Archives For Hayek

[This post adapts elements of “Should ASEAN Antitrust Laws Emulate European Competition Policy?”, published in the Singapore Economic Review (2021). Open access working paper here.]

U.S. and European competition laws diverge in numerous ways that have important real-world effects. Understanding these differences is vital, particularly as lawmakers in the United States, and the rest of the world, consider adopting a more “European” approach to competition.

In broad terms, the European approach is more centralized and political. The European Commission’s Directorate General for Competition (DG Comp) has significant de facto discretion over how the law is enforced. This contrasts with the common law approach of the United States, in which courts elaborate upon open-ended statutes through an iterative process of case law. In other words, the European system was built from the top down, while U.S. antitrust relies on a bottom-up approach, derived from arguments made by litigants (including the government antitrust agencies) and defendants (usually businesses).

This procedural divergence has significant ramifications for substantive law. European competition law includes more provisions akin to de facto regulation. This is notably the case for the “abuse of dominance” standard, in which a “dominant” business can be prosecuted for “abusing” its position by charging high prices or refusing to deal with competitors. By contrast, the U.S. system places more emphasis on actual consumer outcomes, rather than the nature or “fairness” of an underlying practice.

The American system thus affords firms more leeway to exclude their rivals, so long as this entails superior benefits for consumers. This may make the U.S. system more hospitable to innovation, since there is no built-in regulation of conduct for innovators who acquire a successful market position fairly and through normal competition.

In this post, we discuss some key differences between the two systems—including in areas like predatory pricing and refusals to deal—as well as the discretionary power the European Commission enjoys under the European model.

Exploitative Abuses

U.S. antitrust is, by and large, unconcerned with companies charging what some might consider “excessive” prices. The late Associate Justice Antonin Scalia, writing for the Supreme Court majority in the 2003 case Verizon v. Trinko, observed that:

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

This contrasts with European competition-law cases, where firms may be found to have infringed competition law because they charged excessive prices. As the European Court of Justice (ECJ) held in 1978’s United Brands case: “In this case charging a price which is excessive because it has no reasonable relation to the economic value of the product supplied would be such an abuse.”

While United Brands was the EU’s foundational case for excessive pricing, and the European Commission reiterated that these allegedly exploitative abuses were possible when it published its guidance paper on abuse of dominance cases in 2009, the commission had for some time demonstrated apparent disinterest in bringing such cases. In recent years, however, both the European Commission and some national authorities have shown renewed interest in excessive-pricing cases, most notably in the pharmaceutical sector.

European competition law also penalizes so-called “margin squeeze” abuses, in which a dominant upstream supplier charges a price to distributors that is too high for them to compete effectively with that same dominant firm downstream:

[I]t is for the referring court to examine, in essence, whether the pricing practice introduced by TeliaSonera is unfair in so far as it squeezes the margins of its competitors on the retail market for broadband connection services to end users. (Konkurrensverket v TeliaSonera Sverige, 2011)

As Scalia observed in Trinko, forcing firms to charge prices that are below a market’s natural equilibrium affects firms’ incentives to enter markets, notably with innovative products and more efficient means of production. But the problem is not just one of market entry and innovation.  Also relevant is the degree to which competition authorities are competent to determine the “right” prices or margins.

As Friedrich Hayek demonstrated in his influential 1945 essay The Use of Knowledge in Society, economic agents use information gleaned from prices to guide their business decisions. It is this distributed activity of thousands or millions of economic actors that enables markets to put resources to their most valuable uses, thereby leading to more efficient societies. By comparison, the efforts of central regulators to set prices and margins is necessarily inferior; there is simply no reasonable way for competition regulators to make such judgments in a consistent and reliable manner.

Given the substantial risk that investigations into purportedly excessive prices will deter market entry, such investigations should be circumscribed. But the court’s precedents, with their myopic focus on ex post prices, do not impose such constraints on the commission. The temptation to “correct” high prices—especially in the politically contentious pharmaceutical industry—may thus induce economically unjustified and ultimately deleterious intervention.

