Innovation and EU competition law - a trade-off? The next generation Broadband Network in Germany from a legal and economic perspective

Table of Contents

Introduction

Methodology

Structure

1. A theoretic view on Competition and Innovation
1.1 Competition in classical economics
1.2 Ordoliberalism
1.3 The Harvard approach
1.4 Schumpeter and dynamic innovation

2. Implications on Competition law in the European Union

3. EU competition law in the telecommunication sector

4. Facts of the case: Deutsche Telekom and its VDSL network

5. Legal and economic analysis
5.1 New and emerging markets
5.2 Regulation and Innovation

6. EU competition law and innovation: Empirical evidence

7. Conclusion

Annex

Reference List

List of Abbreviations

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Introduction

Broadband development is considered to be central to economic growth in a knowledge-based economy. In Germany, the market leader (Deutsche Telekom) on the telecommunication market recently installed a “next generation” high-speed network (so called VDSL), which is able to transfer phone calls, internet and TV through only one pair of wire to the consumer. The company invested more than 3 Billion Euro. Due to these enormous costs, it claimed to be allowed to refuse competitors access to its new network. If those competitors would be allowed to use the new network, Telekom threatened to stop all investments into this technology, as it would not be profitable. The German Government followed the claim by adopting a new law in December 2006, which was often said to be a “lex Telekom” and guarantees “regulatory holidays” for the new network. The European Commission argues that the protection of a new technology against competitors is against EU competition law and opened a procedure against the German government on the same day.

The question is, whether the strict EU competition law in this case prevents innovation. Starting with the liberalization of the telecommunication market in 1988, the policies of the European Union can be called a “success story”. From state-run monopolies and imperfect competitive conditions with high barriers for new firms to enter the market, the situation has changed dramatically until today: A number of new companies entered the market, prices decreased significantly, and the traditional state-run monopolies lost market shares. Where those monopoly-like situations remain, the EU aims to prevent operators from abusing market power to harm consumers or impede competitors. At the same time, the EU wants to facilitate widespread deployment of new and innovative technologies. Under the heading “i2010”, the digital economy component of the renewed Lisbon strategy, the greater use of telecommunication technologies is said to boost productivity throughout Europe, and generate new services and create jobs. To realize the conditions for a flourishing e-communications environment, the EU has established a detailed regulatory policy. The so-called “Article 7 procedure” allows national Regulatory Authorities to put obligations on companies with significant market power, whenever a persistent market failure occurs.

With this policy, it has often been criticised that the EU focuses too much on its political objective of establishing the internal market, and at the same time disregards economic needs. Different economic schools of thought have different opinions about the extend to which a state should intervene in the market, and whether monopolies are a driving force of competition or impede it. Imprecise formulation in EU law as well as missing definitions make the situation even more complicate. Therefore, the chosen case of German Telekom is a case that needs a fine-tuned balancing of reasons: Economic matters count as much as legal matters, the needs of competitors as much as the needs of Telekom to get back the money for its investments, the aim for affordable innovation as much as the EU’s aim for an internal market.

Methodology

The methodology used to answer the research question will consist of desk research. With regard to the topic, I will concentrate on a number of types of literature and use them for a content analysis: Primary Data in the form of legal acts, green and white papers as provided by the European Union. Between the political and the scientific area we find the big section of “grey literature”, as published by the Directory-General for Research of the European Parliament et al. Besides I will use secondary data from political and economic scientists who have specialized in the telecommunications sector. The topic implicates the use of statistical data, which will be used to clarify the current situation as well as the consequences of the analysed concepts.

Structure

To answer the research question, the paper is divided into five chapters. The first chapter deals with the theoretic perspective on competition and innovation. Different schools of thought are presented in order to answer the question, how economic theory explains the relationship between competition, the role of the state, and innovation. The second chapter has its focus on how this theory has influenced competition law in the European Union. In the third chapter I will in short present the structure of the EU telecommunication law, and give an overview on the most relevant concepts and legal texts. The fourth chapter gives a summary about the case, which will be analyzed in chapter five. Chapter six provides some empirical evidence for the positive relationship between regulatory activity and innovation. The main results are summarized in the conclusion.

1. A theoretic view on Competition and Innovation

The aim of this Chapter is to clarify what different economic approaches tell us about competition law, especially the role of monopolists and the relation between competition and innovation. It is interesting to have a look on this rather theoretic issue, because different economic theories come to quite different conclusions about economic policies.

