Antitrust Regulation

Monopoly power (aka “market power” or “pricing power”) is simply the ability to raise prices without losing all customers. The US economy is increasingly dominated by large firms and all medium-to-large firms have some monopoly power. That is one of the reason bigger firms are more profitable than smaller firms, but even most small businesses also have some amount of monopoly power. About the only producers that do not have market power are tiny businesses that sell commodities (like small farmers) and most workers because most working stiffs are “price takers” who have virtually no ability to negotiate their wages nor the prices of the products they buy.  That doesn’t mean that the labor market is perfect competition however, because large employers have some amount of monopsonistic (buyer) power over workers.  Increasing monopsonistic power could explain why wages have not been rising as fast as labor productivity as shown in this graph from the EPI.

No firms larger than about 50 employees are in perfect competition in their output markets either. These markets are better described as monopolistic competition (if not outright monopoly). In monopolistic competition, there are many competing firms, but each firm tries to make their products slightly different from everyone else. For example, Banana Republic and Urban Outfitters are both selling clothing to the same people and are often competing in the same mall, but they work hard to differentiate their products so that they are not selling exactly the same thing. Product differentiation is an easy way for firms to get a little monopoly power. For example, there are over a million different restaurants in the US, but each firm offers slightly different food with different flavors, services, and branding. This product differentiation is what prevents restaurants from suffering from perfect competition in which they couldn’t raise prices on anything because competitors sell perfect substitutes.  There is still competition which means that profits aren’t very high, but without product differentiation, they could not survive at all.  

Monopolistic competition doesn’t allow monopoly profits because consumers can choose close substitutes, but it does create inefficacies because of lower economies of scale and wasteful efforts to differentiate products.  For example, toothpaste manufacturers spend vast amounts of money marketing the hundreds of different varieties of toothpaste that are available in the US in order to get some customers to pay a little higher markup on some of their brands. When firms use their market power to raise prices (and reduce output), it creates a deadweight loss for society unless they are investing their profits in ways that make society better off (such as by increasing productivity) rather than diverting profits for conspicuous consumption.

The inefficiency and unfairness of monopoly power has been recognized in law for thousands of years. It is why it is illegal for “competing” firms to conspire to raise prices such as:

In France, between 1997 and 2004, the top four laundry detergent producers (Proctor & Gamble, Henkel, Unilever, and Colgate-Palmolive) controlled about 90 percent of the French soap market. Officials from the soap firms were meeting secretly, in out-of-the-way, small cafés around Paris. Their goals: Stamp out competition and set prices.

Around the same time, the top five Midwest ice makers (Home City Ice, Lang Ice, Tinley Ice, Sisler’s Dairy, and Products of Ohio) had similar goals in mind when they secretly agreed to divide up the bagged ice market.

Contrary to popular belief, under U.S. laws, a monopoly is not illegal. In fact, the law grants monopolies for patented inventions in order to increase profits to give more incentive for innovation. Similarly, if a firm out-competes rivals by producing better products, that is not illegal. However, a merger that is intended to raise prices (and profits) by reducing competition is illegal because it hurts the economy (both the median income and per-capita GDP decline). But a big problem is defining a market to know whether there is monopoly power or not:

A monopoly is a firm that sells all or nearly all of the goods and services in a given market. But what defines the “market”?

In a famous 1947 case, the federal government accused the DuPont company of having a monopoly in the cellophane market, pointing out that DuPont produced 75% of the cellophane in the United States. DuPont countered that even though it had a 75% market share in cellophane, it had less than a 20% share of the “flexible packaging materials,” which includes all other moisture-proof papers, films, and foils. In 1956, after years of legal appeals, the U.S. Supreme Court held that the broader market definition was more appropriate, and the case against DuPont was dismissed.

