Tag: Competition

Can Public Enforcement of Competition Policy Increase Distortions in the Economy?

Posted on November 18, 2013 | Policy Brief

High office buildings facing sky representing Institutions and Services Trade

Authors: Vasiliki Bageri, University of Athens, Yannis Katsoulacos, Univeristy of Athens,  and Giancarlo Spagnolo, SITE.

Competition law has recently been introduced in a large number of developed and emerging economies. Most of these countries adopted the common practice of basing antitrust fines on affected commerce rather than on collusive profits, and in some countries caps on fines have been introduced based on total firm sales rather than on affected commerce. Based on recent research, this policy brief explains how a number of large distortions are connected to these policies, which may facilitate competition authorities in their everyday job but at the high risk of harming the consumer and distorting industrial development. We conclude by discussing the possibility to depart from these distortive rules-of-thumb opened by recent advancements in data availability and econometric techniques, as well as by the considerable experience matured in estimating collusive profits when calculating damages in private antitrust litigation.

Competition policy has become a prominent policy in many developing economies, from Brazil to India. Indeed, the available evidence suggests that in countries where law enforcement institutions are sufficiently effective, a well designed and enforced competition policy can significantly improve total and labor productivity growth.

It is already well known that the private enforcement of competition policy can give rise to large distortions: since competition law is enforced by Judges and not by economist, it is easy for firms to strategically use the possibility to sue under the provision of competition law to protect their market position rather than the law being used to protect competition.

It is somewhat less known that a poor public enforcement of Competition Law by publicly funded competition authorities can also end up worsening market distortions rather than curing them. In the reminder of this policy brief we explain why, according to recent research, a mild and suboptimal enforcement of antitrust provisions – in the sense of fines that are too low to deter unlawful conduct (horizontal agreements and cartels in particular) and fines which are based on firm revenue rather than on the extra profits generated by the unlawful conduct, could significantly harm social welfare, even if we abstract from the direct cost the public enforcement of competition law imply for society.

Current Practice in Setting Fines

A very important tool for the effective enforcement of Competition Law is the penalties imposed on violators by regulators and courts. In this policy brief, we uncover a number of distortions that current penalty policies generate, we explain how their size is affected by market characteristics such as the elasticity of demand, and quantify them based on market data.

In contrast to what economic theory predicts, in most jurisdictions, Competition Authorities (CAs), but also courts where in charge, use rules-of-thumbs to set penalties that – although well established in legal tradition and in sentencing guidelines and possibly easy to apply – are hard to justify and interpret in logical economic terms. Thus, antitrust penalties are based on affected commerce rather than on collusive profits, and caps on penalties are often introduced based on total firm sales rather than on affected commerce.

A First Well Known Distortion Due to Legal Practice

A first and obvious distortive effect of penalty caps linked to total (worldwide) firm revenue is that specialized firms which are active mostly in their core market expect lower penalties than more diversified firms that are also active in several other markets than the relevant one. This distortion – why for God’s sake should diversified firms active on many markets face higher penalties than more narrowly focused firms? – could in principle induce firms that are at risk of antitrust legal action to inefficiently under-diversify or split their business to reduce their legal liability.

In a recent paper published in the Economic Journal, we examine two other, less obvious, distortions that occur when the volume of affected commerce is used as a base to calculate antitrust penalties.

A Second Distortion: Poorly Enforced Competition Law May Increase Welfare Losses from Monopoly Power

If expected penalties are not sufficient to deter the cartel, which seems to be the norm given the number of cartels that CAs continue to discover, penalties based on revenue rather than on collusive profits induce firms to increase cartel prices above the monopoly level that they would have set if penalties were based on collusive profits. Intuitively, this would be done in order to reduce revenues and thus the penalty. However, this exacerbates the harm caused by the cartel relative to a monopolized situation with similar penalties related to profits, or even relative to a situation with no penalties due to the distortive effects of the higher price and, in comparison to a situation with no penalties, the presence of antitrust enforcement costs.

