On 7 September 2017 the Competition and Markets Authority (CMA) published a literature review entitled “The deterrent effect of competition authorities’ work” that considers current research on the indirect benefits that consumers receive as a result of competition authorities’ interventions and, more importantly, how such benefits can be quantified.
The background to the current benefit approach
In 2007 the CMA’s predecessor (the Office of Fair Trading) agreed a performance target requiring it to deliver direct financial benefit to consumers at least five times greater than the taxpayer costs of funding the authority. Direct benefits include decreases in prices and monetised improvements in quality and time savings.
With the inception of the CMA, the direct benefit target was increased to a ratio of 10:1 which the CMA has comfortably achieved (this year reporting a direct benefit to cost ratio of 18.6:1).
The tip of the benefit iceberg?
Despite providing a strong endorsement for the CMA, the authority has been quick to point out the target’s limitations. Crucially, no credit is given for indirect benefits, namely deterrence of would-be offenders. According to the CMA, in a perfect enforcement system all wrongdoing would be deterred without the need for investigation. Without pondering on the potential issues of 100 per cent deterrence (such as the realistic dangers of false negatives), the CMA demonstrates the shortcomings of the current test by noting that in this ‘perfect’ system the direct benefit score would be zero.
Further, direct benefit analysis distorts the comparison between different types of enforcement. Market investigations, which typically cover whole markets such as retail energy, score highly (with an annualised benefit of £887 million). By contrast merger investigations, which only deal with a small number of firms directly but may also deter or modify many other potential mergers, only achieve a yearly direct benefit of £143 million. It is clear therefore that only quantifying direct benefits results in warped assessments.
Incorporating deterrence into the current benefits test is, however, not straightforward. The key takeaway from the literature review, which looks at enforcement worldwide, is that there is no known way to quantify this deterrence value. Current literature is also undeveloped in other respects:
- The interrelation of different types of enforcement: there is little analysis on how different types of enforcement interrelate (for example, the CMA speculates that a stricter merger regime would lead to fewer dominance issues under Chapter II of the Competition Act 1998).
- The Atlantic divide: the CMA points out that a large proportion of the literature is based on US markets and competition policy and is therefore less relevant to the UK/EU.
The numbers and conclusions
Currently, the most comprehensive literature studying deterrence focuses on cartels. Based on survey analysis, the CMA estimates that between 4.6 and 28 cartels are deterred for each one detected. Though useful, the CMA highlights that these figures derive from its analysis in reports conducted in 2007 and 2011 and may therefore no longer reflect current reality.
Despite the age of some of the data, the CMA is confident that indirect benefits actually outweigh direct benefits. From assessment of the literature, the CMA estimates that around 50 per cent of cartel harm is deterred as a result of the existence of competition enforcement, with remaining cartels having less stability and durability. The strongest deterrent effect appears to be in relation to overcharge.
The CMA also notes literature which suggests that detecting a cartel can deter others in unrelated markets. Interestingly, research as to the deterring effect of leniency schemes was mixed to the point that the CMA acknowledged it was difficult to draw conclusions.
For mergers, the CMA estimates that between 4 and 18 per cent of potential mergers are abandoned and between 2 and 15 per cent are restructured as a result of the presence of an enforcement regime.
Despite these figures, there is no consistent evidence that increasing the severity of enforcement outcomes increases deterrence. Further there is little research as to which outcome deters most (for example, remedies or prohibitions). The CMA also sets out the potential pitfalls of stricter enforcement, such as greater error costs (being the costs of investigating a false positive). In terms of the funding of merger controls, the CMA welcomed further research on optimum spending.
Beyond cartels and mergers, the literature review found little on key areas of competition enforcement including in relation to vertical agreements and abuse of dominance (though the 2007 and 2011 reports listed above do suggest that between four and ten abuses are deterred by each abuse of dominance decision). The CMA notes that, given the large amount of resources that are allocated to such enforcement, this is a gap in the literature that should be addressed.
The need for further research
This literature review provides a welcome reflection on current practice. Having the ability to accurately measure both the direct and indirect effectiveness of enforcement is crucial to developing regulation.
While the current literature supports the existence of deterrence as a result of the CMA’s work, further research may enable the CMA to quantify such deterrence more accurately and develop new consumer benefit targets.