Federal Trade Commission Protecting America's Consumers

DKT/CASE NO.:P951201

TITLE: HEARINGS ON GLOBAL AND INNOVATION-BASED COMPETITION

PLACE: Washington, D.C.

DATE: October 19, 1995

PAGES: 453 through 640

Meeting Before the Commission

C O R R E C T E D C O P Y

JANUARY 10, 1996

Date: October 19, 1995

Docket No.:P951201

FEDERAL TRADE COMMISSION

I N D E X

WITNESS: EXAMINATION

None.

E X H I B I T S
FOR IDENTIFICATION

Commission's:

None.

FEDERAL TRADE COMMISSION

In the Matter of: )

)
) Docket No.: P951201
HEARINGS ON GLOBAL AND )
INNOVATION-BASED COMPETITION )
Thursday,
October 19, 1995
Federal Trade Commission
Sixth and Pennsylvania Avenues
Room 432
Washington, D.C. 20580

The above-entitled matter came on for hearing,
pursuant to notice, at 9:40 a.m.

SPEAKERS:

ROBERT PITOFSKY
Chairman, Federal Trade Commission

ROSCOE B. STAREK, III
Commissioner, Federal Trade Commission

JANET D. STEIGER
Commissioner, Federal Trade Commission

CHRISTINE A. VARNEY
Commissioner, Federal Trade Commission

SUSAN S. DE SANTI
Director, Policy Planning

DEBRA VALENTINE
Deputy Director, Policy Planning

JOHN HILKE
Economist, Bureau of Economics

SPEAKERS (Continued):

RICHARD FRUEHAN
Carnegie-Mellon, Sloan Foundation Steel Study

TERRENCE W. FAULKNER
Kodak

ANTHONY M. SANTOMERO
University of Pennsylvania
Sloan Foundation Financial Services Study

THOMAS R. HOWELL
Dewey Ballantine
Coalition for Open Trade

DONALD I BAKER
Baker & Miller

ROBERT B. BELL
Wiley, Rein & Fielding
Counsel for Kodak

LLOYD CONSTANTINE
Constantine & Partners

MARK LEDDY
Cleary, Gootlieb, Steen & Hamilton

PHILIP B. NELSON
Economists Inc.

P R O C E E D I N G S

CHAIRMAN PITOFSKY: Good morning, everyone.

I would like to get started. Today we are going to continue our look at the changing competitive environment, and we'll be hearing about increasingly integrated global competition and about an economy in which technological information and innovation is changing the way firms operate.

Once again, we are fortunate to have two people who have conducted studies, financed, I guess, in part by the Sloan Foundation, which help us to give a grounding to our theoretical discussions and some real facts about industries.

Professor Fruehan of Carnegie Mellon will be discussing how the U.S. steel industry has responded to intense competition.

Professor Anthony Santomero of the Wharton School will focus on changes in the financial sector where technological information is changing that industry.

We'll also be hearing from Terrence Faulkner of Eastman Kodak who will describe his experience in markets characterized by technology-intensive competition and globalization.

And Tom Howell, who is an attorney, represents the Coalition for Open Trade.

Professor Richard Fruehan has been at Carnegie Mellon since 1980. He organized the Center for Iron and Steelmaking Research, an NSF Industry/University Cooperative Research Center, and is the Director.

The Center currently has 25 industrial company members, including those in the U.S., Europe, and Asia. He is also the Director of the Sloan Steel Industry Competitiveness Study, a $5 million program involving several universities.

He has authored something like 150 books and papers on various subjects in his field.

It's a pleasure to welcome you here, Dr. Fruehan.

MR. FRUEHAN: Thank you very much.

I appreciate this opportunity to take part in these hearings and to discussion the changing nature of competition in the steel industry, the need for new technologies, and whether adjustments to antitrust laws, regulation, and the enforcement of these are required.

More specifically, I will discuss how innovation takes place, the economic drivers for technologies in the form of steelmaking process and products, and how these technologies will be developed and commercialized in the steel industry.

However, before examining technology, it is useful to examine the changes in the steel industry in the past 30 years and how the industry competes in a global economy.

It is interesting to compare the international status of the U.S. steel industry 30 years ago and today. Thirty years ago, the U.S. industry had the image of being a dominant industry with control of world prices; and the U.S. Government was vigilant in insuring the industry strictly adhere to antitrust laws and regulation.

For example, in the early 1960's at the time of the famous confrontation between President Kennedy and the U.S. steel industry, the industry produced over 25 percent of the steel in the world. Today, that figure has dropped dramatically to below 13 percent.

U.S. Steel was the largest steel firm in the world, producing over 30 percent of the steel for the U.S. market. Bethlehem Steel and other U.S. integrated companies were also among the largest steel companies in the world.

By 1993, only U.S. Steel remained on the list of the top 10 steel producers in the world with only half the production of Nippon Steel in Japan, POSCO in Korea, and Usinor Sacilor in France. No U.S. company produces more than 13 percent of the U.S. steel consumption.

Thirty years ago imports were negligible. Today they are about 30 million tons, representing about 25 to 30 percent of total steel consumption. Today the American steel industry is highly fragmented, with no dominant firms. The companies are not large by international standards, and imports play a significant role in determining steel prices.

As a comparison, there are only three domestic auto companies in the United States. Whereas, there are over 20 competitive steel companies and a high level of imports.

The American steel industry's competitiveness eroded in the 1960's, 70's, and early 80's but has since made a remarkable recovery. The industry has increased productivity by nearly 300 percent in the past decade, become the low-cost producer for the U.S. market, and can produce the vast majority of the grades of steel required by the U.S. industry.

Quality has greatly improved, as exemplified by the rejection rates of poor quality steels by a major U.S. automotive company. In the mid 1980's, the rejection rates were 7 to 8 percent. By 1994, they dropped to below 1/2 of 1 percent, even though the quality standards had increased.

This recovery was accomplished in part by closing around 50 million tons per year of inefficient capacity or about 35 percent of the total and concentrating resources with new technologies in the remaining plants.

During the same period, production in other countries with mature economies and overcapacity, their capacity was not significantly reduced. In some cases, in particular Europe, the companies avoided closure by government assistance. In most cases foreign companies maintained production at reasonably high levels by exporting steel and selling it at below the costs of that in their own country.

The significant improvement in the U.S. industry can also be, in part, attributed to intense national and foreign competition. In the U.S., the scrap-based industry, sometimes referred to as "minimills" -- although, they're not very mini any more; one of the new mills is going to produce over 2 million tons of steel -- these new minimills, by using a low-cost technology, relatively inexpensive scrap and more flexible non-union labor has taken away most of the lower quality steel markets and forced the integrated producers to focus on higher quality products and improve their performance.

Foreign produces in the early 1980's could produce steels of better quality than the U.S. producer, forcing the U.S. integrates to improve in order to remain and regain their market share. Therefore, fair competition has been good for the industry. However, as will be discussed, unfair competition in the form of dumped or subsidized steel greatly reduces the industry's ability to compete.

Maintaining relatively high levels of production is critical for steel companies to be profitable so they have the resources to develop and implement new technologies and to insure an adequate return on their investment.

The capital cost of integrated steel production is enormous. Whereas, no new integrated plants have been built in 20 years, estimate of capital range from $1,000 to $1,500 per annual ton of production. If you compare this with other major industries, the rate of return on this kind of investment is very low.

A four million ton per year plant would cost four to six billion dollars. In addition, there are other fixed costs, in particular labor. Therefore, for a company to get adequate return on capital and cover other fixed costs, it must run at or near capacity and have reasonable selling prices.

In general, if a company is running at less than 80 percent capacity, it loses money, while above 90 percent it's making a profit. Therefore, if the U.S. industry loses as much as 10, or even 5 million tons of its market to unfair traded steel, it's loses its ability to be profitable and ability to invest in new technologies.

Steel imports in 1973 to '76 averaged 12 to 14 percent of consumption but increased steadily to 26 percent by 1984. Imports then decreased to about 18 percent for the period of 1988 to 1992, in part due to the VRA's and in part because the industry became more competitive.

In the early 1990's, the U.S. Commerce department found there was a significant amount of subsidized or dumped imports into the U.S. and imposed temporary duties.

Later, the ITC found that there was only damage to the industry in about half of those cases, and many of these duties were removed. Currently, imports represent 25 to 30 percent of steel consumption.

In understanding the global steel market, it must be noted that many former steel companies are controlled or influenced in national or regional policies. In Japan, MITI sets voluntary production guidelines and provides a forum to bring together industry leaders, government officials, bankers, and other interested parties. Issues such as pricing, output, joint research and rationalization are discussed.

In Europe, the EC or EU has played a similar role.

In addition, there's strong evidence of an international steel cartel which includes many of the international companies with the exception of the U.S.

Through a series of bilateral and multinational agreements, quotas are set with regards to steel trade. At first glance, this may not appear to be of great concern since the U.S. is not involved. However, since there is a worldwide overcapacity in steel production, the U.S. becomes the target for excess capacity.

This is particular true during periods of low demand. In order to maintain production at acceptable levels, non-U.S. firms must export steel, and the only outlet is the U.S. They will sell at costs significantly lower than in their own country in order to maintain production levels. As mentioned earlier, the loss of the additional 5 to 10 million tons above the normal imports drastically affects the profitability of U.S. firms.

With this background, I would now like to address innovations in the steel industry. There have only been two truly revolutionary steelmaking technologies in the past 50 years: oxygen steelmaking and continuous casting.

Oxygen steelmaking reduced the time to produce steel from over five hours in the open hearth to 40 minutes, while continuous casting greatly improved yields, quality, and total energy efficiency.

Today in the U.S., all the integrated production uses oxygen steelmaking, and virtually all of the steel is continuously cast. It took about 20 years for these to replace the older technologies, primarily due to high capital costs.

The vast majority of steelmaking innovation has been incremental and revolutionary. However, the cumulative effect has been tremendous.

I would like to give one example, the development of the high-productivity electric arc furnace. In 1970, it took 180 minutes, 600 kilowatts of energy, and 3 hours of labor to produce one ton of steel in an electric arc furnace.

Today, it takes about 55 minutes, 400 kilowatts of energy, and less than one half of a man hour of labor to produce the same ton.

The U.S. has become a leader in efficiency in the electric arc furnace steel production. This was not accomplished by a single technology but rather about a dozen innovations, including ultra-high power furnaces, oxy-fuel burners, water-cooled panels, and secondary refining. Similar, but possibly less dramatic improvements have occurred in other areas, such as the iron blast furnace.

