Digitized by the Internet Archive
in
2011 with funding from
Boston Library Consortium
Member
Libraries
http://www.archive.org/details/organizingindustOOfish
HB31
.M415
working paper
department
of economics
ORGANIZING INDUSTRIAL ORGANIZATION:
REFLECTIONS ON PARTS 2 AND 3 OF THE
Handbook of Industrial Organization
Franklin M. Fisher
Number 566
October 1990
massachusetts
institute of
technology
50 memorial drive
Cambridge, mass. 02139
is
Fisher
Franklin M.
October 1990
Number 566
'
.
•
ORGANIZING INDUSTRIAL ORGANIZATION: REFLECTIONS ON
parts
and
2
3
of the HaDd&QQls-fif -iDdiistiial-QrgaDizatioD
Franklin M. Fisher
*
Massachusetts Institute of Technology
*
Paper prepared for the B^og|siDg£_.P^pei§_OD_EcoD2mic_Ac£ir
Yi£y Microeconomics Conference,
December,
This paper is
1990.
dedicated to Carl Kaysen on the occasion of his 70th birthday.
Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world.
W. B. Yeats,
"The Second Coming"
Bliss was it in that dawn to be alive,
But to be young was very heaven!
William Wordsworth, "French Revolution"
1.1..
My
Introduction.
task in this paper is to reflect on Parts
2§Dd^2Qi<_2f_lD5ustiial_QigaDisa£i2D.
1.
Richard Scmalensee and Robert D.
2f_lD^usi£ial_Q£ganisatioD,
Tokyo:
These
North-Holland,
1989)
(Amsterdam,
.
are
2
and
3
of the
sections
the
Willig, eds., 3and222k.
New York,
Oxford,
and
All references are to this unless
otherwise stated.
respectively
cal
entitled "Analysis of Market Behavior" and "Empiri-
Methods and Results".
sively theoretical,
empirically
The former section is almost
while the latter,
oriented.
3oth
exclu-
as its name suggests,
sections deal primarily
with
is
the
analysis of markets, particularly of oligopoly.
the
Table of Contents of the entire
low.)
2
"Determinants
Issues
Comparisons",
and
when
Parts
the
of
Organization",
I
speak about "the HSDdboQk"
I
be-
Handbook:
"International
and "Government Intervention
is being written by Alvin Klevorick.
Marketplace"
ence,
Firm and Market
of
reproduced
is
of the remaining sections
review
A
2.
BflDdlSQQlS
(For convenience,
For
in
the
conveni-
shall generally
mean
and 2U
2
Such reflection has two aspects.
Does it succeed in
Is it a good book?
of the BaQd^QQk. itself.
its stated aims?
First, there is the matter
however, is a broader and more impor-
Second,
Reading the SaodQSQk. provides the oppor-
tant set of questions.
tunity for thinking about the state of the art,
organization as a field.
principles?
Where is it?
about industrial
What are the organizing
Where is the field going? Is that the correct desti-
nation?
This latter set of questions are the subject of most of this
But before
paper.
tion, and,
in fact,
I
get to them, the former set deserves atten-
the two sets are not unrelated.
2.»_Ih£_3aDdb22i;_a§_B02k.
begin,
I
doing
low)
,
so
I
then,
(and,
by considering the BaodaQQk. as a book.
indeed,
In
in considering the state of the art be-
necessarily paint with
a
pretty broad brush.
The book is
immense,
and detailed review of the individual chapters would be
tedious,
if not
impossible.
As a result,
there are plenty
of
exceptions
to
criticisms, and
many of my general comments and especially to
my
hope particular authors will forgive me for not
I
pointing them out.
said this,
Having
I
add at once that my first reaction
This is a very good
that of enthusiastic praise.
chapter is
more
far
a
than surveys of the state of the art in
On the other hand,
I
BSDdkSQk straight through.
I
Every
Most of them are
well-written mine of information.
They are coherent essays
area.
book.
particular
a
which themselves add to the art.
do not suggest sitting down to read the
It is not intended for that.
Indeed,
edi-
cannot do better here than quote the advice given by the
of a rather good collection of political jokes
tors
is
(Lukes
and
Galnoor 1987, p. xiii)
One final word of advice to any prospective reader of
the
If you try to follow
volume:
Qq QSi igad it!
King's instructions to the White Rabbit in &lJ.££^JLD_W2D3eir
and go on till you come to
^Begin at the beginning,
laod
the end:
then stop,'
you will very soon become sated and
overcome first with a numbed indifference and then with
some
some sweet,
nausea
(as
with a box of chocolates
We advise,
bitter,
some hard- and some- soft-centered).
rather, judicious sampling.
this
—
—
—
This
intended
wers)
.
is
not criticism,
however,
for cover-to-cover reading
Rather
it
for the Baodacjok. is
(except by exhausted
is intended as a handbook,
whose purpose, as stated by the editors
(p.
a
xi)
not
revie-
reference
work
is
to provide reasonably comprehensive and up-todate surveys of recent developments and the state of knowledge in the major areas of research .
as of the latter
.
part of the 1980s, written at a level suitable for use by
non-specialist economists and students in advanced graduate
courses
.
Is the HaDd^agk. successful in achieving this goal?
only partly so.
In the first place,
I
think
particularly in the theore-
tical chapters of Part
pretty heavy,
going
provided.
(Sensibly/
overview
the
of
2,
the non-specialist will often find the
been
even though the underlying tools have
Part
2
begins with Fudenberg and Tirole's
methods and
results
noncooperative
of
game
theory.
again especially in Part 2,
Further,
to the temptation to deal with their own
succumb
students
because of their work in their respective subject
chosen
urge
the
areas.
occasionally
wrinkles
to decribe all the latest
and
The authors were
This is not necessarily a bad thing.
friends).
some-
latest,
unpublished work (and perhaps that of their
times
But
the authors sometimes
tells the reader more than he or she wants to know, and one comes
away from such discussions without a clear sense that the literature has been systematically surveyed.
