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Competition Policy in a Small Economy:
the Case of Iceland
Friðrik M. Baldursson
Department of Economics
University of Iceland
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Goals of competition policy
• Competition is not an end in itself, but the means to an end
• Main goal: improving efficiency
• Enhancing “welfare” in the economic sense
• Many other conceivable goals
• Protecting smaller firms
• Promoting market integration
• Economic freedom
• Fighting inflation
• Fairness and equity
• For small economies efficiency is the only choice
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Goals & tools of competition policy and enforcment
in Iceland• Icelandic Competition Act, Article 1:
• “The objective of this Act is to promote effective competition and thereby increase the efficiency of the factors of production of society”
• Premise: competition increases efficiency
• Basic tools:• Article 10: Ban on agreements to restrict competition (e.g. price-fixing
and market sharing)
• Article 11: Ban on abuse of dominant position
• Article 17: Merger control
• “Heart of competition policy”: Merger control• CA can block or set conditions for merger if it is deemed to “obstruct
effective competition”
• Article 17 does not explicitly mention efficiency considerations
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The small country handicap
• Small countries can often sustain only a few firms in industries where scale is important
• Many firms operate below minimum efficient scale when producing for domestic market only – higher unit costs of production
• Tendency to oligopoly/monopoly
• Adverse effects of lack of competition• Allocative inefficiency
• prices too high
• supply, quality and variety of goods and services limited
• Productive inefficiency – badly run businesses (“the quiet life”)
• Dynamic inefficiency – lack of innovation and investment
• Adverse effects on growth and standard of living
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Location and integration matter
• In general, oligopoly problems exacerbated by geographic
isolation
• Attenuated by proximity to trading partners
• “Gravity” models indicate how close one economy is to other
economies, taking both sizes and distances into account
• Describe preconditions – matters can be made better or worse by
policies
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"Gravity" Index for OECD Countries
Indicates "economic pull" between each country and other
countries
0
5
10
15
20
25
30
New
Zea
land
Aus
tralia
Mex
ico
Turke
y
Icel
and
Gre
ece
Finla
nd
Portu
gal
Kor
ea
Swed
en
Nor
way
Spain
Hun
gary
Polan
d
Irelan
dU
SA
Aus
tria
Can
ada
Slova
k Rep
ublic
Italy
Den
mar
k
Cze
ch R
epub
lic
Switz
erland
Luxem
bour
g
Franc
e
Nethe
rland
s
U.K
.
Belgi
um
Source: Evans and Hughes (2003)
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HHI Expressed as "Number" of Equal Sized Firms
0
1
2
3
4
5
6
Food
reta
ilO
il
Non
-life
insu
ranc
e
Ban
ks (a
sset
s)
Ban
ks (i
ndiv
idua
ls &
smal
l bus
ines
s
Pharm
acie
s
Telec
omm
unic
atio
ns
Mar
itim
e frei
ght t
rans
port
Air
pass
enge
r tra
nspo
rt
Elect
ricity
gen
erat
ion
Elect
ricity
sale
s
Source: Icelandic Competition Authority
•Based on figures from different periods
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•Source: Nordic Competition Authorities, Report no. 1/2005
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•Source: Nordic Competition Authorities, Report no. 1/2005
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Yet, overall, we don’t do too badly:
•Source: OECD
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Iceland
• Certainly fits the description of a (very) small market economy
• Location does not help
• Oligopolistic market structure in many sectors
• Examples of collusion, abuse of dominance etc.
• Indications of higher prices, but perhaps less marked than one
would expect
• Questions:
• Should Iceland pursue policies that are more lenient or more stringent
than those in neighbouring countries?
• Should we accept oligopoly as a necessary evil, allowing firms to
exploit economies of scale?
• Should we pursue an aggressive policy on all frontiers?
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Policy questions
• Should Iceland pursue policies that are more lenient or more
stringent than those in neighbouring countries?
• Should we accept oligopoly as a necessary evil, allowing firms to
exploit economies of scale?
• Should we pursue an aggressive policy on all frontiers?
