On Monday, April 2, I will leave the Heritage Foundation to enter federal government service. Accordingly, today I am signing off as a regular contributor to Truth on the Market. First and foremost, I owe a great debt of gratitude to Geoff Manne, who was kind enough to afford me access to TOTM. Geoff’s outstanding leadership has made TOTM the leading blog site bringing to bear sound law and economics insights on antitrust and related regulatory topics. I was also privileged to have the opportunity to work on an article with TOTM stalwart Thom Lambert, whose concise book How To Regulate is by far the best general resource on sound regulatory principles (it should sit on the desk of the head of every regulatory agency). I have also greatly benefited from the always insightful analyses of fellow TOTM bloggers Allen Gibby, Eric Fruits, Joanna Shepherd, Kristian Stout, Mike Sykuta, and Neil Turkewitz. Thanks to all! I look forward to continuing to seek enlightenment at truthonthemarket.com.
Archives For Joanna Shepherd
The populists are on the march, and as the 2018 campaign season gets rolling we’re witnessing more examples of political opportunism bolstered by economic illiteracy aimed at increasingly unpopular big tech firms.
The latest example comes in the form of a new investigation of Google opened by Missouri’s Attorney General, Josh Hawley. Mr. Hawley — a Republican who, not coincidentally, is running for Senate in 2018 — alleges various consumer protection violations and unfair competition practices.
But while Hawley’s investigation may jump start his campaign and help a few vocal Google rivals intent on mobilizing the machinery of the state against the company, it is unlikely to enhance consumer welfare — in Missouri or anywhere else.
According to the press release issued by the AG’s office:
[T]he investigation will seek to determine if Google has violated the Missouri Merchandising Practices Act—Missouri’s principal consumer-protection statute—and Missouri’s antitrust laws.
The business practices in question are Google’s collection, use, and disclosure of information about Google users and their online activities; Google’s alleged misappropriation of online content from the websites of its competitors; and Google’s alleged manipulation of search results to preference websites owned by Google and to demote websites that compete with Google.
Mr. Hawley’s justification for his investigation is a flourish of populist rhetoric:
We should not just accept the word of these corporate giants that they have our best interests at heart. We need to make sure that they are actually following the law, we need to make sure that consumers are protected, and we need to hold them accountable.
But Hawley’s “strong” concern is based on tired retreads of the same faulty arguments that Google’s competitors (Yelp chief among them), have been plying for the better part of a decade. In fact, all of his apparent grievances against Google were exhaustively scrutinized by the FTC and ultimately rejected or settled in separate federal investigations in 2012 and 2013.
The antitrust issues
To begin with, AG Hawley references the EU antitrust investigation as evidence that
this is not the first-time Google’s business practices have come into question. In June, the European Union issued Google a record $2.7 billion antitrust fine.
True enough — and yet, misleadingly incomplete. Missing from Hawley’s recitation of Google’s antitrust rap sheet are the following investigations, which were closed without any finding of liability related to Google Search, Android, Google’s advertising practices, etc.:
- United States FTC, 2013. The FTC found no basis to pursue a case after a two-year investigation: “Challenging Google’s product design decisions in this case would require the Commission — or a court — to second-guess a firm’s product design decisions where plausible procompetitive justifications have been offered, and where those justifications are supported by ample evidence.” The investigation did result in a consent order regarding patent licensing unrelated in any way to search and a voluntary commitment by Google not to engage in certain search-advertising-related conduct.
- South Korea FTC, 2013. The KFTC cleared Google after a two-year investigation. It opened a new investigation in 2016, but, as I have discussed, “[i]f anything, the economic conditions supporting [the KFTC’s 2013] conclusion have only gotten stronger since.”
- Canada Competition Bureau, 2016. The CCB closed a three-year long investigation into Google’s search practices without taking any action.
Similar investigations have been closed without findings of liability (or simply lie fallow) in a handful of other countries (e.g., Taiwan and Brazil) and even several states (e.g., Ohio and Texas). In fact, of all the jurisdictions that have investigated Google, only the EU and Russia have actually assessed liability.
As Beth Wilkinson, outside counsel to the FTC during the Google antitrust investigation, noted upon closing the case:
Undoubtedly, Google took aggressive actions to gain advantage over rival search providers. However, the FTC’s mission is to protect competition, and not individual competitors. The evidence did not demonstrate that Google’s actions in this area stifled competition in violation of U.S. law.
The CCB was similarly unequivocal in its dismissal of the very same antitrust claims Missouri’s AG seems intent on pursuing against Google:
The Bureau sought evidence of the harm allegedly caused to market participants in Canada as a result of any alleged preferential treatment of Google’s services. The Bureau did not find adequate evidence to support the conclusion that this conduct has had an exclusionary effect on rivals, or that it has resulted in a substantial lessening or prevention of competition in a market.
Unfortunately, rather than follow the lead of these agencies, Missouri’s investigation appears to have more in common with Russia’s effort to prop up a favored competitor (Yandex) at the expense of consumer welfare.
The Yelp Claim
Take Mr. Hawley’s focus on “Google’s alleged misappropriation of online content from the websites of its competitors,” for example, which cleaves closely to what should become known henceforth as “The Yelp Claim.”
While the sordid history of Yelp’s regulatory crusade against Google is too long to canvas in its entirety here, the primary elements are these:
Once upon a time (in 2005), Google licensed Yelp’s content for inclusion in its local search results. In 2007 Yelp ended the deal. By 2010, and without a license from Yelp (asserting fair use), Google displayed small snippets of Yelp’s reviews that, if clicked on, led to Yelp’s site. Even though Yelp received more user traffic from those links as a result, Yelp complained, and Google removed Yelp snippets from its local results.
In its 2013 agreement with the FTC, Google guaranteed that Yelp could opt-out of having even snippets displayed in local search results by committing Google to:
make available a web-based notice form that provides website owners with the option to opt out from display on Google’s Covered Webpages of content from their website that has been crawled by Google. When a website owner exercises this option, Google will cease displaying crawled content from the domain name designated by the website owner….