1.1 Competition in classical economics

The roots of the classical concept of competition can be found in Adam Smith’s book “The Wealth of Nations”. Smith explains competition as a power which forces prices to a level just covering costs. The main characteristic is the mechanism of the “invisible hand”: Market prices emerge in reaction to consumers’ demands. Because the invisible hand can not operate in a monopoly situation, Smith is suspicious about any kind of cartels or monopolies. “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public or in some contrivance to raise prices.”^[1] In contrast to neo-classical approaches, Smith saw competition as a price-determining force, and not as a market structure.

Classical economics are against government interference in the market, since they believe that the competitive process leads to efficient results. Limited regulation is allowed to ensure that markets can operate freely, and that competitors can enter the market without hindrance. Smith was in favour of a legal framework that prevents abuse by dominant firms.^[2]

1.2 Ordoliberalism

In the 1930s, German researchers were looking for a third way between capitalism and socialism. The practical result is known as social market economy, the theoretic approach behind it is called Ordoliberalism or Freiburg School, since most of the research was done by Walter Eucken at the University of Freiburg. It is a neo-liberal School of thought that recognizes the legal system as a tool to attain economic goals: Law should consist of general, broad rules and not be interventionist. The focus was put on anti-monopoly measures and the free access to the market for competitors. The existence of monopolies is completely inconsistent with Ordoliberalism, instead it asks for “complete competition”.^[3] In any cases where this “complete competition” does not exist, firms should be forced to behave as if competition existed. The enforcement should be guaranteed by independent competition authorities.

1.3 The Harvard approach

In the 1970s, the Harvard approach dominated scientific literature about competition. The Great Depression had raised doubts about free markets, and the practice of antitrust policy in North America had shown that “perfect competition” was more a theoretic concept than reality. In the Harvard approach, the term “workable competition” replaced the former one: The core idea is that imperfections like product heterogeneities, imperfect market transparency, geographical distortions, etc. can be tolerated and even improve competition.

The theoretic assumptions about markets are known as the “structure-conduct-performance paradigm”. This paradigm says that market performance in certain industries depends on the conduct of sellers and buyers. Their conduct is determined by the structure of the relevant market, which again depends on basic conditions such as supply side (labour force, resources, technology) and the demand side (price elasticity, growth, and purchase method).^[4] The policy conclusion of the Harvard approach is mainly the replacement of perfect competition by workable competition. Any kind of antitrust law should work towards this concept. Compared with the previous approaches, government intervention is far-reaching and competition authorities are enjoying large discretionary.

1.4 Schumpeter and dynamic innovation

The prominent economist Schumpeter was the first who linked market structure and the rate of innovation. He recognized competition as a dynamic process of “creative destruction”. Companies invent new products and production methods and establish new markets. This activity gives them temporarily a monopoly position on the market and inspires other companies to copy them. As a consequence, previous products are replaced. In this case, competition is a promoter of economic progress.^[5]

For Schumpeter, a monopoly does not mean something bad as suchs, but it is seen as a necessary factor to promote competition. It is also regarded as being necessary for companies “in order to finance research and development (R&D) costs. Under perfect competition firms will not dare to undertake expensive research because of the associated costs and risks. Large expenditures on R&D without any results to show for can be enough to eliminate a firm from a competitive market.”^[6] In other words: A highly fragmented market may be efficient with regard to allocation, but with regards to innovation it is highly inhospitable. Although this topic is still discussed in economics, Schumpeter concludes that in innovation markets a higher market share should be allowed.

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^[1] Smith, Adam: An Enquiry into the Nature and Causes of the Wealth of Nations. 1776, p. 127/128

^[2] van den Bergh, Roger and Camesasca, Peter: European Competition Law and Economics: A Comparative Perspective. P. 59-61

^[3] Vanberg, Viktor: The Freiburg School: Walter Eucken and Ordoliberalism. Freiburg 2004. P. 13

^[4] Budzinski, Oliver: Pluralism of Competition Policy Paradigms and the Call for Regulatory Diversity. New York 2003, p. 5

^[5] Aghion, Philippe and Howitt, Peter: A model of growth through creative destruction. In: Econometrica, Vol. 60, No. 2. 1992. p. 323-351

^[6] van den Bergh, Roger and Camesasca, Peter: European Competition Law and Economics: A Comparative Perspective. P. 86