Archives For antitrust

Microsoft and its allies (the Microsoft-funded trade organization FairSearch and the prolific Google critic Ben Edelman) have been highly critical of Google’s use of “secret” contracts to license its proprietary suite of mobile apps, Google Mobile Services, to device manufacturers.

I’ve written about this at length before. As I said previously,

In order to argue that Google has an iron grip on Android, Edelman’s analysis relies heavily on ”secret” Google licensing agreements — “MADAs” (Mobile Application Distribution Agreements) — trotted out with such fanfare one might think it was the first time two companies ever had a written contract (or tried to keep it confidential).

For Edelman, these agreements “suppress competition” with “no plausible pro-consumer benefits.”

Microsoft (via another of its front groups, ICOMP) responded in predictable fashion.

While the hysteria over private, mutually beneficial contracts negotiated between sophisticated corporations was always patently absurd (who ever heard of sensitive commercial contracts that weren’t confidential?), Edelman’s claim that the Google MADAs operate to “suppress competition” with “no plausible pro-consumer benefits” was the subject of my previous post.

I won’t rehash all of those arguments here, but rather point to another indication that such contract terms are not anticompetitive: The recent revelation that they are used by others in the same industry — including, we’ve learned (to no one’s surprise), Microsoft.

Much like the release of Google’s MADAs in an unrelated lawsuit, the ongoing patent licensing contract dispute between Microsoft and Samsung has obliged the companies to release their own agreements. As it happens, they are at least as restrictive as the Google agreements criticized by Edelman — and, in at least one way, even more so.

Some quick background: As I said in my previous post, it is no secret that equipment manufacturers have the option to license a free set of Google apps (Google Mobile Services) and set Google as the default search engine. However, Google allows OEMs to preinstall other competing search engines as they see fit. Indeed, no matter which applications come pre-installed, the user can easily download Yahoo!, Microsoft’s Bing, Yandex, Naver, DuckDuckGo and other search engines for free from the Google Play Store.

But Microsoft has sought to impose even-more stringent constraints on its device partners. One of the agreements disclosed in the Microsoft-Samsung contract litigation, the “Microsoft-Samsung Business Collaboration Agreement,” requires Samsung to set Bing as the search default for all Windows phones and precludes Samsung from pre-installing any other search applications on Windows-based phones. Samsung must configure all of its Windows Phones to use Microsoft Search Services as the

default Web Search  . . . in all instances on such properties where Web Search can be launched or a Query submitted directly by a user (including by voice command) or automatically (including based on location or context).

Interestingly, the agreement also requires Samsung to install Microsoft Search Services as a non-default search option on all of Samsung’s non-Microsoft Android devices (to the extent doing so does not conflict with other contracts).

Of course, the Microsoft-Samsung contract is expressly intended to remain secret: Its terms are declared to be “Confidential Information,” prohibiting Samsung from making “any public statement regarding the specific terms of [the] Agreement” without Microsoft’s consent.

Meanwhile, the accompanying Patent License Agreement provides that

all terms and conditions in this Agreement, including the payment amount [and the] specific terms and conditions in this Agreement (including, without limitation, the amount of any fees and any other amounts payable to Microsoft under this Agreement) are confidential and shall not be disclosed by either Party.

In addition to the confidentiality terms spelled out in these two documents, there is a separate Non-Disclosure Agreement—to further dispel any modicum of doubt on that score. Perhaps this is why Edelman was unaware of the ubiquity of such terms (and their confidentiality) when he issued his indictment of the Google agreements but neglected to mention Microsoft’s own.

In light of these revelations, Edelman’s scathing contempt for the “secrecy” of Google’s MADAs seems especially disingenuous:

MADA secrecy advances Google’s strategic objectives. By keeping MADA restrictions confidential and little-known, Google can suppress the competitive response…Relatedly, MADA secrecy helps prevent standard market forces from disciplining Google’s restriction. Suppose consumers understood that Google uses tying and full-line-forcing to prevent manufacturers from offering phones with alternative apps, which could drive down phone prices. Then consumers would be angry and would likely make their complaints known both to regulators and to phone manufacturers. Instead, Google makes the ubiquitous presence of Google apps and the virtual absence of competitors look like a market outcome, falsely suggesting that no one actually wants to have or distribute competing apps.

If, as Edelman claims, Google’s objectionable contract terms “serve both to help Google expand into areas where competition could otherwise occur, and to prevent competitors from gaining traction,” then what are the very same sorts of terms doing in Microsoft’s contracts with Samsung? The revelation that Microsoft employs contracts similar to — and similarly confidential to — Google’s highlights the hypocrisy of claims that such contracts serve anticompetitive aims.

In fact, as I discussed in my previous post, there are several pro-competitive justifications for such agreements, whether undertaken by a market leader or a newer entrant intent on catching up. Most obviously, such contracts help to ensure that consumers receive the user experience they demand on devices manufactured by third parties. But more to the point, the fact that such arrangements permeate the market and are adopted by both large and small competitors is strong indication that such terms are pro-competitive.

At the very least, they absolutely demonstrate that such practices do not constitute prima facie evidence of the abuse of market power.

[Reminder: See the “Disclosures” page above. ICLE has received financial support from Google in the past, and I formerly worked at Microsoft. Of course, the views here are my own, although I encourage everyone to agree with them.]

There is always a temptation for antitrust agencies and plaintiffs to center a case around so-called “hot” documents — typically company documents with a snippet or sound-bites extracted, some times out of context. Some practitioners argue that “[h]ot document can be crucial to the outcome of any antitrust matter.” Although “hot” documents can help catch the interest of the public, a busy judge or an unsophisticated jury, they often can lead to misleading results. But more times than not, antitrust cases are resolved on economics and what John Adams called “hard facts,” not snippets from emails or other corporate documents. Antitrust case books are littered with cases that initially looked promising based on some supposed hot documents, but ultimately failed because the foundations of a sound antitrust case were missing.