That
is less so in the empirical chapters of
here a different problem arises.
a
large set of empirical studies.
Part
For one thing, the material is
of certainty with which we know
16)
and Cohen and Levin
Here,
it.
(Chapter 18) have
hard task of dealing with cross-industry studies.
job of organizing their respective topics,
at
providing a detailed critical guide
literature.
open
theoreti-
is not easy both to describe what is known and also the
It
(Chapter
ful
a
For another, empirical studies vary vastly in quali-
cal theme.
degree
but
It is hard to write a survey of
typically less easy to organize than is the case with
ty.
3,
Since,
as we shall see,
the
really
They do a good
but are less successto
the
underlying
the studies surveyed are
to considerable theoretical objection,
importance
Schmalensee
it is of particular
to sort out which studies and which
conclusions
are
While both chapters (especially
solidly based and which are not.
Schmalensee's)
deal with the underlying
do
problems
involved,
fall down in the perhaps impossible task of carefully sepa-
they
soundly-based studies from more questionable
rating good,
we
Rather
get
the authors'
own (and doubtless
often
ones.
correct)
impressions as to what the literature shows.
It is also often
theoretical chapters have only
the
of
(but not always)
of empirical work.
results
This,
problem in the field itself, and
this connection,
In
Theory
"The
I
the case that the
a
general idea about
reflects
however,
2.
3
out
2
in
Carlton
the contrast is so sharp as to be jarring.
wonders why Carlton's chapter appears in Part
the
deeper
Dennis Carlton's essay (Chapter 15) on
and the Facts of How Markets Clear" stands
Indeed,
considers
a
the
shall discuss it later.
sharp contrast from most of the chapters of Part
3.
authors
One
at all.
actual facts on such things as price changes
and
delivery lags and shows that simple theories cannot explain them.
His chapter is a welcome blend of theory and facts.
In level and
tone, it comes far closer than most of the other chapters of Part
2
to meeting the purpose quoted above.
The
spend
other
theoretical chapters of Part
2,
as
indicated,
little time on systematic examination of empirical
facts.
They mostly pay little attention to empirical work or else resort
to
casual
Saloner's
Antitrust"
observation.
Only occasionally,
excellent piece
(Chapter
9)
on
"Predation,
as in Ordover
and
Monopolization,
and
does one find a real attempt to apply the
theory to the detailed facts of particular industries.
brings me to the subject of work in the field that
This
not well surveyed in the
For a very long time now,
UaDdfiQfllS.
good deal of effort has been spent on in-depth industry
Such
studies,
sure,
provide the basic information from which
can
generalize.
common
(although
important,
HaQSteogk.,
I
do
I
I
can
More
.
from
it
be
still
is
certainly know that it still goes on)
if anything about
to
theory
not know to what extent such work
cannot tell much,
I
a
studies.
varying quality and analytic content,
of
is
the
and this is a gap.
realize,
This is because each industry study tends to be
systematic way.
idiosyncratic
that such work is hard to survey in a
of course,
with
organizing principles linking them
hard
to
do not believe that this is an acci-
find.
(As we shall see,
dent.)
But the BgDd&OQk. fails to make the attempt (although some
I
individual studies are mentioned in passing.)
of
the
comes
SaD^&QQk.
to
a
Bresnahan's
(and of the profession)
symptomatic
It is
that the
closest
survey of work on particular industries
tries with Market Power™.
That chapter,
Timothy
is
essay (Chapter 17) on "Empirical Studies
one
Indus-
of
excellent and interes-
ting in itself, is focussed on work that uses a particular set of
techniques;
The
it does not pretend to survey the wider area.
second area that is not really systematically
surveyed
it is the area of public policy.
Anti-
trust policy issues are indeed discussed in several of the
chap-
is related to the first;
ters (the Ordover and Saloner essay already mentioned,
"Price
Discrimination"
tractual Relations"
(Chapter 10),
Varian on
and Katz on "Vertical Con-
(Chapter 11), for example).
But the Handbook.
makes no separate systematic attempt to tie together economic and
thinking as to public policy on market power
legal
issues.
and
related
Since much of the practical use of industrial organiza-
comes in antitrust cases which also supply the occasion for
tion
substantial work on particular industries, this is an unfortunate
omission.
These two omissions (industry studies and
matters)
antitrust-related
are also troublesome because of the opportunity that
a
systematic
survey (were one possible) might afford to see theory
in action.
The authors of the theory chapters obviously believe
theory
that
studying
particular industries.
after
409)
provides a rich set of tools for
Thus,
an extensive discussion of
Behavior (Chapter
6)
application
Carl Shapiro states
"Theories
of
when
(p.
Oligopoly
:
Let me close with a sort of user's guide to the many
By "user",
one
oligopoly models I have discussed.
I mean
who is attempting to use these models to better understand a
given industry (not someone out to build yet another model).
Here is where the "bag of tools" analogy applies.
After
learning the basic facts about an industry, the analyst with
a
working understanding of oligopoly theory should be able
to
use these tools to identify the main strategic aspects
present in that industry.
Had
the Haodfeesls successfully surveyed industry studies and
analysis of particular antitrust cases,
instructive
to
it might have been
see how those tools have been used or
how
ffliglat
have been used.
such
an exploration would in fact have revealed that views
as
(As we shall see, however,
I
very
they
suspect that
such
that just quoted are far too sanguine about the usefulness of
theory in its present state.)
Before
leaving my discussion of the Bankbook as a book
and
on to the wider arena of what it reveals about the
moving
of the art,
must discuss one minor matter.
I
the UdQ&hQQk is a disgrace.
rect,
The proofreading of
Names are misspelled, sentences are
references to other chapter numbers incor-
ungrammatical,
often
while meaning is seldom totally obscured, one occa-
and,
has to think about what the author must have
sionally
state
meant
to
say.
Three
will suffice here.
examples
Bresnahan
to a "higher or at least higherf aulting
1020)
guage".