Predatory Pricing

A second important area of divergence concerns predatory-pricing cases. U.S. antitrust law subjects allegations of predatory pricing to two strict conditions:

  1. Monopolists must charge prices that are below some measure of their incremental costs; and
  2. There must be a realistic prospect that they will able to recoup these initial losses.

In laying out its approach to predatory pricing, the U.S. Supreme Court has identified the risk of false positives and the clear cost of such errors to consumers. It thus has particularly stressed the importance of the recoupment requirement. As the court found in 1993’s Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., without recoupment, “predatory pricing produces lower aggregate prices in the market, and consumer welfare is enhanced.”

Accordingly, U.S. authorities must prove that there are constraints that prevent rival firms from entering the market after the predation scheme, or that the scheme itself would effectively foreclose rivals from entering the market in the first place. Otherwise, the predator would be undercut by competitors as soon as it attempts to recoup its losses by charging supra-competitive prices.

Without the strong likelihood that a monopolist will be able to recoup lost revenue from underpricing, the overwhelming weight of economic evidence (to say nothing of simple logic) is that predatory pricing is not a rational business strategy. Thus, apparent cases of predatory pricing are most likely not, in fact, predatory; deterring or punishing them would actually harm consumers.

By contrast, the EU employs a more expansive legal standard to define predatory pricing, and almost certainly risks injuring consumers as a result. Authorities must prove only that a company has charged a price below its average variable cost, in which case its behavior is presumed to be predatory. Even when a firm charges prices that are between its average variable and average total cost, it can be found guilty of predatory pricing if authorities show that its behavior was part of a plan to eliminate a competitor. Most significantly, in neither case is it necessary for authorities to show that the scheme would allow the monopolist to recoup its losses.

[I]t does not follow from the case‑law of the Court that proof of the possibility of recoupment of losses suffered by the application, by an undertaking in a dominant position, of prices lower than a certain level of costs constitutes a necessary precondition to establishing that such a pricing policy is abusive. (France Télécom v Commission, 2009).

This aspect of the legal standard has no basis in economic theory or evidence—not even in the “strategic” economic theory that arguably challenges the dominant Chicago School understanding of predatory pricing. Indeed, strategic predatory pricing still requires some form of recoupment, and the refutation of any convincing business justification offered in response. For example, ​​in a 2017 piece for the Antitrust Law Journal, Steven Salop lays out the “raising rivals’ costs” analysis of predation and notes that recoupment still occurs, just at the same time as predation:

[T]he anticompetitive conditional pricing practice does not involve discrete predatory and recoupment periods, as in the case of classical predatory pricing. Instead, the recoupment occurs simultaneously with the conduct. This is because the monopolist is able to maintain its current monopoly power through the exclusionary conduct.

The case of predatory pricing illustrates a crucial distinction between European and American competition law. The recoupment requirement embodied in American antitrust law serves to differentiate aggressive pricing behavior that improves consumer welfare—because it leads to overall price decreases—from predatory pricing that reduces welfare with higher prices. It is, in other words, entirely focused on the welfare of consumers.

The European approach, by contrast, reflects structuralist considerations far removed from a concern for consumer welfare. Its underlying fear is that dominant companies could use aggressive pricing to engender more concentrated markets. It is simply presumed that these more concentrated markets are invariably detrimental to consumers. Both the Tetra Pak and France Télécom cases offer clear illustrations of the ECJ’s reasoning on this point:

[I]t would not be appropriate, in the circumstances of the present case, to require in addition proof that Tetra Pak had a realistic chance of recouping its losses. It must be possible to penalize predatory pricing whenever there is a risk that competitors will be eliminated… The aim pursued, which is to maintain undistorted competition, rules out waiting until such a strategy leads to the actual elimination of competitors. (Tetra Pak v Commission, 1996).

Similarly:

[T]he lack of any possibility of recoupment of losses is not sufficient to prevent the undertaking concerned reinforcing its dominant position, in particular, following the withdrawal from the market of one or a number of its competitors, so that the degree of competition existing on the market, already weakened precisely because of the presence of the undertaking concerned, is further reduced and customers suffer loss as a result of the limitation of the choices available to them.  (France Télécom v Commission, 2009).

