In my just published Heritage Foundation Legal Memorandum, I argue that the U.S. Federal Trade Commission (FTC) should substantially scale back its overly aggressive “advertising substantiation” program, which disincentivizes firms from providing the public with valuable information about the products they sell.  As I explain:

“The . . . [FTC] has a long history of vigorously combating false and deceptive advertising under its statutory authorities, but recent efforts by the FTC to impose excessive ‘advertising substantiation’ requirements on companies go far beyond what is needed to combat false advertising. Such actions threaten to discourage companies from providing useful information that consumers value and that improves the workings of the marketplace. They also are in tension with constitutional protection for commercial speech. The FTC should reform its advertising substantiation policy and allow businesses greater flexibility to tailor their advertising practices, which would further the interests of both consumers and businesses. It should also decline to seek ‘disgorgement’ of allegedly ‘ill-gotten gains’ in cases involving advertising substantiation.”

In particular, I recommend that the FTC issue a revised policy statement explaining that it will seek to restrict commercial speech to the minimum extent possible, consistent with fraud prevention, and will not require onerous clinical studies to substantiate non-fraudulent advertising claims.  I also urge that the FTC clarify that it will only seek equitable remedies (including injunctions and financial exactions) in court for cases of clear fraud.

In my just-published article in The Antitrust Source, I argue that the law and economics literature on patents and error cost analysis demonstrate that the recent focus by U.S. (and foreign) antitrust enforcers on single-firm patent abuses is misplaced, and may reduce incentives to innovate.  I recommend that antitrust enforcers focus instead on restrictions among competing technologies, which are the primary concern of the 1995 U.S. DOJ-FTC Antitrust-IP Guidelines.  I conclude:

“Patent-antitrust enforcement should “stick to its knitting” and focus on transactions that lessen competition among rival technologies or on wrongful actions (not competition on the merits) designed to artificially inflate the market value of a patent beyond its legitimate scope. New antitrust enforcement initiatives that seek to limit returns within the legitimate scope of the patentare unwise. Even if they appeared to restrain licensing fees in the short term, economic theory and evidence suggests that such “creative antitrust enforcement” would undermine incentives to invest in patenting, thereby weakening the patent system and tending to slow innovation and economic growth. Nations seeking to spur their economies would be well advised to avoid such antitrust adventurism.”

As we have reported frequently on this blog (see, e.g., here, here, herehere, here and here) the car dealers have been making remarkably silly arguments in their fight to prevent Tesla from distributing its electrical vehicles directly to consumers. Now, I’m embarrassed to report that they’ve succeeded in moving from silly to disingenuous in my home state of Michigan.

Here’s what happened. In May of 2014, a bill was introduced in the Michigan Legislature to amend the statute dealing with car manufacturer-franchisee relationships. The bill did only one thing substantively—it prohibited manufacturers from coercing dealers not to charge consumers certain kinds of fees. Nothing at all to do with Tesla or direct distribution. Then, on October 1, in a floor amendment, the bill was altered to add a provision at the end of statute reading “this section applies to a manufacturer that sells, services, displays, or advertises its new motor vehicles in this state.” In a single day and as far as I know without any debate, the bill was passed with this new proviso 38-0 in the Senate and 106-1 in the House.

There was only one motivation for the addition of the proviso. Since losing in the Massachusetts Supreme Court in September, the dealers have recognized that decades-old dealer protection statutes may not be interpreted to apply to a company that wants to distribute its cars without using dealers at all. They saw an opportunity to bolster the statute in a way that would make it harder for Tesla to win under the existing law as it did in Massachusetts. And they realized that, on the eve of a close election contest in Michigan, no one would be paying attention to the seemingly innocuous language slipped into an uncontroversial bill at the last minute.

The bill is now sitting on Governor Rick Snyder’s desk for signature or veto. I wrote him a letter today asking him to veto the bill, if for no other reason than to allow the issue to be fairly and openly debated in Michigan. There’s mounting evidence that almost no one in the Legislature had any idea that they were taking sides in the Tesla wars.

