Is EU Competition Policy an Obstacle to Innovation and Growth? - Jan. 2009

Arguments from the ICT and Pharmaceutical Industries

In an interesting essay from the Centre for European Reform - a UK think tank dedicated to improving the quality of the debate on the European Union - Simon Thetford, the CER's chief economist, looked into the EU's competition policy as being a factor in the EU's relatively poor record in innovation. He looked at the ICT and Pharmaceutical sectors in depth - sectors where the tension between innovation and EU competition law is at its most stark (as Thetford puts it). 

In the case of pharmaceuticals, this is because of the financial costs of developing new medicines. Only a small proportion of drugs under development ever reach the market, so firms have to be very big in order to sustain the necessary investment in R&D. In both industries, firms are often creating whole new markets for their products, which inevitably lead to some degree of market power. In addition, there are powerful network effects at work in the ICT sector.  It makes sense for firms to agree on an industry standard, so that equipment and software are compatible. However, this confers monopolies on the firm that owns the patents on the industry standard.

Europe will not be able to compete in the global economy on the basis of its current specialization in medium-technology sectors, such as car manufacturing and electrical engineering. As was explicitly recognized in the EU’s Lisbon agenda of economic reforms launched in 2000, European countries need to improve their record of developing high-tech businesses if they are to prosper. The reasons for Europe’s poor record of innovation are complex, but one rather neglected factor is competition policy. Competition policy needs to foster rather than deter high-tech innovation.

The rules of competition policy should apply to high-tech sectors, just as they do to all others. But, Thetford argues, EU competition policy needs to take into account the special characteristics of high-tech industries as well as the regulatory environments in which firm operate when deciding whether to take action against them for pursuing allegedly anti-competitive practices. The presence of a dominant company does not necessarily point to an uncompetitive market.

The very nature of competition in high-tech sectors creates barriers to entry and positions of market power. High-tech firms often create whole new markets for products, which they inevitably dominate, at least until a rival company comes along and challenges them. It is this temporary market power and the associated profits that help justify their heavy investment in R&D. Forcing innovative companies to share their intellectual property in order to foster competition will lower prices in the short-term. But it will not necessarily be in the interests of competition or the consumer in the longer-term if it undermines incentives for companies to innovate and develop new products.

Thetford looked at these issues with reference to the Commission’s action against Microsoft and its sectoral inquiry into competition in the pharmaceuticals sector. The Commission’s position vis-à-vis Microsoft (along with that of the EU’s Court of First Instance), implies that a dominant company should be forced to share its intellectual property in order to enable other firms to compete with it. In a sector such as ICT where firms compete by investing in R&D, this is problematic. Such a general requirement to share the intellectual fruit of this investment threatens to weaken competition, not strengthen it, to the detriment of consumers.

The Commission’s sectoral inquiry into the pharmaceuticals industry highlights the risks of basing competition policy on an incomplete understanding of the nature of competition in a particular market. Pharmaceutical prices are set by the government or public healthcare body in each of the 27 member-states, and often at levels that are too low to justify investment in innovation. Unless the EU can do something to address the fragmented and unpredictable nature of the market for pharmaceuticals in Europe, it needs to be careful about any action it takes against the pharmaceuticals firms for allegedly anti-competitive practices. Taken in isolation, there is a risk that such action will further undermine R&D expenditure by pharmaceuticals firms in Europe.

Both the Microsoft case and the sectoral inquiry into the pharmaceuticals industry suggest that the Commission needs to employ more economic analysis in its assessment of what makes for competitive markets in high-tech goods. It should provide greater clarity about what constitutes a dominant market position, the circumstances in which a dominant company can be considered to have abused its market position, and what action it can expect from the Commission. It needs to recognize that temporary monopoly positions in high-tech businesses are often inevitable and that taking action against dominant high-tech firms can do more harm than good. If the rules are not clear, or the nature of competition is misunderstood, innovation will suffer.