Antitrust and Economic History: The Historic Failure of the Chicago School of Antitrust

A. Industrialization and the Managerial Revolution

The Industrial Revolution in the United States gained its full stride after the U.S. Civil War. During the antebellum era, agriculture and small industrial enterprises dominated the economy. The small personally managed industrial firms relied on water for power and had few employees. ¹⁰ The lack of sufficient supplies of coal and labor shortages delayed U.S. industrialization compared to Great Britain. ¹¹

Immigration following the 1848 revolutions in Europe and the opening of the anthracite coalmines in Eastern Pennsylvania lifted the constraints on industrialization. ¹² The modern business enterprise in the United States then emerged with the advent of the railroads, which were by far the largest and most dynamic industry of the early industrial revolution. The railroads represented a joint effort by local governments and private interests ¹³ and adopted the corporate form. The early railroads were formed as corporations because they followed the example of the quasi-public canal companies, which were also corporations. ¹⁴

Alfred Chandler described the technical problems involved in the operation of the railroads. The difficulties included coordination of tracking rights, standardization of equipment and procedures, and efforts to control competition. These challenges required skilled middle managers who “were responsible for devising and perfecting a number of basic organizational and technological innovations so central to the efficient operation of the railroads.” ¹⁵ The special requirements of railroad operations initiated the first managerial revolution in the United States. The demand for managers resulted in dramatic societal changes including engineering departments at leading universities, professional societies, and cultural transformations in American cities. ¹⁶ The investment needs of the railroads further formed the basis for the development of other large businesses including steel, machinery, chemicals, refining and distilling, and others. The railroads created mass markets served by new large retail and wholesale firms such as Macy’s, Lord & Taylor, Bloomingdales, Marshall Field’s, and other large retailers. ¹⁷ In turn, the mass market made large-scale production in consumer goods and other products feasible.

There is a common misconception that the Gilded Age was an era of free trade. On the contrary, industrialization in the United States in the 19th century occurred under the protection of a high tariff. The U.S. tariff on manufactured products ranged from 40% to 50% between 1875 and 1913. ¹⁸ Despite such protectionist policies, a global trade revival flourished between 1870 and 1913. While this increased commerce resulted from new technologies such as the telegraph as well as refrigeration, it consisted primarily of trade in agricultural products. ¹⁹

B. Big Business, Bertrand Competition, and Collusive Practices

The railroads and developments in communications helped break down local barriers to competition. ²⁰ As a consequence, the new large firms faced fierce price competition from their peers. We now understand this phenomenon as Bertrand competition with homogeneous products, but it was called “ruinous competition” at the time. ²¹ Another consequence was nominal price deflation which also characterized this period. The wholesale price index in 1890 was 39.2% below its level in 1870. ²² Figure 1 evidences a spectacular decline in average profitability beginning in 1869 and continuing until the end of the 1890 recession at the turn of the century. The profit rate decline created serious macroeconomic instability. A deep recession resulted in 1873, ²³ followed by subsequent recessions in 1876, 1889, and again in 1892. ²⁴ Originally, this period was called the “Great Depression” before the term was appropriated and attached to the depression that began in 1929. Michael Roberts is one of a handful of economists to assemble the economic evidence from this period:

Evidence for a depression in the United States is most dramatically seen in railroad construction, where the financial panic of 1873 was located…. Railroad construction began to recover after 1875, but it did so fitfully and basically remained flat and low during the 1876-78 period, fluctuating around 3,000 miles of construction. Only in 1879 did construction surge again up to 5,000 miles, followed by the biggest surge of all as the 1880s proved to be by far the leading decade of rail construction, followed by a nearly total collapse in the 1890s. ²⁵

C. The Sherman Act

The actions of the trusts fostered significant public hostility. As Thorelli summarized, “it would seem that public concern, as conditioned by developments in the economic, social, constitutional and political fields, at the end of the 1880s had become serious enough to make federal action against the trusts a clear desideratum, if not an absolute necessity.” ²⁹ The increased prices resulting from these trusts and pools had serious consequences for agriculture, urban workers, and small businesses. During the Gilded Age, these groups possessed significant political power that could potentially influence policy. ³⁰ Political pressure mounted until legislative action was unavoidable, and on August 14, 1888, John Sherman introduced the first antitrust bill, which resulted in the eponymous act of 1890. The Senate debated the Sherman bill for 18 months without reaching any consensus on language or scope. Then, on March 27, 1890, the bill was referred to the judiciary committee. ³¹ Within a week, on April 2, 1890, the committee reported out a completely redrafted bill, largely the work of George Edmunds of Vermont. The bill passed the full Senate on April 8, 1890. The vote was nearly unanimous with only one dissenter.

What explains the extended two-year deadlock followed by the swift agreement? At the state level during that time, the political power of big business and the other economic classes including agriculture, small business and to a lesser degree labor were roughly comparable. ³² Big business was politically powerful, but so was agriculture and small business. The rhetoric of the Congressional debates reflects these contending class interests. Supporters of big business stressed the concept of freedom of contract, the right of business to enter into contracts of their choosing. Such freedom, they contended, included the right to enter into contracts with competitors or to buy and sell business property without restriction. Supporters of agriculture, labor, and small business adopted a narrative of free competition and the important role of government in protecting the competitive process. ³³ The compromise bill by Senator Edmunds was sufficiently ambiguous that both sides could read it as supportive of their own position. This ambiguity is evident from the opening line of Section 1 of the Sherman Act that states, “Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States…is declared to be illegal.” The use of the word “all” coupled with the term “restraint of trade” which in the common law referred to only unreasonable restraints of trade sapped the Sherman Act of any plain meaning. The resulting semantic ambiguity implied “all” restraints, and “not all” restraints were within the purview of the Act at the same time. Therefore, decades of judicial interpretation would be required before the Supreme Court would settle on a clear and consistent meaning in the Standard Oil ³⁴ case in 1911.

