Archives For Banking

Big Ink vs. Bigger Tech

Ramsi Woodcock —  30 December 2019

[TOTM: The following is the fifth in a series of posts by TOTM guests and authors on the politicization of antitrust. The entire series of posts is available here.]

This post is authored by Ramsi Woodcock, Assistant Professor, College of Law, and Assistant Professor, Department of Management at Gatton College of Business & Economics, University of Kentucky.

When in 2011 Paul Krugman attacked the press for bending over backwards to give equal billing to conservative experts on social security, even though the conservatives were plainly wrong, I celebrated. Social security isn’t the biggest part of the government’s budget, and calls to privatize it in order to save the country from bankruptcy were blatant fear mongering. Why should the press report those calls with a neutrality that could mislead readers into thinking the position reasonable?

Journalists’ ethic of balanced reporting looked, at the time, like gross negligence at best, and deceit at worst. But lost in the pathos of the moment was the rationale behind that ethic, which is not so much to ensure that the truth gets into print as to prevent the press from making policy. For if journalists do not practice balance, then they ultimately decide the angle to take.

And journalists, like the rest of us, will choose their own.

The dark underbelly of the engaged journalism unleashed by progressives like Krugman has nowhere been more starkly exposed than in the unfolding assault of journalists, operating as a special interest, on Google, Facebook, and Amazon, three companies that writers believe have decimated their earnings over the past decade.

In story after story, journalists have manufactured an antitrust movement aimed at breaking up these companies, even though virtually no expert in antitrust law or economics, on either the right or the left, can find an antitrust case against them, and virtually no expert would place any of these three companies at the top of the genuinely long list of monopolies in America that are due for an antitrust reckoning.

Bitter ledes

Headlines alone tell the story. We have: “What Happens After Amazon’s Domination Is Complete? Its Bookstore Offers Clues”; “Be Afraid, Jeff Bezos, Be Very Afraid”; “How Should Big Tech Be Reined In? Here Are 4 Prominent Ideas”;  “The Case Against Google”; and “Powerful Coalition Pushes Back on Anti-Tech Fervor.”

My favorite is: “It’s Time to Break Up Facebook.” Unlike the others, it belongs to an Op-Ed, so a bias is appropriate. Not appropriate, however, is the howler, contained in the article’s body, that “a host of legal scholars like Lina Khan, Barry Lynn and Ganesh Sitaraman are plotting a way forward” toward breakup. Lina Khan has never held an academic appointment. Barry Lynn does not even have a law degree. And Ganesh Sitaraman’s academic specialty is constitutional law, not antitrust. But editors let it through anyway.

As this unguarded moment shows, the press has treated these and other members of a small network of activists and legal scholars who operate on antitrust’s fringes as representative of scholarly sentiment regarding antitrust action. The only real antitrust scholar among them is Tim Wu, who, when you look closely at his public statements, has actually gone no further than to call for Facebook to unwind its acquisitions of Instagram and WhatsApp.

In more sober moments, the press has acknowledged that the law does not support antitrust attacks on the tech giants. But instead of helping readers to understand why, the press instead presents this as a failure of the law. “To Take Down Big Tech,” read one headline in The New York Times, “They First Need to Reinvent the Law.” I have documented further instances of unbalanced reporting here.

This is not to say that we don’t need more antitrust in America. Herbert Hovenkamp, who the New York Times once recognized as  “the dean of American antitrust law,” but has since downgraded to “an antitrust expert” after he came out against the breakup movement, has advocated stronger monopsony enforcement across labor markets. Einer Elhauge at Harvard is pushing to prevent index funds from inadvertently generating oligopolies in markets ranging from airlines to pharmacies. NYU economist Thomas Philippon has called for deconcentration of banking. Yale’s Fiona Morton has pointed to rising markups across the economy as a sign of lax antitrust enforcement. Jonathan Baker has argued with great sophistication for more antitrust enforcement in general.

But no serious antitrust scholar has traced America’s concentration problem to the tech giants.

Advertising monopolies old and new

So why does the press have an axe to grind with the tech giants? The answer lies in the creative destruction wrought by Amazon on the publishing industry, and Google and Facebook upon the newspaper industry.

Newspapers were probably the most durable monopolies of the 20th century, so lucrative that Warren Buffett famously picked them as his preferred example of businesses with “moats” around them. But that wasn’t because readers were willing to pay top dollar for newspapers’ reporting. Instead, that was because, incongruously for organizations dedicated to exposing propaganda of all forms on their front pages, newspapers have long striven to fill every other available inch of newsprint with that particular kind of corporate propaganda known as commercial advertising.

It was a lucrative arrangement. Newspapers exhibit powerful network effects, meaning that the more people read a paper the more advertisers want to advertise in it. As a result, many American cities came to have but one major newspaper monopolizing the local advertising market.

One such local paper, the Lorain Journal of Lorain, Ohio, sparked a case that has since become part of the standard antitrust curriculum in law schools. The paper tried to leverage its monopoly to destroy a local radio station that was competing for its advertising business. The Supreme Court affirmed liability for monopolization.

In the event, neither radio nor television ultimately undermined newspapers’ advertising monopolies. But the internet is different. Radio, television, and newspaper advertising can coexist, because they can target only groups, and often not the same ones, minimizing competition between them. The internet, by contrast, reaches individuals, making it strictly superior to group-based advertising. The internet also lets at least some firms target virtually all individuals in the country, allowing those firms to compete with all comers.

You might think that newspapers, which quickly became an important web destination, were perfectly positioned to exploit the new functionality. But being a destination turned out to be a problem. Consumers reveal far more valuable information about themselves to web gateways, like search and social media, than to particular destinations, like newspaper websites. But consumer data is the key to targeted advertising.

That gave Google and Facebook a competitive advantage, and because these companies also enjoy network effects—search and social media get better the more people use them—they inherited the newspapers’ old advertising monopolies.

That was a catastrophe for journalists, whose earnings and employment prospects plummeted. It was also a catastrophe for the public, because newspapers have a tradition of plowing their monopoly profits into investigative journalism that protects democracy, whereas Google and Facebook have instead invested their profits in new technologies like self-driving cars and cryptocurrencies.

The catastrophe of countervailing power

Amazon has found itself in journalists’ crosshairs for disrupting another industry that feeds writers: publishing. Book distribution was Amazon’s first big market, and Amazon won it, driving most brick and mortar booksellers to bankruptcy. Publishing, long dominated by a few big houses that used their power to extract high wholesale prices from booksellers, some of the profit from which they passed on to authors as royalties, now faced a distribution industry that was even more concentrated and powerful than was publishing. The Department of Justice stamped out a desperate attempt by publishers to cartelize in response, and profits, and author royalties, have continued to fall.

Journalists, of course, are writers, and the disruption of publishing, taken together with the disruption of news, have left journalists with the impression that they have nowhere to turn to escape the new economy.

The abuse of antitrust

Except antitrust.

Unschooled in the fine points of antitrust policy, it seems obvious to them that the Armageddon in newspapers and publishing is a problem of monopoly and that antitrust enforcers should do something about it.  

Only it isn’t and they shouldn’t. The courts have gone to great lengths over the past 130 years to distinguish between doing harm to competition, which is prohibited by the antitrust laws, and doing harm to competitors, which is not.

Disrupting markets by introducing new technologies that make products better is no antitrust violation, even if doing so does drive legacy firms into bankruptcy, and throws their employees out of work and into the streets. Because disruption is really the only thing capitalism has going for it. Disruption is the mechanism by which market economies generate technological advances and improve living standards in the long run. The antitrust laws are not there to preserve old monopolies and oligopolies such as those long enjoyed by newspapers and publishers.

In fact, by tearing down barriers to market entry, the antitrust laws strive to do the opposite: to speed the destruction and replacement of legacy monopolies with new and more innovative ones.

That’s why the entire antitrust establishment has stayed on the sidelines regarding the tech fight. It’s hard to think of three companies that have more obviously risen to prominence over the past generation by disrupting markets using superior technologies than Amazon, Google, and Facebook. It may be possible to find an anticompetitive practice here or there—I certainly have—but no serious antitrust scholar thinks the heart of these firms’ continued dominance lies other than in their technical savvy. The nuclear option of breaking up these firms just makes no sense.

Indeed, the disruption inflicted by these firms on newspapers and publishing is a measure of the extent to which these firms have improved book distribution and advertising, just as the vast disruption created by the industrial revolution was a symptom of the extraordinary technological advances of that period. Few people, and not even Karl Marx, thought that the solution to those disruptions lay with Ned Ludd. The solution to the disruption wrought by Google, Amazon, and Facebook today similarly does not lie in using the antitrust laws to smash the machines.

Governments eventually learned to address the disruption created by the original industrial revolution not by breaking up the big firms that brought that revolution about, but by using tax and transfer, and rate regulation, to ensure that the winners share their gains with the losers. However the press’s campaign turns out, rate regulation, not antitrust, is ultimately the approach that government will take to Amazon, Google, and Facebook if these companies continue to grow in power. Because we don’t have to decide between social justice and technological advance. We can have both. And voters will demand it.

The anti-progress wing of the progressive movement

Alas, smashing the machines is precisely what journalists and their supporters are demanding in calling for the breakup of Amazon, Google, and Facebook. Zephyr Teachout, for example, recently told an audience at Columbia Law School that she would ban targeted advertising except for newspapers. That would restore newspapers’ old advertising monopolies, but also make targeted advertising less effective, for the same reason that Google and Facebook are the preferred choice of advertisers today. (Of course, making advertising more effective might not be a good thing. More on this below.)

This contempt for technological advance has been coupled with a broader anti-intellectualism, best captured by an extraordinary remark made by Barry Lynn, director of the pro-breakup Open Markets Institute, and sometime advocate for the Author’s Guild. The Times quotes him saying that because the antitrust laws once contained a presumption against mergers to market shares in excess of 25%, all policymakers have to do to get antitrust right is “be able to count to four. We don’t need economists to help us count to four.”

But size really is not a good measure of monopoly power. Ask Nokia, which controlled more than half the market for cell phones in 2007, on the eve of Apple’s introduction of the iPhone, but saw its share fall almost to zero by 2012. Or Walmart, the nation’s largest retailer and a monopolist in many smaller retail markets, which nevertheless saw its stock fall after Amazon announced one-day shipping.

Journalists themselves acknowledge that size does not always translate into power when they wring their hands about the Amazon-driven financial troubles of large retailers like Macy’s. Determining whether a market lacks competition really does require more than counting the number of big firms in the market.

I keep waiting for a devastating critique of arguments that Amazon operates in highly competitive markets to emerge from the big tech breakup movement. But that’s impossible for a movement that rejects economics as a corporate plot. Indeed, even an economist as pro-antitrust as Thomas Philippon, who advocates a return to antitrust’s mid-20th century golden age of massive breakups of firms like Alcoa and AT&T, affirms in a new book that American retail is actually a bright spot in an otherwise concentrated economy.

But you won’t find journalists highlighting that. The headline of a Times column promoting Philippon’s book? “Big Business Is Overcharging you $5000 a Year.” I tend to agree. But given all the anti-tech fervor in the press, Philippon’s chapter on why the tech giants are probably not an antitrust problem ought to get a mention somewhere in the column. It doesn’t.

John Maynard Keynes famously observed that “though no one will believe it—economics is a technical and difficult subject.” So too antitrust. A failure to appreciate the field’s technical difficulty is manifest also in Democratic presidential candidate Elizabeth Warren’s antitrust proposals, which were heavily influenced by breakup advocates.

Warren has argued that no large firm should be able to compete on its own platforms, not seeming to realize that doing business means competing on your own platforms. To show up to work in the morning in your own office space is to compete on a platform, your office, from which you exclude competitors. The rule that large firms (defined by Warren as those with more than $25 billion in revenues) cannot compete on their own platforms would just make doing large amounts of business illegal, a result that Warren no doubt does not desire.

The power of the press

The press’s campaign against Amazon, Google, and Facebook is working. Because while they may not be as well financed as Amazon, Google, or Facebook, writers can offer their friends something more valuable than money: publicity.

That appears to have induced a slew of politicians, including both Senator Warren on the left and Senator Josh Hawley on the right, to pander to breakup advocates. The House antitrust investigation into the tech giants, led by a congressman who is simultaneously championing legislation advocated by the News Media Alliance, a newspaper trade group, to give newspapers an exemption from the antitrust laws, may also have similar roots. So too the investigations announced by dozens of elected state attorneys general.

The investigations recently opened by the FTC and Department of Justice may signal no more than a desire not to look idle while so many others act. Which is why the press has the power to turn fiction into reality. Moreover, under the current Administration, the Department of Justice has already undertaken two suspiciously partisan antitrust investigations, and President Trump has made clear his hatred for the liberal bastions that are Amazon, Google and Facebook. The fact that the press has made antitrust action against the tech giants a progressive cause provides convenient cover for the President to take down some enemies.

