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[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Kristian Stout, (Associate Director, International Center for Law & Economics]


The ongoing pandemic has been an opportunity to explore different aspects of the human condition. For myself, I have learned that, despite a deep commitment to philosophical (neo- or classical-) liberalism, at heart I am pragmatic. I would prefer a society that optimizes for more individual liberty, but I am emphatically not someone who would even entertain the idea of using crises to advance my agenda when it is not clearly in service to amelioration of immediate problems.

Sadly, I have also learned that there are those who are not similarly pragmatic, and are willing to advance their ideological agenda come hell or high water. In this regard, I was disappointed yesterday to see the Gurry IP/COVID Letter passing around Twitter calling for widespread, worldwide interference with the property rights of IPR holders. 

The letter calls for a scattershot set of “remedies” to the crisis that would open access to copyright- and patent-protected inventions and content, including (among other things): 

  • voluntary licensing and non-enforcement of IP;
  • abrogation of IPR by WIPO members using the  “flexibility” in the international IP regime; 
  • the removal of geographical restrictions on IP licenses;
  • forcing patents into COVID-19 patent pools; and 
  • the implementation of compulsory licensing. 

And, unlike many prior efforts to push the envelope on weakening IP protections, the Gurry Letter also calls for measures that would weaken trade secrets and expose confidential business information in order to “achieve universal and equitable access to COVID-19 medicines and medical technologies as soon as reasonably possible.”

Notably, nothing in the letter suggests that any of these measures should be regarded as temporary.

We all want treatments for infection, vaccines for prevention, and ample supply of personal protective equipment as soon as possible, but if all the demands in this letter were met, it would do little to increase the supply of any of these things in the short term, while undermining incentives to develop new treatments, vaccines and better preventative tools in the long run. 

Fundamentally, the letter  reflects a willingness to use the COVID-19 pandemic to pursue an agenda that lacks merit and would be dismissed in the normal course of affairs. 

What is most certainly the case is that we need more innovation now, and we need it faster. There is no reason to believe that mandating open source status or forcing compulsory licensing on the firms doing that work will encourage that work to proceed with all due haste—and every indication that the opposite is the case. 

Where there are short term shortages of certain products that might be produced in much larger quantities by relaxing IP, companies are responding by doing just that—voluntarily. But this is fundamentally different from the imposition of unlimited compulsory licenses.

Further, private actors have displayed an impressive willingness to provide free or low cost access to technologies and content—without government coercion. The following is a short list of some of the content and inventions that have been opened up:

Culture, Fitness & Entertainment

  • HBO Will Stream 500 Hours of Free Programming, Including Full Seasons of ‘Veep,’ ‘The Sopranos,’ ‘Silicon Valley’”
  • Dozens (or more) of artists, both famous and lesser known, are releasing free back catalog performances or are taking part in free live streaming sessions on social media platforms. Notably, viewers are often welcome to donate or “pay what they” want to help support these artists (more on this below).
  • The NBA, NFL, and NHL are offering free access to their back catalogue of games.
  • A large array of music production software can now be used free on extended trials for 3 months (or completely free and unlimited in some cases). 
  • CBS All Access expanded its free trial period.
  • Neil Gaiman and Harper Collins granted permission to Levar Burton to livestream readings from their catalogs.
  • Disney is releasing movies early onto its (paid) Disney+ services.
  • Gold’s Gym is providing free access to its app-based workouts.
  • The Met is streaming free recordings of its Live in HD series.
  • The Seattle Symphony is offering free access to some of its recorded performances.
  • The UK National Theater is streaming some of its most popular plays for free.
  • Andrew Lloyd Weber is streaming his shows online for free.

Science, News & Education

  • Scholastica released free content intended to help educate students stuck at home while sheltering-in-place. 
  • Nearly 100 academic journals, societies, institutes, and companies signed a commitment to make research and data on COVID-19 freely available, at least for the duration of the outbreak.
  • The Atlantic lifted paywall restrictions on access to its COVID-19-related content.
  • The New England Journal of Medicine is allowing free access to COVID-19-related resources.
  • The Lancet allows free access to research it publishes on COVID-19.
  • All material published by theBMJ on the coronavirus outbreak is freely available.
  • The AAAS-published Science allows free access to its coronavirus research and commentary.
  • Elsevier gave full access to its content on its COVID-19 Information Center for PubMed Central and other public health databases.
  • The American Economic Association announced open access to all of its journals until the end of June.
  • JSTOR expanded free access to some of its scholarship.

Medicine & Technology

  • The Global Center for Medical Design is developing license-free PPE designs that can be quickly implemented by manufacturers.
  • Medtronic published “design specifications for the Puritan Bennett 560 (PB560) to allow innovators, inventors, start-ups, and academic institutions to leverage their own expertise and resources to evaluate options for rapid ventilator manufacturing.” It additionally provided software licenses for this technology.
  • AbbVie announced it won’t enforce its patent rights for Kaletra—a drug that may provide treatment for COVID-19 infections. Israel had earlier indicated it would impose compulsory licenses for the drug, but AbbVie is allowing use worldwide. The company, moreover, had donated supplies of the drug to China earlier in the year when the outbreak first became apparent.
  • Google is working with health researchers to provide anonymized and aggregated user location data. 
  • Cisco has extended free licenses and expanded usage counts at no extra charge for three of its security technologies to help strained IT teams and partners ready themselves and their clients for remote work.”
  • Microsoft is offering free subscriptions to its Teams product for six months.
  • Zoom expanded its free access and other limitations for educational institutions around the world.

Incentivize innovation, now more than ever

In addition to undermining the short-term incentives to draw more research resources into the fight against COVID-19, using this crisis to weaken the IP regime will cause long-term damage to the economies of the world. We still will need creators making new cultural products and researchers developing new medicines and technologies; weakening the IP regime will undermine the delicate set of incentives that cultural and scientific production depends upon. 

Any clear-eyed assessment of the broader course of the pandemic and the response to it gives lie to the notion that IP rights are oppressive or counterproductive. It is the pharmaceutical industry—hated as they may be in some quarters—that will be able to marshall the resources and expertise to develop treatments and vaccines. And it is artists and educators producing cultural content who (theoretically) depend on the licensing revenues of their creations for survival. 

In fact, one of the things that the pandemic has exposed is the fragility of artists’ livelihoods and the callousness with which they are often treated. Shortly after the lockdowns began in the US, the well-established rock musician David Crosby said in an interview that, if he could not tour this year, he would face tremendous financial hardship. 

As unfortunate as that may be for Crosby, a world-famous musician, imagine how much harder it is for struggling musicians who can hardly hope to achieve a fraction of Crosby’s success for their own tours, let alone for licensing. If David Crosby cannot manage well for a few months on the revenue from his popular catalog, what hope do small artists have?

Indeed, the flood of unable-to-tour artists who are currently offering “donate what you can” streaming performances are a symptom of the destructive assault on IPR exemplified in the letter. For decades, these artists have been told that they can only legitimately make money through touring. Although the potential to actually make a living while touring is possibly out of reach for many or most artists,  those that had been scraping by have now been brought to the brink of ruin as the ability to tour is taken away. 

There are certainly ways the various IP regimes can be improved (like, for instance, figuring out how to help creators make a living from their creations), but now is not the time to implement wishlist changes to an otherwise broadly successful rights regime. 

And, critically, there is a massive difference between achieving wider distribution of intellectual property voluntarily as opposed to through government fiat. When done voluntarily the IP owner determines the contours and extent of “open sourcing” so she can tailor increased access to her own needs (including the need to eat and pay rent). In some cases this may mean providing unlimited, completely free access, but in other cases—where the particular inventor or creator has a different set of needs and priorities—it may be something less than completely open access. When a rightsholder opts to “open source” her property voluntarily, she still retains the right to govern future use (i.e. once the pandemic is over) and is able to plan for reductions in revenue and how to manage future return on investment. 

Our lawmakers can consider if a particular situation arises where a particular piece of property is required for the public good, should the need arise. Otherwise, as responsible individuals, we should restrain ourselves from trying to capitalize on the current crisis to ram through our policy preferences. 

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Geoffrey A. Manne, (President, ICLE; Distinguished Fellow, Northwestern University Center on Law, Business, and Economics); and Dirk Auer, (Senior Fellow of Law & Economics, ICLE)]

Back in 2012, Covidien, a large health care products company and medical device manufacturer, purchased Newport Medical Instruments, a small ventilator developer and manufacturer. (Covidien itself was subsequently purchased by Medtronic in 2015).

Eight years later, in the midst of the coronavirus pandemic, the New York Times has just published an article revisiting the Covidien/Newport transaction, and questioning whether it might have contributed to the current shortage of ventilators.

The article speculates that Covidien’s purchase of Newport, and the subsequent discontinuation of Newport’s “Aura” ventilator — which was then being developed by Newport under a government contract — delayed US government efforts to procure mechanical ventilators until the second half of 2020 — too late to treat the first wave of COVID-19 patients:

And then things suddenly veered off course. A multibillion-dollar maker of medical devices bought the small California company that had been hired to design the new machines. The project ultimately produced zero ventilators.

That failure delayed the development of an affordable ventilator by at least half a decade, depriving hospitals, states and the federal government of the ability to stock up.

* * *

Today, with the coronavirus ravaging America’s health care system, the nation’s emergency-response stockpile is still waiting on its first shipment.

The article has generated considerable interest not so much for what it suggests about government procurement policies or for its relevance to the ventilator shortages associated with the current pandemic, but rather for its purported relevance to ongoing antitrust debates and the arguments put forward by “antitrust populists” and others that merger enforcement in the US is dramatically insufficient. 

Only a single sentence in the article itself points to a possible antitrust story — and it does nothing more than report unsubstantiated speculation from unnamed “government officials” and rival companies: 

Government officials and executives at rival ventilator companies said they suspected that Covidien had acquired Newport to prevent it from building a cheaper product that would undermine Covidien’s profits from its existing ventilator business.

Nevertheless, and right on cue, various antitrust scholars quickly framed the deal as a so-called “killer acquisition” (see also here and here):

Unsurprisingly, politicians were also quick to jump on the bandwagon. David Cicilline, the powerful chairman of the House Antitrust Subcommittee, opined that:

And FTC Commissioner Rebecca Kelly Slaughter quickly called for a retrospective review of the deal:

The public reporting on this acquisition raises important questions about the review of this deal. We should absolutely be looking back to figure out what happened.

These “hot takes” raise a crucial issue. The New York Times story opened the door to a welter of hasty conclusions offered to support the ongoing narrative that antitrust enforcement has failed us — in this case quite literally at the cost of human lives. But are any of these claims actually supportable?

Unfortunately, the competitive realities of the mechanical ventilator industry, as well as a more clear-eyed view of what was likely going on with the failed government contract at the heart of the story, simply do not support the “killer acquisition” story.

What is a “killer acquisition”…?

Let’s take a step back. Because monopoly profits are, by definition, higher than joint duopoly profits (all else equal), economists have long argued that incumbents may find it profitable to acquire smaller rivals in order to reduce competition and increase their profits. More specifically, incumbents may be tempted to acquire would-be entrants in order to prevent them from introducing innovations that might hurt the incumbent’s profits.

For this theory to have any purchase, however, a number of conditions must hold. Most importantly, as Colleen Cunningham, Florian Ederer, and Song Ma put it in an influential paper

“killer acquisitions” can only occur when the entrepreneur’s project overlaps with the acquirer’s existing product…. [W]ithout any product market overlap, the acquirer never has a strictly positive incentive to acquire the entrepreneur… because, without overlap, acquiring the project does not give the acquirer any gains resulting from reduced competition, and the two bargaining entities have exactly the same value for the project.

Moreover, the authors add that:

Successfully developing a new product draws consumer demand and profits away equally from all existing products. An acquiring incumbent is hurt more by such cannibalization when he is a monopolist (i.e., the new product draws demand away only from his own existing product) than when he already faces many other existing competitors (i.e., cannibalization losses are spread over many firms). As a result, as the number of existing competitors increases, the replacement effect decreases and the acquirer’s development decisions become more similar to those of the entrepreneur

Finally, the “killer acquisition” terminology is appropriate only when the incumbent chooses to discontinue its rival’s R&D project:

If incumbents face significant existing competition, acquired projects are not significantly more frequently discontinued than independent projects. Thus, more competition deters incumbents from acquiring and terminating the projects of potential future competitors, which leads to more competition in the future.

…And what isn’t a killer acquisition?

What is left out of this account of killer acquisitions is the age-old possibility that an acquirer purchases a rival precisely because it has superior know-how or a superior governance structure that enables it to realize greater return and more productivity than its target. In the case of a so-called killer acquisition, this means shutting down a negative ROI project and redeploying resources to other projects or other uses — including those that may not have any direct relation to the discontinued project. 

