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Our antitrust laws are anticompetitive
D E A N S . AMMER
OUR ANTITRUST LAWS ARE ANTICOMPETITIVE An examination of price and quota enforcement Mr. Ammer is director of the Bureau of Business and Economic Research, Northeastern University.
This article summarizes the author's views o f antitrust laws, in theory and in practice, primarily on economic grounds. Such laws, he believes, are worth-while only if they either increase total income and/or distribute income in a more desirable way. They have, however, proved to be inappropriate for contemporary American society; neither objective has been accomplished by their enforcement. Several cases o f the most popular types o f antitrust action, those dealing with price fixing and market quotas, are examined; the author concludes that the result has not been socially beneficial, and that industry would be more competitive and come closer to meeting economically related social objectives if there were no antitrust laws at all. Antitrust laws help create outstanding e m p l o y m e n t opportunities for young lawyers who work for the Justice Department and the Federal Trade Commission. Those who make good almost inevitably wind up earning high
OCTOBER, 1971
incomes in the great Washington and New York law firms that specialize in defending their clients against antitrust violations and counseling them on ways to avoid prosecution by the "trust-busters." This rather specialized contribution of the antitrust laws to economic well-being is not arguable. But any other economic contribution by the Sherman Act and its successors is debatable. Antitrust laws, which we did not really invent, are largely an American phenomenon, one that has been imitated abroad. In the nineteenth century, we discovered that our emerging industrial e c o n o m y was not behaving the way Adam Smith, David Ricardo, and J o h n Stuart Mill said it should. So we tried to change it b y legislation to fit their competitive model. At first, the legislation concentrated on preventing the big businesses that were developing at that time from getting even bigger by pooling their interests in trusts and holding companies. Later, legislation focused more directly on nasty little practices like price fixing in which business of any size could indulge in profitably, in theory at least. Other countries have never been as straight-laced as we have been concerning antitrust. The Japanese, although they still have antitrust legislation on their books that was imposed by an occupying American army, rarely confuse antitrust ideals with economic reality. Price fixing is no more legal in Japan than it is in the United States. But when business is depressed in Japan, the authorities move quickly to prevent price cuts from further depressing the economy. Industry is encouraged to " c o o p e r a t e " to prevent destructive competition. In fact, Japanese antitrust law is sufficiently flexible
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to allow the two biggest steel producers to remerge in their pre-World War II state with a market share that is equivalent to that enjoyed b y the three or four largest producers in the United States. Great Britain is no less flexible. The government recently forced !eading aviation firms to combine into a single monopoly, the British Aviation Corporation. Similarly, they have long encouraged firms in the British textile industry to cooperate in the interests of improved technology and reduced competition.
costs during periods when he has slack capacity. The formulas are anticompetitive in the antitrust sense if they inhibit the businessman from following his intuition in weak markets and cutting prices. They have apparently had some impact on smaller firms; I have met many small businessmen who regard it as almost unethical-and certainly u n p r o f i t a b l e - t o sell below full cost, even though this may sometimes be in their selfish interest.
Do not agree with competitors on specific production quotas. It is perfectly acceptable GROUND RULES IN THE UNITED STATES
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In the Webb-Pomerane Act, Congress gave business more flexibility in cooperating w i t h other firms in sales abroad. But a company-particularly a big o n e - i s subject to fairly tight ground rules in its domestic operations if it wants to avoid being accused of violating our antitrust laws. Most businessmen would agree that certain rules apply if one is to coexist peacefully with the trust-busters.
Be careful when discussing prices with competitors. It is always illegal to agree on a price with a competitor, as plumbing equipm e n t manufacturers recently discovered when they tried to do what electrical equipment manufacturers were caught doing about ten years ago. The practice of being careful to inform competitors about price changes so that they, in turn, can make intelligent pricing decisions would also not be r e c o m m e n d e d b y a company's law firm. But it is probably fairly c o m m o n , and, in the absence of overt collusion or written communication, exists in the gray area of antitrust. Finally, i t is still perfectly legal for a trade association to hire cost accountants to develop "realistic" pricing formulas. In general, these formulas tend to be based on full cost, and it would presumably never occur to the businessman who uses them that it is to his selfish interest to sell at the highest price that covers variable
to negotiate a production quota through some public authority, however. The Texas Railroad Commission has set quotas on oil production in that state for years, allegedly for the purpose of conserving natural resources. Quota setting becomes illegal only when it occurs between private parties. Consequently, the industry that wants quotas should seek a goal that is seemingly above profit maximization and work through some government body. For example, to keep out foreign meat because of possible hoof-and-mouth disease (even from countries with no known record of it) is acceptable to public authority, even if it has the side-effect of limiting the available supply of meat.
If already big, do not buy control of major competitors. This caveat has been tested in the courts so m a n y times that fairly well-defined but complicated rules have developed. In general, if a c o m p a n y is small enough, it can usually acquire competitors up to the limit of its resources, and no one will really care. On the other hand, if a corporation is one of the ten biggest in the country and a leader in its industry, acquisitions within its existing line of business will be looked upon with suspicion. For example, IBM would probably not dare attempt to acquire even a small producer of computers or electric typewriters. In some cases, a company need not
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Our Antitrust Laws Are Anticompetitive
" . . . if a big firm continues hell-bent on an acquisition course, the Justice Department will try to stop it."
account for a huge share of the market to be considered dominant. A&P, for example, has a small and declining share of the food business, but its sales of over $5 billion make it big enough so that any attempt to acquire another food chain would almost certainly be challenged. If the industry is small, a dominant producer of modest size may be locked in by antitrust rules. For example, Ideal Basic Industries has cement sales of less than $140 million, but nevertheless accounts for at least 10 percent of industry output. Ideal would likely be challenged by the Justice Department if it attempted to merge with another cement producer. There are real limits to nonproduct-related acquisitions, and the ground rules are not yet as well-defined as they are with other infractions o f antitrust laws. Apparently, a company with assets of less than about $1 billion can do whatever it pleases as long as its nonproduct-related acquisitions keep it from reaching this critical size. In addition, almost any company can probably pull off one or two acquisitions without attracting Justice Department attention. Ford, the third biggest manufacturer, acquired Philco and Electric Auto Lite without any antitrust problems, although now--a decade l a t e r - t h e trustbusters are trying to force Ford to get out of the spark plug business. International Telephone & Telegraph has grown to become the eleventh biggest manufacturer largely because of its acquisitions, and the Justice Department is only now challenging new acquisitions. Similarly, McDonnell and Douglas came together to become the largest single defense contractor and the fourteenth biggest manufacturer. a
It can safely be assumed, however, that if big firm continues hell-bent on an
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acquisition course, the Justice Department will try to stop it. So far, the department has succeeded, even when it has not been able to prove that the merger increases the market share of a major producer. Northwest Industries, a big conglomerate that derived less than 10 percent of its sales from chemical manufacturers, would have been challenged by the Justice Department had it been able to carry off its merger with B. F. Goodrich, also a minor producer of chemicals. LTV's acquisition of Jones & Laughlin Steel is being allowed only because no one knows how to undo it without forcing LTV into bankruptcy. In effect, Justice Department opposition to these conglomerate-type mergers boils down to the fear that the merged corporation will become too big and too powerful even if the merger does not give it a dominant market share. For example, since LTV was not in the steel business before acquiring J&L, there is no change in the degree of concentration in that industry, where J&L is a medium-sized and not especially efficient producer. To force dissolution under exising laws, the government would have almost certainly based its case on the possibility that LTV might violate the antitrust laws through illegal use of reciprocity. It would have maintained that the purchasing departments of the various LTV companies could use their collective buying power to coerce suppliers into buying steel from J&L. LTV need not have been proved guilty to lose the case. Apparently, the government needs only to prove that the opportunity to sin exists even if the record of the defendant is clean. The precedent is the forced divestment of Penick & Ford's starch-making facilities by its parent, R. J. Reynolds. The government claimed that although Reynolds had never used reciprocity, the company had the power to force its paper suppliers to buy starch from its Penick & Ford division. (Starch is used in the manufacture of paper'.) Reynolds, through its ownership of Penick & Ford, was the only major starch producer that
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was also a major paper buyer; it could, the government suggested, gain an unfair competitive advantage. There are other ways in which businessmen can get into trouble with the Federal Trade Commission or the Justice Department. But usually these involve actions (such as lying to customers or unfairly maligning competitors) that would be repugnant ethically to most businessmen. The four areas we discussed have no such moral overtones (although they sometimes may be attached to illegal price fixing). For example, nonprofit organizations, such as universities and hospitals, regularly engage in price fixing. Although perfectly legal, it is basically no different from price fixing or market quotas set b y competing businessmen. And ethics are never questioned when a business expands either b y acquiring a c o m p a n y in its own industry or in some other nonrelated product line, even if this is later held to be a violation of the antitrust laws. Thus, it is perfectly fair to judge antitrust laws primarily on economic grounds, taking into account the social effects created b y their economic impact.
