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(Acquisitions of independent refiners accounted for 40.7 percent of the increase in refining capacity among the top twenty oil companies between 1959 and 1969.)
The control of pipelines by the vertically integrated majors poses a similar problem. If the pipeline sets a rate well above the competitive cost of transporting crude oil, for example, this imposes no burden on the majors who own the pipeline. To them, it is a bookkeeping transaction involving a transfer of funds from the refinery operation to the pipeline operation. But to the nonintegrated refiner, an excessive pipeline charge is a real cost increase which he cannot recoup elsewhere and which places him at a competitive disadvantage vis-à-vis his integrated competitors.
The integrated majors can also use their control of pipelines as an entry barrier if they choose to exclude or limit flows of crude oil to the independents. According to the FTC report,
this can be done by (1) requiring shipments of minimum size, (2) granting independents irregular shipping dates, (3) limiting available storage at the pipeline terminal, (4) imposing unreasonable product standards upon independent customers of pipelines, and (5) employing other harassing or delaying tactics.16
Thus, in petroleum as elsewhere,17 vertical integration can be used as an instrument for parlaying horizontal power at one stage into strategic leverage over another. Such power is not, as orthodox economists would have us believe, an "optical illusion." It is the very real power to decide whether nonintegrated competitors shall be tolerated, disciplined, coerced, or excluded. It is the power to determine the conditions for entry and the rules for survival in an industry. A vertical oligopoly has this power, because its members are not constrained to play the economist's game of short-run profit maximization and are free, therefore, to pursue the more important long-run goal of protecting themselves and the entire industry structure from competitive erosion.
APOLOGETICS III: CONGLOMERATE POWER
Conglomerate power, according to the conventional wisdom, has even less significance than vertical power. As Donald Turner puts it:
17. See, e.g., W. Adams and J. B. Dirlam, "Steel Imports and Vertical Oligopoly Power," American Economic Review, 54 (September 1964), pp. 626-655. In the public utility sector, a monopolist like AT&T may extend its power from the service field, where it is subject to regulation, into the field of equipment manufacture, in which there are no corresponding checks and balances. FCC, Report of the Investigation of the Telephone Industry in the United States (1939), cited in Edwards, supra n. 12, at 98-99. A patent holder may also try to use his legal monopoly power in one field to gain dominance in another totally different market by exploiting vertical leverage in a buyer-seller relationship. See, e.g., International Salt Co., Inc. v. United States, 332 U.S. 392 (1947).
The rules developed for determining the validity of horizontal and vertical mergers clearly will not do for conglomerate acquisitions generally. In the familiar types of horizontal and vertical merger cases, the Supreme Court has come to place important if not decisive weight on the share of the relevant markets controlled by the acquiring and acquired companies.... But whatever significance can be attached to market shares in these cases, quite clearly the significance becomes less when we deal with conglomerate mergers, and indeed may vanish altogether.18
Why? Because in a conglomerate merger, it is hard to imagine a substantial lessening of competition resulting from the joinder of two firms operating in different geographical areas (market extension mergers) or in different product lines (product extension mergers) or in altogether dissimilar industries (pure conglomerates). How can there be a lessening of competition if none existed between acquirer and acquired to begin with?
Take a specific case: I.T.T., a multinational conglomerate giant, acquires O. M. Scott, a producer of grass seed with a significant but not dominant share of the grass seed market. Conventional theory attaches no significance to this merger, since I.T.T. was not even remotely involved in the production of grass seed prior to the merger. Since I.T.T.-Scott has no larger share of the market than the independent O. M. Scott had before the merger, and therefore presumably no greater control over price, the conventional theorist sees no need to be concerned. Indeed, if a hundred companies in different fields were to merge into one, the theorist would see no accretion of power in such an amalgamation, because no change could be observed in the respective market shares of the formerly independent firms. Their horizontal market power i.e., their monopoly power would be no greater after than it was before the merger. In short, so the argument runs, absolute size is absolutely irrelevant.1
To those untutored in the mystery and esoterica of economics, it might seem relevant that the newcomer to the grass seed business happens to be I.T.T.; that this vast international organization, with assets of more than $8 billion and 400,000 employees, "is constantly working around the clock - in 67 nations on six continents, in activities extending from the Arctic to the Antarctic and quite literally from the bottom of the sea to the moon;" ... 20 that I.T.T.'s list of officers and directors has included such luminaries as a former secretary general of the United Nations, a former premier of Belgium, two members of the British House of Lords, a member of the French National Assembly, a former president of the International Bank for Reconstruction and Development, and a former director of the C.I.A.;21 that the newcomer happens to be a corporation which has sufficient access to the corridors of gov