He also states
(p. 1015,
n„
5)
refers
(p.
theoretical
lan-
that he will "mention a
consistent notation throughout, rather than adopting the notation
of individual papers.
But the greatest of all such quotes comes
from Stiglitz (p. 773, n.
4)
who says of the Walrasian auctioneer
that "no one probably took the tantamount process seriously."
And
I
single out these two authors only because the
are amusing.
slips
The level of care here is consistently low,
and
I
suspect that the authors were not given the opportunity to proofread their own papers.
Having
made
these criticisms,
however,
I
want
again
emphasize that my principal reaction is quite favorable.
every
chapter
educational
(which is not to say that
substantive disagreements with the authors)
.
This is
I
to
found
I
had
no
a
book
of
which authors and editors should be proud.
3 A „Q£g3DisiDg„PiiD£iplg§^2£_lDdHsi£i§l„Qig3Diza£isD
I
important
of considering the state of the art as reflected in Parts
task
and
turn now to the more difficult but rather more
3
of the Handbook.
.
This is not easy to do,
2
for the writing
of
systematic essay requires that one find organizing
a
the very explosion of material reflected in
In this regard,
the
is daunting.
Hsndbofik.
After considerable thought,
I
have decided to proceed in the
way that some of the authors of the Bsndbosk.
same
themes.
Schmalensee (Chapter 16)
,
for example,
chapters
do.
organizes his summary of
"Inter-Industry Studies of Structure and Performance" in terms of
a
begin
Eaton and Lipsey (Chapter
of "Stylized Facts".
series
essay on "Product Differentiation" with a
their
seven "awkward facts that are available to constrain
(p.
725)
that
reports
it
BandkSSlSf
and summarizes the field as seen
shall proceed in similar fashion with a
I
"Organizing Principles."
4.
authors
I
trust
I
series
the
of
4
shall be forgiven for emulating some of
own work a bit too frequently.
Fisher
extent
through
of the BaQd'Qgok. in a different way and referring
the field.
of
theorizing"
the present paper is empirical to the
Since
.
list
12)
That,
too,
to
the
my
is characteristic of
The views here expressed are consonant with those of
(1989)
—
an article whose publication certainly
contri-
buted to my being asked to write this review.
lD£ys££i£l Qigsnizd^ioD
ffil
are
tbQSfi £b§£ 31 £
has.
no oigani.zi.Dg pxi.Dci.plss
sscept
subcases of this one*
This is not a joke.
As we shall see,
deep reasons for such
a
lack,
I
shall begin with pure theory.
number of different ways.
I
believe that there
and it manifests itself in
a
issuli
eiiocissl
Tbe
show
tbeciy is is
of
osarly
tbst
anytbiog sso bapeeox
The principal mode of theorizing in industrial
creation of inter
the
is
examples in which
.-.
problems
of all but their most essential features.
stripped
in effect,
is,
;>_,.
organization
strates
result
The
formalized anecdote in which the theorist demon-
a
outcomes can in fact
certain
that
are
occur
—
sometimes
contrary to what one might have thought.
sort of theory is what
This
plifying
theory"
(Fisher 1989)
have elsewhere called
I
producing counterexamples to general propositions.
may
lead
method
It is a powerful
.
"exemfor
Further,
it
to insights about phenomena that can also be found
in
more general and complex situations.
But the result does not appear to be leading to any "generalizing
theory"
real
content.
list
of
a
(fisher 1989)
or,
indeed,
to a theory with much
Rather it has produced a taxonomy
vast number of possibilities which
—
rules
a
laundry
out
very
little.
This
fact has not escaped the attention of a number of
authors of the Hand^osis
essay on "Cartels,
p.
.
the
Thus Jacquemin and Slade state in their
Collusion and Horizontal Merger" (Chapter
7,
416, emphasis added);
Economic thought concerning collusive p-ractices and
mergers has changed profoundly, mainly in the light of gametheoretic analysis.
Unfortunately, this change has not led
to more general and robust conclusions.
contrary,
On the
it
is the source of a more fragmented view.
The diversity
of
models and results, which are very sensitive to the
assumption selected,
suggests a "case-by-case" approach
where insight into the ways in which firms acquire and
10
It is
maintain positions of market power becomes essential.
nevertheless important to bring to light a typology of
situations and practices for which recent developments in
economic analysis offer sounder theoretical characterizations than in the past.
They later say
(p.
441)
The multiplicity of equilibria is one of the problems
Instead of
associated with the repeated-game approach.
it can explain all
providing us with a theory of oligopoly,
possible behaviors.
states in his essay on "Mobility Barriers and
Gilbert
Value of Incumbency" (Chapter
8,
p.
the
478)
scope for oligopolistic interactions is so wide
[T]he
that a predictive model of how firms behave may be no easier
to construct than a model of the weather based on the formation of water droplets.
He
refers
(p.
509)
to "a taxonomy of behavior in
response
to
entry.
one very important sense,
In
not
the fault of theorists.
have recited them,
rous
One
this situation is
The theoretical facts are as
they
and the possible outcomes are extremely nume-
and assumption-dependent.
Further,
the Folk Theorem
with low enough discount
repeated games assures us that,
this
of course,
for
rates,
phenomenon is endemic in any situation of serious interest.
must not blame the messenger for the bad news (although
one
can be skeptical as to just how surprising the news really is)
theorists
know
about
question
whether
are working on a very useful research agenda.
We now
the
On
.
other hand,
one can
reasonably
that no general results will emerge that map
market
structure into
performance
while theory is often illuminating:
11
simple
outcomes.
facts
Moreover,
stiiBBedrdowD
Tbs
models Qf tbsfiiy o£££D fail
to
siovide
very ijfilBful guides £21 ibe analysis Qt iesl situstiQDS^.
The problem is that real firms operate in a far more complex
world
than
state.
set
a
its
present
exemplifying
Real firms do not set quantity or else set price.
complex variety of strategic variables.
optimistic
above,
is captured by theory in
the
Contrary to
They
the
view expresed in Shapiro's "bag of tools" quote given
analyst working on a particular industry will
not be able to decide what tools apply
Quotations
from
the
Fudenberg and Tirole state
(p.
