OLIGOPOLY COORDINATION, ECONOMIC ANALYSIS, AND THE PROPHYLACTIC ROLE OF HORIZONTAL MERGER ENFORCEMENT.
Date | 01 June 2020 |
Author | Baker, Jonathan B. |
INTRODUCTION 1986 I. THE PROBLEM OF COORDINATED OLIGOPOLY CONDUCT 1991 A. Empirical, Experimental, and Real-World Evidence 1992 B. Economic Theory 1996 C. Summary 2001 II. THE DUBIOUS ARGUMENT FOR SKEPTICISM ABOUT OLIGOPOLY COORDINATION 2002 III. IMPLICATIONS FOR ANTITRUST MERGER ENFORCEMENT 2007 A. Coordinated Effects Involving Purposive Strategic Conduct 2009 B. Coordinated Effects Involving Nonpurposive Strategic Conduct 2012 1. Reinforcing Reactions 2013 2. Diluting Reactions 2014 3. Concluding Comments on the Coordinated Effects of Mergers 2016 CONCLUSION 2017 INTRODUCTION
For decades, the major United States airlines have raised passenger fares through coordinated fare-setting when their route networks overlap, according to the United States Department of Justice. Through its review of company documents and testimony, the Justice Department found that when major airlines have overlapping route networks, they respond to rivals' price changes across multiple routes and thereby discourage competition from their rivals. (1) A recent empirical study reached a similar conclusion: It found that fares have increased for this reason on more than 1000 routes nationwide and even that American and Delta, two airlines with substantial route overlaps, have come close to cooperating perfectly on routes they both serve. (2)
Airlines are not the only major industry in which the major firms reach coordinated outcomes in oligopoly markets (that is, markets in which a small number of firms are significant rivals), leading to higher prices and other harms to buyers. (3) A recent empirical study found that the 2008 joint venture between Miller and Coors allowed the major brewers to coordinate to reduce competition between themselves, thereby increasing the price of beer by an estimated six to eight percent. (4) They plausibly achieved the higher prices through leader-follower pricing. (5)
One possible interpretation of the price increase is that the airlines and brewers engaged in explicit price-fixing or market division--collusive conduct that would violate Section 1 of the Sherman Act and would likely be criminally prosecuted by the Department of Justice if uncovered. That possibility would suggest that express cartels--those operating under explicit agreements--often go undetected and undeterred, consistent with what empirical studies have found. (6) Another interpretation of such evidence, which is also plausible and, we suspect, more likely, is that oligopoly conduct can often lead to coordinated outcomes that restrict competition without firms expressly colluding on an agreement that would violate Section 1 of the Sherman Act. (7) They might achieve those coordinated outcomes purposively, by identifying consensus terms of coordination and deterring cheating, or arrive at those outcomes simply as a consequence of recognizing their interdependence and anticipating the natural and predictable reactions of their rivals to their price changes.
Whether arrived at purposively or not, these examples of coordinated conduct suggest that the possibility of coordination among oligopolists is not effectively prevented by the prospect of Sherman Act liability. (8) This theme contrasts with suggestions by antitrust commentators and courts influenced by the Chicago school: that oligopolies usually perform competitively absent express collusion, and that express collusion itself is difficult and therefore rare. (9) As we describe below, the economics literature does not support those Chicago claims.
In brief summary of economic concepts that we will explain more fully below, (10) we define coordinated oligopoly outcomes as price elevation (11) arising from strategic conduct. We say that a firm acts strategically when in setting prices, the firm takes into account how it expects that its rivals will respond--as one would expect firms to do when those responses would be strong and likely to matter to buyers. (12) In short, when high prices persist because firms are discouraged from cutting price by the anticipated responses of their rivals, we term the outcome coordinated. (13)
We term the outcome coordinated regardless of how those anticipated responses arise. (14) Our point is the breadth of this category, not the creation of new dichotomies, but we nevertheless distinguish two types of responses. When firms act on the expectation that rivals will punish cheating on a common understanding in order to sustain and implement that understanding, we call the strategic conduct "purposive." (15) In other cases, the strategic conduct is "nonpurposive." We use the latter term when firms respond to one another's price changes in a natural and predictable business way, rather than as a part of a scheme or attempt to develop a consensus or deter price-cutting. As Donald Turner explained nearly six decades ago, a rational oligopolist understands that its rivals will "inevitably react" when it cuts prices "because otherwise the price cut will make a substantial inroad on their sales." (16) That rivals will "inevitably react" can lead to coordinated outcomes even when firms do not seek to develop a common understanding or punish cheating. We view the distinction between purposive and nonpurposive conduct as suggestive and useful, but not as setting forth an analytically watertight classification scheme. (17) Indeed, these two forms of strategic conduct can coexist, (18) and there undoubtedly are gray areas.
