The blistering pace at which the European Union put forward and adopted the Digital Markets Act (DMA) has attracted the attention of legislators across the globe. In its wake, countries such as South Africa, India, Brazil, and Turkey have all contemplated digital-market regulations inspired by the DMA (and other models of regulation, such as the United Kingdom’s Digital Markets Unit and Australia’s sectoral codes of conduct).
Racing to be among the first jurisdictions to regulate might intuitively seem like a good idea. By emulating the EU, countries could hope to be perceived as on the cutting edge of competition policy, and hopefully earn a seat at the table when the future direction of such regulations is discussed.
There are, however, tradeoffs involved in regulating digital markets, which are arguably even more salient in the case of emerging markets. Indeed, as we will explain here, these jurisdictions often face challenges that significantly alter the ratio of costs and benefits when it comes to enacting regulation.
Drawing from a paper we wrote with Sam Bowman about competition policy in the Association of Southeast Asian Nations (ASEAN) zone, we highlight below three of the biggest issues these initiatives face.
To Regulate Competition, You First Need to Attract Competition
Perhaps the biggest factor cautioning emerging markets against adoption of DMA-inspired regulations is that such rules would impose heavy compliance costs to doing business in markets that are often anything but mature. It is probably fair to say that, in many (maybe most) emerging markets, the most pressing challenge is to attract investment from international tech firms in the first place, not how to regulate their conduct.
The most salient example comes from South Africa, which has sketched out plans to regulate digital markets. The Competition Commission has announced that Amazon, which is not yet available in the country, would fall under these new rules should it decide to enter—essentially on the presumption that Amazon would overthrow South Africa’s incumbent firms.
It goes without saying that, at the margin, such plans reduce either the likelihood that Amazon will enter the South African market at all, or the extent of its entry should it choose to do so. South African consumers thus risk losing the vast benefits such entry would bring—benefits that dwarf those from whatever marginal increase in competition might be gained from subjecting Amazon to onerous digital-market regulations.
While other tech firms—such as Alphabet, Meta, and Apple—are already active in most emerging jurisdictions, regulation might still have a similar deterrent effect to their further investment. Indeed, the infrastructure deployed by big tech firms in these jurisdictions is nowhere near as extensive as in Western countries. To put it mildly, emerging-market consumers typically only have access to slower versions of these firms’ services. A quick glimpse at Google Cloud’s global content-delivery network illustrates this point well (i.e., that there is far less infrastructure in developing markets):
Ultimately, emerging markets remain relatively underserved compared to those in the West. In such markets, the priority should be to attract tech investment, not to impose regulations that may further slow the deployment of critical internet infrastructure.
Growth Is Key
The potential to boost growth is the most persuasive argument for emerging markets to favor a more restrained approach to competition law and regulation, such as that currently employed in the United States.
Emerging nations may not have the means (or the inclination) to equip digital-market enforcers with resources similar to those of the European Commission. Given these resource constraints, it is essential that such jurisdictions focus their enforcement efforts on those areas that provide the highest return on investment, notably in terms of increased innovation.
This raises an important point. A recent empirical study by Ross Levine, Chen Lin, Lai Wei, and Wensi Xie finds that competition enforcement does, indeed, promote innovation. But among the study’s more surprising findings is that, unlike other areas of competition enforcement, the strength of a jurisdiction’s enforcement of “abuse of dominance” rules does not correlate with increased innovation. Furthermore, jurisdictions that allow for so-called “efficiency defenses” in unilateral-conduct cases also tend to produce more innovation. The authors thus conclude that:
From the perspective of maximizing patent-based innovation, therefore, a legal system that allows firms to exploit their dominant positions based on efficiency considerations could boost innovation.
These findings should give pause to policymakers who seek to emulate the European Union’s DMA—which, among other things, does not allow gatekeepers to put forward so-called “efficiency defenses” that would allow them to demonstrate that their behavior benefits consumers. If growth and innovation are harmed by overinclusive abuse-of-dominance regimes and rules that preclude firms from offering efficiency-based defenses, then this is probably even more true of digital-market regulations that replace case-by-case competition enforcement with per se prohibitions.
In short, the available evidence suggests that, faced with limited enforcement resources, emerging-market jurisdictions should prioritize other areas of competition policy, such as breaking up or mitigating the harmful effects of cartels and exercising appropriate merger controls.
These findings also cut in favor of emphasizing the traditional antitrust goal of maximizing consumer welfare—or, at least, protecting the competitive process. Many of the more recent digital-market regulations—such as the DMA, the UK DMU, and the ACCC sectoral codes of conduct—are instead focused on distributional issues. They seek to ensure that platform users earn a “fair share” of the benefits generated on a platform. In light of Levine et al.’s findings, this approach could be undesirable, as using competition policy to reduce monopoly rents may lead to less innovation.
In short, traditional antitrust law’s focus on consumer welfare and relatively limited enforcement in the area of unilateral conduct may be a good match for emerging nations that want competition regimes that maximize innovation under important resource constraints.
Consider Local Economic and Political Conditions
Emerging jurisdictions have diverse economic and political profiles. These features, in turn, affect the respective costs and benefits of digital-market regulations.
For example, digital-market regulations generally offer very broad discretion to competition enforcers. The DMA details dozens of open-ended prohibitions upon which enforcers can base infringement proceedings. Furthermore, because they are designed to make enforcers’ task easier, these regulations often remove protections traditionally afforded to defendants, such as appeals to the consumer welfare standard or efficiency defenses. The UK’s DMU initiative, for example, would lower the standard of proof that enforcers must meet.
Giving authorities broad powers with limited judicial oversight might be less problematic in jurisdictions where the state has a track record of self-restraint. The consequences of regulatory discretion might, however, be far more problematic in jurisdictions where authorities routinely overstep the mark and where the threat of corruption is very real.
To name but two, countries like South Africa and India rank relatively low in the World Bank’s “ease of doing business index” (84th and 62nd, respectively). They also rank relatively low on the Cato Institute’s “human freedom index” (77th and 119th, respectively—and both score particularly badly in terms of economic freedom). This suggests strongly that authorities in those jurisdictions are prone to misapply powers derived from digital-market regulations in ways that hurt growth and consumers.
To make matters worse, outright corruption is also a real problem in several emerging nations. Returning to South Africa and India, both jurisdictions face significant corruption issues (they rank 70th and 85th, respectively, on Transparency International’s “Corruption Perception Index”).
At a more granular level, an inquiry in South Africa revealed rampant corruption under former President Jacob Zuma, while current President Cyril Ramaphosa also faces significant corruption allegations. Writing in the Financial Times in 2018, Gaurav Dalmia—chair of Delhi-based Dalmia Group Holdings—opined that “India’s anti-corruption battle will take decades to win.”
This specter of corruption thus counsels in favor of establishing competition regimes with sufficient checks and balances, so as to prevent competition authorities from being captured by industry or political forces. But most digital-market regulations are designed precisely to remove those protections in order to streamline enforcement. The risk that they could be mobilized toward nefarious ends are thus anything but trivial. This is of particular concern, given that such regulations are typically mobilized against global firms in order to shield inefficient local firms—raising serious risks of protectionist enforcement that would harm local consumers.
Conclusion
The bottom line is that emerging markets would do well to reconsider the value of regulating digital markets that have yet to reach full maturity. Recent proposals threaten to deter tech investments in these jurisdictions, while raising significant risks of reduced growth, corruption, and consumer-harming protectionism.
President Joe Biden’s July 2021 executive order set forth a commitment to reinvigorate U.S. innovation and competitiveness. The administration’s efforts to pass the America COMPETES Act would appear to further demonstrate a serious intent to pursue these objectives.
Yet several actions taken by federal agencies threaten to undermine the intellectual-property rights and transactional structures that have driven the exceptional performance of U.S. firms in key areas of the global innovation economy. These regulatory missteps together represent a policy “lose-lose” that lacks any sound basis in innovation economics and threatens U.S. leadership in mission-critical technology sectors.
Life Sciences: USTR Campaigns Against Intellectual-Property Rights
In the pharmaceutical sector, the administration’s signature action has been an unprecedented campaign by the Office of the U.S. Trade Representative (USTR) to block enforcement of patents and other intellectual-property rights held by companies that have broken records in the speed with which they developed and manufactured COVID-19 vaccines on a mass scale.
Patents were not an impediment in this process. To the contrary: they were necessary predicates to induce venture-capital investment in a small firm like BioNTech, which undertook drug development and then partnered with the much larger Pfizer to execute testing, production, and distribution. If success in vaccine development is rewarded with expropriation, this vital public-health sector is unlikely to attract investors in the future.
Contrary to increasingly common assertions that the Bayh-Dole Act (which enables universities to seek patents arising from research funded by the federal government) “robs” taxpayers of intellectual property they funded, the development of Covid-19 vaccines by scientist-founded firms illustrates how the combination of patents and private capital is essential to convert academic research into life-saving medical solutions. The biotech ecosystem has long relied on patents to structure partnerships among universities, startups, and large firms. The costly path from lab to market relies on a secure property-rights infrastructure to ensure exclusivity, without which no investor would put capital at stake in what is already a high-risk, high-cost enterprise.
This is not mere speculation. During the decades prior to the Bayh-Dole Act, the federal government placed strict limitations on the ability to patent or exclusively license innovations arising from federally funded research projects. The result: the market showed little interest in making the investment needed to convert those innovations into commercially viable products that might benefit consumers. This history casts great doubt on the wisdom of the USTR’s campaign to limit the ability of biopharmaceutical firms to maintain legal exclusivity over certain life sciences innovations.
Genomics: FTC Attempts to Block the Illumina/GRAIL Acquisition
In the genomics industry, the Federal Trade Commission (FTC) has devoted extensive resources to oppose the acquisition by Illumina—the market leader in next-generation DNA-sequencing equipment—of a medical-diagnostics startup, GRAIL (an Illumina spinoff), that has developed an early-stage cancer screening test.