D. Early Sherman Act Enforcement

Once President Harrison signed the Sherman Act into law, the onus of enforcement passed to the executive branch, and in particular, to the attorney generals. Unlike the states, big business interests dominated the executive administrations during the Gilded Age, and consequently, attorney generals initiated few antitrust cases. ³⁵ During the thirty-two months of the Harrison administration, for example, it brought only seven cases. ³⁶ The Cleveland administration brought eight cases, four of which were against labor. ³⁷ The McKinley administration filed only three antitrust suits. Indeed, the only individual to go to jail in the first few decades of Sherman Act enforcement was Eugene Debs, a labor leader and member of the socialist party.

Once cases began to reach the Supreme Court in the Gilded Age, the Court had to struggle with several difficult issues. For example, the Court had to reconcile the prevailing narrow definition of interstate commerce with antitrust enforcement against national firms. For example, it dismissed the challenge to an acquisition by American Sugar Refining that would have resulted in a 98% market share because the acquired assets were located in a different state than the acquirer. ³⁸ Curiously, the Court had fewer problems upholding the applicability of the Sherman Act to labor activity in In re Debs, even though the legislative history of the Sherman Act indicated Congressional intent to exclude labor from Sherman Act scrutiny. ³⁹ Of great significance was the Court’s decision in United States v. Trans-Missouri Freight Ass’n ⁴⁰ that interpreted Section I of the Sherman Act to apply to all restraints of trade whether reasonable or not. ⁴¹ This decision would mobilize big business to organize to revise the Sherman Act and seek further supplementary antitrust legislation during the Progressive Era.

A. The Corporate Revolution and the Rise of Finance

The giant industrial corporations were in many ways a product of the first great merger wave from 1887 to 1904. With the exception of the railroads, the early large American industrial enterprises were partnerships. The Gilded Age managerial revolution was limited to the middle levels of these partnerships, while owners maintained control at the top. The merger movement altered this structure through the formation of corporations. The corporate form required the replacement of the owners at the top levels of management with boards of directors. These boards were normally comprised of professional managers and banking interests. The merger movement also created the modern financial markets that arose to finance these acquisitions through the sale of securities to the public.

B. The Rise of Instability and the Great Depression

There is no simple explanation for the great crash and the ensuring depression that occurred at the end of the 1920s. Any attempted explanation must distinguish between the initial downturn and the propagating mechanisms that exacerbated and prolonged the decline. This article argues that the instability associated with the rise of big business and the dominance of finance in the Progressive Era was an impetus for the initial decline, and the laissez-faire policy regime of the era limited the possible policy responses that might have precipitated an earlier recovery. Under the laissez-faire policy regime, expansionary fiscal policy was deemed illegitimate, and monetary policy was limited by a religious adhesion to the gold standard.

A. The First Order of Business: Suppress the Influence of Finance

On March 4, 1933, at the nadir of the depression, Franklin Roosevelt was inaugurated. As Thomas Ferguson aptly described, “taking office at the moment of the greatest financial collapse of the nation’s history, President Franklin D. Roosevelt initiated a dazzling burst of government actions designed to square the circle that was baffling governments elsewhere: how to enact major social reforms while preserving both democracy and capitalism.” ¹²⁰ In his augural speech, Roosevelt stated what many thought at the time, that the economic crisis was the creation of “the unscrupulous money changers.” ¹²¹ Two days later on March 6, Roosevelt declared a national bank holiday. ¹²²

Then in June 1933, Roosevelt signed into law the 1933 Banking Act, also known as the Glass–Stegall Act. Its most important provisions were the separation of commercial and investment banking ¹²³ and the establishment of the Federal Deposit Insurance Corporation. ¹²⁴ The Act addressed the swelling public concern that financial interests had diverted bank credit into speculation rather than productive uses. The 1933 Act also preserved the prohibition on interstate branch banking and prohibited interest on demand deposits. ¹²⁵ Regulation Q allowed the Fed to set rates on time deposits. Collectively, the 1933 and 1935 Banking Acts created a banking system that limited competition between banks, and severed bank interconnections, to preserve stability and prevent contagion. The approach was successful. Only two banks failed in the first two terms of the Roosevelt presidency, and there were few large bank failures until bank deregulation began under neoliberalism. ¹²⁶

In addition, the Banking Act of 1935 considerably strengthened the Federal Reserve System by wresting control of the Open Market Committee from the regional banks and placing it under the Federal Reserve Board, thereby increasing its effectiveness. ¹²⁷ The Securities Act of 1933 required disclosure of accurate information about securities and outlawed false statements. The Securities and Exchange Act of 1934 created the Securities and Exchange Commission to regulate securities markets. Critically, these measures combined to curtail the negative influence that finance had exercised over the economy.

B. The Early New Deal

New Deal policy was never entirely consistent. Roosevelt’s early actions succeeded in limiting the power of finance, but in 1933, he did not have wide-ranging plans for industrial restructuring. In June 1933, Congress passed the National Industrial Recovery Act (NIRA). The logic of NIRA harkened back to the success of the War Industries Board and was based on the Gilded Age theory that ruinous competition was inimical to capitalist stability. Hugh Johnson, one of the leaders of the War Industries Board headed the National Recovery Administration (NRA), the agency created by the NIRA. Title I of NIRA created the industry codes that established prices and policy for industry participants. The opaque Section 7(a) guaranteed the right of labor to organize and collectively bargain. Section 5 exempted the codes from the Sherman Act. ¹²⁸ The NRA enacted 546 industrial codes covering 550 industries and it issued 11,000 orders interpreting various code sections.

