In the wake of a blocked merger between the German and French rail giants Siemens and Alstom, Capitalisn’t hosts Luigi Zingales and Kate Waldock debate the role of global antitrust regulators. How do they protect consumers while also helping domestic companies compete with state-supported rivals from China?
Luigi: Hi, I’m Luigi Zingales from the University of Chicago.
Kate: And I’m Kate Waldock from Georgetown University.
Luigi: And this is Capitalisn’t.
Kate: A podcast about what’s working in capitalism today.
Luigi: And, most importantly, what isn’t.
Speaker 1: Big story in France today. We’re expecting news today of a merger in the train-building sector here in France.
Speaker 2: The board of a French group, Alstom, is meeting today to discuss plans to merge with its German rival, Siemens. The idea is to create a European train builder capable of rivaling China’s CRRC.
Luigi: Well, it was poised to be one of the largest mergers in European history. The final deal to combine the French and the German multinational rail companies, Alstom and Siemens, was announced in September of 2017. The idea was extremely popular with politicians in Europe, as one of the central ideas was to create a European champion in the rail market that could compete against China’s growing dominance.
Kate: Can we think of this as if Delta and United Airlines were merging in the United States? It’s a merger of that proportion.
Luigi: Yes. For the European market and for the world market, it is pretty similar. Siemens and Alstom were the second- and third-largest players in the rail industry. Combined, they reach $15 billion in annual revenues. Now, to be fair, two Chinese companies had merged a year before. And now the combined entity, called CRRC, has $30 billion in annual revenue. So even with the merger, this company will be half the size of the Chinese company.
Kate: OK. This merger’s a big deal. Right? Not only is it going to create this massive railway company, but it’s also wrapped up in this narrative about European leadership on this global stage.
Luigi: Yes. It was celebrated by the politicians as a message that the European spirit is alive, the powerful message in a time of populism, nationalism, and social and political divides was overcome by this common spirit of Europe. But they hit a major roadblock.
Margrethe Vestager: We are prohibiting Siemens’s takeover of Alstom’s rail transport business.
Luigi: Interestingly, the person putting up the roadblock is not this populist leader, but it is the European Commissioner for Competition, Margrethe Vestager. On February 6 of this year, her commission struck down the merger. The merger would have created an undisputed market leader in the signaling market and a dominant player in very-high-speed trains. And it would have significantly reduced competition in both these areas, depriving customers, including train operators and rail infrastructure managers, of a choice of suppliers and products.
Margrethe Vestager: To be clear, it’s fine to be big. That’s not the issue here. But we found that competition from other suppliers would have been insufficient to replace the considerable loss of competition due to the merger.
Kate: This whole story raises a lot of questions about mergers, antitrust, global competition with China. But I think a good place to start is to ask: Should they have let this merger go through?
Luigi: Certainly, the market loved this merger. When it was announced, the stock prices of both entities went up. The analysts were talking about basically half a billion euros in synergies, synergies that were mostly a reduction in costs, also some other scale benefits. However, the role of the European Commission on Competition is to analyze whether this merger is hurting consumers or not. Here, we need to be a bit technical because, first of all, we need to separate two markets that are involved here. The first one is the signaling market, that is the market for the signals, the stuff that decides whether the train goes ahead or not to avoid two trains crashing.
Kate: The reason that I’m perpetually late for everything whenever I’m in New York City, because there’s a signal problem basically five times a day.
Kate: Yeah, OK.
Luigi: Exactly. One of the characteristics of this market is that there’s a strong natural effect. If British Railways decides to go with one company, then they want ... Everything has to be compatible with the standards of that company. In particular, historically, British Railways went with GE and Westinghouse. But those divisions were later sold to Alstom and Siemens. Alstom and Siemens control all the patents for all the signalings that are used in Great Britain, for example, and make it very difficult for new competitors to enter and offer an alternative, because all this stuff needs to be backward-compatible. It is very hard to make it backward-compatible if you don’t have the patents.
And, by the way, this is what gives Microsoft such huge power, because you don’t want to lose everything you have done, so you want a system that is backward-compatible with your old programs, and that gives enormous staying power to the incumbent. And, in this market, the two leading systems were done by Alstom and Siemens, and so this backward compatibility was making it extremely hard for anybody else to compete. And they represented 93 percent of all the major signaling spending planned for the years 2016 and 2017. So, we’re really talking about overwhelming dominance that will increase the cost of operating trains and eventually will come down to higher prices for railway services in Europe.
Kate: OK. It sounds like the signaling component would give Alstom and Siemens monopoly power, at least in the UK, but probably in other parts of Europe as well. What about the train production element, or the railway element?
