Russian Economic Reform

Past Articles on the work of each of the 21 Expert Groups can be accessed here:

Anti-monopoly laws, “smart” regulation, and business groups.

Published on July 11 2011
Posted by: jeff

This Group has been very busy and considered a large number of detailed reports, surveys etc, one of which has striking estimates of the costs of “poor institutions”. “Badly functioning institutions” are said to be responsible for 25-30% of the cost of residential and commercial real-estate (in Moscow up to 60%); about 15% additional mark-up in retail trade, and about 10% in communication services. There are also reports of a round-table on “Business Associations and their role in the process of modernization in Russia”, and a report titled “Development and Application of Anti-Monopoly Legislation in Russia: Results and Problems” where the main identified issues are: too much emphasis on a “regulation” approach (for example cost plus) when considering the extent of monopoly price behavior rather than a more “protection of competition” approach; and a lack of independence of anti-monopoly authorities and courts.  

Jeff says that ….

(There is continually talk in Australia about the costs to business caused by excessive regulation. Because there is little quality “hard data” in this area, it is often very difficult to work out what is just “talk” and what are real problem. It is very difficult to measure the cost of excessive or poor regulation. Nevertheless, the Australian Federal Government changed the name of the “Department of Finance” (not to be confused with the “Department of Treasury”, which is the main policy department) to “Department of Finance and Deregulation” and created an “Office of Best Practice Regulation” within it. (The internet site is here: http://www.finance.gov.au/obpr/about/)   I was once “Economics and Taxation Adviser” at an Australian “business association” and I consider that such organizations can play a significant role in reform – provided they do not lobby for extreme ideas and work positively to find solutions. After working my way through the above mentioned Expert Group 4 report on Anti-monopoly laws, it is clear to me that many of the issues being discussed in Russia are similar to those in Australia. However, there are some differences. The Australian ACCC has clear independence, and Australia generally has taken a “protection of competition” approach rather than a “regulation” approach. But this does not mean there are no controversies. Section 46 of the Australian Trade Practices Act, which is concerned with “Misuse of Market Power” has been the subject of several official inquiries. Apart from questions about the exact meaning of the word “misuse” (should it be “abuse”?), there have been endless legal and economic debates about the wording of this section and its interpretation by the courts.) 

The “poor institutions” report to the Group says that these are a “brake” on Russian economic development and “modernization”, as well as a reason for relatively high prices. There is potential to reduce “internal” prices with a better institutional environment and competition.  The main types of poor institutions are related to real-estate. For example, if in Europe it takes 2-3 years to go from business-plan to opening a new hotel, the bureaucratic culture in Russia means that it takes 4-5 years.

Bribes are identified as adding 5-15% to costs of construction projects. There is “legalized corruption” in the sense that in departments with a monopoly on “project planning” and documentation there often “exist kinds of private companies” which possess an informal monopoly processing necessary documentation.

Another report to the Group says that it is necessary to introduce a new system of “smart regulation” based on “regulatory impact assessment”. In OECD countries “smart regulation” is based on the idea of “evidence-based law making”. Amongst other things, attempts are made to put legislation in “plain writing” for the “final user”. There are also mechanisms for evaluating the effect of legislative initiatives on business.

The report called “Business Associations and their role in the process of modernization in Russia” prepared by the Higher School of Economics says that “one of the problems in the 2008-9 crisis was ‘weak mechanism’ for communication between government and business, and this led to an accumulation of ‘negative expectations’ about the business-environment which deepened the slump in production.

There are now hundreds of business associations in Russia. While some are at the federal level, many are at the regional level or represent differing sectors of the economy.

Most of these business associations feel that government bodies to not take advantage of their potential to assist modernization by more effective interaction with them.

The report says that in developed countries business-associations mainly act as lobbyists. In developing countries, however, business-associations also perform as institutions which compensate for “market-failure” and “state-failure”. The first functions are connected with providing information about market conditions, facilitating better qualifications and training for employees, stimulating firms to adopt and observe quality standards (particularly for export markets). The second functions are connected with collective business pressure on the state for defense of property rights, more efficient government and infrastructure development.

The report called “Development and Application of Ant-Monopoly Legislation in Russia: Results and Problems” says that in recent years Russian anti-monopoly legislation has undergone “radical change”.

In 2006 a new law on “Defending Competition” was passed with sharply increased penalties for infringements (including criminal responsibility for restricting competition). This, combined with a more active Anti-monopoly Service, has increased the role of anti-monopoly policy in influencing business activity. 

The effectiveness of anti-monopoly policy in Russia is restricted to a great degree by three factors: the structure of the Russian market; the use of anti-monopoly laws as an instrument of state policy; and by some particular features of the legislation.

