Policy Analysis No. 169                 February 28, 1992

THE MYTH OF PREDATORY PRICING

by Thomas J. DiLorenzo

Thomas J. DiLorenzo holds the Scott L. Probasco, Jr., Chair of
Free Enterprise at the University of Tennessee at Chattanooga.


Executive Summary

The attempt to reduce or to eliminate predatory
pricing is also likely to reduce or eliminate com-
petitive pricing beneficial to consumers.

--Harold Demsetz


Predatory pricing is one of the oldest big business con-
spiracy theories. It was popularized in the late 19th centu-
ry by journalists such as Ida Tarbell, who in History of the
Standard Oil Company excoriated John D. Rockefeller because
Standard Oil's low prices had driven her brother's employer,
the Pure Oil Company, from the petroleum-refining business.(1)
"Cutting to Kill" was the title of the chapter in which
Tarbell condemned Standard Oil's allegedly predatory price
cutting.

The predatory pricing argument is very simple. The
predatory firm first lowers its price until it is below the
average cost of its competitors. The competitors must then
lower their prices below average cost, thereby losing money
on each unit sold. If they fail to cut their prices, they
will lose virtually all of their market share; if they do cut
their prices, they will eventually go bankrupt. After the
competition has been forced out of the market, the predatory
firm raises its price, compensating itself for the money it
lost while it was engaged in predatory pricing, and earns
monopoly profits forever after.

The theory of predatory pricing has always seemed to
have a grain of truth to it--at least to noneconomists--but
research over the past 35 years has shown that predatory
pricing as a strategy for monopolizing an industry is irra-
tional, that there has never been a single clear-cut example
of a monopoly created by so-called predatory pricing, and
that claims of predatory pricing are typically made by com-
petitors who are either unwilling or unable to cut their own
prices. Thus, legal restrictions on price cutting, in the
name of combatting "predation," are inevitably protectionist
and anti-consumer, as Harold Demsetz noted.(2)

Predatory pricing is the Rodney Dangerfield of economic
theory--it gets virtually no respect from economists. But
it is still a popular legal and political theory for several
reasons. First, huge sums of money are involved in predato-
ry pricing litigation, which guarantees that the antitrust
bar will always be fond of the theory of predatory pricing.
During the 1970s AT&T estimated that it spent over $100
million a year defending itself against claims of predatory
pricing. It has been estimated that the average cost to a
major corporation of litigating a predation case is $30
million.(3)

Second, because it seems plausible at first, the idea
of predatory pricing lends itself to political demagoguery,
especially when combined with xenophobia. The specter of a
foreign conspiracy to take over American industries one by
one is extremely popular in folk myth. Protectionist mem-
bers of Congress frequently invoke that myth in attempts to
protect businesses in their districts from foreign competi-
tion.

Third, ideological anti-business pressure groups, such
as Citizen Action, a self-styled consumer group, also employ
the predatory pricing tale in their efforts to discredit
capitalism and promote greater governmental control of in-
dustry. Citizen Action perennially attacks the oil industry
for either raising or cutting prices. When oil and gas
prices go up, Citizen Action holds a press conference to
denounce alleged price gouging. When prices go down, it can
be relied on to issue a "study" claiming that the price
reductions are part of a grand conspiracy to rid the market
of all competitors. And when prices remain constant, price-
fixing conspiracies are frequently alleged.

Fourth, predatory pricing is a convenient weapon for
businesses that do not want to match their competitors'
price cutting. Filing an antitrust lawsuit is a common
alternative to competing by cutting prices or improving
product quality, or both.

Finally, some economists still embrace the theory of
predatory pricing. But their support for the notion is
based entirely on highly stylized "models," not on actual
experience.


The Irrationality of Predatory Pricing

The classic article on predatory pricing was written by
economist John McGee in 1958.(4) McGee examined the famous
1911 Standard Oil antitrust decision that required John D.
Rockefeller to divest his company. Although at that time
popular folklore held that Rockefeller had "monopolized" the
oil refinery business by predatory pricing, McGee showed
that Standard Oil did not engage in predatory pricing; it
would have been irrational to have done so.

Judging from the record, Standard Oil did not use
predatory price discrimination to drive out com-
peting refiners, nor did its pricing practice have
that effect. Whereas there may be a very few
cases in which retail kerosene peddlers or dealers
went out of business after or during price cut-
ting, there is no real proof that Standard's pric-
ing policies were responsible. I am convinced
that Standard did not systematically, if ever, use
local price cutting in retailing, or anywhere
else, to reduce competition. To do so would have
been foolish; and, whatever else has been said
about them, the old Standard organization was
seldom criticized for making less money when it
could readily have made more.(5)

McGee was the first economist to think through the logic of
predatory pricing, laying aside the emotional rhetoric that
had always surrounded it. He concluded that not only would
it have been foolish for Standard Oil to have engaged in
predatory pricing; it would also be irrational for any busi-
ness to attempt to monopolize a market in that way.

