The Competition and Antitrust Law Enforcement Reform Act (CALERA), recently introduced in the U.S. Senate, exhibits a remarkable willingness to cast aside decades of evidentiary standards that courts have developed to uphold the rule of law by precluding factually and economically ungrounded applications of antitrust law. Without those safeguards, antitrust enforcement is prone to be driven by a combination of prosecutorial and judicial fiat. That would place at risk the free play of competitive forces that the antitrust laws are designed to protect.
Antitrust law inherently lends itself to the risk of erroneous interpretations of ambiguous evidence. Outside clear cases of interfirm collusion, virtually all conduct that might appear anti-competitive might just as easily be proven, after significant factual inquiry, to be pro-competitive. This fundamental risk of a false diagnosis has guided antitrust case law and regulatory policy since at least the Supreme Court’s landmark Continental Television v. GTE Sylvania decision in 1977 and arguably earlier. Judicial and regulatory efforts to mitigate this ambiguity, while preserving the deterrent power of the antitrust laws, have resulted in the evidentiary requirements that are targeted by the proposed bill.
Proponents of the legislative “reforms” might argue that modern antitrust case law’s careful avoidance of enforcement error yields excessive caution. To relieve regulators and courts from having to do their homework before disrupting a targeted business and its employees, shareholders, customers and suppliers, the proposed bill empowers plaintiffs to allege and courts to “find” anti-competitive conduct without having to be bound to the reasonably objective metrics upon which courts and regulators have relied for decades. That runs the risk of substituting rhetoric and intuition for fact and analysis as the guiding principles of antitrust enforcement and adjudication.
This dismissal of even a rudimentary commitment to rule-of-law principles is illustrated by two dramatic departures from existing case law in the proposed bill. Each constitutes a largely unrestrained “blank check” for regulatory and judicial overreach.
Blank Check #1
The bill includes a broad prohibition on “exclusionary” conduct, which is defined to include any conduct that “materially disadvantages 1 or more actual or potential competitors” and “presents an appreciable risk of harming competition.” That amorphous language arguably enables litigants to target a firm that offers consumers lower prices but “disadvantages” less efficient competitors that cannot match that price.
In fact, the proposed legislation specifically facilitates this litigation strategy by relieving predatory pricing claims from having to show that pricing is below cost or likely to result ultimately in profits for the defendant. While the bill permits a defendant to escape liability by showing sufficiently countervailing “procompetitive benefits,” the onus rests on the defendant to show otherwise. This burden-shifting strategy encourages lagging firms to shift competition from the marketplace to the courthouse.
Blank Check #2
The bill then removes another evidentiary safeguard by relieving plaintiffs from always having to define a relevant market. Rather, it may be sufficient to show that the contested practice gives rise to an “appreciable risk of harming competition … based on the totality of the circumstances.” It is hard to miss the high degree of subjectivity in this standard.
This ambiguous threshold runs counter to antitrust principles that require a credible showing of market power in virtually all cases except horizontal collusion. Those principles make perfect sense. Market power is the gateway concept that enables courts to distinguish between claims that plausibly target alleged harms to competition and those that do not. Without a well-defined market, it is difficult to know whether a particular practice reflects market power or market competition. Removing the market power requirement can remove any meaningful grounds on which a defendant could avoid a nuisance lawsuit or contest or appeal a conclusory allegation or finding of anticompetitive conduct.
The bill’s transparently outcome-driven approach is likely to give rise to a cloud of liability that penalizes businesses that benefit consumers through price and quality combinations that competitors cannot replicate. This obviously runs directly counter to the purpose of the antitrust laws. Certainly, winners can and sometimes do entrench themselves through potentially anticompetitive practices that should be closely scrutinized. However, the proposed legislation seems to reflect a presumption that successful businesses usually win by employing illegitimate tactics, rather than simply being the most efficient firm in the market. Under that assumption, competition law becomes a tool for redoing, rather than enabling, competitive outcomes.
While this populist approach may be popular, it is neither economically sound nor consistent with a market-driven economy in which resources are mostly allocated through pricing mechanisms and government intervention is the exception, not the rule. It would appear that some legislators would like to reverse that presumption. Far from being a victory for consumers, that outcome would constitute a resounding loss.
The slew of recent antitrust cases in the digital, tech, and pharmaceutical industries has brought significant attention to the investments many firms in these industries make in “intangibles,” such as software and research and development (R&D).
Intangibles are recognized to have an important effect on a company’s (and the economy’s) performance. For example, Jonathan Haskel and Stian Westlake (2017) highlight the increasingly large investments companies have been making in things like programming in-house software, organizational structures, and, yes, a firm’s stock of knowledge obtained through R&D. They also note the considerable difficulties associated with valuing both those investments and the outcomes (such as new operational procedures, a new piece of software, or a new patent) of those investments.
This difficulty in valuing intangibles has gone somewhat under the radar until relatively recently. There has been progress in valuing them at the aggregate level (see Ellen R. McGrattan and Edward C. Prescott (2008)) and in examining their effects at the level of individual sectors (see McGrattan (2020)). It remains difficult, however, to ascertain the value of the entire stock of intangibles held by an individual firm.
There is a method to estimate the value of one component of a firm’s stock of intangibles. Specifically, the “stock of knowledge obtained through research and development” is likely to form a large proportion of most firms’ intangibles. Treating R&D as a “stock” might not be the most common way to frame the subject, but it does have an intuitive appeal.
What a firm knows (i.e., its intellectual property) is an input to its production process, just like physical capital. The most direct way for firms to acquire knowledge is to conduct R&D, which adds to its “stock of knowledge,” as represented by its accumulated stock of R&D. In this way, a firm’s accumulated investment in R&D then becomes a stock of R&D that it can use in production of whatever goods and services it wants. Thankfully, there is a relatively straightforward (albeit imperfect) method to measure a firm’s stock of R&D that relies on information obtained from a company’s accounts, along with a few relatively benign assumptions.
This method (set out by Bronwyn Hall (1990, 1993)) uses a firm’s annual expenditures on R&D (a separate line item in most company accounts) in the “perpetual inventory” method to calculate a firm’s stock of R&D in any particular year. This perpetual inventory method is commonly used to estimate a firm’s stock of physical capital, so applying it to obtain an estimate of a firm’s stock of knowledge—i.e., their stock of R&D—should not be controversial.
All this method requires to obtain a firm’s stock of R&D for this year is knowledge of a firm’s R&D stock and its investment in R&D (i.e., its R&D expenditures) last year. This year’s R&D stock is then the sum of those R&D expenditures and its undepreciated R&D stock that is carried forward into this year.
As some R&D expenditure datasets include, for example, wages paid to scientists and research workers, this is not exactly the same as calculating a firm’s physical capital stock, which would only use a firm’s expenditures on physical capital. But given that paying people to perform R&D also adds to a firm’s stock of R&D through the increased knowledge and expertise of their employees, it seems reasonable to include this in a firm’s stock of R&D.
As mentioned previously, this method requires making certain assumptions. In particular, it is necessary to assume a rate of depreciation of the stock of R&D each period. Hall suggests a depreciation of 15% per year (compared to the roughly 7% per year for physical capital), and estimates presented by Hall, along with Wendy Li (2018), suggest that, in some industries, the figure can be as high as 50%, albeit with a wide range across industries.
The other assumption required for this method is an estimate of the firm’s initial level of stock. To see why such an assumption is necessary, suppose that you have data on a firm’s R&D expenditure running from 1990-2016. This means that you can calculate a firm’s stock of R&D for each year once you have their R&D stock in the previous year via the formula above.
When calculating the firm’s R&D stock for 2016, you need to know what their R&D stock was in 2015, while to calculate their R&D stock for 2015 you need to know their R&D stock in 2014, and so on backward until you reach the first year for which you have data: in this, case 1990.
However, working out the firm’s R&D stock in 1990 requires data on the firm’s R&D stock in 1989. The dataset does not contain any information about 1989, nor the firm’s actual stock of R&D in 1990. Hence, it is necessary to make an assumption regarding the firm’s stock of R&D in 1990.
There are several different assumptions one can make regarding this “starting value.” You could assume it is just a very small number. Or you can assume, as per Hall, that it is the firm’s R&D expenditure in 1990 divided by the sum of the R&D depreciation and average growth rates (the latter being taken as 8% per year by Hall). Note that, given the high depreciation rates for the stock of R&D, it turns out that the exact starting value does not matter significantly (particularly in years toward the end of the dataset) if you have a sufficiently long data series. At a 15% depreciation rate, more than 50% of the initial value disappears after five years.
Although there are other methods to measure a firm’s stock of R&D, these tend to provide less information or rely on stronger assumptions than the approach described above does. For example, sometimes a firm’s stock of R&D is measured using a simple count of the number of patents they hold. However, this approach does not take into account the “value” of a patent. Since, by definition, each patent is unique (with differing number of years to run, levels of quality, ability to be challenged or worked around, and so on), it is unlikely to be appropriate to use an “average value of patents sold recently” to value it. At least with the perpetual inventory method described above, a monetary value for a firm’s stock of R&D can be obtained.
The perpetual inventory method also provides a way to calculate market shares of R&D in R&D-intensive industries, which can be used alongside current measures. This would be akin to looking at capacity shares in some manufacturing industries. Of course, using market shares in R&D industries can be fraught with issues, such as whether it is appropriate to use a backward-looking measure to assess competitive constraints in a forward-looking industry. This is why any investigation into such industries should also look, for example, at a firm’s research pipeline.
Naturally, this only provides for the valuation of the R&D stock and says nothing about valuing other intangibles that are likely to play an important role in a much wider range of industries. Nonetheless, this method could provide another means for competition authorities to assess the current and historical state of R&D stocks in industries in which R&D plays an important part. It would be interesting to see what firms’ shares of R&D stocks look like, for example, in the pharmaceutical and tech industries.
In the hands of a wise philosopher-king, the Sherman Act’s hard-to-define prohibitions of “restraints of trade” and “monopolization” are tools that will operate inevitably to advance the public interest in competitive markets. In the hands of real-world litigators, regulators and judges, those same words can operate to advance competitors’ private interests in securing commercial advantages through litigation that could not be secured through competition in the marketplace. If successful, this strategy may yield outcomes that run counter to antitrust law’s very purpose.
