Government subsidies that selectively favor a particular firm or firms may substantially distort competition within an industry, thereby skewing trading terms, reducing efficiency, and harming consumer welfare.  To its credit, the European Union (EU) seeks to stamp out distortive state aid, as explained by the EU’s administrative and law enforcement arm, the European Commission (EC):

A company which receives government support gains an advantage over its competitors. Therefore, the Treaty [governing the EU] generally prohibits State aid unless it is justified by reasons of general economic development.  To ensure that this prohibition is respected and exemptions are applied equally across the European Union, the European Commission is in charge of ensuring that State aid complies with EU rules. . . .

State aid is defined as an advantage in any form whatsoever conferred on a selective basis to undertakings [businesses] by national public authorities.  Therefore, subsidies granted to individuals or general measures open to all enterprises are not covered by this prohibition and do not constitute State aid (examples include general taxation measures or employment legislation).

A nation’s tax preferences that selectively advantage a specific firm or firms may constitute a form of state aid, and in recent years the EC has challenged various member states’ corporate tax rules that allegedly have such a preferential effect.   Particular attention has focused on an August 2016 EC finding that Apple, Inc. owed roughly $14.5 billion in back taxes to Ireland, due to an Irish tax ruling that granted the company a preferential corporate tax rate in violation of EC state aid principles.

This EC finding, which is opposed by the Irish and U.S Governments and has been appealed to the European courts, is the subject of an April 27 Heritage Foundation “Backgrounder” essay, co-authored by Heritage Senior Fellow David Burton and me.  In our essay, we point out that, whatever the legal merits of this particular holding, the EC’s recent “crusade” against low corporate taxes achieved through various national preferences raises the broader issue of “tax competition” among jurisdictions that may beneficially constrain the size of government.  Our article’s findings and policy recommendations are as follows:

High taxes, especially high marginal income tax rates, have an adverse impact on economic growth, and tax competition among governments imposes a limit on how high governments can raise tax rates and burden the private sector.  Efforts to suppress tax competition or to harmonize taxes are generally an effort to create a “tax cartel” among likeminded governments to keep taxes high. The European Union’s Apple ruling, similar to other recent EU investigations of tax reductions, may have the effect of discouraging beneficial tax competition among European nations.  The United States should reject calls by the Organisation for Economic Co-operation and Development and other multinational bodies to promote “tax harmonization,” which tends to promote overly high tax burdens that discourage economic growth.   The United States also should lead by example, reducing its economically harmful tax burdens and encouraging other countries to do likewise. 

Today, the International Center for Law & Economics (ICLE) released a study updating our 2014 analysis of the economic effects of the Durbin Amendment to the Dodd-Frank Act.

The new paper, Unreasonable and Disproportionate: How the Durbin Amendment Harms Poorer Americans and Small Businesses, by ICLE scholars, Todd J. Zywicki, Geoffrey A. Manne, and Julian Morris, can be found here; a Fact Sheet highlighting the paper’s key findings is available here.

Introduced as part of the Dodd-Frank Act in 2010, the Durbin Amendment sought to reduce the interchange fees assessed by large banks on debit card transactions. In the words of its primary sponsor, Sen. Richard Durbin, the Amendment aspired to help “every single Main Street business that accepts debit cards keep more of their money, which is a savings they can pass on to their consumers.”

Unfortunately, although the Durbin Amendment did generate benefits for big-box retailers, ICLE’s 2014 analysis found that it had actually harmed many other merchants and imposed substantial net costs on the majority of consumers, especially those from lower-income households.

In the current study, we analyze a welter of new evidence and arguments to assess whether time has ameliorated or exacerbated the Amendment’s effects. Our findings in this report expand upon and reinforce our findings from 2014:

Relative to the period before the Durbin Amendment, almost every segment of the interrelated retail, banking, and consumer finance markets has been made worse off as a result of the Amendment.

Predictably, the removal of billions of dollars in interchange fee revenue has led to the imposition of higher bank fees and reduced services for banking consumers.

In fact, millions of households, regardless of income level, have been adversely affected by the Durbin Amendment through higher overdraft fees, increased minimum balances, reduced access to free checking, higher ATM fees, and lost debit card rewards, among other things.

Nor is there any evidence that merchants have lowered prices for retail consumers; for many small-ticket items, in fact, prices have been driven up.

Contrary to Sen. Durbin’s promises, in other words, increased banking costs have not been offset by lower retail prices.

At the same time, although large merchants continue to reap a Durbin Amendment windfall, there remains no evidence that small merchants have realized any interchange cost savings — indeed, many have suffered cost increases.

And all of these effects fall hardest on the poor. Hundreds of thousands of low-income households have chosen (or been forced) to exit the banking system, with the result that they face higher costs, difficulty obtaining credit, and complications receiving and making payments — all without offset in the form of lower retail prices.

Finally, the 2017 study also details a new trend that was not apparent when we examined the data three years ago: Contrary to our findings then, the two-tier system of interchange fee regulation (which exempts issuing banks with under $10 billion in assets) no longer appears to be protecting smaller banks from the Durbin Amendment’s adverse effects.

This week the House begins consideration of the Amendment’s repeal as part of Rep. Hensarling’s CHOICE Act. Our study makes clear that the Durbin price-control experiment has proven a failure, and that repeal is, indeed, the only responsible option.

Click on the following links to read:

Full Paper

Fact Sheet

Summary

Over the last two years, the Scalia Law School’s Global Antitrust Institute (GAI) has taken a leadership role in promoting sound antitrust analysis of intellectual property rights (IPRs), through its insightful analysis of IP-antitrust guidance proffered by governments around the world (including by the United States antitrust agencies).  Key concepts that inform the GAI’s IP commentaries are that IP rights are full-fledged property rights, and should be treated as such; that IP licensing typically is procompetitive and often generates substantial efficiencies; that antitrust agencies should compare the competitive effects of IP licensing restrictions against what would have happened in the “but for” world in which there is no license; and that special limiting rules should not be applied to patents that cover technologies essential to the implementation of standards (“standard-essential patents”).  The overarching theme of the GAI submissions is that IP licensing generally enhances economic welfare and promotes innovation.

On April 13, the GAI once again turned its eye to IP licensing issues, in commenting on the Draft Anti-Monopoly Guidelines on the Abuse of Intellectual Property Rights (Draft Guidelines) propounded by the Chinese Government’s State Council (see here).  This commentary is particularly timely and important, given the vast scale of the Chinese economy and the large number of major companies involved in IP licensing in China.  While the April 13 GAI commentary praises the Draft Guidelines’ stated intent of condemning only those acts that “have the effect of excluding or restricting competition,” it explains that various Draft Guidelines provisions would nevertheless undermine that desirable goal.  Specifically, the commentary makes five key points:

  1. First, the Draft Guidelines do not explicitly recognize an IPR holder’s core right to exclude. The right to exclude is a central feature of IPRs, and economic theory and empirical evidence show that IPRs incentivize the creation of inventions, ideas, and original works.  Relatedly, the Draft Guidelines also do not incorporate throughout the well-accepted methodological principle that, when assessing the possible competitive effects of the use of IPRs, agencies should compare the competitive effect of the IPR use against what would have happened in the “but for” world in which there is no license.  This important analytical approach, which has been used by the U.S. antitrust agencies for the last 20 years, is absent from the Draft Guidelines.
  2. Second, the Draft Guidelines do not incorporate throughout the point that licensing is generally procompetitive. This modern economic understanding of licensing has informed the approach of the U.S. agencies, for example, for more than 20 years. The result is an approach that, with the exception of naked restraints such as price fixing, requires an effects-based analysis under which licensing restraints will be condemned only when any anticompetitive effects outweigh any procompetitive benefits.
  3. Third, and relatedly, the Draft Guidelines appear to create a number of presumptions that certain conduct (such as charging for expired or invalid patents and prohibiting a licensee from challenging the validity of its IPR) will, or is likely to, eliminate or restrict competition. Thus the State Council would be well advised to eliminate such presumptions and to adopt instead an effects-based approach.  This approach would benefit Chinese consumers because presumptions that are not appropriately calibrated are likely to capture conduct that is procompetitive, which is likely to have a chilling effect on potentially beneficial conduct.  Adopting an approach that incorporates these revisions would best serve competition and consumers, as well as China’s goal of becoming an innovation society.
  4. Fourth, the Draft Guidelines appear to create special rules for conduct involving standard-essential patents (SEPs). The State Council would be wise to reconsider this approach.  Instead, antitrust enforcers should ask whether particular conduct involving SEPs, including evasion of a FRAND assurance, has net anticompetitive effects, and should apply the same case-by-case, fact-specific analysis that is employed for non-SEPs.  Imposing special rules for SEPs, including creating presumptions of harm based on breach of contractual commitments such as a FRAND assurance, is not only unwarranted as a matter of competition policy, but also likely to deter participation in standard setting.
  5. Lastly, the State Council should adopt a more compliance-based approach that sets forth basic principles that would allow parties to self-advise. The Draft Guidelines instead set forth a list of factors that the Chinese competition agencies will consider when analyzing specific conduct, yet do not explain the significance of each of the factors or how they will be weighed in the competition agencies’ overall decision-making process.  This approach allows the agencies broad discretion in enforcement decision-making without providing the guidance stakeholders need to protect incentives to innovate and transfer technology that could be subject to Chinese antitrust jurisdiction.  To this end, the GAI’s commentary recommends that the State Council include throughout the Guidelines examples similar to those found in other guidelines, for example the U.S. antitrust agencies’ recently updated 2017 Antitrust Guidelines for the Licensing of Intellectual Property and the Canadian Bureau of Competition’s Intellectual Property Enforcement Guidelines.  Inclusion of illustrative examples will help IP holders understand how the Chinese agencies will apply the basic principles.

