Antitrust Monopolization

The Decline in Monopolization Cases in One Graph

Data Source: U.S. Department of Justice Antitrust Division Workload Statistics FY 1970-2019.


  • I guess the Carter Administration had a lot in store for the nation’s monopolists before Reagan was elected.
  • There was a Clinton bump but no Obama bump.
  • It looks like the lone Section 2 case brought by the Antitrust Division in the last twenty years was against United Regional Health Care System of Wichita Falls, Texas, which quickly settled.
  • Until Google, of course.

(Section 2 of the Sherman Act prohibits monopolization. The Department of Justice is not the only enforcer of Section 2. The Federal Trade Commission and private parties can sue to enforce the law as well, and their actions are not included in this graph.)

Antitrust Monopolization

The Smallness of the Bigness Problem

The tendency to ascribe the problem of inequality that ails us to the bigness of firms is the great embarrassment of contemporary American progressivism. The notion that the solution to poverty is cartels for small business and the hammer for big business is so pre-modern, so mercantilist, that one wonders what poverty of intellect could have led American progressives into it.

Indeed, the contemporary progressive’s shame is all the greater because the original American progressives a century ago, whose name the contemporary progressive so freely appropriates, did not make the same mistake. The original progressives were more modern than progressives today, perhaps because the pre-modern age was not quite so distant from them. Robert Hale, the greatest lawyer-economist of the period, wrote that

[e]ven the classical economists realized . . . competition would not keep the price at a level with the cost of all the output, but would result in a price equal to the cost of the marginal portion of the output. Those who produce at lower costs because they own superior [capital] would reap a differential advantage which Ricardo, in his well-known analysis, designated “economic rent.”

Robert L. Hale, Freedom Through Law: Public Control of Private Governing Power 25-26 (1952).

I suspect that this is absolute Greek to the contemporary progressive. I will kindly explain it below.

But first, it should be noted that the American progressive’s failure to appreciate the smallness of the bigness problem is not shared by Piketty, whom American progressives celebrate without actually reading:

Yet pure and perfect competition cannot alter the inequality r > g, which is not the consequence of any market “imperfection.”

Thomas Piketty, Capital in the Twenty-First Century 573 (Arthur Goldhammer trans., 2017). (Italics mine.)

What does Piketty mean here?

He means what Hale meant, which is that the heart of inequality does not come from monopolists charging supracompetitive prices, however obnoxious we may feel that to be, but rather from the fact that the rich own more-productive assets than do the poor, and so they profit more than the poor even at efficient, competitive prices.

In other words, the rich get richer because their costs are lower and their costs are lower because they own all the best stuff.

No matter how competitive the market, prices will never be driven down to the lower costs faced by the rich, because other people own less-productive assets than do the rich and competition drives prices down to the level of the higher costs associated with producing things with less-productive assets.

(Why can’t price just keep going down, and simply drive the more expensive producers out of the market to the end of dissipating the profits of the less expensive producers? Because there is always a less expensive producer! Price can therefore never dissipate the profits of them all, and anyway demand puts a floor on price: consumers are always bidding prices up until supply satisfies demand.)

Graphically, American progressives have been sweating the “monopoly profit” box without seeming to realize that it’s tiny compared to what remains once you eliminate it, which is the “economic rent” box.

Picketty, the original American progressives, and kindergartners know the difference between big and small. Why don’t we?


Chamberlin Against Trademark

The wastes of advertising, about which economists have so often complained, would be reduced, for no one could afford to build up goodwill by this means, only to see it vanish through the unimpeded entrance of competitors. There would be more nearly equal returns to all producers and the elimination of sustained monopoly profits. All in all, there would be a closer approach to those beneficent results ordinarily pictured as working themselves out under “free competition.”

Edward Hastings Chamberlin, The Theory of Monopolistic Competition: A Re-Orientation of the Theory of Value 274 (7th ed. 1956).

This view, by the father of the theory of monopolistic competition, is of course still radical today. The entirety of Appendix E of The Theory of Monopolistic Competition, which he devotes to this attack on trademark, did not deserve to be forgotten. You can read it all here.

Where I think I differ with Chamberlin on trademark is this passage:

The question is, where does identification leave off and differentiation begin? [Absent trademark, t]here would be mere identification, without further differentiation of product, in the case of two competing goods, identical in every respect, – as to color, shape and design, labels, marks and names, everything excepting only an inconspicuous identification mark or the name and address of the producer. Obviously “protection” which went no further than this would have no economic value to the producer, for it would mean no more to the buyer than does the slip found in a container (and which identifies perfectly), “Packed by No. 23.”