Whenever he could, he restricted o u t p u t in order to hold up prices and, if possible, earn some sort of m o n o p o l y return. The natural w a y to b o o s t profits is to pool resources and agree on identical prices. The original Sherman Act was designed to break up the trusts that legally committed business to identical prices and production quotas. Eighty years of amendments have made the law more complex b u t have n o t changed the assumptions on which it is based. In the antitrust sense, the ideal e c o n o m y still comes closer to the model of Adam Smith than that of J o h n Maynard Keynes, although the latter and his followers have held sway in government circles outside the Antitrust Division for at least thirty years. Economically, the antitrust laws are no more appropriate to contemporary American society than the nineteenth century Karl Marx is to current Soviet society. If they have any effect on total income at all, it is to reduce it. Even worse, they tend to shift income from those who produce a lot and have relatively little of it to those w h o have more and produce relatively little. Let us n o w test this hypothesis on the basic types of antitrust action, relating the law, as indicated b y recent cases, to our economic criteria.
ANTITRUST THEORY Antitrust laws are worth-while if they either increase total income and/or distribute income in a more desirable way. In the pure
A N T I T R U S T IN PRACTICE
competition economic models of the classical economists, total income is maximized because each producer uses all resources at capacity and has no control over price. Income is distributed entirely on the basis of contribution to production and the demand for that factor. Competition, with a tendency of all prices to drop to a level that yields only a market-determined return on capital, minimizes the rent and quasi-rents earned b y society's nonproducers. But, of course, nineteenth century reformers soon discovered that no businessman (or anyone else) voluntarily behaves the way the classical economists said he should.
The most popular type of antitrust enforcement is concerned with price fixing and market quotas. If producers are permitted to band together to set production quotas and prices, it is easy to see how corporate wealth could be increased at the expense of the consumer. In addition, a tight little cartel would inhibit new technology or improvement of any kind, making for n o t only high industry profits b u t also high costs. But late twentieth century practice differs widely from nineteenth century economic theory that is the b a c k b o n e of our antitrust laws. First, let us take cases where the law permits monopoly. Two types of monopolies
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Our Antitrust Laws Are Anticompetitive
are perfectly acceptable: those based on patents and regulated industries, particularly public utilities. Polaroid and Xerox are outstanding examples of patent-type monopolies. Both enjoy outstandingly high profit margins that obviously would not be possible if other producers were free to imitate their products. Even if one does not accept this as a legitimate quasi-rent for innovation, it is fairly easy to prove that the Polaroid or Xerox m o n o p o l y position does not reduce total income or divert it in an antisocial way. The high profits that presumably cause some shift in income from labor to capital are more than offset by enormous earnings both companies enjoy from abroad. These work to boost total income sufficiently so that every American benefits from the m o n o p o l y position of these two firms. In contrast, the taxpayer subsidizes most of the few industries that are genuinely competitive in the Adam Smith sense. The farmer, whose economic position Smith really understood, would take about a 50 percent cut in income if the government left him to the complete mercy of the marketplace. Similarly, the highly competitive textile industry can apparently maintain its present limited state of prosperity, which is based on one of the lowest wage levels in American industry, only because imports are limited by both quotas and duties. Thus, because of government intervention, these truly competitive industries work to distribute income in what an antitruster would regard as a socially undesirable fashion--away from consumers because of artificially high prices to producers. The case for public utility competition is equally absurd. In general, the tighter and more widespread the public utility's m o n o p o l y position, the lower the power rates enjoyed by the consumer. Consumers served by giant, depersonalized power suppliers, such as American Electric Power and the Tennessee Valley Authority, enjoy extremely low power
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rates; those in New England, however, served by m a n y smaller companies, suffer the highest rates. In addition, the tighter the monopoly in both of the above examples, the more progressive the management. New technology is much more likely to come from a monopolistic Polaroid than a farmer or a textile producer. The recent intervention of the Antitrust Division in a railroad merger indicates that a legal, regulated m o n o p o l y is not immune to attempts to prove it is violating the antitrust laws. This is doubly ironic in the case of the railroads. It is an industry that already enjoys all of the disadvantages of monopoly power without any of the advantages. And its possible violation of the antitrust laws (in reducing interrailroad competition through merger) really represents an effort to become more competitive. It is, nevertheless, perhaps appropriate that the Antitrust Division is now showing an interest in railroads, which heretofore have been the exclusive province of the Interstate Commerce Commission. The Antitrust Division's record of the last twenty years or so demonstrates that it is interested almost exclusively in industries that are intrinsically competitive. Industries where there is no evidence of genuine price competition tend to be left alone, even when they fall within the Antitrust Division's legitimate interests.
MAJOR PRICE-FIXING CASES In general, a company is much more likely to feel antitrust wrath if its product is one that almost anyone else can make and if it finds difficulty in distinguishing its product from that of competitors. The major price-fixing cases are consistent with this pattern. The guilty parties have almost always made lessthan-average profits, even during the period when they were antitrust sinners. For example, among conspirators who have been convicted of fixing prices illegally in the last decade have been lobster fishermen, electrical
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equipment firms, and-most recently-plumbing equipment manufacturers. The lobster fishermen are the saddest case. Their work and their incomes have more in c o m m o n with agriculture than with industry (in fact, they are grouped with agriculture in a broad census classification). But, unlike the farmers, they cannot band together legally to introduce an element of imperfect competition into their incomes adequate to offset the highly imperfect markets in which they buy goods and services. If they were imaginative enough, }:hey would get the government to help restrict competition in the interest of "conservation" or to restrict imports from other lobster-producing nations such as South Africa because of national security or political disapproval. Instead, the lobstermen fixed prices and got caught.
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No public sympathy was apparent when most of the nation's electrical equipment manufacturing industry was convicted of price fixing in 1961. Shock and indignation were normal reactions even among businessmen. So widespread was the adverse publicity that at least one of the companies involved felt it necessary to cleanse its tarnished image publicly by promptly firing all of its officials who had been involved in the conspiracy. (There was no purge of top management, however, which maintained that it had not known what was going on.) Yet the electrical equipment industry was in a position much like the lobstermen. The particular product on which prices were fixed was a commonplace item. The technology was well-known, and customers found it difficult to differentiate among products of competing producers. Price fixing was easier to administer among the electrical equipment producers because there were fewer of them. But unlike the lobstermen, who could treat their market as a large impersonal and uninformed mass, the electrical equipment firms sold to a well-informed tightly organized group--the professional buyers of th e public utilities. In the lobster case, both supply and
demand fitted the Adam Smith mold until the lobstermen moved to make the supply side less perfect. In the electrical equipment case, both supply and demand represented imperfect competition. Even with price fixing, it was difficult for the suppliers to gain more than a temporary advantage over their tough, intelligent customers. And, without price fixing, the buyers are probably stronger than sellers. The former legitimately swap information at meetings of their professional association, something the suppliers no longer dare do. One by-product of the people's victory in the electrical equipment conspiracy is that utilities were left with fewer domestic producers than before and less capacity. Foreign producers have helped fill part of the gap, but long lead times on heavy electrical equipment may yet lead to power outages. Had the industry been allowed to make the average profits it enjoyed in its price fixing days, there might have been more capacity to supply d e m a n d . It could therefore be argued that the government did n o t really act in the public interest when it broke up the pricefixing cartel (which had never worked too well anyway). The plumbing equipment case is remarkably similar to electrical equipment, although this conspiracy was smashed eight years later. The plumbing equipment industry is backward technologically, and leading producers have consistently earned a lessthan-average return on capital. The industry's market structure is weak because brand identification is weak and buyers are not quality conscious. Since the industry has not been ingenious enough to get the state to give it some monopolistic protection, it can easily be seen why it was led to price fixing as a last resort. The government victory will undoubtedly help assure that the industry will continue to be sterile technologically, selling its products to master plumber s at prices that yield submarginal returns on capital. It cannot even be argued that this is socially beneficial in any
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Our Antitrust Laws Are Anticompetitive
way when an industry, in effect, subsidizes the friendly master plumber and his household customers. Prices would ultimately be lower if the industry became stronger at the expense of its customers and, in the process, threw off the monopolistic and archaic codes that now perpetuate plumbing inefficiency.