In short, the European approach leaves less room to analyze the concrete effects of a given pricing scheme, leaving it more prone to false positives than the U.S. standard explicated in the Brooke Group decision. Worse still, the European approach ignores not only the benefits that consumers may derive from lower prices, but also the chilling effect that broad predatory pricing standards may exert on firms that would otherwise seek to use aggressive pricing schemes to attract consumers.

Refusals to Deal

U.S. and EU antitrust law also differ greatly when it comes to refusals to deal. While the United States has limited the ability of either enforcement authorities or rivals to bring such cases, EU competition law sets a far lower threshold for liability.

As Justice Scalia wrote in Trinko:

Aspen Skiing is at or near the outer boundary of §2 liability. The Court there found significance in the defendant’s decision to cease participation in a cooperative venture. The unilateral termination of a voluntary (and thus presumably profitable) course of dealing suggested a willingness to forsake short-term profits to achieve an anticompetitive end. (Verizon v Trinko, 2003.)

This highlights two key features of American antitrust law with regard to refusals to deal. To start, U.S. antitrust law generally does not apply the “essential facilities” doctrine. Accordingly, in the absence of exceptional facts, upstream monopolists are rarely required to supply their product to downstream rivals, even if that supply is “essential” for effective competition in the downstream market. Moreover, as Justice Scalia observed in Trinko, the Aspen Skiing case appears to concern only those limited instances where a firm’s refusal to deal stems from the termination of a preexisting and profitable business relationship.

While even this is not likely the economically appropriate limitation on liability, its impetus—ensuring that liability is found only in situations where procompetitive explanations for the challenged conduct are unlikely—is completely appropriate for a regime concerned with minimizing the cost to consumers of erroneous enforcement decisions.

As in most areas of antitrust policy, EU competition law is much more interventionist. Refusals to deal are a central theme of EU enforcement efforts, and there is a relatively low threshold for liability.

In theory, for a refusal to deal to infringe EU competition law, it must meet a set of fairly stringent conditions: the input must be indispensable, the refusal must eliminate all competition in the downstream market, and there must not be objective reasons that justify the refusal. Moreover, if the refusal to deal involves intellectual property, it must also prevent the appearance of a new good.

In practice, however, all of these conditions have been relaxed significantly by EU courts and the commission’s decisional practice. This is best evidenced by the lower court’s Microsoft ruling where, as John Vickers notes:

[T]he Court found easily in favor of the Commission on the IMS Health criteria, which it interpreted surprisingly elastically, and without relying on the special factors emphasized by the Commission. For example, to meet the “new product” condition it was unnecessary to identify a particular new product… thwarted by the refusal to supply but sufficient merely to show limitation of technical development in terms of less incentive for competitors to innovate.

EU competition law thus shows far less concern for its potential chilling effect on firms’ investments than does U.S. antitrust law.

Vertical Restraints

There are vast differences between U.S. and EU competition law relating to vertical restraints—that is, contractual restraints between firms that operate at different levels of the production process.

On the one hand, since the Supreme Court’s Leegin ruling in 2006, even price-related vertical restraints (such as resale price maintenance (RPM), under which a manufacturer can stipulate the prices at which retailers must sell its products) are assessed under the rule of reason in the United States. Some commentators have gone so far as to say that, in practice, U.S. case law on RPM almost amounts to per se legality.

Conversely, EU competition law treats RPM as severely as it treats cartels. Both RPM and cartels are considered to be restrictions of competition “by object”—the EU’s equivalent of a per se prohibition. This severe treatment also applies to non-price vertical restraints that tend to partition the European internal market.

Furthermore, in the Consten and Grundig ruling, the ECJ rejected the consequentialist, and economically grounded, principle that inter-brand competition is the appropriate framework to assess vertical restraints:

Although competition between producers is generally more noticeable than that between distributors of products of the same make, it does not thereby follow that an agreement tending to restrict the latter kind of competition should escape the prohibition of Article 85(1) merely because it might increase the former. (Consten SARL & Grundig-Verkaufs-GMBH v. Commission of the European Economic Community, 1966).

This treatment of vertical restrictions flies in the face of longstanding mainstream economic analysis of the subject. As Patrick Rey and Jean Tirole conclude:

Another major contribution of the earlier literature on vertical restraints is to have shown that per se illegality of such restraints has no economic foundations.

