Still in those early days trade depended not upon the quality of the goods but upon the military force to control the markets. The Dutch consequently valued the island chiefly on account of its strategical position. From Formosa the Spanish commerce between Manila and China, and the Portuguese commerce between Macau and Japan could by constant attacks be made so precarious that much of it would be thrown into the hands of the Dutch, while the latter’s dealings with China and Japan would be subject to no interruptions.
Here Davidson nicely contrasts monopolies based on product quality with monopolies based on force, capitalism with mercantilism. I do not think it is too much to say that democracy, or at least a genuine republicanism, even if autocratic in administration, is the principal bulwark between the two, and that antitrust, when used properly, is meant to round off any remaining mercantilist edges.
When used improperly, antitrust is of course a gunboat all of its own.
As if to remind those who might still be confused about what the antitrust movement against the tech giants is really about, newspapers are now making common cause with app developers to force Apple to delay new privacy protections that would have allowed app users to opt out of targeted advertising.
That’s right, the same newspapers that have been savaging the tech giants for years as evil privacy foes are fighting to stop Apple from making it harder for app developers to exploit your data.
Why? Because newspapers make money from advertising, of course. They are some of the app developers who want to continue to spy on you.
Does newspapers’ double-dealing on privacy suggest that their position on the tech giants more generally is driven by their bottom line rather than the goodness of their hearts?
You bet.
It is an interesting coincidence that newspapers have been busy trashing the tech giants—running articles accusing them not just of privacy violations but everything from monopolization to the addiction of children—just as the tech giants have out-competed them in their principal business line: the distribution of advertising.
Google and Facebook distribute advertising far more effectively than do newspapers because, as the Times itself recently explained:
consumers interact with [Google parent Alphabet] nearly every time they search for information, watch a video, hail a ride, order delivery in an app or see an ad online. Alphabet then improves its products based on the information it gleans from every user interaction, making its technology even more dominant.
Consumers never will interact with news websites as much as they interact with these platforms, and so the product that newspapers offer to advertisers—ad distribution—will never be as effective as the product that Google and Facebook offer to advertisers. The result has been an exodus of advertising dollars from newspapers—which, along with television, were once almost the only game in ad distribution town—to the tech giants.
What newspapers should have done in response to this tech-driven decline in their ad-based business model was to cut the cord with advertising. For advertising, which is all about manipulating readers into buying products they don’t really want to buy, was always a bad fit for a news industry devoted to providing consumers with the information they need to engage in independent decisionmaking.
Newspapers should therefore have seized the opportunity presented by the decline in their advertising revenues to seek out public funding à la the BBC for what is, after all, a sacred public function.
Instead, the industry has appeared to embark on a campaign to scare the tech giants into paying them a share of their advertising revenues. Consider:
The “tech-lash” splashed across newspaper front pages over the past decade. That looks an awful lot like a message from media to big tech: pay up, or we’ll wreck your reputation. Of course, that could just have been driven by newspapers’ concerns about privacy. But newspapers’ opposition to Apple’s privacy safeguards today gives us the answer: not likely.
The drumbeat of articles about courageous antitrust scholars daring to take on big tech. (Nevermind that few of them actually are antitrust scholars.) That looks an awful lot like a message from media to big tech too: pay up, or we’ll get the law to break you into pieces. Of course, that could have been driven instead by newspapers’ concerns that there’s too much concentration in America. But the News Media Alliance’s multi-year campaign for an antitrust exemption that would allow newspapers to cartelize gives us the same answer: not likely.
The House antitrust investigation into big tech, led by a congressman who has been doing the bidding of the News Media Alliance. That too looks an awful lot like a message.
The fawning story in the Times about Tim Sweeney, CEO of Epic games, maker of Fortnite, who is leading an antitrust “crusade” against Apple in search of lower fees. That does look like a message to Apple. (And while I’m on this subject—funny how the article doesn’t mention the Times’ massive conflict of interest in reporting the story. For the Times is publicly supporting Epic, and demanding lower fees for their apps too. But a reader of that article wouldn’t know it.)
It has been a successful campaign so far. If the pen is mightier than the sword, it is perforce mightier than the microchip. The tech giants have already started to open their pocketbooks. It will be interesting to see how badly they cave.
Of course, there are limits to the amount of sympathy one can feel for Google or Facebook. Those companies may be better at what they do than newspapers, but they are better at doing something antisocial: the spying and manipulation that constitute modern commercial advertising. The newspapers’ fight to get cut in on the spoils is ugly, but one set of rogues deserves another.
But Apple is different. The company makes most of its money selling products that genuinely make life easier. And as the company has not tired of reminding us, the fact that its business is not mainly advertising means that its interests are more closely aligned with those of consumers when it comes to privacy than are the interests of any other player in this fight.
Which is why the newspapers’ attacks on Apple are a new low.
For a time, not competing with newspapers for advertising seemed to buy Apple some safety from the media’s antitrust crusade. But when the antitrust shakedown seems to be working against companies that wiped out your old-economy advertising business, why not extend it to one that wants to put the screws on your new-economy advertising business, and see if you can extract lower app store fees while you are at it?
Today’s antitrust movement against big tech may be many things to many people, but one thing it’s not is a progressive movement, even if some of its proponents delight in wrapping themselves in the progressive banner.
That should have been obvious to anyone watching the movement attract Trump Administration backing in assaulting what are probably the most progressive corporations ever. (It’s not normal for corporate employees to block management from accepting lucrative military contracts, and then not get fired.)
But at least now it is completely clear. For “when they tasted of the apple their shame was manifest.”
No court has ever, in 130 years of antitrust practice in the United States, taken the position that dominance in and of itself, absent bad conduct, is illegal. But if you were a reader of The New York Times, you could be forgiven for thinking that as a matter of American law big is bad:
Alphabet was an obvious antitrust target. Through YouTube, Google search, Google Maps and a suite of online advertising products, consumers interact with the company nearly every time they search for information, watch a video, hail a ride, order delivery in an app or see an ad online. Alphabet then improves its products based on the information it gleans from every user interaction, making its technology even more dominant.
