Archives For Bill Kovacic

Today, a group of eighteen scholars, of which I am one, filed an amicus brief encouraging the Supreme Court to review a Court of Appeals decision involving loyalty rebates.  The U.S. Court of Appeals for the Third Circuit recently upheld an antitrust judgment based on a defendant’s loyalty rebates even though the rebates resulted in above-cost prices for the defendant’s products and could have been matched by an equally efficient rival.  The court did so because it decided that the defendant’s overall selling practices, which involved no exclusivity commitments by buyers, had resulted in “partial de facto exclusive dealing” and thus were not subject to the price-cost test set forth in Brooke Group.  (For the uniniated, Brooke Group immunizes price cuts that result in above-cost prices for the discounter’s goods.)  We amici, who were assembled by Michigan Law’s Dan Crane, believe the Third Circuit’s decision threatens to chill proconsumer discounting practices and should be overruled.

The defendant in the case, Eaton, manufactures transmissions for big trucks (semis, cement trucks, etc.).  So did plaintiff Meritor.  Eaton and Meritor sold their products to the four manufacturers of big trucks.  Those “OEMs” installed the transmissions into the trucks they sold to end-user buyers, who typically customized their trucks and thus could select whatever transmissions they wanted.  Meritor claimed that Eaton drove it from the market by entering into purportedly exclusionary “long-term agreements” (LTAs) with the four OEMs.  The agreements did not require the OEMs to purchase any particular amount of Eaton’s products, but they did provide the OEMs with rebates (resulting in above-cost prices) if they bought high percentages of their requirements from Eaton.  The agreements also provided that Eaton could terminate the agreements if the market share targets were not met. Each LTA contained a “competitiveness clause” that allowed the OEM to purchase transmissions from another supplier without counting the purchases against the share target, or to terminate the LTA altogether, if another supplier offered a lower price or better product and Eaton could not match that offering.  Following adoption of the LTAs, Eaton’s market share grew, and Meritor’s shrank.  Before withdrawing from the U.S. market altogether, Meritor filed an antitrust action against Eaton.

Eaton insisted, not surprisingly, that it had simply engaged in hard competition.  It grew its market share by offering a lower price that an equally efficient rival could have matched.  Meritor’s failure, then, resulted from either its relative inefficiency or its unwillingness to lower its price to the level of its cost.  By immunizing above-cost discounted prices from liability, the Brooke Group rule permits and encourages the sort of competition in which Eaton engaged, and it should, the company argued, control here.

The Third Circuit disagreed.  This was not, the court said, a simple case of price discounting.  Instead, Eaton had engaged in what the court called “partial de facto exclusive dealing.”  The exclusive dealing was “partial”  because OEMs could purchase some transmissions from other suppliers and still obtain Eaton’s loyalty rebates (i.e., complete exclusivity was not required).  It was “de facto” because purchasing exclusively (or nearly exclusively) from Eaton was not contractually required but was instead simply the precondition for earning a rebate.  Nonetheless, reasoned the court, the gravamen of Meritor’s complaint was some sort of exclusive dealing, which is evaluated not under Brooke Group but instead under a rule of reason that focuses on the degree to which the seller’s practices foreclose its rivals from available sales opportunities.  Under that test, the court concluded, the judgment against Eaton could be upheld.  After all, Eaton’s sales practices won lots of business from Meritor, whose sales eventually shrunk so much that the company exited the market.

As we amici point out in our brief to the Supreme Court, the Third Circuit ignored the fact that it was Eaton’s discounts that led OEMs to buy so much from the company (and forego its rival’s offerings).  Absent an actual promise to buy a high level of one’s requirements from a seller, any “exclusive dealing” resulting from a loyalty rebate scheme results from the fact that buyers voluntarily choose to patronize the seller over its competitors because the discounter’s products are cheaper.  In other words, low pricing is the very means by which any “exclusivity” — and, hence, any market foreclosure — is achieved.  Any claim alleging that an agreement not mandating a certain level of purchases but instead providing for loyalty rebates results in “partial de facto exclusive dealing” is therefore, at its heart, a complaint about price competition.  Accordingly, it should be subject to the Brooke Group screening test for discounts resulting in above-cost pricing.

