to fast changing technologies. Technological transformationsraise the risk level of investment because it is difficult to predict which technologieswill prove successful and which will not. The greater the risk the greater the need tospread it across multiple operators.

The second course of action was to open the telecommunications sector to privatecapital, through privatisation, liberalisation and deregulation.10 This is now thefavoured policy direction, although as Petrazzini (1995) and Ure (1995) point out,there are numerous interest groups in developing Asian countries — ranging fromministries (for example, China) and the military (for instance, Thailand) to labourunions (such as Bangladesh) and state managers (such as Taiwan) — who have reasonsto oppose or delay such plans. Since each of these steps — privatisation, liberalisationand deregulation — involves the greater participation of the private sector in theindustry, we shall continue to use the term privatisation in its broadest sense to meanthe transfer of at least some ownership or control of telecommunications from the

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state to the private sector through the opening of an enterprise or the industry toprivate capital.

The societies of South and Southeast Asia are undergoing an historical change similarto the changes Europe experienced from the sixteenth to the twentieth century, exceptat an accelerated pace. Within the span of one century they are nation-state building,seeing the struggle to life of political and civil societies, experiencing population shiftsfrom rural to urban communities, industrialising — albeit very unevenly — andbecoming integrated into a world system of production, trade and finance. TheSingapore government, for example, in recognition of the need to develop thecity–state into a regional financial centre, saw the privatisation of Singapore Telecomas a way to boost the status of the Singapore stock exchange (Hukill 1994). Theprocess of economic integration is inevitably uneven, and different centuries ofdevelopment are evident within quite small geographies, as telephone densitiesillustrate. Throughout South, Southeast and East Asia, which is home to 50 per centof the world’s 5.5 billion population, most of the people do not live within 24 hours’walking distance of a telephone. At the same time, the region is home to some of themost advanced telecommunications network facilities in the world, in Japan, HongKong and Singapore; and by 2000 many of the metropolitan cities of the region —Beijing, Shanghai, Bangkok, Kuala Lumpur and Jakarta — will have telephonepenetration rates of between 30 and 50 per cent. This will be dial tone. At the sametime, digital mobile cellular telephony will be widespread, cellular roaming services,including satellite systems, will be common across Asia, Internet access will havebecome ubiquitous, while asynchronous transfer mode (ATM) high-speed data-switching and synchronous digital hierarchy (SDH) or synchronous optical networktechnology (SONET) — the European and North American standards, respectively,— high-speed data transmission will be fully operational in the region’s internationalcities.

This is the context within which Asian countries view telecommunications — one of development — and it overrides specific ideologies. In the case oftelecommunications, development has a double meaning. It means how to bringtelecommunications within reasonable access to the people who will benefit — thegoal of universal service. However, owing to radical changes in technology, it now alsomeans how to modernise the economy through information technology. The reasonfor this second imperative arises not from the technology itself but from the growthof the world market. The growth of Asian economies is dependent upon theirintegration into the world economy, and those deliberately isolated from it, such asBurma (Myanmar) and North Korea, or unable to enter, simply stagnate. The 1990sis the decade when this convergence of world economic forces and informationtechnology has become a priority development issue (see InternationalTelecommunications Union 1995a) and forms the backdrop to telecommunicationspolicy throughout Asia.

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MODELLING PRIVATISATION IN ASIA

Understanding the background to telecommunications policy in Asia, however, doesnot answer the questions: when and why did a particular government in a particularcountry decide to reform, including privatise, its telecommunications industry?Having decided to do so, what determined the form of privatisation? How successfulwas the implementation of the reforms and what factors were decisive in theoutcome? A detailed and comprehensive answer to these questions must await furtherstudy — at the time of writing, an Asia Pacific Economic Cooperation (APEC)consultancy study is being undertaken into these very questions — but we can givesome review of the issues and Asian experiences to date.

We may begin with a consideration of the objectives of privatisation. Having arguedabove that the aims of telecommunications privatisation in Asia are better understoodin terms of national development than in terms of ideologies, it is appropriate tomodel the argument in terms of driving forces and mediating factors which may actas constraints or as issues which determine final outcomes. One set of factors wouldbe contingencies, such as a fiscal crisis, or a sudden change of government or theoverall course of government policies. We have already cited Malaysia as an exampleof fiscal crisis. Another set of factors would arise from the private business sector, themajor users of telecommunications services who are looking for better service andcompetitive pricing, especially the foreign multinationals who can choose theirforeign locations and regional communications hubs. This is a demand-side factor. Athird set of factors would arise from international pressures—for example, from theWTO, APEC and the United States. A fourth set of factors would be associated withthe issue of development, the need to provide an infrastructure for local developmentand the need to provide an attractive environment for foreign investment. The latterissue may be regarded as the supply-side of the demand from multinationals referredto above. We can use as shorthand for each of these sets of factors: fiscal crisis, privatecapital, WTO and teledensity.

Interacting with each of these factors are local constraining or driving elements. Thegovernment, as represented by the Ministry of Finance, stands to lose recurrentforeign exchange revenue from privatisation but to gain a windfall income from thesale of shares, while reducing its liabilities. It is interesting to note from Table 11.3that besides the Philippines, only Hong Kong and Japan operate entirely privateinternational carriers.

Labour unions can be another powerful influence on the timing, extent and form ofprivatisation. In India, Pakistan, Sri Lanka and Bangladesh unions have effectivelyblocked privatisation either totally or to a large extent — and in Thailand also. InMalaysia and Indonesia they have lobbied hard for government commitments toprotect employment, as also in Taiwan where, in January 1996, the government wasforced to concede to worker representation on the soon-to-be incorporatisedChunghwa Telecommunications Company (CTC), which is currently part of the

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Directorate-General of Telecommunications (DGT). Nationalism, which has beensystematised throughout much of Asia in this period of state-building, is a furtherconstraint. In Indonesia, for example, the government has felt it necessary to stepwarily towards privatisation least it be accused of selling-out to foreign interests. InChina foreign direct investment in telecommunications remains taboo, despiteopenness in other areas. Telecommunications continues to be treated as a sacred cow,a national and security asset, rather than as a mass consumption commodity.

Table 11.3 Asian telecommunications companies: revenue, ranking and state ownership

International communications World State

Company revenue (US$m 1994) ranking ownership (%)

KDD (Japan) 2,869 7 0Hongkong Telecom 1,944 8 0Singapore Telecom (Singapore) 1,185 15 89DGT (Taiwan)a 936 17 100Korea Telecom (South Korea) 604 25 80IDC (Japan)b 586 27 0PLDT (Philippines)c 563 28 0ITJ (Japan)d 532 29 0Indosat (Indonesia) 394 33 65China Telecom (China) 382 34 100Telekom Malaysia (Malaysia) 379 35 75VSNL (India) 335 37 85

Notes: a DGT = Directorate General of Telecommunications.b IDC = International Data Corporation.c PLDT = Philippines Long-distance Telephone Company.d ITJ = International Telecom of Japan.

Source: Communications Week International, 27 November 1995, p.17 (which lists Hongkong Telecom under Cable & Wireless, ranked at number 3).

Finally, another factor is local interest groups — lobbyists who have an interest in theindustry. These could include local users, including consumer groups who opposeopening the market for fear that tariff rebalancing will disadvantage domesticsubscribers, but also local aspiring new entrants who want a share of the pie. Theymay welcome foreign partnerships or wish to protect the market for themselves. Ineach case, a study of the local situation, its politics and personal and businessnetworks, needs to be undertaken to reveal its dynamics. Table 11.4 suggests apossible set of forces at work, some showing negative reactions (-) against pressure toopen markets and privatise in the broadest sense, others showing positive responses(+) in favour.

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Table 11.4 Matrix of negative reactions (-) and positive responses (+)

Ministry of Labour Local Drivers Finance unions Nationalism lobby

Fiscal crisis -/+ - + +Private capital + - +/- +WTO +/- - - +/-Teledensity -/+ - -/+ -/+

The above model is schematic but it illustrates some of the potential drivers behindpolicy-making and some of the constituent constraints and influences upon policy-making. Further research at the country level reveals what the InternationalTelecommunications Union (ITU) (1995a) calls three waves of liberalisation: the firstin the mid-1980s led by Japan, Australia and New Zealand; the second coming in thelater 1980s involving many of the ASEAN countries, such as Malaysia, Indonesia,Thailand and Singapore, but also Hong Kong, South Korea and Taiwan; and thethird current wave in Southern Asia and Indo-China. However, as we indicatedabove, in each telecommunications jurisdiction, very different local circumstances ledto many different forms of private capital entry and state–capital relations.

Krzywicki (1994) offers an interesting perspective on the forms of entry of privatecapital in Asia telecommunications markets. He suggests a trade-off between the riskassociated with operator-privatisation, which is most likely in the least developedcountries where a ‘junk the local operator and start again’ approach may be the idealoption, and the inherited skill-set that comes with the stockholder or equityprivatisations of SOTEs in the developed economies. He places most of Asiasomewhere between the two extremes, and argues that operator privatisation does notguarantee that benefits accrue to the country privatising. His main point is thatoutside operators may restructure the local network to their own advantage but,significantly, his example comes not from a less developed country but from NorthAmerica where AT&T took operational control of Unitel, Canada’s second long-distance carrier, and steadily shifted Unitel research and development out of thecountry. Equally problematic with the model is that within the Asia Pacific region,operator-privatisation was pioneered in New Zealand and not in the developingcountries of Asia, where considerable caution has been shown towards foreignnetwork operators.11

Perhaps the more interesting trend across Asia is not the entry of foreign carriers —although many American baby Bells, European and Australian carriers are enteringstrategic alliances — but the role of Asian telecommunications companies enteringthe regional market (Ure 1995, esp. Ch. 4). Thai companies like Charoen Pokphand,Jasmine, Loxley and Shinawatra, Malaysia companies like Sapura and TRI, SingaporeTelecom, Hongkong Telecom, Hong Kong Hutchison Telecom, ChampionTechnologies, Star Paging, Korea Telecom and others, large and small, are penetratingeach other’s markets in local alliances. Japanese companies such as NTT are also very

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active, using their traditional alliances with Japanese trading houses such as Itochu,Marubeni and Sumitomo to open doors in Indonesia and the Philippines. Thenation–state and private capital relationship is therefore being overlaid with capitalwhich is distinctly Asian regional.

The advantage that Asian capital has in this context is that the commercial risksassociated with a potentially volatile and ill-defined state and private capitalrelationship — one in which licences issued today may disappear tomorrow; wheregovernment policies can alter radically over short periods; where regulation is opaque;where the hidden costs of doing business can be very high, and so on — to saynothing of uncertain market demand, are excessive. International Westerncompanies, with stockholder considerations uppermost and every contract andnegotiation put under the close scrutiny of corporate lawyers, are either loath toentangle themselves or find themselves ill-informed and uncertain. Local Asiancapital, often controlled by families, and perhaps more used to the ways of doingbusiness in the region, can enjoy lower transactions costs and are able to accept higherrisk on the basis of extra-contractual understandings.

Of course, there are some economies of scale not available to the small private Asiancompanies, while companies like Hongkong Telecom (Cable & Wireless) andSingapore Telecom are just about as international as AT&T or BT. But it is interestingto speculate that as the region grows and as technologies break down the distinctionsbetween fixed-wireline and wireless communications, it will be Asian capital thatdominates the Asian marketplace, and Asian states that aid that process.

WELFARE EFFECTS OF PRIVATISATION IN ASIA

No comprehensive study of the welfare effects of telecommunications privatisation inAsia has yet been undertaken. In the absence of firm evidence, we may refer to moregeneric studies, and to the partial evidence that does exist. The World Bank (1992)covered 12 enterprises in its study of the welfare effects of privatisation in Chile,Malaysia, Mexico and Britain and came out with a positive overall assessment, butadmitted problems in separating out the effects of privatisation fromcontemporaneous changes in state policies regarding investment, labour regulationand the organisational restructuring of state-owned enterprises. However, only threetelecommunications companies were included in the study, none of them Asian, andin the case of one of them, Telmex of Mexico, the study concluded that consumerswere actually worse off at least in terms of prices. Of course, higher residential tariffsmay get offset by tariff reductions to the business sector which later show up in lowermanufacturing and consumer service prices. Furthermore, the dynamic efficienciesassociated with the implementation of new technologies which privatisation canencourage are not possible to measure in the short time-frame of these policy changes.

Petrazzini and Clark (1996) offer preliminary findings based upon a study of theeffects of liberalisation in 26 developing countries. Since competition is likely to be

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the primary driver towards dynamic welfare effects, and privatisation alone does notguarantee competition, and since, until very recently, competition in Asian countrieshas been confined to value-added services, Petrazzini and Clark choose to use thepresence or absence of competitive entry in the cellular telephone market to correlateto changes in cellular teledensity as a test of the impact of competition onaccessibility. On this welfare measure, the results are unambiguously positive. Butthey also confirm that the threat of competitive entry may be as positive in fixed-wireline teledensity as the onset of competition. The speed with which the PLDTintroduced its Zero-Backlog programme, designed to abolish waiting lists in thePhilippines by 1997, following the announced opening of the market, is theoutstanding example. The results also confirm a correlation between privatisation andgrowth in teledensity, which by intuition we can surmise is associated with theencouragement of increased investment in the sector (see below). Whereas Petrazziniand Clark find a correlation between competition and price reductions, they find nosimilar correlation in the case of privatisation on its own. On the contrary, like theWorld Bank study, they find price increases. Circumstantial evidence would suggestthat this is associated with the interests of private — especially overseas institutional— investors to protect their asset value. The difficulties encountered by PT TelkomIPO in 1995, for example, suggest that country risk is placing a premium uponincome protection. Investors prefer a period of exclusivity to protect theirinvestments, and the approach adopted in Hong Kong during the 1980s and inSingapore in the 1990s has been to grant it. Another factor influencing local tariffs istariff rebalancing, especially between international and local call charges. It is theusual consequence of competition, but in few Asian countries has competition yetfully emerged in international markets. In Japan and South Korea long distance tariffshave fallen significantly relative to local tariffs as the entry of private capital has madethese services competitive, and liberalisation of the domestic market in Hong Konghas also resulted in dramatic falls in international charges as the new local operators— including cellular — are able to deliver calls directly to HKTI and pass on revenueshares (local delivery fees) to their customers. Circumstantial evidence fromeconomies like Hong Kong would suggest that competition has had the effect ofimproving the quality and range of customer services, but Petrazzini and Clark findno general evidence to support this contention for either competition or privatisationin their survey sample.

A distinctive feature of the approach adopted in Asia towards guarding the welfareinterests of stakeholders has been the partial protection afforded to labour.Traditionally, telecommunications staff the world over have been among the mosthighly organised and highly paid technical workers, enjoying the benefits of stateemployment or employment by an entrenched private monopoly, with seniorityadvancement, securely-funded pensions and welfare benefits. The shift from a worldin which telecommunications was regarded as a basic utility to one in which it israpidly acquiring the characteristics of a mass market commodity is perceived bylabour unions as a threat, exposing their conditions of employment to the vagaries of

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a commercially aggressive market economy. Privatisation in developed economies haseverywhere led to substantial staffing reductions, some of it technologically-induced,some of it market-driven cost reduction, even at a time when the industry itself wasexpanding rapidly.

In Asia, however, staff reductions have been more modest, and confined to the moredeveloped economies, like Japan, Hong Kong and Singapore, alongside Australia andNew Zealand in the southern Pacific. Of course, an obvious part of the explanationlies in the degree of development of the networks. Highly developed networks tendto diminish rather than increase the demand for labour, except perhaps for the mostprofessionally skilled. For less developed areas, part of the explanation may lie inPetrazzini’s point that in Chile ‘privatised firms enjoying monopoly protection haveretained most of their labour force [and] privatised companies facing competitivemarkets have sharply reduced their personnel’ (Petrazzini 1995, pp. 8–9), which fitsfor countries like Indonesia and the Philippines where until recently there was nocompetition.12 But often in Asia it is the state, not unfettered market forces, whichdetermines the course of restructuring. For example, according to the InternationalTelecommunications Union (1995b), between l991 and 1994, a period during whichthe market was protected, Singapore Telecom shed 30 per cent of its employees. Overthe same period, when Malaysia was introducing competition, Telekom Malaysiaincreased staff by nearly 3 per cent.

The fact is that in these cases — in Indonesia, Malaysia and Singapore — the stateremains the major shareholder and the attitude the state takes towards the trade-offbetween efficiency and social commitments remains important. In Singapore thegovernment has adopted the view that the economy stage of development requires ahighly efficient information infrastructure. While the Malaysian government sharesthe vision — Vision 2020 (Malaysia’s long-term development plan) — in practice itspopulist appeal and commitment to the Malay bumiputera (‘people of the soil’) over-rides other considerations.

PRIVATISATION AND NETWORK GROWTH

Intuitively, it seems likely that industry privatisation — implying the entry of privatecapital even in the case of SOTEs — will help rather than hinder network expansion.A common objection coming from SOTEs in developing nations has been thatprivate capital has only one consideration — profit — and first resources willtherefore go only to those areas where profits are highest. There are two dimensionshere: one is network growth and the other is network location — where will networksbe built?

It is beyond the scope of this chapter to examine the latter issue, but if it isaccompanied by well-designed policy and regulation, privatisation need not mean aconcentration of resources into wealthier areas to the exclusion of poorer areas. First,growth will naturally penetrate succeeding income group levels. Second, opening the

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markets will increase the total capital resources available to fund growth. Third, well-designed and enforced revenue-sharing and interconnection agreements — especiallythose involving rural and long-distance networks — can generate funds for local smalland medium-sized enterprises (SMEs). As regional and global migration patternscontinue to unfold in parallel with national economic development, forming newtelephone ‘communities of interest’, the opportunities for generating traffic revenuesinto rural areas increase. Fourth, franchises and licences can impose social obligationson major operators. Fifth, levies on operators put into a universal service fund canredistribute resources. Sixth, national network externalities provide a strong basis forpromoting universal service.

Turning to network growth and privatisation: is there evidence that privatisation —as loosely defined in this chapter — stimulates network growth? Again, within thescope of this chapter it is not possible to provide a definitive answer since otherfactors would need detailed investigation, such as the degree of competition, thecommitment of the state, the state of the economy, and so on. Another way to posethe question is: is privatisation either necessary or sufficient? On this question weoffer the following preliminary observations.

Network growth, and therefore investment, can be measured in several ways,including in terms of quality and range of services. A common measure is teledensity— that is, telephone mainlines per 100 inhabitants — but since this is, by definition,affected by the growth in population, it is better to use the absolute growth inmainlines. Table 11.5 uses ITU data to record this growth in terms of the percentagecumulative annual growth rate (CAGR) in the major Asian and South Pacificeconomies over the two periods 1984–90 and 1990–95.

The first set of economies to liberalise their fixed-wireline networks in the 1980s(including SOTE privatisation) — Japan, Australia and New Zealand — did so frompositions of development, with teledensities of 47, 50 and 47 mainlines per 100population, respectively. Of the three, only New Zealand has recorded a higherCAGR in the 1990s. The second wave of fixed-wireline liberalisation, from the late1980s to the early 1990s, embraced two of the Asian ‘tiger’ economies — Hong Kongand South Korea — as well as the developing member states of ASEAN. Hong Kongalready had a teledensity in 1990 of 43, and South Korea 31. In ASEAN, Malaysiahad a teledensity of 9, Thailand 2.4, Philippines 1 and Indonesia 0.6. In contrast toHong Kong, the rapid pace of liberalisation in South Korea has moved slowly — tooslowly according to the dramatic fall in the CAGR 1990–95. The story amongdeveloping ASEAN economies is rather different. Each shows substantial increases ingrowth rates, the Philippines outstandingly so. Although more detailed studies arerequired to analyse the precise sources of growth,13 it seems clear and common-sensical that opening the fixed-wireline markets to outside capital investment booststhe absolute level of telephone penetration.

256 Telecommunications and privatisation in Asia

Table 11.5 Mainline telephones (000s) and cumulative annual growth rates (GAGR)

Mainlines Mainlines Mainlines CAGR (%) CAGR (%)Economy 1984 1990 1995 1984–90 1990–95

Asian OECDAustralia 5,851 7,787 9,200 4.9 3.4New Zealand 1,260 1,469 1,719 2.6 3.2Japan 43,959 54,528 61,000 3.7 2.3

Asian ‘tigers’Hong Kong 1,665 2,475 3,278 6.8 5.8Singapore 760 1,054 1,429 5.6 6.3South Korea 5,595 13,276 18,600 15.5 7.0Taiwan 3,947 6,301 9,175 8.1 7.8

Southeast Asia 3,290Indonesia 536 1,066 3,332 12.1 25.3Malaysia 849 1,588 1,410 11.0 16.0Philippines 505 610 3,482 3.2 18.2Thailand 519 1,325 16.9 21.3

South Asia 294Bangladesh 121 242 11,978 12.2 4.0India 2,898 5,075 2,127 9.8 18.7Pakistan 441 843 204 11.4 20.3Sri Lanka 81 121 7.0 11.0

Indo-China 147Burma 43 70 40,706 8.5 15.9(Myanmar)China 2,774 6,850 5 16.3 42.8Cambodia 5 5 20 0.0 1.6Laos 6 7 1,100 2.9 24.2North Korea 570 780 775 5.4 7.1Vietnam 70 99 5.9 51.1

Source: Derived from International Telecommunications Union data.

But something else seems equally clear — namely, that there are other ways ofmobilising capital for investment in telecommunications besides operatorliberalisation. Singapore has achieved it through state mobilisation of funds andoperator reinvestment in an increasingly prosperous economy. But, significantly,Singapore has joined the third wave of Asian liberalisation, and under the pressure ofthe WTO will open its international as well as its domestic fixed-wireline market tocompetitive entry by 2000. China and Vietnam offer other examples of countriesusing the state to redirect resources and state enterprises to mobilise capital fortelecommunications. But both have also opened their equipment markets to foreigndirect investment and used various revenue-sharing agreements involving what wemight term ‘indirect foreign investment’ in networks. These policies show up in the

Telecommunications and privatisation in Asia—257

spectacular CAGRs in the 1990s. Less dramatic have been the steady growth increasesacross South Asia — with Bangladesh being until recently an exception — reflectinga growing openness to foreign suppliers and foreign investment in this area. Theseeconomies are now part of the third wave.

On this admittedly very circumstantial evidence, it seems that the technological,regulatory and market forces which combine to drive telecommunications networkexpansion are indeed assisted by policies which open the sector to private capital, andthis applies to basic service provision — the issue facing the majority of theeconomies mentioned above — just as much as to advanced so-called ‘value-added’services. At the same time, these cases illustrate the diversity of paths towards greatersector openness, suggesting that in the case of basic service provision in particular, themobilisation of capital resources (we leave aside the important question of humanresources) can be accomplished in different countries using a different combinationof means.

CONCLUSION

Privatisation in developing Asian economies is being driven by the same overallconsiderations as anywhere else, but it has a distinctly local flavour throughout mostof the region. The separating line between state and non-state interests is not rigidand the state frequently wishes to promote local capital formation as an aspect ofnation state-building, and not infrequently as a way to build local support for theruling party, military faction or leading family. A state-sponsored ‘consensus’ is oftenthe preferred approach, especially where the local state is centralised and strong; andthe protection of existing stakeholders is therefore given high priority. In theseeconomies, development is the key issue facing governments, and the role oftelecommunications in development is paramount.

In the more developed Asian economies, the role of information is key to theirsuccessful transition to post-industrial societies, and the upgrading oftelecommunications facilities and the convergence of information technologies is ofparamount importance. Markets rather than consensus politics is the Western model,but even here Asian countries like Japan, South Korea and Singapore attempt toblend the two. Privatisation may be a precondition for the growth of a free market intelecommunications facilities and services, and for free trade-in-telecommunicationsservices now being debated in APEC, GATS and the WTO, but in Asia it remainsembedded in broader industrial, political and social aims.

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APPENDIX 11.1: WIRELINE AND WIRELESS (CELLULAR AND PCN)OPERATORS IN SOUTH AND SOUTHEAST ASIAN ECONOMIES ANDFOREIGN PARTNERS

Hong KongWireline and wireless voice

Company Foreign partner(s) Markets

HongKong Telecom Cable & Wireless (UK) Wireline, cellularHutchison Wireline, cellular,PCNNew T&T Wireline, cellularNew World Alcatel (France), TAC (Thailand) Wireline, PCNPacific Link Vodafone (UK) Cellular, PCNSmartone McCaw (US) MPT (PRC) CellularMandarin Comms. China Travel Service (PRC) PCNPeoples Telephone Co. China Resources (PRC), Unisource (US, France, Germany)PCNP Plus Comms. Telecom Finland PCN

South KoreaWireline and wireless voice

Company Foreign partner(s) Markets

Korea Telecom SOTE — partial privatisation IDD, DLD, localDacom IDD, DLDOnse IDDKorean Mobile Telecom Cellular, pagingHansoi Cellular, pagingLG Telecom Cellular, pagingShinsegi Airtouch & SW Bell (US) Cellular

SingaporeWireline and wireless voice

Company Partner(s) Markets

Singapore Telecom SOTE — partial privatisation Wireline and wirelessMobile One C&W and Hongkong Telecom Wireless

ThailandWireline and wireless voice

Company Partner(s) Markets

CAT SOTE IDD, cellularTOT SOTE Wireline and cellularTelecom Asia Nynex (US) Wireline in BangkokThai T&T NTT (Japan) Wireline outside

Bangkok

Telecommunications and privatisation in Asia—259

Company Partner(s) Markets

Advanced Info Services CellularTotal Access Comms. Cellular

IndonesiaWireline and wireless voice

Company Foreign partner(s) Markets

PT Telkom SOTE — partial privatisation WirelineIndosat SOTE — partial privatisation IDDSatelindo DeTeMobil (Deutsche Telekom) IDD and cellularExcelcomindo Nynex (US) CellularKomselindo CellularMetro Selular CellularRatelindo WLLTelkomsel Cellular

Aria West KSO 3 US West Local loop

Bukaka SingTel KSO 7 Singapore Telecom Local loop

Daya Mitra KSO 6 Cable & Wireless, AIA (Singapore) Local loopMitra Global KSO 4 NTT (Japan), Telstra (Australia) Local loopPramindo KSO 1 France Cable et Radio Local loop

PakistanWireline and wireless

Company Foreign partner(s) Markets

Pakistan Tel Company SOTE — partial listing WirelineMobilink Motorola (US) CellularPakcom/Instaphone Millicom (Bel) CellularPaktel Cable & Wireless (UK) Cellular

Sri LankaWireline and wireless

Company Foreign partner(s) Markets

Sri Lanka Telecom SOTE WirelineCallink Singapore Telecom, IFC CellularCelTel Millicom(US) CellularDialog Telekom Malaysia CellularMobitel Telstra CellularLanka Bell Trans Asia Telecom (Sing) WLLTelia Lanka Telia WLL

260 Telecommunications and privatisation in Asia

MalaysiaWireline and wireless voice

Company Partner(s) Markets

Telekom Malaysia SOTE — partial privatisation Wireline and cellularFiberail (TM/Nat.Rail) DLD and local loopBinariang US West Wireline and cellularMutiara Tel Swiss PTT Wireline and PCNSyarikat Telefon Wireless IWC (US) DLD and local loopTime Telecom WirelineTRI/Celcom Deutsche Telekom Wireline and cellularMRCB Tel PCNMobikom CellularTime Telecom/Sapura PCN

PhilippinesWireline and wireless voice

Company Foreign partner(s) Markets

PDLT Wireline and wirelessBayantel/ICC Nynex (US), Telecom Asia (Thailand) WirelineDigital Telia (Australia) WirelineEastern Cable & Wireless (UK) WirelineExtelcom Millicom (US) Wireline and wirelessGlobe GMCR Singapore Telecom Wireline and wireless

Islacom Deutsche Telekom, Shinawatra Wireline and wireless(Thailand)

PT&T/Capwire Retelcom (South Korea) WirelinePiltel AIG (US) Wireline and wirelessSmart First Pacific (Hongkong), NTT Wireline and wireless

(Japan)Philcom Comsat (US) Wireline

IndiaLocal loop

Company Foreign partner(s) Areas

Mahanagar Telephone SOTE — partial privatisation 2Nigam LtdBharti Telenet 1

Essar Communication Bell Atlantic lHFCL–Bezeq Shinawatra 4Hughes Ispat Nippon Denro, Hughes,

Alltel (US) 1Reliance Nynex 1

Telecommunications and privatisation in Asia—261

Company Foreign partner(s) Areas

Tata Bell Canada 1Techno Telecom Moscow Tele Network 1Telelink Network Harris; Guangdong PTA 1

Cellular

Company Foreign partner(s) Areas

Aircell Digilink Swiss PTT 4

Bharti Cellular STET (Italy) 3Birla Comms AT&T (US) 2BPL Mobile France Telecom 0.1BPL Mobile US West 3CCIL Cellular Airtouch (US) 1

Escotel First Pacific (Hong Kong) 3Essar/Sterling Swiss PTT 1Fascel Kotak (Finland), Shinawatra (Thailand) 2HCL Singapore Telecom 0.1Hexacom PCM Partnership (US) 2Hutchison Max Hutchison (Hong Kong) 1JT Mobile Telia (Sweden), TOT & Jasmine (Thailand) 3Koshika Piltel (Philippines) 3Modi Telstra Telstra (Australia), Telecom Asia (Thailand) 1Modicom Motorola (US) 2Reliance Nynex (US) 7RPG Cellular Comms Airtouch (US) 1Skycell Bell South (US), Millicom (US) 1Tata Bell Canada 1Usha Martin Telekom Malaysia 1

Sources: Ure (1995); Jardine Fleming (1996); Office of Telecommunications Authority— see ‘http:// www.ofta.gov.hk’.

