Categories
Antitrust

Power in Profiles

One strategy that the press has deployed in its war on Amazon, Google, and Facebook is the profile. Because profiles legitimate, and what the press’s war on these companies lacks is legitimate intellectual support. Readers assume that if The New York Times or The Wall Street Journal chooses to write about you, then you must know something, and that causes bureaucrats, legislators, other journalists, and even some academics, all of whom read the papers, to start treating you like you do.

The Times’s profile two years ago of a recent law school graduate who had written a student note attacking Amazon appears to have had this effect.

The Wall Street Journal’s profile of Dina Srinivasan today seems to be trying to do the same thing.

For one strains to find anything in the profile to distinguish Srinivasan other than the fact that she wrote a law review article titled “The Antitrust Case against Facebook.”

Was the article published in a top law review? No. It was published in a specialty law review, rather than the general interest law reviews that make up the first tier of outlets for legal academic work. The Journal tries, appallingly, to make this placement sound like a coup, by saying that the law review in question published her “unsolicited article.” But in law virtually all articles appearing in academic law reviews are unsolicited.

Is Srinivasan an antitrust expert? No. As the article beguilingly informs us, when she wrote her paper Srinivasan had “neither any institutional affiliation or a law license,” though she did have a law degree from Yale that she had “never put to use” (until now, apparently). Indeed, we learn that until recently she’s been unemployed, having “quit her job as a digital advertising executive two years ago.”

Is this pioneering work? No. Srinivasan’s argument that Facebook charges users a price denominated in data rather than dollars is nothing new. In 2017, when Srinivasan wrote her piece, the concept of the data price was literally everywhere one turned in antitrust circles. Two years earlier, in fact, John Newman, a genuine antitrust scholar, made that argument in the University of Pennsylvania Law Review, a top-tier academic journal. Ariel Ezrachi and Maurice Stucke, antitrust scholars at Oxford and the University of Tennessee, respectively, had just published a book saying the same thing. Germany’s antitrust enforcers had undertaken a major investigation of Facebook based on exactly that premise. And a graduate student, Elias Deutscher, was presenting a paper advancing exactly this argument with a great deal more sophistication. No doubt more examples can be found.

But only Srinivasan wrote the idea up as “The Antitrust Case against Facebook.”

Has Srinivasan’s paper in particular met with an unusual level of academic acclaim? No. We are told that she has presented her paper at the “American Antitrust Institute’s annual conference.” AAI is a politically moderate advocacy organization, not an academic forum, and presenting at one of its meetings, while nice, is hardly a high-prestige affair within antitrust circles, let alone a reason to stop the presses. But if you’re not impressed by that (which you shouldn’t be), news flash: the Journal informs readers that Srinivasan “is presenting her work at an international antitrust conference in Brussels this week.” I wish every time I attended an international conference, which I and dozens, if not hundreds, of antitrust scholars do every year, the Journal would write me up.

The paper does little to hide the fact that Srinivasan is no authority on antitrust because the point of this profile is not to report. But to create. And for that all you really need is publicity.

If you aren’t convinced yet that this profile is about advancing the press’s narrow competitive interest in the demise of Facebook, just read the article through to the end. Srinivasan, we learn, is employed again. She is “currently working with The Wall Street Journal’s parent company, News Corp.” Journal publisher Rupert Murdoch has been at war with Facebook for years.

Categories
Antitrust

Qualcomm in One Diagram

The district court’s opinion in the Federal Trade Commission’s case against Qualcomm is 233 pages long, but it really comes down to a single diagram. Because the case is really just this: that Qualcomm excluded rival chip makers from the market by refusing to license patents either to rivals for bundling with their chips or to chip buyers so that the buyers could assemble the bundle on their own.

The licenses are for “standard-essential patents,” meaning patents necessary for chip buyers, who manufacture cell phones, to make phones that comply with industry standards. Chip buyers must, therefore, acquire the licenses to function. Qualcomm sold licenses in a bundle along with its chips, but refused to sell them any other way, either directly to cell phone makers who might want to combine them with chips purchased from Qualcomm’s chip-selling rivals (the “no license no chips” policy), or to rival chip makers who might want to bundle them with their own chips and sell them on to cell phone makers. That made the chips supplied by rival makers undesirable to cell phone makers, because the rival chips did not come with patent licenses and the cell phone makers could not obtain those licenses independently.

The diagram describes a supply chain, with patent licenses, which amount to an essential input into the production a usable chip product for cell phone makers, at the top of the chain. Cell phone makers must acquire both this input and chips themselves to function. The second, middle, level in the supply chain is the physical chip itself. Qualcomm competes in this market, and uses its control over the essential patent input to exert power over rivals in this market. Cell phone makers are just as happy buying licenses and chips separately and assembling them on their own, or buying licenses bundled with chips. Qualcomm excludes rival chip makers by making it impossible for either rival chip makers or cell phone makers to acquire the license and bundle it with rivals’ chips.

