Contestability ‘theory’, its links with Australia’s competition policy, and recent international trade and investment agreements
Citation: Colton, Caroline. (2017). 'Contestability 'Theory', Its Links with Australia's Competition Policy, and Recent International Trade and Investment Agreements' Australian Journal of International Affairs, 71 (3):315-334.
Published online at http://www.tandfonline.com/doi/full/10.1080/10357718.2016.1258690
ABSTRACT: This article examines how contestable market theory (contestability) has come to reconfigure the economic and regulatory concept of competition in order to enhance the compatibility of Australia’s economy with international trade and investment agreements. Australia has recently negotiated and signed a raft of bilateral, plurilateral and regional agreements, including the Trans-Pacific Partnership Agreement and the Australia–China Free Trade Agreement. In order to ensure that Australia meets its obligations and commitments to these agreements, two key advisory bodies—the Harper Panel on Competition Policy Review and the Financial System Inquiry—made recommendations, the majority of which were accepted by the government, to ready Australia’s competition governance and economic policy for greater global integration. Such impact is dependent on, among other things, how domestic competition policy meshes with the free market ideology underpinning such international agreements, which favours the breakdown of barriers to markets. Less well known is the role of contestability in radicalising ideology as it countenances monopolisation and privatisation in the guise of market access by justifying the substitution of actual competition with the mere threat of competition. The article concludes that the monopoly power of transnational corporations will be enhanced through the acquiescence of governments to the new governance regime of the Trans-Pacific Partnership Agreement, which, supported by domestic policy, is set to redraw competition policy in the light of contestability theory. <p. 315>
KEYWORDS: Competition and Consumer Act 2010, competition law, competition policy, contestability, contestable market theory, investment, investor–state dispute settlement (ISDS), market access, trade liberalisation, Trans-Pacific Partnership Agreement (TPPA)
Introduction
Secret for over a decade, the text of the Trans-Pacific Partnership Agreement (TPPA) was finally placed on public display only after negotiations were successfully concluded in Atlanta on October 6, 2015. Its release, however, has not dispelled the uncertainty regarding its final scope, demonstrated when, on October 26, President Joko Widodo announced that Indonesia would become a party to the agreement (Hirschfeld Davis 2015). More countries are expected to join under the US‒ASEAN Expanded Economic Engagement (E3) Initiative (US Department of State 2013). The 12 signatory countries generate
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nearly 40 percent of the world’s gross domestic product (GDP), with the USA, the lead nation, contributing more than half at 22 percent GDP.
The TPPA is a powerful articulation of economic cooperation and agreement, a singular achievement of the 600 or so negotiators representing transnational corporations. The breadth of their success in economically integrating the Asia-Pacific region on terms that meet corporate ambitions is both history in the making and history in the writing, entrenching as normative the primacy of economic outcomes over national legal principles and sociopolitical values.
In this article, I examine the influence of contestable market theory (contestability) on both trade and investment agreements such as the TPPA, and Australian economic and regulatory policy, examining its function as a conceptual framework encompassing both the national and international spheres and directing national policy efforts towards meeting obligations and commitments to the agreements.
The article begins by outlining the origins and key precepts of contestability theory and drawing the links between contestability and free market economics. In examining the origins of contestability, the article examines how the international policy community adopted contestability as an advocacy tool to promote market access, a process that began with the development of the General Agreement on Trade in Services (GATS) framework, which formed the basis for all subsequent trade and investment agreements under the auspices of the World Trade Organization (WTO).
The article then moves to its central argument that contestability theory in domestic economic and regulatory policy is a key thread that joins the Australian economy to international markets via Australia’s obligations and commitments to international agreements. The argument is drawn from an analysis of reports from two government advisory bodies—the Harper Panel on Competition Policy Review and the Financial System Inquiry, both published in 2015. In this frame, contestability’s influence on policy is set against five key areas on which the advisory bodies made recommendations. These are addressed by the article in turn, beginning with competition policy and law, and moving on to investment, financial services, infrastructure investment and procurement. In each of the five sections, the recommendations are juxtaposed against the provisions of the TPPA, with minor referencing to other agreements. The analysis aims to reveal the connections between each of the key areas and the vulnerabilities implicit to that connectivity, not just domestically but globally. Also included under investment is investor–state dispute settlement (ISDS), a new form of enforcement of competition policy and law in Australia created through a process of regulatory coherence with the provisions of ISDS subject agreements.
In conclusion, this article contends that contestability, in extending the perfect competition thesis to monopolies, has added a radical dimension to ‘Hayekian’ free market ideology, which bolsters the power of transnational corporations at the expense of national economic management.
Origins of contestability theory
Contestability theory was conceived in the 1970s by teams of US economists led by William Baumol from Princeton University and New York University, and Elizabeth Bailey from Bell Laboratories, the research arm of telecommunications giant AT&T.
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The theory rose to global prominence as international contestable markets around the time of the formation of the WTO in 1995, and has since played a key role in establishing efficiency and market access as the raison d’être of the Australian economy and the international trade community.
‘Contestability’ is a theory of industrial organisation which claims that even a monopoly will behave competitively if there are no barriers to entry or exit to the market in which the monopoly is operating. Under these conditions, entry into the market is absolutely free and exit is costless, meaning that an ‘entrant suffers no disadvantage’ in terms of cost or production (Baumol 1982, 3–4). The ease of moving in and out of the market will attract potential competitors, thus forcing the incumbent to behave competitively—that is, maintain low prices, often called the ‘entry limit price’. Even unregulated monopolies will not take supernormal profits, as this would encourage new entrants. An incumbent’s purported ‘vulnerability to hit-and-run entry’ by profit-takers is the crucial feature of a contestable market (Baumol 1982, 4).
The theory’s mathematical proofs and textual analysis are all calibrated for results in ‘perfectly contestable markets [which] do not populate the world of reality’ (Baumol 1982, 2). The mismatch between theory and reality is not uncommon in economics and results in one of the discipline’s greatest weaknesses: its poor predictive capabilities (Coats 1993, 60). Contestable market conditions, in actuality, can never be fully realised as they require the absence of sunk costs (such as manufacturing plant or marketing), no consumer brand loyalty, and parity between incumbents and entrants with regard to knowledge and productive capacity. In the world of practice, the authors have only claimed a modest ‘benchmarking’ function, using degrees of contestability to identify the most efficient industrial organisation (Baumol 1982, 2).
When, in his presidential speech to the American Economic Association in 1981, Baumol announced the theory in terms of a ‘rebellion or uprising’, he was invoking the theory’s superior doctrinal status by claiming a ‘unifying analytical structure’ (Baumol 1982, 1), which took account of the size and number of firms from monopoly to many, thus sharing its theoretical frame with perfect competition modelling. Baumol (1982, 2) proclaimed: ‘the invisible hand holds sway. In a perfectly contestable world it seems to rule almost everywhere’.
Contestability theory renders systematically a perspective of monopoly–oligopoly industry structures that is compatible with free market ideology; once carried into the policy space by economists and free market ideologues, it has been used to advocate for the removal of barriers to market entry and exit, such as regulations and taxes. Paradoxically, far from subverting the basic principles of free market capitalism, contestability has come to radicalise the free market agenda. Just how radical that agenda has become in Australia is reflected in the various positions of advisors to Australian governments, even to the point of asserting that government providers are themselves a barrier to entry, and that private providers should prevail (Queensland Commission of Audit 2013, 2–192).
Finding a solution to the problem of uncompetitive monopoly behaviour had long vexed economists, including Milton Friedman and Friedrich Hayek, champions of trade liberalisation and free markets. Friedman (1999, 7) wanted to abolish antitrust designed to constrain monopolies, believing it stymied competition, which would naturally emerge if markets were unregulated. For Hayek (1935, 169), utilities, in particular,
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posed ‘[t]he problem of how, in the absence of real competition, the effects of competition could be simulated and the monopolistic bodies be made to charge prices equivalent to competitive prices’. He did not find a solution, but pointed to the need for one.
Hayek was an internationalist who vehemently believed that it was possible to create what he variously referred to as an interstate federation and an ‘international system of coordination’ guided by the price mechanism in a free market, if inflation was controlled and economic barriers removed, thus allowing a ‘self-directing automatic system’ to function (Levin and Hayek 1980). For Hayek (1939, 131), an interstate federation ‘would do away with impediments as to the movement of men, goods and capital between the states and … would render possible the creation of common rules of law, a uniform monetary system, and common control of communications’. Together with Friedman, who travelled extensively promoting monetarism (as a means of containing inflation) and free markets by way of macroeconomic policies such as deregulation and privatisation, he established an ideological position which became fertile ground for contestability, a theory that proposed furthering the breakdown of regulatory and other barriers.
International contestability of markets
Contestability theory first entered the slipstream of international trade policy in the mid 1990s as a ‘policy advocacy’ tool used by senior officials from the Organisation for Economic Co-operation and Development (OECD) and European Commission (Beviglia Zampetti and Sauvé 1996, 337). They saw its usefulness not as a theory whose calculus could be applied to international markets, but as a ‘notion’ in setting new objectives for market access in the multilateral trading system, ‘so as to further its adaption to the evolving reality of deep integration and the needs of globally-active firms’ (ibid.).
Sir Leon Brittan (1995b, 767), former vice-president of the European Commission and Home Secretary in Margaret Thatcher’s government, had clarified the goal of market access, stating that: ‘GATT [General Agreement on Tariffs and Trade]-style trade liberalization was second best to free trade’. The European Commission was to lead in the formation of the Working Group on Trade and Competition Policy within the WTO, established in the wake of the conclusion of the GATT and GATS Uruguay Round (Graham and Richardson 1997, 4). This marked a perceptible shift in thinking within the trade policy community. Orthodox ideas of competition gave way to a broader approach which sought to achieve competitive parity for ‘foreign competitors’ wishing to enter local markets—in other words, contestability.
Market access was akin to removing country-based distinctions between competitors, which focused initially on border barriers such as goods tariffs and quotas, then later on behind-border barriers such as labour laws and capital controls, which impacted services provision and investment (Young 1999, 185). The world economy was to move towards greater integration as developing countries and transition countries (the former communist states) were absorbed into the market-based world economy. This broad approach was defined as one ‘that embraces the continuum of trade, investment and competition policies, its chief focus being on the need to stem anti-competitive practices that impede what has come to be called the “international contestability of markets”’ (Sauvé 1996, 38).
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Deep integration was framed as the removal of ‘artificial or bureaucratic distinctions between goods, services, ideas, investments/investors and business people’ (ibid.). This trend in international agreements brought the trade policies of nation states into greater alignment with multinational corporations wanting to move goods, services, capital and people unimpeded to their business units and markets around the globe. In order to create internationally contestable markets, the barriers impacting these business models needed to come down. Market access and globalisation, in effect, were conflated with contestability (Graham and Richardson 1997, 20). Contestable market conditions are characteristically free of competitive impediments from both the private and public sectors: ‘the competitive process should not be unduly impaired or distorted by the totality of potential barriers to contestability’ (Sauvé 1996, 38).
Contestability in this period had nudged the perception of competition as an end in itself to one that focused on competitive conditions. No longer did a case have to be made for more competition per se. It was the addendum to competition, or the threat of it, which upended the economic orthodoxy. Contestability simultaneously justified removing barriers to trade and investment to promote competitive conditions and legitimised corporate consolidation into monopoly–oligopoly industry structures by claiming that there were no barriers to entry in a contestable market. In supporting these structures, it claimed to focus on the outcomes of efficiency and fairness (Graham and Richardson 1997, 9) or, later, efficiency and community welfare (Productivity Commission 2014, 2). Competitive conditions producing an attendant efficiency outcome, not competition per se, were the new primary goal.