Such “synergistic” mergers are also — like allegedly “killer” mergers — likely to involve acquirers and targets in the same industry and with technological overlap between their R&D projects; it is in precisely these situations that the acquirer is likely to have better knowledge than the target’s shareholders that the target is undervalued because of poor governance rather than exogenous, environmental factors.  

In other words, whether an acquisition is harmful or not — as the epithet “killer” implies it is — depends on whether it is about reducing competition from a rival, on the one hand, or about increasing the acquirer’s competitiveness by putting resources to more productive use, on the other.

As argued below, it is highly unlikely that Covidien’s acquisition of Newport could be classified as a “killer acquisition.” There is thus nothing to suggest that the merger materially impaired competition in the mechanical ventilator market, or that it measurably affected the US’s efforts to fight COVID-19.

The market realities of the ventilator market and its implications for the “killer acquisition” story

1. The mechanical ventilator market is highly competitive

As explained above, “killer acquisitions” are less likely to occur in competitive markets. Yet the mechanical ventilator industry is extremely competitive. 

A number of reports conclude that there is significant competition in the industry. One source cites at least seven large producers. Another report cites eleven large players. And, in the words of another report:

Medical ventilators market competition is intense. 

The conclusion that the mechanical ventilator industry is highly competitive is further supported by the fact that the five largest producers combined reportedly hold only 50% of the market. In other words, available evidence suggests that none of these firms has anything close to a monopoly position. 

This intense competition, along with the small market shares of the merging firms, likely explains why the FTC declined to open an in-depth investigation into Covidien’s acquisition of Newport.

Similarly, following preliminary investigations, neither the FTC nor the European Commission saw the need for an in-depth look at the ventilator market when they reviewed Medtronic’s subsequent acquisition of Covidien (which closed in 2015). Although Medtronic did not produce any mechanical ventilators before the acquisition, authorities (particularly the European Commission) could nevertheless have analyzed that market if Covidien’s presumptive market share was particularly high. The fact that they declined to do so tends to suggest that the ventilator market was relatively unconcentrated.

2. The value of the merger was too small

A second strong reason to believe that Covidien’s purchase of Newport wasn’t a killer acquisition is the acquisition’s value of $103 million

Indeed, if it was clear that Newport was about to revolutionize the ventilator market, then Covidien would likely have been made to pay significantly more than $103 million to acquire it. 

As noted above, the crux of the “killer acquisition” theory is that incumbents can induce welfare-reducing acquisitions by offering to acquire their rivals for significantly more than the present value of their rivals’ expected profits. Because an incumbent undertaking a “killer” takeover expects to earn monopoly profits as a result of the transaction, it can offer a substantial premium and still profit from its investment. It is this basic asymmetry that drives the theory.

Indeed, as a recent article by Kevin Bryan and Erik Hovenkamp notes, an acquisition value out of line with current revenues may be an indicator of the significance of a pending acquisition in which enforcers may not actually know the value of the target’s underlying technology: 

[Where] a court may lack the expertise to [assess the commercial significance of acquired technology]…, the transaction value… may provide a reasonable proxy. Intuitively, if the startup is a relatively small company with relatively few sales to its name, then a very high acquisition price may reasonably suggest that the startup technology has significant promise.

The strategy only works, however, if the target firm’s shareholders agree that share value properly reflects only “normal” expected profits, and not that the target is poised to revolutionize its market with a uniquely low-cost or high-quality product. Relatively low acquisition prices relative to market size, therefore, tend to reflect low (or normal) expected profits, and a low perceived likelihood of radical innovations occurring.

We can apply this reasoning to Covidien’s acquisition of Newport: 

  • Precise and publicly available figures concerning the mechanical ventilator market are hard to come by. Nevertheless, one estimate finds that the global ventilator market was worth $2.715 billion in 2012. Another report suggests that the global market was worth $4.30 billion in 2018; still another that it was worth $4.58 billion in 2019.
  • As noted above, Covidien reported to the SEC that it paid $103 million to purchase Newport (a firm that produced only ventilators and apparently had no plans to branch out). 
  • For context, at the time of the acquisition Covidien had annual sales of $11.8 billion overall, and $743 million in sales of its existing “Airways and Ventilation Products.”

If the ventilator market was indeed worth billions of dollars per year, then the comparatively small $108 million paid by Covidien — small even relative to Covidien’s own share of the market — suggests that, at the time of the acquisition, it was unlikely that Newport was poised to revolutionize the market for mechanical ventilators (for instance, by successfully bringing its Aura ventilator to market). 

The New York Times article claimed that Newport’s ventilators would be sold (at least to the US government) for $3,000 — a substantial discount from the reportedly then-going rate of $10,000. If selling ventilators at this price seemed credible at the time, then Covidien — as well as Newport’s shareholders — knew that Newport was about to achieve tremendous cost savings, enabling it to offer ventilators not only to the the US government, but to purchasers around the world, at an irresistibly attractive — and profitable — price.

Ventilators at the time typically went for about $10,000 each, and getting the price down to $3,000 would be tough. But Newport’s executives bet they would be able to make up for any losses by selling the ventilators around the world.

“It would be very prestigious to be recognized as a supplier to the federal government,” said Richard Crawford, who was Newport’s head of research and development at the time. “We thought the international market would be strong, and there is where Newport would have a good profit on the product.”

If achievable, Newport thus stood to earn a substantial share of the profits in a multi-billion dollar industry. 

Of course, it is necessary to apply a probability to these numbers: Newport’s ventilator was not yet on the market, and had not yet received FDA approval. Nevertheless, if the Times’ numbers seemed credible at the time, then Covidien would surely have had to offer significantly more than $108 million in order to induce Newport’s shareholders to part with their shares.

Given the low valuation, however, as well as the fact that Newport produced other ventilators — and continues to do so to this day, there is no escaping the fact that everyone involved seemed to view Newport’s Aura ventilator as nothing more than a moonshot with, at best, a low likelihood of success. 

Curically, this same reasoning explains why it shouldn’t surprise anyone that the project was ultimately discontinued; recourse to a “killer acquisition” theory is hardly necessary.

3. Lessons from Covidien’s ventilator product decisions  

The killer acquisition claims are further weakened by at least four other important pieces of information: 

  1.  Covidien initially continued to develop Newport’s Aura ventilator, and continued to develop and sell Newport’s other ventilators.
  2. There was little overlap between Covidien and Newport’s ventilators — or, at the very least, they were highly differentiated
  3. Covidien appears to have discontinued production of its own portable ventilator in 2014
  4. The Newport purchase was part of a billion dollar series of acquisitions seemingly aimed at expanding Covidien’s in-hospital (i.e., not-portable) device portfolio

Covidien continued to develop and sell Newport’s ventilators

For a start, while the Aura line was indeed discontinued by Covidien, the timeline is important. The acquisition of Newport by Covidien was announced in March 2012, approved by the FTC in April of the same year, and the deal was closed on May 1, 2012.

However, as the FDA’s 510(k) database makes clear, Newport submitted documents for FDA clearance of the Aura ventilator months after its acquisition by Covidien (June 29, 2012, to be precise). And the Aura received FDA 510(k) clearance on November 9, 2012 — many months after the merger.

It would have made little sense for Covidien to invest significant sums in order to obtain FDA clearance for a project that it planned to discontinue (the FDA routinely requires parties to actively cooperate with it, even after 510(k) applications are submitted). 

Moreover, if Covidien really did plan to discreetly kill off the Aura ventilator, bungling the FDA clearance procedure would have been the perfect cover under which to do so. Yet that is not what it did.

Covidien continued to develop and sell Newport’s other ventilators

Second, and just as importantly, Covidien (and subsequently Medtronic) continued to sell Newport’s other ventilators. The Newport e360 and HT70 are still sold today. Covidien also continued to improve these products: it appears to have introduced an improved version of the Newport HT70 Plus ventilator in 2013.

If eliminating its competitor’s superior ventilators was the only goal of the merger, then why didn’t Covidien also eliminate these two products from its lineup, rather than continue to improve and sell them? 

At least part of the answer, as will be seen below, is that there was almost no overlap between Covidien and Newport’s product lines.

There was little overlap between Covidien’s and Newport’s ventilators

Third — and perhaps the biggest flaw in the killer acquisition story — is that there appears to have been very little overlap between Covidien and Newport’s ventilators. 

This decreases the likelihood that the merger was a killer acquisition. When two products are highly differentiated (or not substitutes at all), sales of the first are less likely to cannibalize sales of the other. As Florian Ederer and his co-authors put it:

Importantly, without any product market overlap, the acquirer never has a strictly positive incentive to acquire the entrepreneur, neither to “Acquire to Kill” nor to “Acquire to Continue.” This is because without overlap, acquiring the project does not give the acquirer any gains resulting from reduced competition, and the two bargaining entities have exactly the same value for the project.

A quick search of the FDA’s 510(k) database reveals that Covidien has three approved lines of ventilators: the Puritan Bennett 980, 840, and 540 (apparently essentially the same as the PB560, the plans to which Medtronic recently made freely available in order to facilitate production during the current crisis). The same database shows that these ventilators differ markedly from Newport’s ventilators (particularly the Aura).

In particular, Covidien manufactured primarily traditional, invasive ICU ventilators (except for the PB540, which is potentially a substitute for the Newport HT70), while Newport made much-more-portable ventilators, suitable for home use (notably the Aura, HT50 and HT70 lines). 

Under normal circumstances, critical care and portable ventilators are not substitutes. As the WHO website explains, portable ventilators are:

[D]esigned to provide support to patients who do not require complex critical care ventilators.

A quick glance at Medtronic’s website neatly illustrates the stark differences between these two types of devices:

This is not to say that these devices do not have similar functionalities, or that they cannot become substitutes in the midst of a coronavirus pandemic. However, in normal times (as was the case when Covidien acquired Newport), hospitals likely did not view these devices as substitutes.

The conclusion that Covidien and Newport’s ventilator were not substitutes finds further support in documents and statements released at the time of the merger. For instance, Covidien’s CEO explained that:

This acquisition is consistent with Covidien’s strategy to expand into adjacencies and invest in product categories where it can develop a global competitive advantage.

And that:

Newport’s products and technology complement our current portfolio of respiratory solutions and will broaden our ventilation platform for patients around the world, particularly in emerging markets.

In short, the fact that almost all of Covidien and Newport’s products were not substitutes further undermines the killer acquisition story. It also tends to vindicate the FTC’s decision to rapidly terminate its investigation of the merger.

Covidien appears to have discontinued production of its own portable ventilator in 2014

Perhaps most tellingly: It appears that Covidien discontinued production of its own competing, portable ventilator, the Puritan Bennett 560, in 2014.

The product is reported on the company’s 2011, 2012 and 2013 annual reports:

Airway and Ventilation Products — airway, ventilator, breathing systems and inhalation therapy products. Key products include: the Puritan Bennett™ 840 line of ventilators; the Puritan Bennett™ 520 and 560 portable ventilator….

(The PB540 was launched in 2009; the updated PB560 in 2010. The PB520 was the EU version of the device, launched in 2011).

But in 2014, the PB560 was no longer listed among the company’s ventilator products:  

Airway & Ventilation, which primarily includes sales of airway, ventilator and inhalation therapy products and breathing systems.

Key airway & ventilation products include: the Puritan Bennett™ 840 and 980 ventilators, the Newport™ e360 and HT70 ventilators….

Nor — despite its March 31 and April 1 “open sourcing” of the specifications and software necessary to enable others to produce the PB560 — did Medtronic appear to have restarted production, and the company did not mention the device in its March 18 press release announcing its own, stepped-up ventilator production plans.

Surely if Covidien had intended to capture the portable ventilator market by killing off its competition it would have continued to actually sell its own, competing device. The fact that the only portable ventilators produced by Covidien by 2014 were those it acquired in the Newport deal strongly suggests that its objective in that deal was the acquisition and deployment of Newport’s viable and profitable technologies — not the abandonment of them. This, in turn, suggests that the Aura was not a viable and profitable technology.

(Admittedly we are unable to determine conclusively that either Covidien or Medtronic stopped producing the PB520/540/560 series of ventilators. But our research seems to indicate strongly that this is indeed the case).

Putting the Newport deal in context

Finally, although not dispositive, it seems important to put the Newport purchase into context. In the same year as it purchased Newport, Covidien paid more than a billion dollars to acquire five other companies, as well — all of them primarily producing in-hospital medical devices. 

That 2012 spending spree came on the heels of a series of previous medical device company acquisitions, apparently totally some four billion dollars. Although not exclusively so, the acquisitions undertaken by Covidien seem to have been primarily targeted at operating room and in-hospital monitoring and treatment — making the putative focus on cornering the portable (home and emergency) ventilator market an extremely unlikely one. 