NOTES

The original version of this revised study appears in D. J. Ryan (ed.) Privatisation andCompetition in Telecommunications (1997) and is reproduced (with some minor editing) withthe kind permission of the Greenwood Publishing Group, Westport, United States.1 Nor is it simply a process of shifting the balance between the state and private capital as

if these were always separate entities since the beneficiaries of privatisation may well bethe former holders of state power — something not uncommon in Eastern Europe.

2 The PLDT was founded in 1928 under American management, eventually coming underthe ownership of the General Telephone & Electronics Corporation (GTE) in 1956. In1967, in a deal for which he was subsequently indicted by the US Securities andExchange Commission (SEC) (see Manapat 1993), control passed to a local groupheaded by Ramon Cojuangco, a close associate of President Marcos. Hongkong Telecom(HKT) is a holding company of Cable & Wireless plc. (UK, which in 1995 held 57.5per cent of HKT shares, with the China International Trust & Investment Corporation(CITIC) owning a further 10 per cent through its subsidiary CITIC Pacific. HKT owns100 per cent of the Hong Kong dominant domestic carrier, the Hong Kong Telephone

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Company (HKTC); the Hong Kong international carrier, Hongkong TelecomInternational (HKTI); and CSL, which operates cellular, paging and value-added servicesthroughout the territory, and roaming services.

3 For a thorough discussion of IPO procedures and methods of placing an initial valueupon the shares of a SOTE, see the analysis of the IPO of Nippon Telegraph andTelephone (NTT) in Japan.

4 The principle shareholder in China’s new entrants, Lian Tong (Unicom) and Ji Tong, isthe Ministry of Electronic Industries, together with the Ministries of Railways andElectric Power and several state enterprises — for example, the China International Trustand Investment Corporation (CITIC). The Ministry of Defence is also involved inwireless communications through the People Liberation Army (PLA). Many ministriesrun their own private networks. In Vietnam the Ministry of Defence has set up an ArmyTelecommunications Company (ATC) to offer services where the public network is notavailable.

5 NTT was privatised in 1985. According to Naoe (1994), the Nakasone governmentborrowed ideas from both the Reagan and Thatcher administrations.

6 Mrs Thatcher took no risks. Immediately prior to privatisation, the Hong Konggovernment obligingly extended the exclusive operating licence of Hongkong TelecomInternational (HKTI) to the year 2006. HKTI was generating around 70 per cent of therevenues and profits of Cable & Wireless.

7 The first case is Huamei, a 50–50 joint venture between two American companies —SC&M International, comprising a Chicago investment bank and BrooksTelecommunications, a St. Louis-based builder of advanced telecommunicationsnetworks and Galaxy New Technology, a company controlled by COSTIND, themanufacturing, research and development arm of the PLA and the key agency overseeingChina’s aggressive defence conversion effort. The Ministry of Posts andTelecommunications (MPT) and the Ministry of Electronics (MEI) hold small stakes inGalaxy. Huamei (which means ‘China America’ in Mandarin) has built a US$7 millionprototype, state-of-the-art broadband network in Guangzhou. The second case is that ofFirst Star, a joint venture between Singapore Telecom (35 per cent) and subsidiaries ofthe MPT and the Beijing Municipal Government (as the principal local shareholders).Small stakes are held by the Hong Kong-listed ING Beijing Investment Company andAsia Pacific (China) Electrical Company. First Star is to build a nationwide pagingnetwork (see Telecommunications and Infotechnology Forum 1995).

8 For a discussion of telecommunications policy across Asia in this context, see Ure (1995,Chs 2 and 3).

9 However, the Malaysian government was encouraged also by the lobbying of localcompanies eager to enter the industry. Jomo (1994, p. 277) — referencing Kennedy(1991) — records that in 1983 Sapura Holdings, now a private telecommunicationsoperator, commissioned a study by Arthur D. Little entitled ‘The Advantages andFeasibility of Privatizing Jatan Telekom Malaysia’.

10 Deregulation includes moves to free up the use of equipment by non-dominant operatorsand subscribers, the right to install private networks and to by-pass public networks, theright to offer a range of services and a range of tariffs without having to seekauthorisation from the regulator, and so on. Liberalisation refers to the opening ofmarkets to new entrants. Often liberalisation requires a degree of reregulation to ensurefair and free competition, such as the requirement to interconnect, bans ondiscriminatory or predatory pricing, revenue-sharing arrangements, and so on.

11 In the Pacific Islands (Fiji, Kiribati, Micronesia, Papua New Guinea, the SolomonIslands, Tonga, Vanuatu and Western Samoa — ex-colonies or protectorates), thenetworks are largely foreign controlled or operated.

12 In December 1995 the PLDT made its first announcement of staff reductions, at a timewhen it is aggressively expanding its build-out plans to fend off competition from thenew entrants.

13 Also see Ure (1995) for references.

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REFERENCES

Harrington, Andrew (1995) ‘Companies and capital in Asia–Pacific telecommunications’, inJ. Ure (ed.) Telecommunications in Asia: Policy, Planning and Development, Hong Kong:Hong Kong University Press.

Hukill, Mark (1994) ‘The privatisation and regulation of Singapore Telecom’, TelecomJournal 6(3) (July), pp. 26–30.

International Finance Corporation (1995) Privatization: Principles and Practice — Lessons ofExperience Series, Washington DC: World Bank (September).

International Telecommunications Union (ITU) (1995a) World TelecommunicationDevelopment Report, Geneva: ITU.— (1995b) Asia Pacific Telecommunications Indicators, Geneva: ITU.

Jardine Fleming (1996) The Asian Telecoms de-Regulators, Hong Kong: Jardine FlemingSecurities Ltd.

Jomo, K. S. (ed.) (1994) Malaysia Economy in the Nineties, Petaling Jaya: PelandukPublishers.

Kennedy, L. (1991)‘Liberalization, privatization and the politics of patronage’, Paperpresented at the Fourth Annual Conference, International Communications Association,Chicago.

Krzywicki, John (1994) ‘Operator privatisation versus other (better) methods of restructuringin developing Asia–Pacific countries’, Paper presented at the Pacific TelecommunicationsConference, Hawaii, pp. 116–18.

Manapat, Ricardo (1993) Wrong Number: The PLDT Telephone Monopoly, Madrid: Parquedel Buen Retiro.

Naoe, Shigehiko (1994) ‘Japan telecommunications industry: competition and regulatoryreform’, Telecommunications Policy 18(8), pp. 651–7.

Petrazzini, Ben (1995) The Political Economy of Telecommunications Reform in DevelopingCountries: Privatization and Liberalization in Comparative Perspective, Connecticut:Praeger.

Petrazzini, Ben and Theodore Clark (1996) ‘Costs and benefits of telecommunicationsliberalization in developing countries’, Paper presented at the Institute for InternationalEconomics Conference on Liberalisation of Telecommunications Services, WashingtonDC, 29 January.

Smith, Peter and Gregory Staple (1994) ‘Telecommunications sector reform in Asia: toward anew pragmatism’, World Bank Discussion Paper No. 232, Washington DC (January).

Takano, Yoshiro (1992) ‘Nippon Telegraph and Telephone privatisation study: experience ofJapan and lessons for developing countries’, World Bank Discussion Paper No. 179,Washington DC.

Telecommunications and InfoTechnology Forum (1995) ‘Joint ventures in China Telecoms:background briefing paper’, Presented to the Telecommunications and InfoTechnologyForum (Telecommunications Research Project), Centre of Asian Studies, University ofHong Kong, Hong Kong (January).

Ure, John (1995) Telecommunications in Asia: Policy, Planning and Development, Hong Kong:Hong Kong University Press.

Wellenius, Bjorn, Peter Stern, Timothy Nulty and Richard Stern (1989) Restructuring andManaging the Telecommunications Sector, Washington DC: World Bank.

World Bank (1992) Welfare Consequences of Selling Public Enterprises: Case Studies from Chile,Malaysia, Mexico and the UK, Washington DC: World Bank.

12 Japan’s air transport policy at a crossroad

Ushio Chujoh and Hirotaka Yamauchi

The Japanese government is currently the target of much criticism in relation to itsderegulation policies. It is widely recognised that deregulation is required to revitalisethe Japanese economy and keep it internationally competitive. Actual deregulation is,however, in its infancy. The government has been very slow to implement policychanges, especially in the transport sector, despite popular support for deregulation.

Transport policies in Japan are very conservative. Entry and pricing have beenregulated tightly in almost all transport areas, making for highly restrictedcompetition among carriers (the one exception being the trucking industry, which hasenjoyed some pro-competition policies).

Air transport policy is typical of the conservatism of the Japanese government. Airtransport has been severely regulated by the Ministry of Transport (MOT), which hasfailed to respond to the trend worldwide to deregulate airline industries, to promotecompetition both in domestic and international markets in order to make airlinesmore efficient and to provide consumers with more benefits.

While protection of the Japanese air transport industry at the expense of theconsumer was acceptable policy in the 1970s, severe international competition in airtransport in the 1980s and 1990s means that Japanese air transport policies are nowoutmoded.

There is hope, however, in the current strong movement towards administrativereform, following findings that a new zone-fare system which was introduced in thedomestic air transport market in June 1996 would make the market uncompetitive.There are now plans to set up new airlines to challenge the stiff domestic market. Thisis receiving much public applause. While MOT may lift entry controls on allpassenger transport sectors subject to approval by the Administrative ReformCommittee, which is in charge of promoting deregulation under the Prime Minister,such measures will likely come too late, however, to permit Japan to approach worldderegulation standards.

The purpose of this chapter is to survey and evaluate air transport policy in Japan.After a brief look at the industry and its regulatory system, the chapter investigates

Japan’s air transport policy at a crossroad—265

the history of Japanese air transport policy, followed by an examination of the effectsof policy changes over the last decade. International aspects of air transport policy arethen discussed, followed in the concluding section by an assessment of current policy.

MARKET STRUCTURE

The air transport market in Japan is fairly large if one takes into account the size ofthe country. Total revenue per passenger kilometres in the domestic market stood at61 billion in 1994, one-tenth the size of that recorded in the United States. Japanesedomestic routes serviced a total of 75 million passengers, one-sixth that of the USdomestic market.

The biggest airline, Japan Airlines (JAL), had a revenue-per-passenger-kilometre totalof 63 billion across its domestic and international markets in 1994, which was a halfor one-third that of the American mega-airlines. The second carrier, All NipponAirways (ANA), had a revenue-per-passenger-kilometre total of about 39 billion, andthe third carrier, Japan Air Systems (JAS), had a total of about 11 billion. Besides thethree big carriers, there are six scheduled airlines, two of which — Japan Asia Airlines(JAA) and Nippon Cargo Airways (NCA) — offer only international services. AirNippon (ANK), Japan Trans-Ocean Airlines (JTA), Japan Air Commuter (JAC) andAir Hokkaido (AH) service mainly domestic regional and local routes. These carriersare all under the control of the three big airlines. There are also several commuterclass airlines serving the islands and limited intercity routes.

REGULATORY SYSTEM

Japanese air transport markets have developed in a strictly regulated environment.Japan’s Civil Aviation Law, which governs the air transport industry, requires that afirm obtain a licence to enter the market. Airlines also need government approval toadjust their fares, and even for their annual business plans.

Naturally, flying international routes also requires government-negotiated bilateralagreements with other countries. Japan has been a traditionalist in the internationalfield too, with aviation agreements with other countries generally being modelled onthe old Bermuda agreement.

The old regime

At the end of the Second World War, commercial aviation in Japan was banned bythe Allied Forces, and it was only in 1951 that Japanese airlines were allowed torecommence services. The oldest airline, JAL, was founded as a private company inthat year. The company was reorganised in 1953 so as to strengthen its internationalcompetitiveness, following which it became a quasi-governmental company.

266 Japan’s air transport policy at a crossroad

Also in 1953 two domestic carriers were founded and commenced services. The twocompanies eventually suffered financial hardship and were merged, giving birth in1958 to ANA in what was the first step in industrial consolidation of aviation by thegovernment.

Following JAL and ANA, six regional carriers were founded in the late 1950s. Thesecarriers also suffered financially, with some being merged into ANA. Two of them,however — Japan Domestic Airways (JDA) and Toa Airways (TA) — survived untilthe end of the 1960s. In the latter half of the 1960s, JDA and TA entered intocooperative arrangements with ANA and JAL, respectively. It was expected that eachcompany would merge with its partner. This prediction was never realised, however,because the Cabinet Meeting Resolution Concerning Airline Operations in 1970suggested that JDA and TA merge into one company, Toa Domestic Airways (TDA),and that commercial aviation in Japan be operated by the three big companies andtheir associates — JAL, ANA and TDA.

The Japanese government chose a system comprising three airlines rather than two,for a couple of reasons. First, air transport demand was growing very quickly at thetime, and it was agreed that a third airline was an absolute necessity. Second, therewas a strong corporate pressure on government to establish a third airline, leading tochanges in government policy. Either way, the birth of the TDA represented thesecond stage of industrial consolidation under government initiative.

The government not only initiated a policy of consolidation, it also introduced aregulatory mechanism. In 1972 it released a ‘Notice Regarding Airline Operations’,which handed international business and domestic trunk routes to JAL, short-distance international charters and domestic operations to ANA, and domesticregional and some trunk services to TDA.

The intention of this policy was to stabilise business conditions among the threecompanies. Government understanding at the time was that Japan’s airline businesswas in its infancy and could not hope to survive in a competitive environment. Sincethe only lucrative market was comprised of domestic trunk routes(Sapporo–Tokyo–Osaka–Fukuoka–Naha), the issue of whether or not carriers couldobtain licences to operate on the trunk routes was a crucial factor for business. The1970 Cabinet resolution consolidated two rather small companies into one relativelylarge company and made economies of scale possible. TDA was able, as a result, tooffer full services on large trunk routes, with the earnings it derived from these trunkroutes compensating for the regional services deficit. The same held for the other twoairlines. JAL was able to compensate for losses incurred on international services,while ANA was able to cross-subsidise losses on domestic local routes with the surplusderived from trunk routes.

In a sense, the consolidation of small companies into one large one was consistentwith general Japanese industrial policies at that time. For example, in the ironindustry, Nihon Steel Co. and Yahata Steel Co. merged to produce Shin-Nihon Steel

Japan’s air transport policy at a crossroad—267

Co. The automobile manufacturing industry also witnessed a number of mergers andacquisitions in this period.

The main aim of such mergers and acquisitions was to strengthen the internationalcompetitiveness of these industries. On this point, there were some differencesbetween the policies developed for these industries and air transport policy, especiallyin the early 1970s, with the latter emphasising the infant industry aspect more thaninternational competitiveness as such.

The 1970 Cabinet meeting resolution and the ‘Notice from the Minister ofTransport’, which had fixed the basic market structure of the Japanese airline industryin the 1970s, were referred to jointly as the ‘aviation constitution’. The old regimeunder this aviation constitution was intended to secure and nurture the capacity ofall members of the air transport industry by providing a segmented business field foreach firm. This segmentation of the market was also a common feature of Japaneseindustrial policy between the 1950s and the early 1970s.

The old regime survived until the mid-1980s, with all three airline companiesgrowing steadily around the arranged business base. The air transport market as awhole and the network routes grew quickly, in association with the rapid growth ofthe Japanese economy. The role of government intervention in the protection ofinfant industry was a valuable one up until this stage.

Such cartel-oriented government policies, however, meant that airlines incurred hugecosts, as a result of the suppression of competition. Worst of all, the governmentcontinued with such policy even after the industry outgrew its ‘infancy’.

Policy changes in the last decade

The old air transport regime finally collapsed in the mid-1980s, the trigger being theInterim Agreement of the Japan–US Aviation Treaty of 1985 and the signing of itsMemorandum of Understanding. While the Japanese government in the 1970s wasonly willing to permit one international scheduled carrier — namely, JAL — therewas growing opinion that another cargo carrier should be admitted to meet rapidlygrowing international air cargo demand. When a new cargo airline — Nippon CargoAirways (NCA) — was later formed, it applied for a licence to operate in the NorthPacific. The government only granted the licence after controversial discussions andnegotiations with the US government. The Interim Agreement of 1985 was the resultof these negotiations.

The Interim Agreement also allowed other new carriers — both Japanese andAmerican — to start scheduled passenger services, leading to an end to JAL’smonopoly on international scheduled services. Meanwhile, as calls for theliberalisation of the Japanese domestic air industry became louder, the Council forTransport Policy — an official advisory committee to the transport minister —recommended that the ‘aviation constitution’ be abolished and that international

268 Japan’s air transport policy at a crossroad

scheduled services be served by plural carriers; that competition on domestic routesbe promoted by new allowing other airlines to enter certain paired city markets; andthat JAL be completely privatised.

After receiving these recommendations, the Japanese government issued a Cabinetmeeting resolution abolishing the old regime. With respect to domestic competition,the Council for Transport Policy argued that the American style of deregulation didnot suit Japanese circumstances because of the limited capacity of Tokyo International(Haneda) Airport and Osaka International (Itami) Airport and because of thedifferent degrees of competitiveness among the Japanese airlines deriving from pastpolicy. While airport congestion tends to impede fair competition everywhere, thelegacy of different degrees of competitiveness among Japanese airlines smacked ofpaternalistic government policy.

Under the criteria established by the government whereby several carriers could enterinto a paired city market, three companies were able to offer services on a routeservicing more than one million passengers annually, and two companies were able toservice a route carrying more than 700,000 passengers. These criteria have graduallybeen relaxed since then.

The government’s control of fare approval and entry licensing basically remainedunchanged. Even in cases where the above criteria were met, MOT sometimesrejected new entrants. MOT also controlled (and still controls) the number of flightsmade by each airline per route.

Zone-fare system

In response to criticism that its policy changes were minimal, the governmentadopted a setup to make it easier for airlines to offer discounted fares. However,following strong calls for further liberalisation of air fares by the general public, thegovernment adopted a zone-fare system in June 1996.

This system, which is almost the same as that adopted by the European Commissionbefore it implemented its third package of common air transport policy in 1993,involves establishing a fixed price range that allows carriers to set their air fares withinthat range at their own discretion. For example, while in peak travel periods carrierscan set relatively high prices, they are able to offer promotional fares during off-peakperiods. Needless to say, this allows carriers to respond to periods of varying demandwith a flexible fare structure, characterised by all types of discount fares, includingadvance purchase fares.

The upper limit of the permitted fare zone is initially calculated on the basis of theairlines’ actual costs. The lower end of the range is set at 25 per cent less than theupper limit. This range is for normal fares. The carrier can set discount fares at amaximum of 50 per cent below the lower limit. In theory, the lowest a discount fare

Japan’s air transport policy at a crossroad—269

could be set at is 62.5 per cent of the upper limit, though it is unlikely that an airlinewould do so.

While the new scheme allows for a more diverse range of fares, and lower fares,everything depends on the effectiveness of competition in each market. Again, thecrucial point is barriers to new entrants. MOT continues to wield authority overroute licences, which means the air transport market in Japan is still highly regulated.A second barrier is the limited capacity of Haneda Airport. (Airport limitations in theOsaka area disappeared after completion of Kansai International Airport.) Hanedagenerates the biggest profits for domestic carriers and any restriction on the numberof landing slots poses a serious obstacle to new market entry.

The allocation of landing slots is also under the control of MOT. There has been awidespread outcry over the lack of transparency in MOT’s decision-making processes.The Administrative Reform Committee, for instance, insists that the decision-makingprocess be based on an open and visible bidding system, or be determined by pricemechanisms such as peak-load pricing. However, MOT argues that the biddingsystem and other market-oriented allocation mechanisms would benefit those carrierswith the greatest current market share and capital reserves, and would only increasemarket differentials among the competing carriers.

Changes in the market structure

Under the old regime, ANA enjoyed a huge share of the domestic market. This share,however, has gradually declined since the policy changes introduced in 1986. AsFigure 12.1 shows, ANA’s share in 1985 was 57.4 per cent, dropping to 47.2 per centin 1994. It should be noted that ANA’s competitors have not increased their sharesdramatically: JAL and JAS raised their shares from 23.3 per cent to 26.7 per cent and17.2 per cent to 19.9 per cent, respectively. At the same time, however, Air Nippon,a subsidiary of ANA, increased its share by 2.5 percentage points. ANA hastransferred its non-profitable routes to its subsidiary. Examination of the overallpicture leads to the conclusion that the policies adopted in the mid-1980s have notled to any radical changes in market structure.

Some of the reasons ANA has lost little of its share relate to its strong sales networkand brand loyalty in the domestic market, which were nurtured under the ‘oldregime’. In particular, the fact that fare competition was banned until very recentlymeant that new competitors had no effective means to fight an incumbent carrier likeANA.

Another reason shares did not change greatly is associated with airport capacitylimitations. As stated earlier, landing slots at Tokyo’s Haneda airport were restricted,though an expansion project is now under way to rectify this. In such a situation, anincumbent carrier like ANA with a lot of slots at Haneda has enjoyed a competitiveedge over other carriers.

270 Japan’s air transport policy at a crossroad

Figure 12.1 Comparison of shares in the domestic airline market

There is also the matter of passengers in paired city markets in which two or threeairlines are offering services. Figure 12.2 shows percentage changes to passengernumbers by market type: by single, double and triple designation. As a result of policychanges, passenger rates on multiple routes have increased steadily, reaching 72 percent in 1994. In a sense, this means that a majority of passengers could choose carrierson the basis of differences in service or prices. However, as stated above, as carrierswere not granted flexibility in fare setting, passengers on a route flying two or moreairlines have been unable to enjoy the benefits of competition.

Figure 12.2 Passenger numbers by market type, 1986–94

1986 1987 1988 1989 1990 1991 1992 1993 1994

Triple track routes

Double track routes

Single track routes

100%

80%

60%

40%

20%

0%

1994

1984

ANA JAL JAS JTA ANK JAC

0 20 40 60 80 100

Japan’s air transport policy at a crossroad—271

As for the zone-fare system introduced in the domestic market in June 1996, it is stilltoo early to evaluate the effects of the system. Early indications suggest, however, thatconsumers expectations are not being realised, with the carriers’ fares under the newsystem being almost the same; indeed, many fares have actually risen. For example,the ¥43,100 (US$399) round trip fare for the Tokyo–Sapporo route—which, withmore than 7.5 million passengers annually makes it the highest volume route in theworld—rose by between ¥5,400 and ¥6,600 (US$50–$60) (the rates of increasebeing dependent on carriers and periods of use). In addition, since the carriersabolished unrestricted discount fares for round trips, there have been significant pricerises.

INTERNATIONAL AIR TRANSPORT POLICY

International air transport is, in general, carried out on the basis of bilateralagreements that reflect the reciprocal rights and interests of each country. As oftenpointed out, each country’s insistence on its rights and interests in the bilateral systemmeans that negotiations tend to result in lower traffic levels. This is because a countrythat has relatively competitive airlines will try to protect its own industry.

The role of the powerful international cartel that was initiated by the InternationalAir Transport Association (IATA) to ‘stabilise’ international air fares and avoid‘substantial’ competition has mostly shifted to non-cartel cooperative functions suchas providing a debt and credit clearing house. As a result, the degree of competitionin the international market is dependent on bilateral agreements, especially capacitycontrol clauses. While it is true that IATA itself still exists and that IATA trafficconferences are still held regularly to set fares by route, IATA’s ability to tame thecompetition has been reduced.

The conservatism of the Japanese government has been particularly resistant tointernational aviation negotiations. Its basic stance is to protect the Japanese airlineindustry. Something of a turning point in air transport policy came about in 1986,however, when the Transport Policy Consultative Council submitted a report chartinga new direction for aviation policy in Japan.

The report recommended, with respect to international aviation, that multipledesignations be adopted in international markets on a reciprocal basis. Thisrecommendation served to ratify a provisional agreement made in the previous yearpermitting new Japanese and US carriers. ANA and JAS were allowed to commenceUS–Japan services under the agreement, as were, on the tourism side, United Airlines,American Airlines and Delta Airlines.

While not especially liberal, in as much as it did not give carriers much freedom inrelation to capacity or price setting, the agreement did trigger a change in Japaneseinternational air transport policy and provided a starting point for relaxation of the

272 Japan’s air transport policy at a crossroad

conditions on new entry and capacity expansion — with other countries as well aswith the United States.

The reason the Japan–US provisional agreement was less than liberal was due to theJapanese government’s insistence that it was unequal from the viewpoint of Japaneseairlines and that it hampered fair competition between the two countries’ airlines.The Japanese government argued that: first, US carriers have unlimited fifth freedomrights beyond Japan, unlike the Japanese; second, the United States has more ‘fullright carriers’ than Japan (with full right carriers being able to increase or decreasecapacity without advance notice); third, capacity provided by the Americans is muchlarger than that for Japan; and, fourth, as a result of the above imbalance, US carriersget to enjoy a much greater market share than Japanese carriers.

It must be said, however, that not all of these assertions stand up to closeexamination. As far as the imbalance in capacity share and market share is concerned,one cause relates to the failure of Japanese carriers to expand their capacity. It is truethat some inequality exists in ‘beyond rights’ between the two countries, but it isworthwhile noting that these rights are less attractive for Japanese carriers than for UScarriers.

Generally speaking, criticism of Japanese international aviation policy by foreigncountries tends to focus on the difficulties of entering the Japanese market andincreasing capacity. These complaints are thought to stem partly from congestion atJapanese airports (Narita) but also from the conservatism of Japanese policy itself.

The process of negotiation between Japan and the United States illustrates the pointthat it is not easy to liberalise international air transport through bilateral agreements.In order to conclude such agreements, it helps if the interests of each countrycoincide; otherwise, substantial concessions are required by one or the other country.In the case of the US–Netherlands liberal agreement concluded in the summer of1992, the United States hoped to extend the symbolic effects of this agreement toother European countries. The Netherlands made use of these negotiations tostrengthen the global alliance between KLM and Northwest Airlines.

EVALUATION OF JAPAN’S CURRENT AIR TRANSPORT POLICIES

In the following discussion, we assess the Japanese air transport and the new priceregulatory system introduced into the domestic market in 1996 and then evaluateJapan’s current international policy.

Domestic policy

Under the zone-fare system introduced into the Japanese domestic market in 1986,the MOT approves various fares within certain fare zones while air fares for the same

Japan’s air transport policy at a crossroad—273

route are regulated exactly the same as under the previous system. Thus pricing is nowallowed to respond to market conditions, and price competition is permitted.

The new fare system has been condemned on a number of fronts — for example, itresulted in fare increases as most normal fares have actually risen following itsintroduction. However, such criticism misses the point. Normal fares represent themost expensive fares that airlines are allowed to set. Comparison of the new andprevious fare regulatory systems, to be just, needs to be based on real average prices,including normal and discount fares. As domestic air fares in the United Statesdemonstrate, when deregulation is thorough and competition is intense, variousprices can be offered that respond to different segments of a market, the result beingincreased variance of prices. Criticism that the new fare system has led to fareincreases is as misleading as criticism that the deregulated market in the United Statesimposes higher fares than the Japanese market in the context of normal fares.

The new fare system does have its advantages. For instance, it introduces transparencyin pricing to the market. Under the old system, discount fares were available only toinclusive-tour (IT) groups. ‘Illegal’ sale of discounted group fares to individualpassengers was a common practice, however. The boom in advanced purchasediscount fares for individual travellers following the introduction of the new faresystem replaces the ‘illegal’ discounting practices under the old system. The newsystem also allows airlines to set differential fares according to the price elasticity ofthe market — a positive feature that was absent under the old regime.

But all of this depends on continuing restrictions on market entry. If the currentJapanese situation is evaluated by the standards of competition prevailing in theUnited States or the European Union, we can only conclude that Japanese policy isstill too restrictive. Judging from six-months’ experience, average revenue-per-passenger-kilometres have decreased by only 1.1–4.0 per cent, which shows that thenew system may not be able to lower average air fares by more than 20 to 30 per centeven if Japanese carriers engage in more aggressive discounting.

The reason for this is that deregulation has been limited to price control. Unlessmarket entry control is deregulated, there is little pressure on Japanese airlines toabandon their traditional market strategy and become pro-competitive. The ‘uniformmentality’ of the Japanese airline, whereby they wait for ANA, which has the largestmarket share, to set the price, and then follow suit (though never departing by morethan a few hundred yen from ANA’s fares) has attracted considerable criticism. Suchbehaviour is to be expected, however, given the conditions of rigid regulation oncapacity and market entry. If an airline engaged in aggressive pricing in such a market,it would not achieve an increased share of profits, since it would not be able tocompensate for the fare decreases with an increase in routes or capacity. Thus it is onlynatural for the airlines to maintain the market status quo.