The work of reconceptualising and redefining the multilateral governance overseeing this new role for competition in trade policy came through GATS 2000, the WTO’s Millennium negotiating round that would set the trade liberalisation agenda for the global services sector and complete the multilateral framework building on the initial GATS ratified in 1995. Increased liberalisation for the sector was projected to reap an additional US$130 billion annually (Dee and Hanslow 2000, vii). Investments in host countries and greater mobility for service suppliers (labour) were key concerns for an enhanced GATS framework of rules and disciplines, which were to be foundational to all subsequent trade and investment agreements.
Fundamental to the GATS 2000 approach was competition policy and the efficiency precept underlying it, influenced by contestability theory. This was considered imperative to achieving coherence between the culturally nuanced competition policy and law of nation states and competition policy at the international level: ‘without the integration of competition policy disciplines in some manner, it will be very difficult politically for countries to make the necessary reciprocal market access concessions that are essential to move beyond the status quo’ (Warner 1999, 396).
International agreements and advisory body recommendations
Australia has signed numerous trade and investment agreements in the past decade, the most significant being the TPPA, which is the regional behemoth in a loose federation of agreements including the Regional Comprehensive Economic Partnership, bilateral agreements with its Asia-Pacific neighbours, and the plurilateral Trade in Services Agreement and Government Procurement Agreement, which Australia applied to join in 2015.
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Collectively, they form a strong ‘laminate’ structure as they co-exist and cross over each other. The TPPA is companioned by the Transatlantic Trade and Investment Partnership currently being negotiated between the USA and European Union, thus completing the binary structure of the international trade and investment system from the perspective of the US Department of State (Russel 2014).
In determining the reach of changes to domestic competition policy to meet obligations in agreements, the recommendations of two advisory bodies are particularly relevant. The Harper Panel on Competition Policy Review and the Financial System Inquiry were both short-term consultative bodies appointed by the Abbott government in 2014. Members were drawn from transnational consultancies, investment banks, foreign hedge funds, corporate law, foreign and Australian think tanks, and universities. Some members had OECD and government experience. An important adjunct to the Harper Panel’s review was the submission on competition policy made by the Productivity Commission, a permanent independent statutory authority established by the Howard government in 1998 to make recommendations to government on a broad remit of economic and social issues.
Competition policy and law
The Harper Panel was given the task of ensuring that ‘the competition provisions of the Competition and Consumer Act 2010 (CCA) … are driving efficient, competitive and durable outcomes, particularly in light of … increased integration into global markets’ (Harper et al. 2015, 526). In a radical move that will place government activities on the ‘same footing as private parties’ (279), in accordance with the TPPA, the panel has recommended that the anti-competitive conduct provisions of the CCA should reach beyond government businesses to cover ‘government activities that have a trading or commercial character’ (31). The rationale behind this recommendation is that: ‘The Crown (whether in right of the Commonwealth, state and territory, or local governments) has the potential to harm competition through its commercial arrangements entered into with market Participants’ (ibid.). Such a blanket change goes far beyond state-owned enterprises and other commercial enterprises to cover all government activities which are contestable—that is, which a private provider could perform. It thereby arguably embraces most of government, given the private sector’s capacity to plan and implement policy and deliver services. This view is supported by the panel’s conclusion that: ‘government should not be a substitute for the private sector where … contestability can be realised’ (526).
That realisation is being rolled out through the federal government’s Contestability Programme run by the Department of Finance, whereby Commonwealth entities are now subject to a Contestability Framework. This framework was introduced by the 2014–15 federal budget. It aims to find ‘alternative structures, processes or provider arrangements’. The ‘notion of contestability’ is used to shift the emphasis from the function to be carried out to the desired outcome government seeks to achieve for government functions (Department of Finance 2015b).
The influence of contestability is such that the panel recommended that ‘competition’ be redefined in the CCA to include competition from ‘potential imports, not just actual imports’, and service provision that was ‘capable of being rendered’ from outside the country, thereby giving the concept of ‘credible threat of import competition’ a legal
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status (Harper et al. 2015, 57). This could potentially be used to give legislative cover for monopolies and oligopolies forming in the market through mergers or the privatisation of government monopolies.
This approach is also applied to cartels, with the panel recommending the relaxation of cartel provisions in the CCA, focusing on competitive outcome. Thereby, ‘joint ventures and similar forms of business collaboration’ are allowable if they do not ‘substantially lessen competition’. An exemption for ‘trading restrictions that are imposed by one firm on another in connection with the supply or acquisition of goods or services (including IP [intellectual property] licensing)’ was also proposed on the same grounds (58).
The panel grappled with the risks of anti-competitive behaviour by, firstly, promoting the breakdown of barriers to induce competitive threats to market incumbents and, secondly, reframing the misuse of market power provisions in Section 46 of the CCA. The provisions were known to be ineffective. Cases were not getting to court, as it is difficult (and costly) to prove that a corporation has taken advantage of substantial power and did so for a ‘proscribed purpose’ generally considered to be anti-competitive (Merrett 2015).
The new version of Section 46, proposed by the panel and finally accepted by the government in March 2016, removes the need to prove intent and instead introduces an ‘effects test’—that is, ‘the proposed conduct has the purpose, or would have or be likely to have the effect, of substantially lessening competition in that or any other market’ (Harper et al. 2015, 62). The effects test substitutes for the ‘purpose test’, thereby breaking the legal nexus between ‘the degree of market power’ and ‘taking advantage’ of that power by ‘purposefully’ using it to undermine competitors. The shift from intention to effects (outcome of behaviour) means capturing ‘anti-competitive unilateral behaviour’ without constraining ‘vigorous competitive conduct’ (336), thereby claiming to fulfil the remit of competition law to protect the ‘competitive process’ (339). The panel engaged with the debates on the efficacy of an effects test, concluding along with some legal scholars that there were correct arguments on both sides (Merrett 2015; Miller 2015), leaving the merit of the changes to be ultimately measured by the tally of cases successfully prosecuted.
In lieu of the effects test, predatory pricing provisions and 2007 amendments clarifying the meaning of ‘take advantage’ were deemed ‘unnecessary’ (Harper et al. 2015, 62). To ‘take advantage’ means ‘eliminating or substantially damaging a competitor’, ‘preventing the entry of a person’ into a market, or ‘deterring or preventing a person from engaging in competitive conduct’ (CCA 2010, Section 46[1]). This change removes the causal link between industry structure (substantial market power such as monopolies) and ‘take advantage’, which effectively ‘takes “misuse” out of the “misuse of market power” test’, but will not, as argued, ‘curb their competitive behaviour’ (King and Samuel 2015)— that is, in a contestable market, as opposed to an orthodox market where competition actually exists. Here lies a difficulty contended by French (1994, 561–562) in less complex times: ‘The difficulty courts will face is in market definition and thence in determining market power. Like “market” it [market power] is a multi-dimensional abstraction which involves the making of value judgments’. The Harper report does not define a contestable market, but it does characterise competitive processes in terms of contestability, stating: ‘we must foster the smooth entry and exit of suppliers … which means lowering barriers to entry (and exit) wherever possible’ (Harper et al. 2015, 23–24). This new market type, where monopolies are theorised to behave competitively in response to
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latent threats of competition, invites the proposition that market access impeded by government policy or action could be construed as a factor in, or cause of, an anti-competitive outcome. The inventors of contestability theory correspondingly held that market access would enable the market to self-regulate, and that ‘traditional per se indicators of market performance such as concentration, price discrimination, conglomerate mergers, or vertical and horizontal integration do not automatically call for government intervention in contestable markets’ (Baumol, Panzar and Willig 1982, 465).
The comprehensiveness and circularity of the non-interventionist argument calls into question ‘normative and evaluative concepts’ (French 1994, 549) in competition law and the necessity to go beyond ‘preexisting meaning’. Paradoxically, the Harper panel may well give legal leverage to corporate consolidation, effectively privileging monopoly and oligopoly industry structures in the economy, and threatening small and medium enterprises and consumer welfare.
Aligning with the TPPA
Under the TPPA, any party to the agreement must apply its national competition laws to all commercial activities in its territory and ‘to commercial activities outside its borders that have anti-competitive effects within its jurisdiction’ (Trans-Pacific Partnership Agreement 2015, Article 16.1.2). The statement on extraterritorality infers that the actual jurisdiction of national competition laws is not girt by national borders, nor by TPPA party borders, but by the free trade area from whence a claim can come.
The enforcement of extraterritoriality in the TPPA requires the national competition laws of all parties to be synchronised, or what the TPPA denotes as ‘regulatory coherence’ (Trans-Pacific Partnership Agreement 2015, Chapter 25). To this end, the panel recommended amending Section 5 of the CCA to apply to ‘overseas conduct insofar as the conduct relates to trade or commerce within Australia or between Australia and places outside Australia’ (Harper et al. 2015, 57). The panel also considered ease of access for private actions as a way of signalling adherence to TPPA enforcement of national competition laws (ibid.). Private rights of action enable persons (including corporations) the right to seek redress, including injunctive or monetary remedies, for damages ‘caused by a violation of national competition laws, either independently or following a finding of violation by a national competition authority’ in a court or an independent tribunal (Trans-Pacific Partnership Agreement 2015, Article 16.3).
Corralling public sector activity under the national competition laws to achieve parity with TPPA obligations has been foreshadowed by framing government functions as ‘contestable’, and by vaguely defining government commerciality in reference to state-owned enterprises as being ‘orientated towards profit-making’ (Article 17.1). Government entities run the risk of their activities, including decision-making processes and policy functions, being deemed anti-competitive or to adversely impact a trading partner firm’s interests, be they a competitor provider, purchaser or investor. The New South Wales government flagged this to the panel, stating that the ‘broad application of competition laws to government commercial activities risks compromising the policy functions of government’ (Harper et al. 2015, 280). The panel concluded that the continued objective of competition law was to forge economic welfare through greater efficiency. This objective of national competition laws is also prescribed under the TPPA, along with consumer welfare
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(Trans-Pacific Partnership Agreement 2015, Article 16.1). Therefore it is not a matter of internal public policy responding to domestic needs, but rather the necessity for Australia’s competition laws to fulfil the remit of the TPPA along the terms to which Australia has already agreed.
International and ISDS protections
The role of advisory bodies in the investment sphere has been to situate competition policy and law within the context of free market economics and to accord the mechanisms necessary for Australia to integrate with the global economy. The epicentre of this change has been the global financial services sector and its appetite for investment growth.