In sum, the Chinese Government would be well advised to adopt the April 13 commentary’s recommendations in finalizing its Guidelines.  Acceptance of the GAI’s recommendations would benefit consumers and producers, and promote innovation in the Chinese economy.  Once again (as one would expect), a GAI antitrust commentary is spot on.

On Thursday, March 30, Friday March 31, and Monday April 3, Truth on the Market and the International Center for Law and Economics presented a blog symposium — Agricultural and Biotech Mergers: Implications for Antitrust Law and Economics in Innovative Industries — discussing three proposed agricultural/biotech industry mergers awaiting judgment by antitrust authorities around the globe. These proposed mergers — Bayer/Monsanto, Dow/DuPont and ChemChina/Syngenta — present a host of fascinating issues, many of which go to the core of merger enforcement in innovative industries — and antitrust law and economics more broadly.

The big issue for the symposium participants was innovation (as it was for the European Commission, which cleared the Dow/DuPont merger last week, subject to conditions, one of which related to the firms’ R&D activities).

Critics of the mergers, as currently proposed, asserted that the increased concentration arising from the “Big 6” Ag-biotech firms consolidating into the Big 4 could reduce innovation competition by (1) eliminating parallel paths of research and development (Moss); (2) creating highly integrated technology/traits/seeds/chemicals platforms that erect barriers to new entry platforms (Moss); (3) exploiting eventual network effects that may result from the shift towards data-driven agriculture to block new entry in input markets (Lianos); or (4) increasing incentives to refuse to license, impose discriminatory restrictions in technology licensing agreements, or tacitly “agree” not to compete (Moss).

Rather than fixating on horizontal market share, proponents of the mergers argued that innovative industries are often marked by disruptions and that investment in innovation is an important signal of competition (Manne). An evaluation of the overall level of innovation should include not only the additional economies of scale and scope of the merged firms, but also advancements made by more nimble, less risk-averse biotech companies and smaller firms, whose innovations the larger firms can incentivize through licensing or M&A (Shepherd). In fact, increased efficiency created by economies of scale and scope can make funds available to source innovation outside of the large firms (Shepherd).

In addition, innovation analysis must also account for the intricately interwoven nature of agricultural technology across seeds and traits, crop protection, and, now, digital farming (Sykuta). Combined product portfolios generate more data to analyze, resulting in increased data-driven value for farmers and more efficiently targeted R&D resources (Sykuta).

While critics voiced concerns over such platforms erecting barriers to entry, markets are contestable to the extent that incumbents are incentivized to compete (Russell). It is worth noting that certain industries with high barriers to entry or exit, significant sunk costs, and significant costs disadvantages for new entrants (including automobiles, wireless service, and cable networks) have seen their prices decrease substantially relative to inflation over the last 20 years — even as concentration has increased (Russell). Not coincidentally, product innovation in these industries, as in ag-biotech, has been high.

Ultimately, assessing the likely effects of each merger using static measures of market structure is arguably unreliable or irrelevant in dynamic markets with high levels of innovation (Manne).

Regarding patents, critics were skeptical that combining the patent portfolios of the merging companies would offer benefits beyond those arising from cross-licensing, and would serve to raise rivals’ costs (Ghosh). While this may be true in some cases, IP rights are probabilistic, especially in dynamic markets, as Nicolas Petit noted:

There is no certainty that R&D investments will lead to commercially successful applications; (ii) no guarantee that IP rights will resist to invalidity proceedings in court; (iii) little safety to competition by other product applications which do not practice the IP but provide substitute functionality; and (iv) no inevitability that the environmental, toxicological and regulatory authorization rights that (often) accompany IP rights will not be cancelled when legal requirements change.

In spite of these uncertainties, deals such as the pending ag-biotech mergers provide managers the opportunity to evaluate and reorganize assets to maximize innovation and return on investment in such a way that would not be possible absent a merger (Sykuta). Neither party would fully place its IP and innovation pipeline on the table otherwise.

For a complete rundown of the arguments both for and against, the full archive of symposium posts from our outstanding and diverse group of scholars, practitioners and other experts is available at this link, and individual posts can be easily accessed by clicking on the authors’ names below.

We’d like to thank all of the participants for their excellent contributions!

In a recent long-form article in the New York Times, reporter Noam Scheiber set out to detail some of the ways Uber (and similar companies, but mainly Uber) are engaged in “an extraordinary experiment in behavioral science to subtly entice an independent work force to maximize its growth.”

That characterization seems innocuous enough, but it is apparent early on that Scheiber’s aim is not only to inform but also, if not primarily, to deride these efforts. The title of the piece, in fact, sets the tone:

How Uber Uses Psychological Tricks to Push Its Drivers’ Buttons

Uber and its relationship with its drivers are variously described by Scheiber in the piece as secretive, coercive, manipulative, dominating, and exploitative, among other things. As Schreiber describes his article, it sets out to reveal how

even as Uber talks up its determination to treat drivers more humanely, it is engaged in an extraordinary behind-the-scenes experiment in behavioral science to manipulate them in the service of its corporate growth — an effort whose dimensions became evident in interviews with several dozen current and former Uber officials, drivers and social scientists, as well as a review of behavioral research.

What’s so galling about the piece is that, if you strip away the biased and frequently misguided framing, it presents a truly engaging picture of some of the ways that Uber sets about solving a massively complex optimization problem, abetted by significant agency costs.

So I did. Strip away the detritus, add essential (but omitted) context, and edit the article to fix the anti-Uber bias, the one-sided presentation, the mischaracterizations, and the fundamentally non-economic presentation of what is, at its core, a fascinating illustration of some basic problems (and solutions) from industrial organization economics. (For what it’s worth, Scheiber should know better. After all, “He holds a master’s degree in economics from the University of Oxford, where he was a Rhodes Scholar, and undergraduate degrees in math and economics from Tulane University.”)

In my retelling, the title becomes:

How Uber Uses Innovative Management Tactics to Incentivize Its Drivers

My transformed version of the piece, with critical commentary in the form of tracked changes to the original, is here (pdf).

It’s a long (and, as I said, fundamentally interesting) piece, with cool interactive graphics, well worth the read (well, at least in my retelling, IMHO). Below is just a taste of the edits and commentary I added.

For example, where Scheiber writes:

Uber exists in a kind of legal and ethical purgatory, however. Because its drivers are independent contractors, they lack most of the protections associated with employment. By mastering their workers’ mental circuitry, Uber and the like may be taking the economy back toward a pre-New Deal era when businesses had enormous power over workers and few checks on their ability to exploit it.

With my commentary (here integrated into final form rather than tracked), that paragraph becomes:

Uber operates under a different set of legal constraints, however, also duly enacted and under which millions of workers have profitably worked for decades. Because its drivers are independent contractors, they receive their compensation largely in dollars rather than government-mandated “benefits” that remove some of the voluntariness from employer/worker relationships. And, in the case of overtime pay, for example, the Uber business model that is built in part on offering flexible incentives to match supply and demand using prices and compensation, would be next to impossible. It is precisely through appealing to drivers’ self-interest that Uber and the like may be moving the economy forward to a new era when businesses and workers have more flexibility, much to the benefit of all.

