When Uber and Lyft brought competition to the Seattle taxi
market, drivers fought back, asking
the city to let them form a cartel to demand higher wages from rideshare companies.
If that sounds anticompetitive, it is. But petitioning the government for
protection from competition is also completely
legal, because the courts expect that informed voters will make the right
call about whether the petitioners need a bailout.
That system works well enough for cabbies, but not for
another group that has been seeking government protection from competition of
late: writers. In their role as journalists, writers give voters the
information they need to make the right call about bailouts, but writers cannot
be expected to do that dispassionately when they are the ones seeking
Over the past fifteen years, writers’ earnings have nose-dived
thanks to competition from Google, Facebook, and Amazon directed at two of the
main industries that employ writers: newspapers, which have lost
advertising revenue to Google and Facebook, and publishers, which have lost
the ability to dictate book prices as Amazon’s bookselling business has grown.
As a result, writers have quite understandably come to view these companies as a threat to their livelihood. Through the Authors Guild and the News Media Alliance, writers are calling for government protection from competition in the form of antitrust enforcement against Google, Facebook, and Amazon, and an antitrust exemption for newspaper cartels.
But writers’ views on big tech have also carried over into their reporting, making it hard for the public to judge whether government aid is warranted. I will focus on reporting by The New York Times that appears to me—as an antitrust scholar—to be colored by writers’ sense of professional vulnerability to the tech giants. But examples can be found in many other sources.
A Bully Pulpit
One expression of the strength of anti-tech feeling at the Times is the sheer volume of Times reportage suggesting that Google, Facebook and Amazon should be broken up or otherwise prosecuted under the antitrust laws.
In the first seven months of 2019, the Times published more than 300 articles mentioning Google, Facebook, or Amazon and antitrust, including an Op-Ed by a Facebook founder calling for breakup, an article discussing legal changes required to “take down big tech,” and another musing on what Amazon will do once its “domination is complete.”
That’s a lot of ink to spill on an issue that lacks either public or scholarly support. Polls show that the public has little interest in breaking up companies that either employ them, or sell them products at low or zero prices. And although I have decried Facebook’s treatment of app developers, to my knowledge no antitrust specialist has argued for the breakup of Google, Facebook, or Amazon. To the contrary, probably the two most prominent scholars in the field, Herbert Hovenkamp and Carl Shapiro, have urged caution. (Tim Wu, who has written on antitrust, but has much broader interests, has made the limited suggestion that Facebook should unwind its acquisitions of WhatsApp and Instagram.)
Grasping for Scholarly Support
The absence of scholarly support for antitrust action was highlighted by the oddest episode to date in the Times’ reporting on the tech giants. In 2017, the paper reportedextensively on academic work by a law student that sought to make a legal case for antitrust action against Amazon. What surprised antitrust scholars about the publicity wasn’t just that the Times had bypassed experts in the field in favor of promoting student work, but that the work itself broke no new ground.
Firms violate the antitrust laws by taking
steps to disadvantage rivals. But the student, Lina Khan, offered no
evidence of such conduct. Her closest attempt—the argument that Amazon had run
diapers.com out of business by charging very low diaper prices—fell flat
because charging low prices is anticompetitive only if the prices charged are below
cost. Otherwise, low prices are a sign of healthy competition. Khan offered
no evidence of below-cost pricing.
By reporting this work, however, the paper created the
impression that there is an antitrust case to be made against Amazon, one that
the paper reinforced by publishing twoOp-Eds
by Khan and then a profile
by David Streitfeld that went so far as to call her a “legal prodigy.”
Khan’s association with Barry Lynn, a journalist and head of
Open Markets Institute, for which Khan worked both before and after law school,
highlights the close relationship between the Times’s reporting and writers’
grievances against the tech giants. Lynn has written
to the Justice Department on behalf of organized writers calling for antitrust
action against Amazon.
Creating the Impression of Crisis
Equally troubling is the paper’s reporting on the ongoing House investigation into big tech. The Times ran a front page story on the investigation under the headline “Antitrust Troubles Snowball for Tech Giants,” suggesting a groundswell of interest in antitrust action.