It is hard to see the competitive threat. GRAIL is a pre-revenue company that operates in a novel market segment and its diagnostic test has not yet received approval from the Food and Drug Administration (FDA). To address concerns over barriers to potential competitors in this nascent market, Illumina has committed to 12-year supply contracts that would bar price increases or differential treatment for firms that develop oncology-detection tests requiring use of the Illumina platform.
The FTC’s case against Illumina’s re-acquisition of GRAIL relies on theoretical predictions of consumer harm in a market that is not yet operational. Hypothetical market failure scenarios may suit an academic seminar but fall well below the probative threshold for antitrust intervention.
Most critically, the Illumina enforcement action places at-risk a key element of well-functioning innovation ecosystems. Economies of scale and network effects lead technology markets to converge on a handful of leading platforms, which then often outsource research and development by funding and sometimes acquiring smaller firms that develop complementary technologies. This symbiotic relationship encourages entry and benefits consumers by bringing new products to market as efficiently as possible.
If antitrust interventions based on regulatory fiat, rather than empirical analysis, disrupt settled expectations in the M&A market that innovations can be monetized through acquisition transactions by larger firms, venture capital may be unwilling to fund such startups in the first place. Independent development or an initial public offering are often not feasible exit options. It is likely that innovation will then retreat to the confines of large incumbents that can fund research internally but often execute it less effectively.
Wireless Communications: DOJ Takes Aim at Standard-Essential Patents
Wireless communications stand at the heart of the global transition to a 5G-enabled “Internet of Things” that will transform business models and unlock efficiencies in myriad industries. It is therefore of paramount importance that policy actions in this sector rest on a rigorous economic basis. Unfortunately, a recent policy shift proposed by the U.S. Department of Justice’s (DOJ) Antitrust Division does not meet this standard.
In December 2021, the Antitrust Division released a draft policy statement that would largely bar owners of standard-essential patents from seeking injunctions against infringers, which are usually large device manufacturers. These patents cover wireless functionalities that enable transformative solutions in myriad industries, ranging from communications to transportation to health care. A handful of U.S. and European firms lead in wireless chip design and rely on patent licensing to disseminate technology to device manufacturers and to fund billions of dollars in research and development. The result is a technology ecosystem that has enjoyed continuous innovation, widespread user adoption, and declining quality-adjusted prices.
The inability to block infringers disrupts this equilibrium by signaling to potential licensees that wireless technologies developed by others can be used at-will, with the terms of use to be negotiated through costly and protracted litigation. A no-injunction rule would discourage innovation while encouraging delaying tactics favored by well-resourced device manufacturers (including some of the world’s largest companies by market capitalization) that occupy bottleneck pathways to lucrative retail markets in the United States, China, and elsewhere.
Rather than promoting competition or innovation, the proposed policy would simply transfer wealth from firms that develop new technologies at great cost and risk to firms that prefer to use those technologies at no cost at all. This does not benefit anyone other than device manufacturers that already capture the largest portion of economic value in the smartphone supply chain.
Conclusion
From international trade to antitrust to patent policy, the administration’s actions imply little appreciation for the property rights and contractual infrastructure that support real-world innovation markets. In particular, the administration’s policies endanger the intellectual-property rights and monetization pathways that support market incentives to invest in the development and commercialization of transformative technologies.
This creates an inviting vacuum for strategic rivals that are vigorously pursuing leadership positions in global technology markets. In industries that stand at the heart of the knowledge economy—life sciences, genomics, and wireless communications—the administration is on a counterproductive trajectory that overlooks the business realities of technology markets and threatens to push capital away from the entrepreneurs that drive a robust innovation ecosystem. It is time to reverse course.
U.S. and European competition laws diverge in numerous ways that have important real-world effects. Understanding these differences is vital, particularly as lawmakers in the United States, and the rest of the world, consider adopting a more “European” approach to competition.
In broad terms, the European approach is more centralized and political. The European Commission’s Directorate General for Competition (DG Comp) has significant de facto discretion over how the law is enforced. This contrasts with the common law approach of the United States, in which courts elaborate upon open-ended statutes through an iterative process of case law. In other words, the European system was built from the top down, while U.S. antitrust relies on a bottom-up approach, derived from arguments made by litigants (including the government antitrust agencies) and defendants (usually businesses).
This procedural divergence has significant ramifications for substantive law. European competition law includes more provisions akin to de facto regulation. This is notably the case for the “abuse of dominance” standard, in which a “dominant” business can be prosecuted for “abusing” its position by charging high prices or refusing to deal with competitors. By contrast, the U.S. system places more emphasis on actual consumer outcomes, rather than the nature or “fairness” of an underlying practice.
The American system thus affords firms more leeway to exclude their rivals, so long as this entails superior benefits for consumers. This may make the U.S. system more hospitable to innovation, since there is no built-in regulation of conduct for innovators who acquire a successful market position fairly and through normal competition.
In this post, we discuss some key differences between the two systems—including in areas like predatory pricing and refusals to deal—as well as the discretionary power the European Commission enjoys under the European model.
Exploitative Abuses
U.S. antitrust is, by and large, unconcerned with companies charging what some might consider “excessive” prices. The late Associate Justice Antonin Scalia, writing for the Supreme Court majority in the 2003 case Verizon v. Trinko, observed that:
The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices—at least for a short period—is what attracts “business acumen” in the first place; it induces risk taking that produces innovation and economic growth.
This contrasts with European competition-law cases, where firms may be found to have infringed competition law because they charged excessive prices. As the European Court of Justice (ECJ) held in 1978’s United Brands case: “In this case charging a price which is excessive because it has no reasonable relation to the economic value of the product supplied would be such an abuse.”
While United Brands was the EU’s foundational case for excessive pricing, and the European Commission reiterated that these allegedly exploitative abuses were possible when it published its guidance paper on abuse of dominance cases in 2009, the commission had for some time demonstrated apparent disinterest in bringing such cases. In recent years, however, both the European Commission and some national authorities have shown renewed interest in excessive-pricing cases, most notably in the pharmaceutical sector.
European competition law also penalizes so-called “margin squeeze” abuses, in which a dominant upstream supplier charges a price to distributors that is too high for them to compete effectively with that same dominant firm downstream:
[I]t is for the referring court to examine, in essence, whether the pricing practice introduced by TeliaSonera is unfair in so far as it squeezes the margins of its competitors on the retail market for broadband connection services to end users. (Konkurrensverket v TeliaSonera Sverige, 2011)
As Scalia observed in Trinko, forcing firms to charge prices that are below a market’s natural equilibrium affects firms’ incentives to enter markets, notably with innovative products and more efficient means of production. But the problem is not just one of market entry and innovation. Also relevant is the degree to which competition authorities are competent to determine the “right” prices or margins.
As Friedrich Hayek demonstrated in his influential 1945 essay The Use of Knowledge in Society, economic agents use information gleaned from prices to guide their business decisions. It is this distributed activity of thousands or millions of economic actors that enables markets to put resources to their most valuable uses, thereby leading to more efficient societies. By comparison, the efforts of central regulators to set prices and margins is necessarily inferior; there is simply no reasonable way for competition regulators to make such judgments in a consistent and reliable manner.
Given the substantial risk that investigations into purportedly excessive prices will deter market entry, such investigations should be circumscribed. But the court’s precedents, with their myopic focus on ex post prices, do not impose such constraints on the commission. The temptation to “correct” high prices—especially in the politically contentious pharmaceutical industry—may thus induce economically unjustified and ultimately deleterious intervention.
Monopolists must charge prices that are below some measure of their incremental costs; and
There must be a realistic prospect that they will able to recoup these initial losses.
In laying out its approach to predatory pricing, the U.S. Supreme Court has identified the risk of false positives and the clear cost of such errors to consumers. It thus has particularly stressed the importance of the recoupment requirement. As the court found in 1993’s Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., without recoupment, “predatory pricing produces lower aggregate prices in the market, and consumer welfare is enhanced.”
Accordingly, U.S. authorities must prove that there are constraints that prevent rival firms from entering the market after the predation scheme, or that the scheme itself would effectively foreclose rivals from entering the market in the first place. Otherwise, the predator would be undercut by competitors as soon as it attempts to recoup its losses by charging supra-competitive prices.
Without the strong likelihood that a monopolist will be able to recoup lost revenue from underpricing, the overwhelming weight of economic evidence (to say nothing of simple logic) is that predatory pricing is not a rational business strategy. Thus, apparent cases of predatory pricing are most likely not, in fact, predatory; deterring or punishing them would actually harm consumers.
By contrast, the EU employs a more expansive legal standard to define predatory pricing, and almost certainly risks injuring consumers as a result. Authorities must prove only that a company has charged a price below its average variable cost, in which case its behavior is presumed to be predatory. Even when a firm charges prices that are between its average variable and average total cost, it can be found guilty of predatory pricing if authorities show that its behavior was part of a plan to eliminate a competitor. Most significantly, in neither case is it necessary for authorities to show that the scheme would allow the monopolist to recoup its losses.
[I]t does not follow from the case‑law of the Court that proof of the possibility of recoupment of losses suffered by the application, by an undertaking in a dominant position, of prices lower than a certain level of costs constitutes a necessary precondition to establishing that such a pricing policy is abusive. (France Télécom v Commission, 2009).
This aspect of the legal standard has no basis in economic theory or evidence—not even in the “strategic” economic theory that arguably challenges the dominant Chicago School understanding of predatory pricing. Indeed, strategic predatory pricing still requires some form of recoupment, and the refutation of any convincing business justification offered in response. For example, in a 2017 piece for the Antitrust Law Journal, Steven Salop lays out the “raising rivals’ costs” analysis of predation and notes that recoupment still occurs, just at the same time as predation:
[T]he anticompetitive conditional pricing practice does not involve discrete predatory and recoupment periods, as in the case of classical predatory pricing. Instead, the recoupment occurs simultaneously with the conduct. This is because the monopolist is able to maintain its current monopoly power through the exclusionary conduct.