The diagram reflects this by putting Xs through supply arrows leading from patent licenses directly to cell phone (“equipment”) makers and from chip patents to rival chip makers. Because Qualcomm nixed these supply routes for patent licenses, the only way for cell phone makers to obtain licenses was through purchases of Qualcomm chips. Because cell phone makers couldn’t get the licenses independently or through rival chip makers, they had no reason to buy chips from rival chip makers, wiping out those rivals of Qualcomm in the chip market.

Analogy to Pencils and Erasers

It’s as if a pencil manufacturer that also happened to be the world’s exclusive producer of erasers were to refuse to supply erasers to competing pencil makers and also refuse to sell them directly to consumers. The only way to obtain an eraser for use with a pencil would be to purchase an eraser-tipped pencil from the pencil manufacturer. Competing pencil makers would be unable to compete, because most pencil users want to be able to erase.

Actually, the case against Qualcomm is a lot clearer than would be the case against this hypothetical pencil conduct. What ultimately drives antitrust liability in single firm conduct cases is whether the input supplier’s decisions about how to route supply results in an end product that is ultimately better for buyers than alternatives. The inputs here are the patent licenses, and the question is therefore whether Qualcomm’s insistence on only supplying licenses alongside its own chips made those chips better.

The answer has got to be no: a patent license is just a piece of paper– really, just an idea–the guarantee that the licensor won’t sue for infringement. Combining this bit of ephemera with the chips creates no value greater than the sum of its parts. It doesn’t make the chips run faster, or sip less power, or process more data. It adds nothing at all to the product sold by Qualcomm. Cell phone makers can do just as good a job combining the license with Qualcomm’s chips as can Qualcomm, and rival chip makers can do just as good a job combining the license with their chips as can Qualcomm.

By contrast, the pencil maker might be better at affixing erasers to pencils than any other firm in the business, or indeed than pencil consumers, in which case the pencil maker’s insistence on reserving its entire eraser supply to itself might actually make consumers better off. The pencil maker can defend its decision not to treat erasers as a standalone component and supply it to others as necessary for it to improve its end product. Qualcomm just can’t make that kind of argument.

So Qualcomm should lose on the economic merits. Buyers suffer the harmful consequences, in the form of higher chip prices, that come from Qualcomm’s freezing-out of rival chip makers. But buyers enjoy none of the advantages in the form of improvements in the quality of the product offered by Qualcomm, because no such improvements follow from Qualcomm’s bundling of licenses with chips.

At least, the economic case is clear before you take into account that licenses are not normal production inputs, but rather government-granted rights of exclusivity the purpose of which is to aid the grantee in excluding competitors from markets. Patents fail by design to add anything to the products with which firms combine them. Their whole purpose is to exclude, nothing more. Treating a firm’s decision to license only its own products as monopolization in violation of the antitrust laws simply because the license does nothing to enhance the value of the product would make all exercises of patent rights illegal monopolization.

The Importance of the Standards Context

If a refusal to license patents were all there was to this case, the FTC would surely not have brought it. What makes this case special is that Qualcomm’s patents are essential inputs into chip production only because standard-setting bodies chose to incorporate Qualcomm’s patented technologies into industry standards. This matters, because we respect the monopoly power created by a patent only because we assume that it derives from the fact that the patented technology represents an innovation that competitors have failed to match. We assume that what makes a patent necessary for competitors to be in the market is that the patent covers some invention that makes the product better. The patent, and the monopoly power that flows from it, then serves to reward innovative activity, creating incentives for all firms to innovate and improve their products.

But when a patent is a necessary input because a standards body has incorporated it into an industry standard, we cannot be sure that the patent’s essentiality ultimately derives from the fact that the patented invention is better than alternatives. Standard setting bodies often have a menu of technologies that they may incorporate into a standard, each of which is equally innovative and equally suited to accomplishing a given task. That is to say, standard-setting bodies often choose from a menu of competing technologies, none of which is essential precisely because other technologies on the menu accomplish the same task. The standards body must choose only one technology, however, because that’s the point of establishing a technical standard, and it is that step of adopting the technology for the standard, and not the technology’s superiority or uniqueness, that makes the standard essential. All the firms in the industry must adhere to the standard, and the decision of the standards body therefore eliminates all competing, equally innovative technologies, from the field.

The source of the technology’s essentiality, of its ability to confer monopoly power, is therefore the decision of the standard setting body to use the technology, not the fact that the technology is superior to other existing technologies. That eliminates the basic rationale for which the antitrust laws usually allow patent holders to refuse licenses to competitors. The monopoly power that results cannot, in the case of standards-essential patents, be assumed to reward superior performance. It follows that in this unique context, it is proper to proceed to the next step of asking whether a patentee’s decision to lock up access to its patents does anything to improve the products it sells, and to conclude from the fact that it cannot that consumers are harmed.