Unlike the EU, the U.S. Supreme Court in Leegin took account of the weight of the economic literature, and changed its approach to RPM to ensure that the law no longer simply precluded its arguable consumer benefits, writing: “Though each side of the debate can find sources to support its position, it suffices to say here that economics literature is replete with procompetitive justifications for a manufacturer’s use of resale price maintenance.” Further, the court found that the prior approach to resale price maintenance restraints “hinders competition and consumer welfare because manufacturers are forced to engage in second-best alternatives and because consumers are required to shoulder the increased expense of the inferior practices.”

The EU’s continued per se treatment of RPM, by contrast, strongly reflects its “precautionary principle” approach to antitrust. European regulators and courts readily condemn conduct that could conceivably injure consumers, even where such injury is, according to the best economic understanding, exceedingly unlikely. The U.S. approach, which rests on likelihood rather than mere possibility, is far less likely to condemn beneficial conduct erroneously.

Political Discretion in European Competition Law

EU competition law lacks a coherent analytical framework like that found in U.S. law’s reliance on the consumer welfare standard. The EU process is driven by a number of laterally equivalent—and sometimes mutually exclusive—goals, including industrial policy and the perceived need to counteract foreign state ownership and subsidies. Such a wide array of conflicting aims produces lack of clarity for firms seeking to conduct business. Moreover, the discretion that attends this fluid arrangement of goals yields an even larger problem.

The Microsoft case illustrates this problem well. In Microsoft, the commission could have chosen to base its decision on various potential objectives. It notably chose to base its findings on the fact that Microsoft’s behavior reduced “consumer choice.”

The commission, in fact, discounted arguments that economic efficiency may lead to consumer welfare gains, because it determined “consumer choice” among media players was more important:

Another argument relating to reduced transaction costs consists in saying that the economies made by a tied sale of two products saves resources otherwise spent for maintaining a separate distribution system for the second product. These economies would then be passed on to customers who could save costs related to a second purchasing act, including selection and installation of the product. Irrespective of the accuracy of the assumption that distributive efficiency gains are necessarily passed on to consumers, such savings cannot possibly outweigh the distortion of competition in this case. This is because distribution costs in software licensing are insignificant; a copy of a software programme can be duplicated and distributed at no substantial effort. In contrast, the importance of consumer choice and innovation regarding applications such as media players is high. (Commission Decision No. COMP. 37792 (Microsoft)).

It may be true that tying the products in question was unnecessary. But merely dismissing this decision because distribution costs are near-zero is hardly an analytically satisfactory response. There are many more costs involved in creating and distributing complementary software than those associated with hosting and downloading. The commission also simply asserts that consumer choice among some arbitrary number of competing products is necessarily a benefit. This, too, is not necessarily true, and the decision’s implication that any marginal increase in choice is more valuable than any gains from product design or innovation is analytically incoherent.

The Court of First Instance was only too happy to give the commission a pass in its breezy analysis; it saw no objection to these findings. With little substantive reasoning to support its findings, the court fully endorsed the commission’s assessment:

As the Commission correctly observes (see paragraph 1130 above), by such an argument Microsoft is in fact claiming that the integration of Windows Media Player in Windows and the marketing of Windows in that form alone lead to the de facto standardisation of the Windows Media Player platform, which has beneficial effects on the market. Although, generally, standardisation may effectively present certain advantages, it cannot be allowed to be imposed unilaterally by an undertaking in a dominant position by means of tying.

The Court further notes that it cannot be ruled out that third parties will not want the de facto standardisation advocated by Microsoft but will prefer it if different platforms continue to compete, on the ground that that will stimulate innovation between the various platforms. (Microsoft Corp. v Commission, 2007)

Pointing to these conflicting effects of Microsoft’s bundling decision, without weighing either, is a weak basis to uphold the commission’s decision that consumer choice outweighs the benefits of standardization. Moreover, actions undertaken by other firms to enhance consumer choice at the expense of standardization are, on these terms, potentially just as problematic. The dividing line becomes solely which theory the commission prefers to pursue.

