Note: Read the prior installments of this essay series here: Part I; Part II; Part III; Part IV.
In Chapters 3 and 4 of Antitrust: The Case for Repeal, Dominick T. Armentano argues against the primary reasons frequently given for the existence of antitrust laws. He criticizes the perfect competition model, the Neoclassical free-market monopoly model, and the idea that free-market barriers to entry pose problems for consumers.
Problems with Perfect Competition
According to Armentano, “it is difficult to understand the relevance [of perfect competition theory] in a real world of differentiated preferences, economic uncertainty, and dynamic change” (Armentano 1999, p. 33). The real economic problem – the problem competition must solve – is not how to allocate resources given perfect information, but rather one of “understanding how the competitive market process of discovery and adjustment works to coordinate anticipated demand with supply in a world of imperfect information” (Armentano 1999, p. 33). The perfect competition model assumes away this basic problem and is thus irrelevant to the real world.
Armentano continues by noting that the uncertainty of real markets often necessitates product differentiation, advertising, and interfirm coordination — none of which are indicators that competition is being stifled; they simply indicate disequilibrium.
Unfortunately, most of antitrust enforcement has been grounded in the perfect competition model – thereby presuming that outputs less than the theoretical “perfectly competitive output” are somehow “restricted.” Neither this nor antitrust authorities’ suspicion of advertising and interfirm coordination are warranted if the perfect competition model itself is flawed.
As an alternative to the perfect competition model, Armentano proposes the Hayekian view of competition “as an entrepreneurial process of discovery and adjustment under conditions of uncertainty” (Armentano 1999, p. 34). This implies that no a priori way exists to determine whether or to what extent rivalry or cooperation are appropriate in any particular market. Furthermore, in the course of the market purpose, some firms may gain tremendously in market share, whereas others may fail and suffer large losses. Both phenomena are necessary for the discovery process of the market to take place.
Problems with Free-Market Monopoly Theory
Armentano is furthermore skeptical of the “actual ability of a monopoly firm, or a group of colluding firms, to restrict the market supply and realize monopoly prices and profits” (Armentano 1999, p. 35). The Neoclassical free-market monopoly model starts by assuming that a free-market sole producer restricts output and then compares such a restricted output with output under ideal perfect competition conditions. However, Armentano recognizes that “the atomistic equilibrium output level [under perfect competition] is neither possible nor relevant and cannot serve as the welfare benchmark for any comparison” (Armentano 1999, p. 36).
Furthermore, the free market will render any monopolist’s or cartel’s attempts to restrict market output and artificially raise prices extremely short-lived, as when the monopolist raises prices above marginal and average costs, “strong economic incentives then exist to expand current production and to encourage output by new firms,” leading prices to fall and more closely approximate costs (Armentano 1999, p. 36).
If a monopolist tries to dramatically lower its prices in order to deter entry by rivals, this will increase sales and thus lead the market toward a competitive level of output. If the free-market monopolist engages in price discrimination, the output will likewise increase, and the additional units of output will be sold at lower prices. Moreover, an inefficient monopolist by his very inefficiency invites new entry and cannot deter it – while a more efficient monopolist can only deter rivals as a result of his efficiency, in which case there exists no diminution of consumer well-being.
A cartel encounters additional difficulties – as well as all the ones mentioned above. It must also effectively police and coordinate its attempts to restrict output and raise price. In short, “there is little reliable evidence that free-market collusion can allow conspiring firms to capture monopoly profits” (Armentano 1999, p. 37).
Armentano considers the Neoclassical standard of “allocative efficiency” to be “contrived and misleading” – as it neglects the possibility that “a competitive process always operates under free-market monopoly” and “no final atomistic equilibrium condition can ever exist” (Armentano 1999, p. 38). If these are taken into account, free-market monopolies cease to be a problem.