The Prior Dealings Wrinkle

While the case against Qualcomm is therefore clear as an economic matter, it is less clear as a legal matter. The trouble is that Chicago School influence over the antitrust laws has restricted the ability of the courts to decide antitrust cases on the economic merits. The Supreme Court’s Aspen Skiing and Trinko cases suggest that a firm’s decision to lock others out of its supply chain (as Qualcomm has done in effectively supplying patent licenses only to itself in its production of bundles of chips and licenses for sale to cell phone makers) can violate the law only when the decision represents a termination of a prior profitable course of dealing.

That is, unless the firm has a history of voluntarily supplying the input (here patent licenses) to competitors, the firm’s decision not to supply the input cannot violate the antitrust laws.

Thus when a termination of a prior profitable course of dealing does exist, the courts are free to get to the economic merits and decide whether the termination made the product better. But when a termination does not exist, the courts must kill the case, even if the termination does nothing for the product, and therefore must harm consumers. So much is true, at least, if the Supreme Court really meant this to be a hard and fast rule of law. Courts see the existence of a termination as a signal that the firm’s refusal to deal might be motivated by anticompetitive intent, and that is in turn some evidence that the move does not improve the product. Rather than parse through all cases looking for product improvements or the lack thereof, courts prefer to devote their attention only to those in which the existence of a termination suggests that a lack of product improvement is likely. The courts assume that the rest of the cases involve benign, product-improving, conduct.

The FTC has tried to get around this problem by arguing that Qualcomm’s contractual commitment to license its patents to rival chip makers, which Qualcomm made as part of its participation in the organizations that set cell phone standards, amounted to a prior course of dealing. The FTC advances this argument even though at the time that Qualcomm made this commitment, Qualcomm never actually licensed its patents to competing chip makers. Indeed, Qualcomm never did license these patents to competitors, the company only ever promised to do so. If that promise counts as prior dealing, then Qualcomm’s subsequent refusal to carry out its promise and license its patents would constitute a termination of a prior dealing. And, argues the FTC, that prior dealing was notionally profitable because Qualcomm’s commitment included a promise only to license at fair, reasonable and nondiscriminatory (FRAND) terms, which means profitable terms.

The FTC’s argument is obviously an abuse of the concept of a termination of a prior profitable course of dealing. Because a promise to deal profitably in the future is not in fact a prior profitable course of dealing. They are different things. But that does not mean that the FTC should lose, only that the rule toward which the Supreme Court gestured in Aspen Skiing and Trinko is not a great rule, and should not be treated as hard and fast by the courts.

Where, as in the Qualcomm case, the essentiality of a patent to competitors results from the actions of a standards body and not from the innovative superiority of the patented invention, and the firm’s refusal to license did not improve the product as an economic matter, and therefore must have harmed consumers, the courts must hold the defendant liable for monopolization in violation of the Sherman Act.

The courts can continue to treat a termination of a prior profitable course of dealing as suggestive of the potential for consumer harm in a refusal to deal. But when the courts encounter a case in which the essentiality of a patent arises by administrative fiat, rather than market forces, they shouldn’t kill the case on account of the absence of a termination of a prior profitable course of dealing.

Which is why the district court got this case right, and the Ninth Circuit should affirm.

(The FTC has also tried to get around the termination of a prior profitable course of dealing requirement by arguing that Qualcomm’s refusal to license directly to cell phone makers is a separate antitrust violation, distinct from Qualcomm’s refusal to license to rival chip makers. While there is some basis in law for treating this conduct (which amounts to tying) as an independent basis for liability for monopolization, I see it as just an indirect way of refusing to sell to rival chip makers, one to which the termination of a prior profitable course of dealing requirement could apply. Licensing directly to cell phone makers is equivalent to having Qualcomm license to chip makers and then having the chip makers ask cell phone makers to pay a portion of the purchase price of their chips directly to Qualcomm. A willingness on the part of Qualcomm to license either directly to cell phone makers or to rival chip makers would amount to a willingness to supply an input essential to rival chip makers’ success, and Qualcomm’s refusal to license through both channels therefore amounts to a refusal to supply an essential input to competitors. This behavior should count, either way, as a refusal to deal with competitors, and be considered under the legal rules governing such refusals.)

Categories
Antitrust

Is Go the Ultimate Antitrust Boardgame?

Scsc, Gofin, (Ramsi Woodcock added arrows and text to the image.) CC BY-SA 3.0

In the ancient game of Go, players compete by placing stones on a grid board with the goal of enclosing the greatest amount of territory with their stones. Think of the board as a two-dimension product space. For breakfast cereals, for example, one axis might be sweetness and the other crunchiness. The goal of a firm is to field a product that has few close substitutes, that faces competition from products that are quite unlike it, and therefore unlikely to lure away consumers of the firm’s product, allowing the firm to raise prices without worrying about triggering a reduction in demand. The goal of a firm, therefore, is to reserve the largest possible extent of product space to itself. But that’s just what a Go player seeks to do: to exclude his opponent from the largest possible expanse of the Go board.

We can think of the stones that a Go player places on the board as differentiated products. A stone’s location on the board corresponds to a particular combination of the two product attributes represented by the Go board as two-dimensional product space. In the cereal example, a stone placed at the center of the board would represent a breakfast cereal that is half sweet and half crunchy. A stone in one corner might represent a cereal that is very sweet and not crunchy at all.

