Fine and Punishment

The FINANCIAL -- Imagine arriving at a provincial airport in an unnamed Central Asian country. You leave the terminal and go straight to row of waiting taxis. In your Lonely Planet you read that you should pay about $10 for what is a short taxi ride to the city center. You ask the first taxi driver and are quoted a fantasy price of $50. You try to bargain, to no avail. You go to the next taxi, and once again you are quoted $50. You finally go to the third taxi, and lo and behold, it’s the same price, $50. And you don’t even try to bargain anymore…

Now, imagine this to play out over and over again. When you want to buy gasoline. When you want to buy groceries. When you want to buy medication. Frustrating, wouldn’t it be? Or, to quote Brian Shepard, one of the FBI agents that helped break up the Lysine cartel in the United States in the 1990s: “Everyone in this country is a victim of corporate crime by the time they finish breakfast.” So how would you go about breaking up cartels? How does Georgia go about breaking up cartels?

A few days ago the Georgian parliament adopted the draft law “on the Amendments to the Law of Georgia on Free Trade and Competition”. As has been pointed out by Transparency Georgia, this new law introduces several novelties, and has the potential to finally have an impact and to result in the break-up of cartels.

So is all now well and good with this new law? Will cartels be broken up and involved firms be fined and punished? Will Georgian consumer enjoy lower prices for gasoline, pharmaceuticals, and food? On paper, the new law should give reason for optimism.

The new law establishes an independent competition agency, it defines what is and what is not unfair competition, and it stipulates fines for anti-competitive practices. Importantly, these fines are defined as percentage of annual revenue and are supposed to be proportional to the damage, the duration, and the scope of the anti-competitive practice. The law is thus very much in line with EU competition law. Which is not surprising given that competition was and is a key point in the negotiations on the Deep and Comprehensive Free Trade Agreement between Georgia and the European Union.

In theory fines of up to five percent (up to ten percent for repeat offenders) of annual revenue provide a strong deterrent against anti-competitive behavior. But as usual the devil is in the details. Here are a few reasons why:

1. Imagine two firms fixing prices in the retail gasoline market. One firm is well-diversified, not just selling gasoline but also providing other services – from fast food over grocery retail to car repair. The other firm is highly specialized, selling gasoline, and only gasoline. With fines being proportional to annual retail deterrence is strong for the former, but weaker for the latter. This is a problem as it distorts the decisions of firms to diversify or specialize.

2. Imagine a pharmacy chain selling pharmaceuticals, and a pharmaceutical firm manufacturing said pharmaceuticals. Likely the profit/revenue ratio will be lower for the former, the downstream firm, and higher for the latter, the upstream firm. This also poses a problem for the competition agency as fines have to take into account market and firm characteristics, in order for the fine to be appropriate.

3. Cartels increase their member’s profits by increasing prices and reducing market sales (or in other words, revenue). With fines being proportional to annual revenue competition policy gives an additional incentive for firms to increase prices and reduce market sales even further, thus increasing the damage to consumers.

In principle all these could be resolved by fine-tuning fines, not only taking into account the damage, the duration, and the scope of the anti-competitive practice, but also the characteristics of involved firms and markets. This certainly is a tall order. And requires experience and expertise from the new competition agency. Even worse, there is the following:

4. Consider an extreme example – a cartel in the banking sector. Impose large fine and financial stability will be gone. Under these circumstances, can fines be a credible deterrent?

5. Consider a less extreme example –a cartel in the grocery retail sector. Impose large fines, and not only the cartel, but also some retailers will go. Can we be sure that the market will be more competitive, not less?

6. Fines imposed on cartels will be paid by consumers or shareholders, and not by those who are the real culprits: The managers who decided that it is ok to cheat consumers, and to reduce or eliminate competition with illegal practices.

What could be done instead? The competition agency could punish individuals and not firms, making anti-competitive practices a criminal offence. While certainly not without its own problems, criminal sanctions would provide a strong deterrent and would go a long way to alleviate distortions brought about by pecuniary fines.

There is of course a reason why criminal sanctions are not part of the new competition law. While criminal sanctions are common in the US, they are not in the European Union (except for some limited use in a few individual EU member countries). Quite simply, given the need and the intention to emulate EU competition law in Georgia they are not the best starting point for Georgia.

This leaves but one strategy to deal with the unintended consequences of fines: Invest not only into the legal but also the economic expertise of the new competition agency. For several reasons. One, trivially, to understand the anti-competitive practices employed by firms, and the damage caused. Second, to ensure that the economic consequences of fines, both ex-ante and ex-post, are properly understood. Third, to provide for transparent and predictable sanctions by developing guidelines and procedures for the determination of fines, to allow firms to anticipate the consequences of anti-competitive practices.

Recommended for further reading are Vasiliki Bageri, Yannis Katsoulacos and Giancarlo Spagnolo, “The Distortive Effects of Antitrust Fines Based on Revenue”, SITE Working Paper 22, 2012 and the Fall 2010 issue of the Competition Policy International Journal with the colloquium “Who Should Be the Target of Cartel Sanctions?”