In the first place, such practices are very costly for
the large firm, which is always assumed to be the predator.
If price is set below average cost, the largest firm will
incur the largest losses by virtue of having the largest
volume of sales. Losing a dollar on each of 1,000 widgets
sold per month is more costly than losing a dollar on each
of 100 widgets.

Second, there is great uncertainty about how long a
price war would last. The prospect of incurring losses
indefinitely in the hope of someday being able to charge
monopolistic prices will give any business person pause. A
price war is an extremely risky venture.

Standard Oil was not the only trust accused of predato-
ry pricing; antitrust folklore has it that virtually all of
the late-19th-century trusts were guilty of the practice.
However, as I have shown elsewhere, the industries accused
of becoming monopolies during the congressional debates on
the 1890 Sherman Antitrust Act all dropped their prices more
rapidly than the general price level fell during the 10
years before the Sherman Act.(6) It would certainly have been
irrational for those businesses to have engaged in predatory
pricing for an entire decade in the dim hope of someday
being able to charge prices slightly above the competitive
market rate.

Third, there is nothing stopping the competition (or
"prey") from temporarily shutting down and waiting for the
price to return to profitable levels. If that strategy is
employed, price competition will render the predatory pric-
ing strategy unprofitable--all loss and no compensatory
benefit. Alternatively, even if the preyed-upon firms went
bankrupt, other firms could purchase their facilities and
compete with the alleged predator. Such competition is
virtually guaranteed if the predator is charging monopolis-
tic prices and earning above-normal profits.

Fourth, there is the danger that the price war will
spread to surrounding markets and cause the alleged predator
to incur losses in those markets as well.

Fifth, the theory of predatory pricing assumes the
prior existence of a "war chest of monopoly profits" that
the predator can use to subsidize its practice of pricing
below average cost. But how does that war chest come into
being if the firm has not yet become a monopoly? That part
of the theory is simply a non sequitur.

Finally, the opportunity cost of the funds allegedly
used to try to bankrupt rivals must be taken into account.
For predatory pricing to seem rational, the rate of return
on predation must be higher than the market rate of inter-
est; in fact, it must be higher than the expected rate of
return on any other investment the predator might make,
including "investment" in lobbying for protectionism, monop-
oly franchises, and the like. Predation is unlikely, given
the great uncertainties about whether it would have any
positive return at all.


Predatory Counterstrategies

The theory of predatory pricing has always assumed that
a dominant firm is able to manipulate its smaller rivals.
But the potential use of predatory counterstrategies by the
smaller rivals makes the likelihood of successful predatory
pricing extremely remote. Frank Easterbrook has produced a
taxonomy of predatory counterstrategies that has led him to
conclude that "the antitrust offense of predation should be
forgotten."(7)

The predator can recoup its losses only if consumers
cooperate. That is, the strategy will fail if consumers are
able to stock up during the low-price predation period. If
they do so, there can never be a post-predation recoupment
period for the predator. And if the predator responds by
limiting quantity, its rivals can step in and make up the
difference by supplying additional quantities at a higher
price. "A predator that puts a cap on sales thus [preys]
against itself."(8)

Admittedly, consumer stockpiling is not always possi-
ble, and there is another problem related to the predator's
ability to recoup his losses: the "victims" have strong
incentives to ride out the price war, as discussed above,
because of the lure of monopoly profits when the war is
over. The capital markets, moreover, should be willing to
finance the victims because they, after all, are not incur-
ring as large a loss as is the predator. There is a risk,
of course, in providing capital to the victims, but that
risk can be attenuated by charging an appropriate interest
rate. As George Stigler once described it, the victim of
alleged predation, such as that supposedly engineered by
Standard Oil, could go to a lender and say:
There is a threat of a three-month price war,
during which I will lose $10,000, which unfortu-
nately I do not possess. If you lend me $10,000,
I can survive the price war--and once I show your
certified check to Rockefeller the price war will
probably never be embarked upon. Even if the
price war should occur, we will earn more by coop-
eration afterward than the $10,000 loss, or Rocke-
feller would never embark upon the strategy.(9)

Thus, lenders may have a financial incentive to aid the
prey. There is also the possibility that larger firms,
which have their own "deep pockets," will acquire the vic-
tims if it seems profitable to do so.(10)

Even if the victim goes bankrupt, the predator is by no
means guaranteed a monopoly. The bankrupt firm's resources
do not simply disappear; they may be acquired by another
firm (possibly at fire-sale prices). Because the acquiring
firm has lower fixed costs than the predator, it may be able
to underprice the predator.

The victim could also approach its customers and ar-
range for long-term contracts at a price above the predatory
price. The customers would be willing to enter into such
contracts if they realized that the current low price was to
be followed by a monopolistic price.

