Category Archives: Economics

Antitrust Basics: Misleading Herfindahl-Hirschman Index

This is the third entry in the “Antitrust Basics” series. See below for previous posts.

Market concentration is the most common reason for antitrust intervention. If a company has too large a market share, it can abuse that market power to raise prices, restrict output, and engage in all manner of anti-competitive business practices. A merger that would create a dominant player or significantly reduce the number of competitors is likely to be blocked. But how should market concentration be measured? Should it be by number of firms? Or by how much market share the biggest players control?

The Herfindahl-Hirschman Index (HHI) accounts for both factors. It also gives analysts a single numerical score they can work with, ranging from 0 to 10,000. It is also easy to calculate; the Justice Department shares the HHI formula here. A market with a large number of companies, in which each has an equally small market share, will have a low score. A market with few companies and one dominant player will have a high score.

For example, imagine two different markets, each with four companies. In one case, each company has an equal 25 percent market share. This market has an HHI score of 2,500. In the second case, one company has a 97 percent market share, and the other three each have a one percent market share. This yields a 9,412 HHI score, and quite possibly an antitrust case.

According to the Justice Department and Federal Trade Commission’s joint Horizontal Merger Guidelines, an HHI of over 2,500 constitutes a highly concentrated market. The HHI is usually used in mergers to decide whether or not to allow a deal to go through—under the Hart-Scott Rodino Act of 1976, all mergers over a certain size have to be reviewed by regulators before they can be consummated.

According to the guidelines, Mergers in a moderately concentrated market (HHI score of 1,501 to 2,500) that increases HHI by more than 100 points “potentially raise significant competitive concerns and often warrant scrutiny.”

Mergers in a highly concentrated market (HHI of more than 2,500) raising HHI by more than 200 points “will be presumed to be likely to enhance market power.”

These guidelines are not binding. The decision to block such a merger can vary with which party holds power, if a company is receiving bad publicity, or any other factor besides a predictable law. This uncertainty can have a chilling effect on deals that could benefit consumers.

This kind of quantitative analysis makes it easier for the Justice Department or the Federal Trade Commission to decide whether or not to bring a case against a company, or to block a proposed merger.

The HHI has a fatal flaw, though: the relevant market fallacy. The person crunching the numbers can define the relevant market any way they please, and can thus come up with nearly any HHI score they desire. This makes it analytically useless. In fact, during the fact-finding phase of a merger investigation, opposing counsel routinely fight over the relevant market size to be used in that case’s HHI calculations. Whatever decision is reached is arbitrary, and often depends more on the judge’s political views than anything else.

The fact that the Herfindahl-Hirschman Index is so easy to game is by itself fatal. But that is not its only significant problem. As Judge Richard Posner observed in the second edition of his book “Antitrust Law,” “There is no sound basis in economic theory for thinking that if there are just a few major sellers in a market, competition will disappear automatically.” That is an empirical question, and one that regulators are incapable of answering.

This is not necessarily their fault; no one can predict the future. Even the merging companies themselves are unsure how their deal would work out. AOL and Time Warner found this out the hard way. By giving the illusion of quantitative rigor, the HHI often fools regulators into thinking they have solved the knowledge problem that vexes so many policymakers’ plans. This false confidence is dangerous to consumer welfare.

The Herfindahl-Hirschman Index is useless in answering the question of whether a merger or a given level of concentration would cause consumer harm. It should barred from use in antitrust cases.

For more, see Wayne Crews’ and my study, “The Case against Antitrust Law: Ten Areas Where Antitrust Policy Can Move on from the Smokestack Era.” Further resources are at antitrust.cei.org.

Previous posts in Ryan Young’s “Antitrust Basics” series:

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Healthy Attitudes of Inquiry

From p. 6 of Vlad Tarko’s 2017 book Elinor Ostrom: An Intellectual Biography:

Good social scientists are like tourists who have yet to familiarize with the local rules or a little bit like children, asking funny questions about what everyone else just takes for granted.

