A review of the economic basis for broad-based horizontal-merger policy

• Author: Paul A. Pautler
• DOI: 10.1177/0003603X8302800302
• Date: 01 September 1983
• Published date: 01 September 1983
• Subject Matter: Article

The Antitrust Bulletin/Fall 1983

A review

of

the economic basis for

broad-based horizontal-merger policy

BY PAUL A. PAUTLER*

I.

Introduction

571

The eminently believable notion that the concentration

of

pro-

ductive capacity in fewer and fewer hands in a given market will

often lead to higher prices and lower output has been standard

fare for students

of

economics for decades. This concern about

market concentration is evidenced by the large amount

of

re-

search devoted to the theoretical study

of

competition among few

competitors and empirical studies

of

the effects

of

market con-

centration on welfare, prices, and profitability. During the last

decade, however, the basis for this fear

of

concentration has been

attacked by those who argue that increased concentration will

most often lead to (or is the result of) efficient production, lower

costs, and lower prices.

In this article, we attempt to chronicle the debate over the

effects

of

concentration on market performance. In the process

we compare the state

of

our current economic knowledge with

that which existed in 1968. That year was chosen because at that

point the Justice Department's Antitrust Division felt secure

enough in its knowledge

of

the effects

of

market structure on

market performance to issue market-share/concentration-ratio

guidelines for horizontal mergers.' What we find in our review is

The author is an economist with the Federal Trade Commission.

IThe Justice Department offered both horizontal- and vertical-

merger guidelines in 1968. We will be concerned only with horizontal

problems.

©1984by Federal Legal Publications. Inc.

572 The antitrust bulletin

an interesting, and as yet incomplete, metamorphosis in economic

thought over the past few decades. Old ideas are slowly being

modified and new interpretations are being given to classic works

in industrial organization. While it is too soon to say what

ultimate impact the debate over the market-concentration doc-

trine might have, it is already clear that challenges to the tradi-

tional view have altered the consensus from what it was in

1968

and that these challenges have important implications for future

changes in public

policy.

This article is organized as follows: first, the basic concepts of

oligopoly theory that form the foundation for the traditional

view that market concentration can lead to poor economic per-

formance are discussed very briefly. Second, much of the empiri-

cal evidence available on the welfare costs of monopoly and

administered pricing is evaluated to obtain a rough estimate of

the magnitude of the market-power problem and to determine

whether that literature provides a sound basis for broad-based

horizontal-merger guidelines.' Third, a large portion of the litera-

ture on the relationship between concentration and profitability

(or prices) is examined, to answer two

questions-what

was the

economic consensus in

1968,

when the Justice Department merger

guidelines were promulgated; and what is the current state of our

knowledge? The latter question is answered by an examination of

a stylized debate between the "traditionalists" (who believe that

2We will not discuss some other possible bases for broad-based

antitrust action. For instance, the relationships among market structure

and technological progressiveness, political power, and worker aliena-

tion might be used to defend antitrust initiatives. See "The Economics

of Firm Size, Market Structure, and Social Performance," ed. J.

Siegfried (Washington, D.C.: Federal Trade Commission,

1980).

In

addition, case studies of actual mergers might be used to justify market

intervention. We will not discuss the latter literature, however, since it

tends to deal with conglomerate (as opposed to horizontal) mergers and

because it does not lend itself to useful general conclusions. See A.

Fisher and R. Lande, "Efficiency Considerations in Merger Enforce-

ment," 71 California Law Review (forthcoming December

1983);

and F.

M. Scherer, Industrial Market Structure and Economic Performance

(Chicago: Rand McNally,

1980),

pp.

128-41.

Horizontal-merger policy :573

market

concentration

often

leads to

monopoly

power)

and

the

"revisionists" (who

argue

that

market

concentration

is generally

due

to

efficiency considerations). Finally, assuming

the

tradi-

tional

view

to

be correct,

the

literature

on

"critical"

concentra-

tion

or

market-share

levels is examined, to gain insight

into

possible revisions

of

horizontal-merger policy. While

our

review

of

the

literature does

not

lead to a

statement

of

aconsensus view,

it does show

the

evolution

of

thought

and

evidence

on

the

structure/performance

paradigm

through

time.

II. Oligopoly theory and collusion

As

with

almost

every

other

idea in economics,

one

can

argue

that

Adam

Smith

originated

the

thought

that

competitors

would

attempt

to

collude

if

given

the

opportunity, when he

wrote,

"People

of

the

same

trade

seldom meet together, even

for

merri-

ment

and

diversion,

but

the

conversation ends in a conspiracy

against

the

public,

or

in

some

contrivance

to

raise prices."?

Early

economic

impetus

for an antimerger policy

can

also be

traced

to

Augustine

Cournot's

ideas

on

oligopoly theory.'

Cournot's

theoretical

work

indicates

that

an increase in

the

number

of

competitors

in a

market

has

adefinite salubrious

effect

on

market

performance.

His model, which assumes

rather

naive

behavior

on

the

part

of

rivals, shows

that

the

equilibrium

price achieved by noncolluding firms is

above

that

obtained

3A. Smith, The Wealth

of

Nations (New York: Modern Library,

1937), p. 128.

It

is interesting that Smith immediately went on to note:

"It

is impossible to prevent such meetings by any law which could be

executed, or would be consistent with libertyand justice. But though the

law cannot hinder people of the same trade from sometimes assembling

together, it ought do nothing to facilitate such assemblies; much less to

render them necessary." Thus, Smith clearly realized at least one of the

tradeoffs that would have to be made in passing laws that limited the

freedom of groups of firms.

4A. Cournot, Researches Into the Mathematical Principles

oj

the

Theory

of

Wealth, trans. N. Bacon (New York:

Kelly,

1960).