Review of Industrial Organization 6: 161-176, 0 1991 Kluwer Academic Publishers. Printed

1991 in the Netherlands.

Market Dominance under U. S . Antitrust

WILLIAM University

G.

SHEPHERD’

of Massachusetts,

Amherst,

MA

01003,

U.S.A.

In a collection of papers honoring Walter Adams’ work on many parts of the monopoly question, American policies to reduce market dominance are a natural topic. These policies are the country’s traditional method for reducing market power. I will consider their past effects and discuss what might be done in the future. During the 1980s one effect of the Chicago-UCLA and “contestability” ascendancy at the federal antitrust agencies - the result of a kind of coup de la Mu&n Blanc - has been to suspend actions under Section 2 of the Sherman Act.’ But those doctrines are controversial, and they seem already to be giving ground. Hence the supposed “revolution” in antitrust may be slowed, stopped or reversed.3 Section 2 is at rest, but is it moribund or merely napping? Should it be revived? If so, what might it accomplish? In addressing these questions, I will discuss the evolution of market dominance and its relation to price discrimination. My theme accords with Adams’ view that economic power continues to endanger economic performance as well as larger social values. Market power’s harmful effects fall especially on innovation, which is neglected in much of the current theoretical analysis dwelling on the maximization of consumer surplus. Monopoly’s supposed benefits need to be assessed cautiously, not with the naivete that is evident, for example, in much writing about “contestability.” Adams has always reminded us, with his rich sense of history and social theory, that monopoly can have deep impacts throughout society.4 Adam Smith knew it, as did John Stuart Mill, Alfred Marshall, Henry Carter Adams, and the original Chicago School, including Frank H. Knight and Henry C. Simons. In the current honing of tight little models, we often see the loss of this meaning. The main body of the paper discusses the process by which dominance may rise and fade, particularly when price discrimination is involved. I will also discuss some leading antitrust cases against dominance, noting that even the “drastic” remedies were moderate.

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1. Dominance and Ineffective Competition A valid theory of competition must provide not only for static allocative efficiency, but also for innovation and the competitive process itself. The latter two lie outside of much of the “new IO” analysis, which has dealt primarily with the maximizing of static allocative efficiency.5 Elsewhere I and others have assessed the new schools at some length, noting their narrowness, logical defects, and weak empirical foundations.6 Rigor is often obtained by sacrificing reality and/or relevance. The “efficient structure” hypothesis is a central proposition in the “new IO” theory, but it is still merely an untested claim. Market dominance (a market share over 40 percent, with no close rivals) can reflect market imperfections of many kinds. High profits can contain monopoly elements as well as rents. Also, excess profits can have negative effects on companies’ performance. In particular, excess profits may retard innovation, rather than stimulate it. Accordingly, dominance cannot be relied on to provide effective competition; and no real cases of “perfect contestability” (Baumol, Panzar and Willig, 1982; Baumol and Willig, 1986) exist for testing the claim that monopoly will deliver competitive outcomes. Non-collusive game theory also misses the central problem, by assuming away all possible collusion at the start. It is really just about business strategy, rather than about the normative analysis of dominance and possible collusion.’ Effective competition continues to require an absence of dominance; enough competitors to preclude collusion; and ease of entry (see Scherer and Ross, 1990; Shepherd, 1990; Mueller, 1986; and Hay and Vickers, 1987). The presumption that dominance involves ineffective competition could be rebutted by sufficient evidence. But substantial evidence to that effect has not been forthcoming. The burden of proof is against actual dominance. Dominance can only be justified by proof of large scale economies or of strongly superior performance that could not be obtained by alternative means. Ordinarily, superior performance does not require profit rewards much above those for competitive firms (see Shepherd, 1989). Yet dominance is a complex phenomenon, which occurs by an evolution of the market’s structure. A better understanding of that evolution can help guide wise policy choices. Thus, if dominance fades rapidly under natural erosion, then antitrust actions may be unnecessary. In the next section, I explore the conditions which shape the evolution of dominance in the competitive process.

