The Rhetoric of Antitrust

Dr. DiLorenzo is Visiting Professor of American Business at the Center for the Study of American Business at Washington University in St. Louis. He is on leave from George Mason University.

In theory antitrust regulation promotes competition in the marketplace but in reality its results are often anticompetitive. It is routinely used by businesses having problems competing as a tool to keep their competitors from cutting prices, expanding production; and differentiating their products. In short, the conventional view that antitrust regulation is in the “public interest” is a myth. The rhetoric of antitrust is almost always emotional, but rarely logical. And emotion all too often dominates logic in matters of public policy.

One early example of antitrust rhetoric that was clearly harmful to competition was the charge by Judge Learned Hand in the 1945 case, United States v. Aluminum Company of America, that Alcoa violated the antitrust laws because of its practice of “exclusion.” The judge explained Alcoa’s guilt as follows: “We can think of no more effective exclusion [of competitors] than progressively to embrace each new opportunity as it opened, and to face every newcomer with new capacity already geared into a great organization having the advantage of experience, trade connections, and the elite of personnel.”[1] By putting together a “great organization” whose products consumers voluntarily chose over others, Alcoa was found guilty of “anticompetitive” behavior. There are literally hundreds of examples of this type of “reasoning,” which has been called antitrust upside down.[2]

Although there have been some exceptions, things apparently haven’t changed significantly over the past forty years. Antitrust rhetoric continues to defy logic.

As one example, in 1985 the city of Long Beach, California filed a $350 million civil suit against six oil companies, accusing them of “conspiring to depress the price of crude oil pumped from city tidelands in violation of state antitrust laws.”[3] The suit accuses the companies of “posting prices at unreasonably low and noncompetitive levels below fair market value,” and of engaging in “reciprocal exchanges, swaps and buy-sells . . . designed to . . . eliminate . . . price competition of the marketplace.” This is par for the antitrust course: lawsuits alleging that consumers are being harmed by lower prices.

The reality of this suit is that consumers would be harmed by higher energy prices; but Long Beach political authorities must feel that such harm is justified if the city government can bring in more revenue (the rental fee for the tidelands is based on the market value of the oil pumped from them). Thus, the suit alleges that by dropping their prices the companies cost the city at least $350 million in foregone revenues and seeks treble damages.

Although forty years apart, these cases have at least two things in common: 1) They contain rhetoric that is misleading, incomprehensible, or even insulting; and 2) the rhetoric is used to rationalize policies that impede competitive behavior and raise prices, all in the name of protecting consumers.

Such rhetoric appears to be the rule rather than the exception. Let us examine a few of the more common abuses that have become widely accepted and have helped establish the myth of antitrust.

Antitrust Rhetoric Versus Reality

Antitrust regulation has always been concerned with corporate mergers. An entire vocabulary has developed as a means of criticizing them.

The domino effect. Corporate mergers are often opposed on the grounds that they sometimes lead to a “domino effect.” That is, a successful merger spawns other mergers with the ultimate effect being a reduction in the number of firms in an industry and weaker competition. This is one reason why “merger waves,” which have occurred periodically since the late 19th century, have been so widely criticized. According to this line of reasoning, an appropriate public policy is to nip the problem in the bud—to legally prohibit the first merger from taking place—rather than allowing an industry to become monopolized and then, after the fact, seeking a remedy such as divestiture.

This is an appealing and popular theory, but upon close examination it suffers from a number of fatal problems. First, the mere number of business firms in an industry does not necessarily have anything to do with monopoly power. Research over the past two decades has shown that industrial concentration is most often caused by superior efficiency on the part of one or a few firms in an industry, not monopoly.[4] Laws and regulations that prohibit mergers, therefore, have meant the sacrifice of efficiency and lower prices.

Big business is not necessarily bad, for substitute goods, international competition, and potential competition all limit the ability of an unregulated firm to charge monopoly prices, For example, even though the domestic automobile industry is composed of only a few firms, who would seriously accuse it of monopolizing its markets in light of fierce international competition?