The commitments also ensured that websites (like Yelp) that opt out would nevertheless remain in Google’s general index.
Ironically, Yelp now claims in a recent study that Google should show not only snippets of Yelp reviews, but even more of Yelp’s content. (For those interested, my colleagues and I have a paper explaining why the study’s claims are spurious).
The key bit here, of course, is that Google stopped pulling content from Yelp’s pages to use in its local search results, and that it implemented a simple mechanism for any other site wishing to opt out of the practice to do so.
It’s difficult to imagine why Missouri’s citizens might require more than this to redress alleged anticompetitive harms arising from the practice.
Perhaps AG Hawley thinks consumers would be better served by an opt-in mechanism? Of course, this is absurd, particularly if any of Missouri’s citizens — and their businesses — have websites. Most websites want at least some of their content to appear on Google’s search results pages as prominently as possible — see this and this, for example — and making this information more accessible to users is why Google exists.
To be sure, some websites may take issue with how much of their content Google features and where it places that content. But the easy opt out enables them to prevent Google from showing their content in a manner they disapprove of. Yelp is an outlier in this regard because it views Google as a direct competitor, especially to the extent it enables users to read some of Yelp’s reviews without visiting Yelp’s pages.
For Yelp and a few similarly situated companies the opt out suffices. But for almost everyone else the opt out is presumably rarely exercised, and any more-burdensome requirement would just impose unnecessary costs, harming instead of helping their websites.
The privacy issues
The Missouri investigation also applies to “Google’s collection, use, and disclosure of information about Google users and their online activities.” More pointedly, Hawley claims that “Google may be collecting more information from users than the company was telling consumers….”
Presumably this would come as news to the FTC, which, with a much larger staff and far greater expertise, currently has Google under a 20 year consent order (with some 15 years left to go) governing its privacy disclosures and information-sharing practices, thus ensuring that the agency engages in continual — and well-informed — oversight of precisely these issues.
The FTC’s consent order with Google (the result of an investigation into conduct involving Google’s short-lived Buzz social network, allegedly in violation of Google’s privacy policies), requires the company to:
- “[N]ot misrepresent in any manner, expressly or by implication… the extent to which respondent maintains and protects the privacy and confidentiality of any [user] information…”;
- “Obtain express affirmative consent from” users “prior to any new or additional sharing… of the Google user’s identified information with any third party” if doing so would in any way deviate from previously disclosed practices;
- “[E]stablish and implement, and thereafter maintain, a comprehensive privacy program that is reasonably designed to [] address privacy risks related to the development and management of new and existing products and services for consumers, and (2) protect the privacy and confidentiality of [users’] information”; and
- Along with a laundry list of other reporting requirements, “[submit] biennial assessments and reports [] from a qualified, objective, independent third-party professional…, approved by the [FTC] Associate Director for Enforcement, Bureau of Consumer Protection… in his or her sole discretion.”
What, beyond the incredibly broad scope of the FTC’s consent order, could the Missouri AG’s office possibly hope to obtain from an investigation?
Google is already expressly required to provide privacy reports to the FTC every two years. It must provide several of the items Hawley demands in his CID to the FTC; others are required to be made available to the FTC upon demand. What materials could the Missouri AG collect beyond those the FTC already receives, or has the authority to demand, under its consent order?
And what manpower and expertise could Hawley apply to those materials that would even begin to equal, let alone exceed, those of the FTC?
Lest anyone think the FTC is falling down on the job, a year after it issued that original consent order the Commission fined Google $22.5 million for violating the order in a questionable decision that was signed on to by all of the FTC’s Commissioners (both Republican and Democrat) — except the one who thought it didn’t go far enough.
That penalty is of undeniable import, not only for its amount (at the time it was the largest in FTC history) and for stemming from alleged problems completely unrelated to the issue underlying the initial action, but also because it was so easy to obtain. Having put Google under a 20-year consent order, the FTC need only prove (or threaten to prove) contempt of the consent order, rather than the specific elements of a new violation of the FTC Act, to bring the company to heel. The former is far easier to prove, and comes with the ability to impose (significant) damages.
So what’s really going on in Jefferson City?
While states are, of course, free to enforce their own consumer protection laws to protect their citizens, there is little to be gained — other than cold hard cash, perhaps — from pursuing cases that, at best, duplicate enforcement efforts already undertaken by the federal government (to say nothing of innumerable other jurisdictions).
To take just one relevant example, in 2013 — almost a year to the day following the court’s approval of the settlement in the FTC’s case alleging Google’s violation of the Buzz consent order — 37 states plus DC (not including Missouri) settled their own, follow-on litigation against Google on the same facts. Significantly, the terms of the settlement did not impose upon Google any obligation not already a part of the Buzz consent order or the subsequent FTC settlement — but it did require Google to fork over an additional $17 million.
Not only is there little to be gained from yet another ill-conceived antitrust campaign, there is much to be lost. Such massive investigations require substantial resources to conduct, and the opportunity cost of doing so may mean real consumer issues go unaddressed. The Consumer Protection Section of the Missouri AG’s office says it receives some 100,000 consumer complaints a year. How many of those will have to be put on the back burner to accommodate an investigation like this one?
Even when not politically motivated, state enforcement of CPAs is not an unalloyed good. In fact, empirical studies of state consumer protection actions like the one contemplated by Mr. Hawley have shown that such actions tend toward overreach — good for lawyers, perhaps, but expensive for taxpayers and often detrimental to consumers. According to a recent study by economists James Cooper and Joanna Shepherd:
[I]n recent decades, this thoughtful balance [between protecting consumers and preventing the proliferation of lawsuits that harm both consumers and businesses] has yielded to damaging legislative and judicial overcorrections at the state level with a common theoretical mistake: the assumption that more CPA litigation automatically yields more consumer protection…. [C]ourts and legislatures gradually have abolished many of the procedural and remedial protections designed to cabin state CPAs to their original purpose: providing consumers with redress for actual harm in instances where tort and contract law may provide insufficient remedies. The result has been an explosion in consumer protection litigation, which serves no social function and for which consumers pay indirectly through higher prices and reduced innovation.