Legality of Natural Stability Genuinely competitive industries are the ones that get caught price fixing simply because the others can achieve stable prices without violating the law. Most prices are "administered" not because of collusion, but simply because producers are able to differentiate their products and to identify their competitors. Such prices are usually high enough to guarantee efficient producers a profit margin higher than that of the plumbing or electrical equipment firms even in their halcyon pricefixing days. A competitive industry that is not able to differentiate its product is lucky to average a 10 percent return on capital even during periods when it is illegally fixing prices. An average manufacturer may earn 12 percent or more. The few lucky firms that earn a return of over 25 percent (there are just nine of them among the 500 largest industrials) would never knowingly conspire with competitors to fix prices. They do not have to. Their products are looked upon as unique by their customers. In most cases, almost identical competing products are available, but the leader's brand name is so firmly established that the product has become unique. The cosmetics sold b y Avon (with a 35.3 percent return on capital) are typical of this group. In the economic sense, these highly profitable, legally competitive firms are the real "monopolists" in that they redistribute income away from the consumer to the capitalist and restrict o u t p u t in a calculated way in order to maintain price. But, of course, this is not only a perfectly legal condition but one which exists in an over-
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whelming majority of industries. The Avon Products and similar brand-oriented firms are only the most successful; their imitators also do much better than the lobster fishermen even when their brand image is not that well established. Competition is a cat-and-mouse game even when the product has not taken on monopolistic characteristics through brand identification. For example, consumers probably only rarely have strong brand preferences for light bulbs. But producers can earn aboveaverage profits partly because consumers are not especially price conscious when buying these products, but mostly because relatively few producers have national distribution networks. Each producer can pretty much deduce how every other producer will react in the complete absence of any conspiracy. Consequently, prices are stable simply because it is not in the interest of any producer to touch off a price war. The Antitrust Division is powerless to fight when high stable prices are a natural product of the market structure, as is the case with the overwhelming majority of consumer products and also many, if not most, industrial products. This type of price stabilization could theoretically be controlled only if the government were given power to set all prices. But this would not be a procompetitive move, of course. On the contrary, it would turn the e c o n o m y into one vast cartel; whatever competition now exists would immediately be snuffed out by a blizzard of applications for price increases that would descend upon the master price fixer. Concern With "Concentration" Political liberals have long recognized that laws prohibiting price fixing do almost nothing to keep down the cost of living (although most would not agree with m y contention that they work to boost costs in the few backward industries where antipricefixing laws have any significant effect.) Since
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the 1930's it has been customary to hold hearings on so-called "administered prices" every decade or so. Only crackpots or economic innocents maintain that such prices are determined entirely by impersonal supply and demand forces. And some would argue that it would be nice if imperfect competitors could somehow be made more perfect. But the hearings always end without a real s o l u t i o n because there really isn't one. To control imperfect prices is to make them even more imperfect, if not genuinely monopolistic.
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So that all the effort might not appear wasted, such hearings typically conclude with the recommendation that industries be made less "concentrated." The term has, in practice, a very special meaning. The steel industry, for example, has always been looked upon as concentrated by almost everyone. The domestic producers are so few in number that a person of average intelligence could easily memorize the names of the firms that account for 99 percent of all domestic production. Even the smallish producers are fairly big by most standards, with assets that may top $500 million. In contrast, an industry that is dominated by a few small producers is usually not regarded as concentrated in the antitrust sense. For example, two smallish p r o d u c e r s S.O.S. and Brillo-enjoyed 95 percent of the scouring pad market for many years without arousing the interest of the Justice Department. It is easy to explain this indifference. Scouring pads are hardly a basic industry; entry into the market is relatively easy technologically; and fear of additional competition undoubtedly worked to prevent Brillo and S.O.S. from enjoying the full fruits of their duopoly. In fact, Brillo and S.O.S. could have gone their concentrated ways forever had General Foods not acquired S.O.S. The entry of a billion dollar company automatically made the industry "concentrated," and the Federal Trade Commission moved to force General Foods to get rid of S.O.S.
A matter o f size Big firms are normally subject to charges of increasing concentration in an industry and tending to create a monopoly only when they acquire another firm. The company that has always been dominant in an industry has been fairly secure for at least the last twenty years. Alcoa was the last old-style monopoly to bite the dust, and the aluminum industry has been pretty much immune from the antitrust laws since it has come to be dominated by three major domestic producers and maybe a half-dozen minor ones. The price of aluminum ingots continues to be reasonably stable with follow-the-leader pricing, and profits remain high enough to attract new producers.
Other dominant firms have been left alone since, presumably, the Justice Department has not believed it could build a strong case to prove a tendency toward monopoly. In fact, unless there is evidence of price fixing, antitrust law does not bear down until a big company attempts to get even bigger through merger. General Motors, with a 50 percent share of the auto market, has so far been safe. It would probably become vulnerable to antitrust action only if it behaved more like the nineteenth century firms that fitted the classical economists' models. For example, if General Motors used its economic power to boost its market share substantially by cutting prices or stepped-up advertising, it w o u l d almost certainly be a defendant in an antitrust suit. The other two big producers are not immune either. In theory, the Justice Department should welcome anything that made them more competitive with General Motors. If precedent in other industries is any guide, it would fight almost anything that upsets the status quo even while reducing the 50 percent market share of General Motors. A merger of Ford and Chrysler, for example, would almost certainly be illegal even though the combination would still be smaller than General Motors. Thus, antitrust policy is dedicated to maintenance of the status quo. A merger of
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almost any big c o m p a n y with another in the same industry can fairly easily be beaten d o w n with existing laws even if the merged c o m p a n y is smaller than the industry leaders. To be big already is apparently acceptable, but to get bigger and more competitive through merger is bad, even if this triggers competition in the industry. Until quite recently, however, it was perfectly legal for a big c o m p a n y to enter some entirely new field by acquisition. In fact, this is the sort of thing that is most likely to trigger price competition in a capital intensive industry that is not so profitable that it attracts " n e w " money. The newcomer does not necessarily behave like a gentleman. The steel industry is a good example. The industry has earned less-than-average profits for years. Its productivity as measured by man-hours of labor required to produce a ton of a particular type of steel m a y still be higher than that of any other nation's steel industry (although the Japanese must come pretty dose). Yet by American standards, productivity is sluggish. In addition, innovation in the steel industry has been mostly imported. Obviously, it would be in the public interest if fresh competition were to develop in this tired industry. This is, of course, what the antitrust laws should do. But, in practice, new capital has not been attracted to the industry because profits are too low, partly because antitrust laws make it illegal for the industry to fight foreign competition effectively using the double-pricing standards and other devices that permit foreign firms to get rid of their surplus output on the American market. Thus, the only practical way to inject new and, hopefully, more dynamic management into the steel industry would be to encourage more aggressive firms, outside the industry, to buy into it. This is practical because the stock market has put a relatively low value on steel shares for almost a decade, so low that huge profits m a y accrue to an aggressive manage-
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ment that buys into the industry and manages to achieve even minimal results. To buy a steel company, however, one must be big and well-financed. Only rarely can a company like Lykes Steamship acquire a steel company seven times its size (and, in fact, it is testimony to the steel industry's lack of confidence in its own management that this should ever be possible on a completely voluntary basis). More conventional is the acquisition of a steel firm by an already huge c o m p a n y like L.T.V. As defender of the status quo, the Justice Department felt compelled to accuse L.T.V. of tending to create a m o n o p o l y when it acquired Jones & Laughlin Steel. There is one element of truth in the Justice Department charge; if the now troubled L.T.V. does succeed in injecting new life into the heretofore moribund Jones & Laughlin, other steel companies will probably suffer smaller market shares. This is, of course, in the public interest. It may even be in the steel industry's own interest. Only when conglomerates began to look interested did the industry start to show signs of wanting to diversify away from steel. Current law makes it fairly easy for the Antitrust Division to protect existing industries from inroads from what might become unruly competitors. The industry that is doing poorly is, of course, automatically protected from an influx of new capital; no one wants to get into the industry. And, if a new producer does make a mistake and sinks his m o n e y into an industry without promise, the future becomes even less attractive to new capital. The cement industry, as big a villain in the college "government and business" textbooks as the steel industry, temporarily acquired a growth image in the mid-1950's. New investors rushed toward what appeared to be easy money. Two major new facilities constructed in the 1950's plus expansion b y existing firms was enough to kill the industry for at least the next decade. Meanwhile, the Justice Department and the Federal Trade
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"The
most popular
complaint
. . .
has
been based on reciprocity."
Commission moved to protect the producer who was not bold enough to integrate forward into ready-mix and aggregates by preventing established cement producers from buying their customers. One by-product, I am advised by experts in the industry, is that the consumer of cement not only does not enjoy especially low prices but buys from an industry that is technologically more backward than its counterparts in Europe.
