Editors' Preface to Macmillan Studies in Economics

The rapid growth of academic literature in the field 'of economics has posed serious problems for both students and teachers
of the subject. The latter find it difficult to keep pace with more
than a few areas of their subject so that an inevitable trend
towards specialism emerges. The student quickly loses perspective as the maze of theories and models grows and the discipline
accommodates an increasing amount of quantitative techniques.
'Macmillan Studies in Economics' is a new series which sets
out to provide the student with short, reasonably critical
surveys of the developments within the various specialist areas
of theoretical and applied economics. At the same time, the
studies aim to form an integrated series so that, seen as a whole,
they supply a balanced overview of the subject of economics.
The emphasis in each study is upon recent work, but each
topic will generally be placed in a historical context so that the
reader may see the logical development ofthought through time.
Selected bibliographies are provided to guide readers to more
extensive works. Each study aims at a brief treatment of the
salient problems in order to avoid clouding the issues in
detailed argument. Nonetheless, the texts are largely selfcontained, and presume only that the student has some knowledge of elementary micro-economics and macro-economics.
Mathematical exposition has been adopted only where
necessary. Some recent developments in economics are not
readily comprehensible without some mathematics and statistics and quantitative approaches also serve to shorten what
would otherwise be lengthy and involved arguments. Where
authors have found it necessary to introduce mathematical
techniques, these techniques have been kept to a minimum.
The emphasis is upon the economics, and not upon the
quantitative methods. Later studies in the series will provide
analyses of the links between quantitative methods, in particular
econometrics, and economic analysis.

MACMILLAN STUDIES IN ECONOMICS

General Editors:

D.

Executive Editor:

c.

ROWAN

and

G. R. FISHER

D. W. PEARCE

Published
John Burton: WAGE INFLATION
.Miles Fleming: MONETARY THEORY
C. J. Hawkins and D. W. Pearce: CAPITAL INVESTMENT APPR....ISAL
David F. Heathfield: PRODUCTION FUNCTIO!';S
Dudley Jackson: POVERTY
J. E. King: LABOUR ECONOMICS
J. A. Kregel: THE THEORY OF ECONOMIC GROWTH
P. N. Junankar: INVESTMENT: THEORIES AND EVIDENCE
D. W. Pearce: COST-BENEFIT ANALYSIS
Maurice Peston: PUBLIC GOODS AND THE PUBLIC SECTOR
David Robertson: INTERNATIONAL TRADE POLICY
Charles K. Rowley: ANTITRUST AND ECONOMIC EFFICIENCY
G. K. Shaw: FISCAL POLICY
R. Shone: THE PURE THEORY OF INTERNATIONAL TRADE
FrankJ. B. Stilwell: REGIONAL ECONOMIC POLICY
John Vaizey: THE ECONOMICS OF EDUCATION
Peter A. Victor: ECONOMICS OF POLLUTION
Grahame Walshe: INTERNATIONAL MONETARY REFORM

Forthcoming
E. R. Chang: PRINCIPLES OF ECONOMIC ACCOUNTING
G. Denton: ECONOMICS OF INDICATIVE PLANNING
N. Gibson: MONETARY POLICY
C. J. Hawkins: THEORY OF THE FIRM
D. Marston: THE POSSIBILITY OF SOCIAL CHOICE
G. McKenzie: MONETARY THEORY OF lNTER."ifATIONAL TRADE
B. Morgan: MONETARISM VERSUS KEYNESIANISM
S. K. Nath: WELFARE ECONOMICS
A. Peaker: BRITISH ECONOMIC GROWTH SINCE 1945
F. Pennance: HOUSING ECONOMICS
C. Sharp: TRANSPORT ECONOMICS
P. Simmons: DEMAND THEORY
~I. Stabler: AGRICULTURAL ECONOMICS
R. E. Weintraub: GENERAL EQ.UILIBRIUM THEORY
J. Wiseman: PRICING PROBLEMS OP THE NATIONALISED INDUSTRIES

Antitrust and
Economic Efficiency

CHARLES K. ROWLEY
David Dale Professor of Economics,
University of Newcastle upon Tyne

Macmillan Education

 Charles K. Rowley 1973

ISBN 978-0-333-12215-0

ISBN 978-1-349-01113-1 (eBook)

DOI 10.1007/978-1-349-01113-1

All rights reserved. No part of this publication may be reproduced or

transmitted, in any form or by any means, without permission.

First published 1973 by

THE MACMILLAN PRESS LTD

London and Basingstoke

Associated companies in New York Toronto
Dublin Melbourne Johannesburg and Madras
SBN 333 12215 1

To Matjorie

The paperback edition of this book is sold subject to the condition that it shall
not, by way of trade or otherwise, be lent, re-sold, hired out, or otherwise
circulated without the publisher's prior consent in any form of binding or
cover other than that in which it is published and without a similar condition
including this condition being imposed on the subsequent purchaser.

Contents
Acknowledgements
Introduction
The Social Welfare Function
Neo-classical Economics and the Case for Antitrust
The Impact of Scale Economies
The Relevance of X-Inefficiency
Invention and Innovation
Some Orders of Magnitude
The Evidence
Allocative inefficiency
Scale economies
X-inefficiency
Innovation
9 Some Theoretical Complications
Intermediate market models
Advertising and sales promotion
Alternative company objectives
Uncertainty considerations
Externalities
10 Alternative Views on Social Welfare
A liberalist social welfare function
A technocrat's social welfare function
A totalitarian's social welfare function
11 Alternative Approaches to the Problem of
Market Power
Laissez-faire
Fair-rate-of-return regulation
Cost-benefit analysis
Non-discretionary antitrust
Bibliography

1
2
3
4
5
6
7
8

7
13
18
20
25
33
+4

47
47
49
53
55
58

58

60
62
64
65
67
67
70
71
72
72
76
79

83

91

Acknowledgements
I am particularly grateful to my former colleague Michael
A. Crew, with whom I have collaborated closely in recent
years and who has done so much to help shape my views
on antitrust economics. I must also thank Michael Jones-Lee
and Alan T. Peacock, who have written with me on topics
appertaining to this study. Most especially, however, I wish
to thank my wife Marjorie, without whose persistent encouragement and infectious enthusiasm this book would never have
been completed.

C.K.R.

Introduction

The concept of market power is clearly of central importance in

any discussion of antitrust economics and merits serious
attention at the outset of this survey. As with so many important economic concepts, the closer our scrutiny, the more
elusive and intangible the concept appears to be. Small
wonder, perhaps, that so many recent antitrust contributions
sidestep the conceptual issue and proceed as if market power
were a simply identifiable state of the world. In essence,
market power exists when a specific firm (or group of firms
acting in combination) has sufficient control over a particular product or service to determine significantly the terms
on which other firms (or individual consumers) shall have
access to it. However, there are many problems to be overcome
before this concept can be rendered operational for empirical
research.
The concept of market power is best approached by reference
to the polar cases of perfect competition and pure monopoly,
however unrepresentative these cases may seem to be of the
real world. For these polar cases provide a level of generality
which the intermediate models - concerned with monopolistic
competition and oligopoly and grounded on highly particularised assumptions - just cannot match. Furthermore, the rarefied assumptions of the polar cases really do provide a workable
framework for the identification of market power in the real
world.
Perfect competition is derived from four principal assumptions which are designed to provide an impersonal market
in which the pattern of resource allocation is determined by
the fundamental forces of supply and demand. The first
assumption is that each firm is sufficiently large relative to
the total market to be in a position to influence the product

price by changes in its own output rate. The second assumption

is that the product of anyone firm in the industry is identical
(from the consumers' viewpoint) to the product of any other
firm. The third assumption is that all resources are perfectly
mobile and are prepared to move readily in response to the
appropriate economic signals. The fourth assumption is that all
consumers and producers are perfectly informed about the
present market situation (especially concerning the pattern
of product and factor prices). The model of perfect competition,
defined by these four assumptions, is motivated by the basic
postulate of profit maximisation. In consequence, long-run
equilibrium occurs where each firm simultaneously is maximising profit and yet earning only the opportunity cost of
capital required for its continued existence in that industry,
i.e. price is equated with marginal cost and with (minimum)
average cost of each surviving firm.
Pure monopoly, by contrast, is characterised by the existence
of one, and only one, seller in a clearly defined market. In
consequence, the first assumption of the perfect competition
model (which requires a large number of sellers) and the third
assumption (which requires perfect resource mobility) evidently do not obtain. Product homogeneity (the second
assumption) applies inevitably, while perfect knowledge
(the fourth assumption) mayor may not apply but usually
does not. As with perfect competition, the model of pure
monopoly is motivated by the profit maximisation postulate.
In consequence, long-run equilibrium occurs with the monopolist equating marginal cost with marginal revenue, with
marginal cost less than price, and with average cost equal
to or less than average revenue.
In essence, therefore, pure monopoly is the polar opposite
of perfect competition, since competition is completely absent
in the former case but present in an impersonal and nonrivalrous extreme in the latter. In practice, of course, neither
model is approximated by the conditions obtaining in industrial
markets, or at least in the non-socialist sector of the world
economy. Most industrial markets are characterised by the
existence of a relatively small number of independent companies producing slightly different products (further differen-

tiated in many instances by advertising expenditures) for

markets which are often separated (spatially or otherwise)
and in which the quality of products, credit terms and delivery
dates, as well as price, are important strategic variables
which (within limits) remain within the sphere of influence
of the independent companies. Competition between such
companies frequently takes place from widely separated
geographical locations, with the use of perhaps quite different
technologies and with varying factor proportions and under
varying degrees of risk and uncertainty. In such circumstances,
economic theory cannot pronounce on the likely consequences
in terms of market behaviour with the same authority as it
can in dealing with the polar cases of perfect competition and
pure monopoly.
This does not imply, however, that economic theory can
say nothing about competition and market power in realworld markets. For the extent and significance of actual
market power can often be assessed by paying due regard to
the assumptions and implications of the polar models. There
is indeed a well-established presumption that competition will
tend to increase (and market power correspondingly decline)
as the number of firms in a given industry increases, as the
market shares of the larger firms decline, as the information
market becomes more efficient, and as barriers to resource
mobility are eliminated. Perfect competition only represents
the outer limit of this process. It is true that the economist
cannot predict unequivocally just which of the strategic
variables under consideration - price, quality, credit terms,
etc. - will respond most to mounting competition. But this
merely reflects the multi-dimensional nature of the real-world
situation.
It is important to recognise, nevertheless, that forces other
than those outlined above may influence (negatively or positively) the degree of market power which prevails in specific
industrial markets. From the negative viewpoint, one tends to
think immediately in terms of competition (actual or potential)
from imported products which fall within the same market
classification, for national boundaries are rarely fully effective
as barriers to competition. Equally important, however, IS
9

competition (actual or potential) from substitute commodities

which lie outside the market classification adopted for analytic
purposes; for all products are potential substitutes in a world
characterised by scarcity. From the positive viewpoint, one
tends to think immediately of restrictive practices and/or
conditions of price leadership which can create market power
in otherwise competitive circumstances. Equally important,
at least in recent years, however, has been the influences of
state intervention in the industrial system with the prime aim
of suppressing competition in the name of national planning.
Inevitably, influences such as these weaken the ability of
economists to determine the degree of market power solely
by reference to the assumptions of the polar models of perfect
competition and pure monopoly.
Further inferences can be gained, fortunately, by reference
to the implications rather than to the assumptions of these
polar models. For example, an important implication of perfect
competition is the existence of a uniform price for each product
and therefore the absence of price discrimination. This is not
a necessary implication of pure monopoly, since price discrimination is possible in markets characterised by low resource
mobility and/or imperfect knowledge. Evidence that sellers
are able persistently to extract higher net receipts for a product
from some customers than from others constitutes therefore a
prima facie case that market power exists. Unfortunately,
the test is non-reflexive, for the absence of price discrimination
in no sense implies the absence of market power.
A further implication of perfect competition is the absence
(in long-run equilibrium) of unusually high rates of return on
capital. For this reason, a high rate of return on capital is
one of the traditional indicators of the existence of market
power. Unfortunately, the test is ambiguous for a variety of
reasons. In the first place, competitive markets are rarely, if
ever, in equilibrium, and high rates of return on capital may
reflect the presence not of market power but of competitive
disequilibrium; alternatively, high rates of return earned by
surviving firms may reflect high-risk activity and not market
power, and even in perfect competition the perfect knowledge
assumption is restricted to the present and does not encompass

10

the future. In the second place, the existence of market power

does not imply necessarily that rates of return on capital
will be high. The market for the product may be subject to
secular decline, and monopoly can offer only limited protection in such circumstances; alternatively, available high
profits may be squandered in one way or another by management and/or workers in the privileged firm. At best, therefore,
rates of return on capital provide an ambiguous measure of
market power even when the inevitable problems of measurement themselves have been accounted for (Rowley [58]).
The practical problems oflocating market power in the real
world should not be underrated, for they are very considerable.
But neither should they be exaggerated. By careful reference
to the several indicators listed in this introduction, it is possible
to determine within approximate limits the degree of power
which exists in specific markets. This task must be the principal
preoccupation of the antitrust authorities in economies where
real antitrust policies are pursued.
For real antitrust policies are concerned in no sense to
regulate market power, but rather to eliminate such power as
exists and to prevent the emergence of such power as unfettered
market forces would provide. It is important to recognise that
antitrust constitutes a very potent form of state intervention
which conflicts equally as much with strict laissez-faire as
does public regulation and nationalisation policies; for too
frequently antitrust is viewed as the laissez-faire solution to
the market power problem.
It is useful to distinguish between two categories of antitrust
intervention, namely (i) preventive antitrust (designed to
prohibit behaviour which is likely to lessen competition) and
(ii) corrective antitrust (designed to eliminate market power
where it already exists). Preventive antitrust emphasises th~
prohibition both of conspiracies between formally independent
companies and of activities which fall short of conspiracy but
which nevertheless lessen competition, and the restriction of
developing single-firm market power, be it by merger or by
internal expansion. Corrective antitrust encompasses measures
such as divestment of assets, prohibitions on company expansion, penalties for conspiracy, improvements in the infor-

11

mation market, and even tariff reductions in circumstances

where direct intervention is impossible. These are not sources
of state intervention which are likely to provoke quiet smiles
in business circles, as so many of the so-called antitrust policies
of European countries most certainly do.

12

The Social Welfare Function

The essential problem in assessing antitrust as a public policy

instrument is to decide whether social welfare would be
higher if an antitrust policy were to be implemented than if
it were not. Such a decision is impossible until the value
premises upon which social welfare is to be measured have been
detertnined. The traditional starting-point in the economic
theory of public policy is the Pareto principle, and it is
worth outlining the value premises which underpin this
approach before modifying the principle itself in line with
recent discussions of antitrust policy.
The Pareto principle rests on the assumed value judgement
that if one person is better off, and no one is worse off, welfare
is increased. In this sense the Pareto principle defines an
individualistic approach to social welfare and makes it possible
to write an ordinal social welfare function of the form:

w=

W( UI, U2, ... , Us)

(1)

where W is social welfare and U\ U2, ... , Us are the'levels of

utility of each of the s individuals.
Furthermore, the Pareto principle considers an individual
to be the best judge of his own social welfare. This value
assumption (for cases where there are no interdependencies
between the utility functions of the individuals concerned)
makes it possible to write the following ordinal utility functions
for each of the s individuals:

(2)
where Xi is the ith commodity and Vj is the jth productive
service in the economy.
The assumption that any change in the allocation of resources
which increases the social welfare of at least one person without

13

reducing the social welfare of any other person should be treated

as improving total welfare is frequently referred to as the Pareto
value judgement. It implies that W is a monotonically increasing function of any U, i.e.

aw

aUg )0.