In his March 1995 Washington speech, Sir Leon Brittan (1995a, 4), Margaret Thatcher’s envoy to Brussels and later David Cameron’s chief advisor on the UK’s ‘Open for Business’ trade campaign, said: ‘governments still sometimes find it threatening, because free foreign direct investment flows limit administrations’ ability to control and shape their country’s economic destiny’—a situation, he concluded, that was a ‘small price for allowing private sector decision makers to generate economic benefits worldwide’. Twenty years on, such reticence by Australian governments has given way to a national strategy promoting foreign direct investment, in which the investment provisions of the TPPA and bilateral agreements with China, Korea and Japan play a major facilitating role (Austrade 2015, 57). These agreements all register adherence, in one form or another, with Brittan’s ideal for foreign investors:
Published online at http://www.tandfonline.com/doi/full/10.1080/10357718.2016.1258690
ABSTRACT: This article examines how contestable market theory (contestability) has come to reconfigure the economic and regulatory concept of competition in order to enhance the compatibility of Australia’s economy with international trade and investment agreements. Australia has recently negotiated and signed a raft of bilateral, plurilateral and regional agreements, including the Trans-Pacific Partnership Agreement and the Australia–China Free Trade Agreement. In order to ensure that Australia meets its obligations and commitments to these agreements, two key advisory bodies—the Harper Panel on Competition Policy Review and the Financial System Inquiry—made recommendations, the majority of which were accepted by the government, to ready Australia’s competition governance and economic policy for greater global integration. Such impact is dependent on, among other things, how domestic competition policy meshes with the free market ideology underpinning such international agreements, which favours the breakdown of barriers to markets. Less well known is the role of contestability in radicalising ideology as it countenances monopolisation and privatisation in the guise of market access by justifying the substitution of actual competition with the mere threat of competition. The article concludes that the monopoly power of transnational corporations will be enhanced through the acquiescence of governments to the new governance regime of the Trans-Pacific Partnership Agreement, which, supported by domestic policy, is set to redraw competition policy in the light of contestability theory. <p. 315>
KEYWORDS: Competition and Consumer Act 2010, competition law, competition policy, contestability, contestable market theory, investment, investor–state dispute settlement (ISDS), market access, trade liberalisation, Trans-Pacific Partnership Agreement (TPPA)
Introduction
Secret for over a decade, the text of the Trans-Pacific Partnership Agreement (TPPA) was finally placed on public display only after negotiations were successfully concluded in Atlanta on October 6, 2015. Its release, however, has not dispelled the uncertainty regarding its final scope, demonstrated when, on October 26, President Joko Widodo announced that Indonesia would become a party to the agreement (Hirschfeld Davis 2015). More countries are expected to join under the US‒ASEAN Expanded Economic Engagement (E3) Initiative (US Department of State 2013). The 12 signatory countries generate
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nearly 40 percent of the world’s gross domestic product (GDP), with the USA, the lead nation, contributing more than half at 22 percent GDP.
The TPPA is a powerful articulation of economic cooperation and agreement, a singular achievement of the 600 or so negotiators representing transnational corporations. The breadth of their success in economically integrating the Asia-Pacific region on terms that meet corporate ambitions is both history in the making and history in the writing, entrenching as normative the primacy of economic outcomes over national legal principles and sociopolitical values.
In this article, I examine the influence of contestable market theory (contestability) on both trade and investment agreements such as the TPPA, and Australian economic and regulatory policy, examining its function as a conceptual framework encompassing both the national and international spheres and directing national policy efforts towards meeting obligations and commitments to the agreements.
The article begins by outlining the origins and key precepts of contestability theory and drawing the links between contestability and free market economics. In examining the origins of contestability, the article examines how the international policy community adopted contestability as an advocacy tool to promote market access, a process that began with the development of the General Agreement on Trade in Services (GATS) framework, which formed the basis for all subsequent trade and investment agreements under the auspices of the World Trade Organization (WTO).
The article then moves to its central argument that contestability theory in domestic economic and regulatory policy is a key thread that joins the Australian economy to international markets via Australia’s obligations and commitments to international agreements. The argument is drawn from an analysis of reports from two government advisory bodies—the Harper Panel on Competition Policy Review and the Financial System Inquiry, both published in 2015. In this frame, contestability’s influence on policy is set against five key areas on which the advisory bodies made recommendations. These are addressed by the article in turn, beginning with competition policy and law, and moving on to investment, financial services, infrastructure investment and procurement. In each of the five sections, the recommendations are juxtaposed against the provisions of the TPPA, with minor referencing to other agreements. The analysis aims to reveal the connections between each of the key areas and the vulnerabilities implicit to that connectivity, not just domestically but globally. Also included under investment is investor–state dispute settlement (ISDS), a new form of enforcement of competition policy and law in Australia created through a process of regulatory coherence with the provisions of ISDS subject agreements.
In conclusion, this article contends that contestability, in extending the perfect competition thesis to monopolies, has added a radical dimension to ‘Hayekian’ free market ideology, which bolsters the power of transnational corporations at the expense of national economic management.
Origins of contestability theory
Contestability theory was conceived in the 1970s by teams of US economists led by William Baumol from Princeton University and New York University, and Elizabeth Bailey from Bell Laboratories, the research arm of telecommunications giant AT&T.
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The theory rose to global prominence as international contestable markets around the time of the formation of the WTO in 1995, and has since played a key role in establishing efficiency and market access as the raison d’être of the Australian economy and the international trade community.
‘Contestability’ is a theory of industrial organisation which claims that even a monopoly will behave competitively if there are no barriers to entry or exit to the market in which the monopoly is operating. Under these conditions, entry into the market is absolutely free and exit is costless, meaning that an ‘entrant suffers no disadvantage’ in terms of cost or production (Baumol 1982, 3–4). The ease of moving in and out of the market will attract potential competitors, thus forcing the incumbent to behave competitively—that is, maintain low prices, often called the ‘entry limit price’. Even unregulated monopolies will not take supernormal profits, as this would encourage new entrants. An incumbent’s purported ‘vulnerability to hit-and-run entry’ by profit-takers is the crucial feature of a contestable market (Baumol 1982, 4).
The theory’s mathematical proofs and textual analysis are all calibrated for results in ‘perfectly contestable markets [which] do not populate the world of reality’ (Baumol 1982, 2). The mismatch between theory and reality is not uncommon in economics and results in one of the discipline’s greatest weaknesses: its poor predictive capabilities (Coats 1993, 60). Contestable market conditions, in actuality, can never be fully realised as they require the absence of sunk costs (such as manufacturing plant or marketing), no consumer brand loyalty, and parity between incumbents and entrants with regard to knowledge and productive capacity. In the world of practice, the authors have only claimed a modest ‘benchmarking’ function, using degrees of contestability to identify the most efficient industrial organisation (Baumol 1982, 2).
When, in his presidential speech to the American Economic Association in 1981, Baumol announced the theory in terms of a ‘rebellion or uprising’, he was invoking the theory’s superior doctrinal status by claiming a ‘unifying analytical structure’ (Baumol 1982, 1), which took account of the size and number of firms from monopoly to many, thus sharing its theoretical frame with perfect competition modelling. Baumol (1982, 2) proclaimed: ‘the invisible hand holds sway. In a perfectly contestable world it seems to rule almost everywhere’.
Contestability theory renders systematically a perspective of monopoly–oligopoly industry structures that is compatible with free market ideology; once carried into the policy space by economists and free market ideologues, it has been used to advocate for the removal of barriers to market entry and exit, such as regulations and taxes. Paradoxically, far from subverting the basic principles of free market capitalism, contestability has come to radicalise the free market agenda. Just how radical that agenda has become in Australia is reflected in the various positions of advisors to Australian governments, even to the point of asserting that government providers are themselves a barrier to entry, and that private providers should prevail (Queensland Commission of Audit 2013, 2–192).
Finding a solution to the problem of uncompetitive monopoly behaviour had long vexed economists, including Milton Friedman and Friedrich Hayek, champions of trade liberalisation and free markets. Friedman (1999, 7) wanted to abolish antitrust designed to constrain monopolies, believing it stymied competition, which would naturally emerge if markets were unregulated. For Hayek (1935, 169), utilities, in particular,
——— end page 317 ——--
posed ‘[t]he problem of how, in the absence of real competition, the effects of competition could be simulated and the monopolistic bodies be made to charge prices equivalent to competitive prices’. He did not find a solution, but pointed to the need for one.
Hayek was an internationalist who vehemently believed that it was possible to create what he variously referred to as an interstate federation and an ‘international system of coordination’ guided by the price mechanism in a free market, if inflation was controlled and economic barriers removed, thus allowing a ‘self-directing automatic system’ to function (Levin and Hayek 1980). For Hayek (1939, 131), an interstate federation ‘would do away with impediments as to the movement of men, goods and capital between the states and … would render possible the creation of common rules of law, a uniform monetary system, and common control of communications’. Together with Friedman, who travelled extensively promoting monetarism (as a means of containing inflation) and free markets by way of macroeconomic policies such as deregulation and privatisation, he established an ideological position which became fertile ground for contestability, a theory that proposed furthering the breakdown of regulatory and other barriers.
International contestability of markets
Contestability theory first entered the slipstream of international trade policy in the mid 1990s as a ‘policy advocacy’ tool used by senior officials from the Organisation for Economic Co-operation and Development (OECD) and European Commission (Beviglia Zampetti and Sauvé 1996, 337). They saw its usefulness not as a theory whose calculus could be applied to international markets, but as a ‘notion’ in setting new objectives for market access in the multilateral trading system, ‘so as to further its adaption to the evolving reality of deep integration and the needs of globally-active firms’ (ibid.).
Sir Leon Brittan (1995b, 767), former vice-president of the European Commission and Home Secretary in Margaret Thatcher’s government, had clarified the goal of market access, stating that: ‘GATT [General Agreement on Tariffs and Trade]-style trade liberalization was second best to free trade’. The European Commission was to lead in the formation of the Working Group on Trade and Competition Policy within the WTO, established in the wake of the conclusion of the GATT and GATS Uruguay Round (Graham and Richardson 1997, 4). This marked a perceptible shift in thinking within the trade policy community. Orthodox ideas of competition gave way to a broader approach which sought to achieve competitive parity for ‘foreign competitors’ wishing to enter local markets—in other words, contestability.
Market access was akin to removing country-based distinctions between competitors, which focused initially on border barriers such as goods tariffs and quotas, then later on behind-border barriers such as labour laws and capital controls, which impacted services provision and investment (Young 1999, 185). The world economy was to move towards greater integration as developing countries and transition countries (the former communist states) were absorbed into the market-based world economy. This broad approach was defined as one ‘that embraces the continuum of trade, investment and competition policies, its chief focus being on the need to stem anti-competitive practices that impede what has come to be called the “international contestability of markets”’ (Sauvé 1996, 38).
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Deep integration was framed as the removal of ‘artificial or bureaucratic distinctions between goods, services, ideas, investments/investors and business people’ (ibid.). This trend in international agreements brought the trade policies of nation states into greater alignment with multinational corporations wanting to move goods, services, capital and people unimpeded to their business units and markets around the globe. In order to create internationally contestable markets, the barriers impacting these business models needed to come down. Market access and globalisation, in effect, were conflated with contestability (Graham and Richardson 1997, 20). Contestable market conditions are characteristically free of competitive impediments from both the private and public sectors: ‘the competitive process should not be unduly impaired or distorted by the totality of potential barriers to contestability’ (Sauvé 1996, 38).
Contestability in this period had nudged the perception of competition as an end in itself to one that focused on competitive conditions. No longer did a case have to be made for more competition per se. It was the addendum to competition, or the threat of it, which upended the economic orthodoxy. Contestability simultaneously justified removing barriers to trade and investment to promote competitive conditions and legitimised corporate consolidation into monopoly–oligopoly industry structures by claiming that there were no barriers to entry in a contestable market. In supporting these structures, it claimed to focus on the outcomes of efficiency and fairness (Graham and Richardson 1997, 9) or, later, efficiency and community welfare (Productivity Commission 2014, 2). Competitive conditions producing an attendant efficiency outcome, not competition per se, were the new primary goal.
The work of reconceptualising and redefining the multilateral governance overseeing this new role for competition in trade policy came through GATS 2000, the WTO’s Millennium negotiating round that would set the trade liberalisation agenda for the global services sector and complete the multilateral framework building on the initial GATS ratified in 1995. Increased liberalisation for the sector was projected to reap an additional US$130 billion annually (Dee and Hanslow 2000, vii). Investments in host countries and greater mobility for service suppliers (labour) were key concerns for an enhanced GATS framework of rules and disciplines, which were to be foundational to all subsequent trade and investment agreements.
