Monopoly Power !!!

Did US beer mergers cause a price increase? 

 

Orley Ashenfelter, Daniel Hosken, Matthew Weinberg, 18 September 2013

The American football season is here. Bud, Miller, or Coors, the classic American lagers, are the beverage of choice to accompany the big game throughout the US. Despite the recent surge of microbrews and imports, the big three brands still capture more than 60% of the market. With the recent merger of Miller and Coors, only two large national brewers remain. No doubt many beer drinkers have wondered whether this merger has raised the price of their brand.

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Football season is here. Bud, Miller, or Coors, the classic American lagers, are the beverage of choice to accompany the big game throughout the US. Despite the recent surge of microbrews and imports, the big three brands still capture more than 60% of the market. With the recent merger of Miller and Coors only two large national brewers remain. No doubt many beer drinkers have wondered whether this merger has raised the price of their brand.
We have recently taken up the task of answering this question. We did this for two related reasons.

• We wanted to measure net price increases to beer drinkers.
• But we also wanted to see if we could sort out (a) the cost savings that might result from beer production being closer to consumers from (b) the monopolistic pressure on prices that mergers encourage.

As it turns out, breweries make a great place to study these two issues because shipping beer to markets far away is costly.
What did we find? Well, it turns out there were both anti-competitive effects of the merger and cost saving effects. What this means in practice is that whether a beer drinker faced a price increase or a price decrease depended on where the drinker lived. On average prices neither increased nor decreased, with increases in some markets being offset by decreases in others.

Merger effects in principle

In theory, a merger gives the combined firm an incentive to increase price. Some of the sales that would have been lost pre-merger following a price increase are now recaptured because the product portfolio owned by the firm has increased. Simultaneously, the merger can result in reductions in marginal cost that provide the combined firm with an incentive to lower prices.
This cost-versus-margin trade-off has been understood by antitrust economists since at least the publication of Williamson’s (1968) classic paper describing the welfare analysis of mergers. It has been included in the US evaluation of mergers since the publication of the 1982 version of the US Department of Justice’s and Federal Trade Commission’s Horizontal Merger Guidelines. Surprisingly, given their potential importance to policy analysis, there is very little direct evidence that merger specific efficiencies (reductions in marginal cost) can offset the incentive of a merger firm to increase price.

Efficiencies brewed

In June of 2008, the US Department of Justice approved a joint venture between Miller and Coors, then the second and third largest firms in the industry. Although the merger substantially increased concentration in an already concentrated industry, it was allowed because of anticipated reductions in shipping and distribution costs (Heyer et al. 2008). Prior to the merger Coors was brewed in only two locations, while Miller was brewed in six locations more uniformly distributed across the US. The merger was expected to allow the combined firm to economise on shipping costs primarily by moving the production of Coors into Miller plants. These are exactly the kind of cost savings that could offset any incentive to increase prices through a loss of competition.
Two features of the beer industry assist us in estimating the effects of the merger.

• First, by law beer is sold through a three-tier distribution chain.

With minor exceptions, a brewer must first sell its products to a state-licensed distributor who then sells these products to a retail outlet. These regulations effectively split the US into a number of distinct markets in which brewers can charge different wholesale prices without fear that they will be arbitraged away by transhipment.

• Second, there were substantial differences in how the merger was expected to increase concentration and reduce costs across markets in our data.

These two features of beer markets create a natural experiment that allowed us to identify how a merger of firms selling national brands changed pricing.

Research design

The basic idea in our paper is to compare price changes across regions that differed in the size of Miller and Coors prior to the merger and how the merger would reduce the distance to the nearest brewery.

• Figure 1 demonstrates the approach we took in its simplest form.

The figure compares the average price growth before and after the merger of all lager-style beers to changes in predicted increases in concentration and the reduction in distance.

• The first panel shows that average prices grew faster in regions where the merger was expected to increase concentration by more, as measured by the increase in the Herfindhal Index (sum of squared market shares), holding constant the reduction in distance.
• On the other hand, price growth tended to be lower in markets where the reduction in distance to the nearest Coors brewery was greater, holding constant the market power effect.

Figure 1.

We also explored the timing of these two effects. Firms can likely leverage any increase in market power very soon after the merger is consummated or even after it is announced and management teams begin anticipating combining operations. In contrast, efficiencies gained through shifting production will not be realised until the merger is actually consummated and then may be realised only with some time.

• Figure 2 traces out the timing of the effect of the predicted increase in concentration on pricing.

The figure shows that while there is some evidence that the merged firm started increasing prices as soon as the merger was announced, prices increased gradually.
Figure 2.

Figure 3 presents the timing of the effect of the reduced distance on pricing. The figure shows that the reductions in shipping costs were not passed through until about a year and a half after the merger was approved, consistent with industry documents describing the operations of the combined firm.
Figure 3.

