Archives For entrepreneurship

Thanks to Truth on the Market for the opportunity to guest blog, and to ICLE for inviting me to join as a Senior Scholar! I’m honoured to be involved with both of these august organizations.

In Brussels, the talk of the town is that the European Commission (“Commission”) is casting a new eye on the old antitrust conjecture that prophesizes a negative relationship between industry concentration and innovation. This issue arises in the context of the review of several mega-mergers in the pharmaceutical and AgTech (i.e., seed genomics, biochemicals, “precision farming,” etc.) industries.

The antitrust press reports that the Commission has shown signs of interest for the introduction of a new theory of harm: the Significant Impediment to Industry Innovation (“SIII”) theory, which would entitle the remediation of mergers on the sole ground that a transaction significantly impedes innovation incentives at the industry level. In a recent ICLE White Paper, I discuss the desirability and feasibility of the introduction of this doctrine for the assessment of mergers in R&D-driven industries.

The introduction of SIII analysis in EU merger policy would no doubt be a sea change, as compared to past decisional practice. In previous cases, the Commission has paid heed to the effects of a merger on incentives to innovate, but the assessment has been limited to the effect on the innovation incentives of the merging parties in relation to specific current or future products. The application of the SIII theory, however, would entail an assessment of a possible reduction of innovation in (i) a given industry as a whole; and (ii) not in relation to specific product applications.

The SIII theory would also be distinct from the innovation markets” framework occasionally applied in past US merger policy and now marginalized. This framework considers the effect of a merger on separate upstream “innovation markets,i.e., on the R&D process itself, not directly linked to a downstream current or future product market. Like SIII, innovation markets analysis is interesting in that the identification of separate upstream innovation markets implicitly recognises that the players active in those markets are not necessarily the same as those that compete with the merging parties in downstream product markets.

SIII is way more intrusive, however, because R&D incentives are considered in the abstract, without further obligation on the agency to identify structured R&D channels, pipeline products, and research trajectories.

With this, any case for an expansion of the Commission’s power to intervene against mergers in certain R&D-driven industries should rely on sound theoretical and empirical infrastructure. Yet, despite efforts by the most celebrated Nobel-prize economists of the past decades, the economics that underpin the relation between industry concentration and innovation incentives remains an unfathomable mystery. As Geoffrey Manne and Joshua Wright have summarized in detail, the existing literature is indeterminate, at best. As they note, quoting Rich Gilbert,

[a] careful examination of the empirical record concludes that the existing body of theoretical and empirical literature on the relationship between competition and innovation “fails to provide general support for the Schumpeterian hypothesis that monopoly promotes either investment in research and development or the output of innovation” and that “the theoretical and empirical evidence also does not support a strong conclusion that competition is uniformly a stimulus to innovation.”

Available theoretical research also fails to establish a directional relationship between mergers and innovation incentives. True, soundbites from antitrust conferences suggest that the Commission’s Chief Economist Team has developed a deterministic model that could be brought to bear on novel merger policy initiatives. Yet, given the height of the intellectual Everest under discussion, we remain dubious (yet curious).

And, as noted, the available empirical data appear inconclusive. Consider a relatively concentrated industry like the seed and agrochemical sector. Between 2009 and 2016, all big six agrochemical firms increased their total R&D expenditure and their R&D intensity either increased or remained stable. Note that this has taken place in spite of (i) a significant increase in concentration among the largest firms in the industry; (ii) dramatic drop in global agricultural commodity prices (which has adversely affected several agrochemical businesses); and (iii) the presence of strong appropriability devices, namely patent rights.

This brief industry example (that I discuss more thoroughly in the paper) calls our attention to a more general policy point: prior to poking and prodding with novel theories of harm, one would expect an impartial antitrust examiner to undertake empirical groundwork, and screen initial intuitions of adverse effects of mergers on innovation through the lenses of observable industry characteristics.

At a more operational level, SIII also illustrates the difficulties of using indirect proxies of innovation incentives such as R&D figures and patent statistics as a preliminary screening tool for the assessment of the effects of the merger. In my paper, I show how R&D intensity can increase or decrease for a variety of reasons that do not necessarily correlate with an increase or decrease in the intensity of innovation. Similarly, I discuss why patent counts and patent citations are very crude indicators of innovation incentives. Over-reliance on patent counts and citations can paint a misleading picture of the parties’ strength as innovators in terms of market impact: not all patents are translated into products that are commercialised or are equal in terms of commercial value.

As a result (and unlike the SIII or innovation markets approaches), the use of these proxies as a measure of innovative strength should be limited to instances where the patent clearly has an actual or potential commercial application in those markets that are being assessed. Such an approach would ensure that patents with little or no impact on innovation competition in a market are excluded from consideration. Moreover, and on pain of stating the obvious, patents are temporal rights. Incentives to innovate may be stronger as a protected technological application approaches patent expiry. Patent counts and citations, however, do not discount the maturity of patents and, in particular, do not say much about whether the patent is far from or close to its expiry date.

In order to overcome the limitations of crude quantitative proxies, it is in my view imperative to complement an empirical analysis with industry-specific qualitative research. Central to the assessment of the qualitative dimension of innovation competition is an understanding of the key drivers of innovation in the investigated industry. In the agrochemical industry, industry structure and market competition may only be one amongst many other factors that promote innovation. Economic models built upon Arrow’s replacement effect theory – namely that a pre-invention monopoly acts as a strong disincentive to further innovation – fail to capture that successful agrochemical products create new technology frontiers.

