The Effects of Competition: Cartel Policy and the Evolution of Strategy and Structure in British Industry

Published by EH.NET (July 2003)

George Symeonidis, The Effects of Competition: Cartel Policy and the Evolution of Strategy and Structure in British Industry. Cambridge, MA: MIT Press, 2002. x + 542 pp. $55 (cloth), ISBN: 0-262-19468-6.

Reviewed for EH.NET by Margaret C. Levenstein, Department of Economics, University of Massachusetts and University of Michigan Business School.

This well-written, careful, and insightful book examines the impact of the 1956 Restrictive Trade Practices Act; this Act effectively outlawed most price fixing agreements in Great Britain. Symeonidis is particularly interested in two related questions. First, what was the impact of this increase in competition on the level of concentration of British industry? Second, what was the effect of increased competition on innovation and advertising in British industry? He finds that, in all industries, the ban on cartels and the resulting increase in competition led to increases in industry concentration. He argues that increases in competition decreased profits; those profits were restored by reductions in the number of firms in the industry. He finds that, in industries that spent a lot on advertising, those expenditures fell slightly following the elimination of cartels. Advertising was apparently an alternative to price competition. When price competition increased, firms no longer needed and could no longer afford the same level of advertising expenditures. Concentration increased in advertising-intensive industries, but the increase in concentration took place over a longer period of time than in industries with relatively low levels of advertising. He finds that, in industries that spent a lot on research and development, the rate of innovation, both as measured by R&D expenditures and as measured by innovative output, did not change as a result of the increase in competition. But the resulting increases in concentration in R&D-intensive industries were quite substantial.

Symeonidis addresses two theoretical issues that are central to industrial organization. First, he quite explicitly critiques the Structure-Conduct-Performance paradigm. In particular, he rejects the argument that that industry structure — the level of concentration — determines industry conduct — the intensity of competition. Instead he builds on the work of his advisor, John Sutton, to turn S-C-P on its head, arguing that “firm conduct, which is partly determined by exogenous institutional factors, is an important determinant of market structure” (pp. 87-88).1 That is, market structure is not determined, as thousands of students are taught in introductory microeconomics courses every year, by the size of the market and the technology of production. It is determined as well by the strategies pursued by the firms in the industry, by the institutions that govern the nature of competition in the industry, and by the history of competition and cooperation in the industry. This is the most profound point of this whole line of research and it is borne out by this work.

Empirically, Symeonidis finds that there is a simple correlation between industry concentration and the existence of a collusive agreement in the industry. But he argues that capital intensity is what actually increases the likelihood of collusion and that once capital intensity is controlled for, the apparent correlation between industry concentration and the propensity to collude disappears.

[T]here is no evidence of any linear association [between concentration and collusion], although a non-linear relationship is present in some regressions, with both very low and very high concentration hindering collusion. There is strong evidence that collusive pricing is less likely in advertising-intensive industries than in low-advertising industries, and weak evidence that it is less likely in R&D-intensive industries than in low R&D-industries (p. 81).

The second major issue that Symeonidis tackles is the relationship between concentration, competition, and innovation. Much of the existing literature takes industry structure and firm size as exogenous and asks whether more concentrated industries of larger firms are more or less innovative than industries made up of many small firms. Symeonidis’s approach, again following Sutton, treats industry structure as endogenous and the intensity of competition as exogenous. He argues that, if firms are competing intensely, then small firms in an unconcentrated industry will not be able to recoup their investments in R&D. The only way to support R&D if firms are competing intensely in price is to reduce the number of firms in the industry. If price competition is less intense, then an unconcentrated industry structure can still support high R&D investment. His empirical finding is consistent with this argument. When the intensity of price competition increased because of legal changes, firms did not decrease their expenditures on R&D. Instead, concentration in these industries increased, reducing the average number of firms in an industry by about twelve percent (pp. 312-313) and increasing the five firm concentration ratio by about ten percent (p. 265). He hypothesizes that the impact of increased competition was on concentration rather than on R&D expenditures because of the nature of competition in industries that invest a lot in R&D. Any firm that chose to spend less on R&D would quickly become unable to compete at all in an industry where innovation is important. So firms either maintained their R&D expenditures or exited; there was no in-between option.

He does find “evidence of a strong negative relationship between collusion and the number of innovations produced across UK manufacturing industries within the [high R&D intensity industries] during the 1950s” (p. 83). In fact, his measure of innovativeness is three times as high for industries without cartels as those with them. But he argues that this does not necessarily mean that collusion undermines innovation. Most of the inter-industry differences in innovation are attributable to “time-invariant industry characteristics [such as] technological opportunity [and other] … variables difficult to measure or to observe, including random events” (p. 259). In industries with high returns to R&D, Symeonidis argues, it may simply be harder to maintain collusive agreements.

