Archives For economics

How Copyright Drives Innovation in Scholarly Publishing

Adam Mossoff —  5 April 2013

[Cross posted at the Center for the Protection of Intellectual Property blog.]

Today’s public policy debates frame copyright policy solely in terms of a “trade off” between the benefits of incentivizing new works and the social deadweight losses imposed by the access restrictions imposed by these (temporary) “monopolies.” I recently posted to SSRN a new research paper, called How Copyright Drives Innovation in Scholarly Publishing, explaining that this is a fundamental mistake that has distorted the policy debates about scholarly publishing.

This policy mistake is important because it has lead commentators and decision-makers to dismiss as irrelevant to copyright policy the investments by scholarly publishers of $100s of millions in creating innovative distribution mechanisms in our new digital world. These substantial sunk costs are in addition to the $100s of millions expended annually by publishers in creating, publishing and maintaining reliable, high-quality, standardized articles distributed each year in a wide-ranging variety of academic disciplines and fields of research. The articles now number in the millions themselves; in 2009, for instance, over 2,000 publishers issued almost 1.5 million articles just in the scientific, technical and medical fields, exclusive of the humanities and social sciences.

The mistaken incentive-to-invent conventional wisdom in copyright policy is further compounded by widespread misinformation today about the allegedly “zero cost” of digital publication. As a result, many people are simply unaware of the substantial investments in infrastructure, skilled labor and other resources required to create, publish and maintain scholarly articles on the Internet and in other digital platforms.

This is not merely a so-called “academic debate” about copyright policy and publishing.

The policy distortion caused by the narrow, reductionist incentive-to-create conventional wisdom, when combined with the misinformation about the economics of digital business models, has been spurring calls for “open access” mandates for scholarly research, such as at the National Institute of Health and in recently proposed legislation (FASTR Act) and in other proposed regulations. This policy distortion even influenced Justice Breyer’s opinion in the recent decision in Kirtsaeng v. John Wiley & Sons (U.S. Supreme Court, March 19, 2013), as he blithely dismissed commercial incentivizes as being irrelevant to fundamental copyright policy. These legal initiatives and the Kirtsaeng decision are motivated in various ways by the incentive-to-create conventional wisdom, by the misunderstanding of the economics of scholarly publishing, and by anti-copyright rhetoric on both the left and right, all of which has become more pervasive in recent years.

But, as I explain in my paper, courts and commentators have long recognized that incentivizing authors to produce new works is not the sole justification for copyright—copyright also incentivizes intermediaries like scholarly publishers to invest in and create innovative legal and market mechanisms for publishing and distributing articles that report on scholarly research. These two policies—the incentive to create and the incentive to commercialize—are interrelated, as both are necessary in justifying how copyright law secures the dynamic innovation that makes possible the “progress of science.” In short, if the law does not secure the fruits of labors of publishers who create legal and market mechanisms for disseminating works, then authors’ labors will go unrewarded as well.

As Justice Sandra Day O’Connor famously observed in the 1984 decision in Harper & Row v. Nation Enterprises: “In our haste to disseminate news, it should not be forgotten the Framers intended copyright itself to be the engine of free expression. By establishing a marketable right to the use of one’s expression, copyright supplies the economic incentive to create and disseminate ideas.” Thus, in Harper & Row, the Supreme Court reached the uncontroversial conclusion that copyright secures the fruits of productive labors “where an author and publisher have invested extensive resources in creating an original work.” (emphases added)

This concern with commercial incentives in copyright law is not just theory; in fact, it is most salient in scholarly publishing because researchers are not motivated by the pecuniary benefits offered to authors in conventional publishing contexts. As a result of the policy distortion caused by the incentive-to-create conventional wisdom, some academics and scholars now view scholarly publishing by commercial firms who own the copyrights in the articles as “a form of censorship.” Yet, as courts have observed: “It is not surprising that [scholarly] authors favor liberal photocopying . . . . But the authors have not risked their capital to achieve dissemination. The publishers have.” As economics professor Mark McCabe observed (somewhat sardonically) in a research paper released last year for the National Academy of Sciences: he and his fellow academic “economists knew the value of their journals, but not their prices.”

The widespread ignorance among the public, academics and commentators about the economics of scholarly publishing in the Internet age is quite profound relative to the actual numbers.  Based on interviews with six different scholarly publishers—Reed Elsevier, Wiley, SAGE, the New England Journal of Medicine, the American Chemical Society, and the American Institute of Physics—my research paper details for the first time ever in a publication and at great length the necessary transaction costs incurred by any successful publishing enterprise in the Internet age.  To take but one small example from my research paper: Reed Elsevier began developing its online publishing platform in 1995, a scant two years after the advent of the World Wide Web, and its sunk costs in creating this first publishing platform and then digitally archiving its previously published content was over $75 million. Other scholarly publishers report similarly high costs in both absolute and relative terms.

Given the widespread misunderstandings of the economics of Internet-based business models, it bears noting that such high costs are not unique to scholarly publishers.  Microsoft reportedly spent $10 billion developing Windows Vista before it sold a single copy, of which it ultimately did not sell many at all. Google regularly invests $100s of millions, such as $890 million in the first quarter of 2011, in upgrading its data centers.  It is somewhat surprising that such things still have to be pointed out a scant decade after the bursting of the dot.com bubble, a bubble precipitated by exactly the same mistaken view that businesses have somehow been “liberated” from the economic realities of cost by the Internet.

Just as with the extensive infrastructure and staffing costs, the actual costs incurred by publishers in operating the peer review system for their scholarly journals are also widely misunderstood.  Individual publishers now receive hundreds of thousands—the large scholarly publisher, Reed Elsevier, receives more than one million—manuscripts per year. Reed Elsevier’s annual budget for operating its peer review system is over $100 million, which reflects the full scope of staffing, infrastructure, and other transaction costs inherent in operating a quality-control system that rejects 65% of the submitted manuscripts. Reed Elsevier’s budget for its peer review system is consistent with industry-wide studies that have reported that the peer review system costs approximately $2.9 billion annually in operation costs (translating into dollars the British £1.9 billion pounds reported in the study). For those articles accepted for publication, there are additional, extensive production costs, and then there are extensive post-publication costs in updating hypertext links of citations, cyber security of the websites, and related digital issues.

In sum, many people mistakenly believe that scholarly publishers are no longer necessary because the Internet has made moot all such intermediaries of traditional brick-and-mortar economies—a viewpoint reinforced by the equally mistaken incentive-to-create conventional wisdom in the copyright policy debates today. But intermediaries like scholarly publishers face the exact same incentive problems that is universally recognized for authors by the incentive-to-create conventional wisdom: no will make the necessary investments to create a work or to distribute if the fruits of their labors are not secured to them. This basic economic fact—dynamic development of innovative distribution mechanisms require substantial investment in both people and resources—is what makes commercialization an essential feature of both copyright policy and law (and of all intellectual property doctrines).

