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A brief overview of the draft CWA GUIDELINES on licensing of SEPs for 5G and IoT

Natasha Nayak —  12 November 2018

An important but unheralded announcement was made on October 10, 2018: The European Committee for Standardization (CEN) and the European Committee for Electrotechnical Standardization (CENELEC) released a draft CEN CENELAC Workshop Agreement (CWA) on the licensing of Standard Essential Patents (SEPs) for 5G/Internet of Things (IoT) applications. The final agreement, due to be published in early 2019, is likely to have significant implications for the development and roll-out of both 5G and IoT applications.

CEN and CENELAC, which along with the European Telecommunications Standards Institute (ETSI) are the officially recognized standard setting bodies in Europe, are private international non profit organizations with a widespread network consisting of technical experts from industry, public administrations, associations, academia and societal organizations. This first Workshop brought together representatives of the 5G/Internet of Things (IoT) technology user and provider communities to discuss licensing best practices and recommendations for a code of conduct for licensing of SEPs. The aim was to produce a CWA that reflects and balances the needs of both communities.

The final consensus outcome of the Workshop will be published as a CEN-CENELEC Workshop Agreement (CWA). The draft, which is available for public comments, comprises principles and guidelines that prepare a foundation for future licensing of standard essential patents for fifth generation (5G) technologies. The draft also contains a section on Q&A to help aid new implementers and patent holders.

The IoT ecosystem is likely to have over 20 billion interconnected devices by 2020 and represent a market of $17 trillion (about the same as the current GDP of the U.S.). The data collected by one device, such as a smart thermostat that learns what time the consumer is likely to be at home, can be used to increase the performance of another connected device, such as a smart fridge. Cellular technologies are a core component of the IoT ecosystem, alongside applications, devices, software etc., as they provide connectivity within the IoT system. 5G technology, in particular, is expected to play a key role in complex IoT deployments, which will transcend the usage of cellular networks from smart phones to smart home appliances, autonomous vehicles, health care facilities etc. in what has been aptly described as the fourth industrial revolution.

Indeed, the role of 5G to IoT is so significant that the proposed $117 billion takeover bid for U.S. tech giant Qualcomm by Singapore-based Broadcom was blocked by President Trump, citing national security concerns. (A letter sent by the Committee on Foreign Investment in the US suggested that Broadcom might starve Qualcomm of investment, preventing it from competing effectively against foreign competitors–implicitly those in China.)

While commercial roll-out of 5G technology has not yet fully begun, several efforts are being made by innovator companies, standard setting bodies and governments to maximize the benefits from such deployment.

The draft CWA Guidelines (hereinafter “the guidelines”) are consistent with some of the recent jurisprudence on SEPs on various issues. While there is relatively less guidance specifically in relation to 5G SEPs, it provides clarifications on several aspects of SEP licensing which will be useful, particularly, the negotiating process and conduct of both parties.

The guidelines contain 6 principles followed by some questions pertaining to SEP licensing. The principles deal with:

  1. The obligation of SEP holders to license the SEPs on Fair, Reasonable and Non-Discriminatory (FRAND) terms;
  2. The obligation on both parties to conduct negotiations in good faith;
  3. The obligation of both parties to provide necessary information (subject to confidentiality) to facilitate timely conclusion of the licensing negotiation;
  4. Compensation that is “fair and reasonable” and achieves the right balance between incentives to contribute technology and the cost of accessing that technology;
  5. A non-discriminatory obligation on the SEP holder for similarly situated licensees even though they don’t need to be identical; and
  6. Recourse to a third party FRAND determination either by court or arbitration if the negotiations fail to conclude in a timely manner.

There are 22 questions and answers, as well, which define basic terms and touch on issues such as: what amounts as good faith conduct of negotiating parties, global portfolio licensing, FRAND royalty rates, patent pooling, dispute resolution, injunctions, and other issues relevant to FRAND licensing policy in general.

Below are some significant contributions that the draft report makes on issues such as the supply chain level at which licensing is best done, treatment of small and medium enterprises (SMEs), non disclosure agreements, good faith negotiations and alternative dispute resolution.

Typically in the IoT ecosystem, many technologies will be adopted of which several will be standardized. The guidelines offer help to product and service developers in this regard and suggest that one may need to obtain licenses from SEP owners for product or services incorporating communications technology like 3G UMTS, 4G LTE, Wi-Fi, NB-IoT, 31 Cat-M or video codecs such as H.264. The guidelines, however, clarify that with the deployment of IoT, licenses for several other standards may be needed and developers should be mindful of these complexities when starting out in order to avoid potential infringements.

Notably, the guidelines suggest that in order to simplify licensing, reduce costs for all parties and maintain a level playing field between licensees, SEP holders should license at one level. While this may vary between different industries, for communications technology, the licensing point is often at the end-user equipment level. There has been a fair bit of debate on this issue and the recent order by Judge Koh granting FTC’s partial summary motion deals with some of this.

In the judgment delivered on November 6, Judge Koh relied primarily on the 9th circuit decisions in Microsoft v Motorola (2012 and 2015)  to rule on the core issue of the scope of the FRAND commitments–specifically on the question of whether licensing extends to all levels or is confined to the end device level. The court interpreted the pro- competitive principles behind the non-discrimination requirement to mean that such commitments are “sweeping” and essentially that an SEP holder has to license to anyone willing to offer a FRAND rate globally. It also cited Ericsson v D-Link, where the Federal Circuit held that “compliant devices necessarily infringe certain claims in patents that cover technology incorporated into the standard and so practice of the standard is impossible without licenses to all incorporated SEP technology.”

The guidelines speak about the importance of non-disclosure agreements (NDAs) in such licensing agreements given that some of the information exchanged between parties during negotiation, such as claim charts etc., may be sensitive and confidential. Therefore, an undue delay in agreeing to an NDA, without well-founded reasons, might be taken as evidence of a lack of good faith in negotiations rendering such a licensee as unwilling.

They also provide quite a boost for small and medium enterprises (SMEs) in licensing negotiations by addressing the duty of SEP owners to be mindful of SMEs that may be less experienced and therefore lack information from which to draw assurance that proposed terms are FRAND. The guidelines provide that SEP owners should provide whatever information they can under NDA to help the negotiation process. Equally, the same obligation applies on a licensee who is more experienced in dealing with a SEP owner who is an SME.

There is some clarity on time frames for negotiations and the guidelines provide a maximum time that parties should take to respond to offers and counter offers, which could extend up to several months in complex cases involving hundreds of patents. The guidelines also prescribe conduct of potential licensees on receiving an offer and how to make counter-offers in a timely manner.

Furthermore, the guidelines lay down the various ways in which royalty rates may be structured and clarify that there is no one fixed way in which this may be done. Similarly, they offer myriad ways in which potential licensees may be able to determine for themselves if the rates offered to them are fair and reasonable, such as third party patent landscape reports, public announcements, expert advice etc.

Finally, in the case that a negotiation reaches an impasse, the guidelines endorse an alternative dispute mechanism such as mediation or arbitration for the parties to resolve the issue. Bodies such as International Chamber of Commerce and World Intellectual Property Organization may provide useful platforms in this regard.

Almost 20 years have passed since technology pioneer Kevin Ashton first coined the phrase Internet of Things. While companies are gearing up to participate in the market of IoT, regulation and policy in the IoT world seems far from a predictable framework to follow. There are a lot of guesses about how rules and standards are likely to shape up, with little or no guidance for companies on how to prepare themselves for what faces them very soon. Therefore concrete efforts such as these are rather welcome. The draft guidelines do attempt to offer some much needed clarity and are now open for public comments due by December 13. It will be good to see what the final CWA report on licensing of SEPs for 5G and IoT looks like.

 

In Antitrust & Competition, China, European Union, Intellectual Property, International, Patent, Platforms, Standard Setting, Telecommunications, Truth on the Market, Wireless , , , , , , ,
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Fourth Annual Heritage Foundation Antitrust Conference: A Quick Summary

Alden Abbott —  26 January 2018

On January 23rd, the Heritage Foundation convened its Fourth Annual Antitrust Conference, “Trump Antitrust Policy after One Year.”  The entire Conference can be viewed online (here).  The Conference featured a keynote speech, followed by three separate panels that addressed  developments at the Federal Trade Commission (FTC), at the Justice Department’s Antitrust Division (DOJ), and in the international arena, developments that can have a serious effect on the country’s economic growth and expansion of our business and industrial sector.

  1. Professor Bill Kovacic’s Keynote Speech

The conference started with a bang, featuring a stellar keynote speech (complemented by excellent power point slides) by GW Professor and former FTC Chairman Bill Kovacic, who also serves as a Member of the Board of the UK Government’s Competitive Markets Authority.  Kovacic began by noting the claim by senior foreign officials that “nothing is happening” in U.S. antitrust enforcement.  Although this perception may be inaccurate, Kovacic argued that it colors foreign officials’ dealings with the U.S., and continues a preexisting trend of diminishing U.S. influence on foreign governments’ antitrust enforcement systems.  (It is widely believed that the European antitrust model is dominant internationally.)

In order to enhance the perceived effectiveness (and prestige) of American antitrust on the global plane, American antitrust enforcers should, according to Kovacic, adopt a positive agenda citing specific priorities for action (as opposed to a “negative approach” focused on what actions will not be taken) – an orientation which former FTC Chairman Muris employed successfully in the last Bush Administration.  The positive engagement themes should be communicated powerfully to the public here and abroad through active public engagement by agency officials.  Agency strengths, such as FTC market studies and economic expertise, should be highlighted.

In addition, the FTC and Justice Department should act more like an “antitrust policy joint venture” at home and abroad, extending cooperation beyond guidelines to economic research, studies, and other aspects of their missions.  This would showcase the outstanding capabilities of the U.S. public antitrust enterprise.

