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Home , American Capitalism, Economic planning, Edward Chamberlin, Frank Fetter, Fritz Machlup, Joe Bain

23rd Annual Conference of the European Society for the of Economic Thought (ESHET) Banks, and Finance in the History of Economic Thought Lille, France

Oligopoly and tacit at Harvard (1933-1952):

A tool of to reappraise American

Alexandre CHIRAT1, Thibault GUICHERD2

Abstract: This article comes back on the development of industrial organization in Harvard. More specifically, it aims at understanding the process of the of the so-called “Harvard school” which is often presented as a “spontaneous generation” of authors. Indeed, except for the place () and the time period (from the 1930s to the 1950s), very little has been said about a potential research agenda or a set of common and identifiable tools and concepts. This article identifies a specific subject of study that seems to unify all these authors: the development of the theory of in . This latter theory was developed in 1933 by in the scope of his theory of monopolistic and was gradually taken up in several contributions from the 1930s and early 1940s, all of which authors (Mason, Galbraith, Bain, de Chazeau, Triffin, Kaysen, Schumpeter) were directly linked to Harvard during the publication or the writing of their work. The creation of the NRA in 1934 strengthens in the phenomenon. The possibility of tacit collusion in oligopoly then allows the authors to better grasp competitive mechanisms and obvious rigidity. Simultaneously, these authors encountered a range of theoretical problems (such as the differentiated oligopoly, the notion of large group, the meaning of the concept of price rigidity, the hypothesis of rationality or behavior to be retained) that need to be solved and which guide the research of this community. The analysis of tacit collusion in oligopoly then enters into debates among about the “basing point system”. This pricing method was at the time used in the iron, steel and cement industries and led the authors to tackle questions about the effectiveness of existing anti-trust laws. Can this type of price- setting mechanism be considered truly competitive when it is an oligopoly-like situation where are rigid and differentiated? The development of tools for the identification of these translates into a set of contributions focusing on strategic behavior, typologies or the use of price administration. It leads some authors to reappraise the nature of the competition and the foundations of American capitalism.

Keywords: oligopoly, tacit collusion, strategic behavior, Industrial Organization, American Capitalism, Harvard

1 Ph. D Student in (Université Lumière-Lyon 2, France), TRIANGLE. Mail : [email protected] 2 Doctor in Economics (Université Lumière-Lyon 2, France), TRIANGLE. Mail : [email protected]

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0. Introduction

The Harvard Department of Economics of the 1930s is generally recognized as one of the main centers that fosters the theoretical innovations of this so-called period of “High Theory” (Shackle 1967). On one hand, Harvard is the Ellis Island of the Keynesian revolution3. On the other, it is the birthplace of both theory and the emerging field of Industrial Organization (IO). The spreading and reshaping of Keynes’ ideas through America has drawn much attention, whereas the field of IO has been neglected regarding its impact on both economic analysis and policy prescriptions. Yet it has even governed some broader reflexions on the very nature of the American capitalism that echoes the spirit of traditional political . The literature on the birth of IO at Harvard is obviously far from being inexistent. For instance, Jean Tirole (1988) mentioned the “Harvard Tradition” and assimilated with to the “structure-conduct-performance” paradigm developed by Joe Bain4. Richard Posner (1978) mentions a “Harvard School on antitrust policy” which is defined through its post-war opposition to the Chicago School embodied by . The existence of such “Harvard school” is taken for granted. Historians of economic thought have looked for its origin5. Emphasis has been put on the role played by the two Eds - Chamberlin and Mason. Harvard’s tradition of case studies, illustrated by William Ripley’s course on , and it is put forward to explain the empirical stance of the subdiscipline. This literature also traces back the roots of IO to the work of first institutionalist economists (R. Ely, J. , T. Veblen) and their successors of the interwar period (J. M. Clark, W. Hamilton, W. Ripley)6. In a recent paper on “American economists” such as A. Berle, A. Burns, E. Chamberlin, J. M. Clark and G. Means who “sought to explain the as a failure of competition”, Roger Backhouse (2015) states that the links between this literature and the “Harvard school of industrial economics” is “easy to trace”7. However, this story has not been written yet since the demonstration of the existence of the Harvard school in IO is always out of scope.

3 Hansen, Harris and Samuelson generally play the prominent role in these stories. We could also add the impact of two young Canadians economists, Robert Bryce, who followed J. M. Keynes course at Cambridge (UK) in 1934, and Lorie Tarshis. On the at Harvard, see Galbraith (1965, 1981), Samuelson (1988), Tobin (1988), Colander and Landreth (1999), Backhouse (2017). 4 Tirole (1988, 1-4) 5 See Arena (1991), Phillips and Stevenson (1974), Grether (1970). 6 Phillips and Stevenson (1974), Rutherford (2011). 7 Backhouse (2015, 121).

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In fact, the aforementioned papers often convey a vision in terms of “spontaneous generation” of IO at Harvard; in this respect we consider them as unsatisfactory8. It consists in a posteriori agglomeration of actors from the similarities of their research thematic, but without giving any institutional and historical reality on the way these actors have interacted. This paper aims at providing the missing story of the birth of Industrial Organization at Harvard and the diverse paths of its development thank to the identification of a research community in and around Harvard. The task is not as easy as suggested by Backhouse. During the 1930s, the Harvard Department of Economics is a reflection of the interwar pluralism in American economics9. Far from being monolithic, it enters into an important renewal stage of its members. Three former Ph.D students successfully defended their Ph.D thesis – Seymour Harris (1923), Edward Mason (1923) and Edward Chamberlin (1927). Recognized American economists – as John D. Black (1927) in the field of , (1930) in labor economics, (1937) in cycle - and prominent European immigrants - such as Leontief (1931), Schumpeter (1932) and Haberler (1936) - also join the department. In the mid-1930s, Alan Sweezy and came as instructors and many economists are passing their Ph.D grades: (1940), John Cassels (1934), Gardiner Means (1933), Richard Musgrave (1937), (1940), Paul Sweezy (1937), (1938), Donald Wallace (1931), to mention just a few. These names testify the diversity of epistemological approaches and topical among the members of the Department. One may still wonder who then participate to the so-called Harvard Tradition in Industrial Organization (HTIO). Labels school or tradition seem inappropriate since Mason and Bain are the only two figures systematically evoked in the HTIO. Moreover, it does not enable us to grasp the specific role played by the Harvard Department of Economics. This latter can be considered as a research community in itself. Its members share courses, attend seminars, collaborate on research projects, meet up on administrative issues, edit academic review and supervise students’ researches. Still those links do not make a tradition. Therefore, without an emphasis on a unifying criterion, it is impossible to understand the reality behind the label of a HTIO. Here, we defend the thesis that the identification of a specific theoretical notion enables us to delimit a group of actors who participate to its establishment from the 1930s to the 1950s. This unifying concept is the possibility of tacit collusion in oligopoly.

8 See also, for instance, Stephen Martin book Industrial Organization in context (2010, 16) 9 Morgan and Rutherford (1998).

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The original protagonist of our narrative is the “rising star” of Harvard, Edward Hastings Chamberlin10. The publication of his Ph.D dissertation (1927), The Theory of Monopolistic Competition (1933), provides the first economic analysis of oligopoly11. This concept is revolutionary in two respects. First, it allows to think in terms of a continuum of competitive situations between the two ideal cases of pure competition and pure . Second, Chamberlin analyzes the behavior of firms in oligopolistic market by making new assumptions regarding their strategic interactions. The notion of tacit collusion in oligopoly hinges on the assumption that firms have a “recognition of their mutual independence” (Chamberlin 1933, 46-47). Thus, competition not only refers to but also to strategic behaviors of the competitors. One immediately understands why this concept is directly linked to the birth of Industrial Organization. It has been used to build the first markets classifications that one can find in the work of F. Machlup (1937), Mason (1939), Clark (1940), R. Triffin (1940) and Bain (1942). These classifications are useful tools to understand how the environment of a firm affects its behavior and how its behaviors performs the environment back. They led to the “structure-conduct-performance” paradigm which is a notorious one. However, the sequence between these three dimensions do not originally describes a one-way causality. In addition, it is only one aspect of the development of IO. If this notion of tacit collusion in oligopoly and how it spreads in the field enables us to account for the establishment of a restricted research community, this is the pluralism of Harvard Department of Economics which allows us to understand the diverse paths of its development and re-appropriations. Three kinds of work can be distinguished. They are respectively related to theoretical issues, instrumental issues and politico-economical issues. First, the notion of tacit collusion in oligopoly brings the reappraisal of economic analysis. Chamberlin’s Theory of Monopolistic Competition, and Triffin’s dissertation he supervised, illustrate this stance since they aim at providing an alternative to the theory of competition and industry inherited from A. Marshall. Galbraith (1936) and Mason (1938) consider oligopolies’ behavior, such as Chamberlin theorized it, has one of the main causes of differential price rigidities between sectors. This issue was prominent because of the Great Depression as well as the implementation of the NRA. Thus, tacit collusion in oligopoly leads to a reappraisal of price theory so that it could fit reality and nourish macroeconomic reflexions. In the same vein, the price behavior of oligopoly enters both theoretical debate and practical