Fundamental deregulation of supply and entry is necessary, therefore, to change thismentality. To avoid criticism of the new zone-fare system, MOT lowered the so-called

274 Japan’s air transport policy at a crossroad

‘double-designation’ and ‘triple-designation’ criteria. But liberalisation of thesecriteria may not achieve much since the introduction of the new fare system does notpromote competition on routes already being serviced by multiple airlines. Completefreedom to choose routes and a free hand to determine capacity are needed.

MOT insists that capacity constraints caused by a shortage of landing slots at Tokyo’sHaneda airport may not allow for immediate and complete deregulation of supplyand entry. However, deregulation is possible for routes that do not fly in or out ofHaneda. Competition may be intensified on those routes and may no longer sustainthe traditional management strategies of Japan’s airlines. It may even induce morecompetition in the market serving Haneda.

For routes serving Haneda, another effective way to introduce competition may be toauction landing slots at the airport. MOT has shown a preference for granting slotsat Haneda to ‘less incumbent carriers’ (by MOT’s standards) in the domestic market,such as JAL or JAS. However, preferential treatment for late-comers merelyredistributes rents if it is not accompanied by improvements in efficiency among theairlines.

Moreover, ‘less incumbent carriers’ are already incumbents by any set of standards. Asalready mentioned, the management strategies employed by the three establishedcarriers are bound by tradition. In the same way that a caged bird may forget how tofly, these traditional carriers may have lost the ability to implement bold strategies.Radical measures by new entrants may be necessary to bring competition to themarket.

A quick and effective solution may be to encourage new airlines with radicalmarketing concepts to enter the market. Following deregulation in the United States,for example, entry into the market by so-called ‘new airlines’ revitalised that market.In the trans-Atlantic market, Virgin Atlantic Airways introduced an innovativemarketing approach to the traditional airline industry. These new players and theirdifferent approaches stimulated the market and led to improved productivity andmarketing innovations among traditional airlines also.

One such approach in the Japanese case would be to allow foreign airlines to serveJapan’s domestic routes. One of the authors of this chapter has been pushing the linethat if MOT were to liberalise market entry, Japanese entrepreneurs would set up newairlines — which in fact is what has happened. In November 1996 two provisionalcompanies were formed to set up airlines, with one of these companies immediatelyannouncing that it would attempt to cut current prices in half.

One of the problems of Japan’s current liberalisation policy is the incompleteness ofthe deregulation process, as demonstrated by the zone-fare system. Deregulation, if itis not thorough, will not result in effective competition in the market. To createeffective market competition in Japan would demand that each item in the Japanesegovernment’s Three-Year Deregulation Plan received detailed review. Critical of such

Japan’s air transport policy at a crossroad—275

partial liberalisation, the Administrative Reform Committee in charge of promotingderegulation under the Prime Minister recommended in December 1996 that MOTabolish entry and capacity control and introduce a bidding system at Haneda airport,where vested interests on the slots hamper competition. Encouragement of innovativeentrants and implementation of the recommendations of the Administrative ReformCommittee could bring real competition into the Japanese airline market.

But it is not only the government and the airlines that have shown limitedimplementation of deregulation; so too has the Japanese public. Japanese consumerscriticised the abolition of round trip discount fares and fare increases during peaktravel periods — in their mind, deregulation was synonymous with automatic pricedecreases. They have failed to understand that the significance of deregulation lies inchange to the price formation process; that it involves replacing a government-controlled centralised price mechanism with a decentralised, market-based pricesystem.

Given that Japanese carriers have now ‘grown up’, though not without considerableeconomic cost as a consequence of the government’s long-held paternalistic stance, itshould be clear to MOT that it is market forces that encourage efficiency and thatpromoting effective competition among Japan’s carriers will result in substantialbenefits to Japanese consumers.

International policy

In the international market, Japan has long been a traditionalist, despite considerablecriticism from the United States and from Japanese consumers themselves. That Japanseeks to protect its aviation rights while its neighbours go about pursuing liberal airtransport agreements is absurd.

Some critics have suggested that a multilateral agreement or treaty would provide abetter scheme for institutional change that would lead to a more liberal environmentin international air transport. In a multilateral setting, it would be possible to reachunified standards for regulatory procedures, and regulatory processes would becomemore transparent too. These in turn would contribute to liberalisation. The USgovernment has been a proponent of multilateral agreements at a number of forums.

Several multilateral agreements in international aviation are already in existence. TheChicago Convention of 1944 provided the starting point for an international aviationsystem so far as interests other than economic traffic rights are concerned.

In 1980 the United States and the European Civil Aviation Conference (ECAC)signed a Memorandum of Understanding on fare-setting rules. Since the ECAC is therepresentative organisation for aviation departments in Europe, the Memorandumrepresented the first multilateral agreement to be reached on the economic aspects ofair transport. In 1992 the EC Council of Transport Ministers adopted the third

276 Japan’s air transport policy at a crossroad

component of a common air transport market package — in essence, a typicalmultilateral agreement that seeks to liberalise international aviation.

Multilateral schemes would appear to be the ideal means for liberalisation anddevelopment of international air transport. It should be noted, however, thatconsiderable difficulties accompany attempts to formulate multilateral frameworks.For example, individual countries are not acceptable as promoters of multilateralagreements given the keen conflicts of interest that can arise. Even amongorganisations like the International Civil Aviation Organisation, it is difficult to winsufficient approval for the adoption of multilateral approaches. And whilemultilateral agreements are clearly the right way to go about liberalising internationalaviation, they involve considerably long periods of time to achieve. The Japanesegovernment would do well to seize the day and make vigorous efforts to promote aliberal multilateral airline agreement — a move that would also lead to much neededstrengthening of the domestic economy.

13 Power sector reform in MalaysiaPrivatisation and regulation

G. Naidu

The Malaysian power sector consists of three separate systems, each covering aconstituent part of the country. Electricity supply in Peninsular Malaysia is theresponsibility of Tenaga Nasional Berhad (Tenaga), while in the two easternMalaysian states of Sabah and Sarawak, the provision of power is the responsibility ofthe Sabah Electricity Board and the Sarawak Electricity Corporation, respectively.Prior to the implementation of a government reform programme, power in Malaysiawas provided by these three integrated utilities, each a monopoly in its respective areaof jurisdiction.

Since 1990 there have been some changes in the way Malaysia’s power sector isorganised. Reform of the sector has taken two main forms. First, Tenaga NasionalBerhad, the integrated power utility in Peninsular Malaysia, has been privatised, and,second, the government has allowed private sector participation in some spheres ofthe power industry, most notably in power generation. The structural change in thepower sector market as a result of both the privatisation of Tenaga and private sectorparticipation in generation has also brought about a new set of regulatoryarrangements. This chapter provides a broad review of Malaysia’s power sector reformprogramme. The chapter also discusses the rationale and regulatory implications ofthe ongoing reform of Malaysia’s power sector. Malaysia’s liberalisation of its powersector is by no means unique; many other countries in Asia and elsewhere have alsointroduced private sector participation and competition in their power sector and insome cases much more extensively than Malaysia has. Malaysia’s experiencenevertheless brings out the main regulatory issues associated with reform of the powersector.

The liberalisation of Malaysia’s power sector has been largely instituted in PeninsularMalaysia. The power sectors of Sabah and Sarawak have yet to see any substantivereform initiatives, although some private sector involvement in power generation hasbeen sanctioned. For this reason, and others, the discussion in this chapter is confinedto the reforms in Peninsular Malaysia’s power sector.

278 Power sector reform in Malaysia: privatisation and regulation

PENINSULAR MALAYSIA’S POWER SECTOR: AN OVERVIEW

In order to provide a brief background of Peninsular Malaysia’s power sector, thissection summarises the main points of the sector’s growth and development. (A moredetailed description of the supply and demand conditions is provided in theappendix).

Table 13.1 Peninsular Malaysia: power sector supply and demand statistics, 1990–95

1990 1991 1992 1993 1994 1995

Installed capacity (MW) 4,915 4,919 5,662 5,909 7,319 7,475Maximum demand (MW) 3,447 3,990 4,498 4,971 5,610 6,381Gross units generated 21,323 24,125 27,580 30,339 34,470 35,122(GWh)

Electricity sales (GWh)Domestic 3,350.26 3,661.88 4,083.49 4,453.73 5.006.78 5,800.70Commercial 5,153.06 5,592.44 6,347.72 6.962.86 7,892.29 9.132.05Industrial 8,357.21 9,824.94 11,782.87 13,710.23 15,932.56 18,414.18Mining 387.50 301.36 246.56 172.27 93.06 81.05Public lighting 146.22 157.86 170.15 183.65 208.08 229.45

Total 17,394.25 19,538.48 22,630.79 25.482.74 29,132.77 33,657.43

Number of consumersDomestic 2,531,198 2,708,890 2,899,411 3,081,497 3,259,451 3,441,169Commercial 357,694 378,031 401,287 429,841 464,180 524,224Industrial 17,484 8,649 10,283 11,358 12,061 14,174Mining 219 168 123 101 94 71Public lighting 6,678 8,029 9,147 11,154 12,944 15,807

Total 2,903,273 3,103,767 3,320,521 3,533,951 3,784,730 3,995,445

Generation mix (GWh)Hydro 3,233.7 3,646.0 3,495.8 4,004.9 5,528.7 5,125.1Gas 5,148.3 5,792.9 10,446.3 12,680.4 16,145.3 16,149.8Coal 3,273.7 3,662.0 3,836.6 3,879.7 4,081.0 3,974.2Oil 9,538.4 10,672.7 9,595.2 9,655.5 8,470.5 9,431.9Distillate 1282.5 351.5 206.4 118.3 244.8 440.9

Total 21,322.6 24,125.1 272,580.3 30,338.8 34,470.3 35,121.9

Transmission lines (km)275 kV 3,776 3,596 3,635 3,821 4,208 4,323132 kV 5,930 6,510 6,947 7,183 7,524 8,04666 kV 889 894 875 875 875 756

Note: These statistics derive from Tenaga Nasional Berhad and do not include those of the independentpower producers (IPPs).

Sources: Tenaga Nasional Berhad, Annual Report, various years; Tenaga Nasional Berhad, Statistical Bulletin(1994 and 1995); Department of Electricity and Gas Supply (1996).

The basic statistics of Peninsular Malaysia’s power industry are summarised in Table13.1. The data is intended to show the sector’s development between 1990 and 1995.

Power sector reform in Malaysia: privatisation and regulation—279

The trends in Table 13.1 lend support to the view that Peninsular Malaysia’s powersystem is fairly well developed and has, except in 1992–93, kept abreast of the growthin demand for power. The total installed capacity of Tenaga alone—excluding thegenerating capacity of the independent power producers (IPPs)—at the end of theutility’s fiscal year 1995 was 7,475 MW. Currently, the generating capacity ofPeninsular Malaysia’s power system, inclusive of the IPPs, is 10,855 MW. It shouldalso be noted that as a result of the government’s investment in the development ofpower sector infrastructure, electricity coverage in Peninsular Malaysia is almost total.Partly as a result of the government’s rural electrification programme, financed jointlyby Tenaga and the Ministry of Rural Development, the rural areas too have seen aconsiderable increase in service coverage. By the end of 1995, the percentage of ruralhouseholds in Peninsular Malaysia which were served with electricity had risen to 99per cent.

Average electricity consumption figures are shown in Table 13.2. Averageconsumption has been growing steadily since 1990 and certainly much more rapidlythan before. Average domestic and commercial consumption have both risen sharplysince 1990 and so has industrial consumption. Nevertheless, Malaysia’s per capitaconsumption is still assessed as being low by the standards of the developed countries.In 1992, for instance, consumption in Malaysia was only 1,610 kWh per capitacompared to, for example, 10,809 kWh in the United States and 6,700 kWh inJapan.

Table 13.2 Average consumption per Tenaga customer category

Domestic Commercial IndustrialFiscal year (kWh/year) (kWh/year) (MWh/year)

1985 1,214 12,574 1,0501986 1,251 13,101 9641987 1,270 13,341 9981988 1,282 13,675 1,0151989 1,268 13,727 1,0341990 1,324 14,406 1,1171991 1,352 14,794 1,1361992 1,408 15,818 1,1461993 1,445 16,199 1,2071994 1,536 17,003 1,3211995 1,686 17,420 1,299

Ave. growth per annum 1985–95 3.4 3.4 2.2Ave. growth per annum 1990–95 4.9 3.9 3.0

Source: Tenaga Nasional Berhad, Annual Report, various years.

280 Power sector reform in Malaysia: privatisation and regulation

An important aspect of Peninsular Malaysia’s power sector pertains to the generationmix. The Malaysian government is in the process of implementing a ‘four-fuel’diversification policy based on oil, gas, hydro and coal. This four-fuel policy isdesigned to cut down on the use of oil and to promote the use of non-oil indigenousresources. The government’s objective in introducing the policy is also to reduce overdependence on any one source of energy in the generation of power supply. As shownin Table 13.1, the policy has brought about a significant change in generation mix.

Overall, the basic issues of coverage and the provision of sufficient capacity are nowmore or less resolved. While the demand for power is projected to increase rapidly,requiring more investment in capacity expansion and improvements to thetransmission and distribution system, a new priority for Peninsular Malaysia’s powersector should also be the introduction of competition in power supply in order toenhance sector efficiency, as discussed in the remainder of this chapter.

POWER SECTOR REFORM

During the 1980s, and before, provision of power in Peninsular Malaysia was the soleresponsibility of the National Electricity Board (NEB), a wholly government-ownedutility. NEB had a monopoly in the generation, transmission and distribution ofpower throughout Peninsular Malaysia. As a statutory body, the main planning andinvestment decisions of NEB were naturally subject to government approval —namely, by the Economic Planning Unit (EPU) and the Ministry of Finance. Tariffswere fixed and regulated by the Ministry of Energy, Telecommunications and Posts(MOETP) on the basis of proposals by NEB.

Two major developments precipitated reform of Peninsular Malaysia’s power sector.First, the very rapid growth of the Malaysian economy since 1987, particularly in theindustrial sector, created pressures on NEB to raise its corporate efficiency and to givebetter attention to its customers. Second, by about the mid-1980s the Malaysiangovernment had embarked on an extensive privatisation programme. The EPU’s1985 guidelines on privatisation, which set out the rationale for the Malaysiangovernment’s privatisation policy, explicitly included in its proposals the privatisationof state-owned enterprises in the infrastructure sectors, such as NEB. The guidelinesalso recommended promoting private sector provision of services traditionallysupplied by the public sector. It was against the need to improve efficiency, on the onehand, and the implementation of the government’s privatisation policy, on the other,that the Malaysian government as a first step in the reform of the power sectorenacted the Electricity Supply Act 1990 in September 1990. The Act set in motion aprocess that has brought about a great deal of change to Peninsular Malaysia’s powersector, allowing for the privatisation of the power utility and the licensing of IPPs.

Power sector reform in Malaysia: privatisation and regulation—281

Privatisation of the National Electricity Board

Privatisation in the power sector began with the corporatisation of NEB as TenagaNasional Sdn. Berhad (Tenaga). Since then its operations have been regulatedthrough a licence issued by the Director-General of Electricity Supply under Section9 of the Act. The main provisions of the licence granted to Tenaga are as follows:

• as a licensee under the Act, Tenaga is regulated by the Director-General of Electricity Supply, who in turn reports to the MOETP;

• the licence issued to Tenaga is for a period of 21 years;

• the licence also stipulates that any changes in tariffs would require prior written approval from the MOETP; and

• Tenaga must comply with the rural electrical programme.

The corporatised Tenaga was privatised in February 1992 with the flotation of about25 per cent of its shares on the main board of the Kuala Lumpur stock exchange. Thegovernment, through the Ministry of Finance, still owns about three-quarters ofequity in Tenaga, so the company is accountable to the Minister of Finance forfinancial matters pertaining to its operations such as profitability and funding.

Sector unbundling and IPPs

The second component of the power sector reform programme has been the licensingof IPPs. To date the government has either licensed or approved in principle a totalof eight IPP projects in Peninsular Malaysia. (See Table 13.3 for details on the IPPprojects.) Some of these have been commissioned while others are either underconstruction or expected to be built soon. The economic significance of the IPPs isthat they have meant the end of Tenaga’s monopoly in power generation in PeninsularMalaysia.

Table 13.3 illustrates the two phases in the issuance of IPP licences. The first five IPPslisted in the table were all licensed in 1993 and constitute the first phase of theliberalisation of power generation. These IPPs — YTL Power, Genting Sanyen Power,Segari Power Ventures, Port Dickson Power and Powertek — were commissioned ona ‘fast track’ basis in quick succession within an eight-month period in 1993 toovercome severe capacity shortages. These licences amounted to allocating a total of4,115 MW of new capacity, representing almost 70 per cent of Tenaga’s then existingcapacity and half of the total capacity additions approved up to the year 2000.

Since the initial phase one more new IPP licence has been granted to TeknologiTenaga Perlis (in 1995) and approval has been given to two more projects. Theunique feature of the IPP licence to Teknologi Tenaga Perlis is that the company isrequired to export a part of its power production to Thailand. The development ofthe plant would therefore commence after negotiations with the Electricity

282 Power sector reform in Malaysia: privatisation and regulation

Generating Authority of Thailand (EGAT) are completed. An importantdevelopment in the promotion of IPPs is the decision of the government, despite stiffopposition from various parties, to undertake the Bakun hydroelectric power projectin the state of Sarawak. Construction work on the development of the huge 2,400MW capacity hydroelectric plant has already commenced, and the private developer,Ekran Berhad, will be issued an IPP licence in due course. When in operation in theyear 2003, the Bakun plant will transmit 1,553 MW of firm power (13,600 GWh)to the Peninsular system and 100 MW of firm power (876 GWh) to the Sarawakpower system. (It is for this reason that the Bakun project, although located in thestate of Sarawak, is actually a part of Peninsular Malaysia’s power sector.) The latestIPP project to be approved, and for which a letter of intent has been issued, is a coal-fired plant to be developed by Automan Power Producer.

If the privatisation of Tenaga was intended to enhance its efficiency, the second prongof the government’s reform programme — the licensing of IPPs — was initiated byserious supply shortages in the sector. That supply constraints were beginning toemerge is evident from the huge divergence in the growth rates of power supply anddemand during the period leading up to 1993 when the five IPP licences were issued.Peak demand for electricity grew at an unprecedented average rate of 12.9 per cent ayear from 3,447 MW in 1990 to 4,971 MW in 1993. (During this period theelasticity of electricity consumption to GDP was 1.5, indicating the big increase inthe intensity of energy consumption, largely accounted for by the industrial andcommercial sectors.) In contrast, the generation capacity of Tenaga only increased atan average annual rate of 6.3 per cent from 4,915 MW to 5,909 MW. Because thegrowth in generation capacity was only half as fast as the growth in demand, supplyconstraints emerged in the Tenaga system during the 1991–93 period. The reservemargin on electricity supply declined from 42.6 per cent in 1990 to 18.9 per cent in1993, well below the benchmark reserve margin then of at least 25 per cent (see Table13.3). Consequently, Tenaga introduced load shedding during peak hours from 1991onwards. The power shortages worsened, however, and culminated in a nation-wideblackout in September of 1992. It was precisely to overcome the supply shortages thatthe government embarked on the second prong of its power sector reform programme—namely, the introduction of IPPs. The extreme urgency of the situation alsoresulted in the initial set of IPPs being commissioned on ‘fast track’ procedures. Thelicensing of IPPs was also in line with the government’s privatisation policy offacilitating private sector provision of services previously provided by governmentagencies.

Licensing conditions and the power purchase agreements between Tenaga and theIPPs vary but they share some common features. (The following statements, however,only apply to the five IPPs licensed in 1993.) In line with the government’s fueldiversification policy, all five IPPs are gas-fired plants. Three of them are base loadplants while the remaining two are peak load plants (see Table 13.3). The IPPs arebuild–operate–own (BOO) schemes with 21-year power purchase agreements (PPAs)

Tabl

e 13

.3Pe

nins

ular

Mal

aysi

a: in

depe

nden

t po

wer

pro

duce

rs (

IPPs

) Cap

acit

yLo

cati

onim

plem

enta

tion

Pr

ojec

t co

stC

ompa

nylic

ence

issu

edD

ate

(MW

)Pe

riod

(RM

bill

ion)

Rem

arks

Firs

t ph

ase

IPPs

YT

L Po

wer

Pasi

r G

udan

gA

pril

1993

404

1994

–97

2.6

Bas

e lo

ad p

lant

Paka

, Tre

ngga

nu80

819

94–9

7G

enti

ng S

anye

n Po

wer

Sepa

ngJu

ne 1

993

720

1994

–95

1.0

Bas

e lo

ad p

lant

Sega

ri E

nerg

y V

entu

res

Lum

utJu

ly 1

993

1,30

319

94–9

73.

6B

ase

load

pla

ntPo

rt D

icks

on P

ower

Port

Dic

kson

Dec

embe

r 19

9344

019

940.

6Pe

ak lo

ad p

lant

Pow

erte

kTe

lok

Gon

g,

Dec

embe

r 19

9344

019

94–9

50.

7Pe

ak lo

ad p

lant

Mel

aka

Seco

nd p

hase

IPP

sTe

knol

ogi T

enag

a Pe

rlis

aK

uala

San

glan

g,M

arch

199

565

0–

1.6

Perl

isE

kran

Ber

hadb

Bak

un, S

araw

ak–

2,40

019

96–2

002

15.0

Aut

oman

Pow

er P

rodu

cerc

Yan,

Ked

ah–

1,00

0–

–

Not

es:

aL

icen

ce is

sued

in M

arch

199

5 bu

t co

nstr

ucti

on h

as y

et t

o co

mm

ence

. Im

plem

enta

tion

is a

wai

ting

the

con

stru

ctio

n of

the

PG

U p

roje

ct p

ipel

ine

up t

o Pe

rlis

, the

sit

e of

the

IPP

. Lic

ense

e is

als

o ne

goti

atin

g w

ith

EG

AT

of T

haila

nd s

ince

a c

ondi

tion

of

the

licen

ce r

equi

res

that

300

MW

of

inst

alle

d ca

paci

tybe

use

d fo

r ex

port

of

pow

er t

o T

haila

nd.

bA

ltho

ugh

loca

ted

in S

araw

ak, t

he B

akun

hyd

roel

ectr

ic p

ower

pro

ject

is p

rope

rly

an I

PP fo

r th

e Pe

nins

ular

Mal

aysi

a m

arke

t. P

ower

fro

m B

akun

wou

ld b

esu

pplie

d to

Ten

aga

via

a 67

0 km

hig

h vo

ltag

e di

rect

cur

rent

sub

mar

ine

cabl

e. T

he p

roje

ct w

ould

be

the

firs

t hy

droe

lect

ric

IPP

pow

er p

lant

in M

alay

sia.

Alt

houg

h th

e B

akun

hyd

roel

ectr

ic p

ower

pro

ject

is a

n IP

P pr

ojec

t, t

he f

eder

al g

over

nmen

t ha

s ye

t to

issu

e a

licen

ce. T

his

is b

ecau

se t

he ju

risd

icti

on o

f th

e E

lect

rici

ty S

uppl

y A

ct 1

990

is li

mit

ed t

o Pe

nins

ular

Mal

aysi

a an

d un

til t

he le

gal i

ssue

s ar

e so

rted

out

wit

h th

e Sa

raw

ak s

tate

gov

ernm

ent,

an

IPP

licen

ce c

anno

t be

issu

ed t

o B

akun

Ber

hads

, the

pri

vate

dev

elop

er o

f th

e pr

ojec

t.

cT

he m

ost

rece

nt I

PP is

Aut

oman

Pow

er P

rodu

cer.

A le

tter

of

inte

nt h

as b

een

issu

ed t

o th

e co

mpa

ny b

y th

e E

PU. T

he p

lant

, to

be c

ited

in Y

an (

Ked

ah),

wou

ld b

e th

e on

ly c

oal-

fire

d IP

P pl

ant

in P

enin

sula

r M

alay

sia.

Upo

n co

mpl

etio

n of

the

fin

al p

urch

ase

agre

emen

t be

twee

n th

e co

mpa

ny a

nd T

enag

a, t

hego

vern

men

t w

ill is

sue

an I

PP li

cenc

e to

Aut

oman

Pow

er P

rodu

cer.

284 Power sector reform in Malaysia: privatisation and regulation

with Tenaga. (The PPAs are described in more detail in the next section of thechapter.) Tenaga, however, is not only a buyer of IPP electricity, it also has equity insome of the IPPs. Tenaga has bought a 20 per cent share in three of the IPPs — YTLPower, Genting Sanyen Power and Segari Energy Ventures — and a 10 per cent stakein Port Dickson Power. In this connection it should be mentioned that in line withits privatisation policy — and perhaps to ensure that there is real competition amongthe generation companies and Tenaga — the government has limited to 20 per centthe stake that Tenaga may hold in an IPP. There is also some foreign participation inYTL Power (5 per cent), in Genting Sanyen Power (20 per cent) and in Powertek (10per cent). It is the Malaysian government’s policy, however, to limit foreign equityparticipation in the IPPs to a maximum of 25 per cent. Another feature of the IPPsis that the five projects, involving a total investment of RM8.5 billion, have managedto secure full local financing. The Malaysian government has also not offeredsovereign guarantees to any of the IPPs.

PENINSULAR MALAYSIA’S POWER SECTOR: PRESENT STRUCTURE

Until the licensing of IPPs in 1993, power supply to Peninsular Malaysia was solelythe responsibility of Tenaga. The utility had a monopoly on the generation,transmission and distribution of power. The system, however, has now becomesomewhat more complex.

Industry structure

As a result of the reforms instituted by the government, the current industry structureis naturally somewhat different. As shown in Figure 13.1 the power sector nowcomprises both Tenaga and the IPPs. Tenaga is still a vertically-integrated providerand, most importantly, retains a monopoly in the wires component of power supply— that is, in transmission and distribution. Generation of power, which in the pastwas also performed exclusively by Tenaga, is now complemented by the IPP plants,five of which are already at various stages of production, as a result of sectorunbundling.

The generation market

The recent generation market structure is shown in Table 13.4. Out of an estimatedtotal installed capacity of 10,855 MW, generation capacity of the five IPPs already inproduction amounted to 3,210 MW. This constituted a generation market share of30.0 per cent. By 1997, when most of the five first-phase IPPs became fullyoperational, they represented 50 per cent of Peninsular Malaysia’s energy market (interms of GWh) (as estimated on the basis of generation capacity data in November1996).

Power sector reform in Malaysia: privatisation and regulation—285

Table 13.4 Generation capacity, November 1996

Producer Capacity

YTL Paka 780 MWYTL Pasir Gudang 469 MWGenting Sanyen Power 429 MWPD Power 440 MWPowertek 440 MWSegari Energy Ventures 652 MW

Total IPPs 3,210 MWTotal Tenaga 7,645 MW

Grand totala 10,855 MW

Note: a Excluding smaller plants.Source: New Straits Times, 7 November 1996. (Errors in source material have been rectified by the author.)

Power purchase agreements

Because Tenaga retains a monopoly in the transmission and distribution of power, theIPPs must sell their output to Tenaga. Power is supplied to the national grid underthe provisions of the PPAs between Tenaga and the IPPs and the requirements of theMalaysian Grid Code.

The PPAs are negotiated on a case-by-case basis between Tenaga and each IPP. Asthese are commercial agreements, many aspects of the PPAs are confidential. Still, invery broad terms, two types of PPAs contracted between Tenaga and the IPPs can bedistinguished — these being the ‘take-or-pay’ agreement and the fully despatchabletype.

Take-or-pay agreement

In the first IPP licence agreement (issued to YTL Power), power is sold to Tenaga onthe basis of a ‘take-or-pay’ arrangement, with a ‘minimum take’ provision. Under thisPPA, Tenaga is obliged to pay a fixed amount to YTL Power, whether or not it takeselectricity from the company. The take-or-pay contract requires Tenaga to purchase(and YTL Power to supply) 7,450 GWh of energy per annum. In principle, the‘minimum take’ provision of the PPA is assessed as being close to the maximum thatYTL Power can physically deliver.

Note: a Generation figure is for Tenaga.b Loss rates are for 1994.c Total consumption derives from Tenaga statistics.

Source: IPP figures are from Department of Electricity and Gas Supply (1996).