A Third Distortion: Firms at the Bottom of the Value Chain May Pay a Multiple of the Fine Paid by Firms at the Top for an Identical Infringement

Firms with a high revenue/profit ratio, e.g. firms at the end of a vertical production chain, expect larger penalties relative to the same collusive profits that firms with a lower revenue/profit ratio would get. Our empirically based simulations suggest that the welfare losses produced by these distortions can be very large, and that they may generate penalties differing by over a factor of 20 for firms that instead should have faced the same penalty.

Note that this third distortion takes place also when at least for some industries fines are sufficiently high to deter cartels. This distortion means that competition is only enforced in industries that happen to be in the lower end of the production chain, and not in industries where the lack of competition is producing larger social costs. Note also that our estimation is based only on observed fines, i.e. on fines paid by cartels that are not deterred. Since cartels tend to be deterred by higher fines, this suggest that if we could take into account the fines that would have been paid by those cartels that were deterred (if any), the size of the estimated distortion would likely increase!

Concluding remarks

We argue that if one wants to implement a policy, one must be ready to do it well otherwise it may be better to not do it at all. This is particularly relevant for countries with weaker institutional environments where it is likely that political and institutional constraints will not allow for a sufficiently independent and forceful enforcement of the Competition Law.

It is worth noting that – in particular in the US but also increasingly so in the EU – the rules-of-thumb discussed above do not produce any saving in enforcement costs because the prescribed cap on fines requires courts to calculate firms’ collusive profits anyway. Furthermore, the distortions we identified are not substitutes where either one or the other is present. Instead, they are all simultaneously present and add to one another in terms of poor enforcement.

Where there are sufficient resources to allow for a proper implementation and where enforcement of Competition Law is available, developments in economics and econometrics make it possible to estimate illegal profits from antitrust infringements with reasonable precision, as regularly done to assess damages. It is time to change these distortive rules-of-thumb that make revenue so central for calculating penalties, if the only thing the distortions give us is savings in the costs of data collection and illegal profit estimation.

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Managed Competition in Health Insurance Systems in Central and Eastern Europe

Posted on October 28, 2013 | Policy Brief

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This policy brief summarizes common trends in the development of health care systems in the Czech Republic, Slovakia, and Russia in late 1990s–early 2000s. These countries focused on regulated competition between multiple health insurance companies. However, excessive regulation led to various deficiencies of the model. In particular, improvements in such quality indicators of the three health care systems as infant and under-five mortality are unrelated to the presence of multiple insurers or insurer competition.

A number of transition countries in Central and Eastern Europe and the former Soviet Union introduced health care systems with compulsory enrollment, obligatory insurance contributions unrelated to need and coverage according to a specified package of medical services. This so-called social health insurance (SHI) model (Culyer, 2005) is regarded as a means for achieving universal coverage, stable financial revenues, and consumer equity  (Balabanova et al. 2012; Gordeev et al., 2011; Zweifel and Breyer, 2006; Preker et al., 2002). While most transition countries chose to only have a single health insurance provider on the market, the Czech Republic, Slovakia, and Russia allowed competitive (and often private) insurers in the new system. However, the evidence from the three countries shows excessive regulation of health insurers and limited instruments for insurer competition within indebted post-reform health care systems (Naigovzina and Filatov, 2010; Besstremyannaya, 2009; Medved et al., 2005). Consequently, the three countries may have been over-enthusiastic in putting large emphasis on market forces in the reorganization of health care systems in economies with a legacy of central planning (Diamond, 2002).

This brief addresses the results of Besstremyannaya (2010), which assesses the impact of private health insurance companies on the quality of health care system. While various performance measures reflect different goals of national and regional health care systems (Joumard et al., 2010; Propper and Wilson, 2006; OECD, 2004; WHO, 2000), aggregate health outcomes directly related to the quality of health care are commonly infant and under-five mortality (Lawson et al., 2012; Gottret and Schieber, 2006; Wagstaff and Claeson, 2004; Filmer and Pritchett, 1999). Consequently, Besstremyannaya’s (2010) analysis regards mortality indicators as variables reflecting the overall quality of health care system.

The estimations employ data on Russian regions in 2000-2006. The results indicate that regions with only private health insurers have lower infant and under-five mortality. However, given the low degree of competition on the social health insurance market in Russia, we hypothesize that this effect is mostly driven by positive institutional reforms in those regions. Indeed, incorporating the effect of institutional financial environment, we find that the impact of private health insurers becomes insignificant.