Luigi: This is more interesting, because what is called in jargon rolling stock, they’re at roughly 35 percent of combined market share, which by itself would not be so problematic. The issue is that in all the major bids, the number one and number two bidders used to be Alstom and Siemens. So, if you look at all the major expenditures, especially for high-speed rails, there are very few producers able to qualify for the bids. In most of the bidding process, you have three, sometimes four bidders. And if two of them merge, you end up with two or one, which is very problematic.
Kate: Right. On one side, a major con of this concentration issue is that there could be higher prices for consumers. But it sounds like a major pro is that this combined business would be able to combat Chinese competition. Were there any other factors at play here?
Luigi: No. I think that this is exactly the tradeoff. I’ve not seen anybody disputing the fact that according to a traditional antitrust analysis, here there was ample ground to block the merger. All the arguments were in favor of this potential Chinese entry, and, more important, this issue about creating companies big enough to fight in the international arena against Chinese companies.
Kate: It’s not like CRRC is about to take over European rail tomorrow. But there is, A, we live in a world with strong economies of scale. And, B, China has started to have a stronger presence abroad in countries like South America when it comes to their strong champion railway company. Wouldn’t you want strong national champions to be able to compete with China?
Luigi: I think I would like to have efficient companies selling to everywhere in the world. If the Chinese are playing unfairly by subsidizing their companies, there are ways to block them, even within the framework of the World Trade Organization. If you are dumping your product, there is a way which you can block the importation of this product, or slap it with tariffs. There are ways to address unfair competition. The problem is that politicians tend to be too enamored of pushing their own companies, whether they are efficient or not. The idea of a national champion is a very protectionist idea. And in some cases, where there are a lot of economies of scale, there might be some argument to be made. But I think the argument is overused. And, certainly, it seems to have been overused here.
Kate: One thing that puzzles me about this state subsidization argument is that, to me, it sort of seems like it’s analogous to predatory pricing. Right? Think about Amazon charging extra-low rates, money-losing rates on some of its products so that it acquires a dominant market share in that product. It kicks out all the competition. It has enough capital to be able to outlive them, even though it’s losing money in the short term. And, in the long run, they jack up prices. If China’s doing this by subsidizing certain sectors, then, A, doesn’t it actually help consumers from other countries, at least in the short run when that industry is being subsidized? And, B, it seems like that strategy doesn’t really make as much sense from a global perspective, because as soon as you start jacking up prices, once you’ve pushed the other competitors out, then countries can just close off trade to you. Right? They can just be like, “All right. We’re kicking you out of this industry.” And so, it seems like an incredibly risky strategy.
Luigi: Not necessarily, in the sense that we know that there are industries where organizational capabilities cannot be recreated overnight. The risk is that you do an international dumping. You drive out all your competitors. And then you are the only player in the market. I do believe that as you have antitrust at the country, or group of countries, level, like the European Union, you should have antitrust at the world level. And maybe the World Trade Organization should play that role. I don’t think that the possibility of this predatory behavior is zero. But I think there are better ways to address it than trying to do tit-for-tat and subsidize your own industry at the expense of your own consumers in order to prevent that.
Kate: Your argument for why they would be able to stick around and raise prices once they kicked everyone else out of the market is that they basically control industry know-how or trade secrets that other countries don’t have. And so, if you were to somehow impose sanctions on them, kick them out of your local market, you would lose that product or that good for a certain period of time while you caught up to their technological know-how.
Luigi: Yeah. Absolutely. I think that the standard neoclassical theory in economics ignores this time dependence and the time it takes to build some capabilities. But I think in the real world, this is quite important. And there is very important work done by Philippe Aghion and others that looks at how important it is to have competition that is not too far behind, because once the competitors are too far behind in technology, markets don’t work very well. In fact, the tendency of far-behind competitors is to give up, not to try to invest more and compete.
Kate: Right. I wonder if the optimal response isn’t some combination of allowing state subsidization by other countries plus corporate espionage. You allow, let’s say, China, to subsidize your local consumers for a short period of time by charging prices that are really low. But then you make sure that you’re meticulously taking apart their trains and their signal switches so you know exactly what the technology is, so that if you kick them out later on, you won’t be that far behind.
Luigi: Yeah. It seems that espionage has worked more the other way around, so I’m not so sure this is a viable strategy.
Kate: I think that’s true. Fair enough. This sort of reminds me of the Airbus-Boeing example in the airline industry. Right?