The Third Circuit wrongly insisted that Eaton had done something more sinister than win business by offering above-cost loyalty rebates.  It concluded that Eaton “essentially forced” the four OEMs (who likely had a good bit of buyer market power themselves) to accept its terms by threatening “financial penalties or supply shortages.”  But these purported “penalties” and threats of “supply shortages” appear nowhere in the record.

The only “penalty” an OEM would have incurred by failing to meet a purchase target is the denial of a rebate from Eaton.  If that’s enough to make Brooke Group inapplicable, then any conditional price cut resulting in an above-cost price falls outside the decision’s safe harbor, for failure to meet the discount condition would subject buyers to a “penalty.”  Proconsumer price competition would surely be chilled by such an evisceration of Brooke Group.  As for threats of supply shortages, the only thing Meritor and the Third Circuit could point to was Eaton’s contractual right to cancel its LTAs if OEMs failed to meet purchase targets.  But if that were enough to make Brooke Group inapplicable, then the decision’s price-cost test could never apply when a dominant seller offers a conditional rebate or discount.  Because the seller could refuse in the future to supply buyers who fail to qualify for the discount, there would be, under the Third Circuit’s reasoning, not just a loyalty rebate but also an implicit threat of “supply shortages” for buyers that fail to meet the seller’s purchase targets.

This is not the first case in which a plaintiff has sought to evade a price-cost test, and thereby impose liability on a discounting scheme that would otherwise pass muster, by seeking to recharacterize the defendant’s conduct.  A few years back, a plaintiff (Masimo) sought to evade the Ninth Circuit’s PeaceHealth decision, which creates a Brooke Group-like safe harbor for certain bundled discounts that could not exclude equally efficient rivals, by construing the defendant’s conduct as “de facto exclusive dealing.”  Dan Crane and I participated as amici in that case as well.

I won’t speak for Dan, but I for one am getting tired of working on these briefs!  It’s time for the Supreme Court to clarify that prevailing price-cost safe harbors cannot be evaded simply through the use of creative labels like “partial de facto exclusive dealing.”  Hopefully, the Court will heed our recommendation that it review — and overrule — the Third Circuit’s Meritor decision.

[In case you’re interested, the other scholars signing the brief urging cert in Meritor are Ken Elzinga (Virginia Econ), Richard Epstein (NYU and Chicago Law), Jerry Hausman (MIT Econ), Rebecca Haw (Vanderbilt Law), Herb Hovenkamp (Iowa Law), Glenn Hubbard (Columbia Business), Keith Hylton (Boston U Law), Bill Kovacic (GWU Law), Alan Meese (Wm & Mary Law), Tom Morgan (GWU Law), Barak Orbach (Arizona Law), Bill Page (Florida Law), Robert Pindyck (MIT Econ), Edward Snyder (Yale Mgt), Danny Sokol (Florida Law), and Robert Topel (Chicago Business).]

An interesting new joint venture between Oxford University Press, Ariel Ezrachi, and Bill Kovacic (GW).  Sounds like a fantastic idea and with top notch management and might be of interest to many of our readers.

The Journal of Antitrust Enforcement 

Call for Papers – The Journal of Antitrust Enforcement (OUP) Oxford University Press is delighted to announce the launch of a new competition law journal dedicated to antitrust enforcement. The Journal of Antitrust Enforcement forms a joint collaboration between OUP, the Oxford University Centre for Competition Law and Policy and the George Washington University Competition Law Center.

The Journal of Antitrust Enforcement will provide a platform for cutting edge scholarship relating to public and private competition law enforcement, both at the international and domestic levels.

The journal covers a wide range of enforcement related topics, including: public and private competition law enforcement, cooperation between competition agencies, the promotion of worldwide competition law enforcement, optimal design of enforcement policies, performance measurement, empirical analysis of enforcement policies, combination of functions in the mandate of the competition agency, competition agency governance, procedural fairness, competition enforcement and human rights, the role of the judiciary in competition enforcement, leniency, cartel prosecution, effective merger enforcement and the regulation of sectors.

