Market power versus efficiency defense in the European Commission’s merger policy: Evidence on European airline mergers by Adél Németh a Thesis submitted in partial fulfillment of the requirements for the degree of Doctor of Philosophy in Economics Approved Dissertation Committee Prof. Dr. Gert Brunekreeft Name and title of Chair Prof. Dr. Hans-Martin Niemeier Name and title of Committee Member Prof. Dr. Julia Bendul Name and title of Committee Member __________________________________ Date of Defense: May 2nd, 2016 Humanities and Social Sciences Statutory Declaration (on Authorship of a Dissertation) I, Adél Németh hereby declare that I have written this PhD thesis independently, unless where clearly stated otherwise. I have used only the sources, the data and the support that I have clearly mentioned. This PhD thesis has not been submitted for conferral of degree elsewhere. I confirm that no rights of third parties will be infringed by the publication of this thesis. Bremen, May 31, 2016 Signature ___________________________________________________________ IN MEMORY OF MY FATHER ACKNOWLEDGMENT I am particularly grateful to my supervisors, Prof. Gert Brunekreeft and Prof. Hans-Martin Niemeier, for their support and encouragement during all the years of working around and on the dissertation, within the framework of numerous research projects and beyond. I would also like to thank my co- supervisor, Prof. Julia Bendul, for her constructive feedback. I am indebted to my colleagues and friends at the University of Applied Sciences Bremen and the Jacobs University Bremen, who never got tired of assisting me in gathering data, finding contacts and discussing the results, and who always had an open ear for further questions. I am especially grateful to Dr. Vanessa Liebert for her unlimited endorsement inside and outside the (home) office and for Dr. Eric Njoya for his endless interest in debating economics with me. I would like to express my gratitude to Annika Paul, who carefully read and commented on the draft version of the thesis. My PhD fellows, Karsten Fröhlich, Dr. Tolga Ülkü, Dr. Nele Friedrichsen and Dr. Roland Meyer, were always helpful in guiding me in academic life and research practice. The thesis profited from the research projects German Airport Performance (GAP) and German Aviation Benchmarking (GAB) with the financial support of the Federal Ministry of Education and Research. Furthermore, I would like to thank the Erich-Becker-Foundation and the Jacobs University Bremen for providing me with a research grant and enabling an exceptional research stay in Australia, a summer school in Greece and participation in numerous international conferences and high-level PhD courses. I would like to thank the German Aviation Research Society (G.A.R.S.), particularly Wolfgang Grimme, Prof. Frank Fichert, Prof. Jürgen Müller, Prof. Hansjochen Ehmer and Prof. Peter Forsyth, for assisting me with data collection and networking, and for helpful reviews of the research papers that built the base of the PhD thesis. I wish to acknowledge my papers’ co-authors, Prof. Volodymyr Bilotkach (Newcastle University), Prof. Yusaf Akbar (Central European University) and Dr. Ádám Remetei-Filep (European Commission), for their support and guidance. Finally, I will forever be grateful to my parents, who let me go my road; my family, Andreas and my daughter Ida, who attended me on the way; and my friends, especially Vera Hervai, for being there for me. vii STATEMENT ON CONTRIBUTION TO ALL ARTICLES Total own Article Contribution contribution to manuscript Németh, A., 2014. Does efficiency matter? Working Paper. Chapter 1 has been 100 % Available at: http://www.garsonline.de/ introduced here. 1.1.2 and 1.2.6 contain 50 % slightly improved parts; Németh, A. & Remetei-Filep, Á., 2010. The economic analysis of economic literature 3.4.1 and 3.4.2 are based EU airline consolidation: does the Commission get the economics review on models on; while 6.2.1 may right? Working Paper. Available at: http://www.garsonline.de/ related to merger contain parts of our analysis paper. (Ca. 11 pages) Fröhlich, K., Hellmers, J., Holtz, M, Grimme; W., Németh, A. & Niemeier, H-M., 2013. An assessment of the synergies and the 2.2.1; 2.2.3 and 7.3.1 are 20% to each success of cross-border airline mergers and acquisitions in Europe, based on our book In: Forsyth, P., Gillen, D., Hüschelrath, K., Niemeier, H-M. chapter. literature review on &Wolf, H. (editors). 2013. Liberalisation in Aviation. Surrey: (Ca. 7 pages) network effects, Ashgate, pp. 197-220. mergers and alliances; Fröhlich, K., Müller, J., Németh, A., Niemeier, H-M., Njoya, E. such as data analysis 2.2.3 is based on our T., and Pashkin, R., 2011. Vertical Structure of Air Transport: on airline mergers and working paper. (Ca. 0.5 Problems for Competition and Regulation. Working paper. synergy effects pages) Melbourne, GARS. Available at: http://www.garsonline.de/ Németh, A., 2011a. (Market) Power of European Airlines. Table 22 on p. 67 comes Working paper. Sydney: ATRS Air Transport Research Society. 