Roosevelt asked Clarence Darrow to head an NRA review board in 1934. The Darrow Report concluded that NRA was essentially creating small monopolies and labor rights were not improving. ¹²⁹ Before Congress, Darrow testified, “the whole thing was obviously made for the rich man-for big business.” ¹³⁰ Moreover, Johnson’s interpretation of the collective bargaining was largely limited to company unions and NRA did not effectively contribute to union strength. ¹³¹ The Supreme Court ultimately declared NIRA unconstitutional in A.L.A. Schechter Poultry Corp. v. United States. ¹³²

C. The Later New Deal

While the early New Deal took many twists and turns, a consistent theme emerged following the demise of NRA. The policy convergence centered on efforts to reduce the power and income of big business and increase the income and power of the other classes. Ellis Hawley refers to this policy aim as “counterorganization”:

But if one insisted on a dominant theme, he could probably find it in the concept of counterorganization, in the idea of using the government to promote the organization of economically weak groups, thus restoring economic balance…The advantages of stronger economic organization had long been stressed by labor, farm, and small business groups. The relatively new element was the attempt of these groups to enlist governmental aid in developing market power. Labor leaders had now abandoned their former devotion to ‘voluntarism’ and were urging that the government foster unionization, absorb the unemployed, and regulate wages and hours. ¹³³

The Neo-Brandeisians had been lobbying Roosevelt throughout the NRA period to revitalize United States antitrust policy. ¹³⁹ After NRA was declared unconstitutional, they got their chance. In 1937, Robert Jackson (a Neo-Brandeisian and admirer of Woodrow Wilson) was appointed head of the Department of Justice’s Antitrust Division, a position he held until March 1938. During his short tenure, he brought two landmark cases that would guide antitrust law in the post–World War II period: United States v. Socony-Vacuum Oil Company ¹⁴⁰ and United States v. Aluminum Company of America. ¹⁴¹ In March 1938, Thurman Arnold replaced Robert Jackson at the Antitrust Division and served until 1943. Arnold rebuilt the Antitrust Division by significantly increasing its size and budget. ¹⁴² From 1939 to 1941, the Antitrust Division filed more than 180 cases. ¹⁴³ By the time Arnold left the Antitrust Division in 1943, he participated in almost half of all Sherman Act cases ever brought up to that time. ¹⁴⁴ This new potent antitrust policy continued to expand during the golden age of capitalism that followed.

D. The Later New Deal and the Remarkable U.S. Economic Performance

The New Deal policy was remarkably effective. At the end of the 1920s, the top 1% of the population garnered approximately 24% of total income. ¹⁴⁵ During the 1930s, this number dropped to 16.6% before continuing to drop into the post–World War II period. ¹⁴⁶ The New Deal policies of encouraging strong labor unions, more equitable income distribution, high wages, and vigorous antitrust policy resulted in the most spectacular increase in productivity and gross domestic product (GDP) growth in the history of the United States. The average rate of return on capital in the 1920s was nearly 14%. ¹⁴⁷ The economy recovered to this level of profits by 1937. From 1940 to 1949, the rate of profit increased to 23%. ¹⁴⁸ It never again declined to the level of the 1920s until the 1980s. ¹⁴⁹

Figure 1 depicts the striking growth in profits from the 1930s through World War II. These remarkable achievements occurred in an environment of diminished international trade, as global trade had collapsed during World War I and did not revive until 1945. There can be no doubt that between the 1920s and the end of World War II, the American economy experienced a major economic advance. ¹⁵⁰ The average total factor productivity ¹⁵¹ for the years 1900 to 1920 was about 1%. The average for the decade of the 1920s was 2%. It grew to 3% in the 1930s and 2.5% for the 1940s. It remained high at 2% for the years 1950 to 1973, but then dropped to below 1% for the period 1973 to 1990. The reasons for this huge advance in productivity include, among other factors, the exploitation of the late 19th century inventions of electric power and the internal combustion engine, ¹⁵² high wages (a result of strong unions and New Deal legislation, particularly the National Labor Relations Act of 1935), ¹⁵³ and significant government intervention in the economy. High wages led to the substitution of capital for labor. ¹⁵⁴ Alfred Kleinknecht, for example, studied the timing of the implementation of major basic innovations. He found that the period from the 1930s to approximately the late 1940s produced more basic innovations and greater “product-related breakthrough patents” in the 1930s and 1940s than any other period. ¹⁵⁵ According to Alexander Field, “employment of research scientists and engineers grew 72.9 percent between 1929–1933 while employment totals in other occupational categories collapsed. Between 1933 and 1940, R&D employment in U.S. manufacturing almost tripled, from 10,918 to 27,777.” ¹⁵⁶ There is evidence of technical advances in the 1930s in a wide variety of industries including chemicals, automobiles, communications, electronics, transportation, construction, retail and wholesale trade, and other industries. ¹⁵⁷

E. World War II and Continued Success of the New Deal Policies

As early as 1939, the American economy began to respond to the Allies’s increased demand for armaments. ¹⁵⁸ Then an explosion of defense spending began in 1940 when the Selective Service Act instituted the military draft. ¹⁵⁹ Federal expenditures escalated, and wartime production transformed the economy to meet the military need. ¹⁶⁰ In the 1920s, the ratio of federal spending to GDP was about 12%, it rose to 20% during the New Deal, but at the peak of the war effort the size of federal spending was 45%. During World War II, the federal debt also grew even though government had increased the tax base to include virtually all Americans and top rates reached 94%. The ratio of debt to GDP in 1938 was 43%. It ballooned to 114% at the height of the military spending in 1945. Most economists acknowledge that this expansionary fiscal policy contributed to the recovery from the depression. ¹⁶¹