What the story did not disclose is that the Congressman
leading the investigation, David Cicilline—whom the Times quoted extensively
in that article—is a sponsor
of legislation pushed by the News Media Alliance that would allow newspapers to
cartelize for purposes of fighting Google and Facebook. Cicilline has,
Khan to help with the investigation.
Similarly, the Times recently gave front page coverage to a preliminary step by antitrust enforcers to consider an investigation into big tech, and suggested that a case would have merit. But the paper did not mention that the only major antitrust action brought by the Trump Administration to date was the politically-motivated, and failed, attempt to block AT&T’s acquisition of TimeWarner, owner of Trump rival CNN. Given the President’s animus toward Google, Facebook, and Amazon, the opening of an investigation tells little about whether a case would have merit.
The Giant that Didn’t Bark
Further suggestion that writers’ professional concerns are
coloring their coverage of the tech giants comes from the conspicuous absence
of Apple from the paper’s crosshairs. Under the standard measure
of monopoly power, the ability profitably to raise price, Apple has far more
power than Google, Facebook, or Amazon, earning twice
what runner-up Google earned last year.
But it has been hard to find a critical word about Apple in
the Times’s pages.
That may be because Apple has played the role of hero to a
beleaguered trade. In 2009, as the Kindle was sowing panic among publishing
executives, Steve Jobs entered into a cartel
agreement with the major publishers to sell ebooks via iTunes at fixed
prices several dollars above the prices Amazon insisted upon for the Kindle. The
Justice Department frustrated these plans, however, suing to break up the
cartel, and winning
at trial against Apple.
Against this backdrop, other connections between the Times and advocates of breakup appear in a new light. Times writers have repeatedly appeared to cast Elizabeth Warren, who has called for breakup, as the Democratic frontrunner, even as she has lagged in the polls. And the Times endorsed Zephyr Teachout in her failed 2018 bid for New York Attorney General. Teachout, who made her name as a scholar of corruption, rather than antitrust, is, to my knowledge, the only current law scholar publicly to call for breakup of Google and Facebook.
I don’t think there is a writers’ conspiracy here. But just
as you won’t hear a good word from a cabbie about Uber or Lyft—even if these
companies have made life for the rest of us much easier—you won’t hear a good
word from a writer about Google, Facebook, or Amazon. The difference is that
when writers complain, America is forced to listen.
There is a Schumpeterian lesson here too. Schumpeter argued that market power is always in jeopardy from outside the market, and that is in evidence here. Who would have thought a few years ago that an online retailer would one day plan to use the profits generated from dominance in its own market to challenge the vicious telecom oligopoly?
If we suppose that mammals are better creatures than dinosaurs — more advanced, more sophisticated, somehow — then the theory suggests that until the meteor impact the dinosaurs had short-circuited competition from mammals, preventing them from leveraging their superiority to overpower the dinosaurs.
Perhaps the short circuit was the mere fact of dinosaurs’ incumbency. Mammals couldn’t reach livestock size, for example, and compete with larger dinosaurs, simply because dinosaurs already occupied that niche, denying mammals the resources they would need to evolve into it. Similarly, antitrust and innovation economics have long recognized that there are first-mover advantages that can block competition. Indeed, the argument current today that Google and Facebook use their size to acquire startups before they can grow into serious competitors resembles the role dinosaurs’ incumbency may have played in obstructing the development of mammals.
But perhaps instead of confirming our fears about the anticompetitive character of incumbency, the story of dinosaurs and mammals undermines it. For there is no reason to assume that mammals really are the better — more advanced, more sophisticated, somehow — of the two groups. Perhaps if the advantages of incumbency could be eliminated, and dinosaurs and mammals, in fully-developed form, could be set against each other, dinosaurs would emerge victorious.
