Archives For rent seeking

I have previously written at this site (see here, here, and here) and elsewhere (see here, here, and here) about the problem of anticompetitive market distortions (ACMDs), government-supported (typically crony capitalist) rules that weaken the competitive process, undermine free trade, slow economic growth, and harm consumers.  On May 17, the Heritage Foundation hosted a presentation by Shanker Singham of the Legatum Institute (a London think tank) and me on recent research and projects aimed at combatting ACMDs.

Singham began his remarks by noting that from the late 1940s to the early 1990s, trade negotiations under the auspices of the General Agreement on Tariffs and Trade (GATT) (succeeded by the World Trade Organization (WTO)), were highly successful in reducing tariffs and certain non-tariff barriers, and in promoting agreements to deal with trade-related aspects of such areas as government procurement, services, investment, and intellectual property, among others.  Regrettably, however, liberalization of trade restraints at the border was not matched by procompetitive regulatory reform inside borders.  Indeed, to the contrary, ACMDs have continued to proliferate, harming competition, consumers, and economic welfare.  As Singham further explained, the problem is particularly acute in developing countries:  “Because of the failure of early [regulatory] reform in the 1990s which empowered oligarchs and created vested interests in the whole of the developing world, national level reform is extremely difficult.”

To highlight the seriousness of the ACMD problem, Singham and several colleagues have developed a proprietary “Productivity Simulator,” that focuses on potential national economic output based on measures of the effectiveness of domestic competition, international competition, and property rights protections within individual nations.  (The stronger the protections, the greater the potential of the free market to create wealth.)   The Productivity Simulator is able to show, with a regressed accuracy of 90%, the potential gains of reducing distortions in a given country.  Every country has its own curve in the Productivity Simulator – it is a curve because the gains are exponential as one moves to the most difficult reforms.  If all distortions in the world were eliminated (aka, the ceiling of human potential), the Simulator predicts global GDP would rise by 1100% (a conservative estimate, because the Simulator could not be applied to certain very regulatorily-distorted economies for which data were unavailable).   By illustrating the huge “dollars and cents” magnitude of economic losses due to anticompetitive distortions, the Simulator could make the ACMD problem more concrete and thereby help invigorate reform efforts.

Singham also has adapted his Simulator technique to demonstrate the potential for economic growth in proposed “Enterprise Cities” (“e-Cities”), free-market oriented zones within a country that avoid ACMDs and provide strong property rights and rule of law protections.  (Existing city states such as Hong Kong, Singapore, and Dubai already possess e-City characteristics.)  Individual e-City laws, regulations, and dispute-resolution mechanisms are negotiated between individual governments and entrepreneurial project teams headed by Singham.  (Already, potential e-cities are under consideration in Morocco, Saudi Arabia, Saudi Arabia, Bosnia & Herzegovina, and Somalia.)  Private investors would be attracted to e-Cities due to their free market regulatory climate and legal protections.  To the extent that e-Cities are launched and thrive, they may serve as “demonstration projects” for the welfare benefits of dismantling ACMDs.

Following Singham’s presentation, I discussed analyses of the ACMD problem carried out in recent years by major international organizations, including the World Bank, the Organization for Economic Cooperation and Development (OECD, an economic think tank funded by developed countries), and the International Competition Network (a network of national competition agencies and experts legal and economic advisers that produces non-binding “best practices” recommendations dealing with competition law and policy).  The OECD’s  “Competition Assessment Toolkit” is a how-to manual for ferreting out ACMDs – it “helps governments to eliminate barriers to competition by providing a method for identifying unnecessary restraints on market activities and developing alternative, less restrictive measures that still achieve government policy objectives.”  The OECD has used the Toolkit to demonstrate the huge economic cost to the Greek economy (5.2 billion euros) of just a very small subset of anticompetitive regulations.  The ICN has drawn on Toolkit principles in developing “Recommended Practices on Competition Assessment” that national competition agencies can apply in opposing ACMDs.  In a related vein, the ICN has also produced a “Competition Culture Project Report” that provides useful survey-based analysis competition agencies could draw upon to generate public support for dismantling ACMDs.  The World Bank has cooperated with ICN advocacy efforts.  It has sponsored annual World Bank forums featuring industry-specific studies of the costs of regulatory restrictions, held in conjunction with ICN annual conferences, and (beginning in 2015).  It also has joined with the ICN in supporting annual “competition advocacy contests” in which national competition agencies are able to highlight economic improvements due to specific regulatory reform successes.  Developed countries also suffer from ACMDs.  For example, occupational licensing restrictions in the United States affect over a quarter of the work force, and, according to a 2015 White House Report, “licensing requirements raise the price of goods and services, restrict employment opportunities, and make it more difficult for workers to take their skills across State lines.”  Moreover, the multibillion dollar cost burden of federal regulations continues to grow rapidly, as documented by the Heritage Foundation’s annual “Red Tape Rising” reports.

I closed my presentation by noting that statutory international trade law reforms operating at the border could complement efforts to reduce regulatory burdens operating inside the border.  In particular, I cited my 2015 Heritage study recommending that United States antidumping law be revised to adopt a procompetitive antitrust-based standard (in contrast to the current approach that serves as an unjustified tax on certain imports).  I also noted the importance of ensuring that trade laws protect against imports that violate intellectual property rights, because such imports undermine competition on the merits.

In sum, the effort to reduce the burdens of ACMDs continue to be pursued and to be highlighted in research, proposed demonstration projects, and efforts to spur regulatory reform.  This is a long-term initiative very much worth pursuing, even though its near-term successes may prove minor at best.

Recently, I discussed at this site the Supreme Court’s imposition of takings liability on the U.S. Department of Agriculture (“USDA”), because USDA fined a small raisin grower for refusing to cooperate with the California Raisins Marketing Order – which, stripped of the fancy verbiage, is little more than a government-supervised output limitation cartel.  The California raisin cartel is far from unique.  There are many other USDA cartels (and analogous regulatory schemes) out there, the bitter fruits of anti-consumer and corporatist New Deal economic policy.  On August 14, in Humane Society of the United States v. Thomas J. Vilsack, the U.S. Court of Appeals for the D.C. Circuit, applying standing doctrine, took the knives to a less obviously anticompetitive, but no less pernicious, USDA agricultural order, the “Pork Order,” promulgated pursuant to the infelicitously named Pork Act (7 U.S.C. §§ 4801-19).