Thus, for example, progress in crop protection products – and, in particular, in pest- and insect-resistant crops – had fuelled research investments in pollinator protection technology. Moreover, the impact of wider industry and regulatory developments on incentives to innovate and market structure should not be ignored (for example, falling crop commodity prices or regulatory restrictions on the use of certain products). Last, antitrust agencies are well placed to understand that beyond R&D and patent statistics, there is also a degree of qualitative competition in the innovation strategies that are pursued by agrochemical players.

My paper closes with a word of caution. No compelling case has been advanced to support a departure from established merger control practice with the introduction of SIII in pharmaceutical and agrochemical mergers. The current EU merger control framework, which enables the Commission to conduct a prospective analysis of the parties’ R&D incentives in current or future product markets, seems to provide an appropriate safeguard against anticompetitive transactions.

In his 1974 Nobel Prize Lecture, Hayek criticized the “scientific error” of much economic research, which assumes that intangible, correlational laws govern observable and measurable phenomena. Hayek warned that economics is like biology: both fields focus on “structures of essential complexity” which are recalcitrant to stylized modeling. Interestingly, competition was one of the examples expressly mentioned by Hayek in his lecture:

[T]he social sciences, like much of biology but unlike most fields of the physical sciences, have to deal with structures of essential complexity, i.e. with structures whose characteristic properties can be exhibited only by models made up of relatively large numbers of variables. Competition, for instance, is a process which will produce certain results only if it proceeds among a fairly large number of acting persons.

What remains from this lecture is a vibrant call for humility in policy making, at a time where some constituencies within antitrust agencies show signs of interest in revisiting the relationship between concentration and innovation. And if Hayek’s convoluted writing style is not the most accessible of all, the title captures it all: “The Pretense of Knowledge.

The Apple E-Books Antitrust Case: Implications for Antitrust Law and for the Economy

February 15, 2016

The appellate court’s 2015 decision affirming the district court’s finding of per se liability in United States v. Apple provoked controversy over the legal and economic merits of the case, its significance for antitrust jurisprudence, and its implications for entrepreneurs, startups, and other economic actors throughout the economy. Apple has filed a cert petition with the Supreme Court, which will decide on February 19th whether to hear the case.

On Monday, February 15 and Tuesday February 16, Truth on the Market and the International Center for Law and Economics will present a blog symposium discussing the case and its implications.

We’ve lined up an outstanding and diverse group of scholars, practitioners and other experts to participate in the symposium. The full archive of symposium posts can be found at this link, and individual posts can be accessed by clicking on the author’s name below.

Also see our previous posts at Truth on the Market discussing the Apple e-books case for a preview of many of the issues to be discussed.

Shanker Singham of the Babson Global Institute (formerly a leading international trade lawyer and author of the most comprehensive one-volume work on the interplay between competition and international trade policy) has published a short article introducing the concept of “enterprise cities.”  This article, which outlines an incentives-based, market-oriented approach to spurring economic development, is well worth reading.  A short summary follows.

Singham points out that the transition away from socialist command-and-control economies, accompanied by international trade liberalization, too often failed to create competitive markets within developing countries.  Anticompetitive market distortions imposed by government and generated by politically-connected domestic rent-seekers continue to thrive – measures such as entry barriers that favor entrenched incumbent firms, and other regulatory provisions that artificially favor specific powerful domestic business interests (“crony capitalists”).  Such widespread distortions reduce competition and discourage inward investment, thereby retarding innovation and economic growth and reducing consumer welfare.  Political influence exercised by the elite beneficiaries of the distortions may prevent legal reforms that would remove these regulatory obstacles to economic development.  What, then, can be done to disturb this welfare-inimical state of affairs, when sweeping, nationwide legal reforms are politically impossible?

One incremental approach, advanced by Professor Paul Romer and others, is the establishment of “charter cities” – geographic zones within a country that operate under government-approved free market-oriented charters, rather than under restrictive national laws.  Building on this concept, Babson Global Institute has established a “Competitiveness and Enterprise Development Project” (CEDP) designed to promote the notion of “Enterprise Cities” (ECs) – geographically demarcated zones of regulatory autonomy within countries, governed by a Board.  ECs would be created through negotiations between a national government and a third party group, such as CEDP.  The negotiations would establish “Regulatory Framework Agreements” embodying legal rules (implemented through statutory or constitutional amendments by the host country) that would apply solely within the EC.  Although EC legal regimes would differ with respect to minor details (reflecting local differences that would affect negotiations), they would be consistent in stressing freedom of contract, flexible labor markets, and robust property rights, and in prohibiting special regulatory/legal favoritism (so as to avoid anticompetitive market distortions).  Protecting foreign investment through third party arbitration and related guarantees would be key to garnering foreign investor interest in ECs.   The goal would be to foster a business climate favorable to investment, job creation, innovation, and economic growth.  The EC Board would ensure that agreed-to rules would be honored and enforced by EC-specific legal institutions, such as courts.