  1. FTC Panel

A panel on FTC developments (moderated by Dr. Jeff Eisenach, Managing Director of NERA Economic Consulting and former Chief of Staff to FTC Chairman James Miller) followed Kovacic’s presentation.

Acting Bureau of Competition Chief Bruce Hoffman began by stressing that FTC antitrust enforcers are busier than ever, with a number of important cases in litigation and resources stretched to the limit.  Thus, FTC enforcement is neither weak nor timid – to the contrary, it is quite vigorous.  Hoffman was surprised by recent political attacks on the 40 year bipartisan consensus regarding the economics-centered consumer welfare standard that has set the direction of U.S. antitrust enforcement.  According to Hoffman, noted economist Carl Shapiro has debunked the notion that supposed increases in industry concentration even at the national level are meaningful.  In short, there is no empirical basis to dethrone the consumer welfare standard and replace it with something else.

Other former senior FTC officials engaged in a discussion following Hoffman’s remarks.  Orrick Partner Alex Okuliar, a former Attorney-Advisor to FTC Acting Chairman Maureen Ohlhausen, noted Ohlhausen’s emphasis on “regulatory humility” ( recognizing the inherent limitations of regulation and acting in accordance with those limits) and on the work of the FTC’s Economic Liberty Task Force, which centers on removing unnecessary regulatory restraints on competition (such as excessive occupational licensing requirements).

Wilson Sonsini Partner Susan Creighton, a former Director of the FTC’s Bureau of Competition, discussed the importance of economics-based “technocratic antitrust” (applied by sophisticated judges) for a sound and manageable antitrust system – something still not well understood by many foreign antitrust agencies.  Creighton had three reform suggestions for the Trump Administration:

(1) the DOJ and the FTC should stress the central role of economics in the institutional arrangements of antitrust (DOJ’s “economics structure” is a bit different than the FTC’s);

(2) both agencies should send relatively more economists to represent us at antitrust meetings abroad, thereby enabling the agencies to place a greater stress on the importance of economic rigor in antitrust enforcement; and

(3) the FTC and the DOJ should establish a task force to jointly carry out economics research and hone a consistent economic policy message.

Sidley & Austin Partner Bill Blumenthal, a former FTC General Counsel, noted the problems of defining Trump FTC policy in the absence of new Trump FTC Commissioners.  Blumenthal noted that signs of a populist uprising against current antitrust norms extend beyond antitrust, and that the agencies may have to look to new unilateral conduct cases to show that they are “doing something.”  He added that the populist rejection of current economics-based antitrust analysis is intellectually incoherent.  There is a tension between protecting consumers and protecting labor; for example, anti-consumer cartels may be beneficial to labor union interests.

In a follow-up roundtable discussion, Hoffman noted that theoretical “existence theorems” of anticompetitive harm that lack empirical support in particular cases are not administrable.  Creighton opined that, as an independent agency, the FTC may be a bit more susceptible to congressional pressure than DOJ.  Blumenthal stated that congressional interest may be able to trigger particular investigations, but it does not dictate outcomes.

  1. DOJ Panel

Following lunch, a panel of antitrust experts (moderated by Morgan Lewis Partner and former Chief of Staff to the Assistant Attorney General Hill Wellford) addressed DOJ developments.

The current Principal Deputy Assistant Attorney General for Antitrust, Andrew Finch, began by stating that the three major Antitrust Division initiatives involve (1) intellectual property (IP), (2) remedies, and (3) criminal enforcement.  Assistant Attorney General Makan Delrahim’s November 2017 speech explained that antitrust should not undermine legitimate incentives of patent holders to maximize returns to their IP through licensing.  DOJ is looking into buyer and seller cartel behavior (including in standard setting) that could harm IP rights.  DOJ will work to streamline and improve consent decrees and other remedies, and make it easier to go after decree violations.  In criminal enforcement, DOJ will continue to go after “no employee poaching” employer agreements as criminal violations.

Former Assistant Attorney General Tom Barnett, a Covington & Burling Partner, noted that more national agencies are willing to intervene in international matters, leading to inconsistencies in results.  The International Competition Network is important, but major differences in rhetoric have created a sense that there is very little agreement among enforcers, although the reality may be otherwise.  Muted U.S. agency voices on the international plane and limited resources have proven unfortunate – the FTC needs to engage better in international discussions and needs new Commissioners.

Former Counsel to the Assistant Attorney Eric Grannon, a White & Case Partner, made three specific comments:

(1) DOJ should look outside the career criminal enforcement bureaucracy and consider selecting someone with significant private sector experience as Deputy Assistant Attorney General for Criminal Enforcement;

(2) DOJ needs to go beyond merely focusing on metrics that show increased aggregate fines and jail time year-by-year (something is wrong if cartel activities and penalties keep rising despite the growing emphasis on inculcating an “anti-cartel culture” within firms); and

(3) DOJ needs to reassess its “amnesty plus” program, in which an amnesty applicant benefits by highlighting the existence of a second cartel in which it participates (non-culpable firms allegedly in the second cartel may be fingered, leading to unjustified potential treble damages liability for them in private lawsuits).

Grannon urged that DOJ hold a public workshop on the amnesty plus program in the coming year.  Grannon also argued against the classification of antitrust offenses as crimes of “moral turpitude” (moral turpitude offenses allow perpetrators to be excluded from the U.S. for 20 years).  Finally, as a good government measure, Grannon recommended that the Antitrust Division should post all briefs on its website, including those of opposing parties and third parties.

Baker and Botts Partner Stephen Weissman, a former Deputy Director of the FTC’s Bureau of Competition, found a great deal of continuity in DOJ civil enforcement.  Nevertheless, he expressed surprise at Assistant Attorney General Delrahim’s recent remarks that suggested that DOJ might consider asking the Supreme Court to overturn the Illinois Brick ban on indirect purchaser suits under federal antitrust law.  Weissman noted the increased DOJ focus on the rights of IP holders, not implementers, and the beneficial emphasis on the importance of DOJ’s amicus program.

The following discussion among the panelists elicited agreement (Weissman and Barnett) that the business community needs more clear-cut guidance on vertical mergers (and perhaps on other mergers as well) and affirmative statements on DOJ’s plans.  DOJ was characterized as too heavy-handed in setting timing agreements in mergers.  The panelists were in accord that enforcers should continue to emphasize the American consumer welfare model of antitrust.  The panelists believed the U.S. gets it right in stressing jail time for cartelists and in detrebling for amnesty applicants.  DOJ should, however, apply a proper dose of skepticism in assessing the factual content of proffers made by amnesty applicants.  Former enforcers saw no need to automatically grant markers to those applicants.  Andrew Finch returned to the topic of Illinois Brick, explaining that the Antitrust Modernization Commission had suggested reexamining that case’s bar on federal indirect purchaser suits.  In response to an audience question as to which agency should do internet oversight, Finch stressed that relevant agency experience and resources are assessed on a matter-specific basis.

  1. International Panel

The last panel of the afternoon, which focused on international developments, was moderated by Cadwalader Counsel (and former Attorney-Advisor to FTC Chairman Tim Muris) Bilal Sayyed.

Deputy Assistant Attorney General for International Matters, Roger Alford, began with an overview of trade and antitrust considerations.  Alford explained that DOJ adds a consumer welfare and economics perspective to Trump Administration trade policy discussions.  On the international plane, DOJ supports principles of non-discrimination, strong antitrust enforcement, and opposition to national champions, plus the addition of a new competition chapter in “NAFTA 2.0” negotiations.  The revised 2017 DOJ International Antitrust Guidelines dealt with economic efficiency and the consideration of comity.  DOJ and the Executive Branch will take into account the degree of conflict with other jurisdictions’ laws (fleshing out comity analysis) and will push case coordination as well as policy coordination.  DOJ is considering new ideas for dealing with due process internationally, in addition to working within the International Competition Network to develop best practices.  Better international coordination is also needed on the cartel leniency program.

Next, Koren Wong-Ervin, Qualcomm Director of IP and Competition Policy (and former Director of the Scalia Law School’s Global Antitrust Institute) stated that the Korea Fair Trade Commission had ignored comity and guidance from U.S. expert officials in imposing global licensing remedies and penalties on Qualcomm.  The U.S. Government is moving toward a sounder approach on the evaluation of standard essential patents, as is Europe, with a move away from required component-specific patent licensing royalty determinations.  More generally, a return to an economic effects-based approach to IP licensing is important.  Comprehensive revisions to China’s Anti-Monopoly Law, now under consideration, will have enormous public policy importance.  Balanced IP licensing rules, with courts as gatekeepers, are important.  Chinese law still has overly broad essential facilities and deception law; IP price regulation proposals are very troublesome.  New FTC Commissioners are needed, accompanied by robust budget support for international work.

Latham & Watkins’ Washington, D.C. Managing Partner Michael Egge focused on the substantial divergence in merger enforcement practice around the world.  The cost of compliance imposed by European Commission pre-notification filing requirements is overly high; this pre-notification practice is not written down and has escaped needed public attention.  Chinese merger filing practice (“China is struggling to cope”) features a costly 1-3 month pre-filing acceptance period, and merger filing requirements in India are particularly onerous.

Jim Rill, former Assistant Attorney General for Antitrust and former ABA Antitrust Section Chair, stressed that due process improvements can help promote substantive antitrust convergence around the globe.  Rill stated that U.S. Government officials, with the assistance of private sector stakeholders, need a mechanism (a “report card”) to measure foreign agencies’ implementation of OECD antitrust recommendations.  U.S. Government officials should consider participating in foreign proceedings where the denial of due process is blatant, and where foreign governments indirectly dictate a particular harmful policy result.  Multilateral review of international agreements is valuable as well.  The comity principles found in the 1991 EU-U.S. Antitrust Cooperation Agreement are quite useful.  Trade remedies in antitrust agreements are not a competition solution, and are not helpful.  More and better training programs for foreign officials are called for; International Chamber of Commerce, American Bar Association, and U.S. Chamber of Commerce principles are generally sound.  Some consideration should be given to old ICPAC recommendations, such as (perhaps) the development of a common merger notification form for use around the world.