It is for this reason that copyright law has long promoted and secured the value that academics and scholars have come to depend on in their journal articles—reliable, high-quality, standardized, networked, and accessible research that meets the differing expectations of readers in a variety of fields of scholarly research. This is the value created by the scholarly publishers. Scholarly publishers thus serve an essential function in copyright law by making the investments in and creating the innovative distribution mechanisms that fulfill the constitutional goal of copyright to advance the “progress of science.”

DISCLOSURE: The paper summarized in this blog posting was supported separately by a Leonardo Da Vinci Fellowship and by the Association of American Publishers (AAP). The author thanks Mark Schultz for very helpful comments on earlier drafts, and the AAP for providing invaluable introductions to the five scholarly publishers who shared their publishing data with him.

NOTE: Some small copy-edits were made to this blog posting.

 

In copyright, economics, intellectual property, legal scholarship, markets, scholarship, SSRN, technology , , , , , , , , , ,
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Hey Hey! Ho Ho! Partial De Facto Exclusive Dealing Claims Have Got to Go!

Thom Lambert —  27 March 2013

Today, a group of eighteen scholars, of which I am one, filed an amicus brief encouraging the Supreme Court to review a Court of Appeals decision involving loyalty rebates.  The U.S. Court of Appeals for the Third Circuit recently upheld an antitrust judgment based on a defendant’s loyalty rebates even though the rebates resulted in above-cost prices for the defendant’s products and could have been matched by an equally efficient rival.  The court did so because it decided that the defendant’s overall selling practices, which involved no exclusivity commitments by buyers, had resulted in “partial de facto exclusive dealing” and thus were not subject to the price-cost test set forth in Brooke Group.  (For the uniniated, Brooke Group immunizes price cuts that result in above-cost prices for the discounter’s goods.)  We amici, who were assembled by Michigan Law’s Dan Crane, believe the Third Circuit’s decision threatens to chill proconsumer discounting practices and should be overruled.

The defendant in the case, Eaton, manufactures transmissions for big trucks (semis, cement trucks, etc.).  So did plaintiff Meritor.  Eaton and Meritor sold their products to the four manufacturers of big trucks.  Those “OEMs” installed the transmissions into the trucks they sold to end-user buyers, who typically customized their trucks and thus could select whatever transmissions they wanted.  Meritor claimed that Eaton drove it from the market by entering into purportedly exclusionary ”long-term agreements” (LTAs) with the four OEMs.  The agreements did not require the OEMs to purchase any particular amount of Eaton’s products, but they did provide the OEMs with rebates (resulting in above-cost prices) if they bought high percentages of their requirements from Eaton.  The agreements also provided that Eaton could terminate the agreements if the market share targets were not met. Each LTA contained a “competitiveness clause” that allowed the OEM to purchase transmissions from another supplier without counting the purchases against the share target, or to terminate the LTA altogether, if another supplier offered a lower price or better product and Eaton could not match that offering.  Following adoption of the LTAs, Eaton’s market share grew, and Meritor’s shrank.  Before withdrawing from the U.S. market altogether, Meritor filed an antitrust action against Eaton.

Eaton insisted, not surprisingly, that it had simply engaged in hard competition.  It grew its market share by offering a lower price that an equally efficient rival could have matched.  Meritor’s failure, then, resulted from either its relative inefficiency or its unwillingness to lower its price to the level of its cost.  By immunizing above-cost discounted prices from liability, the Brooke Group rule permits and encourages the sort of competition in which Eaton engaged, and it should, the company argued, control here.

The Third Circuit disagreed.  This was not, the court said, a simple case of price discounting.  Instead, Eaton had engaged in what the court called “partial de facto exclusive dealing.”  The exclusive dealing was “partial”  because OEMs could purchase some transmissions from other suppliers and still obtain Eaton’s loyalty rebates (i.e., complete exclusivity was not required).  It was “de facto” because purchasing exclusively (or nearly exclusively) from Eaton was not contractually required but was instead simply the precondition for earning a rebate.  Nonetheless, reasoned the court, the gravamen of Meritor’s complaint was some sort of exclusive dealing, which is evaluated not under Brooke Group but instead under a rule of reason that focuses on the degree to which the seller’s practices foreclose its rivals from available sales opportunities.  Under that test, the court concluded, the judgment against Eaton could be upheld.  After all, Eaton’s sales practices won lots of business from Meritor, whose sales eventually shrunk so much that the company exited the market.

As we amici point out in our brief to the Supreme Court, the Third Circuit ignored the fact that it was Eaton’s discounts that led OEMs to buy so much from the company (and forego its rival’s offerings).  Absent an actual promise to buy a high level of one’s requirements from a seller, any “exclusive dealing” resulting from a loyalty rebate scheme results from the fact that buyers voluntarily choose to patronize the seller over its competitors because the discounter’s products are cheaper.  In other words, low pricing is the very means by which any “exclusivity” — and, hence, any market foreclosure — is achieved.  Any claim alleging that an agreement not mandating a certain level of purchases but instead providing for loyalty rebates results in “partial de facto exclusive dealing” is therefore, at its heart, a complaint about price competition.  Accordingly, it should be subject to the Brooke Group screening test for discounts resulting in above-cost pricing.

The Third Circuit wrongly insisted that Eaton had done something more sinister than win business by offering above-cost loyalty rebates.  It concluded that Eaton “essentially forced” the four OEMs (who likely had a good bit of buyer market power themselves) to accept its terms by threatening “financial penalties or supply shortages.”  But these purported “penalties” and threats of “supply shortages” appear nowhere in the record.

The only “penalty” an OEM would have incurred by failing to meet a purchase target is the denial of a rebate from Eaton.  If that’s enough to make Brooke Group inapplicable, then any conditional price cut resulting in an above-cost price falls outside the decision’s safe harbor, for failure to meet the discount condition would subject buyers to a “penalty.”  Proconsumer price competition would surely be chilled by such an evisceration of Brooke Group.  As for threats of supply shortages, the only thing Meritor and the Third Circuit could point to was Eaton’s contractual right to cancel its LTAs if OEMs failed to meet purchase targets.  But if that were enough to make Brooke Group inapplicable, then the decision’s price-cost test could never apply when a dominant seller offers a conditional rebate or discount.  Because the seller could refuse in the future to supply buyers who fail to qualify for the discount, there would be, under the Third Circuit’s reasoning, not just a loyalty rebate but also an implicit threat of “supply shortages” for buyers that fail to meet the seller’s purchase targets.