Elsewhere, Scheiber’s bias is a bit more subtle, but no less real. Thus, he writes:

As he tried to log off at 7:13 a.m. on New Year’s Day last year, Josh Streeter, then an Uber driver in the Tampa, Fla., area, received a message on the company’s driver app with the headline “Make it to $330.” The text then explained: “You’re $10 away from making $330 in net earnings. Are you sure you want to go offline?” Below were two prompts: “Go offline” and “Keep driving.” The latter was already highlighted.

With my edits and commentary, that paragraph becomes:

As he started the process of logging off at 7:13 a.m. on New Year’s Day last year, Josh Streeter, then an Uber driver in the Tampa, Fla., area, received a message on the company’s driver app with the headline “Make it to $330.” The text then explained: “You’re $10 away from making $330 in net earnings. Are you sure you want to go offline?” Below were two prompts: “Go offline” and “Keep driving.” The latter was already highlighted, but the former was listed first. It’s anyone’s guess whether either characteristic — placement or coloring — had any effect on drivers’ likelihood of clicking one button or the other.

And one last example. Scheiber writes:

Consider an algorithm called forward dispatch — Lyft has a similar one — that dispatches a new ride to a driver before the current one ends. Forward dispatch shortens waiting times for passengers, who may no longer have to wait for a driver 10 minutes away when a second driver is dropping off a passenger two minutes away.

Perhaps no less important, forward dispatch causes drivers to stay on the road substantially longer during busy periods — a key goal for both companies.

Uber and Lyft explain this in essentially the same way. “Drivers keep telling us the worst thing is when they’re idle for a long time,” said Kevin Fan, the director of product at Lyft. “If it’s slow, they’re going to go sign off. We want to make sure they’re constantly busy.”

While this is unquestionably true, there is another way to think of the logic of forward dispatch: It overrides self-control.

* * *

Uber officials say the feature initially produced so many rides at times that drivers began to experience a chronic Netflix ailment — the inability to stop for a bathroom break. Amid the uproar, Uber introduced a pause button.

“Drivers were saying: ‘I can never go offline. I’m on just continuous trips. This is a problem.’ So we redesigned it,” said Maya Choksi, a senior Uber official in charge of building products that help drivers. “In the middle of the trip, you can say, ‘Stop giving me requests.’ So you can have more control over when you want to stop driving.”

It is true that drivers can pause the services’ automatic queuing feature if they need to refill their tanks, or empty them, as the case may be. Yet once they log back in and accept their next ride, the feature kicks in again. To disable it, they would have to pause it every time they picked up a new passenger. By contrast, even Netflix allows users to permanently turn off its automatic queuing feature, known as Post-Play.

This pre-emptive hard-wiring can have a huge influence on behavior, said David Laibson, the chairman of the economics department at Harvard and a leading behavioral economist. Perhaps most notably, as Ms. Rosenblat and Luke Stark observed in an influential paper on these practices, Uber’s app does not let drivers see where a passenger is going before accepting the ride, making it hard to judge how profitable a trip will be.

Here’s how I would recast that, and add some much-needed economics:

Consider an algorithm called forward dispatch — Lyft has a similar one — that dispatches a new ride to a driver before the current one ends. Forward dispatch shortens waiting times for passengers, who may no longer have to wait for a driver 10 minutes away when a second driver is dropping off a passenger two minutes away.

Perhaps no less important, forward dispatch causes drivers to stay on the road substantially longer during busy periods — a key goal for both companies — by giving them more income-earning opportunities.

Uber and Lyft explain this in essentially the same way. “Drivers keep telling us the worst thing is when they’re idle for a long time,” said Kevin Fan, the director of product at Lyft. “If it’s slow, they’re going to go sign off. We want to make sure they’re constantly busy.”

While this is unquestionably true, and seems like another win-win, some critics have tried to paint even this means of satisfying both driver and consumer preferences in a negative light by claiming that the forward dispatch algorithm overrides self-control.

* * *

Uber officials say the feature initially produced so many rides at times that drivers began to experience a chronic Netflix ailment — the inability to stop for a bathroom break. Amid the uproar, Uber introduced a pause button.

“Drivers were saying: ‘I can never go offline. I’m on just continuous trips. This is a problem.’ So we redesigned it,” said Maya Choksi, a senior Uber official in charge of building products that help drivers. “In the middle of the trip, you can say, ‘Stop giving me requests.’ So you can have more control over when you want to stop driving.”

Tweaks like these put paid to the arguments that Uber is simply trying to abuse its drivers. And yet, critics continue to make such claims:

It is true that drivers can pause the services’ automatic queuing feature if they need to refill their tanks, or empty them, as the case may be. Yet once they log back in and accept their next ride, the feature kicks in again. To disable it, they would have to pause it every time they picked up a new passenger. By contrast, even Netflix allows users to permanently turn off its automatic queuing feature, known as Post-Play.

It’s difficult to take seriously claims that Uber “abuses” drivers by setting a default that drivers almost certainly prefer; surely drivers seek out another fare following the last fare more often than they seek out another bathroom break. In any case, the difference between one default and the other is a small change in the number of times drivers might have to push a single button; hardly a huge impediment.

But such claims persist, nevertheless. Setting a trivially different default can have a huge influence on behavior, claims David Laibson, the chairman of the economics department at Harvard and a leading behavioral economist. Perhaps most notably — and to change the subject — as Ms. Rosenblat and Luke Stark observed in an influential paper on these practices, Uber’s app does not let drivers see where a passenger is going before accepting the ride, making it hard to judge how profitable a trip will be. But there are any number of defenses of this practice, from both a driver- and consumer-welfare standpoint. Not least, such disclosure could well create isolated scarcity for a huge range of individual ride requests (as opposed to the general scarcity during a “surge”), leading to longer wait times, the need to adjust prices for consumers on the basis of individual rides, and more intense competition among drivers for the most profitable rides. Given these and other explanations, it is extremely unlikely that the practice is actually aimed at “abusing” drivers.

As they say, read the whole thing!

John E. Lopatka is A. Robert Noll Distinguished Professor of Law at Penn State Law School

People need to eat. All else equal, the more food that can be produced from an acre of land, the better off they’ll be. Of course, people want to pay as little as possible for their food to boot. At heart, the antitrust analysis of the pending agribusiness mergers requires a simple assessment of their effects on food production and price. But making that assessment raises difficult questions about institutional competence.

Each of the three mergers – Dow/DuPont, ChemChina/Syngenta, and Bayer/Monsanto – involves agricultural products, such as different kinds of seeds, pesticides, and fertilizers. All of these products are inputs in the production of food – the better and cheaper are these products, the more food is produced. The array of products these firms produce invites potentially controversial market definition determinations, but these determinations are standard fare in antitrust law and economics, and conventional analysis handles them tolerably well. Each merger appears to pose overlaps in some product markets, though they seem to be relatively small parts of the firms’ businesses. Traditional merger analysis would examine these markets in properly defined geographic markets, some of which are likely international. The concern in these markets seems to be coordinated interaction, and the analysis of potential anticompetitive coordination would thus focus on concentration and entry barriers. Much could be said about the assumption that product markets perform less competitively as concentration increases, but that is an issue for others or at least another day.

More importantly for my purposes here, to the extent that any of these mergers creates concentration in a market that is competitively problematic and not likely to be cured by new entry, a fix is fairly easy. These are mergers in which asset divestiture is feasible, in which the parties seem willing to divest assets, and in which interested and qualified asset buyers are emerging. To be sure, firms may be willing to divest assets at substantial cost to appease regulators even when competitive problems are illusory, and the cost of a cure in search of an illness is a real social cost. But my concern lies elsewhere.

The parties in each of these mergers have touted innovation as a beneficial byproduct of the deal if not its raison d’être. Innovation effects have made their way into merger analysis, but not smoothly. Innovation can be a kind of efficiency, distinguished from most other efficiencies by its dynamic nature. The benefits of using a plant to its capacity are immediate: costs and prices decrease now. Any benefits of innovation will necessarily be experienced in the future, and the passage of time makes benefits both less certain and less valuable, as people prefer consumption now rather than later. The parties to these mergers in their public statements, to the extent they intend to address antitrust concerns, are implicitly asserting innovation as a defense, a kind of efficiency defense. They do not concede, of course, that their deals will be anticompetitive in any product market. But for antitrust purposes, an accelerated pace of innovation is irrelevant unless the merger appears to threaten competition.