In that case the meteor impact did not operate the way some believe that using the antitrust laws to break up Big Tech would operate today. The cataclysm did not free up space for more innovative upstarts to develop and occupy the ecosystem, but rather wiped out a more advanced form, allowing less-developed upstarts to thrive, and then to turn around and use the advantages of incumbency to prevent the more advanced form from returning to its original position of dominance. The meteor laid low the dinosauric epitome of life, and mammals leapt into the space and prevented dinosaurs from coming back. It is hard, when looking at the dinosaurs’ descendants, the birds, with their obsession with beauty, long-term amorous relationships, and increasingly-well-documented intelligence, not to wonder what might have been.
In other words, there is no reason for industrial policymakers to suppose that periodically shaking up the business world using the industrial cataclysm of the deconcentration order must necessarily, through competition, lead to better firms. Some value judgment must be made by policymakers regarding whether what will come next promises to be better than what we have now. Competition is path dependent, a kind of roll of the dice, and there is no guarantee that a new roll will produce better forms than the last. The evolution of the mammals into man — an unmitigated disaster for the global ecosystem — stands as Exhibit One to that sorry fact.
Many firms engage in price discrimination: charging different prices for the same product. The ideal way to do that is to generate reliable information on the willingness of each customer to pay, and then to charge higher prices to those willing to pay more and lower prices to those willing to pay less. But often firms can’t just discriminate in prices directly, either because discriminatory pricing would be politically sensitive, or because firms just don’t know how much buyers are willing to pay. So firms discriminate indirectly, by splitting the product into a base model and then selling optional additions.
By pricing the additions far above the actual incremental cost of adding the addition onto the product, the firm can seduce buyers into bringing price discrimination upon themselves. The buyer who is relatively price insensitive — and therefore has a high willingness to pay — will load up on options, and end up paying a far higher total price for the product than will the price-sensitive buyers, who will go with the base model. If this sounds like the business model of the car industry, that’s because car makers — particularly GM — pioneered this form of covert price discrimination in the mid-20th century.
Is covert price discrimination of this kind good for the economy? If a firm’s overhead is so high that the firm would not be able to cover costs, including overhead costs, at a competitive uniform price, then the answer may be yes. But if not, then price discrimination represents a pure redistribution of wealth from consumers to firms, by allowing firms to raise prices higher than necessary, to those consumers who happen to be willing to pay more.
Boeing’s decision to charge pilots extra to be able to read data from a key sensor used by an anti-stall system in the 737 MAX 8 is a classic example of covert price discrimination. The cost of enabling pilots to read data off the sensor was apprently near zero, but Boeing charged airlines thousands of dollars for that option in order to coax airlines with a higher willingness to pay to pay more for a 737 MAX 8. Predictably, budget airlines, like Lion Air, whose 737 MAX 8 crashed on takeoff, possibly because pilots could not read data off of the sensor, and therefore did not know that the plane’s anti-stall system was malfunctioning, did not choose that option.
If America had a general price regulator — an administrative agency responsible for approving the prices charged by large American businesses, including Boeing — then that regulator would be able to tell us today whether Boeing really needed to price discriminate in order to cover overhead, and therefore whether the high price Boeing charged for that safety option really was justified by its costs. Or whether Boeing’s price discrimination amounted to the charging of above-cost prices — prices that redistribute wealth from consumers to firms, not because the extra wealth is required to make the firm ready, willing, and able to produce, not because the extra wealth is necessary to give investors a reasonable return on their investment, but simply because Boeing, as a member of a two-firm global airplane production duopoly (along with Airbus), had the market power to raise price. And because Boeing thought it had more of a right to airline profits — and ultimately to the hard-earned cash of consumers — than do the airlines that buy planes from Boeing and the consumers that fly on them. If it turns out that the safety option was priced higher to extract monopoly profits from consumers, rather than to cover overhead, then we have in Boeing an example of how market power can inflict not just harm on the pocketbook, but actually take lives.
The existence of a general price regulator would have allowed us to pass judgment on Boeing, because what price regulators do is to extract information from big businesses about their costs, including overhead, and based on that to determine whether these firms need to engage in price discrimination to survive, and if so, how much price discrimination is required to cover costs. Regulators then approve price discrimination — called “demand-based pricing” in regulator-speak — if it is needed to cover costs, and reject it where it amounts to no more than an exercise of monopoly power.