This is not the first case in which a plaintiff has sought to evade a price-cost test, and thereby impose liability on a discounting scheme that would otherwise pass muster, by seeking to recharacterize the defendant’s conduct.  A few years back, a plaintiff (Masimo) sought to evade the Ninth Circuit’s PeaceHealth decision, which creates a Brooke Group-like safe harbor for certain bundled discounts that could not exclude equally efficient rivals, by construing the defendant’s conduct as “de facto exclusive dealing.”  Dan Crane and I participated as amici in that case as well.

I won’t speak for Dan, but I for one am getting tired of working on these briefs!  It’s time for the Supreme Court to clarify that prevailing price-cost safe harbors cannot be evaded simply through the use of creative labels like “partial de facto exclusive dealing.”  Hopefully, the Court will heed our recommendation that it review — and overrule — the Third Circuit’s Meritor decision.

[In case you're interested, the other scholars signing the brief urging cert in Meritor are Ken Elzinga (Virginia Econ), Richard Epstein (NYU and Chicago Law), Jerry Hausman (MIT Econ), Rebecca Haw (Vanderbilt Law), Herb Hovenkamp (Iowa Law), Glenn Hubbard (Columbia Business), Keith Hylton (Boston U Law), Bill Kovacic (GWU Law), Alan Meese (Wm & Mary Law), Tom Morgan (GWU Law), Barak Orbach (Arizona Law), Bill Page (Florida Law), Robert Pindyck (MIT Econ), Edward Snyder (Yale Mgt), Danny Sokol (Florida Law), and Robert Topel (Chicago Business).]

In antitrust, economics, exclusionary conduct, exclusive dealing, law and economics, monopolization, regulation, Supreme Court
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The SHIELD Act: When Bad Economic Studies Make Bad Laws

Adam Mossoff —  15 March 2013

Earlier this month, Representatives Peter DeFazio and Jason Chaffetz picked up the gauntlet from President Obama’s comments on February 14 at a Google-sponsored Internet Q&A on Google+ that “our efforts at patent reform only went about halfway to where we need to go” and that he would like “to see if we can build some additional consensus on smarter patent laws.” So, Reps. DeFazio and Chaffetz introduced on March 1 the Saving High-tech Innovators from Egregious Legal Disputes (SHIELD) Act, which creates a “losing plaintiff patent-owner pays” litigation system for a single type of patent owner—patent licensing companies that purchase and license patents in the marketplace (and who sue infringers when infringers refuse their requests to license). To Google, to Representative DeFazio, and to others, these patent licensing companies are “patent trolls” who are destroyers of all things good—and the SHIELD Act will save us all from these dastardly “trolls” (is a troll anything but dastardly?).

As I and other scholars have pointed out, the “patent troll” moniker is really just a rhetorical epithet that lacks even an agreed-upon definition.  The term is used loosely enough that it sometimes covers and sometimes excludes universities, Thomas Edison, Elias Howe (the inventor of the lockstitch in 1843), Charles Goodyear (the inventor of vulcanized rubber in 1839), and even companies like IBM.  How can we be expected to have a reasonable discussion about patent policy when our basic terms of public discourse shift in meaning from blog to blog, article to article, speaker to speaker?  The same is true of the new term, “Patent Assertion Entities,” which sounds more neutral, but has the same problem in that it also lacks any objective definition or usage.

Setting aside this basic problem of terminology for the moment, the SHIELD Act is anything but a “smarter patent law” (to quote President Obama). Some patent scholars, like Michael Risch, have begun to point out some of the serious problems with the SHIELD Act, such as its selectively discriminatory treatment of certain types of patent-owners.  Moreover, as Professor Risch ably identifies, this legislation was so cleverly drafted to cover only a limited set of a specific type of patent-owner that it ended up being too clever. Unlike the previous version introduced last year, the 2013 SHIELD Act does not even apply to the flavor-of-the-day outrage over patent licensing companies—the owner of the podcast patent. (Although you wouldn’t know this if you read the supporters of the SHIELD Act like the EFF who falsely claim that this law will stop patent-owners like the podcast patent-owning company.)

There are many things wrong with the SHIELD Act, but one thing that I want to highlight here is that it based on a falsehood: the oft-repeated claim that two Boston University researchers have proven in a study that “patent troll suits cost American technology companies over $29 billion in 2011 alone.”  This is what Rep. DeFazio said when he introduced the SHIELD Act on March 1. This claim was repeated yesterday by House Members during a hearing on “Abusive Patent Litigation.” The claim that patent licensing companies cost American tech companies $29 billion in a single year (2011) has become gospel since this study, The Direct Costs from NPE Disputes, was released last summer on the Internet. (Another name of patent licensing companies is “Non Practicing Entity” or “NPE.”)  A Google search of “patent troll 29 billion” produces 191,000 hits. A Google search of “NPE 29 billion” produces 605,000 hits. Such is the making of conventional wisdom.

The problem with conventional wisdom is that it is usually incorrect, and the study that produced the claim of “$29 billion imposed by patent trolls” is no different. The $29 billion cost study is deeply and fundamentally flawed, as explained by two noted professors, David Schwartz and Jay Kesan, who are also highly regarded for their empirical and economic work in patent law.  In their essay, Analyzing the Role of Non-Practicing Entities in the Patent System, also released late last summer, they detailed at great length serious methodological and substantive flaws in The Direct Costs from NPE Disputes. Unfortunately, the Schwartz and Kesan essay has gone virtually unnoticed in the patent policy debates, while the $29 billion cost claim has through repetition become truth.

In the hope that at least a few more people might discover the Schwartz and Kesan essay, I will briefly summarize some of their concerns about the study that produced the $29 billion cost figure.  This is not merely an academic exercise.  Since Rep. DeFazio explicitly relied on the $29 billion cost claim to justify the SHIELD Act, and he and others keep repeating it, it’s important to know if it is true, because it’s being used to drive proposed legislation in the real world.  If patent legislation is supposed to secure innovation, then it behooves us to know if this legislation is based on actual facts. Yet, as Schwartz and Kesan explain in their essay, the $29 billion cost claim is based on a study that is fundamentally flawed in both substance and methodology.

In terms of its methodological flaws, the study supporting the $29 billion cost claim employs an incredibly broad definition of “patent troll” that covers almost every person, corporation or university that sues someone for infringing a patent that it is not currently being used to manufacture a product at that moment.  While the meaning of the “patent troll” epithet shifts depending on the commentator, reporter, blogger, or scholar who is using it, one would be extremely hard pressed to find anyone embracing this expansive usage in patent scholarship or similar commentary today.

