Thursday, October 16, 2008

Sherman Anti-Trust Act May Cause Innovation to Decline

The Sherman Anti-Trust Act (SATA) was passed in 1890. It was initially interpreted as a statement of common law concerning reasonable versus unreasonable restraints of trade. In 1896 in United States v. Trans-Missouri Freight Association the Supreme Court held that only competition amounted to reasonable price setting. In 1904, in the Northern Securities Trust case (involving a railroad trust) the Supreme Court held that even trusts or corporations that combined several companies amounted to unreasonable restraints of trade. Hence, corporate mergers were illegal in this period. In 1911, the Supreme Court revised that view, holding that the Standard Oil Company ought to be broken up because it involved unreasonable restraints of trade and was a "bad" trust. However, there are "per se" violations of the Sherman Anti-Trust Act that don't require a test of reason. These include "any...conspiracy in restraint of trade or commerce".

Thus, the Sherman Anti-trust Act after 1896 illegalized any cartel. But capital investment in manufacturing and capital intensive services may require a degree of price predictability. By making conspiracies in restraint of trade illegal, even where they do not result in excessive prices, the Supreme Court forced many businesses to consider two risks: (1) overproduction, which was characteristic of late 19th century industry as described in David Ames Wells's Recent Economic Changes and (2)prosecution under the Sherman Anti-Trust Act if they attempted to collude to limit the risk of over-production.

The remedy to the per se problem was merger that permitted "reasonable" outcomes. Thus, the automobile industry coalesced into three large firms that did not collude but in effect followed a price leader. But this policy may have had side effects that the Supreme Court did not consider.

In encouraging mergers rather than collusion the court limited the number of managements. Creativity often requires a diversity of ideas. By creating small numbers of top heavy firms with a small number of highly compensated executives with much at risk if their firms failed, innovation may have been curtailed. Part of the reason for the post-Progressive slow down in innovation may be the Sherman Anti-Trust Act.

Exactly why the Supreme Court and Congress preferred a few large firms over many smaller ones that might rig prices for a few years in order to avoid excess production is unclear. A few large firms can rig prices without speaking. So the difference, speaking or not speaking, seems to be of minor economic or moral significance. On the other hand, crushing many mid-sized firms into a few really big ones may have killed the most creative managers, who often may have been surpassed in the pyramid due to gamesmanship and corporate politics. Moreover, a few large firms face much greater risk with respect to experimentation than many small ones. This emphasis on large size coincided with the socialist perspective of Theodore Roosevelt and the Progressives. The Progressives loved large size because it seemed efficient to them, but they failed to grasp the underlying dynamic of creativity.

1 comment:

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