This is a much healthier attitude of inquiry than the capital-C certainty many analysts have in their answers to social problems.

Peter Boettke – F. A. Hayek: Economics, Political Economy and Social Philosophy

Peter Boettke – F. A. Hayek: Economics, Political Economy and Social Philosophy

Boettke has both revived and deepened my appreciation of Hayek. He emphasizes the importance of institutions and rules of the game that I (and many others) thought Hayek had overlooked, at least in comparison to Douglass North, James Buchanan, Mancur Olson, and other thinkers.

He also clears up the common misconception that The Road to Serfdom is a slippery slope argument. Instead, Boettke argues it is an outgrowth of the great socialist calculation debate that dominated the economics profession in the 1920s and 1930s. Hayek’s teacher Ludwig von Mises argued that socialism is impossible because it has no price system. Without prices, any semblance of efficient resource allocation is impossible. Abba Lerner and Oskar Lange countered that not only is a planned economy possible, but experts can have fewer errors, redundancies, and other inefficiencies that come with free markets.

1944’s Road to Serfdom, looking back at this debate, argues that in addition to Mises’ calculation problem, a planned economy is incompatible with liberal institutions. Mises was right about the calculation problem, and Hayek expanded on Mises with his emphasis on knowledge problems, and by thinking of markets as an ongoing discovery procedure, rather than a static equilibrium.

But Hayek’s main point in Road to Serfdom is that the powers an authority would need to exercise to plan economy are incompatible with democracy, and with most forms of personal and economic choice. Planned economies and illiberal governments are a package deal. If a country chooses that package, it can always go back on it—which is why Hayek isn’t making a slippery slope argument. But if you want a planned economy, you cannot also have a free society. And if you want a free society, you cannot have a planned economy.

Chapter 10 I found genuinely inspiring. Boettke reminds the reader that liberalism must be liberal. It is not conservative, it is dynamic, forward-looking, outgoing, and inclusive, even if people look different, come from different countries, or speak different languages. Liberalism is also not progressive. Liberalism emphasizes bottom-up emergent orders over expert plans.

Liberals—in the correct, classical sense—and conservatives formed an alliance in the mid-20th century based on shared anti-communist beliefs, but they have little in common beyond that. Hayek’s essay “Why I Am Not a Conservative” is a key document here. But Boettke, in prose much more passionate than his usual restrained manner, argues that this odd alliance was overdone in Haeyk’s time, and is irrelevant now that communism is gone.

As a result, some thoroughly illiberal people are using the libertarian label to promote illiberal ideas on race, discrimination, immigration, trade, and other issues. This thought problem is causing a major marketing problem for liberals—not to put too fine a point on it, but as one example, many people confuse the Ludwig von Mises Institute’s ideas for those of Mises himself. This is a problem liberals have created for themselves, and the damage that alliances with shadier parts of the right have inflicted to the liberal cause will not be easy to undo.

From the Archives: Peter Navarro on China Trade

Trump trade advisor Peter Navarro is part of the travel team for upcoming U.S.-China trade negotiations. For an idea of what he will add to the discussion, see his book The Coming China Wars. I have also written about some of his economic ideas in the past:

Antitrust Basics: The Relevant Market Fallacy

This is the second entry in the “Antitrust Basics” series. See below for previous posts.

If a firm is charged with having market power, the question naturally arises: in which market? Does Facebook have a monopoly over social networking, especially now that it owns additional networks such as Instagram and WhatsApp? Or does Facebook compete with other uses of leisure time such as movies, television, books, sports, concerts, and countless other ways people can spend their time? Which is the more relevant market? The answer is subjective—a significant problem for a legal case with multi-billion dollar stakes.

Antitrust regulators often try to make their case appear stronger by using an unrealistically narrow definition of a company’s relevant market. I call this tactic the relevant market fallacy. The relevant market fallacy is one of the easiest mistakes to make in all of antitrust analysis. It is also one of the easiest to avoid. Thinking along the different parts of a spectrum illustrates why.

