Archives For truth on the market

As another Israeli-Muslim armed conflict begins, it instructive to consider the lethality of previous conflicts.  The best estimate is that about 35,000 Muslims have been killed in all of the Israel-Muslim conflicts since 1948. During that same period, about 10,000,000 Muslims have been killed by other Muslims.  The Arab-Israeli conflict overall is the 49th deadliest conflict since 1950.  Of the total 85,000,000 deaths in that period, the Israeli-Arab conflict is responsible for .06 percent of all fatalities.  Hard to understand why this conflict generates so much attention and news. Also hard to understand why so many blame Israel for killing Muslims when many many more Muslims have killed each other. (All data from Daniel Pipes website.)

Debates among modern antitrust experts focus primarily on the appropriate indicia of anticompetitive behavior, the particular methodologies that should be applied in assessing such conduct, and the best combination and calibration of antitrust sanctions (fines, jail terms, injunctive relief, cease and desist orders).  Given a broad consensus that antitrust rules should promote consumer welfare (albeit some disagreement about the meaning of the term), discussions tend (not surprisingly) to emphasize the welfare effects of particular practices (and, relatedly, appropriate analytic techniques and procedural rules).  Less attention tends to be paid, however, to whether the overall structure of enforcement policy enhances welfare.

Assuming that one views modern antitrust enforcement as an exercise in consumer welfare maximization, what does that tell us about optimal antitrust enforcement policy design?  In order to maximize welfare, enforcers must have an understanding of – and seek to maximize the difference between – the aggregate costs and benefits that are likely to flow from their policies.  It therefore follows that cost-benefit analysis should be applied to antitrust enforcement design.  Specifically, antitrust enforcers first should ensure that the rules they propagate create net welfare benefits.  Next, they should (to the extent possible) seek to calibrate those rules so as to maximize net welfare.  (Significantly, Federal Trade Commissioner Josh Wright also has highlighted the merits of utilizing cost-benefit analysis in the work of the FTC.)

Importantly, while antitrust analysis is different in nature from agency regulation, cost-benefit analysis also has been the centerpiece of Executive Branch regulatory review since the Reagan Administration, winning bipartisan acceptance.  (Cass Sunstein has termed it “part of the informal constitution of the U.S. regulatory state.”)  Indeed, an examination of general Executive Branch guidance on cost-benefit regulatory assessments, and, in particular, on the evaluation of old policies, is quite instructive.  As stated by the Obama Administration in the context of Office of Management regulatory review, pursuant to Executive Order 13563, retrospective analysis allows an agency to identify “rules that may be outmoded, ineffective, insufficient, or excessively burdensome, and to modify, streamline, expand, or repeal them in accordance with what has been learned.”  Although Justice Department and FTC antitrust policy formulation is not covered by this Executive Order, its principled focus on assessments of preexisting as well as proposed regulations should remind federal antitrust enforcers that scrutinizing the actual effects of past enforcement initiatives is key to improving antitrust enforcement policy.  (Commendably, FTC Chairwoman Edith Ramirez and former FTC Chairman William Kovacic have emphasized the value of retrospective reviews.)

What should underlie cost-benefit analysis of antitrust enforcement policy?  The best approach is an error cost (decision theoretic) framework, which tends toward welfare maximization by seeking to minimize the sum of the costs attributable to false positives, false negatives, antitrust administrative costs, and disincentive costs imposed on third parties (the latter may also be viewed as a subset of false positives).  Josh Wright has provided an excellent treatment of this topic in touting the merits of evidence-based antitrust enforcement.  As Wright points out, such an approach places a premium on hard evidence of actual anticompetitive harm and empirical analysis, rather than mere theorizing about anticompetitive harm (which too often may lead to a misidentification of novel yet efficient business practices).

