A Libertarian Perspective on Economic and Social Policy

Lecture 5

Antitrust Policy

©2007 Jeffrey A. Miron

Introduction

• Despite their reputations for “unbridled” capitalism, U.S. and other market economies impose substantial regulation on businesses.– Antitrust Policies– Regulation of Local Monopolies– Consumer Protection Policies– Entry and Rate Regulation, Licensing

Introduction, continued

• Numerous government agencies involved:– Antitrust Division of the Justice Department– Federal Trade Commission– Consumer Product Safety Commission– Interstate Commerce Commission– Federal Aviation Administration– Departments of Transportation, Housing, etc– State equivalents of many of these.

Introduction, continued

• Current policy in market economies is a long way from the command and control approaches of former Soviet Union, or current policy in North Korea or Cuba, but it is still far from unfettered.

• The general view underlying the current approach is that markets do things pretty well, but various factors (greed, information asymmetries, monopoly) lead to substantial imperfections that are ameliorated by government policies.

Introduction, continued

• Libertarian view is that imperfections exist (although they are frequently smaller than asserted by advocates of intervention), but that interventions have their own problems.

• Thus, laissez-faire is better than the interventions, even though neither is “perfect.”

• This is an empirical question.• This lecture illustrates by focusing on the issue

of antitrust policy.

Outline

• History of Antitrust Policy and Description of Current Practice

• Arguments for Intervention

• Arguments Against Intervention

• Other Regulation of Business

History and Overview

• In the second half of the 19th century, the growth of large corporations – trusts – prompted the adoption of Antitrust Laws:– The Sherman Act, adopted in 1890, outlawed “any

contract, combination … or conspiracy” that was “in restraint of trade.” Also outlawed monopolization and attempts to monopolize.

– The Clayton Act, adopted in 1914, outlawed some kinds of price discrimination, tying, and anti-competitive mergers. Also authorized private suits and exempted labor organizations.

– The FTC, created in 1914, was authorized to promote “fair” competition.

What Do the Antitrust Laws Prohibit?

• Price-Fixing– Explicit agreements among competitors to

maintain a specific price (presumably a high price) and thereby earn monopoly profits.

– Also referred to as cartelization.– Classic example is OPEC.

What Do the Antitrust Laws Prohibit?, continued

• Mergers that substantially lessen competition.– A merger between Coke and Pepsi would

almost certainly be regarded as anti-competitive

– A merger between two of the fifty Chinese restaurants in Central Square would not be.

– Situations in between have received varying degrees of scrutiny over the years (concentration ratio tests)

What Do the Antitrust Laws Prohibit?, continued

• Attempts to monopolize (even if not successful).

• Classic example is predatory pricing:– One firm lowers it price below costs in the

attempt to drive out competitors;– It then becomes a monopoly after the

competitors have left, so it raises its price to the monopoly level.

– Famous alleged example is American Tobacco in the 1890s, early 1900s

What Do the Antitrust Laws Prohibit?, continued

• Monopolization:– Unclear exactly what this means.– Being a monopoly is not, per se, illegal.– But if a firm is a monopolist, any action that

helped create or maintain this situation can be considered monopolization

– One famous alleged example is Microsoft.

What Do the Antitrust Laws Prohibit?, continued

• Practices viewed as enhancing market power even when monopolization is unlikely.– Tying arrangements; e.g., computer hardware

and software– Price discrimination, i.e., charging different

prices to different purchasers.– Vertical mergers– Vertical restrictions, such as resale price

maintenance.

The Argument for Antitrust Policy

• Competition is efficient:– Price equals marginal cost; quantity produced

is socially optimal.

• Monopoly is inefficient:– Price exceeds marginal cost; quantity

produced is sub-optimal.

• Monopoly has “undesirable” distributional implications; producers gain at the expense of consumers.

The Argument for Antitrust:Qualification

• The standard argument makes a key assumption:– No price discrimination.

• For many goods, however, price discrimination is possible:– Under some assumptions, the equilibrium is close to,

or identical to, the competitive outcome, distributional consequences aside.

• Thus, the empirical magnitude of monopoly distortion is unclear in some cases.– Although price discrimination can raise distributional

concerns.

The Argument for Antitrust Policy:Discussion

• The standard analysis is correct as far as it goes:– Other things equal, competition is good.

• But this analysis is incomplete, for several reasons.– It is important to know why market power exists; – It is important to know what other effects merger,

monopoly, and other allegedly anti-competitive practices might have.