There are several reasons why the extremely broad definition of “NPE” or “patent troll” in the study is unusual even compared to uses of this term in other commentary or studies. First, and most absurdly, this definition, by necessity, includes every university in the world that sues someone for infringing one of its patents, as universities don’t manufacture goods.  Second, it includes every individual and start-up company who plans to manufacture a patented invention, but is forced to sue an infringer-competitor who thwarted these business plans by its infringing sales in the marketplace.  Third, it includes commercial firms throughout the wide-ranging innovation industries—from high tech to biotech to traditional manufacturing—that have at least one patent among a portfolio of thousands that is not being used at the moment to manufacture a product because it may be “well outside the area in which they make products” and yet they sue infringers of this patent (the quoted language is from the study). So, according to this study, every manufacturer becomes an “NPE” or “patent troll” if it strays too far from what somebody subjectively defines as its rightful “area” of manufacturing. What company is not branded an “NPE” or “patent troll” under this definition, or will necessarily become one in the future given inevitable changes in one’s business plans or commercial activities? This is particularly true for every person or company whose only current opportunity to reap the benefit of their patented invention is to license the technology or to litigate against the infringers who refuse license offers.

So, when almost every possible patent-owning person, university, or corporation is defined as a “NPE” or “patent troll,” why are we surprised that a study that employs this virtually boundless definition concludes that they create $29 billion in litigation costs per year?  The only thing surprising is that the number isn’t even higher!

There are many other methodological flaws in the $29 billion cost study, such as its explicit assumption that patent litigation costs are “too high” without providing any comparative baseline for this conclusion.  What are the costs in other areas of litigation, such as standard commercial litigation, tort claims, or disputes over complex regulations?  We are not told.  What are the historical costs of patent litigation?  We are not told.  On what basis then can we conclude that $29 billion is “too high” or even “too low”?  We’re supposed to be impressed by a number that exists in a vacuum and that lacks any empirical context by which to evaluate it.

The $29 billion cost study also assumes that all litigation transaction costs are deadweight losses, which would mean that the entire U.S. court system is a deadweight loss according to the terms of this study.  Every lawsuit, whether a contract, tort, property, regulatory or constitutional dispute is, according to the assumption of the $29 billion cost study, a deadweight loss.  The entire U.S. court system is an inefficient cost imposed on everyone who uses it.  Really?  That’s an assumption that reduces itself to absurdity—it’s a self-imposed reductio ad absurdum!

In addition to the methodological problems, there are also serious concerns about the trustworthiness and quality of the actual data used to reach the $29 billion claim in the study.  All studies rely on data, and in this case, the $29 billion study used data from a secret survey done by RPX of its customers.  For those who don’t know, RPX’s business model is to defend companies against these so-called “patent trolls.”  So, a company whose business model is predicated on hyping the threat of “patent trolls” does a secret survey of its paying customers, and it is now known that RPX informed its customers in the survey that their answers would be used to lobby for changes in the patent laws.

As every reputable economist or statistician will tell you, such conditions encourage exaggeration and bias in a data sample by motivating participation among those who support changes to the patent law.  Such a problem even has a formal name in economic studies: self-selection bias.  But one doesn’t need to be an economist or statistician to be able to see the problems in relying on the RPX data to conclude that NPEs cost $29 billion per year. As the classic adage goes, “Something is rotten in the state of Denmark.”

Even worse, as I noted above, the RPX survey was confidential.  RPX has continued to invoke “client confidences” in refusing to disclose its actual customer survey or the resulting data, which means that the data underlying the $29 billion claim is completely unknown and unverifiable for anyone who reads the study.  Don’t worry, the researchers have told us in a footnote in the study, they looked at the data and confirmed it is good.  Again, it doesn’t take economic or statistical training to know that something is not right here. Another classic cliché comes to mind at this point: “it’s not the crime, it’s the cover-up.”

In fact, keeping data secret in a published study violates well-established and longstanding norms in all scientific research that data should always be made available for testing and verification by third parties.  No peer-reviewed medical or scientific journal would publish a study based on a secret data set in which the researchers have told us that we should simply trust them that the data is accurate.  Its use of secret data probably explains why the $29 billion study has not yet appeared in a peer-reviewed journal, and, if economics has any claim to being an actual science, this study never will.  If a study does not meet basic scientific standards for verifying data, then why are Reps. DeFazio and Chaffetz relying on it to propose national legislation that directly impacts the patent system and future innovation?  If heads-in-the-clouds academics would know to reject such a study as based on unverifiable, likely biased claptrap, then why are our elected officials embracing it to create real-world legal rules?

And, to continue our running theme of classic clichés, there’s the rub. The more one looks at the actual legal requirements of the SHIELD Act, the more, in the words of Professor Risch, one is left “scratching one’s head” in bewilderment.  The more one looks at the supporting studies and arguments in favor of the SHIELD Act, the more one is left, in the words of Professor Risch, “scratching one’s head.”  The more and more one thinks about the SHIELD Act, the more one realizes what it is—legislation that has been crafted at the behest of the politically powerful (such as an Internet company who can get the President to do a special appearance on its own social media website) to have the government eliminate a smaller, publicly reviled, and less politically-connected group.

In short, people may have legitimate complaints about the ways in which the court system in the U.S. generally has problems.  Commentators and Congresspersons could even consider revising the general legal rules governing patent ligtiation for all plaintiffs and defendants to make the ligitation system work better or more efficiently (by some established metric).   Professor Risch has done exactly this in a recent Wired op-ed.  But it’s time to call a spade a spade: the SHIELD Act is a classic example of rent-seeking, discriminatory legislation.

In cost-benefit analysis, economics, intellectual property, law and economics, licensing, litigation, patent, politics , , , , , , , , , , , , , ,
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George Will on My “Plausible Judgment” About the Future of the ACA

Thom Lambert —  21 January 2013

In his nationally syndicated column this week, Washington Post columnist George Will highlights what he termed my “plausible judgment” (I’m taking that as high praise!) that the Supreme Court’s Affordable Care Act decision “may have made the ACA unworkable, thereby putting it on a path to ultimate extinction.”

