Catalog

	Table of Contents
p. 71 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions I. Developing Asia and the world II. Economic trends and prospects in developing Asia III. Promoting competition for long-term development Introduction Benefits of competition Competition policy regimes Consistency with other development objectives Competition policy in the context of regional and global integration Issues for implementation Effects on government finances Toward a competitive future Summary and conclusions Endnotes and references Statistical appendix

Asian Development Outlook 2005 : III. Promoting competition for long-term development

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Competition policy in the context of regional and global integration

As globalization proceeds, attention has increasingly turned to the cross-border implications of anticompetitive practices. At the international level, contestability of markets in a foreign country requires either freedom of trade or the establishment of an affiliate in a foreign country and national treatment in order to compete on equal terms with domestic producers.

Trade liberalization

Is a liberal trade policy a complete substitute for competition policy? Or must trade reform be complemented by measures to tackle anticompetitive practices? Which types of anticompetitive practices, if any, have followed trade reforms in Asian economies? To what extent have the benefits of trade reform been eroded by lack of attention to competition policy principles? And to what extent has the removal of government impediments to trade (tariffs, quotas, etc.) been replaced by private anticompetitive practices?

Economic theory suggests that trade liberalization will increase national welfare in a competitive domestic market. The liberalization of trade allows producers to venture into world markets, bringing them export opportunities that allow them to increase output and reduce costs through economies of scale. In addition, because there are more players in export markets, competition among them is likely to be stiffer, forcing producers to increase production efficiency, adopt better marketing techniques, and impose stricter quality control measures on their production techniques. As a result, domestic as well as foreign consumers benefit from lower-priced and higher-quality products.

Similarly, import tariffs are perhaps the most common tool that governments of developing countries use to protect domestic industries and limit competition from outside. Reducing import barriers exposes local producers of tradable goods and services to competition from imports, thereby increasing pressure to raise productivity and keep costs down.

These arguments form the basis for assuming that, for small open economies, trade liberalization provides a market structure that encourages competitive industries and prevents monopolistic behavior. However, there is less consensus on whether it will bring about an increase in national welfare when the domestic market is not competitive. Trade liberalization by itself is usually not enough to keep competition at an optimal level in all economic sectors. In addition, while trade barriers have generally been reduced in many countries, they still exist and new forms, such as contingent protection and antidumping regulations, have sometimes been adopted to replace those that have been removed.

Box 3.9 Malaysia: AFTA commitments and the national car industry The Malaysian national car company, Proton, was established in 1983 as a key component of the country's heavy industrialization program. From the outset, the Government "tilted" the playing field by exempting Proton from import duties on completely knocked-down (CKD) kits. As a result, Proton could sell its cars at 20-30% less than comparable cars produced by other assemblers in the country. By the 1990s, Proton had become the dominant car producer in the Malaysian market. About 75% of passenger vehicle sales are controlled by two firms--Proton with 45% and Perodua with 30%. This dominance was, however, threatened by Malaysia's commitment under the ASEAN Free Trade Area agreement to reduce import duties to 20% by 2005 and to 0-5% by 2008. Implementing these trade liberalization commitments is expected to seriously affect Proton's (and Perodua's) competitiveness. To neutralize the committed reduction in import duties, the Government raised excise duties on passenger cars twice, the first from 1 January 2004, and the second 1 year later. The import duty on CKD passenger cars from ASEAN countries was reduced from 42-80%, to 25% by 2004, then to 0% by 2005; excise duty was increased from 55%, to 60-100%, then to 90-250%. For completely built-up units from ASEAN countries, the import duty was reduced from 140-300% to 70-190%, then to 20%; excise duty was increased from 0% to 60-100%, then to 90-250%. The box table presents a hypothetical computation of the effects of these changes for a local car relative to a foreign CKD car. The effect of the countervailing increase in excise tax is to increase the price of the local car, thereby reducing its price competitiveness relative to the base case. In contrast, the reduction in import duties lowers foreign car prices slightly, as the excise tax increase somewhat neutralizes the downward impact. However, without any increase in excise taxes, consumers would pay substantially less for foreign cars. This illustrates how the impact of trade liberalization (e.g., via import duty reduction) can be neutralized by a government through the use of domestic policies (e.g., excise tax) to support industrial policy. In Malaysia's case, this strategy is probably an interim strategy aimed at buying some time for restructuring the national industry. The prime minister has, in fact, stated that local automotive companies will have to depend less on government protection. Sources: Lee (2005); Asian Development Bank staff.

That the intended benefits of trade reform may not be realized without active enforcement of competition law is a source of complementarity between competition policy and long-term economic performance. The concern here is that reductions in official trade barriers will be replaced by anticompetitive private practices, the latter counteracting the price-reducing effects of trade reforms. For example, lower import tariffs may merely result in higher profit margins for monopolistic (or oligopolistic) importers, with fewer benefits reaching consumers and the broader economy. To the extent that reductions in the prices of imported machinery and other capital equipment bolster investment and enhance dynamic economic performance, then measures to discipline private anticompetitive practices may be required for reductions in trade barriers on these durable goods to translate into higher growth. The enforcement of competition law, therefore, reinforces the effectiveness of cuts in trade barriers on growth-enhancing imports.

