Another Too Big To Fail Firm
Lee E. Ohanian, 05.11.10, 04:04 PM EDT
A United and Continental merger would provide relatively few benefits to the broader economy.
United Airlines and Continental Airlines, the fourth- and fifth-largest American air carriers, recently announced plans to merge, which would make the combined carrier the largest in the world. It is very topical today to discuss "too big to fail" (TBTF) when it comes to assessing the size and characteristics of financial institutions and auto makers, both of which needed large taxpayer cash infusions to continue operating in late 2008 and early 2009.
But if the Continental-United merger is approved by the Department of Justice (DOJ), we are setting ourselves up for another TBTF firm, one with relatively few benefits from the merger to the broader economy.
In gauging the benefits and costs of mergers, policymakers understand that the overall economy benefits from the merger-acquisition process when these transactions reallocate capital and labor to the most efficient and high-value producers. In these cases, mergers and acquisitions reduce costs and expand output, benefiting not only those directly involved with the merging organizations, but also the society more broadly.
However, not all mergers provide consumers with the benefits of lower prices and more output. Another motivation for mergers is to reduce competition and thereby raise prices and reduce output, which harms consumers. This market-power motivation for mergers is particularly strong when the merging companies are large and, if combined, have a substantial market share. The DOJ's merger review process focuses on the possible anticompetitive effects of a merger when deciding on whether to approve a merger.
From society's point of view, assessing any merger involves trading off its possible costs and benefits. While the United-Continental deal will benefit shareholders and others directly involved with those companies, it is unclear whether this merger offers much to the rest of the economy. Both companies have historically struggled in competing with very efficient carriers, such as Southwest Airlines. Will a merged Continental-United substantially improve efficiency and benefit the economy? Or will it be anything like the merger of two other large carriers, Northwest and Republic, with efficiency falling and prices rising substantially following their merger?
The 1986 Northwest-Republic merger is noteworthy because it involved two sizable carriers (though smaller than Continental or United), and it created a near monopoly for the combined Northwest carrier at Minneapolis and Detroit, with nearly 80% market share, and with other carriers having access to very few gates.
This means that even if other carriers had wanted to enter those markets, they couldn't secure enough gates to make it sufficiently profitable. With such high market shares, post-merger Northwest fares through both their Minneapolis and Detroit hubs rose considerably, leading both the Department of Transportation and the General Accounting Office to conclude that those fares were substantially higher than average, and that this reflected limited competition out of the Minneapolis and Detroit airports.
You may have thought that post-merger Northwest would become very profitable as a result of its near monopoly status and high fares at its Minneapolis and Detroit hubs. But it ultimately wasn't that profitable, as costs rose significantly and Northwest declared bankruptcy in 2005. And it is not surprising that costs rose substantially.
James Schmitz, an economist at the Federal Reserve Bank of Minneapolis, has shown that industries with near monopoly power are often plagued by labor problems that are associated with rising costs and low productivity, as workers compete for a share of monopoly profits.