How should antitrust enforcers implement an error cost framework in establishing enforcement policy protocols?  Below I suggest eight principles that, I submit, would align antitrust enforcement policy much more closely with an error cost-based, cost-benefit approach.  These suggestions are preliminary tentative thoughts, put forth solely to stimulate future debate.  I fully recognize that convincing public officials to implement a cost-benefit framework for antitrust enforcement (which inherently limits bureaucratic discretion) will be exceedingly difficult, to say the least.  Generating support for such an approach is a long term project.  It must proceed in light of the political economy of antitrust and more specifically the institutional structure of antitrust enforcement (which Dan Crane has addressed in impressive fashion), topics that merit separate exploration.

First, antitrust enforcers should seek to identify and expound simple rules they will follow in both case selection and evaluation of business conduct, in order to rein in administrative costs.

Second, borrowing from Frank Easterbrook, they should place a greater emphasize on avoiding false positives than false negatives, particularly in the area of unilateral conduct (since false positives may send cautionary signals to third party businesses that the market cannot easily correct).

Third, they should pursue cases based on hard empirically-based indications of likely anticompetitive harm, rather than theoretical constructs that are hard to verify.

Fourth, they should avoid behavioral remedies in merger cases (and, indeed, other cases) to the greatest extent possible, given inherent problems of monitoring and administration posed by such requirements.  (See the trenchant critique of merger behavioral remedies by John Kwoka and Diana Moss.)

Fifth, they should emphasize giving full consideration to efficiencies (including dynamic efficiencies), given their importance to innovation and economic welfare gains.

Sixth, they should announce their positions in public pronouncements and guidelines that are as simple and straightforward as possible.  Agency guidance should be “tweaked” in light of compelling new empirical evidence, but “pendulum swing” changes should be minimized to avoid costly uncertainty.

Seventh, in non per se matters, they should pledge that they will only bring cases when (1) they have substantial evidence for the facts on which they rely and (2) that reasoning from those facts makes their prediction of harm to future competition more plausible than the defendant’s alternative account of the future.  (Doug Ginsburg and Josh Wright recommend that such a standard be applied to judicial review of antitrust enforcement action.)

Eighth, in the area of cartel conduct, they should adjust leniency and other enforcement policies based on the latest empirical findings and economic theory, seeking to pursue optimal detection and deterrence in light of “real world” evidence (see, for example, Greg Werden, Scott Hammond, and Belinda Barnett).

Admittedly, these suggestions bear little resemblance to recent federal antitrust enforcement initiatives.  Indeed, Obama Administration antitrust enforcers appear to me to have been moving farther away from an approach rooted in cost-benefit analysis.  The 2010 Horizontal Merger Guidelines, although more sophisticated than prior versions, give relatively short shrift to efficiencies (as Josh Wright has pointed out).  The Obama Justice Department’s withdrawal in 2009 of its predecessor’s Sherman Act Section Two Report (which had emphasized error costs and proposed simple rules for assessing monopolization cases) highlighted a desire for “aggressive enforcement,” without providing specific guidance for the private sector.  More generally, an assessment by William Shughart and Diana Thomas of antitrust enforcement in the Obama Administration’s first term concluded that antitrust agency activity had moved away from structural remedies and toward intrusive behavioral remedies “in an unprecedented fashion,” yielding suboptimal regulation – a far cry from cost-beneficial norms.

One may only hope (which after all makes “all the difference in the world”) that Federal Trade Commission and Justice Department officials, inspired by their teams of highly qualified economists, may consider according greater weight to cost-benefit considerations and error cost approaches as they move forward.

My son Joe and I have an op-ed in today’s WSJ that should stir up some controversy.

Opinion Wall Street Journal

The Case for Crony Capitalism

Many government regulations choke off entirely legal avenues of potential bank profits.

By

Paul H. Rubin And

Joseph S. Rubin

July 7, 2014 7:34 p.m. ET

Economics has a formal “theory of the second best” that in simplified terms may be expressed this way: If a government intervention leads to inefficiencies in markets but can’t be eliminated, an additional intervention may be the next-best alternative to eliminate the inefficiencies caused by the first.

It’s not the optimal solution to government-induced inefficiency, but it may be the best we can do. And it applies in many cases to what today is variously called “corporate welfare,” “loopholes,” or even “crony capitalism.”

