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A Chicago-school approach to antitrust for developing economies.

I. Introduction

We are now in year 7 A.K. (after Kodak), and "post-Chicago antitrust" is still in vogue.(1) While market-failure theories in industrial organization have never been in short supply, the demand for them is now more robust. Public and private enforcers of the antitrust laws should be circumspect, however, when the validation of their efforts relies so heavily on the occasional and sometimes capricious Supreme Court antitrust decision.

In any case, the recent developments in the U.S. antitrust world offer a lesson for those policy makers who are contemplating antitrust policy for developing economies. Rather than the views inherent in the Kodak decision, it is the Chicago school of antitrust that offers the best hope for policy rationality. Here, I outline the Chicago school of antitrust and discuss why its tenets provide a sound basis for the antitrust policies of any country.

Sound antitrust policy is as elusive as any other sound economic policy, however, so an alternative to the Chicago school of antitrust is also considered. For developing countries, in particular for those post-communist countries attempting to create the basic core of capitalism, antitrust may be an unnecessary and potentially harmful encumbrance. That is, since there is no free lunch it might be better for those countries to skip this particular meal.

II. The emerging influence of the Chicago school of antitrust

Students of U.S. antitrust policy have long been aware that the antitrust laws do not exclusively, or even primarily, serve the purpose of promoting competition and economic efficiency. Two books, Richard Posner's Antitrust Law, An Economic Perspective, published in 1976, and Robert Bork's The Antitrust Paradox, published in 1978, systematically surveyed and analyzed the economic perversities of the antitrust laws, as those laws had come to be interpreted. Bork and Posner applied the economic analysis founded in a rich oral tradition and found in papers written by such Chicago (and UCLA) scholars as Armen Alchian, Yale Brozen, Ronald Coase, Harold Demsetz, Aaron Director, Milton Friedman, Edward Levi, John McGee, Sam Peltzman, Richard Posner, Lester Telser, and the father of modern industrial organization, George Stigler.

The books and articles written by those scholars inspired a dramatic growth in the economic analysis of the antitrust laws.(2) The collective work and the policy implications flowing from it became known as the Chicago school of antitrust. The core of the Chicago school is the application of economic theory and empirical research to real business practices and to the antitrust issues those practices generate. In essence, the Chicago school analyzes how the antitrust laws should be configured if those laws are to promote economic efficiency (or consumer welfare; the two seldom conflict). The Chicago school of antitrust reflects the general Chicago-school-of-economics antipathy to government intervention in competitive markets.

The Chicago school was ascendant at the federal antitrust agencies and in the courts during the 1980s. It is less so now, but its impact on policy is undeniable. (Observing the most recent developments in federal antitrust policy, however, it seems that the free-market advocates won the intellectual battles but lost the policy war.) In any case, the U.S. has had over 100 years of experience with antitrust laws, and that experience--along with the insights of the Chicago school--may be helpful to those countries starting with a clean slate. The policy prescriptions of the Chicago school have never been more relevant.

III. Horizontal agreements, vertical restraints, and monopolization

The appeal of the Chicago school of antitrust is that it provides simple and appropriate rules for curtailing undue agglomerations of market power, while it exonerates efficient or competitively neutral practices. The Chicago school does not advocate an abolition of the antitrust laws. An absence of antitrust laws would produce inefficiencies as some industries attempted to monopolize through merger. In addition, cartels would form whose price and output agreements could be openly monitored and privately enforced.(3) Even if such attempts to acquire market power would ultimately prove unsuccessful, the resources used in the attempts and their demises would be wasteful.

The Chicago school questions the appropriate level of concentration at which to prohibit mergers--a difficult and controversial issue--but not the appropriateness of such a policy in general.(4) Similarly, the Chicago school questions the most appropriate way to define and deter price fixing, but it does not condone price fixing. It follows that there should be prohibitions on mergers at high levels of concentration and on explicit agreements on price and output among horizontal competitors, absent a clear efficiency justification. (It is easy to find potentially efficient cooperation among competitors, such as research joint ventures, production joint ventures, standard setting organizations, sports leagues, and information networks. All of those phenomena call for careful antitrust analysis.) While it is not known what the modern U.S. economy would look like with no antitrust laws, the Chicago school recognizes the misallocation of resources that would flow from horizontal agreements (cartels and mergers for market power) if left unrestrained.