Google is an obvious target for the Times, of course, because Google has eaten its lunch in the competition for advertising dollars. But it’s not an obvious target for anyone who knows something about antitrust, which isn’t in the business of smashing firms that win by being better.
But The New York Journal got its war by whipping Americans into a frenzy against an enemy of its choice. Why shouldn’t The New York Times get its antitrust case against Google?
Unlike in 1898, however, the only Americans who have actually been whipped into a frenzy are the elites: surveys show that Americans still love Google and the other tech giants, at least when they’re not being asked leading questions like: should the government “break up tech companies if they control too much of the economy?” (Actually, the best thing about the surveys is that the tech company Americans like least is the one that elites probably like most: Twitter.)
I suppose that it’s only the elites who matter, however, even those who might pretend not to read the Times. AG Barr is so intent on rushing out a case against Google, presumably because he’s been blinkered into thinking it will clinch a win in November for President Trump, that his line attorneys are in open revolt:
Justice Department officials told lawyers involved in the antitrust inquiry into Alphabet . . . to wrap up their work by the end of September[.] Most of the 40-odd lawyers who had been working on the investigation opposed the deadline. Some said they would not sign the complaint, and several of them left the case this summer.
As PBS tells it: “Remington, who had been sent to Cuba to cover the insurrection, cabled to Hearst that there was no war to cover.” Hearst replied: “You furnish the pictures. I’ll furnish the war.”
Today’s antitrust movement loves to point to the breakup of AT&T as an example of what antitrust enforcers can do when they put their minds to it. The only problem is that the breakup of AT&T was a disaster, and The Wall Street Journal has kindly provided a new example of that today: robocalls.
The breakup of AT&T was a politically-motivated hit, a Nixon-originated project that became the only monopolization case carried through to a conclusion by a Reagan Justice Department that otherwise wanted nothing else to do with antitrust. The target was widely recognized as the standard bearer of progressive managerialism and a leader in progressive labor practices. (Remind you of some other firms that have found themselves in the cross-hairs of an otherwise do-nothing Antitrust Division today?)
The country has little to show for the breakup forty years later. It didn’t eliminate the fundamental bottleneck associated with telephony: the massive last-mile infrastructure required to get calls into consumers’ handsets. That infrastructure is today mostly owned by just three firms, the new AT&T, Verizon, and T-Mobile, because it exhibits great economies of scale.
While the breakup did bring down long-distance rates, that’s a bug, not a feature. The only reason the old AT&T charged high long-distance rates was because the company was engaged in progressive redistribution of wealth, scalping businesses and well-off long-distance powerusers to the end of providing dirt-cheap local phone access and “universal service” to the masses.
Any economist who knows his Ramsey prices will tell you that’s not the most profitable way to set your rates, because long-distance calling is a luxury, but basic phone access is a necessity (911, anyone?). To get the most profit out of the public, you want to charge high prices for the necessity–because people will pay those prices whatever they may be–and low prices for the luxury. The trouble with that from the perspective of distributive justice is that it’s a regressive rate structure: charging the masses high prices and elites low prices.
Which is just what happened after the breakup of Ma Bell.
The court and later Congress forced the Baby Bells that owned the last-mile infrastructure to connect long-distance carriers’ calls, enabling massive entry into the long-distance market and driving down long-distance rates. But consumers don’t just pay for long distance, they also must pay for basic call connection that allows long-distance calls to reach consumers’ handsets.
The price of that went up, for everyone, not just long-distance callers, because the last mile remained a bottleneck, an infrastructure so expensive that few firms can survive in the market. Which is why the Baby Bells, which controlled that infrastructure, never went away.
Liberated from a dominating headquarters weaned on a New Deal politics that demanded the sacrifice of profits in favor of progressive pricing, the Baby Bells now charged whatever they wanted. At last they could enjoy whatever cream they might be able to skim from a public that needs phone service and has nowhere to go. The fact that they dominated regional markets, but not long-distance, gave them the political cover that hulking monopoly Ma Bell never had.
Free to grow fat, they matured into the tri-opoly we have today, one that has distinguished itself in its adherence to the maxim that the greatest reward of monopoly is a quiet life by supplying America with slower mobile internet service than almost any country in the developed world.
But at least we got competition in long distance, right? Now anyone with $10,000 in working capital and a closet to store some routers can be a long-distance provider. Isn’t that a win for local self-reliance?
More like a win for fraud and robocallers, according to the Journal, in a story about the “dozens of little-known carriers that serve as key conduits in America’s telecom system,” connecting robocalls that “in total bilked U.S. consumers out of at least $38 million in 2019.”
The Journal treads lightly here–after all it’s got as much to gain as any newspaper from the current antitrust campaign against the tech giants that have out-competed the paper for advertising revenue in recent years–but it’s hard to disguise the culprit:
These small carriers took hold in the decades following the 1984 breakup of AT&T’s phone system monopoly, which was designed to lower the costs of long-distance calls. They mushroomed during the introduction of internet-based calling services in the 2000s.
The emergence of these small phone companies was in many ways a positive development for consumers who now pay less for long-distance calls. The downside is that the system wasn’t designed to discern between legitimate and illegitimate calls, which are sometimes mixed together as they are passed along. U.S. regulators generally didn’t require these carriers to block calls and in some cases forbade them from doing so as a way of limiting anticompetitive behavior. Some telecommunications experts say that opened the door for smaller carriers to hustle business from robocallers, or simply turn a blind eye to suspect traffic.
Would there have been robocalls if we still had Ma Bell? Unlikely for a company that was so obsessed with control over its network that it famously stamped “BELL SYSTEM PROPERTY – NOT FOR SALE” on every handset in America.
