Archives For COVID-19

On both sides of the Atlantic, 2021 has seen legislative and regulatory proposals to mandate that various digital services be made interoperable with others. Several bills to do so have been proposed in Congress; the EU’s proposed Digital Markets Act would mandate interoperability in certain contexts for “gatekeeper” platforms; and the UK’s competition regulator will be given powers to require interoperability as part of a suite of “pro-competitive interventions” that are hoped to increase competition in digital markets.

The European Commission plans to require Apple to use USB-C charging ports on iPhones to allow interoperability among different chargers (to save, the Commission estimates, two grams of waste per-European per-year). Interoperability demands for forms of interoperability have been at the center of at least two major lawsuits: Epic’s case against Apple and a separate lawsuit against Apple by the app called Coronavirus Reporter. In July, a group of pro-intervention academics published a white paper calling interoperability “the ‘Super Tool’ of Digital Platform Governance.”

What is meant by the term “interoperability” varies widely. It can refer to relatively narrow interventions in which user data from one service is made directly portable to other services, rather than the user having to download and later re-upload it. At the other end of the spectrum, it could mean regulations to require virtually any vertical integration be unwound. (Should a Tesla’s engine be “interoperable” with the chassis of a Land Rover?) And in between are various proposals for specific applications of interoperability—some product working with another made by another company.

Why Isn’t Everything Interoperable?

The world is filled with examples of interoperability that arose through the (often voluntary) adoption of standards. Credit card companies oversee massive interoperable payments networks; screwdrivers are interoperable with screws made by other manufacturers, although different standards exist; many U.S. colleges accept credits earned at other accredited institutions. The containerization revolution in shipping is an example of interoperability leading to enormous efficiency gains, with a government subsidy to encourage the adoption of a single standard.

And interoperability can emerge over time. Microsoft Word used to be maddeningly non-interoperable with other word processors. Once OpenOffice entered the market, Microsoft patched its product to support OpenOffice files; Word documents now work slightly better with products like Google Docs, as well.

But there are also lots of things that could be interoperable but aren’t, like the Tesla motors that can’t easily be removed and added to other vehicles. The charging cases for Apple’s AirPods and Sony’s wireless earbuds could, in principle, be shaped to be interoperable. Medical records could, in principle, be standardized and made interoperable among healthcare providers, and it’s easy to imagine some of the benefits that could come from being able to plug your medical history into apps like MyFitnessPal and Apple Health. Keurig pods could, in principle, be interoperable with Nespresso machines. Your front door keys could, in principle, be made interoperable with my front door lock.

The reason not everything is interoperable like this is because interoperability comes with costs as well as benefits. It may be worth letting different earbuds have different designs because, while it means we sacrifice easy interoperability, we gain the ability for better designs to be brought to market and for consumers to have choice among different kinds. We may find that, while digital health records are wonderful in theory, the compliance costs of a standardized format might outweigh those benefits.

Manufacturers may choose to sell an expensive device with a relatively cheap upfront price tag, relying on consumer “lock in” for a stream of supplies and updates to finance the “full” price over time, provided the consumer likes it enough to keep using it.

Interoperability can remove a layer of security. I don’t want my bank account to be interoperable with any payments app, because it increases the risk of getting scammed. What I like about my front door lock is precisely that it isn’t interoperable with anyone else’s key. Lots of people complain about popular Twitter accounts being obnoxious, rabble-rousing, and stupid; it’s not difficult to imagine the benefits of a new, similar service that wanted everyone to start from the same level and so did not allow users to carry their old Twitter following with them.

There thus may be particular costs that prevent interoperability from being worth the tradeoff, such as that:

  1. It might be too costly to implement and/or maintain.
  2. It might prescribe a certain product design and prevent experimentation and innovation.
  3. It might add too much complexity and/or confusion for users, who may prefer not to have certain choices.
  4. It might increase the risk of something not working, or of security breaches.
  5. It might prevent certain pricing models that increase output.
  6. It might compromise some element of the product or service that benefits specifically from not being interoperable.

In a market that is functioning reasonably well, we should be able to assume that competition and consumer choice will discover the desirable degree of interoperability among different products. If there are benefits to making your product interoperable with others that outweigh the costs of doing so, that should give you an advantage over competitors and allow you to compete them away. If the costs outweigh the benefits, the opposite will happen—consumers will choose products that are not interoperable with each other.

In short, we cannot infer from the absence of interoperability that something is wrong, since we frequently observe that the costs of interoperability outweigh the benefits.

Of course, markets do not always lead to optimal outcomes. In cases where a market is “failing”—e.g., because competition is obstructed, or because there are important externalities that are not accounted for by the market’s prices—certain goods may be under-provided. In the case of interoperability, this can happen if firms struggle to coordinate upon a single standard, or because firms’ incentives to establish a standard are not aligned with the social optimum (i.e., interoperability might be optimal and fail to emerge, or vice versa).

But the analysis cannot stop here: just because a market might not be functioning well and does not currently provide some form of interoperability, we cannot assume that if it was functioning well that it would provide interoperability.

Interoperability for Digital Platforms

Since we know that many clearly functional markets and products do not provide all forms of interoperability that we could imagine them providing, it is perfectly possible that many badly functioning markets and products would still not provide interoperability, even if they did not suffer from whatever has obstructed competition or effective coordination in that market. In these cases, imposing interoperability would destroy value.

It would therefore be a mistake to assume that more interoperability in digital markets would be better, even if you believe that those digital markets suffer from too little competition. Let’s say, for the sake of argument, that Facebook/Meta has market power that allows it to keep its subsidiary WhatsApp from being interoperable with other competing services. Even then, we still would not know if WhatsApp users would want that interoperability, given the trade-offs.

A look at smaller competitors like Telegram and Signal, which we have no reason to believe have market power, demonstrates that they also are not interoperable with other messaging services. Signal is run by a nonprofit, and thus has little incentive to obstruct users for the sake of market power. Why does it not provide interoperability? I don’t know, but I would speculate that the security risks and technical costs of doing so outweigh the expected benefit to Signal’s users. If that is true, it seems strange to assume away the potential costs of making WhatsApp interoperable, especially if those costs may relate to things like security or product design.

Interoperability and Contact-Tracing Apps

A full consideration of the trade-offs is also necessary to evaluate the lawsuit that Coronavirus Reporter filed against Apple. Coronavirus Reporter was a COVID-19 contact-tracing app that Apple rejected from the App Store in March 2020. Its makers are now suing Apple for, they say, stifling competition in the contact-tracing market. Apple’s defense is that it only allowed COVID-19 apps from “recognised entities such as government organisations, health-focused NGOs, companies deeply credentialed in health issues, and medical or educational institutions.” In effect, by barring it from the App Store, and offering no other way to install the app, Apple denied Coronavirus Reporter interoperability with the iPhone. Coronavirus Reporter argues it should be punished for doing so.

No doubt, Apple’s decision did reduce competition among COVID-19 contact tracing apps. But increasing competition among COVID-19 contact-tracing apps via mandatory interoperability might have costs in other parts of the market. It might, for instance, confuse users who would like a very straightforward way to download their country’s official contact-tracing app. Or it might require access to certain data that users might not want to share, preferring to let an intermediary like Apple decide for them. Narrowing choice like this can be valuable, since it means individual users don’t have to research every single possible option every time they buy or use some product. If you don’t believe me, turn off your spam filter for a few days and see how you feel.

In this case, the potential costs of the access that Coronavirus Reporter wants are obvious: while it may have had the best contact-tracing service in the world, sorting it from other less reliable and/or scrupulous apps may have been difficult and the risk to users may have outweighed the benefits. As Apple and Facebook/Meta constantly point out, the security risks involved in making their services more interoperable are not trivial.

It isn’t competition among COVID-19 apps that is important, per se. As ever, competition is a means to an end, and maximizing it in one context—via, say, mandatory interoperability—cannot be judged without knowing the trade-offs that maximization requires. Even if we thought of Apple as a monopolist over iPhone users—ignoring the fact that Apple’s iPhones obviously are substitutable with Android devices to a significant degree—it wouldn’t follow that the more interoperability, the better.

A ‘Super Tool’ for Digital Market Intervention?

The Coronavirus Reporter example may feel like an “easy” case for opponents of mandatory interoperability. Of course we don’t want anything calling itself a COVID-19 app to have totally open access to people’s iPhones! But what’s vexing about mandatory interoperability is that it’s very hard to sort the sensible applications from the silly ones, and most proposals don’t even try. The leading U.S. House proposal for mandatory interoperability, the ACCESS Act, would require that platforms “maintain a set of transparent, third-party-accessible interfaces (including application programming interfaces) to facilitate and maintain interoperability with a competing business or a potential competing business,” based on APIs designed by the Federal Trade Commission.

The only nod to the costs of this requirement are provisions that further require platforms to set “reasonably necessary” security standards, and a provision to allow the removal of third-party apps that don’t “reasonably secure” user data. No other costs of mandatory interoperability are acknowledged at all.

The same goes for the even more substantive proposals for mandatory interoperability. Released in July 2021, “Equitable Interoperability: The ‘Super Tool’ of Digital Platform Governance” is co-authored by some of the most esteemed competition economists in the business. While it details obscure points about matters like how chat groups might work across interoperable chat services, it is virtually silent on any of the costs or trade-offs of its proposals. Indeed, the first “risk” the report identifies is that regulators might be too slow to impose interoperability in certain cases! It reads like interoperability has been asked what its biggest weaknesses are in a job interview.

Where the report does acknowledge trade-offs—for example, interoperability making it harder for a service to monetize its user base, who can just bypass ads on the service by using a third-party app that blocks them—it just says that the overseeing “technical committee or regulator may wish to create conduct rules” to decide.

Ditto with the objection that mandatory interoperability might limit differentiation among competitors – like, for example, how imposing the old micro-USB standard on Apple might have stopped us from getting the Lightning port. Again, they punt: “We recommend that the regulator or the technical committee consult regularly with market participants and allow the regulated interface to evolve in response to market needs.”

But if we could entrust this degree of product design to regulators, weighing the costs of a feature against its benefits, we wouldn’t need markets or competition at all. And the report just assumes away many other obvious costs: “​​the working hypothesis we use in this paper is that the governance issues are more of a challenge than the technical issues.” Despite its illustrious panel of co-authors, the report fails to grapple with the most basic counterargument possible: its proposals have costs as well as benefits, and it’s not straightforward to decide which is bigger than which.

Strangely, the report includes a section that “looks ahead” to “Google’s Dominance Over the Internet of Things.” This, the report says, stems from the company’s “market power in device OS’s [that] allows Google to set licensing conditions that position Google to maintain its monopoly and extract rents from these industries in future.” The report claims this inevitability can only be avoided by imposing interoperability requirements.

The authors completely ignore that a smart home interoperability standard has already been developed, backed by a group of 170 companies that include Amazon, Apple, and Google, as well as SmartThings, IKEA, and Samsung. It is open source and, in principle, should allow a Google Home speaker to work with, say, an Amazon Ring doorbell. In markets where consumers really do want interoperability, it can emerge without a regulator requiring it, even if some companies have apparent incentive not to offer it.

If You Build It, They Still Might Not Come

Much of the case for interoperability interventions rests on the presumption that the benefits will be substantial. It’s hard to know how powerful network effects really are in preventing new competitors from entering digital markets, and none of the more substantial reports cited by the “Super Tool” report really try.

In reality, the cost of switching among services or products is never zero. Simply pointing out that particular costs—such as network effect-created switching costs—happen to exist doesn’t tell us much. In practice, many users are happy to multi-home across different services. I use at least eight different messaging apps every day (Signal, WhatsApp, Twitter DMs, Slack, Discord, Instagram DMs, Google Chat, and iMessage/SMS). I don’t find it particularly costly to switch among them, and have been happy to adopt new services that seemed to offer something new. Discord has built a thriving 150-million-user business, despite these switching costs. What if people don’t actually care if their Instagram DMs are interoperable with Slack?

None of this is to argue that interoperability cannot be useful. But it is often overhyped, and it is difficult to do in practice (because of those annoying trade-offs). After nearly five years, Open Banking in the UK—cited by the “Super Tool” report as an example of what it wants for other markets—still isn’t really finished yet in terms of functionality. It has required an enormous amount of time and investment by all parties involved and has yet to deliver obvious benefits in terms of consumer outcomes, let alone greater competition among the current accounts that have been made interoperable with other services. (My analysis of the lessons of Open Banking for other services is here.) Phone number portability, which is also cited by the “Super Tool” report, is another example of how hard even simple interventions can be to get right.

The world is filled with cases where we could imagine some benefits from interoperability but choose not to have them, because the costs are greater still. None of this is to say that interoperability mandates can never work, but their benefits can be oversold, especially when their costs are ignored. Many of mandatory interoperability’s more enthusiastic advocates should remember that such trade-offs exist—even for policies they really, really like.

[Judge Douglas Ginsburg was invited to respond to the Beesley Lecture given by Andrea Coscelli, chief executive of the U.K. Competition and Markets Authority (CMA). Both the lecture and Judge Ginsburg’s response were broadcast by the BBC on Oct. 28, 2021. The text of Mr. Coscelli’s Beesley lecture is available on the CMA’s website. Judge Ginsburg’s response follows below.]

Thank you, Victoria, for the invitation to respond to Mr. Coscelli and his proposal for a legislatively founded Digital Markets Unit. Mr. Coscelli is one of the most talented, successful, and creative heads a competition agency has ever had. In the case of the DMU [ed., Digital Markets Unit], however, I think he has let hope triumph over experience and prudence. This is often the case with proposals for governmental reform: Indeed, it has a name, the Nirvana Fallacy, which comes from comparing the imperfectly functioning marketplace with the perfectly functioning government agency. Everything we know about the regulation of competition tells us the unintended consequences may dwarf the intended benefits and the result may be a less, not more, competitive economy. The precautionary principle counsels skepticism about such a major and inherently risky intervention.