Douglas Ginsburg, Senior Judge (and former Chief Judge) of the U.S. Court of Appeals for the D.C. Circuit, and former Assistant Attorney General for Antitrust, spoke last, focusing on the European Court of Justice’s Intel decision, which laid bare the deficiencies in the European Commission’s finding of a competition law violation in that matter.

In a brief closing roundtable discussion, Roger Alford suggested possible greater involvement by business community stakeholders in training foreign antitrust officials.

  1. Conclusion

Heritage Foundation host Alden Abbott closed the proceedings with a brief capsule summary of panel highlights.  As in prior years, the Fourth Annual Heritage Antitrust Conference generated spirited discussion among the brightest lights in the American antitrust firmament on recent developments and likely trends in antitrust enforcement and policy development, here and abroad.

In Antitrust & Competition, Antitrust Division, Cartels, China, European Union, Federal Trade Commission, Intellectual Property, International, Justice Department, Patent, Standard Setting, Truth on the Market, United Kingdom , , , , ,
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The European Commission’s Regrettable June 27 Google Antitrust Decision – and Its Broader Implications

Alden Abbott —  28 June 2017

Today I published an article in The Daily Signal bemoaning the European Commission’s June 27 decision to fine Google $2.7 billion for engaging in procompetitive, consumer welfare-enhancing conduct.  The article is reproduced below (internal hyperlinks omitted), in italics:

On June 27, the European Commission—Europe’s antitrust enforcer—fined Google over $2.7 billion for a supposed violation of European antitrust law that bestowed benefits, not harm, on consumers.

And that’s just for starters. The commission is vigorously pursuing other antitrust investigations of Google that could lead to the imposition of billions of dollars in additional fines by European bureaucrats.

The legal outlook for Google is cloudy at best. Although the commission’s decisions can be appealed to European courts, European Commission bureaucrats have a generally good track record in winning before those tribunals.

But the problem is even bigger than that.

Recently, questionable antitrust probes have grown like topsy around the world, many of them aimed at America’s most creative high-tech firms. Beneficial innovations have become legal nightmares—good for defense lawyers, but bad for free market competition and the health of the American economy.

What great crime did Google commit to merit the huge European Commission fine?

The commission claims that Google favored its own comparison shopping service over others in displaying Google search results.

Never mind that consumers apparently like the shopping-related service links they find on Google (after all, they keep using its search engine in droves), or can patronize any other search engine or specialized comparison shopping service that can be found with a few clicks of the mouse.

This is akin to saying that Kroger or Walmart harm competition when they give favorable shelf space displays to their house brands. That’s ridiculous.

Somehow, such “favoritism” does not prevent consumers from flocking to those successful chains, or patronizing their competitors if they so choose. It is the essence of vigorous free market rivalry.  

The commission’s theory of anticompetitive behavior doesn’t hold water, as I explained in an earlier article. The Federal Trade Commission investigated Google’s search engine practices several years ago and found no evidence that alleged Google search engine display bias harmed consumers.

To the contrary, as former FTC Commissioner (and leading antitrust expert) Josh Wright has pointed out, and as the FTC found:

Google likely benefited consumers by prominently displaying its vertical content on its search results page. The Commission reached this conclusion based upon, among other things, analyses of actual consumer behavior—so-called ‘click through’ data—which showed how consumers reacted to Google’s promotion of its vertical properties.

In short, Google’s search policies benefit consumers. Antitrust is properly concerned with challenging business practices that harm consumer welfare and the overall competitive process, not with propping up particular competitors.

Absent a showing of actual harm to consumers, government antitrust cops—whether in Europe, the U.S., or elsewhere—should butt out.

Unfortunately, the European Commission shows no sign of heeding this commonsense advice. The Europeans have also charged Google with antitrust violations—with multibillion-dollar fines in the offing—based on the company’s promotion of its Android mobile operating service and its AdSense advertising service.

(That’s not all—other European Commission Google inquiries are also pending.)

As in the shopping services case, these investigations appear to be woefully short on evidence of harm to competition and consumer welfare.

The bigger question raised by the Google matters is the ability of any highly successful individual competitor to efficiently promote and favor its own offerings—something that has long been understood by American enforcers to be part and parcel of free-market competition.

As law Professor Michael Carrier points outs, any changes the EU forces on Google’s business model “could eventually apply to any way that Amazon, Facebook or anyone else offers to search for products or services.”

This is troublesome. Successful American information-age companies have already run afoul of the commission’s regulatory cops.

Microsoft and Intel absorbed multibillion-dollar European Commission antitrust fines in recent years, based on other theories of competitive harm. Amazon, Facebook, and Apple, among others, have faced European probes of their competitive practices and “privacy policies”—the terms under which they use or share sensitive information from consumers.

Often, these probes have been supported by less successful rivals who would rather rely on government intervention than competition on the merits.

Of course, being large and innovative is not a legal shield. Market-leading companies merit being investigated for actions that are truly harmful. The law applies equally to everyone.

But antitrust probes of efficient practices that confer great benefits on consumers (think how much the Google search engine makes it easier and cheaper to buy desired products and services and obtain useful information), based merely on the theory that some rivals may lose business, do not advance the free market. They retard it.

Who loses when zealous bureaucrats target efficient business practices by large, highly successful firms, as in the case of the European Commission’s Google probes and related investigations? The general public.

“Platform firms” like Google and Amazon that bring together consumers and other businesses will invest less in improving their search engines and other consumer-friendly features, for fear of being accused of undermining less successful competitors.

As a result, the supply of beneficial innovations will slow, and consumers will be less well off.

What’s more, competition will weaken, as the incentive to innovate to compete effectively with market leaders will be reduced. Regulation and government favor will substitute for welfare-enhancing improvement in goods, services, and platform quality. Economic vitality will inevitably be reduced, to the public’s detriment.

Europe is not the only place where American market leaders face unwarranted antitrust challenges.

For example, Qualcomm and InterDigital, U.S. firms that are leaders in smartphone communications technologies that power mobile interconnections, have faced large antitrust fines for, in essence, “charging too much” for licenses to their patented technologies.

South Korea also claimed to impose a “global remedy” that imposed its artificially low royalty rates on all of Qualcomm’s licensing agreements around the world.

(All this is part and parcel of foreign government attacks on American intellectual property—patents, copyrights, trademarks, and trade secrets—that cost U.S. innovators hundreds of billions of dollars a year.)

 

A lack of basic procedural fairness in certain foreign antitrust proceedings has also bedeviled American companies, preventing them from being able to defend their conduct. Foreign antitrust has sometimes been perverted into a form of “industrial policy” that discriminates against American companies in favor of domestic businesses.

What can be done to confront these problems?

In 2016, the U.S. Chamber of Commerce convened a group of trade and antitrust experts to examine the problem. In March 2017, the chamber released a report by the experts describing the nature of the problem and making specific recommendations for U.S. government action to deal with it.

Specifically, the experts urged that a White House-led interagency task force be set up to develop a strategy for dealing with unwarranted antitrust attacks on American businesses—including both misapplication of legal rules and violations of due process.

The report also called for the U.S. government to work through existing international institutions and trade negotiations to promote a convergence toward sounder antitrust practices worldwide.

The Trump administration should take heed of the experts’ report and act decisively to combat harmful foreign antitrust distortions. Antitrust policy worldwide should focus on helping the competitive process work more efficiently, not on distorting it by shacking successful innovators.

One more point, not mentioned in the article, merits being stressed.  Although the United States Government cannot control a foreign sovereign’s application of its competition law, it can engage in rhetoric and public advocacy aimed at convincing that sovereign to apply its law in a manner that promotes consumer welfare, competition on the merits, and economic efficiency.  Regrettably, the Obama Administration, particularly in the latter part of its second term, did a miserable job in promoting a facts-based, empirical approach to antitrust enforcement, centered on hard facts, not on mere speculative theories of harm.  In particular, certain political appointees lent lip service or silent acquiescence to inappropriate antitrust attacks on the unilateral exercise of intellectual property rights.  In addition, those senior officials made statements that could have been interpreted as supportive of populist “big is bad” conceptions of antitrust that had been discredited decades ago – through sound scholarship, by U.S. enforcement policies, and in judicial decisions.  The Trump Administration will have an opportunity to correct those errors, and to restore U.S. policy leadership in support of sound, pro-free market antitrust principles.  Let us hope that it does so, and soon.

In Amazon, Antitrust & Competition, Apple, Copyright, European Union, Facebook, Federal Trade Commission, Google, Intellectual Property, International, International Trade, Patent, Platforms , , , , ,
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The Present State and Future Prospects of the International Competition Network (ICN)

Alden Abbott —  19 May 2017
  1. Introduction

The International Competition Network (ICN), a “virtual” organization comprised of most of the world’s competition (antitrust) agencies and expert non-governmental advisors (NGAs), held its Sixteenth Annual Conference in Porto, Portugal from May 10-12. (I attended this Conference as an NGA.) Now that the ICN has turned “sweet sixteen,” a stocktaking is appropriate. The ICN can point to some significant accomplishments, but faces major future challenges. After describing those challenges, I advance four recommendations for U.S.-led initiatives to enhance the future effectiveness of the ICN.

  1. ICN Background and Successes

The ICN, whose key objective is to promote “soft convergence” among competition law regimes, has much to celebrate. It has gone from a small core of competition authorities focused on a limited set of issues to a collection of 135 agencies from 122 far-flung jurisdictions, plus a large cadre of NGA lawyers and economists who provide practical and theoretical advice. The ICN’s nature and initiatives are concisely summarized on its website:

The ICN provides competition authorities with a specialized yet informal venue for maintaining regular contacts and addressing practical competition concerns. This allows for a dynamic dialogue that serves to build consensus and convergence towards sound competition policy principles across the global antitrust community.