Fundamental to the GATS 2000 approach was competition policy and the efficiency precept underlying it, influenced by contestability theory. This was considered imperative to achieving coherence between the culturally nuanced competition policy and law of nation states and competition policy at the international level: ‘without the integration of competition policy disciplines in some manner, it will be very difficult politically for countries to make the necessary reciprocal market access concessions that are essential to move beyond the status quo’ (Warner 1999, 396).
International agreements and advisory body recommendations
Australia has signed numerous trade and investment agreements in the past decade, the most significant being the TPPA, which is the regional behemoth in a loose federation of agreements including the Regional Comprehensive Economic Partnership, bilateral agreements with its Asia-Pacific neighbours, and the plurilateral Trade in Services Agreement and Government Procurement Agreement, which Australia applied to join in 2015.
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Collectively, they form a strong ‘laminate’ structure as they co-exist and cross over each other. The TPPA is companioned by the Transatlantic Trade and Investment Partnership currently being negotiated between the USA and European Union, thus completing the binary structure of the international trade and investment system from the perspective of the US Department of State (Russel 2014).
In determining the reach of changes to domestic competition policy to meet obligations in agreements, the recommendations of two advisory bodies are particularly relevant. The Harper Panel on Competition Policy Review and the Financial System Inquiry were both short-term consultative bodies appointed by the Abbott government in 2014. Members were drawn from transnational consultancies, investment banks, foreign hedge funds, corporate law, foreign and Australian think tanks, and universities. Some members had OECD and government experience. An important adjunct to the Harper Panel’s review was the submission on competition policy made by the Productivity Commission, a permanent independent statutory authority established by the Howard government in 1998 to make recommendations to government on a broad remit of economic and social issues.
Competition policy and law
The Harper Panel was given the task of ensuring that ‘the competition provisions of the Competition and Consumer Act 2010 (CCA) … are driving efficient, competitive and durable outcomes, particularly in light of … increased integration into global markets’ (Harper et al. 2015, 526). In a radical move that will place government activities on the ‘same footing as private parties’ (279), in accordance with the TPPA, the panel has recommended that the anti-competitive conduct provisions of the CCA should reach beyond government businesses to cover ‘government activities that have a trading or commercial character’ (31). The rationale behind this recommendation is that: ‘The Crown (whether in right of the Commonwealth, state and territory, or local governments) has the potential to harm competition through its commercial arrangements entered into with market Participants’ (ibid.). Such a blanket change goes far beyond state-owned enterprises and other commercial enterprises to cover all government activities which are contestable—that is, which a private provider could perform. It thereby arguably embraces most of government, given the private sector’s capacity to plan and implement policy and deliver services. This view is supported by the panel’s conclusion that: ‘government should not be a substitute for the private sector where … contestability can be realised’ (526).
That realisation is being rolled out through the federal government’s Contestability Programme run by the Department of Finance, whereby Commonwealth entities are now subject to a Contestability Framework. This framework was introduced by the 2014–15 federal budget. It aims to find ‘alternative structures, processes or provider arrangements’. The ‘notion of contestability’ is used to shift the emphasis from the function to be carried out to the desired outcome government seeks to achieve for government functions (Department of Finance 2015b).
The influence of contestability is such that the panel recommended that ‘competition’ be redefined in the CCA to include competition from ‘potential imports, not just actual imports’, and service provision that was ‘capable of being rendered’ from outside the country, thereby giving the concept of ‘credible threat of import competition’ a legal
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status (Harper et al. 2015, 57). This could potentially be used to give legislative cover for monopolies and oligopolies forming in the market through mergers or the privatisation of government monopolies.
This approach is also applied to cartels, with the panel recommending the relaxation of cartel provisions in the CCA, focusing on competitive outcome. Thereby, ‘joint ventures and similar forms of business collaboration’ are allowable if they do not ‘substantially lessen competition’. An exemption for ‘trading restrictions that are imposed by one firm on another in connection with the supply or acquisition of goods or services (including IP [intellectual property] licensing)’ was also proposed on the same grounds (58).
The panel grappled with the risks of anti-competitive behaviour by, firstly, promoting the breakdown of barriers to induce competitive threats to market incumbents and, secondly, reframing the misuse of market power provisions in Section 46 of the CCA. The provisions were known to be ineffective. Cases were not getting to court, as it is difficult (and costly) to prove that a corporation has taken advantage of substantial power and did so for a ‘proscribed purpose’ generally considered to be anti-competitive (Merrett 2015).
The new version of Section 46, proposed by the panel and finally accepted by the government in March 2016, removes the need to prove intent and instead introduces an ‘effects test’—that is, ‘the proposed conduct has the purpose, or would have or be likely to have the effect, of substantially lessening competition in that or any other market’ (Harper et al. 2015, 62). The effects test substitutes for the ‘purpose test’, thereby breaking the legal nexus between ‘the degree of market power’ and ‘taking advantage’ of that power by ‘purposefully’ using it to undermine competitors. The shift from intention to effects (outcome of behaviour) means capturing ‘anti-competitive unilateral behaviour’ without constraining ‘vigorous competitive conduct’ (336), thereby claiming to fulfil the remit of competition law to protect the ‘competitive process’ (339). The panel engaged with the debates on the efficacy of an effects test, concluding along with some legal scholars that there were correct arguments on both sides (Merrett 2015; Miller 2015), leaving the merit of the changes to be ultimately measured by the tally of cases successfully prosecuted.
In lieu of the effects test, predatory pricing provisions and 2007 amendments clarifying the meaning of ‘take advantage’ were deemed ‘unnecessary’ (Harper et al. 2015, 62). To ‘take advantage’ means ‘eliminating or substantially damaging a competitor’, ‘preventing the entry of a person’ into a market, or ‘deterring or preventing a person from engaging in competitive conduct’ (CCA 2010, Section 46[1]). This change removes the causal link between industry structure (substantial market power such as monopolies) and ‘take advantage’, which effectively ‘takes “misuse” out of the “misuse of market power” test’, but will not, as argued, ‘curb their competitive behaviour’ (King and Samuel 2015)— that is, in a contestable market, as opposed to an orthodox market where competition actually exists. Here lies a difficulty contended by French (1994, 561–562) in less complex times: ‘The difficulty courts will face is in market definition and thence in determining market power. Like “market” it [market power] is a multi-dimensional abstraction which involves the making of value judgments’. The Harper report does not define a contestable market, but it does characterise competitive processes in terms of contestability, stating: ‘we must foster the smooth entry and exit of suppliers … which means lowering barriers to entry (and exit) wherever possible’ (Harper et al. 2015, 23–24). This new market type, where monopolies are theorised to behave competitively in response to
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latent threats of competition, invites the proposition that market access impeded by government policy or action could be construed as a factor in, or cause of, an anti-competitive outcome. The inventors of contestability theory correspondingly held that market access would enable the market to self-regulate, and that ‘traditional per se indicators of market performance such as concentration, price discrimination, conglomerate mergers, or vertical and horizontal integration do not automatically call for government intervention in contestable markets’ (Baumol, Panzar and Willig 1982, 465).
The comprehensiveness and circularity of the non-interventionist argument calls into question ‘normative and evaluative concepts’ (French 1994, 549) in competition law and the necessity to go beyond ‘preexisting meaning’. Paradoxically, the Harper panel may well give legal leverage to corporate consolidation, effectively privileging monopoly and oligopoly industry structures in the economy, and threatening small and medium enterprises and consumer welfare.
Aligning with the TPPA
Under the TPPA, any party to the agreement must apply its national competition laws to all commercial activities in its territory and ‘to commercial activities outside its borders that have anti-competitive effects within its jurisdiction’ (Trans-Pacific Partnership Agreement 2015, Article 16.1.2). The statement on extraterritorality infers that the actual jurisdiction of national competition laws is not girt by national borders, nor by TPPA party borders, but by the free trade area from whence a claim can come.
The enforcement of extraterritoriality in the TPPA requires the national competition laws of all parties to be synchronised, or what the TPPA denotes as ‘regulatory coherence’ (Trans-Pacific Partnership Agreement 2015, Chapter 25). To this end, the panel recommended amending Section 5 of the CCA to apply to ‘overseas conduct insofar as the conduct relates to trade or commerce within Australia or between Australia and places outside Australia’ (Harper et al. 2015, 57). The panel also considered ease of access for private actions as a way of signalling adherence to TPPA enforcement of national competition laws (ibid.). Private rights of action enable persons (including corporations) the right to seek redress, including injunctive or monetary remedies, for damages ‘caused by a violation of national competition laws, either independently or following a finding of violation by a national competition authority’ in a court or an independent tribunal (Trans-Pacific Partnership Agreement 2015, Article 16.3).
Corralling public sector activity under the national competition laws to achieve parity with TPPA obligations has been foreshadowed by framing government functions as ‘contestable’, and by vaguely defining government commerciality in reference to state-owned enterprises as being ‘orientated towards profit-making’ (Article 17.1). Government entities run the risk of their activities, including decision-making processes and policy functions, being deemed anti-competitive or to adversely impact a trading partner firm’s interests, be they a competitor provider, purchaser or investor. The New South Wales government flagged this to the panel, stating that the ‘broad application of competition laws to government commercial activities risks compromising the policy functions of government’ (Harper et al. 2015, 280). The panel concluded that the continued objective of competition law was to forge economic welfare through greater efficiency. This objective of national competition laws is also prescribed under the TPPA, along with consumer welfare
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(Trans-Pacific Partnership Agreement 2015, Article 16.1). Therefore it is not a matter of internal public policy responding to domestic needs, but rather the necessity for Australia’s competition laws to fulfil the remit of the TPPA along the terms to which Australia has already agreed.
International and ISDS protections
The role of advisory bodies in the investment sphere has been to situate competition policy and law within the context of free market economics and to accord the mechanisms necessary for Australia to integrate with the global economy. The epicentre of this change has been the global financial services sector and its appetite for investment growth.
In his March 1995 Washington speech, Sir Leon Brittan (1995a, 4), Margaret Thatcher’s envoy to Brussels and later David Cameron’s chief advisor on the UK’s ‘Open for Business’ trade campaign, said: ‘governments still sometimes find it threatening, because free foreign direct investment flows limit administrations’ ability to control and shape their country’s economic destiny’—a situation, he concluded, that was a ‘small price for allowing private sector decision makers to generate economic benefits worldwide’. Twenty years on, such reticence by Australian governments has given way to a national strategy promoting foreign direct investment, in which the investment provisions of the TPPA and bilateral agreements with China, Korea and Japan play a major facilitating role (Austrade 2015, 57). These agreements all register adherence, in one form or another, with Brittan’s ideal for foreign investors:
[They are] free at least from unreasonable and uncompensated expropriation; [have] access to a fully convertible currency, can repatriate their profits at will and are free from unduly onerous performance requirements … [They] will also want to have reasonable treatment from tax authorities (Brittan 1995a, 6).
he alignment of Australia’s financial services sector to the global financial marketplace in order to facilitate the free flow of capital has been a key objective of the Financial System Inquiry (2014, viii), which focused on ‘international integration, including international financial regulation’. Philosophically, the Financial System Inquiry held that ‘the financial system should be subject, and responsive, to market forces, including competition which is preferable to government intervention’, defined in extremis as not only regulation and legislation, but also ‘guidance, general supervision and enforcement’ (9). This is a manifest shift from the ‘light’ interventionist doctrine of the 1990s that convined governments they should be ‘steering not rowing’ (Osborne and Gaebler 1993, 25), evinced by, for example, privatised electricity corporations being constrained by regulatory price control. The Financial System Inquiry, in registering the primacy of contestable market conditions, is effectively calling for governments to relinquish market management—a function that has leveraged governments’ power in both the market and public policy (Bell and Hindmoor 2009). In less than a decade, the vigorous state which Bell and Hindmoor (2009) identified as being the central governance authority in Australia is becoming one whose institutions are losing the ‘knowledge and memory’ of how to govern—that is, the ‘context or continuity for the making of new decisions’ (Tingle 2015, 4). With such a shift in play, it is not surprising that the Financial System Inquiry (2014, 9) claimed that the private sector is best placed to make decisions affecting the ‘efficient allocation of resources’. On this basis, the Financial
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System Inquiry identified a ‘number of distortions that impede the efficient market allocation of financial resources, including taxation, information imbalances and unnecessary regulation’ (xvi). This is very much in line with the thinking of international trade policy circles of the mid 1990s, and with that of the Productivity Commission (2014, 6), which lists regulations, taxes, subsidies, government ownership of businesses and funding of services as instruments of intervention in a free market.