Will focuses on the first of my three major points about the ACA, as interpreted by the Supreme Court.  In finding the penalty for failure to carry health insurance to be a tax, the Court emphasized its “smallness” relative to the cost of purchasing qualifying insurance.  (That was one of three factors the Court cited in explaining why this particular “penalty” is really a tax for constitutional purposes.)  Presumably, if Congress were to raise the penalty to approach the out-of-pocket cost of buying insurance, it would cross the line from a tax to, in the Supreme Court’s words, “prohibitory financial punishment” that is not a tax.  This means that the ACA’s low penalties are constitutionally locked in, at least to a significant degree.  That’s a problem, because the penalties are currently so low that it makes sense for young, healthy people to forego insurance and pay the low penalties instead.  This is because the ACA removes the natural incentive for young, healthy people to carry insurance: the risk that they will not be able to get it at affordable rates if they become sick in the future.  That risk is eliminated by the ACA’s “guaranteed issue” and “community rating” provisions.  The former requires insurance companies to sell insurance to anyone who seeks it; the latter forbids them to charge a higher premium to one who is sick or susceptible to sickness.  If you know you can get insurance at a an affordable rate the minute you need health care (which, if you’re young and healthy, you’re not likely to need anytime soon), then why buy it now?  The ACA’s penalties are theoretically designed to motivate young, healthy people to go ahead and buy insurance (thereby subsidizing premiums for the less-healthy), but they’re way too low to be effective.  And the Supreme Court’s tax reasoning suggests that they will cease to count as a “tax” if they’re raised to the point at which they would be effective.  Of course, once young, healthy people leave the pool of insureds, premiums will rise on everyone else, causing even more healthy people to drop out.  Economists call this adverse selection, and it’s wildly pernicious.

Will lays all this out in his typical elegant fashion.  He concludes that “as the president begins his second term, the signature achievement of his first term looks remarkably rickety.”  Indeed.

For two other reasons the ACA, as construed by the Supreme Court, is destined to fail, see my recent Regulation article, How the Supreme Court Doomed the ACA to Failure.

In economics, health care, health care reform debate, law and economics, markets, regulation
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James M. Buchanan — 1919-2013

Thom Lambert —  9 January 2013

Yet another loss of a giant in the world of law and economics.  On December 19, it was Robert Bork.  Today, we lost economist James M. Buchanan, Nobel laureate, George Mason professor, and one of the fathers of Public Choice economics.  Regular readers of TOTM will know that several of us–including yours truly–have been heavily influenced by the insights of Public Choice (see, e.g., here and here).

I was alerted to Buchanan’s passing by my friend and collaborator, Virginia Law’s Charles Goetz, co-author of the Goetz & McChesney (now Goetz, McChesney & Lambert) antitrust casebook.  I asked Charlie if he’d pen a few words in honor of Buchanan, his dissertation director and mentor, and he heartily agreed to do so.  Here they are:

Nobel Laureate James McGill Buchanan has passed away and one less giant now walks the pathways of Economics, pathways that he extended and widened.  Jim was my dissertation director, my mentor, my sometime colleague and coauthor—and my friend. There is an old compliment that denotes a man “a gentleman and a scholar.”  Jim was certainly both, to the quintessential degree.

I often reflect on how fortunate I’ve been with many things, but certainly among the luckiest of things was to be an Economics graduate student at the University of Virginia in the early 1960’s.  It was a golden time when Jim and a handful of others were midwifing the birth of what came to be known as Public Choice economics.  I got to watch and listen as great men did great things.

I remember what an eye-opening experience it was for me to take Buchanan’s year-long course in Public Finance.  He was an incredibly effective teacher.  He was far from a classroom showman, but had the genius of asking such devilishly interesting and revelatory questions.  I have acknowledged publicly on a number of occasions that, if he could charge me for the intellectual value-added that he created in me, he would be owed a very large sum indeed.  But I am profoundly in his debt, even if not in a pecuniary sense.

In the days and weeks to come, others will write many highly complimentary things about James M. Buchanan as a scholar. Deservedly so.  I would have little new to add to that outpouring.  Still, there is a revealing anecdote about Jim as a man that can come only from me, the sole witness and participant.

Buchanan generally had a very formal relationship with students and I understandably regarded him with awe and no little bit of fear.  But, one day, he gave me a great big smile and told me a story that made me appreciate, for the first time, the lurking, devilish sense of humor that went with this proper Tennessee Gentleman.

“Goetz,” he said, “you’re a New Yorker, aren’t you?  But, . . . you’re a pretty good fellow anyway.”

“I often dislike New Yorkers because they act like obnoxious know-it-alls.  There was a New Yorker like that in my class at Navy Officer Candidate school during World War II.  This fellow didn’t have much use for a simple Tennessee boy like me and tried to lord it over us country boys.  But I fixed him.”

“At the end of our OCS course, the Navy gave us a battery of tests that it used in allocating new ensigns to their first duty assignment.  I started a rumor that this NY fellow had come out second in the whole class.  At first, he denied it since, of course, he had no basis to believe it.  Gradually, though, he began to accept congratulations and to puff up more and more about the compliments.”

“Then I started the second rumor, about our further training to battle the Japanese: the first three men in the class were being sent to One-man Submarine School.”

Somehow, I saw Jim with different eyes after that story.  Maybe you will as well.

Requiescat in pace, J. M. Buchanan, the little-known joker and man of honed wit, wit in more ways than the scholarly.  In the midst of our sadness, maybe a chuckle is good medicine.

Well-said, Charlie.

In economics, george mason university school of law, law and economics, nobel prize, political economy
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The Case for Copyright

Adam Mossoff —  20 November 2012

Mark Schultz, law professor and specialist in copyright law, has written an excellent response to the Republican Study Committee policy brief on copyright law that has been making the rounds on the Internet the past several days.  Although the RSC promptly retracted the policy brief, the blogosphere has erupted in commentary on what appeared to be a radical shift in IP policy by one of the explicitly free market caucuses of GOP members.

Mark’s response is a tour-de-force, if only because in a very brief blog posting, he reveals that much of the RSC policy brief is, at best, based on assumptions about copyright that really require a lot more analytical heavy lifting than anything attempted by its author, or, at worst, simply a highly tendentious reading of copyright law and policy.

Here’s just a small taste of some of Mark’s response:

Some also see copyright as a morally suspect interference with economic freedom because they reject the contention that copyright is property. They instead vilify copyright as an odious monopoly or a government-granted privilege or subsidy.

The monopoly accusation is an elementary and persistent error in the economic analysis of intellectual property, as Edmund Kitch once explained in an article with that very title. Edmund W. Kitch, Elementary and Persistent Errors In The Economic Analysis Of Intellectual Property, 53 Vand. L. Rev. 1727 (2000). Dozens of scholarly articles, hundreds of court cases, and thousands of economics classes have repeated the claim that intellectual property grants a monopoly. As Kitch points out, the persistence of the claim does not lessen the error.

