Report of the Advisory Panel on Efficiencies:- Chapter 1 - The Advisory Panel on Efficiencies

In September 2004, the Competition Bureau launched national consultations on the role of efficiencies under the Competition Act. The consultations involved three elements. First, the Bureau issued a consultation paper entitled The Treatment of Efficiencies in the Competition Act (Canada 2004a). Stakeholders were invited to submit their views on this paper in writing and during round-table sessions in Vancouver, Toronto and Montréal. Second, in October 2004, the Bureau held an international round table with participants from the competition law enforcement authorities of several jurisdictions. Finally, in January 2005, the Bureau appointed the Advisory Panel on Efficiencies to provide an expert opinion on various economic and public policy issues surrounding the treatment of efficiencies in merger review and to prepare an independent report.

The Panel’s mandate was as follows.

• The mandate of the Advisory Panel on Efficiencies is to assess the role that efficiencies should play in the administration and enforcement of the Competition Act (Act) in the context of Canada’s evolving economy. In doing this assessment, it will consider the general economic and business implications of the current treatment of efficiencies under the Act, and comment on the characteristics that the Canadian competition policy framework should have, in order to ensure that efficiencies are properly addressed. This mandate is focussed on the treatment of efficiencies under the merger provisions of the Act, but the Panel may wish to consider the applicability of their findings to the treatment of efficiencies in the context of strategic alliances and other trade practices.
   
• The Panel will provide a broad overview of the general economic and business context in which the efficiencies defence and other provisions of the Competition Act operate in Canada. In particular, the Panel should consider the arguments which link the need for Canada’s approach to efficiencies in merger review, to the nature of the Canadian economy. To this end, the Panel should consider how the Canadian economy and business environment have evolved since 1986. Factors that may be taken into account include the Canada-U.S. free trade agreement (1988); NAFTA (1994); broader trade liberalization within the WTO and through other trade arrangements; changes to the levels of foreign direct investment in Canada and to levels of outward investment from Canada; changes to relative levels of business concentration and business size both domestically and internationally; productivity levels; technology and innovation; the institutionalization and internationalization of corporate ownership and any other matters that the Panel may consider relevant.
   
• As the economy has evolved differently in different sectors, it may be necessary for the Panel to consider whether these differences are relevant for the consideration of efficiencies under the Act. In this context, the Panel will also consider the relevance of the different types of efficiencies in Canadian competition policy and, in particular, the relevance of dynamic efficiencies.

In carrying out its mandate the Panel will:

• Review the consultation paper.
• Review the report of the international roundtable held in October 2004.
• Review the written submissions provided as part of the consultation process.
• Review the report of the roundtable discussions held in Vancouver, Toronto and Montreal.
• Interview interested stakeholder groups and experts it deems appropriate.
• Review any other matters it considers salient to fulfil its mandate.

The Panel will provide the Commissioner of Competition with a written report in June 2005.

The Panel met throughout the winter and spring of 2005 and delivered its final report to the Commissioner of Competition in August 2005.

 

Background

The Competition Act became law in 1986, following almost two decades of academic and policy debate about competition law reform, including the issue of efficiencies. The Economic Council of Canada effectively launched this debate in 1969 with the release of a report that noted that small market size often resulted in Canadian firms being inadequately specialized and having short production runs that were too small to be efficient (Canada 1969). The Economic Council observed that foreign and domestic tariff protection contributed to this inefficiency, although it noted that other factors, such as transportation costs, and non-tariff barriers, such as patents and customs valuations, might have a more powerful impact on market size than tariffs in some sectors (Canada 1969, 74). The Economic Council therefore recommended that Canada adopt competition law and policy that promoted economic efficiency (Canada 1969, 19). Chapter 2 of this report discusses the Economic Council’s recommendations in detail.

In the years following the release of the Economic Council’s report, successive governments introduced several bills in Parliament to amend the competition law. The current efficiency defence became part of Canada’s competition law when Bill C-91 was enacted as the Competition Act in 1986. Under section 96 of the Act the Competition Tribunal may not make an order prohibiting a merger when the merger has brought about or is likely to bring about gains in efficiency. These gains must be those that “will be greater than, and will offset, the effects of any prevention or lessening of competition” resulting from a merger.

Since 1986, the Competition Tribunal has considered the efficiency defence in two cases, but has only allowed one anti-competitive merger to proceed based on the defence. This was the merger of Superior Propane and ICG Propane. In this case, the Tribunal found in its initial decision and again after an appeal that the merger would have several anti-competitive effects, but would also result in efficiency gains that were greater than and offset those effects. (See Chapter 2 for more information on this case.) As a result, the Tribunal rejected the Commissioner of Competition’s challenge to the merger on the basis that the efficiency defence applied.

Following the Superior Propane case, Bill C-249, a private member’s bill that would have repealed the efficiency defence in section 96, was introduced in the House of Commons. In its place, efficiency gains would have become one of a number of factors to be considered in the analysis of whether a merger substantially lessened or prevented competition. This approach is commonly used abroad, particularly in the United States and the European Union. Bill C-249 also proposed a “consumer benefit” requirement, in which the only efficiency gains to count would be those providing benefits to consumers, including competitive prices and increased product choice. The House of Commons passed Bill C-249, but it did not get through the Senate before the 2004 election.

