DP10914 Demand-Driven Integration and Divorcement Policy
Industrial organization's concern with vertical integration has traditionally been limited to considering the effects on market outcomes, in particular product prices: they increase because integration enhances market power, or they decrease because it yields efficiency gains. This note offers a theoretical argument for reverse causality, from prices -- more generally, demand -- to integration. If, as many organizational theories in suggest, integration has positive effects on production efficiency and has any costs that are largely independent of output, then bearing those costs is more attractive when prices are higher, as when there is high demand. Therefore high prices lead to more integration. We discuss evidence for this reverse causality and its implications for regulation.