Competition Policy and Green Growth

Competition Policy and Green Growth

Interactions and challenges

– A joint report by the Nordic competition authorities –

October 2010

Table of Contents

Preface 4

  1.  Executive Summary 5
  2.  Background and Structure of the Report 11
  3.  Competition Policy and Environmental Policy 12
    3.1 Brief Introduction to Environmental Policy 12
    3.2 The Benefits of Competition 13
    3.3 The Relationship between Competition Policy and Environmental Policy 15
    3.3.1. The Impact of Environmental Policy on Competition 16
    3.3.2. The Environmental Impacts of Restrictive Practices 17
    3.4 Concluding Remarks 18
  4.  Environmental Policy Instruments and Competition Implications 20
    4.1 Taxes and Subsidies 20
    4.1.1 Taxes 20
    4.1.2 Subsidies 21
    4.2 Tradable Emission Permits 24
    4.2.1 ETS and the Importance of Effective Competition 24
    4.3 Green Public Procurement 27
    4.3.1 GPP as an Environmental Policy Tool 27
    4.3.2 GPP in a Competition Policy Perspective 29
    4.3.3 Case Material 31
    4.3.4 Concluding Remarks 33
    4.4 Restrictive Effects of Green Measures and the Importance of Advocacy. 33
    4.4.1 Competition Assessment of Green Measures 34
    4.4.2 Advocacy of Market Based Instruments in Environmental Policy 44
  5.  Business Practices in Green Markets 46
    5.1 Antitrust and Green Markets 47
    5.2 Restrictive Practices in Recycling and Waste Management 49
    5.2.1 Spillover effects 49
    5.2.2 Bundling of Demand 51
    5.2.3 Pricing and Fee Structure 54
    5.3 Certification Arrangements and Competition Concerns 58
    5.3.1 Economic Theory and Certification Effects 59
    5.3.2 Certification, Differentiation and Price Premiums 61
    5.3.3 Certification and Trade 63
    5.3.4 Concluding Remarks 63
  6. 6. Future Challenges on the Path to Green Growth 66

Preface

There is a strong and growing policy emphasis on the development of a new and fresh economic and social framework that would enable low-carbon economic growth and development, prevent environmental degradation and enhance quality of life. Reflecting this, Ministers of 34 countries at the OECD Ministerial Council Meeting of June 2009 endorsed a mandate for the OECD to develop a Green Growth Strategy.

In their semi-annual meeting in the Faroe Islands in March 2010, the Directors General of the Nordic competition authorities discussed some of the challenges the competition authorities face in respect of the shift towards green growth.

The Directors emphasised the importance of competition, cost efficiency and coherent policies in a successful shift towards green growth. A crucial element in the shift towards a green growth economy is to remove or reform policies that undermine the transition. The Directors emphasised that assessment of environmental policies must take into account inter alia barriers to entry and limitation of opportunities for effective competition.

In order to establish a common background for addressing future challenges in this context, it was agreed to produce a joint Nordic report which would focus on the relationship between environmental and competition policy.

This is the background to this report. The mandate outlined by the Directors-General calls for a discussion on the relationship between environmental and competition policy, followed up by an overview of environment-related cases faced by the Nordic competition authorities in the last few years and what can be learnt from them in rela- tion to future enforcement, advocacy focus and the development of a green growth strategy.

The members of the working group were:(1)

  •  Martti Virtanen (Martti.Virtanen@kilpailuvirasto.fi)
  •  Ólafur F. Þorsteinsson (olafur@samkeppni.is)
  •  Kjell J. Sunnevåg (kjsu@kt.no) (head)
  •  Mikael Ingemarsson (Mikael.Ingemarsson@kkv.se)
  •  Anders Johansson (Anders.Johansson@kkv.se)

We hope the report will contribute positively to the development of green growth strategies and establish a useful underpinning for the competition authorities’ work on environment-related competition cases in the future.

Bergen/Copenhagen/Helsinki/Nuuk/Reykjavik/Stockholm/Thorshamn

(1) Þorbergur Þórsson of the Icelandic Competition Authority made a valuable contribution to the report in the early stages of the work. Andreas Kryger Jensen and Christian Ølgaard of the Danish Competition Authority provided constructive comments throughout.

1. Executive Summary

Green growth is a concept that involves rethinking economic growth. It is mainly concerned with how economies can grow in a more sustainable way. It evolved out of a strong and increasing policy emphasis on the development of a new economic and social framework designed to enable economic growth and development while preventing environmental degradation and enhancing quality of life. Thus, it has been argued that together with innovation, going green can be a long-term driver of

economic growth through, for example, investment in renewable energy and improved efficiency in the use of energy and materials. Reflecting this new policy focus, the OECD has been given a mandate to develop a Green Growth Strategy.(2)

A successful shift towards the ambitions underlying the green growth strategy can only be achieved through cost efficient and coherent policies. Competition policy has an important role in this context. It is up to the competition authorities to ensure that this relationship receives due attention.

