Botulism milk powder scandal

How fair is China's crackdown on anti-monopoly behaviour?

John Gong says the National Development and Reform Commission may be unfairly using anti-monopoly laws to target multinationals to pander to public sentiment over price-fixing

PUBLISHED : Friday, 09 August, 2013, 12:00am
UPDATED : Friday, 09 August, 2013, 2:31am

The dairy industry is probably the sickest industry in China. Its products are sick. Its managers cheat. The indigenous dairy industry has witnessed one scandal after another, from melamine milk to leather milk and other chemical formulations that are beyond people's imagination. The dairy industry is so sick that consumers in China have totally abandoned indigenous brands, opting for imports instead.

Until last week's news about contaminated ingredients supplied by New Zealand's Fonterra, the problem with imports has been that they are expensive - even by international standards. In fact, the same products from, Western food giants such as Nestle, Danone, Mead Johnson and Abbott Laboratories are sometimes twice as expensive in China as in their countries of origin.

One can certainly blame the high taxes and import duties in China, but even accounting for these, the prices of imported infant formula smack of unwarranted monopoly profits in the eyes of mass consumers. And that is precisely the reason the National Development and Reform Commission went after these companies' pricing and distribution practices to see if they violate China's anti-monopoly law. Now it has come out with total fines of 668 million yuan (HK$840 million).

Only a week ago, in contrast, a higher court in Shanghai slapped Johnson & Johnson with a paltry penalty of 530,000 yuan for exactly the same violation.

Do the alleged pratices really exclude and limit competition of the entire market?

The practices under investigation fall into the broad category called resale price maintenance, which is covered by Article 14 in the anti-monopoly law. The statute explicitly states that manufacturers' acts to fix the prices or set minimum prices their resellers may charge to third parties, meaning end users, are illegal. That is literally what Article 14 partly says, and seems to straightforwardly imply a "per se illegal" principle, which means such an act is illegal by itself.

However, in China's first vertical restraint lawsuit, Rainbow Medical versus Johnson & Johnson, both the intermediate people's court and the higher appeal court in Shanghai added an additional condition that the act at issue must also "exclude and limit competition", which effectively renders the legality of resale price maintenance subject to a "rule of reason" test. That means that the act at issue is not by itself illegal, unless proven that it excludes and limits competition after a careful legal and economic analysis.

The treatment of resale price maintenance in antitrust enforcement is not without controversy in Western countries. Such an act has been historically regarded as a hardcore restriction in Europe as specified in the Treaty on the Functioning of the European Union. That means that resale price maintenance is totally unlawful by itself, similar to the "per se illegal" concept.

In the US, however, resale price maintenance first started out as a "per se illegal" act as in the Supreme Court's ruling in the Dr Miles Medical Company case in 1911. However in the Leegin Creative Leather Products case in 2007, after a close 5-4 vote, the Supreme Court overturned the "illegal per se" principle that had lasted for nearly a century and shifted towards the "rule of reason" principle.

In China, the legal environment concerning resale price maintenance has seen a promiscuous cohabitation of both principles, and their application has not been consistent.

The courts have been clearly championing the "rule of reason" principle, as evidenced by the verdict in Rainbow versus Johnson & Johnson by the Shanghai Intermediate People's Court, as well as the appeal case at the Shanghai Higher People's Court. At antitrust conferences I have attended, judges from the Supreme People's Court in Beijing have repeatedly expressed the same opinion.

However, the administrative venue which is commanded by the NDRC seems to have a different thought. In landmark rulings against the mainland's two largest liquor companies, Maotai and Wuliangye, earlier this year, the NDRC fined the firms 247 million yuan and 202 million yuan respectively for alleged resale price maintenance practices. Is there any rule of reason in these fines? One case has practically none and one case has what I call "a little rule of reason", based on my readings of the case statements issued by the NDRC.

Now back to the infant formula case. I doubt the NDRC's "rule of reason" has any chance of standing up against the same standard set up the court rulings in the Johnson & Johnson case.

The first issue in question is whether the alleged violators have enough market power to warrant a resale price maintenance ruling. My own calculation indicates it to be a marginal case at best, as the market concentration in the infant formula industry is not very high. So why require a resale price maintenance ruling in the first place other than to cater to popular sentiment?

Second, do the alleged resale price maintenance practices really exclude or limit competition in the entire market? The NDRC argues that they exclude and limit competition within the same brand. That is true, but how this limitation and exclusion spill over to inter-brand competition in an industry with relatively low market concentration just baffles me.

Whatever the court's opinions, however, the NDRC is a powerful regulatory authority in China, and it usually has its way when flexing its muscle with private enterprises, especially foreign multinationals operating in China. The record fines this week imposed on six producers of infant milk formula illustrate this.

Companies presently under NDRC investigation are already lowering prices in droves and they all say that they are not going to challenge the NDRC ruling. That is what I call "socialist antitrust with Chinese characteristics".

Most consumers will raise a cheer for the NDRC getting baby food prices down, but is it worth the cost of trampling rule of law for populist politics?

John Gong is associate professor at the University of International Business and Economics in Beijing.