The future of the news

Rate regulation of Amazon, Google, or Facebook is the likely long-term resolution of concerns about these firms’ power. But that won’t bring back newspapers, which henceforth will always play the loom to Google and Facebook’s textile mills, at least in the advertising market.

Journalists and their defenders, like Teachout, have been pushing to restore newspapers’ old monopolies by government fiat. No doubt that would make existing newspapers, and their staffs, very happy. But what is good for Big News is not necessarily good for journalism in the long run.

The silver lining to the disruption of newspapers’ old advertising monopolies is that it has created an opportunity for newspapers to wean themselves off a funding source that has always made little sense for organizations dedicated to helping Americans make informed, independent decisions, free of the manipulation of others.

For advertising has always had a manipulative function, alongside its function of disseminating product information to consumers. And, as I have argued elsewhere, now that the vast amounts of product information available for free on the internet have made advertising obsolete as a source of product information, manipulation is now advertising’s only real remaining function.

Manipulation causes consumers to buy products they don’t really want, giving firms that advertise a competitive advantage that they don’t deserve. That makes for an antitrust problem, this time with real consequences not just for competitors, but also for technological advance, as manipulative advertising drives dollars away from superior products toward advertised products, and away from investment in innovation and toward investment in consumer seduction.

The solution is to ban all advertising, targeted or not, rather than to give newspapers an advertising monopoly. And to give journalism the state subsidies that, like all public goods, from defense to highways, are journalism’s genuine due. The BBC provides a model of how that can be done without fear of government influence.

Indeed, Teachout’s proposed newspaper advertising monopoly is itself just a government subsidy, but a subsidy extracted through an advertising medium that harms consumers. Direct government subsidization achieves the same result, without the collateral consumer harm.

The press’s brazen advocacy of antitrust action against the tech giants, without making clear how much the press itself has to gain from that action, and the utter absence of any expert support for this approach, represents an abdication by the press of its responsibility to create an informed citizenry that is every bit as profound as the press’s lapses on social security a decade ago.

I’m glad we still have social security. But I’m also starting to miss balanced journalism.

1/3/2020: Editor’s note – this post was edited for clarification and minor copy edits.

An oft-repeated claim of conferences, media, and left-wing think tanks is that lax antitrust enforcement has led to a substantial increase in concentration in the US economy of late, strangling the economy, harming workers, and saddling consumers with greater markups in the process. But what if rising concentration (and the current level of antitrust enforcement) were an indication of more competition, not less?

By now the concentration-as-antitrust-bogeyman story is virtually conventional wisdom, echoed, of course, by political candidates such as Elizabeth Warren trying to cash in on the need for a government response to such dire circumstances:

In industry after industry — airlines, banking, health care, agriculture, tech — a handful of corporate giants control more and more. The big guys are locking out smaller, newer competitors. They are crushing innovation. Even if you don’t see the gears turning, this massive concentration means prices go up and quality goes down for everything from air travel to internet service.  

But the claim that lax antitrust enforcement has led to increased concentration in the US and that it has caused economic harm has been debunked several times (for some of our own debunking, see Eric Fruits’ posts here, here, and here). Or, more charitably to those who tirelessly repeat the claim as if it is “settled science,” it has been significantly called into question

Most recently, several working papers looking at the data on concentration in detail and attempting to identify the likely cause for the observed data, show precisely the opposite relationship. The reason for increased concentration appears to be technological, not anticompetitive. And, as might be expected from that cause, its effects are beneficial. Indeed, the story is both intuitive and positive.

What’s more, while national concentration does appear to be increasing in some sectors of the economy, it’s not actually so clear that the same is true for local concentration — which is often the relevant antitrust market.

The most recent — and, I believe, most significant — corrective to the conventional story comes from economists Chang-Tai Hsieh of the University of Chicago and Esteban Rossi-Hansberg of Princeton University. As they write in a recent paper titled, “The Industrial Revolution in Services”: 

We show that new technologies have enabled firms that adopt them to scale production over a large number of establishments dispersed across space. Firms that adopt this technology grow by increasing the number of local markets that they serve, but on average are smaller in the markets that they do serve. Unlike Henry Ford’s revolution in manufacturing more than a hundred years ago when manufacturing firms grew by concentrating production in a given location, the new industrial revolution in non-traded sectors takes the form of horizontal expansion across more locations. At the same time, multi-product firms are forced to exit industries where their productivity is low or where the new technology has had no effect. Empirically we see that top firms in the overall economy are more focused and have larger market shares in their chosen sectors, but their size as a share of employment in the overall economy has not changed. (pp. 42-43) (emphasis added).

This makes perfect sense. And it has the benefit of not second-guessing structural changes made in response to technological change. Rather, it points to technological change as doing what it regularly does: improving productivity.

The implementation of new technology seems to be conferring benefits — it’s just that these benefits are not evenly distributed across all firms and industries. But the assumption that larger firms are causing harm (or even that there is any harm in the first place, whatever the cause) is unmerited. 

What the authors find is that the apparent rise in national concentration doesn’t tell the relevant story, and the data certainly aren’t consistent with assumptions that anticompetitive conduct is either a cause or a result of structural changes in the economy.

Hsieh and Rossi-Hansberg point out that increased concentration is not happening everywhere, but is being driven by just three industries:

First, we show that the phenomena of rising concentration . . . is only seen in three broad sectors – services, wholesale, and retail. . . . [T]op firms have become more efficient over time, but our evidence indicates that this is only true for top firms in these three sectors. In manufacturing, for example, concentration has fallen.

Second, rising concentration in these sectors is entirely driven by an increase [in] the number of local markets served by the top firms. (p. 4) (emphasis added).

These findings are a gloss on a (then) working paper — The Fall of the Labor Share and the Rise of Superstar Firms — by David Autor, David Dorn, Lawrence F. Katz, Christina Patterson, and John Van Reenan (now forthcoming in the QJE). Autor et al. (2019) finds that concentration is rising, and that it is the result of increased productivity:

If globalization or technological changes push sales towards the most productive firms in each industry, product market concentration will rise as industries become increasingly dominated by superstar firms, which have high markups and a low labor share of value-added.

We empirically assess seven predictions of this hypothesis: (i) industry sales will increasingly concentrate in a small number of firms; (ii) industries where concentration rises most will have the largest declines in the labor share; (iii) the fall in the labor share will be driven largely by reallocation rather than a fall in the unweighted mean labor share across all firms; (iv) the between-firm reallocation component of the fall in the labor share will be greatest in the sectors with the largest increases in market concentration; (v) the industries that are becoming more concentrated will exhibit faster growth of productivity; (vi) the aggregate markup will rise more than the typical firm’s markup; and (vii) these patterns should be observed not only in U.S. firms, but also internationally. We find support for all of these predictions. (emphasis added).

This is alone is quite important (and seemingly often overlooked). Autor et al. (2019) finds that rising concentration is a result of increased productivity that weeds out less-efficient producers. This is a good thing. 

But Hsieh & Rossi-Hansberg drill down into the data to find something perhaps even more significant: the rise in concentration itself is limited to just a few sectors, and, where it is observed, it is predominantly a function of more efficient firms competing in more — and more localized — markets. This means that competition is increasing, not decreasing, whether it is accompanied by an increase in concentration or not. 

No matter how may times and under how many monikers the antitrust populists try to revive it, the Structure-Conduct-Performance paradigm remains as moribund as ever. Indeed, on this point, as one of the new antitrust agonists’ own, Fiona Scott Morton, has written (along with co-authors Martin Gaynor and Steven Berry):

In short, there is no well-defined “causal effect of concentration on price,” but rather a set of hypotheses that can explain observed correlations of the joint outcomes of price, measured markups, market share, and concentration. As Bresnahan (1989) argued three decades ago, no clear interpretation of the impact of concentration is possible without a clear focus on equilibrium oligopoly demand and “supply,” where supply includes the list of the marginal cost functions of the firms and the nature of oligopoly competition. 

Some of the recent literature on concentration, profits, and markups has simply reasserted the relevance of the old-style structure-conduct-performance correlations. For economists trained in subfields outside industrial organization, such correlations can be attractive. 

Our own view, based on the well-established mainstream wisdom in the field of industrial organization for several decades, is that regressions of market outcomes on measures of industry structure like the Herfindahl-Hirschman Index should be given little weight in policy debates. Such correlations will not produce information about the causal estimates that policy demands. It is these causal relationships that will help us understand what, if anything, may be causing markups to rise. (emphasis added).

Indeed! And one reason for the enduring irrelevance of market concentration measures is well laid out in Hsieh and Rossi-Hansberg’s paper:

This evidence is consistent with our view that increasing concentration is driven by new ICT-enabled technologies that ultimately raise aggregate industry TFP. It is not consistent with the view that concentration is due to declining competition or entry barriers . . . , as these forces will result in a decline in industry employment. (pp. 4-5) (emphasis added)

The net effect is that there is essentially no change in concentration by the top firms in the economy as a whole. The “super-star” firms of today’s economy are larger in their chosen sectors and have unleashed productivity growth in these sectors, but they are not any larger as a share of the aggregate economy. (p. 5) (emphasis added)

Thus, to begin with, the claim that increased concentration leads to monopsony in labor markets (and thus unemployment) appears to be false. Hsieh and Rossi-Hansberg again:

[W]e find that total employment rises substantially in industries with rising concentration. This is true even when we look at total employment of the smaller firms in these industries. (p. 4)

[S]ectors with more top firm concentration are the ones where total industry employment (as a share of aggregate employment) has also grown. The employment share of industries with increased top firm concentration grew from 70% in 1977 to 85% in 2013. (p. 9)

Firms throughout the size distribution increase employment in sectors with increasing concentration, not only the top 10% firms in the industry, although by definition the increase is larger among the top firms. (p. 10) (emphasis added)

Again, what actually appears to be happening is that national-level growth in concentration is actually being driven by increased competition in certain industries at the local level:

93% of the growth in concentration comes from growth in the number of cities served by top firms, and only 7% comes from increased employment per city. . . . [A]verage employment per county and per establishment of top firms falls. So necessarily more than 100% of concentration growth has to come from the increase in the number of counties and establishments served by the top firms. (p.13)

The net effect is a decrease in the power of top firms relative to the economy as a whole, as the largest firms specialize more, and are dominant in fewer industries:

Top firms produce in more industries than the average firm, but less so in 2013 compared to 1977. The number of industries of a top 0.001% firm (relative to the average firm) fell from 35 in 1977 to 17 in 2013. The corresponding number for a top 0.01% firm is 21 industries in 1977 and 9 industries in 2013. (p. 17)

Thus, summing up, technology has led to increased productivity as well as greater specialization by large firms, especially in relatively concentrated industries (exactly the opposite of the pessimistic stories):  

[T]op firms are now more specialized, are larger in the chosen industries, and these are precisely the industries that have experienced concentration growth. (p. 18)

Unsurprisingly (except to some…), the increase in concentration in certain industries does not translate into an increase in concentration in the economy as a whole. In other words, workers can shift jobs between industries, and there is enough geographic and firm mobility to prevent monopsony. (Despite rampant assumptions that increased concentration is constraining labor competition everywhere…).

Although the employment share of top firms in an average industry has increased substantially, the employment share of the top firms in the aggregate economy has not. (p. 15)

It is also simply not clearly the case that concentration is causing prices to rise or otherwise causing any harm. As Hsieh and Rossi-Hansberg note:

[T]he magnitude of the overall trend in markups is still controversial . . . and . . . the geographic expansion of top firms leads to declines in local concentration . . . that could enhance competition. (p. 37)

Indeed, recent papers such as Traina (2018), Gutiérrez and Philippon (2017), and the IMF (2019) have found increasing markups over the last few decades but at much more moderate rates than the famous De Loecker and Eeckhout (2017) study. Other parts of the anticompetitive narrative have been challenged as well. Karabarbounis and Neiman (2018) finds that profits have increased, but are still within their historical range. Rinz (2018) shows decreased wages in concentrated markets but also points out that local concentration has been decreasing over the relevant time period.

None of this should be so surprising. Has antitrust enforcement gotten more lax, leading to greater concentration? According to Vita and Osinski (2018), not so much. And how about the stagnant rate of new firms? Are incumbent monopolists killing off new startups? The more likely — albeit mundane — explanation, according to Hopenhayn et al. (2018), is that increased average firm age is due to an aging labor force. Lastly, the paper from Hsieh and Rossi-Hansberg discussed above is only the latest in a series of papers, including Bessen (2017), Van Reenen (2018), and Autor et al. (2019), that shows a rise in fixed costs due to investments in proprietary information technology, which correlates with increased concentration. 

So what is the upshot of all this?

  • First, as noted, employment has not decreased because of increased concentration; quite the opposite. Employment has increased in the industries that have experienced the most concentration at the national level.
  • Second, this result suggests that the rise in concentrated industries has not led to increased market power over labor.
  • Third, concentration itself needs to be understood more precisely. It is not explained by a simple narrative that the economy as a whole has experienced a great deal of concentration and this has been detrimental for consumers and workers. Specific industries have experienced national level concentration, but simultaneously those same industries have become more specialized and expanded competition into local markets. 

