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Why is competition law so important for a small island economy?

Competition law has been in force in Jersey for 18 years and aims ‘to promote competition in the supply of goods and services in Jersey’. But what does this mean, how does it relate to productivity and why is it important for the economy of the island? SARAH PRICE explains

Productivity can be understood as the efficient use of available resources in the most effective manner. The more productive an economy is, the greater the level of output that can be produced for a given level of inputs, benefitting the whole economy. Within this context, competition is a key driver in promoting and delivering continuing productivity.

Competition is the rivalry between firms as they fight for customers. They attract customers by meeting their demand through lower prices, higher quality products or services and/or more innovative products and services. In a competitive market, efficient firms supplying the products and services that consumers demand will prosper, inefficient firms will not.

This competitive rivalry can take different forms and is generally described as competition in or for the market.  

Competition in the market is where firms within a market compete for consumer demand. For competition to be effective, there would probably be a number of competing suppliers, easy market entry and exit, with well-informed consumers. In this context, competition is often assessed by the number of firms in a market, their market shares and relative sizes and by how readily consumers switch between products.

In contrast, competition for the market generally describes how firms compete to supply a market. An example of this would be a bidding process for contracts or licences to supply into a market, e.g., tendering for a service, such as local bus routes. Highly innovative markets, for example digital markets, may also be characterised by competition for the market.  In some cases, the most innovative firm may gain a high market share for a period of time until a competitor develops a similar or better product. A good example is the eclipse of MySpace by Facebook.

Anti-competitive behaviour

So, why does it matter that businesses have to fight to gain customers? Surely it would be much easier and more comfortable for everyone concerned if they didn’t have to? Actually, as well as not being great for consumers, this scenario is actually bad for wider businesses as well as the wider economy. It may look like there is choice on the surface, but if suppliers or businesses have colluded to offer the same thing at the same price, that choice is just an illusion.

For consumers: if businesses aren’t competing with each other for new market share or concerned with retaining their existing customers, prices are likely to be artificially high, lower quality and with fewer new products and services.

For businesses: along similar lines, prices paid to suppliers who are not competing are likely to be higher than expected, leaving businesses no choice but to pay the inflated rates. Impacts may also include longer lead times. If suppliers have agreed not to compete, there will be less motivation to look after their customers. Competing suppliers are more likely to be innovative and efficient, and will continue to offer good service rather than risk losing business to a competitor. Smaller businesses may be unable to compete on a level playing field.

For Jersey: whole sectors of the economy can be affected by a lack of effective competition, both within Jersey and between Jersey and the outside world. Government is a significant customer in many sectors, so if it doesn’t have real choice or the ability to get a fair deal, it will also be paying more than necessary, impacting on taxpayers.

Also, if elements of a market become known for being anti-competitive, this will reflect badly both locally and internationally. Jersey will be seen as an unattractive place to do business.

The effect on productivity

Returning to the relationship between productivity and competition, a report by the UK’s Competition and Markets Authority in 2015 addressed two separate but related questions: does stronger competition between firms lead to higher levels of productivity, and does competition policy and enforcement lead to stronger competition and hence higher productivity?1

The evidence collected in that study suggests that competition drives productivity in three main ways:

Within-firm effects: reducing the ‘x-inefficiency’: Competition acts as a disciplining device, placing pressure on managers to become more efficient. This decreases ‘x-inefficiency’ – that is, the difference between the most efficient behaviour that the firm is capable of and its observed behaviour in practice, also known as the ‘within-firm effect’.

When there is strong competition, inefficient firms are unable to stay in the market in the long run. Managers therefore have a powerful  incentive to ensure there is no slack in the system. In contrast, where competition is weaker, managers may be able to reduce their efforts without the same risk of going out of business.

Between-firm effects: ‘market sorting’: Competition ensures that more productive firms increase their market share at the expense of the less productive. Low productivity firms are more likely to be forced to exit the market, to be replaced by firms with higher levels of productivity. This is sometimes called the ‘across-firm’ or ‘market-sorting’ effect.

Innovation: Importantly, competition also drives companies to innovate. Firms will aim to innovate to gain a cost advantage, to differentiate their products or to bring new products to market. This increases dynamic efficiency through technological improvements in production processes or the creation of new products and services. Product and process innovations have the potential to lead a step change in costs or quality, or to create new markets. Competition can be the strongest incentive for firms to innovate, particularly when complemented by an effective intellectual property rights regime (allowing firms to benefit from some of the gains of innovation).