Submission of papers: Original articles that advance the field are published following a peer and editorial review process. The editors welcome submission of papers on all subjects related to antitrust enforcement. Papers should range from 8,000 to 15,000 words (including footnotes) and should be prefaced by an abstract of less than 200 words.

General inquiries may be directed to the editors: Ariel Ezrachi at the Oxford CCLP or William Kovacic at George Washington University. Submission, by email, should be directed to the Managing Editor, Hugh Hollman.

Further information about the journal may be found online:

Judge Ginsburg and I are working on a project for an upcoming festschrift in honor of Bill Kovacic.  The project involves the role of settlements in the pursuit of the goals of antitrust.  In particular, we are looking for examples of antitrust settlements between competition agencies and private parties — in the U.S. or internationally — involving conditions either: (1) clearly antithetical to consumer welfare, or (2) that arguably disserve consumer welfare.  In the former category, examples might include conditions requiring firms to make employment commitments.  The second category might include conditions placing the agency in an ongoing regulatory role or restricting the firm’s ability to engage in consumer-welfare increasing price or non-price competition.

I turn to our learned TOTM readership for help.  Please feel free to leave examples in the comments here — or email me.  Cites and links appreciated.

FTC Chairman Leibowitz recently gave a speech in which he took on a number of issues, but one in particular caught my eye.  In a portion of the speech describing how antitrust has updated its procedures in order to become more efficient and avoid the problem of having decade-long cases focused upon technologies that are obsolete by the time the case is resolved, Leibowitz offers the following example of Commission success:

The best, recent example of the need to move quickly in the high-tech area is our recent Intel case.11 Our investigation of Intel started out very slowly and went on for quite some time, but once the Commission issued process and then a complaint, the litigation proceeded with alacrity and ended with a consent less than a year later.

We think the remedies in the consent do much to protect consumers while still allowing Intel to innovate, develop, and sell new products. And I am proud of the relationship that we have been able to maintain with Intel since then. Still, we might have gained more for consumers: much was lost in the years between the start of the investigation and the litigation’s conclusion, and competition for CPUs and other components in personal computers might have been different had we moved faster initially. And moving quickly might have been fairer to Intel too.

As a result of what we have learned from Intel and other cases, the Commission is no longer bogged down in outmoded procedures. Much of what we’ve done at the Commission in recent years has been to make us better at getting to the bottom of investigations and resolving them faster to ensure that businesses get certainty and consumers get protection quickly. That was at the heart of the changes to our Part 3 rules, you get an antitrust trial, and it is implicit in every effort we make to learn more about industries and develop our internal expertise. We have also pushed to make “go/no go” decisions on investigations earlier so that they don’t linger on. All this reduces expenses and, I believe, allows us to act with a lighter hand.

There is a lot about this strikes me as misguided.

First, lets start broadly.  Striking quickly and striking accurately are two different things.  As John Wooden famously says “never mistake activity for achievement.”  Bill Kovacic has emphasized that case counts alone (nor win rates alone) are not very informative regarding agency performance.   Claims of agency success based upon activity levels in extracting settlements and such should be viewed skeptically without evidence that the activity prevented anticompetitive activity and improved consumer welfare.  Doing things faster doesn’t mean doing them any better.

Second, so what about accuracy?  If Intel is the “best example” the Chairman can come up with of antitrust enforcement in high-tech industries, this is not a good sign for the Commission.  I’ve written quite a bit about the Intel complaint and settlement — and so won’t belabor the point here — but suffice it to say that the evidence does not support the claim that the settlement improved consumer outcomes.  In fact, consumers are probably worse off in my view.  Reasonable minds may differ on these points but it is difficult to evaluate the evidence and come away confident that the settlement is as successful as claimed.  And that’s not even counting the peculiar endorsement it gives Lepage’s, which has been overwhelming condemned a standard which threatens pro-consumer conduct.

Third, the Chairman writes: “And I am proud of the relationship that we have been able to maintain with Intel since then.”  Ugh.  Developing longstanding relationships with Intel and other companies is not something for the Commission to be proud of.  Its just not.  In this case, the relationship derives from the product design elements of the Intel settlement.  Remember this language?