The government also contributed to the productive capacity of the economy by directly building production facilities for the war effort. These plants were government owned but operated by private businesses (GOPO). The government constructed aluminum plants, steel plants, machine tool facilities, plants to produce machine tools and dies, the massive Willow Run facility near Detroit, and numerous forts and bases. Most of these facilities were large-scale projects. ¹⁶² In all, the government may have invested as much as $45 billion in private industrial plants and equipment. ¹⁶³ After the war, private business purchased these assets under the Surplus Property Act of 1944, often at bargain prices. ¹⁶⁴

The War Production Board also facilitated the expansion of existing capacity. ¹⁶⁵ Robert J. Gordon conveyed how, “the entire economy converted to a maximum production regime in which every machine and structure was used twenty-four hours per day if enough workers could be found to staff three shifts.” ¹⁶⁶ Duménil, Glick, and Levy showed that the maximum production regime resulted in the gigantic increase in the rate of profit by economizing on use of existing structures. ¹⁶⁷

The government also sponsored research that would become important after the war. The War effort resulted in advances in radar, materials science, microwave technology, and products such as the jet engine, heavy water, continuous catalytic cracking, silicone, teflon, nylon, the aerosol spray, accelerators, and streptomycin. Vernon Ruttan contended that the government’s research efforts during the war also created radical “general purpose technologies” that would form the foundation of further post–World War II innovations. ¹⁶⁸ Ruttan included aircraft design, nuclear power, and computer technology as key general purpose technologies that emerged from the war effort. ¹⁶⁹

The War Production Board received the power to grant immunity from antitrust scrutiny. ¹⁷⁰ Thurman Arnold had initiated investigations in steel, shipbuilding, aircraft, petroleum, electric equipment, chemicals, and other industries. ¹⁷¹ All of these investigations were suspended during the war. ¹⁷² However, the government did attempt to use the sale of the government facilities to increase competition. For instance, it helped sponsor the entry of Reynolds Aluminum by selling it the government constructed aluminum facilities. This undermined the Alcoa monopoly. Antitrust enforcement would revive and expand after the war during the golden age of capitalism.

A. Antitrust in the Golden Age of Capitalism

The Golden Age of Capitalism was a period of activist antitrust enforcement. A broad per se rule for horizontal conspiracies prevailed based on the holding in United States v. Socony-Vacuum Oil Co. One of the leading merger cases, Brown Shoe Co. v. United States, ¹⁸² articulated the Congressional goals of merger policy to include ¹⁸³ preventing the “rising tide of concentration,” control of vertical and conglomerate mergers, and recognition of noneconomic concerns such as protecting political democracy. ¹⁸⁴ In Brown Shoe, the Court found that an historical trend toward vertical integration along with a small foreclosure of less than 1% was sufficient to condemn the vertical merger, and postmerger market shares ranging from 5% to 57% in the various geographic markets were enough to render a horizontal merger illegal. Significantly, the Supreme Court stated that a merger that increases concentration cannot be “saved, because, on some ultimate reckoning of social or economic debits and credits, it may be deemed beneficial.” In other words, efficiencies were not part of the Court’s merger analysis. The Supreme Court also reaffirmed that small levels of foreclosure can condemn vertical mergers where the target is also a potential entrant, as in Ford Motor Co., v. United States. ¹⁸⁵

The 1968 Merger Guidelines promulgated by the Department of Justice (DOJ) Antitrust Division embodied these principles. The guidelines stated that the DOJ would challenge mergers in markets where the four-firm concentration ratio is above 75% even when the acquiring and acquired firms have market shares smaller than 5%. The criteria became more stringent when there was a trend toward concentration. The Guidelines prohibited vertical mergers involving supplying firms with 10% or more of sales in the market, or purchasing firms with more than 6% of total purchases in the market, unless barriers to entry were low. The 1968 Merger Guidelines also challenged conglomerate mergers involving a potential competitor when the merging firms had significant market shares. ¹⁸⁶

B. The Origins of the Chicago School

The Chicago School of economics emerged from the crucible of a broader intellectual movement called neoliberalism. ¹⁸⁷ Allegedly, the term neoliberalism originated at the Walter Lippmann Colloquium in Paris in 1938. ¹⁸⁸ The Mont Pelerin Society, which held its first meeting in 1947, became the organizing hub of the neoliberal movement. Its leaders included Austrian economists Friedrich Hayek, Ludwig von Mises, Wilhelm Ropke, and Milton Friedman. George Stigler, Gary Becker, and James Buchanan were frequent participants. ¹⁸⁹ The participants in the neoliberal movement did not have a unified theory in all respects. ¹⁹⁰ As the historian Ben Jackson describes, “Among the authors conventionally bracketed together as the founders of neoliberalism, there was, as might be expected, a spectrum of positions on these [economic] issues, rather than a uniform line.” ¹⁹¹ What united these men was their opposition to expanding the role of the state, including opposition to regulation that protected unions and employees, government social programs, public or regulated enterprises, and any obstacles to free trade. ¹⁹²

The two central figures in the neoliberal movement were Frederick Hayek and Milton Friedman. ¹⁹³ A key feature of both thinkers was the tendency to assume way the power and impact of big business. In The Road to Serfdom, published in 1944, Hayek argued that all types of state action, whether central planning or New Deal regulation, illegitimately infringed on human freedom of action. However, nowhere did he express any concern for the enormous growth in firm size which places employees under the strict command and control of managers. ¹⁹⁴ Hayek posited that freedom is advanced only by the market, yet these big businesses are the result of market forces, not government action. Hayek further argued that any command and control regime would result in a failure of economic coordination. He argued that collective action distorts the price information necessary to achieving a position of economic equilibrium, a prerequisite for economic welfare. ¹⁹⁵ Since the publication of Hayek’s work, economists have shown that, contrary to his assertions, market signals and information extracted from prices can yield destabilizing results. ¹⁹⁶ Hayek only assumed that information carried by market prices could achieve equilibrium and create favorable welfare outcomes. He never modeled the process nor did he marshal empirical evidence to support his supposition. Thus, there is little reason today to credit the policies prescriptions that he derived from this theory.

