Decisions to initiate a rulemaking should be viewed through a cost-benefit lens (See summaries of Thom Lambert’s masterful treatment of regulation, of which rulemaking is a subset, here and here). Unless there is a market failure, rulemaking is not called for. Even in the face of market failure, regulation should not be adopted unless it is more cost-beneficial than reliance on markets (including the ability of public and private litigation to address market-failure problems, such as data theft). For a variety of reasons, it is unlikely that FTC rulemaking directed at privacy and data security would pass a cost-benefit test.
As I have previously explained (see here and here), FTC rulemaking pursuant to Section 6(g) of the FTC Act (which authorizes the FTC “to make rules and regulations for the purpose of carrying out the provisions of this subchapter”) is properly read as authorizing mere procedural, not substantive, rules. As such, efforts to enact substantive competition rules would not pass a cost-benefit test. Such rules could well be struck down as beyond the FTC’s authority on constitutional law grounds, and as “arbitrary and capricious” on administrative law grounds. What’s more, they would represent retrograde policy. Competition rules would generate higher error costs than adjudications; could be deemed to undermine the rule of law, because the U.S. Justice Department (DOJ) could not apply such rules; and innovative efficiency-seeking business arrangements would be chilled.
Accordingly, the FTC likely would not pursue 6(g) rulemaking should it decide to address data security and privacy, a topic which best fits under the “consumer protection” category. Rather, the FTC presumably would most likely initiate a “Magnuson-Moss” rulemaking (MMR) under Section 18 of the FTC Act, which authorizes the commission to prescribe “rules which define with specificity acts or practices which are unfair or deceptive acts or practices in or affecting commerce within the meaning of Section 5(a)(1) of the Act.” Among other things, Section 18 requires that the commission’s rulemaking proceedings provide an opportunity for informal hearings at which interested parties are accorded limited rights of cross-examination. Also, before commencing an MMR proceeding, the FTC must have reason to believe the practices addressed by the rulemaking are “prevalent.” 15 U.S.C. Sec. 57a(b)(3).
MMR proceedings, which are not governed under the Administrative Procedure Act (APA), do not present the same degree of legal problems as Section 6(g) rulemakings (see here). The question of legal authority to adopt a substantive rule is not raised; “rule of law” problems are far less serious (the DOJ is not a parallel enforcer of consumer-protection law); and APA issues of “arbitrariness” and “capriciousness” are not directly presented. Indeed, MMR proceedings include a variety of procedures aimed at promoting fairness (see here, for example). An MMR proceeding directed at data privacy predictably would be based on the claim that the failure to adhere to certain data-protection norms is an “unfair act or practice.”
Nevertheless, MMR rules would be subject to two substantial sources of legal risk.
The first of these arises out of federalism. Three states (California, Colorado, and Virginia) recently have enacted comprehensive data-privacy laws, and a large number of other state legislatures are considering data-privacy bills (see here). The proliferation of state data-privacy statutes would raise the risk of inconsistent and duplicative regulatory norms, potentially chilling business innovations addressed at data protection (a severe problem in the Internet Age, when business data-protection programs typically will have interstate effects).
An FTC MMR data-protection regulation that successfully “occupied the field” and preempted such state provisions could eliminate that source of costs. The Magnuson–Moss Warranty Act, however, does not contain an explicit preemption clause, leaving in serious doubt the ability of an FTC rule to displace state regulations (see here for a summary of the murky state of preemption law, including the skepticism of textualist Supreme Court justices toward implied “obstacle preemption”). In particular, the long history of state consumer-protection and antitrust laws that coexist with federal laws suggests that the case for FTC rule-based displacement of state data protection is a weak one. The upshot, then, of a Section 18 FTC data-protection rule enactment could be “the worst of all possible worlds,” with drawn-out litigation leading to competing federal and state norms that multiplied business costs.
The second source of risk arises out of the statutory definition of “unfair practices,” found in Section 5(n) of the FTC Act. Section 5(n) codifies the meaning of unfair practices, and thereby constrains the FTC’s application of rulemakings covering such practices. Section 5(n) states:
The Commission shall have no authority . . . to declare unlawful an act or practice on the grounds that such an act or practice is unfair unless the act or practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition. In determining whether an act or practice is unfair, the Commission may consider established public policies as evidence to be considered with all other evidence. Such public policy considerations may not serve as a primary basis for such determination.
In effect, Section 5(n) implicitly subjects unfair practices to a well-defined cost-benefit framework. Thus, in promulgating a data-privacy MMR, the FTC first would have to demonstrate that specific disfavored data-protection practices caused or were likely to cause substantial harm. What’s more, the commission would have to show that any actual or likely harm would not be outweighed by countervailing benefits to consumers or competition. One would expect that a data-privacy rulemaking record would include submissions that pointed to the efficiencies of existing data-protection policies that would be displaced by a rule.
Moreover, subsequent federal court challenges to a final FTC rule likely would put forth the consumer and competitive benefits sacrificed by rule requirements. For example, rule challengers might point to the added business costs passed on to consumers that would arise from particular rule mandates, and the diminution in competition among data-protection systems generated by specific rule provisions. Litigation uncertainties surrounding these issues could be substantial and would cast into further doubt the legal viability of any final FTC data protection rule.
Apart from these legal risk-based costs, an MMR data privacy predictably would generate error-based costs. Given imperfect information in the hands of government and the impossibility of achieving welfare-maximizing nirvana through regulation (see, for example, here), any MMR data-privacy rule would erroneously condemn some economically inefficient business protocols and disincentivize some efficiency-seeking behavior. The Section 5(n) cost-benefit framework, though helpful, would not eliminate such error. (For example, even bureaucratic efforts to accommodate some business suggestions during the rulemaking process might tilt the post-rule market in favor of certain business models, thereby distorting competition.) In the abstract, it is difficult to say whether the welfare benefits of a final MMA data-privacy rule (measured by reductions in data-privacy-related consumer harm) would outweigh the costs, even before taking legal costs into account.
At least two FTC commissioners (and likely a third, assuming that President Joe Biden’s highly credentialed nominee Alvaro Bedoya will be confirmed by the U.S. Senate) appear to support FTC data-privacy regulation, even in the absence of new federal legislation. Such regulation, which presumably would be adopted as an MMR pursuant to Section 18 of the FTC Act, would probably not prove cost-beneficial. Not only would adoption of a final data-privacy rule generate substantial litigation costs and uncertainty, it would quite possibly add an additional layer of regulatory burdens above and beyond the requirements of proliferating state privacy rules. Furthermore, it is impossible to say whether the consumer-privacy benefits stemming from such an FTC rule would outweigh the error costs (manifested through competitive distortions and consumer harm) stemming from the inevitable imperfections of the rule’s requirements. All told, these considerations counsel against the allocation of scarce FTC resources to a Section 18 data-privacy rulemaking initiative.
But what about legislation? New federal privacy legislation that explicitly preempted state law would eliminate costs arising from inconsistencies among state privacy rules. Ideally, if such legislation were to be pursued, it should to the extent possible embody a cost-benefit framework designed to minimize the sum of administrative (including litigation) and error costs. The nature of such a possible law, and the role the FTC might play in administering it, however, is a topic for another day.
In recent years, a growing chorus of voices has argued that existing merger rules fail to apprehend competitively significant mergers, either because they fall below existing merger-filing thresholds or because they affect innovation in ways that are purportedly ignored.
These fears are particularly acute in the pharmaceutical and tech industries, where several high-profile academic articles and reports claim to have identified important gaps in current merger-enforcement rules, particularly with respect to acquisitions involving nascent and potential competitors (here, here, and here, among many others).
Such fears have led activists, lawmakers, and enforcers to call for tougher rules, including the introduction of more stringent merger-filing thresholds and other substantive changes, such as the inversion of the burden of proof when authorities review mergers and acquisitions involving digital platforms.
However, as we discuss in a recent working paper—forthcoming in the Missouri Law Review and available on SSRN—these proposals tend to overlook the important tradeoffs that would ensue from attempts to decrease the number of false positives under existing merger rules and thresholds.
The paper draws from two key strands of economic literature that are routinely overlooked (or summarily dismissed) by critics of the status quo.
For a start, antitrust enforcement is not costless. In the case of merger enforcement, not only is it expensive for agencies to detect anticompetitive deals but, more importantly, overbearing rules may deter beneficial merger activity that creates value for consumers.
Second, critics tend to overlook the possibility that incumbents’ superior managerial or other capabilities (i.e., what made them successful in the first place) makes them the ideal acquisition partners for entrepreneurs and startup investors looking to sell.
The result is a body of economic literature that focuses almost entirely on hypothetical social costs, while ignoring the redeeming benefits of corporate acquisitions, as well as the social cost of enforcement.
One of the most significant allegations leveled against large tech firms is that their very presence in a market may hinder investments, entry, and innovation, creating what some have called a “kill zone.” The strongest expression in the economic literature of this idea of a kill zone stems from a working paper by Sai Krishna Kamepalli, Raghuram Rajan, and Luigi Zingales.
The paper makes two important claims, one theoretical and one empirical. From a theoretical standpoint, the authors argue that the prospect of an acquisition by a dominant platform deters consumers from joining rival platforms, and that this, in turn, hampers the growth of these rivals. The authors then test a similar hypothesis empirically. They find that acquisitions by a dominant platform—such as Google or Facebook—decrease investment levels and venture capital deals in markets that are “similar” to that of the target firm.
But both findings are problematic. For a start, Zingales and his co-authors’ theoretical model is premised on questionable assumptions about the way in which competition develops in the digital space. The first is that early adopters of new platforms—called “techies” in the authors’ parlance—face high switching costs because of their desire to learn these platforms in detail. As an initial matter, it would appear facially contradictory that “techies” both are the group with the highest switching costs and that they switch the most. The authors further assume that “techies” would incur lower adoption costs if they remained on the incumbent platform and waited for the rival platform to be acquired.
Unfortunately, while these key behavioral assumptions drive the results of the theoretical model, the paper presents no evidence to support their presence in real-world settings. In that sense, the authors commit the same error as previous theoretical work concerning externalities, which have tended to overestimate their frequency.
Second, the empirical analysis put forward in the paper is unreliable for policymaking purposes. The authors notably find that:
[N]ormalized VC investments in start-ups in the same space as the company acquired by Google and Facebook drop by over 40% and the number of deals falls by over 20% in the three years following an acquisition.
However, the results of this study are derived from the analysis of only nine transactions. The study also fails to clearly show that firms in the treatment and controls are qualitatively similar. In a nutshell, the study compares industry acquisitions exceeding $500 million to Facebook and Google’s acquisitions that exceed that amount. This does not tell us whether the mergers in both groups involved target companies with similar valuations or similar levels of maturity. This does not necessarily invalidate the results, but it does suggest that policymakers should be circumspect in interpreting those results.
Finally, the paper fails to demonstrate evidence that existing antitrust regimes fail to achieve an optimal error-cost balance. The central problem is that the paper has indeterminate welfare implications. For instance, as the authors note, the declines in investment in spaces adjacent to the incumbent platforms occurred during a time of rapidly rising venture capital investment, both in terms of the number of deals and dollars invested. It is entirely plausible that venture capital merely shifted to other sectors.
Put differently, on its own terms, the evidence merely suggests that acquisitions by Google and Facebook affected the direction of innovation, not its overall rate. And there is little to suggest that this shift was suboptimal, from a welfare standpoint.
In short, as the authors themselves conclude: “[i]t would be premature to draw any policy conclusion on antitrust enforcement based solely on our model and our limited evidence.”
Mergers and Potential Competition
Scholars have also posited more direct effects from acquisitions of startups or nascent companies by incumbent technology market firms.
Acquisitions of potential or nascent competitors by a dominant firm raise inherent anticompetitive concerns. By eliminating the procompetitive impact of the entry, an acquisition can allow the dominant firm to continue to exercise monopoly power and earn monopoly profits. The dominant firm also can neutralize the potential innovation competition that the entrant would provide.
However, these antitrust theories of harm suffer from several important flaws. They rest upon several restrictive assumptions that are not certain to occur in real-world settings. Most are premised on the notion that, in a given market, monopoly profits generally exceed joint duopoly profits. This allegedly makes it profitable, and mutually advantageous, for an incumbent to protect its monopoly position by preemptively acquiring potential rivals.
Accordingly, under these theories, anticompetitive mergers are only possible when the acquired rival could effectively challenge the incumbent. But these are, of course, only potential challengers; there is no guarantee that any one of them could or would mount a viable competitive threat.
Less obviously, it must be the case that the rival can hope to share only duopoly profits, as opposed to completely overthrowing the incumbent or surpassing them with a significantly larger share of the market. Where competition is “for the market” itself, monopoly maintenance would fail to explain a rival’s decision to sell. Because there would be no asymmetry between the expected profits of the incumbent and the rival, monopoly maintenance alone would not give rise to mutually advantageous deals.
Second, potential competition does not always increase consumer welfare. Indeed, while the presence of potential competitors might increase price competition, it can also have supply-side effects that cut in the opposite direction.
For example, as Nobel laureate Joseph Stiglitz observed, a monopolist threatened by potential competition may invest in socially wasteful R&D efforts or entry-deterrence mechanisms, and it may operate at below-optimal scale in anticipation of future competitive entry.
There are also pragmatic objections. Analyzing a merger’s effect on potential competition would compel antitrust authorities and courts to make increasingly speculative assessments concerning the counterfactual setting of proposed acquisitions.
In simple terms, it is far easier to determine whether a merger between McDonald’s and Burger King would lead to increased hamburger prices in the short run than it is to determine whether a gaming platform like Steam or the Epic Games Store might someday compete with video-streaming or music-subscription platforms like Netflix or Spotify. It is not that the above models are necessarily wrong, but rather that applying them to practical cases would require antitrust enforcers to estimate mostly unknowable factors.
Finally, the real test for regulators is not just whether they can identify possibly anticompetitive mergers, but whether they can do so in a cost-effective manner. Whether it is desirable to implement a given legal test is not simply a function of its accuracy, the cost to administer it, and the respective costs of false positives and false negatives. It also critically depends on how prevalent the conduct is that adjudicators would be seeking to foreclose.
Consider two hypothetical settings. Imagine there are 10,000 tech mergers in a given year, of which either 1,000 or 2,500 are anticompetitive (the remainder are procompetitive or competitively neutral). Suppose that authorities can either attempt to identify anticompetitive mergers with 75% accuracy, or perform no test at all—i.e., letting all mergers go through unchallenged.