In the 1980s and the early to mid-1990s there were a number of trade disputes between the United States (US) and Japan concerning the openness of the latter's markets. Some firms trying to export to Japan claimed that they faced a thicket of private anticompetitive measures. This issue is, therefore, not new in Asia. What is interesting is that non-Japanese Asian economies have begun to see that more open borders do not necessarily result in increased market access opportunities for their exporters or in lower prices for their purchasers.

While an open trade policy would be supportive of competition policy objectives, it is not necessarily a guarantee of competition. Government policies may pose a threat to the attainment of competition objectives, particularly if they give rise to restraints and distortions in trade practices and in the market. All trade policies should therefore comply with an established framework of competition principles. An effective competition policy that ensures that trade policies fall within these contours is in the interests of both consumers and free and fair trade (Government of India 2000).

It can also be the case that instead of engendering competition, trade liberalization results in anticompetitive practices. This can happen either when international cartels simply expand their markets with trade liberalization, or when domestic and foreign firms collude to set prices or market shares. When this occurs, the potential benefits of trade liberalization do not accrue to consumers since government trade barriers are simply replaced with private anticompetitive barriers imposed by suppliers.

It should be stressed that, while international pressure can help, competition from imports is a less robust determinant of beneficial restructuring than competition in domestic markets. This suggests that measures to promote rivalry among domestic firms tend to have a more consistent effect on restructuring--and on dynamic economic performance--than trade liberalization. Therefore, it would be imprudent to rely solely on lowering trade barriers in order to discipline entrenched market power and to provide strong incentives to firms to keep costs under control.

With increasingly open economies, some large producers may undertake steps to protect their markets, including such anticompetitive actions as the establishment of cartels, abuse of dominant position, and abuse of intellectual property rights. Meanwhile, local suppliers could effectively shut out imports in the domestic market through exclusive arrangements with local retailers. The existence of an effective competition policy would ensure that such anticompetitive practices could be challenged and stopped if proven to violate competition principles. An effective competition policy, put in place, can allow trade liberalization to deliver its full potential benefits.

Thus, while bilateral, regional, and multilateral trade agreements have changed the shape of Asia's international trade and competition, competition policy has an important role to play in the domestic market.

India

Until the 1970s, the broad objectives of India's trade policy were across-the-board import substitution and the protection of domestic industry. In addition to the fact that certain key raw materials were produced in the public sector, many commodities were subject to price and quantity controls. Industries providing important commodities (such as edible oils, sugar, fertilizers, pharmaceuticals, aluminum, cement, steel, coal, and petroleum products) were subject to price and quantity controls to varying degrees. This implied that, even in sectors where there was a private sector presence, conditions and outcomes were not competitive. A complex system of excise and corporate taxes further distorted incentives.

Reforms since 1991 have centered on licensing and tariffs. To meet its WTO commitments, India has abolished its quantitative restriction regime. Tariffs are also being reduced in a phased manner from levels that were among the highest in the world. The Government reduced the average applied tariff rate from 125% in 1990/91 to 35% in 1997/98 and to 20% in 2001/02, with the peak rate declining from 335% in 1990/91 to 40% in 1999/2000 and to 35% in 2001/02. In addition, India bound about 3,300--or nearly 70%--of its 4,700 tariff lines. Of these, 99% were bound at rates of 40% or lower, with the applied rates much lower than the binding rates for most products (Mehta 2003). Nontariff barriers were phased out. These reform measures infused and enhanced competition in the market (Kumar 2003, Mehta 2003).

Korea

As another active participant in successive General Agreement on Tariffs and Trade (GATT)/WTO negotiations on trade, the Korean Government has also made efforts to liberalize trade, especially since the 1980s. In the aftermath of the 1997-98 financial crisis, it redoubled its efforts. The simple average bound tariff rate was reduced from 24.4% in 1997 to 18.5% in 2000, while the applied tariff rate fell from 13.4% to about 8.8%. In the context of its postcrisis agreement with the International Monetary Fund and its Uruguay round commitments, the Government removed quantitative restrictions on the eight remaining items subject to balance-of-payments protection as of 1 January 2001. The import diversification system, implemented in 1978 to restrict imports from Japan (and criticized as constituting an unfair trade practice), was abolished in June 1999. Export subsidies and imprecise import-licensing and certification procedures that allegedly distorted international trade have also been discarded (Lee et al. 2004).

In the case of Korea, where the domestic market is not always large enough to realize economies of scale, and where various trade protection measures have distorted the market and prevented domestic companies from operating in an efficient manner, trade liberalization is likely to have a "rationalization effect" by making inefficient firms exit. The remaining firms would then be more likely to benefit from economies of scale. The Korean case illustrates that trade liberalization does not automatically lead to a more competitive domestic market, and that the best outcomes are achieved when liberalization is accompanied by measures to increase competition in the domestic market.

Malaysia

In Malaysia, where competition concerns are addressed through sectoral regulations, some strains between industrial policy, trade liberalization, and competition pressures have become apparent. Box 3.9 gives an example of such strains.

Thailand

Thailand is an open economy, with the value of trade (exports plus imports) representing approximately 108% of GDP in 2001. However, Thailand still maintains high tariffs compared with other ASEAN countries. The country's average applied tariff rate is 38.2% for agricultural products and 13.9% for manufactured goods.

