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[TOTM: The following is part of a symposium by TOTM guests and authors on the 2020 Vertical Merger Guidelines. The entire series of posts is available here.

This post is authored by William J. Kolasky (Partner, Hughes Hubbard & Reed; former Deputy Assistant Attorney General, DOJ Antitrust Division), and Philip A. Giordano (Partner, Hughes Hubbard & Reed LLP).

[Kolasky & Giordano: The authors thank Katherine Taylor, an associate at Hughes Hubbard & Reed, for her help in researching this article.]

On January 10, the Department of Justice (DOJ) withdrew the 1984 DOJ Non-Horizontal Merger Guidelines, and, together with the Federal Trade Commission (FTC), released new draft 2020 Vertical Merger Guidelines (“DOJ/FTC draft guidelines”) on which it seeks public comment by February 26.[1] In announcing these new draft guidelines, Makan Delrahim, the Assistant Attorney General for the Antitrust Division, acknowledged that while many vertical mergers are competitively beneficial or neutral, “some vertical transactions can raise serious concern.” He went on to explain that, “The revised draft guidelines are based on new economic understandings and the agencies’ experience over the past several decades and better reflect the agencies’ actual practice in evaluating proposed vertical mergers.” He added that he hoped these new guidelines, once finalized, “will provide more clarity and transparency on how we review vertical transactions.”[2]

While we agree with the DOJ and FTC that the 1984 Non-Horizontal Merger Guidelines are now badly outdated and that a new set of vertical merger guidelines is needed, we question whether the draft guidelines released on January 10, will provide the desired “clarity and transparency.” In our view, the proposed guidelines give insufficient recognition to the wide range of efficiencies that flow from most, if not all, vertical mergers. In addition, the guidelines fail to provide sufficiently clear standards for challenging vertical mergers, thereby leaving too much discretion in the hands of the agencies as to when they will challenge a vertical merger and too much uncertainty for businesses contemplating a vertical merger. 

What is most troubling is that this did not need to be so. In 2008, the European Commission, as part of its merger process reform initiative, issued an excellent set of non-horizontal merger guidelines that adopt basically the same analytical framework as the new draft guidelines for evaluating vertical mergers.[3] The EU guidelines, however, lay out in much more detail the factors the Commission will consider and the standards it will apply in evaluating vertical transactions. That being so, it is difficult to understand why the DOJ and FTC did not propose a set of vertical merger guidelines that more closely mirror those of the European Commission, rather than try to reinvent the wheel with a much less complete set of guidelines.

Rather than making the same mistake ourselves, we will try to summarize the EU vertical mergers and to explain why we believe they are markedly better than the draft guidelines the DOJ and FTC have proposed. We would urge the DOJ and FTC to consider revising their draft guidelines to make them more consistent with the EU vertical merger guidelines. Doing so would, among other things, promote greater convergence between the two jurisdictions, which is very much in the interest of both businesses and consumers in an increasingly global economy.

The principal differences between the draft joint guidelines and the EU vertical merger guidelines

1. Acknowledgement of the key differences between horizontal and vertical mergers

The EU guidelines begin with an acknowledgement that, “Non-horizontal mergers are generally less likely to significantly impede effective competition than horizontal mergers.” As they explain, this is because of two key differences between vertical and horizontal mergers.

  • First, unlike horizontal mergers, vertical mergers “do not entail the loss of direct competition between the merging firms in the same relevant market.”[4] As a result, “the main source of anti-competitive effect in horizontal mergers is absent from vertical and conglomerate mergers.”[5]
  • Second, vertical mergers are more likely than horizontal mergers to provide substantial, merger-specific efficiencies, without any direct reduction in competition. The EU guidelines explain that these efficiencies stem from two main sources, both of which are intrinsic to vertical mergers. The first is that, “Vertical integration may thus provide an increased incentive to seek to decrease prices and increase output because the integrated firm can capture a larger fraction of the benefits.”[6] The second is that, “Integration may also decrease transaction costs and allow for a better co-ordination in terms of product design, the organization of the production process, and the way in which the products are sold.”[7]

The DOJ/FTC draft guidelines do not acknowledge these fundamental differences between horizontal and vertical mergers. The 1984 DOJ non-horizontal guidelines, by contrast, contained an acknowledgement of these differences very similar to that found in the EU guidelines. First, the 1984 guidelines acknowledge that, “By definition, non-horizontal mergers involve firms that do not operate in the same market. It necessarily follows that such mergers produce no immediate change in the level of concentration in any relevant market as defined in Section 2 of these Guidelines.”[8] Second, the 1984 guidelines acknowledge that, “An extensive pattern of vertical integration may constitute evidence that substantial economies are afforded by vertical integration. Therefore, the Department will give relatively more weight to expected efficiencies in determining whether to challenge a vertical merger than in determining whether to challenge a horizontal merger.”[9] Neither of these acknowledgements can be found in the new draft guidelines.

These key differences have also been acknowledged by the courts of appeals for both the Second and D.C. circuits in the agencies’ two most recent litigated vertical mergers challenges: Fruehauf Corp. v. FTC in 1979[10] and United States v. AT&T in 2019.[11] In both cases, the courts held, as the D.C. Circuit explained in AT&T, that because of these differences, the government “cannot use a short cut to establish a presumption of anticompetitive effect through statistics about the change in market concentration” – as it can in a horizontal merger case – “because vertical mergers produce no immediate change in the relevant market share.”[12] Instead, in challenging a vertical merger, “the government must make a ‘fact-specific’ showing that the proposed merger is ‘likely to be anticompetitive’” before the burden shifts to the defendants “to present evidence that the prima facie case ‘inaccurately predicts the relevant transaction’s probable effect on future competition,’ or to ‘sufficiently discredit’ the evidence underlying the prima facie case.”[13]

While the DOJ/FTC draft guidelines acknowledge that a vertical merger may generate efficiencies, they propose that the parties to the merger bear the burden of identifying and substantiating those efficiencies under the same standards applied by the 2010 Horizontal Merger Guidelines. Meeting those standards in the case of a horizontal merger can be very difficult. For that reason, it is important that the DOJ/FTC draft guidelines be revised to make it clear that before the parties to a vertical merger are required to establish efficiencies meeting the horizontal merger guidelines’ evidentiary standard, the agencies must first show that the merger is likely to substantially lessen competition, based on the type of fact-specific evidence the courts required in both Fruehauf and AT&T.

2. Safe harbors

Although they do not refer to it as a “safe harbor,” the DOJ/FTC draft guidelines state that, 

The Agencies are unlikely to challenge a vertical merger where the parties to the merger have a share in the relevant market of less than 20 percent, and the related product is used in less than 20 percent of the relevant market.[14] 

If we understand this statement correctly, it means that the agencies may challenge a vertical merger in any case where one party has a 20% share in a relevant market and the other party has a 20% or higher share of any “related product,” i.e., any “product or service” that is supplied by the other party to firms in that relevant market. 