The previously referenced studies of airlines and brewing found that firms reached coordinated outcomes but did not seek to distinguish between purposive and nonpurposive conduct. Either type of strategic conduct could result in price leadership (brewing) or be facilitated by greater multimarket contact (airlines). (19) It is nonetheless important for antitrust enforcement to be alert for risks both of purposive and of nonpurposive strategic conduct. Because so much recent antitrust discussion has focused on coordinated outcomes arising from purposive conduct, distinguishing between the two forms--even while recognizing that some strategic conduct is hard to classify--is helpful in drawing proper attention to nonpurposive coordination, and, relatedly, in understanding why antitrust commentators and courts influenced by the Chicago school wrongly dismiss the latter possibility. Distinguishing the two types of strategic conduct also facilitates a detailed economic analysis of the competitive effects of firm conduct, as we illustrate below with respect to evaluating the coordinated effects of horizontal mergers.
As has long been recognized, the difficulty of attacking express cartels and the Sherman Act's circumscribed coverage of other forms of coordination (20) gives horizontal merger enforcement an important prophylactic role: it increases the importance of preventing changes in market structure through a horizontal merger that would make coordinated outcomes more likely or more effective. (21) The Clayton Act focuses on whether a horizontal merger will harm competition, including by making coordination more likely or more effective, regardless of whether the coordination would independently violate the Sherman Act. For this reason, we look to merger enforcement when discussing the implications of our analysis for antitrust. (22)
Although we explore a more detailed and nuanced economic analysis, one important conclusion is straightforward: whether through purposive or nonpurposive conduct, greater concentration can be expected to make coordination more likely, stronger, or more effective. Accordingly, our analysis supports a structural merger policy, by which mergers between rivals that increase concentration significantly in a concentrated market are presumed to harm competition.
In Part I of our Article, we explain why coordinated conduct is a serious concern. We explain in Part II why we disagree with the Chicago views that such conduct is unlikely absent express collusion and that express collusion itself is uncommon. Part III explains how our analysis of coordination should apply to merger enforcement.
THE PROBLEM OF COORDINATED OLIGOPOLY CONDUCT
Modern economics offers many reasons to think that coordinated outcomes may arise and persist in oligopoly markets. We begin with empirical, experimental, and real-world evidence, then review the relevant economic theory.
Empirical, Experimental, and Real-World Evidence
The relevant empirical literature extends beyond the previously discussed studies of airlines and brewing. (23) Studies have found that through strategic conduct leading to coordinated outcomes, prices of cellular telephone services increased between seven and ten percent; and prices for hospital services offered by multi-hospital systems increased between six and seven percent. (24) In one urban retail gasoline market, dominant firms engaged in price leadership to establish, after many years of trying, coordinated prices as high as fifteen percent above those that would otherwise have prevailed without coordination. (25)
Empirical studies have also found that express cartels--one type of purposive coordination--are durable. According to one study, the average cartel lasted approximately eight years, even though many cartels in the sample were terminated by antitrust enforcement. (26) Some cartels have survived more than forty years. (27) These results indicate that coordinated outcomes, once attained, can readily be sustained.
Economists have identified a wide range of factors thought to facilitate coordination. One typical list includes: a small number of firms, simple or homogenous products, open and transparent transactions, excess capacity in the hands of rivals, predictable demand, small and frequent transactions, small buyers, inelastic market demand, low marginal costs relative to price, and high customer switching costs. (28) The experimental economics literature supports many of these predictions--and, in...
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