You may ask if the thin slab casting technology is revolutionary. The process has caused a steelmaking revolution, but the process itself was an incremental change in conventional casting. Plants consisting of a high-productivity EAF and a thin slab caster with inline rolling or similar technology greatly reduces the costs of producing the steel and are being built at an astounding rate. Between 1990 and the year 2000, 18 to 20 million tons per year of such capacity will be built in the United States, revolutionizing the steel industry.

Similarly, one may argue that no completely new steels have been developed in the past 20 years, simply modifications of existing grades. However, half of the steel tonnage produced today is of grades that did not exist 20 years ago. You only have to look at your automobile to appreciate this. Steels for the auto markets are more formable, corrosion resistant, and have a much greater strength-to-weight ratio.

Therefore, whereas new technologies and products have been incremental improvements, the cumulative effect has been enormous.

Due to a number of economic drivers, the rate of change in the steel industry is expected to increase dramatically. The industry is going through a technological revolution which will not only change how steel is made but also the structure of the industry.

The U.S. industry, as opposed to the recent past, is a leader in this revolution. The drivers include the need to reduce capital, environmental concerns and costs, potential raw material shortages, in particular for coke and quality scrap, and ever-increasing customer demands.

To satisfy these drivers, the industry must have processes which produce iron directly with coal, processes that recycle waste oxides, and processes to produce scrap substitutes.

In the past 10 years, the U.S. industry has been playing technological "catch up." It, therefore, could rely on purchased technologies developed elsewhere. However, the industry has caught up. It is now a leader and has a unique set of drivers and, therefore, cannot completely rely on purchased technology in the future.

Since technology is playing a major role in structuring the future steel industry, it is useful to benchmark the U.S. steel industry's R&D capabilities. This was done as part of the Sloan Steel Industry Study.

The major U.S. integrated plants, as you can see on this graph, invest, on average, about .5 of 1 percent in R&D, whereas the international competitors -- such as Nippon Steel, POSCO, and Usinor Sacilor -- this figure is more than double.

For each million tons of production, the U.S. group has 10 researchers, while the number for the international group is over 30. The U.S. scrap-based industry, "minimills," have even less R&D and depend almost exclusively on purchased technology, usually from overseas.

Foreign steel companies make use of national and regional problems and government subsidies for research. For example, the EC funds major research programs while MITI plays a similar role in Japan.

For example, the Japanese have a major program to develop an environmentally friendly steelmaking process funded at over $1 billion primarily by the government. They have also spent five times as much on a process similar to the AISI-DOE direct coal-based ironmaking process, for their similar process

Efforts such as our engineering center at Carnegie Mellon University are collaborative but very small and receive no significant government funding.

About 10 key future steelmaking technologies have been identified as part of our Sloan Study. These are shown on this overview. They range from direct ironmaking technologies, through cokemaking, scrap improvement, all the way down to strip casting.

We asked the major companies if these were critical to their future. As you can see, on average, about 75 answered in the affirmative. Then we asked if you have any current program in the development of these technologies. On average, less than 30 percent indicated they did.

What we see is a technology gap between the U.S. and its global competitors. This may be the result of the U.S. industry's ability to simply purchase technology, poor financial performance in the past decade, or to the fragmentation of the industry so that the critical mass for effective R&D does not exist in a single company.

In terms of antitrust laws and enforcement, I believe they should be less restrictive in the areas of research, development and commercialization of new technologies.

The U.S. industry is fragmented; the companies are smaller than their international competitors; and they do not have the technical and financial resources to carry out a major development program alone.

R&D in any industry can be expensive. However, commercialization of new technologies in the steel industry is extremely costly and with considerable risk.

For example a new direct ironmaking facility unit of one million tons would cost over $250 million. No single company can afford to take the risk on such a technology. Such programs must be a major joint venture. And if the major driver is to satisfy government-imposed environmental regulations, partial government funding should be available for the initial commercial units.

No new integrated facility has been built in the U.S. in over 40 years. The cost would be four to six billion dollars. No single company can afford this. If such a plan is required to remain competitive, joint ventures of U.S. companies should be allowed for such purposes.

In fact, mergers of major U.S. companies would not adversely affect competition, because currently the industry is highly fragmented; and imports and scrap-based producers will always supply adequate competition.

Similarly, the merger of scrap-based producers would not hinder competition. Let me give you one example. If National Steel, Inland Steel, and AK -- three of the six major U.S. firms -- were to merge, their total production would be less than POSCO's in Korea, Nippon Steel's in Japan, Usinor Sacilor's in France, and similar to that of British Steel's in Great Britain. Their production would be less than half of the amount of steel that is imported.

With regards to imports, the U.S. Government should carefully examine evidence concerning the international steel cartel that makes the U.S. the dumping ground for steel resulting from the need of foreign companies to maintain high levels of production.

In conclusion, the steel industry and its companies are no longer dominant in the global economy, and the U.S. industry is highly fragmented.

The industry has made a significant comeback in the past decade, spurred in part by national and international competition. In the recent past, the industry has relied on purchased technologies but may not be able to in the future. The industry's R&D capabilities are less than half of its international competitors.

With regards to antitrust laws and regulation, collaborative R&D should not only be allowed but encouraged. Joint commercialization of new technologies must be allowed because of their excessive costs and risks.

Furthermore, major mergers would not affect the highly competitive nature of the industry.

Finally, the government should be sure the U.S. industry is not being injured by unfair cartels which make the U.S. the dumping ground for overcapacity.

Thank you for your attention.

(Pause.)

CHAIRMAN PITOFSKY: Thank you very much.

If we can, let me ask you a couple of questions.

Two striking things about the steel industry. One is it's about as de-concentrated as any major industry that we are likely to look at; but, two, it's made quite a nice comeback. It may not be dominant in the world, but it certainly is profitable and successful.

It sounds to my like the only adverse consequence of de-concentration is creating an efficient scale for R&D. You urged that the antitrust laws be quite permissive about R&D. It would be hard to be any more permissive than we are.

So that leads me to the question: Is there joint R&D going on in the steel industry of which you are aware?

MR. FRUEHAN: Yes, there is joint R&D at several levels. There is a small basic research activity such as ours, but that's quite small.

U.S. Steel and Bethlehem Steel have a joint research exchange agreement where they look at programs together, primarily in the front end of the business.

But when I talk about -- I'm really talking about the major technologies that have to be developed, the ones in which companies are going to have to invest 10 or 20 researchers and tens of millions of dollars. This is where the critical mass doesn't exist for these kinds of activities.

CHAIRMAN PITOFSKY: It does not now exist? There is not that kind of major commitment to joint R&D for new technologies?

MR. FRUEHAN: Well, there was the AISI direct steelmaking project; and there is also the process of looking at advanced process control.

But if you compare these activities to the $1 billion activity that MITI is sponsoring in Japan or if you look at the kinds of group activities that have gone on in the European Community, these are relatively small.

COMMISSIONER VARNEY: But it's not because the U.S. antitrust laws are precluding the U.S. steel companies from undertaking these kind of R&D joint efforts, are they?

MR. FRUEHAN: I don't know the answer to that.

COMMISSIONER VARNEY: Okay.

COMMISSIONER STAREK: I wouldn't think so, because like any industry, they can take advantage of the National Cooperative Research Act of '84 and the '92 amendments, which permits these R&D joint ventures to go forward.

MR. FRUEHAN: May I ask: Where does R&D stop and commercialization begin? Because R&D in the steel industry is expensive, yes. Commercialization is enormous. The step between AISI direct steelmaking unit, where we were spending tens of millions of dollars, becomes hundreds of millions of dollars to go to the next scale.

That, I think, is the critical step.

COMMISSIONER VARNEY: But, again, I really don't know the answers to these, and I have never looked at these before.

But wouldn't it be up to the companies to create a joint venture R&D agreement and then they would delineate where the commercialization takes place and where the R&D might separate out from the commercialization what their interests are in the commercialization and then we would, presumably, take a look at the joint venture agreement, which is predominantly an R&D agreement?

Again, I think I'm in agreement with everything you said. I'm just not sure if there is an antitrust barrier to doing what is the logical next step that needs to get done in the steel industry.

MS. DeSANTI: Let me ask you, maybe it would help if you could talk a little bit about what you mean by commercialization.

Are you talking about, once the R&D has been done for new technologies, then there's a joint venture that builds one plant that then operates according to that new technology and there are sales from that plant?

MR. FRUEHAN: Yes. The big step in the steel industry is building that first unit. Nobody wants to build the first unit. Everybody is in a race to be the second, okay? because there are so many risks involved and there are so many uncertainties when you put together the first such unit.

I'll give you an example of a new technology. It's a not a U.S. technology; it's a European technology. It's the COREX process. It's going to cost something like six or eight hundred million dollars to build the first unit with cogeneration associated with it.

That's an enormous amount of money for a single company to be looking at it with the kind of returns that they are getting. So consequently there hasn't been one built in the United States. Whereas, there has been one built in South Africa; there are several being built in Korea, et cetera.

MS. DeSANTI: And after the production step, would, then, joint sales be necessary?

MR. FRUEHAN: Yes.

Depending on where you are in the process, you are so far from the end product, it doesn't necessarily have to affect the competitiveness of the final product.

COMMISSIONER VARNEY: Presumably, then, where we could evidence more flexibility is on the front end if there were to be a proposed joint venture on R&D that was very open ended as to what was going to happen on the commercialization end of it in terms of our flexibility.

MR. FRUEHAN: I think that's a fair conclusion, yes.

CHAIRMAN PITOFSKY: Other questions?

COMMISSIONER STAREK: Why do you suppose there hasn't been more consolidation in this industry?

As the Chairman pointed out, it's very concentrated and up against large competitors on --

MR. FRUEHAN: There's a variety of reasons. I think that if you look at the development of steel technologies, the oxygen steelmaking technology came in in the 1960's; and continuous casting was not fully implemented for another 10 or 15 years. That meant there was a large surplus of scrap in the United States that led to the development of what people call the "minimill." I prefer to call it the scrap-based electric furnace producer. This began to fragment the industry. That was one step.

The next step is there has not been a major integrated plant built in 40 years. There is no way for the integrated plants to build a whole new plant because that takes $5 billion; and the kinds of returns that they have been getting in the past decades, it's hard to justify that kind of investment.

So the industry has found a way to be economical with a one million ton plant down in the South or Southwest where there are no unions to worry about, lots of scraps, closer to markets; and so that particular plant or that particular company flourishes; and so you have a multitude of these plants being built. And this fragments the industry.