– It is important to distinguish short and long run.– It is important to recognize the costs of policy.

The Argument for Antitrust Policy,Discussion

• The simple, textbook analysis addresses the question of – cartelization/monopoly/price-fixing

• It does not by itself address the effects of several other practices that policy has attacked under the antitrust framework.– These need a separate analysis.– We will focus for the moment on the issue of

monopoly.

Arguments Against Antitrust:Market Power is Modest

• Existing literature finds only modest evidence of monopoly or market power in U.S. industry.

• In many instances where market power does exist, it is short-lived because of entry.– Instability of cartels is a standard prediction of

economic models, and this prediction is consistent with evidence.

– Introduction of new markets erodes many monopolies, often quickly.

Arguments Against Antitrust:Market Power is Modest, continued• In many instances, market power is created by

government:– Public schools– Post Office– Patents

• In many instances, free trade provides competition.

• In some instances, big companies provide the discipline that creates competition:– Either foster a rival– Or do it themselves

Arguments Against Antitrust:Threat of Acquisition is Good

• Individual companies are not necessarily run in the long-run interests of the owners:– Principal-agent problems.

• But the threat of acquisition provides a counterweight to this problem:– Managers that do not maximize value are

more likely to see their companies bought by others and then find themselves on the street.

Arguments Against Antitrust:Firms Use It Against Each Other

• One way to out-compete rival firms is to lower costs, improve your product, etc.

• An alternative is to complain to DOJ or FTC about your competitor’s behavior.

• If these agencies had “perfect” views, this would not a big problem.

• But in practice, it is a serious issue.– These agencies have lots of discretion.

Arguments Against Antitrust:Uncertainty

• In the absence of antitrust policy, firms considering mergers and acquisitions need only consider the merits.

• In the presence of antitrust, firms must also forecast DOJ/FTC actions.– This added effort is a cost.– These costs delay or prevent potentially

beneficial mergers or acquisitions.

Why Antitrust Generates Uncertainty: An Example

• A key issue in most antitrust enforcement is defining the market:– This is incredibly open to interpretation.

• Consider breakfast cereals. Should the market include– Oatmeal?– Toast?– Eggs?– Left-over frozen pizza?

• Or professional baseball. Does the market include– Pro football, basketball, hockey?– College sports?– Movies, Plays, Opera, Theater?

• Enormous scope for different enforcement depending on the industry, political climates, and the like.

Arguments Against Antitrust:Mergers Can Improve Efficiency

• Why do two firms want to merge, or why does one firm want to acquire another?– One possible reason is to reduce competition.

• But there are also motivations that imply increased economic efficiency:– Economies of scale or scope– Mechanism for cutting costs

• In other cases, motivations might be orthogonal to efficiency, but also often orthogonal to degree of market power.

Arguments Against Antitrust:High P / Low Q Might be OK

• The competitive outcome for P, Q are efficient under certain assumptions.

• But for some goods, there is potentially an argument that the efficient Q is lower:– Goods whose production generate externalities like

pollution– Goods whose consumption is excessive due to

addiction and myopia.

• Allowing market power moves P, Q in the right direction.

Arguments Against Antitrust:Monopoly Profits Induce Innovation• Many goods are initially produced by a

monopolist: the business that introduced the product. – For example, the Palm Pilot.

• Over time, however, imitation and technological progress erode these monopolies:– Blackberries, Treos, Cell Phones, etc.

• If antitrust reduces the profits from innovation, the incentive to create the initial product, or the competing products, falls.

• Thus, a potentially large cost is reduced innovation and technological progress.

Price-Fixing

• Discussion so far addresses mainly antitrust aimed at monopolization/merger.

• What about pure price-fixing?– If there were an anti-trust authority that limited itself to

such cases, the benefit might exceed the harm– But even this conclusion assumes away the dynamics

benefits of monopoly profits on innovation.

• Moreover, this idealized agency does not exist. – Indeed, the history of antitrust illustrates well the

mission creep and overextension that often characterizes government intervention.

“Anti-Competitive Practices”

• Beginning in 1914, anti-trust authorities attempted to sanction many practices beyond monopoly:– Vertical mergers– Vertical restraints such as RPM– Tying arrangements– Price discrimination

• Over the past two decades, these same authorities have gradually backed away from sanctioning these practices:– It is now widely accepted that these practices can be, and

frequently are, pro-competitive.

• But there was a lot of wasted effort in the interim.

