I am the co-editor of the Supreme Court Economic Review, a peer-review publication that is one of the country’s top-rated law and economics journals, along with my colleagues Todd Zywicki and Ilya Somin. SCER, along with its publisher, the University of Chicago Press, have put together a new submissions website. If you have a relevant submission, please submit at the website for our review.
Archive for the ‘law and economics’ Category
New Online Submission Website For Supreme Court Economic Review
Posted by Josh Wright on May 15, 2012
Posted in economics, law and economics, legal scholarship, scholarship, Supreme Court | Leave a Comment »
Richard Thaler on “Slippery Slopes”
Posted by Paul H. Rubin on May 13, 2012
In today’s New York Times, Richard Thaler argues that the Constitutional “slippery slope” argument in the Obamacare case (“Today health care, tomorrow broccoli”) is misguided. This is a strange argument in this particular case. We must remember that all of today’s commerce clause jurisprudence (which everyone agrees has greatly expanded the power of the Federal government to regulate economic activity) rests on Wickard v. Filburn, a 1942 case involving a small wheat and chicken farmer in Ohio. If ever there was a slippery slope, this is it, and it seems rational to fear another in the same Constitutional line.
Posted in commerce clause, constitutional law, health care, health care reform debate, law and economics | 1 Comment »
The folly of the FTC’s Section Five case against Google
Posted by Geoffrey Manne on May 7, 2012
In the past weeks, the chatter surrounding a possible FTC antitrust case against Google has risen in volume, thanks largely to the FTC’s hiring of litigator Beth Wilkinson. The question remains, however, what this aggressive move portends and, more importantly, why the FTC is taking it.
It is worth noting at the outset that, as far as I know, Wilkinson has no antitrust experience; she is a litigator. Now, there’s nothing wrong with an agency enlisting a hired gun to help litigate its cases, but when the hired gun is not hired for her substantive expertise but rather her ability to persuade, it perhaps suggests something about the strength of the agency’s case.
It’s reading tea leaves (a time-honored, if flawed, DC practice), but Wilkinson’s hiring suggests to me that the FTC views its case as one that will require some serious rhetorical handling in order to win. While on its Sherman Act Section 2 merits that would be true anyway, it also suggests to me that the FTC intends to use the case as an opportunity to push – and seek court approval for – the ambitious plans of some of the Commissioners to expand the agency’s powers under Section 5 of the FTC Act. This would be a costly mistake for consumers.
Last year, in an interview with Global Competition Review, FTC Chairman Leibowitz was asked whether the agency was “investigating the online search market.” He declined to answer directly but instead offered this suggestive comment:
What I can say is that one of the commission’s priorities is to find a pure Section Five case under unfair methods of competition. Everyone acknowledges that Congress gave us much more jurisdiction than just antitrust. And I go back to this because at some point if and when, say, a large technology company acknowledges an investigation by the FTC, we can use both our unfair or deceptive acts or practice authority and our unfair methods of competition authority to investigate the same or similar unfair competitive behavior . . . .
Commissioner Rosch has likewise suggested that Section 5 could and should be expanded, precisely to reach activity that would be unreachable under current Section 2 standards. The effort to expand the FTC’s antitrust enforcement under Section 5, and to write out the jurisprudential standards of Section 2, is a troubling one.
Following Sherman Act jurisprudence, traditionally the FTC has understood (and courts have demanded) that antitrust enforcement under Section 5 (as a technical matter, the FTC does not directly enforce Section 2 of the Sherman Act but instead enforces the Act via its Section 5 authority) requires demonstrable consumer harm to apply. But this latest effort reveals an agency pursuing an interpretation of Section 5 that would give it unprecedented and largely-unchecked authority. In particular, the definition of “unfair” competition wouldn’t be confined to the traditional antitrust measures—reduction in output or an output-reducing increase in price—but could expand to, well, just about whatever the agency deems improper.
Most problematically, Commissioner Rosch has suggested that Section Five could address conduct that has the effect of “reducing consumer choice” without requiring any evidence that conduct actually reduces consumer welfare—a theory that only a vanishingly few commentators (essentially one law professor and one FTC lawyer have written the entire body of scholarship on this topic) support. Troublingly, “reducing consumer choice” seems to be a euphemism for “harm to competitors, not competition,” where the reduction in choice is the reduction of choice of competitors who may be put out of business by a competitor’s conduct.
Under Section 2 standards, the FTC would have a tough time winning its case. This is because the agency doesn’t seem to have a theory of harm that reaches consumers—and none of Google’s competitors that have been stoking the flames has offered one. Instead, all of the propounded theories turn on harm to competitors. But the U.S. has a long tradition of resisting enforcement based on harm to competitors without a showing of harm to consumers. If all that were required were harm to competitors, then all pro-competitive conduct would be actionable under the antitrust laws; for what is the aim and effect of competition if not the besting of one’s competitors? The competitive process is by definition one that can “reduce consumer choice.” This is why the great economist Joseph Schumpeter famously called the competitive process one of “creative destruction.”
In fact, the theoretical case against Google depends entirely on the ways it may have harmed certain competitors rather than on any evidence of harm to consumer welfare. For example, Google’s implementation and placement within its organic search results of its own shopping results is alleged to make it difficult for competing product-specific search sites (like Nextag or Amazon, for example) to reach Google’s users. Leaving aside the weakness of the factual allegation (I challenge you to perform a search for a product on Google that doesn’t offer up a mix of retailers, manufacturers, review sites and multiple product search engine results on the first page), it is hard to see how consumers are harmed here.