Finally, it should be kept in mind that the anticipated
monopoly profits of the predator must be discounted to their
present value. The predator firm may realize that possible
monopoly profits in the future are not worth lost profits
today.(11) If that is the case, predatory pricing clearly
does not pay.


Predation or Competition?

The theory of predatory pricing fails to recognize that
price cutting--even below average cost--is a normal activity
in competitive markets. That is because the theory is de-
rived from the so-called perfect competition model of eco-
nomic theory. In an ideal, or "perfectly competitive,"
market, every firm charges an identical price, and in equi-
librium that price is equal to average total cost. Devia-
tions from that benchmark are viewed as market "imperfec-
tions."

The perfect competition theory has its uses, but a more
realistic way of thinking about competition--especially for
public policy purposes--is that of the Austrian economists
who view competition as dynamic rivalry. As Nobel laureate
Friedrich Hayek has stated, "Competition is by its nature a
dynamic process whose essential characteristics are assumed
away by the assumptions underlying static analysis" (i.e.,
perfect competition theory).(12) Competition "is the action
of endeavoring to gain what another endeavors to gain at the
same time."(13) Thus, price cutting, product differentiation,
and advertising are all important elements of a competitive
market according to the Austrian view, but those elements
"are all excluded by definition" from perfect competition
theory. Perfect competition means the absence of all com-
petitive activities."(14)

Once one thinks of competition as rivalry, the notion
of predatory pricing seems bizarre. Cutting prices below
cost is an important way for newer businesses to break into
a market or for older, more established businesses to grab a
larger market share. The former case is exemplified by the
local pizza parlor that tries to lure customers away from
older, more established businesses with a "two-for-one"
special. It may lose money in the short run, but such tem-
porary losses should be viewed as an investment in future
business. The pizza parlor is using lower prices today to
increase its clientele tomorrow. (USA Today lost money for
years before it got off the ground.) The latter case--an
established business that becomes more entrepreneurial and
makes a grab for larger a market share--is exemplified by
Henry Ford.

When Ford declared in 1908, "I will build a motor car
for the great multitude" and produced the Model T, he at
first lost money and market share to Buick, Oldsmobile, and
other competitors.(15) The year 1910 was a good one for the
automobile industry, and Ford's advisers told him to follow
Buick and Oldsmobile by raising the price of the Model T
significantly. Rather than take their advice, however, Ford
dropped his price by 20 percent to $780, which was below his
average total cost. He gambled that the lower price would
greatly expand his sales volume and reduce his per unit
costs, thereby enabling him to make a profit. The gamble
paid off. As George Gilder explained:
Ford set his price not on the basis of his exist-
ing costs or sales but on the basis of the much
lower costs and much expanded sales that might
become possible at the lower price. The effect in
the case of Henry Ford in 1910 was a 60 percent
surge in sales that swept the Model T far ahead of
Buick. . . . In the recession year of 1914, he cut
prices twice, and sales surged up while other
companies failed. By 1916, he had reduced the
price of a Model T to $360 and increased his mar-
ket share from 10 percent to 40 percent. . . .
After cutting prices 30 percent during the 1920
economic crisis, Ford commanded a 60 percent share
of [the] market.(16)

Ford became the dominant firm in the automobile industry by
offering a high-quality product at the lowest price avail-
able. Ford may have "harmed" his competitors by "preying"
on them, but it was all to the benefit of consumers.

If Tarbell and other muckraking journalists had waged
the kind of propaganda campaign against Henry Ford that they
did against John D. Rockefeller, the Model T might never
have been produced. Ford did not always receive favorable
publicity, but neither was he sued for predatory pricing and
forced to divest his company.

It is not an exaggeration to say that all of Henry
Ford's success may have been linked to his below-cost pric-
ing strategy. In his own words:
Our policy is to reduce the price, extend the
operations, and improve the article. You will
note that the reduction of price comes first. We
have never considered any costs as fixed. There-
fore we first reduce the price to the point where
we believe more sales will result. Then we go
ahead and try to make the prices. We do not both-
er about the costs. The new price forces the
costs down.(17)

Ford went on to note that "the more usual way is to take the
costs and then determine the price," but he believed his way
was better.(18) "No one knows what a cost ought to be," he
said, but "one of the ways of discovering [it] . . . is to
name a price so low as to force everybody in the place to
the highest point of efficiency. The low price makes every-
body dig for profits. We make more discoveries concerning
manufacturing and selling under this forced method than by
any method of leisurely investigation."(19)

As Hayek has said, competition is a "discovery proce-
dure," and below-cost pricing has long been an important
element of that procedure and of the benefits it produces
for consumers.(20) Competition provides numerous reasons for
price cutting. Sellers may be meeting their competitors'
price cuts. They may be discounting their prices as a way
of introducing their new and unknown products to consumers.
The goods may be perishable or obsolescent and must there-
fore be sold at any price to avoid losses. The seller may
have built a large-capacity plant that is more efficient
because of higher volume; he charges low prices to stimulate
demand, as did Henry Ford. Or there may be excess capacity
in the market that prompts the seller to charge a price that
minimizes losses until demand increases again.