Respondent shall not make any engineering or design change to a Relevant Product if that change (1) degrades the performance of a Relevant Product sold by a competitor of Respondent and (2) does not provide an actual benefit to the Relevant Product sold by Respondent, including without limitation any improvement in performance, operation, cost, manufacturability, reliability, compatibility, or ability to operate or enhance the operation of another product; provided, however, that any degradation of the performance of a competing product shall not itself be deemed to be a benefit to the Relevant Product sold by Respondent. Respondent shall have the burden of demonstrating that any engineering or design change at issue complies with Section V. of this Order.

I’m sure Intel’s lawyers and engineers have a fine relationship with the FTC.  But lets not mistake that with agency success or something that consumers should celebrate.

Never mistake activity with achievement.

Attorneys earn excess rents by maintaining barriers to entering the legal profession.  Legislation and regulation expanding the scope of work that only an attorney legally can perform is an obvious way in which attorneys attempt to expand or protect the market for their services.  The FTC has a long history of trying to convince state legislators and courts that expanding the scope of the practice of law is likely to have unjustified anticompetitive consequences.   A more subtle way attorneys limit competition for legal services is by interpreting existing legislation and rules in a manner that expands the universe of practices that are considered “unethical” or “unauthorized practice of law.”  In this symposium, I will address the application of antitrust law to this conduct.

The Legal practice no stranger to antitrust scrutiny.  Indeed, in several seminal antitrust cases the Supreme Court has grappled with the tension between a national policy in favor of competition and states’ abilities as sovereigns to regulate the practice of law.  See e.g., Bates v. State Bar of Arizona; Goldfarb v. Virginia; Hoover v. Ronwin.  Taken together, what these cases make clear that entry barriers erected directly by the state supreme court acting in its legislative capacity are ipso facto exempt from antitrust scrutiny as acts of the state sovereign.  Agreements among private attorneys (e.g., via a private state bar association as opposed to a mandatory state bar) to set competitively sensitive variables (like price and advertising), on the other hand, clearly are not unless both the “clear articulation” and “active supervision” tests from Midcal are met.  One area that has yet to be addressed, but which I think merits closer attention, is the use of ethics opinions or threats of enforcement for violations of ethical codes to limit competition in the market for legal services.

Let me provide a hypothetical to motivate this discussion:

  • Imagine a firm that uses a website to match attorneys with potential clients.  The site works like this:  you post on the website that you’re looking for someone to draft partnership agreements under Virginia law for your new business; attorneys who have paid to participate in the platform see your request, and, if interested, post a reply describing their qualifications and in some cases price.  The website make money from attorney subscriptions.  Recently, however, the state bar ethics committee issued an ethical opinion that participation in this platform would violate the state bars’ ethics rules by constituting and illegal payment to a non-attorney (the web site) for a referral.  Now, as an attorney in State X, you have a dilemma.  The website has been quite useful in helping you build your practice, but if you continue to participate, you risk being sued – either by an arm of the state bar, or a private attorney acting to protect the integrity of the legal practice – for violation of ethical rules.  The possible penalties (in addition to legal and opportunity costs to address any ethical challenge) could include fines, suspension, or even disbarment.

In this case, the state has not issued a new rule or regulation that explicitly expands the legal monopoly.  Instead, a group of attorneys (who most likely do not work full time for the state bar) have merely opined on what the state ethics rules require.  This opinion, however, has the practical effect of discouraging use of the online legal platform by threating legal sanctions.   In this manner, it has a clear anticompetitive effect of reducing consumer choice and retarding competition among attorneys.  Established attorneys with large client bases and existing referral systems operated by local bar associations, moreover, are likely to be the primary beneficiaries of this new opinion.

The interesting antitrust questions that arise in this scenario are (1) whether the state action doctrine protects this conduct; and (2) does this conduct constitute a restraint of trade.

Is This State Action?