The ICN is unique as it is the only international body devoted exclusively to competition law enforcement and its members represent national and multinational competition authorities. Members produce work products through their involvement in flexible project-oriented and results-based working groups. Working group members work together largely by Internet, telephone, teleseminars and webinars.

Annual conferences and workshops provide opportunities to discuss working group projects and their implications for enforcement. The ICN does not exercise any rule-making function. Where the ICN reaches consensus on recommendations, or “best practices”, arising from the projects, individual competition authorities decide whether and how to implement the recommendations, through unilateral, bilateral or multilateral arrangements, as appropriate.

The Porto Conference highlighted the extent of the ICN’s influence. Representatives from key international organizations that focus on economic growth and development (and at one time were viewed as ICN “rivals”), including the OECD, the World Bank, and UNCTAD, participated in the Conference. A feature in recent years, the one-day “Pre-ICN” Forum jointly sponsored by the World Bank, the International Chamber of Commerce, and the International Bar Association, this year shared the spotlight with other “sidebar” events (for example, an antitrust symposium cosponsored by UNCTAD and the Japan Fair Trade Commission, an “African Competition Forum,” and a roundtable of former senior officials and academics sponsored by a journal). The Porto Conference formally adopted an impressive array of documents generated over the past year by the ICN’s various Working Groups (the Advocacy, Agency Effectiveness, Cartel, Merger, and Unilateral Conduct Working Groups) (see here and here). This work product focuses on offering practical advice to agencies, rather than theoretical academic speculation. If recent history is in any indication, a substantial portion of this advice will be incorporated within some national laws, and various agencies guidance documents, and strategic plans.

In sum, the ICN is an increasingly influential organization. More importantly, it has, on balance, been a force for the promotion of sound policies on such issues as pre-merger notifications and cartel enforcement – policies that reduce transaction costs for the private sector and tend to improve the quality of antitrust enforcement. It has produced valuable training materials for agencies. Furthermore, the ICN’s Advocacy Working Group, buoyed by a growing amount of academic research (some of it supported by the World Bank), increasingly has highlighted the costs of anticompetitive government laws and regulations, and provided a template for assessing and critiquing regulatory schemes that undermine the competitive process. Most recently, the revised chapter on the “analytical framework for evaluating unilateral exclusionary conduct” issued at the 2017 Porto Conference did a solid job of describing the nature of harm to the competitive process and the need to consider error costs in evaluating such conduct. Other examples of welfare-enhancing ICN proposals abound.

  1. Grounds for Caution Going Forward

Nevertheless, despite its generally good record, one must be cautious in evaluating the ICN’s long-term prospects, for at least five reasons.

First, as the ICN tackles increasingly contentious issues (such as the assessment of vertical restraints, which are part of the 2017-2018 ICN Work Plan, and “dominant” single firm “platforms,” cited specifically by ICN Chairman Andreas Mundt in Porto), the possibility for controversy and difficulty in crafting recommendations rises.

Second, most ICN members have adopted heavily administrative competition law frameworks that draw upon an inquisitorial civil law model, as opposed to the common law adversarial legal system in which independent courts conduct full legal reviews of agency conclusions. Public choice analysis (not to mention casual empiricism and common sense) indicates that as they become established, administrative agencies will have a strong incentive to “do something” in order to expand their authority. Generally speaking, sound economic analysis (bolstered by large staffs of economists) that stresses consumer welfare has been incorporated into U.S. federal antitrust enforcement decisions and federal antitrust jurisprudence – but that is not the case in large parts of the world. As its newer member agencies grow in size and influence, the ICN may be challenged by those authorities to address “novel” practices that stray beyond well-understood competition law categories. As a result, innovative welfare-enhancing business innovations could be given unwarranted scrutiny and thereby discouraged.

Third, as various informed commentators in Porto noted, many competition laws explicitly permit consideration of non-economic welfare-based goals, such as “industrial policy” (including promotion of “national champion” competitors), “fairness,” and general “public policy.” Such ill-defined statutory goals allow competition agencies (and, of course, politicians who may exercise influence over those agencies) to apply competition statutes in an unpredictable manner that has nothing to do with (indeed, may be antithetical to) promotion of a vigorous competitive process and consumer welfare. With the proliferation of international commerce, the costly uncertainty injected into business decision-making by malleable antitrust statutes becomes increasingly significant. The ICN, which issues non-binding recommendations and advice and relies on voluntary interagency cooperation, may have little practical ability to fend off such welfare-inimical politicization of antitrust.

Fourth, for nearly a decade United States antitrust agencies have expressed concern in international forums about lack of due process in competition enforcement. Commendably, in 2015 the ICN did issue guidance regarding “key investigative principles and practices important to effective and fair investigative process”, but this guidance did not address administrative hearings and enforcement actions, which remain particularly serious concerns. The ICN’s ability to drive a “due process improvements” agenda may be inherently limited, due to differences among ICN members’ legal systems and sensitivities regarding the second-guessing of national enforcement norms associated with the concept of “due process.”

Fifth, there is “the elephant outside the room.” One major jurisdiction, China, still has not joined the ICN. Given China’s size, importance in the global economy, and vigorous enforcement of its completion law, China’s “absence from “the table” is a significant limitation on the ICN’s ability to promote economically meaningful global policy convergence. (Since Hong Kong, a “special administrative region” of China, has joined the ICN, one may hope that China itself will consider opting for ICN membership in the not too distant future.)

  1. What Should the U.S. Antitrust Agencies Do?

Despite the notes of caution regarding the ICN’s future initiatives and effectiveness, the ICN will remain for the foreseeable future a useful forum for “nudging” members toward improvements in their competition law systems, particularly in key areas such as cartel enforcement, merger review, and agency effectiveness (internal improvements in agency management may improve the quality of enforcement and advocacy initiatives). Thus, the U.S. federal antitrust agencies, the Justice Department’s Antitrust Division (DOJ) and the Federal Trade Commission (FTC), should (and undoubtedly will) remain fully engaged with the ICN. DOJ and the FTC not only should remain fully engaged in the ICN’s Working Groups, they should also develop a strategy for minimizing the negative effects of the ICN’s limitations and capitalizing on its strengths. What should such a strategy entail? Four key elements come to mind.

First, the FTC and DOJ should strongly advocate against an ICN focus on expansive theories of liability for unilateral conduct (particularly involving such areas as popular Internet “platforms” (e.g., Google, Facebook, and Amazon, among others) and vertical restraints), not tied to showings of harm to the competitive process. The proliferation of cases based on such theories could chill economically desirable business innovations. In countering such novel and expansive condemnations of unilateral conduct, the U.S. agencies could draw upon the extensive law and economics literature on efficiencies and unilateral conduct in speeches, publications, and presentations to ICN Working Groups. To provide further support for their advocacy, the FTC and DOJ should also consider issuing a new joint statement of unilateral conduct enforcement principles, inspired by the general lines of the 2008 DOJ Report on Single Firm Conduct Under Section 2 of the Sherman Act (regrettably withdrawn by the Obama Administration DOJ in 2009). Relatedly, the FTC and DOJ should advocate the right of intellectual property (IP) holders legitimately to maximize returns on their holdings. The U.S. agencies also should be prepared to argue against novel theories of antitrust liability untethered from traditional concepts of antitrust harm, based on the unilateral exploitation of IP rights (see here, here, here, and here).

Second, the U.S. agencies should promote a special ICN project on decision theory and competition law enforcement (see my Heritage Foundation commentary here), under the aegis of the ICN’s Agency Effectiveness Working Group. A decision-theoretic framework aims to minimize the costs of antitrust administration and enforcement error, in order to promote cost-beneficial enforcement outcomes. ICN guidance on decision theory (which would stress the primacy of empirical analysis and the need for easily administrable rules) hopefully would encourage competition agencies to focus on clearly welfare-inimical practices, and avoid pursuing fanciful new theories of antitrust violations unmoored from robust theories of competitive harm. The FTC and DOJ should also work to inculcate decision theory into the work of the core ICN Cartel and Merger Working Groups (see here).

Third, the U.S. agencies should also encourage the ICN’s Agency Effectiveness Working Group to pursue a comprehensive “due process” initiative, focused on guaranteeing fundamental fairness to parties at all stages of a competition law proceeding.  An emphasis on basic universal notions of fairness would transcend the differences inherent in civil law and common law administrative processes. It would suggest a path forward whereby agencies could agree on the nature of basic rights owed litigants, while still preserving differences among administrative enforcement models. Administrative procedure recommendations developed by the American Bar Association’s Antitrust Section in 2015 (see here) offer a good template for consideration, and 2012 OECD deliberations on fairness and transparency (see here) yield valuable background analysis. Consistent with these materials, the U.S. agencies could stress that due process reforms to protect basic rights would not only improve the quality of competition authority decision-making, it would also enhance economic welfare and encourage firms from around the world to do business in reforming jurisdictions. (As discussed above, due process raises major sensitivities, and thus the push for due process improvements should be viewed as a long-term project that will have to be pursued vigorously and very patiently.)

Fourth, working through the ICN’s Advocacy Working Group, the FTC and DOJ should push to substantially raise the profile of competition advocacy at the ICN. A growing body of economic research reveals the enormous economic gains that could be unlocked within individual countries by the removal of anticompetitive laws and rules, particularly those that create artificial barriers to entry and distort trade (see, for example, here and here). The U.S. agencies should emphasize the negative consequences for poorer consumers, reduced innovation, and foregone national income due to many of these anticompetitive barriers, drawing upon research by World Bank and OECD scholars (see here). (Fortunately, the ICN already works with the World Bank to promote an annual contest that showcases economic “success stories” due to agency advocacy.) The FTC and DOJ should also use the ICN as a forum to recommend that national competition authorities accord competition advocacy aimed at domestic regulatory reform relatively more resources and attention, particularly compared to investigations of vertical restraints and novel unilateral conduct. It should also work within the ICN’s guidance and oversight body, the “Steering Group,” to make far-reaching competition advocacy initiatives a top ICN priority.