…The Greyhound bus company may have a near-monopoly on the market for intercity bus transportation, but it is only a small share of the market for intercity transportation if that market includes private cars, airplanes, and railroad service. DeBeers has a monopoly in diamonds, but it is a much smaller share of the total market for precious gemstones and an even smaller share of the total market for jewelry. A small town in the country may have only one gas station: is this gas station a “monopoly,” or does it compete with gas stations that might be five, 10, or 50 miles away?

OpenStax’s Principles of Economics explains that anti-trust regulators began blocking mergers when the biggest four firms in an industry reached a certain concentration in the market, and later regulations began using the more sophisticated Herfindahl-Hirschman Index. However both measures share some weaknesses:

First, they begin from the assumption that the “market” under discussion is well-defined, and the only question is measuring how sales are divided in that market. Second, they are based on an implicit assumption that competitive conditions across industries are similar enough that a broad measure of concentration in the market is enough to make a decision about the effects of a merger. These assumptions, however, are not always correct. In response to these two problems, the antitrust regulators have been changing their approach in the last decade or two.

Defining a market is often controversial. For example, Microsoft in the early 2000s had a dominant share of the software for computer operating systems. However, in the total market for all computer software and services, including everything from games to scientific programs, the Microsoft share was only about 14% in 2014. A narrowly defined market will tend to make concentration appear higher, while a broadly defined market will tend to make it appear smaller.

There are two especially important shifts affecting how markets are defined in recent decades: one centers on technology and the other centers on globalization. In addition, these two shifts are interconnected. With the vast improvement in communications technologies, including the development of the Internet, a consumer can order books or pet supplies from all over the country or the world. As a result, the degree of competition many local retail businesses face has increased. The same effect may operate even more strongly in markets for business supplies, where so-called “business-to-business” websites can allow buyers and suppliers from anywhere in the world to find each other.

Globalization has changed the boundaries of markets. As recently as the 1970s, it was common for measurements of concentration ratios and HHIs to stop at national borders. Now, many industries find that their competition comes from the global market. A few decades ago, three companies, General Motors, Ford, and Chrysler, dominated the U.S. auto market. By 2014, however, these three firms were making less than half of U.S. auto sales, and facing competition from well-known car manufacturers such as Toyota, Honda, Nissan, Volkswagen, Mitsubishi, and Mazda. When HHIs are calculated with a global perspective, concentration in most major industries—including cars—is lower than in a purely domestic context.

Because attempting to define a particular market can be difficult and controversial, the Federal Trade Commission has begun to look less at market share and more at the data on actual competition between businesses. For example, in February 2007, Whole Foods Market and Wild Oats Market announced that they wished to merge. These were the two largest companies in the market that the government defined as “premium natural and organic supermarket chains.” However, one could also argue that they were two relatively small companies in the broader market for all stores that sell groceries or specialty food products.

Rather than relying on a market definition, the government antitrust regulators looked at detailed evidence on profits and prices for specific stores in different cities, both before and after other competitive stores entered or exited. Based on that evidence, the Federal Trade Commission decided to block the merger. After two years of legal battles, the merger was eventually allowed in 2009 under the conditions that Whole Foods sell off the Wild Oats brand name and a number of individual stores, to preserve competition in certain local markets…

This new approach to antitrust regulation involves detailed analysis of specific markets and companies, instead of defining a market and counting up total sales.

Basically, the new approach since the 1980s has been to try to predict whether a merger will be good for consumers by lowering prices or bad for consumers by raising prices (and reducing the quantity of production) rather than focusing on how much one firm controls a particular market. One problem with the new approach is that it is much more complex than a simple index of market concentration and analysis of theoretical benefits to consumers is more uncertain and thus subjective. Another problem is that the new approach cannot measure the effects of greater concentration of economic power upon politics (more potential for corruption and regulatory capture), wages (greater potential for inequality and an increase in wasteful conspicuous consumption), and innovation (which is suppressed by too much monopoly power). These issues can’t be determined in the short-run analysis of consumer benefits that currently dominate anti-trust analysis because they snowball over decades and are too hard to model. The old model for limiting monopoly power was probably better at preventing these long-run problems.