At the start of a game of Go, players place their stones in separate areas, trying to stake out control of whole quadrants of the board, just as firms strive to introduce products that have no close substitutes, ensuring that consumers will be forced to buy the firm’s product at high prices (an animated picture of how a game of Go develops may be found here). We can think of each node in the Go board grid as representing a consumer with a preference for a product with attributes that correspond to that node. If no product has precisely those attributes, the consumer will purchase the product with the closest set of attributes, meaning the product represented by the Go stone on the nearest node to the consumer’s. Placing a stone in an empty quadrant of the board means that the player will get the business of all of the consumers in that quadrant. (Those familiar with the Hotelling location model of differentiated product competition will recognize that this account of Go is just the Hotelling model expanded from one dimension to two. We’re not talking about pizza places along the line that is the Coney Island boardwalk, but pizza places on the grid that is midtown Manhattan.)

Now, firms pioneering a new technology may decide to stop innovating, stop introducing new product flavors, and just coexist in oligopolistic harmony. One of the extraordinary things about Go is that, like firms, the players can stop the game at any time. Whenever both players agree to stop, they count up the territory enclosed by each and the player with the largest territory wins. Just so, when firms collude, the firm with the most desirable product–the product that controls the greatest share of consumer demand–will profit most from the oligopoly.

When to keep fighting and contesting competitors’ markets, and when instead to try to respect competitors’ markets and seek accommodation, is an important question in business strategy. Just as it is in Go. At the start of the game, both players usually believe they can achieve advantage through continued play, and so the game goes on. Competition at the inception of an innovative technology, when a new product space opens up, is often fierce. Think of the competition in streaming video today.

Firms take the battle to each other by striving to make very close substitutes of their competitors’ offerings, cutting into demand for competitors’ products and increasing demand for their own. So it is in Go, too. The players invade each others’ quadrants by placing stones right next to their opponents’, just like firms trying to siphon off rivals’ demand. At the extreme, a firm may create a set of products that so well captures all of the attributes that consumers value in a competitor’s product that demand for the competitor’s product eventually withers and the product is driven from the market. In Go, that happens when one player has placed stones that fully encircle a stone belonging to his opponent. When that happens, the opponent’s stone is removed from the board and the player gains a point. We can think of that point as representing profits enjoyed from having permanently locked up the demand of the consumer represented by the strangled node.

Firms sometimes succeed by driving competing products from the market. But they also often succeed by building up a wall of differentiated products that competitors cannot penetrate. Indeed, the FTC famously alleged in the 1970s that Kellogg did precisely that with breakfast cereals by proliferating the number of cereal flavors that the firm offered. In Go, this is reflected in prolonged struggles between the players to wall off territory (text in Wikipedia accompanying the featured image of this post provides a nice overview of how players control space through these struggles).

Differentiated product competition is the only kind of competition that we have in the real world. If Go is a game of differentiated product competition, does it tell us anything about how to regulate real world competition through antitrust?

Play it and find out.

Categories
Antitrust

The Antitrust Laws Give Chicago Cabbies a Remedy

The New York Times is reporting that New York taxi companies bought hundreds of Chicago taxi medallions–enough to jack up medallion prices–and then turned around and sold them to cabbies, earning monopoly profits. Many cabbies borrowed to buy the medallions and have gone bankrupt.

If the New York companies’ purchase of large numbers of medallions really did give them the power to raise prices, then those companies achieved monopoly power for purposes of the antitrust laws, which define it as the power profitably to raise prices.

It’s not illegal to charge monopoly prices. But it is a violation of Section 7 of the Clayton Act to assemble a monopoly through asset acquisitions, such as the purchase of taxi medallions.

The U.S. Department of Justice and the U.S. Federal Trade Commission have the power to challenge anticompetitive acquisitions after the fact. And they can seek disgorgement of profits, which here would mean an order requiring the New York companies to compensate cabbies for the inflated prices that they paid. The article suggests that in some cases those prices may have been eight times the competitive prices, or $350,000 in monopoly excess per medallion.

The Times suggests that much of the alleged conduct took place six or more years ago. But for civil antitrust actions brought by the government, there is no statute of limitations.

It may also be possible to challenge this conduct as fraud, or market manipulation. But this is a case of the raw acquisition of monopoly power, without any semblance of an efficiency justification, placing it squarely within the core of the antitrust laws. It would be nice to see those laws earn their keep here.

And to see antitrust enforcers return to policing local and regional monopoly power.

Categories
Antitrust

Google’s DNS-Over-TLS Is Good Because Competition in Advertising Is Bad

AT&T and Comcast are complaining to House antitrust investigators that Google’s plan to encrypt DNS, the internet’s addressing system, will prevent them from snooping on web traffic that will remain transparent to Google, giving Google a competitive advantage in targeting advertising to consumers.

