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79 Fed. Res. Bull. 188 (1993)
The Herfindahl-Hirschman Index

handle is hein.journals/fedred79 and id is 376 raw text is: The Herfindahl-Hirschman Index Stephen A. Rhoades, of the Board's Division of Research and Statistics, prepared this technical note. The Herflndahl-Hirschman index, better known as the Herfindahl index, is a statistical measure of concentration. It has achieved an unusual degree of visibility for a statistical index because of its use by the Department of Justice and the Federal Reserve in the analysis of the competitive effects of merg- ers. The Herfindahl index can be used to measure concentration in a variety of contexts. For example, it can be used to measure the concentration of income (or wealth) in U.S. households and also market concentration, that is, the degree of concen- tration of the output of firms in banking or indus- trial markets. It is useful in analyzing horizontal mergers because such mergers affect market con- centration, and economic theory and considerable empirical evidence suggest that, other things equal, the concentration of firms in a market is an impor- tant element of market structure and a determinant of competition. However, despite its visibility, the Herfindahl index is sometimes not understood in terms of its use, measurement, or interpretation in merger analysis. To facilitate and simplify the application of the antitrust laws regarding mergers, in 1982 the Department of Justice published formal numerical guidelines for horizontal mergers (those between firms operating in the same product and geographic markets) based on the Herflndahl index (HIH).' In 1985, the Justice Department proposed somewhat modified numerical guidelines for mergers in the banking industry and published revised guidelines 1. The index was developed independently by the economists A.O. Hirschman (in 1945) and O.C. Herfindahl (in 1950). Hirsch- man presented the index in his book, National Power and the Structure of Foreign Trade (Berkeley: University of California Press, 1945). Herfindnhl's index was presented in his unpublished doctoral dissertation, Concentration in the U.S. Steel Industry (Columbia University, 1950). For more detail on the background of the index, see Albert 0. Hirschman, The Paternity of an Index American Economic Review (September 1964), pp. 761-62. in 1992. These numerical guidelines are used by the Federal Reserve as the first step in analyzing the effect on competition of bank mergers. The guidelines, as applied to banking, specify that if a bank merger would result (1) in a post-merger HHI in a market of less than 1,800 or (2) in a change in the HM of less than 200 (less than 50 in other industries), it is likely that the market structure would not reach a concentration level, or concen- tration would not increase enough, such that firms in the market would have the market power to. maintain prices above the competitive level for a significant period. The HHI is only one element in the analysis of the competitive effects of bank mergers. However, because of the importance attached to market con- centration as an indicator of competition and the relative ease of calculating the HHI, this index serves as an efficient screening device for regula- tors and as a planning tool for bankers. At the Federal Reserve, the HHI is calculated by includ- ing 100 percent of the deposits of commercial banks in a market and at least 50 percent of the deposits of thrift institutions. If the post-merger HHI does not exceed the numerical guidelines, it is generally presumed that the merger would not be seriously anticompetitive, and no further analysis is conducted. If, on the other hand, the post-merger HI exceeds the numerical guidelines, a detailed economic analysis of competition is undertaken to determine whether other factors, such as potential competition, indicate that the market would be more (or less) competitive than the Hi alone suggests. The HHI accounts for the number of firms in a market, as well as concentration, by incorporating the relative size (that is, market share) of all firms in a market. It is calculated by squaring the market shares of all firms in a market and then summing the squares, as follows: n HHJ = Mj)2 i= t

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