In a new paper, Glick, Lozada, and Bush have done both antimonopolism and the antitrust academy a service by making the first real attempt to put the movement in direct conversation with contemporary antitrust method.
GLB have a simple message: welfare economics long ago stopped using willingness to pay to measure consumer welfare, and antitrust should too.
What is more, welfare economics today pursues an eclectic set of approaches to measuring welfare. Some of them suggest that the dispersal of economic power and the availability of small businesses can make people happy.
It follows, argue GLB, that it is entirely consistent with contemporary welfare economics to take these things into account in evaluating mergers or prosecuting monopolies.
The Social Welfare Function
GLB start with the problem that welfare economists faced at the beginning of the 20th century: how to compare the value that different people—say a producer and a consumer—obtain from a transaction in the absence of some universal measure of value.
If the producer gets a profit of $2 and the consumer pays $5 for a bag of apples, did the transaction confer the same amount of value on the two? Are $2 worth the same to the producer as a-bag-of-apples-for-$5 is worth to the consumer?
If there were some universal measure of happiness—denominated in, say, “utils”—then we could answer that question.
We would look up the consumer’s change in pleasure associated with swapping $5 for apples and compare it to the producer’s change in pleasure associated with making a $2 profit. If the former were 50 utils and the latter 30 utils, then we could say that the transaction did not confer the same benefit on both parties.
Economists eventually decided that they would not be able to find a universal metric of happiness. But they hoped that they might be able to glean some information about happiness from the behavior of economic actors.
The first approach that they hit upon was the pareto criterion. It said: the only bad transactions are those into which the parties do not enter voluntarily, because those must make at least one party worse off (the party who would not voluntarily enter into the transaction).
Any transaction the parties do enter into voluntarily is, in contrast, good, because they wouldn’t be willing to enter into it unless the transaction made neither worse off.
It followed that voluntary transactions could be treated as welfare improving—or at least not welfare reducing. The parties were signalling, through their willingness to enter into them, that the transactions were at least not undesirable.
If the producer and consumer voluntarily transact in apples at $5, then welfare could be said not to have been reduced and indeed potentially to have increased. That was the pareto criterion.
It helped welfare economics a bit. But it also failed to answer an important question: what about people who are affected by a transaction but who are not entering into it themselves?
If, for example, two producers merge, and, as a result of the merger, they are able to charge a higher price, consumers are affected. But consumers have no choice over whether the merger takes place.
The pareto criterion tells us that the merger does not make the merging parties worse off. But it tells us nothing about whether the merger makes consumers worse off.
Some way of comparing the costs of the transaction to consumers with the benefits to the merging producers is needed, but the pareto criterion cannot provide it.
Willingness to Pay and Potential Pareto
The solution proposed by some economists in the early 20th century was to use willingness to pay as a measure of happiness.
The idea was that if a consumer would be willing to pay $10 for an apple, then that would be a measure of the pleasure the consumer would get from consuming the apple. By noting that a person should be willing to pay cash for cash on a dollar-for-dollar basis, one could proceed to do with dollars what economists had originally hoped to do with utils.
To return to our example of an apple purchased for $5, if the consumer were in fact willing to pay $10 for the apple, then the value to the consumer of the transaction would be the $10 the consumer would be willing to pay less the $5 price that the consumer actually paid for it.
And the value of the transaction to the producer would be the producer’s $2 profit. It would then follow that the consumer did better than the producer in the transaction because the consumer generated a “surplus” of $5 whereas the producer generated a profit (“producer’s surplus”) of only $2.
This willingness-to-pay approach made it possible to evaluate a merger of producers.
If producers were to merge and drive the price up to $7, then the producers (who, if their costs are as before, would now make a $4 profit) would end up better off than the consumers (who would now enjoy a surplus of $10 less $7, or $3). The merger would reduce the welfare of the consumer by $3.
If antitrust were to adhere to a consumer welfare standard—the rule that mergers that reduce consumer surplus are to be rejected—then this merger would fail the test and be rejected.
