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Mergers Raise Prices, Not Efficiency

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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Economies need competition to work. Almost all basic economic theories, including supply and demand itself, rely on the assumption that companies lower prices to undercut the competition whenever possible. If sellers can set whatever prices they like, that’s a monopoly. And as any good Econ 101 class will teach you, monopolies hold production below its economically efficient level, in order to extract extra profits. Monopolies replace the magic of the invisible hand with a distorting visible one, and the economy shrinks as a result.

In the real world, absolute monopolies are very rare. But even if there is more than one company in a given industry, there can be monopoly-like effects if the number of companies is small enough. This is called “oligopoly,” “market concentration,” or “market power.” And it’s something that can be measured fairly easily. From a recent report by the Council of Economic Advisors, here is a look at how some major sectors of the U.S. economy have become more concentrated in recent years:

More for Monopolies
Percentage point change in industry revenue share of 50 largest companies, 1997-2012
 
Source: Council of Economic Advisors

While a few industries have become less concentrated, most of the move is toward oligopoly. That’s good news for the stock performance of the winning companies, but it could be bad for the economy, since oligopolies can limit production in order to push up prices.

Look in the news, and you can see the trend unfolding -- as well as attempts to fight it. The drugstore chains Walgreens and Rite-Aid are planning a mega-merger, which they’ve delayed (but not canceled) because of antitrust concerns. Alaska Air and Virgin America are in a similar situation. Chemical giants Dow and DuPont are merging too, despite European concerns. These are only a few examples, but the merger boom has been changing the face of the U.S. economy for years now. Mergers took off in the early 2000s, fell after the financial crisis, and have now rebounded to record levels.

Defenders of mergers often claim that they have a positive effect on efficiency. This is a phenomenon that economists call “economies of scale” -- a bigger company can, in theory, lower production costs by reducing fixed costs, standardizing manufacturing processes, combining supply chains and streamlining operations. If these economies of scale are big enough, they could even cancel out the harm done by increasing market concentration.

So this is yet another case where clashing economic theories have to be resolved by turning to data. Bruce Blonigen and Justin Pierce of the Federal Reserve Board have some evidence. In a new paper titled “Evidence for the Effects of Mergers on Market Power and Efficiency,” they look at how mergers in manufacturing affect corporate performance. What they discovered is that mergers usually tend to increase market power -- in other words, they allow companies to increase profits by hiking prices. But they don’t find much evidence for improved efficiency.

Blonigen and Pierce looked at data from 1997 through 2007. They focused on manufacturing because it’s easy to identify production -- in contrast to a service industry like finance, where measuring production is much harder. The authors compare factories that get acquired in a merger to similar factories, and to factories for which a merger has been announced but not yet completed. This allows them to isolate the effect of the merger itself.

They have two big findings. First, markups -- the difference between the cost of production and the price the company charges -- tend to go up after a merger. That means that the companies are getting more market power by combining. But Blonigen and Pierce also find that efficiency doesn’t increase. Plants that get acquired don’t tend to produce more. Nor do companies tend to do much reallocation from less productive factories to more productive ones after a merger. And they don’t reduce administrative operations either. Economies of scale just don’t come into play very much.

So it looks like mergers, at least in recent years in the manufacturing industry, let companies make more profits by raising prices, not by being more efficient. That’s bad news for consumers, and for the economy in general.

The implication is that the U.S. needs to get more serious about antitrust. While it’s true that technological network effects and intellectual property are more important sources of market power than in decades past, that doesn’t mean antitrust is obsolete. The acceleration of mergers, amid evidence that all they do is push up consumer prices, implies that U.S. antitrust authorities should be doing more to combat concentration of market power, not less.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net