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The Sherman Anti-Trust Act of 1890

A more dynamic and open American economic system

03 April 2008
Political cartoon of Rockefeller

19th-century political cartoon of Rockefeller, caricatured as "King of the World" sitting on a barrel of oil. (©Bettman/CORBIS)

(The following article by Rudolph J. R. Peritz is taken from the U.S. Department of State publication Historians on America.)

The Sherman Anti-Trust Act of 1890
By Rudolph J. R. Peritz

In 1890, the United States pioneered competition law and significantly strengthened the future of free markets in the American system by adopting a new federal statute: the Sherman Anti-Trust Act. For the first time in history, a national government had taken responsibility to investigate and, if necessary, prosecute monopolies and price-fixing cartels. Over time, the results of this act, denounced by captains of industry at the time of its passage, would become clear. By limiting a business's ability to dominate its competitors in the marketplace, the new law made the American economic system more dynamic and more open to new competitors and new technologies. The next century saw great economic expansion and heightened living standards in the United States.

The U.S. Congress passed the statute in a time of turbulent industrial change – a time when new technologies of mass production for factory goods of all kinds were giving birth to "big business," a time when widening networks of distribution that followed the post-Civil War standardization of railroad track gauges were stitching a patchwork of regional markets together into a national economy. While these revolutionary developments presaged much greater economic efficiency than had been known in the past, at the same time, entire industries were increasingly controlled by monopolies or cartels. A cartel, it should be noted, is a group of competing companies that have agreed to set prices or take other measures to limit competition among themselves. By enacting the Anti-Trust Act to stem this behavior, Congress tipped the development of free enterprise in the American system toward competition rather than behind-the-scenes market manipulation by powerful private interests. How did Congress come to choose the policy of free competition in 1890? Does the statute retain relevancy in our own time of transition to a globalized and digitized economy? Pursuing these inquiries takes us first to the congressional debates and early court decisions interpreting the law, and then to the recent Microsoft case more than a century later. Although a great deal occurred between these two chapters of economic history, both are set in periods of tempestuous industrial change in the United States and, thus, are particularly instructive episodes of antitrust enforcement.

The Railway Problem

With few exceptions, everyday life in the latter half of the 19th century lacked the telephone, the electric light, and the automobile. Rather, it depended on the horse-drawn wagon and carriage, the kerosene lamp, as well as the new and rapidly expanding network of railroads. Indeed, there was great celebration on the day a "Golden Spike" was driven to complete the first transcontinental railroad in 1869. The idea of a single railroad stretching across the continental United States sparked the imagination of citizens used to stage coach travel and the mail service carried by relay teams of horse riders known as the Pony Express.

Other national railroad lines followed and, together with regional roads and feeder lines, they soon connected the far reaches of interstate commerce. But so many railroads were built so quickly that fierce competition erupted among them and bankruptcies soon followed. Most notably, when the great Northern Pacific Railway defaulted on debts owed to its investment bank, the bank closed its doors, precipitating the Financial Panic of 1873. The New York Stock Exchange closed for 10 days in the fall of that year because the panic threatened to collapse the stock market. As the crisis spread, almost 90 railroads defaulted on bonds, closing more banks and driving the economy into a financial crisis that persisted through the 1870s.

Nonetheless, railroad building continued. As did the difficulties. Into the 1890s, an annual average of 50 railroads were still failing. Everyone acknowledged the "railway problem," but there was no consensus on an acceptable solution.

Congress first approached the problem by passing the Interstate Commerce Act of 1887 to protect small businesses and the railroads themselves from the favorable pricing on freight shipments railroads felt compelled to grant to industrial monopolies and other powerful customers. The law prohibited railroads from engaging in price discrimination – from charging lower prices to powerful customers simply because they demanded them. Still, ferocious pressure continued. The railroads' solution to the demands of their customers was to join together in price-fixing cartels themselves. By the turn of the 20th century, the flight from competition to combination spread far beyond railroads. Giant cartels as well as corporate mergers between competitors were reshaping and consolidating industries throughout the economy – from oil refining and steel production to wooden match and crèpe paper manufacture.

The Rise of Standard Oil

The most famous example involved an accountant from northern Ohio named John D. Rockefeller. By 1859, oil had been discovered in Ontario, Canada, and in western Pennsylvania. Most crude oil from both fields was sent to refineries in northern Ohio for processing into useful forms like kerosene. In less than 15 years, Rockefeller had become an enormously successful businessman because he controlled the Ohio oil refineries and, with them, the entire industry. He used this control as leverage over the railroads, already financially weakened by their own proliferation and intense competition. Their condition allowed Rockefeller the leverage to obtain not only lower rates for transporting his Standard Oil Company products but also a portion of every dollar his rivals paid the railroads. He extracted these payments by approaching each railroad and threatening it with the loss of his business, which was quite substantial and, thus, critical in an industry whose thin profit margin made it dependent on traffic volume.