Milton Friedman, in his book, Capitalism and Freedom, also assumed large firms out of existence. Friedman recognized only two ways to organize society: “One is the central direction involving the use of coercion—the technique of the army and of the modern totalitarian state. The other is voluntary co-operation of individuals—the technique of the market place.” ¹⁹⁷ He argued that the advantage of the market place is that it involves voluntary transactions in which both parties gain. He asserted that a society of individuals that contract voluntarily will result in maximum freedom, ¹⁹⁸ and collective action by the government and labor unions threatens this freedom.

What is ignored is that the bulk of the population are forced to work for corporations, and these corporations use command and control, “the technique of its army,” to deprive workers of all control over their labor. In contrast, Friedman’s corporations are not collective entities, they are assumed to be equivalent to individuals. He stated that “enterprises are private so that the ultimate contracting parties are individuals.” ¹⁹⁹ Accordingly, for Friedman, any exercise of power by corporations over its employees is legitimate, while government action and the collective action of labor in response to that power is not. ²⁰⁰ Again, the neoliberals assumed out of existence the central historical issue of the conduct of big business. ²⁰¹

Nancy Maclean makes a similar point in her discussion of James Buchanan’s work:

The dream of this movement, its leaders will tell you is liberty. ‘I want a society where nobody has power over the other,’ Buchanan told an interviewer early in the new century. ‘I don’t want to control you and I don’t want to be controlled by you.’ It sounds reasonable, fair, and appealing…. This cause defines the ‘you’ its members do not want to be controlled by as the majority of the American people. And its architects have never recognized economic power as a potential tool of domination to them, unrestrained capitalism is freedom…. It would like to reinstate the kind of political economy that prevailed in America at the opening of the twentieth century, when the mass disfranchisement of voters and the legal treatment of labor unions as illegitimate enabled large corporations and wealthy individuals to dominate Congress and most state governments alike, and to feel secure that the nation’s courts would not interfere with their reign. ²⁰²

Neoliberals realized that strong state action was the only way to unwind the New Deal. They believed that “its [the state’s] political program will triumph only if it acknowledges that the conditions for its success must be constructed, and will not come about ‘naturally’ in the absence of concerted effort.” ²⁰³ This required that the state “guarantee the success of the market and its most important participants, modern corporations.” ²⁰⁴ As Chicago economist George Stigler commented in 1960, the “political process is strongly biased toward collectivism.” ²⁰⁵ Stigler suggested that one route to success would require “the restriction of the franchise to property owners, educated classes, employed persons, or some such group.” ²⁰⁶ At the 1954 meeting of the Mont Pelerin Society, James Buchanan argued that the “maintenance of [a] free society may well depend on the removal of certain decisions from majority-vote determination.” ²⁰⁷ Friedman followed this logic by opposing universal suffrage in Southern Africa ²⁰⁸ and established a long-standing relationship with the Pinochet dictatorship in Chile. ²⁰⁹

The neoliberals of the Mont Pelerin Society and the Chicago School were joined at the hip. As Mirowski and Plehwe explain, Hayek worked with Henry Simons to bring Aaron Director to Chicago and to establish the original Chicago School. ²¹⁰ Hayek was instrumental, along with others at the Chicago Law School and the Chicago Department of Economics, including Milton Friedman, in securing funding for the “Free Market Study” under the direction of Aaron Director and Edward Levi. The funding came from the Volker Fund. The project strove to advance the neoliberal project into new areas of policy. The “Antitrust Project” followed The Free Market Study and ran from 1953 to 1957. The project developed the basic Chicago School analysis of antitrust law. The Antitrust Project included work by Aaron Director, Edward Levi, John McGee, Ward Bowman, and Robert Bork. ²¹¹ This effort’s later expansion included a program in law and economics, and research fellowships were granted to Ronald Coase and Richard Posner. ²¹² The subsequent Chicago School “research program” produced a massive number of papers, all of which questioned the premises of the New Deal antitrust policy regime. ²¹³

In their 1956 article, Aaron Director and Edward Levi discussed the emerging views of the Chicago School of economics on the antitrust law. ²¹⁴ They plainly stated their main point: “We believe the conclusions of economics do not justify the application of the antitrust laws in many situations in which the laws are now being applied.” ²¹⁵ Critically, Director and Levi asserted “the act [Sherman Act] arose out of an antipathy towards monopoly, and those restraints which were thought to have consequences of monopoly. And it is in the identification and the prediction of the consequences of monopoly that economics has the most to contribute.” ²¹⁶ Thus, according to the authors, only mergers to monopoly and price-fixing cartels were legitimate objects of antitrust scrutiny. Director and Levi doubted that any single firm actually could exercise true monopoly power. “It is much less common than it was [earlier in time] to have an industry in which one firm has seventy or more percent control over productive capacity or sales.” ²¹⁷ Abusive conduct such as vertical integration, tying price discrimination, resale price maintenance, and exclusionary conduct should not come under antitrust scrutiny because “economic teaching gives little support to the idea that the abuses create or extend monopoly.” ²¹⁸ Thus, Director and Levi redefined the goals and purview of antitrust enforcement and called for a radically scaled back antitrust regime, which presaged the more detailed reconsideration of antitrust put forward by Robert Bork and Richard Posner.