Edward Hastings Chamberlin, The Theory of Monopolistic Competition: A Re-Orientation of the Theory of Value 272 (7th ed. 1956).

Chamberlin’s claim that “Packed by No. 23” is all identification and no differentiation works intuitively for us because we know that the company that employs No. 23 already engages in a great deal of supervision of the quality of No. 23’s work. We have learned that within-brand product quality is pretty good (at least these days), and so we can ignore these little notes, which may be the legacy of an earlier stage in the industrial age in which within-firm quality standards were still something of a work in progress.

But I do think that we would be far more likely to pay attention to No. 23 were it used as a brand name, rather than an identifier of within-brand quality, for there is no great bureaucratic organization standing over all brands in our economy, making sure each meets quality requirements, and willing to “fire” any that shirks or underperforms. To analogize the Consumer Products Safety Commission to a boss to American’s producers would be funny.

And so we would pay attention to No. 23–just as we pay attention to Chanel No. 5–and paying attention is all it takes for identification to cross over into differentiation, as any marketer will tell you. Attention leads to familiarity which leads to irrational preference.

The only way out of differentiation and all the irrational loyalty that comes with it is not to identify. But to do that, without throwing the consumer into a hell of shoddy and fake goods, one must then build up that great bureaucratic organization standing over all brands in our economy, making sure each meets quality requirements, and willing to “fire” any firm that shirks or underperforms.

That is, we must put businesses in the position of poor, hardworking No. 23.

But even if we were to do that, I am not sure that the end would justify the means. For if the point were alone “the elimination of sustained monopoly profits” via the increased price competition that would follow the demise of trademark, as Chamberlin suggests that it would be, I have a better idea: just pass a law that says “charge lower prices.”

If the goal is, instead, to achieve better product quality standards than exist today, then of course the great economy-wide bureaucracy would be needed.

(I thank my colleague Brian Frye for triggering this line of thought.)

Antitrust Monopolization

The Original and Purest Form of Anticompetitive Conduct

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.

James W. Davidson, The Island of Formosa, Past and Present (1903).

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.

Antitrust Monopolization Regulation

Antitrust’s Robocall Paradox

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.

Ryan Tracy & Sarah Krause, Where Robocalls Hide: the House Next Door, Wall Street Journal, August 15, 2020.

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.)

Antitrust Civilization Monopolization Paradise Lost World

Permian-Triassic Extinction Event Antitrust

The Great Dying deconcentrated markets:

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.

Miscellany Monopolization Regulation

Damages as Personalized Pricing in Favor of Wrongdoers

All courts do all day in civil cases in which the remedy is money damages is to engage in personalized pricing in favor of consumers. The plaintiff is the producer, the defendant is the consumer. And the damages amount is the price charged to the defendant for whatever it is that the defendant has taken from the plaintiff in violation of law, whether dignity, reputation, an arm or a leg.

When private enterprise personalizes prices, it chooses the highest possible prices: price equal to the maximum that the consumer is willing to pay. That is, firms strive to engage in perfect price discrimination.

Courts do the opposite. They personalize the prices of legal wrongs to be the lowest possible prices consistent with compensating victims: price equal to the cost to the plaintiff of the violation of law, and not a penny more. That is, courts strive to engage in what I have called perfect cost discrimination.

That’s weird, when you think about it.

All lawbreaking amounts to a forced sale. The defendant who shoots off the plaintiff’s arm forces the plaintiff to sell his arm to the defendant, or at least to sell the defendant the service of having an arm shot off, and whatever attendant satisfaction that provides the defendant, whether in the form of a feeling of security, the pleasures of power and domination, revenge, or what have you.

The law, in prohibiting battery, recognizes in the plaintiff a right to payment for the service. And if the transaction were not forced, and the plaintiff were to have any amount of market power, which we would expect to exist in spades with respect to the subject of many prohibitions–very few people are willing voluntarily to part with their arms, for example–then the plaintiff would almost surely charge a price for the arm above the bare minimum necessary to compensate the plaintiff for the harm. That is, if the exchange were voluntary, the price would in many cases be much in excess of cost, and indeed much closer to the maximum that the defendant would be willing to pay. Indeed, it seems reasonable to suppose that the defendant forces the transaction precisely because the defendant hopes to avoid being charged a price equal to the maximum the defendant is willing to pay.