As a result, independent oil companies were crushed, many of them selling out to Standard Oil. In 1892, the Ohio attorney general won a court order to dissolve the Standard Oil Company, but Rockefeller simply moved to New Jersey, turning it into the first "trust"– a company controlling formerly independent competitors by holding their stock certificates. The old trusts were different from today's holding companies, whose stock portfolios are diversified across industries and, thus, do not raise concerns about monopoly power in particular markets.

Although few companies actually adopted the form of a "trust," the term rapidly became the catchword in public debate over the government's role in a time of such industrial concentration. Some saw increasing industrial concentration as natural and beneficial. Steel baron Andrew Carnegie said that "this overpowering irresistible tendency toward aggregation of capital and increase of size ... cannot be arrested." Even the progressive-minded journalist Lincoln Steffens remarked: "Trusts are natural, inevitable growths out of our social and economic conditions. ... You cannot stop them by force, with laws."

Others saw it differently. They believed that only legal reform could assure a modicum of free competition and a fair distribution of wealth and power among larger and smaller firms. As pressure for reform mounted, some states took legal action against trusts, as they became universally known. But efforts by progressives to break up trusts failed because, like Standard Oil at the time, they could simply move to less reform-minded states with more permissive commercial laws.

As it became clear that states could not or would not curtail the growth of trusts of all types, Congress held hearings on how it might address the issue. In 1888, Senator John Sherman of Ohio introduced his anti-trust bill and declared:

The popular mind is agitated with problems that may disturb social order, and among them all none is more threatening than ... the concentration of capital into vast combinations. ... Congress alone can deal with them and if we are unwilling or unable there will soon be a trust for every product and a master to fix the price for every necessity of life.

Still, there were some in Congress who differed with Senator Sherman. They sided with Carnegie and Steffens as well as Rockefeller, who would later testify before the United States Industrial Commission: "It is too late to argue about the advantages of industrial combinations. They are a necessity."

In particular, the two men from Ohio – Sherman and Rockefeller – disagreed sharply over the prospect and the wisdom of turning the tide of increasing industrial concentration. Rhetorically, they were both speaking in favor of "free competition." But free competition held different meanings for them. For Senator Sherman, it signified competition free from domination by private economic power. It meant that free markets require limits on monopolies, cartels, and similar economic restraints. Rockefeller believed in competition free from government regulation and called for an absolute freedom of contract.

Thus, in 1890, social concerns about massive industrial transformation, economic concerns about the monopolies and cartels that threatened free markets, and political concerns about the fundamental "liberty of the citizen" in a nation where trusts might become very powerful motivated Congress to pass the Sherman Anti-Trust Act.

In the American system, legislation typically serves as the beginning of social change. Thereafter, laws are applied and policies interpreted by the courts, where the sharp divide between the two sons of Ohio, Sherman and Rockefeller, continued to play out for decades.

The Supreme Court Upholds the New Law

Two landmark antitrust cases involving railroads soon reached the Supreme Court, the first in 1896. In United States v. Trans-Missouri Freight Association, the U.S. attorney general sued a railroad cartel whose 18 members argued that they were merely setting reasonable prices to avert ruinous competition. Although the railroads' argument persuaded the lower courts, a divided Supreme Court held the cartel illegal and announced that only the competitive process could set reasonable prices. The Court majority also observed that such "combinations of capital" threatened to "driv[e] out of business the small dealers and worthy men whose lives have been spent therein." A few years later, the Court factions reaffirmed the validity of the Sherman Anti-Trust Act more clearly, uniting to declare that all price-fixing cartels were illegal:

... we can have no doubt that [cartels], however reasonable the prices they fixed, however great the competition they had to encounter, and however great the necessity for curbing themselves by joint agreement from committing financial suicide by ill-advised competition, [are prohibited] because they ... deprive the public of the advantages which flow from free competition.

With overt price-fixing cartels clearly illegal, the railroads turned to mergers as the way to eliminate competition between them. Thus, the second landmark case to test the statute was brought by the U.S. attorney general to break up the Northern Securities Trust, the result of a merger engineered by the financier J. P. Morgan. His group had come to control the faltering Northern Pacific Railway, which competed along 9,000 miles of parallel track with the Union Pacific, amongst whose owners was Rockefeller. To end the cutthroat competition between the two railroads, Morgan persuaded the two ownership groups to merge by exchanging their railroad stock for trust certificates. The federal government brought suit to dissolve the trust.