Under the Common Effective Preferential Tariff scheme--the mechanism by which the ASEAN Free Trade Area (AFTA) was established--tariff rates have been significantly lowered. On 1 January 2003, tariffs on all products were reduced to 0-5%, with the exception of those placed on the scheme's temporary exclusion list, sensitive list (mainly agricultural products), and general exceptions list (mainly products relating to national security, culture, and health). Thailand appears to have the smallest number of items on these lists. In addition, AFTA has a very liberal rule-of-origin regime: to be eligible for preferential tariff rates, products need to contain only 40% local content, a threshold that applies to all products. In effect, this means that many Thai industries are now facing increasingly strong competition from neighboring countries.

The contribution of imports to competition is evident in a study of trade practices in 12 manufacturing industries by Nikomborirak et al. (2002). The authors found that two product markets that were subject to low import tariffs--batteries and light bulbs--did not experience any restrictive business practices even when the market was highly concentrated. In contrast, markets that were protected by high tariffs, such as alcoholic beverages (whiskey and beer) and motorcycles, and those in which goods are not easily traded, such as cement and cellular phone services, experienced competition problems.

As well as being a member of AFTA, Thailand is engaged in the negotiation of bilateral free trade agreements (FTAs) with several countries. It has signed trade and investment framework agreements with Bahrain, PRC, and India, as well as with industrial countries such as US, Japan, and Australia. The country is beginning to feel the impact of these FTAs: the first "early harvest" provisions under the agreement with the PRC required tariffs on most fruit and vegetables to be eliminated by 1 October 2003, leading to an instantaneous influx of fresh food products to Thailand from the PRC. Thailand's FTA with Australia was signed on 5 July 2004. It is believed to have exposed the local automobile market to stiff competition from that country--a production base for large cars--since it came into effect in January 2005.

The Thai services sector appears to be eluding trade liberalization at the bilateral level. Except for the bilateral agreement with the US, which is expected to cover services, there is no clear indication that FTAs will lead to a progressive opening up of the services sector to competition. There are concerns, however, that selective trade liberalization, particularly in certain service sectors, will lead to higher market concentration.

Under the proposed FTA with the US, the entry of large US multinationals could lead, in the longer run, to US domination of Thailand's markets in the absence of competition from other, non-US, multinational operators. For example, if Thailand accedes to the US request to open up the express delivery market to US companies only, global operators such as TNT and DHL will not be allowed to compete, and the domestic market could end up being dominated by a few large American operators, such as Federal Express and Courier.

Thailand has not liberalized any of its service markets in the absence of commitments in its bilateral and multilateral agreements to do so, so empirical evidence on the impact of service liberalization is lacking. Nevertheless, a study by Nikomborirak (2004) indicates that the entry of foreign banks such as ABN Amro, United Overseas Bank, United Bank of Singapore, and Standard Chartered Bank since the crisis, enabled through acquisitions of ailing Thai banks, appears to have broken the domestic banking cartel, bringing about a remarkable improvement in service. Customers now enjoy longer banking hours, more diversified financial services as a result of customer segmentation, and credit card services that are free of annual fees (TFRC 2003).

Bilateral FTAs that involve Thailand and a developed country must contain competition policy provisions to satisfy the GATT requirement that such agreements cover "substantially all trade" (Article XXIV). So far, Australia is the only developed country to sign an FTA with Thailand. The competition policy provisions in the agreement are relatively weak in that they focus mainly on voluntary cooperation between the competition authorities of the two countries.

The FTA between Thailand and the US is likely to contain more advanced commitments on the implementation of domestic competition law. Very briefly, the competition policy chapter in the Singapore-US FTA, on which the Thailand-US agreement is likely to be modeled, requires each party to (i) maintain measures to proscribe anticompetitive conduct, (ii) prohibit SOEs from engaging in restrictive trade practices or abusing their monopoly position unless granted an exception on efficiency grounds, and (iii) ensure that SOEs act solely in accordance with commercial considerations in the sale and purchase of goods or services.

Viet Nam

Over the last two decades, Viet Nam has moved toward a more open, transparent, and enabling trade regime. Rights to trade have been expanded and granted in virtually all sectors of the economy, regardless of ownership. However, the trade regime is still characterized by price controls and quantitative restrictions, which were placed even on imports of goods that were not produced domestically, such as refined oil, fertilizer, steel, cement, and paper.

Most of these protectionist measures created barriers to entry and led to high concentration in affected sectors. Domestic prices for these commodities are often higher than in international markets and neighboring countries. Consequently, firms operating in protected industries reap huge profits but remain inefficient in their operations. While the overall level of protection has been steadily declining as a result of the Government's commitments to its bilateral trading partners, the consequences of protection remain visible.

Import tariffs are also widely used. While the average rate seems to be moderate, the dispersion remains quite high. Manufacturing is still highly protected, even if the effective rate of protection has significantly declined.

At the same time, the Government has adopted export-related measures to counter the effects of its import-substitution and protection policies. These include export promotion schemes, duty drawbacks, tax and duty exemptions, access to preferential credit, and a performance-based rewards system. The dual-policy trade regime makes Viet Nam an interesting case: an economy that has achieved an outstanding export performance despite a highly protected trade regime. The country's trade-to-GDP ratio is about 100%, and export growth has remained at about 20% a year for a decade.