The Neoclassical assumption regarding “technical inefficiency” in a free-market monopoly situation is similarly flawed – as in “any serious attempt to monopolize some free market, business are far more likely to lower costs than they are to raise them, and to expand rather than decrease production. The most effective way to gain and hold a free-market monopoly position is to be more efficient than rivals or potential rivals” (Armentano 1999, p. 38). Furthermore, Armentano believes it is illegitimate to consider the costs of product differentiation as increased costs under free-market monopoly, since differentiated products are fundamentally different from homogeneous products and thus cannot be compared to them.
The Standard Oil Case
The facts surrounding the 1911 Standard Oil Case are frequently misunderstood. Standard Oil never acted to the detriment of consumers; quite the contrary, its tremendous efficiency brought about its fast growth and ability to gain a large market share in oil. Standard Oil’s activities led to tremendous drops in consumer prices; Armentano notes that “prices for kerosene fell from 30 cents a gallon in 1869 to 9 cents in 1880, 7.4 cents in 1890, and 5.9 cents in 1897” (Armentano 1999, p. 41). The market continually remained open to competitors, and Standard Oil’s market share actually fell from 85% in 1890 to 64% in 1911 – by which time Standard Oil had over 147 competitors.
Furthermore, the courts never found Standard Oil guilty of either restricting output or raising prices. Rather, they simply ruled that Standard Oil’s holding company, Standard Oil of New Jersey was “a contract or combination in restraint of trade” and thus outlawed by the Sherman Act; therefore, the courts ruled to dissolve the company. Although the court ostensibly applied the rule of reason to this case, “it is emphatically not true that the High Court presented any specific finding of guilt with respect to the charges of misconduct and monopolistic performance brought against [Standard Oil] by the government… All that the Supreme Court did – contrary to overwhelming conventional wisdom – was conclude that some of Standard’s practices, such as merger, evidenced an unmistakable intent to monopolize and that these practices were unreasonable. Why were they unreasonable? Because the court said that it was obvious that they were” (Armentano 1999, p. 42-43). Clearly, this defining case in the history of antitrust law was based on dubious reasoning at best.
Critique of Empirical Studies
Armentano goes on to criticize empirical studies that assume that market concentration, profitability, and even advertising and product differentiation are measures of monopoly power and thus restrictions of competition. There are severe methodological problems with such studies.
First, these studies measure accounting profit, not economic profit, which may lead to flawed conclusions. “Second, legal monopoly and free-market monopoly might well be inexorably intertwined in the actual business world; tariffs, quotas, licensing, and other legal restrictions always tend to generate economic rents in markets that are otherwise openly competitive” (Armentano 1999, p. 44). Finally, these studies are flawed in using the hypothetical “perfectly competitive” output as a benchmark to which to compare real-world situations.
Armentano acknowledges that legal monopolies, established via government aid, can and do harm consumers. Legal monopolies can be brought about by licensing, quotas, legal franchises, certificates of public convenience, and other means. Voluntary exchanges are thereby prevented and “the competitive market process has been undercut and artificially shortcircuited – by law” (Armentano 1999, p. 45). This will often reduce output and raise prices; efficient producers will often be excluded to the benefit of those who are best at seeking government favors. To add to the problem, no economic incentives exist to remedy the legally-induced reduction of output. In the meantime, firms will continually waste resources lobbying for government favors.
The only legitimate use of antitrust laws, according to Armentano, is “to remove legal restrictions on competition and cooperation” (Armentano 1999, p. 46). But even here it is necessary to proceed with caution so as to avoid prosecuting free-market cooperative agreements among suppliers and to prevent the horrendous damage brought about by private antitrust lawsuits.
Free-Market Barriers to Entry?
Armentano devotes Chapter 4 of Antitrust to addressing alleged free-market barriers to entry such as advertising and product differentiation.
Product differentiation can only occur in a market if consumers have expressed a preference for it and a willingness to bear its costs. If new producers find it difficult to enter a market full of differentiated products, then this is due to the nature of consumer preferences, not to any “unfair advantages” possessed by incumbent firms. As efficient resource allocation requires that resources be put to the uses most valued by consumers, product differentiation is no grounds for antitrust prosecution. Furthermore, anyone is still free to enter a differentiated market and to attempt to convince consumers to support less product differentiation or to find cheaper methods of production.