(3)

The significance for public policy discussion of this value

assumption needs emphasising, for it recognises explicitly the
impossibility of comparing the social welfare of separate
individuals. The Pareto principle is necessarily silent whenever
a change is under consideration which improves the welfare
of some at the cost of a reduction in the welfare of others.
For this reason, the Pareto principle is a powerful ally of those
who support the status quo, since there are few important public
policy changes (as distinct from private transactions) which
harm nobody. Yet a single objection is sufficient to veto a
proposed public policy change if one adheres to the dictates
of the Pareto principle. For this reason, the Pareto principle
is usually modified in contemporary economic analysis as
applied to the field of public policy.
The social welfare function most frequently utilised for this
purpose suppresses the Pareto restriction on making interpersonal utility comparisons and treats the distributional
consequences of any change in resource allocation as irrelevant,
namely:
maximise W= TR+S- (TC-R)
(4)
where W = net economic benefit, TR = total revenue, S = consumers' surplus, TC = total cost and R = inframarginal rent.
Essentially, this is the social welfare function which is widely
employed in cost-benefit analysis and (increasingly) in the
economics of industrial organisation. As Harberger [31] has
recently emphasised, in a paper strongly urging that this
social welfare function should be more widely adopted in
applied welfare economics, there are three important postulates which must first be accepted, namely:
1. The competitive demand price for a given unit measures
the value of that unit to the demander.
14

2. The competitive supply price for a given unit measures

the value of that unit to the supplier.
3. When evaluating the net benefits or costs of a given
action, the costs and benefits accruing to each member
of the relevant group should normally be added without
regard to the individuals to whom they accrue.
Harberger urged that these postulates were both simple
and robust, and that they underlay a long tradition in applied
welfare economics. In particular, they were well suited for
the handling of the very partial equilibrium problems which
applied economists most frequently were asked to pass judgement upon, whilst they could yet be used to deal with the
more elegant optimisation procedures of the theoretical
literature. At the same time they encompassed the essence of
the Pareto principle, with its lengthy pedigree in applied
welfare economics, whilst indeed extending the usefulness of
that principle by suppressing its self-crippling failure to deal
with interpersonal utility comparisons. There is much sense
in his recommendations.
It might be argued, of course, that distributional weights
should be introduced when comparing alternative public
policy proposals; that it is unfair to give the same weight to
benefits received by producers and by consumers; or indeed
that the benefits to rich producers (consumers) should be
evaluated differently from those received by poor producers
(consumers). To argue this is to argue the case that equity and
efficiency considerations cannot really be separated in public
policy discussion, and there is no gainsaying that this may be the
case, especially where massive redistributional consequences
are anticipated.
But this is hardly the case with antitrust policy, which at the
most might be expected to exert only a marginal influence upon
the distribution of income, both as between producers and consumers, and as between the separate producers and the separate
consumers concerned. For even a fully effective antitrust
policy would be unlikely to create much real hardship in
the business community. For the most part, the effected adjustments would be small- minor reductions in profits, wages and

15

salaries, or slower than average rates of increase, some plant

and job relocations, minor adjustments in share values, etc. even where the impact (positive or negative) upon economic
efficiency was much more marked. Moreover, there is no
reason (at least in principle) why iniquities resulting from the
introduction (or abolition) of an antitrust policy should not
be countered by appropriate adjustments elsewhere in the
system, most especially via the fiscal mechanisms of the central
government. It would indeed be a tragedy if all economic
policy discussions of a partial nature were to be emasculated
by equity considerations. For the most part, this tract will
review the case for and against antitrust policies strictly
from the viewpoint of economic efficiency. Readers who disapprove of this decision may find themselves disagreeing with
the implications of the analysis even when they feel entirely
sympathetic to the analysis itsel
This survey is not intended to be a review of welfare economics as such, and it would be inappropriate therefore to
debate the more subtle theoretical problems involved in using
the social welfare function outlined in this section. Suffice it
to say that the social welfare function in question views welfare
maximisation in aggregate terms, views money income as a
useful surrogate for economic welfare and treats the distribution of gains as unimportant. The justification of this
approach is the belief that theoretical comers must be cut if
applied welfare economics is to have any relevance to realworld problems, that 'optimum' income distribution is the
proper concern of voting citizens acting via the ballot-box to
resolve the conflict which is inherent in the distributional
debate, and that the main thrust of micro-economic policy
should be directed towards efficiency considerations.
Finally, it should be emphasised that for the most part this
social welfare function is applied to the antitrust issue with
scant consideration for second-best problems. This may be
treated as reprehensible by some readers, though it follows a
lengthy tradition in applied welfare economics, and Davis
and Whinston [18] have recently offered theoretical support
for the piecemeal approach to public policy discussion. There
is nothing inherent in the social welfare function itself, however,
16

which precludes second-best analysis. As Harberger [31] has

demonstrated, all that would be required would be the addition to the standard partial equilibrium welfare analysis of an
expression designed to take account of known inefficiencies
in the rest of the economy. The reason for ignoring such
possibilities is practical rather than inherent in the social
welfare function. We simply do not know enough about
the working of modern advanced economies to be able to
insert with any confidence an expression designed to take
account of irremediable inefficiencies. Better by far in such
circumstances to leave bad alone.

17

3 N eo-classical Economics and

the Case for Antitrust

The tradition of analysing the welfare effects of market power

by reference to the concept of economic surplus as represented
in the previously defined social welfare function is quite ancient,
encompassing]. Dupuit (1844) and (certainly) Alfred Marshall.
More recently this method has been used by Harberger [30],
who was the first economist to use the concept of economic
surplus to quantify the welfare effects of monopoly. The
neo-classical approach to this issue, as outlined in Fig. 1,
produced an unambiguous 'deadweight' loss of social welfare
from market power and constituted a forceful case in favour
of an antitrust policy.
In Fig. 1, AC represents constant per unit costs, which are
presumed to be identical both for the single-firm monopolist
and (in aggregate) for the competitive industry. DD' represents the demand curve both for the monopolist and for the
competitive industry. The output rate of the competitive
industry is OQ,c and of the monopolist OQ,m (where OQ,c>
OQ,m), while the competitive price is OPe and the monopolist's
price is OPm (where OPe<OPm). The loss of consumers'
surplus attributable to the monopolistic outcome can be
measured (approximately) by the area PmACP e, against
which must be offset the producers' surplus gained by the
monopolist which can be measured (again approximately)
by the area ABPePm. This leaves a net loss of consumers'
surplus which can be measured approximately by the socalled Marshallian triangle of area ABC, which is known now
as the deadweight loss from monopoly.
The case in favour of antitrust rested firmly on this net loss
of surplus which was an unambiguous consequence of neo-

18

Deadweight loss of
consumers' surplus

Price
and

c~t l-------1!1!1~~~-------Pc

D'

Qm

Qc

Output rates

FIG. 1. The deadweight loss from monopoly

classical cost and demand assumptions. Since the latter assumptions were never entirely endorsed by applied economists,
the practical case in favour of antitrust rested less easily than
the theoretical literature would have had it. But a lengthy
period was to elapse before theoretical developments were to
parallel the practical evolution of monopoly policy in the
advanced Western economies.

19

4 The Impact of Scale

Economies
The constant cost assumptions of neo-classical economics were
never widely accepted as a characteristic of the real world, and
the possibility that scale economies might be sacrificed as a
consequence of an effective antitrust policy was always recognised by economists actively engaged in the industrial organisation field. Only in 1968, however (Williamson [84]), was
the possibility of a welfare trade-off between the cost savings
from scale economies and the loss of consumers' surplus
from market power formalised within a social welfare function
framework. In so doing, Williamson restricted his analysis
strictly to the case of mergers, which provided simultaneously
cost savings on the one hand, but prices in excess of the competitive level on the other. Williamson's analysis is easily
extended to the case of the entrenched monopolist and the
possibility of corrective antitrust, and in this sense it may be
viewed' as being generally applicable to the antitrust policy
debate. The essence of the Williamson trade-off approach
to the monopoly problem can be distilled from Fig. 2.
Fig. 2 depicts the case of a proposed merger which would
introduce market power into a previously competitive market
situation. In the pre-merger market, firms are supposed to
produce on identical and constant average cost curves (shortrun) which are represented in aggregate by AG1 The competitive price OP1 is identical with AG1 (a normal profit
equilibrium being assumed) and the competitive output
rate is 0Q.!. By contrast, the post-merger combine is supposed
to produce on a lower, constant average cost curve (again
short-run) depicted by AG2 , but to establish price not merely
in excess of AG2 but indeed in excess of AG1 (i.e. price is higher

20

than in the competitive case despite the availability of scale

economies). In such circumstances, a welfare trade-off is
required between the loss of consumers' surplus due to the
higher price (the shaded area Al in Fig. 2) and the cost savings
gain to the producer (the shaded area A2 in Fig. 2). In naive
terms, if Al exceeds A2 the merger should be disallowed; if
A2 exceeds Al the merger should be encouraged.

Deadweight loss of
consumers' surplus (A,l

Price
and
cost

Cost saving

and
producers'
surplus gain

D'

(A z )

Q,

Output rates

FIG. 2. The Williamson trade-off

In fact, as Koo [41] has recently emphasised, even where

the merger is allowed by reference to the social welfare function
used by Williamson, the solution does not satisfY the necessary
conditions for a Pareto optimum. For a social opportunity loss
due to the inefficient use of the merged resources still remains.
If the consumers were able to bribe, or the government continued to subsidise, the monopolist in the amount ADCP2'
the monopolist might well produce an output Qs and lower
the price to C. This would yield the monopolist the same
amount of profit as in the Williamson solution, while consumers'
surplus would increase to AFCP2 , resulting in a net social

21

gain of ADF. Although the sacrifice of this consumers' surplus

does not affect the trade-off between competition and monopoly
in the Williamson model, it merits serious attention when
examining alternative policies towards market power within
a more fluid comparative institutions framework. For even if a
monopolist can reduce production costs and the consumers'
loss may be more than offset by the monopolist's gain, the
opportunity loss to society resulting from suboptimal production of the commodity in question still remains.
In any event, Williamson emphasised that the welfare
trade-off was by no means the simple procedure that it might
seem to be from the analysis based on Fig. 2, and he advanced
a number of relevant qualifications most of which involved the
introduction of time into what is usually treated as a timeless
exercise in comparative statics.
Once time is introduced, it is evident that significant scale
economies would be achieved ordinarily in the absence of a
merger simply by the internal expansion of existing firms, at
least within a growing market. Such cost savings ordinarily
would be achieved without the increase in market power that
would arise in consequence of the merger going through.
A straightforward comparison between areas Al and A2 in
Fig. 2 is then misleading, and a more complex formulation
involving the discounted values of benefits and costs is necessary.
The most plausible formulation, put forward by Ross [54]
in a comment on Williamson's paper (and Williamson's
reply [85]), is based upon the assumption that internal expansion in a growing market does not worsen the degree of
competition. In such circumstances, Williamson's area Al
understates the deadweight loss attributable to the merger,
since price eventually would fall in the competitive market to
AClI The relevant deadweight loss is then given, not by the
area ABACI, but by the area ADF, which is composed of
ABACI and BACIFD. In comparing a merger as opposed
to internal expansion, one must compare the cost savings
PIBDC against ABACI and BAC1FD. The value of both
PIBDC and BAC1FD will diminish with time, whereas ABACI
will persist.

22

This trade-off must be expressed within a discounting

framework if a serious cost-benefit analysis of mergers is to be
attempted. Designating the cost savings from the merger
by S(t), Williamson's deadweight loss by L(t) and Ross's
additional deadweight loss by LI(t), the relevant comparison is
then
(5)

where V is the discounted value of net benefits and where

S(t) and LI(t) fall over time, whilst L(t) remains constant
over time. S(t) =PIBDC when t=O, L(t) = ABACI for all t, and
LI(t) =BACIFD when t=O.
In an expanding total market it is not sufficient to justify a
merger by reference to the criterion established in equation
(5) above. It is relevant also so to time the merger as to maximise V, and this is no simple task in itself. For it involves
complex judgements as to when the potential scale economies
would be achieved in practice, etc. But these are tasks which
no outside enforcement agency could really be expected
to tackle. Furthermore, mergers are usually too complex to
postpone casually, and a once-for-all judgement at the time
of the proposal is the most that could practically be achieved.
This qualification is even less appropriate in the case of a
static or declining total market.
When assessing a merger proposal within a time dimension,
the enforcement agency must pay due regard also to the possibility that the merger in question might herald, or even trigger
off, a wave of merger proposals within the affected market,
especially when the scale economies at stake are thought to
be considerable. In such circumstances, the cost-benefit
analysis on the initial merger would have to proceed within
an industry context, however complex and speculative this
exercise might prove to be.
Finally, in a brief but perceptive section of his article,
Williamson [84] recognised that the management of a postmerger combine might take advantage of the market power
thereby provided to pursue a range of non-profit objectives.
He admitted that where market power was expected to result

23

in the firm relaxing its least-cost posture, the cost savings in

equation (5) must be adjusted, since economies available
in theory but non-sustainable in practice cannot be admitted
as a benefit in the welfare trade-off. Despite his reference to
Leibenstein's important 1966 article (Leibenstein [42]),
Williamson failed to formalise this qualification within the
context of the X-inefficiency debate.

24

5 The Relevance of
X-Inefficiency
Textbook economic theory for the most part assumes that
firms combine their factor inputs efficiently, thereby minimising production and distribution costs for any selected
rate of output. This assumption seems to follow quite naturally
from the basic postulate that firms set out to maximise profit,
and in part for this reason there has been little effort
made to justify the 'cost-efficiency' concept in the conventional
wisdom of economics. Indeed, the cost-efficiency assumption
held on virtually unchallenged and undiscussed through a
period (1945-65) when just about everything else in economics
was under reconsideration.
The assumption of cost-efficiency found natural support
also in the preoccupation of textbook economics with competitive markets. For competition in its most pronounced
form (the polar case of perfect competition) ensures that only
those firms will survive which have successfully sought out
maximum profits in the context of cost-efficiency. The acknowledged fact that perfect competition did not exist in the
modern advanced economy, the inescapable suggestion that
such competition as actually occurred (frequently oligopolistic
in nature) did not ensure the survivorship characteristics of
perfect competition, and the mounting evidence of monopolistic influences in real-world markets, were not allowed to
disturb the elegant cost assumptions of textbook theory until
the X-inefficiency revolution commenced in earnest with the
publication in 1966 of Harvey Leibenstein's seminal contribution [42].
Leibenstein suggested that in imperfectly competitive
situations production costs would tend in practice to be higher

25

than the minimum level which efficient production could

achieve, largely as a result of management and workers
substituting their own objectives (including a desire for a
quiet life) for those of the equity interests (principally profit
maximisation). The gap between actually attained and minimum attainable production costs was categorised by Leibenstein as X-inefficiency:
firms and economies do not operate on an outer-bound
production possibility surface consistent with their resources.
Rather they actually work on a production surface that is
well within that outer bound. This means that for a variety
of reasons people and organisations normally work neither
as hard nor as effectively as they could. ([42] p. 413)
Although Leibenstein asserted that a positive relationship
existed between the degree of market power and the extent
of X-inefficiency, he did not formalise the relationship explicitly, and this could be viewed as an important omission in
view of the practical importance attached to the X-inefficiency
concept. For this reason, an X-theory of the firm [14] has
recently been developed within the general framework heralded
by Leibenstein's contribution, and grounded upon the conventional postulate of profit maximisation. A brief review
of this theory is helpful before a serious discussion of the welfare
implications of X-inefficiency is attempted.
Profit maximisation is retained as the central objective in
the X-theory of the firm on the supposition that this indeed
is the motivation of the equity shareholders and of their
immediate representatives in whom the property rights are
vested. With the separation between ownership and control the hallmark of the modern corporation - however, clashes
are likely between those who own the equity and those employed within the organisation (management as well as shopfloor labour), whose utility functions cannot be expected to
coincide with those of the equity shareholders. For, contrary
to textbook assumptions, management and workers are not
passively employed like capital in the production process, but
rather pursue objectives of their own, such as leisure, security, an
easy life, etc.

26

Under competitive conditions, fears of bankruptcy and

resulting unemployment force management and labour into
full cooperation with the objectives of the firm. This does not
imply, of course, that competition will improve the quality
of low-grade (or indeed of high-grade) labour, but it does
imply that labour of whatsoever quality will be driven to
co-operate to its best ability with the maximum profits objective.
Once competitive forces weaken, however, the scope for
management and labour non-cooperation arises and X-inefficiency will result in the absence of active policing by the
equity interests. Although non-cooperation may take many
forms, a useful distinction may be made between active noncooperation which results in goal conflicts within the organisation (in extreme cases management may subvert the institution
to its own ends, or politically motivated shop stewards may
disrupt working conditions in the name of the International),
and passive non-cooperation which results from the desire
for a quiet life (in extreme instances management may divide
its attentions between alcohol, lengthy lunches with nubile
secretaries and the golf-course, and shop-floor labour may
divide its attentions between extensive tea-breaks and retiring
to the lavatories for the clandestine inhalation of nicotine).
In circumstances such as these, the equity interests within the
firm would normally recognise the need for 'policing' measures
designed to moderate the incidence of X-inefficiency both
at management and at shop-floor level, whilst management
itself would frequently wish to root out shop-floor inefficiency
which can only serve to depress the discretionary spoils which
management wishes to divert to its own ends. Typically,
policing measures divide on the one hand into the provision
of monetary incentives to induce cooperation (e.g. stock option
schemes and profit-related bonuses for management, and piecerate systems and share participation schemes for shop-floor
labour), and on the other hand into the provision of control
devices (e.g. management consultant investigations and budgetary control systems for management, and work-study
experts, foremen, gate-keepers, watchmen and time-keepers
for shop-floor labour).

27

Policing measures such as those outlined above absorb

economic resources, and for this reason it is unlikely in practice
that policing expenditures will be applied to the point where
labour cooperation is absolute. Rather, resources will be
devoted to policing labour up to the point where marginal
policing costs are equated with marginal cost savings due to
policing. Residual X-inefficiency is inevitable, therefore,
in non-competitive markets, and in any event production
costs must be higher than the hypothetical level that competition might provide since policing costs themselves must be
accounted for.
At first sight it may seem that the combination of policing
costs (if any) and residual X-inefficiency must feature as a
welfare loss to monopoly additional to the Marshallian triangle
when assessing the welfare effects of monopoly by reference to
the social welfare function employed in this survey. Certainly,
this has been the approach adopted [lO, 13]. But in reality the
situation is more complex. For elements of X-inefficiency
reflect producers' surplus taken out in the form of nonmonopoly rewards and as such feature as a relevant argument
in the social welfare function. It is even possible that elements of
the policing expenditures (especially of the inducement category) also reflect producers' surplus. The true measure of
welfare loss from X-inefficiency, therefore, must be calculated
net of producers' surplus [16], and as such almost certainly
will be less than the aggregated measures which have been
employed in recent economic analyses of this issue. Throughout the remainder of this section the X-inefficiency concept
under consideration is net of producers' surplus and does not
feature as a relevant argument in the social welfare function.
Whether or not such X-inefficiency is quantitatively significant
is an empirical question which, for the most part, awaits an
answer at the present time.
It is now possible to show the additional welfare losses imposed by monopoly where a shift from monopoly to competition would lower cost levels by improving X-efficiency.
Fig. 3 portrays two extreme alternatives, namely, the case
where X-inefficiency strikes entirely at marginal cost and the
case where it manifests itself entirely as an overhead effect.
28

The analysis is based upon a diagram initially presented by

Crew and Rowley [13] in response to an earlier analysis by
Comanor and Leibenstein [10].

