Archives For regulatory reform; executive orders

Over the past decade and a half, virtually every branch of the federal government has taken steps to weaken the patent system. As reflected in President Joe Biden’s July 2021 executive order, these restraints on patent enforcement are now being coupled with antitrust policies that, in large part, adopt a “big is bad” approach in place of decades of economically grounded case law and agency guidelines.

This policy bundle is nothing new. It largely replicates the innovation policies pursued during the late New Deal and the postwar decades. That historical experience suggests that a “weak-patent/strong-antitrust” approach is likely to encourage neither innovation nor competition.

The Overlooked Shortfalls of New Deal Innovation Policy

Starting in the early 1930s, the U.S. Supreme Court issued a sequence of decisions that raised obstacles to patent enforcement. The Franklin Roosevelt administration sought to take this policy a step further, advocating compulsory licensing for all patents. While Congress did not adopt this proposal, it was partially implemented as a de facto matter through antitrust enforcement. Starting in the early 1940s and continuing throughout the postwar decades, the antitrust agencies secured judicial precedents that treated a broad range of licensing practices as per se illegal. Perhaps most dramatically, the U.S. Justice Department (DOJ) secured more than 100 compulsory licensing orders against some of the nation’s largest companies. 

The rationale behind these policies was straightforward. By compelling access to incumbents’ patented technologies, courts and regulators would lower barriers to entry and competition would intensify. The postwar economy declined to comply with policymakers’ expectations. Implementation of a weak-IP/strong-antitrust innovation policy over the course of four decades yielded the opposite of its intended outcome. 

Market concentration did not diminish, turnover in market leadership was slow, and private research and development (R&D) was confined mostly to the research labs of the largest corporations (who often relied on generous infusions of federal defense funding). These tendencies are illustrated by the dramatically unequal allocation of innovation capital in the postwar economy.  As of the late 1950s, small firms represented approximately 7% of all private U.S. R&D expenditures.  Two decades later, that figure had fallen even further. By the late 1970s, patenting rates had plunged, and entrepreneurship and innovation were in a state of widely lamented decline.

Why Weak IP Raises Entry Costs and Promotes Concentration

The decline in entrepreneurial innovation under a weak-IP regime was not accidental. Rather, this outcome can be derived logically from the economics of information markets.

Without secure IP rights to establish exclusivity, engage securely with business partners, and deter imitators, potential innovator-entrepreneurs had little hope to obtain funding from investors. In contrast, incumbents could fund R&D internally (or with federal funds that flowed mostly to the largest computing, communications, and aerospace firms) and, even under a weak-IP regime, were protected by difficult-to-match production and distribution efficiencies. As a result, R&D mostly took place inside the closed ecosystems maintained by incumbents such as AT&T, IBM, and GE.

Paradoxically, the antitrust campaign against patent “monopolies” most likely raised entry barriers and promoted industry concentration by removing a critical tool that smaller firms might have used to challenge incumbents that could outperform on every competitive parameter except innovation. While the large corporate labs of the postwar era are rightly credited with technological breakthroughs, incumbents such as AT&T were often slow in transforming breakthroughs in basic research into commercially viable products and services for consumers. Without an immediate competitive threat, there was no rush to do so. 

Back to the Future: Innovation Policy in the New New Deal

Policymakers are now at work reassembling almost the exact same policy bundle that ended in the innovation malaise of the 1970s, accompanied by a similar reliance on public R&D funding disbursed through administrative processes. However well-intentioned, these processes are inherently exposed to political distortions that are absent in an innovation environment that relies mostly on private R&D funding governed by price signals. 

This policy bundle has emerged incrementally since approximately the mid-2000s, through a sequence of complementary actions by every branch of the federal government.

  • In 2011, Congress enacted the America Invents Act, which enables any party to challenge the validity of an issued patent through the U.S. Patent and Trademark Office’s (USPTO) Patent Trial and Appeals Board (PTAB). Since PTAB’s establishment, large information-technology companies that advocated for the act have been among the leading challengers.
  • In May 2021, the Office of the U.S. Trade Representative (USTR) declared its support for a worldwide suspension of IP protections over Covid-19-related innovations (rather than adopting the more nuanced approach of preserving patent protections and expanding funding to accelerate vaccine distribution).  
  • President Biden’s July 2021 executive order states that “the Attorney General and the Secretary of Commerce are encouraged to consider whether to revise their position on the intersection of the intellectual property and antitrust laws, including by considering whether to revise the Policy Statement on Remedies for Standard-Essential Patents Subject to Voluntary F/RAND Commitments.” This suggests that the administration has already determined to retract or significantly modify the 2019 joint policy statement in which the DOJ, USPTO, and the National Institutes of Standards and Technology (NIST) had rejected the view that standard-essential patent owners posed a high risk of patent holdup, which would therefore justify special limitations on enforcement and licensing activities.