Because we have no price regulation of airline production, we simply have no way of telling for sure what Boeing was doing when it decided to charge more for the safety option.
Indeed, the advantage of having a rate regulatory agency goes deeper than just ensuring that firms deploy price discrimination only when it is absolutely necessary to cover costs. Rate regulators have a long history of using their power to approve prices to insist that firms structure their covert price discrimination in a way that is maximally beneficial to consumers. That includes insisting that when firms break their products into base models and sets of options, they do so with a view to safety. Indeed, one of the great benefits of rate regulation is government say over what constitutes an acceptable product. When the airlines were regulated by the Civil Aeronautics Board, for example, the regulator insisted that the airlines maximize the number of direct flights they offer, with the result that today’s layover hell was largely unknown to mid-century fliers.
Boeing has an incentive to make safety features optional, because high willingness-to-pay airlines are more likely to cough up for safety options. But the extra profits that go to Boeing from being able to price discriminate against wealthy airlines come at the cost of delivery of unsafe planes to budget carriers. A rate regulator might well have insisted that that Boeing’s definition of a base aircraft model include far more safety features than it does today.
Of course, the Federal Aviation Administration, which has authority over flight safety, could have mandated that airlines purchase the optional safety features, but chose not to do so. But a rate regulator would have added an additional regulatory safety net, making it possible to stop dangerous pricing at the source — when the prices are chosen — rather than when airlines make decisions about which options to buy, as the FAA would have done.
The elimination of MFNs, argue antitrust experts, will promote competition between Amazon and other ecommerce platforms, by allowing third-party sellers to pass on savings to consumers from doing business on lower-fee platforms. If Barnes & Noble, for example, charges a bookseller less to sell books on the Barnes & Noble website, the bookseller will now be free to charge a lower price for its books on the Barnes & Noble website than the seller charges for the same books on Amazon. That in turn will drive business to the Barnes & Noble website, giving Barnes & Noble a reward for lowering its fees and innovating in cost reduction.
That would be the right way to think about MFNs, if the choice were only between laissez faire and antitrust. But there is in fact a third option, which strictly dominates both of the others. Namely, to regulate Amazon’s fees. If Amazon were required to obtain federal government approval of the fees it charges third-party sellers for use of its platform, then regulators could insist on low fees, and even force Amazon to innovate in cost reduction by mandating fees that are below current costs (preventing Amazon from turning a profit unless it innovates). That would unleash all of the benefits that greater competition between platforms promises to provide.
But it would also preserve advantages that platform competition simply cannot offer. Consumers, after all, like knowing that the price they get on Amazon is the best price available anywhere for the product. Anyone who has wasted hours on one travel website after another trying to find the best airfare knows how much time and effort is required to get the best price when such guarantees do not exist.
Indeed, through MFNs, Amazon effectively leveraged its size to impose a law of one price for consumer products across the internet, and that had huge consumer benefits. Amazon is so big that virtually all products of any interest to consumers are sold through its website. By imposing MFNs, Amazon ensured that consumers wouldn’t need to engage in wasteful and time-consuming searches for the best internet prices when they went to buy online. By going to Amazon, consumers could be sure to find any product available on the internet at the best possible price. Amazon used its size to make life easy for consumers, by turning the internet into a one-stop shop.
We must think of Amazon’s MFNs as accomplishing something that we might ideally want a government regulator to accomplish: making it impossible for anyone, anywhere on the internet, to get ripped off by being charged a higher price for a product than a price available for the same product somewhere else. The MFNs, in other words, were an internet-wide guarantee against price discrimination, that nemesis of all consumer welfare.