Economic theory and empirical evidence support the view that competition is desir- able as it contributes to efficiency in economic activity, thereby increasing the welfare of consumers and society. Healthy rivalry between competing firms ensures that only the most efficient and innovative firms develop and stay in the market. While it is diffi- cult to measure the degree to which effective competition affects productivity and the economy more generally, a number of extensive studies have found a link between stronger competition and higher productivity growth. So competition contributes to economic growth.

There are also important links between competition and environmental policy. Using market mechanisms is important in green growth strategies as it allows appropriate prices to be determined. Price signals reflecting environmental externalities ensure that the correct incentives are in place for pollution abatement and innovation in green technology. Ensuring effective competition is important in this context, since otherwise the price signals cannot be effectively transmitted.

Effective competition and low barriers to entry are also crucial to innovation and market dynamics, which again play an important role in achieving environmental goals at a lower cost. Thus, given a well designed environmental policy, competition supports the achievement of environmental goals in a cost-efficient way.

Environmental regulations, practices or enforcement may affect competition negatively. This in turn may increase the social costs of achieving environmental goals. However, pro-competitive legislation is becoming stronger and is being more effectively enforced in many countries. Thus, one of the challenges the competition authorities face in this regard is helping to ensure that green legislation will not affect competition negatively and that pro-competitive legislation is employed instead. Various advocacy channels can be used to achieve this aim.

Perhaps the most important conclusion to be drawn from the report is that competition policy has an important role to play in the development and implementation of a green growth strategy and in facilitating a successful shift to green growth.

The report is composed of three main chapters. In Chapter 3, the relationship between competition policy and environmental policy is explored. In the remaining parts of the report we have made a distinction between the application of policy instruments and practices. The former refers to tools and means as applied in policies in the

(2) OECD (2009) “A Proposal for Developing a Green Growth Strategy”, (2009)147/REV1.

environmental sphere. The latter refers to the behaviour and practices of companies in the markets. In some cases, these practices are endorsed by the authorities. Accord- ingly, in Chapter 4, a closer look is taken at certain aspects of environmental policies and some of the conflicts that have arisen or might arise between these and competition policy. In Chapter 5 an account is given of how environmental policies are reflected by the practices of market participants through different green schemes. The report concludes with some forward looking perspectives in Chapter 6.

THE RELATIONSHIP BETWEEN COMPETITION POLICY AND ENVIRONMENTAL POLICY

As highlighted in Chapter 3, environmental and competition policy share the common objective of safeguarding and promoting social welfare.

Effective competition can support environmental policy by allowing price signals that reflect environmental externalities to be effectively transmitted. Competition also reinforces environmental policy in that competition-induced innovation efforts and efficiency improvements may be considered important components in a successful environmental policy.

However, environmental policy may harm competition by for instance increasing barriers to market entry. Thus, the OECD recommends that environmental regulatory agencies routinely undertake competition impact assessments of their environmental proposals. The national competition authorities can assist in such assessments, and they must be vigilant in pointing out the restrictive effects on competition of various regula- tions in the environmental area.

Environmental benefits might be adduced as a defence of horizontal practices or arrangements otherwise deemed restrictive under competition law. However, there are strict requirements to be fulfilled in this regard. The measure in question must be

proportional to its aims. There must also be net economic benefits in terms of reduced environmental pressure resulting from the practices or arrangements concerned – compared to a baseline where no action is taken – and the expected economic benefits must outweigh the costs. Such costs include the effects of reduced competition, along with compliance costs for economic operators and effects on third parties.(3)

ENVIRONMENTAL POLICY INSTRUMENTS AND COMPETITION IMPLICATIONS

Governments can choose between two broad categories of policy tools in seeking to respond to and correct for negative environmental externalities: economic and admin- istrative policy tools. Economic tools, such as taxes and subsidies, work indirectly via the price mechanism while tradable permits work through regulated quantities traded in a market. Regulations of a more administrative character are those which for example include specifications of maximum permitted emissions or detailed requirements for products, production processes or technologies. Such approaches are often referred to as command and control approaches.

Chapter 4 focuses on the workings and competitive ramifications of the main environ- mental policy tools. In addition to competition aspects of taxes, subsidies and tradable emission permits, the section also focuses on green public procurement as a green policy tool. Finally, the chapter points out the important advocacy role that competition authorities have in demonstrating potential conflicts when they arise, both to ensure that competition concerns are taken into consideration by the appropriate authorities

(3) See European Commission notice: “Guidelines on the applicability of Article 81 of the EC treaty to horizontal cooperation agreements” (2001/C 3/02).

and to propose how to alleviate the conflict – or even align objectives. Below is a further summary of the contents of the chapter.

