The Basing point System

[Front Matter and Preface]: The front matter and preface introduce Fritz Machlup's economic analysis of the basing-point system, prompted by the 1948 Supreme Court Cement decision. Machlup explains that the book aims to describe the system's operation, history with antitrust laws, and economic consequences, targeting both professional economists and businessmen. [Table of Contents]: A detailed table of contents outlining the eight chapters of the book, covering topics from the mechanics of basing-point pricing to case histories of specific industries and the economic costs of abolishing the system. [Chapter 1: Introduction - The Legal and Political Context]: Machlup situates the basing-point system within the history of anti-competitive law, from 13th-century English common law to the Sherman and Clayton Acts. He highlights the 'astounding performance' of the system, where dozens of firms submit identical bids to the sixth decimal point, prompting political pressure to legalize these practices after they were declared unlawful. [Definitions and Pricing Distinctions]: This section provides rigorous definitions for technical terms used in pricing discussions. Machlup distinguishes between uniform prices (one seller to many buyers) and identical prices (many sellers to one buyer), and explains the mechanics of f.o.b. mill prices versus delivered prices. He also clarifies terms like 'freight allowed', 'freight equalization', and 'freight absorption'. [The Mechanics of Single and Multiple Basing-Point Systems]: Machlup explains the essence of the basing-point technique, which allows sellers to quote identical delivered prices without direct communication by using a shared formula. Through a schematic grid example, he demonstrates how single and multiple basing-point systems function, how 'mill net' prices vary for non-base mills, and defines the concept of a 'natural market territory'. [Plenary Systems and the Nature of Basing-Point Cartels]: The author discusses the 'plenary' system where every mill is a basing point and traces the history of these systems from the 1880 Steel Beam Association to their spread across various industries like sugar and gasoline. He argues that the consistent use of these formulas constitutes an informal price cartel, often requiring trade association 'tools' like freight rate books to ensure identical results. [Price Discrimination and Oppression]: Machlup analyzes the discriminatory nature of the basing-point system, where mill net prices vary based on destination. He distinguishes between 'harmless' discrimination and discrimination 'injurious to competition'. He suggests the system can be an instrument of oppression used by powerful firms to dominate smaller competitors who may not even realize they are being oppressed. [Appendix to Chapter 1: An Exercise in Basing-point Mechanics]: This appendix provides a step-by-step arithmetical exercise to clarify the technical concepts of phantom freight and freight absorption. By modeling three mills on a railroad line, Machlup demonstrates how establishing new basing points can result in 'illusory' changes in freight terminology while potentially reducing real delivered prices and the 'degree of price discrimination'. [Chapter 2: A Problem of Business, Law, Economics, and Politics]: This introductory section of Chapter 2 outlines the complex interrelationships between business policy, legal standards, economic analysis, and political philosophy regarding the basing-point system. Machlup argues that the controversy stems from conflicts between particular vested interests and general principles of economic policy, necessitating a multi-disciplinary approach to understand the ethics, legality, and social consequences of identical delivered pricing. [The Ethics of Business: Oppressing or Killing the Rival]: Machlup examines the ethical dimensions of business practices often labeled as 'collusive' or 'oppressive.' He argues that the 'killing' of inefficient firms through competition is economically beneficial and that ethical responsibility for social outcomes should rest on the legal framework created by society rather than the individual conscience of businessmen. He concludes that businessmen should not be judged by fuzzy ethical standards if their actions are permitted by law. [Collusion, Coöperation, and the Will to Compete]: This section explores the semantic and moral distinction between 'collusion' and 'coöperation' in pricing. Machlup observes a social ambivalence where price fixing is condemned but price maintenance is often viewed as 'ethical' within trades. He argues that the 'will to compete' is not declining naturally but is suppressed whenever the market structure (often due to mergers) allows for successful combination and the avoidance of 'sensible' price behavior. [The Uncertainty of Law and the Ethics of Law Violations]: Machlup addresses the common business complaint regarding the 'uncertainty' of antitrust laws, suggesting it often reflects the risk of being caught rather than genuine ambiguity. He critiques the slow and often toothless enforcement of these laws, which leads to a lack of social stigma for violators. He notes that industry leaders often use camouflage and propaganda to present collusive arrangements as competitive because