If there are 1,000 anticompetitive mergers, applying the test would result in 7,500 correct decisions and 2,500 incorrect ones (2,250 false positives and 250 false negatives). Doing nothing would lead to 9,000 correct decisions and 1,000 false negatives. If the number of anticompetitive deals were 2,500, applying the test would lead to the same number of incorrect decisions as not applying it (1,875 false positives and 625 false negatives, versus 2,500 false negatives). The advantage would tilt toward applying the test if anticompetitive mergers were even more widespread.
This hypothetical example holds a simple lesson for policymakers: the rarer the conduct that they are attempting to identify, the more accurate their identification method must be, and the more costly false negatives must be relative to false positives.
As discussed below, current empirical evidence does not suggest that anticompetitive mergers of this sort are particularly widespread, nor does it offer accurate heuristics to detect the ones that are. Finally, there is little sense that the cost of false negatives significantly outweighs that of false positives. In short, there is currently little evidence to suggest that tougher enforcement would benefit consumers.
Killer acquisitions are, effectively, a subset of the “potential competitor” mergers discussed in the previous section. As defined by Colleen Cunningham, Florian Ederer, and Song Ma, they are those deals where “an incumbent firm may acquire an innovative target and terminate the development of the target’s innovations to preempt future competition.”
Cunningham, Ederer, and Ma’s highly influential paper on killer acquisitions has been responsible for much of the recent renewed interest in the effect that mergers exert on innovation. The authors studied thousands of pharmaceutical mergers and concluded that between 5.3% and 7.4% of them were killer acquisitions. As they write:
[W]e empirically compare development probabilities of overlapping acquisitions, which are, in our theory, motivated by a mix of killer and development intentions, and non-overlapping acquisitions, which are motivated only by development intentions. We find an increase in acquisition probability and a decrease in post-acquisition development for overlapping acquisitions and interpret that as evidence for killer acquisitions. […]
[W]e find that projects acquired by an incumbent with an overlapping drug are 23.4% less likely to have continued development activity compared to drugs acquired by non-overlapping incumbents.
From a policy standpoint, the question is what weight antitrust authorities, courts, and legislators should give to these findings. Stated differently, does the paper provide sufficient evidence to warrant reform of existing merger-filing thresholds and review standards? There are several factors counseling that policymakers should proceed with caution.
To start, the study’s industry-specific methodology means that it may not be a useful guide to understand acquisitions in other industries, like the tech sector, for example.
Second, even if one assumes that the findings of Cunningham, et al., are correct and apply with equal force in the tech sector (as some official reports have), it remains unclear whether the 5.3–7.4% of mergers they describe warrant a departure from the status quo.
Antitrust enforcers operate under uncertainty. The critical policy question is thus whether this subset of anticompetitive deals can be identified ex-ante. If not, is there a heuristic that would enable enforcers to identify more of these anticompetitive deals without producing excessive false positives?
The authors focus on the effect that overlapping R&D pipelines have on project discontinuations. In the case of non-overlapping mergers, acquired projects continue 17.5% of the time, while this number is 13.4% when there are overlapping pipelines. The authors argue that this gap is evidence of killer acquisitions. But it misses the bigger picture: under the authors’ own numbers and definition of a “killer acquisition,” a vast majority of overlapping acquisitions are perfectly benign; prohibiting them would thus have important social costs.
Third, there are several problems with describing this kind of behavior as harmful. Indeed, Cunningham, et al., acknowledge that this kind of behavior could increase innovation by boosting the returns to innovation.
And even if one ignores incentives to innovate, product discontinuations can improve consumer welfare. This question ultimately boils down to identifying the counterfactual to a merger. As John Yun writes:
For instance, an acquisition that results in a discontinued product is not per se evidence of either consumer harm or benefit. The answer involves comparing the counterfactual world without the acquisition with the world with the acquisition. The comparison includes potential efficiencies that were gained from the acquisition, including integration of intellectual property, the reduction of transaction costs, economies of scope, and better allocation of skilled labor.
One of the reasons R&D project discontinuation may be beneficial is simply cost savings. R&D is expensive. Pharmaceutical firms spend up to 27.8% of their annual revenue on R&D. Developing a new drug has an estimated median cost of $985.3 million. Cost-cutting—notably as it concerns R&D—is thus a critical part of pharmaceutical (as well as tech) companies’ businesses. As a report by McKinsey concludes:
The recent boom in M&A in the pharma industry is partly the result of attempts to address short-term productivity challenges. An acquiring or merging company typically designs organization-wide integration programs to capture synergies, especially in costs. Such programs usually take up to three years to complete and deliver results.
Maximizing the efficiency of production labor and equipment is one important way top-quartile drugmakers break out of the pack. Their rates of operational-equipment effectiveness are more than twice those of bottom-quartile companies (Exhibit 1), and when we looked closely we found that processes account for two-thirds of the difference.
In short, pharmaceutical companies do not just compete along innovation-related parameters, though these are obviously important, but also on more traditional grounds such as cost-rationalization. Accordingly, as the above reports suggest, pharmaceutical mergers are often about applying an incumbent’s superior managerial efficiency to the acquired firm’s assets through operation of the market for corporate control.
This cost-cutting (and superior project selection) ultimately enables companies to offer lower prices, thereby benefiting consumers and increasing their incentives to invest in R&D in the first place by making successfully developed drugs more profitable.
In that sense, Henry Manne’s seminal work relating to mergers and the market for corporate control sheds at least as much light on pharmaceutical (and tech) mergers as the killer acquisitions literature. And yet, it is hardly ever mentioned in modern economic literature on this topic.
While Colleen Cunningham and her co-authors do not entirely ignore these considerations, as we discuss in our paper, their arguments for dismissing them are far from watertight.
A natural extension of the killer acquisitions work is to question whether mergers of this sort also take place in the tech industry. Interest in this question is notably driven by the central role that digital markets currently occupy in competition-policy discussion, but also by the significant number of startup acquisitions that take place in the tech industry. However, existing studies provide scant evidence that killer acquisitions are a common occurrence in these markets.
This is not surprising. Unlike in the pharmaceutical industry—where drugs need to go through a lengthy and visible regulatory pipeline before they can be sold—incumbents in digital industries will likely struggle to identify their closest rivals and prevent firms from rapidly pivoting to seize new commercial opportunities. As a result, the basic conditions for killer acquisitions to take place (i.e., firms knowing they are in a position to share monopoly profits) are less likely to be present; it also would be harder to design research methods to detect these mergers.
The empirical literature on killer acquisitions in the tech sector is still in its infancy. But, as things stand, no study directly examines whether killer acquisitions actually take place in digital industries (i.e., whether post-merger project discontinuations are more common in overlapping than non-overlapping tech mergers). This is notably the case for studies by Axel Gautier & Joe Lamesch, and Elena Argentesi and her co-authors. Instead, these studies merely show that product discontinuations are common after an acquisition by a big tech company.
To summarize, while studies of this sort might suggest that the clearance of certain mergers might not have been optimal, it is hardly a sufficient basis on which to argue that enforcement should be tightened.
The reason for this is simple. The fact that some anticompetitive mergers may have escaped scrutiny and/or condemnation is never a sufficient basis to tighten rules. For that, it is also necessary to factor in the administrative costs of increased enforcement, as well as potential false convictions to which it might give rise. As things stand, economic research on killer acquisitions in the tech sector does not warrant tougher antitrust enforcement, though it does show the need for further empirical research on the topic.
Many proposed merger-enforcement reforms risk throwing the baby out with the bathwater. Mergers are largely beneficial to society (here, here and here); anticompetitive ones are rare; and there is little way, at the margin, to tell good from bad. To put it mildly, there is a precious baby that needs to be preserved and relatively little bathwater to throw out.
Take the fulcrum of policy debates that is the pharmaceutical industry. It is not hard to point to pharmaceutical mergers (or long-term agreements) that have revolutionized patient outcomes. Most recently, Pfizer and BioNTech’s efforts to successfully market an mRNA vaccine against COVID-19 offers a case in point.
The deal struck by both firms could naïvely be construed as bearing hallmarks of a killer acquisition or an anticompetitive agreement (long-term agreements can easily fall into either of these categories). Pfizer was a powerful incumbent in the vaccine industry; BioNTech threatened to disrupt the industry with new technology; and the deal likely caused Pfizer to forgo some independent R&D efforts. And yet, it also led to the first approved COVID-19 vaccine and groundbreaking advances in vaccine technology.
Of course, the counterfactual is unclear, and the market might be more competitive absent the deal, just as there might be only one approved mRNA vaccine today instead of two—we simply do not know. More importantly, this counterfactual was even less knowable at the time of the deal. And much the same could be said about countless other pharmaceutical mergers.
The key policy question is how authorities should handle this uncertainty. Critics of the status quo argue that current rules and thresholds leave certain anticompetitive deals unchallenged. But these calls for tougher enforcement fail to satisfy the requirements of the error-cost framework. Critics have so far failed to show that, on balance, mergers harm social welfare—even overlapping ones or mergers between potential competitors—just as they are yet to suggest alternative institutional arrangements that would improve social welfare.
In other words, they mistakenly analyze purported false negatives of merger-enforcement regimes in isolation. In doing so, they ignore how measures that aim to reduce such judicial errors may lead to other errors, as well as higher enforcement costs. In short, they paint a world where policy decisions involve facile tradeoffs, and this undermines their policy recommendations.
Given these significant limitations, this body of academic research should be met with an appropriate degree of caution. For all the criticism it has faced, the current merger-review system is mostly a resounding success. It is administrable, predictable, and timely. Yet it also eliminates a vast majority of judicial errors: even its critics concede that false negatives make up only a tiny fraction of decisions. Policymakers must decide whether the benefits from catching the very few arguably anticompetitive mergers that currently escape prosecution outweigh the significant costs that are required to achieve this goal. There is currently little evidence to suggest that this is, indeed, the case.
The language of the federal antitrust laws is extremely general. Over more than a century, the federal courts have applied common-law techniques to construe this general language to provide guidance to the private sector as to what does or does not run afoul of the law. The interpretive process has been fraught with some uncertainty, as judicial approaches to antitrust analysis have changed several times over the past century. Nevertheless, until very recently, judges and enforcers had converged toward relying on a consumer welfare standard as the touchstone for antitrust evaluations (see my antitrust primer here, for an overview).
While imperfect and subject to potential error in application—a problem of legal interpretation generally—the consumer welfare principle has worked rather well as the focus both for antitrust-enforcement guidance and judicial decision-making. The general stability and predictability of antitrust under a consumer welfare framework has advanced the rule of law. It has given businesses sufficient information to plan transactions in a manner likely to avoid antitrust liability. It thereby has cabined uncertainty and increased the probability that private parties would enter welfare-enhancing commercial arrangements, to the benefit of society.
In a very thoughtful 2017 speech, then Acting Assistant Attorney General for Antitrust Andrew Finch commented on the importance of the rule of law to principled antitrust enforcement. He noted:
[H]ow do we administer the antitrust laws more rationally, accurately, expeditiously, and efficiently? … Law enforcement requires stability and continuity both in rules and in their application to specific cases.
Indeed, stability and continuity in enforcement are fundamental to the rule of law. The rule of law is about notice and reliance. When it is impossible to make reasonable predictions about how a law will be applied, or what the legal consequences of conduct will be, these important values are diminished. To call our antitrust regime a “rule of law” regime, we must enforce the law as written and as interpreted by the courts and advance change with careful thought.
The reliance fostered by stability and continuity has obvious economic benefits. Businesses invest, not only in innovation but in facilities, marketing, and personnel, and they do so based on the economic and legal environment they expect to face.
Of course, we want businesses to make those investments—and shape their overall conduct—in accordance with the antitrust laws. But to do so, they need to be able to rely on future application of those laws being largely consistent with their expectations. An antitrust enforcement regime with frequent changes is one that businesses cannot plan for, or one that they will plan for by avoiding certain kinds of investments.
That is certainly not to say there has not been positive change in the antitrust laws in the past, or that we would have been better off without those changes. U.S. antitrust law has been refined, and occasionally recalibrated, with the courts playing their appropriate interpretive role. And enforcers must always be on the watch for new or evolving threats to competition. As markets evolve and products develop over time, our analysis adapts. But as those changes occur, we pursue reliability and consistency in application in the antitrust laws as much as possible.
Indeed, we have enjoyed remarkable continuity and consensus for many years. Antitrust law in the U.S. has not been a “paradox” for quite some time, but rather a stable and valuable law enforcement regime with appropriately widespread support.
Unfortunately, policy decisions taken by the new Federal Trade Commission (FTC) leadership in recent weeks have rejected antitrust continuity and consensus. They have injected substantial uncertainty into the application of competition-law enforcement by the FTC. This abrupt change in emphasis undermines the rule of law and threatens to reduce economic welfare.
As of now, the FTC’s departure from the rule of law has been notable in two areas:
Its rejection of previous guidance on the agency’s “unfair methods of competition” authority, the FTC’s primary non-merger-related enforcement tool; and
Its new advice rejecting time limits for the review of generally routine proposed mergers.
In addition, potential FTC rulemakings directed at “unfair methods of competition” would, if pursued, prove highly problematic.
Rescission of the Unfair Methods of Competition Policy Statement
The bipartisan UMC Policy Statement has originally been supported by all three Democratic commissioners, including then-Chairwoman Edith Ramirez. The policy statement generally respected and promoted the rule of law by emphasizing that, in applying the facially broad “unfair methods of competition” (UMC) language, the FTC would be guided by the well-established principles of the antitrust rule of reason (including considering any associated cognizable efficiencies and business justifications) and the consumer welfare standard. The FTC also explained that it would not apply “standalone” Section 5 theories to conduct that would violate the Sherman or Clayton Acts.
In short, the UMC Policy Statement sent a strong signal that the commission would apply UMC in a manner fully consistent with accepted and well-understood antitrust policy principles. As in the past, the vast bulk of FTC Section 5 prosecutions would be brought against conduct that violated the core antitrust laws. Standalone Section 5 cases would be directed solely at those few practices that harmed consumer welfare and competition, but somehow fell into a narrow crack in the basic antitrust statutes (such as, perhaps, “invitations to collude” that lack plausible efficiency justifications). Although the UMC Statement did not answer all questions regarding what specific practices would justify standalone UMC challenges, it substantially limited business uncertainty by bringing Section 5 within the boundaries of settled antitrust doctrine.
