Technology, Competition, and Antitrust Enforcement

THE PERCEPTUAL BIAS against market competition and for government control over competition is becoming a greater source of political mischief as technology advances. First, by increasing competition, technological advances are expanding the probability that antitrust activity will be counterproductive. Second, for the very reason that competition is becoming a more potent force for progress, it can strengthen public perception that more antitrust action is needed, thus empowering special-interest groups that see it as a means of capturing private benefits at public expense.

As should be obvious to anyone who cares to think about it, technology is increasing competition by transforming local markets into global ones. Peter Drucker was engaging in only a little hyperbole when he wrote in Atlantic Monthly (October 1999): "Distance has been eliminated ... every business must become globally competitive, even if it manufactures or sells only in a regional or local market. The competition is not local anymore--in fact, it knows no boundaries."

Increasing global competition is unequivocally good for consumers. It reduces any benefit to be derived from antitrust action, even if one assumes that such action is used solely to advance the interests of consumers. However, this is not the sole, or even a very important, objective of government action in general and antitrust action in particular. Indeed, if the Federal government were really concerned with promoting competition, it would give global competition a boost by eliminating all U.S. restrictions on foreign trade. These import restrictions are maintained because the interests of organized groups carry more political weight than do the interests of unorganized consumers. For the same reason, antitrust policy is more concerned with protecting competitors than with protecting and promoting competition.

Political action can never be justified with a blatant admission that it serves narrow private interests at the expense of the general public. Pretense that the action is required by some broad and worthy social objective is essential, and this pretense has to seem plausible to the public. The increasing global competition being driven by improved technology in communication and transportation is motivating responses that, though good for the consumer, are easily presented as growing market power demanding antitrust action.

Escalating modern technology can increase the size of some companies while decreasing the size of others. Computer and communication technologies have lowered the costs of many companies interacting with one another in markets (and gaining the benefits of competitive markets for what they buy and sell), which means the technologies have enabled many people to start small businesses--from magazines to consulting services--in their homes. Other companies have been able to downsize and outsource the production of parts and services (for example, accounting and legal services). As a consequence, where hundreds of workers and large plants were once required to do business, far smaller companies with less labor and plant and equipment can get the same jobs done at lower cost.

These same technologies have allowed other companies to monitor at lower cost the operations of a greater number of remote production and sales facilities from their headquarters, so many businesses have become more cost-effective by growing larger. The larger size might once have allowed workers to shirk their duties, giving rise to production costs that were higher than necessary. Today, because supervisors can monitor their plant workers more effectively, and officers at the firms' headquarters can monitor their supervisors in remote locations via the daily, if not hourly, reports on production data automatically transmitted via company computer networks, the costs of shirking can be reduced, thus increasing efficiency.

Intensified global competition has forced companies everywhere to reexamine their production scales to see how they must be adjusted--upward or downward--to take full advantage of new technologies. Companies have to accommodate new technologies by adjusting their size appropriately to serve the consumer better and meet the competition from global competitors who are also adjusting their size to take advantage of cost savings. Accordingly, with the spread of modern computer and telecommunication technologies, we have witnessed a literal potpourri of scale adjustments in business structures, with many small entrepreneurs emerging while other companies are downsizing and still others are growing larger through internal expansion or mergers.

These technological forces can give rise to firms seeking protection against intense competition from companies making the adjustments successfully. In the downsizing industries, workers and their unions can claim that they are victims of forces beyond their control, which is true, and that they should receive protection by, for instance, regulation through import restrictions. Moreover, public opinion is easily turned against downsizing industries, and hostile public opinion is fertile ground for frivolous antitrust suits that are politically inspired. Clearly, members of Congress work on matters that will get them media attention. Not surprisingly, academic research shows that political pressure affects the number of antitrust cases that are brought and which members' districts will be affected by these cases.

On the other hand, even if companies are, on balance, becoming smaller, a few large and highly publicized mergers can easily obscure this fact, creating a public mindset more favorable to antitrust action. This leads to a fertile political environment for companies that want to hamper their competitors with antitrust action, justified with the spurious claim that mergers are anticompetitive. Even though antitrust action, or the threat of action, that prevents mergers reduces efficiency by stymieing appropriate responses to global competition, it can easily seem to be the right thing to do.