Mr. Coscelli made a point in passing that highlights the difference in our perspectives: He said the SMS [ed., strategic market status] merger regime would entail “a more cautious standard of proof.” In our shared Anglo-American legal culture, a more cautious standard of proof means the government would intervene in fewer, not more, market activities; proof beyond a reasonable doubt in criminal cases is a more cautious standard than a mere preponderance of the evidence. I, too, urge caution, but of the traditional kind.

I will highlight five areas of concern with the DMU proposal.

I. Chilling Effects

The DMU’s ability to designate a firm as being of strategic market significance—or SMS—will place a potential cloud over innovative activity in far more sectors than Mr. Coscelli could mention in his lecture. He views the DMU’s reach as limited to a small number of SMS-designated firms; and that may prove true, but there is nothing in the proposal limiting DMU’s reach.

Indeed, the DMU’s authority to regulate digital markets is surely going to be difficult to confine. Almost every major retail activity or consumer-facing firm involves an increasingly significant digital component, particularly after the pandemic forced many more firms online. Deciding which firms the DMU should cover seems easy in theory, but will prove ever more difficult and cumbersome in practice as digital technology continues to evolve. For instance, now that money has gone digital, a bank is little more than a digital platform bringing together lenders (called depositors) and borrowers, much as Amazon brings together buyers and sellers; so, is every bank with market power and an entrenched position to be subject to rules and remedies laid down by the DMU as well as supervision by the bank regulators? Is Aldi in the crosshairs now that it has developed an online retail platform? Match.com, too? In short, the number of SMS firms will likely grow apace in the next few years.

II. SMS Designations Should Not Apply to the Whole Firm

The CMA’s proposal would apply each SMS designation firm-wide, even if the firm has market power in a single line of business. This will inhibit investment in further diversification and put an SMS firm at a competitive disadvantage across all its businesses.

Perhaps company-wide SMS designations could be justified if the unintended costs were balanced by expected benefits to consumers, but this will not likely be the case. First, there is little evidence linking consumer harm to lines of business in which large digital firms do not have market power. On the contrary, despite the discussion of Amazon’s supposed threat to competition, consumers enjoy lower prices from many more retailers because of the competitive pressure Amazon brings to bear upon them.

Second, the benefits Mr. Coscelli expects the economy to reap from faster government enforcement are, at best, a mixed blessing. The proposal, you see, reverses the usual legal norm, instead making interim relief the rule rather than the exception. If a firm appeals its SMS designation, then under the CMA’s proposal, the DMU’s SMS designations and pro-competition interventions, or PCIs, will not be stayed pending appeal, raising the prospect that a firm’s activities could be regulated for a significant period even though it was improperly designated. Even prevailing in the courts may be a Pyrrhic victory because opportunities will have slipped away. Making matters worse, the DMU’s designation of a firm as SMS will likely receive a high degree of judicial deference, so that errors may never be corrected.

III. The DMU Cannot Be Evidence-based Given its Goals and Objectives

The DMU’s stated goal is to “further the interests of consumers and citizens in digital markets by promoting competition and innovation.”[1] DMU’s objectives for developing codes of conduct are: fair trading, open choices, and trust and transparency.[2] Fairness, openness, trust, and transparency are all concepts that are difficult to define and probably impossible to quantify. Therefore, I fear Mr. Coscelli’s aspiration that the DMU will be an evidence-based, tailored, and predictable regime seem unrealistic. The CMA’s idea of “an evidence-based regime” seems destined to rely mostly upon qualitative conjecture about the potential for the code of conduct to set “rules of the game” that encourage fair trading, open choices, trust, and transparency. Even if the DMU commits to considering empirical evidence at every step of its process, these fuzzy, qualitative objectives will allow it to come to virtually any conclusion about how a firm should be regulated.

Implementing those broad goals also throws into relief the inevitable tensions among them. Some potential conflicts between DMU’s objectives for developing codes of conduct are clear from the EU’s experience. For example, one of the things DMU has considered already is stronger protection for personal data. The EU’s experience with the GDPR shows that data protection is costly and, like any costly requirement, tends to advantage incumbents and thereby discourage new entry. In other words, greater data protections may come at the expense of start-ups or other new entrants and the contribution they would otherwise have made to competition, undermining open choices in the name of data transparency.

Another example of tension is clear from the distinction between Apple’s iOS and Google’s Android ecosystems. They take different approaches to the trade-off between data privacy and flexibility in app development. Apple emphasizes consumer privacy at the expense of allowing developers flexibility in their design choices and offers its products at higher prices. Android devices have fewer consumer-data protections but allow app developers greater freedom to design their apps to satisfy users and are offered at lower prices. The case of Epic Games v. Apple put on display the purportedly pro-competitive arguments the DMU could use to justify shutting down Apple’s “walled garden,” whereas the EU’s GDPR would cut against Google’s open ecosystem with limited consumer protections. Apple’s model encourages consumer trust and adoption of a single, transparent model for app development, but Google’s model encourages app developers to choose from a broader array of design and payment options and allows consumers to choose between the options; no matter how the DMU designs its code of conduct, it will be creating winners and losers at the cost of either “open choices” or “trust and transparency.” As experience teaches is always the case, it is simply not possible for an agency with multiple goals to serve them all at the same time. The result is an unreviewable discretion to choose among them ad hoc.

Finally, notice that none of the DMU’s objectives—fair trading, open choices, and trust and transparency—revolves around quantitative evidence; at bottom, these goals are not amenable to the kind of rigor Mr. Coscelli hopes for.

IV. Speed of Proposals

Mr. Coscelli has emphasized the slow pace of competition law matters; while I empathize, surely forcing merging parties to prove a negative and truncating their due process rights is not the answer.

As I mentioned earlier, it seems a more cautious standard of proof to Mr. Coscelli is one in which an SMS firm’s proposal to acquire another firm is presumed, or all but presumed, to be anticompetitive and unlawful. That is, the DMU would block the transaction unless the firms can prove their deal would not be anticompetitive—an extremely difficult task. The most self-serving version of the CMA’s proposal would require it to prove only that the merger poses a “realistic prospect” of lessening competition, which is vague, but may in practice be well below a 50% chance. Proving that the merged entity does not harm competition will still require a predictive forward-looking assessment with inherent uncertainty, but the CMA wants the costs of uncertainty placed upon firms, rather than it. Given the inherent uncertainty in merger analysis, the CMA’s proposal would pose an unprecedented burden of proof on merging parties.

But it is not only merging parties the CMA would deprive of due process; the DMU’s so-called pro-competitive interventions, or PCI, SMS designations, and code-of-conduct requirements generally would not be stayed pending appeal. Further, an SMS firm could overturn the CMA’s designation only if it could overcome substantial deference to the DMU’s fact-finding. It is difficult to discern, then, the difference between agency decisions and final orders.

The DMU would not have to show or even assert an extraordinary need for immediate relief. This is the opposite of current practice in every jurisdiction with which I am familiar.  Interim orders should take immediate effect only in exceptional circumstances, when there would otherwise be significant and irreversible harm to consumers, not in the ordinary course of agency decision making.

V. Antitrust Is Not Always the Answer

Although one can hardly disagree with Mr. Coscelli’s premise that the digital economy raises new legal questions and practical challenges, it is far from clear that competition law is the answer to them all. Some commentators of late are proposing to use competition law to solve consumer protection and even labor market problems. Unfortunately, this theme also recurs in Mr. Coscelli’s lecture. He discusses concerns with data privacy and fair and reasonable contract terms, but those have long been the province of consumer protection and contract law; a government does not need to step in and regulate all realms of activity by digital firms and call it competition law. Nor is there reason to confine needed protections of data privacy or fair terms of use to SMS firms.

Competition law remedies are sometimes poorly matched to the problems a government is trying to correct. Mr. Coscelli discusses the possibility of strong interventions, such as forcing the separation of a platform from its participation in retail markets; for example, the DMU could order Amazon to spin off its online business selling and shipping its own brand of products. Such powerful remedies can be a sledgehammer; consider forced data sharing or interoperability to make it easier for new competitors to enter. For example, if Apple’s App Store is required to host all apps submitted to it in the interest of consumer choice, then Apple loses its ability to screen for security, privacy, and other consumer benefits, as its refusal   to deal is its only way to prevent participation in its store. Further, it is not clear consumers want Apple’s store to change; indeed, many prefer Apple products because of their enhanced security.

Forced data sharing would also be problematic; the hiQ v. LinkedIn case in the United States should serve as a cautionary tale. The trial court granted a preliminary injunction forcing LinkedIn to allow hiQ to scrape its users’ profiles while the suit was ongoing. LinkedIn ultimately won the suit because it did not have market power, much less a monopoly, in any relevant market. The court concluded each theory of anticompetitive conduct was implausible, but meanwhile LinkedIn had been forced to allow hiQ to scrape its data for an extended period before the final decision. There is no simple mechanism to “unshare” the data now that LinkedIn has prevailed. This type of case could be common under the CMA proposal because the DMU’s orders will go into immediate effect.

There is potentially much redeeming power in the Digital Regulation Co-operation Forum as Mr. Coscelli described it, but I take a different lesson from this admirable attempt to coordinate across agencies: Perhaps it is time to look beyond antitrust to solve problems that are not based upon market power. As the DRCF highlights, there are multiple agencies with overlapping authority in the digital market space. ICO and Ofcom each have authority to take action against a firm that disseminates fake news or false advertisements. Mr. Coscelli says it would be too cumbersome to take down individual bad actors, but, if so, then the solution is to adopt broader consumer protection rules, not apply an ill-fitting set of competition law rules. For example, the U.K. could change its notice-and-takedown rules to subject platforms to strict liability if they host fake news, even without knowledge that they are doing so, or perhaps only if they are negligent in discharging their obligation to police against it.

Alternatively, the government could shrink the amount of time platforms have to take down information; France gives platforms only about an hour to remove harmful information. That sort of solution does not raise the same prospect of broadly chilling market activity, but still addresses one of the concerns Mr. Coscelli raises with digital markets.

In sum, although Mr. Coscelli is of course correct that competition authorities and governments worldwide are considering whether to adopt broad reforms to their competition laws, the case against broadening remains strong. Instead of relying upon the self-corrective potential of markets, which is admittedly sometimes slower than anyone would like, the CMA assumes markets need regulation until firms prove otherwise. Although clearly well-intentioned, the DMU proposal is in too many respects not met to the task of protecting competition in digital markets; at worst, it will inhibit innovation in digital markets to the point of driving startups and other innovators out of the U.K.


[1] See Digital markets Taskforce, A new pro-competition regime for digital markets, at 22, Dec. 2020, available at: https://assets.publishing.service.gov.uk/media/5fce7567e90e07562f98286c/Digital_Taskforce_-_Advice.pdf; Oliver Dowden & Kwasi Kwarteng, A New Pro-competition Regime for Digital Markets, July 2021, available from: https://www.gov.uk/government/consultations/a-new-pro-competition-regime-for-digital-markets, at ¶ 27.

[2] Sam Bowman, Sam Dumitriu & Aria Babu, Conflicting Missions:The Risks of the Digital Markets Unit to Competition and Innovation, Int’l Center for L. & Econ., June 2021, at 13.

Why do digital industries routinely lead to one company having a very large share of the market (at least if one defines markets narrowly)? To anyone familiar with competition policy discussions, the answer might seem obvious: network effects, scale-related economies, and other barriers to entry lead to winner-take-all dynamics in platform industries. Accordingly, it is that believed the first platform to successfully unlock a given online market enjoys a determining first-mover advantage.

This narrative has become ubiquitous in policymaking circles. Thinking of this sort notably underpins high-profile reports on competition in digital markets (here, here, and here), as well ensuing attempts to regulate digital platforms, such as the draft American Innovation and Choice Online Act and the EU’s Digital Markets Act.

But are network effects and the like the only ways to explain why these markets look like this? While there is no definitive answer, scholars routinely overlook an alternative explanation that tends to undercut the narrative that tech markets have become non-contestable.

The alternative model is simple: faced with zero prices and the almost complete absence of switching costs, users have every reason to join their preferred platform. If user preferences are relatively uniform and one platform has a meaningful quality advantage, then there is every reason to expect that most consumers will all join the same one—even though the market remains highly contestable. On the other side of the equation, because platforms face very few capacity constraints, there are few limits to a given platform’s growth. As will be explained throughout this piece, this intuition is as old as economics itself.

The Bertrand Paradox

In 1883, French mathematician Joseph Bertrand published a powerful critique of two of the most high-profile economic thinkers of his time: the late Antoine Augustin Cournot and Léon Walras (it would be another seven years before Alfred Marshall published his famous principles of economics).

Bertrand criticized several of Cournot and Walras’ widely accepted findings. This included Cournot’s conclusion that duopoly competition would lead to prices above marginal cost—or, in other words, that duopolies were imperfectly competitive.

By reformulating the problem slightly, Bertand arrived at the opposite conclusion. He argued that each firm’s incentive to undercut its rival would ultimately lead to marginal cost pricing, and one seller potentially capturing the entire market:

There is a decisive objection [to Cournot’s model]: According to his hypothesis, no [supracompetitive] equilibrium is possible. There is no limit to price decreases; whatever the joint price being charged by firms, a competitor could always undercut this price and, with few exceptions, attract all consumers. If the competitor is allowed to get away with this [i.e. the rival does not react], it will double its profits.