The case was filed in federal court by Harvey Dillenburg (a pork producer) and two organizations whose members include pork producers against the National Pork Board, claiming that it misappropriated millions of dollars from a fund for pork promotion into which all pork producers are required by law to contribute for the benefit of a trade association that is funded and controlled by large pork producers.  The district court dismissed the case for lack of standing, but that decision has now been reversed by the D.C. Circuit.  It is to be hoped that upon remand, the district court will take the next step and slaughter the Pork Order, thereby “bringing home the economic liberties bacon.”  Such an outcome would strike at the abuse of governmental processes by well-organized, powerful businesses, one of the worst aspects of crony capitalism.

The D.C. Circuit’s summary description of the case is instructive:

“The National Pork Board [Board] is a quasi-governmental entity responsible for administering a federal regulatory scheme known as the ‘Pork Order[,]’ [which implements] . . . the Pork Act, . . . the purpose of which is to promote pork in the marketplace. . . .  The Board strengthens, maintains, develops, and expands markets for pork and pork products through research and consumer information campaigns. In exchange for the Board’s efforts on behalf of their industry, pork producers pay the Board a special assessment on each hog they import or sell. . . . 

In 2006, the Board, with the approval of the Secretary of the Department of Agriculture, bought four trademarks associated with the slogan Pork:  The Other White Meat . . . from the National Pork Producers Council [Council], an industry trade group, for $60 million.  [Footnote deleted which explains that the USDA Secretary is charged by statute with reviewing the Pork Board’s actions, but that the reviewing court attributes those actions to the Board.]  The payment terms provide that the Board will pay the Council $3 million annually for twenty years. The Board can terminate the payments at any time with one year’s notice, in which case ownership of the phrase reverts back to the Council. Five years after buying the mark, the Board replaced it with a new motto, Pork:  Be Inspired. Now the Board keeps the initial slogan around as a “heritage brand” that it does not feature in its advertising.

The plaintiffs claim that the Board did not buy the slogan for its value as a marketing tool. They allege that the Board used the purchase of the slogan as a means to cut a sweetheart deal with the Council to keep the Council in business and support its lobbying efforts. They maintain that the Board overpaid for the slogan and that the Board’s shift to the Pork: Be Inspired campaign makes the initial slogan all but worthless.  According to the plaintiffs, the purchase of the mark and continued payment for it was and is arbitrary and capricious.  The plaintiffs also argue that the Board’s purchase of the slogan with the purpose of supporting the Council’s lobbying efforts violates the Pork Act and Order’s prohibitions against the Board spending funds to influence legislation.

The plaintiffs sued the Secretary of the Department of Agriculture under the Administrative Procedure Act seeking an order enjoining the Board’s further payments to the Council and directing the Secretary to claw back what payments he can from the deal.  The district court dismissed the plaintiffs’ suit for lack of Article III standing. . . .  The court held that Dillenburg failed to establish an injury in fact fairly traceable to the Board’s actions that is likely to be redressed by a favorable decision. . . .  It also held that the two plaintiff organizations could not establish standing to sue in their own right or on behalf of their pork-producing members. . . .

[W]e reverse and remand [to the district court].  This case involves a concrete and particularized harm caused by an agency’s failure to confer a direct economic benefit on a statutory beneficiary. We also reject the government’s argument that the plaintiffs have failed to exhaust their administrative remedies.  The statute’s provision for administrative review would not offer the plaintiffs adequate relief, and therefore they were not required to pursue it.”

This case is an example of rent-seeking in action, and, in particular, the abuse of regulatory processes to impose disproportionate costs on less-connected rivals (a phenomenon well-documented in public choice analysis of regulation), as further revealed in the D.C. Circuit’s opinion.  The Council, as a private trade organization, could not require all pork producers to join it and pay dues to support institutional advertising and other pork-related promotional activities.  The Council, however, achieved its goal indirectly by establishing and manipulating government regulation.  It successfully lobbied for passage of the Pork Act, proposed the text that ultimately served as foundation for the Pork Order, and used the Board to exercise regulatory authority over all pork producers.  Part of that exercise of regulatory authority involved the Board’s agreement to pay the Council $60 million for “The Other White Meat” mark.  This fee inevitably would be passed on to all pork industry members (including those that were not members of the Council), which are required by force of law to render payments to the Board.

The Board’s regulatory capture by the Council (the “big industry members’” lobby) is apparent, as further revealed in the Court’s opinion:

“Even though the Board paid for the mark’s development, the Council registered the mark in its own name and as its sole owner. . .  The Board and the Council were so enmeshed that, in 1986 when the Board voted to adopt the campaign [to promote the Other White Meat mark] and so committed itself to spend tens of millions of dollars in assessment funds over two decades on the promotion, it did not execute any licensing agreement or fee contract to formalize that arrangement. . . . [USDA’s] Office of Inspector General concluded in a 1999 audit that the Board ‘had relinquished too much authority to its primary contractor, the [Council], and ha[d] placed the [Council] in a position to exert undue influence over Board budgets and grant proposals.’  That history . . . raises a plausible inference that the Board’s purchase was not the product of arm’s length negotiation.

[Moreover], [b]efore the Board entered the . . . [subsequent formal] licensing agreement [for the Other White Meat mark], the Board’s own economist recommended that the Board pay no more than $375,000 annually to license the mark. . . .  [Furthermore], facts plausibly show[] that, whatever its value when the Board purchased it, the [Other White Meat] mark is no longer worth $3 million per year.”

A more compelling judicial account of the manipulation of government authority to achieve the aims of an organized private lobbying group (namely, using government to foist its promotional and licensing costs on the less-well-connected rivals of the lobbying organization’s members) is hard to imagine.