Such claims can be identified as ideological by the assertions being made typically without reference to data or evidence of practical effect. This free market position has been further abstracted by contestability’s theoretical claim that barriers to market entry stymie competition, and that competition, or the threat of it, is a necessary prerequisite of free trade—that being trade unencumbered by government intervention. The veracity of this logic can only be proven if the instruments of intervention listed by the Productivity Commission and Financial System Inquiry are removed.
Under the TPPA, entering the Australian market will become far easier for foreign investors due to the removal of performance requirements on covered investments. Governments can no longer ‘impose or enforce any requirement, or enforce any commitment or undertaking [from] an investment of an investor of a Party or of a non-Party in its territory’ (Trans-Pacific Partnership Agreement 2015, Article 9.9.1). Nor can the government impose any conditions on the receipt of an advantage by a foreign investor (Article 9.9.2) or stipulate that the senior management are Australian citizens (Article 9.10). These critical injunctions placed on governments by the TPPA will limit their abilities to control foreign direct investment. They will remove policy levers which ensured (a) that an inward foreign investment brought benefits to the local economy, such as stipulating local content or exporting to a given level, purchase of local goods and services, and transfers of technology and proprietary knowledge; (b) that the government was able to proportionally share in the rewards reaped by the investment; and (c) attention to local concerns from senior management.
Investors can also exit the market at will. They are permitted to make transfers in and out of a party’s territory, including profits and revenues from the sale or liquidation of the covered investment in a freely usable currency without delay (Article 9.8). These provisions are critical for a contestable market, allowing the characteristic ‘hit-and-run’ ease of entering a market, profit-taking and then leaving without exit costs, such as capital controls or financial transaction taxes banned by the transfers provision (Faunce 2015, 603).(1)
The Financial System Inquiry’s recommendations strive to inject further competitiveness, extending contestability principles into Australia’s financial regulatory framework, including recommending that withholding taxes on investment incomes repatriated by non-residents be lowered and aligned with regional trading partners (Financial System Inquiry 2014, 279), and that the Australian Securities and Investments Commission consider competition in its mandate (254) to ensure that ‘regulators are more sensitive to the effects of their decisions on competition, international competitiveness and the free flow of capital’ (xvi).
Investor–state dispute settlement
Protecting investments in multiple jurisdictions is an expensive and complex undertaking for transnational corporations. ISDS goes a long way in simplifying the process of claims
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and compensation for agreement infringements by parties. Under the TPPA and agreements with Korea and China, claimants can have their case arbitrated in private international tribunals and heard by arbitrators who can oscillate between judging and presenting for corporate claimants. There is no appeal against decisions, either to the tribunal or to national law courts.
The TPPA’s ISDS regime includes an overreaching definition of ‘investment’ that covers almost every significant component of the Australian economy, including enterprises, equity, debt instruments (including loans), derivatives, various types of contracts, intellectual property rights, rights under permits, licences and authorisations, tangible and intangible property, and property rights (Trans-Pacific Partnership Agreement 2015, Article 9.1). With an ‘investment’ so broadly defined and instruments of intervention or distortion so clearly identified by the Financial System Inquiry and Productivity Commission, an investor may make a claim under ISDS in a free market environment based on interference emanating from the system of governance or government policy. If proven under ISDS, the policy or regulation must be rescinded. The Abbott government flagged the impending retreat of government from the investment space, stating: ‘It is not the Commonwealth Government’s role to direct, or be the principal financier of, development’ (Department of the Prime Minister and Cabinet 2015, 2–3). That role is assigned to ‘global corporations, high net worth individuals and the international capital market’ (62).
The government’s role is made even more tenuous by the wider net of commerciality defining its activities which breach investors’ rights under national competition laws. In this sense, governments are caught in a pincer movement which could take the problem of government performance of its functions beyond ‘regulatory chill’ (threat of litigation leading governments to compromise policy objectives) to one that undermines the ‘structural power’ invested in decision-making (Strange 1988, 25).
These factors, together with the weakening of capital flow controls under the TPPA, would most likely accelerate the ‘retreat of the state’ (Strange 1997) in the face of globalised power generated in financial markets, which Strange (1986) likened to a ‘vast casino’. The state has been relinquishing its ‘provider’ share of the market to the private sector, and retreating to the role of market promoter—a role encapsulated by the term ‘competition state’—as its activities focus on promoting foreign direct investment, marketisation and enmeshment with ‘extraterritorial economic and legal institutions’ (Cerny, Menz and Soederberg 2005, 5). This description of the state fully engaged in its own operational imperatives as a competition state in the context of ‘multilevel governance’ (Cerny, Menz and Soederberg 2005, 6) is unlikely to hold in the contestable environment, for in this iteration of the global market, the imitation of competition takes precedence, leaving the state with ever decreasing reserves of knowledge and functional purpose to leverage a niche in a global economy predicted to be dominated by monopolies (Baran and Sweezy 1966).
However, on the immediate horizon is the intensification of states’ engagement with transnational corporate interests through the network of international agreements, particularly the TPPA, embodied in which is a new supranational level of governance with its own governing body, the Trans-Pacific Partnership Commission, replete with a committee system, disciplines, rules of procedure and ISDS enforcement. The TPPA’s binding commitments are strategically scoped to induce regulatory coherence in order to transition national governments to its regional market regime by removing regulations,
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simplifying the regulations that remain, and making ‘systemic regulatory improvements’ in favour of trade and investment (Trans-Pacific Partnership Agreement 2015, Article 25.4).
ISDS will enforce compliance with TPPA provisions governing the new regional market, defended by the claim of contestable market theory that it will basically be self-regulating, even with the presence of monopolies. The Financial System Inquiry’s recommendations for the ISDS enforcement provisions of the TPPA and China and Korea free trade agreements protect the rights of corporations to ‘challenge capital controls and other macro-prudential financial regulations that promote financial stability’ (Faunce 2015, 603). A nation’s ability to control capital flows, particularly in times of crisis, is a marker of sovereign strength. In the light of ISDS and the volumes of capital involved, this suggests a considerable weakening in Australia.
Foreign direct investment and financial services
In 2014, inward foreign direct investment was AU$644.4 billion, representing 25 percent of total foreign investment into Australia. Outward foreign direct investment that year was AU$540.7 billion (Australian Bureau of Statistics 2015). Inward foreign direct investment availed by the removal of barriers such as thresholds now accounts for 39 percent of GDP (up from 29 percent in 2008) (Austrade 2015, 58). At least 37 percent of the capital inflows in 2014 were sourced from countries with which Australia has an agreement inclusive of ISDS, thereby situating this proportion of the economy within the jurisdiction of international private arbitration. In time, following the recommendations of the advisory bodies, Australia’s national competition laws will be recut to integrate further with this ISDS regime. Government will have relinquished the autonomy invested in Australian law governing a sizeable and growing portion of the economy for an external arbitration regime. There is also the risk of ‘policy contamination’—that is, government actions to achieve social and environmental objectives may cause injury to transnational firms, inciting ISDS claims, which are globally growing in number (Karl 2013, 1).
Between 2008 and 2014, foreign direct investment grew by 84 percent, far higher than the average for developed economies, at 61 percent over the same period (Austrade 2015, 58). The timing of the surge in foreign investment since the 2008 global financial crisis suggests that financial institutions like investment banks, hedge funds and asset managers were looking to move funds and business to new markets as the housing market in the USA and commercial property and development markets elsewhere collapsed (Davis 2011, 307).
Australia is an attractive market. It is economically stable, its currency is periodically very cheap and it has its own enormous pool of assets—the fourth largest in the world—created by the mandatory superannuation scheme introduced by the Keating Labor government in 1992 (Davis 2011, 306). This asset base, which stood at AU$1.995 trillion by December 2015 (Association of Superannuation Funds of Australia 2015), attracted transnational finance corporations to set up offices in Australia following ongoing deregulation in the finance sector from the 1980s. By 2010, most funds under management (AU$1.7 trillion) were managed by international firms, collectively called ‘custodians’ (Davis 2011, 321). The volume of capital available for investment continues to grow dramatically,
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with Deloitte (2013, 7) predicting that assets in superannuation will rise to 180 percent of GDP and that total superannuation assets will reach AU$7.6 trillion by 2033.
The market access provisions of the TPPA and related ISDS clauses covering financial services remove constraints that government may have chosen to impose on foreign financial institutions entering the Australian market. No measures may be imposed on foreign financial institutions or their workforces based on an economic needs test, quotas or type of legal entity (Trans-Pacific Partnership Agreement 2015, Article 11.5). If an investor makes a claim against a measure, arbitrators with financial law expertise may be appointed to the tribunal (Article 11.22). These provisions allow for the circumvention of Australian courts by offshoring the determination process to a private tribunal with pro-investor arbitrators who are not accountable to the Australian populace (Faunce 2015, 601).
Finance is the fastest-growing sector in the Australian economy, clocking up growth rates of 5.1 percent per annum in the period 2002–12, against the next biggest sector, mining, at 3.1 percent. In 2012, the sector’s percentage of GDP was 10 percent, just a nudge below the value of manufacturing and agriculture combined, at 11 percent of GDP (Industry Super Australia 2013, 14–15).(2) What the increase in investment—notably, foreign direct investment—indicates is that Australia is integrating with the global economy through international investment agreements as a matter of competition policy based on free market ideology, rather than through a necessary planned pursuit of foreign exchange to support ‘nation-building’ projects meeting national environmental and social objectives.
Leon Brittan did warn that foreign direct investment would limit aspects of government control over economies. With vice chairman of the UBS AG Investment Bank amongst his other roles (BBC 2010), he would have most likely been aware of the challenges corporations faced in wresting control of capital flows away from national governments. The Financial System Inquiry and Productivity Commission, in effect, identified the grounds on which those challenges could be made, which highlights the power of advisory bodies’ interlocutory role between government and business—a role that facilitates business interests within government circles (Bell and Hindmoor 2009, 169).
Investment in infrastructure and government procurement
Growing markets to meet the demands of global investors has been a macroeconomic policy goal of Australian governments since the 1980s. Prominent amongst these efforts has been privatisation—the sale or lease of government assets and enterprises to the private sector, and the expansion of the related government procurement market.