By the late 1970s, the Chicago School had a well-developed antitrust policy program, wherein the only legitimate goal of antitrust enforcement is to prevent price increases that result from excessive market power. Often referred to as the “consumer welfare” standard, Robert Bork coined this term and argued for “exclusive adherence” to its standard. ²¹⁹ The Chicago School contended that horizontal conspiracies did not require significant enforcement resources because they believed cartels to be unstable with a tendency to self-destruct because of the strong incentive to cheat. ²²⁰ In their view, mergers, particularly mergers that are not to monopoly, are usually efficiency increasing and undertaken for that purpose. ²²¹ They argued that predatory pricing is an irrational business strategy because the predator loses money during the predation stage, and “if he tries to recoup it later by raising his price, new entrants will be attracted.” ²²² Only under very specific conditions does a tying arrangement raise antitrust concerns. ²²³ The logic is that firms face a reservation price on the bundle of tied goods and have the option of raising the price of the tying product in order to obtain any available rents. Consequently, tying is not a profitable strategy unless it results in efficiencies. ²²⁴ Resale price maintenance and nonprice vertical restraints are also efficiency producing because they were necessary for the provision of presale dealer services. ²²⁵ Nor does vertical integration present an antitrust concern. The concern raised by a vertical merger is the foreclosure or inability of a competitor to gain access to vendors or distributors. According to the Chicago School, this scenario would not happen. Vertical mergers merely realigned trading parties and do not cause foreclosure. ²²⁶ Moreover, vertical integration usually involved efficiencies such as the elimination of the double marginalization problem and the elimination of transactions costs from contracting. ²²⁷ In sum, little to no antitrust enforcement was warranted. They maintained that big business seeks efficiencies, which benefit the economy as whole, and the previous antitrust policy had been harmful and unwarranted. In the crisis of the 1970s, the Courts would implement the minimalist Chicago School program.

A. Economic Performance in the Crisis of the 1970s

The 1970s were a period of significant crisis in the United States. The initial fall in the rate of profit in 1966 was a result of competition from Japan and Germany. By the late 1960s, the German and Japanese economies had recovered from World War II and successfully challenged the United States in several major industries including consumer electronics, automobiles, steel, petrochemicals, and other industries. However, there were also other factors at play. Another problem was that the economy appeared to have exhausted the limits of the technologies such as electrification that had undergirded the great leap forward and the golden age of capitalism. ²³² As a consequence, the growth of productivity declined sharply in the 1970s. Robert J. Gordon calculated that total factor productivity on average between 1920 and 1970 was 1.89, but from 1970 to 1994, the rate of total factor productivity growth dropped to 0.57. At the height of the New Deal, total factor productivity had reached 3.0. Additional factors also contributed to the decline including the two Organization of the Petroleum Exporting Countries (OPEC) oil shocks. Ferguson and Rogers describe the 1973 rise in oil prices as “one of world history’s truly momentous events.” ²³³ Because of all these factors, the profit rate for corporations and other firms dropped significantly from a high in 1966 to an historical low point in the 1973 recession. The average profit rate for the decade of the 1970s was 7.9%, a significant reduction from the 1950s and 1960s. The unemployment rate in the 1970s grew to an average of 6.22% per year ²³⁴ and inflation exploded to an average 7.09% per year. These were truly crisis-level statistics.

B. The Impact of the Crisis on the Incomes of the Wealthy and the Political Backlash

The economic crisis of the 1970s harmed every sector of the economy, but particularly affected financial corporations and high-income individuals. Corporate profits fell significantly while the stock market flatlined. ²³⁵ Growing inflation resulted in low real interest rates, near zero in 1971 and negative in 1975, which were detrimental in the financial sector. The average real interest rate between 1971 and 1978 was only 1.2%. The profits of financial corporations suffered as evidenced by their greater profit decline relative to corporations outside the financial sector. ²³⁶ Finally, the 1970s saw the income share of the top 1% of earners reach a post–World War II low. ²³⁷

The economic situation facing corporations, finance, and the wealthy sparked a major political backlash. The backlash took many forms but included what John Saloma referred to as the conservative labyrinth of well-funded conservative think tanks, corporate groups, and other organizations that grew in size and influence in the 1970s. ²³⁸ Emblematic of this revolt was the 1971 memo sent to the U.S. Chamber of Commerce titled “Attack on American Free Enterprise System” by future Supreme Court Justice Lewis Powell. The Powell memo “is widely cited as the beginning of the corporate mobilization to transform American law and politics.” ²³⁹ Powell called for businesses to organize, plan, and understand the importance of political power to their economic interests. According to Peter Temin, Charles Koch “was galvanized by the Powell Memo and formed the Cato Institute,” an organization focused on the proliferation of free market ideas among academics. ²⁴⁰ As described by Jacob Hacker and Paul Pierson, the ensuing counterattack of business was “a domestic version of Shock and Awe.” ²⁴¹ Hacker and Pierson describe the situation:

The number of corporations with public affairs offices in Washington grew from 100 in 1968 to over 500 in 1978. In 1971, only 175 firms had registered lobbyists in Washington, but by 1982, nearly 2500 did. The number of corporate PACs increased from under 300 in 1976 to over 1200 by the middle of 1980…. ²⁴²