The U.S. economy is rife with inefficient interventions—laws, regulations, taxes and subsidies that lead to inefficient markets. What some disparage as crony capitalism is in many cases an attempt to reduce the costs of these interventions.

Consider the Export-Import Bank, a federal agency that assists U.S. firms in financing international transactions. A first-best efficient policy would be to eliminate the agency, on grounds that if private banks will not finance a transaction, then the transaction is not worthwhile. The government shouldn’t become the financier of otherwise unprofitable transactions.

Yet that’s not the whole story. The Foreign Corrupt Practices Act, for example, makes it illegal for U.S. businesses to pay bribes to foreign officials. But it is not always so easy to determine what is illegal, and companies may be penalized for normal business practices. It is certainly not cheap to comply. The Ex-Im Bank website says that “to avoid such consequences [of the FCPA], many firms have implemented detailed compliance programs intended to prevent and to detect any improper payments by employees and by third-party agents.”

This adds to the costs of U.S. firms doing business abroad, lowering the amount of legitimate trade. Maybe the Ex-Im Bank is a reasonable, second-best response. One government subsidy may be necessary to help overcome other inefficiencies imposed by the government to begin with.

The banking bailout is another purported example of cronyism and corporate welfare. The poor lending practices of banks were undoubtedly part of the cause of the Great Recession. But banks, as well as government-sponsored enterprises such as Fannie Mae FNMA +0.50% and Freddie Mac, FMCC +0.51% were under tremendous pressure to make loans to unqualified borrowers.

Many other government regulations choke off entirely legal avenues of potential profit for banks by limiting with whom and under what circumstances they may do business. Examples include the financing of online and payday lenders, and firms that process payments for these lenders. If regulations cause banks to take excessive risks and limit profits, it may be efficient to provide some protection from these risks when things go bad, particularly if the damage is in large part caused by government policies.

Some claim that Medicare Part D, which pays for drugs, was a giveaway to the pharmaceutical industry. But 40 years of research has clearly shown that the Food and Drug Administration’s regulatory process makes drug development and approval unnecessarily and inefficiently expensive. Perhaps, in this environment, supplementing the costs of drugs may move us toward a more efficient drug policy, and bring more life-saving drugs to market.

Corporate taxes are too high, retarding investment. But when cutting rates is impossible, maybe tax breaks that encourage investment of various sorts is the second-best response. Environmental Protection Agency regulations are costly and inefficient. In some cases waivers or exceptions are less a payoff to cronies than a way to counter inefficient restrictions.

A second-best world is messy, and there may be better ways to overcome government-induced inefficiency. Yet sometimes what appear to be special favors may actually be moves in the direction of efficiency.

Of course, some examples of crony capitalism are worthy of the term, and the scorn that goes with it. For example, the various farm price-support programs, including sugar quotas and the ethanol program, which raise food prices world-wide and increase poverty, would be very difficult to justify under any second-best theory.

Nonetheless, as long as there is a push for more regulation, and particularly inefficient regulation, with little opportunity to rein in the already severe drag that these regulations impose on the economy, second-best solutions may be useful to temper some of their costs.

Paul H. Rubin is an economics professor at Emory University. His son, Joseph S. Rubin, is an attorney at Arnall Golden Gregory LLP in Washington, D.C.

 

 

Today’s (July 5, 2014) New York Times has an interesting story about rationing of water in California.  There are apparently rules in place urging people to cut back on water use, but they are apparently not well enforced.  Unsurprisingly, these appeals and unenforced rules are having relatively small effects.  So many municipalities are urging neighbors to report each other for misuses of water.  Economists know that a price increase would be the most efficient method of  limiting use.  But we may not have known that other forms of rationing would lead to increasing conflict among neighbors and increasing ill will.  This is an example of the sort of hostility generated by non-market institutions, as opposed to the cooperation generated by markets, and further evidence of the fundamental morality of markets.   Of course, the Times being what it is, there is no mention of the possibility of price increases to reduce water consumption, although the article does mention “water flowing very cheaply” but there is no suggestion that this should be changed.