they do not believe such cooperation is inherently immoral. [The Ethics of Restraint of Competition]: Producers often justify restraining competition by arguing that price cuts provide negligible benefits to consumers while causing severe harm to the industry, especially during depressions or periods of overcapacity. Machlup cites a candid letter from a Cement Institute trustee admitting that the industry 'must systematically restrain competition or be ruined,' despite public claims that the basing-point system preserves free competition. [The Indecision of Law: Legal Issues and Chronology]: Machlup details the ten primary legal issues involved in the basing-point controversy, ranging from Sherman Act violations to price discrimination under the Robinson-Patman Act. He attributes the 'legal see-saw' and slow resolution of these cases (spanning 1890–1948) to the difficulty of establishing facts and the inadequate funding of government prosecuting agencies, rather than shifts in judicial interpretation. [The Speculations of Economics: Expert Witnesses and Value Judgments]: Machlup discusses the role of economists as expert witnesses in basing-point litigation, noting the potential for bias when scholars are retained by vested interests. He defends the inclusion of the theorist's political philosophy—in his case, 'old-fashioned liberalism'—as a more honest approach than feigning total objectivity. He lists the six major economic consequences of the system, including price fixing, wastes in distribution, and distortion of industrial location. [The Ways of Politics: Legislative Pressure and the Capehart Committee]: Following the 1948 Supreme Court decision against the cement industry, a political campaign emerged to legalize the basing-point system. Machlup describes the formation of the Capehart Committee and the 'high-pressure campaign' by the steel and cement industries, which involved switching to f.o.b. mill pricing and raising prices to blame the Court and the FTC for economic 'dislocations' and 'inflationary' effects. [Political Strategy: Helping Small Business and Pledging Support to Antitrust]: Machlup analyzes the political tactics used to defend the basing-point system, specifically the claim that its abolition harms small business. He points out the contradiction in large firms fighting for a system they claim only benefits their smaller competitors. Finally, he notes the political necessity of pledging '100 per cent' support for the Sherman Act while simultaneously working to undermine its enforcement through special legislation. [Chapter 3: Three Case Histories: Steel, Cement, Corn Products]: This chapter provides detailed historical narratives of the basing-point system as applied in three major American industries: steel, cement, and corn products. It traces the origins of these pricing schemes to early pools and mergers, specifically highlighting the role of the United States Steel Corporation and the Universal Atlas Cement Company. The text details the transition from single to multiple basing-point systems, the impact of the NRA's 'self-government of industry' period in codifying these practices, and the subsequent legal battles with the Federal Trade Commission and the Supreme Court. Machlup argues that these systems were not natural economic evolutions but rather deliberate results of collusive activities and industrial concentration designed to eliminate price competition. [Chapter 4: The Monopolistic Nature of Basing-point Pricing]: Machlup begins an economic and legal analysis of why the basing-point system is inherently monopolistic rather than competitive. He identifies four mutually inconsistent positions taken by industry advocates to defend the system, ranging from the claim that price uniformity proves perfect competition to the argument that the system is a 'natural evolution' of specific industrial conditions. The segment introduces the 'law of indifference' and critiques its misapplication by industry proponents who equate identical delivered price quotations with the uniform equilibrium price found in a perfectly competitive market. [The Fallacy of Perfect Market Price Uniformity]: Machlup critiques the application of classical market theory to the basing-point system, arguing that identical price quotations are not evidence of a perfect market. He highlights how the system violates essential conditions of competition, such as the prohibition of arbitrage and the acceptance of varying net prices from different buyers. [Judicial Interpretation and the Supply and Demand Defense]: This section examines how industries successfully persuaded courts that identical delivered prices resulted from 'active, free and unrestrained competition' rather than collusion. Machlup details the eventual shift in judicial perspective, culminating in the Supreme Court's recognition that such uniformity in cement and steel was likely the result of concerted action. [Market Interpenetration and the Myth of Local Monopolies]: Machlup analyzes the industry argument that the basing-point system prevents local monopolies through 'market interpenetration.' He refutes this by arguing that interpenetration via freight absorption is often a wasteful sharing of markets that excludes true price competition, and that f.o.b. pricing would actually lower prices