What does it mean to “own” something? A simple question (with a complicated answer, of course) that, astonishingly, goes unasked in a recent article in the Pennsylvania Law Review entitled, What We Buy When We “Buy Now,” by Aaron Perzanowski and Chris Hoofnagle (hereafter “P&H”). But how can we reasonably answer the question they pose without first trying to understand the nature of property interests?

P&H set forth a simplistic thesis for their piece: when an e-commerce site uses the term “buy” to indicate the purchase of digital media (instead of the term “license”), it deceives consumers. This is so, the authors assert, because the common usage of the term “buy” indicates that there will be some conveyance of property that necessarily includes absolute rights such as alienability, descendibility, and excludability, and digital content doesn’t generally come with these attributes. The authors seek to establish this deception through a poorly constructed survey regarding consumers’ understanding of the parameters of their property interests in digitally acquired copies. (The survey’s considerable limitations is a topic for another day….)

The issue is more than merely academic: NTIA and the USPTO have just announced that they will hold a public meeting

to discuss how best to communicate to consumers regarding license terms and restrictions in connection with online transactions involving copyrighted works… [as a precursor to] the creation of a multistakeholder process to establish best practices to improve consumers’ understanding of license terms and restrictions in connection with online transactions involving creative works.

Whatever the results of that process, it should not begin, or end, with P&H’s problematic approach.

Getting to their conclusion that platforms are engaged in deceptive practices requires two leaps of faith: First, that property interests are absolute and that any restraint on the use of “property” is inconsistent with the notion of ownership; and second, that consumers’ stated expectations (even assuming that they were measured correctly) alone determine the appropriate contours of legal (and economic) property interests. Both leaps are meritless.

Property and ownership are not absolute concepts

P&H are in such a rush to condemn downstream restrictions on the alienability of digital copies that they fail to recognize that “property” and “ownership” are not absolute terms, and are capable of being properly understood only contextually. Our very notions of what objects may be capable of ownership change over time, along with the scope of authority over owned objects. For P&H, the fact that there are restrictions on the use of an object means that it is not properly “owned.” But that overlooks our everyday understanding of the nature of property.

Ownership is far more complex than P&H allow, and ownership limited by certain constraints is still ownership. As Armen Alchian and Harold Demsetz note in The Property Right Paradigm (1973):

In common speech, we frequently speak of someone owning this land, that house, or these bonds. This conversational style undoubtedly is economical from the viewpoint of quick communication, but it masks the variety and complexity of the ownership relationship. What is owned are rights to use resources, including one’s body and mind, and these rights are always circumscribed, often by the prohibition of certain actions. To “own land” usually means to have the right to till (or not to till) the soil, to mine the soil, to offer those rights for sale, etc., but not to have the right to throw soil at a passerby, to use it to change the course of a stream, or to force someone to buy it. What are owned are socially recognized rights of action. (Emphasis added).

Literally, everything we own comes with a range of limitations on our use rights. Literally. Everything. So starting from a position that limitations on use mean something is not, in fact, owned, is absurd.

Moreover, in defining what we buy when we buy digital goods by reference to analog goods, P&H are comparing apples and oranges, without acknowledging that both apples and oranges are bought.

There has been a fair amount of discussion about the nature of digital content transactions (including by the USPTO and NTIA), and whether they are analogous to traditional sales of objects or more properly characterized as licenses. But this is largely a distinction without a difference, and the nature of the transaction is unnecessary in understanding that P&H’s assertion of deception is unwarranted.

Quite simply, we are accustomed to buying licenses as well as products. Whenever we buy a ticket — e.g., an airline ticket or a ticket to the movies — we are buying the right to use something or gain some temporary privilege. These transactions are governed by the terms of the license. But we certainly buy tickets, no? Alchian and Demsetz again:

The domain of demarcated uses of a resource can be partitioned among several people. More than one party can claim some ownership interest in the same resource. One party may own the right to till the land, while another, perhaps the state, may own an easement to traverse or otherwise use the land for specific purposes. It is not the resource itself which is owned; it is a bundle, or a portion, of rights to use a resource that is owned. In its original meaning, property referred solely to a right, title, or interest, and resources could not be identified as property any more than they could be identified as right, title, or interest. (Emphasis added).

P&H essentially assert that restrictions on the use of property are so inconsistent with the notion of property that it would be deceptive to describe the acquisition transaction as a purchase. But such a claim completely overlooks the fact that there are restrictions on any use of property in general, and on ownership of copies of copyright-protected materials in particular.

Take analog copies of copyright-protected works. While the lawful owner of a copy is able to lend that copy to a friend, sell it, or even use it as a hammer or paperweight, he or she can not offer it for rental (for certain kinds of works), cannot reproduce it, may not publicly perform or broadcast it, and may not use it to bludgeon a neighbor. In short, there are all kinds of restrictions on the use of said object — yet P&H have little problem with defining the relationship of person to object as “ownership.”

Consumers’ understanding of all the terms of exchange is a poor metric for determining the nature of property interests

P&H make much of the assertion that most users don’t “know” the precise terms that govern the allocation of rights in digital copies; this is the source of the “deception” they assert. But there is a cost to marking out the precise terms of use with perfect specificity (no contract specifies every eventuality), a cost to knowing the terms perfectly, and a cost to caring about them.

When we buy digital goods, we probably care a great deal about a few terms. For a digital music file, for example, we care first and foremost about whether it will play on our device(s). Other terms are of diminishing importance. Users certainly care whether they can play a song when offline, for example, but whether their children will be able to play it after they die? Not so much. That eventuality may, in fact, be specified in the license, but the nature of this particular ownership relationship includes a degree of rational ignorance on the users’ part: The typical consumer simply doesn’t care. In other words, she is, in Nobel-winning economist Herbert Simon’s term, “boundedly rational.” That isn’t deception; it’s a feature of life without which we would be overwhelmed by “information overload” and unable to operate. We have every incentive and ability to know the terms we care most about, and to ignore the ones about which we care little.

Relatedly, P&H also fail to understand the relationship between price and ownership. A digital song that is purchased from Amazon for $.99 comes with a set of potentially valuable attributes. For example:

  • It may be purchased on its own, without the other contents of an album;
  • It never degrades in quality, and it’s extremely difficult to misplace;
  • It may be purchased from one’s living room and be instantaneously available;
  • It can be easily copied or transferred onto multiple devices; and
  • It can be stored in Amazon’s cloud without taking up any of the consumer’s physical memory resources.

In many ways that matter to consumers, digital copies are superior to analog or physical ones. And yet, compared to physical media, on a per-song basis (assuming one could even purchase a physical copy of a single song without purchasing an entire album), $.99 may represent a considerable discount. Moreover, in 1982 when CDs were first released, they cost an average of $15. In 2017 dollars, that would be $38. Yet today most digital album downloads can be found for $10 or less.

Of course, songs purchased on CD or vinyl offer other benefits that a digital copy can’t provide. But the main thing — the ability to listen to the music — is approximately equal, and yet the digital copy offers greater convenience at (often) lower price. It is impossible to conclude that a consumer is duped by such a purchase, even if it doesn’t come with the ability to resell the song.

In fact, given the price-to-value ratio, it is perhaps reasonable to think that consumers know full well (or at least suspect) that there might be some corresponding limitations on use — the inability to resell, for example — that would explain the discount. For some people, those limitations might matter, and those people, presumably, figure out whether such limitations are present before buying a digital album or song For everyone else, however, the ability to buy a digital song for $.99 — including all of the benefits of digital ownership, but minus the ability to resell — is a good deal, just as it is worth it to a home buyer to purchase a house, regardless of whether it is subject to various easements.

Consumers are, in fact, familiar with “buying” property with all sorts of restrictions

The inability to resell digital goods looms inordinately large for P&H: According to them, by virtue of the fact that digital copies may not be resold, “ownership” is no longer an appropriate characterization of the relationship between the consumer and her digital copy. P&H believe that digital copies of works are sufficiently similar to analog versions, that traditional doctrines of exhaustion (which would permit a lawful owner of a copy of a work to dispose of that copy as he or she deems appropriate) should apply equally to digital copies, and thus that the inability to alienate the copy as the consumer wants means that there is no ownership interest per se.

But, as discussed above, even ownership of a physical copy doesn’t convey to the purchaser the right to make or allow any use of that copy. So why should we treat the ability to alienate a copy as the determining factor in whether it is appropriate to refer to the acquisition as a purchase? P&H arrive at this conclusion only through the illogical assertion that

Consumers operate in the marketplace based on their prior experience. We suggest that consumers’ “default” behavior is based on the experiences of buying physical media, and the assumptions from that context have carried over into the digital domain.

P&H want us to believe that consumers can’t distinguish between the physical and virtual worlds, and that their ability to use media doesn’t differentiate between these realms. But consumers do understand (to the extent that they care) that they are buying a different product, with different attributes. Does anyone try to play a vinyl record on his or her phone? There are perceived advantages and disadvantages to different kinds of media purchases. The ability to resell is only one of these — and for many (most?) consumers not likely the most important.