On the one hand, users have easy access to competing sites directly from their browser’s address bar and, increasingly importantly, to more persuasive product reviews from friends and colleagues via social media. In this way even the basic factual predicate is faulty, and it’s not even clear that consumer choice itself is reduced if Nextag is absent from Google searches, as the site can be reached by, among other things, links from reviews, links from friends on social media, other general search engines, and every browser address bar.
On the other hand, users are by no means foreclosed from access to actual products (and there is no evidence that I know of that consumer prices or supply are in any way affected) if any particular product search engine doesn’t appear in the top results. Placement of Google’s own product search results in fact streamlines consumers’ access, and Google’s comprehensive and effective search engine ensures that its shopping results are probably better than anyone else’s anyway. The same is true for travel searches, maps, and the range of other complained-of results. Flight information and reservations, location information and maps are widely available online and off through myriad sources other than Google.
The bottom line is that harm to competitors is at least as consistent with pro-competitive as with anti-competitive conduct, and simply counting the number of firms offering competing choices to consumers that happen to appear in the top few Google search results is no way to infer actual consumer harm.
One of the most important shifts in antitrust over the past 30 years has been the move away from indirect and unreliable proxies of consumer harm toward a more direct, effects-based analysis. Like the now archaic focus on market concentration in the structure-conduct-performance framework at the core of “old” merger analysis, the consumer choice framework substitutes an indirect and deeply flawed proxy for consumer welfare for assessment of economically relevant economic effects. By focusing on the number of choices, the analysis shifts attention to the wrong question.
The fundamental question from an antitrust perspective is whether consumer choice is a better predictor of consumer outcomes than current tools allow. There doesn’t appear to be anything in economic theory to suggest that it would be. Instead, it reduces competitive analysis to a single attribute of market structure and appears susceptible to interpretations that would sacrifice a meaningful measure of consumer welfare (incorporating assessment of price, quality, variety, innovation and other amenities) on economically unsound grounds. It is also not the law.
Commissioner Rosch has suggested that the Supreme Court in its 2007 Leegin decision provided a green light for consumer-choice-reducing antitrust theories without a showing of traditional (output-reducing) harm. But as Josh pointed out, the Ninth Circuit has held (in last year’s Brantley v. NBC Universal decision, which Thom has also blogged about here and here) that Leegin more accurately holds precisely the opposite, and coupled with the Court’s 2006 Independent Ink decision, seems clearly to restrict, rather than authorize, a consumer choice claim:
The Supreme Court has noted that both [reduced choice and increased prices] are “fully consistent with a free, competitive market,” [citing Independent Ink] and are therefore insufficient to establish an injury to competition. Thus even vertical agreements that prohibit retail price reductions and result in higher consumer prices . . . are not unlawful absent a further showing of anticompetitive conduct [citing Leegin].
Modern antitrust analysis, both in scholarship and in the courts, quite properly rejects the reductive and unsupported sort of theories that would undergird a Section 5 case against Google. That the FTC might have a better chance of winning a Section 5 case, unmoored from the economically sound limitations of Section 2 jurisprudence, is no reason for it to pursue such a case. Quite the opposite: When consumer welfare is disregarded for the sake of the agency’s power, it ceases to further its mandate. No doubt Beth Wilkinson could help make the rhetorical argument for a Section 5 case against Google based on a tenuous consumer choice theory. But economic substance, not self-aggrandizement by rhetoric, should guide the agency. Competition and consumers are dramatically ill-served by the latter.
Full disclosure: I worked briefly with Beth Wilkinson at Latham and Watkins. Further full disclosure: The International Center for Law and Economics, of which I am the Executive Director, has received support to make research grants from Google, among many other companies and individuals.
[Cross-posted at Forbes]
Posted in antitrust, exclusionary conduct, law and economics, technology | Tagged: Beth Wilkinson, Competition law, Federal Trade Commission, ftc, FTC Act, google, section 5, Sherman Act | Leave a Comment »
More Misguided Derision from Critics of the Verizon-SpectrumCo Wireless Deal
Posted by Geoffrey Manne on April 25, 2012
The pending wireless spectrum deal between Verizon Wireless and a group of cable companies (the SpectrumCo deal, for short) continues to attract opprobrium from self-proclaimed consumer advocates and policy scolds. In the latest salvo, Public Knowledge’s Harold Feld (and other critics of the deal) aren’t happy that Verizon seems to be working to appease the regulators by selling off some of its spectrum in an effort to secure approval for its deal. Critics are surely correct that appeasement is what’s going on here—but why this merits their derision is unclear.
For starters, whatever the objections to the “divestiture,” the net effect is that Verizon will hold less spectrum than it would under the original terms of the deal and its competitors will hold more. That this is precisely what Public Knowledge and other critics claim to want couldn’t be more clear—and thus neither is the hypocrisy of their criticism.
Note that “divestiture” is Feld’s term, and I think it’s apt, although he uses it derisively. His derision seems to stem from his belief that it is a travesty that such a move could dare be undertaken by a party acting on its own instead of under direct diktat from the FCC (with Public Knowledge advising, of course). Such a view—that condemns the private transfer of spectrum into the very hands Public Knowledge would most like to see holding it for the sake of securing approval for a deal that simultaneously improves Verizon’s spectrum position because it is better for the public to suffer (by Public Knowledge’s own standard) than for Verizon to benefit—seems to betray the organization’s decidedly non-public-interested motives.
