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American Economic Association

Antitrust and the New Industrial EconomicsAuthor(s): Richard SchmalenseeReviewed work(s):Source: The American Economic Review, Vol. 72, No. 2, Papers and Proceedings of the Ninety-Fourth Annual Meeting of the American Economic Association (May, 1982), pp. 24-28Published by: American Economic AssociationStable URL: http://www.jstor.org/stable/1802297.

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Antitrustand the New IndustrialEconomicsBy RICHARD SCHMALENSEE*

My assignment here is to assess the impli-cations of recent theoretical work in in-dustrial economics for antitrust in the UnitedStates. I don't have space enough to presenta comprehensive survey of that work, noreven to catalog all recent developments withapparent antitrust implications. I attempt in-stead to describe the general character ofthose implications, limiting myself to a fewillustrative specifics.Industrial economics affects antitrust pol-icy in three different ways. First, it is used inpositive analysis aimed at determiningwhether or not current law has been violatedin specific cases and at assessing damagesdue injured parties. Second, it should beused in evaluating the desirability of reliefthat might be imposed in particular cases inorder to alter structure or conduct if a viola-tion is found. Finally, the tools and results ofindustrial economics are important inputs inthe formulation of general rules of law. Iargue here that the new industrial economicscan contribute a lot to the positive analysisof individual cases, but it has much less tosay about the desirability of particular reliefor of general rules of law. A final sectionbriefly examines some implications of thissituation.

I. PositiveAnalysis f ParticularCasesThe central problem facing an economistconcerned with a particular antitrust case ismodel selection. In order to select an explicitor implicit model of the situation under study,the economist usually must consider suchissues as the sources and magnitudeof marketpower and the economic implications of con-troversial business practices. Available (in-evitably incomplete) evidence must be used

to choose among alternative models. Once amodel has been selected for a particularcase,noneconomists-a judge or jury-must bepersuaded that the proper choice has beenmade. (For a discussion of this task and itsimportance in a particular case, see my 1979paper.) The new industrial economics makespossible an approach to model selection thatcombines the soundest elements of theHarvard and Chicago traditions in industrialeconomics.Recent work follows Harvard in acknowl-edging the possibility of markets not welldescribed by either perfect competition orpure monopoly, and it follows Chicago instressing the value of deductive analysis ofexplicit economic models. In the past decade,the tools of modern economic theory and,increasingly, modern game theory have beenemployed to construct and analyze a varietyof models of imperfect competition. By em-phasizing the construction and use of suchmodels, the new approach encourages theselection of models tailored to be consistentwith the relevant evidence and with the gen-eral principles of economic analysis. (My1978 paper provides an example of this ap-proach.) Careful use of modern theory shouldpermit more precise analysis of individualantitrust cases; at the very least it shouldfocus attention on the most important fac-tual questions in each case. Moreover, deci-sions based on explicit selection of internallyconsistent models can be expected to be moreaccurate than those based on tests involvingsuch things as arbitrary market sharethresholds derived from judicial precedent,not economic analysis. (This argument isdeveloped in detail in my 1979 paper.)While the new industrial economics hasprovided a large and varied menu of marketmodels from which an analyst may select, ithas not yet developed reliable tools for theempiricalanalysis of particular ndustries that

would help one choose models in practice. Inmy 1978 analysis of the ready-to-eat break-

*Sloan School of Management, Massachusetts In-stitute of Technology. I am indebted to the Ford MotorCompany for financial support and to R. Caves, F. M.Fisher, J. E. Harris, P. L. Joskow, P. Steiner, and I. M.Stelzer for helpful comments.