Turning to the state action issue, the ethics committee of a state bar is not the sovereign, so its actions are not ipso facto immune from antitrust scrutiny.  Thus, a necessary condition for state action exemption is that the ethics committee was acting pursuant to a clearly articulated and affirmatively expressed state policy. Less clear, however, is whether this is also a sufficient condition for state action protection.  I argue that it is not, and that in addition the ethics committee must show that the state approved its decision to adopt an interpretation of the ethics rules that was likely to have anticompetitive effects.

Support for this position can be found in the FTC decision, In re North Carolina State Board of Dental Examiners (NCDE), (Feb. 8, 2011).  NCDE concerned a state dental regulatory board composed of private dentists that had sent cease and desist letters to non-dentists who performed teeth whitening procedures.  The Board acted on its interpretation that these non-dentists were engaging in the unauthorized practice of dentistry.  The Dental Board, however, lacked the authority to enjoin anyone from teeth whitening; its statute only allowed it to file a complaint in state court alleging unauthorized practice of dentistry.  The Board claimed state action exemption, arguing that as a state subdivision it needed only to show that it satisfied the clear articulation prong of the Midcal test.  The FTC disagreed, and held that to enjoy state action protection the Board also must show that the state actively supervised its decision to issue the cease and desist letters. (Id. at 9-11).

The important factor in the FTC analysis was its conclusion that the Dental Board’s interests were insufficiently independent from the interest of those it was regulating.  Turning to first principles, the Commission explained:

[I]f a state permits private conduct to go unchecked by market forces, the only assurance the electorate can have that the private parties will act in the public interest is if the state is politically accountable for any resulting anticompetitive conduct . . . .  Decisions that are made by private parties who participate in the market that they regulate are not subject to these political constraints unless these decisions are reviewed by disinterested state actors to assure fealty to state policy.

Id. at 10-11.  The Commission went on to find that the state of North Carolina had not supervised the Dental Board’s decision to classify teeth whitening as the practice of dentistry, thereby restraining competition in the market for teeth whitening, “was subject to any supervision, let along sufficient supervision to convert the Board’s conduct into that of the state of North Carolina. “ Id. at 17.

The reasoning in NCDE is equally applicable to expansive interpretation of rules or statutes to limit competition in legal services.  For example, in the above hypothetical, the ethics committee’s opinion should not enjoy state action protection unless the committee can show that the state reviewed and approved its decision to limit competition.  True, this rule will impose costs, but as I (along with Bill Kovacic) have argued elsewhere (see 90 B.U.L. Rev. 1555, 1597 (2010)) this is the price a state must pay if it wants to circumvent the national policy in favor of competition.  In deference to federalism, Parker and its progeny allow states to adopt policies that contravene the antitrust laws.  But regulatory bodies comprising unelected market participants are not sovereign, so deference to their anticompetitive policies does not vindicate the federalism principles that animate the state action doctrine.   What’s more, these bodies are likely to pose a greater risk to competition than elected officials, who at least are politically accountable for the anticompetitive policies that they pursue.

Finally, I argue that ex post review by a state court of decisions by ethics committees that expand the definition of the practice of law or that suggest some new practice is unethical should be insufficient to constitute active state supervision.   The active supervision prong of Midcal requires the state to approve prices set by a private cartel before they go into effect, so logically it should also require the state to approve ex ante an ethics committee’s decision to interpret ethical rules in a manner that is likely to restrain competition in the market for legal services.

Restraint of Trade?

Even if the ethical committee’s actions are not protected by the state action doctrine, we must also address a second question:  does the ethics committee’s opinion constitute a restraint of trade under the antitrust laws?  In Schachar v. Am. Academy  of Ophthalmology, 870 F.2d 397 (7th Cir. 1989), an ophthalmologist challenged the AAO under the antirust laws for opining that radial keratotomy was an experimental procedure.  Judge Easterbrook held that this could not be a restraint because although the AAO’s opinions carried weight due to its reputation, it had no power to prevent anybody from performing radial keratotomy.   Could the same issue exist for my hypothetical?  Is an opinion by the ethics committee no different from that of a trade association or an expert body?  I argue no, because unlike that AAO in Schachar, the ethics committee is acting under the color of law, which provides a reasonable basis for attorneys licensed in State X to believe that they risk state sanction if they fail to heed the warning.