2. The Evolution of Dominance Consider the basic conditions which create dominance, particularly the competitive process to degenerate into single-firm dominance.

those that lead

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2.1. SOURCES OF EXCESS PROFIT

The competitive process itself may create a normative dilemma, from a possible conflict between (1) the incentives to gain dominance, and (2) the effects of the resulting dominance in harming efficiency and innovation. The problems can occur because all firms naturally seek to dominate their markets, so as to reap the resulting excess profits. Yet if one firm competes so successfully that it does attain dominance, then competitive parity is lost, competition usually becomes ineffective, and monopoly losses from inefficiency and retarded innovation are imposed. Hence the competitive process may be unstable and contradictory, with an inner tendency to eliminate itself. Preserving the firms’ motive for winning, but also avoiding the damage that follows when a complete victory occurs, may seem to be impossible. If dominance arises because of large economies of scale or superior efficiency, then policy steps to restore competition might be said to be “anti-efficient.” If an efficiency-created dominant firm is restrained so as to restore competitive parity, then its (and other firms’) incentives for high effort and superior efficiency might be reduced or eliminated. Accordingly, dominance might offer a Faustian bargain: in order to motivate firms’ competitive efforts to attain superior performance, it may be necessary to sacrifice effective competition itself when dominance occurs. That supposed dilemma is embodied precisely in the efficient-structure claim made by ChicagoUCLA economists and lawyers (Demsetz, 1973, 1974; Bork, 1978; and McGee, 1974; see also Baumol and Ordover, 1985). The seeming dilemma has been used to challenge antitrust policies since its beginnings in the 1890s and particularly during the 1980s. It is necessary, according to Bork and others, to withdraw most antitrust enforcement so as not to impede efficiency. Yet like many supposed dilemmas, this one is actually a matter of degree, rather than necessarily of a pure either-or choice. That can be seen by considering what firms actually do in evolving markets, in seeking their optimal market shares over time. There is an ongoing balancing among several elements, in the process by which high market shares are acquired and maintained. The supposed dilemma may be resolved by analyzing the sequence of choices made by firms. Moreover, the supposed dilemma is irrelevant whenever firms obtain dominance from market imperfections rather than by superior performance. And finally there is a further gap in the supposed dilemma: the firm’s urge to perform well may remain strong even if the profit rewards are kept down to, or near, the competitive levels of profit, rather than at high monopoly levels. High monopoly profits may be entirely unnecessary. In fact, high profits are unnecessary to stimulate innovation in most markets: moderate profit expectations serve to provide powerful motivations throughout the mass of competitive industries (Shepherd, 1989). And high excess profits may later stifle the firm’s innovative performance rather than stimulate it.

164 2.2.

WILLIAM MARKET

STRUCTURES

AND

REWARD

G. SHEPHERD

STRUCTURES

At any rate, one central relationship in the problem is the structure of rewards (i.e., the gradation of firms’ profitability) as it relates to the structure of the market (embodied in firms’ market shares). Also important is the rate at which a high market share will decline over time. Dominance may emerge from either or both of (1) some degrees of scale economies or superior efficiency, and/or (2) an unstable dynamic, cumulative process, in which the profit yields of market share in each period generate a sequence of rising profits and market shares. How that process may occur is a key topic.

2.3. THE

MARKET

SHARE-RATE

OF RETURN

FUNCTION

There is a general market-share-profit-rate relationship (let us call it the MS-RR function), which shows the profit yields of market share (Shepherd, 1975, 1990). The marginal profit yield of market share (we can call it A, the slope of the relationship) may be steeply or slightly gradated, depending on the particular conditions of each market. Consider the sequence of the competitive process. The MS-RR function shows the successive profit rates which a firm attaining dominance can obtain, as its market share rises. A rise along the MS-RR function can generate dominance, because the profits realized in each period enlarge the range of competitive strategies available to the firm in subsequent periods: higher profits permit more aggressive, expensive strategies. Each period’s change in market share then reflects the previous period’s profitability. Hence the MS-RR function can make the competitive process an unstable one, which degenerates into dominance or even pure monopoly if the slope is high. The degree of instability varies directly with the profit yield (the A value). With higher A slopes, competition is less stable and more prone to monopoly, because the successive profit advantages are larger. Dominance can result more rapidly and surely, even if there are no underlying economies of scale or superior efficiency. Imperfections in the market may accentuate the unstable process. Imperfections are of many sorts, including asymmetric control over information, strategic actions, consumer loyalties inculcated by advertising, the intimidation of small rivals, and access to capital and other inputs at favorable prices (Scherer and Ross, 1990; Shepherd, 1990).* These conditions usually favor the firm with the larger market share, because it has larger resources for winning competitive episodes.