The case of predatory pricing illustrates a crucial distinction between European and American competition law. The recoupment requirement embodied in American antitrust law serves to differentiate aggressive pricing behavior that improves consumer welfare—because it leads to overall price decreases—from predatory pricing that reduces welfare with higher prices. It is, in other words, entirely focused on the welfare of consumers.
The European approach, by contrast, reflects structuralist considerations far removed from a concern for consumer welfare. Its underlying fear is that dominant companies could use aggressive pricing to engender more concentrated markets. It is simply presumed that these more concentrated markets are invariably detrimental to consumers. Both the Tetra Pak and France Télécom cases offer clear illustrations of the ECJ’s reasoning on this point:
[I]t would not be appropriate, in the circumstances of the present case, to require in addition proof that Tetra Pak had a realistic chance of recouping its losses. It must be possible to penalize predatory pricing whenever there is a risk that competitors will be eliminated… The aim pursued, which is to maintain undistorted competition, rules out waiting until such a strategy leads to the actual elimination of competitors. (Tetra Pak v Commission, 1996).
Similarly:
[T]he lack of any possibility of recoupment of losses is not sufficient to prevent the undertaking concerned reinforcing its dominant position, in particular, following the withdrawal from the market of one or a number of its competitors, so that the degree of competition existing on the market, already weakened precisely because of the presence of the undertaking concerned, is further reduced and customers suffer loss as a result of the limitation of the choices available to them. (France Télécom v Commission, 2009).
In short, the European approach leaves less room to analyze the concrete effects of a given pricing scheme, leaving it more prone to false positives than the U.S. standard explicated in the Brooke Group decision. Worse still, the European approach ignores not only the benefits that consumers may derive from lower prices, but also the chilling effect that broad predatory pricing standards may exert on firms that would otherwise seek to use aggressive pricing schemes to attract consumers.
Refusals to Deal
U.S. and EU antitrust law also differ greatly when it comes to refusals to deal. While the United States has limited the ability of either enforcement authorities or rivals to bring such cases, EU competition law sets a far lower threshold for liability.
As Justice Scalia wrote in Trinko:
Aspen Skiing is at or near the outer boundary of §2 liability. The Court there found significance in the defendant’s decision to cease participation in a cooperative venture. The unilateral termination of a voluntary (and thus presumably profitable) course of dealing suggested a willingness to forsake short-term profits to achieve an anticompetitive end. (Verizon v Trinko, 2003.)
This highlights two key features of American antitrust law with regard to refusals to deal. To start, U.S. antitrust law generally does not apply the “essential facilities” doctrine.Accordingly, in the absence of exceptional facts, upstream monopolists are rarely required to supply their product to downstream rivals, even if that supply is “essential” for effective competition in the downstream market. Moreover, as Justice Scalia observed in Trinko, the Aspen Skiing case appears to concern only those limited instances where a firm’s refusal to deal stems from the termination of a preexisting and profitable business relationship.
While even this is not likely the economically appropriate limitation on liability, its impetus—ensuring that liability is found only in situations where procompetitive explanations for the challenged conduct are unlikely—is completely appropriate for a regime concerned with minimizing the cost to consumers of erroneous enforcement decisions.
As in most areas of antitrust policy, EU competition law is much more interventionist. Refusals to deal are a central theme of EU enforcement efforts, and there is a relatively low threshold for liability.
In theory, for a refusal to deal to infringe EU competition law, it must meet a set of fairly stringent conditions: the input must be indispensable, the refusal must eliminate all competition in the downstream market, and there must not be objective reasons that justify the refusal. Moreover, if the refusal to deal involves intellectual property, it must also prevent the appearance of a new good.
In practice, however, all of these conditions have been relaxed significantly by EU courts and the commission’s decisional practice. This is best evidenced by the lower court’s Microsoft ruling where, as John Vickers notes:
[T]he Court found easily in favor of the Commission on the IMS Health criteria, which it interpreted surprisingly elastically, and without relying on the special factors emphasized by the Commission. For example, to meet the “new product” condition it was unnecessary to identify a particular new product… thwarted by the refusal to supply but sufficient merely to show limitation of technical development in terms of less incentive for competitors to innovate.
EU competition law thus shows far less concern for its potential chilling effect on firms’ investments than does U.S. antitrust law.
Vertical Restraints
There are vast differences between U.S. and EU competition law relating to vertical restraints—that is, contractual restraints between firms that operate at different levels of the production process.
On the one hand, since the Supreme Court’s Leegin ruling in 2006, even price-related vertical restraints (such as resale price maintenance (RPM), under which a manufacturer can stipulate the prices at which retailers must sell its products) are assessed under the rule of reason in the United States. Some commentators have gone so far as to say that, in practice, U.S. case law on RPM almost amounts to per se legality.
Furthermore, in the Consten and Grundig ruling, the ECJ rejected the consequentialist, and economically grounded, principle that inter-brand competition is the appropriate framework to assess vertical restraints:
Although competition between producers is generally more noticeable than that between distributors of products of the same make, it does not thereby follow that an agreement tending to restrict the latter kind of competition should escape the prohibition of Article 85(1) merely because it might increase the former. (Consten SARL & Grundig-Verkaufs-GMBH v. Commission of the European Economic Community, 1966).
This treatment of vertical restrictions flies in the face of longstanding mainstream economic analysis of the subject. As Patrick Rey and Jean Tirole conclude:
Another major contribution of the earlier literature on vertical restraints is to have shown that per se illegality of such restraints has no economic foundations.
Unlike the EU, the U.S. Supreme Court in Leegintook account of the weight of the economic literature, and changed its approach to RPM to ensure that the law no longer simply precluded its arguable consumer benefits, writing: “Though each side of the debate can find sources to support its position, it suffices to say here that economics literature is replete with procompetitive justifications for a manufacturer’s use of resale price maintenance.” Further, the court found that the prior approach to resale price maintenance restraints “hinders competition and consumer welfare because manufacturers are forced to engage in second-best alternatives and because consumers are required to shoulder the increased expense of the inferior practices.”
The EU’s continued per se treatment of RPM, by contrast, strongly reflects its “precautionary principle” approach to antitrust. European regulators and courts readily condemn conduct that could conceivably injure consumers, even where such injury is, according to the best economic understanding, exceedingly unlikely. The U.S. approach, which rests on likelihood rather than mere possibility, is far less likely to condemn beneficial conduct erroneously.
Political Discretion in European Competition Law
EU competition law lacks a coherent analytical framework like that found in U.S. law’s reliance on the consumer welfare standard. The EU process is driven by a number of laterally equivalent—and sometimes mutually exclusive—goals, including industrial policy and the perceived need to counteract foreign state ownership and subsidies. Such a wide array of conflicting aims produces lack of clarity for firms seeking to conduct business. Moreover, the discretion that attends this fluid arrangement of goals yields an even larger problem.
The Microsoft case illustrates this problem well. In Microsoft, the commission could have chosen to base its decision on various potential objectives. It notably chose to base its findings on the fact that Microsoft’s behavior reduced “consumer choice.”
The commission, in fact, discounted arguments that economic efficiency may lead to consumer welfare gains, because it determined “consumer choice” among media players was more important:
Another argument relating to reduced transaction costs consists in saying that the economies made by a tied sale of two products saves resources otherwise spent for maintaining a separate distribution system for the second product. These economies would then be passed on to customers who could save costs related to a second purchasing act, including selection and installation of the product. Irrespective of the accuracy of the assumption that distributive efficiency gains are necessarily passed on to consumers, such savings cannot possibly outweigh the distortion of competition in this case. This is because distribution costs in software licensing are insignificant; a copy of a software programme can be duplicated and distributed at no substantial effort. In contrast, the importance of consumer choice and innovation regarding applications such as media players is high. (Commission Decision No. COMP. 37792 (Microsoft)).
It may be true that tying the products in question was unnecessary. But merely dismissing this decision because distribution costs are near-zero is hardly an analytically satisfactory response. There are many more costs involved in creating and distributing complementary software than those associated with hosting and downloading. The commission also simply asserts that consumer choice among some arbitrary number of competing products is necessarily a benefit. This, too, is not necessarily true, and the decision’s implication that any marginal increase in choice is more valuable than any gains from product design or innovation is analytically incoherent.
The Court of First Instance was only too happy to give the commission a pass in its breezy analysis; it saw no objection to these findings. With little substantive reasoning to support its findings, the court fully endorsed the commission’s assessment:
As the Commission correctly observes (see paragraph 1130 above), by such an argument Microsoft is in fact claiming that the integration of Windows Media Player in Windows and the marketing of Windows in that form alone lead to the de facto standardisation of the Windows Media Player platform, which has beneficial effects on the market. Although, generally, standardisation may effectively present certain advantages, it cannot be allowed to be imposed unilaterally by an undertaking in a dominant position by means of tying.
The Court further notes that it cannot be ruled out that third parties will not want the de facto standardisation advocated by Microsoft but will prefer it if different platforms continue to compete, on the ground that that will stimulate innovation between the various platforms. (Microsoft Corp. v Commission, 2007)
Pointing to these conflicting effects of Microsoft’s bundling decision, without weighing either, is a weak basis to uphold the commission’s decision that consumer choice outweighs the benefits of standardization. Moreover, actions undertaken by other firms to enhance consumer choice at the expense of standardization are, on these terms, potentially just as problematic. The dividing line becomes solely which theory the commission prefers to pursue.
What such a practice does is vest the commission with immense discretionary power. Any given case sets up a “heads, I win; tails, you lose” situation in which defendants are easily outflanked by a commission that can change the rules of its analysis as it sees fit. Defendants can play only the cards that they are dealt. Accordingly, Microsoft could not successfully challenge a conclusion that its behavior harmed consumers’ choice by arguing that it improved consumer welfare, on net.
