Comment to the Department of Justice and the Federal Trade Commission: Draft Merger Guidelines

By Benjamin Zycher of AEI.

"The Draft Guidelines are fatally flawed analytically, the implementation of which in regulatory merger analysis is likely to yield inefficient decisions, higher costs in the affected sectors, and a reduction in aggregate economic efficiency and consumer welfare. Under the Draft Guidelines, regulatory review of proposed mergers incorporates analysis of demand conditions — elasticities — as relevant indicators of “monopoly power,” whether existing or prospective. Regardless of the degree to which the given market is “competitive,” the Draft Guidelines in effect allow the regulators in a fashion wholly ad hoc to define any set of market conditions as exhibiting ongoing “market power” to be exacerbated by a proposed merger, or potential “market power” to be created or advanced by a proposed merger. Nowhere in the Draft Guidelines is there a delineation of conditions that would lead regulators to approve a proposed merger.

The discussion of entry barriers in the Draft Guidelines is very poor. In a rigorous model of industrial organization, an “entry barrier” is a cost borne by a (potential) entrant not borne by the existing producer, whether the product of a merger or not. None of the “entry barriers” cited in the Draft Guidelines satisfy that fundamental definition, and some are directly inconsistent with the pursuit of efficiency in resource use.

The phrase “scale economies” appears in the draft guidelines only four times, and only in the context of the creation of “entry barriers.” The Agencies have failed to recognize that the achievement of greater scale economies, by reducing production costs, might make consumers better off not only in the specific market directly, but also in other markets also indirectly, by increasing the supply of resources. This is a crucial component of any merger analysis, and the Draft Guidelines ignore it completely.

In the simple case in which technological advance is factor-neutral, the minimum point on the average cost function moves downward and to the right; that is, there is a downward shift in average production costs, and an increase in the efficient size of the firm. Whether there also is an increase in scale economies — the slope of the downward-sloping portion of the U-shaped average cost curve — depends on the specifics of a given technological advance. The Draft Guidelines simply ignore this effect. Given no change in the size of the market, the efficient change in the structure of the market in question is an increase in concentration, notwithstanding the Agencies’ apparent view that any such increase would yield an increase in “market power,” and thus a decline in economic efficiency. This is rather silly.

The Draft Guidelines are fatally flawed, and should not be finalized in this form."