In conclusion, while the Pork Order in and of itself may have only limited economic impact, it is symptomatic of the more general problem of rent-seeking-induced special interest regulation (both federal and state) that, collectively, imposes enormous costs on the American economy.  It is also emblematic of the existence of countless federal government programs for which there is no principled justification in our republic, based on a federal Constitution that establishes limited enumerated powers and focuses on restricting government incursions into individual liberties.  It is to be hoped that the federal courts will keep this in mind and use their full panoply of constitutional tools in empowering private parties to fight cronyist governmental programs.

Nearly all economists from across the political spectrum agree: free trade is good. Yet free trade agreements are not always the same thing as free trade. Whether we’re talking about the Trans-Pacific Partnership or the European Union’s Digital Single Market (DSM) initiative, the question is always whether the agreement in question is reducing barriers to trade, or actually enacting barriers to trade into law.

It’s becoming more and more clear that there should be real concerns about the direction the EU is heading with its DSM. As the EU moves forward with the 16 different action proposals that make up this ambitious strategy, we should all pay special attention to the actual rules that come out of it, such as the recent Data Protection Regulation. Are EU regulators simply trying to hogtie innovators in the the wild, wild, west, as some have suggested? Let’s break it down. Here are The Good, The Bad, and the Ugly.

The Good

The Data Protection Regulation, as proposed by the Ministers of Justice Council and to be taken up in trilogue negotiations with the Parliament and Council this month, will set up a single set of rules for companies to follow throughout the EU. Rather than having to deal with the disparate rules of 28 different countries, companies will have to follow only the EU-wide Data Protection Regulation. It’s hard to determine whether the EU is right about its lofty estimate of this benefit (€2.3 billion a year), but no doubt it’s positive. This is what free trade is about: making commerce “regular” by reducing barriers to trade between states and nations.

Additionally, the Data Protection Regulation would create a “one-stop shop” for consumers and businesses alike. Regardless of where companies are located or process personal information, consumers would be able to go to their own national authority, in their own language, to help them. Similarly, companies would need to deal with only one supervisory authority.

Further, there will be benefits to smaller businesses. For instance, the Data Protection Regulation will exempt businesses smaller than a certain threshold from the obligation to appoint a data protection officer if data processing is not a part of their core business activity. On top of that, businesses will not have to notify every supervisory authority about each instance of collection and processing, and will have the ability to charge consumers fees for certain requests to access data. These changes will allow businesses, especially smaller ones, to save considerable money and human capital. Finally, smaller entities won’t have to carry out an impact assessment before engaging in processing unless there is a specific risk. These rules are designed to increase flexibility on the margin.

If this were all the rules were about, then they would be a boon to the major American tech companies that have expressed concern about the DSM. These companies would be able to deal with EU citizens under one set of rules and consumers would be able to take advantage of the many benefits of free flowing information in the digital economy.

The Bad

Unfortunately, the substance of the Data Protection Regulation isn’t limited simply to preempting 28 bad privacy rules with an economically sensible standard for Internet companies that rely on data collection and targeted advertising for their business model. Instead, the Data Protection Regulation would set up new rules that will impose significant costs on the Internet ecosphere.

For instance, giving citizens a “right to be forgotten” sounds good, but it will considerably impact companies built on providing information to the world. There are real costs to administering such a rule, and these costs will not ultimately be borne by search engines, social networks, and advertisers, but by consumers who ultimately will have to find either a different way to pay for the popular online services they want or go without them. For instance, Google has had to hire a large “team of lawyers, engineers and paralegals who have so far evaluated over half a million URLs that were requested to be delisted from search results by European citizens.”

Privacy rights need to be balanced with not only economic efficiency, but also with the right to free expression that most European countries hold (though not necessarily with a robust First Amendment like that in the United States). Stories about the right to be forgotten conflicting with the ability of journalists to report on issues of public concern make clear that there is a potential problem there. The Data Protection Regulation does attempt to balance the right to be forgotten with the right to report, but it’s not likely that a similar rule would survive First Amendment scrutiny in the United States. American companies accustomed to such protections will need to be wary operating under the EU’s standard.

Similarly, mandating rules on data minimization and data portability may sound like good design ideas in light of data security and privacy concerns, but there are real costs to consumers and innovation in forcing companies to adopt particular business models.

Mandated data minimization limits the ability of companies to innovate and lessens the opportunity for consumers to benefit from unexpected uses of information. Overly strict requirements on data minimization could slow down the incredible growth of the economy from the Big Data revolution, which has provided a plethora of benefits to consumers from new uses of information, often in ways unfathomable even a short time ago. As an article in Harvard Magazine recently noted,

The story [of data analytics] follows a similar pattern in every field… The leaders are qualitative experts in their field. Then a statistical researcher who doesn’t know the details of the field comes in and, using modern data analysis, adds tremendous insight and value.

And mandated data portability is an overbroad per se remedy for possible exclusionary conduct that could also benefit consumers greatly. The rule will apply to businesses regardless of market power, meaning that it will also impair small companies with no ability to actually hurt consumers by restricting their ability to take data elsewhere. Aside from this, multi-homing is ubiquitous in the Internet economy, anyway. This appears to be another remedy in search of a problem.

The bad news is that these rules will likely deter innovation and reduce consumer welfare for EU citizens.

The Ugly

Finally, the Data Protection Regulation suffers from an ugly defect: it may actually be ratifying a form of protectionism into the rules. Both the intent and likely effect of the rules appears to be to “level the playing field” by knocking down American Internet companies.

For instance, the EU has long allowed flexibility for US companies operating in Europe under the US-EU Safe Harbor. But EU officials are aiming at reducing this flexibility. As the Wall Street Journal has reported:

For months, European government officials and regulators have clashed with the likes of Google, Amazon.com and Facebook over everything from taxes to privacy…. “American companies come from outside and act as if it was a lawless environment to which they are coming,” [Commissioner Reding] told the Journal. “There are conflicts not only about competition rules but also simply about obeying the rules.” In many past tussles with European officialdom, American executives have countered that they bring innovation, and follow all local laws and regulations… A recent EU report found that European citizens’ personal data, sent to the U.S. under Safe Harbor, may be processed by U.S. authorities in a way incompatible with the grounds on which they were originally collected in the EU. Europeans allege this harms European tech companies, which must play by stricter rules about what they can do with citizens’ data for advertising, targeting products and searches. Ms. Reding said Safe Harbor offered a “unilateral advantage” to American companies.