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VOL. 72 NO. 2 IMPERFECT COMPETITION AND PUBLIC POLICY 25

fast cereal industry, for example, I used anexplicit, spatial model of rivalry in a dif-ferentiated market. That model could beshown by deductive argument to be con-sistent with the general principles of eco-nomic theory, but its consistency with thefacts of the case and its superiority to alter-native models with different policy implica-tions were not so easily established. I couldnot draw on a set of proven empirical tech-niques for testing industry-specific hypothe-ses about such things as the spatial structureof demand or the existence of significantcollusion.One can expect recent advances in theoryto contribute to the development of suchtechniques, however, just as theoretical de-velopments have served to sharpen the toolsof empirical investigation in other areas ofeconomics. Hypotheses about the nature ofseller conduct may be particularly suscepti-ble to rigorous testing. In an important,pioneering study, Gyoichi Iwata attempts toestimate conjectural variations in an oligop-oly with homogeneous products. He also givestests for Cournot and collusive behavior.Product differentiation requires more com-plex models, of course. But, as TimothyBresnahan's impressive recent study of theautomobile industry shows, it may also aidin the identification of behavior patterns.Behavioral hypotheses involving investmentsin entry deterrence may also be rigorouslytestable. (One might attempt to test formallyLearned Hand's conclusion that Alcoasacrificed current profits by building capac-ity ahead of demand to discourage entry, forinstance.)Application of the new industrial econom-ics to antitrust cases will not be costless, oreven cheap. As the technical sophisticationof theoretical and empirical analysis in in-dustrial economics rises, the costs of anti-trust litigation will rise also. Industry analy-sis using state of the art techniques willrequire more human capital and computertime, and it will take more effort to com-municate such analysis to noneconomistjudges and juries. The sophistication of anti-trust decisions will surely rise more slowlythan the sophistication of economic analysisand testimony.

II. Normative Analysis of Rules and RemediesIn evaluating alternative rules of law, andoften in considering proposed relief in par-ticular cases, one must perform normativeanalysis. This is generally taken by econo-mists to mean that one must be able topredict efficiency consequences. An explicitconcern for economic efficiency has beenone of the hallmarks of recent theoreticalwork in industrial economics, so one mightexpect the new industrial economics to pro-duce normative analysis useful in developinggeneral rules of law. Such analysis has notyet appeared, however, and there are twobasic reasons for doubting that it will appear

in the near future.The first reason is visible in MichaelSpence's recent description of the analyticalapproach of the new industrial economics:My instinct as an economist is to studyindustries on a case-by-case basis,applying and adapting models as ap-propriate. For those of us who do thiskind of work, the differences amongindustries sometimes seem more im-portant or interesting than the similari-ties. And thus we are uncomfortablewith general rules. That, of course, isnot very useful to courts or litigators,who require some general principles orrules on which to hear and argue cases.[p. 58]

Rules of law implicitly consist of rules formodel selection and policy responses condi-tional on the model selected. As Spence'sdescription suggests, the new work finds thatdifferences among industries seem so funda-mentally complex that simple, universallyvalid rules for model selection may not exist.If this is correct, it follows that simple, uni-versally valid rules of law cannot be written.There are two ways around this problem inprinciple. One can explicitly aim for complexrules of law, in which some sets of factsrequire the sort of unstructured rule-of-rea-son-like analysis that Spence describes, whileothers permit straightforward, well-struc-tured policy choice. Alternatively, one canuse information about the frequencies with



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which various theoretical possibilities actu-ally occur to frame simple rules of law basedon generally valid rules for model selection.Both these approaches are difficult enoughthat one cannot hope for definitive resultssoon.The second reason for doubting that thenew industrial economics will produce gen-eral antitrust policy prescriptions in the nearfuture relates to the linkage between modelsand policy responses. Recent theoreticalworkhas focused on explicit models of imperfectcompetition, describing markets in which thestructuralfeatures (like scale economies) thatprevent the emergence of perfect competitionare taken as givens. The new industrial eco-nomics thus recognizes that in many situa-tions, antitrust can only move a market fromone imperfect, distorted equilibrium toanother. This recognition forces one to con-front a particularly difficult class of secondbest problems when analyzing either generalrules or case-specific relief proposals.Second best problems classically arise inthe context of antitrust because of dis-tortions in other markets: if apples aremonopolized, moving the widget marketfrommonopoly to competition may be inefficient.Antitrust commentators typically refuse todeal with such problems on the reasonableground that their intractability in practicewould induce paralysis. (See, for instance,F. M. Scherer, pp. 28-29.) The models of thenew industrial economics indicate clearly thatrelated problems arise because the usualpolicy option is a move toward competitionin some sense, not a move all the way tocompetition. Thus, because of irremediableimperfections in the widget market itself,movements toward competition there maynot enhance efficiency even if all othermarkets in the economy are purely and per-fectly competitive. Such single market, sec-ond best problems are harder to ignore. Ingeneral, and in the new market models inparticular,one needs unrealisticallycompleteknowledge of cost and demand conditions inorder to select among imperfectly compet-itive equilibria.A few examples may serve to illustrate thedifficulties encountered in attempting to de-rive policy prescriptions from the normative