2.4.

COUNTER-FORCES

Yet the cumulative process toward dominance three opposing forces.

will usually encounter one or all of

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1. One is the general process of decay which competition imposes on high market shares, as rivals probe for weaknesses and exert maximum effort to raise their own shares (see Shepherd, 1975, 1990; and Geroski, a chapter in Hay and Vickers, 1987) The general process of erosion is common in markets, though the rate of the erosion (call it E) may vary over a wide range from case to case. And some firms are able to avoid it altogether. 2. A second counter-force is diseconomies of scale. In most markets, minimum efficient scale is reached at rather low market shares, such as 3 to 10 percent of the market (see Scherer and Ross, 1990). At larger sizes there may be constant average costs, as the research literature suggests. Yet many industries involve significant diseconomies, which progressively offset the monopoly-based rising marginal profit yields of market share. That possible up-slope (call it C) penalizes higher market shares and discourages dominance. It could constrain market shares to levels below complete monopoly, even if all other factors would create a lOO-percent market share. 3. The third counter-force is the dominant firm’s own tendency toward X-i@jkiency and u retardation of innovation, as competitive pressure on the firm is reduced. That tendency will slow the rise in the firm’s market share and reinforce the tendency toward erosion of the market share. The net outcome for the firm’s actual market share at each moment will be a vector of these conditions:

Optimum

Market

Share=a function of (A, E, C)

Each firm will hold a market share which reflects the combined effects of those (and possibly other) factors. The coefficients of the factors may vary among industries. But the signs of the partial relationships can be predicted. The sign of A will generally be positive; E’s will be negative; and C’s will also be negative. A high A value may induce dominance to occur even if there are diseconomies of scale. As long as A is greater than C, the net tendency is for the firm to seek a higher market share, even if the diseconomies are significant.

2.5.

EMPIRICAL

EVIDENCE

There is growing evidence about the three main elements: profit yields (A), erosion (E), and diseconomies of scale (C).

166 25.1.

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G. SHEPHERD

The Profit Yield (the A Value)

The cross-industry patterns of MS-RR functions have been studied in fairly great detail (including among others Scherer and Ross, 1990; Shepherd, 1972, 1975, 1986, 1990; Mueller, 1986; Hay and Vickers, 1987). The estimated profit yields lie mainly in the range 0.15 to 0.3, with an intercept at a competitive profit rate which approximates the opportunity cost of capital.’ Thus, a lo-point rise in market share is associated with a 1.5 to 3.0 point rise in the rate of return on equity capital. In contrast, the A slopes implied by Chicago-UCLA analysis are low. The MSRR function would rise toward monopoly rates of return only at very high market shares (above 80 percent).” Yet Chicago-UCLA empirical work has been slight, and so the mainstream estimates are the best indicators of the probable values.

2.5.2.

The Rate of Erosion

of High Market

Shares (the E Value)

The rate of erosion appears generally to be low.” In the US, Japanese and other economies, its average has ranged between 0.3 to 1 percentage point per year.‘* Antitrust actions have caused some of the erosion. A retention of dominance for a decade or more is therefore normal, and further firms surveyed by rises often occur (e.g., in 32 of the 108 high-market-share Geroski, the market shares rose further rather than declining). On average, a 70 percent market share might usually take 10 to 20 years to decline to 60 percent; such a 60 percent share still involves dominance.

2.5.3. Diseconomies

of Scale (the C Value)

Unfortunately, research on the possible diseconomies of scale has been sparse. Economies (in the range below Minimum Efficient Scale) have been studied in more than 40 industries. But the range to the right of MES has largely been ignored in empirical research. The assumption has become popular that average costs are roughly constant above MES. This hypothesis cannot be refuted with the meager evidence now available. Yet if pecuniary economies are indeed significant, then filtering them out from the observed horizontal cost curves would, by implication, leave up-sloping curves representing the true cost conditions. In fact, pecuniary gains are often significant, especially in the form of volume discounts on input prices. Therefore, it follows that there may usually be significant diseconomies embodied in true costs at output levels above minimum efficient scale.