Development of a Social Health Insurance Model in the Czech Republic, Slovakia, and Russia

At the beginning of their economic transition, the Czech Republic, Slovakia, and Russia established a model for universal coverage of citizens by mandatory health insurance (Balabanova et al., 2012; Medved et al., 2005; Sheiman, 1991). The revenues of the new SHI system came from a special payroll tax and from government payments for health care provision to the non-working population. The main reason for combining certain features of taxation-based and insurance-based systems was the desire to establish mandatory health insurance as a reliable source of financing in an environment with unstable budgetary revenues (Lawson and Nemec, 2003; Preker et al., 2002; Sheiman, 1994). The insurance systems instituted in the three transition countries correspond to the major SHI principles implemented in Western Europe: contributions by beneficiaries according to their ability to pay; transparency in the flow of funds; and free access to care based on clinical need (Jacobs and Goddard, 2002).

The Czech Republic, Slovakia, and Russia placed emphasis on regulated competition, decreeing that SHI should be offered by multiple private insurance companies with a free choice of the insurer by consumers. Managers of private insurance companies were assumed to perform better than government executives (Lawson and Nemec, 2003; Sinuraya, 2000; Curtis et al., 1995), so an intermediary role for private insurance companies was seen as a key instrument for introducing market incentives and improving the quality of the health care system (Sheiman, 1991).

However, the activity of health insurance companies in the three countries was heavily regulated, since the content of benefit packages, size of subscriber contributions, and the methods of provider reimbursement were decided by government, and tariffs for health care were frequently revised (Lawson et al., 2012; Rokosova et al., 2005; Zaborovskaya et al., 2005; Praznovcova et al., 2003; Hussey and Anderson, 2003). In particular, Russian health care authorities enforced rigid assignments of areas, whose residents were to be served by a particular health insurance company (Twigg, 1999) and imposed informal agreements with health insurance companies to finance providers regardless of the quality and quantity of the health care (Blam and Kovalev, 2006). As a result, the three countries experienced an initial emergence of a large number of health insurance companies, followed by mergers between them, resulting in high market concentration (Sergeeva, 2006; Zaborovskaya et al., 2005; Medved et al., 2005).

In Russia, the Health Insurance Law (1991) specified that until private insurers appeared in a region, the regional SHI fund or its branches could play the role of insurance companies. Therefore, several types of SHI systems emerged in Russian regions in the 1990s and early 2000s: the regional SHI fund might be the only agent on the SHI market; the regional SHI fund might have branches, acting as insurance companies; SHI might be offered exclusively by private insurance companies; or SHI might be offered by both private insurance companies and branches of the regional SHI fund (Figure 1). The variety of SHI systems reflects the fact that many regions opposed market entry by private insurance companies (Twigg, 1999). Indeed, the boards of directors of regional SHI funds usually included regional government officials (Tompson, 2007; Tragakes and Lessof, 2003) who were reluctant to reduce government control over SHI financing sources (Blam and Kovalev, 2006; Twigg, 2001). The controversy with health insurance legislation created a substantial confusion at the regional and the municipal level (Danishevski et al., 2006).

Figure 1. Health insurance agents in Russia in 2000-2006, (number of regions)

 Slide1

This context suggests that Russian regions provide an interesting study field to address the impact of private health insurance companies on the quality of health care system. In particular, the wide variety of SHI systems across Russian regions, as well as the gradual introduction of the health insurance model in Russia provide a sufficient degree of variation in practices and outcomes to allow for a well-specified empirical analysis.

Data and Results

In our analysis we use data on Russian regional economies between 2000 and 2006 (as based on data availability). Our measures of health outcomes are given by the pooled regional data on infant and under-five mortality. Our key explanatory variable is the presence of only private health insurers in the region. Arguably, the coexistence of public and private health insurance companies does not enable effective functioning of private health insurers owing to their discrimination by the territorial health insurance fund. Therefore, in the empirical estimations we focus on the presence of only private health insurers in the region, regarding it as a measure of effective health insurance model.    The analysis also employs a variety of important socio-economic and geographic variables influencing health outcomes (per capita gross regional product (GRP), share of private and public health care expenditure in gross regional product, share of urban population, average temperature in January).