Recognizing increased innovation as a merger defense raises all of the issues that any efficiencies defense raises, and then some. First, can efficiencies be identified?  For instance, patent portfolios can be combined, and the integration of patent rights can lower transaction costs relative to a contractual allocation of rights just as any integration can. In theory, avenues of productive research may not even be recognized until the firms’ intellectual property is combined. A merger may eliminate redundant research efforts, but identifying that which is truly duplicative is often not easy. In all, identifying efficiencies related to research and development is likely to be more difficult than identifying many other kinds of efficiencies. Second, are the efficiencies merger-specific?  The less clearly research and development efficiencies can be identified, the weaker is the claim that they cannot be achieved absent the merger. But in this respect, innovation efficiencies can be more important than most other kinds of efficiencies, because intellectual property sometimes cannot be duplicated as easily as physical property can. Third, can innovation efficiencies be quantified?  If innovation is expected to take the form of an entirely new product, such as a new pesticide, estimating its value is inherently speculative. Fourth, when will efficiencies save a merger that would otherwise be condemned?  An efficiencies defense implies a comparison between the expected harm a merger will cause and the expected benefits it will produce. Arguably those benefits have to be realized by consumers to count at all, but, in any event, a comparison between expected immediate losses of customers in an input market and expected future gains from innovation may be nearly impossible to make. The Merger Guidelines acknowledge that innovation efficiencies can be considered and note many of the concerns just listed. The takeaway is a healthy skepticism of an innovation defense. The defense should generally fail unless the model of anticompetitive harm in product (or service) markets is dubious or the efficiency claim is unusually specific and the likely benefits substantial.

Innovation can enter merger analysis in an even more troublesome way, however: as a club rather than a shield. The Merger Guidelines contemplate that a merger may have unilateral anticompetitive effects if it results in a “reduced incentive to continue with an existing product-development effort or reduced incentive to initiate development of new products.”  The stark case is one in which a merger poses no competitive problem in a product market but would allegedly reduce innovation competition. The best evidence that the elimination of innovation competition might be a reason to oppose one or more of the agribusiness mergers is the recent decision of the European Commission approving the Dow/DuPont merger, subject to various asset divestitures. The Commission, echoing the Guidelines, concluded that the merger would significantly reduce “innovation competition for pesticides” by “[r]emoving the parties’ incentives to continue to pursue ongoing parallel innovation efforts” and by “[r]emoving the parties’ incentives to develop and bring to market new pesticides.”  The agreed upon fix requires DuPont to divest most of its research and development organization.

Enforcement claims that a merger will restrict innovation competition should be met with every bit the skepticism due defense claims that innovation efficiencies save a merger. There is nothing inconsistent in this symmetry. The benefits of innovation, though potentially immense – large enough to dwarf the immediate allocative harm from a lessening of competition in product markets – is speculative. In discounted utility terms, the expected harm will usually exceed the expected benefits, given our limited ability to predict the future. But the potential gains from innovation are immense, and unless we are confident that a merger will reduce innovation, antitrust law should not intervene. We rarely are, at least we rarely should be.

As Geoffrey Manne points out, we still do not know a great deal about the optimal market structure for innovation. Evidence suggests that moderate concentration is most conducive to innovation, but it is not overwhelming, and more importantly no one is suggesting a merger policy that single-mindedly pursues a particular market structure. An examination of incentives to continue existing product development projects or to initiate projects to develop new products is superficially appealing, but its practical utility is elusive. Any firm has an incentive to develop products that increase demand. The Merger Guidelines suggest that a merger will reduce incentives to innovate if the introduction of a new product by one merging firm will capture substantial revenues from the other. The E.C. likely had this effect in mind in concluding that the merged entity would have “lower incentives . . . to innovate than Dow and DuPont separately.”  The Commission also observed that the merged firm would have “a lower ability to innovate” than the two firms separately, but just how a combination of research assets could reduce capability is utterly obscure.

In any event, whether a merger reduces incentives depends not only on the welfare of the merging parties but also on the development activities of actual and would-be competitors. A merged firm cannot afford to have its revenue captured by a new product introduced by a competitor. Of course, innovation by competitors will not spur a firm to develop new products if those competitors do not have the resources needed to innovate. One can imagine circumstances in which resources necessary to innovate in a product market are highly specialized; more realistically, the lack of specialized resources will decrease the pace of innovation. But the concept of specialized resources cannot mean resources a firm has developed that are conducive to innovate and that could be, but have not yet been, developed by other firms. It cannot simply mean a head start, unless it is very long indeed. If the first two firms in an industry build a plant, the fact that a new entrant would have to build a plant is not a sufficient reason to prevent the first two from merging. In any event, what resources are essential to innovation in an area can be difficult to determine.

Assuming essential resources can be identified, how many firms need to have them to create a competitive environment? The Guidelines place the number at “very small” plus one. Elsewhere, the federal antitrust agencies suggest that four firms other than the merged firm are sufficient to maintain innovation competition. We have models, whatever their limitations, that predict price effects in oligopolies. The Guidelines are based on them. But determining the number of firms necessary for competitive innovation is another matter. Maybe two is enough. We know for sure that innovation competition is non-existent if only one firm has the capacity to innovate, but not much else. We know that duplicative research efforts can be wasteful. If two firms would each spend $1 million to arrive at the same place, a merged firm might be able to invest $2 million and go twice as far or reach the first place at half the total cost. This is only to say that a merger can increase innovation efficiency, a possibility that is not likely to justify an otherwise anticompetitive merger but should usually protect from condemnation a merger that is not otherwise anticompetitive.

In the Dow/DuPont merger, the Commission found “specific evidence that the merged entity would have cut back on the amount they spent on developing innovative products.”  Executives of the two firms stated that they expected to reduce research and development spending by around $300 million. But a reduction in spending does not tell us whether innovation will suffer. The issue is innovation efficiency. If the two firms spent, say, $1 billion each on research, $300 million of which was duplicative of the other firm’s research, the merged firm could invest $1.7 billion without reducing productive effort. The Commission complained that the merger would reduce from five to four the number of firms that are “globally active throughout the entire R&D process.”  As noted above, maybe four firms competing are enough. We don’t know. But the Commission also discounts firms with “more limited R&D capabilities,” and the importance to successful innovation of multi-level integration in this industry is not clear.

When a merger is challenged because of an adverse effect on innovation competition, a fix can be difficult. Forced licensing might work, but that assumes that the relevant resource necessary to carry on research and development is intellectual property. More may be required. If tangible assets related to research and development are required, a divestiture might cripple the merged firm. The Commission remedy was to require the merged firm to divest “DuPont’s global R&D organization” that is related to the product operations that must be divested. The firm is permitted to retain “a few limited [R&D] assets that support the part of DuPont’s pesticide business” that is not being divested. In this case, such a divestiture may or may not hobble the merged firm, depending on whether the divested assets would have contributed to the research and development efforts that it will continue to pursue. That the merged firm was willing to accept the research and development divestiture to secure Commission approval does not mean that the divestiture will do no harm to the firm’s continuing research and development activities. Moreover, some product markets at issue in this merger are geographically limited, whereas the likely benefits of innovation are largely international. The implication is that increased concentration in product markets can be avoided by divesting assets to other large agribusinesses that do not operate in the relevant geographic market. But if the Commission insists on preserving five integrated firms active in global research and development activities, DuPont’s research and development activities cannot be divested to one of the other major players, which the Commission identifies as BASF, Bayer, and Syngenta, or firms with which any of them are attempting to merge, namely Monsanto and ChemChina. These are the five firms, of course, that are particularly likely to be interested buyers.

Innovation is important. No one disagrees. But the role of competition in stimulating innovation is not well understood. Except in unusual cases, antitrust institutions are ill-equipped either to recognize innovation efficiencies that save a merger threatening competition in product markets or to condemn mergers that threaten only innovation competition. Indeed, despite maintaining their prerogative to challenge mergers solely on the ground of a reduction in innovation competition, the federal agencies have in fact complained about an adverse effect on innovation in cases that also raise competitive issues in product markets. Innovation is at the heart of the pending agribusiness mergers. How regulators and courts analyze innovation in these cases will say something about whether they perceive their limitations.

Geoffrey A. Manne is Executive Director of the International Center for Law & Economics

Dynamic versus static competition

Ever since David Teece and coauthors began writing about antitrust and innovation in high-tech industries in the 1980s, we’ve understood that traditional, price-based antitrust analysis is not intrinsically well-suited for assessing merger policy in these markets.

For high-tech industries, performance, not price, is paramount — which means that innovation is key:

Competition in some markets may take the form of Schumpeterian rivalry in which a succession of temporary monopolists displace one another through innovation. At any one time, there is little or no head-to-head price competition but there is significant ongoing innovation competition.