Surprisingly (because their paper has been around for a while and yet this conclusion is rarely recited by advocates for more intervention — although they happily use the paper to support claims of rising concentration), Autor et al. (2019) finds the same thing:

Our formal model, detailed below, generates superstar effects from increases in the toughness of product market competition that raise the market share of the most productive firms in each sector at the expense of less productive competitors. . . . An alternative perspective on the rise of superstar firms is that they reflect a diminution of competition, due to a weakening of U.S. antitrust enforcement (Dottling, Gutierrez and Philippon, 2018). Our findings on the similarity of trends in the U.S. and Europe, where antitrust authorities have acted more aggressively on large firms (Gutierrez and Philippon, 2018), combined with the fact that the concentrating sectors appear to be growing more productive and innovative, suggests that this is unlikely to be the primary explanation, although it may important in some specific industries (see Cooper et al, 2019, on healthcare for example). (emphasis added).

The popular narrative among Neo-Brandeisian antitrust scholars that lax antitrust enforcement has led to concentration detrimental to society is at base an empirical one. The findings of these empirical papers severely undermine the persuasiveness of that story.

[This post is the second in an ongoing symposium on “Should We Break Up Big Tech?” that will feature analysis and opinion from various perspectives.]

[This post is authored by Philip Marsden, Bank of England & College of Europe, IG/Twitter:  @competition_flaneur]

Since the release of our Furman Report, I have been blessed with an uptick in #antitrusttourism. Everywhere I go, people are talking about what to do about Big Tech. Europe, the Middle East, LatAm, Asia, Down Under — and everyone has slightly different views. But the direction of travel is similar: something is going to be done, some action will be taken. The discussions I’ve been privileged to have with agency officials, advisors, tech in-house counsel and complainants have been balanced and fair. Disagreements tend to focus on the “how, now” rather than on re-hashing arguments about whether anything need be done at all. However, there is one jurisdiction which is the exception — and that is the US.   There, pragmatism seems to have been defenestrated — it is all or nothing: we break tech up, or we praise tech from the rooftops. The thing is, neither is an appropriate response, and the longer the debate paralyses the US antitrust community, the more the rest of the world will say “maybe we should see other people” and break with the hard-earned precedent of evidence-based inquiries for which the US agencies are famous.

In the Land of the Free, there is so much broad-brush polarisation. Of course, there is the political main stage, and we have our share of that in the UK too. But in the theatre of American antitrust we have Chicken Littles running around shrieking that all tech platforms are run by creeps, there is an evil design behind every algo tweak or acqui-hire, and the only solution is to ditch antitrust, and move fast and break things, especially break up the G-MAFIA and the upcoming BAT from Asia, ASAP. The Chicken Littles run rings around another group, the ostriches with their heads in the sand saying “nothing to look at here”, the platforms are only forces for good, markets tip tip and tip again, sit back and enjoy the “free” goodies, and leave any mopping up of the tears of whining complainants to fresh “studies” by antitrust enforcers.  

There is also an endemic American debate which is pitched as a deep existential crisis, but seems more of a distraction: this says let’s change the consumer welfare standard and import broader social concerns — which is matched by a shocked response that price-based consumer welfare analysis is surely tried and true, and any alteration would send the heavens crashing down again. I view this as a distraction because from my experience as an enforcer and advisor, I only see an enlightened use of the consumer welfare standard as already considering harms to innovation, non-price effects, and lately privacy. So it may be interesting academic conference-fodder, but it largely misses the point that modern antitrust analysis is far broader, and more aware of non-price harms than it is portrayed.   

The US though is the only jurisdiction I’ve been to lately that seems to generate the most heat in the debates, and the least light. It is also where demands for tech break-ups are loudest but where any suggestion of regulatory intervention is knee-jerk rejected with abject horror. So there is a lot of noise but not much signal. The US seems disconnected from the international consensus on the need for actual action — and is a lone singleton debating its split-brain into the ground. And when they travel to the rest of the world — many American enforcers say — commendably with honesty — “Hey it’s not me, it’s you.”   “You’re the crazy ones with your Google fines, your Amazon own-sales bans, and your Facebook privacy abuse cases, we’ll just press ahead with our usual measured prosecutorial approach — oh and do a big study.”   

The thing is: no one believes the US will be anti-NIKE and “just do nothing”. If that was true there wouldn’t have been a massive drop of tech stock value on the announcement of DOJ, FTC and particularly Senate inquiries.   So some action will come stateside too… but what should that look like?

What I’d like to see is more engagement in the US with the international proposals. In our Furman Report, we supported a consumer welfare standard, but not laissez-faire. We supported a regulatory model developed through participative antitrust, but not common carrier regulation. And we did not favour breakups or presumptions against acquisitions by tech firms.  We tried to do some good, while preventing greater evils. Now, I still think that the most anti-competitive activity I’ve ever seen comes from government not from the abuses of market power of firms, so we do need to tread very carefully in designing our solutions and remedies. But we must remain vigilant against competitive problems in the tech sector and try to get ahead of them, particularly where they are created through structural aspects of these multi-sided markets, consumer inertia, entrenchment and enveloping, even in a world of “free” “goods” and “services”  (all in quotes since not everything online is free, or good, or even a service). So in Furman, we engaged with the debate but we avoided non-informative polarisation; not out of cowardice but to produce something hopefully relevant, informative, and which can actually be acted upon. It is an honour that our current Prime Minister and Chancellor have supported our work, and there are active moves to implement almost all of our proposals.   

We grounded our work in maintaining a focus on a dynamic consumer welfare standard, but we still firmly agreed that more intervention was needed. We concluded this after laying out our findings of myriad structural reasons for regulatory intervention (with no antitrust cause of complaint), and improving antitrust enforcement to address bad conduct as well. We sought to #dialupantitrust — through speeding up enforcement, and modernising merger control analysis — as well as #unlockingdigitalcompetition by developing a pro-competitive code of conduct, and data mobility (not just portability) and open API and similar remedies. There’s been lots of talk about that, and similarly-directed reports from the EU Trio and the Stigler Centre. I think discussing this sort of approach is the most pragmatic, evidence-based way forward: namely a model of participative antitrust, where the tech companies, their customers, consumer groups and government work out how to ensure platforms with strategic market status take on firm conduct obligations to get ahead of problems ex ante, and clear out many of the most toxic exclusionary or exploitative practices.  

Our approach would leave antitrust authorities to focus on the more nuanced behaviour, where #evidencematters and economic analysis and judgment really need to be brought to bear. This will primarily be in merger control — which we argue needs to be more forward-looking, more focussed on dynamic non-price impacts, and more able to address both the likelihood and magnitude of harms in a balanced way. This may also mean that authorities are less accepting of even heavily-sweated entry stories from merging parties. In ex post antitrust enforcement the main problem is speed, and we need to adjust the overall investigatory and appeal mechanism to ensure it is not captured not so much by the defendants and their armies of lawyers and economists, but by the mistaken focus on victory of our own team.   

I’ve seen senior agency lawyers refuse to release a decision until it has been sweated by 10 litigators and 3 QC’s and is “appeal-proof” — which no decision ever is — adding months or even years to the process. And woe betide a case team, inquiry chair or agency head who tries to cut through that — for the response is always “oh so you’re (much sucking of teeth and shaking of heads) content with Legal Risk???”.   This is lazy — I’d much rather work with lawyers whose default is “What are we trying to achieve?” not “I’ll just say No and then head off home” — a flaw that pervades some in-house counsel too. Legal risk is inherent in antitrust enforcement, not something to be feared. Frankly so many agencies have too many levels of internal scrutiny now which — when married to a system of full merits appeals — makes it incredible that any enforcement ever happens at all. And don’t get me started on the gaming inherent in negotiating commitments that may not even be effective but don’t even get a chance to operate before going through years of  review processes dominated by third party “market tests”. These flaws in enforcement systems contribute to the perception (and reality) of antitrust law’s weakness, slowness and inapplicability to reality — and hence fuel the calls for much stronger, much more intrusive and more chilling regulation, that could truly stifle a lot of genuine innovation.   

So our Furman report tries to cut through this, by speeding up antitrust enforcement, making merger control more forward looking — without achieving mathematical certainty but still allowing judgement of what is harmful on balance — and proposes a pro-competitive code of conduct for tech firms to help develop and “walk the talk”.   Developing that code will be a key challenge as we need to further refine what level of economic dependency on a platform customers and suppliers need to have, before that tech co is deemed to have strategic market status and must take on additional responsibilities to act fairly with respect to its customers, users, and suppliers. Fortunately, the British Government’s approval of our plans for a Digital Markets Unit means we can get started — so watch this space.

I’ve never said that this will be easy to do. We have a model in the Groceries Code Adjudicator — which was set up as a competition remedy — after a long market investigation of the offline retail platform market identified a range of harms that could occur, that might even be price-lowering to consumers but could harm innovation, choice and legitimate competition on the merits. A list of platforms was drawn up, a code was applied, and a range of toxic exploitative and exclusionary conduct was driven out of the market, and while not everything is perfect in retailing, far fewer complaints are landing on the CEO’s desk at the Competition & Markets Authority — so it can focus on other priorities. Our view is similar — while recognising that tech is a lot more complicated. Part of our model is thus also drawn on other CMA work with which I was honoured to be involved, a two year investigation of the retail banking platforms, and a degree of supply side and demand side inertia that I had never seen before, except maybe in energy. Here the solution was not — as politicians wanted — to break up the big banks. That would have done nothing good, and a lot of bad. Instead we found that the dynamic between supply and demand was so broken that remedies on both sides of the equation were needed. Here it was truly an example not of “it’s not you, it’s me” but “it’s both of us”: suppliers and consumers were contributing to the problem. We decided not to break up the platforms, though — but open them up — making data they were just sitting on (and which was a form of barrier to entry) available to fintech intermediaries, who would compete to access the data, train their new algos and thereby offer new choice tools to consumers.    

Breakups wold have added limping suppliers to the market, but much less competitive constraint. Opening up their data banks spurred the incumbents on to innovate faster than they might have, and customers to engage more with their banks. Our measure of success wasn’t switching — there is firm evidence that Britons switch their spouses more often than they switch their banks. So the remedy wasn’t breakup, and the KPI isn’t divorce, but is… engagement, on both sides of the relationship. And if it resulted in “maybe we should see other people” and multi-bank, then that is all to the overall good, for customer satisfaction, better engagement, and a more innovative retail banking ecosystem.  

And that is where I think we should seek new remedies in the tech sphere. Breakups wouldn’t help us stimulate a more innovative creative ecosystem. But only opening up platforms after litigating on an essential facilities doctrine for 8 years wouldn’t get us there either. We need informed analysis, with tech experts and competition and consumer officials, to identify the drivers of business developments, to balance the myriad issues that we all have as citizens, and voters, and shoppers, and then to act surgically when we see that a competition law problem of abuse of market power, or structural economic dependency, is causing real harm.  

I believe that the Furman report, and other international proposals from Australia, Canada, the EU, the UK’s Digital Markets Strategy, and enforcement action in the EU, Spain, Germany, Italy and elsewhere will help provide us with natural experiments and targeted solutions to specific problems. And in the process, will help fend off calls for short-term ‘fixes’ like breakups and other regulation that are retrograde and chill rather than go with the flow of — or better — stimulate innovation.   

Finally, we must not lose sight of one of my current bugbears, the incredible dependency we have allowed our governments and private sector to have on a handful of cloud computing companies. This may well have developed through superior skill, foresight and industry, and may be subject to rigorous procurement procedures and testing, but frankly, this is a ‘market’ that is too important to ignore. Social media and advertising may be pervasive but cloud is huge — with defence departments and banks and key infrastructure dependent on what are essentially private sector resiliency programmes. Even more than Facebook’s proposed currency Libra becoming “instantly systemic”, I fear we are already there with cloud: huge benefits, amazing efficiencies, but with it some zombie-apocalypse-level systemic risks not of one bank falling over, but many. Here it may well be that the bigger they are the more resilient they are, and the more able they are to police and rectify problems… but we have heard that before in other sectors and I just hope we can apply our developing proposals for digital platforms, to new challenges as well. The way tech is developing, we can’t live without it — but to live with it, we need to accept more responsibilities as enforcers, consumers and providers of these crucial services. So let’s stay together and work harder to #makeantitrustgreatagain and #unlockdigitalcompetition.   

A recent tweet by Lina Khan, discussing yesterday’s American Express decision, exemplifies an unfortunate trend in contemporary antitrust discourse.  Khan wrote:

The economists cited by the Second Circuit (whose opinion SCOTUS affirms) for the analysis of ‘two-sided’ [markets] all had financial links to the credit card sector, as we point out in FN 4 [link to amicus brief].