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The Justice Department is now trying to protect existing producers in other industries against acquisition by fighting almost any conglomerate type acquisition by any of the 200 largest manufacturers. While small nimble entrepreneurs have occasionally been bold enough to capture firms much bigger than themselves, the usual rule is that a business must be big if it is to acquire a big business. Thus, if the Justice Department is successful, it will accomplish what the most reactionary managements probably could not do on their own.
Of course, the Justice Department cannot hope to prove that the industry has directly become more concentrated when a particular firm is taken over by a conglomerate not already in that industry. It must search for some indirect "proof" of concentration. The most popular complaint in the last year or so has been based on reciprocity. The conglomerate allegedly can use its buying power on behalf of its subsidiaries and thereby force suppliers to buy from the subsidiaries. Reciprocity
The typical pattern is that the conglomerate takes over a company that hag long practiced reciprocity; in most such cases, there has been no evidence that the conglomerate itself--for example, LTV--has practiced reciprocity. On the contrary, reciprocity was universally practiced in the steel industry until recently, at least. Not long ago, an
official of Jones & Laughlin was an officer in the Trade Relations Association, a group dedicated to ethical reciprocity practice. The Justice Department is correct in regarding reciprocity as an anticompetitive practice. But when it keeps a nonoffender out of an industry where the practice is common, it is really working to preserve the status quo of the industry, including its reciprocity. If it wanted to increase competition, it would force the nonoffending conglomerate to impose its nonrecipmcity practice on the subsidiary with the history of reciprocity. The net effect would almost certainly be more competition in the industry. But, of course, it is fairly easy to defend the status quo against new competition. One can simply argue that the newcomer will cheat and use reciprocity. In fact, however, organized reciprocity-the only kind that is really effective and important economicallycannot exist without a rather elaborate record-keeping system. And to function really well, the centralized reciprocity department must be staffed with specialists who know how to analyze these statistics and use them skillfully to upgrade supplier-buyer relationships. A huge corporation could not possibly hide the existence of such a department. Casual reciprocity, like casual prostitution, would still exist. But this is what every purchasing agent has learned to cope with. He will see the salesman who points out that his company is a customer, but he will never buy from that salesman at a higher price. In fact, if there are no good records the salesman who puts too much pressure on reciprocity may find himself getting less business from a purchasing agent who resents being told what to buy. The P.A. can be forced to toe the line only when a highly efficient record system can prove he is shortchanging his suppliercustomer. Thus, the Justice Department should not discourage acquisition by conglomerates of firms that have been living off little but their reciprocity. It should encourage it and insist the reciprocity be eliminated. When it does
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just the opposite, the department is not only supporting the not-so-competitive status q u o but, ironically, even supporting the reciprocity of which it disapproves and, in some cases, now forbids. Centralized record-keeping is a must for a firm that is just beginning to play the reciprocity game, but is less essential in a company that has been playing it for years. Reciprocal patterns tend to become rigid in an industry. In time, the reciprocity process would become less precise with_out records, but this might take years in industries that are changing slowly. In contrast, an aggressive newcomer could cause patterns to become confused almost overnight. Thus, when the Justice Department prevents new firms from entering an industry by acquisition, it works to preserve established trade patterns. This is anticompetitive.
THE CASE AGAINST ANTITRUST The hypothesis of this entire article, of course, is that industry would be more competitive and come closer to meeting economically related social objectives if there were no antitrust laws at all. Clearly, the argument is strongest in conglomerate type acquisitions which tend to shake up old and often stuffy industries. Very few businessmen, at least, would deny that antitrust efforts to eliminate mergers (which really reflect the philosophy that bigness is bad) are anticompetitive. Our argument is weakest when we argue the hypothesis that efforts to stamp out price fixing are contrary to the over-all national economic interest. The gist of the argument to make price fixing less illegal is that firms who fix prices illegally are victims in an economy where most prices are administered in an environment of imperfect competition. The obvious counterargument is that price-fixing laws also inhibit firms that do not get caught. The ideal law would not outlaw price fixing when it was against the long-term
OCTOBER, 1971
national economic interest, but would treat sympathetically joint industry efforts to stabilize prices in industries where excess competition would be destructive. The government case for elimination of price fixing in a particular industry would rest on whether this action was antisocial in fact as well as in nineteenth century economic theory. It would be hard for the government to win a case against an industry where profits were low despite price fixing since, obviously, the antisocial objective of the price fixing had not been achieved. In practice, a stance against price fixing is so firmly a part of our culture that no Administration (especially a Republican one with a probusiness image) would dare suggest that the law against it be relaxed. Instead, I suggest that the problem s h o u l d - a n d almost certainly will-be attacked by the few industries that are seriously affected by unstable prices in a more subtle way. In practice, some part of the industry's freedom will be traded with government for some indirect assurance of price stability. The steel and textile industries have probably already made this trade without realizing it. They are now protected by "voluntary" agreements against imports, the biggest major threat to their stability. In the process, they have undoubtedly also given up some of their ability to resist indirect government efforts to nudge them into taking actions they would not otherwise take. There is the possibility that the import door will be opened a little wider; this club may make them toe the line just as defense contractors "voluntarily" conform to almost any "suggestion" made to them by high government officials, even when it does not have the power of law. While Congress and the general public would probably never accept a law that made price fixing illegal only when its anticompetitive impact could be proved inequitable, there is no reason why they should continue to support the Justice Department's anticompetitive stance on
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mergers. The law can and should be changed, probably in a way that not every businessman would like. Market share, especially when demand for the product is relatively inelastic and substitution possibilities are limited, is evidence of the competitive state of an industry. Bigness is not evidence, nor are most mergers. In general, the Justice Department should encourage mergers that bring new companies into an industry and be indifferent to those that have no significant effect on market share.
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If a firm's market share gets too big, that firm should be encouraged to spin off its subsidiaries. Recent financial history indicates that divestiture in such cases need not be a penalty for success but a reward. The value of the parts turns out to be greater than the value of the whole. If Standard Oil had not been dissolved sixty years ago, it would have become a stodgy c o m p a n y with a gradually declining market share. Antitrust laws and sheer bureaucracy wouid have inhibited it from maintaining its share of a growing market. Instead, the firms that were once part of Standard Oil have, in general, prospered to the benefit of their stockholders, employees, and customers. Of course, Standard Oil did not exactly volunteer for what turned out to be a happy event for all parties concerned. At that time, managements wanted their firms to b e c o m e as big and powerful as possible. Only in the last decade has a substantial n u m b e r of managers come to realize that it is their mission to think smaller as well as to grow. Business has long k n o w n that to be big is not to be bad; it is only just beginning to realize that to be smaller is sometimes to be better. The spin-off stage may be reached long before the business becomes big. The publishing firm Prentice-Hall has spawned at least two competing publishers (Allyn & Bacon and Charles E. Merrill) of college textbooks. Prentice-Hall is smaller than it might have been had it just set up Allyn & Bacon and Merrill as captive houses with competing lists. But, of course, the two
spin-offs compete m u c h more vigorously simply because they have been cut loose from the parent's apron strings, and the original Prentice-Hall stockholders are that much richer as a result. The spin-off did not really come into its own, however, until L.T.V. split Wilson and Company into three parts, and, most recently, spun off what was formerly its captive computer facility. Spin-offs seemed to be gaining in popularity before stock prices began to decline sharply in 1969. PrenticeHall is one of the few cases where the goal has been greater market share for the company's product as distinct from higher market prices for the c o m m o n stock. Such spin-offs are obviously in both the general public interest as well as the more selfish interest of the stockholder. A firm with a 50 percent market share m a y be able to escape antitrust prosecution indefinitely under existing laws as long as it does not move aggressively to increase its share to 75 percent. But stockholders, employees, and the public at large would be better if it split itself into three companies, each with a 15 to 20 percent market share. Each of the new companies would be free to move in whatever direction it wished. The only "losers" would be the man who runs the old firm; inevitably, he would wind up with less personal power than before. This need not inhibit him indefinitely, however, if he is a man of ability. Since to be big is not to be bad in the ideal antitrust environment, there is nothing to prevent an aggressive corporation from becoming at least an important producer in as many industries as it pleases, much as in the Japanese pattern where each group of Zaibitsu go into just about every type of business. Reciprocity is the only real danger that such combinations will become anticompetitive, and it can easily be curbed by simply making it illegal to establish the centralized apparatus that is essential to its smooth functioning. Copyright 1971, Dean S. Ammer
BUSINESS HORIZONS
OUR ANTITRUST LAWS ARE ANTICOMPETITIVE An examination of price and quota enforcement Mr. Ammer is director of the Bureau of Business and Economic Research, Northeastern University.
