INNOVATION AND REGULATION

Transcription

1 INNOVATION AND REGULATION Summary of presentations and discussions, CERRE Expert Workshop 25 April 2013, Brussels Speakers: Prof. Pierre Larouche (CERRE and TiLEC-Tilburg), Jean-Yves Art (Associate General Counsel and Director of Competition Law, Microsoft), Dr Giulio Federico (Economic Analyst, DG Competition), Dr Jan Kees Winters (Senior Economic Advisor, Autoriteit Consument & Markt) Prof. Pierre Larouche, Joint Academic Director of CERRE and Professor of Competition Law at Tilburg University, the College of Europe (Bruges) and the Institut d Etudes Politiques (Paris), presents a research project that has been conducted under his supervision by a multidisciplinary research team of the Tilburg Law and Economics Center (TiLEC) within the framework of GRASP (Growth and Sustainability Policies for Europe), a European research project. This research project studies how major EU-level policy statements on innovation and growth (e.g. the Lisbon Agenda, the Agenda 2020) are integrated and reflected in competition policy, sector-specific regulation, intellectual property law and standardization policy. In order to do this, the research project specifically analyses all the Art. 101 (cartels), Art. 102 (abuse of dominance) and merger control decisions from the European Commission, as well as ECJ decisions on the above and soft-law competition policy instruments (such as block exemptions), since 1990, in two highly innovative sectors, i.e. the ICT and pharmaceutical sectors. From a preliminary look at the data, a number of observations are already clear. First, legal arguments relating to innovation are almost absent in the sample before the mid-2000s. Second, the studied cases do not seem to reflect any systematic thinking and/or a deliberate policy from DG Competition with regard to innovation. This is mainly due to the fact that the general competition law instruments do not go into much detail on the treatment of innovation, and that innovation-related arguments are therefore mostly introduced by the parties in specific cases. Therefore, there is a great diversity of ways in which innovation is factored into competition cases: by affecting market definition, by implying lower barriers to entry in the market assessment phase and by changing the perspective on the remedies that need to be imposed. Prof. Larouche also explains that the lack of systematic thinking on innovation could also be due to the fact that DG Competition might fundamentally be confronted with a nonrepresentative sample of innovation, because competition cases are mostly concerned with firm-driven incremental product innovation. Furthermore, economists generally reject the one-size-fits-all legal approach as they argue that all industrial sectors are structured differently and that innovation should therefore be considered under a different light by competition authorities in these different sectors. As Pierre Larouche points out, this is partly reflected in legal practice through the references to prior cases in legal proceedings. The research shows that ICT cases tend to refer only to other ICT cases, pharma cases to Centre on Regulation in Europe (CERRE) asbl Rue de l Industrie 42 Box 16 - B-1040 Brussels - Belgium Ph: +32 (0) Fax: +32 (0) info@cerre.eu 1/5

