How Economists Distorted Economic Theory to Help Big Companies Get Bigger

Yves here. I felt like slapping my forehead when this post explained the sleight of hand neoclassical economists and their legal allies performed in getting courts to buy off on a definition of “efficiency” for the purposes of evaluating mergers that is not seen as valid in the economics discipline generally. It’s a remarkable case of chicanery in plain sight that just about everyone, including yours truly, missed.

By Mark Glick, Professor, University of Utah; Gabriel Lozada, Associate Professor of Economics, University of Utah; Pavitra Govindan, Assistant Professor of Economics, University of Utah; and Darren Bush, Professor, The University of Houston Law Center Faculty. Originally published at the Institute of New Economic Thinking website

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

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

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

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

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

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

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

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  1. Sam Owen

    Lina Kahn’s stance towards anti-trust is definitely a good thing, but this draft from the FTC and DOJ is coming much too late. What’s the point of being against mergers when all the large companies have already merged and gobbled up most of the market share? Almost every industry now is dominated by an oligopoly anyway.

    There needs to be a retroactive look at past mergers and a purposeful effort to break up existing companies.

    1. John R Moffett

      There will have to be a return to “public good” as a counter to “efficiency”. There really hasn’t been a sense of public good among the ruling elite since the late 1970s. Once Clinton jumped on the efficiency bandwagon the dice were cast and the rest is history. It was now a bipartisan effort to undermine public good in every and any way possible. Small steps aren’t going to undo 50 years of wealth amassment, nor the widespread disdain among the elites for anything that smacks of the New Deal. They will not abandon their decades long march to domination easily. They want much more return on their investment.

  2. chuck roast

    “…the assumptions necessary to ensure that maximizing surplus results in Pareto Efficiency are extreme and unrealistic.” Perfect competition…absolute nonsense. Let us quote Adam Smith…the Adam Smith that the Chicago acolytes have ignored since day one…“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

    Well, if this new anti-monopoly theory and practice gain a foothold, the lens will then be turned to trust-busting. Good luck with that. Recall the U.S. vs Microsoft. That was a brutal undertaking. I can’t imagine the will and determination to carry out such an initiative at scale. And recall also that Eliot Spitzer was the lead for co-plaintiff in the case. What happened to him anyway?

    1. Susan the other

      A brief report (in RT I think) this last week was about how China is looking at a new model of capital which has 6 different components running the spectrum of value from social to environmental to good industry practices. Six dimensional capital which requires that the benefits be spread evenly through society. Wherein economic balance is a fusion which seems to preclude concentrations of wealth and extraction. So do we call this capitalism with Chinese characteristics, or just very good sense? No mention of “monopoly,” but clearly this was meant to prevent imbalances by too much capital accumulation without the obligation to give back.

  3. Terry Flynn

    I’m happy to be corrected, since I no longer have the links to hand (and maybe they’ve been debunked) but I do remember that a lot of the Chairs in Economics in the late 19th and early 20th Century were funded by the “robber barons” and British establishment with the aim of setting up Marxist thought as their straw man.

    They KNEW they could counter Marxism (and the collapse of communism shows the proof of the pudding was in the eating) but what really scared them (and so could not be a “recognised topic” in major economics courses) was Georgism (Land Value Taxation).

    LVT is, ironically, the only form of tax Adam Smith endorsed (no deadweight loss) and he liked it for helping Capitalists establish themselves without having to pay cash to “loser” land barons. It’s ironic that “land” got gobbled up into “capital” to finesse the western neoliberal model and which helped create the neoliberal branch of economics. Result? Enormous companies often underpinned by land and other inherited wealth.

      1. digi_owl

        I dunno. Land is effectively free energy from the sun. Either collected via solar, or as plants for food and industry. Everything else is downstream of that.

        1. Terry Flynn

          I totally agree with the sentiment: everything else is downstream of land. Land itself has been conceptualised in various ways, depending on your personal philosophy/religion – “given by God” was popular during the time of Adam Smith and the Physiocrats, whilst those of us who are agnostic/atheist would lean more towards “the product of nature and definitely not mankind” (with the exception of the tiny tiny percentage that is reclaimed from the sea by Dutch/Chinese/others).

          Thus I have a lot of sympathy with the view that ultimately, all land was “grabbed” by someone, if you go back far enough. Land should therefore be used in its most productive way. LVT seems to encourage this. I do acknowledge that it can’t be implemented overnight, due to inequities it’ll cause in short term. However, I think it would go a long way toward ironing out the gross inequalities in modern society and stop companies from tax avoiding. You can’t hide land. I don’t *think* it is incompatible with MMT either.