286 Power sector reform in Malaysia: privatisation and regulation

Figure 13.1 Electricity supply industry structure in Peninsular Malaysia, 1995

35,122 GWh

Energy Flow 1995 Participants Regulation

Generation

Transmission

Distribution

Consumers

GWh generated:35,122Auxiliary loss = 3.1%

• Capacity additions approved by EPU, JBE and IAPG

Transmissionloss = 4.1%

• Despatch onto National Grid on basis of: i) Malaysian Grid Code (MGC) – lowest variable cost of generation – proximity to load – system stability ii) Power Purchase Agreement (PPA)• Tenaga is currently the Grid System Operator (GSO)

Distributionloss = 7.4%

• Distribution monopoly with Tenaga Recently the government has given a distribution licence to a new township developer in Kuala Lumpur

GWh consumed:33,657

• Performance standards for quality of supply to consumers• Price formula allows for adjustment for: – Inflation – Efficiency – Fuel – IPP cost passthrough

ab

b

b

c

TenagaGeneration SBE

4,618 GWh

311 GWh

117 GWh

119 GWh

–

YTLP

GSP

PDP

Powertek

SEV

EGAT

PUB

Transmission SBE

275 KV: 4,323 km.132 KV: 8,046 km.68 KV: 758 km.

4 main classes:

Total: 4.4 millionPercentage electrification: 100%

Distribution SBE

5 regions:

Northern

Perak

Selangor/FT

Eastern

Southern

Consumers

Industrial (54.7%)

Commercial (27.1%)

Domestic (17.2%)

Others (1%)

Tenaga

NationalGrid

Tenaga as GSO

Power sector reform in Malaysia: privatisation and regulation—287

Fully despatchable basis

The other PPAs are very different in structure. The licences are on a fullydespatchable basis. In these agreements, power is despatched upon the request ofTenaga, subject to the provisions of the Grid Code. Payments to the fullydespatchable plants are, unlike those made to YTL Power, on a two-tier basis: first, afixed capacity payment is made when the IPP plants become available and, second,energy payments are made per kWh for actual supply.

Regulation of the power sector

As in the case of other infrastructure services, the basic thrust of regulatory action inPeninsular Malaysia’s power sector is to balance the objective of making available toconsumers a basic amenity at a reasonable price and at the same time to ensure thatthe suppliers or those being regulated make sufficient returns to support a stablepower industry. The government’s reconciliation of the two objectives constitutes, inessence, the regulatory structure for the industry. The regulation of the power sectorin Malaysia is described in the following.

Regulatory framework

The Electricity Supply Act 1990 broadly defines the regulatory framework for thesector (see Figure 13.2).

The regulatory system clearly involves a number of government agencies. Under theprovisions of the Act, the Minister of Energy, Telecommunications and Posts and hisappointee, the Director-General of the Department of Electricity Supply, areresponsible for:

• issuing licences (section 4[a]);

• the provision of stable, continuous and quality supply of electricity at reasonable prices (sections 4[b, d, e]);

• the promotion of competition in the generation and supply of electricity to, interalia, ensure the optimum supply of electricity at reasonable prices ([section 4[c]);

and

• ensuring the financial viability of the licensees (section 4[f ]).

The Economic Planning Unit of the Prime Minister’s department, being the agencyresponsible for the implementation of the privatisation policy, evaluates andnegotiates the licence conditions with the private companies chosen to be given IPPlicences. The EPU undertakes this task in close consultation with the MOETP. TheMinistry of Finance has influence over many aspects of the latter’s operations onaccount of its controlling shareholding in Tenaga.

288 Power sector reform in Malaysia: privatisation and regulation

The three agencies — the MOETP, the EPU and MOF — report to the PrimeMinister and Cabinet, who are closely involved in power sector policy formulationand who also appear to oversee all aspects of policy implementation in the powersector. Privatisation issues relating to the power sector, the issuing of IPP licences,tariffs and such matters are decided at Cabinet level in Malaysia.

System expansion planning

The Department of Electricity Supply (DES) within the MOETP functions as theplanning department of the government on the question of capacity. DES initiatesexpansion of system capacity whenever system installed capacity is projected to fallbelow the planning criterion of a 35 per cent reserve margin. (The 35 per cent reservemargin was adopted as a benchmark by DES on the recommendation of consultantsappointed by the government after the nation-wide blackout in September 1992.)Recommendations for capacity expansion initiated by DES are submitted throughthe MOETP for evaluation and approval to an EPU-led Inter-Agency PlanningGroup (IAPG) that was formed in 1993 (see Figure 13.2). IAPG membership consistsof the EPU, DES, the MOETP, MOF, the utilities, the Ministry of InternationalTrade and Industry and coopted government authorities such as the Department ofthe Environment. In practice, the Prime Minister and Cabinet appear to play a majorrole in many aspects of capacity expansion. Decisions about who should be allowedto install additional capacity — Tenaga or an IPP — and in the latter case whichprivate company should be given the IPP licence, are actually taken by the PrimeMinister and Cabinet. The final terms of the licence conditions are arrived at afternegotiations between the IPP company and government agencies such as the EPUand the MOETP. The PPA between the private company given the IPP licence andTenaga constitutes another part of the regulatory framework. (See previous section fora discussion of PPAs.)

The Malaysian Grid Code

The present structure of Peninsular Malaysia’s power sector is such that while thereare multiple suppliers of power (Tenaga and the IPPs), for very good economicreasons there is only one transmission grid. As of now the national grid is owned byTenaga, which is also the grid system operator. As Tenaga also retains a monopoly andoperating rights over the wires business and purchases power from the IPPs, there isan obvious need to establish operating rules for the national grid. The Malaysian GridCode provides the framework for operation of the grid.

The Grid Code is a set of technical and operational rules on how the national grid isto be operated in the post-reform privatised and multi-firm generation environment.It defines the rules of network operation and specifies the duties of the generatingcompanies in order to ensure safe, secure, reliable and economic electricity supply andthe provision of access to all users of the national grid without discrimination. The

Power sector reform in Malaysia: privatisation and regulation—289

commercial significance of the Grid Code lies in its ‘merit order operation’, whichdefines the criteria for despatch onto the national grid. In accordance with the GridCode, power is to be despatched to the national grid on the basis of the lowestvariable cost of the suppliers.

Figure 13.2 Regulatory and policy framework for electricity in Peninsular Malaysia

Tariff revision procedure

Electrical consumption in Peninsular Malaysia is priced according to the amount ofconsumption, class of consumer, voltage and time of consumption. The present basicrates were established in 1985.

In the pre-reform era price adjustments were made on the basis of submissions fromNEB, the state-owned utility. NEB’s proposals had to be approved by the MOETPand the government before they could be implemented by the utility. Althoughelectricity tariff revisions still need, as in the past, governmental sanction, in late 1993the government established a more transparent mechanism for tariff adjustmentswhen it approved a tariff adjustment formula. The mechanism for tariff adjustmentis based on the formula CPI-M+Y+K where CPI is the consumer price index, M is afactor which takes into account the efficiency potential of the utility, Y is the fuel costpass-through and the factors to take into account in the purchase of energy fromIPPs, and K is a correction factor for forecasting errors.

Consumer Tenaga

IPPsESD

• Implements policy• Competition/consumer interest/tariffs/licencees financial viability

MOETP IAPG EPU MOF

Prime Minister/CabinetESA 1990

• Established system • Overseas industry/ ministries

• Develops regulation, policy

• Controlling TNB shareholder

290 Power sector reform in Malaysia: privatisation and regulation

The tariff adjustment formula therefore allows Tenaga’s rates to be revised for changesin inflation, efficiency, fuel prices and incorporates a pass-through of the IPPpurchase cost. The average tariff is therefore the weighted average of the price ofelectricity generated by Tenaga and that of the IPPs, with adjustments made forinflation, significant fuel cost changes (and transmission and distribution wheelingcharges). Under the provisions of the tariff adjustment formula the average tariffs areto be revised every three months.

In April 1995, at the fifth of its quarterly reviews under the tariff adjustment formula,Tenaga was allowed to raise its tariff by about 0.8 sen per unit (a 4 per cent increase).This tariff adjustment, incidentally, contained the first IPP pass-through. Afterhaving been in force for just over one month, and following a public outcry, therevised rates were suspended by Cabinet in May 1995. The authorities cited inflationconcerns and a need for a more detailed study of the tariff adjustment formula. InMarch 1996, and in lieu of the quarterly reviews of tariffs foregone since thesuspension of the tariff adjustment formula in May 1995, the government sanctionedan average 8.5 per cent interim increase in Tenaga’s tariffs pending a detailed study ofthe price adjustment formula. A new mechanism for tariff revision is being developedby DES and was expected to be in effect in 1997.

POWER SECTOR REFORM: AN ASSESSMENT

Peninsular Malaysia’s power sector reform programme was initiated in 1990. As aresult of liberalisation, the structure of the power sector now is quite different fromwhat it was when NEB enjoyed a monopoly over all three processes of electricitysupply. Yet, in many respects, the reform programme has fallen well short of creatingan industry structure that would have fostered greater sector efficiency. The followingcomments contain an evaluation of the Malaysian government’s power sector policy.However, since the restructuring of the power sector of Malaysia is still in progressand new policy initiatives are either in the offing or are expected to be taken in themedium term, this commentary should be regarded as no more than a tentativeassessment of the Malaysian government’s power sector policy.

Tenaga’s privatisation and its impact on performance

Tenaga’s performance is generally assessed as having improved since its privatisationin 1990 and its listing in 1992. One consequence of Tenaga’s privatisation has beenthe changes it has facilitated in its organisational structure to make it a more business-like organisation than a public utility. Among the more important of these changeshas been the transformation of its generation, transmission and distribution servicesinto autonomous units known as ‘strategic business units’. Accounting and financialpractices are now such that the performance of each of these units is shown separately.Tenaga’s plans are to eventually convert the three strategic business units into threeseparate companies.

Power sector reform in Malaysia: privatisation and regulation—291

A more tangible sign of the improvements in Tenaga can be seen in its financialperformance (see Table 13.5). Turnover of the company has increased steadily, fromRM4.3 billion in 1990 to RM8.1 billion in fiscal year 1996. Profits of Tenaga alsorose until 1994 but have since declined on account of the large payments to the IPPs.Sales per employee — an important efficiency indicator — have also been improving,with the performance indicator in 1996 nearly twice as high as in 1990 (see Table13.5). It is difficult to see what Tenaga’s performance might have been withoutprivatisation but, on the whole, privatisation of Tenaga is said to have been efficiencyenhancing.

Table 13.5 Tenaga Nasional Berhad: main financial results, FY 1992–96

1992 1993 1994 1995 1996

Turnover (RM billion) 4.283 5.030 5.629 6.855 8.145Pre-tax profit (RM billion) 1.414 1.848 1.981 1.636 1.163Earnings per share (sen) 44.0 50.8 57.0 40.7 25.9Sales per employee (MwH) 847 995 1,119 1,200 1,428

Sources: New Straits Times, 8 November 1996; Tenaga Nasional Berhad, Statistical Bulletin (1994 and1995).

Independent power producers

The major contribution of the IPPs is that they have helped to considerably improvepower availability. Because the projects were licensed on a ‘fast track’ basis, the IPPswere able to quickly eliminate the severe capacity shortages that emerged during 1992and 1993. Furthermore, because the IPP plants are located in different parts ofMalaysia, they have also relieved Tenaga’s transmission problems.

The licensing of IPPs has also brought about a huge amount of private investmentinto the power sector. Total investment by the first five IPPs alone amounts to RM8.5billion (see Table 13.3). In this regard, the IPPs have clearly relieved the public sectorof the burden of having to finance capacity expansion of the power sector. Therefore,in terms of the criteria of relieving the public sector of the financial burden ofinfrastructure development — which is a specific objective of the government’sprivatisation policy — the introduction of IPPs could be said to have succeeded.

IPPs and competition in generation

An important reason for licensing IPPs is that they create the potential forcompetition in power supply. As a result of the regulatory framework that has beenput in place, there is now competition in the generation segment of the power sectorof Peninsular Malaysia. Because the production of four of the IPPs (the exceptionbeing YTL Power) is despatched to the national grid by the grid system operatoraccording to merit order (defined specifically as the variable cost of power supply),despatch of power is in accordance with the real efficiency of the companies. The

292 Power sector reform in Malaysia: privatisation and regulation

Grid Code thus allows for competition among the IPP plants, and between the IPPsand the Tenaga generation plants for production scheduling by the grid systemoperator. In short, the merit order criteria of despatch (as required by the Grid Code)and the use of variable cost of power supply rather than average cost ensures thatpower from the most efficient plants is despatched first, hence minimising the supplycost of electricity.

Project selection process

As mentioned earlier, the first five IPPs were licensed on a ‘fast track’ basis to quicklydevelop sufficient generating capacity in order to avoid the recurrence of the nation-wide power failure of 1992. These IPPs, as well as those licensed since, have not beenselected on the basis of an open bidding process. There was no open bidding for thefirst phase IPP licences because of the urgency to build up capacity in the system.However, there was no open competitive bidding with the subsequent set of IPPseither, including the Bakun hydroelectric project. While the critical supply–demandfailure in 1992–93 may justify the avoidance of open and transparent bid proceduresin the case of the first few IPP licences, the failure to adopt open competitive biddingin the licensing of the latest IPP projects — those of Teknologi Tenaga Perlis, Ekran’sBakun project and Automan Power Producer — is simply inexcusable and representsa major flaw in the power sector reform programme.

Generation capacity

Another criticism of the government’s power sector reform programme is the build-upof excess generation capacity as a result of the licensing of IPP projects. The capacityapproved for installation by the five licensees sanctioned in 1993 amounted to almost70 per cent of Tenaga’s installed capacity in that year. Even in 1997 these five projectsalone still account for 50 per cent of the total production of power by the PeninsularMalaysia system. There is nothing wrong in these market shares in themselves; whatis unfortunate, though, is that the licensing of IPPs has also led to a huge surplusgenerating capacity.

As a result of the IPP programme, by 1994 the reserve margin had recovered to about30 per cent from the all-time low of about 19 per cent in 1993. With more of the newcapacity coming on-stream, most intensely since 1995, Peninsular Malaysia’s powersector is now facing severe excess supply of power capacity. The reserve margin isexpected to range between 71 and 50 per cent from now until the year 1999, clearlyvery much above the recommended reserve margin of 35 per cent (see Table 13.6).The net impact of the high reserve margin is already beginning to show up in Tenaga’sfinancial results. The pre-tax profits of the utility have fallen from nearly RM2 billionin 1994 to less than RM1.2 billion in Tenaga’s fiscal year 1996. Moreover, because theGrid Code requires despatch on the basis of the lowest variable cost, it favours thenewer IPP plants over Tenaga. The utility is thus most vulnerable to demand shortfalls

Power sector reform in Malaysia: privatisation and regulation—293

and excess reserve margins. The tariff adjustment formula, now discontinued, alsoprovided no relief for the excess capacity since there was no pass-through for suchcapacity. In short, under the prevailing regulatory regime, Tenaga bears the costs ofthe high and uneconomic levels of the reserve margins.

Table 13.6 Peninsular Malaysia: installed capacity and peak demand, various years

As at 31 August 1986 1991 1994 1995E 1996E 1997E 1998E 1999E 2000E

Installed capacity (MW) 4,721 4,919 7,339 9,771 11,764 12,508 13,618 13,838 13,838Peak demand (MW) 2,267 3,990 5,610 6,216 6,875 7,590 8,364 9,200 10,102Reserve (MW) 2,454 929 1,729 3,555 4,889 4,918 5,254 4,638 3,736Reserve margin (%) 108.25 23.28 30.82 57.19 71.12 64.80 62.82 50.41 36.98

Source: UBS Global Research (1995).Note: E=estimated

Power purchase agreements

As explained previously, under the IPP licence with YTL Power, Tenaga is obliged topay for a fixed amount of power (7,450 GWh) whether or not it takes the electricity.In efficiency terms, this PPA is not optimal because of the ‘take-or-pay, minimumtake’ provision. The PPAs with the other IPPs — consisting of a two-part tariffschedule involving a per kW capacity charge and a per kWh energy charge — is morein line with the actual components of power generation.

The capacity payments in all the IPPs, including the ‘minimum take’ provision of theYTL agreement, are predicated on a sufficient level of plant availability. (The PPAcontracts incorporate a target plant availability level of 87 per cent with penalties orbonuses for achieving less or more than this target level.) The PPA agreement betweenTenaga and YTL, negotiated under pressure to relieve shortages, unfortunately isinconsistent with the government’s reform policy.

Pricing

The issue of pricing concerns two separate but not unrelated matters. The first relatesto the prices being paid by Tenaga to the IPPs. The cost of IPP power to Tenaga variesbetween 15.8 sen/kWh and 17.8 sen/kWh. These are assessed as being substantiallyhigher than Tenaga’s own production cost, estimated at around 9 sen per unit.(Needless to say, the IPP selling prices were not negotiated on the basis of avoidedutility costs — that is, what it would have cost if Tenaga had generated the poweritself.) Nevertheless, because the IPP plants were established on a ‘fast track’ basis,their costs could have been 20–40 per cent above those of Tenaga projects built undernormal procedures.

Furthermore, insurance costs for private projects can be expected to be higher thanfor a Tenaga project. Likewise, financing costs too will be higher for IPP projects thanfor Tenaga plants. But these do not explain all of the substantial differential between

294 Power sector reform in Malaysia: privatisation and regulation

IPP and Tenaga power supply costs. There are, in the Malaysian power reformprogramme, two additional factors which could explain the high cost of IPP power.First, the IPPs are assured of higher returns (16–18 per cent per year) than Tenaga (8per cent). Second, the mechanism of IPPs could also mean higher power costs becausethere has been no competitive bidding for IPP licences. How important these tworeasons are in explaining the high price of IPP power cannot, however, be ascertained,though they are almost surely relevant. Even the fact that the non-fuel component ofthe IPP costs is fixed (that is, not subject to inflation) and therefore efficiency-inducing is not entirely correct because the IPP non-fuel kWh price calculationactually includes an assumed inflation rate of 4 per cent per annum. The IPPs aretherefore only subject to risk if their real generation cost increases exceed 4 per centa year. On the whole, then, the mechanism of IPPs has meant higher power costs toTenaga and ultimately to consumers. Not all of the increase, however, has beenunavoidable.

The second pricing issue relates to Tenaga’s tariff adjustment procedure. Theimplementation of a specific tariff adjustment formula in 1993 was a hugeimprovement over the earlier price revision mechanism. (The formula was modelledon that of the United Kingdom and was aimed at sharing with consumers risksinherent in the electricity supply business, such as fuel price movements.) The tariffadjustment formula certainly introduced an element of transparency into the entiretariff revision process in the power sector. For this reason, the government’s decisionto suspend it in May 1995 represents a very serious set-back to the development ofan efficient power sector, quite apart from the fact that the decision has also imposedhuge and unfair pressure on Tenaga’s earnings.

General comments

A general conclusion to be drawn from the preceding discussion is that whileMalaysia might have been one of the earliest countries in Asia to have liberalised itspower sector, the scope of its reform programme has been limited to the partialprivatisation of the integrated utility and to the introduction of competition in powergeneration via the licensing of IPPs. Few other major structural reforms have beenforthcoming. Clearly, after more than six years since the commencement of thereform programme, the potential for a more comprehensive restructuring of thesector remains largely unexploited. The reform programme is still in its infancy, withmany of the regulatory issues not yet resolved.

Even within the limited scope of the regulatory reform of the power sector, theachievements have not been wholly satisfactory. A number of major flaws inMalaysia’s power sector reform have already been identified and can be summarisedas follows. First, the licensing of IPPs has not been implemented in an open andtransparent manner via bidding procedures. The failure to grant licences on the basisof the best possible offers simply means that the benefits of instituting competition

Power sector reform in Malaysia: privatisation and regulation—295

‘for’ the market (as opposed to competition ‘in’ the market) have been lost. Second,the large generating capacity that has been created as a result of the IPP programmeis also a case of regulatory failure. Similarly, the ‘take-or-pay’ PPA is also a glaringdeficiency of the programme. Finally, the suspension of the tariff adjustment formulaconstitutes an inexcusable policy reversal and one that is clearly inconsistent with thenurturing of an efficient power industry.

There is, as described earlier, a regulatory structure of sorts to oversee thedevelopment and restructuring of the power sector. But its performance is clearly notvery satisfactory. To a large extent the explanation for this lies in the government’sfailure (or maybe refusal) to institute transparent mechanisms and procedures toregulate the sector. There are two plausible reasons for this. One is that the powersector reforms have not been insulated from the pursuit of political goals andobjectives. Political considerations have often undermined the achievement ofeconomic goals. Two, the partial and not total privatisation of Tenaga has also been afactor that has prevented the evolution of clear-cut, efficiency-driven sector policies.Ironically, although the government is the majority shareholder in Tenaga, it is theutility company that has borne the brunt of the government’s errors and policyreversals.

FUTURE POWER SECTOR SCENARIOS

Recently, and in response to the problems in the power sector, some of which werealluded to in earlier sections of this chapter, the Malaysian government has taken anumber of important decisions that will have an effect on the future development andstructure of Peninsular Malaysia’s power sector. First, in order to address the problemof excess generating capacity, the government has decided that no more IPP projectswill be licensed until the year 2000. Until then all capacity expansion, if required, willbe undertaken by Tenaga. Second, in a related decision, the government has alsodeclared its intention to create a generation market share of 70:30 between Tenagaand IPPs. Both these decisions were clearly motivated by the need to protect Tenaga’sfinancial position and performance. Third, the government has in principle acceptedthe idea that all future generation projects should be open for competitive bidding.(The details on how the competitive bids are to be organised have yet to beannounced.) While this commitment will lead to a clear improvement over pastpractice, how this procedure is to be reconciled with the market share targets is notknown. On account of the huge payments to IPPs by Tenaga and because of theireffects on the latter’s financial performance, the Malaysian government has called onthe IPPs to share some of the ‘burden’ and ‘social responsibilities’ currently borne byTenaga. It has identified the financing of the rural electrification programme as onearea for IPP participation. While the government has ruled out any renegotiation ofthe IPP terms, the efficacy of the government’s suggestion that the IPPs help Tenagais unclear.

296 Power sector reform in Malaysia: privatisation and regulation

On the more substantive issues of sector deregulation, including the general directionin which the reform programme would move, the government has made few specificpronouncements. Clearly, however, the technology of the electricity industry anddevelopments in regulatory economics allow for a much more competitive industrystructure than is the case with Peninsular Malaysia’s power sector now. One possibleand achievable industry structure for Peninsular Malaysia is illustrated in Figure 13.3.The main features of this more competitive industry structure can be summarised asfollows:

• Competition in the generation sector can be intensified between Tenaga and the IPPs and could include co-generation plants.

• Since transmission is a natural monopoly, the grid could continue to be owned byTenaga or its subsidiary. The transmission company would be a common carrier. But the grid system operator should be an independent or neutral company, unlikenow where Tenaga is the operator as well as the network owner.

• While distribution is also a natural monopoly, there is no real economic reason forTenaga to have a nation-wide franchise over the distribution component of the power sector. New distribution companies could be licensed to operate local distribution networks.

• New supply companies can be encouraged to buy power in bulk from any of the generation companies and to sell to customers directly by wheeling power throughthe Tenaga-owned transmission company, with local distributors paying wheelingcharges for the use of the wires network.

Figure 13.3 also shows the range of choices available to consumers and the powerpurchase agreements that are possible among the industry players.

The Malaysian government is not yet committed to an industry structure along thelines illustrated in Figure 13.3. It has nevertheless accepted the need for anindependent grid system operator in view of the multiplicity of generators. Thegovernment has also licensed a private company to distribute power in a newtownship near the federal capital of Kuala Lumpur, but there have been no furtherdevelopments on the liberalisation of the distribution sector. On the contrary, therecent pronouncements of the Malaysian government would seem to suggest thatTenaga, the integrated utility company, will continue to have a monopoly over thewires business at least until the year 2000. In all probability then, no major structuralchanges are expected in Peninsular Malaysia’s power sector in the near future.

Power sector reform in Malaysia: privatisation and regulation—297

Figure 13.3 Possible new industry structure: competitive framework (operating and tradingframework)

CONCLUSION

Malaysia’s experience in power sector deregulation is limited. The government hasobviously not exploited the full potential for liberalisation of the sector. DespiteMalaysia’s limited experience in power sector reform, this chapter has identified themain regulatory issues associated in reform of any power sector. They include theneed for transparency in policy formulation and implementation. There is a clearneed also to ensure that the PPAs with IPPs are equitable arrangements. Deregulationof the power sector requires the formulation of an efficiency-inducing grid code and,preferably, an independent grid system operator. An important area for regulatoryoversight is the pricing of power, including a transparent price adjustment formula.Finally, the need for an adequate regulatory framework to administer a morecompetitive industry structure cannot be overstated.

Generationcompanies

GSO'Neutral',non-business,technicaladministrator

Wheelingcompany

Franchiseddistributioncompanies

Facilitatorcompanies

Customers

Co-generation

plants

Tenagageneration company

Tenaga wiredistribution company

Tenaga supplycompany

New supplycompanies

New wiredistributioncompanies

Legend: Electricity PPA

IPPs

GSO

Transmission company

Customers

298 Power sector reform in Malaysia: privatisation and regulation

APPENDIX 13.1: PENINSULAR MALAYSIA’S POWER SECTOR

This appendix provides no more than background for more detailed discussion of thereform of Peninsular Malaysia’s power sector in the main text of the chapter.

Installed capacity: The total installed capacity of Tenaga Nasional Berhad (Tenaga) atthe end of its fiscal year 1995 was 7,475 MW. (This figure excludes the installedcapacity of private sector producers who have been licensed to generate power as partof the government’s reform programme for the sector.) System peak demand in theyear was 6,381 MW. (Table 13.1 contains details of the growth of the PeninsularMalaysia’s power sector in the 1990s.) Tenaga’s generating capacity thus grew at anaverage of 8.7 per cent a year between 1990 and 1995. As a result, Tenaga’s installedcapacity in 1995 was more than 50 per cent higher than in 1990.

Generation: In terms of units of electricity produced, Tenaga generated about 35,122GWh of electrical power in 1995, up by 65 per cent from the 21,323 GWh itgenerated in the year 1990.

Growth of sales: As for sales, in line with the growth of the Malaysian economy of over8 per cent per annum since the late 1980s, total sales in 1995 were nearly double1990 sales. This constitutes a 14.1 per cent increase in sales a year in the last fiveyears. In contrast, average annual sales growth in the 1980s was only 7.7 per cent.

Customer mix: As for its customer base, Tenaga currently serves about 3.99 millioncustomers. The breakdown of sales and number of customers are shown in Table13.1. (Briefly, and as of 1995, its customers were as follows: 3,411,169 domestic;524,224 commercial; 14,174 industrial; 71 mining; and 15,807 public lighting.) Interms of sales to the various customer categories, the industrial sector is Tenaga’slargest customer, accounting for 54.7 per cent of total sales in 1995.

Average consumption: Clearly, the growth rate in the 1990s is much more marked insales than in number of customers, indicating that average consumption perconsumer has been growing steadily. Average electricity consumption per customer inPeninsular Malaysia is summarised in Table 13.2. The increase of unit consumptionbetween 1990–95 when compared to the average rate at which electricityconsumption rose between 1985 and 1990 is obvious. Average domestic andcommercial consumption have both increased sharply since 1990 as a result of risingliving standards and increasing urbanisation. The biggest absolute contribution tooverall sales, however, has come from industrial consumption. The high growth ofindustrial consumption — 3.0 per cent a year since 1990 compared to a 1.2 per centannual increase between 1985 and 1990 — is attributable to the very rapid growthof manufacturing activity in Malaysia. The emergence of larger and more automatednew plants and the increase in the production of existing plants further compoundedthe sudden surge in the average consumption of industrial users.

Generation mix: In the past, electricity generation was largely by oil-fired powerstations, either residual fuel or diesel oil, with some contribution from hydro stations.

Power sector reform in Malaysia: privatisation and regulation—299

In recent years, the government has implemented a ‘four-fuel’ diversification policyfocused on oil, gas, hydro and coal. The strategy is aimed at cutting down the use ofoil and promoting the use of non-oil indigenous resources such as gas, hydro andcoal. The objective is also to reduce overdependence on any one source of energy. Thefour-fuel policy has brought about a significant change in the generation mix ofpower supply in Peninsular Malaysia. Generation based on natural gas has shown thebiggest increase in recent years, representing in 1995 around 46 per cent of Tenaga’senergy generation. (In 1990 the share of gas in the Tenaga supply system was only24.1 per cent.) In 1995 oil represented the second largest source of energy generation,but its contribution has fallen sharply in relative terms from 44.7 per cent in 1990 to26.9 per cent in 1996. Hydropower stations have seen their relative share decreaseslightly from around 15.2 per cent in 1990 to 14.6 per cent in 1995. Utilisation ofcoal represents about 11.3 per cent of Tenaga’s generation mix now, down from its15.4 per cent share in 1990.

Electricity coverage: Urban electricity coverage in Peninsular Malaysia is now 100 percent. For rural households too there has been a considerable increase in coverage. In1990, for instance, rural electricity coverage already amounted to 91 per cent. By theend of 1995 the percentage of rural households in Peninsular Malaysia served withelectricity had risen to 99 per cent.

