The Mythology of Horizontal Merger Efficiencies

Economists had to distort economic theory to fashion their merger “efficiency” arguments

Numerous economists have noticed the dramatic increase in monopoly profits accruing to US firms since 1980. As one example, a recent review of this literature and an updated measure of wealth generated from market power in the United States from 1870 to 2010 can be found in the new book by Mordecai Kurz. The impact of unchecked market power has contributed to an increase in inequality, has helped reduce investment and growth, and is a factor in harming democracy. Joseph Stiglitz makes the case for how rising market power and concentration have contributed to income inequality. Thomas Phillipon shows how rising market power has undermined investment and growth. Robert Lande has recently argued that the rise of powerful firms is a factor in undermining democracy. As Louis Brandeis reportedly quipped: “We may have democracy, or we may have wealth concentrated in a few hands, but we can’t have both.”

Rising concentration is a direct result of the weak antitrust enforcement that resulted from the influence of conservative economists who propagated the Consumer Welfare Standard. As Elizabeth Popp Berman describes in detail in her book, big business turned to conservative economists to dismantle the New Deal consensus regulatory scheme. Their primary weapon was to argue that policy should advance so-called “efficiencies” rather than rights and values that were the primary justifications for the New Deal Consensus. “Efficiency” arguments were at the forefront of the deregulation movement in the 1970s and 1980s and in the dismantling of vigorous antitrust enforcement. “Efficiency” required that antitrust be scaled back to address only consumer welfare, lower prices, and greater output, while the traditional goals that motivated Congress to pass the antitrust laws, such as the protection of democracy, workers, small business, and income distribution, had to fall by the wayside.

Slowly the pendulum is righting itself. The New Merger Guidelines (the “Guidelines”) issued in draft by the DOJ and FTC have taken a big step back from Chicago-style economics and seek to return merger control to the original principles set forth by the Warren Court and Congressional intent: decentralization of political power, preserving small business, and, as Khan and Vaheesan point out, decreasing inequality. Not surprisingly, the Guidelines have been met with a barrage of withering criticism. For example, Jason Furman and Carl Shapiro have little positive to say about the new Guidelines in their WSJ Op-Ed, except their praise for the section of the Guidelines that retains a merger rebuttal based on “efficiencies.” In our new INET working paper, “The Horizontal Merger Efficiency Fallacy,” we challenge both the theoretical coherence and the empirical relevance of an “efficiency” defense for mergers that raise concentration. We show that the antitrust economists had to distort economic theory to fashion their merger “efficiency” arguments. They do this by substituting the businessman’s definition of “efficiency,” cost savings, for the economic theory of Pareto Efficiency. Moreover, the empirical evidence that mergers do not generate cost savings has now accumulated to embarrassing levels.

To begin with, in Antitrust, but in no other area of economic analysis of the law nor in economic theory, do “efficiencies” mean “cost savings.” In contrast, economic theory suggests that some cost savings lower rather than raise social welfare. For example, cost savings from lower wages, greater unemployment, or redistribution between stakeholders can both lower social welfare (suitably defined) and reduce prices. Only if one adopts the discredited surplus theory of economic welfare, or the original Consumer Welfare Standard, can one clearly link cost savings to economic welfare, because lower cost increases consumer and/or producer surplus. As we show elsewhere, this theory has been thoroughly discredited by welfare economists. (And even using the discredited surplus theory of welfare, an increase in consumer or producer surplus that comes at the expense of input supplier surplus can also lower welfare.)

In stark contrast to the businessman’s definition of efficiency, for economists, “efficiency” only means Pareto efficiency. As discussed by Mas-Colell’s leading Microeconomics textbook (Chapter 10), the assumptions necessary to ensure that maximizing surplus results in Pareto Efficiency are extreme and unrealistic. These assumptions include quasilinear utility, perfectly competitive markets, and lump-sum wealth redistributions that maximize social welfare. Thus, there is no plausible way to reconcile Pareto Efficiency, which is what efficiencies mean in economic theory, with cost savings, which is the definition used by antitrust specialists and is adopted in the new Guidelines.

In merger control, it is assumed from the outset that mergers result in cost savings. As many economists have recognized, most recently Nancy Rose & Jonathan Sallat, the merging parties are already credited for “efficiencies” (cost savings) in the “standard efficiency credit” which undergirds the merger safe harbor in low and moderate concentrated markets. After all, absent any cost savings, why allow any merger that even weakly increases concentration? A concentration screen that allows some mergers and not others must be assuming that all mergers come with some socially beneficial cost savings. But do they? As we show in the working paper, there is no empirical research to suggest that mergers that increase concentration actually lower costs and pass on the benefits to consumers. As one district court commented, “The Court is not aware of any case, and Defendants have cited none, where the merging parties have successfully rebutted the government’s prima facie case on the strength of the efficiencies.” We have been unable to locate any study of merger efficiencies showing cost savings that are passed on as lower prices to consumers. Indeed, most studies show that mergers result in higher prices, lower economic performance, and less research and development. Yet conservative economists perpetuate the myth of consistently beneficial mergers.

Our working paper is therefore both a theoretical and empirical critique of the myth of horizontal merger efficiencies.

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