(I do have to admit, however, that another communications monopoly still with us today provides something of a counterexample. The largest category of mail delivered by the U.S. Postal Service is advertising.)
The complexity of an ecosystem can be estimated by the relative number of species: if a handful of species dominate, and the rest carve out a marginal existence, then the ecosystem is said to be simple. But if large numbers of species coexist together in similar numbers, then the ecosystem is far more complex, with a much wider web of interactions between species. By totting up the number of species living together at any one time in the fossil record, it’s possible to come up with an “index” of complexity, and the results are somewhat surprising. Rather than a gradual accrual of complexity over time, it seems that there was a sudden gearshift after the great Permian extinction. Before the extinction, for some 300 million years, marine ecosystems had been split roughly fifty-fifty between the simple and complex; afterwards, complex systems outweighed simple ones by three to one, a stable and persistent change that has lasted another 250 million years to this day. So rather than gradual change there was a sudden switch. Why?
According to paleontologist Peter Wagner, at the Field Museum of Natural History in Chicago, the answer is the spread of motile organisms. The shift took the oceans from a world that was largely anchored to the spot — lamp-shells, sea lilies, and so on, filtering food for meager low-energy living — to a new, more active world, dominated by animals that move around, even if as inchingly as snails, urchins and crabs. Plenty of animals moved around before the extinction, of course, but only afterwards did they become dominant. Why this gearshift took place after the Permian mass extinction is unknown, but might perhaps relate to the greater “buffering” against the world that comes with a motile lifestyle. If you move around, you often encounter rapidly changing environments, and so you need greater physical resilience. So it could be that the more motile animals had an edge in surviving the drastic environmental changes that accompanied the apocalypse . . . . The doomed filter feeders had nothing to cushion them against the blow.
Nick Lane, Life Ascending: The Ten Great Inventions of Evolution 145-46 (2009).
There is much food for antitrust thought in evolutionary history if you think of firms as representing methods of extracting value from the consumer environment. That makes them like species, all the members of which tend to use the same methods of extracting value from the natural environment. One species of bird uses long bills to get worms. Another uses short bills. And so on.
The Advantage of Incumbency
The Great Dying teaches a number of lessons. First, like the Cretaceous–Paleogene extinction event about which I have written before, it suggests the advantages of incumbency. The fact that less motile organisms have not reattained their former dominant position in the 250 million years of relative competition that has prevailed since the Great Dying tells you that less motile organisms were not particularly competitive relative to motile organisms. And yet for the 300 million years until the Great Dying they dominated, despite the parallel existence of more motile organisms. Why? Perhaps simply because they evolved first.
Industrial organization economists have long warned about these “first-mover advantages,” but the antitrust laws ignore them. The “conduct requirement” in antitrust holds that simply being dominant is not an offense in itself. There are plenty of good reasons for that rule, because it’s easy to use it to punish justified market success. But one bad reason to support the rule is that the dominant firm is always the better firm. If the history of the Great Dying is any guide, incumbency does sometimes protect uncompetitive firms.
Competition’s Good Side or The Virtue of Theft
The Great Dying’s second lesson for antitrust has to do with motility, for motility means, at least in part, predation and theft. Creatures that move can seek out new environments not yet colonized by stationary organisms feeding off minerals or sunlight. But one of the major things that motile organisms also do is to predate. Motility lets you range across the environment eating the organisms that have done the hard work for you of generating energy from light and inanimate matter.
We think of theft as being a problem in the law. We like to say that theft reduces incentives for innovation and economic growth because it means that innovators can’t fully reap the fruits of their productive labors. The plant that has a leaf torn off by some vicious armored predator has done the environmentally-friendly work of converting light to energy without so much as emitting a single carbon atom, and yet here the fruits of its labors have been stolen from it. Fortunately, we say, in the business context the law is there to stop such theft.
But the fact that the flourishing of motility after the Great Dying was correlated with an increase in ecosystem complexity—a reduction in species dominance—suggests that theft is not necessarily bad, at least if deconcentration of markets is your thing.
This is a familiar point, approached from a different angle. Industrial organization scholars have long pointed out that the strength of intellectual property protection matters. Make the patent term too lengthy and innovation will fall below optimal levels, because inventors won’t be able to build on prior art to create the next generation of inventions. It follows that if patent rights are too strong, then theft of intellectual property could actually lead to more innovation, and richer and more complex markets. Similarly, when a monopolist ties up a source of supply and uses it to suffocate competitors, theft would bring more competition to the market.
Antitrust recognizes the importance of theft for competition, although antitrust—probably wisely—doesn’t say so in quite such stark terms.
Every time antitrust enforcers order a dominant firm to supply an essential input to competitors—and antitrust does do that occasionally, even in the United States—antitrust is, objectively speaking, revising a property right. Which is to say: authorizing disadvantaged firms to steal from the dominant firm.
The nice thing is that when you’re the law you get to define the boundaries of the law, so you can plausibly say it’s not theft that you’re authorizing, but rather that the dominant firm’s ownership rights over the essential input never actually included the right to deny the input to competitors.
Regardless how it’s characterized, antitrust’s forced dealing remedy does allow other firms to take the fruits of the defendant’s labors, and for a price that must be less than their value, otherwise the taking would provide no competitive succor to the beneficiaries. That’s legalized predation in the biological sense. The aftermath of the Great Dying suggests that it’s probably justified, at least if the goal is to deconcentrate markets.
Competition’s Bad Side or The Horror of Predation
But at the same time, one must proceed with caution in celebrating the complexification of ecosystems that followed the Great Dying, because complexity and competition are not ends in themselves.
There’s a reason for which biologists also refer to the great age before any predators had evolved, the Ediacaran period, as the “Garden of the Ediacara.” We can view the rise of motility and predation, and the demise of filter feeder dominance after the Great Dying, as leading to a golden age of competition and complexity. It’s the golden age we live in today (or lived in until we started wiping out large parts of it starting with the end of the last ice age).
