TITLE: HEARINGS ON GLOBAL AND INNOVATION-BASED COMPETITION
PLACE: Washington, D.C.
DATE: November 14, 1995
PAGES: 1943 through 2139
C O R R E C T E D C O P Y
January 12, 1996
Meeting Before the Commission
Date: November 14, 1995
FEDERAL TRADE COMMISSION
I N D E X
E X H I B I T S
FEDERAL TRADE COMMISSION
In the Matter of: )
) Docket No.: P951201
HEARINGS ON GLOBAL AND )
INNOVATION-BASED COMPETITION )
November 14, 1995
Federal Trade Commission
Sixth and Pennsylvania Avenues
Washington, D.C. 20580
The above-entitled matter came on for hearing,
pursuant to notice, at 9:30 a.m.
Chairman, Federal Trade Commission
JANET D. STEIGER
Commissioner, Federal Trade Commission
ROSCOE B. STAREK III
Commissioner, Federal Trade Commission
CHRISTINE A. VARNEY
Commissioner, Federal Trade Commission
SUSAN S. DE SANTI
Director, Policy Planning
Deputy Director, Policy Planning
LAURA A. WILKINSON
Deputy Assistant Director, Merger I Division
Bureau of Competition
THOMAS R. IOSSO
Economist, Bureau of Economics
RICHARD J. GILBERT
Professor, University of California, Berkeley
Morgan, Lewis & Bockius
ROBERT H. LANDE
Professor, University of Baltimore
Jones, Day, Reavis & Pogue
Assistant Attorney General, Florida
Professor, Northeastern University
Professor, MIT, for Kodak
Jones, Day, Reavis & Pogue
Professor, Brooklyn Law School
P R O C E E D I N G S
COMMISSIONER STAREK: Good morning. We're ready to start. All of our witnesses have arrived in sufficient time to get off to a good start, even in lieu of the rather dramatic, poor weather.
This is the 12th day of our hearings on global competition, and we have assembled this morning four distinguished witnesses to talk to us about two things.
Our first two witnesses will continue the dialogue that we have had in previous sessions on efficiencies and how we should weigh efficiencies in the analysis that we do with regard to mergers or other transactions.
And our second two witnesses will talk about efficiencies as well as analysis in a particular industry, one that we have concentrated on before and where we've had some very interesting testimony from previous witnesses; and that's the hospital industry.
Our first witness this morning is Robert Lande who is a Professor at the University of Baltimore School of Law where he teaches antitrust, law, and economics, and throws in torts for good measure. He's been a member of that law school's faculty since 1987.
Before that he was an associate at Jones, Davis, Reavis, & Pogue, where he specialized, of course, in antitrust law.
And between 1978 to 1984, Bob worked in the Planning Office of the Bureau of Competition here at the Federal Trade Commission.
Professor Lande has published extensively on a variety of antitrust issues, and we look forward to your testimony this morning.
Thank you for coming.
MR. LANDE: Thank you. Thank you very much, Commissioner. I'm honored to be here. I really appreciate it.
I'm delivering this on behalf of myself and my co-author, Alan Fisher. The title of our talk is Efficiency Considerations in Merger Enforcement. And we're trying to address the issue of what should society do to get efficiencies from merger cases?
Basically, we believe that a case-by-case efficiencies defense is unwise and unworkable for a large number of reasons that I'll go into, including in particular -- the sad record of predictability of whether efficiencies will arise in particular cases.
We instead recommend implicit incorporation of efficiencies into merger enforcement by, ceteris paribus, raising the numerical thresholds in the Merger Guidelines.
Let me explain.
First the legislative mandate. I think Congress cared much more about price than efficiency. If you read the legislative debates of either the Cellar-Kefauver Act, the Clayton Act, the FTC Act, the Sherman Act there is a common thread; and that thread is Congress didn't want price to consumers to go up on account of a merger or other anti-competitive activity.
Proponents of antitrust legislation would say: If we don't pass the law, prices to consumers might go up.
Opponents of antitrust legislation would say: Nonsense. Price to consumers won't go up even if we don't pass this legislation.
No one really had in mind the Williamsonian trade-off of higher prices but that would be justified on the basis of net efficiency.
Well, does a price standard for merger enforcement mean that efficiencies are not relevant? Well, hardly.
To the extent that costs go down, everything else being equal, price will also go down or price will not rise, even if market power increases on account of a merger. So efficiencies are relevant in that they can hold prices down.
Okay. Now the question comes: How much of a cost savings is required to prevent prices from going up even if there is an increase in market power?
Now it degenerates into the wonderful world of economics, and it depends on all kinds of assumptions. If you're in an oligopoly setting, somewhere between 0 and 9 percent efficiency would be necessary to prevent prices from going up.
If you think, however, that there could be a merger to a monopoly or a merger to collusion, then you might need much higher cost savings to prevent price to consumers from rising, 10, 20, 30, even a 50 percent cost savings could be required under plausible behavioral scenarios to prevent prices to consumers from increasing.
Now, these amounts, these cost savings are much greater than would be required under the Williamsonian trade-off. That is, many people who argue we should let prices to consumers rise if there's a net efficiency would say that an efficiency in the 2 to 5 percent range would be sufficient to offset the inefficiency from higher price.
We're not sure about those precise figures; but, regardless, we think that Congress wanted a price standard, that is prices to consumers were not supposed to rise on account of a merger.
Well, regardless of whether you use a price standard or an efficiency standard, we believe that a case-by-case analysis of efficiencies is unwise and unworkable for a number of reasons.
Mergers often generate efficiencies. Everybody agrees on that. There's no doubt about that. But mergers -- it is notoriously difficult to predict in advance whether a particular merger is likely to generate efficiencies.
Efficiencies tend to be in the eye of the beholder. Let me contrast with you first an internal Federal Trade Commission study from the mid 1980s of approximately a four-year period.
The Commission looked at every merger that was above-Guidelines, above the numerical guidelines level and tried to see whether at least one bureau believed that this merger was likely to lead to significant efficiencies.
This internal FTC study found that 23 percent of above-Guideline mergers were predicted by one bureau or the other at the Commission to be likely to result in significant efficiencies.
Let me contrast that with the experience of Douglas Ginsberg when he was the head of the Antitrust Division. He said he never saw even one merger where he predicted in advance that it was likely to lead to significant efficiencies. Efficiencies are unpredictable and in the eye of the beholder.
The case-by-case analysis of efficiencies gives rise to staggering complications. I have written some of them in my outline, others in articles that reference in my work.
Judge Bork, in referring to the complications that would arise from a case-by-case efficiencies trade-off, said that it would take the resources of the Ford Foundation to do it correctly. And I believe Judge Bork was right. It's extraordinarily difficult to do it right on a case-by-case basis.
Furthermore, if you really are interested in furthering consumer welfare via merger, what about the affect of the merge on quality, on variety, on innovation? Wouldn't you also have to take those into account? And those, I think, are even harder to predict than cost savings from a merger. This analysis would, of course, have to be done under great time pressure, very, very expensive to do.
For all of these reasons, we think that a case-by-case efficiencies defense is unwise.
What about a conditional efficiencies defense?
That is, what about allowing the merger to go forward and then after some period of time, such as three years or some other period of time, then reevaluating the merger?
Well, this could have possible advantages in that it could yield some additional efficiencies for mergers; it could give companies an incentive to seek out efficiency-creating mergers.
I would add another personal advantage from this kind of analysis, that it could double the consulting and legal fees for someone like myself. That is, we would be trying merger cases twice. We would try them once when the merger is being consummated, and then we'd try them again three or four years later; and someone like myself could earn additional money from this kind of procedure.
You, of course, are interested in social policy, not my welfare. So your opinion as to whether this goes as a plus or minus might differ from mine, of course.
Disadvantages of a conditional merger efficiency defense.
My basic problem is that of history. History suggests that a conditional defense simply will not work. Once a merger has been consummated, it tends to stay consummated. Recall what happened pre-Hart-Scott-Rodino. Recall the days of the midnight merger. A firm would merge at midnight, they would scramble the eggs by the morning, and then dare a federal judge to unscramble it after even a day or a week or so. And you want a judge to have the guts to unscramble a merger after three years? I'm just afraid it's just not going to be done.
One of the main reasons why Hart-Scott-Rodino was passed was to stop mergers from being consummated because Congress knew that once a merger is consummated, it is almost certainly going to stay consummated.
This is especially true after three years. The firms would have scrambled the assets, made one company out of two companies. It's just very unlikely a judge would have the guts to split it into two companies.
Furthermore, the record pre-Hart-Scott-Rodino of divestiture was not a good one at all. But even when a divestiture was ordered in a merger case, the divested entity was a shell of its former self. The acquiring company would milk it of trade secrets, of customers lists, of marketing strategy, of key personnels. And what it would divest would frequently not be a viable entity.
I believe that the Canadian experience in this way might also be instructive. Canada does have a conditional approval procedure for its own merger enforcement.
According to public records, they have conditionally approved more than 50 mergers in Canada. And according to public sources, they have not unwound even one of those 50. Again, once a merger is consummated, unless there is something extraordinary going on, it's not going to be unwound.
Other reasons to question the wisdom of a conditional efficiency defense. If a firm knows that its merger might be unwound after three years, it might be reluctant to share key strategy decisions, key marketing information, make the necessary long-term capital investments. In short, the possibility that the merger might be unwound after three years, could prevent the realization of some of the desired efficiencies.
Let's look at how we would evaluate whether the efficiency gains actual occurred after three years or whatever.
First of all, how would the Commission conduct these studies? These studies would be very, very complicated. Where are you going to get the resources to conduct these studies? How long would these studies take to do?
I've got a tentative timeline on how long these studies might occur. And I believe that just studying whether the efficiency arose in any one particular merger would take a minimum of a year, more likely a year and a half or even two years to do.
You can image the complication if a company said, well, our efficiencies didn't arise in the first three years; but now in the additional year and a half in which we have been studying it and debating, now the efficiencies arose, and you're not going to let them present this kind of evidence.
Furthermore, what if costs go down? Costs go down because of many factors. It's going to be very difficult to sort out whether costs went down because of the merger or because of many, many, other factors.
Okay. Finally, a conditional efficiency defense would put the Commission in a very weak position vis-a-vis merging parties. That is, since you supposedly have the right to unwind a merger after three years, the parties can come back and say: What? You don't believe my efficiency claim? Let us merge, and then you can always unwind it after three years.
After three years, one of three things might happen:
First, they could get lucky and maybe the efficiencies will arise. Okay?
Second, they might get before a judge that just doesn't have the guts to unwind a merger once it's been consummated, once the eggs have been scrambled for three years, once the companies have had three years to creatively juggle the books from an accounting perspective.
Or, finally, even if they do have to give up the assets, they've had three years to milk the assets of information, marketing strategy, key personnel, et cetera, et cetera.
So, in short, I believe that a case-by-case efficiencies defense is unwise for all the reasons that I've given.
I believe that the best way to incorporate efficiency considerations in merger enforcement is, everything else being equal, raise the numerical thresholds in the Merger Guidelines. I believe that doing so will achieve two goals. You will get most, but not all, efficiencies for mergers and prevent most, but not all, market power effects.
COMMISSIONER STAREK: Well, thank you, Professor, for very interesting remarks. Appreciate it.
So much for the Canadian model. I guess we can move onto our next witness.
What I thought we would do would be to hear now from Joe Kattan and then interrupt for some questions and that includes from the audience. If anybody in the audience would like to ask a question, there are cards out on the table where the statements are located. Just fill it out, and we'll try to ask it to our panelists.
Following Joe's presentation, then, as I said, we will have a round of questions. And I would encourage our other panelists, if they have questions or comments during that period, to chime in.
And then we'll take a break and hear from our final two witnesses.
So our next witness is Joe Kattan who is a partner with Morgan, Lewis & Bockius, here in Washington, D.C., where he specializes in antitrust counseling and litigation.
He concentrates on a variety of aspects, including mergers, acquisitions, joint ventures, intellectual property, high technology, and transnational antitrust.
And before he joined Morgan Lewis in October of 1993, Joe headed the Bureau of Competition's Office of Policy and Evaluation here at the Federal Trade Commission.
Joe's also quite active in the ABA's Section of Antitrust Law, where he serves as the Developments Editor of the Antitrust Magazine.
And he is the author of numerous articles, including, in my view, a brilliant article on efficiencies of merger analysis which I re-read again last night to prepare for these hearings. And I can't get over how much I think of that article.
So, thank you, Joe. Let's hear what you have to say.
MR. KATTAN: Thank you, Commissioner. It's an honor to be here today.
I have two principal messages today: First, that the Commission's current approach to evaluating efficiencies in the merger context is fundamentally sound; and the Commission's approach is successful because the analysis of efficiencies is one of those areas where we actually witness the much heralded flexibility of modern antitrust analysis that we hear about so much in the speeches of antitrust enforcers.
The reality is that we have something resembling two complimentary efficiencies policies. One is set out in the Merger Guidelines. And that's the policy that seeks to determine whether the transaction-specific efficiencies will outweigh the effect of a predicted diminution in competition so as to permit a merger to go toward, notwithstanding the diminution in competition.
The other policy I think is a more pragmatic policy. And, again, it's a complimentary policy, I believe, that is based on the recognition that tremendous evidentiary difficulties are associated with the issue of efficiencies and that antitrust policy must accommodate itself to allow mergers and acquisitions to capture efficiencies other than through an efficiencies defense.
And I believe that under this policy the enforcers have adjusted the competitive effects standards that are set out in the Guidelines to account for scale economies, in the case of distressed industries, perhaps more to prevent the loss or erosion of scale economies; and in the context of R&D-intensive industries, to recognize the limited number of firms that can compete in an area that is characterized by such massive scale economies.
I think this is clearly the right balance and, although there is room for improvement in this area, as there is in any endeavor, this two-pronged approach is a sensible way, I think, to deal with the complexities of the issues.
Now, I will also talk a little bit about the non-merger side, and I think my message here is going to be quite different. For the past seven years, the Commission has, I believe, marched to the beat of a different drummer. It's the Mass Board drummer.
It has adopted an approach that calls upon respondents to prove that challenged practices produce efficiencies that are both plausible and valid and subject practices to antitrust condemnation when such proof is not forthcoming or falls short, even when the Commission has not put forward a compelling or, indeed, a plausible anti-competitive story.
This is not an exaggeration. To be sure competitive practice must be deemed inherently suspect under the Commission's approach to put a respondent in the unusual position of having to prove its innocence before the Commission puts forward any evidence of anti-competitive effect.
But I suggest that those of you who have been involved in the enforcement process here at the Commission ask yourself the following question in gauging whether this is a meaningful constraint: In how many horizontal restraint cases that have been brought to your attention for your review did the FTC staff apply a full-blown rule of reason analysis?
I suspect that the figure is quite meager.
Let me begin on the happier note, which is mergers. I think that, even though the judiciary has been quite hospitable to efficiency claims now for two decades, since probably 1977 with Sylvania, the much trumpeted efficiency defense has yet to make a strong impact on merger analysis. And the problem, I believe, is one of proof.
Chairman Pitofsky has observed that claims of efficiencies are easy to assert and sometimes difficult to disprove. In my experience, the obverse is true as well: Valid efficiency claims can be extraordinarily difficult to prove.
So we have a situation where invalid claims can be easy to assert, can be difficult to disprove and very good efficiency claims can be very difficult to prove.
The reason for that is that the antitrust enforcers, quite properly, want proof not only of the nature and the quantum of the efficiencies that a transaction is likely to bring about, but also the proof that those efficiencies cannot be captured without the transaction through means that are less restrictive of competition. And this is a reasonable and sensible position. After all, why should efficiencies save an otherwise anti-competitive transaction if we can figuratively have the cake and eat it too, which is to say secure the efficiencies without paying the competitive price.
Now, on top of that, enforcers ask for proof that the efficiencies be passed on to consumers. This is, I think, a more controversial requirement. Professor Lande alluded to it. And there's little that I can add to the debate on this subject. I would say this, my sympathies lie clearly with the Chicagoans on the subject; but I think that Bob Lande and the people on his side of the debate probably have the stronger legal argument.
Now, these requirements, legitimate though they are, create difficult problems with proof. Merging parties must go beyond the proof of savings to create but-for worlds with or without the merger to filter out the savings that can be attained only with the transaction. Then they must take another difficult econometric task of showing that prices after the merger is consummated will not go up, even if the merger will have some conjectured anti-competitive effects.
To put it very simplistically, the respondent essentially must show that the monopoly price, after the merger, will be lower than the competitive price in the absence of the merger because the efficiencies are so powerful.
It's a daunting task, and it's little wonder that very few have scaled this peak.
Now, I think, though, that literal application of the standard does tend to produce rigidities. In the area of the merger enforcement, the antitrust enforcement agencies need to find the right balance. And I think that they have found the right balance by adjusting the core analysis to account indirectly for the enhanced likelihood that certain transactions are likely to bring about efficiencies or at least prevent the erosion or loss of efficiencies.
It's no accident that we seldom see a challenge of a defense industry merger or a hospital merger, a software merger where we are going from five companies to four. Most challenges in these industries -- and these are very, very different industries -- have involved situations of four going to three or three going to two. It will be a rare case where there will four or more surviving companies in those sectors.
So essentially what I think has happened is that the agencies have, sub silentio adjusted the numerical presumptions of the Merger Guidelines to accommodate the efficiencies that are inherent in certain transactions in some industries and which do not lend themselves to easy proof. Problems of proof I think are intractable. Perhaps I'm not as extreme in that view as Bob is, who believes that they can never be overcome. But I think he has a very valid point in asserting that these are very, very difficult issues that are very difficult to a address, particularly in the context of investigation which one is trying to conclude in the matter of three to four months.
This is a tremendously important safety valve. And I think it has allowed the enforcement agencies to circumvent, in most cases, the difficult problems of proof and yet accommodate in some fashion the need to credit the efficiency side of the ledger.
If I had a criticism -- and it's hard to come up with one, but I'll offer one anyway -- I would like to see more enforcement lawyers to suspend their skepticism when defense counsel walk in and proffer an efficiencies defense.
I know that you have heard a lot of incredible efficiencies stories, but there are a lot of good efficiencies stories out there. And one does have the feeling that the agencies simply are perhaps a little bit too skeptical.
I would also dearly, dearly, love to hear one of the agencies acknowledge that there have been instances in which efficiencies did, in fact, trump an anti-competitive story. There are far more rumored instances of that happening then there are real instances, but I believe that there are real instances. And neither agency has yet to acknowledge that, yes, there has been a transaction we did not challenge because efficiencies out-weighed the anti-competitive story; notwithstanding the HSR constraints on confidentiality. I think the agencies can acknowledge that.
Now, I think it's also important for the agencies to understand why we on the defense side continue to proffer efficiencies stories even though it's, essentially, a losing proposition as I have just put it. There's a very good reason for why we do that. It's important for enforcers to understand the business reasons that underlie a transaction.
Even if I can't prove econometrically that the $25 million in annual R&D savings that will result from a merger will be passed on to consumers, either because the time is too short or because the task is just too difficult, if I can show the agency that those savings will be attained, at least I can dispel that the mistaken notion that the observed $10 million price premium that somebody has noted reflects some kind of monopoly premium.
I think the agencies need to understand the efficiencies stories because they inform their assessment of the competitive effects of the deal. If they understand that companies are motivated by cost savings, even if those cost savings don't trump the competitive story that the agencies may have, it may inform their judgment as to what is motivating the deal. And I think that's very important.
So far I've taken the position that the agency's position and the Commission's position with respect to efficiencies has been quite thoughtful.
I'm going to shift gears and move to the non-merger side because there, I think -- and I'm going to be very blunt. Those of you who know me know that I'm pretty blunt. The Commission's approach to efficiency is non-merger cases is seriously disconnected from the mainstream of contemporary antitrust analysis.
I hope that the Commission will use the occasion of these hearings to re-examine the so-called Mass Board analysis to horizontal restraint and recognize that this is an approach which substitutes labels for competitive analysis, avoids the hard questions of competitive effects, and routinely penalizes conduct that does not and cannot have anti-competitive effects.
Mass Board is an anti-competitive doctrine, and the time has come to recognize this unfortunate fact.
Under Mass Board, as you know, the Commission places the onus on the respondent to prove that efficiencies are both plausible and valid in order to escape antitrust condemnation whenever the Commission concludes that a practice is inherently suspect.
Given the enormous difficulties that can be associated with proving valid efficiencies, the effect of this approach is invariably to condemn conduct that may or may not be efficient but has not been and cannot be shown to have anti-competitive effects.
This approach knows no analogue outside the walls of this building, with the possible exception of the 601 building.
Under the approach that's used by the judiciary and the Justice Department, rule of reason analysis begins with an evaluation of the anti-competitive effect of a course of conduct, including evaluation of market power. And efficiency justifications are addressed only if that first stage of the analysis indicates that the conduct may harm competition.
This is also the rule of reason approach which is articulated in the new antitrust guidelines for the licensing of intellectual property, and it's the only sensible approach.
Now, I think that Mass Board was conceived as a way to capture the near per se cases, the type of cases that the Supreme Court dealt with in Indiana Federation of Dentists where it really analyzed course of conduct summarily without really looking at market structure.
Yet, I think in implementation Mass Board has become a substitute for analysis. The Commission has never given content to the term inherently suspect. I believe the term really is inherently elastic because the breadth of circumstances in which I've seen FTC lawyers apply it. In the many years in which I served an evaluation function at the Bureau of Competition, I seldom reviewed a staff recommendation that analyzed the horizontal restraint case under the rule of reason.
This record tells us that, at least at the FTC, the efficiencies are not a defense but part of the respondent's affirmative burden of proof.
This is an approach which I think is virtually tailored made, albeit -- and I'll mix my metaphors here -- as a result of a design flaw rather than tension to yield incorrect outcomes. And I think that this effect is compounded by the tremendous uncertainty that the approach engenders.
Consider a deal in which two competitors collaborate to develop a new product and market the product jointly and they agree not to market the product in competition with one another. There's little doubt that the agreement can be used to effectuate an anti-competitive scheme. But there's equally little doubt that the agreement will have pro-competitive effects in the vast majority of cases. And this is for the standard free riding arguments that I'm not going to get into because I assume everyone here knows.
Now is this a case that the Commission will evaluate under Mass Board? I hope not. But the IP guidelines tell me that the FTC believes that some intellectual property transactions can be evaluated under Mass Board. And I still haven't figured out how that can be. The same coincident they think is true for the Justice Department, which pointedly distanced itself from Mass Board in the Guidelines. I have never seen another set of Guidelines that are issued by both agencies in which one approach is designated as that of a single agency.