It's not necessarily a bad thing. On the other hand, it reduces the critical mass that's required for major developments; and if you really want to have a major new plant, then you're not going to have the critical mass.

And you're going to say: Well, let's keep on building scrap-based plants. We're going to have a scrap shortage, not necessarily a total scrap shortage; but we're going to have a scrap shortage for the quality that is that's required for these scrap-based producers to go into the higher value-added markets.

So, we can't continually build scrap-based plants because there's something called "the conversation of mass." There's not enough iron units out there to do that. So we're going to need virgin iron units being made either in a blast furnace or COREX or some new technology. And that's going to require a lot of capital.

COMMISSIONER STAREK: Just one last question. If there is strong evidence that there's an international cartel operating that is excluding the U.S. companies, why don't our companies sue?

MR. FRUEHAN: I think we have an expert on the panel who knows a lot more than I do about this, and I'll leave any comments to him if that's okay.

I'm a lot of things. A lawyer, I am not.

MS. DeSANTI: I want to go back to the R&D issue and just clarify for a little bit more about where I think the antitrust intersection is.

Under the recent amendments to the National Cooperative Research and Production Act, it's clear that companies could form a joint venture, file a notification that would give them single damages rather than treble damages for any suit that was brought. But the antitrust leniency has not extended into the joint selling of the product, which is part of what I'm asking about with regard to sales.

What are other factors other than antitrust, however, that may be impediments to these types of joint ventures forming?

What sorts of business factors may be operating to deter companies from forming these joint ventures?

MR. FRUEHAN: My experience has been -- and I'm talking about front-end developments only -- is that companies make independent decisions on where they are going to go.

Let me give you one example. Bethlehem Steel made an independent decision to upgrade all of its cokemaking facilities and spend several hundred millions of dollars. Their enthusiasm for a coal-based direct steelmaking process became less intense. Whereas, maybe some of the other companies had an interest in such development.

So decisions are made by individual companies that may affect whether they want to see these kind of joint developments going forward. It may, in fact, negatively impact their competitiveness in the short run.

MS. DeSANTI: I see. So they can have different short-run incentives that would conflict with what may be an overall long-run incentive for the industry.

MR. FRUEHAN: That is correct. And it comes back to, you know, do we have a national economic program, et cetera, et cetera, for the long-term. But we have individual companies making individual decisions that are the best for them at that time.

MS. DeSANTI: I would also like to follow up, we have been hearing some in other industries about collaboration with customers that's ongoing that's facilitating R&D.

Is any of that occurring in the steel industry?

MR. FRUEHAN: Yes, there's quite a bit of that going on in the steel industry. I think the best examples of this are the cooperative agreements with the automotive manufactures and things of that sort. We're looking and trying to develop lower-weight materials for the automotive market, more corrosive-resistant materials.

I think those could be improved, but they have certainly gone a long way in the steel industry to get more involved with the customer. And I don't know if you would say it was necessarily big, joint R&D developments; but certainly there is a lot more cooperation in defining goals and what has to be done.

MS. DeSANTI: But, again, that's not the type of collaboration that would get us to the new technology; is that correct?

MR. FRUEHAN: No. My major concern is the front-end of steelmaking. Before you get down to the competitive product, where if you want to build a new blast furnace, we are talking a half billion dollars if we are going to build a state of the art blast furnace. And this is where the problem is. Or if we're going to develop this new direct ironmaking process or a scrap substitute process.

MS. DeSANTI: Just to change the subject a little, to what extent is geographic location near the customers important in sales of steel?

MR. FRUEHAN: In some markets, it's quite important and others it's not. I personally believe geographic concern is not necessarily as important as some people think. I mean you can't be out in Utah and produce something for somebody in Maine; but you don't have to be right next door either.

I think in locating plants more important concerns are what kind of labor laws there are, what's the scrap supply, what is the general transportation system. Because to produce a ton of steel, you have to transport into your plant over two and a half tons of material; and you only send out one ton of material. So in some senses, if you are thinking about transportation it's more important to be closer to the source of the raw materials.

MS. DeSANTI: And my final question is: Could you expand a little bit on the difference between how the U.S. steel industry went through its adjustment when its competitive position was declining versus how that occurred in Europe, what you think the costs and benefits were of the two different processes?

MR. FRUEHAN: Yeah, I would be glad to.

By the way, that was a major part of our Sloan Study; and we have several working papers on that. So if want to fax me or something, I will see that you get those.

But we made several trips to Europe and, more recently, to Japan. It was done in the United States much faster, and it was a much more painful readjustment. But in the long-term, it was probably more efficient.

In Europe, they are still haggling over the shutting down of plants and redistributing production. And they actually just recently gave up; they swept it under the rug because they could afford to do that because we are in a steel boom right now and there isn't this great need to shut down capacity.

But once the steel industry goes through one of its valleys again, that's going to be a major issue in Europe, this capacity reduction.

But they have been trying to do it by planning, and government subsidies have always kept inefficient plants running in Europe. Whereas, in the U.S., the only thing that has kept some of them is bankruptcy laws. But in the U.S., it was much more painful, much more sudden, and probably more efficient.

CHAIRMAN PITOFSKY: Thank you.

We move now from steel to an entirely different segment of the economy and that's financial services.

Dr. Anthony Santomero is the Richard K. Mellon Professor of Finance and Director of the Wharton Financial Institution Center at The Wharton School at the University of Pennsylvania.

He is a leading author on financial institution risk management and banking structure and a recognized consultant to major banks and regulatory agencies in the U.S., Europe, and the Far East.

As a leading consultant, he has advised the Federal Reserve Board of Governors, the FDIC, and the General Accounting Office on a wide range of issues relating to capital regulation and structural reform.

Dr. Santomero.

MR. SANTOMERO: Well, it is a pleasure being here. And it is a different industry, and it will be a different presentation as well.

What I will try to do is talk a little bit about what's going on in the financial sector that is driving the change in the banking industry; talk a little bit about what we've been investigating in connection with those changes; and then try to step back a little bit and sort of say, all right, what are the lessons as they relate to the FTC's interests that we are coming up with, rather indirectly, I may add. Only because of our Center's focus being more on the microeconomic issues of managing the individual institutions.

The first thing I would point out is that the banking industry is going through a dramatic change, as we see if we just pick up the newspaper yesterday and saw the most recent contested merger offer.

When we look at things like that, the first things we tend to do, as academicians, is sit back and sort of say, let's try to understand what this industry does for a living and figure out how its industrial structure follows from its drivers, namely the features of the industry that are essential.

From our, perspective come down to saying that the banking industry basically does only three things for the economy. They are three rather important things, but they come down to basically three things.

The first is it provides the necessary financial resources for real sector investment in the economy. And in that regard, it has many competitors in the direct capital market and other substitute industries.

Secondly, it provides savers a vehicle for investment that is increasingly important as the baby boomers get older and as savings through this vehicle seem to be declining in fact.

And, third, the industry basically deals with the risk between these two players. I'm trying to build a very large steel plant at the time when I want a demand deposit that I can write a check on tomorrow morning is somewhat problematic, and the firm is left in the middle of dealing with savers on one hand that want liquidity and low risk and investment opportunities that are higher risk and, indeed, much longer term.

From that perspective, the banking industry has its roots and, if you will, makes loans and takes deposits. Over the last 30 years -- and it's about that long -- the industry, however, has been undergoing substantial change. The best way to summarize the change is a decline in market share, and one can question whether or not that has been a decline in the industry itself or a decline in the industry's position vis-a-vis the overall financial community.

We provide you, in the handout that I provided for these hearings, a series of tables that illustrates the decline in its position.

Starting off first with Table 1, which is a banking share in the total financial sector, funding from 1952 to about 1994, and using the Flow of Funds data of the Board of Governors, you'll notice that the market share of the banking industry has declined from roughly 50 percent to roughly 25 over that period of consideration.

Now, most of us recognize that and have little pieces of what's going on and think about, for example, as a phenomenon associated with money market funds, taking deposits out of the banking industry.

The adjoining tables argue, however, that it's much more broad based than that. Indeed, if you look at the lending activity of the industry, you will notice the commercial and industrial loans have been declining over that same period of time while finance company loans have been expanding rather dramatically, and commercial paper has continued to be important.

On the commercial side, you can make the case that primary borrowers are, in fact, not using the banks to any appreciable extent these days, going directly to the market, rather than through the banking industry.

On the other side of their balance sheet, looking at their deposit base, Table 3 illustrates that bank time and savings deposits have been declining rather consistently over the same period of time relative to fixed income mutual funds.

And, indeed, if you move to Table 5, their transaction balances have dropped rather dramatically relative to money market mutual funds, something that at least I know from personal experience and I'm sure some of you do as well.

Now, you might step back and say: What's driving the changes in this industry? One answer, in some sense the superficial one, is, well, competitors have taken market share. But let's try to figure out what's driving the volatility in the industry itself.

And if you look over this period of time, we kind of center on four things that are driving the changes in the industry.

The first is that the economic environment that the industry experienced over the last half century has been an economic environment that has not been very congenial for a banking industry that's supposed to make long-term loans with regulated prices on their liability side.

We have had unstable financial environments; we've had global competition; we've had an expansion of inflation into double digits and then down to low levels.

As a result of that, the industry's original charts and original design didn't fit very well with the macroeconomic environment in which we were operating our financial community and, indeed, the industrial community as well.

Second, there has been competitive pressure on this industry. But the competitive pressure on the industry has come in different ways.

We usually think of competition, or at least I usually think of competition from the point of view of new entrants in the marketplace; and, clearly, there has been new entry into this place, both in terms of non-banks into banking-type products and in foreign banks into the American banking market in various ways.

But, in addition, we have had competition because customers are getting smarter; therefore, isolated markets have been disappearing to a greater extent than, perhaps, people, years ago, thought it would.

And in addition, financial innovation has changed the very nature of the products and the ability to compete. The example I like thinking of in that regard is the mortgage market, a mortgage which, when I grew up, was something a bank gave and held because they had no choice suddenly gets put together in computer technology and sold off in 47 different ways to 25 different players.

The third area that's important to understand the changes in this market is the technological change that has taken place.

Telecommunications and computer technology have had an enormous affect on this industry. In many respects you can argue that actually the industry is being dragged into this revolution as opposed to leading it.

And what has happened, first of all, is technology has changed the cost of remote access to the customer and has changed the nature of the market itself.

Second, computer technology has made products possible that were not possible before. For example, again the mortgage example, we could not have diced and chopped up mortgages the way we did if we were doing it by hand.

