The New York Times
April 11, 1998

How the Antitrust Wars Wax and Wane

By LAURENCE ZUCKERMAN

Is the price of airline seats a product of the free market or the result of underhanded business tactics?

This week when the Clinton administration accused the major airlines of acting like predators and squeezing their smaller competitors out of business, it entered a century-old intellectual debate on antitrust law and the free market.

How these ideas play out could end up influencing how much Americans pay for everything from airline tickets to computer software, from beer to cellophane tape.

On one side is the so-called Chicago school, scholars like Robert Bork and Richard Posner who argue that predatory pricing rarely if ever exists and that, in the long run, the market will adjust.

On the other is a group of young lawyers and economists referred to -- not surprisingly -- as the post-Chicago school, who have challenged their predecessors and are providing the intellectual muscle for the Clinton administration's antitrust assault.

Using game theory and other new approaches to economic analyses, they argue that successful predatory pricing strategies are not as rare and irrational as the Chicago school thought, especially when they are combined with a variety of exclusive deals and other tactics that don't involve price.

Ever since the Sherman Antitrust Act was passed in 1890, rigorous enforcement has ebbed and flowed, an indication of both the ill-defined nature of antitrust law and the ambivalent feelings judges, politicians and the public have had toward big business over the years.

But few Americans would question the existence of predatory pricing. The image of the rapacious monopolist who ruined his competitors or weakened and then swallowed them by using his deep pockets to cut prices below cost has been deeply ingrained in the public mind since the Gilded Age.

The man who helped establish the standard was John D. Rockefeller. His Standard Oil Co. allegedly employed a grab-bag of nefarious practices, including predatory pricing, frivolous lawsuits and bribery, to take over more than 100 companies and amass control over 85 percent of the country's oil refining capacity. The company was broken up in 1911 in one of the first high-profile antitrust cases.

But predatory pricing, much like Supreme Court Justice Potter Stewart's famous observation about pornography, is a lot easier to decry than to define. When the Supreme Court held that Standard Oil had indeed violated the Sherman Act, it neglected to say exactly how.

Decades later, John McGee, an economist at the University of Chicago, went back and carefully reviewed the case. His landmark article in 1958 concluded that there was no evidence that Standard Oil used predatory pricing to gain its monopoly.

The study had enormous impact what became the Chicago school, which applied neo-classical economic theory to antitrust cases. What they concluded was that predatory pricing was extremely rare because after driving a competitor out of business and then raising prices, the would-be monopolist would simply attract new competitors into the market.

These new theories attacked the conventional wisdom that reigned from the 1930s through the 1960s, often referred to as the Harvard school, that predatory pricing was a common and rational practice.

"The courts had terrible views of economics," says Bork, the former solicitor general and federal appeals court judge, who is a leading exponent of the Chicago school. "It was folk economics. They sort of took antitrust at face value and never took into account the doctrines that were in play, many of which were wrong."

Bork's 1978 book, "The Antitrust Paradox: A Policy at War With Itself," is considered one of the most eloquent expressions of the Chicago school approach. In it, he wrote, "Unsophisticated theories of predation abound, leading to drastic overestimations of its likelihood."

Since the goal of antitrust law is to protect consumers against unfairly high prices, the courts have long held that anyone claiming to be the victim of predatory pricing must not only prove that the alleged predator is charging prices below cost, he must also prove that the predator can make back the money lost as well as additional profits.

In the view of the Chicago school, this rarely if ever happens. Instead of protecting competition, the Chicago scholars concluded, the courts were depriving consumers of the benefits of lower prices.

"The confusion between a price cut and a predatory cut led to a lot of bad results," Bork said.

The Supreme Court has agreed. In a 1993 decision successfully argued by Bork, the court confirmed that a jury was mistaken when it found the cigarette maker Brown & Williamson guilty of predatory pricing and awarded rival Liggett $148.8 million in damages. Even if Brown & Williamson sold below cost, the court held, Liggett couldn't prove that Brown & Williamson would have been able to recoup on that investment.