Taxes and subsidies

Environmental taxes are an important tool for solving the environmental externality problem, not least because direct taxes on emissions are considered economically efficient. Environmental taxes give polluters an incentive to reduce their pollution to the point where further reduction would cost more than paying the tax. There are, however, important challenges. One is to determine the correct tax level. Another relates to the fact that efficiency requires all polluters to face the same tax level at the margin. Tradable emission permits can resolve the problem of how to determine the correct price of emissions, provided that certain requirements are met.

Subsidies can refer to a variety of transfers, payments, supports (such as tax exemp- tions) and protections associated with government policies. When considering the introduction of subsidies as a means of achieving environmental goals, it is important to conduct a broad analysis of the net effects on welfare before reaching a decision. Conversely, environmental policies that involve the elimination of environmentally harmful subsidies are generally in line with competition policy.

Tradable emission permits

The EU Emission Trading Scheme (ETS) is regarded as one of the cornerstones of EU climate policy. The price of tradable emission permits plays a role similar to that of a tax. In the ETS, the total number of permits issued and the marginal abatement costs together determine the price for emissions. Thus, for a given total quota, the actual emissions price is determined by the market. The Nordic competition authorities have on several occasions argued that emission permits in general should be auctioned and should cover as many emission sources as possible, and also that incumbents should have no preferential treatment compared to newcomers.

For an emission trading scheme to function properly, competition in the permit market must be effective. When auctioning emission permits, auction design is important to ensure efficient pricing and avoid collusion. Thus, the competition authorities must seek to deter and detect collusive practices before, during and after the auction process.

Green public procurement

Public procurement is in itself a powerful tool, given its size in relation to GDP in the respective Nordic countries. Green public procurement (GPP) can hasten the develop- ment of markets for green goods. But a certain amount of caution should be exercised before it is used.

GPP should only be used if the external effect is not internalised by other regulatory instruments. If other regulatory instruments fulfil the object of internalising an external effect, adding further regulatory instruments – for instance by imposing environmental criteria in public procurement – may lead to inefficiencies from a socio-economic point of view. If the external effect is partly internalised by other regulatory instruments, GPP could be used and be designed to complement the policy tool in place.

It is also important to be aware that GPP can have a negative impact on competition if the restrictions imposed lead to significantly fewer firms being able to submit bids. This may increase costs for the procuring entities. GPP can also lead to higher prices due to investment being required to enable actors to submit bids. Finally, if the use of GPP is to have a real impact on the environment, it is important that the procuring entity iden-

tifies the product groups for which there is substantial procurement and that the product will be used in sufficient volumes to have a significant impact on the environment.

More fundamentally, the criteria and procurement process must comply with the basic principles of European Community law on public procurement, including non-discrimi- nation, equal treatment, transparency, proportionality and mutual recognition.

Restrictive effects of green measures and the importance of advocacy

The transition to green growth implies that a host of green instruments will be imple- mented in many different areas. Promoting correct pricing of environmental goods

is crucial to a cost-efficient environmental policy and proper innovation incentives. This can best be achieved through effective competition, since otherwise price signals reflecting environmental externalities cannot be effectively transmitted. Thus competition authorities have the essential task of advocating market based instruments in envi- ronmental policy.

Competition authorities also have an important role in identifying and analysing regu- lations that may unduly distort or restrict competition. When assessing the competi- tive impact of specific regulatory green measures, the OECD Competition Assessment Toolkit offers valuable guidance, both to the competition authorities and the relevant sector authorities. In many instances, green measures can be restructured to minimise harm to competition.

Competition authorities should also seek to advocate green measures that are less distorting to competition and endeavour to promote an efficient compromise between competition and environmental policy where appropriate. This function may also contribute significantly to the task of improving regulatory quality in the environmental area.

To succeed, initiatives must be timely, and political support should be sought. In addi- tion, it is clear that changes take time and therefore perseverance may be required.

BUSINESS PRACTICES IN GREEN MARKETS

Environmental policies can be reflected in business practices related to various green schemes, for instance recycling or waste management or through different certification arrangements.

An important point in Chapter 5 is that many of the schemes have given rise to concern from a competition policy standpoint. An equally important point is that many of the schemes can be designed in such a way that competition in fact supports environmental goals more cost efficiently. The chapter starts with a brief account of specificities of antitrust efforts in ‘green markets’.