I guess it was about in 1970, the Federal Reserve Bank of Atlanta actually did a study in which they suggested that every white collar working in the United States would be clearing checks if the technology didn't change. And while the technology did change, now we are dicing and chopping and passing all over the place.

Finally, our whole notion of regulation has changed, and that's caused changes in the industry. Regulation used to be, when I was a graduate student, centered around the issue of competition on one hand, safety and soundness on the other; and that was usually a prescription for, more or less, status quo definitions of markets and products.

Over time, however, there has been an urge towards more efficiency; there has been an urge towards satisfying the saver rather than protecting the bank from a competitive market for its deposit base.

The net result is there has been a willingness to consider changes in markets, everything from geography to product definition, that has caused the industry to change.

As a result of that, the industry is functioning in an environment in the 1990's and in the year 2000 that's going to be quite different than the industry -- that I remember when I grew up in the banking area.

We concentrate on it by saying that what that means is, the impact of all these changes is the industry has to be much more attuned to, number one, managing its profit. It could no longer depend upon the regulatory notion of a fair rate of return in its environment; and, therefore, has to think about profit drivers and competitive positions and products that make money and products that lose money.

And, secondly, it has to manage its risk much more carefully. It has to manage its risk much more carefully, first of all, because the world is a more dangerous place; and, second of all, the cushions in that world are, by the nature of this competition change, a lot softer. And as a result, we have to worry about it.

In that context, the financial service industry study that has been conducted under the Sloan grant has tried to examine what's going on in the industry from the point of view of the main drivers of these two things; namely, profitability analysis and risk analysis.

We have done so by having four major research projects. And what we tend to do is we build a research project around a team of faculty that spend about a year or two sounding out whether or not this is something that's important, not only can we do it or do we want to do it, but rather, is it a main driver of the performance of the industry; and then, after a while, figuring out whether we can do it and then rolling it out.

In that process, we have rolled out four major projects in the study. The first one I have listed in my discussion is risk management, which I myself am responsible for most directly; but it was, in fact, the second major project we embarked.

The first one was on the study of productivity and efficiency in the industry, worrying about the managing of profit, if you will.

The way we thought about it was the use of capital and labor in the industry and what was driving its change and how effective was the industry in analyzing it.

The second piece, which is the first project in your list, is the risk management area. And there, we decided that the second major problem with the industry was managing risk. How do you manage risk for an organization that is as complex as the banking industry firms that we're talking about here?

Managing risk is pretty easy if you're managing the risk of a particular instrument or a particular trade. Or at least finance knows how to approach that problem and, to a first approximation, can do it well. It doesn't mean they do do it well. It means they can do it well.

The big challenge for the industry is: How do you manage a very large organization of 100 or $200 billion portfolio? And how do you capture what, indeed, you have in your portfolio and what the risks are distributed throughout the organization?

So risk management became a second major focus of the industry study.

The third area we are ramping up on are competitive structures of markets: What's the right structure for a financial service industry? What's the right structure in terms of product array for the banking industry? Is the German style of universal banking better or less good? Is the Japanese, the keiretsu structure, better or less good? Interestingly enough, when we started this project, you would have had one answer on that second question. Right now, there's quite a different answer. And trying to analyze what's really going on with these structures is why universities exist, I guess.

The fourth project, which we are just starting to roll out, is a study of the mutual fund industry, as an industry. Most of the time, when we study mutual funds, we study performance and rank performance. And there's an endless series of performance analyses and rankings out there. But what we were going to be starting on is a study of the industry itself as a member of the financial service community so we understand what's really going on behind the mutual funds and the money market mutual fund competitors.

Now, what are we getting so far by way of results?

Well, if I can turn to page 5 of my remarks, I'll spend a little bit of time -- and only that -- on some of the results we're getting in terms of risk management.

The way we think about risk management for the financial service sector is that the financial service sector is, indeed, in the middle of the financial flows of the economy.

The environment that I just described before is effectively changing the environment in which the institution is functioning. That results in a series of financial risks that the firm has to deal with and manage. And we have captured that in the diagram as the usual definitions of market risk, credit risk, counterparty risk, operational risk, a whole series of other risks like legal, regulatory, environmental risks.

And what we have been doing is spending our time on the question of, okay, given the flow of a financial transaction -- and for the major firms, you have to keep in mind a firm of $100 billion in asset size is not uncommon in the first tier, that means their capital will flow through the bank at about $100 billion a day. So the total balance sheet and the flows have to be kept in sync. It's not like most other organizations where a balance sheet isn't really the flow through.

In that kind of environment, what we have been investigating is, all right, with this kind of flow through, how do you manage your risks? What risks should be managed? What kind of organizational structures are best suitable to handling these risks?

And, interestingly enough, what you see is the industry is evolving to answer these questions. One way of describing some of the financial innovations that have taken place in the financial sector is that these financial innovations are ways of transferring risk rather than taking risk.

The simplest example I can offer you in the financial service industry is the pension fund area, where years ago a pension fund was guaranteed by the pension fund provider, and now we have the difference between defined benefit and defined payment plans.

What's happening is risk is being shifted. And that is happening throughout the financial sector. And what we have been investigating is: Should risk be absorbed by the industry? When should it be transferred? If it is being absorbed by the industry, what are the best systems set up to deal with these risks?

Now, there has been a lot of discussion recently about disasters in the risk-taking industry, most recently things like Barings and Daiwa. But the truth of the matter is, those aren't the kinds of things that trouble the industry most. Those are control problems. Those are control problems associated with the inability of the system to function and keep tabs on who is taking the risks.

The more complicated problems of the industry to get its hand around is: How do you measure the risks that are present in the industry? How do you know what your risk is?

Because, indeed, if you look at the business cycle exposure in terms of exposures to risk, over the last 20 years enormous volumes of losses have taken place on credit risks. How do you measure credit risk? How do you measure the quality of the portfolio? How do you measure your loss expectations in the portfolio? That's a major concern.

Interest rate risk: How do you measure it in your total position? And how do you deal with it?

So our study in risk management is centering on managerial needs to understand the risk in an environment that is changing.

The second area that I want to spend a little time on and talk about our results is in the are of market performance productivity and efficiency.

I mentioned to you when we started the projects, what we generally did is we got together with the industry and said: Look, is this an important issue?

And one of the things we did very early in the project was we concentrated on the question of process in the industry; and we sent out a team to six different banks that were relatively homogeneous -- and by that I mean, about the same size, about the same geographic franchise -- and we asked them very simple questions like: How do you open up a checking account? The answer was, anywhere from 6 to 45 different computer screens and anywhere from 10 to 50 minutes. We figured, well, there is a lot of heterogeneity here. This is probably something we should worry about.

We, therefore, spent a good deal of time trying to map the process and to analyze the differences in process. The second area we spent a good deal of time on is the use of technology.

Number one, how do you decide to make a technological investment? And, number two, how are you using the technology capability that is presently on the table?

Our results there have been quite substantial. Indeed, our total sample in terms of a very large survey of process and expenditures is 70 percent of the entire retail deposit base of the United States. That's our sample. Needless to say, we have got a lot of data pointing.

What we are finding is that there is, indeed, a large amount of heterogeneity in terms of process in the industry. That's number one.

Number two, technology is a major feature. Technological expense is a major feature of the industry; yet, the use of technology is pretty primitive at this point. And what I mean by that is, number one, the decision to invest in technology is usually not grounded in the kind of rigor that one would expect or hope. It is usually in terms of a strategic advantage. And you say: Well, what does that mean? Well, we have to do it. Well, have you looked at the numbers as to whether or not it's advisable to do it? And the answer is: Well, yeah, we cooked up the numbers, so it's advisable to do it.

Number two, technological functionality is far greater than the actual use. That is to say, if we actually spent no money on technology over the next, I would say, three years and actually taught people how to use the function that they have, we could dramatically increase the technology of the industry.

Number three, we looked at how we are using people. And here again is a wide array of results. And we tried to correlate the results to actual outcomes. And what we seem to be finding -- and this is a tentative result -- is that there are basically two models that are relatively efficient in this industry: One model of no empowerment, which might be described as a mass production model; and the second one of tailored products. This is, after all, a service industry where the service providers and the service users are intertwined in a very special way.

And as a result, to the extent that you can provide personalized tailored services and charge for those services, that's an effective product array.

But what we find is anything in the middle doesn't work. You can't give people a little power or even quite a lot of power. You either have to allow them to control the process, or you have to take away all freedom of control, because the two extremes are the only ones that are efficient; and the industry is slowly evolving along those lines.

Human resource practices are an issue in the industry for a number of reasons. The first of which is the example I just gave you: How you use them for effective production. The second is that employment levels are quite high in the industry, and employment levels are declining in the industry because of an over-banking phenomenon which is taken as given.

Now, with this set of results, what can we say? Or to put it more broadly, if we look at this in the context of all of the work we have been doing in the financial sector, what does it have to say about the nature of the financial sector that is relevant to the way the FTC thinks about questions of the market?

I offer you a few observations. The first is, one of the things that we have found to be clear is that the banking industry doesn't exist. There is something called the financial service industry. And that the differences across the banking industry are probably larger than the differences across competitors in any particular product array.

In that regard, we want to think about the state of the industry from the point of the state of the financial sector rather than the state of any particular set of banks.

Who are the players? Well, the players change according to what product you're talking about, what geography you're talking about, and what level of product. There is an international banking market. There is a national banking market. There is a local banking market. There is a market for credit cards. There's a market for C&I loans. The net result is competitors vary.

And when you start talking about individuals and you sort of say, who is your competitor to, let us say, the bank, the usual answer is, for what? And where? And the answers, therefore, change in a kind of overlapping of markets and competitors. And that's an important thing to keep aware of.

A number of years ago, I served as a visiting scholar to the Federal Reserve. At that time, we used to spend a lot of our time defining markets by hills and valleys and rivers and mountains for Pennsylvania in the third district. There are no hills and valleys in the telecommunications system. There are no hills and valleys in the mailbox. And for many products, that's really what the competitive environment is.

We end by saying: There are really no simple answers to this. And part of the reason is the market is still in transition; the industry is still in transition, as evidenced by the continued consolidation not only in the banking market but also starting to occur in the mutual fund market and has occurred in the investment banking market. This is an industry that is very much in transition.

And the net result is, players change, market shares changes, rather dramatically; and as long as you don't depend upon lifetime employment, it's a fairly dynamic place to work.

Thank you.

(Pause.)