Thus, while “when in Rome…” is generally good advice, the Data Protection Regulation appears to be aimed primarily at removing the “advantages” of American Internet companies—at which rent-seekers and regulators throughout the continent have taken aim. As mentioned above, supporters often name American companies outright in the reasons for why the DSM’s Data Protection Regulation are needed. But opponents have noted that new regulation aimed at American companies is not needed in order to police abuses:

Speaking at an event in London, [EU Antitrust Chief] Ms. Vestager said it would be “tricky” to design EU regulation targeting the various large Internet firms like Facebook, Amazon.com Inc. and eBay Inc. because it was hard to establish what they had in common besides “facilitating something”… New EU regulation aimed at reining in large Internet companies would take years to create and would then address historic rather than future problems, Ms. Vestager said. “We need to think about what it is we want to achieve that can’t be achieved by enforcing competition law,” Ms. Vestager said.

Moreover, of the 15 largest Internet companies, 11 are American and 4 are Chinese. None is European. So any rules applying to the Internet ecosphere are inevitably going to disproportionately affect these important, US companies most of all. But if Europe wants to compete more effectively, it should foster a regulatory regime friendly to Internet business, rather than extend inefficient privacy rules to American companies under the guise of free trade.

Conclusion

Near the end of the The Good, the Bad, and the Ugly, Blondie and Tuco have this exchange that seems apropos to the situation we’re in:

Bloeastwoodndie: [watching the soldiers fighting on the bridge] I have a feeling it’s really gonna be a good, long battle.
Tuco: Blondie, the money’s on the other side of the river.
Blondie: Oh? Where?
Tuco: Amigo, I said on the other side, and that’s enough. But while the Confederates are there we can’t get across.
Blondie: What would happen if somebody were to blow up that bridge?

The EU’s DSM proposals are going to be a good, long battle. But key players in the EU recognize that the tech money — along with the services and ongoing innovation that benefit EU citizens — is really on the other side of the river. If they blow up the bridge of trade between the EU and the US, though, we will all be worse off — but Europeans most of all.

During the recent debate over whether to grant the Obama Administration “trade promotion authority” (TPA or fast track) to enter into major international trade agreements (such as the Trans-Pacific Partnership, or TPP), little attention has been directed to the problem of remaining anticompetitive governmental regulatory obstacles to liberalized trade and free markets.  Those remaining obstacles, which merit far more public attention, are highlighted in an article coauthored by Shanker Singham and me on competition policy and international trade distortions.

As our article explains, international trade agreements simply do not reach a variety of anticompetitive welfare-reducing government measures that create de facto trade barriers by favoring domestic interests over foreign competitors.  Moreover, many of these restraints are not in place to discriminate against foreign entities, but rather exist to promote certain favored firms. We dub these restrictions “anticompetitive market distortions” or “ACMDs,” in that they involve government actions that empower certain private interests to obtain or retain artificial competitive advantages over their rivals, be they foreign or domestic.  ACMDs are often a manifestation of cronyism, by which politically-connected enterprises successfully pressure government to shield them from effective competition, to the detriment of overall economic growth and welfare.  As we emphasize in our article, existing international trade rules have been able to reach ACMDs, which include: (1) governmental restraints that distort markets and lessen competition; and (2) anticompetitive private arrangements that are backed by government actions, have substantial effects on trade outside the jurisdiction that imposes the restrictions, and are not readily susceptible to domestic competition law challenge.  Among the most pernicious ACMDs are those that artificially alter the cost-base as between competing firms. Such cost changes will have large and immediate effects on market shares, and therefore on international trade flows.

Likewise, with the growing internationalization of commerce, ACMDs not only diminish domestic consumer welfare – they increasingly may have a harmful effect on foreign enterprises that seek to do business in the country imposing the restraint.  The home nations of the affected foreign enterprises, moreover, may as a practical matter find it not feasible to apply their competition laws extraterritorially to curb the restraint, given issues of jurisdictional reach and comity (particularly if the restraint flies under the colors of domestic law).  Because ACMDs also have not been constrained by international trade liberalization initiatives, they pose a serious challenge to global welfare enhancement by curtailing potential trade and investment opportunities.

Interest group politics and associated rent-seeking by well-organized private actors are endemic to modern economic life, guaranteeing that ACMDs will not easily be dismantled.  What is to be done, then, to curb ACMDs?

As a first step, Shanker Singham and I have proposed the development of a metric to estimate the net welfare costs of ACMDs.  Such a metric could help strengthen the hand of international organizations (including the International Competition Network, the World Bank, and the OECD) – and of reform-minded public officials – in building the case for dismantling these restraints, or (as a last resort) replacing them with less costly means for benefiting favored constituencies.  (Singham, two other coauthors, and I have developed a draft paper that delineates a specific metric, which we hope will be suitable for public release in the near future.)

Furthermore, free market-oriented think tanks can also be helpful by highlighting the harm special interest governmental restraints impose on the economy and on economic freedom.  In that regard, the Heritage Foundation’s excellent work in opposing cronyism deserves special mention.

Working to eliminate ACMDs and thereby promoting economic liberty is an arduous long-term task – one that will only succeed in increments, one battle at a time (the current principled effort to eliminate the Ex-Im Bank, strongly supported by the Heritage Foundation, is one such example).  Nevertheless, it is very much worth the candle.

Earlier this week the New Jersey Assembly unanimously passed a bill to allow direct sales of Tesla cars in New Jersey. (H/T Marina Lao). The bill

Allows a manufacturer (“franchisor,” as defined in P.L.1985, c.361 (C.56:10-26 et seq.)) to directly buy from or sell to consumers a zero emission vehicle (ZEV) at a maximum of four locations in New Jersey.  In addition, the bill requires a manufacturer to own or operate at least one retail facility in New Jersey for the servicing of its vehicles. The manufacturer’s direct sale locations are not required to also serve as a retail service facility.