What’s particularly infuriating is that the dealers are apparently arguing that the amendment has nothing to do with Tesla. Their argument apparently is that since the original statute already applied to Tesla, the amendment can’t be about Tesla. Instead, they assert, it’s just meant to clarify that “all manufacturers” are covered by the statute. This is beyond disingenuous. There’s no doubt that the dealers inserted this language to deal with their fear of a repeat of Massachusetts in Michigan. There’s no other logical explanation for the amendment. I mean, if not Tesla, who’s the manufacturer they were worried might not be covered by the existing legislation? GM? Ford? Sorry, guys, we’re not idiots.

Politics is dirty; crony capitalism is often the way of things. We shouldn’t be shocked. But nor should we stand for this kind of nonsense.

I highly recommend that free market aficionados attend or listen to the Heritage Foundation’s October 7 program on economic liberties and the Constitution.  This event, hosted by my colleague Paul Larkin, will feature presentations by constitutional litigator Clark Neily of the Institute for Justice and two brilliant market-oriented Constitutional scholars – Professors Randy Barnett and David Bernstein.  The program will highlight recent legal thinking that may reinvigorate efforts to rein in rent-seeking and restore a proper respect for constitutionally-guaranteed economic liberties.  If you cannot watch the program live, it will be available shortly thereafter for viewing on the Heritage Foundation’s website.

The cause of limiting governmental incursions on constitutionally-protected economic freedoms is far from hopeless.  As a Heritage Foundation Special Report released yesterday explains, recent federal court decisions are beginning to put real teeth into the “rational basis” test for reviewing protectionist state laws under the Due Process and Equal Protection Clauses of the Constitution.  For example, several courts have held that mere protectionism, standing alone, does not provide a sufficient rationale to justify a law under rational basis review.  Also, there may be some potential for striking down highly restrictive laws based on “changed circumstances,” for applying the First Amendment to excessive limitations on speech imposed by occupational licensing regulations, or for invoking antitrust to strike down inadequately supervised or articulated anticompetitive statutes.

Stay tuned for future work by Heritage scholars on economic liberties.

Shanker Singham of the Babson Global Institute (formerly a leading international trade lawyer and author of the most comprehensive one-volume work on the interplay between competition and international trade policy) has published a short article introducing the concept of “enterprise cities.”  This article, which outlines an incentives-based, market-oriented approach to spurring economic development, is well worth reading.  A short summary follows.

Singham points out that the transition away from socialist command-and-control economies, accompanied by international trade liberalization, too often failed to create competitive markets within developing countries.  Anticompetitive market distortions imposed by government and generated by politically-connected domestic rent-seekers continue to thrive – measures such as entry barriers that favor entrenched incumbent firms, and other regulatory provisions that artificially favor specific powerful domestic business interests (“crony capitalists”).  Such widespread distortions reduce competition and discourage inward investment, thereby retarding innovation and economic growth and reducing consumer welfare.  Political influence exercised by the elite beneficiaries of the distortions may prevent legal reforms that would remove these regulatory obstacles to economic development.  What, then, can be done to disturb this welfare-inimical state of affairs, when sweeping, nationwide legal reforms are politically impossible?

One incremental approach, advanced by Professor Paul Romer and others, is the establishment of “charter cities” – geographic zones within a country that operate under government-approved free market-oriented charters, rather than under restrictive national laws.  Building on this concept, Babson Global Institute has established a “Competitiveness and Enterprise Development Project” (CEDP) designed to promote the notion of “Enterprise Cities” (ECs) – geographically demarcated zones of regulatory autonomy within countries, governed by a Board.  ECs would be created through negotiations between a national government and a third party group, such as CEDP.  The negotiations would establish “Regulatory Framework Agreements” embodying legal rules (implemented through statutory or constitutional amendments by the host country) that would apply solely within the EC.  Although EC legal regimes would differ with respect to minor details (reflecting local differences that would affect negotiations), they would be consistent in stressing freedom of contract, flexible labor markets, and robust property rights, and in prohibiting special regulatory/legal favoritism (so as to avoid anticompetitive market distortions).  Protecting foreign investment through third party arbitration and related guarantees would be key to garnering foreign investor interest in ECs.   The goal would be to foster a business climate favorable to investment, job creation, innovation, and economic growth.  The EC Board would ensure that agreed-to rules would be honored and enforced by EC-specific legal institutions, such as courts.