A second’ problem with the domino theory is that the root cause of many merger waves isefficiency: one efficiency-enhancing merger encourages others. If one merger allows the newly- restructured firm to become more efficient due to economies of scale, for instance, other firms must follow suit to remain competitive.

A third problem is that the domino theory assumes that judges, regulators, economists, or politicians know something they cannot possibly know: the most efficient organization of an industry. That is, they presume to know whether three firms, thirteen firms, or thirty firms is the most “appropriate” number and to possess knowledge of the most efficient scale of each firm.

This knowledge can only be gleaned, however, by trial and error in the marketplace. Firms are constantly changing their size, structure, and methods of operation in order to discover the most cost-effective (and therefore profitable) procedures.

To legally ban a merger on the grounds that it would lead to a “nonoptimal” organization of industry is pretentious. To make such an argument is to claim to know what can only be discovered by allowing the merger (and the entire market process) to take place. Such pretentiousness is at the heart of the U.S. Justice Department’s arbitrarily-drawn “merger guidelines,” whereby it threatens to legally block any merger that might result in any one firm making a certain (arbitrarily-chosen) share of market sales.

Foreclosure. One economist recently complained that by not challenging enough vertical mergers the Reagan administration was “discouraging competition” by “gutting the antitrust statutes.”[5] This view reflects the conventional wisdom regarding vertical mergers, which occur when a manufacturer merges with a raw material supplier or a distributor. Such mergers have often been banned by antitrust authorities because purchasing a raw material supplier would allegedly “foreclose” rivals (of the manufacturer) from the raw materials. To merge with a retailer is viewed as equally evil, for it purportedly cuts off competitors from channels of distribution.

The absurdity of this reasoning is the assumption that increased purchases of raw materials by one business means there is less (or none) for others. Economic activity, in other words, is a zero-sum game according to this view. But as long as there is a demand for the raw materials someone will supply them to whoever wants them. Consider the example of a steel manufacturer that purchases a coal company. It will profit by having its own easily-accessible coal supply as well as by selling coal to others, including its rivals. After all, if it doesn’t sell the coal, someone else will. It is not clear why vertically-integrated steel manufacturers or other coal producers should be expected to turn their backs on profit opportunities. Whenever there is a vertical merger nothing would prevent other coal companies from doing additional business, so that no one is “foreclosed” from anything.

What about a manufacturer that merges with a distributor? This sometimes occurs because it is cheaper for some businesses to retail their goods through their own subsidiaries rather than independent distributors. It also gives the manufacturer more control over marketing strategies and procedures. This might “foreclose” other firms from using that particular distributor, but so what? Nothing is stopping them from integrating.

When a corporation runs to the antitrust authorities and requests that they block a vertical merger by a competitor it is a sure sign that the merger would permit lower prices or better product distribution. After all, if such mergers really were anticompetitive and caused higher prices one would hardly expect to observe competitors bringing antitrust suits. They would either be pleased that their competitor is raising his prices or would happily raise their own prices as well.

Squeezing. Vertical mergers between, say, a steel producer and a coal mine are sometimes objected to on the basis that nonintegrated steel producers are allegedly “squeezed” between (their own) higher coal costs and lower steel prices charged by the integrated producer. This is said to create a monopoly.

The problem with this argument is that there is nothing stopping any other steel producer from becoming vertically integrated if that is what it takes to become more efficient. More-over, if “squeezing” causes lower costs and prices, what’s wrong with that?

Antitrust complaints of squeezing are typically made by businesses who prefer not to compete by cutting costs and dropping prices. This charge is especially specious in industries where there are many firms, close substitute goods, and international competition. The steel industry is a good example.[6]

Price discrimination. Section 2 of the Clayton Antitrust Act outlaws price discrimination, or charging different prices for goods “of like grade and quality” in different geographical markets if the effect is “to substantially lessen competition.” Regulated or government-owned monopolies such as public utilities have long engaged in this practice as a way of exercising their government-sanctioned monopoly power. The Clayton Act does not apply to these obvious monopolies but has been used to regulate the pricing practices of private businesses in markets where monopoly power is much less obvious, if not nonexistent. Even though price discrimination is, in theory, a means of exercising monopoly power, not obtaining it, in practice the enforcement of the doctrine is used as a regulatory tool against businesses where there is no good reason to suspect monopoly power to even exist.