The bill amends current law to allow any ZEV manufacturer to directly or indirectly buy from and directly sell, offer to sell, or deal to a consumer a ZEV if the manufacturer was licensed by the New Jersey Motor Vehicle Commission (MVC) on or prior to January 1, 2014.  This bill provides that ZEVs may be directly sold by certain manufacturers, like Tesla Motors, and preempts any rule or regulation that restricts sales exclusively to franchised dealerships.  The provisions of the bill would not prevent a licensed franchisor from operating under an existing license issued by the MVC.

At first cut, it seems good that the legislature is responding to the lunacy of the Christie administration’s previous decision to enforce a rule prohibiting direct sales of automobiles in New Jersey. We have previously discussed that decision at length in previous posts here, here, here and here. And Thom and Mike have taken on a similar rule in their home state of Missouri here and here.

In response to New Jersey’s decision to prohibit direct sales, the International Center for Law & Economics organized an open letter to Governor Christie based in large part on Dan Crane’s writings on the topic here at TOTM and discussing the faulty economics of such a ban. The letter was signed by more than 70 law professors and economists.

But it turns out that the legislative response is nearly as bad as the underlying ban itself.

First, a quick recap.

In our letter we noted that

The Motor Vehicle Commission’s regulation was aimed specifically at stopping one company, Tesla Motors, from directly distributing its electric cars. But the regulation would apply equally to any other innovative manufacturer trying to bring a new automobile to market, as well. There is no justification on any rational economic or public policy grounds for such a restraint of commerce. Rather, the upshot of the regulation is to reduce competition in New Jersey’s automobile market for the benefit of its auto dealers and to the detriment of its consumers. It is protectionism for auto dealers, pure and simple.

While enforcement of the New Jersey ban was clearly aimed directly at Tesla, it has broader effects. And, of course, its underlying logic is simply indefensible, regardless of which particular manufacturer it affects. The letter explains at length the economics of retail distribution and the misguided, anti-consumer logic of the regulation, and concludes by noting that

In sum, we have not heard a single argument for a direct distribution ban that makes any sense. To the contrary, these arguments simply bolster our belief that the regulations in question are motivated by economic protectionism that favors dealers at the expense of consumers and innovative technologies. It is discouraging to see this ban being used to block a company that is bringing dynamic and environmentally friendly products to market. We strongly encourage you to repeal it, by new legislation if necessary.

Thus it seems heartening that the legislature did, indeed, take up our challenge to repeal the ban.

Except that, in doing so, the legislature managed to write a bill that reflects no understanding whatever of the underlying economic issues at stake. Instead, the legislative response appears largely to be the product of rent seeking,pure and simple, offering only a limited response to Tesla’s squeaky wheel (no pun intended) and leaving the core defects of the ban completely undisturbed.

Instead of acknowledging the underlying absurdity of the limit on direct sales, the bill keeps the ban in place and simply offers a limited exception for Tesla (or other zero emission cars). While the innovative and beneficial nature of Tesla’s cars was an additional reason to oppose banning their direct sale, the specific characteristics of the cars is a minor and ancillary reason to oppose the ban. But the New Jersey legislative response is all about the cars’ emissions characteristics, and in no way does it reflect an appreciation for the fundamental economic defects of the underlying rule.

Moreover, the bill permits direct sales at only four locations (why four? No good reason whatever — presumably it was a political compromise, never the stuff of economic reason) and requires Tesla to operate a service center for its cars in the state. In other words, the regulators are still arbitrarily dictating aspects of car manufacturers’ business organization from on high.

Even worse, however, the bill is constructed to be nothing more than a payoff for a specific firm’s lobbying efforts, thus ensuring that the next (non-zero-emission) Tesla to come along will have to undertake the same efforts to pander to the state.

Far from addressing the serious concerns with the direct sales ban, the bill just perpetuates the culture of political rent seeking such regulations create.

Perhaps it’s better than nothing. Certainly it’s better than nothing for Tesla. But overall, I’d say it’s about the worst possible sort of response, short of nothing.

Our TOTM colleague Dan Crane has written a few posts here over the past year or so about attempts by the automobile dealers lobby (and General Motors itself) to restrict the ability of Tesla Motors to sell its vehicles directly to consumers (see here, here and here). Following New Jersey’s adoption of an anti-Tesla direct distribution ban, more than 70 lawyers and economists–including yours truly and several here at TOTM–submitted an open letter to Gov. Chris Christie explaining why the ban is bad policy.

Now it seems my own state of Missouri is getting caught up in the auto dealers’ ploy to thwart pro-consumer innovation and competition. Legislation (HB1124) that was intended to simply update statutes governing the definition, licensing and use of off-road and utility vehicles got co-opted at the last minute in the state Senate. Language was inserted to redefine the term “franchisor” to include any automobile manufacturer, regardless whether they have any franchise agreements–in direct contradiction to the definition used throughout the rest of the surrounding statues. The bill defines a “franchisor” as:

“any manufacturer of new motor vehicles which establishes any business location or facility within the state of Missouri, when such facilities are used by the manufacturer to inform, entice, or otherwise market to potential customers, or where customer orders for the manufacturer’s new motor vehicles are placed, received, or processed, whether or not any sales of such vehicles are finally consummated, and whether or not any such vehicles are actually delivered to the retail customer, at such business location or facility.”

In other words, it defines a franchisor as a company that chooses to open it’s own facility and not franchise. The bill then goes on to define any facility or business location meeting the above criteria as a “new motor vehicle dealership,” even though no sales or even distribution may actually take place there. Since “franchisors” are already forbidden from owning a “new motor vehicle dealership” in Missouri (a dubious restriction in itself), these perverted definitions effectively ban a company like Tesla from selling directly to consumers.

The bill still needs to go back to the Missouri House of Representatives, where it started out as addressing “laws regarding ‘all-terrain vehicles,’ ‘recreational off-highway vehicles,’ and ‘utility vehicles’.”

