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Monopoly and Antitrust Policy
(Part F)
by
Charles Lamson
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Remedies for Monopoly: Antitrust Policy
Historically, governments in market economies have assumed two basic and seemingly contradictory roles with respect to imperfectly competitive industries: (1) they promote competition and restrict market power, primarily through antitrust laws, and (2) they restrict competition by regulating industries. The Development of Antitrust Law: Historical Background The period immediately following the Civil War was one of rapid growth and change in the United States. As migrants headed to the open spaces, population swelled in the West as well as in the East. Railroads were built between all major cities. And in 1869 a golden spike driven at Promontory Point, Utah, completed the transcontinental railroad line linking the East with California. Between 1864 and 1874, what was already a substantial rail network doubled in size. At the same time, factories sprang up to accommodate new methods of production. Between 1870 and 1913, the economy grew faster than at any other time in U.S. history. Before the Civil War, most firms had been small and their markets local. The high cost of horse-drawn and water transportation limited access to local markets, and production technologies were efficient only on a small scale. However, the railroads opened up the nation, and the firms began to compete for national markets. Many of the new technologies exhibited economies of scale; real advantages to size in some industries soon became apparent. Communications technology also changed. In 1877, an inventor offered to sell to Western Union, for $100,000, a patent on a new method of sending information over wires. Alexander Graham Bell's asking price was too high for Western Union, and it turned down the offer. Within 10 years, telephone lines operated by Bell companies crisscrossed the country, linking city after city.  As all these forces drew the United States together, the character of the economy changed. Small firms selling to local markets were replaced by large firms selling to regional and national markets. With size came power, and with power came hunger for more power. Competition was fierce and often brutal. The successful exercise of power meant driving competition out of business and controlling markets, and for many firms these became explicit goals. Thousands of smaller firms were gobbled up by big ones. Cartels fixed prices and controlled output. Price-cutting to drive competitors out of business was common. In this climate, the trust flourished. Under these arrangements, shareholders of independent firms agreed to give up their stock in exchange for trust certificates and that entitled them to a share of the trust's common profits. A group of trustees then operated the trust as a monopoly, controlling output and setting price. It was not long before people saw that something was wrong with the system that had emerged. Small independent farmers facing large powerful railroads and declining agricultural prices began to organize. Formed in 1867, the National Grange became a strong pressure group on behalf of farmers against the power of big business. At the same time, life for the laboring classes in the cities and in factory towns was grim, with child labor, long hours, meager wages, and crowded housing in slums. "Big business" was held responsible, and its image was probably best captured in cartoons of grotesquely fat men with big cigars and diamond stickpins crushing workers and farmers underfoot. Perhaps the best-known and most vilified of these "robber barons" was Jay Gould, in manipulating railroad stocks and trying to monopolize the railroad business. In 1881, Gould controlled more miles of railroad track than any other individual or group. While recent research shows that Gould may not have been as evil as most history history books portray him, there is no question that he wielded enormous power (Case & Fair, 2004).  Landmark Antitrust Legislation Even though public sentiment increasingly favored reform, faith in the market and in private enterprise also remained strong. In response to public pressure, Congress began to formulate antitrust legislation. In 1887, it created the Interstate Commerce Commission (ICC) to oversee and correct abuses in the railroad industry; in 1890, it passed the Sherman Act, which declared monopoly and trade restraints illegal. To control monopoly power in general, the Sherman Act turned not to regulation and public enterprise but instead to competition and the market. The Sherman Act of 1890 The real substance of the Sherman Act is contained in two short sections: Section 1. Every contract, combination in the form of trust or otherwise, or conspiracy, and restraint of trade or commerce among the several states, or with foreign nations, is hereby declared to be illegal. . . . Section 2. Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several states, or with foreign nations, shall be deemed guilty of a misdemeanor, and, on conviction thereof, shall be punished by a fine not exceeding $5,000, or by imprisonment not exceeding one year, or by both said punishments, in the discretion of the court. The biggest problem with the Sherman Act lies in its interpretation. Its language seemed to declare monopolistic structure, as well as certain kinds of monopolistic conduct, to be illegal, but it was unclear what specific acts were to be considered "restraint of trade." Competition itself can act as a restraint.  