AG Hawley’s investigation seems almost tailored to duplicate the FTC’s extensive efforts — and to score political points. Or perhaps Mr. Hawley is just perturbed that Missouri missed out its share of the $17 million multistate settlement in 2013.
Which raises the spectre of a further problem with the Missouri case: “rent extraction.”
It’s no coincidence that Mr. Hawley’s investigation follows closely on the heels of Yelp’s recent letter to the FTC and every state AG (as well as four members of Congress and the EU’s chief competition enforcer, for good measure) alleging that Google had re-started scraping Yelp’s content, thus violating the terms of its voluntary commitments to the FTC.
It’s also no coincidence that Yelp “notified” Google of the problem only by lodging a complaint with every regulator who might listen rather than by actually notifying Google. But an action like the one Missouri is undertaking — not resolution of the issue — is almost certainly exactly what Yelp intended, and AG Hawley is playing right into Yelp’s hands.
Google, for its part, strongly disputes Yelp’s allegation, and, indeed, has — even according to Yelp — complied fully with Yelp’s request to keep its content off Google Local and other “vertical” search pages since 18 months before Google entered into its commitments with the FTC. Google claims that the recent scraping was inadvertent, and that it would happily have rectified the problem if only Yelp had actually bothered to inform Google.
Indeed, Yelp’s allegations don’t really pass the smell test: That Google would suddenly change its practices now, in violation of its commitments to the FTC and at a time of extraordinarily heightened scrutiny by the media, politicians of all stripes, competitors like Yelp, the FTC, the EU, and a host of other antitrust or consumer protection authorities, strains belief.
But, again, identifying and resolving an actual commercial dispute was likely never the goal. As a recent, fawning New York Times article on “Yelp’s Six-Year Grudge Against Google” highlights (focusing in particular on Luther Lowe, now Yelp’s VP of Public Policy and the author of the letter):
Yelp elevated Mr. Lowe to the new position of director of government affairs, a job that more or less entails flying around the world trying to sic antitrust regulators on Google. Over the next few years, Yelp hired its first lobbyist and started a political action committee. Recently, it has started filing complaints in Brazil.
Missouri, in other words, may just be carrying Yelp’s water.
The one clear lesson of the decades-long Microsoft antitrust saga is that companies that struggle to compete in the market can profitably tax their rivals by instigating antitrust actions against them. As Milton Friedman admonished, decrying “the business community’s suicidal impulse” to invite regulation:
As a believer in the pursuit of self-interest in a competitive capitalist system, I can’t blame a businessman who goes to Washington [or is it Jefferson City?] and tries to get special privileges for his company.… Blame the rest of us for being so foolish as to let him get away with it.
Taking a tough line on Silicon Valley firms in the midst of today’s anti-tech-company populist resurgence may help with the electioneering in Mr. Hawley’s upcoming bid for a US Senate seat and serve Yelp, but it doesn’t offer any clear, actual benefits to Missourians. As I’ve wondered before: “Exactly when will regulators be a little more skeptical of competitors trying to game the antitrust laws for their own advantage?”
Geoffrey A. Manne is Executive Director of the International Center for Law & Economics
Dynamic versus static competition
Ever since David Teece and coauthors began writing about antitrust and innovation in high-tech industries in the 1980s, we’ve understood that traditional, price-based antitrust analysis is not intrinsically well-suited for assessing merger policy in these markets.
For high-tech industries, performance, not price, is paramount — which means that innovation is key:
Competition in some markets may take the form of Schumpeterian rivalry in which a succession of temporary monopolists displace one another through innovation. At any one time, there is little or no head-to-head price competition but there is significant ongoing innovation competition.
Innovative industries are often marked by frequent disruptions or “paradigm shifts” rather than horizontal market share contests, and investment in innovation is an important signal of competition. And competition comes from the continual threat of new entry down the road — often from competitors who, though they may start with relatively small market shares, or may arise in different markets entirely, can rapidly and unexpectedly overtake incumbents.
Which, of course, doesn’t mean that current competition and ease of entry are irrelevant. Rather, because, as Joanna Shepherd noted, innovation should be assessed across the entire industry and not solely within merging firms, conduct that might impede new, disruptive, innovative entry is indeed relevant.
But it is also important to remember that innovation comes from within incumbent firms, as well, and, often, that the overall level of innovation in an industry may be increased by the presence of large firms with economies of scope and scale.
In sum, and to paraphrase Olympia Dukakis’ character in Moonstruck: “what [we] don’t know about [the relationship between innovation and market structure] is a lot.”
What we do know, however, is that superficial, concentration-based approaches to antitrust analysis will likely overweight presumed foreclosure effects and underweight innovation effects.
We shouldn’t fetishize entry, or access, or head-to-head competition over innovation, especially where consumer welfare may be significantly improved by a reduction in the former in order to get more of the latter.
As Katz and Shelanski note:
To assess fully the impact of a merger on market performance, merger authorities and courts must examine how a proposed transaction changes market participants’ incentives and abilities to undertake investments in innovation.
At the same time, they point out that
Innovation can dramatically affect the relationship between the pre-merger marketplace and what is likely to happen if the proposed merger is consummated…. [This requires consideration of] how innovation will affect the evolution of market structure and competition. Innovation is a force that could make static measures of market structure unreliable or irrelevant, and the effects of innovation may be highly relevant to whether a merger should be challenged and to the kind of remedy antitrust authorities choose to adopt. (Emphasis added).
Dynamic competition in the ag-biotech industry
These dynamics seem to be playing out in the ag-biotech industry. (For a detailed look at how the specific characteristics of innovation in the ag-biotech industry have shaped industry structure, see, e.g., here (pdf)).