This is classic rent-seeking regulation at its finest, using contrived and contorted legislation–not to mention last-minute, underhanded legislative tactics–to prevent competition and innovation that, as General Motors itself pointed out, is based on a more economically efficient model of distribution that benefits consumers. Hopefully the State House…or the Governor…won’t be asleep at the wheel as this legislation speeds through the final days of the session.

I thank Truth on the Market (and especially Geoff Manne) for adding me as a regular TOTM blogger, writing on antitrust, IP, and regulatory policy. I am a newly minted Senior Legal Fellow at the Heritage Foundation, and alumnus of BlackBerry and the Federal Trade Commission.

Representatives of over 100 competition agencies from around the globe, joined by “non-governmental advisors” (NGAs) from think tanks, universities and the private sector, gathered in Marrakech two weeks ago for the 13th Annual Conference of the International Competition Network (ICN).

The ICN, founded in 2001, seeks to promote “soft convergence” in competition law and policy by releasing non-binding (but highly influential) recommended “best practices,” holding teleseminars and workshops, and disseminating educational and training materials for use by governments.  ICN members produce their output through flexible project-oriented and results-based working groups, dealing with mergers, unilateral conduct, cartels, competition advocacy, and agency effectiveness (how to improve agency performance).  (I have been involved in ICN work since 2006, as a U.S. Federal Trade Commission representative and an NGA.  The term “competition” is generally employed in lieu of “antitrust” in most foreign jurisdictions.)

The Marrakech Conference yielded two new sets of recommended practices, focused on competition assessment and predatory pricing.  (I will have more to say on predatory pricing in my next blog post.)  To the extent they are eventually implemented in the U.S., the competition assessment recommendations could lower the burden of government-imposed regulatory restrictions to the benefit of American consumers and American competitiveness.

As then FTC Chairman Tim Muris observed in 2003, in highlighting the importance of combating government-imposed competitive restraints,

[a]ttempting to protect competition by focusing solely on private restraints is like trying to stop the flow of water at a fork in a stream by blocking only one of the channels.  Unless you block both channels, you are not likely to even slow, much less stop, the flow. Eventually, all the water will flow toward the unblocked channel.

Indeed, anticompetitive government regulations that restrict entry, protect state-sponsored firms, and otherwise dampen the competitive process are legion, and widely viewed as imposing far greater harm to consumer welfare than the purely private restraints traditionally condemned by antitrust. Because they operate openly and are backed by the enforcement power of government, public restraints, unlike private restraints, cannot be undermined by market forces, and thus are far more likely to have sweeping and harmful long-term effects.

The FTC and other competition agencies have employed “competition advocacy” to argue against particular anticompetitive government restrictions, but those efforts historically have been limited in number, scope, and effectiveness.  Despite the huge potential welfare benefits from lifting anticompetitive restrictions, those restraints typically are the fruits of successful lobbying by private beneficiaries of competitive distortions, or by “public interest” groups that trust rule by government fiat over market forces.  Moreover, consumers at large are generally ill-informed about regulatory harms and the costs to organize in favor of reform efforts are prohibitive.

Recently, however, international organizations, including the OECD, UNCTAD, and the World Bank, have stepped forward to highlight the costs of public sector regulatory restraints and to help competition agencies spot and advocate against different sorts of restrictions.  Building on these initiatives (and in particular the OECD’s Competition Assessment Toolkit), the ICN’s Advocacy Working Group drafted Recommended Practices on Competition Assessment (RPCA) that the ICN adopted and released as a new consensus product in Marrakech.

The RPCA apply broadly to proposed and existing legislation, regulations, and policies that may restrict competition.  Recognizing that government competition agencies differ greatly in their capacities and ability to influence other government bodies, the RPCA note that competition assessments can take many forms, ranging from recommendations drawn from application of general economic theory to resource-intensive competition impact assessments, with many variations in between.  The RPCA stress that they are intended to provide guidance, not require particular assessments, and that government entities other than competition agencies can carry out valuable assessment work.

The RPCA provide a comprehensive “soup to nuts” template for agencies tasked with assessments, comprising both process-related and substantive elements:

  • A competition assessment should identify an existing or proposed policy that may unduly restrict competition and evaluate its likely impact on competition;
  • Competition agencies should advocate for a policymaking environment that promotes consideration of competition principles (including delineation of legal authority and openness to outside sources of advice);
  • A transparent process should be used to conduct assessments;
  • Agencies should focus assessments on types of restrictions that pose the greatest threat to competition, and design selection criteria (which are described) to prioritize competition assessment among other advocacy activities;
  • Agencies should consider institutional arrangements and relationships with policymakers in building assessment programs (practical advice designed to enhance the political viability of assessments);
  • Agencies should consider whether a competitive restriction is reasonably related to the goals of the policy under review and whether the policy goal could be achieved without harming competition or in a less restrictive manner;
  • A competition assessment should start by identifying and considering the goals and objectives of the policy in question and review prior work in the area;
  • Agencies should consider how a policy’s restrictions are likely to influence the market structure and behavior of firms and customers in the market or neighboring markets;
  • Once a restraint and its possible competitive effects have been identified, agencies should evaluate the likely competitive effects on the basis of sound economic theory, and, where feasible, on empirical evidence;
  • Agencies should carefully consider the form of competition assessment most appropriate for a particular situation (i.e., agencies should be free to issue a formal or informal opinion with flexibility as to the manner of delivery);
  • Agencies should seek to deliver a competition assessment in a timely fashion; and,
  • Agencies should engage with interested third parties (e.g., policy organizations and domestic peer agencies) to promote policymakers’ consideration of an assessment.

The RPCA shine particularly bright in providing a concise yet nuanced evaluation of the sorts of restraints that are most likely to undermine the competitive process, including a cogent discussion of barriers to entry, exit, or expansion within a market; of policies that control how firms are allowed to compete in a market; of policies that shield firms from competitive pressure; and of policies that control the choices available to consumers.  The RPCA also highlight the value of attempting, where feasible, to derive quantitative welfare estimates of the costs of particular restrictions, based on a neutral metric and other tools of economic analysis.  Over the next year further work will be done on cataloguing existing case studies that contain welfare estimates and on the derivation of a metric.