But Feld amasses some more specific criticisms. Each falls flat.
For starters, Feld claims that the spectrum licenses Verizon proposes to sell off (Lower (A and B block) 700 MHz band licenses) would just end up in AT&T’s hands—and that doesn’t further the scolds’ preferred vision of Utopia in which smaller providers end up with the spectrum (apparently “small” now includes T-Mobile and Sprint, presumably because they are fair-weather allies in this fight). And why will the spectrum inevitably end up in AT&T’s hands? Writes Feld:
AT&T just has too many advantages to reasonably expect someone else to get the licenses. For starters, AT&T has deeper pockets and can get more financing on better terms. But even more importantly, AT&T has a network plan based on the Lower 700 MHz A &B Block licenses it acquired in auction 2008 (and from Qualcomm more recently). It has towers, contracts for handsets, and everything else that would let it plug in Verizon’s licenses. Other providers would need to incur these expenses over and above the cost of winning the auction in the first place.
Allow me to summarize: AT&T will win the licenses because it can make the most efficient, effective and timely use of the spectrum. The horror!
Feld has in one paragraph seemingly undermined his whole case. If approval of the deal turns on its effect on the public interest, stifling the deal in an explicit (and Quixotic) effort to ensure that the spectrum ends up in the hands of providers less capable of deploying it would seem manifestly to harm, not help, consumers.
And don’t forget that, whatever his preferred vision of the world, the most immediate effect of stopping the SpectrumCo deal will be that all of the spectrum that would have been transferred to—and deployed by—Verizon in the deal will instead remain in the hands of the cable companies where it now sits idly, helping no one relieve the spectrum crunch.
But let’s unpack the claims further. First, a few factual matters. AT&T holds no 700 MHz block A spectrum. It bought block B spectrum in the 2008 auction and acquired spectrum in blocks D and E from Qualcomm.
Second, the claim that this spectrum is essentially worthless, especially to any carrier except AT&T, is betrayed by reality. First, despite the claimed interference problems from TV broadcasters for A block spectrum, carriers are in fact deploying on the A block and have obtained devices to facilitate doing so effectively.
Meanwhile, Verizon had already announced in November of last year that it planned to transfer 12 MHz of A block spectrum in Chicago to Leap (note for those keeping score at home: Leap is notAT&T) in exchange for other spectrum around the country, and Cox recently announced that it is selling its own A and B block 700 MHz licenses (yes, eight B block licenses would go to AT&T, but four A block licenses would go to US Cellular).
Pretty clearly these A and B block 700 MHz licenses have value, and not just to AT&T.
Feld does actually realize that his preferred course of action is harmful. According to Feld, even though the transfer would increase spectrum holdings by companies that aren’t AT&T or Verizon, the fact that it might also facilitate the SpectrumCo deal and thus increase Verizon’s spectrum holdings is reason enough to object. For Feld and other critics of the deal the concern is over concentrationin spectrum holdings, and thus Verizon’s proposed divestiture is insufficient because the net effect of the deal, even with the divestiture, would be to increase Verizon’s spectrum holdings. Feld writes:
Verizon takes a giant leap forward in its spectrum holding and overall spectrum efficiency, whereas the competitors improve only marginally in absolute terms. Yes, compared to their current level of spectrum constraint, it would improve the ability of competitors [to compete] . . . [b]ut in absolute terms . . . the difference is so marginal it is not helpful.
Verizon has already said that they have no plans (assuming they get the AWS spectrum) to actually use the Lower MHz 700 A & B licenses, so selling those off does not reduce Verizon’s lead in the spectrum gap. So if we care about the spectrum gap, we need to take into account that this divestiture still does not alleviate the overall problem of spectrum concentration, even if it does improve spectrum efficiency.
But Feld is using a fantasy denominator to establish his concentration ratio. The divestiture only increases concentration when compared to a hypothetical world in which self-proclaimed protectors of the public interest get to distribute spectrum according to their idealized notions of a preferred market structure. But the relevant baseline for assessing the divestiture, even on Feld’s own concentration-centric terms, is the distribution of licenses under the deal without the divestiture—against which the divestiture manifestly reduces concentration, even if only “marginally.”
Moreover, critics commit the same inappropriate fantasizing when criticizing the SpectrumCo deal itself. Again, even if Feld’s imaginary world would be preferable to the post-deal world (more on which below), that imaginary world simply isn’t on the table. What is on the table if the deal falls through is the status quo—that is, the world in which Verizon is stuck with spectrum it is willing to sell and foreclosed from access to spectrum it wants to buy; US Cellular, AT&T and other carriers are left without access to Verizon’s lower-block 700 MHz spectrum; and the cable companies are saddled with spectrum they won’t use.
Perhaps, compared to this world, the deal does increase concentration. More importantly, compared to this world the deal increases spectrum deployment. Significantly. But never mind: The benefits of actual and immediate deployment of spectrum can never match up in the scolds’ minds to the speculative and theoretical harms from increased concentration, especially when judged against a hypothetical world that does not and will not ever exist.
But what is most appalling about critics’ efforts to withhold valuable spectrum from consumers for the sake of avoiding increased concentration is the reality that increased concentration doesn’t actually cause any harm.