By the time Covidien was purchased by Medtronic the deal easily cleared antitrust review because of the lack of overlap between the company’s products, with Covidien’s focusing predominantly on in-hospital, “diagnostic, surgical, and critical care” and Medtronic’s on post-acute care.

Newport misjudged the costs associated with its Aura project; Covidien was left to pick up the pieces

So why was the Aura ventilator discontinued?

Although it is almost impossible to know what motivated Covidien’s executives, the Aura ventilator project clearly suffered from many problems. 

The Aura project was intended to meet the requirements of the US government’s BARDA program (under the auspices of the U.S. Department of Health and Human Services’ Biomedical Advanced Research and Development Authority). In short, the program sought to create a stockpile of next generation ventilators for emergency situations — including, notably, pandemics. The ventilator would thus have to be designed for events where

mass casualties may be expected, and when shortages of experienced health care providers with respiratory support training, and shortages of ventilators and accessory components may be expected.

The Aura ventilator would thus sit somewhere between Newport’s two other ventilators: the e360 which could be used in pediatric care (for newborns smaller than 5kg) but was not intended for home care use (or the extreme scenarios envisioned by the US government); and the more portable HT70 which could be used in home care environments, but not for newborns. 

Unfortunately, the Aura failed to achieve this goal. The FDA’s 510(k) clearance decision clearly states that the Aura was not intended for newborns:

The AURA family of ventilators is applicable for infant, pediatric and adult patients greater than or equal to 5 kg (11 lbs.).

A press release issued by Medtronic confirms that

the company was unable to secure FDA approval for use in neonatal populations — a contract requirement.

And the US Government RFP confirms that this was indeed an important requirement:

The device must be able to provide the same standard of performance as current FDA pre-market cleared portable ventilators and shall have the following additional characteristics or features: 

Flexibility to accommodate a wide patient population range from neonate to adult.

Newport also seems to have been unable to deliver the ventilator at the low price it had initially forecasted — a common problem for small companies and/or companies that undertake large R&D programs. It also struggled to complete the project within the agreed-upon deadlines. As the Medtronic press release explains:

Covidien learned that Newport’s work on the ventilator design for the Government had significant gaps between what it had promised the Government and what it could deliverboth in terms of being able to achieve the cost of production specified in the contract and product features and performance. Covidien management questioned whether Newport’s ability to complete the project as agreed to in the contract was realistic.

As Jason Crawford, an engineer and tech industry commentator, put it:

Projects fail all the time. “Supplier risk” should be a standard checkbox on anyone’s contingency planning efforts. This is even more so when you deliberately push the price down to 30% of the market rate. Newport did not even necessarily expect to be profitable on the contract.

The above is mostly Covidien’s “side” of the story, of course. But other pieces of evidence lend some credibility to these claims:

  • Newport agreed to deliver its Aura ventilator at a per unit cost of less than $3000. But, even today, this seems extremely ambitious. For instance, the WHO has estimated that portable ventilators cost between $3,300 and $13,500. If Newport could profitably sell the Aura at such a low price, then there was little reason to discontinue it (readers will recall the development of the ventilator was mostly complete when Covidien put a halt to the project).
  • Covidien/Newport is not the only firm to have struggled to offer suitable ventilators at such a low price. Philips (which took Newport’s place after the government contract fell through) also failed to achieve this low price. Rather than the $2,000 price sought in the initial RFP, Philips ultimately agreed to produce the ventilators for $3,280. But it has not yet been able to produce a single ventilator under the government contract at that price.
  • Covidien has repeatedly been forced to recall some of its other ventilators ( here, here and here) — including the Newport HT70. And rival manufacturers have also faced these types of issues (for example, here and here). 

Accordingly, Covidien may well have preferred to cut its losses on the already problem-prone Aura project, before similar issues rendered it even more costly. 

In short, while it is impossible to prove that these development issues caused Covidien to pull the plug on the Aura project, it is certainly plausible that they did. This further supports the hypothesis that Covidien’s acquisition of Newport was not a killer acquisition. 

Ending the Aura project might have been an efficient outcome

As suggested above, moreover, it is entirely possible that Covidien was better able to realize the poor prospects of Newport’s Aura project and also better organized to enable it to make the requisite decision to abandon the project.

A small company like Newport faces greater difficulties abandoning entrepreneurial projects because doing so can impair a privately held firm’s ability to raise funds for subsequent projects.

Moreover, the relatively large share of revue and reputation that Newport — worth $103 million in 2012, versus Covidien’s $11.8 billion — would have realized from fulfilling a substantial US government project could well have induced it to overestimate the project’s viability and to undertake excessive risk in the (vain) hope of bringing the project to fruition.  

While there is a tendency among antitrust scholars, enforcers, and practitioners to look for (and find…) antitrust-related rationales for mergers and other corporate conduct, it remains the case that most corporate control transactions (such as mergers) are driven by the acquiring firm’s expectation that it can manage more efficiently. As Henry G. Manne put it in his seminal article, Mergers and the Market for Corporate Control (1965): 

Since, in a world of uncertainty, profitable transactions will be entered into more often by those whose information is relatively more reliable, it should not surprise us that mergers within the same industry have been a principal form of changing corporate control. Reliable information is often available to suppliers and customers as well. Thus many vertical mergers may be of the control takeover variety rather than of the “foreclosure of competitors” or scale-economies type.

Of course, the same information that renders an acquiring firm in the same line of business knowledgeable enough to operate a target more efficiently could also enable it to effect a “killer acquisition” strategy. But the important point is that a takeover by a firm with a competing product line, after which the purchased company’s product line is abandoned, is at least as consistent with a “market for corporate control” story as with a “killer acquisition” story.

Indeed, as Florian Ederer himself noted with respect to the Covidien/Newport merger, 

“Killer acquisitions” can have a nefarious image, but killing off a rival’s product was probably not the main purpose of the transaction, Ederer said. He raised the possibility that Covidien decided to kill Newport’s innovation upon realising that the development of the devices would be expensive and unlikely to result in profits.

Concluding remarks

In conclusion, Covidien’s acquisition of Newport offers a cautionary tale about reckless journalism, “blackboard economics,” and government failure.

Reckless journalism because the New York Times clearly failed to do the appropriate due diligence for its story. Its journalists notably missed (or deliberately failed to mention) a number of critical pieces of information — such as the hugely important fact that most of Covidien’s and Newport’s products did not overlap, or the fact that there were numerous competitors in the highly competitive mechanical ventilator industry. 

And yet, that did not stop the authors from publishing their extremely alarming story, effectively suggesting that a small medical device merger materially contributed to the loss of many American lives.

The story also falls prey to what Ronald Coase called “blackboard economics”:

What is studied is a system which lives in the minds of economists but not on earth. 

Numerous commentators rushed to fit the story to their preconceived narratives, failing to undertake even a rudimentary examination of the underlying market conditions before they voiced their recriminations. 

The only thing that Covidien and Newport’s merger ostensibly had in common with the killer acquisition theory was the fact that a large firm purchased a small rival, and that the one of the small firm’s products was discontinued. But this does not even begin to meet the stringent conditions that must be fulfilled for the theory to hold water. Unfortunately, critics appear to have completely ignored all contradicting evidence. 

Finally, what the New York Times piece does offer is a chilling tale of government failure.

The inception of the US government’s BARDA program dates back to 2008 — twelve years before the COVID-19 pandemic hit the US. 

The collapse of the Aura project is no excuse for the fact that, more than six years after the Newport contract fell through, the US government still has not obtained the necessary ventilators. Questions should also be raised about the government’s decision to effectively put all of its eggs in the same basket — twice. If anything, it is thus government failure that was the real culprit. 

And yet the New York Times piece and the critics shouting “killer acquisition!” effectively give the US government’s abject failure here a free pass — all in the service of pursuing their preferred “killer story.”

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Daniel Takash,(Regulatory policy fellow at the Niskanen Center. He is the manager of Niskanen’s Captured Economy Project, https://capturedeconomy.com, and you can follow him @danieltakash or @capturedecon).]

The pharmaceutical industry should be one of the most well-regarded industries in America. It helps bring drugs to market that improve, and often save, people’s lives. Yet last year a Gallup poll found that of 25 major industries, the pharmaceutical industry was the most unpopular– trailing behind fossil fuels, lawyers, and even the federal government. The opioid crisis dominated the headlines for the past few years, but the high price of drugs is a top-of-mind issue that generates significant animosity toward the pharmaceutical industry. The effects of high drug prices are felt not just at every trip to the pharmacy, but also by those who are priced out of life-saving treatments. Many Americans simply can’t afford what their doctors prescribe. The pharmaceutical industry helps save lives, but it’s also been credibly accused of anticompetitive behavior–not just from generics, but even other brand manufacturers.

These extraordinary times are an opportunity to right the ship. AbbVie, roundly criticized for building a patent thicket around Humira, has donated its patent rights to a promising COVID-19 treatment. This is to be celebrated– yet pharma’s bad reputation is defined by its worst behaviors and the frequent apologetics for overusing the patent system. Hopefully corporate social responsibility will prevail, and such abuses will cease in the future.

The most effective long-term treatment for COVID-19 will be a vaccine. We also need drugs to treat those afflicted with COVID-19 to improve recovery and lower mortality rates for those that get sick before a vaccine is developed and widely available. This requires rapid drug development through effective public-private partnerships to bring these treatments to market.

Without a doubt, these solutions will come from the pharmaceutical industry. Increased funding for the National Institutes for Health, nonprofit research institutions, and private pharmaceutical researchers are likely needed to help accelerate the development of these treatments. But we must be careful to ensure whatever necessary upfront public support is given to these entities results in a fair trade-off for Americans. The U.S. taxpayer is one of the largest investors in early to mid-stage drug research, and we need to make sure that we are a good investor.

Basic research into the costs of drug development, especially when taxpayer subsidies are involved, is a necessary start. This is a feature of the We PAID Act, introduced by Senators Rick Scott (R-FL) and Chris Van Hollen (D-MD), which requires the Department of Health and Human Services to enter into a contract with the National Academy of Medicine to figure the reasonable price of drugs developed with taxpayer support. This reasonable price would include a suitable reward to the private companies that did the important work of finishing drug development and gaining FDA approval. This is important, as setting a price too low would reduce investments in indispensable research and development. But this must be balanced with the risk of using patents to charge prices above and beyond those necessary to finance research, development, and commercialization.

A little sunshine can go a long way. We should trust that pharmaceutical companies will develop a vaccine and treatments or coronavirus, but we must also verify these are affordable and accessible through public scrutiny. Take the drug manufacturer Gilead Science’s about-face on its application for orphan drug status on the possible COVID-19 treatment remdesivir. Remedesivir, developed in part with public funds and already covered by three Gilead patents, technically satisfied the definition of “orphan drug,” as COVID-19 (at the time of the application) afflicted fewer than 200,000 patents. In a pandemic that could infect tens of millions of Americans, this designation is obviously absurd, and public outcry led to Gilead to ask the FDA to rescind the application. Gilead claimed it sought the designation to speed up FDA review, and that might be true. Regardless, public attention meant that the FDA will give Gilead’s drug Remdesivir expedited review without Gilead needing a designation that looks unfair to the American people.

The success of this isolated effort is absolutely worth celebrating. But we need more research to better comprehend the pharmaceutical industry’s needs, and this is just what the study provisions of We PAID would provide.

There is indeed some existing research on this front. For example,the Pharmaceutical Researchers and Manufacturers of America (PhRMA) estimates it costs an average of $2.6 billion to bring a new drug to market, and research from the Journal of the American Medical Association finds this average to be closer to $1.3 billion, with the median cost of development to be $985 million.

But a thorough analysis provided under We PAID is the best way for us to fully understand just how much support the pharmaceutical industry needs, and just how successful it has been thus far. The NIH, one of the major sources of publicly funded research, invests about $41.7 billion annually in medical research. We need to better understand how these efforts link up, and how the torch is passed from public to private efforts.

Patents are essential to the functioning of the pharmaceutical industry by incentivizing drug development through temporary periods of exclusivity. But it is equally essential, in light of the considerable investment already made by taxpayers in drug research and development, to make sure we understand the effects of these incentives and calibrate them to balance the interests of patients and pharmaceutical companies. Most drugs require research funding from both public and private sources as well as patent protection. And the U.S. is one of the biggest investors of drug research worldwide (even compared to drug companies), yet Americans pay the highest prices in the world. Are these prices justified, and can we improve patent policy to bring these costs down without harming innovation?

Beyond a thorough analysis of drug pricing, what makes We PAID one of the most promising solutions to the problem of excessively high drug prices are the accountability mechanisms included. The bill, if made law, would establish a Drug Access and Affordability Committee. The Committee would use the methodology from the joint HHS and NAM study to determine a reasonable price for affected drugs (around 20 percent of drugs currently on the market, if the bill were law today). Any companies that price drugs granted exclusivity by a patent above the reasonable price would lose their exclusivity.

