Sense and Nonsense About Monopoly
Railing at "monopolists" has always been good populist politics, whether or not there were really any monopolists around. So it was that last year Senator Philip Hart introduced S. 1167, dubbed the Industrial Reorganization Act. Despite being elected by the citizens of Michigan, Sen. Hart manages to consider General Motors a monopoly, and wants the Government to break it up.
Conventional antitrust statutes define monopolization in terms of such things as "restraint of trade" and other allegedly anticompetitive acts that cause harm to others. Not so with Sen. Hart's bill. Frustrated at the difficulty of proving the harm caused by large corporations, Hart's bill would define bigness as badness. It would "make monopoly power a per se violation" of the antitrust laws. And what would constitute "monopoly power"? The bill provides simple numerical formulas, in terms of such factors as industry "concentration ratios" (i.e. the extent to which a large share of a particular market is "concentrated" in the hands of a few companies). Thus, G.M.'s 45 percent share of the U.S. auto market would be defined by the Act as monopoly power, and would be flatly outlawed. A Special Commission and Court would be set up to dismember the offending companies.
In response to this incredible proposal, a number of leading free-market scholars testified before Sen. Hart's Subcommittee on Antitrust and Monopoly. One such figure was Prof. Henry G. Manne, whose testimony forms the basis of this article. Although the major news media gave extensive, enthusiastic coverage to the witnesses favorable to Hart's bill, they totally ignored the testimony of Manne, Harold Demsetz, and other free-market spokesmen. To help redress the balance, REASON is proud to publish Dr. Manne's well-argued case. The article has previously appeared in Barron's (May 20, 1974) and is published here with their permission.
The political and intellectual debate about the cause and effects of corporate size and industrial concentration has continued without resolution for nearly a century now. Apparently we are no closer to agreement today than we were during the murky and confusing debates on the Sherman Act over 85 years ago. The subject still affords a happy hunting ground for anyone seeking simplistic and often sensational solutions to questions of vast complexity.
I should like, therefore, to isolate the few aspects of the industrial organization field on which there may be general professional agreement and address myself primarily to the question of how best to secure greater benefits of industrial competition in relation to what we know and what we do not know.
We may start any logical analysis of this subject by pointing out that a high concentration ratio could signify either that relatively large size firms are efficient or that they have engaged in monopolization of some sort. It should be noted, however, that the efficiency argument does not in any sense mean that only one size of firm is optimal or will survive in a given industry. A competitive industry may well generate firms in a variety of efficient sizes. Further, various combinations of numbers of large and small firms may occur in a competitive industry with all of them operating at high levels of technological efficiency.
But it is essential to understand at the outset a point many economists seem to ignore. There are economies of scale other than the purely technological ones relating to the size of a factory or the output of a given plant. Competitive marketing strategies, management, labor laws, tax rules, safety regulations, communications, and a host of other issues may all lend themselves to economies of scale in firm size, as well as account for varying optimal sizes for firms within an industry. Probably the single most significant nontechnological basis for large size relates to economies in complying with the myriad regulations affecting market contractual arrangements. That is, we have by various market regulations often made it cheaper to handle production through intrafirm arrangements, thus swelling size, than through contracting in the open market. An honest study of these costs, and the resultant effects, seems more overdue than another public debate over size and concentration.
It may not be remiss at this point to compare what we know about political parties to issues in industry. In the completely free political structures allowed by the U.S. Constitution, we have developed only two significant political parties. And one of these, measured by party registrations, is significantly larger than the other. Generally in the last 45 years it has achieved an overwhelming superiority of all votes cast. It would seem, by all of the criteria used by proponents of this bill to judge General Motors Corporation or IBM, that the Democratic Party should forthwith be reorganized into nine, or some other arbitrary number, of smaller, safer, more competitive, more innovative, and less politically powerful organizations. How else, after all, can we expect our system of democracy to survive, competing interests to be recognized, and freedom to prevail?
I am, of course, merely paraphrasing some of the rhetoric used by economists who have previously testified before this Committee. But the analogy is in no sense farfetched, and indeed the specter of only two competing political parties in a nation whose central government has become as powerful as ours, is more frightening to any thoughtful citizen than the vision of 200 large domestic corporations each competing in many ways for the consumers' dollars.
Yet no one with enough influence to be taken seriously has suggested that our political system is evil or that it exhibits monopolistic characteristics that could only be corrected by altering the structure of the parties. Still, it is a sobering thought.