These protective measures discouraged foreign competitors from venturing into the domestic market; the impact on domestic competition is, however, less clear. In some cases, such as for rice, easing export quotas increased the number of small private traders that buy paddy from farmers and sell processed rice to exporting companies. Competition toughened among rice traders, and paddy farmers obtained better prices. However, in most other sectors where quotas were removed in 2000, there has been little noticeable impact on domestic competition, as the number of firms has more or less remained the same.

In Viet Nam, the motivations for protection have not always been clear. Price and quantitative controls were formerly placed even on imported goods and commodities not produced in Viet Nam at the time, such as refined oils, fertilizers, some kinds of steel, cement, and even paper. Quantitative restrictions now apply only to petroleum and sugar, but 5 years ago they were placed on over a dozen commodities. Petroleum is still on the list because the Government considers it a strategic commodity that it needs to supply smoothly and monopolistically (Government of Viet Nam 2002). Sugar is on the list because of a government program initiated in 1994 to build a sugar industry capable of ensuring self-sufficiency in supply. The program failed, owing to the inefficiency of the sugar mills (Dapice 2003). Nevertheless, the Government retained quantitative quotas on sugar imports in order to protect the mills from foreign competition and support farmers who relied on the mills to take their sugarcane. Motorcycles and cement were on the list until recently because the Government wanted to support these infant industries.

The incidence of protection across industries is mixed, but its impact on competition is clear: most protectionist measures have created barriers to entry and led to high concentration in the affected sectors. Domestic prices for commodities in protected sectors are generally higher than those in international markets as well as in neighboring countries. For example, in 1999 1 ton of cement cost $29 in Korea, $39 in Singapore, and $46 in Thailand, but $73 in Viet Nam (CIE 1999). Firms operating in protected industries tend to earn huge profits, but their capacity to meet the challenges of deepening integration and increasing competition is in doubt. Honda, for example, reportedly accrued large profits even during the Asian crisis because of its protected position in the market. Most heavily protected industries, such as cement and motorcycles, appear to be uncompetitive (CIEM 2002). The overall level of protection has been declining gradually but steadily, but the consequences of protection are still visible.

The average tariff rate in Viet Nam seems moderate, but dispersion remains high, suggesting that the distortionary impact of tariffs is significant (Table 3.2). The average import-weighted tariff for all commodities was nearly 21% in 1997, falling slightly to 19.6% in 2003. However dispersion as measured by the coefficient of variation was as high as 130.7% in 2003. Manufacturing remains the most protected sector in the economy even though the effective rate of protection fell significantly from 121% in 1997 to 46% in 2003 (Athukorala 2004).

Aware of the negative effects that import substitution and protection policies may have on other sections of the economy, especially exporters, the Government has often introduced countermeasures or neutralizing measures in the form of export promotion initiatives, duty drawbacks, exemptions from some domestic taxes and fees, preferential credit, and, recently, a performance-based rewards system. In 2001, for example, with exports slowing due to weaker demand in international markets, the Government adopted a series of export promotion measures aimed at encouraging firms to expand their exports and find new partners and markets. A value-added tax (VAT) rebate and exemption scheme for exporters and a program of awards for improved export performance were also implemented. Before the export quota on rice was eased and subsequently abolished in 1997, a special fund was set up to support those who bought and exported rice under government orders. A study of the textile and garment sector shows that, although the official tariffs were quite high (at 31% in 1997 and 28% in 2002 for textiles, and 42% in 1997 and 49% in 2002 for wearing apparel), most companies in the sector are exempt from import duties.¹⁴

To what extent have these external market interventions affected competition in Viet Nam? One thing is clear: they have reduced foreign competition in the domestic market. What is less clear is their impact on domestic competition. In some cases, the removal of protection has led to significant improvements in competition, evidenced by an increase in new entries and a fall in prices and profits per unit. The abolition of the quota on rice exports and the decision to allow private firms to export the commodity in 1998, for example, led to the emergence of numerous small private rice traders who bought paddy from farmers and sold processed rice to exporting companies. Competition in the rice market may have been very tough for these rice traders, but growers obtained better prices. The difference between the export price of rice in Viet Nam and Thailand narrowed significantly due to these measures (Vu 2001). But in other cases the impact of the removal of protection is not so clear. There is a danger that some monopolies will simply change from being government owned to being privately owned or having mixed ownership. Most quotas were removed in 2000, but competition in some sectors shows little sign of change if one looks at the number of firms or price indicators.

People's Republic of China

Of particular interest in the PRC is the prevalence of local protectionism. For historical reasons, local governments have had a strong incentive to protect local enterprises from competition from other regions. This has contributed to the duplication of investments and to excess capacity in some industries, and thus the PRC's low degree of industrial concentration.

Local protectionism has taken such forms as imposing taxes on commodities made in other provinces, banning exports to other regions of locally made raw materials that are of high quality or in short supply,¹⁵ or even preventing law enforcement officers from dealing with local firms that counterfeit the brands of other regions (Lin 2001). With the move toward fiscal decentralization since 1978, local governments have had a strong incentive to shield local firms and protect their tax base. The desire to guarantee local employment is another economic as well as political incentive for local government officials. Throughout the 1990s, local governments competed to attract FDI, even adopting protective measures that would ensure the profitability of locally based foreign firms (Box 3.10).

