Competitors should be allowed to cooperate to reduce the emission of greenhouse gases and contribute to the Paris Agreement’s goals to prevent climate change. It is fair and efficient to exempt such cooperation from the competition laws, if the total benefits of the cooperation outweigh the negative effects on prices and choice for the consumers of the cooperating companies. In its draft Horizontal Guidelines, the European Commission seems to require that for this balancing exercise only a proportionate part of the total benefits relative to the group of affected consumers can be used to outweigh the negative effects, and that the balance should be at least neutral. In essence, this interpretation would require that the consumers who are responsible for the emission of greenhouse gases, need to be compensated in full for the costs of not contributing to climate change. That is simply not fair and not efficient, and will block impactful cooperation among competitors to reach the Paris Agreement’s goals.
What is fair and efficient in the face of climate change?
Speech by Martijn Snoep, Chairman of ACM (The Netherlands Authority for Consumers and Markets), at the Swedish Competition Authority’s annual seminar “The Pros and Cons” on 30 May 2022
Ladies and Gentlemen,
If you have difficulty imagining what the consequences of climate change are, I advise you to read the Ministry for the Future by Kim Stanley Robinson. It is a work of hard science-fiction. It’s fiction, but based on hard science. The book starts with a gloomy picture of a not too distant future in which the world is confronted with the real life consequences of climate change. The most haunting chapter of the Ministry for the Future is the extreme heatwave in India which is killing millions of people. Current events in India could be just a prelude to what is still to come. The book makes very clear that the consequences of climate change were caused by the failure of all of us, today, to implement the 2015 Paris Agreement in a proper and timely manner. And it’s a fact and not science fiction, that we are indeed not on track to meet the Paris Agreement’s goals.
We are facing what could be the biggest market failure and the biggest regulatory failure in the history of mankind. This market failure is caused by the negative externalities of the production and consumption of many of the products and services we consume. They come with significant hidden costs that are not included in the price, the costs of climate change. And we are passing on the bulk of these costs to the world’s children and their children’s children.
In addition to this market failure, there is also a regulatory failure. Preferably, governments step in to redress market failures through regulation, either by imposing output restrictions, like emission limits, or by imposing taxes on consumption to incorporate the negative externalities in the price, or by doing a bit of both. But if governments would do so to prevent climate change, products and services will inevitably become much more expensive. And therein lies the problem. Citizens will have to pay more now, in order to avoid the no-doubt much higher costs of climate change in the future. However, we have a short-term political cycle and future generations, who will ultimately bear the bulk of these costs, are underrepresented in our political process. As we can see all around us already, this will make it extremely hard for governments to introduce regulation that will lead to price increases at or close to the “ true price” , being the price which incorporates the negative externalities.
And what about the companies themselves? Can’t they provide a breakthrough by turning their climate-endangering production processes into more climate friendly ones, voluntarily? I’m sure they would be able to do so technically, at least overtime, but they need a business case. If the willingness to pay of consumers for climate-neutral products and services is lower than the climate-neutral cost price, and the cheaper, climate-endangering alternative is still available, there will be no business case. Do we really believe that consumers are able to overcome their bias for the present – that is to say: not giving more weight to short term payoffs (low prices) than to long term ones (no climate change)? Our behavioral research – measuring revealed preferences as opposed to stated preferences – shows that the temptation of lower prices is simply too strong, regardless the amount of information that is given on the product’s impact on climate change. And this even assumes that consumers are able to pay the higher prices, while in reality we know that in many countries large groups of consumers live from hand to mouth and simply cannot afford to pay more for their basic necessities such as food, heating and transportation.
So we have a market failure. We have governments incapable of doing what is necessary out of fear of losing the current electorate. And we have businesses incapable of doing what is necessary out of fear of losing customers. But there is some hope coming from three other stakeholders: capital, labor and the courts.
More and more investors and banks with long-term perspectives, fuelled by ESG-rules, demand more climate action by the companies in which they invest. Also, in the hunt for talent, current and future employees of companies increasingly expect more climate action from their employers. Recently, UN Secretary General even called on graduates not to join “climate wreckers”, companies which are destroying the climate. And in addition to pressure from capital and labor, there are also the courts. Particularly in Europe, public interest litigation is putting significant additional pressure on companies to change their production processes.
But these pressures are not felt evenly across the world. Faraway competitors may face very different realities. Also, there can be a difference between publicly held and privately owned businesses and between local and overseas ownership. And the intensity and demands from talent may differ across regions. And nowhere is the pressure from public interest litigation stronger than in Western Europe. As a result, there is no international level playing field when it comes to external pressures to turn companies to climate-neutral production processes, which is adding to the first mover disadvantage.
So in the midst of the market failure, the regulatory failure and the uneven external pressures, is there a way out? Yes there is, that is if everyone is ready to play its part.