MONOPOLY VS. LARGE SIZE
However, to return to industrial organization, the economic effects of monopoly power are twofold, and indeed the entire logical argument against monopoly, as opposed to large size per se, rests on these arguments. One is that these firms are in a position to realize unwarranted high profits, and the second is that monopoly power causes an allocation of resources to their less efficient uses. Unfortunately the latter point, while it may express the more significant informed concern about monopoly, is not subject to any direct tests of which I am aware, since we do not have any nonmarket standards for determining allocational efficiency. We are forced, therefore, by the nature of the data and techniques available, to limit ourselves to making comparative studies of returns in different industries and firms. And even this must be done with a clear understanding that our statistical and accounting techniques for assembling this data and interpreting it are not terribly reliable.
Nonetheless the studies done to date strongly indicate that there is little or no significant correlation between industrial concentration and corporate profits. To be sure, if one selects a particular year with peculiar characteristics, the figures can be made to appear otherwise, but in general, over a significant period of time, this lack of correlation seems well substantiated.
This is not to say, however, that no firm in a concentrated industry may not be realizing monopoly profits. The studies referred to only indicate that there is no causal relationship between concentration on the one hand and monopoly profit on the other. We are, it appears, as apt to find companies earning a higher than market rate of return in nonconcentrated industries as in concentrated ones.
Indeed, one thing on which there is unequivocal agreement among economists—a rare circumstance indeed—is that monopoly rates of return are realized regularly in some of the least concentrated industries imaginable, those for personal services. Members of the medical profession, many other licensed professionals, and members of strong craft unions in particular all appear to display this characteristic. Again, as with political parties, it is rare to hear of remedial legislation being offered to remedy this clear monopoly problem.
In the industrial sector on the other hand, where remedies for unproved problems abound, monopoly rates of return, when they do occur, seem unlikely to persist for a significant period of time. The reasons for believing this have little to do with the complex econometric industry models and concentration ratios so popular in this computer era.
To begin, unless entry into an industry is actually prevented by law or private coercion, it is highly unlikely that new firms will not enter any industry in which some firms are presently and persistently realizing monopoly profits. The information cannot be hidden for long. In this fashion, as the new firms increase total industry production, they compete down the monopoly profits previously being realized and will frequently be more efficient than the older firms.
This process of competitive entry is so powerful, and so irresistible without government protection, that we need only consider one possible limitation to it as a complete solution to any monopoly problem, real or imagined. There may be substantial nonproduction costs for entering an industry. These would mainly be entry costs associated with government regulations, since any other costs should be considered merely capitalized costs of production applicable to any firm in the industry. To the extent that these artificial entry costs exceed the present discounted value of anticipated net revenues from production and sales, monopoly profits can persist.
In its most extreme form, when entry into an industry is made illegal (as when a certificate of public convenience and necessity cannot be acquired), entry costs become infinite. Then any monopoly returns being realized by firms presently in the industry can be anticipated to continue indefinitely.
But it should be emphasized that merely because the most efficient size for a new firm is large in no sense implies that artificially high returns to existing firms can persist. Start-up costs are simply costs of production and the fact that they are high because the most efficient size plant is relatively large certainly does not imply any monopoly power in the existing firms. There is no difference from an economic point of view in a large capital outlay for plant financed through periodic payments on bonds and equivalent periodic payments made for raw materials in another industry with low start-up costs. Each should be viewed as production costs. Yet some economists erroneously persist in referring to one of these as a "barrier to entry" and the other as a competitive cost.
PRIVATE MONOPOLIES?
The next reason for suggesting that S.1167 addresses itself to a largely imaginary issue is the growing body of evidence that private firms are incapable of perpetuating a monopoly or cartel by private means—though the same evidence also shows that they have frequently made the attempt. Recent historical works have made clear what economic theory had long implied about the perpetuation of monopolies: that it is prohibitively expensive to maintain a monopoly through purely private means. Especially to be recommended is the important work of Professor Ellis Hawley entitled The New Deal and The Problem of Monopoly (Princeton, 1966).
About the only clear case one can imagine of long-term private exaction of monopoly rents are those in which racketeers use physical coercion to restrict competition and prevent entry. Naturally we have no evidence about rates of return in such industries, but since such behavior is clearly illegal, its persistence would reflect largely a failure of law enforcement by governmental authorities rather than any evidence that private monopolization is normally persistent. In any event this type of behavior has not, at least in recent history, characterized any known efforts of large scale private industry in America.