I cannot say with confidence that the case that I just outlined will be evaluated by the FTC under the rule of reason and that the practice will not be deemed inherently suspect. And the problem that I have is that, in proving efficiencies, my experience, very often the kind of restraint that I mentioned, results not from some complex study that was undertaken by company staff that indicates that there is a potential for free riding but because a corporate executive has a hunch that a co-venture may engage in opportunistic behavior. Is that a valid efficiency? I think it ought to be, because the deal wouldn't take place otherwise. But I worry that the same approach that defines business practices inherently suspect will be less than wholly receptive to efficiency justifications that are based on hunches.
Now, okay, it's true that my uncertainty as to whether you will accept the corporate executive's explanation won't disappear if you do away with Mass Board.
Even in a rule of reason analysis, I have to face the same uncertainty. But there is a big difference. In most cases, the efficiency justification won't matter because we will never get to it. We will only get to it if the Commission has proffered a valid anti-competitive story. That is what Mass Board permits the Commission to avoid.
I think that if the Commission takes no other action as a result of these hearings, renouncing the Mass Board standard should be the one action that it does take.
COMMISSIONER STAREK: We thank you. That was not only quite thoughtful but remarkably timely, in that we have an opportunity to take a look at Mass Board analysis here up coming in the very near future; and your remarks are quite timely.
Also, your comments on the intellectual property guidelines and the incorporation or non-incorporation of the Mass Board standard for intellectual property are also quite timely because the two folks who spent the most time discussing that very issue are in the room, as you well know.
MR. GILBERT: Some of us will never forget.
MS. DeSANTI: Although we try.
COMMISSIONER STAREK: And the results you see, I guess, is the result of our differing views on certain matters.
In any event, thank you for some really fascinating testimony.
Let's see. I'm not quite sure where to begin, but maybe with Joe. And to follow up on your comments on analysis of efficiencies in non-merger situations.
It sounds to me like the problem that you have with the Mass Board analysis is the lack of definition of what, in fact is an inherently suspect restraint.
Now, is that right, or is that too simple?
In other words, is that where the problem is in the analysis?
MR. KATTAN: I think it's a fair point to begin, but that can entail a whole host of issues.
In my experience I've seen the Mass Board approach applied in such situations in which trade associations that memberships that accounted for 10 percent of the professionals or businesses competing in a particular market, where just looking at that single fact, you could say this simply could not have competitive effect.
So what I'm suggesting is that, unless the inherently suspect category is limited to these near per se cases that the Supreme Court had in find in Indiana Dentist and, frankly, in BMI, then you really need to undertake a full-blown rule of reason.
What the Supreme Court did fundamentally is take cases that had been in the per se category -- BMI, for example, is a good example -- and place them outside the per se category into a quick look category.
What I think the Commission has done is take cases that have been additionally analyzed with the rule of reason category and placed them under the quick look.
So it's fundamentally at odds with what the Supreme Court intended in BMI and the cases that followed.
COMMISSIONER STAREK: I sort of agree with that, and I think you know I've written on this in a couple of cases; and I may well have the opportunity in the future to write on this.
We do have this analysis set up for us really by the Supreme Court. And Mass Board is just sort of incorporating and refining, in my view, the analysis that the Court has told us to take.
It sounds to me like not only do you have a difficulty with how the Commission has defined what is an inherently suspicious restraint but also a problem that we don't employ a market power screen.
Is that what you're really alluding to?
MR. KATTAN: I think a market power screen is fundamental in all but the per se or maybe the near per se cases because you can't really get a grip on the competitive impact of a practice without assessing market power.
I would even settle for a quick market power screen, something less than a full-fledged market power screen, but something that would at least address the kind of case that I talked about where you take a look at it and say: This couldn't possibly have an effect. It's a small association. 10 percent of the providers of whatever service it is. Why are we chasing this?
COMMISSIONER STAREK: Well, you're preaching to the choir. I think I have suggested something along those lines in the past.
MS. DeSANTI: Yeah, I just wanted to pursue a little bit further Commissioner Starek's question on the inherently suspect category.
Now, is there a way that you would see to take that inherently suspect category and make it analogous to per se? Is that the kind of approach that you might be thinking about?
MR. KATTAN: Yes, it is. I think one of the unfortunate things about the development of the law in this area -- we all know we live in an era where most of the law is decided by consent decree.
It's very, very rare for the Commission, or indeed the courts, to express themselves on cases that are brought by the agency. So the problem we have is that the Commission has really not had the opportunity to refinery the standard. And it's entirely possible that if it had had that opportunity to refine it in a litigated setting, it could move it closer toward that per se category; but it hasn't gotten there thus far.
MS. DeSANTI: Let me ask you this, too: There are those who have claimed that the rule of reason state of the case law is not exactly clear and simple and concise; and it has its own complexities and the issue of whether a market power screen is the only way to go is still an issue in the case law.
I haven't had a chance to review your written testimony, but do you have anything in the way of proposals set out there for what you think the right way to simplify this approach is?
MR. KATTAN: If I had my druthers -- I do not have a proposal a such. If I had my druthers, Commission would only apply the rule of reason approach.
Now, it is true that in applying the rule of reason approach courts every once in a while say: Well, geez. This is really a quick look case. And look at a case through quick look lens. And there aren't very crisp standards that tell you when quick look is going to be applied and when it isn't.
This is a complex area of the law, and I would like to offer more transparency; but it's probably beyond my ability.
MS. DeSANTI: I doubt that. But let me just be clear on one thing, then. In general you don't agree with retaining a per se standard?
I'm taking it out of the Mass Board context. But, in general, you're saying antitrust should use the full rule of reason or a quick look rule of reason rather than a per se standard?
MR. KATTAN: Well, certainly in the case of price fixing and the remaining per se categories, which are price fixing and market division and bid rigging, I would favor the retention of per se standard. I'm not questioning that at all.
MS. DeSANTI: Okay.
MS. VALENTINE: Joe, one thing that's somewhat striking about all of this is that while, in the non-merger context, you seem to be arguing that you don't want to get to the efficiency justification until the agency has proffered an anti-competitive story -- I think there is a great deal of sense in that -- when you look back on the merger side and look at efficiencies, it sounds as if you're rolling it all back together again in one ball and saying, don't rely on an efficiencies defense but package it all together somehow in an anti-competitive or competitive effects story up front.
And it also sounded as if Bob was doing a bit of that in saying there can't be an efficiencies defense; we'll just raise the thresholds.
And I would like to ask you what you want to raise the thresholds to.
But I guess could both of you address why you really think that's a better way to go in the merger context? I think in particularly in light of the fact that last week I thought with a different group of people we may have ended up precisely at the other end of the spectrum, which is, you know, don't bother to get to efficiencies until you have established an anti-competitive effects story.
COMMISSIONER STAREK: Yeah, let me just add that in the testimony this morning it was referred to both ways, you know, both as a part of the anti-competitive effects analysis as well as a defense. And so I would like to put you on the spot here.
MR. KATTAN: I guess I should go first. Since I'm the one who was caught in the contradiction, I ought to address it.
COMMISSIONER STAREK: I don't catch you in very many.
MR. KATTAN: And I don't think that it's a contradiction.
MS. VALENTINE: I knew you'd say that.
MR. KATTAN: Let me try to explain. I think that in assessing, first of all, the competitive effects of the merger, it's important for the agencies to understand both the market setting in which a merger is occurring and the motivations for a merger. And by motivation I don't mean intent-type issues but what is really driving the merger from a business standpoint.
MS. VALENTINE: That's two motives.
MR. KATTAN: I go back to the example that I gave.
If I can demonstrate to the agency that there really are $25 million in cost savings that I'm anticipating in a merger, without going through the rigors of establishing that they will be passed on to consumers, because I might not be able to establish that, and it might not be true. Nevertheless this fact can inform the Commission's judgment as to whether there is an anti-competitive story there.
You may look at a deal and say: Geez, you know, there is a very large premium being paid here and what is the reason for the premium that's being paid? Is it higher prices that are going to be captured at the end of the road. And so that's appears, on its face, to be something that you might want to question.
So that's one part of it. The other part of it is that there are some industries in which, for structural reasons, one can conclude that it's unrealistic to expect that we can maintain the number of competitors that would bring us within the Merger Guidelines safe harbor range. In areas like software development -- and I'm taking that just as an example because it would be true for numerous R&D intensive markets -- to the extent that you're going to spend the same amount on R&D whether you sell one copy or 10,000 copies or a million copies of a product -- and I don't care whether the product is software or something more tangible -- you're likely to wind up with a market structure where you have very few competitors.
And the question, then, is: How do we get there? We know that at the end of the road we're going to have very few competitors. Do we do that through some kind of survival of the fittest competition? Or do we get there through some other means that recognizes that trying to stop the transaction, trying to preserve a market structure that is not consonant with the dynamics of the industry is like putting your finger in the dike. You'll keep it there for a while; but at the end of the day, it will burst.
I hope that's responsive. I'm not sure that I addressed the contradiction. But maybe Bob can help me out.
MR. LANDE: Well, one possible way to address the contradiction is, often in the non-merger area, there's no alternative but to look for efficiencies. That is you can do a market power screen, an anti-competitive effects screen; but then after that you often you just have to get into the efficiency question.
In mergers, there is another way to get most efficiencies that is implicit in corporation through, ceteris paribus, raising the Guidelines. So maybe that's a way out of the contradiction for Joe.
Then you ask the question, if there is going to be implicit incorporation, if we are going to -- is it time to think about raising the numbers in the Merger Guidelines?
Well, Joe said -- and I think he's absolutely right -- that we've already done that implicitly in some areas: hospital mergers, defense mergers, and maybe other areas.
Chairman Pitofsky wrote a celebrated article years ago when he said, you know, we're really -- these numbers in the Guidelines -- I mean, the numbers say -- and I paraphrase -- above 100 and above 1800 we're going to get real tough. And Pitofsky wrote a celebrated article saying, that's not quite true. We don't really get tough above 100 and 1800; it's more like -- it's been a while since I read it -- 200-2000, 250-2200. I can't remember what numbers he gave. Maybe someone else can remember that better than I can.
I guess each of us could have their own numbers. What should the numbers in the Guidelines be above which we're, quote, going to get tough?
Let me suggest you look, as an example, to the new Merger Guidelines of the National Association of Attorneys General. They have -- I believe it's footnote 35 -- their own we're really going to get tough numbers of a change of 200 -- a Herfindahl change of 200 to a level of 2500.
These are numbers just to think about. And I suspect everyone in this room would have, perhaps, somewhat different numbers. My co-author and myself would probably have different numbers that we would put in as the upper standard of the Guidelines above which we think the Commission should, quote, really get tough.
But, you know, it's a democratic administration. If anybody could raise the numbers in the Merger Guidelines, it's going to be democrats, like the current administration. Much easier for democrats to do it than for republicans to do it.
MR. GILBERT: The old Nixon to China.
MS. DeSANTI: Nixon to China, exactly.
MR. SIMS: Roscoe, could I make a --
COMMISSIONER STAREK: Sure.
MR. SIMS: -- a point here?
As I look around the room, it looks like I'm one of the older people in the room, so I'll give a little history lesson.
What Bob is articulating and I think what Joe Kattan is saying -- although, I'm not as clear on that -- is really an argument that has a very distinguished heritage and lineage in antitrust going back to Derek Bok, within a decade of the passing of the Cellar-Kefauver Act, writing a very important law review article saying: Wait a minute. We can't make this too complicated or we'll never get it down. We have to have simple bright line rules, or we'll never get the congressional purpose, which he perceived as preventing mergers that might have some anti-competitive effect from happening. We'll never get that congressional purpose implemented.
Don Baker was probably the most articulate modern proponent of that, still articulates that. And I think Bob Lande is following in those footsteps.
If I could sort of pejoratively characterize this approach, it would go like this: It's too tough to figure out the right answer, so let's just have some arbitrary rules that we hope will give us the right answer most of the time.
And while that sounds not so bad when we're sitting here talking policy, it's a lot harder to make sound persuasive and desirable in the context of a particular case in a particular courtroom involving particular entities and particular people.
And I think the history of antitrust enforcement over the years since the passage of the Cellar-Kefauver Act, where we started off with quite simple rules indeed, and we have now moved to significantly more complicated analyses. And if you were to sit down and be able to sketch out the analyses that actually go on inside this building and inside the DOJ as opposed to the ones that are presented in court by those agencies, you'd find that they're very complex indeed
I think we have simply passed by the notion that we're going to be able to undertake these really rich analyses inside our own offices for whom we stand out and explain it in public, whether it's in speeches or in courtrooms or the like, we're going to be able to fall back to some simple arbitrary rules that don't take account, on their face, of this richer analysis.
I think this is the message we are hearing from many parts of the bar and academia in these hearings in terms of, especially, of how you ought to go about employing an efficiencies analysis. And it's certainly the message that you're hearing from the courts as the agencies continue to have difficulty taking this simplistic version of their internal rich analysis and selling it to judges.
MS. DeSANTI: I wanted to see if I could get you to agree to maybe one modification in your pejorative characterization of Bob's approach, which is: You said it's too tough to take all of these specific efficiencies into account. Would you agree that -- part of the message I think I'm hearing is, it's way too costly, and part of the what the agency should take into account in making these assessments are transaction costs and burdens not only on the agencies but on the outside parties.
MR. SIMS: Yeah. I think that's true. I mean, it certainly would make the process more complicated and more expensive and more time-consuming for everyone.
But in part you have here a policy choice as well. I mean, there's -- if you come at this from the perspective of I want to be as sure as I can be that I'm going to prevent anti-competitive mergers, then you come at it from the -- you know, let's have an enforceable system; let's have a system that is relatively cheap, relatively easy to apply, relatively easy to articulate.
If you come at it from the perspective of I don't want to stop pro-competitive efficiency-creating mergers, unless it's absolutely necessary, which is just the opposite side of the coin, then you probably opt for a more complicated, more time consuming, less enforceable, inevitably, system of analysis and enforcement.
MS. DeSANTI: I would like to have you respond to -- in a sense, what you're saying is we can have bright lines, the plaintiff always wins as -- I forget which case it was -- but the rule was the government always wins; or we can have unclear lines and more particularized enforcement, and the government always loses.
And that seems like an unpalatable kind of choice. But I'm interested in getting Rich Gilbert's comments on all of this.
MR. GILBERT: Yeah, I would like to put a different spin on what I think Bob is saying. I have a difficult time thinking about the Merger standards in terms of a strict market share requirement or HHI requirement, particularly since we know that the competitive effects of a merger should not depend on how you draw the boundaries of the market.
It's really a question of who's the next best competitor, and that should show up whether you use a small market definition or a large market definition.
I think what Bob is saying, or at least the way I interpret what you're saying -- is that if we believe there's a presumption that there are efficiency justifications in mergers, then we should apply a greater level of certainty to the anti-competitive effects.
But I would like to hear it put that way rather than a particular numerical calculation.
I'd also like to comment -- I think this is relevant also to what Joe was saying. I didn't hear a contradiction in what Joe was saying. Because I thought what he was saying is that for both mergers and non-mergers you must first identify the anti-competitive effect and demonstrate and prove the anti-competitive effect before, then, going on to an efficiencies analysis.
The efficiency analysis is complex. It can be hard to show efficiencies that are there. It can be hard to disprove efficiencies either way. But one must first establish the anti-competitive effects before moving on to that next stage.
MR. LANDE: Could I add just a couple of things?
COMMISSIONER STAREK: Sure.
MR. LANDE: I guess I'd agree with Joe Sim's position a lot more if I thought we could reliably predict efficiencies in advance of the transaction.
Unfortunately, I think our record is just very poor. That is, as Joe Kattan eloquently said, there are many cases where you know there are going to be efficiencies; you can't prove it. Many other cases where the exact opposite occurs. And the record of proving them in advance, I'm afraid is just a very, very poor record.
I wonder if many of Joe's concerns and also Rich's concerns could be accommodated by a bigger safe harbor, if you will. I hate to get back to raising the numerical thresholds, but -- I know that wouldn't totally alleviate either of your concerns; but wouldn't it alleviate some of your concerns in this area if we have a bigger safe harbor?
MR. KATTAN: May I just jump in? I would like to see less emphasis placed on the numerical standards than we see today and not more of it.
I think, particularly when you get outside the beltway, there's this perception that, geez, you know, we've got a deal that's over 1830; we're going to have tough sledding. And the message has not been articulated. And I think it's as Joe says, something happens within the confines of this building, and the offices that surround it within the next two or three miles up and down Pennsylvania Avenue, that we don't hear outside this area; the agencies don't articulate in court where they fall back on Philadelphia National Bank and away from the richness of the analysis that they conduct internally.
I think we need that richness because the world is not that simple. We should make it simple where we can. And as Rich said, the numbers convey a false sense of precision. You know, it depends on how you define your market. Once you define your market, then you draw your numbers and you get it down to the fourth digit, 3493, and it sounds very, very precise. But it's based on what goes into it. And you know the old adage about that.
COMMISSIONER STAREK: Well, thank you. I agree. We had a very extensive debate about just the point that Bob is making when we redid the Guidelines in 1992. And we came to the conclusion that maybe that was not the time. I think you're suggesting, of course, that maybe now is the time. We appreciate it.
MR. SIMS: Roscoe, if I could make just one little point.
COMMISSIONER STAREK: Joe.
MR. SIMS: It wouldn't really make much difference in the real world to change the Guideline numbers from 1800 to 2000 or 100 to 200. That's really not what you're talking about here. You're talking about situations where traditional application of the Guidelines, using narrow market analyses as the agencies tend to do in courtrooms, are producing Herfindahl's of 4,000 and 5,000 and changes of, you know, 800 and 1200.
So I really don't think Bob's solution attacks at least what I see as the basic problem. And the only way to attack that problem is, unfortunately, to get more complicated because the world is not a simple place.
COMMISSIONER STAREK: Tom?
MR. IOSSO: Yeah, I just had a quick follow up.
If we want to get the agencies to have their feet kept to the fire and to show the world that we're more interested in the competitive effects and possibly the efficiencies analysis, how do we do that?
And how do we get beyond just having the people at large believe that, you know, 1,000 or 1800 and that's it?
MR. KATTAN: I don't have a good answer to that. I think part of it is simply the message that the agency articulates when -- through speeches and through the filings that it makes in court.
But having said that, I can tell you that I recognize the second part is unrealistic. Because once you have decided that you want to challenge a deal, you're going to go in there and site Philadelphia National Bank and say we're doing you a big, big favor by even letting you speak about efficiencies.
And you're going to talk about numerical presumptions. Because, simply, that is your litigating position. Once you've decided you want to challenge a case, the bureaucratic impulse that the litigators are going to have is to try to make the strongest case -- and they have an obligation to do that -- to make the strongest case that they can based on the case law.
So all of the richness that you see within this building -- well, not all of it -- but much of it gets lost I think. And I'm not sure that I have a good answer to that.
MR. LANDE: I'm also not sure that I have a good answer. And I hate to sound like a one-note player and this is a note that I'm unaccustomed to signing, given my political philosophy.
But if you want to send a clear signal that we care more about efficiencies, we want beneficial mergers to take place, if you were to do some adjustments of the numerical threshold, I think it could send a very positive signal to American business.
MR. IOSSO: Are there any drawbacks? Does anybody see drawbacks to raising the safe harbor zone or the presumption?
MR. KATTAN: I think I do. And, again, I guess I'm speaking against my political grain, in that the issues vary from market to market.
There are markets where it makes sense and experience has taught us that it makes sense to adjust the numerical thresholds, not in the numbers that we tell the world, but in how we really analyze things once we get beyond the numbers.
There are markets in which the Merger Guidelines do a pretty good job of capturing the issues that we should be concerned with or the competitive effects that we should be concerned with.
So as long as the agencies maintain the flexibility that they've shown under the '92 Guidelines, I really don't have a major complaints here. I think the agencies have been doing fine.
MR. SIMS: Can I just offer a different answer to the first question? I mean my answer would differ from Joe Kattan's.
Joe says that once you've decided to challenge the merger, you then change -- you know, it's like going into the telephone booth and putting on your cape. I mean, you change from a policy oriented, let's figure out the right answer agency to let's win this case.
I mean that is the problem. That is a major part of the problem. If you were willing to stand up and defend the analysis that you actually use inside these halls in a courtroom, sure you're going to lose some cases when you do that; and some of those cases are going to be more complicated. But if you were willing to stand up and do that, that would, I think, go a long ways toward ending this problem that I think all of us see, that the agency is, you know, doing one thing and saying another when it stands up and speaks.
COMMISSIONER STAREK: Well, thank you. It sounds like I have to give more speeches.
I think at this point we should take a five, seven-minute break, give our reporter an opportunity to change the tape.
We will then reconvene and have the presentations from Rich Gilbert and Joe Sims and then take up our discussion again with the added benefit of their thoughts and testimony.
(Whereupon, a brief recess was taken.)
COMMISSIONER STAREK: All right. We are ready to reconvene. In this part of the session, we will take a look at one industry, hospitals, and see whether or not the kinds of analysis that the agencies are engaged in with regard to hospital mergers is appropriate and whether or not efficiencies are being weighed effectively in hospital mergers and whether failing firm and failing division analysis is appropriate to this particular industry.
Our next witness is Rich Gilbert who is a Professor of economics and business administration at the University of California at Berkely. He is also a principal in the Law and Economics Consulting Group.
As everybody here knows, I'm sure, from 1993 to just May of this year, Professor Gilbert was the Deputy Assistant Attorney General for Economics in the Antitrust Division of the Department of Justice where, among many other activities, he played certainly a major role in the development of the joint DOJ/FTC Antitrust Guidelines for the Licensing of Intellectual Property.
Before he joined the Department of Justice, Professor Gilbert was the Director of the University of California's Energy Institute and served as Associate Editor of The Journal of Industrial Economics, The Journal of Economic Theory, and The Review of Industrial Organization.
Rich, thank you for joining us again. Appreciate it. Look forward to your remarks.
MR. GILBERT: Thank you, Commission Starek. It's a great pleasure to be here for a second time at these hearings on global competition policy.
When Susan and Debra invited me to participate for a second round, I was delighted to have the opportunity; but I also took that occasion, knowing that this would be my last opportunity to be here, to offer a remark about what I thought the priorities should be in terms of antitrust enforcement challenges facing the agencies.