Because market-oriented EC rules will not affect market-distortive laws elsewhere within the host country, well-organized rent-seeking elites may not have as strong an incentive to oppose creating ECs.  Indeed, to the extent that a share of EC revenues is transferred to the host country government (depending upon the nature of the EC’s charter), elites might directly benefit, using their political connections to share in the profits.  In short, although setting up viable ECs is no easy matter, their establishment need not be politically unfeasible.  Indeed, the continued success of Hong Kong as a free market island within China (Hong Kong places first in the Heritage Foundation’s Index of Economic Freedom), operating under the Basic Law of Hong Kong, suggests the potential for ECs to thrive, despite having very different rules than the parent state’s legal regime.  (Moreover, the success of Hong Kong may have proven contagious, as China is now promoting a new Shanghai Free Trade Zone thaw would compete with Hong Kong and Singapore.)

The CEDP is currently negotiating the establishment of ECs with a number of governments.  As Singham explains, successful launch of an EC requires:  (1) a committed developer; (2) land that can be used for a project; (3) a good external infrastructure connecting the EC with the rest of the country; and (4) “a government that recognizes the benefits to its reform agenda and to its own economic plan of such a designation of regulatory autonomy and is willing to confront its own challenges by thinking outside the box.”  While the fourth prerequisite may be the most difficult to achieve, internal pressures for faster economic growth and increased investment may lead jurisdictions with burdensome regulatory regimes to consider ECs.

Furthermore, as Singham stresses, by promoting competition on the merits, free from favoritism, a successful EC could stimulate successful entrepreneurship.  Scholarly work points to the importance of entrepreneurship to economic development.

Finally, the beneficial economic effects of ECs could give additional ammunition to national competition authorities as they advocate for less restrictive regulatory frameworks within their jurisdictions.  It could thereby render more effective the efforts of the many new national competition authorities, whose success in enhancing competitive conditions within their jurisdictions has been limited at best.

ECs are no panacea – they will not directly affect restrictive national regulatory laws that benefit privileged special interests but harm the overall economy.  However, to the extent they prove financial successes, over time they could play a crucial indirect role in enhancing competition, reducing inefficiency, and spurring economic growth within their host countries.

Tesla Wins Big in Massachusetts

Dan Crane —  18 September 2014

On September 15, Tesla won a big victory in Massachusetts. As we have previously chronicled at length on TOTM ( see, e.g., here, here, herehere, here and here), the car dealers are waging a state-by-state ground war to prevent Tesla from bypassing them and distributing directly to consumers. The dealers invoke 1950s-era franchise protection laws that are obsolete given the radical changes in automotive market in the intervening years and, in any event, have nothing to do with a company like Tesla that doesn’t use dealers at all. In Massachusetts State Automobile Dealers Ass’n, Inc. v. Tesla Motors MA, Inc., -2014 WL 4494167, the Supreme Judicial Court held that the dealers lacked standing to challenge Tesla’s direct distribution since the Massachusetts statute was intended to protect dealers from oppression by franchising manufacturers, not from competition by manufacturers who didn’t franchise at all. As we have previously detailed, there is no legitimate pro-consumer reason for prohibiting direct distribution.

What I found most telling about the Court’s decision was its quotation of a passage from the dealers’ brief. As readers may recall, the dealers have previously asserted that prohibiting direct distribution is necessary to break up the manufacturer’s “retail monopoly,” create price competition, and ensure that consumers get lower prices — arguments that are facially ludicrous as a matter of economics. But now listen to what the dealers have to say in Massachusetts:

Unless the defendants are enjoined, they will be allowed to compete unfairly with the dealers as their model of manufacturer owned dealerships with remote service centers will allow Tesla and Tesla MA financial savings which would not be available to Massachusetts dealers who must spend considerably to conform to Massachusetts law. This could cause inequitable pricing which also [could] cause consumer confusion and the inability to fairly consider the various automobiles offered.