Her implicit point—made more explicitly in the linked brief, which referred to the economists’ studies as “industry-funded”—was that economic analysis should be discounted if the author has ever received compensation from a firm that might benefit from the proffered analysis.

There are two problems with this reasoning.  First, it’s fallacious.  An ad hominem argument, one addressed “to the person” rather than to the substance of the person’s claims, is a fallacy of irrelevance, sometimes known as a genetic fallacy.  Biased people may make truthful claims, just as unbiased people may get things wrong.  An idea’s “genetics” are irrelevant.  One should assess the substance of the actual idea, not the identity of its proponent.

Second, the reasoning ignores that virtually everyone is biased in some way.  In the antitrust world, those claiming that we should discount the findings and theories of industry-connected experts urging antitrust modesty often stand to gain from having a “bigger” antitrust.

In the common ownership debate about which Mike Sykuta and I have recently been blogging, proponents of common ownership restrictions have routinely written off contrary studies by suggesting bias on the part of the studies’ authors.  All the while, they have ignored their own biases:  If their proposed policies are implemented, their expertise becomes exceedingly valuable to plaintiff lawyers and to industry participants seeking to traverse a new legal minefield.

At the end of our recent paper, The Case for Doing Nothing About Institutional Investors’ Common Ownership of Small Stakes in Competing Firms, Mike and I wrote, “Such regulatory modesty will prove disappointing to those with a personal interest in having highly complex antitrust doctrines that are aggressively enforced.”  I had initially included a snarky footnote, but Mike, who is far nicer than I, convinced me to remove it.

I’ll reproduce it here in the hopes of reducing the incidence of antitrust ad hominem.

Professor Elhauge has repeatedly discounted criticisms of the common ownership studies by suggesting that critics are biased.  See, e.g., Elhauge, supra note 26, at 1 (observing that “objections to my analysis have been raised in various articles, some funded by institutional investors with large horizontal shareholdings”); id. at 3 (“My analysis of executive compensation has been critiqued in a paper by economic consultants O’Brien and Waehrer that was funded by the Investment Company Institute, which represents institutional investors and was headed for the last three years by the CEO of Vanguard.”); Elhauge, supra note 124, at 3 (observing that airline and banking studies “have been critiqued in other articles, some funded by the sort of institutional investors that have large horizontal shareholdings”); id. at 17 (“The Investment Company Institute, an association of institutional investors that for the preceding three years was headed by the CEO of Vanguard, has funded a couple of papers to critique the empirical study showing an adverse link between horizontal shareholding and airline prices.”); id. (observing that co-authors of critique “both have significant experience in the airline industry because they consulted either for the airlines or the DOJ on airline mergers that were approved notwithstanding high levels of horizontal shareholding”); id. at 19 (“The Investment Company Institute has responded by funding a second critique of the airline study.”); id. at 23-24 (“Even to the extent that such studies are not directly funded by industry, when an industry has been viewed as benign for a long time, confirmation bias is a powerful force that will incline many to interpret any data to find no adverse effects.”).  He fails, however, to acknowledge his own bias.  As a professor of antitrust law at one of the nation’s most prestigious law schools, he has an interest in having antitrust be as big and complicated as possible: The more complex the doctrine, and the broader its reach, the more valuable a preeminent antitrust professor’s expertise becomes.  This is not to suggest that one should discount the assertions of Professor Elhauge or other proponents of restrictions on common ownership.  It is simply to observe that bias is unavoidable and that the best approach is therefore to evaluate claims according to their substance, not according to who is asserting them.

Even if institutional investors’ common ownership of small stakes in competing firms did cause some softening of market competition—a claim that is both suspect as a theoretical matter and empirically shaky—the policy solutions common ownership critics have proposed would do more harm than good.

Einer Elhauge has called for public and private lawsuits against institutional investors under Clayton Act Section 7, which is primarily used to police anticompetitive mergers but which literally forbids any stock acquisition that substantially lessens competition in a market. Eric Posner, Fiona Scott Morton, and Glen Weyl have called on the federal antitrust enforcement agencies (FTC and DOJ) to promulgate an enforcement policy that would discourage institutional investors from investing and voting shares in multiple firms within any oligopolistic industry.

As Mike Sykuta and I explain in our recent paper on common ownership, both approaches would create tremendous decision costs for business planners and adjudicators and would likely entail massive error costs as institutional investors eliminated welfare-enhancing product offerings and curtailed activities that reduce agency costs.

Decision Costs

The touchstone for liability under Elhauge’s Section 7 approach would be a pattern of common ownership that caused, or likely would cause, market prices to rise. Elhauge would identify suspect patterns of common ownership using MHHI∆, a measure that assesses incentives to reduce competition based on, among other things, the extent to which investors own stock in multiple firms within a market and the market shares of the commonly owned firms. (Mike described MHHI∆ here.) Specifically, Elhauge says, liability would result from “any horizontal stock acquisitions that have created, or would create, a ∆MHHI of over 200 in a market with an MHHI over 2500,” if “those horizontal stock acquisitions raised prices or are likely to do so.”

The administrative burden this approach would place on business planners would be tremendous. Because an institutional investor can’t directly control market prices, the only way it could avoid liability would be to ensure either that the markets in which it was invested did not have an MHHI greater than 2500 or that its acquisitions’ own contribution to MHHI∆ in those markets was less than 200. MHHI and MHHI∆, though, are largely determined by others’ investments and by commonly owned firms’ market shares, both of which change constantly. This implies that business planners could ensure against liability only by continually monitoring others’ activities and general market developments.

Adjudicators would also face high decision costs under Elhauge’s Section 7 approach. First, they would have to assess complicated econometric studies to determine whether adverse price effects were actually caused by patterns of common ownership. Then, if they decided common ownership had caused a rise in prices, they would have to answer a nearly intractable question: How should the economic harm from common ownership be allocated among the investors holding stakes in multiple firms in the industry? As Posner et al. have observed, “MHHI∆ is a collective responsibility of the holding pattern” in markets in which there are multiple intra-industry diversified investors. It would not work to assign liability only to those diversified investors who could substantially reduce MHHI∆ by divesting, for oftentimes the unilateral divestment of each institutional investor from the market would occasion only a small reduction in MHHI∆. An aggressive court might impose joint liability on all intra-industry diversified investors, but the investor(s) from whom plaintiffs collected would likely seek contribution from the other intra-industry diversified investors. Denying contribution seems intolerably inequitable, but how would a court apportion damages?

In light of these administrative difficulties, Posner et al. advocate a more determinate, rule-based approach. They would have the federal antitrust enforcement agencies compile annual lists of oligopolistic industries and then threaten enforcement action against any institutional investor holding more than one percent of the stock in such an industry if the investor (1) held stock in more than one firm within the industry, and (2) either voted its shares or engaged firm managers.

On first glance, this enforcement policy approach might appear to reduce decision costs: Business planners would have to do less investigation to avoid liability if they could rely on trustworthy, easily identifiable safe harbors; adjudicators’ decision costs would fall if the enforcement policy made it easier to identify illicit investment patterns. But the approach saddles antitrust enforcers with the herculean task of compiling, and annually updating, lists of oligopolistic industries. Given that the antitrust agencies frequently struggle with the far more modest task of defining markets in the small number of merger challenges they file each year, there is little reason to believe enforcers could perform their oligopoly-designating duties at a reasonable cost.

Error Costs

Even greater than the proposed policy solutions’ administrative costs are their likely error costs—i.e., the welfare losses that would stem from wrongly deterring welfare-enhancing arrangements. Such costs would result if, as is likely, institutional investors were to respond to the policy solutions by making one of the two changes proponents of the solutions appear to prefer: either refraining from intra-industry diversification or remaining fully passive in the industries in which they hold stock of multiple competitors.

If institutional investors were to seek to avoid liability by investing in only one firm per concentrated industry, retail investors would lose access to a number of attractive investment opportunities. Passive index funds, which offer retail investors instant diversification with extremely low fees (due to the lack of active management), would virtually disappear, as most major stock indices include multiple firms per industry.

Moreover, because critics of common ownership maintain that intra-industry diversification at the institutional investor level is sufficient to induce competition-softening in concentrated markets, each institutional investor would have to settle on one firm per concentrated industry for all its funds. That requirement would impede institutional investors’ ability to offer a variety of actively managed funds organized around distinct investment strategies—e.g., growth, value, income etc. If, for example, Southwest Airlines were a growth stock and United Airlines a value stock, an institutional investor could not offer both a growth fund including Southwest and a value fund including United.

Finally, institutional investors could not offer funds designed to bet on an industry while limiting exposure to company-specific risks within that industry. Suppose, for example, that a financial crisis led to a precipitous drop in the stock prices of all commercial banks. A retail investor might reasonably conclude that the market had overreacted with respect to the industry as a whole, that the industry would likely rebound, but that some commercial banks would probably fail. Such an investor would wish to invest in the commercial banking sector but to hold a diversified portfolio within that sector. A legal regime that drove fund families to avoid intra-industry diversification would prevent them from offering the sort of fund this investor would prefer.

Of course, if institutional investors were to continue intra-industry diversification and seek to avoid liability by remaining passive in industries in which they were diversified, the funds described above could still be offered to investors. In that case, though, another set of significant error costs would arise: increased agency costs in the form of managerial misfeasance.

Unlike most individual shareholders, institutional investors often hold significant stakes in public companies and have the resources to become informed on corporate matters. They have a stronger motive and more opportunity to monitor firm managers and are thus particularly well-poised to keep managers on their toes. Institutional investors with long-term investor horizons—including all index funds, which cannot divest from their portfolio companies if firm performance suffers—have proven particularly beneficial to firm performance.

Indeed, a recent study by Jarrad Harford, Ambrus Kecskés, & Sattar Mansi found that investment by long-term institutional investors enhanced the quality of corporate managers, reduced measurable instances of managerial misbehavior, boosted innovation, decreased debt maturity (causing firms to become more exposed to financial market discipline), and increased shareholder returns. It strains credulity to suppose that this laundry list of benefits could similarly be achieved by long-term institutional investors that had no ability to influence managerial decision-making by voting their shares or engaging managers. Opting for passivity to avoid antitrust risk, then, would prevent institutional investors from achieving their agency cost-reducing potential.

In the end, proponents of additional antitrust intervention to police common ownership have not made their case. Their theory as to why current levels of intra-industry diversification would cause consumer harm is implausible, and the empirical evidence they say demonstrates such harm is both scant and methodologically suspect. The policy solutions they have proposed for dealing with the purported problem would radically rework an industry that has provided substantial benefits to investors, raising the costs of portfolio diversification and enhancing agency costs at public companies. Courts and antitrust enforcers should reject their calls for additional antitrust intervention to police common ownership.

Mike Sykuta and I have been blogging about our new paper responding to scholars who contend that institutional investors’ common ownership of small stakes in competing firms significantly reduces market competition and should be restricted.  (FTC Commissioner Noah Phillips cited the paper yesterday in his excellent prepared remarks on common ownership.)  Mike first described the purported competitive problem.  I then set forth some problems with the anticompetitive theory common ownership critics have asserted.

When confronted with criticisms of their theory, common ownership critics have pointed to the empirical evidence Mike mentioned. In the most high-profile study, researchers correlated changes in commercial air fares with changes in “MHHI∆”, an index designed to measure the degree to which common ownership has reduced the incentive to compete. They concluded that common ownership has increased airfares by three to seven percent. A similar study of the commercial banking industry correlated banking fees and interest on deposit accounts with “GHHI”, a metric similar to MHHI∆. That study concluded that common ownership has led to higher fees and lower interest rates for depositors.

Common ownership critics have treated these studies as a trump card. The authors of the airline study, for example, brushed off a criticism of their anticompetitive theory with the following retort: “This argument falls short of explaining why, empirically, taking into account shareholders’ economic interests does help to explain firms’ product market behavior.”

Of course, to demonstrate “empirically” that institutional investors’ “economic interests” influence their portfolio companies’ “product market behavior” (i.e., cause the companies to charge higher prices, etc.), researchers would need to (1) correctly identify institutional investors’ economic interests with respect to their portfolio firms’ product market behavior, and (2) establish that those interests cause firms to act as they do. On those crucial tasks, the airline and banking studies fall short.

In assessing institutional investors’ economic interests, the studies have assumed that if an institutional investor reports holding a similar percentage of each firm in a market—say, five percent of the stock of each major airline—then it must have an “economic interest” in maximizing industry rather than own-firm profits. Such an assumption is unwarranted. That is because each institutional investor’s reported holdings, set forth on forms it must submit under Section 13(f) of the Securities Exchange Act, aggregate its holdings across all its funds. Such aggregation paints a misleading picture of the institutional investor’s actual economic interest.