for local consumers rather than creating monopolies. [Evaluating Price Competition: New Basing-Points and Deviations]: The author evaluates whether price competition persists through the creation of new basing-points or secret price cuts. He concludes that new basing-points rarely lead to lower prices due to implicit retaliation, and while secret rebates exist, they primarily benefit large buyers, thereby reinforcing market concentration rather than fostering general competition. [Natural Evolution and Oligopolistic Coordination]: Machlup critiques the 'natural evolution' defense, which claims the basing-point system emerged spontaneously from technological and market forces without collusion. He argues that while the inclination toward cooperation is 'natural' for businessmen, the specific mechanics of the system—such as identical price formulas—require deliberate coordination and cannot be explained by non-cooperative oligopoly theory. [Open-Price Systems and Coöperative Compliance Mechanisms]: This segment discusses the role of open-price associations and cooperative freight rate services in maintaining the basing-point system. Machlup argues that these mechanisms go beyond mere information sharing; they are designed to ensure that all competitors calculate identical delivered prices, effectively eliminating the uncertainty inherent in true competition. [The Role of Freight Rate Services and Price Leadership]: This segment examines the mechanisms of the basing-point system, specifically the use of cooperative freight rate services to ensure price uniformity and the role of price leadership. Machlup argues that while price leadership is common in concentrated industries like steel and cement, it does not disprove collusion; rather, it often facilitates the enforcement of the basing-point system through the influence of dominant firms. [Price Leadership and the Natural Evolution Argument]: Machlup critiques the theory that the basing-point system evolved naturally from price leadership without collusion. He distinguishes between different types of price leadership and argues that the fear of losses among smaller firms is an effect of the system's operation rather than its cause, suggesting that the relationship between leaders and followers is rarely casual or unplanned. [Enforcement of Obedient Followership and Punitive Basing-Points]: This section details the methods used to enforce adherence to the basing-point system, including moral suasion, price raiding, and the creation of 'punitive basing-points' to discipline recalcitrant firms. It highlights a specific case in the cement industry during the Great Depression where a producer was forced into submission through drastic price reductions imposed by competitors. [The Relationship Between Leaders, Followers, and the System]: Machlup explores the complex relationship between price leaders and followers, characterizing it as a mixture of coercion and voluntary partnership. He argues that while price leadership and the basing-point system can exist independently, they are mutually reinforcing in practice, as the system provides the leader with the tools to control a vast array of prices and prevent independent policies by smaller firms. [Refutation of Natural Evolution and Judicial Recognition of Collusion]: The final section of this chunk concludes the refutation of the 'natural evolution' theory of basing-point systems. Machlup asserts that the system is a result of deliberate monopolistic development and collaboration rather than spontaneous competitive forces. He cites judicial shifts, including Supreme Court rulings in the Cement Institute case, which began to recognize that identical group behavior in pricing constitutes evidence of illegal concerted action. [Chapter 5: The Discriminatory Nature of Basing-point Pricing]: Machlup introduces Chapter 5 by arguing that basing-point pricing is inherently discriminatory, despite historical denials by industry advocates. He proposes a 'test of non-discrimination' based on seller indifference toward buyer characteristics and location, concluding that basing-point sellers fail this test by insisting on destination-based pricing. [Refusal to Sell F.O.B. Mill and Diversion of Shipments]: This section examines how industries using the basing-point system, particularly steel and cement, refuse to sell f.o.b. mill under the guise of buyer convenience. Machlup details the measures taken to prevent buyers from 'diverting' shipments to closer destinations to capture freight savings, such as limiting trucking credits and refusing f.o.b. quotes even to the federal government. [Discriminatory Non-Discrimination and the Meaning of Competition]: Machlup critiques the industry's 'Code of Ethics' which labeled the prevention of shipment diversion as a measure against discrimination—a 'humorous juggling' of terms. He explores the complex relationship between discrimination and competition, arguing that the ability to discriminate presupposes monopolistic power and discretion in price-making, contradicting the industry's claim that matching prices at destinations is purely competitive. [Meeting Competition in Good Faith and Legal Rulings]: The text analyzes the legal defense of 'meeting competition in good faith' under the Clayton Act. Machlup highlights Supreme Court