Again, NCDE is illuminating.  Following the Commission’s state action decision, and after a full trial, the ALJ found that the Board’s conduct related to non-dentist teeth whiteners constituted an unreasonable restraint of trade. (see   He based this finding on two grounds: the nature of the Board’s conduct coupled with its power to exclude competitors, which flowed from the fact that it was a state agency; and evidence that the Board’s actions actually caused some non-dentist teeth whiteners to exit the marketplace.   It would be hard to distinguish a state bar’s ethics committee’s expansive interpretation of an ethical requirement from the facts in NCDE; both regulatory bodies have the power to exclude competition because their opinions, unlike those of a private association, carry the possibility of legal sanction for non-compliance.

UPDATE 3:  It just keeps getting better.  Now we’ve added Mike Baye, formerly Director of the Bureau of Economics at the FTC, now returned to his post at Indiana.  He’ll be moderating and I’m sure commenting on many of the papers. 

UPDATE 2: And now Susan DeSanti, newly-appointed Director of the Office of Policy and Planning at the FTC has signed on for our industry/regulator roundtable.  A not-to-be-missed event! 

UPDATE:  We’re delighted to announce that Bill Kovacic will be joining us to deliver the conference’s morning keynote, as well.  A great conference just got even better!

 For the third year, Josh and I have organized the annual George Mason Law School/Microsoft Conference on the Law and Economics of Innovation.  The conference is at the Arlington Hilton on May 7; registration is free. 

This year’s conference is on “Online Markets vs. Traditional Markets,” and once again we have a stellar line-up.  The (beautifully re-designed) conference website is here.  You can register for the conference here

This year features a keynote address from Susan Athey (Harvard Economics; Clark Medal winner), as well as the following presentations:

Peter Klein (Missouri Economics)– Does the New Economy Need a New Economics?
Thomas W. Hazlett (George Mason Law) – The Role of Exclusive Spectrum Rights in Wireless Network Innovations: Of Newtons, Blackberries, iPhones & G-Phones
Eric Goldman (Santa Clara Law) – The Economics of Reputational Information

Florencia Marotta-Wurgler (NYU Law) – Does Anyone Read Fine Print? A Test of the Informed Minority Hypothesis
Howard Beales (George Washington Business) – Public Goods, Private Information, and Anonymous Transactions: Providing a Safe and Interesting Internet
Peter Swire (Ohio State Law) – Privacy and Antitrust

Philip J. Weiser (Colorado Law; DOJ)— Re-evaluating the Theory and Realities of Online Contracts
Randal C. Picker (Chicago Law) — The Mediated Book
F. Scott Kieff (Wash U. Law (moving to George Washington Law)) — Commerce in the Shadow of the Commons: Business Models in Cyberspace

We’ll also have an industry roundtable to reflect on the day with representatives from Microsoft, Amazon and Facebook.

Should be a great conference–Please join us!

Michael Carrier has written a timely and interesting book.  Like Dan, I’m still digesting it (which means, in translation: I have not yet read every word).  There is much to like about the book, in particular its accessible format and content.  I do fear that it is a bit overly ambitious, however, hoping both to educate the completely un-initiated as well as to develop a more advanced agenda, and at times it reads like two separate books.

I suppose related to this criticism are my more detailed comments, which perhaps distill down to this: The book repeatedly and appropriately canvasses both sides of some pretty heated debates, nicely presenting the most basic arguments, and suggesting if not saying that these are matters about which we are profoundly uncertain.  Nevertheless, with what seems to me to be little support (and with only essentially-anecdotal empirical support), Carrier then chooses sides. 

For example, as I discuss a bit more below, the concept of the innovation market is contentious and unsettled.  Carrier presents truncated versions of both sides of this debate and then summarily votes in favor of innovation markets, slyly offering to confine the analysis to pharmaceutical industry mergers, but nevertheless offering a “framework for innovation-market analysis.”  Frankly, the framework strikes me as little more than a stylized merger analysis under the Guidelines, with a “Schumpeterian Defense” thrown in for good measure (but extremely limited, and essentially the same as the traditional failing firm defense).  I see little here to suggest that the innovation market analysis, even as styled by Carrier, will do much effectively to incorporate dynamic efficiency concerns into antitrust.  And there are other examples.  I would have preferred to see a book that went into far greater depth in defending these sorts of choices among uncertain alternatives.