This result is mainly driven by the assumption that, unlike in Cournot’s model, firms can immediately respond to their rival’s chosen price/quantity. In other words, Bertrand implicitly framed the competitive process as price competition, rather than quantity competition (under price competition, firms do not face any capacity constraints and they cannot commit to producing given quantities of a good):

If Cournot’s calculations mask this result, it is because of a remarkable oversight. Referring to them as D and D’, Cournot deals with the quantities sold by each of the two competitors and treats them as independent variables. He assumes that if one were to change by the will of one of the two sellers, the other one could remain fixed. The opposite is evidently true.

This later came to be known as the “Bertrand paradox”—the notion that duopoly-market configurations can produce the same outcome as perfect competition (i.e., P=MC).

But while Bertrand’s critique was ostensibly directed at Cournot’s model of duopoly competition, his underlying point was much broader. Above all, Bertrand seemed preoccupied with the notion that expressing economic problems mathematically merely gives them a veneer of accuracy. In that sense, he was one of the first economists (at least to my knowledge) to argue that the choice of assumptions has a tremendous influence on the predictions of economic models, potentially rendering them unreliable:

On other occasions, Cournot introduces assumptions that shield his reasoning from criticism—scholars can always present problems in a way that suits their reasoning.

All of this is not to say that Bertrand’s predictions regarding duopoly competition necessarily hold in real-world settings; evidence from experimental settings is mixed. Instead, the point is epistemological. Bertrand’s reasoning was groundbreaking because he ventured that market structures are not the sole determinants of consumer outcomes. More broadly, he argued that assumptions regarding the competitive process hold significant sway over the results that a given model may produce (and, as a result, over normative judgements concerning the desirability of given market configurations).

The Theory of Contestable Markets

Bertrand is certainly not the only economist to have suggested market structures alone do not determine competitive outcomes. In the early 1980s, William Baumol (and various co-authors) went one step further. Baumol argued that, under certain conditions, even monopoly market structures could deliver perfectly competitive outcomes. This thesis thus rejected the Structure-Conduct-Performance (“SCP”) Paradigm that dominated policy discussions of the time.

Baumol’s main point was that industry structure is not the main driver of market “contestability,” which is the key determinant of consumer outcomes. In his words:

In the limit, when entry and exit are completely free, efficient incumbent monopolists and oligopolists may in fact be able to prevent entry. But they can do so only by behaving virtuously, that is, by offering to consumers the benefits which competition would otherwise bring. For every deviation from good behavior instantly makes them vulnerable to hit-and-run entry.

For instance, it is widely accepted that “perfect competition” leads to low prices because firms are price-takers; if one does not sell at marginal cost, it will be undercut by rivals. Observers often assume this is due to the number of independent firms on the market. Baumol suggests this is wrong. Instead, the result is driven by the sanction that firms face for deviating from competitive pricing.

In other words, numerous competitors are a sufficient, but not necessary condition for competitive pricing. Monopolies can produce the same outcome when there is a present threat of entry and an incumbent’s deviation from competitive pricing would be sanctioned. This is notably the case when there are extremely low barriers to entry.

Take this hypothetical example from the world of cryptocurrencies. It is largely irrelevant to a user whether there are few or many crypto exchanges on which to trade coins, nonfungible tokens (NFTs), etc. What does matter is that there is at least one exchange that meets one’s needs in terms of both price and quality of service. This could happen because there are many competing exchanges, or because a failure to meet my needs by the few (or even one) exchange that does exist would attract the entry of others to which I could readily switch—thus keeping the behavior of the existing exchanges in check.

This has far-reaching implications for antitrust policy, as Baumol was quick to point out:

This immediately offers what may be a new insight on antitrust policy. It tells us that a history of absence of entry in an industry and a high concentration index may be signs of virtue, not of vice. This will be true when entry costs in our sense are negligible.

Given what precedes, Baumol surmised that industry structure must be driven by endogenous factors—such as firms’ cost structures—rather than the intensity of competition that they face. For instance, scale economies might make monopoly (or another structure) the most efficient configuration in some industries. But so long as rivals can sanction incumbents for failing to compete, the market remains contestable. Accordingly, at least in some industries, both the most efficient and the most contestable market configuration may entail some level of concentration.

To put this last point in even more concrete terms, online platform markets may have features that make scale (and large market shares) efficient. If so, there is every reason to believe that competition could lead to more, not less, concentration. 

How Contestable Are Digital Markets?

The insights of Bertrand and Baumol have important ramifications for contemporary antitrust debates surrounding digital platforms. Indeed, it is critical to ascertain whether the (relatively) concentrated market structures we see in these industries are a sign of superior efficiency (and are consistent with potentially intense competition), or whether they are merely caused by barriers to entry.

The barrier-to-entry explanation has been repeated ad nauseam in recent scholarly reports, competition decisions, and pronouncements by legislators. There is thus little need to restate that thesis here. On the other hand, the contestability argument is almost systematically ignored.

Several factors suggest that online platform markets are far more contestable than critics routinely make them out to be.

First and foremost, consumer switching costs are extremely low for most online platforms. To cite but a few examples: Changing your default search engine requires at most a couple of clicks; joining a new social network can be done by downloading an app and importing your contacts to the app; and buying from an alternative online retailer is almost entirely frictionless, thanks to intermediaries such as PayPal.

These zero or near-zero switching costs are compounded by consumers’ ability to “multi-home.” In simple terms, joining TikTok does not require users to close their Facebook account. And the same applies to other online services. As a result, there is almost no opportunity cost to join a new platform. This further reduces the already tiny cost of switching.

Decades of app development have greatly improved the quality of applications’ graphical user interfaces (GUIs), to such an extent that costs to learn how to use a new app are mostly insignificant. Nowhere is this more apparent than for social media and sharing-economy apps (it may be less true for productivity suites that enable more complex operations). For instance, remembering a couple of intuitive swipe motions is almost all that is required to use TikTok. Likewise, ridesharing and food-delivery apps merely require users to be familiar with the general features of other map-based applications. It is almost unheard of for users to complain about usability—something that would have seemed impossible in the early 21st century, when complicated interfaces still plagued most software.

A second important argument in favor of contestability is that, by and large, online platforms face only limited capacity constraints. In other words, platforms can expand output rapidly (though not necessarily costlessly).

Perhaps the clearest example of this is the sudden rise of the Zoom service in early 2020. As a result of the COVID pandemic, Zoom went from around 10 million daily active users in early 2020 to more than 300 million by late April 2020. Despite being a relatively data-intensive service, Zoom did not struggle to meet this new demand from a more than 30-fold increase in its user base. The service never had to turn down users, reduce call quality, or significantly increase its price. In short, capacity largely followed demand for its service. Online industries thus seem closer to the Bertrand model of competition, where the best platform can almost immediately serve any consumers that demand its services.

Conclusion

Of course, none of this should be construed to declare that online markets are perfectly contestable. The central point is, instead, that critics are too quick to assume they are not. Take the following examples.

Scholars routinely cite the putatively strong concentration of digital markets to argue that big tech firms do not face strong competition, but this is a non sequitur. As Bertrand and Baumol (and others) show, what matters is not whether digital markets are concentrated, but whether they are contestable. If a superior rival could rapidly gain user traction, this alone will discipline the behavior of incumbents.

Markets where incumbents do not face significant entry from competitors are just as consistent with vigorous competition as they are with barriers to entry. Rivals could decline to enter either because incumbents have aggressively improved their product offerings or because they are shielded by barriers to entry (as critics suppose). The former is consistent with competition, the latter with monopoly slack.

Similarly, it would be wrong to presume, as many do, that concentration in online markets is necessarily driven by network effects and other scale-related economies. As ICLE scholars have argued elsewhere (here, here and here), these forces are not nearly as decisive as critics assume (and it is debatable that they constitute barriers to entry).

Finally, and perhaps most importantly, this piece has argued that many factors could explain the relatively concentrated market structures that we see in digital industries. The absence of switching costs and capacity constraints are but two such examples. These explanations, overlooked by many observers, suggest digital markets are more contestable than is commonly perceived.

In short, critics’ failure to meaningfully grapple with these issues serves to shape the prevailing zeitgeist in tech-policy debates. Cournot and Bertrand’s intuitions about oligopoly competition may be more than a century old, but they continue to be tested empirically. It is about time those same standards were applied to tech-policy debates.

The patent system is too often caricatured as involving the grant of “monopolies” that may be used to delay entry and retard competition in key sectors of the economy. The accumulation of allegedly “poor-quality” patents into thickets and portfolios held by “patent trolls” is said by critics to spawn excessive royalty-licensing demands and threatened “holdups” of firms that produce innovative products and services. These alleged patent abuses have been characterized as a wasteful “tax” on high-tech implementers of patented technologies, which inefficiently raises price and harms consumer welfare.

Fortunately, solid scholarship has debunked these stories and instead pointed to the key role patents play in enhancing competition and driving innovation. See, for example, here, here, here, here, here, here, and here.

Nevertheless, early indications are that the Biden administration may be adopting a patent-skeptical attitude. Such an attitude was revealed, for example, in the president’s July 9 Executive Order on Competition (which suggested an openness to undermining the Bayh-Dole Act by using march-in rights to set prices; to weakening pharmaceutical patent rights; and to weakening standard essential patents) and in the administration’s inexplicable decision to waive patent protection for COVID-19 vaccines (see here and here).

Before it takes further steps that would undermine patent protections, the administration should consider new research that underscores how patents help to spawn dynamic market growth through “design around” competition and through licensing that promotes new technologies and product markets.

Patents Spawn Welfare-Enhancing ‘Design Around’ Competition

Critics sometimes bemoan the fact that patents covering a new product or technology allegedly retard competition by preventing new firms from entering a market. (Never mind the fact that the market might not have existed but for the patent.) This thinking, which confuses a patent with a product-market monopoly, is badly mistaken. It is belied by the fact that the publicly available patented technology itself (1) provides valuable information to third parties; and (2) thereby incentivizes them to innovate and compete by refining technologies that fall outside the scope of the patent. In short, patents on important new technologies stimulate, rather than retard, competition. They do this by leading third parties to “design around” the patented technology and thus generate competition that features a richer set of technological options realized in new products.

The importance of design around is revealed, for example, in the development of the incandescent light bulb market in the late 19th century, in reaction to Edison’s patent on a long-lived light bulb. In a 2021 article in the Journal of Competition Law and Economics, Ron D. Katznelson and John Howells did an empirical study of this important example of product innovation. The article’s synopsis explains:

Designing around patents is prevalent but not often appreciated as a means by which patents promote economic development through competition. We provide a novel empirical study of the extent and timing of designing around patent claims. We study the filing rate of incandescent lamp-related patents during 1878–1898 and find that the enforcement of Edison’s incandescent lamp patent in 1891–1894 stimulated a surge of patenting. We studied the specific design features of the lamps described in these lamp patents and compared them with Edison’s claimed invention to create a count of noninfringing designs by filing date. Most of these noninfringing designs circumvented Edison’s patent claims by creating substitute technologies to enable participation in the market. Our forward citation analysis of these patents shows that some had introduced pioneering prior art for new fields. This indicates that invention around patents is not duplicative research and contributes to dynamic economic efficiency. We show that the Edison lamp patent did not suppress advance in electric lighting and the market power of the Edison patent owner weakened during this patent’s enforcement. We propose that investigation of the effects of design around patents is essential for establishing the degree of market power conferred by patents.

In a recent commentary, Katznelson highlights the procompetitive consumer welfare benefits of the Edison light bulb design around:

GE’s enforcement of the Edison patent by injunctions did not stifle competition nor did it endow GE with undue market power, let alone a “monopoly.” Instead, it resulted in clear and tangible consumer welfare benefits. Investments in design-arounds resulted in tangible and measurable dynamic economic efficiencies by (a) increased competition, (b) lamp price reductions, (c) larger choice of suppliers, (d) acceleration of downstream development of new electric illumination technologies, and (e) collateral creation of new technologies that would not have been developed for some time but for the need to design around Edison’s patent claims. These are all imparted benefits attributable to patent enforcement.

Katznelson further explains that “the mythical harm to innovation inflicted by enforcers of pioneer patents is not unique to the Edison case.” He cites additional research debunking claims that the Wright brothers’ pioneer airplane patent seriously retarded progress in aviation (“[a]ircraft manufacturing and investments grew at an even faster pace after the assertion of the Wright Brothers’ patent than before”) and debunking similar claims made about the early radio industry and the early automobile industry. He also notes strong research refuting the patent holdup conjecture regarding standard essential patents. He concludes by bemoaning “infringers’ rhetoric” that “suppresses information on the positive aspects of patent enforcement, such as the design-around effects that we study in this article.”

The Bayh-Dole Act: Licensing that Promotes New Technologies and Product Markets

The Bayh-Dole Act of 1980 has played an enormously important role in accelerating American technological innovation by creating a property rights-based incentive to use government labs. As this good summary from the Biotechnology Innovation Organization puts it, it “[e]mpowers universities, small businesses and non-profit institutions to take ownership [through patent rights] of inventions made during federally-funded research, so they can license these basic inventions for further applied research and development and broader public use.”

The act has continued to generate many new welfare-enhancing technologies and related high-tech business opportunities even during the “COVID slowdown year” of 2020, according to a newly released survey by a nonprofit organization representing the technology management community (see here):  

° The number of startup companies launched around academic inventions rose from 1,040 in 2019 to 1,117 in 2020. Almost 70% of these companies locate in the same state as the research institution that licensed them—making Bayh-Dole a critical driver of state and regional economic development;
° Invention disclosures went from 25,392 to 27,112 in 2020;
° New patent applications increased from 15,972 to 17,738;
° Licenses and options went from 9,751 in ’19 to 10,050 in ’20, with 60% of licenses going to small companies; and
° Most impressive of all—new products introduced to the market based on academic inventions jumped from 711 in 2019 to 933 in 2020.

Despite this continued record of success, the Biden Administration has taken actions that create uncertainty about the government’s support for Bayh-Dole.  