Because market-oriented EC rules will not affect market-distortive laws elsewhere within the host country, well-organized rent-seeking elites may not have as strong an incentive to oppose creating ECs.  Indeed, to the extent that a share of EC revenues is transferred to the host country government (depending upon the nature of the EC’s charter), elites might directly benefit, using their political connections to share in the profits.  In short, although setting up viable ECs is no easy matter, their establishment need not be politically unfeasible.  Indeed, the continued success of Hong Kong as a free market island within China (Hong Kong places first in the Heritage Foundation’s Index of Economic Freedom), operating under the Basic Law of Hong Kong, suggests the potential for ECs to thrive, despite having very different rules than the parent state’s legal regime.  (Moreover, the success of Hong Kong may have proven contagious, as China is now promoting a new Shanghai Free Trade Zone thaw would compete with Hong Kong and Singapore.)

The CEDP is currently negotiating the establishment of ECs with a number of governments.  As Singham explains, successful launch of an EC requires:  (1) a committed developer; (2) land that can be used for a project; (3) a good external infrastructure connecting the EC with the rest of the country; and (4) “a government that recognizes the benefits to its reform agenda and to its own economic plan of such a designation of regulatory autonomy and is willing to confront its own challenges by thinking outside the box.”  While the fourth prerequisite may be the most difficult to achieve, internal pressures for faster economic growth and increased investment may lead jurisdictions with burdensome regulatory regimes to consider ECs.

Furthermore, as Singham stresses, by promoting competition on the merits, free from favoritism, a successful EC could stimulate successful entrepreneurship.  Scholarly work points to the importance of entrepreneurship to economic development.

Finally, the beneficial economic effects of ECs could give additional ammunition to national competition authorities as they advocate for less restrictive regulatory frameworks within their jurisdictions.  It could thereby render more effective the efforts of the many new national competition authorities, whose success in enhancing competitive conditions within their jurisdictions has been limited at best.

ECs are no panacea – they will not directly affect restrictive national regulatory laws that benefit privileged special interests but harm the overall economy.  However, to the extent they prove financial successes, over time they could play a crucial indirect role in enhancing competition, reducing inefficiency, and spurring economic growth within their host countries.

Last week a group of startup investors wrote a letter to protest what they assume FCC Chairman Tom Wheeler’s proposed, revised Open Internet NPRM will say.

Bear in mind that an NPRM is a proposal, not a final rule, and its issuance starts a public comment period. Bear in mind, as well, that the proposal isn’t public yet, presumably none of the signatories to this letter has seen it, and the devil is usually in the details. That said, the letter has been getting a lot of press.

I found the letter seriously wanting, and seriously disappointing. But it’s a perfect example of what’s so wrong with this interminable debate on net neutrality.

Below I reproduce the letter in full, in quotes, with my comments interspersed. The key take-away: Neutrality (or non-discrimination) isn’t what’s at stake here. What’s at stake is zero-cost access by content providers to broadband networks. One can surely understand why content providers and those who fund them want their costs of doing business to be lower. But the rhetoric of net neutrality is mismatched with this goal. It’s no wonder they don’t just come out and say it – it’s quite a remarkable claim.

Open Internet Investors Letter

The Honorable Tom Wheeler, Chairman
Federal Communications Commission
445 12th Street, SW
Washington D.C. 20554

May 8, 2014

Dear Chairman Wheeler:

We write to express our support for a free and open Internet.

We invest in entrepreneurs, investing our own funds and those of our investors (who are individuals, pension funds, endowments, and financial institutions).  We often invest at the earliest stages, when companies include just a handful of founders with largely unproven ideas. But, without lawyers, large teams or major revenues, these small startups have had the opportunity to experiment, adapt, and grow, thanks to equal access to the global market.

“Equal” access has nothing to do with it. No startup is inherently benefitted by being “equal” to others. Maybe this is just careless drafting. But frankly, as I’ll discuss, there are good reasons to think (contra the pro-net neutrality narrative) that startups will be helped by inequality (just like contra the (totally wrong) accepted narrative, payola helps new artists). It says more than they would like about what these investors really want that they advocate “equality” despite the harm it may impose on startups (more on this later).

Presumably what “equal” really means here is “zero cost”: “As long as my startup pays nothing for access to ISPs’ subscribers, it’s fine that we’re all on equal footing.” Wheeler has stated his intent that his proposal would require any prioritization to be available to any who want it, on equivalent, commercially reasonable terms. That’s “equal,” too, so what’s to complain about? But it isn’t really inequality that’s gotten everyone so upset.

Of course, access is never really “zero cost;” start-ups wouldn’t need investors if their costs were zero. In that sense, why is equality of ISP access any more important than other forms of potential equality? Why not mandate price controls on rent? Why not mandate equal rent? A cost is a cost. What’s really going on here is that, like Netflix, these investors want to lower their costs and raise their returns as much as possible, and they want the government to do it for them.

As a result, some of the startups we have invested in have managed to become among the most admired, successful, and influential companies in the world.

No startup became successful as a result of “equality” or even zero-cost access to broadband. No doubt some of their business models were predicated on that assumption. But it didn’t cause their success.

We have made our investment decisions based on the certainty of a level playing field and of assurances against discrimination and access fees from Internet access providers.

And they would make investment decisions based on the possibility of an un-level playing field if that were the status quo. More importantly, the businesses vying for investment dollars might be different ones if they built their business models in a different legal/economic environment. So what? This says nothing about the amount of investment, the types of businesses, the quality of businesses that would arise under a different set of rules. It says only that past specific investments might not have been made.