The antitrust lawsuit filed by Epic Games against Apple in August 2020, and Apple’s antitrust lawsuit against Qualcomm (settled in April 2019), suggest that antitrust law is heading in this unfortunate direction.
From rent-minimization to rent-maximization
The first step in converting antitrust law from an instrument to minimize rents to an instrument to maximize rents lies in expanding the statute’s field of application on the apparently uncontroversial grounds of advancing the public interest in “vigorous” enforcement. In surprisingly short order, this largely unbounded vision of antitrust’s proper scope has become the dominant fashion in policy discussions, at least as expressed by some legislators, regulators, and commentators.
Following the new conventional wisdom, antitrust law has pursued over the past decades an overly narrow path, consequently overlooking and exacerbating a panoply of social ills that extend well beyond the mission to “merely” protect the operation of the market pricing mechanism. This line of argument is typically coupled with the assertion that courts, regulators and scholars have been led down this path by incumbents that welcome the relaxed scrutiny of a purportedly deferential antitrust policy.
This argument, and related theory of regulatory capture, has things roughly backwards.
Placing antitrust law at the service of a largely undefined range of social purposes set by judicial and regulatory fiat threatens to render antitrust a tool that can be easily deployed to favor the private interests of competitors rather than the public interest in competition. Without the intellectual discipline imposed by the consumer welfare standard (and, outside of per se illegal restraints, operationalized through the evidentiary requirement of competitive harm), the rhetoric of antitrust provides excellent cover for efforts to re-engineer the rules of the game in lieu of seeking to win the game as it has been played.
Epic Games v. Apple
In suggesting that a jury trial would be appropriate in Epic Games’ suit against Apple, the district court judge reportedly stated that the case is “on the frontier of antitrust law” and [i]t is important enough to understand what real people think.” That statement seems to suggest that this is a close case under antitrust law. I respectfully disagree. Based on currently available information and applicable law, Epic’s argument suffers from two serious vulnerabilities that would seem to be difficult for the plaintiff to overcome.
A contestably narrow market definition
Epic states three related claims: (1) Apple has a monopoly in the relevant market, defined as the App Store, (2) Apple maintains its monopoly by contractually precluding developers from distributing iOS-compatible versions of their apps outside the App Store, and (3) Apple maintains a related monopoly in the payment processing services market for the App Store by contractually requiring developers to use Apple’s processing service.
This market definition, and the associated chain of reasoning, is subject to significant doubt, both as a legal and factual matter.
Epic’s narrow definition of the relevant market as the App Store (rather than app distribution platforms generally) conveniently results in a 100% market share for Apple. Inconveniently, federal case law is generally reluctant to adopt single-brand market definitions. While the Supreme Court recognized in 1992 a single-brand market in Eastman Kodak Co. v. Image Technical Services, the case is widely considered to be an outlier in light of subsequent case law. As a federal district court observed in Spahr v.Leegin Creative Leather Products (E.D. Tenn. 2008): “Courts have consistently refused to consider one brand to be a relevant market of its own when the brand competes with other potential substitutes.”
The App Store would seem to fall into this typical category. The customer base of existing and new Fortnite users can still accessthe gamethrough multiple platforms and on multiple devices other than the iPhone, including a PC, laptop, game console, and non-Apple mobile devices. (While Google has also removed Fortnite from the Google Play store due to the added direct payment feature, users can, at some inconvenience, access the game manually on Android phones.)
Given these alternative distribution channels, it is at a minimum unclear whether Epic is foreclosed from reaching a substantial portion of its consumer base, which may already access the game on alternative platforms or could potentially do so at moderate incremental transaction costs. In the language of platform economics, it appears to be technologically and economically feasible for the target consumer base to “multi-home.” If multi-homing and related switching costs are low, even a 100% share of the App Store submarket would not translate into market power in the broader and potentially more economically relevant market for app distribution generally.
An implausible theory of platform lock-in
Even if it were conceded that the App Store is the relevant market, Epic’s claim is not especially persuasive, both as an economic and a legal matter. That is because there is no evidence that Apple is exploiting any such hypothetically attributed market power to increase the rents extracted from developers and indirectly impose deadweight losses on consumers.
In the classic scenario of platform lock-in, a three-step sequence is observed: (1) a new firm acquires a high market share in a race for platform dominance, (2) the platform winner is protected by network effects and switching costs, and (3) the entrenched platform “exploits” consumers by inflating prices (or imposing other adverse terms) to capture monopoly rents. This economic model is reflected in the case law on lock-in claims, which typically requires that the plaintiff identify an adverse change by the defendant in pricing or other terms after users were allegedly locked-in.
The history of the App Store does not conform to this model. Apple has always assessed a 30% fee and the same is true of every other leading distributor of games for the mobile and PC market, including Google Play Store, App Store’s rival in the mobile market, and Steam, the dominant distributor of video games in the PC market. This long-standing market practice suggests that the 30% fee is most likely motivated by an efficiency-driven business motivation, rather than seeking to entrench a monopoly position that Apple did not enjoy when the practice was first adopted. That is: even if Apple is deemed to be a “monopolist” for Section 2 purposes, it is not taking any “illegitimate” actions that could constitute monopolization or attempted monopolization.
The logic of the 70/30 split
Uncovering the business logic behind the 70/30 split in the app distribution market is not too difficult.
The 30% fee appears to be a low transaction-cost practice that enables the distributor to fund a variety of services, including app development tools, marketing support, and security and privacy protections, all of which are supplied at no separately priced fee and therefore do not require service-by-service negotiation and renegotiation. The same rationale credibly applies to the integrated payment processing services that Apple supplies for purposes of in-app purchases.
These services deliver significant value and would otherwise be difficult to replicate cost-effectively, protect the App Store’s valuable stock of brand capital (which yields positive spillovers for app developers on the site), and lower the costs of joining and participating in the App Store. Additionally, the 30% fee cross-subsidizes the delivery of these services to the approximately 80% of apps on the App Store that are ad-based and for which no fee is assessed, which in turn lowers entry costs and expands the number and variety of product options for platform users. These would all seem to be attractive outcomes from a competition policy perspective.
Epic would object to this line of argument by observing that it only charges a 12% fee to distribute other developers’ games on its own Epic Games Store.
Yet Epic’s lower fee is reportedly conditioned, at least in some cases, on the developer offering the game exclusively on the Epic Games Store for a certain period of time. Moreover, the services provided on the Epic Games Store may not be comparable to the extensive suite of services provided on the App Store and other leading distributors that follow the 30% standard. Additionally, the user base a developer can expect to access through the Epic Games Store is in all likelihood substantially smaller than the audience that can be reached through the App Store and other leading app and game distributors, which is then reflected in the higher fees charged by those platforms.
Hence, even the large fee differential may simply reflect the higher services and larger audiences available on the App Store, Google Play Store and other leading platforms, as compared to the Epic Games Store, rather than the unilateral extraction of market rents at developers’ and consumers’ expense.
Antitrust is about efficiency, not distribution
Epic says the standard 70/30 split between game publishers and app distributors is “excessive” while others argue that it is historically outdated.
Neither of these are credible antitrust arguments. Renegotiating the division of economic surplus between game suppliers and distributors is not the concern of antitrust law, which (as properly defined) should only take an interest if either (i) Apple is colluding on the 30% fee with other app distributors, or (ii) Apple is taking steps that preclude entry into the apps distribution market and lack any legitimate business justification. No one claims evidence for the former possibility and, without further evidence, the latter possibility is not especially compelling given the uniform use of the 70/30 split across the industry (which, as noted, can be derived from a related set of credible efficiency justifications). It is even less compelling in the face of evidence that output is rapidly accelerating, not declining, in the gaming app market: in the first half of 2020, approximately 24,500 new games were added to the App Store.
If this conclusion is right, then Epic’s lawsuit against Apple does not seem to have much to do with the public interest in preserving market competition.
Ironically (and, as Dirk Auer has similarly observed), there is a symmetry between Epic’s claims against Apple and the claims previously pursued by Apple (and, concurrently, the Federal Trade Commission) against Qualcomm.
In that litigation, Apple contested the terms of the licensing arrangements under which Qualcomm made available its wireless communications patents to Apple (more precisely, Foxconn, Apple’s contract manufacturer), arguing that the terms were incompatible with Qualcomm’s commitment to “fair, reasonable and nondiscriminatory” (“FRAND”) licensing of its “standard-essential” patents (“SEPs”). Like Epic v. Apple, Apple v. Qualcomm was fundamentally a contract dispute, with the difference that Apple was in the position of a third-party beneficiary of the commitment that Qualcomm had made to the governing standard-setting organization. Like Epic, Apple sought to recharacterize this contractual dispute as an antitrust question, arguing that Qualcomm’s licensing practices constituted anticompetitive actions to “monopolize” the market for smartphone modem chipsets.
Theory meets evidence
The rhetoric used by Epic in its complaint echoes the rhetoric used by Apple in its briefs and other filings in the Qualcomm litigation. Apple (like the FTC) had argued that Qualcomm imposed a “tax” on competitors by requiring that any purchaser of Qualcomm’s chipsets concurrently enter into a license for Qualcomm’s SEP portfolio relating to 3G and 4G/LTE-enabled mobile communications devices.
Yet the history and performance of the mobile communications market simply did not track Apple’s (and the FTC’s continuing) characterization of Qualcomm’s licensing fee as a socially costly drag on market growth and, by implication, consumer welfare.
If this assertion had merit, then the decades-old wireless market should have exhibited a dismal history of increasing prices, slow user adoption and lagging innovation. In actuality, the wireless market since its inception has grown relentlessly, characterized by declining quality-adjusted prices, expanding output, relentless innovation, and rapid adoption across a broad range of income segments.
Given this compelling real-world evidence, the only remaining line of argument (still being pursued by the FTC) that could justify antitrust intervention is a theoretical conjecture that the wireless market might have grown even faster under some alternative IP licensing arrangement. This assertion rests precariously on the speculative assumption that any such arrangement would have induced the same or higher level of aggregate investment in innovation and commercialization activities. That fragile chain of “what if” arguments hardly seems a sound basis on which to rewrite the legal infrastructure behind the billions of dollars of licensing transactions that support the economically thriving smartphone market and the even larger ecosystem that has grown around it.