The FTC’s announcement of the UMC Policy Statement rescission unhelpfully proclaimed that “the time is right for the Commission to rethink its approach and to recommit to its mandate to police unfair methods of competition even if they are outside the ambit of the Sherman or Clayton Acts.” As a dissenting statement by Commissioner Christine S. Wilson warned, consumers would be harmed by the commission’s decision to prioritize other unnamed interests. And as Commissioner Noah Joshua Phillips stressed in his dissent, the end result would be reduced guidance and greater uncertainty.
In sum, by suddenly leaving private parties in the dark as to how to conform themselves to Section 5’s UMC requirements, the FTC’s rescission offends the rule of law.
New Guidance to Parties Considering Mergers
For decades, parties proposing mergers that are subject to statutory Hart-Scott-Rodino (HSR) Act pre-merger notification requirements have operated under the understanding that:
The FTC and U.S. Justice Department (DOJ) will routinely grant “early termination” of review (before the end of the initial 30-day statutory review period) to those transactions posing no plausible competitive threat; and
An enforcement agency’s decision not to request more detailed documents (“second requests”) after an initial 30-day pre-merger review effectively serves as an antitrust “green light” for the proposed acquisition to proceed.
Those understandings, though not statutorily mandated, have significantly reduced antitrust uncertainty and related costs in the planning of routine merger transactions. The rule of law has been advanced through an effective assurance that business combinations that appear presumptively lawful will not be the target of future government legal harassment. This has advanced efficiency in government, as well; it is a cost-beneficial optimal use of resources for DOJ and the FTC to focus exclusively on those proposed mergers that present a substantial potential threat to consumer welfare.
Two recent FTC pronouncements (one in tandem with DOJ), however, have generated great uncertainty by disavowing (at least temporarily) those two welfare-promoting review policies. Joined by DOJ, the FTC on Feb. 4 announced that the agencies would temporarily suspend early terminations, citing an “unprecedented volume of filings” and a transition to new leadership. More than six months later, this “temporary” suspension remains in effect.
Citing “capacity constraints” and a “tidal wave of merger filings,” the FTC subsequently published an Aug. 3 blog post that effectively abrogated the 30-day “green lighting” of mergers not subject to a second request. It announced that it was sending “warning letters” to firms reminding them that FTC investigations remain open after the initial 30-day period, and that “[c]ompanies that choose to proceed with transactions that have not been fully investigated are doing so at their own risk.”
The FTC’s actions interject unwarranted uncertainty into merger planning and undermine the rule of law. Preventing early termination on transactions that have been approved routinely not only imposes additional costs on business; it hints that some transactions might be subject to novel theories of liability that fall outside the antitrust consensus.
[T]he FTC may challenge deals that “threaten to reduce competition and harm consumers, workers, and honest businesses.” Adding in harm to both “workers and honest businesses” implies that the FTC may be considering more ways that transactions can have an adverse impact other than just harm to competition and consumers [citation omitted].
Because consensus antitrust merger analysis centers on consumer welfare, not the protection of labor or business interests, any suggestion that the FTC may be extending its reach to these new areas is inconsistent with established legal principles and generates new business-planning risks.
More generally, the Aug. 6 FTC “blog post could be viewed as an attempt to modify the temporal framework of the HSR Act”—in effect, an effort to displace an implicit statutory understanding in favor of an agency diktat, contrary to the rule of law. Commissioner Wilson sees the blog post as a means to keep investigations open indefinitely and, thus, an attack on the decades-old HSR framework for handling most merger reviews in an expeditious fashion (see here). Commissioner Phillips is concerned about an attempt to chill legal M&A transactions across the board, particularly unfortunate when there is no reason to conclude that particular transactions are illegal (see here).
Finally, the historical record raises serious questions about the “resource constraint” justification for the FTC’s new merger review policies:
Through the end of July 2021, more than 2,900 transactions were reported to the FTC. It is not clear, however, whether these record-breaking HSR filing numbers have led (or will lead) to more deals being investigated. Historically, only about 13 percent of all deals reported are investigated in some fashion, and roughly 3 percent of all deals reported receive a more thorough, substantive review through the issuance of a Second Request. Even if more deals are being reported, for the majority of transactions, the HSR process is purely administrative, raising no antitrust concerns, and, theoretically, uses few, if any, agency resources. [Citations omitted.]
Proposed FTC Competition Rulemakings
The new FTC leadership is strongly considering competition rulemakings. As I explained in a recent Truth on the Market post, such rulemakings would fail a cost-benefit test. They raise serious legal risks for the commission and could impose wasted resource costs on the FTC and on private parties. More significantly, they would raise two very serious economic policy concerns:
First, competition rules would generate higher error costs than adjudications. Adjudications cabin error costs by allowing for case-specific analysis of likely competitive harms and procompetitive benefits. In contrast, competition rules inherently would be overbroad and would suffer from a very high rate of false positives. By characterizing certain practices as inherently anticompetitive without allowing for consideration of case-specific facts bearing on actual competitive effects, findings of rule violations inevitably would condemn some (perhaps many) efficient arrangements.
Second, competition rules would undermine the rule of law and thereby reduce economic welfare. FTC-only competition rules could lead to disparate legal treatment of a firm’s business practices, depending upon whether the FTC or the U.S. Justice Department was the investigating agency. Also, economic efficiency gains could be lost due to the chilling of aggressive efficiency-seeking business arrangements in those sectors subject to rules. [Emphasis added.]
In short, common law antitrust adjudication, focused on the consumer welfare standard, has done a good job of promoting a vibrant competitive economy in an efficient fashion. FTC competition rulemaking would not.
Recent FTC actions have undermined consensus antitrust-enforcement standards and have departed from established merger-review procedures with respect to seemingly uncontroversial consolidations. Those decisions have imposed costly uncertainty on the business sector and are thereby likely to disincentivize efficiency-seeking arrangements. What’s more, by implicitly rejecting consensus antitrust principles, they denigrate the primacy of the rule of law in antitrust enforcement. The FTC’s pursuit of competition rulemaking would further damage the rule of law by imposing arbitrary strictures that ignore matter-specific considerations bearing on the justifications for particular business decisions.
Fortunately, these are early days in the Biden administration. The problematic initial policy decisions delineated in this comment could be reversed based on further reflection and deliberation within the commission. Chairwoman Lina Khan and her fellow Democratic commissioners would benefit by consulting more closely with Commissioners Wilson and Phillips to reach agreement on substantive and procedural enforcement policies that are better tailored to promote consumer welfare and enhance vibrant competition. Such policies would benefit the U.S. economy in a manner consistent with the rule of law.
U.S. and European competition laws diverge in numerous ways that have important real-world effects. Understanding these differences is vital, particularly as lawmakers in the United States, and the rest of the world, consider adopting a more “European” approach to competition.
In broad terms, the European approach is more centralized and political. The European Commission’s Directorate General for Competition (DG Comp) has significant de facto discretion over how the law is enforced. This contrasts with the common law approach of the United States, in which courts elaborate upon open-ended statutes through an iterative process of case law. In other words, the European system was built from the top down, while U.S. antitrust relies on a bottom-up approach, derived from arguments made by litigants (including the government antitrust agencies) and defendants (usually businesses).
This procedural divergence has significant ramifications for substantive law. European competition law includes more provisions akin to de facto regulation. This is notably the case for the “abuse of dominance” standard, in which a “dominant” business can be prosecuted for “abusing” its position by charging high prices or refusing to deal with competitors. By contrast, the U.S. system places more emphasis on actual consumer outcomes, rather than the nature or “fairness” of an underlying practice.
The American system thus affords firms more leeway to exclude their rivals, so long as this entails superior benefits for consumers. This may make the U.S. system more hospitable to innovation, since there is no built-in regulation of conduct for innovators who acquire a successful market position fairly and through normal competition.
In this post, we discuss some key differences between the two systems—including in areas like predatory pricing and refusals to deal—as well as the discretionary power the European Commission enjoys under the European model.
U.S. antitrust is, by and large, unconcerned with companies charging what some might consider “excessive” prices. The late Associate Justice Antonin Scalia, writing for the Supreme Court majority in the 2003 case Verizon v. Trinko, observed that:
The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices—at least for a short period—is what attracts “business acumen” in the first place; it induces risk taking that produces innovation and economic growth.
This contrasts with European competition-law cases, where firms may be found to have infringed competition law because they charged excessive prices. As the European Court of Justice (ECJ) held in 1978’s United Brands case: “In this case charging a price which is excessive because it has no reasonable relation to the economic value of the product supplied would be such an abuse.”
While United Brands was the EU’s foundational case for excessive pricing, and the European Commission reiterated that these allegedly exploitative abuses were possible when it published its guidance paper on abuse of dominance cases in 2009, the commission had for some time demonstrated apparent disinterest in bringing such cases. In recent years, however, both the European Commission and some national authorities have shown renewed interest in excessive-pricing cases, most notably in the pharmaceutical sector.
European competition law also penalizes so-called “margin squeeze” abuses, in which a dominant upstream supplier charges a price to distributors that is too high for them to compete effectively with that same dominant firm downstream:
[I]t is for the referring court to examine, in essence, whether the pricing practice introduced by TeliaSonera is unfair in so far as it squeezes the margins of its competitors on the retail market for broadband connection services to end users. (Konkurrensverket v TeliaSonera Sverige, 2011)
As Scalia observed in Trinko, forcing firms to charge prices that are below a market’s natural equilibrium affects firms’ incentives to enter markets, notably with innovative products and more efficient means of production. But the problem is not just one of market entry and innovation. Also relevant is the degree to which competition authorities are competent to determine the “right” prices or margins.
As Friedrich Hayek demonstrated in his influential 1945 essay The Use of Knowledge in Society, economic agents use information gleaned from prices to guide their business decisions. It is this distributed activity of thousands or millions of economic actors that enables markets to put resources to their most valuable uses, thereby leading to more efficient societies. By comparison, the efforts of central regulators to set prices and margins is necessarily inferior; there is simply no reasonable way for competition regulators to make such judgments in a consistent and reliable manner.
Given the substantial risk that investigations into purportedly excessive prices will deter market entry, such investigations should be circumscribed. But the court’s precedents, with their myopic focus on ex post prices, do not impose such constraints on the commission. The temptation to “correct” high prices—especially in the politically contentious pharmaceutical industry—may thus induce economically unjustified and ultimately deleterious intervention.
Monopolists must charge prices that are below some measure of their incremental costs; and
There must be a realistic prospect that they will able to recoup these initial losses.
In laying out its approach to predatory pricing, the U.S. Supreme Court has identified the risk of false positives and the clear cost of such errors to consumers. It thus has particularly stressed the importance of the recoupment requirement. As the court found in 1993’s Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., without recoupment, “predatory pricing produces lower aggregate prices in the market, and consumer welfare is enhanced.”
Accordingly, U.S. authorities must prove that there are constraints that prevent rival firms from entering the market after the predation scheme, or that the scheme itself would effectively foreclose rivals from entering the market in the first place. Otherwise, the predator would be undercut by competitors as soon as it attempts to recoup its losses by charging supra-competitive prices.
Without the strong likelihood that a monopolist will be able to recoup lost revenue from underpricing, the overwhelming weight of economic evidence (to say nothing of simple logic) is that predatory pricing is not a rational business strategy. Thus, apparent cases of predatory pricing are most likely not, in fact, predatory; deterring or punishing them would actually harm consumers.
[I]t does not follow from the case‑law of the Court that proof of the possibility of recoupment of losses suffered by the application, by an undertaking in a dominant position, of prices lower than a certain level of costs constitutes a necessary precondition to establishing that such a pricing policy is abusive. (France Télécom v Commission, 2009).
This aspect of the legal standard has no basis in economic theory or evidence—not even in the “strategic” economic theory that arguably challenges the dominant Chicago School understanding of predatory pricing. Indeed, strategic predatory pricing still requires some form of recoupment, and the refutation of any convincing business justification offered in response. For example, in a 2017 piece for the Antitrust Law Journal, Steven Salop lays out the “raising rivals’ costs” analysis of predation and notes that recoupment still occurs, just at the same time as predation:
[T]he anticompetitive conditional pricing practice does not involve discrete predatory and recoupment periods, as in the case of classical predatory pricing. Instead, the recoupment occurs simultaneously with the conduct. This is because the monopolist is able to maintain its current monopoly power through the exclusionary conduct.
The case of predatory pricing illustrates a crucial distinction between European and American competition law. The recoupment requirement embodied in American antitrust law serves to differentiate aggressive pricing behavior that improves consumer welfare—because it leads to overall price decreases—from predatory pricing that reduces welfare with higher prices. It is, in other words, entirely focused on the welfare of consumers.
The European approach, by contrast, reflects structuralist considerations far removed from a concern for consumer welfare. Its underlying fear is that dominant companies could use aggressive pricing to engender more concentrated markets. It is simply presumed that these more concentrated markets are invariably detrimental to consumers. Both the Tetra Pak and France Télécom cases offer clear illustrations of the ECJ’s reasoning on this point:
[I]t would not be appropriate, in the circumstances of the present case, to require in addition proof that Tetra Pak had a realistic chance of recouping its losses. It must be possible to penalize predatory pricing whenever there is a risk that competitors will be eliminated… The aim pursued, which is to maintain undistorted competition, rules out waiting until such a strategy leads to the actual elimination of competitors. (Tetra Pak v Commission, 1996).
[T]he lack of any possibility of recoupment of losses is not sufficient to prevent the undertaking concerned reinforcing its dominant position, in particular, following the withdrawal from the market of one or a number of its competitors, so that the degree of competition existing on the market, already weakened precisely because of the presence of the undertaking concerned, is further reduced and customers suffer loss as a result of the limitation of the choices available to them. (France Télécom v Commission, 2009).
In short, the European approach leaves less room to analyze the concrete effects of a given pricing scheme, leaving it more prone to false positives than the U.S. standard explicated in the Brooke Group decision. Worse still, the European approach ignores not only the benefits that consumers may derive from lower prices, but also the chilling effect that broad predatory pricing standards may exert on firms that would otherwise seek to use aggressive pricing schemes to attract consumers.
Refusals to Deal
U.S. and EU antitrust law also differ greatly when it comes to refusals to deal. While the United States has limited the ability of either enforcement authorities or rivals to bring such cases, EU competition law sets a far lower threshold for liability.
As Justice Scalia wrote in Trinko:
Aspen Skiing is at or near the outer boundary of §2 liability. The Court there found significance in the defendant’s decision to cease participation in a cooperative venture. The unilateral termination of a voluntary (and thus presumably profitable) course of dealing suggested a willingness to forsake short-term profits to achieve an anticompetitive end. (Verizon v Trinko, 2003.)