Innovative industries are often marked by frequent disruptions or “paradigm shifts” rather than horizontal market share contests, and investment in innovation is an important signal of competition. And competition comes from the continual threat of new entry down the road — often from competitors who, though they may start with relatively small market shares, or may arise in different markets entirely, can rapidly and unexpectedly overtake incumbents.

Which, of course, doesn’t mean that current competition and ease of entry are irrelevant. Rather, because, as Joanna Shepherd noted, innovation should be assessed across the entire industry and not solely within merging firms, conduct that might impede new, disruptive, innovative entry is indeed relevant.

But it is also important to remember that innovation comes from within incumbent firms, as well, and, often, that the overall level of innovation in an industry may be increased by the presence of large firms with economies of scope and scale.

In sum, and to paraphrase Olympia Dukakis’ character in Moonstruck: “what [we] don’t know about [the relationship between innovation and market structure] is a lot.”

What we do know, however, is that superficial, concentration-based approaches to antitrust analysis will likely overweight presumed foreclosure effects and underweight innovation effects.

We shouldn’t fetishize entry, or access, or head-to-head competition over innovation, especially where consumer welfare may be significantly improved by a reduction in the former in order to get more of the latter.

As Katz and Shelanski note:

To assess fully the impact of a merger on market performance, merger authorities and courts must examine how a proposed transaction changes market participants’ incentives and abilities to undertake investments in innovation.

At the same time, they point out that

Innovation can dramatically affect the relationship between the pre-merger marketplace and what is likely to happen if the proposed merger is consummated…. [This requires consideration of] how innovation will affect the evolution of market structure and competition. Innovation is a force that could make static measures of market structure unreliable or irrelevant, and the effects of innovation may be highly relevant to whether a merger should be challenged and to the kind of remedy antitrust authorities choose to adopt. (Emphasis added).

Dynamic competition in the ag-biotech industry

These dynamics seem to be playing out in the ag-biotech industry. (For a detailed look at how the specific characteristics of innovation in the ag-biotech industry have shaped industry structure, see, e.g., here (pdf)).  

One inconvenient truth for the “concentration reduces innovation” crowd is that, as the industry has experienced more consolidation, it has also become more, not less, productive and innovative. Between 1995 and 2015, for example, the market share of the largest seed producers and crop protection firms increased substantially. And yet, over the same period, annual industry R&D spending went up nearly 750 percent. Meanwhile, the resulting innovations have increased crop yields by 22%, reduced chemical pesticide use by 37%, and increased farmer profits by 68%.

In her discussion of the importance of considering the “innovation ecosystem” in assessing the innovation effects of mergers in R&D-intensive industries, Joanna Shepherd noted that

In many consolidated firms, increases in efficiency and streamlining of operations free up money and resources to source external innovation. To improve their future revenue streams and market share, consolidated firms can be expected to use at least some of the extra resources to acquire external innovation. This increase in demand for externally-sourced innovation increases the prices paid for external assets, which, in turn, incentivizes more early-stage innovation in small firms and biotech companies. Aggregate innovation increases in the process!

The same dynamic seems to play out in the ag-biotech industry, as well:

The seed-biotechnology industry has been reliant on small and medium-sized enterprises (SMEs) as sources of new innovation. New SME startups (often spinoffs from university research) tend to specialize in commercial development of a new research tool, genetic trait, or both. Significant entry by SMEs into the seed-biotechnology sector began in the late 1970s and early 1980s, with a second wave of new entrants in the late 1990s and early 2000s. In recent years, exits have outnumbered entrants, and by 2008 just over 30 SMEs specializing in crop biotechnology were still active. The majority of the exits from the industry were the result of acquisition by larger firms. Of 27 crop biotechnology SMEs that were acquired between 1985 and 2009, 20 were acquired either directly by one of the Big 6 or by a company that itself was eventually acquired by a Big 6 company.

While there is more than one way to interpret these statistics (and they are often used by merger opponents, in fact, to lament increasing concentration), they are actually at least as consistent with an increase in innovation through collaboration (and acquisition) as with a decrease.

For what it’s worth, this is exactly how the startup community views the innovation ecosystem in the ag-biotech industry, as well. As the latest AgFunder AgTech Investing Report states:

The large agribusinesses understand that new innovation is key to their future, but the lack of M&A [by the largest agribusiness firms in 2016] highlighted their uncertainty about how to approach it. They will need to make more acquisitions to ensure entrepreneurs keep innovating and VCs keep investing.

It’s also true, as Diana Moss notes, that

Competition maximizes the potential for numerous collaborations. It also minimizes incentives to refuse to license, to impose discriminatory restrictions in technology licensing agreements, or to tacitly “agree” not to compete…. All of this points to the importance of maintaining multiple, parallel R&D pipelines, a notion that was central to the EU’s decision in Dow-DuPont.

And yet collaboration and licensing have long been prevalent in this industry. Examples are legion, but here are just a few significant ones:

  • Monsanto’s “global licensing agreement for the use of the CRISPR-Cas genome-editing technology in agriculture with the Broad Institute of MIT and Harvard.”
  • Dow and Arcadia Biosciences’ “strategic collaboration to develop and commercialize new breakthrough yield traits and trait stacks in corn.”
  • Monsanto and the University of Nebraska-Lincoln’s “licensing agreement to develop crops tolerant to the broadleaf herbicide dicamba. This agreement is based on discoveries by UNL plant scientists.”

Both large and small firms in the ag-biotech industry continually enter into new agreements like these. See, e.g., here and here for a (surely incomplete) list of deals in 2016 alone.

At the same time, across the industry, new entry has been rampant despite increased M&A activity among the largest firms. Recent years have seen venture financing in AgTech skyrocket — from $400 million in 2010 to almost $5 billion in 2015 — and hundreds of startups now enter the industry annually.

The pending mergers

Today’s pending mergers are consistent with this characterization of a dynamic market in which structure is being driven by incentives to innovate, rather than monopolize. As Michael Sykuta points out,

The US agriculture sector has been experiencing consolidation at all levels for decades, even as the global ag economy has been growing and becoming more diverse. Much of this consolidation has been driven by technological changes that created economies of scale, both at the farm level and beyond.

These deals aren’t fundamentally about growing production capacity, expanding geographic reach, or otherwise enhancing market share; rather, each is a fundamental restructuring of the way the companies do business, reflecting today’s shifting agricultural markets, and the advanced technology needed to respond to them.

Technological innovation is unpredictable, often serendipitous, and frequently transformative of the ways firms organize and conduct their businesses. A company formed to grow and sell hybrid seeds in the 1920s, for example, would either have had to evolve or fold by the end of the century. Firms today will need to develop (or purchase) new capabilities and adapt to changing technology, scientific knowledge, consumer demand, and socio-political forces. The pending mergers seemingly fit exactly this mold.

As Allen Gibby notes, these mergers are essentially vertical combinations of disparate, specialized pieces of an integrated whole. Take the proposed Bayer/Monsanto merger, for example. Bayer is primarily a chemicals company, developing advanced chemicals to protect crops and enhance crop growth. Monsanto, on the other hand, primarily develops seeds and “seed traits” — advanced characteristics that ensure the heartiness of the seeds, give them resistance to herbicides and pesticides, and speed their fertilization and growth. In order to translate the individual advances of each into higher yields, it is important that these two functions work successfully together. Doing so enhances crop growth and protection far beyond what, say, spreading manure can accomplish — or either firm could accomplish working on its own.

The key is that integrated knowledge is essential to making this process function. Developing seed traits to work well with (i.e., to withstand) certain pesticides requires deep knowledge of the pesticide’s chemical characteristics, and vice-versa. Processing huge amounts of data to determine when to apply chemical treatments or to predict a disease requires not only that the right information is collected, at the right time, but also that it is analyzed in light of the unique characteristics of the seeds and chemicals. Increased communications and data-sharing between manufacturers increases the likelihood that farmers will use the best products available in the right quantity and at the right time in each field.

Vertical integration solves bargaining and long-term planning problems by unifying the interests (and the management) of these functions. Instead of arm’s length negotiation, a merged Bayer/Monsanto, for example, may better maximize R&D of complicated Ag/chem products through fully integrated departments and merged areas of expertise. A merged company can also coordinate investment decisions (instead of waiting up to 10 years to see what the other company produces), avoid duplication of research, adapt to changing conditions (and the unanticipated course of research), pool intellectual property, and bolster internal scientific capability more efficiently. All told, the merged company projects spending about $16 billion on R&D over the next six years. Such coordinated investment will likely garner far more than either company could from separately spending even the same amount to develop new products. 