While the MFNs did prevent third-party sellers from passing the gains from buying on cheaper platforms on to consumers, the MFNs’ elimination of price discrimination was also valuable to consumers. To give but one example, consider that price discriminating firms frequently use search costs to distinguish between high and low willingness to pay buyers: they offer lower prices only to those who signal their inability to pay more by engaging in wasteful searches for better prices. The poor must clip coupons to get lower prices — or waste time searching for better prices on seller websites or obscure platforms — whereas the rich sail through checkout lines. The MFNs spared consumers such indignities.
Their demise undermines the public benefit of one internet price that Amazon was able to provide to consumers thanks to the firm’s size. And that’s why government regulation of Amazon’s fees is better than either laissez faire or the antitrust solution of simply eliminating the MFNs.
A fee-regulated Amazon would be unable to take advantage of the MFNs to charge higher fees, or to fail to continue to invest in innovations that would reduce the cost of providing platform services, thus the concerns about MFNs that antitrust and competition policy are intended to address would also be addressed by fee regulation. But fee regulation would not require elimination of the MFNs, and would therefore preserve the huge benefits to consumers that come from the guarantee of always being able to find the lowest internet price in one place: Amazon.
Thus fee regulation would realize all of the benefits of competition, while inflicting none of the costs on consumers. As in so many areas, we must therefore understand the antitrust victory here to be only relative at best. Society might be better off as a result of the demise of Amazon’s MFNs, but only if the gains to consumers in the form of more platform competition happen to outweigh the losses to consumers from the demise of the guarantee of one internet price and the associated return of price discrimination. But even if society is rendered better off by the demise of the MFNs, it certainly is not rendered as much better off as it would be were policymakers simply to step in to regulate Amazon’s fees and allow MFNs, and the Internet of one price, to prevail.
Much of the popular discussion of the trust question has proceeded upon the assumption that trusts are the result of some sort of immoral conduct which should be made illegal. But the same facts which led to the grant of exclusive franchises (legal monopolies) in the case of local public utilities, have led also to a belief that many of the monopolies which have grown without formal legal grant may likewise be beneficial if subjected to proper public control. The courts in this country, as well as many economists who specialize on “trusts,” have long since come to the conclusion that the anti-trust laws, even if desirable, do not in all cases furnish a sufficient solution of the monopoly problem, and that accordingly governmental price-fixing may be a desirable supplement. But neither the courts nor the teachers of “trusts” seem fully to realize that the determination of a “fair price” is not a search for some objective fact, but that it involves the adoption of a policy; and that the policy cannot be adopted intelligently without a drastic revision of accepted economic theory as well as the accepted theory of private ownership; and that the officials charged with the formation of the policy must perforce resort to some theory as to the proper distribution of income and as to the channels into which industry should flow.
Robert Lee Hale, Economic Theory and the Statesman, in The Trend of Economics 189, 193 (Rexford Guy Tugwell, ed., 1924).
Commentators regard the [Alcoa] case as one of the most powerful statements in antitrust jurisprudence for the robust efforts to constrain dominant firms. Discussions of the case often place [eminent progressive jurist] Learned Hand at the center of attention and ascribe to Hand the views espoused in the court’s decision. Hand believed otherwise. He disliked the antitrust laws from his earliest days in public life. In a representative statement of his views, Hand wrote to a friend in 1914:
“I do not agree by any means that the Sherman Act is of value or that the progressive party should take its position against monopoly. . . . I have always suspected that there are monopolies possible which depend for their maintenance wholly upon economic efficiency and which it would be an economic blunder to destroy.”
. . .
In a separate memorandum [in the Alcoa case], Learned Hand noted: “There are two possible ways of dealing with [monopolies]: to regulate, or to forbid, them. Since we have no way of regulating them [because regulatory legislation has not been put into place], we forbid them. I don’t think much of that way, but I didn’t set it up; and now the ordinary run of our fellow-citizens — some, even of the ‘rugged individualists’ — regard the Sherman Act as the palladium of their liberties.”
Andrew I. Gavil et al., Antitrust Law in Perspective 475, 477 (3d ed. 2017).