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EFFECT!5

Together, the high A values and low decay rates indicate that there are usually high and sustained profit rewards for the capture of dominance. Also, the profit incentives to defend dominance are high. Therefore many market structures are likely to be unstable, with a dynamic tendency toward cumulative, non-efficient dominance. The key is the relatively high A values, compared to low E values. To put it in capsule form: the general, underlying conditions lead to the prediction that dominance usually pays and dominance usually stays. Dominance can, and perhaps usually does, arise simply because of the monopoly-profit yields. To that extent, the supposed normative dilemma is imaginary rather than real, in the normal case. Dominance can be expected to evolve and persist because its private rewards are high. Conversely, to that extent, dominance has little or no general, proven claim for existence on normative grounds.

3. Price Discrimination and Dominance Now I turn to another element in the evolution of dominance, looking in more detail at the conditions which create high profit yields (that is, a high A value). This element is the strategic use of price discrimination. Strategic price discrimination has long been recognized as an important force for creating and retaining market dominance. But the topic was long put into a kind of limbo, especially during the 1940s to the 1980s when the preoccupation with oligopoly was strong in the profession. Oligopoly tends to minimize price discrimination, compared to single-firm dominance. Focusing now on dominance, we need to revive the importance of price discrimination. It is particularly important to contrast those conditions of price discrimination which are anti-competitive with those which are neutral or pro-competitive. That is the subject of this section. All firms (whatever their market shares) apply discriminatory pricing for strategic purposes. The scope for a firm’s discrimination generally increases - at least ordinally within a given market - in line with its market share. As market share increases, the firm’s range of demand elasticities among its customers will increase, and so do its abilities to segment those groups and prevent reselling among them.

3.1.

THE

ROLE

OF MARKET

SHARES

When market shares are small, price discrimination will be tried but will be harmless to competition. Indeed, as Adelman observed long ago, discrimination can be intensely pro-competitive, as the flexible discounting of specific prices erodes a price structure that includes prices which have been raised to monopolistic levels.13

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At the opposite extreme is monopoly, where the structure of price discrimination can become thorough, systematic and sustained. The firm will seek to refine its pricing, not only as a way to maximize current profits but also to forestall small rivals and entrants as part of long-run profit maximizing. The dominant firm conducts, as it were, a multi-sided war, with continual adjustments in response to exogenous changes. Its specific price responses are most severe on the individual products where it is most strongly challenged and/or where it sees its greatest long-term total advantages. That is, price cutting is sharpest on products with relatively higher elasticity of demand. Accordingly, firms generally follow discriminatory (or “Ramsey”) pricing in the short run, with their price cutting tending to be in line with the inverse-elasticity rule (see among others Baumol, Panzar and Willig, 1982; and Tirole, 1988). Therefore strategic discrimination appears to deliver short-run efficient pricing, as aligned with the given array of demand conditions. But there are two anti-efficient properties to the discrimination, which the proponents of Ramsey pricing have ignored. First, Ramsey pricing has efficiency properties only when the firm is a classic deficit-bound natural monopoly, lacking sub-additivity (that is, when its marginal costs are below its average costs for individual outputs). l4 Many dominant firms do not fit the assumptions of that extreme case. Moreover, those firms that do fit it now will need to evolve out of that natural-monopoly situation on their way to becoming just one among several comparable rivals under effective competition. Second, the true competitive situation is usually dynamic, not static, in a process over time. Pricing actions have later consequences, and so the dominant firm may often deviate from Ramsey prices in order to pursue long-run objectives with complex strategies toward various specific outputs. Typically, the dominant firm regards certain of its outputs as critical to its long-run position. Accordingly, the firm may often sacrifice short-run profits in order to build these outputs up or to prevent rivals from succeeding in them. Alternatively, the discriminatory prices themselves may be part of a long-run strategy that creates or preserves a higher degree of monopoly. Therefore, efficient Ramsey pricing is neither easily assured nor necessarily socially optimal, either in the short run or long run. But it is indeed assured that as firms gain market share, they will engage in increasingly thorough and systematic price discrimination, to serve their long-run objectives. Conversely, a firm beginning with a formerly-regulated monopoly position will deploy price discrimination as a central part of its strategy for retaining its monopoly. 3.2. MONOPOLY EFFECTS: HIGH MARKET DISCRIMINATION

