An Introduction to Competition Policy in the Auto Industry

An Expert's View about Major Industries in Japan

Posted on: 3 Apr 2010

The automobile sector is one that never ceases to demand the attention of regulators and commentators alike because of its economic importance, strategic and systemic influence and its traditional status as a source of prestige and national pride. Thus a distinct competition policy had to be created for it over the years on both sides of the Atlantic. This piece begins by outlining the specificities of the motor industry before detailing two particular issues where competition decision-makers have had to bend rules for the car sector: namely regarding trade protections and distribution systems. The paper then concludes by looking to how previous experience could influence the approach of the authorities towards auto-makers in the current troubled economic times.

An Introduction to Competition Law and Policy in the Modern Automobile Industry Conor C Talbot European University Institute, Florence [Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] Introduction The automobile industry is one that never ceases to cause controversy and consternation within legal and political circles in Europe and beyond. A major employer, investor and stakeholder in several other related industries, its influence can be felt far beyond the traditional motor heartlands, so it is not surprising that it has proved to be one of the most effective lobby-groups that Brussels, Washington or many state capitals have ever witnessed. Of course, it has not all been plain sailing for the industry over the years and this resorting to political anti-chambers was often born out of financial necessity. As such, the treatment of the motor sector ? which as we shall see has shifted from downright deferential in the 1980s to somewhat sceptical nowadays ? could serve as a good indicator for how governments, and competition authorities in particular, should deal with highly integrated and systemically important industries which have fallen on tough times. In this piece, it is proposed to focus on two particular areas of policy where the motor industry has seen its own interests gradually succumb to those of the public good. Firstly, as regards international trade policy car producers were initially treated with something approaching reverence and granted far-reaching protections against more efficient competitors despite the obvious harm being caused to final consumers as a result. However, as global economies liberalised and the value of open markets became clearer the influence of the car lobby decreased dramatically, and with it the market shares of the traditional domestic champions in both Europe and the US. By charting the way in which the authorities firstly appeased and then out-reasoned the vested interests at play, some valuable lessons could be learned for decision-makers in the current difficult economic climate. Electronic copy available at: http://ssrn.com/abstract=1577869 [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] Similarly, the policy approach towards regulating distribution channels for new vehicles began with a significant amount of lee-way being granted to manufacturers/dealers, but as the second section will illustrate, this trend has now shifted towards an effects-based analysis maximising the benefits received by consumers while still taking into account the specificities of the industry. Having studied how authorities on both sides of the Atlantic have dealt with the motor industry in an historical context, this paper will conclude by examining how the current painful adjustments forced upon the industry by the global economic downturn could be broached by decision-makers torn between bottom-line efficiency and industrial stability and well-being. By way of introduction, however, a brief account of the specificities and unique characteristics of this flagship industry must be given before the legal measures adopted in its favour can be understood, and the changes forced upon it can be appreciated. For the purposes of this paper, the terms car, motor vehicle and auto are interchangeable and refer to passenger vehicles intended for civilian use. 1(a) Overview of Industry: Size and Significance in Context While on paper the size of the automobile industry relative to overall activity may appear small at first glance, the importance of its inter-linkages with other manufacturing industries, research and design initiatives and even the underlying national self-esteem must not be underestimated. Thus, as we shall see, the knock-on impact of a crisis in the industry can have considerable effects on a country?s (or even a region?s) political and economic situation. There is a dramatic variation in the size and importance of the industry between neighbouring countries, which adds an extra dynamic to regional dealings especially in Europe. For example, automobiles account for almost 4% of total output in the Czech Republic and Germany, while it is almost non-existent in several other EU count 1ries. Even these numbers, however, understate the size of the automobile-related workforce, as a higher number of people are employed in the automobile value chain e.g. both downstream, in services such as car financing, insurance and maintenance, and upstream, in steel and transport. According to industry sources, this entire supply chain directly or indirectly supports 13 million jobs, representing one third of all manufacturing jobs in the EU27.2 Similarly, in the United States total 1 (OECD, 2009a) 2 (IHS Global Insight, March 2009) Electronic copy available at: http://ssrn.com/abstract=1577869 [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] automobile-related employment, including both manufacturing and services, has been estimated at 3.3% of total US employment3. A further indicator of the significance of the role played by the car sector, albeit again gleaned from industry sources, is the estimated ?20bn invested annually in Research and Development by manufacturers. This large-scale investment is crucial for survival in such a face-paced industry, and it makes undoubted trickle-down contributions to advancements in areas such as electronics, informatics and energy efficient technology. This also ties in with the traditional status of car-makers as flag bearers for the industrial and technological prowess of a nation, and the contribution made by such companies to national pride and esteem is well-documented and not without political resonanc 4e. As we will study in greater detail below, this was one of the arguments behind the notion that a particular nation state ought to host (and, if necessary, nurture and promote) such an industry almost regardless of the absence of any comparative advantage. Although national policies can be used to create or develop certain comparative advantages, that the promotion of national automotive champions went further than this often was due to 5 an overblown, if understandable, sense of strategically importance. 