Fred S. McChesney
The Concise Encyclopedia of Economics


by Fred S. McChesney
About the Author

Before 1890 the only "antitrust" law was the common law. Contracts that allegedly restrained trade (price-fixing agreements, for example) often were not legally enforceable, but such contracts did not subject the parties to any legal sanctions. Nor were monopolies generally illegal. Economists generally believe that monopolies and other restraints of trade are bad because they usually have the effect of reducing total output and, therefore, aggregate economic welfare (see Monopoly). Indeed, the term "restraint" of trade indicates exactly why economists dislike monopolies and cartels. But the law itself did not penalize monopolies. The Sherman Act of 1890 changed all that. It outlawed cartelization (every "contract, combination... or conspiracy" that was "in restraint of trade") and monopolization (including attempts to monopolize).

The Sherman Act defines neither the practices that constitute restraints of trade nor monopolization. The second important antitrust statute, the Clayton Act, passed in 1914, is somewhat more specific. It outlaws, for example, certain types of price discrimination (charging different prices to different buyers), "tying" (making someone who wants to buy good A buy good B as well), and mergers—but only when the effects of these practices "may be substantially to lessen competition or to tend to create a monopoly." The Clayton Act also authorizes private antitrust suits and triple damages, and exempts labor organizations from the antitrust laws.

Economists did not lobby for the antitrust statutes, or even support them. Rather, their passage is generally ascribed to the influence of populist "muckrakers" such as Ida Tarbell, who frequently decried the supposed ability of emerging corporate giants ("the trusts") to increase prices and exploit customers by reducing production. One reason that most economists were indifferent to the law was their belief that any higher prices achieved by the supposed anticompetitive acts were more than outweighed by the price-reducing effects of greater operating efficiency and lower costs. Interestingly, Tarbell herself conceded that the trusts might be more efficient producers, as did "trustbuster" Teddy Roosevelt.

Only recently have economists looked at the empirical evidence (what has happened in the real world) to see whether the antitrust laws were needed. The popular view that cartels and monopolies were rampant at the turn of the century now seems incorrect to most economists. Thomas DiLorenzo has shown that the trusts against which the Sherman Act supposedly was directed were, in fact, expanding output many times faster than overall production was increasing nationwide; likewise, the trusts' prices were falling faster than those of all enterprises nationally. In other words, the trusts were doing exactly the opposite of what economic theory says a monopoly or cartel must do to reap monopoly profits.

Anticompetitive Practices

In referring to contracts "in restraint of trade," or to arrangements whose effects "may be substantially to lessen competition or to tend to create a monopoly," the principal antitrust statutes are relatively vague. Little statutory guidance is provided for distinguishing benign from malign practices. Thus, judges have been left to decide for themselves which practices run afoul of the antitrust laws.

An important judicial question has been whether a practice should be treated as "per se illegal" (that is, devoid of redeeming justification and so automatically outlawed) or whether it should be judged by a "rule of reason" (its legality to depend on how it is used and on its effects in particular situations).

To answer such questions, judges sometimes have turned to economists for guidance. In the early years of antitrust, though, economists were of little help. They had not extensively analyzed arrangements like tying, information sharing, resale price maintenance, and other commercial practices challenged in antitrust suits. But as the cases exposed areas of economic ignorance or confusion about different commercial arrangements, economists turned to solving the various puzzles.

Indeed, analyzing the efficiency rationale for practices attacked in antitrust litigation has dominated the intellectual agenda of economists who study what is called industrial organization. Economic analysis of a challenged practice typically has proceeded in two phases. Initially, economists concluded that an unfamiliar commercial arrangement that was not explicable in a model of perfect competition must be anti-competitive. In the past thirty to forty years, however, economic evaluations of various practices have undergone a revolution. Economists now see that the perfect competition model relies on assumptions, such as everyone having perfect information and zero transaction costs, that are inappropriate for analyzing real-world production and distribution problems.

The use of more sophisticated assumptions in their models has caused economists to conclude that many practices previously deemed suspect are not typically anticompetitive. This change in evaluations has been reflected in the courts. Per se liability has increasingly been superseded by rule-of-reason analysis reflecting the procompetitive potential of a given practice. Under the rule of reason, courts have become increasingly sophisticated in analyzing information and transaction costs and the ways that contested commercial practices can reduce them. The sophistication of economists and judges has increased in several important areas.

Vertical contracts. Most antitrust practitioners used to believe that vertical mergers (that is, one company acquiring another that is either a supplier or customer) reduced competition. Today, most antitrust experts believe that vertical integration usually is not anticompetitive.