What such a practice does is vest the commission with immense discretionary power. Any given case sets up a “heads, I win; tails, you lose” situation in which defendants are easily outflanked by a commission that can change the rules of its analysis as it sees fit. Defendants can play only the cards that they are dealt. Accordingly, Microsoft could not successfully challenge a conclusion that its behavior harmed consumers’ choice by arguing that it improved consumer welfare, on net.

By selecting, in this instance, “consumer choice” as the standard to be judged, the commission was able to evade the constraints that might have been imposed by a more robust welfare standard. Thus, the commission can essentially pick and choose the objectives that best serve its interests in each case. This vastly enlarges the scope of potential antitrust liability, while also substantially decreasing the ability of firms to predict when their behavior may be viewed as problematic. It leads to what, in U.S. courts, would be regarded as an untenable risk of false positives that chill innovative behavior and create nearly unwinnable battles for targeted firms.

A recently published book, “Kochland – The Secret History of Koch Industries and Corporate Power in America” by Christopher Leonard, presents a gripping account of relentless innovation and the power of the entrepreneur to overcome adversity in pursuit of delivering superior goods and services to the market while also reaping impressive profits. It’s truly an inspirational American story.

Now, I should note that I don’t believe Mr. Leonard actually intended his book to be quite so complimentary to the Koch brothers and the vast commercial empire they built up over the past several decades. He includes plenty of material detailing, for example, their employees playing fast and loose with environmental protection rules, or their labor lawyers aggressively bargaining with unions, sometimes to the detriment of workers. And all of the stories he presents are supported by sympathetic emotional appeals through personal anecdotes. 

But, even then, many of the negative claims are part of a larger theme of Koch Industries progressively improving its business practices. One prominent example is how Koch Industries learned from its environmentally unfriendly past and implemented vigorous programs to ensure “10,000% compliance” with all federal and state environmental laws. 

What really stands out across most or all of the stories Leonard has to tell, however, is the deep appreciation that Charles Koch and his entrepreneurially-minded employees have for the fundamental nature of the market as an information discovery process. Indeed, Koch Industries has much in common with modern technology firms like Amazon in this respect — but decades before the information technology revolution made the full power of “Big Data” gathering and processing as obvious as it is today.

The impressive information operation of Koch Industries

Much of Kochland is devoted to stories in which Koch Industries’ ability to gather and analyze data from across its various units led to the production of superior results for the economy and consumers. For example,  

Koch… discovered that the National Parks Service published data showing the snow pack in the California mountains, data that Koch could analyze to determine how much water would be flowing in future months to generate power at California’s hydroelectric plants. This helped Koch predict with great accuracy the future supply of electricity and the resulting demand for natural gas.

Koch Industries was able to use this information to anticipate the amount of power (megawatt hours) it needed to deliver to the California power grid (admittedly, in a way that was somewhat controversial because of poorly drafted legislation relating to the new regulatory regime governing power distribution and resale in the state).

And, in 2000, while many firms in the economy were still riding the natural gas boom of the 90s, 

two Koch analysts and a reservoir engineer… accurately predicted a coming disaster that would contribute to blackouts along the West Coast, the bankruptcy of major utilities, and skyrocketing costs for many consumers.

This insight enabled Koch Industries to reap huge profits in derivatives trading, and it also enabled it to enter — and essentially rescue — a market segment crucial for domestic farmers: nitrogen fertilizer.

The market volatility in natural gas from the late 90s through early 00s wreaked havoc on the nitrogen fertilizer industry, for which natural gas is the primary input. Farmland — a struggling fertilizer producer — had progressively mismanaged its business over the preceding two decades by focusing on developing lines of business outside of its core competencies, including blithely exposing itself to the volatile natural gas market in pursuit of short-term profits. By the time it was staring bankruptcy in the face, there were no other companies interested in acquiring it. 

Koch’s analysts, however, noticed that many of Farmland’s key fertilizer plants were located in prime locations for reaching local farmers. Once the market improved, whoever controlled those key locations would be in a superior position for selling into the nitrogen fertilizer market. So, by utilizing the data it derived from its natural gas operations (both operating pipelines and storage facilities, as well as understanding the volatility of gas prices and availability through its derivatives trading operations), Koch Industries was able to infer that it could make substantial profits by rescuing this bankrupt nitrogen fertilizer business. 

