minor abberations and imperfections, free markets and democratic political institutions add up to an effective system of social control.

APOLOGETICS I: HORIZONTAL POWER

Having changed the name of our discipline from political economy to economics, the purveyors of the current orthodoxy pretend that power does not exist or that, at worst, it causes only minor and transitory distortions in an otherwise workable system. There is one exception. Even orthodox economists accord scientific recognition to monopoly or horizontal market power, i.e., thể influence exercised by a single seller or a group of dominant sellers over price and output decisions in the marketplace.

But horizontal market power, they are quick to point out, is a problem more troublesome in theory than in practice. After all, in most markets there are mitigating forces notably interindustry or substitute competition, countervailing power, and the Schumpeterian gales of creative destruction which tend to neutralize the effectiveness of horizontal power combinations. Thus, the theory of interindustry competition2 tells us that a high concentration level in the tin can industry is reduced to practical insignificance by the substitute competition of glass bottles, paper cartons, and plastic containers. The dominance of the major oil companies is neutralized by the availability of such substitute fuels as coal, nuclear energy, oil shales, tar sands, and nuclear, solar, and geothermal energy. Similarly according to the theory of countervailing power, the real restraints on a firm's dominance are not vested in its competitors, but in its suppliers and customers; they are imposed, not from the same side of the market but from the opposite side. Hence industrial concentration is no cause for concern; monopolistic exploitation is more conjecture than reality. Finally, according to Professor Schumpeter, the capitalist process is rooted not in classical price competition, but rather the competition from the new commodity, the new technology, the new source of supply, the new type of organization competition which commands a decisive cost or quality advantage and which strikes not at the margin of the profits and outputs of existing firms, but at their very foundations and their very lives. The very essence of capitalism, according to Schumpeter, is the perennial gale of creative destruction in which existing power positions and entrenched advantage are constantly displaced by new organizations and new power complexes. This gale of creative destruction is not only the harbinger of progress, but also the built-in safeguard against the vices of monopoly and privilege.*

These apologetics, of course, are based on the rather arrogant assumption that only economists understand the mitigating forces which limit a firm's

31-717 O 79-9

2. See, e.g., Clair Wilcox, "On the Alleged Ubiquity of Oligopoly," American Economic Review Proceedings, 40 (May 1950), pp. 67-73.

3. J. K. Galbraith, American Capitalism: The Concept of Countervailing Power (Houghton Mifflin 1952).

4. Joseph A. Schumpeter, Capitalism, Socialism, and Democracy (Harper Bros.

market power. The presumption is that monopolists or oligopolists are either unaware of these forces or, more importantly, that they accept them with passive resignation. The reverse is true. Businessmen are quite sensitive to their power position, and constantly strive to liberate themselves from the forces which limit their discretion and confine their freedom of action. Thus, on the interindustry competition front, the tin can oligopolists appreciate the desirability of market extension mergers into glass, paper, and plastic containers. The major oil companies, as Table 27 indicates, are fully cognizant of the

TABLE 27

Diversification in the Energy Industries by the 25 Largest Petroleum Companies, Ranked by Assets, 1970

Source: National Economic Research Associates, Washington, D.C.

1. Includes Hooker Chemical Company.

2. Includes Skelly and Tidewater.

3. Includes reported British Petroleum assets.

XX

Χ

xx

Χ

X

XXX

X

X

advantages derived from control over such substitute fuels as coal, oil shale, and nuclear energy, and are merging into these fields with remarkable success. (According to a House of Representatives Small Business Subcommittee, the majors already control approximately 84 percent of United States oil refining capacity; about 72 percent of the natural gas production and reserve ownership; 30 percent of domestic coal reserves and 20 percent of the domestic production capacity; and over 50 percent of the uranium reserves and 25 percent of the uranium milling capacity." While there are no reliable data on control over oil shales, the majors have already begun their apparently successful campaign to invade the government's multitrillion barrel domain bý organizing joint ventures to lease federal shale lands.") In short, firms subject to interindustry competition fully understand its potential danger, the need to subvert it, and the action required to accomplish that objective.

Similarly, with respect to countervailing power, dominant firms are not unaware of the discipline to which it subjects them. They proceed, therefore, with such strategies as vertical integration, top-level financial control, and tacit vertical collusion to blend the opposite sides of the market into one to combine "original" and "countervailing" power into a framework of coalescing power. In doing so, they once again neutralize one of the forces which ostensibly makes horizontal concentration compatible with the public interest.

Finally, with respect to the gale of creative destruction, it is quite apparent that firms with market power appreciate the danger of the gale and the damage it might cause. Instinctively, they understand that storm shelters have to be built to protect themselves against this destructive force, because the mechanism which is of undoubted public benefit carries with it exorbitant private costs. And so they build private storm shelters wherever possible within the parameters of benign neglect by the antitrust authorities; and, where private monopolies and cartels are patently unlawful, unfeasible, or inadequate, they increasingly turn to the government for succor and support. Those who possess entrenched power need not be told that manipulating the state for private ends is perhaps the most felicitous instrument for insulating themselves against, and immunizing themselves from, the Schumpeterian gale. In sum, the market forces on which orthodox economists seem to rely as an amelioration and mitigation of horizontal power concentrations do not constitute what can reasonably be called an effective control mechanism. These forces may operate in the right direction, but they provide no systematic structural safeguards, nor do they compel conduct which in any predictable sense will serve the public interest.