Translation: Direct distribution leads to cost savings that are reflected in lower (“inequitable!”) prices to consumers.

Surely right, since a Justice Department study found that direct distribution could save over $2,200 per vehicle. But coming from the car dealers?  Who would have thunk it?

Section 5 of the Federal Trade Commission Act proclaims that “[u]nfair methods of competition . . . are hereby declared unlawful.” The FTC has exclusive authority to enforce that provision and uses it to prosecute Sherman Act violations. The Commission also uses the provision to prosecute conduct that doesn’t violate the Sherman Act but is, in the Commission’s view, an “unfair method of competition.”

That’s somewhat troubling, for “unfairness” is largely in the eye of the beholder. One FTC Commissioner recently defined an unfair method of competition as an action that is “‘collusive, coercive, predatory, restrictive, or deceitful,’ or otherwise oppressive, [where the actor lacks] a justification grounded in its legitimate, independent self-interest.” Some years ago, a commissioner observed that a “standalone” Section 5 action (i.e., one not premised on conduct that would violate the Sherman Act) could be used to police “social and environmental harms produced as unwelcome by-products of the marketplace: resource depletion, energy waste, environmental contamination, worker alienation, the psychological and social consequences of producer-stimulated demands.” While it’s unlikely that any FTC Commissioner would go that far today, the fact remains that those subject to Section 5 really don’t know what it forbids.  And that situation flies in the face of the Rule of Law, which at a minimum requires that those in danger of state punishment know in advance what they’re not allowed to do.

In light of this fundamental Rule of Law problem (not to mention the detrimental chilling effect vague competition rules create), many within the antitrust community have called for the FTC to provide guidance on the scope of its “unfair methods of competition” authority. Most notably, two members of the five-member FTC—Commissioners Maureen Ohlhausen and Josh Wright—have publicly called for the Commission to promulgate guidelines. So have former FTC Chairman Bill Kovacic, a number of leading practitioners, and a great many antitrust scholars.

Unfortunately, FTC Chairwoman Edith Ramirez has opposed the promulgation of Section 5 guidelines. She says she instead “favor[s] the common law approach, which has been a mainstay of American antitrust policy since the turn of the twentieth century.” Chairwoman Ramirez observes that the common law method has managed to distill workable liability rules from broad prohibitions in the primary antitrust statutes. Section 1 of the Sherman Act, for example, provides that “[e]very contract, combination … or conspiracy, in restraint of trade … is declared to be illegal.” Section 2 prohibits actions to “monopolize, or attempt to monopolize … any part of … trade.” Clayton Act Section 7 forbids any merger whose effect “may be substantially to lessen competition, or tend to create a monopoly.” Just as the common law transformed these vague provisions into fairly clear liability rules, the Chairwoman says, it can be used to provide adequate guidance on Section 5.

The problem is, there is no Section 5 common law. As Commissioner Wright and his attorney-advisor Jan Rybnicek explain in a new paper, development of a common law—which concededly may be preferable to a prescriptive statutory approach, given its flexibility, ability to evolve with new learning, and sensitivity to time- and place-specific factors—requires certain conditions that do not exist in the Section 5 context.

The common law develops and evolves in a salutary direction because (1) large numbers of litigants do their best to persuade adjudicators of the superiority of their position; (2) the closest cases—those requiring the adjudicator to make fine distinctions—get appealed and reported; (3) the adjudicators publish opinions that set forth all relevant facts, the arguments of the parties, and why one side prevailed over the other; (4) commentators criticize published opinions that are unsound or rely on welfare-reducing rules; (5) adjudicators typically follow past precedents, tweaking (or occasionally overruling) them when they have been undermined; and (6) future parties rely on past decisions when planning their affairs.