In fact, it is simply inappropriate to assess the likely competitive effects of this or any other transaction in this industry by assessing concentration based on spectrum holdings. Of key importance here is the reality that spectrum alone—though essential to effective competitiveness—is not enough to amass customers, let alone confer market power. In this regard it is well worth noting that the very spectrum holdings at issue in the SpectrumCo deal, although significant in size, produce precisely zero market share for their current owners.
Even the FCC recognizes the weakness of reliance upon market structure as an indicator of market competitiveness in its most recent Wireless Competition Report, where the agency notes that highly concentrated markets may nevertheless be intensely competitive.
And the DOJ, in assessing “Economic Issues in Broadband Competition,” has likewise concluded both that these markets are likely to be concentrated and that such concentration does not raisecompetitive concerns. In large-scale networks “with differentiated products subject to large economies of scale (relative to the size of the market), the Department does not expect to see a large number of suppliers.” Rather, the DOJ cautions against “striving for broadband markets that look like textbook markets of perfect competition, with many price-taking firms. That market structure is unsuitable for the provision of broadband services.”
Although commonly trotted out as a conclusion in support of monopolization, the fact that a market may be concentrated is simply not a reliable indicator of anticompetitive effect, and naked reliance on such conclusions is inconsistent with modern understandings of markets and competition.
As it happens, there is detailed evidence in the Fifteenth Wireless Competition Report on actual competitive dynamics; market share analysis is unlikely to provide any additional insight. And the available evidence suggests that the tide toward concentration has resulted in considerable benefits and certainly doesn’t warrant a presumption of harm in the absence of compelling evidence to the contrary specific to this license transfer. Instead, there is considerable evidence of rapidly falling prices, quality expansion, capital investment, and a host of other characteristics inconsistent with a monopoly assumption that might otherwise be erroneously inferred from a structural analysis like that employed by Feld and other critics.
In fact, as economists Gerald Faulhaber, Robert Hahn & Hal Singer point out, a simple plotting of cellular prices against market concentration shows a strong inverse relationship inconsistent with an inference of monopoly power from market shares:
Today’s wireless market is an arguably concentrated but remarkably competitive market. Concentration of resources in the hands of the largest wireless providers has not slowed the growth of the market; rather the central problem is one of spectrum scarcity. According to the Fifteenth Report, “mobile broadband growth is likely to outpace the ability of technology and network improvements to keep up by an estimated factor of three, leading to a spectrum deficit that is likely to approach 300 megahertz within the next five years.”
Feld and his friends can fret about the phantom problem of concentration all they like—it doesn’t change the reality that the real problem is the lack of available spectrum to meet consumer demand. It’s bad enough that they are doing whatever they can to stop the SpectrumCo deal itself which would ensure that spectrum moves from the cable companies, where it sits unused, to Verizon, where it would be speedily deployed. But when they contort themselves to criticize even the re-allocation of spectrum under the so-called divestiture, which would directly address the very issue they hold so dear, it is clear that these “protectors of consumer rights” are not really protecting consumers at all.
[Cross-posted at Forbes]
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Posted in antitrust, business, doj, federal communications commission, law and economics, markets, monopolization, politics, technology, telecommunications | Tagged: at&t, Feld, Harold Feld, Public Knowledge, spectrum, SpectrumCo, t-mobile, US Cellular, Verizon, wireless | 3 Comments »
The procompetitive story that could undermine the DOJ’s e-books antitrust case against Apple
Posted by Geoffrey Manne on April 12, 2012
Did Apple conspire with e-book publishers to raise e-book prices? That’s what DOJ argues in a lawsuit filed yesterday. But does that violate the antitrust laws? Not necessarily—and even if it does, perhaps it shouldn’t.
Antitrust’s sole goal is maximizing consumer welfare. While that generally means antitrust regulators should focus on lower prices, the situation is more complicated when we’re talking about markets for new products, where technologies for distribution and consumption are evolving rapidly along with business models. In short, the so-called Agency pricing model Apple and publishers adopted may mean (and may not mean) higher e-book prices in the short run, but it also means more variability in pricing, and it might well have facilitated Apple’s entry into the market, increasing e-book retail competition and promoting innovation among e-book readers, while increasing funding for e-book content creators.
The procompetitive story goes something like the following. (As always with antitrust, the question isn’t so much which model is better, but that no one really knows what the right model is—least of all antitrust regulators—and that, the more unclear the consumer welfare effects of a practice are, as in rapidly evolving markets, the more we should err on the side of restraint).
Apple versus Amazon
Apple–decidedly a hardware company–entered the e-book market as a device maker eager to attract consumers to its expensive iPad tablets by offering appealing media content. In this it is the very opposite of Amazon, a general retailer that naturally moved into retailing digital content, and began selling hardware (Kindle readers) only as a way of getting consumers to embrace e-books.
The Kindle is essentially a one-trick pony (the latest Kindle notwithstanding), and its focus is on e-books. By contrast, Apple’s platform (the iPad and, to a lesser degree, the iPhone) is a multi-use platform, offering Internet browsing, word processing, music, apps, and other products, of which books probably accounted–and still account–for a relatively small percentage of revenue. Importantly, unlike Amazon, Apple has many options for promoting adoption of its platform—not least, the “sex appeal” of its famously glam products. Without denigrating Amazon’s offerings, Amazon, by contrast, competes largely on the basis of its content, and its devices sell only as long as the content is attractive and attractively priced.