Antitrust litigation as business strategy
Given the absence of compelling evidence of competitive harm from Qualcomm’s allegedly anticompetitive licensing practices, Apple’s litigation would seem to be best interpreted as an economically rational attempt by a downstream producer to renegotiate a downward adjustment in the fees paid to an upstream supplier of critical technology inputs. (In fact, those are precisely the terms on which Qualcomm in 2015 settled the antitrust action brought against it by China’s competition regulator, to the obvious benefit of local device producers.) The Epic Games litigation is a mirror image fact pattern in which an upstream supplier of content inputs seeks to deploy antitrust law strategically for the purposes of minimizing the fees it pays to a leading downstream distributor.
Both litigations suffer from the same flaw. Private interests concerning the division of an existing economic value stream—a business question that is matter of indifference from an efficiency perspective—are erroneously (or, at least, reflexively) conflated with the public interest in preserving the free play of competitive forces that maximizes the size of the economic value stream.
Conclusion: Remaking the case for “narrow” antitrust
The Epic v. Apple and Apple v. Qualcomm disputes illustrate the unproductive rent-seeking outcomes to which antitrust law will inevitably be led if, as is being widely advocated, it is decoupled from its well-established foundation in promoting consumer welfare—and not competitor welfare.
Some proponents of a more expansive approach to antitrust enforcement are convinced that expanding the law’s scope of application will improve market efficiency by providing greater latitude for expert regulators and courts to reengineer market structures to the public benefit. Yet any substitution of top-down expert wisdom for the bottom-up trial-and-error process of market competition can easily yield “false positives” in which courts and regulators take actions that counterproductively intervene in markets that are already operating under reasonably competitive conditions. Additionally, an overly expansive approach toward the scope of antitrust law will induce private firms to shift resources toward securing advantages over competitors through lobbying and litigation, rather than seeking to win the race to deliver lower-cost and higher-quality products and services. Neither outcome promotes the public’s interest in a competitive marketplace.
What is a search engine? This might seem like an innocuous question, but it lies at the heart of the US Department of Justice and state Attorneys’ General antitrust complaint against Google, as well as the European Commission’s Google Search and Android decisions. It is also central to a report published by the UK’s Competition & Markets Authority (“CMA”). To varying degrees, all of these proceedings are premised on the assumption that Google enjoys a monopoly/dominant position over online search. But things are not quite this simple.
Despite years of competition decisions and policy discussions, there are still many unanswered questions concerning the operation of search markets. For example, it is still unclear exactly which services compete against Google Search, and how this might evolve in the near future. Likewise, there has only been limited scholarly discussion as to how a search engine monopoly would exert its market power. In other words, what does a restriction of output look like on a search platform — particularly on the user side?
Answering these questions will be essential if authorities wish to successfully bring an antitrust suit against Google for conduct involving search. Indeed, as things stand, these uncertainties greatly complicate efforts (i) to rigorously define the relevant market(s) in which Google Search operates, (ii) to identify potential anticompetitive effects, and (iii) to apply the quantitative tools that usually underpin antitrust proceedings.
In short, as explained below, antitrust authorities and other plaintiffs have their work cut out if they are to prevail in court.
Consumers demand information
For a start, identifying the competitive constraints faced by Google presents authorities and plaintiffs with an important challenge.
Even proponents of antitrust intervention recognize that the market for search is complex. For instance, the DOJ and state AGs argue that Google dominates a narrow market for “general search services” — as opposed to specialized search services, content sites, social networks, and online marketplaces, etc. The EU Commission reached the same conclusion in its Google Search decision. Finally, commenting on the CMA’s online advertising report, Fiona Scott Morton and David Dinielli argue that:
General search is a relevant market […]
In this way, an individual specialized search engine competes with a small fraction of what the Google search engine does, because a user could employ either for one specific type of search. The CMA concludes that, from the consumer standpoint, a specialized search engine exerts only a limited competitive constraint on Google.
(Note that the CMA stressed that it did not perform a market definition exercise: “We have not carried out a formal market definition assessment, but have instead looked at competitive constraints across the sector…”).
In other words, the above critics recognize that search engines are merely tools that can serve multiple functions, and that competitive constraints may be different for some of these. But this has wider ramifications that policymakers have so far overlooked.
When quizzed about his involvement with Neuralink (a company working on implantable brain–machine interfaces), Elon Musk famously argued that human beings already share a near-symbiotic relationship with machines (a point already made by others):
The purpose of Neuralink [is] to create a high-bandwidth interface to the brain such that we can be symbiotic with AI. […] Because we have a bandwidth problem. You just can’t communicate through your fingers. It’s just too slow.
Commentators were quick to spot this implications of this technology for the search industry:
Imagine a world when humans would no longer require a device to search for answers on the internet, you just have to think of something and you get the answer straight in your head from the internet.
As things stand, this example still belongs to the realm of sci-fi. But it neatly illustrates a critical feature of the search industry.
Search engines are just the latest iteration (but certainly not the last) of technology that enables human beings to access specific pieces of information more rapidly. Before the advent of online search, consumers used phone directories, paper maps, encyclopedias, and other tools to find the information they were looking for. They would read newspapers and watch television to know the weather forecast. They went to public libraries to undertake research projects (some still do), etc.
And, in some respects, the search engine is already obsolete for many of these uses. For instance, virtual assistants like Alexa, Siri, Cortana and Google’s own Google Assistant offering can perform many functions that were previously the preserve of search engines: checking the weather, finding addresses and asking for directions, looking up recipes, answering general knowledge questions, finding goods online, etc. Granted, these virtual assistants partly rely on existing search engines to complete tasks. However, Google is much less dominant in this space, and search engines are not the sole source on which virtual assistants rely to generate results. Amazon’s Alexa provides a fitting example (here and here).
Along similar lines, it has been widely reported that 60% of online shoppers start their search on Amazon, while only 26% opt for Google Search. In other words, Amazon’s ability to rapidly show users the product they are looking for somewhat alleviates the need for a general search engine. In turn, this certainly constrains Google’s behavior to some extent. And much of the same applies to other websites that provide a specific type of content (think of Twitter, LinkedIn, Tripadvisor, Booking.com, etc.)
Finally, it is also revealing that the most common searches on Google are, in all likelihood, made to reach other websites — a function for which competition is literally endless:
The upshot is that Google Search and other search engines perform a bundle of functions. Most of these can be done via alternative means, and this will increasingly be the case as technology continues to advance.
This is all the more important given that the vast majority of search engine revenue derives from roughly 30 percent of search terms (notably those that are linked to product searches). The remaining search terms are effectively a loss leader. And these profitable searches also happen to be those where competition from alternative means is, in all likelihood, the strongest (this includes competition from online retail platforms, and online travel agents like Booking.com or Kayak, but also from referral sites, direct marketing, and offline sources). In turn, this undermines US plaintiffs’ claims that Google faces little competition from rivals like Amazon, because they don’t compete for the entirety of Google’s search results (in other words, Google might face strong competition for the most valuable ads):
108. […] This market share understates Google’s market power in search advertising because many search-advertising competitors offer only specialized search ads and thus compete with Google only in a limited portion of the market.
Critics might mistakenly take the above for an argument that Google has no market power because competition is “just a click away”. But the point is more subtle, and has important implications as far as market definition is concerned.
Authorities should not define the search market by arguing that no other rival is quite like Google (or one if its rivals) — as the DOJ and state AGs did in their complaint:
90. Other search tools, platforms, and sources of information are not reasonable substitutes for general search services. Offline and online resources, such as books, publisher websites, social media platforms, and specialized search providers such as Amazon, Expedia, or Yelp, do not offer consumers the same breadth of information or convenience. These resources are not “one-stop shops” and cannot respond to all types of consumer queries, particularly navigational queries. Few consumers would find alternative sources a suitable substitute for general search services. Thus, there are no reasonable substitutes for general search services, and a general search service monopolist would be able to maintain quality below the level that would prevail in a competitive market.
(162) For the reasons set out below, there is, however, limited demand side substitutability between general search services and other online services. […]
(163) There is limited substitutability between general search services and content sites. […]
(166) There is also limited substitutability between general search services and specialised search services. […]
(178) There is also limited substitutability between general search services and social networking sites.
Ad absurdum, if consumers suddenly decided to access information via other means, Google could be the only firm to provide general search results and yet have absolutely no market power.
Take the example of Yahoo: Despite arguably remaining the most successful “web directory”, it likely lost any market power that it had when Google launched a superior — and significantly more successful — type of search engine. Google Search may not have provided a complete, literal directory of the web (as did Yahoo), but it offered users faster access to the information they wanted. In short, the Yahoo example shows that being unique is not equivalent to having market power. Accordingly, any market definition exercise that merely focuses on the idiosyncrasies of firms is likely to overstate their actual market power.
Given what precedes, the question that authorities should ask is thus whether Google Search (or another search engine) performs so many unique functions that it may be in a position to restrict output. So far, no one appears to have convincingly answered this question.
What does market power look like in search?
Similar uncertainties surround the question of how a search engine might restrict output, especially on the user side of the search market. Accordingly, authorities will struggle to produce evidence (i) the Google has market power, especially on the user side of the market, and (ii) that its behavior has anticompetitive effects.
Consider the following:
The SSNIP test (which is the standard method of defining markets in antitrust proceedings) is inapplicable to the consumer side of search platforms. Indeed, it is simply impossible to apply a hypothetical 10% price increase to goods that are given away for free.
This raises a deeper question: how would a search engine exercise its market power?
For a start, it seems unlikely that it would start charging fees to its users. For instance, empirical research pertaining to the magazine industry (also an ad-based two-sided market) suggests that increased concentration does not lead to higher magazine prices. Minjae Song notably finds that:
Taking the advantage of having structural models for both sides, I calculate equilibrium outcomes for hypothetical ownership structures. Results show that when the market becomes more concentrated, copy prices do not necessarily increase as magazines try to attract more readers.
It is also far from certain that a dominant search engine would necessarily increase the amount of adverts it displays. To the contrary, market power on the advertising side of the platform might lead search engines to decrease the number of advertising slots that are available (i.e. reducing advertising output), thus showing less adverts to users.
