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Boeing McDonnell Douglas: A Merger Too Far

January 1, 1997 


Initial news coverage of the recent corporate merger announcement between Boeing and McDonnell Douglas has been very positive, and treats the merger almost as if it is a fait accompli. But the government still has to rule on anti-trust concerns before the deal may proceed. The high costs of the merger - to taxpayers, to the economy, and even to Boeing itself - mean that the Administration should not approve the deal. After years of corporate takeovers and concentration in the defense industry, this is a merger too far.

What has happened to the trust-busting days of Teddy Roosevelt? At the turn of the last Century, the nation realized the costs of monopoly, and that more competition improved the functioning of our economy. Approaching the turn of our Century, we seem to have forgotten some of these hard- learned lessons about the strengths, weaknesses, and management of our capitalist system. Dazzled by the seductiveness of mergers like Boeing-McDonnell Douglas, the largest ever in aerospace, we have ignored the downside costs of merger frenzy.

To begin with, if this merger proceeds, it is likely to hit the public with a heavy bill. The Defense Department's controversial policy of paying corporations for "restructuring" costs after mergers means taxpayers will likely have to fork over a huge sum to Boeing. Lockheed Martin billed the government for almost $1 billion after its smaller merger in 1995.

The Administration's merger payments policy makes merger decisions like Boeing's far from free-market decisions. Prior administrations acted to prevent the formation of mega-corporations in defense, but the Clinton Administration has actively subsidized concentration in the industry. Unfortunately, rather than let the market shake itself out, the subsidy policy has pushed corporate merging farther than it should go. In the short run a merged corporation may charge less on a particular contract or two, but the Administration has yet to fully examine the long-term costs to the Pentagon of reduced competition.

Much of the initial commentary on the merger has assumed that the deal is good for the economy as a whole. Boeing's freedom to focus all of its energy on combating its sole remaining commercial aircraft competitor, Airbus of Europe, will supposedly boost the economy's international competitiveness. But in the longer-run a two-company oligopoly begins to resemble a monopoly: price competition withers away, innovation declines, and ultimately international competitiveness suffers.

The long-term drag on the economy of near-monopoly can be especially pronounced when, as in the aircraft industry, "entry costs" are prohibitively high for firms wishing to get into the industry. Nor is it clear that McDonnell Douglas was about to dry up and blow away without the merger. McDonnell Douglas was competitive and profitable in certain markets, such as smaller jets. The company did get bumped out of the large Joint Strike Fighter program in November, but the program will likely face the usual cutbacks, and the company might have received substantial subcontracting work. In fact, sharing more of the actual production work among losing bidders may be a useful alternative model for the government to help deal with a smaller market, as already practiced in naval shipbuilding.

The Boeing-McDonnell Douglas merger is also likely to have a ripple effect, spawning other mergers as other defense firms combine in order to keep up with the two gorillas, Boeing and Lockheed Martin. Northrop Grumman, Raytheon, Hughes defense and Texas Instruments defense are all frequently mentioned merger candidates. The ripple effect will accelerate defense industry concentration, further reducing already limited competition.

Similarly, the indirect and longer term costs that Boeing faces may not make the merger such a smart corporate move. The corporation has argued that its plunge neck-high into defense waters will provide "balance" in its business to counteract short-term business cycles in the commercial aircraft sector. The problem with boosting the defense side is that defense procurement is in long term decline. Other companies are desperately trying to convert out of defense work or focus on "core" business - like Boeing's enviably strong commercial airliner base.

The other danger for Boeing is increased exposure to the corrupting influence of poor defense business practices. Defense contractors routinely deliver products that are faulty, well behind schedule, and far over budget - a recipe for disaster in the commercial sector. So much new defense work at once - two weeks earlier Boeing announced plans to acquire Rockwell defense work as well - risks debilitating Boeing's competitive commercial operations.

The costs to Boeing of the merger are, in the end, its own business. But the costs to the economy in reduced competition, and the costs to the public of subsidizing these mergers, call for the Administration to halt this excessive corporate combination. If the Administration continues to push excessive corporate concentration it may find itself building bridges back to the dark days of unchecked 19th century monopolies rather than forward to a 21st century of efficient economic competition.

Founded in 1981, the Project On Government Oversight (POGO) is a nonpartisan independent watchdog that champions good government reforms. POGO's investigations into corruption, misconduct, and conflicts of interest achieve a more effective, accountable, open, and ethical federal government.

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