The Myth of Predatory Pricing
by Thomas J. DiLorenzo
Thomas J. DiLorenzo holds the Scott L. Probasco, Jr., Chair of Free Enterprise at the University of Tennessee at Chattanooga.
Executive Summary
The attempt to reduce or to eliminate predatory pricing is also likely to reduce or eliminate com petitive pricing beneficial to consumers.
--Harold Demsetz
Predatory pricing is one of the oldest big business conspiracy theories. It was popularized in the late 19th century by journalists such as Ida Tarbell, who in History of the Standard Oil Company excoriated John D. Rockefeller because Standard Oil's low prices had driven her brother's employer, the Pure Oil Company, from the petroleum-refining business.(1) "Cutting to Kill" was the title of the chapter in which Tarbell condemned Standard Oil's allegedly predatory price cutting................
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The Futile Search for a Predatory Pricer
Even though predatory pricing was part of the theoretical underpinning of the original federal antitrust laws, and there have been hundreds of federal antitrust cases based on claims of predatory pricing, economists and legal scholars have to this day failed to provide an unambiguous example of a single monopoly created by predatory pricing. (In contrast, no such ambiguity exists in the case of government-sanctioned monopolies created by protectionism, exclusive franchising, grandfather clauses, occupational licensing, and other government-imposed barriers to competition.)
The theory of predatory pricing is no longer widely accepted by economists, but it was the conventional wisdom before McGee's 1958 article. The economics profession--and antitrust practitioners--accepted the notion as a matter of faith even though no one (before McGee) had conducted a systematic economic analysis of predatory pricing.
By 1970 more than 120 federal (and thousands of private) antitrust cases in which predatory pricing was alleged had been brought under the 1890 Sherman Act. Yet in a 1970 study of the so-called gunpowder trust--43 corporations in the explosives industry--Kenneth Elzinga stated, after an extensive literature search, that "to my knowledge no one has ever examined in detail, as McGee did, other alleged incidents of predatory pricing."(21) Elzinga found no evidence that the gunpowder trust--which had been accused of predatory pricing--actually practiced it.
Shortly after Elzinga's work appeared, Ronald H. Koller examined the "123 federal antitrust cases since the passage of the Sherman Act in 1890 in which it was alleged that behavior generally resembling predation had played a significant role."(22) Ninety-five of those cases resulted in convictions, even though in only 26 of the cases was there a trial that "produced a factual record adequate for the kind of analysis employed" by Koller.(23) Apparently, many of the defendants decided it was cheaper to plead guilty than to defend themselves.
Even though no systematic analysis of predatory pricing was performed in any of the 123 cases, Koller established the following criteria for independently determining whether a monopoly was established by predatory pricing: Did the accused predator reduce its price to less than its short-run average total cost? If so, did it appear to have done so with a predatory intent? Did the reduction in price succeed in eliminating a competitor, precipitating a merger, or improving "market discipline"?
Koller's criteria give predatory pricing theory more credit than it deserves. As was explained earlier, below- cost pricing per se is not necessarily a sign of predatory behavior; it is a normal feature of competitive markets. Moreover, determining predatory intent is an exercise that is far beyond the capabilities of any economist and for which mystics might be better suited. And "eliminating a competitor" is the very purpose of all competition.
Employing those criteria for determining predatory behavior, Koller found that below-cost pricing "seems to have been at least attempted" in only seven cases.(24) That, of course, proves nothing about monopolizing behavior, given the fact that below-cost pricing can be just as easily construed as competitive behavior. Koller claims that in four of the cases low prices seemed to have been motivated by the desire to eliminate a rival. One would hope so! The entire purpose of competitive behavior--whether cutting prices or improving product quality--is to eliminate one's rivals.
Even in the cases where a competitor seemed to have been eliminated by low prices, "in no case were all of the competitors eliminated."(25) Thus, there was no monopoly, just lower prices. Three cases seem to have facilitated a merger, but mergers are typically an efficient alternative to bankruptcy, not a route to monopoly. In those cases, as in the others, the mergers did not result in anything remotely resembling a monopolistic industry, as defined by Koller (i.e., one with a single producer).