Antitrust and green markets

In the European Commission’s guidelines,(4) the section focusing on horizontal environ- mental agreements, it is stated that by nature, such agreements should be considered to be in breach of Article 101(1) TFEU if the cooperation is not genuinely concerned with environmental objectives but serves to conceal anti-competitive practices. And even where a particular environmental scheme may be endorsed by the authorities, this may not be used as an excuse for practices involving abuse of dominance.

(4) See European Commission notice: “Guidelines on the applicability of Article 81 of the EC treaty to horizontal cooperation agreements” (2001/C 3/02).

Although some cases may be relatively clear-cut, there may be a host of borderline cases. Moreover, it is possible that even though a particular environmental agreement may raise concerns from a competition point of view, i.e. since the agreement falls under Article 101(1) TFEU or the national equivalents, the agreement may also bring economic benefits. These benefits, even at individual or aggregate consumer level, may outweigh the negative effect on competition. For this to be the case, it must be clear that the measure cannot be achieved through less restrictive means, i.e. that it is propor- tionate to the aim. To pass the test in Article 101(3) TFEU, the economic benefits should moreover stem from reduced environmental pressure resulting from the agreement, as compared to a baseline where no action is taken, i.e. the expected economic benefits must outweigh the costs in terms of reduced competition.

Restrictive practices in recycling and waste management

Recycling and waste management are booming industries in many countries. Industry- wide arrangements, e.g. through branch organisations or industry-owned schemes have become quite common and are in many cases endorsed by environmental authorities. This applies in particular to recycling and waste management. Most environment-related cases encountered by the Nordic competition authorities in recent years have involved recycling and waste management.

As the cases reviewed clearly show, even though there may be good arguments in favour of industry-wide arrangements, including economies of scale, operational efficiency and avoidance of non-participating producers getting a ‘free ride’, various aspects of these schemes may also cause serious competition concerns through:

  •  risk of spillover effects,
  •  bundling of demand, and
  •  pricing and fee structure.

The cases also show that in many instances, there are alternative approaches based on competition, or at least approaches involving a less restrictive impact on competi- tion through which environmental authorities can achieve their objectives in a more cost efficient way. The competition authorities have important roles, both in terms of applying competition law to cases where the anti-competitive effects outweigh the economic benefits and of advocating competition-based solutions more widely.

It is also worth noting that a significant share of the cases considered by Nordic compe- tition authorities related to green schemes have been closed through the application of ‘soft enforcement’, where the elements in the schemes causing concern were changed voluntarily in response to views expressed by the competition authorities.

Certification arrangements and competition concerns

Product certification highlights the specific characteristics of a product. Certification is primarily used to signify that a product has one or more credence attributes, i.e. characteristics that are invisible and difficult to judge. For that reason, certification can significantly reduce the transaction costs associated with information gathering. As buyers get more information it becomes easier for them to adapt their consumption choices in accordance with their preferences. More information can also enhance consumer mobility and thereby improve market performance.

Certification has become increasingly important, also in green markets. It has for instance become a key element in marketing organic food products. It has also been receiving growing attention in sectors like construction and taxi services. When certification is introduced, producers have a greater incentive to develop product qualities that consumers demand.

There may however be incentives for businesses to influence the certification criteria so that their own products are favoured over competing products. Furthermore, attempts may be made to increase costs to rivals, e.g. by lobbying for a narrow product category definition or monitoring mechanisms that disfavour competitors. In cases where the certification standard places foreign producers at a disadvantage, this may have a nega- tive impact on international trade flows and international competition.

The effect of certification on welfare depends on how well the certification standard is designed (it needs to be non-discriminatory) and whether effective competition prevails. The competition authorities have an important role in this context through advocacy and, where appropriate, enforcement.

Forward-looking perspectives

Competition has a significant impact on the efficiency of environmental policy. Consequently, competition policy and the efficient enforcement of competition law should form an integral part of any green growth strategy. As environmental and competition policies share the common objective of safeguarding and promoting social welfare, we must strive to make execution of environmental policy and competition policy mutually supportive.

Experience has shown that existing environmental policies or schemes may restrict competition by raising barriers to entry and limiting incentives or opportunities for effective competition. The Nordic competition authorities have been active in pointing out these restrictive effects.

The Nordic competition authorities have also been firm and outspoken advocates of market-based approaches in environmental policy. When designing market based policy instruments, it is important to consider how well the ‘newly created’ markets will function. If it appears likely that price formation in a newly formed market will be strongly affected by market power, a different design should be considered.

Competition advocacy and competition enforcement focusing on the restrictive effects of various green schemes on competition will remain an important task for the competition authorities in the future and constitute an important contribution to the overall success of green growth strategies.

Advocacy efforts on the part of competition authorities will lend important support to the OECD Ministers’ aim of “establishing appropriate regulations and policies to ensure clear and long-term price signals encouraging efficient environmental outcomes”.