Luigi: Yes. In fact, politicians in Europe have used this example because they’re very proud of their Airbus success, if you want to call it that. And they claim that without Airbus today, we would have much less competition in the airplane-building industry, which is true. Now, one of the questions is: If Airbus was not around, would McDonnell Douglas and Boeing have been allowed to merge? And probably the answer would have been no. So, I think that it’s very hard to do a what-if analysis. What we do know is that, for strategic reasons, Europe is subsidizing the Airbus industry quite significantly in order to have their national champion.
Kate: Yeah. My take on this whole global antitrust policy issue is … This isn’t really my idea. I’m an acolyte of Eleanor Fox, who’s an NYU law professor, who’s been doing research on global antitrust for decades. She is a proponent of what she calls the cosmopolitan view of antitrust, or of global antitrust. I like to think of it as the “What would Jesus do” view of antitrust, which is that countries should view antitrust regulation as if they were maximizing the welfare of everybody in the world. You shouldn’t just be concerned with your own constituency. You should be concerned about everyone’s welfare.
And if that’s true, then that means that Margrethe Vestager should be thinking about people in foreign markets, people in South America, for example, where if the merger were blocked between Alstom and Siemens in the EU, that means that CRRC might be able to have monopoly power in other countries. And that would hurt citizens of other countries. But at the same time, all right, if that creates a regional or a local monopoly, then they need to lower barriers to entry within the EU to let China come in and compete locally. So, it’s a little bit counterintuitive. But I think that it actually makes sense in the long run.
Luigi: I have to say I’m incredibly impressed by Margrethe Vestager, because her decision was not easily explainable from political considerations. She is one of the candidates to become the head of the European Commission after the European election in May of this year. And clearly annoying the two largest countries and the two most powerful countries in Europe, Germany and France, does not seem to be an obvious way to gain that position. I think that we have to give kudos to the European institutions and the European leaders to have been able to do something that was not obvious from a political point of view. There is a pretty important cost that she’s paying at this moment.
Kate: There’s another point that I think is interesting, which is: What does a world look like when you have a bunch of major players, most of whom decide to enact antitrust policy on a regional level? The United States says, for example, “We’re going to protect American companies. We’re not going to let foreign companies in. And we’re going to enact antitrust regulation within the US.” And then the European Commission does that too in Europe, so that they’re allowing for competition amongst European companies, but they’re not letting foreign companies in. And then in the rest of the world, you have one major player, let’s say China, that’s amassing very serious economic influence in the remaining regions where they don’t have a champion in a particular industry. Aren’t there serious political economy consequences down the road that Vestager might be overlooking?
Luigi: I see two potential problems. Number one, if you really think that there are enormous economies of scale and that the bigger companies will dominate the world, this behavior will favor Chinese companies over American or European companies. I tend to believe that except when it comes to data, or except in some specific circumstances, this is not such a huge problem that deserves to be treated so aggressively. Now, the second point is: What happens to the countries that are not protected by any antitrust rules? Who is going to dominate those countries? I think that in that sense, it’s not obvious why the Chinese should dominate, because American and European companies can try to consolidate those operations without getting into trouble with any authority. So, I think that it is a [far west], and is a [far west]for everybody.
Kate: OK. I still think that maybe if it’s just limited to rolling stock, then we don’t need to be too worried. But if it comes to all manufactured goods, and we end up looking at markets like South America and Africa that end up importing most of these goods from China at the end of the day, I think that does allow them to amass a significant amount of political influence in those countries. Even if we’re competing with China, we being the US or Europe, in high-tech industries, I think that if they become the single, dominant, monopolistic manufacturing power in major regions abroad, I think that’s reason to be concerned from a political perspective. Agree to disagree on that one.
The approach of the European Commission towards this merger seems to be one of, oh, company A combines with company B. They have over X percent of the market in this product. That’s too much. We’re not going to allow it to happen. Isn’t that sort of an outdated view of antitrust policy?
Luigi: Certainly, an approach that looks very regionally at market share and puts a very strong cap on market share is considered old-fashioned and probably outdated. However, I don’t think that’s what the commission is doing. And the discussion we had before proves it. It looks very differently at, for example, the signaling component where there is a really dominant market position, and the rolling stock component where this is less problematic. But it looks at, also, the ability to enter. Some people claim that market share is irrelevant as long as there’s free entry. The tension which we have seen playing out in the debate after the EU decision is whether we should have an antitrust policy.