(or
are
Haod^QSlS
often
if any do)
illuminating
here.
292, emphasis added)
[F]irms typically do not only choose a time to enter a
market, but also decide on the scale of entry,
the type of
product to produce, etc.
This dstsil can prove unmanagewhich is why industrial organization economists have
able,
frequently abstracted it away . . . .
Jacquemin and Slade state
(p.
447)
In all
of these models,
price wars are equilibrium
This is
strategies of supergames;
no one ever cheats.
models
from
practical
perhaps
a
shortcoming
of
these
a
[1]
intuitive
if not from a game-theoretic point of view.
Our
feeling is that firms do intentionally cheat on collusive
agreements (recall the electrical-equipment conspiracy)
and
that there are many reasons why price wars occur in addition
to demand shocks.
Nevertheless, economists have devised few
theories to explain cheating in collusive agreements.
Reinganum states in her essay on "The Timing of Innovation:
Research, Development, and Diffusion"
(Chapter 14, p. 905):
One
important goal of future research should be to
develop testable models of industry equilibrium behavior.
The papers summarized here have used stark models in order
to
identify the significant characteristics of firms, markets and innovations which are likely to affect incentives
to
invest and/or adopt [innovations].
But since it
is
largely restricted to .
special cases
.
., this work
has not yet had a significant impact on the applied literature in industrial organization;
policy
its usefulness for
.
12
.
.
For these purpurposes should also be considered limited.
the
one needs a predictive model which encompasses
poses,
innovation
and
characteristics.
of
firm,
industry
range
full
Cohen and Levin, writing on "Empirical Studies of Innovation
and Market Structure"
(Chapter 18)
agree with this, although they
are certainly not wholly pessimistic
(p.
1096, emphasis added)
One difficulty with testing recent game-theoretic models of R&D rivalry is that they analyze behavior in highly
Moreover, many
.
stylized and counterf actual settings.
depend on typically unverifia.
of the results obtained
ble assumptions concerning the distribution of information,
and the sequence of
the identity of the decision variables,
moves.
Nonetheless,
empirical effort on the effect and
Inspiration
importance of strategic behavior is warranted.
might be drawn from Lieberman's (1987) empirical examination
of the role of entry deterrence in affecting capacity expanHe
sion in a sample of chemical and metals industries.
concluded that strategic considerations were not paramount
in most industries,
but he identified several specific instances in which strategic considerations may have been
important.
.
.
In
(p. 538,
.
.
something of the same vein,
Ordover and
Saloner
state
emphasis in original)
[T]heoretical findings and prescriptions are difficult
to translate into workable and enforceable standards that in
3££U3l fl)3£ls££ §§££iDgs would, without fail, promote conduct
without fail, prothat enhances social welfare and would,
mote conduct that harms welfare.
The source of the problem
is the strategic setting itself.
In the context of strategic interactions,
is difficult to distinguish between
it
those actions which are intended to harm actual (and potential) rivals [,] that stifle competition,
and thereby reduce
economic welfare, and those actions which harm present rivals and discourage future entry but which, nevertheless,
promote economic welfare.
as legal scholars are often
Or,
fond of saying,
actions which are consistent with "competition on the merits".
Stripped-down models can,
Eaton
tion"
in fact,
be very useful, but, as
and Lipsey observe in their essay on "Product Differentia(Chapter 12, p. 759),
results
is no advantage."
"
[T]
ractability in deriving incorrect
For "incorrect" read
"inapplicable".
Industrial organization theory has a long way to go.
13
The journey is not made easier by:
dq
Iqy
Same.
wsans sill theoLists bsvs
a
attitude
casual
tflWat^S what CQQSti£ut£§ xerif icatiQD*
With
models
choose
to
one can reasonably ask what could constitute the verifica-
from,
tion
bewildering variety of possible
a
falsification
or
of a particular model.
sometimes an underlying attitude that
a
there
Here
theory has been "success-
or "applicable" if one can use it to tell a logically
ful"
story of what might have happened
sistent
is
—
a
story
con-
consistent
with the very few facts that the theorist happens to know.
quote from Cohen and Levin given above is one illustra-
The
Others can be found in the very casual citation of certain
tion.
antitrust cases by some authors.
This
5.
Thus, to take an example that
is definitely Q9£ to say that all authors
are casual in this regard.
2aQ£JbQQk
Ordover and
of
the
Saloner,
for
example, have read the literature on the cases they cite.
I
know well,
contracts
only
does
cited again
in
IglS2J_y.»<_IB£J
is cited as providing an
and entry prevention
(p.
502 n.).
so in terms of the plaintiff's
(p.
507 n.)
example
case
In fact the
allegations.
of
It
is
for the effects of "locked-in" customers
producing alleged price discrimination.
Here the allegation
made no economic sense and the principal so-called "lock-in" part
of the case was not the one cited.
find.
7,
(These points are not hard to
See Fisher, McGowan and Greenwood 1983, pp. 196-204, 316-
325-8.)
14
To continue with the computer industry,
Gilbert writes (pp.
514-5, emphasis added)
the Gaskins model
Despite its theoretical limitations,
dynamic limit pricing (along with its refinements) is an
appealing description of pricing behavior for industries
The exogenous
that are characterized by dominant firms.
is
not theoretically justispecification of the entry flow
fied,
but it may capture an important element of dynamic
competition.
.
If it wsrs possible to model [certain
underlying] aspects of the entry processs (sis)
the result
££Ul£ be an entry flow rate that appears similar to the
Gaskins model.
For these reasons, it is not surprising that the Gaskins model has been used SUSSSSSfully in
empirical models of dominant firm pricing, such as
Brock (1972).
of
.
.
,
.
.
The
suggest
computer
of course,
issue,
that
.