One inconvenient truth for the “concentration reduces innovation” crowd is that, as the industry has experienced more consolidation, it has also become more, not less, productive and innovative. Between 1995 and 2015, for example, the market share of the largest seed producers and crop protection firms increased substantially. And yet, over the same period, annual industry R&D spending went up nearly 750 percent. Meanwhile, the resulting innovations have increased crop yields by 22%, reduced chemical pesticide use by 37%, and increased farmer profits by 68%.
In her discussion of the importance of considering the “innovation ecosystem” in assessing the innovation effects of mergers in R&D-intensive industries, Joanna Shepherd noted that
In many consolidated firms, increases in efficiency and streamlining of operations free up money and resources to source external innovation. To improve their future revenue streams and market share, consolidated firms can be expected to use at least some of the extra resources to acquire external innovation. This increase in demand for externally-sourced innovation increases the prices paid for external assets, which, in turn, incentivizes more early-stage innovation in small firms and biotech companies. Aggregate innovation increases in the process!
The same dynamic seems to play out in the ag-biotech industry, as well:
The seed-biotechnology industry has been reliant on small and medium-sized enterprises (SMEs) as sources of new innovation. New SME startups (often spinoffs from university research) tend to specialize in commercial development of a new research tool, genetic trait, or both. Significant entry by SMEs into the seed-biotechnology sector began in the late 1970s and early 1980s, with a second wave of new entrants in the late 1990s and early 2000s. In recent years, exits have outnumbered entrants, and by 2008 just over 30 SMEs specializing in crop biotechnology were still active. The majority of the exits from the industry were the result of acquisition by larger firms. Of 27 crop biotechnology SMEs that were acquired between 1985 and 2009, 20 were acquired either directly by one of the Big 6 or by a company that itself was eventually acquired by a Big 6 company.
While there is more than one way to interpret these statistics (and they are often used by merger opponents, in fact, to lament increasing concentration), they are actually at least as consistent with an increase in innovation through collaboration (and acquisition) as with a decrease.
For what it’s worth, this is exactly how the startup community views the innovation ecosystem in the ag-biotech industry, as well. As the latest AgFunder AgTech Investing Report states:
The large agribusinesses understand that new innovation is key to their future, but the lack of M&A [by the largest agribusiness firms in 2016] highlighted their uncertainty about how to approach it. They will need to make more acquisitions to ensure entrepreneurs keep innovating and VCs keep investing.
It’s also true, as Diana Moss notes, that
Competition maximizes the potential for numerous collaborations. It also minimizes incentives to refuse to license, to impose discriminatory restrictions in technology licensing agreements, or to tacitly “agree” not to compete…. All of this points to the importance of maintaining multiple, parallel R&D pipelines, a notion that was central to the EU’s decision in Dow-DuPont.
And yet collaboration and licensing have long been prevalent in this industry. Examples are legion, but here are just a few significant ones:
- Monsanto’s “global licensing agreement for the use of the CRISPR-Cas genome-editing technology in agriculture with the Broad Institute of MIT and Harvard.”
- Dow and Arcadia Biosciences’ “strategic collaboration to develop and commercialize new breakthrough yield traits and trait stacks in corn.”
- Monsanto and the University of Nebraska-Lincoln’s “licensing agreement to develop crops tolerant to the broadleaf herbicide dicamba. This agreement is based on discoveries by UNL plant scientists.”
Both large and small firms in the ag-biotech industry continually enter into new agreements like these. See, e.g., here and here for a (surely incomplete) list of deals in 2016 alone.
At the same time, across the industry, new entry has been rampant despite increased M&A activity among the largest firms. Recent years have seen venture financing in AgTech skyrocket — from $400 million in 2010 to almost $5 billion in 2015 — and hundreds of startups now enter the industry annually.
The pending mergers
Today’s pending mergers are consistent with this characterization of a dynamic market in which structure is being driven by incentives to innovate, rather than monopolize. As Michael Sykuta points out,
The US agriculture sector has been experiencing consolidation at all levels for decades, even as the global ag economy has been growing and becoming more diverse. Much of this consolidation has been driven by technological changes that created economies of scale, both at the farm level and beyond.
These deals aren’t fundamentally about growing production capacity, expanding geographic reach, or otherwise enhancing market share; rather, each is a fundamental restructuring of the way the companies do business, reflecting today’s shifting agricultural markets, and the advanced technology needed to respond to them.
Technological innovation is unpredictable, often serendipitous, and frequently transformative of the ways firms organize and conduct their businesses. A company formed to grow and sell hybrid seeds in the 1920s, for example, would either have had to evolve or fold by the end of the century. Firms today will need to develop (or purchase) new capabilities and adapt to changing technology, scientific knowledge, consumer demand, and socio-political forces. The pending mergers seemingly fit exactly this mold.
As Allen Gibby notes, these mergers are essentially vertical combinations of disparate, specialized pieces of an integrated whole. Take the proposed Bayer/Monsanto merger, for example. Bayer is primarily a chemicals company, developing advanced chemicals to protect crops and enhance crop growth. Monsanto, on the other hand, primarily develops seeds and “seed traits” — advanced characteristics that ensure the heartiness of the seeds, give them resistance to herbicides and pesticides, and speed their fertilization and growth. In order to translate the individual advances of each into higher yields, it is important that these two functions work successfully together. Doing so enhances crop growth and protection far beyond what, say, spreading manure can accomplish — or either firm could accomplish working on its own.
The key is that integrated knowledge is essential to making this process function. Developing seed traits to work well with (i.e., to withstand) certain pesticides requires deep knowledge of the pesticide’s chemical characteristics, and vice-versa. Processing huge amounts of data to determine when to apply chemical treatments or to predict a disease requires not only that the right information is collected, at the right time, but also that it is analyzed in light of the unique characteristics of the seeds and chemicals. Increased communications and data-sharing between manufacturers increases the likelihood that farmers will use the best products available in the right quantity and at the right time in each field.
