Monday, July 8, 2013
Posted by D. Daniel Sokol
Herbert J. Hovenkamp, University of Iowa - College of Law has an excellent piece Bork on Vertical Integration: Leverage, Foreclosure, and Efficiency.
ABSTRACT: Robert H. Bork wrote his fist article about vertical integration and antitrust policy in 1954, a year after he graduated from the University of Chicago Law School. He noted a recent increase in antitrust attacks on vertical integration and disagreed with those who believed that these attacks were a novelty. At the time, judicial hostility toward vertical integration was rampant. But Bork overstated his case about the period prior to the 1930s. Through the 1920s judicial attitudes toward vertical integration were more benign than Bork suggested. This position was largely consistent with the pre-Depression economics literature, which emphasized production cost savings and, to a lesser extent, savings in transaction costs.
That all changed with the Depression and the New Deal. From then through the 1960s the dominant school of industrial organization was hostile toward vertical integration. Ronald Coase's "Nature of the Firm" lay ignored by all, including Bork, while writers relentlessly criticized both vertical ownership and vertical contractual integration as devices of monopoly. The dominant critiques can be roughly classified as "leverage" and "foreclosure," although the line between the two is often blurred.
Richard Posner once identified the rise of the Chicago School with the critique of "leverage" arguments against firms that operated in multiple markets. Looking back at centrist industrial organization theory in the 1950s and 1960s, he described it as "untheoretical, descriptive, institutional, and even metaphorical." As the prime example he offered the "leverage" theory of ties, which he attributed to Donald F. Turner, Edward Mason, and Joe S. Bain.
Bork's mature thought about vertical integration, presented in The Antitrust Paradox in 1978, was beguilingly simple. First, if vertical integration created efficiencies, then a vertically integrated firm would have cost advantages over unintegrated rivals. In that case vertical integration would deter unintegrated entry, but it is not antitrust's purpose to condemn cost savings. Second, if vertical integration did not create any efficiencies, then it would not impede entry by anyone. Firms that wished to enter at one stage alone could contract with firms at the other stage and be just as efficient as the vertically integrated firm. Third, if vertical integration resulted in higher costs, then vertically integrated firms would decline in favor of unintegrated firms. Fourth, in competitively structured markets vertical integration would lead to self-dealing, but that would do no more than force realignment in purchasing and sale patterns. Bork's observations were built on an extraordinarily narrow conception of entry barriers. He barely mentioned patents or other intellectual property rights. There was no conception that sunk costs plus risk could facilitate entry deterrence.