The history of U.S. technology markets and policies casts great doubt on the wisdom of this weak-IP policy trajectory. The repeated devaluation of IP rights is likely to be a “lose-lose” approach that does little to promote competition, while endangering the incentive and transactional structures that sustain robust innovation ecosystems. A weak-IP regime is particularly likely to disadvantage smaller firms in biotech, medical devices, and certain information-technology segments that rely on patents to secure funding from venture capital and to partner with larger firms that can accelerate progress toward market release. The BioNTech/Pfizer alliance in the production and distribution of a Covid-19 vaccine illustrates how patents can enable such partnerships to accelerate market release.  

The innovative contribution of BioNTech is hardly a one-off occurrence. The restoration of robust patent protection in the early 1980s was followed by a sharp increase in the percentage of private R&D expenditures attributable to small firms, which jumped from about 5% as of 1980 to 21% by 1992. This contrasts sharply with the unequal allocation of R&D activities during the postwar period.

Remarkably, the resurgence of small-firm innovation following the strong-IP policy shift, starting in the late 20th century, mimics tendencies observed during the late 19th and early-20th centuries, when U.S. courts provided a hospitable venue for patent enforcement; there were few antitrust constraints on licensing activities; and innovation was often led by small firms in partnership with outside investors. This historical pattern, encompassing more than a century of U.S. technology markets, strongly suggests that strengthening IP rights tends to yield a policy “win-win” that bolsters both innovative and competitive intensity. 

An Alternate Path: ‘Bottom-Up’ Innovation Policy

To be clear, the alternative to the policy bundle of weak-IP/strong antitrust does not consist of a simple reversion to blind enforcement of patents and lax administration of the antitrust laws. A nuanced innovation policy would couple modern antitrust’s commitment to evidence-based enforcement—which, in particular cases, supports vigorous intervention—with a renewed commitment to protecting IP rights for innovator-entrepreneurs. That would promote competition from the “bottom up” by bolstering maverick innovators who are well-positioned to challenge (or sometimes partner with) incumbents and maintaining the self-starting engine of creative disruption that has repeatedly driven entrepreneurial innovation environments. Tellingly, technology incumbents have often been among the leading advocates for limiting patent and copyright protections.  

Advocates of a weak-patent/strong-antitrust policy believe it will enhance competitive and innovative intensity in technology markets. History suggests that this combination is likely to produce the opposite outcome.  

Jonathan M. Barnett is the Torrey H. Webb Professor of Law at the University of Southern California, Gould School of Law. This post is based on the author’s recent publications, Innovators, Firms, and Markets: The Organizational Logic of Intellectual Property (Oxford University Press 2021) and “The Great Patent Grab,” in Battles Over Patents: History and the Politics of Innovation (eds. Stephen H. Haber and Naomi R. Lamoreaux, Oxford University Press 2021).

[TOTM: The following is part of a digital symposium by TOTM guests and authors on the legal and regulatory issues that arose during Ajit Pai’s tenure as chairman of the Federal Communications Commission. The entire series of posts is available here.

Jerry Ellig was a research professor at The George Washington University Regulatory Studies Center and served as chief economist at the Federal Communications Commission from 2017 to 2018. Tragically, he passed away Jan. 20, 2021. TOTM is honored to publish his contribution to this symposium.]

One significant aspect of Chairman Ajit Pai’s legacy is not a policy change, but an organizational one: establishment of the Federal Communications Commission’s (FCC’s) Office of Economics and Analytics (OEA) in 2018.

Prior to OEA, most of the FCC’s economists were assigned to the various policy bureaus, such as Wireless, Wireline Competition, Public Safety, Media, and International. Each of these bureaus had its own chief economist, but the rank-and-file economists reported to the managers who ran the bureaus – usually attorneys who also developed policy and wrote regulations. In the words of former FCC Chief Economist Thomas Hazlett, the FCC had “no location anywhere in the organizational structure devoted primarily to economic analysis.”