This article summarizes the author's views o f antitrust laws, in theory and in practice, primarily on economic grounds. Such laws, he believes, are worth-while only if they either increase total income and/or distribute income in a more desirable way. They have, however, proved to be inappropriate for contemporary American society; neither objective has been accomplished by their enforcement. Several cases o f the most popular types o f antitrust action, those dealing with price fixing and market quotas, are examined; the author concludes that the result has not been socially beneficial, and that industry would be more competitive and come closer to meeting economically related social objectives if there were no antitrust laws at all. Antitrust laws help create outstanding e m p l o y m e n t opportunities for young lawyers who work for the Justice Department and the Federal Trade Commission. Those who make good almost inevitably wind up earning high
OCTOBER, 1971
incomes in the great Washington and New York law firms that specialize in defending their clients against antitrust violations and counseling them on ways to avoid prosecution by the "trust-busters." This rather specialized contribution of the antitrust laws to economic well-being is not arguable. But any other economic contribution by the Sherman Act and its successors is debatable. Antitrust laws, which we did not really invent, are largely an American phenomenon, one that has been imitated abroad. In the nineteenth century, we discovered that our emerging industrial e c o n o m y was not behaving the way Adam Smith, David Ricardo, and J o h n Stuart Mill said it should. So we tried to change it b y legislation to fit their competitive model. At first, the legislation concentrated on preventing the big businesses that were developing at that time from getting even bigger by pooling their interests in trusts and holding companies. Later, legislation focused more directly on nasty little practices like price fixing in which business of any size could indulge in profitably, in theory at least. Other countries have never been as straight-laced as we have been concerning antitrust. The Japanese, although they still have antitrust legislation on their books that was imposed by an occupying American army, rarely confuse antitrust ideals with economic reality. Price fixing is no more legal in Japan than it is in the United States. But when business is depressed in Japan, the authorities move quickly to prevent price cuts from further depressing the economy. Industry is encouraged to " c o o p e r a t e " to prevent destructive competition. In fact, Japanese antitrust law is sufficiently flexible
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to allow the two biggest steel producers to remerge in their pre-World War II state with a market share that is equivalent to that enjoyed b y the three or four largest producers in the United States. Great Britain is no less flexible. The government recently forced !eading aviation firms to combine into a single monopoly, the British Aviation Corporation. Similarly, they have long encouraged firms in the British textile industry to cooperate in the interests of improved technology and reduced competition.
costs during periods when he has slack capacity. The formulas are anticompetitive in the antitrust sense if they inhibit the businessman from following his intuition in weak markets and cutting prices. They have apparently had some impact on smaller firms; I have met many small businessmen who regard it as almost unethical-and certainly u n p r o f i t a b l e - t o sell below full cost, even though this may sometimes be in their selfish interest.
Do not agree with competitors on specific production quotas. It is perfectly acceptable GROUND RULES IN THE UNITED STATES
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In the Webb-Pomerane Act, Congress gave business more flexibility in cooperating w i t h other firms in sales abroad. But a company-particularly a big o n e - i s subject to fairly tight ground rules in its domestic operations if it wants to avoid being accused of violating our antitrust laws. Most businessmen would agree that certain rules apply if one is to coexist peacefully with the trust-busters.
Be careful when discussing prices with competitors. It is always illegal to agree on a price with a competitor, as plumbing equipm e n t manufacturers recently discovered when they tried to do what electrical equipment manufacturers were caught doing about ten years ago. The practice of being careful to inform competitors about price changes so that they, in turn, can make intelligent pricing decisions would also not be r e c o m m e n d e d b y a company's law firm. But it is probably fairly c o m m o n , and, in the absence of overt collusion or written communication, exists in the gray area of antitrust. Finally, i t is still perfectly legal for a trade association to hire cost accountants to develop "realistic" pricing formulas. In general, these formulas tend to be based on full cost, and it would presumably never occur to the businessman who uses them that it is to his selfish interest to sell at the highest price that covers variable
to negotiate a production quota through some public authority, however. The Texas Railroad Commission has set quotas on oil production in that state for years, allegedly for the purpose of conserving natural resources. Quota setting becomes illegal only when it occurs between private parties. Consequently, the industry that wants quotas should seek a goal that is seemingly above profit maximization and work through some government body. For example, to keep out foreign meat because of possible hoof-and-mouth disease (even from countries with no known record of it) is acceptable to public authority, even if it has the side-effect of limiting the available supply of meat.
If already big, do not buy control of major competitors. This caveat has been tested in the courts so m a n y times that fairly well-defined but complicated rules have developed. In general, if a c o m p a n y is small enough, it can usually acquire competitors up to the limit of its resources, and no one will really care. On the other hand, if a corporation is one of the ten biggest in the country and a leader in its industry, acquisitions within its existing line of business will be looked upon with suspicion. For example, IBM would probably not dare attempt to acquire even a small producer of computers or electric typewriters. In some cases, a company need not
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Our Antitrust Laws Are Anticompetitive
" . . . if a big firm continues hell-bent on an acquisition course, the Justice Department will try to stop it."
account for a huge share of the market to be considered dominant. A&P, for example, has a small and declining share of the food business, but its sales of over $5 billion make it big enough so that any attempt to acquire another food chain would almost certainly be challenged. If the industry is small, a dominant producer of modest size may be locked in by antitrust rules. For example, Ideal Basic Industries has cement sales of less than $140 million, but nevertheless accounts for at least 10 percent of industry output. Ideal would likely be challenged by the Justice Department if it attempted to merge with another cement producer. There are real limits to nonproduct-related acquisitions, and the ground rules are not yet as well-defined as they are with other infractions o f antitrust laws. Apparently, a company with assets of less than about $1 billion can do whatever it pleases as long as its nonproduct-related acquisitions keep it from reaching this critical size. In addition, almost any company can probably pull off one or two acquisitions without attracting Justice Department attention. Ford, the third biggest manufacturer, acquired Philco and Electric Auto Lite without any antitrust problems, although now--a decade l a t e r - t h e trustbusters are trying to force Ford to get out of the spark plug business. International Telephone & Telegraph has grown to become the eleventh biggest manufacturer largely because of its acquisitions, and the Justice Department is only now challenging new acquisitions. Similarly, McDonnell and Douglas came together to become the largest single defense contractor and the fourteenth biggest manufacturer. a
It can safely be assumed, however, that if big firm continues hell-bent on an
OCTOBER, 1971
acquisition course, the Justice Department will try to stop it. So far, the department has succeeded, even when it has not been able to prove that the merger increases the market share of a major producer. Northwest Industries, a big conglomerate that derived less than 10 percent of its sales from chemical manufacturers, would have been challenged by the Justice Department had it been able to carry off its merger with B. F. Goodrich, also a minor producer of chemicals. LTV's acquisition of Jones & Laughlin Steel is being allowed only because no one knows how to undo it without forcing LTV into bankruptcy. In effect, Justice Department opposition to these conglomerate-type mergers boils down to the fear that the merged corporation will become too big and too powerful even if the merger does not give it a dominant market share. For example, since LTV was not in the steel business before acquiring J&L, there is no change in the degree of concentration in that industry, where J&L is a medium-sized and not especially efficient producer. To force dissolution under exising laws, the government would have almost certainly based its case on the possibility that LTV might violate the antitrust laws through illegal use of reciprocity. It would have maintained that the purchasing departments of the various LTV companies could use their collective buying power to coerce suppliers into buying steel from J&L. LTV need not have been proved guilty to lose the case. Apparently, the government needs only to prove that the opportunity to sin exists even if the record of the defendant is clean. The precedent is the forced divestment of Penick & Ford's starch-making facilities by its parent, R. J. Reynolds. The government claimed that although Reynolds had never used reciprocity, the company had the power to force its paper suppliers to buy starch from its Penick & Ford division. (Starch is used in the manufacture of paper'.) Reynolds, through its ownership of Penick & Ford, was the only major starch producer that
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was also a major paper buyer; it could, the government suggested, gain an unfair competitive advantage. There are other ways in which businessmen can get into trouble with the Federal Trade Commission or the Justice Department. But usually these involve actions (such as lying to customers or unfairly maligning competitors) that would be repugnant ethically to most businessmen. The four areas we discussed have no such moral overtones (although they sometimes may be attached to illegal price fixing). For example, nonprofit organizations, such as universities and hospitals, regularly engage in price fixing. Although perfectly legal, it is basically no different from price fixing or market quotas set b y competing businessmen. And ethics are never questioned when a business expands either b y acquiring a c o m p a n y in its own industry or in some other nonrelated product line, even if this is later held to be a violation of the antitrust laws. Thus, it is perfectly fair to judge antitrust laws primarily on economic grounds, taking into account the social effects created b y their economic impact.