This may seem like a price control at first blush, but it isn’t–for two reasons. First, this only applies to drugs developed with taxpayer dollars, which any COVID-19 treatments or cures almost certainly would be considering the $785 million spent by the NIH since 2002 researching coronaviruses. It’s an accountability mechanism that would ensure the government is getting its money’s worth. This tool is akin to ensuring that a government contractor is not charging more than would be reasonable, lest it loses its contract.

Second, it is even less stringent than pulling a contract with a private firm overcharging the government for the services provided. Why? Losing a patent does not mean losing the ability to make a drug, or any other patented invention for that matter.This basic fact is often lost in the patent debate, but it cannot be stressed enough.

If patents functioned as licenses, then every patent expiration would mean another product going off the market. In reality, that means that any other firm can compete and use the patented design. Even if a firm violated the price regulations included in the bill and lost its patent, it could continue manufacturing the drug. And so could any other firm, bringing down prices for all consumers by opening up market competition.

The We PAID Act could be a dramatic change for the drug industry, and because of that many in Congress may want to first debate the particulars of the bill. This is fine, assuming  this promising legislation isn’t watered down beyond recognition. But any objections to the Drug Affordability and Access Committee and reasonable pricing regulations aren’t an excuse to not, at a bare minimum, pass the study included in the bill as part of future coronavirus packages, if not sooner. It is an inexpensive way to get good information in a single, reputable source that would allow us to shape good policy.

Good information is needed for good policy. When the government lays the groundwork for future innovations by financing research and development, it can be compared to a venture capitalist providing the financing necessary for an innovative product or service. But just like in the private sector, the government should know what it’s getting for its (read: taxpayers’) money and make recipients of such funding accountable to investors.

The COVID-19 outbreak will be the most pressing issue for the foreseeable future, but determining how pharmaceuticals developed with public research are priced is necessary in good times and bad. The final prices for these important drugs might be fair, but the public will never know without a trusted source examining this information. Trust, but verify. The pharmaceutical industry’s efforts in fighting the COVID-19 pandemic might be the first step to improving Americans’ relationship with the industry. But we need good information to make that happen. Americans need to know when they are being treated fairly, and that policymakers are able to protect them when they are treated unfairly. The government needs to become a better-informed investor, and that won’t happen without something like the We PAID Act.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Jacob Grier, (Freelance writer and spirits consultant in Portland, Oregon, and the author of The Rediscovery of Tobacco: Smoking, Vaping, and the Creative Destruction of the Cigarette).]

The COVID-19 pandemic and the shutdown of many public-facing businesses has resulted in many sudden shifts in demand for common goods. The demand for hand sanitizer has drastically increased for hospitals, businesses, and individuals. At the same time, demand for distilled spirits has fallen substantially, as the closure of bars, restaurants, and tasting rooms has cut craft distillers off from their primary buyers. Since ethanol is a key ingredient in both spirits and sanitizer, this situation presents an obvious opportunity for distillers to shift their production from the former to the latter. Hundreds of distilleries have made this transition, but it has not without obstacles. Some of these reflect a real scarcity of needed supplies, but other constraints have been externally imposed by government regulations and the tax code.

Producing sanitizer

The World Health Organization provides guidelines and recipes for locally producing hand sanitizer. The relevant formulation for distilleries calls for only four ingredients: high-proof ethanol (96%), hydrogen peroxide (3%), glycerol (98%), and sterile distilled or boiled water. Distilleries are well-positioned to produce or obtain ethanol and water. Glycerol is used in only small amounts and does not currently appear to be a substantial constraint on production. Hydrogen peroxide is harder to come by, but distilleries are adapting and cooperating to ensure supply. Skip Tognetti, owner of Letterpress Distilling in Seattle, Washington, reports that one local distiller obtained a drum of 34% hydrogen peroxide, which stretches a long way when diluted to a concentration of 3%. Local distillers have been sharing this drum so that they can all produce sanitizer.

Another constraint is finding containers in which to the put the finished product. Not all containers are suitable for holding high-proof alcoholic solutions, and supplies of those that are recommended for sanitizer are scarce. The fact that many of these bottles are produced in China has reportedly also limited the supply. Distillers are therefore having to get creative; Tognetti reports looking into shampoo bottles, and in Chicago distillers have re-purposed glass beer growlers. For informal channels, some distillers have allowed consumers to bring their own containers to fill with sanitizer for personal use. Food and Drug Administration labeling requirements have also prevented the use of travel-size bottles, since the bottles are too small to display the necessary information.

The raw materials for producing ethanol are also coming from some unexpected sources. Breweries are typically unable to produce alcohol at high enough proof for sanitizer, but multiple breweries in Chicago are donating beer that distilleries can bring up to the required purity. Beer giant Anheuser-Busch is also producing sanitizer with the ethanol removed from its alcohol-free beers.

In many cases, the sanitizer is donated or sold at low-cost to hospitals and other essential services, or to local consumers. Online donations have helped to fund some of these efforts, and at least one food and beverage testing lab has stepped up to offer free testing to breweries and distilleries producing sanitizer to ensure compliance with WHO guidelines. Distillers report that the regulatory landscape has been somewhat confusing in recent weeks, and posts in a Facebook group have provided advice for how to get through the FDA’s registration process. In general, distillers going through the process report that agencies have been responsive. Tom Burkleaux of New Deal Distilling in Portland, Oregon says he “had to do some mighty paperwork,” but that the FDA and the Oregon Board of Pharmacy were both quick to process applications, with responses coming in just a few hours or less.

In general, the redirection of craft distilleries to producing hand sanitizer is an example of private businesses responding to market signals and the evident challenges of the health crisis to produce much-needed goods; in some cases, sanitizer represents one of their only sources of revenue during the shutdown, providing a lifeline for small businesses. The Distilled Spirits Council currently lists nearly 600 distilleries making sanitizer in the United States.

There is one significant obstacle that has hindered the production of sanitizer, however: an FDA requirement that distilleries obtain extra ingredients to denature their alcohol.

Denaturing sanitizer

According to the WHO, the four ingredients mentioned above are all that are needed to make sanitizer. In fact, WHO specifically notes that it in most circumstances it is inadvisable to add anything else: “it is not recommended to add any bittering agents to reduce the risk of ingestion of the handrubs” except in cases where there is a high probably of accidental ingestion. Further, “[…] there is no published information on the compatibility and deterrent potential of such chemicals when used in alcohol-based handrubs to discourage their abuse. It is important to note that such additives may make the products toxic and add to production costs.”

Denaturing agents are used to render alcohol either too bitter or too toxic to consume, deterring abuse by adults or accidental ingestion by children. In ordinary circumstances, there are valid reasons to denature sanitizer. In the current pandemic, however, the denaturing requirement is a significant bottleneck in production.

The federal Tax and Trade Bureau is the primary agency regulating alcohol production in the United States. The TTB took action early to encourage distilleries to produce sanitizer, officially releasing guidance on March 18 instructing them that they are free to commence production without prior authorization or formula approval, so long as they are making sanitizer in accordance with WHO guidelines. On March 23, the FDA issued its own emergency authorization of hand sanitizer production; unlike the WHO, FDA guidance does require the use of denaturants. As a result, on March 26 the TTB issued new guidance to be consistent with the FDA.

Under current rules, only sanitizer made with denatured alcohol is exempt from the federal excise tax on beverage alcohol. Federal excise taxes begin at $2.70 per gallon for low-volume distilleries and reach up to $13.50 per gallon, significantly increasing the cost of producing hand sanitizer; state excise taxes can raise these costs even higher.

More importantly, denaturing agents are scarce. In a Twitter thread on March 25, Tognetti noted the difficulty of obtaining them:

To be clear, if I didn’t have to track down denaturing agents (there are several, but isopropyl alcohol is the most common), I could turn out 200 gallons of finished hand sanitizer TODAY.

(As an additional concern, the Distilled Spirits Council notes that the extremely bitter or toxic nature of denaturing agents may impose additional costs on distillers given the need to thoroughly cleanse them from their equipment.)

Congress attempted to address these concerns in the CARES Act, the coronavirus relief package. Section 2308 explicitly waives the federal excise tax on distilled spirits used for the production of sanitizer, however it leaves the formula specification in the hands of the FDA. Unless the agency revises its guidance, production in the US will be constrained by the requirement to add denaturing agents to the plentiful supply of ethanol, or distilleries will risk being targeted with enforcement actions if they produce perfectly usable sanitizer without denaturing their alcohol.

Local distilleries provide agile production capacity

In recent days, larger spirits producers including Pernod-Ricard, Diageo, and Bacardi have announced plans to produce sanitizer. Given their resources and economies of scale, they may end up taking over a significant part of the market. Yet small, local distilleries have displayed the agility necessary to rapidly shift production. It’s worth noting that many of these distilleries did not exist until fairly recently. According to the American Craft Spirits Association, there were fewer than 100 craft distilleries operating in the United States in 2005. By 2018, there were more than 1,800. This growth is the result of changing consumer interests, but also the liberalization of state and local laws to permit distilleries and tasting rooms. That many of these distilleries have the capacity to produce sanitizer in a time of emergency is a welcome, if unintended, consequence of this liberalization.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Tim Brennan, (Professor, Economics & Public Policy, University of Maryland; former FCC; former FTC).]

Thinking about how to think about the coronavirus situation I keep coming back to three economic ideas that seem distinct but end up being related. First, a back of the envelope calculation suggests shutting down the economy for a while to reduce the spread of Covid-19. This leads to my second point, that political viability, if not simple fairness, dictates that the winners compensate the losers. The extent of both of these forces my main point, to understand why we can’t just “get the prices right” and let the market take care of it. Insisting that the market works in this situation could undercut the very strong arguments for why we should defer to markets in the vast majority of circumstances.

Is taking action worth it?

The first question is whether shutting down the economy to reduce the spread of Covid-19 is a good bet. Being an economist, I turn to benefit-cost analysis (BCA). All I can offer here is a back-of-the-envelope calculation, which may be an insult to envelopes. (This paper has a more serious calculation with qualitatively similar findings.) With all caveats recognized, the willingness to pay of an average person in the US to social distancing and closure policies, WTP, is

        WTP = X% times Y% times VSL,

where X% is the fraction of the population that might be seriously affected, Y% is the reduction in the likelihood of death for this population from these policies, and VSL is the “value of statistical life” used in BCA calculations, in the ballpark of $9.5M.

For X%, take the percentage of the population over 65 (a demographic including me). This is around 16%. I’m not an epidemiologist, so for Y%, the reduced likelihood of death (either from reduced transmission or reduced hospital overload), I can only speculate. Say it’s 1%, which naively seems pretty small. Even with that, the average willingness to pay would be

        WTP = 16% times 1% times $9.5M = $15,200.

Multiply that by a US population of roughly 330M gives a total national WTP of just over $5 trillion, or about 23% of GDP. Using conventional measures, this looks like a good trade in an aggregate benefit-cost sense, even leaving out willingness to pay to reduce the likelihood of feeling sick and the benefits to those younger than 65. Of course, among the caveats is not just whether to impose distancing and closures, but how long to have them (number of weeks), how severe they should be (gathering size limits, coverage of commercial establishments), and where they should be imposed (closing schools, colleges).  

Actual, not just hypothetical, compensation

The justification for using BCA is that the winners could compensate the losers. In the coronavirus setting, the equity considerations are profound. Especially when I remember that GDP is not a measure of consumer surplus, I ask myself how many months of the disruption (and not just lost wages) from unemployment should low-income waiters, cab drivers, hotel cleaners, and the like bear to reduce my over-65 likelihood of dying. 

Consequently, an important component of this policy to respect equity and quite possibly obtaining public acceptance is that the losers be compensated. In that respect, the justification for packages such as the proposal working (as I write) through Congress is not stimulus—after all, it’s  harder to spend money these days—as much as compensating those who’ve lost jobs as a result of this policy. Stimulus can come when the economy is ready to be jump-started.

Markets don’t always work, perhaps like now 

This brings me to a final point—why is this a public policy matter? My answer to almost any policy question is the glib “just get the prices right and the market will take care of it.” That doesn’t seem all that popular now. Part of that is the politics of fairness: Should the wealthy get the ventilators? Should hoarding of hand sanitizer be rewarded? But much of it may be a useful reminder that markets do not work seamlessly and instantaneously, and may not be the best allocation mechanism in critical times.

That markets are not always best should be a familiar theme to TOTM readers. The cost of using markets is the centerpiece for Ronald Coase’s 1937 Nature of the Firm and 1960 Problem of Social Cost justification for allocation through the courts. Many of us, including me on TOTM, have invoked these arguments to argue against public interventions in the structure of firms, particularly antitrust actions regarding vertical integration. Another common theme is that the common law tends toward efficiency because of the market-like evolutionary processes in property, tort, and contract case law.