The emails show that in 2013 Facebook cut off Twitter’s access to its users’ Facebook friend lists to cripple the growth of Twitter’s once-popular short-form video sharing service, Vine, which Twitter shuttered in 2016. The emails also show that Facebook used acquisition of the startup Onavo to spy on users, identifying WhatsApp as a serious threat in the process, and later acquiring that company, presumably to eliminate it as a competitor.
Both of these actions harmed competition, by eliminating what antitrust lawyers call “nascent competitors,” firms that could have matured into serious competitive threats to Facebook. Vine might have helped Twitter develop out of its microblogging niche into a full-fledged social media platform in direct competition with Facebook. And the same might have been true for WhatsApp, which could have leveraged its huge user base and privacy commitment to expand beyond chat into Facebook’s social media heartland.
But most antitrust policymakers today are unlikely to see either Facebook’s calculated crippling of Vine, or the company’s snooping on nascent competitor WhatsApp, as problematic. For antitrust policymakers today, refusing to share and espionage are examples of the kind of no-holds-barred striving to win that ensures that competition yields results for consumers. As the greatest living antitrust scholar today, Herbert Hovenkamp, put it in a recent treatise, making firms share with competitors — which is what Facebook refused to do when it cut Vine’s access to friend lists —
is manifestly hostile toward the general goal of the antitrust laws. It serves to undermine rather than encourage rivals to develop alternative[s] . . . of their own.
Fortunately, there is actually a strong case to be made that Facebook’s treatment of Vine, at least, violated existing antitrust laws. But before getting to that case, let’s look more closely at exactly what Facebook did to Vine and what’s wrong with antitrust’s prevailing approach to that kind of conduct.
It’s clear that access to Facebook friend lists was key to Vine’s growth, because that allowed users in effect to port part of their existing social network from Facebook over to Vine, and then to use it to do something — post short-form videos — that Facebook at the time did not yet allow users to do.
By in effect preventing users from porting their network to Vine, Facebook denied Vine an essential input — the infrastructure to port the Facebook network into Vine — that was key to allowing Vine to break into the social media market.
Two Minds About Sharing
Refusals to deal have long vexed antitrust enforcers because they appear to be at once good and bad for competition.
They are bad for competition because if the input is truly essential, then the refusal to supply it to a competitor is fatal to the competitor. Indeed, if “input” is defined broadly enough, all anticompetitive behavior amounts to a denial of access to an essential input of one kind or another. You cannot harm competition any other way.
At the same time that refusals to deal appear bad for competition, however, they also appear to be good for competition, albeit competition of the bare-knuckle sort.
The toughest races are those in which you can expect no help from the other participants. The refusal of a firm to deal with competitors just creates an incentive for those competitors to go beyond the withheld input in question to find a new way to survive, to innovate, to create, to surpass.
This view of the virtues of no-holds-barred competition serves as the basis for the current ascendancy of the “Colgate Doctrine,” the antitrust rule that a firm has no general duty to deal with competitors. The doctrine takes its name from a 1919 case in which the U.S. Supreme Court permitted Colgate, charmingly described by Justice McReynolds as “a corporation engaged in manufacturing soap and toilet articles and selling them throughout the Union,” to refuse to sell its products to discounters.
[i]n the absence of any purpose to create or maintain a monopoly, the [antitrust laws do] not restrict the long recognized right of trader or manufacturer engaged in an entirely private business, freely to exercise his own independent discretion as to parties with whom he will deal.
For most of the century during which this language has been on the books, antitrust enforcers quite reasonably read the paean to business freedom in the second clause in conjunction with the first — “[i]n the absence of any purpose to create or maintain a monopoly” — to mean that the right to refuse to deal, whatever its extent, has no purchase whatsoever on the antitrust laws, which are dedicated to preventing the creation and maintenance of monopoly.
But in recent decades, the courts have preferred to drop the qualification contained in the first clause altogether, and to recognize a general right to refuse to deal even when the creation and maintenance of monopoly are rather baldly at stake. As Justice Scalia put it in an infamous 2007 opinion,
Firms may acquire monopoly power by establishing an infrastructure that renders them uniquely suited to serve their customers. Compelling such firms to share the source of their advantage is in some tension with the underlying purpose of antitrust law, since it may lessen the incentive for the monopolist, the rival, or both to invest in those economically beneficial facilities.
