Chapter 8

REGULATION  AND
ANTI-TRUST LAWS

Competition is not easily suppressed even when there are only a few independent firms. . . competition is a tough weed, not a delicate flower.

George J. Stigler{242}

In the late nineteenth century, the American government began to respond to monopolies and cartels by both directly regulating the prices which monopolies and cartels were allowed to charge and by taking punitive legal action against these monopolies and cartels under the Sherman Anti-Trust Act of 1890 and other later anti-trust legislation. Complaints about the high prices charged by railroads in places where they had a monopoly led to the creation of the Interstate Commerce Commission in 1887, the first of many federal regulatory commissions created to control the prices charged by monopolists.

During the era when local telephone companies were monopolies in their respective regions and their parent company— the American Telephone and Telegraph Company—had a monopoly of long-distance service, the Federal Communications Commission controlled the prices charged by A.T.&T., while state regulatory agencies controlled the price of local phone service. Another approach has been to pass laws against the creation or maintenance of a monopoly or against various practices, such as price discrimination, growing out of non-competitive markets. These anti-trust laws were intended to allow businesses to operate without the kinds of detailed government supervision which exist under regulatory commissions, but with a sort of general surveillance, like that of traffic police, with intervention occurring only when there are specific violations of laws.

REGULATORY  COMMISSIONS

Although the functions of a regulatory commission are fairly straightforward in theory, in practice its task is far more complex and, in some respects, impossible. Moreover, the political climate in which regulatory commissions operate often leads to policies and results directly the opposite of what was expected by those who created such commissions.

Ideally, a regulatory commission would set prices where they would have been if there were a competitive marketplace. In practice, there is no way to know what those prices would be. Only the actual functioning of a market itself could reveal such prices, with the less efficient firms being eliminated by bankruptcy and only the most efficient surviving, and their lower prices now being the market prices. No outside observers can know what the most efficient ways of operating a given firm or industry are. Indeed, many managements within an industry discover the hard way that what they thought was the most efficient way to do things was not efficient enough to meet the competition, and have ended up losing customers as a result. The most that a regulatory agency can do is accept what appear to be reasonable production costs and allow the monopoly to make what seems to be a reasonable profit over and above such costs.

Determining the cost of production is by no means always easy. As noted in Chapter 6, there may be no such thing as “the” cost of production. The cost of generating electricity, for example, can vary enormously, depending on when and where it is generated. When you wake up in the middle of the night and turn on a light, that electricity costs practically nothing to supply, because the electricity-generating system must be kept operating around the clock, so it has much unused capacity in the middle of the night, when most people are asleep. But, when you turn on your air conditioner on a hot summer afternoon, when millions of other homes and offices already have  their air conditioners on, that may help strain the system to its limit and necessitate turning on costly standby generators, in order to avoid blackouts.

It has been estimated that the cost of supplying the electricity required to run a dishwasher, for example, at a time of peak electricity usage, can be 100 times greater than the cost of running that same dishwasher at a time when there is a low demand for electricity.{243} Turning on your dishwasher in the middle of the night, like turning on a light in the middle of the night, costs the electricity-generating system practically nothing, since the electricity has to be generated around the clock in any case.

 There are many reasons why additional electricity, beyond the usual capacity of the system, may be many times more costly per kilowatt hour than the usual costs when the system is functioning within its usual capacity. The main system that supplies vast numbers of consumers can make use of economies of scale to produce electricity at its lowest cost, while standby generators typically produce less electricity and therefore cannot take full advantage of economies of scale, but must produce at higher costs per kilowatt hour. Sometimes technological progress gives the main system lower costs, while obsolete equipment is kept as standby equipment, rather than being junked, and the costs of producing additional electricity with this obsolete equipment is of course higher. Where additional electricity has to be purchased from outside sources when the local generating capacity is at its limit, the additional cost of transmitting that electricity from greater distances raises the cost of the additional electricity to much higher levels than the cost of electricity generated closer to the consumers.

More variations in “the” cost of producing electricity come from fluctuations in the costs of the various fuels— oil, gas, coal, nuclear— used to run the generators. Since all these fuels are used for other things besides generating electricity, the fluctuating demand for these fuels from other industries, or for use in homes or automobiles, makes their prices unpredictable. Hydroelectric dams likewise vary in how much electricity they can produce when rainfall varies, increasing or reducing the amount of water that flows through the generators. When the fixed costs of the dam are spread over differing amounts of electricity, the cost per kilowatt hour varies accordingly.

How is a regulatory commission to set the rates to be charged consumers of electricity, given that the cost of generating electricity can vary so widely and unpredictably? If state regulatory commissions set electricity rates based on “average” costs of generating electricity, then when there is a higher demand or a shorter supply within the state, out-of-state suppliers may be unwilling to sell electricity at prices lower than their own costs of generating the additional electricity from standby units. This was part of the reason for the much-publicized blackouts in California in 2001. “Average” costs are irrelevant when the costs of generation are far above average at a particular time or far below average at other times.