.
is what constitutes
serious knowledge of the
a
"success".
complexities
the
of
does not lead one to believe that this
industry
I
is
a
however appealing it may seem for its relative
terrific example,
simplicity.
Similarly,
the
notion that merger policy should be made on
the assumption that real firms follow Cournot behavior is
naive,
(Farrell and Shapiro 1990). The fact that theo-
if not bizarre.
can produce a simplified model with clean results does not
rists
mean that the world works in that way.
Further,
surveyed
wrong.
with
in
The
the
the idea that the cross-section empirical
Part
3
somehow verify simplistic theory
difficulties with such studies (perhaps
studies
is
especially
use of accounting profitability) do not appear
fully appreciated by theorists.
(See, for example, pp.
now turn to
a
consideration of such empirical work.
15
to
be
437, 449,
and 455, and Shapiro 1989, p. 133.)
I
simply
Musb
is
wcils^
The
eopiiicai
Dfit
wciIsj.
escecislly ciossriodustiy
eiDBiiicfll
iofQimed by loi SQmetimes aboutl tbegiy*
years of drought of industrial organization theory were
years in which the cross-section farmers went on
planting.
Not
surprisingly, the harvest was not bountiful, and the recent flood
of theory has not irrigated the crops
Cross-sectional attempts to verify (or disprove?) the struc-
ture-conduct-performance
based in theory.
tively
paradigm
have never been very
soundly
Not only has theory not provided much quantita-
useful guidance as to exactly how structure affects
per-
formance, even at the level of what variables should be used, but
the
empirical
practitioners have often had only
a
rudimentary
understanding of what theory did say.
An
the
outstanding
(but not the only)
area of capital theory,
example of this came
where inability to move beyond
simplest one-period model was striking indeed.
ly,
in
the
More specifical-
attempts to use profitability as the basic measure of perfor-
mance simply misunderstood both the role and even the measurement
of profitability in economic theory.
In the first place,
it is not true that there are no econo-
mic profits earned in competition.
of
the competitive process.
profits
Profits are the driving force
Only in long-run
(adjusted for risk) driven to zero.
equilibrium
It is a major mis-
take -- and one that runs consistently throughout economics
behave as though all that matters is long-run equilibrium.
petition is a dynamic process;
and
the
fact
real firms operate in real
that economists find it hard to
16
are
deal
with
—
to
Comtime,
such
dynamics does not make them go away.
Put this aside
firm
f
however,
and suppose that comparison of
industry's profitability to some "normal" standard is in
or
What profita-
fact an appropriate way to test for market power.
To the extent that it is
bility measure should be used?
priate
a
to
present
speak in terms of profit rates at all
discounted
values
at some suitable
opposed
(as
rate
approto
return)
of
economic thory teaches that the risk-adjusted profit rate that is
under competition is the internal or economic rate
equalized
—
return
of
that rate that makes the present value of the stream of
returns from investment equal to the direct capital costs.
The profitability rate used in cross-section studies is
(admittedly hard to measure) magnitude.
this
dies
used
accounting rate of return
the
stockholders'
equity or by the value of capital
capital
stock
purchasc-d
profits
while
current
profits are earned in
Since
future
to
because
of
of
information
(Indeed, the remarkable fact
that there should exist any circumstances under which the two
are closely related.)
Nevertheless, despite the fact that others
had made similar points in the past,
of surprise
lot
and
by
it should come as no surprise that
about the economic rate of return.
is
part
measures do not in fact carry a great deal
such
divided
stock).
now is done so with an eye
investments made in the past,
many stu-
Rather,
(profits
not
I
this fact did cause quite a
(not to say outraged protest)
pointed it out some years ago.
when John
McGowan
(Fisher and McGowan
1983;
see also, e.g., Long and Ravenscraft 1984 and Fisher 1984)..
A similar problem infects studies using a different profita-
17
—
measure
bility
favorable
the profits-sales ratio.
assumptions,
in
fact equal
of
monopoly
(or
Even
it turns out that this quantity does not
(price minus marginal cost
divided
all
except under yeiy special circumstances.
price)
measure
possibly even approximate) the Lerner
power
quite
making
by
(Fisher, 1987a).
These are not difficult results to derive from the theory of
Yet at least one leading practitioner seems to
firm.
the
wholly unaware that the economic rate of return was of
been
importance.
Others
_".,
:
any
HcGowan and Greenwood, 1983, p. 257.)
(See Fisher,
simply
have
_t hard to believe that they were
measuring
the wrong thing.
progress
Some
has been made.
Recently focus has
shifted
from profits to prices as a performance measure (Weiss, ed. 1989)
~
something
that
comparison
The
6.
of prices by different firms
that the goods being priced be (or be made)
apparently simple cases,
such
Schmalensee,
has its own serious problems.
promptness,
ease of
That this can make
a
dealing,
(1989)
who understands the issues involved gets round them by
literature
and
substantial diffe-
rence has been forcefully pointed out by Newmark
the
Even in
comparable.
this may not be easy, since goods carry
attributes as service,
general firm reputation.
requires
surveying
as providing "stylized facts" rather than
solid
results.
Those "stylized facts" often concern accounting profi-
tability,
and industrial organization theory may need to explain
them.
But
one must not yield to the temptation to suppose that
the explanation is that the magnitudes studied in empirical
are
work
necessarily closely allied to those which are the objects of
18
theory.
(if less pervasive)
A somewhat similar
Temin
and
I
long ago pointed out that the theory
of
does not yield an unambiguous prediction as to the
firm
of firm size on research and development
the
effects
in the presence of
(See Fisher and Temin 1973, 1979, Rodriguez
economies of scale.
That result holds both for
and Kohn and Scott 1982.)
1979,
(R&D)
Here
scale.
literature on innovation and returns to
empirical
Peter
problem arises in the
input and R&D output.
R&D
Yet the literature keeps on growing.
Cohen and Levin's treatment of this issue in their survey of
"Empirical
18)
is
Studies of Innovation and Market Structure"
perhaps indicative of the impatience
with such demonstrations.
feel
They state
(Chapter
workers
empirical
(p.