In sum, despite over 100 federal antitrust cases based on predatory pricing, Koller found absolutely no evidence of any monopoly having been established by predatory pricing between 1890 and 1970. Yet at the time Koller's study was published (1971), predatory pricing had long been part of the conventional wisdom. The work of McGee, Elzinga, and other analysts had not yet gained wide recognition.
The search for the elusive predatory pricer has not been any more successful in the two decades since Koller's study appeared. The complete lack of evidence of predatory pricing, moreover, has not gone unnoticed by the U.S. Supreme Court. In Matsu****a Electric Industrial Co. v. Zenith Radio (1986), the Court demonstrated knowledge of the above-mentioned research in declaring, effectively, that predatory pricing was about as common as unicorn sightings.
Zenith had accused Matsu****a and several other Japanese microelectronics companies of engaging in predatory pricing--of using profits from the Japanese market to subsidize below-cost pricing of color television sets in the United States. The Supreme Court ruled against Zenith, recognizing in its majority opinion that
a predatory pricing conspiracy is by nature speculative. Any agreement to price below the competitive level requires the conspirators to forgo profits that free competition would offer them. The forgone profits may be considered an investment in the future. For the investment to be rational, the conspirators must have a reasonable expectation of recovering, in the form of later monopoly profits, more than the losses suffered.(26)
The Court also noted that "the success of such schemes is inherently uncertain: the short-run loss is definite, but the long-run gain depends on successfully neutralizing the competition."(27) The Court continues, "There is a consensus among commentators that predatory pricing schemes are rarely tried, and even more rarely successful."(28)
In that case, Zenith and RCA were obviously attempting to use the antitrust laws, via their accusation of predatory pricing, to eliminate some of their foreign competition. The Court determined, for example, that "two decades after their conspiracy is alleged to have commenced, petitioners appear to be far from achieving their goal: the two largest shares of the retail market in television sets are held by RCA and . . . Zenith, not by any of the petitioners."(29) Moreover, the share of the market held by Zenith and RCA "did not decline . . . during the 1970s," which provides further evidence that "the conspiracy does not in fact exist."(30)
The Court concluded by warning potential litigants of the folly of bringing predatory pricing cases.
Cutting prices in order to increase business often is the very essence of competition. Thus, mistaken inferences in cases such as this one are especially costly, because they chill the very conduct the antitrust laws are designed to protect.(31)
Since predatory pricing schemes "require conspirators to suffer losses in order eventually to realize . . . gains," the Court concluded that "economic realities tend to make predatory pricing conspiracies self-deterring."(32)
What predatory pricing comes down to is a theory and a legal doctrine that are still used by inefficient firms to try to get the coercive powers of government to attain for them what they cannot attain in the marketplace. As former Federal Trade Commission chairman James Miller has written, government has all too often used predatory pricing as a vehicle for instructing businesses to "stop competing, leave your competitors alone, raise your prices."(33)
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Conclusions
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Harold Demsetz is right. The attempt to reduce or eliminate so-called predatory pricing will only eliminate competitive pricing, which is beneficial to consumers.(53) Predatory pricing is simply illogical, although there are some highly stylized economic models that claim that it is feasible under certain assumptions. Other research has shown, however, that predatory pricing cannot even be replicated under laboratory conditions by "experimental" economics.(54) In either case, an unambiguous example of a free-market monopoly that was established as a result of predatory pricing has yet to be found.
Unfortunately, the doctrine of predatory pricing still motivates antitrust suits and other protectionist pleadings. Significantly, it is legislation and regulation enacted in the name of predatory pricing (not predatory pricing itself) that are truly monopolizing. Government--not the free market--is the source of monopoly.
http://www.cato.org/pubs/pas/pa-169.html
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