10 The expression is Backhouse’s one (2017, 111). 11 On the genesis of Chamberlin’s theory, see Guicherd (2017, 2018).

4 implementation of price control at the Office for Price Administration12. It brings us to the second kind of works, more applied than theoretical. If American Economics was progressively experiencing a theoretical turn between the 1930s and the 1960s, Chamberlin’s theoretical concept has been in fact appropriated by Harvard economists for empirical analysis in order to tackle practical problems. One can mention a report on the steel and iron industry, which explicitly refers to this notion of tacit collusion in oligopoly (Daugherty and al., 1937). The adjective “tacit” is due to the firms’ collusive behavior despite the absence of any explicit agreement between them. In the 1940s and 1950s, this problem is at the core of a major controversy between economists around Harvard, namely the burning issue of the Basing Point System (BPS). The way tacit collusion is theoretically treated determines the perception of anti-trust laws. Either collusion is explained by explicit agreement, leading to , which is thus judged as an anti-competitive practice. On the other hand collusion appears as the result of the rational behavior of firms and have to be considered as the expression of the process of competition. Members of our research community around Harvard mainly endorse this second view because of a specific “oligopolistic rationality” (Kaysen 1949a). As our narrative provides the rationale behind their general skepticism about anti-trust laws, it led us to consider a third kind of works: books dealing with broader issues dealing with the growing importance of oligopoly in the American system. In the spirit of nineteenth century , those authors use Chamberlin’s theory as a starting point for their attempts to provide an analysis of the dynamic of twentieth century capitalism. The works of J. Schumpeter (1942), Clark (1948) and Galbraith (1952a) are purely representative of this reappropriation and extension of Chamberlin’s initial concern. As the notion of oligopoly cannot be distinguished from the growing concern about concentration and the emergence of great corporations, they discuss the dilemma of modern American Capitalism between efficiency and competition. Roger Backhouse (2015) has shown that, as soon as the 1920s, American economists start to deal with the failure of competition. But with the concomitance of the Great Depression, the Keynesian Revolution and the Monopolistic Competition Revolution, these reflexions on the changing nature of capitalism increased. A lot of economists were losing faith regarding the nature of the competitive system and their certitude concerning

12 See for instance Galbraith (1941) and Clark (1941) answers to Hansen (1941) concerning the issue of the required measures to counter wartime .

5 the foundations of Economics13. Their beliefs were also shaken by controversies on the resource allocation under , the “managerial revolution” and the debate on “secular stagnation” that mainly takes place in the very yard of Harvard14. As stated before, the aim of our paper is to show that this is a precise research community, which emerged around the notion of oligopolistic tacit collusion and fosters the development of HTIO. To this end, we used both published literature and archives materials. Thus, we provide new insights, both theoretical and historical, on how the Chamberlinian notion of oligopoly is at the core of a reexamination of the concept of competition, a reappraisal of price theory, specific cases studies, debates over anti-trust legislation and renewed visions of American capitalism. Our narrative begins by presenting the unifying theoretical content of Chamberlin’s concept of oligopolistic tacit collusion (Section 1). We then focus on the direct spreading of this concept to attest that a community emerged at Harvard around this notion between 1933 and 1937 (Section 2). Our network of Harvard economists being identified, we show how, between 1937 and 1942, the notion of oligopoly has been used to provide a reappraisal of competition through the construction of a new tool: classifications of market structures (Section 3). This tool of the IO was a requirement for two of its instrumental purposes: providing theoretical insights to drive empirical studies and to evaluate anti-trust legislation. We then highlight that the theorical notion coined by Chamberlin, and the reappropriation by his colleagues, is a central issue of the BPS debate which helps understanding their skepticism against anti-trust law (Section 4). Finally, we examine the attempts from members of this community who seize the oligopoly question to put it back in systemic reflexions on the nature of American Capitalism (Section 5). Before starting our narration, we would like to provide a justification of the temporal framework of our paper. We choose to speak about a research community as Chamberlin’s notion has quickly been seized. However, if we stopped our narration at the beginning of the 1940s, when the subfield of IO institutionalized itself, we would have missed some major ramifications of its spread. There are two main reasons explaining why we stopped our story in 1952. The first one is the publication of American Capitalism by John Kenneth Galbraith. He appropriates, combines, discusses and synthetizes the ideas of many contributors to this research community - Chamberlin (1933), Galbraith (1936), Clark (1940), Bain (1942),

13 For instance, the 8th of August 1941, Frank H. Knight, as a leading interwar American economist, wrote to Clarence Ayres: “I have to say frankly, that between the institutionalists, the planners, and the Keynesites, I no longer pretend to know what is economics or what is an economist!”. (Samuels 1977, 509). 14 See Hansen (1938), Schumpeter (1942), A. Sweezy (1943), P. Sweezy (1942) on secular stagnation.

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Schumpeter (1942), Mason (1949), Machlup (1949) – so as to provide a general theory of competition in modern America. The second reason is the publication of the two volumes of the Survey on Contemporary Economics sponsored by the AEA. They represent the crystallization of economic knowledge at that time. In the first volume, initially published in 1948 and printed in 1952 for the third times, Joe Bain wrote the chapter entitled “Price and Production Policies” which is the first extensive review of the IO literature15. In the second volume (1952), Andreas Papandreou, a Greek economist also working at Harvard until 1947, wrote a chapter entitled “Some basic problem in the ”. Both Bain and Papandreou put forward the fact that (GT) could become an important tool for the future of IO and the theory of the firm. This new framework seems adequate to deal with strategic interactions characterizing oligopolistic markets. This association between GT and IO is nowadays taken for granted. Even if Von Neumann and Morgenstern published their book in 1944 and Morgenstern applied it to the problem of oligopoly four years later, it was only prominent until 1952. Thus, our paper could also be read as a story on strategic interactions analysis in IO before the turn toward GT as a tool. It starts with the well-known but sparsely read book of Chamberlin.

1. Chamberlin’s theory of Oligopoly (1927-1933)

According to few authors, the word “oligopoly” has been introduced in economics by Chamberlin16. In “On the Origin of ‘Oligopoly’”, he shows that this statement is incorrect. In economics, the adjective oligopolistische is first used in the book Theorie des Geld und Kreditwirtschaft from Karl Schlesinger (1914)17. However, “oligopoly” and all other English forms came from Chamberlin, even if the study of market situations where the number of competitors is small can be found from almost a century ago18; indeed the seminal work of Auguste Cournot in Recherches sur les principes mathématiques de la théorie des richesses (1838) immediately comes to mind. However, oligopoly is never named nor studied in itself. The situation with a limited number of sellers is also systematically treated through as

15 See Bain (1948). 16 Nichol (1934), Schumpeter and Nichol (1934), Stackelberg (1934). 17 Concerning the word itself, its first occurrence in Latin can be found in the original version of ’s Utopia (1518) and appears in a French translation from 1789 (Chamberlin 1957, 35). 18 As soon as 1929, Chamberlin had the term ‘oligopoly’ in mind and should have appeared in his article “Duopoly: Where Sellers are Few”. The Quarterly Journal of Economics’ editor F. W. Taussig denied it. He considered this word as a “monstrosity” (Chamberlin 1957, 33). Chamberlin had then to wait 1933 to have the freedom to include it.

7 a simplified situation where two competitors are facing each other. In this respect, Chamberlin is no exception. He builds his oligopoly theory as a generalization of a duopolistic situation. This latter takes root from pre-existing duopoly theories19. Despite the similar initial conditions, Chamberlin notices that Cournot, Bertrand and Edgeworth come to contradictory conclusions. To solve this divergence, he proposes a reformulation of those models by adding a new hypothesis that unifies them into a single solution. In his duopoly theory, Chamberlin supposes a capacity of anticipation and farsightedness from competitors. It differs from preceding where competitors were just acting by considering opponents prices and quantities as fixed, given and exogenous20. In Chamberlin’s model, this hypothesis allows the two enterprises to forecast all the consequences of their actions and consequently to choose directly the most profitable option. If applied to Cournot and Edgeworth theories, this hypothesis leads to a situation of tacit collusion. The rational behavior for competitors consists in sharing the monopoly by splitting the monopoly quantity and charging the monopoly price. To go from duopoly to oligopoly, Chamberlin increases the number of competitors in his model to show that his result remains valid as long as competitors are able to recognize their mutual dependence. The impact a competitor’s action over the price, quantity and profit of other competitors is the specific source of its . However, it gradually fades away as the number of competitors’ increases. This strengthens the around the capacity of rivals to take properly account of their interdependence. According to Chamberlin, the border between the existence and the absence of the mutual dependence recognition is porous. But the price falls directly from the monopoly level to the competitive one as soon as competition becomes “pure” (Chamberlin 1933, 48). In this approach, oligopoly is a full-blown market structure leading to specific results, very different from monopoly, monopolistic competition or pure competition ones. It is however based on a hypothesis about competitors’ behavior that can be generalized to any case. Their ability to use such capacity to foresight may vary depending on market situations. The recognition of interdependence is irrelevant in a monopoly situation - unless the enterprise considers the threat of potential competition21. It is non-sense in pure competition. Chamberlin

19 Three versions of Chamberlin’s duopoly (and oligopoly) are known: the third chapter of his 1927 Ph. D thesis, the 1929 article and the third chapter of The Theory of Monopolistic Competition. We refer mostly to this latter. 20 Known as reaction function in standard . 21 Potential competition is important in Clark (1923, 1940), Schumpeter (1942) or Bain (1950).