Local protectionism leads to market fragmentation and thus to low regional specialization. The eight-firm concentration ratios reported in Table 3.3 are consistent with widespread local protectionism in the PRC. Although the degree of concentration has generally increased since 1995, very few industries have a concentration ratio above 50%, and for most the ratio is below 20%.

The central Government has long been trying to prohibit regional protectionism. This was the intention of Article 6 of the State Council's Provisional Regulations Concerning Development and Protection of the Socialist Competition Mechanism, issued as early as 1980. Enforcement of these regulations has, however, been poor.

Trade-related exemptions

In many countries, export cartels are outside the scope of competition law. In India, for example, an exception to the provisions on anticompetitive agreements protects the right of any person to export goods or services from India. Many countries regard export cartels as competition-restricting, but nevertheless exempt them from competition law because they do not affect competition in the domestic market. A further justification for their exemption is that countries do not wish to shackle their export efforts for fear of disturbing their trade balance or balance of payments.

Between them, Evenett, Levenstein, and Suslow (2001) and OECD (2003a) identified 15 countries whose competition laws explicitly or implicitly exclude export cartels. Meanwhile, the proponents of export cartels argue that they are a lawful way of realizing cost-reducing and output-enhancing efficiencies (OECD 2003b). However, exemption of export cartels goes against the concept of free competition, as the circumstances relating to a soda ash cartel operating in India make clear (Box 3.11).

As mentioned in the box, India's new Competition Act has extraterritorial reach. The jurisdiction of the competition authority extends to restrictive trade practices employed by enterprises outside India that have the effect of preventing, distorting, or restricting competition in India, or that give rise to restrictive trade practices in the country. On the provisions relating to extraterritorial jurisdiction in the MRTP Act, the Supreme Court of India ruled that the MRTP Commission would obtain jurisdiction only after goods had been imported and a restrictive trade practice had been found to have taken place.

In Korea, in 2002 the Korea Fair Trade Commission (KFTC) took the unprecedented step of applying Korean antitrust law extra­territorially to six foreign manufacturers of graphite electrodes and imposed fines on the manufacturers for price fixing. The following year the KFTC concluded a large-scale investigation into an alleged international cartel by six foreign vitamin manufacturers, again levying fines. Later that year, it introduced a system of notification of foreign-to-foreign mergers. This series of moves to regulate behavior that has taken place outside the domestic jurisdiction reflects a growing concern about the economic impact of such behavior on the domestic market.

As far as anticompetitive practices are concerned, trade liberalization is a double-edged sword. The country studies highlight cases where reforms have led to foreign firms undermining domestic anticompetitive practices, lowering prices toward costs. However, the very lowering of trade barriers also enables foreign firms to more profitably engage in anticompetitive acts in Asian economies. Without the threat of competition law-related sanctions, cross-border traders and their domestic rivals will be tempted to replace lower government barriers to trade with agreements to keep prices high. Competition law and its effective enforcement thus play an important role in maximizing the benefits of trade liberalization.

Box 3.13 Impact of mergers and acquisitions in India The following cases highlight the increased concentration resulting from mergers and acquisitions in India. The consumer goods industry Since 1913, Unilever has generally opted for mergers and acquisitions as a means of establishing its business presence in India. Initially, Unilever took over several companies engaged in the trade of soaps and consolidated them. A subsidiary of Unilever, Hindustan Lever Limited (HLL) followed the same strategy in efforts to expand its activities and strengthen its market presence. Prior to 1991, HLL acquired a number of small enterprises that had run into financial difficulties. These acquisitions expanded HLL's activities and allowed it to diversify into, among other things, garments and marine products. Following the Government's 1991 liberalization policies, HLL sought to restructure its diversified product range and strengthen its market presence by engaging in further mergers and acquisitions. Tea, ice cream, frozen foods, coffee, and detergents were among the products it added to its portfolio in the last decade. As a result, the market share of HLL and its associates has steadily increased (Box table). The soda industry Consumer goods are generally sensitive to changes in market networks and brand loyalties. As a result, multinational enterprises tend to exploit the established marketing and distribution networks as well as brand loyalties of their acquired enterprises. A case in point is Coca-Cola, which reentered the Indian market (which it had left in 1977) in 1993 by acquiring Parle, at that time the largest player in the Indian soda market. Parle already had several well-established brands and boasted of a nationwide network of bottling and marketing facilities. This gave Coca-Cola an advantage over its rival Pepsi. Pepsi had entered the country in 1988, but was still struggling with a 25% share compared with market leader Parle's 60%. In acquiring Parle, Coca-Cola profitably used Parle's bottling and marketing network, besides taking advantage of Parle's popular brand presence in sodas. Following Coca-Cola's success, Pepsi acquired Duke, a smaller soda manufacturer, in its efforts to build its market share. Today, Coca-Cola and Pepsi dominate the soda market in India, with their respective shares believed to be 50% and 48%. Source: Chakravarthy (2005).