Finally, it is not obvious that market power would lead search engines to significantly degrade their product (as this could ultimately hurt ad revenue). For example, empirical research by Avi Goldfarb and Catherine Tucker suggests that there is some limit to the type of adverts that search engines could profitably impose upon consumers. They notably find that ads that are both obtrusive and targeted decrease subsequent purchases:
Ads that match both website content and are obtrusive do worse at increasing purchase intent than ads that do only one or the other. This failure appears to be related to privacy concerns: the negative effect of combining targeting with obtrusiveness is strongest for people who refuse to give their income and for categories where privacy matters most.
The preceding paragraphs find some support in the theoretical literature on two-sided markets literature, which suggests that competition on the user side of search engines is likely to be particularly intense and beneficial to consumers (because they are more likely to single-home than advertisers, and because each additional user creates a positive externality on the advertising side of the market). For instance, Jean Charles Rochet and Jean Tirole find that:
The single-homing side receives a large share of the joint surplus, while the multi-homing one receives a small share.
Here, if it wishes to interact with an agent on the single-homing side, the multi-homing side has no choice but to deal with that agent’s chosen platform. Thus, platforms have monopoly power over providing access to their single-homing customers for the multi-homing side. This monopoly power naturally leads to high prices being charged to the multi-homing side, and there will be too few agents on this side being served from a social point of view (Proposition 4). By contrast, platforms do have to compete for the single-homing agents, and high profits generated from the multi-homing side are to a large extent passed on to the single-homing side in the form of low prices (or even zero prices).
All of this is not to suggest that Google Search has no market power, or that monopoly is necessarily less problematic in the search engine industry than in other markets.
Instead, the argument is that analyzing competition on the user side of search platforms is unlikely to yield dispositive evidence of market power or anticompetitive effects. This is because market power is hard to measure on this side of the market, and because even a monopoly platform might not significantly restrict user output.
That might explain why the DOJ and state AGs analysis of anticompetitive effects is so limited. Take the following paragraph (provided without further supporting evidence):
167. By restricting competition in general search services, Google’s conduct has harmed consumers by reducing the quality of general search services (including dimensions such as privacy, data protection, and use of consumer data), lessening choice in general search services, and impeding innovation.
Given these inherent difficulties, antitrust investigators would do better to focus on the side of those platforms where mainstream IO tools are much easier to apply and where a dominant search engine would likely restrict output: the advertising market. Not only is it the market where search engines are most likely to exert their market power (thus creating a deadweight loss), but — because it involves monetary transactions — this side of the market lends itself to the application of traditional antitrust tools.
Looking at the right side of the market
Finally, and unfortunately for Google’s critics, available evidence suggests that its position on the (online) advertising market might not meet the requirements necessary to bring a monopolization case (at least in the US).
For a start, online advertising appears to exhibit the prima facie signs of a competitive market. As Geoffrey Manne, Sam Bowman and Eric Fruits have argued:
Over the past decade, the price of advertising has fallen steadily while output has risen. Spending on digital advertising in the US grew from $26 billion in 2010 to nearly $130 billion in 2019, an average increase of 20% a year. Over the same period the Producer Price Index for Internet advertising sales declined by nearly 40%. The rising spending in the face of falling prices indicates the number of ads bought and sold increased by approximately 27% a year. Since 2000, advertising spending has been falling as a share of GDP, with online advertising growing as a share of that. The combination of increasing quantity, decreasing cost, and increasing total revenues are consistent with a growing and increasingly competitive market.
Second, empirical research suggests that the market might need to be widened to include offline advertising. For instance, Avi Goldfarb and Catherine Tucker show that there can be important substitution effects between online and offline advertising channels:
Using data on the advertising prices paid by lawyers for 139 Google search terms in 195 locations, we exploit a natural experiment in “ambulance-chaser” regulations across states. When lawyers cannot contact clients by mail, advertising prices per click for search engine advertisements are 5%–7% higher. Therefore, online advertising substitutes for offline advertising.
Of course, a careful examination of the advertising industry could also lead authorities to define a narrower relevant market. For example, the DOJ and state AG complaint argued that Google dominated the “search advertising” market:
97. Search advertising in the United States is a relevant antitrust market. The search advertising market consists of all types of ads generated in response to online search queries, including general search text ads (offered by general search engines such as Google and Bing) […] and other, specialized search ads (offered by general search engines and specialized search providers such as Amazon, Expedia, or Yelp).
Likewise, the European Commission concluded that Google dominated the market for “online search advertising” in the AdSense case (though the full decision has not yet been made public). Finally, the CMA’s online platforms report found that display and search advertising belonged to separate markets.
But these are empirical questions that could dispositively be answered by applying traditional antitrust tools, such as the SSNIP test. And yet, there is no indication that the authorities behind the US complaint undertook this type of empirical analysis (and until its AdSense decision is made public, it is not clear that the EU Commission did so either). Accordingly, there is no guarantee that US courts will go along with the DOJ and state AGs’ findings.
In short, it is far from certain that Google currently enjoys an advertising monopoly, especially if the market is defined more broadly than that for “search advertising” (or the even narrower market for “General Search Text Advertising”).
The preceding paragraphs have argued that a successful antitrust case against Google is anything but a foregone conclusion. In order to successfully bring a suit, authorities would notably need to figure out just what market it is that Google is monopolizing. In turn, that would require a finer understanding of what competition, and monopoly, look like in the search and advertising industries.
Apple’s legal team will be relieved that “you reap what you sow” is just a proverb. After a long-running antitrust battle against Qualcomm unsurprisingly ended in failure, Apple now faces antitrust accusations of its own (most notably from Epic Games). Somewhat paradoxically, this turn of events might cause Apple to see its previous defeat in a new light. Indeed, the well-established antitrust principles that scuppered Apple’s challenge against Qualcomm will now be the rock upon which it builds its legal defense.
But while Apple’s reversal of fortunes might seem anecdotal, it neatly illustrates a fundamental – and often overlooked – principle of antitrust policy: Antitrust law is about maximizing consumer welfare. Accordingly, the allocation of surplus between two companies is only incidentally relevant to antitrust proceedings, and it certainly is not a goal in and of itself. In other words, antitrust law is not about protecting David from Goliath.
Jockeying over the distribution of surplus
Or at least that is the theory. In practice, however, most antitrust cases are but small parts of much wider battles where corporations use courts and regulators in order to jockey for market position and/or tilt the distribution of surplus in their favor. The Microsoft competition suits brought by the DOJ and the European commission (in the EU and US) partly originated from complaints, and lobbying, by Sun Microsystems, Novell, and Netscape. Likewise, the European Commission’s case against Google was prompted by accusations from Microsoft and Oracle, among others. The European Intel case was initiated following a complaint by AMD. The list goes on.
The last couple of years have witnessed a proliferation of antitrust suits that are emblematic of this type of power tussle. For instance, Apple has been notoriously industrious in using the court system to lower the royalties that it pays to Qualcomm for LTE chips. One of the focal points of Apple’s discontent was Qualcomm’s policy of basing royalties on the end-price of devices (Qualcomm charged iPhone manufacturers a 5% royalty rate on their handset sales – and Apple received further rebates):
“The whole idea of a percentage of the cost of the phone didn’t make sense to us,” [Apple COO Jeff Williams] said. “It struck at our very core of fairness. At the time we were making something really really different.”
This pricing dispute not only gave rise to high-profile court cases, it also led Apple to lobby Standard Developing Organizations (“SDOs”) in a partly successful attempt to make them amend their patent policies, so as to prevent this type of pricing.
However, in a highly ironic turn of events, Apple now finds itself on the receiving end of strikingly similar allegations. At issue is the 30% commission that Apple charges for in app purchases on the iPhone and iPad. These “high” commissions led several companies to lodge complaints with competition authorities (Spotify and Facebook, in the EU) and file antitrust suits against Apple (Epic Games, in the US).
Of course, these complaints are couched in more sophisticated, and antitrust-relevant, reasoning. But that doesn’t alter the fact that these disputes are ultimately driven by firms trying to tilt the allocation of surplus in their favor (for a more detailed explanation, see Apple and Qualcomm).
Pushback from courts: The Qualcomm case
Against this backdrop, a string of recent cases sends a clear message to would-be plaintiffs: antitrust courts will not be drawn into rent allocation disputes that have no bearing on consumer welfare.
The best example of this judicial trend is Qualcomm’s victory before the United States Court of Appeal for the 9th Circuit. The case centered on the royalties that Qualcomm charged to OEMs for its Standard Essential Patents (SEPs). Both the district court and the FTC found that Qualcomm had deployed a series of tactics (rebates, refusals to deal, etc) that enabled it to circumvent its FRAND pledges.
However, the Court of Appeal was not convinced. It failed to find any consumer harm, or recognizable antitrust infringement. Instead, it held that the dispute at hand was essentially a matter of contract law:
To the extent Qualcomm has breached any of its FRAND commitments, a conclusion we need not and do not reach, the remedy for such a breach lies in contract and patent law.
This is not surprising. From the outset, numerous critics pointed that the case lied well beyond the narrow confines of antitrust law. The scathing dissenting statement written by Commissioner Maureen Olhaussen is revealing:
[I]n the Commission’s 2-1 decision to sue Qualcomm, I face an extraordinary situation: an enforcement action based on a flawed legal theory (including a standalone Section 5 count) that lacks economic and evidentiary support, that was brought on the eve of a new presidential administration, and that, by its mere issuance, will undermine U.S. intellectual property rights in Asia and worldwide. These extreme circumstances compel me to voice my objections.
In reaching its conclusion, the Court notably rejected the notion that SEP royalties should be systematically based upon the “Smallest Saleable Patent Practicing Unit” (or SSPPU):
Even if we accept that the modem chip in a cellphone is the cellphone’s SSPPU, the district court’s analysis is still fundamentally flawed. No court has held that the SSPPU concept is a per se rule for “reasonable royalty” calculations; instead, the concept is used as a tool in jury cases to minimize potential jury confusion when the jury is weighing complex expert testimony about patent damages.
Similarly, it saw no objection to Qualcomm licensing its technology at the OEM level (rather than the component level):
Qualcomm’s rationale for “switching” to OEM-level licensing was not “to sacrifice short-term benefitsin order to obtain higher profits in the long run from the exclusion of competition,” the second element of the Aspen Skiing exception. Aerotec Int’l, 836 F.3d at 1184 (internal quotation marks and citation omitted). Instead, Qualcomm responded to the change in patent-exhaustion law by choosing the path that was “far more lucrative,” both in the short term and the long term, regardless of any impacts on competition.