As explained by the Congressional Research Service, “march-in rights allow the government, in specified circumstances, to require the contractor or successors in title to the patent to grant a ‘nonexclusive, partially exclusive, or exclusive license’ to a ‘responsible applicant or applicants.’ If the patent owner refuses to do so, the government may grant the license itself.” Government march-in rights thus far have not been invoked, but a serious threat of their routine invocation would greatly disincentivize future use of Bayh-Dole, thereby undermining patent-backed innovation.

Despite this, the president’s July 9 Executive Order on Competition (noted above) instructed the U.S. Commerce Department to defer finalizing a regulation (see here) “that would have ensured that march-in rights under Bayh Dole would not be misused to allow the government to set prices, but utilized for its statutory intent of providing oversight so good faith efforts are being made to turn government-funded innovations into products. But that’s all up in the air now.”

What’s more, a new U.S. Energy Department policy that would more closely scrutinize Bayh-Dole patentees’ licensing transactions and acquisitions (apparently to encourage more domestic manufacturing) has raised questions in the Bayh-Dole community and may discourage licensing transactions (see here and here). Added to this is the fact that “prominent Members of Congress are pressing the Biden Administration to misconstrue the march-in rights clause to control prices of products arising from National Institutes of Health and Department of Defense funding.” All told, therefore, the outlook for continued patent-inspired innovation through Bayh-Dole processes appears to be worse than it has been in many years.

Conclusion

The patent system does far more than provide potential rewards to enhance incentives for particular individuals to invent. The system also creates a means to enhance welfare by facilitating the diffusion of technology through market processes (see here).

But it does even more than that. It actually drives new forms of dynamic competition by inducing third parties to design around new patents, to the benefit of consumers and the overall economy. As revealed by the Bayh-Dole Act, it also has facilitated the more efficient use of federal labs to generate innovation and new products and processes that would not otherwise have seen the light of day. Let us hope that the Biden administration pays heed to these benefits to the American economy and thinks again before taking steps that would further weaken our patent system.     

The U.S. economy survived the COVID-19 pandemic and associated government-imposed business shutdowns with a variety of innovations that facilitated online shopping, contactless payments, and reduced use and handling of cash, a known vector of disease transmission.

While many of these innovations were new, they would have been impossible but for their reliance on an established and ubiquitous technological infrastructure: the global credit and debit-card payments system. Not only did consumers prefer to use plastic instead of cash, the number of merchants going completely “cashless” quadrupled in the first two months of the pandemic alone. From food delivery to online shopping, many small businesses were able to survive largely because of payment cards.

But there are costs to maintain the global payment-card network that processes billions of transactions daily, and those costs are higher for online payments, which present elevated fraud and security risks. As a result, while the boom in online shopping over this past year kept many retailers and service providers afloat, that hasn’t prevented them from grousing about their increased card-processing costs.

So it is that retailers are now lobbying Washington to impose new regulations on payment-card markets designed to force down the fees they pay for accepting debit and credit cards. Called interchange fees, these fees are charged by banks that issue debit cards on each transaction, and they are part of a complex process that connects banks, card networks, merchants, and consumers.

Fig. 1: A basic illustration of the 3- and 4-party payment-processing networks that underlie the use of credit cards.

Regulation II—a provision of 2010’s Dodd–Frank Wall Street Reform and Consumer Protection Act commonly known as the “Durbin amendment,” after its primary sponsor, Senate Majority Whip Richard Durbin (D-Ill.)—placed price controls on interchange fees for debit cards issued by larger banks and credit unions (those with more than $10 billion in assets). It required all debit-card issuers to offer multiple networks for “routing” and processing card transactions. Merchants now want to expand these routing provisions to credit cards, as well. The consequences for consumers, especially low-income consumers, would be disastrous.

The price controls imposed by the Durbin amendment have led to a 52% decrease in the average per-transaction interchange fee, resulting in billions of dollars in revenue losses for covered depositories. But banks and credit unions have passed on these losses to consumers in the form of fewer free checking accounts, higher fees, and higher monthly minimums required to avoid those fees.

One empirical study found that the share of covered banks offering free checking accounts fell from 60% to 20%, the average monthly checking accounts fees increased from $4.34 to $7.44, and the minimum account balance required to avoid those fees increased by roughly 25%. Another study found that fees charged by covered institutions were 15% higher than they would have been absent the price regulation; those increases offset about 90% of the depositories’ lost revenue. Banks and credit unions also largely eliminated cash-back and other rewards on debit cards.

In fact, those who have been most harmed by the Durbin amendment’s consequences have been low-income consumers. Middle-class families hardly noticed the higher minimum balance requirements, or used their credit cards more often to offset the disappearance of debit-card rewards. Those with the smallest checking account balances, however, suffered the most from reduced availability of free banking and higher monthly maintenance and other fees. Priced out of the banking system, as many as 1 million people might have lost bank accounts in the wake of the Durbin amendment, forcing them to turn to such alternatives as prepaid cards, payday lenders, and pawn shops to make ends meet. Lacking bank accounts, these needy families weren’t even able to easily access their much-needed government stimulus funds at the onset of the pandemic without paying fees to alternative financial services providers.

In exchange for higher bank fees and reduced benefits, merchants promised lower prices at the pump and register. This has not been the case. Scholarship since  implementation of the Federal Reserve’s rule shows that whatever benefits have been gained have gone to merchants, with little pass-through to consumers. For instance, one study found that covered banks had their interchange revenue drop by 25%, but little evidence of a corresponding drop in prices from merchants.

Another study found that the benefits and costs to merchants have been unevenly distributed, with retailers who sell large-ticket items receiving a windfall, while those specializing in small-ticket items have often faced higher effective rates. Discounts previously offered to smaller merchants have been eliminated to offset reduced revenues from big-box stores. According to a 2014 Federal Reserve study, when acceptance fees increased, merchants hiked retail prices; but when fees were reduced, merchants pocketed the windfall.

Moreover, while the Durbin amendment’s proponents claimed it would only apply to big banks, the provisions that determine how transactions are routed on the payment networks apply to cards issued by credit unions and community banks, as well. As a result, smaller players have also seen average interchange fees beaten down, reducing this revenue stream even as they have been forced to cope with higher regulatory costs imposed by Dodd-Frank. Extending the Durbin amendment’s routing provisions to credit cards would further drive down interchange-fee revenue, creating the same negative spiral of higher consumer fees and reduced benefits that the original Durbin amendment spawned for debit cards.

More fundamentally, merchants believe it is their decision—not yours—as to which network will route your transaction. You may prefer Visa or Mastercard because of your confidence in their investments in security and anti-fraud detection, but later discover that the merchant has routed your transaction through a processor you’ve never heard of, simply because that network is cheaper for the merchant.

The resilience of the U.S. economy during this horrible viral contagion is due, in part, to the ubiquitous access of American families to credit and debit cards. That system has proved its mettle this past year, seamlessly adapting to the sudden shift to electronic payments. Yet, in the wake of this American success story, politicians and regulators, egged on by powerful special interests, instead want to meddle with this system just so big-box retailers can transfer their costs onto American families and small banks. As the economy and public health recovers, Congress and regulators should resist the impulse to impose new financial harm on working-class families.

[This post adapts elements of “Technology Mergers and the Market for Corporate Control,” forthcoming in the Missouri Law Review.]

In recent years, a growing chorus of voices has argued that existing merger rules fail to apprehend competitively significant mergers, either because they fall below existing merger-filing thresholds or because they affect innovation in ways that are purportedly ignored.

These fears are particularly acute in the pharmaceutical and tech industries, where several high-profile academic articles and reports claim to have identified important gaps in current merger-enforcement rules, particularly with respect to acquisitions involving nascent and potential competitors (here, here, and here, among many others).

Such fears have led activists, lawmakers, and enforcers to call for tougher rules, including the introduction of more stringent merger-filing thresholds and other substantive changes, such as the inversion of the burden of proof when authorities review mergers and acquisitions involving digital platforms.

However, as we discuss in a recent working paper—forthcoming in the Missouri Law Review and available on SSRN—these proposals tend to overlook the important tradeoffs that would ensue from attempts to decrease the number of false positives under existing merger rules and thresholds.

The paper draws from two key strands of economic literature that are routinely overlooked (or summarily dismissed) by critics of the status quo.

For a start, antitrust enforcement is not costless. In the case of merger enforcement, not only is it expensive for agencies to detect anticompetitive deals but, more importantly, overbearing rules may deter beneficial merger activity that creates value for consumers.

Second, critics tend to overlook the possibility that incumbents’ superior managerial or other capabilities (i.e., what made them successful in the first place) makes them the ideal acquisition partners for entrepreneurs and startup investors looking to sell.

The result is a body of economic literature that focuses almost entirely on hypothetical social costs, while ignoring the redeeming benefits of corporate acquisitions, as well as the social cost of enforcement.

Kill Zones

One of the most significant allegations leveled against large tech firms is that their very presence in a market may hinder investments, entry, and innovation, creating what some have called a “kill zone.” The strongest expression in the economic literature of this idea of a kill zone stems from a working paper by Sai Krishna Kamepalli, Raghuram Rajan, and Luigi Zingales.

The paper makes two important claims, one theoretical and one empirical. From a theoretical standpoint, the authors argue that the prospect of an acquisition by a dominant platform deters consumers from joining rival platforms, and that this, in turn, hampers the growth of these rivals. The authors then test a similar hypothesis empirically. They find that acquisitions by a dominant platform—such as Google or Facebook—decrease investment levels and venture capital deals in markets that are “similar” to that of the target firm.

But both findings are problematic. For a start, Zingales and his co-authors’ theoretical model is premised on questionable assumptions about the way in which competition develops in the digital space. The first is that early adopters of new platforms—called “techies” in the authors’ parlance—face high switching costs because of their desire to learn these platforms in detail. As an initial matter, it would appear facially contradictory that “techies” both are the group with the highest switching costs and that they switch the most. The authors further assume that “techies” would incur lower adoption costs if they remained on the incumbent platform and waited for the rival platform to be acquired.

Unfortunately, while these key behavioral assumptions drive the results of the theoretical model, the paper presents no evidence to support their presence in real-world settings. In that sense, the authors commit the same error as previous theoretical work concerning externalities, which have tended to overestimate their frequency.

Second, the empirical analysis put forward in the paper is unreliable for policymaking purposes. The authors notably find that:

[N]ormalized VC investments in start-ups in the same space as the company acquired by Google and Facebook drop by over 40% and the number of deals falls by over 20% in the three years following an acquisition.

However, the results of this study are derived from the analysis of only nine transactions. The study also fails to clearly show that firms in the treatment and controls are qualitatively similar. In a nutshell, the study compares industry acquisitions exceeding $500 million to Facebook and Google’s acquisitions that exceed that amount. This does not tell us whether the mergers in both groups involved target companies with similar valuations or similar levels of maturity. This does not necessarily invalidate the results, but it does suggest that policymakers should be circumspect in interpreting those results.

Finally, the paper fails to demonstrate evidence that existing antitrust regimes fail to achieve an optimal error-cost balance. The central problem is that the paper has indeterminate welfare implications. For instance, as the authors note, the declines in investment in spaces adjacent to the incumbent platforms occurred during a time of rapidly rising venture capital investment, both in terms of the number of deals and dollars invested. It is entirely plausible that venture capital merely shifted to other sectors.

Put differently, on its own terms, the evidence merely suggests that acquisitions by Google and Facebook affected the direction of innovation, not its overall rate. And there is little to suggest that this shift was suboptimal, from a welfare standpoint.

In short, as the authors themselves conclude: “[i]t would be premature to draw any policy conclusion on antitrust enforcement based solely on our model and our limited evidence.”

Mergers and Potential Competition

Scholars have also posited more direct effects from acquisitions of startups or nascent companies by incumbent technology market firms.

Some scholars argue that incumbents might acquire rivals that do not yet compete with them directly, in order to reduce the competitive pressure they will face in the future. In his paper “Potential Competition and Antitrust Analysis: Monopoly Profits Exceed Duopoly Profits,” Steven Salop argues:

Acquisitions of potential or nascent competitors by a dominant firm raise inherent anticompetitive concerns. By eliminating the procompetitive impact of the entry, an acquisition can allow the dominant firm to continue to exercise monopoly power and earn monopoly profits. The dominant firm also can neutralize the potential innovation competition that the entrant would provide.

However, these antitrust theories of harm suffer from several important flaws. They rest upon several restrictive assumptions that are not certain to occur in real-world settings. Most are premised on the notion that, in a given market, monopoly profits generally exceed joint duopoly profits. This allegedly makes it profitable, and mutually advantageous, for an incumbent to protect its monopoly position by preemptively acquiring potential rivals.

Accordingly, under these theories, anticompetitive mergers are only possible when the acquired rival could effectively challenge the incumbent. But these are, of course, only potential challengers; there is no guarantee that any one of them could or would mount a viable competitive threat.

Less obviously, it must be the case that the rival can hope to share only duopoly profits, as opposed to completely overthrowing the incumbent or surpassing them with a significantly larger share of the market. Where competition is “for the market” itself, monopoly maintenance would fail to explain a rival’s decision to sell.  Because there would be no asymmetry between the expected profits of the incumbent and the rival, monopoly maintenance alone would not give rise to mutually advantageous deals.

Second, potential competition does not always increase consumer welfare.  Indeed, while the presence of potential competitors might increase price competition, it can also have supply-side effects that cut in the opposite direction.

For example, as Nobel laureate Joseph Stiglitz observed, a monopolist threatened by potential competition may invest in socially wasteful R&D efforts or entry-deterrence mechanisms, and it may operate at below-optimal scale in anticipation of future competitive entry.