1071,
emphasis
added)
[Fisher and Temin] demonstrated,
amsDg 2£h§£ £hiDS§r
that an elasticity of R&D [input] with respect to size in
excess of one does not necessarily imply an elasticity of
innovative output with respect to size greater than one.
Kohn and Scott
established the conditions under which
.
imply the
the existence of the former relationship does
latter.
.
They
then
problem
go
.
on to what they consider the
stemming
from
the argument that
fundamental"
"more
"Schumpeter
did
not
postulate a continuous effect of firm size on innovation."
The
point is that the proposition as to the
relations
tween the two elasticities is a relatively minor one.
be-
Among the
demonstrated was that the litera-
"other things" that Temin and
I
ture
(and probably was not able to test)
was not in fact testing
any of the propositions which it purported to examine.
ly,
that didn't stop anybody.
19
Apparent-
picture of careless disregard for theory by
This
empirical
workers is, of course, too general to be totally accurate.
over,
in one area, at least,
More-
it is certainly not correct.
Bresnahan's essay (Chapter 17) surveys "Empirical Studies of
It reports on econometric studies
Industries with Market Power."
of
particular industries undertaken to test whether those indus-
behave competitively and to measure
tries
literature recognizes
[cannot
cost
be]
(p.
1012)
market
power.
This
that "[f] inns' price-cost margins
taken to be observables
[since]
economic
marginal
cannot be directly or straightforwardly observed."
...
At
least as important:
Individual industries are taken to have important idiosyncracies.
is likely that institutional detail at the
It
and even more
industry level will affect firms' conduct,
likely that it will affect the analyst's measurement strateThus, practitioners in this literature are skeptical of
gy.
indususing the comparative statics of variations across
tries or markets as revealing anything except when the
markets are closely related.
literature stands out from most of the empirical
This
surveyed
On
the
in the Ban^QfiQJs in that it certainly does
the other hand,
game-theoretic
use
work
theory.
the theory it uses is not closely related to
analyses of Part
2.
Further,
while
progress has been made in the detection of market power,
some
Bresna-
han states (pp. 1053, 1055):
Only a very little has been learned from the new methods about the relationship between market power and industrial structure.
•
•
•
We know essentially nothing about the causes,
or even
the systematic predictors of market power,
but have come a
long way in working out how to measure them.
Maybe
measurement
so.
I
success,
am more skeptical than Bresnahan
but there can be no doubt
20
that
about
our
empirical
attempts
to
relations
test,
or estimate the parameters
between structure and performance have not
of
and
the kinds of analytic defects pointed
ignoring
results
most
only be said to be uncertain
can
grounds
ambiguous.
and
The empi-
literature makes essentially no use of the modern
rical
results,
is hardly surprising,
which
methods
since theory
providing propositions that are testable in practice
Principle
above,
out
the explosion in theory is having no effect.
Further,
the
succeeded.
taking the general empirical literature on its own
Even
or
verify,
is
not
(Organizing
3)
4..-&_Besear£h_&geDda
failure of the empirical literature is not an accident,
The
Indeed, in one (not very helpful sense)
however.
does indeed confirm the results of theory.
that literature
The principal result
of theory in this area is that nearly anything can happen
nizing Principle
2)
.
(Orga-
There is no simple mapping from elementary
(let alone imperfect) measures of structure such as concentration
or
Those models (such as the
firm size into performance.
sim-
plest Cournot models) that suggest there is arrive at that result
by
stripping
the
problem of features essential to
under-
the
Hence the
standing of real industries (Organizing Principle
3)
empirical
ambiguous
does
the prediction of theory (although not in a
very
indeed
finding
verify
that such relationships
are
.
helpful way)
short,
In
dead,
simple
if
(and
the
structure-conduct-performance
this is a big if)
one thinks of it
paradigm
as
structural measures to conduct and performance
21
is
relating
characte-
The theoretical counterpart to this is that the program
ristics.
of investigating how perfectly rational opponents will behave
simplified settings has failed as well (or,
overly
has succeeded too far)
of
if you wish,
Despite outward appearances,
.
in
industrial organization is not in a happy state,
the field
at least as
regards the analysis of oligopoly markets and related subjects.
This conclusion,
of
rests on a somewhat limited view
however,
what the appropriate research agenda for industrial organizareally
tion
is„
as
little
to those who carefully read Fellner's CfilDPStitiflD-fllDfiDg
surprise
(Fellner
tbg^Eey
failures just described come
The
1949)
or have worked extensively
on
industry
The simple-structure-measures-cum-rational-behavior mo-
studies.
does not lead to very useful results because the context
del
particular
industries in which firms operates
strongly
of
affects
which outcome they will or can achieve
I
give the simplest example.
low enough discounting)
(with
maximizing)
of
the
sensible
In an infinitely repeated game
the
,
cooperative
(joint-profit-
outcome is typically a Nash equilibrium
number of firms or of industry
independent
concentration.
person supposes that such an outcome is just as
Yet
no
likely
when there are a thousand equally-sized firms as it is when there
are two.
nor
a
In this sense,
justification
modern theory provides neither a guide
for studies that attempt
measure
the
such an attempt is not thereby rendered senseless.
We
to
effect of concentration or numbers on outcomes.
Yet
think that the two cases just described differ,
not because
the
Nash equilibria are fundamentally different in the two cases, but
22
because
two-firm
the
industry will somehow find it
easier
achieve the cooperative outcome than will the thousand-firm
Further,
true.
If
all give at least verbal reasons why
can
we
numbers
to
one.
that
is
and concentration were all that mattered
to
such ability, then empirical studies attempting to relate perfor-
mance
to numbers and concentration would
(properly measured)
be
successful despite the Folk Theorem.
Further,
7.
policy
merger
would be entirely sensible.
measures
that relies on such
On this, see Fisher
(1987b)
.
The difficulty, of course, is that numbers and concentration
are not all that matter.
matter
as well.