1 (b) Overview of Industry: Structure and Specificities As alluded to above, the structure of the vehicle manufacturing business is highly complex as it sees players going beyond developing and building cars to engage in testing, marketing and distribution, maintenance, recycling and disposal. Interestingly, ancillary activities have now become a major source of profit for the large scale auto-makers who have lucrative side-operations in providing spare parts and credit to their dealer network, leasing operations and final 6 customers. In recent years these non- automotive divisions of a car-maker?s business have generated more profits than their core manufacturing operations and in some years appear to have been the only source of profits, thereby supporting the loss 3 (OECD, 2009b) 4 See e.g., Remarks of US President Obama, 30 March 2009:?We cannot, and must not, and we will not let our auto industry simply vanish. This industry is like no other -- it's an emblem of the American spirit; a once and future symbol of America?s success.? Available at: http://www.whitehouse.gov/the_press_office/Remarks-by-the-President-on-the-American-Automotive- Industry-3/30/09/. See further, (Koshar, 2004) 5 See (Geroski, 2005) 6 e.g. Ford Motor Credit financed 77% of their U.S. dealer inventories in 2008, according to their 2008 10-K Form, cited by US Treasury Secretary advisor Ron Bloom in his testimony to the Congressional Oversight Committee, available at: http://www.treas.gov/press/releases/tg563.htm [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] making automotive arm 7. The obvious difficulty here is that these in-house finance companies are also now encountering a squeeze on funds for new loans and leases due to ongoing financial crisis. As regards the competition between car-makers themselves, this has benefitted greatly from the partial adoption of common standards in many markets making it attractive for new entrants and at the same time deterring even marginal players from exiting. What has resulted is a highly competitive environment with relatively low degrees of market concentration. For vehicle manufactures, however, this has resulted in very tight operating margins which UBS8 calculates to have averaged below 3% over the last five years, and has perhaps encouraged the continued move towards ancillary activities in search of profits. The industry is capital intensive, with a relatively high capital-to-labour ratio9, and in many countries a large share of the production is exported, with EU car-makers being the leading industrial contributor to net external EU trade 10. It consists of a relatively small number of large mass-producing firms which are supported by a global network of specialised suppliers. To illustrate the systemic integration of the industry, one has to understand that up to three quarters of the value of a typical vehicle is contributed by suppliers; while a typical mass-volume European vehicle manufacturer trades with around 800 suppliers and has dealings worth about ?30bn per year with them 11. The resulting economic geography of the industry is complex, with automakers and part suppliers forming relationships on a globa 12l scale. As local consumer preferences require car-makers to alter the design of their vehicles to suit the needs of specific markets, the emergence of a truly global single market is unlikely13. Nevertheless, the heavy engineering work of vehicle development is centralised in or near the design headquarters of leading firms. Due to manufacturers? desire to avoid costs and risk, suppliers have taken on a larger role in design, and in turn have established their own design centres close to those of their major customers to facilitate collaboration.14 In global terms the industry has grown continuously in recent decades due to ever increasing global demand ? largely from emerging markets ? with overall car production rising by a compound annual rate of growth of 2.44% from 1970 to 2007.15 At the same time, the minimum efficient scale of production has 7 It is often said in auto circles that GMAC ?invented financing?. See further (OECD, 2009a). 8 Cited in (IHS Global Insight, March 2009) 9 (OECD, 2009a) 10 (IHS Global Insight, March 2009) 11 Idem 12 (Sturgeon, Memedovic, Van Biesebroeck, & Gereffi, 2009) 13 (Humphrey, 2000) 14 (Sturgeon & Biesebroeck, 2009) 15 (KPMG, December 2008) [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] increased over time, spur 16ring mergers and acquisitions in order to gain economies of scale. Despite the apparent stable growth in demand, the industry has experienced some highly publicised marriages, break- ups and melt-downs over the past decade ? including disastrous mergers, de-mergers and bankruptcies. These difficulties have been exacerbated since the onset of the current crisis because the sector has started to face a number of structural challenges, including overcapacity and market saturation as a result of strong vehicle sales in the previous decade, fuelled especially by aggressive discounting in the United States. In fact, even in recent years there has been distinct shift towards de-concentration and the break-up of overly ambitious multi-brand groups. In particular the sector has witnessed unprecedented scale backs of the most overstretched car super-groups: General Motors (GM) lost Saturn, Saab and soon possibly Hummer while Ford cut Aston Martin, Jaguar and Land Rover loose. BMW had a similarly unsuccessful experience with MG Rover, eventually having to retreat and accept defeat with the ill-fated English br 17and. The complexity of the automotive industry with its multiplicity of brands, supplier relationships and distribution networks means that it is very difficult to attain the usual objectives of synergies and cost-savings from a merger. However, analysts see it as equally unlikely that smaller spin-off companies, such as Saturn or Saab, can survive as stand-alone businesses because they simply lack the required scale. Hence the future may be one of pragmatic alliances and cross-shareholdings that fall short of outright merger, perhaps along the lines of the airline industry. These also fall short of perfection in practice (although Renault-Nissan is an example of it working) and such a move would again raise the question of the role ? actual or potential ? for competition policy in the industry: does it have the tools and the independence to control the behaviour of a tight-knit and well connected oligopoly? The rest of this paper will focus on events in the recent past where competition authorities and governments in general have had to grapple with this mammoth industry and its considerable political lobby, in the aim of rendering it more open, efficient and competitive. It begins with a look at how the protectionist barriers built up around car-makers on both sides of the Atlantic have been dealt with, before looking to the approach taken towards similar problems regarding the regulation of distribution channels for new vehicles. Finally, the ongoing restructuring and incentive schemes undertaken recently by governments concerned about the survival of the industry will be examined in light of the lessons learned from previous experiences. 16 (European Monitoring Centre on Change, 2004) 17 (Wells P. , 2009b) [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] 2. Trade Protections for the Car Sectors in US and EU In the face of increasing globalisation and liberalisation of the automotive industry, the initial reaction of most car-makers in the western world was to seek shelter from their governments in any way they could. The preferred option in the 1980s and 1990s was to convince national legislatures to adopt protectionist measures curtailing foreign imports, ostensibly to allow domestic producers time to adapt their systems and methods to the more efficient competition from abroad. What resulted were often downright cynical exclusionary tactics, imposed upon foreign governments by importing administrations under immense pressure from the car lobby. Although they did indeed buy domestic producers time, their effectiveness in actually benefitting the domestic industry is more questionable than ever now in light of rapidly changing consumer needs. 