The Wall Street Journal
December 26, 2002
COMMENTARY
Antitrust's Real Legacy
By PETER HUBER
Eighteen months ago, United Airlines and US Airways were both so strong,
apparently, that by combining forces they would have acquired unlawful
power to gouge consumers and make out like bandits. It was on that
logic, in any event, that our vigilant antitrust authorities resolved to
keep the two companies safely apart.
Both are now in bankruptcy.
It's not a new phenomenon: The competitive structures of the industries
that are now keeping the bankruptcy courts so busy -- notably telecom,
electric power and air transport -- have been shaped by regulatory
commissions and antitrust courts who don't understand a thing about the
subtle, complex economic forces that govern these capital-intensive
network industries. Clumsy government policies intended to promote
competition have played a pivotal role in creating boom-bust cycles.
Innovations and Subsidies
In the 1960s, long before the Internet made such capabilities
commonplace, American Airlines pioneered the invention of a computerized
reservations system (SABRE) that would eventually process millions of
online transactions and allow for frequent fine-tuning of prices. United
Airlines followed with its Apollo system. Both systems included flights
from other carriers, but favored their own carriers' inventories. The
innovations were revolutionary because of their impact on filling seats
-- all important in a capital-intensive industry.
In 1984, however, regulators ordered American and United to stop giving
their own flights any priority in their reservation systems, and to
route inquiries in ways that took no account of the carrier's identity
or its fee structures. This gave a big boost to other large companies
that had neglected to invest early and effectively in comparable
technology, and made it easier for small upstarts to enter the business
and pick off profitable routes here and there. Bottom line: The
industry's two largest players lost control of a key asset that they had
built themselves, that perfectly complemented their extensive route
systems, and that they would badly need, over the long term, to maintain
stable profitability in a newly competitive environment.
Similar crises of regulation and inefficiency can be seen among other
comparably structured industries to an even more aggravated degree. In
the electric power industry, which has suffered enormous meltdowns in
California, matching capacity at plants and capacity in wires with
demand at the far end is shorted by a rusting system in which the
flexibility to change prices is prescribed by a slow and cumbersome
regulatory process.
To meet that challenge, utilities traditionally built and owned the
plants that supplied most of the power to their wires, and signed
long-term contracts with stable suppliers for the rest. Much of what has
passed for "deregulation" of electric power in the last decade has
consisted of orders to sever those links. Pacific Gas & Electric is in
bankruptcy as a direct consequence of directives of that character;
several other major utilities came perilously close to joining it before
California threw out the whole sorry scheme. The state now blames others
for having manipulated the market it tried to set up. But the whole
point of owning assets and signing long-term contracts is to insulate
yourself from price swings, whatever their cause.
Even seasoned investors and prudent corporate managers often misjudge
the prospects for profit in industries that require huge amounts of
capital to be invested years before it earns any return. Dumb money
rushes in when capacity is tight and prices are high; prices then drop
and asset values shrivel a few years later when there's a glut. But this
natural cycle has been greatly amplified by regulatory policies that
grease competitive entry at the front end of the cycle, and refuse to
countenance any final exit at the back end.
Look at the adventures of telecom. The logic for breaking up the old
Bell System in 1984 was to separate long-distance from local markets, to
unleash competition on the long-distance side of the divide. Through the
1980s and into the '90s, however, federal regulators wouldn't let AT&T
cut its long-distance prices, because the authorities feared --
correctly -- that AT&T could quickly wipe out at least one of its major
competitors if it were free to do so. For good measure, regulators
directed additional subsidies toward the upstarts by allowing them to
pay much less than AT&T for their connections to local networks.
This scheme was maintained until burgeoning data markets attracted
massive amounts of new investment. Then prices collapsed, and the entire
long-distance industry is now on the brink of bankruptcy, with WorldCom
over the falls.
Mergers have often been the rational response to looming capacity
excesses in network industries, because larger companies can sell,
retire and downsize by attrition much more smoothly than smaller ones.
United Airlines and US Airways tried that approach in 2001, but (as we
know) the authorities effectively concluded that the traveling public
would be better served if the two companies found their own, independent
ways into bankruptcy instead. WorldCom tried to merge with Sprint in
1999, but Justice wouldn't hear of it. WorldCom is now in bankruptcy and
Sprint probably would be too, but for the revenues it earns from the
local phone and wireless companies that it also owns.
Since competitors in network industries must interconnect, hand off
traffic, and share customers and facilities, these industries spawn
private antitrust suits as well, and they too have had far-reaching
impacts on market structures. Antitrust litigators helped fund the young
MCI when they extracted about $190 million in damages from AT&T and the
Bell companies in 1985 -- the defendants had, once again, allegedly
failed to grant MCI, their direct competitor, sufficiently ready access
to their own networks. Covad is now suing Verizon and BellSouth, on
exactly the same theory.
The bankruptcy laws, which might at least clean things up at the end of
the day, now often make things worse. Chapter 11 "is like going to a car
wash," one solvent but disheartened CEO of a small telephone company
observed last July. Insolvent competitors "go in, they get their debt
hosed off and they come back." Covad, which is now suing everyone else
for damages, walked away from $1.4 billion in debt in a bankruptcy court
in 2001; it now boasts of its "great-looking balance sheet -- perhaps
the best in telecom."
What we now see in these industries is cut-throat competition among
competitors that are collectively headed for insolvency, and who won't
stop competing even when they do stop paying their debts. This isn't
good for employees or creditors, whose long term interest lies in being
able to market their specialized skills and products to a thriving
industry. It's terrible for investors across the whole market because so
many other sectors depend on the health of the infrastructure companies.
And while consumers may benefit in the short run, the market will get
its payback later, by postponing new investment in network expansion and
innovation.
'Cuisinart' Policies
Regulators and antitrust courts must come to grips with the economic
realities of network industries. Huge economies of scope and scale mean
that competition will inevitably involve small numbers of very large
players. 'Cuisinart' policies that chop and dice networks, services and
corporations into little pieces don't promote competition, they undercut
it. Most of the time, it's a mistake to force companies to share
reservation systems, power transmission lines, copper loops and other
core assets, on terms minutely prescribed by regulators. Such meddling
promotes a short-term illusion of competition, but not the long-term
reality.
Mr. Huber, a senior fellow at the Manhattan Institute, is a partner in a
Washington firm that represents a number of telecom clients, including
several Bell companies.