He finds a somewhat different empirical result in his study of advertising-intensive firms. His analytical model of advertising is essentially identical to his model of R&D. Firms choose to invest in either R&D or advertising; by doing so they increase consumers’ willingness to pay for their products in the future. In different industries, the effect of R&D or advertising on consumers’ willingness to pay differs, but the payoff is known in advance and is completely exogenous. But while for R&D-intensive industries, the effect of increasing competition was felt solely in increased concentration, with no change in R&D expenditures, the effect of the 1956 Act in advertising-intensive industries was felt both in advertising expenditures and in increased concentration. Symeonidis argues that the reason for the difference in the impact of advertising and R&D is that while high-intensity and low-intensity advertising firms can co-exist within a single industry, competing against one another, it is much harder for low-R&D firms to compete against high-R&D firms, by offering a low price. So there is more homogeneity within industries with respect to R&D than there is with respect to advertising.

Symeonidis finds that industries without cartels have much higher advertising expenditures than cartelized industries. He argues that this is not the result of collusion to reduce advertising expenditures; rather firms are more likely to turn to collusive pricing in industries where advertising is ineffective. He argues that this is why during a period of declining advertising intensity (because of the advent of television and other exogenous changes), advertising fell more in formerly collusive industries than in non-collusive industries. Those were industries in which advertising was less effective to begin with.

Symeonidis’s treatment of advertising will not be entirely satisfying to advertising historians who have analyzed in detail the active role that firms play in shaping their markets and their consumers to influence “the effectiveness” of their advertising dollars. But even if Symeonidis’s assumption of the exogeneity of advertising effectiveness is not literally correct, it is still useful to the advertising historian to learn how an increase in competition affects firms’ investments in advertising. Symeonidis is careful enough in framing his questions that none of what he finds is vitiated by the assumption of exogeneity, so there is much that non-quantitative historians or those who don’t use formal models can learn from this analysis.

This book is based on a dissertation written under John Sutton at the London School of Economics. Sutton’s work illustrates that the divide between economic theory and economic history is not necessary, and that bridging those gaps can have real payoffs. While most of Sutton’s own research is theoretical, he draws heavily on historical and empirical studies of industrial organization. He pays attention to historical detail and to the ways that history shapes present possibilities. Symeonidis’s study reflects and does proud Sutton’s tutelage. It uses theory, empirical data and formal econometric analysis, and qualitative historical and institutional analysis to pull together a very elegant treatment of the shift in British competition policy (what we in the United States call “anti-trust policy”) from one that was permissive regarding explicit price-fixing or output-restriction agreements to one that banned them. The study places this policy change in its historical context, relying largely on secondary sources for its political and institutional analysis. Symeonidis uses an extremely carefully and conscientiously developed data set to evaluate the theory. The appendices outlining the collusive agreements from which Symeonidis constructed his data set will, all by themselves, make this book one of value for historians of British industry and the history of industry cooperation. He also presents several case studies of individual industries. These case studies are quite nice in illuminating the dynamics of the story that he tells, as well as demonstrating the usefulness of economic theory in understanding industry history, even where the history seems to be at variance with the standard model.

Symeonidis’s finding that the 1956 change in competition policy led to a decline in the number of explicit price-fixing agreements in British industry, and that that the resulting increase in competition led to a subsequent increase in concentration will ring familiar to the ears of many. U.S. economic historians have frequently noted a similar pattern following the introduction of anti-trust prohibitions in the United States in the late nineteenth century. In the United States the 1890 Sherman Act ban on price fixing preceded by twenty-five years the Clayton Act regulation of mergers. In the intervening twenty-five years, concentration increased significantly in a large number of U.S. industries. Current European Union policy is similarly quite clear and explicit about limitations on price fixing and output restrictions, but the European Courts have limited the European Commission’s attempts to enforce a rigorous merger policy. Ongoing discussions in the World Trade Organization and among developing countries favor a sequencing of competition policies, with bans on explicit price-fixing and output-restriction preceding the development of merger policy. Symeonidis’s work provides a timely reminder about the unintended effects of such sequencing. Rather than achieving greater competition, we may instead find ourselves with greater concentration. That increase in concentration will not be reversed by itself, but can have long-lasting effects on things as varied as the direction of innovation and in important industries like communication and media, the vibrancy of democracy.

The theoretical model presented in the book assumes that the profits of the firms that remain in the industry increase as other firms exit, but the mechanism for this increase in profit is not made explicit. In particular, it is left open whether the increase in profits arises from an increase in prices, say as a result of Cournot competition, or a decrease in costs, as a result of higher cost firms being the first to exit the industry. Symeonidis is careful not to rule out either of these possibilities. And while they are both consistent with the theoretical and empirical findings of the book, the difference between the two — increases in price or decreases in costs — is extremely important for policy analysis.