The RPCA are no short-term panacea, but rather a practical manifesto for long-run regulatory reform.  They shed a useful spotlight on categories of economically harmful regulations that occur in a wide range of countries – not just in historically state-dominated economies.  Rent-seeking is ubiquitous, and regulations too often reflect wealth-destructive competitive limitations masquerading in public interest dress in all sorts of jurisdictions, including the United States.  Given the recent rapid rise in U.S. regulatory activity, the identification of U.S. federal and state government rules that undermine competition surely will remain a target-rich zone for competition advocates.

Let’s hope that, over time, when the political tides yield greater support for economic liberty, the lessons of Marrakech will point the way to repealing welfare-destructive regulatory impositions across the globe.

Earlier this month, Representatives Peter DeFazio and Jason Chaffetz picked up the gauntlet from President Obama’s comments on February 14 at a Google-sponsored Internet Q&A on Google+ that “our efforts at patent reform only went about halfway to where we need to go” and that he would like “to see if we can build some additional consensus on smarter patent laws.” So, Reps. DeFazio and Chaffetz introduced on March 1 the Saving High-tech Innovators from Egregious Legal Disputes (SHIELD) Act, which creates a “losing plaintiff patent-owner pays” litigation system for a single type of patent owner—patent licensing companies that purchase and license patents in the marketplace (and who sue infringers when infringers refuse their requests to license). To Google, to Representative DeFazio, and to others, these patent licensing companies are “patent trolls” who are destroyers of all things good—and the SHIELD Act will save us all from these dastardly “trolls” (is a troll anything but dastardly?).

As I and other scholars have pointed out, the “patent troll” moniker is really just a rhetorical epithet that lacks even an agreed-upon definition.  The term is used loosely enough that it sometimes covers and sometimes excludes universities, Thomas Edison, Elias Howe (the inventor of the lockstitch in 1843), Charles Goodyear (the inventor of vulcanized rubber in 1839), and even companies like IBM.  How can we be expected to have a reasonable discussion about patent policy when our basic terms of public discourse shift in meaning from blog to blog, article to article, speaker to speaker?  The same is true of the new term, “Patent Assertion Entities,” which sounds more neutral, but has the same problem in that it also lacks any objective definition or usage.

Setting aside this basic problem of terminology for the moment, the SHIELD Act is anything but a “smarter patent law” (to quote President Obama). Some patent scholars, like Michael Risch, have begun to point out some of the serious problems with the SHIELD Act, such as its selectively discriminatory treatment of certain types of patent-owners.  Moreover, as Professor Risch ably identifies, this legislation was so cleverly drafted to cover only a limited set of a specific type of patent-owner that it ended up being too clever. Unlike the previous version introduced last year, the 2013 SHIELD Act does not even apply to the flavor-of-the-day outrage over patent licensing companies—the owner of the podcast patent. (Although you wouldn’t know this if you read the supporters of the SHIELD Act like the EFF who falsely claim that this law will stop patent-owners like the podcast patent-owning company.)

There are many things wrong with the SHIELD Act, but one thing that I want to highlight here is that it based on a falsehood: the oft-repeated claim that two Boston University researchers have proven in a study that “patent troll suits cost American technology companies over $29 billion in 2011 alone.”  This is what Rep. DeFazio said when he introduced the SHIELD Act on March 1. This claim was repeated yesterday by House Members during a hearing on “Abusive Patent Litigation.” The claim that patent licensing companies cost American tech companies $29 billion in a single year (2011) has become gospel since this study, The Direct Costs from NPE Disputes, was released last summer on the Internet. (Another name of patent licensing companies is “Non Practicing Entity” or “NPE.”)  A Google search of “patent troll 29 billion” produces 191,000 hits. A Google search of “NPE 29 billion” produces 605,000 hits. Such is the making of conventional wisdom.

The problem with conventional wisdom is that it is usually incorrect, and the study that produced the claim of “$29 billion imposed by patent trolls” is no different. The $29 billion cost study is deeply and fundamentally flawed, as explained by two noted professors, David Schwartz and Jay Kesan, who are also highly regarded for their empirical and economic work in patent law.  In their essay, Analyzing the Role of Non-Practicing Entities in the Patent System, also released late last summer, they detailed at great length serious methodological and substantive flaws in The Direct Costs from NPE Disputes. Unfortunately, the Schwartz and Kesan essay has gone virtually unnoticed in the patent policy debates, while the $29 billion cost claim has through repetition become truth.

In the hope that at least a few more people might discover the Schwartz and Kesan essay, I will briefly summarize some of their concerns about the study that produced the $29 billion cost figure.  This is not merely an academic exercise.  Since Rep. DeFazio explicitly relied on the $29 billion cost claim to justify the SHIELD Act, and he and others keep repeating it, it’s important to know if it is true, because it’s being used to drive proposed legislation in the real world.  If patent legislation is supposed to secure innovation, then it behooves us to know if this legislation is based on actual facts. Yet, as Schwartz and Kesan explain in their essay, the $29 billion cost claim is based on a study that is fundamentally flawed in both substance and methodology.

In terms of its methodological flaws, the study supporting the $29 billion cost claim employs an incredibly broad definition of “patent troll” that covers almost every person, corporation or university that sues someone for infringing a patent that it is not currently being used to manufacture a product at that moment.  While the meaning of the “patent troll” epithet shifts depending on the commentator, reporter, blogger, or scholar who is using it, one would be extremely hard pressed to find anyone embracing this expansive usage in patent scholarship or similar commentary today.