By contrast, the EU guidelines state that,

The Commission is unlikely to find concern in non-horizontal mergers . . . where the market share post-merger of the new entity in each of the markets concerned is below 30% . . . and the post-merger HHI is below 2,000.[15] 

Both the EU guidelines and the DOJ/FTC draft guidelines are careful to explain that these statements do not create any “legal presumption” that vertical mergers below these thresholds will not be challenged or that vertical mergers above those thresholds are likely to be challenged.

The EU guidelines are more consistent than the DOJ/FTC draft guidelines both with U.S. case law and with the actual practice of both the DOJ and FTC. It is important to remember that the raising rivals’ costs theory of vertical foreclosure was first developed nearly four decades ago by two young economists, David Scheffman and Steve Salop, as a theory of exclusionary conduct that could be used against dominant firms in place of the more simplistic theories of vertical foreclosure that the courts had previously relied on and which by 1979 had been totally discredited by the Chicago School for the reasons stated by the Second Circuit in Fruehauf.[16] 

As the Second Circuit explained in Fruehauf, it was “unwilling to assume that any vertical foreclosure lessens competition” because 

[a]bsent very high market concentration or some other factor threatening a tangible anticompetitive effect, a vertical merger may simply realign sales patterns, for insofar as the merger forecloses some of the market from the merging firms’ competitors, it may simply free up that much of the market, in which the merging firm’s competitors and the merged firm formerly transacted, for new transactions between the merged firm’s competitors and the merging firm’s competitors.[17] 

Or, as Robert Bork put it more colorfully in The Antitrust Paradox, in criticizing the FTC’s decision in A.G. Spalding & Bros., Inc.,[18]:

We are left to imagine eager suppliers and hungry customers, unable to find each other, forever foreclosed and left languishing. It would appear the commission could have cured this aspect of the situation by throwing an industry social mixer.[19]

Since David Scheffman and Steve Salop first began developing their raising rivals’ cost theory of exclusionary conduct in the early 1980s, gallons of ink have been spilled in legal and economic journals discussing and evaluating that theory.[20] The general consensus of those articles is that while raising rivals’ cost is a plausible theory of exclusionary conduct, proving that a defendant has engaged in such conduct is very difficult in practice. It is even more difficult to predict whether, in evaluating a proposed merger, the merged firm is likely to engage in such conduct at some time in the future. 

Consistent with the Second Circuit’s decision in Fruehauf and with this academic literature, the courts, in deciding cases challenging exclusive dealing arrangements under either a vertical foreclosure theory or a raising rivals’ cost theory, have generally been willing to consider a defendant’s claim that the alleged exclusive dealing arrangements violated section 1 of the Sherman Act only in cases where the defendant had a dominant or near-dominant share of a highly concentrated market — usually meaning a share of 40 percent or more.[21] Likewise, all but one of the vertical mergers challenged by either the FTC or DOJ since 1996 have involved parties that had dominant or near-dominant shares of a highly concentrated market.[22] A majority of these involved mergers that were not purely vertical, but in which there was also a direct horizontal overlap between the two parties.

One of the few exceptions is AT&T/Time Warner, a challenge the DOJ lost in both the district court and the D.C. Circuit.[23] The outcome of that case illustrates the difficulty the agencies face in trying to prove a raising rivals’ cost theory of vertical foreclosure where the merging firms do not have a dominant or near-dominant share in either of the affected markets.

Given these court decisions and the agencies’ historical practice of challenging vertical mergers only between companies with dominant or near-dominant shares in highly concentrated markets, we would urge the DOJ and FTC to consider raising the market share threshold below which it is unlikely to challenge a vertical merger to at least 30 percent, in keeping with the EU guidelines, or to 40 percent in order to make the vertical merger guidelines more consistent with the U.S. case law on exclusive dealing.[24] We would also urge the agencies to consider adding a market concentration HHI threshold of 2,000 or higher, again in keeping with the EU guidelines.

3. Standards for applying a raising rivals’ cost theory of vertical foreclosure

Another way in which the EU guidelines are markedly better than the DOJ/FTC draft guidelines is in explaining the factors taken into consideration in evaluating whether a vertical merger will give the parties both the ability and incentive to raise their rivals’ costs in a way that will enable the merged entity to increase prices to consumers. Most importantly, the EU guidelines distinguish clearly between input foreclosure and customer foreclosure, and devote an entire section to each. For brevity, we will focus only on input foreclosure to show why we believe the more detailed approach the EU guidelines take is preferable to the more cursory discussion in the DOJ/FTC draft guidelines.

In discussing input foreclosure, the EU guidelines correctly distinguish between whether a vertical merger will give the merged firm the ability to raise rivals’ costs in a way that may substantially lessen competition and, if so, whether it will give the merged firm an incentive to do so. These are two quite distinct questions, which the DOJ/FTC draft guidelines unfortunately seem to lump together.

The ability to raise rivals’ costs

The EU guidelines identify four important conditions that must exist for a vertical merger to give the merged firm the ability to raise its rivals’ costs. First, the alleged foreclosure must concern an important input for the downstream product, such as one that represents a significant cost factor relative to the price of the downstream product. Second, the merged entity must have a significant degree of market power in the upstream market. Third, the merged entity must be able, by reducing access to its own upstream products or services, to affect negatively the overall availability of inputs for rivals in the downstream market in terms of price or quality. Fourth, the agency must examine the degree to which the merger may free up capacity of other potential input suppliers. If that capacity becomes available to downstream competitors, the merger may simple realign purchase patterns among competing firms, as the Second Circuit recognized in Fruehauf.

The incentive to foreclose access to inputs: 

The EU guidelines recognize that the incentive to foreclose depends on the degree to which foreclosure would be profitable. In making this determination, the vertically integrated firm will take into account how its supplies of inputs to competitors downstream will affect not only the profits of its upstream division, but also of its downstream division. Essentially, the merged entity faces a trade-off between the profit lost in the upstream market due to a reduction of input sales to (actual or potential) rivals and the profit gained from expanding sales downstream or, as the case may be, raising prices to consumers. This trade-off is likely to depend on the margins the merged entity obtains on upstream and downstream sales. Other things constant, the lower the margins upstream, the lower the loss from restricting input sales. Similarly, the higher the downstream margins, the higher the profit gain from increasing market share downstream at the expense of foreclosed rivals.

The EU guidelines recognize that the incentive for the integrated firm to raise rivals’ costs further depends on the extent to which downstream demand is likely to be diverted away from foreclosed rivals and the share of that diverted demand the downstream division of the integrated firm can capture. This share will normally be higher the less capacity constrained the merged entity will be relative to non-foreclosed downstream rivals and the more the products of the merged entity and foreclosed competitors are close substitutes. The effect on downstream demand will also be higher if the affected input represents a significant proportion of downstream rivals’ costs or if it otherwise represents a critical component of the downstream product.