8 note that this is precisely the loss of such market power that leads sellers to differentiate their products, resulting in a situation of monopolistic competition. We do not expose in details the informal aspect of his oligopoly theory and its blind spots. Let us just remind that Chamberlin’s duopoly is simply build on the two most famous duopolies of that time - Cournot and Edgeworth - and their convergent reinterpretations of graphical representations. Despite the groundbreaking aspect of his concept of oligopoly, two main problems remain. First, Chamberlin’s oligopoly cannot claim some degree of generality. Concerning agents’ ability to affect the market structure, Chamberlin leaves a significant void. He simply states that the distinction between pure competition and oligopoly relies not only on each competitor’s recognition of their influence upon others, but also on their ability to be aware that their responses will be conditioned by rival’s awareness of this interdependence. In other words, even if the interdependence is clear and well known, the propensity of each competitor to follow and to hold the optimal private choice is uncertain. Secondly, still remain important ambiguities surrounding the links between an oligopoly situation (the number of competitors) and the theoretical framework of monopolistic competition (product differentiation) in which it is poorly integrated. The articulation between situations of oligopoly and monopolistic competition is blurred, especially when competitors applying the latter when the former is not possible. In a situation of oligopoly, the production on the market can be assumed as homogenous and then can be called ‘industry’. This is no longer true in monopolistic competition where the notion of ‘group’ prevails along with problem of the definition of its boundaries. According to Chamberlin, the differentiated oligopoly, or ‘small group’ is practically relevant and important to discuss (Chamberlin 1933, 100-4). In later works he will even redefine the theory of monopolistic competition as a combination of both oligopoly and product differentiation22. This is how numerous members of the research community we identified use his work. The withdrawal of the notion of the Marshallian industry allows the definition of a group regarding the interactions between its members. In this respect, this idea is an important theoretical tool that Chamberlin provides which besides legitimates the difference between his theory and Robinson’s . In the latter, strategic interactions are absent and market imperfections, including product differentiation, are supposed as given and exogenous. Their contemporaries are thus facing a kind of dilemma: do they adopt the imperfect and monopolistic competition theory on the basis of the general principles and hypothesis they

22 Guicherd (2018).

9 share?23 In this case, the theory enables theorists to describe the whole continuum of possibilities between monopoly and pure competition by assuming that competitors adapt their policies according to given market structure. Or do they recognize the preponderance of strategic interactions causing differentiation and making the notion of industry obsolete? If so, competitors’ behaviors influence the structure of the market and break the determinism of price and quantity equilibrium. But the result of such strategic behaviors could lead to some indetermination. The economists are then struck by the question of knowing what is a “normal price”?

2. The immediate spreading of Chamberlin’s oligopoly at Harvard (1934- 1937)

As stated before, Harvard Department of Economics entered a renewal stage of its member in the 1930s. While Taussig and Ripley were retiring, new professors and Ph.D. candidates brought new blood. In this de facto research community Chamberlin and Mason bridge between the old and the new generation. That is why they play a crucial role in the establishment of HTIO. Between 1927 and 1932, both are in charge of the courses on economics of transportation while Ripley teaches economics of corporations in the second semester. Starting from 1932, the two Eds taught both semesters with their course “Monopolistic industries and their ”. Links between members of the department are embodied by their academic contacts and some will directly find echoes in their theoretical contributions. A first example is given by Donald Wallace Market Control in the Aluminum Industry (1937a), which is considered as the canonical case study at Harvard24. This book is adapted from his Ph.D thesis, defended in 1931 under the supervision of Taussig and Ripley. In the preface, Wallace acknowledges Chamberlin and Mason and refers to the “two discussion groups at Harvard” in which he was involved and he presented his chapter XV25. One undoubtedly corresponds to the seminar on “Industrial Organization and Price Policy” organized by Mason. Wallace’s chapter makes an explicit exposition of the collusive possibilities given by an oligopoly structure and concludes to the legitimate pubic intervention (1937a, 338-41). Thus, even before being hired

23 Despite the difference granted by the integration of strategic behavior, many common points are blindingly obvious. For the most striking, one may quote the use of marginal curves for the equilibrium of the individual firm or the tangency solution. 24 Grether (1970, 83). 25 Wallace (1937a, x).

10 as professor, Chamberlin and Mason, in collaboration with predecessors, were deeply engaged in theoretical discussions around the idea of oligopoly and collusion. Being at the center of numerous theoretical controversies, oligopoly could retrospectively appear to be a concept as old as economics. However, as a new economic notion puts forward by The Theory of Monopolistic Competition, it had to find its place in economics. As soon as 1934, Heinrich Von Stackelberg used it in Marktform und Gleichgewicht26. The term is used in his etymological dimension and is often assimilated with the duopoly it is based on27. Oligopoly is connected to other theoretical issues like the optimal size of firms by J. V. Robinson (1934) and the increasing with the number of competitors by Schumpeter and A. Nichol (1934). However, there is no contribution from 1934 making a direct link between oligopoly and tacit collusion. This trend of etymological use continues in 1935 and 1936. However two contributions, one a year, catch our attention because of the emphasis on tacit collusion. Geoffrey Shepherd uses the term oligopoly in its Chamberlinian definition in his article « Competition and Oligopoly » published in the Journal of Farm Economics. Thanks to the possibility of tacit collusion in such a structure, he explains the differences of policies between manufacturing and agricultural sectors during the Great Depression. Shepherd’s position is not surprising. Known as a statistician and econometrician, he taught in Iowa State University after he defended his Ph.D thesis in Harvard in 1932. According to acknowledgment, he likely interacted with Chamberlin (Shepherd 1935, 575-7). In 1936 too, only one contribution hinges its utilization of oligopoly on the idea of recognition of mutual dependence between sellers. It is written by John Kenneth Galbraith, who was at that time instructor at Harvard28. Published in The Quarterly Journal of Economics edited by Harvard University, Galbraith also attacks the theoretical problem of explaining differential price rigidities that has been observed by Means (1935). To this extent, he explicitly refers to Chamberlin’s book and quotes his article from 1929 “Duopoly: Value Where Sellers Are Few”. Chamberlin’s initial contribution on tacit collusion in oligopoly focuses on single firms and their supposed behavior, a methodology close to what is now called microeconomics. In his history of the Department, Edward Mason explains that and others macroeconomic issues “let him cold”29. But with “Monopoly power and prices rigidity”,

26 Expressions like ‘Cournot oligopoly’ or ‘Bowley oligopoly’ cannot be found before this publication, where its author explicitly praises Chamberlin for coining the concept (Stackelberg 1934, 2). 27 Bitterman (1934), Schumpeter et Nichol (1934), Nichol (1934). 28 Galbraith was originally trained, as Shepperd, in agricultural economics at Berkeley (1931-1934). 29 Mason and Lamont (1982, 423).

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Galbraith paves the way to a process of appropriation that links microeconomics to Industrial Organization and (1936)30. He judges the explanation of prices rigidity by costs rigidity as unsatisfactory since agricultural costs were sticky during the depression meanwhile prices fall down. If price rigidity is impossible in case of pure competition, Galbraith argues to Means that monopoly power alone cannot explain why “” should be more rigid31. In fact, if an enterprise with discretionary power over its prices and production has to maintain them rigid in response to a reduced demand, it is for reasons that still need to be provided. Galbraith finds two groups of explanations. The first one hinges on the assumption of profit maximization but provides amendments regarding the temporal horizon of the firm (short run versus long run maximization) and the process of prices adjustment (menu costs)32. The second group of explanations depends on the assumption of “a ‘rational’ selection of rigid prices” in terms of maximization so as to consider the role played by customs, habits and strategic interactions in price policies choice. Chamberlin’s assumption of a “mutual dependence recognized” enables Galbraith to explain differential prices rigidity between concentrated industrial sectors and competitive ones. Rigidity pricing acts as a convention to reduce the uncertainty of sellers’ behavior.

“Students of duopoly and oligopoly have noted a variety of assumptions which may be made as to the foresight of individual sellers and the degree of interdependence which they recognize in formulating their price and production policies[33]. It is believed, however, that there will be general agreement with the suggestion that the case of most practical importance is where the individuals concerned behave, however imperfectly, as though there was but one – that they recognize fairly completely the interdependence of their fortunes. The extreme likehood in practice that tacit or formal understandings will be present under oligopoly situations (or rather will replace them) increases the probability of such a result” (1936, 466).

30 This paper was written and published before Galbraith read Keynes’ General Theory. Galbraith spent a semester at Cambridge (UK) in 1938. There he met a Ph.D. candidate from Berkeley, who rapidly became a member of Harvard, namely John Dunlop. When this latter wrote against Keynes’ assumption of a negative correlation between nominal and real , he explicitly referred to Galbraith’s paper to provide theoretical arguments (Dunlop 1938, 47). 31 In the same way Chamberlin defines monopoly power as control over supply, Galbraith defines monopoly power as follows: “the power of the seller to exercise control over supply and price, regardless of whether he is enabled to do so as the result of a monopoly position or because of a condition of duopoly, oligopoly or monopolistic competition in the industry” (1936, 458). 32 Means (1935) and Galbraith (1936) are the first economists to deal with this explanation of nominal prices rigidity, famous since Barro’s work (1972). See Wolman (2000). 33 Here Galbraith refers to Chamberlin.