Finally, the Court concluded that a firm breaching its FRAND pledges did not automatically amount to anticompetitive conduct:
We decline to adopt a theory of antitrust liability that would presume anticompetitive conduct any time a company could not prove that the “fair value” of its SEP portfolios corresponds to the prices the market appears willing to pay for those SEPs in the form of licensing royalty rates.
Taken together, these findings paint a very clear picture. The Qualcomm Court repeatedly rejected the radical idea that US antitrust law should concern itself with the prices charged by monopolists — as opposed to practices that allow firms to illegally acquire or maintain a monopoly position. The words of Learned Hand and those of Antonin Scalia (respectively, below) loom large:
The successful competitor, having been urged to compete, must not be turned upon when he wins.
To safeguard the incentive to innovate, the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.
Other courts (both in the US and abroad) have reached similar conclusions
For instance, a district court in Texas dismissed a suit brought by Continental Automotive Systems (which supplies electronic systems to the automotive industry) against a group of SEP holders.
Continental challenged the patent holders’ decision to license their technology at the vehicle rather than component level (the allegation is very similar to the FTC’s complaint that Qualcomm licensed its SEPs at the OEM, rather than chipset level). However, following a forceful intervention by the DOJ, the Court ultimately held that the facts alleged by Continental were not indicative of antitrust injury. It thus dismissed the case.
Likewise, within weeks of the Qualcomm and Continental decisions, the UK Supreme court also ruled in favor of SEP holders. In its Unwired Planet ruling, the Court concluded that discriminatory licenses did not automatically infringe competition law (even though they might breach a firm’s contractual obligations):
[I]t cannot be said that there is any general presumption that differential pricing for licensees is problematic in terms of the public or private interests at stake.
In reaching this conclusion, the UK Supreme Court emphasized that the determination of whether licenses were FRAND, or not, was first and foremost a matter of contract law. In the case at hand, the most important guide to making this determination were the internal rules of the relevant SDO (as opposed to competition case law):
Since price discrimination is the norm as a matter of licensing practice and may promote objectives which the ETSI regime is intended to promote (such as innovation and consumer welfare), it would have required far clearer language in the ETSI FRAND undertaking to indicate an intention to impose the more strict, “hard-edged” non-discrimination obligation for which Huawei contends. Further, in view of the prevalence of competition laws in the major economies around the world, it is to be expected that any anti-competitive effects from differential pricing would be most appropriately addressed by those laws.
All of this ultimately led the Court to rule in favor of Unwired Planet, thus dismissing Huawei’s claims that it had infringed competition law by breaching its FRAND pledges.
In short, courts and antitrust authorities on both sides of the Atlantic have repeatedly, and unambiguously, concluded that pricing disputes (albeit in the specific context of technological standards) are generally a matter of contract law. Antitrust/competition law intercedes only when unfair/excessive/discriminatory prices are both caused by anticompetitive behavior and result in anticompetitive injury.
Apple’s Loss is… Apple’s gain.
Readers might wonder how the above cases relate to Apple’s app store. But, on closer inspection the parallels are numerous. As explained above, courts have repeatedly stressed that antitrust enforcement should not concern itself with the allocation of surplus between commercial partners. Yet that is precisely what Epic Game’s suit against Apple is all about.
Indeed, Epic’s central claim is not that it is somehow foreclosed from Apple’s App Store (for example, because Apple might have agreed to exclusively distribute the games of one of Epic’s rivals). Instead, all of its objections are down to the fact that it would like to access Apple’s store under more favorable terms:
Apple’s conduct denies developers the choice of how best to distribute their apps. Developers are barred from reaching over one billion iOS users unless they go through Apple’s App Store, and on Apple’s terms. […]
Thus, developers are dependent on Apple’s noblesse oblige, as Apple may deny access to the App Store, change the terms of access, or alter the tax it imposes on developers, all in its sole discretion and on the commercially devastating threat of the developer losing access to the entire iOS userbase. […]
By imposing its 30% tax, Apple necessarily forces developers to suffer lower profits, reduce the quantity or quality of their apps, raise prices to consumers, or some combination of the three.
And the parallels with the Qualcomm litigation do not stop there. Epic is effectively asking courts to make Apple monetize its platform at a different level than the one that it chose to maximize its profits (no more monetization at the app store level). Similarly, Epic Games omits any suggestion of profit sacrifice on the part of Apple — even though it is a critical element of most unilateral conduct theories of harm. Finally, Epic is challenging conduct that is both the industry norm and emerged in a highly competitive setting.
In short, all of Epic’s allegations are about monopoly prices, not monopoly maintenance or monopolization. Accordingly, just as the SEP cases discussed above were plainly beyond the outer bounds of antitrust enforcement (something that the DOJ repeatedly stressed with regard to the Qualcomm case), so too is the current wave of antitrust litigation against Apple. When all is said and done, Apple might thus be relieved that Qualcomm was victorious in their antitrust confrontation. Indeed, the legal principles that caused its demise against Qualcomm are precisely the ones that will, likely, enable it to prevail against Epic Games.
Speaking about his new book in a ProMarket interview, David Dayen inadvertently captures what is perhaps the essential disconnect between antitrust reformers (populists, neo-Brandeisians, hipsters, whatever you may call them) and those of us who are more comfortable with the antitrust status quo (whatever you may call us). He says: “The antitrust doctrine that we’ve seen over the last 40 years simply does not match the lived experience of people.”
Narratives of Consumer Experience of Markets
This emphasis on “lived experience” runs through Dayen’s antitrust perspective. Citing to Hal Singer’s review of the book, the interview notes that “the heart of Dayen’s book is the personal accounts of ordinary Americans—airline passengers, hospital patients, farmers, and small business owners—attempting to achieve a slice of the American dream and facing insurmountable barriers in the form of unaccountable private monopolies.” As Singer notes in his review, “Dayen’s personalized storytelling, free of any stodgy regression analysis, is more likely to move policymakers” than are traditional economic arguments.
Dayen’s focus on individual narratives — of the consumer’s lived experience — is fundamentally different than the traditional antitrust economist’s perspective on competition and the market. It is worth exploring the differences between the two. The basic argument that I make below is that Dayen is right but also that he misunderstands the purpose of competition in a capitalist economy. A robustly competitive market is a brutal rat race that places each individual on an accelerating treadmill. There is no satiation or satisfaction for the individual consumer in these markets. But it is this very lack of satisfaction, this endless thirst for more, that makes competitive markets so powerful, and ultimately beneficial, for consumers.
This is the fundamental challenge and paradox of capitalism. Satisfaction requires perspective that most consumers often don’t feel, and that many consumers never will feel. It requires the ability to step off that treadmill occasionally and to look how far society and individual welfare has come, even if individually one feels like they have not moved at all. It requires recognizing that the alternative to an uncomfortable flight to visit family isn’t a comfortable one, but an unaffordable one; that the alternative to low cost, processed foods, isn’t abundant higher-quality food but greater poverty for those who already can least afford food; that the alternative to a startup being beholden to Google’s and Amazon’s terms of service isn’t a market in which they have boundless access to these platforms’ infrastructures, but one in which each startup needs to entirely engineer its own infrastructure. In all of these cases, the fundamental tradeoff is between having something that is less perfect than an imagined ideal of it, and not having it at all.
What Dayen refers to as consumers’ “lived experience” is really their “perceived experience.” This is important to how markets work. Competition is driven by consumers’ perception that things could be better (and by entrepreneurs’ perception that they can make it so). This perception is what keeps us on the treadmill. Consumers don’t look to their past generations and say “wow, by nearly every measure my life can be better than theirs with less effort!” They focus on what they don’t have yet, on the seemingly better lives of their contemporaries.
This description of markets may sound grotesquely dehumanizing. To the extent that it really is, this is because we live in a world of scarcity. There will always be tradeoffs and in a literally real way no consumer will ever have everything that she needs, let alone that she wants.
On the flip side, this is what drives markets to make consumers better off. Consumers’ wants drive producers’ factories and innovators’ minds. There is no supply curve without a demand curve. And consumers are able to satisfy their own needs by becoming producers who work to satisfy the wants and needs of others.
A Fair Question: Are Markets Worth It?
Dayen’s perspective on this description of markets, shared with his fellow reform-minded anti-antitrust crusaders, is that the typical consumers’ perceived experience of the market demonstrates that markets don’t work — that they have been captured by monopolists seeking to extract every ounce of revenue from each individual consumer. But this is not a story of monopolies. It is more plainly the story of markets. What Dayen identifies as a problem with the markets really is just the markets working as they are supposed to.
If this is just how markets work, it is fair to ask whether they are worth it. Importantly, those of us who answer “yes” need not be blind to or dismissive of concerns such as Dayen’s — to the concerns of the typical consumer. Economists have long recognized that capitalist markets are about allocative efficiency, not distributive efficiency — about making society as a whole as wealthy as possible but not about making sure that that wealth is fairly distributed.
The antitrust reform movement is driven by advocates who long for a world in which everyone is poorer but feels more equal, as opposed to what they perceive as a world in which a few monopolists are extremely wealthy and everyone else feels poor. Their perception of this as the but-for world is not unreasonable, but it is also not accurate. The better world is the one with thriving, prosperous, markets,in which consumers broadly feel that they share in this prosperity. It may be the case that such a world has some oligopolies and even monopolies — that is what economic efficiency sometimes looks like.
But those firms’ prosperity need not be adverse to consumers’ experience of the market. The challenging question is how we achieve this outcome. But that is a question of politics and macroeconomic policy, and of corporate social policy. It is a question of national identity, whether consumers’ perception of the economic treadmill can pivot from one of perceived futility to one of recognizing their lived contributions to society. It is one that antitrust law as it exists today contributes to answering, but not one that antitrust law on its own can ever answer.
On the other hand, were we to follow the populists’ lead and turn antitrust into a remedy for the perceived maladies of the market, we would risk the engine that improves consumers’ actual lived experience. The alternative to an antitrust driven by economic analysis and that errs on the side of not disrupting markets in favor of perceived injuries is an antitrust in which markets are beholden to the whims of politicians and enforcement officials. This is a world in which litigation is used by politicians to make it appear they are delivering on impossible promises, in which litigation is used to displace blame for politicians’ policy failures, in which litigation is used to distract from socio-political events entirely unrelated to the market.