Businesses that accuse their rivals of predation are
simply unwilling or unable to produce efficiently enough to
meet their rivals' lower prices.


The Futile Search for a Predatory Pricer

Even though predatory pricing was part of the theoreti-
cal underpinning of the original federal antitrust laws, and
there have been hundreds of federal antitrust cases based on
claims of predatory pricing, economists and legal scholars
have to this day failed to provide an unambiguous example of
a single monopoly created by predatory pricing. (In con-
trast, no such ambiguity exists in the case of government-
sanctioned monopolies created by protectionism, exclusive
franchising, grandfather clauses, occupational licensing,
and other government-imposed barriers to competition.)

The theory of predatory pricing is no longer widely
accepted by economists, but it was the conventional wisdom
before McGee's 1958 article. The economics profession--and
antitrust practitioners--accepted the notion as a matter of
faith even though no one (before McGee) had conducted a
systematic economic analysis of predatory pricing.

By 1970 more than 120 federal (and thousands of pri-
vate) antitrust cases in which predatory pricing was alleged
had been brought under the 1890 Sherman Act. Yet in a 1970
study of the so-called gunpowder trust--43 corporations in
the explosives industry--Kenneth Elzinga stated, after an
extensive literature search, that "to my knowledge no one
has ever examined in detail, as McGee did, other alleged
incidents of predatory pricing."(21) Elzinga found no evi-
dence that the gunpowder trust--which had been accused of
predatory pricing--actually practiced it.

Shortly after Elzinga's work appeared, Ronald H. Koller
examined the "123 federal antitrust cases since the passage
of the Sherman Act in 1890 in which it was alleged that
behavior generally resembling predation had played a signif-
icant role."(22) Ninety-five of those cases resulted in con-
victions, even though in only 26 of the cases was there a
trial that "produced a factual record adequate for the kind
of analysis employed" by Koller.(23) Apparently, many of the
defendants decided it was cheaper to plead guilty than to
defend themselves.

Even though no systematic analysis of predatory pricing
was performed in any of the 123 cases, Koller established
the following criteria for independently determining whether
a monopoly was established by predatory pricing: Did the
accused predator reduce its price to less than its short-run
average total cost? If so, did it appear to have done so
with a predatory intent? Did the reduction in price succeed
in eliminating a competitor, precipitating a merger, or
improving "market discipline"?

Koller's criteria give predatory pricing theory more
credit than it deserves. As was explained earlier, below-
cost pricing per se is not necessarily a sign of predatory
behavior; it is a normal feature of competitive markets.
Moreover, determining predatory intent is an exercise that
is far beyond the capabilities of any economist and for
which mystics might be better suited. And "eliminating a
competitor" is the very purpose of all competition.

Employing those criteria for determining predatory
behavior, Koller found that below-cost pricing "seems to
have been at least attempted" in only seven cases.(24) That,
of course, proves nothing about monopolizing behavior, given
the fact that below-cost pricing can be just as easily con-
strued as competitive behavior. Koller claims that in four
of the cases low prices seemed to have been motivated by the
desire to eliminate a rival. One would hope so! The entire
purpose of competitive behavior--whether cutting prices or
improving product quality--is to eliminate one's rivals.

Even in the cases where a competitor seemed to have
been eliminated by low prices, "in no case were all of the
competitors eliminated."(25) Thus, there was no monopoly,
just lower prices. Three cases seem to have facilitated a
merger, but mergers are typically an efficient alternative
to bankruptcy, not a route to monopoly. In those cases, as
in the others, the mergers did not result in anything re-
motely resembling a monopolistic industry, as defined by
Koller (i.e., one with a single producer).

In sum, despite over 100 federal antitrust cases based
on predatory pricing, Koller found absolutely no evidence of
any monopoly having been established by predatory pricing
between 1890 and 1970. Yet at the time Koller's study was
published (1971), predatory pricing had long been part of
the conventional wisdom. The work of McGee, Elzinga, and
other analysts had not yet gained wide recognition.

The search for the elusive predatory pricer has not
been any more successful in the two decades since Koller's
study appeared. The complete lack of evidence of predatory
pricing, moreover, has not gone unnoticed by the U.S. Su-
preme Court. In Matsushita Electric Industrial Co. v. Ze-
nith Radio (1986), the Court demonstrated knowledge of the
above-mentioned research in declaring, effectively, that
predatory pricing was about as common as unicorn sightings.