There are also pragmatic objections. Analyzing a merger’s effect on potential competition would compel antitrust authorities and courts to make increasingly speculative assessments concerning the counterfactual setting of proposed acquisitions.

In simple terms, it is far easier to determine whether a merger between McDonald’s and Burger King would lead to increased hamburger prices in the short run than it is to determine whether a gaming platform like Steam or the Epic Games Store might someday compete with video-streaming or music-subscription platforms like Netflix or Spotify. It is not that the above models are necessarily wrong, but rather that applying them to practical cases would require antitrust enforcers to estimate mostly unknowable factors.

Finally, the real test for regulators is not just whether they can identify possibly anticompetitive mergers, but whether they can do so in a cost-effective manner. Whether it is desirable to implement a given legal test is not simply a function of its accuracy, the cost to administer it, and the respective costs of false positives and false negatives. It also critically depends on how prevalent the conduct is that adjudicators would be seeking to foreclose.

Consider two hypothetical settings. Imagine there are 10,000 tech mergers in a given year, of which either 1,000 or 2,500 are anticompetitive (the remainder are procompetitive or competitively neutral). Suppose that authorities can either attempt to identify anticompetitive mergers with 75% accuracy, or perform no test at all—i.e., letting all mergers go through unchallenged.

If there are 1,000 anticompetitive mergers, applying the test would result in 7,500 correct decisions and 2,500 incorrect ones (2,250 false positives and 250 false negatives). Doing nothing would lead to 9,000 correct decisions and 1,000 false negatives. If the number of anticompetitive deals were 2,500, applying the test would lead to the same number of incorrect decisions as not applying it (1,875 false positives and 625 false negatives, versus 2,500 false negatives). The advantage would tilt toward applying the test if anticompetitive mergers were even more widespread.

This hypothetical example holds a simple lesson for policymakers: the rarer the conduct that they are attempting to identify, the more accurate their identification method must be, and the more costly false negatives must be relative to false positives.

As discussed below, current empirical evidence does not suggest that anticompetitive mergers of this sort are particularly widespread, nor does it offer accurate heuristics to detect the ones that are. Finally, there is little sense that the cost of false negatives significantly outweighs that of false positives. In short, there is currently little evidence to suggest that tougher enforcement would benefit consumers.

Killer Acquisitions

Killer acquisitions are, effectively, a subset of the “potential competitor” mergers discussed in the previous section. As defined by Colleen Cunningham, Florian Ederer, and Song Ma, they are those deals where “an incumbent firm may acquire an innovative target and terminate the development of the target’s innovations to preempt future competition.”

Cunningham, Ederer, and Ma’s highly influential paper on killer acquisitions has been responsible for much of the recent renewed interest in the effect that mergers exert on innovation. The authors studied thousands of pharmaceutical mergers and concluded that between 5.3% and 7.4% of them were killer acquisitions. As they write:

[W]e empirically compare development probabilities of overlapping acquisitions, which are, in our theory, motivated by a mix of killer and development intentions, and non-overlapping acquisitions, which are motivated only by development intentions. We find an increase in acquisition probability and a decrease in post-acquisition development for overlapping acquisitions and interpret that as evidence for killer acquisitions. […]

[W]e find that projects acquired by an incumbent with an overlapping drug are 23.4% less likely to have continued development activity compared to drugs acquired by non-overlapping incumbents.

From a policy standpoint, the question is what weight antitrust authorities, courts, and legislators should give to these findings. Stated differently, does the paper provide sufficient evidence to warrant reform of existing merger-filing thresholds and review standards? There are several factors counseling that policymakers should proceed with caution.

To start, the study’s industry-specific methodology means that it may not be a useful guide to understand acquisitions in other industries, like the tech sector, for example.

Second, even if one assumes that the findings of Cunningham, et al., are correct and apply with equal force in the tech sector (as some official reports have), it remains unclear whether the 5.3–7.4% of mergers they describe warrant a departure from the status quo.

Antitrust enforcers operate under uncertainty. The critical policy question is thus whether this subset of anticompetitive deals can be identified ex-ante. If not, is there a heuristic that would enable enforcers to identify more of these anticompetitive deals without producing excessive false positives?

The authors focus on the effect that overlapping R&D pipelines have on project discontinuations. In the case of non-overlapping mergers, acquired projects continue 17.5% of the time, while this number is 13.4% when there are overlapping pipelines. The authors argue that this gap is evidence of killer acquisitions. But it misses the bigger picture: under the authors’ own numbers and definition of a “killer acquisition,” a vast majority of overlapping acquisitions are perfectly benign; prohibiting them would thus have important social costs.

Third, there are several problems with describing this kind of behavior as harmful. Indeed, Cunningham, et al., acknowledge that this kind of behavior could increase innovation by boosting the returns to innovation.

And even if one ignores incentives to innovate, product discontinuations can improve consumer welfare. This question ultimately boils down to identifying the counterfactual to a merger. As John Yun writes:

For instance, an acquisition that results in a discontinued product is not per se evidence of either consumer harm or benefit. The answer involves comparing the counterfactual world without the acquisition with the world with the acquisition. The comparison includes potential efficiencies that were gained from the acquisition, including integration of intellectual property, the reduction of transaction costs, economies of scope, and better allocation of skilled labor.

One of the reasons R&D project discontinuation may be beneficial is simply cost savings. R&D is expensive. Pharmaceutical firms spend up to 27.8% of their annual revenue on R&D. Developing a new drug has an estimated median cost of $985.3 million. Cost-cutting—notably as it concerns R&D—is thus a critical part of pharmaceutical (as well as tech) companies’ businesses. As a report by McKinsey concludes:

The recent boom in M&A in the pharma industry is partly the result of attempts to address short-term productivity challenges. An acquiring or merging company typically designs organization-wide integration programs to capture synergies, especially in costs. Such programs usually take up to three years to complete and deliver results.

Another report finds that:

Maximizing the efficiency of production labor and equipment is one important way top-quartile drugmakers break out of the pack. Their rates of operational-equipment effectiveness are more than twice those of bottom-quartile companies (Exhibit 1), and when we looked closely we found that processes account for two-thirds of the difference.

In short, pharmaceutical companies do not just compete along innovation-related parameters, though these are obviously important, but also on more traditional grounds such as cost-rationalization. Accordingly, as the above reports suggest, pharmaceutical mergers are often about applying an incumbent’s superior managerial efficiency to the acquired firm’s assets through operation of the market for corporate control.

This cost-cutting (and superior project selection) ultimately enables companies to offer lower prices, thereby benefiting consumers and increasing their incentives to invest in R&D in the first place by making successfully developed drugs more profitable.

In that sense, Henry Manne’s seminal work relating to mergers and the market for corporate control sheds at least as much light on pharmaceutical (and tech) mergers as the killer acquisitions literature. And yet, it is hardly ever mentioned in modern economic literature on this topic.

While Colleen Cunningham and her co-authors do not entirely ignore these considerations, as we discuss in our paper, their arguments for dismissing them are far from watertight.

A natural extension of the killer acquisitions work is to question whether mergers of this sort also take place in the tech industry. Interest in this question is notably driven by the central role that digital markets currently occupy in competition-policy discussion, but also by the significant number of startup acquisitions that take place in the tech industry. However, existing studies provide scant evidence that killer acquisitions are a common occurrence in these markets.

This is not surprising. Unlike in the pharmaceutical industry—where drugs need to go through a lengthy and visible regulatory pipeline before they can be sold—incumbents in digital industries will likely struggle to identify their closest rivals and prevent firms from rapidly pivoting to seize new commercial opportunities. As a result, the basic conditions for killer acquisitions to take place (i.e., firms knowing they are in a position to share monopoly profits) are less likely to be present; it also would be harder to design research methods to detect these mergers.

The empirical literature on killer acquisitions in the tech sector is still in its infancy. But, as things stand, no study directly examines whether killer acquisitions actually take place in digital industries (i.e., whether post-merger project discontinuations are more common in overlapping than non-overlapping tech mergers). This is notably the case for studies by Axel Gautier & Joe Lamesch, and Elena Argentesi and her co-authors. Instead, these studies merely show that product discontinuations are common after an acquisition by a big tech company.

To summarize, while studies of this sort might suggest that the clearance of certain mergers might not have been optimal, it is hardly a sufficient basis on which to argue that enforcement should be tightened.

The reason for this is simple. The fact that some anticompetitive mergers may have escaped scrutiny and/or condemnation is never a sufficient basis to tighten rules. For that, it is also necessary to factor in the administrative costs of increased enforcement, as well as potential false convictions to which it might give rise. As things stand, economic research on killer acquisitions in the tech sector does not warrant tougher antitrust enforcement, though it does show the need for further empirical research on the topic.

Conclusion

Many proposed merger-enforcement reforms risk throwing the baby out with the bathwater. Mergers are largely beneficial to society (here, here and here); anticompetitive ones are rare; and there is little way, at the margin, to tell good from bad. To put it mildly, there is a precious baby that needs to be preserved and relatively little bathwater to throw out.

Take the fulcrum of policy debates that is the pharmaceutical industry. It is not hard to point to pharmaceutical mergers (or long-term agreements) that have revolutionized patient outcomes. Most recently, Pfizer and BioNTech’s efforts to successfully market an mRNA vaccine against COVID-19 offers a case in point.

The deal struck by both firms could naïvely be construed as bearing hallmarks of a killer acquisition or an anticompetitive agreement (long-term agreements can easily fall into either of these categories). Pfizer was a powerful incumbent in the vaccine industry; BioNTech threatened to disrupt the industry with new technology; and the deal likely caused Pfizer to forgo some independent R&D efforts. And yet, it also led to the first approved COVID-19 vaccine and groundbreaking advances in vaccine technology.

Of course, the counterfactual is unclear, and the market might be more competitive absent the deal, just as there might be only one approved mRNA vaccine today instead of two—we simply do not know. More importantly, this counterfactual was even less knowable at the time of the deal. And much the same could be said about countless other pharmaceutical mergers.

The key policy question is how authorities should handle this uncertainty. Critics of the status quo argue that current rules and thresholds leave certain anticompetitive deals unchallenged. But these calls for tougher enforcement fail to satisfy the requirements of the error-cost framework. Critics have so far failed to show that, on balance, mergers harm social welfare—even overlapping ones or mergers between potential competitors—just as they are yet to suggest alternative institutional arrangements that would improve social welfare.

In other words, they mistakenly analyze purported false negatives of merger-enforcement regimes in isolation. In doing so, they ignore how measures that aim to reduce such judicial errors may lead to other errors, as well as higher enforcement costs. In short, they paint a world where policy decisions involve facile tradeoffs, and this undermines their policy recommendations.

Given these significant limitations, this body of academic research should be met with an appropriate degree of caution. For all the criticism it has faced, the current merger-review system is mostly a resounding success. It is administrable, predictable, and timely. Yet it also eliminates a vast majority of judicial errors: even its critics concede that false negatives make up only a tiny fraction of decisions. Policymakers must decide whether the benefits from catching the very few arguably anticompetitive mergers that currently escape prosecution outweigh the significant costs that are required to achieve this goal. There is currently little evidence to suggest that this is, indeed, the case.

Over the past decade and a half, virtually every branch of the federal government has taken steps to weaken the patent system. As reflected in President Joe Biden’s July 2021 executive order, these restraints on patent enforcement are now being coupled with antitrust policies that, in large part, adopt a “big is bad” approach in place of decades of economically grounded case law and agency guidelines.

This policy bundle is nothing new. It largely replicates the innovation policies pursued during the late New Deal and the postwar decades. That historical experience suggests that a “weak-patent/strong-antitrust” approach is likely to encourage neither innovation nor competition.

The Overlooked Shortfalls of New Deal Innovation Policy

Starting in the early 1930s, the U.S. Supreme Court issued a sequence of decisions that raised obstacles to patent enforcement. The Franklin Roosevelt administration sought to take this policy a step further, advocating compulsory licensing for all patents. While Congress did not adopt this proposal, it was partially implemented as a de facto matter through antitrust enforcement. Starting in the early 1940s and continuing throughout the postwar decades, the antitrust agencies secured judicial precedents that treated a broad range of licensing practices as per se illegal. Perhaps most dramatically, the U.S. Justice Department (DOJ) secured more than 100 compulsory licensing orders against some of the nation’s largest companies. 

The rationale behind these policies was straightforward. By compelling access to incumbents’ patented technologies, courts and regulators would lower barriers to entry and competition would intensify. The postwar economy declined to comply with policymakers’ expectations. Implementation of a weak-IP/strong-antitrust innovation policy over the course of four decades yielded the opposite of its intended outcome. 

Market concentration did not diminish, turnover in market leadership was slow, and private research and development (R&D) was confined mostly to the research labs of the largest corporations (who often relied on generous infusions of federal defense funding). These tendencies are illustrated by the dramatically unequal allocation of innovation capital in the postwar economy.  As of the late 1950s, small firms represented approximately 7% of all private U.S. R&D expenditures.  Two decades later, that figure had fallen even further. By the late 1970s, patenting rates had plunged, and entrepreneurship and innovation were in a state of widely lamented decline.

Why Weak IP Raises Entry Costs and Promotes Concentration

The decline in entrepreneurial innovation under a weak-IP regime was not accidental. Rather, this outcome can be derived logically from the economics of information markets.

Without secure IP rights to establish exclusivity, engage securely with business partners, and deter imitators, potential innovator-entrepreneurs had little hope to obtain funding from investors. In contrast, incumbents could fund R&D internally (or with federal funds that flowed mostly to the largest computing, communications, and aerospace firms) and, even under a weak-IP regime, were protected by difficult-to-match production and distribution efficiencies. As a result, R&D mostly took place inside the closed ecosystems maintained by incumbents such as AT&T, IBM, and GE.