Some opponents of Bill C-249 argued that it did not recognize the unique nature of the Canadian economy, referring to the smaller size, greater geographical diversity, and greater openness and world-trade orientation of the Canadian economy as compared to, for example, the American economy. These opponents argued that these characteristics amounted to reasons to retain section 96 as a uniquely Canadian approach to efficiency in merger review.

Some commentators made similar arguments during the Bureau’s recent consultations. By contrast, other participants argued that repealing section 96 and having efficiency gains become one item in a list of factors to assess would be more consistent with Canadian economic conditions than is the efficiency defence. This is because this approach would allow efficiency gains to be more routinely considered in merger cases. These participants emphasized that the Superior Propane case is the only case since 1986 in which the efficiency defence has been applied.

 

How the Panel addressed its mandate

The Panel addressed its mandate by breaking it down into three questions.

1. What was the Economic Council of Canada’s rationale for recommending in 1969 that efficiencies be given specific consideration as an “offsetting public benefit” (Canada 1969, 116) in merger review and how were these recommendations reflected in the 1986 Competition Act?
2. To what extent is specific consideration of efficiencies still warranted today, given the changes to the Canadian economy that have occurred since 1969 and good public policy practices?
3. If specific consideration of efficiencies is still warranted, what should be the characteristics of the treatment of efficiencies in the Competition Act?

The Panel’s mandate required it to assess the arguments linking the efficiency defence to the state of the Canadian economy, in particular changes to the Canadian economy since 1986. However, as discussed in Chapter 2, Canada’s efficiency defence was adopted based on the 1969 recommendations of the Economic Council of Canada. In 1986, Parliament neither revisited nor questioned these recommendations in light of economic changes that had occurred in the intervening 17 years. Accordingly, the Panel has focused its economic analysis on changes to the economy that have occurred since 1969.

When drafting this report, the Panel was mindful that its mandate only required it to comment on the general characteristics of the treatment of efficiencies in competition policy. The Panel examined these characteristics from an economic perspective, not from a legal or technical, drafting perspective.

The Panel’s report focuses on the treatment of efficiencies in the merger context. In Appendix A, the Panel has also provided comments on the treatment of efficiencies in competition law as it applies to strategic alliances, which, as with mergers, are a form of business combination. The Panel decided not to comment on other trade practices that may be reviewed under the Competition Act (e.g. abuse of dominant position, refusal to deal, tied selling and exclusive dealing), since each involves unique economic considerations and none are analogous or similar to mergers.

Finally, the Panel is aware that its report is just one facet of the broad consultations. As a result, Panel members tried to avoid duplicating the input of other stakeholders.

 

Key concepts

The Panel relied on the following definitions of key efficiency concepts.

Allocative efficiency is a measure of the degree to which resources available to the economy are allocated to their most valuable uses. Mergers that create market power may decrease allocative efficiency by providing incentives for firms to profitably increase prices by reducing output, thereby causing consumers to limit their consumption (Canada 2004a, 41). This impedes consumption of goods and services that generate more value through consumption than through the real resource cost of supply. The loss of allocative efficiency due to a merger that results in an anti-competitive price increase is known as the deadweight loss (Canada 2004b, paras. 8.22–8.23).

Productive efficiency refers to the optimal use of resources, such as labour and capital, for the production of goods and services. In particular, productive efficiency is a measure of how much output is produced relative to factor inputs, such as labour, capital (plant and equipment) and technology. An increase in productive efficiency implies that more output can be produced with the same inputs. Productive efficiency is maximized when a given level of output is produced at the minimum real resource cost (Canada 2004a, 41).

Dynamic efficiency is defined in the anti-trust literature as “the effect of a merger on the introduction of new products, the development of more efficient productive processes, and the improvement of product quality and service. In particular, dynamic efficiency refers to the efficiency of the framework for decision making over time. … Gains in dynamic efficiency may affect other categories of efficiencies,” namely allocative and productive efficiencies (Canada 2004a, 44).

Productivity is a measure of how efficiently the economy’s resources are transformed into the production of goods and services. It measures how much output is produced relative to the factor inputs, namely labour, capital (plant and equipment) and technology. An increase in productivity implies that more output can be produced with the same inputs.

A related concept is x-efficiency, a term coined by American economist Harvey Liebenstein to characterize the organizational efficiency of firms (Liebenstein 1966). The converse concept, “x-inefficiency,” typically refers to the difference between the maximum (or theoretical) productive efficiency achievable by a firm and the actual productive efficiency attained (Canada 2004b, n. 113). The more a firm is insulated from competitive pressures, the more “fat” it may have in its organization and thus the greater its x-inefficiency.

Static efficiency comprises both allocative (demand-side) efficiency and productive (supply-side) efficiency.

 

About this report

The next four chapters explore these concepts, and others, as follows:

• Chapter 2 examines the historical rationale for the efficiency defence and the current treatment of efficiencies in merger review under the Competition Act.
• Chapter 3 looks at how the Canadian economy has changed in the last 35 years and the effect these changes have had on productivity, and examines whether the economic factors that motivated the creation of the efficiency defence still hold. 
• Chapter 4 explores the link between competition and innovation.
• Chapter 5 reviews the treatment of efficiencies in merger review in other jurisdictions.

The report concludes with a series of recommendations about the characteristics of a reformed efficiencies regime (Chapter 6).