2 other pharma cases, etc. This allows for the development of slightly different analytical grids within the same general framework for the treatment of innovation in competition cases in practice. Prof. Larouche explains that there have broadly been three schools of thought on the link between competition and innovation. The first theory, developed by Joseph Schumpeter, argues that in order to foster innovation, firms need to be able to extract extra profits out of new products and processes. Therefore, the Schumpeterian view on innovation is that there is a trade-off between competition and innovation. The second theory, developed by Kenneth Arrow, postulates that firms will only be driven to innovate if they are under the constant threat of being outpaced by competitors and therefore puts forward the view that competition and innovation go hand in hand. A third, more recent theory, developed by Philippe Aghion, aims to reconcile Schumpeter s and Arrow s views, by postulating (and demonstrating empirically), that the relationship between competition and innovation is an inverted-u, i.e. that innovation first tends to increase together with competition if the overall level of competition is low, and that it then tends to decrease if competition becomes too pronounced. Regarding the substantive treatment of innovation in competition cases, Prof. Larouche shows that the Commission systematically favours Arrow s theory on the link between competition and innovation, stating that more competition will lead to more innovation. However, he also explains that the Commission s stance could be reconciled with Aghion s theory of innovation, as DG Competition mostly intervenes in cases where competition is absent or not well developed, and therefore in cases where both theories yield similar conclusions. When comparing the situation in Europe and in the US, some academics have advocated the use of special competition law provisions for innovative markets (as is already the case in the US). According to Pierre Larouche, this would be a mistake, as it would lead to endless legal battles about the classification of markets, which would most certainly not reflect factual differences in innovation patterns. Furthermore, the European Commission has, in his view, a more sensible approach to innovation than their American counterparts, because they consider innovation arguments at every stage of the competition policy process (market definition, market conduct and remedies) and because they understand that there is more to innovation than simply ensuring rewards and incentives for investors. Regarding innovation, DG Competition argues that its aim when instructing competition cases is to keep, as much as possible, potential innovation paths open, i.e. make sure that neither anticompetitive behaviour nor decisions by competition authorities would preclude innovation. Prof. Pierre Larouche points out that this general behavioural rule leads to different attitudes by the competition authority, depending on the intensity of the conflict between market players. In low-intensity clashes (e.g. Intel rebates), the attitude of the European Commission is to keep innovation paths open for newcomers by restricting the behaviour of the dominant firm, and this is facilitated by the fact that it only has limited effect on the innovation incentives of the latter. In medium-intensity clashes, DG Competition is theoretically faced with a dilemma: the more it preserves the innovation paths of new entrants, the more it will _CEW_Innovation 2/5

3 reduce the innovation incentives of the dominant firm. Therefore, in such cases, there is no optimal solution. Pierre Larouche explains that in such cases, the Commission often restricts abusive practices by the dominant player (e.g. Microsoft bundling case). The reasoning behind such decisions is that the control of the innovation paths should not be left in the hands of the dominant firm. Finally, in high-intensity clashes, the competition authority cannot avoid picking winners, even unintentionally. Therefore, competition authorities are at some point forced to make a statement about the relative quality of the offerings of the dominant firms and its contenders. An alternative to this subjective argument, though not advisable from Pierre Larouche s perspective, would be to systematically presume against the defendant in such cases. Finally, Pierre Larouche notes that the Commission generally works within existing value networks (to conduct market definition and market assessment), which leads it to take more account of sustaining innovation than of disruptive innovation. However, he also explains that there is, in his view, not much that competition authorities can do about disruptive innovation, except keeping firms nervous, i.e. promote competition sufficiently so that firms enter into an innovation race with their competitors. To conclude, Pierre Larouche points out that this analysis of competition policy brings some interesting insights on how innovation should be brought into the picture by sectoral regulators. First, the task of NRAs might be more complicated because it cannot be presumed, as with competition policy, that they intervene in cases where Aghion s and Arrow s theories of innovation overl ap. Therefore, sector regulators will need to make a more explicit hypothesis about the interaction between competition and innovation, which raises the probability of regulatory failure. Second, it is also more complicated in sectoral regulation to keep innovation paths open irrespective of technology, and efforts towards technological neutrality in telecommunications regulation are therefore a welcome development. Finally, Pierre Larouche insists on the fact that, like competition policy, sector regulation is often limited to firm-driven innovation, which makes it more vulnerable to missing out on open, user-driven, non firm-centred innovation models. Jean-Yves Art, Associate General Counsel and Director of Competition Policy at Microsoft, frames the debate about innovation and competition policy in a different way. For him, the only question that matters is: If the competition authority had not intervened, would the innovation landscape in the sector be any different? From his own experience, this is not an easy question to answer, as competition policy is often not transparent enough in its proceedings and precise enough in its provisions to be able to fully measure what the counterfactual situation would look like. Furthermore, he also points out that the Commission firmly believes in Arrow s theory according to which more competition leads to more innovation, but that, although alternative views exist in the policy debate, DG Competition takes this position for granted and does not offer any justification as to why they chose Arrow over Schumpeter. This lack of justification in theory is also translated into concrete cases. Jean-Yves Art explains that in the Microsoft interoperability case for example, the Commission argued that increased innovation would come from competitors being able to use Microsoft s disclosed _CEW_Innovation 3/5