By selecting, in this instance, “consumer choice” as the standard to be judged, the commission was able to evade the constraints that might have been imposed by a more robust welfare standard. Thus, the commission can essentially pick and choose the objectives that best serve its interests in each case. This vastly enlarges the scope of potential antitrust liability, while also substantially decreasing the ability of firms to predict when their behavior may be viewed as problematic. It leads to what, in U.S. courts, would be regarded as an untenable risk of false positives that chill innovative behavior and create nearly unwinnable battles for targeted firms.
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.
Economist Josh Hendrickson asserts that the Jones Act is properly understood as a Coasean bargain. In this view, the law serves as a subsidy to the U.S. maritime industry through its restriction of waterborne domestic commerce to vessels that are constructed in U.S. shipyards, U.S.-flagged, and U.S.-crewed. Such protectionism, it is argued, provides the government with ready access to these assets, rather than taking precious time to build them up during times of conflict.
We are skeptical of this characterization.
Although there is an implicit bargain behind the Jones Act, its relationship to the work of Ronald Coase is unclear. Coase is best known for his theorem on the use of bargains and exchanges to reduce negative externalities. But the negative externality is that the Jones Act attempts to address is not apparent. While it may be more efficient or effective than the government building up its own shipbuilding, vessels, and crew in times of war, that’s rather different than addressing an externality. The Jones Act may reflect an implied exchange between the domestic maritime industry and government, but there does not appear to be anything particularly Coasean about it.
Rather, close scrutiny reveals this arrangement between government and industry to be a textbook example of policy failure and rent-seeking run amok. The Jones Act is not a bargain, but a rip-off, with costs and benefits completely out of balance.
The Jones Act and National Defense
For all of the talk of the Jones Act’s critical role in national security, its contributions underwhelm. Ships offer a case in point. In times of conflict, the U.S. military’s primary sources of transport are not Jones Act vessels but government-owned ships in the Military Sealift Command and Ready Reserve Force fleets. These are further supplemented by the 60 non-Jones Act U.S.-flag commercial ships enrolled in the Maritime Security Program, a subsidy arrangement by which ships are provided $5 million per year in exchange for the government’s right to use them in time of need.
In contrast, Jones Act ships are used only sparingly. That’s understandable, as removing these vessels from domestic trade would leave a void in the country’s transportation needs not easily filled.
The law’s contributions to domestic shipbuilding are similarly meager. if not outright counterproductive. A mere two to three large, oceangoing commercial ships are delivered by U.S. shipyards per year. That’s not per shipyard, but all U.S. shipyards combined.
Given the vastly uncompetitive state of domestic shipbuilding—a predictable consequence of handing the industry a captive domestic market via the Jones Act’s U.S.-built requirement—there is a little appetite for what these shipyards produce. As Hendrickson himself points out, the domestic build provision serves to “discourage shipbuilders from innovating and otherwise pursuing cost-saving production methods since American shipbuilders do not face international competition.” We could not agree more.
What keeps U.S. shipyards active and available to meet the military’s needs is not work for the Jones Act commercial fleet but rather government orders. A 2015 Maritime Administration report found that such business accounts for 70 percent of revenue for the shipbuilding and repair industry. A 2019 American Enterprise Institute study concluded that, among U.S. shipbuilders that construct both commercial and military ships, Jones Act vessels accounted for less than 5 percent of all shipbuilding orders.
If the Jones Act makes any contributions of note at all, it is mariners. Of those needed to crew surge sealift ships during times of war, the Jones Act fleet is estimated to account for 29 percent. But here the Jones Act also acts as a double-edged sword. By increasing the cost of ships to four to five times the world price, the law’s U.S.-built requirement results in a smaller fleet with fewer mariners employed than would otherwise be the case. That’s particularly noteworthy given government calculations that there is a deficit of roughly 1,800 mariners to crew its fleet in the event of a sustained sealift operation.
Beyond its ruinous impact on the competitiveness of domestic shipbuilding, the Jones Act has had other deleterious consequences for national security. The increased cost of waterborne transport, or its outright impossibility in the case of liquefied natural gas and propane, results in reduced self-reliance for critical energy supplies. This is a sufficiently significant issue that members of the National Security Council unsuccessfully sought a long-term Jones Act waiver in 2019. The law also means fewer redundancies and less flexibility in the country’s transportation system when responding to crises, both natural and manmade. Waivers of the Jones Act can be issued, but this highly politicized process eats up precious days when time is of the essence. All of these factors merit consideration in the overall national security calculus.
To review, the Jones Act’s opaque and implicit subsidy—doled out via protectionism—results in anemic and uncompetitive shipbuilding, few ships available in time of war, and fewer mariners than would otherwise be the case without its U.S.-built requirement. And it has other consequences for national security that are not only underwhelming but plainly negative. Little wonder that Hendrickson concedes it is unclear whether U.S. maritime policy—of which the Jones Act plays a foundational role—achieves its national security goals.
The toll exacted in exchange for the Jones Act’s limited benefits, meanwhile, is considerable. According to a 2019 OECD study, the law’s repeal would increase domestic value added by $19-$64 billion. Incredibly, that estimate may actually understate matters. Not included in this estimate are related costs such as environmental degradation, increased congestion and highway maintenance, and retaliation from U.S. trade partners during free-trade agreement negotiations due to U.S. unwillingness to liberalize the Jones Act.
Against such critiques, Hendrickson posits that substantial cost savings are illusory due to immigration and other U.S. laws. But how big a barrier such laws would pose is unclear. It’s worth considering, for example, that cruise ships with foreign crews are able to visit multiple U.S. ports so long as a foreign port is also included on the voyage. The granting of Jones Act waivers, meanwhile, has enabled foreign ships to transport cargo between U.S. ports in the past despite U.S. immigration laws.
Would Chinese-flagged and crewed barges be able to engage in purely domestic trade on the Mississippi River absent the Jones Act? Almost certainly not. But it seems perfectly plausible that foreign ships already sailing between U.S. ports as part of international voyages—a frequent occurrence—could engage in cabotage movements without hiring U.S. crews. Take, for example, APL’s Eagle Express X route that stops in Los Angeles, Honolulu, and Dutch Harbor as well as Asian ports. Without the Jones Act, it’s reasonable to believe that ships operating on this route could transport goods from Los Angeles to Honolulu before continuing on to foreign destinations.
But if the Jones Act fails to meet U.S. national security benefits while imposing substantial costs, how to explain its continued survival? Hendrickson avers that the law’s longevity reflects its utility. We believe, however, that the answer lies in the application of public choice theory. Simply put, the law’s costs are both opaque and dispersed across the vast expanse of the U.S. economy while its benefits are highly concentrated. The law’s de facto subsidy is also vastly oversupplied, given that the vast majority of vessels under its protection are smaller craft such as tugboats and barges with trivial value to the country’s sealift capability. This has spawned a lobby aggressively dedicated to the Jones Act’s preservation. Washington, D.C. is home to numerousindustrygroupsandlabororganizations that regard the law’s maintenance as critical, but not a single one that views its repeal as a top priority.
It’s instructive in this regard that all four senators from Alaska and Hawaii are strongJonesActsupporters despite their states being disproportionatelyburdened by the law. This seeming oddity is explained by these states also being disproportionately home to maritime interest groups that support the law. In contrast, Jones Act critics Sen. Mike Lee and the late Sen. John McCain both hailed from land-locked states home to few maritime interest groups.
Disagreements, but also Common Ground
For all of our differences with Hendrickson, however, there is substantial common ground. We are in shared agreement that the Jones Act is suboptimal policy, that its ability to achieve its goals is unclear, and that its U.S.-built requirement is particularly ripe for removal. Where our differences lie is mostly in the scale of gains to be realized from the law’s reform or repeal. As such, there is no reason to maintain the failed status quo. The Jones Act should be repealed and replaced with targeted, transparent, and explicit subsidies to meet the country’s sealift needs. Both the country’s economy and national security would be rewarded—richly so, in our opinion—from such policy change.
Chances are, if you have heard of the Jones Act, you probably think it needs to be repealed. That is, at least, the consensus in the economics profession. However, this consensus seems to be driven by an application of the sort of rules of thumb that one picks up from economics courses, rather than an application of economic theory.
For those who are unaware, the Jones Act requires that any shipping between two U.S. ports is carried by a U.S.-built ship with a crew of U.S. citizens that is U.S.-owned and flies the U.S. flag. When those who have memorized some of the rules of thumb in the field of economics hear that description, they immediately think “this is protectionism and protectionism is bad.” It therefore seems obvious that the Jones Act must be bad. After all, based on this description, it seems like it is designed to protect U.S. shipbuilders, U.S. crews, and U.S.-flagged ships from foreign competition.
Critics seize on this narrative. They point to the higher cost of Jones Act ships in comparison to those ships that fly foreign flags and argue that the current law has costs that are astronomical. Based on that type of criticism, the Jones Act seems so obviously costly that one might wonder how it is possible to defend the law in any way.
I reject this criticism. I do not reject this over some minor quibble with the numbers. In true Hendricksonian fashion, I reject this criticism because it gets the underlying economic theory wrong.
Let’s start by thinking about some critical issues in Coasean terms. During peacetime, the U.S. Navy does not need maintain the sort of capacity that it would have during a time of war. It would not be cost-effective to do so. However, the Navy would like to expand its capacity rapidly in the event of a war or other national emergency. To do so, the country needs shipbuilding capacity. Building ships and training crews to operate those ships, however, takes time. This might be time that the Navy does not have. At the very least, this could leave the United States at a significant disadvantage.
Of course, there are ships and crews available in the form of the U.S. Merchant Marine. Thus, there are gains from trade to be had. The government could pay the Merchant Marine to provide sealift during times of war and other national emergencies. However, this compensation scheme is complicated. For example, if the government waits until a war or a national emergency, this could create a holdup problem. Knowing that the government needs the Merchant Marine immediately, the holdup problem could result in the government paying well-above-market prices to obtain these services. On the other hand, the government could simply requisition the ships and draft the crews into service whenever there is a war or national emergency. Knowing that this is a possibility, the Merchant Marine would tend to underinvest in both physical and human capital.