2 (a) US Approach Firstly, looking to the US the attitude towards the automobile industry changed radically during in the late 1970s beginning with the federal loan guarantees extended to Chrysler following its threatened financial collaps 18e . The second oil-price crisis and a general recession led to a huge increase in imports of fuel efficient foreign imports around this time ? with Japanese imports into the US increasing by 500% between 1973 and 1980.19 This sparked a period of highly charged debates about fairness in automotive trading conditions and saw the beginning of an activist era of federal interventionism the likes of which had never been seen before. In the event, the administration?s hand was forced somewhat by a Bill proposed by a Missouri senator under severe pressure from Ford and the United Auto Workers (UAW) union.20 This led to a bizarre spell of political wrangling whereby the US government eventually pressured the Japanese authorities into using their foreign exchange rules to adopt an inappropriately named Voluntary Export R 1estraint 2. To avoid antitrust problems potentially arising from a purely private manufacturers? action (not to mention the difficulty of persuading understandably reluctant manufacturers), the Japanese government issued a mandatory order, on May 1, 1981, by which exports to the United States were limited to 1.68 million per annum. Further protectionist policies followed throughout the 1980s in the US, aiming primarily at 18 (Hyde, 2003) 19 (Cooney & Yacobucci, 2008) 20 97th Congress, Feb 5 1981, Senator Danworth. S 396, 97 Cong, 1st Sess, 127 Cong Rec S.1018 21 (De Kieffer, 1981-1982) [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] requiring foreign-owned companies to locally produce more of the vehicles sold there, as well as ones aimed at improving consumer awareness about imported vehicles and parts, such as the American Automobile Labelling 22 Act , to varying degrees of suc 23cess . Running parallel to these developments were internal changes in the North American motor industry which saw a growing reliance on ?just-in-time? inventory systems. This continues to see US, Canadian and Mexican maquiladora operators hold a natural advantage over products shipped long distances from China and other low-cost Asian exporting countries. On top of this, of course, both the central governments of Mexico and Canada, as well as provincial, state and local governments, continue to seek to attract or keep auto plants through incentive programs, as do U.S. states and localities. Overall, however, these protectionist measures seem to have had unintended effects which outweighed their temporary benefits to the industry. Although the Japanese companies did become large U.S. employers, the UAW was not able to unionise their plants as efficiently as they had with the 24 Big Three, so the foreign firms retained a considerable competitive advantage on that score. Ironically, while successfully manufacturing in the United States, the Japanese companies were also able to move their imports up-market, gaining large profits on vehicles, in part because of the scarcity value accruing from trade restriction 25s. Furthermore, the high rate of growth in global manufacturing capacity over the past number of decades has been due in part to companies from Japan investing hugely in so-called ?transplant? operations in the North American market as a substitute for importing. Together with growing automotive manufacturing capacity elsewhere, especially in Asia, this had the effect of creating a problem of overcapacity. In the long term the result could be more serious rationalisation and industry closures, especially in North America, as well as in Japan and Europe, the other two traditional major producing regions. Meanwhile, US manufacturers of pickup trucks still benefit from the 25% ?chicken tariff? on imported pickup trucks. This tariff was established in 1963 in response to European restrictions on U.S. frozen chicken parts, as a component of its Common Agricultural Policy (CAP). In retaliation, the United States established high tariffs on a number of products then imported mainly from Europe, including pickup trucks primarily produced by Volkswagen in Germany at the time. Although Japanese companies began assembling pick-ups in the US during the 1990s the chicken-tariff had already served its purpose: foreign brands accounted for two-thirds of the American car market, but only about a third of that for light trucks. 22 Section 355 of P.L. 102-388, 6 October 1992 23 (Kavalauskas & Kahane, December 2001) 24 The term commonly used to refer to GM, Ford and Chrysler (in all its various incarnations). 25 (Cooney & Yacobucci, 2008) [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] The downside of this is evident today with rising gas prices and a general move towards smaller more efficient cars; US automakers find themselves leaders of a doomed market. The US policy shifted again during the 1990s to focus more using WTO channels to open Japanese markets to imports of motor vehicles and parts from the United States, culminating in a US-Japanese bilateral agreement in 1996 while United States has brought or participated in trade barrier cases against such countries as Brazil, India, Indonesia, Korea and the Philippine 26s although overall these efforts appear to have had little effect on the reduction of the American trade deficit in the area. Again, we see how the US trade delegations are prepared to use any and all means open to them to rigorously defend and protect its domestic auto industry. This is undoubtedly prompted by the need for short term political results, and seems to be done almost regardless of the long-term effects on the industry ? not to mention consumers. 2. (b) European Approach In Europe, meanwhile, similar reasoning and arguments from sector representatives initially saw decision- makers bring policy down the same road, but the changing dynamic within the Community eventually saw industry interests outweighed and a different and in most respects better outcome reached. Initially, individual member states mirrored their transatlantic cousins and formally or informally limited the numbers of Japanese imports (over and above the levies already charged on imports from other European states) from 1975 onwards. West Germany, for instance, controlled imports pursuant to a gentlemen?s agreement the precise details of which are still not known, while the Italians availed of a reciprocal right to limit imports open to them under an arrangement imposed upon them by Japan at a time when the Japanese feared a deluge of imported cheap Italian 27cars . However, numerous EC governments did not impose limits at the time so with the Single European Act in 1986 and the removal of restrictions on the movement of goods, it became clear that a collective approach was required. After much bitter negotiating both internally and with the Japanese, the European Commission completed an extraordinary agreement with the Japanese Ministry of International Trade and Industry in July 1991 whereby quantitative limits were placed on Japanese motor vehicle exports to the Community as a whole and to specified member states until the year 2000. The influence of carmakers over the contents of these ?Elements of Consensus? was clearly felt when three (VW, Fiat and Renault) of the four major mass- 26 (Cooney & Yacobucci, 2008) 27 (Mason, 1994) [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] producers came together to form ACEA28 and effectively vetoed the original draft proposal as they deemed too generous to the Japanese. Following their protestations to their respective national governments, a tougher attitude was taken by the European negotiators. Although the manufacturers did not receive the length or scope of protection they demanded, severe restrictions were imposed on both imports and transplant operations ? even if the secretive and ad hoc nature of the agreement meant that they were vague, ambiguous and hotly contested when it came to interpretations.29 The issue has continued to cause tension at an institutional level in Brussels. Generally speaking, DG Internal Market has played the role of a proud parent-state and was in favour of the