Zenith had accused Matsushita and several other Japa-
nese microelectronics companies of engaging in predatory
pricing--of using profits from the Japanese market to subsi-
dize below-cost pricing of color television sets in the
United States. The Supreme Court ruled against Zenith,
recognizing in its majority opinion that
a predatory pricing conspiracy is by nature specu-
lative. Any agreement to price below the competi-
tive level requires the conspirators to forgo
profits that free competition would offer them.
The forgone profits may be considered an invest-
ment in the future. For the investment to be
rational, the conspirators must have a reasonable
expectation of recovering, in the form of later
monopoly profits, more than the losses suffered.(26)

The Court also noted that "the success of such schemes is
inherently uncertain: the short-run loss is definite, but
the long-run gain depends on successfully neutralizing the
competition."(27) The Court continues, "There is a consensus
among commentators that predatory pricing schemes are rarely
tried, and even more rarely successful."(28)

In that case, Zenith and RCA were obviously attempting
to use the antitrust laws, via their accusation of predatory
pricing, to eliminate some of their foreign competition.
The Court determined, for example, that "two decades after
their conspiracy is alleged to have commenced, petitioners
appear to be far from achieving their goal: the two largest
shares of the retail market in television sets are held by
RCA and . . . Zenith, not by any of the petitioners."(29)
Moreover, the share of the market held by Zenith and RCA
"did not decline . . . during the 1970s," which provides
further evidence that "the conspiracy does not in fact ex-
ist."(30)

The Court concluded by warning potential litigants of
the folly of bringing predatory pricing cases.
Cutting prices in order to increase business often
is the very essence of competition. Thus, mistak-
en inferences in cases such as this one are espe-
cially costly, because they chill the very conduct
the antitrust laws are designed to protect.(31)

Since predatory pricing schemes "require conspirators to
suffer losses in order eventually to realize . . . gains,"
the Court concluded that "economic realities tend to make
predatory pricing conspiracies self-deterring."(32)

What predatory pricing comes down to is a theory and a
legal doctrine that are still used by inefficient firms to
try to get the coercive powers of government to attain for
them what they cannot attain in the marketplace. As former
Federal Trade Commission chairman James Miller has written,
government has all too often used predatory pricing as a
vehicle for instructing businesses to "stop competing, leave
your competitors alone, raise your prices."(33)


"Dumping" on Competition

Even though predatory pricing is vacuous in both theory
and reality, and has been viewed as such by the Supreme
Court, the doctrine lives on. Special-interest groups that
wish to undermine competition have no incentives to pay
attention to the theory and reality of predatory pricing.
In fact, as economist Gordon Tullock has written:
Special interest groups normally have an interest
in diminishing the information of the average
voter. If they can sell him some false tale which
supports their particular effort to rob the trea-
sury, it pays. They have resources and normally
make efforts to produce this kind of misinforma-
tion.(34)

Thus, the myth of predatory pricing will continue to be
perpetrated in the courts and in the legislature. So-called
anti-dumping laws are an example. In the context of inter-
national trade, "dumping" occurs when a foreign manufacturer
sells a product in the United States at a lower price than
is charged in the home market. Such price differentials can
be easily explained by competition: New entrants in a for-
eign market must offer low prices to induce consumers to try
their products. Fierce competition in the domestic market
is also a reason for price differentials.

Anti-dumping laws ignore the competitive aspects of
price cutting and invoke predatory pricing as a rationale
for protectionism. For example, in November 1987 the U.S.
Department of Commerce ruled that "Japanese companies vio-
lated international trade laws by failing to increase their
prices to match the sharp rise in the value of the yen."(35)
With the rise in the value of the yen, Japanese goods sold
in the United States became relatively more expensive. The
Japanese producers responded by cutting their costs, prices,
and profit margins to remain competitive, to the great sat-
isfaction of American consumers. According to the Commerce
Department, Japanese export prices declined by 23 percent
between 1985 and 1987.(36) Despite significant benefits to
American consumers, the Reagan administration's Commerce
Department attempted to "force" Japanese companies to raise
their prices.

Such a policy is absurd not only because it obviously
harms American consumers but also because, under it, the
American government effectively enforces a cartel pricing
arrangement that benefits foreign manufacturers. The Japa-
nese companies may have wanted to raise their prices and
earn monopolistic profits, but competition prohibited it.
Being prosecuted under the anti-dumping laws achieved for
them what they were not able to achieve for themselves in
the marketplace.

The same anti-consumer policies prevail today. In June
1991 the Bush Commerce Department launched an investigation
of alleged dumping of Japanese minivans in the American
market. If successful, the investigation could lead to
"forcing up prices of Japanese . . . cars."(37) The Big Three
domestic automakers were advocating Japanese price increas-
es, which they hoped would "blunt the Japanese advance" in
the minivan market.(38) The Big Three at that time controlled
88 percent of the minivan market, but they complained that
their sales were "weakened by the unfair pricing."(39) They
accused Japanese automakers of charging prices in the United
States that were 30 percent lower than those charged in
their home country. There could not be a more specious
argument for using the coercive powers of government to
thwart competition and to harm consumers.