M
M'
Price em
and
cost

C'm
Cc

Output rotes

FIG. 3. The X-inefficiency welfare loss

In Fig. 3, Comanor and Leibenstein assumed that a shift

from monopoly to competition would reduce the monopoly
rent per unit of output by a units, but that it would also reduce
costs by x per unit from Cm to Ce. On this basis, they distinguished the various components of welfare loss resulting from
monopoly. Wa was the perceived welfare loss which measured
allocative inefficiency, and as usual it is illustrated by the
Marshallian triangle ABC. However, the full measure of
allocative inefficiency was given by Wax, since X-inefficiency
affected the level of marginal cost, and this is measured by the
triangle ADE. Wx was defined as the welfare loss from Xinefficiency and refers to the higher costs, Cm)Ce, used to
produce the restricted level of output. This loss is defined by
the area CmCcDB. Thus ql is the difference in output rate
resulting from the shift from monopoly to competition ex-

29

elusive of the cost effect, while q2 is the difference in output

rate directly associated with the cost reduction.
In contrast, where X-inefficiency manifests itself as an overhead effect, the monopoly output rate, even with X-inefficiency,
would be OZ')OZ where marginal cost is equated with marginal revenue, and the monopoly price would be OM'<OM.
In order to preserve the same total cost as that defined
by Comanor and Leibenstein, it is necessary to construct
through B a rectangular hyperbola which cuts demand
between C and E at G. The average cost inclusive of overhead
X-inefficiency of producing the monopoly output rate OZ'
is C'm.
In such circumstances, the welfare loss from X-inefficiency,
W'z, is given by the area C'mCcD'B' and is identical to the
loss, W z , described by Comanor and Leibenstein. The apparent
welfare loss from allocative inefficiency, W'a, defined by the
triangle A'B'C', may be greater than, less than or equal to
that defined by the triangle ABC. The full measure of allocative
inefficiency in the overhead effect case, W'az, is defined by the
triangle A'D'E and is clearly less than that determined by
Comanor and Leibenstein. The differential gain attributable
to the shift from monopoly to competition in the latter case is
defined by the area AA'D'D. The total output-rate adjustment
in the oyerhead effect case, Z',N, is clearly less than that
posited by Comanor and Leibenstein, Z,N. The q2 component
of the latter solution has no counterpart in the overhead effect
case, since marginal cost is not affected by the elimination
of X-inefficiency.
In markets where scale economies do not exist, the introduction of X-inefficiency reinforces the case in favour of
antitrust poliey, and no additional welfare trade-off is required.
Where scale economies are at stake, X~inefficiency considerations further complicate an already complex welfare trade-off
between the costs and benefits of antitrust policy. For in such
circumstances the cost increases from X-inefficiency must be
offset against the scale economies which are potentially
available before the Williamson trade-off can be applied.
Alternative implications for antitrust policy are outlined in
Fig. 4 in 'naive' form.

30

Price

and AC3 r---+'--+---

cost

AC2r---+--~---~-~A~

O2

0,

Output rates

FIG. 4. X-inefficiency versus scale economies

In Fig. 4 the competitive industry is assumed to produce at

constant cost on the cost curve ACl and to operate at output
rate OQ.l and at price OPl. The single-firm monopolist, by contrast, is assumed to benefit from scale economies but to suffer
from X-inefficiency. On the one hand, where X-inefficiency
does not swallow up all available economies, the firm might
produce on the cost curve AC2( <ACl ), operating at output
rate OQ.2( <OQ.l) and at price OP2()OPl ). The relevant
Williamson-type trade-off is then between the area of effective
cost savings Pl EGAC2 and the area of the Marshallian triangle
CEACl This trade-off must be less favourable to the monopolist
than the strict Williamson welfare trade-off would be. On
the other hand, where X-inefficiency exceeds potential-scale
economies, the monopolist might produce on the cost curve
ACa()ACl ) , operating at output rate OQ.a( (OQ.l) and at
price OPa()OPl ). No trade-off is then required since the cost
losses measured by the area ACaHDPl must be added to the
loss of consumers' surplus, measured by the triangle ADACl , to
obtain the uncompensated welfare loss due to monopoly.

31

A more sophisticated version of this approach, which would

be required if a fully-fledged cost-benefit approach to the
market power problem were to be put into operation, would
need to take full account of the likely time profile of the Xinefficiency impact and to modify accordingly the relevant
discounting procedures for the Williamson trade-off, most
particularly as outlined in equation (5). The practical problems encountered by such an approach are discussed further
in a later section of this survey.

32

6 Invention and Innovation

Invention has been defined succinctly [48] as the process
whereby conventional inputs and general knowledge are
combined to produce technical knowledge, whereas innovation
is usefully defined as invention applied commercially for the
first time. The close relationship between these separate
processes does not necessarily imply that the social welfare
problems they present are identical, though in many respects
the two processes can be jointly analysed from the viewpoint
of antitrust policy. A useful introduction to the general welfare
economics of inventive activity is available in the recent
controversy between Arrow [2], Demsetz [21] and Yamey
[89] as to the most appropriate allocation of resources for
invention. Attention is centred in this survey upon one aspect
of this debate, namely, the most appropriate form of organisation for the invention process.
Arrow examined the incentives to invent for monopolistic
and competitive markets by comparing the potential profits
from an invention with the costs, and in so doing by centring
attention upon an inherent property of information, namely,
its indivisibility in use. The special assumptions of the Arrow
model must be noted. He defined a competitive situation
as one in which the industry produced under competitive
conditions whilst the inventor was able to set an arbitrary
royalty for the use of his invention. The monopoly situation
was defined as one in which only the monopoly itself could
invent, i.e. as a situation in which barriers to entry were significant. On this basis, Arrow proceeded to demonstrate that
the incentive to invent was less under monopolistic than under
competitive conditions, but that even the latter case provided
a less than socially desirable degree of incentive. He centred
A.A.E.E.-B

33

attention upon the case of the cost-reducing invention, as is

illustrated by Fig. 5.
In Fig. 5, constant costs are assumed both before and after
the invention, the unit costs being c before the invention and
c' <c after the invention. The competitive price before invention will therefore be c. r is the per unit royalty set by the
inventor to the competitive industry so as to maximise the

FIG. 5. Incentives to invent under competition and monopoly

size of the rectangle c'puv. This results in a price for the product
of the competitive industry equal to p. Arrow defined P' =c'puv.
Thus an inventor selling to the competitive industry would
invest in inventing as long as the cost of the invention to him
was less than P'.
By contrast, in the monopoly case Arrow set the price at
w to maintain that rate of output for which c=MR. The
profit, P, is given by the rectangle cwxy. Following the invention, units costs would fall from c to c' and the new profitmaximising price would be p, yielding a new profit rectangle
equal to P'. On this basis, Arrow concluded that the incentive
to invent was less under monopolistic than under competitive
34

conditions. For the inventor selling to a competitive industry

would be willing to invent if his cost was less than P', whereas
the monopolist would be willing only if the cost of inventing
was less than P' -P, which must always be less than P'.
Demsetz attacked Arrow's conclusions by challenging two
aspects of the latter's model, namely (i) the assumption that
the inventor possessed the monopoly power to discriminate in
the royalty charges set for the two industries, and (ii) the
failure to take account of the normal monopoly incentives in
the monopoly purchasing the invention. When proper account
was taken of these matters, Demsetz argued that Arrow's
conclusions were false.
Suppose, for example, that the inventor somehow was
restricted to charging all users of the invention identical unit
royalties, measured by p - c' in Fig. 5. Then both the competitive industry and the monopolist must accept p - c' as the
price of an input. The competitive industry would pay a
total royalty equal to P' to the inventor, while the monopoly
would pay half this amount. This is the normal restrictive
effect of non-discriminating monopoly, which Demsetz proceeded to remove by defining MR in Fig. 5 to be the demand
curve facing the competitive industry. For any given unit
cost, both the monopoly and the competitive industry would
produce the same output rate and would both pay the same
total royalty to the inventor. There would be no special adverse
effect of monopoly on the incentive to invention.
The case where royalties were not equalised for the two
industries requires a slightly different treatment. The relevant
situation is outlined in Fig. 6.
In Fig. 6, Dm and MRm represent the demand and the
marginal revenue curves facing the monopolist, while Do and
MRo characterise the industry demand facing the competitive
industry, where MRm=Do. At cost=c, the competitive
industry produces output cu, since demand must equal marginal
cost under competition, and the monopolist would produce
the output rate cu since marginal cost must equal marginal
revenue. Thus the effect of monopoly on the output rate has
been removed. At cost c, the monopolist receives profit P = cptu,
whereas with the cost-reducing invention the monopoly profit
35

FIG. 6. Incentives to invent with royalty discrimination

is p" =c'P'yx. The incentive to monopoly invention is pIt -Po

The best that the inventor can do if he sells the invention to
an equal-size competitive industry is to obtain a permit
royalty equal to p' -c', causing the competitive industry to
produce at output rate P'v, thereby maximising the inventor's
total royalty c'p'vw. The question at issue is whether the incentive to invention offered by the competitive industry,
c'P'vw=P', is greater or smaller than pIt -Po
In Fig. 6, P" - P' is clearly greater than P, suggesting that
the monopolist offers a greater inducement to invest. Demsetz
proved that this result was not an optical illusion but completely
general to his model in a mathematical appendix to his paper.
On this basis, Demsetz concluded that where patent protection
provided monopoly powers to the inventor, antitrust in the
product market should be pursued less diligently than considerations of output restrictions alone would dictate, for,
at least in the linear model of two industries of equal size,
the more monopolistic would give the greater encouragement to invention.
36

The Arrow-Demsetz debate abstracted deliberately from

certain important institutional factors which influence perceptibly the incentive to invention in the real world. Yamey
[89] re-examined the monopoly-competition controversy in
the light of certain of these institutional factors, emphasising
that the Arrow-Demsetz debate referred essentially to a
situation of bilateral monopoly with lump-sum payments.
With bilateral monopoly, an element of indeterminacy is
introduced into the pricing process with bargaining possibilities that affect the degree of risk confronting the inventor.
Yamey re-examined the debate over the incentive to invent
from this viewpoint.
In particular, the degree of risk encountered by the inventor
was greater in his dealings with a monopolistic producer than
with a competitive industry, since the bargaining customarily
would take place after the inventor had committed resources
to invention. In such circumstances, indeed, the risk of exploitation would be tempered only by the monopsonist's
interest in the acquisition of future inventions from the same
inventor, and certainly the incentive to invent would be less
than that indicated in the formal analysis, unless the terms of
payment were settled before the inventor committed himself to
heavy outlays.
Even this safeguard, however, would be the less practicable
(from the inventor's viewpoint) the more difficult it was to
determine objectively the extent of the cost reduction anticipated with the aid of the invention. The scope for argument
and conflict in practice could be substantial, so adding to
the risks of invention. In extreme cases, where the invention
was designed to make possible the production of a new product
whose specifications and production costs were then unknown,
no settlement might be possible before resources were committed by the inventor. The inventor's already difficult
bargaining position is further weakened, moreover, by his
dependence upon the monopsonist customer for estimates of
product demand which play an important role in the ArrowDemsetz approach. For these reasons, Yamey contended that
an important aspect of the traditional case against monopoly
must be brought back into the calculation.

37

As Yamey noted, Arrow avoided many of the problems

raised above by assuming that in the monopolistic situation
only the monopolist producer itself was able to invent.
But even then the dependence of the inventor upon the
market assessment of its sale customer could not easily be
rationalised. Indeed, the dependence on a single decisionmaking entity for market knowledge in a context of uncertainty
constituted a major disability of monopoly as a form of economic organisation.
It is more usual to analyse the invention market (and its
imperfections) on the assumption that the producing firms
are responsible both for their own inventions and also for
any consequential innovations. For the most part this is a
more realistic approach, at least for modern industrial economies. Somewhat different public policy problems are then
posed than those which are central to the Arrow-Demsetz
debate on invention incentives, and the antitrust implications
(including the patent law implications) merit attention. The
specific peculiarities of knowledge that make its markets so
imperfect are (i) the lumpiness ofthe inventive inputs necessary
to produce knowledge, and (ii) the high degree of spillover (or
low degree of appropriability) that accompanies the inventive
process.
Lumpiness in the costs of invention is a consequence of the
fact that knowledge is expensive to produce but cheap to
reproduce. The unimportance of 'marginal cost' relative to
'average cost' implies that the normal market mechanism
will not function effectively in the absence of state intervention,
and that either there will be no production of knowledge or
that such production will be concentrated in a small number
of firms.
It is important to emphasise, however, that lumpiness in
the production of knowledge is not entirely analogous to
the case of increasing returns to scale in the production
of knowledge. Rather, such lumpiness reflects a strong asymmetry between the original discoverers and the subsequent
rediscoverers of knowledge, in that knowledge once attained
(mually at great cost) is normally assimilated at a relatively
low cost by others. Moreover, it is perhaps important even in

38

this latter respect to distinguish between the transmission

costs ofinformation (which are frequently very low indeed) and
the costs of absorbing new knowledge of technology (which
may be high). Hence the assumption of low marginal costs
of information transfer may be less valid for technical knowledge than for general knowledge.
The second (and closely related) feature of the knowledge
market is the problem of spillovers or of inappropriability,
characterised in the absence of state intervention by the
inability of inventing firms to capture all the fruit of their
inventions. Arrow [2] in particular is sceptical about the
ability of inventors to capture the value of their information
for themselves. The case of complete inappropriability is
quite unrealistic, of course, since there are always lags and
frictions in the transmission process which enable the inventing
firm to appropriate some of the benefits. The typical case, in
the absence of state intervention, is that of inventions which are
only partially appropriable, and which in part become a free
good. In such circumstances, a public policy dilemma is posed.
On the one hand, if information is to be produced privately,
its producers must be able to appropriate the fruits of their
labours. On the other hand, if the marginal cost of transmitting
knowledge is as low as is commonly believed, there is good
reason for encouraging the 'theft' of information to avoid the
loss of consumers' surplus which is inevitable if prices are
established in excess of marginal transmission costs.
Various solutions to this policy dilemma have been put
forward in the invention literature. Arrow [2] has suggested
that for optimal allocation to invention it might be necessary
for the government or some other non-profit-motivated agency
to finance research and invention. Whether or not public
production should accompany public finance to extend the
market in invention then remains as a contentious issue.
By contrast, Demsetz [21] has argued forcibly that a
private enterprise solution is entirely possible, with suitable
support from patent legislation, since appropriability is
largely a matter of legal arrangements and the enforcement
of such arrangements. The degree to which knowledge is
privately appropriable can be increased by raising the penal-

39

ties for patent violations and by increasing the allocation of

resources to the policing of patent violations.
Demsetz avoids the public policy dilemma posed by the
indivisibility in use of invention by rejecting the notion that
economic activity can be partitioned into the act of producing
knowledge and the act of disseminating already produced
knowledge. Since one of the main functions of paying a
positive price is to encourage others to invest the resources
required to sustain a continuing flow of production, Demsetz
contended that the efficiency with which the existing stock of
information is used cannot be judged without examining the
effects on production. Demsetz concluded that the problem
might well be best resolved by a private property system
that reduced the cost of contracting and raised the cost of
free-loading, while at the same time providing incentives and
guidance for investment in producing information. Patent
laws and patent enforcement would have a major role to
play in such a system, though the problems involved in determining the optimum patent (and indeed the optimum rate of
diffusion of knowledge) should not be underestimated.
The remaining issue, which is indeed of central importance
from the viewpoint of antitrust policy, concerns the comparative
stimulus to innovation of competition and monopoly in markets
characterised by uncertainty and in which the processes of
invention and innovation are combined within a single enterprise. This is indeed one of the most discussed issues in the
economic theory of industrial organisation, and yet one in
which a convincing a priori judgement is most elusive. A brief
review of the more plausible theories is all that can be offered
at this stage.
The conventional wisdom at the present time, following
Schumpeter [63], Galbraith [29] and others, supports the
theory that large size and structural monopoly are most
conducive to technical progress. To quote Galbraith:
... a benign Providence ... has made the modern industry
of a few large firms an almost perfect instrument for inducing
technical change. It is admirably equipped for financing
technical development. Its organisation provides strong

40

incentives for undertaking development and putting it

into effect. ([28])
This view is justified by reference in part to scale economies
which are assumed to exist in the inventive and innovative
processes, in part to the greater ability of monopolistic than of
competitive firms in appropriating the fruits of their labours,
and in part to the more efficient response of monopolistic
firms to an environment characterised by risk and uncertainty.
The view that there are significant scale economies in the
inventive process has been thoroughly debated in recent years.
It is essentially an empirical matter which will be re-examined
in a subsequent section of this survey. The view that monopolists are better at appropriation than competitive firms is
correct within the framework of laissez-faire, but does not hold
up once patent legislation is envisaged. The issues raised by
risk and uncertainty require further treatment, since One of
the essential properties of the inventive process is that the outcome is so uncertain, and in an economy characterised by
risk-aversion, unless facilities exist for the shifting of risk to
those who are less risk-averse, or for risk reduction, private
markets will discriminate against risky enterprises and,
inevitably, will provide for a suboptimal allocation of resources
to invention.
Arrow [2] has argued forcibly that real economic systems
do not possess adequate facilities for the shifting of risk; that
comprehensive markets in commodity options do not in fact
exist and that even a perfect market in insurance facilities
would pose serious problems of moral hazard, since the insurance policy itself would affect adversely the incentive of the
insured. Since invention is a risky process, Arrow concluded
that there was bound to be some discrimination against investment in inventive and research activities, although it
could be minimised by conducting research in large firms
with diversified invention portfolios. Although Demsetz [21]
questioned the relevance of Arrow's analysis, pointing out
that risk shifting and the elimination of moral hazard were
themselves scarce resources which must be economised, he did
not deny that the presence of risk posed problems for com-