Because the public is unlikely to be familiar with all the economic complications involved, they are likely to be outraged at having to pay electricity rates far higher than they are used to. In turn, this means that politicians are tempted to step in and impose price controls based on the old rates. And, as already noted in other contexts, price controls create shortages— in this case, shortages of electricity that result in blackouts. A larger quantity demanded and a smaller quantity supplied has been a very familiar response to price controls, going back in history long before electricity came into use. However, politicians’ success does not depend on their learning the lessons of history or of economics. It depends far more on their going along with what is widely believed by the public and the media, which may include conspiracy theories or belief that higher prices are due to “greed” or “gouging.”

Halfway around the world, attempts to raise electricity rates in India were met by street demonstrations, as they were in California. In the Indian state of Karnataka, controlled politically by India’s Congress Party at the time, efforts to change electricity rates were opposed in the streets by one of the opposition parties. However, in the neighboring state of Andhra Pradesh, where the Congress Party was in the opposition, it led similar street demonstrations against electricity rate increases.{244} In short, what was involved in these demonstrations was neither ideology nor party but an opportunistic playing to the gallery of public misconceptions.

The economic complexities involved when regulatory agencies set prices are compounded by political complexities. Regulatory agencies are often set up after some political crusaders have successfully launched investigations or publicity campaigns that convince the authorities to establish a permanent commission to oversee and control a monopoly or some group of firms few enough in number to be a threat to behave in collusion as if they were one monopoly. However, after a commission has been set up and its powers established, crusaders and the media tend to lose interest over the years and turn their attention to other things. Meanwhile, the firms being regulated continue to take a keen interest in the activities of the commission and to lobby the government for favorable regulations and favorable appointments of individuals to these commissions.

The net result of these asymmetrical outside interests on these agencies is that commissions set up to keep a given firm or industry within bounds, for the benefit of the consumers, often metamorphose into agencies seeking to protect the existing regulated firms from threats arising from new firms with new technology or new organizational methods. Thus, in the United States, the Interstate Commerce Commission— initially created to keep railroads from charging monopoly prices to the public— responded to the rise of the trucking industry, whose competition in carrying freight threatened the economic viability of the railroads, by extending the commission’s control to include trucking.

The original rationale for regulating railroads was that these railroads were often monopolies in particular areas of the country, where there was only one rail line. But now that trucking undermined that monopoly, by being able to go wherever there were roads, the response of the I.C.C. was not to say that the need for regulating transportation was now less urgent or perhaps even unnecessary. Instead, it sought— and received from Congress— broader authority under the Motor Carrier Act of 1935, in order to restrict the activities of truckers. This allowed railroads to survive under the new economic conditions, despite truck competition that was more efficient for various kinds of freight hauling and could therefore often charge lower prices than the railroads charged. Trucks were now permitted to operate across state lines only if they had a certificate from the Interstate Commerce Commission declaring that the trucks’ activities served “public convenience and necessity” as defined by the I.C.C. This kept truckers from driving railroads into bankruptcy by taking away as many of their customers as they could have in an unregulated market.

In short, freight was no longer being hauled in whatever way required the use of the least resources, as it would be under open competition, but only by whatever way met the arbitrary requirements of the Interstate Commerce Commission. The I.C.C. might, for example, authorize a particular trucking company to haul freight from New York to Washington, but not from Philadelphia to Baltimore, even though these cities are on the way. If the certificate did not authorize freight to be carried back from Washington to New York, then the trucks would have to return empty, while other trucks carried freight from D.C. to New York.

From the standpoint of the economy as a whole, enormously greater costs were incurred than were necessary to get the work done. But what this arrangement accomplished politically was to allow far more companies— both truckers and railroads— to survive and make a profit than if there were an unrestricted competitive market, where the transportation companies would have no choice but to use the most efficient ways of hauling freight, even if lower costs and lower prices led to the bankruptcy of some railroads whose costs were too high to survive in competition with trucks. The use of more resources than necessary entailed the survival of more companies than were necessary.

While open and unfettered competition would have been economically beneficial to the society as a whole, such competition would have been politically threatening to the regulatory commission. Firms facing economic extinction because of competition would be sure to resort to political agitation and intrigue against the survival in office of the commissioners and against the survival of the commission and its powers. Labor unions also had a vested interest in keeping the status quo safe from the competition of technologies and methods that might require fewer workers to get the job done.