CHAIRMAN PITOFSKY: Thank you.

I wonder if you would say a little more about the international market. Which are the products that, today or in the next five years or ten years, are likely to be described as in international market?

If someone wants to borrow a billion dollars to build a new steel mill, is that an international market transaction today?

MR. SANTOMERO: Yes.

I guess the way I think about it is, in fact, this notion of clusters of transactions in a three-tiered market, the first tier being kind of the international capital market. And in that international capital market, you have the whole set of players internationally in both bonds and direct lending and syndication.

The second, the national marketplace -- and rather obviously, you know, some firms will be in both or move from one to the next. But there is a national credits market, for example. The number of transactions are uniquely national just because of the laws that regulate those transactions and the need for physical identification, like clearing systems.

And the third, local markets. And local markets themselves used to be, quite literally, towns but are, increasingly, regions these days with competition within a region being the dominant kind of competition rather then the very local market area.

CHAIRMAN PITOFSKY: Thank you.

One other question. And it's sort of a soft question, but it's one that we hear a lot. It has to do with this waive of mergers among very large banks.

And the issue is this: What are the efficiencies that are driving this waive of mergers?

As has been alleged at times, is the only efficiency sort of laying off people?

When you get two big banks coming together, I mean, are there new products? Are there better products? Or is it just a question of just reducing the labor force?

MR. SANTOMERO: I think this is an enormously important issue, not only for you as a Commission but in general for the market.

Let me try to put together a few pieces in answering that.

The first piece is: What do we know about efficiencies of delivery in the banking marketplace?

There are the following pieces of data -- and these data seem to be worldwide phenomenon, not just American -- economies of scale and scope beyond a very small size don't seem to be very important.

Variations of efficiency, independent of size, seem to be much greater than any economies merely by size.

And no matter where you run that test, that seems to be true. So one way of describing the efficiencies that are alleged to take place associated with merger activities is a more efficient provider of services taking over a less efficient provider of services, not just economies of scale in the delivery of service.

So that's the first thing. And I think the unfortunate part about it, it's kind of like a poker game where everyone thinks they're the winning, most efficient firm; except there are some very clear incidents of wide variation of efficiency for the same size.

The second point I would like to make, which is a different point, has to do with the merger waive itself. And then I'll try to put them all together.

The merger waive, to my mind -- there are two things to keep in mind. One of the things that is happening in this most recent merger waive is that the presumption of over-banked American market is being addressed. Mergers are an exit strategy for many CEO's and many banks.

Second, there are two kinds of mergers that are taking place that are changing the shape of the market place. One is an in-market merger that works directly at the local competitive marketplace and reduces the capacity there. And symptomatic of that would be the Chemical/Chase merger, for example. And you can say the Welds/First Interstate proposal. All right?

The second is an expansion of geography associated with building a large regional network. And by "regions," we're now talking about very large regions. An example there would be First Union and First Fidelity being an obviously, most recent example.

Now, those are totally different animals in terms of why it's being done and how it's being done. They have lots in common. You've got the need to integrate and to bring systems up to speed and to have the organization function as one organization, which frequently takes place in two phases. First of all, everybody merges as equals until one is less equal than the other. So you kind of go through this putting together the organization and then integrating the organization at a later phase.

Now, in the in-market mergers, it's quite clear that the goal of these in-market mergers is to reduce the number of outlets and, therefore, employment and branches, because there are enormous inefficiencies in the present system.

In most of the markets where that has taken place up to this point, it has been markets that are highly contested markets, highly competitive markets; so the fact that there are only three corners of a main intersection with banks rather than four doesn't really bother us very much.

Now, could you follow that to a point where you did worry? Presumably, yes. But that's not what's been happening at this point.

Now, how do you bring new products as a result of this new merger?

Well, there's some capability when you start talking about creating a massive presence. For example, a First Union a First Fidelity where you expand your geographic flow and you build up some expertise which is unique to one organization and bring it to the second organization, you can tell a story that says we have broadened out the product line.

But, indeed, most of the product line broadening doesn't take place through mergers. It takes place either by growing or acquiring other capabilities. The most immediate example that we have seen over the last several years has been the expansion of investment product availability to bank customers through the -- either creation or the purchase of mutual fund capability by the banking industry. And the contested market at the moment happens to be insurance and annuities.

But that's not directly from the mergers but rather from bringing new products through this marketplace. The rationale there is the bankers view themselves as having an array of customers in a geographic franchise; and, therefore, wish to push more products into the set so that their customers don't have to deal with multiple vendors for their financial services.

That's the way we would say it. They'd say they could cross-sell their product array to their existing customers groups.

And, of course, not everybody can do that, because if I had a broker, a savings bank, a commercial bank, and a mutual fund and if they were all trying to sell me all the products, somebody is going to lose in that process. All right? And probably not one of these will get all of the product array, but there's going to be less activity in that regard.

CHAIRMAN PITOFSKY: Very helpful.

Christine?

COMMISSIONER VARNEY: If you had to vote today between German, Japanese, and U.S. styles of competitive markets -- if you did have to vote today -- it sounded as if you were evolving in your evaluation of which of these may be best -- from your competitive perspective of managing risk and improving profit, which one would you go with?

And are our businesses moving more towards German-like styles?

MR. SANTOMERO: Let me just make a couple of comments before I vote.

The nature of these financial sectors are subtly more different than at first appear. Originally, when you start thinking about this question, you think about the German universal bank model as a model where banks are allowed to do a wide array of things, as are investment banks are allowed to do a wide array of things. So it's a levelling of the playing field -- in the terminology that you no doubt have heard quite a lot about -- in terms of product array.

In that regard, I think there is a general consensus of the studies and also in our group that expanding the product array makes sense for the reasons we have been talking about.

There's another set of things that we have been investigating more recently which has to do with the whole nature of corporate governance associated with a German-style universal model. Who controls what as opposed to what products are being offered by whom. And that's a more complicated question, and that's the one we're still in the midst of, first of all, trying to understand.

So that second one, I don't want to vote on.

The first one, however, it seems to be the case that we have concluded -- something that I myself had written about a number of years ago, and maybe that's why we concluded it, I don't know -- and that is that the arbitrary divisions that may have once made sense of geography and product and maturity no longer make sense as a way of thinking about the financial service product array.

CHAIRMAN PITOFSKY: Very good.

Let's take a very brief break. We will resume at five to 11:00.

(Whereupon, a recess was taken from 10:47 a.m. to 11:00 a.m.)

CHAIRMAN PITOFSKY: We ought to resume.

Our third speaker this morning is Terrence Faulkner, Director of Strategic Planning and Vice President of Eastman Kodak.

Previously he was Director of Technology Planning and Imaging and was Assistant to the Director of Research.

Before that, his positions included Laboratory Head of Technical Intelligence and Assistant to the Director of the Photographic Technology Division.

Mr. Faulkner.

MR. FAULKNER: Thank you.

For 150 years, the photography industry has been based on the manufacture of sensitized silver halide materials. That technological basis now in the process of changing, and I will address some of the implications of that technology substitution later in my remarks.

But for clarity, we should first focus on the silver halide manufacturers. The photographic products that they manufacture include the familiar color negative film used by consumers, the colored papers that are used prints, x-ray films, motion picture films, graphics arts films, and a range of other related products. The current set of silver halide manufacturers includes: Kodak, Fuji, Agfa, Konica, DuPont, 3M, Polaroid, International Paper in the form of its subsidiaries Ilford and Anitec, and Mitsubishi.

The first four companies that I listed account for over 80 percent of industry revenues worldwide. And all nine, account for well over 95 percent. Every major participant in this industry must compete on a worldwide basis in order to succeed. And all nine of the companies that I listed do sell their products in the United States.

Global competition has intensified as the rate of growth, and the silver halide business has begun to slow. And it's not surprising that when Eastman Kodak sought to vacate consent decrees originally entered in 1921 and 1954, both the District Court and the Court of Appeals found that the relevant geographic market for amateur color film did include the United States, Western Europe, and Japan.

Now, looking at the technology aspect to this, Kodak invested $860 million in 1994 in research and development, or about 6.3 percent of revenues. And we will spend even more on R&D in 1995. We have consistently ranked in the top 10 companies in the United States in terms of the number of patents awarded.

Our competitors also invest heavily in R&D. Fuji, for example, has been in the list of the top 10 companies receiving U.S. patents for six of the last seven years.

There is a continuing strong competition to achieve the highest levels of product performance. But silver halide technology is now more than 150 years old, and product performance improvements are increasingly expensive to obtain.

Yet, the innovation that we have can, generally, be characterized as incremental in character. One consequence of this increasingly expensive R&D is that the new advanced photographic system, or APS, that will be introduced next year was jointly developed by five companies. Kodak and Fuji were joined by three camera manufacturers. Another reason for that cooperation was the need to have a worldwide standard for the new format.

Even with the sharing of development costs, all of the manufacturers of APS products will need to compete on a global basis in order to achieve a reasonable return on their substantial investments. In past decades, Kodak could drive a new standard by itself; but that is no longer possible.

Silver halide-based photography has already been replaced by electronic imaging in some applications. Electronic news gathering replaced 16 millimeter film in the television market. Later, video cameras and magnetic tape replaced the Super 8 movie cameras and film used for home movies in the consumer market. This technology substitution will continue on an application-by-application basis.

Now it's important to understand that there is not always a sharp boundary between silver halide and digital imaging. Hybrid products, such as Kodak's Photo CD, do exist. And a Photo CD contains digitized images scanned from traditional silver halide film, and this provides a bridge between silver halide and digital imaging.

But I should also note that several of the silver halide manufacturers have developed digital imaging products. Besides Kodak, these include Fuji, Agfa, and Konica.

Like all technology substitutions, this substitution of digital technology for silver halide enables new entrants. Consumer electronic companies, such as Sony, Matshushita, and Sharp, face very low entry barriers. And the same is true, to a lesser degree, of companies in the computer industry such as Apple and Microsoft.

The new digital video motion cameras that have been introduced by Sony, JVC, and Matshushita over the last two months do all contain a still picture function. A very small extension of their electronic products line enables them to offer consumers a color print that's much like the ones obtained from a traditional silver halide camera.

In digital imaging, information and images are much the same thing. Digital technology is enabling the convergence of imaging information and communications. In the vernacular of our times, "bits are bits."

This is dissolving old industry boundaries, and we must now accept the existence of an emerging imaging industry that is much larger than that defined by the nine silver halide manufacturers I mentioned earlier.