This perspective is a useful reminder that the benefits of markets should always be “compared to what?” In one familiar case, the benefits of markets are clear when compared to the snail’s pace, limited information, and political manipulability of administrative price setting. But when one is talking about national emergencies and the inelastic demands, distributional consequences, and the lack of time for the price mechanism to work its wonders, one can understand and justify the use of the plethora of mandates currently imposed or contemplated. 

The common law also appears not to be a good alternative. One can imagine the litigation nightmare if everyone who got the virus attempted to identify and sue some defendant for damages. A similar nightmare awaits if courts were tasked with determning how the risk of a pandemic would have been allocated were contracts ideal.

Much of this may be belaboring the obvious. My concern is that if those of us who appreciate the virtues of markets exaggerate their applicability, those skeptical of markets may use this episode to say that markets inherently fail and more of the economy should be publicly administered. Better to rely on facts rather than ideology, and to regard the current situation as the awful but justifiable exception that proves the general rule.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Ramsi Woodcock, (Assistant Professor of Law, University of Kentucky; Assistant Professor of Management, Gatton College of Business and Economics).]

Specialists know that the antitrust courses taught in law schools and economics departments have an alter ego in business curricula: the course on business strategy. The two courses cover the same material, but from opposite perspectives. Antitrust courses teach how to end monopolies; strategy courses teach how to construct and maintain them.

Strategy students go off and run businesses, and antitrust students go off and make government policy. That is probably the proper arrangement if the policy the antimonopolists make is domestic. We want the domestic economy to run efficiently, and so we want domestic policymakers to think about monopoly—and its allocative inefficiencies—as something to be discouraged.

The coronavirus, and the shortages it has caused, have shown us that putting the antimonopolists in charge of international policy is, by contrast, a very big mistake.

Because we do not yet have a world government. America’s position, in relation to the rest of the world, is therefore more akin to that of a business navigating a free market than it is to a government seeking to promote efficient interactions among the firms that it governs. To flourish, America must engage in international trade with a view to creating and maintaining monopoly positions for itself, rather than eschewing them in the interest of realizing efficiencies in the global economy. Which is to say: we need strategists, not antimonopolists.

For the global economy is not America, and there is no guarantee that competitive efficiencies will redound to America’s benefit, rather than to those of her competitors. Absent a world government, other countries will pursue monopoly regardless what America does, and unless America acts strategically to build and maintain economic power, America will eventually occupy a position of commercial weakness, with all of the consequences for national security that implies.

When Antimonopolists Make Trade Policy

The free traders who have run American economic policy for more than a generation are antimonopolists playing on a bigger stage. Like their counterparts in domestic policy, they are loyal in the first instance only to the efficiency of the market, not to any particular trader. They are content to establish rules of competitive trading—the antitrust laws in the domestic context, the World Trade Organization in the international context—and then to let the chips fall where they may, even if that means allowing present or future adversaries to, through legitimate means, build up competitive advantages that the United States is unable to overcome.

Strategy is consistent with competition when markets are filled with traders of atomic size, for then no amount of strategy can deliver a competitive advantage to any trader. But global markets, more even than domestic markets, are filled with traders of macroscopic size. Strategy then requires that each trader seek to gain and maintain advantages, undermining competition. The only way antimonopolists could induce the trading behemoth that is America to behave competitively, and to let the chips fall where they may, was to convince America voluntarily to give up strategy, to sacrifice self-interest on the altar of efficient markets.

And so they did.

Thus when the question arose whether to permit American corporations to move their manufacturing operations overseas, or to permit foreign companies to leverage their efficiencies to dominate a domestic industry and ensure that 90% of domestic supply would be imported from overseas, the answer the antimonopolists gave was: “yes.” Because it is efficient. Labor abroad is cheaper than labor at home, and transportation costs low, so efficiency requires that production move overseas, and our own resources be reallocated to more competitive uses.

This is the impeccable logic of static efficiency, of general equilibrium models allocating resources optimally. But it is instructive to recall that the men who perfected this model were not trying to describe a free market, much less international trade. They were trying to create a model that a central planner could use to allocate resources to a state’s subjects. What mattered to them in building the model was the good of the whole, not any particular part. And yet it is to a particular part of the global whole that the United States government is dedicated.

The Strategic Trader

Students of strategy would have taken a very different approach to international trade. Strategy teaches that markets are dynamic, and that businesses must make decisions based not only on the market signals that exist today, but on those that can be made to exist in the future. For the successful strategist, unlike the antimonopolist, identifying a product for which consumers are willing to pay the costs of production is not alone enough to justify bringing the product to market. The strategist must be able to secure a source of supply, or a distribution channel, that competitors cannot easily duplicate, before the strategist will enter.

Why? Because without an advantage in supply, or distribution, competitors will duplicate the product, compete away any markups, and leave the strategist no better off than if he had never undertaken the project at all. Indeed, he may be left bankrupt, if he has sunk costs that competition prevents him from recovering. Unlike the economist, the strategist is interested in survival, because he is a partisan of a part of the market—himself—not the market entire. The strategist understands that survival requires power, and all power rests, to a greater or lesser degree, on monopoly.

The strategist is not therefore a free trader in the international arena, at least not as a matter of principle. The strategist understands that trading from a position of strength can enrich, and trading from a position of weakness can impoverish. And to occupy that position of strength, America must, like any monopolist, control supply. Moreover, in the constantly-innovating markets that characterize industrial economies, markets in which innovation emerges from learning by doing, control over physical supply translates into control over the supply of inventions itself.

The strategist does not permit domestic corporations to offshore manufacturing in any market in which the strategist wishes to participate, because that is unsafe: foreign countries could use control over that supply to extract rents from America, to drive domestic firms to bankruptcy, and to gain control over the supply of inventions.

And, as the new trade theorists belatedly discovered, offshoring prevents the development of the dense, geographically-contiguous, supply networks that confer power over whole product categories, such as the electronics hub in Zhengzhou, where iPhone-maker Foxconn is located.

Or the pharmaceutical hub in Hubei.

Coronavirus and the Failure of Free Trade

Today, America is unprepared for the coming wave of coronavirus cases because the antimonopolists running our trade policy do not understand the importance of controlling supply. There is a shortage of masks, because China makes half of the world’s masks, and the Chinese have cut off supply, the state having forbidden even non-Chinese companies that offshored mask production from shipping home masks for which American customers have paid. Not only that, but in January China bought up most of the world’s existing supply of masks, with free-trade-obsessed governments standing idly by as the clock ticked down to their own domestic outbreaks.  

New York State, which lies at the epicenter of the crisis, has agreed to pay five times the market price for foreign supply. That’s not because the cost of making masks has risen, but because sellers are rationing with price. Which is to say: using their control over supply to beggar the state. Moreover, domestic mask makers report that they cannot ramp up production because of a lack of supply of raw materials, some of which are actually made in Wuhan, China. That’s the kind of problem that does not arise when restrictions on offshoring allow manufacturing hubs to develop domestically.

But a shortage of masks is just the beginning. Once a vaccine is developed, the race will be on to manufacture it, and America controls less than 30% of the manufacturing facilities that supply pharmaceuticals to American markets. Indeed, just about the only virus-relevant industries in which we do not have a real capacity shortage today are food and toilet paper, panic buying notwithstanding. Because fortunately for us antimonopolists could not find a way to offshore California and Oregon. If they could have, they surely would have, since both agriculture and timber are labor-intensive industries.

President Trump’s failed attempt to buy a German drug company working on a coronavirus vaccine shows just how damaging free market ideology has been to national security: as Trump should have anticipated given his resistance to the antimonopolists’ approach to trade, the German government nipped the deal in the bud. When an economic agent has market power, the agent can pick its prices, or refuse to sell at all. Only in general equilibrium fantasy is everything for sale, and at a competitive price to boot.

The trouble is: American policymakers, perhaps more than those in any other part of the world, continue to act as though that fantasy were real.

Failures Left and Right

America’s coronavirus predicament is rich with intellectual irony.

Progressives resist free trade ideology, largely out of concern for the effects of trade on American workers. But they seem not to have realized that in doing so they are actually embracing strategy, at least for the benefit of labor.

As a result, progressives simultaneously reject the approach to industrial organization economics that underpins strategic thinking in business: Joseph Schumpeter’s theory of creative destruction, which holds that strategic behavior by firms seeking to achieve and maintain monopolies is ultimately good for society, because it leads to a technological arms race as firms strive to improve supply, distribution, and indeed product quality, in ways that competitors cannot reproduce.

Even if progressives choose to reject Schumpeter’s argument that strategy makes society better off—a proposition that is particularly suspect at the international level, where the availability of tanks ensures that the creative destruction is not always creative—they have much to learn from his focus on the economics of survival.

By the same token, conservatives embrace Schumpeter in arguing for less antitrust enforcement in domestic markets, all the while advocating free trade at the international level and savaging governments for using dumping and tariffs—which is to say, the tools of monopoly—to strengthen their trading positions. It is deeply peculiar to watch the coronavirus expose conservative economists as pie-in-the-sky internationalists. And yet as the global market for coronavirus necessities seizes up, the ideology that urged us to dispense with producing these goods ourselves, out of faith that we might always somehow rely on the support of the rest of the world, provided through the medium of markets, looks pathetically naive.

The cynic might say that inconsistency has snuck up on both progressives and conservatives because each remains too sympathetic to a different domestic constituency.

Dodging a Bullet

America is lucky that a mere virus exposed the bankruptcy of free trade ideology. Because war could have done that instead. It is difficult to imagine how a country that cannot make medical masks—much less a Macbook—would be able to respond effectively to a sustained military attack from one of the many nations that are closing the technological gap long enjoyed by the United States.

The lesson of the coronavirus is: strategy, not antitrust.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Geoffrey A. Manne, (President, ICLE; Distinguished Fellow, Northwestern University Center on Law, Business, and Economics).]

There has been much (admittedly important) discussion of the economic woes of mass quarantine to thwart the spread and “flatten the curve” of the virus and its health burdens — as well as some extremely interesting discussion of the long-term health woes of quarantine and the resulting economic downturn: see, e.g., previous work by Christopher Ruhm suggesting mortality rates may improve during economic downturns, and this thread on how that might play out differently in the current health crisis.

But there is perhaps insufficient attention being paid to the more immediate problem of medical resource scarcity to treat large, localized populations of acutely sick people — something that will remain a problem for some time in places like New York, no matter how successful we are at flattening the curve. 

Yet the fact that we may have failed to prepare adequately for the current emergency does not mean that we can’t improve our ability to respond to the current emergency and build up our ability to respond to subsequent emergencies — both in terms of future, localized outbreaks of COVID-19, as well as for other medical emergencies more broadly.

In what follows I lay out the outlines of a proposal for an OPTN (Organ Procurement and Transplantation Network) analogue for allocating emergency medical resources. In order to make the idea more concrete (and because no doubt there is a limit to the types of medical resources for which such a program would be useful or necessary), let’s call it the VPAN — Ventilator Procurement and Allocation Network.

As quickly as possible in order to address the current crisis — and definitely with enough speed to address the next crisis — we should develop a program to collect relevant data and enable deployment of medical resources where they are most needed, using such data, wherever possible, to enable deployment before shortages become the enormous problem they are today

Data and information are important tools for mitigating emergencies

Hal’s post, especially in combination with Julian’s, offers a really useful suggestion for using modern information technology to help mitigate one of the biggest problems of the current crisis: The ability to return to economic activity (and a semblance of normalcy) as quickly as possible.

What I like most about his idea (and, again, Julian’s) is its incremental approach: We don’t have to wait until it’s safe for everyone to come outside in order for some people to do so. And, properly collected, assessed, and deployed, information is a key part of making that possible for more and more people every day.

Here I want to build on Hal’s idea to suggest another — perhaps even more immediately crucial — use of data to alleviate the COVID-19 crisis: The allocation of scarce medical resources.

In the current crisis, the “what” of this data is apparent: it is the testing data described by Julian in his post, and implemented in digital form by Hal in his. Thus, whereas Hal’s proposal contemplates using this data solely to allow proprietors (public transportation, restaurants, etc.) to admit entry to users, my proposal contemplates something more expansive: the provision of Hal’s test-verification vendors’ data to a centralized database in order to use it to assess current medical resource needs and to predict future needs.

The apparent ventilator availability crisis

As I have learned at great length from a friend whose spouse is an ICU doctor on the front lines, the current ventilator scarcity in New York City is worrisome (from a personal email, edited slightly for clarity):

When doctors talk about overwhelming a medical system, and talk about making life/death decisions, often they are talking about ventilators. A ventilator costs somewhere between $25K to $50K. Not cheap, but not crazy expensive. Most of the time these go unused, so hospitals have not stocked up on them, even in first-rate medical systems. Certainly not in the US, where equipment has to get used or the hospital does not get reimbursed for the purchase.