First, to add to the necessary democratic legitimacy, governments should set clear and measurable climate-change reducing goals for each relevant sector of the economy, combined with a trade adjustment mechanism to protect against imports from countries without such goals. The general goals of the Paris Agreement, the more concrete goals of the European Green Deal and the proposal for a Carbon Border Adjustment Mechanism are all steps into the right direction. Now, all governments should set specific goals per sector.
Second, governments should put in place tax measures to gradually compensate low-income consumers for the increased costs of living, in particular when it comes to basic necessities. The harsh reality is that we can no longer bank on future generations, so the cost of living for today’s citizens will increase. But this should and can only be done in a way that provides a realistic perspective for people with low incomes.
And third, in order to avoid the government having to micro-manage the economy, each economic sector should sit down to assess how these sectoral goals can be met, preferably individually by companies themselves, or through vertical cooperation in the supply chain, or, if that is indispensable for reaching these goals, through horizontal cooperation among competitors. Such cooperation could, for example, consist of agreements to jointly phase out polluting production processes, to jointly develop new production processes and produce climate-neutral inputs or to jointly stop selling products that negatively impact the climate. It is important to note that such agreements should not – for lack of indispensability – include any agreement on the price of climate-neutral products and services. The competitive process for these products and services should function unfettered by the cooperation.
So, in this third part, we, the competition authorities around the world, have to play our role, because traditionally any horizontal cooperation among competitors is frowned upon by us as it may restrict certain parameters of competition. We are the ones holding the key to this part.
In the chapter on sustainability in the draft Horizontal Guidelines, the European Commission reveals how it intends to use this key. The draft is definitely a big step in the right direction but it does not bring the clarity much needed, namely guidance on allowing indispensable, impactful cooperation among competitors to reduce the emission of greenhouse gasses to meet the goals of the Paris Agreement and to avoid the drastic consequences of climate change.
Any meaningful cooperation to incorporate these negative externalities will have a significant effect on prices and is likely to exceed the average consumers’ willingness to pay. Therefore, these types of cooperation critically depend on the Commission’s assessment whether consumers are getting a “fair share” of the benefits within the meaning of EU competition law.
And, contrary to the ACM’s draft sustainability guidelines, this is precisely where the Commission’s draft guidelines stop short of providing sufficiently precise guidance. In particular, two policy-driven interpretations by the Commission are creating confusion and could make it virtually impossible to meet the fair share test in practice.
First, the Commission seems to insist that a fair share means that the balance of the harms (the price increase or reduction of choice) and the benefits (the contribution to no climate change) seems at least neutral for the consumers of the products or services negatively affected by the cooperation and that benefits should fully compensate for the harms. But why do these consumers need to be compensated in full for the costs of not contributing to climate change? Wouldn’t it be fairer (and economically more efficient compared to the counter factual, i.e. no agreement en no regulation) to leave the consumers – who are also the polluters – uncompensated for the harms, as long as the cooperation has a total net positive effect for the world, including these consumers?
Second, in situations where the benefits are global, like avoiding climate change, according to the Commission, the Commission seems to suggest that only a proportionate amount of those benefits can be used in the fair share test. So, for example, in the case of a European-wide agreement to reduce the impact of emissions from fossil fuel cars, the higher price or reduction of consumer choice will affect the entire European population of car owners. The benefits from the agreement will affect the entire world. But as Europe only has 5% of the global population, in the Commission’s logic, not more than 5% of these collective benefits can be used for the fair share test. So even if the idea that fairness implies a neutral balance of the harms and benefits for the consumers, the benefit-allocation restriction would make the fair share test insurmountable in practice.
The root cause of the problem is that the Commission lumps together all ESG-related sustainability benefits ranging from animal welfare to greenhouse gas reduction, subjecting them to the same fair share test and ignoring the context and in particular whether there are negative externalities of the size and magnitude of climate change. From an economic perspective such hard and fast rules do not promote efficiency and from a legal perspective they are not fair. You always have to look at the context to identify what is fair. Full compensation can indeed be fair and efficient in some situations but not fair and efficient in other ones.
To be more specific, and in line with the ACM’s draft sustainability guidelines, I understand the rationale of the Commission’s policy to stick to full compensation (or consumer neutrality) when there are no negative externalities. For example, consumers who are eating meat from maltreated animals are not inflicting harm on other people, now or in the future. In that case, requiring full compensation by benefits appreciated by these consumers is justifiable. But why do business class travellers need to be fully compensated for the harms inflicted by a hypothetical agreement between airlines that requires to take into account the negative externalities of flying?
Therefore, in the case of agreements that aim to redress these negative externalities, there is no sensible justification for requiring that the consumers need to be compensated in full for, in essence, not contributing to climate change. That is simply not fair and not efficient.
What is fair and efficient in the face of climate change, is that an agreement that is indispensable for the agreement’s contribution to the reduction of the emission of greenhouse gases is exempted from the competition laws, if the total benefits outweigh the negative effects on prices and choice for the consumers negatively affected by the agreement. That is the type of fairness and efficiency we need in the face of the dramatic consequences of climate change. And since the Commission is holding the key, I hope that the Commission will clarify in its draft guidelines that this is indeed the case.