Given these problems, the solution is to agree to terms ahead of time. The Merchant Marine agrees to provide their services to the government during times of war and other national emergencies in exchange for compensation. The way to structure that compensation in order to avoid holdup problems and underinvestment is to provide this compensation in the form of peacetime subsidies.
Thus, the government provides peacetime subsidies in exchange for the services of the Merchant Marine during wartime. This is a straightforward Coasean bargain.
Now, let’s think about the Jones Act. The Jones Act ships are implicitly subsidized because ships that do not meet the law’s criteria are not allowed to engage in port-to-port shipping in the United States. The requirement that these ships need to be U.S.-owned and fly the U.S. flag gives the government the legal authority to call these ships into service. The requirement that the ships are built in the United States is designed to ensure that the ships meet the needs of the U.S. military and to subsidize shipbuilding in the United States. The requirement to use U.S. crews is designed to provide an incentive for the accumulation of the necessary human capital. Since the law restricts ships with these characteristics for port-to-port shipping within the United States, it provides the firms rents to compensate them for their service during wartime and national emergencies.
Critics, of course, are likely to argue that I have a “just so” theory of the Jones Act. In other words, they might argue that I have simply structured an economic narrative around a set of existing facts. Those critics would be wrong for the following reasons.
First, the Jones Act is not some standalone law when it comes to maritime policy. There is a long history in the United States of trying to determine the optimal way to subsidize the maritime industry. Second, if this type of policy is just a protectionist giveaway, then it should be confined to the maritime industry. However, this isn’t true. The United States has a long history of subsidizing transportation that is crucial for use in the military. This includes subsidies for horse-breeding and the airline industry. Finally, critics would have to explain why wasteful maritime policies have been quickly overturned, while the Jones Act continues to survive.
The critics also dramatically overstate the costs of the Jones Act. This is partly because they do not understand the particularities of the law. For example, to estimate the costs, critics often compare the cost of the Jones Act ships to ships that fly a foreign flag and use foreign crews. The argument here is that the repeal of the Jones Act would result in these foreign-flagged ships with foreign crews taking over U.S. port-to-port shipping.
There are two problems with this argument. One, cabotage restrictions do not originate with the Jones Act. Rather, the law clarifies and closes loopholes in previous laws. Second, the use of foreign crews would be a violation of U.S. immigration law. Furthermore, this type of shipping would still be subject to other U.S. laws to which these foreign-flagged ships are not subject today. Given that the overwhelming majority of the cost differential is explained by differences in labor costs, it therefore seems hard to understand from where, exactly, the cost savings of repeal would actually come.
None of this is to say that the Jones Act is the first-best policy or that the law is sufficient to accomplish the military’s goals. In fact, the one thing that critics and advocates of the law seem to agree on is that the law is not sufficient to accomplish the intended goals. My own work implies a need for direct subsidies (or lower tax rates) on the capital used by the maritime industry. However, the critics need to be honest and admit that, even if the law were repealed, the cost savings are nowhere near what they claim. In addition, this wouldn’t be the end of maritime subsidies (in fact, other subsidies already exist). Instead, the Jones Act would likely be replaced by some other form of subsidy to the maritime industry.
Many defense-based arguments of subsidies are dubious. However, in the case of maritime policy, the Coasean bargain is clear.
We can expect a decision very soon from the High Court of Ireland on last summer’s Irish Data Protection Commission (“IDPC”) decision that placed serious impediments in the transfer data across the Atlantic. That decision, coupled with the July 2020 Court of Justice of the European Union (“CJEU”) decision to invalidate the Privacy Shield agreement between the European Union and the United States, has placed the future of transatlantic trade in jeopardy.
In 2015, the EU Schrems decision invalidated the previously longstanding “safe harbor” agreement between the EU and U.S. to ensure data transfers between the two zones complied with EU privacy requirements. The CJEU later invalidated the Privacy Shield agreement that was created in response to Schrems. In its decision, the court reasoned that U.S. foreign intelligence laws like FISA Section 702 and Executive Order 12333—which give the U.S. government broad latitude to surveil data and offer foreign persons few rights to challenge such surveillance—rendered U.S. firms unable to guarantee the privacy protections of EU citizens’ data.
The IDPC’s decision employed the same logic: if U.S. surveillance laws give the government unreviewable power to spy on foreign citizens’ data, then standard contractual clauses—an alternative mechanism for firms for transferring data—are incapable of satisfying the requirements of EU law.
The implications that flow from this are troubling, to say the least. In the worst case, laws like the CLOUD Act could leave a wide swath of U.S. firms practically incapable doing business in the EU. In the slightly less bad case, firms could be forced to completely localize their data and disrupt the economies of scale that flow from being able to process global data in a unified manner. In any case, the costs for compliance will be massive.
But even if the Irish court upholds the IDPC’s decision, there could still be a path forward for the U.S. and EU to preserve transatlantic digital trade. EU Commissioner for Justice Didier Reynders and U.S. Commerce Secretary Gina Raimondo recently issued a joint statement asserting they are “intensifying” negotiations to develop an enhanced successor to the EU-US Privacy Shield agreement. One can hope the talks are both fast and intense.
It seems unlikely that the Irish High Court would simply overturn the IDPC’s ruling. Instead, the IDCP’s decision will likely be upheld, possibly with recommended modifications. But even in that case, there is a process that buys the U.S. and EU a bit more time before any transatlantic trade involving consumer data grinds to a halt.
After considering replies to its draft decision, the IDPC would issue final recommendations on the extent of the data-transfer suspensions it deems necessary. It would then need to harmonize its recommendations with the other EU data-protection authorities. Theoretically, that could occur in a matter of days, but practically speaking, it would more likely occur over weeks or months. Assuming we get a decision from the Irish High Court before the end of April, it puts the likely deadline for suspension of transatlantic data transfers somewhere between June and September.
That’s not great, but it is not an impossible hurdle to overcome and there are temporary fixes the Biden administration could put in place. Two major concerns need to be addressed.
U.S. data collection on EU citizens needs to be proportional to the necessities of intelligence gathering. Currently, the U.S. intelligence agencies have wide latitude to collect a large amount of data.
The ombudsperson the Privacy Shield agreement created to be responsible for administering foreign citizen data requests was not sufficiently insulated from the political process, creating the need for adequate redress by EU citizens.
As Alex Joel recently noted, the Biden administration has ample powers to effect many of these changes through executive action. After all, EO 12333 was itself a creation of the executive branch. Other changes necessary to shape foreign surveillance to be in accord with EU requirements could likewise arise from the executive branch.
Nonetheless, Congress should not take that as a cue for complacency. It is possible that even if the Biden administration acts, the CJEU could find some or all of the measures insufficient. As the Biden team works to put changes in place through executive order, Congress should pursue surveillance reform through legislation.
Theoretically, the above fixes should be possible; there is not much partisan rancor about transatlantic trade as a general matter. But time is short, and this should be a top priority on policymakers’ radars.
(note: edited to clarify that the Irish High Court is not reviewing SCC’s directly and that the CLOUD Act would not impose legal barriers for firms, but practical ones).
In the wake of its departure from the European Union, the United Kingdom will have the opportunity to enter into new free trade agreements (FTAs) with its international trading partners that lower existing tariff and non-tariff barriers. Achieving major welfare-enhancing reductions in trade restrictions will not be easy. Trade negotiations pose significant political sensitivities, such as those arising from the high levels of protection historically granted certain industry sectors, particularly agriculture.
Nevertheless, the political economy of protectionism suggests that, given deepening globalization and the sudden change in U.K. trade relations wrought by Brexit, the outlook for substantial liberalization of U.K. trade has become much brighter. Below, I address some of the key challenges facing U.K. trade negotiators as they seek welfare-enhancing improvements in trade relations and offer a proposal to deal with novel trade distortions in the least protectionist manner.
Two New Challenges Affecting Trade Liberalization
In addition to traditional trade issues, such as tariff levels and industry sector-specific details, U.K, trade negotiators—indeed, trade negotiators from all nations—will have to confront two relatively new and major challenges that are creating several frictions.
First, behind-the-border anticompetitive market distortions (ACMDs) have largely replaced tariffs as the preferred means of protection in many areas. As I explained in a previous post on this site (citing an article by trade-law scholar Shanker Singham and me), existing trade and competition law have not been designed to address the ACMD problem:
[I]nternational trade agreements simply do not reach a variety of anticompetitive welfare-reducing government measures that create de facto trade barriers by favoring domestic interests over foreign competitors. Moreover, many of these restraints are not in place to discriminate against foreign entities, but rather exist to promote certain favored firms. We dub these restrictions “anticompetitive market distortions” or “ACMDs,” in that they involve government actions that empower certain private interests to obtain or retain artificial competitive advantages over their rivals, be they foreign or domestic. ACMDs are often a manifestation of cronyism, by which politically-connected enterprises successfully pressure government to shield them from effective competition, to the detriment of overall economic growth and welfare. …
As we emphasize in our article, existing international trade rules have been able to reach ACMDs, which include: (1) governmental restraints that distort markets and lessen competition; and (2) anticompetitive private arrangements that are backed by government actions, have substantial effects on trade outside the jurisdiction that imposes the restrictions, and are not readily susceptible to domestic competition law challenge. Among the most pernicious ACMDs are those that artificially alter the cost-base as between competing firms. Such cost changes will have large and immediate effects on market shares, and therefore on international trade flows.
Second, in recent years, the trade remit has expanded to include “nontraditional” issues such as labor, the environment, and now climate change. These concerns have generated support for novel tariffs that could help promote protectionism and harmful trade distortions. As explained in a recent article by the Special Trade Commission advisory group (former senior trade and antitrust officials who have provided independent policy advice to the U.K. government):
[The rise of nontraditional trade issues] has renewed calls for border tax adjustments or dual tariffs on an ex-ante basis. This is in sharp tension with the W[orld Trade Organization’s] long-standing principle of technological neutrality, and focus on outcomes as opposed to discriminating on the basis of the manner of production of the product. The problem is that it is too easy to hide protectionist impulses into concerns about the manner of production, and once a different tariff applies, it will be very difficult to remove. The result will be to significantly damage the liberalisation process itself leading to severe harm to the global economy at a critical time as we recover from Covid-19. The potentially damaging effects of ex ante tariffs will be visited most significantly in developing countries.