Section 5 “adjudication,” such as it is, doesn’t look anything like this. Because the Commission has exclusive authority to bring standalone Section 5 actions, it alone picks the disputes that could form the basis of any common law. It then acts as both prosecutor and judge in the administrative action that follows. Not surprisingly, defendants, who cannot know the contours of a prohibition that will change with the composition of the Commission and who face an inherently biased tribunal, usually settle quickly. After all, they are, in Commissioner Wright’s words, both “shooting at a moving target and have the chips stacked against them.” As a result, we end up with very few disputes, and even those are not vigorously litigated.

Moreover, because nearly all standalone Section 5 actions result in settlements, we almost never end up with a reasoned opinion from an adjudicator explaining why she did or did not find liability on the facts at hand and why she rejected the losing side’s arguments. These sorts of opinions are absolutely crucial for the development of the common law. Chairwoman Ramirez says litigants can glean principles from other administrative documents like complaints and consent agreements, but those documents can’t substitute for a reasoned opinion that parses arguments and says which work, which don’t, and why. On top of all this, the FTC doesn’t even treat its own enforcement decisions as precedent! How on earth could the Commission’s body of enforcement decisions guide decision-making when each could well be a one-off?

I’m a huge fan of the common law. It generally accommodates the Hayekian “knowledge problem” far better than inflexible, top-down statutes. But it requires both inputs—lots of vigorously litigated disputes—and outputs—reasoned opinions that are recognized as presumptively binding. In the Section 5 context, we’re short on both. It’s time for guidelines.

PayPal co-founder Peter Thiel has a terrific essay in the Review section of today’s Wall Street Journal.  The essay, Competition Is for Losers, is adapted from Mr. Thiel’s soon-to-be-released book, Zero to One: Notes on Startups, or How to Build the Future.  Based on the title of the book, I assume it is primarily a how-to guide for entrepreneurs.  But if the rest of the book is anything like the essay in today’s Journal, it will also offer lots of guidance to policy makers–antitrust officials in particular.

We antitrusters usually begin with the assumption that monopoly is bad and perfect competition is good. That’s the starting point for most antitrust courses: the professor lays out the model of perfect competition, points to all the wealth it creates and how that wealth is distributed (more to consumers than to producers), and contrasts it to the monopoly pricing model, with its steep marginal revenue curve, hideous “deadweight loss” triangle, and unseemly redistribution of surplus from consumers to producers. Which is better, kids?  Why, perfect competition, of course!

Mr. Thiel makes the excellent and oft-neglected point that monopoly power is not necessarily a bad thing. First, monopolists can do certain good things that perfect competitors can’t do:

A monopoly like Google is different. Since it doesn’t have to worry about competing with anyone, it has wider latitude to care about its workers, its products and its impact on the wider world. Google’s motto–“Don’t be evil”–is in part a branding ploy, but it is also characteristic of a kind of business that is successful enough to take ethics seriously without jeopardizing its own existence.  In business, money is either an important thing or it is everything. Monopolists can think about things other than making money; non-monopolists can’t. In perfect competition, a business is so focused on today’s margins that it can’t possibly plan for a long-term future. Only one thing can allow a business to transcend the daily brute struggle for survival: monopoly profits.

Fair enough, Thiel. But what about consumers? That model we learned shows us that they’re worse off under monopoly.  And what about the deadweight loss triangle–don’t forget about that ugly thing! 

So a monopoly is good for everyone on the inside, but what about everyone on the outside? Do outsize profits come at the expense of the rest of society? Actually, yes: Profits come out of customers’ wallets, and monopolies deserve their bad reputations–but only in a world where nothing changes.

Wait a minute, Thiel. Why do you think things are different when we inject “change” into the analysis?

In a static world, a monopolist is just a rent collector. If you corner the market for something, you can jack up the price; others will have no choice but to buy from you. Think of the famous board game: Deeds are shuffled around from player to player, but the board never changes. There is no way to win by inventing a better kind of real estate development. The relative values of the properties are fixed for all time, so all you can do is try to buy them up.

But the world we live in is dynamic: We can invent new and better things. Creative monopolists give customers more choices by adding entirely new categories of abundance to the world. Creative monopolies aren’t just good for the rest of society; they’re powerful engines for making it better.

