Remembrance of Things Past: Antitrust, Ideology, and the Development of Industrial Economics

• Date: 01 April 2007
• Pages: 25-57
• Published date: 01 April 2007
• DOI: https://doi.org/10.1016/S0573-8555(06)82002-X
• Author: Stephen Martin

CHAPTER 2

Remembrance of Things Past:

Antitrust, Ideology, and

the Development of Industrial Economics

Stephen Martin

Department of Economics, Purdue University,403 West State Street,West Lafayette,

IN 47907-2056, USA

E-mail address: smartin@purdue.edu

Keywords: antitrust, industrial economics, ideology

JEL classifications: B2, L0, L4

Why study the mistakes of the past?

Reaction in a faculty meeting to the suggestion that the Ph.D. program

include a required course on the history of economic thought.1

2.1. Introduction

What it is that economics can, does, or should bring to antitrust is a topic that

turns up fairly often in the literature.2The question of what antitrust has brought

to industrial economics has received less attention, and it is that question to

which I devote myself in this essay.

Stigler (1982, p. 6) has noted the income redistribution consequences of an-

titrust for the economics profession. Such transfers accrue to individual mem-

bers of the profession, and are not my topic. Closer to what I have in mind is

the invaluable role of antitrust as a rich source of raw material for industrial

economists (Coase, quoted in Kitch, 1983, p. 193):

I think you can often learn more about how the economic system works by reading law books

and cases in law books than you can be reading economics books because you do get descrip-

tions of actual business practices which are difficult to explain.

1I owe this heading to an anecdote of my late teacher and onetime colleague WalterAdams.

2See among others Bok (1960),Sullivan (1977),Baxter (1983),Turner et al. (1983) and Rowe

et al. (1984). Let me note here that anonymous referees have suggested that I include in this chapter

a discussion of the impacts of contrasting schools of thought in industrial economics on antitrust.

That is an interesting topic, and one I take up in Martin (2007).

CONTRIBUTIONS TO ECONOMIC ANALYSIS © 2007 ELSEVIER B.V.

VOLUME 282 ISSN: 0573-8555 ALL RIGHTS RESERVED

DOI: 10.1016/S0573-8555(06)82002-X

26 S. Martin

But this raw material is not without its price. I will argue that the antitrust

policy implications that can be drawn from scientific research by industrial

economists have drawn ideological currents into academic debate as moths are

drawn to a flame, and that this phenomenon contributes to explaining a puzzle

that has continued for a period now going on thirty years. This puzzle is the

ability of advocates who favor a minimal role of antitrust enforcement in the

economy to portray their views, to the legal community, as generally accepted

by economists, when this claim is now and has always been manifestly incorrect.

Concerning the current views of the profession, Bolton et al. (2000, p. 2242)

write

A powerful tension has arisen between the foundations of current legal policyand modern eco-

nomic theory. The courts adhere to a static, non-strategic view of predatory pricing, believing

this view to be an economic consensus. This consensus, however,is one most economists no

longer accept.

U.S. courts continue to be heavily influenced by what Posner (2001, p. 194,

fn. 2) terms “orthodox ‘Chicago School’” views toward most strategic behav-

ior, not merely predatory pricing. Bolton et al. are correct that most economists

do not now accept the orthodox Chicago School analysis. Consideration of the

literature suggests that orthodox Chicago School views were never accepted by

mainstream economists.

Of course, scientific validity is not a matter of majority vote, and as John

Bates Clark wrote long ago (1887, p. 45) “Conclusions reached by valid rea-

soning are always as true as the hypotheses from which they are deduced. If we

admit the fact of unlimited competition, we concede in advance many doctrines

which current opinion is now disposed to reject.” Mainstream economists have

never disputed that the policy recommendations of the orthodox Chicago School

follow as a matter of logic from the assumption that observed prices and quanti-

ties can be treated as good approximations to long-run competitive equilibrium

values (see the discussion, below, of Reder, 1982). What has never been ac-

cepted by most industrial economists is that it is appropriate to make this “good

approximation” assumption.