  1. Conclusion

The ICN is a worthwhile international organization that stands at a crossroads. Having no permanent bureaucracy (its website is maintained by the Canadian Competition Bureau), and relying in large part on online communications among agency staff and NGAs to carry out its work, the ICN represents a very good investment of scare resources by the U.S. Government. Absent thoughtful guidance, however, there is a danger that it could drift and become less effective at promoting welfare-enhancing competition law improvements around the world. To avert such an outcome, U.S. antitrust enforcement agencies (joined by like-minded ICN members from other jurisdictions) should proactively seek to have the ICN take up new projects that hold out the promise for substantive and process-based improvements in competition policy worldwide, including far-reaching regulatory reform. A positive ICN response to such initiatives would enhance the quality of competition policy. Moreover, it could contribute in no small fashion to increased economic welfare and innovation in those jurisdictions that adopted reforms in response to the ICN’s call. American businesses operating internationally also would benefit from improvements in the global competition climate generated by ICN-incentivized reforms.

 

 

 

In Amazon, Antitrust & Competition, Antitrust Division, Barriers to Entry, China, Economic Theory, Error Costs, Exclusionary Conduct, Facebook, Federal Trade Commission, Google, Intellectual Property, International, International Trade, Justice Department, Platforms, Regulation, Regulatory Reform, Truth on the Market, Vertical Restraints , , , , , , ,
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Experts’ Report Proposes Greater Coordination of U.S. Competition Law and Trade Law Policies

Alden Abbott —  15 March 2017

On March 14, the U.S. Chamber of Commerce released a report “by an independent group of experts it commissioned to consider U.S. responses to the inappropriate use of antitrust enforcement actions worldwide to achieve industrial policy outcomes.”  (See here and here.)  I served as rapporteur for the report, which represents the views of the experts (leading academics, practitioners, and former senior officials who specialize in antitrust and international trade), not the position of the Chamber.  In particular, the report calls for the formation of a new White House-led working group.  The working group would oversee development of a strategy for dealing with the misuse of competition policy by other nations that impede international trade and competition and harm U.S. companies.  The denial of fundamental due process rights and the inappropriate extraterritorial application of competition remedies by foreign governments also would be within the purview of the working group.

The Chamber will hold a program on April 10 with members of the experts group to discuss the report and its conclusions.  The letter transmitting the report to the President and congressional leadership states as follows:

Today, nearly every nation in the world has some form of antitrust or competition law regulating business activities occurring within or substantially affecting its territory. The United States has long championed the promotion of global competition as the best way to ensure that businesses have a strong incentive to operate efficiently and innovate, and this approach has helped to fuel a strong and vibrant U.S. economy. But competition laws are not always applied in a transparent, accurate and impartial manner, and they can have significant adverse impacts far outside a country’s own borders. Certain of our major trading partners appear to have used their laws to actually harm competition by U.S. companies, protecting their own markets from foreign competition, promoting national champions, forcing technology transfers and, in some cases, denying U.S. companies fundamental due process.

Up to now, the United States has had some, but limited, success in addressing this problem. For that reason, in August of 2016, the U.S. Chamber of Commerce convened an independent, bi-partisan group of experts in trade and competition law and economics to take a fresh look and develop recommendations for a potentially more effective and better-integrated international trade and competition law strategy.

As explained by the U.S. Chamber in announcing the formation of this group,

The United States has been, and should continue to be, a global leader in the development and implementation of sound competition law and policy. . . . When competition law is applied in a discriminatory manner or relies upon non-competition factors to engineer outcomes in support of national champions or industrial policy objectives, the impact of such instances arguably goes beyond the role of U.S. antitrust agencies. The Chamber believes it is critical for the United States to develop a coordinated trade and competition law approach to international economic policy.

The International Competition Policy Expert Group (“ICPEG”) was encouraged to develop “practical and actionable steps forward that will serve to advance sound trade and competition policy.”

The Report accompanying this letter is the result of ICPEG’s work. Although the U.S. Chamber suggested the project and recruited participants, it made no effort to steer the content of ICPEG’s recommendations.

The Report is addressed specifically to the interaction of competition law and international trade law and proposes greater coordination and cooperation between them in the formulation and implementation of U.S. international trade policy. It focuses on the use of international trade and other appropriate tools to address problems in the application of foreign competition policies through 12 concrete recommendations.

Recommendations 1 through 6 urge the Trump Administration to prioritize the coordination of international competition policy through a new, cabinet-level White House working group (the “Working Group”) to be chaired by an Assistant to the President. Among other things, the Working Group would:

  • set a government-wide, high-level strategy for articulating and promoting policies to address the misuse of competition law by other nations that impede international trade and competition and harm U.S. companies;
  • undertake a 90-day review of existing and potential new trade policy tools available to address the challenge, culminating in a recommended “action list” for the President and Congress; and
  • address not only broader substantive concerns regarding the abuse of competition policy for protectionist and discriminatory purposes, but also the denial of fundamental process rights and the extraterritorial imposition of remedies that are not necessary to protect a country’s legitimate competition law objectives.

Recommendations 7 through 12 focus on steps that should be taken with international organizations and bilateral initiatives. For example, the United States should consider:

  • the feasibility and value of expanding the World Trade Organization’s regular assessment of each member government by the Trade Policy Review Body to include national competition policies and encourage the Organisation for Economic Cooperation and Development (OECD) to undertake specific peer reviews of national procedural or substantive policies, including of non-OECD countries;
  • encouraging the OECD and/or other multilateral bodies to adopt a code enumerating transparent, accurate, and impartial procedures; and
  • promoting the application of agreements under which nations would cooperate with and take into account legitimate interests of other nations affected by a competition investigation.

The competition and trade law issues addressed in the Report are complex and the consequences of taking any particular action vis-a-vis another country must be carefully considered in light of a number of factors beyond the scope of this Report. ICPEG does not take a view on the actions of any particular country nor propose specific steps with respect to any actual dispute or matter. In addition, reasonable minds can differ on ICPEG’s assessment and recommendations. But we hope that this Report will prompt appropriate prioritization of the issues it addresses and serve as the basis for the further development of a successful policy and action plan and improved coordination and cooperation between U.S. competition and trade agencies.

In Antitrust & Competition, International, International Trade, Truth on the Market , , , , , ,
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Truth on the Market welcomes our newest blogger, Neil Turkewitz

Geoffrey Manne —  23 November 2016

Neil TurkewitzTruth on the Market is delighted to welcome our newest blogger, Neil Turkewitz. Neil is the newly minted Senior Policy Counsel at the International Center for Law & Economics (so we welcome him to ICLE, as well!).

Prior to joining ICLE, Neil spent 30 years at the Recording Industry Association of America (RIAA), most recently as Executive Vice President, International.

Neil has spent most of his career working to expand economic opportunities for the music industry through modernization of copyright legislation and effective enforcement in global markets. He has worked closely with creative communities around the globe, with the US and foreign governments, and with international organizations (including WIPO and the WTO), to promote legal and enforcement reforms to respond to evolving technology, and to promote a balanced approach to digital trade and Internet governance premised upon the importance of regulatory coherence, elimination of inefficient barriers to global communications, and respect for Internet freedom and the rule of law.

Among other things, Neil was instrumental in the negotiation of the WTO TRIPS Agreement, worked closely with the US and foreign governments in the negotiation of free trade agreements, helped to develop the OECD’s Communique on Principles for Internet Policy Making, coordinated a global effort culminating in the production of the WIPO Internet Treaties, served as a formal advisor to the Secretary of Commerce and the USTR as Vice-Chairman of the Industry Trade Advisory Committee on Intellectual Property Rights, and served as a member of the Board of the Chamber of Commerce’s Global Intellectual Property Center.

You can read some of his thoughts on Internet governance, IP, and international trade here and here.

Welcome Neil!

In Administrative, Announcements, Copyright, Intellectual Property, International, International Center for Law & Economics, International Trade, Regulatory Reform, Truth on the Market , , , , , , , ,
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Balto on the Apple e-books case: Skip the (Apple) appetizer and get to the (McWane) main course

David Balto —  15 February 2016

The “magic” of Washington can only go so far. Whether it is political consultants trying to create controversy where there is basic consensus, such as in parts of the political campaign, or the earnest effort to create a controversy over the Apple decision, there may be lots of words exchanged and animated discussion by political and antitrust pundits, but at the end of the day it’s much ado about not much. For the Apple case, even though this blog has attracted some of the keenest creative antitrust thinkers, a simple truth remains – there was overwhelming evidence that there was a horizontal agreement among suppliers and that Apple participated or even led the agreement as a seller. This is, by definition, a hub-and-spoke conspiracy that resulted in horizontal price fixing among ebook suppliers – an activity worthy of per se treatment.

The simplicity of this case belies the controversy of the ruling and the calls for Supreme Court review. Those that support Apple’s petition for certiorari seem to think that the case is a good vehicle to address important questions of policy in the law. Indeed, ICLE submitted an excellent brief making just such a case. But, unfortunately, the facts of this case are not great for resolving these problems.

For example, some would like to look at this case not as a horizontal price fixing agreement among competitors facilitated by a vertical party, but instead as a series of vertical agreements. This is very tempting, because the antitrust revolution was built on the back of fixing harmful precedent of per se condemnation of vertical restraints. Starting with GTE Sylvania, the Supreme Court has repeatedly applied modern economic learning to vertical restraints and found that there are numerous potential procompetitive benefits that must be accounted for in any proper antitrust analysis of a vertical agreement.