Unless the contention is that businesses would be systematically worse under a different rule, this is irrelevant. I have seen that claim made, and it’s implicit here, of course, but I’ve seen no evidence to actually support it. Businesses thrive in unequal, cost-ladened environments all the time. It costs about $4 million/30 seconds to advertise during the Super Bowl. Budweiser and PepsiCo paid multiple millions this year to do so; many of their competitors didn’t. With inequality like that, it’s a wonder Sierra Nevada and Dr. Pepper haven’t gone bankrupt.

Indeed, our investment decisions in Internet companies are dependent upon the certainty of an equal-opportunity marketplace.

Again, no they’re not. Equal opportunity is a euphemism for zero cost, or else this is simply absurd on its face. Are these investors so lacking in creativity and ability that they can invest only when there is certainty of equal opportunity? Don’t investors thrive – aren’t they most needed – in environments where arbitrage is possible, where a creative entrepreneur can come up with a risky, novel way to take advantage of differential conditions better than his competitors? Moreover, the implicit equating of “equal-opportunity marketplace” with net neutrality rules is far-fetched. Is that really all that matters?

This is a good time to make a point that is so often missed: The loudest voices for net neutrality are the biggest companies – Google, Netflix, Amazon, etc. That fact should give these investors and everyone else serious pause. Their claim rests on the idea that “equality” is needed, so big companies can’t use an Internet “fast lane” to squash them. Google is decidedly a big company. So why do the big boys want this so much?

The battle is often pitched as one of ISPs vs. (small) content providers. But content providers have far less to worry about and face far less competition from broadband providers than from big, incumbent competitors. It is often claimed that “Netflix was able to pay Comcast’s toll, but a small startup won’t have that luxury.” But Comcast won’t even notice or care about a small startup; its traffic demands will be inconsequential. Netflix can afford to pay for Internet access for precisely the same reason it came to Comcast’s attention: It’s hugely successful, and thus creates a huge amount of traffic.

Based on news reports and your own statements, we are worried that your proposed rules will not provide the necessary certainty that we need to make investment decisions and that these rules will stifle innovation in the Internet sector.

Now, there’s little doubt that legal certainty aids investment decisions. But “certainty” is not in danger here. The rules have to change because the court said so – with pretty clear certainty. And a new rule is not inherently any more or less likely to offer certainty than the previous Open Internet Order, which itself was subject to intense litigation (obviously) and would have been subject to interpretation and inconsistent enforcement (and would have allowed all kinds of paid prioritization, too!). Certainty would be good, but Wheeler’s proposed rule won’t likely do anything about the amount of certainty one way or the other.

If established companies are able to pay for better access speeds or lower latency, the Internet will no longer be a level playing field. Start-ups with applications that are advantaged by speed (such as games, video, or payment systems) will be unlikely to overcome that deficit no matter how innovative their service.

Again, it’s notable that some of the strongest advocates for net neutrality are established companies. Another letter sent out last week included signatures from a bunch of startups, but also Google, Microsoft, Facebook and Yahoo!, among others.

In truth it’s hard to see why startup investors would think this helps them. Non-neutrality offers the prospect that a startup might be able to buy priority access to overcome the inherent disadvantage of newness, and to better compete with an established company. Neutrality means that that competitive advantage is impossible, and the baseline relative advantages and disadvantages remain – which helps incumbents, not startups. With a neutral Internet – well, the advantages of the incumbent competitor can’t be dissipated by a startup buying a favorable leg-up in speed and the Netflix’s of the world will be more likely to continue to dominate.

Of course the claim is that incumbents will use their huge resources to gain even more advantage with prioritized access. Implicit in this must be the assumption that the advantage that could be gained by a startup buying priority offers less return for the startup than the cost imposed on it by the inherent disadvantages of reputation, brand awareness, customer base, etc. But that’s not plausible for all or even most startups. And investors exist precisely because they are able to provide funds for which there is a likelihood of a good return – so if paying for priority would help overcome inherent disadvantages, there would be money for it.

Also implicit is the claim that the benefits to incumbents (over and above their natural advantages) from paying for priority, in terms of hamstringing new entrants, will outweigh the cost. This is unlikely generally to be true, as well. They already have advantages. Sure, sometimes they might want to pay for more, but in precisely the cases where it would be worth it to do so, the new entrant would also be most benefited by doing so itself – ensuring, again, that investment funds will be available.

Of course if both incumbents and startups decide paying for priority is better, we’re back to a world of “equality,” so what’s to complain about, based on this letter? This puts into stark relief that what these investors really want is government-mandated, subsidized broadband access, not “equality.”

Now, it’s conceivable that that is the optimal state of affairs, but if it is, it isn’t for the reasons given here, nor has anyone actually demonstrated that it is the case.

Entrepreneurs will need to raise money to buy fast lane services before they have proven that consumers want their product. Investors will extract more equity from entrepreneurs to compensate for the risk.

Internet applications will not be able to afford to create a relationship with millions of consumers by making their service freely available and then build a business over time as they better understand the value consumers find in their service (which is what Facebook, Twitter, Tumblr, Pinterest, Reddit, Dropbox and virtually other consumer Internet service did to achieve scale).