Competition in digital markets

The development of digital markets has brought great economic benefits; however they also present new challenges for the effective operation of competition. Digital markets can support businesses in finding new customers and the ability to grow quickly, driving economic growth and innovation. However, these markets can be characterised by the power of a few large firms and it may be the nature of digital markets that allows these firms to achieve this power.

Competition can be the strongest incentive for firms to innovate, particularly when complemented by an effective intellectual property rights regime.

The features of digital markets that may lead to this increased market concentration are network effects, multi-sided markets and the role of data, which lead to a risk of a small number of large firms.

With the creation of firms with durable and entrenched market power comes the risk that these firms will have the ability and incentive to raise prices, reduce choice, quality, and innovation, and limit access to those markets for competitors.

How is competition supported in Jersey?

In 2005, the Competition Law came into force in Jersey. It is administered by the Jersey Competition Regulatory Authority (JCRA), an independent statutory body established in 2001. This law follows international best practice, covering anti-competitive arrangements, abuse of a dominant position, and merger control. Alongside this the JCRA has an active market study programme and supports consumers.

Deterring anti-competitive behaviour

The JCRA carries out investigations into anti-competitive conduct in Jersey which can have far-reaching consequences in distorting markets and disadvantaging Jersey consumers. The key factors which must be determined are whether any anti-competitive conduct has occurred, whether by way of an anti-competitive arrangement or the abuse of a dominant position, and also the extent of its impact on a market.

Anti-competitive arrangements: arrangements that substantially lessen competition are illegal. These arrangements could be in the form of a written contract or an informal understanding. Whether an agreement is deliberately anti-competitive or not, if it has the purpose, effect or likely effect of substantially lessening competition in a market it is illegal. Even if the agreement is not put into practice, the act of reaching (or attempting to reach) any anti-competitive arrangement is also illegal.

Taking advantage of market power: some businesses have a dominant position in a market. This in itself is not illegal; however it is illegal to abuse that dominant position. A dominant company can take advantage of its market power to drive a competitor out of business or to prevent new competitors from starting up. This can reduce or eliminate competition from a market. There are various types of behaviour that are illegal.

It is often difficult to distinguish such behaviour from aggressive but legal competition which will benefit consumers. For example, cutting prices to win customers is usually a sign of competition, but in some circumstances can harm it. Likewise, aggressive rivalry by large businesses may not be illegal as large businesses also have a right to compete. However, they are not allowed to take advantage of their market power to prevent others from competing effectively.

Overall, there is robust evidence that anti-competitive behaviour leads to higher prices and reduced productivity, and therefore interventions by competition authorities can lead to lower prices and increased productivity.

Preventing harmful mergers

The JCRA administers a mandatory clearance regime for certain mergers and acquisitions, and will only give approval if it is satisfied that the merger is unlikely to have the effect of substantially lessening competition in a market.

To assess this the JCRA examines whether a merger is likely to substantially lessen competition if the merger proceeds compared with the likely state of competition if the merger does not proceed. A lessening of competition is generally the same as an increase in market power and it creates an environment in which a company can raise prices and reduce the quality of goods and services to levels that would not exist if there was a competitive market.

The most important impact of merger policy on productivity is through wider deterrence of potentially anti-competitive mergers which would reduce competition.

Studying markets

The JCRA also undertakes market studies that can make recommendations to change the way markets work to help improve competition. A market study is a flexible tool to explore this, consider whether competition is working well and, if not, what can be done to improve it. As part of a market study the JCRA considers the relationship between consumer behaviour and the market structure as well as the behaviour of firms in that market. By looking at these types of relationships and other factors, the JCRA can determine whether recommendations designed to encourage changes in consumer behaviour, business behaviour, or both, will help address any market problems found.

These recommendations often focus on barriers to entry erected by firms or by government or areas where there is insufficient information for the market to work efficiently. If left unaddressed, these barriers can have significant negative implications on productivity.

Supporting consumers

There is a link between consumer policy and productivity. Consumer policy can help empower consumers to drive stronger competition, which in turn has a positive impact on productivity.

Consumers can encourage competition by choosing to buy from the firm that offers the best combination of price, quality, and product characteristics. Firms that offer the same goods at higher prices, or less innovative products, lose business and are forced to change or leave the market. Empowered, active consumers are therefore central in creating the incentives for firms to compete.

The JCRA’s focus is on encouraging consumers to be active market participants. This is often a theme of the JCRA’s market studies. For example, in groceries a key recommendation was to improve price transparency with investment in the Jersey Consumer Council’s price comparison service, to encourage greater price based competition.

Sarah Price

Sarah Price is chief operating officer at the Jersey Competition and Regulatory Authority.

1 Competition and Markets Authority (2015). Productivity and competition: A summary of the evidence. 9 July.