They may be right that DNS-Over-TLS will give Google a competitive advantage, but that’s good for consumers, not bad. Because advertising undermines consumer sovereignty, and more competition in the targeting of advertisements means more targeted advertising.

That is the irony of antitrust scrutiny of Google’s power in the advertising market more generally. Advocates of greater antitrust enforcement seem to think that smashing Google’s advertising monopoly will somehow increase privacy and benefit the public. They’re wrong.

It is a staple of antitrust economics that more competition means more output, and in the market to use consumer data to target advertisements, that means more targeted advertising. Google, Comcast, and AT&T will race to hoover up every last bit of consumer information, subject it to the most sophisticated data analysis methods known to science, and use the insights generated thereby to induce consumers to buy their clients’ brands. (Of course, Google, Comcast, and AT&T may compete with each other to offer privacy protections to users, but that can go only so far, because they also compete with each other for advertising dollars based on the amount of data on consumers they can leverage to target ads.)

Competition is great in markets that produce products that benefit consumers. But it is terrible in markets that produce products that harm consumers, because it makes those markets more productive. That’s why the tobacco oligopoly was a good thing. And that’s why the 21st Amendment, which repealed Prohibition, gave the states the power to promote monopolization of the distribution of alcohol.

And targeted advertising really is bad for consumers. As I pointed out not long ago (summary here), the information age has eliminated the sole economic justification for advertising–that it provides consumers with useful product information that they cannot find anywhere else–leaving advertising with a single functional use for firms: to manipulate consumers into buying products that they do not really prefer (otherwise the advertising wouldn’t be needed to induce them to buy the products). Targeted advertising magnifies this manipulative power.

As recently as the late 1970s, antitrust enforcers in the United States understood that advertising’s manipulative function harms competition, by putting firms that produce products that consumers do in fact prefer at a competitive disadvantage. In that period, the FTC brought, and sometimes won, a series of cases against large advertisers, arguing that their attempts to promote their products were anticompetitive.

The FTC did not bring those cases against firms that distribute advertising, which at that time were mostly newspaper and television companies. The FTC brought those cases against the firms that paid those newspaper and television companies to distribute their advertising. Because the FTC understood that the competitive threat posed by advertising is not that the platforms that distribute ads tend toward monopoly, but that the advertising those platforms distribute itself undermines competition in the markets in which advertised products are sold.

In other words, in the 1970s, antitrust enforcers understood which level of the advertising distribution chain to target in order to benefit consumers. Today, the House seems fixated on the wrong level, on the platforms that distribute advertising rather than the markets in which advertising is deployed to harm competition.

That fixation may be due to the influence exerted by the newspaper industry on the House investigation. The market to distribute advertising tends toward monopoly because size is an advantage: the more eyeballs you can reach, the more valuable is your platform to advertisers. For most of the 20th century, newspapers ran the advertising distribution monopolies. But Google beat them–and took over as advertising monopolist–by offering a better product to advertisers. The newspapers look to have turned to antitrust enforcers to try to get back into the game.

That should make consumers, and anyone worried about privacy, very concerned. Because it means that the new antitrust movement isn’t about consumer welfare, or privacy, but about ensuring that newspapers and telecoms get their fair share of consumer data and consumer exploitation.

And that brings me back to DNS-Over-TLS. Today, the non-encryption of DNS lets any firm on the internet, including Google, AT&T, and Comcast, snoop on your internet usage. DNS-Over-TLS would limit the snoopers to Google. That’s a net gain for consumers, and anyone concerned about privacy, which is why it is supported by the non-profit Mozilla Foundation, which makes the Firefox web browser, as well as the Electronic Frontier Foundation. To the extent that DNS-Over-TLS helps Google protect its advertising distribution monopoly against new entrants like AT&T, the technology harms competitors, and will allow Google to continue to extract high fees from firms that buy advertising. But higher fees mean fewer ads, which is good for consumers.

If we see the House move against this technology, we’ll know for sure whose side it is on.

Categories
Antitrust Monopolization Regulation

Cost Discrimination

One hears constantly about the power of technology to enable the consumer-harmful practice of price discrimination, which is the charging, to each consumer of a given product, of a price equal to the maximum that the consumer is willing to pay for that product. But one hears very little about the power of technology to enable the consumer-beneficial practice of cost discrimination, which is the foisting upon each firm of a price equal to the minimum that firm is willing to accept in exchange for selling a given product.

That’s not because the technology isn’t there. In fact, because big business invested in supply chain automation long before the tech giants made possible the snooping needed to identify consumer willingness to pay, the technology needed for cost discrimination is more developed than the technology needed for price discrimination. The reason we don’t hear about cost discrimination is that the technology needed to implement it is in the hands of firms, rather than the consumers who would benefit from cost discrimination.

This state of affairs isn’t surprising, since firms are few relative to consumers, and therefore more likely to have the pooled resources and capacity for unified action needed to invest in and implement a discrimination scheme. Yes, consumers have review websites, and price aggregators, but that’s a far cry from the centralized acquisition and analysis of data, and the ability to bargain as a unit based upon it, that firms enjoy.