From the above it would appear that the electricity supply system in PeninsularMalaysia is reasonably well developed. Malaysia’s per capita consumption is still lowby world standards. In 1992, the last year for which such comparative statistics areavailable, consumption in Malaysia was only 1,610 kWh per capita, compared to10,809 kWh for the United States and 6,700 kWh for Japan. Average consumptionin Singapore was 6,420 kWh but per capita consumption levels in Thailand (760kWh) and Indonesia (200 kWh) were less than in Malaysia. Nevertheless, withcoverage approaching 100 per cent even in rural areas, the challenges facingPeninsular Malaysia’s power sector are somewhat different from those in the past. Themain challenge in the future will not be to increase coverage but to meet the rapidgrowth in demand for power and enhanced sector efficiency. Another importantchallenge will be the need to improve the transmission and distribution network.

REFERENCES

Department of Electricity and Gas Supply (1996) Statistics of the Electricity Supply Industry ofMalaysia, Kuala Lumpur: Department of Electricity and Gas Supply.

Tenaga Nasional Berhad, Annual Report, various issues, Kuala Lumpur: Tenaga.Tenaga Nasional Berhad, Statistical Bulletin (1994 and 1995), Kuala Lumpur: Tenaga.UBS Global Research (1995) ‘Malaysian power sector: dawn of the independents’, March.

14 Liberalisation and privatisation of the Thai power sectorIssues and perspectives

Thiraphong Vikitset

Until the early 1990s, power generation in Thailand was solely the responsibility ofthe state-owned Electricity Generating Authority of Thailand (EGAT). EGAT hadinvested steadily in expanding its power capacity in order to meet growth in powerdemand of approximately 14 per cent per annum during the last decade.

During the Sixth Five-Year Development Plan (1987–91), EGAT invested a total ofUS$4 billion in capacity expansion, of which US$2.12 billion was financed byforeign borrowing (National Energy Policy Office 1988a, p. 32). Thai governmentpolicy limited total public sector foreign borrowing to US$1 billion per year, andsince EGAT’s external borrowing amounted to an average of US$424 million a year,or 42 per cent of the public sector debt ceiling, the government was obliged to act.

It did so by implementing privatisation and liberalisation in the early l990s.Liberalisation means that private power producers can now participate in powergeneration by producing power for sale to EGAT, while privatisation has allowedEGAT to set up subsidiary companies and reorganise its structure along the lines ofa private enterprise, with its subsidiaries permitted to offer shares to the public.

In addition to alleviating public sector investment, liberalisation and privatisation areexpected to promote competition and efficiency in the power sector. While it is stilltoo soon to judge its success in any conclusive manner, it is possible to discuss aframework to gauge the impact of liberalisation and privatisation thus far in terms ofinduced changes in sector efficiency and the distribution of benefits among theparties concerned — namely, the power authorities, producers and consumers.

Ideally, the gains in efficiency from liberalisation and privatisation in the power sectorwould lead to lower service costs, implying a lessening of the investment burden onthe power sector. The lower investment requirement releases resources for other usefulactivities. In addition, lower service costs increase the consumer surplus of residentialpower consumers and the producer surplus of industrial and business powerconsumers. Finally, liberalisation provides efficient private power producers with‘acceptable’ rates of return on their investment.

Liberalisation and privatisation of the Thai power sector: issues and perspectives—301

Factors that affect the success or failure of privatisation are organisation of the powersector, the power tariff structure, and the method of implementing liberalisation andprivatisation.

The purpose of this chapter is to examine the development of liberalisation andprivatisation in the Thai power sector and to discuss their possible effects on servicecosts and on the distribution of benefits between power authorities, private powerproducers and consumers.

The chapter is organised into five sections. The second section presents a brief reviewof power sector organisations in Thailand. The third section reviews the present tariffstructure, which has been in effect since 1991. The fourth section traces the processof liberalisation and privatisation in the Thai power sector from its beginnings in theearly 1990s. The fifth section analyses the possible effects of liberalisation andprivatisation on power sector efficiency and the distribution of benefits among theaffected parties. Finally, the sixth section presents a summary and some conclusions.

ORGANISATION OF THE POWER SECTOR

The power sector in Thailand is organised around three state enterprises: EGAT isresponsible for power generation and transmission for the whole kingdom; theMetropolitan Electricity Authority (MEA) is responsible for the distribution of powerto consumers in the Bangkok metropolitan areas and the neighbouring provinces ofSamut Prakarn and Nonthaburi; and the Provincial Electricity Authority (PEA) isresponsible for the distribution of power to consumers in those provincial areas thatlie outside MEA’s jurisdiction. Both MEA and PEA purchase their power from EGATfor distribution to their consumers. EGAT also sells a relatively small amount ofpower to its few direct consumers and buys a small amount of power from Laos andMalaysia.

Figure 14.1 Structure of the power sector

Cabinet

Energy Policy Committee

Ministry of Interior Prime Minister's Office

EGATPEAMEA

302 Liberalisation and privatisation of the Thai power sector: issues and perspectives

Figure 14.1 shows the structure of the power sector in Thailand. Below the Cabinetis the Energy Policy Committee (EPC), chaired by the prime minister, which was setup by Cabinet in 1986 to oversee all energy policy matters. The members of the EPCcomprise former deputy prime ministers, ministers in departments responsible forenergy affairs, secretary-generals and directors of energy-related agencies. The officialresponsibilities of the EPC are:

• to formulate energy policies and action plans for Cabinet approval;

• to oversee and coordinate plans between energy sub-committees, government agencies and state enterprises in relation to such energy policies;

• to recommend relevant strategies and measures required to implement policies formulated by Cabinet;

• to follow Cabinet directives on energy policy formulation;

• to regulate and oversee the National Energy Policy Office; and

• to formulate criteria and guidelines for pricing energy resources that are consistentwith their economic value (National Energy Policy Office 1989b, p. 1).

Even though the EPC must follow the policy directives of Cabinet, the latter hasdelegated authority to the EPC to formulate and implement its energy policies. TheEPC is then required only to notify Cabinet once the policy has been implemented.

The EPC has two sub-committees to assist with policy formulation. The sub-committee on petroleum, chaired by a former deputy prime minister, oversees allpetroleum policy issues, including pricing. The sub-committee on energy policyformulation, also chaired by a former deputy prime minister, oversees all policy issuesrelated to electricity, coal and lignite, hydroelectric energy, unconventional energy,and also electricity pricing. The two sub-committees, which have been upgraded tocommittee status, have authority to set up working groups to propose strategies,measures and action plans to facilitate the implementation of policies.

The National Energy Policy Office (NEPO) was also set up in 1986, initially with thestatus of a division, to serve as a secretariat to the EPC and its two sub-committees.NEPO’s status was upgraded to that of a department in 1989.

There is, as yet, no official regulatory body in the Thai power sector. However, NEPOacts as a link between the EPC and the three power authorities. The link is establishedthrough the secretary-general of NEPO or nominated representatives serving asmembers in various sub-committee and working groups. For example, the workinggroup on the role of private power producers has as its members representatives fromEGAT, MEA, PEA, NEPO, the Ministry of Finance and nominated experts. It isthrough this link that NEPO regulates the power sector according to policyformulated by the EPC. The EPC has considered the possibility of setting up anindependent regulatory body to oversee the power sector. However, this is not

Liberalisation and privatisation of the Thai power sector: issues and perspectives—303

expected to happen in the near future due to the time-consuming legal processesinvolved in passing such an act.

As for the other bodies shown in Figure 14.1, EGAT is under the jurisdiction of theprime minister’s office, whereas MEA and PEA’s operations fall under the jurisdictionof the Ministry of Interior. Members of the EPC also include ministers of the primeminister’s office and the Ministry of Interior.

THE POWER TARIFF STRUCTURE

Before 1986 the objectives behind tariff revision in the power industry were notformally documented. Changes in tariff structure or tariff rates must be consideredand approved by Cabinet before they can be announced and implemented. After theEPC was set up in 1986 and delegated its authority for electricity pricing to the sub-committee on energy policy formulation, the process by which electricity is pricedbecame somewhat depoliticised. As a result, there was a major revision of the powertariff structure to better reflect the economic costs of service in 1986 and again in1989. The stated objectives of tariff revisions were that:

• the tariff must reflect the economic costs of service;

• the tariff must generate sufficient revenue to yield at least an 8 per cent return onrevalued assets as stipulated in the World Bank covenant; and

• the tariff must be acceptable and convenient to apply (Lorchirachoonkul and Vikitset 1986).

The first objective can be realised by setting the tariff rates in line with their respectivelong-run marginal service costs, computed on the basis of EGAT’s powerdevelopment plan (PDP), as derived from power forecasts. The load forecast workinggroup, set up by the sub-committee on energy policy formulation, comprisesmembers from the three power authorities and other related agencies. The workinggroup is responsible for long-range power forecasting, which is updated annually.EGAT’s PDP for power generation and transmission, consistent with the powerforecasts, is designed to provide power at minimum cost. Similarly, the distributionplans formulated by MEA and PEA are also based on forecasts published by the loadforecast working group.

Long-run marginal costs are estimated as the average incremental costs (AIC), whichmay be expressed algebraically as

(14.1)

where I = investment in year t, Q1 = incremental demand in year t, and r = discount rate.

∆

AICt

T I t

r t

t

T Q

r

=∑

∑

+

= +

( )

( )

1

1

1

1

∆

304 Liberalisation and privatisation of the Thai power sector: issues and perspectives

The AIC approach may also be used to estimate marginal capacity costs, marginalenergy costs and marginal consumer costs — the three components of costs in thepower sector that are required for tariff design. The power plant types selected underEGAT’s least cost plan during the period 1990 through to 2001, and which providedthe basis for tariffs in the power industry tariff in 1989, are shown in Table 14.1.

Table 14.1 Types of power plant

Power plant type Capacity (MW) Per cent

Hydroelectric 1,752 13.4Combined cycle 3,448 26.3Peaking gas turbine 500 3.8Dual-fired thermal 1,800 3.7Lignite thermal 4,200 32.1Imported coal power 1,400 10.7Total 13,100 100.0

The marginal costs of generation estimated by the AIC approach may be interpretedas the average marginal costs of this total plant mix. Similarly, the marginal costs ofMEA and PEA, which include EGAT’s marginal generation and transmission costs,may be interpreted as ‘average’ marginal costs for the areas under their jurisdiction.

Table 14.2 presents examples of typical data from the development plan required toestimate marginal capacity costs. The discount rate of 8 per cent, which is the rateused to evaluate public projects in Thailand, was used in the marginal costestimations. Marginal capacity costs and marginal customer costs are computed asbaht/kw/month and baht/customer/month respectively to conform to the powerbilling period. Marginal energy costs are computed as baht/kwh. Table 14.3 presentsthe long-run marginal costs of service computed from power development plans forthe period 1990 through to 2001.

Table 14.2 Example of typical power plants in the power development plan, 1996–2001

Capacity Capital FixedName addition Life cost O&Ma

Year Month of unit (mw) (years) (baht) (baht)

1996 March South Bangkok 600 25 x y2001 January Ao Phai 700 25 w v

Note: a operating and maintenance costs.

Government policy requires that retail tariffs be uniform throughout the country. Inother words, a consumer in a given consumer group will confront the same tariffregardless of location.

In order to satisfy the uniform tariff policy, the marginal costs of service are computedas if there were one single power system. The marginal costs computed within this

Liberalisation and privatisation of the Thai power sector: issues and perspectives—305

framework may be interpreted as the average marginal costs of service for the wholecountry. Since MEA’s marginal costs are relatively greater than PEA’s correspondingmarginal costs, the average marginal costs of service for the whole system, ascomputed in this manner, are greater than MEA’s corresponding marginal costs andlower than PEA’s corresponding marginal costs.

Table 14.3 Marginal costs of service, 1991 (1989 prices)

Capacity Energy ConsumerUtilities (baht/kW/month) (baht/kwh) (baht/consumer)

EGAT 291 0.744MEA

Sub-transmission 325 0.7568Primary 382 0.7845 1,727Secondary 410 0.8147 103

PEASub-transmission 372 0.7582

Primary 428 0.7922 1,711Secondary 499 0.8512 89

Notes: Sub-transmission = 69 KV and above.Primary = 12–24 KV.Secondary = less than 12 KV.25 baht = US$1.

Source: Monenco (1991).

The marginal cost-based tariff more than satisfies the financial target for the case ofThailand, since it generates revenue that yields a rate of return in excess of theminimum target rate.1 The third objective of the power tariff is rather abstract and isinterpreted to mean that the tariff must not cause an ‘excessive’ financial burden onpower consumers, especially low-income consumers.

In addition, the tariff structure must enable the large power consumers to reduce theirpower bills through more efficient power usage that improves their load factors. Sincea pure marginal cost-based tariff results in increases in power bills for all consumers,the first two objectives are compromised by the third objective. This is accomplishedby adjusting the marginal cost tariff downward until an 8 per cent rate of return forthe power sector is realised. Nevertheless, the present power tariff, implemented in1991, reflects marginal costs of service more closely than the previous tariff structure(Monenco 1991).

Table 14.4 Comparison between tariff rates and marginal costs, 1991–96

Average tariff rate (baht/kwh)

Consumer groups Marginal cost Present tariff Ratio

Small residential 4.33 1.20 0.2771Large residential 2.42 1.93 0.7975Small general services 2.13 2.28 1.0704

306 Liberalisation and privatisation of the Thai power sector: issues and perspectives

Average tariff rate (baht/kwh)

Consumer groups Marginal cost Present tariff Ratio

Medium general services 1.82 1.71 0.9396Primary 1.82 1.66 0.9121Secondary 1.85 1.94 1.0486

Large general services 1.62 1.51 0.9321Sub-transmission 1.55 1.44 0.9290Primary 1.71 1.59 0.9298

Specific business 1.76 1.64 0.9318Sub-transmission 1.54 1.60 1.0390Primary 1.79 1.64 0.9162Secondary 1.76 1.72 0.9773

Government and non-profit 1.81 1.70 0.9392Sub-transmission 1.57 1.48 0.9427Primary 1.76 1.65 0.9375Secondary 2.00 1.87 0.9350

Agricultural pumping 1.89 1.17 0.6190

Source: As for Table 14.2.

Table 14.4 compares the final ‘compromised’ tariff rates, which yield an 8 per centrate of return on revalued assets for the whole power sector, with the marginal costsby customer groups. With the exception of the residential group and the agriculturalpumping group, the average tariff rates for other consumer groups account for over90 per cent of the marginal costs. The average tariff rate for the country isapproximately 80 per cent of the marginal costs.

The 1991 tariff contains an automatic adjustment to energy charges based on the1989 fuel prices. These are adjusted whenever there are changes in fuel prices, cost ofpurchased power, value added tax, property tax and the cost of demand-sidemanagement programmes.

Changes in the above items are monitored continuously by the working group set upby the sub-committee on energy policy formulation referred to earlier. Wheneverchanges in the cost of these items result in increased energy charges of more than 2satang/kwh, the latter are adjusted accordingly, as are the charges to consumers.Approval from the sub-committee on energy policy formulation is not required, asexplained earlier.

The uniform retail tariff policy implies financial difficulties for PEA and financialwindfalls for MEA. This financial imbalance is redressed by the transfer pricingmechanism that operates between EGAT, PEA and MEA.

In 1991, in order to balance the rate of return between the three power utilities,EGAT achieved its required bulk tariff of 1.2067 baht/kwh by selling its power toPEA at the rate of 0.9630 baht/kwh and to MEA at the rate of 1.4682 baht/kwh. Ineffect, MEA channels its subsidy to PEA through EGAT’s bulk tariff.

Liberalisation and privatisation of the Thai power sector: issues and perspectives—307

Adjustments in the bulk tariff are made whenever adjustments occur in the retailtariff, after allowing for losses in the PEA and MEA systems. The bulk rate wasadjusted in March 1995 when EGAT’s rate of return began to decline as itsinvestment was greater than expected. Selling prices to MEA and PEA were increasedto 1.4865 baht/kwh and 1.0910 baht/kwh respectively for an average bulk rate of1.2640 baht/kwh.

PRIVATISATION AND LIBERALISATION OF THE POWER SECTOR

The general policy guideline for privatisation and liberalisation insists that suchpolicy must not ‘burden’ the general public. In following this guideline, the EPC,assisted by NEPO, ‘regulates’ the power sector, especially in the areas of powerpurchase price agreements between EGAT and the independent power producers,procurement of fuels for power generation, transfer of pricing between the threepower authorities, and reliability and quality of the power system (National PolicyOffice 1996a, p. 28). In practice, all the working groups that deliberate on theseissues under the direction of the EPC have NEPO representatives as members.

Privatisation of power generation

Under EPC policy guidelines, the 1968 EGAT Act, which governs the operation ofEGAT, was amended in 1992 to pave the way for privatisation of EGAT. In line withgovernment policy, EGAT has been directed to:

• divest some of its power plants to its own subsidiary company, which may issue shares on the stock exchange;

• purchase electricity from small power producers; and

• purchase electricity from independent power producers.

The amended Act allows EGAT to set up a subsidiary company through which a jointventure with the private sector may be formed. Currently, EGAT has a subsidiarycompany — the Electricity Generation Company (EGCO) — through which it holdsall shares initially. At the end of 1994 EGAT sold its 4 x 308 MW Rayong combinedcycle power plant to EGCO. In January 1995 EGCO shares were divested on theThai stock exchange, which reduced EGAT’s shareholding to 48 per cent.

Divestiture of EGCO’s shares on the Thai stock exchange will help alleviate publicsector investment in the power sector and reduce pressure on the foreign borrowingsceiling.2 Share divestiture will also transform EGCO into a private company.

Currently, EGAT is contracted to purchase electricity from EGCO at 1.07 baht/kwhfor a period of 20 years. The contract allows for adjustments to the purchase price asa result of inflation. EGCO also has an option to purchase the Khanom power plant.

308 Liberalisation and privatisation of the Thai power sector: issues and perspectives

It is expected that negotiations on the Khanom purchase will be concluded in thenear future.

In addition to setting up a subsidiary company, EGAT is planning to reorganise itsoperation into six business units (transmission system, power plant, maintenance,lignite mining, engineering and construction) and five operative units (policy andplanning, accounting and finance, administration, business development andhydroelectric power).

The six business units will operate like private companies and EGAT will initially bethe sole shareholders in these companies. Eventually, the business unit shares, withthe exception of the transmission business unit, will be offered to the public on theThai stock exchange. The transmission business units and the five operative units willremain under EGAT and retain their state enterprise status.

Privatisation of power distribution

The MEA and PEA are currently undergoing restructuring. In 1995 Cabinetapproved, in principle, restructuring of PEA as proposed by the Southern ElectricInternational (1995) study.

The Southern Electric International study recommended that PEA be reorganisedinto four regional distribution companies, in the form of subsidiaries. PEA will be thesole shareholder of these companies. The restructuring of PEA requires that the 1960PEA Act, which governs the operation of PEA, be amended. Since amendment of theAct is likely to be a time-consuming process, restructuring of PEA is not expected tobe completed in the near future. MEA was also planning to restructure and wasexpected to submit a plan for Cabinet approval by the end of 1996.

Liberalisation

Under the amended EGAT Act, private power producers (PPP) are allowed togenerate power and sell their output to EGAT. PPPs are of two kinds: small powerproducers (SPP) and independent power producers (IPP). The SPPs produceelectricity from renewable energy such as wind energy, solar energy, mini-hydroplants, agricultural waste or production waste, transformed products such as rice-husks, bagasse, biogass, municipal waste or dendothermal fuels (supplemented to theextent of less than 25 per cent of total thermal energy by commercial fuels) and fromco-generation processing.

Under the EPC’s general guidelines on power purchase agreements, EGAT’s ‘avoidedcosts’ and the purchasing price structure must be used as a basis for such agreementso as to avoid case-by-case negotiation (National Energy Policy Office 1988b, p. 36).In order to promote fair competition, the EPC has also directed that the tax structure

Liberalisation and privatisation of the Thai power sector: issues and perspectives—309

and incentives given to the SPPs and IPPs must be compatible with those of EGATin the calculation of financial costs.

The sub-committee on energy policy formulation has set up an IPP selection sub-committee to screen and select projects submitted by the IPP. The sub-committee ischaired by the governor of EGAT, with members comprised of representatives fromNEPO, NESDB and the Fiscal Policy Department, with the deputy-governor ofEGAT acting as the sub-committee secretary. The selection of SPPs is EGAT’sresponsibility.

Small power producers

EGAT began to solicit power from SPPs in 1992. Initially, the maximum purchasefrom a given SPP was set at 50 MW but later was increased to 60 MW (NationalEnergy Policy Office 1994a, p. 16). An SPP wishing to sell power in excess of 60 MWwill be considered on a case-by-case basis. In any event, the purchase limit may notexceed 90 MW. A qualifying SPP must adhere to technical and other conditions asstipulated by EGAT (National Energy Policy Office 1996b, pp. 12–27). Total powerpurchased from SPPs was limited to 300 MW in 1992 but later was raised to 1,444MW and then to 3,200 MW in 1996. EGAT has also announced a schedule of pricesfor power purchased from SPPs. Prices depend on duration of contracts, whichtypically vary from less than five years to 25 years (see Table 14.5).

Table 14.5 Contract duration and capacity payments

Contract duration Payment

5 to 10 years 164 baht/kw/monthMore than 10 years but less than 15 years 204 baht/kw/monthMore than 15 years but less than 20 years 227 baht/kw/monthMore than 20 years but less than 25 years 302 baht/kw/month

The energy price is set at 0.85 baht/kwh. Producers with non-firm contracts of lessthan five years do not receive capacity payments; rather, they receive energy prices of0.87 baht/kwh. Initially, price adjustments are made on the same basis as adjustmentsmade to energy charges for medium and large general service retail customersregardless of the SPP’s fuel types.

These adjustments were later modified to better reflect changes in the SPPs fuel costs,and these depend upon the fuel type used by the SPP. Adjustments formula exist fornatural gas, fuel oil, coal and lignite. Energy payments are adjusted if the actual fuelprices deviate from the benchmark price set on 1 August 1995. In the event that anSPP uses other types of fuel, it may select either the adjustment which follows fromthe adjustment of energy charges in the retail tariff or the fuel oil adjustment formula.The selected formula in this case will be used throughout the contract period.

310 Liberalisation and privatisation of the Thai power sector: issues and perspectives

Currently, EGAT purchases 418.6 MW of power from 24 small power producers.Nineteen of the SPPs are non-firm producers with a combined capacity of 174.6MW. The remaining 244 MW of power comes from firm producers.3

Independent power producers

During the period 1997 through 2002, the IPPs are expected initially to contribute4,200 MW of power capacity. However, it is expected that power consumption willincrease at a faster rate than predicted in EGAT’s power development plan for 1995to 2001 (National Energy Policy Office 1996c, pp. 7–9).

In anticipation of increases in power demand, the EPC asked EGAT and NEPO toconsider the possibility of expanding power purchases from IPPs, after the SPPpurchase limit increased to 3,200 MW. In response to this EPC directive, EGAT andNEPO revised their power purchase plan involving IPPs (see Table 14.6).

Revision of the IPP power purchase plan will increase total system capacity to 34,109MW in 2003 to satisfy 25,506 MW of demand, which implies a reserve margin ofabout 25 per cent.

Table 14.6 Revision of the IPP power purchase plan (MW)

Period Initial purchase plan Revised purchase plan Total

1999–2000 1,400 300 1,7002001 2,800 0 2,8002002 0 700 7002003 0 600 600Total 4,200 1,600 5,800

Source: National Energy Policy Office (1996c, p. 8).

The IPP must meet the technical conditions specified by EGAT. The duration of thecontract must be between 20 and 25 years and the power plant must be a base loador intermediate load plant with a capacity not greater than 1,400 MW. There is someflexibility with respect to the selection of fuel used by the IPP. Unconventional fuel(except nuclear), local natural gas with a firm contract with the Petroleum Authorityof Thailand (PTT) or producers, imported natural gas (LNG), local lignite, importedcoal and lignite, fuel oil, and orimulsion can be used for power generation (NationalEnergy Policy Office 1994b). The IPP is also required to meet official environmentalstandards as laid down by the government. EGAT has specified additionalenvironmental standards where no official standards exist — for example, in relationto sulfur dioxide content in the atmosphere.

The IPP may select its project site, though EGAT’s preference is for the followingseven sites (in descending order): the central region (Monenco 1991) (upperBangkok: Saraburi, Lopburi, Ang Thong, Singburi, Ayuddhaya, Nakhon Nayok), thewest coast of Thailand (Prachuap Kirikarn, Petchaburi, Samut Sahhon, Samut

Liberalisation and privatisation of the Thai power sector: issues and perspectives—311

Songkram), and the east coast of Thailand (Cholburi, Rayong, Chanthaburi, PrachinBuri, Srakaew), and other regions.

Contrary to the SPP case, where EGAT announced the power purchase prices, IPPsare required to propose power purchase prices themselves. Power purchase prices willbe on the basis of a two-part tariff with an availability component estimated inbaht/kw/year and an energy component measured in baht/kwh.

The availability component will cover capital investment of IPP projects, fixedoperating and maintenance (O&M) expenses, including spare parts, and returns onshareholder equity. The availability component is compatible with demand charges inretail tariffs. The energy component will cover energy expenses for generation,including variable O&M. The energy component is compatible with energy chargesin retail tariffs. The IPP is also required to submit its method or formula foradjustment to energy charges when changes occur in the relevant energy prices.

The IPP selection sub-committee will consider proposed power purchase prices andnon-price factors, attaching a 60 per cent weight to the proposed power purchaseprice and a 40 per cent weight to non-price factors. The weight attached to the non-price factor is disaggregated into 25 per cent for project viability, 4 per cent for choiceof fuel and fuel diversity, and 11 per cent for other factors.

The 25 per cent weighting for project viability may be disaggregated further into 11per cent for level of development, 7 per cent for financial status and ability to arrangethe bidder’s financing, and 7 per cent for the bidder’s experience. The 11 per centweighting attached to other factors is diaggregated into 6 per cent for site locationand 5 per cent for proposed exceptions to the specified conditions of theannouncement. The selection committee reserves the right to reject all proposedprojects. Upon completion of selection, the committee will present the results to theEGAT board of directors for approval.

The process of electricity solicitation by the IPPs began in December 1994 andinitially called for a total capacity of 3,800 MW, to be increased later to 4,200 MW.All IPP project plans were to be submitted to EGAT by June 1995. By the end ofJune, EGAT had received bids for 50 projects from 32 international consortia with atotal capacity of 37,500 MW. EGAT has screened 21 projects for furtherconsideration.

The first-round screening resulted in 13 projects bidding for first-phase sales(1999–2000) with total capacity of 6,184 MW and eight projects bidding for second-phase sales (2002) with total capacity of 8,250 MW. In terms of chosen fuel, naturalgas has been nominated in 16 of the proposed projects; lignite in four of the projects;with the other project proposing to use orimulsion. Currently, EGAT has short-listedthe bids to eight consortia, and is currently planning to implement in mid-1997 asecond round of power solicitation from IPPs in accordance with the revised purchaseplan.

312 Liberalisation and privatisation of the Thai power sector: issues and perspectives

Power purchase between power authorities and other producers

Before the amendment of the EGAT Act, power could only be purchased fromEGAT. Amendment of the EGAT Act now allows EGAT to purchase power fromSPPs, IPPs and from its own subsidiaries. The power purchase agreement betweenEGAT and EGCO also allows EGCO to sell its electricity directly to third partiessubject to EGAT’s approval.

Similarly, the SPPs and the IPPs are allowed to sell their electricity directly to thirdparties in surrounding areas at unregulated prices. However, they are not allowed tosell power directly to MEA and PEA. These two distribution authorities are stillrequired to buy power directly from EGAT.

The EPC has considered the possibility of allowing the PPPs to sell power directly tothird parties through a common carrier or the power authorities’ lines and to pay therelevant power authorities for this right. However, liberalisation of distributionactivities is not expected in the immediate future.

Figure 14.2 Power system before and after privatisation

BEFORE

AFTER

Other*

*Laos and Cambodia

EGAT

MEA PEADirect

customers

Customers Customers

EGAT

Directcustomers PEA

IPP

SPP

Other sub.

P1 P2 P3 P4

Customers Customers

Sales tocustomers insurroundingareas

Other

EGCO

MEA

Liberalisation and privatisation of the Thai power sector: issues and perspectives—313

Figure 14.2 compares the generation and distribution systems before and afterprivatisation and liberalisation of the power sector. In addition to its own generation,and purchases from Laos and Malaysia, privatisation and liberalisation has enabledEGAT to purchase power from EGCO, SPPs, IPPs and other future subsidiaries.

POSSIBLE EFFECTS OF PRIVATISATION AND LIBERALISATION

Effect on service costs

The Thai economy stands to gain if liberalisation and privatisation in the powersector induce lower service costs, which will result in lower long-run marginal costs.The efficiency gains from liberalisation and privatisation may be evaluated bycomparing the power purchase prices between EGAT and other power producers withEGAT’s avoided service costs.

EGAT’s avoided costs, the basis for power purchase prices, should be the cost ofservice that can be avoided by EGAT, if a given power plant using a least cost poweris replaced by another producer’s power plant. For example, if EGAT identified apower plant of a successful IPP as a replacement for the South Bangkok power plantin Table 14.2, the avoided capacity costs would be the South Bangkok capital cost ofx baht and the fixed O&M cost of y baht/kw. These costs should allow for powerlosses compatible with EGAT’s corresponding losses at an 8 per cent discount rate,the rate which is used in marginal cost estimation.