For example, while Vanguard’s Section 13(f) filing reports ownership of a similar percentage of American, Delta, Southwest, and United Airlines—suggesting an economic interest in industry profit maximization—the picture looks very different at the individual fund level:

  • Vanguard’s Value Index Fund (VIVAX) holds significant stakes in American, Delta, and United (0.46%, 0.45%, and 0.42%, respectively) but holds no Southwest stock. VIVAX does best if United, American, and Delta usurp business from Southwest.
  • Vanguard’s Growth Index Fund (VIGRX) holds a significant stake in Southwest (0.59%) but holds no stake in American, Delta, or United. Investors in VIGRX would prefer that Southwest win business from American, Delta, and United.
  • Vanguard’s Mid-Cap Index Fund (VIMSX) and Mid-Cap Value Index Fund (VMVIX) hold significant stakes in United (1.00% and 0.321%, respectively) but hold no stock in American, Delta, or Southwest. Investors in VIMSX and VMVIX would prefer that United win business from American, Delta, and Southwest.
  • Vanguard’s PRIMECAP Core Fund (VPCCX) holds stakes in all four major airlines, but its share of Southwest (1.49%) is twice its share of American (0.72%), nearly four times its share of United (0.38%), and seven-and-a-half times its share of Delta (0.198%). Investors in VPCCX would prefer that Southwest grow at the expense of American, United, and Delta. They would also prefer that American win business from United and Delta, and that United win business from Delta.

We could go on, but the point should be clear: Because returns to retail investors in the funds of Vanguard and similar institutions turn on fund performance, the competitive outcome that maximizes retail investors’ profits will differ among funds.

Proponents of restrictions on common ownership might respond that even if an institutional investor’s individual funds have conflicting preferences, the institutional investor as an entity must have some preference about whether to maximize industry profits or the profits of a particular company. Because it cannot honor all its individual funds’ conflicting preferences with respect to competitive outcomes, the institutional investor will settle on the compromise strategy that maximizes its individual funds’ aggregate returns: industry profit maximization.  Such a strategy would be the first choice of the institution’s funds holding relatively equal shares of all firms within a market.  And, while the first choice of the institution’s funds that are disproportionately invested in one firm would be to maximize that firm’s profits, those funds would do better with industry profit maximization than with the first-choice strategy of other of the institution’s funds, i.e., those that are disproportionately invested in a different firm.

But even if maximization of industry profits leads to the greatest aggregate returns for an institutional investor’s funds, such a strategy may not be the best outcome for the institutional investor itself. An institutional investor typically wants to maximize its profits, which will grow as it attracts retail investors into its funds versus those of its competitors and steers those investors toward the funds that earn it the greatest profits (fees less costs). To assess an institutional investor’s preferences with regard to the returns of its different funds, then, one must know (1) the degree to which each fund’s attractiveness vis-à-vis rivals’ similar funds turns on portfolio returns, and (2) the profit margin each fund delivers to the institutional investor.

For funds tracking popular stock indices, portfolio returns play little role in winning business from rival fund sponsors.  (For example, higher returns on the stocks in the S&P 500 are unlikely to attract investors to BlackRock’s S&P 500 index fund over Fidelity’s or Vanguard’s.) Moreover, the fees charged on such funds, and thus the institutional investor’s potential profit margins, are extraordinarily low. For actively managed funds, portfolio returns are far more significant in attracting investors, and management fees are higher. The upshot is that an institutional investor, in determining what competitive outcome it prefers, will attach little weight to the competitive preferences of passive index funds and more weight to the preferences of actively managed funds, with that weight growing as the funds provide the institutional investor with higher profit margins.

It is quite possible, then, for an intra-industry diversified institutional investor to prefer a competitive outcome other than the maximization of industry profits, even if industry profit maximization would maximize the aggregate returns of its individual funds. Consider, for example, an institutional investor that offers funds similar to the following Vanguard funds:

  • Vanguard’s 500 Index Fund (VFIAX) holds near equivalent interests in American, Delta, Southwest, and United and would thus do best with a strategy of industry profit maximization. Its expense ratio (annual fees divided by total fund amount) is 0.04 percent.
  • Vanguard’s Value Index Fund (VIVAX) holds similar stakes in American, Delta, and United but does not hold Southwest stock. Its expense ratio is 0.18 percent.
  • Vanguard’s PRIMECAP Core Fund (VPCCX) holds a much higher stake in Southwest than in the other airlines and has an expense ratio of 0.46 percent, 2.5 times as great as the no-Southwest VIVAX fund and 11.5 times as high as the fully diversified VFIAX fund.
  • Vanguard’s Capital Opportunity Fund (VHCAX) holds significantly higher shares of Southwest and United (1.74% and 1.55%, respectively) than of Delta and American (0.65% and 1.16%, respectively). Its expense ratio is 0.38, more than twice as great as the no-Southwest VIVAX fund and 9.5 times the fully diversified VFIAX fund.

This institutional investor’s Southwest-heavy funds (those resembling Vanguard’s VPCCX and VHCAX funds) charge much higher fees than its fully diversified index fund (the one resembling VFIAX, for which fund returns are unimportant) and significantly higher fees than its funds that are more heavily invested in airlines besides Southwest (those resembling VIVAX).  Thus, despite being intra-industry diversified at the institutional level, this institutional investor may do best if Southwest maximizes own-firm profits.

The point here is that discerning an institutional investor’s actual economic interest requires drilling down to the level of its individual funds, something the common ownership studies have not done. Thus, contrary to the assertion of the airline study’s authors, the common ownership studies have not shown “empirically” that “taking into account shareholders’ economic interests does help to explain firms’ product market behavior.” Indeed, they have never established what those economic interests are.

Even if institutional investors’ aggregated holdings accurately revealed their economic interests with respect to competitive outcomes, the common ownership studies would still be deficient because they fail to show that those economic interests caused portfolio firms’ “product market behavior.” As explained above, the common ownership studies employ MHHI∆ (or a similar measure) to assess institutional investors’ interests in competition-softening. They then correlate changes in that metric with changes in portfolio firms’ pricing behavior. The problem is that MHHI∆ is itself affected by factors that independently influence market prices. It is thus improper to infer that changes in MHHI∆ caused changes in portfolio firms’ pricing practices; the pricing changes could have resulted from the very factors that changed MHHI∆. In other words, MHHI∆ is an endogenous measure.

To see why this is so, consider the three-step process involved in calculating MHHI∆ (which Mike described). The first step is to assess, for every coupling of competing firms in the market (e.g., Southwest/Delta, United/American, Southwest/United, etc.), the degree to which the controlling investors in each of the firms would prefer that it avoid competing with the other. The second step considers the market shares of the two firms in the coupling to determine the competitive significance of their incentives not to compete with each other. (The idea is that reduced head-to-head competition by bit players matters less for overall market competition than does reduced competition by major players.) The final step is to aggregate the effect of common ownership-induced competition-softening throughout the overall market by summing the softened competition metrics for each coupling of competitors within the market.

Given this process for calculating MHHI∆, there are at least two sources of endogeneity in the metric. One arises because of the second step. To assess the significance to market competition of any two firms’ incentives to reduce competition between themselves, the market shares of those two firms must be incorporated into the metric. But factors that influence market shares may also influence market prices apart from any common ownership effect.

Suppose, for example, that five institutional investors hold significant and equal stakes (say, 3%) in each of the four airlines servicing a particular air route and that none of the airlines has another significant shareholder. The air route at issue is subject to seasonal demand fluctuations. In the low season, the market is divided among the four airlines so that one has 40% of the business and the other three have 20% each. The MHHI∆ for this market would be 7200. When the high season rolls around, demand for flights along the route increases, but the leading airline is capacity constrained, so additional ticket sales go to the other airlines.  The market shares of the airlines in the high season are equal: 25% each.

On these facts, the increase in demand causes MHHI∆ to rise from 7200 to 7500.  But the increase in demand is also likely to raise ticket prices. We thus see an increase in MHHI∆ that correlates with an increase in ticket prices, but the price change is not caused by the change in MHHI∆. Instead, the two changes have a common, independent cause.

Endogeneity also creeps in during the third step in calculating MHHI∆.  In that step, the “cross MHHI∆s” of all the couplings in the market—the metrics assessing for each coupling the extent to which common ownership will cause the two firms to compete less vigorously—are summed. Thus, as the number of firms participating in the market (and thus the number of couplings) increases, the MHHI∆ will tend to rise. While HHI (the market concentration measure) will decrease as the number of competing firms rises, MHHI∆ (the measure of common ownership pricing incentives) will increase.

For example, suppose again that five institutional investors hold equal stakes (say, 3%) of each airline servicing a market and that the airlines have no other significant shareholders. If there are two airlines servicing the market and their market shares are equivalent, HHI will be 5000, MHHI∆ will be 5000, and MHHI (HHI + MHHI∆) will be 10000. If a third airline enters and grows so that the three airlines have equal market shares, HHI will drop to 3333, MHHI∆ will rise to 6667, and MHHI will remain constant at 10000. If a fourth airline enters and the airlines split the market evenly, HHI will fall to 2500, MHHI∆ will rise further to 7500, and MHHI will again total 10000.

This is problematic, because the number of participants in the market is affected by consumer demand, which also affects market prices. In the market described above, for example, the third or fourth airline might enter the market in response to an increase in demand, and that increase might simultaneously cause market price to rise. We would see, then, a price increase that is correlated with, but not caused by, an increase in MHHI∆; increased demand would be the cause of both the higher prices and the increase in MHHI∆.

In the end, then, the empirical evidence of competition-softening from common ownership is not the trump card proponents of common ownership restrictions proclaim it to be.

Mike Sykuta and I have been blogging about our recent paper on so-called “common ownership” by institutional investors like Vanguard, BlackRock, Fidelity, and State Street. Following my initial post, Mike described the purported problem with institutional investors’ common ownership of small stakes in competing firms.

As Mike explained, the theory of anticompetitive harm holds that small-stakes common ownership causes firms in concentrated industries to compete less vigorously, since each firm’s top shareholders are also invested in that firm’s rivals.  Proponents of restrictions on common ownership (e.g., Einer Elhauge and Eric Posner, et al.) say that empirical studies from the airline and commercial banking industries support this theory of anticompetitive harm. The cited studies correlate price changes with changes in “MHHI∆,” a complicated index designed to measure the degree to which common ownership encourages competition-softening.

We’ll soon have more to say about MHHI∆ (admirably described by Mike!) and the shortcomings of the airline and banking studies.  (Look for a “Problems With the Evidence” post.)  First, though, a few words on why the theory of anticompetitive harm from small-stakes common ownership is implausible.

Common ownership critics’ theoretical argument proceeds as follows:

  • Premise 1:    Because institutional investors are intra-industry diversified, they benefit if their portfolio firms seek to maximize industry, rather than own-firm, profits.
  • Premise 2:    Corporate managers seek to maximize the returns of their corporations’ largest shareholders—intra-industry diversified institutional investors—and will thus pursue maximization of industry profits.
  • Premise 3:    Industry profits, unlike own-firm profits, are maximized when producers refrain from underpricing their rivals to win business.

Ergo:

  • Conclusion:  Intra-industry diversification by institutional investors reduces price competition and should be restricted.

The first two premises of this argument are, at best, questionable.

With respect to Premise 1, it is unlikely that intra-industry diversified institutional investors benefit from, and thus prefer, maximization of industry rather than own-firm profits. That is because intra-industry diversified mutual funds tend also to be inter-industry diversified. Maximizing one industry’s profits requires supracompetitive pricing that tends to reduce the profits of firms in complementary industries.

Vanguard’s Value Index Fund, for example, holds around 2% of each major airline (1.85% of United, 2.07% of American, 2.15% of Southwest, and 1.99% of Delta) but also holds:

  • 1.88% of Expedia Inc. (a major retailer of airline tickets),
  • 2.20% of Boeing Co. (a manufacturer of commercial jets),
  • 2.02% of United Technologies Corp. (a jet engine producer),
  • 3.14% of AAR Corp. (the largest domestic provider of commercial aircraft maintenance and repair),
  • 1.43% of Hertz Global Holdings Inc. (a major automobile rental company), and
  • 2.17% of Accenture (a consulting firm for which air travel is a significant cost component).

Each of those companies—and many others—perform worse when airlines engage in the sort of supracompetitive pricing (and corresponding reduction in output) that maximizes profits in the airline industry. The very logic suggesting that intra-industry diversification causes investors to prefer less competition necessarily suggests that inter-industry diversification would counteract that incentive.

Of course, whether any particular investment fund will experience enhanced returns from reduced price competition in the industries in which it is intra-industry diversified ultimately depends on the composition of its portfolio. For widely diversified funds, however, it is unlikely that fund returns will be maximized by rampant competition-softening. As the well-known monopoly pricing model depicts, every instance of supracompetitive pricing entails a deadweight loss—i.e., an allocative inefficiency stemming from the failure to produce units that create greater value than they cost to produce. To the extent an index fund is designed to reflect gains in the economy generally, it will perform best if such allocative inefficiencies are minimized. It seems, then, that Premise 1—the claim that intra-industry diversified institutional investors prefer competition-softening so as to maximize industry profits—is dubious.