One way for consumers to implement cost discrimination would be by organizing themselves into data-savvy cooperatives for purposes of negotiating prices with firms. Another would be for startups to step in as middlemen, taking a cut from consumers in exchange for engaging in data-based bargaining on their behalf.

But another solution is for the government to create an administrative agency with the power to regulate consumer prices. It turns out that there is ample precedent for government price regulators to dictate cost-discriminatory prices.

Here, for example, is an account of the Federal Power Commission doing just that for wellhead natural gas rates in 1965:

Pricing designed to encourage supply could also create “economic rents” (profits above a normal return) for gas producers with old, inexpensive reserves. Neither the producers’ brief for fair field prices nor the staff’s preference for rates based on average historical costs seemed acceptable or sufficient. It was the young economist Alfred Kahn, serving as an expert witness, who suggested a two-tied pricing structure: separate prices for old gas and new gas. Here, from the commission’s perspective, was an ideal political, and perhaps economic, solution. “The two-price system,” wrote the commission, “thus holds out a reward to encourage producers to engage in further exploration and development while preventing excess and unnecessary revenues from the sale of gar developed at a period when there was no special exploratory activity directed to gas discovery.”

Richard H.K. Vietor, Contrived Competition: Regulation and Deregulation in America 113-14 (1994).

The old gas here corresponds to inframarginal units of production and the new gas corresponds to marginal units of production. Economists were once acutely aware of the problem that even under perfect competition the inframarginal units can enjoy a windfall at the competitive price, so long as the cost to their owners of producing those units happens to be below the cost of the marginal units, which determine the competitive price.

David Ricardo famously explained all of English aristocratic wealth in these terms. The aristocrats take the best land by force, he observed, and cultivation of that land is relatively inexpensive, because it is the best land. The rest take land that is more expensive to cultivate. Because the competitive price for agricultural goods must be high enough to pay the higher cost of cultivating the poorer-quality, hence marginal, land, the price must then be above the cost to the aristocracy of cultivating the best land, leaving the aristocracy with great profits.

Just so, the FPC worried that the producers of the old gas, who had come upon the gas only as an accident as part of explorations for oil, and therefore had incurred a gas exploration cost of zero, would enjoy a windfall if prices were set to cover the costs of bringing new gas from the ground through dedicated and costly explorations. So the FPC approved prices that discriminated against the old gas producers based on their lower exploration costs.

Consumers don’t know enough about the costs incurred by the firms that sell to them to insist on low prices when buying from firms with low costs. Which is why I suspect that government price regulation will be the only way for consumers eventually to enjoy some of the pricing-based fruits of the information age.

Categories
Antitrust

John Bates Clark’s Peculiar Case for the Distributive Justice of the Perfectly Competitive Market

The argument for the efficiency of the perfectly competitive market is familiar: large numbers of firms selling an undifferentiated product will compete price to marginal cost, ensuring that everyone who can afford to pay the cost of production gets access to the product.

But is the distribution of wealth between buyers and sellers that is created by marginal cost pricing fair?

Today, economists agree that the distribution of wealth created by marginal cost pricing is entirely arbitrary. For the distribution of wealth is determined by inframarginal units of production, not marginal units. The benefit to me of the tenth unit of production of a particular good might be $10, and that might be just equal to the marginal cost of producing the tenth unit, making the market price under perfect competition in turn $10. But the gain I get from buying all ten units is determined by the value to me of each of the first nine units I purchase, not the marginal tenth, and the value I get from the first nine may be very much higher than $10. If I get $20 of enjoyment from each of the first nine units, then my gain from my purchase of ten units, net of the price of $10 that I pay for each unit, is $90. If the marginal cost of production is a constant $10 over all units, the gain to the producer is $0. That’s hardly fair to the producer. All of the gains from trade, defined as the difference between the value conferred on consumers by production and the costs of that production, go to me. Even though price is set equal to marginal cost.

It is for this reason that a century ago economists rejected the promotion of competition as a means of guaranteeing a fair distribution of wealth. They embraced competition because it is efficient–I am able to purchase every unit for which I am willing to pay the cost of production, so the economy produces all of the gains from trade of which it is capable–but they recognized that some other means was needed to achieve a fair distribution of wealth. That other means was the tax system. Raise my taxes by $45 and reduce the producer’s by $45 and now the gains from trade are distributed equally between us.

Given our current understanding of the distributive importance of inframarginal units of production, it is startling to discover that a century ago John Bates Clark, a giant of conservative economics, made a vigorous case not just for the efficiency but also for the distributive justice of perfectly competitive markets. His distributive case was rejected almost as soon as it was made, and has since sunk into obscurity. But that leaves me wondering: How could Clark have been unaware of the fact that the distribution of wealth is determined by inframarginal units, not marginal units? Did he just not understand marginalist economics? The few contemporary scholarly discussions of Clark’s work that I have encountered fail to explain.