And, furthermore, the notion that consumers better understood their rights — and the limitations on ownership — in the physical world and that they carried these well-informed expectations into the digital realm is fantasy. Are we to believe that the consumers of yore understood that when they bought a physical record they could sell it, but not rent it out? That if they played that record in a public place they would need to pay performance royalties to the songwriter and publisher? Not likely.

Simply put, there is a wide variety of goods and services that we clearly buy, but that have all kinds of attributes that do not fit P&H’s crabbed definition of ownership. For example:

  • We buy tickets to events and membership in clubs (which, depending upon club rules, may not be alienated, and which always lapse for non-payment).
  • We buy houses notwithstanding the fact that in most cases all we own is the right to inhabit the premises for as long as we pay the bank (which actually retains more of the incidents of “ownership”).
  • In fact, we buy real property encumbered by a series of restrictive covenants: Depending upon where we live, we may not be able to build above a certain height, we may not paint the house certain colors, we may not be able to leave certain objects in the driveway, and we may not be able to resell without approval of a board.

We may or may not know (or care) about all of the restrictions on our use of such property. But surely we may accurately say that we bought the property and that we “own” it, nonetheless.

The reality is that we are comfortable with the notion of buying any number of limited property interests — including the purchasing of a license — regardless of the contours of the purchase agreement. The fact that some ownership interests may properly be understood as licenses rather than as some form of exclusive and permanent dominion doesn’t suggest that a consumer is not involved in a transaction properly characterized as a sale, or that a consumer is somehow deceived when the transaction is characterized as a sale — and P&H are surely aware of this.

Conclusion: The real issue for P&H is “digital first sale,” not deception

At root, P&H are not truly concerned about consumer deception; they are concerned about what they view as unreasonable constraints on the “rights” of consumers imposed by copyright law in the digital realm. Resale looms so large in their analysis not because consumers care about it (or are deceived about it), but because the real object of their enmity is the lack of a “digital first sale doctrine” that exactly mirrors the law regarding physical goods.

But Congress has already determined that there are sufficient distinctions between ownership of digital copies and ownership of analog ones to justify treating them differently, notwithstanding ownership of the particular copy. And for good reason: Trade in “used” digital copies is not a secondary market. Such copies are identical to those traded in the primary market and would compete directly with “pristine” digital copies. It makes perfect sense to treat ownership differently in these cases — and still to say that both digital and analog copies are “bought” and “owned.”

P&H’s deep-seated opposition to current law colors and infects their analysis — and, arguably, their failure to be upfront about it is the real deception. When one starts an analysis with an already-identified conclusion, the path from hypothesis to result is unlikely to withstand scrutiny, and that is certainly the case here.

  1. Introduction

For nearly two years, the Global Antitrust Institute (GAI) at George Mason University’s Scalia Law School has filed an impressive series of comments on foreign competition laws and regulations.  The latest GAI comment, dated March 19 (“March 19 comment”), focuses on proposed revisions to the Anti-Unfair Competition Law (AUCL) of the People’s Republic of China, currently under consideration by China’s national legislature, the National People’s Congress.  The AUCL “coexists” with China’s antitrust statute, the Anti-Monopoly Law (AML).  The key concern raised by the March 19 comment is that the AUCL revisions not undermine the application of sound competition law principles in the analysis of bundling (a seller’s offering of several goods as part of a single package sale).  As such, the March 19 comment notes that the best way to avoid such an outcome would be for the AUCL to avoid condemning bundling as a potential “unfair” practice, leaving bundling practices to be assessed solely under the AML.  Furthermore, the March 19 comment wisely stresses that any antitrust evaluation of bundling, whether under the AML (the preferred option) or under the AUCL, should give weight to the substantial efficiencies that bundling typically engenders.

  1. Highlights of the March 19 Comment

Specifically, the March 19 comment made the following key recommendations:

  • The National People’s Congress should be commended for having deleted Article 6 of an earlier AUCL draft, which prohibited a firm from “taking advantage of its comparative advantage position.” As explained in a March 2016 GAI comment, this provision would have undermined efficient contractual negotiations that could benefited consumer as well as producer welfare.
  • With respect to the remaining draft provisions, any provisions that relate to conduct covered by China’s Anti-Monopoly Law (AML) be omitted entirely.
  • In particular, Article 11 (which provides that “[b]usiness operators selling goods must not bundle the sale of goods against buyers’ wishes, and must not attach other unreasonable conditions”) should be omitted in its entirety, as such conduct is already covered by Article 17(5) of the AML.
  • In the alternative, at the very least, Article 11 should be revised to adopt an effect-based approach under which bundling will be condemned only when: (1) the seller has market power in one of the goods included in the bundle sufficient to enable it to restrain trade in the market(s) for the other goods in the bundle; and (2) the anticompetitive effects outweigh any procompetitive benefits.  Such an approach would be consistent with Article 17(5) of the AML, which provides for an effects-based approach that applies only to firms with a dominant market position.
  • Bundling is ubiquitous and widely used by a variety of firms and for a variety of reasons (see here). In the vast majority of cases, package sales are “easily explained by economies of scope in production or by reductions in transaction and information costs, with an obvious benefit to the seller, the buyer or both.”   Those benefits can include lower prices for consumers, facilitate entry into new markets, reduce conflicting incentives between manufacturers and their distributors, and mitigate retailer free-riding and other types of agency problems.  Indeed (see here), “bundling can serve the same efficiency-enhancing vertical control functions as have been identified in the economic literature on tying, exclusive dealing, and other forms of vertical restraints.”
  • The potential to harm competition and generate anticompetitive effects arises only when bundling is practiced by a firm with market power in one of the goods included in the bundle. As the U.S. Supreme Court explained in Jefferson Parrish v. Hyde (1984), “there is nothing inherently anticompetitive about package sales,” and the fact that “a purchaser is ‘forced’ to buy a product he would not have otherwise bought even from another seller” does not imply an “adverse impact on competition.”  Rather, for bundling to harm competition there would have to be an exclusionary effect on other sellers because bundling thwarts buyers’ desire to purchase substitutes for one or more of the goods in the bundle from those other sellers to an extent that harms competition in the markets for those products (see here).
  • Moreover, because of the widespread procompetitive use of bundling, by firms without and firms with market power, making bundling per se or presumptively unlawful is likely to generate many Type I (false positive) errors which, as the U.S. Supreme Court explained in Verizon v. Trinko (2004), “are especially costly, because they chill the very conduct the antitrust laws are designed to protect.”
  1. Conclusion

In sum, the GAI’s March 19 comment does an outstanding job of highlighting the typically procompetitive nature of bundling, and of calling for an economics-based approach to the antitrust evaluation of bundling in China.  Other competition law authorities (including, for example, the European Competition Commission) could benefit from this comment as well, when they scrutinize bundling arrangements.

Thanks to Truth on the Market for the opportunity to guest blog, and to ICLE for inviting me to join as a Senior Scholar! I’m honoured to be involved with both of these august organizations.

In Brussels, the talk of the town is that the European Commission (“Commission”) is casting a new eye on the old antitrust conjecture that prophesizes a negative relationship between industry concentration and innovation. This issue arises in the context of the review of several mega-mergers in the pharmaceutical and AgTech (i.e., seed genomics, biochemicals, “precision farming,” etc.) industries.

The antitrust press reports that the Commission has shown signs of interest for the introduction of a new theory of harm: the Significant Impediment to Industry Innovation (“SIII”) theory, which would entitle the remediation of mergers on the sole ground that a transaction significantly impedes innovation incentives at the industry level. In a recent ICLE White Paper, I discuss the desirability and feasibility of the introduction of this doctrine for the assessment of mergers in R&D-driven industries.

The introduction of SIII analysis in EU merger policy would no doubt be a sea change, as compared to past decisional practice. In previous cases, the Commission has paid heed to the effects of a merger on incentives to innovate, but the assessment has been limited to the effect on the innovation incentives of the merging parties in relation to specific current or future products. The application of the SIII theory, however, would entail an assessment of a possible reduction of innovation in (i) a given industry as a whole; and (ii) not in relation to specific product applications.

The SIII theory would also be distinct from the innovation markets” framework occasionally applied in past US merger policy and now marginalized. This framework considers the effect of a merger on separate upstream “innovation markets,i.e., on the R&D process itself, not directly linked to a downstream current or future product market. Like SIII, innovation markets analysis is interesting in that the identification of separate upstream innovation markets implicitly recognises that the players active in those markets are not necessarily the same as those that compete with the merging parties in downstream product markets.

SIII is way more intrusive, however, because R&D incentives are considered in the abstract, without further obligation on the agency to identify structured R&D channels, pipeline products, and research trajectories.