This highlights two key features of American antitrust law with regard to refusals to deal. To start, U.S. antitrust law generally does not apply the “essential facilities” doctrine.Accordingly, in the absence of exceptional facts, upstream monopolists are rarely required to supply their product to downstream rivals, even if that supply is “essential” for effective competition in the downstream market. Moreover, as Justice Scalia observed in Trinko, the Aspen Skiing case appears to concern only those limited instances where a firm’s refusal to deal stems from the termination of a preexisting and profitable business relationship.
While even this is not likely the economically appropriate limitation on liability, its impetus—ensuring that liability is found only in situations where procompetitive explanations for the challenged conduct are unlikely—is completely appropriate for a regime concerned with minimizing the cost to consumers of erroneous enforcement decisions.
In practice, however, all of these conditions have been relaxed significantly by EU courts and the commission’s decisional practice. This is best evidenced by the lower court’s Microsoft ruling where, as John Vickers notes:
[T]he Court found easily in favor of the Commission on the IMS Health criteria, which it interpreted surprisingly elastically, and without relying on the special factors emphasized by the Commission. For example, to meet the “new product” condition it was unnecessary to identify a particular new product… thwarted by the refusal to supply but sufficient merely to show limitation of technical development in terms of less incentive for competitors to innovate.
EU competition law thus shows far less concern for its potential chilling effect on firms’ investments than does U.S. antitrust law.
There are vast differences between U.S. and EU competition law relating to vertical restraints—that is, contractual restraints between firms that operate at different levels of the production process.
On the one hand, since the Supreme Court’s Leegin ruling in 2006, even price-related vertical restraints (such as resale price maintenance (RPM), under which a manufacturer can stipulate the prices at which retailers must sell its products) are assessed under the rule of reason in the United States. Some commentators have gone so far as to say that, in practice, U.S. case law on RPM almost amounts to per se legality.
Furthermore, in the Consten and Grundig ruling, the ECJ rejected the consequentialist, and economically grounded, principle that inter-brand competition is the appropriate framework to assess vertical restraints:
This treatment of vertical restrictions flies in the face of longstanding mainstream economic analysis of the subject. As Patrick Rey and Jean Tirole conclude:
Another major contribution of the earlier literature on vertical restraints is to have shown that per se illegality of such restraints has no economic foundations.
Unlike the EU, the U.S. Supreme Court in Leegintook account of the weight of the economic literature, and changed its approach to RPM to ensure that the law no longer simply precluded its arguable consumer benefits, writing: “Though each side of the debate can find sources to support its position, it suffices to say here that economics literature is replete with procompetitive justifications for a manufacturer’s use of resale price maintenance.” Further, the court found that the prior approach to resale price maintenance restraints “hinders competition and consumer welfare because manufacturers are forced to engage in second-best alternatives and because consumers are required to shoulder the increased expense of the inferior practices.”
The EU’s continued per se treatment of RPM, by contrast, strongly reflects its “precautionary principle” approach to antitrust. European regulators and courts readily condemn conduct that could conceivably injure consumers, even where such injury is, according to the best economic understanding, exceedingly unlikely. The U.S. approach, which rests on likelihood rather than mere possibility, is far less likely to condemn beneficial conduct erroneously.
Political Discretion in European Competition Law
EU competition law lacks a coherent analytical framework like that found in U.S. law’s reliance on the consumer welfare standard. The EU process is driven by a number of laterally equivalent—and sometimes mutually exclusive—goals, including industrial policy and the perceived need to counteract foreign state ownership and subsidies. Such a wide array of conflicting aims produces lack of clarity for firms seeking to conduct business. Moreover, the discretion that attends this fluid arrangement of goals yields an even larger problem.
The Microsoft case illustrates this problem well. In Microsoft, the commission could have chosen to base its decision on various potential objectives. It notably chose to base its findings on the fact that Microsoft’s behavior reduced “consumer choice.”
The commission, in fact, discounted arguments that economic efficiency may lead to consumer welfare gains, because it determined “consumer choice” among media players was more important:
Another argument relating to reduced transaction costs consists in saying that the economies made by a tied sale of two products saves resources otherwise spent for maintaining a separate distribution system for the second product. These economies would then be passed on to customers who could save costs related to a second purchasing act, including selection and installation of the product. Irrespective of the accuracy of the assumption that distributive efficiency gains are necessarily passed on to consumers, such savings cannot possibly outweigh the distortion of competition in this case. This is because distribution costs in software licensing are insignificant; a copy of a software programme can be duplicated and distributed at no substantial effort. In contrast, the importance of consumer choice and innovation regarding applications such as media players is high. (Commission Decision No. COMP. 37792 (Microsoft)).
It may be true that tying the products in question was unnecessary. But merely dismissing this decision because distribution costs are near-zero is hardly an analytically satisfactory response. There are many more costs involved in creating and distributing complementary software than those associated with hosting and downloading. The commission also simply asserts that consumer choice among some arbitrary number of competing products is necessarily a benefit. This, too, is not necessarily true, and the decision’s implication that any marginal increase in choice is more valuable than any gains from product design or innovation is analytically incoherent.
The Court of First Instance was only too happy to give the commission a pass in its breezy analysis; it saw no objection to these findings. With little substantive reasoning to support its findings, the court fully endorsed the commission’s assessment:
As the Commission correctly observes (see paragraph 1130 above), by such an argument Microsoft is in fact claiming that the integration of Windows Media Player in Windows and the marketing of Windows in that form alone lead to the de facto standardisation of the Windows Media Player platform, which has beneficial effects on the market. Although, generally, standardisation may effectively present certain advantages, it cannot be allowed to be imposed unilaterally by an undertaking in a dominant position by means of tying.
The Court further notes that it cannot be ruled out that third parties will not want the de facto standardisation advocated by Microsoft but will prefer it if different platforms continue to compete, on the ground that that will stimulate innovation between the various platforms. (Microsoft Corp. v Commission, 2007)
Pointing to these conflicting effects of Microsoft’s bundling decision, without weighing either, is a weak basis to uphold the commission’s decision that consumer choice outweighs the benefits of standardization. Moreover, actions undertaken by other firms to enhance consumer choice at the expense of standardization are, on these terms, potentially just as problematic. The dividing line becomes solely which theory the commission prefers to pursue.
What such a practice does is vest the commission with immense discretionary power. Any given case sets up a “heads, I win; tails, you lose” situation in which defendants are easily outflanked by a commission that can change the rules of its analysis as it sees fit. Defendants can play only the cards that they are dealt. Accordingly, Microsoft could not successfully challenge a conclusion that its behavior harmed consumers’ choice by arguing that it improved consumer welfare, on net.
By selecting, in this instance, “consumer choice” as the standard to be judged, the commission was able to evade the constraints that might have been imposed by a more robust welfare standard. Thus, the commission can essentially pick and choose the objectives that best serve its interests in each case. This vastly enlarges the scope of potential antitrust liability, while also substantially decreasing the ability of firms to predict when their behavior may be viewed as problematic. It leads to what, in U.S. courts, would be regarded as an untenable risk of false positives that chill innovative behavior and create nearly unwinnable battles for targeted firms.
This post is authored by Nicolas Petit himself, the Joint Chair in Competition Law at the Department of Law at European University Institute in Fiesole, Italy, and at EUI’s Robert Schuman Centre for Advanced Studies. He is also invited professor at the College of Europe in Bruges.]
A lot of water has gone under the bridge since my book was published last year. To close this symposium, I thought I would discuss the new phase of antirust statutorification taking place before our eyes. In the United States, Congress is working on five antitrust bills that propose to subject platforms to stringent obligations, including a ban on mergers and acquisitions, required data portability and interoperability, and line-of-business restrictions. In the European Union (EU), lawmakers are examining the proposed Digital Markets Act (“DMA”) that sets out a complicated regulatory system for digital “gatekeepers,” with per se behavioral limitations of their freedom over contractual terms, technological design, monetization, and ecosystem leadership.
Proponents of legislative reform on both sides of the Atlantic appear to share the common view that ongoing antitrust adjudication efforts are both instrumental and irrelevant. They are instrumental because government (or plaintiff) losses build the evidence needed to support the view that antitrust doctrine is exceedingly conservative, and that legal reform is needed. Two weeks ago, antitrust reform activists ran to Twitter to point out that the U.S. District Court dismissal of the Federal Trade Commission’s (FTC) complaint against Facebook was one more piece of evidence supporting the view that the antitrust pendulum needed to swing. They are instrumental because, again, government (or plaintiffs) wins will support scaling antitrust enforcement in the marginal case by adoption of governmental regulation. In the EU, antitrust cases follow each other almost like night the day, lending credence to the view that regulation will bring much needed coordination and economies of scale.
But both instrumentalities are, at the end of the line, irrelevant, because they lead to the same conclusion: legislative reform is long overdue. With this in mind, the logic of lawmakers is that they need not await the courts, and they can advance with haste and confidence toward the promulgation of new antitrust statutes.
The antitrust reform process that is unfolding is a cause for questioning. The issue is not legal reform in itself. There is no suggestion here that statutory reform is necessarily inferior, and no correlative reification of the judge-made-law method. Legislative intervention can occur for good reason, like when it breaks judicial inertia caused by ideological logjam.
The issue is rather one of precipitation. There is a lot of learning in the cases. The point, simply put, is that a supplementary court-legislative dialogue would yield additional information—or what Guido Calabresi has called “starting points” for regulation—that premature legislative intervention is sweeping under the rug. This issue is important because specification errors (see Doug Melamed’s symposium piece on this) in statutory legislation are not uncommon. Feedback from court cases create a factual record that will often be missing when lawmakers act too precipitously.
Moreover, a court-legislative iteration is useful when the issues in discussion are cross-cutting. The digital economy brings an abundance of them. As tech analysist Ben Evans has observed, data-sharing obligations raise tradeoffs between contestability and privacy. Chapter VI of my book shows that breakups of social networks or search engines might promote rivalry and, at the same time, increase the leverage of advertisers to extract more user data and conduct more targeted advertising. In such cases, Calabresi said, judges who know the legal topography are well-placed to elicit the preferences of society. He added that they are better placed than government agencies’ officials or delegated experts, who often attend to the immediate problem without the big picture in mind (all the more when officials are denied opportunities to engage with civil society and the press, as per the policy announced by the new FTC leadership).
Of course, there are three objections to this. The first consists of arguing that statutes are needed now because courts are too slow to deal with problems. The argument is not dissimilar to Frank Easterbrook’s concerns about irreversible harms to the economy, though with a tweak. Where Easterbook’s concern was one of ossification of Type I errors due to stare decisis, the concern here is one of entrenchment of durable monopoly power in the digital sector due to Type II errors. The concern, however, fails the test of evidence. The available data in both the United States and Europe shows unprecedented vitality in the digital sector. Venture capital funding cruises at historical heights, fueling new firm entry, business creation, and economic dynamism in the U.S. and EU digital sectors, topping all other industries. Unless we require higher levels of entry from digital markets than from other industries—or discount the social value of entry in the digital sector—this should give us reason to push pause on lawmaking efforts.
The second objection is that following an incremental process of updating the law through the courts creates intolerable uncertainty. But this objection, too, is unconvincing, at best. One may ask which of an abrupt legislative change of the law after decades of legal stability or of an experimental process of judicial renovation brings more uncertainty.
Besides, ad hoc statutes, such as the ones in discussion, are likely to pose quickly and dramatically the problem of their own legal obsolescence. Detailed and technical statutes specify rights, requirements, and procedures that often do not stand the test of time. For example, the DMA likely captures Windows as a core platform service subject to gatekeeping. But is the market power of Microsoft over Windows still relevant today, and isn’t it constrained in effect by existing antitrust rules? In antitrust, vagueness in critical statutory terms allows room for change. The best way to give meaning to buzzwords like “smart” or “future-proof” regulation consists of building in first principles, not in creating discretionary opportunities for permanent adaptation of the law. In reality, it is hard to see how the methods of future-proof regulation currently discussed in the EU creates less uncertainty than a court process.
The third objection is that we do not need more information, because we now benefit from economic knowledge showing that existing antitrust laws are too permissive of anticompetitive business conduct. But is the economic literature actually supportive of stricter rules against defendants than the rule-of-reason framework that applies in many unilateral conduct cases and in merger law? The answer is surely no. The theoretical economic literature has travelled a lot in the past 50 years. Of particular interest are works on network externalities, switching costs, and multi-sided markets. But the progress achieved in the economic understanding of markets is more descriptive than normative.
Take the celebrated multi-sided market theory. The main contribution of the theory is its advice to decision-makers to take the periscope out, so as to consider all possible welfare tradeoffs, not to be more or less defendant friendly. Payment cards provide a good example. Economic research suggests that any antitrust or regulatory intervention on prices affect tradeoffs between, and payoffs to, cardholders and merchants, cardholders and cash users, cardholders and banks, and banks and card systems. Equally numerous tradeoffs arise in many sectors of the digital economy, like ridesharing, targeted advertisement, or social networks. Multi-sided market theory renders these tradeoffs visible. But it does not come with a clear recipe for how to solve them. For that, one needs to follow first principles. A system of measurement that is flexible and welfare-based helps, as Kelly Fayne observed in her critical symposium piece on the book.
Another example might be worth considering. The theory of increasing returns suggests that markets subject to network effects tend to converge around the selection of a single technology standard, and it is not a given that the selected technology is the best one. One policy implication is that social planners might be justified in keeping a second option on the table. As I discuss in Chapter V of my book, the theory may support an M&A ban against platforms in tipped markets, on the conjecture that the assets of fringe firms might be efficiently repositioned to offer product differentiation to consumers. But the theory of increasing returns does not say under what conditions we can know that the selected technology is suboptimal. Moreover, if the selected technology is the optimal one, or if the suboptimal technology quickly obsolesces, are policy efforts at all needed?
Last, as Bo Heiden’s thought provoking symposium piece argues, it is not a given that antitrust enforcement of rivalry in markets is the best way to maintain an alternative technology alive, let alone to supply the innovation needed to deliver economic prosperity. Government procurement, science and technology policy, and intellectual-property policy might be equally effective (note that the fathers of the theory, like Brian Arthur or Paul David, have been very silent on antitrust reform).