analysis of the new industrial economics. AsRichard Posner (1979) notes, the Harvardtradition initially condemned all tyingarrangements as providing leverage thatpermitted the multiplication of monopolypositions. Chicago countered that the con-cept of leverage is without theoretical sup-port, that tying is generally a form of pricediscrimination, and that ties should be legalbecause price discrimination is generally ef-ficiency enhancing. But, as Posner notes, re-cent work shows that price discriminationachieved through tying arrangements mayreduce efficiency under some conditions.While some general statements can be made(see my 1981 paper), theoretical analysis sug-gests the nonexistence of simple tests thatone could actually apply in particular casesto determine whether banning tying con-tracts would enhance efficiency.The recent burst of theoretical work onprecommitment to deter entry of new rivalsellers and predation to eliminate such sellersprovides a second example. (See AvinashDixit for an overview of this work.) Thougha good deal of this analysis has been inspiredby debates about antitrust policy toward.predatory pricing, it has not producedsimple policy prescriptions with clear ef-ficiency properties. As Michael Spence notes,recent work shows that the welfare effectsof increasing the stringency of the definitionof predatory behavior are far from unam-biguous (p. 57), since such an increase mayjust induce more investment in entry deter-rence. And, as Spence goes on to point out,... . there are no known, unambiguouslybeneficial simple rules that can be applied toinvestments prior to entry... (p. 60).More generally, recent work indicates thatpolicies that facilitate entry into particularmarkets may raise or lower net surplus, de-pending on the exact conditions in thosemarkets. My 1976 paper shows that profit-able entry may be inefficient, Joseph Stiglitz(1981) shows that potential competition canlower welfare, and C. C. von Weiszacker(1980) shows that lowering entry barriersmay also lower efficiency. Product differenti-ation adds another layer of complexity. It isdifficult to evaluate changes in the set of

products produced in general or in particular



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VOL. 72 NO. 2 IMPERFECT COMPETITION AND PUBLIC POLICY 27

cases because the market almost neverinduces production of the first best optimalset. (See, for instance, the comparatively weaknormative conclusions of my 1978 paper, orthe analysis of Roger Koenker and MartinPerry, and the references they cite.)I do not mean to suggest that all recenttheoretical work in industrial economicsencounters single market, second best prob-lems that prevent the derivation of simpleefficiency-enhancing policy prescriptions.The emerging literature on contestablemarkets is an obvious exception to any suchgeneralization, as that literature shows thatmany policy issues simplify drastically whensunk costs are relatively unimportant. (SeeElizabeth Bailey, Avinash Dixit, and the ref-erences they cite.)But, on the whole, recent research indi-cates that in many areas one cannot confi-dently predict the efficiency consequences ofparticular antitrust relief in individual caseswithout the sort of detailed quantitative in-formation generally necessary to solve sec-ond best problems and generally unavailablein antitrust litigation. This research is cer-tainly useful for criticizing existing rules oflaw that are too simple or based on inde-fensible economic analysis. And further the-oretical and empirical work may yieldworkable rules of law that are generally pro-ductive, despite second best problems, and itmay yield techniques for the design of gener-ally productive case-specific relief. It is toosoon to tell whether this will occur in manyareas, however.