In more detail:  First off, the arc of the introductory section on antitrust is familiar: A swinging pendulum from under- to over-enforcement (and back again) describes the history of antitrust, and the optimal is somewhere in the middle.  But Bill Kovacic has masterfully decimated this argument before (although that hasn’t stopped it persisting: to wit Commissioner Rosch’s 2007 speech on US and EU antitrust enforcement asking again if the pendulum has swung too far.)  As Kovacic says

It is bad enough that the narrative distorts actual enforcement experience to accentuate the pendulum’s movements. Worse, by obscuring the actual path of policy, the pendulum narrative impedes our understanding of how federal antitrust enforcement has developed and of what antitrust agencies must do to improve the quality of competition policy in the future.

Kovacic is surely correct that a more nuanced analysis of US antitrust history identifies far less of a pendulum and rather a consistent evolution.

Carrier’s book bolsters the historical narrative with the traditional theoretical one:  Crandall and Winston versus Baker: Antitrust enforcement is costly and harmful versus “no it’s not.” (Actually Baker’s argument is more complex than that, but that’s the basic idea).  But, alas, Baker relies primarily on four lax experiments as described on p. 67 of Carrier’s book to support the contention that . . . less enforcement leads to more cartels.  Well, sure.  Where enforcement is more lax, you get more cartels.  But nothing in the examples supports the notion that less enforcement leads to more monopolization, and nothing supports the notion that less enforcement against monopolies is harmful to society.  (The examples aren’t really great at supporting the notion that lax enforcement of more nuanced forms of concerted action than cartels harms consumers, either).  But this book is largely about unilateral conduct (and to a lesser extent mergers), not cartels, so it’s not at all clear to me that Baker’s work refutes the relevant portions of Crandall & Winston for present purposes.

Moreover, it has to be said that the actual evidence on mergers is really mixed, as a recent NERA study in Antitrust makes clear.

This all may seem like a quibble about an introductory point, but it’s much more than that.  I can’t help but notice that everyone who adopts the pendulum narrative does so to make the point that today’s antitrust enforcement is too lax and should be beefed up—history demands it.  This book is no exception.  But, of course, starting from the point of view that more antitrust is good for innovation, it is not surprising that Carrier finds this to be true throughout the book.  Meanwhile, the actual evidence says something pretty close to “reduced antitrust may result in more cartel activity”—which Adam Smith said, too, and which is a far more limited claim.

The primary focus for Carrier in discussing antitrust and innovation is so-called “innovation markets.” These are, in essence, markets consisting of R&D (as opposed to the traditional antitrust analysis of product markets).  And as Carrier notes the theory behind innovation markets is that a merger between the only two, or two of a few, firms in R&D might increase the incentive to suppress at least one of the research paths.

That’s the theory, anyway.  But as Carrier himself points out (although he dismisses this criticism), “we do not know the market structure most conducive to innovation.”  We don’t know about the relationship between concentration and innovation what we know about the relationship between concentration and price—and we don’t even know much about that.  The evolution of unilateral effects analysis in modern merger thinking is that market concentration not a good predictor of effect.  Josh has a great forthcoming paper on this (forthcoming in a book Josh and I are editing together), and an early draft is here

The fundamental flaw in the innovation market concept is precisely this:  That we don’t know about the relationship between market structure and effect, and error costs are high.  The two—two—most fundamental flaws in the innovation market concept are precisely this:  That we don’t know about the relationship between market structure and effect, error costs are high, and competition is multidimensional.  The three—three—fundamental flaws in the innovation market concept are . . .

I won’t belabor the points here too much, but it’s pretty straightforward that a) increased concentration might actually be good for incentivizing R&D (increasing expected returns to investment), b) innovation is precisely where error costs are highest and you don’t have to believe all that Schumpeter wrote to get that, and c) competition is multidimensional, and while concentration might seem to harm consumers on one dimension, it may benefit them on another—and we don’t know the magnitude of the tradeoff, or even exactly how to make it.

