Why European Champions is a bad idea.

Spoiler: French and German government want to create “European Champions”. Following the EC decision to block the merger between Alstom and Siemens, Berlin, and Paris push for less strict competition rules in the EU. They were later joined by Rome and Warsaw.  Pushing for European Champions is a bad idea. EU competition rules are designed to benefit consumers. Consumers will be harmed by relaxed competition rules that allow some firms to gain more market power by weakened competition.   

In concentrated markets become, prices are higher, and outputs are lower. Profits are higher but real wages are lower, so capital shares of income are higher and labour shares lower. Income inequality is higher in a society with weak competition.

In fact, it would be counterproductive to amend the pro-competitive EU framework for making it easier to subsidise potential large EU tech firms. Intense competition on domestic markets is beneficial for innovation and export competition on international markets.

Berlin and Paris want to change the current EU competition rules to make it possible for a more active EU industrial policy to create European Champions. To do so, they want to change key EU competition rules and trade policies. Regarding competition rules, they want to change the state-aid rules so that it will be easier to subsidise firms’ large innovation projects. They also want to change the merger guidelines to take competition from non-EU firms on markets outside the EU, into account. Regarding trade policy, more possibilities to block non-EU direct investments in “strategic technologies and assets which are critical”, are asked for.

These demands for changes in EU policies are based in the fact that most large tech firms in the world are founded in either USA or China. I don’t know whether this depends on more relaxed competition rules and/or more government subsidies in these countries. I leave that question to others.

 

USA is a bad example with strong concentration..

 

My concern is that changes in competition rules will change the focus of competition rules from consumers to producers. As I showed in this post about The Crumbling States of America, weaker competition and stronger concentration on US markets has led to higher profits, lower investments, lower growth, and increased inequality. The post was largely based on “Deaths of Despair” by Anne Case & Angus Deaton and “The Great Reversal. How America gave up on free markets”, by Thomas Philippon.

Philippon not only analyses US developments, but he also compares US to EU. He finds that EU markets are more competitive, yielding lower profits, higher investments, higher growth, and reduced inequality (or at least less).

This is also confirmed in an OECD study by Bajgar et. al. They find that concentration has increased both in Europe and North America and that the American levels and growth rates exceed the European, c.f. Figure 1.

Figure 1. Concentration for Manufacturing and Services industries in Europe vs North America.  

Source: Bajgar, M. et. al. (2019). “Industry Concentration in Europe and North America” OECD Productivity Working Paper. January 2019. No. 18. https://www.oecd-ilibrary.org/economics/industry-concentration-in-europe-and-north-america_2ff98246-en

 

…high profit rates..

 

The higher concentration rates imply that the dominant firms’ market powers are stronger in the US and therefore also that mark-ups and profits are higher. Gutierrez and Philippon (2018) show that while US profit rates have increased, profit rates in the EU remain stable, c.f. Figure 2.

Figure 2. Profit rates in the EU vs USA

Source: Gutierrez & Philippon (2018). How EU Markets Became More Competitive Than US Markets: A Study of Institutional Drift. https://www.stern.nyu.edu/sites/default/files/assets/documents/EUComp_GutierrezPhilippon.pdf Note: The profit rate is defined as Gross Operating Surplus over production.

 

…and low labour shares

 

The result are not sensitive to variations in industry mix or alternative measures of the profit rate. Higher profit rates translate into lower labour shares, c.f. Figure 3.

Figure 3. Labour shares in the EU vs USA.

Source: Gutierrez & Philippon (2018). How EU Markets Became More Competitive Than US Markets: A Study of Institutional Drift https://www.stern.nyu.edu/sites/default/files/assets/documents/EUComp_GutierrezPhilippon.pdf

 

Gutierrez and Philippon also show how higher concentration and mark-ups in the USA lead to higher prices and lower productivity growth.

 

Independent EU institutions and pro-competitive policies made EU markets more competitive than USA

 

The different developments are explained by differences in institutions between the EU and USA. Gutierrez & Philippon (2019) find that EU institutions protect free markets more than any member states and more than USA. The independence of the European Commission, and especially DG Competition has made it more pro-competition than competition authorities in the different EU member states. Also, DG Competition is more independent that its US counterparts which has meant that enforcement of competition rules has remained stable in Europe while it has become laxer in the US. Overall, EU has become relatively more pro-competition than the US over the past 15 years. Product market regulations and barriers to entry have decreased in Europe, while they have remained stable or increased in the US. And Gutierrez and Philippon found no evidence of a negative impact of the EU pro-competition framework on innovation. If anything, (relative) enforcement is associated with faster future (relative) productivity growth, although the effects are small.

The evidence so far does not lend any support to the Franco-German demands for a less pro-competitive framework in the EU. What about the claim that the existing EU rules hamper the growth of large EU tech companies? While theory may seem ambiguous about the relationship between competition and innovation, there is a large empirical literature pointing to a positive relationship as shown in this study by Bloom et. al. (2019).

And the case for not amending the EU pro-competition framework is further supported by studies that show that intense competition on domestic markets increases firms’ competitiveness on international markets. Pro-competition frameworks with low barriers of entry and exit facilitate export success. An important lesson is that pro-competitive framework or conditions are important not only for the producers of the final export goods, but also in the upstream industries that supply intermediate products for the exporters, see for example this study and references therein. This last point is something that is completely missing in the Franco-German ideas for creating EU Champions.

There’s an old saying that goes “nothing is new under the sun”. This is confirmed by a study by the European Commission in 2006 where proposals from the usual suspects, France and Germany, for creating Industrial Champions were discussed. The authors do not find any clear evidence in favour of letting bureaucrats and politicians “pick winners”.

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