Conventional business firms have much more frequently turned to the State or Federal Government for assistance when their private efforts to monopolize have failed. Competition is after all the most dreaded and threatening process any business firm can confront. Before its power the mighty cringe and giants beg for surcease. And when either the many or an influential few have "demonstrated a need for help," as the cliche has it, our government has long shown its helpful readiness to respond.
In fact, in this function of protecting competitive firms from the harsh rigors of competition, the government has demonstrated a significant comparative advantage over the private sector, apparently because its coercive powers are so much greater. But the reasons avowed for such protective legislation rarely describe honestly the actual motivation of either the industry seeking the protection or the government officials granting it. We are always told that government regulation is adopted to prevent unfair competition, to protect the consumer from shoddy or unsafe products, to avoid monopoly pricing, to prevent fraudulent behavior, to conserve future supplies of goods, to save the environment, or to protect American producers and consumers from a foreign menace. But we are rarely told the extent to which these regulations are encouraged or later supported for anticompetitive reasons. More likely we are treated to homilies about government-business partnerships and the social responsibility of corporations.
But who in politics will openly condemn the anticompetitive effects of the restraints government puts on competition today? Consider just for starters, how much the public would benefit from free entry into transportation or the television broadcasting industry; or from the repeal of tariffs and import quotas; or from a free market price for milk. Yet the suggestion that we repeal these obvious restrictions on competition brings howls of protest from the interests presently protected and a strange silence from some of the same political representatives who express the most concern about the alleged monopolistic practices of big business.
Another reason that industrial monopolies are unlikely to persist in the absence of government protection is that most industrial markets today are in reality international markets. Few significant industrial items today involve such high transportation costs relative to price that the oceans provide a significant natural barrier to competition. This fact alone makes most of the data presently used to describe concentration in American industries almost useless. For instance, it is not uncommon to hear General Motors spoken of as having approximately one-half of the United States' automobile market, with a clear insinuation that this statistic signifies monopoly power.
But the facts do not bear out the insinuation. While General Motors did, until recently, make about half the automobiles sold within the United States and is naturally afforded some benefit over foreign competition by shipping costs, that does not tell us very much, since locational advantages are an important factor in any competitive situation. It would be foolish ever to try to act as if they did not exist. Still General Motors' fraction of free world vehicle production is approximately 22 percent, a figure that even the most ardent GM-baiters would not claim is sufficient to dominate an industry.
No one can honestly believe that the American automobile industry has not been subjected to intense competitive pressures from new entry in recent years. In the period since World War II the total number of corporations offering distinctive styles, sizes, and qualities of automobiles in the American market has risen perhaps five-fold, and the survivors now account for over one-and-a-half million vehicle sales a year. Names like Volkswagen, Datsun, Toyota and Volvo have become more common household words here than DeSoto, Edsel, Hudson or Corvair.
THE CONSPIRACY
These then are some of the reasons the various economic arguments against industrial concentration remain unpersuasive. There is, however, a "political" argument that should also be considered. It is that some corporations are so large that they are able to "control" the government, presumably as it were, to "buy" the protection, the subsidy, the transportation system, the war, or whatever they want from the government. The argument that companies like Standard Oil, du Pont and General Motors run our Federal, State and local governments like dictators is no longer simply a Marxist myth about the American system. It has become common fare for television commentators, journalists, self-styled consumer spokesmen and certain academics, all of whom speak with one voice—and a forked tongue.
Unfortunately the energy utilized in making these assertions is about the only force behind them, and again it does not require complicated empirical studies to show the error, or perhaps the mendacity, behind these assertions. Has the automobile industry, for example, been more successful in Washington than the environmentalists? Have the petroleum companies spent as much money lobbying for protective legislation as has the National Education Association? Has the steel industry received as much bounty from our seemingly universal Federal welfare system as have the elderly, the uneducated, or those stricken with a desire to engage in farming?
One could go on like this almost endlessly. But to ask these rhetorical questions is sufficient to make the point. There is simply no correlation between the concentration ratio in an industry, or the size of its firms, and the effectiveness of the industry in the halls of government. This scare argument about the political power of large corporations is a sham. We all know that the institutions that influence policies in Washington are those that can deliver the votes or utilize their finances to secure votes. And these are the very practices that large corporations are relatively weakest in performing, especially as compared to unions, farmers, consumer organizations, environmentalists, and other large voting blocks. There is even less substance to this political argument about corporate concentration than there is to the economic ones.