After the I.C.C.’s powers to control the trucking industry were eventually reduced by Congress in 1980, freight charges declined substantially and customers reported a rise in the quality of the service.{245} This was made possible by greater efficiency in the industry, as there were now fewer trucks driving around empty and more truckers hired workers whose pay was determined by supply and demand, rather than by union contracts. Because truck deliveries were now more dependable in a competitive industry, businesses using their services were able to carry smaller inventories, saving in the aggregate tens of billions of dollars.

The inefficiencies created by regulation were indicated not only by such savings after federal deregulation, but also by the difference between the costs of interstate shipments and the costs of intrastate shipments, where strict state regulation continued after federal regulation was cut back. For example, shipping blue jeans within the state of Texas from El Paso to Dallas cost about 40 percent more than shipping the same jeans internationally from Taiwan to Dallas.{246}

Gross inefficiencies under regulation were not peculiar to the Interstate Commerce Commission. The same was true of the Civil Aeronautics Board, which kept out potentially competitive airlines and kept the prices of air fares in the United States high enough to ensure the survival of existing airlines, rather than force them to face the competition of other airlines that could carry passengers cheaper or with better service. Once the CAB was abolished, airline fares came down, some airlines went bankrupt, but new airlines arose and in the end there were far more passengers being carried than at any time under the constraints of regulation. Savings to airline passengers ran into the billions of dollars.{247}

These were not just zero-sum changes, with airlines losing what passengers gained. The country as a whole benefitted from deregulation, for the industry became more efficient. Just as there were fewer trucks driving around empty after trucking deregulation, so airplanes began to fly with a higher percentage of their seats filled with passengers after airline deregulation, and passengers usually had more choices of carriers on a given route than before. Much the same thing happened after European airlines were deregulated in 1997, as competition from new discount airlines like Ryanair forced British Airways, Air France and Lufthansa to lower their fares.{248}

In these and other industries, the original rationale for regulation was to keep prices from rising excessively but, over the years, this turned into regulatory restrictions against letting prices fall to a level that would threaten the survival of existing firms. Political crusades are based on plausible rationales but, even when those rationales are sincerely believed and honestly applied, their actual consequences may be completely different from their initial goals. People make mistakes in all fields of human endeavor but, when major mistakes are made in a competitive economy, those who were mistaken can be forced from the marketplace by the losses that follow. In politics, however, those regulatory agencies often continue to survive, after the initial rationale for their existence is gone, by doing things that were never contemplated when their bureaucracies and their powers were created

ANTI-TRUST  LAWS

With anti-trust laws, as with regulatory commissions, a sharp distinction must be made between their original rationales and what they actually do. The basic rationale for anti-trust laws is to prevent monopoly and other non-competitive conditions which allow prices to rise above where they would be in a free and competitive marketplace. In practice, most of the famous anti-trust cases in the United States have involved some business that charged lower prices than its competitors. Often it has been complaints from these competitors which caused the government to act.

Competition versus Competitors

The basis of many government prosecutions under the anti-trust laws is that some company’s actions threaten competition. However, the most important thing about competition is that it is a condition in the marketplace. This condition cannot be measured by the number of competitors existing in a given industry at a given time, though politicians, lawyers and assorted others have confused the existence of competition with the number of surviving competitors. But competition as a condition is precisely what eliminates many competitors.

Obviously, if it eliminates all competitors, then the surviving firm would be a monopoly, at least until new competitors arise, and could in the interim charge far higher prices than in a competitive market. But that is extremely rare. However, the specter of monopoly is often used to justify government policies of intervention where there is no serious danger of a monopoly. For example, back when the A & P grocery chain was the largest retail chain in the world, more than four-fifths of all the groceries in the United States were sold by other grocery stores. Yet the Justice Department brought an anti-trust action against A & P, using the company’s low prices, and the methods by which it achieved those low prices, as evidence of “unfair” competition against rival grocers and rival grocery chains.

Throughout the history of anti-trust prosecutions, there has been an unresolved confusion between what is detrimental to competition and what is detrimental to competitors. In the midst of this confusion, the question of what is beneficial to the consumer has often been lost sight of.

What has often also been lost sight of is the question of the efficiency of the economy as a whole, which is another way of looking at the benefits to the consuming public. For example, fewer scarce resources are used when products are bought and sold in carload lots, as large chain stores are often able to do, than when the shipments are sold and delivered in much smaller individual quantities to numerous smaller stores. Both delivery costs and selling costs are less per unit of product when the product is bought and sold in large enough amounts to fill a railroad boxcar. The same principle applies when a huge truck delivers a vast amount of merchandise to a Wal-Mart Supercenter, as compared to delivering the same total amount of merchandise to numerous smaller stores scattered over a wider area.

Production costs are also lower when the producer receives a large enough order to be able to schedule production far ahead, instead of finding it necessary to pay overtime to fill many small and unexpected orders that happen to arrive at the same time.