In today’s (Sunday, June 22, 2014) New York Times Steven Rattner Has a column  that at first appears to get the economics right, but blows it at the end.  Most of the column is an explanation of why increased automation will not cause unemployment.  He describes past fears of automation leading to unemployment, going back to 1589, and shows that these fears have always been incorrect.  (He did not mention President Obama’s fear of ATM machines.)  But at the very end of the column, he presents what he believes to be the cause of unemployment.  “That honor belongs to globalization, and particularly the ability of companies to substitute far less expensive and increasingly skilled labor in developing countries.”  Of course, this claim is just as absurd as the claim that automation is causing unemployment.  Mr. Rattner is a smart man, although not an economist, and it is not clear whether his misguided diagnosis is due to ignorance or to politics — an unwillingness to blame increased regulation and particularly Obamacare for the slow growth in employment.

Feel free to follow me, Alden Abbott, @AldenAbbott1

Today’s New York Times has an interesting article on restaurant reservations (Julia Moskin, “Getting a Good Table by Flicking an App, Not Greasing a Palm,” Saturday, June 14, p. A1, As the title suggests, there are now various apps and online services that obtain hot restaurant reservations and then sell them to willing buyers. This process of course creates welfare gains for patrons who prefer paying to waiting in line (either physically or on endless telephone calls and redials). It can also create welfare gains for the restaurants themselves, both by reducing costly no-shows and sometimes by sharing in the revenue from the sale of the reservation. It is another example of the gains that can be realized by reducing transactions costs by using the internet and its progeny.
Let’s be clear about the gains. Reservations at a restaurant are worth more at some times of the week (Saturday night) than at other times (Wednesday noon.) Restaurants capitalize on some of these differences – cheaper lunch menus are standard. But in general restaurants have not charged more for Friday or Saturday nights than for other days, probably because of high transactions costs of such differential pricing. These new services allow differential pricing by day of the week and other factors leading to different demand. This differential pricing is in the form of a fixed charge for reservations. If part of the premium goes to the restaurant itself, then the restaurant can increase revenue without changing menu prices. Ultimately this will lead either to increased supply of high end restaurants or to reduced menu prices, or likely some combination. Diners will benefit from reduced prices or increased availability, and restaurants will gain as well. There is an efficiency gain from saving the time wasted by diners in waiting for seats or reservations. Part of the gains will go to those developing the apps, as a reward for their efforts.
What is also interesting about the article is the discussion of the “controversial” nature of these transactions. To an economist, anything that reduces transactions costs and allocates resources more efficiently to those willing to pay the most is efficient and so desirable. The developers of the apps seem to understand this. But to others, including many restaurateurs themselves, the system is immoral. One says “It’s online bribery.” Another, on learning that reservations are being sold online, says “Of course it bothers me.” Another “has crusaded against third-party reservation services.”
Much of my recent writing has been about the dislike of markets, including an article (Folk Economics), my Presidential Address to the Southern Economic Association, and a Wall Street Journal op-ed. In the case of reservation apps, the dislike probably comes from a variant of the zero-sum fallacy – the view that new institutions redistribute money and the ignoring of real benefits created for all parties. But it is particularly sad that even successful entrepreneurs – the founders and owners of successful restaurants –do not understand the benefits from efficient institutional arrangements.

 

David Brat

Paul H. Rubin —  11 June 2014

I do not know David Brat and had never heard of him before he won the primary.  I have looked at his Vita.  However, I am bothered by seeing him called a free market economist and a Randian.  Apparently one of the major issues distinguishing him from Mr. Cantor is Mr. Brat’s opposition to immigrants and immigration reform.  I cannot understand how someone can be a free market economist and opposed to immigration reform. Our immigration laws are a major limitation on free exchange, and anyone who really favors free markets must be in favor of major reforms, including allowing those who are here illegally to legalize their status.

