The New Zealand Commerce Commission’s despair at the instruments available to it to prevent firms with substantial market power from using that power for anti-competitive purposes runs deep.
The matter dominated the agenda at the Commission’s conference in Wellington last month where US competition expert Professor Andrew Gavil was wheeled in to critique the “counterfactual test” on which the Commission must rely to enforce section 36 of the Commerce Act (our equivalent to section 46 of the Australian Trade Practices Act).
Section 36 provides that a person with a substantial degree of power in a market must not take advantage of that power for the purpose of restricting entry to, or reducing competition in, that or any other market.
The Privy Council first used counterfactual analysis to determine unlawful use of market power in 1994, adopting the Australian approach in Queensland Wire. The test requires the Court, when deciding whether there has been a misuse of market power, to determine whether the conduct in question would have occurred in a hypothetical competitive market. If the answer is yes, there has been no taking advantage and so no breach.
The technique has become a particular source of irritation to the Commission in recent years as the losses have mounted in cases such as BOPE, Carter Holt Harvey and Telecom 0867 (although, the Commission did successfully prosecute Telecom for breach of section 36 in the Data Tails case).
As its frustration has risen, the Commission has looked to international experts to help it make its argument.
Professor Gavil argued that the test is inherently unreliable and fundamentally biased toward incumbents in that it fails to acknowledge that some conduct by firms with market power can be harmful, even if it is the kind of conduct we would expect also from a firm without market power. The result, he says, is to suppress innovation by allowing firms with market power to squash the new entrant’s challenge before it gets going.
Similar conclusions were reached in a research paper requested by Commission Chair Dr Mark Berry six months earlier from the US Institute for Consumer Antitrust Studies, which described the counterfactual test as “not an effective enforcement tool”.
It is a measure of the strength of the Commission’s concern at this issue that, when submitting last year on a Bill which will give it shiny new powers to fight cartel conduct, the Commission grumped that it was “a missed opportunity” because it did not address the problems around section 36.
The Commission pushed for a broader approach before the New Zealand Supreme Court in 2009, relying in part on amendments to New Zealand section 36 in 2001 and Australian section 46 in 2007 and 2008. However, instead of loosening the counterfactual test’s grip, as the Commission had hoped, the Supreme Court tightened it, ruling that:
“having a range of tests, all potentially applying, depending on the circumstances and whether a comparative approach can “cogently” be adopted, would not assist predictability of outcome”
“All of the relevant reasoning involves, either expressly or implicitly, consideration of what the dominant firm would have done in a competitive market; that is, in a market in which hypothetically it is not dominant.”
Before the significant setback created by this judgment, the Commission had been developing guidelines to support section 36, but that work was discontinued. Asked at the October conference whether there were any plans to resuscitate the project, Dr Berry suggested there was little point while the law was in such an unsatisfactory state.
Given the weight of resolve within the Commission, it seems inevitable that at some stage a New Zealand government will agree to a review. If that happens, there will be some tough thinking for policy makers regarding how to strike a balance between allowing the big players to compete hard while at the same time facilitating the emergence of innovative new business models into the market.
The counterfactual test operates so that business strategies available to firms in competitive conditions are also available to firms with market power. This can often benefit consumers; for example, by leaving those firms free to lower prices.
An alternative “effects test” would, in Professor Gavil’s words, put a “thumb on the scale” in favour of new entrants. It does so by disallowing “normal” competitive conduct on the basis that, because it is being undertaken by a firm with market power, it could cause collateral damage to emerging firms.
So in deciding whether to grant the Commission a new section 36, lawmakers need to ask: what would we lose by handicapping firms with market power in this way? And would any such losses be outweighed by gains as innovative new entrants are afforded greater scope to develop?
The Commission clearly believes that better outcomes will emerge if we abandon counterfactual analysis for section 36. It will be interesting to understand the basis for that belief – or indeed any contrary belief – as the debate develops.