Anti-trust regulation also bans particular business practices that big firms can use to compete unfairly with smaller rivals and it is hard for giant monopolies to avoid using their power to compete unfairly. This is why monopolies are occasionally broken up. Illegal business practices include:

predatory pricing occurs when the existing firm (or firms) reacts to a new firm by dropping prices very low, until the new firm is driven out of the market, at which point the existing firm raises prices again. This pattern of pricing is aimed at deterring the entry of new firms into the market. But in practice, it can be hard to figure out when pricing should be considered predatory. Say that American Airlines is flying between two cities, and a new airline starts flying between the same two cities, at a lower price. If American Airlines cuts its price to match the new entrant, is this predatory pricing? Or is it just market competition at work? A commonly proposed rule is that if a firm is selling for less than its average variable cost—that is, at a price where it should be shutting down—then there is evidence for predatory pricing. But calculating in the real world what costs are variable and what costs are fixed is often not obvious, either.

…The most famous restrictive practices case of recent years was a series of lawsuits by the U.S. government against Microsoft—lawsuits that were encouraged by some of Microsoft’s competitors. All sides admitted that Microsoft’s Windows program had a near-monopoly position in the market for the software used in general computer operating systems. All sides agreed that the software had many satisfied customers. All sides agreed that the capabilities of computer software that was compatible with Windows—both software produced by Microsoft and that produced by other companies—had expanded dramatically in the 1990s. Having a monopoly or a near-monopoly is not necessarily illegal in and of itself, but in cases where one company controls a great deal of the market, antitrust regulators look at any allegations of restrictive practices with special care.

The antitrust regulators argued that Microsoft had gone beyond profiting from its software innovations and its dominant position in the software market for operating systems, and had tried to use its market power in operating systems software to take over other parts of the software industry. For example, the government argued that Microsoft had engaged in an anticompetitive form of exclusive dealing by threatening computer makers that, if they did not leave another firm’s software off their machines (specifically, Netscape’s Internet browser), then Microsoft would not sell them its operating system software. Microsoft was accused by the government antitrust regulators of tying together its Windows operating system software, where it had a monopoly, with its Internet Explorer browser software, where it did not have a monopoly, and thus using this bundling as an anticompetitive tool. Microsoft was also accused of a form of predatory pricing; namely, giving away certain additional software products for free as part of Windows, as a way of driving out the competition from other makers of software.

In April 2000, a federal court held that Microsoft’s behavior had crossed the line into unfair competition, and recommended that the company be broken into two competing firms. However, that penalty was overturned on appeal, and in November 2002 Microsoft reached a settlement with the government that it would end its restrictive practices.

Although Microsoft was never subjected to much actual anti-trust penalty by the end of the case, the very fact that Microsoft was being investigated from 1992-2002 for anti-trust problems was healthy for competition in the tech industry. For example, without this anti-trust case, it is possible that we would not have Google nor Apple today. The growth of Google depended on an open internet and Microsoft was being investigated for using its control over computer operating systems to control the internet by monopolizing internet browsers. Without any constraints, Microsoft might have crushed the young Google Corporation just like it had crushed many other promising internet startups like Netscape (which was the focus for Microsoft’s anti-trust trial). During the court case, Microsoft had been arguing that they didn’t have a monopoly over personal computers because Apple Computer provided competition by producing a small fraction of the market for computers. Then Apple Corporation filed for bankruptcy! So Microsoft rescued Apple by buying $150m in Apple shares (which had been nearly worthless) and committing to develop key software like Microsoft Office for the Apple operating system, their main “rival.”

So without the anti-trust case motivating Microsoft to rescue Apple, the world would never have gotten the Ipod, Iphone nor any of the other consumer products that Apple subsequently developed.

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Posted in Public Finance

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