The results of the first set of our empirical estimations demonstrate that the presence of only private health insurers in a region leads to lower infant and under-five mortality. Furthermore, an increase in the share of private health care expenditure in GRP leads to a decrease in both mortality indicators. The result is consistent with numerous findings about the association between personal income and health status in Russia (Balabanova et al., 2012; Sparling, 2008).

Prospective reimbursement of health care providers is associated with a decrease in infant and under-five mortality. The finding suggests the existence of a quasi-insurance mechanism in the Russian SHI market. Operating in an institutional environment where provider reimbursement is based on prospective payment, private insurance companies in effect shift a part of their risk to providers (Glied, 2000; Sheiman, 1997; Chernichovsky et al., 1996).

Table 1. Factors leading to decreased infant and under-five mortality in Russia

Slide1

Notes: * indicates that the coefficient is statistically significant in a parametric regression

Although our analysis shows that the presence of only private health insurers is statistically associated with improvements in infant and under-five mortality, we believe that the influence is indirect. Namely, the overall positive institutional environment in the region may result in both a decrease of mortality indicators and a lower coercion of regional authorities towards the presence of private health insurance companies.

To test this hypothesis, we use financial risk in a region as a measure of institutional environment and incorporate it in the analysis through an instrumental variable approach. (We measure financial risk by an expertly determined rank ordered variable by RA expert rating agency; this variable reflects the balance of the budgets of enterprises and governments in the region, with lower ranks corresponding to smaller risk.)

In line with our hypothesis, the results suggest that the presence of private health insurance companies now becomes insignificant in explaining infant and under-five mortality.

Discussion

The existing literature suggests that the improvement in infant and under-five mortality in the Czech Republic, Slovakia, and Russia can be attributed primarily to an increase of health care spending (Gordeev et al. 2011; Besstremyannaya, 2009; Lawson and Nemec, 2003) rather than being an effect of the social health insurance model with multiple competing insurers. It should be noted that insufficient government payments for the non-working population and a decline of the gross domestic product in the early transition years left SHI systems in the three countries indebted (Naigovzina and Filatov, 2010; Sheiman, 2006; Medved et al., 2005), which undermined the development of the managed competition in the health care provision.

In Russia (and also in the Czech Republic and Slovakia) there is little competition between insurers, and surveys show that the main factors causing consumers to change their health insurance company are change of work or residence, and not dissatisfaction with the insurer (Baranov and Sklyar, 2009). The fact that law suits on defense of SHI patient rights are rarely submitted to courts through health insurers (Federal Mandatory Health Insurance Fund, 2005) may also be evidence of the failure of Russian health insurance companies to win customers on the basis of their competitive strengths.

Summary and Policy Implications

The above findings as well as the other mentioned literature suggest that improvements of infant and under-five mortality in the Czech Republic, Slovakia, and Russia are not associated with the positive role of managed competition in the social health insurance system. In particular, in Russia the decrease in infant and under-five mortality is likely to be related to financial environment, rather than the existence of insurance mechanisms or competition between health insurance companies. One possible explanation of this absence of effect may come from the excessive regulation of the private insurance markets, as well as the insufficient competition between insurers. Importantly, the health insurance reform, implemented in Russia in 2010, both addressed underfinancing (by raising payroll tax rates) and took a step towards fostering provider competition, by allowing private providers to enter the social health insurance market (Besstremyannaya 2013). However, insurance companies are still not endowed with effective instruments for encouraging quality by providers, which may greatly undermine their efficiency.

