Antitrust Policy and Regulation 18 CHAPTER 18 Antitrust

Antitrust Policy and Regulation 18 CHAPTER 18 Antitrust Policy and Regulation We have always known that heedless self-interest was bad morals; we now know that it is bad economics. — Franklin Delano Roosevelt Mc. Graw-Hill/Irwin Copyright © 2010 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

Antitrust Policy and Regulation 18 Chapter Goals • Explain the difference between the structure and the performance methods of judging competition • Outline a brief history of U. S. antitrust policy • Discuss the resolution of the IBM, AT&T, and Microsoft antitrust cases • Differentiate among horizontal, vertical, and conglomerate mergers 18 -2

Antitrust Policy and Regulation 18 Chapter Goals • Discuss the five reasons why unrelated firms would want to merge • Compare U. S. antitrust policy with antitrust policy of other countries • Explain three alternatives to antitrust policy that government can use to affect the competitive process 18 -3

Antitrust Policy and Regulation 18 Antitrust Policy: Judgment by Performance or Structure? • Antitrust policy is the government’s policy toward the competitive process • There are two competing views of competition: • Judgment by performance: We should judge the competitiveness of markets by the behavior (performance) of the firms in the market • Judgment by structure: We should judge the competitiveness of markets by the structure of the industry 18 -4

Antitrust Policy and Regulation 18 History of U. S. Antitrust Laws • Americans generally favor laissez-faire, but populist sentiment fears bigness and monopoly • A trust or cartel is a combination of firms that have not actually merged, but act as a single entity to set common prices and govern the output of individual member firms • A trust often acts like a monopoly • Cartels and trusts, which developed during the late 1800 s, led to the passage of the Sherman Act, the Clayton Act, and the Federal Trade Commission Act 18 -5

Antitrust Policy and Regulation 18 The Sherman Antitrust Act • The Sherman Antitrust Act of 1890 was a law designed to regulate the competitive process • The two main provisions of the Act were: 1. “Every contract, combination, or conspiracy in restraint of trade is illegal” 2. “Every person who shall monopolize…shall be deemed guilty of a misdemeanor” • The act was broad and sweeping, but vague 18 -6

Antitrust Policy and Regulation 18 The Sherman Antitrust Act • In the 1890 s, economists debated if: • Mergers reflected increased economies of scale • Mergers were attempts to restrict output and generate monopoly profits • Competition was strong enough to limit monopolies • Trusts should be broken up by the government 18 -7

Antitrust Policy and Regulation 18 Application: The Standard Oil and American Tobacco Cases Examples of judging market competitiveness by performance • A firm is considered a monopoly only if it commits monopolistic abuses • In 1911 the Supreme Court found Standard Oil and the American Tobacco Company, both structural monopolies, guilty of unfair business practices and were broken up • In the 1920 U. S. Steel case, the Court ruled that while the company was a structural monopoly, it was not a monopoly in performance • U. S. Steel was not required to break up into smaller companies 18 -8

Antitrust Policy and Regulation 18 The Clayton Act The Clayton Antitrust Act of 1914 made four monopolistic practices illegal when their effect was to lessen competition: 1. Price discrimination 2. Tie-in contracts 3. Interlocking directorships 4. Purchase of a competitor’s stock 18 -9

Antitrust Policy and Regulation 18 The Federal Trade Commission Act • The Federal Trade Commission Act of 1914 made it illegal: 1. To use “unfair methods of competition” 2. To engage in “unfair or deceptive acts or practices” … whether or not those actions had any effect on competition • In 1938 the Federal Trade Commission was given the job of preventing false and deceptive advertising 18 -10

Antitrust Policy and Regulation 18 Application: The ALCOA Case Examples of judging market competitiveness by structure • Judgment by performance governed antitrust policy until the ALCOA case of 1945 • The court did not rule that ALCOA had engaged in unfair practices, but that it dominated the market by expanding capacity and keeping prices low • The court changed its viewpoint to judging markets by structure 18 -11

Antitrust Policy and Regulation 18 Judging Markets by Structure or Performance: The Reality • Judging by structure is practical though seemingly unfair • If a firm is competing so successfully that all the other firms leave the industry, the successful firm will be a monopolist • With judgment by performance, each action of a firm must be analyzed on a case-by-case basis, which is difficult to do • Judging by structure may have problems, but it is necessary 18 -12

Antitrust Policy and Regulation 18 Determining the Relevant Market and Industry • Choosing the relevant market when evaluating competitiveness is difficult to do • The relevant industry in the ALCOA case was the aluminum industry, not the metals industry at large • The relevant industry in the Du Pont case (1956) was flexible wrap including aluminum foil and wax paper, not cellophane • Du Pont was not considered a monopolist even though it sold 100% of cellophane • Mergers are also scrutinized 18 -13

