Who Are You Calling A Price Theorist Anyway?: Commissioner Rosch Takes on the HMGs Economist “Architects”

Josh Wright —  19 August 2010

Commissioner Rosch has offered an interesting separate statement on the new HMGs.  While favoring the new guidelines generally, Commissioner Rosch offers several criticisms.  I concur with a few of these criticisms, for example, Commissioner Rosch also argues for a more empirical approach to merger analysis.  I agree with that general proposition despite, as we shall see below, the fact that the Commissioner offers it along with the peculiar distinction between “economic evidence” which he rejects and “empirical evidence”.  The Commissioner should be applauded for putting these criticisms, as well as those with which I disagree of course, on the record.

But in reading Commissioner Rosch’s separate statement on the new HMGs, I was intrigued by what seems to be a mistake the Commissioner has made repeatedly.  As I’ve pointed out previously, Commissioner Rosch is both mistaken and at times seems to be confused view about what price theory is.   One should not conflate this intrigue with surprise.  I’ve commented before on the Commissioner’s obsession with attacking price theory, an arm of microeconomics Commissioner Rosch views as the exclusive domain of the evil empire known as the Chicago School, and his general confusion about the Chicago School, its contributions to industrial organization economics generally and antitrust specifically, distinguishing it from what is now generally referred to as Post-Chicago economics, and a variety of other issues.

I’m afraid the Commissioner’s statement offers more of the same confusion and tired anti-economics rhetoric.  And while could attempt to dismiss the lack of understanding as a semantic and harmless error, I don’t think so.  We are talking about real policy here.  The HMGs have tremendous practical import.  And misunderstanding economics, and the role of economics in antitrust, is not harmless.  I’ll discuss the statement in greater detail below the fold.

Commissioner Rosch begins by claiming that the process implemented to create the Guidelines guaranteed that the new HMGs would not reflect what he views as three major changes since the 1992 HMGs: (1) that the “Commission is increasingly challenging mergers in preliminary injunction and administrative (Part 3) proceedings;” (2) that the “economic theories embedded in the 1992 Guidelines emphasized price effects almost exclusively. Increasingly, the Agencies and courts have considered nonprice effects, like effects on quality, variety, and innovation, to be no less important;” and (3) that “for a variety of reasons, many, if not most, courts have relied on empirical evidence instead of economic evidence, and have considered economic evidence as corroborative of that empirical evidence, if they have considered it at all.  This process inevitably led to overemphasis on economic formulae and models based on price theory.”

What is the link between the process and these resulting omissions from the new HMGs that Commissioner Rosch finds objectionable?   Rosch writes:

[T]he perspectives of all stakeholders were not considered equally. First, of the six architects of the project, three were economists trained and steeped in price theory. To be sure, some of the Commission attorneys responsible for reviewing mergers ex ante and/or explaining to the Commission how they planned to present and defend their challenges in court or in Part 3 were consulted in connection with the project. But the three economists initiated and largely managed this project. Second, there was indeed a series of workshops held around the country, and a number of comments were submitted respecting these Guidelines. But the participants in the workshops were mostly members of the defense bar, academics, and other kindred souls, and the comments apparently given the most serious attention by the project’s architects (and incorporated in these Guidelines) largely reflected those same perspectives. Third, long before these Guidelines were finalized, representations were made to the ABA Antitrust Section about the changes in the 1992 Guidelines that were likely to occur. Indeed at least one private meeting was held with the Section’s leadership regarding their desire for changes in the April 2010 draft of the Guidelines.

I don’t want to play guessing games on the identifies of three economists “steeped in price theory,” or the other three “architects” of the project.  But its pretty safe to say, and likely a sure bet, that at least two of the economists Rosch labels as architects are Carl Shapiro (Chief Economist at the DOJ) and Joe Farrell (Director of the Bureau of Economics at the FTC).   Any doubters?  Here’s a hint from Commissioner Rosch:

Indeed, both Section 4.1.3, blessing for the first time the use of critical loss analysis in dealing with market definition, and Section 6.1, dealing with the likelihood of unilateral effects in differentiated product mergers, incorporate the concepts, if not the exact models, that two of the architects of the project have proposed in economic papers and articles in order to determine whether such effects were likely.