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References

  • Balabanova D, Roberts B, Richardson E, Haerpfer C, McKee V. 2012. Health Care Reform in the Former Soviet Union: Beyond the Transition. Health Services Research  47(2): 840-864.
  • Baranov IN, Sklyar TM. 2009. Problemy strakhovoi modeli zdravookhraneniya na primere Moskwy i Sankt-Peterburga (Problems of insurance model in health care: the example of Moscow and Saint Petersburg). In X International Conference on the Problems of Development of Economy and Society, Yasin E.G (ed),  Moscow: Higher School of Economics, vol.2.
  • Besstremyannaya GE. 2013. Razvitie systemy obyazatelnogo meditsinskogo strakhovaniya v Rossijskoi Federatsii (Development of the Mandatory Health Insurance system in the Russian Federation)  Federalizm 3: 201-212
  • Besstremyannaya GE. 2010. Essays in Empirical Health Economics. PhD thesis. Keio University (Tokyo).
  • Besstremyannaya GE. 2009. Increased public financing and health care outcomes in Russia. Transition Studies Review 16: 723-734.
  • Blam I, Kovalev S. 2006. Spontaneous commercialization, inequality and the contradictions of the mandatory medical insurance in transitional Russia. Journal of International Development 18: 407–423.
  • Culyer AJ (2005)  The Dictionary of Health Economics, Edward Elgar.
  • Danishevski K, Balabanova D, McKee M, Atkinson S. 2006. The fragmentary federation: experiences with the decentralized health system in Russia. Health Policy and Planning 21: 183–194.
  • Gordeev VS, Pavlova M, Groot W. 2011. Two decades of reforms. Appraisal of the financial reforms in the Russian public healthcare sector. Health Policy 102(2-3): 270-277.
  • Hussey P, Anderson GF. 2003. A comparison of single- and multi-payer health insurance systems and options for reform. Health Policy 66: 215-228.
  • Jacobs R, Goddard M. 2002. Trade-offs in social health insurance systems. International Jthenal of Social Economics 29(11): 861-875.
  • Lawson C, Nemec J, Sagat V. 2012. Health care reforms in the Slovak and Czech Republics 1989-2011: the same or different tracks? Ekonomie a management  1, 19-33.
  • Lawson C, Nemec J. 2003. The political economy of Slovak and Czech health policy: 1989-2000. International Political Science Review 24(2): 219-235.
  • Medved J, Nemec J, Vitek L. 2005. Social health insurance and its failures in the Czech Republic and Slovakia: the role of the state. Prague Economic Papers 1:64-81.
  • Praznovcova L, Suchopar J, Wertheimer AI. 2003. Drug policy in the Czech Republic. Jthenal of Pharmaceutical Finance, Economics and Policy 12(1): 55-75.
  • Preker AS, Jakab M, Schneider M. 2002. Health financing reforms in Central and Eastern Europe and the former Soviet Union, in Funding Health Care: Options for Europe, Mossalos E., Dixon A., Figueras J., Kutzin J. (Eds.), European Observatory on Health Care Systems Series: Open University Press, 2002.
  • Rokosova M, Hava P, Schreyogg J, Busse R. 2005. Health care systems in transition: Czech Republic. Copenhagen, WHO Regional Office for Europe on behalf of the European Observatory on Health Systems and Policies.
  • Sheiman I. 1991. Health care reform in the Russian Federation. Health Policy 19: 45–54.
  • Sheiman I. 2006. O tak nazyvaemoi konkurentnoi modeli obyazatelnogo meditsinskogo strahovaniya (On so-called competitive model of mandatory health insurance). Menedzher Zdravoohraneniya 1: 52-58.
  • Sheiman I. 1997. From Beveridge to Bismarck: Health Financing in the Russian Federation’. In Innovations in Health Care Financing, Schieber G. (ed.), Discussion Paper 365, 1997, Washington DC: The World Bank.
  • Sinuraya T. 2000. Decentralization of the health care system and territorial medical insurance coverage in Russia: friend or foe? European Jthenal of Health Law 7:15–27.
  • Sparling AS. 2008. Income, drug, and health: evidence from Russian elderly women. PhD dissertation. University North Carolina at Chapel Hill, UMI Dissertations Publishing.
  • Tompson W. 2007.  Healthcare reform in Russia: problems and perspectives. Working Papers 538, OECD Economics Department
  • Tragakes E, Lessof S. 2003.Russian Federation, Health Care Systems in Transition, The European Observatory, WHO, Europe.
  • Twigg J. 1999. Obligatory medical insurance in Russia: the participants’ perspective. Social Science and Medicine 49: 371–382.
  • Twigg, JL. 2001. Russian healthcare reform at the regional level: status and impact. Post-Soviet Geography and Economics 42: 202–219.
  • Zaborovskaya AS, Chernets VA, Shishkin SV. 2005. Organizatsiya upravleniya  i finansirovaniya zdravoohraneniyem v subjektah Rossijskoi Federatsii v 2004 godu (Organization of management and finance of healthcare in Russian regions in 2004)
  • Zweifel P, Breyer F. The economics of social health insurance. In The Elgar Companion to Health Economics, Jones A. (ed.), Edward Elgar, 2006.
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The European Commission against Gazprom: Should Gas Contracting Arrangement Be Changed?