Unpredictable orders also increase the likelihood of slow periods when there is not enough work to keep all the workers employed. Workers who have to be laid off at such times may find other jobs, and not all of them may return when the first employer has more orders to fill, thus making it necessary for that employer to hire new workers, which entails training costs and lower productivity until the new workers gain enough experience to reach peak efficiency. Moreover, employers unable to offer steady employment may find recruiting workers to be more difficult, unless they offer higher pay to offset the uncertainties of the job.

In all these ways, production costs are higher when there are unpredictable orders than when a large purchaser, such as a major department store chain, can contract for a large amount of the supplier’s output over a considerable span of time, enabling cost savings to be made in production, part of which go to the chain in lower prices as well as to the producer as lower production costs that leave more profit. Yet this process has long been represented as big chain stores using their “power” to “force” suppliers to sell to them for less. For example, a report in the San Francisco Chronicle said:

 

For decades, big-box retailers such as Target and Wal-Mart Stores have used their extraordinary size to squeeze lower prices from suppliers, which have a vested interest in keeping them happy.{249}

 

But what is represented as a “squeeze” on suppliers for the sole benefit of a retail chain with “power” is in fact a reduction in the use of scarce resources, benefitting the economy by freeing some of those resources for use elsewhere. Moreover, despite the use of the word “power,” chain stores have no ability to reduce the options otherwise available to the producers. A producer of towels or toothpaste has innumerable alternative buyers and was under no compulsion to sell to A & P in the past or to Target or Wal-Mart today. Only if the economies of scale make it profitable to supply a large buyer with towels or toothpaste (or other products) will the supplier find it advantageous to cut the price below what would otherwise be charged. All economic transactions involve mutual accommodation and each transactor has to make the deal a net benefit to the other transactor, in order to have a deal at all.

Despite economies of scale, the government has repeatedly taken anti-trust action against various companies that gave quantity discounts that the authorities did not like or understand. There was, for example, a well-known anti-trust action against the Morton Salt Company in the 1940s for giving discounts to buyers who bought carload lots of their product. Businesses that bought less than a carload lot of salt were charged $1.60 a case, those who bought carload lots were charged $1.50 a case, and those who bought 50,000 cases or more in a year’s time were charged $1.35. Because there were relatively few companies that could afford to buy so much salt and many more that could not, “the competitive opportunities of certain merchants were injured,” according to the Supreme Court, which upheld the Federal Trade Commission’s actions against Morton Salt.{250}

The government likewise took action against the Standard Oil Company in the 1950s for allowing discounts to those dealers who bought oil by the tank car.{251} The Borden Company was similarly brought into court in the 1960s for having charged less for milk to big chain stores than to smaller grocers.{252} In all these cases, the key point was that such price differences were considered “discriminatory” and “unfair” to those competing firms unable to make such large purchases.

While the sellers were allowed to defend themselves in court by referring to cost differences in selling to different classes of buyers, the apparently simple concept of “cost” is by no means simple when argued over by rival lawyers, accountants and economists. Where neither side could prove anything conclusively about the costs— which was common— the accused lost the case. In a fundamental departure from the centuries-old traditions of Anglo-American law, the government need only make a superficial or prima facie case, based on gross numbers, to shift the burden of proof to the accused. This same principle and procedure were to reappear, years later, in employment discrimination cases under the civil rights laws. As with anti-trust cases, these employment discrimination cases likewise produced many consent decrees and large out-of-court settlements by companies well aware of the virtual impossibility of proving their innocence, regardless of what the facts might be.

The emphasis on protecting competitors, in the name of protecting competition, takes many forms and has appeared in other countries besides the United States. A European anti-trust case against Microsoft was based on the idea that Microsoft had a duty to accommodate competitors who might want to attach their software products to the Microsoft operating system. Moreover, the rationale of the European decision was defended in a New York Times editorial:

 

Microsoft’s resounding defeat in a European antitrust case establishes welcome principles that should be adopted in the United States as guideposts for the future development of the information economy.

The court agreed with European regulators that Microsoft had abused its operating system monopoly by incorporating its Media Player, which plays music and films, into Windows. That shut out rivals, like RealPlayer. The decision sets a sound precedent that companies may not leverage their dominance in one market (the operating system) to extend it into new ones (the player).

The court also agreed that Microsoft should provide rival software companies the information they need to make their products work with Microsoft’s server software.{253}

 

The New York Times editorial seemed surprised that others saw the principle involved in this anti-trust decision as “a mortal blow against capitalism itself.”{254} But when free competition in the marketplace is replaced by third-party intervention to force companies to facilitate their competitors’ efforts, it is hard to see that as fostering competition, as distinguished from protecting competitors.