41

petitive markets. It is instructive, therefore, to explore the

implications of centralising invention into a small number of
monopolistic agents.
Nordhaus [48] has recently examined this policy alternative
for invention activities characterised by 'mild uncertainty"
which is defined as 'conditions under which the underlying
stochastic processes are sufficiently regular so that the firm
can form reliable estimates of the probability distribution of
alternatives and act accordingly'. In such circumstances, he
was able to follow the axioms of expected-utility maximisation
in applying portfolio-selection theory to the invention problem.
The fundamental result of this application is that firms can
decrease the riskiness of their investments by diversifying
among projects with some statistical independence. Thus,
provided that the probability distributions of returns to invention are sufficient regular, firms will be able to reduce their
risk by engaging in a large number of projects. Furthermore,
firms with large research laboratories which are engaged in
many projects will have smaller risks than smaller firms with
proportionately sized research laboratories. On both counts
there is good reason to expect small firms to be disadvantaged.
On the other hand, Nordhaus suggested that the distribution
of returns to research might well be so irregular that the results
of portfolio-selection theory would not hold for the invention
process. In particular, work by Scherer [61] indicated that
the value of patents was distributed in the tail according to
the arc-sine distribution. This distribution is badly behaved
in that it possesses neither finite mean nor variance. A firm
facing such a distribution could not reduce risk by diversifying
or by adding to its total list of projects. Risk would increase as
the number of projects increased because the law of large
numbers does not hold for the arc-sine distribution. Under
such circumstances, the risk-averse firm would do well to
concentrate upon a single invention only, and the risk-reduction argument in favour of invention monopolies would not
hold. Too much must not be made of this possibility. But the
risk-reduction theory must needs be presented more cautiously
than is general in the invention liter!lture.
In so far as scale economies do exist in the innovation

42

process - and if they are limited in invention there is good

reason to believe that they are significant in development - it
might be thought that this alone would support the case for
monopoly in the overall welfare trade-off. As with scale
economies in production, however, this is too simple. For Xinefficiency is likely to strike just as much at the inventive as
at the productive processes of the monopolistic firm. Indeed,
Leibenstein [43] has applied the X-inefficiency hypothesis
specifically to the inventive processes, and his analysis certainly
complements other contributions which have emphasised the
incentive aspects of competition in invention and innovation.
The impact of monopoly upon technical progress - be it
positive or negative - can now be introduced formally into
the Williamson-type welfare model employed in this study.
Following Williamson [84], the method will be illustrated by
reference to the case where monopoly is expected on balance
to retard technical progress, and the trade-off will be restricted
to that between scale economies gained and technical progress
lost (i.e. price effects are ignored). How large a change in the
rate of technical progress would be required to offset available
scale economies? Williamson obtained a crude estimate by
denoting as 8 the ratio of the immediate post-merger to premerger average costs (so that 1 - 8 is the immediate decimal
fraction reduction in average costs), by denoting as gl the
rate of productivity increase in the absence of the merger and as
g2 the rate if the merger was approved. Q,(t) is the output in
period t and r is the social discount rate. In such circumstances,
the loss of technical progress would just offset scale economies
i.e. the discounted value of costs under each condition would
be the same when the following equality holds:

fa; [(AG) Q, (t)e-U1t]e-rtdt =fa; [8(AG) Q, (t) e-u2t] e-rtdt.

0:,

(6)

Assuming that output increases exponentially at the rate

the critical value of g2 is given by:

g2 = BgI- (1- 8)(r-0:).

(7)

43

7 Some Orders of Magnitude

The nature of the social welfare trade-off which is central to
the antitrust debate has been outlined in purely theoretical
terms in Sections 4 and 5 of this paper. What are the practical
implications for the policy debate? Williamson [84, 85]
derived some guideline orders of magnitude from the 'naive'
trade-off model between scale economies and allocative
inefficiency. Although these guidelines exclude X-inefficiency
considerations, the latter are easily incorporated by treating
cost savings as net of X-inefficiency.
It will be remembered that the net allocative effect of antitrust in the Williamson naive model (see Fig. 2) is given
by the difference between the two areas A2 - AI. The area A2
is given by (AC2-ACI )Q2 or [LI (AC) Q2], while Al is given
approximately by HP2-PI)(QI- (2) or t(LlP)(LlQ). The net
economic effect of antitrust intervention will be positive if
the following inequality holds:
[LI (AC)] Q2 - t(LlP) (LlQ) <0.

(8)

Dividing through by Q2 and substituting for LlQ/Q the expression y( LIP/P) where y is the elasticity of demand, we have:
LI(AC) -!(LlP)y~ <0.

(9)

Williamson defined a new variable, k, as an index of premerger (or post-antitrust) market power, which would take
on values greater than or equal to unity. The price before the
merger (or post-antitrust) is equal to k(ACI ), and thus k= 1
is equivalent to a situation of trivial pre-merger (or postantitrust) market power. Where k= 1, dividing equation (9) by
PI =k(ACI ) we obtain:
44

Ll (AC) _ ~ (LlP) 2(0

AC
2Y P
.

(10)

This expression must be corrected, however, by a factor

which depends upon the nature of the demand curve (De
Prano and Nugent [24]). On the assumption (preferred by
Williamson) that the demand curve is a constant elasticity
function in the relevant region, it is necessary to divide (9)
by PI Ql where PI =kACI and to substitute y(LlP/P1) for
LlQ/Ql' The inequality in (10) then becomes:
Ll(AC) _ ~ g.I(LlP)2(0
AC
2Y Q2 PI
.

(11)

The inequality outlined in (11) is correct as a guideline for

antitrust intervention where pre-merger market power is
negligible, i.e. where k= 1. However, where k)1 the expression
overstates the welfare gain from cost savings, and therefore
excessively weakens the case for antitrust intervention by
neglecting part of the producers' surplus from pre-merger
profits. The parallel test expression to the inequality in (11) now
becomes:
Ll(AC) _ [tk(LlP) +k-l]yLlP. QI(O.
ACI
PI
PI Q2

(12)

The k-l term in (12) was omitted from (11) and reflects
the neglected part of pre-merger profits mentioned above.
The degree to which this modification affects the trade-off
relationship varies directly with the value of k. Williamson
argued that values of k in the neighbourhood of 100 would
be typical and that values as high as 105 would obtain occasionally. On this basis, he estimated the percentage cost reductions sufficient to offset various percentage price increases for
selected demand elasticities (assumed to be constant in the
relevant range) for values of k= 100 and 105. The results
are outlined in Table 1.
It is evident from Table 1 that relatively small percentage
cost reductions are sufficient to offset quite substantial percentage price increases in the Williamson trade-off model,
especially where pre-merger (or post-antitrust) market power

45

PERCENTAGE COST REDUCTIONS

Table 1
[(LlAC/AC1 )

100]

(NET OF X-INEFFICIENCY)

SUFFICIENT TO OFFSET PERCENTAGE PRICE INCREASES

SELECTED VALUES OF

LIP/PIx 100
5
10
20
30

Y AND k = 100 AND 105

y=2
k = 100 k = 105
026
1-05
4-40
1035

078
215
682
1428

y=l
k=100 k=105
012
050
200
450

038
103
310
621

[LIP/PI X 100]

FOR

y=i

k= 100 k= 105
006
024
095
210

019
050
1-48
290

Source: O. E. Williamson, 'Economies as an Antitrust Defense: Reply',

American Economic Review (Dec 1969) p. 957.

is insignificant (i.e. where k = 100). The greater the value of

k, the less attractive are scale economies as an antitrust defence,
but even with k = 105, Williamson felt able to endorse his
earlier conclusion that 'a merger which yields nontrivial real
economies must produce substantial market power and
result in relatively large price increases for net allocative
effects to be negative'. This conclusion must be modified, of
course, to take account of X-inefficiency considerations,
since scale economies which are practically unavailable cannot
feature as a cost of antitrust intervention in the welfare tradeoff. Clearly, the welfare trade-off is more complex than
Williamson was willing to allow, and reference to the available
empirical evidence is now essential.

8 The Evidence
A survey such as this cannot pretend to offer a comprehensive
review of the evidence on the various welfare gains and losses
attributable to antitrust intervention. Rather, a brief indication of the more significant findings is provided in this section
with reference to allocative inefficiency and X-inefficiency as
welfare gains and scale economies as welfare losses from antitrust intervention. Great confidence should not be placed in
these results, which are often based upon relatively casual
empiricism.
ALLOCATIVE INEFFICIENCY
The empirical evidence on allocative inefficiency is far from
comprehensive, but suggests that the welfare gains that can
be achieved by antitrust intervention (and/or by tariff
reductions) are exceedingly small, at least in capitalist economies. Leibenstein [42] usefully summarised evidence compiled
between 1929 and 1970 for the U.S.A., the U.K. and for
certain European economies in a table here reproduced as
Table 2.
In view of the very considerable attention paid by economists
to problems of allocative inefficiency, the estimates outlined in
Table 2 are quite startlingly low and are suggestive indeed
that a large number of economists may themselves be guilty of a
misallocation of research resources. For this reason alone,
there may be some scepticism as to the accuracy of the research
findings. Yet it is relatively simple to demonstrate that these
findings are to be expected, with the aid of the diagram employed by Harberger [30] which is depicted in Fig. 7.

47

Table 2
CALCULATED 'WELFARE Loss' AS PERCENTAGE OF GROSS OR NET NATIONAL
PRODUCT ATTRIBUTED TO MISALLOCATION OF RESOURCES

Study

Source

A. C. Harberger
D. Schwartzman
T. Scitovsky
J. Wemelsfelder
L. H.Janssen
H. G. Johnson
A. Singh

Count~)I

Loss

Cause

A.E.R. 1954
U.S.A. 1929
Monopoly
].P.E.1960
U.S.A. 1954
Monopoly
(1 )
Common Market
Tariffs
1952
E.]. 1960
Germany 1958
Tariffs
Italy 1960
(2)
Tariffs
Manchester
U.K. 1970
Tariffs
School 1958
(3)
Montevideo
Tariffs
Treaty countries

(%)

007
001
005

018
max 010
max 100
max 00075

Sources:
(1) Economic Theory and Western European Integration (Stanford, 1958).
(2) Free Trade, Protection and Customs Unions (Leiden, 1961).
(3) Unpublished calculation.
Overall source: H. Leibenstein, 'A11ocative Efficiency vs. X-Efficiency', American
Ewnomic Review (.June 1966) p. 393.

Price
and

cost

CP

Output rates

MP

=monopoly price

CP = competitive price

FIG. 7. Welfare loss from allocative inefficiency

48

In Fig. 7 the familiar welfare loss from monopoly is represented

by the shaded (MarshalIian) triangle ABC. An approximation
to this area is obtained by multiplying the price differential,
AB, by the quantity differential, BC, by one-half and by
multiplying this by the proportion of national income in
industries involving the misallocation. By reference to a
numerical example incorporating quite enormous figures for
the misallocation, Leibenstein [42] demonstrated how insignificant would be the impact on national income. He
assumed tl}at 50 per cent of national output was produced
in monopolised industries, that the price differential was 20 per
cent, and that the average elasticity of demand was 15. In
these circumstances, allocative inefficiency would amount to
I! per cent of national income. A priori analysis, therefore,
endorses the research findings outlined in Table 2.
SCALE ECONOMIES
Returns to scale relate to the impact upon average costs of
production of varying rates of output per unit of time for a
given commodity, on the assumption that production at each
scale is effected in the most efficient manner available. In
this sense the scale curve is both timeless (though time-dated,
since technical knowledge and factor prices are assumed to
be constant) and entirely abstract. It is in no sense surprising,
therefore, to find that empirical analysis on returns to scale
presents formidable, if not indeed insurmountable, problems.
Moreover, as Alchian [1] has emphasised, the two-dimensional concept of returns to scale outlined above is less complex than that required for empirical analysis since returns to
scale in the real world is a multi-dimensional concept, relating
average cost to many other variables in addition to that of
the rate of output per unit of time. In particular, average cost
may well be a function also of the number of periods of production envisaged, of the total volume of production envisaged,
and of the precise timing of the start to production. In such
circumstances, a range of different 'scale curves' would exist at
any point in time and the choice between them would depend
49

upon the precise requirements of the investigation. Inevitably,

this must cloud any attempt to assess in overall terms the
significance of scale economies within a particular economy.
Furthermore, the social welfare implications of specific
returns to scale will vary from industry to industry and from
country to country according to the overall size of the market
under consideration. Scale economies which might present
formidable problems for the maintenance of competition in
an Australian market might prove entirely insignificant
within the context of the U.S.A. (or even the U.K.). It is
essential, therefore, from the viewpoint of antitrust policy, to
treat scale as a relative measure based upon the size of the
market (or the economy) under consideration. For large
markets are obviously better able than small markets to take
advantage of scale economies without an attendant sacrifice of
allocative efficiency. This adds to the complexity of absolute
scale analysis all the problems referred to in the introductory
section of this survey concerning the definition and the delimitation of markets. The general studies of returns to scale
discussed in this survey relate for the most part to the U.K.
and the U.S. economies. The reader is advised to exercise
caution in further generalising the results of these studies to
other economies. Only the most tentative conclusions are
possible in any case in a study of this kind.
The most recent analysis of returns to scale in U.K. and U.S.
manufacturing industry is that recently completed by Pratten
[53] for the Department of Applied Economics at Cambridge,
employing the engineering approach. The advantages and
limitations of this approach to scale analysis are well known.
In the present author's view, the engineering approach
(which centres attention almost exclusively upon technical
returns to scale) tends to overstate the advantages of largescale production (Stigler [67]). Certainly, Pratten concluded
that in absolute terms scale economies were considerable in
many industries:
The effects of scale vary for each type of plant over different
ranges of scale, for plants and firms in different industries
and for firms following different strategies within an industry.

50

Nevertheless, our estimates show that there are substantial

technical economies of scale for the production of many
products. ([53] p. 302)
Furthermore, Pratten urged that the range of output to
which scale economies applied and the magnitude of such
economies were increasing with time, as a consequence of the
rapid growth of output of manufactured products, of technical
change, of the substitution of synthetic for natural materials,
of improvements in transport and communications, of improvements in managerial expertise, and the increasing
relative importance of research and development expenditures. He concluded that the achievement of the maximum
economies of scale was not compatible, in the U.K. at least,
with the existence of competition between many firms for a
large number of products:
If an economy were being built up from scratch and the
benefits of competition were ignored, our estimates of
economies of scale suggest that there should be a very high
degree of concentration of production of many products ...
([53] p. 313).
Pratten's conclusions, which are relatively unfavourable
for antitrust policy, are not endorsed, however, by a close
research associate, Silberston [66], in an interpretative essay
based on the Pratten evidence. From the viewpoint of public
policy, Silberston emphasised the need to evaluate the significance of scale economies relative to the size of the relevant
market rather than in absolute terms. Following a detailed
reassessment of Pratten's evidence, Silberston concluded that
there was not so great a conflict, within the U.K. context,
between scale economies and competition policy:
It seems to me now, however, more important to consider
industries with 'significant' economies of scale, in the sense
in which I have used the term here - i.e. industries with a
combination of high indicated scales in relation to the
market and high initial capital and other costs. Table III

51

is, I believe, weighted quite heavily in favour of these

particular industries. If this is so, it is probably fair to conclude that there are comparatively few industries which have
'significant' economies of scale in this sense - in relation
always, of course, to the size of the United Kingdom market.
([66] p. 386)
The second set of studies referred to in this survey are based
upon the survivor technique (Stigler [67]) approach to the
analysis of returns to scale and relate exclusively to the U.S.A.
The conclusions drawn are based upon the important survey
article by Shepherd published in 1967. It should be emphasised
that the survivor technique provides at best only a very crude
measure of returns to scale, be they for plants or for firms, and
that it is ill-suited for analysing the welfare trade-off between
scale economies and antitrust since the surviving scale sizes
are not necessarily optimal in terms of social welfare. Nevertheless, the survivor technique is probably as useful a measure
of returns to scale as the engineering approach as applied
in practice, especially in analysing plant rather than firm
SIzes.
Shepherd [65] referred to the evidence compiled between
1958 and 1967 by Stigler, Saving and Weiss, as well as to
additional tests of his own analysing returns to scale in the
U.S.A. For the most part, the analysis centred UPOD. plants
rather than upon firms. A significant finding was the high
frequency of decline in the largest-size categories of plant,
especially between 1947 and 1958. Of the 133 industries
tested, 78 showed declines in the share of the largest plants,
measured in terms of numbers employed. The relatively few
industries which showed an increase in the share of the largest
plants between 1947 and 1958 had been characterised by an
unusually high rate of growth in value-added, and for this
reason concentration had actually declined in four out of the
six such industries for which data were available. Altogether,
Shepherd concluded that there had been no widespread shift
at all towards larger plants, and even where increases in plant
size had occurred, this had not led to rises in concentration.
The time period encompassed by Shepherd's analysis, it is