Bottom Line on Antitrust:Perfect versus Actual Antitrust

• If a benevolent dictator ran antitrust policy, and pursued only the most egredious cases, there might be a net benefit from antitrust.

• But real world implementation will differ from this ideal, and to a substantial degree.

• Thus, in practice, it is probably better to avoid antitrust policy altogether.

Other Regulation of Business

• Regulation of Local Monopoly

• Restrictions on Advertising

Regulation of Local Monopoly

• For certain goods, it seems inefficient to have multiples suppliers because the structure of costs involves major capital investments but small marginal costs:– Telephone, cable, internet.

• But if there is only one supplier, it will charge a monopoly price, which is inefficient.

• Thus, it would seem to make sense to regulate:– Set prices at “average costs,” i.e., below the

monopoly price but enough above MC so that the activity breaks even on average.

Regulation of Local Monopoly, continued

• This argument makes sense as far as it goes, but there are several problems.

• First, the regulation is cumbersome in practice; induces lots of inefficiencies.– Setting prices, making capital decisions is hard; – And under regulation, they adjust slowly.

• Second, regulation reduces the incentive to innovate around the local monopoly:– Cell phones; VOIP; satellite TV; cable over phone

lines; Wifi; and other innovations yet to appear.

Regulation of Local Monopoly, continued

• Thus, in the short run (i.e., given the existing technology), regulation of local monopoly might make sense.

• But once one accounts for the long run impacts, the value becomes far less clear.

• The libertarian “hunch” is that laissez-faire would be better overall, due to the dynamic effects on innovation.

Restrictions on Advertising

• Government enforces rules about “fair” advertising.

• The standard motivation is that, if not regulated, firms will use advertising to con people into lots of stupid purchases.

• Without question, some firms are dishonest and some consumers are naïve.

• But there are substantial costs of regulating advertising.

Costs of Restrictions on Advertising

• There is actually little evidence that advertising has a big effect in getting people to purchase goods they do not want;– The puzzle is in the opposite direction.

• Much advertising contains useful information:– Restrictions can prevent both the good and “ bad.”

• Independent groups can and do provide a check on the claims made by businesses: – Consumer reports

• Restraining advertising runs up against protections for free speech.

• Restricting advertising can inhibit competition.

Consumer Protection

• Beyond restrictions on advertising, there are other government agencies and policies that seek to protect consumers by means of various “ex ante” constraints on what products can be sold and under what conditions.– CPSC– Warning labels– Lemon Laws– Mandatory return periods

Consumer Protection, continued

• The standard assumption is that, without these government agencies, laws, etc., businesses will take advantage of consumers to a huge degree.

• There is no doubt it will occur on occasion.

• But there are two important anti-dotes:– Competition– Tort Liability

Competition Disciplines Bad Behavior by Businesses

• Firms that lie about their products or produce faulty merchandise will lose out to firms that do not.

• One way that “good” firms succeed is by using advertising to attract and keep business, which makes restrictions on advertising especially bad.

• And competitors are eager to point out the false claims or lousy products of rivals.

Tort Liability Also Disciplines Businesses

• Tort liability means that someone who commits a “tort,” a “wrong,” is liable for the damages.

• Thus, a business that sells a product that injures someone must compensate the victim.

• If this system works smoothly, it provides the appropriate economic incentive to avoid marketing products deceptively.

Tort Liability Also Disciplines Businesses, continued

• There has been much criticism of the tort system in recent years:– Partly because of notorious cases like the cup of coffee from

McDonald’s– Partly because of claims that tort liability has raised business

costs enormously.

• There have no doubt been excesses and abuses.• But many of the complaints are self-serving and

exaggerated claims by those disciplined by the system.• And using tort liability is far better than the “ex ante”

restraints of regulation.– Only adversely affects the “bad” suppliers;– Regulation imposes costs on all suppliers; easily too broad.

Conclusions

• Antitrust policy appears well-intentioned. But: – Much antitrust enforcement over the past century

focused on targets that are now considered ill-advised.

– Antitrust unquestionably has the potential to generate more harm than good, such as by discouraging innovation and competitive actions.

– There is no empirical assessment that shows a benefit; certainly substantial costs in some cases.

• So, there might be a case for minimal antitrust policy aimed solely at pure price-fixing. – But slopes have been slippery in the past and are

likely to be so again.

Conclusions, continued

• Most other kinds of business regulation likely do more harm than good.

• The general negatives include increased costs and the limiting competition.

• Tort Liability and competition are the most effective remedies for “bad” businesses.