June 12, 1998

ANTITRUST, BY ALAN GREENSPAN

Memo To: SSU Students on summer break
From: Jude Wanniski
Re: Guest Lecture

(Based on a paper given at the Antitrust Seminar 
of the National Association of Business Economists, 
Cleveland, September 25, 1961. Published by 
Nathaniel Branden Institute, New York, 1962.)

The world of antitrust is reminiscent of Alice's Wonderland: 
everything seemingly is, yet apparently isn't, simultaneously. 
It is a world in which competition is lauded as the 
basic axiom and guiding principle, yet "too much" competition
 is condemned as "cutthroat." It is a world in which actions 
designed to limit competition are branded as criminal when
 taken by businessmen, yet praised as "enlightened" when 
initiated by the government. It is a world in which the law 
is so vague that businessmen have no way of knowing 
whether specific actions will be declared illegal until they
 hear the judge's verdict -- after the fact.

In view of the confusion, contradictions, and legalistic 
hairsplitting which characterize the realm of antitrust,
 I submit that the entire antitrust system must be 
opened for review. It is necessary to ascertain and to
 estimate: (a) the historical roots of the antitrust laws, 
and (b) the economic theories upon which these laws 
were based.

Americans have always feared the concentration of arbitrary 
power in the hands of politicians. Prior to the Civil War, 
few attributed such power to businessmen. It was recognized 
that government officials had the legal power to compel 
obedience by the use of physical force -- and that 
businessmen had no such power. A businessman needed 
customers. He had to appeal to their self-interest.

This appraisal of the issue changed rapidly in the immediate 
aftermath of the Civil War, particularly with the coming
 of the railroad age. Outwardly, the railroads did not have
 the backing of legal force. But to the farmers of the West,
 the railroads seemed to hold the arbitrary power previously
 ascribed solely to the government. The railroads appeared 
unhampered by the laws of competition. They seemed able 
to charge rates calculated to keep the farmers in seed 
grain -- no higher, no lower. The farmer’s protest took the
 form of the National Grange movement, the organization 
responsible for the passage of the Interstate 
Commerce Act of 1887.

The industrial giants, such as Rockefeller's Standard Oil Trust, 
which were rising during this period, were also alleged to 
be immune from competition, from the law of supply and
 demand. The public reaction against the trusts culminated
 in the Sherman Act of 1890.

It was claimed then -- as it is still claimed today -- 
that business, if left free, would necessarily develop into
 an institution vested with arbitrary power. 
Is this assertion valid? Did the post-Civil War period 
give birth to a new form of arbitrary power? Or did the 
government remain the source of such power, with 
business merely providing a new avenue through which
 it could be exercised? This is the crucial historical question.

The railroads developed in the East, prior to the Civil War, 
in stiff competition with one another as well as with the 
older forms of transportation -- barges, riverboats, and 
wagons. By the 1860's there arose a political clamor 
demanding that the railroads move west and tie California 
to the nation: national prestige was held to be at stake. 
But the traffic volume outside of the populous East was 
insufficient to draw commercial transportation westward. 
The potential profit did not warrant the heavy cost of 
investment in transportation facilities. In the name of 
"Public policy" it was, therefore, decided to subsidize the 
railroads in their move to the West.

Between 1863 and 1867, close to one hundred million acres
 of public lands were granted to the railroads. 
Since these grants were made to individual roads, no competing
 railroads could vie for traffic in the same area in the West.
 Meanwhile, the alternative forms of competition 
(wagons, riverboats, etc.) could not afford to challenge the 
railroads in the West. Thus, with the aid of the federal government, 
a segment of the railroad industry was able to "break free' from 
the competitive bounds which had prevailed in the East.