Effect of power purchases from SPPs

In solicitating power from an SPP, EGAT’s announced capacity component of thepower purchase prices increases with the length of the contract and no capacitypayments are offered for contracts under five years. The structure of the announcedSPP power purchase price is compatible with the structure of EGAT’s avoided costs.If a typical power plant takes approximately five years to commission and has a usefullife of 25 years, then an SPP contract of less than five years implies that no EGATplant in its power development plan can be replaced during this contracted period. Acontract of less than five years enables EGAT to prolong the commissioning of itspower plant for five years. EGAT thus avoids only energy expenses when it buyspower from an SPP under this contract. After the end of the five-year contract, EGAThas to commission its own power plant. Thus, avoided energy costs only exist for lessthan five-year contracts, which is interpreted to be the short-run marginal energycost.

For a contract of more than five years — for example, a 15-year contract — EGAT’spower plant would have been commissioned and in operation for about 10 years inthe absence of an SPP contract. In this case, there are avoided capacity costs as wellas avoided energy costs. However, the capacity payment would be equivalent to the

314 Liberalisation and privatisation of the Thai power sector: issues and perspectives

avoided power plant for only 10 years. Full capacity payments will be offered for acontract of more than 20 years, since, in this case, SPP power will be equivalent toEGAT’s avoided plant for its entire life.

For a contract of over 20 years, the avoided cost is based on EGAT’s AIC adjusted to1992 prices, being the average for the whole power system. It is assumed that theavoided transmission costs for EGAT are insignificant so that EGAT’s avoided costsare considered to be generation costs.

The AIC for EGAT’s capacity of 291 baht/kw/month in 1989 prices includestransmission costs. Removal of the transmission component results in a generationcomponent of 210 baht/kw/month. Since the AIC allows for a 15 per cent reservemargin for capacity, the reserve margin component is removed because the SPP is notrequired to provide a reserve margin in its proposal.

The AIC is computed on an economic basis — that is, no transfer payment items areconsidered as costs, so it is adjusted for transfer payments that are compatible withEGAT’s corresponding items. EGAT’s transfer payments include import duties,‘bonuses’, and remittances to the Ministry of Finance. Table 14.7 summarises EGAT’savoided costs used as a basis for SPP power purchase prices.

As SPP power purchase prices were announced in 1992, the values in Table 14.7 wereadjusted to 1992 prices. It should be noted that announced capacity payments for 20to 25-year contracts are the same as EGAT’s full avoided costs. Capacity payments forcontracts of less than 20 years but greater than five years are adjusted according to theduration of the contract. It should also be noted that energy payments are lower thanEGAT’s avoided energy costs.

Table 14.7 Avoided costs for SPPs (1989 prices)

Short-run Long-run Long-run Items MCe a MCe MC pb

Generation 0.749 0.680 210Delivered to transmissionc 0.773 0.708 218.7Removal of reserve

margind 0.773 0.708 190.2Inclusion of taxes 0.889 0.770 206.9Remittance and bonus 0.889 (1.175) 0.770 (0.899) 258.6 (302.2)

Notes: Figures in parentheses are values in 1992 prices.a MCe = marginal energy cost in baht/kwh.b MCp = marginal capacity cost in baht/kw/month. Adjusted for reserve margin of 15

per cent or 218.7/1.15.c Losses allowed are slightly lower than used in the national AIC computations.d Adjusted for reserve margin of 15 per cent or 218. 7/1.15.

Source: As for Table 14.2.

Liberalisation and privatisation of the Thai power sector: issues and perspectives—315

Announcement of SPP power purchase prices implies that a given SPP is competingwith the EGAT system and not directly with other SPPs. If the purchase prices areannounced as maximum limits and the SPP is required to submit a price bid, EGATcan select a group of projects affecting the lowest price bids, which would promotecompetition within the SPP group and increase generation efficiency.

It should also be noted that the announced power purchase prices are based onEGAT’s AIC for generation, which is the average AIC for the whole power system.The power purchase prices based on this AIC are simple to administer since theseprices apply to all SPP projects. However, the use of the national AIC as a basis forpower purchase prices may lead to increases in service costs imposed on powerconsumers, for a number of reasons.

EGAT must still commission its own power plants to complete the generation system.In the event that an SPP power plant replaces an EGAT power plant with marginalcosts lower than the national AIC but purchased at the national AIC, EGAT mustcommission the remaining power plants in the system with higher marginal coststhan the national AIC. In this case, when EGAT’s power is combined with the SPPpower purchased at the national AIC, service costs to consumers will be higher thanthe costs prior to liberalisation.

In order to avoid this scenario, EGAT needs to identify and announce which of itspower plants can be replaced by SPP power plants, along with costs. This willcorrespond to the avoided costs as defined above and may be used as power purchaseprices for the SPP. However, this pricing method will be more complex to administerthan the method that uses a uniform AIC for power purchase prices.

Effect of power purchase from EGCO

Privatisation led to the setting up of EGCO, an EGAT subsidiary on the generationside. EGCO purchased a Rayong combined cycle power plant from EGAT and is nowa public company with shares traded on the Thai stock exchange. EGAT purchasespower from EGCO at 1.07 baht/kwh. The Rayong power plant was not constructedby EGCO but was originally in EGAT’s power development plans and has alreadybeen commissioned. Thus, privatisation in this case simply denotes transfer ofownership from EGAT to EGCO, which is managed and run largely by formerEGAT personnel.

In terms of avoided costs, the Rayong power plant is simply substituted in EGAT’spower development plan. The purchase price of 1.07 baht/kwh is slightly higher thanthe marginal cost under EGAT as a result of ‘transaction’ costs. The benefits ofprivatisation lie in the alleviation of foreign public borrowings in the power sectorfrom the trading of EGCO shares on the Thai stock exchange.

316 Liberalisation and privatisation of the Thai power sector: issues and perspectives

Effect of power purchase from IPPs

Since IPPs are required to submit price bids, EGAT needs to compare these bids withits avoided costs, as defined above. If the purchase price agreement between EGATand the IPPs is equal to the avoided costs, the long-run marginal costs will remainedunchanged. In this case, service costs to consumers will also remained unchanged.Gains in efficiency may be realised if the power purchase prices are lower thanEGAT’s avoided service costs.

If the avoided costs as defined above are not used as benchmarks for IPP powerpurchase prices, the resulting power price purchase agreement may affect the servicecosts to final consumers. If one uses, for simplicity, the long-run marginal costs of thesystem computed by the AIC approach as in the SPP case, service costs to powerconsumers may increase for the reason explained above in the SPP case.

In the case of IPP power solicitation, projects are over 20 years long and their powerplants are more compatible with EGAT’s power plant. It should be relatively simpleto identify which of EGAT’s power plants will be replaced by compatible IPP powerplants. EGAT may formally publish its power development plan with information onpower plant costs by plant types and sites. Such information assists the IPPs in plantselection and in preparing their price bids.

EGAT can now solicit power from IPPs by plant types and sites. The focus ofcompetition between the IPPs will now be by plant type, where the selectioncommittee may select the IPP, ceteris paribus, with the potential to substitute a givenplant in the power development plan and offer the lowest price. For example, if twoIPP lignite-fired projects exist that have potential to substitute for EGAT’s lignite-fired power plant A with capital investment of B baht in the power development plan,the power purchase price should not be higher than the avoided cost of B baht. TheIPP with the lower price bid, ceteris paribus, will then be awarded the contract tosupply power. These prices may be adjusted for transfer payment items as in the SPPcase.

If this approach is adopted, the purchase price will be based on avoided costs asdefined above. When the IPP’s power is combined with EGAT’s own power, the long-run marginal costs, as computed by the AIC, will at least remain unchanged.

Viability of the SPP/IPP projects

Even though SPPs do not compete with IPPs, the former have an advantage inevaluating projects from the outset since they know exactly what price is being offeredfor the projects’ power, whereas the IPP under the current bidding process is requiredto propose a purchase price, which adds more uncertainty to the project. Since SPPprojects are on a much smaller scale, and SPP fuels are based on residual fuels such asbagasse, their commercial fuel requirements are less critical than those of the IPPs.

Liberalisation and privatisation of the Thai power sector: issues and perspectives—317

The viability of an IPP project depends upon cost, the ability to manage risksassociated with power plant operations, control of losses in the power system,procurement of fuel supplies, and the power purchase price agreement reached withEGAT and third parties.

The cost to an IPP with no link to a capital market is likely to exceed thecorresponding cost sustained by EGAT. The IPP’s higher costs may be offset to acertain extent, if it is correct to assume that the IPP’s more flexible organisationimplies relatively more efficient project management. More efficient projectmanagement may lead to reduced power losses, lower investment cost and better riskmanagement in relation to fluctuations in the foreign exchange market, for example.

One possible bottleneck for the IPPs lies in a lack of trained power plant operatorsand technicians, since IPP projects are relatively new in Thailand. Initially, personnelare likely to be expatriates or ‘imported’ from EGAT, which exacerbates thepublic–private sector ‘brain drain’ problem. The lack of trained personnel mayincrease power plant operating costs, which is detrimental to an IPP’s efficiency.

Procurement of energy supplies is another issue that needs to be addressed. Naturalgas and lignite are the two major fuels in the power sector. Before the commencementof IPP projects, EGAT mines its own lignite, which is priced on the basis of itsmarginal cost. The marginal cost of lignite is used as a basis to compute the marginalenergy cost. An IPP with a lignite-fired power plant will be hard-pressed to securelignite supplies that are competitive with EGAT’s, unless it mines its own lignite. Inaddition, installation of scrubber systems is required so as to protect the environment,which will raise the capacity cost of the plant.

Procurement of natural gas prior to privatisation approximates to a bilateralmonopoly, where EGAT purchases natural gas only from the Petroleum Authority ofThailand (PTT). If IPPs with gas-fired power plants purchase natural gas solely fromthe PTT, the situation approximates a monopoly market where the relatively largernumber of IPPs tends to weaken their bargaining power. Attempts to secure naturalgas such as LNG from external sources are likely to raise marginal energy costs.

Effects on power authority

Power sales among the IPPs, SPPs and third parties impact on the financial positionsof the power authorities. Third-party power sales by IPPs and SPPs will lower theamount of power that EGAT sells to MEA, PEA and to its direct consumers, whichin turn implies similar decreases in the amount of power sold at the retail level.

Reduction in the amount of wholesale power affects EGAT’s financial position. Bulktariffs under privatisation are based on the ‘average’ marginal costs of generation andtransmission of EGAT’s system and purchased power from the IPPs and SPPs.Assuming that power from the IPPs is purchased at EGAT’s avoided costs, themarginal cost-based bulk tariff would remain unchanged. In this scenario, reductions

318 Liberalisation and privatisation of the Thai power sector: issues and perspectives

in EGAT’s own generation levels due to the IPPs’ third-party sales will depress its netprofits due to lower power sales.

Assuming that the rate of EGAT’s investment declines in proportion to the rate ofincreases in its own power generation, the rate of return for EGAT may not besignificantly affected, and hence the bulk tariff may be compatible with the levelattained prior to privatisation.

Initially, the rate of EGAT’s investment may fail to match the reduction in its shareof power generation. In this event, EGAT will experience a decline in its rate ofreturn, which will necessitate adjustments in the bulk tariff to a level that generatesthe required rate of return. The higher bulk tariff will then be passed on to finalconsumers through a higher retail tariff. Even if the purchased power from the IPPsincreases the average marginal costs of service, the higher costs may still be passed onto the final power consumers.

Power sales between IPPs and third parties may affect the financial positions of thedistribution authorities, even if a higher bulk tariff is passed on to final consumers.Third parties that power purchase directly from the IPPs consist of large industrialand business consumers with relatively high load factors.

Currently, the tariff rates of these consumers are over 90 per cent of the marginalcosts. Logically, these consumers will purchase power from the IPPs if the agreedprices are at least equal to current tariff rates. Reduced power purchases by theseconsumers will lower the system load factor.

Large industrial and business consumers fall under the two-part tariff, with itsdemand and energy charges. Monthly revenue from power sales is the sum of revenuegenerated from the demand and energy charges. In order to illustrate the effect of achange in load factor on the distribution authorities, the energy charge in baht/kwhis converted to baht/kw by the relationship baht/kw = (baht/kwh)(kwh/kw) =(baht/kwh)(L)(730 hours), where L is the load factor and 730 is the number of hoursin one month. The monthly revenue per kilowatt is thus R=DC+EC(730L) where Ris the total revenue from power sales per kilowatt, DC is the demand charge revenue,and EC denotes the energy charge revenue.

A one percentage change in load factor would lower total revenue per kilowatt by thepercentage change equal to

where L and R are the mean load factor and total revenue respectively. As an example,consider PEA’s marginal capacity cost-based demand charge of 428 baht/kw/monthand marginal energy cost-based energy charge of 0.7922 baht/kwh at the primarylevel. Since the PEA load factor is about 63 per cent, a 1 per cent drop in the loadfactor will lower revenue by 730(0.7922)(0.63)/792.33 or 0.46 per cent.

dR

dl

L

REC

L

R

.= 730 .

Liberalisation and privatisation of the Thai power sector: issues and perspectives—319

Losses in the distribution authorities’ revenue due to deterioration in the system loadfactor may not be passed on to the remaining consumers under the existing automaticadjustment clause. These revenue losses will eventually constitute another transferpricing issue.

Under the present legal framework, MEA and PEA are not allowed to purchase powerdirectly from the IPP, which affects the distribution of benefits among the threepower authorities. If the distribution authorities are allowed to purchase powerdirectly from IPPs with lower marginal costs than EGAT, some of the benefits will betransferred from EGAT to the distribution authorities.

SUMMARY AND CONCLUSIONS

Privatisation and liberalisation of the Thai power sector only started in the early1990s and focused chiefly on generation. This is not unexpected, however, given thefast growth of EGAT’s investment, which has exerted pressure on the externalborrowing limits of the public sector. In addition to alleviating the public sectorinvestment and hence pressure on the public foreign borrowing ceiling, it is expectedthat privatisation and liberalisation will also promote competition and efficiency; andthis, hopefully, will lead to lower service costs for power consumers.

Privatisation of the power sector has focused on EGAT, which has set up EGCO asits subsidiary company. EGCO operates like a private company, with its shares tradedon the Thai stock exchange. EGCO has since purchased a Rayong combined cyclepower plant from EGAT which is in EGAT’s development plan and has already beencommissioned.

In addition to setting up subsidiary companies, EGAT is restructuring five of itsbusiness units now operating as private companies, while its remaining operatingunits still retain their state enterprise status. Since this reorganisation is still in its veryearly stages, it is premature to evaluate its effect in relation to service costs. PEA andMEA are also undergoing reorganisation, though they have both retained their stateenterprise status.

Liberalisation also focuses on the generation side of power supply. EGAT can nowpurchase power from its own subsidiary company, as well as from the SPPs and IPPs.SPP power purchase prices are published along with power purchase announcements.Published prices are based on EGAT’s avoided costs, which is in fact the AIC used innational tariff design. IPPs are required to state their own power purchase prices ifthey wish to sell power to EGAT. It is not clear which definition of avoided costsshould be used as a basis for IPP power purchase agreements.

No liberalisation has yet been undertaken in the area of distribution, however. TheIPPs and SPPs are required to sell power to EGAT and to consumers in theirsurrounding areas. They are not allowed to sell power directly to MEA and PEA. TheEPC is considering allowing private power producers to sell power to consumers via

320 Liberalisation and privatisation of the Thai power sector: issues and perspectives

a common carrier using MEA and PEA lines, but this is not likely to materialise inthe near future.

It is premature to evaluate the effects of liberalisation and privatisation of the powersector on service costs to consumers and distribution of benefits between the powerauthorities, the private power producers and consumers. However, some observationscan be made. First, the sale of the Rayong power plant to EGCO does not promotecompetition since it involves transfer of ownership of an already-commissioned powerplant from EGAT to EGCO. In addition, the transaction costs of power plant salesare likely to increase service costs slightly. The major beneficiary at this point appearsto be the public sector, with the advantage to be obtained from reduced foreignborrowing.

Power purchase prices for SPP projects are transparent since EGAT announces these.However, the AIC computed for the national tariff, which forms the basis of the SPPpurchase prices, may not provide an appropriate basis for power purchase prices sinceit could lead to higher service costs.

EGAT needs to publish its power development plans with relevant costs. Such anannouncement would provide a benchmark to help private power producers evaluateprojects. In addition, if EGAT is able to identify which of its plants could be replacedby SPP power, its actual avoided costs, and not average avoided costs, may bedetermined and used as basis for power purchase prices. No competition exists amongthe SPPs since all projects received are subject to the same prices regardless of theircost. In order to promote competition, SPPs should be required to submit price bids.

The announcement of EGAT’s costs by plant type and site will also help the IPPsevaluate projects. In this manner, the avoided cost of contracting a particular IPPplant can be determined and the power purchase price based on this avoided cost willmake sure that service costs, at least, remain at a level prior to liberalisation.

Power sales between IPPs, SPPs and their consumers in surrounding areas atunregulated prices contradict uniform tariff policy. This policy will tend to worsenthe financial position of MEA and PEA, which will raise the issue of transfer pricingbetween the three power authorities. The financial positions of MEA and PEA mayimprove, however, if they are allowed to purchase power directly from the SPPs andIPPs.

The EPC needs to address the consistency of the uniform national tariff and theanticipated financial difficulties of MEA and PEA in future expansion of IPP, SPPand third-party sales.

In the near future, more subsidiaries, including more IPPs and SPPs, will participatein power sector activities. Sales by EGAT of commissioned power plant to itssubsidiary, as in the Rayong case, should not be allowed. These subsidiaries must bemade to compete with other IPPs on the same basis.

Liberalisation and privatisation of the Thai power sector: issues and perspectives—321

In order to support the EPC’s directive that privatisation and liberalisation should notlead to more financial burdens on power consumers, the effects of current powerpurchase prices by the SPPs and IPPs on service costs needs to be evaluated andreviewed — and in the very near future.

NOTES

1 This is because marginal cost is greater than average cost.2 However, it is not clear whether privatisation will reduce total foreign borrowings, being

the sum of private and public borrowings.3 Power purchase contracts of over five years are regarded as ‘firm’, whereas power purchase

contract under five years are regarded as ‘non-firm’.

REFERENCES

Lorchirachoonkul, Vichit and Thiraphong Vikitset (1986) Thailand Power Tariff Structure,Report Submitted to the National Energy Administration, Bangkok.

Monenco (1991) (in association with NIDA), Marginal Cost Based Electric Power Tariff,Report submitted to the National Energy Office, April.

National Energy Policy Office (1988a) ‘Policy guidelines for private power producers’participation in the power sector’, Energy Policy Journal, November.— (1988b) ‘Guidelines for private participation in power generation’, Energy PolicyJournal, November. — (1989a) ‘Policy guidelines for private power producers’ participation in the powersector’, Energy Policy Journal, June–July.— (1989b) ‘Changing the status of NEPO into a department’, Energy Policy Journal,June–July.— (1994a) ‘Revisions of purchase conditions from SPPs’, Energy Policy Journal,October–December. — (1994b) ‘Policy of power solicitation from IPPs’, Energy Policy Journal, April–June. — (1996a) ‘Policy guidelines for restructuring the power sector’, Energy Policy Journal,January–March. — (1996b) ‘Power solicitation from SPPs’, Energy Policy Journal, July–September.— (1996c) ‘Revision of power solicitation from IPPs’, Energy Policy Journal,July–September.

Southern Electric International (1995) Feasibility Study for Privatisation of ProvincialElectricity Authority, Report submitted to the Provincial Electricity Authority, February.

15 Summary of discussion

Heather Smith

The discussion at the Twenty-third Pacific Trade and Development (PAFTAD)Conference echoed the wider themes of the conference: alternative systems ofindustrial organisation; the nature of competition law and competition policy; therelationships between competition policy and trade policy in the Asia Pacificeconomies; and liberalisation, deregulation and privatisation. The relevance of thesefor the Asia Pacific Economic Cooperation (APEC) forum, for which competitionpolicy is one of 15 specific areas for APEC action plans, underlay much of thediscussion.

SYSTEMS OF INDUSTRIAL ORGANISATION

In focusing on alternative business systems, participants discussed the evolution ofbusiness systems in the Asia Pacific—whether and to what extent business systemswould converge as firms became more market-oriented. Wendy Dobson’s openingpaper set the scene by presenting a conceptual framework from which to analyse andcompare different types of relations-based business organisations in Asia and theirevolution over time. Peter Petri extended this by contrasting national competitivesystems and performance among Organisation for Economic Cooperation andDevelopment (OECD) economies. A prominent theme drawn out by Justin YifuLin’s paper, and one that underlay much of the discussion, was the role of the state ininfluencing business systems.

Issues of convergence

While recognising the high degree of diversity of Asian business systems, discussioncentred on the future evolution of business systems and the issue of convergence —whether market forces would bring about more convergence between ‘Western’ and‘Asian’ firms. While participants differed on the degree of convergence of variousbusiness systems, overall the consensus was that there would be no convergencetowards a single equilibrium.

Some participants took issue with Dobson’s distinction of drawing a line between‘Asian’ and ‘Western’ business systems. Akira Kohsaka considered Dobson’s

Summary of discussion—323

dichotomy of business systems of ‘Western’ and ‘Asian’ as somewhat brutal. Kohsakasaw the dichotomy not so much one of geography or culture but rather as stages ofdevelopment or industrialisation. Peter Drysdale, on the other hand, thoughtDobson’s dichotomisation may be the best way to approach the subject because itchallenged the way we think about business organisations in Asia. There was, he said,no question that Asian countries have different corporate organisations and businessnetworks, so maybe there were no generalisations that could be made except in thecontext of the evolution of corporate and organisation structures in the dynamic ofindustrialisation. Dobson stuck by her distinction because she saw it as a usefulstarting point from which to observe the evolutionary question of what happenswhen governments exit the market. Petri, Justin Lin and Merit Janow also foundsharp characterisations useful because, as Ralph Huenemann remarked, the blurringof boundaries of definitions bedevilled any useful empirical research.

For several conference participants, thinking of the evolution of business systems in adevelopmental context was a useful starting point from which to examine howbusiness is organised in different countries and how that may affect the operation ofthe market or the nature of competition. John Ure and Steve Parker stressed theimportance of viewing the reform of business networks from a historical perspective,but in the context of developmentalist factors in political systems as conditioningbehaviour. Dobson thought family-owned enterprises, in lacking imperfect legalsystems and imperfect factor and product markets, tended to work with those withwhich they can create sanctions and informal relationships (trust). Kohsaka cited theJapanese experience, where in the early stages of industrialisation when financialsystems were not well developed, it was natural for corporate groups to concentratearound centres of financing that could establish the institutional structures tomobilise savings. However, Kohsaka, along with Hugh Patrick, regarded the implicitcontract and trust-based relationship as not unique to Asia but intrinsic to developingcountries in general as a means to minimise risks and save transaction costs. Family-owned conglomerates, Patrick pointed out, were the norm in all countries, so therewas a common historical dynamic whether it was Germany or Korea. Conglomerateschange over time, particularly as they require finance. With generational change,questions of professional management also become important.

Nonetheless, weak Asian legal systems in influencing the institutional evolution ofbusiness structures was still obviously important. Parker saw weak legal systems ashaving developed primarily for political reasons. Strong executive branches did notwant a strong judiciary system that could overrule their mandate. For this reason,Parker argued, Asian legal systems would remain weak, offering limited reliability forcommercial dispute settlement. Patrick identified the major problem in business asthe risk of trusting others, noting that the formation of relationships engenderedtrust. Strong legal systems ameliorated but did not eliminate the need for trust

Several participants drew on their own country experience to highlight both thediversities of business relations and the problems associated with various types of

324 Summary of discussion

business networks. Soogil Young drew attention to the chaebol problem in Korea.Policy-makers and the public, he said, were divided as to the costs and benefits of thechaebol system of business organisation, and whether it should be regulated to preventexcessive diversification or deregulated to cope with globalisation. Young-Ki Lee alsohad in mind the Korean experience when questioning whether market competitionreally did change business organisations given the formation of strategic alliances.Marra Tzu-Han Yang wondered whether Taiwan’s small and medium-sized enterprises(SMEs) firms could really be seen as a network system given their flexibility andcapacity to continually reorganise. Because SMEs were involved in only one or twofunctions, outsourcing was important, a feature which differentiated them fromKorean and Japanese business networks.

There was considerable discussion about how business systems would evolve overtime. Kohsaka considered that the key for understanding this process was to look atthe Japanese keiretsu, which since the early 1990s had come under tremendous stressas they adjusted to the high yen, greater competition from abroad, and the economicdownturn at home. The question was whether the Japanese firms’ centralised controlsystems, which rely on home-based control of core technologies but with highlyintegrated producer and marketing systems, can remain competitive. Will Japanexport their essentially closed production networks from Japan to East Asian regionalproduction and distribution on a competitive basis, or will they have to change theirstrategies and organisational characteristics? On the policy side, will host countriesand third countries like the United States allow them to transfer these closed systems,essentially transferring the US–Japan ‘systems’ trade conflict to a regionalUS–Japanese–Asian network conflict? How Japanese firms react to these pressures tochange will be a key barometer to whether we will see convergence to Western orsome other kinds of business systems.

In also thinking about future evolution, Florian Alburo challenged participants tothink about the convergence of Asian firms with other Asian firms. Parker saw marketand competitive pressures as pushing different countries’ firms to converge in theirbusiness approaches in Asia, including US firms, who clearly operated differently inAsia than in the United States. Mari Pangestu and Steve Parker thought a morenuanced analysis to the one provided by Dobson was required in order to understandthe evolution of conglomerates in the development of Southeast Asia. This wasespecially important because other countries, like Vietnam, were looking for examplesto follow. It was, Parker argued, a more open question than that implied by Dobson— namely, how different are Southeast Asia Chinese conglomerates compared tothose in the rest of Asia? He also disagreed with Dobson that conglomerates ventureoutside the region to diversify risk because the rules in Southeast Asia are not welldefined. In general, Parker noted, the big conglomerates were not frontier investors— rather, the smaller Chinese family firms were. Conglomerates are successfulprimarily where they know the rules of the game and can manipulate them. PoncianoIntal pinpointed the more fundamental issue of government control of factor markets

Summary of discussion—325

(distortions) as to why there were concentrations of business groups in certaincountries.

One indicator of convergence and the evolution of business systems was whether theyare capable of creating innovation. The question in Parker’s mind was whether thekeiretsu and chaebol groups would become leading innovators for the products andtechnologies of the future, or would smaller, more flexible firms be needed. If so, thiswould require major policy changes in Japan and Korea, particularly within financialsystems that would need to provide funding more easily to smaller firms. Po-ChiChen offered the view that while it was not easy for small firms in Taiwan to competein the international market, he was confident that, with their experience of pastcooperation and networks and their flexibility and competitiveness in world markets,they could succeed.

Parker, Dobson and Pangestu all said more study was required in understanding howbusiness strategies are evolving independently of governments and how the evolutionof business structures is likely to impact on government policy process beyondcompetition policy. This, Pangestu added, was because competition policy was asensitive issue in developing Asia, and additional study and consultation was neededto understand how domestic business structures operate before rushing intocompetition policy and the harmonisation of competition law.

Discussion focused on the dynamic evolution of markets and competitive relationswithin them that affect the structure and efficiency of markets over time. In focusingon the Anglo-Saxon extreme of business systems, Petri distinguished between nationalbusiness systems with regard to labour and capital market flexibility, corporategovernance structures and industrial organisations. Petri noted that the flexibility ofthe US system, together with unilateral decision-making systems in corporategovernance, had facilitated the structural transformations of the 1990s. However,Young-Ki Lee questioned the degree to which the wave of mergers and acquisitionsin the 1980s and the flexibility of the US labour and capital market had contributedto the shift of US industries to new technological frontiers. Would the shift not havehappened without mergers and acquisitions, or was the US labour market so tightthat releasing the labour force from traditional sectors was inevitable to fill thedemand for labour in the new sectors? And if US labour and financial markets weremore flexible and efficient relative to other countries during the 1960s and 1970s,why then did the structural adjustment of US industries only take place in the 1990s?

Although Petri’s analysis showed that the US economy was performing well on anintercountry comparison among five OECD countries, Chong-Yah Lim doubted thiswould hold for an intercontemporal comparison between the 1980s and 1990s. SteveParker and Alan Bollard were also unconvinced that the 1990s represents a period ofradical change compared to 1980s. Instead, Parker saw the 1980s as being a period ofrapid change as the United States went through a major revamping of itsmanufacturing sector, while the European Union and Japan resisted change. Supply-

326 Summary of discussion

side responses were also a factor. The 1980s were driven by Japanese competitivenessin consumer goods. This had now shifted, with US consumer demand for consumertechnology leading product standards and driving US innovation andcompetitiveness. More generally, Kohsaka raised the question of how to connecttypologies of different systems to the process of structural adjustment. How much isbusiness cycle and how much is difference in business systems?