development of a strong EU motor industry capable of competing with the world?s best. DG Competition?s concern with consumer interests, on the other hand, meant they necessarily wanted to see competition increasing first, with market forces dictating any restructuring. At Member State level, meanwhile, the motor industry has been another one of those areas where dirigiste and free market policies have clashed. Some countries ? for instance, Italy and France ? have remained more ready than others to turn to protectionism. In the UK, for instance, where there is no longer a nationally owned motor industry, the vested interest lobby has been weakened while since the Thatcher era it has consistently sought to maximise inward investment in order to generate wealth, jobs and favourable effects on the balance of payments. The accession countries are of a similar opinion for similar reasons because, apart from the Czech Republic, there is no real feeling of car manufacturing being an indigenous industry. Thus, the long-term trend has undoubtedly been towards greater competition, industrial restructuring and free trade so even though DG Markt supported the EU-Japanese ?Accord? in 199130 the EU industry had improved its efficiency sufficiently that by 2001 there was reluctance even on its part to call for further covert protectionism. This overview of the development of this area of policy shows the primordial importance of the vested interest?s influence over national government decision-making ? highlighted by the fact that as long as Member States were prepared to sponsor their national car industry actors the protectionist measures remained in place. It also demonstrates, conversely, the pro-liberalisation bias of the Commission because once decision-making had been handed over to Brussels, the sector was progressively opened up. The car 28 Association des Constructeurs Européens d?Automobiles. The fourth mass-producer, Peugeot-Citroen, was initially excluded because its Chairman Jacques Calvet was unprepared to move from his particularly hard-line stance towards the Japanese. 29 (Mason, 1994) 30 (Rhys, 2004) [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] industry, once regarded as the centrepiece of national interest and industrial policy has been liberalised in the face of powerful lobbying from some of Europe?s biggest employers, and in the name of European consumers. 3. New Car Distribution in US and EU In an almost parallel fashion the systems through which car-makers have traditionally gotten their product to final consumers have come under very close scrutiny in the last decade on both sides of the Atlantic, but again the differing dynamics at play amongst the decision-making bodies have seen contrasting outcomes develop. The parties at the table, the stakes and the arguments being used are all similar here to in the above section. Governments have traditionally tried to protect their national producers from East Asian import competition and stuck closely to traditional political economy arguments against ?unfair? competition. The arguments forwarded by the car industry, however, for the maintenance of selective and exclusive distribution systems (SED) were based, ironically, on well-established efficiency arguments related to marketing externalities, better known as the free-rider problem. By way of background, the modern thinking in this area was greatly influenced by the Chicago School theories of antitrust. According to this school of thought, vertical restraints almost never restrict competition, unless one of the parties enjoys significant power in the relevant market. The US cou 31rts took the position that vertical non-price restraints should be invalidated only when they have demonstrable adverse effects on inter-brand competition, even if they tend to reduce intra-brand competition. The reasoning is that vertical restraints enable manufacturers to create efficiencies, thereby enhancing inter-brand competition for the benefit of consumers. The consumer's ability to substitute a different brand for the same product provides a significant check on the exploitation of intra-brand market power. Hence, vertical restraints become problematic only if the supplier or the retailer enjoys a 32 significant power on the overall relevant market. The first major achievement of the vested interests here was to convince the EU Commission that somehow the car distribution sector was different from other goods sectors and therefore required special treatment. When the motor distribution franchise system was first created, it could be argued that a system 31 e.g. Continental TV Inc. v GTE Sylvania Inc. (1977) 433 U.S. 36 32 (Gerrard, 2003) [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] of exclusive franchises was necessary to launch the industry. Given the antiquated transportation and communications network, local stocks of cars and local information dissemination were critical functions necessary to stimulate and meet demand in a timely manner. It was felt that the assets necessary to create a national distribution and service system for automobiles might not be forthcoming without reasonable assurances against cut throat competition. Even today, dealers maintain that they play an essential role in making the marketing of cars feasible on an individual level. It is undeniable that they deflect a certain degree of financial risk away from the manufacturers by putting their own capital at risk thereby freeing the manufacturer to spend its resources on research and development. Industry estimates in the US indicate that the average dealership has approximately $2.5 million invested in land, buildings, furniture, fixtures and equipment and will typically hold a 60?90 day supply of new cars. In total, U.S. franchised dealers are said to have more capital invested in their businesses than the world?s largest autom 3ak 3ers. 3. (a) History and Development of US System Two main policy goals underscored the initial development of the US approach, and they are indicative of the dilemma being faced by decision makers ever since. One was the perceived imbalance in bargaining power between the big car manufacturers and dealers, which were assumed to be relatively small. This shows the difficulty of finding a balance between competition and fairness, which arises often in debates between carmakers, distributors and policy-makers. The second was the notion that preservation of independent automobile dealers was an important benefit for consumers, because local dealers might have greater sensitivity to local preferences and provide better overall service. The US National Auto Dealer Association (?NADA?) has acknowledged with something closer to pride than regret that ?the auto dealership is one of the most regulated private businesses in the country 34.? This regulation began with a federal statute commonly known 5as the Auto Dealers? Day in Court A 3ct in 1956. This Act sought to protect dealerships from unfair exploitation and abuse by car-making super-groups by 33 (NADA, 2008) 34 NADA Public Affairs, Franchise Laws in the Age of the Internet, January 4, 2001: available at www.nada.org. 35 Federal Automobile Dealers' Franchise Act, 15 U.S.C. §1221 et seq [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] giving them a federal cause of action against any manufacturer for failure ?to act in good faith?36 in their franchise arrangement. By the 1970s however, networks of distributors were well established all around the country and these once small and vulnerable dealers had grown dramatically in size and influence. They then gradually sought to use their local clout to protect their market positions through the enactment of laws restricting entry into the automobile distribution market. Between 1969 and 1980, approximately 40 states enacted legislation to protect the exc 