A great many other things are likely to
As Carlton states in his essay on how
markets
clear (Chapter 15, p. 911):
[M]uch of
industrial organization seems fixated on
answering how the behavior of markets differs as industry
concentration changes.
Although this is certainly an interesting question, industry concentration is only one of many
ways in which markets can differ. Market liquidity, heterogeneity of product, variability in demand and supply,
the
ability to hold inventories, and the ability to plan are
also interesting characteristics,
and differences in these
characteristics lead to different market behavior.
Yet the
effect of these other characteristics has received much less
attention from industrial organization economists than the
effect of differences in industry concentration.
Further,
once
one leaves the question of market
clearing,
list of interesting characteristics gets longer still.
studies pay little attention to this,
rical
the
But empi-
and theory has
ma-
naged mostly to verify that the list is long.
I
believe
that the proper research agenda
for
industrial
organization is the study of how the context of particular industries
or
market situations affects the ability to
23
achieve
the
joint-profit-maximizing outcome.
I
do not believe that this
Further,
most of modern theory is doing.
what
as
is
have else-
I
do not believe
that
the theoretical tools currently so popular are particularly
well
explained in detail (Fisher 1989)
where
,
I
suited for that task.
Lacking strong guidance from theory, we need to know what in
This surely requires the dstailgd. study of parti-
f§St happens.
The cross-section literature is too simplistic
cular industries.
to be of much assistance here,
theorists
some
of
Principle
4)
surveyed
by
but
regard,
structural
*= K~
tit>
U
and the somewhat casual
towards empirical
is of no help at all.
Bresnahan
it
verification
richly
adequate to describe the
this
in
articulated
con-
underlying
O /
description
wrong
of course,
empirical
to jump into
without any guiidance from theory,
but it would
to suppose that we do not have any such guidance.
generally (but only generally) know what can matter.
need
literature
is at least potentially useful
It is always dangerous,
is
(Organizing
(The econometric
too suffers from a lack of
variables
attitude
We
be
do
The problem
that we have known that for more than forty years.
What
we
to know is what aspects of the contextual setting matter in
practice.
This may be where experimental methods come in.
his essay,
Plott,
in
"An Updated Review of Industrial Organization; Appli-
cations of Experimental Methods"
(Chapter 19)
,
lists
number of
a
cogent reasons for the use of such methods (pp. 1165-9)
.
He does
not explicitly mention the possibility that by carefully controlling
the context in which market-like games are played,
24
one can
insight into what aspects of context are likely
gain
matter
non-experimental situations.
in
But
really
to
possibility
that
comes across from his survey.
5*-£0D£ludiD9~&£Ha£k£
Despite
my favorable remarks on the HaDdbflQk.
itself,
this
Yet,
des-
essay will no doubt convey a somewhat negative tone.
this need not be
pite
my comments on the state of the field,
time
to be depressed about industrial organization.
The
field
revolution
Even though that
has
been undergoing a revolution.
has
not produced results nearly as exciting or relevant as
to some of the revolutionaries,
seem
a
the revolution is not
they
yet
over
two poems quoted as epigraphs to this paper give diffe-
The
descriptions
rent
times.
of what it is like to live
revolutionary
in
The poem by Yeats can be taken as describing the anarchy
consequent on the destruction of an old order; that by Wordsworth
describes the opportunity that such times create,
especially for
the young.
If attention can now be turned to the sort of agenda
outlined,
context
to
the
I
have
theory and empirical study of the effects
of
enough
to
on outcomes,
to the analysis of models rich
capture the facts of real industrial situations, then the promise
outlined in the Wordsworth quote can be achieved.
But
believe
as
just
that promise has not been achieved as yet.
Those
that it has (and who are inclined to dismiss my
those of an old-geezer-in-training) might
do
who
remarks
well
to
reflect on the fact that the full title of the Wordsworth poem is
25
"French
Revolution,
mencement."
As
I
as
It Appeared to Enthusiasts at Its
said earlier,
long way to go.
26
industrial organization
Comhas
a
BefeieDces
Brock,
G.
(Cambridge:
Ibfi-U-S A -COBDUtfiI-lDdUStIX
(1975)
Ballinger)
Fellner, W.
(1949)
GQmp££i£isD_3ID3Dg..£be_,E£W (New York: Alfred A.
Knopf)
"Horizontal Mergers: An Equili-
Farrell, J. and C. Shapiro (1990)
brium Analysis", Ameiican-EcflDQIDiS-BSYifiw 80:107-26.
F.M.
Fisher,
"The Misuse of Accounting Rates of
(1984)
Return:
Reply", AraeiisaD-BSGDfilDiS-BSYigw 74:509-17.
Fisher, F.M.
(1987a)
"On the Misuse of the Profits-Sales Ratio to
Infer Monopoly Power", BAiffl^JfluiDal-C/f-ECADGroisS 18:384-96.
Fisher,
F.M.
(1987b)
"Horizontal Mergers: Triage and Treatment",
JSl»rD3l_of. ^ScoDSmic^EeiSPectiyes 1 : 23-40
Fisher,
F.M.
(1989)
"Games Economists Play:
RAND w j2UID3l~flf-ESSDSffliSS 20:113-24.
View",
Fisher, F.M. and J.J. McGowan (1983)
Rates
of
Noncooperative
a
Return to infer Monopoly
"On the Misuse of Accounting
Profits",
AmeiicaD-SSQDfilDiS
BiYisw 73:82-97.
Fisher,
F.M.,
J.J.
McGowan
and J.G.Greenwood
(1983)
Eflldsd*
SpiDdlsdx-aDd-r3u£il3£e^i-EssDfla)ic».AD3lysis-3Dd-l} J iS*-y J .IBtJ
(Cambridge: MIT Press)
Fisher,
and
F.M.
Development:
Imply? "
Fisher,
and P.
,
F.M.
.
Temin (1973) "Returns to Scale in Research
What
Does the
Schumpeterian
jQyiD3l-ef-E2li£i£Sl-£CflD2IDy 81 56-70
:
and P. Temin (1979)
Hypothesis
.
