The Challenges to Antitrust in a Changing Economy conference, put on by CPI and CCIA at Harvard Law School two weeks ago, was an opportunity for today’s antitrust establishment, on both the (center) left and right, to react to recent calls from activists and journalists loosely associated with the Open Markets Institute for a radical increase in antitrust enforcement. In particular, the conference provided a view of how establishment scholars have been processing OMI’s extraordinary influence on progressive thinking, not to mention the national press, over the past couple of years. (I don’t mean “establishment” pejoratively here, but only to signal that these are leading scholars in antitrust law and economics teaching at leading schools.)
The most serious challenge to the antitrust status quo as an intellectual matter has interestingly come not from OMI, but from finance economists, who have shown in recent years that firm margins, which are the difference between revenues and costs, have experienced an abnormal expansion over the past two decades or so, a period that corresponds uncannily to the period over which antitrust enforcement has been in decline. Margins are the profits of common parlance, and the implication of this work is that firms are generating greater profits than they ever could before, and have been doing it both in periods of recession — such as the Great Recession of 2007 — and in periods of economic expansion, such as that taking place right now.
These scholars — top flight economists all — have shown that none of the variables you might think would account for increased profitability, such as increased investment in new technologies, explain this trend. The explanation that leaps out, one that these scholars have not been able to explain away with their data, is that firms have been leveraging the greater market power permitted to them by declines in antitrust enforcement to extract more profits from markets.
This conclusion has been supported by data showing an increase in market concentration over the past twenty years, the absence of expanded margins in Europe, which has not seen a decline in antitrust enforcement, and increased concentration in U.S. labor markets and a corresponding stagnancy in U.S. wages. Much of this evidence, and its implications for antitrust policy, was brilliantly summarized by leading antitrust economist Fiona Scott Morton in her keynote address at the 2018 Mannheim Centre for Competition and Innovation Annual Conference, signalling that the radical spirit of the times might be making its way into the antitrust establishment through the data-rich conduit of the margins work being done by finance economists.
Speakers at the CPI/CCIA conference two weeks ago pushed back against the evidence both of rising margins and of rising concentration. NYU’s Larry White kicked off the day with an attack on the margins evidence. He argued that the finance economists are missing something important that the industrial organization (IO) economists who traditionally have taken the lead in antitrust policy debates learned in the 1970s: namely, that margins can’t be measured.
The trouble, argued White, is that costs are difficult to define. Subtract away the costs of all physical inputs, compensation to workers, and the like, and you still might not end up with an accurate measure of margins, because some of the remaining amount may be necessary — necessary in the way that all costs are necessary to production — to serve as a cushion against an unexpected shock to revenues. Or to compensate innovators, or managers with special skills, and so on.
Invoking noted mid-20th-century IO economist Leonard Weiss, who was long an advocate of greater antitrust enforcement, White pointed out that it was Weiss who in the 1970s finally came to recognize that margin data were unreliable, and concluded that going forward antitrust policy would need to be based on observation of price effects, rather that margin effects. White’s point was that absent an accurate way to measure margins, antitrust policy must make do with looking to see whether prices, rather than margins, are rising abnormally in the economy. And prices, notably, have not been going up abnormally, creating no basis for increased antitrust enforcement. Finance economists, argued White, weren’t around for the bruising quarter-century-long quest to measure margins and relate them to concentration levels that took place in industrial organization economics during antitrust’s Postwar golden age, and therefore are making the same mistakes today that IO economists once made.
The trouble with White’s argument is that it proves too much, because antitrust is through and through dedicated to the measurement and prohibition of anticompetitively-generated margins, whether antitrust is willing to admit it or not. So giving up on the measurement of margins means giving up on antitrust. White himself seemed inadvertently to advertise this point at the end of his presentation. In the final portion of his remarks, White observed that the margins problem rears its head in antitrust today whenever the courts require proof of market power, because market power is the power profitably to raise price above competitive levels, and profits are margins. But precisely because the requirement of proof of market power is ubiquitous in antitrust law — a staple of the “rule of reason” standard applied to both collusion claims under Section 1 of the Sherman Act and monopolization claims under Section 2 — White’s skepticism about the possibility of measuring margins translates into skepticism about the entire antitrust project. Take White’s position seriously, and there should not only be no radical increase in antitrust enforcement, but no antitrust at all.
