Antitrust and Democracy: Adam Smith was Right

By: Dan Mogin

Antitrust, monopolies, price gouging and deregulation have been in the news lately. The Justice Department case against Microsoft over its internet browser and operating system practices is about to resume, although rumors of settlement are in the wind. The FTC and Intel have announced a settlement of another highly publicized high technology antitrust case. The largest potential merger in history –Exxon-Mobil — is undergoing antitrust review. A number of other high profile cases have been in the headlines lately and the air is abuzz with the question of whether antitrust should apply to high technology industries. We will hear even more as the effects of 80’s and 90’s consolidation of the economy and economic power surface. What is antitrust?? Mere mention of the word often causes eyes to glaze over. Yet, the general public has a great intuitive understanding of antitrust — or pro-competition — and its relationship to our free market economy and democratic political system. It also has a huge stake in it. The purpose of this article is to briefly explore the history of our antitrust laws and their enforcement.

In a nutshell, the purpose of the antitrust/pro-competition laws is to protect consumers, to encourage free and open competition in the marketplace and to prevent unreasonable restraints of any trade or commerce. The meaning of these key words are not mysterious or arcane. Each word and phrase means exactly what they appear to say. We want truly free and open markets. We want maximum competition. The goal is for consumers to receive better goods and services at the lowest cost. The first antitrust economist was also the first free market economist — Adam Smith. It is no coincidence that Smith wrote his capitalist manifesto, The Wealth of Nations, in 1776, at the same time that America’s Founding Fathers were declaring their political independence. The American Revolution was every bit as much about escaping from monarchy and dispersing political power as it was about escaping from monopoly and dispersing economic power; economic self-determination and political self determination go hand in glove.

When Adam Smith wrote The Wealth of Nations, most nations were mercantilist economies. Mercantilism was a form of state directed capitalism where the monarchy granted monopolies to a privileged few. These quasi-governmental monopolies were particularly instrumental in the development of colonies, including in the New World. Their powers to control trade and commerce were vast. Indeed, the tea dumped in Boston Harbor belonged to one such monopoly, the British East India Company. The powers and problems of monopolies were not lost on the Founding Fathers. Their revolt against the monarchy of King George was also a revolt against his trading monopolies which extracted monopoly rents or private taxes. Fittingly, given this history, the Supreme Court has proclaimed that the antitrust laws are the Bill of Rights for the economy. Consider the following passages authored by Adam Smith more than 200 years ago. On individual initiative: “in promoting his own interest… an individual intends only his own gain, and is led by an invisible hand; thus promoting the social good.” On cartels: “people of the same trade seldom meet together, even for merriment or diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” On monopoly: “monopolists, by keeping the market constantly understocked, by never fully supplying the effectual demand, sell their commodities much above the natural price, and raise their emoluments, whether they consist in wages or profit, greatly above their natural rate.” Smith’s words are the philosophical backbone of our antitrust laws. At the turn of the century, America’s evolution from an agricultural society to an industrial state accelerated, causing dislocation. There are many parallels to our own transformation from an industrial to an information economy. Large combines controlled or monopolized many of our basic industries. These were organized as trusts that functioned as holding companies. Trusts facilitated what we now call horizontal arrangements between firms that would otherwise be competitors; mergers between competitors are the ultimate horizontal combination.

At the same time, trusts expanded their activities from production and to distribution to wholesaling and on to retail. For example, the railroads controlled not just transportation but vast resources like land, timber and mining properties as well as distribution channels. The Standard Oil Trust controlled the oil business from the wellhead through refining, transportation, shipping, pipelines, tank wagons, distributors, etc.– all in the age before gasoline and the automobile, when the “new light” of kerosene ruled the day. Such control throughout the distribution chain by a single firm is called vertical integration.

As the trusts grew and exercised their monopoly power, prices for basic goods and services rose dramatically. Western farmers and ranchers in particular felt that the railroads were squeezing them dry with high monopoly transportation rates and low crop prices paid by railroad affiliated distributors and middlemen. They believed that the railroads were leveraging their monopoly of the transportation platform into other areas and thus stifling competition– another form of private taxation without representation. Political scandals resulted when the trusts’ cozy relationships with lawmakers were exposed by muckrakers. One reaction to these forces was the rise of the Populist and Progressive political movements which protested against the power of the trusts. Antitrust was a hot political issue and enjoyed strong public support.

In 1890, Senator John Sherman, an Ohio Republican, introduced and Congress passed the Sherman Act. It was intended to codify and strengthen existing unfair competition laws so that any person injured in their business or property could sue for anticompetitive actions. It remains our basic antitrust law. Government enforcement actions, including criminal penalties, are allowed. The Act has two basic sections. The first prohibits combinations or agreements in restrain of trade, such as price fixing, output restrictions between competitors, group boycotts and the like. The second prohibits monopolization or attempts to monopolize. Woodrow Wilson’s election in 1912 paved the way for enactment of the Clayton Act in 1914. Its primary purposes were to combat price discrimination or selling a product at different prices to buyers that are similarly situated, to control corporate mergers that might tend to create a monopoly or substantially lessen competition and to allow private enforcement of the antitrust laws by injured parties. Congress also passed the Federal Trade Commission Act in 1914 in partial reaction to fears that the federal judiciary was predisposed to hobble effective antitrust enforcement. During this period, many states enacted their own antitrust and unfair competition laws.