52

interesting to note, was that within which the conventional

wisdom that returns to scale were on the increase was most
rampant. Shepherd's conclusions scarcely endorse the conventional wisdom (see also Weiss [82]).
The evidence on returns to scale is far from satisfactory at
the present time, in large part owing to the intractability of
the concept in empirical analysis. Such evidence as has been
examined above does not suggest that scale economies pose
the serious threat to antitrust policy that has been conventionally supposed. This does not imply that a case for perfect
competition could be supported by reference to the Williamson
trade-off model. Scale economies would normally negate this
policy alternative. In the real world, however, the policy
trade-off is not restricted to the alternatives of perfect competition and pure monopoly. Intermediate cases in which
some allocative inefficiency is accepted as the price for some
scale economies are highly relevant. The theoretical implications for social welfare analysis of introducing these intermediate cases are explored in a later section of this survey.
X-INEFFICIENCY
The concept of X-inefficiency was only introduced into economics in 1966 with Leibenstein's seminal contribution, and
the measurement problems encountered in trying to track
down its existence, not to say its magnitude, in the industrial
system are considerable, i.e. on a par with returns to scale.
It is not surprising, therefore, to find that existing evidence
is patchy and that a great deal of research is necessary before
confident conclusions may be drawn as to its importance in
the U.K. and the U.S. economies. Nevertheless, such evidence
as exists is suggestive that X-inefficiency may indeed assume
significant dimensions.
For the most part, the available evidence must be derived
as a by-product from studies conducted with different objectives than that of measuring X-inefficiency - productivity
studies, efficiency audits, regulatory investigations, planning
surveys and the like - and Leibenstein provided by far the most

53

comprehensive survey of such accumulated information in

his 1966 article. Leibenstein's evidence [42], perhaps inevitably,
was not systematically analysed. Statistics were taken from
a variety of economies (underdeveloped as well as advanced)
and incorporated wide variations in types of industries and
firms. No attempt was made to link evidence on X-inefficiency
at all systematically to the presence or absence of competition
in the markets under consideration, nor was there any serious
attempt to eliminate any effects of scale upon costs before
discussing the incidence of X-inefficiency. For these reasons,
Leibenstein's conclusions must be viewed circumspectly. Nevertheless, it is not entirely without significance that
Leibenstein felt able to pronounce, as a result of this survey,
that 'the main burden of these findings is that X-inefficiency
exists, and that improvement in X-efficiency is a significant
source of increased output' and that 'we have instances where
competitive pressures from other firms or adversity lead to
efforts toward cost reduction, and the absence of such pressures
tends to cause costs to rise'. Leibenstein concluded that for a
variety of reasons people and organisations normally worked
neither as hard nor as effectively as they might, and that
significant improvements in productivity could be achieved
by the elimination of X-inefficiency.
Additional support for Leibenstein's hypothesis is to be
found in the empirical work of Williamson [83], which
was designed to test a managerial theory of firm behaviour.
Williamson was concerned with the possibility that the management of firms protected from competitive pressures might
take out potential profit in the form of 'management slack',
characterised by the appointment of excessive staff, the purchase of excessive management amenities and the payment
of excessive management emoluments. This is X-inefficiency
by another name. In contrast to Leibenstein, Williamson
assumed throughout that shop-floor labour was optimally
employed.
Williamson tested this proposition by a series of case-study
investigations of firms in the U.S.A., and convincingly demonstrated that where firms encountered commercial setbacks,
perhaps as a consequence of increased competition, they reacted

54

by rooting out surplus management expenditures which had

grown during more prosperous times. In one case study,
contrary to expectations, Williamson found a similar response
pattern at shop-floor as well as at management level. If it
could be shown that this process was truly reflexive (Le. that
a return to prosperity resulted once again in increased Xinefficiency), the case in favour of Leibenstein's hypothesis
would strengthen notably.
Further support for Leibenstein's hypothesis is also to be
found in the present author's recent study of steel production
in the U.K. and the U.S.A. (Rowley [60]). A close relationship
was apparent in both industries between the level of Xinefficiency and the degree of monopoly power, with the less
competitive U.K. steel industry appearing to be markedly
more X-inefficient throughout the period of the investigation,
namely, 1950-67. In addition, there was some association
between X-inefficiency and scale of production, with the giant
United States Steel Corporation showing clear signs of Xinefficiency and suffering in consequence a continuing loss of
market share.
It would be imprudent to make excessive claims for the
relevance of X-inefficiency for the antitrust debate at the present time. On the other hand, it would be equally reckless to
ignore it completely. Further research is necessary before the
results outlined in this section can be generalised to the economies of the U.K. and the U.S.A. with any confidence. But
preliminary findings suggest that X-inefficiency considerations
may yet reverse the trend in public policy towards encouraging
large-scale production which has been such a prominent
feature at least of the U.K. economy during the past decade.
INNOVATION
The theoretical relevance of invention and innovation for the
antitrust debate was outlined in Section 6 of this survey.
Its empirical significance as yet cannot be determined since
the evidence on the relationship between innovation and market
power is inconsistent. A brief review of the available evidence

55

suggests, nevertheless, that the conventional wisdom that

innovation is benefited by large scale and by market power is
insupportable. Indeed, Williamson [84] himself, on the basis
of research by Mansfield and Scherer, suggested that progressiveness was almost certainly promoted by at least some
elements of competition at virtually every stage of an industry's
development, though he recorded a neutral judgement on
the issue when incorporating the technical progress factor into
his trade-off model.
Mansfield's research [46], based on U.S. data, suggested
that there was a negative correlation between rate of innovation and size of firm, with medium-sized firms performing
markedly better than the largest firms in petroleum, coal
and steel. Scherer [61] analysed the patent behaviour of a
sample of 448 firms selected from the Fortune list of the 500
largest industrial corporations in 1955, and concluded that
'the evidence does not support the hypothesis that corporate
bigness is especially favourable to high inventive output'.
These results are both consistent with the view that X-inefficiency tends to outweigh scale economies in the innovative
activity of large firms. Williamson [84], using Mansfield's
data, obtained a negative correlation between the proportion
of innovations introduced by the four largest firms and industrial concentration. But this was strictly a small numbers
result in which great confidence should not be placed. Indeed,
in a subsequent survey Williamson (with Turner [87]) concluded that there was no statistically significant relationship
between innovation and market concentration: 'there is no
such general relationship between innovational efficiencies
and large size or market concentration as would render
materially less appropriate an anti-monopoly or deconcentration policy that is sound on other economic grounds' ([87]
p. 139).
Williamson's conclusions were based entirely on a survey of
U.S. data. Freeman [26] analysed the relationship between
size of firm, research and development, and innovation by
reference to statistics relating to O.E.C.D. countries, and
entered a cautious conclusion that discussion of the relative
importance of large and small firms in industrial innovation

56

was sterile ifit ignored inter-industry differences and variations

in technology. His parting comment is probably a fair reflection of the present state of knowledge on the implications of
innovation for the antitrust debate: 'The concluding point
of this paper is that so far as policy in the U.K. is concerned,
we really have to consider the problem industry by industry
and look at the matter empirically in each case' ([26] p. 154).

57

9 Some Theoretical
Complications
It has proved convenient so far to evaluate the debate on
antitrust policy by reference to the polar cases of perfect
competition and pure monopoly. In this way important
insights have been gained into the relevant issues in the antitrust debate. Nevertheless, these cases are not representative
of real-world market organisation and it is now necessary to
review the more important modifications to the trade-off
analysis which are required once more realistic cases are
countenanced.

INTERMEDIATE MARKET MODELS

The two most commonly encountered cases of intermediate
market models in the theoretical literature are monopolistic
competition and oligopoly. Monopolistic competition retains
the assumptions of many producers, free entry and perfect
knowledge employed in the model of perfect competition, but
introduces new assumptions of product differentiation and
significant scale economies. Profit maximisation is retained
as the generative assumption. In consequence, long-run
market equilibrium implies a tangency solution in which only
normal profit is earned but in which marginal cost is less than
price, as is illustrated in Fig. 8.
In Fig. 8, D represents the demand curve and MR the corresponding marginal revenue curve of the individual producer.
LAC represents the firm's long-run average cost curve and MC
the corresponding marginal cost curve. The profit-maximising
output rate is at OQ, with price at OP. Normal profit only
(written into LAC) is obtained in competitive equilibrium and,

58

Price
and

cost

Output rates

FIG. 8. Long-run equilibrium under monopolistic competition

as with perfect competition, firms are driven to operate upon

an X-efficient cost platform. In terms of Paretian criteria, of
course, the monopolistic competition solution is generally
inefficient in that it violates the necessary conditions for
exchange efficiency (Telser [77]). In terms of our social welfare function also there is some loss of consumers' surplus
and some loss of scale economies as a result of the divergence
between price and marginal cost, and some loss of scale economies as a result of the divergence between marginal cost and
long-run average cost. It is not possible to determine by a
priori discussion whether monopolistic competition is superior
or inferior to perfect competition as a welfare-maximising
agency since scale economies might be achieved in the former
but sacrificed in the latter solution as the price for the gain in
consumers' surplus. Nor is it possible to compare monopolistic
competition with pure monopoly since the loss of scale economies in the former case must be offset against likely losses
of consumers' surplus and via X-inefficiency in the latter
solution. Undoubtedly, the substitution of monopolistic
competition for perfect competition in the trade-off analysis

59

further complicates an already complex problem, perhaps

with only trivial improvements in the realism of the exercise.
If this is true of monopolistic competition, it is true afortiori of
oligopoly, where some knowledge of initial strategies and of the
reaction function of each and every competitor is required
before the outside observer can possibly inform himself of
the likely price-output rate implications of the competitive
process, and it is most especially true of the limiting case of
duopoly which is characterised by extreme indeterminacy
from the theoretical viewpoint. For this reason, oligopoly
models are rarely utilised in the economic theory of public
policy, despite their intrinsic appeal on grounds of realism.
Perhaps the most that can be said of competitive oligopoly
is that X-inefficiency for the most part is likely to be rooted out,
though pockets of ' inert area' are perhaps more likely than under
perfect or monopolistic competition, whilst sacrifices of scale
economies are likely to be less extensive than under either
alternative. The implications for allocative inefficiency are
indeterminate. More precise conclusions could only be derived
by severely restricting the assumptions of most oligopoly
models, with the implication that a pragmatic case-study
approach would be essential. None of this is to deny the
presumption, referred to in the introduction, to the effect that
competition in general will tend to increase as the number
of firms in the oligopolistic market rises, as the market share
of the largest firm diminishes, as the market in information
becomes more efficient and as barriers to resource mobility
diminish. Despite this presumption, however, the introduction
of oligopoly into the social welfare trade-off raises wellnigh
intractable problems for the antitrust debate.
ADVERTISING AND SALES PROMOTION
Reference to entry barriers directs attention to an additional
important but highly complicating influence at work in realworld economies, namely, advertising and sales promotion.
I t is not surprising that trade-off approaches to the antitrust
debate typically ignore the issue of advertising despite the
60

latter's empirical significance in most consumer product

markets. For the introduction of advertising - and with it
the ensuing interdependence between cost and demand curves
for the individual firm - makes a welfare trade-off such as
that envisaged in this survey almost impossible, since all the
relevant magnitudes of social welfare gain and loss are sensitive to shifts in the level and/or the composition or effectiveness
of the advertising budget. Furthermore, since successful
advertising almost inevitably results in a shift in consumer
preferences, it is not clear that like will be traded-off against
like in the social welfare analysis.
Nor is this all. For economics cannot yet speak out with
confidence on the complex relationship between advertising,
market organisation and market performance, despite the
spate of recent contributions both at the theoretical and
empirical level. For the theory is ambiguous and the evidence
contradictory. On the one hand, it is argued, for instance,
that advertising is a method of reducing the costs of search in
an uncertain environment and of thereby improving the
market in information (Stigler [68]). On the other hand, it
is argued that advertising is a device for distorting the preferences of the unwary consumer and of raising or reinforcing
entry barriers into the market in question by intensifying
existing product differentiation. The welfare implication~
of these two alternative viewpoints are entirely different.
The empirical situation is equally confusing. Following a
detailed econometric analysis, it was possible in 1964 for
Telser [76] to conclude that 'there is little empirical support
for an inverse association between advertising and competition, despite some plausible theorising to the contrary'.
Following an equally detailed analysis, it was possible in
1967 for Comanor and Wilson [11] to conclude that 'factor5
which promote product differentiation may be as important
as those which influence the size distribution of firms in terms
of their effect upon the achievement of market power'. In
such circumstances (and this conflict is typical of the advertising debate), agnosticism may be the only legitimate position
for the outside observer.
This does not imply, of course, that advertising should be

61

ignored in the social welfare trade-off in markets where it

features as a significant item of expenditure. Rather, it means
that the welfare trade-off must be more complex and the conclusions derived less unambiguous than in other cases. Some
form of sensitivity analysis might arguably be incorporated
into the trade-off analysis to assess the public policy significance of alternative views on the role of advertising.
ALTERNATIVE COMPANY OBJECTIVES
The trade-off approach to the antitrust debate conventionally
assumes that all firms are motivated by the profit maximisation
objective. No concessions are made to the possibility that company objectives themselves may not be entirely independent
of market structure. Yet, recent developments in the theory
of the firm suggest that objectives other than profit maximisation are increasingly important in markets sheltered from
competitive pressures. In competitive markets (be they perfectly competitive, monopolistically competitive or in many
cases oligopolistic) firms have no alternative but to pursue
profit maximisation if they attach positive utility to longterm survival. But by definition this is not the case for companies which are sheltered from competitive pressures and which
enjoy discretionary power in their product markets. Once
alternative objectives are considered, however, the social
welfare implications of pure monopoly are less unambiguous
than the trade-off analysis so far has suggested, and the tradeoff approach is rendered yet more complicated. This problem
is briefly illustrated in Fig. 9.
In Fig. 9, D represents the conventional demand curve of
the pure monopolist and MR the corresponding marginal
revenue curve. AC represents the average cost curve (excluding
X-inefficiency in order to simplify the diagram) and MC the
corresponding marginal cost curve. The profit maximisation
solution is at output rate OQl and price OP1 and is the solution
normally incorporated into the trade-off analysis. Suppose,
however, that the monopolist were motivated to maximise
sales revenue rather than profit. The appropriate solution
would then be at output rate 0Q.2 and price OP,., which

62

P31--'t--*""-~

Price A \--0\---1-.
and 1

cost

P2 1----l..---++-"'-

o
Output rates

FIG. 9. Price-output implications of alternative objectives

happens to be superior to the profit maximisation solution

in terms both of scale economies and of allocative efficiency.
The minimum profit constraint (written into the AC curve) is
satisfied in this example at the full sales-revenue-maximising
solution. Suppose, alternatively, that the firm was motivated
to pursue some management utility function such as that
specified by Williamson [83], subject to a minimum profit
constraint and which incorporated staff and emolument
arguments. Following Williamson, suppose further that staff
and emolument expenditures were overhead costs unaffected
by output rate, but that staff expenditures included an advertising component which shifted demand in a positive relationship. The equilibrium solution might well take the form
outlined in Fig. 9, with output rate at OQa and price at OPa,
with demand at Dm and marginal revenue at MR m, and with
average cost, inclusive of management expenditures, at ACm
It would then be quite complicated to compare the pure
monopoly with a competitive solution for the reasons outlined
in the earlier discussion on advertising and sales promotion.

63

It is clear from this brief discussion that the trade-off analysis

is rendered more complex, and any results much less unambiguous, by the introduction of alternative company objectives
in the case of pure monopoly. Yet this may well be a
direction that a convincing trade-off analysis cannot afford
to ignore.

UNCERTAINTY CONSIDERATIONS
For the most part, the conventional trade-off approach treats
both the competitive and the monopolistic cases as though
the component firms were reacting against a stable and known
environment. This is a highly implausible assumption. In
practice, neither the cost nor the demand curves of the firm(s)
concerned are likely to remain stable over any appreciable
period of time, but are likely to shift in response to changing
technology and changing factor prices on the one hand, and to
changing preference or income levels on the other. In such
circumstances, the firms themselves are unlikely to be well informed about the nature of the environment at any point in
time and may well be forced to pursue their respective objectives indirectly, perhaps adopting some iterative search
procedure, which itself might be adjusted in the light of experience. To incorporate such a process into the trade-off
analysis would indeed present formidable problems.
Furthermore, the introduction of uncertainty may often
raise fundamental questions as to just what is the 'best' available technology for a given product market, and therefore
just what is the nature of the minimum cost platform available
to the firm. This will especially be true of such markets as
electricity and steel, which are beset by relatively unpredictable
variations in demand which present periodic peak-load
problems. For it is by no means clear in such circumstances
that low-cost but inflexible techniques are superior to highercost but more flexible techniques which can adjust output
rates more economically in response to unexpected variations
in demand. In such circumstances, what might appear as
X-inefficiency from an ex post vantage-point might well have

64

been X-efficient from the ex ante position viewed at the moment

of production.
EXTERNALITIES
Externalities exist where the activities of producers (or indeed
of consumers) have beneficial consequences for others for which
it is not feasible to charge or detrimental consequences for
others for which it is not feasible to require recompense.
In such circumstances, the existence of perfect competition
would fail to achieve efficiency in production and/or exc4ange
and some form of government intervention is required. Must
such intervention render the antitrust approach irrelevant,
or inopportune, where otherwise it might be justified?
In attempting to answer this question, it is necessary to
distinguish between three principal types of externality,
namely (i) the absence or underspecification of property
rights typified by the classic 'smoky chimney/hand laundry'
example; (ii) the presence of indivisibilities in the production
function manifesting itself in 'natural monopoly' conditions
such as allegedly exist in the public utilities; and (iii) the presence of public-good characteristics, in which one person's
consumption of a commodity in no way restricts the consumption of that commodity by other persons but in which the
exclusion principle is inapplicable, e.g. as in the case of defence. The implications of government intervention for the
antitrust debate differ with respect to each of these categories.
The first category of externality poses few problems for the
antitrust debate. For the private market's departure from optimal resource allocation can often be countered (by legislation
to prescribe property rights, by tax-subsidy or even by specific
control interventions) in a manner which does not fundamentally
affect the pattern of market organisation. Evidently, intervention which restricts or expands the size of the total market
must have some impact upon the nature of the market.
Rarely would this impact be likely to change the market in
kind as well as in degree.
The second category of externality does pose more serious
A.A.E.E.-C

65

problems for antitrust intervention. However, there is no

reason in principle why natural monopolies should escape the
social welfare trade-off simply on the grounds of pronounced
indivisibility in production. Indeed, it has been argued
[49] that in certain instances antitrust-enforced competition
may well prove the optimum solution to the natural monopoly
problem, though clearly this will be less frequent than in
industries in which scale economies are less pronounced.
The third category of externality does indeed present less
tractable problems which are usually resolved by advocating
a public-enterprise solution. Even in this instance, however, the
implications for antitrust appear less discouraging once
considerations of X-inefficiency are accounted for. It must be
accepted, nevertheless, that the relatively few markets in
which public-good characteristics are pronounced may have to
be exempted from the normal provisions of an antitrust
welfare trade-off unless improvements in the designations of
property rights should succeed in eliminating the free-rider
problem by reinvoking exclusion possibilities. Phillips [52]
has recently suggested that since externalities of this kind
appear to be growing in importance (together with other
types of externality which in his view cannot be accommodated
without significant effects on market structure), policy instruments other than those fostering competitive market performance are becoming more and more essential. In view of th~
growing concern about preservation of the environment
both in the U.S.A. and the U.K., Phillips' suggestion cannot
go unheeded.