Emblematic of Koch’s philosophy of only making long-term investments, 

[o]ver the next ten years, [Koch Industries] spent roughly $500 million to outfit the plants with new technology while streamlining production… Koch installed a team of fertilizer traders in the office… [t]he traders bought and sold supplies around the globe, learning more about fertilizer markets each day. Within a few years, Koch Fertilizer built a global distribution network. Koch founded a new company, called Koch Energy Services, which bought and sold natural gas supplies to keep the fertilizer plants stocked.

Thus, Koch Industries not only rescued midwest farmers from shortages that would have decimated their businesses, it invested heavily to ensure that production would continue to increase to meet future demand. 

As noted, this acquisition was consistent with the ethos of Koch Industries, which stressed thinking about investments as part of long-term strategies, in contrast to their “counterparties in the market [who] were obsessed with the near-term horizon.” This led Koch Industries to look at investments over a period measured in years or decades, an approach that allowed the company to execute very intricate investment strategies: 

If Koch thought there was going to be an oversupply of oil in the Gulf Coast region, for example, it might snap up leases on giant oil barges, knowing that when the oversupply hit, companies would be scrambling for extra storage space and willing to pay a premium for the leases that Koch bought on the cheap. This was a much safer way to execute the trade than simply shorting the price of oil—even if Koch was wrong about the supply glut, the downside was limited because Koch could still sell or use the barge leases and almost certainly break even.

Entrepreneurs, regulators, and the problem of incentives

All of these accounts and more in Kochland brilliantly demonstrate a principal salutary role of entrepreneurs in the market, which is to discover slack or scarce resources in the system and manage them in a way that they will be available for utilization when demand increases. Guaranteeing the presence of oil barges in the face of market turbulence, or making sure that nitrogen fertilizer is available when needed, is precisely the sort of result sound public policy seeks to encourage from firms in the economy. 

Government, by contrast — and despite its best intentions — is institutionally incapable of performing the same sorts of entrepreneurial activities as even very large private organizations like Koch Industries. The stories recounted in Kochland demonstrate this repeatedly. 

For example, in the oil tanker episode, Koch’s analysts relied on “huge amounts of data from outside sources” – including “publicly available data…like the federal reports that tracked the volume of crude oil being stored in the United States.” Yet, because that data was “often stale” owing to a rigid, periodic publication schedule, it lacked the specificity necessary for making precise interventions in markets. 

Koch’s analysts therefore built on that data using additional public sources, such as manifests from the Customs Service which kept track of the oil tanker traffic in US waters. Leveraging all of this publicly available data, Koch analysts were able to develop “a picture of oil shipments and flows that was granular in its specificity.”

Similarly, when trying to predict snowfall in the western US, and how that would affect hydroelectric power production, Koch’s analysts relied on publicly available weather data — but extended it with their own analytical insights to make it more suitable to fine-grained predictions. 

By contrast, despite decades of altering the regulatory scheme around natural gas production, transport and sales, and being highly involved in regulating all aspects of the process, the federal government could not even provide the data necessary to adequately facilitate markets. Koch’s energy analysts would therefore engage in various deals that sometimes would only break even — if it meant they could develop a better overall picture of the relevant markets: 

As was often the case at Koch, the company… was more interested in the real-time window that origination deals could provide into the natural gas markets. Just as in the early days of the crude oil markets, information about prices was both scarce and incredibly valuable. There were not yet electronic exchanges that showed a visible price of natural gas, and government data on sales were irregular and relatively slow to come. Every origination deal provided fresh and precise information about prices, supply, and demand.

In most, if not all, of the deals detailed in Kochland, government regulators had every opportunity to find the same trends in the publicly available data — or see the same deficiencies in the data and correct them. Given their access to the same data, government regulators could, in some imagined world, have developed policies to mitigate the effects of natural gas market collapses, handle upcoming power shortages, or develop a reliable supply of fertilizer to midwest farmers. But they did not. Indeed, because of the different sets of incentives they face (among other factors), in the real world, they cannot do so, despite their best intentions.