Controlling an entire R&D process and pipeline of traits for resistance, chemical treatments, seeds, and digital complements would enable the merged firm to better ensure that each of these products works together to maximize crop yields, at the lowest cost, and at greater speed. Consider the advantages that Apple’s tightly-knit ecosystem of software and hardware provides to computer and device users. Such tight integration isn’t the only way to compete (think Android), but it has frequently proven to be a successful model, facilitating some functions (e.g., handoff between Macs and iPhones) that are difficult if not impossible in less-integrated systems. And, it bears noting, important elements of Apple’s innovation have come through acquisition….

Conclusion

As LaFontaine and Slade have made clear, theoretical concerns about the anticompetitive consequences of vertical integrations are belied by the virtual absence of empirical support:

Under most circumstances, profit–maximizing vertical–integration and merger decisions are efficient, not just from the firms’ but also from the consumers’ points of view.

Other antitrust scholars are skeptical of vertical-integration fears because firms normally have strong incentives to deal with providers of complementary products. Bayer and Monsanto, for example, might benefit enormously from integration, but if competing seed producers seek out Bayer’s chemicals to develop competing products, there’s little reason for the merged firm to withhold them: Even if the new seeds out-compete Monsanto’s, Bayer/Monsanto can still profit from providing the crucial input. Its incentive doesn’t necessarily change if the merger goes through, and whatever “power” Bayer has as an input is a function of its scientific know-how, not its merger with Monsanto.

In other words, while some competitors could find a less hospitable business environment, consumers will likely suffer no apparent ill effects, and continue to receive the benefits of enhanced product development and increased productivity.

That’s what we’d expect from innovation-driven integration, and antitrust enforcers should be extremely careful before thwarting or circumscribing these mergers lest they end up thwarting, rather than promoting, consumer welfare.

Nicolas Petit is Professor of Law at the University of Liege (Belgium) and Research Professor at the University of South Australia (UniSA)

This symposium offers a good opportunity to look again into the complex relation between concentration and innovation in antitrust policy. Whilst the details of the EC decision in Dow/Dupont remain unknown, the press release suggests that the issue of “incentives to innovate” was central to the review. Contrary to what had leaked in the antitrust press, the decision has apparently backed off from the introduction of a new “model”, and instead followed a more cautious approach. After a quick reminder of the conventional “appropriability v cannibalizationframework that drives merger analysis in innovation markets (1), I make two sets of hopefully innovative remarks on appropriability and IP rights (2) and on cannibalization in the ag-biotech sector (3).

Appropriability versus cannibalization

Antitrust economics 101 teach that mergers affect innovation incentives in two polar ways. A merger may increase innovation incentives. This occurs when the increment in power over price or output achieved through merger enhances the appropriability of the social returns to R&D. The appropriability effect of mergers is often tied to Joseph Schumpeter, who observed that the use of “protecting devices” for past investments like patent protection or trade secrecy constituted a “normal elemen[t] of rational management”. The appropriability effect can in principle be observed at firm – specific incentives – and industry – general incentives – levels, because actual or potential competitors can also use the M&A market to appropriate the payoffs of R&D investments.

But a merger may decrease innovation incentives. This happens when the increased industry position achieved through merger discourages the introduction of new products, processes or services. This is because an invention will cannibalize the merged entity profits in proportions larger as would be the case in a more competitive market structure. This idea is often tied to Kenneth Arrow who famously observed that a “preinvention monopoly power acts as a strong disincentive to further innovation”.

Schumpeter’s appropriability hypothesis and Arrow’s cannibalization theory continue to drive much of the discussion on concentration and innovation in antitrust economics. True, many efforts have been made to overcome, reconcile or bypass both views of the world. Recent studies by Carl Shapiro or Jon Baker are worth mentioning. But Schumpeter and Arrow remain sticky references in any discussion of the issue. Perhaps more than anything, the persistence of their ideas denotes that both touched a bottom point when they made their seminal contribution, laying down two systems of belief on the workings of innovation-driven markets.

Now beyond the theory, the appropriability v cannibalization gravitational models provide from the outset an appealing framework for the examination of mergers in R&D driven industries in general. From an operational perspective, the antitrust agency will attempt to understand if the transaction increases appropriability – which leans in favour of clearance – or cannibalization – which leans in favour of remediation. At the same time, however, the downside of the appropriability v cannibalization framework (and of any framework more generally) may be to oversimplify our understanding of complex phenomena. This, in turn, prompts two important observations on each branch of the framework.

Appropriability and IP rights

Any antitrust agency committed to promoting competition and innovation should consider mergers in light of the degree of appropriability afforded by existing protecting devices (essentially contracts and entitlements). This is where Intellectual Property (“IP”) rights become relevant to the discussion. In an industry with strong IP rights, the merging parties (and its rivals) may be able to appropriate the social returns to R&D without further corporate concentration. Put differently, the stronger the IP rights, the lower the incremental contribution of a merger transaction to innovation, and the higher the case for remediation.

This latter proposition, however, rests on a heavy assumption: that IP rights confer perfect appropriability. The point is, however, far from obvious. Most of us know that – and our antitrust agencies’ misgivings with other sectors confirm it – IP rights are probabilistic in nature. There is (i) no certainty that R&D investments will lead to commercially successful applications; (ii) no guarantee that IP rights will resist to invalidity proceedings in court; (iii) little safety to competition by other product applications which do not practice the IP but provide substitute functionality; and (iv) no inevitability that the environmental, toxicological and regulatory authorization rights that (often) accompany IP rights will not be cancelled when legal requirements change. Arrow himself called for caution, noting that “Patent laws would have to be unimaginably complex and subtle to permit [such] appropriation on a large scale”. A thorough inquiry into the specific industry-strength of IP rights that goes beyond patent data and statistics thus constitutes a necessary step in merger review.

But it is not a sufficient one. The proposition that strong IP rights provide appropriability is essentially valid if the observed pre-merger market situation is one where several IP owners compete on differentiated products and as a result wield a degree of market power. In contrast, the proposition is essentially invalid if the observed pre-merger market situation leans more towards the competitive equilibrium and IP owners compete at prices closer to costs. In both variants, the agency should thus look carefully at the level and evolution of prices and costs, including R&D ones, in the pre-merger industry. Moreover, in the second variant, the agency ought to consider as a favourable appropriability factor any increase of the merging entity’s power over price, but also any improvement of its power over cost. By this, I have in mind efficiency benefits, which can arise as the result of economies of scale (in manufacturing but also in R&D), but also when the transaction combines complementary technological and marketing assets. In Dow/Dupont, no efficiency argument has apparently been made by the parties, so it is difficult to understand if and how such issues have played a role in the Commission’s assessment.

Cannibalization, technological change, and drastic innovation

Arrow’s cannibalization theory – namely that a pre-invention monopoly acts as a strong disincentive to further innovation – fails to capture that successful inventions create new technology frontiers, and with them entirely novel needs that even a monopolist has an incentive to serve. This can be understood with an example taken from the ag-biotech field. It is undisputed that progress in crop protection science has led to an expanding range of resistant insects, weeds, and pathogens. This, in turn, is one (if not the main) key drivers of ag-tech research. In a 2017 paper published in Pest Management Science, Sparks and Lorsbach observe that:

resistance to agrochemicals is an ongoing driver for the development of new chemical control options, along with an increased emphasis on resistance management and how these new tools can fit into resistance management programs. Because resistance is such a key driver for the development of new agrochemicals, a highly prized attribute for a new agrochemical is a new MoA [method of action] that is ideally a new molecular target either in an existing target site (e.g., an unexploited binding site in the voltage-gated sodium channel), or new/under-utilized target site such as calcium channels.

This, and other factors, leads them to conclude that:

even with fewer companies overall involved in agrochemical discovery, innovation continues, as demonstrated by the continued introduction of new classes of agrochemicals with new MoAs.

Sparks, Hahn, and Garizi make a similar point. They stress in particular that the discovery of natural products (NPs) which are the “output of nature’s chemical laboratory” is today a main driver of crop protection research. According to them:

NPs provide very significant value in identifying new MoAs, with 60% of all agrochemical MoAs being, or could have been, defined by a NP. This information again points to the importance of NPs in agrochemical discovery, since new MoAs remain a top priority for new agrochemicals.

More generally, the point is not that Arrow’s cannibalization theory is wrong. Arrow’s work convincingly explains monopolists’ low incentives to invest in substitute invention. Instead, the point is that Arrow’s cannibalization theory is narrower than often assumed in the antitrust policy literature. Admittedly, Arrow’s cannibalization theory is relevant in industries primarily driven by a process of cumulative innovation. But it is much less helpful to understand the incentives of a monopolist in industries subject to technological change. As a result of this, the first question that should guide an antitrust agency investigation is empirical in nature: is the industry under consideration one driven by cumulative innovation, or one where technology disruption, shocks, and serendipity incentivize drastic innovation?