But these observations regarding horizontal agreements are as old as economics itself. The fundamental contribution of the Chicago school of antitrust is this: only horizontal agreements should come under the scrutiny of the antitrust laws. Through the application of economic theory, empirical research, and case study, the Chicago school has come to view virtually all nonhorizontal arrangements as the competitive market at work. Thus, the Chicago school tends to limit the purview of the antitrust laws to horizontal agreements exclusively.

It follows that, unlike horizontal agreements, vertical restraints are not an appropriate target of the antitrust laws. The term "vertical restraints" refers to agreements between a firm and its downstream distributors or its upstream suppliers.(5) Such agreements may deal with price, advertising, dealer territories, or franchise practices. Such agreements are generally efficient and, thus, procompetitive. Does that mean that they are always efficient? Perhaps not, but most are, and attempting to differentiate between the efficient and the inefficient will not generate net benefits to the economy. The economic theories that would justify challenging vertical restraints are either discredited or inapplicable in the real world. That anticompetitive explanations for such agreements can be developed by economists does not mean either that such explanations can be applied or that such agreements can be productively regulated.

After horizontal and vertical arrangements, all other possible antitrust violations tend to be labeled as monopolization. Monopolization in this sense includes those cases that challenge the behavior of a single firm with regards to its prices, its scale of output, its degree of vertical integration, how it contracts with its suppliers, or to whom it chooses to sell its products. (Note that there is not always a clear distinction between vertical restraints and monopolization.) Monopolization cases involve allegations with such colorful names as predatory pricing, nonprice predation, price discrimination, essential facilities, price-squeezes, and foreclosure.

As with vertical restraints, those nonhorizontal activities referred to as monopolization should not be restricted. Such activities are generally efficient and procompetitive, the result of one firm offering superior products or services, or arranging production more efficiently than its competitors. Again, as with vertical restraints, the theories that would justify challenging such activities are inapplicable in the real world. Claims of monopolization against a single firm are virtually always attempts to chill competition and distort an efficient market arrangement. As Posner notes:

Too often the antitrust suits ... were brought by or on behalf of

inefficient competitors against their deservedly more successful rivals.

... There was a time in the 1970s where almost every one of America's

best firms--the flagships of capitalism, the firms that were the

envy of other nations--was under antitrust siege.(6)

Over the years, a list of firms that found themselves under scrutiny without having entered into agreements of any sort with their competitors, and often for competing too vigorously, would include Alcoa, General Electric, Schwinn, Parke-Davis, IBM, du Pont, Procter & Gamble, and most recently Kodak and Microsoft.

The category of monopolization would also include the parts sales and service policies of durable goods manufacturers, the stuff of the Kodak decision.(7) In such cases, a manufacturer is trying to monopolize the sale of, well, its own products. Kodak refused to sell copier repair parts to competitor service providers. The Kodak case embraces much that is bad about antitrust thinking. It attempts to find remedy in the antitrust laws for a practice that has nothing to do with market power and, even if it did, cannot in any meaningful sense be remedied by the antitrust laws. One can only wonder why the Supreme Court would reverse 20 years of progress by elevating to an antitrust issue a particular business decision that was at worst an example of post-contractual opportunism. As Justice Scalia warned in the Kodak dissent, the service and parts distribution practices of many durable goods manufacturers may once again be called into question under the antitrust laws, just as in the bad old days of antitrust. Kodak is not post-Chicago, it is pre-Chicago.(8)

IV. Public ignorance and private enforcement

An implication of the above discussion is that there is much that economists, policy makers, and judges do not know. Only within the last 20 years or so have economists begun to understand the economic functions served by contractual agreements between a distributor and a manufacturer. A business practice should not be presumed to serve no worthwhile purpose just because it is not understood. As Coase states:

One important result of this preoccupation with the monopoly problem

is that if an economist finds something--a business practice of one

sort or other--that he does not understand, he looks for a monopoly

explanation. And as we are very ignorant in this field [industrial

organization], the number of ununderstandable practices tends to be rather

large, and the reliance on a monopoly explanation is frequent.(9)

That insight, about the predilection for the market-power explanation in the face of ignorance about the workings of the market, remains valid. Economists can generate market failure theories with alacrity. Such theories are specialized and inapplicable in the real world of policy enforcement. The Chicago school has been criticized for an undue reliance on neoclassical economics. It is ironic, then, that the opponents of the Chicago school now rely on narrow and complex models which, for their application, require that perfect information be available to regulators and courts.

Another implication of the preceding policy prescriptions is that there is a limited role for private enforcement of the antitrust laws. When private parties can file antitrust claims, government enforcement is likely to be a small part of the antitrust structure. Figures for the U.S. suggest that more than twenty private cases are filed for every federal government case, and that was before Kodak.(10) No matter how wise or unwise government policy is, private parties will use the antitrust laws to harass competitors, dispute contracts, redistribute profits, and free-ride on the efforts and reputations of others. These tendencies are exacerbated when there are greater multiples of damages awarded under the antitrust laws than under contract law. The excesses of private enforcement flow from the broad range of activities that can be called into question under the antitrust laws. Such cases make for bad law, bad economics, and bad policy--as if government enforcement were not bad enough.

Intelligent application of the minimalist policy described above would require the best efforts of any country's antitrust authorities. The proper role for government intervention will still be uncertain and controversial. In any case, the minimalist approach inherent in the Chicago school of antitrust respects the market but, more importantly, realizes the limitations of the government as well as the market in insuring competition.

V. Is no antitrust better than real antitrust?

There is also a Chicago school of regulation. That school, founded by George Stigler, tries to explain the actual causes and effects of regulations.(11) Hence, economists have two jobs when analyzing public policy. One is to understand and demonstrate which policy is most efficient--the task undertaken by the Chicago school of antitrust--and the other is to understand and demonstrate why those policy recommendations are ignored--the task undertaken by the Chicago school of regulation. As George Stigler presents this dichotomy:

Clever economists have displayed an obtuseness in this matter that is

difficult to believe. They will say, not year after year but generation

after generation, "Parliament, do you not realize that free trade would

increase the national income?" As if the Parliament did not know this!(12)

(There are those who argue that the Parliament really does not know about the benefits of free trade, but that preaching is pointless since ignorance is strongly preferred.) As with trade restrictions, the same may be said of agricultural subsidies, price controls, and complicated tax codes. Of course, the same may be said of overreaching antitrust laws. Such policies are economically inefficient, but they are politically efficient. They are crafted by clever people with the intent of subsidizing well-represented groups and taxing poorly-represented groups. A law usually accomplishes what was intended. The Chicago school of regulation seeks to understand and explain actual government policies.(13)

Optimal policies and the real world never meet. Since there are no omniscient and benevolent dictators, every government policy, no matter how worthy its goals, entails costs as well as benefits. That markets are not perfect does not itself justify government intervention, because government intervention is not perfect either. Over 80 years ago, the economist Arthur Pigou noted a truth all too often forgotten:

It is not sufficient to contrast the imperfect adjustments of unfettered

private enterprise with the best adjustment that economists in their

studies can imagine. For we cannot expect that any public authority

will attain, or will even wholeheartedly seek, that ideal. Such authorities

are liable alike to ignorance, to sectional pressure and to personal

corruption by private interest.(14)

Concerning the antitrust laws, Richard Epstein makes the same point:

[I]t should never be assumed that any ideal antitrust policy will survive

unscathed the hurly-burly pressures of a political environment, in

which the incentives for individual actors often cut at cross-purposes

with the one sensible objective of an antitrust law. Quite simply, it is

too easy in a political setting to forge an antitrust law that is more

intent on protecting the position of marginal competitors than on

ensuring the preservation of open markets. ...(15)

One of the most famous quotes in economics--actually the most infamous redaction--argues that there is no free lunch in dealing with even the most explicit of anticompetitive acts:

People of the same trade seldom meet together, even for merriment

and diversion, but the conversation ends in a conspiracy against the

public, or in some contrivance to raise prices. It is impossible indeed

to prevent such meetings, by any law which either could be executed,

or would be consistent with liberty and justice.(16)

Market power may be preferable to the inefficiencies and injustices generated by inappropriate antitrust laws.