So is Premise 2, the claim that corporate managers will pursue industry rather than own-firm profits when their largest shareholders prefer that outcome. For nearly all companies in which intra-industry diversified institutional investors collectively hold a significant proportion of outstanding shares, a majority of the stock is still held by shareholders who are not intra-industry diversified. Those shareholders would prefer that managers seek to maximize own-firm profits, an objective that would encourage the sort of aggressive competition that grows market share.

There are several reasons to doubt that corporate managers would routinely disregard the interests of shareholders owning the bulk of the company’s stock. For one thing, favoring intra-industry diversified investors holding a minority interest could subject managers to legal liability. The fiduciary duties of corporate managers require that they attempt to maximize firm profits for the benefit of shareholders as a whole; favoring even a controlling shareholder (much less a minority shareholder) at the expense of other shareholders can result in liability.

More importantly, managers’ personal interests usually align with those of the majority when it comes to the question of whether to maximize own-firm or industry profits. As sellers in the market for managerial talent, corporate managers benefit from reputations for business success, and they can best burnish such reputations by beating—i.e., winning business from—their industry rivals. In addition, most corporate managers receive some compensation in the form of company stock. They maximize the value of that stock by maximizing own-firm, not industry, profits. It thus seems unlikely that corporate managers would ignore the interests of stockholders owning a majority of shares and cause their corporations to refrain from business-usurping competition.

In the end, then, two key premises of common ownership critics’ theoretical argument are suspect.  And if either is false, the argument is unsound.

When confronted with criticisms of their theory of anticompetitive harm, proponents of common ownership restrictions generally point to the empirical evidence described above. We’ll soon have some thoughts on that.  Stay tuned!

As Thom previously posted, he and I have a new paper explaining The Case for Doing Nothing About Common Ownership of Small Stakes in Competing Firms. Our paper is a response to cries from the likes of Einer Elhauge and of Eric Posner, Fiona Scott Morton, and Glen Weyl, who have called for various types of antitrust action to reign in what they claim is an “economic blockbuster” and “the major new antitrust challenge of our time,” respectively. This is the first in a series of posts that will unpack some of the issues and arguments we raise in our paper.

At issue is the growth in the incidence of common-ownership across firms within various industries. In particular, institutional investors with broad portfolios frequently report owning small stakes in a number of firms within a given industry. Although small, these stakes may still represent large block holdings relative to other investors. This intra-industry diversification, critics claim, changes the managerial objectives of corporate executives from aggressively competing to increase their own firm’s profits to tacitly colluding to increase industry-level profits instead. The reason for this change is that competition by one firm comes at a cost of profits from other firms in the industry. If investors own shares across firms, then any competitive gains in one firm’s stock are offset by competitive losses in the stocks of other firms in the investor’s portfolio. If one assumes corporate executives aim to maximize total value for their largest shareholders, then managers would have incentive to soften competition against firms with which they share common ownership. Or so the story goes (more on that in a later post.)

Elhague and Posner, et al., draw their motivation for new antitrust offenses from a handful of papers that purport to establish an empirical link between the degree of common ownership among competing firms and various measures of softened competitive behavior, including airline prices, banking fees, executive compensation, and even corporate disclosure patterns. The paper of most note, by José Azar, Martin Schmalz, and Isabel Tecu and forthcoming in the Journal of Finance, claims to identify a causal link between the degree of common ownership among airlines competing on a given route and the fares charged for flights on that route.

Measuring common ownership with MHHI

Azar, et al.’s airline paper uses a metric of industry concentration called a Modified Herfindahl–Hirschman Index, or MHHI, to measure the degree of industry concentration taking into account the cross-ownership of investors’ stakes in competing firms. The original Herfindahl–Hirschman Index (HHI) has long been used as a measure of industry concentration, debuting in the Department of Justice’s Horizontal Merger Guidelines in 1982. The HHI is calculated by squaring the market share of each firm in the industry and summing the resulting numbers.

The MHHI is rather more complicated. MHHI is composed of two parts: the HHI measuring product market concentration and the MHHI_Delta measuring the additional concentration due to common ownership. We offer a step-by-step description of the calculations and their economic rationale in an appendix to our paper. For this post, I’ll try to distill that down. The MHHI_Delta essentially has three components, each of which is measured relative to every possible competitive pairing in the market as follows:

  1. A measure of the degree of common ownership between Company A and Company -A (Not A). This is calculated by multiplying the percentage of Company A shares owned by each Investor I with the percentage of shares Investor I owns in Company -A, then summing those values across all investors in Company A. As this value increases, MHHI_Delta goes up.
  2. A measure of the degree of ownership concentration in Company A, calculated by squaring the percentage of shares owned by each Investor I and summing those numbers across investors. As this value increases, MHHI_Delta goes down.
  3. A measure of the degree of product market power exerted by Company A and Company -A, calculated by multiplying the market shares of the two firms. As this value increases, MHHI_Delta goes up.

This process is repeated and aggregated first for every pairing of Company A and each competing Company -A, then repeated again for every other company in the market relative to its competitors (e.g., Companies B and -B, Companies C and -C, etc.). Mathematically, MHHI_Delta takes the form:

where the Ss represent the firm market shares of, and Betas represent ownership shares of Investor I in, the respective companies A and -A.

As the relative concentration of cross-owning investors to all investors in Company A increases (i.e., the ratio on the right increases), managers are assumed to be more likely to soften competition with that competitor. As those two firms control more of the market, managers’ ability to tacitly collude and increase joint profits is assumed to be higher. Consequently, the empirical research assumes that as MHHI_Delta increases, we should observe less competitive behavior.

And indeed that is the “blockbuster” evidence giving rise to Elhauge’s and Posner, et al.,’s arguments  For example, Azar, et. al., calculate HHI and MHHI_Delta for every US airline market–defined either as city-pairs or departure-destination pairs–for each quarter of the 14-year time period in their study. They then regress ticket prices for each route against the HHI and the MHHI_Delta for that route, controlling for a number of other potential factors. They find that airfare prices are 3% to 7% higher due to common ownership. Other papers using the same or similar measures of common ownership concentration have likewise identified positive correlations between MHHI_Delta and their respective measures of anti-competitive behavior.

Problems with the problem and with the measure

We argue that both the theoretical argument underlying the empirical research and the empirical research itself suffer from some serious flaws. On the theoretical side, we have two concerns. First, we argue that there is a tremendous leap of faith (if not logic) in the idea that corporate executives would forgo their own self-interest and the interests of the vast majority of shareholders and soften competition simply because a small number of small stakeholders are intra-industry diversified. Second, we argue that even if managers were so inclined, it clearly is not the case that softening competition would necessarily be desirable for institutional investors that are both intra- and inter-industry diversified, since supra-competitive pricing to increase profits in one industry would decrease profits in related industries that may also be in the investors’ portfolios.

On the empirical side, we have concerns both with the data used to calculate the MHHI_Deltas and with the nature of the MHHI_Delta itself. First, the data on institutional investors’ holdings are taken from Schedule 13 filings, which report aggregate holdings across all the institutional investor’s funds. Using these data masks the actual incentives of the institutional investors with respect to investments in any individual company or industry. Second, the construction of the MHHI_Delta suffers from serious endogeneity concerns, both in investors’ shareholdings and in market shares. Finally, the MHHI_Delta, while seemingly intuitive, is an empirical unknown. While HHI is theoretically bounded in a way that lends to interpretation of its calculated value, the same is not true for MHHI_Delta. This makes any inference or policy based on nominal values of MHHI_Delta completely arbitrary at best.

We’ll expand on each of these concerns in upcoming posts. We will then take on the problems with the policy proposals being offered in response to the common ownership ‘problem.’

 

 

 

 

 

 

On July 24, as part of their newly-announced “Better Deal” campaign, congressional Democrats released an antitrust proposal (“Better Deal Antitrust Proposal” or BDAP) entitled “Cracking Down on Corporate Monopolies and the Abuse of Economic and Political Power.”  Unfortunately, this antitrust tract is really an “Old Deal” screed that rehashes long-discredited ideas about “bigness is badness” and “corporate abuses,” untethered from serious economic analysis.  (In spirit it echoes the proposal for a renewed emphasis on “fairness” in antitrust made by then Acting Assistant Attorney General Renata Hesse in 2016 – a recommendation that ran counter to sound economics, as I explained in a September 2016 Truth on the Market commentary.)  Implementation of the BDAP’s recommendations would be a “worse deal” for American consumers and for American economic vitality and growth.

The BDAP’s Portrayal of the State of Antitrust Enforcement is Factually Inaccurate, and it Ignores the Real Problems of Crony Capitalism and Regulatory Overreach

The Better Deal Antitrust Proposal begins with the assertion that antitrust has failed in recent decades:

Over the past thirty years, growing corporate influence and consolidation has led to reductions in competition, choice for consumers, and bargaining power for workers.  The extensive concentration of power in the hands of a few corporations hurts wages, undermines job growth, and threatens to squeeze out small businesses, suppliers, and new, innovative competitors.  It means higher prices and less choice for the things the American people buy every day. . .  [This is because] [o]ver the last thirty years, courts and permissive regulators have allowed large companies to get larger, resulting in higher prices and limited consumer choice in daily expenses such as travel, cable, and food and beverages.  And because concentrated market power leads to concentrated political power, these companies deploy armies of lobbyists to increase their stranglehold on Washington.  A Better Deal on competition means that we will revisit our antitrust laws to ensure that the economic freedom of all Americans—consumers, workers, and small businesses—come before big corporations that are getting even bigger.

This statement’s assertions are curious (not to mention problematic) in multiple respects.

First, since Democratic administrations have held the White House for sixteen of the past thirty years, the BDAP appears to acknowledge that Democratic presidents have overseen a failed antitrust policy.

Second, the broad claim that consumers have faced higher prices and limited consumer choice with regard to their daily expenses is baseless.  Indeed, internet commerce and new business models have sharply reduced travel and entertainment costs for the bulk of American consumers, and new “high technology” products such as smartphones and electronic games have been characterized by dramatic improvements in innovation, enhanced variety, and relatively lower costs.  Cable suppliers face vibrant competition from competitive satellite providers, fiberoptic cable suppliers (the major telcos such as Verizon), and new online methods for distributing content.  Consumer price inflation has been extremely low in recent decades, compared to the high inflationary, less innovative environment of the 1960s and 1970s – decades when federal antitrust law was applied much more vigorously.  Thus, the claim that weaker antitrust has denied consumers “economic freedom” is at war with the truth.

Third, the claim that recent decades have seen the creation of “concentrated market power,” safe from antitrust challenge, ignores the fact that, over the last three decades, apolitical government antitrust officials under both Democratic and Republican administrations have applied well-accepted economic tools (wielded by the scores of Ph.D. economists in the Justice Department and Federal Trade Commission) in enforcing the antitrust laws.  Antitrust analysis has used economics to focus on inefficient business conduct that would maintain or increase market power, and large numbers of cartels have been prosecuted and questionable mergers (including a variety of major health care and communications industry mergers) have been successfully challenged.  The alleged growth of “concentrated market power,” untouched by incompetent antitrust enforcers, is a myth.  Furthermore, claims that mere corporate size and “aggregate concentration” are grounds for antitrust concern (“big is bad”) were decisively rejected by empirical economic research published in the 1970s, and are no more convincing today.  (As I pointed out in a January 2017 blog posting at this site, recent research by highly respected economists debunks a few claims that federal antitrust enforcers have been “excessively tolerant” of late in analyzing proposed mergers.)

More interesting is the BDAP’s claim that “armies of [corporate] lobbyists” manage to “increase their stranglehold on Washington.”  This is not an antitrust concern, however, but, rather, a complaint against crony capitalism and overregulation, which became an ever more serious problem under the Obama Administration.  As I explained in my October 2016 critique of the American Antitrust Institute’s September 2008 National Competition Policy Report (a Report which is very similar in tone to the BDAP), the rapid growth of excessive regulation during the Obama years has diminished competition by creating new regulatory schemes that benefit entrenched and powerful firms (such as Dodd-Frank Act banking rules that impose excessive burdens on smaller banks).  My critique emphasized that, “as Dodd-Frank and other regulatory programs illustrate, large government rulemaking schemes often are designed to favor large and wealthy well-connected rent-seekers at the expense of smaller and more dynamic competitors.”  And, more generally, excessive regulatory burdens undermine the competitive process, by distorting business decisions in a manner that detracts from competition on the merits.

It follows that, if the BDAP really wanted to challenge “unfair” corporate advantages, it would seek to roll back excessive regulation (see my November 2012 article on Trump Administration competition policy).  Indeed, the Trump Administration’s regulatory reform program (which features agency-specific regulatory reform task forces) seeks to do just that.  Perhaps then the BDAP could be rewritten to focus on endorsing President Trump’s regulatory reform initiative, rather than emphasizing a meritless “big is bad” populist antitrust policy that was consigned to the enforcement dustbin decades ago.

