The demise of regulation in ocean shipping: a study in the evolution of competition policy and the predictive power of microeconomics.

• Author: Sagers, Chris

ABSTRACT

Over its 140 year history, ocean liner shipping has almost always enjoyed an antitrust exemption permitting price-fixing cartels of ocean carriers. The exemption was premised on the belief that problems of cost and capacity inherent in the trade can be resolved only by horizontal collusion. Now that that exemption has been whittled away by deregulatory efforts, the pre- and post-deregulation evidence presents one of the world's rare opportunities for natural experiment on the behavior and effectiveness of collusive cartel pricing.

Moreover, because normal and effective competition never really existed prior to 1998, the normative foundation of the antitrust exemption was based almost entirely on theoretically modeled economic arguments. Observing the industry 's behavior under deregulation is therefore a before-and-after opportunity to test the predictive accuracy of at least one body of economic argument. Finally, the evolution of shipping policy is also part of a larger historiography--the shipping exemption reflects the larger story of government efforts to cope with the problems of industrial organization.

TABLE OF CONTENTS I. INTRODUCTION II. AN OVERVIEW OF OCEAN LINER SHIPPING III. LEGAL BACKGROUND IV. DESIRABILITY OF THE EXEMPTION: THEORY AND EMPIRICAL EVIDENCE A. Capacity Rationalization and Unstable Price B. The Theory of the Empty Core C. Susceptibility to Oligopoly Conditions D. Does the Conference System Result in Supracompetitive Price? E. Will Competition Lead to Inadequate Returns, Investment Uncertainty, and Lower Service Quality? V. WHY WOULD HARMFUL CONFERENCE ACTIVITY NOT INVITE CHEATING AND NEW ENTRY.'? VI. CONCLUSIONS: THE FUTURE OF THE EXEMPTION AND A BIT OF HISTORICAL PERSPECTIVE A. Retention of the Antitrust Exemption B. The Bigger Picture I. INTRODUCTION

Among the world's most active reform movements in international trade and business regulation is the effort to deregulate ocean shipping fully. During its 140 year history, the shipping industry has almost always been shielded, everywhere in the world, from competition law and open competition. (1) Accordingly, until quite recently most pricing and output decisions were made by horizontal cartel. (2) Like all other transportation sectors, however, the industry has faced increasing efforts to remove its regulatory protections and subject it to open competition. Indeed, the industry was partially deregulated under U.S. law by legislation that took effect in 1999. (3) More recently, there have been unsuccessful attempts to do away with the U.S. antitrust exemption entirely, (4) and though the effort has not yet reached floor consideration in Congress, it has had significant support. (5) The European Commission is poised to do the same with its ocean shipping exemption within the next year or so, (6) and similar reform proceedings recently have taken place in Australia, Canada, Japan, and South Korea. (7) Other influential critiques of ocean shipping exemptions also have emerged, notably from the Organization for Economic Cooperation and Development (OECD) and from economists at the World Bank. (8) Deregulatory reforms are among the key issues before the U.S. Antitrust Modernization Commission, a congressionally appointed panel of experts currently studying the antitrust laws. (9)

And yet the privileged status of this particular industry not only lingers, it is fiercely defended. This is in part because "deregulation" is still a relatively young phenomenon in which even impartial observers express some doubts, (10) and there remains enough uncertainty that traditionally regulated firms can claim they still need an exemption from antitrust laws. (11) But a devoted core of advocates continues to believe that ocean shipping is in some way special and poorly suited for open competition. Interestingly, a small collection of academics remains convinced that ocean shipping is a real-world case of a special, rarely tested theoretical problem described as the problem of the "empty core." (12)

This moment of world attention is therefore an opportune one for consideration of a number of important issues of policy and economic theory. Again, the industry was partially deregulated in 1999. (13) The pre- and post-deregulation evidence now available presents one of the world's rare opportunities for natural experiment on the behavior and effectiveness of collusive cartel pricing (rare because price-fixing is normally illegal and therefore done in secret). Likewise, because normal and effective competition never existed prior to 1999, the normative foundation of the antitrust exemption was based almost entirely on theoretically modeled economic arguments. Observing the industry's behavior under deregulation is therefore a before-and-after opportunity to test the predictive accuracy of a body of economic argument, including the "empty core" theory. Finally, shipping deregulation tells a larger historiographical story of an evolution in U.S. competition policy.