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The year 1937 can be considered as a turning point. Indeed, a lot of articles are now defining oligopoly not only as a group of few sellers but as a situation where competitors can have strategic interactions which may result in tacit collusion. Such contributions are no longer the exception and are quantitatively as represented as articles using oligopoly in its etymological sense. Two main reasons can explain this trend. The first is the running of the AEA Roundtable on monopolistic competition in December 1936 and the second the publication of the report The Economics of the Iron and Steel Industry by Carrol Daugherty, Melvin de Chazeau and Samuel Stratton. Those two latter are directly linked to Harvard. De Chazeau and Stratton both studied industries regulation in Harvard in 1930 and respectively wrote dissertations entitled Some chapters in the regulation of the electric industry in Massachusetts and Some chapters on the of the fine steels industry in the . Their report is representative of the reappropriation of Chamberlin’s concept in order to undertake empirical studies. One major explanation of price policies in iron and steel industries is based on the possibility of tacit collusion between oligopolists34. Even if theoretical discussion is incremental, this report fosters several papers which contribute to the spreading of Chamberlin’s conception of oligopoly35. The reason is that The Economics of the Iron and Steel Industry raised a burning practical issue. Not only the authors define those two industries as oligopolistic on the basis of observed price rigidity. But they also explain this rigidity by the Basing Point System (BPS) which allows collusion between sellers36. Such a system had been identified by J. M. Clark in 1935 in the Report of the National Recovery Administration on the operation of the basing point system in the iron and steel industry (NRA 1935, 60-1). It consists in price policies where two sellers charge the same price regardless of their spatial localization, so that consumers pay phantom freight costs. During the whole period considered here, the competitive nature of the BPS is a subject of numerous controversies involving Harvard economists. This question will be developed in the fourth section of this paper. In 1936, AEA’s president Alvin Johnson proposed Chamberlin to organize a roundtable whose discussions will focus around new theories of competition37. This is the second main source that spread its oligopoly theory. Among contributions using this notion in the following

34 The first occurrence of the word ‘oligopoly’ comes along with a footnote which refers to Chamberlin’s idea of the possibility of a collusion. All other occurrences explicitly quote Chamberlin’s contribution (Daugherty et al. 1937, 558, 588). 35 Bain (1937), Bober (1937), de Chazeau (1937) Fetter (1937) and Humphrey (1937). This latter discusses Means (1935), Galbraith (1936) and Wallace (1937b). 36 Daugherty et al. (1937, 618, 698-703) 37 Aslanbeigui and Oakes (2011).

13 year, we identify « Monopolistic Competition and Economic Realism » by John Cassels - who wrote a dissertation entitled A Study of Milk Prices at Harvard, Donald Wallace’s review of Arthur Burns’ The Decline of Competition and Paul Sweezy’s paper “On the Definition of Monopoly”38. This latter paper is used by as an introduction in his article “Monopoly and Competition: A Classification of Market Positions” (1937). Machlup proposed a pioneer market classification which matches perfectly Chamberlin’s theory. He retained two variables: the number of sellers and the differentiation of their products. This is not surprising since he attended to the AEA Roundtable on monopolistic competition and made few years a stay at Harvard, among other universities, thanks to a grant from the Rockefeller foundation. He even submitted the manuscript of his paper to Chamberlin in order to know whether it could be published in the AER. Chamberlin considered it as “excellent”. He therefore wrote to Dewey, the editor of the review, to assert that Machlup’s paper “should by all means be accepted” 39. The confirmation of strong connections between these economists is also given by a letter from de Chazeau to Chamberlin, dated from January 1936:

“Your suggestions se my chapters in the steel industry have just arrived and, although I have not yet had an opportunity to relate them specifically to the manuscript, I know that they will be a great help to me in making final revisions. In fact, I have delayed even re-rereading my stuff until I should have your criticisms, Mason’s, Wallace’s, and Clark’s before me. Now that they are all present, I shall set forth in earnest.” (De Chazeau to Chamberlin, January the 17th, 1936, CPP).

Finally, in 1937, only two publications establishing an explicit link between oligopoly and tacit collusion showed no direct link with Harvard or Chamberlin and may be the object of : Stigler (1937) and Hayek (1937)40. However, debates around oligopoly and tacit collusion took place within a precise research community composed of Cassels, Chamberlin, De Chazeau ,Galbraith, Machlup, Mason, Schumpeter, Stratton, Sweezy and Wallace. The only person who does not show direct link with Harvard is J. M. Clark. But as we can read in the

38 Cassels (1937, 386-8), Wallace (1937b, 383), Sweezy (1937). 39 Chamberlin to Dewey, 19th of May 1937, Chamberlin Personal Papers (CPP), Duke University (NC). Concerning correspondence between Chamberlin and Machlup : Machlup to Chamberlin, 8th of January 1937, Chamberlin to Machlup, 20th of January 1937 and Machlup to Chamberlin, 22nd of April 1937, CPP, Duke University (NC) 40 Stigler might have assisted to Chamberlin’s roundtable at the 1936 AEA meeting since it took place at Chicago. He passed its Ph.D there in 1938 under the supervision of F. Knight. The latter shares strong links with Chamberlin: he was Chamberlin’s first economic teacher in Iowa and their Ph.D were both supervised by Allyn Young.

14 previous letter, De Chazeau puts him naturally in the group. This is not surprising because of the theoretical debt from Chamberlin to Clark (1923). This debt is well known since Clark is one of the most referenced authors in his 1927 Ph. D thesis and in successive editions of The Theory of Monopolistic Competition. Moreover, in 1939, Clark sent to Chamberlin a draft of his future article on workable competition41. As we will see in the next section, this publication is a key moment regarding the emergence of market structures classifications as a new tool for the analysis of the nature and consequence of competition42.

3. From Chamberlin oligopoly to the building of markets structures (1937-1942)

The classifications of markets structures are always recognized as the primary tool of the HTIO. The aim of this section is threefold. First, we expose the fact that the building of market classification directly derives from Chamberlin’s theory of oligopoly. Second, we show that the diversity of market structures’ classifications comes from the pluralism of approach of economics between members of the research community. Third, it enables us to provide the rationale behind the different reappropriations of Chamberlin’s concept. The main protagonists of the development of markets classifications are Machlup (1937), Mason (1939), Clark (1940), Triffin (1940) and Bain (1942). Their works can be considered as a direct legacy from their predecessors. As stated before, Machlup built the first market classification based on a “threefold classification of number of sellers (one, few, many) and twofold classification of product difference”. This typology aims at formalizing Chamberlin’s new insights, so that Bain labels it as the “Chamberlinian market classification” (1948, 159). However, it is not satisfactory from an empirical point of view since some members of the community consider economics as a relevant guide to public policies. Edward Mason is particularly representative of this stance. In 1938, he published in the other review hosted at Harvard, The Review of Statistics and Economics, a paper similar to a literature review on “Price Inflexibility”. Drawing on Galbraith’s work (1936) among others, he aimed at identifying another meaning of price flexibility as well as the differences between both statistical and theoretical apprehensions43. Regarding the latter, Mason states that “price flexibility in the normative sense may be

41 CPP, Duke University (NC). On the institutionalist reception of Chamberlin’s book, see Fiorito (2010). 42 Clark is also linked to another member of this group, John Kenneth Galbraith. Both work for the OPA between 1940 and 1943. 43 Mason thus mentions the statistical study of Mills (1927), Means (1935), Burns (1936) and Humphrey (1937).

15 considered as a relationship between actual and desirable price behavior”. The normative superiority of competitive price theory has generally been thrown out by the members of this research community. More particularly, they have to tackle the task of knowing what a good price is, especially because of the recognition of the existence of great corporations and oligopoly markets. For this purpose, Mason argues that economist must be able to provide “judgement of the probable consequences for relevant economic quantities of type of prices behavior different from the one observed” (1938, 57)44. However, the task is far from straightforward. If Chamberlin’s assumption of mutual dependence recognized removes the indeterminacy in duopoly, oligopoly does not conform to simple laws – even from a theoretical viewpoint45. This is the consequence of opening the economics door to strategic dimension of enterprises’ behaviors whereas the oligopoly pricing and production policies result from numerous variables that have been empirically observed. That is why extensive classifications of markets structures appear as a tool required for passing normative judgment. They must help to organize the empirical research on American enterprises, to judge the probable consequences of their operations and finally to know how industries situations could be improved. Tuesday 29th December, Mason started tackling the challenge of building markets classifications in the paper he presented at the annual meeting of the AEA. Fritz Machlup, whose classification lacks some crucial variables affecting firms’ behaviors according to Mason, was there as a discussant. Published the following year in the AER, “Prices and Production Policies of Large-Scale Enterprise” is regularly considered as the illustration of what IO originally was. It aims at mapping both internal and external factors of the firm which exert an influence on firms’ price and production decisions. However, Mason does not provide a classification grounded on the variables identified. He acknowledges that he was still working on it with Wallace. His conviction that this tool would provide useful guide for public policies is however firmly asserted since it could inform on the desirability or dangerousness of price flexibility according to the characteristics of each industry. It could also help implementing anti-trust law by furnishing “evidence of violations” and then passing judgment on the desirability of public intervention in order to correct the failures of price competition (Mason 1939, 64, 69, 74). A year later, at the annual AEA meeting taking place in Philadelphia, two sessions were devoted to the questions Mason tried to tackle. On Thursday afternoon, the 28th December 1939,

44 See also Mason (1939, 73). 45 On this matter, see Knight’s (1946) communication and Chamberlin’s (1946) reply at the AEA session on the “New frontiers in Economic thought” that took place in Cleveland.