On May 9, 2014, in Horne v. Department of Agriculture, the Ninth Circuit struck a blow against economic liberty by denying two California raisin growers’ efforts to recover penalties imposed against them by the U.S. Department of Agriculture (USDA).  The growers’ heinous offense was their refusal to continue participating in a highly anticompetitive cartel.  In order to understand this bizarre miscarriage of justice, which turns orthodox anti-cartel policy on its head, a bit of background is in order.  

Perhaps the most serious affront to a sound consumer welfare-based American antitrust policy is the persistence of federal government-sponsored agricultural cartels.  In a form of bureaucratic schizophrenia, while the Justice Department works hard to send private cartelists to jail, and grants leniency to informers who undermine cartels, the U.S. Agriculture Department (USDA) seeks to punish individuals who undercut USDA-sponsored cartels created pursuant to Agricultural Marketing Agreement Act marketing orders.  Those orders establish antitrust-exempt government-approved frameworks under which private industry members restrict output and raise the price of specific crops, in the name of ensuring “orderly” markets.  (Various scholars, such as Mario Loyola, have explored the public choice explanations for the private-public collusion that leads to marketing orders and other government-supported cartels.)    

A particularly notorious USDA cartel is the California Raisin Marketing Order (“Raisin Order”), in operation since 1949, which establishes a Raisin Administrative Committee (“RAC”).  The RAC is comprised almost entirely of self-interested raisin growers and packers (it is comprised of 47 growers and packers, plus a public member).  The RAC sets annual raisin “reserve tonnage” requirements as a percentage of the overall crop, with the remainder comprising “free raisins.”  “Reserve raisins” are diverted from the market but may be released when supplies are low.  Under the Raisin Order, raisin producers convey their entire crop to raisin packer-distributors known as “handlers,” with producers receiving a pre-negotiated price for the free tonnage.  Handlers sell free tonnage raisins on the open market, and divert the RAC-required percentage of each producer’s crop to the account of the RAC.  The RAC tracks how many raisins each producer contributes to the reserve pool, and has a regulatory duty to sell them in a way that maximizes producer returns.  The RAC finances its activities from reserve raisin sales proceeds, and disburses whatever net income remains to producers.  Reserve raisins are diverted to “low value” markets, such as the export sector, while American consumers typically buy free raisins.  The Raisin Order imposes substantial harm on American consumers:  for example, in 2001 free raisins sold for $877.50 per ton compared to $250 per ton for reserve raisins, and the free raisins/reserve raisins price ration approached 10/1 in 1984 and 1991

California raisin producers Marvin and Laura Horne sought to evade these cartel strictures by handling their own raisin crop, rather than selling it to traditional handlers, against whom the reserve requirement of the Raisin Order clearly operated.  Similarly, by buying and handling other producers’ raisins for a per-pound fee, the Hornes believed that they could avoid the Raisin Order’s definition of “handler” with respect to those purchased raisins.  A USDA judicial officer disagreed, finding the Hornes liable for numerous Order violations and fining them over $695,000, including an assessment of nearly $484,000 for the dollar value of the raisins not held in reserve. 

The Hornes challenged this USDA order in federal district court, arguing that they were not “handlers” within the meaning of the Raisin Order and that the order violated the Fifth Amendment’s Takings Clause and the Eighth Amendment’s prohibition against excessive fines.  The district court granted summary judgment for USDA on all counts.  On appeal, the Ninth Circuit affirmed the application of the Raisin Order and the denial of the Eighth Amendment claim, but held that the Court of Federal Claims rather than the district court had jurisdiction over the takings claim.  The U.S. Supreme Court granted certiorari on the jurisdictional issue only, holding that the Hornes could assert their takings claim in district court.  The Supreme Court remanded for a determination of the merits of the takings claim, and on May 9 the Ninth Circuit, applying de novo review, affirmed the district court’s rejection of that claim.