By preventing a merger, an antitrust suit can confer immediate benefits to identifiable people by, for example, eliminating the threat of layoffs. (Even when mergers increase company size, they commonly result in layoffs as some of the workers in the two companies that merge become redundant in the new larger company.) This benefit is appreciated and easily seen to be the direct result of the antitrust action. Meanwhile, the costs of a less-competitive and less-productive economy are delayed, diffused, and unlikely ever to be noticed. Even if noticed, they will not be traced back to, and blamed on, the antitrust action that caused them.

The network effects that have assumed more importance with advances in computing and telecommunications and have created so much efficiency have also altered public perception in favor of antitrust action and increased the political demand for such action, even though it reduces, rather than promotes, competition. The competition that takes place when network effects are present is exactly the type of competition economist Joseph A. Schumpeter describes as "creative destruction," maintaining that it tends not to "strike at the margins of the profits and the outputs of the existing companies but at their very lives." As Stan J. Liebowitz and Stephen E. Margolis point out in Winners, Losers and Microsoft, "The new entrant [in a network situation] seeks not to coexist with the incumbent, but rather to replace it."

Obviously, companies supplying incompatible versions of the same network product can, and do, coexist, but such coexistence is typically one-sided, with one firm in a dominant position, and is seldom very stable for long. If we use the term "monopoly" loosely, network industries tend to be serial monopolies, with the dominant company being constantly vulnerable to a relatively rapid decline in market share. Such competition is seldom welcomed by those subjected to the discipline and disruption it imposes. (Netscape certainly did not like Microsoft's assault on its browser market.) Such spirited competition can, and often does, motivate companies to appeal to government to hamper the competition with antitrust sanctions against their successful rivals.

No matter what the phase in the competitive cycle of serial monopolies that typically describes network markets, a superficially plausible case can be made for antitrust action. Since network industries are seldom stable with anything close to equal market shares across companies, successful competition in these industries will almost always lead to a dominant position. This means aggressive price and quality competition by companies designed to achieve some critical mass of users that tips the market in the direction of their product. Such aggressive activity is easily seen, with justification, as an effort to monopolize.

That the company under suspicion is acting just the opposite of a traditional monopolist by cutting price (possibly to zero or less) and rapidly expanding output is not accepted as a defense against an antitrust charge. Antitrust advocates argue that, with network effects, price-cutting and output expansion can lead to an entrenched monopoly. The reasoning is that, once enough people begin using a product, they are locked in since so many others are also doing so. Thus, low price and expanding output are seen as violating antitrust laws, as has been charged in the Microsoft case.

A company that escapes the antitrust dragnet initially and achieves a dominant position is vulnerable to antitrust charges by virtue of its dominance. It is likely charging higher prices than it did to achieve a large market share. Such higher prices can be justified as making up for the lower prices charged earlier--prices that were likely less than cost. Even with increased prices as the network becomes more fully developed, the ratio of price to value provided can still be declining because of the increasing value generated by the network effect. Even so, dominant network companies face severe constraints on their ability to raise prices if they are to have much hope of maintaining their dominance for long. The same network dynamics that allow rapid growth in market share make dominant companies vulnerable to rapid declines as well. Those that live by the tipping phenomenon can die by the tipping phenomenon.

Regardless of the behavioral differences between a dominant network company and the standard monopolist, antitrust advocates seize upon dominance as justification for action. In the case of network companies, dominance is supposedly even more pernicious to competition because of the lock-in effect: Once everyone is using a dominant company's technology or variation of a technology, it is extremely difficult for a rival to get people to switch to its technology, even if it is superior to that of the dominant company. It is not in the interest of any individual to switch unilaterally, even though all would be better off if everyone switched together. Because it is difficult to coordinate the actions of large numbers of people, the dominant company supposedly has enormous market power it can exploit.

The weakness of this lock-in argument should be apparent. If lock-in were a serious problem, it would be hard to explain the numerous examples of new technologies prevailing over existing and widely used technologies that generated large network benefits. Almost everyone listened to AM radio broadcasts not too long ago, and their radios received only AM signals. No one would buy an FM radio because there were no FM signals. No one would broadcast FM signals because no one had FM radios--at least that is the lock-in argument.

The argument could be made to explain why compact discs could not replace vinyl records, and why color television could not replace black-and-white TV. Of course, these replacements did take place, and similar replacement of widely used network products continues to occur. WordStar was the dominant word-processing software in the early 1980s, but that didn't prevent WordPerfect from dominating the market by the early 1990s. WordPerfect has since given way to Word. If network effects create lock-ins, it seems that the locks are rather easy to pick.

