Anti-monopoly legislation in China

In August 2008, the Chinese government passed an anti-monopoly law. As China is a transition economy, many foreign economists welcomed this law on the grounds that it might encourage Chinaâ€™s transition to a free market economy.

This law is being applied in the area of acquisitions (or the purchase) of one firm by another, the objective being to prevent the establishment of very large firms that would limit competition. In the six months since the law was passed, the commerce ministry had decided on 25 such cases. All were approved except one: the commerce ministry rejected Coca-Colaâ€™s application to buy Huiyuan, Chinaâ€™s largest juice company.

Coca-Cola offered to buy Huiyuan at a price (US$2.4 billion) estimated to be three times the Chinese firmâ€™s value. This purchase would have represented a type of foreign direct investment (FDI) in which a foreign firm acquires control of a domestic firm. Coca-Cola already holds about half the Chinese market for carbonated drinks, but the juice market is far less dominated by a single large firm. If the purchase had gone ahead, Coca-Cola together with Huiyuan would control just over 20 % of the juice market.

The rejection of the acquisition came as a surprise to many who expected the deal to go through. Coca-Cola had offered a very high price, and it has made major investments in China, making it one of the most attractive buyers of local firms. Many economists wondered if this was a government attempt to prevent a popular local brand from falling into foreign ownership.

The Chinese authorities argue that the rejection of the acquisition was based on possible negative impacts on domestic competition. The acquisition would have concentrated too much power in one firm. Coca-Colaâ€™s brand name would make it difficult for new firms to enter the juice market because of brand loyalty that acts as a barrier to entry. Coca-Colaâ€™s economies of scale and dominant position in the market would hurt small competitors and prevent entry of new firms, while consumers would face higher prices and less choice as a result of Coca-Colaâ€™s monopoly power.

a) Define the following terms indicated in bold in the text:

(i) free market economy (paragraph 1)
(ii) monopoly (paragraph 5).

b) Using an appropriate diagram, explain how Coca-Colaâ€™s economies of scale could â€œhurt small competitorsâ€ (paragraph 5).

c) Using an appropriate diagram, explain how Coca-Colaâ€™s â€œdominant positionâ€ (paragraph 5) may enable it to make supernormal (abnormal) profits in the long run.

d) Using information from the text/data and your knowledge of economics, evaluate Chinaâ€™s commerce ministryâ€™s decision to reject Coca-Colaâ€™s application to buy Huiyuan.

Anti-monopoly legislation in China In August 2008, the Chinese g...