When a statute is unclear, it usually falls to the courts to provide clarification. Unfortunately, the courts only added to the confusion in the early years of antitrust legislation and enforcement. In 1911, two major antitrust cases were brought before the Supreme Court. The two companies involved, Standard Oil and American Tobacco, seemed to epitomize the textbook definition of monopoly, and both appeared to exhibit the structure and the conduct outlawed by the Sherman Act. Standard Oil controlled about 91 percent of the refining industry; and although the exact figure is still disputed, the American Tobacco Trust probably controlled between 75 percent and 90 percent of the market for all tobacco products except cigars (Case & Fair, 2004). Both companies had used tough tactics to swallow up competition or to drive it out of business. Not surprisingly, the Supreme Court found both firms guilty of violating sections 1 and 2 of the Sherman Act and ordered their dissolution. The court made clear, however, that the Sherman Act did not outlaw every action that seemed to restrain trade, only those that were "unreasonable." In enunciating this rule of reason, the court seemed to say that structure alone was not a criterion for unreasonableness. Thus it was possible for a near-monopoly not to violate the Sherman Act as long as it had won its market using "reasonable" tactics. Subsequent cases confirmed that a firm could be convicted of violating the Sherman Act only if it had exhibited unreasonable conduct. Between 1911 and 1920, cases were brought against Eastman Kodak, International Harvester, United Shoe Machinery, and United States Steel. The first three controlled overwhelming shares of their respective markets and the fourth controlled 60 percent of the country's capacity to produce steel. Nevertheless, all cases were dismissed on the grounds that these companies had shown no evidence of "unreasonable conduct." The enunciation of the rule of reason did little to clarify the language of the Sherman Act, and just what explicit acts the court would deem "unreasonable" remained a mystery. The original supporters of the act were upset by the lack of enforcement; business simply wanted to know the rules of the game. In response, Congress went back to the drawing board in 1914 and passed the Clayton Act and the Federal Trade Commission Act.  The Clayton Act and the Federal Trade Commission, 1914 Designed both to strengthen the Sherman Act and to clarify the rule of reason, the Clayton Act of 1914 outlawed a number of specific practices. First, it made tying contracts illegal. Such contracts force a customer to buy one product to obtain another. Second, it limited mergers that would "substantially lessen competition or tend to create a monopoly." Third, it banned price discrimination---charging different customers different prices for reasons other than changes in cost or matching competitors' prices. The Federal Trade Commission (FTC), created by Congress in 1914, was established to investigate "the organization, business conduct, practices, and management" of companies that engage in interstate commerce. At the same time, the act establishing the commission added another vaguely worded prohibition to the books: "unfair methods of competition in commerce are hereby declared unlawful." The determination of what constituted "unfair" behavior was left up to the commission. The FTC was also given the power to issue: "cease and desist orders" where it found behavior in violation of the law. Nonetheless, the legislation of 1914 retained the focus on conduct, and thus the rule-of-reason remained central to all antitrust action in the courts. The Alcoa Case, 1945 The history of antitrust law has been an ongoing struggle between the rule of reason and various actions and outcomes that the courts have declared per se (intrinsic) violations of antitrust law. For example, a per se rule against price fixing evolved over a number of years until 1926, when the Supreme Court held unequivocally that price fixing violates Section 1 of the Sherman Act whether the resulting price is reasonable or not. Prior to 1945, most antitrust law enforcement continued to focus on conduct. In most cases, the rule-of-reason determined whether the conduct was or was not illegal. Even though United States Steel grew large enough to dominate the market for iron and steel, for example, it did not coerce its remaining rivals or conspire to fix prices, and thus it did not engage in unreasonable conduct. As the court said, "The law does not make mere size (italics added) an offense or the existence of an exerted power an offense." In short, the courts decreed it was not illegal to be a benevolent monopoly.  This was the basic position of the Court until 1945, when the rule of reason was challenged in a different way in the landmark Alcoa case. The United States charged the Aluminum Company of America (Alcoa) with violating Section 2 of the Sherman Act by monopolizing the market for newly refined aluminum. At the same time, Alcoa controlled 90 percent of the raw aluminum market. The court did not hold that any specific behavior, or conduct, by which Alcoa achieved it's monopoly position was in itself illegal. It said, in fact, that Alcoa had used "normal prudent, but not predatory business practices. . . . These included building capacity well ahead of demand." Instead, it was the structure of the market itself that led Judge Learned Hand to order the dissolution of Alcoa: No monopolist monopolizes unconscious of what he is doing. So here "Alcoa" meant to keep, and did keep, that complete and exclusive hold upon the ingot market with which it started. That was to "monopolize" that market, however innocently it otherwise proceeded. One other case is worth a brief note here, because it extended the Sherman Act as it was interpreted in the Alcoa case to cover an oligopoly that was acting like a monopoly. In 1946, the United States brought suit against the three largest domestic cigarette producers. The court found no specific evidence of collusion, but did find that the firms had acted as if they were taking account of each other's behavior in setting prices. The case, in essence, extended the law to include tacit collusion as well as explicit conspiracy.  *CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 269-273* end |
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