Hmmm.  Recent economic papers or articles from DOJ or FTC economists dealing with unilateral effects and critical loss?  Any ideasAnyone?  Joking aside, there is no doubt Commissioner Rosch is referencing Farrell and Shapiro here.  As for the third?  Maybe Howard Shelanski?  Or maybe Greg Werden.  Maybe somebody else.  Who knows.

Here’s the point.  Farrell and Shapiro are both very accomplished economists.  They are also economists that I’ve disagreed with on a number of issues — some involving mergers and others involving single firm conduct.   To the extent that Commissioner Rosch’s operating definition of price theory is that it is the domain of the Chicago School, and it is, it is quite safe to say that neither Farrell or Shapiro are “price theorists” in the sense that just about anybody (including Rosch) uses this term.  I’m sure this is the first time either has been described as a “price theorist” or Chicago School collaborator.   Both made their names developing economic theory involving network effects, which is central to post-Chicago economics models concerned with the conditions under which network effects can lead to barriers to entry, durable monopoly power and an incentive for exclusionary conduct.  In fact, network effects were the economic foundation of the Microsoft and Visa cases brought by the DOJ under Joel Klein.  And Carl Shapiro was the expert witness for (of all plaintiffs) the state AGs in the remedy proceeding. The whole idea that they are “price theorists,” when price theory refers to the neoclassical model of perfect competition, is silly.  So is the whole idea that we’ve got a high-ranking antitrust enforcement official trying to make “price theorist” into a derogatory term.

But let’s be clear — neither carry the water for the “members of the defense bar” and their “kindred souls.”    In addition to the attack being unnecessary, and erroneous, it also just doesn’t make any sense.  In one sentence, the “architects” are captured by the Chicago School/ price theory embraced by the defense bar; in the next, they are crazy interventionists who want to use high margins as evidence of likely anticompetitive effects.

So what?  Rosch’s first and second points are combined to suggest that the Chicago School somehow took over the HMG drafting process and the hearings to reflect defense-oriented views.  Nonsense.  First, the economists Rosch refers to are not Chicago School economists.  Second, the Commission and DOJ invited participants in the workshops — and so far as I can tell, are not under the influence of the Chicago School.  Indeed, the current agencies have been proud to announce that the Chicago School is “dead” or “on life support” or “retired.”  The complaint that the dead hand of the Chicago School has somehow taken over Farrell, Shapiro, the FTC and the DOJ doesn’t quite pass the laugh test.  First, the Commissioner complained that the Barnett administration did not evenhandedly invite relevant stakeholders to the Section 2 hearings; and now he complains that the Leibowitz FTC and Varney DOJ’s are guilty of the same offense.

Second, the new HMGs simply do not move the agencies’ merger analysis in a non-interventionist direction.  As many have pointed out, the move is likely to (if anything) result in smaller relevant markets.  Seems like an odd thing for an orthodox Chicagoan to push.  The view that the new HMGs are the result of right-wing capture of the process is — lets say, lacking both logic and supporting evidence.

Third, with respect to the actual economics, the only thing I can think of that connects unilateral effects theories and the UPP test in any form to Chicago School “price theory,” is that both involve prices.  But that is not how Commissioner Rosch used and has repeatedly used the term price theory — not to mention the link to defendant interests a few sentences away.   Price theory involves the neoclassical model of perfect competition as a starting point.  Evaluation of differentiated product models generally takes place in a Bertrand game, but in any case, is generally a game-theoretic exercise rather than one relying exclusively on price theory.   On the matter of describing the work of Farrell & Shapiro and all others who have done important work on the economics of unilateral effects, this just seems like a mistake.