18. Donald F. Turner, "Conglomerate Mergers and Section 7 of the Clayton Act," 48 Harv. L. Rev., 1315-1316 (1965).
19. Report of the Attorney General's National Committee to Study the Antitrust Laws (1955), p. 325.
20. I.T.T., Annual Report (1968), p. 7.
21. See testimony by W. F. Mueller, Senate Small Business Committee, Hearings, Role of Giant Corporations, Part 2, 1971, pp. 1097-1098.
ernment power to offer the C.I.A. and the National Security Council a grant of $1 million to assist in the overthrow of a constitutional Latin American republic,22 that it is a political-economic entity which can propose a $400,000 donation to finance the Republican National Convention, and then miraculously persuade the Justice Department to forego an appeal of three I.T.T. merger cases to the Supreme Court and settle instead for an amiable consent decree.23
Pretending that a firm with I.T.T.'s absolute size and aggregate power is a run-of-the-mill newcomer to the grass seed business is not unlike the suggestion that injecting Kareem Abdul Jabbar into a grade school basketball game would have no impact on preexisting power relationships or the probable outcome of the contest. As Kenneth Elzinga, counsel to former Antitrust Chief Richard McLaren, explains:
The Scott seed company, under the aegis of I.T.T., will find the federal government far more approachable than it ever did in its independent status. And Scott is more likely to use this position to gain favors regarding taxes, import competition, government contracts, and other amenities which give it an advantage over its rivals, thereby lessening competition in the grass seed industry.... Note also that I.T.T.-Scott will probably not have to pummel competing grass seed companies, in a manner reminiscent of John D. Rockefeller, to persuade them to shun aggressive, competitive behavior. The rival managers need not be graduates of the Wharton School to realize that their old adversary Scott must now, command more respect. And common sense tells us that potential competitors, possibly willing to spar with an independent Scott, will look elsewhere before entering the ring with an I.T.T.-Scott.24
In short, conglomerate power does make a difference. It derives not from monopoly or oligopoly control of a particular market, but from diversification over a whole range of markets. It enables a firm, endowed with absolute size and the deep purse, to "outbid, outspend, and outlose" its smaller rivals, 25 and thus to insure its survival almost irrespective of its performance. Finally, as recent events have demonstrated, it conveys a unique access to political power and the opportunity to transform the state into an instrument of privilege creation and protection.
22. See Subcommittee on Multinational Corporations of the Senate Committee on Foreign Relations, Report, The International Telephone and Telegraph Company and Chile, 1970-71, 93rd Congress, 1st Session, at 4-5 (June 21, 1973). See also N.Y. Times, February 28, 1974.
23. W. F. Mueller, "The I.T.T. Settlement: A Deal With Justice?," Industrial Organization Review, 1 (1973), pp. 67-86; Harlan M. Blake, "Beyond the I.T.T. Case," Harper's Magazine June 1972, pp. 74-78.
24. W. Adams, "Politics, Power and the Large Corporation," (forthcoming).
25. C. D. Edwards, "Conglomerate Business as a Source of Power," in National Bureau for Economic Research, ed., Business Concentration and Price Policy (Princeton Univ. Press 1955); see also Harlan M. Blake, "Conglomerate Mergers and the Antitrust Laws," 73 Colum. L. Rev. 555-592 (1973).
THE PUBLIC POLICY QUESTION
The essence of a firm's economic power is the ability to insulate itself from the social control mechanism imposed by the market or by government or by both. It is the capacity "to avoid market or political sanctions for poor performance." "26 The basic elements of such power are the ability (1) to exploit mutual interdependence, and (2) to erect barriers against new competition, and thus stifle the emergence of alternative sources of supply. The manifestations of this power may occur in a horizontal, vertical, or conglomerate structural context.