66

10

Alternative Views on
Social Welfare

The philosophy which underpins the social welfare function

outlined in Section 2 of this survey is essentially that of the
Pareto principle, with its concern for the welfare of all individuals in society rather than with some organic concept of the
state, and with its emphasis that each individual in society
must be considered to be the best judge of his own welfare.
So extensive is the acceptance of this philosophy in economics
that few economists would feel the necessity even of referring
to these value judgements, which must be accepted before the
public policy implications of Paretian analysis can have any
relevance to the real world. This reticence is to be deplored,
not least because the Paretian value judgements may well be
less widely accepted outside than they appear to be within the
economics profession. The implications of three alternative
approaches to the antitrust debate are briefly outlined in
this section.

A LIBERALIST SOCIAL WELFARE FUNCTION

It is frequently assumed that the value assumptions embedded
in Paretian welfare economics are the same as those which
underpin the liberal (or whiggist) outlook, especially in the
light of the former's emphasis upon consumer sovereignty as a
fundamental axiom. In reality, however, the affinity between
the two sets of value judgements which underpin these separate
approaches is more apparent than real, and it is not at all
surprising therefore to find that public policy pronouncements

67

based upon liberalist philosophy are frequently at odds with

equivalent pronouncements based upon the Pareto principle
(Peacock and Rowley [49, 50]).
Above all else, liberalist philosophy is concerned to minimise
restrictions on individual freedom, whether such restrictions
are imposed by private bodies or by the state. Within limits,
therefore, the liberal is prepared to trade-off material welfare
as a worthwhile sacrifice for the preservation of freedom.
The major threat to individual freedom is seen to stem from
concentrations of political and economic power, whether
in the hands of the state, of bureaucrats, of firms or of private
citizens. For the liberal is acutely aware of the potential
for abuse in any system characterised by significant discretionary power and, perhaps more important still, of the difficulty
of eliminating such discretionary power when once it has been
established. Liberals have a preference in this respect for a
system which encourages voluntary exchange through market
processes and a belief that competitive capitalism provides
the strongest safeguard for such a system. They further share a
belief in decentralised government rooted in the democratic
tradition and a dislike of any philosophy of government
which upholds the doctrine that the state is a being independent of the individuals of which it is composed.
How does this view of liberalist philosophy square with the
Pareto principle? The first Paretian value assumption, which
directs attention to the welfare of individuals, is common
to both. But the second, which emphasises that the individual
is the best judge of his own welfare, is not. For there is no
guarantee that individuals will necessarily associate their
immediate economic requirements with the preservation of
freedom in the longer term, even if they should value freedom
at all. In such circumstances, the liberal will wish to assess
the situation within a wider system of values, if necessary
trading-off consumer sovereignty (in the Paretian sense)
against freedom from discretionary power. This does not
imply that the liberal will reject his own philosophy in a
sustained attempt to 'force people to be free'. Rather will he
try to persuade them to change their own preference schedules
and to introduce freedom into their utility functions. Such an

68

exercise would be conducted within the democratic framework

which liberalism itself has helped to build.
The liberal, when making his own evaluation in the antitrust debate, might well retain the social welfare function
outlined in Section 2 of this survey in a form modified to take
account of the freedom issue, i.e. he would be prepared to
work within the essential framework of the Pareto principle
(Peacock and Rowley [50]). In principle, the modifications are
straightforward. The benefits from large-scale production (i.e.
the costs of antitrust intervention) as measured by the conventional social welfare function would be discounted by a
factor which increased monotonically (linearly or exponentially according to taste) as the degree of associated market
power (appropriately defined) itself increased. Sufficient
flexibility could be introduced, in the choice both of the initial
discount rate and of its rate(s) of increase, to satisfy a wide
range ofliberal positions.
The difficult problem would remain of devising an effective
index to measure market power and changes in such market
power (on the prior assumption that the market itself was
correctly determined). For the purpose of the antitrust debate,
such an index would need to incorporate some assessment of
the likelihood of price leadership or collusion, especially in
oligopolistic markets, as well as of single-firm monopolisation.
In the light of Stigler's important contribution to the theory of
oligopoly, the index now most widely regarded as a barometer
of market power is the Herfindahl Index, which is defined as:
I-n

H=

i=,

S;

where S, is the market share of the ith firm in an industry

composed of n firms. The Herfindahl Index is a measure of
relative concentration which is highly sensitive to changes in
market structure. If this measure were to be adopted, the
discount factor to be applied to the cost savings expected from
scale economies could be made to vary in association with
the Herfindahl Index. Clearly, the liberal would be willing
to accept antitrust intervention in excess of that which would

69

be forthcoming by reference to the unmodified social welfare

function.

A TECHNOCRAT'S SOCIAL WELFARE FUNCTION

Not everyone places so high a value on individual freedom as
does the liberal, and even those who do so may well not
identify the preservation of freedom with the avoidance of
political and economic concentrations of power. Many who
would endorse the objective of consumer sovereignty as enshrined in the Pareto principle are highly suspicious of competitive capitalism, with its emphasis upon rivalry rather than
upon cooperation and with its undertones of violence and
chicanery. Rather are they enamoured of large-scale enterprise, and most especially of enterprise capable, in consequence
of its discretionary power in existing markets and of its wider
influence over market demand generally, of fostering longterm forward planning and close cooperation both with other
enterprise and with government itself. Those who endorse'
this 'Schumpeterian' [63] or 'Galbraithian' [29] view of
capitalist progress are prepared to tolerate a greater degree
of allocative and X-inefficiency in the present than would be
allowed following the application of the conventional social
welfare function as the price for longer-term economic growth
and, perhaps, for social cohesion and stability. Such peoplehere denoted as technocrats - are no less entitled to their
value judgements and (in the present state of knowledge on
the determinants of growth) to their hypotheses concerning
economic growth than are the disciples of Pareto and the
whiggist liberals.
The implications for the conventional social welfare function
are precisely the reverse of the liberal case. The benefits from
antitrust intervention, measured in the form of improved
allocative efficiency and improved X-efficiency, would be
discounted by a factor which might vary with associated
changes in the Herfindahl Index. Inevitably, this would
imply that antitrust intervention justified by reference to the
conventional social welfare function would be rejected by the

70

technocrat. It is important to recognise that the technocrat's

judgement, if logically justified by reference to his value
assumptions, is in no sense morally inferior to that of the
Pareto principle. Indeed, there is no scientific way of comparing the two solutions.
A TOTALITARIAN'S SOCIAL WELFARE FUNCTION
Both the liberals and the technocrats for the most part accept
the axiom of consumer sovereignty which is enshrined in the
Pareto principle, and for this reason they are able to work
within the general framework of Paretian economics. This is
not true of the totalitarian - whether of the Left or of the Right
- who rejects the axiom of consumer sovereignty in favour
of some organic view of the state. In such circumstances, the
social welfare function outlined in this survey has no relevance
whatsoever for the antitrust debate.
This does not mean, however, that the issue of centralisation or decentralisation of economic power is dead in totalitarian economies. For this indeed tends to be one of the most
fundamental issues of controversy within the ruling elites.
But the controversy tends to centre upon issues of power and
power relationships and upon dynamic interactions between
economic organisation and socio-political relationships rather
than upon straightforward issues of economic efficiency, of
the kind which come up for consideration within the context
of the Pareto principle. In this sense Marxist and fascist
commentators indict disciples of the Pareto principle as conservative apologists for the capitalist system and deny totally
the relevance of modem welfare economics as a normative
basis for the development of public policy. Once again, it is
to be emphasised that in so far as totalitarian attitudes to
market organisation are consistent with the value premises of
totalitarian philosophy, there is no scientific means of ranking
them against their various Paretian-bound counterparts.

71

I I

Alternative Approaches to
the Problem of Market
Power

The merits and demerits of market power will clearly vary.

both in character and degree, from one case to another, and
for this reason a pragmatic cost-benefit approach to public
policy might seem essential. Yet the cost-benefit approach
to the market power problem has its critics as well as its advocates, and a range of alternative policies merits consideration. This survey restricts attention to four separate approaches
to market power, all of which have been practised or are
currently operational in the economies of the U.S.A. and the
U.K., namely (1) laissez-faire; (2) fair-rate-of-return regulation; (3) cost-benefit analysis; and (4) non-discretionary
antitrust. Although public enterprise is an alternative solution,
it cannot fairly be treated in the space available. Many of the
issues encountered in the regulations approach are relevant
also for public enterprise. For the most part, discussion is at a
theoretical level, with only illustrative references to past or to
existing institutional arrangements. Throughout the discussion
three separate aspects of the market power problem are carefully
distinguished, namely (i) restrictive agreements; (ii) horizontal
mergers and acquisitions; and (iii) single-firm monopolisation.

LAISSEZ-FAIRE
Essentially, the laissez-faire approach to the market power
problem is one (a) of denying that the problem in fact exists,
or (b) of rejecting the notion that it can be corrected by the
available instruments of public policy, or (more usually) some

72

combination of the two approaches. The basis of this policy

approach is the view that market forces can be relied upon,
without outside intervention, to maximise social welfare
subject to irremovable constraints of the environment. Despite
the general post-war shift in emphasis away from laissez7iaire
in favour of interventionist policy, the laissez7iaire approach
to the market power problem retains influential support in
certain academic as well as business circles (Friedman [27];
Stigler [71]).
In part, the laissez7iaire case rests upon the view that the
market economy is fundamentally competitive and, indeed,
that the most intractable pockets of market power are those
which exist as a consequence of state intervention. For in
the absence of massive scale economies, monopoly profits
serve as a signal for new firms to enter the market and/or
for existing competitors to expand their output. Other entry
barriers - often state-induced - are not expected to obstruct
competitive forces in the longer haul, at least where the profit
incentives are at all marked. Even market power based upon
scale economies is susceptible to technical progress and, in
the last event, market power grounded upon such economies
would be endorsed even by a fully-fledged cost-benefit analysis.
Those who advocate the laissez7iaire approach are equally
agreed that scale economies are less significant and less pervasive, that restrictive agreements are less widespread and less
effective, and that the merger movement is less monopolistic
than proponents of state intervention would allow. Recent
empirical analysis is not at all unfavourable to the laissez7iaire
viewpoint.
In part, moreover, the case for the laissez-faire approach is
grounded upon a view of the state itself which is less charitable
than that customarily represented in the economic theory of
public policy. For in assessing the social welfare impact of
state intervention within a comparative institutions framework,
advocates of laissez-faire reject the notion of the state as impartial and omniscient servant of the public good in favour
of a more realistic view of vote-maximising politicians operating on an environment characterised by uncertainty and
riddled with pressure-group activities, within the context

73

of a two-party, majority-voting political system (Downs

[25]). In such latter circumstances, many of the idealised
forms of state intervention cannot be relied upon and the more
likely compromise solutions are often less appetising from the
social welfare viewpoint. Indeed, the doctrine first enunciated
by Adam Smith, that political and bureaucratic controls
always lead to inefficiency without accomplishing anything
else, sometimes seems to be uncomfortably near to the truth as
a judgement on the modern advanced economy.
Rejection of the 'nirvana' view of government carries with it
damaging implications for any form of state intervention as a
solution to the problem of market power (Rowley [57]).
Certainly, within the U.K. (and to a lesser extent the U.S.A.)
median preference voters are torn, in their assessments of
antitrust, between the coveted economies of large scale on
the one hand and the potential abuses of market power on
the other. Since antitrust is rarely if ever a central facet of
government policy, politicians tend to be ill-informed on voter
preferences. In such circumstances, a vote-conscious, riskaverse government would introduce inconsistent legislation,
obstructing in the one statute the action laid down in the other,
or, more cynically, would legislate for antitrust and then refuse
to vote the funds necessary for its effective implementation.
Furthermore, any pro-competition platform would quickly
encounter producer pressure-groups designed to maintain
existing market power. Advocates of laissez-faire take a pessimistic view of any antitrust programme weathering successfully
the combined pressures of uncertainty in the political marketplace and sustained producer lobbying. Better, they argue, an
imperfect market solution than an emasculated antitrust
alternative.
The regulation approach to the market power problem
suffers more than any other from this rejection of the nirvana
view of government. On the one hand, regulators unlike judges
are dependent upon the government for their jobs, for the
approval of their budgets, for their legal authority and for
their financial support. In such circumstances, the regulatory
authorities are unlikely to conduct their duties in a manner
contrary to the prevailing interests of central government,

74

which will be themselves conditioned by pressures in the political market-place. On the other hand, regulators are unlikely in
the longer haul to preserve full independence from the companies subjected to regulatory intervention. For the regulated
companies have obvious incentives to subvert the regulatory
machinery to their own advantage (Bernstein [7]). If they are
successful, the consequences for social welfare may prove
extremely damaging.
It would be misleading, however, to leave the impression
that the laissez-faire advocates are prepared to rest their case
upon a complacent view of the working of market processes
coupled with a critical (not to say cynical) view of the working
of political and bureaucratic processes. For those who advocate
taking no action of an antitrust nature are usually aware of
defects in the market system and of the beneficial implications
of certain kinds of restricted intervention by the state. In
particular, imperfections in the capital market are viewed
as being the most serious of all impediments to competition.
Fiscal incentives for firms to plough back their profits directly
into capital formation and thereby to avoid in part at least
the market test on new projects are viewed with especial
distaste. For this reason, advocates of laissez-faire are usually
insistent proponents of fiscal change designed to eliminate
incentives for firms to pursue plough-back policy (Friedman
[27]). Furthermore, improvements in accounting practices,
designed to foster efficient markets in information, are usually
urged as essential measures to improve competition pressures
directly in the commodity markets and indirectly via the capital market. Measures such as these cannot strictly be denoted
as antitrust intervention, since they do not form part of a
systematic policy of state intervention to deal with market
power. But they are indicative that even the advocates of
laissez-faire recognise that there is a role for the state in connection with the market power problem.