Establishment of OEA involved four significant changes. First, most of the FCC’s economists (along with data strategists and auction specialists) are now grouped together into an organization separate from the policy bureaus, and they are managed by other economists. Second, the FCC rules establishing the new office tasked OEA with reviewing every rulemaking, reviewing every other item with economic content that comes before the commission for a vote, and preparing a full benefit-cost analysis for any regulation with $100 million or more in annual economic impact. Third, a joint memo from the FCC’s Office of General Counsel and OEA specifies that economists are to be involved in the early stages of all rulemakings. Fourth, the memo also indicates that FCC regulatory analysis should follow the principles articulated in Executive Order 12866 and Office of Management and Budget Circular A-4 (while specifying that the FCC, as an independent agency, is not bound by the executive order).

While this structure for managing economists was new for the FCC, it is hardly uncommon in federal regulatory agencies. Numerous independent agencies that deal with economic regulation house their economists in a separate bureau or office, including the Securities and Exchange Commission, the Commodity Futures Trading Commission, the Surface Transportation Board, the Office of Comptroller of the Currency, and the Federal Trade Commission. The SEC displays even more parallels with the FCC. A guidance memo adopted in 2012 by the SEC’s Office of General Counsel and Division of Risk, Strategy and Financial Innovation (the name of the division where economists and other analysts were located) specifies that economists are to be involved in the early stages of all rulemakings and articulates best analytical practices based on Executive Order 12866 and Circular A-4.

A separate economics office offers several advantages over the FCC’s prior approach. It gives the economists greater freedom to offer frank advice, enables them to conduct higher-quality analysis more consistent with the norms of their profession, and may ultimately make it easier to uphold FCC rules that are challenged in court.

Independence.  When I served as chief economist at the FCC in 2017-2018, I gathered from conversations that the most common practice in the past was for attorneys who wrote rules to turn to economists for supporting analysis after key decisions had already been made. This was not always the process, but it often occurred. The internal working group of senior FCC career staff who drafted the plan for OEA reached similar conclusions. After the establishment of OEA, an FCC economist I interviewed noted how his role had changed: “My job used to be to support the policy decisions made in the chairman’s office. Now I’m much freer to speak my own mind.”

Ensuring economists’ independence is not a problem unique to the FCC. In a 2017 study, Stuart Shapiro found that most of the high-level economists he interviewed who worked on regulatory impact analyses in federal agencies perceive that economists can be more objective if they are located outside the program office that develops the regulations they are analyzing. As one put it, “It’s very difficult to conduct a BCA [benefit-cost analysis] if our boss wrote what you are analyzing.” Interviews with senior economists and non-economists who work on regulation that I conducted for an Administrative Conference of the United States project in 2019 revealed similar conclusions across federal agencies. Economists located in organizations separate from the program office said that structure gave them greater independence and ability to develop better analytical methodologies. On the other hand, economists located in program offices said they experienced or knew of instances where they were pressured or told to produce an analysis with the results decision-makers wanted.

The FTC provides an informative case study. From 1955-1961, many of the FTC’s economists reported to the attorneys who conducted antitrust cases; in 1961, they were moved into a separate Bureau of Economics. Fritz Mueller, the FTC chief economist responsible for moving the antitrust economists back into the Bureau of Economics, noted that they were originally placed under the antitrust attorneys because the attorneys wanted more control over the economic analysis. A 2015 evaluation by the FTC’s Inspector General concluded that the Bureau of Economics’ existence as a separate organization improves its ability to offer “unbiased and sound economic analysis to support decision-making.”

Higher-quality analysis. An issue closely related to economists’ independence is the quality of the economic analysis. Executive branch regulatory economists interviewed by Richard Williams expressed concern that the economic analysis was more likely to be changed to support decisions when the economists are located in the program office that writes the regulations. More generally, a study that Catherine Konieczny and I conducted while we were at the FCC found that executive branch agencies are more likely to produce higher-quality regulatory impact analyses if the economists responsible for the analysis are in an independent economics office rather than the program office.