As markets integrate, international anticompetitive practices--especially those associated with abuses of dominant position and international cartelization--have received more attention in Asian policy circles. Although Asian enforcement experience against foreign anticompetitive practices is mixed, such enforcement would not have been possible without a competition law in the first place. The latter is a prerequisite for enforcement and for nurturing international cooperation to tackle these price-raising acts.

At the international level, in 1980 the United Nations' General Assembly adopted a "Set of Multilaterally Agreed Equitable Principles and Rules for the Control of Restrictive Business Practices" (the "UN Set"). The 1995 Osaka Action Agenda of the Asia-Pacific Economic Cooperation forum (APEC) included competition policy as one of 15 policy areas to be developed by member countries, noting that:

APEC economies will enhance the competitive environment in the Asia-Pacific region by introducing or maintaining effective and adequate competition policy and/or laws and associated enforcement policies, ensuring the transparency of the above and promoting cooperation among the APEC economies, thereby maximizing, inter alia, the efficient operation of markets, competition among producers and consumer benefits (Asia-Pacific Economic Cooperation 1995).

This was reinforced by a collective action plan and individual action plans in the area of competition policy, and in 1999 by the APEC Principles to Enhance Competition and Regulatory Reform.

In July 2004, the General Council of WTO decided that three of the four Doha round Singapore issues (competition policy, investment, and government procurement, but not trade facilitation) would not be included in the Doha round negotiations, and that developing countries needed more capacity building and institution building in these areas first. However, given the importance of competition in ensuring economic efficiency in both its static and dynamic aspects, competition policy remains of considerable interest to developing countries in both the domestic and international contexts, as evidenced by the number of developing country representatives and their active participation in the discussions.

Indeed, in the context of multilateral negotiations, "developed country protectionism … is bad not only for developing country producers and consumers everywhere but also for developed country credibility in global negotiations to remove trade barriers. What is needed is more globalization, not less" (Vickers 2003, p. 8).

Foreign direct investment

Another related Singapore issue, and another source of complementarity between competition law and dynamic economic performance, is investment. In particular, appropriate enforcement of competition law both enhances the attractiveness of an economy as a location for foreign investment and is important for maximizing the benefits that flow from such investment.¹⁶

Various questions arise. Would the enactment and enforcement of competition policy also deter some FDI? Is such policy necessary to ensure that foreign direct investors do not engage in anticompetitive acts, including driving out local firms? Do cross-border mergers and acquisitions, which many Asian countries have experienced on a sizable scale for the first time in recent years, pose a particular problem in this regard? Developing countries have long considered cross-border anticompetitive practices a major concern, resulting in the formulation (and updating every 5 years) of the UN Set at UNCTAD.

Overall, FDI inflows can contribute significantly to development, especially if they are of the greenfield type. This is because such investments have a greater potential for knowledge inflow than mergers and acquisitions. In addition, they generally increase the number of players in the market, thereby increasing competition. However, even greenfield FDI can lead to predatory pricing and abuses of dominant positions.

Thus, while most developing countries have already opened their doors to foreign investors, governments are well aware that there is no guarantee that the potential benefits of FDI will automatically accrue to the host economies.¹⁷ This is partly because FDI does not always result in a more competitive market structure. FDI, in the form of cross-border M&A activity in particular, may lead to concentration and market dominance in certain industries. Since such activity often merely results in an increase in the stake of foreign investors in existing domestic firms, it may not increase the number of market players. In such an event, the dominant firm could have price-setting abilities and would likely enjoy higher profit margins.

Alternatively, affiliates of different multinational corporations (MNCs) could set up competing businesses in a developing host country. If the parent MNCs in the home country or countries merge their operations, the affiliates in the host country are likely to eventually merge as well, possibly creating a dominant firm, or worse, a monopoly. It could very well be the case that the merger eliminates competition in the host country but not in the MNCs' home country (or countries).

Competition policy should, therefore, operate in concert with FDI liberalization. A typical relevant provision in competition laws is the ban on any merger, acquisition, or takeover that will allow the newly merged entity a dominant position in the market or prevent competitors from gaining access to a market. To complicate matters, avoiding these consequences entails the adoption of effective competition policy in both the home and host countries.

Generally, MNCs are attracted to locations with competition policies already in place. This is because the existence of a competition policy indicates some commitment by the government to ensure a level playing field among investors, whether domestic or foreign. In addition, the presence of an effective competition policy reduces the uncertainty faced by prospective foreign investors in terms of when and how the authorities might implement a new policy.

Thus, government policy on FDI must be consistent with the objectives of competition policy in order for developing countries to gain the full benefits of FDI. Governments generally avoid trying to attract foreign investors by granting anticompetitive concessions, such as monopoly rights to particular markets or industries, because it is likely that the overall impact on the economy will turn out to be negative in the long run.

The following brief review of the six countries highlights the diversity of their experiences with respect to the impact of FDI on competition in their domestic economies.

People's Republic of China

In the PRC, since an open-door policy was adopted in the late 1970s, inward FDI has been a major driving force for increased competition. The emergence of foreign-invested companies greatly changed the landscape of competition in almost all industries. However, entry of foreign investors is far from free. They are subject to numerous government regulations. Every new project involving foreign investment must be approved either by the concerned provincial and/or regional government or by the Ministry of Commerce (formerly the Ministry of Foreign Trade and Economic Cooperation), depending on the size of the investment.