Concerns such as Dayen’s are timeless and not unreasonable. But the reflexive action is not the answer to such concerns. Rather, the response always must be to ask “opposed to what?” What is the but-for world? Here, Dayen and his peers suffer both Type I and Type II errors. They misdiagnose antitrust and non-competitive markets as the cause of their perceived problems. And they are overly confident in their proposed solutions to those problems, not recognizing the real harms that their proposed politicization of antitrust and markets poses.
In an age of antitrust populism on both ends of the political spectrum, federal and state regulators face considerable pressure to deploy the antitrust laws against firms that have dominant market shares. Yet federal case law makes clear that merely winning the race for a market is an insufficient basis for antitrust liability. Rather, any plaintiff must show that the winner either secured or is maintaining its dominant position through practices that go beyond vigorous competition. Any other principle would inhibit the competitive process that the antitrust laws are designed to promote. Federal judges who enjoy life tenure are far more insulated from outside pressures and therefore more likely to demand evidence of anticompetitive practices as a predicate condition for any determination of antitrust liability.
This separation of powers between the executive branch, which prosecutes alleged infractions of the law, and the judicial branch, which polices the prosecutor, is the simple genius behind the divided system of government generally attributed to the eighteenth-century French thinker, Montesquieu. The practical wisdom of this fundamental principle of political design, which runs throughout the U.S. Constitution, can be observed in full force in the current antitrust landscape, in which the federal courts have acted as a bulwark against several contestable enforcement actions by antitrust regulators.
In three headline cases brought by the Department of Justice or the Federal Trade Commission since 2017, the prosecutorial bench has struck out in court. Under the exacting scrutiny of the judiciary, government litigators failed to present sufficient evidence that a dominant firm had engaged in practices that caused, or were likely to cause, significant anticompetitive effects. In each case, these enforcement actions, applauded by policymakers and commentators who tend to follow “big is bad” intuitions, foundered when assessed in light of judicial precedent, the factual record, and the economic principles embedded in modern antitrust law. An ongoing suit, filed by the FTC this year after more than 18 months since the closing of the targeted acquisition, exhibits similar factual and legal infirmities.
Strike 1: The AT&T/Time-Warner Transaction
In response to the announcement of AT&T’s $85.4 billion acquisition of Time Warner, the DOJ filed suit in 2017 to prevent the formation of a dominant provider in home-video distribution that would purportedly deny competitors access to “must-have” content. As I have observed previously, this theory of the case suffered from two fundamental difficulties.
First, content is an abundant and renewable resource so it is hard to see how AT&T+TW could meaningfully foreclose competitors’ access to this necessary input. Even in the hypothetical case of potentially “must-have” content, it was unclear whether it would be economically rational for post-acquisition AT&T regularly to deny access to other distributors, given that doing so would imply an immediate and significant loss in licensing revenues without any clearly offsetting future gain in revenues from new subscribers.
Second, home-video distribution is a market lapsing rapidly into obsolescence as content monetization shifts from home-based viewing to a streaming environment in which consumers expect “anywhere, everywhere” access. The blockbuster acquisition was probably best understood as a necessary effort to adapt to this new environment (already populated by several major streaming platforms), rather than an otherwise puzzling strategy to spend billions to capture a market on the verge of commercial irrelevance.
Strike 2: The Sabre/Farelogix Acquisition
In 2019, the DOJ filed suit to block the $360 million acquisition of Farelogix by Sabre, one of three leading airline booking platforms, on the ground that it would substantially lessen competition. The factual basis for this legal diagnosis was unclear. In 2018, Sabre earned approximately $3.9 billion in worldwide revenues, compared to $40 million for Farelogix. Given this drastic difference in market share, and the almost trivial share attributable to Farelogix, it is difficult to fathom how the DOJ could credibly assert that the acquisition “would extinguish a crucial constraint on Sabre’s market power.”
To use a now much-discussed theory of antitrust liability, it might nonetheless be argued that Farelogix posed a “nascent” competitive threat to the Sabre platform. That is: while Farelogix is small today, it may become big enough tomorrow to pose a threat to Sabre’s market leadership.
But that theory runs straight into a highly inconvenient fact. Farelogix was founded in 1998 and, during the ensuing two decades, had neither achieved broad adoption of its customized booking technology nor succeeded in offering airlines a viable pathway to bypass the three major intermediary platforms. The proposed acquisition therefore seems best understood as a mutually beneficial transaction in which a smaller (and not very nascent) firm elects to monetize its technology by embedding it in a leading platform that seeks to innovate by acquisition. Robust technology ecosystems do this all the time, efficiently exploiting the natural complementarities between a smaller firm’s “out of the box” innovation with the capital-intensive infrastructure of an incumbent. (Postscript: While the DOJ lost this case in federal court, Sabre elected in May 2020 not to close following similarly puzzling opposition by British competition regulators.)
Strike 3: FTC v. Qualcomm
The divergence of theories of anticompetitive risk from market realities is vividly illustrated by the landmark suit filed by the FTC in 2017 against Qualcomm.
The litigation pursued nothing less than a wholesale reengineering of the IP licensing relationships between innovators and implementers that underlie the global smartphone market. Those relationships principally consist of device-level licenses between IP innovators such as Qualcomm and device manufacturers and distributors such as Apple. This structure efficiently collects remuneration from the downstream segment of the supply chain for upstream firms that invest in pushing forward the technology frontier. The FTC thought otherwise and pursued a remedy that would have required Qualcomm to offer licenses to its direct competitors in the chip market and to rewrite its existing licenses with device producers and other intermediate users on a component, rather than device, level.
Remarkably, these drastic forms of intervention into private-ordering arrangements rested on nothing more than what former FTC Commissioner Maureen Ohlhausen once appropriately called a “possibility theorem.” The FTC deployed a mostly theoretical argument that Qualcomm had extracted an “unreasonably high” royalty that had potentially discouraged innovation, impeded entry into the chip market, and inflated retail prices for consumers. Yet these claims run contrary to all available empirical evidence, which indicates that the mobile wireless device market has exhibited since its inception declining quality-adjusted prices, increasing output, robust entry into the production market, and continuous innovation. The mismatch between the government’s theory of market failure and the actual record of market success over more than two decades challenges the policy wisdom of disrupting hundreds of existing contractual arrangements between IP licensors and licensees in a thriving market.
The FTC nonetheless secured from the district court a sweeping order that would have had precisely this disruptive effect, including imposing a “duty to deal” that would have required Qualcomm to license directly its competitors in the chip market. The Ninth Circuit stayed the order and, on August 11, 2020, issued an unqualified reversal, stating that the lower court had erroneously conflated “hypercompetitive” (good) with anticompetitive (bad) conduct and observing that “[t]hroughout its analysis, the district court conflated the desire to maximize profits with an intent to ‘destroy competition itself.’” In unusually direct language, the appellate court also observed (as even the FTC had acknowledged on appeal) that the district court’s ruling was incompatible with the Supreme Court’s ruling inAspen SkiingCo. v. Aspen Highlands Skiing Corp., which strictly limits the circumstances in which a duty to deal can be imposed. In some cases, it appears that additional levels of judicial review are necessary to protect antitrust law against not only administrative but judicial overreach.
Axon v. FTC
For the most explicit illustration of the interface between Montesquieu’s principle of divided government and the risk posed to antitrust law by cases of prosecutorial excess, we can turn to an unusual and ongoing litigation, Axon v. FTC.
The HSR Act and Post-Consummation Merger Challenges
The HSR Act provides regulators with the opportunity to preemptively challenge acquisitions and related transactions on antitrust grounds prior to those transactions having been consummated. Since its enactment in 1976, this statutory innovation has laudably increased dealmakers’ ability to close transactions with a high level of certainty that regulators would not belatedly seek to “unscramble the egg.” While the HSR Act does not foreclose this contingency since regulatory failure to challenge a transaction only indicates current enforcement intentions, it is probably fair to say that M&A dealmakers generally assume that regulators would reverse course only in exceptional circumstances. In turn, the low prospect of after-the-fact regulatory intervention encourages the efficient use of M&A transactions for the purpose of shifting corporate assets to users that value those assets most highly.
The FTC’s Belated Attack on the Axon/Vievu Acquisition
Dealmakers may be revisiting that understanding in the wake of the FTC’s decision in January 2020 to challenge the acquisition of Vievu by Axon, each being a manufacturer of body-worn camera equipment and related data-management software for law enforcement agencies. The acquisition had closed in May 2018 but had not been reported through HSR since it fell well below the reportable deal threshold. Given a total transaction value of $7 million, the passage of more than 18 months since closing, and the insolvency or near-insolvency of the target company, it is far from obvious that the Axon acquisition posed a material competitive risk that merits unsettling expectations that regulators will typically not challenge a consummated transaction, especially in the case of what is a micro-sized nebula in the M&A universe.
These concerns are heightened by the fact that the FTC suit relies on a debatably narrow definition of the relevant market (body-camera equipment and related “cloud-based” data management software for police departments in large metropolitan areas, rather than a market that encompassed more generally defined categories of body-worn camera equipment, law enforcement agencies, and data management services). Even within this circumscribed market, there are apparently several companies that offer related technologies and an even larger group that could plausibly enter in response to perceived profit opportunities. Despite this contestable legal position, Axon’s court filing states that the FTC offered to settle the suit on stiff terms: Axon must agree to divest itself of the Vievu assets and to license all of Axon’s pre-transaction intellectual property to the buyer of the Vievu assets. This effectively amounts to an opportunistic use of the antitrust merger laws to engage in post-transaction market reengineering, rather than merely blocking an acquisition to maintain the pre-transaction status quo.
Does the FTC Violate the Separation of Powers?
In a provocative strategy, Axon has gone on the offensive and filed suit in federal district court to challenge on constitutional grounds the long-standing internal administrative proceeding through which the FTC’s antitrust claims are initially adjudicated. Unlike the DOJ, the FTC’s first stop in the litigation process (absent settlement) is not a federal district court but an internal proceeding before an administrative law judge (“ALJ”), whose ruling can then be appealed to the Commission. Axon is effectively arguing that this administrative internalization of the judicial function violates the separation of powers principle as implemented in the U.S. Constitution.