In essence, Apple’s iPad is a platform; Amazon’s Kindle is a book merchant wrapped up in a cool device.
What this means is that Apple, unlike Amazon, is far less interested in controlling content prices for books and other content; it hardly needs to control that lever to effectively market its platform, and it can easily rely on content providers’ self interest to ensure that enough content flows through its devices.
In other words, Apple is content to act as a typical platform would, acting as a conduit for others’ content, which the content owner controls. Amazon surely has “platform” status in its sights, but reliant as it is on e-books, and nascent as that market is, it is not quite ready to act like a “pure” platform. (For more on this, see my blog post from 2010).
The Agency Model
As it happens, publishers seem to prefer the Agency Model, as well, preferring to keep control over their content in this medium rather than selling it (as in the brick-and-mortar model) to a retailer like Amazon to price, market, promote and re-sell at will. For the publishers, the Agency Model is essentially a form of resale price maintenance — ensuring that retailers who sell their products do not inefficiently discount prices. (For a clear exposition of the procompetitive merits of RPM, see this article by Benjamin Klein).
(As a side note, I suspect that they may well be wrong to feel this way. The inclination seems to stem from a fear of e-books’ threat to their traditional business model — a fear of technological evolution that can have catastrophic consequences (cf. Kodak, about which I wrote a few weeks ago). But then content providers moving into digital media have been consistently woeful at understanding digital markets).
So the publishers strike a deal with Apple that gives the publishers control over pricing and Apple a cut (30%) of the profits. Contrary to the DOJ’s claim in its complaint, this model happens to look exactly like Apple’s arrangement for apps and music, as well, right down to the same percentage Apple takes from sales. This makes things easier for Apple, gives publishers more control over pricing, and offers Apple content and a good return sufficient to induce it to market and sell its platform.
It is worth noting here that there is no reason to think that the wholesale model wouldn’t also have generated enough content and enough return for Apple, so I don’t think the ultimate motivation here for Apple was higher prices (which could well have actually led to lower total return given fewer sales), but rather that it wasn’t interested in paying for control. So in exchange for a (possibly) larger slice of the pie, as well as consistency with its existing content provider back-end and the avoidance of having to monitor and make pricing decisions, Apple happily relinquished decision-making over pricing and other aspects of sales.
The Most Favored Nation Clauses
Having given up this price control, Apple has one remaining problem: no guarantee of being able to offer attractive content at an attractive price if it is forced to try to sell e-books at a high price while its competitors can undercut it. And so, as is common in this sort of distribution agreement, Apple obtains “Most Favored Nation” (MFN) clauses from publishers to ensure that if they are permitting other platforms to sell their books at a lower price, Apple will at least be able to do so, as well. The contracts at issue in the case specify maximum resale prices for content and ensure Apple that if a publisher permits, say, Amazon to sell the same content at a lower price, it will likewise offer the content via Apple’s iBooks store for the same price.
The DOJ is fighting a war against MFNs, which is a story for another day, and it seems clear from the terms of the settlement with the three setting publishers that indeed MFNs are a big part of the target here. But there is nothing inherently problematic about MFNs, and there is plenty of scholarship explaining why they are beneficial. Here, and important among these, they facilitate entry by offering some protection for an entrant’s up-front investment in challenging an incumbent, and prevent subsequent entrants from undercutting this price. In this sense MFNs are essentially an important way of inducing retailers like Apple to sign on to an RPM (no control) model by offering some protection against publishers striking a deal with a competitor that leaves Apple forced to price its e-books out of the market.
There is nothing, that I know of, in the MFNs or elsewhere in the agreements that requires the publishers to impose higher resale prices elsewhere, or prevents the publishers from selling throughApple at a lower price, if necessary. That said, it may well have been everyone’s hope that, as the DOJ alleges, the MFNs would operate like price floors instead of price ceilings, ensuring higher prices for publishers. But hoping for higher prices is not an antitrust offense, and, as I’ve discussed, it’s not even clear that, viewed more broadly in terms of the evolution of the e-book and e-reader markets, higher prices in the short run would be bad for consumers.
The Legal Standard
To the extent that book publishers don’t necessarily know what’s really in their best interest, the DOJ is even more constrained in judging the benefits (or costs) for consumers at large from this scheme. As I’ve suggested, there is a pretty clear procompetitive story here, and a court may indeed agree that this should not be judged under a per se liability standard (as would apply in the case of naked price-fixing).
Most important, here there is no allegation that the publishers and Apple (or the publishers among themselves) agreed on price. Rather, the allegation is that they agreed to adopt a particular business model (one that, I would point out, probably resulted in greater variation in price, rather than less, compared to Amazon’s traditional $9.99-for-all pricing scheme). If the DOJ can convince a court that this nevertheless amounts to a naked price-fixing agreement among publishers, with Apple operating as the hub, then they are probably sunk. But while antitrust law is suspicious of collective action among rivals in coordinating on prices, this change in business model does not alone coordinate on prices. Each individual publisher can set its own price, and it’s not clear that the DOJ’s evidence points to any agreement with respect to actual pricing level.
