Market Structure and Industrial Performance: A Review of Statistical Findings

The most generally accepted raison d'etre for State intervention in economic affairs has been that a free market could not sustain competition: unregulated capitalism would inherently spawn monopolies, and these monopolies would inherently “misallocate” scarce economic resources.

Economists have weaned two generations of students on the notion that the structure of a market determines the degree of “competition” on that market and, ultimately, the economic performance to be expected from that market. Economists still routinely argue that if markets are “purely competitive” in structure (small firms producing homogeneous products) they will automatically generate a situation where price and marginal cost are equated, in other words, good economic performance. Anything less than pure competition—all real production situations!—necessarily misallocates “society’s” resources and justifies, according to this view, State intervention (the antitrust laws, et cetera) in the public interest.

Recently, some enterprising economists have gone beyond the theoretical arguments and have sought to “measure” the resource misallocation suggested by the classical theories of competition. Empirical studies abound, students are assured, that “prove” that large firms misallocate resources, or that profit rates (an indicator of “performance”) and industrial concentration are positively correlated, or that, generally, market structure is a reliable guide to probable economic performance. Indeed, the issue is thought to be so settled, that it has simply become an article of faith among antitrust and “industrial organization” practitioners and need never, apparently, be questioned again.

John Vernon’s Market Structure and Industrial Performance: A Review of Statistical Findings may, hopefully, begin to crack the unwarranted professional smugness concerning structure/performance. Professor Vernon dispassionately reviews the conventional theories of competition and monopoly and all the important empirical studies that attempt to relate structure to performance or measure the misallocations of resources associated with “monopoly power.” His incisive and marvelously objective treatment of the issues casts serious doubt on both the relevancy. of the assumptions surrounding “pure competition” and the methodology and conclusions discovered in these studies. Indeed, he concludes the entire discussion by noting that the supposed link between structure and performance is so tenuous that “solid factual support for public policy in this area does not exist.” (One can almost hear the hot air escaping from the sails of the antitrust enthusiasts now!)

To indicate the sort of issues examined in the Vernon book, take the “advertising controversy.” Most economists have accepted the notion that advertising expenditures are a serious “barrier to entry” that serve only to limit effective competition between firms in the American economy. They argue that advertising wastefully enhances a phony product differentiation, increases concentration, and ultimately bestows higher profits on the firms that spend the most.

According to Vernon, however, both the “theory” and the proof that would warrant such a pessimistic view concerning advertising are open to the most serious question. He notes arguments that advertising can increase competition and says that it would be sheer nonsense to ignore that fact. More pointedly, he relates that a review of the leading empirical studies on the subject does not bear out the belief that a solid, positive correlation exists between advertising and industrial concentration or profit. Some important studies have found no such relationship, and even the studies that found a correlation lose that correlation when their sample size is increased to make them more representative. As in many other areas of the “monopoly problem,” there is more wishful thinking here than hard fact.

In summary, the Vernon book is valuable because it reviews and criticizes the classical theories of competition and monopoly, because it exposes the questionable methodology employed in all empirical studies of structure/performance, because it reviews in summary the most important and influential conclusions of these studies, and because it contains an excellent bibliography in the industrial organization area. It is deficient in ways that libertarians might easily anticipate. Vernon does not involve himself in moral issues, does not reject completely the theory of pure competition and the classical theories of competition and monopoly, does not call for the abandonment of antitrust, and does not even hint that the notion of “monopoly power” and even “concentration” might relate more to political factors (tariffs, patents, defense contracts, et cetera) than to anything inherent in laissez-faire capitalism. Nonetheless, the book is a valuable contribution toward clarity and light in an area dominated by holy myth.

Reviewed by D. T. Armentano / Economics (140 Pages) / BFL Price $4.95