37lusive franchises that had lost their economic rationale. The voluntary franchise relationships were turned into mandatory restrictions imposed by state law which usually subject the granting of a license to establish a new dealership to the approval of a State Motor Vehicle Board, inevitably dominated by existing dealers. Such restrictions on entry harm consumers by enabling dealers secure higher margins, increasing consumers' search costs and preventing efficiencies from being passed on 38. Indeed, the costs of those restrictions for consumers have been estimated in the range of six to eight per cent 39 per car. It must be remembered that dealers are no longer lambs to the slaughter; in the US they are often large chains with access to legal expertise and are more than capable of negotiating fair economic terms. Manufacturers, in contrast, have actually experienced a sharp reduction in their market power, due to a sharp increase in the number of brands and models sold. It has been said that the only durable and effective restraints on competition are those imposed by government 40, and yet the US finds itself in the almost paradoxical position that government restraints on competition are antitrust immune under Parker v. Brown41 while the vigorous lobbying which brought about the situation here is protected under No 42err and its progeny. State legislatures are free to take into consideration noncompetition values and dealers cannot be criticised as they responded as any business would when endangered by economic change: they turned to politicians to protect their interests. What is most indicative of the continued strength of the car dealer lobby is the way in which the GM and Chrysler dealers were able to largely survive the culls mandated by the Obama Administration?s Auto Task Force. Even after the bankruptcy-imposed restructurings, both maintain franchise agreements with 36 15 U.S.C. § 1222 37 (Gerrard, 2003) 38 See e.g. E.W. Eckard, ?The Effect of State Automobile Dealer Entry Regulation on New Car Prices? [1985] 24 Econ. Inq. 226, 228 39 See (CFA, 2001), pp.21-22. 40 (Leary, 2001) 41 317 U.S. 341 (1943) 42 Eastern R.R. Presidents Conference v. Noerr Motor Freight Inc., 365 U.S. 127 (1961) [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] the substantial major 3ity of their dea 4lers. For example, the New Chrysler's network maintains 87% of the old Chrysler's dealers by volume while the New GM, for instance, will have more rural and small town dealers than Toyota, who sells almost as many cars, has total dealers in the whole country. 3. (b) (i) Evolution of the European Distribution System In a matter of around fifteen years, the EU car distribution sector has shifted from being one of the most protected havens of European industry to being faced with open competition. As we shall see, the relative changes in political sway and outlook of the leading car-producing member states was again a main dr 44iving force behind the evolution of policy in this controversial area. To take a familiar starting point here too, it was intense pressure from the car producers and distributors that inspired the EU Commission to adopt Regulation 123/8545 (hereafter 123/85) which granted complete SED rights to the industry. These highly concessionary measures were to be in place for ten years but importantly were subject to an eighteen month long review before their expiration. The key areas of concern at the time were the significant price differentials for the same vehicles that existed between member states, which of course was important in the context of the newly established Single Market. A first criticism of choosing such an elaborate way to oversee distribution systems is that, in practice and in principle, adopting a formal regulation has the effect of narrowing the choices available to large manufacturers as their freedom to contract is restrained within the four walls of the text 46. However the Commission always seemed alive to this fact and attempted to perform a balancing act between such restrictions and the likely gains for consumers of a stable distribution network. Added to this was the widely held belief that, as a general rule, manufacturers tend to lack the entrepreneurial skills and local market knowledge needed to run showrooms profitably. The Commission decided to largely retain the key SED measures following the regular review, but Regulation 1475/9547 (hereafter 1475/95) did see slight movements towards the liberalisation of the sector as it conferred more freedom to car distributors to sell more than one brand of car. In light of the context of the rapidly integrating Common Market, the EU Commission again set out that it would closely 43 See testimony of Ron Bloom before the House Judiciary Commercial and Administrative Law Subcommittee, July 21 2009, available at http://www.treas.gov/press/releases/tg222.htm 44 (Akbar, 2003) 45 Regulation (EEC) No 123/85 of 12 December 1984, OJ 1985 , L 15 , p. 16 46 (Gerrard, 2003) 47 Commission Regulation (EC) No 1475/95 of 28 June 1995, OJ L 145, p. 25-34 [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] monitor the relationship between the SED and price differentials in cars between member states ? which it viewed as anathema to the European project and was determined to eradicate. Also inserted in the list of ?black clauses? was a ban on attempts to frustrate consumers in the EU from making cross-border purchases while the ECJ gradually became active in prosecuting car manufacturers for anti-competitive pr 8actices, such as impeding parallel impor 4ts. Despite the car industry?s attempts to exempt the area from competition rules indefinitely, the BER was renewed for only seven years, by which time the competition landscape would have changed drastically. As it was, the public and stakeholder consultation process on Regulation 1400/200249 (hereafter 1400/2002), designed to replace 1475/95, began more than two years before the latter expired which in hindsight was perhaps the death knell for the practice of pure SED in Europe. Some of the key changes in dynamic which caused the motor industry?s grip on their trade protections to loosen were also brought to bear on the distribution systems. Firstly, the new Competition Commissioner Mario Monti had previously been Commissioner for the Internal Market and had spent a significant amount of time during his tenure attempting to enforce single market liberalisation ? experience which probably informed his stance on the value of renewing 1475/95. Secondly, the EU-Japan ?Elements of Consensus? accord had expired leading to increasing pressure for intra-EU liberalisation in light of the increased presence of non-EU manufacturers present on the market. Added to this were the changes in the ownership structures of major manufacturers added to the meant that national political support for ?national champions? by the member states was weakened. These changes in national government sympathies, especially the UK and German government positions, caused by the takeover of Rover by BMW and the merger between Daimler and Chrysler respectively, were very important in the development of Regulation1400/2002 (hereafter 1400/2002) 50. In 1400/2002, a number of symbolic changes were made which illustrated that the motor lobby was no longer in complete control of its own legal framework. For instance, distributors were granted the legal right to sell more than one brand of car on the same premises and crucially restrictions on the location of distribution outlets that granted territorial monopolies to distributors were prohibited. On the servicing of cars, further liberalisation included allowing distributors to sub-contract servicing of vehicles to independent repairers as long as they meet criteria set by the manufacturer. This can be seen as the beginning of the end of