Or we can view the rise of motility and predation as destroying a peaceful Eden in which life competed principally on the virtuous project of converting the inanimate into the animate, of extracting energy from the physical environment, rather than from other living things.
From this perspective, if over the first 300 million years of the existence of complex life evolution tended to hit a wall, and for eons life did not get much better at converting the inanimate to the animate, then that says something about the limits of biology. It does not tell us that the motility, predation, and theft that followed represented an improvement.
From this perspective, the rise of motility and predation was instead a symptom of evolution’s defeat. When life could no longer advance by getting better at converting inanimate matter to animate matter, it turned on itself, leading to the hell of predator-prey competition that has characterized the past 250 million years. If only there had been a world government in the Ediacaran capable of enforcing the basic rules of criminal and property law!
Life would have stayed happy.
In general, the antitrust laws today are much more sympathetic to this dark view of predation than to the other. Antitrust enforcers for the most part shy away from revising property rights. And the legal system as a whole, of which antitrust is just a part, gives great priority to property. The natural world is, of course, the state of nature. And if there is one thing that separates civilization from the state of nature, it’s the concept of property, the notion that theft is to be curtailed, and that evolution within civilization is to take place along the old Ediacaran lines, with each attempting to better himself other than at the expense of others.
Over its first 300 million years, complex life does seem to have hit a wall in bettering itself through virtuous, non-predatory competition, at least so far as the biochemistry of energy production out of inanimate matter is concerned. Our inability to generate energy other than by burning fossil fuels shows that for all our own ingenuity we humans haven’t managed to outdo nature either. We live off the productive labors of other creatures, including both living plants and those dead so long as to have been ground into oil. That makes us, and the horror we have meant for the planet, the logical extreme end of the triumph of motility and predation after the Great Dying.
But the fact that civilization’s vision, honored however often in the breach, is fundamentally Ediacaran, suggests to me that there is hope. Climate disaster is effectively forcing us to extend the property laws we enforce within civilization to the life outside of it. With luck, the virtuous, non-predatory competition that results will help us achieve the breakthrough that life could not, and allow us to advance into new methods for generating energy from the inanimate.
Todd Henderson and Steven Kaplan commit one of the more basic economic mistakes I have encountered, one all the more embarrassing because they are Chicago lawyers and economists.
They write that the private equity industry should not be judged based on its low returns net of fees because “[w]hile this is the appropriate metric for the decision about whether an individual should invest, what matters for society is how much wealth they create above the next-best alternative.” If you don’t net out the fees, they argue, then private equity shows large returns, and those returns reflect the creation of social value.
What Henderson and Kaplan have done here, in case you missed it just now, is to argue that an industry is productive by redefining a cost—and not just any cost, but that sacredest of sacreds, the fund fee—as social value.
But if they really mean to do that, which I doubt, then they’re actually making the case that private equity earns excess—read unnecessary—profits. Profits that represent a redistribution of wealth from consumers to private equity firms.
Unfortunately, Costs Are Costs
Let’s say that you decide to build a fence, but you’re terrible at it. You nail in all the slats askew and some of them fall off on the way to market. The cost to you was $50 in materials and $30 in labor, judged by the wage in your next best alternative line of employment.
Because your fence is a disaster, however, you are only able to sell the thing for $70, resulting in a loss of $10. Economics teaches that your fence business is a waste of economic resources. You expended $80 in combined value of resources to generate a product that created only $70 of value for consumers.
But Henderson and Kaplan say no. You have created $20 in value, the difference between the price of $70 paid by consumers and your materials costs of $50, because, well, if we ignore your $30 in labor costs, then you did!
What they don’t seem to realize is that the only way you can actually make that $30 in labor costs evaporate is if you don’t actually have an opportunity cost there for your labor; no one would have paid you a dime at any alternative employment. But if that’s true, and your costs really are just $50, then you didn’t need to charge $70 for the fence in order to have an incentive to build it. You just needed to charge $50, and so your $20 in profits are pure and unnecessary appropriation of surplus.
Which means that Henderson and Kaplan are inadvertently arguing that private equity is overpaid.
The Distinction between Value and Cost
But I really don’t think that’s what Henderson and Kaplan mean to argue. I think they are just confused about the relationship between value and cost, a confusion that is, alas, all too common in debates regarding law and economics, as I outline in a recent law review article.
The distinction between value and cost turns in fact on another distinction, that between utility and value.
The fence, even a badly constructed fence, has some utility for consumers, and that utility is measured by the maximum price that consumers are willing to pay for the fence: $70. In trying to avoid netting out costs and focusing instead on gross magnitudes, Henderson and Kaplan seem to be trying to say that utility and social value are one and the same.
But that $70 doesn’t represent value for society, because it does not account for the costs—the disutility—associated with generating it. If society must give up $80 in order to make a $70 fence, then society loses. Utility and social value just aren’t the same thing, as any careful undergraduate economics student should know.
To figure out how much value a business creates, you have to compare the utility the firm generates for those who use its products with the disutility—the costs!—the firm must create in order to produce those products. That is, value is a net quantity, it’s the difference between the maximum that consumers are willing to pay for the product and the cost of producing it. So the social value of private equity isn’t measured just by the gross returns that it generates, but by the returns it brings in net of costs.
All costs.
Fund Fees Are Costs
Including fund fees.
Costs in the economic sense are all harms that must be suffered in order for production to take place. The lost fees associated with not engaging in their next best alternative mode of employment outside of the private equity industry represent a cost, a harm, incurred by private equity funds in pursuing their work of privately acquiring and running firms. The fees that private equity firms charge must therefore be high enough fully to compensate them for this harm, otherwise they would not do private equity.
Henderson and Kaplan simply cannot ignore those fees in calculating the social value of private equity. They measure the harm of opportunities foregone to engage in private equity, the very harm of not sending physicists and engineers into physics and engineering, but instead allocating them to private equity funds, that critics of private equity decry.