With this, any case for an expansion of the Commission’s power to intervene against mergers in certain R&D-driven industries should rely on sound theoretical and empirical infrastructure. Yet, despite efforts by the most celebrated Nobel-prize economists of the past decades, the economics that underpin the relation between industry concentration and innovation incentives remains an unfathomable mystery. As Geoffrey Manne and Joshua Wright have summarized in detail, the existing literature is indeterminate, at best. As they note, quoting Rich Gilbert,

[a] careful examination of the empirical record concludes that the existing body of theoretical and empirical literature on the relationship between competition and innovation “fails to provide general support for the Schumpeterian hypothesis that monopoly promotes either investment in research and development or the output of innovation” and that “the theoretical and empirical evidence also does not support a strong conclusion that competition is uniformly a stimulus to innovation.”

Available theoretical research also fails to establish a directional relationship between mergers and innovation incentives. True, soundbites from antitrust conferences suggest that the Commission’s Chief Economist Team has developed a deterministic model that could be brought to bear on novel merger policy initiatives. Yet, given the height of the intellectual Everest under discussion, we remain dubious (yet curious).

And, as noted, the available empirical data appear inconclusive. Consider a relatively concentrated industry like the seed and agrochemical sector. Between 2009 and 2016, all big six agrochemical firms increased their total R&D expenditure and their R&D intensity either increased or remained stable. Note that this has taken place in spite of (i) a significant increase in concentration among the largest firms in the industry; (ii) dramatic drop in global agricultural commodity prices (which has adversely affected several agrochemical businesses); and (iii) the presence of strong appropriability devices, namely patent rights.

This brief industry example (that I discuss more thoroughly in the paper) calls our attention to a more general policy point: prior to poking and prodding with novel theories of harm, one would expect an impartial antitrust examiner to undertake empirical groundwork, and screen initial intuitions of adverse effects of mergers on innovation through the lenses of observable industry characteristics.

At a more operational level, SIII also illustrates the difficulties of using indirect proxies of innovation incentives such as R&D figures and patent statistics as a preliminary screening tool for the assessment of the effects of the merger. In my paper, I show how R&D intensity can increase or decrease for a variety of reasons that do not necessarily correlate with an increase or decrease in the intensity of innovation. Similarly, I discuss why patent counts and patent citations are very crude indicators of innovation incentives. Over-reliance on patent counts and citations can paint a misleading picture of the parties’ strength as innovators in terms of market impact: not all patents are translated into products that are commercialised or are equal in terms of commercial value.

As a result (and unlike the SIII or innovation markets approaches), the use of these proxies as a measure of innovative strength should be limited to instances where the patent clearly has an actual or potential commercial application in those markets that are being assessed. Such an approach would ensure that patents with little or no impact on innovation competition in a market are excluded from consideration. Moreover, and on pain of stating the obvious, patents are temporal rights. Incentives to innovate may be stronger as a protected technological application approaches patent expiry. Patent counts and citations, however, do not discount the maturity of patents and, in particular, do not say much about whether the patent is far from or close to its expiry date.

In order to overcome the limitations of crude quantitative proxies, it is in my view imperative to complement an empirical analysis with industry-specific qualitative research. Central to the assessment of the qualitative dimension of innovation competition is an understanding of the key drivers of innovation in the investigated industry. In the agrochemical industry, industry structure and market competition may only be one amongst many other factors that promote innovation. Economic models built upon Arrow’s replacement effect theory – namely that a pre-invention monopoly acts as a strong disincentive to further innovation – fail to capture that successful agrochemical products create new technology frontiers.

Thus, for example, progress in crop protection products – and, in particular, in pest- and insect-resistant crops – had fuelled research investments in pollinator protection technology. Moreover, the impact of wider industry and regulatory developments on incentives to innovate and market structure should not be ignored (for example, falling crop commodity prices or regulatory restrictions on the use of certain products). Last, antitrust agencies are well placed to understand that beyond R&D and patent statistics, there is also a degree of qualitative competition in the innovation strategies that are pursued by agrochemical players.

My paper closes with a word of caution. No compelling case has been advanced to support a departure from established merger control practice with the introduction of SIII in pharmaceutical and agrochemical mergers. The current EU merger control framework, which enables the Commission to conduct a prospective analysis of the parties’ R&D incentives in current or future product markets, seems to provide an appropriate safeguard against anticompetitive transactions.

In his 1974 Nobel Prize Lecture, Hayek criticized the “scientific error” of much economic research, which assumes that intangible, correlational laws govern observable and measurable phenomena. Hayek warned that economics is like biology: both fields focus on “structures of essential complexity” which are recalcitrant to stylized modeling. Interestingly, competition was one of the examples expressly mentioned by Hayek in his lecture:

[T]he social sciences, like much of biology but unlike most fields of the physical sciences, have to deal with structures of essential complexity, i.e. with structures whose characteristic properties can be exhibited only by models made up of relatively large numbers of variables. Competition, for instance, is a process which will produce certain results only if it proceeds among a fairly large number of acting persons.

What remains from this lecture is a vibrant call for humility in policy making, at a time where some constituencies within antitrust agencies show signs of interest in revisiting the relationship between concentration and innovation. And if Hayek’s convoluted writing style is not the most accessible of all, the title captures it all: “The Pretense of Knowledge.

TOTM is pleased to welcome guest blogger Nicolas Petit, Professor of Law & Economics at the University of Liege, Belgium.

Nicolas has also recently been named a (non-resident) Senior Scholar at ICLE (joining Joshua Wright, Joanna Shepherd, and Julian Morris).

Nicolas is also (as of March 2017) a Research Professor at the University of South Australia, co-director of the Liege Competition & Innovation Institute and director of the LL.M. program in EU Competition and Intellectual Property Law. He is also a part-time advisor to the Belgian competition authority.

Nicolas is a prolific scholar specializing in competition policy, IP law, and technology regulation. Nicolas Petit is the co-author (with Damien Geradin and Anne Layne-Farrar) of EU Competition Law and Economics (Oxford University Press, 2012) and the author of Droit européen de la concurrence (Domat Montchrestien, 2013), a monograph that was awarded the prize for the best law book of the year at the Constitutional Court in France.

One of his most recent papers, Significant Impediment to Industry Innovation: A Novel Theory of Harm in EU Merger Control?, was recently published as an ICLE Competition Research Program White Paper. His scholarship is available on SSRN and he tweets at @CompetitionProf.

Welcome, Nicolas!

On March 14, the U.S. Chamber of Commerce released a report “by an independent group of experts it commissioned to consider U.S. responses to the inappropriate use of antitrust enforcement actions worldwide to achieve industrial policy outcomes.”  (See here and here.)  I served as rapporteur for the report, which represents the views of the experts (leading academics, practitioners, and former senior officials who specialize in antitrust and international trade), not the position of the Chamber.  In particular, the report calls for the formation of a new White House-led working group.  The working group would oversee development of a strategy for dealing with the misuse of competition policy by other nations that impede international trade and competition and harm U.S. companies.  The denial of fundamental due process rights and the inappropriate extraterritorial application of competition remedies by foreign governments also would be within the purview of the working group.

The Chamber will hold a program on April 10 with members of the experts group to discuss the report and its conclusions.  The letter transmitting the report to the President and congressional leadership states as follows:

Today, nearly every nation in the world has some form of antitrust or competition law regulating business activities occurring within or substantially affecting its territory. The United States has long championed the promotion of global competition as the best way to ensure that businesses have a strong incentive to operate efficiently and innovate, and this approach has helped to fuel a strong and vibrant U.S. economy. But competition laws are not always applied in a transparent, accurate and impartial manner, and they can have significant adverse impacts far outside a country’s own borders. Certain of our major trading partners appear to have used their laws to actually harm competition by U.S. companies, protecting their own markets from foreign competition, promoting national champions, forcing technology transfers and, in some cases, denying U.S. companies fundamental due process.

Up to now, the United States has had some, but limited, success in addressing this problem. For that reason, in August of 2016, the U.S. Chamber of Commerce convened an independent, bi-partisan group of experts in trade and competition law and economics to take a fresh look and develop recommendations for a potentially more effective and better-integrated international trade and competition law strategy.

As explained by the U.S. Chamber in announcing the formation of this group,

The United States has been, and should continue to be, a global leader in the development and implementation of sound competition law and policy. . . . When competition law is applied in a discriminatory manner or relies upon non-competition factors to engineer outcomes in support of national champions or industrial policy objectives, the impact of such instances arguably goes beyond the role of U.S. antitrust agencies. The Chamber believes it is critical for the United States to develop a coordinated trade and competition law approach to international economic policy.

The International Competition Policy Expert Group (“ICPEG”) was encouraged to develop “practical and actionable steps forward that will serve to advance sound trade and competition policy.”

The Report accompanying this letter is the result of ICPEG’s work. Although the U.S. Chamber suggested the project and recruited participants, it made no effort to steer the content of ICPEG’s recommendations.

The Report is addressed specifically to the interaction of competition law and international trade law and proposes greater coordination and cooperation between them in the formulation and implementation of U.S. international trade policy. It focuses on the use of international trade and other appropriate tools to address problems in the application of foreign competition policies through 12 concrete recommendations.