          1. Revenant

            It *can* be implememted overnight if you pair it with Irving Fisher’s Chicago Plan, to buy out the entire stock of mortgage debt and introduce non-credit money.


            Every debt gets cancelled by government credit and the equity boon gets taxed away. Implement this at the same time as LVT to tax away future land gains.

            In my preferred, LVT would be an annual payment whose NPV equals the land value, which would be determined as the NPV of actual or imputed rent less the NPV of a deemed yield on capital invested in the buildings upon the land – so the more you invest in the buildings and infrastructure on the land, the less the implied land value and the less you pay in land value tax, leaving an incentive for development because it would generate positive cashflows).

          2. Weil

            Commodified under capitalism and the enclosure movements in England and the US.

            All land is monetized under the profit before people approach to insanity.

            You can go back to Locke to see the dillemmas he etched out for us to think about.

            But only classical economists like Marx saw capitalism as a system born of history.

            And land use, as we call it, is firmly in the hands of those that own the land.

            This is the way it has always been and why it must change as you suggest.

  4. Carolinian

    This is above my non economic head but my understanding of the orginal antitrust movement is that it was all about ensuring competition and not necessarily about optimum social outcomes. In other words people like FDR were out to save capitalism from itself rather than endorse socialism.

    So it’s about power as much as price and less about saving “small” business than making sure there are enough same size businesses to keep each other under control.

    Meanwhile most businesses quite naturally want the opposite at least in their later, decadent stages. Early Silicon Valley was seething with competition–decadent current tech not so much. As someone says upthread there may be no magic wand to send things back to the way they used to be. But keeping the eye on the ball means worrying about power.

    1. Weil

      No monopoly wants competition. That is why they are organized as monopolies.

      We now have cartel-transnational monopolies that own large portions of th world’s resources and services.

      How do you expropriate these expropriators?

      Often people talk to me about drug cartels and think they are in Colombia or Peru or Ecuador.

      They are, but the biggest cartels are in the US and they are known as banks and there is no cartel other than banks that can serve the purpose banks serve.

  5. Kouros

    This discussion reminds me a bit of the arguments made to enact land enclosures in England at the beginning of industrial revolution: efficiency, productivity were ideas flung about to kick people off the commons, deprive them of the ability to subsist, and force them into growing cities and new factories that needed cheap labour…

    Of course, a lot of the commons being on marginal lend, the new owners could never prove that they actually increased productivity of the said land…

    1. digi_owl

      Yeah i think you can trace much of modern economic thinking back to the “enlightenment”, where words got twisted to shield the burgeoning merchant and industrial elite from the monarchy.

    2. Weil

      Correct and the new neo-enclosure movement promises to be more brutal, as we have seen.

      Obama kicked ten million out of their homes by bailing out banks not people. And that was not even ‘public land’.

      Ravaging what is left of public land and private land is the game plan.

      What you describe is the new digital dark ages of medieval debt peonage and work for food die for oil.

      Factories will come to America, free enterprise zones, and federal land will be given to them for Americans to produce those T-shirts they adore so much.

      If they are lucky and AI doesn’t hit first.

      And they will learn to ‘compete’ with China and India, along with what is ever left of poor Bangladesh.

      But the GDP will go up and so will the stock market.

      As for wages, that was so ‘yesterday’.

  6. Jason

    The Marshallian surplus-maximizing approach to economic welfare generally works only if in the backdrop you have (1) full employment of resources, so that the effects on input suppliers can be ignored because they can always find viable alternative uses, and (2) redistribution of income is done at the macro level, so that the poor get the support they need. These are achievable conditions in the right political climate, which unfortunately doesn’t describe the United States.

    I don’t think the move to enshrining Pareto efficiency is helpful because deciding on the compensation of losers will paralyze any policy that changes the status quo – including actions such as breaking up monopolies or raising taxes on the rich! I think to support stronger anti-trust actions, it is enough to show that the proported cost savings of past mergers have mostly not been realized.

  7. animalogic

    Are monopolies a direct affect of the contradictions inherent in capitalism — or a kind of 2nd order affect of the ” corruption” inherent in a system that seems to drive people towards greed & cupidity?

    1. Weil

      Monopolies are the result of control of the means of production, both monetary and technological, by a few capitalist firms.

      Thy organize for monopolies much the same as workers organize for unions.

      Monopolies wish to protect their own reason for being: profits.

      And so to monopolize is to control market share and thus avoid the messy, fake competition we are forced to hear about all day long.