Whenever he could, he restricted o u t p u t in order to hold up prices and, if possible, earn some sort of m o n o p o l y return. The natural w a y to b o o s t profits is to pool resources and agree on identical prices. The original Sherman Act was designed to break up the trusts that legally committed business to identical prices and production quotas. Eighty years of amendments have made the law more complex b u t have n o t changed the assumptions on which it is based. In the antitrust sense, the ideal e c o n o m y still comes closer to the model of Adam Smith than that of J o h n Maynard Keynes, although the latter and his followers have held sway in government circles outside the Antitrust Division for at least thirty years. Economically, the antitrust laws are no more appropriate to contemporary American society than the nineteenth century Karl Marx is to current Soviet society. If they have any effect on total income at all, it is to reduce it. Even worse, they tend to shift income from those who produce a lot and have relatively little of it to those w h o have more and produce relatively little. Let us n o w test this hypothesis on the basic types of antitrust action, relating the law, as indicated b y recent cases, to our economic criteria.
ANTITRUST THEORY Antitrust laws are worth-while if they either increase total income and/or distribute income in a more desirable way. In the pure
A N T I T R U S T IN PRACTICE
competition economic models of the classical economists, total income is maximized because each producer uses all resources at capacity and has no control over price. Income is distributed entirely on the basis of contribution to production and the demand for that factor. Competition, with a tendency of all prices to drop to a level that yields only a market-determined return on capital, minimizes the rent and quasi-rents earned b y society's nonproducers. But, of course, nineteenth century reformers soon discovered that no businessman (or anyone else) voluntarily behaves the way the classical economists said he should.
The most popular type of antitrust enforcement is concerned with price fixing and market quotas. If producers are permitted to band together to set production quotas and prices, it is easy to see how corporate wealth could be increased at the expense of the consumer. In addition, a tight little cartel would inhibit new technology or improvement of any kind, making for n o t only high industry profits b u t also high costs. But late twentieth century practice differs widely from nineteenth century economic theory that is the b a c k b o n e of our antitrust laws. First, let us take cases where the law permits monopoly. Two types of monopolies
BUSINESS HORIZONS
Our Antitrust Laws Are Anticompetitive
are perfectly acceptable: those based on patents and regulated industries, particularly public utilities. Polaroid and Xerox are outstanding examples of patent-type monopolies. Both enjoy outstandingly high profit margins that obviously would not be possible if other producers were free to imitate their products. Even if one does not accept this as a legitimate quasi-rent for innovation, it is fairly easy to prove that the Polaroid or Xerox m o n o p o l y position does not reduce total income or divert it in an antisocial way. The high profits that presumably cause some shift in income from labor to capital are more than offset by enormous earnings both companies enjoy from abroad. These work to boost total income sufficiently so that every American benefits from the m o n o p o l y position of these two firms. In contrast, the taxpayer subsidizes most of the few industries that are genuinely competitive in the Adam Smith sense. The farmer, whose economic position Smith really understood, would take about a 50 percent cut in income if the government left him to the complete mercy of the marketplace. Similarly, the highly competitive textile industry can apparently maintain its present limited state of prosperity, which is based on one of the lowest wage levels in American industry, only because imports are limited by both quotas and duties. Thus, because of government intervention, these truly competitive industries work to distribute income in what an antitruster would regard as a socially undesirable fashion--away from consumers because of artificially high prices to producers. The case for public utility competition is equally absurd. In general, the tighter and more widespread the public utility's m o n o p o l y position, the lower the power rates enjoyed by the consumer. Consumers served by giant, depersonalized power suppliers, such as American Electric Power and the Tennessee Valley Authority, enjoy extremely low power
OCTOBER, 1971
rates; those in New England, however, served by m a n y smaller companies, suffer the highest rates. In addition, the tighter the monopoly in both of the above examples, the more progressive the management. New technology is much more likely to come from a monopolistic Polaroid than a farmer or a textile producer. The recent intervention of the Antitrust Division in a railroad merger indicates that a legal, regulated m o n o p o l y is not immune to attempts to prove it is violating the antitrust laws. This is doubly ironic in the case of the railroads. It is an industry that already enjoys all of the disadvantages of monopoly power without any of the advantages. And its possible violation of the antitrust laws (in reducing interrailroad competition through merger) really represents an effort to become more competitive. It is, nevertheless, perhaps appropriate that the Antitrust Division is now showing an interest in railroads, which heretofore have been the exclusive province of the Interstate Commerce Commission. The Antitrust Division's record of the last twenty years or so demonstrates that it is interested almost exclusively in industries that are intrinsically competitive. Industries where there is no evidence of genuine price competition tend to be left alone, even when they fall within the Antitrust Division's legitimate interests.
MAJOR PRICE-FIXING CASES In general, a company is much more likely to feel antitrust wrath if its product is one that almost anyone else can make and if it finds difficulty in distinguishing its product from that of competitors. The major price-fixing cases are consistent with this pattern. The guilty parties have almost always made lessthan-average profits, even during the period when they were antitrust sinners. For example, among conspirators who have been convicted of fixing prices illegally in the last decade have been lobster fishermen, electrical
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equipment firms, and-most recently-plumbing equipment manufacturers. The lobster fishermen are the saddest case. Their work and their incomes have more in c o m m o n with agriculture than with industry (in fact, they are grouped with agriculture in a broad census classification). But, unlike the farmers, they cannot band together legally to introduce an element of imperfect competition into their incomes adequate to offset the highly imperfect markets in which they buy goods and services. If they were imaginative enough, }:hey would get the government to help restrict competition in the interest of "conservation" or to restrict imports from other lobster-producing nations such as South Africa because of national security or political disapproval. Instead, the lobstermen fixed prices and got caught.
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No public sympathy was apparent when most of the nation's electrical equipment manufacturing industry was convicted of price fixing in 1961. Shock and indignation were normal reactions even among businessmen. So widespread was the adverse publicity that at least one of the companies involved felt it necessary to cleanse its tarnished image publicly by promptly firing all of its officials who had been involved in the conspiracy. (There was no purge of top management, however, which maintained that it had not known what was going on.) Yet the electrical equipment industry was in a position much like the lobstermen. The particular product on which prices were fixed was a commonplace item. The technology was well-known, and customers found it difficult to differentiate among products of competing producers. Price fixing was easier to administer among the electrical equipment producers because there were fewer of them. But unlike the lobstermen, who could treat their market as a large impersonal and uninformed mass, the electrical equipment firms sold to a well-informed tightly organized group--the professional buyers of th e public utilities. In the lobster case, both supply and
demand fitted the Adam Smith mold until the lobstermen moved to make the supply side less perfect. In the electrical equipment case, both supply and demand represented imperfect competition. Even with price fixing, it was difficult for the suppliers to gain more than a temporary advantage over their tough, intelligent customers. And, without price fixing, the buyers are probably stronger than sellers. The former legitimately swap information at meetings of their professional association, something the suppliers no longer dare do. One by-product of the people's victory in the electrical equipment conspiracy is that utilities were left with fewer domestic producers than before and less capacity. Foreign producers have helped fill part of the gap, but long lead times on heavy electrical equipment may yet lead to power outages. Had the industry been allowed to make the average profits it enjoyed in its price fixing days, there might have been more capacity to supply d e m a n d . It could therefore be argued that the government did n o t really act in the public interest when it broke up the pricefixing cartel (which had never worked too well anyway). The plumbing equipment case is remarkably similar to electrical equipment, although this conspiracy was smashed eight years later. The plumbing equipment industry is backward technologically, and leading producers have consistently earned a lessthan-average return on capital. The industry's market structure is weak because brand identification is weak and buyers are not quality conscious. Since the industry has not been ingenious enough to get the state to give it some monopolistic protection, it can easily be seen why it was led to price fixing as a last resort. The government victory will undoubtedly help assure that the industry will continue to be sterile technologically, selling its products to master plumber s at prices that yield submarginal returns on capital. It cannot even be argued that this is socially beneficial in any
BUSINESS HORIZONS
Our Antitrust Laws Are Anticompetitive
way when an industry, in effect, subsidizes the friendly master plumber and his household customers. Prices would ultimately be lower if the industry became stronger at the expense of its customers and, in the process, threw off the monopolistic and archaic codes that now perpetuate plumbing inefficiency.
