Exemption from the Competition Law – Has the Government made its case?

By Stephen Crosswell Senior Consultant, Competition, Telecommunications & Media Herbert Smith Kong

For the Competition Forum held on 9 December 2008

Introduction

Questions as to how to structure a general competition law in (including whether the Government and statutory bodies should get a wholesale exemption) need to be assessed, I believe, taking into account the unique structure of Hong Kong's constitution and economy.

I therefore start my presentation today with a statement that will be a timely reminder for those from Hong Kong and perhaps a useful introduction for those visiting from other jurisdictions.

Hong Kong is a capitalist society. It is probably the most capitalist society in the world. But this is not an accident of history: it is a matter of long standing government policy and, since the enactment of Hong Kong's Basic Law, it is a constitutional right guaranteed to the people of Hong Kong.

Article 5 provides that:

"The socialist system and policies shall not be practised in the Hong Kong Special Administrative Region, and the previous capitalist system and way of life shall remain unchanged for 50 years."

There is no room for ambiguity in this and it is not a matter of degrees. Just as other constitutional rights are not protected piecemeal, any significant level of socialist policy in the government and administration of Hong Kong is, I would suggest, unlawful.

It is also necessary that the capitalist nature of Hong Kong be reflected in, and inform, Government policy making. Essentially, this requires that Hong Kong protect private property rights while giving market forces the widest possible reign. Consistent with this, the has adopted a 'small government, big business' policy, at the centre of which is a focus on free trade, low taxation and minimal government. Also consistent with this is the light handed sector-specific approach that has been taken to competition policy in Hong Kong to date.

The light handed approach to competition policy has meant that there has not, historically, been a great deal of consideration of the interaction of Hong Kong's policy of minimal government and competition law. Having said this, an example of how this policy interacts with competition law is found in the liberalization of the domestic and external telecommunications franchises that

1 commenced in the mid to late 1990s and the history of competition law enforcement in the sector to date.

Telecommunications is one of the few sectors in Hong Kong subject to competition law at present. When the franchises were first removed and the industry opened to competition, ex ante regulatory intervention was exercised on various fronts, on the basis that new entrants had to deal with an incumbent in a dominant position. Market failure was presumed in this situation and regulatory facilitation of competition (i.e. liberalization) was pursued by the regulator.

However, the telecommunications regulator has since concluded that the market is fully liberalized, ex ante regulation is being removed and under the prevailing ex post competition law the regulator has expressly stated that there should only be intervention (i) "in the clear circumstances that market forces have failed, or are likely to fail"1 and (ii) "it is demonstrable that regulation can do better".2

It will immediately be seen that this two-pronged test, while being consistent with Hong Kong's market led policy, sets a high threshold for intervention under an ex post competition regime. Even when it can be shown that there has been anticompetitive conduct, it is often difficult to convincingly make the case that regulatory intervention "can do better".

I believe that it is fair to say, as a matter of general principle, that the threshold for intervention under competition laws in Europe (including the EU and its member States), the United States and other jurisdictions with established competition laws, such as Japan, Canada, Australia and New Zealand is not, and has not historically been, so high. Although all vary in their degrees of interventionism, they do not, as a matter of policy, apply such a strict two-stage threshold for intervention.

Whether such an approach to competition law in other jurisdictions can be justified by broader policy considerations that their governments seek to pursue is not a matter I will dwell on. It is not a relevant question in Hong Kong, given Hong Kong's unique constitutional framework. I will confine myself to observing that it is not surprising in the face of Hong Kong's market driven policy that, with limited exceptions, Hong Kong has chosen not to promote regulatory intervention in the market, and this has, I would submit, been one of the great contributors to Hong Kong's current position and prosperity.

General competition law in Hong Kong

With that introduction, it should be clear that the challenge for Hong Kong, if it is to introduce a general competition law, is to develop a law and enforcement policy that is consistent with its unique constitution: in other words, a competition law and policy consistent with capitalism.

The Government appears to be seeking to avoid a detailed and potentially inflexible competition law, insofar as it has proposed general prohibitions against:

(i) agreements or concerted conduct; and

(ii) abuse of market power;

1 Telecommunications Authority "Deregulation for Fixed-Mobile Convergence – Second Consultation Paper" dated 14 July 2006, para S5. 2 Telecommunications Authority "Deregulation for Fixed Mobile Convergence – Statement" dated 27 April 2007, para 17.

2 where such agreements or conduct have the purpose or effect of significantly lessening competition in a market.

This approach lends itself to clear and straight-forward drafting while enshrining (with the possible exception of merger regulations) principles of competition law commonly seen in other jurisdictions. This fundamental distinction between multi-firm and single firm conduct sits at the heart of much competition law and antitrust analysis around the world and is a flexible and useful tool in competition analysis.