With a bad case of this virus you can put somebody — the sickest of the sickest — on one of those for three days and many of them don’t die. That frames a brutal capacity issue in a local area. And that is what has happened in Italy. They did not have enough ventilators in specific cities where the cases spiked. The mortality rates were much higher solely due to lack of these machines. Doctors had to choose who got on the machine and who did not. When you read these stories about a choice of life and death, that could be one reason for it.

Now the brutal part: This is what NYC might face soon. Faster than expected, by the way. Maybe they will ship patients to hospitals in other parts of NY state, and in NJ and CT. Maybe they can send them to the V.A. hospitals. Those are the options for how they hope to avoid this particular capacity issue. Maybe they will flatten the curve just enough with all the social distancing. Hard to know just now. But right now the doctors are pretty scared, and they are planning for the worst.

A recent PBS Report describes the current ventilator situation in the US:

A 2018 analysis from the Johns Hopkins University Center for Health Security estimated we have around 160,000 ventilators in the U.S. If the “worst-case scenario” were to come to pass in the U.S., “there might not be” enough ventilators, Dr. Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases, told CNN on March 15.

“If you don’t have enough ventilators, that means [obviously] that people who need it will not be able to get it,” Fauci said. He stressed that it was most important to mitigate the virus’ spread before it could overwhelm American health infrastructure.

Reports say that the American Hospital Association believes almost 1 million COVID-19 patients in the country will require a ventilator. Not every patient will require ventilation at the same time, but the numbers are still concerning. Dr. Daniel Horn, a physician at Massachusetts General Hospital in Boston, warned in a March 22 editorial in The New York Times that “There simply will not be enough of these machines, especially in major cities.”

The recent report of 9,000 COVID-19-related deaths in Italy brings the ventilator scarcity crisis into stark relief: There is little doubt that a substantial number of these deaths stem from the unavailability of key medical resources, including, most importantly, ventilators.  

Medical resource scarcity in the current crisis is a drastic problem. And without significant efforts to ameliorate it it is likely to get worse before it gets better. 

Using data to allocate scarce resources: The basic outlines of a proposed “Ventilator Procurement and Allocation Network”

But that doesn’t mean that the scarce resources we do have can’t be better allocated. As the PBS story quoted above notes, there are some 160,000 ventilators in the US. While that may not be enough in the aggregate, it’s considerably more than are currently needed in, say, New York City — and a great number of them are surely not currently being used, nor likely immediately to need to be used. 

The basic outline of the idea for redistributing these resources is fairly simple: 

  1. First, register all of the US’s existing ventilators in a centralized database. 
  2. Second (using a system like the one Hal describes), collect and update in real time the relevant test results, contact tracing, demographic, and other epidemiological data and input it into a database.
  3. Third, analyze this data using one or more compartmental models (or more targeted, virus-specific models) — (NB: I am the furthest thing from an epidemiologist, so I make no claims about how best to do this; the link above, e.g., is merely meant to be illustrative and not a recommendation) — to predict the demand for ventilators at various geographic levels, ranging from specific hospitals to counties or states. In much the same way, allocation of organs in the OPTN is based on a set of “allocation calculators” (which in turn are intended to implement the “Final Rule” adopted by HHS to govern transplant organ allocation decisions).   
  4. Fourth, ask facilities in low-expected-demand areas to send their unused (or excess above the level required to address “normal” demand) ventilators to those in high-expected-demand areas, with the expectation that they will be consistently reallocated across all hospitals and emergency care facilities according to the agreed-upon criteria. Of course, the allocation “algorithm” would be more complicated than this (as is the HHS Final Rule for organ allocation). But in principle this would be the primary basis for allocation. 

Not surprisingly, some guidelines for the allocation of ventilators in such emergencies already exist — like New York’s Ventilator Allocation Guidelines for triaging ventilators during an influenza pandemic. But such guidelines address the protocols for each facility to use in determining how to allocate its own scarce resources; they do not contemplate the ability to alleviate shortages in the first place by redistributing ventilators across facilities (or cities, states, etc.).

I believe that such a system — like the OPTN — could largely work on a voluntary basis. Of course, I’m quick to point out that the OPTN is a function of a massive involuntary and distortionary constraint: the illegality of organ sales. But I suspect that a crisis like the one we’re currently facing is enough to engender much the same sort of shortage (as if such a constraint were in place with respect to the use of ventilators), and thus that a similar system would be similarly useful. If not, of course, it’s possible that the government could, in emergency situations, actually commandeer privately-owned ventilators in order to effectuate the system. I leave for another day the consideration of the merits and defects of such a regime.

Of course, it need not rely on voluntary participation. There could be any number of feasible means of inducing hospitals that have unused ventilators to put their surpluses into the allocation network, presumably involving some sort of cash or other compensation. Or perhaps, if and when such a system were expanded to include other medical resources, it might involve moving donor hospitals up the queue for some other scarce resources they need that don’t face a current crisis. Surely there must be equipment that a New York City hospital has in relative surplus that a small town hospital covets.

But the key point is this: It doesn’t make sense to produce and purchase enough ventilators so that every hospital in the country can simultaneously address extremely rare peak demands. Doing so would be extraordinarily — and almost always needlessly — expensive. And emergency preparedness is never about ensuring that there are no shortages in the worst-case scenario; it’s about making a minimax calculation (as odious as those are) — i.e., minimizing the maximal cost/risk, not mitigating risk entirely. (For a literature review of emergency logistics in the context of large-scale disasters, see, e.g., here)

But nor does it make sense — as a policy matter — to allocate the new ventilators that will be produced in response to current demand solely on the basis of current demand. The epidemiological externalities of the current pandemic are substantial, and there is little reason to think that currently over-taxed emergency facilities — or even those preparing for their own expected demand — will make procurement decisions that reflect the optimal national (let alone global) allocation of such resources. A system like the one I outline here would effectively enable the conversion of private, constrained decisions to serve the broader demands required for optimal allocation of scarce resources in the face of epidemiological externalities

Indeed — and importantly — such a program allows the government to supplement existing and future public and private procurement decisions to ensure an overall optimal level of supply (and, of course, government-owned ventilators — 10,000 of which already exist in the Strategic National Stockpile — would similarly be put into the registry and deployed using the same criteria). Meanwhile, it would allow private facilities to confront emergency scenarios like the current one with far more resources than it would ever make sense for any given facility to have on hand in normal times.

Some caveats

There are, as always, caveats. First, such a program relies on the continued, effective functioning of transportation networks. If any given emergency were to disrupt these — and surely some would — the program would not necessarily function as planned. Of course, some of this can be mitigated by caching emergency equipment in key locations, and, over the course of an emergency, regularly redistributing those caches to facilitate expected deployments as the relevant data comes in. But, to be sure, at the end of the day such a program depends on the ability to transport ventilators.

In addition, there will always be the risk that emergency needs swamp even the aggregate available resources simultaneously (as may yet occur during the current crisis). But at the limit there is nothing that can be done about such an eventuality: Short of having enough ventilators on hand so that every needy person in the country can use one essentially simultaneously, there will always be the possibility that some level of demand will outpace our resources. But even in such a situation — where allocation of resources is collectively guided by epidemiological (or, in the case of other emergencies, other relevant) criteria — the system will work to mitigate the likely overburdening of resources, and ensure that overall resource allocation is guided by medically relevant criteria, rather than merely the happenstance of geography, budget constraints, storage space, or the like.     

Finally, no doubt a host of existing regulations make such a program difficult or impossible. Obviously, these should be rescinded. One set of policy concerns is worth noting: privacy concerns. There is an inherent conflict between strong data privacy, in which decisions about the sharing of information belong to each individual, and the data needs to combat an epidemic, in which each person’s privately optimal level of data sharing may result in a socially sub-optimal level of shared data. To the extent that HIPAA or other privacy regulations would stand in the way of a program like this, it seems singularly important to relax them. Much of the relevant data cannot be efficiently collected on an opt-in basis (as is easily done, by contrast, for the OPTN). Certainly appropriate safeguards should be put in place (particularly with respect to the ability of government agencies/law enforcement to access the data). But an individual’s idiosyncratic desire to constrain the sharing of personal data in this context seems manifestly less important than the benefits of, at the very least, a default rule that the relevant data be shared for these purposes.

Appropriate standards for emergency preparedness policy generally

Importantly, such a plan would have broader applicability beyond ventilators and the current crisis. And this is a key aspect of addressing the problem: avoiding a myopic focus on the current emergency in lieu of more clear-eyed emergency preparedness plan

It’s important to be thinking not only about the current crisis but also about the next emergency. But it’s equally important not to let political point-scoring and a bias in favor of focusing on the seen over the unseen coopt any such efforts. A proper assessment entails the following considerations (surely among others) (and hat tip to Ron Cass for bringing to my attention most of the following insights):

  1. Arguably we are overweighting health and safety concerns with respect to COVID-19 compared to our assessments in other areas (such as ordinary flu (on which see this informative thread by Anup Malani), highway safety, heart & coronary artery diseases, etc.). That’s inevitable when one particular concern is currently so omnipresent and so disruptive. But it is important that we not let our preparations for future problems focus myopically on this cause, because the next crisis may be something entirely different. 
  2. Nor is it reasonable to expect that we would ever have been (or be in the future) fully prepared for a global pandemic. It may not be an “unknown unknown,” but it is impossible to prepare for all possible contingencies, and simply not sensible to prepare fully for such rare and difficult-to-predict events.
  3. That said, we also shouldn’t be surprised that we’re seeing more frequent global pandemics (a function of broader globalization), and there’s little reason to think that we won’t continue to do so. It makes sense to be optimally prepared for such eventualities, and if this one has shown us anything, it’s that our ability to allocate medical resources that are made suddenly scarce by a widespread emergency is insufficient. 
  4. But rather than overreact to such crises — which is difficult, given that overreaction typically aligns with the private incentives of key decision makers, the media, and many in the “chattering class” — we should take a broader, more public-focused view of our response. Moreover, political and bureaucratic incentives not only produce overreactions to visible crises, they also undermine the appropriate preparation for such crises in the future.
  5. Thus, we should create programs that identify and mobilize generically useful emergency equipment not likely to be made obsolete within a short period and likely to be needed whatever the source of the next emergency. In other words, we should continue to focus the bulk of our preparedness on things like quickly deployable ICU facilities, ventilators, and clean blood supplies — not, as we may be wrongly inclined to do given the salience of the current crisis, primarily on specially targeted drugs and test kits. Our predictive capacity for our future demand of more narrowly useful products is too poor to justify substantial investment.
  6. Given the relative likelihood of another pandemic, generic preparedness certainly includes the ability to inhibit overly fast spread of a disease that can clog critical health care facilities. This isn’t disease-specific (or, that is, while the specific rate and contours of infection are specific to each disease, relatively fast and widespread contagion is what causes any such disease to overtax our medical resources, so if we’re preparing for a future virus-related emergency, we’re necessarily preparing for a disease that spreads quickly and widely).

Because the next emergency isn’t necessarily going to be — and perhaps isn’t even likely to be — a pandemic, our preparedness should not be limited to pandemic preparedness. This means, as noted above, overcoming the political and other incentives to focus myopically on the current problem even when nominally preparing for the next one. But doing so is difficult, and requires considerable political will and leadership. It’s hard to conceive of our current federal leadership being up to the task, but it’s certainly not the case that our current problems are entirely the makings of this administration. All governments spend too much time and attention solving — and regulating — the most visible problems, whether doing so is socially optimal or not.   

Thus, in addition to (1) providing for the efficient and effective use of data to allocate emergency medical resources (e.g., as described above), and (2) ensuring that our preparedness centers primarily on generically useful emergency equipment, our overall response should also (3) recognize and correct the way current regulatory regimes also overweight visible adverse health effects and inhibit competition and adaptation by industry and those utilizing health services, and (4) make sure that the economic and health consequences of emergency and regulatory programs (such as the current quarantine) are fully justified and optimized.

A proposal like the one I outline above would, I believe, be consistent with these considerations and enable more effective medical crisis response in general.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Hal Singer, (Managing Director, econONE; Adjunct Professor, Georgeown University, McDonough School of Business).]

In these harrowing times, it is a natural to fixate on the problem of testing—and how the United States got so far behind South Korea on this front—as a means to arrest the spread of Coronavirus. Under this remedy, once testing becomes ubiquitous, the government could track and isolate everyone who has been in recent contact with someone who has been diagnosed with Covid-19. 