16 he was the Chairman of a session entitled “Preserving competition versus regulating ” where Wallace (1940) presented a paper. As a discussant, Melvin De Chazeau emphasized in few words the questions that fussed over participants of our research community. How anti-trust law, conceived to struggle against “trust”, has to be adapted to deal with oligopoly situations? To what extent and in which industry “oligopoly is a function of the inherent economic characteristics of production and ”? Which means should be use so that business price policies move in “socially desirable directions”? (Mason and al. 1940). The next afternoon, participated to a session on “Costs functions and their relation to imperfect competition” and finally provides the first extensive markets classification Mason was asking for. It leads to the publication of his famous paper “Toward a Concept of Workable Competition” (1940). Clark calls for departing from normative standard of ideal competition since markets are always “imperfect” or “monopolistic”. He aims, like Mason, at determining which kinds of market structures are viable and how they could be practicably improved. He identifies not less than ten variables that are present in the economics literature to finally provide a classification with thirteen cases whose “indebtedness to professor Chamberlin is obvious”. But he goes beyond his theory of oligopoly. In reality, there is intermediate situations that are “more competitive” than the case of pure “oligopoly” – where few sellers quoted their prices according to the recognition of their mutual independence so as to reach monopoly profits – but also “more workable” than a situation with open prices degenerating in cut-throat competition46. Clark’s typology of markets structures does not always seem consistent because of the procedure used to the determining variables. Nonetheless, the tool was taking shape.

1940 also is the year when Robert Triffin’s thesis, defended in 1937 and entitled Monopolistic Competition and General Equilibrium, was published. Under the supervision of Chamberlin, Triffin proposes a tool which enables to theoretically identify an oligopoly. It hinges on a rejection of the Marshallian notion of industry that Chamberlin judged inconsistent to grasp phenomenon of products differentiation. Triffin’s goal was to dismiss the analysis in favor of general equilibrium. But price theory still needs to identify “markets”, that is to say groups of competitors without falling into arbitrary criterions of identification of a group. To this extent, Triffin uses the tool of cross-elasticities. This measurement of a competitor’s policy impact over his rivals’ prices, quantities or profits helps

46 Clark (1940, 244, 242, 253). If quoted prices are nowadays a standard, a lot of products, not only in agricultural sectors, experienced at that time day-to-day variations.

17 the analyst to delimit such a group and to know its nature. Even better, cross-elasticities can be considered as an objective measure of mutual dependence recognized between oligopolists. In 1941, Triffin emphasized the importance of cross-elasticities in “Monopoly in particular- equilibrium and in general-equilibrium economics”. In many contributions of that period, monopoly power was measured according to the elasticity of demand addressed to a firm47. Triffin argues that the differentiation of market structures cannot be based on this simple analysis of demand elasticity, since it can be similar in monopoly, oligopoly or pure competition depending on circumstances. Moreover, uncertainty on competitor’s reaction, which is fundamental in the establishment of an oligopoly situation, is not caught by elasticity of demand. At first glance, one may be surprised that Robert Triffin’s work on cross-elasticities has been ignored by Mason, regarding the tight bounds between Harvard members. In fact, Triffin provides a tool for identifying oligopoly, a necessary step in order to understand enterprises’ price behavior and then implementing public policies if the former is judged contrary to public interest. In addition, both Mason and Triffin are looking for tools providing objectivation of oligopoly situations. But Mason’s ignorance of cross-elasticities is easily understandable. As Triffin, Mason dismisses the elasticity of firms’ as a relevant tool for identifying monopoly power but the reason he gives is different: the mere fact that economist did not know the slope of demand curves48. How could they know the value of cross-elasticities? As soon as 1939, Mason clearly distinguishes two paths in IO. First, “the analytical method”, which implicitly refers to Chamberlin and Triffin, that focuses “on rival’s reactions as considerations in the determination of price or production policies and on the importance of non-price forms of competition”. Second, the “statistical approach” that starts with the empirical investigation of price policies implemented by enterprises and then attempt “to correlate” these variations to those of other economic variables (Mason 1939, 63-5). Here is the apex of the methodological divergences maintained between the members of our research community regarding the precedence between theory/deduction and empiric/induction.

“Some theorists, pursuing their analysis on a high plane, refer to work as “tool making” rather than “tool using”. A “toolmaker”, however, who construct tools which no “tool user”

47 See Lerner (1934) and Sweezy (1937). 48 Mason (1939, 62, 64). Referring to Cassels’ study on milk (1934), Mason acknowledged that the individual demand curve could be approximate if one dispose from empirical data on the variables he identifies as relevant to build market structure. Bain explains that individual demand curve in oligopoly can be determinate only if there is collusion that leads to a repartition of the total market shares between sellers (1948, 138).

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can use is making a contribution of limited significance. Some knowledge of the use of tools is probably indispensable to their effective fabrication” (Mason 1939, 62).

Mason “devoted [his] time to try to work out classification of markets that would permit an analysis of the relationships between the structure of markets [and] the behavior of the firm”49. But this is Joe Bain who published a more complete and consistent classification than Machlup and Clark’s ones. Bain passed his Ph.D dissertation, entitled The Value, Depreciation and Replacement of Durable , under the supervision of none other than Chamberlin, Mason and Schumpeter. Published in the QJE, Bain’s “Market classifications in Modern Price Theory” appears as the direct product of our research community. He starts by arguing that Chamberlin’s price theory, as logic as it is, presents the shortcomings of firm behaviors’ oversimplification and lack of empirical verification50. Presenting Machlup (1937) classification, he identifies the shortcoming seen by Mason, more precisely that markets differ according to many other characteristics than just the number of sellers and product differences. He adds that without others characteristics, Chamberlin’s and Machlup’s works are disappointing. In fact, as we put forward before, the result of oligopoly is in fine dependent of the assumption regarding seller’s anticipations and strategic interactions.

“Oligopoly [being] an extremely broad category”, Bain’s market classification aims at putting in light different patterns of price policies. The implicit idea is that adding other objective variables may enable economists to observe regularities and increase their understanding of strategic interaction without sounding human motives (Bain 1942). Bain’s classification hinges on six variables: the number of sellers, the durability of the product, the differentiation of the product, the variation of the product, the number of buyers and the nature of buyers. Each of this criterion is twofold, so that he obtains a classification with 64 cases. These criterions were already mention in Mason (1939) as relevant to the purpose. Bain explains that his work has been fostered by his participation to the Harvard seminar in IO and Price Policy. From this exhaustive classification presented as a hypothesis that should be submitted to empirical verification, he proposes a shorter one reduced to 14 cases. He excludes those which have no sufficient counterpart in the real world “to justify generalization” (Bain 1942, 566-9, 573).

49 Letter from Mason to Phillips, 23 February 1973. Cited in Phillips and Stevenson (1974, 336). 50 But he praises Chamberlin’s theory in front of those of Robinson (1933) and Hicks (1939), since the former recognizes a difference in number of sellers and product difference lead to difference pricing policies. Bain (1942, 561-2, 565).

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In less than a decade, the publication of Chamberlin’s oligopoly theory irradiated the work of a community of economists around Harvard. It leads gradually to researches institutionalized by AEA in 1941 under the label “Industrial Organization”. This is the successive re- appropriations of his work that lead to the construction of a new tool for economists. One may argue that accounting the steps of construction of market classifications have chased out the issue of tacit collusion in oligopoly from the narration. However, we think it had not: oligopoly appears as the third main theoretical market situation between monopoly and pure competition. It enables economists to avoid the existence of a perfect continuum of situations between those two extremes and helps the legislator to design his different interventions. As soon as one remembers that market classifications aims at improving economist’s judgment about price policies consequences and anti-trust policies, the burning issue of the nature of collusive nature of oligopoly is strengthened. The topic of anti-trust policies obviously opens an endless literature. But thanks to the identification of a precise research community during the first two phases, it enables us to focus on specific controversies around the Basing Point System. We then provide the rationale behind the general skepticism against anti-trust policy that characterizes the Harvard research community in IO.