White likely didn’t see that implication because he believes, as much of the antitrust establishment seems to believe today, that it is possible somehow to use price effects as a substitute for margin effects in deciding whether firms have power over markets. The argument for using price effects goes like this. Instead of trying to identify markets in which price increases are profitable, and then to scrutinize the behavior of firms in those markets to make sure that they are not profiting by actively squelching competition, antitrust enforcers need only look to see whether suspect firms could increase prices over competitive levels in any of the goods they sell. If prices could go up, and statistical analysis shows that the increase would not be due to irrelevant factors such as an increase in input costs, then it is safe to assume that the increase in prices would be due to the anticompetitive conduct. The apparent beauty of this approach is that there is no need to measure margins.
Or is there? What antitrust economists all ought to know, but perhaps don’t want to admit to themselves, is that when they consider price effects they are always also implicitly measuring margins. How? When they control for changes in input prices, of course. Price effects can have many causes, and antitrust is not a price stability regime. Antitrust wants to condemn conduct — like horizontal mergers — that leads to higher prices only when those higher prices are a result of anticompetitive conduct, and not the result of increases in costs. But that just puts any student of price effects in the position of having to distinguish between price effects that are driven by higher margins — the channel through which all anticompetitive conduct affects prices — and price effects that are driven by costs or other extraneous factors. When an econometrician controls for input cost increases, the econometrician is really just measuring margins, implicitly using a metric that expresses margins as revenues less input costs. (The funny thing is that this simple approach to margins is precisely the one that White, and the Chicago School in the 1970s, so roundly criticized the earlier Postwar establishment for employing.)
In other words, margins in antitrust are everywhere, and unavoidable. Indeed, you cannot have antitrust without the measurement of margins, because anticompetitive conduct is uniquely identifiable through the abnormal margins that the conduct makes possible. Anticompetitive conduct that does not increase margins simply is not anticompetitive. Conduct must somehow fail to squelch competition, and therefore fail to enable the firm to extract more value from consumers, in order to be anticompetitive.
Of course, the reverse is not true, higher margins can be caused by factors other than anticompetitive conduct, but that does not permit antitrust to ignore margin effects; the subject of antitrust is precisely margins caused by certain types of conduct. To give up on the ability of economics to measure margins is to give up on antitrust. Despite declines in enforcement since the late 1970s, today’s antitrust establishment has been unwilling to give up on antitrust, and it has dealt with the immense cognitive dissonance associated with practicing a discipline that it believes impossible to practice by using the classic cognitive strategies of denial and avoidance. The establishment today acts as if the show can go on without the measurement of margins, which of course it cannot.
I put this problem to the panel, and the responses were highly instructive. Bruce Kobayashi, current head of the FTC’s Bureau of Economics, stated that “everything” the Bureau does involves the measurement of margins. Antitrust cannot function without it. And White, to his credit, threw up his hands, seemingly agreeing that if the measurement of margins really is impossible, then there can be no antitrust enterprise.
In a way, this debate cuts right to the heart of antitrust’s agony of the past forty years. Until the mid-1970s, antitrust enforcement in the U.S. was vigorous. The Chicago School attack that lowered enforcement was based primarily on radical skepticism about the ability of economic science to identify truly anticompetitive conduct, and that skepticism was in turn expressed in a skepticism about the ability of economics to measure margins. Perhaps finance economists will drive renewed faith in the power of economics to engage in such measurement, but even if they don’t, we need to come to terms with the fact that the actions of IO economists have already spoken louder than their words. In continuing to muddle along measuring margins while professing not to be able to measure them, IO economists have been telling us for the last thirty years that yes, you can measure margins, and run an entire policy sector based on them.
Recognizing that fact may be all we need to cure antitrust of its present timidity.