Dealing with New Trade Challenges in the Least Protectionist Manner
A broad approach to U.K. trade liberalization that also addresses the two new trade challenges is advanced in a March 2 report by the U.K. government’s Trade and Agricultural Commission (TAC, an independent advisory agency established in 2020). Although addressed primarily to agricultural trade, the TAC report enunciates principles applicable to U.K. trade policy in general, considering the impact of ACMDs and nontraditional issues. Key aspects of the TAC report are summarized in an article by Shanker Singham (the scholar who organized and convened the Special Trade Commission and who also served as a TAC commissioner):
The heart of the TAC report’s import policy contains an innovative proposal that attempts to simultaneously promote a trade liberalising agenda in agriculture, while at the same time protecting the UK’s high standards in food production and ensuring the UK fully complies with WTO rules on animal and plant health, as well as technical regulations that apply to food trade.
This proposal includes a mechanism to deal with some of the most difficult issues in agricultural trade which relate to animal welfare, environment and labour rules. The heart of this mechanism is the potential for the application of a tariff in cases where an aggrieved party can show that a trading partner is violating agreed standards in an FTA.
The result of the mechanism is a tariff based on the scale of the distortion which operates like a trade remedy. The mechanism can also be used offensively where a country is preventing market access by the UK as a result of the market distortion, or defensively where a distortion in a foreign market leads to excess exports from that market. …
[T]he tariff would be calibrated to the scale of the distortion and would apply only to the product category in which the distortion is occurring. The advantage of this over a more conventional trade remedy is that it is based on cost as opposed to price and is designed to remove the effects of the distorting activity. It would not be applied on a retaliatory basis in other unrelated sectors.
In exchange for this mechanism, the UK commits to trade liberalisation and, within a reasonable timeframe, zero tariffs and zero quotas. This in turn will make the UK’s advocacy of higher standards in international organisations much more credible, another core TAC proposal.
The TAC report also notes that behind the border barriers and anti-competitive market distortions (“ACMDs”) have the capacity to damage UK exports and therefore suggests a similar mechanism or set of disciplines could be used offensively. Certainly, where the ACMD is being used to protect a particular domestic industry, using the ACMD mechanism to apply a tariff for the exports of that industry would help, but this may not apply where the purpose is protective, and the industry does not export much.
I would argue that in this case, it would be important to ensure that UK FTAs include disciplines on these ACMDs which if breached could lead to dispute settlement and the potential for retaliatory tariffs for sectors in the UK’s FTA partner that do export. This is certainly normal WTO-sanctioned practice, and could be used here to encourage compliance. It is clear from the experience in dealing with countries that engage in ACMDs for trade or competition advantage that unless there are robust disciplines, mere hortatory language would accomplish little or nothing.
But this sort of mechanism with its concomitant commitment to freer trade has much wider potential application than just UK agricultural trade policy. It could also be used to solve a number of long standing trade disputes such as the US-China dispute, and indeed the most vexed questions in trade involving environment and climate change in ways that do not undermine the international trading system itself.
This is because the mechanism is based on an ex post tariff as opposed to an ex ante one which contains within it the potential for protectionism, and is prone to abuse. Because the tariff is actually calibrated to the cost advantage which is secured as a result of the violation of agreed international standards, it is much more likely that it will be simply limited to removing this cost advantage as opposed to becoming a punitive measure that curbs ordinary trade flows.
It is precisely this type of problem solving and innovative thinking that the international trading system needs as it faces a range of challenges that threaten liberalisation itself and the hard-won gains of the post war GATT/WTO system itself. The TAC report represents UK leadership that has been sought after since the decision to leave the EU. It has much to commend it.
Assessment and Conclusion
Even when administered by committed free traders, real-world trade liberalization is an exercise in welfare optimization, subject to constraints imposed by the actions of organized interest groups expressed through the political process. The rise of new coalitions (such as organizations committed to specified environmental goals, including limiting global warming) and the proliferation of ADMCs further complicates the trade negotiation calculus.
Fortunately, recognizing the “reform moment” created by Brexit, free trade-oriented experts (in particular, the TAC, supported by the Special Trade Commission) have recommended that the United Kingdom pursue a bold move toward zero tariffs and quotas. Narrow exceptions to this policy would involve after-the-fact tariffications to offset (1) the distortive effects of ACMDs and (2) derogation from rules embodying nontraditional concerns, such as environmental commitments. Such tariffications would be limited and cost-based, and, as such, welfare-superior to ex ante tariffs calibrated to price.
While the details need to be worked out, the general outlines of this approach represent a thoughtful and commendable market-oriented effort to secure substantial U.K. trade liberalization, subject to unavoidable constraints. More generally, one would hope that other jurisdictions (including the United States) take favorable note of this development as they generate their own trade negotiation policies. Stay tuned.
[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.
This post is authored by Eline Chivot, (Senior Policy Analyst, Center for Data Innovation, Information Technology and Innovation Foundation.).]
As the COVID-19 outbreak led to the shutdown of many stores, e-commerce and brick-and-mortar shops have been stepping up efforts to facilitate online deliveries while ensuring their workers’ safety. Without online retail, lockdown conditions would have been less tolerable, and confinement measures less sustainable. Yet a recent French court’s ruling on Amazon seems to be a justification for making life more difficult for some of these businesses and more inconvenient for people by limiting consumer choice. But in a context that calls for as much support to economic activity and consumer welfare as possible, that makes little sense. In fact, the court’s decision is symptomatic of how countries use industrial policy to treat certain companies with double standards.
On April 24, Amazon lost its appeal of a French court order requiring the platform to stop delivering “non-essential items” until it evaluates workers’ risk of coronavirus exposure in its six French warehouses. The online retailer is now facing penalties of about 100,000 euros (about $110,000) per delivery, and was given 48 hours to reduce its warehouse activities and operations.
But the complexity of logistics would make it difficult to adjust and limit deliveries to just “essential items.” Given the novelty of the situation, there were no official, precise, and pre-determined lists in place, nor was there clarity about who gets to decide, nor was there a common understanding of what customers would consider essential services or goods. As a result, Amazon temporarily closed its six French distribution centers, and is now shipping to its French customers from its warehouses in other European countries. If France wants to apply such measure for worker safety in this time of crisis, that’s clearly its right. But the requirement should apply to all online retailers equally, not just to the American company Amazon.
The court’s decision was made on the grounds that Amazon had not implemented sufficient safety measures for its workers. The turnaround last week of trade unions (who had initiated the complaints against Amazon and called for the shutdown of its facilities) and their proposition to “gradually” resume operations speak volume. Like many other companies, Amazon had invested in additional safety measures for its employees during the crisis, distributed masks and gloves to its workers, had taken their temperatures before their shifts, had built testing capacity, and proactively decided to prioritize the delivery of essential goods. Like many other companies, Amazon had to rapidly cope with unprecedented circumstances it wasn’t prepared to handle, while having to juggle a surge in online orders during lockdowns and make do with some governments’ unclear guidance regarding safety measures.
But France has long prioritized worker welfare over broad economic welfare—which includes worker welfare, but also consumer welfare and economic growth. Yet, in this case, that prioritization seems to only apply to Amazon. French retailers like Fnac, Cdiscount, Spartoo, and La Redoute did not face the same degree of judicial scrutiny despite similar complaints about distribution centers. Nor did they have to restrict their deliveries to “essential goods.” But in France, it seems, what is good for French geese isn’t good for U.S. ganders. In fact, the real issue appears to be the French application of industrial policy. According to a union representative of Fnac, this is about “preventing Amazon from gaining market share over French retailers during lockdown,” so that the latter can reap the benefits. Using the crisis as an excuse to restructure the French retail sector is certainly one creative application of industrial policy.
Moreover, by applying these restrictions (either just to Amazon or across all retailers who engage in e-commerce), the French government is deepening the economic crisis. The restrictions it has imposed on Amazon are likely to accentuate the losses many French small- and medium-sized companies are already facing because of the COVID-19 crisis, while also having longer-term negative consequences for its logistics network in France. Many such firms rely on Amazon’s platform to sell, ship, and develop their business, and now have to turn to more expensive delivery services. In addition, the reduction in activity by its distribution centers could force Amazon to furlough many of its 9,300 French workers.
According to the unions, Amazon’s activity is judged “nonessential to the life of the country.” Never mind that Amazon partners with French retailers like Casino and is rescuing brands like Deliveroo during the crisis. In addition, online companies like Amazon, HelloFresh and Instacarthired more workers to manage growing demands during the crisis, while others had to furlough or layoff their staff. Beyond, French brands will need economically robust allies like Amazon to compete with Chinese state-backed giants like Alibaba that are expanding their footprint in European markets, and that have come under fire for dubious workplace practices.
Finally, the French court’s decision is an inconvenience to the 22.2 million people in France who order via Amazon, depend on efficient home deliveries to cope with strict confinement measures, and are now being told what is essential or not. With Amazon relying on other European warehouses for deliveries and being forced to limit them to items such as IT products, health and nutrition items, food, and pet food, consumers will be faced with delayed deliveries and reduced access to product variety. The court’s decision also hurts many French merchants who use Amazon for warehousing and fulfillment, as they are effectively locked out of accessing their stock.
Non-discrimination is, or least should be, a core principle of rule-of-law nations. It appears that, at least in this case, France does not think it should apply to non-French firms.
[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.
This post is authored by John Newman, Associate Professor, University of Miami School of Law; Advisory Board Member, American Antitrust Institute; Affiliated Fellow, Thurman Arnold Project, Yale; Former Trial Attorney, DOJ Antitrust Division.)]