So you would expect the law to provide the plaintiff with something closer to the bargain that the plaintiff would have struck voluntarily with the defendant. That at least would ensure that the defendant enjoys no gain from breaking the law and forcing a transaction.

But the law doesn’t see it that way.

The “rightful position” principle in remedies teaches that courts should measure damages in order to put the plaintiff in the position that the plaintiff would have occupied if the defendant had not engaged in the bad act. That causes courts to set the lowest possible price for breaking the law, rather than a price that approximates the voluntary price. For the position that the plaintiff would have occupied without the bad act is assumed to be the one in which no transaction takes place at all and the harm of the transaction has therefore not been inflicted. So damages under this measure just equal the amount necessary to compensate for harm. That is, the cost of the transaction to the plaintiff.

Law and economics scholars have made much of this cost-based baseline, arguing that it leads to optimal deterrence. The idea is that it forces the bad actor to internalize the costs of his actions. And so he will only act to break the law if the gains to him exceed the costs, which is to say, only if cost-benefit analysis shows that the action is efficient.

But that ignores something rather important about optimally-deterrent pricing: there isn’t just one optimal price. So long as the price the defendant pays for the forced sale is personalized, which it must be in a legal system in which judges award damages on a case-by-case basis, any price between cost and the maximum the defendant is willing to pay for the harm is optimally deterring.

Only a price above the maximum that the defendant is willing to pay–as opposed to cost–prevents the defendant from forcing the sale when the benefit exceeds the cost. So only such an extraordinarily high price is non-optimal. The maximum the defendant would be willing to pay is a measure of the benefit to the defendant. So only a price above that maximum drives the defendant away. There isn’t one optimally deterring price, but a range, that from cost all the way up to the maximum the defendant is willing to pay.

Where the courts set the price of illicit conduct within that range matters, because price determines the distribution of wealth between the plaintiff and the defendant, the victim and the injurer. By setting the price equal to cost, courts today achieve the perverse outcome of allowing the injurer to retain all of the gains associated with the forced transaction.

To fully appreciate this perversion, imagine that you decide voluntarily to sell your house. You could sell it at cost, including a reasonable return on investment. But that would be disappointing. What you’d like to do is sell it at the highest price anyone is willing to pay for it. If you do, then you extract all of the value created by the transfer. The buyer obviously places a higher value on the house than you do, otherwise he wouldn’t buy and you wouldn’t sell, and because you charge the highest price the buyer is willing to pay, you cause the buyer to pay out all of that excess value over to you.

By contrast, if you sell at a price equal to cost, including a reasonable return on investment, you don’t extract any of the excess value buyers place on the house. What you paid plus a reasonable return is the value you place on the house, the reasonableness of the return being enough to make you sell at that price. So when you sell at that price, the buyer pays you your valuation, and not a penny more.

Selling at a price equal to cost, including a reasonable return on investment, doesn’t therefore enrich you at all. It just lets you break even in a sense: you give up your house in exchange for a price equal to the value you place on the house.

But now suppose that you decide not to sell the house. You don’t like the price the buyer is offering. You believe the buyer is willing to pay more and you want to hold out until he does. And the buyer responds by bursting in your door one morning, holding a gun to your head, and telling you to clear out permanently, which of course you do, before filing a lawsuit. Now the buyer has forced a sale, and the law of trespass allows the court to dictate to the buyer the price that he must pay for your house.

Under current rules on the measurement of damages, the court would award you cost plus a reasonable return on investment, and not a penny more! The buyer could walk away with all of the gains from trade.

(Let’s put aside the fact that almost any court would issue an injunction here allowing you to repossess your house. Perhaps you’re emotionally scarred and don’t want to live there anymore, so all you demand is money damages. And let’s suppose also that your lawyer commits malpractice and fails to request punitives or damages for emotional distress.)

Which means that current damages rules turn over the entirety of the surplus generated by a violation of law to the wrongdoer! They embody the policy that the wealth generated by illegal transactions should be allocated to the scofflaw.

Which, again, is weird.

Now, you might object that courts award damages equal only to costs because the maximum that the wrongdoer would be willing to pay for the privilege of breaking the law is a thing difficult to calculate.

But so too are costs.