The Government (or governments) also sets requirements on modes of foreign entry. Prior to the mid-1990s, formation of joint ventures was the main FDI mode of entry, driven by the Government's desire for local partners to learn about and adopt advanced foreign technologies. In addition, the Government used local content requirements in an attempt to foster backward linkages from FDI (via vertical technology transfer to local suppliers). Only with the PRC's WTO accession in January 2002 were wholly foreign-owned enterprises allowed.

FDI in the PRC has generally affected industrial structures through two channels. First, increased competition from foreign companies that are often equipped with superior technology and management drives out inefficient local firms from the market, leading to a higher degree of industrial concentration. Second, foreign firms often merge with or acquire top domestic enterprises in relevant markets. Foreign enterprises have thus become dominant players in such industries as automobiles, cellular phone production, household chemical products (e.g., detergents and skin care products), and soft drinks. These developments have sown concern that foreign enterprises might soon dominate most industries, and domestic firms may be driven out of business (Box 3.12).

As a result of the varying experiences of domestic firms under the control of foreign investors, the Government has issued regulations to monitor FDI-related M&A activity. An M&A notification/evaluation system was set up in March 2003, aimed at promoting and regulating foreign investment and introducing advanced technology and management experience from abroad, improving the utilization of foreign investment, rationalizing the allocation of resources, ensuring employment, and safeguarding fair competition and national economic security. The regulation also stipulates that mergers and acquisitions must not create excessive concentration, eliminate or hinder competition, disturb social and economic order, or harm public interests.¹⁸

Foreign investments involved in the merger or acquisition of a domestic enterprise are required to notify the Ministry of Commerce and the State Administration of Industry and Commerce if:

1. the turnover of a party to the merger or acquisition in the domestic market in the current year exceeds CNY1.5 billion;
2. the foreign investors have merged with or acquired 10 domestic enterprises in the relevant industry within 1 year;
3. the market share of a party to the merger or acquisition in the domestic market is 20%; or
4. the market share of a party to the merger or acquisition in the domestic market will reach 25% as a result of the transaction. Since the regulations apply only to foreign firms, there is widespread concern among foreign investors that future antimonopoly legislation may not be applied equally to foreign and domestic firms.

India

In line with its 1991 economic reforms, the Government adopted a liberal policy toward FDI, which involved:

• expanding the list of industries open to FDI and limiting the negative list of industries to those that need to be regulated for security or environmental reasons;
• expanding the list of industries subject to automatic approval of FDI;
• removing the 40% limit on foreign ownership except for a short list of sectors subject to caps;
• granting national treatment to companies with more than 40% foreign ownership; and
• gradually dismantling performance requirements.

These reforms significantly promoted competition in the domestic economy, as the reduced restrictions encouraged the entry of FDI. The result has been a steady rise in FDI inflows from only $75 million in 1991 to $4.3 billion in 2003.

In addition, the Government stopped merger surveillance and regulation in 1991, when the MRTP Act was amended to exclude M&A supervision. This caused a significant rise in cross-border M&A activity, with the average annual number of mergers and acquisitions increasing from fewer than five before 1991 to 51 between 1992 and 2003.

Despite the proliferation of M&A activity between April 1999 and January 2004, the concentration indexes of most of the affected industries show little change. In a few specific cases, however, mergers and acquisitions involving MNCs have resulted in some concentration (Box 3.13).

Korea

As did the governments of the PRC and India, the Korean Government gradually liberalized the services sector from the 1980s to the mid-1990s. After the Asian financial crisis, however, the Government undertook more dramatic liberalization measures and aggressive solicitation of foreign investment. Ceilings on foreign equity ownership in the stock market were eliminated, cross-border mergers and acquisitions were allowed, and foreign land ownership was fully liberalized. As a result, FDI increased substantially. However, as in India, M&A activity seems to have had a tightening effect on market concentration, illustrating that FDI does not automatically lead to more competition in the market (Box 3.14).

The case of the Korean seed industry illustrates that market share is an inefficient measure of market dominance. Other indicators such as the ability to restrict prices and supply should be considered as well. While investment policy alone may have a limited role in promoting competition, it can be supplemented by trade liberalization policy (such as reduced import tariffs to encourage more importing, and thus, more competition), together with effective implementation of competition policy (e.g., M&A regulation) to ensure increased competition in the domestic economy.

Malaysia

FDI has also been an important source of capital in Malaysia's development, where it continues to be regarded in a positive light in manufacturing, partly because most manufacturing FDI is related to export activities. It provides capital, imports technology, generates employment, and earns foreign exchange. FDI in the services sector also confers such benefits. However, when FDI in services competes with home-grown small businesses, such investments are perceived to incur social costs as they tend to drive out small businesses (Box 3.15).

Meanwhile, mergers and acquisitions involving foreign interests are encouraged, but are required to secure approval from the Foreign Investment Committee in the Prime Minister's Department if they exceed equity thresholds set by the Government. The limit on foreign equity participation limits the amount of resources that domestic firms can source from foreign investors to compete in the market. FDI that is export oriented, however, used to be exempt from this requirement. In addition, the Government relaxed limits on foreign equity participation in private enterprises after the Asian financial crisis. Although there is a dearth of studies on the impact of mergers and acquisitions in Malaysia, relaxing foreign equity participation requirements is generally expected to contribute to increased competition in the domestic economy.