SHARES AND SYSTEMATIC

The implications can be illustrated simply by bringing together market shares and the degree of systematicness of the discrimination. One imagines a rectangular

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diagram, with market share on the horizontal axis and systematicness of discrimination on the vertical axis. Pro-competitive discrimination would be down in the lower left-hand corner of the rectangle, where firms have only small market shares and their attempts to apply discrimination are sporadic rather than systematic. Their attempts at discriminatory pricing are flexible and effective in promoting competition, against each other and against firms with larger market shares. In contrast, anti-competitive discrimination would be in the upper-right-hand comer of the rectangle, where dominant firms and pure monopolies apply systematic discrimination. The discrimination then tends to entrench or enlarge the dominance still further. The edges of these two comer zones in the rectangle are blurred, not precise, and the extent of the zones may vary to fit the conditions of differing markets. If there are any degrees of imperfections in the market, then the dominant firm’s range of choices, and the anti-competitive impacts of those choices, are increased. For example, if there are customer loyalties and lags in shifting to rivals, then the dominant firm can increase its long-run effect for any given array of prices, or increase its short-run profits while maintaining market share. These impacts can begin at market shares below 50 percent, if say a 30 percent firm has no rival above 10 percent. It may be able to gain extra profits by discrimination and then use those profits in subsequent periods to deepen its strategic discrimination in order to raise its market share. Although all firm are using discrimination, the leading firm may simply be able to do more of it and to use its profits cumulatively to increase its dominance. In this way, discrimination may be a key cause of instability of the competitive process. Without discrimination, the leading firm would be less able to pin-point its rivals and generate excess profits for further pin-point pricing and rises in market share. An important recent example is U.S. airlines, where discriminatory pricing has reached exceedingly thorough patterns, allied with single-airline dominance of many of the larger “hub” airports. In the reverse case, of a monopoly that has been deregulated, the dominant firm will use discrimination as an instrument to retain the monopoly. Recently, AT&T as the former-monopoly supplier of long-distance telephone service has illustrated this problem. Even if Ramsey pricing occurs along inverse-elasticity lines, with short-run efficiency effects, the long-run emergence of effective competition will be slowed, postponed or prevented.

4. Leading Section 2 Cases Against Dominant Firms In light of these points aboutthe origins and evolution of dominance, and about price discrimination’s role, we can turn to some actual United States cases reducing dominance. What worked? How drastic did actions need to be?

170 4.1. GENERAL

WILLIAM

G. SHEPHERD

PATTERNS

The first wave of Section 2 cases was extremely ambitious. No fewer than 6 of the 10 largest firms in the economy were subjected to suits or negotiations about substantial changes. The wave of Section 2 actions succeeded in forcing some changes on most of the defendants, including Standard Oil, American Tobacco, AT&T, DuPont, and the meatpackers. The two later waves (in 1937-1951 and 1969-1982) had lesser targets, attacked fewer of them, and generally had less success in forcing changes. It may be that the main problem cases have successively been cured, leaving more marginal cases for later actions. That is a controversial matter, because important dominant-firm candidates have remained into the 1990s including IBM, Eastman Kodak, Boeing Aircraft, Procter & Gamble, Campbell Soup, and most major-city newspapers. A prominent element in the antitrust cases was the effort to reduce systematic price discrimination. In cases involving United Shoe Machinery, IBM, Xerox, and others, price discrimination was a main target. But perhaps the most striking feature of Section 2 “trust-busting” actions is the mildness of the structural changes actually imposed. Most of these remedies have only removed links among firms, rather than imposing internal surgery on fully formed enterprises. As we will see, Standard Oil and AT&T - the two most spectacular cases - only unbundled the links among the separate firms. And the Xerox, Alcoa, and other cases have adopted indirect, non-structural remedies in order to seek lower degrees of monopoly.

4.2. LEADING

CASES

I will focus on this moderacy briefly, in discussing the Standard Oil, Alcoa, Xerox, and AT&T cases.