Ownership of a property right alone does not accord the owner a monopoly. The hallmark of a monopoly is market power. Owning something that is unique—whether it is a song, a story, or a house—does not give one that kind of power. Even a beautiful house in a nice location cannot command monopoly prices. The same is true of copyrighted works.

There’s more, including a great discussion about whether copyright really is justified, either morally or constitutionally, as only a social utility enhancing monopoly grant, something near and dear to my own scholarly work in the related field of patent law.  Mark concludes his response with a brilliant exposition on how, contrary to the RSC policy brief author’s claim that copyright violates laissez faire capitalism, copyright in fact makes it possible for private ordering to develop and to take root in a flourishing free market.

As Instapundit likes to say: Read the whole thing!

DISCLOSURE: Mark’s response is posted on the blog for the Copyright Alliance, and Mark and I are both members of the Academic Advisory Board of the Copyright Alliance.

In constitutional law, copyright, economics, intellectual property, law and economics, politics
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Ginsburg & Wright on Behavioral Law and Economics: Its Origins, Fatal Flaws, and Implications for Liberty

Josh Wright —  19 September 2012

My paper with Judge Douglas H. Ginsburg (D.C. Circuit; NYU Law), Behavioral Law & Economics: Its Origins, Fatal Flaws, and Implications for Liberty, is posted to SSRN and now published in the Northwestern Law Review.

Here is the abstract:

Behavioral economics combines economics and psychology to produce a body of evidence that individual choice behavior departs from that predicted by neoclassical economics in a number of decision-making situations. Emerging close on the heels of behavioral economics over the past thirty years has been the “behavioral law and economics” movement and its philosophical foundation — so-called “libertarian paternalism.” Even the least paternalistic version of behavioral law and economics makes two central claims about government regulation of seemingly irrational behavior: (1) the behavioral regulatory approach, by manipulating the way in which choices are framed for consumers, will increase welfare as measured by each individual’s own preferences and (2) a central planner can and will implement the behavioral law and economics policy program in a manner that respects liberty and does not limit the choices available to individuals. This Article draws attention to the second and less scrutinized of the behaviorists’ claims, viz., that behavioral law and economics poses no significant threat to liberty and individual autonomy. The behaviorists’ libertarian claims fail on their own terms. So long as behavioral law and economics continues to ignore the value to economic welfare and individual liberty of leaving individuals the freedom to choose and hence to err in making important decisions, “libertarian paternalism” will not only fail to fulfill its promise of increasing welfare while doing no harm to liberty, it will pose a significant risk of reducing both.

Download here.

 

In behavioral economics, behavioral economics, consumer financial protection bureau, consumer protection, economics, free to choose, Hayek, law and economics
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Have Elhauge and Wickelgren Undermined the Rule of Per Se Legality for Above-Cost Loyalty Discounts?

Thom Lambert —  12 September 2012

Einer Elhauge and Abraham Wickelgren, of Harvard and the University of Texas, respectively, have recently posted to SSRN a pair of provocative papers on loyalty discounts (price cuts conditioned on the buyer’s purchasing some amount, usually a percentage of its requirements, from the seller).  Elhauge and Wickelgren take aim at the assertion by myself and others (e.g., Herb Hovenkamp) that loyalty discounts should be per se legal if they result in a discounted per-unit price that is above the seller’s incremental per-unit cost.  E&W would cast the liability net further.

We advocates of per se legality for above-cost loyalty discounts base our position on the fact that such discounts generally cannot exclude aggressive rivals that are as efficient as the discounter.  Suppose, for example, that widgets are normally sold for a dollar each but that a seller whose marginal cost is $.88/widget offers a 10% loyalty rebate to any buyer who purchases 80% of its widget requirements from the seller.  Because the $.90 discounted price exceeds the discounter’s marginal cost, any equally efficient widget producer could compete with the discount by lowering its own price to a level above its cost.

But what if the loyalty rebate actually causes a rival to be less efficient than the discounter? Some have argued that this may occur, even with above-cost loyalty discounts, when scale economies are significant.  Suppose that the market for tennis balls consists of two brands, Pinn and Willson, that current market shares, reflective of consumer demand, are 60% for the Pinn and 40% for Willson,  and that retailers typically stock the two brands in those proportions. Assume also that it costs each manufacturer $.90 to produce a can of tennis balls, that each sells to retailers for $1 per can, and that minimum efficient scale in this market (the lowest production level at which all available scale economies are exploited) occurs at a level of production equal to 35% of market demand. Suppose that Pinn, the dominant manufacturer, offers retailers a 10% loyalty rebate on all purchases made within a year if they buy 70% of their requirements for the year from Pinn.

While the $.90 per unit discounted price is not below Pinn’s cost, it might have the effect of driving Willson, an equally efficient rival, from the market. Willson could avoid losing market share and thus falling below minimum efficient scale only if it matched the full dollar amount of Pinn’s discount on its smaller base of sales. It wouldn’t be able to do so, though, without pricing below its cost.

Consider, for example, a typical retailer that initially (before the rebate announcement) satisfied its requirements by purchasing sixty cans of Pinn for $60 and forty cans of Willson for $40. After implementation of the rebate plan, the retailer could save $7 on its 100-can tennis ball requirements by spending $63 to obtain seventy Pinn cans and $30 to obtain thirty Willson cans. The retailer and others like it would thus have a strong incentive to shift purchases from Willson to Pinn.  To prevent a loss of market share that would drive it below minimum efficient scale, Willson would need to lower its price to provide retailers with the same total dollar discount, but on a smaller base of sales (40% of a typical retailer’s requirements rather than 60%). This would cause it to lower its price below its cost.  For example, Willson could match Pinn’s $7 discount to the retailer described above only by reducing its $1 per-unit price by 17.5 cents ($7.00/40 = $.175), which would require it to price below its cost of $.90 per unit.

When one considers dynamic effects, examples like this don’t really undermine the case for a rule of per se legality for above-cost loyalty discounts. Had the nondominant rival (Willson) charged a price equal to its marginal cost prior to implementation of Pinn’s loyalty rebate, it would have enjoyed a price advantage and likely would have grown its market share to a point at which Pinn’s loyalty rebate strategy could not drive it below minimum efficient scale. Moreover, a strategy that would prevent a nondominant but equally efficient firm from being harmed by a dominant rival’s above-cost loyalty rebate would be for the non-dominant firm to give its own volume discounts from the outset, securing up-front commitments from enough buyers (in exchange for discounted prices) to ensure that its production stayed above minimum efficient scale. Such a strategy, which would obviously benefit consumers, would be encouraged by a rule that evaluated loyalty discounts under straightforward Brooke Group principles and thereby signaled to manufacturers that they must take steps to protect themselves from above-cost loyalty discounts. In the end, then, any equally efficient rival that is committed to engaging in vigorous price competition ought not to be excluded by a dominant seller’s above-cost loyalty rebate.