long-standing practices of the industry and represented a remarkable change and 48 (Akbar, 2003) 49 Commission Regulation 1400/2002 of 31 July 2002 OJ L 203, 01.08.2002, pages 30-41 50 Idem [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] power shift in the industry away from national producers and member states towards consumers and the EU Commission. In general, most of the key modifications provided by the 1400/2002 aimed at improving the functioning of the internal market through the promotion of intra-brand competition, so as to enable consumers to finally derive their fair share of benefits from the system. The renewed BER was nonetheless criticised for its intrusive and potentially rigid character that deprived manufacturers of the necessary freedom needed to organise efficiently their distribution networks. Under the 2002 BER, manufacturers had a flexible choice between a system of territorial exclusivity or of selective distribution, subject to market share thresholds. In a selective distribution system, products can be bought and resold only by officially appointed distributors, who are granted protections in return for their investment in furthering the producer?s brand. The choice of a qualitative selective distribution is very much favoured, however, since it is the most likely to further market integration and to promote intra-brand competition, while the option to implement a quantitative selective distribution scheme is limited by provisions such as those allowing dealers the freedom to establish sales outlets in any location and to assign their rights to another distributor, thereby undermining thereby the very concept of quantitative selective distribution. The overall objective of the MVBE was to reinforce dealers' independence vis-à-vis manufacturers, and it also saw the ending of the practice of manufacturers imposing a mandatory requirement on distributors to carry out repair and maintenance work too. As manufacturers can no longer tie both businesses, distributors are free to refer their customers for servicing, honouring of warranties or recall work to authorised repairers thereby allowing them focus on the sales side if they wish. 3. (b)(ii) Review of 1400/2002 In light of the expiry of 1400/2002 in May 2010, the Commission began its as-yet-ongoing review procedure in May 2008 with a refreshingly frank appraisal of the Regul 51ation?s worth in practice. The Commission recognised that some aspects of it may have helped to protect competition in the markets for new motor vehicle distribution, and especially in the markets for after-sales services, to the benefit of consumers. However, it also noted that parts of it may have actually run counter the Commission's 51 Commission Evaluation Report on the operation of Regulation (EC) N° 1400/2002 concerning motor vehicle distribution and servicing, available at http://ec.europa.eu/competition/sectors/motor_vehicles/block_exemption.html [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] general policy objective of promoting innovative distribution models and lowering entry barriers to authorised networks. Thus, although the 2002 BER had aimed to remove the straitjacket effects of sector- specific legislation but, conversely, it appeared that several provisions of the BER risk constraining contracting parties in a way that may not be indispensable to protect effective competition.52 By using an objective effects-based approach, free from industry bias but still responsive to and cognisant of its needs, the Commission evaluated whether or not a sector specific BER was actually required to achieve the most appropriate outcomes. Overall the sales market was adjudged to be reasonably healthy with a decline in real prices, successful new entries, relatively few exits, decreasing concentration and increased consumer choice taken as signs of a generally dynamic competitive environment 53. Indeed, the vigorous inter-brand competition resulting from these successful new market entries was deemed to be such that the risk of parallel single-brand networks creating entry barriers is actually far lower than that foreseen by the Commission in 2000. This finding of the BER being a regulatory step too far is a recurring theme through-out the Commission?s appraisal, and is found again as regards the multi-franchising provisions. Here, by causing manufacturers to fear a dilution of their brand images the BER may have prompted them to set even higher selection standards ? which may in turn have required further brand-specific investments from dea 4lers and resulted in higher overall cos 5ts. Again the Commission reiterates that creating dynamism and diversity in the market was a key aim of the BER but regrets that the sector-specific provisions regarding quantitative selective models have not been very effective in that few dealers have moved to open secondary outlets. Moreover, Article 4(1)(g) of the 2002 Regulation, which provides that dealers must be free to sub-contract out repair and maintenance services has also been ineffective ? simply because very few dealers have chosen to abandon what is a very lucrative part of their business model 55. The competitive environment on the motor vehicle distribution markets appears to have considerably improved since the Commission last evaluated the position in 2000. Encouragement can be taken from the fact that cross-border intra-brand competition appears to have flourished, as prices between Member States have converged and cases of hindrances to parallel trade have significantly diminished. This evolution seems, however, to be mainly due to external factors, in that in an increasingly global economic context, market forces have led the sector to develop positively in a way initially not foreseen by the 52 Ibid at p.6 53 Ibid, at p.3 54 Ibid, at p.4 55 Ibid, at p.5 [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] Commission. Indeed, the appraisal concludes with the brutally honest summation that the provisions of the BER which diverged from the general principles of Regulation 2790/1999 may be regarded as overly strict, too complex and even redundant in modern market conditions 56. In looking towards its future choice of policy, the Commission has been careful to take into account the current economic conditions being faced by the whole sector. Overall, the industry has been hit particularly hard, mainly because it was already carrying structural overcapacities and significant deadweight. In this context the Commission has recognised the importance of setting out a clear and predictable competition policy framework for the sector, so as to avoid uncertainty and to take due account its importance to the European economy 57. Moreover, the any policy choice should avoid constraints which are not justified by the objective of protecting competition on the market and which may instead hamper industry efforts to become more competitive at a global lev 58el. In its Communication of 22 July 200959 on the review of the competition regime for the motor vehicle sector, the Commission?s services build on its earlier evaluation and truly came of age by breaking free of the shackles of the lobbyists. It found no evidence that agreements between vehicle manufacturers and dealers would continue to require different treatment as compared to agreements in any other sector and therefore proposed to apply the general competition rules from 31 May 2013, after a three-year adaptation period, granted to take account of brand-specific long-term investments made by dealers. Given that stakeholders are virtually unanimous that the sector should continue to benefit from a block exemption, whether general or sector-specific, this is a sensible move in line with its general trend of moving away from overly formalistic BERs and towards common frameworks supplemented by guidance from the