On December 20, 1991, the Bush Commerce Department
ruled in favor of the Big Three. It charged Mazda with the
"crime" of selling minivans in the United States for 7.19
percent less than in Japan; Toyota was "guilty" of selling
its minivans in America at 0.95 percent less than in
Japan.(40) Because of that ruling, which is being appealed,
the U.S. government will impose tariffs on Japanese prod-
ucts, which will enable the domestic automakers to charge
even higher prices. Consumers will unequivocally be harmed.

Unfortunately, such anti-consumer policies, all adopted
to punish "predatory pricing," are becoming increasingly
prevalent. The United States Business and Industrial Coun-
cil, a collection of protectionist businesses, is organized
to "demand a tougher trade stance with Japan by raising
tariffs on Japanese cars and electronic products."(41) A sim-
ilar sentiment was voiced by Patrick J. Buchanan in December
1991 when he announced his candidacy for the Republican
party's presidential nomination. In his announcement Bu-
chanan spoke of "predatory traders of Europe and Asia who
have targeted this or that American industry for dumping and
destruction" and promised that, if he is elected, "they will
find themselves on a collision course with the President of
the United States."(42)

Regardless of Buchanan's personal political fate,
special-interest groups seem to be increasingly dependent on
the discredited predatory pricing argument for advancing the
cause of protectionism. The national Democratic party is
also stepping up its Japan-bashing efforts by proposing ever
more restrictive trade legislation.

The myth of predatory pricing also threatens consumer
welfare via the domestic policy route. One recent example
is the latest of a long line of attacks on the oil industry
by the self-described "consumer" group, Citizen Action. In
a September 1991 report that warns ominously that "Big Oil"
has allegedly "taken control of America's gasoline markets,"
Citizen Action singles out the Arco Oil Company for some
unexpected praise. Arco, the report claims, is now "the
dominant force in the refining and marketing of petroleum on
the U.S. West Coast" because of "a combination of unexpected
risk-taking, shrewd corporate planning and investment, [and]
aggressive leadership."(43) The company "eliminated its cred-
it cards, expanded its gasoline sales per station, created a
chain of convenience stores on many of its gasoline station
sites in order to maximize profits. . . . All of these ac-
tions made good economic sense. They reduced costs, in-
creased efficiency and maximized profits."(44)

But Citizen Action's "praise" is not genuine. Rather
than applauding its efficiencies, Citizen Action ascribes
diabolical motivations to Arco, alleging "a ruthless deter-
mination to weaken, intimidate and eventually eliminate the
independent refiners, wholesalers and marketers" with its
low-cost, low-price strategy.(45) Arco is guilty of using its
organizational efficiencies to "sharply lower the wholesale
and retail price of gasoline," thereby "squeezing both inde-
pendent refiners and marketers."(46)

The end result of the alleged monopolization of the
West Coast market was that, according to Citizen Action's
own data, "by 1990, Arco [was] number 1 with 19 percent of
the market."(47) In other words, Arco was (and is) nothing
close to a monopolist. Its efficiencies allowed it to be-
come more competitive and improve its market position over
the positions of Shell, Chevron, Unocal, and myriad other
competitors, but it still has less than one-fifth of the
market.

There are no entry barriers in the gasoline market;
competition remains vigorous; and real gasoline prices have
been falling. Citizen Action's claim that Arco has gained a
monopoly through predatory pricing is simply preposterous.
By Citizen Action's own admission, Arco's increased market
share is due to its enhanced efficiency and lower prices.
Nevertheless, Citizen Action tries to convince the readers
of its report that black is white and white is black with
the following horror stories.

Arco stations in two California towns north
of San Bernardino are selling gas 20 [cents] below
the market.

Motorists are queuing up at four
recently-opened Arco stations in Victorville and
Hisperia, Calif.

Arco's remodeled am/pms post street prices of
58.9 [cents] for regular leaded; 68.9 [cents] for
regular unleaded; 78.9 [cents] for premium un-
leaded.

Closest competition from a major: Shell whose
regular leaded sells for 79.9 [cents] for premium
unleaded--21 [cents]/gallon above Arco's.(48)

Worse yet, says Citizen Action, Arco's super-efficient,
low-price strategies are being "quickly emulated by the
other major companies."(49) One could only hope that all in-
dustries would emulate such strategies!

The Citizen Action report also warns that similar
price-cutting strategies are being employed in Nevada and
urges congressional action to put an end to them, all in the
name of consumer protection! Oddly, there is very little
mention of the impact on consumers of Arco's price cutting;
the primary concern is "market share." The report reveals
virtually no understanding on the part of its authors of the
economic literature that shows that industrial concentration
per se is by no means anti-competitive.(50) Becoming a "domi-
nant" firm or rendering an industry more "concentrated" by
cutting prices and improving product or service quality is
desirable and should be encouraged. Citizen Action seems
more concerned with ideological assaults on "big" business
than with consumer protection, its ostensible purpose.

