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p. 72 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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Issues for implementation

Recent empirical research has confirmed that barriers to entry are substantially higher in developing economies than in industrial nations (Djankov et al. 2002, De Soto 2000). If reforms cannot be introduced to effectively lower these barriers--perhaps because in some situations poor governance practices cannot be eliminated in any realistic time frame--then dynamic efficiency may actually be best served by competition policy measures that prevent incumbent firms from setting higher prices for customers over the longer term.

In many developing countries, the benefits of competition policy have yet to emerge visibly, because enforcement has been hampered by lack of resources, reliable data, or sufficient information about production costs, market shares, and consumer behavior. In Thailand for example, the Trade Competition Commission has not yet determined the criteria for threshold market share that will both define a "dominant" business and determine a postmerger level of market concentration that would trigger mandatory premerger notification. As a result, all practices that should be classified as abuse of dominance and all mergers that may foreclose future competition are currently exempt.

Even so, in many areas of Asia competition authorities have played an important role in the formulation of liberalization, privatization, and deregulation policies, ensuring that the objectives of those policies induce growth.

The manner in which competition policy is implemented and enforced has important implications for its effects on macroeconomic performance and on the poor. Competition issues may be handled through sectoral regulations, as in Malaysia, or through economy-wide legislation, as in the other five countries discussed. The agency delegated to enforce competition policy may be independent or may answer to a particular ministry. It may be centralized or decentralized. Development of a culture of competition may be left to the competition authority or it may be undertaken through other means, such as via the educational system. Enforcement of competition law may depend primarily on administrative decisions or on recourse to the judicial system.

As economies open up, governments have to make the transition from a protectionist, regulatory regime to a new emphasis on efficiency and innovation. This may require a focus on microeconomic, or second generation, reforms. Governments need to ensure more effective R&D and other support schemes, better physical infrastructure, legal reform, improved education, and administrative reform.

Initial conditions

The diversity of the six countries studied has influenced their implementation and enforcement experiences. Table 3.4 highlights their diversity while Table 3.5 illustrates some of the key aspects of their implementation experiences.

The PRC's human capital base is comparatively strong, with near universal literacy, segments of technical excellence, and R&D strengths for innovation. Its foreign trade and investment have expanded rapidly. In contrast, its commercial institutions have historically been weak, and the country scores poorly in international comparisons of corruption and protection of property rights. But institutional quality is improving quickly, and physical infrastructure is being upgraded rapidly, facilitating the entry of firms.

India's human capital base has pockets of international excellence alongside quite high levels of illiteracy. Until recently, its inward-looking strategy meant that it was unable to exploit its human capital strengths in the global economy. Its commercial environment is broadly predictable, and the legal system cumbersome but independent. It also has the highest level of decentralized economic policy making among the six countries. The 1991 reforms and their aftermath have begun to transform the commercial environment, but the unfinished reform agenda is long and complex.

Korea's development strategy has been underpinned by exceptional strength in certain areas. It reached OECD levels of educational achievement and R&D expenditures at comparatively low levels of per capita income. Its infrastructure and institutional quality are good. External factors--aspiring to membership of international organizations and the Asian crisis--have been important factors in its policy reforms.

Malaysia emerges as a country with comparatively high institutional quality, excellent physical infrastructure, and large public investments in education, much of it designed to redress past ethnic imbalances. It has had the most consistent commercial policy environment of the six. Nevertheless, there are concerns that the independence of its legal system may have weakened over the past two decades, there has been a persistent loss of high-level non-bumiputra human capital, and it faces competition from below (especially the PRC) and from above (the Asian newly industrializing economies).

Thailand scores well on most indicators, with the principal exception of human capital. In consequence, during the 1990s, as real wages began to rise quickly in the wake of rapid economic growth, it experienced difficulty in managing the transition out of labor-intensive activities. It has become progressively more open in its trade and FDI policies. Historically, its legal and commercial institutions were not strong, but physical infrastructure is generally good.