Even the government knows this: That is why one of the departments works hard to create monopolies (by granting patents to new inventions) even though another part hunts them down (by prosecuting antitrust cases). It is possible to question whether anyone should really be rewarded a monopoly simply for having been the first to think of something like a mobile software design. But something like Apple’s monopoly profits from designing, producing and marketing the iPhone were clearly the reward for creating greater abundance, not artificial scarcity: Customers were happy to finally have the choice of paying high prices to get a smartphone that actually works. The dynamism of new monopolies itself explains why old monopolies don’t strangle innovation. With Apple’s iOS at the forefront, the rise of mobile computing has dramatically reduced Microsoft’s decadeslong operating system dominance.

…If the tendency of monopoly businesses was to hold back progress, they would be dangerous, and we’d be right to oppose them. But the history of progress is a history of better monopoly businesses replacing incumbents. Monopolies drive progress because the promise of years or even decades of monopoly profits provides a powerful incentive to innovate. Then monopolies can keep innovating because profits enable them to make the long-term plans and finance the ambitious research projects that firms locked in competition can’t dream of.

Geez, Thiel.  You know who you sound like?  Justice Scalia. Here’s how he once explained your idea (to shrieks and howls from many in the antitrust establishment!):

The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices–at least for a short period–is what attracts “business acumen” in the first place. It induces risk taking that produces innovation and economic growth. To safeguard the incentive to innovate, the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.

Sounds like you and Scalia are calling for us antitrusters to update our models.  Is that it?

So why are economists obsessed with competition as an ideal state? It is a relic of history. Economists copied their mathematics from the work of 19th-century physicists: They see individuals and businesses as interchangeable atoms, not as unique creators. Their theories describe an equilibrium state of perfect competition because that is what’s easy to model, not because it represents the best of business.

C’mon now, Thiel. Surely you don’t expect us antitrusters to defer to you over all these learned economists when it comes to business.

Recently I highlighted problems with the FTC’s enforcement actions targeting companies’ data security protection policies, and recommended that the FTC adopt a cost-benefit approach to regulation in this area.  Yesterday the Heritage Foundation released a more detailed paper by me on this topic, replete with recommendations for new FTC guidance and specific reforms aimed at maintaining appropriate FTC oversight while reducing excessive burdens.  Happy reading!

A century ago Congress enacted the Clayton Act, which prohibits acquisitions that may substantially lessen competition. For years, the antitrust enforcement Agencies looked at only one part of the ledger – the potential for price increases. Agencies didn’t take into account the potential efficiencies in cost savings, better products, services, and innovation. One of the major reforms of the Clinton Administration was to fully incorporate efficiencies in merger analysis, helping to develop sound enforcement standards for the 21st Century.

But the current approach of the Federal Trade Commission (“FTC”), especially in hospital mergers, appears to be taking a major step backwards by failing to fully consider efficiencies and arguing for legal thresholds inconsistent with sound competition policy. The FTC’s approach used primarily in hospital mergers seems uniquely misguided since there is a tremendous need for smart hospital consolidation to help bend the cost curve and improve healthcare delivery.

The FTC’s backwards analysis of efficiencies is juxtaposed in two recent hospital-physician alliances.

As I discussed in my last post, no one would doubt the need for greater integration between hospitals and physicians – the debate during the enactment of the Affordable Care Act (“ACA”) detailed how the current siloed approach to healthcare is the worst of all worlds, leading to escalating costs and inferior care. In FTC v. St. Luke’s Health System, Ltd., the FTC challenged Boise-based St. Luke’s acquisition of a physician practice in neighboring Nampa, Idaho.

In the case, St. Luke’s presented a compelling case for efficiencies.

As noted by the St. Luke’s court, one of the leading factors in rising healthcare costs is the use of the ineffective fee-for-service system. In their attempt to control costs and abandon fee-for-service payment, the merging parties effectively demonstrated to the court that the combined entity would offer a high level of coordinated and patient-centered care. Therefore, along with integrating electronic records and increasing access for under-privileged patients, the merged entity can also successfully manage population health and offer risk-based payment initiatives to all employed physicians. Indeed, the transaction consummated several months ago has already shown significant cost savings and consumer benefits especially for underserved patients. The court recognized

[t]he Acquisition was intended by St. Luke’s and Saltzer primarily to improve patient outcomes. The Court believes that it would have that effect if left intact.

