U.S. antitrust law aims to increase the economic efficiency of markets by preventing firms from unduly limiting competition. More efficient markets spur the product and service innovations that deliver greater value to consumers and help drive the nation’s long-term economic growth, economists say. Most markets in the real world violate many assumptions of perfect competition; in other words, firms often have some power to set price, products are heterogeneous, information is imperfect, and there are some entry and exit barriers.
Regulators may weigh a host of complex factors before deciding whether and how to intervene, including appropriate economies of scale, relevant market size, innovation implications, and foreign competition. In many ways, the evolution of U.S. antitrust law can be best understood through a look at major Supreme Court cases.
U.S. antitrust law has roots in the robber-baron days when legislators sought to regulate interstate trade and restrain the growth of and abuses by monopolies such as Standard Oil. Many firms seeking to grow were hindered by state laws limiting a corporation’s size. To circumvent these restrictions, business leaders began combining assets into a new consolidated entity known as a "trust." Today, antitrust policy is broader and seeks to limit a wide array of anticompetitive actions, such as price-fixing, bid-rigging, divvying up customers, and mergers that can corner markets.
The first major antitrust law was the 1890 Sherman Act, which prohibited monopolies, as well as contracts, combinations, trusts, and behaviors that resulted in "unreasonable restraint of trade." However, the law was not specific on what constituted restraint of trade.
In 1902, amid a wave of major corporate mergers, the administration of President Theodore Roosevelt sued to break up Northern Securities, a great railroad trust with high-profile backers such as J.P. Morgan and John D. Rockefeller. The firm’s dissolution cemented Roosevelt’s reputation as a "trust-buster." In 1911, the Supreme Court ordered the breakup of petroleum behemoth Standard Oil into thirty-four smaller firms. Some of them evolved into familiar names such as Exxon, Mobil, Conoco, Amoco, and Chevron.
President Woodrow Wilson strengthened the U.S. antitrust regime in 1914 with the Clayton Antitrust Act and the creation of the Federal Trade Commission (FTC). Clayton widened the scope of prohibited anticompetitive behaviors, including mergers that reduce market competition, exclusive dealing and tying arrangements, and price discrimination between different buyers that tends to create a monopoly. Clayton’s prohibitions were the basis for cases such as the 1936 tying case against IBM requiring lessees of tabulating machines to buy only IBM punch cards.
The FTC, charged primarily with consumer protection, can challenge unfair competition independently of the Department of Justice (DOJ). Few other nations have two independent watchdog agencies—an arrangement that some analysts say is inefficient and creates uncertainty for businesses. Today, the agency with greater expertise in a particular industry tends to take the lead, but jurisdiction is still shared. In cases such as Google, both agencies may investigate without ultimately pursuing a case.
Subsequent laws, such as the Robinson-Patman Act of 1936, which strengthened prohibitions on price discrimination, have since been enacted, but the evolution of U.S. antitrust law has largely been driven by judicial review, particularly by the Supreme Court. Experts describe this legal dynamic as a "common law" approach to antitrust, since it allows the law to adapt as needed.
"Because there are so few Supreme Court antitrust decisions each year—and because each one sets precedent that will govern the application of the antitrust laws in the lower courts for decades to come—each decision is an event of major significance for antitrust enforcers and the antitrust bar," says R. Hewitt Pate, former assistant attorney general for the antitrust division.
As the Progressive Era gave way to the roaring twenties, a period dominated by successive Republican administrations, Washington’s focus on antitrust ebbed. However, the administration of President Franklin Delano Roosevelt and the New Deal era saw a resurgence in federal and state oversight of industry.
The 1950s and 1960s saw an increased focus on the ill effects of barriers to entry and a diminished emphasis on the potential benefits from economies of scale. For instance, in 1962, the Supreme Court acknowledged that the merger of Brown Shoe had potential benefits for consumers due to greater economies of scale, but decided that promoting greater competition among viable small businesses was more desirable, even if higher prices result.
Through the 1970s, economists gained greater voice in antitrust enforcement agencies, and the Chicago School gained prominence. These economists, led by Milton Friedman, advocated for less government intervention in the economy and saw most barriers to entry as less significant than earlier thought. Indeed, rulings of the 1970s overturned precedents that had established "per se prohibitions," in which an act is by its nature illegal. The courts instead required economic rationale to prove deleterious effects on consumers or competition.
In 1972, U.S. v. General Dynamics effectively overturned Brown Shoe by declaring that market-share statistics were insufficient to block a merger if a threat to competition could not be demonstrated. In 1977, the Supreme Court overturned the 1967 Schwinn ruling, finding that GTE Sylvania could establish territories for franchisees, within reason.
In the 1980s and 1990s, the increasing role of game theory in antitrust policy helped reveal subtle strategies firms can employ to potentially wound rivals. For instance, a retailer that offers to match any competing sales offer may seem, at first glance, to be consumer friendly. However, by applying game theory, it can be interpreted as an anticompetitive strategy to keep prices artificially high by removing the incentive for other retailers to decrease prices. This perspective helped the FTC prevent the merger [PDF] of the baby food businesses of H.J. Heinz and Beach-Nut in 2001.
