The “bigness is badness” doctrine dominated antitrust policy from 1945 to the 1970s. But the doctrine always had its critics. If a firm is more efficient than its competitors, why should it be punished? Critics of the antitrust laws point to the fact that of the 500 largest companies in the United States in 1950, over 100 no longer exist. New firms, including such giants as Walmart, Microsoft, and Federal Express, have taken their place. The critics argue that the emergence of these new firms is evidence of the dynamism and competitive nature of the modern corporate scene.
There is no evidence to suggest, for example, that the degree of concentration across all industries has increased over the past 25 years. Global competition and the use of the internet as a marketing tool have increased the competitiveness of a wide range of industries. Moreover, critics of antitrust policy argue that it is not necessary that an industry be perfectly competitive to achieve the benefits of competition. It need merely be contestable—open to entry by potential rivals. A large firm may be able to prevent small firms from competing, but other equally large firms may enter the industry in pursuit of the high profits earned by the initial large firm. For example, Time Warner, primarily a competitor in the publishing and entertainment industries, has in recent years become a main competitor in the cable television market.
Currently, the Justice Department follows guidelines based on the Herfindahl– Hirschman Index (HHI). The HHI, introduced in an earlier chapter, is calculated by summing the squared percentage market shares of all firms in an industry, where the percentages are expressed as whole numbers (for example 30% would be expressed as 30). The higher the value of the index, the greater the degree of concentration. Possible values of the index range from 0 in the case of perfect competition to 10,000 (=1002) in the case of a monopoly.
Current guidelines stipulate that any industry with an HHI under 1,000 is unconcentrated. Except in unusual circumstances, mergers of firms with a postmerger index under 1,000 will not be challenged. The Justice Department has said it would challenge proposed mergers with a postmerger HHI between 1,000 and 1,800 if the index increased by more than 100 points. Industries with an index greater than 1,800 are deemed highly concentrated, and the Justice Department has said it would seek to block mergers in these industries if the postmerger index would increase by 50 points or more. Table 16.1 summarizes the use of the HHI by the Justice Department.
If the postmerger Herfindahl-Hirschman Index is found to be… |
then the Justice Department will likely take the following action. |
Unconcentrated (<1,000) |
No challenge |
Moderately concentrated (1,000–1,800) |
Challenge if postmerger index changes by more than 100 points. |
Highly concentrated (>1,800) |
Challenge if postmerger index changes by more than 50 points. |
The Department of Justice (DOJ) and the Federal Trade Commission (FTC) have adopted the following guidelines for merger policy based on the Herfindahl-Hirschman Index.
U.S. Department of Justice and Federal Trade Commission, 1992 Horizontal Merger Guidelines, issued April 2, 1992, revised April 8, 1997.
One difficulty with the use of the HHI is that its value depends on the definition of the market. With a sufficiently narrow definition of the market, even a highly competitive market could have an HHI close to the value for a monopoly. The late George Stigler commented on the difficulty in a fanciful discussion of the definition of the relevant market for cameras:
“Consider the problem of defining a market within which the existence of competition or some form of monopoly is to be determined. The typical antitrust case is an almost impudent exercise in economic gerrymandering. The plaintiff sets the market, at a maximum, as one state in area and including only aperture-priority SLR cameras selling between $200 and $250. This might be called J-Shermanizing the market, after Senator John Sherman. The defendant will in turn insist that the market be world-wide, and include not only all cameras, but all portrait artists and all transportation media, since a visit is a substitute for a picture. This might also be called T-Shermanizing the market, after the Senator’s brother, General William Tecumseh Sherman. Depending on who convinces the judge, the concentration ratio will be awesome or trivial, with a large influence on the verdict.” G. J. Stigler, “The Economists and the Problem of Monopoly,” American Economic Review Papers and Proceedings 72:2 (May 1982): 8– 9.
Of course, the definition of the relevant market is not a matter of arbitrarily defining the market as absurdly narrow or broad. There are economic tests to determine the range of goods or services that should be included in a particular market. Consider, for example, the market for refrigerators. Given the relatively low cost of shipping refrigerators, the relevant area might encompass all of North America, given the existence of the North American Free Trade Agreement (NAFTA), which establishes a tariff-free trade zone including Canada, the United States, and Mexico. What sorts of goods should be included? Presumably, any device that is powered by electricity or by natural gas and that keeps things cold would qualify. Certainly, a cool chest that requires ice that people take on picnics would not be included. The usual test is the cross price elasticity of demand. If it is high between any two goods, then those goods are candidates for inclusion in the market.
Should the entire world be the geographic region for the market for refrigerators? That is an empirical question. If the cross price elasticities for refrigerator brands worldwide are high, then one would conclude that the world is the relevant geographical definition of the market.
In the 1980s both the courts and the Justice Department held that bigness did not necessarily translate into badness, and corporate mergers proliferated. In the period 1982–1989 there were almost 200 mergers and acquisitions of firms whose value exceeded $1 billion. The total value of these companies was nearly half a trillion dollars.
Megamergers continued in the 1990s and into the 21st-century. In 2000, there were 212 mergers valued at $1 billion or more and in 2006 nearly that many. Since then, merger activity has decreased, in part due to turmoil in financial markets. Matt Krantz, “Merger Market Arrives At ’Good spot’; 2006 the Busiest Takeover Year Since End Of ’90s Bull,” USA Today, November 7, 2006, p. 3B; and Matt Krantz, “Big Day for Buyouts, But Tepid Pace Forecase To Continue; Credit Crunch and Other Economic Fears Take Toll,” USA Today, December 18, 2007, p. 1B.