2. Background and Structure of the Report

Green growth is a concept that involves rethinking economic growth. Mainly it is about how economies can grow in a more sustainable way. It has evolved out of a strong and increasing policy emphasis on the development of a new economic and social framework capable of promoting economic growth and development while preventing environmental degradation and enhancing quality of life. Thus it has been argued that together with innovation, the greening process can be a long-term driver of economic growth, for instance through investment in renewable energy and improved efficiency in the use of energy and materials. Reflecting this new policy focus, the OECD has adopted a mandate to develop a Green Growth Strategy.(5)

A successful shift towards the ambitions underlying the green growth strategy can only be achieved through cost efficient and coherent policies. Competition policy has an important role to play in this context.

The main goal of this report is to further explore the linkages between competition and environmental policy, especially the role of competition in a green growth context – both conceptually and through specific enforcement cases encountered by the Nordic competition authorities.

The conceptual aspects of the linkages between environmental and competition policy are explained and explored in Chapter 3. Included is a summary of the main aspects of environmental policy and the benefits of competition.

A distinction has been made in the rest of the report between the application of policy instruments and business practices. The former refers to the framework and execu- tion as it is determined by policies in the environmental sphere. The latter refer to the practices of the companies in green markets, for instance involving recycling or waste management. In quite a few areas, these practices are endorsed by the authorities.

In line with this distinction, we first take a look at environmental policies and the extent to which these might raise concerns from a competition standpoint. We then present advocacy cases which relate to concerns from a competition standpoint.

The main concerns of competition authorities with respect to green markets – namely the obligation of competition authorities to deter and detect collusive practices and abuse of dominance – are presented in Chapter 5. We then focus on business practices in the waste and recycling industry. This is the area where most of the environment- related Nordic case experience has been gained; relevant cases are presented in blue fact boxes summarising the background, reason and conclusion of each case.

The last section of Chapter 5 contains an account of certification arrangements. Such schemes have become quite common in green markets. These arrangements are explained and cases identified where these arrangements may raise concerns – or be beneficial – from a competition and general welfare standpoint.

Finally, in Chapter 6, some forward-looking perspectives are presented.

(5) OECD (2009). “A Proposal for Developing a Green Growth Strategy”, (2009)147/REV1.

3. Competition Policy and Environmental Policy

Environmental and competition policy share the common objective of safeguarding and promoting social welfare. Furthermore, it may be said that both are constructed by the state to correct market failures.

However, each of these policies addresses a different aspect of welfare. While environ- mental policy promotes social welfare by seeking to correct for environmental exter- nalities, competition policy contributes to economic efficiency, thereby increasing the welfare of consumers and society.

There are, however, important links between competition and environmental policy. Making use of the market mechanism can be highly supportive in green growth strate- gies since it facilitates the formation of correct price signals. These price signals ensure that the correct incentives are in place for pollution abatement and innovation in green technology. Ensuring effective competition is important in this context, since otherwise price signals reflecting environmental externalities can not be effectively transmitted.

Effective competition and low barriers to entry are also crucial to innovation and market dynamics, which again play an important role in achieving environmental goals at a lower cost. Thus, given a well designed environmental policy, competition supports the achievement of environmental goals in a cost efficient way.

However, the links between environmental policy and competition policy are not solely of an advantageous nature. They may in some cases involve counterproductive effects. Environmental regulations, practices and/or enforcement may impair competition and thus increase the social costs of achieving environmental goals.

Before we proceed to explore the relationship further, however, we will first give a brief introduction to environmental policy.

3.1 Brief Introduction to Environmental Policy

Typically, the main goal of environmental policy is to limit the harmful effects of production or consumption on the environment. These effects fall into a category known in economics as externalities. These can be either positive or negative. A negative externality occurs when the activity of one entity adversely affects the utility and welfare of others without the effect being transmitted through market prices. In reality, these negative effects are costs of production that neither the producer nor his customers need to carry directly because they are imposed on others. These others could be contemporary inhabitants or later generations in the home country or abroad. In some cases, the environmental policy goal of correcting for externalities is fulfilled simply by imposing pollution limits or restrictions on the production causing the nega- tive externalities.(6)  More commonly, however, the goal of environmental policy is met by steering producers or consumers towards more environment friendly practices by making the acts causing the externality more costly for them.(7)

Generally, it may be said that the most important expedient used in environmental

(6) For simplicity, we will hereafter mostly speak of production and producers as the cause of externalities. This is due to the fact that the focus of competition authorities is naturally more on production than consumption.

(7) In Chapter 4, some of the key policy instruments of environmental policy are presented and explored in the context of competition policy.

policy is to constrain firms to internalise the external costs which their production process imposes upon others, or in other words, to compel firms to take all the production costs into account, including the costs associated with the externalities resulting from their activities.