We find that the efficiency effect eventually nearly exactly offset the market power effect in the average market. Despite reducing the number of macro brewers in the US from three to two, the Miller/Coors merger did not harm the average consumer.

Conclusion

Over the past 20 years a large number of studies have studied how mergers have changed pricing. In a meta-analysis, Kwoka (2013) shows that most studies have found that prices rise after competitors merge. However, not all papers find price increases. The evidence in the petroleum industry is mixed, and Ashenfelter and Hosken (2010) found that four out of five large mergers of retail consumer-product manufacturers raised prices. Presumably, cost savings are the reason why some of the studied mergers of competitors did not result in higher prices. Our current work suggests this is the case and takes a step towards getting inside the black box of how mergers change pricing incentives.

References

Ashenfelter, Orley and Daniel Hosken, “The Effects of Mergers on Prices: Evidence from Mergers on the Enforcement Margin,” Journal of Law and Economics, 2010, 53 (3), 417-66.
Heyer, Ken, Carl Shapiro and Jeffrey Wilder, “The Year in Review: Economics at the Antitrust Division, 2008-2009,” Review of Industrial Organization, 2008, 35, 349-67.
Kwoka, Jon E., “Does Merger Control Work? A Retrospective on US Enforcement Actions and Merger Outcomes,” Antitrust Law Journal, 2013, 38 (3)
Williamson, Oliver, “Economies as an Antitrust Defense: The Welfare Tradeoffs,” The American Economic Review, March 1968, 58 (1), 18-36

In Praise of Art Forgery

Fakes say some interesting things about the economics of art

Sep 21st 2013 |From the print edition

WHAT makes an artist great? Brilliant composition, no doubt. Superb draughtsmanship, certainly. Originality of subject or of concept, sometimes. But surely true greatness means that the creator of a painting has brought a certain je ne sais quoi to the work as well.
There is, however, a type of person who seems to sait perfectly well what that quoi is, and can turn it out on demand. In 1945, for example, a Dutchman named Han van Meegeren faced execution for selling a national art treasure, in the form of a painting by Vermeer, to Hermann Göring, Hitler’s deputy. His defence was that it was a forgery he had painted himself. When asked to prove it by copying a Vermeer he scorned the offer. Instead he turned out a completely new painting, “Jesus Among the Doctors”, in the style of the master, before the eyes of his incredulous inquisitors.
Göring, who was facing a little local difficulty at the time, did not sue van Meegeren. But that has not been the experience of Glafira Rosales, an art dealer in New York who admitted this week that she has, over the past 15 years, fooled two local commercial art galleries into buying 63 forged works of art for more than $30m. She is being forced to give the money back, and is still awaiting sentence.

A load of Pollocks

Ms Rosales is guilty of passing goods off as something they are not, and should take the rap for the fraud. But although art forgers do a certain amount of economic damage, they also provide public entertainment by exposing the real values that lie at the heart of the art market.
That art market pretends that great artists are inimitable, and that this inimitability justifies the often absurd prices their work commands. Most famous artists are good: that is not in question. But as forgers like van Meegeren and Pei-Shen Qian, the painter who turned out Ms Rosales’s Rothkos and Pollocks, show, they are very imitable indeed. If they were not, the distinction between original and knock-off would always be obvious. As Ms Rosales’s customers have found, no doubt to their chagrin, it isn’t.
If the purchasers of great art were buying paintings only for their beauty, they would be content to display fine fakes on their walls. The fury and embarrassment caused by the exposure of a forger suggests this is not so.
Expensive pictures are primarily what economists call positional goods—things that are valuable largely because other people can’t have them. The painting on the wall, or the sculpture in the garden, is intended to say as much about its owner’s bank balance as about his taste. With most kit a higher price reduces demand. But art, sports cars and fine wine invert the laws of economics. When the good that is really being purchased is evidence that the buyer has forked out a bundle, price spikes cause demand to boom.
All this makes the scarcity and authenticity that underpin lofty valuations vital. Artists forget this at their peril: Damien Hirst’s spot pictures, for instance, plummeted in value when it became clear that they had been produced in quantities so vast nobody knew quite how many were out there, and when the market lost faith in a mass-production process whose connection with the original artist was, to say the least, tenuous.
Ms Rosales’s career is thus a searing social commentary on a business which purports to celebrate humanity’s highest culture but in which names are more important than aesthetics and experts cannot tell the difference between an original and a fake. Unusual, authentic, full of meaning—her life itself is surely art, even if the paintings were not. (The Economist)

After a Financial Flood, Pipes Are Still Broken

 

 

 

 

 This is a slightly longer article than usual but it is about the fifth anniversary of a major economic collapse.