The principal challenges in Viet Nam still relate to establishing the infrastructure that underpins a market-based economy since property rights, the legal system, financial intermediation, and physical infrastructure are all poorly developed. Illiteracy levels are low, but so too is the pool of internationally experienced entrepreneurs. Many small and household enterprises operate in an insecure commercial environment, while SOE reform lags. The quality of the physical and commercial infrastructure shows pronounced regional differences.

In their competition regimes, it is useful to divide the six countries into three groups. The first comprises those with historically very restrictive regimes, which have opened up during the past quarter century, namely PRC, India, and Viet Nam. The second covers those that have traditionally been reasonably open, and become progressively more so--Malaysia and Thailand. Finally is the special case of Korea, which was initially highly selective in its opening up, and which has become progressively more open to competition over time. None of the sample countries has become less open toward competition.

In some cases, it is possible to date the promotion of greater competition as part of a package of major general reforms. In Korea, there was gradual liberalization from the late 1980s, with major reforms in the late 1990s in the wake of the economic crisis. In the PRC, the reform process began in 1978, strengthened in the late 1980s, and further consolidated in 2002 on accession to WTO. In India, 1991 is regarded as the key reform year. In Viet Nam, it was the late 1980s doi moi reforms, with further liberalization around 2000. In contrast, Thailand, and particularly Malaysia, have always been quite open to competition, and over time have become progressively more so. In neither of these have there been major swings in the policy pendulum.

A range of internal and external factors was operational. These factors include a recognition that outward-oriented economies grow more quickly, and that it is possible to achieve national objectives in an open economy context. Competitive liberalizations--keeping up with one's neighbors--have been another factor. Foreign pressures, including a desire to join international agencies, have often contributed. Conversely, the demise of an international benefactor (the former Soviet Union) was a major trigger in Viet Nam's reforms.

Competition policy enforcement may differ between regions. Three of the six countries (PRC, India, Malaysia) feature quite high levels of decentralized economic policy making. (Local protectionism in the PRC was highlighted above.) Thailand has been pursuing a policy of industrial decentralization for some time, with implications for competition at local levels. In all but Malaysia, economic authority is being progressively devolved away from the center at varying degrees and speeds. In addition, there are large interindustry differences in protection, and thus competition, in all six countries. SOEs frequently receive preferential treatment, especially in PRC, India, and Viet Nam.

In some cases, such as Viet Nam, many of the broader problems associated with the business environment were barely addressed in the first round of reforms: red tape, corruption, insecure property rights, an ill-defined legal environment, poor physical infrastructure, limited financial development, and the huge, inefficient, and privileged SOE sector. The reforms have been a "positive-sum game," since growth has accelerated. But there have been losers too, notably among the bureaucrats who dispensed power and patronage, the SOEs sheltered from competition, and the labor unions in cosseted (especially state-owned) industries.

In Korea, too, there seems to have been ambivalence about recent reforms in sections of the bureaucracy that are reluctant to relinquish control. To overcome this attitude, reformers have proposed the establishment of "free economic zones," where liberalization (particularly of labor markets) can proceed more quickly than elsewhere, highlighting the importance of competition in factor markets. It is unlikely that Korea could achieve its current objective of becoming an economic hub for Northeast Asia unless these reforms are introduced and implemented successfully.

Korea undertook its major liberalizations after it had become democratic, but in any case it appears that external factors were a major trigger for reform. Two factors in particular stand out. One was the Government's desire to join international organizations (GATT then OECD), membership of which required reform. The second was the Asian financial crisis when, in spite of intense nationalist sentiment, the Government felt it had no choice but to open up the economy.

Promotion of competition can also play an important role during the recovery of crisis-hit economies. With weak consumer demand, tight government budgets, and investment that has been reduced by lowered confidence, exports are critical in the immediate recovery period. Crucial to the competitiveness of exports is the efficiency gains from competition. The 1997—98 Asian crisis also served as a reminder that restrictions on competition may appear compatible with an open trade and FDI regime, while mounting tensions may remain hidden.