As discussed below this is especially true for a recent case brought by the FTC, FTC v. St. Luke’s, currently pending before the Ninth Circuit Court of Appeals, in which the FTC at each pleading stage has consistently relied on “hot” documents to make its case.

The crafting and prosecution of civil antitrust cases by federal regulators is a delicate balancing act. Regulators must adhere to well-defined principles of antitrust enforcement, and on the other hand appeal to the interests of a busy judge. The simple way of doing this is using snippets of documents to attempt to show the defendants knew they were violating the law.

After all, if federal regulators merely had to properly define geographic and relevant product markets, show a coherent model of anticompetitive harm, and demonstrate that any anticipated harm would outweigh any procompetitive benefits, where is the fun in that? The reality is that antitrust cases typically rely on economic analysis, not snippets of hot documents. Antitrust regulators routinely include internal company documents in their cases to supplement the dry mechanical nature of antitrust analysis. However, in isolation, these documents can create competitive concerns when they simply do not exist.

With this in mind, it is vital that antitrust regulators do not build an entire case around what seem to be inflammatory documents. Quotes from executives, internal memoranda about competitors, and customer presentations are the icing on the cake after a proper antitrust analysis. As the International Center for Law and Economics’ Geoff Manne once explained,

[t]he problem is that these documents are easily misunderstood, and thus, while the economic significance of such documents is often quite limited, their persuasive value is quite substantial.

Herein lies the problem illustrated by the Federal Trade Commission’s use of provocative documents in its suit against the vertical acquisition of Saltzer Medical Group, an independent physician group comprised of 41 doctors, by St. Luke’s Health System. The FTC seeks to stop the acquisition involving these two Idaho based health care providers, a $16 million transaction, and a number comparatively small to other health care mergers investigated by the antitrust agencies. The transaction would give St. Luke’s a total of 24 primary care physicians operating in and around Nampa, Idaho.

In St. Luke’s the FTC used “hot” documents in each stage of its pleadings, from its complaint through its merits brief on appeal. Some of the statements pulled from executives’ emails, notes and memoranda seem inflammatory suggesting St. Luke’s intended to increase prices and to control market share all in order to further its strength relative to payer contracting. These statements however have little grounding in the reality of health care competition.

The reliance by the FTC on these so-called hot documents is problematic for several reasons. First, the selective quoting of internal documents paints the intention of the merger solely to increase profit for St. Luke’s at the expense of payers, when the reality is that the merger is premised on the integration of health care services and the move from the traditional fee-for-service model to a patient-centric model. St Luke’s intention of incorporating primary care into its system is in-line with the goals of the Affordable Care Act to promote over all well-being through integration. The District Court in this case recognized that the purpose of the merger was “primarily to improve patient outcomes.” And, in fact, underserved and uninsured patients are already benefitting from the transaction.

Second, the selective quoting suggested a narrow geographic market, and therefore an artificially high level of concentration in Nampa, Idaho. The suggestion contradicts reality, that nearly one-third of Nampa residents seek primary care physician services outside of Nampa. The geographic market advanced by the FTC is not a proper market, regardless of whether selected documents appear to support it. Without a properly defined geographic market, it is impossible to determine market share and therefore prove a violation of the Clayton Antitrust Act.

The DOJ Antitrust Division and the FTC have acknowledged that markets can not properly be defined solely on spicy documents. Writing in their 2006 commentary on the Horizontal Merger Guidelines, the agencies noted that

[t]he Agencies are careful, however, not to assume that a ‘market’ identified for business purposes is the same as a relevant market defined in the context of a merger analysis. … It is unremarkable that ‘markets’ in common business usage do not always coincide with ‘markets’ in an antitrust context, inasmuch as the terms are used for different purposes.

Third, even if St. Luke’s had the intention of increasing prices, just because one wants to do something such as raise prices above a competitive level or scale back research and development expenses — even if it genuinely believes it is able — does not mean that it can. Merger analysis is not a question of mens rea (or subjective intent). Rather, the analysis must show that such behavior will be likely as a result of diminished competition. Regulators must not look at evidence of this subjective intent and then conclude that the behavior must be possible and that a merger is therefore likely to substantially lessen competition. This would be the tail wagging the dog. Instead, regulators must first determine whether, as a matter of economic principle, a merger is likely to have a particular effect. Then, once the analytical tests have been run, documents can support these theories. But without sound support for the underlying theories, documents (however condemning) cannot bring the case across the goal line.

Certainly, documents suggesting intent to raise prices should bring an antitrust plaintiff across the goal line? Not so, as Seventh Circuit Judge Frank Easterbrook has explained:

Almost all evidence bearing on “intent” tends to show both greed and desire to succeed and glee at a rival’s predicament. … [B]ut drive to succeed lies at the core of a rivalrous economy. Firms need not like their competitors; they need not cheer them on to success; a desire to extinguish one’s rivals is entirely consistent with, often is the motive behind competition.

As Harvard Law Professor Phil Areeda observed, relying on documents describing intent is inherently risky because

(1) the businessperson often uses a colorful and combative vocabulary far removed from the lawyer’s linguistic niceties, and (2) juries and judges may fail to distinguish a lawful competitive intent from a predatory state of mind. (7 Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law § 1506 (2d ed. 2003).)

So-called “hot” documents may help guide merger analysis, but served up as a main course make a paltry meal. Merger cases rise or fall on hard facts and economics, and next week we will see if the Ninth Circuit recognizes this as both St. Luke’s and the FTC argue their cases.

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.