Progress in this area began in the fifties with work by Aaron Director and the Antitrust Project at the University of Chicago. Robert Bork, a scholar involved with this project (and later the federal judge whose unsuccessful nomination to the U.S. Supreme Court caused much controversy), showed that if firm A has monopoly power, vertically integrating with firm B (or acquiring B) does not increase A's monopoly power in its own industry. Nor does it give A monopoly power in B's industry if that industry was competitive in the first place.

Lester Telser, also of the University of Chicago, showed in a famous 1960 article that manufacturers used resale price maintenance ("fair trade") not to create monopoly at the retail level, but to stimulate nonprice competition among retailers. Since retailers operating under fair trade agreements could not compete by cutting price, noted Telser, they would instead compete by demonstrating the product to uninformed buyers. If the product is a sophisticated one that requires explaining to prospective buyers, resale price maintenance can be a rational—and competitive—action by a manufacturer. The same rationale can account for manufacturers' use of exclusive sales territories. This new learning about vertical contracts had had a large impact on judicial antitrust rulings.

Horizontal contracts. Changes in the assessment of horizontal contracts (agreements among competing sellers in the same industry) have come more slowly. Economists remain almost unanimous in condemning all horizontal price-fixing. Yet Fred S. McChesney and Donald Dewey have indicated that price-fixing may actually be procompetitive in some situations, and Peter Asch and Joseph Seneca have shown empirically that price-fixers have not earned higher than normal profits. Other practices that some people believed make it easier for competitors to fix prices have been shown to have procompetitive explanations. Sharing of information among competitors, for example, may not necessarily be a prelude to price-fixing; it can, instead, have an independent efficiency rationale.

Perhaps the most important change in economists' understanding has occurred in the area of mergers. Particularly with the work of Joe Bain and of George Stigler in the fifties, economists (and courts) inferred that there was a lack of competition in markets simply from the fact that an industry had a high four-firm concentration ratio (the percentage of sales accounted for by the four largest firms in the industry). But later work by economists like Yale Brozen and Harold Demsetz demonstrated that correlations between concentration and profits either were transitory or were due more to superior efficiency than to anticompetitive conduct. Their work followed that of Oliver Williamson, who showed that even a merger that caused a large increase in monopoly power would be efficient if it produced only slight cost reductions. As a result of this new evidence and new thinking, economists and judges no longer assume that concentration alone indicates monopoly. The Department of Justice Merger Guidelines promulgated in the eighties have deemphasized concentration as a factor inviting government challenge of a merger.

Nonmerger monopolization. Worries about monopoly have generally been declining with the realization that various practices traditionally thought to be monopolizing devices (including vertical contracts, as discussed above) actually have procompetitive explanations. Likewise, belief in the efficacy of predatory pricing—cutting price below cost—as a monopolization device has diminished. Work begun by John McGee in the late fifties (also an outgrowth of the Chicago Antitrust Project) showed that firms are highly unlikely to use predatory pricing to create monopoly. That work is reflected in recent Supreme Court opinions expressing skepticism about predation as a rational strategy for achieving monopoly profits in most situations.

As older theories of monopolization have died, newer ones have hatched. In the eighties, economists began to lay out new monopolization models based on strategic behavior, often relying on game-theory constructs. They postulated that companies could monopolize markets by raising rivals' costs (sometimes called "cost predation"). For example, if firm A competes with firm B and supplies inputs to both itself and B, A could raise B's costs by charging a higher price to B. It remains to be seen whether economists will ultimately accept the proposition that raising a rival's costs can be a viable monopolizing strategy, or how the practice will be treated in the courts. But courts have begun to impose antitrust liability on firms possessing supposedly "essential facilities" when they deny access to those facilities to competitors.

The recent era of antitrust reassessment has resulted in general agreement among economists that the most successful instances of cartelization and monopoly pricing have involved companies that enjoy the protection of government regulation of prices and government control of entry by new competitors. Occupational licensing and trucking regulation, for example, have allowed competitors to alter terms of competition and legally prevent entry into the market. Unfortunately, monopolies created by the federal government are almost always exempt from antitrust laws, and those created by state governments frequently are exempt as well. Municipal monopolies (e.g., taxicabs, utilities) may be subject to antitrust action but often are protected by statute.

The Effects of Antitrust

With the hindsight of better economic understanding, economists now realize that one undeniable effect of antitrust has been to penalize numerous economically benign practices. Horizontal and especially vertical agreements that are clearly useful, particularly in reducing transaction costs, have effectively been banned. A leading example is the continued per se illegality of resale price maintenance. Antitrust also increases transaction costs because firms must hire lawyers and often litigate to avoid antitrust liability.