It does seem pretty clear that there is coordination here on the shift in business models. But sometimes antitrust law condones such collective action to take account of various efficiencies (think standard setting or joint ventures or collective rights groups like BMI). Here, there is a more than plausible case that coordinated action to move to a plausibly-more-efficient business model was necessary and pro-competitive. If Apple can convince a court of that, then the DOJ has a rule of reason case on its hands and is facing a very uphill battle.
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Posted in antitrust, business, contracts, error costs, law and economics, MFNs, resale price maintenance, technology | Tagged: Amazon, Apple, doj, IBooks, iPad, Most favoured nation, United States Department of Justice | 4 Comments »
Potential Problems with an FDA Model for Regulating Financial Products
Posted by Thom Lambert on April 2, 2012
New York Times columnist Gretchen Morgenson is arguing for a “pre-clearance” approach to regulating new financial products:
The Food and Drug Administration vets new drugs before they reach the market. But imagine if there were a Wall Street version of the F.D.A. – an agency that examined new financial instruments and ensured that they were safe and benefited society, not just bankers. How different our economy might look today, given the damage done by complex instruments during the financial crisis.
The idea Morgenson is advocating was set forth by law professor Eric Posner (one of my former profs) and economist E. Glen Weyl in this paper. According to Morgenson,
[Posner and Weyl] contend that new instruments should be approved by a “financial products agency” that would test them for social utility. Ideally, products deemed too costly to society over all – those that serve only to increase speculation, for example – would be rejected, the two professors say.
While I have not yet read the paper, I have some concerns about the proposal, at least as described by Morgenson.
First, there’s the knowledge problem. Even if we assume that agents of a new “Financial Products Administration” (FPA) would be completely “other-regarding” (altruistic) in performing their duties, how are they to know whether a proposed financial instrument is, on balance, beneficial or detrimental to society? Morgenson suggests that “financial instruments could be judged by whether they help people hedge risks – which is generally beneficial — or whether they simply allow gambling, which can be costly.” But it’s certainly not the case that speculative (“gambling”) investments produce no social value. They generate a tremendous amount of information because they reflect the expectations of hundreds, thousands, or millions of investors who are placing bets with their own money. Even the much-maligned credit default swaps, instruments Morgenson and the paper authors suggest “have added little to society,” provide a great deal of information about the creditworthiness of insureds. How is a regulator in the FPA to know whether the benefits a particular financial instrument creates justify its risks?
When regulators have engaged in merits review of investment instruments — something the federal securities laws generally eschew — they’ve often screwed up. State securities regulators in Massachusetts, for example, once banned sales of Apple’s IPO shares, claiming that the stock was priced too high. Oops.
In addition to the knowledge problem, the proposed FPA would be subject to the same institutional maladies as its model, the FDA. The fact is, individuals do not cease to be rational, self-interest maximizers when they step into the public arena. Like their counterparts in the FDA, FPA officials will take into account the personal consequences of their decisions to grant or withhold approvals of new products. They will know that if they approve a financial product that injures some investors, they’ll likely be blamed in the press, hauled before Congress, etc. By contrast, if they withhold approval of a financial product that would be, on balance, socially beneficial, their improvident decision will attract little attention. In short, they will share with their counterparts in the FDA a bias toward disapproval of novel products.
In highlighting these two concerns, I’m emphasizing a point I’ve made repeatedly on TOTM: A defect in private ordering is not a sufficient condition for a regulatory fix. One must always ask whether the proposed regulatory regime will actually leave the world a better place. As the Austrians taught us, we can’t assume the regulators will have the information (and information-processing abilities) required to improve upon private ordering. As Public Choice theorists taught us, we can’t assume that even perfectly informed (but still self-interested) regulators will make socially optimal decisions. In light of Austrian and Public Choice insights, the Posner & Weyl proposal — at least as described by Morgenson — strikes me as problematic. [An additional concern is that the proposed pre-clearance regime might just send financial activity offshore. To their credit, the authors acknowledge and address that concern.]
Posted in economics, financial regulation, Hayek, Knowledge Problem, law and economics, regulation | 4 Comments »
More Bailout Fallout: Non-buyer’s Remorse
Posted by Michael Sykuta on March 12, 2012
An interesting story in the WSJ Online today about American International Group (AIG)’s use of a standard tax write-off and the political firestorm it is creating…all because the Washington establishment thought it could hide behind semantics during the bailout era.
The benefits at issue were accrued by AIG as it amassed record losses amid the financial crisis; the U.S. tax code allows businesses to “carry forward” such net operating losses to offset future tax obligations, in effect saving on future tax bills. But those carry-forwards can vanish if a company is taken over or sold, an exception that prevents healthy companies from avoiding taxes by buying firms with significant losses.
The criticism from the former members of the congressional panel stems from a series of Treasury determinations beginning in late 2008 that said the federal government’s bailout of AIG, General Motors Co. and other firms didn’t constitute a sale.
The US government acquired as much as 90% ownership in AIG during the bailout era. Under most any definition, such a shift would be considered a change in corporate control. However, because the Treasury Dept. wanted to maintain the illusion that government was not taking over large swaths of the US economy, it pronounced that these bailouts were not what any student of financial markets understood them to be: an exchange of equity control and strings on management for access to cash. In short, a sale of control.