The antitrust laws as they will actually be enacted and applied are not going to be ideal. They may be so far from ideal that no antitrust laws would be better. It is for this and other reasons--discussed in the next section--that the emerging economies of Eastern Europe and the former Soviet Union may do better to wait rather than enact any antitrust laws at this stage in their transformation.

VI. Development, free trade, and antitrust

The former communist bloc is made up for the most part of small countries, or at least small economies. No single policy is more important to the development of a small economy than unencumbered international trade--not only in goods and services but in capital as well. Without free trade, a small country cannot enjoy the benefits of specialization and exchange that access to larger markets allows. Without the free movement of capital, no country can attract outside investment. To insure poverty, all that a country needs is to put up a wall around itself; the smaller the country the poorer it will be. Hence, free trade is essential to the development of the post-communist countries; without free trade it will matter little what else they do.

Not only is free trade essential for development, in a small country it can make antitrust concerns largely irrelevant. No matter how large their share of the local economy, domestic producers will have no market power if they must compete with producers from other countries. Local markets, such as services and distribution, tend to be easy to enter on a small scale and are likely to be competitive under any circumstances. Free trade is the best competition policy a small country can have. A noteworthy observation on this relationship between the antitrust and the trade authorities comes from Jan Tumlir:

The antitrust implications of import quotas, for example, bring into

focus a curious symbiosis of two large bureaucratic establishments in

contemporary democratic governments. One, the antitrust establishment,

is trying to enforce competition at home; the other, the trade

policy establishment, is trying to stop it at the border. They are busily

making, work for each other, taking in each other's washing.(17)

Perhaps the post-communist countries can adopt some genuine guarantee of free trade, such as constitutional protection. If the antitrust authorities were to spend their time on that endeavor, so much the better. But lobbying for free trade is unlikely to be either the mandate or the focus of antitrust authorities. After all, free trade would reduce the demand for their services.

The potential harm of misguided antitrust policy to newly emerging economies should not be discounted. First, these countries will be fragile, both politically and economically, and it would not take much hindrance to stifle their development. Investors and entrepreneurs in such an environment do not need to labor under the scrutiny of antitrust bureaucrats. (Considering that voluntary exchange itself was sometimes a capital offense in these countries, it is frightening to imagine what aspects of the free market antitrust officials might find excessive.) Second, even a proper antitrust policy deals well only with stable firms and industries; it does not deal well with uncertainty and rapid change. There will be nothing but uncertainty and rapid change in post-communist countries as state-owned firms are privatized and new industries arise. Antitrust may well hinder their evolution.

As a general matter, the post-communist countries should not emulate America. The U.S. is a wealthy nation able to afford wasteful policies. The rapidly developing Asian nations, which for the most part have eschewed antitrust laws, are better models. Post-communist countries have the awesome task of developing the basic infrastructure of capitalism. They have to resurrect the two pillars of free society: property rights and civil rights, which define economic liberty and political liberty. They have to regenerate contract and commercial law, and civil and criminal law. Compared to those issues, antitrust is barely a detail. Post-communist countries will have ample opportunity to rein in the excesses of rampant capitalism, if they should be so fortunate as to find themselves in that situation. Antitrust policy at this stage in their development is harsh medicine for an imaginary illness.