Legality of Natural Stability Genuinely competitive industries are the ones that get caught price fixing simply because the others can achieve stable prices without violating the law. Most prices are "administered" not because of collusion, but simply because producers are able to differentiate their products and to identify their competitors. Such prices are usually high enough to guarantee efficient producers a profit margin higher than that of the plumbing or electrical equipment firms even in their halcyon pricefixing days. A competitive industry that is not able to differentiate its product is lucky to average a 10 percent return on capital even during periods when it is illegally fixing prices. An average manufacturer may earn 12 percent or more. The few lucky firms that earn a return of over 25 percent (there are just nine of them among the 500 largest industrials) would never knowingly conspire with competitors to fix prices. They do not have to. Their products are looked upon as unique by their customers. In most cases, almost identical competing products are available, but the leader's brand name is so firmly established that the product has become unique. The cosmetics sold b y Avon (with a 35.3 percent return on capital) are typical of this group. In the economic sense, these highly profitable, legally competitive firms are the real "monopolists" in that they redistribute income away from the consumer to the capitalist and restrict o u t p u t in a calculated way in order to maintain price. But, of course, this is not only a perfectly legal condition but one which exists in an over-
OCTOBER, 1971
whelming majority of industries. The Avon Products and similar brand-oriented firms are only the most successful; their imitators also do much better than the lobster fishermen even when their brand image is not that well established. Competition is a cat-and-mouse game even when the product has not taken on monopolistic characteristics through brand identification. For example, consumers probably only rarely have strong brand preferences for light bulbs. But producers can earn aboveaverage profits partly because consumers are not especially price conscious when buying these products, but mostly because relatively few producers have national distribution networks. Each producer can pretty much deduce how every other producer will react in the complete absence of any conspiracy. Consequently, prices are stable simply because it is not in the interest of any producer to touch off a price war. The Antitrust Division is powerless to fight when high stable prices are a natural product of the market structure, as is the case with the overwhelming majority of consumer products and also many, if not most, industrial products. This type of price stabilization could theoretically be controlled only if the government were given power to set all prices. But this would not be a procompetitive move, of course. On the contrary, it would turn the e c o n o m y into one vast cartel; whatever competition now exists would immediately be snuffed out by a blizzard of applications for price increases that would descend upon the master price fixer. Concern With "Concentration" Political liberals have long recognized that laws prohibiting price fixing do almost nothing to keep down the cost of living (although most would not agree with m y contention that they work to boost costs in the few backward industries where antipricefixing laws have any significant effect.) Since
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the 1930's it has been customary to hold hearings on so-called "administered prices" every decade or so. Only crackpots or economic innocents maintain that such prices are determined entirely by impersonal supply and demand forces. And some would argue that it would be nice if imperfect competitors could somehow be made more perfect. But the hearings always end without a real s o l u t i o n because there really isn't one. To control imperfect prices is to make them even more imperfect, if not genuinely monopolistic.
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So that all the effort might not appear wasted, such hearings typically conclude with the recommendation that industries be made less "concentrated." The term has, in practice, a very special meaning. The steel industry, for example, has always been looked upon as concentrated by almost everyone. The domestic producers are so few in number that a person of average intelligence could easily memorize the names of the firms that account for 99 percent of all domestic production. Even the smallish producers are fairly big by most standards, with assets that may top $500 million. In contrast, an industry that is dominated by a few small producers is usually not regarded as concentrated in the antitrust sense. For example, two smallish p r o d u c e r s S.O.S. and Brillo-enjoyed 95 percent of the scouring pad market for many years without arousing the interest of the Justice Department. It is easy to explain this indifference. Scouring pads are hardly a basic industry; entry into the market is relatively easy technologically; and fear of additional competition undoubtedly worked to prevent Brillo and S.O.S. from enjoying the full fruits of their duopoly. In fact, Brillo and S.O.S. could have gone their concentrated ways forever had General Foods not acquired S.O.S. The entry of a billion dollar company automatically made the industry "concentrated," and the Federal Trade Commission moved to force General Foods to get rid of S.O.S.
A matter o f size Big firms are normally subject to charges of increasing concentration in an industry and tending to create a monopoly only when they acquire another firm. The company that has always been dominant in an industry has been fairly secure for at least the last twenty years. Alcoa was the last old-style monopoly to bite the dust, and the aluminum industry has been pretty much immune from the antitrust laws since it has come to be dominated by three major domestic producers and maybe a half-dozen minor ones. The price of aluminum ingots continues to be reasonably stable with follow-the-leader pricing, and profits remain high enough to attract new producers.
Other dominant firms have been left alone since, presumably, the Justice Department has not believed it could build a strong case to prove a tendency toward monopoly. In fact, unless there is evidence of price fixing, antitrust law does not bear down until a big company attempts to get even bigger through merger. General Motors, with a 50 percent share of the auto market, has so far been safe. It would probably become vulnerable to antitrust action only if it behaved more like the nineteenth century firms that fitted the classical economists' models. For example, if General Motors used its economic power to boost its market share substantially by cutting prices or stepped-up advertising, it w o u l d almost certainly be a defendant in an antitrust suit. The other two big producers are not immune either. In theory, the Justice Department should welcome anything that made them more competitive with General Motors. If precedent in other industries is any guide, it would fight almost anything that upsets the status quo even while reducing the 50 percent market share of General Motors. A merger of Ford and Chrysler, for example, would almost certainly be illegal even though the combination would still be smaller than General Motors. Thus, antitrust policy is dedicated to maintenance of the status quo. A merger of
BUSINESS HORIZONS
Our Antitrust Laws Are Anticompetitive
almost any big c o m p a n y with another in the same industry can fairly easily be beaten d o w n with existing laws even if the merged c o m p a n y is smaller than the industry leaders. To be big already is apparently acceptable, but to get bigger and more competitive through merger is bad, even if this triggers competition in the industry. Until quite recently, however, it was perfectly legal for a big c o m p a n y to enter some entirely new field by acquisition. In fact, this is the sort of thing that is most likely to trigger price competition in a capital intensive industry that is not so profitable that it attracts " n e w " money. The newcomer does not necessarily behave like a gentleman. The steel industry is a good example. The industry has earned less-than-average profits for years. Its productivity as measured by man-hours of labor required to produce a ton of a particular type of steel m a y still be higher than that of any other nation's steel industry (although the Japanese must come pretty dose). Yet by American standards, productivity is sluggish. In addition, innovation in the steel industry has been mostly imported. Obviously, it would be in the public interest if fresh competition were to develop in this tired industry. This is, of course, what the antitrust laws should do. But, in practice, new capital has not been attracted to the industry because profits are too low, partly because antitrust laws make it illegal for the industry to fight foreign competition effectively using the double-pricing standards and other devices that permit foreign firms to get rid of their surplus output on the American market. Thus, the only practical way to inject new and, hopefully, more dynamic management into the steel industry would be to encourage more aggressive firms, outside the industry, to buy into it. This is practical because the stock market has put a relatively low value on steel shares for almost a decade, so low that huge profits m a y accrue to an aggressive manage-
OCTOBER, 1971
ment that buys into the industry and manages to achieve even minimal results. To buy a steel company, however, one must be big and well-financed. Only rarely can a company like Lykes Steamship acquire a steel company seven times its size (and, in fact, it is testimony to the steel industry's lack of confidence in its own management that this should ever be possible on a completely voluntary basis). More conventional is the acquisition of a steel firm by an already huge c o m p a n y like L.T.V. As defender of the status quo, the Justice Department felt compelled to accuse L.T.V. of tending to create a m o n o p o l y when it acquired Jones & Laughlin Steel. There is one element of truth in the Justice Department charge; if the now troubled L.T.V. does succeed in injecting new life into the heretofore moribund Jones & Laughlin, other steel companies will probably suffer smaller market shares. This is, of course, in the public interest. It may even be in the steel industry's own interest. Only when conglomerates began to look interested did the industry start to show signs of wanting to diversify away from steel. Current law makes it fairly easy for the Antitrust Division to protect existing industries from inroads from what might become unruly competitors. The industry that is doing poorly is, of course, automatically protected from an influx of new capital; no one wants to get into the industry. And, if a new producer does make a mistake and sinks his m o n e y into an industry without promise, the future becomes even less attractive to new capital. The cement industry, as big a villain in the college "government and business" textbooks as the steel industry, temporarily acquired a growth image in the mid-1950's. New investors rushed toward what appeared to be easy money. Two major new facilities constructed in the 1950's plus expansion b y existing firms was enough to kill the industry for at least the next decade. Meanwhile, the Justice Department and the Federal Trade
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DEAN S. AMMER
"The
most popular
complaint
. . .
has
been based on reciprocity."
Commission moved to protect the producer who was not bold enough to integrate forward into ready-mix and aggregates by preventing established cement producers from buying their customers. One by-product, I am advised by experts in the industry, is that the consumer of cement not only does not enjoy especially low prices but buys from an industry that is technologically more backward than its counterparts in Europe.