The confusion between the two things is long standing. Back when Kodachrome was the leading color film in the world, it was also what was aptly called “the most complicated film there is to process.”{255} Since Eastman Kodak had a huge stake in maintaining the reputation of Kodachrome, it sought to protect that reputation by processing all Kodachrome itself, so it sold the processing and the film together, rather than risk having other processors turn out substandard results that could be seen by consumers as deficiencies of the film. Yet an anti-trust lawsuit forced Kodak to sell the processing and the film separately, in order not to foreclose that market to other film processors. The fact that all other Kodak films were sold without processing included might suggest that Kodak was not out to foreclose the processing market but to protect the quality and reputation of one particular film that was especially difficult to process. Yet the focus on protecting competitors prevailed in the courts.

“Control” of the Market

The rarity of genuine monopolies in the American economy has led to much legalistic creativity, in order to define various companies as monopolistic or as potential or “incipient” monopolies. How far this could go was illustrated when the Supreme Court in 1962 broke up a merger between two shoe companies that would have given the new combined company less than 7 percent of the shoe sales in the United States.{256} The court likewise in 1966 broke up a merger of two local supermarket chains which, put together, sold less than 8 percent of the groceries in the Los Angeles area.{257} Similarly arbitrary categorizations of businesses as “monopolies” were imposed in India under the Monopolies and Restrictive Trade Practices Act of 1969, where any enterprises with assets in excess of a given amount (about $27 million) were declared to be monopolies and restricted from expanding their business.{258}

A standard practice in American courts and in the literature on anti-trust laws is to describe the percentage of sales made by a given company as the share of the market which it “controls.” By this standard, such now defunct companies as Pan American Airways “controlled” a substantial share of their respective markets, when in fact the passage of time showed that they controlled nothing, or else they would never have allowed themselves to be forced out of business. The severe shrinkage in size of such former giants as A & P likewise suggests that the rhetoric of “control” bears little relationship to reality. But such rhetoric remains effective in courts of law and in the court of public opinion.

Even in the rare case where a genuine monopoly exists on its own— that is, has not been created or sustained by government policy— the consequences in practice have tended to be much less dire than in theory. During the decades when the Aluminum Company of America (Alcoa) was the only producer of virgin ingot aluminum in the United States, its annual profit rate on its investment was about 10 percent after taxes. Moreover, the price of aluminum went down over the years to a fraction of what it had been before Alcoa was formed. Yet Alcoa was prosecuted under the anti-trust laws and convicted.{259}

Why were aluminum prices going down under a monopoly, when in theory they should have been going up? Despite its “control” of the market for aluminum, Alcoa was well aware that it could not jack up prices at will, without risking the substitution of other materials— steel, tin, wood, plastics— for aluminum by many users. Technological progress lowered the costs of producing all these materials and economic competition forced the competing firms to lower their prices accordingly.

This raises a question which applies far beyond the aluminum industry. Percentages of the market “controlled” by this or that company ignore the role of substitutes that may be officially classified as products of other industries, but which can nevertheless be used as substitutes by many buyers, if the price of the monopolized product rises significantly. Whether in a monopolized or a competitive market, a technologically very different product may serve as a substitute, as television did when it replaced many newspapers as sources of information and entertainment or when “smart phones” that could take pictures provided devastating competition for the simple, inexpensive cameras that had long been profitable for Eastman Kodak. Phones and cameras would be classified as being in separate industries when calculating what percentage of the market was “controlled” by Kodak, but the economic reality said otherwise.

In Spain, when high-speed trains began operating between Madrid and Seville, the division of passenger traffic between rail and air travel went from 33 percent rail and 67 percent air to 82 percent rail and 18 percent air.{260} Clearly many people treated air and rail traffic as substitute ways of traveling between these two cities. No matter how high a percentage of the air traffic between Madrid and Seville might be carried (“controlled”) by one airline, and no matter how high a percentage of the rail traffic might be carried by one railroad, each would still face the competition of all air lines and all rail lines operating between these cities.

Similarly, in earlier years, ocean liners carried a million passengers across the Atlantic in 1954 while planes carried 600,000. But, eleven years later, the ocean liners were carrying just 650,000 passengers while planes now carried four million.{261} The fact that these were technologically very different things did not mean that they could not serve as economic substitutes. In twenty-first century Latin America, airlines have even competed successfully with buses.  According to the Wall Street Journal:

 

The new low-cost carriers in Brazil, Mexico and Colombia are largely avoiding competition with incumbent full-service airlines.  Instead, they are stimulating new traffic by adding cheap, no-frills flights to secondary cities that, for many residents, had long required day-long bus rides.

Largely as a result, the number of airline passengers in these countries has surged. The newfound mobility has opened up the flow of commerce and drastically cut travel times in areas with poor roads, virtually no rail service and stretches of harsh terrain.{262}

 

One low-cost airline offers flights into Mexico City for “about half the price of the 14-hour overnight bus ride.”{263} In Brazil and Colombia it is much the same story.  In both these countries, new low-cost airlines have reduced bus travel somewhat and greatly increased air travel, as the total number of people traveling has grown. Planes and buses are obviously very different technologically, but they can serve the same purpose and compete against each other in the marketplace— a crucial fact overlooked by those who compile data on how large a share of the market some company “controls.”