The BDAP’s Specific Proposals Would Harm the Economy and Reduce Consumer Welfare

Unfortunately, the BDAP does more than wax nostalgic about old-time “big is bad” antitrust policy.  It affirmatively recommends policy changes that would harm the economy.

First, the BDAP would require “a broader, longer-term view and strong presumptions that market concentration can result in anticompetitive conduct.”  Specifically, it would create “new standards to limit large mergers that unfairly consolidate corporate power,” including “mergers [that] reduce wages, cut jobs, lower product quality, limit access to services, stifle innovation, or hinder the ability of small businesses and entrepreneurs to compete.”  New standards would also “explicitly consider the ways in which control of consumer data can be used to stifle competition or jeopardize consumer privacy.”

Unlike current merger policy, which evaluates likely competitive effects, centered on price and quality, estimated in economically relevant markets, these new standards are open-ended.  They could justify challenges based on such a wide variety of factors that they would incentivize direct competitors not to merge, even in cases where the proposed merged entity would prove more efficient and able to enhance quality or innovation.  Certain less efficient competitors – say small businesses – could argue that they would be driven out of business, or that some jobs in the industry would disappear, in order to prompt government challenges.  But such challenges would tend to undermine innovation and business improvements, and the inevitable redistribution of assets to higher-valued uses that is a key benefit of corporate reorganizations and acquisitions.  (Mergers might focus instead, for example, on inefficient conglomerate acquisitions among companies in unrelated industries, which were incentivized by the overly strict 1960s rules that prohibited mergers among direct competitors.)  Such a change would represent a retreat from economic common sense, and be at odds with consensus economically-sound merger enforcement guidance that U.S. enforcers have long recommended other countries adopt.  Furthermore, questions of consumer data and privacy are more appropriately dealt with as consumer protection questions, which the Federal Trade Commission has handled successfully for years.

Second, the BDAP would require “frequent, independent [after-the-fact] reviews of mergers” and require regulators “to take corrective measures if they find abusive monopolistic conditions where previously approved [consent decree] measures fail to make good on their intended outcomes.”

While high profile mergers subject to significant divestiture or other remedial requirements have in appropriate circumstances included monitoring requirements, the tone of this recommendation is to require that far more mergers be subjected to detailed and ongoing post-acquisition reviews.  The cost of such monitoring is substantial, however, and routine reliance on it (backed by the threat of additional enforcement actions based merely on changing economic conditions) could create excessive caution in the post-merger management of newly-consolidated enterprises.  Indeed, potential merged parties might decide in close cases that this sort of oversight is not worth accepting, and therefore call off potentially efficient transactions that would have enhanced economic welfare.  (The reality of enforcement error cost, and the possibility of misdiagnosis of post-merger competitive conditions, is not acknowledged by the BDAP.)

Third, a newly created “competition advocate” independent of the existing federal antitrust enforcers would be empowered to publicly recommend investigations, with the enforcers required to justify publicly why they chose not to pursue a particular recommended investigation.  The advocate would ensure that antitrust enforcers are held “accountable,” assure that complaints about “market exploitation and anticompetitive conduct” are heard, and publish data on “concentration and abuses of economic power” with demographic breakdowns.

This third proposal is particularly egregious.  It is at odds with the long tradition of prosecutorial discretion that has been enjoyed by the federal antitrust enforcers (and law enforcers in general).  It would also empower a special interest intervenor to promote the complaints of interest groups that object to efficiency-seeking business conduct, thereby undermining the careful economic and legal analysis that is consistently employed by the expert antitrust agencies.  The references to “concentration” and “economic power” clarify that the “advocate” would have an untrammeled ability to highlight non-economic objections to transactions raised by inefficient competitors, jealous rivals, or self-styled populists who object to excessive “bigness.”  This would strike at the heart of our competitive process, which presumes that private parties will be allowed to fulfill their own goals, free from government micromanagement, absent indications of a clear and well-defined violation of law.  In sum, the “competition advocate” is better viewed as a “special interest” advocate empowered to ignore normal legal constraints and unjustifiably interfere in business transactions.  If empowered to operate freely, such an advocate (better viewed as an albatross) would undoubtedly chill a wide variety of business arrangements, to the detriment of consumers and economic innovation.

Finally, the BDAP refers to a variety of ills that are said to affect specific named industries, in particular airlines, cable/telecom, beer, food prices, and eyeglasses.  Airlines are subject to a variety of capacity limitations (limitations on landing slots and the size/number of airports) and regulatory constraints (prohibitions on foreign entry or investment) that may affect competitive conditions, but airlines mergers are closely reviewed by the Justice Department.  Cable and telecom companies face a variety of federal, state, and local regulations, and their mergers also are closely scrutinized.  The BDAP’s reference to the proposed AT&T/Time Warner merger ignores the potential efficiencies of this “vertical” arrangement involving complementary assets (see my coauthored commentary here), and resorts to unsupported claims about wrongful “discrimination” by “behemoths” – issues that in any event are examined in antitrust merger reviews.  Unsupported references to harm to competition and consumer choice are thrown out in the references to beer and agrochemical mergers, which also receive close economically-focused merger scrutiny under existing law.  Concerns raised about the price of eyeglasses ignore the role of potentially anticompetitive regulation – that is, bad government – in harming consumer welfare in this sector.  In short, the alleged competitive “problems” the BDAP raises with respect to particular industries are no more compelling than the rest of its analysis.  The Justice Department and Federal Trade Commission are hard at work applying sound economics to these sectors.  They should be left to do their jobs, and the BDAP’s industry-specific commentary (sadly, like the rest of its commentary) should be accorded no weight.

Conclusion

Congressional Democrats would be well-advised to ditch their efforts to resurrect the counterproductive antitrust policy from days of yore, and instead focus on real economic problems, such as excessive and inappropriate government regulation, as well as weak protection for U.S. intellectual property rights, here and abroad (see here, for example).  Such a change in emphasis would redound to the benefit of American consumers and producers.

 

 

Today, the International Center for Law & Economics (ICLE) released a study updating our 2014 analysis of the economic effects of the Durbin Amendment to the Dodd-Frank Act.

The new paper, Unreasonable and Disproportionate: How the Durbin Amendment Harms Poorer Americans and Small Businesses, by ICLE scholars, Todd J. Zywicki, Geoffrey A. Manne, and Julian Morris, can be found here; a Fact Sheet highlighting the paper’s key findings is available here.

Introduced as part of the Dodd-Frank Act in 2010, the Durbin Amendment sought to reduce the interchange fees assessed by large banks on debit card transactions. In the words of its primary sponsor, Sen. Richard Durbin, the Amendment aspired to help “every single Main Street business that accepts debit cards keep more of their money, which is a savings they can pass on to their consumers.”

Unfortunately, although the Durbin Amendment did generate benefits for big-box retailers, ICLE’s 2014 analysis found that it had actually harmed many other merchants and imposed substantial net costs on the majority of consumers, especially those from lower-income households.

In the current study, we analyze a welter of new evidence and arguments to assess whether time has ameliorated or exacerbated the Amendment’s effects. Our findings in this report expand upon and reinforce our findings from 2014:

Relative to the period before the Durbin Amendment, almost every segment of the interrelated retail, banking, and consumer finance markets has been made worse off as a result of the Amendment.

Predictably, the removal of billions of dollars in interchange fee revenue has led to the imposition of higher bank fees and reduced services for banking consumers.

In fact, millions of households, regardless of income level, have been adversely affected by the Durbin Amendment through higher overdraft fees, increased minimum balances, reduced access to free checking, higher ATM fees, and lost debit card rewards, among other things.

Nor is there any evidence that merchants have lowered prices for retail consumers; for many small-ticket items, in fact, prices have been driven up.

Contrary to Sen. Durbin’s promises, in other words, increased banking costs have not been offset by lower retail prices.

At the same time, although large merchants continue to reap a Durbin Amendment windfall, there remains no evidence that small merchants have realized any interchange cost savings — indeed, many have suffered cost increases.

And all of these effects fall hardest on the poor. Hundreds of thousands of low-income households have chosen (or been forced) to exit the banking system, with the result that they face higher costs, difficulty obtaining credit, and complications receiving and making payments — all without offset in the form of lower retail prices.

Finally, the 2017 study also details a new trend that was not apparent when we examined the data three years ago: Contrary to our findings then, the two-tier system of interchange fee regulation (which exempts issuing banks with under $10 billion in assets) no longer appears to be protecting smaller banks from the Durbin Amendment’s adverse effects.

This week the House begins consideration of the Amendment’s repeal as part of Rep. Hensarling’s CHOICE Act. Our study makes clear that the Durbin price-control experiment has proven a failure, and that repeal is, indeed, the only responsible option.

Click on the following links to read:

Full Paper

Fact Sheet

Summary

The antitrust industry never sleeps – it is always hard at work seeking new business practices to scrutinize, eagerly latching on to any novel theory of anticompetitive harm that holds out the prospect of future investigations.  In so doing, antitrust entrepreneurs choose, of course, to ignore Nobel Laureate Ronald Coase’s warning that “[i]f an economist finds something . . . that he does not understand, he looks for a monopoly explanation.  And as in this field we are rather ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on monopoly explanations frequent.”  Ambitious antitrusters also generally appear oblivious to the fact that since antitrust is an administrative system subject to substantial error and transaction costs in application (see here), decision theory counsels that enforcers should proceed with great caution before adopting novel untested theories of competitive harm.

The latest example of this regrettable phenomenon is the popular new theory that institutional investors’ common ownership of minority shares in competing firms may pose serious threats to vigorous market competition (see here, for example).  If such investors’ shareholdings are insufficient to control or substantially influence the strategies employed by the competing firms, what is the precise mechanism by which this occurs?  At the very least, this question should give enforcers pause (and cause them to carefully examine both the theoretical and empirical underpinnings of the common ownership story) before they charge ahead as knights errant seeking to vanquish new financial foes.  Yet it appears that at least some antitrust enforcers have been wasting no time in seeking to factor common ownership concerns into their modes of analysis.  (For example, The European Commission in at least one case presented a modified Herfindahl-Hirschman Index (MHHI) analysis to account for the effects of common shareholding by institutional investors, as part of a statement of objections to a proposed merger, see here.)

A recent draft paper by Bates White economists Daniel P. O’Brien and Keith Waehrer raises major questions about recent much heralded research (reported in three studies dealing with executive compensation, airlines, and banking) that has been cited to raise concerns about common minority shareholdings’ effects on competition.  The draft paper’s abstract argues that the theory underlying these concerns is insufficiently developed, and that there are serious statistical flaws in the empirical work that purports to show a relationship between price and common ownership:

“Recent empirical research purports to show that common ownership by institutional investors harms competition even when all financial holdings are minority interests. This research has received a great deal of attention, leading to both calls for and actual changes in antitrust policy. This paper examines the research on this subject to date and finds that its conclusions regarding the effects of minority shareholdings on competition are not well established. Without prejudging what more rigorous empirical work might show, we conclude that researchers and policy authorities are getting well ahead of themselves in drawing policy conclusions from the research to date. The theory of partial ownership does not yield a specific relationship between price and the MHHI. In addition, the key explanatory variable in the emerging research – the MHHI – is an endogenous measure of concentration that depends on both common ownership and market shares. Factors other than common ownership affect both price and the MHHI, so the relationship between price and the MHHI need not reflect the relationship between price and common ownership. Thus, regressions of price on the MHHI are likely to show a relationship even if common ownership has no actual causal effect on price. The instrumental variable approaches employed in this literature are not sufficient to remedy this issue. We explain these points with reference to the economic theory of partial ownership and suggest avenues for further research.”

In addition to pinpointing deficiencies in existing research, O’Brien and Waehrer also summarize serious negative implications for the financial sector that could stem from the aggressive antitrust pursuit of partial ownership for the financial sector – a new approach that would be at odds with longstanding antitrust practice (footnote citations deleted):

“While it is widely accepted that common ownership can have anticompetitive effects when the owners have control over at least one of the firms they own (a complete merger is a special case), antitrust authorities historically have taken limited interest in common ownership by minority shareholders whose control seems to be limited to voting rights. Thus, if the empirical findings and conclusions in the emerging research are correct and robust, they could have dramatic implications for the antitrust analysis of mergers and acquisitions. The findings could be interpreted to suggest that antitrust authorities should scrutinize not only situations in which a common owner of competing firms control at least one of the entities it owns, but also situations in which all of the common owner’s shareholdings are small minority positions. As [previously] noted, . . . such a policy shift is already occurring.

Institutional investors (e.g., mutual funds) frequently take positions in multiple firms in an industry in order to offer diversified portfolios to retail investors at low transaction costs. A change in antitrust or regulatory policy toward these investments could have significant negative implications for the types of investments currently available to retail investors. In particular, a recent proposal to step up antitrust enforcement in this area would seem to require significant changes to the size or composition of many investment funds that are currently offered.