The EU guidelines recognize that the incentive to foreclose actual or potential rivals may also depend on the extent to which the downstream division of the integrated firm can be expected to benefit from higher price levels downstream as a result of a strategy to raise rivals’ costs. The greater the market shares of the merged entity downstream, the greater the base of sales on which to enjoy increased margins. However, an upstream monopolist that is already able to fully extract all available profits in vertically related markets may not have any incentive to foreclose rivals following a vertical merger. Therefore, the ability to extract available profits from consumers does not follow immediately from a very high market share; to come to that conclusion requires a more thorough analysis of the actual and future constraints under which the monopolist operates.

Finally, the EU guidelines require the Commission to examine not only the incentives to adopt such conduct, but also the factors liable to reduce, or even eliminate, those incentives, including the possibility that the conduct is unlawful. In this regard, the Commission will consider, on the basis of a summary analysis: (i) the likelihood that this conduct would be clearly be unlawful under Community law, (ii) the likelihood that this illegal conduct could be detected, and (iii) the penalties that could be imposed.

Overall likely impact on effective competition: 

Finally, the EU guidelines recognize that a vertical merger will raise foreclosure concerns only when it would lead to increased prices in the downstream market. This normally requires that the foreclosed suppliers play a sufficiently important role in the competitive process in the downstream market. In general, the higher the proportion of rivals that would be foreclosed in the downstream market, the more likely the merger can be expected to result in a significant price increase in the downstream market and, therefore, to significantly impede effective competition. 

In making these determinations, the Commission must under the EU guidelines also assess the extent to which a vertical merger may raise barriers to entry, a criterion that is also found in the 1984 DOJ non-horizontal merger guidelines but is strangely missing from the DOJ/FTC draft guidelines. As the 1984 guidelines recognize, a vertical merger can raise entry barriers if the anticipated input foreclosure would create a need to enter at both the downstream and the upstream level in order to compete effectively in either market.

* * * * *

Rather than issue a set of incomplete vertical merger guidelines, we would urge the DOJ and FTC to follow the lead of the European Commission and develop a set of guidelines setting out in more detail the factors the agencies will consider and the standards they will use in evaluating vertical mergers. The EU non-horizontal merger guidelines provide an excellent model for doing so.


[1] U.S. Department of Justice & Federal Trade Commission, Draft Vertical Merger Guidelines, available at https://www.justice.gov/opa/press-release/file/1233741/download (hereinafter cited as “DOJ/FTC draft guidelines”).

[2] U.S. Department of Justice, Office of Public Affairs, “DOJ and FTC Announce Draft Vertical Merger Guidelines for Public Comment,” Jan. 10, 2020, available at https://www.justice.gov/opa/pr/doj-and-ftc-announce-draft-vertical-merger-guidelines-public-comment.

[3] See European Commission, Guidelines on the assessment of non-horizontal mergers under the Council Regulation on the control of concentrations between undertakings (2008) (hereinafter cited as “EU guidelines”), available at https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52008XC1018(03)&from=EN.

[4] Id. at § 12.

[5] Id.

[6] Id. at § 13.

[7] Id. at § 14. The insight that transactions costs are an explanation for both horizontal and vertical integration in firms first occurred to Ronald Coase in 1932, while he was a student at the London School of Economics. See Ronald H. Coase, Essays on Economics and Economists 7 (1994). Coase took five years to flesh out his initial insight, which he then published in 1937 in a now-famous article, The Nature of the Firm. See Ronald H. Coase, The Nature of the Firm, Economica 4 (1937). The implications of transactions costs for antitrust analysis were explained in more detail four decades later by Oliver Williamson in a book he published in 1975. See Oliver E. William, Markets and Hierarchies: Analysis and Antitrust Implications (1975) (explaining how vertical integration, either by ownership or contract, can, for example, protect a firm from free riding and other opportunistic behavior by its suppliers and customers). Both Coase and Williamson later received Nobel Prizes for Economics for their work recognizing the importance of transactions costs, not only in explaining the structure of firms, but in other areas of the economy as well. See, e.g., Ronald H. Coase, The Problem of Social Cost, J. Law & Econ. 3 (1960) (using transactions costs to explain the need for governmental action to force entities to internalize the costs their conduct imposes on others).

[8] U.S. Department of Justice, Antitrust Division, 1984 Merger Guidelines, § 4, available at https://www.justice.gov/archives/atr/1984-merger-guidelines.

[9] EU guidelines, at § 4.24.

[10] Fruehauf Corp. v. FTC, 603 F.2d 345 (2d Cir. 1979).

[11] United States v. AT&T, Inc., 916 F.2d 1029 (D.C. Cir. 2019).

[12] Id. at 1032; accord, Fruehauf, 603 F.2d, at 351 (“A vertical merger, unlike a horizontal one, does not eliminate a competing buyer or seller from the market . . . . It does not, therefore, automatically have an anticompetitive effect.”) (emphasis in original) (internal citations omitted).

[13] AT&T, 419 F.2d, at 1032 (internal citations omitted).

[14] DOJ/FTC draft guidelines, at 3.

[15] EU guidelines, at § 25.

[16] See Steven C. Salop & David T. Scheffman, Raising Rivals’ Costs, 73 AM. ECON. REV. 267 (1983).

[17] Fruehauf, supra note11, 603 F.2d at 353 n.9 (emphasis added).

[18] 56 F.T.C. 1125 (1960).

[19] Robert H. Bork, The Antitrust Paradox: A Policy at War with Itself 232 (1978).

[20] See, e.g., Alan J. Meese, Exclusive Dealing, the Theory of the Firm, and Raising Rivals’ Costs: Toward a New Synthesis, 50 Antitrust Bull., 371 (2005); David T. Scheffman and Richard S. Higgins, Twenty Years of Raising Rivals Costs: History, Assessment, and Future, 12 George Mason L. Rev.371 (2003); David Reiffen & Michael Vita, Comment: Is There New Thinking on Vertical Mergers, 63 Antitrust L.J. 917 (1995); Thomas G. Krattenmaker & Steven Salop, Anticompetitive Exclusion: Raising Rivals’ Costs to Achieve Power Over Price, 96 Yale L. J. 209, 219-25 (1986).

[21] See, e.g., United States v. Microsoft, 87 F. Supp. 2d 30, 50-53 (D.D.C. 1999) (summarizing law on exclusive dealing under section 1 of the Sherman Act); id. at 52 (concluding that modern case law requires finding that exclusive dealing contracts foreclose rivals from 40% of the marketplace); Omega Envtl, Inc. v. Gilbarco, Inc., 127 F.3d 1157, 1162-63 (9th Cir. 1997) (finding 38% foreclosure insufficient to make out prima facie case that exclusive dealing agreement violated the Sherman and Clayton Acts, at least where there appeared to be alternate channels of distribution).