5. Concentration by Competing Raw Fuel Industries in the Energy Market and Its Impact on Small Business, 92nd Congress, 2nd Session (1972).

6. See, eg., Wall Street Journal, February 13, 1974.

7. For an extended critique of the countervailing power theory, see W. Adams, "Competition, Monopoly, and Countervailing Power," Quarterly Journal of Economics, 67 (November 1953), pp. 469-492.

APOLOGETICS II: VERTICAL POWER

Vertical power, orthodox economists assure us, has no economic signifi. cance except as an extension of preexisting horizontal market control. If restraint of trade exists, it is the horizontal elements that need to be singled out for remedial treatment, not the vertical structure. Robert Bork, before he became solicitor general, explained the issue as follows: monopoly power is the power to alter market price; such power depends on percentage control of the market and ease of entry; vertical integration does not change either the degree of market control or the ease of entry; vertical integration does not affect price policy because an integrated firm will maximize profits at each level and set output as though each level at which it operates were independent from all other levels (except in the bilateral monopoly case); the vertical squeeze, therefore, is an optical illusion — representing nothing more than price cutting at one level in the vertical chain." Bork's policy conclusion was that "in the antitrust context the law should not concern itself at all with vertical integration by acquisition, growth, or contract. This is to say that there should be no antitrust law about vertical mergers, exclusive dealing contracts, resale price maintenance or dealer market division by individual manufacturers or suppliers, or any other vertical relationships." 10 Or as Sam Peltzman put it more succinctly, "the appropriate vertical integration policy is, in fact, no policy at all.” 11

This begs the question. It is undoubtedly true that vertical integration, absent horizontal power, poses no policy problem; but it is also true that vertical integration is a mechanism for harnessing market power and transmitting it through successive stages of production and distribution. As Corwin Edwards points out:

[S]o long as the vertically integrated concern is self-contained, its occupancy of successive stages in the process of production and distribution does not accord it additional power beyond that which springs from its proportion of the market at a particular stage or from its aggregate size. But where such a concern has been disproportionately integrated, so that at one or more stages of production or distribution it acts as supplier or customer for enterprises with which it is in competition at later stages, the existence of vertical integration may become the basis for a special type of power. If a disproportionately integrated concern is big enough to be important to its competitors, it has the power to squeeze them.12

8. J. J. Spengler, "Vertical Integration and Antitrust Policy," Journal of Political Economy, 58 (August 1950), pp. 347-352.

9. Robert Bork, "Vertical Integration and the Sherman Act: The Legal History of a Misconception," 22 U. Chi. L. Rev., 194-201 (1954), italics supplied.

10. "Vertical Integration and Competitive Processes," in Weston and Peltzman, eds., Public Policy Toward Mergers (Goodyear Publ. Co. 1969), p. 149.

11. "Issues in Vertical Integration Policy," in Weston and Peltzman, supra n. 10, at 176.

12. Corwin D. Edwards, Maintaining Competition (McGraw-Hill 1949), p. 98.

A firm so integrated can discipline its nonintegrated competitors through a foreclosure of access to markets, denial of supplies, or manipulation of relative prices so as to effect a simple or double squeeze. Vertical integration, therefore, when it is combined with elements of horizontal power and dual distribution, can be made a formidable barrier to entry. It becomes a structural obstacle to workable competition and tends to relegate competition to the interstices and fringes of an industry.

The petroleum industry is a case in point. Consider, for example, the combined effect of vertical integration and the depletion allowance on independent refiners. The depletion allowance encourages the integrated companies to report their profits at the crude oil stage rather than at the refining or marketing stage. The majors have an incentive, therefore, to post a high price on crude oil which they then "sell" to their own refineries as well as to independents. For the vertically integrated companies, the high price for crude is simply a bookkeeping transaction. Its effect is to increase profits on crude, reduce tax payments, and (in spite of lower profits at the refining stage) to increase total profits for the integrated concern. For the independent refiner, by contrast, the increase in crude prices means a decrease in both refining profits and total profits; being nonintegrated, he cannot recoup the narrowed margins in refining at some other stage of operations.

By way of illustration, assuming a 271⁄2 percent depletion allowance, an integrated concern that can supply 77 percent of its refinery needs with its own crude oil production stands to gain from an increase in crude prices even if the increase is not passed on at the refining stage. If the integrated company has a self-sufficiency ratio in excess of 38.5 percent, it stands to gain even if it passes on only one-half of the crude oil price increase.13 In other words, an integrated company could decide to operate its refineries at zero or subnormal profits and thus discipline, squeeze, or bankrupt the nonintegrated refiners who are both its customers for crude and its competitors in the sale of refined products. (Incidentally, fifteen of the top seventeen refiners in the United States have a crude oil self-sufficiency ratio in excess of 38.5 percent.) 14

As the FTC concluded in its recent petroleum report, "The [vertical integration] system contained all the elements essential to a squeeze on refining profits and could be overcome only if the potential refining entrant could enter [the industry] on a vertically integrated basis." 15. By thus raising the cost of entry at the refining stage, vertical integration in and of itself becomes a formidable entry barrier which few newcomers can afford to hurdle. It is also a barrier to the established independent refiners, many of whom eventually give up the battle for survival and sell out to their integrated rivals.

13. Cf. M. de Chazeau and A. E. Kahn, Integration and Competition in the Petroleum Industry (Yale Univ. Press 1959), pp. 221-222.

14. FTC Preliminary Staff Report, Investigation of the Petroleum Industry (1973), p.

15. Id. at 26.