Writing on a clean slate, Axon’s claim is eminently reasonable. The fact that FTC-paid personnel sit on both sides of the internal adjudicative process as prosecutor (the FTC litigation team) and judge (the ALJ and the Commissioners) locates the executive and judicial functions in the hands of a single administrative entity. (To be clear, the Commission’s rulings are appealable to federal court, albeit at significant cost and delay.) In any event, a court presented with Axon’s claim—as of this writing, the Ninth Circuit (taking the case on appeal by Axon)—is not writing on a clean slate and is most likely reluctant to accept a claim that would trigger challenges to the legality of other similarly structured adjudicative processes at other agencies. Nonetheless, Axon’s argument does raise important concerns as to whether certain elements of the FTC’s adjudicative mechanism (as distinguished from the very existence of that mechanism) could be refined to mitigate the conflicts of interest that arise in its current form.
Antitrust vigilance certainly has its place, but it also has its limits. Given the aspirational language of the antitrust statutes and the largely unlimited structural remedies to which an antitrust litigation can lead, there is an inevitable risk of prosecutorial overreach that can betray the fundamental objective to protect consumer welfare. Applied to the antitrust context, the separation of powers principle mitigates this risk by subjecting enforcement actions to judicial examination, which is in turn disciplined by the constraints of appellate review and stare decisis. A rich body of federal case law implements this review function by anchoring antitrust in a decisionmaking framework that promotes the public’s interest in deterring business practices that endanger the competitive process behind a market-based economy. As illustrated by the recent string of failed antitrust suits, and the ongoing FTC litigation against Axon, that same decisionmaking framework can also protect the competitive process against regulatory practices that pose this same type of risk.
[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 Eric Fruits, (Chief Economist, International Center for Law & Economics).]
While much of the world of competition policy has focused on mergers in the COVID-19 era. Some observers see mergers as one way of saving distressed but valuable firms. Others have called for a merger moratorium out of fear that more mergers will lead to increased concentration and market power. In the meantime, there has been a growing push for increased nationalization of a wide range of businesses and industries.
In most cases, the call for a government takeover is not a reaction to the public health and economic crises associated with coronavirus. Instead, COVID-19 is a convenient excuse to pursue long sought after policies.
Last year, well before the pandemic, New York mayor Bill de Blasio called for a government takeover of electrical grid operator ConEd because he was upset over blackouts during a heatwave. Earlier that year, he threatened to confiscate housing units from private landlords, “we will seize their buildings, and we will put them in the hands of a community nonprofit that will treat tenants with the respect they deserve.”
With that sort of track record, it should come as no surprise the mayor proposed a government takeover of key industries to address COVID-19: “This is a case for a nationalization, literally a nationalization, of crucial factories and industries that could produce the medical supplies to prepare this country for what we need.” Dana Brown, director of The Next System Project at The Democracy Collaborative, agrees, “We should nationalize what remains of the American vaccine industry now, thereby assuring that any coronavirus vaccines produced can be made as widely available and as inexpensive soon as possible.”
Dan Sullivan in the American Prospect suggests the U.S. should nationalize all the airlines. Some have gone so far as calling for nationalization of the U.S. oil industry.
On the one hand, it’s clear that de Blasio and Brown have no confidence in the price system to efficiently allocate resources. Alternatively, they may have overconfidence in the political/bureaucratic system to efficiently, and “equitably,” distribute resources. On the other hand, as Daniel Takash points out in an earlier post, both pharmaceuticals and oil are relatively unpopular industries with many Americans, in which case the threat of a government takeover has a big dose of populist score settling:
Yet last year a Gallup poll found that of 25 major industries, the pharmaceutical industry was the most unpopular–trailing behind fossil fuels, lawyers, and even the federal government.
In the early days of the pandemic, France’s finance minister Bruno Le Maire promised to protect “big French companies.” The minister identified a range of actions under consideration: “That can be done by recapitalization, that can be done by taking a stake, I can even use the term nationalization if necessary.” While he did not mention any specific companies, it’s been speculated Air France KLM may be a target.
The Italian government is expected to nationalize Alitalia soon. The airline has been in state administration since May 2017, and the Italian government will have 100% control of the airline by June. Last week, the German government took a 20% stake in Lufthansa, in what has been characterized as a “temporary partial nationalization.” In Canada, Prime Minister Justin Trudeau has been coy about speculation that the government might nationalize Air Canada.
Obviously, these takeovers have “bailout” written all over them, and bailouts have their own anticompetitive consequences that can be worse than those associated with mergers. For example, RyanAir announced it will contest the aid package for Lufthansa. RyanAir chief executive Michael O’Leary claims the aid will allow Lufthansa to “engage in below-cost selling” and make it harder for RyanAir and its rival low-cost carrier EasyJet to compete.
There is also a bit of a “national champion” aspect to the takeovers. Each of the potential targets are (or were) considered their nation’s flagship airline. World Bank economists Tanja Goodwin and Georgiana Pop highlight the risk of nationalization harming competition:
These [sic] should avoid rescuing firms that were already failing. … But governments should also refrain from engaging in production or service delivery in industries that can be served by the private sector. The role of SOEs [state owned enterprises] should be assessed in order to ensure that bailout packages are not exclusively and unnecessarily favoring a dominant SOE.
To be sure, COVID-19 related mergers could raise the specter of increased market power post-pandemic. But, this risk must be balanced against the risks posed by a merger moratorium. These include the risk of widespread bankruptcies (that’s another post) and/or the possibility of nationalization of firms and industries. Either option can reduce competition which can bring harm to consumers, employees, and suppliers.
The goal of US antitrust law is to ensure that competition continues to produce positive results for consumers and the economy in general. We published a letter co-signed by twenty three of the U.S.’s leading economists, legal scholars and practitioners, including one winner of the Nobel Prize in economics (full list of signatories here), to exactly that effect urging the House Judiciary Committee on the State of Antitrust Law to reject calls for radical upheaval of antitrust law that would, among other things, undermine the independence and neutrality of US antitrust law.
A critical part of maintaining independence and neutrality in the administration of antitrust is ensuring that it is insulated from politics. Unfortunately, this view is under attack from all sides. The President sees widespread misconduct among US tech firms that he believes are controlled by the “radical left” and is, apparently, happy to use whatever tools are at hand to chasten them.
Meanwhile, Senator Klobuchar has claimed, without any real evidence, that the mooted Uber/Grubhub merger is simply about monopolisation of the market, and not, for example, related to the huge changes that businesses like this are facing because of the Covid shutdown.
Both of these statements challenge the principle that the rule of law depends on being politically neutral, including in antitrust.
Our letter, contrary to the claims made by President Trump, Sen. Klobuchar and some of the claims made to the Committee, asserts that the evidence and economic theory is clear: existing antitrust law is doing a good job of promoting competition and consumer welfare in digital markets and the economy more broadly, and concludes that the Committee should focus on reforms that improve antitrust at the margin, not changes that throw out decades of practice and precedent.
The letter argues that:
The American economy—including the digital sector—is competitive, innovative, and serves consumers well, contrary to how it is sometimes portrayed in the public debate.
Structural changes in the economy have resulted from increased competition, and increases in national concentration have generally happened because competition at the local level has intensified and local concentration has fallen.
Lax antitrust enforcement has not allowed systematic increases in market power, and the evidence simply does not support out the idea that antitrust enforcement has weakened in recent decades.
Existing antitrust law is adequate for protecting competition in the modern economy, and built up through years of careful case-by-case scrutiny. Calls to throw out decades of precedent to achieve an antitrust “Year Zero” would throw away a huge body of learning and deliberation.
History teaches that discarding the modern approach to antitrust would harm consumers, and return to a situation where per se rules prohibited the use of economic analysis and fact-based defences of business practices.
Common sense reforms should be pursued to improve antitrust enforcement, and the reforms proposed in the letter could help to improve competition and consumer outcomes in the United States without overturning the whole system.
The reforms suggested include measures to increase transparency of the DoJ and FTC, greater scope for antitrust challenges against state-sponsored monopolies, stronger penalties for criminal cartel conduct, and more agency resources being made available to protect workers from anti-competitive wage-fixing agreements between businesses. These are suggestions for the House Committee to consider and are not supported by all the letter’s signatories.
Some of the arguments in the letter are set out in greater detail in the ICLE’s own submission to the Committee, which goes into detail about the nature of competition in modern digital markets and in traditional markets that have been changed because of the adoption of digital technologies.
[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.
[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 Steve Cernak, (Partner, Bona Law).]
The antitrust laws have not been suspended during the current COVID-19 crisis. But based on questions received from clients plus others discussed with other practitioners, the changed economic conditions have raised some new questions and put a new slant on some old ones.
Under antitrust law’s flexible rule of reason standard, courts and enforcers consider the competitive effect of most actions under current and expected economic conditions. Because those conditions have changed drastically, at least temporarily, perhaps the antitrust assessments of certain actions will be different. Also, in a crisis, good businesses consider new options and reconsider others that had been rejected under the old conditions. So antitrust practitioners and enforcers need to be prepared for new questions and reconsiderations of others under new facts. Here are some that might cross their desks.
Benchmarking had its antitrust moment a few years ago as practitioners discovered and began to worry about this form of communication with competitors. Both before and since then, the comparison of processes and metrics to industry bests to determine where improvement efforts should be concentrated has not raised serious antitrust issues – if done properly. Appropriate topic choice and implementation, often involving counsel review and third-party collection, should stay the same during this crisis. Companies implementing new processes might be tempted to reach out to competitors to learn best practices. Any of those companies unfamiliar with the right way to benchmark should get up to speed. Counsel must be prepared to help clients quickly, but properly, benchmark some suddenly important activities, like methods for deep-cleaning workplaces.
Joint ventures where competitors work together to accomplish a task that neither could alone, or accomplish it more efficiently, have always received a receptive antitrust review. Often, those joint efforts have been temporary. Properly structured ones have always required the companies to remain competitors outside the joint venture. Joint efforts among competitors that did not make sense before the crisis might make perfect sense during it. For instance, a company whose distribution warehouse has been shut down by a shelter in place order might be able to use a competitor’s distribution assets to continue to get goods to the market.