4 code. However plausible this may be ex ante, Mr Art argues that the opposite case could also be made: competitors will use considerable manpower to understand Microsoft s code, and this duplication of resources, which is by definition costly, might not lead to significant innovation. These preconceived views on innovation held by DG Competition cast considerable doubt on the truthfulness of competition policy. And although they might be proven to be right or wrong ex post, they certainly lack any ex ante justification. According to Jean-Yves Art, in order to construct a thorough framework for the inclusion of innovation into competition policy, two fundamental questions need to be raised. First, policy makers should look at how important innovation actually is in practice in a given sector and whether innovation really is a key component of competitive drivers. If this is the case, competition authorities should also understand the nature of innovation in the sector (product or process, firm-driven or user-driven, incremental or disruptive innovation). Second, the authorities should also consider carefully whether the remedies they impose are actually capable of influencing the parameters influencing innovation choices (e.g. patentability, access to financing). Dr Giulio Federico, Economic Analyst at DG Competition, refutes that the European Commission has an outdated way of considering innovation in competition cases by blindly sticking to Arrow s theories. He points out that the Commission actually has a view on innovation that is reflected in Aghion s theory (and empirics), i.e. DG Competition believes (and follows in this the current academic consensus) that there exists an inverted- U shape relation between innovation and competition. However, he points out that empirical work carried out by Aghion has shown that the downward-sloping part of the inverted-u curve (which matches Schumpeter s view rather than Arrow s) is only reached for markets with a CR4 1 of 50% or less, i.e. markets with more than 8 active firms, which is unlikely to be the case in practice in competition policy. Furthermore, Dr Federico points out that the fact that DG Competition mostly handles cases dealing with incremental innovation does not necessarily imply that it is confronted with a biased sample of innovation. This might simply reflect the fact that most innovation that does occur is incremental in nature and not disruptive. Giulio Federico also adds that it cannot be said that competition policy does not matter in industries with a high rate of disruptive innovation (such as the ICT sector), because, even if a disruptive innovation did happen that completely altered the market structure, competition policy might still have had positive effects in the short term before innovation materialised. To conclude, Dr Federico also highlights that there are some conceptual differences between antitrust and merger cases that need to be taken into account in the analytical framework. In merger cases, market power may arise due to the combination of competing assets, rather than due to past innovation efforts, and policies aimed at limiting market power through merger control therefore generally do not directly deter innovation. In antitrust cases on the other hand, dominance may well be causally linked to past innovation activities and antitrust policy may therefore have a direct impact on innovation incentives. 1 The CR4, or four-firm concentration ratio, is a market concentra tion measure that reflects the percentage of the overall market that is obtained by summing the market shares of the 4 largest firms in the market _CEW_Innovation 4/5

5 Dr Jan Kees Winters, Senior Economic Advisor at the Dutch Authority for Consumers and Markets, explains that the link between competition policy and innovation policy can run in both directions, because it has been shown that innovation policy tools such as patent settlements and royalties can lead to cartel outcomes (Shapiro, 1985). Jan Kees Winters also points out that competition policy might come in fundamental conflict with innovation policy because of their differing objectives. He reminds the audience that the objective of competition policy is to maximise overall consumer welfare, but that innovation might sometimes increase the productive efficiency of firms while being detrimental to consumer welfare. Finally, Jan Kees Winters stresses that the one million dollar question about the theoretical relationship between competition policy and innovation (i.e. the Schumpeter-Arrow-Aghion debate) might not matter that much outside of academics for practitioners. This is due to the fact that, even if a general relationship can be derived between competition and innovation, this cannot decide a specific case and case handlers at competition authorities will still have to do what they already do, namely look at the specifics of the case to reach a decision _CEW_Innovation 5/5