There are, of course, exceptions to the limited normative content of modern economic theory. In some areas, economic theory is more predictive of consumer harms, like in relation to algorithmic collusion, interlocking directorates, or “killer” acquisitions. But the applications are discrete and industry-specific. All are insufficient to declare that the antitrust apparatus is dated and that it requires a full overhaul. When modern economic research turns normative, it is often way more subtle in its implications than some wild policy claims derived from it. For example, the emerging studies that claim to identify broad patterns of rising market power in the economy in no way lead to an implication that there are no pro-competitive mergers.
Similarly, the empirical picture of digital markets is incomplete. The past few years have seen a proliferation of qualitative research reports on industry structure in the digital sectors. Most suggest that industry concentration has risen, particularly in the digital sector. As with any research exercise, these reports’ findings deserve to be subject to critical examination before they can be deemed supportive of a claim of “sufficient experience.” Moreover, there is no reason to subject these reports to a lower standard of accountability on grounds that they have often been drafted by experts upon demand from antitrust agencies. After all, we academics are ethically obliged to be at least equally exacting with policy-based research as we are with science-based research.
Now, with healthy skepticism at the back of one’s mind, one can see immediately that the findings of expert reports to date have tended to downplay behavioral observations that counterbalance findings of monopoly power—such as intense business anxiety, technological innovation, and demand-expansion investments in digital markets. This was, I believe, the main takeaway from Chapter IV of my book. And less than six months ago, The Economist ran its leading story on the new marketplace reality of “Tech’s Big Dust-Up.”
Similarly, the expert reports did not really question the real possibility of competition for the purchase of regulation. As in the classic George Stigler paper, where the railroad industry fought motor-trucking competition with state regulation, the businesses that stand to lose most from the digital transformation might be rationally jockeying to convince lawmakers that not all business models are equal, and to steer regulation toward specific business models. Again, though we do not know how to consider this issue, there are signs that a coalition of large news corporations and the publishing oligopoly are behind many antitrust initiatives against digital firms.
Now, as is now clear from these few lines, my cautionary note against antitrust statutorification might be more relevant to the U.S. market. In the EU, sunk investments have been made, expectations have been created, and regulation has now become inevitable. The United States, however, has a chance to get this right. Court cases are the way to go. And unlike what the popular coverage suggests, the recent District Court dismissal of the FTC case far from ruled out the applicability of U.S. antitrust laws to Facebook’s alleged killer acquisitions. On the contrary, the ruling actually contains an invitation to rework a rushed complaint. Perhaps, as Shane Greenstein observed in his retrospective analysis of the U.S. Microsoft case, we would all benefit if we studied more carefully the learning that lies in the cases, rather than haste to produce instant antitrust analysis on Twitter that fits within 280 characters.
 But some threshold conditions like agreement or dominance might also become dated.
It will have some positive effects on economic welfare, to the extent it succeeds in lifting artificial barriers to competition that harm consumers and workers—such as allowing direct sales of hearing aids in drug stores—and helping to eliminate unnecessary occupational licensing restrictions, to name just two of several examples.
But it will likely have substantial negative effects on economic welfare as well. Many aspects of the order appear to emphasize new regulation—such as Net Neutrality requirements that may reduce investment in broadband by internet service providers—and imposing new regulatory requirements on airlines, pharmaceutical companies, digital platforms, banks, railways, shipping, and meat packers, among others. Arbitrarily imposing new rules in these areas, without a cost-beneficial appraisal and a showing of a market failure, threatens to reduce innovation and slow economic growth, hurting producers and consumer. (A careful review of specific regulatory proposals may shed greater light on the justifications for particular regulations.)
Antitrust-related proposals to challenge previously cleared mergers, and to impose new antitrust rulemaking, are likely to raise costly business uncertainty, to the detriment of businesses and consumers. They are a recipe for slower economic growth, not for vibrant competition.
An underlying problem with the order is that it is based on the false premise that competition has diminished significantly in recent decades and that “big is bad.” Economic analysis found in the February 2020 Economic Report of the President, and in other economic studies, debunks this flawed assumption.
In short, the order commits the fundamental mistake of proposing intrusive regulatory solutions for a largely nonexistent problem. Competitive issues are best handled through traditional well-accepted antitrust analysis, which centers on promoting consumer welfare and on weighing procompetitive efficiencies against anticompetitive harm on a case-by-case basis. This approach:
Deals effectively with serious competitive problems; while at the same time
Cabining error costs by taking into account all economically relevant considerations on a case-specific basis.
Rather than using an executive order to direct very specific regulatory approaches without a strong economic and factual basis, the Biden administration would have been better served by raising a host of competitive issues that merit possible study and investigation by expert agencies. Such an approach would have avoided imposing the costs of unwarranted regulation that unfortunately are likely to stem from the new order.
Finally, the order’s call for new regulations and the elimination of various existing legal policies will spawn matter-specific legal challenges, and may, in many cases, not succeed in court. This will impose unnecessary business uncertainty in addition to public and private resources wasted on litigation.
Advocates of legislative action to “reform” antitrust law have already pointed to the U.S. District Court for the District of Columbia’s dismissal of the state attorneys general’s case and the “conditional” dismissal of the Federal Trade Commission’s case against Facebook as evidence that federal antitrust case law is lax and demands correction. In fact, the court’s decisions support the opposite implication.
The Risks of Antitrust by Anecdote
The failure of a well-resourced federal regulator, and more than 45 state attorney-general offices, to avoid dismissal at an early stage of the litigation testifies to the dangers posed by a conclusory approach toward antitrust enforcement that seeks to unravel acquisitions consummated almost a decade ago without even demonstrating the factual predicates to support consideration of such far-reaching interventions. The dangers to the rule of law are self-evident. Irrespective of one’s views on the appropriate direction of antitrust law, this shortcut approach would substitute prosecutorial fiat, ideological predilection, and popular sentiment for decades of case law and agency guidelines grounded in the rigorous consideration of potential evidence of competitive harm.
The paucity of empirical support for the exceptional remedial action sought by the FTC is notable. As the district court observed, there was little systematic effort made to define the economically relevant market or provide objective evidence of market power, beyond the assertion that Facebook has a market share of “in excess of 60%.” Remarkably, the denominator behind that 60%-plus assertion is not precisely defined, since the FTC’s brief does not supply any clear metric by which to measure market share. As the court pointed out, this is a nontrivial task in multi-sided environments in which one side of the potentially relevant market delivers services to users at no charge.
While the point may seem uncontroversial, it is important to re-appreciate why insisting on a rigorous demonstration of market power is critical to preserving a coherent body of law that provides the market with a basis for reasonably anticipating the likelihood of antitrust intervention. At least since the late 1970s, courts have recognized that “big is not always bad” and can often yield cost savings that ultimately redound to consumers’ benefit. That is: firm size and consumer welfare do not stand in inherent opposition. If courts were to abandon safeguards against suits that cannot sufficiently define the relevant market and plausibly show market power, antitrust litigation could easily be used as a tool to punish successful firms that prevail over competitors simply by being more efficient. In other words: antitrust law could become a tool to preserve competitor welfare at the expense of consumer welfare.
The Specter of No-Fault Antitrust Liability
The absence of any specific demonstration of market power suggests deficient lawyering or the inability to gather supporting evidence. Giving the FTC litigation team the benefit of the doubt, the latter becomes the stronger possibility. If that is the case, this implies an effort to persuade courts to adopt a de facto rule of per se illegality for any firm that achieves a certain market share. (The same concept lies behind legislative proposals to bar acquisitions for firms that cross a certain revenue or market capitalization threshold.) Effectively, any firm that reached a certain size would operate under the presumption that it has market power and has secured or maintained such power due to anticompetitive practices, rather than business prowess. This would effectively convert leading digital platforms into quasi-public utilities subject to continuous regulatory intervention. Such an approach runs counter to antitrust law’s mission to preserve, rather than displace, private ordering by market forces.
Even at the high-water point of post-World War II antitrust zealotry (a period that ultimately ended in economic malaise), proposals to adopt a rule of no-fault liability for alleged monopolization were rejected. This was for good reason. Any such rule would likely injure consumers by precluding them from enjoying the cost savings that result from the “sweet spot” scenario in which the scale and scope economies of large firms are combined with sufficiently competitive conditions to yield reduced prices and increased convenience for consumers. Additionally, any such rule would eliminate incumbents’ incentives to work harder to offer consumers reduced prices and increased convenience, since any market share preserved or acquired as a result would simply invite antitrust scrutiny as a reward.
Remembering Why Market Power Matters
To be clear, this is not to say that “Big Tech” does not deserve close antitrust scrutiny, does not wield market power in certain segments, or has not potentially engaged in anticompetitive practices. The fundamental point is that assertions of market power and anticompetitive conduct must be demonstrated, rather than being assumed or “proved” based largely on suggestive anecdotes.
Perhaps market power will be shown sufficiently in Facebook’s case if the FTC elects to respond to the court’s invitation to resubmit its brief with a plausible definition of the relevant market and indication of market power at this stage of the litigation. If that threshold is satisfied, then thorough consideration of the allegedly anticompetitive effect of Facebook’s WhatsApp and Instagram acquisitions may be merited. However, given the policy interest in preserving the market’s confidence in relying on the merger-review process under the Hart-Scott-Rodino Act, the burden of proof on the government should be appropriately enhanced to reflect the significant time that has elapsed since regulatory decisions not to intervene in those transactions.
It would once have seemed mundane to reiterate that market power must be reasonably demonstrated to support a monopolization claim that could lead to a major divestiture remedy. Given the populist thinking that now leads much of the legislative and regulatory discussion on antitrust policy, it is imperative to reiterate the rationale behind this elementary principle.
This principle reflects the fact that, outside collusion scenarios, antitrust law is typically engaged in a complex exercise to balance the advantages of scale against the risks of anticompetitive conduct. At its best, antitrust law weighs competing facts in a good faith effort to assess the net competitive harm posed by a particular practice. While this exercise can be challenging in digital markets that naturally converge upon a handful of leading platforms or multi-dimensional markets that can have offsetting pro- and anti-competitive effects, these are not reasons to treat such an exercise as an anachronistic nuisance. Antitrust cases are inherently challenging and proposed reforms to make them easier to win are likely to endanger, rather than preserve, competitive markets.
There is little doubt that Federal Trade Commission (FTC) unfair methods of competition rulemaking proceedings are in the offing. Newly named FTC Chair Lina Khan and Commissioner Rohit Chopra both have extolled the benefits of competition rulemaking in a major law review article. What’s more, in May, Commissioner Rebecca Slaughter (during her stint as acting chair) established a rulemaking unit in the commission’s Office of General Counsel empowered to “explore new rulemakings to prohibit unfair or deceptive practices and unfair methods of competition” (emphasis added).
In short, a majority of sitting FTC commissioners apparently endorse competition rulemaking proceedings. As such, it is timely to ask whether FTC competition rules would promote consumer welfare, the paramount goal of competition policy.
In a recently published Mercatus Center research paper, I assess the case for competition rulemaking from a competition perspective and find it wanting. I conclude that, before proceeding, the FTC should carefully consider whether such rulemakings would be cost-beneficial. I explain that any cost-benefit appraisal should weigh both the legal risks and the potential economic policy concerns (error costs and “rule of law” harms). Based on these considerations, competition rulemaking is inappropriate. The FTC should stick with antitrust enforcement as its primary tool for strengthening the competitive process and thereby promoting consumer welfare.
A summary of my paper follows.
Legal Risks of Competition Rulemaking
Section 6(g) of the original Federal Trade Commission Act authorizes the FTC “to make rules and regulations for the purpose of carrying out the provisions of this subchapter.” Section 6(g) rules are enacted pursuant to the “informal rulemaking” requirements of Section 553 of the Administrative Procedures Act (APA), which apply to the vast majority of federal agency rulemaking proceedings.
Before launching Section 6(g) competition rulemakings, however, the FTC would be well-advised first to weigh the legal risks and policy concerns associated with such an endeavor. Rulemakings are resource-intensive proceedings and should not lightly be undertaken without an eye to their feasibility and implications for FTC enforcement policy.
Only one appeals court decision addresses the scope of Section 6(g) rulemaking. In 1971, the FTC enacted a Section 6(g) rule stating that it was both an “unfair method of competition” and an “unfair act or practice” for refiners or others who sell to gasoline retailers “to fail to disclose clearly and conspicuously in a permanent manner on the pumps the minimum octane number or numbers of the motor gasoline being dispensed.” In 1973, in the National Petroleum Refiners case, the U.S. Court of Appeals for the D.C. Circuit upheld the FTC’s authority to promulgate this and other binding substantive rules. The court rejected the argument that Section 6(g) authorized only non-substantive regulations concerning regarding the FTC’s non-adjudicatory, investigative, and informative functions, spelled out elsewhere in Section 6.
In 1975, two years after National Petroleum Refiners was decided, Congress granted the FTC specific consumer-protection rulemaking authority (authorizing enactment of trade regulation rules dealing with unfair or deceptive acts or practices) through Section 202 of the Magnuson-Moss Warranty Act, which added Section 18 to the FTC Act. Magnuson-Moss rulemakings impose adjudicatory-type hearings and other specific requirements on the FTC, unlike more flexible section 6(g) APA informal rulemakings. However, the FTC can obtain civil penalties for violation of Magnuson-Moss rules, something it cannot do if 6(g) rules are violated.
In a recent set of public comments filed with the FTC, the Antitrust Section of the American Bar Association stated:
[T]he Commission’s [6(g)] rulemaking authority is buried in within an enumerated list of investigative powers, such as the power to require reports from corporations and partnerships, for example. Furthermore, the [FTC] Act fails to provide any sanctions for violating any rule adopted pursuant to Section 6(g). These two features strongly suggest that Congress did not intend to give the agency substantive rulemaking powers when it passed the Federal Trade Commission Act.
Rephrased, this argument suggests that the structure of the FTC Act indicates that the rulemaking referenced in Section 6(g) is best understood as an aid to FTC processes and investigations, not a source of substantive policymaking. Although the National Petroleum Refiners decision rejected such a reading, that ruling came at a time of significant judicial deference to federal agency activism, and may be dated.