By GRETCHEN MORGENSO

 IT’S been five years since the bankruptcy filing of Lehman Brothers set off the worst economic crisis in the United States since the Great Depression. With the perspective that distance provides, it’s worth asking: Is our financial system safer and sounder today than it was back then?

Many of the nation’s bankers, lawmakers and regulators might well say yes, arguing that safeguards have been put in place to protect against another cataclysm. The voluminous Dodd-Frank law, with its hundreds of rules and new regulatory regimes, was the centerpiece of these efforts.

And yet, for all the new regulations governing derivatives, mortgages and bank holding companies, a crucial vulnerability remains. It’s found in our vast and opaque securities financing system, known as the repurchase obligation or repo market. Now $4.6 trillion in size, it is where almost every financial crisis since the 1980s has begun. Little has been done, however, to reduce its risks.

The repo market, also known as the wholesale funding market, is the plumbing of the financial system. Without it, money could not flow freely, and banks, brokerage firms and asset managers would not be able to conduct their trades and open for business each day.

When institutions sell securities in this market, they do so with the promise that they can be repurchased the next day — hence the “repo market” name. By using this market, banks can finance their securities holdings relatively cheaply, money market funds can invest cash productively and institutions can borrow securities so they can sell them short or deliver them in other types of trades.

Among the biggest participants that provide funding in this market are the money market mutual funds; they lend their cash to banks and other institutions, accepting collateral like mortgage securities in exchange. The money market funds accept a small amount of interest on these overnight loans in exchange for being able to unwind the transactions daily, if need be.

When markets are operating smoothly, most wholesale funding trades are not unwound the next day. Instead, they are rolled over, with both parties agreeing to renew the transaction. But if a participant decides not to renew because of concerns about a trading partner’s potential failure, trouble can arise.

In other words, this is a $4.6 trillion arena operating on trust, which can disappear in an instant.

Both Bear Stearns and Lehman Brothers collapsed after their trading partners in the repo market became nervous and stopped lending them money. For decades, the firms had financed their holdings of illiquid and long-term assets — like mortgage securities and real estate — in the overnight repo markets. Not only was the repo borrowing low-cost, it also allowed them to leverage their operations. Best of all, accounting rules let repo participants set aside little in the way of capital against the trades.

“It was a very unstable form of funding during the crisis and it is still a problem,” said Sheila Bair, former head of the Federal Deposit Insurance Corporation, and chairwoman of the Systemic Risk Council, a nonpartisan group that advocates financial reforms, in an interview. “The repo market is also highly interconnected because the trades are done between financial institutions.”

Some government officials have also voiced concerns recently about risks in the repo market. William C. Dudley, president of the Federal Reserve Bank of New York, referred to the issue in a February speech and Ben S. Bernanke, the Fed chairman, discussed the problems with wholesale funding in a speech in May. The Securities and Exchange Commission published a bulletin in July on the vulnerabilities in the repo market as they relate to money market funds.

Another problem in this market is that only two banks — Bank of New York Mellon and, to a lesser degree, JPMorgan Chase — dominate the business. There used to be a number of clearing banks, as the banks that stand in the middle of the trades are known, but the ranks have dwindled because of industry consolidation.

Unfortunately, these weaknesses remain. “A lot of things have been done to address a lot of specific problems but it doesn’t seem like anything has been done to address the overall problem of institutions losing access to financing,” said Scott Skyrm, a repo market veteran and author of “The Money Noose — Jon Corzine and the Collapse of MF Global.”

Mr. Skyrm said regulators appeared to be tackling the problem through a back door involving capital requirements. For example, new leverage ratios proposed by the international Basel Committee and United States financial regulators would require banks for the first time to set aside capital against the assets they finance in the repo markets. A recent report from J.P. Morgan estimates that under the Basel proposal, the eight largest domestic banks would have to raise $28 billion to $34 billion in capital relating to their repo business.

Banks are likely to consider an alternative: shrinking their repo operations. But the liquidity in this titanic market is essential for the government’s financing of its debt. As the J.P. Morgan report noted, trading volumes in the United States government bond market are closely linked to the amount of repos outstanding. So any contraction in the arena may reduce liquidity in the Treasury market.

SOME experts think that the answer to the repo problem lies in creating a central clearing platform that would allow all participants, not just the banks, to trade directly. Similar platforms have been mandated for derivatives under Dodd-Frank and could be constructed to support the wholesale funding market.

While such an entity would be a too-big-to-fail institution, so are the two banks now serving as intermediaries. And a central clearing platform could be set up as a utility, with officials monitoring transactions and requiring margin payments to finance bailouts in the event of a participant’s default.

Peter Nowicki, the former head of several large bank repo desks, is an advocate of this idea. “Repo is the last over-the-counter market that’s not headed toward central clearing and the Fed should mandate a change,” he said. “Should a large dealer have a problem or the clearing banks have an issue, the repo market could shut down.”

