Global Policy Forum

by Ajit Singh & Rahul Dhumale

One of the most important reasons why some kind of competition policy for developing countries has become imperative is the gigantic merger wave which has gripped the world economy in the 1990s. As the chart below shows, between 1990 and 1998 the value of worldwide mergers and acquisitions rose nearly fivefold. Most of this merger activity took place within the US. Data reported in the Financial Times (FT, October 25, 1999) and not reproduced here suggests that of the total worldwide merger activity of nearly $2.5 trillion, almost $1.6 trillion represented takeovers and mergers within the United States; much of the remaining activity occurred in other industrial countries.

A significant characteristic of the present merger wave is the large incidence of cross border takeovers and mergers. This type of merger activity has become progressively important with the increasing integration of the world financial markets over the last two decades.¹ However, most of the cross border amalgamations also take place among the industrial countries themselves. Nevertheless, during this decade, a considerable proportion of foreign direct investment (FDI) by industrial country firms in developing countries has taken the form of acquisition of existing enterprises rather than green field investment. UNCTAD (1999) data suggests that if China (which among developing countries has not only been the largest recipient of FDI, but most of this investment has also been green field) is excluded, the share of mergers and acquisitions in the accumulated FDI rises from 22 per cent during 1988 to 1991 to an average of 72 per cent in the time span 1992 to 1997.

Periodic waves of mergers have been an integral part of the capitalist development since its inception.² Mergers and acquisitions represent an important mechanism for reorganization and restructuring of a market economy.³ Many of the leading corporations in the world today are the products of mergers affected in previous merger waves. Economic theory suggests that mergers can have both positive and negative effects on welfare. At the simplest level, the former may take the form of synergy among the amalgamating firms, and/or economies of scale which improve efficiency and reduce costs of production; the latter may arise from increased monopoly power of the merged firms which may be welfare reducing.⁴

Both in the US and UK one of the most important and the largest merger movements occurred a hundred years ago, during the 1890s. Although rigorous empirical work has not yet been done on the subject, back-of-the-envelope calculations suggest that the merger boom of the 1990s, taking into account the effects of factors such as the growth in the size of the economy and the rate of inflation may be the biggest ever recorded notably in the US.⁵ This wave has already resulted in increased concentration in a wide range of industries including aerospace, defence equipment, power equipment, home machinery, automobile and automobile components, pharmaceuticals, soft drinks, snack foods, chemical fertilizers, retailing, accountancy and financial services (Nolan,1998).⁶

The merger boom of the 1990s is of course not entirely an exogenous or autonomous event. As indicated earlier, it is in part caused by liberalization and globalization, closer integration of world markets through finance and trade, and the creation of the European single market, among other factors. Firms are jockeying for strategic advantages in the new environment through mergers, acquisitions, and other kinds of tie-ups.⁷ However, once some large takeovers have occurred in a particular industry, this creates an oligopolistic disequilibrium in the sense that the market shares of leading firms are disturbed. As a consequence, other giants are obliged to follow in order to maintain their share in the world market. In this sense, evidence suggests many mergers in the present wave are defensive, but that does not stop their overall effect in a number of cases from being welfare-reducing due to potential reduction in competition as outlined above.

2.1 Competition policy implications for developing countries

Whether the mergers take place in the US or Europe or through cross border takeovers in developing countries themselves, there are serious competition policy concerns for developing countries. If the largest producers in, say, the US automobile industry merge, this may not only lead to anti-competitive behaviour in the US but also similar or worse behaviour in developing countries (e.g. cartelization of markets, increased barriers to entry). The US has long had a competition policy which provides it with a defence against such welfare-reducing consequences of mergers.

In the famous example of the Boeing-McDonnell Douglas takeover case, although both companies were located in the US, the European Community objected to the merger on account of its potentially competition-reducing effects in Europe.⁸ The Community was able to extract important concessions from Boeing before the merger was approved. It is also now commonplace for jurisdictions in other industrial countries to scrutinize separately all large proposed mergers for their effects on competition even if they occur abroad.⁹

Leaving aside perhaps China, India, Brazil, and the small number of relatively advanced newly industrializing countries (NICs), the vast majority of developing countries will find it difficult to stop anti-competitive behaviour by the local subsidiaries of merging large corporations in industrial countries. These corporations may behave competitively within industrial countries because of the effective competition regulations of the latter but may indulge in anti-competitive practices in developing countries. A Ghana or a Tanzania is likely to find it difficult to prove, let alone punish, predation or collusive pricing by large industrial country corporations.