Cooperation is the basis of productivity. The war of all against all is not a good model for any economy.
Who said it—a rose-emoji Twitter Marxist, or a card-carrying member of the laissez faire Chicago School of economics? If you guessed the latter, you’d be right. Frank Easterbrook penned these words in an antitrust decision written shortly after he left the University of Chicago to become a federal judge. Easterbrook’s opinion, now a textbook staple, wholeheartedly endorsed a cooperative agreement between two business owners not to compete with each another.
But other enforcers and judges have taken a far less favorable view of cooperation—particularly when workers are the ones cooperating. A few years ago, in an increasingly rare example of interagency agreement, the DOJ and FTC teamed up to argue against a Seattle ordinance that would have permitted drivers to cooperatively bargain with Uber and Lyft. Why the hostility from enforcers? “Competition is the lynchpin of the U.S. economy,” explained Acting FTC Chairman Maureen Ohlhausen.
Should workers be able to cooperate to counter concentrated corporate power? Or is bellum omnium contra omnes truly the “lynchpin” of our industrial policy?
The coronavirus pandemic has thrown this question into sharper relief than ever before. Low-income workers—many of them classified as independent contractors—have launched multiple coordinated boycotts in an effort to improve working conditions. The antitrust agencies, once quick to condemn similar actions by Uber and Lyft drivers, have fallen conspicuously silent.
Why? Why should workers be allowed to negotiate cooperatively for a healthier workplace, yet not for a living wage? In a society largely organized around paying for basic social services, money is health—and even life itself.
Unraveling the Double Standard
Antitrust law, like the rest of industrial policy, involves difficult questions over which members of society can cooperate with one another. These laws allocate “coordination rights”. Before the coronavirus pandemic, industrial policy seemed generally to favor allocating these rights to corporations, while simultaneously denying them to workers and class-action plaintiffs. But, as the antitrust agencies’ apparent about-face on workplace organizing suggests, the times may be a-changing.
Some of today’s most existential threats to societal welfare—pandemics, climate change, pollution—will best be addressed via cooperation, not atomistic rivalry. On-the-ground stakeholders certainly seem to think so. Absent a coherent, unified federal policy to deal with the coronavirus pandemic, state governors have reportedly begun to consider cooperating to provide a coordinated regional response. Last year, a group of auto manufacturers voluntarily agreed to increase fuel-efficiency standards and reduce emissions. They did attract an antitrust investigation, but it was subsequently dropped—a triumph for pro-social cooperation. It was perhaps also a reminder that corporations, each of which is itself a cooperative enterprise, can still play the role they were historically assigned: serving the public interest.
Going forward, policy-makers should give careful thought to how their actions and inactions encourage or stifle cooperation. Judge Easterbrook praised an agreement between business owners because it “promoted enterprise”. What counts as legitimate “enterprise”, though, is an eminently contestable proposition.
The federal antitrust agencies’ anti-worker stance in particular seems ripe for revisiting. Its modern origins date back to the 1980s, when President Reagan’s FTC challenged a coordinated boycott among D.C.-area criminal-defense attorneys. The boycott was a strike of sorts, intended to pressure the city into increasing court-appointed fees to a level that would allow for adequate representation. (The mayor’s office, despite being responsible for paying the fees, actually encouraged the boycott.) As the sole buyer of this particular type of service, the government wielded substantial power in the marketplace. A coordinated front was needed to counter it. Nonetheless, the FTC condemned the attorneys’ strike as per se illegal—a label supposedly reserved for the worst possible anticompetitive behavior—and the U.S. Supreme Court ultimately agreed.
Reviving Cooperation
In the short run, the federal antitrust agencies should formally reverse this anti-labor course. When workers cooperate in an attempt to counter employers’ power, antitrust intervention is, at best, a misallocation of scarce agency resources. Surely there are (much) bigger fish to fry. At worst, hostility to such cooperation directly contravenes Congress’ vision for the antitrust laws. These laws were intended to protect workers from concentrated downstream power, not to force their exposure to it—as the federal agencies themselves have recognized elsewhere.
In the longer run, congressional action may be needed. Supreme Court antitrust case law condemning worker coordination should be legislatively overruled. And, in a sharp departure from the current trend, we should be making it easier, not harder, for workers to form cooperative unions. Capital can be combined into a legal corporation in just a few hours, while it takes more than a month to create an effective labor union. None of this is to say that competition should be abandoned—much the opposite, in fact. A market that pits individual workers against highly concentrated cooperative entities is hardly “competitive”.
Thinking more broadly, antitrust and industrial policy may need to allow—or even encourage—cooperation in a number of sectors. Automakers’ and other manufacturers’ voluntary efforts to fight climate change should be lauded and protected, not investigated. Where cooperation is already shielded and even incentivized, as is the case with corporations, affirmative steps may be needed to ensure that the public interest is being furthered.
The current moment is without precedent. Industrial policy is destined, and has already begun, to change. Although competition has its place, it cannot serve as the sole lynchpin for a just economy. Now more than ever, a revival of cooperation is needed.
[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.
At a time when nations are engaged in bidding wars in the worldwide market to alleviate the shortages of critical medical necessities for the Covid-19 crisis, it certainly bares the question, have free trade and competition policies resulting in efficient global integrated market networks gone too far? Did economists and policy makers advocating for efficient competitive markets not foresee a failure of the supply chain in meeting a surge in demand during an inevitable global crisis such as this one?
The failures in securing medical supplies have escalated a global health crisis to geopolitical spats fuelled by strong nationalistic public sentiments. In the process of competing to acquire highly treasured medical equipment, governments are confiscating, outbidding, and diverting shipments at the risk of not adhering to the terms of established free trade agreements and international trading rules, all at the cost of the humanitarian needs of other nations.
Since the start of the Covid-19 crisis, all levels of government in Canada have been working on diversifying the supply chain for critical equipment both domestically and internationally. But, most importantly, these governments are bolstering domestic production and an integrated domestic supply network recognizing the increasing likelihood of tightening borders impacting the movement of critical products.
For the past 3 weeks in his daily briefings, Canada’s Prime Minister, Justin Trudeau, has repeatedly confirmed the Government’s support of domestic enterprises that are switching their manufacturing lines to produce critical medical supplies and of other “made in Canada” products.
As conditions worsen in the US and the White House hardens its position towards collaboration and sharing for the greater global humanitarian good—even in the presence of a recent bilateral agreement to keep the movement of essential goods fluid—Canada’s response has become more retaliatory. Now shifting to a message emphasizing that the need for “made in Canada” products is one of extreme urgency.
On April 3rd, President Trump ordered Minnesota-based 3M to stop exporting medical-grade masks to Canada and Latin America; a decision that was enabled by the triggering of the 1950 Defence Production Act. In response, Ontario Premier, Doug Ford, stated in his public address:
Never again in the history of Canada should we ever be beholden to companies around the world for the safety and wellbeing of the people of Canada. There is nothing we can’t build right here in Ontario. As we get these companies round up and we get through this, we can’t be going over to other sources because we’re going to save a nickel.
Premier Ford’s words ring true for many Canadians as they watch this crisis unfold and wonder where would it stop if the crisis worsens? Will our neighbour to the south block shipments of a Covid-19 vaccine when it is developed? Will it extend to other essential goods such as food or medicine?
There are reports that the decline in the number of foreign workers in farming caused by travel restrictions and quarantine rules in both Canada and the US will cause food production shortages, which makes the actions of the White House very unsettling for Canadians. Canada’s exports to the US constitute 75% of total Canadian exports, while imports from the US constitute 46%. Canada’s imports of food and beverages from the US were valued at US $24 billion in 2018 including: prepared foods, fresh vegetables, fresh fruits, other snack foods, and non-alcoholic beverages.
The length and depth of the crisis will determine to what extent the US and Canadian markets will experience shortages in products. For Canada, the severity of the pandemic in the US could result in further restrictions on the border. And it is becoming progressively more likely that it will also result in a significant reduction in the volume of necessities crossing the border between the two nations.
Increasingly, the depth and pain experienced from shortages in necessities will shape public sentiment towards free trade and strengthen mainstream demands of more nationalistic and protectionist policies. This will result in more pressure on political and government establishments to take action.
The reliance on free trade and competition policies favouring highly integrated supply chain networks is showing cracks in meeting national interests in this time of crisis. This goes well beyond the usual economic factors of contention between countries of domestic employment, job loss and resource allocation. The need for correction, however, risks moving the pendulum too far to the side of protectionism.
Free trade setbacks and global integration disruptions would become the new economic reality to ensure that domestic self-sufficiency comes first. A new trade trend has been set in motion and there is no going back from some level of disintegrating globalised supply chain productions.
How would domestic self-sufficiency be achieved?
Would international conglomerates build local plants and forgo their profit maximizing strategies of producing in growing economies that offer cheap wages and resources in order to avoid increased protectionism?
Will the Canada-United States-Mexico Agreement (CUSMA) known as the NEW NAFTA, which until today has not been put into effect, be renegotiated to allow for production measures for securing domestic necessities in the form of higher tariffs, trade quotas, and state subsidies?
Are advanced capitalist economies willing to create State-Owned Industries to produce domestic products for what it deems necessities?
Many other trade policy variations and options focused on protectionism are possible which could lead to the creation of domestic monopolies. Furthermore, any return to protected national production networks will reduce consumer welfare and eventually impede technological advancements that result from competition.
Divergence between free trade agreements and competition policy in a new era of protectionism.
For the past 30 years, national competition laws and policies have increasingly become an integrated part of free trade agreements, albeit in the form of soft competition law language, making references to the parties’ respective competition laws, and the need for transparency, procedural fairness in enforcement, and cooperation.
Similarly, free trade objectives and frameworks have become part of the design and implementation of competition legislation and, subsequently, case law. Both of which are intended to encourage competitive market systems and efficiency, an implied by-product of open markets.