100% from here. Available at: http://www.atrsworld.org 35 % Bilotkach, V., Müller, J. & Németh, A., 2014. Estimating the 3.4.4 is based on; while gathering and consumer welfare effects of de-hubbing: The case of Malév 5.4 is mainly identical to preparing data, Hungarian Airline. Transportation Research Part E: Logistics and our research paper. historical review on Transportation Review 66, pp. 51-65. (Ca. 9 pages) Malév Chapter 4 is based on; 50 % Németh, A. & Niemeier, H.-M., 2012. Airline mergers in Europe - while 6.2.1 may contain literature review; An overview on the market definition of the EU commission. parts of our research investigation on case Journal of Air Transport Management 22, pp. 45-52. paper. decisions; describing (Ca. 23 pages) merger regulation Akbar, Y., Németh, A. & Niemeier, H.-M., 2014. Here we go again. Permanently failing Organisations. Journal of Air Transport 35% Management 35, pp. 1-11. literature review; 5.3 is mainly identical to describing the history our research paper. The paper above is based on my own working paper: and the performance (Ca. 7 pages) Németh, A., 2011b. Strategies for Eastern European Airlines: The of Malév, CSA and case of Malév Hungarian Airline. Available at: LOT http://www.crninet.com/2011/c12c.pdf, Brussels: CRNI Competition and Regulation in Network Industries. Németh, A., 2015. A dynamic competitive assessment of the recent Chapter 6 has been Lufthansa mergers, Working Paper. Available at: 100 % introduced here. http://www.garsonline.de/ ix ABSTRACT According to microeconomics, mergers result in a more concentrated industry. This fact is hardly questionable, but the discussion about whether concentration is good or bad for society leads us to a lively debate, called the efficiency defense: do mergers increase market power or efficiency? How does merger policy take market power and efficiency into consideration? My work investigates the circumstances and consequences of merger appraisal in passenger airline markets in Europe between 1995 and 2015. The analysis tries to identify the role of consolidation driven by market power, efficiency and bankruptcy. The thesis introduces economic principles, models and policy choices behind the efficiency defense, and explains why the European Commission did not consider efficiency as a core criterion for their decision to allow or prevent takeovers. In summary, efficiencies could be considered in the merger process under the total welfare approach, which also contains efficiency gains from producer surplus increase. The author believes that efficiency is the ordinary aim of companies, but the reason behind mergers is to increase market presence, market share or with other words: market power. Competition policy should therefore improve a transparent and smart framework to regulate market power. xi CONTENTS STATEMENT ON CONTRIBUTION TO ALL ARTICLES IX ABSTRACT XI INTRODUCTION 1 1 EFFICIENCY DEFENSE AND BEYOND 5 1.1 INTRODUCTION 5 1.1.1 THE WILLIAMSON TRADE-OFF 6 1.1.2 THE MORE ECONOMIC APPROACH 7 1.1.3 THE EFFICIENCY DEFENSE AND ITS PARADOX 8 1.2 ECONOMIC SCHOOLS OF ANTITRUST 10 1.2.1 NEOCLASSICAL THEORY, THE CRADLE OF ANTITRUST 10 1.2.2 THE HARVARD SCHOOL, LIMITING MONOPOLY AND MARKET POWER 11 1.2.3 THE CHICAGO SCHOOL AND THE HARDCORE ECONOMISTS, ENHANCING EFFICIENCY 12 1.2.4 THE HARVARD VS. CHICAGO BATTLE 13 1.2.5 NEW INDUSTRIAL ORGANIZATION: A MARRIAGE BETWEEN THE HARVARD AND CHICAGO SCHOOLS 15 1.2.6 THE EUROPEAN SCHOOL: A MORE ECONOMIC APPROACH 16 1.3 SYNTHESES ON COMPETITION POLICY 19 1.3.1 IS CONCENTRATION THE EVIDENCE OF MARKET POWER OR OF EFFICIENCY? 19 1.3.2 WHAT DOES EFFICIENCY MEAN? 21 1.3.3 DO ENTRY BARRIERS EXIST OR ARE THE MARKETS CONTESTABLE? 24 1.3.4 DO WE NEED GOVERNMENT INTERVENTION? 25 1.4 WELFARE STANDARDS AND APPLICATIONS 31 1.4.1 TOTAL WELFARE STANDARD, FIRST ATTEMPTS IN CANADA AND IN AUSTRALIA 31 1.4.2 CONSUMER SURPLUS STANDARD: EVIDENCE FROM THE UK 33 1.4.3 ALTERNATIVE WELFARE STANDARDS AND GERMANY 35 1.5 MORE, BUT WHICH ECONOMIC APPROACH? WILLIAMSON’S EFFECT ON EC MERGER POLICY 38 1.6 CONCLUSIONS 41 2 EFFICIENCY TRADE-OFF IN PRACTICE: THE EUROPEAN COMMISSION 42 2.1 INTRODUCTION 42 2.1.1 THE SCP MODEL – EXTENDED BY EFFICIENCIES 43 2.1.2 THE TYPOLOGY OF EFFICIENCIES IN THE EC’S MERGER REGULATION 44 2.2 EFFICIENCY GAINS IN AVIATION 46 2.2.1 COMPETITIVE ADVANTAGES: MERGERS VERSUS ALLIANCES 47 2.2.2 COST, REVENUE AND RISK SYNERGIES – FOCUS ON ECONOMIC THEORIES 51 2.2.3 NETWORK EFFECTS: DO THEY INCREASE