Posted on June 4, 2013 | Policy Brief

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This policy brief discusses EC’s claim that Gazprom abuses its dominant position. I argue that parts of the claim, like denying Third Party Access, are warranted but others related to the contracts offered by Gazprom to different Member States need not be. In fact, major market players in Europe offer similar contracting forms. In this case, the literature on the competitive effect of long-term supply contracts have stressed that such effect depends on the exact contract arrangement. For example, offering multi-years contract may indeed increase the competition on one part of the market. Having a gas supply contract with a price fully linked to the price of a gas hub may on the other hand reduce the competition among big gas suppliers. Hence, the assessment of Gazprom’s abuse of dominant position should be based on a careful analysis of the many contracting forms that have been agreed between Gazprom and customers in the Member States.

On the 4th of September 2012, the European Commission (EC) opened a proceeding against Gazprom, investigating whether Gazprom has abused its dominant market position in Central and Eastern Europe’s gas supply (see http://europa.eu/rapid/press-release_IP-12-937_en.htm?locale=en). The allegation relies on two different points. First, Gazprom has been accused of denying access to its network pipeline when requested by competing gas supplier. Second, the contractual arrangement offered by Gazprom itself has been under scrutiny. A Gazprom contract usually includes a “destination clause”, that forbids any gas reselling by the buyer. Moreover, the typical Gazprom contract usually specifies a fixed quantity (with a take or pay clause) at a price indexed to the oil price (see Sartori, 2013 for a more extensive description of the EC’s proceeding.)

The objective of this policy brief is to discuss the EC’s claim of Gazprom’s abuse of dominant position. I argue that while the denial of Third Party Access appears as an obvious case of abuse of dominant position, the contractual arrangements offered by Gazprom need not be.

Characterization of Gazprom’s Abuse of Dominant Position

Denying access to Gazprom’s pipelines limits competition and thereby benefits Gazprom as controlling a pipeline constitutes a natural monopoly. This fact has been recognized for a long time with the requirement for a third party access to gas networks in the EU Gas Directive (Directive 2009/73/EC). The first part of the proceeding thus seems to be justified.

The EC proceeding also found that the contractual arrangements offered by Gazprom reflected an abuse of dominant position. The claim is that Gazprom locked in its customers. When signing a contract with Gazprom, buyers agreed on a fixed quantity irrespective of their “real” consumption (“take or pay” clause) and are not allowed to resale ex post excess quantity on the market (“destination clause”). Given that gas contracts usually are signed for many years, the lock-in period can be long. Moreover, the price of the gas contract is usually pegged to the oil price so that it reflects current supply and demand conditions for oil rather than for gas. One implication is that the contracted gas prices did not reflect the severe drop in the gas market price in 2008 (BP report, 2012).

The EC’s allegation that Gazprom has abused its dominant position is thus based not only on the fact that Gazprom is denying third party access to its pipelines but also on the long term contracts with a fixed quantity and an oil indexed price.

Next, I argue that the second part of the claim is questionable. Forcing Gazprom to propose contracts with flexible quantities, shorter contract lengths and no indexation to the oil price may not limit the abuse of Gazprom’s dominance. Depending on the exact contract arrangement (quantity, duration, and indexation), the abuse of dominant position could be more or less severe.

Contract Arrangement and Market Competition

It is important to stress that the major gas suppliers of Europe, like Sonatrach or Statoil, offer similar contract arrangements. So, are long-term supply contract arrangements pro or anticompetitive given that all major competitors use such contracts? The answer to this question typically depends on the contractual details. In what follows, I discuss briefly when contracts provided by major market players could alleviate the abuse of dominant position.