Upholding regulations in court. In Michigan v. EPA, the Supreme Court held that it is unreasonable for agencies to refuse to consider regulatory costs if the authorizing statute does not prohibit them from doing so. This precedent will likely increase judicial expectations that agencies will consider economic issues when they issue regulations. The FCC’s OGC-OEA memo cites examples of cases where the quality of the FCC’s economic analysis either helped or harmed the commission’s ability to survive legal challenge under the Administrative Procedure Act’s “arbitrary and capricious” standard. More systematically, a recent Regulatory Studies Center working paper finds that a higher-quality economic analysis accompanying a regulation reduces the likelihood that courts will strike down the regulation, provided that the agency explains how it used the analysis in decisions.

Two potential disadvantages of a separate economics office are that it may make the economists easier to ignore (what former FCC Chief Economist Tim Brennan calls the “Siberia effect”) and may lead the economists to produce research that is less relevant to the practical policy concerns of the policymaking bureaus. The FCC’s reorganization plan took these disadvantages seriously.

To ensure that the ultimate decision-makers—the commissioners—have access to the economists’ analysis and recommendations, the rules establishing the office give OEA explicit responsibility for reviewing all items with economic content that come before the commission. Each item is accompanied by a cover memo that indicates whether OEA believes there are any significant issues, and whether they have been dealt with adequately. To ensure that economists and policy bureaus work together from the outset of regulatory initiatives, the OGC-OEA memo instructs:

Bureaus and Offices should, to the extent practicable, coordinate with OEA in the early stages of all Commission-level and major Bureau-level proceedings that are likely to draw scrutiny due to their economic impact. Such coordination will help promote productive communication and avoid delays from the need to incorporate additional analysis or other content late in the drafting process. In the earliest stages of the rulemaking process, economists and related staff will work with programmatic staff to help frame key questions, which may include drafting options memos with the lead Bureau or Office.

While presiding over his final commission meeting on Jan. 13, Pai commented, “It’s second nature now for all of us to ask, ‘What do the economists think?’” The real test of this institutional innovation will be whether that practice continues under a new chair in the next administration.

On April 15, President Obama issued Executive Order 13725, “Steps to Increase Competition and Better Inform Consumers and Workers to Support Continued Growth of the American Economy” (“the Order”).  At first blush, the Order appears quite promising.  It commendably (1) praises competitive markets as a cornerstone of the American economy, and (2) sets the promotion of competitive markets as “a shared priority across the Federal Government.”  The Order then directs executive branch departments and agencies (“agencies”) with “authorities that could be used to enhance competition” to “eliminate regulations that restrict competition without corresponding benefits to the American public.”  Furthermore, agencies are to identify ways they “can promote competition through pro-competitive rulemaking and regulations” and  “by eliminating regulations that restrict competition without corresponding benefits to the American public.”  What’s more, within sixty days agencies shall report to the White House:

“[R]ecommendations on agency-specific actions that eliminate barriers to competition, promote greater competition, and improve consumer access to information needed to make informed purchasing decisions.  Such recommendations shall include a list of priority actions, including rulemakings, as well as timelines for completing those actions. . . .  Subsequently, agencies shall report semi-annually to the President . . . on additional actions that they plan to undertake to promote greater competition.”

Finally, the Order praises the value of federal antitrust enforcement, and directs agencies to cooperate with the two federal antitrust enforcers, the U.S. Federal Trade Commission and the U.S. Department of Justice.

While a presidential nod to the importance of competition and the benefits of procompetitive regulatory reform is always welcome, I fear that the Order is little more than cheap symbolism and is not intended to have real effect.  (I hope, of course, that I am wrong about this.)  Similarly, technology policy writer and fellow Truth on the Market blogger Kristian Stout has opined that “there is nothing in the Order . . . to provide any confidence that competition will, in fact, be promoted.”  This pessimism, unfortunately, is warranted.  It stems from the Obama Administration’s sad history of pursuing policies that are antithetical to procompetitive regulatory reform.