And I was asked to participate in the forthcoming session on network effects in high technology markets, and my response was I thought there were even greater challenges, certainly when I was at the Antitrust Division, in the area of antitrust enforcement policy and health care.
And so I said: Would you mind if I spoke on that subject? And that explains why I'm at the table here today and likely will not be there for the network session.
I will limit my remarks to hospital mergers. That's what I spent the most time on when I was at the Division; although, I think these issues extend to joint ventures and various other combinations in the health care industry.
As we are all aware, the forces of managed care, declining subsidies for Medicare and Medicaid, the substitution of out-patient services for traditional in-patient procedures have combined to impose tremendous financial strains on the nation's hospitals.
They've responded to these forces by searching for new ways to lower costs and to increase their revenues. For many of the hospitals, their alternative has been to close down their operations completely or to seek a partner for a merger.
As a result, the number of U.S. community hospitals has declined from over 5,700 in 1984 to under 5,300 1993.
Now, the sheer magnitude of the number of hospital mergers is itself a challenge for antitrust enforcement. I felt that when I was at the Antitrust Division, the Division could exist on nothing but a diet of hospital mergers. That could keep us busy for the entire time.
Now, looking at these mergers, it was certainly clear that many of the transactions appeared to be motivated by pro-competitive desires to reduce costs and to improve the quality of their services.
In some cases, the structural changes, or at least there was a concern that the structural changes were a response to competitive forces from managed care and might have consequences on price and output. And our job at the Division, of course, was to figure out which category each transaction belonged to, which was not an easy job.
And what I will talk about today is a proposal to look further into how to make this categorization. Although, I don't promise any solutions or any answers.
The Federal Trade Commission and the Department of Justice in their joint statements of enforcement policy in health care I think have made a very important contribution to the industry by describing what types of transactions are likely to raise antitrust concerns and what types of transactions are less likely to warrant antitrust concerns.
But I think that the statements do a much better job of describing antitrust enforcement policy with respect to joint ventures and physician network transactions than they do for hospital mergers. Certainly the safe harbors are a step, a contribution; but the vast number of proposed hospital mergers don't even raise, don't come close to raising the safe harbor concerns. They are far above the safe harbors.
As Joe Sims is going to point out, I think, in greater detail, the fact is that most hospital mergers tend, on their face, to raise antitrust concerns because the markets for the services appear to be quite local.
Outside of urban areas, it means that, at least on their face, the conventional merger thresholds that we have been talking about this morning are likely to be exceeded by almost all of the transactions.
The agencies have responded to this wave of hospital mergers, all above the typical thresholds, by abstaining from challenging many mergers and acquisitions that would be challenged under a literal application of the Guidelines or even a conventional applications to most industries. But the agencies have not articulated the economic or policy reasons for their judgments.
Now, I'm not here to suggest a rewriting of the Merger Guidelines, and I would not suggest an increase in the merger thresholds, the HHI thresholds for the hospital industry.
I believe the Guidelines are flexible enough to allow mergers in concentrated markets to proceed without challenge when those transactions are unlikely to raise anti-competitive concerns.
And, in fact, I think my main message is that there is evidence that mergers in hospital markets that appear very concentrated on their face are, in fact, not anti-competitive and so that a proper analysis of the Merger Guidelines should show that, indeed, there is not an anti-competitive risk from these transactions, or at least from most of these transactions.
So I am not advocating a rewriting of Guidelines. What I am calling for is a study of this industry, and I think that the Commission could do a great service here by actually commissioning a group, an effort, to study the effects of hospital mergers that have occurred in the past decade or so.
Now, the problems that arise, if I can go through the typical analysis, of course, which is to identify product markets and geographic markets and competitive effects and efficiency justifications, the problems that arise in hospital markets, we already talked about the geographic scope issue on the product side, the typical approach is to define a cluster, a product market cluster of services that, in all aspects of this cluster of acute care services, there is competition, increasing competition from -- on the high side of the acute care services, there's competition from regional hospitals that offer tertiary or near-tertiary care; on the low side, the less intensive side of these services, there's increasing competition from out-patient clinics.
What is left? Probably obstetric care, to some extent. But even there there's competition from maternity clinics and from regional hospitals that offer sophisticated neonatal services. So this cluster approach itself raises a lot of problems in determining just what is the anti-competitive market, what is the market in which there may be anti-competitive effects?
Now, in terms of the possible effects on price in those markets, the agencies have not given a -- well, the agencies certainly have not made any exemption for the non-profit status of most hospitals.
I believe the number is about 80 percent of U.S. hospitals are not-for-profit. I don't believe a not-for-profit exemption is warranted. Non-profits have financial objectives just as proprietary hospitals have financial objectives; and these objectives may be very similar: Both need to raise funds to invest in new services and to attract physicians to their services; non-profits may use surplus funds to sponsor other activities, in which case the hospital can be just a profit center for those activities.
So it's not obvious that there should be a difference. But it's also not obvious that there is not a difference between not-for-profit and proprietary hospitals. And a number of studies have identified important differences in the behavior of not-for-profits and for-profit hospitals with respect to prices and outputs. And I think it's a mistake to simply dismiss the not-for-profit category as saying that it's irrelevant to the analysis.
Now, another example of where not-for-profit status raises important issues is what I would call spillover effects from one market to another. One would expect a profit maximizing firm to set the profit maximizing price in each product market.
So, for example, if we have a paper company, I would expect the paper company would maximize the price of cardboard and also maximize the price of newsprint.
If there were a merger that affected the market in cardboard, one would not have to see if that merger also has affects on the price of newsprint because you could, at least to a first order approximation, isolate these different markets.
In a not-for-profit situation, it's less likely that you can do that because, if the institution has a revenue constraint, for some reason, then if competitive circumstances change, if managed care, for example, makes it more difficult to charge a target price for the managed care customers, well, then, maybe you'd have to make up those revenue losses by raising prices for your indemnity patients.
So there might be spillover affects which complicate the impacts of the competitive analysis. In that case, we're just trading off impacts in one market for another market. Again, the evidence of these affects is mixed, but I don't think they can be dismissed either.
I would like to mention efficiencies in particular. Hospitals have become quite adept at proposing efficiency justifications. And the agencies have been very good at reacting to these proposals as well as and considering them.
Actually, I think the hospital markets are an example of where efficiency claims are routinely evaluated; and it's done in sometimes under a one-year period. So it shows that the efficiency analysis is possible. It's very complicated, but it's possible.
If all of the claimed efficiencies that I have seen in proposed hospital mergers are valid, then I would expect, at least if one took a Chicago view and did not require that all of these efficiencies be passed on in the short run to consumers, that you would -- that the conclusion would be that most of these transactions, if not all of these transactions, would raise economic welfare, including both the welfare of the merged parties as well as the welfare of the consumers.
But are they valid? That is the question. And are these efficiencies passed on to consumers?
I think there is evidence that suggests that the efficiency market power trade-off in hospitals is much greater than we acknowledge or we have tended to acknowledge.
I have just recently undertaken a study of California hospitals along with my colleague Carlo Cardilli. This was based on 1992 data collected by David Dranove and Will White, for 203 non-profit and proprietary private hospitals in California.
And the result of this analysis I found rather striking. What we looked at was the price cost margins of these hospitals and controlled for a number of factors, such as managed care penetration, the number of hospitals in a fairly rudimentary defined geographic market, the size of the hospital, the status of the hospital, the usual explanatory variables, the percentage of Medicare and Medicaid patients.
And what we found, as one would expect, a significant negative correlation between price cost margins and the penetration of managed care. The greater the managed care, the lower the profit margin of the hospital. That was not too surprising. What was more surprising was complete absence of any relationship between price costs margins and the number of hospitals in the defined geographic market.
We could find no discernible difference between single hospital markets, duopoly hospital markets, triopoly hospital markets between any number. There was just simply no effect.
And, indeed, at least one other study that we've come across has reached a similar conclusion; and just recently there's a third study that indicated it to me, but I'm still looking it up. These results are incomplete. I don't put them forward as any type of conclusory study about the effects of competition in hospital markets. But they are strongly suggestive to me that we have to take the complexity of competition in health care markets very seriously.
It also suggests to me that there are very great potential benefits from an investigation by the Commission -- sponsored by the Commission of competitive effects in hospital markets and particularly the effects of mergers.
Now, you might ask: Why should the Commission do this? And why another study? What will that do?
I think there are very good reasons why the Commission should do it. First, the Commission has investigatory powers that other researchers don't have. The Commission will be able to focus on markets where mergers have actually occurred.
The kinds of studies that I have just cited are examples of just a cross section of hospital markets with different numbers of hospitals. They don't record before and after a merger or acquisition. And I think it's also the fact that the Commission has available a very skilled staff of analysts who are sensitive to these concerns and can identify the issues much better than most.
I wouldn't expect a study of this kind to be conclusory. It's not going to be the final word in this market. But I think there are enough uncertainties that it can make a considerable impact to help resolving them.
If you do this, I would focus on the following set of questions I'd ask:
Do hospitals in more concentrated markets charge higher prices?
Does the structure/conduct/performance relationship differ for non-profits and proprietary hospitals?
Is there a close relation between promised efficiency measures and the actual measures that are implemented after a hospital merger?
This is very important because we may not be able to identify the effects of those measures. But at the very least, we can see if hospitals do what they say that they plan to do when they make a proposal to merge.
Is there evidence that mergers in concentrated markets have led to higher prices?
Is there evidence that mergers in concentrated markets have led to changes in the breadth and quality of services?
Is there evidence that mergers in concentrated markets have slowed the rate of managed care penetration?
Have discounts secured by managed care payers resulted in higher prices for other payers?
And, finally, is there any evidence of cost shifting that's different for for-profit and not-for-profit hospitals?
I think those are some of the questions that I would focus on, and I would urge the Commission to sponsor such an investigation. I think there's an opportunity here to address a critical area to the U.S. economy, and the Commission is well positioned to do it.
COMMISSIONER STAREK: Thank you very much, Rich. Very interesting remarks, and I am looking forward to you completing the study that you're engaged in about the relationship between the price cost margins and the level of market concentration in the hospitals of California that you're looking at. It sounds very interesting.
I'm pleased that the Director of our Bureau of Economics arrived just in time to hear your proposal to utilize his services and keep his economists from participating in our casework. He may want to join us at the table and cross examine you on this proposal. But you have raised some very interesting questions, and I appreciate it.
Our final witness this morning -- in preparation for our final witness this morning, I selected one of my most colorful ties that I own. But in no way did I meet the standard set by our next, Joe Sims, who has a tie collection rivaled only, I'm sure, by Rush Limbaugh.
MR. SIMS: I have much better taste than Rush Limbaugh.
COMMISSIONER STAREK: I agree. I agree.
So I did not meet the test. In addition to having an outstanding tie collection, Joe is a partner in the Washington office of Jones, Davis, Reavis & Pogue, where he practices antitrust and related government regulation.
Joe has been at Jones Day since 1978. And before that, he held a variety of positions at the Antitrust Division over at the Department of Justice, including Deputy Assistant Attorney General for Policy Planning and Legislation and Deputy Assistant Attorney General for Regulated Industries and Foreign Commerce.
Joe's a member of the ABA Antitrust Law Section; and, among other things, is the former Chair of the Section 1 Committee and Civil Practice and Procedure Committee.
He is a regular author and has contributed to a number of ongoing debates at the Commission during my tenure and contributed, in my view, quite constructively.
Joe, thank you for coming. Appreciate it.
MR. SIMS: Thank you, Commissioner. And let me both congratulate the Commission and its staff for undertaking what I think is a very constructive and useful exercise; and I think all of us in the Antitrust Bar and the other constituencies that are affected by your actions are looking forward to seeing the impact of these hearings, which I'm sure will be positive; but we're all interested to see exactly in what way.
And thank you for letting me participate in this important effort.
We're here to talk today about distressed industries, and I'm going to use the hospital industry as the exemplar here. And let me say at the beginning, because I do have some specific suggestions at the end, that I fully recognize the practical difficulties in trying to deal with these problems: To try to protect the obvious and important public interest in competition and yet properly evaluate other important and legitimate consumers interests. This is tough stuff. And there is no clear right and wrong in this area.
And so I appreciate and understand the difficulties that the Commission and the DOJ and any antitrust enforcer would have in trying to properly weigh all of these important issues.
Why look at the hospital industry as an illustration here? Well, first of all, there's no doubt that it's distressed. The hospital industry is in a mess at the moment, in significant part because of changes in government policy. The government, through construction subsidies and payment mechanisms, encouraged a significant expansion of hospital capacity in the decades following World War II.
And through changes in payment mechanisms, the end of those construction subsidies, and a variety of other forces is encouraging -- and, indeed, one would argue requiring the significant consolidation of what has become substantial excess capacity today.
So this is an industry which is both in trouble and is in trouble in significant part because of changes in government policy that it no doubt had some impact on and influence over but certainly did not control.
It's also a good example to deal with because it's quite clear for those of us who are dealing with the industry and the agencies that people inside the agencies understand a lot of these problems. They fully perceive the various forces that are at work here. They are having, I think -- and I think many of them would admit -- some great difficulty in figuring out how to deal with them and how to take them into proper account in the analysis.
But there real isn't any argument about the problem and the forces. The argument is: How do we deal with them?
And it's a good example for another reason. And that is that what has been happening so far in the antitrust agencies isn't working. I think Rich is right. And I think Joe and Bob made this point earlier today, that the agencies, in their internal analysis, and in their exercise of prosecutorial discretion have essentially rewritten the guidelines in some way that isn't articulated but that opens the doors for significant numbers of mergers which, on their face, would clearly violate Merger Guidelines numbers, to go forward unchallenged in the hospital business.
There have been a lot of hospital mergers. Most of those mergers, on their face, would violate Merger Guidelines standards. The agency has challenged -- both agencies, the Antitrust Division and DOJ -- have challenged relatively few of those transactions.
But the interesting fact, which I wasn't as clear on until I went back and looked it up for the purpose of these hearings, is that they almost always lose when they challenge hospitals mergers. There, as I can count them, have been seven times in which the DOJ or the FTC has tried to block a hospital merger, and they've lost five.
Now, one of those went off on state action grounds; so if you take that out, let's make it four out of six. So two-thirds of the time, in what should be dunk shot cases, under a preliminary injunction standard that heavily favors the agency, they're losing.
This is a message. This is a message that says something is wrong in the process. In most other industries these cases wouldn't even be brought because counsel to the parties would advise their clients that they had no chance of winning. Here they're not only brought but they're lost. So what's the explanation?
Well, my idiosyncratic and unscientific explanation for this is that you have to go in and argue your case before somebody who doesn't read Areeda and Turner at night, a local federal judge who's a generalist, who's familiar with the community, who probably knows even something about hospital problems because he talks to people who are hospital trustees or related thereto. And the agencies have typically attempted to take into these generalist courts a fairly cramped antitrust analysis.
I'm being overly simplistic for purposes of illustration. But basically, too concentrated a market, the concentration is going to go up a lot as a result of this merger. It's not likely that a new hospital will enter; so, therefore, we win.
Now, obviously, it is not quite that simplistic; but the point is that the agencies have typically sought to give a fairly skimpy anti-competitive analysis story in a situation in which the people they're talking to probably have some perception that it's a lot more complicated than that.
And as a result -- again, this is my idiosyncratic view of reading the case decision -- the trial courts are going out of their way to find some reason, some excuse, some hook, however implausible or irrational in some cases, to find a way for the agency not to win.
And that's happened, now, as I say, in four out of six cases. And the agency in the situations that they've lost have been able to reverse that decision only once.
So even when move away from the local judge into a collection of generalists not associated with the community, you're still not able to convince them that the trial judge has abused his discretion or otherwise that should be reversed.
So the process, as it's now being undertaken by the agencies, isn't producing the kinds of results that the agencies would want or that you would reasonably expect under the circumstances, which tells me that something is wrong.
What's wrong? What's wrong is that, while the agencies understand the complicated forces that are at work in these industries and indeed take them into account in some significant measure in making enforcement decisions, particularly when they stand up in court, they not only ignore them but deny their existence or relevance. They don't give proper weight to the unique character of this industry, as Rich said, an industry in which 80 percent of the suppliers are non-profit institutions, which I dare say is not replicated in any other significant industry in the country.
They refuse to accept or try to hold to impossibly high standards of proof the articulated efficiency benefits in transactions. They, as it was described to me by somebody at another agency, in the context of one of these transactions, they don't do antitrust by referendum. So they pay little attention to community views and opinions unless, of course, those community views and opinions can be incorporated in affidavits which can be helpful in the litigation context, in which case they become quite valid.
And they don't give sufficient weight to the heavy influence of government in creating this problem or the heavy reliance on government reimbursements as a revenue source for these institutions.
The agency tends to put way too much emphasis on structure and on structural assumptions that are more articles of faith than empirically provable even in normal industry context and which have much less relevance in this industry.
And they continue to -- the agencies, as a rule, continue to hue to the, well, if there's only going to be three or two or one, the way to get to three or two or one is to let them fight it out and see which three or two or one survives.
And while this has a lot of attractions as a general, theoretical matter in what I'll call traditional industries or normal industries, it has some serious implications for the quality of health care and the ability of local non-profit institutions to deliver a range of health care that a community wants and expects and needs in the hospital business.
And, you know, there is a practical point here as well. In many of the situations that we're talking about, we are talking about a community that already has four hospitals or three hospitals or two hospitals, and they're going down to three or two or one.
If we're talking about going from a triopoly to a duopoly, we're not talking about going from optimal to incredibly suboptimal.
And, query: Is this difference worth the cost and effort of the enforcement exercise?
I don't know what the numbers are. But I would wager, as Rich indicated, that some very high proportion of the transactions that you actually spend time reviewing, as opposed to the ones that get Hart-Scott filed, but that you actually spend time reviewing, are hospitals mergers.
And, query: If you look back on what the agencies have accomplished in terms of the exercise of those resources, I think it would be very hard to establish that resources have been worth the benefits.
So how would you change this? How can you do it better?
You know, it's tempting to say: Just do it better, but that isn't very helpful, obviously. And I point out in my testimony a variety of ways in which I think the agencies, both agencies, could do it better.
But I'd like to suggest that you think about it from a different angle. And here I recognize I'm sort of stepping outside the boundaries of traditional antitrust enforcement and sort of normal bureaucratic imperatives. But, you know, put yourself in the position, if I was running the world and I was faced with this problem, what would I do?
Would I look only at economic analysis? Would I think about Herfindahl's? Or would I sit back and say: Well, wait a minute, what's good about two -- if I'm talking about a two to one, to take the hardest case -- what's good about having two hospitals and what's bad about having two hospitals? And do those things balance out?
Well, what's good about having two hospitals is, obviously, they might prevent price gouging to some extent, not certain but they might. Duopolies sometimes engage in coordinated pricing behavior all by themselves. But it's possible that you could have some price competition or potential for price competition. They certainly preserve choice. And that's a value. Worth something. It may be worth a lot to some people.
They create incentives. How strong? Hard to tell. But they create some incentives for efficient operations so that you can gain some competitive advantage in what is becoming a more competitive marketplace.
And they may make it easier for new entry and changes in delivery mechanisms to find their way into a particular community.
We all know the stories, and the Commission has brought cases, where existing providers have done a variety of things to try to prevent or obstruct or impede a change in the delivery system or the payment system or the kinds of providers that will be available in a particular community.
So those are all benefits of two hospitals. But what are the burdens? What are the costs? In what ways might one hospital be better?
Well, you might have lower costs. In fact, in most situations you almost certainly could have lower costs in operating a single facility where there had previously been two, highly duplicated, highly underutilized facilities.
You might improve quality. There's lots of empirical evidence out there that in many medical services, increased volume has improved the quality of outcomes. So where you were previously splitting volumes, if you could combine those volumes, you might well improve quality.
It might well be the case that a single, more financially stable hospital with generally higher quality would be able to provide a broader range of more sophisticated services locally, as opposed to making people travel some distance to receive those services.
There have been communities that I have been involved with that, where significant elements in that community thought it was extremely important to have a high quality, efficient, low-cost hospital as a tool in ongoing community development to attract and continue to attract new business opportunities to that community.
And there have been communities that I've been involved in where, as horrible as this will sound to this room of antitrust lawyers and economists, where significant elements of the community thought that it was highly desirable to have the hospital, in effect, cross subsidize a variety of services that they thought were necessary, useful, desirable, but would have some difficulty explicitly receiving tax revenues to support.
So, if you're running the world and you're faced with this two-to-one possibility, you might conclude that, well, yeah, there are some costs as well as some benefits to hospitals. And is there a way to get the cost -- or some of those costs without giving up all the benefits? Or, indeed, what's the trade-off?
That's the way, if you were not an antitrust enforcement agency but you were just in charge of making this decision you'd go about making this decision?
And it seems to me that if the antitrust agencies are going to continue to be relevant in this field where you're going to continue to have significant stress, you're going to have a significant shakeout in the number of hospitals in this country -- estimates vary all over the lot -- but it is entirely possible that somewhere between 25 and 50 percent of the hospitals that now exist in this country will not exist 10 years from now.
So there is going to be a significant consolidation. And if the agencies want to be relevant in deciding how that consolidation goes forward, it seems to me you're going to have to move more toward the if I was running the world approach and away from the let me just do traditional antitrust analysis.
Well, how do you do that? What you do, I think -- and the only way you can realistically do it -- is you have to be more welcoming and opening in analyzing the possible competitive effects of these mergers.
As Rich indicated, product market and geographic market definitions ought to be changing today from the way they were made five years ago or even three years ago because the industry is changing; and there is an enormous amount of difference in how services are delivered today and an even greater change perceivable in the future.
The two most recent decisions that the agency has lost in Dubuque and Joplin, if you take at face value the opinions, both of those courts were saying: Wait a minute. You've looked at the past. I want to look at the future.
And while I think in both cases it's probably exaggerated and may not hold together in pristine detail, the concept is fair. The antitrust agencies always are struggling to try to predict the future from looking at the past and making sure that they don't get trapped in the old ways of thinking when there are really big changes coming ahead.
This is an area where that's particularly important. So you have to be more open and more future-looking in terms of your competitive effects analysis. And you certainly have to be willing and able to take into account a richer efficiencies test.
The notion, for example, that we're going to insist in every situation on clear proof that efficiencies, even provable efficiencies will be passed on to consumers within some definitive time period is a notion that I think is not a sensible notion to apply in an industry where you're talking about essentially all non-profit entities.
And I would also strongly support Rich's idea of a study. This is an area where people are making policy and making enforcement decisions on the basis of very imperfect information.
