It is well established that effective competition is a key mechanism for improving outcomes for consumers. There is a concern that regulation can have the effect of stifling competition, and thereby deprive customers of these benefits, for example through raising barriers to entry. At the same time, different forms of regulation have an important role to play in supporting competition, for example by providing the legal and economic frameworks within which competition takes place. It is therefore important to take into account the benefits as well as the costs when considering the impact of regulation.
The purpose of this report, available here, is to summarise existing evidence about the impact of regulation on competition, both in terms of the academic research and the way in which regulation is designed and implemented in practice. It does so as follows:
Section 2 introduces the topic.
Competition and regulation are sometimes portrayed as mutually exclusive; for instance, either you have competition policy to promote competition or you have regulatory policy to replicate the operation of competitive markets. Instead, competition and regulatory policy are more often than not complementary and there can be significant benefits from an approach which combines both. The real issue in terms of the interplay of regulation and competition is one of balance: how to design and implement regulation that complements / supports competition and does not adversely affect incentives on firms to compete both in the short and long run.
The complexity of the relationship between regulation and competition is not a particularly new or revolutionary idea. However, the on-going debate about the interaction of competition and regulation is particularly relevant now for a number of reasons, such as the effects of digitalisation, the need to take into account growing rates of innovation, the recognition that competition not always works well for vulnerable consumers, and the development of new approaches to regulation.
Section 3 provides an overview of the impact of regulation on competition.
Regulation is important to the functioning of competitive markets. As well as promoting competition and economic growth, governments can intervene in markets for a range of economic and other public policy reasons: e.g. addressing market failures due to externalities and the existence of public goods; protecting consumers and the environment; safeguarding the health and safety of workers, etc. Regulation can affect the competitive process (i.e. how firms compete with one another) and / or market outcomes (e.g.by imposing limits on the prices that can be charged to consumers).
The four main ways in which a regulatory measure might be expected to have an impact on competition are through: (a) Limiting the number or range of firms in a market; (b) Restricting the ability of firms to compete; (c) Reducing the incentives on firms to compete; (d) Limiting the choices and information available to consumers.
Section 4 summarises research about the impact of regulation on competition.
The report reviews recent academic research into three specific areas: the interaction between regulation and competition; regulation and its impact on innovation through its impact on competition; and the development of effective regulation.
Regulation and competition – The literature reveals that the relationship between regulation and growth can be positive or negative depending on the type of regulation. Product market regulation is the area where the theoretical mechanisms and the empirical evidence are the most conclusive, and the key channel by which product market regulations affects growth is by creating barriers to entry and therefore affecting the level of competition in markets. Countries with lower levels of product market regulation – which in turn enables stronger competition – tend to have higher levels of productivity growth.
Barriers to entry are one of the most important inhibitors to competition and of well-functioning markets. The evidence indicates that regulation can have a major impact on competition both by creating absolute barriers to entry, and by imposing high administrative or compliance costs on new or potential entrants. The evidence also suggests that there is a case for policymakers pro-actively to identify and reduce / remove regulatory barriers to entry where possible.
Regulation and innovation – Regulation can either be detrimental to innovation or be used to incentivise innovation in a given sector. The Report discusses three broad issues and the links between them: (a) The costs of complying with regulation: high compliance costs tend to reduce the incentives as well as the funds available for research and development; (b) The importance of the overall approach to innovation and ensuring that the regulatory approach is appropriate. There is a risk that seeking to extend existing regulation to disruptive entrants – particularly at the instigation of incumbent firms – can stifle that innovation; and, (c) There should be a proper evaluation of what the appropriate regulatory framework should be to deal with new technologies, rather than some automatic levelling up process of existing regulation.
Effective Regulation – The processes involved in the design of regulation can have a significant impact on competition and innovation. Three main factors can influence the development of effective regulation: (i) the information that is available to those developing regulation; (ii) the external factors that can influence regulation; and (iii) the costs to firms of engaging with the regulatory process.
Section 5 considers what practical guidance / advice is available to policymakers to help them assess the impact of regulation on competition
The Report describes the processes and guidance used by government departments, agencies and sector regulators in the UK to assess the impact of regulation – including the CMA’s own Competition Impact Assessment guidelines, HMT’s Green Book, the Better Regulation Framework Guidance, and the Regulatory Policy Committee Guidance. The Report also looks at a number of cases studies, e.g. the Financial Services Authority’s (‘the FSA’) Mortgage Market Review, Transport for London’s proposed changes to the licensing of private hire vehicles in London, or Ofgem’s 2010 Retail Market Review.
This analysis leads to a number of conclusions. In particular: (i) as part of the process of impact assessing new regulations (or changes to existing regulations), the extent to which there is a consideration of the impact on competition and innovation appears to vary; (ii) in a number of instances an explicit requirement to consider the impact on competition of regulatory proposals does not exist; (iii) even where the impact on competition is taken into account, there is a risk that it has a narrow focus on static competition effects (e.g. on the impact on price) and that other aspects of the competitive process are not properly assessed.
Section 6 considers alternative forms of regulation.
Although effective competition is a means for improving outcomes for consumers, there can be circumstances in which some form of regulation to promote competition may be necessary. However, regulation can pose particular challenges when it comes to fast-moving markets or markets in which there is disruption.
Principles-based regulation can help to promote more innovation-friendly regulation. The Report sets out three regulatory approaches which could enable regulation to be made more responsive and better able to adapt to new challenges compared to detailed rules or rigid prohibitions on types of behaviour. The three approaches are: (a) Codes of conduct; (b) More flexible approaches to regulation e.g. regulatory sandboxes; and, (c) Participative Regulation / Business Review letters. Regulatory reviews and sunset clauses can also be a means of promoting more innovation-friendly regulation.
Section 7 puts forward recommendations.
These recommendations are for strengthening the existing processes for assessing the impact of regulation on competition, and ensuring that regulation can support competition and innovation. The key principle behind them is that there should be an increased focus on competition and innovation as part of the process of developing, assessing and evaluating regulatory interventions. Importantly, this process should consider not just price effects but also consider other dimensions of competition, such as service quality and innovation.