4.2.1. Standard Oil This case attacked the country’s most notorious monopoly, created originally in the 1870s. By 1910 it was the largest company in the U.S.. Standard Oil had used abusive acts, including forcing railroads to pay back rebates to it from shipping charges, not only on its own oil shipments but also on each barrel shipped by its rivals. Standard Oil also used deep selective price cuts in order to acquire its small local rivals. The company turned out to be an ideal candidate for attack. Its market share was close to 90 percent, it had a history of abuses, its profits were high, its product was simple and not innovative, and its defense was inept. There was also a nationwide groundswell of attacks on the company by state and local officials and by injured private interests. The federal attack therefore had a wide popular base of support.

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The Standard Oil combine had consisted of numerous state-wide companies, each dominant in its area. This combine was dissolved in 1913 into its individual local monopolies, with no attempt to divide or restructure the individual companies. Competition was slow to develop, but in about 15-20 years competition had become reasonably strong.

4.2.2. Alcoa

The Aluminum Company of America’s monopoly on aluminum dated from before 1900, based on patents. From this beginning, Alcoa extended a seemingly-permanent dominance over the industry. A 1910-1913 case was dropped, but a second try starting in 1937 led to a conviction in 1945. Alcoa had committed no clearly abusive actions, but its whole set of strategies had been to “build ahead of the market” and to make entry extremely difficult for newcomers. The final decision treated these strategies as amounting to deliberate monopolizing behavior. Yet the cure was mild; two new World War II aluminum plants built by Alcoa for the government were sold off to other companies (Kaiser and Reynolds). No other penalty or substantial cure was applied. A tight oligopoly was created in place of the virtual monopoly.

4.2.3. Xerox

The Xerox company introduced the first plain-paper copier in 1961 and proceeded to grow astronomically. It extended its patent monopoly into a luxuriant array of related patents, thereby preventing most attempts at new entry. Xerox also adopted extremely refined and complex pricing strategies to suppress new competition. They approached the extensive nature of IBM’s own vast strategic price discrimination starting in the 1950s. The FTC included strong action against Xerox’s strategic pricing, as part of its case initiated against Xerox in 1973. The case alleged a 90 percent share of plain-paper copiers and various unfair actions. In 1975 the FTC’s settlement with Xerox merely required opening up some of Xerox’s patents to others. Two new Japanese competitors (Savin and Ricoh) soon entered the market, perhaps coincidentally, not because of the patent access. They were able to succeed partly because Xerox’s price structure set high margins on the smaller copiers, where Xerox had had a particularly high degree of market power. Xerox’s market share slipped to about 50 percent, and it has stayed roughly at that level. Here again, the antitrust action was modest, not drastic. Patent access may have encouraged other firms to enter, but no structural remedy was involved.

172 4.2.4. The AT&T

WILLIAM

G. SHEPHERD

Case 1974 to 1984

The AT&T case is by far the leading American antitrust restructuring action. It followed on two earlier attempts (in 1911-1913 and 1949-1955) to reduce AT&T’s market position. AT&T had aggressively sought to control the whole telephone sector, from equipment supply to local operating systems and long-distance traffic. Rather than reflecting possible superior performance in the marketplace, AT&T’s extra monopoly power merely reflected skill in getting and holding monopoly franchises from governments. Economic evidence consistently showed that AT&T was slow to innovate and significantly X-inefficient in its operations. AT&T did not need to meet market tests, even though the sector was increasingly rich in technological opportunities.

4.2.5. The Case When a. third case against AT&T was prepared and then filed in 1974, competition was already being introduced into parts of the sector by other actions. Major changes had begun after 1967 with the MCI and Carterfone decisions by the Federal Communications Commission. The 1974 case merely moved the changes along more rapidly and directly. By late 1981, AT&T was clearly losing the antitrust case at trial. AT&T agreed to a settlement that required it to divest its operating companies. The Antitrust Division offered AT&T a choice: either divest AT&T’s 22 local operating companies, or divest Western Electric and the long-distance monopoly. AT&T took the first choice, keeping long-distance service and the equipment businesses, which it regarded as leading-edge technology markets promising rapid growth. The transitional frictions of the divestiture proved to be significant but not highly disruptive, and the newly-separated parts of AT&T began competing with each other more vigorously than most experts had expected. Western Electric quickly lost its status as the sole supplier of equipment to the operating telephone companies. AT&T encountered shocks, as its formerly-sheltered internal culture encountered market pressures. Much of its previous production capacity in Western Electric was soon closed as obsolete, and AT&T has had mixed success in developing and marketing new products. In particular, AT&T has largely abandoned its efforts to compete in the computer market by selling its own products. In short, the onset of competition has imposed the classic effects on this former monopoly. The rate of innovation has been raised markedly, and AT&T has been forced into greater X-efficiency and innovation. Despite continuing minor frictional costs, the economic yields of the case have been high. There is no significant pressure to reunify the old Bell system. AT&T retains dominance in the important long-distance telephone-service market. Its complex pricing behavior there illustrates the dominant-firm use of strategic