Efficient investment, according to the Harper panel, is a factor of competition policy which enables the price signal to determine the optimum investment in and use of infrastructure and natural resources (Harper et al. 2015, 26). The price signal also prevails in the allocation of natural resources, eclipsing environmental regulations, planning and zoning as mechanisms of constraint (27). However, contestability theory asserts that firms in contestable markets need to set prices to reflect marginal costs of production. Taking supernormal profits because consumer demand is high risks attracting new entrants, and deep price discounting also signals the possibility for profit-taking to entrants, so the imperative is to control the price to stave off competitors.
Under the TPPA, governments must grant investors access rights to natural resources, network services (utilities like telecommunications) consumed by the public, and
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infrastructure projects such as pipelines and roads (Trans-Pacific Partnership Agreement 2015, Article 9.1). These rights give investors access to resources to be exploited on the basis of the price mechanism, and are thus calibrated to commercial objectives. The only requirement made by the TPPA on an investment activity with regard to environmental, health or other regulatory objectives is that it be ‘sensitive’ to those objectives (Article 9.15). Governments (as parties) will be made responsible (and therefore liable) for ensuring that enterprises have duly incorporated international corporate social responsibly into their internal policies, which they can chose to act on in a voluntary capacity (Article 9.16).
The price signal is also privileged in procurement, unless a public interest can be determined by the procuring entity (government) (Article 15.15.4). In an agreement where objectives, other than commercial objectives, are not able to be governed by obligations, commitments or sanctions, citing the public interest becomes something foreign to the process. Further, based on the assumption that price signals should prevail, governments and regulatory authorities may have to withdraw regulations, such as price controls, which prevent or distort the operation of the price mechanism in a free market.
In addition to the repeal of predatory pricing (CCA 2010, Section 46), the panel also recommended that price-signalling provisions be repealed and replaced with an extension to Section 45 of the CCA in order ‘to prohibit a person [corporation] engaging in a concerted practice with one or more other persons that has the purpose, effect or likely effect of substantially lessening competition’—with ‘concerted’ meaning ‘jointly arranged or carried out or co-ordinated’ (Harper et al. 2015, 60). Such acts of collusion will remain difficult to prosecute, particularly when legal practices like price-matching are commonplace.
The panel also recommended the deregulation of electricity and gas retail prices (202). In February 2016, the Queensland government announced that electricity retail prices in south-east Queensland were to be deregulated, and Energex and Ergon Energy, the state-owned electricity corporations, would merge. The chief executive officer of Ergon Energy, Ian McLeod, in a 2015 interview said of the future that it would be ‘an environment without cross-subsidisation and … the market should prevail’ (Parkinson 2015). The preclusion of cross-subsidisation is a prerequisite for the operation of a contestable market. By substituting ‘distributive equity’ through regulation, with the separation of low-cost markets from higher-cost markets, each being defined by sustainable prices, which by definition ‘are feasible in a free market without any subsidy’, consumers would be protected from ‘higher than necessary’ pricing. Relief for consumers in high-cost markets comes over time as new entrants with improved or different products, such as renewable energy, bring prices down, whilst socially wasteful incursions from firms with the same product are, in theory, kept at bay by sustainable pricing (Baumol, Panzar and Willig 1982, 354, 356). In a scenario where the government decides to re-regulate electricity prices because constituents are calling for cross-subsidies to be reinstated, the government would be exposed to claims for compensation under ISDS and private rights of action in national competition laws.
Government procurement
Governments globally expend vast sums on infrastructure projects, maintenance of assets and service provision. This expenditure has generative effects of resounding importance economically due to the size of projects and ongoing demand. Removing barriers to
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market access to the procurement sector through such mechanisms as public–private partnerships, outsourcing and commissioning is enabling private enterprise to take control of that demand, while leaving fiscal responsibility with governments. Exemplifying this change is the establishment of a programme management office within NSW Roads and Maritime Services by Advisian, the consultancy arm of global infrastructure mining giant Worley Parsons. In 2012, it implemented a ‘contestability reform program’ for road maintenance, giving it control over the tendering process (Cashen 2016).
Much of the attention has been on privatising ‘natural monopolies’ like telecommunications, water supply and toll roads that require significant expenditure on maintenance and new infrastructure. The switch from public sector control to private monopoly-oligopoly control has been based on contestability’s promise that it will enhance competition in these types of industries (Sturgess 2012, 109), even though transnational corporations are further consolidating their market share—for example, toll roads (Millar and Schneiders 2016).
The panel concurs with these overall trends by way of considering privatisation ‘as a form of procurement: the transfer of assets from the public to the private sector rather than a transfer of activities—in effect, procurement that is not repeated’ (Harper et al. 2015, 273). Liberalising market access to government procurement has long been seen as a key to boosting the contestability of international services markets as large, secure procurement markets with low levels of public-private corruption and effective access, serves to boost growth in trade in services within the economy overall, not just procurement markets (Sauvé 1996, 51). In OECD countries, procurement averaged 12.1 percent of GDP in 2013 (OECD 2015, 136). Contestability was also seen as potent in this government procurement space because ‘procurement regimes for services, even those that explicitly discriminate against foreign suppliers, are unlikely to have major permanent repercussions on domestic or foreign welfare so long as the markets are contestable’ (Evenett and Hoekman 1999, 144). Further, they contended that contestable markets would ‘obviate the need for multilateral rules on procurement’ if the GATS framework expanded market access and national treatment commitments (Evenett and Hoekman 1999, 144). (3) This was not an argument against the WTO’s governance role, as the multilateral disciplines still had a role in mandating transparency for the purposes of alleviating corruption and rent-seeking (Evenett and Hoekman 1999, 144). However, the removal of barriers to market access countenanced the dependency on free market economic truisms and the belief that contestability would ensure competitive behaviour.
The first GATS agreement exempted procurement by government agencies for their own use; that initially was left to the Agreement on Government Procurement (GPA), a voluntary agreement which came into force in 1981 (World Trade Organization 2016a). The GPA’s procurement and transparency rules effectively paralleled the GATS regime on the elimination of discrimination on trade in goods and services. At this time, the Department of Foreign Affairs and Trade recommended that Australia abstain from joining the GPA because it would not give Australia access to the US procurement market. That was to come in limited terms with the signing of the Australia–US Free Trade Agreement in 2004 (Weiss, Thurbon and Mathews 2004, 88).
In April 2015, Australia applied to join the GPA, and it now awaits accession to the agreement along with China. This will enable the completion of the China–Australia Free Trade Agreement negotiations on commitments to market access across a wide
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range of services, including information and communication technology, finance and transport (China–Australia Free Trade Agreement 2015, Article 16.8). The application will no doubt be successful, as discrimination barriers have already been removed. The Commonwealth Procurement Rules have for some years proscribed supplier discrimination on the basis of ‘size, degree of foreign affiliation or ownership, location, or the origin of their goods and services’ (Department of Finance 2014, 16). Both the GPA and the TPPA remove other forms of preferential treatment of domestic suppliers by disallowing ‘offsets’ such as the use of domestic content (Trans-Pacific Partnership Agreement 2015, Article 15.4.6)—noting exemptions including motor vehicles and defence hardware (Annex 15-A)—and by establishing a bid challenge system, giving all suppliers (local and foreign) recourse to an independent review body to challenge procurement decisions of government (Article 15.19).
In 2014–15, the Commonwealth government procured nearly AU$59.5 billion worth of goods and services (Department of Finance 2015a). This purchasing power is an important lever used by governments to promote secondary policy objectives—for example, growing domestic industries, regional development, employment programmes and environmental sustainability (OECD 2015, 138). The TPPA seriously curtails this function of governments by narrowing their autonomous purchasing decisions to dedicated programmes chiefly aimed at facilitating participation by small and medium-sized enterprises in the procurement market (Trans-Pacific Partnership Agreement 2015, Article 15.21).
One of the most significant changes derives from a shift to ‘outcomes-based procurement’, defined by the Harper panel as a shift from an output focus to a performance outcome focus. It illustrates this idea using floor-waxing—going from ‘contractor must strip and re-wax the floors weekly (output focus)’ to the highly subjective ‘floors must be clean and have a uniformly glossy finish (outcome focus)’ (Harper et al. 2015, 270–271). This approach complies with the TPPA, which denotes ‘technical specifications in terms of performance and functional requirements, rather than design or descriptive characteristics’ (Trans-Pacific Partnership Agreement 2015, Article 15.12.2[a]).
Government will be exposed to ISDS claims if it applies a technical specification with the purpose or effect of creating an unnecessary obstacle to trade between the parties (Article 15.12.1). This includes specifying ‘a particular trademark or trade name, patent, copyright, design, type, specific origin, producer or supplier’ (Article 15.12.3). That customer choice and insistence on specified standards could be construed as a market barrier, so that only generalised technical specifications which condone subjective performance can apply, is likely to diminish standards and the knowledge base they are derived from. In effect, the biggest consumer in the country (government) no longer has a right to information, which the Productivity Commission (2014, 6) says is essential for consumer welfare in a contestable market.
Conclusion
Submitting to TPPA provisions and governance and ‘the market’ translates into obligations and commitments that governments must honour under threat of trade sanctions. The Harper panel, in redesigning Australia’s competition regime, recommended establishing the Australian Council for Competition Policy, charged with ‘monitoring progress in implementing agreed reforms and publicly reporting on progress annually’ (Harper et al.
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2015, 77). This meets obligations under the TPPA to set up a ‘national or central coordinating body’ (Trans-Pacific Partnership Agreement 2015, Article 25.4.1) to ‘make recommendations for systemic regulatory improvements and publicly report on regulatory measures’ (Article 25.4.2[d]). This is the crux of what the Harper panel called ‘[d]eepening Australia’s integration with the world’ (Harper et al. 2015, 16), echoing the ‘deep integration’ served by the notion of international contestable markets—a concept that has travelled incognito with free market ideology since the 1990s.
This momentous change, led by the USA, which has brought a whole new tier of regional governance into being, was for a decade kept largely secret by the embargo on TPPA transcripts. The embodiment of this change—the Trans-Pacific Partnership Commission and the Asia-Pacific market it oversees— is proffered as a kind of proxy for various government functions, competition policy and law, with implications for Australia’s national environmental and social objectives and national economic management.
The purpose of this article has been to show how contestability has radicalised free market ideology by providing the rationale to disassemble pro-competition governance and other protections in favour of unfettered market access. This ongoing process has enabled transnational corporations to enjoy enhanced monopoly powers and control over capital flows, backed by the mechanisms of international agreements which are imbued with contestability notions.
Ironically, in 1994, the year contestability emerged as a force in repurposing international agreements, Baumol delivered lectures at his Alma Mater, the London School of Economics, where he criticised orthodox free trade theories based on his concerns about the destabilising effect of global capital flows. He suggested that national economies are better protected by targeted government policy (Baumol and Gomory 2000, 8). A far deeper irony emerges, however, from Hayek’s utopian sentiments, expressed in his September 1939 essay, where he states: ‘the abolition of economic barriers between the members of the federation is … an indispensable condition for the achievement of the main purpose of federation … to secure peace’ (Hayek 1939, 131). The breaking down of economic barriers and aspects of the state apparatus that maintains them has left a vacuum which is being filled by transnational corporations which are accumulating powers that were once the preserve of the state and international governance bodies. At this juncture in history, where the new order is still emergent, Hayek’s (1944, 163) portent from another time and place of rupture may offer salutary pause: ‘Perhaps even more than elsewhere current notions of what is desirable and practicable are here still of a kind which may well produce the opposite of what they promise’.