There are, in fact, a significant number of highly successful hospital mergers out there in the country, mergers that have accomplished their cost saving goals and where there is not some Armageddon of monopolistic conduct.
There is, if the agency is willing to spend the time and resources to discover it, I think, a lot of information out there which could inform its judgments of likely competitive effects and could justify taking a much more welcoming view to some of these efficiencies arguments.
Now, there are some other solutions. And I think these other solutions, while they have their own problems, are also worthy of consideration. And I've outlined three of those in my testimony.
And, basically, those are, essentially, remove this field from standard antitrust jurisdiction and give it back to the states under a form of public interest balancing kind of judgment made by people closer to the scene of the crime, if you will, or where the effects will be felt, than the antitrust agencies are.
That has all sorts of dangers if you worry about the affect of local politics and agency capture and all those sort of things. But it also has the potential benefits of taking this closer to the affected personnel.
You could have a different federal statute, like that kind of a state statute which the antitrust agencies would enforce which would require them to undertake a different kind of antitrust analysis, not under the Clayton Act but under the 1996 Hospital Merger Improvements Act, where you would be required to make an affirmative balancing of the factors that were eventually found in the statute.
Again, most antitrust lawyers and economists would say: Oh, my God. You're going to let the Congress -- open the door and let the Congress write a statute on hospital mergers? You know, think of all the terrible possibilities.
Well, yeah, there are a lot of terrible possibilities; but at least it's theoretically possible to do it and do it right.
And then the final suggestion I make is that you could leave the world the way it is except change the burden of proof. As a practical matter today, the burden of proof on showing that there will be no anti-competitive effects and showing that there will be significant efficiencies is shifted to the proponents of the merger almost instantly.
If you're talking about a three to two or two to one, the mindset of the agency is, this is a problem; show me it's not. So as a practical matter, the burden of proof of explaining why this doesn't violate the law or shouldn't be challenged is on the proponents of the transaction.
You could shift that burden of proof, allow some other agency -- interesting as to what agency it should be -- but some other agency to do an analysis of the potential public benefits of this transaction in terms of reduced costs, better access, higher quality, et cetera. Present that interpretation or analysis to the antitrust agencies and then the antitrust agencies would have the burden, if it chose to, to challenge a transaction to show that it's -- the likely anti-competitive effects outweighed those pro-competitive benefits or other benefits.
Now, again, there's all sorts of reasons why that could be a problem as well. And I'm not suggesting that any of these solutions are necessarily better than the antitrust agencies undertaking the more -- the enriched kind of analysis that I have suggested. But they are different possibilities that could, at least theoretically, produce public interest benefits.
So, I guess, in conclusion, the only thing I'm certain of is that the current situation isn't working very well. It's not working very well for the industry, for the people involved in these hospital transactions who are, by and large, I'm convinced, trying to accomplish something that they think is beneficial for their communities.
It's not working for the agencies, who are having a heck of a hard time trying to figure out what to do; and then once they decide to do it, they're losing in court.
And it's probably as a result of those two things not really working in the public interest. And we need to change the approach. And I've offered a few suggestions that at least are worth thinking about.
COMMISSIONER STAREK: Well, thank you. They certainly are worth thinking about.
I think most of us here have given a considerable amount of thought to hospital merger analysis and how it can be improved. And I think maybe we ought to take a look at some of the areas here.
First is the product market. It seems to me -- and I agree with you -- maybe we are outdated here in some of these transactions by using our standard product markets that the courts have laid out several years and that maybe that needs to be refined. And I think we've had a case where that's been defined.
Geographic market analysis is just really tough in these cases, as you well know; and a lot of them hinge on that. And maybe there's some suggestions that the panel might have on how we can improve defining those markets, whether there are any changes that should be done to our Elzinga-Hogarty analysis or a whatever.
I think, thirdly, efficiency. We had testimony here earlier at this hearing from a fellow who runs a management associate group who -- basically, he's a management associate for hospitals, and is called upon by merging parties to do efficiency analysis oftentimes so that they can be presented to the antitrust enforcement agencies.
And his point was that he's never done an honest one in his life. He thinks that the efficiencies are extraordinarily difficult to isolate and told us to be extremely skeptical of any kind of efficiencies that are proffered by merging parties because they just aren't believable. I don't know if that's true, but that was his thesis. And he had been in this business for 30 years or something.
And then, finally, maybe the answer to this dilemma lies in a different view of failing firm, a different view by the enforcement agencies as to what constitutes a failing firm or a failing division of that firm.
Because, as you point out correctly, Joe, hospitals are distressed; there's huge excess capacity in the markets. And oftentimes in cases that have been presented during my tenure here, we've seen instances where arguments have been made that: Well, this guy's just going to go out of business in another three to five years. And so why can't we salvage the workable assets and make a stronger competitor in the market?
So with that, Maybe somebody has a response to one of those four points I made as to how this analysis that we engage in can be improved.
MR. LANDE: I would only like to offer one observation. And that is, I certainly agree, maybe we should expand the failing company defense somewhat, call it a floundering company or look further into the future, however you want to phrase it; but maybe that's certainly one aspect worth thinking about.
MR. SIMS: Let me just make a couple of points on two of your points.
The efficiencies point is correct but only so far as it goes, it seems to me. It is extremely difficult, as a practical matter, for merging hospitals to arrive at a consensual -- because that's what it must be before they're merged -- a consensual consolidation plan, in detail, without creating severe concerns and maybe even significant opposition from individuals, physicians, and others who would be adversely affected.
It may not have any competitive significance, but it has an awful lot of significance to the doctor who has built his medical office building next door to the one hospital and his specialty is going to be put over in the other hospital five miles away.
And so the practical problems of trying to do a definitive consolidation savings analysis are very great. You also have some information exchange problems which you have to worry about during that process.
But I think that that's really a red herring in very significant ways. If you're talking about two facilities essentially next door to each other serving the same community with essentially duplicative services, there is, inevitably, going to be the opportunity for very substantial savings.
And that opportunity is going to be much higher after the consolidation is completed, after a board for the consolidated hospital is selected and after they can make decisions and enforce those decisions because they have a consolidated hospital than it is going to be when the two hospitals are sitting there trying to worry not only about dealing with each other but dealing with all of their other constituency interests.
Sure there are some risks that not all of the potential savings will be accomplished immediately and maybe ever. Because we're talking about people and real life problems and things are messier than they are when you sit down and write them in paper.
But I think it's an excuse more than anything else for the agency to say, well, you know, you haven't really proven that these efficiencies are, in fact, going to be accomplished. Well, it would be insanity for them not to accomplish as many of them as they could accomplish. It would make no sense at all. And it's demonstrably clear that there are significant potential efficiencies available.
So I think that really is a red herring.
On the -- now, I've been so long that I lost your last point.
What was your last point, Roscoe?
Oh, the failing firm thing.
Yeah, on the failing firm, I personally am very skeptical of different rules for distressed industries, quasi distressed industries. I mean, who decides what the distressed industries are? And what criteria do you have to meet? I mean, is it a long down cycle or a short extreme down cycle?
Maybe we could agree that the defense industry and the hospital industry are stressed. But I'll bet you there's a ton of industries out there that think they're distressed that we might not agree to. So I'm not very sanguine about that as a useful device.
And failing firm, failing firm probably doesn't get you to where you want to be. What you ought to be trying to think about here is where these industries are going to end up. There's no way that you can deal with the problems of the hospital business, for example, by insisting upon -- even by liberalizing but then insisting upon meeting some specific failing firm criteria because these hospitals -- these are high fixed-cost businesses, they have significant sunk costs. They can stretch out their failure for a very long time if they are forced to. But that's not necessarily in the interest of the hospital or the community they serve. And so I don't think even an expanded failing firm defense really takes cares of the problem.
COMMISSIONER STAREK: Let me just throw out one more thing since you raised it. You used as an example the two hospitals who are five miles apart who are merging. And we see that a lot, where local hospitals are trying to merge.
But what is distressing to the enforcers, or at least to this enforcer, is when we know that there are other bids for the hospital that's, you know, basically being consolidated by a larger hospital from either a large national for-profit chain or from even a group of non-profits who are from outside the area.
We have had instances like this. And yet the parties insist on going forward with this particular transaction when clearly another purchaser has made the determination that it's in their interest to make a bid which is foreclosed by the merging parties.
That's another thing I wanted to throw out here because it is probably the most distressing thing, to me anyway, in some of these situations that we faced here.
MR. SIMS: Well, I don't know what everybody else's view would be; but I'm not going to give you an answer that's going to make you less distressed, I don't think.
And, again, this is idiosyncratic, based on my experience with a fair number of these situations in relatively smaller communities.
If you're dealing with non-profit institutions that are effectively community managed, either they're community hospitals with self-perpetuating boards, or they're religious institutions that have transferred the effective operation of the hospital to the community board.
And they have come to the frequently painful conclusion that this individual institution that they have nurtured over the years -- maybe 100 years or more -- now has to depart. I mean it has to either be absorbed into another institution or they have to create yet a third institution from the diseased bodies, if you will, of these two.
Those are very, very tough things for them to do. I mean, just on a personal level, these are very tough decisions for them to make.
Sometimes there are -- especially if you have a religious hospital and a community non-religious hospital, the religious issues get very wrapped up in that. These are problems that these people really strain over. They get themselves to the point, finally, where they have said: Okay, I don't like it. It's not what I would choose. But I'm convinced by the merits of the argument that it makes sense for the community and so, okay, we'll grudgingly do it this way.
And they've worked themselves to that point. And then they get to the antitrust agency, and the antitrust agency says: Well, I mean, what about Buyer X or Buyer Y or Buyer Z? Especially, in many instances, if that alternative buyer is a for-profit institution.
And these trustees sit there and say: Wait a minute. Wait a minute. We've got enough trouble getting over the hurdle with an institution we know, with people we understand, that share our values, that we're very comfortable with. Now you're asking us to take in strangers and do this.
This is a peculiarly personal kind of decision for most of these trustees, all of whom are volunteers, you know, who believe in the mission of the institution, of providing health care to the community; and who have a lot of trouble treating this as just an ordinary piece of economic analysis.
And you tell them less competitive alternatives and they say: What's the point here? I mean, that's not in their lexicon.
So as a practical matter, it's very, very difficult for the people involved in putting these things together to switch gears and look at these other alternatives.
And even if they'll look at them, it's extremely difficult for them to get to the level of comfort they think they need to be at in terms of what this means for the community in order to do these decisions.
I think -- and this is where my answer will not make you any less distressed, because it really doesn't give you much of a solution to the problem. I think these kinds of transactions are, or should be to the extent they can be determined to be, community decisions.
If the community is comfortable with these transactions but there is another possible transaction that, theoretically, might make more sense from the outsider's perspective and the community looks at that and hears the outsider's perspective and says, No, I want to go with this one; I like this one better, that ought to be the community's decision.
Now, you can fairly say, Well, how do I know that's the community and not just 10 wackos sitting on the board here or 10 people who like their privileged position, well, yeah, that's a tougher question; and it's hard to answer.
But you can, I think, as a practical mater, figure out whether it's a community decision, not only by how much opposition there is expressed; but you can go out and you can find -- you can search out interest in this.
In one transaction not involving this agency, we did a survey and presented that survey as evidence of what the community view was on this.
Now, you know, again, lots of complications and lots of ways that it can be skewed and lots of problems in it. But there are ways that you can figure that out.
And once the community decides that it's willing to take the risk that this is a less attractive competitive solution, but it's a solution that we feel more comfortable with, my personal view is the antitrust agency shouldn't stand in their way.
COMMISSIONER STAREK: Thank you.
MR. GILBERT: I don't want to disagree with what Joe said. I think there are some very important points, but I would like to at least emphasize a different perspective.
And that is, a lot of the discussion that we have heard has to do with trying to predict the future of the health care industry.
I believe a great strength of antitrust enforcement is that normally antitrust enforcers do not try to predict the future of industries. My impression, that's what regulatory commissions like to do. They like to decide how the industry that they are required to regulate will evolve and, in a kind of parental way, guide it along the best path.
I have great doubts about the ability to do that; and, instead, I think that making sure that competitive concerns are respected provides the best way for an industry to develop; and I think that's also true of the health care industry.
Where I have expressed my doubts about current antitrust enforcement really focuses on whether there are, indeed, anti-competitive effects that we would tend to predict based on experience from other industries.
So it's not that we have to shape this industry along different rules. It's really whether our old way of thinking applies to this industry and leads to similar conclusions. It may be that, for all the reasons we have discussed -- including the community values and the non-profit objectives and everything else, the importance of scale economies and efficiencies -- that maybe we don't have the same order of concern about competitive effects.
MS. VALENTINE: Rich, one follow up on that. You noted before that the efficiency market power trade-off in this area may be greater than we have acknowledged.
And Joe clearly seems to be on the side of us not worrying about whether efficiencies should be passed on to consumers.
One of his colleagues last week said: Well, you know, I think we all know the efficiencies are there. They're hard to measure; they're hard to define and find. But, in fact, the real issue is preserving some sort of competition to ensure that those efficiencies, in fact, are passed on.
Where do you come out on this spectrum? And how do we ensure that efficiencies go somewhere?
MR. GILBERT: Well, first on the efficiencies themselves, in my time at the Antitrust Division, I was impressed with the detailed nature of the efficiency claims that were presented in proposed hospital mergers.
Now, it may well be that these efficiencies are produced by the Walt Disney affiliate of the production company.
MS. VALENTINE: Commissioner Starek was just describing that.
MR. GILBERT: And maybe they're all total fantasies.
But, if nothing else, on those efficiencies, you can -- I believe it's possible to at least to check whether merged entities have gone through the motions.
You don't know if the efficiencies would actually lead to the -- if the motions will lead to the efficiency benefits that are claimed. And for that matter, you don't even know if they don't do them whether they have achieved efficiencies in other ways. But you can check that aspect of it.
I also believe that it is important to maintain some element of competition in this industry in order to actually, ultimately achieve those claimed efficiencies.
But I am at least open, from what I have seen, to the possibilities that competition comes from diverse sources or from more remote institutions or from overlaps in product markets that extend outside the particular cluster that we've been focusing on and the agencies have been focusing on.
But I do believe that competition is important for the health care market as it is for all markets, particularly with managed care.
MS. DeSANTI: I just want to clarify a couple of things for the record.
First, to be fair to Mr. Pitts, I don't think he was saying that efficiency claims were total fantasy. Simply that they are very hard to know ahead of time, as Joe was pointing out, it's hard to know before the two entities have a chance to actually examine how each other works -- which, of course, pre-merger they're not allowed to do -- it's hard to know where these efficiencies are going to come from. Although, you may very well have a very good sense of the magnitude of the efficiencies that are likely to result from a particular transaction.
The other thing is I simply wanted to note for the record -- and I know there are other people who have questions -- that the American Hospital Association was invited to participate in the panel this morning. And they thought they were going to be able to send a representative, but we learned a short time ago that they would not be able to. However, they will be submitting written testimony for the record. And we're looking forward to their written testimony as a way to complete the record on these issues.
COMMISSIONER STAREK: They're busy lobbying Congress.
MS. VALENTINE: Yeah, that's right.
COMMISSIONER STAREK: Are there other --
MS. VALENTINE: Steve, one quick follow up -- oh, I'm sorry. Did you want to follow up on that?
MR. IOSSO: Yeah. Related to what Rich Gilbert just said, you point to the anti-competitive effects potential for mergers as really what the problem is or not the problem. And in that way, again, in the little application of the Guidelines -- of course, the Guidelines have an competitive effect section -- so a little application of the Guidelines is not to say above 1800 we block the merger. So we have to look at that and see what the competitive effects are.
You were reporting some results that show that possibly there isn't a price concentration relationship in California. But weren't there some published studies that did show in the managed care environment in California that there was a relationship between increases in price and increases in concentration?
I'm thinking Melnick did one and possibly Dranove. I'm not sure.
MR. GILBERT: I believe those results emphasize the correlation between the penetration of managed care and price cost results.
I mean, specifically the study that I was presenting here was based on the Dranove work. So it's the same data set. So, hopefully, we should be both reporting the same results with it.
So I mean there may be some results showing concentration effects with respect to managed care in the managed care environment. But from what we're seeing, it's very important to isolate the effect of managed care from the effect of concentration.
And, also, it's also important to note -- and this is one of the complexities of work in this area -- that there's a simultaneous relationship between the entry of managed care and the structural characteristics of the marketplace. So unraveling those effects can be very complicated as well.
Let me just take the opportunity to make one more remark. I am saying that you can do the competitive effects analysis in the Guideline framework, but that you have to also take seriously many of the factors that Joe has mentioned, that I have mentioned, that tend, I think, to be minimized in the antitrust analysis.
I think competition is important, but so is the non-profit objective that might be relevant in the industry. Competition is important, but you have to recognize it can come from many different places outside even the -- what appears to be the geographic market.
So the framework for the analysis is there. But it appears to me that the framework has to be more -- or should be more comprehensive than it perhaps has been applied in the past.
MR. KATTAN: I would like to ask the panelist about an adverse competitive effect that I think is neglected in the hospital mergers.
I promised Bob Lande that lightning can strike twice, and I'll come at him from the left again.
If seems to me that hospital mergers offer a unique capacity to create a negative externality. And by that I mean hospitals, in general, undertake a certain amount of treatment of patients on a non-paying basis, indigent care.
And one of the things that one observes in a good number of mergers, particularly those involving national chains, is a reduction upon consummation of the merger in the non-paying patient load that the hospital will bear and, with it, a shift of that obligation and that added cost to some of the competitors.
Now, suppose if you have a situation -- and this is actually a case that I had here at the FTC only a few months ago -- where there's a competitor with a demonstrable history shifting indigent care to other institutions, that is engaged in a horizontal acquisition within a relevant market, so that it is a predictable consequence of the transaction that costs will be shifted to competitors who will then be asked to assume and bear those higher costs -- some of these competitors may be non-profit who, for a variety of constraints are unable to shift those costs again somewhere else -- should that be a competitive effect that should be taken into account?
And I can tell you that in the one case that I'm referring to, the staff wasn't very interested in that issue, who figuratively offered to validate my parking but not much more than.
So I wonder -- and I'd like to hear from both Rich and Joe about that.
MR. GILBERT: And was one of the merging parties a for-profit institution?
MR. KATTAN: Yes.
MR. GILBERT: Well, it's my view that one has to take seriously the different objectives of for-profit and not-for-profit entities. They may not be that different. But there's not conclusive evidence that they are the same.
MR. SIMS: I don't think I can add much to that. I have represented and been opposed to both for-profits and non-profits.
I think as a general proposition, for-profit institutions approach the delivery of health care more like a business than non-profit institutions do, which is not to say non-profit businesses ignore business considerations because they don't.
But non-profit institutions, particularly community-based non-profit institutions -- my impression is, worry a lot more about things that don't appear on the balance sheet or really wouldn't appear on the balance sheet than do for-profit institutions, just as a general -- as a wild generalization, which we'll probably have Rick Scott all over me.
MS. VALENTINE: Just one last quick question, Joe.
Since you aren't a real fan of special treatment for distressed industries or particular industries, is it fair, then, that your eloquent arguments that we have heard today on going from three to two or two to one may be heard by us from you on behalf of other industries and other clients? Or is this limited to health care and hospitals?
MR. SIMS: No, I don't see any reason why, conceptually, this ought to be limited to the health care business. I think there are some quite unique circumstances in the hospital business that may not be replicated in many, if any, other businesses.
But it's certainly conceptually possible that different unique circumstances would drive you to a similar conclusion.
You know, the Chairman obviously spent some time thinking about this very issue in the context of the defense industry; and he and all of the members of his task force concluded that they shouldn't have different rules, that unique circumstances there were easily manageable within the context of the ordinary Merger Guidelines analysis.
It might be the case in the hospital business. Although, I'm not as convinced of that as the task force was in the defense industry. And if it is, if you can take all those into account, then there's no reason why you can't take the unique attributes of any other industry directly into account under those things.
I wouldn't be willing to say that three to two or two to one is always bad except in the hospital industry. There may be other industries in which you can make comparable or analogous arguments.
COMMISSIONER STAREK: Gary?
MR. ZANFAGNA: I just have a quick question. I thought I heard today, more or less, that there is a richer analysis performed internally; but often when you get in court or in the public, the analysis gets truncated and it gets more simplified and perhaps is not what takes place on a daily basis inside the agency.
And, Joe, your proposals, specifically the task force proposal, struck me as an attempt, perhaps, to bring to the public an otherwise richer analysis that takes place internally, particularly a separate statute requiring a richer analysis or giving it to another agency.
Is that fair? Or do you think that the internal analysis itself needs to be enriched, at least in the hospital industry?
MR. SIMS: Both. I mean, the internal analysis is, obviously, much richer than the externally articulated analysis. But even the internal analysis does not, in my view, take account of the relevant factors in the way that it should.
So we need a better, broader, internal analysis. But I agree with you. In fact, some of the suggestions that I made were designed specifically to try to illuminate this richer -- and require public articulation of this richer analysis.
COMMISSIONER STAREK: Well, thank you all very much. It's been a most interesting and enjoyable morning. I appreciate all of you coming and sharing with us your thoughts and recommendations as to how we can do this better. And I think we are reconvening with another panel at 1:30 this afternoon.
(Whereupon, a luncheon recess was taken at 12:00
p.m. until 1:30 p.m.)
A F T E R N O O N S E S S I O N
COMMISSIONER STEIGER: Well, good afternoon.
It's a great pleasure for me to chair these hearings this afternoon. We have a very distinguished panel.
On behalf of the Chairman and all of my colleagues here at the Commission, our thanks for your time and your contributions to this afternoon and, some of you, tomorrow morning as well.
I think we will proceed with each speaker and then open it up for a roundtable of questions because we don't want to miss the presentations of any of you.
And with that, we will ask Assistant Attorney General Lizabeth Leeds to start.
She is with, of course, the Florida Attorney General's Office. I can't believe she left Florida to come here today, but we are particularly grateful to her.
And she has held this position since 1990. She's been actively involved in all areas of antitrust enforcement, including investigation and litigation of price fixing, customer allocation, and monopolization claims.
Among her many accomplishments, she was lead counsel for the Attorney General's Office in the United States v. Morton Plant Health System, Inc., which was the first jointly filed federal/state antitrust case.
Before joining the Attorney General's staff in Florida, Ms. Leeds was associated with the law firms of Olwine, Connelly and Dewey Ballantine in New York.
Welcome. And thank you for leading off for us today.
MS. LEEDS: Thank you. I'm delighted to be here.