As GLB note, the willingness to pay concept made it possible to consider tradeoffs as well.
The merger might, for example, also reduce the costs of production of the merged firms from $3 to $0.50, thereby increasing the merging firms’ profits on the transaction from $4 to $6.50.
If one were to view the goal of the antitrust laws as the maximization of total welfare—meaning the maximization of the combined surplus of producers and consumers, however that surplus may be distributed between them—this cost reduction would justify the merger. It would expand the sum of producer and consumer surplus from $7 ($2 for the producers and $5 for the consumer) to $9.50 ($6.50 for the producers and $3 for the consumer).
Moreover, the merger might even be said to satisfy the consumer welfare standard if one were to adhere to the peculiar sophistry that any increase in total welfare should count as an increase in consumer welfare because the increase in total welfare could be redistributed to consumers.
Because the merged producers could be forced to pay the $2.50 increase in total welfare to the consumer, leaving the consumer with $5.50, which is more than the $5 he would have without the merger, the deal could, according to this peculiar sophistry, be classified as consumer welfare enhancing.
At least in potential. And if such a transfer were made, then the consumer and the producers alike would welcome the deal (the producers would be left with $4, which is more than the $3 in profit earned without the deal). Hence GLB refer to this as the “potential pareto criterion”. It is also called the Kaldor-Hicks efficiency criterion.
Economists should have, and, indeed, did, realize from the start that willingness to pay was a doomed approach because a person’s willingness to pay changes with his budget.
Two people who would be willing to pay the same amount for an apple if they had the same wealth would likely be willing to pay vastly different amounts if one were poor and the other rich. The rich person might be willing to pay much more for the apple than would a cash-strapped poor person.
One can avoid this problem by supposing that the poor man is willing to pay less for an apple because he in fact would derive less pleasure from it. He might have to deny his child meat in order to be able to afford the apple, and that might ruin his meal.
But viewing actual pleasure as perfectly consonant with willingness to pay amounts to shoehorning subjective feelings into budget constraints.
It is just as likely that the poor man who did make such a substitution would feel a great deal of guilty pleasure. His rational faculties might enable him to forego that pleasure and give his child meat. But that does not mean that his pleasure centers would not be the worse for it. They would be.
If wealth effects matter, however, then one cannot compare producer and consumer surpluses—or indeed the surpluses generated by any two people.
One cannot say, for example, that a merger that decreases cost by $2.50 is on net a good thing if it results in a price increase of only $2 because $2.50 is more than $2, so the total amount of pleasure generated by the economy has gone up. For if the producers are rich but the consumer poor, then the $2 cost to the consumer might inflict more pain on him than the $2.50 increase in profits for the producers.
Redistribution of those $2.50 in benefits to the consumer is now required for efficiency and not just to achieve distributive justice. If efficiency is about increasing the total amount of happiness generated by the economy, and those $2.50 make the consumer happier than the producers, then efficiency requires that the $2.50 go to the consumer.
If the only implication of wealth effects were that redistribution from rich to poor is required for efficiency, then wealth effects would not be particularly problematic for progressives.
But very often a policy change not only creates a benefit and raises a price, as in our merger example, but also inflicts an economic cost in the sense of precluding some production—or aspect thereof—that consumers value.
The merger might, for example, not only reduce apple production costs by $2.50 but also lead to slightly less tasty apples. Perhaps the merger saves on costs by enabling the sale of an orchard that produced particularly tasty apples but was also relatively costly to maintain.
If the consumer’s maximum willingness to pay falls by $2 because the apple is less tasty, then the willingness to pay measure suggests that the merger should go ahead. The benefits in terms of a reduction in costs of $2.50 exceed the costs in terms of a reduction in the value of the apple to consumers of $2. There is a net gain of $0.50.
To be sure, if the price again rises to $7 as a result of the merger, consumers find themselves even worse off than before. Their surplus falls to $1 (a maximum willingness to pay of $8 less a price of $7).