VII. Conclusion

There are three lessons here for developing economies. First, an appropriate policy for a rapidly developing small economy--or for any country for that matter--would be a minimal one. It would recognize the costs and limitations of gathering information. It would also anticipate the political pressure and private incentives to distort the antitrust laws once they are adopted. Second, that the antitrust laws can in theory be beneficial is well known and is by itself irrelevant. The potential benefits of an ideal antitrust policy are but one entry in the ledger. The relevant issue is whether the antitrust laws as they will actually be applied will be beneficial. Third, for a small economy, free trade is crucial. And free trade has the additional benefit of alleviating antitrust concerns. In sum, newly emerging economies should approach antitrust warily; no antitrust policy might be better than one that expands beyond a minimalist framework. What Easterbrook says about the U.S. system of antitrust is even more relevant for small economies:

There is another form of competition--competition among national

economic and legal systems. If the United States persists in using

high-risk (and therefore high-cost) methods, it will face competition

from other legal systems that reduce risk by giving rapid and binding

answers. Nations that give prompt, consistent, answers to complex

questions--and count on market forces rather than on regulation to

correct mistakes--will be successful in this competition. Competition

is ruthless; world competition the most ruthless of all.(18)

Countries that ignore that insight will find themselves so much the poorer.

(1) For examples of "post- Chicago" symposia discussing the Kodak decision, see 7 ANTITRUST 4 (1992) and 63 ANTITRUST L. J. 445 (1992). "Kodak" is shorthand for Eastman Kodak Co. v. Image Technical Services, Inc., 112 S. Ct. 2072 (1992).

(2) Many others (from Chicago and elsewhere) could have been included in the list and to them I apologize. The bibliography is well known and too extensive to list here. Recent surveys on various antitrust topics can be found in D. W. CARLTON & J. M. PERLOFF, MODERN INDUSTRIAL ORGANIZATION (2d ed. 1994); F. S. MCCHESNEY & W. F. SHUGART II, THE CAUSES AND CONSEQUENCES OF ANTITRUST (1995); W. K. Viscusi, J. M. VERNON & J. E. HARRINGTON, JR., ECONOMICS OF REGULATION AND ANTITRUST (2d ed. 1995). On the origins of the Chicago school, see R. BORK, THE ANTITRUST PARADOX (1978); R. Posner, The Chicago School of Antitrust Analysis, 127 U. PA. L. REV. 925 (1979). The philosophy of the Chicago school has never been better described and applied than in the antitrust writings of Frank H. Easterbrook. See F. H. Easterbrook, Ignorance and Antitrust, in ANTITRUST, INNOVATION, AND COMPETITIVENESS (T. J. Jorde & D. J. Teece, eds., 1992); F. H. Easterbrook, Monopolization: Past, Present, Future, 61 ANTITRUST L. J. 99 (1992); F. H. Easterbrook, On Identifying Exclusionary Conduct, 61 NOTRE DAME L. REV. 972 (1986); F. H. Easterbrook, Workable Antitrust Policy, 84 MICH. L. REV. 1696 (1986); F. H. Easterbrook, The Limits of Antitrust, 63 TEX. L. REV. 1 (1984).

(3) It is generally held that under common law tradition such agreements would not be publicly enforceable, that is, enforceable through contracts.

(4) The general merger issue is, of course, not without controversy. For example, B. E. Eckbo, Mergers and the Value of Antitrust Deterrence, 47 J. FIN. 1005 (1992), finds little demand for anticompetitive, mergers in Canada where they were until recently largely unregulated.

(5) Those wishing to regulate such agreements have the rhetorical advantage that such voluntary arrangements are referred to as restraints.

(6) R. Posner, 100 Years of Antitrust, WALL ST. J., June 29, 1990, at A12.

(7) The infirmities of the Kodak decision are described in R. BORK, THE ANTITRUST PARADOX (2d ed. 1993); G. A. Hay, Is the Glass Half Empty or Half-Full?: Reflections on the Kodak Case, 62 ANTITRUST L. J. 177 (1993); B. Klein, Market Power in Antitrust: Economic Analysis After Kodak, 3 SUP. CT. ECON. REV. 43 (1993); J. Lopatka, The Court's Economic Gibberish, LEGAL TIMES, July 27, 1992, at S34; M. Schwartz & G. J. Werden, A Quality Signaling Rationale for Aftermarket Tying, 64 ANTITRUST L. J. 387 (1996); C. Shapiro, Aftermarkets and Consumer Welfare, 63 ANTITRUST L. J. 483 (1995); C. Shapiro & D. J. Teece, Systems Competition and Aftermarkets: An Economic Analysis of Kodak, 39 ANTITRUST BULL. 135 (1994). For the other side of the issue, see the references in note 1.