Now the Treasury Department’s ruling is coming back to bite. Under the US tax code, AIG and its investors have a legal right to carry forward losses from the financial crisis to offset taxable earnings now. But now legal-scholar-turned-bureaucrat-turned-politician Elizabeth Warren, and others, want to change the rules after the fact. Warren is calling on Congress to “end this special tax break”. I’m not sure what exactly is so “special” about this tax break, since it applies to any business, not just those bailed out by the Feds. So is Warren suggesting all businesses should be prohibited from carrying forward losses? Or only businesses whose losses the Federal government wasn’t willing to tolerate in the first place? After all, if the Treasury had let nature take its course, AIG (and many other bailout recipients who are now wondering about their own ability to carry forward losses) would have been bought–albeit likely in pieces–and this whole issue would be moot.
What’s really interesting about this whole argument is that Treasury still holds 70%–a controlling interest–of AIG’s stock. AIG reported their beneficial tax breaks weeks ago. Presumably Treasury is paying attention to their investments and knew about that decision, possibly even before it was publicly released. So why didn’t they exercise their controlling interest and stop management from electing to use the carry forward? More importantly, Treasury is the “owner” that stands to gain the most from this tax benefit. So what exactly is Ms. Warren and others complaining about?
Either way, this is a mess of Treasury’s own making with its semantic gamesmanship on whether the bailout should be named for the government take-over that it was. Seems like we have a bit of non-buyer’s remorse.
Posted in business, law and economics, Sykuta, taxes, truth on the market | 5 Comments »
Is Dental Care a Preventive Measure Health Insurers Must Cover? Let’s Hope Not.
Posted by Thom Lambert on March 1, 2012
I recently heard an ominous NPR story on the rise in trips to the emergency room by people seeking dental treatment. In 2009 alone, Tennessee’s emergency rooms had more than 55,000 dental-related visits — five times as many as for burns. Florida’s emergency rooms experienced over 115,000 ER visits for dental matters in 2010. Charges for those visits totaled $88 million.
This is a big problem. Emergency rooms aren’t set up to treat dental patients, and the charges they impose dwarf those dentists charge for emergency work, much less for the sort of routine dental service that prevents dental emergencies in the first place. A huge amount of money could be saved if people — especially the poor folks who tend to use the emergency room for dental work — would just go to the dentist.
One approach to the problem would be to try to reduce the cost of preventive dental care. The vast majority of routine dental care can be (and, it seems from my own experience, usually is) provided by technicians who have some relatively low-cost specialized training but are not licensed dentists who have earned an expensive degree from a dental school. If regulators gave these folks more leeway to provide routine services without having to send their bills through a dentist who is sure to mark them up, the price of routine preventive services would fall, and more low-income folks would purchase them. The dental lobby, however, fights tooth and nail against this sort of reform.
A more likely policy response may come under the Affordable Care Act (aka Obamacare). As we’ve recently seen in the brouhaha over the Obama Administration’s contraception mandate, the Affordable Care Act requires that insurers fully cover, without any copayment requirement, any preventive measures that the United States Preventive Services Task Force (USPSTF) has rated “A” or “B” in terms cost-effectiveness. Birth control and the so-called “morning after” pill were so rated, which is why the Obama Adminstration is requiring that employer-provided insurance policies cover them.
Isn’t basic dental service (routine cleanings, check-ups, etc.) a cost-effective preventive measure? It certainly prevents serious and costly disease. According to the USPTF’s grade definitions, a preventive measure will receive an A or B rating if there is at least a “moderate certainty that the net benefit is moderate to substantial.” The NPR report and the Pew Study on which it’s based suggest that routine dental services would surely earn an A or B rating. If they’re so designated by USPTF, then it would seem that employer-provided insurance policies would have to cover them. [Note that I use the awkward "it would seem" phrase because I haven't scoured the gazillion-page statute to see if there's some sort of exemption that would except dental services; there may well be.]
“So what?”, you ask. Why would it be a bad thing if health insurance routinely covered dental procedures that would prevent serious ailments down the road? More people would then take the cost-effective precautions, thereby reducing the overall cost of health care.
Perhaps. But greatly expanding insurance coverage of dental services would likely have an unintended (except from the dentists’ perspective!) consequence: It would drive up the price of dentistry. In the current environment in which most people lack dental insurance or have relatively stingy policies, consumers are intensely interested in the price of dental services. Dentists respond by competing on price or, what is the same thing, the provision of “free” services like teeth whitening for new customers. Cheapos like me just go to a different dentist for every routine cleaning in order to get a new customer discount each time.
If employer-provided health insurance begins to cover the full price of routine dental services — an outcome that would seem to be required by the Affordable Care Act — then we can expect these promotions to end. Why would dentists compete on price when the customers selecting the dentists have no skin in the game? Insurers might inject some price competition by setting maximum prices for “in network” dentists, but price competition at this level is far less vigorous than when the consumer is directly paying her own money out of pocket. (Compare, e.g., price competition over LASIK treatments, purchased out of pocket, to price competition for routine doctor visits, which insurance covers in large part.)
As economist after economist after economist explained in the debate over the Affordable Care Act, a primary reason for spiraling health care costs is the prevalence of generous third-party insurance that covers almost everything and thereby decimates patients’ incentive to shop on – and thus providers’ incentive to compete on — price. Expanding this pernicious dynamic into the realm of dental services would be disastrous for all except dentists.