75

FAIR-RATE-OF-RETURN REGULATION
Regulation of the rate of return on capital of specific firms,
whether of a continuous or an ad hoc variety, is designed to
prevent firms with significant market power from exploiting
their position by charging monopoly prices. This approach
allows market power to take place without antitrust intervention. In the U.S.A., continuous fair-rate-of-return regulation is a prevalent feature of the public utilities. In the U.K.
such regulation is predominantly ad hoc in character, practised
by such bodies as the Monopolies Commission (in an advisory
capacity) and, until recently, by the National Board for
Prices and Incomes. However, the now defunct Iron and Steel
Board practised continuous regulation of the British steel
industry between 1953 and 1967 (Howe [33]).
Regulatory commissions are usually authorised to establish
prices which will provide a fair rate of return on capital for
the monopolist firm, taking account of all relevant circumstances. In this way it is hoped to combine the cost-saving
benefits from large-scale production with the minimum possible
loss of consumer benefits. The loss would not normally be
zero since the normal profit position would be a tangency
solution between average revenue and average cost, with
marginal cost less than price (Telser [77]). The regulatory
commission is usually given access to the accounting records
of the regulated firm and must rely substantially upon such
information in establishing fair-rate-of-return prices. It is
not omniscient, of course, though this fact does not come
across at all clearly from reading much of the regulatory
literature.
If firms always combined their factor inputs efficiently
and produced at minimum cost, if the prices of factor inputs
always reflected their opportunity cost, and if the accounting
ledgers of the firm accurately reflected the costs incurred,
the task of the regulatory commission, though difficult, would
be manageable. Merely to indicate these requirements is
to underline the immensity of the real-world problems faced
by regulatory commissions.
For in practice there is little reason to suppose, in the ab-

76

sence of competition, that the regulated firms will combine

their factor inputs efficiently and produce at minimum cost.
There is perhaps even less reason to suppose that the accounting ledgers will provide an accurate reflection of company
activities. The regulators are rarely in a position to confront
the firms' accountants with alternative cost estimates. In
such circumstances, the discretionary power of the regulated
firms is considerable. In periods of inflation there are additional
problems in the selection of the most appropriate measure of
profit and of capital, and there is no necessary reason why fair
rates of return assessed in terms of historic cost measurements
should coincide with fair rates of return assessed in terms of
replacement or reproduction cost measurements (Rowley
[58]). This provides at once an additional degree of freedom
and an obvious bone of contention between the regulators
and the regulated.
There is, however, a yet more pernicious problem raised
by the regulatory approach to the market power problem,
which becomes evident in cases where the fair-rate-of-return
solution provides profits which are less than those which an unregulated firm could extract from its market, and where the
regulators are not omniscient with respect to cost information.
For in such circumstances the regulated firm has every incentive
to increase its X-inefficiency, taking out in the quiet and more
comfortable life the very discretionary profits which the regulators are intent on eliminating (Williamson [82]; Kafoglis
[39]).
One such response to regulatory intervention, first noted by
Averch and Johnson [3], is that of increasing capital employed
beyond the efficient level as a means of raising total profit
(since the fair rate of return is calculated as a percentage on
the rate base) as well as raising costs above the minimum level
theoretically available. In such circumstances, regulation
would actually create X-inefficiency in the use of capital
inputs, however successful the application of fair-rate-of-return
criteria. To avoid such consequences, a number of economists
(Klevorick [40]) have advocated that the maximum rate of
return allowed in regulated industries should be related
inversely to the value of a company's capital in order to

77

penalise wasteful capital expenditure. However, there is no

reason whatsoever to suppose that such a practice would
discriminate effectively between companies which employed
capital efficiently and those which employed capital wastefully,
and for this reason the proposal cannot be supported.
More generally, however, firms subjected to fair-rate-ofreturn regulation, irrespective as to whether they are profit
maximisers, sales revenue maximisers, management discretion
maximisers, etc., are likely to respond by allowing costs to
drift upwards via X-inefficiency of a non-specific nature,
i.e. not tied to capital inputs alone (Kafoglis [39]; Rowley
[60]). The regulatory authorities would have to be extremely
vigilant to protect against this outcome. Indeed, perhaps
the relevant issue is not whether regulation will result in Xinefficiency but rather whether X-inefficiency would lift out
discretionary profit in its entirety. Profit incentives for regulated
firms to pursue X-efficiency would seem essential, even though
they do imply some deviation from the fair-rate-of-return
principle, if regulation is not to be entirely negated by firm
responses.
Such a profit incentive to X-efficiency in production already exists, albeit fortuitously, in the guise of the regulatory
lag, i.e. the existence of a lag in the adjustment of prices by
the regulators in response to changes in costs. This lag, the
consequence of bureaucratic delay rather than of regulatory
policy, enables the regulated firm to increase its profits, at
least temporarily, when it succeeds in lowering costs. Regulatory lag at the present time is unintentional, a by-product
of the high transaction costs of major price reviews. But Baumol
[5] has recently suggested that regulatory lag should be formalised as an explicit aspect of regulatory policy. There is much
sense in this proposal.
There can be no certainty, of course, that the regulatory
authority will in fact pursue fair-rate-of-return regulations
as assiduously as textbooks conventionally assume. Indeed,
the questionable independence of the regulators from the
pressure of the political system has already been discussed.
Perhaps more serious, however, is the possibility that the
regulated firms might successfully subvert the regulation

78

machinery to their own ends, thereby extending rather than

diminishing their pre-regulation market power (Bernstein [7]).
This outcome is more likely in the case of firms which encounter
continuous regulation by a single commission than in the case of
firms which periodically face regulation following ad hoc
investigations. In any event, there is a serious case for evaluating
regulation within a realistic framework which makes allowance
for the human factor and which takes account of recent
developments in the economics of bureaucracy.
The foregoing discussion emphasises the deficiencies and
limitations of the regulation approach to the problem of
market power. It should not be assumed, however, that there
is no case and no public sympathy for this form of state intervention (Telser [77, 78]). For it does represent a serious
attempt to combine the achievement of scale economies with a
minimum loss of consumer benefits, and as such it is tolerated,
if not indeed welcomed, as a widespread form of intervention
both in the U.K. and in the U.S.A. Those who recognise the
potential for abuse in the regulation approach are as frequently
concerned to introduce further checks and safeguards as they are
to jettison the approach entirely in favour of some other public
policy alternative. There can be no doubt whatsoever that
regulation will retain its place as a relevant policy instrument
in treating the market power problem in the U.S.A. and the
U.K., especially for cases of market power which derive from
single-firm dominance.
COST-BENEFIT ANALYSIS
The cost-benefit analysis approach to the market power
problem recognises that restrictive agreements, mergers and
existing monopoly positions may result in both welfare gains
and welfare losses, and requires that the expected performance
of the company or companies concerned should be fully
investigated before a verdict is passed. In principle, a thoroughgoing cost-benefit analysis is impossible in the absence of a
carefully defined social welfare function which determines
what is to be treated as a welfare gain and what as a welfare

79

loss, and which assigns appropriate weights to these various

categories. The fullest formal statement of such a social
welfare function presently available in the theoretical literature
of economics is that by Williamson [84]. Modifications of
Williamson's approach, designed to reflect alternative viewpoints, have been advanced in this survey. Despite the evident
advantages of such an approach in clarifying the welfare issues,
no such formal social welfare function has ever been applied
in practice by countries which endorse the pragmatic, costbenefit analysis approach to the market power problem.
Rather, a set of ill-defined and sometimes contradictory
guidelines have supported pragmatic investigation.
Nevertheless, the formal social welfare function approach,
to which so much attention has been devoted in this survey,
clearly merits serious consideration at a time when costbenefit and cost-effectiveness techniques have assumed such
importance in public-sector decision-making generally. The
principal components of such an analysis in terms of Williamson's social welfare function have already been outlined in this
survey, but a brief assessment of the task encountered by those
responsible for such an exercise is now necessary.
The first task, inevitably, would be that of determining the
degree of market power which would exist following the application of appropriate antitrust instruments and comparing
this with the degree of market power which would exist in
the absence of such intervention, taking full account of market
reactions. It is important to recognise that this task is a sine
qua non for a realistic cost-benefit analysis, since the differential
market power under consideration is of quite central significance for the measurement of welfare gains and losses.
The second task would be that of determining the objectives
of the company or the companies concerned under each of the
relevant market organisation alternatives. Profit maximisation
can no longer be taken for granted, at least in markets characterised by discretionary power, and a multitude of alternative
maximands compete for consideration. Yet in the absence of
some judgement on motivation, attempts to isolate the priceoutput implications for cost-benefit analysis are practically
meaningless.

80

In the light of this information, the task of assessing the relevant consumer and producer benefits at issue could be set in
motion. It would not be simple (Crew and Rowley [12]).
As a prerequisite for assessing the loss of consumer benefits
from allocative inefficiency in the market power solution, it
would be necessary (a) to identify the relevant portion of the
market demand curve (and this is not always feasible from an
econometric viewpoint); (b) to identity the likely price-output
implications of the market power solution; and (c) to identify
the corresponding price-output implications of the antitrust
solution (complex indeed in oligopolistic cases). As a prerequisite for assessing the welfare loss from X-inefficiency,
it would be necessary to define the functional relationship
between X-inefficiency and market power and to determine
just which components of X-inefficiency constituted a welfare
loss. No easy task this, since accounting data are practically
useless and the exercise almost entirely hypothetical. As a
prerequisite for assessing the welfare gain from scale economies
in the market power solution, it would be necessary to determine the likely scale of operation both of the monopolist
and of the rival firms in the competitive solution, and to
define the functional relationship between average cost and
the scale of activity. Once again this is no easy task, since
accounting data at best defines a single point on the production
function and there are serious limitations (already discussed)
in alternative approaches to the measurement of scale returns.
This exercise is sufficiently daunting in the most stable of
market environments and on assumptions of instantaneous
adjustment. In the real world, characterised by volatile
market conditions and significant time-lags in the adjustment
process, the task appears daunting in the extreme, especially
since the analysis could not be once-for-all but would necessarily
have to be periodically renewed as market conditions altered.
At best the estimated net benefit or net loss associated with the
market power solution would be subject to wide error bars,
and where the judgement was at all close, the error bars
might be wider than the net benefit or loss thrown up by the
analysis. Nor should the resources devoted to the cost-benefit
analysis be treated as free goods. For the opportunity cost of
81

pragmatic inquiry - which includes not only the cost of the

resources committed to the inquiry by the state, but also the
cost of the resources committed by the companies concernedis often extremely high. The question must be asked, therefore,
whether in economic terms cost-benefit analysis is justified
even when unambiguous results are obtained. In a perverse
sense, what is needed is a cost-benefit analysis of the costbenefit analysis approach to the market power problem!
Further problems arise, in cases where antitrust intervention
appears justified, of ensuring that suitable policy instruments
are available. For there is little point in engaging in costly
analysis when there is no prospect of obtaining an effective
antitrust solution should it be required. In this respect merger
proposals present the least problem, since they can be rejected
without any significant institutional problems arising. Since
most of the recent theoretical work on antitrust has centred
attention upon merger investigations, few serious enforcement
problems have been envisaged. But the same is not true of
restrictive agreements and single-firm monopolisation.
Restrictive agreements, it is true, can be banned, and indeed
non-compliance with a prohibition could be made a serious
offence in criminal as well as in civil law. This could raise the
costs of non-compliance to an uneconomic level. But this is to
beg the question as to what precisely constitutes a restrictive
agreement, and indeed opens the door to all sorts ofinformation
agreements and understandings which company lawyers
devise as a means of maintaining market power without
falling foul of the law. The problems encountered in applying
antitrust intervention to single-firm monopolists would seem
to be yet more serious. For whatever measures are applied
to the firm itself-and prohibitions on further expansion and
divestiture of assets spring readily to mind - they are bound to
disrupt market performance with perhaps serious short-term
consequences for social welfare. Equally, measures designed
to increase competition from outside sources - for example,
tariff reductions and state-subsidised competition - raise perhaps quite serious problems for the balance of payments and
the fiscal activities of central government. These costs of enforcement are especially relevant in comparing the antitrust

82

with the laissez-faire approach to the market power problem,

and they will come under scrutiny again in evaluating nondiscretionary antitrust.
In principle, it is clear that the cost-benefit approach is the
main logical consequence of evaluating market power by
reference to a social welfare function, and for this reason it
is favoured by many economists who have been concerned
(Beesley [6]; Howe [34]; Sutherland [73]; Williamson [84])
closely with the recent theoretical debate. In a world characterised by perfect knowledge and by zero transaction costs, the
approach could scarcely be faulted. Unfortunately, these
characteristics are not features of the world we live in (Demsetz [19]). Furthermore, the question cannot be avoided as
to whether the cost-benefit analysis is to take place within
the framework of the administrative or the judicial process.
For the most part, economists tend to favour the flexibility of
the administrative approach for pragmatic investigations,
and certainly the law courts would find it difficult to treat the
subtle points of economic analysis that would inevitably arise
in the trade-off approach. But reliance upon administrators
raises once again many of the issues of political pressure on
bureaucratic relationships which were examined more extensively in connection with the regulation approach.
NON-DISCRETIONARY ANTITRUST
Of the four principal approaches discussed in this survey, this
is the only approach to the problem of market power which
can fairly be called an antitrust policy (Crew and Rowley
[12, 15]). Non-discretionary antitrust rejects the notion that
market power can best be treated by pragmatic cost-benefit
analysis in favour of a more dogmatic treatment based upon
rules. The characteristic of this approach is that it equates
social welfare with the maintenance or reinvigoration of competition and that it attempts to achieve this latter objective
via a set of non-discretionary rules enforceable through the
judicial and/or the administrative process. In principle, at
least, this is the market power approach currently operative
83

in the U.S.A., though in practice significant deviations from

non-discretionary antitrust are tolerated even by the U.S.
antitrust authorities.
At first sight, at least, an approach based upon rules appears
at once less complicated and less ambiguous than either the
regulation or the cost-benefit approach, and also more easily
enforceable, on the assumption that the penalties for noncompliance can be higher in the presence than in the absence
of clear-cut policy guidelines. For those who value economy
and unambiguity in market power policy, therefore, the nondiscretionary approach would seem to have much to commend
it. What form, then, might an approach based upon rules
take in practice?
Firstly, there would be a cogent case for prohibiting all
agreements in restraint of trade, on the principle that scale
benefits can very rarely be significant in such circumstances
since the participating firms retain their independent identities,
and that the benefit side of a cost-benefit analysis in any event
would be lightly weighted. Such a policy is operated in the
U.S.A. via the provisions of the Sherman Act of 1890, but has
been rejected in the U.K. in favour of a more pragmatic approach, albeit one in which the onus of proof is placed against
those who are desirous of maintaining a restrictive agreement.
A prohibitory approach of this kind would still present problems for the antitrust authorities on issues such as the precise
definition of restraint of trade and the precise definition of
the term 'agreement'. Indeed, the U.S. courts have devoted
much time in debating these issues, and not always with great
success. In particular, the twilight zone between conspiracy
and 'conscious parallelism of action' presents particular
problems for the enforcement authorities who, perhaps wisely,
have tended to demand evidence of conspiracy before condemning as restrictive agreements the behaviour of companies
brought before them for judgement. For the most part, however, this branch of non-discretionary policy presents few
really serious problems of interpretation (though detection
procedures are necessarily costly and sophisticated), and the
business community cannot fairly complain of uncertainty
and ambiguity in this aspect of the law.

84

The use of non-discretionary rules in handling merger

proposals presents less tractable problems, however, not least
because the approach itself is less easily justified by casual
reference to Paretian-based social welfare functions, since the
scale economies sacrificed by such a policy might well be considerable. For the essence of a non-discretionary policy tawards mergers is the prohibition of all mergers which would
raise the market share of the resulting combine above an acceptable limit, irrespective of the net benefits which might be
bestowed by such a merger. There are evident problems in
deciding just what is the precise market under consideration
and just what the acceptable market-share limits shall be.
A judgement on these issues would be of crucial importance,
since the decision whether or not to allow a merger to proceed would follow inevitably from such judgements.
The problem of market definition in antitrust investigations
is a very real one which has dogged the U.S. antitrust authorities throughout the twentieth century (and indeed the U.K.
cost-benefit analysts since 1948). For Section 7 of the Clayton
Act prescribes both a product and a geographical dimension
of the relevant market, but leaves the process of definition
to the courts. Despite the plethora of criteria (often quite
impracticable) showered upon the courts by economistsincluding coefficients of cross-elasticity of demand and/or
supply beloved by the textbook writers, who never sully their
hands on the real world - the U.S. antitrust authorities have
fallen back upon the somewhat crude criterion of 'reasonable
interchangeability of use, quality and price'. It is obvious
that this criterion leaves considerable discretion for subjective
judgement on the part of the antitrust authorities, and that
it does not really direct their attention to precise issues. But
it is probably the best that can be done.
It has been argued (Howe [34]) that the difficulty of market
definition in merger cases is an important weakness in the
non-discretionary approach, and this cannot be denied. In
particular, it is a relative disadvantage of non-discretionary
antitrust when compared with the laissez-faire and the regulation approaches to the market power problem, where issues
of market definition really do not arise. But it is in a sense a

85

rclative advantage of non-discretionary antitrust when compared with the cost-benefit analysis approach, since the latter
approach encounters the market definition problem at the
outset and must resolve it before proceeding to yet thornier
issues.
Given some definition of the market, the non-discretionary
antitrust approach must next resolve the issue of what is an
acceptable market-share limit beyond which mergers should
be prohibited. This is no easy task, since features other than
the number and relative size of the firms in a market (most
notably the level of entry barriers and the degree of product
differentiation) affect the incidence of competition in specific
commodity markets and the precise relationship between
market structure and market performance is not known at
the present time. Moreover, market-share rules cannot be
formulated without any reference whatsoever to the size of
the economy under consideration, unless scale issues are to be
given zero weights in the formulation of rules. For this reason,
merger rules operated, for example, by the U.S. antitrust
authorities might well be more stringent than those operated
by the U.K. (though perhaps equivalent to those operated by a
fully integrated and expanded European Economic Community).
It is interesting to illustrate the practical development of
non-discretionary rules to the merger problem by reference
to the Merger Guidelines published in 1968 by the U.S.
Department ofJustice:

1. In highly concentrated markets, the four largest firms

accounting for approximately 75 per cent or more of the

total sales, the Department will ordinarily challenge a
horizontal merger if the merging firms account for
approximately the following percentages of the markets:
Acquiring Firm
4 per cent or more
10 per cent or more
15 pe~ cent or more

Acquired Firm
4 per cent or more
2 per cent or more
I per cent or more

2. In less highly concentrated markets, the four largest

firms accounting for less than approximately 75 per cent
86

of sales, the Department will ordinarily challenge if

the merging firms account for approximately the following
percentages of the market:
Acquiring Firm
5 per cent
10 per cent
15 per cent
20 per cent
25 per cent or more

Acquired Firm
5 per cent
4 per cent
3 per cent
2 per cent
1 per cent

3. Where the market shares of the merging companies are

less than those indicated above, a challenge may still
be made if there is a significant trend in the market
toward increased concentration. (Howe [35])
The Department of Justice has emphasised that the guidelines are intended as guidelines and not as rules, and that, in
exceptional circumstances, it may not regard its market-share
guidelines as conclusive. Moreover, the U.S. courts themselves
may not necessarily endorse the guidelines of the Department
of Justice in dealing with contested cases. Nevertheless, the
publication of such detailed guidelines indicates the trend
to non-discretionary antitrust in dealing with horizontal
merger proposals in the U.S.A. It would not be difficult to
devise equivalent guidelines for British merger policy, albeit
with somewhat higher market share percentage to take account
of the smaller total market, and perhaps with reference to the
Herfindahl Index as a better measure of high and low concentration than the simple concentration ratios used by the
Department of Justice. A strict policy of non-discretionary
antitrust would presumably demand that these guidelines
should be treated as rules by those appointed to enforce the
antitrust laws and that no deviations should be allowed even
in 'exceptional' cases.
It is the essence of non-discretionary antitrust, 0 course,
that any merger proposal which fails to satisfY the ecablished
rules on market share must be condemned. No discussion is
allowed on the possible welfare gains and losses consequent
upon such a prohibition. For this reason, non-discretionary