Because of my customer allocation duties, I've been a little bit tardy in getting my comments to you. I have a pretrial order due to the defendants tomorrow. So I have been a tad distracted. But I am, nevertheless, delighted to be here today.
And although I will be discussing the position of the National Association of Attorneys General, otherwise known as NAAG, regarding the role of failing firm defense and antitrust policy, I must give the usual disclaimer that I speak only for myself, not for my office, not for NAAG, and not for any other attorneys general.
One cannot discuss the need for changes, if any, current antitrust enforcement policy without first reviewing the existing policy at both the federal and state levels.
Of course, as all antitrust scholars and practitioners know, current policy, particularly in the area of failing firm or declining industry, is far from cast in stone and is, as is all policy, subject to the prejudices and preferences of those whose task it is to enforce it.
In April of 1992, DOJ and the FTC issued the revised Horizontal Merger Guidelines. Section 5 of the Guidelines specifically addresses the issue of the failing firms and existing assets.
Even if the concentration thresholds are exceeded, the federal agencies, in theory, recognize that a merger is not likely to create or enhance market power or to facilitate its exercise if imminent failure of one of the merging firms would cause the assets of that firm to exit the relevant market.
According to the Federal Guidelines, failure is imminent only if the following conditions are satisfied:
First, the firm must be unable to meet its financial obligations in the near future.
Second, successful reorganization under Chapter 11 must not be possible.
Third, the firm must have made unsuccessful and good faith efforts to find a reasonable alternative acquirer that both keeps the assets in the market and is less dangerous to competition.
And, finally, absent the acquisition, the assets of the failing firm would exit the relevant market.
A reasonable alternative offer is viewed as any offer to purchase the assets of the failing firm for a price above the liquidation value of those assets.
The Federal Guidelines also recognize a defense for failing divisions of an otherwise healthy firm. To qualify as a failing division under the Federal Guidelines, the division, first, must have a negative cash flow on an operating basis. Second, the assets of the division must exit the relevant market in the near term if the acquisition does not occur. Because the parent company can manipulate its internal costs and revenues, the agencies require evidence not based solely on management's plans that could be prepared solely for the purpose of demonstrating negative cash flow or the prospect of exit from the relevant market. Finally, the owner of the failing division must demonstrate that there are no competitively preferable alternative purchasers for the division.
Many people have noted that this is not a particularly easy standard to meet.
The NAAG Guidelines, which were issued in the spring of 1993, parallel, through great measure, the Federal Guidelines. However, there are some differences. And in the area of the failing firm defense, there are, indeed, differences. The NAAG Guidelines adopt the failing firm defense as the only defense to on otherwise anti-competitive merger.
In its Executive Summary, the NAAG Guidelines make clear that the burden of the showing that the failing firm's resources are so depleted and the chance for rehabilitation so remote that the firm is doomed to fail and that burden is on the proponent of the merger.
The NAAG Guidelines consider evidence that the firm could not successfully reorganize under Chapter 11 to be highly relevant.
Likewise, the proponents of the merger must demonstrate that the failing firm made reasonable good faith efforts to find a less anti-competitive buyer and that no less anti-competitive alternative was available.
Although similar to the failing firm defense contained in the Federal Guidelines, the NAAG Guidelines treat the inability of a firm to successfully reorganize under bankruptcy laws as relevant, while under the Federal Guidelines it is required.
Additionally, the Federal Guidelines require that the assets of the failing firm exit the market if the acquisition does not occur. The NAAG Guidelines do not contain such a requirement.
Another significant difference between the Federal and State Guidelines is in the treatment of the failing division defense. The Federal Guidelines contain such a defense. The NAAG Guidelines do not.
However, state attorneys general may exercise their prosecutorial discretion in declining to challenge a merger involving a failing division of an otherwise healthy firm.
Because the failing division defense is easily manipulated, and is therefore susceptible to abuse, the NAAG Guidelines require that the three elements of the failing firm defense be demonstrated by clear and convincing evidence by the proponent of the merger.
Enforcement agencies adopt guidelines to provide a uniform framework for evaluating an action, to advise the community at large as to the substantive standards to be used by the reviewer, and to articulate the analytical framework the reviewer will be using.
Guidelines are simply that, a guide to the issues and facts of primary interest to an enforcement agency. They cannot and should not be a laundry list of everything an agency might consider relevant. Because what is relevant varies from transaction to transaction, and no laundry list can ever be complete.
As all antitrust practitioners know, ours is a fact-intensive discipline. An overly detailed list of do's and don'ts can result in wooden application by the courts, thus, leading to less effective and less rational antitrust policy.
In our system of jurisprudence, theories or defenses embedded in guidelines are invariably subject to the scrutiny and interpretations of the courts. The failing firm defense is no exception.
And, the failing firm defense has been received by the courts with less than an enthusiastic standing ovation.
Current law is strict. Because the failing firm defense allows what would otherwise be an illegal, anti-competitive transaction to proceed, satisfying its requirements is difficult.
For example, courts have required a showing of impending financial collapse before accepting the failing firm defense. Simply showing the firms profits or sales are declining, that loans may be called in or that the company does, indeed, intend to exit absent an acquisition is insufficient to invoke the failing firm defense.
This reluctance by the court to accept the failing firm defense means that a proponent of the defense stands the best chance of success at the pre-litigation phase.
Enforcement agencies, particularly in this era of consolidation, may be convinced in the case of a marginally anti-competitive acquisition of an allegedly failing firm that the agency's resources might be better deployed elsewhere.
In this context, the argument that a firm is failing or troubled can be used to convince an enforcer that the anti-competitive effects of the merger are far less than the numbers would indicate.
Consequently, evaluation of the health of the acquired firm is, in practice, an integral part of merger analysis. It would be a mistake for anyone to assume that the agencies blindly apply their respective guidelines without consider of the actual and evolving conditions in the market under the microscope. If such application were the case, the courts would be flooded with merger enforcement actions.
Because this is, in fact, not the reality and in truth merger challenges are rare, it should be evident that the agencies consider the facts particular to the transaction prior to bringing the enforcement action.
Although many commentators and practitioners would argue that the approach taken by the Guidelines is antiquated and ignores the real world, I believe that they underestimate the evaluative process of the antitrust enforcers.
We do, indeed, take into account real world market dynamics in evaluating proposed transactions. Moreover, given the recent cooperation between the state and federal agencies, an even clearly knowledge of and feel for the market in question has been achieved. This is particularly true in the case of hospital mergers.
Although firms that do not face imminent business failure cannot successfully invoke the failing firm defense, their condition is, nevertheless, relevant for Section 7 analysis. The relative health and viability of a firm is highly relevant in determining the true competitive effects of the proposed acquisition.
Moreover, if a firm is truly troubled, its market shares should be reflective of this fact. Indeed, one would expect to see declining market shares over time in such case.
The argument that an industry is in decline or is undergoing some special set of circumstances, making it less viable unless consolidation is accomplished, is a variation on the failing firm defense.
Although this argument is not explicitly recognized by either state or federal enforcement agencies, it has been a factor in recent merger analysis. For example, in the area of hospital mergers, the merging parties often point to the changing market conditions as motivating factors for consolidation.
As patient census fall and more operations are performed on an out-patient basis, more and more hospitals will argue that mergers are necessary for survival.
In a capital-intensive industry, such as in-patient acute care, welfare is not necessarily served by many inefficient competitors.
I, for one, have heard this argument more times than I can count.
Consolidation into several competing systems may be the only way to ensure competition in the long run. Arguments of this nature are often considered by antitrust enforcers in determining whether to challenge a proposed transaction and in formulating appropriate remedies.
In conclusion, the failing firm defense and its various permutations are a part of antitrust jurisprudence. With increased globalization of the marketplace and increased competitive pressures placed on firms as a result of it, we are sure to see this defense raised more frequently.
Although some may argue that this changing environment requires a form of relaxation of the conditions required to assert the failing firm defense, I for one believe that such change is not necessary.
As a practical matter, enforcement agencies do take into account the health of the merging firms and do exercise their prosecutorial discretion accordingly.
Indeed, the rigorous competitive effects analysis undertaken by enforcement agencies every day is sufficient to ensure the valid claims of failure and changing market conditions are carefully considered and evaluated.
COMMISSIONER STEIGER: Thank you, Ms. Leeds, in particular for that extremely useful comparison of NAAG and the Federal Merger Guides on this very important area of failing firm. Again, we do thank you very much for making the effort to be with us today.
MS. LEEDS: And I appreciate the opportunity to be here.
COMMISSIONER STEIGER: We sort of go under the theory that there's kind of a dispensation for government officials as to the timing of presenting materials.
That's a dispensation that I made up. But I extend it to you since it would be rare that my paper would be here for your edification very much in advance either.
We will move now to a very familiar figure to the world of antitrust. Edward Correia is a Professor of Law at Northeastern University School of Law in Boston, where he teaches antitrust law, constitutional law, legislation, and other subjects.
I don't know where he finds time to do the other subjects, but we might ask him.
During the 94-95 academic year, he was named the Urban Law and Public Policy Distinguished Professor.
And we congratulate you on that, by the way.
MR. CORREIA: Thank you.
COMMISSIONER STEIGER: Professor Correia served as Chief Counsel and Staff Director for the Senate Antitrust Subcommittee and was Chief Judiciary Committee counsel for Senator Howard M. Metzenbaum.
Prior to these positions, he served as a Senior Attorney Advisor for Commissioner Michael Pertschuk of the Federal Trade Commission.
We welcome an alum and a distinguished one at that. Would you proceed for us.
MR. CORREIA: Thank you very much. It feels good to be back here at the Commission. I suppose in retrospect this could have been broadened to include insolvent governments as well as insolvent firms.
COMMISSIONER STEIGER: It would have been appropriate.
MR. CORREIA: I hope it's not failing.
If we view the -- either the essential or an essential goal in merger enforcement as keeping output up -- because output up means prices go down -- and we view output as directly related to capacity, making some simplifying assumptions, it seems to me we start out with a pretty simple proposition in this area that if a firm's assets are really going to exit the market and a merger will preserve those assets in the market, it's always better to have the merger.
Now, that's the simple case. And the reason that's true is that, under almost all realistic circumstances, the output from a merger is not going to be decreased as much as the output of the firm exiting the market.
So that, in a sense, is the simple case, the risk of failure that's certain or very close to certainty.
On the other hand, if the risk of failure falls below 50 percent, let's say, or some threshold level, then you might say the risk of failure is so speculative that you don't want to consider it.
So that means that the problem of these in between cases, the risk of failure that's short of certainty but more than some threshold amount.
Now what you should do about those? Or what should the Commission and the courts do?
Well, Citizen Publishing formulated a very tough test, as we all know. It did that at the time the court was generally hostile to mergers, probably at a time when the Supreme Court and maybe the country as a whole did not appreciate that mergers could be efficient and good for consumers under a broader range of circumstances than was thought of at that time.
So Citizen Publishing was probably quite possibly wrong as a matter of congressional intent. Probably wrong as a matter of a simple output measure. So it's worth rethinking it. And if you add social cost to the equation, then that makes Citizen Publishing even more questionable.
Now, if we begin to depart from Citizen Publishing, we're into a more difficult world as far as administrative decisionmaking. And, in fact, there is a very principled argument that administrability concerns alone should drive you to stick with something as tough or as rigid or as clear as Citizen Publishing.
Now, we used to say that in the case of efficiencies. I think I remember making that argument myself a number of times. But, in fact, the antitrust agencies have come around to the view that they can roughly speak and quantify efficiencies at the prosecutorial enforcement stage.
Merger law or merger enforcement is certainly not an exact science, but it is a science, I think that's fair to say, a rough science. It's not guesswork. So I think it's fair to consider the possibility of doing more balancing at that pre-enforcement stage, balancing the risk of failure versus the competitive harm from the merger, more so than the Guidelines now and more so than Citizen Publishing allows.
Now, let me talk about some other elements of the way Citizen Publishing works. The requirement that the acquired firm goes out -- or the firm to be acquired goes out and shops for an alternative purchaser is certainly a good requirement. That shapes planning. It shapes the conduct of counsel for before the merger is presented to the Commission. Cases such as Harbour Investments make that point very clear. That's a good requirement. It should be maintained.
The problem comes when there is an alternative purchasers on the scene and it's being compared to the other purchaser. Now the competitor purchaser is always willing to pay more. You wouldn't have an antitrust problem if the competitive purchaser paid less because then the out-of-market producer would pay more; and that's where the acquired firm would go.
So the problem comes up when the firm in the market pays more. Now, why does that firm in the market want to pay more, substantially more? Well, of course, the fear has been it's that market power premium. But I suggest in the paper, it's worthwhile to step back and think how often that market power premium scenario really occurs.
Very few mergers create single firm market power. Most mergers are troublesome because they create a concentrated industry which is going to lead, in theory, to higher prices because of oligopolistic interdependence.
Now, a firm that wants to buy another firm that's actually losing money on the theory that oligopolistic interdependence is going to raise prices enough to make that acquisition profitable, it seems to me, is a very large gamble for any firm to take.
Now merger enforcement, all the way back to Brown Shoe, is based upon probabilities, quite properly. But the threshold risk of anti-competitive harm that would cause the Justice Department or the FTC to challenge a merger may be much less than the threshold that a companies actually needs before it spends real money on an acquisition.
So I guess my point is this, to summarize, we ought to rethink when that market power premium really occurs, because there's quite possibly a market power premium and then there's an efficiency premium; and somehow you have to try to pull those apart, not an easy job. But both of them may be going on.
Let me talk about social costs for a minute. If you look -- I think the score is about three to one on Supreme Court decisions, three times they say consider social cost; and one time they kind of gloss over it.
So let's say that most of the precedents say consider social costs. If you go back and look at the legislative history like almost every other of the antitrust laws, it's a little bit hard to determine. But there's a good case that Congress thought social costs would be considered. Therefore, I think it's certainly at least an open issue that social costs should be considered somehow. The trick is how to do it.
I think it's very undesirable for the judiciary to try to consider social costs in an individual case. And I feel this way about other aspects of the antitrust laws, too. Separation of power concerns alone would say that the judiciary, the least politically accountable branch, should not make these wide-ranging trade-offs, unless Congress says: Go make these wide-ranging trade-offs. The executive branch, however, is more politically accountable. And the case is stronger there.
So I think it's fair to say that there's a stronger case for the agencies to consider social costs somehow.
Now, my own view is that it's impractical for the agencies themselves to consider social costs in an individual acquisition. I think that you would end up having to make decisions about the cost to a community of an individual failed firm and the diverse local economy and where those workers could be absorbed and so on. And as I think I say in the paper, a Member of Congress might say: You're speculating with my constituents. And I think there would be a point to that.
On the other hand, if you swing all the way to the other side and say, We can't consider social costs, it seems to me that a member of the public might say, Wait a minute. I understand the Department of Commerce is trying to prevent economic dislocation in the community. I understand the Department of Labor is trying to do that. You don't even think about the antitrust agencies? You agencies over here don't know what this other hand of the government is doing?
And that's not a very satisfactory result either.
So my suggestion is that the agencies take into account social costs in this way: That if there is a case for easing the requirements to apply the failing company defense -- and I think there is, and I have suggested two -- considering risk of failure short of that close-to-certainly threshold and taking a harder look at that market power premium scenario, if you build those considerations into your general formulation, you will then ease the application of that standard. That, in effect, is taking social costs into consideration, too. And that, I think, is the best way to do it, in the general formulation of the defense, not the specific analysis of a particular case, which I frankly think would raise more problems than it would be worth.
Beyond that, I'll wait for questions in our discussions.
COMMISSIONER STEIGER: You may be assured you will have them. A fascinating scenario that you bring to us and a suggestion. I think we will have no trouble finding you if there is a decision to rewrite the Merger Guidelines in this area. But, indeed, a very provocative and most interesting approach. Thank you very much. And we will get back to questions. After we have heard still more and very interesting testimony.
Professor Waller, is distinguished -- as are all of our panelists. I find his offering particularly useful because he does delve into the EC and New Zealand, of all things, as to how they deal with a failing firm. It's a fascinating history that you bring us, Doctor, and one that we are lucky to have on our record.
Spencer Waller is a Professor at the Brooklyn Law School. And before joining the law school faculty in 1990, he was an Associate with Freeborn & Peters in Chicago.
From 1985 to 1987, he was a Special Attorney with the Chicago Strike Force in the Criminal Division of the Department of Justice.
From 1985 to 1989, he was part of the adjunct faculty at IIT/Chicago-Kent College of Law. He currently serves as Associate Director at the Center for the Study of International Business Law, at the Brooklyn Law School. And he is on the appeals board of the Interactive Video Ratings Association.
We may have to have you come back for consumer protection.
As you go through your remarks, Doctor, would you be kind enough to tell us how you happened to be in New Zealand. It's an interesting story.
MR. WALLER: I would be delighted. I'm very pleased to be here.
I am an alum of the Commission of sorts as well. My first summer job after my first year of law school, I worked for the Chicago Regional Office of the FTC and enjoyed the experience tremendously.
COMMISSIONER STEIGER: I'm going to look into it immediately as to why we lost you to Justice.
MR. WALLER: Anyway, I wish circumstances had permitted me to join the Commission as well after law school.
But my remarks are to look at, from a comparative perspective, some of the systems that other countries use to look at these issues. And neither my paper nor in my written remarks am I going to get into the details of exactly how South Korea versus Japan handles a particular thing. But I think there's some helpful overviews.
And I think, because of other papers and the other speakers, I'm not going to discuss, at this stage, the U.S. treatment of failing firms. I'll tying stick to the international and comparative side.
I hope to be able to give you some ideas as to why and how certain foreign systems are successful, or more successful, in addressing these issues and which systems are less successful.
And by success, I mean how well the foreign systems meet the foreign needs. And that doesn't automatically mean that a successful system abroad would translate to the United States. And one of the themes of my remarks is that, despite the fact that some of these issues are handled well in other countries and other systems, I think it's fairly unlikely that we can learn lessons from them and adopt a system in the United States that meets one or more of these foreign characteristics.
The United States stands alone in not having a general public interest-type exemption to its antitrust laws. I would disagree with Professor Correia a little bit. We can get into that more on the discussion. I'm a little bit more of a purist about the role of social costs and antitrust enforcement. And I think, at least as a matter of case law, the United States is severely limited into how we can take those things into account, at least once the cases reaches the courts.
But most of the foreign systems do not have a specific failing firm doctrine. And in a lesser number of cases, they may have a specific efficiencies doctrine; but what they have is some broad ability to say, yes, but.
All of the systems that I have looked at, in varying details, most have some way of people coming to an agency or coming to the executive branch of government and say: We know what we're doing on balance will harm competition, but it's nonetheless good for our country or the public interest. And then they make their argument, and there's a hearing, and there's a decision.
I read cases like National Society of Professional Engineers, the Supreme Court's opinion in the Commission's trial lawyers case that's largely off limits in the United States system.
But foreign systems are characterized by having a general public interest exception where you can make that yes-but argument, yes we know we were hurting competition, but there's some other reason, like employment, or other social values, which mean that you should permit this to go forward. And I mean this more broadly than just merger enforcement.
It comes up, under most systems, for agreements between competitors that restrict competition, mergers and acquisitions as well. But almost never can you exempt single firm abuse of a dominant position on public interest grounds, probably because the concept of an abuse of a dominant position would let the enforcement agency sort of work that in deciding how to proceed. You don't want a second level of public interest exemption.
My paper has an appendix that quickly surveys 10 different countries and how they handle these issues. I can limit my remarks to two foreign systems that I think do a fairly good job at handling public interest-type exemptions without it degenerating into a collapse of antitrust enforcement and preventing individual cases from degenerating into just sort of a political lobbying free for all.
And I would cite as the examples the European Union New Zealand. New Zealand's a little bit off the beaten track, but I got to learn and I got to admire the competition enforcement in New Zealand.
I was asked to give a paper on the prospects for the harmonization of antitrust. And as part of singing for my supper and the trip that I was able to take as a result of participating in this conference, they asked me to participate in a panel discussion on a recent decision by the New Zealand Commerce Commission, exempting on public interest grounds, an acquisition of a failing firm which may well be an example of a market power premium, which I'll talk about in a moment.
But both the European Union and New Zealand have done a pretty good job in creating systems that permit the consideration of non-competitive or public interest factors. Under the European Union's competition law, agreements which would restrict or injure competition are illegal under Article 85 of the Treaty of Rome. Article 85(1) describes when those agreements are illegal. Article 85(2) tells you that illegal agreements are void. But Article 85(3) permits companies, whose agreements are in violation of the treaty, to seek an individual exemption from the European Commission.
The European Commission is an adjudicative body that has no direct analogue in the United States Government. But it is generally considered to be part of the executive function of the European Union.
Article 85(3) allows the European Commission to grant an antitrust exemption on a case-by-case basis if there are four factors:
The agreement must contribute to improving production or distribution or promoting technical or economic progress.
It must allow consumers a fair share of the resulting benefits.
It may only impose restrictions which are indispensable in obtaining the benefits.
And it must not be capable of eliminating competition in a substantial portion of the market in question.
These are factors that are enshrined at the treaty level, as a result, will be enforced by the European Court of Justice if there is a challenge to a Commission decision under Article 85(3).
The reason the Commission has guidance in this area, is that Article 85(3) is part of how antitrust serves the needs of the European Union. The goal of the European Union is to create a single internal market and broaden and deepen that market.
And every once in a while, there are agreements that are anti-competitive but, nonetheless, serve this bigger goal of market integration. And Article 85(3), guided by the language and goals of the treaty, give the Commission that safety valve to say every once in a while, yes, this is a little bit anti-competitive on balance; but nonetheless, it serves the overall goals of the community.
I think that's very different from our rule of reason. People often confuse the two. The Commission is saying under Article 85(3), on balance, a lessening of competition but saved by other goals and principles that U.S. law normally wouldn't get into.
Article 85(3) has been used to handle distressed industries and industrial policy to an extent to restructure the synthetic fiber industry as I have discussed in the paper.
And it's been used in an overall principled manner, although, from time to time the suspicion has been that it's being used to create European champions where they're looking to create a player on a global market, which may be fine for the community but affect the trading partners in adverse ways.
The Commission in using this tool to restructure distressed industries, dying industries, failing industries, helping failing firms not only has the overall goals of the community to guide it, but it also has non-antitrust powers that help.
The Commission has jurisdiction over the anti-competitive practices of member state governments, state and local governments in a way that's the antithesis of our state action Nor Pennington Parker v. Brown doctrines. So it can get at public restraints also.