Recently, US anti-trust authorities imposed a fine of US$700 million on the leading European producers of vitamins for creating a cartel to charge high prices to consumers. If such cartels can operate in the US with all its regulatory machinery and its extra-territorial reach, the task of adequately policing such abuses is likely to be beyond the capacity of most developing countries' competition authorities. These considerations suggest that the huge current international merger movement, even though it is largely occurring in advanced countries, has potentially serious adverse implications for developing countries. Therefore, the latter not only need competition policies in their own countries but also international and South-South co-operation. They need to involve the international community in co-operative action against potentially anti-competitive practices of the mammoth corporations which are emerging in industrial countries as a consequence of the current merger wave.

2.2 Level playing fields

The analysis of the international merger wave also suggests another area of concern for the more advanced developing countries. This relates to the question of unequal competition between large multinational and big domestic corporations in these countries. Even the largest developing country corporations tend to be much smaller than the industrial country multinationals. The large merger wave of the 1990s is likely to make this disparity even bigger. By means of worldwide mergers and tie-ups, the advanced country corporations are able to integrate their international operations. This may be a source of genuine technical economies of scale, but evidence indicates that in most industries average cost curves are L-shaped, that is to say, after a threshold size which is relatively small and which most of these giant corporations would already have achieved even before mergers, costs do not fall as the size of the firm increases. The economies which nevertheless the multinationals are able to achieve through integration are those relating to bulk buying of inputs, reduced cost of capital due to large size as well as economies achieved in advertising and other marketing activities on a large scale. To the extent that these economies depend on the market power of the multinational in relation to inputs, the cost saving measures are not necessarily welfare enhancing; furthermore, these "pecuniary economies" create barriers to entry which make the markets less contestable.¹⁰

During the last 50 years, Japan, as well as many NICs in Asia and Latin America, have been able to foster the development of big businesses to the advantage of these countries' overall economic development. This has usually been achieved through various kinds of state support. These large domestic corporations, which are privately owned, have often been the leaders in the diffusion of new technologies and the adaptation of imported technologies to domestic circumstances.¹¹ However, in the current, new international economic environment these firms are likely to be handicapped in three significant ways:

1) through the limiting of state aid as part of WTO disciplines;

2) through the increased size and market power both in the
product and input markets of large multinationals;

3) through increased barriers to entry and contestability which the merger boom creates.

In these circumstances, it will be much more difficult than before for large developing country corporations to become even national let alone international players.

It is normal for multinationals to complain that there is not a level playing field between themselves and national corporations which are government supported; hence, the multinationals' demand for "national treatment". However, the actual situation is often quite the opposite: the playing fields are tilted in favour of multinationals who invariably have considerable market power. Liberalization and globalization, together with the international merger movement, are making these fields more unequal even from the perspective of large developing country corporations.

1 For comparison with previous merger waves, see the discussion in Singh, 1993; Hughes, 1992 and Hughes and Singh, 1980.

2 Evidence suggests that mergers are not randomly distributed over time but occur in waves. See, for example, Golbe and White, 1988.

3 For the differences between mergers and acquisitions (or takeovers) and their implications, see Singh, 1971.

4 It is important, however, to remember that not all mergers necessarily lead to increased monopoly power; even when they do, they are not always welfare reducing. Some of these points will be elaborated in the following sections. (See further Scherer and Ross, 1992; Singh, 1992a, 1992b).

5 For an analysis of the relative magnitude of previous merger waves, see Golbe and White, 1988; Singh, 1993; Hughes and Singh, 1980.

6 The above discussion has been concerned only with mergers, but other kinds of tie-ups and co-operative arrangements between firms can have similar anti-competitive effects. Often a case-by-case investigation is needed to determine the size of such effects. However, the observations in footnote 8 remain relevant.

7 Co-operation between firms can take various form with mergers and acquisitions representing one end of the spectrum in which two or more firms are amalgamated together into a single legal entity. Other kinds of inter-firm co-operation may involve joint ventures, technology sharing agreements, and outright cartels. Some forms of co-operation may be benign, e.g., technology sharing, while others (e.g. cartels) are not, and may reduce social welfare more than full scale mergers between firms.

8 See further Khemani, 1998; WTO, 1997.

9 See further Jenny, 1999 and Fox, 1999.

10 For a comprehensive discussion of the economies of scale and of scope, and of multiplant economies of scale, see Scherer and Ross, 1990.

11 See further Amsden, 1989 and Singh, 1995a.

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