Thailand

In the small, open, economy of Thailand, foreign trade and investment--and thus foreign suppliers and service providers--have played a major role in its development. The most important law governing foreign-controlled businesses in Thailand is the Foreign Business Act of 1999. The act identifies a negative list of sectors where foreign ownership is prohibited or limited. Businesses listed in category 1 are absolutely prohibited to foreigners¹⁹ unless there is an exception contained in a special law or treaty. These include the mass media, as well as rice, animal husbandry, and other resource-based businesses. Those in category 2 are businesses that concern national security or safety, or are involved with local art, culture, handicrafts, or natural resources and the environment. Foreigners are not permitted to start new businesses listed in this category unless they obtain special permission from the minister with the approval of the cabinet.

Category 3 contains businesses that the Government believes are not yet competitive and are thus vulnerable to foreign competition. These include mining, salt farming, forestry, fishery, professional services, and all services unless specified in the ministerial regulations. Similar to category 2, foreigners may obtain special permission to operate businesses listed under this category, but from the Director General and the Foreign Business Committee. To obtain a license, applicants must be able to convince the relevant local authorities that local firms cannot competently conduct the particular investment project.

Based on the list of businesses prohibited to foreigners, manufacturing is generally open to foreign investment, bar a few businesses concerned with national security, small and medium enterprises, and the environment. The services sector, however, remains relatively closed as in Malaysia, since category 3 includes "other categories of service business except those prescribed in the ministerial regulations."

In addition, sector-specific legislation may impose even more stringent conditions for foreign participation. For example, the Telecommunications Act 2001 limits the foreign equity share of a facility-based operator to only 25%. The resulting relatively closed service sector contributes to inefficiencies, which, in turn, impose costs on manufacturing.

While the entry of foreign companies generally promotes greater competition that benefits consumers, in a few cases, it has had the opposite effect, such as the case of the cement industry in Thailand (Box 3.16).

Viet Nam

Viet Nam's policy toward FDI has become more liberal and open in recent years, but restrictions still exist that effectively limit competition. On the surface, these measures appear to limit only foreign competition. In reality, they serve to protect all incumbents from both foreign and domestic competitors. The restrictions take the following forms.

Restricted sectors and forms of operation. Currently, FDI is not allowed to operate in certain sectors. In telecommunications and media, for example, only business cooperation contracts are permitted. In other sectors like oil and gas, air transportation and airport construction, forest­ation and tourism, foreign firms can only operate in joint ventures with at least one local partner. Until 2004, foreign firms were not allowed to be part of listed companies.

Performance-based requirements. FDI in Viet Nam is also subject to local content, export share, and legal capital requirements. Foreign partners are required to contribute at least 30% of total capital in any joint-venture arrangement. Meanwhile, local content requirements are perhaps the most complicated regulation on FDI. Motorbike manufacturers, for instance, are required to achieve a local content ratio of 5-10% by the second year of operation, which should eventually reach 60% in 5-6 years. Tax rates imposed are also based on these performance indicators. Export performance requirements, on the other hand, are now limited to only 14 items and enforcement is questionable.

Regulations in the financial and land markets. Foreign firms have traditionally had limited or no rights to possess land in Viet Nam. Recently, the Government extended land use rights to overseas Vietnamese (many of whom are foreign investors) and it is currently considering legislation enabling land use rights to be mortgaged with offshore banks. Small and medium enterprises and the private sector still have limited access to credit compared with big SOEs and foreign firms, due to complicated collateral requirements.

Foreign direct investment and competition policy

We have seen that, in recent years all of the six countries studied have generally been open to FDI. However, this has not always resulted in increased competition in their domestic markets. This is because other government regulations and policies have created barriers to the development of free competition. In the PRC and Viet Nam, for example, local content requirements are used to encourage backward linkages. This provides a constraint for FDI firms trying to obtain their inputs from the best possible source, and compels them to use local suppliers instead. Thus, even with FDI liberalization, increased competition is not guaranteed, as in some cases other regulations effectively limit the inflow of FDI.

In India, Korea, Malaysia, and Thailand, protection of small-scale firms prevents entry by large firms in certain sectors and industries. As a result, some service industries such as retailing have remained uncompetitive in spite of FDI liberalization. In Korea, retail stores larger than 1,000 square meters need approval by the local government advisory board, but these boards generally have strong connections with existing retailers, who lobby against the big retailers. In Malaysia, as noted above, more stringent conditions were initially imposed on foreign-owned hypermarkets in efforts to protect small local retail stores. Eventually a 5-year ban on the establishment of new foreign-owned hypermarkets was enforced. This contributed to continued inefficiencies in the domestic retail industry.

Effectively enforced competition law discourages the wrong sort of FDI without placing inordinate burdens on efficiency-enhancing foreign investments. However, poorly or arbitrarily enforced competition law can deter overseas investors. Moreover, there is a role for competition advocacy to ensure that the inducements offered and requirements placed on foreign investors do not seriously distort competition in Asian markets. In a competitive environment without distortions, FDI can contribute substantially to growth and development.

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