The incentive to innovate

This gets to the core problem that Hayek described concerning how best to facilitate efficient use of dispersed knowledge in such a way as to achieve the most efficient allocation and distribution of resources: 

The various ways in which the knowledge on which people base their plans is communicated to them is the crucial problem for any theory explaining the economic process, and the problem of what is the best way of utilizing knowledge initially dispersed among all the people is at least one of the main problems of economic policy—or of designing an efficient economic system.

The question of how best to utilize dispersed knowledge in society can only be answered by considering who is best positioned to gather and deploy that knowledge. There is no fundamental objection to “planning”  per se, as Hayek notes. Indeed, in a complex society filled with transaction costs, there will need to be entities capable of internalizing those costs  — corporations or governments — in order to make use of the latent information in the system. The question is about what set of institutions, and what set of incentives governing those institutions, results in the best use of that latent information (and the optimal allocation and distribution of resources that follows from that). 

Armen Alchian captured the different incentive structures between private firms and government agencies well: 

The extent to which various costs and effects are discerned, measured and heeded depends on the institutional system of incentive-punishment for the deciders. One system of rewards-punishment may increase the extent to which some objectives are heeded, whereas another may make other goals more influential. Thus procedures for making or controlling decisions in one rewards-incentive system are not necessarily the “best” for some other system…

In the competitive, private, open-market economy, the wealth-survival prospects are not as strong for firms (or their employees) who do not heed the market’s test of cost effectiveness as for firms who do… as a result the market’s criterion is more likely to be heeded and anticipated by business people. They have personal wealth incentives to make more thorough cost-effectiveness calculations about the products they could produce …

In the government sector, two things are less effective. (1) The full cost and value consequences of decisions do not have as direct and severe a feedback impact on government employees as on people in the private sector. The costs of actions under their consideration are incomplete simply because the consequences of ignoring parts of the full span of costs are less likely to be imposed on them… (2) The effectiveness, in the sense of benefits, of their decisions has a different reward-inventive or feedback system … it is fallacious to assume that government officials are superhumans, who act solely with the national interest in mind and are never influenced by the consequences to their own personal position.

In short, incentives matter — and are a function of the institutional arrangement of the system. Given the same set of data about a scarce set of resources, over the long run, the private sector generally has stronger incentives to manage resources efficiently than does government. As Ludwig von Mises showed, moving those decisions into political hands creates a system of political preferences that is inherently inferior in terms of the production and distribution of goods and services.

Koch Industries: A model of entrepreneurial success

The market is not perfect, but no human institution is perfect. Despite its imperfections, the market provides the best system yet devised for fairly and efficiently managing the practically unlimited demands we place on our scarce resources. 

Kochland provides a valuable insight into the virtues of the market and entrepreneurs, made all the stronger by Mr. Leonard’s implied project of “exposing” the dark underbelly of Koch Industries. The book tells the bad tales, which I’m willing to believe are largely true. I would, frankly, be shocked if any large entity — corporation or government — never ran into problems with rogue employees, internal corporate dynamics gone awry, or a failure to properly understand some facet of the market or society that led to bad investments or policy. 

The story of Koch Industries — presented even as it is through the lens of a “secret history”  — is deeply admirable. It’s the story of a firm that not only learns from its own mistakes, as all firms must do if they are to survive, but of a firm that has a drive to learn in its DNA. Koch Industries relentlessly gathers information from the market, sometimes even to the exclusion of short-term profit. It eschews complex bureaucratic structures and processes, which encourages local managers to find opportunities and nimbly respond.

Kochland is a quick read that presents a gripping account of one of America’s corporate success stories. There is, of course, a healthy amount of material in the book covering the Koch brothers’ often controversial political activities. Nonetheless, even those who hate the Koch brothers on account of politics would do well to learn from the model of entrepreneurial success that Kochland cannot help but describe in its pages. 

On Debating Imaginary Felds

Gus Hurwitz —  18 September 2013

Harold Feld, in response to a recent Washington Post interview with AEI’s Jeff Eisenach about AEI’s new Center for Internet, Communications, and Technology Policy, accused “neo-conservative economists (or, as [Feld] might generalize, the ‘Right’)” of having “stopped listening to people who disagree with them. As a result, they keep saying the same thing over and over again.”