The answer, it turns out, is that Clark understood marginalism, and the argument that inframarginal units determine the distribution of wealth. But he thought he had a convincing rejoinder. Here he is in his magnum opus, The Distribution of Wealth:

The man that we are studying is a society in himself: he makes things and he alone uses them. [The value to him of the last unit that he produces] measures the effective utility of everything that he makes. Though [the value to him of the first unit that he produces] may measure the absolute benefit conferred by the loaf that satisfies hunger, the real importance of having that loaf is far less. If this necessary article were taken away, the man would devote a final hour to bread-making, and would go without the article otherwise secured by that final increment of work. Destroy his day’s supply of food, and what he goes without will be luxuries naturally secured by the terminal period of labor. [The value to him of the last unit that he produces] measures the utility of those luxuires, and it measures therefore the effective service rendered by the supply of necessaries that are produced in an equal period of work. Any [inframarginal unit] will have a true importance measured by [the value to him of the last unit that he produces]; since, if it were lost, there would be diverted to the replacing of it some work that would otherwise secure an article having an importance measured by [the value to him of the last unit that he produces]. As it is of no more real consequence to the man to keep one of these articles than it is to keep any other, [the value to him of the last unit that he produces] measures the subjective value of each of them. . . . Bread and the other necessaries of life are absolutely more important than jewelry and other luxuries; but in effective utility the complements are all on a par, since, if any one of them were destroyed, the result would be to make the community go without the last.

John Bates Clark, The Distribution of Wealth: A Theory of Wages, Interest, and Profits 385, 388 (1914).

Clark’s argument is that if any one of the inframarginal units (Clark calls this bread, or another necessity, to illustrate that it is valued more highly than the marginal unit) is destroyed, the only actual unit that disappears from production is the marginal unit (Clark calls the marginal unit a luxury good to illustrate the fact that the consumer values it less than inframarginal units), because one unit is subtracted from output. Because consumers lose the value of the marginal unit when the inframarginal unit is destroyed, it follows, according to Clark, that the true value of the inframarginal unit is actually the value to the consumers of the marginal unit.

That allows Clark to treat all inframarginal units as having no value to the consumer that is separate from the value of the marginal unit, which is to say that it allows him to ignore entirely the value of inframarginal units and to treat the value to the consumer of the marginal unit as the entire value of production. It then follows that because the competitive price equals both the value of the marginal unit to the consumer and the marginal cost of producing that additional unit, there is in fact no surplus generated by any transaction, and the consumer pays a price exactly equal to the value the consumer receives from production and the producer is paid a price exactly equal to the producer’s cost of production. Thus the problem of distributive justice is not so much resolved in a fair way by competitive markets as it is eliminated entirely, because under competition there are, according to Clark, no gains from trade at all, just a buyer and a seller who both subsist on a knife’s edge, buying and selling at a competitive price that leaves both just as well off as each would be had neither entered the market at all.

But is Clark right to argue that inframarginal units have no real value to consumers, because their disappearance would, individually, deprive the consumer only of the marginal unit?

Of course not. The enjoyment you get from eating your first scoop of ice cream is real, whether you eat a second scoop or not. And the enjoyment you get from eating your first scoop of ice cream really is greater than the enjoyment you get from eating your second scoop of ice cream, notwithstanding the fact that if your first scoop is somehow clawed back, you won’t be able to eat that second scoop and get the lesser enjoyment from it. Indeed, once that first scoop is clawed back, your second scoop becomes your first scoop, and your enjoyment of it goes up. That’s why monopolies restrict output. They know consumers place a higher value on the first few units they consume, allowing monopolies to charge them higher prices.

Clark’s argument implies that the more you eat, the less valuable your meal is to you, because the less valuable is your last bite. That’s highly counterintuitive. Few would prefer a cracker for dinner to a four course meal, even if the last bite of that four course meal is worth less to them than would the first bite of that cracker. So why did Clark come up with such a view?

It seems to me that the strangeness of Clark’s theory is a measure of the level of disappointment felt by those who believed in the justice of competitive markets at the implication of the marginalism that the distribution of wealth in competitive markets is arbitrary. True, marginalism validated the Adam Smithian faith in the efficiency of competitive markets. But what had always been at stake in economic debates was the morality of the market, and this marginalism could not prove.

Clark’s failure to prove the distributive justice of the competitive market is a warning to those today who would promote greater antitrust enforcement and competition more generally as a solution to economic inequality. Indeed, the progressives of Clark’s own day, who were profoundly concerned about economic inequality, tended to reject antitrust and competition as solutions.

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Antitrust Monopolization Regulation

It’s about Price, not Competition

One thing we are going to encounter a lot as the anti-big-tech crusade gets under way is the confusion of pricing problems with competition problems. Consider the attack on Apple’s promotion of its own apps on its App Store. This looks like a competition problem: Apple is using its proprietary App Store infrastructure unfairly to promote its own products over those of rivals. Get a court applying the antitrust laws to order Apple to stop doing that, and, it appears, the problem is solved.