At one end of the spectrum, every individual product can be seen as its own relevant market. A sandwich at one restaurant is different from a similar sandwich sold at another restaurant next door, even if they are the same price. One restaurant might offer better service, better ambience, or some other nonprice characteristic that differentiates it from its competitor. In that sense, there are two different products operating in different markets appealing to different sets of consumer preferences.

At the other end of the spectrum, the only relevant market is as big as the entire global economy. That sandwich also competes against all other types of food in a global supply chain—and any non-food item a person might spend their money on instead. Whichever point on the spectrum an analyst decides is right for a given case is an arbitrary decision. It is largely a matter of semantics, and often analytically useless in determining consumer benefits.

As with most things in the real world, most relevant markets fall somewhere in between these two extremes. Amazon controls roughly half of online retail, but a much smaller fraction of total retail. Which is the proper relevant market? Amazon’s success with online retail has also caused traditional retailers such as Walmart and Target to massively change their business strategies to match consumer desires. The relevant market is not only debatable in size and scope, but it is constantly changing shape. And that change is happening far faster than the speed of litigation.

When satellite radio companies Sirius and XM merged, critics argued that the combined firm would have a monopoly on satellite radio, and the merger should have been blocked. Once again, they defined the relevant market too small. Satellite radio competes with terrestrial radio, streaming radio, on-demand music streaming, podcasts, audio books, and more.

As political candidates, pundits, and activists tout statistics for this or that company’s market dominance, keep in mind they are often committing the relevant market fallacy. It doesn’t take long to check, and it’s well worth the small effort.

For more, see Wayne Crews’ and my study, “The Case against Antitrust Law: Ten Areas Where Antitrust Policy Can Move on from the Smokestack Era.” Further resources are at antitrust.cei.org.

Previous posts in Ryan Young’s “Antitrust Basics” series:

Where Does Progress Come From?

According to economic historian Joel Mokyr, progress comes from technological change–which can’t happen without pro-technology and pro-change cultural values. Science is necessary but not sufficient; same with culture. It takes both. Societies with one but not the other have their merits, but ultimately fail to progress. New advances will either fail to stick, or will be repressed. While respect for tradition is a normal and good thing, most cultures throughout history have gone too far with it and become outright neophobic.

Cultural rejection of progress goes at least as far back as the Greek poet Hesiod, who lived between 800-700 B.C. He described history as a continuous process of decay. The initial Golden Age of the gods degrades down to a still-divine Silver Age, then a Bronze Age. This is followed by a Heroic Age (think mortal half-gods such as Perseus and Heracles). History finally reaches the dull, rusting Iron Age where people now live. This is a rather different worldview than one finds in Enlightenment thinking or, say, Wired magazine.

More recently, China showed a spark of valuing progress during the Song dynasty, which lasted from 960-1279 AD. But the succeeding Ming dynasty shut the experiment down by destroying trading ships devaluing innovation, raising up values such as security and tradition instead.

Joel Mokyr, on p. 248 of his 2016 book A Culture of Growth: The Origins of the Modern Economy, offers that a rebellious youthful streak can in fact be a good thing in the long run:

The idea of progress is logically equivalent to an implied disrespect of previous generations.

Herbert A. Simon – Administrative Behavior, 4th Edition: A Study of Decision-Making Processes in Administrative Organisations

Herbert A. Simon – Administrative Behavior, 4th Edition: A Study of Decision-Making Processes in Administrative Organisations

Realistic, subjective, and humble—probably a reflection of Simon’s time at the University of Chicago. Rather than the typical snake-oil management guru who pretends to know everything, Simon that there is no perfect structure for an organization. Every possibility has at least some drawbacks. Simon instead emphasizes the need to treat organizational structure as an ongoing process, rather than a finished product. Often personnel will dictate what structures work best, and personnel change over time. Technology has its own impacts, and Simon even in 1947 saw that computers would have significant effects on the workplace. Part of trial is error, and wise managers will accept this as part of the process. The trick is being humble enough to admit mistakes and being flexible enough to try different approaches with more promise.