Antitrust Policy and Regulation 18 Recent Antitrust Enforcement • Since the 1980 s, the government has been more lenient in antitrust cases because of: • Change in the American ideology • Globalization of the U. S. economy • The increasing complexity of technology • There have been three recent important computer and telecommunications cases: 1. IBM 2. AT&T 3. Microsoft 18 -14

Antitrust Policy and Regulation 18 The IBM Case • In 1967, the Justice Department sued IBM for violation of antitrust laws: • IBM unfairly bundled hardware, software, and maintenance service • IBM constantly redesigned its hardware, so that competitors couldn’t keep up • In its defense, IBM argued: • The market was larger than the government claimed • Changing technology and customer demand forced it to constantly upgrade its equipment 18 -15

Antitrust Policy and Regulation 18 The IBM Case • The government dropped its suit in 1982 • Mainframe computers were replaced by PCs • Globalization of the computer industry made IBM’s dominance in the U. S. far less important • The prosecution likely led to IBM’s problems in the 1990 s • IBM didn’t buy the DOS operating system from Microsoft because of the litigation • PCs replaced mainframes 18 -16

Antitrust Policy and Regulation 18 The AT&T Case • Up until 1982, AT&T was a regulated natural monopoly • It controlled most long-distance and local telephone services • It produced telephones and other communications equipment • Satellite transmissions and fiber-optic cable began to compete for long-distance service • Competitors sued because they felt AT&T was charging too much to access its local lines 18 -17

Antitrust Policy and Regulation 18 The AT&T Case: Resolution • In 1982, AT&T agreed to divest its 22 local operating companies, which merged into the seven Baby Bells • It kept its long-distance telephone service, manufacturing arm, and Bell Laboratories • Other firms emerged as long-distance competitors and rates fell • Local rates doubled and tripled 18 -18

Antitrust Policy and Regulation 18 Developments Since the AT&T Case • By 2005 the Baby Bells had merged into four companies: SBC Communications, Verizon, Bell South, and Qwest • In 1995, AT&T had divided itself into three companies: AT&T, Lucent, and National Cash Register • In 2005, AT&T and SBC Communications (Cingular Wireless) merged as a new AT&T • Finally in 2006, the new AT&T was taken over by Bell South to become the new, new at&t 18 -19

Antitrust Policy and Regulation 18 The Microsoft Case • Microsoft controls about 50% of the market for software and over 90% of the operating systems market • In 1998, the Justice Department charged Microsoft with: 1. Possessing monopoly power in the PC operating systems market 2. Tying other Microsoftware products to its Windows operating system 3. Entering into agreements that keep computer manufacturers that install Windows from offering competing software 18 -20

Antitrust Policy and Regulation 18 The Microsoft Case Is Microsoft a monopolist? • The software industry is characterized by barriers to entry in the form of: • Network externalities • Economies of scale • In a static framework • With its 90% market share, Microsoft is a monopoly • From a dynamic perspective • There is potential competition from other operating systems and the merging of hardware and software 18 -21

Antitrust Policy and Regulation 18 The Microsoft Case Is Microsoft a Predatory Monopolist? • The Justice Department argued that Microsoft had acted unfairly in gaining its large share of the software market and maintaining barriers to entry • By directing the development of software to favor Windows, Microsoft strengthened the barrier to entry created by network externalities • Microsoft penalized PC manufacturers that installed Windows if they also installed competing software 18 -22

Antitrust Policy and Regulation 18 The Microsoft Case: Resolution • In 2000 the court ruled that Microsoft violated the Sherman Act by using anti-competitive means to maintain its monopoly power • In the settlement Microsoft agreed that: • It would not prohibit PC makers from using competing products • It would release technical information on Windows improvements to software makers • It could continue to bundle e-mail and media players with Windows 18 -23

Antitrust Policy and Regulation 18 Microsoft, the European Union, and the Internet • While Microsoft was negotiating with regulators in the U. S. , it also faced antitrust investigation in the EU • The EU has fined Microsoft repeatedly for antitrust violations • In 2007, technology had changed and Microsoft now faces competition from free software offered by Google online 18 -24

Antitrust Policy and Regulation 18 Assessment of U. S. Antitrust Policy • Economic scholars’ overall assessment of antitrust policy is mixed • In certain cases, such as the IBM case, most agree that antitrust prosecution went too far • Most believe that other decisions (as in the Standard Oil and American Tobacco cases) set a healthy precedent by encouraging a more competitive U. S. business environment 18 -25