Kodak, I believe, is better positioned than any other U.S. company to become a leader in digital imaging. We have invested more than $3 billion in electronical imaging R&D over the last 15 years. But there is no guarantee that we will succeed. Large additional investments in the development of products, channels, and markets will be required to build a successful, value-generating digital imaging business.

The Japanese consumer electronics companies, in particular, have a strong position that can easily be extended into digital imaging. If Kodak fails, then it is likely that the new digital imaging industry will be centered overseas.

Now, to fully appreciate the situation that Kodak and at other silver halide manufacturers face, we must also consider the industry consolidation that is now under way. There are several forces that are driving the consolidation in the silver halide industry, and I've already described the substitution of digital electronics technology for silver halide chemistry.

That limits growth within silver halide, and this, coupled with excess industry capacity, increases price-based competition. The more marginal manufacturers then begin to drop out.

Another force driving industry consolidation is increasing customer power. In the consumer market, a few major customers like WalMart account for an increasingly large percentage of all film sales. These large retailers demand the lowest possible price from the manufacturers, who are competing with one another for scarce shelf space.

And then they often use film as a loss leader to attract consumers into their stores. Smaller retailers then also press for these lower prices.

In the health care market, group purchasing organizations come together to negotiate multi-year contracts for large volumes of x-ray films. Product performance does matter, but price is increasingly the determining factor in who gets the contract. This can lead to a winner takes all outcome where the winners are the companies with the best technologies and the lowest manufacturing cost.

And in silver halide manufacturing, cost is very much a function of scale. Increased scale is an important tool for reducing manufacturing costs, and these reductions are essential since, in some categories, sensitized goods prices are declining at rates in excess of 5 percent per year.

Industry consolidation is taking several forms among the silver halide manufacturers. Some small companies such as Orwo and Oriental, have declared bankruptcy. Some large companies are divesting entire divisions. For example, DuPont is in the process of divesting its Medical Imaging division or they are exiting product lines. Agfa has exited motion picture color negative film. DuPont has exited industrial x-ray film.

Now, as you consider changes to U.S. antitrust policy, the first point that I would make is that markets must be defined globally. That is certainty true in the photographic industry, and I believe that it is increasingly true in many other industries as well.

A second point is that market definition needs to be more forward looking. The rate at which technology is driving change does seem to continually increase. Technology substitution inevitably drives changes in industry boundaries. Kodak saw this emergence of electronic imaging coming more than 15 years ago and did begin to shift its R&D spending accordingly. Just as manufacturers do, government policymakers must also anticipate these kinds of changes when they define market boundaries.

In the case of the photographic industry, we must recognize not only an existing global silver halide industry but also an emerging imaging industry that includes both silver halide and digital electronics companies. And, again, I'm sure that similar trends are occurring in other industries.

The third point that I would make is that antitrust enforces need to be more receptive to allowing U.S. companies to actively participate in an industry consolidation in those cases where that process is occurring. U.S. companies must have the same freedom that foreign companies have to acquire a weak competitor, either in whole or in part; and that could be in the form of a product line, physical assets, other assets, such as intellectual properties or brands.

This is especially critical in industries where there are large fixed costs and manufacturing scale is necessary for survival.

Whatever the letter of Japanese antitrust regulation may be, I have no doubt that the Japanese Government will not stand in the way of a Japanese photographic company when it wants to acquire a competitor.

If a Japanese company can combine the advantage of manufacturing scale with the advantage of a protected home market, then the resultant lack of a level playing field will greatly disadvantage Kodak in the global market. And if Kodak's core silver halide business becomes significantly less profitable, then we will not have the sustained cash flows that we need to fund a successful transition to digital imaging.

This leads into a fourth point. Where foreign competition policy conflicts with U.S. policy in a way that hampers U.S. companies, the U.S. antitrust agencies need to be more active in pushing for open markets and enlightened competition policy.

Finally, I want to thank you for the opportunity to describe the current situation in the photographic industry and to suggest what some of the implications of that situation might be for the revision of antitrust policy.

(Pause.)

CHAIRMAN PITOFSKY: Thank you very much.

Let me ask you the recurring question of these hearings -- and put aside the two consent orders which are unusual and, of course, restrain Kodak in a special way -- are you aware of actual transactions, mergers, joint ventures, licenses, patent arrangements, that American antitrust law prevented Kodak from consummating and especially those where Fuji probably could have gone ahead and done the very same thing under their system?

MR. FAULKNER: Yeah. The current situation, Mr. Chairman, is one more of a dampening effect.

Let's take the case of DuPont which has announced that it wishes to divest its medical imaging division. Naturally, Kodak, obviously, looked at that. And one of the first things external counsel told us is that there was a 100 percent probability that this would be questioned and went on about all of the vast amount of paperwork that we were going to have to generate in order to proceed with that. That had a dampening effect.

Now, there are other factors, of course, that we considered as well. And at this point in time, there hasn't been an actual case where that has occurred, where the blockage has occurred.

My own view is that we are in the early accelerating phase of this industry consolidation, and I expect that there will be, over the next -- whether it's next year or the year after, but at some point in the foreseeable future, an occasion where it will be in Kodak's strategic interests to move forward and consider an acquisition.

And, therefore, what I'm worried about here more is anticipation of a problem than the past existence of a problem.

CHAIRMAN PITOFSKY: Other questions?

Debra.

MS. VALENTINE: You mentioned at one point that, although product attributes mattered, essentially competition -- I think this was in the context of an x-ray product of yours -- was really taking place on the basis of price.

And one of the things that we are hearing at times is that in technology-driven industries, in fact, people do care about product attributes.

Are you finding, generally, that with all of your products, no matter how simple or complicated they are, that at the end of the day, price is really what matters?

MR. FAULKNER: You would have to say it varies appreciably from one product category to another.

Price matters more in a product like color paper where, first of all, you're selling essentially to the trade; and the trade may very well regard color papers as being very similar in their product performance.

For a product like color neg film that is purchased directly by the consumer, performance does matter more. For some especially high-tech products within the medical imaging mammography film, performance will matter more. But, again, over on the graphics film side, there will be categories where price matters more.

So it will be really quite a range of situations across the product categories. But what has changed, what is different, as a function of time, is that price has become increasingly important. It may not, today, be the dominant factor for every category.

MS. VALENTINE: Thank you.

CHAIRMAN PITOFSKY: Susan?

MS. DeSANTI: I have a question. You've talked some about antitrust making market definition more forward looking; and it's certainly one of the issues that has confronted the Commission -- most recently, say, for example, in the Lilly-PCS transaction -- there is an industry that clearly is in transition, analogous to the way you're talking about silver halide going to digital imaging.

And one of the issues that's come up is the sort of process issue of: How would companies react if the Commission were to say: "All right. We are going to limit our reaction to this particular transaction but we're going to keep it under continuing scrutiny."

How would -- and I'd be interested in your views on your company's reaction to that. And, in addition, how would you react if there were a provision for a conditional approval that said: Well, the Commission would condition its approval of the transaction going forward depending on whether certain factors happen in the future, as it looks at the moment like will happen, but where none of us are completely certain actually will?

And that could be entry by others into the market or other kinds of factors.

MR. FAULKNER: I understand, I think, the theory of that. I'm not quite sure how it would work out in practice.

If you gave conditional approval, is your implication, then, that at some later point, several years later, you might ask for it to be broken apart?

MS. DeSANTI: Yes. And that's part of the distinction I'm making between continuing scrutiny which might be, okay, but then later on the Commission has to come in and show that, in fact, things have not worked out as was anticipated, versus conditional approval whereby, you know, "Okay. It didn't work out," we know that it's going to be broken up in some way.

MR. FAULKNER: Yeah. Well, obviously, a continued scrutiny would be preferable to having been blocked in the first place. But I think it would depend on the particular situation.

In some cases, irreversible change might have occurred. Some older manufacturing facilities might have been taken out of production so there -- I can foresee practical problems that might arise. But I have no problem with the theory that you describe. I would just be concerned about what are the practical difficulties that it would encounter.

MS. DeSANTI: Beyond the scrambling of assets or shutting down of assets, are there other practical problems you can imagine?

MR. FAULKNER: In some parts of the industry, of course, relationships are very important. For example, that's true in the motion picture industry, the sale of motion picture films.

Obviously, a change of control would probably permanently change the nature of those kinds of relationships. "Permanently" is probably too strong a word. But it would substantially change them.

CHAIRMAN PITOFSKY: Good. Thank you very much.

Our final speaker this morning is Thomas Howell, a partner at the law firm of Dewey Ballantine. His practice focuses on antitrust, trade regulation, and competition matters. And he represents several corporations in complex antitrust cases.

Currently, Mr. Howell represents Eastman Kodak concerning Japanese market barriers in the consumer photographic film and paper market. He is also counsel of six major U.S. producers of flat-rolled stool products and anti-dumping and countervailing duty actions against foreign producers and represents U.S. firms in disputes with Japan involving semiconductors, soda ash, and telecommunications.

It's a pleasure to welcome you here.

MR. HOWELL: Thank you, Mr. Chairman. I appreciate the opportunity to speak today.

I'm appearing on behalf of the Coalition for Open Trade, or COT, which is a group of U.S. manufacturers and labor unions, which was established to address the problems presented for U.S. competitiveness by private anti-competitive practices abroad.

You've asked us to address the question of when location matters for businesses; and I have attempted to frame the same question a little bit differently to ask: What are the implications for U.S. industries of the dramatic imbalances in the level of national antitrust enforcement in an environment in which competition is increasingly global?

To put it more simply, is a firm based in the United States at a competitive disadvantage internationally relative to a firm based in Europe or Japan simply because of differences in antitrust enforcement and policy?

I would submit to begin with that an imbalance in national antitrust regimes exists between the industrialized countries, and it's dramatic.

The U.S. stands at one pole with the most rigorous enforcement, and Japan is at the other pole. The EU, Canada, Scandinavia, and others fall somewhere in between.

A few statistics highlight just how far apart the poles are. Between 1982 and 1992, the United States handed down 879 criminal convictions for antitrust violations. In the same period, Japan recorded 2 for violations of the Anti-monopoly Law.

During the same period, there were over 8,000 civil antitrust actions brought in U.S. courts; and during the same period in Japan, there were 15. And, thus far, no action has ever succeeded.

Looking behind those figures, one finds patters of institutional behavior and underlying values that differ fundamentally among the industrialized countries.

Here, the Federal Trade Commission and the Antitrust Division have a relatively simple mandate to enforce the laws vigorously -- and they do -- against the anti-competitive business practices. They function, in effect, a lot like law enforcement agencies in other areas.