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price discrimination to deter small rivals and new entry. AT&T has made individual discriminatory price deals with over 77 major customers. Yet the FCC has attempted to remove the remaining regulatory constraints from AT&T, on the claim that AT&T is now under effective competitive constraints. There are now only two significant rivals, MCI with about 15 percent and US Sprint with 10 percent. They are evolving into coexistence as a three-firm oligopoly, dominated by AT&T. In this setting, the FCC deregulation would be premature, and it has been enjoined on appeal in the federal courts. 4.2.6. Lessons This case has revived the prospects for Section 2 as an instrument for major changes. It also shows how easy it is to untie links among separate businesses. Most of the changes from this case (as also in earlier ones) merely removed the connection between AT&T and its operating companies. Note that AT&T was allowed a major choice about what to divest. This demonstrates that a solution can allow a lot of choice to the firm, rather than be rigidly imposed. Also, the remedy needs to be reinforced with constraints against strategic discrimination and mergers, until the dominance is gone and numerous competitors provide effective competition. Otherwise, there may evolve an asymmetric tight oligopoly, in which the few firms adopt soft competition and deter entry.

5. Candidates for Possible Future Actions Elsewhere I have listed a number of possible candidates for Section 2 action (Shepherd, 1990a). Each requires complex study, but three of them (airline fortress hubs, AT&T in long-distance service, and bulk electricity in several regions) are derived from state actions of some kind, and so they lack the supposed ChicagoUCLA efficiency justification. Some cases (including those) might involve regulatory and/or legislative actions rather than simple Section 2 cases. The newspaper industry poses seemingly the most difficult case of a11.r5 The degree of dominance is very high in scores of cities. Moreover, in about 20 cities the two newspapers have come to be jointly operated, and most competition between them has actually ceased. Advertising rates, for example, closely approximate the pure-monopoly levels in many of those cities. On top of that degree of monopoly, large newspaper chains own many of the newspapers in the middlesized and smaller cities, probably adding to the degree of monopoly power by raising entry barriers. Not only is virtual monopoly widespread and entrenched. Its harmful effects may be particularly large. Monopoly’s impacts on freedom of the press (that is, on news content and the diversity of views) may far exceed in importance the price-raising effects in, say, detergents and film. Yet public policies have done nothing to reverse the trend. The policies embody an acceptance of the newspap-

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ers’ claims that dominance reflects technical economies of scale. Hence the Newspaper Preservation Act of 1970 permits the newspapers to merge under jointoperating agreements, rather than requiring them to maintain competition. In fact, the underlying “economies” may actually be much smaller, and they appear to arise primarily from advertising factors rather than from economies of production and distribution. A number of smaller cities, such as Little Rock, Arkansas, manage to retain vigorous newspaper competition, even though muchlarger newspapers in big cities have claimed that monopoly is inevitable. The industry is ripe for objective study and possibly a critical review of the 1970 policy and of the chain ownership of smaller newspaper monopolies. At the least there could be critical study of the claims for economies of scale and of the impacts of monopoly on prices, diversity, and news content.