Some joint ventures of competitors have received special antitrust assurances for decades. The National Cooperative Research and Production Act of 1993 was originally passed in 1984 to protect research joint ventures of competitors. It was later extended to certain joint production efforts and standard development organizations. The law confirms that certain joint ventures of competitors will be judged under the rule of reason. If the parties file a very short notice with the DOJ Antitrust Division and FTC, they also will receive favorable treatment regarding damages and attorney’s fees in any antitrust lawsuit. For example, competitors cooperating on the development of new virus treatments might be able to use NCRPA to protect joint research and even production of the cure.
Horizontal mergers that permanently combine the assets of two competitors are unlikely to be justified under the antitrust laws by small transitory blips in the economic landscape. A huge crisis, however, might be so large and create such long-lasting effects that certain mergers suddenly might make sense, both on business and antitrust grounds. That rationale was used during the most recent economic crisis to justify several large mergers of banks although other large industrial mergers considered at the same time were abandoned for various reasons. It is not yet clear if that reasoning is present in any industry now.
Remote communication among competitors
On a much smaller but more immediate scale, the new forms of communication being used while so many of us are physically separated have raised questions about the usual antitrust advice regarding communication with competitors. Antitrust practitioners have long advised clients about how to prepare and conduct an in-person meeting of competitors, say at a trade association convention. That same advice would seem to apply if, with the in-person convention cancelled, the meeting will be held via Teams or Zoom. And don’t forget: The reminders that the same rules apply to the cocktail party at the bar after the meeting should also be given for the virtual version conducted via Remo.co.
While antitrust law is focused on actions by private parties that might prevent markets from properly working to serve consumers, the same rationales apply to unnecessary government interference in the market. The current health crisis has turned the spotlight back on certificate of need laws, a form of “brother may I?” government regulation that can allow current competitors to stifle entry by new competitors. Similarly, regulations that have slowed the use of telemedicine have been at least temporarily waived.
Solving the current health crisis and rebuilding the economy will take the best efforts of both our public institutions and private companies. Antitrust law as currently written and enforced can and should continue to play a role in aligning incentives so we need not rely on “the benevolence of the butcher” for our dinner and other necessities. Instead, proper application of antitrust law can allow companies to do their part to (reviving a slogan helpful in a prior national crisis) keep America rolling.
This is the fourth, and last, in a series of TOTM blog posts discussing the Commission’s recently published Google Android decision (the first post can be found here, and the second here, and the third here). It draws on research from a soon-to-be published ICLE white paper.
The previous parts of this series have mostly focused on the Commission’s factual and legal conclusions. However, as this blog post points out, the case’s economic underpinnings also suffer from important weaknesses.
Two problems are particularly salient: First, the economic models cited by the Commission (discussed in an official paper, but not directly in the decision) poorly match the underlying facts. Second, the Commission’s conclusions on innovation harms are out of touch with the abundant economic literature regarding the potential link between market structure and innovation.
The wrong economic models
The Commission’s Chief Economist team outlined its economic reasoning in an article published shortly after the Android decision was published. The article reveals that the Commission relied upon three economic papers to support its conclusion that Google’s tying harmed consumer welfare.
Each of these three papers attempts to address the same basic problem. Ever since the rise of the Chicago-School, it is widely accepted that a monopolist cannot automatically raise its profits by entering an adjacent market (i.e. leveraging its monopoly position), for instance through tying. This has sometimes been called the single-monopoly-profit theory. In more recent years, various scholars have refined this Chicago-School intuition, and identified instances where the theory fails.
While the single monopoly profit theory has been criticized in academic circles, it is important to note that the three papers cited by the Commission accept its basic premise. They thus attempt to show why the theory fails in the context of the Google Android case.
Unfortunately, the assumptions upon which they rely to reach this conclusion markedly differ from the case’s fact pattern. These papers thus offer little support to the Commission’s economic conclusions.
For a start, the authors of the first paper cited by the Commission concede that their own model does not apply to the Google case:
Actual antitrust cases are fact-intensive and our model does not perfectly fit with the current Google case in one important aspect.
The authors thus rely on important modifications, lifted from a paper by Frederico Etro and Cristina Caffara (the second paper cited by the Commission), to support their conclusion that Google’s tying was anticompetitive.
The second paper cited by the Commission, however,is equally problematic.
The authors’ underlying intuition is relatively straightforward: because Google bundles its suite of Google Apps (including Search) with the Play Store, a rival search engine would have to pay a premium in order to be pre-installed and placed on the home screen, because OEMs would have to entirely forgo Google’s suite of applications. The key assumption here is that OEMs cannot obtain the Google Play app and pre-install and place favorably a rival search app.
But this is simply not true of Google’s contractual terms. The best evidence is that rivals search apps have indeed concluded deals with OEMs to pre-install their search apps, without these OEMs losing access to Google’s suite of proprietary apps. Google’s contractual terms simply do not force OEMs to choose between the Google Play app and the pre-installation of a rival search app. Etro and Caffara’s model thus falls flat.
More fundamentally, even if Google’s contractual terms did prevent OEMs from pre-loading rival apps, the paper’s conclusions would still be deeply flawed. The authors essentiallyassume that the only way for consumers to obtain a rival app is through pre-installation. But this is a severe misreading of the prevailing market conditions.
Users remain free to independently download rival search apps. If Google did indeed purchase exclusive pre-installation, users would not have to choose between a “full Android” device and one with a rival search app but none of Google’s apps. Instead, they could download the rival app and place it alongside Google’s applications.
A more efficient rival could even provide side payments, of some sort, to encourage consumers to download its app. Exclusive pre-installation thus generates a much smaller advantage than Etro and Caffara assume, and their model fails to reflect this.
Finally, the third paper by Alexandre de Cornière and Greg Taylor, suffers from the exact same problem. The authors clearly acknowledge that their findings only hold if OEMs (and consumers) are effectively prevented from (pre-)installing applications that compete with Google’s apps. In their own words:
Upstream firms offer contracts to the downstream firm, who chooses which component(s) to use and then sells to consumers. For our theory to apply, the following three conditions need to hold: (i) substitutability between the two versions of B leads the downstream firm to install at most one version.
The upshot is that all three of the economic models cited by the Commission cease to be relevant in the specific context of the Google Android decision. The Commission is thus left with little to no economic evidence to support its finding of anticompetitive effects.
Critics might argue that direct downloads by consumers are but a theoretical possibility. Yet nothing could be further from the truth. Take the web browser market: The Samsung Internet Browser has more than 1 Billion downloads on Google’s Play Store. The Opera, Opera Mini and Firefox browsers each have over a 100 million downloads. The Brave browser has more than 10 million downloads, but is growing rapidly.
In short the economic papers on which the Commission relies are based on a world that does not exist. They thus fail to support the Commission’s economic findings.
An incorrect view of innovation
In its decision, the Commission repeatedly claimed that Google’s behavior stifled innovationbecause it prevented rivals from entering the market. However, the Commission offered no evidence to support its assumption that reduced market entry on would lead to a decrease in innovation:
(858) For the reasons set out in this Section, the Commission concludes that the tying of the Play Store and the Google Search app helps Google to maintain and strengthen its dominant position in each national market for general search services, increases barriers to entry, deters innovation and tends to harm, directly or indirectly, consumers.
(859) First, Google’s conduct makes it harder for competing general search services to gain search queries and the respective revenues and data needed to improve their services.
(861) Second, Google’s conduct increases barriers to entry by shielding Google from competition from general search services that could challenge its dominant position in the national markets for general search services:
(862) Third, by making it harder for competing general search services to gain search queries including the respective revenues and data needed to improve their services, Google’s conduct reduces the incentives of competing general search services to invest in developing innovative features, such as innovation in algorithm and user experience design.
In a nutshell, the Commission’s findings rest on the assumption that barriers to entry and more concentrated market structures necessarily reduce innovation. But this assertion is not supported by the empirical economic literature on the topic.
For example, a 2006 paper published by Richard Gilbert surveys 24 empirical studies on the topic. These studies examine the link between market structure (or firm size) and innovation. Though earlier studies tended to identify a positive relationship between concentration, as well as firm size, and innovation, more recent empirical techniques found no significant relationship. Gilbert thus suggests that:
These econometric studies suggest that whatever relationship exists at a general economy-wide level between industry structure and R&Dis masked by differences across industriesin technological opportunities, demand, and the appropriability of inventions.
This intuition is confirmed by another high-profile empirical paper by Aghion, Bloom, Blundell, Griffith, and Howitt. The authors identify an inverted-U relationship between competition and innovation. Perhaps more importantly, they point out that this relationship is affected by a number of sector-specific factors.
Finally, reviewing fifty years of research on innovation and market structure, Wesley Cohen concludes that:
Even before one controls for industry effects, the variance in R&D intensity explained by market concentration is small. Moreover, whatever relationship that exists in cross sections becomes imperceptible with the inclusion of controls for industry characteristics, whether expressed as industry fixed effects or in the form of survey-based and other measures of industry characteristics such as technological opportunity, appropriability conditions, and demand. In parallel to a decades-long accumulation of mixed results, theorists have also spawned an almost equally voluminous and equivocal literature on the link between market structure and innovation.
The Commission’s stance is further weakened by the fact that investments in the Android operating system are likely affected by a weak appropriability regime. In other words, because of its open source nature, it is hard for Google to earn a return on investments in the Android OS (anyone can copy, modify and offer their own version of the OS).
Loosely tying Google’s proprietary applications to the OS is arguably one way to solve this appropriability problem. Unfortunately, the Commission brushed these considerations aside. It argued that Google could earn some revenue from the Google Play app, as well as other potential venues. However, the Commission did not question whether these sources of income were even comparable to the sums invested by Google in the Android OS. It is thus possible that the Commission’s decision will prevent Google from earning a positive return on some future investments in the Android OS, ultimately causing it to cut back its investments and slowing innovation.
The upshot is that the Commission was simply wrong to assume that barriers to entry and more concentrated market structures would necessarily reduce innovation. This is especially true, given that Google may struggle to earn a return on its investments, absent the contractual provisions challenged by the Commission.
In short, the Commission’s economic analysis was severely lacking. It relied on economic models that had little to say about the market it which Google and its rivals operated. Its decisions thus reveals the inherent risk of basing antitrust decisions upon overfitted economic models.
As if that were not enough, the Android decision also misrepresents the economic literature concerning the link (or absence thereof) between market structure and innovation. As a result, there is no reason to believe that Google’s behavior reduced innovation.