[22] See, e.g., United States, et al. v. Comcast, 1:11-cv-00106 (D.D.C. Jan. 18, 2011) (Comcast had over 50% of MVPD market), available at https://www.justice.gov/atr/case-document/competitive-impact-statement-72; United States v. Premdor, Civil No.: 1-01696 (GK) (D.D.C. Aug. 3, 2002) (Masonite manufactured more than 50% of all doorskins sold in the U.S.; Premdor sold 40% of all molded doors made in the U.S.), available at https://www.justice.gov/atr/case-document/final-judgment-151.

[23] See United States v. AT&T, Inc., 916 F.2d 1029 (D.C. Cir. 2019).

[24] See Brown Shoe Co. v. United States, 370 U.S. 294, (1962) (relying on earlier Supreme Court decisions involving exclusive dealing and tying claims under section 3 of the Clayton Act for guidance as to what share of a market must be foreclosed before a vertical merger can be found unlawful under section 7).

On December 1, 2017, in granting certiorari in Salt River Project Agricultural Improvement and Power District v. SolarCity Corp., the U.S. Supreme Court agreed to consider “whether orders denying antitrust state-action immunity to public entities are immediately appealable under the collateral-order doctrine.”  At first blush, this case might appear to involve little more than a narrow technical question regarding the availability of interlocutory appeals.  But more fundamentally, this matter may afford the Supreme Court yet another opportunity to weigh in on the essential nature of the antitrust state action doctrine (albeit indirectly), in deciding whether the existence of state action immunity should be decided prior to the litigation of substantive antitrust suits.

Background

The Salt River Power District (SRP) is the only supplier of traditional electrical power in Phoenix, and is a subdivision of the State of Arizona.  SRP has lobbied successfully for special governmental status and has used its longstanding ties to government to advance the interests of its private shareholders.  (This sort of tale comes as no surprise to students of public choice.)  Counsel for respondent SolarCity discussed these ties in their brief opposing certiorari:

[SRP] was created in 1903 to take advantage of a federal law that provided interest-free loans for landowners to build reclamation projects to irrigate their lands.  During the Great Depression, SRP successfully lobbied the Arizona legislature for a law denominating it a political subdivision of Arizona so the landowners who ran SRP could avoid income taxes and sell tax-free bonds. . . .  Arizona denominates SRP a public entity, but as th[e] [U.S. Supreme] Court . . . explained [in a 1981 case involving [the right of local non-landowner residents to vote on SRP policy determinations], SRP and organizations like it are “essentially business enterprises, created by and chiefly benefitting a specific group of landowners.” . . . .  Among other things, SRP lacks “the crucial powers of sovereignty typical of a general purpose unit of government” and SRP’s electric business does not implicate any traditional sovereign power. . . . 

SRP’s retail electric business is unregulated. The business answers only to its own self-interested Board, not a public utility commission or any similar independent body. . . .   42 (ER55). SRP is thus free to serve private, not public interests. . . .  SRP takes profits from electricity sales and uses them to subsidize irrigation and canal water so that, for example, certain agricultural interests can farm cheaply by a city in the desert. . . . 

 In short, [as the Supreme Court explained in 1981,] SRP makes money from electric customers and pays out dividends in the form of irrigating “private lands for personal profit.”

 

SolarCity sells and leases rooftop solar-energy panels in Arizona.  It alleges that SRP used its special government subsidies to drive it out of the market for the supply of those panels to customers in the SRP district area.  Specifically, according to counsel for SolarCity:

As solar generation increased in popularity and efficiency, SRP started to view solar as a long-term competitive threat to its electricity sales and profits. . . .  Facing competition for the first time ever, SRP had a choice between competing in the market or using its monopoly power to exclude competition. . . .  SRP first attempted to compete on the merits by developing its own solar offerings. . . .  However, consumers continued to prefer SRP’s solar competitors. . . .  Then, rather than offer consumers a better product or value, SRP used its unregulated market power to impose terms that lock customers into remaining what SRP calls “requirements” customers—those who satisfy all their electric needs from, and deal exclusively with, SRP. . . .

SRP’s plan [which imposed a large penalty on any customer who obtained power from its own solar system] worked. . . .  The new requirements it mandated for its customers had a drastic anticompetitive effect. . . .  New rooftop solar applications—from customers of any firm, not just SolarCity—dropped by about 96 percent. . . .  SolarCity was forced to stop selling in SRP territory and to relocate employees.

SolarCity sued SRP for Sherman Antitrust Act violations in Arizona federal district court.  SRP moved to dismiss under the antitrust state action doctrine, which (as Professor Herbert Hovenkamp puts it) “exempts qualifying state and local government regulation from federal antitrust [law], even if the regulation at issue compels an otherwise clear violation of the law.”  The district court denied the motion to dismiss, and the Ninth Circuit affirmed.  The Ninth Circuit panel opinion (Judge Michelle Friedland, joined by Judges Alex Kozinski and Ronald Lee Gilman) assessed the applicability of the “collateral order doctrine,” which allows an appeal of a non-final district court decision if it is:  (1) conclusive; (2) addresses a question separate from the merits of the underlying case; and (3) raises “some particular value of a high order” that will evade effective review if not considered immediately.  The Ninth Circuit emphasized the Supreme Court’s teaching that the collateral order doctrine is a “narrow exception” that must be “strictly applied.”  It concluded that, “because the state-action doctrine is a defense to liability and not an immunity from suit, the collateral-order doctrine does not give us jurisdiction here [footnotes omitted].”

In its brief supporting its writ of certiorari, SRP stressed that an interlocutory appeal was justified here because“[a] denial of state-action immunity, like a denial of state sovereign immunity, offends state sovereignty, dignity, and autonomy. . . .  [T]he decision below threatens the dignity and autonomy of the states, as well as the division of regulatory power between the state and federal governments, by allowing a political subdivision of a state to be subjected to prolonged litigation for engaging in conduct that was clearly authorized by the state.”

In short, the Supreme Court has been asked to take fundamental federalism principles into account in weighing the applicability of the collateral order doctrine.

Discussion

Set aside for the moment the narrow question of the applicability of specific collateral order doctrine criteria in this case.   Assuming the validity of the facts summarized above, this matter highlights the always-present anticompetitive potential of enabling private parties to exercise monopoly power under the mantle of state authority.  Let us briefly examine, then, key state action principles that apply to essentially private conduct that seeks to shelter under a governmental cloak.

Commendably, in Midcal and 324 Liquor, the Supreme Court made it clear that the state action doctrine does not enable state governments to directly authorize purely private actors to violate the Sherman Act, free from state oversight.  But should an entity such as SRP that is in essence an unregulated for-profit private enterprise, acting in an anticompetitive fashion, be free to undermine the competitive process (benefiting from government subsidies to boot) merely because a century-old state law characterized it as a state political subdivision?