The U.S. Supreme Court’s April 2021 decision in AMG Capital Management v. FTC further bolsters the “statutory structure” argument that Section 6(g) does not authorize substantive rulemaking. In AMG, the U.S. Supreme Court unanimously held that Section 13(b) of the FTC Act, which empowers the FTC to seek a “permanent injunction” to restrain an FTC Act violation, does not authorize the FTC to seek monetary relief from wrongdoers. The court’s opinion rejected the FTC’s argument that the term “permanent injunction” had historically been understood to include monetary relief. The court explained that the injunctive language was “buried” in a lengthy provision that focuses on injunctive, not monetary relief (note that the term “rules” is similarly “buried” within 6(g) language dealing with unrelated issues). The court also pointed to the structure of the FTC Act, with detailed and specific monetary-relief provisions found in Sections 5(l) and 19, as “confirm[ing] the conclusion” that Section 13(b) does not grant monetary relief.
By analogy, a court could point to Congress’ detailed enumeration of substantive rulemaking provisions in Section 18 (a mere two years after National Petroleum Refiners) as cutting against the claim that Section 6(g) can also be invoked to support substantive rulemaking. Finally, the Supreme Court in AMG flatly rejected several relatively recent appeals court decisions that upheld Section 13(b) monetary-relief authority. It follows that the FTC cannot confidently rely on judicial precedent (stemming from one arguably dated court decision, National Petroleum Refiners) to uphold its competition rulemaking authority.
In sum, the FTC will have to overcome serious fundamental legal challenges to its section 6(g) competition rulemaking authority if it seeks to promulgate competition rules.
Even if the FTC’s 6(g) authority is upheld, it faces three other types of litigation-related risks.
First, applying the nondelegation doctrine, courts might hold that the broad term “unfair methods of competition” does not provide the FTC “an intelligible principle” to guide the FTC’s exercise of discretion in rulemaking. Such a judicial holding would mean the FTC could not issue competition rules.
Second, a reviewing court might strike down individual proposed rules as “arbitrary and capricious” if, say, the court found that the FTC rulemaking record did not sufficiently take into account potentially procompetitive manifestations of a condemned practice.
Third, even if a final competition rule passes initial legal muster, applying its terms to individual businesses charged with rule violations may prove difficult. Individual businesses may seek to structure their conduct to evade the particular strictures of a rule, and changes in commercial practices may render less common the specific acts targeted by a rule’s language.
Economic Policy Concerns Raised by Competition Rulemaking
In addition to legal risks, any cost-benefit appraisal of FTC competition rulemaking should consider the economic policy concerns raised by competition rulemaking. These fall into two broad categories.
First, competition rules would generate higher error costs than adjudications. Adjudications cabin error costs by allowing for case-specific analysis of likely competitive harms and procompetitive benefits. In contrast, competition rules inherently would be overbroad and would suffer from a very high rate of false positives. By characterizing certain practices as inherently anticompetitive without allowing for consideration of case-specific facts bearing on actual competitive effects, findings of rule violations inevitably would condemn some (perhaps many) efficient arrangements.
Second, competition rules would undermine the rule of law and thereby reduce economic welfare. FTC-only competition rules could lead to disparate legal treatment of a firm’s business practices, depending upon whether the FTC or the U.S. Justice Department was the investigating agency. Also, economic efficiency gains could be lost due to the chilling of aggressive efficiency-seeking business arrangements in those sectors subject to rules.
A combination of legal risks and economic policy harms strongly counsels against the FTC’s promulgation of substantive competition rules.
First, litigation issues would consume FTC resources and add to the costly delays inherent in developing competition rules in the first place. The compounding of separate serious litigation risks suggests a significant probability that costs would be incurred in support of rules that ultimately would fail to be applied.
Second, even assuming competition rules were to be upheld, their application would raise serious economic policy questions. The inherent inflexibility of rule-based norms is ill-suited to deal with dynamic evolving market conditions, compared with matter-specific antitrust litigation that flexibly applies the latest economic thinking to particular circumstances. New competition rules would also exacerbate costly policy inconsistencies stemming from the existence of dual federal antitrust enforcement agencies, the FTC and the Justice Department.
In conclusion, an evaluation of rule-related legal risks and economic policy concerns demonstrates that a reallocation of some FTC enforcement resources to the development of competition rules would not be cost-effective. Continued sole reliance on case-by-case antitrust litigation would generate greater economic welfare than a mixture of litigation and competition rules.
Interrogations concerning the role that economic theory should play in policy decisions are nothing new. Milton Friedman famously drew a distinction between “positive” and “normative” economics, notably arguing that theoretical models were valuable, despite their unrealistic assumptions. Kenneth Arrow and Gerard Debreu’s highly theoretical work on General Equilibrium Theory is widely acknowledged as one of the most important achievements of modern economics.
But for all their intellectual value and academic merit, the use of models to inform policy decisions is not uncontroversial. There is indeed a long and unfortunate history of influential economic models turning out to be poor depictions (and predictors) of real-world outcomes.
This raises a key question: should policymakers use economic models to inform their decisions and, if so, how? This post uses the economics of externalities to illustrate both the virtues and pitfalls of economic modeling. Throughout economic history, externalities have routinely been cited to support claims of market failure and calls for government intervention. However, as explained below, these fears have frequently failed to withstand empirical scrutiny.
Today, similar models are touted to support government intervention in digital industries. Externalities are notably said to prevent consumers from switching between platforms, allegedly leading to unassailable barriers to entry and deficient venture-capital investment. Unfortunately, as explained below, the models that underpin these fears are highly abstracted and far removed from underlying market realities.
Ultimately, this post argues that, while models provide a powerful way of thinking about the world, naïvely transposing them to real-world settings is misguided. This is not to say that models are useless—quite the contrary. Indeed, “falsified” models can shed powerful light on economic behavior that would otherwise prove hard to understand.
Fears surrounding economic externalities are as old as modern economics. For example, in the 1950s, economists routinely cited bee pollination as a source of externalities and, ultimately, market failure.
The basic argument was straightforward: Bees and orchards provide each other with positive externalities. Bees cross-pollinate flowers and orchards contain vast amounts of nectar upon which bees feed, thus improving honey yields. Accordingly, several famous economists argued that there was a market failure; bees fly where they please and farmers cannot prevent bees from feeding on their blossoming flowers—allegedly causing underinvestment in both. This led James Meade to conclude:
[T]he apple-farmer provides to the beekeeper some of his factors free of charge. The apple-farmer is paid less than the value of his marginal social net product, and the beekeeper receives more than the value of his marginal social net product.
If, then, apple producers are unable to protect their equity in apple-nectar and markets do not impute to apple blossoms their correct shadow value, profit-maximizing decisions will fail correctly to allocate resources at the margin. There will be failure “by enforcement.” This is what I would call an ownership externality. It is essentially Meade’s “unpaid factor” case.
It took more than 20 years and painstaking research by Steven Cheung to conclusively debunk these assertions. So how did economic agents overcome this “insurmountable” market failure?
The answer, it turns out, was extremely simple. While bees do fly where they please, the relative placement of beehives and orchards has a tremendous impact on both fruit and honey yields. This is partly because bees have a very limited mean foraging range (roughly 2-3km). This left economic agents with ample scope to prevent free-riding.
Using these natural sources of excludability, they built a web of complex agreements that internalize the symbiotic virtues of beehives and fruit orchards. To cite Steven Cheung’s research:
Pollination contracts usually include stipulations regarding the number and strength of the colonies, the rental fee per hive, the time of delivery and removal of hives, the protection of bees from pesticide sprays, and the strategic placing of hives. Apiary lease contracts differ from pollination contracts in two essential aspects. One is, predictably, that the amount of apiary rent seldom depends on the number of colonies, since the farmer is interested only in obtaining the rent per apiary offered by the highest bidder. Second, the amount of apiary rent is not necessarily fixed. Paid mostly in honey, it may vary according to either the current honey yield or the honey yield of the preceding year.
But what of neighboring orchards? Wouldn’t these entail a more complex externality (i.e., could one orchard free-ride on agreements concluded between other orchards and neighboring apiaries)? Apparently not:
Acknowledging the complication, beekeepers and farmers are quick to point out that a social rule, or custom of the orchards, takes the place of explicit contracting: during the pollination period the owner of an orchard either keeps bees himself or hires as many hives per area as are employed in neighboring orchards of the same type. One failing to comply would be rated as a “bad neighbor,” it is said, and could expect a number of inconveniences imposed on him by other orchard owners. This customary matching of hive densities involves the exchange of gifts of the same kind, which apparently entails lower transaction costs than would be incurred under explicit contracting, where farmers would have to negotiate and make money payments to one another for the bee spillover.
In short, not only did the bee/orchard externality model fail, but it failed to account for extremely obvious counter-evidence. Even a rapid flip through the Yellow Pages (or, today, a search on Google) would have revealed a vibrant market for bee pollination. In short, the bee externalities, at least as presented in economic textbooks, were merely an economic “fable.” Unfortunately, they would not be the last.
Lighthouses provide another cautionary tale. Indeed, Henry Sidgwick, A.C. Pigou, John Stuart Mill, and Paul Samuelson all cited the externalities involved in the provision of lighthouse services as a source of market failure.
Here, too, the problem was allegedly straightforward. A lighthouse cannot prevent ships from free-riding on its services when they sail by it (i.e., it is mostly impossible to determine whether a ship has paid fees and to turn off the lighthouse if that is not the case). Hence there can be no efficient market for light dues (lighthouses were seen as a “public good”). As Paul Samuelson famously put it:
Take our earlier case of a lighthouse to warn against rocks. Its beam helps everyone in sight. A businessman could not build it for a profit, since he cannot claim a price from each user. This certainly is the kind of activity that governments would naturally undertake.
He added that:
[E]ven if the operators were able—say, by radar reconnaissance—to claim a toll from every nearby user, that fact would not necessarily make it socially optimal for this service to be provided like a private good at a market-determined individual price. Why not? Because it costs society zero extra cost to let one extra ship use the service; hence any ships discouraged from those waters by the requirement to pay a positive price will represent a social economic loss—even if the price charged to all is no more than enough to pay the long-run expenses of the lighthouse.
More than a century after it was first mentioned in economics textbooks, Ronald Coase finally laid the lighthouse myth to rest—rebutting Samuelson’s second claim in the process.
What piece of evidence had eluded economists for all those years? As Coase observed, contemporary economists had somehow overlooked the fact that large parts of the British lighthouse system were privately operated, and had been for centuries:
[T]he right to operate a lighthouse and to levy tolls was granted to individuals by Acts of Parliament. The tolls were collected at the ports by agents (who might act for several lighthouses), who might be private individuals but were commonly customs officials. The toll varied with the lighthouse and ships paid a toll, varying with the size of the vessel, for each lighthouse passed. It was normally a rate per ton (say 1/4d or 1/2d) for each voyage. Later, books were published setting out the lighthouses passed on different voyages and the charges that would be made.
In other words, lighthouses used a simple physical feature to create “excludability” and prevent free-riding. The main reason ships require lighthouses is to avoid hitting rocks when they make their way to a port. By tying port fees and light dues, lighthouse owners—aided by mild government-enforced property rights—could easily earn a return on their investments, thus disproving the lighthouse free-riding myth.
Ultimately, this meant that a large share of the British lighthouse system was privately operated throughout the 19th century, and this share would presumably have been more pronounced if government-run “Trinity House” lighthouses had not crowded out private investment:
The position in 1820 was that there were 24 lighthouses operated by Trinity House and 22 by private individuals or organizations. But many of the Trinity House lighthouses had not been built originally by them but had been acquired by purchase or as the result of the expiration of a lease.
Of course, this system was not perfect. Some ships (notably foreign ones that did not dock in the United Kingdom) might free-ride on this arrangement. It also entailed some level of market power. The ability to charge light dues meant that prices were higher than the “socially optimal” baseline of zero (the marginal cost of providing light is close to zero). Though it is worth noting that tying port fees and light dues might also have decreased double marginalization, to the benefit of sailors.
Samuelson was particularly weary of this market power that went hand in hand with the private provision of public goods, including lighthouses:
Being able to limit a public good’s consumption does not make it a true-blue private good. For what, after all, are the true marginal costs of having one extra family tune in on the program? They are literally zero. Why then prevent any family which would receive positive pleasure from tuning in on the program from doing so?
However, as Coase explained, light fees represented only a tiny fraction of a ship’s costs. In practice, they were thus unlikely to affect market output meaningfully:
[W]hat is the gain which Samuelson sees as coming from this change in the way in which the lighthouse service is financed? It is that some ships which are now discouraged from making a voyage to Britain because of the light dues would in future do so. As it happens, the form of the toll and the exemptions mean that for most ships the number of voyages will not be affected by the fact that light dues are paid. There may be some ships somewhere which are laid up or broken up because of the light dues, but the number cannot be great, if indeed there are any ships in this category.
Samuelson’s critique also falls prey to the Nirvana Fallacy pointed out by Harold Demsetz: markets might not be perfect, but neither is government intervention. Market power and imperfect appropriability are the two (paradoxical) pitfalls of the first; “white elephants,” underinvestment, and lack of competition (and the information it generates) tend to stem from the latter.
Which of these solutions is superior, in each case, is an empirical question that early economists had simply failed to consider—assuming instead that market failure was systematic in markets that present prima facie externalities. In other words, models were taken as gospel without any circumspection about their relevance to real-world settings.
The Tragedy of the Commons
Externalities were also said to undermine the efficient use of “common pool resources,” such grazing lands, common irrigation systems, and fisheries—resources where one agent’s use diminishes that of others, and where exclusion is either difficult or impossible.
The most famous formulation of this problem is Garret Hardin’s highly influential (over 47,000 cites) “tragedy of the commons.” Hardin cited the example of multiple herdsmen occupying the same grazing ground:
The rational herdsman concludes that the only sensible course for him to pursue is to add another animal to his herd. And another; and another … But this is the conclusion reached by each and every rational herdsman sharing a commons. Therein is the tragedy. Each man is locked into a system that compels him to increase his herd without limit—in a world that is limited. Ruin is the destination toward which all men rush, each pursuing his own best interest in a society that believes in the freedom of the commons.
In more technical terms, each economic agent purportedly exerts an unpriced negative externality on the others, thus leading to the premature depletion of common pool resources. Hardin extended this reasoning to other problems, such as pollution and allegations of global overpopulation.
Although Hardin hardly documented any real-world occurrences of this so-called tragedy, his policy prescriptions were unequivocal:
The most important aspect of necessity that we must now recognize, is the necessity of abandoning the commons in breeding. No technical solution can rescue us from the misery of overpopulation. Freedom to breed will bring ruin to all.