In other words: “Subsidize us. We’re worth it.” Maybe. But this is probably more revealing than intended. The Internet cost something to someone to build. (Actually, it cost more than a trillion dollars to broadband providers). This just says “we shouldn’t have to pay them for it now.” Fine, but who, then, and how do you know that forcing someone else to subsidize these startup companies will actually lead to better results? Mightn’t we get less broadband investment such that there is little Internet available for these companies to take advantage of in the first place? If broadband consumers instead of content consumers foot the bill, is that clearly preferable, either from a social welfare perspective, or even the self interest of these investors who, after all, do ultimately rely on consumer spending to earn their return?

Moreover, why is this “build for free, then learn how to monetize over time” business model necessarily better than any other? These startup investors know better than anyone that enshrining existing business models just because they exist is the antithesis of innovation and progress. But that’s exactly what they’re saying – “the successful companies of the past did it this way, so we should get a government guarantee to preserve our ability to do it, too!”

This is the most depressing implication of this letter. These investors and others like them have been responsible for financing enormously valuable innovations. If even they can’t see the hypocrisy of these claims for net neutrality – and worse, choose to propagate it further – then we really have come to a sad place. When innovators argue passionately for stagnation, we’re in trouble.

Instead, creators will have to ask permission of an investor or corporate hierarchy before they can launch. Ideas will be vetted by committees and quirky passion projects will not get a chance. An individual in dorm room or a design studio will not be able to experiment out loud on the Internet. The result will be greater conformity, fewer surprises, and less innovation.

This is just a little too much protest. Creators already have to ask “permission” – or are these investors just opening up their bank accounts to whomever wants their money? The ones that are able to do it on a shoestring, with money saved up from babysitting gigs, may find higher costs, and the need to do more babysitting. But again, there is nothing special about the Internet in this. Let’s mandate zero cost office space and office supplies and developer services and design services and . . . etc. for all – then we’ll have way more “permission-less” startups. If it’s just a handout they want, they should say so, instead of pretending there is a moral or economic welfare basis for their claims.

Further, investors like us will be wary of investing in anything that access providers might consider part of their future product plans for fear they will use the same technical infrastructure to advantage their own services or use network management as an excuse to disadvantage competitive offerings.

This is crazy. For the same reasons I mentioned above, the big access provider (and big incumbent competitor, for that matter) already has huge advantages. If these investors aren’t already wary of investing in anything that Google or Comcast or Apple or… might plan to compete with, they must be terrible at their jobs.

What’s more, Wheeler’s much-reviled proposal (what we know about it, that is), to say nothing of antitrust law, clearly contemplates exactly this sort of foreclosure and addresses it. “Pure” net neutrality doesn’t add much, if anything, to the limits those laws already do or would provide.

Policing this will be almost impossible (even using a standard of “commercial reasonableness”) and access providers do not need to successfully disadvantage their competition; they just need to create a credible threat so that investors like us will be less inclined to back those companies.

You think policing the world of non-neutrality is hard – try policing neutrality. It’s not as easy as proponents make it out to be. It’s simply never been the case that all bits at all times have been treated “neutrally” on the Internet. Any version of an Open Internet Order (just like the last one, for example) will have to recognize this.

Larry Downes compiled a list of the exceptions included in the last Open Internet Order when he testified before the House Judiciary Committee on the rules in 2011. There are 16 categories of exemption, covering a wide range of fundamental components of broadband connectivity, from CDNs to free Wi-Fi at Starbucks. His testimony is a tour de force, and should be required reading for everyone involved in this debate.

But think about how the manifest advantages of these non-neutral aspects of broadband networks would be squared with “real” neutrality. On their face, if these investors are to be taken at their word, these arguments would preclude all of the Open Internet Order’s exemptions, too. And if any sort of inequality is going to be deemed ok, how accurately would regulators distinguish between “illegitimate” inequality and the acceptable kind that lets coffee shops subsidize broadband? How does the simplistic logic of net equality distinguish between, say, Netflix’s colocated servers and a startup like Uber being integrated into Google Maps? The simple answer is that it doesn’t, and the claims and arguments of this letter are woefully inadequate to the task.

We need simple, strong, enforceable rules against discrimination and access fees, not merely against blocking.

No, we don’t. Or, at least, no one has made that case. These investors want a handout; that is the only case this letter makes.

We encourage the Commission to consider all available jurisdictional tools at its disposal in ensuring a free and open Internet that rewards, not disadvantages, investment and entrepreneurship.

… But not investment in broadband, and not entrepreneurship that breaks with the business models of the past. In reality, this letter is simple rent-seeking: “We want to invest in what we know, in what’s been done before, and we don’t want you to do anything to make that any more costly for us. If that entails impairing broadband investment or imposing costs on others, so be it – we’ll still make our outsized returns, and they can write their own letter complaining about ‘inequality.’”

A final point I have to make. Although the investors don’t come right out and say it, many others have, and it’s implicit in the investors’ letter: “Content providers shouldn’t have to pay for broadband. Users already pay for the service, so making content providers pay would just let ISPs double dip.” The claim is deeply problematic.

For starters, it’s another form of the status quo mentality: “Users have always paid and content hasn’t, so we object to any deviation from that.” But it needn’t be that way. And of course models frequently coexist where different parties pay for the same or similar services. Some periodicals are paid for by readers and offer little or no advertising; others charge a subscription and offer paid ads; and still others are offered for free, funded entirely by ads. All of these models work. None is “better” than the other. There is no reason the same isn’t true for broadband and content.

