Mergers, Investments in Cost Reduction and Welfare

Abstract

For a long time, an important discussion in economics has focused on the welfare effects of horizontal mergers and on policies associated with such mergers. Most researchers seem to agree on a general tradeoff according to which potential cost savings from a merger have to be set against the price-raising effects which frequently result from the corresponding increase in concentration. An influential view suggests that the effect of cost savings can be expected to dominate because cost reduction applies to all inframarginal output. Williamson's (1968) senminal contribution provided reasons for the cost reduction effect to dominate. Hjalmarsson (1976) argued that this conclusion might be particularly plausible for small countries such as those in Scandinavia. However, this traditional approach takes the source and magnitude of cost reductions as exogenous. The main contribution of the present paper is to model endogenously the size of potential cost reductions from a merger. In this respect, it is shown that mergers typically imply cost reductions, but that this effect is outweighed by the adverse decrease in output. Consequently, this paper provides a plausible counter-example to the view that cost savings outweigh output reduction in welfare terms. In general, the structure of cost savings from mergers might differ from case to case and the actual savings might be difficult to observe. Such cost savings can be of a static nature, based on economies of scale or scope, or they can be of a dynamic nature, based on learning or innovative activity. Here, we concentrate on cost savings based on the fact that merger expectations might change fixed cost expenditures on R & D activity, which will affect the level of marginal costs. Proponents of mergers often refer to mergers as necessary to support sufficiently extensive R&D investment