Competition is central to the process of globalization. Competition benefits the economy since domestic factors of production are able to maximize their returns, subject to the institutional constraints they face. Competition is also presumed to constitute a spur to better economic policy, to the extent that the option of "exit" for investors exerts a policy discipline on governments. In most cases, potential tension between industrial policy and promotion of competition is handled by ensuring competition in the domestic market, but not necessarily with equal treatment for foreign rivals.

Openness to the international economy varies significantly among the six countries (Table 3.4 above). All have become more open to trade since 1990, as indicated by both trade reforms and rising export-to-GDP ratios. This ratio has increased by more than 50% in three of the countries (PRC, India, and Thailand) and substantially in the others. Malaysia and Thailand were among a very small group of developing economies classified by Sachs and Warner (1995) as "always open." Both exhibit very high trade orientation, quite low average tariffs, modest interindustry tariff dispersion, and limited incidence of nontariff barriers. Qualitative indicators support this conclusion. Korea now has fairly low average tariff rates. Notwithstanding recent reforms, PRC, India, and Viet Nam still have relatively high tariffs, and a higher incidence of nontariff barriers than the other three countries. The more protected an economy is, the more limited competition is, reducing allocative efficiency.

Among the six, Korea's trade and investment regime has arguably been the most unusual. From the early 1960s, it achieved very rapid export-led growth in the context of (until recently) very restrictive policies toward imports (except those required by export-oriented firms) and FDI. Its industrial policy resulted in tremendous achievements but also high costs. In addition to tariff reform and a reduced incidence of nontariff barriers, Korea's reforms in the 1990s included a reduction in the number of subsidy programs, as well as customs simplification. A desire to join both GATT/WTO and OECD, and the imperative to reform in the wake of the 1997-98 crisis, drove much of the liberalization.

Viet Nam's reengagement with the international economy is of fairly recent origin. Typical of a late reformer, its official trade regime remains opaque and poorly documented. Only quite recently was a formal tariff schedule released. It still retains very high levels of protection (several hundred percent) for its automotive, sugar, and garment industries. Much protection is firm-specific in nature, tailored to the needs of inefficient SOEs. Viet Nam aspires to WTO membership soon, which constitutes a powerful incentive to continue and broaden the reform process.

Political commitment to promoting competition and to ensuring the independence of the competition authority plays a large role in effective implementation. In the case of Thailand, intense lobbying has caused delays in the adoption of a threshold market share to define a dominant position. The country's Trade Competition Commission also suffers from human resource and capacity constraints, funding limitations, lack of protection of confidentiality, and limited public awareness and support.

When enforcement is handled through administrative decisions in a decentralized manner, the potential exists for inconsistent enforcement across locations. In the PRC, local State Development and Reform Commission branches have had some success in breaking price agreements among suppliers, such as among nine travel agencies collectively setting minimum package prices for trips to Southeast Asia. However, stronger coordination of the network of local implementation/enforcement agencies may be necessary to deal with (or stave off) instances of local protectionism.

Several key points emerge from this survey of approaches to, and experiences with, implementing competition policy. Notwithstanding their diversity, almost all developing Asian economies have adopted progressively more open policies toward competition during the past decade or two, and this trend seems set to continue. This more open posture has been accompanied by the adoption of more liberal trade and FDI regimes, a process that has had profound implications for the promotion of competition. These changes have been so rapid in some cases that the policy and institutional framework has been unable to keep pace.

A major challenge for policy makers is keeping up with a rapidly changing international commercial environment. As with FDI, for an economy to reap the full benefits of competition, the quality of incentives, institutions, and infrastructure matters more than before. In transitional economies, the first round of reforms typically focuses on macroeconomic stabilization and partial trade liberalization, while other, microeconomic, components essential for competition typically lag.

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