Furthermore, Armentano rejects the critique of some product differentiation as frivolous and unnecessary by noting that the revealed preferences of consumers are what must ultimately decide between necessary and superfluous product differentiation. If consumers “are willing to pay substantially more for some differentiation, then it is demonstrably not frivolous and the resources it uses are not misallocated” (Armentano 1999, p. 54). It is possible for firms to waste resources in trying to figure out exactly what consumers prefer – but this is because firms must anticipate consumers’ preferences before those preferences are explicitly revealed, thus leading to a potential for error and miscalculation. Such mistakes are inevitable, even given strong free-market incentives not to make them. Nothing in antitrust law can make these mistakes any less frequent.
Advertising in a free market is, likewise, not a problem. Armentano notes that treating advertising as a superfluous “selling expense” apart from production expenses “is totally arbitrary. All business costs are selling costs in the sense that all resources are expended with the purpose of selling products to consumers at a profit” (Armentano 1999, p. 58). Advertising would indeed be unnecessary in a “perfectly competitive” market with perfect information, but this is not a real-world possibility.
Armentano does not perceive a problem with firms who advertise more efficiently than others; this is not a misallocation of resources. “The only obvious waste here is on the part of the firms that advertise less efficiently” (Armentano 1999, p. 59).
Furthermore, Armentano sees nothing problematic with firms that take advantage of low-cost technologies and economies of scale to maintain dominant positions in a market. Such dominance is purely legitimate, as it is due to efficient firms’ ability to more readily satisfy consumer preferences. The very point of the market process is to discover the most efficient way to enhance consumer well-being; this has nothing to do with a specific number of competitors, and it is quite possible that one firm or a few firms might be more suited to supplying consumer wants in a given market than a multitude of firms.
Nor is some firms’ easier access to financial capital a barrier to genuine competition. Armentano notes that “Financial capital, like all resources, cannot be free to all who would want to use it, and its costs must be borne by those who intend to use it productively” (Armentano 1999, p. 63). Some firms may be able to acquire capital at lower costs because they have demonstrated that they are lower risks and have been able to show through their past activities that they are able to use capital successfully. Insofar as capital costs are a barrier to entry, they enable more efficient users of capital to exclude less efficient ones – which is not a problem for consumers. Furthermore, this barrier is routinely overcome, as thousands of new firms receive access to capital; the only problematic barriers to capital are those erected by the law.
Nor is “predatory pricing” a problem in a free market. Armentano mentions the difficulty of distinguishing genuinely “predatory” practices from routine competitive price reductions and product innovations. He asks: “which costs are relevant for such determinations? Average costs? Marginal costs? Long-run marginal costs? Why are historical accounting costs relevant at all?” (Armentano 1999, p. 65). Furthermore, “predatory practices cannot succeed without direct consumer-buyer support” (Armentano 1999, p. 65). If buyers are displeased by a certain firm’s price cutting, they are always free to patronize that firm’s competitors. The fact that this does not happen means that such “predatory” price reductions do not harm consumers. Furthermore, antitrust proponents cannot legitimately claim to know the long-run preferences of buyers better than the buyers do themselves – and moreover, consumers “can surely decide their own time preferences and then decide whether the advantages of short-run price reductions exceed the possible disadvantages of fewer suppliers in the future” (Armentano 1999, p. 65).
Armentano applies the same logic to so-called non-price predatory practices. It is up to consumers to choose whether a new product innovation will reduce the number of competitors – and if consumers do so, this is not problematic. Armentano notes that “it would be difficult to imagine an antitrust intervention as potentially dangerous or damaging to future consumer welfare as this sort of innovation regulation” which would block the introduction of new and superior products (Armentano 1999, p. 66).
Moreover, predatory practices have a high likelihood of failure for the firm who undertakes them; the financial risks of predation are themselves tremendous disincentives from engaging in the practice, and history has shown extremely few unambiguous instances of predatory behavior.