The “spirit” of recent Supreme Court jurisprudence suggests that the answer should be no, and that the Court may be willing to look beyond the formality of a legislative designation (in this case, “state political subdivision”) to questions of political accountability.  In 2015, In North Carolina Dental Board, the Court rejected the claim that state action immunity applied to the self-interested actions of a state dental regulatory board stacked with dentists (the board barred competition from non-dentists in tooth whitening).  In so doing, the Court held that entities designated as state agencies are not exempt from active supervision when they are controlled by market participants, because immunizing such entities from federal antitrust challenge would pose the risk of self-dealing that the Court had warned against in prior decisions, such as Midcal.

A legal formalist might respond that a mere state board is of a lesser dignity than a state political subdivision, such as SRP, which directly exercises state sovereign power, and, as such, is not subject to “active supervision” requirements.  Functionally, however, SRP acts in all respects like a private company, except that it benefits from certain special state subsidies that assist it in undermining competition.  Recognizing that reality, the Court might be willing to say that it will look beyond formal legislative designations to the actual role of a state entity in deciding whether it is, or is not, engaging in “sovereign action.”  (State instrumentalities engaging in classic sovereign functions, such as a state supreme court or state treasury department, would not raise this sort of problem.)

More specifically, the Court might wish to consider whether federal antitrust law should be applicable when a state instrumentality that does not have the attributes of a classic private business – such as a state owned-controlled- and operated electric company, for example – engages in business activity and uses its governmental ties to subvert competition.  Such a company might, for instance, predate against competing private companies by pricing below its own cost to drive out and keep out rivals, relying on taxpayer funding to support its activities.  Activity of this sort could be made subject to a “market participant exception” to the state action doctrine (at the very least requiring state active supervision), as recommended by the Federal Trade Commission’s 2004 State Action Task Force Report.  Such an exception, which has not yet been specifically addressed by the Supreme Court, would reduce the returns to anticompetitive business activity engaged in by privileged “state” agents, thereby promoting commercial freedom and vibrant markets.  And, as two learned commentators recently pointed out, it would not offend federalism principles that underlie the antitrust state action doctrine (footnote references deleted):

[T]he state does not act within its sovereign prerogative when engaged in economic conduct.  It cannot be that the government is truly exercising sovereign powers when acting in the same way as its private citizens.  Thus, restricting the prerogative of state and local governments to engage in economic conduct does not abrogate sovereign immunity.  Therefore, the federalism concerns underpinning the . . . [state action] immunity doctrine are not in play when the State acts as an ordinary market-participant on equal-footing with private citizens.

The policy and federalism justifications for denying state action immunity to an unsupervised state agency acting as a commercial operator would apply “in spades” to SRP, which, as has been seen, in all material respects looks like a purely private actor.

Let’s return now to the specific question before the Supreme Court.  While state action doctrinal issues (including, of course, a possible market operator exception) are not directly presented in the SRP v. SolarCity case, they may well flavor the approach the Court takes in determining the availability of interlocutory appeals of state action immunity denials.  The clear and ringing invocation of federalism principles in petitioners’ brief for certiorari suggests a possible doctrinal hook.  In particular, the Court might determine that respect for the dignity and role of states as coordinate sovereigns compels a finding that denials of antitrust state action immunity should be subject to immediate review.

A ruling that state action questions should be decided “up front” might, however, prove a pyrrhic victory for petitioners.  Counsel for respondents have ably pointed out the quintessentially private commercial nature of SRP’s activities, which could amply support a judicial finding of no state action immunity – whether based on the somewhat novel “market participant” exception or because of inadequate state supervision.

Conclusion

The Supreme Court’s decision in SPR v. SolarCity will determine the narrow issue of the availability of interlocutory appeals to an antitrust defendant that is denied a dismissal on antitrust state action grounds.  A holding that authorizes such appeals also would have the incidental salutary effect of furthering efficiency, by eliminating a significant source of costly uncertainty affecting the litigation of cases that fall under the shadow of the “state action” umbrella.

More broadly, the facts in SPR v. SolarCity highlight a potential future clarification of the antitrust state action doctrine – establishment of a clear “market participant” exception to state action immunity.  Such an exception commendably would promote effective market processes without offending federalism.  It would also tend to diminish returns to (and thereby weaken incentives to engage in) rent seeking by those firms that seek to obtain a business advantage through special government privilege, rather than through competition on the merits.

In its February 25 North Carolina Dental v. Federal Trade Commission decision, the U.S. Supreme Court held that a state regulatory board that is controlled by market participants in the industry being regulated cannot invoke “state action” antitrust immunity unless it is “actively supervised” by the state. Will this decision discourage harmful protectionist regulation, such as the prohibition on tooth whitening by non-dentists at issue in this case? Will it also interfere with the ability of states to shape their regulatory programs as they see fit? U.S. Federal Trade Commissioner Maureen Ohlhausen will address this important set of questions in a March 31 luncheon presentation at the Heritage Foundation, with Clark Neily of the Institute for Justice and Misha Tseytlin of the West Virginia State Attorney General’s Office providing expert commentary. (You may view this event online or register to attend it in person here).

Just in time for this event, the Heritage Foundation has released a legal memorandum on “North Carolina Dental Board and the Reform of State-Sponsored Protectionism.”  The  memorandum explains that North Carolina Dental “has far-reaching ramifications for the reform of ill-conceived protectionist state regulations that limit entry into myriad professions and thereby harm consumers. In holding that a state regulatory board controlled by market participants in the industry being regulated cannot cloak its anticompetitive rules in ‘state action’ antitrust immunity unless it is ‘actively supervised’ by the state, the Court struck a significant blow against protectionist rent-seeking legislation and for economic liberty. The states may re-examine their licensing statutes in light of the Court’s decision, but if they decline to revise their regulatory schemes to eliminate their unjustifiable exclusionary effect, there may well be yet another round of challenges to those programs—this time based on the federal Constitution.”

U.S. antitrust law focuses primarily on private anticompetitive restraints, leaving the most serious impediments to a vibrant competitive process – government-initiated restraints – relatively free to flourish.  Thus the Federal Trade Commission (FTC) should be commended for its July 16 congressional testimony that spotlights a fast-growing and particularly pernicious species of (largely state) government restriction on competition – occupational licensing requirements.  Today such disciplines (to name just a few) as cat groomers, flower arrangers, music therapists, tree trimmers, frozen dessert retailers, eyebrow threaders, massage therapists (human and equine), and “shampoo specialists,” in addition to the traditional categories of doctors, lawyers, and accountants, are subject to professional licensure.  Indeed, since the 1950s, the coverage of such rules has risen dramatically, as the percentage of Americans requiring government authorization to do their jobs has risen from less than five percent to roughly 30 percent.