Vertical integration solves bargaining and long-term planning problems by unifying the interests (and the management) of these functions. Instead of arm’s length negotiation, a merged Bayer/Monsanto, for example, may better maximize R&D of complicated Ag/chem products through fully integrated departments and merged areas of expertise. A merged company can also coordinate investment decisions (instead of waiting up to 10 years to see what the other company produces), avoid duplication of research, adapt to changing conditions (and the unanticipated course of research), pool intellectual property, and bolster internal scientific capability more efficiently. All told, the merged company projects spending about $16 billion on R&D over the next six years. Such coordinated investment will likely garner far more than either company could from separately spending even the same amount to develop new products.
Controlling an entire R&D process and pipeline of traits for resistance, chemical treatments, seeds, and digital complements would enable the merged firm to better ensure that each of these products works together to maximize crop yields, at the lowest cost, and at greater speed. Consider the advantages that Apple’s tightly-knit ecosystem of software and hardware provides to computer and device users. Such tight integration isn’t the only way to compete (think Android), but it has frequently proven to be a successful model, facilitating some functions (e.g., handoff between Macs and iPhones) that are difficult if not impossible in less-integrated systems. And, it bears noting, important elements of Apple’s innovation have come through acquisition….
Conclusion
As LaFontaine and Slade have made clear, theoretical concerns about the anticompetitive consequences of vertical integrations are belied by the virtual absence of empirical support:
Under most circumstances, profit–maximizing vertical–integration and merger decisions are efficient, not just from the firms’ but also from the consumers’ points of view.
Other antitrust scholars are skeptical of vertical-integration fears because firms normally have strong incentives to deal with providers of complementary products. Bayer and Monsanto, for example, might benefit enormously from integration, but if competing seed producers seek out Bayer’s chemicals to develop competing products, there’s little reason for the merged firm to withhold them: Even if the new seeds out-compete Monsanto’s, Bayer/Monsanto can still profit from providing the crucial input. Its incentive doesn’t necessarily change if the merger goes through, and whatever “power” Bayer has as an input is a function of its scientific know-how, not its merger with Monsanto.
In other words, while some competitors could find a less hospitable business environment, consumers will likely suffer no apparent ill effects, and continue to receive the benefits of enhanced product development and increased productivity.
That’s what we’d expect from innovation-driven integration, and antitrust enforcers should be extremely careful before thwarting or circumscribing these mergers lest they end up thwarting, rather than promoting, consumer welfare.
Levi A. Russell is Assistant Professor, Agricultural & Applied Economics, University of Georgia and a blogger at Farmer Hayek.
Commenting on Microsoft’s antitrust suit 18 years ago, Milton Friedman said the following:
Your industry, the computer industry, moves so much more rapidly than the legal process, that by the time this suit is over, who knows what the shape of the industry will be.
Though the legal process seems to be moving quickly in the cases of Dow/Dupont, ChemChina/Syngenta, and Bayer/Monsanto, seed technology is moving fast as well. With recent breakthroughs in gene editing, seed technology will be more dynamic, cheaper, and likely subject to far less regulation than the current transgenic technology.
GMO seeds produced using current techniques are primarily designed with specific insect control and herbicide tolerance. Gene editing has the potential to go much further by creating drought and disease tolerance as well as improving yield. It’s difficult to know precisely how this new technology will be integrated into the industry, but its effects are likely to promote innovation from outside the three large firms that will result from the mergers and acquisitions mentioned above.
As in the food industry, small gene editing startups will be able to develop new traits with the intention of being acquired by one of the large firms in the industry. By allowing small firms to enter the seed biotech industry, gene editing will provide the sort of external innovation Joanna Shepherd notes is so important in understanding antitrust cases.
Joanna Shepherd is Professor of Law at Emory University School of Law.
Today, three of the largest proposed mergers — Bayer/Monsanto, Dow/Dupont, and ChemChina/Syngenta — face scrutiny in both the U.S. and Europe over concerns that the mergers will slow innovation in crop biotechnology and crop protection. The incorporation of innovation effects in the antitrust analysis of these agricultural/biotech mergers is quickly becoming more mainstream in both the U.S. and E.U. The concerns are premised on the idea that, by merging existing competitors into one firm, consolidation will reduce incentives to develop new products in the future. Since 2015, the Department of Justice has opposed proposed mergers between Applied Materials/Tokyo Electron, Comcast/Time Warner Cable, and Halliburton/Baker Hughes at least partly based on innovation concerns. Similarly, the European Commission has raised innovation concerns in its analyses of several mergers since 2015, including Biomet/Zimmer Holdings, GlaxoSmithKline/Novartis, and BASE/ Liberty Global.
Although most of these contested deals are not based exclusively on innovation markets, fear of harms to innovation often result in the required divestiture of innovation-related assets. For example, both the FTC and European Commission allowed the 2014 merger between Medtronic/Covidien only on the condition that Covidien divest its drug-coated balloon catheter business to protect innovation in that market. And just this week, Dupont agreed to divest a large part of its existing pesticide business, including its global R&D organization, to secure approval for the Dow/Dupont merger in the EU.
Certainly the incorporation of innovation effects in antitrust analysis could be relevant in specific mergers or acquisitions if the consolidating firms are the primary innovators in the area, the firms innovate internally, and there are limited sources of external innovation. However, in many industries, this model simply doesn’t apply. Take, for example, the pharmaceutical industry; as I explain in a recent Article, concerns about consolidation’s impact on drug innovation are largely based on an outdated understanding of the innovation ecosystem in the pharmaceutical industry.
Today, most drug innovation originates not in traditional pharmaceutical companies, but in biotech companies and smaller firms, where a culture of nimble decision-making and risk-taking facilitates discovery and innovation. In fact, about two-thirds of New Molecular Entities approved by the FDA originate in biotech and small pharmaceutical companies, and these companies account for almost 70 percent of the current global pipeline of drugs under development.
To complete the development process and commercialize their drugs, biotech companies regularly collaborate with large pharmaceutical companies that push drugs through the grueling late-stage clinical trials and regulatory hurdles of the FDA, organize their manufacturing and distribution capabilities to bring the drugs to market, and mobilize their vast sales force to quickly achieve peak sales. In this current ecosystem, biotech and pharmaceutical firms are each able to specialize in what they do best, bringing expertise and efficiencies to the innovation process.