Commission?s services. In brief, the major changes for motor vehicle distribution under the regime of the general Vertical BER60 will be: a maximum market share for exemption under the BER of only 30 per cent; the possibility of imposing stricter single branding requirements on dealers than under the MV-BER; the possibility of preventing dealers from opening additional sales outlets; the possibility of requiring dealers also to 56 Ibid, at p.12 57 Commission Impact Assessment Report accompanying the Communication, COM (2009) 388 final, 22.7.2009, available at http://ec.europa.eu/competition/sectors/motor_vehicles/block_exemption.html 58 Commission Communication on The Future Competition Law Framework applicable to the motor vehicle sector, COM(2009) 388 final, Brussels, 22.7.2009 59 Idem. 60 Commission Regulation (EC) No 2790/1999 of 22 December 1999, OJ L336/21 [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] operate a repair shop; and contractual protection for dealers will no longer be a prerequisite for exemption.61 Since stakeholders in the sector have been accustomed to sector-specific regulations since 1985 and have expressed a clear desire for legal certainty, the Commission will adopt sector-specific guidelines on areas of potential doubt, such as: when single-branding requirements will be deemed to be foreclosing and outside the exemption; on the rules for assessing cases where the relevant market share exceeds 30%; and on the Commission?s position regarding appropriate contractual protections for distributors in light of Regulation 1/2003?s reemphasis of the boundaries between competition and contractual domains. The need for guidance in this last particular field is strikingly illustrated by the Commission?s own assessment of the operation of the BER where it finds that, of the 322 informal complaints that the Commission received between 2004 and 2007, the vast majority did not relate to genuine competition issues but rather to inter partes commercial dispu 62tes. 3 (b) (iii) Evaluation of Options Overall, we can see that the Commission has attempted to respond to the main criticism of the previous formalised system that it tended to freeze present relationships and did not enable manufacturers to adapt their networks to market evolut 63ions. The evolutionary character of the system in the US is meanwhile ensured by the fact that the broadly drafted provisions there can receive different court interpretations over time. However, the European policy choice can be further defended as the structure promotes legal certainty and is reviewed regularly using a consultation process relatively free from capture. Closely linked with the question of certainty is the intent of the European Commission to provide a set of rules valid for the entire EU, in order to avoid the problem raised by the patchwork of federal and state regulations that have hindered transparency and efficient distribution in the US, as well as to promote cross-border transactions. Both sets of law-makers have a similar interest in creating a level playing field within which the market can flourish. The best way to realise this objective in a market economy remains the consistent promotion of the healthy process of competition, at both the inter-brand and intra-brand levels, hence requiring, 61 http://www.freshfields.com/publications/pdfs/2009/jul09/26411.pdf 62 Commission Evaluation Report on the Operation of Regulation 1400/2002 concerning Motor vehicle Distribution and Servicing, May 2008, available at http://ec.europa.eu/competition/sectors/motor_vehicles/block_exemption.html 63 (Gerrard, 2003) [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] among other measures, the abolition of restrictions on entry despite the very strong political lobby of the dea 64lers. From this overview one can observe a choice between two contrasting modes of attaining similar objectives, with both sets of law-makers constrained by their imperfect circumstances. The US regime combines laissez-faire antitrust rules with direct statutory intervention aimed at protecting dealers, but remains unable to free itself sufficiently from the lobbying power of both dealers and manufacturers despite their current weak condition. The EU scheme appears set to move on from using flawed interventionist statute towards bringing the sector into line with other equivalent industries, while still leaving room to recognise its specificities and unique nature. 4. Conclusion: Responses to Economic Crisis and Lessons Learned (?) The automobile industry has been severely affected by the economic downturn. Car sales collapsed across the board at the start of the crisis in almost all OECD countries, with an average fall of more than 20% from September 2008 to January 2009.65 Manufacturers? high fixed costs and low margins mean that a period of lower sales can quickly send companies into 6the red 6. Given the high purchase price of new vehicles relative to monthly income, the availability of credit finance is a crucial factor, and at a time when global capital markets are virtually closed the effects can ripple out to the automotive industry with dev 67astating effect. Especially worrying is the fate of the hundreds and thousands of smaller suppliers that may not have the resources to sustain credit shortages and withdrawals of bridging loans. It should be remembered that much of the innovation in the supply chain actually resides at the lower tier levels, which are often small 68 and medium sized enterprises with limited capital. Overall, a significant number of bankruptcies in the supplier sector are expected in the near term future, which will tend to increase concentration. The trend away from vertical integration may even be reversed as vehicle manufacturers have to ensure their supply chain is stable. A phase of industrial consolidation would be normal during or immediately following 64 (Rhys, 2004) 65 (OECD, 2009a) 66 (IHS Global Insight, March 2009) 67 (IHS Global Insight, March 2009) 68 (Freyssenet & Lung, 2000) [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] sharp downturns but the industry?s track record with M&A deals in the last 15 years has been very poor which along may prevent significant restructuring and capacity reduction. As explained above, the car industry is quite geographically concentrated so it is not surprising that the governments of affected regions acted to introduce temporary alleviating measures, including incentives for customers to replace old cars (so-called ?cash for clunkers? schemes) as well as loans, guarantees or subsidies directly to firm 69s. As most of the schemes are now ending, the full GDP impact will be seen this year and will depend on the size of the ?payback effect?, i.e. to what extent programmes pulled forward sales which will then not occur in the near futur 70e. Support has also taken the form of direct government intervention in industry restructuring. Clearly, this could lead to distortions in the Europe-wide vehicle market, especially for those member states with the largest motor industries and therefore with the most to lose from a protracted and painful demand slowdown.71 In the global context, these auto-assistance measures could also be contrary to WTO state subsidy restrictions but since virtually all major car exporters have implemented some industry aid, any country that brings the first case to the WTO can expect to be challenged with a case against their own auto m 72easures. Therefore, it is unlikely that WTO cases will arise on these measures, if for no other reason than that it looks bad for the pot to call the kettle black. Examples include the involvement of the US government in the restructuring of GM and Chrysler, and the attempted influencing by the German government of GM?s choice of buyer for its European subsidiary Opel. This intervention raised