If private equity can’t generate a decent return after netting out those costs, then private equity is social waste.
Unless They Represent Redistribution
The only way private equity fees don’t count as costs is if they not only fully compensate private equity firms for not engaging in some other line of business, but go beyond that to provide additional compensation. In which case some portion of the private equity fee can only represent one thing: an appropriation by private equity of the social value that private equity generates.
That is, private equity fees can only be ignored in the calculation of social value, as Henderson and Kaplan argue that they should be, if they represent an appropriation, by the private equity industry, of social value, defined as the value generated by their activities in excess of costs. And because Henderson and Kaplan appear to argue that we can count all private equity fees as social value, they are arguing that all private equity fees represent pure redistribution of social value from consumers to firms.
But precisely because social value is value in excess of cost, defined as the minimum necessary to compensate for all harms, it is value that does not need to be paid to firms in order to induce them to create social value. (Okay, it is necessary to pay private equity a penny more than cost, so that doing private equity makes firms strictly better off than they would be in their next-best alternative employments. Or just a ha’penny. Or a mill. But you get my point.) So what Henderson and Kaplan are arguing, in effect, is that private equity is taking more out of markets than is necessary to induce them to do private equity.
Government could, if Henderson and Kaplan are right, therefore dictate lower private equity fund fees without reducing social value one bit. Which sounds like a great idea to me.
Inframarginalists Don’t Make This Mistake
What really seems to have gotten Henderson and Kaplan into hot water is a lack of attention to the distribution of wealth between buyers and sellers in individual markets, what Michael Guttentag once described to me in conversation as “inframarginalism,” in contrast to the “marginalism” of a microeconomics that focuses on problems of efficiency.
What matters for efficiency-oriented lawyers and economists is that all units of output for which buyers are willing to pay marginal cost actually get produced. Which means that marginalists are interested in the cost-benefit analysis of the marginal unit of production.
Inframarginalists, by contrast, are interested in how the aggregate social value created over all of the other units produced by the firm—the inframarginal units—is distributed between buyers and sellers.
So social value is a bread and butter concept for inframarginalists. If they can’t define it properly—by netting costs out of willingness to pay—they can’t do their work.
And because inframarginalists know where social value begins and ends, they are unlikely to make the same mistake as Henderson and Kaplan.
The realization that a tight monopoly is preferable under certain circumstances to a looser arrangement in which competition is present comes hard to a Western economist. Nonetheless, the preceding argument compels recognition that a no-exit situation will be superior to a situation with some limited exit on two conditions:
(1) if exit is ineffective as a recuperation mechanism, but does succeed in draining from the firm or organization its more quality-conscious, alert, and potentially activist customer members; and
(2) if voice could be made into an effective mechanism once these customers or members are securely locked in.
There are doubtless many situations in which the first condition applies . . . .
Albert O. Hirschman, Exit, Voice and Loyalty: Responses to Decline in Firms, Organizations and States 55 (1970).
The assumption that people behave rationally does a lot of work in economics, but perhaps its most important function is to allow economists to assume that mutually beneficial deals always get done. If a seller places a value of a $5 on a good, and a buyer a value of $10, the assumption goes, the seller and buyer will agree on a price somewhere between $5 and $10, and trade will take place, simply because the exchange is mutually beneficial.
Economists and their detractors have spent at least half a century tearing apart the assumption that good deals always get done, first through the lens of transaction costs, and later through behavioral economics. Transaction costs dealt only a glancing blow to the assumption, however, because additional costs don’t really undermine it. One can certainly accept that some deals do not get done because the cost of negotiating them–the legal fees, the time required to induce the other party to accept a particular share of the benefits generated by the deal, and so on–are too high, without giving up on the notion that good deals, defined to be those that are mutually beneficial after transaction costs are taken into account, still always do get done.
Behavioral economics has turned out to be harder to dismiss because it suggests that neither party to a transaction may actually want to execute mutually beneficial trades. If the seller doesn’t place the right value on his good, thinking it is worth $20 to him when instead it is worth $5, and the buyer thinks the good is worth $5 to him when instead it is worth $10, then the two will not be able to agree on a price, and so a mutually beneficial trade will not take place. But objections based on behavioral economics are not what interest me about the assumption that good deals always get done.
What is really interesting about the struggle over whether good deals get done is that economics has always needed the fact that some good deals do not get done to create the tension that gives economic inquiry its meaning. An economics in which good deals always get done is an utterly uninteresting, unrealistic, and indeed solipsistic undertaking. And economics has always understood that. Long before transaction cost economics and behavioral economics, economists were careful to build into their models discrete loci of irrationality in order to give the models meaning. Without these areas of irrationality, the models would lack what a creative writing teacher would tell you is the essential element of any story: conflict.
But if a novelist were to try to introduce tension into a plot this way, by asking the main character to treat similarly situated supporting characters differently for arbitrary and unexplained reasons, the novel would be panned.
Consider, for example, as doctrinaire and orthodox a model as the general equilibrium model of Arrow and Debreu. If these men had really taken the assumption that all good deals get done seriously, they would have started with a bunch of households and firms, written down their utility and production functions, and then: bam! The model would have been done. For the assumption that all good deals get done would then have ensured that all trades that, according to the utility functions and production functions they had written down, are mutually beneficial, would then immediately be carried out.
To give the story the conflict it needs to be of interest, Arrow and Debreu added another assumption: that prices are uniform in all markets. (This assumption does not of course originate with them, but their model represents a sort of apotheosis of orthodox economics, making it useful to frame the discussion around it.) Uniform pricing creates tension because when prices are uniform a seller can make more money by intentionally refusing to sell to certain buyers, even when those sales would be mutually beneficial. This is the classic problem of the inefficiency of the uniformly-pricing monopolist.
Consider a seller who places $5 of value on a good and has two prospective buyers, one who places $100 of value on the good and the other who places $10 of value on the good. Without the uniform pricing restriction, the seller would always sell to both buyers, because whatever profits he happened to generate from his sale to the first buyer he could always increase by selling to the second buyer as well.