This specialization has dramatically changed the share of internally-developed versus externally-developed drugs in the pharmaceutical industry. Whereas in the 1970s and early 1980s, almost all drug discovery and early stage development took place inside traditional pharmaceutical companies, today, the companies increasingly shift resources away from internal R&D expenditures and projects and towards external sources of innovation. Externally-sourced drugs now account for an incredible 74 percent of new drugs registered with the FDA for sale in the U.S. Internal R&D is no longer the primary source of drug innovation in large pharmaceutical companies.
As a result, antitrust analyses that focus on pharmaceutical mergers’ impacts on internal R&D and innovation largely miss the point. In the current innovation ecosystem, where little drug innovation originates internally, a merger’s impact on internal R&D expenditures or development projects is oftentimes immaterial to aggregate drug innovation. In many consolidated firms, increases in efficiency and streamlining of operations free up money and resources to source external innovation. To improve their future revenue streams and market share, consolidated firms can be expected to use at least some of the extra resources to acquire external innovation. This increase in demand for externally-sourced innovation increases the prices paid for external assets, which, in turn, incentivizes more early-stage innovation in small firms and biotech companies. Aggregate innovation increases in the process!
Thus, proper antitrust analyses must take into account the innovation ecosystem in the merging firms’ industries. In industries in which most innovation originates externally, as in the pharmaceutical industry, analyses should be less concerned with mergers’ impacts on internal innovation, and more focused on whether consolidation will increase demand for externally-sourced innovation and, ultimately, increase aggregate drug innovation.
TOTM is pleased to welcome guest blogger Nicolas Petit, Professor of Law & Economics at the University of Liege, Belgium.
Nicolas has also recently been named a (non-resident) Senior Scholar at ICLE (joining Joshua Wright, Joanna Shepherd, and Julian Morris).
Nicolas is also (as of March 2017) a Research Professor at the University of South Australia, co-director of the Liege Competition & Innovation Institute and director of the LL.M. program in EU Competition and Intellectual Property Law. He is also a part-time advisor to the Belgian competition authority.
Nicolas is a prolific scholar specializing in competition policy, IP law, and technology regulation. Nicolas Petit is the co-author (with Damien Geradin and Anne Layne-Farrar) of EU Competition Law and Economics (Oxford University Press, 2012) and the author of Droit européen de la concurrence (Domat Montchrestien, 2013), a monograph that was awarded the prize for the best law book of the year at the Constitutional Court in France.
One of his most recent papers, Significant Impediment to Industry Innovation: A Novel Theory of Harm in EU Merger Control?, was recently published as an ICLE Competition Research Program White Paper. His scholarship is available on SSRN and he tweets at @CompetitionProf.
Welcome, Nicolas!
Today the International Center for Law & Economics (ICLE) submitted an amicus brief to the Supreme Court of the United States supporting Apple’s petition for certiorari in its e-books antitrust case. ICLE’s brief was signed by sixteen distinguished scholars of law, economics and public policy, including an Economics Nobel Laureate, a former FTC Commissioner, ten PhD economists and ten professors of law (see the complete list, below).
Background
Earlier this year a divided panel of the Second Circuit ruled that Apple “orchestrated a conspiracy among [five major book] publishers to raise ebook prices… in violation of § 1 of the Sherman Act.” Significantly, the court ruled that Apple’s conduct constituted a per se unlawful horizontal price-fixing conspiracy, meaning that the procompetitive benefits of Apple’s entry into the e-books market was irrelevant to the liability determination.
Apple filed a petition for certiorari with the Supreme Court seeking review of the ruling on the question of
Whether vertical conduct by a disruptive market entrant, aimed at securing suppliers for a new retail platform, should be condemned as per se illegal under Section 1 of the Sherman Act, rather than analyzed under the rule of reason, because such vertical activity also had the alleged effect of facilitating horizontal collusion among the suppliers.
Summary of Amicus Brief
The Second Circuit’s ruling is in direct conflict with the Supreme Court’s 2007 Leegin decision, and creates a circuit split with the Third Circuit based on that court’s Toledo Mack ruling. ICLE’s brief urges the Court to review the case in order to resolve the significant uncertainty created by the Second Circuit’s ruling, particularly for the multi-sided platform companies that epitomize the “New Economy.”
As ICLE’s brief discusses, the Second Circuit committed several important errors in its ruling:
First, As the Supreme Court held in Leegin, condemnation under the per se rule is appropriate “only for conduct that would always or almost always tend to restrict competition” and “only after courts have had considerable experience with the type of restraint at issue.” Neither is true in this case. Businesses often employ one or more forms of vertical restraints to make entry viable, and the Court has blessed such conduct, categorically holding in Leegin that “[v]ertical price restraints are to be judged according to the rule of reason.”
Furthermore, the conduct at issue in this case — the use of “Most-Favored Nation Clauses” in Apple’s contracts with the publishers and its adoption of the so-called “agency model” for e-book pricing — have never been reviewed by the courts in a setting like this one, let alone found to “always or almost always tend to restrict competition.” There is no support in the case law or economic literature for the proposition that agency models or MFNs used to facilitate entry by new competitors in platform markets like this one are anticompetitive.
Second, the negative consequences of the court’s ruling will be particularly acute for modern, high-technology sectors of the economy, where entrepreneurs planning to deploy new business models will now face exactly the sort of artificial deterrents that the Court condemned in Trinko: “Mistaken inferences and the resulting false condemnations are especially costly, because they chill the very conduct the antitrust laws are designed to protect.” Absent review by the Supreme Court to correct the Second Circuit’s error, the result will be less-vigorous competition and a reduction in consumer welfare.
This case involves vertical conduct essentially indistinguishable from conduct that the Supreme Court has held to be subject to the rule of reason. But under the Second Circuit’s approach, the adoption of these sorts of efficient vertical restraints could be challenged as a per se unlawful effort to “facilitate” horizontal price fixing, significantly deterring their use. The lower court thus ignored the Supreme Court’s admonishment not to apply the antitrust laws in a way that makes the use of a particular business model “more attractive based on the per se rule” rather than on “real market conditions.”