clear concerns that plans concerning factory closures across countries were not entirely based on business considerations. Indeed, in October 2009, the Competition Comm 73issioner Neelie Kroes wrote to the German Minister for the Economy, identifying 'significant indications' that the German government aid only if its preferred buyer for Opel was chosen. As such, this aid would have amounted to using public money to distort free and fair competition, and thus thoroughly contrary to the who 4le spirit and ideal of the common mark 7et. There are more examples of governments subsidising specific firms, particularly in France, where President Sarkozy has apparently offered ?6bn in government support to Renault and Peugeot-Citroen contingent on reassurances for jobs in Franc 75e. These kinds of measures are sure to meet with objection, especially in Eastern Europe where French car 69 (OECD, 2009a) 70 (OECD, 2009a) 71 (IHS Global Insight, March 2009) 72 (Brunel & Hufbauer, 2009) 73 See Press Release Reference: MEMO/09/460 of 16/10/2009 74 (Wells P. , 2009a) 75 (Lyons, 2009) [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] companies are essentially being asked to shut down. Moreover, forcing French companies to produce in France could result in higher costs for manufacturers which would clearly not improve the competitive position of the F 6rench car industry 7. It is a debate that goes to the heart of the purpose of the European project and can mean quite different outcomes for workers depending on whether they live in Belgium, Germany, Spain or th 7e UK 7. The high wages of car-workers reflect higher skills and it is clear that alternative employment opportunities for laid off workers may involve considerable less skilled jobs and correspondingly lower wages. The skills embodied in those workers will simply be lost (?stranded?). Indeed, the failing firm defence to a merger was created purely to prevent the similar problem of the disappearance of assets from production. Car companies? operations, primarily located in industrial zones, often of considerable age and no longer state of the art, nonetheless, represent assets with some remaining productive capability. Yet these too will simply be lost resources to society, since there are almost surely no buyers interested in acquiring and operating such capi 78tal. There is also a much larger question here. In principle the free-market system works through economic signals and the process of competition. If a business fails in the market, the maintenance of that business imposes a social and economic cost of resources invested that could have been placed elsewhere - probably somewhere more productive. If businesses were not allowed to fail, Europe would slowly but surely drown under the weight of moribund assets. This is the point of European competition policy. It is there to prevent national governments from propping up 'their' companies at the expense of the rest of the 79 community. Looking to previous bail-out schemes, the treatment of Chrysler Corporation in the late 1970s and the federal loan guarantees provided to that company in 1980-81 served to mark the beginning of an activist 80 era of federal intervention in automotive trade issues. A brief look at the steps taken in the US shows a real danger of similar outcomes, even if a more subtle approach is being taken. Firstly, simply appointing a specialised Auto Task Forc 81e indirectly strengthens the ties between car companies and the 76 (Brunel & Hufbauer, 2009) 77 (Wells P. , 2009a) 78 (Kwoka, 2009) 79 (Wells P. , 2009a) 80 The Chrysler Loan Guarantee Act 1979 included union concessions, state-level aid packages, and allowed the company to borrow $1.2 billion from private sector sources in 1980. Within three years, the company had paid off its loans and the federal government actually made a substantial profit on Chrysler stock it had held as collateral. See (Hyde, 2003) cited by (Cooney & Yacobucci, 2008). 81 See statement of US Treasury Secretary Geithner, http://www.treas.gov/press/releases/tg207.htm [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] government, thereby improving their credit ratings relative to their foreign competito 82rs. This follows in a long tradition of US administrations being unable or unwilling to cut their auto sector loose and open it to the full rigours of the market. Encouragingly, however, a relatively transparent and facts-based83 approach has been taken to solving the GM and Chrysler dilemmas, but whether the White House will be able to retain a tough stance if future market conditions worsen is unclear. While the rhetoric recalls the value of the industry to the American economy and society, a painful line will have to be drawn at some stage and the fear is that the industry has been bailed out and protected too many times for it to ever stand on its own four wheels. This is not to say that the approach on this side of the Atlantic is beyond reproach. As mentioned above the individual Member States have been unashamedly acting to preserve their national industries. Meanwhile, the European Commission has found that Sweden?s guarantee for a European Investment Bank loan that would co-finance Saab's sale by current owner GM to tiny Dutch car-maker Spyker to be in line with its Temporary Framework for state aid measures, which gives Member States additional scope to facilitate access to financing in the present economic and 84financial crisis. While it is too early to see the full story here, this deal would not appear to make rational economic sense when we consider the industry trend has been to group together to survive the tough times. However, preliminary press reports speak of Saab extending its operations beyond its traditional niche, and of Spyker expecting to see profits before 201285. Either way, the same fear of institutions and administrations being blinded by the history and prestige of former national champions remains front and centre in many analysts? ey 86es. In conclusion then, it would appear that the lessons of the past are indeed clearly visible to the decision- makers of today ? whether they choose to see them or not is a different matter. 82 (Brunel & Hufbauer, 2009) 83 See, e.g. the Obama Administration?s Fact Sheet on the Viability of GM and Chrysler, available at: http://www.whitehouse.gov/assets/documents/Fact_Sheet_GM_Chrysler_FIN.pdf 84 See IP /08/1993, available at: http://ec.europa.eu/competition/sectors/motor_vehicles/news.html. Case number N 541/2009, awaiting release of non-confidential version 85 See, Eric Mayne ?Spyker, GM Seal Deal; Saab Studying Entry-Level Model?, WardsAuto.com, Feb 23, 2010 86 (Wells P. , 2009b) [EUI Draft Working Paper ? Please Do Not Cite, Comments Most Welcome] Bibliography ACEA . (2009). European Automobile Industry Report 09/10. Brussels: Association des Constructeurs d'Automobiles Européens. Akbar, Y. (2003). Slip Sliding Away? The Changing Politics of European Car Distribution. Business and Politics , 5 (2), 175. Bohman, E., Stenbrink, P., & Rosenberg, J. (2003). Overhauling European Auto Distribution. McKinsey Quarterly (1), 134-142. Brunel, C., & Hufbauer, G. (2009). Money for the Auto Industry: Consistent with WTO Rules? Petersman Institute Briefing , PB 4. CFA. (2001). A Roadblock on the Information Superhighway: Anti-competitive Restrictions on Automotive Markets. Washington, DC: Consumer Federation of America. CFA. (2002). Bringing New Auto Sales and Service into the 21st Century. Washington, DC: Consumer Federation of America. Cooney, S., & Yacobucci, B. (2008). U.S. Motor Vehicle Industry: Federal Financial Assistance and Restructuring,A Report for Congress. Washington, DC: Congress Research Service. De Kieffer, D. (1981-1982). Antitrust and the Japanese Auto Quotas. Antit
Posted: 03 April 2010

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