Paradoxically, the antitrust campaign against patent “monopolies” most likely raised entry barriers and promoted industry concentration by removing a critical tool that smaller firms might have used to challenge incumbents that could outperform on every competitive parameter except innovation. While the large corporate labs of the postwar era are rightly credited with technological breakthroughs, incumbents such as AT&T were often slow in transforming breakthroughs in basic research into commercially viable products and services for consumers. Without an immediate competitive threat, there was no rush to do so. 

Back to the Future: Innovation Policy in the New New Deal

Policymakers are now at work reassembling almost the exact same policy bundle that ended in the innovation malaise of the 1970s, accompanied by a similar reliance on public R&D funding disbursed through administrative processes. However well-intentioned, these processes are inherently exposed to political distortions that are absent in an innovation environment that relies mostly on private R&D funding governed by price signals. 

This policy bundle has emerged incrementally since approximately the mid-2000s, through a sequence of complementary actions by every branch of the federal government.

  • In 2011, Congress enacted the America Invents Act, which enables any party to challenge the validity of an issued patent through the U.S. Patent and Trademark Office’s (USPTO) Patent Trial and Appeals Board (PTAB). Since PTAB’s establishment, large information-technology companies that advocated for the act have been among the leading challengers.
  • In May 2021, the Office of the U.S. Trade Representative (USTR) declared its support for a worldwide suspension of IP protections over Covid-19-related innovations (rather than adopting the more nuanced approach of preserving patent protections and expanding funding to accelerate vaccine distribution).  
  • President Biden’s July 2021 executive order states that “the Attorney General and the Secretary of Commerce are encouraged to consider whether to revise their position on the intersection of the intellectual property and antitrust laws, including by considering whether to revise the Policy Statement on Remedies for Standard-Essential Patents Subject to Voluntary F/RAND Commitments.” This suggests that the administration has already determined to retract or significantly modify the 2019 joint policy statement in which the DOJ, USPTO, and the National Institutes of Standards and Technology (NIST) had rejected the view that standard-essential patent owners posed a high risk of patent holdup, which would therefore justify special limitations on enforcement and licensing activities.

The history of U.S. technology markets and policies casts great doubt on the wisdom of this weak-IP policy trajectory. The repeated devaluation of IP rights is likely to be a “lose-lose” approach that does little to promote competition, while endangering the incentive and transactional structures that sustain robust innovation ecosystems. A weak-IP regime is particularly likely to disadvantage smaller firms in biotech, medical devices, and certain information-technology segments that rely on patents to secure funding from venture capital and to partner with larger firms that can accelerate progress toward market release. The BioNTech/Pfizer alliance in the production and distribution of a Covid-19 vaccine illustrates how patents can enable such partnerships to accelerate market release.  

The innovative contribution of BioNTech is hardly a one-off occurrence. The restoration of robust patent protection in the early 1980s was followed by a sharp increase in the percentage of private R&D expenditures attributable to small firms, which jumped from about 5% as of 1980 to 21% by 1992. This contrasts sharply with the unequal allocation of R&D activities during the postwar period.

Remarkably, the resurgence of small-firm innovation following the strong-IP policy shift, starting in the late 20th century, mimics tendencies observed during the late 19th and early-20th centuries, when U.S. courts provided a hospitable venue for patent enforcement; there were few antitrust constraints on licensing activities; and innovation was often led by small firms in partnership with outside investors. This historical pattern, encompassing more than a century of U.S. technology markets, strongly suggests that strengthening IP rights tends to yield a policy “win-win” that bolsters both innovative and competitive intensity. 

An Alternate Path: ‘Bottom-Up’ Innovation Policy

To be clear, the alternative to the policy bundle of weak-IP/strong antitrust does not consist of a simple reversion to blind enforcement of patents and lax administration of the antitrust laws. A nuanced innovation policy would couple modern antitrust’s commitment to evidence-based enforcement—which, in particular cases, supports vigorous intervention—with a renewed commitment to protecting IP rights for innovator-entrepreneurs. That would promote competition from the “bottom up” by bolstering maverick innovators who are well-positioned to challenge (or sometimes partner with) incumbents and maintaining the self-starting engine of creative disruption that has repeatedly driven entrepreneurial innovation environments. Tellingly, technology incumbents have often been among the leading advocates for limiting patent and copyright protections.  

Advocates of a weak-patent/strong-antitrust policy believe it will enhance competitive and innovative intensity in technology markets. History suggests that this combination is likely to produce the opposite outcome.  

Jonathan M. Barnett is the Torrey H. Webb Professor of Law at the University of Southern California, Gould School of Law. This post is based on the author’s recent publications, Innovators, Firms, and Markets: The Organizational Logic of Intellectual Property (Oxford University Press 2021) and “The Great Patent Grab,” in Battles Over Patents: History and the Politics of Innovation (eds. Stephen H. Haber and Naomi R. Lamoreaux, Oxford University Press 2021).

ICLE at the Oxford Union

Sam Bowman —  13 July 2021

Earlier this year, the International Center for Law & Economics (ICLE) hosted a conference with the Oxford Union on the themes of innovation, competition, and economic growth with some of our favorite scholars. Though attendance at the event itself was reserved for Oxford Union members, videos from that day are now available for everyone to watch.

Charles Goodhart and Manoj Pradhan on demographics and growth

Charles Goodhart, of Goodhart’s Law fame, and Manoj Pradhan discussed the relationship between demographics and growth, and argued that an aging global population could mean higher inflation and interest rates sooner than many imagine.

Catherine Tucker on privacy and innovation — is there a trade-off?

Catherine Tucker of the Massachusetts Institute of Technology discussed the costs and benefits of privacy regulation with ICLE’s Sam Bowman, and considered whether we face a trade-off between privacy and innovation online and in the fight against COVID-19.

Don Rosenberg on the political and economic challenges facing a global tech company in 2021

Qualcomm’s General Counsel Don Rosenberg, formerly of Apple and IBM, discussed the political and economic challenges facing a global tech company in 2021, as well as dealing with China while working in one of the most strategically vital industries in the world.

David Teece on the dynamic capabilities framework

David Teece explained the dynamic capabilities framework, a way of understanding business strategy and behavior in an uncertain world.

Vernon Smith in conversation with Shruti Rajagopalan on what we still have to learn from Adam Smith

Nobel laureate Vernon Smith discussed the enduring insights of Adam Smith with the Mercatus Center’s Shruti Rajagopalan.

Samantha Hoffman, Robert Atkinson and Jennifer Huddleston on American and Chinese approaches to tech policy in the 2020s

The final panel, with the Information Technology and Innovation Foundation’s President Robert Atkinson, the Australian Strategic Policy Institute’s Samantha Hoffman, and the American Action Forum’s Jennifer Huddleston, discussed the role that tech policy in the U.S. and China plays in the geopolitics of the 2020s.

President Joe Biden named his post-COVID-19 agenda “Build Back Better,” but his proposals to prioritize support for government-run broadband service “with less pressure to turn profits” and to “reduce Internet prices for all Americans” will slow broadband deployment and leave taxpayers with an enormous bill.

Policymakers should pay particular heed to this danger, amid news that the Senate is moving forward with considering a $1.2 trillion bipartisan infrastructure package, and that the Federal Communications Commission, the U.S. Commerce Department’s National Telecommunications and Information Administration, and the U.S. Agriculture Department’s Rural Utilities Service will coordinate on spending broadband subsidy dollars.

In order to ensure that broadband subsidies lead to greater buildout and adoption, policymakers must correctly understand the state of competition in broadband and not assume that increasing the number of firms in a market will necessarily lead to better outcomes for consumers or the public.

A recent white paper published by us here at the International Center for Law & Economics makes the case that concentration is a poor predictor of competitiveness, while offering alternative policies for reaching Americans who don’t have access to high-speed Internet service.

The data show that the state of competition in broadband is generally healthy. ISPs routinely invest billions of dollars per year in building, maintaining, and upgrading their networks to be faster, more reliable, and more available to consumers. FCC data show that average speeds available to consumers, as well as the number of competitors providing higher-speed tiers, have increased each year. And prices for broadband, as measured by price-per-Mbps, have fallen precipitously, dropping 98% over the last 20 years. None of this makes sense if the facile narrative about the absence of competition were true.

In our paper, we argue that the real public policy issue for broadband isn’t curbing the pursuit of profits or adopting price controls, but making sure Americans have broadband access and encouraging adoption. In areas where it is very costly to build out broadband networks, like rural areas, there tend to be fewer firms in the market. But having only one or two ISPs available is far less of a problem than having none at all. Understanding the underlying market conditions and how subsidies can both help and hurt the availability and adoption of broadband is an important prerequisite to good policy.

The basic problem is that those who have decried the lack of competition in broadband often look at the number of ISPs in a given market to determine whether a market is competitive. But this is not how economists think of competition. Instead, economists look at competition as a dynamic process where changes in supply and demand factors are constantly pushing the market toward new equilibria.

In general, where a market is “contestable”—that is, where existing firms face potential competition from the threat of new entry—even just a single existing firm may have to act as if it faces vigorous competition. Such markets often have characteristics (e.g., price, quality, and level of innovation) similar or even identical to those with multiple existing competitors. This dynamic competition, driven by changes in technology or consumer preferences, ensures that such markets are regularly disrupted by innovative products and services—a process that does not always favor incumbents.

Proposals focused on increasing the number of firms providing broadband can actually reduce consumer welfare. Whether through overbuilding—by allowing new private entrants to free-ride on the initial investment by incumbent companies—or by going into the Internet business itself through municipal broadband, government subsidies can increase the number of firms providing broadband. But it can’t do so without costs―which include not just the cost of the subsidies themselves, which ultimately come from taxpayers, but also the reduced incentives for unsubsidized private firms to build out broadband in the first place.

If underlying supply and demand conditions in rural areas lead to a situation where only one provider can profitably exist, artificially adding another completely reliant on subsidies will likely just lead to the exit of the unsubsidized provider. Or, where a community already has municipal broadband, it is unlikely that a private ISP will want to enter and compete with a firm that doesn’t have to turn a profit.

A much better alternative for policymakers is to increase the demand for buildout through targeted user subsidies, while reducing regulatory barriers to entry that limit supply.

For instance, policymakers should consider offering connectivity vouchers to unserved households in order to stimulate broadband deployment and consumption. Current subsidy programs rely largely on subsidizing the supply side, but this requires the government to determine the who and where of entry. Connectivity vouchers would put the choice in the hands of consumers, while encouraging more buildout to areas that may currently be uneconomic to reach due to low population density or insufficient demand due to low adoption rates.

Local governments could also facilitate broadband buildout by reducing unnecessary regulatory barriers. Local building codes could adopt more connection-friendly standards. Local governments could also reduce the cost of access to existing poles and other infrastructure. Eligible Telecommunications Carrier (ETC) requirements could also be eliminated, because they deter potential providers from seeking funds for buildout (and don’t offer countervailing benefits).

Albert Einstein once said: “if I were given one hour to save the planet, I would spend 59 minutes defining the problem, and one minute resolving it.” When it comes to encouraging broadband buildout, policymakers should make sure they are solving the right problem. The problem is that the cost of building out broadband to unserved areas is too high or the demand too low—not that there are too few competitors.

The recent launch of the international Multilateral Pharmaceutical Merger Task Force (MPMTF) is just the latest example of burgeoning cooperative efforts by leading competition agencies to promote convergence in antitrust enforcement. (See my recent paper on the globalization of antitrust, which assesses multinational cooperation and convergence initiatives in greater detail.) In what is a first, the U.S. Federal Trade Commission (FTC), the U.S. Justice Department’s (DOJ) Antitrust Division, offices of state Attorneys General, the European Commission’s Competition Directorate, Canada’s Competition Bureau, and the U.K.’s Competition and Market Authority (CMA) jointly created the MPMTF in March 2021 “to update their approach to analyzing the effects of pharmaceutical mergers.”

To help inform its analysis, in May 2021 the MPMTF requested public comments concerning the effects of pharmaceutical mergers. The MPMTF sought submissions regarding (among other issues) seven sets of questions:   

  1. What theories of harm should enforcement agencies consider when evaluating pharmaceutical mergers, including theories of harm beyond those currently considered?
  2. What is the full range of a pharmaceutical merger’s effects on innovation? What challenges arise when mergers involve proprietary drug discovery and manufacturing platforms?
  3. In pharmaceutical merger review, how should we consider the risks or effects of conduct such as price-setting practices, reverse payments, and other ways in which pharmaceutical companies respond to or rely on regulatory processes?
  4. How should we approach market definition in pharmaceutical mergers, and how is that implicated by new or evolving theories of harm?
  5. What evidence may be relevant or necessary to assess and, if applicable, challenge a pharmaceutical merger based on any new or expanded theories of harm?
  6. What types of remedies would work in the cases to which those theories are applied?
  7. What factors, such as the scope of assets and characteristics of divestiture buyers, influence the likelihood and success of pharmaceutical divestitures to resolve competitive concerns?

My research assistant Andrew Mercado and I recently submitted comments for the record addressing the questions posed by the MPMTF. We concluded:

Federal merger enforcement in general and FTC pharmaceutical merger enforcement in particular have been effective in promoting competition and consumer welfare. Proposed statutory amendments to strengthen merger enforcement not only are unnecessary, but also would, if enacted, tend to undermine welfare and would thus be poor public policy. A brief analysis of seven questions propounded by the Multilateral Pharmaceutical Merger Task Force suggests that: (a) significant changes in enforcement policies are not warranted; and (b) investigators should employ sound law and economics analysis, taking full account of merger-related efficiencies, when evaluating pharmaceutical mergers. 