Even though some degree of licensing responds to legitimate health and safety concerns (i.e., no fly-by-night heart surgeons), much occupational regulation creates unnecessary barriers to entry into a host of jobs.  Excessive licensing confers unwarranted benefits on fortunate incumbents, while effectively barring large numbers of capable individuals from the workforce.  (For example, many individuals skilled in natural hair braiding simply cannot afford the 2,100 hours required to obtain a license in Iowa, Nebraska, and South Dakota.)  It also imposes additional economic harms, as the FTC’s testimony explains:  “[Occupational licensure] regulations may lead to higher prices, lower quality services and products, and less convenience for consumers.  In the long term, they can cause lasting damage to competition and the competitive process by rendering markets less responsive to consumer demand and by dampening incentives for innovation in products, services, and business models.”  Licensing requirements are often enacted in tandem with other occupational regulations that unjustifiably limit the scope of beneficial services particular professionals can supply – for instance, a ban on tooth cleaning by dental hygienists not acting under a dentist’s supervision that boosts dentists’ income but denies treatment to poor children who have no access to dentists.

What legal and policy tools are available to chip away at these pernicious and costly laws and regulations, which largely are the fruit of successful special interest lobbying?  The FTC’s competition advocacy program, which responds to requests from legislators and regulators to assess the economic merits of proposed laws and regulations, has focused on unwarranted regulatory restrictions in such licensed professions as real estate brokers, electricians, accountants, lawyers, dentists, dental hygienists, nurses, eye doctors, opticians, and veterinarians.  Retrospective reviews of FTC advocacy efforts suggest it may have helped achieve some notable reforms (for example, 74% of requestors, regulators, and bill sponsors surveyed responded that FTC advocacy initiatives influenced outcomes).  Nevertheless, advocacy’s reach and effectiveness inherently are limited by FTC resource constraints, by the need to obtain “invitations” to submit comments, and by the incentive and ability of licensing scheme beneficiaries to oppose regulatory and legislative reforms.

Former FTC Chairman Kovacic and James Cooper (currently at George Mason University’s Law and Economics Center) have suggested that federal and state antitrust experts could be authorized to have ex ante input into regulatory policy making.  As the authors recognize, however, several factors sharply limit the effectiveness of such an initiative.  In particular, “the political feasibility of this approach at the legislative level is slight”, federal mandates requiring ex ante reviews would raise serious federalism concerns, and resource constraints would loom large.

Antitrust law challenges to anticompetitive licensing schemes likewise offer little solace.  They are limited by the antitrust “state action” doctrine, which shields conduct undertaken pursuant to “clearly articulated” state legislative language that displaces competition – a category that generally will cover anticompetitive licensing requirements.  Even a Supreme Court decision next term (in North Carolina Dental v. FTC) that state regulatory boards dominated by self-interested market participants must be actively supervised to enjoy state action immunity would have relatively little bite.  It would not limit states from issuing simple statutory commands that create unwarranted occupational barriers, nor would it prevent states from implementing “adequate” supervisory schemes that are designed to approve anticompetitive state board rules.

What then is to be done?

Constitutional challenges to unjustifiable licensing strictures may offer the best long-term solution to curbing this regulatory epidemic.  As Clark Neily points out in Terms of Engagement, there is a venerable constitutional tradition of protecting the liberty interest to earn a living, reflected in well-reasoned late 19th and early 20th century “Lochner-era” Supreme Court opinions.  Even if Lochner is not rehabilitated, however, there are a few recent jurisprudential “straws in the wind” that support efforts to rein in “irrational” occupational licensure barriers.  Perhaps acting under divine inspiration, the Fifth Circuit in St. Joseph Abbey (2013) ruled that Louisiana statutes that required all casket manufacturers to be licensed funeral directors – laws that prevented monks from earning a living by making simple wooden caskets – served no other purpose than to protect the funeral industry, and, as such, violated the 14th Amendment’s Equal Protection and Due Process Clauses.  In particular, the Fifth Circuit held that protectionism, standing alone, is not a legitimate state interest sufficient to establish a “rational basis” for a state statute, and that absent other legitimate state interests, the law must fall.  Since the Sixth and Ninth Circuits also have held that intrastate protectionism standing alone is not a legitimate purpose for rational basis review, but the Tenth Circuit has held to the contrary, the time may soon be ripe for the Supreme Court to review this issue and, hopefully, delegitimize pure economic protectionism.  Such a development would place added pressure on defenders of protectionist occupational licensing schemes.  Other possible avenues for constitutional challenges to protectionist licensing regimes (perhaps, for example, under the Dormant Commerce Clause) also merit being explored, of course.  The Institute of Justice already is performing yeoman’s work in litigating numerous cases involving unjustified licensing and other encroachments on economic liberty; perhaps their example can prove an inspiration for pro bono efforts by others.

Eliminating anticompetitive occupational licensing rules – and, more generally, vindicating economic liberties that too long have been neglected – is obviously a long-term project, and far-reaching reform will not happen in the near term.  Nevertheless, while we the currently living may in the long run be dead (pace Keynes), our posterity will be alive, and we owe it to them to pursue the vindication of economic liberties under the Constitution.

The National Collegiate Athletic Association’s (NCAA’s) longstanding cartel-like arrangements once again are facing serious legal scrutiny.  On June 9 a federal antitrust trial opened in Oakland featuring college athletes’ attempt to enjoin the NCAA from exploiting the athletes’ names, images, and likenesses (“rights of publicity”) for profitRights of publicity are a well-recognized form of intellectual property.  Although the factual details concerning the means by which NCAA institutions may have extracted those rights (for example, from signed waivers that may have been required as a condition for receipt of athletic scholarships) remain to be developed, a concerted NCAA effort to exploit the athletes’ IP, if proven, would be highly anticompetitive.  Consistent with the TOTM tradition of highlighting challenges to NCAA competitive arrangements, let’s look at what’s at stake.

The NCAA is involved in major sports-related revenue-producing projects with its corporate partners, such as Electronic Arts (EA), a $4 billion company that produces video games.  The money is big – EA’s NCAA Football game alone is reported to bring in over $200 million a year in gross revenues.  Although the NCAA has denied using player likenesses in video games, the creators of the NCAA Football series have indicated that actual athletes’ jersey numbers and attributes are used, a fact apparently known to NCAA executives.  Moreover, recent separate $20 million and $40 million settlements agreed to by the NCAA and EA in suits brought by college athletes provide additional indications that the NCAA may be aware that it has exploited college players’ rights of publicity.

So what is the antitrust angle?  In dealing with student athletes, the NCAA, which represents the interests of its member colleges, acts like a monopsony cartel, as Judge Posner has noted, and as Blair and Harrison have explained in detail.  Anticompetitive monopsony buyer agreements have long been struck down by the courts as Sherman Act violations, as in Mandeville Farms and in National Macaroni Manufacturers v. FTC, and occasionally have been the subject of criminal prosecution.

This does not necessarily mean, however, that all restrictions the NCAA places on student athletes run afoul of the antitrust laws.  As the Supreme Court made clear in the 1984 NCAA case, the federal antitrust laws apply to the NCAA, but competitive restraints may pass muster if they are justifiable means of fostering competition among amateur athletic teams, such as uniform rules defining the conditions of a sports contest, the eligibility of participants, or the sharing of responsibilities and benefits integral to the NCAA’s joint venture.