(Appellants’ Reply Brief at 22, FTC v. St. Luke’s Health Sys., No 14-35173 (9th Cir. Sept. 2, 2014).)

But the court gave no weight to the efficiencies primarily because the FTC set forward the wrong legal roadmap.

Under the FTC’s current roadmap for efficiencies, the FTC may prove antitrust harm via predication and presumption while defendants are required to decisively prove countervailing procompetitive efficiencies. Such asymmetric burdens of proof greatly favor the FTC and eliminate a court’s ability to properly analyze the procompetitive nature of efficiencies against the supposed antitrust harm.

Moreover, the FTC basically claims that any efficiencies can only be considered “merger-specific” if the parties are able to demonstrate there are no less anticompetitive means to achieve them. It is not enough that they result directly from the merger.

In the case of St. Luke’s, the court determined the defendants’ efficiencies would “improve the quality of medical care” in Nampa, Idaho, but were not merger-specific. The court relied on the FTC’s experts to find that efficiencies such as “elimination of fee-for-service reimbursement” and the movement “to risk-based reimbursement” were not merger-specific, because other entities had potentially achieved similar efficiencies within different provider “structures.” The FTC and their experts did not indicate the success of these other models nor dispute that St. Luke’s would achieve their stated efficiencies. Instead, the mere possibility of potential, alternative structures was enough to overcome merger efficiencies purposed to “move the focus of health care back to the patient.” (The case is currently on appeal and hopefully the Ninth Circuit can correct the lower court’s error).

In contrast to the St. Luke’s case is the recent FTC advisory letter to the Norman Physician Hospital Organization (“Norman PHO”). The Norman PHO proposed a competitive collaboration serving to integrate care between the Norman Physician Association’s 280 physicians and Norman Regional Health System, the largest health system in Norman, Oklahoma. In its analysis of the Norman PHO, the FTC found that the groups could not “quantify… the likely overall efficiency benefits of its proposed program” nor “provide direct evidence of actual efficiencies or competitive effects.” Furthermore, such an arrangement had the potential to “exercise market power.” Nonetheless, the FTC permitted the collaboration. Its decision was instead decided on the basis of Norman PHO’s non-exclusive physician contracting provisions.

It seems difficult if not impossible to reconcile the FTC’s approaches in Boise and Norman. In Norman the FTC relied on only theoretical efficiencies to permit an alliance with significant market power. The FTC was more than willing to accept Norman PHO’s “potential to… generate significant efficiencies.” Such an even-handed approach concerning efficiencies was not applied in analyzing efficiencies in St. Luke’s merger.

The starting point for understanding the FTC’s misguided analysis of efficiencies in St. Luke’s and other merger cases stems from the 2010 Horizontal Merger Guidelines (“Guidelines”).

A recent dissent by FTC Commissioner Joshua Wright outlines the problem – there are asymmetric burdens placed on the plaintiff and defendant. Using the Guidelines, FTC’s merger analysis

embraces probabilistic prediction, estimation, presumption, and simulation of anticompetitive effects on the one hand but requires efficiencies to be proven on the other.

Relying on the structural presumption established in United States v. Philadelphia Nat’l Bank, the FTC need only illustrate that a merger will substantially lessen competition, typically demonstrated through a showing of undue concentration in a relevant market, not actual anticompetitive effects. If this low burden is met, the burden is then shifted to the defendants to rebut the presumption of competitive harm.

As part of their defense, defendants must then prove that any proposed efficiencies are cognizable, meaning “merger-specific,” and have been “verified and do not arise from anticompetitive reductions in output or service.” Furthermore, merging parties must demonstrate “by reasonable means the likelihood and magnitude of each asserted efficiency, how and when each would be achieved…, how each would enhance the merged firm’s ability and incentive to compete, and why each would be merger-specific.”