Only it’s not solved, because the heart of the problem is not Apple’s creation of an unlevel playing field in app competition. The heart of the problem is that Apple owns the App Store itself.

And for that problem, there is no competitive solution. As Chicago School scholars pointed out long ago, if a company has a monopoly on upstream infrastructure, the company can use that monopoly to extract all of the profits from downstream businesses that rely on the infrastructure, by charging high fees for access.

So long as Apple retains the power to set the fees that it charges software developers for selling apps through the app store, Apple will be able to suck all the value out of those downstream businesses. Forcing Apple to let those businesses compete with Apple’s own apps on a level playing field will not solve the problem because app developers will still need to pay Apple a fee for access that Apple has discretion to set.

Indeed, it is a mistake to think that Apple’s promotion of its own apps on the app store reflects anticompetitive intent. Because Apple could extract all of the profits from competing developers through fees, even without selling any apps of its own, Apple’s reasons for selling its own apps in the App store, and indeed for promoting them over rival apps, can only have other purposes. Most likely, for a firm that has repeatedly demonstrated the desirability to consumers of tight integration of product components, Apple sells its own apps, and promotes them preferentially, because Apple believes that its own apps are actually better, and that when consumers search for new apps, consumers want to know if Apple has a relevant offering. (I know I do.)

What should trouble us about the App Store is not that Apple manages competition on that platform–the company has every reason to do that with a view to making consumers happy–but rather that Apple’s control of the platform allows the company to extract all of the gains created by the platform for itself through fees, leaving relatively little for other app developers, or for consumers themselves.

The only way to solve that problem using competition would be to lessen Apple’s control over the App Store itself. But doing that would destroy the closed app ecosystem that has differentiated the iPhone positively in the minds of consumers from the mayhem and unreliability of Android phones. Letting iPhone owners install apps from anywhere is a recipe for trouble.

In the App Store, as in most tech platforms, we have an efficient market structure. But a monopolistic one. That means that complaints about fairness ultimately must amount to complaints about price, not competition. The solution can therefore only be price regulation, not antitrust.

Categories
Antitrust

Antitrust Blowback

The New York Times spent the spring and summer brazenly promoting antitrust enforcement against its own enemies, Google, Facebook, and Amazon, even though those companies are hardly in the first rank of firms in need of the antitrust hammer. (Telecoms, anyone?) All three are implicated in a decline in writer earnings, thanks to the competition the three have brought to the newspaper and publishing industries, and the Times seemed to want to put a stop to that.

But now the Times is shocked to find that the Trump Administration is engaging in a “cruel parody of antitrust enforcement” in its investigation into the car companies that have worked with California to improve emissions standards. The Administration’s apparent view that the car companies are guilty of collusion is, according to the Times, “[a] nakedly political abuse of authority.” That’s rich given the Times’s own apparent efforts to exploit the antitrust laws for private gain.

Where, incidentally, was the Times’s charge of foul motives when the Trump Administration opened antitrust investigations into Google, Facebook, and Amazon this summer? Absent, of course. The Times celebrated the opening of those investigations knowing full well that President Trump harbors animus toward each of those three liberal corporate bastions, and indeed knowing that the only antitrust case in which the Trump Administration had shown any interest so far was the politically-motivated attack on a merger involving Trump enemy CNN.

Categories
Antitrust Monopolization World

The Lord Grand Secretary on Regulated Monopoly

The present plan for unifying the salt and iron monopoly is not alone that profit may accrue to the state, but that in the future the fundamental of agriculture may be established and the non-essential repressed, cliques dispersed, extravagance prohibited, and plurality of offices stopped. In ancient times the famous mountains and great marshes were not given as fiefs to be the monopolized profit of inferiors, because the profit of the mountains and the sea and the produce of the broad marshes are the stored up wealth of the Empire and by rights ought to belong to the privy coffers of the Crown; but Your Majesty has unselfishly assigned them to the State Treasurer to assist and succor the people. Ne’er-do-wells and upstarts desiring to appropriate the produce of the mountains and the seas as their own rich inheritance, exploit the common people. Therefore many are those who advise to put a stop to these practices.

Iron implements and soldiers’ weapons are important in the service of the Empire and should not be made the gainful business of everybody. Formerly the great families, aggressive and powerful, obtained control of the profit of the mountains and sea, mined iron at Shih-ku and smelted it, and manufactured salt. One family would collect a host of over a thousand men, mostly exiles who had gone far from their native hamlets, abandoning the tombs of their ancestors. Attaching themselves to a great house and collecting in the midst of mountain fastnesses and barren marshes, they made wickedness and counterfeiting their business, seeking to build up the power of their clique. Their readiness to do evil was also great. Now since the road of recommending capable men has been opened wide, by careful selection of the supervising officers, restoring peace to the people does not wait on the abolition of the salt and iron monopoly.

Esson M. Gale, Discourses on Salt and Iron : A Debate on State Control of Commerce and Industry in Ancient China, Chapters I-XIX: Translated from the Chinese of Huan K’uan with Introduction and Notes 34-35 (1931).