Third, the court based its decision that per se review was appropriate largely on the fact that e-book prices increased following Apple’s entry into the market. But, contrary to the court’s suggestion, it has long been settled that such price increases do not make conduct per se unlawful. In fact, the Supreme Court has held that the per se rule is inappropriate where, as here, “prices can be increased in the course of promoting procompetitive effects.”
Competition occurs on many dimensions other than just price; higher prices alone don’t necessarily suggest decreased competition or anticompetitive effects. Instead, higher prices may accompany welfare-enhancing competition on the merits, resulting in greater investment in product quality, reputation, innovation or distribution mechanisms.
The Second Circuit presumed that Amazon’s e-book prices before Apple’s entry were competitive, and thus that the price increases were anticompetitive. But there is no support in the record for that presumption, and it is not compelled by economic reasoning. In fact, it is at least as likely that the change in Amazon’s prices reflected the fact that Amazon’s business model pre-entry resulted in artificially low prices, and that the price increases following Apple’s entry were the product of a more competitive market.
Previous commentary on the case
For my previous writing and commentary on the the case, see:
- “The Second Circuit’s Apple e-books decision: Debating the merits and the meaning,” American Bar Association debate with Fiona Scott-Morton, DOJ Chief Economist during the Apple trial, and Mark Ryan, the DOJ’s lead litigator in the case, recording here
- Why I think the Apple e-books antitrust decision will (or at least should) be overturned, Truth on the Market, here
- Why I think the government will have a tough time winning the Apple e-books antitrust case, Truth on the Market, here
- The procompetitive story that could undermine the DOJ’s e-books antitrust case against Apple, Truth on the Market, here
- How Apple can defeat the DOJ’s e-book antitrust suit, Forbes, here
- The US e-books case against Apple: The procompetitive story, special issue of Concurrences on “E-books and the Boundaries of Antitrust,” here
- Amazon vs. Macmillan: It’s all about control, Truth on the Market, here
Other TOTM authors have also weighed in. See, e.g.:
- The Second Circuit Misapplies the Per Se Rule in U.S. v. Apple, Alden Abbott, here
- The Apple E-Book Kerfuffle Meets Alfred Marshall’s Principles of Economics, Josh Wright, here
- Apple and Amazon E-Book Most Favored Nation Clauses, Josh Wright, here
Amicus Signatories
- Babette E. Boliek, Associate Professor of Law, Pepperdine University School of Law
- Henry N. Butler, Dean and Professor of Law, George Mason University School of Law
- Justin (Gus) Hurwitz, Assistant Professor of Law, Nebraska College of Law
- Stan Liebowitz, Ashbel Smith Professor of Economics, School of Management, University of Texas-Dallas
- Geoffrey A. Manne, Executive Director, International Center for Law & Economics
- Scott E. Masten, Professor of Business Economics & Public Policy, Stephen M. Ross School of Business, The University of Michigan
- Alan J. Meese, Ball Professor of Law, William & Mary Law School
- Thomas D. Morgan, Professor Emeritus, George Washington University Law School
- David S. Olson, Associate Professor of Law, Boston College Law School
- Joanna Shepherd, Professor of Law, Emory University School of Law
- Vernon L. Smith, George L. Argyros Endowed Chair in Finance and Economics, The George L. Argyros School of Business and Economics and Professor of Economics and Law, Dale E. Fowler School of Law, Chapman University
- Michael E. Sykuta, Associate Professor, Division of Applied Social Sciences, University of Missouri-Columbia
- Alex Tabarrok, Bartley J. Madden Chair in Economics at the Mercatus Center and Professor of Economics, George Mason University
- David J. Teece, Thomas W. Tusher Professor in Global Business and Director, Center for Global Strategy and Governance, Haas School of Business, University of California Berkeley
- Alexander Volokh, Associate Professor of Law, Emory University School of Law
- Joshua D. Wright, Professor of Law, George Mason University School of Law
Truth on the Market is delighted to welcome our newest blogger, Joanna Shepherd. Joanna is a Professor of Law at Emory School of Law and holds an adjunct position in the Emory Economics Department (where she also earned her PhD). At the law school she teaches Torts, Law and Economics, Analytical Methods for Lawyers, and Legal and Economic Issues in Health Policy. She also frequently teaches economics courses to law professors and federal and state judges.
Joanna is also a senior scholar at the International Center for Law and Economics.
Joanna’s research focuses on various law & econ topics. Her recent research has examined issues related to the healthcare and pharmaceutical industries, tort reform, litigation practice, and judicial behavior. Her works has appeared in the Michigan Law Review, Vanderbilt Law Review, Southern California Law Review, New York University Law Review, Duke Law Journal, UCLA Law Review, The Journal of Legal Studies, The Journal of Law & Economics, The American Law & Economics Review, Health Matrix, and The American Journal of Law & Medicine, among others. Joanna is also an author of the textbook, Economic Analysis for Lawyers, with Henry Butler and Christopher Drahozal. Her research has been discussed in numerous newspapers, including the Wall Street Journal and the New York Times, and has been cited by several courts including the Supreme Court.
You can find links to Joanna’s scholarship on her SSRN page.
Welcome Joanna!
FTC Commissioner Josh Wright will give a keynote luncheon address titled, “The Need for Limits on Agency Discretion and the Case for Section 5 UMC Guidelines.” Project members will discuss the themes raised in our inaugural report and how they might inform some of the most pressing issues of FTC process and substance confronting the FTC, Congress and the courts. The afternoon will conclude with a Fireside Chat with former FTC Chairmen Tim Muris and Bill Kovacic, followed by a cocktail reception.