In an April 19 commentary on the Order, Susan Dudley, Director of George Washington University’s Regulatory Studies Center, pointed out that the Council of Economic Advisers Issues Brief accompanying the Order (“Brief”) made no reference to the bipartisan deregulatory successes of the 1970s and 1980s, which featured the elimination of certain agencies and the “removal of unnecessary regulation in several previously-regulated industries, with resulting improvements in innovation and consumer welfare.”  Moreover, as Dudley further explained, the Obama Administration’s longstanding anticompetitive and pro-regulatory policies fly in the face of the procompetitive regulatory reform goals that inform the Order and the Brief:

Recent years have seen a resurgence of economic regulation, which may be contributing to the decline in competition and innovation that the issue brief decries.  Regulations under the Affordable Care Act and Dodd-Frank Act, for example, limit prices, control entry, and constrain service quality.  The flurry of standards mandating the energy-efficiency of appliances and fuel-economy of vehicles restricts consumer choices.  And, many would argue that Federal Communications Commission’s net neutrality rules and the Department of Labor’s fiduciary rules—two areas that . . . [the Brief] highlight[s] as illustrating the “pro-competition progress” on which the executive order will build—are indeed anticompetitive, limiting the arrangements that could emerge from competitive markets, and potentially harming innovation.

The ever-increasing size and scope of the economic harm imposed by the Obama Administration’s regulatory programs, alluded to by Dudley, has been documented in “Red Tape Rising,” an annual report produced by Heritage Foundation scholars James L. Gattuso and Diane Katz.  The 2015 Red Tape Rising report (the 2016 version will be released later this spring) reported these sobering findings (footnotes omitted):

The number and cost of government regulations continued to climb in 2014, intensifying Washington’s control over the economy and Americans’ lives.  The addition of 27 new major rules last year pushed the tally for the Obama Administration’s first six years to 184, with scores of other rules in the pipeline.  The cost of just these 184 rules is estimated by regulators to be nearly $80 billion annually, although the actual cost of this massive expansion of the administrative state is obscured by the large number of rules for which costs have not been fully quantified.  Absent substantial reform, economic growth and individual freedom will continue to suffer. . . .  Many more regulations are on the way, with another 126 economically significant rules on the Administration’s agenda, such as directives to farmers for growing and harvesting fruits and vegetables; strict limits on credit access for service members; and, yet another redesign of light bulbs.

To combat this regulatory morass, the 2015 Red Tape Rising study made these recommendations:

Immediate reforms should include requiring legislation to undergo an analysis of regulatory impacts before a floor vote in Congress, and requiring every major regulation to obtain congressional approval before taking effect. Sunset deadlines should be set in law for all major rules, and independent agencies should be subject—as are executive branch agencies—to the White House regulatory review process.

If the Obama Administration is truly serious about procompetitive regulatory reform, and wants to confound the skeptics, it should endorse the Red Tape Rising recommendations as follow-on steps taken in light of the Order.  Also, the Administration should take additional specific helpful actions, including, for example:  (1) requiring that the agency regulatory reform recommendations called for by the Order be evaluated by the Office of Management and Budget’s expert regulatory review arm, the Office of Information and Regulatory Affairs (OIRA); (2) publicly committing to rooting out of anticompetitive and non-cost-beneficial regulations, on the basis of OIRA reviews of agency recommendations; and (2) preparing a discrete legislative package of targeted statutory reforms to diminish the burden of federal regulation, which could be taken up by the next Administration.  Simultaneously, the White House could recant its prior public support for over-regulatory initiatives taken by specific agencies, such as its endorsement of anti-innovation Federal Communications Commission “net neutrality” (see a scholarly critique here) and set-top box (see my critical commentary here) rules.  By acting in this manner, the Obama Administration would demonstrate its commitment to the spirit of the Order, and, thus, to the promotion of a more vibrant and efficient American economy.

In order to move in the direction I recommend, the Administration would have to reject the notion that market competition can somehow be micromanaged and improved upon by enactment of enlightened “pro-competitive” regulatory guidance.  This notion, which was articulated by Oscar Lange among many others (see, for example, Lange’s “On the Economic Theory of Socialism,” here and here), presumes in the extreme that government bureaucrats are able to set optimal economy-wide rules and prices that generate economic efficiency.  Friedrich Hayek effectively refuted this notion as a matter of theory (see, for example, Hayek’s “The Use of Knowledge in Society”), and nearly a century of failed socialist experiments have refuted it as a matter of empirical fact.  What’s more, even “limited” issue-specific government regulation has too often reduced economic welfare and efficiency, as predicted by public choice theory (see, for example, here).  Perhaps some wise senior official will take these teachings to heart and convince the Obama White House to apply them henceforth – but I am not holding my breath.