(Full disclosure: The Center for Internet, Communications, and Technology Policy includes TechPolicyDaily.com, to which I am a contributor.)

Perhaps to the surprise of many, I’m going to agree with Feld. But in so doing, I’m going to expand upon his point: The problem with anti-economics social activists (or, as we might generalize, the ‘Left’)[*] is that they have stopped listening to people who disagree with them. As a result, they keep saying the same thing over and over again.

I don’t mean this to be snarky. Rather, it is a very real problem throughout modern political discourse, and one that we participants in telecom and media debates frequently contribute to. One of the reasons that I love – and sometimes hate – researching and teaching in this area is that fundamental tensions between government and market regulation lie at its core. These tensions present challenging and engaging questions, making work in this field exciting, but are sometimes intractable and often evoke passion instead of analysis, making work in this field seem Sisyphean.

One of these tensions is how to secure for consumers those things which the market does not (appear to) do a good job of providing. For instance, those of us on both the left and right are almost universally agreed that universal service is a desirable goal. The question – for both sides – is how to provide it. Feld reminds us that “real world economics is painfully complicated.” I would respond to him that “real world regulation is painfully complicated.”

I would point at Feld, while jumping up and down shouting “J’accuse! Nirvana Fallacy!” – but I’m certain that Feld is aware of this fallacy, just as I hope he’s aware that those of us who have spent much of our lives studying economics are bitterly aware that economics and markets are complicated things. Indeed, I think those of us who study economics are even more aware of this than is Feld – it is, after all, one of our mantras that “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” This mantra is particularly apt in telecommunications, where one of the most consistent and important lessons of the past century has been that the market tends to outperform regulation.

This isn’t because the market is perfect; it’s because regulation is less perfect. Geoff recently posted a salient excerpt from Tom Hazlett’s 1997 Reason interview of Ronald Coase, in which Coase recounted that “When I was editor of The Journal of Law and Economics, we published a whole series of studies of regulation and its effects. Almost all the studies – perhaps all the studies – suggested that the results of regulation had been bad, that the prices were higher, that the product was worse adapted to the needs of consumers, than it otherwise would have been.”

I don’t want to get into a tit-for-tat over individual points that Feld makes. But I will look at one as an example: his citation to The Market for Lemons. This is a classic paper, in which Akerlof shows that information asymmetries can cause rational markets to unravel. But does it, as Feld says, show “market failure in the presence of robust competition?” That is a hotly debated point in the economics literature. One view – the dominant view, I believe – is that it does not. See, e.g., the EconLib discussion (“Akerlof did not conclude that the lemon problem necessarily implies a role for government”). Rather, the market has responded through the formation of firms that service and certify used cars, document car maintenance, repairs and accidents, warranty cars, and suffer reputational harms for selling lemons. Of course, folks argue, and have long argued, both sides. As Feld says, economics is painfully complicated – it’s a shame he draws a simple and reductionist conclusion from one of the seminal articles is modern economics, and a further shame he uses that conclusion to buttress his policy position. J’accuse!

I hope that this is in no way taken as an attack on Feld – and I wish his piece was less of an attack on Jeff. Fundamentally, he raises a very important point, that there is a real disconnect between the arguments used by the “left” and “right” and how those arguments are understood by the other. Indeed, some of my current work is exploring this very disconnect and how it affects telecom debates. I’m really quite thankful to Feld for highlighting his concern that at least one side is blind to the views of the other – I hope that he’ll be receptive to the idea that his side is subject to the same criticism.

[*] I do want to respond specifically to what I think is an important confusion in Feld piece, which motivated my admittedly snarky labelling of the “left.” I think that he means “neoclassical economics,” not “neo-conservative economics” (which he goes on to dub “Neocon economics”). Neoconservativism is a political and intellectual movement, focused primarily on US foreign policy – it is rarely thought of as a particular branch of economics. To the extent that it does hold to a view of economics, it is actually somewhat skeptical of free markets, especially of lack of moral grounding and propensity to forgo traditional values in favor of short-run, hedonistic, gains.