Note that exogenous factors beyond technological frontiers also promote drastic innovation. This point ought not to be overlooked. A sizeable amount of the specialist scientific literature stresses the powerful innovation incentives created by changing dietary habits, new diseases (e.g. the Zika virus), global population growth, and environmental challenges like climate change and weather extremes. In 2015, Jeschke noted:

In spite of the significant consolidation of the agrochemical companies, modern agricultural chemistry is vital and will have the opportunity to shape the future of agriculture by continuing to deliver further innovative integrated solutions. 

Words of wisdom caution for antitrust agencies tasked with the complex mission of reviewing mergers in the ag-biotech industry?

Ioannis Lianos is Professor of Global Competition Law and Public Policy, UCL Faculty of Laws and Chief Researcher, HSE-Skolkovo Institute for Law and Development

The recently notified mergers in the seed and agro-chem industry raise difficult questions that competition authorities around the world would need to tackle in the following months. Because of the importance of their markets’ size, the decision reached by US and EU competition authorities would be particularly significant for the merging parties, but the perspective of a number of other competition authorities in emerging and developing economies, in particular the BRICS, will also play an important role if the transactions are to move forward.

The factors of production segment of the food value chain, which has been the focus of most recent merger activity, has been marked by profound transformations the last three decades. One may note the development of new technologies, starting with deliberate hybridization to marker-assisted breeding and the most recent advances in genetic engineering or genetic editing with CRISPR/Cas technology, as well as the advent of “digital agriculture” and “precision farming”. These technologies are of course protected by IP rights consisting of patents, plant variety rights, trademarks, trade secrets, and geographical indications.

These IP rights enable seed companies to prevent farmers from saving seeds of the protected variety, sharing it with their neighbours or selling it informally (“brown bagging”), but also to prevent competing plant breeders from using a protected variety in the development of a new variety (cumulative innovation), as well as to prevent competing seed producers from multiplying and marketing the protected variety without a license or using a protected product name and logos. Seed laws requiring compulsory seed certification with the aim to police seed quality also offer some form of protection to breeders, in the absence of IPRs.

Technology-driven growth has not been the only major transformation of this economic sector. Its consolidation, in particular in the factors of production segment, has been particularly important in recent years.

The consolidation of the factors of production segment

Concentration in the world and EU markets for seeds

In the seeds sector, a number of merger waves, starting in the mid-1980s, have led to the emergence of a relatively concentrated market structure of 6 big players thirty years later (Monsanto, Syngenta, DuPont, BASF, Bayer, and Dow).

The most recent merger wave started in July 2014 when Monsanto made a number of acquisition offers to Syngenta. These offers were rejected, but the Monsanto bid triggered a number of other M&A transactions that were announced in 2015 and 2016 between the various market leaders in the factors of production segment. In November 2015, Syngenta accepted the offer of ChemChina (which owns ADAMA, one of the largest agrochemical companies in the world). In December 2015, Dupont and Dow announced their merger. In September 2016, Bayer put forward a merger deal with Monsanto. During the same month, a deal was announced between two of the leaders in the market for fertilizers, Potash Corp and Agrium. In November 2015, it was reported that Deere & Co. (the leader in agricultural machinery) had agreed to buy Monsanto’s precision farming business. This deal was opposed by the US Department of Justice as it would have led Deere to control a significant part of the already highly concentrated US high-speed precision planting systems market.

The level of concentration varies according to the geographical market and the type of crop. If one looks at the situation in Europe, with regard to the sale of seeds, the market appears to be less concentrated than the global seed market. The picture is also slightly different for certain types of crop. For instance, it is reported that the seed market for sugar beets shows the largest concentration, with the first three companies (CR3) controlling a staggering 79% of the market (HHI: 2444), while for Maize seeds CR3 is 56% (HHI: 1425). High levels of concentration are also noted in the market for tomato seeds with Monsanto controlling 20% of registered seed varieties. What is more striking, however, is the speed of this consolidation process, as the bulk of this increase in the concentration level of the industry occurred in the last twenty years, the levels of concentration in the mid-1990s being close to those in 1985.

But the existence of a relatively concentrated market constitutes the tip of a much bigger consolidation iceberg between the market leaders that takes various forms: joint ventures, various cross-licensing and trait licensing agreements between the “Big Six”, distribution agreements, collaborations, research agreements and R&D strategic alliances, patent litigation settlements, to which one may add the recently concluded post-patent genetic trait agreements. Furthermore, one may not exclude the possibility of consolidation by stealth, in view of the important growth in common ownership in various sectors of the economy, as institutional investors simultaneously hold large blocks of other same-industry firms.

Which concentration level will be considered for merger purposes?

Market structure and concentration is, of course, just one step in the assessment of mergers and should be followed by a more thorough analysis of the possible anticompetitive effects and efficiencies, if the level of concentration resulting from the merger raises concerns. While the EU market for seeds could not be characterized as highly concentrated before this most recent merger wave, if one applies the conventional HHI measure, it remains possible that if the mergers first notified to the European Commission are approved without conditions with regard to seed markets, the concentration level that the Commission will consider when assessing the following notified merger will respectively increase. One may project that, as the Dow/Dupont merger has been recently cleared without conditions relating to the seed industry, it will be more difficult for the ChemChina/Syngenta merger to be approved without conditions, and even more so for the Bayer/Monsanto merger that will be the last one examined. Indeed, as the Commission made clear in its press release announcing its decision on the Dow/Dupont transaction,

The Commission examines each case on its own merits. In line with its case practice, the Commission assesses parallel transactions according to the so-called “priority rule” – first come, first served. The assessment of the merger between Dow and DuPont has been based on the currently prevailing market situation.

The assessment as to whether a merger would give rise to a Significant Impediment of Effective Competition (SIEC) is based on a counterfactual analysis where the post-merger scenario is compared to a hypothetical scenario absent the merger in question. The latter is normally taken to be the same as the situation before the merger is consummated. However, the Commission may take into account future changes to the market that can “reasonably be foreseen”. The identification of the proper counterfactual can be complicated by the fact that there can be more than one merger occurring in parallel in the same relevant market. Under the mandatory notification regime, the Commission does not factor into the counterfactual analysis a merger notified after the one under assessment. On the basis of the identified counterfactual, the Commission then proceeds with the definition of the relevant product and geographic market. That means that when assessing the Dow/Dupont merger, the Commission did not take into account the (future) market situation that would result from the notified merger between ChemChina and Syngenta, which was a known fact during the period of the assessment of the Dow/Dupont merger, as this was notified a few months after the notification of the Dow/Dupont transaction.

Explaining concentration levels

The consolidation of the industry may be explained by various factors at play. One may put forward a “natural” causes explanation, in view of the existence of endogenous sunk costs that may lead to a reduction in the number of firms active in this industry. John Sutton has famously argued that high concentration may persist in many manufacturing industries, even in the presence of a substantial increase in demand and output, when firms in the industry decide to incur, in addition to “exogenous sunk costs”, that is the costs that any firm will have to incur upon entry into the market, “endogenous sunk costs”, which include cost for R&D and other process innovations, with the aim to increase their price-cost margin. If all firms invest in endogenous sunk costs, in the long run this investment will produce little or no profit, as the competitive advantage gained by each firm’s investment will be largely ineffective if all other firms make a similar investment. This may lead to a fall in the industry’s profitability in the long-term and to a concentrated market. The recent consolidation movement in the industry may also be understood as a way to deal with externalities arising out of the expansion of the IP protection in recent decades.

Consolidation may also occur because of the merging companies’ quest for market share by purchasing potential competition, acquiring local market leaders or companies with diversified distribution networks and an established customer base. Market leaders may also strive to constitute one-stop shop platforms for farmers, combining an offering of seeds, traits, and chemicals, that would enhance the farmers’ technological dependence vis-à-vis large agrochemical and seed companies.

These large agro-chem groups forming a tight oligopoly will be able to exploit eventual network effects that may result from the shift towards data-driven agriculture and to block new entry in the factors of production markets. It is increasingly clear that market players in this industry have made the choice of positioning themselves as fully integrated providers, or the orchestrators/partners of an established network, offering a package of genetic transformation technology and genomics, traits, seeds, and chemicals. One may argue that this package of ‘complementary’ products and technologies may form a system competing with other systems (‘systems competition’). A question that would need to be tackled, when assessing the plausibility of the “system competition” thesis, would be to determine the existence of distinct relevant markets affected by the mergers. Could research, breeding and development/marketing of the various kinds of seeds be considered as part of the same or of different relevant markets? I address this question and the effects of these mergers on output, prices, and consumer choice in more detail in a separate paper (I. Lianos & D. Katalevsky, Merger Activity in the Factors of Production Segments of the Food Value Chain: A Critical Assessment (forthcoming)).