Fourth, would a focus on price theory, correctly defined, ignore non-price competition?  Are Chicago School price theorists guilty of focusing exclusively on price and ignoring non-price dimensions of competition?  Here’s a short reading list for interested TOTM readers.  How about George Stigler, Price and Non-Price Competition (1968), Douglas H. Ginsburg, Nonprice Competition, Antitrust Bulletin 83 (1993), Harold Demsetz, The Intensity and Dimensionality of Competition; Klein and Murphy, Vertical Restraint as Contract Enforcement Mechanisms (1988). There’s a ton more.

But the basic point here is that a logical link or two is missing from Rosch’s accusation about price theory to the outcomes adopted by the HMGs that he does not like is.  In this case, for example, the focus on price effects.  Rosch believes that a focus on price theory somehow results in lack of consideration of non-price competition.  Using the correct definition of price theory, that assertion is demonstrably wrong (see above) and simply a misunderstanding of the relevant literature and economic fundamentals.  Further, while Farrell & Shapiro can defend themselves, I’m quite sure they would not endorse the proposition that the HMGs exclude or minimize the consideration of non-price effects.

The logic is also missing between Rosch’s claims about price theory (even ignoring the weird argument that the Chicagoans took over the process) and the other bad outcomes.  Does antitrust economics as understood from the price-theoretic perspective have an inherent bias that would lead one to misstate in merger guidelines what sorts of evidence might be available in a Part III proceeding or PI rather than full trial?  I’m not even sure what the argument is here.  And Rosch doesn’t make one.

Fifth, Rosch cites FTC v. Staples for the proposition that “courts have relied on empirical evidence instead of economic evidence, and have considered economic evidence as corroborative of that empirical evidence, if they have considered it at all.”  Really?  Staples is a rejection of economics over some non-economic thing called empiricism?   That is certainly not how I teach the case.  Its certainly not how the government brought the case.  Its not the way that Jon Baker, Bill Baer, or George Cary discuss the case.  And its certainly not the way that Judge Posner, who has called Staples the “coming of age” for modern merger analysis, describes the case.  This whole passage, and the distinction between economic evidence and “empirical evidence” is confused.  Perhaps the Commissioner is of the view that all the “numbers” and “formulae” in the economic evidence lend it to be less useful or have less predictive power than the business school buzzwords and aggressive talk in management documents?  Anybody who believes this position ought to read Geoff Manne on the subject.

I’m afraid, stripped of the superficial and confusing cover-up, the Commissioner’s statement is incredibly consistent with a worldview that would like to reduce the role of economics in antitrust generally to at most, a complementary player, and perhaps less.   Interestingly, the rhetorical strategy has been to label parts of economic theory that are not conducive to the Commissioner’s goals for antitrust as belonging to the “dead” “orthodox” and “discredited” Chicago School.  Now, apparently, to the extent that the work of Post-Chicagoans like Farrell and Shapiro is inconsistent with those priors, they are “price theorists” belonging to the same school.  Notice any trend?  Behavioral economists — I’m talking to you.

I’ll have more thoughts on the substantive content of the HMGs themselves in the near future.   But I thought the separate statement warranted separate commentary because it highlighted some interesting and important issues.  The separate statement, were I an economist in either agency, and especially “the architects,” would land somewhere between disturbing and offensive.  Taken in conjunction with some of the other statements that have come from Commission leadership, but particularly Commissioner Rosch, economists at the Commission have good reason to feel like their hard work has been undervalued and their role at the Commission shrinking when it comes to antitrust analysis.

Reducing the role of economics and economists in antitrust is a serious threat.  It is economics that guided the evolution of the law from its perverse state in the 1960s to where it is now — imperfect, but a much improved doctrine that is much more consistent with modern economic thought and empirical evidence than it was just decades ago.  If economic theory or new empirical evidence leads us to change our thinking on what the law should be in terms of maximizing consumer welfare — so be it.  Let’s have that debate on the merits.  Shrinking the role of economics at the agencies, ending around serious economic analysis through the use of Section 5, and questioning the motives of economists with whom one disagrees do an end-around that sort of debate.   The separate statement is yet another in a line of Commissioner Rosch’s public statements that are consistent with a reduction in the reliance of rigorous economic thinking as a part of antitrust analysis.

That is not a good thing for consumers.