Young-Ki Lee saw some US firms as adopting an ‘enterprise’ model of operations thatborrowed from certain Japanese keiretsu practices, specifically the reliance oncooperation among a group of manufacturers, suppliers and finance companies. Incontrast, some Japanese companies are relaxing their ties with suppliers. But althoughmerger and acquisition activities had become more common in Japan, Young-Ki Leethought it too early to adopt the view that Japan is converging towards the US systemas far as the conduct of its market for corporate control is concerned. Nationalstructures within the economic system of each country are themselves adjusting, butthey are not being abandoned, so that expectations concerning their ultimateconvergence should be kept modest. Young also saw limits to the convergence thesis,while Petri was of two minds—it depended on the system. Dobson saw organisationallearning as capping any movement towards convergence because learning may resultin imitation rather than necessarily in duplication. In also commenting on therelationship between competition and convergence, Michael Trebilcock thoughteconomists tended to confuse convergence between inputs and output markets. Whycould one not contemplate multiple equilibria of input side and single equilibriumon output side?

It was not clear to Peter Lloyd what competition was between—economic systems,governments, markets, or what? He offered the view that competition betweensystems is much broader than the factors suggested by Petri, and that other aspects ofgovernment policy such as tax system, regulatory regime, R&D subsidies, andtechnology development were also important. Business systems were convergingunder the process of globalisation, and this in turn is putting pressure ongovernments. Competition itself was a powerful force with more convergenceoccurring than we knew, and Petri cited public utilities and direct foreign investmentas examples of where the world was converging towards a US model. English alsosought to broaden the discussion by identifying several other factors that had affectedchanges since the 1960s and 1970s and would continue to impact oncompetitiveness. These included time horizons which differentiate economies, thenature of democratic institutions, the form and stability of political institutions, theimportance of federal and centralised structures of government, and differences in thedegree of external orientation of the economy.

Summary of discussion—327

The role of the state

The role of the state as the key factor in determining how business systems wouldevolve over time invoked considerable discussion. Kohsaka in an earlier context hadnoted that government involvement had been a significant factor in shaping theoriginal form of business systems across economies in the region. For example, thezaibatsu after establishing themselves in the prewar period were then forced toconsolidate in the interwar period as part of the government’s efforts to adapt to theunfavourable domestic as well as international economic environment. This, Kohsakaargued, was not unique to Japan, citing Korea’s developmental state as the drivingforce behind the establishment of the chaebol, and the Kuomintang (KMT)-relatedbusiness groups as the driving force behind the SME groups in Taiwan.

As governments lower trade and investment barriers, business strategies becomeimportant, more so than the ability of government policy to influence them. In thissense, Parker argued, it was important to understand how home-based differences infirms evolve and how they affect political-economic decision-making in terms ofgovernments undertaking their own unilateral reforms and how it will expand intothe Asia Pacific Economic Cooperation (APEC) and World Trade Organisation(WTO) processes, given that the WTO assumes common forms of business areoperating.

Drawing on the Southeast Asian experience, Pangestu highlighted the importantchanges taking place as conglomerates come under pressure to change, become moretransparent and go public. Multinationals, Parker remarked, were also influential inpushing for reform. Firms were not sitting back but actively lobbying for changeswithin countries. It was also important within the context of the APEC process tounderstand how conflicts arise from having different types of business structure.Parker gave the example of the United States as viewing Japanese and Koreanproduction networks as merely an expansion of closed networks. However, not allparticipants viewed the state’s role as significant. Edward Chen considered that thestate’s role was overstated, with technological, legal and economic factors being moreimportant.

One area where most participants saw the state still playing a large role was stateenterprise sector. This was particularly the case of China, where most of the problemsof competition or lack of it are associated with state enterprises. This gave rise todiscussion of how the state can exit the market, although, in practice, participants sawthe issue as being much more complex and diffuse. Discussion centred on the themeof Justin Lin’s paper — namely, the paradoxical coexistence of productivity increaseand profitability decline in China’s state-owned enterprises (SOEs). Lin offered theexplanation of this paradox as the capacity of enterprise managers to embezzle so asto hide profits from the state. However, Ralph Huenemann and Lawrence Krausedoubted this was the primary explanation. A more obvious and persuasiveexplanation was that, although SOE productivity was rising, the productivity of SOE

328 Summary of discussion

competitors (township and village enterprises, on the one hand, and various forms ofjoint ventures with foreigners, on the other) was rising even faster, and thisdifferential productivity gain had squeezed SOE profits.

While Huenemann also agreed with Lin that many of the current problems of SOEsarose from the incomplete nature of the reforms to date, it remained, he said, an openquestion whether further reform of the SOEs is seen as urgent, or even politicallydesirable. Krause saw it as a much broader issue, encompassing income distributionissues, regional differences among SOEs, and the provision of welfare extendingbeyond pensions to encompass housing, health care and all the other fringe benefitsthat have been delivered through the work unit. To this end, fiscal reform was aprecondition to many of the other reforms suggested. Lim regarded the transitionalissue in moving from the plan to the market as one of pricing. Price inflation wasinevitable, and as Eastern Europe showed, can destabilise society. China hadunderstandably been cautious and had done well to avoid the ‘big bang’ approach.Kohsaka, like Krause, saw the reform of the SOEs as first and foremost a fiscal issue,but highlighted regional differences as being important given the poorer provinces’dependence on SOEs as a revenue source.

In approaching reform, Parker argued that SOE reform needed to be coordinatedalong with private sector development. The East Asian experience showed thatprivatisation of SOEs was not necessary, and that as long as it did not cause too muchmacroeconomic instability, there was space for non-state entrepreneurial firms todevelop, and some cushion to provide for vested interests. Rong-I Wu disagreed,arguing that the Taiwan experience showed that in a competitive market, SOEscannot compete with private-owned enterprises, so that privatisation was eventuallythe answer.

Edward Chen saw the problem to be resolved as not so much one of privatisation butof how to rejuvenate the weak SOEs to make them profitable and how to maintainmomentum of efficiency. Some of the profitable SOEs are already listed on worldstock markets, and in that sense are already well down the road to privatisation.Alexander Pouzanov saw the Chinese approach as pragmatic — as long as there were results, less attention was paid to the logic of the reform. Russia, he said, hadbeen less pragmatic than China, the result being little or no growth. The key tosuccess in Russian reform of SOEs was management rather than ownership. Despitethe change of ownership structure there had been no change in performance, butwhen SOEs (rather than joint stock companies or privatised companies) were put intoa competitive environment, they showed greater results.

COMPETITION POLICY AND COMPETITION LAW

What became clear during discussion is that competition law varies widely — sixAPEC economies including Hong Kong and Singapore do not yet have explicitcompetition policies — as do competition policies, as a broader concept, and the

Summary of discussion—329

implementation of laws and policies. Competition is quite country-specific, withvarying institutional arrangements, and involved an evolutionary process ofdevelopment. The meaning of competition policy should be taken in its broad sensein creating a competitive environment and not taken narrowly to mean antitrust andcompetition laws.

Pangestu cautioned against pushing developing countries too fast or prematurely toadopt competition policy in the narrow sense. The important thing at this stage wasto push for continued deregulation and reforms, removal of price controls, andstrengthening of institutions and the legal system. In this regard, sequencing orphasing of competition laws was important. Without an institutional mechanism andsystem to ensure an effective, transparent, independent and accountable competitionpolicy agency, there was the danger of misuse and abuse. Globalisation of markets wasalso an important factor affecting the reform process. In developing Asian countries,competition for markets and investment had been an overriding factor drivingliberalisation, more so than the Uruguay Round or any of the regional commitments.But the role of multilateral and regional trading agreements and donor agencies wascrucial in providing policy-makers with international ‘pressure’ and additionalarguments to sell and help lock in reforms.

Given this, discussion shifted to the type of competition policy countries in theregion would move to adopt and the most appropriate time to adopt competitionpolicies. On the ‘when’ question, Edward Chen was against introducing competitionlaw prematurely. In many cases, technological change would determine when acountry was ready — for example, when there were potential entrants such as in thecase of telecommunications. At this stage, developing countries needed to payattention to the behaviour of firms rather than move too readily to regulate thestructure of the industry. Merit Janow was sceptical, however, asking: when wasn’t anindustry ready in light of global trends and international market developments? Onthe other hand, Edward Chen also saw countries as having little choice but toliberalise and to adopt a rigorous competition policy. One reason was to gain marketaccess to other countries’ domestic markets. For an increasingly service-orientedeconomy like Hong Kong where non-tradeables were significant, a comprehensivecompetition policy was crucial to maintaining competitiveness. Young saw theemergence of the competition policy issue in the newly-industrialising economies(NIEs) as a sign of success of development, but it also made governments reluctant todo rash things for fear of killing the goose that lays the golden egg. Yet, if a countrydelayed taking action, it could miss the right timing, as the problem of chaebol inKorea now indicated. The real question, as Tain-Jy Chen saw it, was how muchcompetition law would actually enhance the competitiveness of the economy. DespiteTaiwan having a competition policy for five years, there appeared to be no dramaticchange in terms of competition in the Taiwan economy. This raised the question inhis mind: at what stage of development do countries need competition law?

330 Summary of discussion

Drysdale remarked that Edward Chen had raised an important issue — namely, theimportance of nesting the evolution of appropriate competition policy in itsappropriate institutional context. Motivations for adopting laws differed. TheEuropean Union had adopted measures as a means of pressuring countries to adoptdomestic competition policy laws for market access, for foreign investment and forthe export of services. For Japan, the agenda was different: to remove anticompetitivemeasures such as antidumping, countervailing duties, rules of origin and safeguardmeasures.

Ure’s assessment was that moving the process forward would differ greatly across Asia,and he regarded Pangestu’s earlier point about leadership support as crucial to theprocess. It could not, he said, be done in nice clean steps. In practice, the process wasmore conflated and for this reason political leadership was necessary to support theprocess, followed by market entry to then drive it. Other issues such as the costs ofregulation needed to be taken into account, given that the financial resources did notyet exist within many Asian countries. The aims of regulators were also likely to differacross countries. In fact, Ponciano Intal viewed one of the contributions ofTrebilcock’s paper as drawing out the fact that the United States, Canada and theEuropean Union adopted antitrust laws under very different historical circumstancesand with different motivations. This, Intal said, indicated that antitrust laws in thethree economies were adopted in the context of a largely closed economy, eitherbecause trade formed a small part of the economies (the United States and theEuropean Union) and/or because there was high protection (Canada in the 1980s).

Bollard regarded the issue of enforcement as central to any discussion of competitionpolicy because it directed the focus on to the judicial system to enforce competitionlaw, and because a light-handed competition policy was more likely to require heavy-handed enforcement. To this end, it was impossible to discuss one without the other.Drysdale agreed, adding that competition policy and competition law wereinextricably linked, and that dichotomisation was not helpful to debate. Lloyd,however, suggested that progress was unlikely unless we form a clear economic viewof whether competition policy is good or bad and what aspect or practices may beharmful. Pangestu concurred with Lloyd, arguing that we needed to be clear on theobjective of why we have competition policy, which in developing countries was notalways the case.

What did this imply with respect to the issue of competition policy in theinternational trading system? First, a broader view of competition policy made bettersense than pure antitrust policy or competition law. Second, the scope and focus ofcompetition law in each country may need to be viewed in the dynamic context ofindustry and structural adjustments and changing policy imperatives over time. AsIntal saw the process: as an economy developed and the scope for further trade andinvestment liberalisation and deregulation substantially narrowed, the need for a wellfunctioning competition law increased, thereby encouraging the country to institutethe necessary policy, legal and institutional changes. Thus, a call for harmonised

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antitrust policies and competition law internationally was at this stage premature. Fora developing country like the Philippines, competition law was a second orderpriority issue in the sense that it aimed to support the overall drive to improve thecompetitive environment in the country. The limited capable manpower indeveloping countries to review and adjudicate cases also needed to be take intoaccount. There was, Intal said, always the danger that the enforcement of competitionlaw could become a source of corruption and create additional uncertainty and costfor the business sector.

In fact, Young observed that except for Singapore and Hong Kong, all East Asianeconomies seem to be having problems overcoming entrenched domestic interestsopposing entry barriers and non-competitive practices and regulations. Hisimpression from Wisarn Pupphavesa’s paper was that Thailand had made littleprogress in opening up to competition because the objective had been to promotetrade and investment, and, in that context, nurturing competition had beensubservient to that goal. This was changing as industrialisation proceeded, remindinghim of the East Asian flying geese pattern in the approach to coping with competitivepolicy problems. In addition to industry policy objectives, Patrick read Thailand’scompetition policy as having the political objective of the maintenance of stableprices for consumer goods. Therefore, the best competition policy that Thailandcould pursue in a practical sense was to decrease tariffs from 30 per cent, not just inthe ASEAN Free Trade Area (AFTA) but globally down to 5–10 per cent. Ian McEwinsuggested that Thailand introduce a register of business practices and agreements sothat information about them could be collected and widely disseminated. Throughknowledge of these practices, a better understanding of the extent to which theyimpede growth and the welfare of the Thai people would come. Political pressureswould follow.

One of the unexplored resistances to implementing competition law was the role offoreign business and the processes of giving special tariffs or other privileges toforeigners in complicating the development of competition policy. English wonderedto what extent the set of policies adopted by Thailand and other Southeast Asiancountries in attracting Japanese investment was related to competition policyobjectives. Drysdale commented that English had indirectly raised a significantissue—that a number of countries in East Asia were susceptible to the inducement ofproviding monopoly by fiat or franchise monopoly to foreigners, particularly intrying to attract direct foreign investment.

Conference participants discussed whether the benefits from competition policymight break down in an open economy. This was explicitly addressed by McEwin,who argued that domestic competition law may not promote a country’s economicwelfare in an open economy. For countries with little international rule-makingpower, the optimal strategy was unclear and depended on a country’s particularcircumstances. But, given that small countries cannot influence competition laws inother countries, the optimal strategy is likely to be to implement an effective domestic

332 Summary of discussion

competition law. In doing so, both the traded and non-traded sectors become moreinternationally competitive.

Competition polices, however, could not be considered in isolation from social goalsor political realities. Competition laws may not suit national aspirations or mayinvolve income redistributions that are politically unacceptable. Without aninternational redistribution (or side-payment) mechanism, there would seem to belittle chance of achieving full harmonisation of competition law even if all countriesagreed they would be better off. At the end of the day, McEwin said, we may have tolive with different competition laws, enforced differently, accepting that competitionlaws may play a secondary role to political and social goals.

How can a country introduce a general competition law where the costs to those wholose are likely to be more visible than the longer-term, less obvious, benefits? Pressureto introduce competition laws more generally and to enforce them should come fromwithin each country because of the demonstrated benefits and not be imposed fromoutside. McEwin drew on the Australian example, where much of the pressure fortougher competition law came, not only from consumer groups, but also frombusinesses suffering from anticompetitive agreements and practices. Businessconfidence, he said, had improved through greater transparency and knowledge thatthere were remedies available against anticompetitive behaviour by competitors,suppliers and customers. What was required was more information about restrictivepractices and agreements, which could help better inform policy-makers and helpgalvanise domestic forces to apply political pressures for more competition. Thegathering of data about the extent of restrictive practices and agreements was alsouseful in building up political pressure from consumer and business groups for theintroduction of competition laws.

Pangestu sought to reiterate the ‘when’ issue. More needed to be done on the tradeand investment liberalisation front without going all the way to competition law. Shewas concerned about the premature introduction of competition law in countrieswhich lacked the institutional capability of implementing and enforcing law andresources needed to monitor it.

Trade and competition policy

Competition policy is very closely related, and in a complicated manner, to industrialand trade policy. Because of the complex interaction, most participants sawinternational agreements on competition policy as difficult to achieve. A minimumstandards approach was proposed to address the most egregious types of privateanticompetitive restraints, such as dominant market power and exclusionarybehaviour, naked price fixing and bid rigging. Peer pressure, study and consultationto increase and monitor the application of domestic laws was required rather thantrade bodies pressuring for harmonisation.

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Sooyong Kim saw conflicts between competition policy and industrial and tradepolicy emerging when competition policy measures were directed towards marketstructure rather than the conduct of market participants. When being directedtowards market structure, policy should focus on maintaining enough sellers bybreaking up monopoly power or preventing market concentration. But industrialpolicy in many developing countries and small advanced countries, he said, tried tosupport large producers in order to achieve economies of scale, in production,marketing and R&D. In Korea, the success of past industrial and trade policies ingiving rise to the chaebol now raised serious concerns about concentration ofeconomic power. Competition policy practices were aimed not just at correctingabuses of market power but at trying to hinder the growth of potential market power.But now the concern was that such policies created obstacles to the growth ofcompetitiveness of major Korean companies now actively expanding in the worldmarket.

Because countries often have differing objectives, free competition may not always bethe optimal policy, especially for developing countries. Siow Yue Chia drew attentionto the many circumstances in which governments wished to implement competitionpolicy to restrict competition between foreign and domestic firms and amongdomestic firms in pursuit of various aspects of industrial policy—protecting SMEs,strategic alliances to achieve industrial upgrading and promote internationallycompetitive firms, repression of the financial sector, and the imposition of restrictionsto prevent ‘excessive competition’. Indeed, T. J. Chen saw the main purpose ofTaiwan’s competition policy as being to protect the SMEs. The policy was based onfour major economic objectives—how to prevent large firms from abusing SMEs (viatheir dominant position); how to prevent excess competition among SMEs; how toallow SMEs to collaborate in order to compete against large firms; and how to make(financial) resources accessible to SMEs.

There was considerable discussion as to whether competition policy issues should bediscussed at the multilateral or regional level. Siow Yue Chia disagreed with Rong-IWu and Yun-Peng Chu’s suggestion that multilateral negotiations focus oncompetition policy rather than trade policy. Trade policy, she countered, was moreclearly defined and neater to negotiate and reach multilateral agreement on.Competition policy was complex in terms of definition, measurement and consensus-building because it impinged on a wide range of domestic considerations. Chia alsodoubted whether multilateral cooperation in competition policy was the best way ofachieving contestability of markets. While action on both fronts was required,removing trade barriers may be more direct and effective. Further movement toliberalise and implement General Agreement on Trade in Services (GATS) disciplines,Tein-Chen Chou told participants, could have a greater effect on global competitionthan pursuit of multilateral competition policy discipline. But because there was noguarantee free trade would lead to a social optimum, another approach would be toimprove mechanism for the international coordination of competition policy. For

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example, the United States and the European Union have reached agreement in thedomain of mergers and this could be a model for other countries.

Yue, Janow and Pangestu all considered it premature to address harmonisation ofcompetition policy in the WTO. They, along with several other participants,suggested that APEC was the appropriate forum for competition policy discussion,engaging in consciousness-raising and agreement on general principles. Developingcountries, Pangestu argued, viewed the introduction of competition policy in tradesuspiciously as another potentially disguised protection. Furthermore, the WTO atthis stage did not possess the capability or capacity to deal with such a complex issue.APEC was a more promising forum because competition policy was already identifiedas a topic for discussion and, as Chia said, represented a smaller group of ‘like-mindedcountries’ that could begin the process of education, increasing knowledge, andexposing policy-makers to ideas. APEC’s agenda was to begin to define competitionpolicy and deregulation, and to come up with a set of principles on competitionpolicy. However, like Chia, Pangestu also regarded discussion of which forum wasbest for discussion of trade and competition policy as not an either/or issue.Competition policy should be addressed in all forums and there should be synergy.There was, though, a lot of value in talking about competition policy in APECbecause it could be discussed in a non-threatening way. It would be easier to achieveconsensus in APEC and extend any initiatives to the WTO at a later stage after thelearning effect had taken place.

In the meantime, the best competition policy for APEC was probably liberalisationof trade and investment to make markets more contestable. As trade and investmentbarriers in the Asia Pacific fall, competition policy to deal with internal marketbarriers becomes increasingly important to ensure that markets are indeedcontestable. Most participants agreed that a common starting point of principle forboth sets of policies was non-discrimination between domestic and imported (orexported) goods and services, and national treatment of foreign and domestic firms.Lloyd thought the best thing the WTO could do is not to develop a comprehensive-based competition policy but to press for more trade and investment liberalisation ofgoods and services that have pro-competitive effects.

While most participants agreed the best antitrust policy was free trade, as Tein-ChenChou pointed out, even with free trade, international competition will be affected bymarket imperfections that create static and dynamic inefficiencies. Edward Chendrew on the examples of Hong Kong and Singapore to argue that free trade andinvestment policies under certain circumstances were not a guarantee of domesticcompetition. He cited Hong Kong’s property market as a case where above-normalprofits had not resulted in foreign access. Free trade was also no guarantee in aneconomy like Hong Kong’s where invisible barriers to entry and where non-tradeableservices were such a large share of GNP. Similarly, Young argued that the removal ofbarriers to trade and investment did not guarantee that competitive order wouldprevail in the domestic market. Korea in the early 1980s was characterised by

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macroeconomic stability, import opening and antimonopoly law. By the early 1990sthere were still layers of regulatory constraints and barriers to new entrants, and theproblems of chaebol had not decreased in weight.

Participants expressed concern about US motivations in competition policy,particularly the way in which the United States uses antidumping laws as a traderemedy, and the spread of this restrictive policy instrument to other countries.Edward Chen strongly rejected Janow’s assessment that the United States wasreluctant to push competition policy linked to trade. He regarded the US approachas exhibiting double standards in demanding national treatment in areas where theypossess comparative advantage but in other areas being more reluctant. Politicaleconomy aspects of self-interest were the greatest obstacle to harmonisinginternational competition measures. Drysdale concurred with Chen, adding thatcareful studies in the political economy of trade indicated that the policy agenda ininternational negotiations is driven by sectoral interests in trade and services.

While not wishing to see reciprocity established as a principle driving theharmonisation of competition policy, Petri nonetheless wondered why one could notnegotiate issues of market access where competition policy seems to be the barrier.While there was nothing wrong with countries negotiating in the way they had in thepast in dealing with tariffs, Trebilcock argued that this needed to be distinguishedfrom the unilateral action whereby the United States has threatened Super 301measures against Japan if it does not change its competition policy. That, he said, isnot the way tariff negotiations proceed.

Countries in the Asia Pacific have taken very different legislative approaches tocompetition policy. Moreover, there are huge differences in their administrativecapacity to enforce the laws they have. At best, a possible agreement would find onlyminimal consensus. In light of this, Krause saw antidumping enforcement asnecessary and suggested that competition policy would not likely replace it in thenear future. The real issue then was to prevent abuses, by clarifying procedures,introducing dispute settlement in APEC, and preventing cases of frivolousharassment. Kihwan Kim had reservations about current procedures dealing withantidumping. A more promising way, he said, would be to amend and/or expandsome WTO provisions and expand Article 23(1b), as it currently only allowed theWTO to raise an issue when a government matter is involved. Lloyd also argued thatantidumping procedures needed more urgent attention. Article 6 of the GeneralAgreement on Tariffs and Trade (GATT), he asserted, was misguided and ultimatelywould need to be removed or rewritten.

Petri suggested that the long-term goal should be to get rid of antidumping as adomestic policy measure in exchange for a tough competition policy against verticalrestraints. Trebilcock was more hesitant, cautioning that vertical restraints were trickydomestically as a matter of theory, and application of theory to facts was even morecontentious internationally given differences in industrial organisation between

336 Summary of discussion

countries. A constructive suggestion put forth by Trebilcock was that there is a dealto be negotiated whereby the United States got rid of antidumping in return fortough competition laws which are also implemented in other countries. There were,he said, elements of this in the North American Free Trade Agreement (NAFTA),whereby trade remedies determination is subject to binational panel review. However,this solution lay in the distant future

It was also argued that there is little evidence that predatory pricing, which is themain intellectual argument for antidumping, occurred much in practice; and that,where it does, competition laws provide the more appropriate policy instrument.McEwin gave the example of Australia and New Zealand, which had abolishedantidumping laws and harmonised their abuse of dominant position provisions inrelation to cross-border predatory pricing. Since then there had not been a singlecross-border predatory pricing action. This, Trebilcock said, was not because therewas confusion as to what constitutes predatory pricing but rather because there neverhad been any.

Harmonisation

Given these systemic differences, harmonisation of competition policies and lawsamong APEC members is very far away — indeed, it appears unrealistic in theforeseeable future; and since harmonisation is not an end in itself it may not even bedesirable. Participants had widely diverging views of what harmonisation ofcompetition policy meant and what the benefits might be. The issue always is:harmonisation to what set of norms and rules?

Issues of national sovereignty were also likely to be a constraint. Lloyd argued thoughthat views of national sovereignty and what is feasible can change dramatically overtime. At this stage, the debate on competition policy, harmonisation and prospectsfor convergence was very new and appeared exceedingly difficult. Yet, the history ofGATT in such areas as industrial standards and mutual recognition indicated thatviews of what is possible and desirable can change swiftly over a short period of time.Convergence, Lloyd predicted, would come about through the critical examinationby economists of the arguments put up by developing economies for the supposedbenefits of allowing collusive behaviour and cartels. Convergence of ideas will lead toconvergence of policies.

Given the diversity of policy and laws, Bollard and Lloyd argued that countries in theregion should at least agree on a minimum set of principles as their competitionpolicies and laws. Kihwan Kim wondered whether they had in mind a non-bindingagreement and, if so, would an agreement based on minimum standards then becomea trivial agreement? In addition, how trade-promoting would such an minimumagreement be? R. D. Cremer agreed with Kim, arguing that he saw no point in theadoption of non-binding minimum standards. Lloyd responded by pointing out thatwhile non-binding agreements can be ineffective, they are not worthless. An

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agreement on principles may influence behaviour, but the ultimate argument for non-binding agreements was that they would lead eventually to binding principles.

Discussion again returned to the most appropriate forum for consideration ofcompetition policy issues. While Bollard and Lloyd viewed APEC’s commitment toachieve the harmonisation of policies and laws as a desirable objective, Kihwan Kimqueried whether it was wise to include harmonisation of competition policies andlaws on APEC’s agenda. Compared to the WTO, he said, APEC had less capabilityto formally resolve such questions as harmonisation of competition policies and laws.The WTO could deal with harmonisation issues by incorporating the principles ofcompetition laws into the relevant antidumping provisions of the GATT/WTO. Itwas, he said, time to make the GATT/WTO relevant to the actions and practices ofplayers in the private sector that restrict trade when economic activities are rapidlyglobalising and private actions have consequences for the world trading system.

Cremer was also in favour of encouraging the WTO to adopt a supranationalcompetition policy regime for transnational transactions, leaving member states toregulate purely domestic transactions. Trebilcock was not receptive to this, drawingon an earlier point made by Tien-Chen Chou that a very high percentage oftransactions (around 40 per cent), especially in mergers and acquisitions and the jointventures field, are transnational so agreement among members of the WTO would beneeded to get some supranational competition policy regime that applies to a hugevolume of economic activity — and that would be impossible. Lloyd also did not seethe WTO as the appropriate forum when one thought of a ‘global’ competitionauthority with the power to investigate and prosecute, although this did not mean theWTO should not have a important role in addressing competition policy, notably inGATS and in the telecommunications agreement relating to essential facilities andnetworks. Sooyong Kim viewed neither forum as appropriate. Individual countrieshave very different assessments on cartels, mergers, technology exchange agreements,vertical integration and price discrimination. Such differences, he said, would makeit difficult, and even unwise, to harmonise competition laws at APEC or WTO levels.

Larry Dongxiao Qui thought more discussion was required on the likely effects ofharmonisation. Unlike trade policy, he said, we do not always know what is the ‘best’policy and what are the standards towards which countries should converge. Manyoptimal policies heavily depend on the nature of market competition, the number offirms in the industry, and other factors. One example was whether it was good policyto allow R&D joint ventures. In some situations, especially when the spillover issmall, R&D joint ventures are often viewed as collusion. But if the spillover was large,R&D joint ventures increase R&D investment and favoured competition. WhileLloyd pointed to the benefits of harmonisation in reducing transaction costs andincreasing market efficiency, Qui saw the former as clear, while the latter was less so.If harmonisation leads to an adoption of the standards that result in the highestefficiency among all standards, then harmonisation will increase market efficiency.

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Otherwise it may not. By definition, harmonisation in itself did not guaranteeadoption of the ‘best’ standards.

The dynamics associated with harmonisation of competition policy were also likelyto be different from those of trade liberalisation. Petri pointed out that whatproducers in fact wanted was for other markets to be even less competitive becausedomestic producers could gain from the higher prices in foreign markets. In thissense, policy-makers did not have this natural deal whereby they can appease theirhome producers by telling them that foreigners are also making their markets morecompetitive. On a related issue, Kohsaka highlighted the fact that the extension ofproduction networks and deepening international division of labour was giving riseto internationalised producer surpluses. Kohsaka thought conference participants hadhad largely ignored discussion of the welfare effects of competition policy onconsumers. What was actually required, Kohsaka proposed, was some globalmonitoring device to monitor the distribution of international producer surpluses.

