Economic models, high-priced consultants and ethical analysis

A colleague sent me a ProPublica article that explains how some “professors make more than a thousand bucks an hour peddling mega-mergers.” That’s a lot of money, even by consulting standards. MBA business consultants can charge between $200 and $600 an hour. Top partners in consulting firms might charge between $800 and $1200. A Wall Street Journal article in 2011 reported that top lawyers charged as much as $1000 an hour. But some economists are pulling in $1300 an hour as consultants.

To be fair, in a free market buyers and sellers should be able to negotiate for exchange prices. If someone is demanding $1300 an hour for their services and another is willing to pay it, then there is nothing objectionably wrong about the arrangement.

In this case the economic consultants are hired by firms that want to merge with or acquire other companies. The consultants are tasked with building a strong case, based on solid and objective economic principles and evidence, that the merger is in the interest of the industry, business, consumers and everyone else. What makes the article interesting is not that there are high priced economic consultants. It is that these consultants often get the antitrust analysis wrong. They build the arguments on speculation. They ignore or trivialize inconsistent or contradictory evidence. They use “junk science,” in the words of a Justice Department official quoted in the article.

A cynic might say that companies are paying the economists whatever price they will accept to argue whatever the company wants them to say, regardless of economics. Apologies to my lawyer friends, but isn’t this what lawyers do? So economists are on the same level as lawyers now?

Economics is a science. And economic models, when used appropriately, can provide a degree of objective assessment. The subjectivity comes in determining which economic models to use and what evidence to incorporate into the analysis. The ethical problem arises when the prospect of financial gain (in this case, a $1300 an hour contract) influences which models and what evidence to utilize. As noted by the authors, “The government’s reliance on economic models rests on the notion that they’re more scientific than human judgment. Yet merger economics has little objectivity. Like many areas of social science, it is dependent on assumptions, some explicit and some unseen and unexamined. That leaves room for economists to follow their preconceptions, and their wallets.”

The implication is that government regulators might be convinced a proposal is best for stakeholders (notice I didn’t use the word stockholders) when it is really only in the interest of the company seeking the merger–and comes at the expense of other stakeholders. In the case of a proposed merger between cell phone companies AT&T and T-Mobile, the economic consultant wanted to make this argument: “That even though prices would have risen for customers, the companies would have achieved large cost savings. The gain for AT&T shareholders … would have justified the merger, even if cell phone customers lost out.”

Let’s hear it for the economists.

Potash peril

Potash refers to a variety of compounds that contain potassium. Plants require potassium (chemical label is K) for their development, along with Nitrogen (N) and Phosphorus (P). These three chemicals are the key ingredients of fertilizers and are thus widely used in plant agriculture.

The largest potash producer in the world in terms of production capacity and market value is Potash Corporation of Canada. It has a market value of roughly $14 billion and controls 15 percent of global production and 19 percent of production capacity, according to the company’s website. There are larger companies in minerals and mining (e.g., the UK’s Rio Tinto Group), but none dominates potash production like Potash Corp.

The Wall Street Journal reports today that Potash Corp is merging with Agrium, also a Canadian fertilizer company, the combination of which will be a company with $21 billion in annual revenue and controlling 23 percent of global potash production capacity but 60 percent of capacity in North America. The two companies justify the merger as we might expect–stabilizing prices, lowering production costs, accessing other markets, etc.

Now, if US farmers want to buy fertilizer, they will likely have to get if from the combined company. Farmers are concerned, as they should be. According to the WSJ, “The deal likely would sow further unease among North American farmers wary of reduced competition and higher prices as top seed and pesticide developers pursue their own tie-ups. Already grappling with a three-year slide in major crop prices, some farmers are concerned that mergers between some of the world’s largest farm-supply companies will consolidate pricing power among fewer players and lead to higher costs at a time when farmers are scrimping to eke out profits.”

Efficiency is good, as are lower costs. But as I noted in a previous post, so is choice. Where do we draw the line when struggling with efficiency versus choice? Will the combined company pass on the cost savings to farmers by lowering prices of fertilizer? I hope so. But then I hope for $100 bills to rain on my home, too.

Consolidation in the agricultural seed and chemical industry

The Wall Street Journal reported that German company Bayer increased its share-price offer for the purchase of Monsanto. If (or when) the merger happens, the combined company will dominate an already-concentrated agricultural seed and chemical industry. I don’t have current figures on global industry concentration ratios, but the main players in agricultural seed and chemicals are Monsanto, Syngenta, DuPont, Dow Chemical, BASF and Bayer. According to the WSJ article, Monsanto previously tried taking over Syngenta but failed, DuPont and Dow Chemical are merging, and China’s National Chemical is buying out Syngenta. Monsanto is also seeking an alliance with BASF.

These companies are already tightly aligned. For example, all participate in cross-licensing agreements with each other in a host of technology sharing arrangements, most notably in genetically-engineered seed traits. Phil Howard, a sociologist at Michigan State University, graphically documented these relationships in 2013 (see his cross-licensing agreements and seed industry structure graphics). The Farm Journal provides a similar report (here), with graphics for the top five seed companies in each year from 2010 to 2014.

Many economists support mergers like these in the name of increased efficiency. Often there are economies of scale associated with the development and distribution of technologies, such as genetically modified crops and agricultural chemicals, which can lower costs for firms and, in theory, for buyers of the companies’ products. This is a good thing. But when choice is reduced in the name of efficiency, I wonder whether it is always worth it. Having options is powerful. Limiting choices has the potential to create dependencies and redistribute power. Are farmers’ and consumers’ interests really served by having fewer companies serve them? Some may say that choices and options will not be affected, since the products offered by the companies would still be available. But when they are offered by one firm rather than many, is that really the same?

Efficiency is good, but so is choice. Can we seek a balance of efficiency and choice?