A. The Success of the Chicago School Antitrust Program

The first significant Chicago School antitrust success at the Supreme Court was Continental T.V. Inc. v. GTE Sylvania Inc. ²⁵⁵ There, Louis Powell (of memo fame), writing for the 6-2 majority, held that nonprice vertical restraints warrant only rule of reason analysis. As a result, vertical exclusive customer and territory restrictions became very difficult to challenge. The standard for proving vertical conspiracies was also elevated in Monsanto Co. v. Spray-Rite Service Corp., ²⁵⁶ and the per se rule against Resale Price Maintenance slowly eroded away until it was finally eliminated in Leegin Creative Leather Products v. PSKS, Inc. ²⁵⁷

In the late 1970s and the 1980s, the Court began to carve out exceptions to the per se rule against horizontal price fixing. The GTE Sylvania decision had signaled that a “demanding standard” should be applied before the per se rule should be applied. ²⁵⁸ In Broadcast Music, Inc. v. Columbia Broadcasting System, Inc., ²⁵⁹ the court carved out the exception for situations where horizontal coordination was plausibly needed in order to offer a “new product.” In National Collegiate Athletic Association v. Board of Regents of University of Oklahoma, ²⁶⁰ the Court found that the NCAA came within the new product exception to the per se rule. I do not mean to suggest that BMI and Board of Regents were purely the result of the influence of the Chicago School. While the Chicago School contended that cartels were unstable and less worrisome than earlier thought, there were legitimate limits to the application of the Socony Vacuum approach. For instance, integrated entities, like firms and partnerships, could not reasonably be subject to the per se rule. However, the Chicago School swayed the Courts to make exceptions even for more loosely integrated structures like the NCAA. ²⁶¹ The Chicago School’s skepticism about cartel stability also contributed to the higher burden that emerged for proof of conspiracy in Matsushita Electric Industrial Co. v. Zenith Radio Corp. ²⁶² and Bell Atlantic Corp. v. Twombly. ²⁶³

The Chicago School influence also led to a more permissive approach to mergers. In United States v. General Dynamics Corp., ²⁶⁴ the Court rejected the DOJ’s reliance on market shares challenging the assumption that they reflected future competitive significance. Extending the departure from earlier precedent, lower courts also engineered several defenses to a merger challenge. In United States v. Syufy Enterprises, ²⁶⁵ the 9th Circuit allowed a merger with high market shares because of evidence of easy entry, as did the D.C. Circuit in United States v. Baker Hughes Inc. ²⁶⁶ Then, in Federal Trade Commission v. University Health, Inc., ²⁶⁷ the 11th Circuit held that evidence of substantial efficiencies can be used to rebut evidence of higher concentration.

Since 1982, the various versions of the Horizontal Merger Guidelines published by the DOJ and FTC weakened earlier agency merger enforcement. ²⁶⁸ The current 2010 Horizontal Merger Guidelines requires much more than the original structural presumptions mandated by the Court in the Brown Shoe and Philadelphia Bank cases. Instead, the Guidelines require that the agencies develop and prove an anticompetitive scenario that would likely result from the proposed merger. Even if that exacting hurdle is met, a showing of easy entry or possibly significant efficiencies can still defeat the case for the merger challenge.

Finally, the Chicago School completely eviscerated any FTC or DOJ interest in enforcing the Robinson–Patman Act, despite the fact that both Congress and the Courts have resisted the wholesale abandonment of that law. While the Robinson–Patman is still viable, the Courts have whittled away at the Morton Salt ²⁶⁹ approach, making the burden for meeting the cost justification defense lighter, while rendering the element of competitive injury (and antitrust injury for private plaintiffs) much more difficult.

B. Higher Profits and Income from Globalization

Quinn Slobodian describes how a central tenet of the neoliberal agenda was free trade and globalization. ²⁹⁹ Indeed, neoliberal economists had earlier pushed for an elimination of capital controls. The United States and most European countries lifted capital controls in the 1970s, and many developing countries eliminated capital controls in the 1980s and 1990s. ³⁰⁰ The result of liberalized trade and capital movements for the United States has been a rise of investment by U.S. companies abroad and an increase in corporate profits extracted from the rest of the world. ³⁰¹

This investment abroad primarily involved a shift of manufacturing activity from industrialized countries to developing countries, with a significant number of U.S. companies moving off shore. ³⁰² U.S. multinational firms then exported much of this production back to the United States. The incentives behind these machinations are obvious. Corporations can extract significant concessions from American labor by threatening to move production facilities abroad. Further, corporations can avoid corporate taxes by moving to lower tax locations.

The motivations for these moves were distributional, yet the neoliberal economic theory insists that free trade is always efficient, and therefore invariably beneficial in the long run to the U.S. economy. Indeed, economic theory is clear that gains from trade only occur under specific assumptions. One such assumption is that no externalities exist. ³⁰³ For example, if the United States closes manufacturing facilities because it can import Chinese manufactured goods more cheaply, there may be no gain if the relocation of U.S. manufacturing firms harms other domestic firms and industries. Gary Pisano and Willy Shih of Harvard Business School make the case that clustered manufacturing such as in California’s Silicon Valley creates a complex web of collective R&D, engineering, and manufacturing that facilitates innovation. They argue that the offshoring of manufacturing necessarily leads to migration of R&D, suppliers, employee talent, and other complementary inputs. Pisano and Shih show how government policy is critically important to protect and nurture the “industrial commons” and the United States has reduced such support compared to other countries in the neoliberal era. ³⁰⁴