In 1904, a bare majority of the Supreme Court approved the government action to break up the railroad trust. Four of the nine justices dissented, insisting that the merger, like any commercial contract, was simply a sale of property. For them, free competition meant the right to sell or exchange one's business free from government intervention, regardless of its actual impact on the market. The Court majority, however, insisted that free competition calls for attention to the impact on the market. Crucially, it determined that the Anti-Trust Act prohibited this particular merger because the resulting trust necessarily eliminated competition between the railroads and created a monopoly. The Court declared:

The mere existence of such a combination and the power acquired by the holding company as its trustee, constitute a menace to, and a restraint upon, that freedom of commerce which Congress intended to recognize and protect, and which the public is entitled to have protected. If such combination be not destroyed, all the advantages that would naturally come to the public under the operation of the general laws of competition ... will be lost.

Even as the Sherman Act played out in the railroad industry, Rockefeller's Standard Oil Trust continued to wage a relentless assault on the petroleum industry. His vision of a unified and efficient network of petroleum production and distribution entailed a methodical program of intimidation that left his rivals with no choice but to sell out for pennies on the dollar.

But in 1902, President Teddy Roosevelt took action that would make his reputation as a "trust-buster": On his instruction, the U.S. attorney general filed suit to break up Standard Oil, whose predatory conduct had come to symbolize the entire trust problem. Court cases can take a long time, but in 1911, the Supreme Court finally held that Standard Oil had illegally monopolized the petroleum industry. Simply put, its success had not been fairly won. The result was a decree to dissolve Standard Oil into 33 separate companies known as "baby Standards."

The Anti-Trust Act was a resounding success, or so it seemed. Price-fixing cartels were stopped in their tracks and the notorious Northern Securities and Standard Oil trusts were no more. The Washington Post would declare on May 18, 1911, that the Supreme Court decision "dissolves the once sovereign Standard Oil Company as a criminal corporation. ... [H]onest men will find security from alarms and indictments, while dishonest men will see in it the certainty of punishment. ... [I]t has given the country assurance of justice and progress in its industry."

But in retrospect the success was not so clear. First, the break up of Standard Oil permitted its shareholders to retain ownership and control of the 33 baby Standards. Thus they were not independent companies, except in name. Furthermore, in congressional hearings several years later, evidence showed that their profits had actually increased, suggesting the break up had certainly not diminished their economic power, whatever their structure on paper had come to resemble. Yet there were others who pointed not to Rockefeller's ruthlessness but to his success in creating an efficient distribution network, and to the benefits to consumers of decreasing prices for petroleum products in those years. But in the end it was a question of competition on the merits, not competitive success by any means. Indeed, Nobel Laureate Douglass C. North has recently written that the success of free market economies depends on the belief that participants will have a fair opportunity to succeed.

Antitrust Law and the Modern Age

More recent critics of the Anti-Trust Act point to as many as five merger waves, the first beginning in the late 19th century. For example, General Motors Corporation and the now-defunct AT&T and U.S. Steel corporations resulted from mergers that successfully consolidated the automobile, telecommunications, and steel industries for the better part of the 20th century. In the critics' view, the Anti-Trust Act, in spite of its affirmation by the Court, did not reverse the trend toward industrial concentration and, with it, the increasing consolidation of economic and political power that had originally moved Congress to act in 1890. Yet since the1970s, in spite of the enormous authority and prestige of corporations in American life, the Justice Department and the Federal Trade Commission in both Republican and Democratic administrations have accepted their statutory responsibility to review all large mergers and often insisted on changes to reduce their anti-competitive effects. Indeed, the AT&T monopoly of telephone service was broken up during Ronald Reagan's first term.

Still, it is particularly hard to ignore the fact that even after a century of trust-busting, legal mergers have consolidated the oil industry into a sector now dominated by a few large multinational corporations. Indeed, the argument that concentration is good continues. Moreover, times have changed, many argue: Global competition reduces the tension between the benefits of large-scale enterprise and the harms of industrial concentration. Others insist that tensions have not lessened but rather shifted from the national to the international stage, as evidenced by disputes adjudicated by the World Trade Organization and similar groups.

Nonetheless, thanks to Senator Sherman, the commitment to prohibit price-fixing has remained resolute: In 1999, for example, the federal government concluded its case against an international vitamin cartel when its members agreed to fines approaching $1 billion and to imprisonment of the corporate managers involved. As a general matter, there is an international consensus about the economic evils of price-fixing cartels as unjustifiable restraints of competition. More than 100 countries have enacted competition laws modeled on the Sherman Anti-Trust Act – from the European Union and its member states to Japan and Zambia.