It has been shown that firms may have less incentive to exercise market power, if they have large contract positions (e.g. Allaz and Vila, 1993). Intuitively, a firm obtains a leadership position by selling contracts before going on the spot market. Motivated by this opportunity, all players participate in the contract market and as a consequence compete more aggressively overall. Offering long-term supply contracts may therefore enhance competition among gas suppliers.

The competitive effect of long-term supply contract may not always be present when suppliers and buyers repeatedly sign contracts. In a dynamic setup, it has been shown that allowing contracting for major players may reduce competition. Contracting could be used to reduce demand elasticity by increasing spot market exposure (e.g. Mahenc and Salanié, 2004). Contracting could also increase the likelihood and severity of collusion (Ferreira, 2003; Le Coq, 2004; Liski and Montero, 2006). The reason is that a collusive agreement is easier to sustain in a dynamic setup if firms offer contracts. A collusive strategy is sustainable provided that firms have no incentives to cheat, i.e. the repeated collusive profits exceed the immediate profit from the deviation and the price war following defection. The short run gains from cheating are reduced if all firms have signed contracts as the defecting firm will not capture the demand already covered by competitors’ contract sales. Compared to the case with no contracts, this reduces the gains from defection without changing the punishment path, and therefore makes collusion easier to sustain. In a dynamic setup, offering contracts may therefore increase the likelihood of collusion.

Green and Le Coq (2010) have shown, however, that the anti-competitive effect of contracts depends on their duration. The longer the contracts last, the more difficult it is to sustain collusion. Intuitively, a deviation from the collusive agreement will trigger punishments, which depend on the contract duration. The longer the contract lasts, the smaller would be the punishment profit, which would increase the incentive to deviate.

The contract price’s format also matters when estimating the anti-competitive effect of any contract arrangement. The stronger the degree of indexation to the spot price the easier it is to sustain collusion (Le Coq, 2013). In particular, if a contract price would be fully indexed on a gas spot (hub) price, irrespective of the contract’s duration, it is always easier to collude. The intuition underlying this result is two-fold.

First, given that the contracted quantities are not traded in the spot market, contracts reduce the size of the market that a deviator can serve when undercutting the rival’s price. Second, given that the contract’s price equals the spot price, the contract does not affect profit levels in the punishment phase. Consequently, profits in the punishment phase can be driven down to zero just as in the case when there is no contract market. Moreover, contracts with others forms of indexation have the same qualitative effects, provided that the indexation to the spot price is sufficiently strong. Interestingly, with full indexation, the anti-competitive effect of supply contract holds even if contracted quantities are flexible (can be renegotiated).

To conclude, changing the contract arrangement between Gazprom and European customers may not alleviate the abuse of Gazprom’s dominant position. A detailed analysis of the (many) contract arrangements offered by Gazprom needs to be conduct first to be able to make such claim.

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References

  • Allaz, B., Vila, J.-L., 1993. Cournot competition, forward markets and efficiency. Journal of Economic Theory 59 (1), 1–16.
  • BP Statistical Review of World Energy June 2012
  • Directive 2009/73/EC of the European Parliament and of the Council concerning common rules for the internal market in natural gas and repealing Directive 2003/55/EC, OJ L 211.
  • Ferreira, J.L., 2003. Strategic interaction between futures and spot markets. Journal of Economic Theory 108 (1), 141–151.
  • Liski, M., Montero, J.-P., 2006. Forward trading and collusion in oligopoly. Journal of Economic Theory 131 (1), 212–230.
  • Le Coq, C., 2004. Long-term supply contracts and collusion in the electricity market. Stockholm, SSE/EFI Working Paper Series in Economics and Finance 552.
  • Le Coq, C., 2013 Supply Contracts and Competition on the Spot: How indexation and duration matter? Mimeo.
  • Le Coq, C., R. Green, 2010 The Length of Contracts and Collusion International Journal of Industrial Organization 28(1), 21-29, 2010.
  • Mahenc, P., Salanié, F., 2004. Softening competition through forward trading. Journal of Economic Theory 116 (2), 282–293.
  • Sartori N., 2013. The European Commission vs. Gazprom: An Issue of Fair Competition or a Foreign Policy Quarrel? IAI working paper 13103