Antitrust Policy and Regulation 18 Mergers, Acquisitions, and Takeovers • During the 1990 s and early 2000 s, firms have been breaking up and merging to achieve economies of scope and economies of scale • A merger is a general term meaning the act of combining two firms, may occur as: • Takeovers which are the purchase of one firm by a shell firm that then takes direct control of all the purchased firm’s operations • Acquisitions which are transactions in which a company buys another company and the purchaser has the right of direct control over the resulting operation (but does not always exercise that right) 18 -26

Antitrust Policy and Regulation 18 Mergers • A horizontal merger is the merging of two companies in the same industry • Standard Oil, AT&T and Cingular are examples • A vertical merger is a combination of two companies that are involved in different phases of producing a product • An example is the Du. Pont/General Motors case • A conglomerate merger is the merging of two companies in relatively unrelated industries • Tyco is an example of a conglomerate merger 18 -27

Antitrust Policy and Regulation 18 Reasons for Mergers Five reasons unrelated firms combine are: 1. To achieve economies of scope 2. To get a good buy 3. To diversify 4. To ward off a takeover bid 5. To strengthen their political-economic influence 18 -28

Antitrust Policy and Regulation 18 Recent Merger Activity • Mergers rose significantly in the late 1990 s and into the early 2000 s • The primary reasons for the increase are globalization, deregulation, and technological change • At the same time that these mergers are taking place, firms are also engaging in deacquisitions when one company’s sale of either parts of another company it has bought or parts of itself • The U. S. market structure is a continually changing landscape 18 -29

Antitrust Policy and Regulation 18 International Competition and Antitrust Policy in Other Countries • When people talk about competition, they often mean international competition • More and more, U. S. antitrust policy makers see the international market as the relevant • The European Commission (EC), the EU’s antitrust agency, favors a strong European antirust policy • Given the ongoing globalization of markets, we can expect more and more jurisdictional legal battles in antitrust policy 18 -30

Antitrust Policy and Regulation 18 Sovereign Wealth Funds • A recent institutional change with important market structure effects is the establishment of sovereign wealth funds which are investment funds held by governments • A number of governments with large trade and budget trade surpluses are accumulating assets in several wealth funds • New rules will be developed about what companies sovereign wealth funds can own, and what role they can play in voting the stock that they do own 18 -31

Antitrust Policy and Regulation 18 Regulation, Government Ownership, and Industrial Policies Governments can affect the competitive process by: • Regulating the activities of firms with: • Price regulations, regulation directed at industries that have natural monopoly elements • Social regulations that affect aspects such as working conditions and product quality • Owning and taking charge of the firms and controlling them directly • Industrial policy is a formal policy that governments take towards business • Influences firms with laws and taxes 18 -32

Antitrust Policy and Regulation 18 Chapter Summary • Antitrust policy is the government’s policy toward the competitive process • The competitiveness of markets can be judged by: • Performance – behavior of firms in the market • Structure – number of firms in the industry and their market share • Important antitrust laws include: • The Sherman Antitrust Act • The Clayton Act • The Federal Trade Commission Act 18 -33

Antitrust Policy and Regulation 18 Chapter Summary • Important antitrust cases involved: • AT&T • IBM • Microsoft • Three types of mergers are: • Horizontal – two firms in the same industry • Vertical – two companies in different industries, one of which is a supplier for the other • Conglomerate – combination of two companies in relatively unrelated industries 18 -34

Antitrust Policy and Regulation 18 Chapter Summary • Reasons unrelated firms would want to merge are: • To achieve economies of scope • To get a good buy • To diversify • To ward off a takeover bid • To strengthen their political-economic influence 18 -35

Antitrust Policy and Regulation 18 Chapter Summary • The increasing internationalization of the U. S. market has changed U. S. antitrust policy from looking at just domestic competition to considering international competition • Antitrust issues are by nature global, but a country’s antitrust laws are not • Other than antitrust policy, government affects the competitive process through regulation, government ownership, and industrial policy 18 -36

Antitrust Policy and Regulation 18 Preview of Chapter 19: Work and the Labor Market • Use theory of rational choice to explain why an increase in the marginal tax rate is likely to reduce the quantity of labor supplied • Discuss four factors that influence the elasticity of market labor supply • Discuss four factors that influence the elasticity of market labor demand • Explain how the demand for labor is a derived demand • Define monopsony and bilateral monopoly • Explain real-world characteristics of labor markets in terms of market, political, and social forces • Discuss three types of discrimination 18 -37