Recommendations 1 through 6 urge the Trump Administration to prioritize the coordination of international competition policy through a new, cabinet-level White House working group (the “Working Group”) to be chaired by an Assistant to the President. Among other things, the Working Group would:

  • set a government-wide, high-level strategy for articulating and promoting policies to address the misuse of competition law by other nations that impede international trade and competition and harm U.S. companies;
  • undertake a 90-day review of existing and potential new trade policy tools available to address the challenge, culminating in a recommended “action list” for the President and Congress; and
  • address not only broader substantive concerns regarding the abuse of competition policy for protectionist and discriminatory purposes, but also the denial of fundamental process rights and the extraterritorial imposition of remedies that are not necessary to protect a country’s legitimate competition law objectives.

Recommendations 7 through 12 focus on steps that should be taken with international organizations and bilateral initiatives. For example, the United States should consider:

  • the feasibility and value of expanding the World Trade Organization’s regular assessment of each member government by the Trade Policy Review Body to include national competition policies and encourage the Organisation for Economic Cooperation and Development (OECD) to undertake specific peer reviews of national procedural or substantive policies, including of non-OECD countries;
  • encouraging the OECD and/or other multilateral bodies to adopt a code enumerating transparent, accurate, and impartial procedures; and
  • promoting the application of agreements under which nations would cooperate with and take into account legitimate interests of other nations affected by a competition investigation.

The competition and trade law issues addressed in the Report are complex and the consequences of taking any particular action vis-a-vis another country must be carefully considered in light of a number of factors beyond the scope of this Report. ICPEG does not take a view on the actions of any particular country nor propose specific steps with respect to any actual dispute or matter. In addition, reasonable minds can differ on ICPEG’s assessment and recommendations. But we hope that this Report will prompt appropriate prioritization of the issues it addresses and serve as the basis for the further development of a successful policy and action plan and improved coordination and cooperation between U.S. competition and trade agencies.

I recently became aware of a decision from the High Court in South Africa that examines an interesting intersection of freedom of expression, copyright and contract. It addresses the issue of how to define the public interest in an environment of relatively unguarded rhetoric about the role of copyright in society that is worth exploring. But first, a quick recap of the relevant facts, none of which were in issue.

A well known filmmaker, Ms. SE Vollenhoven, was hired by South African broadcaster, SABC, to produce a documentary film exposing certain governmental improprieties. In her contract with SABC, Vollenhoven transferred all copyright interests to SABC in exchange for compensation. SABC ultimately decided that it was uncomfortable with the product, and decided against releasing it. Vollenhoven initiated a discussion with SABC in an effort to buy back the rights to the film, but SABC refused, leading SABC to seek an injunction preventing Vollenhoven from engaging in any acts that would infringe their rights in the film.

For the purposes of this analysis, let’s assume that all equities are with Vollenhoven, and that the public would gain from the release of the film. I am not in a position to make such a judgment personally, but certainly my sympathies would be with a filmmaker whose own expressive work is relegated to the dustbins due to a decision by a business partner to keep the film out of the public eye. Her frustration is clearly understandable. Let’s further assume that the government pressured SABC into not releasing the film—not because in fact I assume this, but because it is certainly possible, and I want to examine the copyright questions in a light least hospitable to the assertion of copyright. There is an axiom in legal circles that “bad facts make bad law,” but sometimes bad facts allow us to observe legal principles without artifice or obstruction in ways that are useful for our understanding of fundamental principles of law and justice.

This is just such a case. Much as we might sympathize with Vollenhoven, the arguments presented by her counsel would require us to believe that the rejection of free will that undergirds freedom of contract and self-determination is a legitimate price in the quest for perceived freedom. I believe that is a fundamentally flawed proposition, and that willingness to constrain free will that allows a person to determine the scope of her consent undermines rather than advances the public good. The ends, even assuming that they are noble and just, do not justify a means that eliminates consent while seeking to improve the human condition. Vollenhoven and amici (we will get to them later)  ask us to reject free will to achieve freedom. But there is no freedom at the end of that road. As the Court brilliantly and succinctly observed: “a limitation of freedom is irreconcilable with the right of choice.

There are a number of equitable doctrines under which contracts may be vitiated, for example when they are the result of duress or where the consent required for formation of a contract is found to be absent. But here, no such equitable doctrines would apply. Vollenhoven was an accomplished filmmaker who freely negotiated a contract with SABC for her services. There is no suggestion from any party that the contract was somehow unfair, nor are we talking about the application of a non-negotiated provision of law vesting copyright in an employer or commissioning party. Vollenhoven herself does not assert anything different. Her unhappiness with the result of the contract is understandable, but doesn’t justify the attempt to circumvent it through a novel and dangerous mischaracterization of copyright laws and exceptions thereto.

This is where things get interesting. Since the contract under which SABC obtained the copyright in the documentary was unassailable, Vollenhoven and her supporters determined to “free the film” by asserting an implied exception to copyright laws to permit dissemination of information in the public interest. This took a variety of forms, all of which eventually defaulted to the proposition that the public’s interest in access superseded the copyright owner’s interest in protection. I take particular note of the participation of the Freedom of Expression Institute (FXI) on behalf of Vollenhoven since they most perfectly articulate the position that copyright is a form of censorship, having written in their 2015 copyright reform submission to DTI that: “FXI believes that copyright law and free speech are fundamentally in conflict. It should come as no surprise, at all, that both governments and the private sector use copyright law to suppress speech and dissent.” Vollenhoven’s counsel, as summarized by the Court, argued that the Copyright law exists, inter alia, “to promote the free spread of art, ideas and information, not to hinder it and to regulate copyright so as to enhance a vibrant culture in South Africa. Thus on a purposeful interpretation of the Act, so it is argued, it is not just to protect owners of copyright but to advance the public good.”

The Court was unimpressed, finding that: “There is nothing…to support the meaning of public good relied on by the Respondents. Their construction of public good or welfare is equated to dissemination of ideas and this is nowhere to be found or implied….The view that copyright aims to promote public disclosure and dissemination of works cannot be regarded as a true reflection of the purpose or intent of the Act and is not part of our copyright law. The Respondents’  conception of the purposes of the Copyright Act is overbroad. The Act by no means purports to regulate or promote the free spread of ideas although it undoubtedly is a mechanism by which this result may be effected. It is straining the proper limits of the Act to find some kind of implied condition of dissemination in the conferral of copyright.”

And of course, the Court is absolutely correct–enjoining the distribution of the film doesn’t prevent the distribution of the information/ideas contained therein, only the specific original expression of said ideas. Vollerhoven, or anyone else, remains free to tell stories through separate vehicles. As the Court explained: “[Vollerhoven] concedes readily that the respondents have right to tell the story in a different work and have not attempted to stifle this form of expression. In truth the respondents’ freedom of speech is not impinged at all. What is impinged is the use of the work which the respondents sold to the applicant and were substantially rewarded monetarily. The copyrights are vested by law in the applicants. This cannot be conflated with an infringement of freedom of speech. Vollenhoven shows that she is alive to the distinction between the work and the underlying story or idea and does not shirk from asserting her rights to exploit the story as she is well entitled to do.”

The contrary rule argued by her counsel and by FXI is untenable, and would require embracing the perverse logic that the protection of expression is itself a restriction on freedom of expression, a proposition worthy of Wonderland’s Red Queen. If the right of access enjoyed by the public always supersedes the individual’s right to control the uses of her property, then copyright is truly meaningless. FXI’s position essentially acknowledges this. While I think that FXI is mistaken, and fails to capture how copyright serves to democratize the production of original cultural materials for the benefit of society, I will at least give them credit for their directness. Perhaps they believe that state support for the arts is a better tool for sustaining creators. Perhaps they believe in private patronage. But unlike many of their copyright-skeptic peers in the west, they at least own their narrative and don’t feel the need to say that they believe in copyright while rejecting any modality for its protection. It’s a flawed vision that fails to reflect that the interests of the public are served by sustaining creators, and by protecting fundamental human rights in connection with the creation of original works. But it is a vision. Hopefully one that will evolve through an increased recognition that ensuring consent in a technological universe that celebrates lack of permission is central to advancing our humanity and retaining and celebrating our cultural differences.

The antitrust industry never sleeps – it is always hard at work seeking new business practices to scrutinize, eagerly latching on to any novel theory of anticompetitive harm that holds out the prospect of future investigations.  In so doing, antitrust entrepreneurs choose, of course, to ignore Nobel Laureate Ronald Coase’s warning that “[i]f an economist finds something . . . that he does not understand, he looks for a monopoly explanation.  And as in this field we are rather ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on monopoly explanations frequent.”  Ambitious antitrusters also generally appear oblivious to the fact that since antitrust is an administrative system subject to substantial error and transaction costs in application (see here), decision theory counsels that enforcers should proceed with great caution before adopting novel untested theories of competitive harm.