Several participants considered Bollard’s ‘similarity index’ (of measuring the degree ofsimilarity between the laws of APEC economies) to be a major advance inunderstanding similarity or divergence in competition policy commitment.Individual APEC members’ commitments to implementing competition policy,though, were far from the state from which the index was best applied — namely,Australia and New Zealand. Lloyd suggested Bollard go beyond a bilateral to amultilateral comparison so that changes in the level of the index could be interpretedas convergence. Qui also suggested Bollard extend his analysis by seeking to explainconvergence using multivariate regression analysis. However, Bollard thought hiscountry’s overall convergence index had been slightly misinterpreted and for thisreason was hesitant to adopt Qui’s suggestion. The index, he said, should not beviewed as an index of liberalisation, or of welfare, rather as an index of average, or‘meanness’, of how close each country was to some mean of all the other countries.There was nothing good or bad about it. Just because New Zealand was closest to theaverage and China furthest away did not say anything about welfare change. Lloydalso doubted the applicability of Qui’s suggestion but for the reason that severalAPEC countries did not have competition policies. However, Lloyd thought Qui’ssuggestion that subsets of competition policy be used to calculate an index ofcompetition policy was a useful one.

Beyond the Australia–New Zealand experience, Janow sought clarification onwhether there existed any other examples of enforcement officials working togetherin a serious way. There were, she said, examples of it between the European Unionand the United States and between the United States and Canada, although it had yetto reach the point where jurisdictions would undertake investigations at the requestof the other. She subscribed to the view that we were not likely to go far multilaterally,and that the deepest we could go is bilaterally. Janow also questioned how one couldtell if a country is enforcing the laws it has on its books. Was there a way of evaluatingthis and could such an exercise be undertaken not for dispute settlement purposes but

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to increase pressure on systems that are not enforcing their own laws? The OECD,for example, had developed indexes based on number of cases, number ofinvestigative staff, size of fines, and so on. While it was possible to develop indexes ofinvestigation, Trebilcock was more in favour of procedural precedents like thosecurrently contained in trade-related intellectual property provisions (TRIPs), orChapter 19 of NAFTA, which allowed complainants to appeal to a supranationalpanel for review of whether domestic determinations reflected a country’s owndomestic laws.

LIBERALISATION, DEREGULATION AND PRIVATISATION

Many of the issues raised in earlier discussion were highlighted in a practical sense bythe papers that focused on the privatisation and deregulatory experience of theenergy, telecommunications and airline sectors of selected East Asian economies.Clearly, the motivations of governments embarking on reform differed amongcountries and this reflected, at least partially, differences in the weighting given toeconomic efficiency versus social and political goals. Privatisation was only one aspectof sector reform and this may not be a necessary or sufficient condition to achieveefficiency.

The reform experience of the Thai and Malaysian power sectors gave rise to themeswhich later emerged in discussions on the telecommunications and airline sector.While G. Naidu in his paper expressed concern about the partial privatisation ofMalaysia’s state power utility (Tenaga), David Hong saw the merit of privatisation inpromoting competition and efficiency, not in the degree of privatisation itself. Whileprivatisation may improve operational efficiency, he queried whether it necessarilypromotes competition. In fact, he interpreted Thiraphong Vikitset’s analysis assuggesting that the power market in Thailand was not more competitive afterprivatisation. In this sense, both David Hong and Shujiro Urata thought it importantto know what had happened to retail rates since privatisation, whether the cost ofservice was lower, and whether the rate of return was ‘normal’ and the market morecompetitive. Urata also wondered why, in Malaysia’s case, privatisation of Tenaga wasonly partial. Naidu responded that the government viewed power as a strategicallyimportant sector and was reluctant to fully privatise and institute a transparentcompetitive bidding procedure given that the sector provided opportunities for rent-seeking.

Yen Peng Chu and David Hong observed several similarities between the Thai andMalaysian privatisation experiences and that of Taiwan. In Taiwan, there have been atleast two elements at work that have prevented government from embarking on amore rapid liberalisation policy. One was the objection of power company employees,who are sizeable in number and politically powerful. A second was the governmentreluctance to open the market to competition, especially at the distribution end, forfear of creating chaos should one of the suppliers go bankrupt.

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Privatisation did not automatically mean greater competition or entry. A betterarrangement, Urata suggested, could be monopoly policy with price monitoring.However, Pouzanov said Russia’s experience showed privatisation in a naturalmonopoly sector without the corresponding instalment of competition could resultin an even greater monopoly structure. Determining the appropriate policies towardsthe power sector, Urata said, depended on other factors—the level of technology,which in power generation is changing rapidly, and evidence of scale economies. Ifthere were scale economies, there was little rationale in dividing the industry intoparts. The appropriate policy was to let a monopoly firm operate and regulate thepricing practices of the firm. Trade liberalisation would also give rise to competitivepressure, making it unnecessary to privatise. While we tended to think of power asnon-tradeable, Urata commented, it should really be thought of as tradeable, giventhat there was talk of Thailand importing power from Laos.

Kohsaka saw the issue as one of how to share the risks. Both Kohsaka and IppeiYamazawa wondered what role foreign investment was playing in the process.Yamazawa said his understanding from APEC discussions was that infrastructurebuilding was being opened up to the private sector, with the power sector the first tobe opened to foreign investment.

Similar issues arose in discussion of the telecommunications sector.Telecommunications privatisation in Asia was particularly topical, because, as Ming-Sheng Tseng pointed out, most of the Asian countries were still at the beginning oftheir telecommunications liberalisation process; and because telecommunicationsliberalisation was one of the current major issues on both the multilateral andregional trade agenda. Asian governments, however, were also reluctant to relinquishcontrol of the industries to the private sector because of fiscal considerations, politicalrisks and labour issues. The telecommunications industry, Tseng noted, was stillregarded as a strategic industry, although governments also recognised that anadvanced telecommunications industry was essential to ongoing economic expansion.

In some ways, though, Tseng viewed the course of action taken by Asian countries asnot that different from that of developed countries. It was not necessarily true, hesaid, that developed countries had commenced their telecommunicationsprivatisation process by giving up complete control. Ure added that most developedcountries tended to hold back a ‘golden share’, giving them power to veto over privateownership. However, because of the distinctive characteristics ofgovernment–business relationships, the essence and forms of privatisation in Asiawere not quite the same as those in developed countries.

What then are the economic implications of Asian-styled privatisation? Will this typeof liberalisation lead to less efficient resource allocation than in developed countries?If so, what kind of policy approach is required? Tseng speculated that because Asiancountries have quite different political and economic contexts, the privatisationexperiences of developed countries would not be as relevant for developing

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economies. Privatisation, in both developed countries and in some developingcountries, had tended to be followed by a dramatic cut in employee numbers in thetelecommunications operator (as Singapore Telecom’s shedding of 30 per cent of itsemployees showed). Such courses of action would carry enormous political risks forincumbent governments in developing countries. Moreover, developing countries donot usually have well-developed institutions to absorb the impact of such drasticaction. Ure was of the view, though, that the case could not be made thatgovernments have to liberalise and privatise to have an efficient and well-runtelecommunications network. Singapore and Hong Kong are living proof of that —until recently, one was a privatised regulated monopoly, while the other was a statemonopoly.

The impact of privatisation on consumer welfare was also discussed. Tariff rebalancewas an issue. Tseng gave the example of Taiwan’s independent operator, Chung-HwaTelecom, which upon partial privatisation had submitted a tariff rebalance proposalwhich saw the cost of a local five-minute telephone call increase by 80 per cent, whilerates for international and mobile calls fell significantly. The welfare effect of this ratechange clearly favoured international calls and wireless users. This gave rise todiscussion of a wider problem—just where did the benefits lie in the liberalisation oftelecommunications? Ure was sympathetic to Kwang-Cheng Chen’s argument thatrich countries would inevitably benefit from the changing structure of internationaltelecommunications. While the problem of bringing services to rural areas indeveloping countries remained unsolved, the changing technology and financing oftelecommunications was giving rise to two interesting changes. First, the technologieswere offering opportunities to produce solutions like bringing telephony to ruralareas; and, second, the experience of regulating liberalisation was raising new ways ofbringing a phone service to rural areas in a way that could actually make money. Theexample of the Philippines was a case in point. In fact, Chen stated that of all thesectors under discussion, telecommunications was unique in facing a fundamentaltechnology change in the future. This raised an important issue for APEC—the needto consider creating a more homogeneous technology or standards in thetelecommunications industry.

How foreign companies were being incorporated into markets in the region wascritical to the final structure of the local telecommunications industry. Ure pointedout that entry by traditional Western corporates had been difficult, partly because indeveloping countries commercial law and regulation is not clearly defined and theissuing of licences is opaque. Yet, telecommunications traditionally had been anindustry which required large-scale and lumpy investment. Many local entrants inAsia could not provide that scale of investment and were not necessarily in theindustry for the long term, whereas foreign companies had the capital, managerialexpertise and technology.

While telecommunications was clearly on the APEC agenda, air transport remainedoutside multilateral processes of the WTO and APEC. Yet, restrictive bilateral

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agreements operating in East Asia represented a major constraint on raisingcompetitiveness, offering little incentive to restructure and become competitive andestablish multiple hub systems throughout Asia. In fact, Young and Lloyd bothlikened the system of bilateral agreements to bilateral import quotas under theMultifibre Agreement.

Despite this, Anming Zhang saw the airline industry as an example of where therewas convergence in government policy. Since the United States passed its AirlineDeregulation Act in 1978, other countries had followed suit in the direction ofderegulation and/or privatisation and in promoting airline competition. However,Zhang’s reading of the literature also led him to think there existed circumstanceswhen a policy of consolidation of domestic industry would best serve the jointinterests of consumers and national economy, while in other cases a policy ofdeconsolidation of the domestic airline industry is preferable. Different countries maythus have different optimal policies with respect to consolidation and/ordeconsolidation policy—optimal in the sense of maximising each country’s socialwelfare. This suggested that harmonisation of competition policy in the airlineindustry may not be Pareto efficient for all countries involved, which suggested anon-cooperative approach to harmonisation, especially at the early stage of the process.

In Japan’s case, it was believed that a strong domestic competition policy would notonly improve consumer benefits but would also encourage carriers to becomeefficient, enhance productivity and control costs. In turn, this would make Japanesecarriers more competitive in the international market, and make Japanese carriersattractive partners in a global network. Zhang saw Ushio Chujoh and HirotakaYamauchi’s paper as raising several fundamental questions. Why did deregulation takeplace in the Japanese air transport industry? Have the changes under deregulationworked? In turn, have the changes produced the market structure that is intended orbelieved to more efficient, and has it or is it likely to improve consumer welfare?Chujoh and Yamauchi’s paper, Zhang thought, tended to imply that Japan’s airlineindustry was deregulated not because economists or politicians knew what thederegulated equilibrium would look like but because they believed the deregulatedoutcome would be better than the regulated one. In this sense, it was important to beaware of the broad global support for deregulatory policies and privatisation.

As to what market structure could result from air transport deregulation, Cremer sawthe jury as still being out. While there was a possibility that there will be morecompetitors, some of the literature suggested that, in principle, there were noeconomies of scale in the airline business, and that the barriers to entry were not veryhigh for new airlines. The start-up of new airlines seemed to confirm this at firstglance. But it was also possible that the number of competitors would be reduced tojust a few, which might reinforce calls for renewed price regulation. This was becausethe product that airlines are offering is much more complex than flying someonefrom A to B.

Summary of discussion—343

Changes in consumer welfare, which different competition regimes produce, may alsobe difficult to evaluate if the product is differentiated. By way of example, Cremercited the New Zealand experience where, until 1986, Air New Zealand had had amonopoly on trunk routes, after which the New Zealand Commerce Commissiongranted permission to Ansett New Zealand to operate on the same routes.Competition led to a vast improvement of domestic air services in New Zealand. Onthe international trans-Tasman route, a new competitor entered the market but wentout of business. Did this suggest that there was more competition or less? Certainly,there was contestability, but did it actually have more competition? If a morecompetitive market structure has indeed been created, has this increased consumerwelfare? Empirical studies of the development of deregulation in particular countriesand industries were necessary to build up a body of empirical evidence to support thetheoretical notion of the superiority of free competition, and to show its limitations.

CONCLUSION

By clarifying the commonalities and differences in competition policies and practicesamong the APEC members, participants provided important input into the APECprocess of consideration of competition policy issues. This was especially significant,as the Joint Declaration of the 1997 Singapore WTO Meeting had proposed toestablish a working group programme to look at the relationship betweencompetition policy and the WTO so as to identify problems that might require actionin the WTO framework. Peter Drysdale and Ted English emphasised thecontribution PAFTAD participants could make to this process.

Lloyd and several others saw great value in pushing trade and investmentliberalisation on a multi-track basis—domestic reform, APEC-led discussion, and inthe WTO. A lot of evidence was accumulating, Lloyd said, that negotiations atdifferent levels were reinforcing. APEC was useful for exploring new ideas andbringing countries together in a productive dialogue. The area of facilitation waswhere several participants saw APEC as breaking new ground. The general globalenvironment, Alburo added, was also conducive to what APEC was doing.

PAFTAD participants, Parker said, could also add value to this process by explainingmore credibly the APEC process in the domestic political economies of their owncountries. This arose from Yamazawa’s assessment of the APEC Manila Action Plansthat most APEC members had only assured progress over the next several years andthat further encouragement was needed to maintain the momentum required for allmembers to reach their Bogor goals in time. Two mechanisms of encouragement werecurrently in place—the ‘rolling plan formula’, and the incorporation of the businesssector into the APEC process. Yamazawa suggested that a third be added—‘independent analysis by academia’, which would help publicise the APEC process,offer objective analysis and attract support from the private sector.

Airbus, 110airline industry, 15, 19, 66, 79, 109, 214,

218, 219, 264–276, 339, 341, 342, 343Air New Zealand, 343Alburo, Florian, 324, 343All Nippon Airways (ANA), 19, 265–6,

269–70, 271, 273Ansett New Zealand, 343Apple, 59Archer Daniels Midland Co., 221ASEAN Free Trade Area (AFTA), 33, 331Asia Pacific Economic Cooperation (APEC),

3, 8, 10, 11, 23, 24, 45, 121–55,157–75, 178, 180, 181, 188, 195, 196,225, 249, 257, 322, 328, 334, 335, 336,337, 338, 341, 343Committee on Trade and Investment,11, 12, 140, 160, 181, 188Eminent Persons Group (EPG), 10, 139,180–1Manila Action Plans, 343Osaka Action Plan 1995, 11, 12, 139-40, 157, 160Telecoms Working Group forums, 245

Australia, 9, 10, 11, 23, 111, 113, 128,129–3, 135, 138, 139, 142, 143–155,159, 162, 167, 180, 181–2, 187,188–91, 216, 225, 332, 336, 338Hilmer Report 1993, 129, 148telecommunications, 242, 244, 251,254, 255, 259Trade Practices Act 1965, 146, 148, 149,151Trade Practices Act 1974, 144, 147, 150,151Trade Practices Commission, 139, 147,148see also CER agreement

auto industry, 42–3, 53

Bangladesh, 241, 247, 249, 257Belgium, 95Boeing, 110, 111Bogor Declaration 1994, 10, 139Bollard, Alan, 8, 9, 11–12, 13, 325, 330,

336, 337, 338build–transfer–lease (BTL), 246build–transfer–operate (BTO), 207, 244Burma, 239, 242, 248business systems, 24–45

Chinese, 2, 28–9, 31–2, 33, 324Hong Kong, 28–9, 33–34, 35Japanese, 2, 7, 26–7, 30–2, 33, 34, 35,323, 324, 325, 326, 327Korean, 2, 27, 30–2, 33, 34, 35, 323–4,325, 333, 335German, 323Southeast Asian, 2, 29–30, 33, 34, 35Taiwanese, 28–9, 31–2, 33, 35, 324

Cambodia, 242Canada, 6, 8, 9, 10, 17, 87, 90, 94–5,

98–103, 110–11, 129–33, 138, 139,142, 143, 159, 167, 181–2, 188–91,222, 261, 330, 338Competition Tribunal, 95, 98, 99, 100,101Restrictive Trade Practices Commission(RTPC), 94, 95

capital mobility, 4, 49, 59–61, 66, 325Caribbean, 241Chen, Edward, 327, 328, 330, 334, 335Chen, Kwang-Cheng, 341Chen, Tain-Jy, 329, 333Chia, Siow Yue, 333, 334Chile, 245, 252

Index

China, 4–6, 9, 13, 23, 70–84, 130–4, 139,140, 142, 161, 181–2, 188–91, 327,328, 338dual-track system, 74–5, 80telecommunications, 242, 243, 245,247, 250, 256, 258

Chinese Taipei, 130–3, 139, 140, 142, 143,181–2, 189–91

Chou, Tein-Chen, 333, 334, 337Chu, Peng Yen, 339Chu, Yun-Peng, 8, 13–4, 333Chujoh, Ushio, 342Cisco Systems, 59Closer Economic Relations (CER)

agreement, 11, 23, 113, 121–55, 180,187, 225

Connaught Laboratories, 183convergence, 1, 2, 3, 6, 8, 9, 11, 12, 15, 23,

24, 37, 44, 49, 52, 121–55, 163, 164,183, 191, 324, 325, 336, 337, 338, 342

Cremer, R.D., 336, 337, 342, 343customer premises equipment (CPE), 237

Daewoo, 28debt crisis, 245, 247de Havilland, 110Dell, 59Digital Equipment, 59Dobson, Wendy, 2–3, 322, 323, 324, 325,

326Drysdale, Peter, 323, 330, 331, 335, 343

Eastern Europe, 6, 245, 328Electricity Generating Authority of Thailand

(EGAT), 21–2, 204, 281–2, 301–4,306–20

electronics industry, 39, 40, 41–3energy, 18, 20, 71, 277–99, 300–21, 339,

340English, Ted, 326, 331, 343Europe, 3, 6, 7, 10, 11, 17, 19, 23, 48–53,

56, 59, 62, 63, 66, 87, 90, 95–102,104–5, 107, 109–12, 128, 129, 138,140, 159, 187, 192, 222, 223, 225, 245,248, 273, 325, 328, 330, 334, 338

European Commission, 94, 96, 98, 99, 100,109, 138, 142

European Council, 97–8

Fiji, 242Finland, 258

France, 3, 49, 54, 55, 56–7, 58, 60, 62, 63,65, 67, 95, 110, 192, 258, 259

General Agreement on Tariffs and Trade(GATT), 7, 104, 105, 106, 107, 108,109, 125, 137, 139, 157, 170, 179, 180,181, 185, 188, 245, 335, 336, 337

General Agreement on Trade and Services(GATS), 224–5, 245, 257, 333, 337

General Dynamics, 59, 64, 65Germany, 3, 10, 35, 36, 49, 54, 55, 56–7,

58, 60, 62, 63, 65, 95, 139, 192Gillette-Wilkinson merger, 129Glass–Steigel Act, 52globalisation, 2, 4, 13, 15, 24, 30, 38–43,

52, 157, 181, 182, 210, 214, 226, 324,329, 337

gradualism, 1, 6, 12, 23, 324, 325Great Depression, 93, 94

harmonisation, 1, 6, 7, 10, 11, 12, 21, 23,102, 104, 111, 112, 113, 130, 139-40,143, 150, 151, 153, 159, 163-9, 191,193, 195, 220, 221, 228, 332, 335, 336,338

Hitachi, 27Hong, David, 339Hong Kong, 9, 13, 24, 37, 134, 161, 162,

163, 170, 181–2, 188, 261, 328, 329,331, 334, 341telecommunications, 237, 239, 241,242, 247, 248, 249, 251–5, 258

Huenemann, Ralph, 323, 327, 328Hyundai, 28

IBM, 59India, telecommunications, 241, 243, 245,

247, 249, 250, 260Indonesia, 9, 13, 41, 42, 133, 161, 181–2,

188, 299telecommunications, 238, 241, 242,243, 244–5, 247, 249, 250, 251, 252,254, 255, 258

Institute Merieux, 183Intal, Ponciano, 324, 330, 331intellectual property, 15, 121, 128, 196,

203, 207International Air Transport Association

(IATA), 271International Civil Aviation Organisation

(ICAO), 276

Index—345

International Finance Corporation (IFC),245

internationalisation, see globalisationInternational Labour Organisation (ILO),

204International Telecommunications Union,

245Internet, 240, 248Italy, 35, 63, 95, 99, 110, 192

Janow, Merit, 15–6, 17, 323, 329, 334, 335,338

Japan, 3, 6, 9, 10, 18, 19, 23, 24, 37, 39,40, 41, 42, 44, 48–55, 58, 59, 60, 62,63, 65, 66, 67, 107-8, 130-5, 139, 142,143, 163, 167, 181–2, 188–91, 223,279, 299, 324, 325, 326, 327, 330, 331,335, 342air transport policy, 264–76Antimonopoly Act, 222deregulation and regulatory reform, 213,216, 222, 223Economic Planning Agency (EPA), 216telecommunications, 241, 242, 244,245, 248, 249, 250, 251, 252, 253, 254,256, 257, 258, 259

Japan Airlines (JAL), 19, 265–6, 267–8,269–70, 274

Japan Air Systems (JAS), 265–6, 269–70,271, 274

Japan Fair Trade Commission (JFTC), 38,138, 195

Japan–US Aviation Treaty, 267

Kim, Kihwan, 335, 336Kim, Sooyong, 333, 337Kohsaka, Akira, 322, 323, 324, 326, 327,

328, 338Korea, 9, 18, 24, 36, 37, 44, 130–4, 142,

143, 167, 181–2, 188–91, 327, 329,333, 334telecommunications, 241, 243, 245,247, 250, 251, 253, 255, 257, 258, 260

Korea Fair Trade Commission (KFTC), 38Krause, Lawrence, 327, 328, 335

labour mobility, 4, 49, 55–59, 66, 325Laos, 242, 301, 313, 340Latin America, 240, 241, 245Lee, Young-Ki, 324, 325, 326leveraged buy-outs (LBOs), 61–2, 63Lim, Chong-Yah, 325, 328

Lin, Justin, 4–5, 322, 323, 327, 328Lloyd, Peter, 12–13, 16, 326, 330, 334, 335,

336, 337, 338, 341, 343Lucky Goldstar, 28Luxembourg, 95

Macau, 239Malaysia, 2, 9, 13, 23, 39, 40, 133, 161,

181–2, 188, 238, 277–99, 301, 313,339National Electricity Board (NEB), 20,280, 289, 290power sector, 20–1, 277–99telecommunications, 240, 241, 243–5,247, 249–52, 254, 255, 259, 260, 261

Malaysian Grid Code, 20, 288–9Matsushita, 27McEwin, Ian, 331, 332, 335, 336Mexico, 9, 113, 130–3, 142, 143, 162,

181–2, 188–91telecommunications, 252

Microsoft, 59mineral products, 31Mitsubishi, 27Mitsui, 27Mongolia, 9, 133multinational enterprises (MNEs), 13, 39,

41, 179, 180, 182, 196, 206, 249, 327

Naidu, G., 20–1, 339NASDAQ, 63Netherlands, the, 95, 272Netscape, 63New Zealand, 8, 9, 11, 23, 84, 111, 113,

128, 129–5, 138, 139, 142, 143, 143–6,148–55, 161, 162, 167, 180, 181–2,187, 225, 336, 338, 343telecommunications, 238, 242, 243,244, 245, 251, 254, 255Commerce Act 1986, 148-9

non-state-owned enterprises (non-SOEs),79, 80, 82, 84

North American Free Trade Agreement(NAFTA), 7, 10, 104, 106, 107, 111,112, 113, 114, 138, 148, 180, 195, 336,339

North Korea, 239, 248

Organisation for Economic Cooperation andDevelopment (OECD), 9, 15, 18, 133,137, 138, 148, 157, 158, 159, 179, 209,212, 213, 220, 227, 245, 322, 325, 339

346 Index

Competition Law and PolicyDevelopment Committee, 102, 113, 137

Organisation of Petroleum ExportingCountries (OPEC), 123

Pacific Economic Cooperation Council(PECC), 138, 193

Pakistan, 242, 247, 249, 258Pangestu, Mari, 324, 325, 327, 329, 330,

332, 334Papua New Guinea, 9, 13, 134, 161Parker, Steve, 323, 324, 325, 327, 328, 343Patrick, Hugh, 323, 331Petri, Peter A., 3–4, 322, 323, 326, 335,

338Philippines, 9, 130–4, 142, 143, 162,

181–2, 188, 331, 341telecommunications, 238, 241, 242,245, 249, 250, 252, 253, 254, 255, 260,261

Pilkington Glass, 107, 183, 192Pohang Iron and Steel Company, 79Pouzanov, Alexander, 328, 339private automatic branch exchange (PABX),

237property rights, 5, 73, 79, 84, 104, 237pulp and paper, 31Pupphavesa, Wisarn, 14–5, 331

Qui, Larry Dongxiao, 337, 338

Russia, 328, 340

Samsung, 28Singapore, 9, 13, 18, 37, 134, 161, 162,

163, 170, 181–2, 188, 223, 299, 328,331, 334, 341telecommunications, 239, 240, 241,243, 247, 248, 250, 251, 252–4, 256–9

Singapore Airlines, 79, 270small and medium-sized enterprises (SMEs),

28, 29, 31, 32, 34, 35, 41, 255, 324,327, 333

Solomon Airlines, 242Sri Lanka, 242, 249, 258state-owned enterprises (SOEs), 5, 6, 71-84,

164, 327, 328steel, 53, 79, 95Sumitomo, 27Super 301 measures, 335Sweden, 261system friction, 103–6, 112

Taiwan, 2, 9, 10, 24, 37, 39, 40, 44, 167,327, 328, 329, 333, 339, 341telecommunications, 241, 245, 247,249, 250, 251

Taiwan Fair Trade Commission (TFTC), 38telecommunications, 4, 15, 17–8, 32, 53,

213, 214, 216, 218, 224, 237–57, 329,337, 339, 340, 341

Tenega Nasional Berhad, 20–1, 277, 281,284, 285, 286, 287–91, 292, 293, 294,295–6, 297, 298–9

textile industry, 31, 41Thailand, 2, 9, 14–5, 23, 39, 40, 41, 42,

130–4, 142, 143, 162, 181–2, 188, 286,299, 331, 339, 340competition regulation and policy,198–208Energy Policy Committee, 21, 301,302–3, 307, 308, 310, 312, 320Express Transport Organisation (ETO),204Metropolitan Electricity Authority(MEA), 21–2, 301–5, 306–8, 312,317–20National Energy Policy Office, 302, 307,309, 310, see also EGATpower sector, 21, 300–21Price Control and Anti-Monopoly Act,14, 199, 207Provincial Electricity Authority (PEA),21–2, 301, 302–5, 306–8, 312, 317–20telecommunications, 240, 241, 242,243, 244, 247, 249, 251, 255, 258, 260,261

Toa Domestic Airways (TDA), 19, 266Toray, 27Toyota, 27trade friction, 227trade-related investment measures agreement

(TRIMs), 125, 179, 180, 206, 225trade-related investment provisions accord

(TRIPs), 125, 180, 225, 339transportation, 31, 72trans-Tasman anti-dumping measure, 11,

143-4, 152–4trans-Tasman competition law, 12, 144,

152–4Treaty of Rome, 10, 96, 99, 100, 102, 107,

138Trebilcock, Michael, 6–7, 13, 326, 330,

335, 336, 337

Index—347

Tseng, Ming-Sheng, 340, 341

United Kingdom, 3, 49, 54, 56–7, 58, 59,60, 62, 63, 65, 66, 96, 101, 107, 192,294telecommunications, 244, 245, 252,258, 259

United Nations Conference on Trade andDevelopment (UNCTAD), 137

United States, 3, 4, 6, 8, 9, 10, 15, 16, 17,18, 37, 39, 40, 41, 42, 43, 48–67, 87,90–4, 95, 97, 98, 101–3, 104–7, 108,111, 112, 113, 130–4, 138, 139, 142-3,149, 159, 163, 167, 181–2, 183,189–91, 192, 265, 267, 272, 273, 275,279, 299, 324, 325, 326, 327, 330,334–6, 338, 342deregulation and regulatory reform,209–20, 222, 226Federal Trade Commission, 92, 98, 110,140, 159, 183Initial Public Offering (IPO) market, 63Sherman Act, 90–2, 94, 95, 107, 146telecommunications, 243, 244–5, 249,258, 259–61

Urata, Shujiro, 339, 340Ure, John, 17–19, 323, 330, 340, 341Uruguay Round, 198, 329

Vanuatu, 242Vautier, Kerrin W., 8, 9, 11–12, 13Vietnam, 9, 133, 324

telecommunications, 242, 243, 245, 256Vikitset, Thiraphong, 21, 339Vivorakij, Araya, 17–19

World Bank, 245, 252World Trade Organisation (WTO), 3, 7, 17,

24, 45, 104, 106, 112, 113, 125, 137,157, 158, 159, 163, 170, 179, 180, 181,187, 188, 196, 198, 206, 207, 214, 220,223, 224–5, 227, 228, 245, 249, 256,257, 327, 334, 335, 337, 341, 343

Wu, Rong-I, 8, 13–4, 328, 333

Yamauchi, Hirotaka, 19, 342Yamazawa, Ippei, 340, 342

Zhang, Anming, 342

348 Index