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Difficult role of Competition Authority
• If too aggressive, may prevent efficient developments taking
place
• If too permissive, may cause entrenchment of market power
• Basic tension: market power vs. firm efficiency
• In larger economies CAs may focus on market power without
paying too much attention to efficiency aspects
• Problem: Gulliver in Lilliput
• Locally large
• Internationally small
• However: we should not underestimate the power of
competition for innovation and growth
• Icelandic experience of the last 15-20 years; EEA agreement
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Implications for competition policy
• A vigorous competition policy must be pursued• There is no choice, we do not want the quiet life
• However, economies of scale must be taken into account to some extent
• Benchmarks and rules of thumb used in large economies should not be uncritically applied, e.g. in merger analysis
• Oligopolistic structure is inevitable
• Relatively stronger emphasis on preventing collusive behaviour and abuse of dominance than in larger economies
• Make markets as open, contestable and integrated as possible• Stimulate entry into Icelandic markets
• Set conditions for expansion of Icelandic firms to other markets
• A wide range of policies, laws and regulation play a role
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Policy in action: Icelandic banks
• Structure in 2000: 3 commercial banks – 2 state owned, 1 investment bank (Kaupthing), >20 savings banks
• In preparation for privatisation of state banks the state sought to merge the two banks – substantial efficiency gains claimed
• CA was asked for opinion and came out against the merger due to the increased concentration that would follow
• Merger plans were abandoned; both banks privatised; one later merged with Kaupthing to form KBB
• Structure now: 3 “large” commercial banks, >20 savings banks
• Market understood that in order to grow, the banks must grow outside Iceland
• All the commercial banks now have substantial operations abroad
• 70% of the income of KBB comes from outside Iceland
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Other important policies
• Market contestability• Lowering barriers to trade and investment
• Clear and transparent rules and legislation
• Encouraging entrepreneurship
• Market integration in a wide sense
• Many policies not thought of as part of competition policy matter
• Less state control: Privatisation
• Zoning
• Currency regime
• Helps not only in attracting entry of foreign and local firms in Icelandic markets, but also helps Icelandic business expand to other markets
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Lowering barriers to trade and investment
• A very important complement to traditional competition policy
• Iceland has reduced barriers in many ways in recent years – has
one of the least restrictive overall product market regulations in
the OECD
• By OECD measures we can still do better in encouraging
entrepreneurship – mainly by simplifying administrative
procedures
• Iceland has the most restrictive FDI rules in all OECD countries
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Product Market Regulation in OECD
•Source: OECD
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0.0
0.1
0.1
0.2
0.2
0.3
0.3
0.4
0.4
0.5
Unite
d Kingd
om
Belgium
Ger
man
y
Net
herla
nds
Ireland
Den
mar
kIta
ly
Franc
e
Gre
ece
Unite
d Sta
tes
Swed
en
Spa
in
Por
tuga
l
Hun
gary
Switz
erland
Nor
way
Cze
ch R
epub
lic
Finland
New
Zea
land
Polan
d
Japa
n
Kor
ea
Aus
tralia
Aus
tria
Mex
ico
Can
ada
Turke
y
Icelan
d
OECD
Restrictions on foreign personnel and operationalfreedom
Screening requirements
Limits of foreign ownership
OECD indicators of FDI restrictions, 2001
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Should competition be pursued in all sectors?
• Traditionally, the electricity sector was considered the
archetypical natural monopoly
• Today, EU countries and many others pursue competition in
generation and sales of electricity
• Iceland has followed the same path
• Still remains to be seen whether this is a viable solution
• Alternative: regulated state monopoly
• Which evil is worse?
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Should powers of CA be strengthened?
• The new Competition Act gives the CA extensive powers to take
measures against infringements of Articles 10, 11 and 12 (e.g.
price-fixing and abuse of dominance)
• May impose behavioural and structural remedies
• Same applies for merger cases
• Difficult to see need for more powers in this regard
• However, need a stronger CA: rapid economic growth, intense
merger activity etc. call for more resources
• There may also be economies of scale in regulatory and
surveillance activities which a small economy should take
advantage of to utilise resources better
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Intra-sector-, cross-holdings and market transparency
• Ownership of many firms characterised by intra-sector and cross-holdings
• Natural to a limited extent
• Strategic holdings within same oligopolistic sector are negative from a competition policy point of view
• Influence and information
• Market transparency
• Forward contracts in shares with pro-forma ownership (i.e. the “owner” does not retain voting rights) increasingly common
• Make the market more opaque
• Negative from an overall market point of view, especially for smaller investors
• Negative from a competition policy point of view
• To some extent the international market has already sent a clear message regarding the cross-holdings phenomenon
• Is further regulation needed?
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Conclusion
• Preconditions for Iceland are bound to lead to an oligopolistic
structure in many sectors
• No sense in trying to maintain or achieve similar structure as in
much larger economies
• All the more need for a vigorous competition policy of the
proper kind
• Market opening and integration are essential parts of an overall
policy…
• …and they are win-win policies
• Have been travelling down this road
• Keep going, in the same direction!