This view of the Apple e-book case is especially tempting because the Supreme Court’s work in this area of the law is not done. For example, the Supreme Court needs to update the law on exclusive dealing and loyalty discounts to reflect post-GTE Sylvania thinking, something I have written extensively on (including here at TOTM: here, here and here) in the context of the McWane case. (Which is also up for cert review). However, the facts of this case simply make this a bad case to resolve any matter of vertical restraint law. Apple was not approaching publishers individually, but aggressively orchestrating a scheme that immediately raised e-book prices by 30% and ensured that Apple’s store could not be undercut by any competitor. Consumers were very obviously harmed and the horizontal price fixing conspiracy could not have taken place without Apple’s involvement.

Of course in the court of public opinion (which is not an antitrust court) Apple attempted to wear the garb of the Robin Hood for consumers suggesting it was just trying to respond to Amazon’s dominance over ebooks. But the Justice Department and the court quickly saw through that guise. The proper response to market dominance is to compete harder. And that’s what happened. Apple’s successful entry into the e-book market seems to provide a more effective response than any cartel. But this does not show that there were procompetitive benefits of Apple’s anticompetitive actions worthy of rule of reason treatment. To the contrary, prices rose and output fell during the conduct at issue – exactly what one would expect to see following anticompetitive activities.

This argument also presupposes that Amazon’s dominance was bad for consumers. This is refuted by Scalia in Trinko:

The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices–at least for a short period–is what attracts “business acumen” in the first place; it induces risk taking that produces innovation and economic growth. 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.

The other problem with this line of thinking is that it suggests that it is OK to violate the antitrust laws to prevent a rival from charging too low of a price. This would obviously be bad policy. If Amazon was maintaining its dominant position through anticompetitive conduct, then there exists recourse in the law. As the old adage states, two wrongs do not make a right.

The main problem with the Apple e-book case is that it is a very simple case that lightly brushes against up against areas of law that and questions of policy that are attractive for Supreme Court review. There are important policy issues that still need to be addressed by the Supreme Court, but these facts don’t present them.

The Supreme Court does have an important job in helping antitrust law evolve in a sensible fashion. But this case is a soggy appetizer when there is a much more engaging main course about to be served. A cert petition has been filed in the FTC’s case against McWane, which provides a chance to update the law of exclusive dealing which the Court has not grappled with since the days of Sputnik (Only a slight exaggeration). And in McWane the most important business groups Including the Chamber of Commerce and the National Association of Manufacturers have explained that the confusion and obscurity in this area and the mischief of the lower court’s decisions create real impediments to procompetitive conduct. Professors of law and economics (including several TOTM authors) also wrote in support of the petition.

The Court should skip the appetizer and get to the main course.

In Amazon, Antitrust & Competition, Apple, Exclusive Dealing, Monopolization, Platforms, Supreme Court, Symposium on the Apple E-Books Antitrust Case: Implications for Antitrust and for the Economy, Vertical Restraints , , , , , , , , , , , , , , , , , , , ,
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Josh Wright’s Unfinished Legacy: Reforming FTC Consumer Protection Enforcement

totmauthor —  26 August 2015

by Berin Szoka, President, TechFreedom

Josh Wright will doubtless be remembered for transforming how FTC polices competition. Between finally defining Unfair Methods of Competition (UMC), and his twelve dissents and multiple speeches about competition matters, he re-grounded competition policy in the error-cost framework: weighing not only costs against benefits, but also the likelihood of getting it wrong against the likelihood of getting it right.

Yet Wright may be remembered as much for what he started as what he finished: reforming the Commission’s Unfair and Deceptive Acts and Practices (UDAP) work. His consumer protection work is relatively slender: four dissents on high tech matters plus four relatively brief concurrences and one dissent on more traditional advertising substantiation cases. But together, these offer all the building blocks of an economic, error-cost-based approach to consumer protection. All that remains is for another FTC Commissioner to pick up where Wright left off.

Apple: Unfairness & Cost-Benefit Analysis

In January 2014, Wright issued a blistering, 17 page dissent from the Commission’s decision to bring, and settle, an enforcement action against Apple regarding the design of its app store. Wright dissented, not from the conclusion necessarily, but from the methodology by which the Commission arrived there. In essence, he argued for an error-cost approach to unfairness:

The Commission, under the rubric of “unfair acts and practices,” substitutes its own judgment for a private firm’s decisions as to how to design its product to satisfy as many users as possible, and requires a company to revamp an otherwise indisputably legitimate business practice. Given the apparent benefits to some consumers and to competition from Apple’s allegedly unfair practices, I believe the Commission should have conducted a much more robust analysis to determine whether the injury to this small group of consumers justifies the finding of unfairness and the imposition of a remedy.

…. although Apple’s allegedly unfair act or practice has harmed some consumers, I do not believe the Commission has demonstrated the injury is substantial. More importantly, any injury to consumers flowing from Apple’s choice of disclosure and billing practices is outweighed considerably by the benefits to competition and to consumers that flow from the same practice.

The majority insisted that the burden on consumers or Apple from its remedy “is de minimis,” and therefore “it was unnecessary for the Commission to undertake a study of how consumers react to different disclosures before issuing its complaint against Apple, as Commissioner Wright suggests.”

Wright responded: “Apple has apparently determined that most consumers do not want to experience excessive disclosures or to be inconvenienced by having to enter their passwords every time they make a purchase.” In essence, he argued, that the FTC should not presume to know better than Apple how to manage the subtle trade-offs between convenience and usability.

Wright was channeling Hayek’s famous quip: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” The last thing the FTC should be doing is designing digital products — even by hovering over Apple’s shoulder.

The Data Broker Report

Wright next took the Commission to task for the lack of economic analysis in its May 2013 report, “Data Brokers: A Call for Transparency and Accountability.” In just four footnotes, Wright extended his analysis of Apple. For example:

Footnote 85: Commissioner Wright agrees that Congress should consider legislation that would provide for consumer access to the information collected by data brokers. However, he does not believe that at this time there is enough evidence that the benefits to consumers of requiring data brokers to provide them with the ability to opt out of the sharing of all consumer information for marketing purposes outweighs the costs of imposing such a restriction. Finally… he believes that the Commission should engage in a rigorous study of consumer preferences sufficient to establish that consumers would likely benefit from such a portal prior to making such a recommendation.

Footnote 88: Commissioner Wright believes that in enacting statutes such as the Fair Credit Reporting Act, Congress undertook efforts to balance [costs and benefits]. In the instant case, Commissioner Wright is wary of extending FCRA-like coverage to other uses and categories of information without first performing a more robust balancing of the benefits and costs associated with imposing these requirements

The Internet of Things Report

This January, in a 4-page dissent from the FTC’s staff report on “The Internet of Things: Privacy and Security in a Connected World,” Wright lamented that the report neither represented serious economic analysis of the issues discussed nor synthesized the FTC’s workshop on the topic:

A record that consists of a one-day workshop, its accompanying public comments, and the staff’s impressions of those proceedings, however well-intended, is neither likely to result in a representative sample of viewpoints nor to generate information sufficient to support legislative or policy recommendations.

His attack on the report’s methodology was blistering:

The Workshop Report does not perform any actual analysis whatsoever to ensure that, or even to give a rough sense of the likelihood that the benefits of the staff’s various proposals exceed their attendant costs. Instead, the Workshop Report merely relies upon its own assertions and various surveys that are not necessarily representative and, in any event, do not shed much light on actual consumer preferences as revealed by conduct in the marketplace…. I support the well-established Commission view that companies must maintain reasonable and appropriate security measures; that inquiry necessitates a cost-benefit analysis. The most significant drawback of the concepts of “security by design” and other privacy-related catchphrases is that they do not appear to contain any meaningful analytical content.

Ouch.

Nomi: Deception & Materiality Analysis

In April, Wright turned his analytical artillery from unfairness to deception, long the more uncontroversial half of UDAP. In a five-page dissent, Wright accused the Commission of essentially dispensing with the core limiting principle of the 1983 Deception Policy Statement: materiality. As Wright explained:

The materiality inquiry is critical because the Commission’s construct of “deception” uses materiality as an evidentiary proxy for consumer injury…. Deception causes consumer harm because it influences consumer behavior — that is, the deceptive statement is one that is not merely misleading in the abstract but one that causes consumers to make choices to their detriment that they would not have otherwise made. This essential link between materiality and consumer injury ensures the Commission’s deception authority is employed to deter only conduct that is likely to harm consumers and does not chill business conduct that makes consumers better off.

As in Apple, Wright did not argue that there might not be a role for the FTC; merely that the FTC had failed to justify bringing, let alone settling, an enforcement action without establishing that the key promise at issue — to provide in-store opt-out — was material.

The Chamber Speech: A Call for Economic Analysis

In May, Wright gave a speech to the Chamber of Commerce on “How to Regulate the Internet of Things Without Harming its Future: Some Do’s and Don’ts”:

Perhaps it is because I am an economist who likes to deal with hard data, but when it comes to data and privacy regulation, the tendency to rely upon anecdote to motivate policy is a serious problem. Instead of developing a proper factual record that documents cognizable and actual harms, regulators can sometimes be tempted merely to explore anecdotal and other hypothetical examples and end up just offering speculations about the possibility of harm.

And on privacy in particular:

What I have seen instead is what appears to be a generalized apprehension about the collection and use of data — whether or not the data is actually personally identifiable or sensitive — along with a corresponding, and arguably crippling, fear about the possible misuse of such data.  …. Any sensible approach to regulating the collection and use of data will take into account the risk of abuses that will harm consumers. But those risks must be weighed with as much precision as possible, as is the case with potential consumer benefits, in order to guide sensible policy for data collection and use. The appropriate calibration, of course, turns on our best estimates of how policy changes will actually impact consumers on the margin….