By contrast, in Japan and the EU and elsewhere antitrust agencies weight the needs of antitrust enforcement against an array of other policy concerns. In some cases, they actually use cartels and other anti-competitive groupings as proactive instruments of industrial policy. And there are many, many examples of this in the last 20 years in both Japan and the EU.

In many other cases -- and probably cases that are of more concern to our association -- anti-competitive groupings are I tacitly other even overtly tolerated by government authorities.

In Japan, enforcement has become so weak that trade associations publish information about horizontal and vertical price discussions in their newsletters among their members.

In one recent case -- I have set forth in my written submission -- an association executive even boasted in the press how he helped to fix prices and then sent the JFTC investigator scurrying away by browbeating them verbally.

The fact that one doesn't read stores like this in the Washington Post simply underscores the dramatic differences that exist between countries in this area, reflecting divergent national traditions that have evolved since the early years of this century out of the early period of industrialization.

Here, the big business "trusts" that grew up after the Civil war gave rise to a popular movement, the "Antitrust" movement that's eventually been enshrined in the antitrust laws in institutions like this one. It's become, as Franklin Roosevelt said, as American as the constitution itself, the antitrust laws. This movement built on earlier traditions of common law hostility toward monopolies that go way back in our history.

Elsewhere, traditions which were much different arose. In Imperial Germany, cartel agreements were enforceable in the courts, and an entire industrial culture grew up based on industrial solidarity and the mitigation of competition in its more extreme forms.

And that also has roots in Germany going back to the Middle Ages.

The body of German economic scholarship arose which held that cartels were a superior form of business organizations to the laissez-faire model favored by England and later carried over to the United States.

The German scholars concluded that cartels operating from behind closed markets ensured higher levels of investment and research and development than could occur in open and competitive markets. This view is disparaged, of course, universally by Anglo-American economists; but it reflects attitudes that are widely held abroad and are actually put in practice above.

The German ideas of industrial organization proved very compelling in Japan after visits by study teams to Germany, notably a 1931 visit by prime minister of Japan.

Japan adopted legislation in the '30s that made possible the creation of cartels on an industry-by-industry basis which greatly enhanced the size and power of the Zaibatsu, which were the forerunner of the Keiretsu that we now confront today. Many of Japan's contemporary industrial groups, including Fuji, trace their lineage to this period of early industrial consolidation.

These national cartels were rapidly projected into the international arena so that by the beginning of World War II, by one estimate, over two-thirds of all the goods that moved in international trade were regulated by these private groups, international cartels.

World War II interrupted this process. The United States ended up occupying both Japan and Germany.

We broke up the cartels in Zaibatsu in the late 40's. An anti-monopoly law was imposed on Japan. And a Fair Trade Commission, patterned on this Commission, was set up.

In Germany, cartels and Konzerne or the industrial groups were taken apart by the occupation authorities. We didn't impose, but strongly influenced, arm twisted the German Bundestag to enact anti-cartel legislation in the early '50s; and an anti-cartel agency, the Bundeskartellant, was established.

We advanced a proposal for an International Trade Organization designed to eliminate not only government barriers to trade but private restraints of trade.

It failed in the latter effort. The proposals were incorporated in the Havana Charter in the late '40s, but they were never adopted.

The Justice Department, in the late '40s, brought a series of consent decree actions against the international cartels essentially designed to force American companies out. The assumption was that if the Americans were the biggest companies in various industries -- which they were at that time -- the big cartels would fall apart; and they did when the Americans pulled out. And we saw a new era really of highly competitive behavior in the international markets.

Our antitrust ideas did not win universal acceptance but they gained many adherents in Europe and in Japan.

The influence of our doctrine has receded since the zenith in this period of the late '40s and early '50s. As the Cold War came on, we began to halt our drive against the Konzerne and the Zaibatsu. These groups in both countries began to reconstitute themselves, quietly at first but, ultimately, quite openly.

We saw a dramatic example of this last year when a paper group in Japan was broken up in the late '40s has been re-established in 1994 through a series of mergers and consolidations. And they're back where they were in the '40s before the occupation began.

Anti-cartel legislation was weakly enforced in both countries. And I would say in Germany as well as Japan this was the case. And they were undermined by amendments and bureaucratic hostility from ministries friendly to industry.

In Japan, the Fair Trade Commission generally ignored widespread anti-competitive activity -- and there are dramatic examples of this that have come to light in the Kodak case that has taken place -- across a broad spectrum of Japanese industries; and when, generally, when it's taken action, it's been very weak by our standards.

International cartels re-formed much more quietly then they did before the War, but they are back in business again.

Our own efforts to establish international institutions that would ensure a liberal trading order was successful in terms of government restraints on trade. We have seen a liberalization as a result of the GATT and successive rounds of multi-lateral trade negotiations that have brought government barriers down dramatically.

However, there was never a comparable organization governing restrictive private practices; and as a result, this area is totally unregulated by international discipline.

What's evolved since the War is an imbalance in competition policy. Competition rules you find everywhere. You find them in all the industrialized countries and they are very strictly enforced in one country. This one. It's very spotty elsewhere, which permits a good deal of anti-competitive activity to flourish, not always with impunity.

And there are cartels that are regularly broken up by the European authorities, in particular, DG-IV. But it is still spotty even in the European Union under an activist antitrust commissioner.

In general, the United States has shown less interest in delving into such matters in other countries. The Clinton administration has indicated it's going to devote more attention to restrictive practices abroad. But, in general, our emphasis has been much less.

In the rare cases when we do act, a hue and cry is raised of "U.S. unilateralism, attempts to impose our values on other countries. I am sure that you are aware that every time there's even a hint that U.S. antitrust laws will be enforced, extraterritorially there is a problem, an international problem, a diplomatic problem with other countries.

The result, a modus vivendi has evolved in which we don't meddle too much with these kinds of practices in other countries.

Now what does that mean for U.S. businesses? I would submit that it should be regarded as an unsatisfactory state of affairs. And there are several reasons for that.

First of all, restrictive practices abroad foreclose U.S. participation in foreign markets. That's a problem not only because we lose revenues from foregone exports but because a protected cartelized market serves as a form of subsidy, a profit sanctuary, if you will, which can be used to finance an aggressive R&D and sales strategy all over the world.

Also, in high-tech, a protected market contributes to learning economies. As accumulative volume of output increases, costs are reduced dramatically and can give a protected producer a cost advantage all over the world.

Closed markets and cartels foster dumping in world markets. We have seen examples of this in steel, televisions, semiconductors, consumer photographic paper, telecommunications equipment. In some cases we have seen dumping literally destroy an entire U.S. industry. The most dramatic case was televisions.

Over the long run, the imbalance in competition policy affects the location of industry itself. People don't want to invest in a free-fire zone where dumping is endemic. And one does not see investment taking place there.

Conversely, investments flow towards cartelized markets where economic rents and diminished market risk makes such investments attractive. That phenomenon was recognized by the German economists earlier in this century. We see this phenomenon in the steel industry where as you see there is difficulty in investing in R&D and new plants in this market. In part, a banker who is asked to fund an investment like that will say: Where is my return going to come from?

In some cases, during the recent past, I would say particularly the early '80s, the answer would have been: There will be no return and possible you will lose your original investment as well.

Whereas, in other countries, those kinds of risks were not present. And that was reflected ultimately in the rate of investment and ultimately in the location of industries. You find that the industries -- you find overcapacity in Japan and the EU and, essentially, not enough capacity here to supply our own domestic demands.

Now, a number of factors inhibit effective U.S. problems posed by the imbalance in antitrust enforcement between national markets.

I've identified several here. First, what I call an information problem. We don't know enough about what's going on abroad any more. The burden has fallen on the private sector to do this. We do it sporadically, and the information is very spotty and I guess what an economist would call anecdotal. Our resources are limited. We don't have subpoena power and other resources available to the government.

That leads to a second problem, because there's not enough information, which is a thinking problem. We have, basically, a very theoretical approach to a lot of these issues. It's a widely held view, for example, that has been expressed by an Assistant Attorney General for Antitrust that cartels are inefficient. If our foreign competitors want to form them, then we should go ahead and let them, because they're only hurting themselves.

That theory is a good theory; it's just not consistent with commercial reality. And, as a result, you can see commercial outcomes that reflect flawed thinking on the part of our policymakers.

Third, we have an institutional problem. We have a trade policy apparatus that concerns itself with objectionable foreign government actions that injury U.S. producers. It avoids injurious private conduct with the exception of the anti-dumping remedy.

We have an antitrust policy apparatus that concerns itself with private foreign actions which hurt U.S. consumers. It avoids situations where foreign governments are involved. And it doesn't, generally, concern itself with injury to U.S. producers. The exception there I think is the export foreclosure cases in which we have seen relatively few.

The kind of anti-competitive activity which concerns COT's members -- which is anti-competitive private foreign conduct that hurts U.S. producers -- falls in the cracks between these two institutional structures.

As a practical matter, what U.S. industries have got left to work with institutionally as a remedy is the anti-dumping law. The antitrust remedies have not worked well for U.S. industries who have tried to use them in the international arena. In fact, I'd go so far as to say they just don't work, period, in most cases. I would be very hesitant to propose to a general counsel of one of our clients an antitrust case in most cases as a remedy for the problems they're facing abroad. It's the equivalent of proposing a land war in Asia with the likelihood of similar outcome.

The anti-dumping laws are an important tool, but they're imperfect. Criticism, in fact, of the anti-dumping laws, I think, in part, reflects the fact they've been asked to do too much, to bridge too wide of an institutional gap. They are being used in a variety of situations where the imposition of anti-dumping duties simply is not enough to deal with a very complex international competitive problem.

I'd note that this agency, the Commission, has been known to intervene in anti-dumping actions to impose the imposition of anti-dumping duties which places it in the anomalous role of, in effect, the proponent of anti-competitive combinations abroad.

Now, this is little bit of a -- I'm still sore about this. In one episode about 10 years ago, the Japanese 64 KD ram producers were involved in an anti-dumping action -- this was 1986 -- and the Commission intervened at the International Trade Commission. And they submitted a study that showed that, essentially, the Japanese 64 KD ram industry was a highly competitive industry, that is they were a model of atomistic competition.

The economist who prepared that report did not speak Japanese, had never been to Japan and, as far as I was concerned, didn't know much about what was going on over there.

In fact, had this person read Sankei and Nihon Keizai Shimbun and the other Japanese mainline papers at the time, this person would have learned that those producers were in a production cartel, they were jointly restraining output with the purpose of maintaining higher stable prices. And this was all being reported publicly in Japan.