Like the anticompetitive restrictions on member colleges’ separate television contracts struck down by the Supreme Court in NCAA, however, the NCAA’s profiting from student athletes’ rights of publicity is not vital to the preservation of balanced collegiate amateur competition.   Likewise, it is not needed to avoid the payment of student salaries that some might argue smacks of disfavored “professionalism” (although others would argue it promotes healthy competition and avoids exploitation of athletes).  In contrast, a policy of vindicating athletes’ right of publicity enables them to capture the value of the intellectual property generated by their accomplishments, and thus incentivizes outstanding athletic achievements, consistent with the legitimate ends of NCAA competitions.  Proof of a concerted effort by the NCAA to deny this benefit to student athletes and instead to share the IP-generated proceeds only with member institutions would, if shown, appear to lack any cognizable efficiency justification, and thus be ripe for antitrust condemnation.

Whatever the outcome of the current rights of publicity litigation, the NCAA may expect to face antitrust scrutiny on a number of fronts.  This is as it should be.  While the organization clearly yields efficiencies that benefit consumers (such as establishing and overseeing rules and standards for many collegiate sports), its inherent temptation to act as a classic cartel for the financial benefit of its members will not disappear.  Indeed, its incentive to seek monopoly profits may rise, as the money generated by organized athletics and related entertainment offshoots continues to grow.  Accordingly, antitrust enforcers should remain vigilant, and efforts to obtain NCAA-specific statutory antitrust exemptions, even if well-meaning, should be resisted.

I testified Thursday on H.R. 1946, the “Preserving our Local Hometown Independent Pharmacies Act of 2011,” in front of the House Committee on the Judiciary Subcommittee on Intellectual Property, Competition and the Internet.  The Act, as implied by the title, would establish an antitrust exemption for smaller pharmacies.  The hearing lineup is available here.  My written testimony is available here.  The basic case against antitrust exemptions to allow price-fixing is pretty clear as a matter of economics — e.g. the Antitrust Modernization Commission strongly opposes such exemptions on both public choice and consumer welfare grounds.  As I discuss in my testimony, that case is made stronger in the health care context.

For more on the case against antitrust exemptions, see here, here, and here.

Todd Zywicki and I recently filed (along with Keith Hylton, Fred McChesney, and TOTM’s own Thom Lambert) an amicus brief in support of certiorari in a Fifth Circuit Tobacco Master Settlement Case.  We argue that the state action exception to the antitrust laws, i.e. Parker immunity, should not be extended to cover a multistate government-created cartel such as this one.  The net impact of the MSA, with the help of the state AG’s, is to entrench a tobacco cartel and harm consumers.  As Todd points out in his post at the VC, Alan Morrison, Richard Epstein, and Kathleen Sullivan filed another brief in the same case challenging the multistate agreement under the Compact Clause of the Constitution.   We argue that the underlying logic of Parker v. Brown is that of competitive federalism and rejects the extension of immunity for a massive interstate cartel.

While I’m focused on health care and antitrust, the question above is the subject of a conference at the Harvard Law School Petrie‐Flom Center which looks like it has a great lineup.  The conference is November 12th.  Here is the conference description (HT: Larry Solum).

Petrie-Flom Center for Health Law Policy, Biotechnology and Bioethics at Harvard Law School will be hosting a one-day meeting on Friday, November 12, 2010 on the subject of whether Congress should repeal the McCarran-Ferguson Act. There are a limited number of spaces available for specialists in the field who would like to attend. Requests for attendance will be accepted on the basis of availability. If you would like to attend or have any questions, please email petrie-flom@law.harvard.edu Please note that unfortunately, funding for travel to Cambridge is not available and must be provided by attendee’s home institution.

Conference Description
In 1944, the U.S. Supreme Court, in United States v. South-Eastern Underwriters Association, held that the Commerce Clause authorized the federal government to regulate insurance companies. The next year, in direct response, Congress passed the McCarran-Ferguson Act, effectively shielding the business of insurance from federal antitrust regulation, except the regulation of boycott, coercion and intimidation, so long as state law regulates anticompetitive conduct. Shortly thereafter, a debate arose as to whether the federal antitrust law exemption should be repealed. With the recent flurry of federal reform of health care insurance markets, the current debate has centered on whether Congress should repeal the McCarran-Ferguson Act’s antitrust exemption for health care insurers. The one-day conference will bring together regulators, industry actors and academics working in the fields of business, law and economics to discuss the pros and cons of repealing the McCarran-Ferguson Act’s federal antitrust exemption for health care insurers. For information on presenters and paper topics see here>> http://www.law.harvard.edu/programs/petrie-flom/events/conferences/insurance.pdf

Here is the agenda.

 

Economist and occasional TOTM guest blogger Steve Salop (Georgetown) recently sent me the following questions spurred by the local debate over Governor McConnell’s proposal to private the retailing of alcoholic beverages:

I have my first antitrust class of the semester tomorrow.  Among the issues I teach the first week are (1) the fact that demand curves slope down; (2) restrictions on competition tend to reduce output and consumer welfare; (3) state regulation is often used to restrict output.  While procrastinating from class preparation today, I read a Washington Post article about the controversy in Virginia over whether to privatize liquor stores.  The article quotes an epidemiologist who sounds like a closet economist: “If you make it easier to drink, people will drink more. … It’s as simple and basic as that.  This seemed like a great example to use for my class.  (Of course, it’s a little more complicated.  The epidemiologist also said, “And if people drink more, we have more alcohol-related problems.”  And, then he gave his statement, “it’s as simple and basic as that.” )  Okay, there are externalities, even in Virginia.  But, here is where I got confused.  The article refers to a study by George Mason economist Don Boudreaux who apparently did a study (available here) that showed that state privatization did not lead to more alcohol-related problems, at least not more alcohol-related deaths.

So, I have two questions: What should I tell my students about the basics of demand theory?, and the overarching benefits of antitrust over regulation?  Or, is this just one of those “politics trumps economics” arguments: the demand for limited government outweighs the law of downward-sloping demand.

Here a few thoughts.

First, its good to know that Steve and I teach the same things on the first day of antitrust class.  Things are apparently not too different, at least when it comes to antitrust class, on the other side of the Potomac.

Second, to frame the issues for readers, state-imposed restrictions on competition take many forms and are a common problem faced by antitrust authorities, they often involve “boards” appointed by the state granted authority to regulate particular industries, including the imposition of barriers to entry (recall Eric Helland’s post on the monks fighting against restrictions imposed by the Louisiana funeral industry board — indeed, I remember fondly my time at the Federal Trade Commission with the “Dirty Boards” team whose task was to identify these boards).  The economic welfare analysis for many of these restrictions in straightforward.  The restriction on competition reduces output, raises price, and reduces consumer welfare.  What makes the state restrictions on alcoholic beverages more interesting from an economic perspective is that there is at least a plausible claim to be made that reducing output will also reduce the external social costs associated with alcohol consumption, producing benefits that could potentially offset the negative consumer welfare effects.  The relative magnitudes of these effects is an empirical question.