Net neutrality claims that the only proper price to charge on the content side of the market is zero. (Congratulations: You’re in the same club as that cutting-edge, innovative technology, the check, which is cleared at par by government fiat. A subsidy that no doubt explains why checks have managed to last this long). As an economic matter, that’s possible; it could be that zero is the right price. But it most certainly needn’t be, and issues revolving around Netflix’s traffic and the ability of ISPs and Netflix cost-effectively to handle it are evidence that zero may well not be the right price.

The reality is that these sorts of claims are devoid of economic logic — which is presumably why they, like the whole net neutrality “movement” generally, appeal so gratuitously to emotion rather than reason. But it doesn’t seem unreasonable to hope for more from a bunch of savvy financiers.


Richard Epstein replies to Judge Posner’s Apple v. Motorola opinion and follow-up article in The Atlantic.

The anti-patent sentiment has just been fueled by a remarkable opinion by Judge Richard Posner, my long-time colleague at the University of Chicago, sitting as a trial judge in the major case, Apple v. Motorola. The high-profile case concerns five patents—four by Apple and one by Motorola—that are involved in mobile phone technology, and it has drawn more than its fair share of attention. Judge Posner took the extraordinary step of dismissing the claims of both sides with prejudice—meaning, the case cannot be filed again elsewhere—on the grounds that neither side could make good on its argument for either damages or injunctions.

Thus, when the dust settled, there was no reason at all to have a trial on whether either side had infringed the patents of the other. In a subsequent piece written for The Atlantic, grandly entitled “Why There are Too Many Patents in America,” Posner delivered a general critique of the patent system, discussing the broader issues involved in his judicial decision.

There is much of interest, as always, in Epstein’s column.  But the closing section on damages and injunctions is where the action is:

What is so striking about Posner’s relentless dissection of the imprecision in these claims was that he could apply it with equal conviction in any patent software dispute. The estimates of damages under the law are not confined to a single standard, but often involve an uncertain choice between reasonable royalties for licensing the patent and actual damages that were incurred because the patents were not licensed. The injunctive relief is (or at least should be) awarded precisely because it is so difficult to figure out what those damages really ought to be.

But Posner said that he would not allow an injunction if the best that the plaintiffs could garner was $1 in nominal damages. That surely seems over the top, because if there is infringement, the one number that is manifestly wrong is $1. A more sensible approach here, therefore, is to mix and marry the two remedies, so that the injunction does not pull the past product off the market, but awards some damages for past losses, while giving the infringer some period of time—say three to six months—to invent around the patent for future output. This then sets the stage for a negotiated license if that is cheaper.

By putting the remedial cart before the liability horse, we have the odd situation that no one can find out anything about the strength of the patent or the potential range of damages. If that is done on a common basis, then we will have knocked out the entire patent system for software, without having the slightest idea of the relative strength of the Apple and Motorola contentions.

The Posner decision looks doubly worrisome against the backdrop of his ominous Atlantic column, which shows his ill-concealed disdain for a complex industry with which he has had no direct engagement. It is an odd way to make patent policy. Right now, a similar Apple-Samsung dispute is before Judge Lucy Koh, which will involve a real trial. The Posner opinion is already on the fast track to appeal before the Federal Circuit, which will give us more information as to whether these submarine assaults on the patent system will take hold. Let us hope that Posner’s mysterious patent adventurism dies a quick and deserved death.

Do go read the whole thing.  For interested readers, here is Posner’s Atlantic column.

Judge Douglas Ginsburg (D.C. Circuit Court of Appeals; NYU Law) and I have posted “Dynamic Antitrust and the Limits of Antitrust Institutions” to SSRN.  Our article is forthcoming in Volume 78 (2) of the Antitrust Law Journal.  We offer a cautionary note – from an institutional perspective – concerning the ever-increasing and influential calls for greater incorporation of models of dynamic competition and innovation into antitrust analysis by courts and agencies.

Here is the abstract:

The static model of competition, which dominates modern antitrust analysis, has served antitrust law well.  Nonetheless, as commentators have observed, the static model ignores the impact that competitive (or anti-competitive) activities undertaken today will have upon future market conditions.  An increased focus upon dynamic competition surely has the potential to improve antitrust analysis and, thus, to benefit consumers.  The practical value of proposals to increase the use of dynamic analysis must, however, be evaluated with an eye to the institutional limitations that antitrust agencies and courts face when engaged in predictive fact-finding.  We explain and evaluate both the current state of dynamic antitrust analysis and some recent proposals that agencies and courts incorporate dynamic considerations more deeply into their analyses.  We show antitrust analysis is not willfully ignorant of the limitations of static analysis; on the contrary, when reasonably confident predictions can be made, they are readily incorporated into the analysis.  We also argue agencies and courts should view current proposals for a more dynamic approach with caution because the theories underpinning those proposals lie outside the agencies’ expertise in industrial organization economics, do not consistently yield determinate results, and would place significant demands upon reviewing courts to question predictions based upon those theories.  Considering the current state of economic theory and empirical knowledge, we conclude that competition agencies and courts have appropriately refrained from incorporating dynamic features into antitrust analysis to make predictions beyond what can be supported by a fact-intensive analysis.

You can download the paper here.