Wright concedes that the “vast majority of work that the Consumer Protection Bureau performs simply does not require significant economic analysis because they involve business practices that create substantial risk of consumer harm but little or nothing in the way of consumer benefits.” Yet he notes that the Internet has made the need for cost-benefit analysis far more acute, at least where conduct is ambiguous as its effects on consumers, as in Apple, to avoid “squelching innovation and depriving consumers of these benefits.”

The Wrightian Reform Agenda for UDAP Enforcement

Wright left all the building blocks his successor will need to bring “Wrightian” reform to how the Bureau of Consumer Protection works:

  1. Wright’s successor should work to require economic analysis for consent decrees, as Wright proposed in his last major address as a Commissioner. BE might not to issue a statement at all in run-of-the-mill deception cases, but it should certainly have to say something about unfairness cases.
  2. The FTC needs to systematically assess its enforcement process to understand the incentives causing companies to settle UDAP cases nearly every time — resulting in what Chairman Ramirez and Commissioner Brill frequently call the FTC’s “common law of consent decrees.”
  3. As Wright says in his Nomi dissent “While the Act does not set forth a separate standard for accepting a consent decree, I believe that threshold should be at least as high as for bringing the initial complaint.” This point should be uncontroversial, yet the Commission has never addressed it. Wright’s successor (and the FTC) should, at a minimum, propose a standard for settling cases.
  4. Just as Josh succeeded in getting the FTC to issue a UMC policy statement, his successor should re-assess the FTC’s two UDAP policy statements. Wright’s successor needs to make the case for finally codifying the DPS — and ensuring that the FTC stops bypassing materiality, as in Nomi.
  5. The Commission should develop a rigorous methodology for each of the required elements of unfairness and deception to justify bringing cases (or making report recommendations). This will be a great deal harder than merely attacking the lack of such methodology in dissents.
  6. The FTC has, in recent years, increasingly used reports to make de facto policy — by inventing what Wright calls, in his Chamber speech, “slogans and catchphrases” like “privacy by design,” and then using them as boilerplate requirements for consent decrees; by pressuring companies into adopting the FTC’s best practices; by calling for legislation; and so on. At a minimum, these reports must be grounded in careful economic analysis.
  7. The Commission should apply far greater rigor in setting standards for substantiating claims about health benefits. In two dissents, Genelink et al and HCG Platinum, Wright demolished arguments for a clear, bright line requiring two randomized clinical trials, and made the case for “a more flexible substantiation requirement” instead.

Conclusion: Big Shoes to Fill

It’s a testament to Wright’s analytical clarity that he managed to say so much about consumer protection in so few words. That his UDAP work has received so little attention, relative to his competition work, says just as much about the far greater need for someone to do for consumer protection what Wright did for competition enforcement and policy at the FTC.

Wright’s successor, if she’s going to finish what Wright started, will need something approaching Wright’s sheer intellect, his deep internalization of the error-costs approach, and his knack for brokering bipartisan compromise around major issues — plus the kind of passion for UDAP matters Wright had for competition matters. And, of course, that person needs to be able to continue his legacy on competition matters…

Compared to the difficulty of finding that person, actually implementing these reforms may be the easy part.

In Apple, Data Privacy & Security, Federal Trade Commission, Law & Economics, Platforms, Section 5, Symposium Honoring the Honorable Joshua Wright , , , , , , , , , , , , , , , ,
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Intellectual Property, Innovation and Economic Growth: Mercatus Gets it Wrong

Adam Mossoff —  28 August 2014

[Cross posted at the CPIP Blog.]

By Mark Schultz & Adam Mossoff

A handful of increasingly noisy critics of intellectual property (IP) have emerged within free market organizations. Both the emergence and vehemence of this group has surprised most observers, since free market advocates generally support property rights. It’s true that there has long been a strain of IP skepticism among some libertarian intellectuals. However, the surprised observer would be correct to think that the latest critique is something new. In our experience, most free market advocates see the benefit and importance of protecting the property rights of all who perform productive labor – whether the results are tangible or intangible.

How do the claims of this emerging critique stand up? We have had occasion to examine the arguments of free market IP skeptics before. (For example, see here, here, here.) So far, we have largely found their claims wanting.

We have yet another occasion to examine their arguments, and once again we are underwhelmed and disappointed. We recently posted an essay at AEI’s Tech Policy Daily prompted by an odd report recently released by the Mercatus Center, a free-market think tank. The Mercatus report attacks recent research that supposedly asserts, in the words of the authors of the Mercatus report, that “the existence of intellectual property in an industry creates the jobs in that industry.” They contend that this research “provide[s] no theoretical or empirical evidence to support” its claims of the importance of intellectual property to the U.S. economy.

Our AEI essay responds to these claims by explaining how these IP skeptics both mischaracterize the studies that they are attacking and fail to acknowledge the actual historical and economic evidence on the connections between IP, innovation, and economic prosperity. We recommend that anyone who may be confused by the assertions of any IP skeptics waving the banner of property rights and the free market read our essay at AEI, as well as our previous essays in which we have called out similarly odd statements from Mercatus about IP rights.

The Mercatus report, though, exemplifies many of the concerns we raise about these IP skeptics, and so it deserves to be considered at greater length.

For instance, something we touched on briefly in our AEI essay is the fact that the authors of this Mercatus report offer no empirical evidence of their own within their lengthy critique of several empirical studies, and at best they invoke thin theoretical support for their contentions.

This is odd if only because they are critiquing several empirical studies that develop careful, balanced and rigorous models for testing one of the biggest economic questions in innovation policy: What is the relationship between intellectual property and jobs and economic growth?

Apparently, the authors of the Mercatus report presume that the burden of proof is entirely on the proponents of IP, and that a bit of hand waving using abstract economic concepts and generalized theory is enough to defeat arguments supported by empirical data and plausible methodology.

This move raises a foundational question that frames all debates about IP rights today: On whom should the burden rest? On those who claim that IP has beneficial economic effects? Or on those who claim otherwise, such as the authors of the Mercatus report?

The burden of proof here is an important issue. Too often, recent debates about IP rights have started from an assumption that the entire burden of proof rests on those investigating or defending IP rights. Quite often, IP skeptics appear to believe that their criticism of IP rights needs little empirical or theoretical validation, beyond talismanic invocations of “monopoly” and anachronistic assertions that the Framers of the US Constitution were utilitarians.

As we detail in our AEI essay, though, the problem with arguments like those made in the Mercatus report is that they contradict history and empirics. For the evidence that supports this claim, including citations to the many studies that are ignored by the IP skeptics at Mercatus and elsewhere, check out the essay.

Despite these historical and economic facts, one may still believe that the US would enjoy even greater prosperity without IP. But IP skeptics who believe in this counterfactual world face a challenge. As a preliminary matter, they ought to acknowledge that they are the ones swimming against the tide of history and prevailing belief. More important, the burden of proof is on them – the IP skeptics – to explain why the U.S. has long prospered under an IP system they find so odious and destructive of property rights and economic progress, while countries that largely eschew IP have languished. This obligation is especially heavy for one who seeks to undermine empirical work such as the USPTO Report and other studies.

In sum, you can’t beat something with nothing. For IP skeptics to contest this evidence, they should offer more than polemical and theoretical broadsides. They ought to stop making faux originalist arguments that misstate basic legal facts about property and IP, and instead offer their own empirical evidence. The Mercatus report, however, is content to confine its empirics to critiques of others’ methodology – including claims their targets did not make.

For example, in addition to the several strawman attacks identified in our AEI essay, the Mercatus report constructs another strawman in its discussion of studies of copyright piracy done by Stephen Siwek for the Institute for Policy Innovation (IPI). Mercatus inaccurately and unfairly implies that Siwek’s studies on the impact of piracy in film and music assumed that every copy pirated was a sale lost – this is known as “the substitution rate problem.” In fact, Siwek’s methodology tackled that exact problem.

IPI and Siwek never seem to get credit for this, but Siwek was careful to avoid the one-to-one substitution rate estimate that Mercatus and others foist on him and then critique as empirically unsound. If one actually reads his report, it is clear that Siwek assumes that bootleg physical copies resulted in a 65.7% substitution rate, while illegal downloads resulted in a 20% substitution rate. Siwek’s methodology anticipates and renders moot the critique that Mercatus makes anyway.

After mischaracterizing these studies and their claims, the Mercatus report goes further in attacking them as supporting advocacy on behalf of IP rights. Yes, the empirical results have been used by think tanks, trade associations and others to support advocacy on behalf of IP rights. But does that advocacy make the questions asked and resulting research invalid? IP skeptics would have trumpeted results showing that IP-intensive industries had a minimal economic impact, just as Mercatus policy analysts have done with alleged empirical claims about IP in other contexts. In fact, IP skeptics at free-market institutions repeatedly invoke studies in policy advocacy that allegedly show harm from patent litigation, despite these studies suffering from far worse problems than anything alleged in their critiques of the USPTO and other studies.

Finally, we noted in our AEI essay how it was odd to hear a well-known libertarian think tank like Mercatus advocate for more government-funded programs, such as direct grants or prizes, as viable alternatives to individual property rights secured to inventors and creators. There is even more economic work being done beyond the empirical studies we cited in our AEI essay on the critical role that property rights in innovation serve in a flourishing free market, as well as work on the economic benefits of IP rights over other governmental programs like prizes.

Today, we are in the midst of a full-blown moral panic about the alleged evils of IP. It’s alarming that libertarians – the very people who should be defending all property rights – have jumped on this populist bandwagon. Imagine if free market advocates at the turn of the Twentieth Century had asserted that there was no evidence that property rights had contributed to the Industrial Revolution. Imagine them joining in common cause with the populist Progressives to suppress the enforcement of private rights and the enjoyment of economic liberty. It’s a bizarre image, but we are seeing its modern-day equivalent, as these libertarians join the chorus of voices arguing against property and private ordering in markets for innovation and creativity.