That changes with uniform pricing, because then the price the seller charges the first buyer must be the same as the price the seller charges the second buyer. If the seller is able to negotiate a price of $95 with the first buyer (a price the first buyer will, under the all-good-deals-get-done assumption, accept because he places a value of $100 on the good, and so would enjoy a net gain of $5 from the deal), then the seller will not sell at all to the second buyer, who is only willing to pay up to $10 for the good and therefore won’t buy at a price of $95. So a deal with the second buyer becomes impossible, even though, if a lower price could be charged to the second buyer, a deal would be mutually beneficial. If the seller and the second buyer could agree on a price of $7, for example, the seller would earn an additional $2 of profit.
But that price is impossible under uniform pricing, because to charge the second buyer $7 would require that the seller charge the first buyer $7 as well, eliminating $83 of profit from the deal with the first buyer relative to the $90 earned at a price of $95, in exchange for a paltry gain of only $2 in profit on the second deal. The seller could still ensure that all good deals get done, by charging that $7 price, or any price between $5 and $10, but it is not in the interest of the seller to do that.
Now the Arrow and Debreu model has the opportunity to become interesting, by giving the conditions under which all mutually beneficial deals will still get done, in spite of the uniform pricing restriction and therefore in spite of the failure of the assumption that all good deals get done as a general matter. In particular, the Arrow and Debreu model makes clear that perfect competition, or some other mechanism that leads to competitive prices, is required for all good deals to get done when prices are uniform. Competition ensures that if one seller tries to charge $95, the $90 in profits generated thereby will induce other sellers to enter the market and steal the buyer’s business by charging a slightly lower price, and as competition intensifies that price will be bid down to the $5 of value that sellers place on the product, ensuring that the second buyer is able to purchase the product as well. All good deals get done after all. By circumscribing the assumption that good deals always get done using a restriction that is realistic–many goods are sold at uniform prices–the model poses a problem that has a certain verisimilitude–how to ensure that all good deals get done when prices are uniform–and then gives the conditions sufficient to solve the problem (e.g., competitive markets).
All economic models follow the same playbook: all economic models create tension and practical interest by limiting the general economic assumption that all good deals get done in some way (usually, but not always by assuming that prices are uniform), and then trying to show what legal rules or policy interventions might be needed to ensure that all good deals do get done anyway. (Another example is the assumption of risk aversion in insurance economics.)
What is so peculiar about this rhetorical posture of economics is that the baseline assumption is always that good deals do always get done, and the model is then built around the introduction of some discrete deviation from that assumption. The model never starts from the assumption that good deals never get done.
Which gives all economic models an internally discordant character.
Why, for example, should I assume that when the monopolist charges $95 to the first buyer, that buyer will magically trade at that price, simply because trade is mutually beneficial, but at the same time I should also accept that the seller won’t try to charge a lower price in order to be able to engage in mutually-beneficial trade with the second buyer? Yes, the seller generates more profit by charging the higher price and selling only to one buyer. But by the same token, the first buyer could enjoy a greater net gain from the transaction by insisting on paying no more than $80 for the good, as opposed to the $95 price that I am asked to assume that the buyer will accept. The buyer does better insisting on a lower price, and if the seller insists on a higher price, then the two might never reach a deal, as Robert Cooter so insightfully pointed out years ago. I am therefore asked to accept that the profit motive is not the be-all-and-end-all for the seller and the first buyer, otherwise I could not assume that the good will sell at $95, and yet I am asked to accept that the profit motive is the be-all-and-end-all for the seller in relation to the second buyer, which is why the seller won’t think twice about pricing the second buyer out of the market and missing an opportunity for mutually beneficial trade with the second buyer. Why ever would that be the case?
Of course, it is in the nature of the introduction of a deviation from the assumption that good deals always get done to have such dissonance. But that just begs the question: does it make sense to rely upon inconsistent behavioral assumptions within the same model?
Keep in mind that in order for uniform pricing to give rise to tension in the Arrow and Debreu model, the same individual seller must be willing to compromise profits for the sake of completing mutually-beneficial transactions with buyers who are willing to pay high prices–inframarginal buyers, they’re called–but not be willing to compromise profits for the sake of completing mutually-beneficial transactions with buyers who are able to pay only lower prices–marginal buyers, these are called. There seems to be no basis for assuming that sellers are socially oriented with respect to inframarginal buyers but rapaciously-profit-driven with respect to marginal buyers, other than the rhetorical need of model builders to introduce tension into the stories they are telling about economic activity.
But if a novelist were to try to introduce tension into a plot this way, by asking the main character to treat similarly situated supporting characters differently for arbitrary and unexplained reasons, the novel would be panned. The trouble for economists is that if they start adding content to the personalities of economic actors, they end up falling down the behavioral economics rabbit hole. There are too many different personality types from which to select , and the mathematics required to build models in any case becomes intractable. But if economists stick with the basic assumption that all good deals get done, then they paint a Panglossian portrait of economic activity that leaves them unable to identify economic problems or solve them. The result is an economic theory built on arbitrary and self-contradictory assumptions about when deals get done.
A more tenable theoretical approach would be to accept that good deals don’t always get done, all the time, in all circumstances. That means that even in competitive markets, sellers will fail to sell to buyers at the market price. That also means that in monopoly markets, sellers may fail to sell to inframarginal buyers at the monopoly price. Laying off absolute assumptions regarding whether deals always get done should also release economics from going to the opposite extreme: assuming that when good deals do not always get done good deals must therefore never get done. Which means that we should not be surprised to come upon monopolists that charge competitive prices.