Adam Smith’s declaration of economic independence thus evolved into law. The goals of a free market controlled by individual choice and individual action were codified. Monopolies, cartels and discrimination were outlawed. Like the civil rights laws, however, early judicial decisions refused to apply the antitrust laws in the intended manner. Courts imposed impossible burdens of proof contrary to statutory language or usually found the evidence somehow lacking. In its first case involving the Sherman Act, the Supreme Court refused to even apply the statute to the sugar trust that controlled over 98% of the country’s sugar refining capacity. Subsequent judicial decisions also stifled the legislative intent. The Justice Department adopted a policy of non-enforcement. It was not until trust-buster Teddy Roosevelt attacked the Standard Oil Trust that early antitrust enforcement gained any real traction with the federal judiciary. Even today, judicial attitudes toward antitrust enforcement and consumer protection range from outward hostility to strict enforcement. For example, the Supreme Court has acknowledged that consumer benefit is the paramount goal of our antitrust law. Yet one Supreme Court decision, Illinois Brick. V. Illinois effectively slams the federal courthouse door on consumers allowing only “direct purchasers” access to federal court. But if you buy a can of beans at the grocery store, or a computer at the discount store, you are not a direct purchaser of the product in relation to the manufacturers and distributors, even though you are most assuredly paying a higher price as the costs of antitrust violations–supra-competitive prices–are passed on through the chin of distribution. Executive branch enforcement policies change with each Administration’s attitude toward big business. (One famous incident involved allegations that a lobbyist for ITT offered a bribe to the Nixon Administration to drop an antitrust investigation into the company’s operations. Part of the alleged bribe would have brought the 1972 Republican convention to San Diego convention facilities owned by ITT. The lobbyist died of lung cancer just as the story was breaking). The Reagan Administration’s radical non-enforcement policies set off the merger wave of the 80’s and 90’s; its effects will not be fully understood for at least another decade.

One frequently misunderstood area is the prohibition against monopolies. It is often said that the goal of every vigorous competitor is to achieve a monopoly and reap the resulting profits. While this may be true, the antitrust laws are not intended to punish successful companies simply because of their success or large companies simply because of their size. Because we want consumers to get the best for the least through the free market, only conduct that excludes competitors, stifles innovation, limits supply or raises prices is prohibited. Obviously, monopolies that are obtained by unlawful means are not allowed. But monopolies that are lawfully obtained, such as those with superior products, prices or management, are only liable if they abuse their monopoly power and exclude, stifle or limit competition. The current Microsoft case raises all of these issues. Many argue that antitrust is arcane and applies only to smokestack industries. This is nonsense: the railroads and Standard Oil were the high technology companies of their day. Similarly, in the mid 1970’s the Government launched two giant monopolization cases involving some of the highest technology companies of the era. In one, AT&T agreed to divest itself of certain assets including the local telephone companies known as the Regional Bell Operating Companies. In the other, IBM defeated the governments’ attempts to break it up. The stocks of AT&T, the RBOCs and their spin-offs has increased many times over. The same thing happened in the Standard Oil case. In contrast, after winning its case, IBM refused to change. As a result, it was brutally punished by the market and went through a long period of decline, downsizing and restructuring followed by rebuilding. Both the computer and telephone markets experienced profound technological change and innovation. Which consumers received better goods and services at a lower price?? Which company and shareholders are better off ?? These are the $64,000 questions.

Another misconception is the belief that antitrust policy is a form of regulation. It is not. Linking antitrust with regulation is a rhetorical device that attempts to tar antitrust with the well deserved discreditation of regulated or planned economies by confusing the two. Antitrust policy lies between regulation and an “anything goes” or laissez-faire economic policy. Unlike regulation, the antitrust laws do not dictate outputs or prices. To the contrary, they attempt to allow customers and competitors in affected markets to challenge alleged restraints to effective competition. This is the legal equivalent of local control or decentralization. The purpose of the antitrust laws is to restore competition and protect the free market, not regulate it. Antitrust authorities do not intervene in the operations of free markets, but attempt to restore freedom and competition through legal process checked by judges and juries. Unlike laissez-faire, under antitrust laws sheer market power cannot be used to corrupt the functioning of the free market.

The federal antitrust laws also grant the government limited tools to practice some preventative medicine in the area of corporate acquisitions to prevent or limit monopolies from being created or enhanced. To block a merger, the Government must show that the combination might tend to create a monopoly or substantially lessen competition. Merger review duties are shared by the Justice Department and the FTC. If the 90’s have taught us anything, it is that runaway consolidation is an anathema to competition. Governmental antitrust enforcement is not and should never become a type of industrial policy. Since its beginning, meaningful enforcement of the antitrust laws has frequently been stifled by the judicial and the executive branches of government. Because it involves marketplace behavior, there are few bright lines. There is a lot of misinformation about its purposes. Big business is both powerful and creative when it attempts to bypass these laws. Challenges to the status quo are rarely welcome. But the public understands the linkage between antitrust and economic freedom of choice. Truly free markets mean more competition, more goods, more choices, lower prices and enhanced product quality. These are the result of individual initiative and Adam Smith’s “invisible hand”.

The antitrust laws are pro-competition, anti-collusion, anti-monopoly and anti-discrimination. What could be better than that?? Why shouldn’t they be enforced to the letter and spirit of the law?? Are any types of “judicial activism” or Executive Branch politics acceptable in this arena?? Why shouldn’t the public –sitting as jurors– after full review of the evidence determine whether real world acts and practices enhance or impede the functioning of the free market ?? They have the most to gain and the most to loose. Should manufacturers be allowed control over prices charged by others?? When do mergers and consolidations become anticompetitive?? These are the big questions; the answers aren’t easy. But we all benefit from understanding antitrust and the benefits of competition as well as by requiring the debate to be conducted in public, not in the towers of power. Daniel J. Mogin is a San Diego attorney specializing in antitrust and consumer protection matters.

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