Notes
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A summary version of this article was published online (19 Feb 2017).
https://www.internationalaffairs.org.au/australianoutlook/contestability-theory-radicalising-the-free-market/
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System Inquiry identified a ‘number of distortions that impede the efficient market allocation of financial resources, including taxation, information imbalances and unnecessary regulation’ (xvi). This is very much in line with the thinking of international trade policy circles of the mid 1990s, and with that of the Productivity Commission (2014, 6), which lists regulations, taxes, subsidies, government ownership of businesses and funding of services as instruments of intervention in a free market.
Such claims can be identified as ideological by the assertions being made typically without reference to data or evidence of practical effect. This free market position has been further abstracted by contestability’s theoretical claim that barriers to market entry stymie competition, and that competition, or the threat of it, is a necessary prerequisite of free trade—that being trade unencumbered by government intervention. The veracity of this logic can only be proven if the instruments of intervention listed by the Productivity Commission and Financial System Inquiry are removed.
Under the TPPA, entering the Australian market will become far easier for foreign investors due to the removal of performance requirements on covered investments. Governments can no longer ‘impose or enforce any requirement, or enforce any commitment or undertaking [from] an investment of an investor of a Party or of a non-Party in its territory’ (Trans-Pacific Partnership Agreement 2015, Article 9.9.1). Nor can the government impose any conditions on the receipt of an advantage by a foreign investor (Article 9.9.2) or stipulate that the senior management are Australian citizens (Article 9.10). These critical injunctions placed on governments by the TPPA will limit their abilities to control foreign direct investment. They will remove policy levers which ensured (a) that an inward foreign investment brought benefits to the local economy, such as stipulating local content or exporting to a given level, purchase of local goods and services, and transfers of technology and proprietary knowledge; (b) that the government was able to proportionally share in the rewards reaped by the investment; and (c) attention to local concerns from senior management.
Investors can also exit the market at will. They are permitted to make transfers in and out of a party’s territory, including profits and revenues from the sale or liquidation of the covered investment in a freely usable currency without delay (Article 9.8). These provisions are critical for a contestable market, allowing the characteristic ‘hit-and-run’ ease of entering a market, profit-taking and then leaving without exit costs, such as capital controls or financial transaction taxes banned by the transfers provision (Faunce 2015, 603).(1)
The Financial System Inquiry’s recommendations strive to inject further competitiveness, extending contestability principles into Australia’s financial regulatory framework, including recommending that withholding taxes on investment incomes repatriated by non-residents be lowered and aligned with regional trading partners (Financial System Inquiry 2014, 279), and that the Australian Securities and Investments Commission consider competition in its mandate (254) to ensure that ‘regulators are more sensitive to the effects of their decisions on competition, international competitiveness and the free flow of capital’ (xvi).
Investor–state dispute settlement
Protecting investments in multiple jurisdictions is an expensive and complex undertaking for transnational corporations. ISDS goes a long way in simplifying the process of claims
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and compensation for agreement infringements by parties. Under the TPPA and agreements with Korea and China, claimants can have their case arbitrated in private international tribunals and heard by arbitrators who can oscillate between judging and presenting for corporate claimants. There is no appeal against decisions, either to the tribunal or to national law courts.
The TPPA’s ISDS regime includes an overreaching definition of ‘investment’ that covers almost every significant component of the Australian economy, including enterprises, equity, debt instruments (including loans), derivatives, various types of contracts, intellectual property rights, rights under permits, licences and authorisations, tangible and intangible property, and property rights (Trans-Pacific Partnership Agreement 2015, Article 9.1). With an ‘investment’ so broadly defined and instruments of intervention or distortion so clearly identified by the Financial System Inquiry and Productivity Commission, an investor may make a claim under ISDS in a free market environment based on interference emanating from the system of governance or government policy. If proven under ISDS, the policy or regulation must be rescinded. The Abbott government flagged the impending retreat of government from the investment space, stating: ‘It is not the Commonwealth Government’s role to direct, or be the principal financier of, development’ (Department of the Prime Minister and Cabinet 2015, 2–3). That role is assigned to ‘global corporations, high net worth individuals and the international capital market’ (62).
The government’s role is made even more tenuous by the wider net of commerciality defining its activities which breach investors’ rights under national competition laws. In this sense, governments are caught in a pincer movement which could take the problem of government performance of its functions beyond ‘regulatory chill’ (threat of litigation leading governments to compromise policy objectives) to one that undermines the ‘structural power’ invested in decision-making (Strange 1988, 25).
These factors, together with the weakening of capital flow controls under the TPPA, would most likely accelerate the ‘retreat of the state’ (Strange 1997) in the face of globalised power generated in financial markets, which Strange (1986) likened to a ‘vast casino’. The state has been relinquishing its ‘provider’ share of the market to the private sector, and retreating to the role of market promoter—a role encapsulated by the term ‘competition state’—as its activities focus on promoting foreign direct investment, marketisation and enmeshment with ‘extraterritorial economic and legal institutions’ (Cerny, Menz and Soederberg 2005, 5). This description of the state fully engaged in its own operational imperatives as a competition state in the context of ‘multilevel governance’ (Cerny, Menz and Soederberg 2005, 6) is unlikely to hold in the contestable environment, for in this iteration of the global market, the imitation of competition takes precedence, leaving the state with ever decreasing reserves of knowledge and functional purpose to leverage a niche in a global economy predicted to be dominated by monopolies (Baran and Sweezy 1966).
However, on the immediate horizon is the intensification of states’ engagement with transnational corporate interests through the network of international agreements, particularly the TPPA, embodied in which is a new supranational level of governance with its own governing body, the Trans-Pacific Partnership Commission, replete with a committee system, disciplines, rules of procedure and ISDS enforcement. The TPPA’s binding commitments are strategically scoped to induce regulatory coherence in order to transition national governments to its regional market regime by removing regulations,
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simplifying the regulations that remain, and making ‘systemic regulatory improvements’ in favour of trade and investment (Trans-Pacific Partnership Agreement 2015, Article 25.4).
ISDS will enforce compliance with TPPA provisions governing the new regional market, defended by the claim of contestable market theory that it will basically be self-regulating, even with the presence of monopolies. The Financial System Inquiry’s recommendations for the ISDS enforcement provisions of the TPPA and China and Korea free trade agreements protect the rights of corporations to ‘challenge capital controls and other macro-prudential financial regulations that promote financial stability’ (Faunce 2015, 603). A nation’s ability to control capital flows, particularly in times of crisis, is a marker of sovereign strength. In the light of ISDS and the volumes of capital involved, this suggests a considerable weakening in Australia.
Foreign direct investment and financial services
In 2014, inward foreign direct investment was AU$644.4 billion, representing 25 percent of total foreign investment into Australia. Outward foreign direct investment that year was AU$540.7 billion (Australian Bureau of Statistics 2015). Inward foreign direct investment availed by the removal of barriers such as thresholds now accounts for 39 percent of GDP (up from 29 percent in 2008) (Austrade 2015, 58). At least 37 percent of the capital inflows in 2014 were sourced from countries with which Australia has an agreement inclusive of ISDS, thereby situating this proportion of the economy within the jurisdiction of international private arbitration. In time, following the recommendations of the advisory bodies, Australia’s national competition laws will be recut to integrate further with this ISDS regime. Government will have relinquished the autonomy invested in Australian law governing a sizeable and growing portion of the economy for an external arbitration regime. There is also the risk of ‘policy contamination’—that is, government actions to achieve social and environmental objectives may cause injury to transnational firms, inciting ISDS claims, which are globally growing in number (Karl 2013, 1).
Between 2008 and 2014, foreign direct investment grew by 84 percent, far higher than the average for developed economies, at 61 percent over the same period (Austrade 2015, 58). The timing of the surge in foreign investment since the 2008 global financial crisis suggests that financial institutions like investment banks, hedge funds and asset managers were looking to move funds and business to new markets as the housing market in the USA and commercial property and development markets elsewhere collapsed (Davis 2011, 307).
Australia is an attractive market. It is economically stable, its currency is periodically very cheap and it has its own enormous pool of assets—the fourth largest in the world—created by the mandatory superannuation scheme introduced by the Keating Labor government in 1992 (Davis 2011, 306). This asset base, which stood at AU$1.995 trillion by December 2015 (Association of Superannuation Funds of Australia 2015), attracted transnational finance corporations to set up offices in Australia following ongoing deregulation in the finance sector from the 1980s. By 2010, most funds under management (AU$1.7 trillion) were managed by international firms, collectively called ‘custodians’ (Davis 2011, 321). The volume of capital available for investment continues to grow dramatically,
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with Deloitte (2013, 7) predicting that assets in superannuation will rise to 180 percent of GDP and that total superannuation assets will reach AU$7.6 trillion by 2033.
The market access provisions of the TPPA and related ISDS clauses covering financial services remove constraints that government may have chosen to impose on foreign financial institutions entering the Australian market. No measures may be imposed on foreign financial institutions or their workforces based on an economic needs test, quotas or type of legal entity (Trans-Pacific Partnership Agreement 2015, Article 11.5). If an investor makes a claim against a measure, arbitrators with financial law expertise may be appointed to the tribunal (Article 11.22). These provisions allow for the circumvention of Australian courts by offshoring the determination process to a private tribunal with pro-investor arbitrators who are not accountable to the Australian populace (Faunce 2015, 601).
Finance is the fastest-growing sector in the Australian economy, clocking up growth rates of 5.1 percent per annum in the period 2002–12, against the next biggest sector, mining, at 3.1 percent. In 2012, the sector’s percentage of GDP was 10 percent, just a nudge below the value of manufacturing and agriculture combined, at 11 percent of GDP (Industry Super Australia 2013, 14–15).(2) What the increase in investment—notably, foreign direct investment—indicates is that Australia is integrating with the global economy through international investment agreements as a matter of competition policy based on free market ideology, rather than through a necessary planned pursuit of foreign exchange to support ‘nation-building’ projects meeting national environmental and social objectives.
Leon Brittan did warn that foreign direct investment would limit aspects of government control over economies. With vice chairman of the UBS AG Investment Bank amongst his other roles (BBC 2010), he would have most likely been aware of the challenges corporations faced in wresting control of capital flows away from national governments. The Financial System Inquiry and Productivity Commission, in effect, identified the grounds on which those challenges could be made, which highlights the power of advisory bodies’ interlocutory role between government and business—a role that facilitates business interests within government circles (Bell and Hindmoor 2009, 169).
Investment in infrastructure and government procurement
Growing markets to meet the demands of global investors has been a macroeconomic policy goal of Australian governments since the 1980s. Prominent amongst these efforts has been privatisation—the sale or lease of government assets and enterprises to the private sector, and the expansion of the related government procurement market.
Efficient investment, according to the Harper panel, is a factor of competition policy which enables the price signal to determine the optimum investment in and use of infrastructure and natural resources (Harper et al. 2015, 26). The price signal also prevails in the allocation of natural resources, eclipsing environmental regulations, planning and zoning as mechanisms of constraint (27). However, contestability theory asserts that firms in contestable markets need to set prices to reflect marginal costs of production. Taking supernormal profits because consumer demand is high risks attracting new entrants, and deep price discounting also signals the possibility for profit-taking to entrants, so the imperative is to control the price to stave off competitors.