4. Tacit collusion, BPS and anti-trust laws

The whole history of BPS goes way beyond the scope of this paper51. The first economists dealing with it were (Princeton), John Commons (Wisconsin) and William Ripley (Harvard) in a report for The Federal Commission52. It finds echoes in Fetter’s publication of The Masquerade of Monopoly (1931) in which he unconditionally condemns the BPS practice and laments the decreasing competitive nature of American industries. Even if it can be refined, the logic of price policies under a BPS is simple to understand. It is based on a geographical repartition of the few competitors of a market. Among them, a productive unit emerges as a reference, let us say because of its better capacity to produce. This reference unit charges its price for the whole territory, each buyer paying this price plus the transport cost. If another productive unit can supply the same places than the reference unit, it will charge the exact same price as there is no incentive to charge lower. Indeed, its assumed limited productive capacity does not enable it to supply entirely this

51 For more details, see Stocking (1950). 52 As mentioned in many references, see for instance Machlup (1949, 48).

20 demand and the opportunity of being closer generates an incentive to mimic the rival’s price53. As soon as a firm is identified as a basing point, other firms can understand the benefit of following this price instead of implementing aggressive pricing that would end in a cut-throat price competition. We do not defend here the idea of a direct relationship between Chamberlinian oligopoly and the BPS. The spatial differentiation in the latter is, in itself, a big difference with the assumed homogeneity by Chamberlin. But it is still interesting to report a correspondence between him and about his famous article “Stability in Competition”. Chamberlin had already in mind the instability of a spatial duopoly in the case where one of the competitors cannot supply the whole demand. The perfect inelasticity assumed by Hotelling allows the other seller to propose any price on the unsatisfied demand, encouraging the first one to follow this raise (Hotelling 1929, 45).54 In addition, the existence BPS raises a question that could be addressed from Chamberlin’s theory. Is this system grounded on explicit agreements between sellers or on tacit collusion? On the one hand, explicit agreement is forbidden, and the existence of evidences makes possible law enforcement. On the other hand, may BPS be the product of tacit collusion? In 1935, the National Recovery Administration and more specifically J. M. Clark accuses this pricing method as collusive55. As soon as 1923 in The Economics of Overhead Costs, Clark was already underlining the propensity of competitors to avoid price competition (Clark 1923, 417). De Chazeau, Daugherty and Stratton take Clark’s overhead costs as a theoretical source for their analysis of BPS in iron and steel industry56. Like Clark, they consider the industry as collusive. But a difference is the use they made of Chamberlin’s oligopoly which allows them to explain competitors’ behavior. BPS is possible because of the recognition of

53 For instance, a firm based in New-York produces a good whose f.o.b. price is $20. Because of transportation costs, this good is proposed $22 in Boston, $24 in Chicago and $30 in Los Angeles. Another producer based in Salt Lake City can charge his good $30 in Los Angeles as well even if its production cost is $22 and the transportation cost $6 per unit. This opportunistic profit earned is called freight absorption. 54 “Now I have worked it over more carefully and have reached a conclusion which, if true, is damaging to what I understand to be your central thesis – that stability is assured by the fact that “the quantity sold by each is considered as a continuous function of the differences in price” (p. 44). It seems to me that rather that it is assured by the fact that the supplies of the sellers are unlimited. […] Since you have assumed absolute inelasticity of demand, it would seem that the solution would be infinity for both p1 and p2, q1 and q2 being indeterminate, if the demand were taken to be elastic, the upper limit would be finite, and it would pay A to set his price at same point lower than B (instead of at infinity).” (Chamberlin to Hotelling, July the 25th 1930, Chamberlin Personal Papers, Duke University) 55 NRA (1935, 60-1). In its report, NRA recommends a “mill-base system” instead of the BPS. It consists in the obligation for sellers to quote their prices f.o.b. or to impose an uniform price for all of them. This is what Fetter will name “mill-base rule” (Fetter 1937). 56 This idea is also a major source of inspiration for Chamberlin’s theory and was already present in his 1927 Ph.D. dissertation.

21 mutual dependence. In addition, they do not defend the interruption of the BPS for two main reasons. First, the oligopolistic nature of the industry is explained by technological characteristics of the productive process. It is consequently vain to believe that public policy could restore “competition”. Second, the end of this practice would cause heavy prejudices because of important already made in the industry and depending on BPS (Daugherty et al. 1937, 533, 558, 547). In a comment of the report, “The New Plea for Basing-Point Monopoly”, Fetter shows his skepticism about the analysis done in The Economics of the Iron and Steel Industry. Whereas the authors of the report assert that, under oligopoly condition, BPS is possible without “tacit understandings nor on collusive agreement” 57, Fetter is not even convinced by the tacit nature of collusion. “The actual non competitive situation where sellers are few is to be viewed as resulting only from certain subtle, undefinable, and mystical moves causing men to conform with a mathematically exact noncompetitive formula”. There must be explicit agreements behind such a pricing system, which he condemns since prices in BPS are generally assumed to be above the “competitive prices” taken as a normative benchmark (Fetter 1937, 585, 579)58. This controversy progressively moves toward a discussion on the benefits and shortcomings of alternative pricing system that could be more desirable than the BPS (De Chazeau 1938, Fetter 1938). Controversies go on by an exchange between Clark (1943) and Vernon Mund (1942, 1943) Partly due to the role played by Chamberlin’s concept of tacit collusion in oligopoly, many participants of our research community took part to the BPS controversies. In 1942, another student of Harvard, Arthur Smithies, added his brick to the wall59. As he reminds in a footnote, his article “Aspects of the Basing Point System” has been corrected by Fritz Machlup and Isaiah L. Sharfman, a former professor of Chamberlin60. Without any surprise, Smithies confirmed De Chazeau and Clark’s point of view and wishes to give more details about the determination of price determination in BPS. Like Chamberlin before him, he studies the behavior of two identical competitors reached the same conclusion: the possibility of tacit collusion. If the solution is reached, there is indeed no incentive for both competitors to change their

57 Daugherty et al. (1937, 572) 58 The controversies then move toward some alternative pricing system that could be more desirable than the BPS (De Chazeau 1938, Fetter 1938) 59 He defended his Ph.D thesis “Theory of Production” in 1934 under the supervision of Schumpeter. 60 About the link between Chamberlin and Sharfman, see Chamberlin (1961) and Guicherd (2017).

22 policy. On the other hand, asymmetry between producers may increase opportunities of deviance from collusion61. In 1948, Supreme Court concluded that quoting the delivered price was illegal, putting an end to the BPS practice. The decision was praised by Fetter (1948) and brought a new impetus on this controversy. Machlup (1949) devoted a whole book to the subject: The basing-point system: an economic analysis of a controversial pricing practice. Another latecomer in our community, Carl Kaysen, published three papers and a review of Machlup’s in the QJE and the RSE62. His « Basing Point Pricing and Public Policy » came from a group of discussions on anti-trust laws at Harvard. After exposing the main characteristics of the BPS analysis, he confirms the existence of collusive behaviors and explains it by an “oligopolistic rationality”. (Kaysen 1949a, 289, 291, 294)63. The idea behind the expression is the same as the one put forward by Galbraith a decade earlier (1936). A seller in oligopoly can have a for price rigidity since it reduces the uncertainty regarding others’ behavior. From these debates emerges a first line of cleavage between what George Stocking respectively labelled the “conspiracy school” and the “spontaneous evolution” school (1950). Members of the first school are primarily Fetter, Machlup and Mund64. Since the BPS is the product of explicit agreement and leads to the waste that characterized monopolists’ practices, it is considered as illegal and must be fought with the help of anti-trust laws. On the contrary, members of the “spontaneous evolution” school think that BPS could result from independent decision-making by sellers. The members of our community around Harvard mostly belong to this latter. As Stockings clearly show, this cleavage could be interpreted as to different instrumental use of Chamberlin’s theoretical contribution.

“Chamberlin, primarily a theorist, gave a powerful weapon to policy-maker. Unfortunately, it has proven a double-edge sword, wielded lustily both by those who favor and those who fear Big Business. Opponents of Big Business have argued that since oligopolists behave

61 This paper will lead to a short controversy between Smithies and Virgil Salera (1943) who denies the possibility of tacit collusion in the BPS. 62 Kaysen (1949a, 1949b, 1950, 1951). During World War two, he was hired in OSS by Mason in 1942, who convince him to reach Harvard University. He received his M. A. in 1947 and defended his Ph. D in 1954 on anti- trust laws. 63 The idea is the same as the one put forward by Galbraith a decade earlier when he argues that a seller in oligopoly has preference for price rigidity since it reduces the uncertainty regarding others’ behavior. Kaysen and Galbraith were close collaborators during the 1950s and 1960s. 64 See also Stigler’s presentation of each side (1949). Dealing with the emergence of a BPS, Stigler does not tackle the possibility a tacit oligopoly (1949), nor it will be explored in its famous article “A Theory of Oligopoly” in which he analyses the stability of an explicit collusion (1964). In the 1950s, Stigler appears as an inheritor of this latter school as the leading figure of the Chicago Tradition in IO identified by Posner (1978).

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like monopolists and since oligopoly is inevitable, the government must regulate Business in the public interest. Proponents have used the Chamberlinian doctrine as a defense in anti- trust proceedings” (Stocking 1950, 162).

Recognizing that oligopoly market results as a monopoly indeed leads some economists to praise the use of anti-trust legislation and its adaptation to tackle the oligopoly problem. Even the tacit nature of collusion or the private rationality behind the behavior of sellers in oligopoly do not necessarily lead to the idea that any public intervention are to be proscribed. It has rekindled the pleas for a social control of business65. The tacit nature of collusion, the spontaneous nature of oligopoly market and the practical difficulty of its implementation have obviously often reduced the confidence in anti-trust legislation66. For these reasons, Mason advocates an application of anti-trust legislation according to “rules of reason” rather than “rules per se” (1956). As Clark soon argue, collusion is neither harmful nor good per se (1943, 296). Economists need to go on using the tools they built to carry empirical investigations on the merits and shortcomings of the industrial system67. Doing so, they stimulate some works that attempt to reappraise the real nature of American Capitalism that seems very far from its founding myth of free competition.