Moreover, even if a loyalty rebate could occasionally drive an aggressive, equally efficient rival from the market, a rule of per se legality for above-cost loyalty discounts would still be desirable on error cost grounds.  An alternative rule subjecting above-cost loyalty discounts to potential treble damages liability would chill all sorts of non-exclusionary discounting practices, so that the social losses from reduced price competition would exceed any social gains from the elimination of those rare discounts that could exclude aggressive, efficient rivals. In short, the social costs resulting from potential false convinctions under a broader liability rule would overwhelm the social costs from false acquittals under the per se legality rule I have advocated.

The two new papers by Elhauge and Wickelgren contend that I and other per se legality advocates are missing a key anticompetitive threat posed by loyalty discounts even in the absence of scale economies: their potential to chill price competition.

The first E&W paper addresses loyalty discounts involving “buyer commitment”—i.e., a promise by buyers receiving the discount that they will purchase some percentage of their requirements from the discounter (not its rivals) in the future.  According to E&W, the discounter who agrees to this sort of arrangement will be less likely to give discounts to uncommitted (“free”) buyers in the future.  This is because, E&W say, the discounter knows that if it cuts prices to such buyers, it will have to reduce its prices to committed buyers by the agreed-upon discount percentage.  The discounter’s rivals, knowing that the discounter won’t cut prices to attract free buyers, will similarly abstain from aggressive price competition.  “The result,” E&W maintain, “is inflated prices to free buyers, which also means inflated prices to committed buyers because they are priced at a loyalty discount from those free buyer prices.”  Despite these adverse consequences, E&W contend, buyers will agree to competition-reducing loyalty discounts because much of their cost is externalized:  “[W]hen one buyer agrees to a loyalty discount, all buyers suffer from the higher prices that result from less aggressive competition,” so “an incumbent supplier need not compensate an individual buyer who agrees to a loyalty discount for the losses that all other buyers suffer.”

The second E&W paper contends that loyalty discounts may soften price competition and injure consumers even when they do not involve buyer commitment to purchase from the discounter in the future.  According to E&W, “[b]ecause the loyalty discount requires the seller to charge loyal buyers less than buyer who are not covered by the loyalty discount, the seller cannot lower prices to uncovered buyers without also lowering prices to loyal buyers.”  Given the increased cost of competing for uncovered buyers  (i.e., any price concession will require further concessions to covered buyers), the seller is likely to cede uncovered buyers to its rival, which will reduce the rival’s incentive to compete aggressively for buyers covered by the loyalty discount.  In short, E&W contend, the loyalty discount will facilitate a market division scheme between the discounter and its rival.

As is typical for an Elhauge paper, there’s some elaborate modeling and math in both of these papers.  The analysis appears to be rigorous.  It seems to me, though, that there’s a significant problem with both papers: Each assumes that loyalty discounts are structured so that the discounter promises to reduce the price from the amount collected in sales to others.  While I’m reluctant to make sweeping claims about how loyalty discounts are typically structured, I don’t think loyalty discounts usually work this way.

Loyalty discounts could be structured many ways.  The seller could offer a discount from a pre-determined price—e.g., “The price is $1 per widget, but if you purchase at least 80% of your widgets from me, I’ll charge you only $.90/widget.”  Such a discount doesn’t create the incentive effect that underlies E&W’s theories of anticompetitive effect, for there’s no reason for the seller not to reduce others’ widget prices in the future.  Alternatively, the seller could offer a discount off a list price that is subject to change—e.g., “If you purchase 80% of your requirements from me, I’ll charge you 10% less than the posted list price.”  This sort of discount might discourage sellers from lowering list prices, but it shouldn’t dissuade them from also giving others a break from list prices.  Indeed, in many industries hardly anyone pays list price.  The only loyalty discounts that threaten the effects E&W fear are those where the discount is explicitly tied to the price charged to others—e.g., “If you purchase 80% of your requirements from me, I’ll charge you 10% less than the lowest price I’m charging others.”

This last sort of loyalty discount might have the effects E&W predict, but I’ve never seen such a discount.  The loyalty discounts and rebates I encountered as an antitrust lawyer resembled the first two types discussed above: discounts off pre-determined prices or discounts off official list prices (from which price concessions were regularly granted to others).  The loyalty discounts that E&W model really just look like souped-up “Most Favored Nations” clauses, where the seller promises not just to meet, but to beat, the price it offers to other favored buyers.  It may make sense to police such clauses, but wouldn’t we do so using the standards governing MFN clauses rather than the rules and standards governing loyalty discounts?  After all, it’s the seller’s promise to beat its other price concessions, not the buyer’s loyalty, that causes the purported anticompetitive harm.

UPDATE:

I just recalled that this is not the first time we at TOTM have addressed Prof. Elhauge’s models of loyalty discounts containing a Most Favored Nations-like provision. FTC Commissioner-Appointee Josh Wright made a similar point about a paper Elhauge produced before these two.  If you found this post at all interesting, please read Josh’s earlier (and more rigorous) post. Sorry about that, Mr. Commish-to-be.

In antitrust, economics, error costs, law and economics, regulation
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Free Uber

Josh Wright —  6 September 2012

From the NY Times:

Uber, a company based in San Francisco, is introducing a smartphone app to New York that allows available taxi drivers and cab-seeking riders to find one another. The company said the service would begin operating on Wednesday in 105 cabs — a bit less than 1 percent of the city’s more than 13,000 yellow cabs. Uber added that it hoped to recruit 100 new drivers each week.

But the program may have a significant problem: Taxi officials say that Uber’s service may not be legal since city rules do not allow for prearranged rides in yellow taxis. They also forbid cabbies from using electronic devices while driving and prohibit any unjustified refusal of fares. (Under Uber’s policy, once a driver accepts a ride through the app, no other passenger can be picked up.)

So, who else might be interested in fighting the rise of Uber and similar services?

The influx of apps appears to have created a moment of unity among yellow-taxi, livery and black-car operators, all of whom have raised concerns about the apps’ legality. Some industry officials said the commission was not acting forcefully enough; the result, said Avik Kabessa, the chief executive of Carmel Car and Limousine Service and a member of the board of the Livery Roundtable, a group representing livery drivers, is a New York City version of “the Wild West.”  An analysis conducted by the Metropolitan Taxicab Board of Trade, which represents yellow-taxi operators, identified what it deemed to be 11 potential violations of taxi guidelines in Uber’s model. These included charging a tip automatically, not allowing for cash payments and turning away passengers while being on duty.