One of the most worrisome statistics in antitrust is that for every case brought by government, private plaintiffs bring twenty. The majority of cases are filed to hinder, not help, competition. According to Steven Salop, formerly an antitrust official in the Carter administration, and Lawrence J. White, an economist at New York University, most private antitrust actions are filed by two groups. The most numerous private actions are brought by parties who are in a vertical arrangement with the defendant (e.g., dealers or franchisees) and who, therefore, are unlikely to have suffered from any truly anticompetitive offense. Usually, such cases are attempts to convert simple contract disputes (compensable by ordinary damages) into triple-damage payoffs under the Clayton Act.

The second most frequent private case is that brought by competitors. Because competitors are hurt only when a rival is acting procompetitively by increasing its sales and decreasing its price, the desire to hobble the defendant's efficient practices must motivate at least some antitrust suits by competitors. Thus, case statistics suggest that the anticompetitive costs from "abuse of antitrust," as New York University economists William Baumol and Janusz Ordover refer to it, may actually exceed any procompetitive benefits of antitrust laws.

The case for antitrust does not get stronger when economists examine the kinds of antitrust cases brought by government. In a series of studies done in the early seventies, economists assumed that important losses to consumers from limits on competition existed, and constructed models to identify the markets where these losses would be greatest. Then they compared the markets where government was enforcing antitrust laws with the markets where governments should enforce the laws if consumer well-being were the government's paramount concern. The studies concluded unanimously that the size of consumer losses from monopoly played little or no role in government enforcement of the law.

Economists have also examined particular kinds of antitrust cases brought by the government to see whether anticompetitive acts in these cases were likely. The empirical answer usually is no. This is true even in price-fixing cases, where the evidence indicates that the companies targeted by the government either were not fixing prices or were doing so unsuccessfully. Similar conclusions arise from studies of merger cases and of various antitrust remedies obtained by government; in both instances results are inconsistent with antitrust's supposed goal of consumer well-being.

If public-interest rationales do not explain antitrust, what does? A final set of studies has shown empirically that, at least in part, patterns of antitrust enforcement are motivated by political pressures unrelated to aggregate economic welfare. For example, antitrust is useful to politicians in stopping mergers that would result in plant closings or job transfers in their home districts.

About the Author

Fred S. McChesney is the Class of 1967 James B. Haddad Professor of Law at Northwestern University School of Law, and a professor in the Kellogg Graduate School of Business.

Further Reading

Asch, Peter, and J. J. Seneca. "Is Collusion Profitable?" Review of Economics and Statistics 53 (February 1976): 1-12.

Baumol, William J., and Janusz A. Ordover. "Use of Antitrust to Subvert Competition." Journal of Law and Economics 28 (May 1985): 247-65.

Bittlingmayer, George. "Decreasing Average Cost and Competition: A New Look at the Addyston Pipe Case." Journal of Law and Economics 25 (October 1982): 201-29.

Bork, Robert H. "Vertical Integration and the Sherman Act: The Legal History of an Economic Misconception." University of Chicago Law Review 22 (Autumn 1954): 157-201.

Bork, Robert H. The Antitrust Paradox: A Policy at War with Itself. 1978.

Brozen, Yale. "The Antitrust Task Force Deconcentration Recommendation." Journal of Law and Economics 13 (October 1970): 279-92.

Coate, Malcolm B., Richard S. Higgins, and Fred S. McChesney. "Bureaucracy and Politics in FTC Merger Challenges." Journal of Law and Economics 33 (October 1990): 463-82.

Demsetz, Harold. "Industry Structure, Market Rivalry, and Public Policy." Journal of Law and Economics 16 (April 1973): 1-9.

Dewey, Donald. "Information, Entry and Welfare: The Case for Collusion." American Economic Review 69 (September 1979): 588-593.

DiLorenzo, Thomas J. "The Origins of Antitrust: An Interest-Group Perspective." International Review of Law and Economics 5 (June 1985): 73-90.

McGee, John S. "Predatory Price Cutting: The Standard Oil (N.J.) Case." Journal of Law and Economics 1 (1958): 137-69.

Shughart, William F., II, and Robert D. Tollison. "The Positive Economics of Antitrust Policy: A Survey Article." International Review of Law and Economics 5 (June 1985): 39-57.

Stigler, George J. "The Economists and the Problem of Monopoly." In Stigler. The Economist as Preacher and Other Essays, 38-54. 1982.

Telser, Lester G. "Why Should Manufacturers Want Fair Trade?" Journal of Law and Economics 3 (October 1960): 86-105.

Williamson, Oliver E. "Economies as an Antitrust Defense: The Welfare Tradeoffs." American Economic Review 58 (March 1968): 18-35.

Return to top