The logic and evidence of the Citizen Action report are
laughable. But such "logic" has also been used by members
of Congress who wish to protect businesses in their dis-
tricts from competition. The proposed Petroleum Marketing
Competition Enhancement Act (H.R. 2966), for example, claims
to be designed to "prevent unfair competition," but elimi-
nating the word "unfair" would probably reveal the true
intent of the act.

Gasoline marketers who do not wish to compete in a free
market and who want government to intervene to protect their
profit margins are lobbying for that act. Ostensibly a
response to alleged predatory pricing by the major oil com-
panies, the act would make it "unlawful for a refiner to
sell motor fuel, to any customer for resale, at a price
which is higher than the refiner's adjusted retail price for
the same or similar grade or quality of motor fuel from a
direct operated outlet in the same geographic area." It
would also make it "unlawful for a refiner to enter into any
scheme or agreement to set, change, or maintain maximum
retail prices of motor fuel provided, that this . . . shall
not apply to a refiner's retail sales at its direct operated
outlets."

By making it unlawful for a refiner to write a contract
to maintain maximum retail prices, that provision would tend
to increase prices. The objective of the bill is to "guar-
antee" the profit margins of gasoline middlemen by trying to
isolate them from the forces of supply and demand, a futile
objective if ever there was one. The effect of the law
would be higher prices for consumers and a system of price
controls. Any law that guarantees profit margins would have
to do so by setting prices by governmental rules and regula-
tions rather than by market forces. Price controls were, of
course, a disaster when last implemented in the 1970s.

The purpose of this discussion is not necessarily to
evaluate in detail the probable effects of the misnamed
"Petroleum Marketing Competition Enhancement Act" but to
make the point that the whole idea that gasoline middlemen
need and deserve governmental protection from competition is
rooted in the idea of predatory pricing. Similarly mischie-
vous policies are found in many other industries.


Conclusion

The government's alleged right to tell citizens how
they may use their legally and peacefully acquired property,
and at what prices they may sell it, should be questioned.
The question is, What right does government have to inter-
fere with a business person who is peacefully striving to
earn a living by cutting, raising, or maintaining stable
prices? Are private property and individual freedom of
choice desirable social institutions, or aren't they? To
advocate a law regulating or eliminating "predatory" price
cutting is to answer that question in the negative: Any
proposal to interfere with voluntary market pricing arrange-
ments is simply a denial of the legitimacy of private prop-
erty rights and individual freedom of choice. From a natu-
ral rights perspective, laws designed to regulate predatory
pricing--or any other kind of pricing--are improper. As
Armentano has eloquently stated:
This [natural rights] theory holds that individu-
als have inalienable rights to life, liberty, and
property. These rights imply the liberty of any
person or persons to enter into any noncoercive
trading agreement on any terms mutually accept-
able, to produce and trade any factor or good that
they own, and to keep any property realized by
such free exchange. This perspective would hold
that it is right to own and use property; it is
right to employ that property in any manner that
does not infringe on anyone else's property
rights; it is right to trade any or all of that
property to anyone else on any terms mutually
acceptable; and that it is right to keep and enjoy
the fruits of that effort. . . . Consequently, it
would be wrong . . . to outlaw or regulate certain
types of business contracts, organizational struc-
tures, or business cooperation.(51)

That perspective has a long history. In one of the
most famous passages of Wealth of Nations, Adam Smith warns
of the pervasiveness of business conspiracies: "People of
the same trade seldom meet together, even for merriment and
diversion, but the conversation ends in a conspiracy against
the public, or in some contrivance to raise prices."(52) But
in the very next sentence Smith added: "It is impossible
indeed to prevent such meetings by any law which either
could be executed, or would be consistent with liberty and
justice." Smith clearly recognized the potential for busi-
ness conspiracies; but whether they were likely or not, he
believed that any government regulation of them was im-
proper.

Harold Demsetz is right. The attempt to reduce or
eliminate so-called predatory pricing will only eliminate
competitive pricing, which is beneficial to consumers.(53)
Predatory pricing is simply illogical, although there are
some highly stylized economic models that claim that it is
feasible under certain assumptions. Other research has
shown, however, that predatory pricing cannot even be repli-
cated under laboratory conditions by "experimental" econom-
ics.(54) In either case, an unambiguous example of a
free-market monopoly that was established as a result of
predatory pricing has yet to be found.

Unfortunately, the doctrine of predatory pricing still
motivates antitrust suits and other protectionist pleadings.
Significantly, it is legislation and regulation enacted in
the name of predatory pricing (not predatory pricing itself)
that are truly monopolizing. Government--not the free
market--is the source of monopoly.


Notes

(1) Ida Tarbell, The History of the Standard Oil Company
(New York: Peter Smith, 1950). Tarbell's brother, William,
was treasurer of Pure Oil Company.