The weakness of the lock-in argument is not enough to offset its political attractiveness. It provides a superficially plausible cover for those who benefit from a particular antitrust action against a rival network company, or from a more active antitrust policy in general. Furthermore, even though antitrust action against a network company reduces competition and efficiency, it seems to create benefits at no apparent cost. If a network company is broken up once it has achieved a dominant position, the effect may well be to reduce the price it can charge for its product, though the reduction will probably not be all that great. Nevertheless, even a small price reduction will be seen as an immediate benefit, and one easily attributable to antitrust policy. The cost from such a breakup will be real and significant, surely dwarfing the immediate benefit of lower prices, but this cost is unlikely to be noticed, or attributed to antitrust policy even if it is. The antitrust action will send a signal to other companies that the private payoff to establishing a widely used network is not as high as would otherwise be the case.

In other words, the antitrust action reduces the ability of companies to internalize the network benefits their products create by lowering initial prices to expand networks (allowing consumers to capture some of the benefits) and increasing prices as networks grow larger (allowing the companies to capture some of the benefits). The immediate effect is to cause increased prices on network products in the early stages of use. Opposed to the price reductions on the well-established network product, these price increases will be less noticed since they apply to products not as widely used, and they will not be as obviously connected to the antitrust action that caused them.

Long-run effect

The long-run effect is that fewer new network products will succeed against existing products, since antitrust (in the name of promoting competition) will have reduced the payoff to the type of aggressive competition required to overcome the advantage of the status quo. This can actually benefit the company the antitrust action is directed against, the one that has already established a widely used network, by allowing it (or the collection of its broken-up parts) to maintain its dominant position much longer than otherwise. This long-run cost of less technological progress can be very large, but again it will not likely be traced back to the antitrust action that caused it. For the very reasons technology is increasing the benefits from competition, it is creating the superficial appearance that competition is being reduced, which empowers special interests to justify antitrust action that benefits them at public expense.

Technological advances are making market competition a more potent force for prosperity and progress and undermining any justification there ever was for government to pursue an active antitrust policy. However, technology is also increasing special-interest demands for antitrust action and making the political process more responsive to those demands by increasing the public perception that such action is urgently needed to protect against anticompetitive behavior.

Reductions in the costs of transportation and communication are expanding the size of markets, intensifying competition as businesses must be ever more responsive to consumers who can now buy products with little regard to political divisions or distance. Some businesses can best respond to this competition by merging and/or downsizing their workforces. Yet, mergers are easily depicted as increasing industrial concentration that demands an antitrust response, and downsizing workforces imposes highly visible, though temporary, costs that can turn public opinion against "big business." This creates a political climate that makes it easier for companies buffeted by global competition to excite public sentiment in favor of antitrust action.

Technology is creating major industries in which network effects are important. These industries are characterized by extremely vigorous competition, best described by Schumpeter's discussion of "creative destruction." It is greatly benefiting consumers with powerful new products and services inconceivable just a generation ago. While serving consumers, this competition threatens competitors who have seen, or worry that they will see, their market share plummet as new companies with better products offer consumers more value for their money. Although the reality is more competition, the appearance is less competition as one company serially dominates the supply of important products. This appearance facilitates organized interests that can benefit by using antitrust activity to suppress competition.

This discussion can be interpreted as pessimistic. The technological advances that increase competition and the benefits it creates are fostering political perversity in the form of antitrust litigation that undermines those benefits. Nevertheless, we see reasons for optimism. By increasing the mobility of productive capital, technology is slowly (too slowly), but surely, eroding the power of government to regulate, manipulate, and tax productive activity. Physical capital is becoming smaller and easier to move around, but, more important, capital is increasingly taking the form of knowledge and information that can be transported electronically to almost any place on the globe in a matter of seconds.

This is leading to a form of global competition that governments are trying to suppress, with increasing difficulty, and that is the competition among governments over their tax bases. The government that gets too heavy-handed with burdensome taxation and mindless regulation will find more of its tax base escaping to those parts of the world where the political environment is more conducive to productivity. The concern has long been that the power of government is undermining the productivity of private markets. This remains a legitimate concern, but, increasingly, the productivity of private markets is undermining the power of government. The pernicious political effects of technological advances are being countered to some degree with more propitious effects.

Dwight R. Lee is an adjunct fellow of the Center for the Study of American Business, Washington University in St. Louis (Mo.), and professor of economics, University of Georgia, Athens. Richard B. McKenzie is professor of economics and management, Graduate School of Management, University of California at Irvine.

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