Jettisoning absolute assumptions about whether good deals get done would prevent economics from making grand claims, such as the claim of the Arrow and Debreu model that competitive markets are always efficient. But it would not make economic theory useless. Economic theory could still tell us plenty about potentials: such as the amount of gain that would be created were policymakers to encourage buyers and sellers to strive to make mutually beneficial deals whenever possible. (Guido Calabresi makes a similar point when he argues that economics should focus less on how to expand the production possibilities curve and more on how to get the economy to that curve.) It would also help explain economic institutions that economics has so far been unable to penetrate.
Like advertising. The classic economic explanation for advertising is that it provides consumers with useful product information, something that is almost impossible to believe in the information age, if it ever was credible. But in a world in which good deals don’t always get done, there is another potential economic justification for advertising: that it seeks to overcome whatever cognitive or bargaining failures otherwise prevent good deals from getting done. In a world in which mutually beneficial transactions don’t always happen, because consumers are irrational, one would expect to find sellers spending large amounts of money trying to cajole buyers into buying, even in situations in which the deals on offer are good for buyers and so in theory they should embrace them without needing to be persuaded to do so. (That would go some ways toward undermining my own argument here that persuasive advertising must be bad for consumers, because absent advertising rational consumers always purchase the products that are best for them.)
There’s nothing wrong with the use of simplifying assumptions in economics, or in thought of any kind. But the use of inconsistent assumptions about behavior in the same model–often in relation to the same economic actors in the model–is a different story.
And all of economic theory is based upon doing just that.
Ben Smith must be congratulated for writing one of the few accounts in the Times of the battle between Big News and Big Tech even to acknowledge that there are two players in this fight, and that both are pursuing their own private interests, not necessarily the public interest.
Smith gets it right when he observes that: “The battle between [tech] platforms and publishers is . . . an old-fashioned political brawl between powerful industries.” Contrast that to “To Take Down Big Tech, They First Need to Reinvent the Law,” the headline of a story that appeared in the Times last summer, and you see why there is cause to celebrate this tick back in the direction of balanced journalism.
Smith follows a popular playbook in the press’s attempts to drum up political support for smashing its tech rivals: lionizing those who help them. No doubt this is the first time that Australian competition regulator Rod Sims has been called a “pugnacious 69-year-old” defending the public against “railroads, ports, and phone companies.”
And no doubt American regulators get the message: take the media’s side and the media will talk you up too.
But Smith really does deserve kudos for trying to be balanced. After all, he comes out and says it: “politicians remain eager to please the press that covers them.”
And: “[T]he power of the press, even nowadays, makes it a formidable political force. Rupert Murdoch’s bare-knuckled News Corp . . . has long led the fight to claw back revenue from the tech giants, and hostility to Google bleeds through the pages of The Times of London and Fox News’s airwaves.”
Of course, the same hostility “fairly bleeds” through the pages of the The New York Times as well. But it would be asking too much for the Times itself to acknowledge that.
I do wish though that Smith would drop a link when he goes on to observe that “much of the American media rejects the idea that it is crusading in its pages to support its publishers’ business agenda.” Last I checked, no one of any prominence had even called out the media for the brazen, self-interested, savaging of big tech that has been running above the fold in newspapers across the country for several years now.
Much less have I read a rejection of such criticism authored by any editorial page anywhere. The press is still a long way away from coming clean to its readers about this issue. All the more reason to thank Smith for finally acknowledging that there is a conflict of interest.
You also have to admire this bit of very journalistic commentary-through-juxtaposition in Smith’s piece: “Facebook, after taking a huge public beating for its role amplifying misinformation . . . has moved to give publishers what they want: money, mostly . . . . writing checks in the seven figures to publishers.” You’d have to be a very dull reader indeed not to see “shakedown” blinking here in red, all caps.
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But I haven’t said a word yet about the actual subject matter of Smith’s piece.
It’s this: the media industry has been arguing that Google and Facebook should pay newspapers for the links to news stories that Google provides on its search engine and that Facebook users spend endless hours sharing and discussing on Facebook. And the industry has made some headway in convincing government regulators in Australia and France to mandate such payments.
But is there a good argument for making Google and Facebook pay? Although there have been attempts to spin the problem of compensation into a copyright question — is a snippet of text from a news article included in a Google search result subject to copyright by newspapers? — the basic argument is that Google and Facebook would be a lot less valuable to their users if there were no journalism out on the internet for Google to help users find and for Facebook to help users share.
It follows that newspapers are contributing value to Google and Facebook, and should therefore receive compensation for that value.
The trouble with this argument is that there is no general rule that anyone who receives value from someone else should pay compensation for it. Imagine if you had to pay every pretty face you encountered on the street for the pleasure you take in a glance. There’s no doubt that Google and Facebook would be a lot less useful if there were no world for Google to reproduce in search results or for Facebook users to discuss on Facebook. That doesn’t mean that Google and Facebook should be made to pay all of their revenues out to the whole world in exchange for the value the whole world contributes to Google and Facebook’s websites.
The rule that policymakers actually do follow is to try wherever possible to ensure that those who produce value are paid enough to cover their costs of producing that value. That’s not at all the same as requiring full compensation for all the value producers confer on others.
That is, the basic rule on when to recognize a right to payment–otherwise known as a property right–is that producers of value should have enough of a right to payment to cover their costs. Because that is enough to ensure that they have the resources necessary to continue to produce the valuable things that they make. But beyond that, no one has, or should have, a right to payment simply in virtue of having conferred value on others.
Otherwise, no one could get any enjoyment out of the works of others! If a firm creates $10 of value for you, you would then be required to pay $10 of value back to the firm, for a net gain of zero. Clearly, a rule that value conferred must give rise to compensation simply because value has been conferred is unworkable.
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The newspaper industry may be wrong to argue that value conferred gives rise to a right to payment. But the industry does, however, have a good case that at present it is not receiving even enough compensation to pay its costs of production, which suggests at least that it should have a right to more compensation from someone. Local newspapers across the country are shuttering. And the big papers that remain have had to sacrifice care and balance in their reporting in order to attract readers and protect their bottom lines. While the industry still takes in enough revenue to produce news, it no longer takes in enough to produce news of optimal quality.