Those bringing anti-trust lawsuits generally seek to define the relevant market narrowly, so as to produce high percentages of the market “controlled” by the enterprise being prosecuted. In the famous anti-trust case against Microsoft at the turn of the century, for example, the market was defined as that for computer operating systems for stand-alone personal computers using microchips of the kind manufactured by Intel. This left out not only the operating systems running Apple computers but also other operating systems such as those produced by Sun Microsystems for multiple computers or the Linux system for stand-alone computers.

In its narrowly defined market, Microsoft clearly had a “dominant” share. The anti-trust lawsuit, however, did not accuse Microsoft of jacking up prices unconscionably, in the classic manner of monopoly theory. Rather, Microsoft had added an Internet browser to its Windows operating system free of charge, undermining rival browser producer Netscape.

The existence of all the various sources of potential competition from outside the narrowly defined market may well have had something to do with the fact that Microsoft did not raise prices, as it could have gotten away with in the short run— but at the cost of jeopardizing its long-run sales and profits, since other operating systems could have been substituted for Microsoft’s system, if the prices of these other operating systems were right. In 2003, the city government of Munich in fact switched from using Microsoft Windows in its 14,000 computers to using Linux{264}— one of the systems excluded from the definition of the market that Microsoft “controlled,” but which was nevertheless obviously a substitute.

In 2013, the Department of Justice filed an anti-trust lawsuit to prevent the brewers of Budweiser and other beers from buying full ownership of the brewer of Corona beer. Ownership of all the different brands of beer involved would have given the brewers of Budweiser “control” of 46 percent of all beer sales in the United States, as “control” is defined in anti-trust rhetoric. In reality, the merger would still leave a majority of the beer sold in the country in the hands of other brewers, of which more than 400 new brewers were added the previous year, raising the total number of brewers to an all-time high of 2,751. More fundamentally, defining the relevant market as the beer market ignored the fact that beer was just one alcoholic beverage— and “beer has been losing market share on this wider playing field for a decade or more” to other alcoholic drinks, according to the Wall Street Journal.{265}

The spread of international free trade means that even a genuine monopoly of a particular product in a particular country may mean little if that same product can be imported from other countries. If there is only one producer of widgets in Brazil, that producer is not a monopoly in any economically meaningful sense if there are a dozen widget manufacturers in neighboring Argentina and hundreds of widget makers in countries around the world. Only if the Brazilian government prevents widgets from being imported does the lone manufacturer in the country become a monopoly in a sense that would allow higher prices to be charged than would be charged in a competitive market.

If it seems silly to arbitrarily define a market and “control” of that market by a given firm’s current sales of domestically produced products, it was not too silly to form the basis of a landmark U.S. Supreme Court decision in 1962, which defined the market for shoes in terms of “domestic production of nonrubber shoes.” By eliminating sneakers, deck shoes, and imported shoes of all kinds, this definition increased the defined market share of the firms being charged with violating the anti-trust laws— who in this case were convicted.

Thus far, whether discussing widgets, shoes, or computer operating systems, we have been considering markets defined by a given product performing a given function. But often the same function can be performed by technologically different products. Corn and petroleum may not seem to be similar products belonging in the same industry but producers of plastics can use the oil from either one to manufacture goods made of plastic.

When petroleum prices soared in 2004, Cargill Dow’s sales of a resin made from corn oil rose 60 percent over the previous year, as plastics manufacturers switched from the more expensive petroleum oil.{266} Whether or not two things are substitutes economically does not depend on whether they look alike or are conventionally defined as being in the same industry. No one considers corn as being in the petroleum industry or considers either of these products when calculating what percentage of the market is “controlled” by a given producer of the other product. But that simply highlights the inadequacy of “control” statistics.

Even products that have no functional similarity may nevertheless be substitutes in economic terms. If golf courses were to double their fees, many casual golfers might play the game less often or give it up entirely, and in either case seek recreation by taking more trips or cruises or by pursuing a hobby like photography or skiing, using money that might otherwise have been used for playing golf. The fact that these other activities are functionally very different from golf does not matter. In economic terms, when higher prices for A cause people to buy more of B, then A and B are substitutes, whether or not they look alike or operate alike. But laws and government policies seldom look at things this way, especially when defining how much of a given market a given firm “controls.”