The Bush and Reagan administrations were also influenced by the Chicago school and rarely invoked the antitrust laws.

In the most recent swing of the pendulum, the Clinton administration has stepped up antitrust enforcement. Post-Chicago thinking forms the intellectual foundation behind its decisions to block several mergers as well as some of its most controversial investigations, including that of Microsoft Corp.

Many of the shapers of post-Chicago thought have held or currently hold key positions at both the Justice Department's antitrust division and the Federal Trade Commission, which share federal antitrust enforcement. Others, such as Joel Klein, the head of the antitrust division, have heartily embraced post-Chicago thinking.

"We regard a predatory strategy as a real possibility," said FTC Chairman Robert Pitofsky, who describes himself as a member of the post-Chicago camp.

The post-Chicago approach does not reject the Chicago school in the same way Chicago thinkers such as Bork and Posner attacked the Harvard school. Indeed, some post-Chicago scholars even cite Bork for inspiring some of their theories. Like their predecessors, the post-Chicago thinkers are firm believers in market forces, but they say the market doesn't always come to the rescue and therefore government intervention may be needed.

"As the economic models have advanced, we have gotten a better understanding of strategic behavior and that reopens the question of predation," said Steven Salop, professor of economics and law at the Georgetown University Law Center who has written several articles credited with advancing post-Chicago thought.

In the case of the airlines, for example, the Clinton administration has said that the major carriers not only cut their prices when they were challenged by small competitors charging lower prices on certain routes; they also wooed away most of the passengers by flooding the routes with cheap flights leaving at more convenient times. When the smaller competitor gives up, the major airline cuts service and raises prices again.

Bork and the Chicago school argue that this strategy makes no sense because planes can quickly be redeployed into the market once prices rise. Therefore, the major airline could never recover the money it lost by lowering its prices.

But the post-Chicago school counters that the ability of the major airlines to drive out one or two challengers on a few routes has the added value of scaring off new challengers who would expect to get the same treatment. This demonstration effect makes the likelihood of recouping the major carrier's original investment a lot higher. It was cited in a speech last year by Roger Fones, the prosecutor leading the Justice Department's antitrust investigation of the airlines.

"There are things that are rational in a game theory model that look irrational from a straightforward neoclassical view," said Garth Saloner, Magowan professor of economics and strategic management at Stanford University's business school and a leading member of the post-Chicago camp.

The post-Chicago school has also examined the predatory nature of a host of exclusive deals in which dominant companies use their power not simply to cut their prices but to raise the cost of doing business for their smaller rivals.

For example, the FTC is investigating charges that spice maker McCormick & Co. may have gone too far in its efforts to pay supermarkets to give its products prominent shelf space. The Justice Department is investigating Anheuser-Busch for signing exclusive agreements with beer distributors and paying them extra fees if they don't distribute rival brands.

Another theory involves a company using its dominance of one market to force its way into another. That is what the Justice Department claims Microsoft was doing when it forced computer makers who wanted to buy its Windows operating system to load its Web browsing software also. And it is also related to charges that 3M forces distributors eager to get its popular self-stick notes to also buy its less popular cellophane tape.

Whether the post-Chicago theories end up having as far-reaching influence as the Chicago school will ultimately be decided by the Supreme Court. The record so far has been mixed. The court appeared to subscribe to some post-Chicago theories in a 1992 decision involving Eastman Kodak Co., but the next year it gave a ringing endorsement of the Chicago approach in the Brown & Williamson case.

In addition, at least two of the nine justices, Stephen Breyer and Antonin Scalia, are known as strong followers of the Chicago school.

But the post-Chicagoans are optimistic that their time may be coming. "The P word is still a dirty word in some antitrust circles," Saloner said, speaking of predation. "But there is always a lag between the theory and the legal system."