I cannot imagine what the Japanese must have thought hearing this expert testimony about how their industry was functioning.

That's just an example of the problems I've already mentioned.

The final problem is a growing tendency to prescribe multi-lateral legal rules as a way of resolving these problems. That's a good idea as long as there is a consensus on what the problems are.

I think here, there's a basic difficulty in that we want to discipline these practices. Our trading partners want to discipline us, that is our attempts to regulate or reach out at those practices. And we're coming at the problem from opposite directions. And I see very little hope of a reasonable system of new multi-lateral rules evolving over the near term.

The question, then, arises what the Commission can do under current law or reasonably foreseeable modifications of the law. Really, that's a difficult question. We haven't got the answers to that all together. I think it's commendable that you are making this effort now to sort of take a fresh look at this issue. And COT is going to think about it some more as well.

I will say that the Commission could begin to help address the information deficit. One of the best, I think, studies of this problem that's ever been done was done here in 1916. It was called "Report on Cooperation in America's Export Trade," and it was a comprehensive study drawn from all over the world that is still a classic; and it's an excellent piece of work; and it was an empirical study of the problem in the real world. The Commission can still do that. It's an investigatory agency, and I think it would be a great contribution.

There's maybe a role for expanded Commission activities in export foreclosure cases. That may involve modifications of existing laws.

And one could look, for example, at the anti-dumping law as a way of looking at the mechanisms that have been applied there to obtain information, which is one of the most difficult issues in these kinds of cases. There are ways to do this.

The Commission might consider some of the mechanisms that are used now by the Commerce Department in those kinds of cases.

There is always, I think, a benefit in considering the international context when evaluating a merger. Without getting into that in much depth, I think that in many cases, looking at the milieu in which a U.S. industry is operating internationally is important, considering a merger analysis. And I'm not sure that it's always done.

Finally, I think the idea of a broader dialogue is a good one among the various parts of the government. We had a discussion in the United States in the '30s during the New Deal about the problem of industrial organization.

It was not so much a discussion of the international or global competition as how should industries be organized and how strict should the anti-competitive rules be. We began at one pole in the early '30s with the National Recovery Act, where we essentially had industry cartels or codes of conduct that included price and output regulation.

We ended up at the end of the decade with reinforced Antitrust Division and stronger enforcement, which is ultimately where we have come out at the end of it.

I think the discussion was a very interesting discussion that we had. We had a lot of people coming from all parts of the country to debate this. And I think at the end of it, what emerged was a national consensus and a system that was so good that it's, as President Roosevelt said, become almost as American as the constitution.

I think a debate that embraces a number of agencies and a number of different constituencies on this issue, this issue of global antitrust policy, is a very good idea. And I commend you for taking what I believe to be the first step in this direction.

Thank you.

(Pause.)

CHAIRMAN PITOFSKY: Thank you for the broad review of these issues.

Let me raise this question. It is true that there is a dramatic imbalance between antitrust here and antitrust in other countries, and we are not about to abandon our anti-cartel policy no matter what the Japanese do.

And, of course, in many parts of the world, they are getting somewhat more active in enforcing their law against cartels.

But I gather what you're saying is that, maybe if we enforce our antitrust laws more vigorously when American producers are injured abroad that might be of some assistance.

We are pretty vigorous when American consumers are injured by foreign companies but not when American producers are.

Would you qualify that to say that, at least in the first round, we ought to choose instances where the practices that injure American producers abroad are illegal abroad?

Because there is this great imbalance; and our law is so different from their law, if we start enforcing our law without taking into account the imbalance, then, of course, we get accused of imperialism and that sort of thing.

MR. HOWELL: I think the answer is, yes.

For one thing, the laws are pretty good abroad. Most of the kind of conduct that COT members are concerned about is illegal.

The conduct that Kodak is complaining about is illegal in Japan. And you get away from this whole issue of imposing our values on someone else, all we're saying is -- you could even go so far as to take the way the law is interpreted in those countries, which Kodak has done, and said: All right. How does at the Fair Trade Commission -- how do they apply their own law to this kind of practice according to their only publications and so on? And encourage them to apply the law that way.

That is not an act of imperialism. That's simply saying: You ought to be doing what you say you're doing.

CHAIRMAN PITOFSKY: It's a positive comity notion that at least, first step, we ask them to enforce their law; and then if they don't, we consider what we ought to do.

MR. HOWELL: Yeah. Or if you believe that, in this case, the enforcement efforts would be futile because of the way the agency has conducted itself, then you have to go to the next step.

But I think, yes, you could take care of a lot of this problem simply by securing enforcement of existing law. A lot of this problem would go away.

CHAIRMAN PITOFSKY: Now, I wonder if you would say a little more about the information deficit, the extent to which transparency would be a collateral approach that could help open up markets and so forth?

Are there some examples of that that you have in mind?

MR. HOWELL: Well, in these activities, cartels don't thrive very well under publicity. Japan is an exception, I guess, because this stuff is reported in the papers and nobody seems to care.

You shed light on these activities, though, and they tend to -- people become angry. Customers that are paying higher prices then they think they should be. In fact, it happened in this country at the turn of the century when people began to see what the trusts were costing consumers, how the dumping was giving foreign consumers a better deal than Americans were getting. The result was outrage.

And you actually saw this in Japan last year when the high prices of photo finishing paper came to light as a result of a U.S. anti-dumping action. That became news in Japan, and people began to ask: Why are we paying these ridiculous prices?

So I think getting the information and then getting it out, without anything more, just nothing else, that will help to solve the problem. A few salutary enforcement actions, of course, help to dramatize it, put it in the public eye.

You will find that when the trusts were broken up here, the Antitrust Division didn't go after every industry. They went after a few of them; and they essentially set a public example of a few, and the rest, the culture changed. I think that could be done. There is a role for antitrust enforcement, as Roosevelt used the presidency as a pulpit. You hold up some examples and you say this is terrible; it's not good for anybody in other countries; and it ought to change.

CHAIRMAN PITOFSKY: Thank you.

Other questions?

MS. VALENTINE: Actually, on the "sunshine as disinfectant" theory, I think that Mike Scherer also has thought about this idea of publishing information about cartels. Now, he suggests it's more at a multi-lateral level, that all cartels register, provide information; if they don't, that one investigates.

Are you suggesting that any multi-lateral efforts are less likely to be successful than national ones? Or do you see any use for a multi-lateral approach to just getting information out about cartels?

And, obviously, that would go over time, I think, to reaching a consensus about whether --

MR. HOWELL: The kind of thing you are describing is exactly where the international effort could be useful, because it doesn't require a consensus or value judgments about various kinds of behavior.

We're not saying: Let's have international rules that ban rationalization groups or some other kind of activity that people in Sweden might think is reasonable.

All we're saying is we want you to register and tell us what you're doing. That's certainly a very appropriate role for the OECD or some other multi-lateral body to undertake.

COMMISSIONER STAREK: Do you think that the increased information sharing amongst national competition authorities will help alleviate some of the problems that you have articulated?

MR. HOWELL: I'll tell you some of my concerns.

One is, for example, when our information is given over by our side to Japan, there have been problems in the past with information leaking to expose sources, et cetera, so that the result is, there is an inhibition on our ability or willingness to share information with the U.S. Government. There's a concern that it will be shared, in turn, and then the sources will be breached.

There's also the concern about what we're getting back on the other side. For example, when all this stuff in Japan is occurring and reported in the paper about very blatant, what we would call "per se" violations of the antitrust laws, and yet nothing is reported to our Department of Justice pursuant to these agreements by the JFTC, the question is: What is the value of an agreement like that?

Now, can it be made to work? Sure.

Is it working now? I would question whether it is very well.

COMMISSIONER STAREK: Thank you.

CHAIRMAN PITOFSKY: Well, thank you, all, very much for an exceptionally interesting morning. And we will resume at 1:30 this afternoon.

(Whereupon, at 12:00 p.m., the hearing was recessed, to reconvene this same day at 1:30 p.m.)

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A F T E R N O O N S E S S I O N

1:30 p.m.

COMMISSIONER STEIGER: Okay. The Chairman is delivering remarks outside of the city. He will be here when he gets here.

It is my pleasant duty to thank you on his behalf, on behalf of my colleagues and the wonderful group putting the hearings together.

We know that we have an astonishing array of talent who has given us some time this afternoon. We are extremely grateful and trust we will make this as painless as possible for you. But there's never been anything painless for you guys at the federal level.

The topic is: "Market Definition, Market Power and Entry in Light of Global Competition."

Phil Nelson is a distinguished economist, Principal, Senior Vice President, and Senior Economist at Economists Incorporated.

He's doubly distinguished because he's an FTC alum. This gives him almost a deified status in the place. He served here as economic adviser to Commissioner Calvani, Assistant Director for Competition Analysis and Deputy Assistant Director for Economic Evidence.

His PhD is from Yale, as at least are two other degrees. And he is a member of the American Economic Association and a referee of prestigious journals too many to mention.

With that, we're most anxious to hear what you have to say. Would you start off for us.

MR. NELSON: Okay. I'm glad to be here.

When I was preparing my oral remarks -- there are some written remarks that are available, and I'll give a shortened version of it -- but when I was preparing the oral remarks, I was reminded of a story that a lot of economists know; and since a lot of you are attorneys in the audience, I thought I would share it with you.

The story involves a group consisting of a lawyer, a doctor, and engineer, and an economist debating what profession is God. And so the lawyer, as usual, starts it off and says: God must have been a great lawyer because who, but a great lawyer, could have written the 10 Commandments?

And then the doctor chimes in and says: No, no, no. Long before the 10 Commandments, God created Eve out of Adam's rib. Who, but a great doctor, could have done that?

The engineer jumps in and says: Nah, but long before that, God created the heavens and earth out of chaos. Who, but a great engineer, could have done that?

The economist speaks and says: And who do you think created the chaos?

COMMISSIONER STEIGER: Well done.

MR. NELSON: And so I started thinking about that in terms of this because there is a lot of debate and argument about: If you see some imports, you know, should you include foreign competitors in the market? And to what extent should you include them? And I was wondering whether there really was a lot of disagreement out there.

And the second contribution I thought I might make is to provide at least some overview of the economic analysis that is out there that might address that question.

And so the first thing I did was I sent out a survey to a large number of lawyers, actually 176 lawyers, who are active and practicing before the Federal Trade Commission, the Department of Justice. I got the names, both from an Americ