While we leave it to interested readers to review our specific comments, this commentary highlights one key issue which we stressed—the importance of giving due weight to efficiencies (and, in particular, dynamic efficiencies) in evaluating pharma mergers. We also note an important critique by FTC Commissioner Christine Wilson of the treatment accorded merger-related efficiencies by U.S. antitrust enforcers.   

Discussion

Innovation in pharmaceuticals and vaccines has immensely significant economic and social consequences, as demonstrated most recently in the handling of the COVID-19 pandemic. As such, it is particularly important that public policy not stand in the way of realizing efficiencies that promote innovation in these markets. This observation applies directly, of course, to pharmaceutical antitrust enforcement, in general, and to pharma merger enforcement, in particular.

Regrettably, however, though general merger-enforcement policy has been generally sound, it has somewhat undervalued merger-related efficiencies.

Although U.S. antitrust enforcers give lip service to their serious consideration of efficiencies in merger reviews, the reality appears to be quite different, as documented by Commissioner Wilson in a 2020 speech.

Wilson’s General Merger-Efficiencies Critique: According to Wilson, the combination of finding narrow markets and refusing to weigh out-of-market efficiencies has created major “legal and evidentiary hurdles a defendant must clear when seeking to prove offsetting procompetitive efficiencies.” What’s more, the “courts [have] largely continue[d] to follow the Agencies’ lead in minimizing the importance of efficiencies.” Wilson shows that “the Horizontal Merger Guidelines text and case law appear to set different standards for demonstrating harms and efficiencies,” and argues that this “asymmetric approach has the obvious potential consequence of preventing some procompetitive mergers that increase consumer welfare.” Wilson concludes on a more positive note that this problem can be addressed by having enforcers: (1) treat harms and efficiencies symmetrically; and (2) establish clear and reasonable expectations for what types of efficiency analysis will and will not pass muster.

While our filing with the MPMTF did not discuss Wilson’s general treatment of merger efficiencies, one would hope that the task force will appropriately weigh it in its deliberations. Our filing instead briefly addressed two “informational efficiencies” that may arise in the context of pharmaceutical mergers. These include:

More Efficient Resource Reallocation: The theory of the firm teaches that mergers may be motivated by the underutilization or misallocation of assets, or the opportunity to create welfare-enhancing synergies. In the pharmaceutical industry, these synergies may come from joining complementary research and development programs, combining diverse and specialized expertise that may be leveraged for better, faster drug development and more innovation.

Enhanced R&D: Currently, much of the R&D for large pharmaceutical companies is achieved through partnerships or investment in small biotechnology and research firms specializing in a single type of therapy. Whereas large pharmaceutical companies have expertise in marketing, navigating regulation, and undertaking trials of new drugs, small, research-focused firms can achieve greater advancements in medicine with smaller budgets. Furthermore, changes within firms brought about by a merger may increase innovation.

With increases in intellectual property and proprietary data that come from the merging of two companies, smaller research firms that work with the merged entity may have access to greater pools of information, enhancing the potential for innovation without increasing spending. This change not only raises the efficiency of the research being conducted in these small firms, but also increases the probability of a breakthrough without an increase in risk.

Conclusion

U.S. pharmaceutical merger enforcement has been fairly effective in forestalling anticompetitive combinations while allowing consumer welfare-enhancing transactions to go forward. Policy in this area should remain generally the same. Enforcers should continue to base enforcement decisions on sound economic theory fully supported by case-specific facts. Enforcement agencies could benefit, however, by placing a greater emphasis on efficiencies analysis. In particular, they should treat harms and efficiencies symmetrically (as recommend by Commissioner Wilson), and fully take into account likely resource reallocation and innovation-related efficiencies. 

In what has become regularly scheduled programming on Capitol Hill, Facebook CEO Mark Zuckerberg, Twitter CEO Jack Dorsey, and Google CEO Sundar Pichai will be subject to yet another round of congressional grilling—this time, about the platforms’ content-moderation policies—during a March 25 joint hearing of two subcommittees of the House Energy and Commerce Committee.

The stated purpose of this latest bit of political theatre is to explore, as made explicit in the hearing’s title, “social media’s role in promoting extremism and misinformation.” Specific topics are expected to include proposed changes to Section 230 of the Communications Decency Act, heightened scrutiny by the Federal Trade Commission, and misinformation about COVID-19—the subject of new legislation introduced by Rep. Jennifer Wexton (D-Va.) and Sen. Mazie Hirono (D-Hawaii).

But while many in the Democratic majority argue that social media companies have not done enough to moderate misinformation or hate speech, it is a problem with no realistic legal fix. Any attempt to mandate removal of speech on grounds that it is misinformation or hate speech, either directly or indirectly, would run afoul of the First Amendment.

Much of the recent focus has been on misinformation spread on social media about the 2020 election and the COVID-19 pandemic. The memorandum for the March 25 hearing sums it up:

Facebook, Google, and Twitter have long come under fire for their role in the dissemination and amplification of misinformation and extremist content. For instance, since the beginning of the coronavirus disease of 2019 (COVID-19) pandemic, all three platforms have spread substantial amounts of misinformation about COVID-19. At the outset of the COVID-19 pandemic, disinformation regarding the severity of the virus and the effectiveness of alleged cures for COVID-19 was widespread. More recently, COVID-19 disinformation has misrepresented the safety and efficacy of COVID-19 vaccines.

Facebook, Google, and Twitter have also been distributors for years of election disinformation that appeared to be intended either to improperly influence or undermine the outcomes of free and fair elections. During the November 2016 election, social media platforms were used by foreign governments to disseminate information to manipulate public opinion. This trend continued during and after the November 2020 election, often fomented by domestic actors, with rampant disinformation about voter fraud, defective voting machines, and premature declarations of victory.

It is true that, despite social media companies’ efforts to label and remove false content and bar some of the biggest purveyors, there remains a considerable volume of false information on social media. But U.S. Supreme Court precedent consistently has limited government regulation of false speech to distinct categories like defamation, perjury, and fraud.

The Case of Stolen Valor

The court’s 2011 decision in United States v. Alvarez struck down as unconstitutional the Stolen Valor Act of 2005, which made it a federal crime to falsely claim to have earned a military medal. A four-justice plurality opinion written by Justice Anthony Kennedy, along with a two-justice concurrence, both agreed that a statement being false did not, by itself, exclude it from First Amendment protection. 

Kennedy’s opinion noted that while the government may impose penalties for false speech connected with the legal process (perjury or impersonating a government official); with receiving a benefit (fraud); or with harming someone’s reputation (defamation); the First Amendment does not sanction penalties for false speech, in and of itself. The plurality exhibited particular skepticism toward the notion that government actors could be entrusted as a “Ministry of Truth,” empowered to determine what categories of false speech should be made illegal:

Permitting the government to decree this speech to be a criminal offense, whether shouted from the rooftops or made in a barely audible whisper, would endorse government authority to compile a list of subjects about which false statements are punishable. That governmental power has no clear limiting principle. Our constitutional tradition stands against the idea that we need Oceania’s Ministry of Truth… Were this law to be sustained, there could be an endless list of subjects the National Government or the States could single out… Were the Court to hold that the interest in truthful discourse alone is sufficient to sustain a ban on speech, absent any evidence that the speech was used to gain a material advantage, it would give government a broad censorial power unprecedented in this Court’s cases or in our constitutional tradition. The mere potential for the exercise of that power casts a chill, a chill the First Amendment cannot permit if free speech, thought, and discourse are to remain a foundation of our freedom. [EMPHASIS ADDED]

As noted in the opinion, declaring false speech illegal constitutes a content-based restriction subject to “exacting scrutiny.” Applying that standard, the court found “the link between the Government’s interest in protecting the integrity of the military honors system and the Act’s restriction on the false claims of liars like respondent has not been shown.” 

While finding that the government “has not shown, and cannot show, why counterspeech would not suffice to achieve its interest,” the plurality suggested a more narrowly tailored solution could be simply to publish Medal of Honor recipients in an online database. In other words, the government could overcome the problem of false speech by promoting true speech. 

In 2012, President Barack Obama signed an updated version of the Stolen Valor Act that limited its penalties to situations where a misrepresentation is shown to result in receipt of some kind of benefit. That places the false speech in the category of fraud, consistent with the Alvarez opinion.

A Social Media Ministry of Truth

Applying the Alvarez standard to social media, the government could (and already does) promote its interest in public health or election integrity by publishing true speech through official channels. But there is little reason to believe the government at any level could regulate access to misinformation. Anything approaching an outright ban on accessing speech deemed false by the government not only would not be the most narrowly tailored way to deal with such speech, but it is bound to have chilling effects even on true speech.

The analysis doesn’t change if the government instead places Big Tech itself in the position of Ministry of Truth. Some propose making changes to Section 230, which currently immunizes social media companies from liability for user speech (with limited exceptions), regardless what moderation policies the platform adopts. A hypothetical change might condition Section 230’s liability shield on platforms agreeing to moderate certain categories of misinformation. But that would still place the government in the position of coercing platforms to take down speech. 

Even the “fix” of making social media companies liable for user speech they amplify through promotions on the platform, as proposed by Sen. Mark Warner’s (D-Va.) SAFE TECH Act, runs into First Amendment concerns. The aim of the bill is to regard sponsored content as constituting speech made by the platform, thus opening the platform to liability for the underlying misinformation. But any such liability also would be limited to categories of speech that fall outside First Amendment protection, like fraud or defamation. This would not appear to include most of the types of misinformation on COVID-19 or election security that animate the current legislative push.

There is no way for the government to regulate misinformation, in and of itself, consistent with the First Amendment. Big Tech companies are free to develop their own policies against misinformation, but the government may not force them to do so. 

Extremely Limited Room to Regulate Extremism

The Big Tech CEOs are also almost certain to be grilled about the use of social media to spread “hate speech” or “extremist content.” The memorandum for the March 25 hearing sums it up like this:

Facebook executives were repeatedly warned that extremist content was thriving on their platform, and that Facebook’s own algorithms and recommendation tools were responsible for the appeal of extremist groups and divisive content. Similarly, since 2015, videos from extremists have proliferated on YouTube; and YouTube’s algorithm often guides users from more innocuous or alternative content to more fringe channels and videos. Twitter has been criticized for being slow to stop white nationalists from organizing, fundraising, recruiting and spreading propaganda on Twitter.

Social media has often played host to racist, sexist, and other types of vile speech. While social media companies have community standards and other policies that restrict “hate speech” in some circumstances, there is demand from some public officials that they do more. But under a First Amendment analysis, regulating hate speech on social media would fare no better than the regulation of misinformation.

The First Amendment doesn’t allow for the regulation of “hate speech” as its own distinct category. Hate speech is, in fact, as protected as any other type of speech. There are some limited exceptions, as the First Amendment does not protect incitement, true threats of violence, or “fighting words.” Some of these flatly do not apply in the online context. “Fighting words,” for instance, applies only in face-to-face situations to “those personally abusive epithets which, when addressed to the ordinary citizen, are, as a matter of common knowledge, inherently likely to provoke violent reaction.”

One relevant precedent is the court’s 1992 decision in R.A.V. v. St. Paul, which considered a local ordinance in St. Paul, Minnesota, prohibiting public expressions that served to cause “outrage, alarm, or anger with respect to racial, gender or religious intolerance.” A juvenile was charged with violating the ordinance when he created a makeshift cross and lit it on fire in front of a black family’s home. The court unanimously struck down the ordinance as a violation of the First Amendment, finding it an impermissible content-based restraint that was not limited to incitement or true threats.

By contrast, in 2003’s Virginia v. Black, the Supreme Court upheld a Virginia law outlawing cross burnings done with the intent to intimidate. The court’s opinion distinguished R.A.V. on grounds that the Virginia statute didn’t single out speech regarding disfavored topics. Instead, it was aimed at speech that had the intent to intimidate regardless of the victim’s race, gender, religion, or other characteristic. But the court was careful to limit government regulation of hate speech to instances that involve true threats or incitement.

When it comes to incitement, the legal standard was set by the court’s landmark Brandenberg v. Ohio decision in 1969, which laid out that:

the constitutional guarantees of free speech and free press do not permit a State to forbid or proscribe advocacy of the use of force or of law violation except where such advocacy is directed to inciting or producing imminent lawless action and is likely to incite or produce such action. [EMPHASIS ADDED]

In other words, while “hate speech” is protected by the First Amendment, specific types of speech that convey true threats or fit under the related doctrine of incitement are not. The government may regulate those types of speech. And they do. In fact, social media users can be, and often are, charged with crimes for threats made online. But the government can’t issue a per se ban on hate speech or “extremist content.”

Just as with misinformation, the government also can’t condition Section 230 immunity on platforms removing hate speech. Insofar as speech is protected under the First Amendment, the government can’t specifically condition a government benefit on its removal. Even the SAFE TECH Act’s model for holding platforms accountable for amplifying hate speech or extremist content would have to be limited to speech that amounts to true threats or incitement. This is a far narrower category of hateful speech than the examples that concern legislators. 

Social media companies do remain free under the law to moderate hateful content as they see fit under their terms of service. Section 230 immunity is not dependent on whether companies do or don’t moderate such content, or on how they define hate speech. But government efforts to step in and define hate speech would likely run into First Amendment problems unless they stay focused on unprotected threats and incitement.

What Can the Government Do?

One may fairly ask what it is that governments can do to combat misinformation and hate speech online. The answer may be a law that requires takedowns by court order of speech after it is declared illegal, as proposed by the PACT Act, sponsored in the last session by Sens. Brian Schatz (D-Hawaii) and John Thune (R-S.D.). Such speech may, in some circumstances, include misinformation or hate speech.

But as outlined above, the misinformation that the government can regulate is limited to situations like fraud or defamation, while the hate speech it can regulate is limited to true threats and incitement. A narrowly tailored law that looked to address those specific categories may or may not be a good idea, but it would likely survive First Amendment scrutiny, and may even prove a productive line of discussion with the tech CEOs.