6. Conclusion Much has transpired since Walter Adams and Horace Gray warned in 1955 about the dangers of state creation of monopoly. The dangers remain the same. But mainstream researchers have led the efforts for deregulation in railroads, airlines, gas and electric utilities, stock markets, banking, and other markets. ChicagoUCLA doctrines have played a part in the 1980s but they have often run to excess, in advocating deregulation at any cost. One result of that approach has been the savings and loan scandal of the 1980s where a wholesale removal of all restraints led to unforeseen economic damage. Also among the mainstream instruments, Section 2 has been applied to reduce market dominance in a number of important industries. Section 2 will continue to be only one tool for reducing market power, but it can be important. A renunciation of such an effective instrument is unwise. By helping to lead the mainstream critique of monopoly, Walter Adams has added to important policy actions. The policy-oriented tradition in the profession has been enriched by his skill and erudition. Adams’ contribution can also be seen in perspective of the changes under way in eastern Europe, the Soviet Union, and various third world countries (from Argentina and Nicaragua to Vietnam) that are adopting major privatizing actions. There, efforts are beginning toward converting thousands of state monopolies to some sort of effective competition, under some forms of private ownership. This vast set of experiments calls for caution and sophistication. There is a danger that, instead, simple Chicago-UCLA and “contestability” lessons will be applied, which accept high market dominance on the possibility that small rivals and new entry will nullify the market power. If that happens, thousands of newlyprivatized monopolies may be entrenched for decades. Already there has been a large volume of private activity by western European, American and Japanese companies, seeking to exploit these opportunities by merging or linking with the state monopolies before they are devolved into competitive conditions. There can

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be little confidence that effective competition will result from developments, if mainstream concerns about effective competition This new frontier calls for the wisdom, clarity, skepticism, and standing of many Walter Adamses. Our field continues to need and he has helped to set the standards for them.

175 these complex are absent. human undersuch qualities,

Notes ’ Professor of Economics, University of Massachusetts, Amherst, MA, U.S.A. I am indebted to Eleanor M. Fox, Harold Demsetz, William J. Baumol, John S. Heywood, Henry W. de Jong, Takeo Nakao, Harry M. Trebing, Donald J. Dewey, and seminar participants at numerous conferences and universities, for advice about the ideas in this paper. Fuller coverage is provided in my The Economics oflndustrial Organization, 3rd ed., Englewood Cliffs, N.J.: Prentice-Hall, 1990, and my Public Policies Toward Business, 8th ed., Homewood, 111.:Richard D. Irwin, 1991. This paper draws in part on my ‘Some Aspects of Dynamic Analysis and Industrial Change’, a chapter in Peter de Wolf, ed., Competition in Europe: Essays in Honor of Henk W. de Jong, Dordrecht: Kluwer Academic Publishers, 1991. ’ See for example Eleanor M. Fox and Lawrence A. Sullivan, 1987, 1989. 3 For a view that the changes have amounted to a “revolution’, see John E. Kwoka, Jr., and Lawrence J. White, eds., 1989. 4 See especially Adams, 1990; Adams and Brock, 1989, 1990; Adams and Dirlam, 1964; and Adams and Gray, 1955. 5 See for example Carlton and Perloff, 1990, Shughart, 1990, and Tirole, 1988, for presentation of ‘new IO’ theory. 6 For critical evaluations, see Scherer and Ross, 1990; Shepherd, 1988, 1990; Fisher, 1989; and Fox and Sullivan, 1987. ’ See Fisher, 1989; and Shapiro, 1989. * Cheaper capital will be available when a higher market share reduces risk, so that the risk-adjusted cost of capital is lower. ’ Geroski (in Hay and Vickers, 1987) arrives at a consensus estimate for A of about 0.2, after reviewing several other studies as well. lo That is because Chicago-UCLA analysts commonly regard competition as being effective even when a dominant firm has up to 80 percent of the market and only small rivals. ii For reviews of the evidence, see Shepherd (1975, covering Japanese conditions 1952-1966, and 1990); and Geroski (in Hay and Vickers 1987). i* Weiss and Pascoe observed only a 7 point average decline during 1950-75 (only 0.3 points per year), in a panel of 23 large US firms with initial market shares above 40 percent. A panel of 47 UK firms showed declines averaging 0.3 to 0.8 points per year (Shaw and Simpson, 1985). In Japanese dominant-firm industries during 1952-1966, shares declined an average of 1.5 points per year (Shepherd, 1975). l3 In Adelman’s words, sporadic discrimination “. . . like a high wind, seizes on small openings and Fzevices in an orderly price structure and tears it apart” (Adelman, 1949). On sub-additivity and the efficiency properties of discrimination (or “Ramsey” pricing), see Baumol, Panzar and Willig, 1982; Tirole, 1988. i5 See Bagdikian (1987), among other studies of monopoly elements in the newspaper industry.

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