As stated in a recent speech by FTC Commissioner Joshua Wright,

the critical lesson of the modern economic approach to mergers is that post-merger changes in pricing incentives and competitive effects are what matter.

The FTC’s merger policy “has long been dominated by a focus on only one side of the ledger—anticompetitive effects.” In other words the defendants must demonstrate efficiencies with certainty, while the government can condemn a merger based on a prediction. This asymmetric enforcement policy favors the FTC while requiring defendants meet stringent, unyielding standards.

As the ICLE amicus brief in St. Luke’s discusses, not satisfied with the asymmetric advantage, the plaintiffs in St. Luke’s attempt to “guild the lily” by claiming that efficiencies can only be considered in cases where there is a presumption of competitive harm, perhaps based solely on “first order” evidence, such as increased market shares. Of course, nothing in the law, Guidelines, or sound competition policy limits the defense in that fashion.

The court should consider efficiencies regardless of the level of economic harm. The question is whether the efficiencies will outweigh that harm. As Geoff recently pointed out:

There is no economic basis for demanding more proof of claimed efficiencies than of claimed anticompetitive harms. And the Guidelines since 1997 were (ostensibly) drafted in part precisely to ensure that efficiencies were appropriately considered by the agencies (and the courts) in their enforcement decisions.

With presumptions that strongly benefit the FTC, it is clear that efficiencies are often overlooked or ignored. From 1997-2007, FTC’s Bureau of Competition staff deliberated on a total of 342 efficiencies claims. Of the 342 efficiency claims, only 29 were accepted by FTC staff whereas 109 were rejected and 204 received “no decision.” The most common concerns among FTC staff were that stated efficiencies were not verifiable or were not merger specific.

Both “concerns” come directly from the Guidelines requiring plaintiffs provide significant and oftentimes impossible foresight and information to overcome evidentiary burdens. As former FTC Chairman Tim Muris observed

too often, the [FTC] found no cognizable efficiencies when anticompetitive effects were determined to be likely and seemed to recognize efficiency only when no adverse effects were predicted.

Thus, in situations in which the FTC believes the dominant issue is market concentration, plaintiffs’ attempts to demonstrate procompetitive reasoning are outright dismissed.

The FTC’s efficiency arguments are also not grounded in legal precedent. Courts have recognized that asymmetric burdens are inconsistent with the intent of the Act. As then D.C. Circuit Judge Clarence Thomas observed,

[i]mposing a heavy burden of production on a defendant would be particularly anomalous where … it is easy to establish a prima facie case.

Courts have recognized that efficiencies can be “speculative” or be “based on a prediction backed by sound business judgment.” And in Sherman Act cases the law places the burden on the plaintiff to demonstrate that there are less restrictive alternatives to a potentially illegal restraint – unlike the requirement applied by the FTC that the defendant prove there are no less restrictive alternatives to a merger to achieve efficiencies.

The FTC and the courts should deem worthy efficiencies wherein there is a reasonable likelihood that procompetitive effects will take place post-merger. Furthermore, the courts should not look at efficiencies inside a vacuum. In healthcare, policies and laws, such as the effects of the ACA, must be taken into account. The ACA promotes coordination among providers and incentivizes entities that can move away from fee-for-service payment. In the past, courts relying on the role of health policy in merger analysis have found that efficiencies leading to integrated medicine and “better medical care” are relevant.

In St. Luke’s the court observed that “the existing law seemed to hinder innovation and resist creative solutions” and that “flexibility and experimentation” are “two virtues that are not emphasized in the antitrust law.” Undoubtedly, the current approach to efficiencies makes it near impossible for providers to demonstrate efficiencies.

As Commissioner Wright has observed, these asymmetric evidentiary burdens

do not make economic sense and are inconsistent with a merger policy designed to promote consumer welfare.

In the context of St. Luke’s and other healthcare provider mergers, appropriate efficiency analysis is a keystone of determining a merger’s total effects. Dismissal of efficiencies on the basis of a rigid, incorrect legal procedural structure is not aligned with current economic thinking or a sound approach to incorporate competition analysis into the drive for healthcare reform. It is time for the FTC to set efficiency analysis in the right direction.