Hating Capitalism

Paul H. Rubin —  13 May 2012

One topic that has long interested me is the source of dislike or hatred of capitalism; my Southern Economics Journal article “Folk Economics” (ungated version)  dealt in part with this topic. Today’s New York Times has an op-ed, “Capitalists and Other Psychopaths” by William Deresiewicz, who has taught English at Yale and Columbia, that both illustrates and explains this hatred.  What is interesting about this column is that it is entirely about the character and behavior of “the rich” including entrepreneurs.  The job creating function of business is briefly mentioned but most of the article focuses on “fraud, tax evasion, toxic dumping, product safety violations, bid rigging, overbilling, perjury.”

What is nowhere mentioned is anything to do with the goods and services produced by business.  This is a common attitude of critics of capitalism.  In many cases, capitalists may suffer the same personality defects as the rest of us.  And, as Mr. Deresiewicz points out, scientists, artists and scholars may also be hard working and smart.  But capitalism does not reward moral worth or hard work.  Capitalism rewards providing stuff  that other people are willing to pay for.  While is is easy to point out the stupidity of the critique (Mr. Deresiewicz has written and seems proud of his book, published by a capitalist publisher and available from various capitalist booksellers) that is not my point.  Rather, this column is interesting in that it is a pristine example of a totally irrelevant critique of capitalism, written by what is a smart person.  He does cite Adam Smith, but seems to misunderstand the basic functioning of markets.  Markets reward what one does, not what one is.

Ritter, Gao and Zhu ask, Where have all the IPOs Gone?  Well, not to young men everywhere, but to the older men and women who run the big companies that have replaced public markets as the key venture capital exit. Here’s the abstract:

During 1980-2000, an average of 311 companies per year went public in the U.S. Since the technology bubble burst in 2000, the average has been only 102 initial public offerings (IPOs) per year, with the drop especially precipitous among small firms. Many have blamed the Sarbanes-Oxley Act of 2002 and the 2003 Global Settlement’s effects on analyst coverage for the decline in U.S. IPO activity. We offer an alternative explanation. We posit that the advantages of selling out to a larger organization, which can speed a product to market and realize economies of scope, have increased relative to the benefits of remaining as an independent firm. Consistent with this hypothesis, we document that there has been a decline in the profitability of small company IPOs, and that small company IPOs have provided public market investors with low returns throughout the last three decades. Venture capitalists have been increasingly exiting their investments with trade sales rather than IPOs, and an increasing fraction of firms that have gone public have been involved in acquisitions. Our analysis suggests that IPO volume will not return to the levels of the 1980s and 1990s even with regulatory changes.

Why has this happened?  The authors suggest that “there has been a structural change over time that has increased the profitability of large firms that can realize economies of scope, speed products to market, and realize economies of scale in information technology.” For example, Apple could “assign a veritable army of engineers to rapidly implement new technologies into its consumer electronics products, such as the iPad, iPod, and iPhone. * * *No small independent company could implement new technology so rapidly and sell tens of millions of units to consumers in a matter of months.”

On the demand side, “the internet has made comparison shopping easier for consumers * * * Increased speed of communication thus leads to both a greater advantage from implementing new technology quickly, and a greater opportunity cost of waiting.”

If the authors are right, the future of innovation is mainly in large firms. (Not entirely:  the data doesn’t exclude the possibility of more Facebooks, Zyngas and Groupons.) Small firms might come up with the initial ideas, but big firms will become more influential in determining which ideas succeed. 

The question then becomes whether the structure of big firms will adapt to their new role by staying entrepreneurial and receptive to innovation. Big firms tend to get bureaucratized and complacent.  We have needed new blood to shake up the incumbents.  Big firms will have to offer decentralized decision-making and innovative compensation policies (insider trading?). 

Here is where deregulation could be useful:  not in determining the number of IPOs, but in letting today’s big firms offer the incentive structures and flexibility that enabled them to grow up to be what they are today.

Welcome Baby 7B!

Thom Lambert —  31 October 2011

According to the United Nations, sometime around Halloween a newborn baby will push the world’s population above seven billion people.  Welcome to our spectacular planet, Little One!

I should warn you that not everyone will greet your arrival as enthusiastically as I.  A great many smart folks on our planet—especially highly educated people in rich countries like my own—have fallen under the spell of this fellow named Malthus, who once warned that our planet was “overpopulated.”  Although Mr. Malthus’s ideas have been proven wrong time and again, his smart and influential disciples keep insisting that your arrival spells disaster, that this lonely planet just can’t support you. 

Now my own suspicion is that modern day Malthusians, who are smart enough to know that actual events have discredited their leader’s theories, continue to parrot Mr. Malthus’s ideas because they lend support to all manner of governmental intervention into private affairs.  (These smarty-pants Malthusians, who are well-aware of their own intelligence, tend to think they can arrange things better than the “men and women on the spot” and are constantly looking for reasons to go meddling in others’ business!)  Whatever their motivation, Mr. Malthus’s disciples just won’t shut up about how our planet is overpopulated.

You should know, though, that this simply isn’t true.  The first time you hear one of Mr. Malthus’s followers decrying your very existence by insisting that our planet is overpopulated, you should ask him or her:  “Overpopulated relative to what?”  Modern Malthusians can never give a good answer to that question, though they always try.