It’s also disconcerting that Mercatus appears to abandon its exceptionally high standards for scholarly work-product when it comes to IP rights. Its economic analyses and policy briefs on such subjects as telecommunications regulation, financial and healthcare markets, and the regulatory state have rightly made Mercatus a respected free-market institution. It’s unfortunate that it has lent this justly earned prestige and legitimacy to stale and derivative arguments against property and private ordering in the innovation and creative industries. It’s time to embrace the sound evidence and back off the rhetoric.

In Copyright, Intellectual Property, Law & Economics, Patent, Telecommunications , , , , , , , , , , , , , , , ,
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The Curious Case of the Proxy Access Rule

J.W. Verret —  22 July 2011

Well, well.  It looks like the heatwave hitting DC has encouraged the Judges on the panel reviewing the SEC’s proxy access rule to finish their opinion earlier than expected.  The rule has been struck down by the DC Circuit as arbitrary and capricious for failure to meet the SEC’s mandate to consider the effect of new rules on efficiency, competition and capital formation.  I suspect there will be a torrent of blogging about this one.

The Court found that the SEC failed to consider the potential costs of empowering conflicted investors, like Union Pension funds.  It’s ironic that in an over 400 page rule, the SEC offered no discussion of this issue.  The Court found that the SEC failed to properly consider the frequency with which shareholders would bring proxy contests.  The Court also noted that a company’s fiduciary duties might compel a board to resist a proxy access nominee, and found that the SEC failed to adequately consider the effect of this problem.  The Court also found that the SEC failed to consider readily available empirical data which questioned the benefits of the rule, giving particular attention to the Buckberg/Macey Report.  It also questioned the persuasiveness of an empirical study on which the SEC relied (See J. Harold Mulherin & Annette B. Poulsen, Proxy Contests & Corporate Change: Implications for Shareholder Wealth, 47 J. Fin. Econ. 279 (1998)).

This decision brings to light a fundamental problem at the SEC.  Speaking against my own interest as a securities lawyer, I think it is an agency with too many lawyers and not enough economists.  The Federal Reserve and Federal Trade Commission are better regulators because they have teams of sharp economists to consider the effects of new rules.  As Senator Shelby noted in a recent hearing, the SEC on the other hand has over a thousand lawyers and less than 25 economists.  Today’s decision is one of the predictable results.  So were similar decisions striking down rules on the same basis in American Equity v. SEC and in Chamber of Commerce v. SEC.

The SEC has now proposed rules on proxy access in 2011, 2009, 2007 and 2003.  It still doesn’t have a rule in place.  That’s a lot of man hours to put into writing a rule that is never ultimately adopted.  I wonder if Chairman Schapiro will look to re-write the rule given all the deadlines she is facing under Dodd-Frank.  I don’t think we’ve seen the last of Rule 14a-11, but I think it may be awhile before it is resurrected.  What would a new SEC rule look like?  I doubt it would cover investment companies, as the opinion gave particular attention to the SEC’s decision to apply the rule to them.  I would also suspect it would allow for an opt-out procedure.  We’ll see.

Let’s not forget that the changes to Rule 14a-8 are still in place.  So shareholders can still adopt election bylaws which specify proxy access procedures at a particular company.  It’s never to early for boards to consider putting into place the proxy access defenses that I have developed.

In Banking, Corporate & Securities Law, Federal Trade Commission, Financial Regulation, Truth on the Market ,
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Immigration, preemption and regulatory coordination

Larry Ribstein —  27 May 2011

The Supreme Court has issued yet another preemption opinion in Chamber of Commerce v. Whiting.  The federal Immigration Reform and Control Act makes it unlawful to employ a known unauthorized alien and preempts state sanctions “other than through licensing and similar laws.”

The majority held this didn’t preempt Arizona’s broad definition of license to include such documents as articles of incorporation, certificates of partnership and foreign firms’ authority to transact business in the state. Five conservative justices rejected express preemption, four (excluding Thomas) rejected implied preemption, and there were two separate dissents joined by a total of three liberal justices (Kagan was recused).

I’m interested in this partly because of my work in progress with Erin O’Hara O’Connor on Preemption and Regulatory Coordination (preliminary draft summarized here, and applied to the Court’s recent arbitration decision here).  

It’s hard to disagree with the dissenters that Arizona’s additional sanctions are inconsistent with the milder and more tentative approach of the federal law.   The question is whether the Arizona law is saved by the licensing exception.

Erin’s and my regulatory coordination theory arguably helps justify if not explain the result.  Employment rules generally vary from state to state. Adding immigration variations doesn’t necessarily make them much more onerous, especially given Arizona’s use of federal standards.  Thus, there’s arguably a greater need for interstate coordination for arbitration cases that might find themselves in courts all over the country than for employment practices that are necessarily based in specific states and turn on state-specific factors. This policy could drive the result if preemption is ambiguous. 

Another aspect of the immigration case particularly interested me.  The majority held that the “licensing and similar laws” savings clause allowed Arizona to suspend or revoke articles of incorporation, certificates of partnership and grants of authority to foreign firms for companies that employed illegal workers.  The court said:

A license is “a right or permission granted in accordance with law . . . to engage in some business or occupation, to do some act, or to engage in some transaction which but for such license would be unlawful.” Webster’s Third New International Dictionary 1304 (2002). Articles of incorporation and certificates of partnership allow the formation of legal entities and permit them as such to engage in business and transactions “which but for such” authorization “would be unlawful.”

The Court based this interpretation on the Administrative Procedure Act.  It’s not clear this definition should be controlling. In any event, it involves a fundamental misunderstanding of the nature of a corporation.  Business associations are contracts or sets of contracts among the participants.  See, e.g., Butler and Ribstein, Opting Out of Fiduciary Duties:  A Response to the Anti-Contractarians, 65 Washington Law Review 1 (1990).  Articles of incorporation or certificates of partnership don’t allow people to engage in transactions that otherwise would be illegal, they just make it easier to enter into these governance arrangements.  (However, grants of authority to foreign business associations might be a different matter.)

The main exception to this generalization is limited tort liability.  I don’t think this takes limited liability out of the contractual realm (see my Limited Liability and Theories of the Corporation, 50 Md. L. Rev. 80 (1991)).  But even if it does it still leaves business association formations a long way from the type of license that IRCA must have been referring to that allows firms to engage in certain types of business.

In any event, asssuming preemption was unclear here, our coordination policy would not tip the scale toward preemption.

In Administrative Law, Corporate & Securities Law, Jurisdictional Competition, Regulation ,
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Small Business Financing Post-Crisis

Michael Sykuta —  9 March 2011

Tomorrow I will be attending a symposium on small business financing sponsored by the Entrepreneurial Business Law Journal‘s at the Moritz College of Law at the Ohio State University. I’m on a panel entitled “Recessionary Impacts on Equity Capital,” which is a bit misleading–or at least a bit different that the topic I offered to speak on, which is the effect of the recession and recent financial crisis on small business financing more generally. The rest of the day includes presentations governmental and policy responses to the crisis and practical implications of constricted capital. A copy of the schedule and list of speakers is available. I’m not very familiar with any of the other panelists, but the luncheon address will be given by Al Martinez-Fonts, Executive Vice President, U.S. Chamber of Commerce.

I’m going to focus on a few basic points and highlight some of the myths around small businesses and small business financing that drives poor policy. My first objective is to lay out a simple framework for thinking about financing deals, or any deal for that matter. Namely, the idea that every transaction involves allocations of value, uncertainty and decision rights; and the deal itself provides structure on those allocations by specifying the incentive systems, performance measures and decision rights that address both parties’ interests. How those structures are designed determine the nature of risk exposure and incentive conflicts that may affect the ex post value and performance of the deal.

In a sense, there is nothing new in small business financing post-crisis.  The fundamentals are the same. There is a multitude of contractual terms to address the various kinds of incentive issues and uncertainties that exist in the current market environment. To the extent there is anything truly unique about the current context, they are less about the financial market itself than about broader regulatory and economic issues. For example, much of the uncertainty affecting credit-worthiness have to do with economic and cash flow uncertainties stemming from upheavals in the regulatory landscape for small businesses, including health care. Uncertainty concerning implementation of financial market reforms passed in July 2010 create uncertainties for lenders. These uncertainties exacerbate the usual economic uncertainties of new and small businesses during an economic recovery period.

During the recession itself, “stimulus” spending distorted the credit-worthiness of small businesses in industries that were more directly benefited by government handouts and by the security provided small businesses that supply large, publicly-administered and guaranteed businesses (such as in the auto industry).  Thus, federal and state economic policy to “create jobs” in some sectors distorted the incentives to lend to different groups of small businesses, likely reducing employment in other sectors.

Finally, I’m going to suggest that talking about “small business” financing is a misnomer if we are truly motivated by a care of job creation. A recent paper by John Haltiwanger, Ron Jarmin, and Javier Miranda illustrates that business size is not the key determinant of job creation in the US, as is often argued in the media and policy circles. (HT: Peter Klein at O&M) They find that it is young firms, which happen to be small, not small firms in general that provide the job creation. Ironically, these young firms are also the ones for whom financing is most difficult due to the nascent stage of development and uncertainty. Thus, policies directed to firms based on size alone further distort capital availability from other (larger) companies that are equally likely to create jobs. Since this distortion is not costless, the policies are not welfare-neutral by simply switching where jobs are created, but likely to reduce welfare overall.

So now you don’t need to rush to Columbus, Ohio, to hear what I’ll have to say–unless you want to see the fireworks in person. But now you’ll know what’s going on in case there is news of more upset around the horse shoe in Columbus.

In Financial Regulation, Regulation ,
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