But it is far from obvious that Google and Facebook should be the institutions to pay the costs of better journalism. True, those two companies now earn the advertising revenues that once sustained the media industry. But that’s because Google and Facebook distribute advertising better than do newspapers, not because Google and Facebook have used monopoly power to strike down more-innovative newspaper rivals.
And anyway the vulnerability of the newspaper industry to competition from Google and Facebook–two companies that don’t, actually, produce any news of their own–points to a deeper problem that can’t be solved by forcing these firms to subsidize the newspaper industry: that the market in which the media industry generates its revenues isn’t actually the market for news.
It’s the market for advertising.
That has always been a huge problem for newspapers, because a newspaper’s core mission is to tell the truth, whereas advertising’s core mission is to manipulate consumers into buying products they would not buy otherwise, and the more so in the information age. It makes no sense to fund an industry devoted to arming the public against manipulation–political and otherwise–through the distribution of commercial attempts to manipulate the public.
Which is why addressing the current jeopardy of journalism by tying newspapers back into advertising revenue streams, generated now through the medium of Google and Facebook, would represent a lost opportunity–to wean the newspaper industry off of dirty money.
What governments should be doing to save journalism is to set up direct government subsidies for newspapers, the way many Western European countries, and Britain, have long subsidized television news through a dedicated tax.
Detractors of this approach warn that government support could compromise journalistic independence. But here’s the thing: if Congress rides to the industry’s rescue by passing legislation advocated by the News Media Alliance that would allow the industry to negotiate compensation from Google and Facebook, that too would be a government subsidy. Few are under any illusions about that fact, not least the journalists who are currently busy rewarding friendly politicians with positive news coverage. A hostile President, or Congress, won’t think twice about demanding good press in exchange for support for such legislation. Indeed, that’s exactly what politicians who are backing the legislation are already getting in exchange.
If we’re getting government-subsidized media either way, we should at least get it without the advertising, and the additional layer of conflicts with commercial interests that entails.
Of course when, as Smith reports in a different piece, “[t]he most heated debate in places where . . . nonprofit news executives gather . . . is whether it’s ever safe or ethical to take government funding,” not whether it’s safe or ethical to take money from corporate interests in exchange for running corporate propaganda, there seems to be little hope for this approach.
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Smith writes that the war between Big News and Big Tech is not just about private interests but also about “economic principle.” He’s right that the newspaper industry has tried to cast itself as the nation’s last line of defense against monopolization of the economy by the tech giants. But this craven and profoundly disingenuous appeal to the public interest was belied from the start by the industry’s advocacy of legislation that would allow newspapers to cartelize in violation of the antitrust laws in order to negotiate payments from the tech giants.
Demanding a cut of a monopolist’s profits is not the modus operandi of an industry committed to competitive markets. A News Corp. executive’s quip to Mark Zuckerberg about Facebook’s capitulation to modest payments–“what took you so long?”–says it all.
Of course, newspapers have also pressed for breakup of the tech giants, which is more like what one would expect from genuine antimonopoly advocates. But that, like all the bad press newspapers have heaped on Big Tech over the past few years, has just been about maintaining a bargaining position, the stick required to scare Google and Facebook into opening their wallets.
Once Big Tech does cut in the newspapers, don’t hold your breath waiting for the newspaper industry to continue the crusade for greater competition in America.
I have argued elsewhere that Elizabeth Warren’s proposed rule that firms not be allowed to compete on their own platforms makes no sense because a platform is just a production input, and all firms must own at least some of their inputs in order to exist. Does your company own its own office computers? Then it competes on its own platform.
But even when a company doesn’t compete on its own platform, the company will often have exactly the same incentive to favor some platform users over others that Warren seems to want to eliminate through her proposed rule.
Consider a shopping mall. The owner of the mall will not typically own any of the stores that lease space in the mall. So the mall owner doesn’t compete on its own platform. (At least not on the mall platform, but certainly on others. The mall owner doubtless owns a few computers.)
But even so, the mall owner does still have an incentive to favor some of its lessees over others, just as the owner would have an incentive to favor its own stores over those of competitors if the owner were to integrate downstream into retail and compete on its own platform. Suppose, for example, that the mall owner has a history of being able to negotiate more favorable lease terms from one restaurant in the mall than from another. The mall owner might then have an incentive not to renew the lease of the other restaurant, in order to make way for expansion of the first.
The lesson here is that whether a platform owner competes on its own platform or not, the owner will have a financial interest in all of the firms that do compete on the owner’s platform (because they all must pay the owner for access), and that interest is unlikely to be equal across all competitors on the platform. Indeed, a platform owner’s financial interest in a particularly profitable client is no different in effect than a platform owner’s financial interest in a business that the owner owns.
If we are not troubled by the fact that a platform owner that does not compete on its own platform will regularly use its power to pick winners–which is just was a mall owner does when it refuses to renew the lease of one shop, but continues that of another–then we should not be troubled by the fact that a platform owner that does compete on its own platform will sometimes favor its own businesses over those of competitors.
It seems fairly clear that what really bothers Warren is not that as a general matter platforms have an incentive to pick winners, whether themselves or others, on their own platforms, but rather that some specific platforms, like Amazon, may not be wielding that power wisely, or perhaps have so much power that government oversight of their decisionmaking is appropriate.
But the solution to that problem is not to gin up a broad general principle, like the one that no firm should be able to compete on its own platform, and then let that principle loose to wreak havoc across the economy. The solution is to empower a regulatory agency to supervise the platform in question, and decide, in light of the specifics of that particular business, whether intervention to supervise the platform’s choices is warranted.
That’s what the FCC did forever with respect to AT&T, back when AT&T was the nation’s only telecommunications platform. And that’s what can be done with Amazon, or other tech giants, to address concerns about possible arbitrary use of platform power.