Implications of the Smallness of an Economy for Merger Remedies

Author:Katri Paas
Position:LL.M., Attorney, Lepik & Luhaäär LAWIN Law Firm

1. Effects of smallness on competition - 2. Remedies in the case of anti-competitive mergers - 2.1. Overview of some procedural considerations related to merger remedies - 2.2. Types of remedies - 2.3. Principles of the choice of remedies in various competition regimes - 2.4. Justifications for the wider use of behavioural remedies in small economies - 2.4.1. Lack of enforcement power - 2.4.2.... (see full summary)


Katri Paas

LL.M., Attorney, Lepik & Luhaäär LAWIN Law Firm

Implications of the Smallness of an Economy for Merger Remedies

There has been increasing discussion in recent years concerning the particularities of small economies in the context of competition law and policy1. It has been generally recognised that market structures in small economies tend to be more concentrated than market structures in large economies, where economies of scale and scope are important. There have been voices arguing that such features may call for specifically tailored competition rules2.

This article studies the implications related to the small size of an economy for merger control and, in particular, remedies applicable in merger control. The article questions whether the principles applicable to the use of merger remedies in large economies are equally appropriate in small economies.

In order to seek an answer to this question, section 1 of this article first discusses in brief the effects of the smallness of an economy on competition, pointing to some factors that tend to cause distinct outcomes in small economies, such as high concentration rates and entry barriers. Section 2 of this article deals with remedies applicable in the case of anti-competitive (illegal) mergers, first giving a brief overview of some procedural considerations related to merger remedies, the different types of remedies applicable in merger control, and the principles for the choice of remedies in various competition regimes. Thereafter, it discusses the justification for wider use of behavioural remedies in small economies, as compared to large economies, coupled with various case studies. Finally, some conclusions follow.

It should be noted at the outset that, even though there are various ways to define smallness of an economy, for the purposes of this article economies whose population is below 10 million are considered small. Setting of any such dividing line is a rough decision, and as the threshold for smallness is moved up or down, the weight of the various arguments concerning the particularities of small economies changes - the specific features associated with smallness grow progressively more apparent the smaller the nation and less apparent the closer the size of the nation is to the threshold.

1. Effects of smallness on competition

One of the most widely recognised effects of smallness of an economy is the difficulty of achieving minimum efficient scale (MES) for domestic firms, on account of low domestic demand. As Michal S. Gal has put it, "[t]he basic handicap resulting from small size is the need to produce at levels that cater to a large portion of demand in order to achieve minimum costs of production"3. Therefore, small economies can support only a small number of competitors in many industries, which is why their markets tend to be highly concentrated4.

In many cases, the problem of smallness of domestic markets can be mitigated by opening the markets to trade - foreign markets can broaden the sources of demand and increase the potential for actualising the expansion that is necessary for achieving MES, by exploiting economies of scale and scope. At the same time, imports can supplement or replace lacking domestic production. This means that where domestic production is too costly or impossible because of the problem of achieving MES or on account of scarcity or lack of resources, import goods could satisfy the demand in small economies5.

The benefits of trade have been recognised around the world, and, with respect to many goods; this has greatly alleviated the problems of achieving MES domestically and has opened up many domestic markets to competition from foreign firms as well. As a result, the majority of markets in small, open economies are composed, solely or to a great extent, of imported products; and the number of markets that are solely or mostly supplied by domestic products is rather limited6.

However, even in the case of the most liberal trade regulations, barriers to trade may still exist. Therefore, an economy's openness to trade cannot fully resolve the problems related to small size in every industry. This is because of the existence of irremovable barriers to trade, such as natural barriers (e.g., oceans, mountains, and large distances), cultural or language differences, consumer preferences, and high transportation costs7. The effect of such factors on trade depends greatly on the nature of the goods or services8. For instance, perishable goods (such as fresh milk products and fresh bakery products) that have a short storage life can be traded only within limited distances. Similarly, trade is unlikely where the value-to-weight or value-to-size ratio of the goods in question would render transportation irrational on account of high costs9. Other factors, such as consumer preferences, culture, and language differences can complicate trade as a consequence of the need to customise the goods for the target market or of the need to break the established brand loyalty with respect to domestic products10.

Such obstacles to trade are likely to cause proportionally more significant segmentation in certain economies than in others. The more distant the economy is from its potential trade partners either naturally or culturally, the higher are the barriers to trade and the larger is the number of non-tradable sectors. Furthermore, an economy being of small size may discourage trade, because the investment costs of adapting to local consumer preferences or language requirements are proportionately higher as compared to those in large economies. Therefore, small and/or distant economies will always be more prone to face problems of achieving MES, particularly with respect to non-tradable goods and those goods that face significant trade barriers.

Furthermore, smallness of an economy could constitute a factor raising entry barriers for potential market participants. Since the demand in small markets is limited, certain kinds of entry barriers, such as lack of economies of scale and scope, are likely to be harder to overcome in small economies than in large ones. This is because an entrant with plants of less than MES would face cost disadvantages vis-à-vis firms with MES plants. It has been reasoned that if MES is large relative to demand and if the cost penalties for operating below MES are substantial, a new firm would have to enter the market at such a large scale that the combined output of all firms operating in the market could be sold only at substantially reduced prices, perhaps even below average total cost, unless one of the firms exits the market11. Moreover, a small market can be unattractive also simply because of the maximum potential total return on investment being smaller than that in large markets.

Small size may also create more competition problems if the existing competitors control concentrated, vertically-linked markets. In particular, the existence of high MES levels in one market might limit entry into a vertically-linked market if it requires a new entrant to enter more than one market in the chain of manufacturing and distribution, or if it significantly raises that entrant's costs relative to the costs of its rivals12. Such impediment can be both structural and strategic in nature13.

With MES considerations left to the side, limited human resources can also constitute an entry barrier, since small population size often constrains the availability of human capital, especially skilled labour. Furthermore, most small economies are also small in geographic terms, which tends to entail a limited and less diversified supply of natural, irreproducible resources14.

Such problems are exacerbated to the extent that domestic regulations inhibit rather than enhance competition. For example, the existence of country-specific distribution regulations could constrain market entry. Thus, it is of particular importance for small economies to ensure the openness of distribution systems and not maintain regulations favouring the existing market participants15. In sectors where competition is severely limited, regulation targeted at loosening the ties present between various existing market participants may be needed to limit the potential costs imposed by the presence of market power16. As will be seen below, in the case of mergers that are potentially anti-competitive, remedies can be applied for such regulation.

2. Remedies in the case of anti-competitive mergers
2.1. Overview of some procedural considerations related to merger remedies

Whenever a merger would have serious anti-competitive effects, it is usually deemed illegal in all jurisdictions where merger control is in force. Depending on the procedural arrangements (either a pre-merger notification system or post-merger assessment), the competition authority investigating such a merger is tasked with prohibiting the merger or declaring its illegality in order to avoid detriment to competition17.

Alternatively, most jurisdictions allow modifications to be made in the merger arrangements in order to remove or at least mitigate the competition concerns raised by the merger; i.e., remedies are applied. Such modifications constitute commitments by the merging parties to fulfil certain obligations or achieve certain outcomes, such as to divest some assets or businesses, or to act in a specified manner. The competition authority's approval...

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