5. The nature of post-war American Capitalism

The spreading of Chamberlin’s theory, the building of market classifications and the debates around BPS and more generally antitrust laws irradiated the works of all the members of the community. In 1948, the AEA sponsored the publication of a Survey of Contemporary Economics. Two members of our research community, Galbraith and Bain, respectively wrote chapters on “Monopoly and the Concentration of Economic Power” and “Prices and Production Policies”. Both shared the conviction that oligopoly is now the dominant form of competition in the American industry68. Both papers attest that, whatever authors’ assumptions regarding the causes leading to the emergence of oligopoly and the nature of collusion, all protagonists of our story have discussed the pros and cons of their operations. If theoretical and empirical investigations usually focused on specific industries, some authors of the research community have attempted to provide a reappraisal of the nature of the whole American economy. Since

65 On the main forms of social control and planification advocated, see Balisciano (1998) 66 See Mason (1956), Schumpeter (1942), Kaysen (1949a), Galbraith (1948) 67 These investigations led through the “industrial section” of the National Resources Planning Board (1939, 1940) headed by Gardiner Means and in the numerous T.N.E.C monographies. For a survey of empirical studies, see Bain (1948). 68 Galbraith (1948, 127) and Bain (1948, 136). Stigler’s note it in his review of the survey (1949, 95-6).

24 oligopoly is the new distinctive characteristic and the new driving force of in the economy, the dynamic of capitalism is changing. As a primary observer of the Chamberlinian Revolution at Harvard, is the first economist who considered the prevalence of the oligopolistic and monopolistic nature of competition and who put it in a systemic analysis of the dynamic of capitalism. When he arrived in 1932, Schumpeter was already an accomplished economist. As soon as December 1933, he headed an AEA session on” imperfect competition” to which Chamberlin took part. The following year, he published the paper with A. Nichol which linked the question of oligopoly to the elasticity of demand (1934). He was also close to Mason and Chamberlin69. In his History of the Economic Analysis, he would argue that Chamberlin’s theory deserved the success it has received. However, his first book published at Harvard, Business Cycle, carries not important traces of any influence (1939). Chamberlin himself notes that the book still presents the “basic defense” of “ as the theoretical norm” (1951a, 137). Has its presence influenced the early thoughts of the members our community? Schumpeter’s disdain towards Institutionnalism, the and does not help70. One can however notices that his Theory of Economic Development was translated in 1934. In a letter sent by Mason to Galbraith in 1977, he reminds that the book has the merit, “in the middle of the Marshallian era with this complete concern for static analysis”, to emphasize on dynamic analysis, though it concentrates on the entrepreneur who progressively disappear because of the rise of Big Business71. This exchange is explained by Galbraith’s review of Schumpeter’s most famous piece. Galbraith’s dismiss of The Theory of Economic Development aims at contrasting with the relevance he found in Capitalism Socialism and Democracy (1942)72. Indeed, Schumpeter integrated the theory of oligopoly with the publication of this book and his analysis of the historical development of capitalism. Even if the scope of the book goes far beyond the reappraisal of competition in the line of Chamberlin, it has a crucial place since it directly precedes the chapter “On the process of creative destruction”73. Schumpeter argues

69 Mason and Lamont (1982). 70 Schumpeter role was however important in the rediscovery of Marx ideas. He supervised the Ph. D. thesis of Paul Sweezy who was famous as a Marxist in Harvard as he taught “Economics of Socialism” in 1940. 71 Letter from the 27 March 1977. John Kenneth Galbraith Personal Papers (JKGPP), JFK Library, Serie 9, Box 947. See also Mason (1951, 143). 72 Galbraith to Mason, letter from the 7th of April 1977. JKGPP, JFK Library, Serie 9, Box 947. Galbraith’s review of Capitalism, Socialism and Democracy appears in New Society, 14th April 1977. Galbraith also wrote a highly critical review of Schumpeter’s History for The reporter, 17th August 1954. JKGPP, JFK Library, Serie 9, Box 940. 73 Schumpeter (1942, 79). Even Schumpeter’s theory of democracy proposed in the final part of the book is influenced by the economics of monopolistic competition, especially his treatment of the effect of .

25 that “as soon as the prevalence of monopolistic competition or of oligopoly or of a combination of the two is recognized”, the result of price theory in the “schema of perfect competition” is “either inapplicable or much more difficult to prove”. As we have seen and if perfect competition is taken as normative benchmark, Chamberlin’s theory could lead to the condemnation of oligopolists since they tend to behave as monopolists. However, Schumpeter argues that the reality of the must be examine through a dynamic and systemic perspective. Yet the increasing concentration of the industry does lead to restriction since the beginning of the century. The classical result that monopoly and oligopoly lead to capitalist sabotage needs to be proven. Moreover, restriction in short run could be required for long run expansion (Schumpeter 1942, 78-88, 52)74. As those arguing that the emergence of oligopoly result from a spontaneous evolution, especially due to technological requirements, Schumpeter sees the growing concentration as a result of the competitive process. This process is not a “necessary evil”. It has been proven very successful from an economic viewpoint75. He puts forwards four main arguments. First, this capitalism of great units has proved to be more stable than nineteenth century capitalism. Especially, “tacit understandings about price competition may be effective remedies under conditions of depression”76. Second, because specialization and rationalization, great corporations, are often more effective than small ones. He rejects the idea of a productive superiority of perfect competition, that hinge on the dubious assumption that firms, whatever their sizes, have the same method of production. Third, great corporations are those which generate innovations and foster the technological development responsible for living standards’ raises. Fourth, monopoly positions are always temporary and not absolute, because of the creative and destructive nature of the technological process and potential competition (1942, 87-106). Schumpeter’s plea of capitalism through the defense of Big Business achievements does not pass unnoticed among the members of our community. Carl Kaysen puts it forward in the debate over BPS to argue that higher margins provided by this “might then act to stimulate a more rapid increase in capacity” (1949a, 302). Even if he used to work in the framework of perfect competition, Chamberlin highlights how Schumpeter sees the

74 The recognition of a taste for diversity that characterizes monopolistic competition theory also makes more complex the result of . See Galbraith (1938) and Chamberlin (1950). 75 If Schumpeter predicted the disappearance of capitalism, one must remind that it is not due to its economic failures. On this issue and its link with debates on secular stagnation at Harvard, see Potier (2015) et Dockès (2015). 76 (1942, 91).

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“overwhelming importance” of product heterogeneity and oligopoly (1951a, 138). Edward Mason laments the lack of operationality of Schumpeter theory of competition. It could hardly be a guide to implement public policy. But he nonetheless praises his “drastic and effective” critique of anti-trust policy, since he also contests the idea that “the exclusion of market power” would necessarily “assure the efficient use of resources” (Mason 1951, 139). Finally, John Kenneth Galbraith, in American Capitalism, which is full of references to the work of the research community we identify, argues that while his analysis belong to another tradition of economic than Schumpeter’s one, he reaches “similar conclusions” regarding the role played by oligopoly for inducing technical change (1952, 86-8).

As stated before, American Capitalism can be read as a syncretism of the work of the research community we identified, since he explicitly refers to the theoretical work of Bain, Chamberlin, Clark, Mason, Machlup and Means. Understanding Galbraith’s main thesis implies to deal with one last reappropriation of Chamberlin’s oligopoly theory. In fact, this latter could not only be applied to the buyer side of goods market (), but also to one specific market, namely the Labor one77. This is particularly visible in the report The impact of the Union, who follows two meeting days of economists organized by the Institute on the Structure of the Labor Market. Among the well-known participants were two members of our community, Clark and Chamberlin78. As for price policies, Clark clearly distinguishes the theoretical and the normative issues: “what determines wages” and “what wages are economically sound” (1951, 1). In his paper “monopoly power of labor”, Chamberlin applies the same tool he used to analyze the product market. This leads him to an analysis in terms of “” on the labor market, where unions and oligopoly compete for the appropriation of monopoly profits (1951b, 179). If debates turn around the real importance of unions power and the consequences of their revendications regarding and inflation, almost all participants recognized their growing power79. This interaction between all kinds of oligopoly that characterized the American economy is precisely the subject of Galbraith’s book. As in 1936, Galbraith puts forward a dual view of the American system. If one side quite operates classical competitive markets, another side, is dominated by few firms. As the

77 As soon as 1942, the Harvard economists John Dunlop analyzez the situation of Labor by combining classifications of product markets and labor markets. Dunlop (1942) and Dunlop and Higgins (1942). 78 The others were Haberler, Knight, Boulding, Friedman, Samuelson and McCord Wright. 79 Friedman is an exception.

27 members of our community, he argues that oligopoly situations emerged because of technological requirements, great firms operating in these markets tend to avoid price competition and antitrust laws are not necessarily relevant to fight oligopoly. Following Clark and criticizing the old liberal tradition to condemn monopoly, he argue that the consequence of this monopoly power are not as bad as what is suggested by classical price theory. Following Schumpeter, he puts forward the efficiency on these big corporations and the transitory dimension of monopoly power, “to maintain a convention against innovation requires a remarkably comprehensive form of collusion” (1952a, 89). But he goes further by arguing that the private monopoly power automatically tends to give birth to a “” on the other side of the market.