IF properly administered, this principle based approach to drafting (which avoids an overly prescriptive and inflexible application of the law) should serve Hong Kong's policy goal of a competition law that gives pre-eminence to market forces. However, whether the law will meet this policy goal turns to a large degree on whether due regard will be given to the higher threshold for intervention under competition law that must necessarily apply in Hong Kong.

Some issues particular to Hong Kong

The degree to which Hong Kong adheres to the "small government, big business" principle is relevant to whether wholesale exemption from any new competition law can be justified by the Government. The reason for this should be easy to see. If the Hong Kong Government does not engage in many areas of activity that are, as a matter of policy, engaged in by governments that put less emphasis on market forces, then it is much easier as a practical matter, to consider exemptions on a case by case basis. The feasibility of the exercise makes the argument compelling that a rule of reason approach to exemptions be adopted, particularly in view of the limited scope the Hong Kong Government has for raising legitimate policy grounds for exemptions.

As I will endeavour to demonstrate, the case for a wholesale exemption may be even harder for the Government to make in Hong Kong because, although the Government has fairly minimal bureaucracy, it does engage in areas of activity that should be the preserve of the private sector and, importantly, has considerable influence and control over the supply of land, conditions of land development and the commercial/residential building markets.

Small government, big business

One may or may not go so far as to accept Rothbard's argument that the only form of monopoly is that which arises from a grant of privilege from the State restricting sale or production.3 In fact, it is a highly controversial question in economics whether private monopoly can develop in an open capitalist market and be sustained for a period of time sufficient to cause market failure.4

However, there is virtually no debate in mainstream economics about the inefficiency of government monopolies – those created by coercive State power - and the distortions in the competitive process that they can cause. This critique extends not only to Government-owned business/industries but also to franchises, exclusive licences and other instruments used by Government, without good reason, to restrict entry into a particular field of economic activity.

3 Murray N. Rothbard, Man, Economy, and State, Volume II (D. Van Nostrand Company, Inc., 1962), pp. 561–66. See also Journal of Economic Literature, September-October, 1974, p 593. 4 For example, there is an enormous amount of literature around what has been loosely referred to as Schumpeter's theory of "creative destruction", which considers innovation to be the engine of capitalism that is both driven by and tempers pursuit of monopoly.

3 It is this philosophy, premised on a belief that private entrepreneurs are better positioned to make decisions about allocation and deployment of capital than politicians and bureaucrats, that sits behind Hong Kong's 'small government' policy. Hong Kong has successfully applied this policy to keep regulation to a minimum in some areas. Examples include the low tax rate in Hong Kong and the simple tax structure, minimal duties, one of the most open borders in the world for trade in goods5 and significantly lower expenditure on social services as a percentage of GDP than most other industrialised economies.6

Hong Kong obviously does provide various public services and, where the case justifies it, exemptions from competition law should be considered. However, given Hong Kong's small Government the case for wholesale exemptions is hard to make and, to ensure that due consideration is given to Hong Kong's market driven policy, each application should be judged on its own merits. I will return to this shortly, when examining the Government's arguments put forward in support of the exemption.

Government in the private sector

Despite Hong Kong's 'small government' policy, the Government does engage in activities in a number of areas which would generally be regarded as the preserve of private industry. Examples include: Ocean Park, , mixed commercial and residential estates such as , commercial shopping centres (the Hong Kong Housing Authority (HA) states: "The … HA owns a vast portfolio of shopping centres providing enormous business opportunities…"),7 promotional venues and provision of parking.

The Government is also proposing to construct a cruise ship terminal at Kai Tak to "help Hong Kong become a regional cruise hub"8 and the West Cultural District which it describes as "an important strategic project that will support Hong Kong's development as a creative economy and global metropolis".9

Of considerable importance in this context is the Government's continued regulation of land. In Hong Kong the Government controls:

1. supply - releasing plots of land to the market through an auction process; and

2. land development policy - through, for example, lease covenants, the land premium system and the Urban Renewal Authority.

There has been various criticism of the Government's influence over land in the debate about introduction of a general competition law. At least one commentator has gone so far as to say

5 Hong Kong still has strict immigration laws and professional qualification requirements in various sectors that restrict the openness of its borders to trade in various services. 6 The Heritage Foundation puts the figure at approximately 15.2% in recent years (Heritage Foundation website at: http://www.heritage.org/index/country.cfm?ID=HongKong), as compared to government expenditure of, for example, 36.8% of GDP in the US, 44.7% of GDP in the United Kingdom and 38.2% of GDP in Japan. 7 Hong Kong Housing Authority Website at: http://www.housingauthority.gov.hk/en/commercial/shopsstalls/0,,1-0-0-0,00.html. 8 Secretary for Economic Development & Labour Stephen Ip, http://news.gov.hk/en/category/businessandfinance/061024/html/061024en03003.htm. 9 The 2008-09 Policy Address, para 4.