Given the potential policy implications of this research and the less than obvious connections between small minority ownership interests and anticompetitive price effects, it is important to be particularly confident in the analysis and empirical findings before drawing strong policy conclusions. In our view, this requires a valid empirical test that permits causal inferences about the effects of common ownership on price. In addition, the empirical findings and their interpretation should be consistent with the observed behavior of firms and investors in the economic and legal environments in which they operate.

We find that the airline, banking, and compensation papers [that deal with minority shareholding] fall short of these criteria.”

In sum, at the very least, a substantial amount of further work is called for before significant enforcement resources are directed to common minority shareholder investigations, lest competitively non-problematic investment holdings be chilled.  More generally, the trendy antitrust pursuit of common minority shareholdings threatens to interfere inappropriately in investment decisions of institutional investors and thereby undermine efficiency.  Given the great significance of institutional investment for vibrant capital markets and a growing, dynamic economy, the negative economic welfare consequences of such unwarranted meddling would likely swamp any benefits that might accrue from an occasional meritorious prosecution.  One may hope that the Trump Administration will seriously weigh those potential consequences as it examines the minority shareholding issue, in deciding upon its antitrust policy priorities.

On February 28, the Heritage Foundation issued a volume of essays by leading scholars on the law and economics of financial services regulatory reform entitled Prosperity Unleashed:  Smarter Financial Regulation.  This Report, which is well worth a read (in particular, by incoming Trump Administration officials and Members of Congress), is available online.

The Report’s 23 chapters, which deal with different aspects of financial markets, reflect 10 core principles:

  1. Private and competitive financial markets are essential for healthy economic growth.
  2. The government should not interfere with the financial choices of market participants, including consumers, investors, and uninsured financial firms. Regulators should focus on protecting individuals and firms from fraud and violations of contractual rights.
  3. Market discipline is a better regulator of financial risk than government regulation.
  4. Financial firms should be permitted to fail, just as other firms do. Government should not “save” participants from failure because doing so impedes the ability of markets to direct resources to their highest and best use.
  5. Speculation and risk-taking are what make markets operate. Interference by regulators attempting to mitigate risks hinders the effective operation of markets.
  6. Government should not make credit and capital allocation decisions.
  7. The cost of financial firm failures should be borne by managers, equity-holders, and creditors, not by taxpayers.
  8. Simple rules—such as straightforward equity capital requirements—are preferable to complex rules that permit regulators to micromanage markets.
  9. Public-private partnerships create financial instability because they create rent-seeking opportunities and misalign incentives.
  10. Government backing for financial activities, such as classifying certain firms or activities as “systemically important,” inevitably leads to government bailouts.

The chapters deal with these specific topics (the following summary draws upon the introduction to the Report):

Chapter 1, “Deposit Insurance, Bank Resolution, and Market Discipline,” explains how government-backed deposit insurance weakens market discipline, increases moral hazard, and leads to higher financial risk than the economy would have otherwise, thus weakening the banking system as a whole.

Chapter 2, “A Simple Proposal to Recapitalize the U.S. Banking System,” follows with a brief look at the failure of the Basel rules and a discussion of how banks’ historical capital ratios—a key measure of bank safety—have fallen as regulations have increased.  The author proposes a regulatory off-ramp, whereby banks could opt out of the current regulatory framework in return for meeting a minimum leverage ratio of at least 20 percent.

Chapter 3, “A Better Path for Mortgage Regulation,” provides a brief history of federal mortgage regulation.  This essay shows that, prior to Dodd–Frank, the preferred federal policy was to protect mortgage borrowers through mandatory disclosure as opposed to directly regulating the content of mortgage agreements.  The author argues that the vibrancy of the mortgage market has suffered because the basic disclosure approach has succumbed to regulation via content restrictions.

Chapter 4, “Money and Banking Provisions in the 2016 Financial CHOICE Act: A Major Step Toward Financial Security,” evaluates the reforms in the CHOICE Act, the first major piece of legislation written to replace large portions of the Dodd–Frank Wall Street Reform and Consumer Protection Act (a far-reaching statute whose provisions are at odds with its name). The author discusses the CHOICE Act’s regulatory off-ramp—and one potential alternative—because a similar approach could be used to implement a broad set of bank regulation reforms.

Chapter 5, “Securities Disclosure Reform,” delves into the law and economics of mandatory disclosure requirements, both in connection with new securities offerings and ongoing disclosure obligations.  The author explains that disclosure requirements have become so voluminous that they obfuscate rather than inform, making it more difficult for investors to find relevant information.

Chapter 6, “The Case for Federal Pre-Emption of State Blue Sky Laws,” recommends improving the efficiency and effectiveness of capital markets through federal pre-emption of state securities “blue sky” laws, which impose state registration requirements on companies seeking to issue securities.  Blue sky laws inefficiently retard the flow of capital from investors to businesses.

Chapter 7, “How to Reform Equity Market Structure: Eliminate ‘Reg NMS’ and Build Venture Exchanges,” tackles the seemingly opaque topic of U.S. equity market structure.  The essay argues that the increasingly fragmented structure of today’s equities markets has been shaped as much, if not more, by legislative and regulatory action than by the private sector.  The author calls on the Securities and Exchange Commission (SEC) to consider rescinding Reg NMS and replacing it with rules (and rigorous disclosure requirements) that allow free and competitive markets to dictate much of market structure.

Chapter 8, “Reforming FINRA,” explains that FINRA, the primary regulator of broker-dealers, is neither a true self-regulatory organization nor a government agency, and that FINRA is largely unaccountable to the industry or to the public.  The chapter broadly outlines alternative approaches that Congress and the regulators can take to fix these problems, and it recommends specific reforms to FINRA’s rule-making and arbitration process.

Chapter 9, “Reforming the Financial Regulators,” argues that financial regulation should establish a framework for financial institutions based on their ability to serve consumers, investors, and Main Street companies.  This view is starkly at odds with the current “macroprudential” trend in financial regulation, which places governmental regulators—with their purportedly greater understanding of the financial system—at the top of the decision-making chain.

Chapter 10, “The World After Chevron,” discusses the Supreme Court’s decision in Chevron U.S.A. Inc. v. Natural Resources Defense Council, a case that has generated considerable controversy among policymakers over the past decade.  The Chevron decision effectively transferred final interpretive authority from the courts to the agencies in any case where Congress did not itself answer the precise dispute.  Reform-minded policymakers have long called on Congress to return that ultimate decision-making authority to the federal courts.

Chapter 11, “Transparency and Accountability at the SEC and at FINRA,” describes how these two regulatory bodies—the two mostly responsible for governing the U.S. securities sector—lack the structural safeguards necessary to ensure that they exercise their authority with the consent of the American public.  The chapter provides recommendations for fixing these deficiencies, such as giving respondents a choice of federal court or administrative proceedings with the SEC, and allowing FINRA to exist as a purely voluntary, private industry association.

Chapter 12, “The Massive Federal Credit Racket,” provides an extensive list of the more than 150 federal credit programs that provide some form of government backing.  These programs consist of direct loans and loan guarantees for housing, agriculture, energy, education, transportation, infrastructure, exporting, and small businesses, as well as insurance programs to cover bank and credit union deposits, pensions, flood damage, crop damage, and acts of terrorism.  Government financing programs are often sold to the public as economic imperatives, particularly during downturns, but they are instruments of redistributive policies that mainly benefit those with the most political influence rather than those with the greatest need.

Chapter 13, “Reforming Last-Resort Lending: The Flexible Open-Market Alternative,” proposes a plan to reform the Federal Reserve’s means for preserving liquidity for financial as well as nonfinancial firms, especially during financial emergencies, but also in normal times.  The essay proposes, among other things, to replace the existing Fed framework with a single standing (as opposed to temporary) facility to meet extraordinary as well as ordinary liquidity needs as they arise.  The goal is to eliminate the need for ad hoc changes in the rules governing the lending facility, or for special Fed, Treasury, or congressional action.

Chapter 14, “Simple, Sensible Reforms for Housing Finance,” advocates establishing a national title database to prevent the sort of clerical errors that plagued the foreclosure process during the housing crash of 2007 to 2009.  The author also recommends eliminating government support for all mortgages with low down payments, and for refinancing loans that increase the borrower’s mortgage debt.  Both types of loans encourage households to take on debt rather than accumulate wealth.

Chapter 15, “A Pathway to Shutting Down the Federal Housing Finance Enterprises,” provides an overview of all the federal housing finance enterprises and argues that Congress should end these failed experiments.  The federal housing finance enterprises, cobbled together over the last century, today cover more than $6 trillion (60 percent) of the outstanding single-family residential mortgage debt in the United States.  Over time, the policies implemented through these enterprises have inflated home prices, led to unsustainable levels of mortgage debt for millions of people, cost federal taxpayers hundreds of billions of dollars in bailouts, and undermined the resilience of the housing finance system.

Chapter 16, “Fixing the Regulatory Framework for Derivatives,” discusses government preferences for derivatives and repurchase agreements (repos)—an often ignored but integral part of the many policy problems that contributed to the 2008 crisis.  As the essay explains, the main problem with the pre-crisis regulatory structure for derivatives and repos was that the bankruptcy code included special exemptions (safe harbors) for these financial contracts.  The safe harbors were justified on the grounds that they would prevent systemic financial problems, a theory that proved false in 2008.  The chapter concluded that eliminating all safe harbors for repos and derivatives would affect the market because counterparties would have to account for more risk, a desirable outcome.

Chapter 17, “Designing an Efficient Securities-Fraud Deterrence Regime,” explains that the main flaws in the current approach to securities-fraud deterrence in the U.S., and recommends several reforms to fix these problems.  This essay recommends that the government should credibly threaten individuals who would commit fraud with criminal penalties, and pursue corporations only if their shareholders would otherwise have poor incentives to adopt internal control systems to deter fraud.

Chapter 18, “Financial Privacy in a Free Society,” stresses the importance of maintaining financial privacy—a key component of life in a free society—while policing markets for fraudulent (and other criminal) behavior.  The current U.S. financial regulatory framework has expanded so much that it now threatens this basic element of freedom.  For instance, individuals who engage in cash transactions of more than a small amount automatically trigger a general suspicion of criminal activity, and financial institutions of all kinds are forced into a quasi-law-enforcement role.  The chapter recommends seven reforms that would better protect individuals’ privacy rights and improve law enforcement’s ability to apprehend and prosecute criminals and terrorists.

Chapter 19, “How Congress Should Protect Consumers’ Finances,” provides an overview of consumer financial protection law, and then provide several recommendations on how to modernize the consumer financial protection system.  The goal of these reforms is to fix the federal consumer financial protection framework so that it facilitates competition, consumer protection, and consumer choice.  The authors recommend transferring all federal consumer protection authority to the Federal Trade Commission, the agency with vast regulatory experience in consumer financial services markets.

I will have a bit more to say about my co-authored contribution, “How Congress Should Protect Consumers’ Finances,” in my next post.

Chapter 20, “Reducing Banks’ Incentives for Risk-Taking via Extended Shareholder Liability,” examines changes in shareholder liability that could better align incentives and reduce the moral hazard problems that result in excessively risky financial institutions.  The authors describe how under extended liability, an arrangement common in banking history, shareholders of failed banks have an obligation to repay the remaining debts to creditors.

Chapter 21, “Improving Entrepreneurs’ Access to Capital: Vital for Economic Growth,” shows how existing rules and regulations hinder capital formation and entrepreneurship.  The essay explains that several groups usually support the current complex, expensive, and economically destructive system because excessive regulation helps keep their competitors at bay.  The author describes more than 25 policy reforms to reduce or eliminate state and federal regulatory barriers that hinder entrepreneurs’ access to capital.

Chapter 22, “Federalism and FinTech,” provides an in-depth look at how financial technology or “FinTech” companies are beginning to utilize advances in communications, data processing, and cryptography to compete with traditional financial services providers.  Some of the most powerful FinTech applications are removing geographic limitations on where companies can offer services and, in general, lowering barriers to entry for new firms.  As the essay explaints, this newly competitive landscape is exposing weaknesses, inefficiency, and inequity in the U.S. financial regulatory structure.

Chapter 23, “A New Federal Charter for Financial Institutions,” proposes a new banking charter under which a financial institution would be regulated more like banks were regulated before the modern era of bank bailouts and government guarantees.  Under the proposed charter, which is similar to a regulatory off-ramp approach, banks that choose to fund themselves with higher equity would be faced mostly with regulations that focus on punishing and deterring fraud, and fostering the disclosure of information that is material to investment decisions.  The charter explicitly includes a prohibition against receiving government funds from any source, and even excludes the financial institution from FDIC deposit insurance eligibility.

In conclusion, Prosperity Unleashed sets forth the elements of a legislative and regulatory reform agenda for the financial services sector, which has the potential for stimulating economic growth and innovation while benefiting consumers and businesses alike.  I will have a bit more to say about my co-authored contribution, “How Congress Should Protect Consumers’ Finances,” in my next post.