The Stolper–Samuelson Theorem in economics holds that trade will always involve absolute harm to some groups. ³⁰⁵ According to Harvard trade economist Dani Rodrik, “In a wealthy country such as the United States, these are likely to be unskilled workers such as high school dropouts. This renders the whole notion of ‘gains from trade’ suspect, since it is not at all clear how we can decide whether a country as a whole is better off when some people gain and others lose.” ³⁰⁶ The estimated gains from moving to full free trade are small, less than 1% of GDP. ³⁰⁷ Yet the impact on distribution can be many orders of magnitude larger. ³⁰⁸ Of course, there are many contributing factors to inequality. ³⁰⁹ However, Tim Noah estimates that “[t]rade with low-wage nations, which was negligible until the twenty-first century is responsible for 12 to 13 percent of the Great Divergence [rising inequality], and perhaps more.” ³¹⁰ It is also questionable whether developing countries themselves are better off from free trade. Successful development has historically required industrial and tariff policies and the regulation of financial interests. ³¹¹

C. Financialization of the Economy

An important consequence of neoliberalism has been a financialization of the economy, reminiscent of that of the 1920s, but on a larger scale. No longer constrained by New Deal controls, the size, power, and profitability of the financial sector have grown to unprecedented proportions in the neoliberal era. ³¹² The share of the finance and insurance industry in GDP in the United States grew sharply after 1974, rising from approximately 4.5% to just below 9% by 2010. ³¹³ Under the New Deal policy regime, nonfinancial corporate profits exceeded financial profits, whereas under neoliberalism this relationship was reversed. By 1985, the financial sector had greater profitability. ³¹⁴ The two main contributing factors to this reversal were the growth of debt and the rise in interest rates. The real rate of interest under the Reagan Administration was 6.8% (compared to less than 2% in the 1970s) with a high of 8.7% in 1981. ³¹⁵ The net debt (borrowing minus lending) of nonfinancial firms grew from 79% of GDP in 1952 to 192% of GDP in 2008. ³¹⁶ As in the 1920s, financial interest engineered a booming stock market. As Duménil and Levy describe, “taking the first quarter of 1980 as 1, the New York Stock Exchange (NYSE) index peaked at 5.45 in the third quarter of 2000, prior to the crash in 2000–2001.” ³¹⁷

2. The Impact of Financialization: Diversion of Profits to Finance

Figure 2 comes from a recent paper by Gérard Duménil and Dominique Levy in which they demonstrate that the primary effect of the process of financialization has been to divert profits away from productive uses by nonfinancial corporations. ³³⁵ As shown earlier, neoliberalism has led to an increase in profits, a result of lower wages and lax antitrust enforcement. The dark line on Figure 2 depicts the raise in corporate profits. However, these profits have been siphoned off to the high incomes of corporate executives and top-level managers, higher interest payments to support corporate debt, and dividends and share buybacks aimed at increasing the corporation’s stock value. The dotted line shows the remaining retained earnings, which are available for productive investment, innovation, and growth. In contrast to total profits, retained earnings declined in the 1970s and now hovers around zero.

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Figure 2.

Distributed profits (interests, dividends, and buybacks of stocks shares): (—) Retained profits: (-----).

Investment is highly correlated with retained earnings. ³³⁶ The low and falling retained earnings helps explain why neoliberal policies have resulted in falling rates of investment and declining growth. ³³⁷ In ironic contrast to the ostensible promises of trickledown theory of economic growth, neoliberal policies have been largely distributional in nature, reducing the income of the nonbusiness classes only to divert resources away from productive investment into the consumption of the wealthy.

D. An Assessment of Economic Performance under Neoliberalism

Neoliberalism and the free market were supposed to bring economic prosperity by removing the unnatural influences of government and labor unions. The combination was supposed to create the optimal incentives for efficiency. Ostensibly, the handsoff policy toward mergers would unleash the corporate dynamism and lead to greater growth and output. After four decades of such promises, the evidence shows that this new prosperity and dynamism is illusory. Compared with the Golden Age of Capitalism, the Age of Neoliberalism has turned in a dismal economic performance. Table 1 compares the two periods on a variety of economic measures: ³³⁸

Table 1 shows the superiority of economic performance in the golden age of capitalism under the New Deal policy regime. On average, GDP growth per year was more than a percentage point lower under neoliberalism than during the Golden Age. These levels of economic growth differences can have a massive impact on the ability of a society to increase the welfare of its citizens. Simultaneously, profits, wages, and productivity were higher in the golden age than under neoliberalism. The higher earlier growth rate created the ability to invest more and reduce unemployment. Finally, neoliberalism has significantly heightened the income and wealth inequality, which is the root cause of many of our present social ills. ³⁴⁰

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Table 1.

Economic Performance in the Golden Age and Under Neoliberalism. ³³⁸

Year	Real GDP Growth Rate	Profit Rate	Labor Productivity Growth Rate	Real Wage Growth Rate	Unemployment Rate	Investment Growth Rate	Top 1% Share of Income
Golden Age (1947–1973)	3.88	19.95	2.36	2.28	4.77	8.95	10.61
Neoliberalism (1980–2015)	2.51	16.86	1.18	1.12	6.42	5.25	17.01

Neoliberalism also delivered the Great Recession of 2008, the worst crisis since the Great Depression. However, it is significant that the Great Recession was contained, but not without great cost. This important improvement shows that the institutions that control the macroeconomy have become more effective since 1929. I leave as an open question whether neoliberalism has contributed to this improvement or rather whether it predated its rise to ideological dominance.

Finally, one cannot simply attribute the stronger performance in the golden age of capitalism to greater U.S. world domination following World War II. At the end of the war, the Marshall Plan transferred $13 billion in U.S. grants (about 5% of GDP in 1948) to rebuild Europe. There was comparatively little international trade, and the United States opened its markets to European exports on very favorable terms in order to facilitate American political goals. ³⁴¹ Thus, the root cause of the superiority of the golden age of capitalism lies elsewhere.