An intelligent, non-economist acquaintance sent me a question about whether increasing concentration ratios warrant heavy-handed antitrust actions. Because his question was general enough, I’ll only reproduce my response here.
Here’s what I wrote back.
Thanks for thinking of me. You’re far from alone in raising these important questions.
The first thing I’ll say is that defining the relevant market is an impossible task, and one that’s usually subject to political maneuvering in antitrust cases. The defense attorneys want to define the market with sufficient breadth, while the prosecution has every incentive to define it narrowly. Ultimately, this question is not answerable in an objective fashion by some third party. What matters is how consumers subjectively evaluate different goods. For instance, is Google truly a monopolist when when there are so many other ways to acquire information?
It’s also important to not equate “big” with “bad.” Many economists, for over a century, have argued that you can’t derive any immediate welfare implications from a firm’s size. Traditionally, economists have argued that we should distinguish between firms that have become large as a result of rent-seeking (that is, seeking special privileges from government) and those which have become dominant through superior satisfaction of consumer wants. Those that achieve success by way of the latter means make the world a wealthier place for everyone, even if one side effect is a high concentration ratio. Firms that “abuse” their newfound market niche by raising prices, restricting output, or cutting quality are inviting new entry, provided that government hasn’t erected artificial entry barriers. The threat of potential entry disciplines firms even when a market is comprised of only a handful of sellers.
This distinction between alternative means of achieving market dominance is why myself and many other economists are highly skeptical of policy aimed at curbing firm size. Antitrust skeptics see the market as a competitive, dynamic process that repeatedly selects for those firms that are best at satisfying consumer preference. I’d argue that highly dominant firms (dominant at what?), when they aren’t shielded by government-enacted entry barriers, tend to be fairly ephemeral.
The historical record seems to agree. All the classic examples—Standard Oil, A&P grocery stores, Alcoa, JC Penney, MySpace, etc… were all once considered unstoppable juggernauts, but had relatively limited heydays and were eventually outcompeted by superior rivals. This is true even for network industry firms like MySpace, where being a first-mover is of tremendous advantage. (See this infamous piece, humorous in retrospect.)
If my view of the market as a place of perpetual churn is correct, antitrust is analogous to a punishment for the winners—who have (temporarily) won precisely by making the world a wealthier place. On this view, antitrust is like setting up a system that assesses a fine on whoever wins the hundred-meter dash at the Olympics and then expecting this system to reveal who the world’s fastest man is. Suppose a cure for cancer is possible. The first firm to discover the cure would have a 100% market share and could be prosecuted under antitrust laws.
In other words, the existence of a particular distribution of incomes/profits/firm sizes/whatever, is not enough to infer any welfare implications by itself. What matters is the institutional environment within which these firms are seeking profits. In a context where private property rights are well-protected and where there’s little opportunity to seek privileges from government, the existence of large firms may simply reflect the fact that some sellers are better at satisfying consumer preferences than others. If we care about making the world a better place, this is something to celebrate. These firms are creating wealth, and much of that wealth goes to consumers. But to the extent that government is handing out lots of special privileges, then a high concentration ratio might simply reflect the fact that some firms are better at attaining crony, political favors. They are benefitting at the expense of their rivals and consumers; this is truly zero-sum, but market interaction is always positive sum.
An implication is that it’s always important to ask why concentration ratios have increased. There is significant debate on this topic, and there is much evidence suggesting that government-enacted entry barriers are a significant driver. I’ll offer just one example. Take the “Americans with Disabilities Act.” The ADA required that businesses incur a host of fixed costs to make their facilities handicap accessible. For enormous firms like Wal-Mart, a regulation like this amounts to pennies.
For mom-and-pop operations, having to double the size of their bathrooms to comply with the new regulations could represent a doubling of their costs. The result is that large firms are shielded from new entrants and this contributes to higher concentration ratios. This is not mere speculation; large firms sunk significant resources into lobbying for these regulations, which is puzzling when you consider their costs would increase as a result of the law being passed. It’s less puzzling when you realize that these regulations raise large firms’ rivals’ costs disproportionately to their own. To the extent that concentration ratios are increasing due to regulations like these (and there are tens of thousands like it), I’d agree that concentration is undesirable, but I’d argue the solution is repealing these indirect entry barriers.
It’s a naïve view of antitrust to assume that regulators are disinterested actors, seeking to promote consumer welfare. (In fact, some scholars are ready to jettison the historic consumer welfare standard altogether in service of other goals antitrust might achieve). What, then, does antitrust look like in the real world? The overwhelming majority of antitrust cases are not brought by consumers, but by firms that have been outcompeted by their rivals in the marketplace (for every 1 antitrust suit brought by a consumer, some 20 are filed by rival firms).
Another reason to be skeptical of antitrust is that it can harm consumers by, ironically, leading to higher prices. This can occur when (say) a merger which would have permitted economies of scale to be achieved is blocked. If technologies are changing such that ever-larger firm sizes are needed to access economies of scale, then mindlessly attacking concentration ratios can reduce consumer welfare. Firms fearing that they’ll charged with “predatory pricing” may also hesitate when cutting prices would have been their strategy otherwise.
There’s much more that could be said, especially as thinking in competition economics is changing rapidly (and not always for the better…) For more, check out Louis Rouanet’s review of Tomas Philippon’s The Great Reversal.