Third, as Steve’s question observes, the obvious effect of privatization, lifting the competitive restriction, will be to increase output and reduce prices.  The law of demand is pretty easy to follow here.  But doesn’t the law of demand also imply that greater competition and reduced prices implies greater social costs in the form of more “problem drinking?”

On the margin, yes!  Why?  The state restrictions on retail competition as well as those at the wholesaler level, raise price to both marginal consumers with higher demand elasticities at current prices (a 1% increase in price will result in a decrease in consumption greater than 1%)  and infra-marginal drinkers with more inelastic demand at current prices (a 1% increase in price will result in a decrease in consumption less than 1%).  As Steve notes, the law of demand implies that unless the drinkers who create those social harms have perfectly inelastic demand, that is, there consumption is entirely invariant to changes in prices, there will be “some” effect on consumption from “problem drinkers,” and thus some positive effect in reducing external costs (see my earlier post on the CARE Act’s odd approach to burdens of proof regarding this issue).

But note that the source of externalities in this example come from a concentrated group.  As Cook and Moore (2002, p.122) note, “those in the top decile of the drinking distribution consume more than half of all ethanol. Since alcohol problems are also highly concentrated in this group, it seems reasonable to target alcohol-control policies at them.”  The impact of regulatory changes on alcohol consumption and behavior in this concentrated group should the margin focused upon for analysis of the magnitude of any “temperance” effect.

Fourth, as a sidenote, several studies have shown a negative relationship between alcohol prices (often measured by excise taxes) and socially harmful behavior. For example, Saffer & Grossman (1987) and Kenkel (1993) report negative relationships between alcohol prices and drunk-driving. Coate & Grossman (1988) find a negative relationship between price and self-reported underage drinking, but this result disappears when religion and other covariates are introduced. More recently, Markowitz & Grossman (1998) find a negative relationship between state beer excise taxes and domestic violence.  As Cooper and Wright point out in our paper, one potential reason for this seeming inconsistency between Boudreaux’s results (and the other results referred to in the article finding that deregulation increases consumption without increasing social harms, as well as our own results, discussed below) may be that earlier work on the relationship between alcohol prices and the harms we measure was based on samples from the 1970s and early 1980s and thus unable to include the effect of ZT and BAC08 laws. Consistent with more recent research [e.g., Carpenter (2004); Dee (2001)], it appears that ZT and BAC08 laws are important sources of reductions in drunk-driving and teen drinking. Specifically, our results suggest that ZT and BAC08 laws reduce alcohol-related accidents by 7-8% and 4-5%, respectively.

But there is no reason to believe that this reduction will be large, much less large enough to offset the welfare losses imposed on consumers in the form of higher prices and reduced output.  That is an empirical question.

Fifth, the studies finding that reductions in output associated with state-imposed restrictions on competition are not necessarily correlated with significant reductions in the social ills associated with problem drinking (alcohol-related deaths, DUIs, etc.) are consistent with what Cooper and Wright find in our recently study of state post and hold laws.  The post and hold laws operate at the wholesale level, but are also restrictions on competition, making price competition between wholesalers more expensive by prohibiting short-term price reductions, and of course, facilitating collusion by requiring that wholesalers share future price information with rivals in advance.  To review, we find that post and hold laws result in significant reductions in output — representing consumer welfare losses — without any statistically or practically relevant reduction in measures of alcohol-related social costs.  The lack of measurable effect may be because the reduction in consumption is relatively small, leading to only small behavioral changes for those in the top of the alcohol consumption distribution.

So — I’ve written a lot and am not sure I’ve answered Steve’s original question.  What should he tell his antitrust class about demand theory, antitrust vs. regulation, and political economy of privatization in light of the Virginia ABC example?  Here’s a few answers:

1. The Virginia ABC example does nothing to change the bottom line: (1) the law of demand lives on, (2) restrictions on competition reduce output and raise price and reduce consumer welfare, and (3) states frequently restrict competition with the predicted consequences — I might add the Demsetzian point that these state imposed restrictions are the toughest to get rid of, even for antitrust.

2. Calculating the impact of a regulatory change on consumer welfare can be tough.  Here, I think highlighting the tradeoff between welfare reductions of the conventional antitrust sort and reducing negative externalities would be a very useful exercise for the class.   On the theoretical end, I think it requires the distinction between marginal and infra-marginal consumers that is tool antitrust lawyers should have in their toolkit (price discrimination, market definition, vertical restraints, etc.).  While predicting the output effects are straightforward, the welfare analysis is a bit more complicated in economic terms.

3. For antitrust lawyers, it is worth thinking about how to convince a generalist judge about the relevant economics in this setting.   Having students understand the complexities and learn to simultaneously teach, translate and persuade the court of the relevant economic and empirical analysis is something we should be encouraging the students to think about on day one.

4. I can’t think of any great examples for the demand for limited government trumping the law of demand, but the persistence of the state alcohol monopolies despite their negative economic consequences on consumers gives a wonderful opportunity to talk about cartel formation and stability, as well as the political economy of these laws more generally.  For politics trumping economics more generally, see “Rent Control” or the proposed antitrust exemption for newspapers.

The Comprehensive Alcohol Regulatory Effectiveness Act — yes, the “CARE Act” — or HR 5034, is a piece of legislation aimed at supporting “State-based alcohol regulation.”  Recall the Supreme Court’s decision in Granholm v. Heald, which held that states could either allow in-state and out-of-state retailers to directly ship wine to consumers or could prohibit it for both, but couldn’t ban direct shipment only for out-of-state sellers while allowing in for in-state sellers.  Most states thus far have opened up direct shipping laws to the benefit of consumers.    While we occasionally criticize the Federal Trade Commission from time to time here at TOTM, its own research demonstrating that state regulation banning direct shipment and e-commerce harmed consumers is an excellent example of the potential for competition research and development impacting regulatory debates.  Indeed, Justice Kennedy’s majority opinion in Granholm cites the FTC study (not to mention co-blogger Mike Sykuta’s work here) a number of times.  But in addition to direct shipment laws, there are a whole host of state laws regulating the sale and distribution of alcohol.  Some of them have obviously pernicious competitive consequences for consumers as well as producers.  The beneficiaries are the wholesalers who have successfully lobbied for the protection of the state.  Fundamentally, the CARE Act aims to place these laws beyond the reach of any challenge under the Commerce Clause as per Granholm, the Sherman Act, or any other federal legislation.  Whether the CARE Act has any ancillary social benefits is an important empirical question — but you can bet that the first-order effect of the law, if it were to go into effect, would be to increase beer, wine and liquor prices.  More on the CARE Act and state regulation of alcoholic beverages below the fold.

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