But the merging producers can, at least in theory, make up for this by transferring $2 to the consumer to offset the price increase and by transferring at least $2 of the cost reduction they enjoy as well, ensuring that the consumer ends up with at least the $5.00 in surplus the consumer would have enjoyed without the deal.
And the producers, who initially enjoyed an increase in profits of $5.50 ($2.50 in cost reductions plus $2.00 from the increase in price) end up better off so long as they do not pay more than $5.50 to the consumer.
So all parties can, in theory, end up better off.
That’s because the benefits created by the merger exceed the costs by $0.50. Once one uses transfers to correct for the resulting price increase and to compensate the consumer for his loss, which is smaller than the producers’ gains, there is necessarily some net gain left over that producers and consumer can divide up, leaving them all better off.
The potential pareto criterion is satisfied and, if the transfers are actually made, so is the consumer welfare standard.
If wealth effects matter, however, then one cannot reliably compare the $2.50 benefit in terms of production cost savings to the $2 loss associated with the reduced tastiness of the apple. If the consumer is poor, then the consumer may place a dollar value on the reduction in tastiness of the apple that is far below the actual loss of pleasure the consumer would suffer in consuming a less tasty apple.
If there were utils and we could compare the value of the production cost savings to the producers to the reduction in the consumer’s happiness associated with the less tasty apple, we might find that the producers’ gain is 100 utils and the consumer’s loss is 1000 utils, resulting in a net reduction in happiness due to the merger.
Wealth effects prevent the consumer from registering his dissatisfaction in terms of willingness to pay, however, and so the merger appears to offer a net gain when in fact it does not.
It follows that the producers will never be able fully to compensate the consumer for the loss without incurring a loss themselves, and so according to the potential pareto criterion the merger should be blocked.
If we nevertheless treat willingness to pay as a measure of welfare, however, the deal will appear to be welfare increasing and the deal will go through, reducing overall happiness.
Wealth effects cause willingness to pay to lead to bad policymaking.
Wealth effects also undermine the commensurability of values with respect to the same person.
To see why, let’s go back to the example in which the merger raises prices but doesn’t reduce the tastiness of apples.
If unwinding the merger would reduce the price of an apple from $7 to $5, it is clear that the consumer becomes $2 richer. He saves $2, which he can now spend on other things.
In order for willingness to pay to be a useful proxy for welfare, one would, then, like to be able to say that the consumer is made just as well off by the price reduction as he would have been had he been given $2 in cash in lieu of the price increase.
But if willingness to pay depends on wealth, we cannot say that a $2 cash payment would leave the consumer in the same position as the consumer would be had price fallen by $2.
If a consumer cares more for apples the richer that he is, then the consumer will prefer a $2 cut in the price of apples to a $2 cash payment. Given his stronger preference for apples, the consumer might want to plow the $2 savings on apples into buying more apples, and that money would buy more apples at the lower apple price than would a $2 cash payment used to purchase more apples at the higher price.
It follows that the consumer would require a cash payment in excess of $2 in order to be made as happy as he would be if the price of apples were reduced by $2.
Similarly, we might ask whether taxing away $2 from the consumer when prices are low would leave the consumer just as happy as the consumer would be were he to experience a $2 price increase.
Again the answer would be “no.”
When the price of apples increases, it is clear that the consumer becomes poorer; his wealth buys him less. If the consumer’s taste for apples decreases with poverty, however, then the consumer will prefer a $2 increase in the price of apples to having $2 of cash taxed away from him.
Because he prefers other things to apples as he becomes poorer, the consumer will place a higher value on cash, which he can use to buy things other than apples, than he places on the price of apples.
But if a tax of $2 makes him less happy than he would be under an increase in the price of apples of $2, then a tax of less than $2 is equivalent, from his perspective, to an increase in the price of apples of $2.
So, overall, we have the peculiar result that a $2 price reduction is equivalent to a cash payment of more than $2 but a $2 price increase is equivalent to a cash reduction of less than $2.