The latest example of this regrettable phenomenon is the popular new theory that institutional investors’ common ownership of minority shares in competing firms may pose serious threats to vigorous market competition (see here, for example).  If such investors’ shareholdings are insufficient to control or substantially influence the strategies employed by the competing firms, what is the precise mechanism by which this occurs?  At the very least, this question should give enforcers pause (and cause them to carefully examine both the theoretical and empirical underpinnings of the common ownership story) before they charge ahead as knights errant seeking to vanquish new financial foes.  Yet it appears that at least some antitrust enforcers have been wasting no time in seeking to factor common ownership concerns into their modes of analysis.  (For example, The European Commission in at least one case presented a modified Herfindahl-Hirschman Index (MHHI) analysis to account for the effects of common shareholding by institutional investors, as part of a statement of objections to a proposed merger, see here.)

A recent draft paper by Bates White economists Daniel P. O’Brien and Keith Waehrer raises major questions about recent much heralded research (reported in three studies dealing with executive compensation, airlines, and banking) that has been cited to raise concerns about common minority shareholdings’ effects on competition.  The draft paper’s abstract argues that the theory underlying these concerns is insufficiently developed, and that there are serious statistical flaws in the empirical work that purports to show a relationship between price and common ownership:

“Recent empirical research purports to show that common ownership by institutional investors harms competition even when all financial holdings are minority interests. This research has received a great deal of attention, leading to both calls for and actual changes in antitrust policy. This paper examines the research on this subject to date and finds that its conclusions regarding the effects of minority shareholdings on competition are not well established. Without prejudging what more rigorous empirical work might show, we conclude that researchers and policy authorities are getting well ahead of themselves in drawing policy conclusions from the research to date. The theory of partial ownership does not yield a specific relationship between price and the MHHI. In addition, the key explanatory variable in the emerging research – the MHHI – is an endogenous measure of concentration that depends on both common ownership and market shares. Factors other than common ownership affect both price and the MHHI, so the relationship between price and the MHHI need not reflect the relationship between price and common ownership. Thus, regressions of price on the MHHI are likely to show a relationship even if common ownership has no actual causal effect on price. The instrumental variable approaches employed in this literature are not sufficient to remedy this issue. We explain these points with reference to the economic theory of partial ownership and suggest avenues for further research.”

In addition to pinpointing deficiencies in existing research, O’Brien and Waehrer also summarize serious negative implications for the financial sector that could stem from the aggressive antitrust pursuit of partial ownership for the financial sector – a new approach that would be at odds with longstanding antitrust practice (footnote citations deleted):

“While it is widely accepted that common ownership can have anticompetitive effects when the owners have control over at least one of the firms they own (a complete merger is a special case), antitrust authorities historically have taken limited interest in common ownership by minority shareholders whose control seems to be limited to voting rights. Thus, if the empirical findings and conclusions in the emerging research are correct and robust, they could have dramatic implications for the antitrust analysis of mergers and acquisitions. The findings could be interpreted to suggest that antitrust authorities should scrutinize not only situations in which a common owner of competing firms control at least one of the entities it owns, but also situations in which all of the common owner’s shareholdings are small minority positions. As [previously] noted, . . . such a policy shift is already occurring.

Institutional investors (e.g., mutual funds) frequently take positions in multiple firms in an industry in order to offer diversified portfolios to retail investors at low transaction costs. A change in antitrust or regulatory policy toward these investments could have significant negative implications for the types of investments currently available to retail investors. In particular, a recent proposal to step up antitrust enforcement in this area would seem to require significant changes to the size or composition of many investment funds that are currently offered.

Given the potential policy implications of this research and the less than obvious connections between small minority ownership interests and anticompetitive price effects, it is important to be particularly confident in the analysis and empirical findings before drawing strong policy conclusions. In our view, this requires a valid empirical test that permits causal inferences about the effects of common ownership on price. In addition, the empirical findings and their interpretation should be consistent with the observed behavior of firms and investors in the economic and legal environments in which they operate.

We find that the airline, banking, and compensation papers [that deal with minority shareholding] fall short of these criteria.”

In sum, at the very least, a substantial amount of further work is called for before significant enforcement resources are directed to common minority shareholder investigations, lest competitively non-problematic investment holdings be chilled.  More generally, the trendy antitrust pursuit of common minority shareholdings threatens to interfere inappropriately in investment decisions of institutional investors and thereby undermine efficiency.  Given the great significance of institutional investment for vibrant capital markets and a growing, dynamic economy, the negative economic welfare consequences of such unwarranted meddling would likely swamp any benefits that might accrue from an occasional meritorious prosecution.  One may hope that the Trump Administration will seriously weigh those potential consequences as it examines the minority shareholding issue, in deciding upon its antitrust policy priorities.

  1. Overview

A‌merica’s antitrust laws have long held a special status in the ‌federal statutory hierarchy.  The Supreme Court of the United States, for example, famously stated that the “[a]ntitrust laws in general, and the Sherman Act in particular, are the Magna Carta of free enterprise.”  Thus, when considering the qualifications of a nominee to the U.S. Supreme Court, the nominee’s views (if any) on antitrust are unquestionably of interest.  Such an assessment is particularly significant today, given the fact that the Court has had only one remaining antitrust expert (Justice Breyer, who taught antitrust at Harvard), since the sad demise of Justice Scalia (author of the landmark Trinko opinion on the limits of monopolization law).

Fortunately, we know a great deal about the antitrust perspective of Judge Neil Gorsuch, President Trump’s first nominee to the Supreme Court.  Judge Gorsuch authored several well-reasoned and highly persuasive antitrust opinions as a Tenth Circuit judge, which show him to be respectful of Supreme Court precedent and fully aware of the nuances of modern antitrust analysis.  This is not surprising, since Judge Gorsuch in recent years has taught antitrust law at the University of Colorado Law School.  In addition, he had exposure to antitrust matters as Principal Deputy Associate Attorney General during the George W. Bush Administration.  What’s more, he worked on major antitrust cases as an associate and then a partner at the Kellogg Huber law firm (see here).  Recent commentaries by highly respected antitrust lawyers on Judge Gorsuch’s antitrust jurisprudence manifest great respect for his mastery of the field (see, for example, here and here) – and put to shame a non-antitrust lawyer’s jejeune and misleading “hit piece” on Judge Gorsuch’s antitrust record (see here) that displays a woeful ignorance of the nature of antitrust analysis (see, for example, Ed Whelan’s devastating critique of that screed, here).

In short, Judge Gorsuch is extremely well-versed in antitrust and thus ideally positioned to make important contributions to the Supreme Court’s antitrust jurisprudence, should he be confirmed.  A quick evaluation of Judge Gorsuch’s decisions in antitrust cases confirms this conclusion.

  1. Judge Gorsuch’s Antitrust Opinions

Let’s take a look at three antitrust opinions authored by Judge Gorsuch, two of which deal with refusals to deal, and one of which concerns municipal antitrust immunity.  All three decisions show an appreciation for the underlying economic efficiency rationale that undergirds modern mainstream antitrust analysis, consistent with Supreme Court case law pronouncements.

a.  Four Corners Nephrology, Associates, PC v. Mercy Medical Center of Durango, 582 F.3d 1216 (10th 2009). To provide Durango, Colorado, residents and Southern Ute Indian tribe members with greater access to kidney dialysis and other nephrology services, Mercy Medical Center, a non-profit hospital, together with the tribe, sought to entice Dr. Mark Bevan to join the hospital’s active staff.  When Dr. Bevan declined, the hospital hired somebody else.  To convince that physician and others to settle in Durango, and aware that starting a nephrology practice was likely to prove unprofitable for the foreseeable future, the hospital and tribe agreed to underwrite up to $2.5 million in losses they expected the practice to incur.  To protect its investment, Mercy made its new practice the exclusive provider of nephrology services at the hospital.

Dr. Bevan sued, contending that Mercy’s refusal to deal with other nephrologists, including himself, amounted to the monopolization, or attempted monopolization, of the market for physician nephrology services in the Durango area.  The district court granted summary judgment to the hospital.

Judge Gorsuch’s Sixth Circuit panel opinion affirmed, for two reasons.  First, he held that the hospital had no antitrust duty to share its facilities with Dr. Bevan at the expense of its own nephrology practice.  It stressed that in demanding access to Mercy’s facilities, Dr. Bevan sought to share, not to undo, the hospital’s putative monopoly.  According to Judge Gorsuch, that is not what the antitrust laws are about:  they seek to advance competition, not advantage competitors.  Judge Gorsuch deftly distinguished the Supreme Court’s 1985 Aspen Skiing decision, which upheld a Sherman Act Section 2 refusal to deal claim based on a monopolist ski resort’s discontinuation of a joint ticketing arrangement with a smaller resort (a decision deemed “at or near the outer boundary of §2 liability” in Justice Scalia’s Trinko opinion).  He noted that defendant terminated a profitable long-term contractual relationship in Aspen Skiing, in order to achieve long-term anticompetitive goals.  In the instant case, however, the hospital was seeking to avoid an unprofitable short-term relationship with the plaintiff doctor – an action consistent with legal competition on the merits, as in TrinkoSecond, Judge Gorsuch held that plaintiff had suffered no antitrust injury, because it was seeking to share in monopoly profits, not to undo a monopoly and thereby benefit consumers.