There are several reasons why the extremely broad definition of “NPE” or “patent troll” in the study is unusual even compared to uses of this term in other commentary or studies. First, and most absurdly, this definition, by necessity, includes every university in the world that sues someone for infringing one of its patents, as universities don’t manufacture goods.  Second, it includes every individual and start-up company who plans to manufacture a patented invention, but is forced to sue an infringer-competitor who thwarted these business plans by its infringing sales in the marketplace.  Third, it includes commercial firms throughout the wide-ranging innovation industries—from high tech to biotech to traditional manufacturing—that have at least one patent among a portfolio of thousands that is not being used at the moment to manufacture a product because it may be “well outside the area in which they make products” and yet they sue infringers of this patent (the quoted language is from the study). So, according to this study, every manufacturer becomes an “NPE” or “patent troll” if it strays too far from what somebody subjectively defines as its rightful “area” of manufacturing. What company is not branded an “NPE” or “patent troll” under this definition, or will necessarily become one in the future given inevitable changes in one’s business plans or commercial activities? This is particularly true for every person or company whose only current opportunity to reap the benefit of their patented invention is to license the technology or to litigate against the infringers who refuse license offers.

So, when almost every possible patent-owning person, university, or corporation is defined as a “NPE” or “patent troll,” why are we surprised that a study that employs this virtually boundless definition concludes that they create $29 billion in litigation costs per year?  The only thing surprising is that the number isn’t even higher!

There are many other methodological flaws in the $29 billion cost study, such as its explicit assumption that patent litigation costs are “too high” without providing any comparative baseline for this conclusion.  What are the costs in other areas of litigation, such as standard commercial litigation, tort claims, or disputes over complex regulations?  We are not told.  What are the historical costs of patent litigation?  We are not told.  On what basis then can we conclude that $29 billion is “too high” or even “too low”?  We’re supposed to be impressed by a number that exists in a vacuum and that lacks any empirical context by which to evaluate it.

The $29 billion cost study also assumes that all litigation transaction costs are deadweight losses, which would mean that the entire U.S. court system is a deadweight loss according to the terms of this study.  Every lawsuit, whether a contract, tort, property, regulatory or constitutional dispute is, according to the assumption of the $29 billion cost study, a deadweight loss.  The entire U.S. court system is an inefficient cost imposed on everyone who uses it.  Really?  That’s an assumption that reduces itself to absurdity—it’s a self-imposed reductio ad absurdum!

In addition to the methodological problems, there are also serious concerns about the trustworthiness and quality of the actual data used to reach the $29 billion claim in the study.  All studies rely on data, and in this case, the $29 billion study used data from a secret survey done by RPX of its customers.  For those who don’t know, RPX’s business model is to defend companies against these so-called “patent trolls.”  So, a company whose business model is predicated on hyping the threat of “patent trolls” does a secret survey of its paying customers, and it is now known that RPX informed its customers in the survey that their answers would be used to lobby for changes in the patent laws.

As every reputable economist or statistician will tell you, such conditions encourage exaggeration and bias in a data sample by motivating participation among those who support changes to the patent law.  Such a problem even has a formal name in economic studies: self-selection bias.  But one doesn’t need to be an economist or statistician to be able to see the problems in relying on the RPX data to conclude that NPEs cost $29 billion per year. As the classic adage goes, “Something is rotten in the state of Denmark.”

Even worse, as I noted above, the RPX survey was confidential.  RPX has continued to invoke “client confidences” in refusing to disclose its actual customer survey or the resulting data, which means that the data underlying the $29 billion claim is completely unknown and unverifiable for anyone who reads the study.  Don’t worry, the researchers have told us in a footnote in the study, they looked at the data and confirmed it is good.  Again, it doesn’t take economic or statistical training to know that something is not right here. Another classic cliché comes to mind at this point: “it’s not the crime, it’s the cover-up.”

In fact, keeping data secret in a published study violates well-established and longstanding norms in all scientific research that data should always be made available for testing and verification by third parties.  No peer-reviewed medical or scientific journal would publish a study based on a secret data set in which the researchers have told us that we should simply trust them that the data is accurate.  Its use of secret data probably explains why the $29 billion study has not yet appeared in a peer-reviewed journal, and, if economics has any claim to being an actual science, this study never will.  If a study does not meet basic scientific standards for verifying data, then why are Reps. DeFazio and Chaffetz relying on it to propose national legislation that directly impacts the patent system and future innovation?  If heads-in-the-clouds academics would know to reject such a study as based on unverifiable, likely biased claptrap, then why are our elected officials embracing it to create real-world legal rules?

And, to continue our running theme of classic clichés, there’s the rub. The more one looks at the actual legal requirements of the SHIELD Act, the more, in the words of Professor Risch, one is left “scratching one’s head” in bewilderment.  The more one looks at the supporting studies and arguments in favor of the SHIELD Act, the more one is left, in the words of Professor Risch, “scratching one’s head.”  The more and more one thinks about the SHIELD Act, the more one realizes what it is—legislation that has been crafted at the behest of the politically powerful (such as an Internet company who can get the President to do a special appearance on its own social media website) to have the government eliminate a smaller, publicly reviled, and less politically-connected group.

In short, people may have legitimate complaints about the ways in which the court system in the U.S. generally has problems.  Commentators and Congresspersons could even consider revising the general legal rules governing patent ligtiation for all plaintiffs and defendants to make the ligitation system work better or more efficiently (by some established metric).   Professor Risch has done exactly this in a recent Wired op-ed.  But it’s time to call a spade a spade: the SHIELD Act is a classic example of rent-seeking, discriminatory legislation.

Merger Retrospective

Steve Salop —  4 April 2011

Several years ago, the DOJ cleared a merger between Whirlpool and Maytag.   The primary defense was that post-merger prices could not rise because of intense competition from foreign competitors like LG and Samsung. Apparently the actual competition was more than Whirlpool wanted to bear.  Guess What?  Mr. Laissez-Faire Antitrust, meet Dr. Public Choice.  The Wall Street Journal has reported that Whirlpool has filed a dumping complaint against LG and Samsung.   Whirlpool’s dumping complaint involves refrigerators and the merger concerns involved washers and dryers more than refrigerators.  But, the complaint sends a signal to LG and Samsung.  The comlaint also certainly does raise a caution about relying on foreign competition, and suggests a potential remedial provision.