If this be so, what is the appropriate social control mechanism to deal with economic power? Demsetz gives us a Hobson's choice:
Should our efforts be directed to the task of reducing the degree of government intervention, or should we seek to restructure industries and to modify the competitive tactics used by firms? Those who subscribe to the belief that self-sufficient monopoly is the main problem will answer this question by seeking more intervention, while those who see the source of monopoly in government intervention will seek to reduce the role of government in our economy.27
Demsetz himself clearly opts for the latter course of action, but feels that its implementation "is hardly the province of the economist."
I find part of Demsetz' argument highly persuasive. Indeed, some twenty years ago, in Monopoly in America: The Government as Promoter, Horace Gray and I concluded that the great aggregations of power in this country are not the will of God. They do not conform to some inexorable law of nature. They are not a response to technological or economic imperatives. We found that, in large measure, these power aggregations are the result of unwise, discriminatory, and privilege-creating actions of government. They are the creatures of political power exercised as a reflection of, and on behalf of, private economic power.2
Conceding, therefore, that government is a promoter of monopoly, the political economist still faces two additional questions. First, is the government the only villain or is it probable that, even in the absence of government intervention, private interests will succeed in forging conspiracies, mergers, and monopolies which are immune from public control and contrary to the public interest? Second, if the government is indeed the only culprit, is this not largely a reflection of the power distribution in the economy? Is it not imperative to strive for a decentralization of the power structure precisely in order to reduce the likelihood that government will become an Elizabethan handmaiden of private interests? I submit that both these questions must be
26. W. J. Adams, "Market Structure and Corporate Power," 74 Colum. L. Rev. (1974).
27. "Two Systems of Belief About Monopoly," this volume, Chapter 4.
28. W. Adams and H. M. Gray, Monopoly in America: The Government as Promoter (Macmillan 1955).
answered in the affirmative. As political economists and heirs of Adam Smith, and as a gesture to empirical relevance, we simply cannot afford to assume that politics and economics operate in separate, hermetically sealed spheres.29
Let me illustrate this proposition again by reference to the petroleum industry. Here, government has certainly played the role described by Demsetz and others. In the name of conservation and national defense, it has provided the indispensable legal underpinnings for an industrywide cartel. It has done for the oil companies what they could not legally do for themselves without violating the per se prohibitions of the antitrust laws against price-fixing and market allocations.
The process is familiar, although for the moment it may be of only historical interest. The Bureau of Mines in the Department of the Interior publishes monthly estimates of the market demand for petroleum (at desired prices, of course), thus establishing a national production quota. Under the Interstate Oil Compact, approved by Congress, these estimates are broken down into quotas for each of the oil-producing states which, in turn, through various prorationing devices, allocate "allowable production" to individual wells. Oil produced in violation of these prorationing regulations is branded as "hot oil," and the federal government prohibits its shipment in interstate commerce. Also, to buttress this output-restriction and price-maintenance scheme against potential competition, the government protects the industry with a tariff of 10.5 cents per barrel on crude oil and with import quotas (belatedly suspended in May 1973). Finally, to top off these indirect subsidies with more visible favors, the government authorizes oil companies to charge off a 22 percent depletion allowance against their gross income, to "expense" their intangible drilling costs, and to apply their foreign tax and royalty payments as an offset against their obligations to the United States Treasury.
The absurdity of these government restrictions hardly requires detailed comment. For example, it is incontrovertible that the import quotas originally justified by national self-sufficiency and national defense considerations had the following deleterious effects:30 (1) supply was artificially limited and domestic prices were artificially raised; (2) domestic reserves were utilized at an accelerated rate while foreign production was artificially kept out of the American market; (3) the United States was less self-sufficient in 1974 than it was when the import restraints were first imposed; (4) the construction of domestic refinery capacity a key factor in the current energy crisis was inhibited by the systematic exclusion of foreign crude oil; and (5) the taxpayer was forced to subsidize overseas operations which yielded no benefits to him.
29. See, e.g., J. K. Galbraith's presidential address to the American Economic Association, "Power and the Useful Economist," American Economic Review, 63 (March 1973), pp. 1-11.
30. See, e.g., testimony by Jesse Markham and A. E. Kahn before the Special Subcommittee on Integrated Oil Operations of the Senate Committee on the Interior and Insular Affairs, 93rd Congress, 1st Session (December 12, 1973 and November 28, 1973, respectively).