"The Schumpeterian Hypothesis:
Reply", jQy£D3l-3f_E2li£i£3l-.E£0;D2Sy 87:386-9.
Kohn, M.G. and J.T. Scott
(1982)
27
"Scale Economies in Research and
The Schumpeterian Hypothesis",
Development:
JfiUIDSl-fif-lDr
dUStlial-fiCODfllDiCS 30:239-49.
Lieberman, M.B.
(1987)
Empirical
"Excess Capacity as a Barrier to Entry: An
Reappraisal,
JfiUlDSl-j
^LUStlial-SsCDfiSdcS
35:607-27.
Lukes,
and I. Galnoor
S.
(1987)
NO^LsugbiDg-Ustteii-A^CfilleStiSD
(London: Penguin).
Q£-Esli£i£5l-Jclses
W.Fo and D.J. Ravenscraft (1984)
Long,
Rates of Return:
"The Misuse of Accounting
Comment", Ame£isaD„£SSDfiSi£-Beyisy 74:494-
500.
Newmark, C.
"Do High Prices Indicate Collusion? A Critical
(1989)
Review of Price-Concentration Studies", North Carolina State
University (unpublished)
Rodriguez*
C.A.
(1979)
Schumpeterian
"A Conmment on Fisher and Temin on
Hypothesis",
the
ZQULU&l*.Q£„EQli£,isal~ES9BQm
87:383-5.
Shapiro,
C.
(1989)
"The Theory of Business Strategy", BANQ_Jo-uj--
DSl^Qf«,£S9QQIBiSS 20:125-37.
Weiss,
ed.
L.,
Press)
(1989)
CfiDC£DfcI3£iiHL.3DJ3..Erifle
.
28
(Cambridge:
MIT
CONTENTS OF THE HANDBOOK
VOLUME
PART
1
I
DETERMINANTS OF FIRM AND MARKET ORGANIZATION
-
I
Chapter
1
j
Technological Determinants of Firm and Industry Structure
JOHN
C.
_
i
PANZAR
!
!
Chapter 2
The Theory of the Firm
BENCT R. HOLM5TROM and JEAN TIROLE
-
Chapter 3
Transaction Cost Economics
OLIVER
E.
WILLIAMSON
Chapter 4
Vertical Integration: Determinants
MARTIN
K.
and
Effects
PERRY
"-
PART 2 - ANALYSIS OF MARKET BEHAVIOR
~
Noncooperative
Overview
- -
DREW FUDENBERG
Chapter 5
Game
Theory
and JEAN
for Industrial Organization:
TIROLE
Chapter 6
Theories of Oligopoly
Behavior
"
CARL SHAPIRO "
_.
Chapter?
and Horizontal Merger
ALEXIS JACQUEMIN and MARGARET E SLADE
Cartels. Collusion,
An
Introduction and
Contents of the Handbook
viii
I
Chapter 8
\
Mobility Barriers and the Value of Incumbency
j
RICHARD
J_
i.
GILBERT
*
Chapter 9
Preuaiion, Monopolization, and Antitrust
JANUSZ
A.
ORDOVER
and
-{
GARTH SALONER
!
-?
Chapter 10
]
Price Discrimination
HAL
R.
VAR1AN
1
Chapter 11
i
-
Vertical Contractual Relations
MICHAEL
L.
~
KATZ
Chapter 12
'
Product Difierentiation
B CURTIS
EATON
and
RICHARD
G. L1PSEY
J
1M
-.
Chapter 13
\
Imperfect Information in the Product Market
E
JOSEPH
;
-
STIGLITZ
'...-•
»
Chapter 14
i
The Timing of Innovation: Research, Development, and
JENNIFER
4
3
Diffusion
REINGANUM
F.
1
Chapter 15
The Theory and the Facts
of
How
Markets Clear:
Is Industrial
Organization
Valuable for Understanding Macroeconomics?
DENNIS W. CARLTON
4
-3
VOLUME
PART
3-
II
EMPIRICAL METHODS AND RESULTS
Imer-Industrv Studies of Structure and Performance
RICHARD SCHMA1.ENSEE
Chapter 1
Empirical Studies of Industries with Market Power
TIMOTHY
F.
BRESNAHAN
Contents of the Handbook
ix
Chanter IM
Empirical Studies of Innovation and Market Structure
WESLEY
M.
COHEN
and
RICHARD
C.
LEVIN
Chapter 19
^
An Updated Review
Methods
CHARLES
R.
of Industrial Organization: Applications of Experimental
PLOTT
PART 4 -INTERNATIONAL ISSUES AND COMPARISONS
Chaptei 20
Industrial Organization
PAUL
—
--
-i
Chapter 21
Internationa! Differences in Industrial Organization
"_
™F t; r RICHARD
:
f ^^ PART
:
;
and International Trade
KRUGMAN
R.
5
E.
CAVES
-
-GOVERNMENT INTERVENTION
IN
~
Economic Perspectives on
y-Z -_i., A
;
.
-iTJiir:'
"~~_
ROGER
G.
the Politics of Regulation
NOLL
_ Chapter 23
Polides
Natural Monopolies
——.—~ Optimal
RONALD BRaEUTIGAM
'•"
for
R.
-
.
^»-
-...;
.
..
Chapter 24
Design of Regulatorv Mechanisms and Institutions
DAVID
P.
BARON
Chapter 25
The Effects of Economic Regulation
PAUL L. JOSKOW and NANCY L. ROSE
-
-
Chapter
-
THE MARKETPLACE
li?0?i£fr Chapter 22
--v;:ir-l'
:
2t>
The Economics of Health, Safety, and Environmental Regulation
HOWARD K. GRUENSPECHT and LESTER B. LAVE
33
3
05
1
Date Due
30
igg'1
5
AUG 26
SEP 24
199
1991
^>
Lib-26-67
MIT LIBRARIES
3
DWl
TOAD 0D7D1STS
fl