Commensurability would, of course, require that all these things be equal.
And so we see that wealth effects not only prevent us from saying that a $2 gain to the producers creates the same amount of pleasure as a $2 gain to a consumer, but also that a $2 gain to the consumer via a price reduction creates the same amount of pleasure as a $2 cash payment. And the same can be said of losses.
GLB don’t acknowledge that between- and within-person incommensurability both stem from the same problem of wealth effects. But they do a good job of discussing both.
They also spend considerable time refuting the arguments of mainstream economists that within-person incommensurability is small and can be ignored.
But even if it were small, and indeed, even if wealth effects were not a problem for commensurability between persons either, willingness to pay would remain a highly problematic measure of value.
There is no basis for supposing that, just because two people having the same wealth level are willing to pay the same amount for a particular good, they will get the same level of pleasure from it.
Indeed, it is possible that two people who place the same relative values on all goods, and so are willing to pay the exact same amount for each good, might experience very different levels of pleasure from consuming them.
One person might take almost no pleasure from any good. Another might be sent into fits of ecstasy by the smallest purchase.
So long as the relative pleasure conferred by each good vis a vis the other goods is the same for both people, each will be willing to pay the same amount for each good. They will divide their budgets between goods in exactly the same way despite deriving very different levels of pleasure from them.
The Return to the Social Welfare Function
As GLB relate, welfare economists responded to these limitations by giving up on what might be called the overall “revealed value” approach to measuring welfare embodied in the pareto criterion and potential pareto (i.e., willingness-to-pay-based) criterion.
These criteria took a common revealed value approach because they both tried to read value from the actions of economic agents.
Whether a transaction satisfied the pareto criterion could be determined by checking to see whether the parties entered into it voluntarily. If they did, then it followed that neither party was made worse off.
And if a consumer purchased an apple at $10 but not at $11, one could infer that the maximum the consumer was willing to pay for apples was $10 and use that number to determine by how much the consumer could be compensated, pursuant to the potential pareto criterion, for the loss of an apple.
Under both approaches, economic agents were assumed to reveal the pleasure they take in goods via their actions, enabling economists to identify changes in welfare associated with various policies without needing direct access to the pleasure centers in consumers’ brains in order to make those determinations.
With the demise of willingness to pay, welfare economists would no longer try to find a way to read the pleasure and pain of consumers through their economic behavior.
Instead, they would return to the direct approach that they had abandoned more than fifty years before; they would try to measure happiness directly.
They took a variety of approaches to this problem. They would ask people if they are happy or not in various situations; they would study health indicators such as longevity, freedom from disease, and so on, in various situations; they would consult psychologists and neurologists.
Based on the results of these inquiries, they would identify the material circumstances most likely to be conducive to happiness and recommend economic policies (such as antitrust cases) that produce those circumstances.
Medical inquiry might determine, for example, that spinach is good for consumers. Welfare economists would then respond by ranking policy choices that lead to more spinach consumption higher than those that lead to less.
This was a departure from the willingness to pay approach, according to which welfare economists would have given spinach consumption the ranking implied by the dollar value that consumers revealed themselves to be willing to pay for spinach relative to what they would pay for other things.
Now other branches of science, and not revealed preference, determined the ranking.
This takes us up to the present state of welfare economics.
And for GLB, this completes the argument for taking political power and small businesses into account in doing antitrust.
According to GLB, one can no longer argue that, because consumers are manifestly willing to pay high prices charged by dominant firms, consumers like big firms and like the influence they have over politics.
Consumers’ willingness to pay is no reliable measure of the pleasure they get from buying the products of politically influential, small-business-destroying monopolists.
Instead, as already mentioned, GLB point to studies that suggest that consumers are happier in democratic environments free of concentrations of economic power. And that consumers are happier when they have access to small businesses.
It follows, argue GLB, that it is perfectly reasonable, per current practice in welfare economics, to argue that mergers that increase consumer surplus in the willingness-to-pay sense nevertheless make consumers unhappy, and should therefore be targeted for antitrust enforcement.