As with many other theoretical externalities, empirical scrutiny revealed that these fears were greatly overblown. In her Nobel-winning work, Elinor Ostrom showed that economic agents often found ways to mitigate these potential externalities markedly. For example, mountain villages often implement rules and norms that limit the use of grazing grounds and wooded areas. Likewise, landowners across the world often set up “irrigation communities” that prevent agents from overusing water.
Along similar lines, Julian Morris and I conjecture that informal arrangements and reputational effects might mitigate opportunistic behavior in the standard essential patent industry.
These bottom-up solutions are certainly not perfect. Many common institutions fail—for example, Elinor Ostrom documents several problematic fisheries, groundwater basins and forests, although it is worth noting that government intervention was sometimes behind these failures. To cite but one example:
Several scholars have documented what occurred when the Government of Nepal passed the “Private Forest Nationalization Act” […]. Whereas the law was officially proclaimed to “protect, manage and conserve the forest for the benefit of the entire country”, it actually disrupted previously established communal control over the local forests. Messerschmidt (1986, p.458) reports what happened immediately after the law came into effect:
Nepalese villagers began freeriding — systematically overexploiting their forest resources on a large scale.
In any case, the question is not so much whether private institutions fail, but whether they do so more often than government intervention. be it regulation or property rights. In short, the “tragedy of the commons” is ultimately an empirical question: what works better in each case, government intervention, propertization, or emergent rules and norms?
More broadly, the key lesson is that it is wrong to blindly apply models while ignoring real-world outcomes. As Elinor Ostrom herself put it:
The intellectual trap in relying entirely on models to provide the foundation for policy analysis is that scholars then presume that they are omniscient observers able to comprehend the essentials of how complex, dynamic systems work by creating stylized descriptions of some aspects of those systems.
In 1985, Paul David published an influential paper arguing that market failures undermined competition between the QWERTY and Dvorak keyboard layouts. This version of history then became a dominant narrative in the field of network economics, including works by Joseph Farrell & Garth Saloner, and Jean Tirole.
The basic claim was that QWERTY users’ reluctance to switch toward the putatively superior Dvorak layout exerted a negative externality on the rest of the ecosystem (and a positive externality on other QWERTY users), thus preventing the adoption of a more efficient standard. As Paul David put it:
Although the initial lead acquired by QWERTY through its association with the Remington was quantitatively very slender, when magnified by expectations it may well have been quite sufficient to guarantee that the industry eventually would lock in to a de facto QWERTY standard. […]
Competition in the absence of perfect futures markets drove the industry prematurely into standardization on the wrong system — where decentralized decision making subsequently has sufficed to hold it.
Unfortunately, many of the above papers paid little to no attention to actual market conditions in the typewriter and keyboard layout industries. Years later, Stan Liebowitz and Stephen Margolis undertook a detailed analysis of the keyboard layout market. They almost entirely rejected any notion that QWERTY prevailed despite it being the inferior standard:
Yet there are many aspects of the QWERTY-versus-Dvorak fable that do not survive scrutiny. First, the claim that Dvorak is a better keyboard is supported only by evidence that is both scant and suspect. Second, studies in the ergonomics literature find no significant advantage for Dvorak that can be deemed scientifically reliable. Third, the competition among producers of typewriters, out of which the standard emerged, was far more vigorous than is commonly reported. Fourth, there were far more typing contests than just the single Cincinnati contest. These contests provided ample opportunity to demonstrate the superiority of alternative keyboard arrangements. That QWERTY survived significant challenges early in the history of typewriting demonstrates that it is at least among the reasonably fit, even if not the fittest that can be imagined.
In short, there was little to no evidence supporting the view that QWERTY inefficiently prevailed because of network effects. The falsification of this narrative also weakens broader claims that network effects systematically lead to either excess momentum or excess inertia in standardization. Indeed, it is tempting to characterize all network industries with heavily skewed market shares as resulting from market failure. Yet the QWERTY/Dvorak story suggests that such a conclusion would be premature.
Killzones, Zoom, and TikTok
If you are still reading at this point, you might think that contemporary scholars would know better than to base calls for policy intervention on theoretical externalities. Alas, nothing could be further from the truth.
For instance, a recent paper by Sai Kamepalli, Raghuram Rajan and Luigi Zingales conjectures that the interplay between mergers and network externalities discourages the adoption of superior independent platforms:
If techies expect two platforms to merge, they will be reluctant to pay the switching costs and adopt the new platform early on, unless the new platform significantly outperforms the incumbent one. After all, they know that if the entering platform’s technology is a net improvement over the existing technology, it will be adopted by the incumbent after merger, with new features melded with old features so that the techies’ adjustment costs are minimized. Thus, the prospect of a merger will dissuade many techies from trying the new technology.
Although this key behavioral assumption drives the results of the theoretical model, the paper presents no evidence to support the contention that it occurs in real-world settings. Admittedly, the paper does present evidence of reduced venture capital investments after mergers involving large tech firms. But even on their own terms, this data simply does not support the authors’ behavioral assumption.
And this is no isolated example. Over the past couple of years, several scholars have called for more muscular antitrust intervention in networked industries. A common theme is that network externalities, switching costs, and data-related increasing returns to scale lead to inefficient consumer lock-in, thus raising barriers to entry for potential rivals (here, here, here).
But there are also countless counterexamples, where firms have easily overcome potential barriers to entry and network externalities, ultimately disrupting incumbents.
Zoom is one of the most salient instances. As I have written previously:
To get to where it is today, Zoom had to compete against long-established firms with vast client bases and far deeper pockets. These include the likes of Microsoft, Cisco, and Google. Further complicating matters, the video communications market exhibits some prima facie traits that are typically associated with the existence of network effects.
Along similar lines, Geoffrey Manne and Alec Stapp have put forward a multitude of other examples. These include: The demise of Yahoo; the disruption of early instant-messaging applications and websites; MySpace’s rapid decline; etc. In all these cases, outcomes do not match the predictions of theoretical models.
More recently, TikTok’s rapid rise offers perhaps the greatest example of a potentially superior social-networking platform taking significant market share away from incumbents. According to the Financial Times, TikTok’s video-sharing capabilities and its powerful algorithm are the most likely explanations for its success.
While these developments certainly do not disprove network effects theory, they eviscerate the common belief in antitrust circles that superior rivals are unable to overthrow incumbents in digital markets. Of course, this will not always be the case. As in the previous examples, the question is ultimately one of comparing institutions—i.e., do markets lead to more or fewer error costs than government intervention? Yet this question is systematically omitted from most policy discussions.
My argument is not that models are without value. To the contrary, framing problems in economic terms—and simplifying them in ways that make them cognizable—enables scholars and policymakers to better understand where market failures might arise, and how these problems can be anticipated and solved by private actors. In other words, models alone cannot tell us that markets will fail, but they can direct inquiries and help us to understand why firms behave the way they do, and why markets (including digital ones) are organized in a given way.
In that respect, both the theoretical and empirical research cited throughout this post offer valuable insights for today’s policymakers.
For a start, as Ronald Coase famously argued in what is perhaps his most famous work, externalities (and market failure more generally) are a function of transaction costs. When these are low (relative to the value of a good), market failures are unlikely. This is perhaps clearest in the “Fable of the Bees” example. Given bees’ short foraging range, there were ultimately few real-world obstacles to writing contracts that internalized the mutual benefits of bees and orchards.
Perhaps more importantly, economic research sheds light on behavior that might otherwise be seen as anticompetitive. The rules and norms that bind farming/beekeeping communities, as well as users of common pool resources, could easily be analyzed as a cartel by naïve antitrust authorities. Yet externality theory suggests they play a key role in preventing market failure.
Along similar lines, mergers and acquisitions (as well as vertical integration, more generally) can reduce opportunism and other externalities that might otherwise undermine collaboration between firms (here, here and here). And much of the same is true for certain types of unilateral behavior. Tying video games to consoles (and pricing the console below cost) can help entrants overcome network externalities that might otherwise shield incumbents. Likewise, Google tying its proprietary apps to the open source Android operating system arguably enabled it to earn a return on its investments, thus overcoming the externality problem that plagues open source software.
All of this raises a tantalizing prospect that deserves far more attention than it is currently given in policy circles: authorities around the world are seeking to regulate the tech space. Draft legislation has notably been tabled in the United States, European Union and the United Kingdom. These draft bills would all make it harder for large tech firms to implement various economic hierarchies, including mergers and certain contractual arrangements.
This is highly paradoxical. If digital markets are indeed plagued by network externalities and high transaction costs, as critics allege, then preventing firms from adopting complex hierarchies—which have traditionally been seen as a way to solve externalities—is just as likely to exacerbate problems. In other words, like the economists of old cited above, today’s policymakers appear to be focusing too heavily on simple models that predict market failure, and far too little on the mechanisms that firms have put in place to thrive within this complex environment.
The bigger picture is that far more circumspection is required when using theoretical models in real-world policy settings. Indeed, as Harold Demsetz famously put it, the purpose of normative economics is not so much to identify market failures, but to help policymakers determine which of several alternative institutions will deliver the best outcomes for consumers:
This nirvana approach differs considerably from a comparative institution approach in which the relevant choice is between alternative real institutional arrangements. In practice, those who adopt the nirvana viewpoint seek to discover discrepancies between the ideal and the real and if discrepancies are found, they deduce that the real is inefficient. Users of the comparative institution approach attempt to assess which alternative real institutional arrangement seems best able to cope with the economic problem […].
AT&T’s $102 billion acquisition of Time Warner in 2019 will go down in M&A history as an exceptionally ill-advised transaction, resulting in the loss of tens of billions of dollars of shareholder value. It should also go down in history as an exceptional ill-chosen target of antitrust intervention. The U.S. Department of Justice, with support from many academic and policy commentators, asserted with confidence that the vertical combination of these content and distribution powerhouses would result in an entity that could exercise market power to the detriment of competitors and consumers.
The chorus of condemnation continued with vigor even after the DOJ’s loss in court and AT&T’s consummation of the transaction. With AT&T’s May 17 announcement that it will unwind the two-year-old acquisition and therefore abandon its strategy to integrate content and distribution, it is clear these predictions of impending market dominance were unfounded.
This widely shared overstatement of antitrust risk derives from a simple but fundamental error: regulators and commentators were looking at the wrong market.
The DOJ’s Antitrust Case against the Transaction
The business case for the AT&T/Time Warner transaction was straightforward: it promised to generate synergies by combining a leading provider of wireless, broadband, and satellite television services with a leading supplier of video content. The DOJ’s antitrust case against the transaction was similarly straightforward: the combined entity would have the ability to foreclose “must have” content from other “pay TV” (cable and satellite television) distributors, resulting in adverse competitive effects.
This foreclosure strategy was expected to take two principal forms. First, AT&T could temporarily withhold (or threaten to withhold) content from rival distributors absent payment of a higher carriage fee, which would then translate into higher fees for subscribers. Second, AT&T could permanently withhold content from rival distributors, who would then lose subscribers to AT&T’s DirectTV satellite television service, further enhancing AT&T’s market power.
Many commentators, both in the trade press and significant portions of the scholarly community, characterized the transaction as posing a high-risk threat to competitive conditions in the pay TV market. These assertions reflected the view that the new entity would exercise a bottleneck position over video-content distribution in the pay TV market and would exercise that power to impose one-sided terms to the detriment of content distributors and consumers.
Notwithstanding this bevy of endorsements, the DOJ’s case was rejected by the district court and the decision was upheld by the D.C. appellate court. The district judge concluded that the DOJ had failed to show that the combined entity would exercise any credible threat to withhold “must have” content from distributors. A key reason: the lost carriage fees AT&T would incur if it did withhold content were so high, and the migration of subscribers from rival pay TV services so speculative, that it would represent an obviously irrational business strategy. In short: no sophisticated business party would ever take AT&T’s foreclosure threat seriously, in which case the DOJ’s predictions of market power were insufficiently compelling to justify the use of government power to block the transaction.
The Fundamental Flaws in the DOJ’s Antitrust Case
The logical and factual infirmities of the DOJ’s foreclosure hypothesis have been extensively and ably covered elsewhere and I will not repeat that analysis. Following up on my previous TOTM commentary on the transaction, I would like to emphasize the point that the DOJ’s case against the transaction was flawed from the outset for two more fundamental reasons.
False Assumption #1
The assumption that the combined entity could withhold so-called “must have” content to cause significant and lasting competitive injury to rival distributors flies in the face of market realities. Content is an abundant, renewable, and mobile resource. There are few entry barriers to the content industry: a commercially promising idea will likely attract capital, which will in turn secure the necessary equipment and personnel for production purposes. Any rival distributor can access a rich menu of valuable content from a plethora of sources, both domestically and worldwide, each of which can provide new content, as required. Even if the combined entity held a license to distribute purportedly “must have” content, that content would be up for sale (more precisely, re-licensing) to the highest bidder as soon as the applicable contract term expired. This is not mere theorizing: it is a widely recognized feature of the entertainment industry.
False Assumption #2
Even assuming the combined entity could wield a portfolio of “must have” content to secure a dominant position in the pay TV market and raise content acquisition costs for rival pay TV services, it still would lack any meaningful pricing power in the relevant consumer market. The reason: significant portions of the viewing population do not want any pay TV or only want dramatically “slimmed-down” packages. Instead, viewers increasingly consume content primarily through video-streaming services—a market in which platforms such as Amazon and Netflix already enjoyed leading positions at the time of the transaction. Hence, even accepting the DOJ’s theory that the combined entity could somehow monopolize the pay TV market consisting of cable and satellite television services, the theory still fails to show any reasonable expectation of anticompetitive effects in the broader and economically relevant market comprising pay TV and streaming services. Any attempt to exercise pricing power in the pay TV market would be economically self-defeating, since it would likely prompt a significant portion of consumers to switch to (or start to only use) streaming services.
The Antitrust Case for the Transaction
When properly situated within the market that was actually being targeted in the AT&T/Time Warner acquisition, the combined entity posed little credible threat of exercising pricing power. To the contrary, the combined entity was best understood as an entrant that sought to challenge the two pioneer entities—Amazon and Netflix—in the “over the top” content market.
Each of these incumbent platforms individually had (and have) multi-billion-dollar content production budgets that rival or exceed the budgets of major Hollywood studios and enjoy worldwide subscriber bases numbering in the hundreds of millions. If that’s not enough, AT&T was not the only entity that observed the displacement of pay TV by streaming services, as illustrated by the roughly concurrent entry of Disney’s Disney+ service, Apple’s Apple TV+ service, Comcast NBCUniversal’s Peacock service, and others. Both the existing and new competitors are formidable entities operating in a market with formidable capital requirements. In 2019, Netflix, Amazon, and Apple TV expended approximately $15 billion, $6 billion, and again, $6 billion, respectively, on content; by contrast, HBO Max, AT&T’s streaming service, expended approximately $3.5 billion.