Sometimes they say “living space.”  But that’s plain silly.  Our planet is really pretty huge.  Indeed, if all seven billion people on the planet moved to the state ofAlaska, each person would have 2,300 square feet of living space!  Now I realize lots of cities get crowded, but that’s because people choose to live in those areas—they’ve decided that the benefits of enhanced economic opportunity in a densely populated area outweigh the costs of close confines.  If they really wanted extra living space, they could easily find it in our planet’s vast uninhabited (or sparsely inhabited) regions.

Sometimes modern day Malthusians say the planet is overpopulated relative to available food.  Wrong again.  In the nations of the world where institutions have evolved to allow people to profit from coming up with new ideas that enhance welfare, individuals have developed all sorts of ways to get more food from less land.  Accordingly, food production has always outpaced population growth.  Now, modern day Malthusians will probably tell you that food prices have been rising in recent years — a sign that food is getting scarcer relative to people’s demand for it.  But that’s because governments, beholden to powerful agricultural lobbyists, have been requiring that huge portions of agricultural output be diverted to fuel production even though the primary biofuel (ethanol) provides no environmental benefit.  As usual, it’s actually bad government policy, not population growth, that’s creating scarcity.

In recent days, Mr. Malthus’s disciples have insisted that the world is overpopulated relative to available resources.  Nothing new here.  Back in the 1970s, lots of smart folks contended that the earth was quickly running out of resources and that drastic measures were required to constrain continued population growth.  One of those smarty pants was Stanford University biologist Paul Ehrlich, who, along with his wife Anne and President Obama’s science czar John Holdren, asked (in all seriousness): “Why should the law not be able to prevent a person from having more than two children?”  (See Paul R. Ehrlich, Anne H. Ehrlich & John P. Holdren, Ecoscience 838 (1977).)  (Ehrlich also proclaimed, in his 1968 blockbuster The Population Bomb, that “The battle to feed all of humanity is over. In the 1970s hundreds of millions of people will starve to death in spite of any crash programs embarked upon now. At this late date nothing can prevent a substantial increase in the world death rate.”)

In 1980, Prof. Ehrlich bet economist Julian Simon (a jolly fellow who would have welcomed your birth!) that the booming population would raise demand for resources so much that prices would skyrocket.  Mr. Simon thought otherwise and therefore allowed Prof. Ehrlich to pick five metals whose price he believed would rise over the next decade.  As it turns out, the five metals Prof. Ehrlich selected — chromium, copper, nickel, tin, and tungsten — fell in price as clever, profit-seeking humans discovered both how to extract more from the earth and how to substitute other, cheaper substances.  Mr. Simon was not at all surprised.  He recognized that the long-term price trend of most resources points downward, indicating that resources are becoming more plentiful, relative to human needs, over time.  (Modern Malthusians may point to some recent price trends showing rising prices for some resources, especially precious metals.  It’s likely, though, that those price increases are due to the fact that central banks all over the world have been creating lots and lots of money, thereby threatening inflation and causing investors to hold their wealth in the form of commodities.)

The fundamental mistake Mr. Malthus’s disciples make, Little One, is to assume that our planet is the ultimate source of resources.  That’s just not true.  Our planet does contain lots of useful “stuff,” but it’s human ingenuity — something only you and those like you can provide — that turns that stuff into “resources.”  Take oil, for instance.  For most of human history, messy crude oil was a source of annoyance for landowners.  It polluted their water and fouled their property.  But when whale oil prices started to rise in response to scarcity (or, put differently, when the world started to look “overpopulated” relative to whale oil), some clever, profit-seeking folks discovered how to turn that annoyance into kerosene, and eventually petroleum.  Voila!  A “resource” was created!

Just as people once worried about overpopulation relative to whale oil supplies, lots of folks now worry about overpopulation relative to crude oil.  Well I’m not that worried, and you shouldn’t be either.  As oil prices rise, more and more clever profit-seekers will turn their energies toward finding new ways to obtain oil (e.g., hydraulic facturing), new techniques for reducing oil requirements (e.g., enhanced efficiency), and new substitutes for oil (e.g., alternative fuels).  Mr. Malthus’s disciples will continue to fret about the limits to growth, but the historical record is clear on this one:  Human ingenuity — the ultimate resource — always outpaces the diminution in useful “stuff.”

And so, Little Resource, your arrival on our planet should be celebrated, not scorned!  As you and your fellow newborns flex your creative muscle, you’ll develop new sources of wealth for the world.  As you do so, birth rates will plummet, as they typically do when societies become wealthier, and the demand for a cleaner environment, demand that rises with wealth, will grow.  We therefore need not worry about “overpopulation.”

We do, though, need to ensure the survival of those institutions — property rights, free markets, the rule of law — that encourage resource-creating innovation.  I, for one, promise to do my best to defend those institutions so that you and your fellow newborns can add to our planet’s resource base.

Another of Russ Roberts’ and John Papola’s brilliant “Keynes vs. Hayek” rap videos is now online.  (If you missed the first one, it’s here.)

Whereas the first video focused largely on monetary policy, this one looks mainly at fiscal policy.  Both are truly masterful.  I’m amazed that Roberts and Papola were able to incorporate so much of the substance of the debates into such short videos.  I’m also amazed at the resemblance between “John S. Papola, MD” (producer Papola’s father maybe?) and Ben Bernanke.  Uncanny.