As might be expected, the subsidies attracted the kind of 
promoters who always exist on the fringe of the business 
community and who are constantly seeking an "easy deal."
 Many of the new western railroads were shabbily built: 
they were not constructed to carry traffic, but to acquire 
land grants. The western railroads were true monopolies in 
the textbook sense of the word. They could, and did, behave
 with an aura of arbitrary power. But that power was not 
derived from a free market. It stemmed from governmental 
subsidies and governmental restrictions. (Chapter 7)

When, ultimately, western traffic increased to levels which 
could support other profit-making transportation carriers, 
the railroads' monopolistic power was soon undercut. 
In spite of their initial privileges, they were unable to withstand 
the pressure of free competition. In the meantime, however, 
an ominous turning point had taken place in our economic history: 
the Interstate Commerce Act of 1887. That Act was not necessitated
 by the "evils" of the free market. Like subsequent legislation 
controlling business, the Act was an attempt to remedy the economic
 distortions which prior government interventions had created, 
but which were blamed on the free market. 
The Interstate Commerce Act, in turn, produced new distortions
 in the structure and finances of the railroads. Today, it is proposed
 that these distortions be corrected by means of further subsidies.
 The railroads are on the verge of final collapse, yet no one challenges 
the original misdiagnosis to discover -- 
and correct -- the actual cause of their illness.

To interpret the railroad history of the nineteenth century 
as "proof" of the failure of a free market, is a disastrous error. 
The same error -- which persists to this day -- was the nineteenth 
century's fear of the "trusts." The most formidable of the "trusts" 
was Standard Oil. Nevertheless, at the time of the passage of 
the Sherman Act, a pre-automotive period, the entire petroleum 
industry amounted to less than one percent of the Gross National 
Product and was barely one-third as large as the shoe industry. 
It was not the absolute size of the trusts, but their dominance 
within their own industries that gave rise to apprehension. 
What the observers failed to grasp, however, was the fact that 
the control by Standard Oil, at the turn of the century, of more 
than eighty percent of refining capacity made economic sense 
and accelerated the growth of the American economy.

Such control yielded obvious gains in efficiency, through the 
integration of divergent refining, marketing, and pipeline operations;
 it also made the raising of capital easier and cheaper. 
Trusts came into existence because they were the most efficient
 units in those industries which, being relatively new, were too small 
to support more than one large company

Historically, the general development of industry has taken the 
following course: an industry begins with a few small firms; in time,
 many of them merge; this increases efficiency and augments profits. 
As the market expands, new firms enter the field, thus cutting down 
the share of the market held by the dominant firm. This has been 
the pattern in steel, oil, aluminum, containers, and numerous other 
major industries. The observable tendency of an industry's dominant 
companies eventually to lose part of their share of the market, is not
 caused by antitrust legislation, but by the fact that it is difficult to 
prevent new firms from entering the field when the demand for a 
certain product increases. Texaco and Gulf, for example, would have
 grown into large firms even if the original Standard Oil Trust had not
 been dissolved. Similarly, the United States Steel Corporation's 
dominance of the steel industry half a century ago would have been 
eroded with or without the Sherman Act.

It takes extraordinary skill to hold more than fifty percent of a large 
industry's market in a free economy. It requires unusual productive ability,
 unfailing business judgment, unrelenting effort at the continuous 
improvement of one's product and technique. 
The rare company which is able to retain its share of the market 
year after year and decade after decade does so by means of 
productive efficiency -- and deserves praise, not condemnation.

The Sherman Act may be understandable when viewed as a projection 
of the nineteenth century's fear and economic ignorance. 
But it is utter nonsense in the context of today's economic knowledge.
 The seventy additional years of observing industrial development should
 have taught us something. If the attempts to justify our antitrust 
statutes on historical grounds are erroneous and rest on a 
misinterpretation of history, the attempts to justify them on theoretical 
grounds come from a still more fundamental misconception.

In the early days of the United States, Americans enjoyed a large 
measure of economic freedom. Each individual was free to produce 
what he chose, and sell to whomever he chose, at a price mutually 
agreed upon. If two competitors concluded that it was to their mutual 
self-interest to set joint price policies, they were free to do so. 
If a customer requested a rebate in exchange for his business, a firm 
(usually a railroad) could comply or deny as it saw fit. 
According to classical economics, which had a profound influence on 
the nineteenth century, competition would keep the economy in balance.