Uber and similar services face similar threats in other cities, including here in DC, where Uber faced the “Uber Amendments” which would require Uber to charge five times the price of a cab!  At least the DC Commission was incredibly clear about the role of the regulation: to suppress competition and harm consumers:

Explanation and Rationale
· This section would clarify how sedan services operate.

· Sedans would be required to charge a minimum fare of 5 times the drop rate for taxicabs.

· Sedans would be required to charge time and distance rates that are greater as those for taxicabs.

· These requirements would ensure that sedan service is a premium class of service with a substantially higher cost that does not directly compete with or undercut taxicab service.

Here is Uber’s response to the DC Council:

The Council’s intention is to prevent Uber from being a viable alternative to taxis by enacting a price floor to set Uber’s minimum fare at today’s rates and no less than 5 times a taxi’s minimum fare. Consequently they are handicapping a reliable, high quality transportation alternative so that Uber cannot offer a high quality service at the best possible price. It was hard for us to believe that an elected body would choose to keep prices of a transportation service artificially high – but the goal is essentially to protect a taxi industry that has significantexperience in influencing local politicians. They want to make sure there is no viable alternative to a taxi in Washington DC, and so on Tuesday (tomorrow!), the DC City Council is going to formalize that principle into law.

There appears to be subsequent history, including a temporary shelving of the Amendment with the potential to bring it back on its own in the future.  Councilwoman and George Washington Law Prof Mary Cheh is a force behind the Uber Amendment and complained that a settlement could not be reached with Uber that would shed the requirement of having prices 5 times higher, but retain a price differential in the name of shielding taxi cabs from competition (emphasis my own):

Establishing a minimum fare is important to distinguish premium sedan service from traditional taxicab service and to prevent sedans from directly competing with or undercuting taxicabs.  Taxi companies want minimum fares that are much higher than what I am proposing in my amendment.  However, I believe that simply preserving the status quo is appropriate and reasonable.

I am deeply disappointed that Uber has decided that it no longer supports this amendment that we negotiated in good faith.  The taxi industry is one that has been regulated for a very long time.  If Uber wishes to operate taxis, then it is free to do so, but it should then be subject to the same regulations and requirements of taxis.

As I frequently point out on the blog, local barriers to entry cause substantially greater dissipation of consumer surplus than is conventionally acknowledged (e.g., here, here, and here).

HT: Hal Singer.

In barriers to entry, business, economics, licensing, markets, technology
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The Nirvana Fallacy is Not the “Fiction” Fallacy

Adam Mossoff —  28 August 2012

In a response to my essay, The Trespass Fallacy in Patent Law, in which I explain why patent scholars like Michael Meurer, James Bessen, T.J. Chiang and others are committing the nirvana fallacy in their critiques of the patent system, my colleague, T.J. Chiang writes at PrawfsBlawg:

The Nirvana fallacy, at least as I understand it, is to compare an imperfect existing arrangement (such as the existing patent system) to a hypothetical idealized system. But the people comparing the patent system to real property—and I count myself among them—are not comparing it to an idealized fictional system, whether conceptualized as land boundaries or as estate boundaries. We are saying that, based on our everyday experiences, the real property system seems to work reasonably well because we don’t feel too uncertain about our real property rights and don’t get into too many disputes with our neighbors. This is admittedly a loose intuition, but it is not an idealization in the sense of using a fictional baseline. It is the same as saying that the patent system seems to work reasonably well because we see a lot of new technology in our everyday experience.

I would like to make two quick points in response to T.J.’s attempt at wiggling out from serving as one of the examples I identify in my essay as a patent scholar who uses trespass doctrine in a way that reflects the nirvana fallacy.

First, what T.J. describes as what he is doing — comparing an actual institutional system to a “loose intuition” about another institutional system — is exactly what Harold Demsetz identified as the nirvana fallacy (when he roughly coined the term in 1969).  When economists or legal scholars commit the nirvana fallacy, they always justify their idealized counterfactual standard by appeal to some intuition or gestalt sense of the world; in fact, Demsetz’s example of the nirvana fallacy is when economists have a loose intuition that regulation always works perfectly to fix market failures.  These economists do this for the simple reason that they’re social scientists, and so they have to make their critiques seem practical.

It’s like the infamous statement by Pauline Kael in 1972 (quoting from memory): “I can’t believe Nixon won, because I don’t know anyone who voted for him.” Similarly, what patent scholars like T.J. are doing is saying: “I can’t believe that trespass isn’t clear and efficient, because I don’t know anyone who has been involved in a trespass lawsuit or I don’t hear of any serious trespass lawsuits.”  Economists or legal scholars always have some anecdotal evidence — either personal experiences or merely an impressionistic intuition about other people — to offer as support for their counterfactual by which they’re evaluating (and criticizing) the actual facts of the world. The question is whether such an idealized counterfactual is a valid empirical metric or not; of course, it is not.  To do this is exactly what Demsetz criticized as the nirvana fallacy.

Ultimately, no social scientist or legal scholar ever commits the “nirvana fallacy” as T.J. has defined it in his blog posting, and this leads to my second point.  The best way to test T.J.’s definition is to ask: Does anyone know a single lawyer, legal scholar or economist who has committed the “nirvana fallacy” as defined by T.J.?  What economist or lawyer appeals to a completely imaginary “fictional baseline” as the standard for evaluating a real-world institution?

The answer to this question is obvious.  In fact, when I posited this exact question to T.J. in an exchange we had before he made his blog posting, he could not answer it.  The reason why he couldn’t answer it is because no one says in legal scholarship or in economic scholarship: “I have a completely made-up, imaginary ‘fictionalized’ world to which I’m going to compare to a real-world institution or legal doctrine.”  This is certainly is not the meaning of the nirvana fallacy, and I’m fairly sure Demsetz would be surprised to learn that he identified a fallacy that according to T.J. has never been committed by a single economist or legal scholar. Ever.

In sum, what T.J. describes in his blog posting — using a “loose intuition” of an institution an empirical standard for critiquing the operation of another institution — is the nirvana fallacy. Philosophers may posit completely imaginary and fictionalized baselines — it’s what they call “other worlds” — but that is not what social scientists and legal scholars do.  Demsetz was not talking about philosophers when he identified the nirvana fallacy.  Rather, he was talking about exactly what T.J. admits he does in his blog posting (and which he has done in his scholarship).

In economics, intellectual property, law and economics, legal scholarship, patent, scholarship
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