The Clayton Act is a lawyer’s dream, for it is left up to the courts to decide whether products are of “like grade and quality.” This is inherently difficult, however, for consumers may view the quality of each item differently, depending on their own subjective preferences. For instance, even if two commodities are physically identical people may assign different quality levels to them because of the commodity’s association with a popular brand name. It is not clear that such differences can legitimately be ignored. In the minds of consumers the products would not be identical. In short, deciding what constitutes “like grade and quality” is not as easy as it seems, even for items which can be graded chemically or by other physical means.

The Clayton Act does allow for price cutting in one geographical market if the price reduction occurs because of cost reductions or follows “in good faith” the price reduction of a

competitor. The problem, however, is that if one’s competitor initiates the price cutting, the competitor can be sued for price discrimination if the price cut was not “in good faith.” Furthermore, a seller has no sure way of knowing that his competitor’s price cut was in good faith without access to the competitor’s cost data. A seller does not know whether the price reduction be is about to meet is itself legal. Meeting an illegal discount has been ruled illegal.[7]

Thus, if one initiates price cutting one can be sued for violating the Clayton Act; if one raises a price in one geographical market there is also the possibility of being sued; ordinary competitive practices like quantity discounts are sometimes ruled out;[8] and if prices are held constant in all markets it is possible a price-fixing conspiracy case can be brought. No matter what a businessman does with his pricing policies he can be dragged into court for violating the Clayton Act. In the name of competition, “good faith,” and “consumer protection” this act impairs price competition. It is only because of modest enforcement levels that the law hasn’t eliminated more price competition.

Predatory pricing. This is where a business is said to have a “war chest” of monopoly profits that it falls back on while pricing its product below cost temporarily in order to drive its competitors out of the market. However, economists have had a difficult time documenting such episodes,[9] and in theory it would appear to be unwise for any businessman to try to monopolize a market in this way. Even if a gas station owner, for instance, drove the station across the street out of business there is nothing preventing consumers from avoiding “monopoly” prices by going elsewhere. Moreover, if a “local monopoly” is established the monopoly profit would quickly attract new businesses, eventually eliminating any above-normal profits. There is also the possibility that a competitor will only temporarily shut down during the price-cutting period and then go back on the market when the higher prices are charged, thereby denying the “predator” any long-term gain. In short, predatory pricing guarantees a short-term loss of money, while the prospects of ever making long-term monopoly profits are bleak at best.

Furthermore, the reasoning behind the predatory pricing theory appears logically inconsistent. It assumes a “war chest” of monopoly profits to already exist which is used to finance the practice of temporarily pricing below cost. But how are the monopoly profits generated if the monopoly is supposedly created and main-ruined in the first place by predatory pricing?

The notion of predatory pricing has spawned endless litigation, and many of the subsequent judgments have been arbitrary, subjective, and damaging to competition. The problem is that if company A brings an antitrust complaint against company B it is known with certainty that, up to that point, consumers have benefited from company B’s price cuts (and company A’s as well if it followed suit). But for a court to deem such price cutting as “predatory” requires knowledge by the court of company B’s intent. Did it cut price just to compete, or is it acting as a predator? This is impossible to know with certainty. Despite all these problems, predatory pricing has become part of the antitrust folklore. And the problems are empirical as well as theoretical. In the first (and probably most famous) predatory pricing case, Standard Oil of Indiana, operated by John D. Rockefeller, was found guilty of monopolizing the petroleum market through predatory pricing, among other means. However, John McGee[10] has shown that no evidence was ever even submitted to the courts that Rockefeller even attempted it.