Judge Gorsuch’s careful reasoning in Four Corners adroitly cabined Aspen Skiing’s problematic reasoning.  Future courts could benefit from his approach to help rein in inappropriate antitrust attacks on refusals to deal that manifest competition on the merits.

b.  Novell, Inc. v. Microsoft Corporation, 731 F.3d 1064 (10th 2013).  Novell produced office software, including WordPerfect, Microsoft Word’s leading rival in word processing applications.  Microsoft initially gave independent software vendors, including Novell, pre-release access to design information which would enable them to produce applications for Windows 95.  Microsoft subsequently changed its policy, however, denying such access prior to the release of Windows 95.  This decision significantly delayed, but did not preclude, third party companies from developing Windows 95 applications.  Novell sued Microsoft, alleging that Microsoft’s actions helped it maintain its monopoly in the market for Intel-compatible personal computer operating systems.  The district court granted judgment for Microsoft as a matter of law, and the Tenth Circuit affirmed.

In his opinion, Judge Gorsuch framed the standard of liability for illegal monopolization under Section 2 of the Sherman Act in a decision-theoretic manner that would gladden the hearts of law and economics mavens:  “the question . . . is whether, based on the evidence and experience derived from past cases, the conduct at issue before us has little or no value beyond the capacity to protect the monopolist’s market power—bearing in mind the risk of false positives (and negatives) any determination on the question of liability might invite, and the limits on the administrative capacities of courts to police market terms and transactions.”

Applying this set of general principles in light of the case law and the facts presented, Judge Gorsuch ably dissected and rejected Novell’s theories of antitrust harm, explaining that Novell’s claims did not squeeze “through the narrow needle of [antitrust] refusal to deal doctrine.”  Specifically, Microsoft’s actions failed to pass Aspen Skiing muster.  Even though “[a] voluntary and profitable relationship clearly existed between Microsoft and Novell[,]. . . Novell . . .  presented no evidence from which a reasonable jury could infer that Microsoft’s discontinuation of this arrangement suggested a willingness to sacrifice short-term profits, let alone in a manner that was irrational but for its tendency to harm competition.”  The court also rejected Novell’s alternative claim of an antitrust violation based on an “affirmative” act of interference with a rival rather than on a refusal to deal.  As Judge Gorsuch explained, “neither Trinko nor Aspen Skiing suggested this is enough to evade their profit sacrifice test, and we refuse to do so either.  Whether one chooses to call a monopolist’s refusal to deal with a rival an act or omission, interference or withdrawal of assistance, the substance is the same”.  Finally, Novell’s third theory, that Microsoft acted deceptively when it gave pretextual reasons for withdrawing key compatibility information from Novell, similarly proved unavailing.  According to Judge Gorsuch, “[deception] . . . wasn’t the cause of Novell’s injury or any possible harm to consumers—Microsoft’s refusal to deal was. . . .  Even if Microsoft had behaved [non-deceptively,] just as Novell sa[id] it should have, it would have helped Novell not at all.”

Novell, like Kay Electric, reflects Judge Gorsuch’s understanding of the importance of curtailing inappropriate antitrust attacks on the right not to deal with competitors.  It also manifests his keen appreciation for protecting a successful firm’s market-driven economic incentives from being undermined by antitrust attacks.  Finally, and most significantly, this decision highlights Judge Gorsuch’s understanding that decision theory is of central importance in administering a rules-based antitrust legal system (see here for a discussion of the role of decision theory in Roberts Court antitrust decisions).

c.  Kay Electric Cooperative v. City of Newkirk, Oklahoma, 647 F.3d 1039 (10th 2011). In this case, the Tenth Circuit, per Judge Gorsuch, reversed and remanded a district court’s dismissal of an antitrust suit filed against a municipal electricity provider.  Kay, an Oklahoma rural electric cooperative, offered to provide electricity to a new jail being built in an area just outside the city boundaries of Newkirk.  The City of Newkirk responded by annexing the area and issuing its own service offer.  As Judge Gorsuch pithily explained, “Kay’s offer was much the better but the jail still elected to buy electricity from Newkirk.  Why?  Because Newkirk is the only provider of sewage services in the area and it refused to provide any sewage services to the jail – that is, unless the jail also bought the city’s electricity.  Finding themselves stuck between a rock and a pile of sewage, the operators of the jail reluctantly went with the city’s package deal.”  Kay responded by suing Newkirk for unlawful tying and attempted monopolization in violation of the Sherman Antitrust Act.  The district court found Newkirk “immune” from liability as a matter of law, and Kay appealed.

Judge Gorsuch surveyed the Supreme Court’s confusing case law on state action antitrust immunity, which shields state-sanctioned restraints of trade from Sherman Act scrutiny.  He noted that “though it’s hard to see a way to reconcile all of the [Supreme] Court’s competing statements in this area, we can say with certainty this much – a municipality surely lacks antitrust ‘immunity’ unless it can bear the burden of showing that its challenged conduct was at least a foreseeable (if not explicit) result of state legislation [emphasis in the original].”  The judge brilliantly parsed the “muddled” jurisprudence and found three “bright lines” that were “enough to allow us to dispose of this appeal with confidence.”  First, “a state’s grant of a traditional corporate chapter to a municipality isn’t enough to make the municipality’s subsequent anticompetitive conduct foreseeable.”  Second, “the fact that a state may have authorized some forms of municipal anticompetitive conduct isn’t enough to make all forms of anticompetitive conduct foreseeable [emphasis in the original].”  Third, “when asking whether the state has authorized the municipality’s anticompetitive conduct we look to and preference the most specific direction issued by the state legislature on the subject.”  Applying these rules to the facts at hand (including relevant Oklahoma statutes), the judge concluded “that it quickly becomes clear that Newkirk enjoys no immunity.”

Judge Gorsuch’s Kay Electric opinion displays great facility in reconciling respect for antitrust federalism with the Sherman Act’s goal of rooting out unreasonable constraints on free market competition.  His concise ruling ably cuts through the complexities of the opaque (to be generous) antitrust state action doctrine decisions to identify clear administrable principles that, if broadly adopted, would reduce uncertainty regarding the legal status of anticompetitive municipal conduct.  In short, if Kay Electric is any indication, Judge Gorsuch may be just the jurist needed to bring greater (and badly needed) clarity to the Supreme Court’s treatment of state action controversies.

  1. Conclusion

In sum, Judge Gorsuch’s antitrust opinions reflect a sound grounding in law and economics and decision theory, combined with a respect for Supreme Court precedent, careful attention to traditional judicial craftsmanship, and a respect for the appropriate contours of antitrust federalism.  Accordingly, the Supreme Court’s antitrust jurisprudence would unquestionably benefit by having Judge Gorsuch join the Court.  For this and for so many other reasons (see, for example, here), Judge Gorsuch merits swift confirmation by the Senate.

On February 28, the Heritage Foundation released Prosperity Unleashed:  Smarter Financial Regulation, a Report that lays bare the heavy and unnecessary burdens imposed on our economy by defective financial regulations, and proposed market-oriented regulatory reforms that would benefit American producers, consumers, and the overall economy.  In a recent Truth on the Market blog commentary, I summarized the key findings and recommendations set forth in the Report’s 23 chapters.  In this commentary, I explore in greater detail chapter 19 of the Report, “How Congress Should Protect Consumers’ Finances,” co-authored by George Mason University Foundation Professor of Law Todd J. Zywicki and me.

Chapter 19 makes the case for legislative reform that would eliminate the U.S. Consumer Financial Protection Bureau’s oversight of consumer protection in financial markets and transfer such authority to the U.S. Federal Trade Commission (key excerpts with footnote references omitted follow):

Free-market competition is key to the efficient provision of the goods and services that consumers desire. More generally, the free market promotes innovation and overall economic welfare. Imperfect information can, however, limit the ability of competition to be effective in benefiting consumers and the economy. In particular, inaccurate information about the quality and attributes of market offerings may lead consumers to make mistaken purchase decisions—in other words, consumers may not get what they think they bargained for. This will lead to the distrust of market processes, as sellers find it harder to differentiate themselves from their competition. The end result is less-effective competition, less consumer satisfaction, and lower economic welfare.

Fraudulent or deceptive statements regarding product or service attributes, and negative features of products or services that become evident only after sale, are prime examples of inaccurate information that undermines trust in competitive firms. Accordingly, the government has a legitimate role in seeking to curb fraud, deception, and related informational problems. Historically, the federal government’s primary consumer protection agency, the U.S. Federal Trade Commission (FTC), has taken the lead in bringing enforcement actions against businesses that distort markets by engaging in “deceptive” or “unfair” practices when marketing their offerings to consumers. In recent decades, the FTC has taken an economics-focused approach in these areas. Specifically, it has limited “deception prosecutions” to cases where consumers acting reasonably were misled and tangibly harmed, and “unfairness prosecutions” to situations involving consumer injury not outweighed by countervailing benefits (a cost-benefit approach). In other words, although the FTC may have erred from time to time in specific cases, its general approach has avoided government overreach and has been conducive to enhancing marketplace efficiency and consumer welfare.