The process by which concentration adjusts in response to changes in profits is through entry and exit. Thus the assumption of free entry and exit, even in the presence of collusive agreements, is critical. Symeonidis specifically tests this assumption in the book. He finds that long-run profits do not change for firms in formerly collusive industries (though they do dip following the dissolution of their cartels). He argues that if cartels had created barriers to entry, long run profits would have fallen after the demise of the cartel. Another possibility is that the actions that cartels take to restrict entry, such as creating joint distribution mechanisms or restricting the diffusion of technological knowledge, may continue to restrict entry even after formal collusion is abandoned. He correctly concludes that “… the monitoring of entry conditions into industries is a key priority for competition policy” (p. 20).

Symeonidis’s analysis of the effect of the 1956 Restrictive Trade Practices Act on research and development and advertising expenditures also depends on the assumption that these strategic variables were not themselves the subject of collusive agreements. Rather, changes in R&D and advertising in formerly collusive industries are the result of increases in price competition among the extant firms, not the result of a change in the collusive agreement per se. He has carefully examined the agreements among the firms in his sample and notes that it was quite rare for them to include any agreement or restrictions on investment, R&D, or advertising. The one exception to this was in the electrical and electrical equipment industries, where patent pooling agreements were quite common. There have been several important recent theoretical contributions that model “semi-collusion” where prices are agreed upon but investment is not.2 Symeonidis’s work will help to ground that growing line of theoretical research.

We should be careful not to presume that we can extend this finding — that collusion focuses on prices and quantities and ignores other important strategic variables, such as advertising and investment — to other cartels. As Symeonidis acknowledges, these agreements were written in a particular historical, legal, and institutional context. Many of these agreements were made in relatively unconcentrated industries and were explicitly open to any new entrants to the industry. He even speculates that the agreements that were submitted were often somewhat different from industry practice prior to the passage of the 1956 legislation, as they were crafted so as, hopefully, to meet the approval of the Monopolies and Restrictive Practices Commission. (Most did not.) Thus they were quite explicitly relatively weak agreements. That has not always been the case in more recent, secret, illegal cartels. For example, in a recently prosecuted international cartel, trial testimony indicates that graphite electrode manufacturers from the U.S., Japan, and Germany did discuss long-term investment plans and modify them to facilitate continued collusion.3

One important question is whether or not the agreements Symeonidis studies were actually effective. This is particularly relevant given the convincing evidence that that entry was easy and was accommodated by incumbent firms and that the agreements did not restrict investment. Symeonidis argues that they were effective, but what he shows is that members followed the agreements, not that the agreements raised prices above or restricted output below “competitive” levels: “The available case-study information on collusive prices also supports the view that the agreements were, in general, effective. Prices of outside firms were typically lower than the cartel prices, although sometimes they were identical or only marginally lower” (p. 38-9).

Thus it is possible that in many industries eliminating formal agreements had little effect on the intensity of competition. Still, Symeonidis does find changes in concentration in industries that were required to eliminate their agreements that were significantly greater than in other industries. This alone provides support for his contention that the agreements did restrict certain kinds of competition.

Symeonidis gives long detailed descriptions of, and justifications for, the variables he chooses to use in his empirical analyses. These do not always make for scintillating reading, but they are refreshingly honest and allow for a fair and complete appraisal of his findings. They also provide an excellent example of how an empirical researcher can grapple with complex issues arising from economic theory, econometrics, and specific historic events and make choices that allow one to draw useful conclusions about both history and theory, despite all.

Notes: 1. See John Sutton, Sunk Costs and Market Structure: Price Competition, Advertising, and the Evolution of Concentration, MIT 1996, and Technology and Market Structure: Theory and History, MIT 1999.

2. See, for example, C. Fershtman and N. Gandal, “Disadvantageous Semicollusion,” International Journal of Industrial Organization, 12 (1994), 141-54; C. Fershtman and E. Muller, “Capital Investment and Price Agreement in Semicollusive Markets,” RAND Journal of Economics, 17 (1986), 214-26; F. Steen and L. S?rgard, “Semicollusion in the Norwegian Cement Market,” European Economic Review, 43 (1999), 1775-96; and C. Fershtman and A. Pakes, “A Dynamic Oligopoly with Collusion and Price Wars.” RAND Journal of Economics, 32:2 (1998), 207-236.

3. Margaret C. Levenstein, Valerie Y. Suslow, and Lynda Oswald, “Contemporary International Cartels and Developing Countries: Economic Effects and Implications for Competition Policy” Antitrust Law Journal, 71:3 (2003).

Margaret C. Levenstein is Associate Professor of Economics at the University of Massachusetts and Visiting Associate Professor of Business Economics and Public Policy at the University of Michigan Business School. Her current research interests include international cartels and international competition policy and the role of local and regional financial institutions in economic development. She is the author of Accounting for Growth: Information Systems and the Creation of the Large Corporation (Stanford University Press, 1998). She is working on a book with Valerie Suslow and Simon Evenett entitled International Cartels in Global Markets. The three are also the co-authors of “International Cartel Enforcement: Lessons from the 1990s,” The World Economy: Special Global Trade Policy Issue, 24:9 (2001), 1221-1245.