Concluding Thoughts

Much of the rhetoric of antitrust cannot withstand close scrutiny. Nevertheless, it has been employed for the past 95 years to rationalize policies that are increasingly recognized as counterproductive. This should have been expected, for even the rhetoric spoken during the Congressional debates over the first Federal antitrust law, the Sherman Act of 1890, reflect specious arguments. Contrary to the standard account of the origins of antitrust, the 19th-century trusts were cutting prices and expanding production rapidly.[11] But the Act’s sponsor, Senator John Sherman, attacked them because he felt that such price cutting interfered with the government’s protectionist trade policies. “The trusts have subverted the tariff system; they undermined the policy of government to protect . . . American industries by levying duties on imported goods.”[12] Congressman William Mason, who played an important part in the House debates over the Sherman Act, condemned the trusts because even though they “made products cheaper,” they “destroyed legitimate competition and have driven honest men from legitimate business enterprises.”[13] This is classic antitrust doubletalk: cutting prices is “bad” because it “destroys competition.” Price cutting is, of course, the essence of competition and its chief benefit to consumers.

In short, we need to be more skeptical of antitrust rhetoric. A current example of the potential for emotive rhetoric to dominate discussion of the dangers of big business is the emerging public policy discussion about corporate takeovers. Just consider some of the rhetoric involved: raiders, poison pills, sharks, shark repellent, white knights, golden parachutes, greenmail, and so on. Such rhetoric tends to overshadow the real issues of consumer and stockholder welfare with arguments that often cannot be supported by either logic or factual information.

In summary, it is instructive to recall what economist Alan Greenspan said of antitrust more than twenty-five years ago:

The world of antitrust is reminiscent of Alice’s Wonderland: everything seemingly is, yet apparently isn’t, simultaneously. It is a world in which competition is lauded as the basic axiom and guiding principle, yet “too much” competition is condemned as “cutthroat.” It is a world in which actions de-signed to limit competition are branded as criminal when taken by businessmen, yet praised as “enlightened” when initiated by the government. It is a world in which the law is so vague that businessmen have no way of knowing whether specific actions will be declared illegal until they hear the judge’s verdict—after the fact. In view of the confusion, contradictions, and legalistic hairsplitting which characterize the realm of antitrust, I submit that the entire antitrust system must be opened for review.[14]

It is high time we followed this advice.

1.   United States v. Aluminum Company of America, 148 F.2d 416 (2nd Cir. 1945), p. 431.

2.   See Dominick Armentano, Antitrust and Monopoly: Anatomy of a Policy Failure (New York: Wiley, 1982).

3.   “California City Files Suit Against Oil Firms,” Washington Post, March 5, 1985. p. D-2.

4.   Such evidence is contained in H. Goldschmid, H. Mann, and F. Weston, eds. Industrial Concentration: The New Learning (Boston: Little, Brown, 1974); and Brozen, Concentration. Mergers and Public Policy (New York: Macmillan, 1982)•

5.   Willard F. Mueller, “Toward Greater Economic Concentration,” St. Louis Post-Dispatch. August 5, 1986, p. 3-B.

6.   For a discussion of such cases see Eugene Singer, Antitrust Economics (Englewood Cliffs, N.J.: Prentice Hall, 1968).

7.   Federal Trade Commission v. A. E. Staley Manufacturing Co. et al., 324 U.S. 746 (1945).

8.   In a case in which the Federal Trade Commission accused the Morton Salt Company of price discrimination on the basis of volume discounts, the FTC argued that such practices harmed cer tain wholesalers (who did not receive the discounts) since they “must either sell at competitive prices and in so doing reduce their possible profits . . . or attempt to sell at higher prices. . . .” See Federal Trade Commission v. Morton Salt Company, 334 U.S. (1940), p. 43.

9.   See John McGee, “Predatory Pricing Revisited,” Journal of Law and Economics. April 1981.

10.   John McGee, “Predatory Pricing: The Standard Oil (N.J.) Case,” Journal of Law and Economics, April 1958.

11.   Thomas J. DiLorenzo, “The Origins of Antitrust: An Interest-Group Perspective,” International Review of Law and Economics, vol. 5, 1985, pp. 73-90.

12.   Congressional Record, 51st Congress, 1st Session, Senate, June 20, 1890, p. 4100.

13.   Congressional Record, 51st Congress, 1st Session, House, June 20, 1890, p. 2558.