Peculiarities of Russian market are high barriers to entry; “conservative structure” of most sectors; predominance of markets with high concentration; and the secondary importance of domestic markets for big national sellers actively competing in global markets – which complicates the task of developing competition. In such markets there is a powerful stimulus for participants to reject rivalry, and a high possibly of big companies unilaterally restricting competition.

The majority of hindrances to the development of competition in Russia cannot be removed even with the assistance of ideal application of ideal anti-monopoly laws.

Compared to their foreign counterparts, Russia’s anti-monopoly authorities have been overloaded with responsibilities. In conditions of limited resources – both financial and expert – decisions can all too easily be made. However, for many issues – for example, suppressing restrictions on competition by government authorities, prevention of unconscionable competitive conduct, struggle against corruption and for competition in government purchasing, resolving conflicts between regulatory branches – the anti-monopoly authorities have been left as the only decision maker.

Despite some extremely complex problems and a not very favorable situation, the FAS in recent years has had successes. One undoubted success has been the tougher penalties and lowering of the threshold of significance for agreement on transaction involving economic concentration. As a result there has been a decline in the most offensive restrictions on competition. The anti-monopoly organizations have also received sufficient instruments for punishment – and consequently, for prevention – of restricted competition.

In recent years the anti-monopoly legislation has increasingly been used as an instrument of protecting one economic group and damaging the interests of another. This is particularly the case in statutes regulating as acceptable or unacceptable different types of vertical agreement.

Even more, application of some anti-monopoly statutes is actually capable of restricting competition. Demands for non-discriminatory clauses in agreements leads to retailers not having the right to compensate for different competitive advantages of suppliers with different conditions in agreements with them. In such conditions they simply reject conclusion of agreements with new contractors, which, on the logic of this statute, must offer the same conditions as existing contractors who have demonstrated their reliability.

The defect in “protecting competitors and/or contractors” as opposed to defending competition is revealed by the regulations which mean that it is enough to infringe on the interest of another to qualify the activity as abuse/misuse of dominant position. It almost presumes illegal any price set by a dominant market participant, which adversely affects the interests of a contractor.

Moreover, illegality becomes the difference in price, set in different contracts (in so far as, naturally, the interests that whose who pay more have been harmed). Such an approach was used in case against “big four” oil companies: completely ignoring arguments about delivery to different customers depending on volume, on date, on frequency, and the on length of the relationship leading to different costs. 

In practice, following standards of legal conduct have been created: sell to all at same price, and if it seems unprofitable – generally do not sell to outside the limits of the corporate structure. Thus, the prohibition on discrimination increase the attractiveness for vertical-integrated companies of internal transactions, and lowers the stimulus to sell to independent customers.

There is a troubling tendency in application of the legislation connected with defining prices as “monopoly high”. The law “On Defence of Competition” has two, equally important criteria, for determining “monopoly high prices” – prices above comparable prices in a competitive market, and prices exceeding economically substantiated expenses and profits. In practice, the second approach has become dominant.

An explanation of Supreme Arbitration Court in 2008 allows the use of “excess of price above the sum economically substantiated by expenses and profits” as an indicator of “monopoly high prices” if analysis does not reveal a comparable market. The predominance of this accounting approach – characteristic of regulatory sectors – to assessment of prices sets ultra-high requirements for a market to qualify as comparable.

As a result, the same problems which are characteristic for tariff regulation have arisen: a spasmodic search for criteria defining “economic validity” of expenses and profits and incentives for companies to exaggerate accounting expenses.

In principle, the setting of high prices by even a dominating seller does not necessarily signify restricted competition. High prices set by a dominating seller will stimulate other sellers to increase production and attract potential competitors to enter the market.

Such high prices should be examination only in cases prices for services from key facilities in regulated sectors, when there is no competition and is unlikely to be competition in the medium-term, and where there is an ability to compete in adjoining markets using key mainly key facilities.

In remaining markets the prevention of high price setting may have quite unexpected results, including lowering the stimulus for entry of potential competitors, in other words to restrict competition.

Overall, the results of the application of anti-monopoly legislation in Russia in terms of “promoting the development of competition” have been mixed.

In order for there to be an improvement, a choice needs to be made between two principally different strategies. Either anti-monopoly policy return to its position in policy aimed at protecting competition (with reasonable demarcations between legal and illegal activity and with reasonable standards of proof), or anti-monopoly policy continue to be applied as an instrument for achieving current political and populist goals.

In the second case, anti-monopoly policy will cease to be an instrument for supporting competition, retaining its name but not the essence. 

If the first choice is made, it is necessary to give anti-monopoly institutions and courts true independence. They need to be beyond political pressure to be capable of reasonable and effective decisions.