87

antitrust has been criticised as being excessively dogmatic

(Howe [34]). There are two ways of viewing this criticism.
The first is to accept that non-discretionary antitrust cannot
be justified by strict reference to economic theory, that not
enough is known about the relative significance of scale
economies and X-inefficiency, about the relationship between
market structure and market performance, or even about
company motivation, to justify taking such a dogmatic standpoint on the market power issue. In such circumstances,
those supporting non-discretionary antitrust must do so for
reasons that are not strictly economic, but derive from their
particular political and social philosophy (Peacock and Rowley [50]). Clearly, those who adhere to a liberalist social welfare function would be more inclined to such action than those
who subscribe to other philosophies.
There is, however, an alternative way of viewing the nondiscretionary approach to merger policy which squares more
closely with the dictates of economic analysis (Crew and Rowley [12, 15]). This viewpoint rests upon the acknowledged
uncertainty and high transaction costs surrounding the costbenefit investigations into merger proposals. A case is arguable
on these grounds that the pragmatic approach is neither the
most economical nor the most effective method of dealing
with the merger problem. This is in no sense to deny that
benefits may flow from pragmatic investigation. Rather it is
to suggest that the benefits derived therefrom are unlikely
in practice to outweigh the costs. In such circumstances, a
decision between non-discretionary antitrust on the one hand
and laissez-faire on the other is seen to rest on a general judgement as to the overall gains and benefits at risk within the
economy at large. Those who come down in favour of nondiscretionary antitrust, following this approach, will do so
whilst recognising that in some cases mergers will be prohibited
which would confer net benefits upon society. They accept
this cost as the price of avoiding the uncertainty and high
costs of pragmatic inquiry.
The non-discretionary approach to single-firm monopolisation presents additional problems which are largely avoided
in dealing with merger proposals, since existing institutional

88

arrangements must be disrupted where antitrust measures are

applied to existing monopolists. Once again, the non-discretionary approach would emphasise structural rather than
performance criteria, and any firm which enjoyed a greater
share of properly defined market than the rules allowed (the
rules might be more generous than in the case of mergers)
would expect antitrust intervention. A range of instruments
would be available, including attacks on entry barriers by
lowering tariffs, controlling sales promotion, etc., subsidising
new entry, prohibitions on the absolute growth of the monopolist in a growing total market, and so on. In extreme cases,
and where the technique of production so allowed, divestiture
decrees might be imposed, though action of this severity would
be the exception rather than the rule, and would be imposed
only where alternative methods seemed inopportune. Only
where completely intractable problems existed (as for example
in the case of public goods and chronic production indivisibilities) might antitrust intervention be waived in favour of
regulatory or public enterprise alternatives.
It has been argued (Howe [34]) that such a non-discretionary
approach to monopoly power, which might split up large
companies without reference to the way in which they had
used their power, would be considered by the business community to be an affront to the laws of natural justice. Certainly,
even U.S. antitrust policy, despite the legislative support for
non-discretionary intervention, has avoided such unquestioning
intervention by invoking the 'rule of reason' as some defence
for vetting company performance. On the other hand, it
is possible to exaggerate the hardship actually created for the
business community by non-discretionary rules. For divestiture
decrees would be rare occurrences. For the most part, the necessary adjustments would be small, involving perhaps minor
reductions in the rates of increase of wages and salaries, some
job reductions and relocations, cuts in profit performance,
minor reductions in share valuations, etc., and there are much
worse affronts to the laws of natural justice than these, especially when there are expected overall net benefits for society
at large. Moreover, businessmen themselves would at least
know from where the main thrust of antitrust intervention

89

was to be expected. Reductions in uncertainty from this aspect

of public policy might serve to soothe ruffled dignities.
The transaction costs of this aspect of the non-discretionary
approach are inevitably higher than for restrictive agreements
and merger proposals, and the problems of ensuring that policy is
effectively enforced are also higher. In these respects, the
laissez-faire approach to existing monopolies compares favourably. On the other hand, for those who take a pessimistic view
of the ability of unfettered market forces to maintain competition and who believe that X-inefficiency is significantly associated with market power, the non-discretionary antitrust
approach has much to commend it.
The issue remains as to whether non-discretionary antitrust
policy is better implemented via the administrative or via
the judicial process. Recent developments in the economics of
politics (Downs [25]) and in the economic theory of bureaucratic behaviour (Bernstein [7]) (already outlined in this
survey) present a strong case for reliance upon judicial procedures. That the judiciary itself is susceptible to outside
pressures cannot be denied, but both the nature of judicial
appointments (with the emphasis upon tenure) and the
emphasis in public policy itself generally upon the integrity
of the 'rule of law' give reason to suppose that the judiciary
would stand out as the least corruptible of all the instruments
for the handling of non-discretionary antitrust policy.

90

Bibliography
[1]
[2]

[3]
[4]
[5]

[6]

[7]
[8]
[9]
[10]
[11]

A. Alchian, 'Costs and Outputs', in M. Abramovitz

(ed.), The Allocation of Economic Resources (Stanford U.P.,
1959) pp. 23-40.
K. Arrow, 'Economic Welfare and the Allocation of
Resources for Invention', in N.B.E.R., The Rate and
Direction of Inventive Activiry (Princeton U.P., 1962)
pp.609-26.
H. Averch and L. Johnson, 'A Behaviour of the Firm
under Regulatory Constraint', American Economic Review
(Dec 1962).
J. S. Bain, Barriers to New Competition (Harvard U.P.,
Cambridge, Mass., 1956).
W. J. Baumol, 'Reasonable Rules for Rate Regulation',
in A. Phillips and O. E. Williamson (eds), Prices:
Issues in Theory, Practice, and Public Policy (Pennsylvania
V.P., Philadelphia, 1966).
M. E. Beesley, 'Economic Effects of National Planning
Policies towards Mergers and Acquisitions', in B. W.
Denning (ed.), Corporate Long Range Planning (Longman,
London, 1969).
M. H. Bernstein, Regulating Business by Independent
Commission (Princeton U.P., 1955).
J. M. Buchanan, 'A Public Choice Approach to Public
Utility Pricing', Public Choice (fall 1968).
J. M. Buchanan, Cost and Choice (Markham, 1969).
W. S. Comanor and H. Leibenstein, 'Allocative Efficiency, X-Efficiency and the Measurement of Welfare
Losses', Economica (Aug 1969).
W. S. Comanor and T. A. Wilson, 'Advertising Market
Structure and Performance', Review of Economics and
Statistics (Nov 1967).

91

[12]
[13]
[14]
[15]
[16]
[17]
[18]
[19]
[20]
[21]
[22]
[23]
[24]
[25]
[26]

92

M. A. Crew and C. K. Rowley, 'Antitrust Policy:

Economics versus Management Science', Moorgate and
Wall Street (autumn 1970).
M. A. Crew and C. K. Rowley, 'On Allocative Efficiency,
X-Efficiency and the Measurement of Welfare Loss',
Economica (May 1971).
M. A. Crew, M. Jones-Lee and C. K. Rowley, 'XTheory versus Management Discretion Theory', Southern
Economic Journal (Oct 1971).
M. A. Crew and C. K. Rowley, 'Antitrust Policy:
The Application of Rules', Moorgate and Wall Street
(autumn 1971).
M. A. Crew and C. K. Rowley, 'A Note on X-Efficiency',
Economic Journal (Dec 1972).
J. M. Currie, J. A. Murphy and A. Schmitz, 'The
Concept of Economic Surplus and its Use in Economic
Analysis', Economic Journal (Dec 1971).
O. A. Davis and A. Whinston, 'Welfare Economics
and the Theory of Second Best', Review of Economic
Studies (1965).
H. Demsetz, 'The Exchange and Enforcement of
Property Rights', Journal ofLaw and Economics (Oct 1964).
H. Demsetz, 'Why Regulate Utilities?' Journal of Law
and Economics (Apr 1968).
H. Demsetz, 'Information and Efficiency: Another
Viewpoint', Journal of Law and Economics (Apr 1969).
H. Demsetz, 'The Private Production of Public Goods',
Journal of Law and Economics (Oct 1970).
H. Demsetz, 'On the Regulation of Industry: A Reply',
Journal of Political Economy (Mar-Apr 1971).
M. E. De Prano and J. B. Nugent, 'Economies as an
Antitrust Defense: Comment', American Economic Review
(Dec 1969).
A. Downs, An Economic Theory of Democracy (Harper &
Row, New York, 1957).
C. Freeman, 'Size of Firm, R. and D., and Innovation',
and 'Innovation and Size of Firm', in J. B. Heath (ed.),
International Conference on Monopolies, Mergers and Restrictive Practices (H.M.S.O., London, 1971).

[27]
[28]
[2.9]
[30]
[31]
[32]
[33]

[34]
[35]
[36]
[37]
[38]
[39]
[ 40]

[41]
[42]
[43]

M. Friedman, Capitalism and Freedom (Chicago U.P.,

1962).
J. K. Galbraith, American Capitalism: The Concept of
Countervailing Power (Penguin Books, Harmondsworth,
1970).
J. K. Galbraith, The New Industrial State (Penguin
Books, Harmondsworth, 1968).
A. C. Harberger, 'Monopoly and Resource Allocation',
American &anomic Review (May 1954).
A. C. Harberger, 'Three Postulates for Applied Welfare
Economics: An Interpretative Essay', Journal of Economic
Literature (Sep 1971).
B. Hindley, Industrial Merger anti Public Policy, Hobart
Paper No. 50 (Institute of Economic Affairs, London,
1970).
M. Howe, 'The Iron and Steel Board and Steel Pricing,
1953-196 7', Scottish Journal ofPolitical Economy (June 1968).
M. Howe, 'Antitrust Policy: Rules or Discretionary
Intervention', Moorgale and Wall Street (spring 1971).
M. Howe, 'British Merger Policy Proposals and American Experience', Scottish Journal of Political Economy
(Feb 1972).
Industrial Policy Group, The Structure and Efficiency of
British Industry, Paper No. 6 (London, 1970).
Industrial Policy Group, The Control of Monopoly,
Paper No. 8 (London, 1971).
Industrial Policy Group, Merger Policy, Paper No. 9
(London, 1971).
M. Kafoglis, 'Output of the Restrained Firm', American
Economic Review (Sep 1969).
A. K. Klevorick, 'Graduated Fair Return: A Regulatory Proposal', American Economic Review (June 1966).
S. E. Koo, 'A Note on the Social Welfare Loss Due to
Monopoly', Southern Economic Journal (Oct 1970).
H. Leibenstein, 'Allocative Efficiency vs. X-Efficiency',
American &onomic Review (June 1966).
H. Leibenstein, 'Organisational or Frictional Equilibria,
X-Efficiency and the Rate of Innovation', QuarterlJ
Journal of Economics (Nov 1969).
93

[44]

[45]

[46]
[47]
[48]
[49]
[50]
[51]

[52]

[33]
[54]
[55]
[56]
[57]
[58]
[59]

94

R. G. Lipsey and K. Lancaster, 'The General Theory

of Second Best', Review of Economic Studies (1956).
P. J. McNulty, 'Allocative Efficiency vs. X-Efficiency:
Comment', American Economic Review (Dec 1967).
E. Mansfield, Industrial Research and Technological Innovation
(Norton, New York, 1968).
S. K. Nath, A Reappraisal of Welfare Economics (Routledge
& Kegan Paul, London, 1969).
W. D. Nordhaus, Invention, Growth and Welfare (M.I.T.
Press, Cambridge, Mass., 1969).
A. T. Peacock and C. K. Rowley, 'Welfare Economics
and the Public Regulation of Natural Monopoly',
Journal of Public Economics (June 1972).
A. T. Peacock and C. K. Rowley, 'Pareto Optimality
and the Political Economy of Liberalism', JouT1Ull
of Political Economy (May-June 1972).
A Phillips, 'Structure, Conduct and Performance - and
Performance, Conduct and Structure', in J. W. Markham and G. F. Papanek (eds), Industrial Organisation
and Economic Development (Houghton Mifflin, Boston,
1970).
A. Phillips, 'The Objectives of Economic Policy: The
Contribution of Antitrust', in J. B. Heath (ed.), International Conference on Monopolies, Mergers and Restrictive
Practices (H.M.S.O., London, 1971).
C. F. Pratten, Economies of Scale in Manufacturing Industry
(Cambridge U.P., 1971).
P. Ross, 'Economies as an Antitrust Defense: Comment',
American Economic Review (Dec 1968).
C. K. Rowley, The British Monopolies Commission (Allen
& Unwin, London, 1966).
C. K. Rowley, 'Mergers and Public Policy', Journal
of Law and Economics (Apr 1968).
C. K. Rowley, 'Monopoly in Britain: Private Vice but
Public Virtue?' Moorgate and Wall Street (autumn 1968).
C. K. Rowley, 'The Monopolies Commission and Rate
of Return on Capital', Economic Journal (Mar 1969).
C. K. Rowley, 'The Monopolies Commission and Rate
of Return on Capital: A Reply', Economic Journal

[60]
[61]
[62]

[63]
[64]
[65]

[66]
[67]
[68]
[69]
[70]

[71]
[72]

[73]
[74]
[75]

(Sep 1971) and 'A Further Reply', Economic Journal

(June 1972).
C. K. Rowley, Steel and Public Poliry (McGraw-Hill,
Maidenhead, 1971).
F. M. Scherer, 'Firm Size, Market Structure, Opportunity and the Output of Patented Inventions', American
Economic Review (Dec 1965).
F. M. Scherer, Industrial Market Structure and Market
Performance (Rand McNally, Chicago, 1970).
J. A. Schumpeter, Capitalism, Socialism and Democracy
(Allen & Unwin, London, 1950).
J. P. Shelton, 'Allocative Efficiency vs. X-Efficiency:
Comment', American Economic Review (Dec 1967).
W. G. Shepherd, 'What Does the Survivor Technique
Show about Economies of Scale?', Southern Economic
Journal (July 1967).
A. Silberston, 'Economies of Scale in Theory and
Practice', Economic Journal (Mar 1972) supplement.
G. J. Stigler, 'The Economies of Scale', Journal of Law
and Economics (Vol. I, Oct 1958).
G. J. Stigler and C. Friedland, 'What Can Regulators
Regulate?: The Case of Electricity', Journal of Law and
Economics (Oct 1962).
G.1. Stigler, 'The Economics of Information', Journal
of Political Economy (June 1961).
G. J. Stigler, 'A Theory of Oligopoly', Journal of Political
Economy (Feb 1964).
G. J. Stigler, 'The Economic Effects of the Antitrust
Laws', Journal of Law and Economics (Oct 1966).
G. J. Stigler, The Organisation of Industry (Irwin, Homewood, 111., 1968).
A. Sutherland, The Monopolies Commission in Action
(Cambridge U.P., 1970).
A. Sutherland, 'The Management of Mergers Policy',
in A. Cairncross (ed.), The Managed Economy (Blackwell,
Oxford, 1970).
A. Sutherland, 'A Critique of Dr Rowley', Economic
Journal (Mar 1971) and 'A Rejoinder', Economic Journal
(June 1972).
95

[76]
[77]

[78]
[79]

[80]

[81]
[82]
[83]
[84]
[85]

[86]
[87]

[88]
[89]

L. G. Telser, 'Advertising and Competition', Journal of

Political Economy (Dec 1964).
L. G. Telser, 'On the Regulation of Industry: A Note',
Journal of Political Economy (Nov-Dec 1969).
L. G. Telser, 'On the Regulation of Industry: A Rejoinder', Journal of Political Economy (Mar-April 1971).
D. F. Turner, 'The Scope of Antitrust and Other
Economic Regulatory Policies', inJ. W. Markham and
G. F. Papanek (eds), Industrial Organisation and Economic
Development (Houghton Mifflin, Boston, 1970).
R. Turvey, 'Marginal Cost', Economic Journal (June
1969).
M. A. Utton, 'Future Prospects for Merger Policy',
Bankers'Magazine (Sep 1970).
L. Weiss, 'The Survival Technique and the Extent of
Suboptimal Capacity', Journal of Political Economy (1964).
O. E. Williamson, The Economics of Discretionary Behaviour (Markham, U.S.A., 1964).
O. E. Williamson, 'Economics as an Antitrust Defense',
American Economic Review (Mar 1968).
O. E. Williamson, 'Economics as an Antitrust Defense:
Reply', American Economic Review (Dec 1968) and
'Reply', American Economic Review (Dec 1969).
O. E. Williamson, 'The Limits of Antitrust', American
Economic Review (May 1969).
O. E. Williamson and D. F. Turner, 'Market Structure
in Relation to Technical and Organisational Innovations', in J. B. Heath (ed.), International Conference on
Monopolies' Mergers and Restrictive Practices (H.M.S.O.,
London, 1971).
J. Wiseman, 'Public Utility Pricing: An Empty Box',
Oxford Economic Papers (1957).
B. S. Yamey, 'Monopoly, Competition and the Incentive to Invent: A Comment', Journal of Law and
Economics (Apr 1970).