Various policy instruments can be applied in the enforcement of environmental policy. The types of instruments may be divided into two broad categories: market based instruments and non-market based instruments. Market based instruments are intended to work through price signals. The most common tools in this category are environmen- tally-related taxes, charges and fees, tradable permits, and removal of environmentally harmful subsidies. The application of non-market instruments involves influencing the behaviour of firms, households or individuals through means other than price signals.

These include command-and-control regulations, policies to support green technologies and innovation, and voluntary approaches based on the dissemination of information and negotiated agreements between government and specific industrial sectors in order to address a specific environmental concern.8

Successful environmental policy leads to correct or adequate pricing of externalities that have not previously been priced or have been inadequately priced. Hence, a more effi- cient allocation of the factors of production, including natural resources, is promoted.

Moreover, the policy affects the competitiveness both of firms that have relied on the inadequately priced resources and their rivals in the market. The effect of the policy on economic efficiency can be compared to the impact of the abolishment of a distortive subsidy.

Environmental policy is generally formulated and implemented on a national basis. This is the case even though many of the externalities affecting the environment are by no means confined within national borders but are international in character. In recent years, however, there has been a growing willingness among nations to cooperate in this area and international institutions such as the OECD have played a key role in this regard.

As less developed countries are typically less able to afford environmental protec- tion, they have a stronger incentive to set lax environmental standards. The firms that operate in poorer countries may therefore sometimes be expected to enjoy a compara-

tive advantage in this respect over the firms that operate in richer countries which have set stricter standards. This is mainly because stricter environmental regulation normally imposes extra costs on companies.

Since environmental policy entails costs for companies, it is evident that environmental regulations can and do have effect on markets – and hence on market competition.

Thus, as comparative prices and production costs of various goods and services change, competition-related problems may arise. These are discussed in Chapter 3.3.1.

3.2 The Benefits of Competition

The purpose of competition law is to further competition and thereby promote efficient utilisation of society’s resources, i.e. economic efficiency. Competition policy can be thought of as a combination of competition advocacy, competition law and its enforce- ment. The importance of competition policy can only be properly understood by finding out what exactly the benefits of competition are, and how they are created.

In economic theory, competition is desirable because it increases the welfare of consumers by contributing to efficiency in economic activity. Rivalry between individual firms ensures that only the most efficient and innovative firms stay in the market.9

8 OECD (2010), Green Growth Strategy Interim Report: Implementing Our Commitment For a Sustainable Future, C/MIN(2010)5, p. 20.

9 See, for example Stigler, G. J. (1987), Competition, in Eatwell, J., M. Milgate, and P. Newman, The New Palgrave, London, Macmillan.

Moreover, competition is a continuous process that works through efficient utilisation of companies’ resources, free entry and exit from the market, and ample incentives to innovate. This is graphically depicted in Figure 1.

Figure 1. Competition increases productivity

Competition improves utilisation of companies’ resources. This is because the relative gain to businesses from increased efficiency is comparatively greater in competitive markets than non-competitive markets. Therefore, managers have greater incentive to implement efficiency measures where competition is strong. Thus competition does tend to minimise inefficient practices in companies and lead to increased productivity.(10)

Free entry to the market is one of the main prerequisites of effective competition. Companies that cannot keep up with development in the market will gradually exit the market. This enables more efficient companies to gradually replace the less efficient companies and leads to higher productivity in the economy as a whole.(11)

The incentive to innovate is generally stronger where competition is vibrant. Innovation creates new products and services that benefit consumers and other companies. However, the link between innovation and competition is complex.

Substantial empirical analytical work has been done to analyse the link between competition and innovation. In general a stronger competitive environment leads to more innovation.(12) The reason is that companies innovate to escape competition, (the “escape competition” effect). However, some researchers have identified an inverted U-shaped

(10) See, for instance Bloom, N. and Van Reenen, J. (2007), Measuring and Explaining Management Practi- ces across Firms and Countries, The Quarterly Journal of Economics, Vol. 72(4) pp. 1351–1408 and Green, A. and Mayes, D. (1991), Technical Inefficiency in Manufacturing Industries, The Economic Journal, Vol. 101(406), pp. 523–538.

(11) The share of total productivity growth due to entry and exit vary from country to country. An OECD analysis shows that firm turnover accounted for 10–40 per cent of productivity growth in manufacturing industries in 6 OECD countries during the period 1987 to 1999. See: Scarpetta, S., Hemmings, P., Tressel,

T. and Woo, J. (2002), The role of policy and institutions for productivity and firm dynamics: Evidence from micro and industry, OECD Economics Department Working Paper No. 329.