In that regard, the competition legal framework in Canada, the Competition Act, seeks to maintain and strengthen competitive market forces by encouraging maximum efficiency in the use of economic resources. Provisions to determine the level of competitiveness in the market consider barriers to entry, among them, tariff and non-tariff barriers to international trade. These provisions further direct adjudicators to examine free trade agreements currently in force and their role in facilitating the current or future possibility of an international incumbent entering the market to preserve or increase competition. And it goes further to also assess the extent of an increase in the real value of exports, or substitution of domestic products for imported products.
It is evident in the design of free trade agreements and competition legislation that efficiency, competition in price, and diversification of products is to be achieved by access to imported goods and by encouraging the creation of global competitive suppliers.
Therefore, the re-emergence of protectionist nationalistic measures in international trade will result in a divergence between competition laws and free trade agreements. Such setbacks would leave competition enforcers, administrators, and adjudicators grappling with the conflict between the economic principles set out in competition law and the policy objectives that could be stipulated in future trade agreements.
The challenge ahead facing governments and industries is how to correct for the cracks in the current globalized competitive supply networks that have been revealed during this crisis without falling into a trap of nationalism and protectionism.
[TOTM: The following is part of a blog series by TOTM guests and authors on the law, economics, and policy of the ongoing COVID-19 pandemic. The entire series of posts is available here.
This post is authored by Ramsi Woodcock, (Assistant Professor of Law, University of Kentucky; Assistant Professor of Management, Gatton College of Business and Economics).]
Specialists know that the antitrust courses taught in law schools and economics departments have an alter ego in business curricula: the course on business strategy. The two courses cover the same material, but from opposite perspectives. Antitrust courses teach how to end monopolies; strategy courses teach how to construct and maintain them.
Strategy students go off and run businesses, and antitrust students go off and make government policy. That is probably the proper arrangement if the policy the antimonopolists make is domestic. We want the domestic economy to run efficiently, and so we want domestic policymakers to think about monopoly—and its allocative inefficiencies—as something to be discouraged.
The coronavirus, and the shortages it has caused, have shown us that putting the antimonopolists in charge of international policy is, by contrast, a very big mistake.
Because we do not yet have a world government. America’s position, in relation to the rest of the world, is therefore more akin to that of a business navigating a free market than it is to a government seeking to promote efficient interactions among the firms that it governs. To flourish, America must engage in international trade with a view to creating and maintaining monopoly positions for itself, rather than eschewing them in the interest of realizing efficiencies in the global economy. Which is to say: we need strategists, not antimonopolists.
For the global economy is not America, and there is no guarantee that competitive efficiencies will redound to America’s benefit, rather than to those of her competitors. Absent a world government, other countries will pursue monopoly regardless what America does, and unless America acts strategically to build and maintain economic power, America will eventually occupy a position of commercial weakness, with all of the consequences for national security that implies.
When Antimonopolists Make Trade Policy
The free traders who have run American economic policy for more than a generation are antimonopolists playing on a bigger stage. Like their counterparts in domestic policy, they are loyal in the first instance only to the efficiency of the market, not to any particular trader. They are content to establish rules of competitive trading—the antitrust laws in the domestic context, the World Trade Organization in the international context—and then to let the chips fall where they may, even if that means allowing present or future adversaries to, through legitimate means, build up competitive advantages that the United States is unable to overcome.
Strategy is consistent with competition when markets are filled with traders of atomic size, for then no amount of strategy can deliver a competitive advantage to any trader. But global markets, more even than domestic markets, are filled with traders of macroscopic size. Strategy then requires that each trader seek to gain and maintain advantages, undermining competition. The only way antimonopolists could induce the trading behemoth that is America to behave competitively, and to let the chips fall where they may, was to convince America voluntarily to give up strategy, to sacrifice self-interest on the altar of efficient markets.
And so they did.
Thus when the question arose whether to permit American corporations to move their manufacturing operations overseas, or to permit foreign companies to leverage their efficiencies to dominate a domestic industry and ensure that 90% of domestic supply would be imported from overseas, the answer the antimonopolists gave was: “yes.” Because it is efficient. Labor abroad is cheaper than labor at home, and transportation costs low, so efficiency requires that production move overseas, and our own resources be reallocated to more competitive uses.
This is the impeccable logic of static efficiency, of general equilibrium models allocating resources optimally. But it is instructive to recall that themen who perfected this model were not trying to describe a free market, much less international trade. They were trying to create a model that a central planner could use to allocate resources to a state’s subjects. What mattered to them in building the model was the good of the whole, not any particular part. And yet it is to a particular part of the global whole that the United States government is dedicated.
The Strategic Trader
Students of strategy would have taken a very different approach to international trade. Strategy teaches that markets are dynamic, and that businesses must make decisions based not only on the market signals that exist today, but on those that can be made to exist in the future. For the successful strategist, unlike the antimonopolist, identifying a product for which consumers are willing to pay the costs of production is not alone enough to justify bringing the product to market. The strategist must be able to secure a source of supply, or a distribution channel, that competitors cannot easily duplicate, before the strategist will enter.
Why? Because without an advantage in supply, or distribution, competitors will duplicate the product, compete away any markups, and leave the strategist no better off than if he had never undertaken the project at all. Indeed, he may be left bankrupt, if he has sunk costs that competition prevents him from recovering. Unlike the economist, the strategist is interested in survival, because he is a partisan of a part of the market—himself—not the market entire. The strategist understands that survival requires power, and all power rests, to a greater or lesser degree, on monopoly.
The strategist is not therefore a free trader in the international arena, at least not as a matter of principle. The strategist understands that trading from a position of strength can enrich, and trading from a position of weakness can impoverish. And to occupy that position of strength, America must, like any monopolist, control supply. Moreover, in the constantly-innovating markets that characterize industrial economies, markets in which innovation emerges from learning by doing, control over physical supply translates into control over the supply of inventions itself.
The strategist does not permit domestic corporations to offshore manufacturing in any market in which the strategist wishes to participate, because that is unsafe: foreign countries could use control over that supply to extract rents from America, to drive domestic firms to bankruptcy, and to gain control over the supply of inventions.
And, as the new trade theorists belatedly discovered, offshoring prevents the development of the dense, geographically-contiguous, supply networks that confer power over whole product categories, such as the electronics hub in Zhengzhou, where iPhone-maker Foxconn is located.
Today, America is unprepared for the coming wave of coronavirus cases because the antimonopolists running our trade policy do not understand the importance of controlling supply. There is a shortage of masks, because China makes half of the world’s masks, and the Chinese have cut off supply, the state having forbidden even non-Chinese companies that offshored mask production fromshippinghome masks for which American customers have paid. Not only that, but in January China bought up most of the world’s existing supply of masks, with free-trade-obsessed governments standing idly by as the clock ticked down to their own domestic outbreaks.
New York State, which lies at the epicenter of the crisis, has agreed to pay five times the market price for foreign supply. That’s not because the cost of making masks has risen, but because sellers are rationing with price. Which is to say: using their control over supply to beggar the state. Moreover, domestic mask makers report that they cannot ramp up production because of a lack of supply of raw materials, some of which are actually made in Wuhan, China. That’s the kind of problem that does not arise when restrictions on offshoring allow manufacturing hubs to develop domestically.
But a shortage of masks is just the beginning. Once a vaccine is developed, the race will be on to manufacture it, and America controls less than 30% of the manufacturing facilities that supply pharmaceuticals to American markets. Indeed, just about the only virus-relevant industries in which we do not have a real capacity shortage today are food and toilet paper, panic buying notwithstanding. Because fortunately for us antimonopolists could not find a way to offshore California and Oregon. If they could have, they surely would have, since both agriculture and timber are labor-intensive industries.
President Trump’s failed attempt to buy a German drug company working on a coronavirus vaccine shows just how damaging free market ideology has been to national security: as Trump should have anticipated given his resistance to the antimonopolists’ approach to trade, the German government nipped the deal in the bud. When an economic agent has market power, the agent can pick its prices, or refuse to sell at all. Only in general equilibrium fantasy is everything for sale, and at a competitive price to boot.
The trouble is: American policymakers, perhaps more than those in any other part of the world, continue to act as though that fantasy were real.
Failures Left and Right
America’s coronavirus predicament is rich with intellectual irony.
Progressives resist free trade ideology, largely out of concern for the effects of trade on American workers. But they seem not to have realized that in doing so they are actually embracing strategy, at least for the benefit of labor.
As a result, progressives simultaneously reject the approach to industrial organization economics that underpins strategic thinking in business: Joseph Schumpeter’s theory of creative destruction, which holds that strategic behavior by firms seeking to achieve and maintain monopolies is ultimately good for society, because it leads to a technological arms race as firms strive to improve supply, distribution, and indeed product quality, in ways that competitors cannot reproduce.
Even if progressives choose to reject Schumpeter’s argument that strategy makes society better off—a proposition that is particularly suspect at the international level, where the availability of tanks ensures that the creative destruction is not always creative—they have much to learn from his focus on the economics of survival.
By the same token, conservatives embrace Schumpeter in arguing for less antitrust enforcement in domestic markets, all the while advocating free trade at the international level and savaging governments for using dumping and tariffs—which is to say, the tools of monopoly—to strengthen their trading positions. It is deeply peculiar to watch the coronavirus expose conservative economists as pie-in-the-sky internationalists. And yet as the global market for coronavirus necessities seizes up, the ideology that urged us to dispense with producing these goods ourselves, out of faith that we might always somehow rely on the support of the rest of the world, provided through the medium of markets, looks pathetically naive.
The cynic might say that inconsistency has snuck up on both progressives and conservatives because each remains too sympathetic to a different domestic constituency.
Dodging a Bullet
America is lucky that a mere virus exposed the bankruptcy of free trade ideology. Because war could have done that instead. It is difficult to imagine how a country that cannot make medical masks—much less a Macbook—would be able to respond effectively to a sustained military attack from one of the many nations that are closing the technological gap long enjoyed by the United States.
The lesson of the coronavirus is: strategy, not antitrust.
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