Theories and assessment of harm to innovation

Because of space constraints, I will only focus here on the assessment of the possible effects of these mergers on innovation. The emergence of integrated technology/traits/seeds/chemicals platforms may place barriers to new entry, as companies wishing to enter the market(s) would need to offer an integrated solution to farmers. This may stifle disruptive innovation if, in the absence of the merger, firms were able to enter one or two segments of the market (e.g. research and breeding) without the need to offer an “integrated” platform product. One should also take note of the fact that although traditional breeding methods required important resources and a considerable investment of time (because of long breeding cycles) and thus provided large economies of scale leading to the emergence of large market players, the latest genome-editing technologies, particularly CRISPR/Cas, may constitute more efficient and less resource intensive and time-consuming breeding methods, that offer opportunities for the emergence of more competitive and less integrated market structures in the traits/seeds segment(s).

Assessing the effects on innovation will be a crucial part of the merger assessment, for the European Commission as well as for all other competition authorities with jurisdiction to examine the specific merger(s). It is true that the EU market is mainly a conventional seed market, and not a GM seeds market, but it is also clear that all of the Big Six have an integrated strategy for R&D for all types of crops, working on “traditional” marker-assisted breeding, or the more recent forms of predictive breeding that have become commercially possible with the reduction of the cost of genome sequencing and the use of IT, but also on genetically engineered seeds. Assessing the possible effects of each merger on innovation will be a quite complex exercise in view of the need to focus not only on existing technologies but also on the possibility of new technologies emerging in the future.

Competition authorities may use different methodologies to assess these future effects: the definition of innovation markets as it is the case in the US, or a more general assessment of the existence of an effect on innovation constituting a SIEC in Europe. In its recent decision on the Dow/Dupont merger, the European Commission found that the merger may have reduced innovation competition for pesticides by looking to the ability and the incentive of the parties to innovate. The Commission emphasised that this analysis was not general but was based on “specific evidence that the merged entity would have lower incentives and a lower ability to innovate than Dow and DuPont separately” and “that the merged entity would have cut back on the amount they spent on developing innovative products”. That said, the Commission also mentioned the following, which I think may be of relevance to the competition assessment of the other pending mergers:

Only five companies (BASF, Bayer, Syngenta and the merging parties) are globally active throughout the entire R&D process, from discovery of new active ingredients (molecules producing the desired biological effect), their development, testing and regulatory registration, to the manufacture and sale of final formulated products through national distribution channels. Other competitors have no or more limited R&D capabilities (e.g. as regards geographic focus or product range). After the merger, only three global integrated players would remain to compete with the merged company, in an industry with very high barriers to entry. The number of players active in specific innovation areas would be even lower than at the overall industry level.

This type of assessment looks close to the filter of the existence of at least four independent technologies that constitute a commercially viable alternative, in addition to the licensed technology controlled by the parties to the agreement, that the Commission usually employs in its Transfer of Technology Guidelines in order to exclude the possibility that a licensing agreement may restrict competition and thus infringe Article 101 TFEU. There is no reason why the Commission would apply a different approach in the context of merger control. The above indicate that the Commission may view more negatively mergers that lead to less than four or three independent technologies in the relevant market(s).

Hidden/Not usually considered social costs

One may also assess the mergers in the seeds and agro-chem market from a public interest perspective, in view of the broader concerns animating public policy in this context and the existence of a nexus of international commitments with regard to biodiversity, sustainability, the right to food, as well as the emphasis put by some competition law regimes on public interest analysis (e.g. South Africa). The aim will be to assess the full social costs of these transactions, to the extent, of course, this is practically possible. This may be more achievable in merger control regimes where it is not courts that make the final decisions to clear, or not to clear, the merger, as there may be limits to the adjudication of certain broader public interest concerns, but integrated competition law agencies, or branches of the executive power, as it is formally the case in the EU.

Although public interest considerations do not form part of the substantive test of EU merger control, Article 21(4) EUMR includes a legitimate interest clause, which provides that Member States may take appropriate measures to protect three specified legitimate interests: public security, plurality of the media and prudential rules, and other unspecified public interests that are recognised by the Commission after notification by the Member State. If a Member State wishes to claim an additional legitimate interest, other than the ones listed above, it shall communicate this to the Commission. And the Commission must then decide, within 25 working days, whether the additional interest is compatible with EU law, and qualifies as an article 21(4) legitimate interest. This should not be excluded a priori, in particular in view of the importance of biodiversity, environmental protection, and employment in the EU treaties as well as broader international commitments to the right to food.

Food production is, of course, an area of great economic and geopolitical importance. According to UN estimates, by 2050 the world population will increase to nine billion, and catering to this additional demand would require an increase of 70% more food. This puts a strong pressure to increase output, which intensifies even more environmental impact, given increasing sustainability challenges (degradation of soil and reduction of arable land due to urban sprawl, water scarcity, biofuel consumption, climate change, etc.). Food security becomes an increasingly important issue on the agenda of the developing world.

The projected mergers in the seed and agro-chem industry will greatly affect the future control of food production and innovation in order to improve yields and feed the world. One may ask if such important decisions should be based on a narrowly confined test that mostly focuses on effects on output, price and to a certain extent innovation, or if one should adopt a broader consideration of the full social costs of such transactions, to the extent that these may be assessed and eventually quantified.

This may have the additional benefit to enable the participation in the merger process as third parties of a number of NGOs representing broader citizens’ interests in environmental protection and biodiversity, which is currently impossible with the quite narrow procedural requirements for third party intervenors in EU merger control (as the test for admission as third party intervenors is usually met only by competitors, suppliers, and customers). I think that all the affected interests and stakeholders should be offered an opportunity to participate in the decision-making process, thus increasing its efficiency (if one takes a participation-centred approach) and legitimacy, in particular for matters of major social importance as is the control of the global food supply chain(s).

It may be argued, if one takes a pessimistic, Malthusian perspective, that we are doomed to face famine and malnutrition, unless considerable amounts of investment are made in R&D in this sector. In view of the fall of public investments and the important role private investments have played in this area, one may argue that higher levels of consolidation in the sector could lead to higher profitability (at the expense of farmers) without necessarily leading to immediate effects on food prices, as the farming segment is driven by atomistic competition in most markets, and therefore farmers will not have the ability to pass on, at least in the short term, the eventual overcharges to the final consumers. Of course, such an approach may not factor in the effects of these mergers to the livelihood of around half a billion farmers in the world and their families, most of whom do not benefit from subsidies guaranteeing an acceptable standard of living.

It also assumes that higher profitability would lead to higher investments in R&D, a claim that has been recently questioned by research indicating that large firms prefer to retain earnings and distribute them to shareholders and the management rather than invest them in R&D. But, more generally, a simple question that one may ask is “are the projected mergers necessary in order to promote innovation in this sector”? Answering this question may bring a great sense of clarity as to the various dimensions of these mergers competition authorities would need to take into account. And the burden of proof to provide a convincing answer to this question remains on the notifying parties!

Levi A. Russell is Assistant Professor, Agricultural & Applied Economics, University of Georgia and a blogger at Farmer Hayek.

Commenting on Microsoft’s antitrust suit 18 years ago, Milton Friedman said the following:

Your industry, the computer industry, moves so much more rapidly than the legal process, that by the time this suit is over, who knows what the shape of the industry will be.

Though the legal process seems to be moving quickly in the cases of Dow/Dupont, ChemChina/Syngenta, and Bayer/Monsanto, seed technology is moving fast as well. With recent breakthroughs in gene editing, seed technology will be more dynamic, cheaper, and likely subject to far less regulation than the current transgenic technology.

GMO seeds produced using current techniques are primarily designed with specific insect control and herbicide tolerance. Gene editing has the potential to go much further by creating drought and disease tolerance as well as improving yield. It’s difficult to know precisely how this new technology will be integrated into the industry, but its effects are likely to promote innovation from outside the three large firms that will result from the mergers and acquisitions mentioned above.

As in the food industry, small gene editing startups will be able to develop new traits with the intention of being acquired by one of the large firms in the industry. By allowing small firms to enter the seed biotech industry, gene editing will provide the sort of external innovation Joanna Shepherd notes is so important in understanding antitrust cases.