It also has jurisdiction to limit and adjudicate the lawfulness of subsidies granted by member state governments to industry. So it has a complete package. When it is trying to restructure an industry, it has antitrust rules, it has anti-subsidy tools, and it has anti-public restraint tools to get the job done.
So when I say that Article 85(3) is a success, I mean it in the sense that it meets the European Union's needs and that it fits within their system and they have a compete package to address the problems they're seeking to solve.
New Zealand is a little bit different. And this is really going to be my only other example. New Zealand has a robust competition law, since 1986, their Commerce Act. They are using antitrust as a form of light regulation as they vigorously deregulate and privatize their economy.
They are a small country far away, but they are very sophisticated at this work, and they are very good at it.
They have a provision in their commerce act that allows, basically, for all agreements and for mergers and acquisitions, a way for the companies to petition the New Zealand Commerce Commission and ask them to grant an authorization is the term. And authorization can be granted as long as the agreement represents a benefit to the public, benefit to the public which would outweigh the lessening in competition that would likely result.
None of that's really defined very well in the statute. The statute says that Commerce Commission should look at efficiencies in making that determination. It doesn't get into it much more than that. The Commerce Commission has issued guidelines for how you analyze public benefits and detriments. But that's a matter of their discretion. They have published guidelines, which I could provide if that's of interest to the Commission and the staff.
But this is all put to the test in a recent case that I was commenting on when I was down in New Zealand. Their meat industry is of vital importance to their economy and is in great distress. There's a tremendous amount of overcapacity.
I should also point out that when you're reading really long antitrust opinions about agreements in the meat packing industry, you tend to learn a degree of detail about the processing of food that you could live without.
But there's a very large and important company called Weddel that is in the meat packing industry in New Zealand. And they were insolvent, and they were in receivership, and they had shut down completely. They were out of the market.
The remaining competitors in this industry formed a consortium for the purpose of buying Weddel and permanently take the capacity off the market. That was the goal.
The lenders who were going to finance this acquisition and shut down were sufficiently nervous about the antitrust implications that they demanded, either formally or informally, I'm not really sure, as a condition of the loan, that this transaction be authorized under this public interest exemption procedure.
And as a result, the buyers went before the New Zealand Commerce Commission in a real test case. It was not the first time this law had been used, but it was extremely vital.
Imagine an industry that accounts for 15 percent of your exports, an even larger share of your gross domestic product. It's the principal employer in many parts of New Zealand. And it's also the buyer of the sheep and cattle from the many farmers that are out there. And there is an argument as to whether the public interest benefits out-weighed the lessening of competition.
And the Commission had to do kind of a three-step dance. First, it had to decide if it had jurisdiction; and it gets kind of complicated. Because in order for them to have jurisdiction, this has to be the kind of agreement that is likely to injure competition. Sort they sort of went through whether or not there was some showing of a lessening of competition. They defined the market relatively narrowly, which the parties liked because, if you define the market broadly, the likelihood was there'd be no finding of lessening of competition so they couldn't grant the authorization. They couldn't grant the authorization, the lenders wouldn't lend the money, and it wouldn't take place.
So they went through a whole discussion about why this was likely to injure competition. And they were probably right, that it's likely to injure competition a little. Capacity would be reduced somewhat. The time that farmers had to wait to have their cattle and sheep would increase. Things would be a little bit worse during the peak season; but there wouldn't be that much of an effect during the rest of the year. Prices paid for sheep and lamb and cattle and calves would probably be depressed a little bit was their finding. But on balance, they said, all right, there's some lessening of competition.
The harder question is were there going to be benefits to the public that out-weighed this relatively minor injury to competition.
There's a provision under New Zealand law where the government can weigh in and make a statement of interest, and they did. In fact, this case and one of its predecessors in the meat industry are the only two times the Government of New Zealand has ever shown up to say what they think; and they supported authorization in both cases.
So against the background of a very powerful and important industry going through a very painful, long-term readjustment and a government that supported this, the New Zealand Commerce Commission did its best to quantify the harm to competition with and without this authorization. Without the authorization, some of the meat packing plants would come back into market and some wouldn't. And they kind of went through the facts of how they thought that would play out; versus if they granted the authorization, the insolvent company's assets were purchased and permanently, you know, turned into lost condos, shopping centers, torn down, or whatever would happen; but they would never, ever come back on the market because of the covenants that the various parties gave.
They concluded that there were four main benefits.
The first benefit was the removal of fixed costs. I think that can be viewed ambiguously. One way it may represent a kind of efficiencies that authorization processes seek to promote. Viewed another way, it represents the collective reduction of output by, in this case, a joint dominant firm seeking to extract monopoly risks, which would result in both wealth transfers and deadweight loss to society.
The Commission rejected two additional types of benefits. They said that increased investment in international marketing and processing and R&D was a little bit too indirect and unquantifiable for them.
And they concluded there were no net social benefits in terms of unemployment and that sort of thing.
But they did accept a group of arguments that disagreement would help industries self-confidence and international reputation and the ability to maintain and develop New Zealand as a high-end seller of a brand of high-end meat products rather than just a commodity supplier in a world market. And New Zealand lamb enjoys an excellent reputation in the like, and they're seeking to promote and increase that.
All these factors seemed to be really important to the Commission. Although, at least as an outsider, I found it difficult to understand this as the principal basis of authorization. I noticed in the testimony there was one witness who said that if the authorization was not granted, the industry would enter into a "spiral of doom." So the factors seemed to be important.
So, on balance, the Commission found some harm to competition and a number of public interest factors that they ultimately thought outweighed the harm to competition. And I can't disagree with them in the exercise of their expertise in this case. But I think what's important from their perspective is there was a net gain for New Zealand. If this worked and the industry became lean and mean and better able to exploit international markets, as much as they sell in New Zealand, they sell 10 times more for export.
So to the extent they develop market power out of this, they would be injuring their own economy a little, but really exercising their market power versus foreign buyers I think to the ultimate benefit of the industry and New Zealand. And that's what I understand that decision to be about.
Well, you can do it well or you could do it poorly. And I think New Zealand does it pretty well, and I think the European Union does it pretty well. The question is: Could the United States adapt such mechanisms to our system as we have historically practiced competition law and competition enforcement by both the FTC and the Department of Justice?
I don't think it's manageable. I don't think this is the kind of case-by-case decision that the Commission would want to be in. I think the Commission and the Department of Justice have great expertise at measuring the net competitive effects of proposed agreements and transactions.
And I think any antitrust agency, by virtue of its training and experience and history, has relatively little experience at quantifying and evaluating public interest factors and then weighing them against the harm to competition that we have more certainty about.
I think such processes are inherently political. I think they play against the strengths of the agency and open up a case-by-case fight where the politically powerful industries would often prevail and other industries would be taking their chances.
But leaving that aside, I see these systems of public interest exemptions and authorizations working where there is a tradition where almost or the important agreements get submitted for advanced notification and review by the agencies involved.
It's the tradition in Europe. It's becoming more of the tradition in New Zealand because of having authorization practices. But I would suggest again that the Department of Justice and the FTC do not want to be in the business of, not just pre-merger notification and review but pre-agreement notification and review and the granting of individual exemptions and then having to draft block exemptions because you can't read 30,000 applications for distribution vertical systems.
It's a long way of saying I don't think it's for us.
But the final reason I don't think it is for us is that it may be appropriate from time to time to think about these social costs and to take them into account in tipping the balance in close cases. But moving toward a formal system of case-by-case exemptions or authorizations would turn every enforcement decision from the exercise of informed expert discretion into some kind of an adversarial or semi-adversarial proceeding with parties opposed, parties in favor, and a lengthy and expensive set of hearings, and judicial appeal that may well work for others; but I wouldn't recommend it for us.
COMMISSIONER STEIGER: I think we are extremely fortunate that New Zealand forced you to sing for your supper on more than one occasion because this is a very useful comparison, I think, for us. I'll be interested, as we go on with the discussion, as to whether you think the high monetary thresholds for mergers in the EU have any impact. And if so, whether it relates to exemptions or is it a completely separate matter.
We turn now to Dr. Jerry Hausman, the John and Jennie S. MacDonald Professor of Economics at MIT and certainly no stranger to this nor to the world of antitrust.
His academic areas of research include econometrics, the use of statistical techniques to analyze economic data, and applied micreconomics.
In 1985, he received the John Bates Clark Award from the American Economics Association for the most outstanding contributions to economics made by an economist under the age of 40. And he has also received the Frisch Medal from the Econometric Society.
He has published papers too numerous to mention in the areas of fields antitrust and industrial organization and has served as an expert witness in antitrust cases at this Commission and in the courts.
Dr. Hausman, are you going to shed some light on our dilemma here with failing firms?
MR. HAUSMAN: Yes. A lot of people say that the world of antitrust in Washington is an insider's game; but I'm an outsider from Boston. So I'm going to take a different approach.
Number one, I'm not going to talk about hospitals today. I think enough has been talked about that.
But, number two, I'm going to talk about this from an economic perspective.
And I think that's quite important because part of the insider's game, at least the oral tradition as I know it, is number one, you never win a case in front of the Commissioner or the Justice Department based on efficiencies. And, number two, you never win on failing firms. So I found this whole topic quite interesting in the sense that we're talking about two defenses that are never successful.
So what I thought I would do instead is to do this in terms of economic analysis and turn it around and kind of look at it from first principals. Okay?
So I would like to make three points right off hand:
Number one, I'm not going to be a talking about perfectly competitive industries today. So everybody remembers about perfectly competitive industries, those of microscopic firms and they compete against each other.
And to some extent, the failing firm defense, my reading of it, as with most of the Guidelines, it has, in the back of its mind, a perfectly competitive world while we actually live in an imperfect competitive world. So a lot of what the Guidelines does is incorrect, as a matter of economics, because of that distinction.
So really what I think the Guidelines needs to do -- and I'm not saying that it doesn't, because, certainly in part 2 of the Guidelines, is it should look to consumers.
Why do we have antitrust laws in this country? Well, last I knew it was because we were supposed to make consumers better off. And I think if one looks at declining industries -- which is what I'm going to talk about -- and looks to consumers, you don't need an efficiency defense, you don't need a failing firm defense. But what you can talk about is, if we let firms combine, is this going to be good for consumers?
Now, what I want to talk about are industries, which, although they're declining, R&D is still important; and I'll give some examples. And then I want to come up with a very easy test, because I know lawyers like rules of thumb -- I've been told that, too. And I'm going to come up with a rule of thumb that so long as the output of the merging firm increases after the merger, that it's pro-competitive and helps consumers.
And this actually doesn't have much to do with declining industries at all. This is actually a general fact, which I'm going to try to convince you of today. And I've tried to convince the staff of, with mixed success, in the past.
So I think that in mergers in high-tech industries, R&D industries, I don't really think that this whole -- whatever they call it at Justice -- innovation markets. I think that's just silly from an economics point of view.
But if you're going to actually do it right from a consumer point of view and say, is output going to increase, that gives you the right standard. And we don't have to have all this innovation markets which nobody ever saw, no one will ever see.
So I'm going to explain things the right way.
Okay. Well, today, though, I will just specifically look at declining industries. A lot of industries have this predictable life cycle in which they grow very fast and then they mature and then they start to decline at some point or other.
And in an imperfectly competitive world, we have a lot of sunk costs both in terms of the equipment, but also in terms of R&D. Of course, R&D are a very large sunk cost.
So I'm thinking of an industry here, if you could think of X-ray film. X-ray film is being used less and less. Doctors are afraid of over-exposing their patients to radiation. But also we're moving to a digital world. Okay? So a lot of X-ray film has now been switched to digital; and that will happen increasingly in the future. So the decline for X-ray film -- the demand for X-ray film is declining. Nevertheless, X-ray film is extremely important for mammograms, which are how doctors partly check for breast cancer. That still hasn't been digitized, and it won't be for a very long time.
And companies like Kodak and Fuji are doing a lot of R&D to produce better X-ray film. So they're sort of in this conundrum in which the industry is declining, profits are being squeezed and everybody's waiting for somebody to exit.
Okay? So we have the usual characters out there. We have Kodak, DuPont, 3M. Those are the U.S. companies. We have Axel which is the German company. We have to Japanese companies, Conica and Fuji.
That's too many for this industry because the demand curve is moving inwards. How are we going to fix this? Because with fewer firms what would happen is there would be more R&D because you'd spend the R&D, you'd have more demand and you could do it.
But DuPont has already announced publicly that it's going it get out of the medical business, but they're having a lot of trouble finding a buyer because nobody else is going to buy them until -- because, you know, they can't go up and compete. If DuPont can't do it standing alone with all their scientists and engineers, Phil Proger's firm is not going to be able to buy DuPont and compete. I mean, that goes without saying.
COMMISSIONER STEIGER: I think no one will conclude that at the moment.
MR. HAUSMAN: Another area which the Chairman and I have had -- excuse me, Commissioner Steiger and I have had great experience in this, graphic arts film, using the printing industry.
DuPont has announced -- or at least the rumor has been for the last two or three years that they want to get out of the graphics art film, same five companies worldwide.
For those of you who know anything about printing, you'll know that the graphics arts film is being used a lot less because you can do it on an Apple Computer with a Power Mac Chip now; and so you use a lot less film.
Again, who's going to go out and buy them? It's unlikely that Proger Incorporated, since they can't do it in X-ray film could do it in graphic arts.
So these are just two products, and I could list a lot more. You can see that you have these industries in which R&D is still important, we're still producing better X-ray film, better film; and we're in an attrition game: Who's going to blink first? Okay?
DuPont could not claim its a failing firm. That would not pass the laugh test. And even at the failing division level -- you know, I can't speak for them -- but I think they would be hard pressed to say they're in imminent danger of leaving the market.
Okay. So what's to be done about this? Well, here's the way I think it should be done: What you should, as I said in my introduction, is to look at this from a consumer point of view.
So if you believe, or if the firms can convince the Commission or the Justice Department, that R&D would lead to -- would increase with one less firm, and if they can convince the regulatory agencies that this will lead to higher quality products -- which should not be difficult, that, I think, they can base on history -- then so long as they can pass one test, which is to say that consumer diamond will be higher than it would otherwise be, even if prices go up, even if prices were to up -- then it's a pro-competitive merger. Okay? And that's what I'm going to convince you of today.
Well, there's a mathematical way; and there's an intuitive way to think about this. Let me try the intuitive way first.
The intuitive way goes something like the following: Paul Samuelson, when he was a PhD student at Harvard came up with something called Revealed Preference in economics. And the intuition of that says if I present -- or if the economy presents a person -- I'll use Mr. Proger again since he's sitting across from me. If we present him with two different situations in which he has a choice to buy certain goods at certain prices and he has a budget constraint, okay? So he has only a certain amount of money to spend, he will pick the one that he likes the best, because that's the basis of economics. And he reveals that, one, he prefers one situation to the other by buying it. Okay?
So think about this in terms of my hypothetical situation in which Time Number One sells out there; and there's a certain price, a certain quality, and he buys 10 units. Okay? And the prices of all the goods are the same, and he has the same budget constraint. It won't be in practice, but we can do that econometrically.
Then at Time Number Two, the price has not gone up by 5 or 10 percent; but instead of buying 10 units, he only buys eight units. Well, if he only buys 8 units, he's been made worse off by the higher price; and his utility has gone down and he's been hurt as a consumer, taking Phil as a representative consumer.
If on the other hand, rather than buying 10 units, he buys 12 units, despite the price going up, no one forced him to buy 12 units. He bought 12 units because he's better off buying 12 units than if he had bought 10 units.
Okay? So according to Samuelson's Revealed Preference theory, he has revealed that he is better off. I'm taking Phil to be the representative consumer. And, therefore, it's a pro-competitive merger.
So no matter what happens to price, you have to take quality into account as well. And if he reveals preferences, after you adjust for factors that may change, that he's better off with the higher quality, it should be allowed to go through.
Okay. So now let me do this in terms of some economics. For those economists in the crowed -- and I know that there are at least a few that I recognize from previous work here -- they might know that Mike Spence has a famous paper from 1975. Mike Spence is now the Dean of the Business School at Stanford, and I think a high probability to win the Nobel Prize, a great economist. He has a paper back in 1975 that says even if output increases that consumers aren't necessarily better off. Okay?
And the reason for that is, although Phil may be the marginal consumer and buy more, the person sitting beside him, Professor Waller, may buy less. He's an infer-marginal customer, and he's been hurt. And he may be hurt more than Phil has helped. And that's sort of Mike Spence's paper.
Well, that's actually not quite correct. And what was left out of that theory is that the firm will only produce a new product if it increases its profits. So I'm going to assume that firms are profit maximizing; and because they're profit maximizing, it turns out that consumers can really only be hurt if the elasticity demand increases too much.
And if the elasticity of demand increases too much, consumer surplus goes down. And that's Mike Spence's point. But profits also go down.
Okay. So I do all these equations in the paper, and I say that if you assume that firms are profit maximizing -- which is an assumption that the Commission always makes so far as I know, apart from maybe hospitals, but I mean for most types of firms, firms that are doing the best they can for their shareholders -- then you can get an explicit bound on how much the elasticity can change.
So if you turn to my last page of my handout and you look at Figure 1, what you see is that demand curve one is the original demand curve. The price is P-1. Quantity is Q-1. And then the second demand curve in period P-2, the price has gone up. The quantity has increased.
And the question to be asked is the shaded area, which is how consumers are hurt by an increase in price more or less in the area between the two demand curves, which is a change in consumer surplus. And Spence showed it could go either way.
But what I prove under the assumption that firms are profit maximizing, is that for linear demand curves, consumers could never be hurt. I develop an explicit bound and say that second demand curve, D-2, can't be too horizontal. That's what causes a problem in Spence's paper. Because if it's too horizontal, firms would not introduce a new product because they could make more money with the old product.
And then in Figure 2 for long linear demand curves, under the assumption that the demand curves don't cross, I prove a similar result under what -- and, you know, you need to look at the paper -- but under what I consider to be quite reasonable economic conditions.
So long as when quality improves consumers buy more, they're better off. And so, therefore, under Section 2 of the Guidelines, the merger should be permitted.
Okay. But what's my experience here at the Commission? Okay? My experience is the Commission -- I won't name names, but I'll be glad to afterwards if anyone's curious -- is that what somebody always says at the meeting is, well, that's an efficiencies defense, because some lawyer once told me that under General Dynamics it's very hard to get courts to accept efficiency defenses.
And I say, that's wrong. That this is under Section 2, Competitive Effects, because just as the Bureau of Labor Statistics now adjusts computer prices for quality, that the FTC or the Justice Department or the Merger Guidelines also needs to quality adjust prices when they look at mergers.
And if you quality adjust prices -- which is really all I'm doing here -- and demand goes up, that means the quality has improved sufficiently so that the consumers, their quality adjusted prices has gone down. That's with the Revealed Preference.
So this is not an efficiencies argument at all. This is a straight Section 2 Guidelines consideration.
And it's my view that if people actually looked at things in the correct way and said, Are consumers going to be made better off or worse off and sort of quit trying to pigeon hole things in legal boxes about what courts might or might not have said and whether the lawyer feels that he or she has a better or worse chance of winning if it goes to court, that we would have a better standard.
In many of the declining industries we would ask the question: Are consumers going to be made better or worse off by the merger in the sense of whether or not they will buy more after the merger, and if they do, it's pro-competitive; and the merger, in fact, should be allowed.
COMMISSIONER STEIGER: Thank you, Doctor. I predict fearlessly that somebody is going to ask you why you say that no one will ever see an innovation market. And that's going to be an interesting topic for our discussion section I think. And thank you for the paper.
And, indeed, we do have our own distinguished economists in the audience. And they're probably already running the regression analysis as we speak.
Our final panelist this afternoon is Phil Proger, whose name has been taken in vain several times. And in the best of good humor, he has let us decide that he isn't going to buy a major chemical company, but he is going to be a wining consumer.
He truly needs no introduction. Even without all of that, he's a partner of Jones, Day, Reavis & Pogue, where he has practiced since 1989.
He is the Coordinator of the firm's Government Regulation Group. And in his antitrust practice, Mr. Proger has paid particular attention to mergers and acquisitions as well, of course, as to the application of antitrust law to the delivery of health care services.
I would note that he has chaired the National Health Care Lawyers Association's annual seminar Antitrust in the Health Care Field since its inception in 1977.
And what a service that has been to practitioners in that field, Phil.
Among other things, he's also a member of the editorial boards of Managed Care Law Report and Healthcare Systems Strategy Report and has served as Publications Officer of the ABA's Antitrust Law Section.
We are extremely pleased that he would come back and join us on a topic related, I know, to his discussion of a week or so ago.
But anything you can tell us, Phil, from your vantage point as a long-term practitioner in the antitrust field, we will be most grateful to hear.
MR. PROGER: Well, thank you very much, Commissioner Steiger. I want to say that I do appreciate the patients to have me back a second time. And I would be a little bit remiss this time if I didn't mention just at the outset my appreciation publicly and it should be on the record to Susan DeSanti and Debra Valentine for all the courtesies the staff and others have shown the participants in organizing this. And I also want to thank -- I'll mispronounce your name -- Thomas Iosso and Gary Zanfagna who did a background paper on this subject that I found very helpful. I wanted to acknowledge that.
This has actually been sort of a joy for me. Talking about efficiencies last week and failing company this week has forced me to think about issues that, as a practitioner, sometimes we get a little away form sort of the anchors of antitrust analysis and into the nitty-gritty practice before the agencies; and we kind of lose sight of where all this comes from.
And it's resulted in me doing, frankly, a lot of thinking that I'm deeply appreciative to you for forcing me to do. And it's resulted, by the way, in a lot of discussions with my partner Joe Sims on this subject. It's fair to say -- and I understand Joe distanced himself a little bit from me this morning. That's okay. I told him that if they asked me that, I was going to deny even knowing him.
But it's been extremely helpful to me, and I just want to express my appreciation to the Commission for inviting me and for holding these hearings. I think in the end, we're all going to be better off for having this, and I look forward to the outcome.
In thinking about what we were talking about today and listening to the other speakers who have spoken wisely before me -- although I do want to know in the question and answer period from Professor Waller whether the witness who testified of the Spiral of Doom is for it or against it. That's a fairly important consideration of the analysis.
I think that what I started to think about, as I looked at the questions for today, is what really were the questions? I think it's very important to start off by getting the question right if you're trying to think about these things in an intelligent way.
And actually, I think we asked the right two questions. And I just want to start off by seeing if we agree on what the questions are.