KEY TAKEAWAYS
- The government uses antitrust policies to maintain competitive markets in the economy.
- The Sherman Antitrust Act of 1890 and subsequent legislation defined illegal business practices, but these acts are subject to widely varying interpretations by government agencies and by the courts.
- Although price-fixing is illegal per se, most business practices that may lessen competition are interpreted under the rule of reason.
- The Justice Department and Federal Trade Commission use the Herfindahl-Hirschman Index to determine whether mergers should be challenged in particular industries.
TRY IT!
According to what basic principle did the U.S. Supreme Court find Eastman Kodak not guilty of violating antitrust laws? According to what basic principle did the Court block the merger of Brown Shoe Company and one of its competitors, United Shoe Machinery? Do you agree or disagree with the Court’s choices?
Case in Point: Does Antitrust Policy Help Consumers?
The Department of Justice and the Federal Trade Commission spend a great deal of money enforcing U.S. antitrust laws. Firms defending themselves may spend even more.
The government’s first successful use of the Sherman Act came in its action against Standard Oil in 1911. The final decree broke Standard into 38 independent companies. Did the breakup make consumers better off?
In 1899, Standard controlled 88% of the market for refined oil products. But, by 1911, its share of the market had fallen to 64%. New discoveries of oil had sent gasoline prices down in the years before the ruling. After the ruling, gasoline prices began rising. It does not appear that the government’s first major victory in an antitrust case had a positive impact on consumers.
In general, antitrust cases charging monopolization take so long to be resolved that, by the time a decree is issued, market conditions are likely to have changed in a way that makes the entire effort seem somewhat frivolous. For example, the government charged IBM with monopolization in 1966. That case was finally dropped in 1982 when the market had changed so much that the original premise of the case was no longer valid. In 1998 the Department of Justice began a case against against Microsoft, accusing it of monopolizing the market for Internet browsers by bundling the browser with its operating system, Windows. A trial in 2000 ended with a judgment that Microsoft be split in two with one company having the operating system and another having applications. An appeals court overturned that decision a year later.
Actions against large firms such as Microsoft are politically popular. However, neither policy makers nor economists have been able to establish that they serve consumer interests.
We have seen that the Department of Justice and the Federal Trade Commission have a policy of preventing mergers in industries that are highly concentrated. But, mergers often benefit consumers by achieving reductions in cost. Perhaps the most surprising court ruling involving such a merger came in 1962 when the Supreme Court ruled that a merger in shoe manufacturing would achieve lower costs to consumers. The Court prevented the merger on grounds the new company would be able to charge a lower price than its rivals! Clearly, the Court chose to protect firms rather than to enhance consumer welfare.
What about actions against price-fixing? The Department of Justice investigates roughly 100 price-fixing cases each year. In many cases, these investigations result in indictments. Those cases would, if justified, result in lower prices for consumers. But, economist Michael F. Sproul, in an examination of 25 price-fixing cases for which adequate data were available, found that prices actually rose in the four years following most indictments.
Economists Robert W. Crandall and Clifford Winston have asked a very important question: Has all of this effort enhanced consumer welfare? They conclude that the Department of Justice and the Federal Trade Commission would best serve the economy by following a policy of benign neglect in cases of monopolization, proposed mergers, and efforts by firms to exploit technological gains by lowering price. The economists conclude that antitrust actions should be limited to the most blatant cases of price-fixing or mergers that would result in monopolies. In contrast, law professor Jonathan Baker argued in the same journal that such a minimalist approach could be harmful to consumer welfare. One argument he makes is that antitrust laws and their enforcement create a deterrence effect.
A recent paper by Orley Ashenfelter and Daniel Hosken analyzed the impact of five mergers in the consumer products industry that seemed to be most problematic for antitrust enforcement agencies. In four of the five cases prices rose following the mergers and in the fifth case the merger had little effect on price. While they do not conclude that this small study should be used to determine the appropriate level of government enforcement of antitrust policy, they state that those who advocate less intervention should note that the price effects were not negative, as they would have been if these mergers were producing cost decreases and passing them on to consumers. Those advocating more intervention should note that the price increases they observed after these mergers were not very large.
Sources: Orley Ashenfelter and Daniel Hosken, “The Effect of Mergers on Consumer Prices: Evidence from Five Selected Cases,” National Bureau of Economic Research Working Paper13859, March 2008; James B. Baker, “The Case for Antitrust Enforcement,” Journal of Economic Perspectives, 17:4 (Fall 2003): 27–50; Robert W. Crandall and Clifford Winston, “Does Antitrust Policy Improve Consumer Welfare? Assessing the Evidence,” Journal of Economic Perspectives, 17:4 (Fall 2003): 3–26; Michael F. Sproul, “Antitrust and Prices,” Journal of Political Economy, 101 (August 1993): 741–54.
ANSWER TO TRY IT! PROBLEM
In the case of Eastman Kodak, the Supreme Court argued that the rule of reason be applied. Even though the company held a dominant position in the film industry, its conduct was deemed reasonable. In the proposed merger between United Shoe Machinery and Brown Shoe, the court clearly chose to protect the welfare of firms in the industry rather than the welfare of consumers.
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