In short, the combined entity faced stiff competition from existing and reasonably anticipated competitors, requiring several billions of dollars on “content spend” to even stay in the running. Far from being able to exercise pricing power in an imaginary market defined by DOJ litigators for strategic purposes, the AT&T/Time Warner entity faced the challenge of merely surviving in a real-world market populated by several exceptionally well-financed competitors. At best, the combined entity “threatened” to deliver incremental competitive benefits by adding a robust new platform to the video-streaming market; at worst, it would fail in this objective and cause no incremental competitive harm. As it turns out, the latter appears to be the case.
The Enduring Virtues of Antitrust Prudence
AT&T’s M&A fiasco has important lessons for broader antitrust debates about the evidentiary standards that should be applied by courts and agencies when assessing alleged antitrust violations, in general, and vertical restraints, in particular.
Among some scholars, regulators, and legislators, it has become increasingly received wisdom that prevailing evidentiary standards, as reflected in federal case law and agency guidelines, are excessively demanding, and have purportedly induced chronic underenforcement. It has been widely asserted that the courts’ and regulators’ focus on avoiding “false positives” and the associated costs of disrupting innocuous or beneficial business practices has resulted in an overly cautious enforcement posture, especially with respect to mergers and vertical restraints.
In fact, these views were expressed by some commentators in endorsing the antitrust case against the AT&T/Time-Warner transaction. Some legislators have gone further and argued for substantial amendments to the antitrust law to provide enforcers and courts with greater latitude to block or re-engineer combinations that would not pose sufficiently demonstrated competitive risks under current statutory or case law.
The swift downfall of the AT&T/Time-Warner transaction casts great doubt on this critique and accompanying policy proposals. It was precisely the district court’s rigorous application of those “overly” demanding evidentiary standards that avoided what would have been a clear false-positive error. The failure of the “blockbuster” combination to achieve not only market dominance, but even reasonably successful entry, validates the wisdom of retaining those standards.
The fundamental mismatch between the widely supported antitrust case against the transaction and the widely overlooked business realities of the economically relevant consumer market illustrates the ease with which largely theoretical and decontextualized economic models of competitive harm can lead to enforcement actions that lack any reasonable basis in fact.
The U.S. Supreme Court’s just-published unanimous decision in AMG Capital Management LLC v. FTC—holding that Section 13(b) of the Federal Trade Commission Act does not authorize the commission to obtain court-ordered equitable monetary relief (such as restitution or disgorgement)—is not surprising. Moreover, by dissipating the cloud of litigation uncertainty that has surrounded the FTC’s recent efforts to seek such relief, the court cleared the way for consideration of targeted congressional legislation to address the issue.
But what should such legislation provide? After briefly summarizing the court’s holding, I will turn to the appropriate standards for optimal FTC consumer redress actions, which inform a welfare-enhancing legislative fix.
The Court’s Opinion
Justice Stephen Breyer’s opinion for the court is straightforward, centering on the structure and history of the FTC Act. Section 13(b) makes no direct reference to monetary relief. Its plain language merely authorizes the FTC to seek a “permanent injunction” in federal court against “any person, partnership, or corporation” that it believes “is violating, or is about to violate, any provision of law” that the commission enforces. In addition, by its terms, Section 13(b) is forward-looking, focusing on relief that is prospective, not retrospective (this cuts against the argument that payments for prior harm may be recouped from wrongdoers).
Furthermore, the FTC Act provisions that specifically authorize conditioned and limited forms of monetary relief (Section 5(l) and Section 19) are in the context of commission cease and desist orders, involving FTC administrative proceedings, unlike Section 13(b) actions that avoid the administrative route. In sum, the court concludes that:
[T]o read §13(b) to mean what it says, as authorizing injunctive but not monetary relief, produces a coherent enforcement scheme: The Commission may obtain monetary relief by first invoking its administrative procedures and then §19’s redress provisions (which include limitations). And the Commission may use §13(b) to obtain injunctive relief while administrative proceedings are foreseen or in progress, or when it seeks only injunctive relief. By contrast, the Commission’s broad reading would allow it to use §13(b) as a substitute for §5 and §19. For the reasons we have just stated, that could not have been Congress’ intent.
The court’s opinion concludes by succinctly rejecting the FTC’s arguments to the contrary.
What Comes Next
The Supreme Court’s decision has been anticipated by informed observers. All four sitting FTC Commissioners have already called for a Section 13(b) “legislative fix,” and in an April 20 hearing of Senate Commerce Committee, Chairwoman Maria Cantwell (D-Wash.) emphasized that, “[w]e have to do everything we can to protect this authority and, if necessary, pass new legislation to do so.”
What, however, should be the contours of such legislation? In considering alternative statutory rules, legislators should keep in mind not only the possible consumer benefits of monetary relief, but the costs of error, as well. Error costs are a ubiquitous element of public law enforcement, and this is particularly true in the case of FTC actions. Ideally, enforcers should seek to minimize the sum of the costs attributable to false positives (type I error), false negatives (type II error), administrative costs, and disincentive costs imposed on third parties, which may also be viewed as a subset of false positives. (See my 2014 piece “A Cost-Benefit Framework for Antitrust Enforcement Policy.”
Monetary relief is most appropriate in cases where error costs are minimal, and the quantum of harm is relatively easy to measure. This suggests a spectrum of FTC enforcement actions that may be candidates for monetary relief. Ideally, selection of targets for FTC consumer redress actions should be calibrated to yield the highest return to scarce enforcement resources, with an eye to optimal enforcement criteria.
Consider consumer protection enforcement. The strongest cases involve hardcore consumer fraud (where fraudulent purpose is clear and error is almost nil); they best satisfy accuracy in measurement and error-cost criteria. Next along the spectrum are cases of non-fraudulent but unfair or deceptive acts or practices that potentially involve some degree of error. In this category, situations involving easily measurable consumer losses (e.g., systematic failure to deliver particular goods requested or poor quality control yielding shipments of ruined goods) would appear to be the best candidates for monetary relief.
Moving along the spectrum, matters involving a higher likelihood of error and severe measurement problems should be the weakest candidates for consumer redress in the consumer protection sphere. For example, cases involve allegedly misleading advertising regarding the nature of goods, or allegedly insufficient advertising substantiation, may generate high false positives and intractable difficulties in estimating consumer harm. As a matter of judgment, given resource constraints, seeking financial recoveries solely in cases of fraud or clear deception where consumer losses are apparent and readily measurable makes the most sense from a cost-benefit perspective.
Consumer redress actions are problematic for a large proportion of FTC antitrust enforcement (“unfair methods of competition”) initiatives. Many of these antitrust cases are “cutting edge” matters involving novel theories and complex fact patterns that pose a significant threat of type I error. (In comparison, type I error is low in hardcore collusion cases brought by the U.S. Justice Department where the existence, nature, and effects of cartel activity are plain). What’s more, they generally raise extremely difficult if not impossible problems in estimating the degree of consumer harm. (Even DOJ price-fixing cases raise non-trivial measurement difficulties.)
For example, consider assigning a consumer welfare loss number to a patent antitrust settlement that may or may not have delayed entry of a generic drug by some length of time (depending upon the strength of the patent) or to a decision by a drug company to modify a drug slightly just before patent expiration in order to obtain a new patent period (raising questions of valuing potential product improvements). These and other examples suggest that only rarely should the FTC pursue requests for disgorgement or restitution in antitrust cases, if error-cost-centric enforcement criteria are to be honored.
Unfortunately, the FTC currently has nothing to say about when it will seek monetary relief in antitrust matters. Commendably, in 2003, the commission issued a Policy Statement on Monetary Equitable Remedies in Competition Cases specifying that it would only seek monetary relief in “exceptional cases” involving a “[c]lear [v]iolation” of the antitrust laws. Regrettably, in 2012, a majority of the FTC (with Commissioner Maureen Ohlhausen dissenting) withdrew that policy statement and the limitations it imposed. As I concluded in a 2012 article:
This action, which was taken without the benefit of advance notice and public comment, raises troubling questions. By increasing business uncertainty, the withdrawal may substantially chill efficient business practices that are not well understood by enforcers. In addition, it raises the specter of substantial error costs in the FTC’s pursuit of monetary sanctions. In short, it appears to represent a move away from, rather than towards, an economically enlightened antitrust enforcement policy.
In a 2013 speech, then-FTC Commissioner Josh Wright also lamented the withdrawal of the 2003 Statement, and stated that he would limit:
… the FTC’s ability to pursue disgorgement only against naked price fixing agreements among competitors or, in the case of single firm conduct, only if the monopolist’s conduct has no plausible efficiency justification. This latter category would include fraudulent or deceptive conduct, or tortious activity such as burning down a competitor’s plant.
As a practical matter, the FTC does not bring cases of this sort. The DOJ brings naked price-fixing cases and the unilateral conduct cases noted are as scarce as unicorns. Given that fact, Wright’s recommendation may rightly be seen as a rejection of monetary relief in FTC antitrust cases. Based on the previously discussed serious error-cost and measurement problems associated with monetary remedies in FTC antitrust cases, one may also conclude that the Wright approach is right on the money.
Finally, a recent article by former FTC Chairman Tim Muris, Howard Beales, and Benjamin Mundel opined that Section 13(b) should be construed to “limit the FTC’s ability to obtain monetary relief to conduct that a reasonable person would know was dishonest or fraudulent.” Although such a statutory reading is now precluded by the Supreme Court’s decision, its incorporation in a new statutory “fix” would appear ideal. It would allow for consumer redress in appropriate cases, while avoiding the likely net welfare losses arising from a more expansive approach to monetary remedies.
The AMG Capital decision is sure to generate legislative proposals to restore the FTC’s ability to secure monetary relief in federal court. If Congress adopts a cost-beneficial error-cost framework in shaping targeted legislation, it should limit FTC monetary relief authority (recoupment and disgorgement) to situations of consumer fraud or dishonesty arising under the FTC’s authority to pursue unfair or deceptive acts or practices. Giving the FTC carte blanche to obtain financial recoveries in the full spectrum of antitrust and consumer protection cases would spawn uncertainty and could chill a great deal of innovative business behavior, to the ultimate detriment of consumer welfare.
The Competition and Antitrust Law Enforcement Reform Act (CALERA), recently introduced in the U.S. Senate, exhibits a remarkable willingness to cast aside decades of evidentiary standards that courts have developed to uphold the rule of law by precluding factually and economically ungrounded applications of antitrust law. Without those safeguards, antitrust enforcement is prone to be driven by a combination of prosecutorial and judicial fiat. That would place at risk the free play of competitive forces that the antitrust laws are designed to protect.
Antitrust law inherently lends itself to the risk of erroneous interpretations of ambiguous evidence. Outside clear cases of interfirm collusion, virtually all conduct that might appear anti-competitive might just as easily be proven, after significant factual inquiry, to be pro-competitive. This fundamental risk of a false diagnosis has guided antitrust case law and regulatory policy since at least the Supreme Court’s landmark Continental Television v. GTE Sylvania decision in 1977 and arguably earlier. Judicial and regulatory efforts to mitigate this ambiguity, while preserving the deterrent power of the antitrust laws, have resulted in the evidentiary requirements that are targeted by the proposed bill.
Proponents of the legislative “reforms” might argue that modern antitrust case law’s careful avoidance of enforcement error yields excessive caution. To relieve regulators and courts from having to do their homework before disrupting a targeted business and its employees, shareholders, customers and suppliers, the proposed bill empowers plaintiffs to allege and courts to “find” anti-competitive conduct without having to be bound to the reasonably objective metrics upon which courts and regulators have relied for decades. That runs the risk of substituting rhetoric and intuition for fact and analysis as the guiding principles of antitrust enforcement and adjudication.
This dismissal of even a rudimentary commitment to rule-of-law principles is illustrated by two dramatic departures from existing case law in the proposed bill. Each constitutes a largely unrestrained “blank check” for regulatory and judicial overreach.
Blank Check #1
The bill includes a broad prohibition on “exclusionary” conduct, which is defined to include any conduct that “materially disadvantages 1 or more actual or potential competitors” and “presents an appreciable risk of harming competition.” That amorphous language arguably enables litigants to target a firm that offers consumers lower prices but “disadvantages” less efficient competitors that cannot match that price.
In fact, the proposed legislation specifically facilitates this litigation strategy by relieving predatory pricing claims from having to show that pricing is below cost or likely to result ultimately in profits for the defendant. While the bill permits a defendant to escape liability by showing sufficiently countervailing “procompetitive benefits,” the onus rests on the defendant to show otherwise. This burden-shifting strategy encourages lagging firms to shift competition from the marketplace to the courthouse.
Blank Check #2
The bill then removes another evidentiary safeguard by relieving plaintiffs from always having to define a relevant market. Rather, it may be sufficient to show that the contested practice gives rise to an “appreciable risk of harming competition … based on the totality of the circumstances.” It is hard to miss the high degree of subjectivity in this standard.
This ambiguous threshold runs counter to antitrust principles that require a credible showing of market power in virtually all cases except horizontal collusion. Those principles make perfect sense. Market power is the gateway concept that enables courts to distinguish between claims that plausibly target alleged harms to competition and those that do not. Without a well-defined market, it is difficult to know whether a particular practice reflects market power or market competition. Removing the market power requirement can remove any meaningful grounds on which a defendant could avoid a nuisance lawsuit or contest or appeal a conclusory allegation or finding of anticompetitive conduct.
The bill’s transparently outcome-driven approach is likely to give rise to a cloud of liability that penalizes businesses that benefit consumers through price and quality combinations that competitors cannot replicate. This obviously runs directly counter to the purpose of the antitrust laws. Certainly, winners can and sometimes do entrench themselves through potentially anticompetitive practices that should be closely scrutinized. However, the proposed legislation seems to reflect a presumption that successful businesses usually win by employing illegitimate tactics, rather than simply being the most efficient firm in the market. Under that assumption, competition law becomes a tool for redoing, rather than enabling, competitive outcomes.
While this populist approach may be popular, it is neither economically sound nor consistent with a market-driven economy in which resources are mostly allocated through pricing mechanisms and government intervention is the exception, not the rule. It would appear that some legislators would like to reverse that presumption. Far from being a victory for consumers, that outcome would constitute a resounding loss.