(2) Harold Demsetz, "Barriers to Entry," American Economic
Review 72 (May 1982): 52-56.

(3) Frank Easterbrook, "Predatory Strategies and
Counterstrategies," University of Chicago Law Review 48
(1981): 334.

(4) John McGee, "Predatory Price Cutting: The Standard Oil
(N.J.) Case," Journal of Law and Economics 1 (April 1958):
13769.

(5) Ibid., p. 168.

(6) Thomas J. DiLorenzo, "The Origins of Antitrust: An
Interest Group Perspective," International Review of Law and
Economics 5 (Fall 1985): 7390.

(7) Easterbrook, p. 337.

(8) Ibid., p. 269.

(9) George Stigler, "Imperfections in the Capital Market,"
Journal of Political Economy 75 (June 1967): 116.

(10) Easterbrook, p. 269.

(11) Ibid.

(12) Friedrich Hayek, "The Meaning of Competition," in his
Individualism and Economic Order (Chicago: University of
Chicago Press, 1974), p. 94.

(13) Ibid., p. 96.

(14) Ibid.

(15) Quoted in George Gilder, The Spirit of Enterprise (New
York: Simon and Schuster, 1984), p. 155.

(16) Ibid., p. 157.

(17) Ibid., p. 159.

(18) Ibid.

(19) Ibid.

(20) Friedrich Hayek, "Competition as a Discovery Procedure,"
in his New Studies in Philosophy, Politics, Economics and
the History of Ideas (Chicago: University of Chicago Press,
1978), pp. 17990.

(21) Kenneth G. Elzinga, "Predatory Pricing: The Case of the
Gunpowder Trust," Journal of Law and Economics 13 (April
1970): 223.

(22) Ronald H. Koller, "The Myth of Predatory Pricing: An Em
pirical Study," Antitrust Law and Economics Review 4 (Summer
1971): 110.

(23) Ibid.

(24) Ibid., p. 112.

(25) Ibid., p. 113.

(26) Matsushita Electric Industrial Co. v. Zenith Radio 475
U.S. 590, Supreme Court Reporter, 1986, p. 1357.

(27) Ibid.

(28) Ibid.

(29) Ibid., p. 1358.

(30) Ibid., p. 1359.

(31) Ibid., p. 1360.

(32) Ibid.

(33) James C. Miller and Paul Pautler, "Predation: The Chang
ing View in Economics and the Law," Journal of Law and Eco
nomics 28 (May 1985): 502.

(34) Gordon Tullock, Welfare for the WelltoDo (Dallas:
Fisher Institute, 1983), p. 71.

(35) Stuart Auerbach, "Japanese Companies Violated Trade
Laws," Washington Post, November 20, 1987, p. D1.

(36) Ibid.

(37) Eduardo Lachica and Joseph B. White, "Washington Is Ex
pected to Investigate Alleged Dumping of Japanese Minivans,"
Wall Street Journal, June 20, 1991, p. B3.

(38) Ibid.

(39) Frederick Standish, "Big Three Charge Japanese with
'Dumping' Minivans," Washington Times, June 7, 1991, p. G4.

(40) "Japanese Dumping Minivans," Chattanooga Times, December
21, 1991, p. B8.

(41) Stuart Auerbach, "Conservative Group Attacks Free
Trade," Washington Post, November 26, 1991, p. C1.

(42) Hobart Rowen, "Forward into the Past," Washington Post
National Weekly Edition, December 30January 5, 1992, p. 5.

(43) Citizen Action, "Destroying Competition and Raising
Prices: How Big Oil Has Taken Control of America's Gasoline
Markets," Washington, September 1991, p. 58.

(44) Ibid., p. 59.

(45) Ibid.

(46) Ibid.

(47) Ibid., p. 60.

(48) Ibid., p. 61.

(49) Ibid., p. 60.

(50) Works they ignore include Yale Brozen, Concentration,
Mergers and Public Policy (New York: MacMillan, 1983); John
McGee, In Defense of Industrial Concentration (New York:
Praeger, 1971); Harvey Goldschmidt, Patrick Mann, and Fred
Weston, Industrial Concentration: The New Learning (Boston:
Little, Brown, 1974).

(51) Dominick Armentano, Antitrust and Monopoly (New York:
Wiley, 1982), p. 8. See also Roger Pilon, "Corporations and
Rights: On Treating Corporate People Justly," Georgia Law
Review 13, no. 4 (Summer 1979): 1245-1370.

(52) Adam Smith, An Inquiry into the Nature and Causes of the
Wealth of Nations (Indianapolis: Liberty Fund, 1981),
p. 145.

(53) Demsetz, pp. 4757.

(54) R. Mark Isaac and Vernon L. Smith, "In Search of Preda
tory Pricing," Journal of Political Economy, April 1985,
pp. 32045.


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