Recently Senator Hart stated that "time is running out for those," like himself, "who would like to see competition given a real try in the market place." However, to Senator Hart the reason competition has not been tried lies in what he termed "the evident failure of the existing structure [of industry]." That is, Senator Hart simply defines competition to preclude firms of a certain size, or industries with a certain concentration ratio. Having asserted this definition, Senator Hart has, not illogically, proposed S.1167, the Industrial Reorganization Act, to "make monopoly power a per se violation [of the antitrust laws] and…establish a Special Commission and Court to oversee the restructuring of seven major industrial sectors of the economy." The restructuring would take the form of super-antitrust decrees ordering, among other things, substantial divestitures by firms in affected industries.
Senator Hart has argued in defense of this bill that it would allow the government to intervene "only on a one-shot basis. It would," he continued, "restrict industries where this would not sacrifice efficiencies. Then it would get [the government] out of the market."
NICE TRY, BUT…
I should be the first to congratulate Senator Hart on the statement of this worthy goal of getting the government out of the market. Unfortunately, however, I do not think that the vehicle chosen by Senator Hart will ever carry us to this brave new world. To be successful in this stated aim the following dreams would have to come true: the members of both the Special Commission and the Court established by the Bill would have to be satisfied merely to complete their assigned task and then abdicate their tremendous power and authority; they would have to know now to satisfactorily define and identify the limits of the industries to be restructured; the Government regulation would not sacrifice significant efficiencies or economies of scale; and the incentive for new firms to enter an industry would not be diminished by the threat of a punitive response to success. The lessons of history, economic theory, and practical politics argue overwhelmingly against every one of these assumptions.
No one can seriously believe that a Federal agency that has once tasted the addictive power of dissolving or restructuring the largest industries in America would quietly abdicate its political power when that job was done. Such a group will develop its own political interests, alliances, obligations and claims, and the very absence of concrete, objective economic standards of performance will guarantee that political criteria will prevail in their determinations.
By an iron law of bureaucracy this agency would do all in its power to perpetuate itself and expand its authority. And by a subsection of the same iron law, it would succeed. We have yet to see in the history of American industrial regulation an agency dissolved or liquidated after its initial task was accomplished. I see nothing in the proposed legislation suggesting that it is likely to happen here.
In the same speech Senator Hart alluded to the tremendous amount of resources that the petroleum industry has expended in gaining protection and subsidies from Congress. He is correct, of course, but he seemed to overlook the fact that it takes two to make that bargain. And as we look around at various industries, we are constrained to ask who has not done this. And more to the point, who has not succeeded?
It is unhappily almost impossible to name a significant industry in the United States that has not gained some degree of protection from the rigors of competition from Federal, State, or local governments. It appears, therefore, that the real costs of securing government assistance or protection from competition are not very large, even though the economic costs to the public may be enormous. Whatever the process is by which industries and firms achieve this governmental assistance, we can only be certain that if it were made more difficult or more costly to gain those favors, less of this "political good" would be demanded in the political marketplace.
But the solution to inefficiencies created by government controls cannot lie in still more controls. The politically responsible task ahead for Congress is to dismantle our existing regulatory monster before it strangles us. We have spawned a gigantic bureaucracy whose own political power threatens the democratic legitimacy of government. We are rapidly moving towards the worst features of a centrally planned economy with none of the redeeming political, economic, or ethical features usually claimed for such systems.
It is, as Senator Hart has stated, already late. In fact it may be too late. I have futilely urged the business community itself to stop seeking economic favors from the government. But, as should perhaps be expected by anyone who urges corporate social responsibility, I have gotten nowhere with this argument.
Now with a fearful sense that there may in fact be no one left to listen or to act, I would still urge this Committee to forcefully reject any new regulatory gimmicks and to get down to the much more serious task of freeing American competition from its single most serious opponent, the United States Government.
Henry G. Manne is Distinguished Professor of Law at the University of Miami Law School, and Director of its Center for Studies in Law and Economics. He received a B.A. in economics from Vanderbilt University, after which he studied law at the University of Chicago and Yale Law Schools, receiving his doctorate from the latter. Prior to his University of Miami post, Dr. Manne taught at the law schools of St. Louis University, the University of Wisconsin, and George Washington University. Most recently he was Keenan Professor of Law and Political Science at the University of Rochester. He has published some 65 articles, including "Fighting Back Against Controls" in the April 1974 issue of REASON. His most recent book is Wall Street in Transition, a comprehensive survey of the effects of SEC regulations, just published by NYU Press, and his The Economics of Legal Relationships will appear this spring.