But while many theories of the classical economists -- 
such as their description of the working of a free economy 
-- were valid, their concept of competition was ambiguous and led to 
confusion in the minds of their followers. It was understood to mean 
that competition consists merely of producing and selling the maximum
 possible, like a robot, passively accepting the market price as a law of 
nature, never making any attempt to influence the conditions of the market.

The businessmen of the latter half of the nineteenth century, however, 
aggressively attempted to affect the conditions of their markets by advertising,
 varying production rates, and bargaining on price with suppliers and customers.
 Many observers assumed that these activities were incompatible with the
 classical theory. They concluded that competition was no longer working effectively.
 In the sense in which they understood competition, it had never worked or 
existed, except possibly in some isolated agricultural markets. 
But in a meaningful sense of the word, competition did, and does, exist-in 
the nineteenth century as well as today.

"Competition" is an active, not a passive, noun. It applies to the entire 
sphere of economic activity, not merely to production, but also to trade; 
it implies the necessity of taking action to affect the conditions of the 
market in one's own favor. The error of the nineteenth-century observers 
was that they restricted a wide abstraction -- competition -- to a narrow 
set of particulars, to the "passive" competition projected by their own 
interpretation of classical economics. As a result, they concluded that the 
alleged "failure" of this fictitious "passive competition" negated the entire 
theoretical structure of classical economics, including the demonstration of 
the fact that laissez-faire is the most efficient and productive of all possible 
economic systems. They concluded that a free market, by its nature, leads 
to its own destruction -- and they came to the grotesque contradiction of 
attempting to preserve the freedom of the market by government controls,
 i.e., to preserve the benefits of laissez-faire by abrogating it.

The crucial question which they failed to ask is whether "active" competition 
does inevitably lead to the establishment of coercive monopolies, as they supposed 
-- or whether a laissez-faire economy of "active" competition has a built-in regulator
 that protects and preserves it. That is the question which we must now examine.

A "coercive monopoly" is a business concern that can set its prices and production
 policies independent of the market, with immunity from competition, from the law
 of supply and demand. An economy dominated by such monopolies would be rigid 
and stagnant. The necessary precondition of a coercive monopoly is closed entry 
-- the barring of all competing producers from a given field. 
This can be accomplished only by an act of government intervention, in the form
 of special regulations, subsidies, or franchises. Without government assistance,
 it is impossible for a would-be monopolist to set and maintain his prices and 
production policies independent of the rest of the economy. 
For if he attempted to set his prices and production at a level that would yield 
profits to new entrants significantly above those available in other fields, 
competitors would be sure to invade his industry.

The ultimate regulator of competition in a free economy is the capital market. 
So long as capital is free to flow, it will tend to seek those areas which 
offer the maximum rate of return. The potential investor of capital does 
not merely consider the actual rate of return earned by companies within
 a specific industry. His decision concerning where to invest depends on 
what he himself could earn in that particular line. The existing profit rates
 within an industry are calculated in terms of existing costs. He has to 
consider the fact that a new entrant might not be able to achieve at once 
as low a cost structure as that of experienced producers.

Therefore, the existence of a free capital market does not guarantee 
that a monopolist who enjoys high profits will necessarily and immediately 
find himself confronted by competition. What it does guarantee is that a 
monopolist whose high profits are caused by high prices, rather than low 
costs, will soon meet competition originated by the capital market.

The capital market acts as a regulator of prices, not necessarily of profits.
 It leaves an individual producer free to earn as much as he can by lowering 
his costs and by increasing his efficiency relative to others. 
Thus, it constitutes the mechanism that generates greater incentives to increased 
productivity and leads, as a consequence, to a rising standard of living.