A good start, but there are several pitfalls from “contact tracing” or what I call “standalone testing.” First, it creates an outsized role for government and raises privacy concerns relating to how data on our movements and in-person contacts are shared. Second, unless the test results were instantaneously available and continuously updated, data from the tests would not be actionable. A subject could be clear of the virus on Tuesday, get tested on Wednesday, and be exposed to the virus on Friday.

Third, and one easily recognizable to economists, is that standalone testing does not provide any means by which healthy subjects of the test can credibly signal to their peers that they are now safe to be around. Given the skewed nature of economy towards services—from restaurants to gyms and yoga studios to coffee bars—it is vital that we interact physically. To return to work or to enter a restaurant or any other high-density environment, both the healthy subject must convey to her peers that she is healthy, and other co-workers or patrons in a high-density environment must signal their health to the subject. Without this mutual trust, healthy workers will be reluctant to return to the workplace or to integrate back into society. It is not enough for complete strangers to say “I’m safe.” How do I know you are safe?

As law professor Thom Lambert tweeted, this information problem is related to the famous lemons problem identified by Nobel laureate George Akerlof: We “can’t tell ‘quality’ so we assume everyone’s a lemon and act accordingly. We once had that problem with rides from strangers, but entrepreneurship and technology solved the problem.”

Akerlof recognized that markets were prone to failure in the face of “asymmetric information,” or when a seller knows a material fact that the buyer does not. He showed a market for used cars could degenerate into a market exclusively for lemons, because buyers rationally are not willing to pay the full value of a good car and the discount they would impose on all sellers would drive good cars away.

To solve this related problem, we need a way to verify our good health. Borrowing Lambert’s analogy, most Americans (barring hitchhikers) would never jump in a random car without knowledge that the driver worked for a reputable ride-hailing service or licensed taxi. When an Uber driver pulls up to the curb, the rider can feel confident that the driver has been verified (and vice versa) by a third party—in this case, Uber—and if there’s any doubt of the driver’s credentials, the driver typically speaks the passenger’s name when the door is still ajar. Uber also mitigated the lemons problem by allowing passengers and drivers to engage in reciprocal rating.

Similarly, when a passenger shows up at the airport, he presents a ticket, typically in electronic form on his phone, to a TSA officer. The phone is scanned by security, and verification of ticket and TSA PreCheck status is confirmed via rapid communication with the airline. The same verification is repeated at stadium venues across America, thanks in part to technology developed by StubHub.

A similar verification technology could be deployed to solve the trust problem relating to Coronavirus. It is meant to complement standalone testing. Here’s how it might work:

Each household would have a designated testing center in their community and potentially a test kit in their own homes. Testing would done routinely and free of charge, so as to ensure that test results are up to date. (Given the positive externalities associated with mass testing and verification, the optimal price is not positive.) Just as an airline sends confirmation of a ticket purchase, the company responsible for administering the test would report the results within an hour to the subject and it would store for 24 hours in the vendor’s app. In contrast to the invasive role of government in contact tracing, the only role for government here would be to approve of qualified vendors of the testing equipment.

Armed with third-party verification of her health status on her phone, the subject could present these results to a gatekeeper at any facility. Suppose the subject typically takes the metro to work, and stops at her gym before going home. Under this regime, she would present her phone to three gatekeepers (metro, work, gym) to obtain access. Of course, subjects who test positive for Coronavirus would not gain access to these secure sites until the virus left their system and they subsequently test negative. Seems harsh for them, but imposing this restriction isn’t really a degradation in mobility relative to the status quo, under which access is denied to everyone.

When I floated this idea on Twitter a few days ago, it was generally well received, but even supporters spotted potential shortcomings. For example, users could have a fraudulent app on their phones, or otherwise fake a negative result. Yet government sanctioning of a select groups of test vendors should prevent this type of fraud. Private gatekeepers such as restaurants presumably would not have to operate under any mandate; they have a clear incentive not only to restrict access to verified patrons, but also to advertise that they have strict rules on admission. By the same token, if they did, for some reason, allowed people to enter without verification, they could do so. But patrons’ concern for their own health likely would undermine such a permissive policy.

Other skeptics raised privacy concerns. But if a user voluntarily conveys her health status to a gatekeeper, so long as the information stops there, it’s hard to conceive a privacy violation. Another potential violation would be an equipment vendor’s sharing information of a user’s health status with third parties. Of course, the government could impose restrictions on a vendor’s data sharing as a condition of granting a license to test and verify. But given the circumstances, such sharing could support contact tracing, or allow supplies to be mobilized to certain areas where there are outbreaks. 

Still others noted that some Americans lack phones. For these Americans, I’d suggest paper verification would suffice, or even better yet, subsidized phones.

No solution is flawless. And it’s incredible that we even have to think this way. But who could have imagined, even a few weeks ago, that we would be pinned in our basements, afraid to interact with the world in close quarters? Desperate times call for creative and economically sound measures.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Eric Fruits, (Chief Economist, International Center for Law & Economics).]

The Wall Street Journal reports congressional leaders have agreed to impose limits on stock buybacks and dividend payments for companies receiving aid under the COVID-19 disaster relief package. 

Rather than a flat-out ban, the draft legislation forbids any company taking federal emergency loans or loan guarantees from repurchasing its own stock or paying shareholder dividends. The ban lasts for the term of the loans, plus one year after the aid had ended.

In theory, under a strict set of conditions, there is no difference between dividends and buybacks. Both approaches distribute cash from the corporation to shareholders. In practice, there are big differences between dividends and share repurchases.

  • Dividends are publicly visible actions and require authorization by the board of directors. Shareholders have expectations of regular, stable dividends. Buybacks generally lack such transparency. Firms have flexibility in choosing the timing and the amount of repurchases, subject to the details of their repurchase programs.
  • Cash dividends have no effect on the number of shares outstanding. In contrast, share repurchases reduce the number of shares outstanding. By reducing the number of shares outstanding, buybacks increase earnings per share, all other things being equal. 

Over the past 15 years, buybacks have outpaced dividend payouts. The figure above, from Seeking Alpha, shows that while dividends have grown relatively smoothly over time, the aggregate value of buybacks are volatile and vary with the business cycle. In general, firms increase their repurchases relative to dividends when the economy booms and reduce them when the economy slows or shrinks. 

This observation is consistent with a theory that buybacks are associated with periods of greater-than-expected financial performance. On the other hand, dividends are associated with expectations of long-term profitability. Dividends can decrease, but only when profits are expected to be “permanently” lower. 

During the Great Recession, the figure above shows that dividends declined by about 10%, the amount of share repurchases plummeted by approximately 85%. The flexibility afforded by buybacks provided stability in dividends.

There is some logic to dividend and buyback limits imposed by the COVID-19 disaster relief package. If a firm has enough cash on hand to pay dividends or repurchase shares, then it doesn’t need cash assistance from the federal government. Similarly, if a firm is so desperate for cash that it needs a federal loan or loan guarantee, then it doesn’t have enough cash to provide a payout to shareholders. Surely managers understand this and sophisticated shareholders should too.

Because of this understanding, the dividend and buyback limits may be a non-binding constraint. It’s not a “good look” for a corporation to accept millions of dollars in federal aid, only to turn around and hand out those taxpayer dollars to the company’s shareholders. That’s a sure way to get an unflattering profile in the New York Times and an invitation to attend an uncomfortable hearing at the U.S. Capitol. Even if a distressed firm could repurchase its shares, it’s unlikely that it would.

The logic behind the plus-one-year ban on dividends and buybacks is less clear. The relief package is meant to get the U.S. economy back to normal as fast as possible. That means if a firm repays its financial assistance early, the company’s shareholders should be rewarded with a cash payout rather than waiting a year for some arbitrary clock to run out.

The ban on dividends and buybacks may lead to an unintended consequence of increased merger and acquisition activity. Vox reports an email to Goldman Sachs’ investment banking division says Goldman expects to see an increase in hostile takeovers and shareholder activism as the prices of public companies fall. Cash rich firms who are subject to the ban and cannot get that cash to their existing shareholders may be especially susceptible takeover targets.

Desperate times call for desperate measures and these are desperate times. Buyback backlash has been brewing for sometime and the COVID-19 relief package presents a perfect opportunity to ban buybacks. With the pressures businesses are under right now, it’s unlikely there’ll be many buybacks over the next few months. The concern should be over the unintended consequences facing firms once the economy recovers.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Julian Morris, (Director of Innovation Policy, ICLE).]

SARS-CoV2, the virus that causes COVID-19, is now widespread in the population in many countries, including the US, UK, Australia, Iran, and many European countries. Its prevalence in other regions, such as South Asia, much of South America, and Africa, is relatively unknown. The failure to contain the virus early on has meant that more aggressive measures are now necessary in order to avoid overwhelming healthcare systems, which would cause unacceptable levels of mortality. (Sadly, Italy’s health system has already been overwhelmed, forcing medical practitioners to engage in the most awful triage decisions.) Many jurisdictions, ranging from cities to entire countries, have chosen to implement mandatory lockdowns. These will likely have the desired effect of slowing transmission in the short term, but they cannot be maintained indefinitely. The challenge going forward is how to contain the spread of the virus without destroying the economy. 

In this post I will outline the elements of a proposal that I hope might do that. (I’ve been working on this for about a week and in the meantime some of the ideas have been advanced by others. E.g. this and this. Great minds clearly think alike.)

1. Identify those who have had COVID-19 and have recovered — and allow them to go back to work

While there are some reports of people who have had COVID-19 becoming reinfected, this seems to be very rare (a recent primate study implies reinfection is impossible) and the alleged cases may have been a result of false negative tests followed by relapse by patients. The general presumption is that having the disease is likely to confer immunity for several months at least. Moreover, people with immunity who no longer show symptoms of the disease are very unlikely to transmit the disease. Allowing those people to go back to work will lessen the burden of the lockdown without appreciably increasing the risk of infection

One group of such people is readily identifiable, though small: Those who tested positive for COVID-19 and subsequently recovered. Those people should be permitted to go back to work immediately.

2. Where possible, test, trace, treat, isolate

The town of Vo in Northern Italy, the site of the first death in the country from COVID-19, appears to have stopped the disease from spreading in about three weeks. It did so through a combination of universal testing, two weeks of strict lockdown, and quarantine of cases.  Could this be replicated elsewhere? 

Vo has a population of 3,300, so universal testing was not the gargantuan exercise it would be in, say, the continental US. Some larger jurisdictions have had similar success without resorting to universal testing and lockdown. South Korea managed to contain the spread of SARS-CoV2 relatively quickly through a combination of: social distancing (including closing schools and restricting large gatherings), testing anyone who had COVID-19 symptoms (and increasingly those without symptoms), tracing and testing of those who had contact with those symptomatic individuals, treating those with severe symptoms, quarantining those who tested positive but had no or only mild symptoms (the quarantine was monitored using a phone app and strictly enforced), and publicly sharing detailed information about the known incidence of the virus. 

A study of 181 cases in China published in the Annals of Internal Medicine found that the mean incubation period for COVID-19 is just over 5 days and only about 1 in 100 cases take longer than 14 days. By implication, if people have been strictly following the guidelines on avoiding contact with others, washing/sanitizing hands, sanitizing other objects, and avoiding hand-to-face contact, it should be possible, after two weeks of lockdown, to identify the vast majority of people who are not infected by testing everyone for the presence of SARS-CoV2 itself.

But that’s a series of big ifs. Since it takes a few days for the virus to replicate in the body to the point at which it is detectable, people who have recently been infected might test negative. Also, it is unlikely to be feasible logistically to test a significant proportion of the population for SARS-CoV2 in a short period of time. Existing tests require the use of RT-PCR, which is expensive and time consuming, not least because it can only be done at a lab, and while the capacity for such tests is increasing, it is likely around 50,000 per day in the entire US. 

Test, trace, treat, and isolate may be a feasible option for towns and even cities that currently have relatively low incidence of SARS-CoV2. However, given the lethargic progress of testing in places such as the US, UK and India, and hence poor existing knowledge of the extent of infection, it will not be a universal panacea.

3. Test as many people as possible for the presence of antibodies to SARS-CoV2

Outside those few places that have dramatically ramped up testing, it is likely that many more people have had COVID-19 than have been tested, either because they were asymptomatic or because they did not require clinical attention. Many, perhaps most of those people will no longer have the virus in their system but they should still have antibodies (indicating immunity). In order to identify those people, there should be widespread testing for antibodies to SARS-CoV2. 

Antibody tests are inexpensive, quick, and some can be done at home with minimal assistance. Numerous such tests have already been produced or are in development (see the list here). For example, Chinese manufacturer Innovita has produced a test that appears to be effective; in a clinical trial of 447 patients, it identified the presence of antibodies to SARS-CoV2 in 87.3 % of clinically confirmed cases of COVID-19 (i.e. there were approximately 13% false negatives) but zero false positives. Innovita’s test was approved by China’s equivalent of the FDA and has been used widely there. 