(12) See, for instance, Blundell, R.., Griffith, R. and van Reenen, J. (1999), Market Share, Market Value and Innovation in a Panel of British Manufacturing Firms, Review of Economic Studies nr. 66, pp. 529–554. and Geroski, P. A. (1990), Innovation, Technological Opportunity, and Market Structure, Oxford Economic Papers, Vol. 42(3), pp. 586–602.

relationship between innovation and competition, where the level of innovation is low when competition in the market is very weak and also, surprisingly, when competition is very strong.(13) It is possible that contrasting empirical findings regarding the source of innovation can, depending on the level of competition, be attributed to some particu- lars of the institutional environments (such as law and regulations) in the respective markets.

It is difficult to quantify how much effective competition affects productivity and the economy more generally, but a number of extensive studies have found that stronger competition is associated with higher productivity.(14)

Thus, there is a link between competition and productivity and competition and innovation respectively. These links may lend support to the notion that effective competition reinforces environmental policy as increased innovation and increased efficiency can be considered important parts of a successful environmental policy. This is based on the fact that increased costs for companies resulting from compliance with environmental policy requirements and the pricing of environmental externalities make greater innova- tion and higher productivity even more meaningful.

Further, it follows from the discussion above that ensuring effective competition is very important to the success of environmental policy in ensuring that price signals reflecting environmental externalities are effectively transmitted. Effective competition is also crucial to ensure the efficiency of markets for tradable emission permits, as explained in Chapter 4.

In the following sections the links between competition and environmental policy will be explored.

3.3 The Relationship between Competition Policy and Environmental Policy

Both environmental policy and competition policy are devised by the state to correct market failures.(15) Such failures arise for instance due to lack of incentives to preserve the natural or physical environment and frequently ample incentives for companies to engage in anti-competitive practices.

Thus, environmental and competition policies share the common objective of defending and maximising some measure of social welfare as other government policies generally do. However, each of these policies addresses an entirely different aspect of welfare.

While environmental policy promotes social welfare by seeking to correct for environ mental externalities, competition policy promotes consumer welfare and economic efficiency by seeking to fight anti-competitive practices and regulations.

Since environmental and competition policies share a common objective of maximising social welfare, it goes without saying that it is important that the construction and execution of these two policies do not prevent, or in other ways hamper, each other‘s effectiveness – but instead, ideally, reinforce each other‘s effectiveness. Unfortunately, there are various situations where the means used to attain the ends of each policy disrupt the other’s effectiveness, and their harmonisation and concordant execution are therefore required to promote and maximise social welfare.

(13) See, for instance, Aghion, P., Bloom, N., Blundell, R., Griffith, R,. and Howitt, P. (2005),Competition and innovation: An inverted-u relationship, The Quarterly Journal of Economics, pp. 701–728. and Kilponen

J. and Santavirta T. (2007), When do R&D subsidies boost innovation? Revisiting the inverted U-shape. Bank of Finland Research Discussion Papers 10.

(14) The 2009 Nordic report, Competition policy and financial crisis, covers this issue in greater depth and refers to a number of studies.

(15) Market failures refer to situations where markets cannot fulfil their function of allocating resources optimally. Apart from externalities, market failures may arise through the presence of market power, public goods and asymmetric information. The last concept is further discussed in Section 5.3.

We can identify three broad issues that would need to be taken into account and explored in relation to the link between competition policy and environmental policy:

  • Environmental impacts in the assessment of restrictive practices under competition law
  •  How various environmental policy-based law, regulations or regulatory measures affect competition, including the capacity of competition to fulfil its societal functions
  •  How competition and competition policy affect various environmental policy based law, regulations or regulatory measures; thereby influencing the effectiveness of environmental policy

The first bullet point concerns the extent to which competition authorities can take environmental impacts into account in their assessment of alleged restrictive practices. The second bullet point concerns the competition implications of environmental policy. The third bullet point is beyond the scope of this report as it concerns the environmental implications of competition and competition policy.(16) Instead, the focus here is on the issues in the first and second bullet points.

3.3.1. The Impact of Environmental Policy on Competition

Environmental policy and competition policy share the common objective of preserving and increasing social welfare as mentioned earlier. In some cases there would appear to be almost perfect harmony between the two policies. Arguably, this perfect harmony exists primarily in the case of harmful subsidies, e.g. to agriculture, fisheries and fossil fuels, which may not only cause harm to the environment but also distort competi- tion.(17) The two policies also share the common objective of promoting efficient use of resources since the reinforcement of economic efficiency is an important goal of common competitio law in the EEA.

However, environmental policy may harm competition and lead to social costs which may outweigh the environmental benefits it is intended to provide. These potential negative instances and situations are explained below.