Under the TPPA, governments must grant investors access rights to natural resources, network services (utilities like telecommunications) consumed by the public, and
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infrastructure projects such as pipelines and roads (Trans-Pacific Partnership Agreement 2015, Article 9.1). These rights give investors access to resources to be exploited on the basis of the price mechanism, and are thus calibrated to commercial objectives. The only requirement made by the TPPA on an investment activity with regard to environmental, health or other regulatory objectives is that it be ‘sensitive’ to those objectives (Article 9.15). Governments (as parties) will be made responsible (and therefore liable) for ensuring that enterprises have duly incorporated international corporate social responsibly into their internal policies, which they can chose to act on in a voluntary capacity (Article 9.16).
The price signal is also privileged in procurement, unless a public interest can be determined by the procuring entity (government) (Article 15.15.4). In an agreement where objectives, other than commercial objectives, are not able to be governed by obligations, commitments or sanctions, citing the public interest becomes something foreign to the process. Further, based on the assumption that price signals should prevail, governments and regulatory authorities may have to withdraw regulations, such as price controls, which prevent or distort the operation of the price mechanism in a free market.
In addition to the repeal of predatory pricing (CCA 2010, Section 46), the panel also recommended that price-signalling provisions be repealed and replaced with an extension to Section 45 of the CCA in order ‘to prohibit a person [corporation] engaging in a concerted practice with one or more other persons that has the purpose, effect or likely effect of substantially lessening competition’—with ‘concerted’ meaning ‘jointly arranged or carried out or co-ordinated’ (Harper et al. 2015, 60). Such acts of collusion will remain difficult to prosecute, particularly when legal practices like price-matching are commonplace.
The panel also recommended the deregulation of electricity and gas retail prices (202). In February 2016, the Queensland government announced that electricity retail prices in south-east Queensland were to be deregulated, and Energex and Ergon Energy, the state-owned electricity corporations, would merge. The chief executive officer of Ergon Energy, Ian McLeod, in a 2015 interview said of the future that it would be ‘an environment without cross-subsidisation and … the market should prevail’ (Parkinson 2015). The preclusion of cross-subsidisation is a prerequisite for the operation of a contestable market. By substituting ‘distributive equity’ through regulation, with the separation of low-cost markets from higher-cost markets, each being defined by sustainable prices, which by definition ‘are feasible in a free market without any subsidy’, consumers would be protected from ‘higher than necessary’ pricing. Relief for consumers in high-cost markets comes over time as new entrants with improved or different products, such as renewable energy, bring prices down, whilst socially wasteful incursions from firms with the same product are, in theory, kept at bay by sustainable pricing (Baumol, Panzar and Willig 1982, 354, 356). In a scenario where the government decides to re-regulate electricity prices because constituents are calling for cross-subsidies to be reinstated, the government would be exposed to claims for compensation under ISDS and private rights of action in national competition laws.
Government procurement
Governments globally expend vast sums on infrastructure projects, maintenance of assets and service provision. This expenditure has generative effects of resounding importance economically due to the size of projects and ongoing demand. Removing barriers to
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market access to the procurement sector through such mechanisms as public–private partnerships, outsourcing and commissioning is enabling private enterprise to take control of that demand, while leaving fiscal responsibility with governments. Exemplifying this change is the establishment of a programme management office within NSW Roads and Maritime Services by Advisian, the consultancy arm of global infrastructure mining giant Worley Parsons. In 2012, it implemented a ‘contestability reform program’ for road maintenance, giving it control over the tendering process (Cashen 2016).
Much of the attention has been on privatising ‘natural monopolies’ like telecommunications, water supply and toll roads that require significant expenditure on maintenance and new infrastructure. The switch from public sector control to private monopoly-oligopoly control has been based on contestability’s promise that it will enhance competition in these types of industries (Sturgess 2012, 109), even though transnational corporations are further consolidating their market share—for example, toll roads (Millar and Schneiders 2016).
The panel concurs with these overall trends by way of considering privatisation ‘as a form of procurement: the transfer of assets from the public to the private sector rather than a transfer of activities—in effect, procurement that is not repeated’ (Harper et al. 2015, 273). Liberalising market access to government procurement has long been seen as a key to boosting the contestability of international services markets as large, secure procurement markets with low levels of public-private corruption and effective access, serves to boost growth in trade in services within the economy overall, not just procurement markets (Sauvé 1996, 51). In OECD countries, procurement averaged 12.1 percent of GDP in 2013 (OECD 2015, 136). Contestability was also seen as potent in this government procurement space because ‘procurement regimes for services, even those that explicitly discriminate against foreign suppliers, are unlikely to have major permanent repercussions on domestic or foreign welfare so long as the markets are contestable’ (Evenett and Hoekman 1999, 144). Further, they contended that contestable markets would ‘obviate the need for multilateral rules on procurement’ if the GATS framework expanded market access and national treatment commitments (Evenett and Hoekman 1999, 144). (3) This was not an argument against the WTO’s governance role, as the multilateral disciplines still had a role in mandating transparency for the purposes of alleviating corruption and rent-seeking (Evenett and Hoekman 1999, 144). However, the removal of barriers to market access countenanced the dependency on free market economic truisms and the belief that contestability would ensure competitive behaviour.
The first GATS agreement exempted procurement by government agencies for their own use; that initially was left to the Agreement on Government Procurement (GPA), a voluntary agreement which came into force in 1981 (World Trade Organization 2016a). The GPA’s procurement and transparency rules effectively paralleled the GATS regime on the elimination of discrimination on trade in goods and services. At this time, the Department of Foreign Affairs and Trade recommended that Australia abstain from joining the GPA because it would not give Australia access to the US procurement market. That was to come in limited terms with the signing of the Australia–US Free Trade Agreement in 2004 (Weiss, Thurbon and Mathews 2004, 88).
In April 2015, Australia applied to join the GPA, and it now awaits accession to the agreement along with China. This will enable the completion of the China–Australia Free Trade Agreement negotiations on commitments to market access across a wide
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range of services, including information and communication technology, finance and transport (China–Australia Free Trade Agreement 2015, Article 16.8). The application will no doubt be successful, as discrimination barriers have already been removed. The Commonwealth Procurement Rules have for some years proscribed supplier discrimination on the basis of ‘size, degree of foreign affiliation or ownership, location, or the origin of their goods and services’ (Department of Finance 2014, 16). Both the GPA and the TPPA remove other forms of preferential treatment of domestic suppliers by disallowing ‘offsets’ such as the use of domestic content (Trans-Pacific Partnership Agreement 2015, Article 15.4.6)—noting exemptions including motor vehicles and defence hardware (Annex 15-A)—and by establishing a bid challenge system, giving all suppliers (local and foreign) recourse to an independent review body to challenge procurement decisions of government (Article 15.19).
In 2014–15, the Commonwealth government procured nearly AU$59.5 billion worth of goods and services (Department of Finance 2015a). This purchasing power is an important lever used by governments to promote secondary policy objectives—for example, growing domestic industries, regional development, employment programmes and environmental sustainability (OECD 2015, 138). The TPPA seriously curtails this function of governments by narrowing their autonomous purchasing decisions to dedicated programmes chiefly aimed at facilitating participation by small and medium-sized enterprises in the procurement market (Trans-Pacific Partnership Agreement 2015, Article 15.21).
One of the most significant changes derives from a shift to ‘outcomes-based procurement’, defined by the Harper panel as a shift from an output focus to a performance outcome focus. It illustrates this idea using floor-waxing—going from ‘contractor must strip and re-wax the floors weekly (output focus)’ to the highly subjective ‘floors must be clean and have a uniformly glossy finish (outcome focus)’ (Harper et al. 2015, 270–271). This approach complies with the TPPA, which denotes ‘technical specifications in terms of performance and functional requirements, rather than design or descriptive characteristics’ (Trans-Pacific Partnership Agreement 2015, Article 15.12.2[a]).
Government will be exposed to ISDS claims if it applies a technical specification with the purpose or effect of creating an unnecessary obstacle to trade between the parties (Article 15.12.1). This includes specifying ‘a particular trademark or trade name, patent, copyright, design, type, specific origin, producer or supplier’ (Article 15.12.3). That customer choice and insistence on specified standards could be construed as a market barrier, so that only generalised technical specifications which condone subjective performance can apply, is likely to diminish standards and the knowledge base they are derived from. In effect, the biggest consumer in the country (government) no longer has a right to information, which the Productivity Commission (2014, 6) says is essential for consumer welfare in a contestable market.
Conclusion
Submitting to TPPA provisions and governance and ‘the market’ translates into obligations and commitments that governments must honour under threat of trade sanctions. The Harper panel, in redesigning Australia’s competition regime, recommended establishing the Australian Council for Competition Policy, charged with ‘monitoring progress in implementing agreed reforms and publicly reporting on progress annually’ (Harper et al.
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2015, 77). This meets obligations under the TPPA to set up a ‘national or central coordinating body’ (Trans-Pacific Partnership Agreement 2015, Article 25.4.1) to ‘make recommendations for systemic regulatory improvements and publicly report on regulatory measures’ (Article 25.4.2[d]). This is the crux of what the Harper panel called ‘[d]eepening Australia’s integration with the world’ (Harper et al. 2015, 16), echoing the ‘deep integration’ served by the notion of international contestable markets—a concept that has travelled incognito with free market ideology since the 1990s.
This momentous change, led by the USA, which has brought a whole new tier of regional governance into being, was for a decade kept largely secret by the embargo on TPPA transcripts. The embodiment of this change—the Trans-Pacific Partnership Commission and the Asia-Pacific market it oversees— is proffered as a kind of proxy for various government functions, competition policy and law, with implications for Australia’s national environmental and social objectives and national economic management.
The purpose of this article has been to show how contestability has radicalised free market ideology by providing the rationale to disassemble pro-competition governance and other protections in favour of unfettered market access. This ongoing process has enabled transnational corporations to enjoy enhanced monopoly powers and control over capital flows, backed by the mechanisms of international agreements which are imbued with contestability notions.
Ironically, in 1994, the year contestability emerged as a force in repurposing international agreements, Baumol delivered lectures at his Alma Mater, the London School of Economics, where he criticised orthodox free trade theories based on his concerns about the destabilising effect of global capital flows. He suggested that national economies are better protected by targeted government policy (Baumol and Gomory 2000, 8). A far deeper irony emerges, however, from Hayek’s utopian sentiments, expressed in his September 1939 essay, where he states: ‘the abolition of economic barriers between the members of the federation is … an indispensable condition for the achievement of the main purpose of federation … to secure peace’ (Hayek 1939, 131). The breaking down of economic barriers and aspects of the state apparatus that maintains them has left a vacuum which is being filled by transnational corporations which are accumulating powers that were once the preserve of the state and international governance bodies. At this juncture in history, where the new order is still emergent, Hayek’s (1944, 163) portent from another time and place of rupture may offer salutary pause: ‘Perhaps even more than elsewhere current notions of what is desirable and practicable are here still of a kind which may well produce the opposite of what they promise’.
Notes
- Barring transaction taxes represents a considerable loss of potential income for government given that the Australian financial market’s total annual turnover (over the counter and exchange traded) is AU$135 trillion. This figure is 84 times the size of Australia’s nominal GDP (Australian Trade Commission 2016, 56).
- As of June 2015, the financial sector’s asset holdings were AU$7 trillion, four times Australia’s nominal GDP (Austrade 2015, 54).
- National treatment accords a WTO member ‘treatment no less favorable than that it accords to its own like services and service suppliers’ and most-favoured-nation treatment accords ‘treatment no less favourable than that it accords to like services and service suppliers of any other country’ (World Trade Organization 2016b, Article XVII[1], Article II).
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A summary version of this article was published online (19 Feb 2017).
https://www.internationalaffairs.org.au/australianoutlook/contestability-theory-radicalising-the-free-market/