In the United States, the Anti-Trust Act has both enunciated and strengthened an enduring commitment to opening markets to new technologies and new groups. No longer do a few wealthy businessmen like Rockefeller and Carnegie, Vanderbilt and Dupont, dominate commercial enterprise and control economic opportunity. As the 20th century progressed, the inventive energies bubbling at the core of the American economy were unleashed to create new centers of innovation and entrepreneurial activity, whether in Hollywood, on Madison Avenue, or across the Internet from California's Silicon Valley to its counterparts in the environs of Austin and Boston.

The Microsoft Case

The dialectic of concentration versus competition continues, even as it mutates into new forms. It should come as no surprise that our own time of dramatic technological and economic transformation has given rise to a second great monopolization case: Since 1990, Microsoft Corporation, the software manufacturer, has been investigated and sued by the U.S. federal government and 20 U.S. states, as well as by the European Union and numerous private plaintiffs. Notably, the Anti-Trust Act, a 19th century statute, was still at the heart of the U.S. cases seeking to curb Microsoft's allegedly anticompetitive conduct in high technology industries at the cusp of the 21st century.

Bill Gates and Paul Allen founded Microsoft in the 1970s. Allen would leave the company while Gates cultivated an image of youthful exuberance and geeky innovation. But behind Gates's public persona was a corporate strategist whose tactics of competition some have likened to those of John D. Rockefeller. Microsoft Windows is clearly the dominant operating system for personal computers (PCs) just as Standard Oil was the dominant distribution system for the petroleum industry. In the U.S. government case against Microsoft, the United States District Court in Washington, D.C., found that Microsoft retained its dominance by intimidating computer companies as powerful as Intel and IBM and as frail as Apple Computer into withholding from consumers products that had the potential to challenge Microsoft Windows software.

Various tribunals ultimately found that Microsoft illegally monopolized the major market for PC operating systems. Unlike Standard Oil, however, Microsoft was not broken up. It was ordered to cease discriminatory pricing and product access policies, and to share basic information about its Windows PC operating system needed for rivals to compete more effectively and freely with Microsoft in the market for applications software on the Windows platform.

In the European Union case, the Commission imposed similar restrictions as well as a fine of 497.2 million Euros. Microsoft settled numerous suits worldwide, both public and private, at a cost of additional billions of dollars.

As a result, the ethos of the information technology industry changed. Companies began to engage more freely in research that competes fundamentally with Microsoft technology. Indeed, Microsoft has recently embarked on a new course of patent cross-licensing that is a radical departure from its history of sharp competition. While it is too early to assess the ultimate impact of Microsoft's shift toward cooperation, what is clear is that the Sherman Anti-Trust Act has retained its legal relevance and has already had a substantial role to play in regulating the commerce of the Information Age.

Has the Anti-Trust Act made a difference in the United States over the past century? The answer is clearly yes with respect to overt price-fixing cartels and with respect to the most flagrant examples of predatory commercial monopolies. But the effect on corporate mergers and other commercial acquisitions and, thus, on industry concentration, is less certain. On the one hand, there is evidence that corporate mergers have continued to proliferate throughout the century (often failing to produce the efficiencies promised by consolidation). On the other, globalization and federal oversight in the spirit of Senator Sherman has arguably diminished their anticompetitive effects. In a nation characterized by a powerful ethos of free competition, the Sherman Act has – often successfully – mediated between two partially contradictory consequences of that ethos: a commitment to competition unfettered by excessive government regulation, and freedom from market domination by powerful private interests.

Commerce continues, but in a world that has changed. Everyday life now includes global telephone service, as well as satellite and cable radio and television. Medical research has opened new doors to improved health and increased longevity. The Internet offers fingertip access to economic goods, a medium for political voice, and instant interpersonal communication. As the 21st century unfurls, the Sherman Act will face the increasing challenge of mediating tensions between competition policy and the legal monopolies granted by patent and copyright protection, which appear to be the most important forms of wealth in the emerging information society.

Rudolph J. R. Peritz is a professor of law and director of the IProgress Project at New York Law School. He teaches courses in antitrust law, intellectual property law, contract law, cyberlaw, and jurisprudence. Before entering the legal profession, he was a software engineer and programmer for mainframe computer systems. He has been visiting professor at LUISS University, Rome, Italy, and at the University of Essex in the United Kingdom. He has written two books and numerous articles on competition law, intellectual property rights, and cyberlaw. He is currently at work on a project entitled The Political Economy of Progress. Professor Peritz's book Competition Policy in America, published by Oxford University Press, is considered a classic in the field.