The first question was: Should antitrust law make adjustments to the failing firm defense to enable the rationalization of overcapacity in a declining demand or changing industry?
It seems to me to ask the question: What does antitrust law do about an industry that is experiencing contraction or consolidation?
And I think that's a pretty useful question to think about.
The second question was: Should the failing firm defense remain the same or even be made more stringent?
And it didn't tie itself to a declining industry or a consolidating industry or an ailing industry. So I think it's important to start off with the two very distinct questions here. One, which is actually the second question, but I'll put first is: Is the failing firm defense an appropriate defense?
And, two, I would just change a little bit, to strike the failing firm part of the question and simply say: What should be antitrust policy with respect to rationalization and declining demand industries?
And Professor Hausman started off right before me by, I think, really dealing with that broader and, I think, very significant question.
Now, if you're going to start answering these questions, I think you got to start off with some basic disclaimers as to what your views are, because the linchpin of your analysis is going to be the underlying assumptions.
And I start off with an assumption that others may agree or disagree but is pretty fundamental to me, which is competition is not the goal. It's the means.
I agree with Professor Hausman that it appears to me that the goal is consumer welfare. And competition happens to be one of a number of means that you can achieve it, and the one that I happen to think is the most efficient; most intelligent; and, frankly, the most democratic, with a small D. And I'm glad our country has relied mostly on it.
If the goal was competition -- if the goal was consumer welfare and competition is the means to achieve consumer welfare, then we always have as a goal to protect competition to protect the means.
And I think the analysis we're looking at here is one that questions whether or not we are serving consumer welfare as well as we can through our failing firm defense in two specific instances. One, where we simply have a firm that is doing poorly in an otherwise fine industry, competitive and robust or not competitive and robust but not, certainly, declining in demand and not consolidating. Or, two, in a consolidating situation.
It strikes me -- and I've always kind of thought this way -- that the failing firm defense is realistically -- actually, again, as Professor Hausman pointed out -- not really much of a defense. And Bill Baxter, a long time ago I heard him speak, made the comment that he didn't see the need for a failing firm defense because the real issue was the competitive effects; and I agree with that.
And so when we look at the failing firm defense, particularly after International Shoe or Citizen Publishing, or the Merger Guidelines, I guess, in Section 5(1), we have four criteria to employ. And what you have is a very narrow, very stringent defense that requires the failing entity division or firm to be, as we all know: One, unable to meet its forthcoming current obligations; two, beyond reorganization and Chapter 11 -- a particularly Draconian standard -- that, absent this acquisition, the assets are going to exit the market -- well, exit the relevant market, maybe not a market, but this particular market, which I think is a relevant concern; and that there be no alternative purchaser who would be preferable from a competitive standpoint.
Now, I may be wrong, but it's hard for me to envision significant adverse competitive effects from the acquisition of a firm in such dismal shape.
I mean you're talking about a standard where they can't meet their current obligations; they even cannot successfully reorganize in bankruptcy; and if you don't do this deal, their assets are going to exit the relevant market; I think, a fortiori, you've got Catch-22. You've answered your question. I don't see how you're going to have an adverse competitive effect.
That's a perfectly rational, it seems to me, antitrust policy. The basic underlying tenet of the antitrust laws are acquisitions that don't have anticompetitive effects and do not lessen competition are ones that are perfectly appropriate and we encourage, particularly when they bring about some efficiencies, which was the subject of the discussion last week.
So for me, the failing firm defense is neither, as the question asked, too broad or too narrow; I think it's a recognition in another form of basically the competitive effects test. And I think that's the right test to look at what the competitive effects are.
If you think of it that way, then when you come to the issue of what do you do in declining demand consolidating industries, I think you begin to realize that the failing firm defense, in and of itself, is not the answer and shouldn't be the focus of enforcement policy under the antitrust laws.
Several things. One is, I'm going to assume for this discussion today, when you're thinking about these type of industries, you're generally thinking about industries that are relatively concentrated in their particular antitrust markets that have high fixed costs and that collusion is not really the issue we're most concerned about.
They're already reasonably concentrated and already have a fair degree of the ability to collude in the industries as it is.
The real issue that we're going to focus on here is unilateral effects or market power.
That's not going to be true in every single instance, and I think you've got to look at it carefully. I think collusion shouldn't be read out of this. I don't mean to suggest that. But for purpose of today, I think it's helpful to think of this in a market power context as opposed to a collusive context.
Now, whether you talk about health, defense, financial services, retailing, today -- all of which are undergoing massive consolidations -- what you've got is an attempt to deal with consumer welfare as the industries consolidate. Competition is a process that will bring about the consolidation. And I think the question people ask is, frankly: Is competition the most efficient or an efficient means to achieve a rationalization of those assets?
And, in the end, you know, my view of it is, competition still is the right model. I think within the competition model and the antitrust laws that seek to protect that model, there is sufficient flexibility for an agency like the Federal Trade Commission or other antitrust enforcers to take into account the factors that this panel has all talked about, the social welfares, the efficiencies, into some reasonable analysis to sort of determine, from a prosecutorial standpoint and a discretion standpoint, what's really appropriate for consumers?
So from my standpoint, I think that the correct analysis is a Section 7 analysis in these industries. I think we need to look at competitive effects in these industries. And I think what we need to look at is this balancing, these trade-offs.
On the one hand, we need to look and weigh the potential adverse effects of the transaction to consumers from decreased competition and increased market power versus the potential efficiencies and particularly -- harking back to my testimony last week -- the likelihood that those efficiencies will be passed on to consumers.
And I would suggest, under these circumstances, that it would be appropriate to give efficiencies more weight in the equation.
I think that you've got a lot of circumstances here where the efficiencies, if not achieved through this transaction, are likely to be lost. And I think there is some net gain to consumers by preserving the efficiencies.
I may be getting my economics wrong, and Professor Hausman will correct me, but my recollection is that economists generally agree that even a monopolist prices in relationship to its cost. And while I'm not suggesting we allow mergers to monopoly because there are efficiencies, I am suggesting that the net loss of efficiencies is an important consideration in the analysis here.
So, are the antitrust laws flexible enough to deal with these issues? I think so.
Do we need special exemptions here for particular industries so they don't have antitrust scrutiny to allow them to rationalize and consolidate? Do we need Congress to legislate? I think not. I don't think it's necessary.
How do we do it? I think that we still do the traditional competitive effects analysis with one slight deviation. I would have the agencies give greater weight and pay more attention to the efficiencies in these transactions and particularly whether the efficiencies, but for this transaction, are going to be lost.
Which turns me to my last point, which is the alternative purchaser. I guess this is the only point I'd disagree with Professor Correia on.
I really think that we need to think about the alternative purchaser prong of this test. One is it strikes me that the alternative purchaser, in some sense, is a form of industrial policy, not competition policy. Because what it says is, if you have two purchasers both of whom may not have an adverse, anti-competitive effect; but if you want to avail yourself of this defense, we are going to pick one we deem more preferable. That's more of an industrial policy, it strikes me, than a competition policy.
But, two, what the alternative purchaser doctrine tends to do is put a premium on a purchaser who cannot obtain efficiencies. It's usually a rival from outside the market who is going to be the more desirable alternative purchaser. And if that's the case, well, then we've lost the efficiencies.
And if you're really talking about failing company and the situation that you've met the other prongs of the test, one has to ask what this new purchaser, who brings no efficiencies to transaction and, therefore, no efficiency consumer benefit, is going to do to this failing entity that's going to make it viable where the previous owners have not.
Now, we could assume mismanagement or human capitalist failed; but we don't traditionally do that in antitrust analysis. We tend to hold that equal. And so I'm not sure what is the value of forcing a purchaser that comes from outside the industry when you've got an industry of declining demand, overcapacity; and what you're trying to do is formulate a reasoned policy to eliminate excess capacity and make the industry more efficient.
So I'll conclude by saying I think competition is a viable model here. I think the antitrust laws have the discretion and the broadness in the Section 7 analysis to incorporate these type of considerations.
I don't think we need special exemptions for particular industries or even special standards.
I do think we should give more weight to efficiencies.
And I would question the alternative purchaser prong.
Thank you again for having me, and I look forward to the questions.
COMMISSIONER STEIGER: As always, you make a wonderful contribution, Phil. Thank you for that.
We do need to take a break to allow our reporter to change his tapes, so this might be an appropriate time to do it. And then we will return in about 10 minutes and ask the panelists, certainly not to criticize each other, but comment, if you would.
And I'm wondering if what we're beginning to hear here is that the basic issue is not, perhaps, the failing firm defense but something less than, and what its treatment is. And I think Ed has given us a start on that. I would throw that out as one suggestion.
And we'll look forward to your comments when we get back.
(Whereupon, a brief recess was taken.)
COMMISSIONER STEIGER: I think we can resume our afternoon session and enter into a colloquy.
I am reminded that I owe you all a debt of thanks. There cannot be an easier job than moderating this kind of panel. You basically just have to get out of the way and let great minds work.
And if we can't -- with two distinguished professors of law, a distinguished economist, a distinguished state enforcer of the antitrust laws, and a distinguished practitioner -- solve all of this between now and 4 o'clock, something is definitely wrong.
But I am going to start out and get my pet question in. It may not be even directly related.
But, Dr. Hausman, why do you say no one has ever seen an innovation market?
MR. HAUSMAN: Well, when you think about a product, a product has a price and it has quality involved. It has what economists call "product attributes." And embodied in those product attributes may be innovations.
Now, I'm not saying that there could never be an innovation market. You might have somebody who does contracts research. Arthur Little used to do contract research. So in that sense, you could have an innovation market. But that's not what these new Guidelines and all look at.
So the right way to look at this is to say: What do firms sell and what do consumers buy? And they buy and sell products. And there's a trade off: Higher quality, higher price, lower quality, lower price, and any mix in between. And in fact, in term of quality, if you think about personal computers -- we were talking that during the break -- you could have a faster chip, you could have fax modem, you can have more hard disk space, you can have a color monitor, you can have a black and white monitor. So there are a lot of attributes that trade off.
But I've never -- you know, with this small exception of doing contract research -- I never see anyone buying and selling innovation. So if I want to look at a merger in a market where there's innovation, what I would say is, very much like my paper, will this lead to a product which consumers want to buy more?
If you just raise the price and don't improve the quality, consumers will buy less. It's anti-competitive.
But if you can improve the quality, even though the price goes up, then people will buy more. So I think this whole idea -- I mean, apart from perhaps being a strategic legal ploy -- it just doesn't make economic sense, because no one ever buys and sells this.
And in terms of economic markets, if you don't buy and sell it, if you don't have transactions, if money isn't going over the table, then you don't analyze it that way. So from my point of view it's just clearly wrong; and it would be much better to look at the goods and services as a bundle of what people buy and sell. Part of it will be attributes where innovation is important; part of it will be price.
But you can't separate it like Solomon did with the babies and say we're only going to look at the innovation part; we're only going to look at the price part; we're only going to look at the quality part. That makes no economic sense. It's just wrong.
MS. VALENTINE: If I could maybe follow up on that with one little thing, and then we will get -- actually this will lead back to failing firms, I hope.
On the one hand, it didn't surprise me that you said you didn't believe in innovation markets or had rarely seen one. But what I found somewhat strange was that while we did get, you know, banged over the head by many people a few weeks ago and they kept telling us, there can't be innovation markets; and that's because there's no relationship between concentration and innovation, nor do we know whether fewer or more firms account for or will cause more or less R&D.
And yet I think what you are asking us to assume today was, in fact, sort of precisely what we need to prove that there should be innovation markets.
I think what I heard you say was that we should assume that, if this merger that you were talking about were to go through, you'd see more R&D with that one firm than two firms, and also that that increased R&D would lead to an improved quality product. And that was, of course, another thing that everyone kept telling us: Well, you don't know that more R&D will lead to better products, improved quality products.
So get me through your assumptions in your theory first, because once I get past that, I'm more with you.
MR. HAUSMAN: I think there are three things I would like to respond to.
Number one, we shouldn't look at concentration. But that's not just here. No important question in antitrust economics ever gets settled on merger share correctly. Okay?
So the Guidelines can be used as a screen to say that if, you know, the shares are very small, it's not worth us looking at; I have no problem with that. But beyond that, in terms of will firms with more or less concentration innovate more? That's a very controversial thing in economics. Schumpeter -- I'm sure you heard all of this a couple of weeks ago -- wrote many papers on this or about destructive competition and all that kind of stuff.
But there's just no answer. Just as in almost anything, apart from the monopoly situation; concentration doesn't indicate whether or not firms will compete more or less.
That's the fundamental fallacy of the Merger Guidelines. That's 1930's Harvard economics. They were never a very good department anyway compared to MIT, and that's been written into the Guidelines unfortunately.
COMMISSIONER STEIGER: We expect a defense from the Boston area at the very least.
MR. HAUSMAN: But then getting onto the next two points, you shouldn't assume that there's going to be more R&D. Okay?
So in other words, firms could come in; and they could say, we want to merge, scouts honor, we're going to do more R&D. You shouldn't believe that.
MS. VALENTINE: Okay.
MR. HAUSMAN: Okay. But a firm can come in and say, there are projects that, in the normal course of business that we've looked at, and we would do; but we can't get enough sales to do them. Okay?
MS. VALENTINE: Okay.
MR. HAUSMAN: So you would need proof.
And then the last point that you asked is, why would they do the R&D and not have more quality?
Well, again, I want to go back to the point of profit maximization. If the firms aren't regulated, you know, ala AT&T with Bell Labs years ago, they will not do more R&D unless they believe that they can come out with a better product which will sell more. Otherwise, it's not profit maximizing and they would be cheating their shareholders. Okay?
So I think really all you really need as proof is to say that, in the normal course of business, we've looked at these projects; we can't guarantee you -- merger analysis is a predictive enterprise. But there are these projects which our engineers have identified which would improve the products and we believe that we could sell more; otherwise we wouldn't do it. But we can't make enough money to do it now. You know, however, if we could sell more, we do believe we could do it.
MS. VALENTINE: So you would be coming in with evidence to help us get over those?
MR. HAUSMAN: Exactly.
COMMISSIONER STEIGER: Phil Proger?
MR. PROGER: Well, one, I guess, I start off with the premise that's probably no comfort to him, I agree with Professor Hausman. I've had a hard time understanding this concept of innovation markets and talked at length to a number of people.
But I think his answer in the discussion points out what I think is the underlining sort of fundamental principle here, which is the Merger Guidelines as a whole process of analysis really does, to some large extent, have it right, which is what we're trying to do is make an analysis of competitive effects. I agree with his concentration point, too, which is, I think it's an initial hurdle; but once you're past it, then you have look at truly what's going on in the market.
Innovation is a form of competition. Quality adjusted price is an important form of competition. And you have to make a judgement as to whether or not this merger is going to adversely affect, one way or the other, the incentives of people to innovate.
And what we're really talking about is we're trying to make a prediction in the future of what's going to happen to competition and predict the incentives of -- well, we're going to predict what firms are going to do when we're talking about market power and unilateral effects. And you've got to look at their incentives.
If you take that back to the whole concept here of markets where you have declining demand and you look at consolidation, one of the trade-offs you're making is that you're going to, as a result of the transaction, allow a firm to become, presumably, larger but more efficient.
And we know that efficiencies have to do somewhat with what firm's incentives are, too. So in any of the analysis, I think you've got to come back to the Merger Guidelines, to competitive effects, and to the incentives that are left for the parties in the marketplace to compete or not to compete.
COMMISSIONER STEIGER: Professor Waller?
MR. WALLER: I know we're going back to the a topic that was more formally on the table 10 days ago or so; but I think -- I don't know precisely how that discussion went when you focused on innovation markets.
My two cents is, I find the concept of an innovation market appealing; and my feeling is there probably are such markets occasionally.
But my feeling is that it's not a fertile place for the investment of great resources because in those cases where you can clearly identify them, they're almost always going to be global in nature, almost always going to have multiple players, and almost never pose a risk of great power within your innovation market when you can find one; and more importantly, where that is a legitimate risk of great power in a properly identified innovation market, it can be very hard to measure.
And I just think back to my work as a very junior attorney with the Department of Justice struggling with any number of Hart-Scott-Rodino or other merger-related investigations where in the real world and the time frames you have to analyze these things, it's quite difficult to get a handle on market shares and the structure of industries for goods and services.
And when you extend it to the concept of innovation markets, you're coming very close to pulling numbers out of the air. And you can certainly read portions of the Merger Guidelines as saying, you know, the agencies will estimate these numbers where they can't find hard evidence.
And I'm afraid that that will be the majority of the time.
COMMISSIONER STEIGER: We will go back to failing firms. I'll try to give us a segue into it, which may or may not work.
How would you assess, in a distressed industry, the possible value of dual tracks of R&D?
Would you not consider this in your assessment?
And does this have anything to do with Phil's suggestion that we should consider efficiencies, and I believe with the Assistant Attorney General's suggestion that the actual competitive health of a firm is going to be taken into account in any event in a somewhat less than failing firm situation.
Is there any tie between any of the above?
Or would Professor Hausman tell us that there is no way of determining whether one or two tracks or three tracks of R&D is a matter for our consideration?
MR. CORREIA: Well, I'll try -- I'm sorry. Were you going to respond?
MS. LEEDS: Go right ahead.
MR. CORREIA: I hope this is responsive.
I do think that in a distressed industry situation, there are at least two things going on when mergers are on the table.
There are efficiencies claims. And there are failing company claims. And they tend to be all intertwined together. But they are distinct.
The failing company claim is that some additional capacity can be kept in the market. Even though the market is going to shrink, it's not going to shrink quite as much because some capacity will be kept in through merger.
The efficiency claim is that some consolidation or some acquisition is going to be efficient and reduce cost for the merged firm. And you really -- it's really useful, I think, to try to separate those to the extent you can.
Now, I said this briefly in the paper. The problem is that you've really got all kinds of possibilities. It could be that there are -- you can get costs down by individual firms shrinking. But, frankly, mergers don't help. That capacity is going to exit the industry one way or the other. And it's just as good -- in fact, from the competitor's point of view and a social welfare point of view -- to let those firms -- as the defense industry used to say -- shrink in place.
On the other hand, it could be that -- and I think this is true in the defense industry, at least they started it, and I think there's probably some reason to believe it -- that as those firms shrink, it's actually efficient to reshuffle assets so that you have smaller firms but they look different than they did before the industry became in distress, in effect.
However, I do think the reason -- because you have all those possibilities going on, that situation doesn't lend itself to a particularly easy formula. That's the reason I'm not so much for these rigid definitions of what a distressed industry is that is internal to a different merger standard.
But let me say this, and then that will be my final point for the moment, that history is replete with examples where industries tried to shrink capacity on their own. That's what Socony did.
The oil industry bought up gasoline. The refinery company picked a dancing partner -- that's the way they used to talk in Texas -- they still do talk in Texas that way and Oklahoma where I'm from -- in order to shrink output and get prices up.
That was per se illegal then; it's per se illegal today. I can't imagine that you would look at an industry on its own to deciding to shrink output as a considered action and say that's not a per se restriction of output. It would be.
COMMISSIONER STEIGER: Professor Waller?
MR. WALLER: I think we ought to go back and just talk about what aspect of what the core of the failing firm defense is about. We don't get to it very often because almost never do you satisfy all the rigorous criteria as it's been applied by the Supreme Court and now the Merger Guidelines.
But I don't think we've settled one way or another as to whether we're making a judgment that, well, this company is going out of business anyway and all the
anti-competitive harm that's going to happen has already occurred and maybe a little less harm will occur if we allow the merger rather than the exit.
To me, that's playing the antitrust game.
But the other vision of the failing firm defense is: Well, people can make the argument that the merger will be more anti-competitive than just outright failure and exit. But we should allow it because we want to be nice to shareholders; we want to be nice to mergers; we want to take the sting out of what's going to happen to the communities involved, et cetera, et cetera.
So the first is the antitrust game. The second is the, yes, it's an antitrust violation probably; but we're going to think about some other things. And I think we need to sort that out to see which -- I don't think we'll ever decide which was the basis historically for it. But I think we need to sort out in our minds what should be the basis for it, in order to answer the questions about whether we should tinker with it.
I agree with Professor Hausman that if these efficiencies and other things can be played in the antitrust game, then there may be no net anti-competitive effects.
But some versions of the failing firms acknowledge the anti-competitive effects and want to talk about some other things. And I need to know which game we're playing to say -- you know, to get my honest opinion as to whether the rule's right in its current form.
MS. VALENTINE: Well, I mean, you said you thought at one point that you disagreed with something about social costs that Eddie Correia said. And that might be one way to flush this out.
I mean, are there social costs that one doesn't capture in a balancing of competitive or anti-competitive effects that we are or should be taking account of here?
I think I did hear Phil say that if, in fact, you meet the failing firm defense -- I think this was Phil; it may have been someone else -- but, essentially, at the end of the day, you don't have to worry about anti-competitive effects because, you know, the guy is so far down the road that you've answered the anti-competitive effects question
MR. PROGER: Oh, but that doesn't go to the social cost question.
MS. VALENTINE: Right. So maybe what we should try -- I mean, I think that Eddie thought that some Supreme Court cases incorporated some social cost things, which are possibly different from what you, Spencer, thought the social costs were.
MR. CORREIA: Here's the difference that came up in the original point -- but there may be others, too.
I think it's an open question whether courts can consider social costs in the sense that I don't think Professional Engineers resolved it.
Professional Engineers dealt with rule of reason in a Section 1 case. I'd have to go back and look at dictum; but it still would be dictum even if it's in there that that was -- Stevens was talking about all antitrust analysis. I really don't think he was. I think Professional Engineers leaves it open.
Now, there is a better argument that Citizen Publishing doesn't leave it open; although, Citizen Publishing refers to social costs, in fact, it formulates a defense. It seems to be a rather on/off situation. You either meet it and you have an absolute defense. Or you don't meet it, and it's off the table.
But there is dictum in there that says: The failing firm defense is to protect shareholders, communities, and workers and so on.
So I think if you look at what the Supreme Court says, yes you should consider it, my point about policy is that the antitrust agencies, it's certainly open from a legal point of view. And I think it's advisable to consider social cost in the general formulation of the defense, not in the application of an individual case.
COMMISSIONER STEIGER: Assistant Attorney General, you were going to offer a comment way back when.
MS. LEEDS: Yeah, I guess that it's wandered so much that I probably have several comments now.
I think one of the things -- and I think that Professor Hausman's conversation with Debra Valentine helped clarify it for me, because I had understood the Professor to say that just by consolidating you were going to get more R&D. I think I came out with the same misimpression as --.