However, Congress has not allowed the FTC to exercise economy-wide oversight over consumer protection, in general, and fraud and deception, in particular. For many years, a hodgepodge of different federal financial service regulators were empowered to regulate the practices of a wide variety of financial industry entities, with the FTC only empowered to oversee consumer financial protection with respect to the narrow category of “non-bank financial institutions.” As part of the 2010 Dodd–Frank financial reform legislation, Congress created a new Consumer Financial Protection Bureau (CFPB), loosely tied to the Federal Reserve Board. While Dodd–Frank mandated shared CFPB–FTC consumer protection jurisdiction over non-bank financial institutions, it transferred all other authority over the many separate consumer financial protection laws to the CFPB alone. The CFPB is simultaneously one of the most powerful and least-accountable regulatory bodies in United States history. In marked contrast to the FTC’s economics-based approach, the CFPB intervenes in financial market consumer-related practices in a heavy-handed arbitrary fashion that ignores sound economics. The upshot is that far from improving market efficiency, the CFPB reduces market efficiency, to the detriment of consumers, producers, and the overall economy. In short, the CFPB’s actions are a prime example of government failure.

The substantive powers of the CFPB are vast and ill-defined. The CFPB has power to regulate the terms and marketing of every consumer credit product in the economy. And, because many small businesses use personal credit to start and grow their businesses (such as personal credit cards, home equity lines of credit, and even products like auto title loans), the CFPB possesses substantial control over much of the allocation of small-business credit as well. The CFPB has the power to take enforcement and regulatory action against “unfair, deceptive, and abusive” consumer credit terms, an authority that the CFPB has exercised with gusto. Moreover, the CFPB has deliberately eschewed regulatory rule-making that would clarify these terms, preferring to engage in case-by-case enforcement actions that undermine predictability and chill vigorous competition and innovation. Yet despite the broad authority granted to the CFPB, its appetite is broader still: The CFPB has taken action to regulate products such as cellphone billing, for-profit career colleges, and even loans made by auto dealers (despite express jurisdictional limits in Dodd–Frank regarding the latter).

The consequences of this unchecked authority have been disastrous for consumers and the economy. Complicated rules with high compliance costs have choked off access to mortgages, credit cards, and other financial products. Overwhelmed by the costs and uncertainty of regulatory compliance, small banks have exited traditional lines of business, such as home mortgages, and feared entering new lines, such as small-dollar loans. Consistent with the general effects of Dodd–Frank, the CFPB has contributed to the consolidation of the American financial sector, making big banks bigger, and forcing consolidation of small banks. By imposing one-size-fits-all bureaucratic underwriting standards on community banks and credit unions, the CFPB has deprived these actors of their traditional model of relationship lending and intimate knowledge of their customers—their lone competitive advantage over megabanks.

Perhaps the most tragic element of the CFPB train wreck is the missed opportunity for reform that it represents. At the time of Dodd–Frank, the system of consumer financial protection was badly in need of modernization: The existing system was cumbersome, incoherent, and ineffective. Fragmented among multiple federal agencies with authority over different providers of financial services, the federal system lacked the ability to lay down a coherent regulatory regime that would promote competition, consumer choice, and consumer protection consistent with the realities of a 21st-century economy and technology. While there is little evidence that the financial crisis resulted from a breakdown of consumer financial protection (as opposed to safety and soundness issues), reform was timely. But Dodd–Frank squandered a once-in-a-generation opportunity to bring about real reform.

In this chapter, we briefly make the case that some degree of reform of the consumer financial protection system was appropriate, in particular, the consolidation of consumer financial protection in one federal agency. However, we challenge the apparatus constructed by Dodd–Frank that created a new unaccountable super-regulator with a tunnel vision focus on a narrow definition of “consumer protection.” Instead, we argue that existing substantive powers were largely sufficient to the task of consumer protection, and that Congress could have achieved better results by acting within the existing institutional framework by simply consolidating authority in the FTC. By working within the existing framework of long-standing substantive authorities and institutional arrangements, Congress could have provided the needed modernization of the federal consumer financial protection system without the unintended consequences that have resulted from the creation of the CFPB. . . .

Consolidating the powers granted to the CFPB in the FTC, which still retains certain regulatory responsibilities with respect to consumer finance, would have a number of advantages over the course chosen in Dodd–Frank.

First, the FTC is a multimember, bipartisan commission. This is an important improvement over the structure of the CFPB, which [is led by a single unaccountable director and] is neither an independent commission nor an executive agency. . . . 

[Second,] [t]he FTC [,unlike the CFPB,] is . . . subject to Congress’s appropriations process, an important check on the agency’s actions. . . .

Finally, the FTC has a large Bureau of Economics, staffed with academically trained economists who would be ideally suited to take into account the regulatory economic policy issues, discussed herein, to which the CFPB has paid no heed. This would make it far more likely that agency regulatory decisions affecting consumer credit markets would be taken in light of the effects of agency actions on consumer welfare and the broader economy. . . .

[In conclusion,] [e]liminating the CFPB’s authority over consumer protection in financial services, and transferring such authority to the FTC, would greatly improve the current sorry state of affairs. Admittedly, the FTC is a less-than-perfect agency, and even a multimember-commission structure does not prevent institutional mistakes from being made and repeated by the majority. All in all, however, as an accountable institution, the FTC is far superior to the CFPB. Consolidating this authority with the FTC—where it should have been in the first place—will better allow free markets to promote innovation and overall economic welfare. Strengthening this legal framework to provide a single, clearly defined, properly limited set of rules will facilitate competition among financial firms, thus protecting consumers and providing them with better choices.

On February 28, the Heritage Foundation issued a volume of essays by leading scholars on the law and economics of financial services regulatory reform entitled Prosperity Unleashed:  Smarter Financial Regulation.  This Report, which is well worth a read (in particular, by incoming Trump Administration officials and Members of Congress), is available online.

The Report’s 23 chapters, which deal with different aspects of financial markets, reflect 10 core principles:

  1. Private and competitive financial markets are essential for healthy economic growth.
  2. The government should not interfere with the financial choices of market participants, including consumers, investors, and uninsured financial firms. Regulators should focus on protecting individuals and firms from fraud and violations of contractual rights.
  3. Market discipline is a better regulator of financial risk than government regulation.
  4. Financial firms should be permitted to fail, just as other firms do. Government should not “save” participants from failure because doing so impedes the ability of markets to direct resources to their highest and best use.
  5. Speculation and risk-taking are what make markets operate. Interference by regulators attempting to mitigate risks hinders the effective operation of markets.
  6. Government should not make credit and capital allocation decisions.
  7. The cost of financial firm failures should be borne by managers, equity-holders, and creditors, not by taxpayers.
  8. Simple rules—such as straightforward equity capital requirements—are preferable to complex rules that permit regulators to micromanage markets.
  9. Public-private partnerships create financial instability because they create rent-seeking opportunities and misalign incentives.
  10. Government backing for financial activities, such as classifying certain firms or activities as “systemically important,” inevitably leads to government bailouts.

The chapters deal with these specific topics (the following summary draws upon the introduction to the Report):

Chapter 1, “Deposit Insurance, Bank Resolution, and Market Discipline,” explains how government-backed deposit insurance weakens market discipline, increases moral hazard, and leads to higher financial risk than the economy would have otherwise, thus weakening the banking system as a whole.

Chapter 2, “A Simple Proposal to Recapitalize the U.S. Banking System,” follows with a brief look at the failure of the Basel rules and a discussion of how banks’ historical capital ratios—a key measure of bank safety—have fallen as regulations have increased.  The author proposes a regulatory off-ramp, whereby banks could opt out of the current regulatory framework in return for meeting a minimum leverage ratio of at least 20 percent.

Chapter 3, “A Better Path for Mortgage Regulation,” provides a brief history of federal mortgage regulation.  This essay shows that, prior to Dodd–Frank, the preferred federal policy was to protect mortgage borrowers through mandatory disclosure as opposed to directly regulating the content of mortgage agreements.  The author argues that the vibrancy of the mortgage market has suffered because the basic disclosure approach has succumbed to regulation via content restrictions.

Chapter 4, “Money and Banking Provisions in the 2016 Financial CHOICE Act: A Major Step Toward Financial Security,” evaluates the reforms in the CHOICE Act, the first major piece of legislation written to replace large portions of the Dodd–Frank Wall Street Reform and Consumer Protection Act (a far-reaching statute whose provisions are at odds with its name). The author discusses the CHOICE Act’s regulatory off-ramp—and one potential alternative—because a similar approach could be used to implement a broad set of bank regulation reforms.