rulings (Staley and Cement Institute cases) which established that while individual price matching may be lawful, the systematic adoption of a discriminatory pricing system like the basing-point method does not constitute 'good faith' competition. [Variations in Mill Net Prices: Base vs. Non-Base Mills]: Machlup provides a technical breakdown of how mill net prices vary for both basing-point mills and non-basing-point mills. He defines 'mill net price' as the revenue net of actual transportation costs and enumerates seven scenarios for each mill type, illustrating how phantom freight and freight absorption are often illusory artifacts of the chosen standard of comparison. [The Futility of Outlawing Phantom Freight Alone]: This section argues that proposals to outlaw phantom freight while permitting freight absorption are futile. Machlup explains that phantom freight can be easily transformed into base price differentials by increasing the number of basing points, without changing the actual discriminatory prices paid by consumers. [The Favored and the Harmed: Regional Inequity]: Machlup identifies who wins and loses under discriminatory pricing. He argues that even if discrimination appears reciprocal, it results in economic waste (cross-hauling) that harms all buyers. Furthermore, he explains how the system creates a bias in favor of established industrial regions and against developing ones, citing the corn syrup industry as an example. [Discrimination Against 'Western' Customers and Industrial Retardation]: Using an abstract 'East' vs. 'West' model, Machlup demonstrates how a large established mill can use the basing-point system to retard the growth of a smaller, newer mill in a different region. The smaller mill is forced to dump products into distant markets at low nets while the larger mill maintains high-price sales in the smaller mill's home territory. [Domination Through Local Price Discrimination]: Machlup compares the basing-point system to the 'local price cutting' practiced by Standard Oil. He explains how large firms use the system as an automatic enforcement instrument to control weaker rivals, forcing them to follow price leads or face financial ruin, thereby preventing them from expanding their market share. [The Streamlined Model of Oppression]: This section describes how the basing-point system 'streamlines' oppression. Unlike overt price wars, the system allows large firms to quietly take business from small competitors at equal prices. The large firm's ability to absorb freight across a national market makes it impossible for a local small firm to compete on price without sacrificing its own survival. [Technological Efficiency vs. Systemic Power]: Machlup challenges the idea that large firms dominate solely due to technological efficiency. Through an arithmetical illustration of two mills with equal costs but different capacities, he proves that the 'right' to discriminate to meet competition allows the larger firm to drive the smaller one into losses simply by interpenetrating its market. [Arithmetical Illustration of Market Interpenetration]: Machlup provides a detailed arithmetical model (Fig. 4) showing how a large mill (I) and a small mill (D) interact. He demonstrates that when both mills absorb freight to 'meet competition' in each other's territories, the absolute loss of revenue hits the smaller mill's profit margin much harder, eventually pushing it below total costs while the large mill remains profitable. [The Strategic Interests of the Giant Firm]: Machlup examines why large firms maintain discriminatory pricing: to facilitate cheap mergers, manage cyclical declines in demand, and retard the secular growth of regional independents. He argues that the system acts as a barrier to entry for newcomers by making regional markets unattractive for new, independent investment. [A Roman Peace: The Social Psychology of the Cartel]: Machlup describes the 'Roman peace' of the basing-point system, where the lack of overt price wars masks a system of total control. He explains why small businesses often fail to protest: a lack of economic understanding, a feeling of 'protection' within the cartel, and fear of reprisal from industry leaders. [Classifying Types of Geographic Price Discrimination]: This section classifies geographic discrimination into collusive and oppressive types. Machlup distinguishes between collusion as a means to achieve discrimination (European style) and discrimination as a by-product of a collusive pricing formula (basing-point style). He notes that formula-pricing is primarily a tool for concerted action and price identity. [Discrimination to Limit Competition Among Customers]: Machlup discusses geographic discrimination used to limit competition among a firm's own customers (distributors). This includes zone pricing and uniform delivered prices for branded goods to facilitate resale price maintenance. He notes that while this limits competition among buyers, it is generally legal if non-collusive. [Noncollusive Discrimination: Free Delivery and Dumping]: Machlup explores non-collusive forms of discrimination, such as uniform prices due to the inconvenience of calculating freight or for building consumer goodwill. He also discusses 'dumping' surplus stocks in foreign or distant markets, noting that while