      Monopolies should be seen as unions of capital.

      They are cartels when they, as monopolies, form unions with other monopolies.

      This is how fascism arose and in many ways how it is arising again today.— internationally.

  8. Paul Art

    Nothing can be done unless we wean 401Ks and pensions off the stock market. Any regulatory moves on companies that are monopolies or members of an oligopoly will cause their stock prices to crash and therefore will not be supported by the public when they see their nest eggs accelerate downward and their retirements irreparably harmed. We need a heart-lung machine for the pension and 401K fix. The government must wait for the next big crash and then offer a public option for long term investment to compete with the stock market. I for one would rather dump my retirement funds into something that gives a 6% return over 30 years. What made the 401K “defined contribution” such an exquisite Trojan Horse for Wall Street was it neatly shifted the responsibility for retirement from the Corporations to the employees themselves using their greed as motivation. I remember in my younger years in Silicon Valley when Mosaic went public and we all got stock options and how everyone at work would be glued to the IPO news all around us. The bait and switch was beautifully done. All those books that continue to be written about how you can retire in 10 years if you just have the right investment strategy. Once enough people are weaned off this Ponzi scheme, then we can think of dismembering the monopolies. Obama could have done this in 2008 when the time was ripe. In 2008 a well organized Left could have changed everything but then the Blue Dogs did such an excellent job of decimating anything liberal in the 1970s. Today the Left is rudderless, devoid of any leadership that can motivate youngsters like “Naders Raiders”. Bernie is all we have and he does not have much time and he is definitely not the savage fighter Nader was. Leaders are everything. We need good leaders. The World never achieved anything worthwhile without them.

  9. Vicky Cookies

    Bless the scholars and advocates at INET for their saintly patience in taking the time to seriously rebut what seem always to have bad faith arguments to justify increasing monopoly power which upper class policymakers and regulators likely were not psychologically capable of seeing as such. Anti-trust enforcement may improve as a result of these and other efforts, though the increasingly irate crowd with the pitchforks probably help too.

  10. Mira Martin-Parker

    I think most Western economics is grounded in witchcraft. In physics, what’s empirically perceivable has already occurred by the time we recognize it. There’s an imperceptible time gap between energetic transmission point, sentient reception point, and cognitive identification. Thus, much of what economists are “looking at” in proposing their theories are shadows, reflections, and echoes of events already past. Most economists are literally stuck in the past, the more dependent they are on empirically verifiable content only. In nature, energy is transmitted primarily from source points above and behind us, or conversely below and beneath us. We cannot observe things, and observed energetic source points simultaneously. Scientists must consult their previous impressions (mental images), past experience (beliefs), and present internal states (emotions), in addition to information provided by the senses. Depending upon their personal degree of experience/knowledge, their predictions will be correspondingly accurate or inaccurate in degrees. Ironically, it’s by observing sensory illusions such as shadows, reflections, and echoes that humans attain their degrees of knowledge regarding the lived environment. It’s not by observing solely things, but by observing non-things (sense illusions) and material things combined, and noting their logical differences (cyclical rotations between extreme opposing states, light/dark, etc), that scientific theories are attained.

    The witches do this thought work for pay from rich patrons. Real teachers are often homeless and barefoot and demonized, like Socrates. Especially here in this wicked-ass witch-filled and witch-founded country. Especially here in its capital city San Francisco, governed by dark witches of the worst kind…


  11. Kiddoc

    John Micheal Greer has described efficiency as the opposite of resiliency. We are living with resultant brittle systems, that work poorly when just-in-time breaks down, or abandoned back-up systems (costly, “inefficient”) are needed. Shortages promptly appear when the sole operator cuts one too many corners, and a plant goes out of service. Higher profits, for a less functional substitution, may result. Emergency waiving of regulations, such as those to limit pollution, price-gouging or monopoly, do not help.

    Not all inflation is money printing….

  12. Anthony douglas

    Ok, I can appreciate that science has to proceed and there is great value in actually answering these questions, but at the same time I could have told you in a snap way back in 1980 that their arguments are trash, and I’m no expert.

    The problem is not that they made a convincing argument and fooled people. Not at all. I guarantee you a lot of people saw right through them, but they had too much power and all they really needed was excuses and a little grease to slide through what they wanted.

    There are much more fundamental problems with this democracy. Certainly this kind of research and expert opion is important in the right context, and it still helps. But honestly , if we could just have a more general ability to resist such influence, regardless of their trashy arguments, that would help a lot more than any argument or research could. And for the long term we need both, yes.


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