The Ninth Circuit acknowledged that USDA linked a monetary exaction (the penalty imposed for failure to comply with the Raisin Order) to specific property (the reserved raisins) and that the Hornes faced a choice – give the RAC the raisins or face a penalty.  Because the government did not literally seize raisins from the Holmes’ land or remove money from their bank account, the court held that the USDA’s action had to be analyzed as a potential regulatory taking.  The court then noted that the Takings Clause affords less protection to personal property than to real property, and that the Hornes did not lose all economically valuable use of their property.  The court asserted that the Hornes’ rights with respect to the reserved raisins were not extinguished because they retained a claim on certain future proceeds from reserved raisin sales (even though, as the Hornes pointed out, the “equitable distribution” of reserved sales might be zero).  The court reasoned that even though the Hornes might not receive cash distributions in some years, the reserved raisins were not “permanently occupied,” and that the RAC’s diversion of reserved raisins inured to the Hornes’ benefit by stabilizing raisin prices.  The court viewed the raisin diversion program as granting a conditional government benefit in exchange for an exaction.  In short, by smoothing price fluctuations in the raisin industry, the Raisin Order made “market conditions predictable” and thereby bore a “sufficient nexus” to a legitimate interest the government sought to protect.  (The court never asked why the reduction of consumer welfare and the imposition of deadweight losses through industry cartelization is a legitimate government interest.)  Moreover, the RAC’s imposition of a reserve requirement on all producers was roughly proportional to the USDA’s market stabilizing goal as reflected in the Raisin Order.  Thus, applying the nexus/proportionaliy test of Nollan v. California Coastal Commission and Dolan v. City of Tigard, the Ninth Circuit held that the application of the Marketing Order to the Hornes’ activities did not constitute a taking.

Stripped of its convoluted reasoning and highly selective application of Supreme Court precedents, the Ninth Circuit’s holding indicates that industrious and entrepreneurial individuals will not be allowed to avoid and thereby undermine agricultural cartels through creative commercial innovations.  It means that individuals engaging in a legitimate business activity who wish not to contribute their product to a cartel that is imposed on them may suffer loss of their property, merely because the government approves of the cartel and wishes to protect it by punishing “cheaters.”  But when the government is the ringmaster, odious cartels are miraculously transformed into praiseworthy citizens who promote the public interest by “stabilizing” markets. 

Whatever the ultimate outcome of the Hornes’ legal saga, the Ninth Circuit’s crabbed analysis highlights the absurdity of imposing government financial exactions on private commercial conduct that unequivocally raises consumer welfare and enhances competition.  The egregiousness of this conduct is amplified when the government penalizes a business for refusing to transfer some of its property to a third party (here, the RAC), without assurance of being compensated.  Whether the business chooses to incur the penalty or instead accedes to the transfer, basic logic demonstrates that its property is being taken.  Hopefully, future courts will keep this in mind and be willing to apply the Takings Clause to analogous scenarios. 

If faced by a serious possibility of having to pay “just compensation” under the Takings Clause, the USDA may become less willing to sanction cartel avoiders through overly expansive interpretations of its agricultural marketing orders.  That in turn could encourage additional businesses to seek creative ways to opt out of these arrangements.  The end result could be the gradual weakening and ultimate dismantling of the marketing order framework.  Even better, the USDA could choose to act unilaterally tomorrow and move to rescind marketing order regulations.  (That might be asking too much, of course.)

We’re delighted to announce the newest addition to our blogging roster, Alden Abbott.

Alden recently joined the Heritage Foundation as Senior Fellow and Deputy Director of the Center for Legal and Judicial Studies. For two years ending in April 2014, he was Director, Global Patent Law and Competition Strategy at Blackberry.

Alden has been at the center of the US antitrust universe for most of his career. When he retired from the FTC in 2012, he had served as Deputy Director of the Office of International Affairs for three years. Before that he was Director of Policy and Coordination, FTC Bureau of Competition; Acting General Counsel, Department of Commerce; Chief Counsel, National Telecommunications and Information Administration; Senior Counsel, Office of Legal Counsel, DOJ; and Special Assistant to the Assistant Attorney General for Antitrust, DOJ.

Alden is also an Adjunct Professor at George Mason Law School, a member of the Leadership of the American Bar Association’s Antitrust Section, and a Non-Governmental Advisor to the International Competition Network.

We look forward to Alden’s posts here at TOTM, the first of which will follow shortly.