And that, five years after the Lehman collapse, would be an unconscionable failure.

 

What Stock to Buy?

What Stock to Buy? Hey, Mom, Don’t Ask Me

 

By N. GREGORY MANKIW

OVER the last few weeks, as the stock market has reached new highs, my thoughts have turned to my 85-year-old mother.

“O.K. Mr. Smarty-Pants,” she often asks me, “what stock should I buy now?”

She first asked me this question when I was an undergraduate at Princeton, majoring in economics. She asked again when I was a graduate student at M.I.T., earning a Ph.D. in economics. And she has asked it regularly during the last three decades when I have been an economics professor at Harvard.

Unfortunately, she has never been happy with my answers, which are usually evasive. Nothing in the toolbox of economists makes us good stock pickers.

Yet we economists have written countless studies about the stock market. Here is a summary of what we know:

THE MARKET PROCESSES INFORMATION QUICKLY One prominent theory of the stock market — the efficient markets hypothesis — explains how answering my mother’s question would be a fool’s errand. If I knew anything good about a company, that news would be incorporated into the stock’s price before I had the chance to act on it. Unless you have extraordinary insight or inside information, you should presume that no stock is a better buy than any other.

This theory gained public attention in 1973 with the publication of “A Random Walk Down Wall Street,” by Burton G. Malkiel, the Princeton economist. He suggested that so-called expert money managers weren’t worth their cost and recommended that investors buy low-cost index funds. Most economists I know follow this advice.

PRICE MOVES ARE OFTEN INEXPLICABLE Even if changes in stock prices are unpredictable, as efficient markets theory suggests, we should be able to explain these changes after the fact. That is, we should be able to identify the news that causes stock prices to rise and fall. Sometimes we can, but often we can’t.

In 1981, Robert J. Shiller, a regular contributor to this column and an economics professor at Yale, published a paper in The American Economic Review called, “Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends?” He argued that stock prices were too volatile. In particular, they fluctuated much more than a rational valuation of the underlying fundamentals would.

Mr. Shiller’s paper prompted a storm of controversy. My reading of the subsequent academic literature is that his conclusions, though not all his techniques, have survived the debate. Stock prices seem to have a life of their own.

Advocates of market rationality now say that stock prices move in response to changing risk premiums, though they can’t explain why risk premiums move as they do. Others suggest that the market moves in response to irrational waves of optimism and pessimism, what John Maynard Keynes called the “animal spirits” of investors. Either approach is really just an admission of economists’ ignorance about what moves the market.

HOLDING STOCKS IS A GOOD BET The large, often inexplicable movements in stock prices might deter someone from holding stocks in the first place. Many Americans, even some with significant financial assets, avoid stocks altogether. But doing so is a mistake, because the risk of holding stocks is amply rewarded.

In 1985, Rajnish Mehra and Edward C. Prescott, both now at Arizona State University, published a paper in the Journal of Monetary Economics called “The Equity Premium: A Puzzle.” They pointed out that over a long time span, stocks have earned, on average, about 6 percent more per year than safe assets like Treasury bills. This large premium, they said, is hard to explain with standard economic models. Sure, stocks are risky, so you can never be certain you’ll earn the premium, but they are not risky enough to justify such a large expected return.

Since the paper was published, economists have made some limited progress in explaining the equity premium. In any event, the large premium has convinced most of us that stocks should be part of everyone’s financial plan. I allocate 60 percent of my financial assets to equities.

Stocks may be an especially good deal today. According to a recent study by two economists at the Federal Reserve Bank of New York, given the low level of interest rates, the equity premium now is the highest it has been in 50 years.

DIVERSIFICATION IS ESSENTIAL Every time a company experiences a catastrophic decline — consider Enron or Lehman Brothers — reports emerge about employees who held most of their wealth in company stock. These stories leave economists slapping their heads. If there is one thing we know for sure, it is that sensible financial management requires diversification.

So, if you have more than 5 percent of your assets in any one company, call your broker and sell. Doing otherwise means exposing yourself to extra risk without extra reward.

SMART INVESTORS THINK GLOBALLY One widely documented failure of diversification is what economists call home bias. People tend to invest disproportionately in their home country.

Most economists take a more global perspective. The United States represents a bit under half of the world’s stock portfolio. Because Europe, Japan and the emerging markets don’t move in lock step with the United States, it makes sense to invest abroad as well.

Which brings me back to my mother’s question: If I could pick just one stock for someone to buy, what would it be? I would now suggest something like the Vanguard Total World Stock exchange-traded fund, which started trading in 2008. In one package, you can get low cost and maximal diversification. It may not be as exciting as trying to pick the next Apple or Google, but you’ll sleep better at night.

N. Gregory Mankiw is a professor of economics at Harvard.