The Willingness to Pay Measure Is about Choice, Not Happiness
GLB’s paper presents a powerful rejoinder to any antitruster who might have been under the misapprehension that willingness to pay is a good measure of happiness. There are surely some out there.
But I suspect that the paper will not win too many converts, because what attracts people to willingness to pay is not that it is a good measure of happiness, but instead that it is the best way of doing justice to consumer choice that we have.
Welfare economics embodies a tension felt throughout the modern human rights project regarding who decides what happiness means.
Do we study human beings as if they were complex robots, figure out what makes these machines happiest, and impose those conditions on them? Or do we let the machines decide what makes them happiest?
GLB tell the story of welfare economics as if the field has always been interested only in the first option: to figure out what makes people happy and then impose those conditions upon their economic lives.
Under this assumption, GLB’s conclusion follows immediately from the arc of welfare economics. Willingness to pay is not a good measure. Others must be found.
But, as GLB acknowledge, economists have known almost from the inception of the willingness to pay approach in the 1940s that it was unsound. Why hasn’t the field moved on?
GLB chalk it up to “zombie economics.”
The real reason is that many people want to preserve a space in which consumers can vote for what they want through their purchase decisions.
That is, these people don’t view economics as a descriptive science but rather as a democratic project. It is the project of empowering consumers to vote on the character and magnitude of production through their purchase decisions.
The willingness to pay measure is ultimately built upon such a foundation, because willingness to pay is measured by observing the prices at which consumers do and do not buy.
The measure is highly imperfect, even incoherent, but it is the only way economics knows to recommend policy changes that account for the votes consumers have cast in markets. It honors their choices.
Happiness surveys, public health information, and the like are based on consumer input, but they are not based on purchase decisions—they are not based on circumstances in which consumers are forced to put their money where their mouths are.
Of course, the question whether consumers should take direction from experts regarding what to buy, or make those choices themselves, has already been resolved in favor of consumer choice.
Neither GLB nor anyone else will be able to impose purchases on consumers unless consumers vote to elect political leaders who take the GLB approach.
If antitrust enforcers decide to follow GLB’s paper, but consumers don’t like it, consumers can always vote political leaders into office who will sack those enforcers or give them new legislative commands to follow.
The premise of the economic project of enabling consumers to vote through their purchase decisions is, however, that the electoral process is defective.
The assumption is that, at least with respect to industrial production, consumers are better able to choose by voting through purchase decisions than by voting for elected representatives to direct production.
That is the subject of public choice theory. It is the view that, at least with respect to some matters, markets are more democratic than democracy.
People who hold this view won’t be swayed by GLB. In their view, markets are most likely to maximize happiness if they are structured to read it in consumers’ purchase decisions, not if they are structured by consumers’ elected representatives to achieve happiness according to any other measure.
Ultimately, the battle in antitrust over the consumer welfare standard, is, like all battles over regulation, a battle over the legitimacy of the electoral process.
And yet progressives have spent remarkably little time contesting the public choice view of the electoral process and government regulation as inherently vulnerable to capture.
I suspect that is in part because many progressives share the public choice intuition.
Indeed, distrust of government seems to be one of the major reasons for which some progressives have focused in recent years on strengthening antitrust instead of pursuing the projects that earlier generations of progressives thought were more likely to be effective, such as price regulation and taxation.
Even an antitrust that imposes an external standard of happiness on markets instead of trying to read a standard from consumer purchase decisions pays a certain amount of respect to those purchase decisions. It is oriented toward preserving markets and empowering consumer choice within them.
In contrast, taxation and price regulation are relatively indifferent to those goals. They represent a pure privileging of choice via the electoral process over choice via markets.
And to many people from both left and right operating in an essentially anti-statist culture, that’s scary.
The irony, then, may be that the worldview required to overturn the consumer welfare standard in antitrust is undermined by progressives’ own attraction to antitrust as a vehicle for progressive change.