Policy discussions about the use of personal data often have “less is more” as a background assumption; that data is overconsumed relative to some hypothetical optimal baseline. This overriding skepticism has been the backdrop for sweeping new privacy regulations, such as the California Consumer Privacy Act (CCPA) and the EU’s General Data Protection Regulation (GDPR).

More recently, as part of the broad pushback against data collection by online firms, some have begun to call for creating property rights in consumers’ personal data or for data to be treated as labor. Prominent backers of the idea include New York City mayoral candidate Andrew Yang and computer scientist Jaron Lanier.

The discussion has escaped the halls of academia and made its way into popular media. During a recent discussion with Tesla founder Elon Musk, comedian and podcast host Joe Rogan argued that Facebook is “one gigantic information-gathering business that’s decided to take all of the data that people didn’t know was valuable and sell it and make f***ing billions of dollars.” Musk appeared to agree.

The animosity exhibited toward data collection might come as a surprise to anyone who has taken Econ 101. Goods ideally end up with those who value them most. A firm finding profitable ways to repurpose unwanted scraps is just the efficient reallocation of resources. This applies as much to personal data as to literal trash.

Unfortunately, in the policy sphere, few are willing to recognize the inherent trade-off between the value of privacy, on the one hand, and the value of various goods and services that rely on consumer data, on the other. Ideally, policymakers would look to markets to find the right balance, which they often can. When the transfer of data is hardwired into an underlying transaction, parties have ample room to bargain.

But this is not always possible. In some cases, transaction costs will prevent parties from bargaining over the use of data. The question is whether such situations are so widespread as to justify the creation of data property rights, with all of the allocative inefficiencies they entail. Critics wrongly assume the solution is both to create data property rights and to allocate them to consumers. But there is no evidence to suggest that, at the margin, heightened user privacy necessarily outweighs the social benefits that new data-reliant goods and services would generate. Recent experience in the worlds of personalized medicine and the fight against COVID-19 help to illustrate this point.

Data Property Rights and Personalized Medicine

The world is on the cusp of a revolution in personalized medicine. Advances such as the improved identification of biomarkers, CRISPR genome editing, and machine learning, could usher a new wave of treatments to markedly improve health outcomes.

Personalized medicine uses information about a person’s own genes or proteins to prevent, diagnose, or treat disease. Genetic-testing companies like 23andMe or Family Tree DNA, with the large troves of genetic information they collect, could play a significant role in helping the scientific community to further medical progress in this area.

However, despite the obvious potential of personalized medicine, many of its real-world applications are still very much hypothetical. While governments could act in any number of ways to accelerate the movement’s progress, recent policy debates have instead focused more on whether to create a system of property rights covering personal genetic data.

Some raise concerns that it is pharmaceutical companies, not consumers, who will reap the monetary benefits of the personalized medicine revolution, and that advances are achieved at the expense of consumers’ and patients’ privacy. They contend that data property rights would ensure that patients earn their “fair” share of personalized medicine’s future profits.

But it’s worth examining the other side of the coin. There are few things people value more than their health. U.S. governmental agencies place the value of a single life at somewhere between $1 million and $10 million. The commonly used quality-adjusted life year metric offers valuations that range from $50,000 to upward of $300,000 per incremental year of life.

It therefore follows that the trivial sums users of genetic-testing kits might derive from a system of data property rights would likely be dwarfed by the value they would enjoy from improved medical treatments. A strong case can be made that policymakers should prioritize advancing the emergence of new treatments, rather than attempting to ensure that consumers share in the profits generated by those potential advances.

These debates drew increased attention last year, when 23andMe signed a strategic agreement with the pharmaceutical company Almirall to license the rights related to an antibody Almirall had developed. Critics pointed out that 23andMe’s customers, whose data had presumably been used to discover the potential treatment, received no monetary benefits from the deal. Journalist Laura Spinney wrote in The Guardian newspaper:

23andMe, for example, asks its customers to waive all claims to a share of the profits arising from such research. But given those profits could be substantial—as evidenced by the interest of big pharma—shouldn’t the company be paying us for our data, rather than charging us to be tested?

In the deal’s wake, some argued that personal health data should be covered by property rights. A cardiologist quoted in Fortune magazine opined: “I strongly believe that everyone should own their medical data—and they have a right to that.” But this strong belief, however widely shared, ignores important lessons that law and economics has to teach about property rights and the role of contractual freedom.

Why Do We Have Property Rights?

Among the many important features of property rights is that they create “excludability,” the ability of economic agents to prevent third parties from using a given item. In the words of law professor Richard Epstein:

[P]roperty is not an individual conception, but is at root a social conception. The social conception is fairly and accurately portrayed, not by what it is I can do with the thing in question, but by who it is that I am entitled to exclude by virtue of my right. Possession becomes exclusive possession against the rest of the world…

Excludability helps to facilitate the trade of goods, offers incentives to create those goods in the first place, and promotes specialization throughout the economy. In short, property rights create a system of exclusion that supports creating and maintaining valuable goods, services, and ideas.

But property rights are not without drawbacks. Physical or intellectual property can lead to a suboptimal allocation of resources, namely market power (though this effect is often outweighed by increased ex ante incentives to create and innovate). Similarly, property rights can give rise to thickets that significantly increase the cost of amassing complementary pieces of property. Often cited are the historic (but contested) examples of tolling on the Rhine River or the airplane patent thicket of the early 20th century. Finally, strong property rights might also lead to holdout behavior, which can be addressed through top-down tools, like eminent domain, or private mechanisms, like contingent contracts.

In short, though property rights—whether they cover physical or information goods—can offer vast benefits, there are cases where they might be counterproductive. This is probably why, throughout history, property laws have evolved to achieve a reasonable balance between incentives to create goods and to ensure their efficient allocation and use.

Personal Health Data: What Are We Trying to Incentivize?

There are at least three critical questions we should ask about proposals to create property rights over personal health data.

  1. What goods or behaviors would these rights incentivize or disincentivize that are currently over- or undersupplied by the market?
  2. Are goods over- or undersupplied because of insufficient excludability?
  3. Could these rights undermine the efficient use of personal health data?

Much of the current debate centers on data obtained from direct-to-consumer genetic-testing kits. In this context, almost by definition, firms only obtain consumers’ genetic data with their consent. In western democracies, the rights to bodily integrity and to privacy generally make it illegal to administer genetic tests against a consumer or patient’s will. This makes genetic information naturally excludable, so consumers already benefit from what is effectively a property right.

When consumers decide to use a genetic-testing kit, the terms set by the testing firm generally stipulate how their personal data will be used. 23andMe has a detailed policy to this effect, as does Family Tree DNA. In the case of 23andMe, consumers can decide whether their personal information can be used for the purpose of scientific research:

You have the choice to participate in 23andMe Research by providing your consent. … 23andMe Research may study a specific group or population, identify potential areas or targets for therapeutics development, conduct or support the development of drugs, diagnostics or devices to diagnose, predict or treat medical or other health conditions, work with public, private and/or nonprofit entities on genetic research initiatives, or otherwise create, commercialize, and apply this new knowledge to improve health care.

Because this transfer of personal information is hardwired into the provision of genetic-testing services, there is space for contractual bargaining over the allocation of this information. The right to use personal health data will go toward the party that values it most, especially if information asymmetries are weeded out by existing regulations or business practices.

Regardless of data property rights, consumers have a choice: they can purchase genetic-testing services and agree to the provider’s data policy, or they can forgo the services. The service provider cannot obtain the data without entering into an agreement with the consumer. While competition between providers will affect parties’ bargaining positions, and thus the price and terms on which these services are provided, data property rights likely will not.

So, why do consumers transfer control over their genetic data? The main reason is that genetic information is inaccessible and worthless without the addition of genetic-testing services. Consumers must pass through the bottleneck of genetic testing for their genetic data to be revealed and transformed into usable information. It therefore makes sense to transfer the information to the service provider, who is in a much stronger position to draw insights from it. From the consumer’s perspective, the data is not even truly “transferred,” as the consumer had no access to it before the genetic-testing service revealed it. The value of this genetic information is then netted out in the price consumers pay for testing kits.

If personal health data were undersupplied by consumers and patients, testing firms could sweeten the deal and offer them more in return for their data. U.S. copyright law covers original compilations of data, while EU law gives 15 years of exclusive protection to the creators of original databases. Legal protections for trade secrets could also play some role. Thus, firms have some incentives to amass valuable health datasets.

But some critics argue that health data is, in fact, oversupplied. Generally, such arguments assert that agents do not account for the negative privacy externalities suffered by third-parties, such as adverse-selection problems in insurance markets. For example, Jay Pil Choi, Doh Shin Jeon, and Byung Cheol Kim argue:

Genetic tests are another example of privacy concerns due to informational externalities. Researchers have found that some subjects’ genetic information can be used to make predictions of others’ genetic disposition among the same racial or ethnic category.  … Because of practical concerns about privacy and/or invidious discrimination based on genetic information, the U.S. federal government has prohibited insurance companies and employers from any misuse of information from genetic tests under the Genetic Information Nondiscrimination Act (GINA).

But if these externalities exist (most of the examples cited by scholars are hypothetical), they are likely dwarfed by the tremendous benefits that could flow from the use of personal health data. Put differently, the assertion that “excessive” data collection may create privacy harms should be weighed against the possibility that the same collection may also lead to socially valuable goods and services that produce positive externalities.

In any case, data property rights would do little to limit these potential negative externalities. Consumers and patients are already free to agree to terms that allow or prevent their data from being resold to insurers. It is not clear how data property rights would alter the picture.

Proponents of data property rights often claim they should be associated with some form of collective bargaining. The idea is that consumers might otherwise fail to receive their “fair share” of genetic-testing firms’ revenue. But what critics portray as asymmetric bargaining power might simply be the market signaling that genetic-testing services are in high demand, with room for competitors to enter the market. Shifting rents from genetic-testing services to consumers would undermine this valuable price signal and, ultimately, diminish the quality of the services.

Perhaps more importantly, to the extent that they limit the supply of genetic information—for example, because firms are forced to pay higher prices for data and thus acquire less of it—data property rights might hinder the emergence of new treatments. If genetic data is a key input to develop personalized medicines, adopting policies that, in effect, ration the supply of that data is likely misguided.

Even if policymakers do not directly put their thumb on the scale, data property rights could still harm pharmaceutical innovation. If existing privacy regulations are any guide—notably, the previously mentioned GDPR and CCPA, as well as the federal Health Insurance Portability and Accountability Act (HIPAA)—such rights might increase red tape for pharmaceutical innovators. Privacy regulations routinely limit firms’ ability to put collected data to new and previously unforeseen uses. They also limit parties’ contractual freedom when it comes to gathering consumers’ consent.

At the margin, data property rights would make it more costly for firms to amass socially valuable datasets. This would effectively move the personalized medicine space further away from a world of permissionless innovation, thus slowing down medical progress.

In short, there is little reason to believe health-care data is misallocated. Proposals to reallocate rights to such data based on idiosyncratic distributional preferences threaten to stifle innovation in the name of privacy harms that remain mostly hypothetical.

Data Property Rights and COVID-19

The trade-off between users’ privacy and the efficient use of data also has important implications for the fight against COVID-19. Since the beginning of the pandemic, several promising initiatives have been thwarted by privacy regulations and concerns about the use of personal data. This has potentially prevented policymakers, firms, and consumers from putting information to its optimal social use. High-profile issues have included:

Each of these cases may involve genuine privacy risks. But to the extent that they do, those risks must be balanced against the potential benefits to society. If privacy concerns prevent us from deploying contact tracing or green passes at scale, we should question whether the privacy benefits are worth the cost. The same is true for rules that prohibit amassing more data than is strictly necessary, as is required by data-minimization obligations included in regulations such as the GDPR.

If our initial question was instead whether the benefits of a given data-collection scheme outweighed its potential costs to privacy, incentives could be set such that competition between firms would reduce the amount of data collected—at least, where minimized data collection is, indeed, valuable to users. Yet these considerations are almost completely absent in the COVID-19-related privacy debates, as they are in the broader privacy debate. Against this backdrop, the case for personal data property rights is dubious.

Conclusion

The key question is whether policymakers should make it easier or harder for firms and public bodies to amass large sets of personal data. This requires asking whether personal data is currently under- or over-provided, and whether the additional excludability that would be created by data property rights would offset their detrimental effect on innovation.

Swaths of personal data currently lie untapped. With the proper incentive mechanisms in place, this idle data could be mobilized to develop personalized medicines and to fight the COVID-19 outbreak, among many other valuable uses. By making such data more onerous to acquire, property rights in personal data might stifle the assembly of novel datasets that could be used to build innovative products and services.

On the other hand, when dealing with diffuse and complementary data sources, transaction costs become a real issue and the initial allocation of rights can matter a great deal. In such cases, unlike the genetic-testing kits example, it is not certain that users will be able to bargain with firms, especially where their personal information is exchanged by third parties.

If optimal reallocation is unlikely, should property rights go to the person covered by the data or to the collectors (potentially subject to user opt-outs)? Proponents of data property rights assume the first option is superior. But if the goal is to produce groundbreaking new goods and services, granting rights to data collectors might be a superior solution. Ultimately, this is an empirical question.

As Richard Epstein puts it, the goal is to “minimize the sum of errors that arise from expropriation and undercompensation, where the two are inversely related.” Rather than approach the problem with the preconceived notion that initial rights should go to users, policymakers should ensure that data flows to those economic agents who can best extract information and knowledge from it.

As things stand, there is little to suggest that the trade-offs favor creating data property rights. This is not an argument for requisitioning personal information or preventing parties from transferring data as they see fit, but simply for letting markets function, unfettered by misguided public policies.