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The Justice Department is now trying to protect existing producers in other industries against acquisition by fighting almost any conglomerate type acquisition by any of the 200 largest manufacturers. While small nimble entrepreneurs have occasionally been bold enough to capture firms much bigger than themselves, the usual rule is that a business must be big if it is to acquire a big business. Thus, if the Justice Department is successful, it will accomplish what the most reactionary managements probably could not do on their own.
Of course, the Justice Department cannot hope to prove that the industry has directly become more concentrated when a particular firm is taken over by a conglomerate not already in that industry. It must search for some indirect "proof" of concentration. The most popular complaint in the last year or so has been based on reciprocity. The conglomerate allegedly can use its buying power on behalf of its subsidiaries and thereby force suppliers to buy from the subsidiaries. Reciprocity
The typical pattern is that the conglomerate takes over a company that hag long practiced reciprocity; in most such cases, there has been no evidence that the conglomerate itself--for example, LTV--has practiced reciprocity. On the contrary, reciprocity was universally practiced in the steel industry until recently, at least. Not long ago, an
official of Jones & Laughlin was an officer in the Trade Relations Association, a group dedicated to ethical reciprocity practice. The Justice Department is correct in regarding reciprocity as an anticompetitive practice. But when it keeps a nonoffender out of an industry where the practice is common, it is really working to preserve the status quo of the industry, including its reciprocity. If it wanted to increase competition, it would force the nonoffending conglomerate to impose its nonrecipmcity practice on the subsidiary with the history of reciprocity. The net effect would almost certainly be more competition in the industry. But, of course, it is fairly easy to defend the status quo against new competition. One can simply argue that the newcomer will cheat and use reciprocity. In fact, however, organized reciprocity-the only kind that is really effective and important economicallycannot exist without a rather elaborate record-keeping system. And to function really well, the centralized reciprocity department must be staffed with specialists who know how to analyze these statistics and use them skillfully to upgrade supplier-buyer relationships. A huge corporation could not possibly hide the existence of such a department. Casual reciprocity, like casual prostitution, would still exist. But this is what every purchasing agent has learned to cope with. He will see the salesman who points out that his company is a customer, but he will never buy from that salesman at a higher price. In fact, if there are no good records the salesman who puts too much pressure on reciprocity may find himself getting less business from a purchasing agent who resents being told what to buy. The P.A. can be forced to toe the line only when a highly efficient record system can prove he is shortchanging his suppliercustomer. Thus, the Justice Department should not discourage acquisition by conglomerates of firms that have been living off little but their reciprocity. It should encourage it and insist the reciprocity be eliminated. When it does
BUSINESS HORIZONS
Our Antitrust Laws Are Anticompetitive
just the opposite, the department is not only supporting the not-so-competitive status q u o but, ironically, even supporting the reciprocity of which it disapproves and, in some cases, now forbids. Centralized record-keeping is a must for a firm that is just beginning to play the reciprocity game, but is less essential in a company that has been playing it for years. Reciprocal patterns tend to become rigid in an industry. In time, the reciprocity process would become less precise with_out records, but this might take years in industries that are changing slowly. In contrast, an aggressive newcomer could cause patterns to become confused almost overnight. Thus, when the Justice Department prevents new firms from entering an industry by acquisition, it works to preserve established trade patterns. This is anticompetitive.
THE CASE AGAINST ANTITRUST The hypothesis of this entire article, of course, is that industry would be more competitive and come closer to meeting economically related social objectives if there were no antitrust laws at all. Clearly, the argument is strongest in conglomerate type acquisitions which tend to shake up old and often stuffy industries. Very few businessmen, at least, would deny that antitrust efforts to eliminate mergers (which really reflect the philosophy that bigness is bad) are anticompetitive. Our argument is weakest when we argue the hypothesis that efforts to stamp out price fixing are contrary to the over-all national economic interest. The gist of the argument to make price fixing less illegal is that firms who fix prices illegally are victims in an economy where most prices are administered in an environment of imperfect competition. The obvious counterargument is that price-fixing laws also inhibit firms that do not get caught. The ideal law would not outlaw price fixing when it was against the long-term
OCTOBER, 1971
national economic interest, but would treat sympathetically joint industry efforts to stabilize prices in industries where excess competition would be destructive. The government case for elimination of price fixing in a particular industry would rest on whether this action was antisocial in fact as well as in nineteenth century economic theory. It would be hard for the government to win a case against an industry where profits were low despite price fixing since, obviously, the antisocial objective of the price fixing had not been achieved. In practice, a stance against price fixing is so firmly a part of our culture that no Administration (especially a Republican one with a probusiness image) would dare suggest that the law against it be relaxed. Instead, I suggest that the problem s h o u l d - a n d almost certainly will-be attacked by the few industries that are seriously affected by unstable prices in a more subtle way. In practice, some part of the industry's freedom will be traded with government for some indirect assurance of price stability. The steel and textile industries have probably already made this trade without realizing it. They are now protected by "voluntary" agreements against imports, the biggest major threat to their stability. In the process, they have undoubtedly also given up some of their ability to resist indirect government efforts to nudge them into taking actions they would not otherwise take. There is the possibility that the import door will be opened a little wider; this club may make them toe the line just as defense contractors "voluntarily" conform to almost any "suggestion" made to them by high government officials, even when it does not have the power of law. While Congress and the general public would probably never accept a law that made price fixing illegal only when its anticompetitive impact could be proved inequitable, there is no reason why they should continue to support the Justice Department's anticompetitive stance on
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DEAN S. AMMER
mergers. The law can and should be changed, probably in a way that not every businessman would like. Market share, especially when demand for the product is relatively inelastic and substitution possibilities are limited, is evidence of the competitive state of an industry. Bigness is not evidence, nor are most mergers. In general, the Justice Department should encourage mergers that bring new companies into an industry and be indifferent to those that have no significant effect on market share.
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If a firm's market share gets too big, that firm should be encouraged to spin off its subsidiaries. Recent financial history indicates that divestiture in such cases need not be a penalty for success but a reward. The value of the parts turns out to be greater than the value of the whole. If Standard Oil had not been dissolved sixty years ago, it would have become a stodgy c o m p a n y with a gradually declining market share. Antitrust laws and sheer bureaucracy wouid have inhibited it from maintaining its share of a growing market. Instead, the firms that were once part of Standard Oil have, in general, prospered to the benefit of their stockholders, employees, and customers. Of course, Standard Oil did not exactly volunteer for what turned out to be a happy event for all parties concerned. At that time, managements wanted their firms to b e c o m e as big and powerful as possible. Only in the last decade has a substantial n u m b e r of managers come to realize that it is their mission to think smaller as well as to grow. Business has long k n o w n that to be big is not to be bad; it is only just beginning to realize that to be smaller is sometimes to be better. The spin-off stage may be reached long before the business becomes big. The publishing firm Prentice-Hall has spawned at least two competing publishers (Allyn & Bacon and Charles E. Merrill) of college textbooks. Prentice-Hall is smaller than it might have been had it just set up Allyn & Bacon and Merrill as captive houses with competing lists. But, of course, the two
spin-offs compete m u c h more vigorously simply because they have been cut loose from the parent's apron strings, and the original Prentice-Hall stockholders are that much richer as a result. The spin-off did not really come into its own, however, until L.T.V. split Wilson and Company into three parts, and, most recently, spun off what was formerly its captive computer facility. Spin-offs seemed to be gaining in popularity before stock prices began to decline sharply in 1969. PrenticeHall is one of the few cases where the goal has been greater market share for the company's product as distinct from higher market prices for the c o m m o n stock. Such spin-offs are obviously in both the general public interest as well as the more selfish interest of the stockholder. A firm with a 50 percent market share m a y be able to escape antitrust prosecution indefinitely under existing laws as long as it does not move aggressively to increase its share to 75 percent. But stockholders, employees, and the public at large would be better if it split itself into three companies, each with a 15 to 20 percent market share. Each of the new companies would be free to move in whatever direction it wished. The only "losers" would be the man who runs the old firm; inevitably, he would wind up with less personal power than before. This need not inhibit him indefinitely, however, if he is a man of ability. Since to be big is not to be bad in the ideal antitrust environment, there is nothing to prevent an aggressive corporation from becoming at least an important producer in as many industries as it pleases, much as in the Japanese pattern where each group of Zaibitsu go into just about every type of business. Reciprocity is the only real danger that such combinations will become anticompetitive, and it can easily be curbed by simply making it illegal to establish the centralized apparatus that is essential to its smooth functioning. Copyright 1971, Dean S. Ammer
BUSINESS HORIZONS