The history of the Aluminum Company of America prior to World War II illustrates
 the process. Envisaging its self-interest and long-term profitability in terms 
of a growing market, ALCOA kept the price of primary aluminum at a level 
compatible with the maximum expansion of its Market. At such a price level,
 however, profits were forthcoming only by means of tremendous efforts to 
step up efficiency and productivity. ALCOA was a monopoly -- the only producer 
of primary aluminum -- but it was not a coercive monopoly, i.e., it could not 
set its price and production policies independent of the competitive world. 
In fact, only because the company stressed cost-cutting and efficiency, 
rather than raising prices, was it able to maintain its position as sole producer 
of primary aluminum for so long. Had ALCOA attempted to increase its profits by 
raising prices, it soon would have found itself competing with new entrants in 
the primary aluminum business.

In analyzing the competitive processes of a laissez-faire economy, one must 
recognize that capital outlays (investments in new plant and equipment either 
by existing producers or new entrants) are not determined solely by current profits. 
An investment is made or not made depending upon the estimated discounted 
present worth of expected future profits. Consequently, the issue of whether 
or not a new competitor will enter a hitherto monopolistic industry, is determined
 by his expected future returns. The present worth of the discounted expected 
future profits of a given industry is represented by the market price of the 
common stock of the companies in that industry. If the price of a particular 
company's stock (or an average for a particular industry) rises, the move implies
 a higher present worth for expected future earnings.

Statistical evidence demonstrates the correlation between stock prices 
and capital outlays, not only for industry as a whole, but also within major
 industry groups. Moreover, the time between the fluctuations of stock prices
 and the corresponding fluctuations of capital expenditures is rather short, 
a fact which implies that the process of relating new capital investments 
to profit expectations is relatively fast. If such a correlation works as well 
as it does, considering today's governmental impediments to the free movement
 of capital, one must conclude that in a completely free market the process 
would be much more efficient.

The churning of a nation's capital, in a fully free economy, would be continuously 
pushing capital into profitable areas -- and this would effectively control the 
competitive price and production policies of business firms, making a coercive 
monopoly impossible to maintain. It is only in a so-called mixed economy that 
a coercive monopoly can flourish, protected from the discipline of the capital 
markets by franchises, subsidies, and special privileges from governmental regulators.

To sum up: The entire structure of antitrust statutes in this country is a jumble 
of economic irrationality and ignorance. It is the product: (a) of a gross misinterpretation 
of history, and (b) of rather naive, and certainly unrealistic, economic theories.

As a last resort, some people argue that at least the antitrust laws haven't 
done any harm. They assert that even though the competitive process itself 
inhibits coercive monopolies, there is no harm in making doubly sure by declaring 
certain economic actions to be illegal.

But the very existence of those undefinable statutes and contradictory case
 law inhibits businessmen from undertaking what would otherwise be sound 
productive ventures. No one will ever know what new products, processes, 
machines, and cost-saving mergers failed to come into existence, killed by 
the Sherman Act before they were born. No one can ever compute the price 
that all of us have paid for that Act which, by inducing less effective use of capital,
 has kept our standard of living lower than would otherwise have been possible.

No speculation, however, is required to assess the injustice and the damage 
to the careers, reputations, and lives of business executives jailed under 
the antitrust laws. Those who allege that the purpose of the antitrust laws
 is to protect competition, enterprise, and efficiency, need to be reminded 
of the following quotation from Judge Learned Hand's indictment of ALCOA's
 so-called monopolistic practices:

It was not inevitable that it should always anticipate increases in the demand
 for ingot and be prepared to supply them. Nothing compelled it to keep 
doubling and redoubling its capacity before others entered the field. 
It insists that it never excluded competitors; but we can think of no more 
effective exclusion than progressively to embrace each new opportunity as 
it opened, and to face every newcomer with new capacity already geared 
into a great organization, having the advantage of experience, trade 
connections and the elite of personnel.

ALCOA is being condemned for being too successful, too efficient, 
and too good a competitor. Whatever damage the antitrust laws may have
 done to our economy, whatever distortions of the structure of the nation's 
capital they may have created, these are less disastrous than the fact that
 the effective purpose, the hidden intent, and the actual practice of the 
antitrust laws in the United States have led to the condemnation of the 
productive and efficient members of our society because 
they are productive and efficient.