The obligations the firms must adhere to under environmental regulations are normally costly from the standpoint of individual firms since they usually raise the costs of production. Thus, it is evident that environmental regulations can and do have effect on the market and hence market competition. One of the consequences of environmental policies may for instance be to change the comparative prices and production costs of the various goods and services that are exchanged in the marketplace, e.g. due to a requirement imposed on firms by the regulator to change their production methods.

Environmental regulation tends to have different effects on firms depending on their size. Although some environmental regulations seem to favour smaller firms, large firms generally seem to face lower per-unit costs of compliance to a given regulation.(18) This means that environmental regulation tends to affect smaller firms comparatively more than big firms. This can easily be understood in the light of the effect of increased fixed costs on average production costs. Often, there are substantial fixed costs associated with compliance, i.e. costs that are the same whether output is large or small.(19)      This means that the fixed costs of compliance will lead to a smaller increase in average

(16) The importance of effective competition to determine the correct environmental tax level via tradable permit systems can be seen as a positive environmental implication of competition policy.

(17) Basic economic theory holds that subsidies distort domestic resource allocation processes in general and can adversely affect international trade. Regarding discussion concerning agricultural subsidies, see e.g. p. 37 in Green Growth Strategy Interim Report: Implementing Our Commitment For a Sustainable Future, C/MIN(2010)5 issued by the OECD.

(18) OECD (2006), Environmental regulation and competition, DAF/COMP(2006)30, p. 19. This source cites various studies in support of this contention.

(19) A rise in fixed costs can stem from changes in production processes or machinery, and from the increased administrative tasks associated with compliance with the regulation, including dealings with public agencies. In the same way, environmental regulation may also lead to disproportional profit impact in cases where there are some companies that enjoy economies of scope and some that do not.

production costs for a producer who produces a large quantity of a product than for one who produces a small quantity.(20)

Where environmental regulation tends to place a proportionally smaller burden on large firms, it is conducive to more concentrated markets because it has the effect of enlarging the minimum efficient scale of the firm. Where this applies, it will almost inevitably lead to decreased competition. It is therefore possible that the resulting increase in market concentration will lead to significant welfare costs due to lack of competition. There is also another risk to competition associated with the introduction of environ- mental policy. It is the risk that incumbent firms, i.e. firms that are already established in the market, will use environmental concerns for predatory purposes and lobby for stricter environmental standards than are efficient – in order to raise the entry barriers to the market. This can lead to greater production costs for the incumbent firms – but if they are secure in the market this can nevertheless be a profitable option for them as it leads to increased market power.

Furthermore, firms that are already in the market tend to face less stringent standards than firms that are starting production.(21) There are various reasons for this but one of the most important ones is that it tends to be more expensive to improve the environ- mental characteristics of production facilities afterwards than it is to build them up to standard in the beginning. This sometimes leads to a form of regulation often referred to as ‘grandfathering’, which recognises this difference in costs and places stricter envi- ronmental demands on the new entrants to the market than on incumbent and other already established firms. This may create a barrier to entry to the market as newcomers face higher production costs as a result of the more stringent standards they have to comply with than the incumbents.

The time spent on procedural matters and red-tape is sunk cost, i.e. irrecoverable investment expenditure which can slow down the speed at which entry can occur and be costly in itself. When regulatory requirements lead to greater sunk costs, they also tend to lead to higher barriers to entry since sunk costs generally have the effect of raising barriers to entry. Thus, an increase in sunk costs related to market entry makes markets less contestable than before, which in turn tends to lead to deteriorating market performance. It should be noted in this context that a rise in exit costs, which may arise due to more stringent requirements in environmental policies, also tends to raise the barriers to entry since such costs are sunk.

3.3.2. The Environmental Impacts of Restrictive Practices

As explained earlier, environmental benefits enhance social welfare.(22) In principle, these benefits constitute efficiency gains as defined in competition law. Therefore, environmental benefits could be used to defend horizontal practices or arrangements otherwise deemed restrictive under competition law. In order to turn this notion into an integral part of the enforcement procedures under competition law it would be neces- sary to evaluate the environmental economic benefits and compare them to the esti- mated social costs of potentially diminished competition resulting from the practices or arrangements in question.

To defend restrictive practices merely because they bring some unspecified and unquantified social good is not sufficient. To accept such vague arguments would render competition law and competition policy ineffective, turn it into a part of some general social policy. If environmental impact is translated into clear costs or cost savings to society, the requirement of efficiencies as defined in competition law is taken

(20) OECD (2006), Environmental regulation and competition, DAF/COMP(2006)30, p. 20.

(21) OECD (2006), Environmental regulation and competition, DAF/COMP(2006)30, p. 26.

(22) Note that in this report environmental benefits stand for improved quality and safety of the natural environment or preservation of existing quality and safety of the natural environment.

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