III. Conclusions and ImplicationsUse of the new industrial economics inindividual antitrust cases is likely to raiseboth the quality and the cost of court deci-sions on factual issues that arise under cur-rent antitrust rules. Unless enforcement ofthose rules is generally efficiency enhancing,however, that increase in precision may notbe worth its cost. And recent theoreticalwork suggests that in many policy areas (suchas tying contracts and entry deterrence)theremay exist no workable rules that are gener-

ally efficiency enhancing.

As in macroeconomics, increased uncer-tainty about the consequences of interven-tion argues against attempts to fine-tune per-formance. Attempts to make marginalchanges in inherently imperfect markets arecertain to be expensive and may not increaseefficiency even if successful. To the extentthat they are concerned with efficiency, theenforcement agencies should thus con-centrate their efforts in areas (like price fix-ing) where it can be convincingly argued thatsuccessful cases generally create net benefits.In other areas of the law (like monopoliza-tion), they should at least hesitate to bringcases in which there does not exist a specificrelief proposal likely to enhance efficiency.Efficiency-enhancing changes in structure orconduct do not necessarily exist everywherecompetition is imperfect, and the design ofproductive relief often requires the carefuluse of sophisticated economic analysis.Moreover, since the vast majority of anti-trust cases are brought by private plaintiffsunconcerned with the economy's overall per-formance, reexamination of the law may bein order in areas in which workable effi-ciency-enhancing rules cannot be found. Ifsome existing rules have ambiguous ef-ficiency implications, and if efficiency is themain goal of antitrustpolicy, vigorous privateenforcement of such rules is no more justifi-able than vigorous public enforcement. Onthe other hand, if the real objections to suchthings as tying contracts and Robinson-Pat-man style price discrimination have nothingto do with economic efficiency, it is not clearwhy cases involving such practices should beweighted down with difficult questions (likethe importance of monopoly power) that re-late mainly to efficiency. Where future theo-retical and empirical work does not yieldrules of law with good efficiency properties,these and related issues will deserve seriousattention.

REFERENCESBailey, ElizabethE., Contestability and theDesign of Regulatory and AntitrustPolicy, American Economic Review Pro-ceedings, May 1981, 71, 178-82.Bresnahan, imothyF., Competition and Col-



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lusion in the American Automobile In-dustry: The 1955 Price War, mimeo.,1980.Dixit, AvinashK., Recent Developments inthe Theory of Imperfect Competition,American Economic Review Proceedings,May 1982, 72, 12-17.Iwata,Gyoichi, Measurement of ConjecturalVariations in Oligopoly, Econometrica,September 1974, 42, 947-66.Koenker,RogerW. and Perry,MartinK., Prod-uct Differentiation, Monopolistic Compe-tition, and Public Policy, Bell Journal ofEconomics, Spring 1981, 12, 217-31.Posner,RichardA., The Chicago School ofAntitrust Analysis, University of Penn-sylvania Law Review, April 1979, 127,925-48.Scherer, F. M., Industrial Market Structureand Economic Performance, 2nd ed.,Chicago: Rand McNally, 1980.Schmalensee,Richard, Is More CompetitionNecessarily Good?, Industrial Organiza-

tion Review, 1976, 4, 120-21.. Entry Deterrence in the Ready-to-Eat Breakfast Cereal Industry, Bell Jour-nal of Economics,Autumn 1978, 9, 305-27., On the Use of Economic Models inAntitrust: The ReaLemon Case, Univer-sity of Pennsylvania Law Review, April1979, 127, 994-1050., Monopolistic Two-Part PricingArrangements, Bell Journal of Economics,Autumn 1981, 11, 445-66.Spence,A. Michael, Competition, Entry, andAntitrust Policy, in Steven C. Salop, ed.,Strategy, Predation, and AntitrustAnalysis,Washington: U.S. Federal Trade Commis-sion, 1981, ch. 2.

Stiglitz, Joseph E., Potential CompetitionMay Reduce Welfare, American Eco-nomic Review Proceedings, May 1981, 71,184-89.von Weizsacker,C. C., A Welfare Analysis ofBarriersto Entry, Bell Journal of Econom-ics, Autumn 1980, 11, 399-420.


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