Chapter 5, “Securities Disclosure Reform,” delves into the law and economics of mandatory disclosure requirements, both in connection with new securities offerings and ongoing disclosure obligations.  The author explains that disclosure requirements have become so voluminous that they obfuscate rather than inform, making it more difficult for investors to find relevant information.

Chapter 6, “The Case for Federal Pre-Emption of State Blue Sky Laws,” recommends improving the efficiency and effectiveness of capital markets through federal pre-emption of state securities “blue sky” laws, which impose state registration requirements on companies seeking to issue securities.  Blue sky laws inefficiently retard the flow of capital from investors to businesses.

Chapter 7, “How to Reform Equity Market Structure: Eliminate ‘Reg NMS’ and Build Venture Exchanges,” tackles the seemingly opaque topic of U.S. equity market structure.  The essay argues that the increasingly fragmented structure of today’s equities markets has been shaped as much, if not more, by legislative and regulatory action than by the private sector.  The author calls on the Securities and Exchange Commission (SEC) to consider rescinding Reg NMS and replacing it with rules (and rigorous disclosure requirements) that allow free and competitive markets to dictate much of market structure.

Chapter 8, “Reforming FINRA,” explains that FINRA, the primary regulator of broker-dealers, is neither a true self-regulatory organization nor a government agency, and that FINRA is largely unaccountable to the industry or to the public.  The chapter broadly outlines alternative approaches that Congress and the regulators can take to fix these problems, and it recommends specific reforms to FINRA’s rule-making and arbitration process.

Chapter 9, “Reforming the Financial Regulators,” argues that financial regulation should establish a framework for financial institutions based on their ability to serve consumers, investors, and Main Street companies.  This view is starkly at odds with the current “macroprudential” trend in financial regulation, which places governmental regulators—with their purportedly greater understanding of the financial system—at the top of the decision-making chain.

Chapter 10, “The World After Chevron,” discusses the Supreme Court’s decision in Chevron U.S.A. Inc. v. Natural Resources Defense Council, a case that has generated considerable controversy among policymakers over the past decade.  The Chevron decision effectively transferred final interpretive authority from the courts to the agencies in any case where Congress did not itself answer the precise dispute.  Reform-minded policymakers have long called on Congress to return that ultimate decision-making authority to the federal courts.

Chapter 11, “Transparency and Accountability at the SEC and at FINRA,” describes how these two regulatory bodies—the two mostly responsible for governing the U.S. securities sector—lack the structural safeguards necessary to ensure that they exercise their authority with the consent of the American public.  The chapter provides recommendations for fixing these deficiencies, such as giving respondents a choice of federal court or administrative proceedings with the SEC, and allowing FINRA to exist as a purely voluntary, private industry association.

Chapter 12, “The Massive Federal Credit Racket,” provides an extensive list of the more than 150 federal credit programs that provide some form of government backing.  These programs consist of direct loans and loan guarantees for housing, agriculture, energy, education, transportation, infrastructure, exporting, and small businesses, as well as insurance programs to cover bank and credit union deposits, pensions, flood damage, crop damage, and acts of terrorism.  Government financing programs are often sold to the public as economic imperatives, particularly during downturns, but they are instruments of redistributive policies that mainly benefit those with the most political influence rather than those with the greatest need.

Chapter 13, “Reforming Last-Resort Lending: The Flexible Open-Market Alternative,” proposes a plan to reform the Federal Reserve’s means for preserving liquidity for financial as well as nonfinancial firms, especially during financial emergencies, but also in normal times.  The essay proposes, among other things, to replace the existing Fed framework with a single standing (as opposed to temporary) facility to meet extraordinary as well as ordinary liquidity needs as they arise.  The goal is to eliminate the need for ad hoc changes in the rules governing the lending facility, or for special Fed, Treasury, or congressional action.

Chapter 14, “Simple, Sensible Reforms for Housing Finance,” advocates establishing a national title database to prevent the sort of clerical errors that plagued the foreclosure process during the housing crash of 2007 to 2009.  The author also recommends eliminating government support for all mortgages with low down payments, and for refinancing loans that increase the borrower’s mortgage debt.  Both types of loans encourage households to take on debt rather than accumulate wealth.

Chapter 15, “A Pathway to Shutting Down the Federal Housing Finance Enterprises,” provides an overview of all the federal housing finance enterprises and argues that Congress should end these failed experiments.  The federal housing finance enterprises, cobbled together over the last century, today cover more than $6 trillion (60 percent) of the outstanding single-family residential mortgage debt in the United States.  Over time, the policies implemented through these enterprises have inflated home prices, led to unsustainable levels of mortgage debt for millions of people, cost federal taxpayers hundreds of billions of dollars in bailouts, and undermined the resilience of the housing finance system.

Chapter 16, “Fixing the Regulatory Framework for Derivatives,” discusses government preferences for derivatives and repurchase agreements (repos)—an often ignored but integral part of the many policy problems that contributed to the 2008 crisis.  As the essay explains, the main problem with the pre-crisis regulatory structure for derivatives and repos was that the bankruptcy code included special exemptions (safe harbors) for these financial contracts.  The safe harbors were justified on the grounds that they would prevent systemic financial problems, a theory that proved false in 2008.  The chapter concluded that eliminating all safe harbors for repos and derivatives would affect the market because counterparties would have to account for more risk, a desirable outcome.

Chapter 17, “Designing an Efficient Securities-Fraud Deterrence Regime,” explains that the main flaws in the current approach to securities-fraud deterrence in the U.S., and recommends several reforms to fix these problems.  This essay recommends that the government should credibly threaten individuals who would commit fraud with criminal penalties, and pursue corporations only if their shareholders would otherwise have poor incentives to adopt internal control systems to deter fraud.

Chapter 18, “Financial Privacy in a Free Society,” stresses the importance of maintaining financial privacy—a key component of life in a free society—while policing markets for fraudulent (and other criminal) behavior.  The current U.S. financial regulatory framework has expanded so much that it now threatens this basic element of freedom.  For instance, individuals who engage in cash transactions of more than a small amount automatically trigger a general suspicion of criminal activity, and financial institutions of all kinds are forced into a quasi-law-enforcement role.  The chapter recommends seven reforms that would better protect individuals’ privacy rights and improve law enforcement’s ability to apprehend and prosecute criminals and terrorists.

Chapter 19, “How Congress Should Protect Consumers’ Finances,” provides an overview of consumer financial protection law, and then provide several recommendations on how to modernize the consumer financial protection system.  The goal of these reforms is to fix the federal consumer financial protection framework so that it facilitates competition, consumer protection, and consumer choice.  The authors recommend transferring all federal consumer protection authority to the Federal Trade Commission, the agency with vast regulatory experience in consumer financial services markets.

I will have a bit more to say about my co-authored contribution, “How Congress Should Protect Consumers’ Finances,” in my next post.

Chapter 20, “Reducing Banks’ Incentives for Risk-Taking via Extended Shareholder Liability,” examines changes in shareholder liability that could better align incentives and reduce the moral hazard problems that result in excessively risky financial institutions.  The authors describe how under extended liability, an arrangement common in banking history, shareholders of failed banks have an obligation to repay the remaining debts to creditors.

Chapter 21, “Improving Entrepreneurs’ Access to Capital: Vital for Economic Growth,” shows how existing rules and regulations hinder capital formation and entrepreneurship.  The essay explains that several groups usually support the current complex, expensive, and economically destructive system because excessive regulation helps keep their competitors at bay.  The author describes more than 25 policy reforms to reduce or eliminate state and federal regulatory barriers that hinder entrepreneurs’ access to capital.

Chapter 22, “Federalism and FinTech,” provides an in-depth look at how financial technology or “FinTech” companies are beginning to utilize advances in communications, data processing, and cryptography to compete with traditional financial services providers.  Some of the most powerful FinTech applications are removing geographic limitations on where companies can offer services and, in general, lowering barriers to entry for new firms.  As the essay explaints, this newly competitive landscape is exposing weaknesses, inefficiency, and inequity in the U.S. financial regulatory structure.

Chapter 23, “A New Federal Charter for Financial Institutions,” proposes a new banking charter under which a financial institution would be regulated more like banks were regulated before the modern era of bank bailouts and government guarantees.  Under the proposed charter, which is similar to a regulatory off-ramp approach, banks that choose to fund themselves with higher equity would be faced mostly with regulations that focus on punishing and deterring fraud, and fostering the disclosure of information that is material to investment decisions.  The charter explicitly includes a prohibition against receiving government funds from any source, and even excludes the financial institution from FDIC deposit insurance eligibility.

In conclusion, Prosperity Unleashed sets forth the elements of a legislative and regulatory reform agenda for the financial services sector, which has the potential for stimulating economic growth and innovation while benefiting consumers and businesses alike.  I will have a bit more to say about my co-authored contribution, “How Congress Should Protect Consumers’ Finances,” in my next post.