A far better way to address the problem of underutilization of preventive dental services would be to lower the cost of those services by liberalizing dentistry regulation (i.e., allowing trained non-dentists, who are cheaper, to do more). The dental lobby will oppose such a move, and the Affordable Care Act, I fear, provides it with an alternative policy to endorse and pursue. Yet another example of how the Affordable Care Act’s effort to increase insurance coverage undermines efforts to reduce costs.
Posted in economics, health care reform debate, law and economics, licensing, regulation | 2 Comments »
A Decision-Theoretic Approach to Insider Trading Regulation
Posted by Thom Lambert on January 19, 2012
Regular readers will know that several of us TOTM bloggers are fans of the “decision-theoretic” approach to antitrust law. Such an approach, which Josh and Geoff often call an “error cost” approach, recognizes that antitrust liability rules may misfire in two directions: they may wrongly acquit harmful practices, and they may wrongly convict beneficial (or benign) behavior. Accordingly, liability rules should be structured to minimize total error costs (welfare losses from condemning good stuff and acquitting bad stuff), while keeping in check the costs of administering the rules (e.g., the costs courts and business planners incur in applying the rules). The goal, in other words, should be to minimize the sum of decision and error costs. As I have elsewhere demonstrated, the Roberts Court’s antitrust jurisprudence seems to embrace this sort of approach.
One of my long-term projects (once I jettison some administrative responsibilities, like co-chairing my school’s dean search committee!) will be to apply the decision-theoretic approach to regulation generally. I hope to build upon some classic regulatory scholarship, like Alfred Kahn’s Economics of Regulation (1970) and Justice Breyer’s Regulation and Its Reform (1984), to craft a systematic regulatory model that both avoids “regulatory mismatch” (applying the wrong regulatory fix to a particular type of market failure) and incorporates the decision-theoretic perspective.
In the meantime, I’ve been thinking about insider trading regulation. Our friend Professor Bainbridge recently invited me to contribute to a volume he’s editing on insider trading. I’m planning to conduct a decision-theoretic analysis of actual and proposed insider trading regulation.
Such regulation is a terrific candidate for decision-theoretic analysis because stock trading on the basis of material, nonpublic information itself is a “mixed bag” practice: Some instances of insider trading are, on net, socially beneficial; others create net welfare losses. Contrast, for example, two famous insider trading cases:
- In SEC v. Texas Gulf Sulphur, mining company insiders who knew of an unannounced ore discovery purchased stock in their company, knowing that the stock price would rise when the discovery was announced. Their trading activity caused the stock price to rise over time. Such price movement might have tipped off landowners in the vicinity of the deposit and caused them not to sell their property to the company (or to do so only at a high price), in which case the traders’ activity would have thwarted a valuable corporate opportunity. If corporations cannot exploit their discoveries of hidden value (because of insider trading), they’ll be less likely to seek out hidden value in the first place, and social welfare will be reduced. TGS thus represents “bad” insider trading.
- Dirks v. SEC, by contrast, illustrates “good” insider trading. In that case, an insider tipped a securities analyst that a company was grossly overvalued because of rampant fraud. The analyst recommended that his clients sell (or buy puts on) the stock of the fraud-ridden corporation. That trading helped expose the fraud, creating social value in the form of more accurate stock prices.
These are just two examples of how insider trading may reduce or enhance social welfare. In general, instances of insider trading may reduce social welfare by preventing firms from exploiting and thus creating valuable information (as in TGS), by creating incentives for deliberate mismanagement (because insiders can benefit from “bad news” and might therefore be encouraged to “create” it), and perhaps by limiting stock market liquidity or reducing market efficiency by increasing bid-ask spreads. On the other hand, instances of insider trading may enhance social welfare by making stock markets more efficient (so that prices better reflect firms’ expected profitability and capital is more appropriately channeled), by reducing firms’ compensation costs (as the right to engage in insider trading replaces managers’ cash compensation—on this point, see the excellent work by our former blog colleague, Todd Henderson), and by reducing the corporate mismanagement and subsequent wealth destruction that comes from stock mispricing (mainly overvaluation of equity—see work by Michael Jensen and yours truly).
Because insider trading is sometimes good and sometimes bad, rules restricting it may err in two directions: they may acquit/encourage bad instances, or they may condemn/prevent good instances. In either case, social welfare suffers. Accordingly, the optimal regulatory regime would seek to minimize the sum of losses from improper condemnations and improper acquittals (total error costs), while keeping administrative costs in check.
My contribution to Prof. Bainbridge’s insider trading book will employ decision theory to evaluate three actual or proposed approaches to regulating insider trading: (1) the “level playing field” paradigm, apparently favored by many prosecutors and securities regulators, which would condemn any stock trading on the basis of material, nonpublic information; (2) the legal status quo, which deems “fraudulent” any insider trading where the trader owes either a fiduciary duty to his trading partner or a duty of trust or confidence to the source of his nonpublic information; and (3) a laissez-faire, “contractarian” approach, which would permit corporations and sources of nonpublic information to posit their own rules about when insiders and informed outsiders may trade on the basis of material, nonpublic information. I’ll then propose a fourth disclosure-based alternative aimed at maximizing social welfare by enhancing the social benefits and reducing the social costs of insider trading, while keeping decision costs in check.
Stay tuned…I’ll be trying out a few of the paper’s ideas on TOTM. I look forward to hearing our informed readers’ thoughts.
Posted in 10b-5, error costs, insider trading, law and economics, markets, regulation, securities regulation | Comments Off