This Article sets forth two major themes. First, deregulatory experience suggests that ocean liner markets can perform well under normal price competition, contrary to long-standing claims from the industry and some academics. The carriers themselves have long argued that peculiar cost and capacity problems of their trade would render performance under competition impossible. Prior to deregulation, a body of theoretical work grew to support the carriers' claims, bolstering the argument that they required antitrust immunity. (14) Some empirical support developed as well. (15) Criticism also predated deregulation, (16) however, and grew after the 1999 legislation to include studies by governmental and non-governmental organizations critical of the conference system in light of deregulatory experience. (17)

Second, the evolution of shipping policy is part of a larger history which mirrors the overall evolution of competition policy itself. Things are now different than they were in 1916, when the United States adopted its first shipping policy (18)--markets are different, industry is different, microeconomics is very different, and both the law and the law's esteem for the views of academic economists are different. The nature and prominence of statutory displacements of antitrust in favor of regulation are also very different and, as will be seen, the story of the shipping exemption reflects the larger story of government efforts to cope with perceived problems of industrial organization.

What this history says about the way Congress works and about the use of abstract theory in the making of public policy is particularly interesting. There is a different and more plausible explanation for the plight of shipping than the one on which Congress based federal policy for nearly a century, and the reason for the continuing misunderstanding has been a predictive failure of economic theory. In short, a likely well-intentioned theoretical error by Congress--made at a time of historic, worldwide technological change and economic distress--gave rise to a situation in which carriers made substantial capital commitments to an inefficient market organization. Despite the flaws in this situation, the carriers' interests predominantly lay in preserving that status quo. As will be seen, it was quite easy for carriers and their academic supporters to explain theoretically that this inefficient organization was actually a natural one and to characterize the healthy process of forced exit that would result from deregulation as "destructive competition." Those efforts persist even now, despite the weighty deregulatory evidence that the theory was inaccurate. (19)

The remainder of the Article proceeds in five parts. Parts II and III summarize the history of the ocean shipping industry and the legal background of its regulation. Part III examines the economic situation and the state of economic thinking in the United States during the late nineteenth century, which explain the real origins of the policy. Parts IV and V proceed to the heart of the inquiry, which is a critical examination of the a priori theoretical claims upon which the policy was traditionally defended. In particular, Part V addresses a key theoretical question: if the shipping cartels permitted by U.S. policy were in fact harmful or poorly behaved, why did they not simply encourage disciplinary entry or cheating by their own members? Finally, Part VI addresses the key issue of policy left open in shipping regulation, namely whether the industry's transition to full competition should be completed. The evidence suggests that the collusive conduct still permitted continues to harm shippers and consumers, and there is no evidence of any pro-competitive upside to the collusive conduct except the same arguments used for years to defend the now defunct conference system itself. In conclusion, Part VI also attempts to place the story of shipping regulation into a larger historical picture.

2. AN OVERVIEW OF OCEAN LINER SHIPPING

   Ocean liner shipping (20) is by far the most common mode of international transport of goods (21) and the chief means by which U.S. goods are shipped in foreign commerce. (22) While it remains among the world's most vital industries and of great significance to the U.S. economy, (23) the industry is now fairly concentrated worldwide, and none of its major participants are U.S. owned. All but two of the world's top twenty lines are based in Western Europe or Southeast Asia, and neither of the exceptions are U.S. owned. (24)

   The U.S. government has directly regulated the industry for almost its entire existence. A chief feature of U.S. policy, which is currently embodied in the amended Shipping Act of 1984 (Shipping Act), (25) is exemption from the antitrust laws for price-fixing cartels of ocean carriers. The policy's premise is the belief that problems of cost and capacity inherent in the trade can be resolved only...