In Section 2.2, I discuss the rise of industrial economics as a branch of mi-

croeconomics. In Section 2.3, I review the rise of the first Chicago School of

industrial economics, which advocated affirmative government action to ob-

tain and maintain good market performance. In Section 2.4, I turn to the rise

of the Second Chicago School, which argued that no such government action

was needed, and that markets could, with few exceptions, be treated as if they

were in long-run perfectly competitive equilibrium (the “good approximation”

assumption). Section 2.5 discusses the oligopoly problem, its role in dislodg-

ing the structure–conduct–performance paradigm by the Second Chicago School

as a source of antitrust advice and in the rise of game theoretic approaches to

the analysis of imperfectly competitive markets by economists. Section 2.6 dis-

cusses the evolution of the Second Chicago School in the face of the evident

failure of mainstream economists to accept the good approximation assumption.

Remembrance of Things Past 27

Section 2.7 concludes with a few remarks on ideology and its impact on indus-

trial economics.

2.2. Early development of industrial economics 3

2.2.1. Origins

Industrial economics is generally said to have emerged as a distinct branch of mi-

croeconomics with Edward S. Mason’s Harvardseminar of the 1930s (Markham

and Papanek, 1970, pp. vii–viii), but the topics that occupy industrial economists

have concerned economists since before the emergence of political economy as

a distinct branch of the social sciences in 1776.

Policy questions that remain at the heart of industrial organization were the

subject of widespread academic and popular debate in the United States be-

tween 1880 and 1900, a debate that continued at only a slightly less intense

level between 1900 and 1920. Seven of the first 10 presidents of the Ameri-

can Economic Association played active roles in this debate.4Marshall’s 1919

Industry and Trade made international comparisons in industrial organization

and drew conclusions for economic development. Like the bourgeois gentleman

who spoke prose without realizing it, economists who studied “railway prob-

lems” (Ripley, 1907) or “trust and corporation problems” (Burns, 1937, p. 663)

studied industrial economics in everything but name.

But they did so using analytical tools that seemed to them to be ill-suited to

the task. The mainstream price theory of the early twentieth century consisted of

a theory of competitive markets and a theory of monopoly,with a vast wasteland

in between.5This theory of competitive markets was not the modern model of

perfect competition, but its Marshallian predecessor. To classify a market as

competitive in this sense required only that it (Andrews, 1951 , p. 141) “would

be possible for other businesses to produce a commodity with the same technical

specifications as the product of any particular firm, and to offer it for sale to that

firm’s customers.” If this condition were met (Andrews, 1951, pp. 141–142),

“the possibility of entry of other producers would ensure that long-run price

would be equal to the normal average cost of production.”

Economists of the period were aware of the disconnect between the implica-

tions of this theory of competitive markets and the industrial world around them

(Marshall, 1925 [written in 1890], p. 268):

3For discussions of the development of the field of industrial economics, see Bain (1949a,

pp. 129–133),E.T. Grether (1970),Phillips and Stevenson (1974),David Dale Martin (1976),Hay

and Morris (1979),Schmalensee (1982a, 1982b, 1987, 1988),Davies and Lyons (1989),Bonanno

and Brandolini (1990), and, from a perspective of legalscholarship, Hovenkamp (1991, Chapter 22).

4These are Francis A. Walker, John Bates Clark, Henry C. Adams, Arthur T. Hadley, Richard T.

Ely, Edwin R.A. Seligman, and Jeremiah W. Jenks. The works of two others (Tassig and Patten)on

tariff policy touched upon topics that would now be classified in industrial economics.

5Schumpeter (1934, p. 249);Bain (1944, p. 4);Stigler (1949, p. 12);Andrews (1951, p. 141; 1952,

p. 72);Schneider (1967, p. 139).