No Such Thing as a Free Lunch: Principles of Economics (Part 73)

“What I'm saying to you this morning is that Communism forgets that life is individual. Capitalism forgets that life is social, and the Kingdom of Brotherhood is found neither in the thesis of Communism nor the antithesis of capitalism but in a higher synthesis.”

― Martin Luther King Jr.

Monopolistic Competition and Oligopoly (Part H)

by

Charles Lamson

The Role of Government

Regulation of Mergers

The Clayton Act of 1914 (as mentioned in part 63 of this analysis) had given government the authority to limit mergers that might "substantially lessen competition in an industry." The Celler-Kefauver Act of 1950 enabled the Justice Department to monitor and enforce these provisions.

In 1968, the Justice Department issued its first guidelines designed to reduce uncertainty about the mergers it would find acceptable. The 1968 guidelines were strict. For example, if the largest four firms in an industry controlled 75 percent or more of a market, an acquiring firm with a 15 percent market share would be challenged if it wanted to acquire a firm that controlled as little as an additional 1 percent of the market.

In 1982, the Antitrust Division---in keeping with President Reagan's hands-off policy toward big business---issued a new set of far more lenient guidelines. Revised in 1984, they remain in place today. The 1982/1984 standards are based on a measure of market structure called the Herfindahl-Hirschman Index (HHI). The HHI is calculated by expressing the market share of each firm in the industry as a percentage, squaring these figures, and adding. For example, in an industry in which two firms each control 50 percent of the market, the index is:

Table 5 shows HHI calculations for several hypothetical industries. The Justice Department's courses of action, summarized in Figure 10 are as follows: If the Herfindahl-Hirschman index is less than 1,000, the industry is considered unconcentrated, and any proposed merger will go unchallenged by the justice department. If the index is between 1,000 and 1,800, the department will challenge any merger that would increase the index by over 100 points. Herfindahl indexes above 1,800 mean that the industry is considered concentrated already, and the justice department will challenge any merger that pushes the index up more than 50 points.

In 1992 the Department of Justice and the Federal Trade Commission (FTC) issued joint horizontal merger guidelines updating and expanding the 1984 guidelines. The most interesting part of the new provisions is that the government will examine each potential merger to determine if it enhances the firms' power to engage in "coordinated interaction" with other firms in the industry. The guidelines define "coordinated interaction" as:

actions by a group of firms that are profitable for each of them only as the result of the accommodating reactions of others. This behavior includes tacit or express collision, and may or may not be lawful in and of itself.

 

A Proper Role?

Certainly there is much to guard against in the behavior of large, concentrated industries. Barriers to entry, large size, and product differentiation all lead to market power and to potential inefficiency. Barriers to entry and collusive behavior stop the market from working toward an efficient allocation of resources.

For several reasons, however, economists no longer attack industry concentration with the same fervor they once did. First, the theory of contestable markets shows that even firms in highly concentrated industries can be pushed to produce efficiently under certain market circumstances. Second, the benefits of product differentiation and product competition are real, at least in part. After all, a constant stream of new products and new variations of old products comes to the market almost daily. Third, the effects of concentration on the rate of research and development spending are, at worst, mixed. It is certainly true that large firms do a substantial amount of the total research in the United States. Finally in some industries, substantial economies of scale simply preclude a completely competitive structure. 

In addition to the debate over the desirability of industrial concentration, there is a never-ending debate concerning the role of government in regulating markets. One view is that high levels of concentration lead to an efficiency and that government should act to improve the allocation of resources---to help the market work more efficiently. This logic has been used to justify the laws and other regulations aimed at moderating noncompetitive behavior.

An opposing view holds that the clearest examples of effective barriers to entry are those actually created by governments. this view holds that government regulation in past years has been ultimately anticompetitive and has made the allocation of resources less efficient than it would have been with no government involvement. Those who earn positive profits have an incentive to spend resources to protect themselves and their profits from competitors. This rent-seeking behavior may include using the power of government.

Complicating the debate further there is international competition. Increasingly, firms are faced with competition from foreign firms in domestic markets at the same time that they are competing with other multinational firms for a share of foreign markets. We live in a truly global economy today. Thus, firms that dominate a domestic market may be fierce competitors in the international arena. This has implications for the proper role of government. Some contend that instead of breaking up AT&T, the government should have allowed it to be a bigger, stronger international competitor. We will return to this debate in a future post. 

*CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 300-301* 

end