(8) And it is fairly typical pre-Chicago. See G. B. Spivack & C. T. Ellis, Kodak: Enlightened Antitrust Analysis and Traditional Tying Law, 62 ANTITRUST L. J. 203 (1993).

(9) R. H. Coase, Industrial Organization: A Proposal for Research, in POLICY ISSUES AND RESEARCH OPPORTUNITIES IN INDUSTRIAL ORGANIZATION 68 (V. R. Fuchs ed., 1972).

(10) See W. F. Shugart, Private Antitrust Enforcement: Compensation, Deterrence or Extortion 2, 13 REGULATION 53 (1990), for a discussion of the tendencies of private antitrust enforcement. With regards to other antitrust regimes that merit further study, Canada, Japan, and the European Community more strictly limit private enforcement than does the U.S.

(11) For general surveys, see the textbook references in note 2 as well as CHICAGO STUDIES IN POLITICAL ECONOMY(G. J. Stigler ed., 1988).

(12) G. J. STIGLER, ECONOMISTS AND PUBLIC POLICY: THE G. WARREN NUTTER LECTURES IN POLITICAL ECONOMY 8 (American Enterprise Institute, 1982).

(13) There is no necessary conflict between these two roles that economists play. The distinction is the usual one between positive and normative analysis. There can be tension, however, especially in the area of antitrust. For an insightful discussion, see F. S. McChesney, Be True to Your School: Chicago's Contradictory Views of Antitrust and Regulation, 11 CATO J. 775 (1991).

(14) A. C. PIGOU, WEALTH AND WELFARE 247-48 (1912).

(15) R. A. EPSTEIN, SIMPLE RULES FOR A COMPLEX WORLD 126 (1995).

(16) ADAM SMITH, THE WEALTH OF NATIONS 128 (Modern Library Edition, 1937). (Emphasis added.)

(17) J. TUMLIR, PROTECTIONISM: TRADE POLICY IN DEMOCRATIC SOCIETIES 54 (American Enterprise Institute, 1985).

(18) F. H. Easterbrook, Ignorance and Antitrust, supra note 2, at 110.

AUTHOR'S NOTE: More than the usual disclaimer applies. I use with deference the term "Chicago school of antitrust." Defining a school of thought is always difficult, and some of the founders and proponents of the Chicago school may disagree with some of the generalizations that follow. For helpful comments, I thank without implicating John Lopatka. This article follows from a series of articles comprising a dialog with the antitrust agencies and from a speech given at a World Bank conference on competition policy for developing countries. See R. Boner & J. Langenfeld, Reply, 15 REGULATION 5 (1992); P. Godek, Reply, 15 REGULATION 4 (1992); P. Godek, Reply, 15 INT'L MERGER L. 20 (1991); P. Godek, One U.S. Export Eastern Europe Does Not Need, 13 INT'L MERGER L. 2 (1991), reprinted in 15 REGULATION 20 (1992); P. Godek, Antitrust Will Stifle, Not Spur Eastern Growth, WALL ST. J. EUR., July 26, 1991, at 8; J. Langenfeld & M. Blitzer, Is Competition Policy the Last Thing Central and Eastern Europe Need?, 6 Am. U. J. INT'L L. & POL'Y 347 (1991); J. Ordover & R. Pittman, Antitrust: One Important Component of the Transformation of Eastern Europe, 15 INT'L MERGER L. 18 (1991); J. Ordover & R. Pittman Reply, 15 REGULATION 5 (1992). The view in this article has recently been echoed by M. Feldstein, Russia's Rebirth, WALL ST. J., Sept. 8, 1997, at A18.

PAUL E. GODEK, Economists Incorporated, Washington, D.C.
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Title Annotation:Competition Policies for Developing European Economies
Author:Godek, Paul E.
Publication:Antitrust Bulletin
Date:Mar 22, 1998
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