Balancing Economies of Scale and Market Power
Most economists agree that antitrust policy should balance the potential economic harm from greater concentration of market power with the benefits offered by large enterprises with economies of scale. Positive economies of scale allow larger firms to charge lower prices to attract more customers. Often the question for regulators is: How big is "too big"?
In markets with extreme positive economies of scale that have little benefit from differentiation, the market can be most efficiently served by one firm, a natural monopoly. One example is water distribution; society would be ill served by the additional costs of overlapping networks of pipes. In cases such as utilities, the lone firm is often closely regulated.
Externalities, in which an economic decision spills over and affects others, can occur so that the prevailing market price does not capture all costs or benefits. An example is positive network effects, in which the value of a service increases with the number of users. Network effects often occur in new technologies such as social media. If these effects are strong, then one firm may quickly gain dominance, its very size becoming a strength difficult for new entrants to overcome.
Operating systems have network effects. As more users adopt a common platform, other users benefit from enhanced interoperability; more developers tailor their software to the larger user base. Acknowledging these benefits, DOJ’s case against Microsoft was not focused on the existence of a near monopoly in the operating system market, but rather the company’s alleged attempts to leverage that market power to dominate in other areas, such as Internet browsing and office-productivity software.
Defining the Market
Government regulators must define the market and a firm’s position in it when assessing the need for intervention. DOJ defines market participants as firms that currently earn revenue in a market as well as those firms that could rapidly enter a market with little sunk cost. But this is often a complex question.
For instance, the merger of Sirius and XM in 2008 created a dominant firm in satellite radio, which could have hurt consumers through higher prices. However, if the market is defined more broadly as music delivery, there are a host of potential competitors, including terrestrial radio, Internet streaming services, CDs, iPods, etc. These alternatives, in addition to potential efficiency gains, persuaded the DOJ to approve the merger in 2008.
The difficulty of market definition is exacerbated by the unpredictable technological change that can rapidly reform markets. In 1984, the government broke up AT&T’s telephone monopoly into seven "Baby Bells" in order to encourage competition in the long-distance market. While landline long-distance rates did ultimately fall, the technology’s importance is far less today. Through later mergers, the seven became three, and one even gobbled up its former parent company. Today, Verizon Wireless and AT&T share a combined 70 percent of the growing U.S. mobile phone market, with accusations of uncompetitive behavior.
Economists are divided over whether market power aids innovation [PDF]. Economist Joseph Schumpeter theorized that substantial market power allowed some firms to engage in long-term research and development (R&D) that brought about major innovations. An example is Bell Labs, the R&D arm of AT&T, whose bevy of far-reaching innovations from the laser to the transistor was paid for by monopoly profits.
Other economists suggest dominant firms innovate less. Large barriers to entry can insulate existing technologies. However, when barriers to entry are small, the mere threat of new competition may push a dominant incumbent to innovate. Antitrust authorities may share some of the credit for the rapid innovation in the communications market since AT&T’s breakup in 1984.
Converging Antitrust Policies?
In today’s global economy, antitrust policies of foreign governments matter greatly. Many developing nations have derived their antitrust legal framework from Western models, often as a condition of trade agreements. The United States provides antitrust technical assistance to several emerging-economy nations, including Russia, China, Brazil, and India. Economists say a nation’s success in regulating anticompetitive behavior is a function of many factors, including its level of economic development, openness to trade, and level of corruption.
The general focus of U.S. antitrust policy is the preservation of competition that protects consumer interests. In contrast, European antitrust policy is more focused on protecting competitors. Analysts say these different perspectives may have prompted the European Commission to reject the proposed merger of GE and Honeywell in 2001, a union Washington had already green-lighted. Still, the two are moving closer together due to mutual consultation, converging guidelines, and the work of nongovernmental bodies.
Multinational corporations are particularly interested in the convergence of global antitrust policies. "Every time I talk with executives doing business around the world, consistency of antitrust enforcement is their top concern for me," said Christine A. Varney, assistant attorney general for the antitrust division, at a CFR meeting in 2009. "A single antitrust enforcer can affect businesses and consumers worldwide. A lack of unity creates significant difficulties for firms developing business strategies in a global economy."
In early 2014, EU antitrust authorities once again signaled a willingness to go further than their U.S. counterparts. They settled a three-year-old antitrust case with Google that required the U.S. tech giant to change several practices related to its dominant Internet search business, including the way it displays competitors’ results. "The concessions are far-reaching and have the clear potential of restoring a level playing field with competitors," said EU antitrust commissioner Joaquín Almunia. "No antitrust authority in the world has obtained such concessions." Just one year prior, the FTC dropped its inquiry into Google, ruling that consumers were not harmed by the firm’s search practices. Google did pledge to change operations related to other business, like patented technology use.