Domestically, as well as internationally, as the area that can be served by given producers expands, the degree of statistical dominance or “control” by local producers in any given area means less and less. For example, as the number of newspapers published in given American communities declined substantially after the middle of the twentieth century, with the rise of television, much concern was expressed over the growing share of local markets “controlled” by the surviving papers. In many communities, only one local newspaper survived, making it a monopoly as defined by the share of the market it “controlled.” Yet the fact that newspapers published elsewhere became available over wider and wider areas made such statistical “control” less and less meaningful economically.

For example, someone living in the small community of Palo Alto, California, 30 miles south of San Francisco, need not buy a Palo Alto newspaper to find out what movies are playing in town, since that information is readily available from the San Francisco Chronicle, which is widely sold in Palo Alto, with home delivery being easy to arrange. Still less does a Palo Alto resident have to rely on a local paper for national or international news.

Technological advances have enabled the New York Times and the Wall Street Journal to be printed in California as readily as in New York, and at the same time, so that these became national newspapers, available in communities large and small across America. USA Today achieved the largest circulation in the country with no local origin at all, being printed in numerous communities across the country.

The net result of such widespread availability of newspapers beyond the location of their headquarters has been that many local “monopoly” newspapers had difficulties even surviving financially, in competition with larger regional and national newspapers, much less making any extra profits associated with monopoly. Yet anti-trust policies based on market share statistics among locally headquartered newspapers continued to impose restrictions on mergers of local papers, lest such mergers leave the surviving newspapers with too much “control” of their local market. But the market as defined by the location of a newspaper’s headquarters had become largely irrelevant economically.

An extreme example of how misleading market share statistics can be was the case of a local movie chain that showed 100 percent of all the first-run movies in Las Vegas. It was prosecuted as a monopoly but, by the time the case reached the 9th Circuit Court of Appeals, another movie chain was showing more first-run movies in Las Vegas than the “monopolist” that was being prosecuted. Fortunately, sanity prevailed in this instance. Judge Alex Kozinski of the 9th Circuit Court of Appeals pointed out that the key to monopoly is not market share— even when it is 100 percent— but the ability to keep others out. A company which cannot keep competitors out is not a monopoly, no matter what percentage of the market it may have at a given moment. That is why the Palo Alto Daily News is not a monopoly in any economically meaningful sense, even though it is the only local daily newspaper published in town.

Focusing on market shares at a given moment has also led to a pattern in which the U. S. government has often prosecuted leading firms in an industry just when they were about to lose that leadership. In a world where it is common for particular companies to rise and fall over time, anti-trust lawyers can take years to build a case against a company that is at its peak— and about to head over the hill. A major anti-trust case can take a decade or more to be brought to a final conclusion. Markets often react much more quickly than that against monopolies and cartels, as early twentieth century trusts found when giant retailers like Sears, Montgomery Ward and A & P outflanked them long before the government could make a legal case against them.

“Predatory” Pricing

One of the remarkable theories which has become part of the tradition of anti-trust law is “predatory pricing.” According to this theory, a big company that is out to eliminate its smaller competitors and take over their share of the market will lower its prices to a level that dooms the competitor to unsustainable losses, forcing it out of business when the smaller company’s resources run out. Then, having acquired a monopolistic position, the larger company will raise its prices— not just to the previous level, but to new and higher levels in keeping with its new monopolistic position. Thus, it recoups its losses and enjoys above-normal profits thereafter, at the expense of the consumers, according to the theory of predatory pricing.

One of the most remarkable things about this theory is that those who advocate it seldom even attempt to provide any concrete examples of when this ever actually happened. Perhaps even more remarkable, they have not had to do so, even in courts of law, in anti-trust cases. Nobel Prizewinning economist Gary Becker has said: “I do not know of any documented predatory-pricing case.”{267}

Yet both the A & P grocery chain in the 1940s and the Microsoft Corporation in the 1990s were accused of pursuing such a practice in anti-trust cases, but without a single example of this process having gone to completion. Instead, their current low prices (in the case of A & P) and the inclusion of a free Internet browser in Windows software (in the case of Microsoft) have been interpreted as directed toward that end— though not with having actually achieved it.

Since it is impossible to prove a negative, the accused company cannot disprove that it was pursuing such a goal, and the issue simply becomes a question of whether those who hear the charge choose to believe it.

Predatory pricing is more than just a theory without evidence. It is something that makes little or no economic sense. A company that sustains losses by selling below cost to drive out a competitor is following a very risky strategy. The only thing it can be sure of is losing money initially. Whether it will ever recover enough extra profits to make the gamble pay off in the long run is problematical. Whether it can do so and escape the anti-trust laws as well is even more problematical— and anti-trust laws can lead to millions of dollars in fines and/or the dismemberment of the company. But, even if the would-be predator manages somehow to overcome these formidable problems, it is by no means clear that eliminating all existing competitors will mean eliminating competition.