4 that "land ownership and property development are the true sources of Hong Kong's competition problems".10

It is not surprising that Government control of land should come under such attack in the context of a competition law debate in Hong Kong, when economists as eminent as Ludwig von Mises have stated that "[g]enuine monopolies can be established only by control of land or mineral resources".11 [emphasis added]

Hong Kong's land system has particular potential to distort efficient outcomes because of the relatively limited space available in Hong Kong, the Government's tight control over supply, the hurdles created by the land premium system and the way that many developments (e.g. Urban Renewal Authority projects) are centrally planned. Such a process will naturally favour significant economies of scale.12 This also has the potential to distort competition in numerous related sectors of the economy, such as the retail sector. Urban Renewal Authority projects, in particular, often result in the destruction of entire neighbourhoods, including all of the small to medium-sized (often family run) enterprises that have hitherto grown and flourished in those areas.

Has the Government made its case?

It is against this background that I ask whether the Government has made its case for exemptions.

Economic benefit exemptions

The Government has proposed exemptions (including block exemptions) on grounds of economic benefit. Under this exemption the Government proposes an agreement may be exempted, on application, or the Commission may issue a block exemption in respect of a category of agreements, that is likely to yield economic benefit that outweighs any anti-competitive harm. Subject to how it may be implemented, this is not an apparently objectionable exemption. It simply appears to provide for ex ante examination of whether a particular agreement or group of agreements raises competition concerns, giving the opportunity for increased regulatory certainty for contracting parties.

Public interest and public policy exemptions

The Government proposes an exclusion on the grounds of public interest for undertakings13 entrusted with the operation of services of general economic interest, such as essential public services of an economic nature. It appears the Government is suggesting this might, but will not necessarily, apply to industries such as public transport, water supply, power supply and postal services. This would not be surprising given the existing regulatory structure of various of these

10 Hans Mahncke, Hong Kong's Competition Problem, Hong Kong Lawyer November 2008 issue, p 69 at 71. 11 Ludwig von Mises, Liberalism in the Classic Tradition (3rd Edition, 1985), p 92. 12 It is important to note that I am not saying current market structures in Hong Kong are, necessarily, anticompetitive. To reach a view on that would require very considerable competition analysis. The point is simply that the current regulatory impediments in the land system should be removed to ensure that markets are working as efficiently as they can, unless it is shown both that (i) this would result in market failure and (ii) the current regulatory structure can do better in economic welfare terms. 13 The Government notes that if an organization is not engage in economic activity it would not fall within the definition of 'undertaking' and would not, in any event, be subject to the application of the conduct rates (Chtr VII para 5).

5 industries in Hong Kong but might be difficult to justify in industries such as transport, given the high contestability and developed infrastructure in the region.

Next is the exclusion on public policy grounds, which the Government says will only be invoked where there are "sound reasons of public policy for so doing".14 It is not clear yet how this exclusion might operate. However, if limited and applied on a 'rule of reason' basis and only in exceptional circumstances, it may not be objectionable.

In fact, I suggest below that it is this exclusion that should be used to assess, under a rule of reason test, whether Government and statutory bodies should be subject to the competition law, rather than the wholesale exemption that has been proposed.

Wholesale exemption for Government and statutory bodies - case made?

The Government gives various justifications for the proposed exemption. I consider each in turn.

1. “Activities of the public sector almost invariably would fall under the criteria for exemptions and exclusions”

This argument has an obvious circularity to it and lacks analysis or justification.

Having said this, the most obvious response is that, if activities of Government and statutory bodies are likely to fall within a public policy exemption, then assess them under that criteria, which requires "sound reasons" for the exemption to be shown.

This is a particularly compelling argument where, as we have seen, public sector Government is minimal, because of Hong Kong's adherence to its "small government, big business" policy (under which one can only assume the Government is keen to ensure efficiency in its administration).

Further strength is added to this argument by the Government's proposal to limit application of the law to "undertakings", i.e. organizations engaging in economic activity, thus providing a significant degree of immediate protection for many purely public aspects of Government. This is an important point. If the law is only going to apply to organizations engaging in economic activity, then, by definition, it would only apply to Government and statutory bodies in so far as they were carrying out economic activities. It is difficult to see how the Government could credibly oppose this.

This leads to a further concern with a per se exemption for Government, that it draws attention away from whether the bodies that would enjoy the exemption are truly operating in the public sphere or, instead, engaging in economic/commercial activities.