disturbing to competitors, it is not necessarily illegal or economically harmful if occasional and non-collusive. [Exploiting Demand Elasticities and Oligopolistic Competition]: The text analyzes how a monopolist or oligopolist might use discrimination to exploit varying demand elasticities. Machlup argues that consistent formula-pricing (like the basing-point system) cannot be non-collusive because true competitive matching would be irregular and based on changing plant conditions, whereas formula-pricing relies on fear of reprisal. [Counter-Discrimination: Secret Price Cuts]: Machlup concludes the chapter by discussing 'counter-discrimination'—secret price concessions to large buyers that undermine the official basing-point structure. While these favor large fabricators, they reintroduce competition among sellers and can lead to real price reductions for consumers, though they are often suppressed by the cartel's punitive measures. [Chapter 6: The Economic Consequences: Competition, Transportation Costs, Prices]: Machlup introduces the systematic analysis of the economic effects of basing-point pricing, focusing on competition, transportation wastes, and price structures. He establishes that the only meaningful way to evaluate these effects is by comparing the system to specific alternatives, primarily compulsory f.o.b. mill pricing. He refutes the idea that basing-point systems are a natural competitive development and argues that they function as a mechanism to suppress price competition. [The Degree of Competition and Independence in Price Making]: This section examines how the pricing system affects the degree of competition, defined primarily as price competition. Machlup argues that under a uniform f.o.b. mill system, individual firms face a higher elasticity of demand because they can lower prices without the immediate, low-cost local retaliation possible under basing-point systems. He cites Frank A. Fetter and T.N.E.C. papers to discuss the relationship between discrimination and monopoly, concluding that f.o.b. mill pricing would likely increase competition and capacity utilization. [Ruinous Competition and Wastes in Transportation]: Machlup addresses the industry argument that abolishing basing-points leads to 'ruinous' competition, arguing instead that local price wars are actually easier to sustain under discriminatory systems than under uniform f.o.b. pricing. He then details the 'wastes of cross-hauling,' where goods are shipped unnecessarily long distances because buyers have no price incentive to choose the nearest mill. He quotes Charles M. Schwab on the dissipation of profits through unnecessary transportation. [Measuring Cross-Hauling and Suppressed Production]: This segment explores the difficulty of measuring the costs of cross-hauling due to lack of industry data. Machlup discusses the 'principle of limited freight absorption' proposed by John M. Clark and analyzes how the system suppresses production in certain regions. He argues that even one-way shipments without freight absorption can be 'wasteful' if they occur because the basing-point system prevented the development of local capacity or the utilization of existing local mills. [Expensive Transportation and Price Flexibility]: Machlup discusses how basing-point systems discourage the use of cheaper transportation methods like trucks or waterways, as these might 'disrupt' the identical delivered price structure. He also examines the 'fabrication-in-transit' (f.i.t.) privilege and its role in cross-hauling. Finally, he addresses price flexibility, noting that while industries claim 'stability' is beneficial, it often results in drastic variations in output and employment during economic downturns. [Geographic Price Structure and Long-Run Price Levels]: Machlup analyzes the impact of the system on geographic price structures, showing how it deprives consumers of the natural advantages of their location. He addresses the 1948 shift to f.o.b. pricing in steel and cement, explaining that the resulting price increases were due to postwar inflation and industry 'administered' price adjustments rather than the inherent nature of f.o.b. pricing. He concludes that in the long run, f.o.b. pricing would lower average delivered prices through transportation savings and increased competition. [Chapter 7: Control, Utilization, Expansion, and Location of Capacity]: Machlup begins Chapter 7 by discussing how the basing-point system facilitates the concentration of control within an industry. He notes that the system works most reliably when a few dominant firms can enforce rules. He outlines how concentration increases through construction, scrapping of small-firm capacity, and mergers, and how the pricing system helps maintain this control by suppressing the growth of smaller competitors. [Concentration and the 'Umbrella' Theory of Growth]: Machlup examines how the basing-point system facilitates market concentration by making mergers more attractive and entry more difficult for small competitors. He critiques the 'umbrella theory,' which suggests the system fostered growth in the Midwest; instead, he argues the system actually retarded regional growth by allowing eastern producers to serve midwestern consumers without freight penalties while penalizing midwestern producers for shipping