Full Agenda:
- Lunch and Keynote Address (12:00-1:00)
- FTC Commissioner Joshua Wright
- Introduction to the Project and the “Questions & Frameworks” Report (1:00-1:15)
- Gus Hurwitz, Geoffrey Manne and Berin Szoka
- Panel 1: Limits on FTC Discretion: Institutional Structure & Economics (1:15-2:30)
- Jeffrey Eisenach (AEI | Former Economist, BE)
- Todd Zywicki (GMU Law | Former Director, OPP)
- Tad Lipsky (Latham & Watkins)
- Geoffrey Manne (ICLE) (moderator)
- Panel 2: Section 5 and the Future of the FTC (2:45-4:00)
- Paul Rubin (Emory University Law and Economics | Former Director of Advertising Economics, BE)
- James Cooper (GMU Law | Former Acting Director, OPP)
- Gus Hurwitz (University of Nebraska Law)
- Berin Szoka (TechFreedom) (moderator)
- A Fireside Chat with Former FTC Chairmen (4:15-5:30)
- Tim Muris (Former FTC Chairman | George Mason University) & Bill Kovacic (Former FTC Chairman | George Washington University)
- Reception (5:30-6:30)
Howard Beales
Terry Calvani
James Cooper
Jeffrey Eisenach
Gus Hurwitz
Thom Lambert
Tad Lipsky
Geoffrey Manne
Timothy Muris
Paul Rubin
Joanna Shepherd-Bailey
Joe Sims
Berin Szoka
Sasha Volokh
Todd Zywicki
The state of New York is considering a cap on noneconomic damages (“pain and suffering”) for malpractice in order to save money. The New York Times story asks
“… who benefits from caps — doctors or insurers — and whether the measures inflict unintended negative consequences upon victims of medical errors, including plaintiffs’ inability to find lawyers to take their cases.”
But in fact the evidence is that consumers actually benefit from such a cap. In a paper published in the Journal of Law and Economics in 2007 Joanna Shepherd and I examined the effect of various tort reforms on accidental death rates in states for the period 1981-2000. We found that overall states that had passed tort reforms had lower accidental death rates, probably because of the increased availability of physicians in emergency rooms and other settings. For the particular case of damage caps, we found that overall these caps led to a total of 5000 fewer deaths. So we can have our cake and eat it too — caps will save money and also make New Yorkers safer.
Lisa Fairfax kicked off an interesting discussion over at the Glom regarding some reasons why untenured folks should not engage in empirical scholarship. The basic message: it takes too long, is too hard (to get data, mostly), may not be received well by tenure committees. There are some great comments to the post defending the enterprise of empirical legal scholarship by the untenured and the theme is picked up at ELS Blog. Many thanks to Lisa for kicking off this very interesting and important discussion. It is a valuable discussion of some of the tradeoffs facing those who would like to include empirical work in their research agenda pre-tenure. Understanding the risks associated with undertaking your research agenda, whatever it is, is certainly a better option than going in blind.
I think Bill Henderson’s comment has it about right:
“In the fall of 2001, as I job-talked my first empirical article, I remember hearing the caveat on pre-tenure empirical work from the chair an appointments committee. But two years later, an IU colleague told me, “In this business, we spend a lot of time doing scholarship. You’ve got to follow your star.”
So which advice is better? In my case, I could not follow both. So I picked empiricism because I loved the work.
… .
Sure, two years from now I may not get tenure (I remain optimistic!), but intellectually, this has been the best five years of my life. Why give in to fear? Follow that damn star.”
Bill’s comment, to me, gets to the heart of the matter. While law school tenure standards are light relative to social science departments, tenure is not guaranteed. Young empirical scholars, like juniors in many other fields, must make some tough choices about their research agendas and make some fairly subjective judgments about the potential costs and benefits of those decisions over time. We law professors have the opportunity to follow whatever research agenda we desire, not to mention a pretty wonderful job in the meantime. Not to minimize the obvious utility of the other suggestions in the comments for those seeking tenure (find an institution that values empirical work, find publicly available data, etc.), but I think the best advice an untenured faculty member can get is to find a research agenda they are passionate about and then put your head down and get to work.
Speaking of empirical scholarship, and on a bit of a tangent, yesterday I spoke at SEALS panel dedicated to the topic of “Empirical Law and Economics.” I presented my empirical paper on the consumer welfare consequences of slotting allowances, uncreatively but hopefully appropriately titled, “Slotting Contracts and Consumer Welfare” (forthcoming in the Antitrust Law Journal).
The panel featured presentations by the Glom’s Fred Tung and Joanna Shepherd (both of Emory Law School). Both papers were took on very interesting and important research questions and were very carefully done. At other conferences, like ALEA, I typically sit on panels that are topic specific, i.e. antitrust. While I very much enjoy that model, which allows me to talk to specialists in my field, this panel was particularly enjoyable for me because it tied together empirical papers from very different fields: corporate governance, torts, and antitrust. Fred presented work co-authored by Joanna Shepherd and Albert Yoon (Northwesetern) entitled “Cross Monitoring and Corporate Governance” examining the role of banks in reducing agency costs. Joanna presented “Tort Reform and Accidental Deaths,” a thought provoking and excellent study co-authored by Paul Rubin of the impact of a number of tort reform measures on accidental deaths. Here is the abstract:
Theory suggests that tort reform could have either of two impacts on accidents. First, reforms could increase accidents as tortfeasors internalize less of the costs of externalities, and thus, have less incentive to reduce the risk of accidents. Second, tort reforms could decrease accidents as lower expected liability costs result in lower prices, enabling consumers to buy more risk-reducing products such as medicines, safety equipment, and medical services, and as consumers take additional precautions to avoid accidents. We test which effect dominates by examining the effect of tort reforms on non-motor vehicle accidental death rates, using panel-data techniques. We find that caps on noneconomic damages, a higher evidence standard for punitive damages, product liability reform, and prejudgment interest reform lead to fewer accidental deaths, while reforms to the collateral source rule lead to increased deaths. Overall, the tort reforms in the states between 1981-2000 have led to an estimated 22,000 fewer accidental deaths.
UPDATE: Paul Horwitz and Larry Solum offer some additional thoughts.
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