The power of buyers – that is to say of firms, consumers cooperative, unions and the state of the market considered – countervails the power of the sellers. Thus, it led to some equilibrium as it did in classical model but by another mechanism. Galbraith attributes to this mechanism of power and countervailing power the success of the American system to foster opulence. It allows to benefit from the productive capacity of great corporations without suffering too much inconvenient. He gives several examples. Referring to Machlup’s work on the BPS (1949), he depicts how the power of the large firms of the automobile industry in Detroit countervails the power of the steel producers (123). He also depict the unions, which are generally strong in concentrated industry, as a countervailing power in front of oligopoly powers. As Chamberlin (1951b), he also puts forward the idea that unions and management of great corporations mostly quarrel over the repartition of these monopoly profits and puts forward the risk that oligopolistic market generated an inflationary process under condition of excessive demand80. Even if he recognized the role of the state to help the emergence of countervailing power, Galbraith presents it as a “self-generating force” that has replaced “competition” 81. Some economists point out that it could be seen as a form of competitive behavior. He also dismisses the concept of “bilateral monopoly” used by Chamberlin and others. It led to some incomprehension. In a letter dated 18 March 1954, John Maurice Clark told him that he “couldn’t accept […] the completely passive role of buyers under competition”. His concept of counter-vailing power could precisely leads to reinvestigate the “sadly neglected concept of bargaining power”, since “it is neither competition nor monopoly” that operate but “a variety”.

80 See also Galbraith (1952b), Clark (1951). 81 Galbraith (1952a, 113).

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This is why he questions him on the reason why he has asserted in his “provocative book”, Clark was “meditating” to use it in a paper, that “bilateral monopoly is a blind alley”. In his reply from 25th March, Galbraith answered straightforward.

“My reference to bilateral monopoly’s being a blind alley for economists grows out of the fact that it was considered in the past to be accidental or adventitious rather than self- generating. So long as economists assume that bilateral monopoly occurred when a position of strength on one side of the market ‘happened’ to be opposed by another position of strength across the market it was hardly worth worrying about. My argument of course, is that a position of strength tends to beget a protective answering position. To the extent that this leads to bilateral monopoly or bilateral oligopoly the latter is not adventitious, but like the tendency toward competition (or monopoly) an organic phenomenon” (Galbraith to Clark)82.

Galbraith’s thesis on the organic nature of oligopoly in modern capitalism has of course unleashed controversies. These are the same authors who were opposed to the members of our research community who write the more critical reviews83. Recognizing some quality to the book, Vernon Mund thinks that Galbraith “fails to recognize the injury to consumers which results from the collusive action of labor groups and organized producers” and minimizes the importance of concentration that does not respond to technological requirements but rather to financial interests (Mund 1952, 576). In an AEA session devoted to his concept of countervailing power, George Stigler goes far beyond. In addition to some technical details regarding the conditions when countervailing power operates and some counterexamples, he reproaches Galbraith to provide a “dogma” rather than a “theory”. It is rather too difficult to validate his hypothesis that “bilateral oligopoly generally leads to socially tolerable results” (Stigler 1954, 10, 13). As our story has to come to an end, it transports back to the starting point. This is Edward Chamberlin who was the Chairman of that session and Galbraith claims that economists own him “a debt” for having shown that “economic power in the economy is pervasive” and “goes far beyond the limits set by the classical concepts of monopoly” (Galbraith 1954, 6).

82 JKGPP, JFK Library, Serie 3, Box 9. 83 Adolph Berle and praise the book.

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6. Conclusion

In this paper, we have exposed an extensive story of the Harvard’s Department of Economics from the 1930s to the early 1950s. The main difference with existing literature relies on the identification of a notion unifying very different actors. We believe that, without the identification of tacit collusion in oligopoly, one can make links between Harvard economists but cannot gather them all. Describing a “school” or a “tradition” without it necessitates to consider an unexplained emergence of vaguely convergent theories in a common place as satisfactory. On the other hand, many unsatisfactory plot holes remain in this kind of story which are ultimately founded on some obvious lack of methodology and precise definitions. The idea of tacit collusion in oligopoly’s spreading and reformulations is then a powerful tool to establish strong links between monopolistic competition theory, Industrial Organization genesis, implication of Harvard’s members in public interventions and the emergence of brand new viewpoints on American Capitalism dynamics. Nevertheless, we do not claim that the identification of this notion is an answer in itself to all theoretical and practical motives in Harvard’s Department. In the same way, we said very little about the spreading of the notion outside Harvard and the resulting controversies. A very important example is, of course, the full costs approach. We will not give here all details of the controversies that took place in the 1950s, in which Chamberlin took part. But there are two important articles from 1939 that are impossible to ignore, namely R. F. Harrod’s “Price and Cost in Entrepreneur’s Policy” and R. L. Hall and C. J. Hitch’s “Price Theory and Business Behaviour”, both published in Oxford Economic Papers. Concerning the latter, Hall and Hitch do not only quote Chamberlin and recognize him as a pioneer in oligopoly’s inquiries, but also use a Chamberlinian classification of markets (Hall and Hitch 1939, 14). Harrod’s article, on the other hand, shows a real confusion between cases studied by Chamberlin. He concludes to a failure from economists to reach some consensus about duopoly and oligopoly’s formalization. He then rejects oligopoly’s differentiation because of its “intellectual interest but no practical application”84 (Harrod 1939, 5). Moreover, Harrod considers that reality show more often a “subtle blend of monopoly and oligopoly” (ibid. 6), a case which is necessarily vague because never defined. Even more important is the turning point in 1947-1948 when the rising of Game Theory challenged the methodological relevance of Harvard’s market structures. K. W. Rothschild’s

84 In this respect, articles show an important divergence in viewpoints.

30 article “Price Theory and Oligopoly” first starts as a rejoinder of the idea of the mutual dependence between few sellers. Like Bain, he criticized price theories built on given and exogenous conditions of demand and supply. However, he regreted that all those contributors did not further examine competitors’ propensity to perform market structures according to their possible interactions. He then proposed to turn to pure strategic approaches by evoking Theory of Games and Economic Behaviour (1944) by J. Von Neuman and O. Morgenstern. One may however notice that, in this book, oligopoly is rarely evoked but systematically in relation with other particular market situations, such as bilateral monopolies or duopolies85. In 1948, Oskar Morgenstern studied links between imperfect competition, oligopoly and monopoly on one side and game theory on the other one. He made several assertions, establishing a clear continuity with Rothschild’s article86. He proposed the abandonment of different market approaches and pleads “to know how the individual, pursuing his maximum interest, should behave on all types of market” (Morgenstern 1948, 11, our italics). He then asserts “Economic theory must therefore indicate how the firm or the individual should behave under all conceivable conditions.” He speaks in favor of the Robinson Crusoé duopolistic thinking (ibid. 13), in other words the abandonment of empirical basis for theoretical purposes. Morgenstern’s article is immediately followed by an interesting discussion87. The first is William Jaffé who rejected all preceding duopoly and oligopoly theories because of their failure to find a determinate solution and reducing them to mere ignorance (Jaffé et al. 1948, 19). Nevertheless, he shows his skepticism about Morgenstern’s ability to provide a solution88. Some members of our community expressed their views regarding the emergence of Game Theory for the study of oligopoly. First, Joe Bain, in his survey on IO, suggests that this “well- developed and new theoretical system”, since it provides “a new approach to the formation of business decisions under conditions of recognized mutual independence”, could influence IO in a way that “will be interesting to observe” (1948, 162). Among personal papers of John Kenneth Galbraith’s course on “Business Organization and Public Regulation”, which he taught at Harvard in the year 1951-1952, he identifies von Neuman and Morgenstern’s book as a different attempt different from Bain’s one to build a general theory of oligopoly, which is

85 Morgenstern and Von Neumann (1944, 1, 13, 14, 47, 504). 86 Which can be discussed as Rothschild is not quoted. 87 This discussion deals with Morgenstern’s article and H. Gregg Lewis’s “Some Observations of Duopoly Theory” in which he proposes a graphic approach to duopoly theories. 88 “Perhaps the nature of duopolistic behavior is not amenable to systematic analysis, but I doubt that. At best the theory of games or war can only be part of such analysis.” (ibid., 21). In a similar way, Martin Bronfenbrenner accuses the theory of imperfect competition (or monopolistic competition) to divide price theory instead of looking for an unifying principle. He recognizes Morgenstern’s merit but is cautious on its capacity to bring a final point to this problem.

31 perceived “as an exercise in strategies”89. Nothing can be asserted concerning his view on Game Theory, but he will obviously neither use it in his following works. The last member of the community who pays attention to Game Theory of Economic Behavior was Carl Kaysen. He wrote an extensive review in the RES entitle “A Revolution in Economic Theory?”. The first aim of his review was to present a tool which was relatively new to the economist profession. After highlighting the relevance of their framework to deal with the two person zero-sum games, Kaysen explains why the study of 3 or n-person games “becomes a study of coalitions” to avoid indeterminacy. He illustrates his former exposition with economic applications such as bilateral monopoly (two persons games) or the case where two buyers face a single seller (three persons games). He then concludes on the case of a duopoly, which originally fosters the analysis of oligopoly. He argues that “traditional theory”, as Game Theory, give no solution to the duopoly problem which “do not depend on the use of arbitrary element”, in other words without being forced to specify the reaction function of one of the rivals. He thinks that “the study of actual markets” undertaken by IO economists precisely reduces the “arbitrariness” nature of the assumption regarding the reaction function of rivals. He thus wonders whether Game Theory, thanks to the incorporation of these facts described by market structure analysis, could also provide a “solution” that could be “free of indeterminacy”. In other words, he suggests that market classifications could help finding some pattern in the formation of markets’ coalitions (1946, 14-5).

89 JKGPP, Serie 5, Box 519.

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