Failure to subject Government or statutory bodies that are operating in an economic or commercial capacity to competition law would put them at a significant competitive and/or regulatory advantage over private organizations that were subject to such a law and the burdens it necessarily entails.

The discipline of a competition framework would also encourage the Government to critically examine the efficiency arguments around its current activities in the commercial sphere and to question whether continued Government involvement is justified. This is a

14 May 2008 Consultation Paper, Chtr VII, Proposal 49.

6 particularly important discipline on Government in Hong Kong, given Hong Kong's "markets first" policy.

2. “Ensure that the operation of Government and statutory bodies would not be affect by unfounded and misconceived complaints”

There is a certain irony in this argument that cannot go unnoticed.

In a market driven economy such as Hong Kong, the question has to be asked why business should be shackled with the burden of potentially "unfounded and misconceived" complaints if Government finds that burden intolerable.

The fact is that the Government observed in the May 2008 Consultation paper, in response to a similar concern raised by private industry, that private complaints would be subject to various safeguards against excessive litigation.15 These safeguards can be applied equally to vexatious claims against Government or statutory bodies.

Frankly, if this were sufficient reason to justify a wholesale exemption for Government, then every business in Hong Kong would be equally justified in seeking exemption.

Such reasoning, if accepted, would also promote a damaging culture within Government agencies, suggesting that they were immune from the necessity to behave efficiently or to be exposed to competition where possible. This would fundamentally undermine the proper administration of Hong Kong's small government principle (i.e. small government must also be efficient government).

3. “Hong Kong has a relatively small public sector”

All of the arguments made in relation to point 1 above apply equally here.

Further, it is not clear how the Government argues that the size of Government in Hong Kong is a relevant factor. If the argument is that small government is unlikely to be able to engage in anticompetitive conduct because of its size, then this is something that should be addressed on a case by case basis, if the situation arises. However, it should be remembered in this regard that Government has a considerable advantage in any activity it undertakes – a monopoly on the coercive use of force.

4. “Many services that are provided in other economies by the public sector are in Hong Kong provided by the private sector”

It is quite impossible to see the logic in this argument. If appears to do nothing to support the Government's case for exemptions. If anything, it would strengthen the case for private sector exemptions.

5. “The main concern is anti-competitive conduct in the private sector”

The short, and admittedly somewhat flippant, response to this is that if Government does not think it will breach the law, then it should not be concerned about being subject to it.

However, further points can be made.

15 See p 38 of the May 2008 Consultation on the proposed competition law.

7 First, this argument puts things entirely on their head because, as noted above, it is widely accepted that the most damaging influence on markets and healthy competition is Government monopoly and other unjustified interference by Government in economic activity.

Secondly, the use of the word 'main' suggests an express concession that there are competition concerns in Government owned or controlled enterprises (which would not come as a surprise to anyone who has been involved in privatisation of government industries in other countries). So, again, one needs to ask, why the exemption?

Finally, and perhaps most importantly, as we have seen above, Government is engaged in a number of private sector activities and potentially distorts competition in numerous sectors by the manner in which it controls land supply and use in Hong Kong. To grant the Government an exemption in this area will result in a law that can address some of the symptoms but which is incapable of providing a cure.

What do other jurisdictions do?

The appropriateness of any regime for Hong Kong obviously needs to be assessed on its own merits and taking into account Hong Kong's unique constitution and economic/political structure. However, it is worth observing that numerous jurisdictions around the world subject their governments to competition law, particularly in so far as their public bodies or undertakings engage in economic activities.

If these economies, many of which are mixed market economies with a high degree of government involvement in the economy, do not exempt their governments from the rigours of competition law, then it is very hard to see why a capitalist economy such as Hong Kong should.

It is worth noting that a United Nations Conference on Trade and Development report in 2002 observed that "[i]n a number of jurisdictions, exemptions are granted for "special" sectors such as … government enterprises. In most of these cases there are no credible bases for exempting these sectors or types of economic activities from competitive pressures".16

Summary

In short, there is no apparent justification for the Government's proposed wholesale exemption.

The introduction of a general competition law is an important opportunity to review and assess the merits of current Government activity against a strict economic efficiency criteria. This should be welcomed as consistent with Hong Kong's desire to have minimal and efficient Government.

We have seen remarkable increases in competitiveness, productivity, wages and real living standards around the world as a result of privatization of once state-controlled industries, reduced bureaucracy, restriction of government intervention in the market place and increasingly market- oriented policies. A wholesale Government exemption from the constraints of competition law in Hong Kong would, as well as undermining the very essence of Hong Kong's capitalist constitution, run entirely counter to this trend.

16 United Nations Conference on Trade and Development, "Application of Competition Law: Exemptions and Exceptions", UNCTAD/DITC/CLP/Misc.25, p 32.

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