Even when a rival firm has been forced into bankruptcy, its physical equipment and the skills of the people who once made it viable do not vanish into thin air. A new entrepreneur can come along and acquire both, perhaps at low distress sale prices for both the physical equipment and the unemployed workers, enabling the new competitor to have lower costs than the old— and hence to be a more dangerous competitor, able to afford to charge lower prices or to provide higher quality at the same price.

As an illustration of what can happen, back in 1933 the Washington Post went bankrupt, though not because of predatory pricing. In any event, this bankruptcy did not cause the printing presses, the building, or the reporters to disappear. All were acquired by publisher Eugene Meyer, at a price that was less than one-fifth of what he had bid unsuccessfully for the same newspaper just four years earlier. In the decades that followed, under new ownership and management, the Washington Post grew to become the largest newspaper in the nation’s capital. By the early twenty-first century, the Washington Post had one of the five largest circulations in the country.

Had some competitor driven the paper into bankruptcy by predatory pricing back in 1933, that predatory competitor would have accomplished nothing except to enable the Post to rise again, with Eugene Meyer now having lower production costs than the previous owner— and therefore being a more formidable competitor.

Bankruptcy can eliminate particular owners and managers, but it does not eliminate competition in the form of new people, who can either take over an existing bankrupt enterprise or start their own new business from scratch in the same industry. Destroying a particular competitor— or even all existing competitors— does not mean destroying competition, which can take the form of new firms being formed. In short “predatory pricing” can be an expensive venture, with little prospect of recouping the losses by subsequent monopoly profits. It can hardly be surprising that predatory pricing remains a theory without concrete examples. What is surprising is how seriously that unsubstantiated theory is taken in anti-trust cases.

Benefits and Costs of Anti-Trust Laws

Perhaps the most clearly positive benefit of American anti-trust laws has been a blanket prohibition against collusion to fix prices. This is an automatic violation, subject to heavy penalties, regardless of any justification that might be attempted. Whether this outweighs the various negative effects of other anti-trust laws on competition in the marketplace is another question.

The more stringent anti-monopoly laws in India produced many clearly counterproductive results before these laws were eventually repealed in 1991. Some of India’s leading industrialists were prevented from expanding their highly successful enterprises, lest they exceed an arbitrary financial limit used to define a “monopoly”— regardless of how many competitors that “monopolist” might have. As a result, Indian entrepreneurs often applied their efforts and capital outside of India, providing goods, employment, and taxes in other countries where they were not so restricted. One such Indian entrepreneur, for example, produced fiber in Thailand from pulp bought in Canada and sent this fiber to his factory in Indonesia for converting to yarn. He then exported the yarn to Belgium, where it would be made into carpets.{268}

It is impossible to know how many other Indian businesses invested outside of India because of the restrictions against “monopoly.” What is known is that the repeal of the Monopolies and Restrictive Trade Practices Act in 1991 was followed by an expansion of large-scale enterprises in India, both by Indian entrepreneurs and by foreign entrepreneurs who now found India a better place to establish or expand businesses. What also increased dramatically was the country’s economic growth rate, reducing the number of people in poverty and increasing the Indian government’s ability to help them, because tax revenues rose with the rising economic activity in the country.

Although India’s Monopolies and Restrictive Trade Practices Act was intended to rein in big business, its actual effect was to cushion businesses from the pressures of competition, domestic and international— and the effect of that was to reduce incentives toward efficiency. Looking back on that era, India’s leading industrialist, Ratan Tata of Tata Industries, said of his own huge conglomerate:

 

The group operated in a protected environment. The less-sensitive companies didn’t worry about their competition, didn’t worry about their costs and had not looked at newer technology. Many of them didn’t even look at market shares.{269}

 

In short, cushioned capitalism produced results similar to those under socialism. When India’s economy was later opened up to competition, at home and abroad, it was a shock. Some of the directors of Tata Steel “held their heads in their hands” when they learned that the company now faced an annual loss of $26 million because freight rates had gone up. In the past, they could simply have raised the price of steel accordingly but now, with other steel producers free to compete, local freight charges could not simply be passed on in higher prices to the consumers, without risking bigger losses through a loss of customers to global competitors. Tata Steel had no choice but to either go out of business or change the way they did business. According to Forbes magazine:

 

Tata Steel has spent $2.3 billion closing decrepit factories and modernizing mines, collieries and steelworks as well as building a new blast furnace. . .From 1993 to 2004 productivity skyrocketed from 78 tons of steel per worker per year to 264 tons, thanks to plant upgrades and fewer defects.{270}

 

By 2007, the Wall Street Journal was reporting that Tata Steel’s claim to be the world’s lowest-cost producer of steel had been confirmed by analysts.{271} But none of these adjustments would have been necessary if this and other companies in India had continued to be sheltered from competition under the guise of preventing “monopoly.” India’s steel industry, like its automobile industry and its watch industry, among others, were revolutionized by competition.