I think that the people in favor of a complete laissez-faire approach, where the government will not intervene in any situation, believe that these costs are minimal, and that the costs of the government intervening and meddling with the market system are bigger than the distortion created by monopolies. I disagree with that, especially when you tend to delegate this authority, not to a capricious government, but to an institution with some constraints like the European Commission on Competition, that has some objective standards on deciding whether the market power is excessive or not, and has the courage to stand up to political pressure, as Margrethe Vestager seems to have done. So, I think that under the proper institutional constraint, the benefit of the antitrust policy outweighs the cost of having it.
Kate: I think that it’s clearly not true that the government is the only source of monopolistic power. Think about very high capital-intensive projects. Or think about industries in which there are a lot of network externalities. Think about why Google search engine is so dominant. It’s not because ... Maybe there are certain government regulations that are involved, but really, it’s because everyone uses Google. And that’s what makes Google better. And I think that there’s plenty of historical examples of how natural monopolies can arise, which is why we need antitrust regulators.
You seem to take a pretty rosy view on Margrethe Vestager’s decision here. I think just because she opposed political influence coming from France and Germany doesn’t necessarily mean that it’s the right decision. And I think that we need to keep in mind that the way that the incentives are set up in the European Commission seem to be that if you care about your own local election outcomes, by local I mean within your own country, that can lead you to make decisions that aren’t necessarily best from a regional EU perspective.
Luigi: I think that this decision is good on its merits. And I am positively surprised, and it doesn’t happen very often to me, I’m positively surprised that it did take place in spite of the powerful interests. So, I think we should spend some time thinking about why it worked in this case, so as to make it possible in other cases. There are plenty of examples of mergers that did go through because of political pressure, both in the United States and in Europe. I think that it is refreshing to see an example of the opposite.
Kate: I disagree with you on this one. I appreciate that Vestager seems like a good leader. And I think that she was acting in the interests of European consumers. But I think that she was not acting in the interests of global consumers. And I think putting up protectionist policies in which you’re only regulating the EU market, and you’re not letting in foreign competitors, I think that, at the end of the day, leads to a toxic global antitrust environment.
Luigi: Wait. I’m not so sure why she’s hurting consumers around the world.
Kate: Because if CRRC, this Chinese railway company, is the dominant player in, let’s say São Paulo, as you mentioned earlier, then the consumers there might be worse off, because the CRRC can charge higher prices for them. If we look at how big of a market share China has amassed globally, and if we consider that it couldn’t enter certain markets, such as Europe, because it didn’t meet qualifications, it makes me a little nervous that this does seem sort of like a natural monopoly situation, in which what’s going on is that China’s taking over this market in countries which it’s allowed to enter. And there are protections being put up in certain regions, such as the EU, that allow for a different type of market locally, but that everywhere else consumers will be hurt because there isn’t a natural monopoly situation going on.
Luigi: An internal market is an advantage only to the extent it is protected and is not open to free trade. Sweden is a small country, especially in terms of people, but it has many large multinationals. Why? Because they’ve been able to export all over the world. So, I think that if there is a problem here, and I agree with you that there is a problem, the problem is China is too protectionist and does not open its market to foreign competition. And many of the purchases are captive purchases. And so, we should ask ourselves whether, number one: Was it a good idea to let China in the World Trade Organization without imposing that China plays by market rules? And I think that now that we have already done that, we should decide whether we should apply more pressure to force China to play by market rules. If China does not play by market rules, then I think that other countries feel legitimized to do the same. And then we are in a situation of a race to protectionism that will be detrimental to everybody.
Kate: I just think that Vestager’s decision is a race to protectionism. And what it does is that it meets China in terms of what China’s policies have been on European grounds, but it leaves a void in the rest of the world where they don’t have a natural competitor to be able to deal with China.
Luigi: I disagree. I think in the rest of the world, Alstom and Siemens are competing fine. And the rest of the world benefited from having two instead of one extra competitor. We know that auctions when you have two or three players tend to not lead to market outcomes. You have to have at least four or five players. An extra player makes a gigantic difference, not just for European countries, but for all the countries.
Kate: OK. But then you’re making the argument that the synergies aren’t as big as they proposed, that these economies of scale of being one large firm in a global market, they’re overblown.
Luigi: I think that, yeah, I do agree. I think they are overblown. And I think that even looking at their numbers, it seems that a lot of the synergies that they present are in reducing the prices for their suppliers and reducing administrative expenses. They don’t talk about these gigantic benefits of R&D. This is looking at the merger plan between Alstom and Siemens, so I think that they’re not as big as we make them to be.
Kate: All right. Well, if your argument is that large corporations tend to overstate the value of synergies, then I agree with you on that one.
Luigi: That’s an easy one.