MR. HAUSMAN: Just let me interject. I am not talking about the steel industry today. They all hung around the Duquesnes Club; and whatever happened to them, they deserved.
MS. VALENTINE: You said you'd give examples.
MS. LEEDS: But I was happy to hear that what we as enforcers should be looking for is proof that this merger or this consolidation will give the surviving company the motivation to innovate. And I think that that's something that's important for enforcers to consider.
Getting back to the social costs-- which I think is a very, very interesting question, particularly from a practical standpoint -- early on, and I don't remember who made the comment -- it was probably on the other side of the room since I know it wasn't on this side -- it was sort of, well, you don't want the congressman running in and saying, you know, not my constituents. And I think to some extent that ignores the reality of the way merger enforcement occurs even today.
I think that if a merger is important enough to a community and there is enough community outcry, the agency will be hearing from the politicians who are a little bit interested in this.
And certainly at the state level, when you're talking about a more localized effect -- I'm not necessarily talking about a congressman, but perhaps a county commissioner who may be a little bit more open. And I think that they already put their two cents in. Whether the agencies consider that or not is a different issue. And how you measure that is a different issue.
And I guess another interesting comment is, does the consolidation cause more harm than actual exit? And that's something that I personally wrestle with when I look at sort of the hospital situation, when you've got -- and I know not everybody here is into hospitals, but it's been my primary interest -- particularly in Florida where you've got a state that's got a certificate of need. So you have sort of a given capacity, and everybody's saying -- you know, everybody's justifying or attempting to justify mergers by saying, well, you know, you've got 20 percent occupancy rate or 60 percent occupancy and, you know, that's just inefficient and we need to consolidate in order to take care of that.
But one of the things that I find lacking in people's efficiency analysis and the efficiencies arguments that they offer to us is: Well, what are you going to do about that excess capacity? Are you actually going to take those beds out of the market? Or are you going to kind of keep them in and warehouse them? And where is that going?
And I think that that's something that, from an enforcement standpoint, I would like to see more of when we're talking about efficiencies as: Well, where are we going with this excess capacity argument. We all know that some excess capacity is important to have, and a lot of industries have too much excess capacity. But isn't it -- as was pointed out in the background paper, if you start out with, say, three firms of equal size and one buys the other, even if there's excess capacity, then you have one gorilla and one smaller firm and is that really better even though the assets aren't exiting where you would have two more equal players if the hospital just exited on its own.
COMMISSIONER STEIGER: We've got a lot of commentary here.
Let's go first to Phil.
MR. PROGER: Well, I'm really intrigued with this discussion on social costs because I mean I think social policy, jobs, shareholder values, and interests are perfectly legitimate interests for society to have.
For one reason or another, maybe fortunately or unfortunately, they don't happen to be written into the antitrust regime or the statute. But Congress has made the decision. Other nations have put them in. The Bundeskartelant decisions can be appealed to the Ministry of Economics; and they can weigh some of these factors in.
But Section 7 doesn't talk about social costs. It talks about the effect on competition, which I view as a proxy for consumer welfare.
So, one, I think to some extent we are all somewhat constrained by the regime that Congress has set up. And I don't believe that Congress, in that regime, permitted consumers to be hurt long-term for the benefit of shareholders. I think that, at least to date, has been weighed; and it comes out that we're in favor of consumer welfare.
Secondly, I do think -- and I think this is where Lizabeth was going -- you really have to look at what is going on here. I think if you have two plants side by side, each with 40 or 50 percent excess capacity, and say one is failing, that there's a big distinction between allowing them to come together and having the new owner not merge them, not gain any efficiencies, but just continue operate two plants side by side, with a lot of excess capacity, versus having the new owner consolidate into one plant, lower their minimal efficient scale -- not lower their minimal efficient scale -- but get to minimal efficient scale. And lower the costs in the industry.
And I think that's where -- and I think you're right, that we don't give enforcers enough credit for thinking about these things. I think that's where antitrust enforcement policy has to come in.
Some judgment as to what are the obtainable efficiencies and some judgment as to whether or not they're going to be attained, and then finally some judgment, not easy to make, as to whether they're going to get passed on.
So simply allowing someone to acquire someone because you're going to keep the assets into the market, seems to me to not answer the question very well. We've got to go on and figure out what is going to happen to those assets and the costs in the markets.
COMMISSIONER STEIGER: Professor Hausman.
And then I want to turn to Laura Wilkinson, who has been a very key member of our litigation team's cases that involved industry downsizing or rationalizing. And I think she has been waiting to ask a few questions.
But, Professor Hausman, do make your comment.
MR. HAUSMAN: Yeah, I was just going to respond to two points. First, I think the social cost thing is a bit misguided. I agree with what Phil just said, but in a sense it doesn't matter.
Let's think about this.
We know, just to quote Phil's point before, that all firms, even including monopolists, minimize their costs because that's how you make the most profits to your shareholders. Again, I want to put non-profit hospitals off to one side, because I don't know enough about how they operate.
But if I'm a profit-making firm, there's going to be a certain amount of output; and I'm going to produce that in the least cost way.
So social costs really don't enter from the employee's point of view and the community's point of view because, if demand is shrinking and there's enough demand out there, you're not going to employ the employees because you don't have anything for them to make. You're not going to have them just painting the floors or doing something like that, because you're cheating your shareholders.
And so the social costs don't have anything to do with the merger or the failing firm defense. They have to do with the underlying economic environment. There is not enough demand out there.
Now, if you let the merger happen and price goes up, the social costs go up because price goes up and demand follows, and you lay off even more employees because you've cut the demand for your product.
So I don't think that we need to have social costs coming in because they're given by the outside economic environment. And there's nothing that can be done in the failing firm. If you allow two companies to merge, apart from this R&D point and expand output, if demand is going to continue contracting, there's nothing the firms can do. They're just going to have to lay off the employees. You know, they're going to have to close plants. They're going to have to lay off the employees, and the market economy takes care of that.
Now, on the other hand, the shareholders -- or the bond holders -- from my point of view, they get no special consideration whatsoever. They are the residual claimants. They took the risk. And, in fact, I might have bought the shares fully knowing that this industry was going to decline and in decline and thinking that my company that I bought the shares in was a little more efficient than the other; and the other would get out first, and I would make some money.
So you never should feel too sorry for shareholders, I don't think, or bond holders. But the employees we really should worry about. And we should have training programs and whatever when this happens. But the failing firm defense is the wrong way to do it, because demand has declined and we have foreign competition. Whatever it is, we can't solve that by letting two firms merge, unless they can do R&D and improve the product.
And the other point, which Commissioner Steiger brought up that I would just like to briefly refer to is, she said, well, should we have two or three tracks, if I understand your question, Commission.
I'm always wary of ending up with one firm in an industry. So I would want to look at that very closely.
But if you get into the oligopoly situation where even after the merger you're going to have two, three, or four firms left -- which is my film example -- I think you need to be less worried in this situation than you might usually be.
And the reason why is that this industry is already having significant competition because that's why its demand is declining. Computers are out there taking demand away from film. And if you don't do the R&D, you're just going to shoot yourself in the foot. Because the computers just keep improving faster and faster. And if you don't try to keep up with them, you're going to kill yourself. That's what the steel industry did. They sat around the Duquesnes Club. I was brought up in that area. And they kept saying: Life is unfair. But the Germans put in basic oxygen furnaces. And they had a better technology. The Americans could have put it in, but they just kept saying life is unfair. So they deserved what they got.
But I think in most of these industries, now that you have much more foreign competition and you don't have these tariff barriers or other barriers to stop the foreign competition, even thought you may be in an oligopoly situation, it is typically -- perhaps not always, you'll need to look at it -- in the industry and in the remaining firms's best interest to spend money on R&D or they're just going to kill themselves faster.
And because they have all these assets which are unusable in other uses, that's why they're sunk costs, they will find it worthwhile to do the R&D to be able to better compete with the other industries that are taking away their demand.
COMMISSIONER STEIGER: Laura, did that raise anything?
MS. WILKINSON: Well, actually I had a question really for Professor Correia.
You suggest that in the failing firm context, the competitor acquirer is going to be paying a higher price so that's why they're the acquirer and that we should look to see whether the premium is more for efficiencies rather than market power.
And my question comes from the practical side. How do you assume that the companies will be able to show that it's coming more from efficiencies than from market power?
And how will we be able to assess that?
And the same thing in terms of the assessment of whether the firm is actually failing, you say we should relax that. Where do you think we should draw the line and be able to actually assess that in the pre-merger context?
MR. CORREIA: Well, I think that those are very good questions because, in real life, it's very difficult to make these probabilistic assessments, which, after all, is what you're doing; your making probability judgments.
I think what I said -- or at least I made this clear in the paper perhaps -- on that alternative purchaser -- I think Phil said something like this, too -- I think that market power scenario that we've always worried about traditionally, the market power premium scenario probably happens in the real world less than we used to think it happened, because of the probability assessment by the managers of the acquiring firm. That's a big risk for them to put out real money to buy a firm that's losing money unless they can turn that company around.
It strikes me intuitively that it would be a rather narrow range of circumstances when they're betting on price increases to do that.
As a practical matter, what I said was, in the paper at least, give their efficiency claim some added weight. Because you already are going to have to judge those efficiency claims anyway, because you're judging efficiencies as a matter of prosecutorial discretion.
The acquiring firm in the failing firm context will always make efficiency claims. I think they deserve some additional weight when they're going to buy a failing firm and I think maybe that's -- you're able to do that as a practical matter.
Now, how to judge the risk of failure. Well, I can remember doing a few of these things, too; and what you have is a bunch of accountants come in and, you know, they say, "Look, you know, we can't meet our bills"; and then you say, "Well, that's temporary because you could meet your bills a year ago," and the market is going to look this way, and you happen to have a product that's going to be a hot product a year from now. Very, very difficult things to do.
You're already making probability judgments. All I'm saying is: Lower your threshold a bit. If you're operating at the 90 percent threshold before you call it a failing firm now, drop it to 80 percent, drop it to 75 percent.
I think you're making those kind of judgments already.
MS. WILKINSON: I guess, also, for Professor Hausman, on a practical side, how do you propose that we assess this consumer welfare?
It seems a particularly -- we wouldn't be able to draw these nice demand and supply curves. How would we actually assess that, whether there's going to be a quality adjusted price differential after the merger?
MR. HAUSMAN: I think, if we can work backwards, the firm, as a matter of economics, will not do the R&D unless it thinks it can improve quality, because otherwise it's wasting its money. Because if it's going to do R&D and it's not going to improve the quality, people aren't going to buy any more; and they might as well have stuck with the old-quality product. So I think you can take the profit maximizing motive as given.
The thing that you have to prove, though -- or have to accept as proof or have to be convinced, I guess, from your point of view is that there are identifiable areas of R&D which the firm's engineers have previously come up with but do not pass the hurdle rate with the current industry structure.
But if the firm were able to increase its size by buying someone else and increase the demand, they would then pass the hurdle rate. So this is what I tried to answer before, you would be very wary of somebody coming in and just making it up, saying: "Well, we never looked at this stuff before, but now that we want to merge, we just had these great ideas and, you know, we're going to come out with this new product and it's going to be the greatest thing since Wonder bread.
If I were in your shoes, I would turn that down.
On the other hand, if they have an R&D department, which these industries typically have, and they have been turning out ideas but just could not prove them up because they're too small in relationship to the market, then I think you're ready to go.
MS. WILKINSON: But wouldn't you find in most industries that the engineers are going to have a wish list of things they'd like to do if they had a whole lot more money?
And can't they just sort of bring that out at this time and say: "Look, these are the things we would have done"?
MR. HAUSMAN: That's a good question, Laura. But as I try to say in the paper, the hurdle rate in a declining industry will be higher than it is in a regular industry.
Let's say that in a regular industry -- however they want to do it, given the risk -- it's going to be 18 or 19 percent. In a declining industry, you should use a higher hurdle rate than that because of the economics. That's what I discuss in the paper.
And in that type of situation, what I'm thinking is there's this wedge between the firms private incentive and the social incentive. And, yeah, everybody has a wish list; but if this firm says, well, because we're in a failing industry, rather than 18 percent hurdle rate, we're going to use a 23 percent hurdle rate. And what I'm saying is that if they were to merge and have higher demand, they would be able to lower that hurdle rate and would be able to do the R&D.
MS. WILKINSON: Okay. Well, then I look forward to reading your paper. I didn't have time to read it before this and look at the difference in the hurdle rates.
MR. HAUSMAN: You'll like it.
COMMISSIONER STEIGER: By the time we get to restudy his paper, we will have the regression analysis run; isn't that right, from our economists?
MS. LEEDS: I just wanted to add, in looking back over my notes, one more sort of throw-something-else-into-the pot, I guess, about these social costs issues.
And again, back to the experience in other countries, for example the New Zealand sort of yes, but. And I think to some extent, some of the states have tried to do that, particularly in the health care field where they have these sort off, come to us first, tell us about what you want to do, and, you know, we'll take a look at it and we'll give you an exemption.
The problem, of course, in our system of government is that does not necessarily guarantee an exemption from the federal authorities. And I think to the extent that that is not a given, people have been hesitant to avail themselves of that option, even when it is out there.
And an additional innovation by some states -- and certainly the feds -- is this business review process, which certainly gives at least the real world some idea of what's going to fly and what isn't going to reply.
But I think that it was very interesting for me to hear about, and to read on the plane this morning, about New Zealand and how they sort of balance all that. And I think that, on the state level, that is occurring or trying to occur.
The question is how we can rationalize that with our federalist approach to government.
MS. DeSANTI: I have a question for Professor Waller. I'm interested in knowing whether you have any information on how these yes-but situations have worked out in practice.
I'm interested in part because we have some testimony during the course of these hearings indicating that, for some industries in the United States that have gone through very bumpy transitions but where competition was, in fact, the force that produced the rationalization, quote, unquote, of the industry, it was a bumpy ride but we got to a more competitive, more efficient structure, more quickly than, say, in Europe where there were rationalization agreements in the same industry.
I'm wondering if you have any light that you can shed on that in light of your comparative studies?
MR. WALLER: I've never done any empirical work on that particular question. But I've read some of the people who have.
And to me, the most telling -- I'm trying to reach back to make sure I have the writer's name. I believe it's a professor named Tony Freyer, who did an historical study of U.S. and English antitrust policy toward big business; and the English are the closest of all the systems that I studied, that they come to the closest to sort of having eviscerated the whole idea of having an antitrust law in the name of the general public interest.
For years and years and years, you know, they have given us the common law principles that have evolved into the Sherman Act. But for reasons that I can't entirely explain, early on, they allowed the kind of arguments that we never allowed in -- after the passage of the Sherman Act, the early price fixing cases, the defendant said, oh, but this is reasonable because we fixed a reasonable price. And the Supreme Court said, no, you don't understand what we mean. And then they went, well, okay, our next try is this is reasonable because our industry just isn't right for competition. Then the Supreme Court said, no, you don't understand that argument either. And gradually we got to the rule of reason as it's been interpreted, meaning does it unreasonably restrict competition.
The British veered off in a different direction and allowed all kinds of arguments why blatant naked restrictions on competition were nonetheless reasonable or desirable in a general sense of that term.
And Freyer's study suggested that what you got as a result of that were lots of industries characterized by firms that were not coming close to the relevant economies of scale and were characterized by the existence of some version of a cartel or something awfully close to that years into the future; where that affected America was that the cartel couldn't be pursued but that mergers were relatively permissive and were pursued and, as a result, in his view, one of the contributing factors to Britain losing its industrial preeminence was the fact that they were willing to tolerate all kinds of sort of public interest reasons to allow restrictions on competition where the U.S. ended up with world class industries because they merged rather than colluded under various public interest rationales.
MR. PROGER: I think Spencer's comments are very helpful, particularly if you understand the historical precedent, to understand why I think the competition model still works.
One of the fundamental problems you had -- and the U.S. put its own particular spin on it -- is, historically, the competition laws that we got from England and that they had were not consumer welfare laws. They were actually protect competitor laws.
And when we -- when Kansas and Iowa and some of the states started passing the statutes and then when we did, we inherited a common law that had prohibitions against restraints on alienation. And they didn't deal with competition. They really dealt with what competitors, suppliers, manufacturers could do.
And, quickly, our courts, as well as theirs, had to sort or rationalize that because it didn't work.
We went in the way of consumer welfare. They didn't quite go in that way. And, hence, you got a very different system.
But I was really struck on the questions raised about how do you handle this. And it strikes me that if you can get over the hurdle that we made an election at some point that our laws were designed to protect consumer welfare and that we were going to promote competition as a means to do so and that we didn't figure social costs in that equation -- whether they should be or not, we didn't and haven't -- then if you're protecting consumer welfare and you look at this, I think that the answer is: We've really done pretty well with the analytical discipline we've developed. And that means you've got to really understand what's going on in the marketplace.
There are inherent limitations on this. In merger analysis, we're trying to predict the future. Well, no one can do that. So you use some models, some assumptions; but essentially there's no substitute for trying to understand what's going on. And you can't really talk in generalities here.
For example, we keep talking about an industry with decline in demand and you want to have consolidation of two manufacturing plants. It's very important to know, to measure that analysis in terms of antitrust markets, to understand why demand is declining.
Just to give a simple illustration I just thought about sitting here, let's say you have an industry where, for some reason, bottles and cans have historically not been cross elastic, that they have haven't been price sensitive. And then something changes. It's because cans were way too expensive for certain end uses. And something happens in their manufacturing process and they knock their prices way down. And all of a sudden, they're competitive and they're a good alternative use in these end uses and they start taking away market share from bottles. So that in the end, bottles are left with a lot of excess capacity, they're too expensive for a lot of end uses, and you've got an industry that's declining.
Now the industry goes to rationalize. I think it's very important to understand why. And if one of the reasons why it's rationalizing is, because of historic accident, it's costs are too high and because some players think by coming together they can obtain efficiencies, lower their costs and now, once again, become a competitive substitute in the end uses where cans had taken over, that's very different, it seems to me, antitrust enforcement policy than in a situation where, what you've got is an industry where there are no substitutes, demand is -- well, there's always substitutes in some finite sense -- I apologize, Jerry. And I can't even see him. I don't have my glasses on, but I recognized my mistake immediately.
But in another industry where products are very imperfect substitutes and there's no next cost substitute and for whatever reason you've got historical excess capacity -- I mean, we could be foolish, we overbuilt for the demand. Now the reason is simple as that. You may have a very different enforcement policy to the rationalization of those assets.
And it seems to me competitive analysis, the type of Section 7 analysis we do, if properly done, is flexible enough to take those considerations into account and, in fact, do, should.
MR. CORREIA: Just a couple of words on this point.
Neither the legislative history of Cellar-Kefauver nor Supreme Court cases, nor the text of Section 7 preclude considering social costs.
And, in fact, they point generally toward considering social costs. And how you do it is another matter. But we're certainly not foreclosed from the history of that statute.
I do think, as a general matter, though, it only comes up in kind of a narrow range of circumstances.
The typical case is going to be a situation where output is going to basically resolve the issue one way or the other. If it's pretty clear a firm's assets are going to exit the market, as I said earlier, it's better to allow that merger than to see those assets exit the market.
That's the easy case.
It's when the risk of failure starts to go down that at some point the social cost may affect your threshold.
Now, let me just go back to this issue of the yes-but or however we were formulating that. There's really no good way to do that. I mean, we struggle with it a lot in this country. When you've got -- demand is falling and prices are going down and the industry comes in -- or people are losing money, they want to get output down. They always want to get output down.
Now, there are three ways to do it: You can do it on your own, let the industry do it on their own. That's what Appalachian Coals did.
That's the only case, by the way, where the Supreme Court ever referred to a distressed industry. There's a line in there, the industry was in distress. That's the original distressed industry.
You can let government bless it, the executive branch bless it, or Congress bless it. That's the old hot oil case during the depression and the refinery case. That's exactly what those cases did, government participated in restricting output.
But the industry -- the problem is the industry will restrict output in a way that gets prices up. Consumer welfare is being ignored in that situation.
You can let government planners do it, and our current Secretary of Labor has occasionally written that, well, we ought to do that. That raises all kinds of problem. And the country's not been willing to do it.
And the third way to do it is let the market do it. Very painful. But that's the route we have chosen. And that means that there's going to be a lot of uncertainty out there. People are going to make wrong guesses. There are going to be people out of work for a while. But ultimately the industry will shrink and that is, more or less, the way we have chosen it. And I agree, it's worked pretty well.
COMMISSIONER STEIGER: On that note, I had a request for one final question from Laura. So yours will be the last one.
MS. WILKINSON: Okay. For Mr. Proger, you mentioned that you thought the alternative purchaser prong should be changed because in part, it places a premium on companies that would not have efficiencies.
I guess assuming that we're looking only to horizontal competitors and, therefore, that we're looking at companies that would not have efficiencies -- maybe I have this backwards.
But couldn't there also be efficiencies if the company was a vertical integrating company rather than a horizontal competitor and, therefore, the alternative purchaser prong might actually include efficiencies?
MR. PROGER: Well, sure there could. But the basis of the doctrine is that you're going to choose the purchaser that has the least anti-competitive effect.
And to the extent that you may have a vertical purchaser that can obtain efficiencies but somehow there could be horizontal adverse effects, you would still prefer -- at least as I understand the doctrine, the agency would still prefer someone that has no relationship to the marketplace.
Well, a fortiori, as a matter of logic, if that purchaser has no relationship to the marketplace, I don't believe that you're going to obtain any efficiencies, and so you've lost them.
MS. WILKINSON: Okay. Maybe I didn't understand the point you made earlier.
COMMISSIONER STEIGER: On that, on behalf of our distinguished panel here at this table, from the FTC, our thanks to Professors, Practitioners, Enforcers, for a very enlightening and very useful afternoon from the point of the view of the Commissioners.
Thank you so much.
(Whereupon, at 4:00 p.m., the hearing was concluded.)
C E R T I F I C A T E
DOCKET/FILE NUMBER: P951201
CASE TITLE: GLOBAL AND INNOVATION-BASED COMPETITION
HEARING DATE: November 14, 1995
I HEREBY CERTIFY that the transcript contained herein is a full and accurate transcript of the notes taken by me at the hearing on the above cause before the FEDERAL TRADE COMMISSION to the best of my knowledge and belief.
DATED: November 14, 1995
SIGNATURE OF REPORTER
GREGG J. POSS
(NAME OF REPORTER - TYPED)