east. [Concentrated Control Through Decentralized Production]: The author addresses the argument that f.o.b. mill pricing would disadvantage small single-plant firms in favor of large multi-plant concerns. He refutes this by showing that the basing-point system actually provides larger firms with more power to engage in oppressive local price cutting even where they have no plants, whereas f.o.b. pricing limits this power to areas where they own physical mills. [Mergers, New Entries, and Capacity Utilization]: Machlup argues that the abolition of the basing-point system would improve the earnings of independent mills with locational advantages, making them less susceptible to forced mergers. He also discusses how the removal of uncertainty regarding regional business under f.o.b. pricing reduces risks for new entrants, ultimately concluding that the basing-point system maintains high concentration and reduces the utilization of productive capacity. [The Pure Theory of Discriminating Monopoly and Output Volume]: This section critiques the abstract economic theory that price discrimination necessarily increases output. Machlup argues that in the context of the basing-point system, discrimination is a tool for maintaining monopoly power and matching prices rather than expanding the market. He highlights a paradox in business psychology where producers believe in sales expansion through freight equalization but remain skeptical of expansion through direct price reductions. [Analysis of Four Cases of Geographic Price Discrimination]: Machlup presents four hypothetical cases to demonstrate that typical basing-point practices (matching prices and swapping orders) do not increase total industry output. He concludes that because the system results in higher delivered prices and higher transportation costs, it inherently reduces the degree of utilization of a given productive capacity compared to a uniform f.o.b. mill price system. [Expansion and Location of Productive Capacity]: The author explores how the basing-point system influences the expansion and location of industrial capacity. While some argue it causes overexpansion by protecting obsolete plants, others suggest it retards growth by discouraging new entrants. Machlup discusses Schumpeter's defense of cartel-like restraints but concludes that the system generally distorts location by favoring old production centers (like Pittsburgh) over peripheral markets. [Location of Fabricating Industry and Social Costs of Centralization]: Machlup analyzes the 'centripetal' pull the basing-point system exerts on fabricating industries, forcing them to locate near old supply centers rather than regional markets. He discusses the long-term 'multiplier effect' of these locational decisions and the resulting social costs, including urban overcrowding and wasteful transportation. He concludes that the mal-location of industry caused by the system will persist as a social burden long after the system itself is abolished. [Chapter 8: The Cost of Abolishing the System]: Machlup summarizes the economic consequences of the basing-point system, including reduced competition, transportation waste, and distorted price structures. He then evaluates the social and economic costs of abolishing the system, specifically addressing the transition to uniform f.o.b. mill pricing. He argues that while some industries claim they cannot withstand price competition, these fears are often based on a misunderstanding of marginal costs and a desire to avoid losses during depressions. The segment concludes that the Federal Trade Commission's role is to stop collusive practices, and that a shift to f.o.b. pricing is the most practical way to ensure a break from such conduct in concentrated industries. [Industrial Relocation and Capital Losses]: This section examines the potential need for industrial relocation following the abolition of basing-point pricing. Machlup distinguishes between private capital losses and social losses, arguing that the destruction of capital values in mal-located plants is not a loss to society but a necessary adjustment to technological and locational efficiency. He critiques the 'vested rights' argument, noting that industries were long aware of the system's illegality. He also discusses the cost of relocation in terms of investment funds and resources, asserting that such investments are as productive as any other if they lead to more efficient future production. [Labor Mobility and the 'Ghost Town' Argument]: Machlup addresses the social concerns regarding labor displacement and the creation of 'ghost towns' resulting from industrial relocation. While acknowledging the hardships faced by immobile workers in specialized communities, he argues that society has a moral obligation to facilitate adjustment rather than suppress innovation or resist economic change. He suggests that the timing of such changes is crucial, noting that the current period of high economic activity is the ideal time to minimize the costs of frictional unemployment. [Index of Subjects and Names]: A comprehensive index for the book 'The Basing Point System', listing key terms, legal cases (such as Aetna Portland Cement Co. v. FTC), and authors/thinkers (such as J. M. Clark, Frank Fetter, and Senator Capehart) discussed throughout the text.