Scanwell Health, a San Francisco-based startup, has an exclusive license to produce Innovita’s test in the U.S. and has already begun the process for obtaining approval from the US FDA under its Emergency Use Authorization. Scanwell estimates that the total cost of the test, including overnight shipping of the kit and support from a doctor or nurse practitioner from Lemonaid Health, will be around $70. One downside to Scanwell Health’s offering, however, is that it expects it to take 6-8 weeks to begin shipping testing kits once it receives authorization from the FDA

So far, the FDA has approved at least one SARS-CoV2 antibody test, produced by Aytu Bioscience in Colorado. But Aytu’s test is designed for use by physicians, not at home. In Europe, at least one antibody test, produced by German company PharmACT, is already available. (That test has similar characteristics to Innovita’s.) Another has been approved by the MHRA in the UK for physician use and is awaiting approval for home use; the UK government has ordered 3.5 million of these tests, with the aim of distributing 250,000 per day by the end of April. 

Unfortunately, some people who have antibodies to SARS-CoV2 will also still be infectious. However, because different antibodies develop at different times during the course of infection, it may be possible to distinguish those who are still infectious from those who are no longer infectious. Specifically, immunoglobulin (Ig) M is present in larger amounts while the viral load is still present, while IgG is present in larger amounts later on (see e.g. this and the figure below). So, by testing for the presence of both IgM and IgG it should be possible to identify a large proportion of those who have had COVID-19 but are no longer infectious. (The currently available antibody tests result in about 13 percent false negatives, making them inappropriate as a means of screening out those who do not have COVID-19. But they produce zero false positives, making them ideal for identifying those who definitely have or have had COVID-19). In essence, people whose IgG test is positive but IgM test is negative can then go back to work. In addition, people who have had COVID-19 symptoms, are now symptom-free, and test positive for antibodies, should be allowed to go back to work.

4. Test for SARS-Cov2 among those who test negative for antibodies — and ensure that everyone who tests positive remains in isolation

Those people who test negative for SARS-CoV2 using the quick antibody immunoassay, as well as those who are positive for both IgG and IgM (indicating that they may still be infectious) should then be tested for SARS-CoV2 using the RT-PCR test described above. And those who test negative for SARS-CoV2 should then be permitted to go back to work. But those who test positive should be required to remain in isolation— and seek treatment if necessary.

5. Repeat steps 3 and 4 until nobody tests positive for COVID-19

By repeating steps 3 and 4, it should be possible gradually to enable the vast majority of the population to return to work, and thence to a life of greater normalcy, within a matter of weeks.

6. Some (possibly rather large) caveats

All of this relies on: (a) the ability rapidly to expand testing and (b) widespread compliance with isolation requirements. Neither of these conditions is by any means guaranteed, not least because the rules effectively discriminate in favor of people who have had COVID-19, which may create a perverse incentive to violate not only the isolation requirements but all the recommended hygiene practices — and thereby intentionally become infected with SARS-CoV2 on the presumption that they will then be able to go back to work sooner than otherwise. So, before this is rolled out, it is important to ensure that there will be widespread testing for COVID-19 in a timeframe shorter than the likely total time for contracting and recovering from COVID-19.

In addition, if test results are to be used as a means of establishing a person’s ability to travel and work while others are still under lockdown, it is important that there  be a means of verifying the status of individuals. That might be possible through the use of an app, for example; such an app might also provide policymakers to make better resources allocation decisions too. 

Also, at-risk individuals should be strongly advised to remain in isolation until there is no further evidence of community transmission. 

7. The Mechanics of Testing

Given that there are not currently sufficient tests available for everyone to be tested in most locations, one obvious question is: who should be tested? As noted above, it makes sense initially to target those who have had COVID-19 symptoms and have recovered. Since only those people who have had such symptoms—and possibly their physician if they presented with their symptoms—will know who they are, this will rely largely on trust. (It’s possible that self-reporting apps could help.) 

But it may make sense initially to target tests more narrowly. The UK is initially targeting the antibody detection kits to healthcare and other key workers—people who are essential to the continued functioning of the country. That makes sense and could easily be applied in other places. 

Assuming that key workers can be supplied with antibody detection kits quickly, distribution should then be opened up more widely. No doubt insurance companies will be making decisions about the purchase of testing kits. Ideally, however, individuals should be able to buy kits such as Scanwell’s without going through a bureaucratic process, whether that be their insurance company or the NHS. And vendors should be free to price kits as they see fit, without worrying about the prospect of being subject to price caps such as those imposed by Medicaid or the VA, which have the perverse effect of incentivising vendors to increase the list price. Finally, in order to increase the supply of tests as rapidly as possible, regulatory agencies should be encouraged to issue emergency approvals as quickly as possible. Having more manufacturers with a diverse array of tests available will increase access to testing more quickly and likely lead to more accurate testing too. Agencies such as the FDA should see this as their absolute priority right now. If the Mayo clinic can compress 6 months’ product development into a month, the FDA can surely do its review far more quickly too. Lives—and the economy—depend upon it.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Sam Bowman, (Director of Competition Policy, ICLE).]

No support package for workers and businesses during the coronavirus shutdown can be comprehensive. In the UK, for example, the government is offering to pay 80% of the wages of furloughed workers, but this will not apply to self-employed people or many gig economy workers, and so far it’s been hard to think of a way of giving them equivalent support. It’s likely that the bill going through Congress will have similar issues.

Whether or not solutions are found for these problems, it may be worth putting in place what you might call a ‘backstop’ policy that allows people to access money in case they cannot access it through the other policies that are being put into place. This doesn’t need to provide equivalent support to other packages, just to ensure that everyone has access to the money they need during the shutdown to pay their bills and rent, and cover other essential costs. The aim here is just to keep everyone afloat.

One mechanism for doing this might be to offer income-contingent loans to anyone currently resident in the country during the shutdown period. These are loans whose repayment is determined by the borrower’s income later on, and are how students in the UK and Australia pay for university. 

In the UK, for example, under the current student loan repayment terms, once a student has graduated, their earnings above a certain income threshold (currently £25,716/year) are taxed at 9% to repay the loan. So, if I earn £30,000/year and have a loan to repay, I pay an additional £385.56/year to repay the loan (9% of the £4,284 I’m earning above the income threshold); if I earn £40,000/year, I pay an additional £1,285.56/year. The loan incurs an annual interest rate equal to an annual measure of inflation plus 3%. Once you have paid off the loan, no more repayments are taken, and any amount still unpaid thirty years after the loan was first taken out is written off.

In practice, these terms mean that there is a significant subsidy to university students, most of whom never pay off the full amount. Under a less generous repayment scheme that was in place until recently, with a lower income threshold for repayment, out of every £1 borrowed by students the long-run cost to the government was 43.3p. This is regarded by many as a feature of the system rather than a bug, because of the belief that university education has positive externalities, and because this approach pools some of the risk associated with pursuing a graduate-level career (the risk of ending up with a low-paid job despite having spent a lot on your education, for example).

For loans available to the wider public, a different set of repayment criteria could apply. We could allow anyone who has filed a W-2 or 1099 tax statement in the past eighteen months (or filed a self-assessment tax return in the UK) to borrow up to something around 20% of median national annual income, to be paid back via an extra few percentage points on their federal income tax or, in the UK, National Insurance contributions over the following ten years, with the rate returning to normal after they have paid off the loan. Some other provision may have to be made for people approaching retirement.

With a low, inflation-indexed interest rate, this would allow people who need funds to access them, but make it mostly pointless for anyone who did not need to borrow. 

If, like student tuition fees, loans were written off after a certain period, low earners would probably never pay back the entirety of the ‘loan’ – as a one-off transfer (ie, one that does not distort work or savings incentives for recipients) to low paid people, this is probably not a bad thing. Most people, though, would pay back as and when they were able to. For self-employed people in particular, it could be a valuable source of liquidity during an unexpected period where they cannot work. Overall, it would function as a cash transfer to lower earners, and a liquidity injection for everyone else who takes advantage of the scheme.

This would have advantages over money being given to every US or UK citizen, as some have proposed, because most of the money being given out would be repaid, so the net burden on taxpayers would be lower and so the deadweight losses created by the additional tax needed to pay for it would be smaller. But you would also eliminate the need for means-testing, relying on self-selection instead.

The biggest obstacle to rolling something like this out may be administrative. However, if the government committed to setting up something like this, banks and credit card companies may be willing to step in in the short-run to issue short-term loans in the knowledge that people could be able to repay them once the government scheme was set up. To facilitate this, the government could guarantee the loans made by banks and credit card companies now, then allow people to opt into the income-contingent loans later, so there was no need for legislation immediately.

Speed is extremely important in helping people plug the gaps in their finances. As a complement to the government’s other plans, income-contingent loans to groups like self-employed people may be a useful way of catching people who would otherwise fall through the cracks.

[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.

This post is authored by Mark Jamison, (Director and Gunter Professor, Public Utility Research Center, University of Florida and Visiting Scholar with the American Enterprise Institute.).]

The economic impacts of the coronavirus pandemic, and of the government responses to it, are significant and could be staggering, especially for small businesses. Goldman Sachs estimates a potential 24% drop in US GDP for the second quarter of 2020 and a 4% decline for the year. Its small business survey found that a little over half of small businesses might last for less than three months in this economic downturn. Small business employs nearly 60 million people in the US. How many will be out of work this year is anyone’s guess, but the number will be large.

What should small businesses do? First, focus on staying in business because their customers and employees need them to be healthy when the economy begins to recover. That will certainly mean slowing down business activity and decreasing payroll to manage losses, and managing liquidity.

Second, look for opportunities in the present crisis. Consumers are slowing their spending, but they will spend for things they still need and need now. And there will be new demand for things they didn’t need much before, like more transportation of food, support for health needs, and crisis management. Which business sectors will recover first? Those whose downturns represented delayed demand, such as postponed repairs and business travel, rather than evaporated demand, such as luxury items.

Third, they can watch for and take advantage of government support programs. Many programs simply provide low-cost loans, which do not solve the small-business problem of customers not buying: Borrowing money to meet payroll for idle workers simply delays business closure and makes bankruptcy more likely. But some grants and tax breaks are under discussion (see below).

Fourth, they can renegotiate loans and contracts. One of the mistakes lenders made in the past is holding stressed borrowers’ feet to the fire, which only led to more, and more costly loan defaults. At least some lenders have learned. So lenders and some suppliers might be willing to receive some payments rather than none.

What should government do? Unfortunately, Washington seems to think that so-called stimulus spending is the cure for any economic downturn. This isn’t true. I’ll explain why below, but let me first get to what is more productive. 

The major problem is that customers are unable to buy and businesses are unable to produce because of the responses to the coronavirus. Sometimes transactions are impossible, but there are times where buying and selling is simply made more costly by the pandemic and the government responses. So government support for the economy should address these problems directly.

For buyers, government officials should recognize that buying is hard and costly for them. So policies should include improving their abilities to buy during this time. Sales tax holidays, especially on healthcare, food, and transportation would be helpful. 

Waivers of postal fees would make e-commerce cheaper. And temporary support for fixed costs, such as mortgages, would free money for other things. Tax breaks for the gig economy would lower service costs and provide new employment opportunities. And tax credits for durables like home improvements would lower costs of social distancing.

But the better opportunities for government impact are on the business side because small business affects both the supply of services and the incomes of consumers.

For small business policy, my American Enterprise Institute colleagues Glenn Hubbard and Michael Strain have done the most thoughtful work that I have seen. They note that the problems for small businesses are that they do not have enough business activity to meet payroll and other bills. This means that “(t)he goal should be to replace a large portion of the revenue (not just the payroll expenses) those businesses would have generated in the absence of being shut down due to the coronavirus.” 

They suggest policies to replace 80 percent of the small business revenue loss. How? By providing grants in the form of government-backed commercial loans that are forgiven if the business continues and maintains payroll, subject to workers being allowed to quit if they find better opportunities. 

What else might work? Tax breaks that lower business costs. These can be breaks in payroll taxes, marginal income tax rates, equipment purchases, permitting, etc., including tax holidays. Rollback of current business losses would trigger tax refunds that improve businesses finances. 

One of the least useful ideas for small businesses is interest-free loans. These might be great for large businesses who are largely managing their financial positions. But such loans fail to address the basic small business problem of keeping the doors open when customers aren’t buying.

Finally, why doesn’t traditional stimulus work, even in other times of economic downturn? Traditional spending-based stimulus assumes that the economic problem is that people want to build things, but not buy them. That’s not a very good assumption. Especially today, where the problems are the higher cost of buying, or perhaps the impossibility of buying with social distancing, and the higher costs of doing businesses. Keeping businesses in business is the key to supporting the economy.