For costs are themselves maxima that someone would be willing to pay. The cost of an injury is the maximum that the victim would be willing to pay to avoid the injury. The cost of your house is what you paid for it plus a reasonable return on investment only because that is the maximum that you would be willing to pay to avoid having it destroyed or taken from you. More than that and you could buy a better house. And there is a subjectively element in that cost calculation: the reasonableness of the return is subjective. Current rules in theory should force courts to take that subjective element into account in awarding you compensation for harm equal to cost. And if courts can do that, they should be able to answer the question what the maximum that the wrongdoer would be willing to pay might be, including any subjective element thereof. (Indeed, courts should already do this in restitution cases, of which more below.)

You might also object that the maximum that the wrongdoer would be willing to pay is always less than the cost to the victim, because otherwise the wrongdoer would just be able to enter into a voluntary transaction with the victim to inflict the harm.

But I don’t think that’s right, at least if we want to maintain the fiction of rational decisionmaking that is all of the fun of law and economics and which itself underpins the whole theory of optimal deterrence I wish to complicate here.

The wrongdoer knows that undertaking the bad act will result in liability, and so when the wrongdoer acts, he does so knowing that he will pay a price. If the price is too high, which it will be if he inflicts a harm for which he would not be willing to pay, then he will not act. The courts therefore never can extract damages from wrongdoers in amounts above those which wrongdoers are willing to pay. If they do, wrongdoers simply will not act.

The economic problem for the courts is precisely to find the price that is high enough to ensure that the wrongdoer will not act unless he values the harm more than the victim, but not so high as to prevent the wrongdoer from acting when he does value the harm more than the victim. The trouble is that under current damages rules the courts always choose the lowest possible price.

Now, I don’t mean to suggest that the law is entirely deaf to the problem of gains from trade. One can almost always bring an unjust enrichment action and obtain the remedy of restitution, which does provide the plaintiff with the gains from trade.

But here’s the thing: restitution is an alternative remedy. Either you get restitution, or you get damages, but you don’t get both.

So a plaintiff can receive compensation for the costs to the plaintiff of illegal activity, or the gains enjoyed by the defendant, but not both. Whether the plaintiff opts for one or the other, therefore, the plaintiff will never receive a price for what he gives up equal to the maximum that the defendant is willing to pay, because the maximum that the defendant is willing to pay must equal both the cost to the plaintiff–the value the plaintiff placed on the harm–and the gains to the defendant of inflicting the harm, the excess over plaintiff’s valuation that makes the rational defendant willing to break the law in the first place.

Do punitive damages pick up the slack? It’s true that the pleasure a wrongdoer derives from inflicting harm is in itself probably sufficient to convert an intentional tort into one of malice, and that in turn can lead to punitive damages. But the doctrine of punitive damages suffers from terrible incoherence; we know that it is meant to punish, but does that mean to take some of the ill-gotten gains, or all of them, or to take more than those gains? Unless we are very lucky, punitive damages will either leave some gains with the wrongdoer or charge the wrongdoer a price in excess of willingness to pay, preventing the wrongdoer from engaging in efficient conduct.

Only a reconceptualization of the “rightful position” principle to require that courts measure damages by the maximum the defendant is willing to pay, rather than the cost to the plaintiff, would ensure that defendants do not enjoy gains from the illicit trade that is every offense under the law.

In closing, a word on the relevance of personalized pricing. Why does it matter here that, in engaging in case by case adjudication, judges effectively personalize the price of offenses?

It matters because personalized pricing is efficient whether the price charged is equal to cost or to the maximum the buyer is willing to pay. When prices can’t be personalized, and price is therefore one-size-fits-all for an entire market of buyers and sellers, then there is likely only one price that does not price some buyers or sellers willing to engage in mutually beneficial trades out of the market. That’s the price equal to marginal cost, the competitive price. And that price distributes the gains from trade between all buyers and sellers in the market in a single unique way. Try to change that distribution, by raising or lowering the price, and efficiency suffers: some buyers or sellers will be priced out of the market.

With personalized pricing, however, the court can vary the price charged to one buyer-seller pair–the defendant and plaintiff before the court–without changing the price charged to other pairs, so regardless the price the court chooses in one case, buyers and sellers won’t be priced out of the market in other cases. So the case-by-case character of adjudication opens up a world of distributive options with respect to the market for illegal activity that would not exist if the courts were to engage in one-size-fits-all damages calculations.

It’s a world that the law has failed so far fully to recognize and exploit.

Antitrust Monopolization Regulation

Wherein Henderson and Kaplan Confuse Value and Cost

Or Why We Need More Inframarginalism

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.

Antitrust Monopolization Regulation

Getting Big

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).
Antitrust Monopolization Philoeconomica

Economic Plotting

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.