On the first point, I would refer our readers to Schumpeter, of course, but also to another paper in our forthcoming book: “Rewarding Innovation Efficiently: The Case for Exclusive Rights,” by Vincenzo Denicolo and Luigi Franzoni.  The article demonstrates that, especially when innovations are large (in Carrier’s term, “drastic”), maximal rights (in the article, patent rights, but the concept should carry over into market structure, as well) incentivize optimal innovation, even though product market competition is weakened.   The odd thing is that Carrier draws precisely the opposite conclusion—that drastic innovations call for less, not more, concentration of returns.  But a significant body of literature suggests that in markets with leaders (monopolists) and endogenous entry (the more realistic assumption that entry is dependent on profitability rather than exogenously determined and independent of profitability), leaders will, if anything, overinvest in innovation.  See, for an excellent example, Federico Etro, “Endogenous Market Structure and Antitrust Policy.”An important point from that paper is summed up in a succinct quote from it:

A main point emerging from our analysis of the behavior of market leaders facing or not facing endogenous entry is that standard measures of the concentration of a market have no relation with the market power of the leaders and may lead to misleading welfare comparisons.

Just so, and I wonder why claims that market concentration are clearly bad for welfare, particularly in extremely ill-understood “innovation markets,” survive with no empirical support.

On the second, I would just point out that there is almost no discussion of error costs in the book—no discussion of bureaucratic agency issues, judicial process problems, public choice problems, and the like—other than to criticize excessive copyright protection for . . . precisely the same reason one might refrain from excessive antitrust enforcement.  Again, particularly when talking about unsettled concepts being enforced by imperfect agencies, I would like to see some more restraint.  To be fair, Carrier does try in several places to cabin the extent of his proposals (as I mentioned, (almost) confining the innovation market analysis to the pharmaceutical industry, for example), but I would have expected to see some justification for this cabining in clearer expressions of the kinds of institutional dysfunction that can systematically tar the antitrust enterprise.

Finally, on the third point (but more generally related to all three), referring to the critiques of the innovation market theory, Carrier writes:

There is an element of truth to each of these critiques.  In many cases we do not know all the potential innovators or the optimal relationship between R&D and innovation.  For that reason an expansive notion of the innovation-market concept is not appropriate.

How about the concept is not appropriate, full stop?  We’re talking about markets with—excuse my French—a lot of shit we don’t know.  Why are we intervening at all?  Why are we not, at most, attempting to incorporate a more dynamic analysis into our traditional assessment of product market structure and behavior?  Given the complex and poorly understood relationships between investment in R&D, market structure, price, quality, speed of innovation, and welfare effects, shouldn’t even the cabined notion of the innovation-market concept be viewed with extreme distrust?  Having set up the general framework, but then being forced to limit it to pharma mergers, I would like to see a firmer expression of uncertainty.

Let me finish with a comment on the applicability of the analysis even to the pharma industry: It’s not so clear cut, even there.  I’ll take just one example: Drastic versus nondrastic innovation.  Carrier claims that we do, in fact, know the optimal market structure for pharma in part because for drastic innovations (the sort common to pharma), “competition is superior to monopoly.”  I struggle to find the support for this contention in theory, but I know it is not true in practice that pharma trucks only in drastic innovation.  Of course, to some obvious extent this is true: Many of the most important innovations in the pharmaceutical industry are drastic.  But, in fact, although commonly dismissed by critics as a form of gaming the regulatory system, it is also true that pharmaceutical companies are constantly tweaking their products, changing chemical compositions slightly, changing pill coatings, changing dosages, etc.  These nondrastic changes, while certainly less, well, drastic, than the big breakthroughs, may be no less important.  The human body is a complex system, and I imagine Carrier and many other pharma industry critics are not physiologists.  I think the claim that these small adjustments amount to gaming the system and can be and should be deterred—or disregarded in designing the “optimal market structure” for the industry—is a faulty one, and a reflection more of what we don’t understand about complex, innovative industries than what we do.

I have much more to say about this thought-provoking book, but I’ll leave it for battle in the comments.