This notion that triumph of any kind in the free market is a necessary incentive for progress filters our understanding of competition through the fearsome metaphor of natural selection, survival of the fittest, the war of all against all, the Origin of Species.
According to this view, the lion did not need antitrust restrictions on refusals to deal to evolve out of the primordial soup, and if the lion goes extinct because humans fail to share habitat, that represents a triumph of competition, because the lion will then be replaced with a creature that obviously represents an evolutionary advance: us. Moreover, the argument goes, if the lion had been forced to share with the ape back when the lion was the king of beasts, the ape likely would never have needed to learn to walk upright, to heave javelins at passing herds, and eventually to invent the computer.
The natural selection metaphor is a big mistake, because the apparent virtues of natural selection are subject to severe survivorship bias. We’re here, and living and thinking, so our evolution must have been a success. But all those creatures who never came to exist — imagine whatever god or fairy you wish, so long as the creature is better than us according to whatever metric you prefer — aren’t here to observe the failure of their natural selection, because they never came to be.
The only thing we can say for sure about natural selection is that it selects; we cannot say that it selects well, for the criteria according to which it selects are unregulated. Natural selection is undirected, and therefore unreliable, selection. The rumpled paper airplane that is natural selection spirals off in whatever random direction the environment happens to impose upon it, with no guarantee that the direction is good, let alone the best, according to any metric we as human beings might hope to use as measure. Climate change, and the very real prospect of the imminent termination of life on earth, is a convenient reminder that the direction of evolution — evolution that has led to us — may be very bad indeed.
It follows that to consign our markets to the same law of the jungle that has produced us is a big mistake. Indeed, it is the sort of mistake that would scandalize our forebears, who, living closer to that state of nature themselves, understood our human advantage to be our capacity to choose the criteria according to which selection proceeds, rather than to submit to the random criteria of the jungle. Our talent for directing our own selection, not to mention the selection of other creatures (think of your dog) is our great advantage. (Indeed, our forebears understood this perhaps too well, leading to an excessive affection for absolute monarchy and planned economies. Ancient Egypt springs to mind, with its conscious glorying in divine kingship as antidote to the chaos of the natural world.)
To continue to escape nature, we must continue to choose the criteria according to which we select ourselves, and that is as true when we structure our markets as when we design our education system. Markets are themselves just machines for the selection of the things we want the economy to produce, with profitability determining winners and bankruptcy determining losers. These machines are useful to us only to the extent that they select for the characteristics that are most helpful to us. A market that selects for sloth, or for behavior designed to take wealth from others without providing a quality product in exchange, is not a useful market. The way to make markets select for desirable characteristics is to ensure that the undesirable characteristics provide no advantage.
The question that refusals to deal really pose is whether permitting firms to horde essential inputs selects for characteristics that are good for the economy. And here the answer must be no. If the input denied to competitors is truly essential, then there is no obvious way to invent around it, and so the characteristic that legalizing such refusals selects is talent for identifying and appropriating essential inputs that deliver the firm from having to compete hard on all the other characteristics that we really value, such as good management, incessant innovation, quality, distribution, and low costs. Allowing refusals to deal unlevels the field.
Selecting for skill at destroying competition may of course incidentally sweep in some characteristics that we care about — ambition, of course, and innovativeness aimed at finding or creating the essential inputs — but the presence of this anticompetitive selector pulls the market out of focus, sapping competitive energies away from the things we care about — low prices and high quality — and toward monopoly.
Sometimes the question is muddied by the need to ensure that innovative firms are able to cover the costs of research and development before competitors appropriate their innovations, pile into the market, and erode profit margins. In these cases, it is the refusal to deal that keeps the playing field level, instead of skewing it, by ensuring that innovators get the proper rewards. But true refusal to deal cases are different. True refusal to deal cases involve a refusal to supply an essential input when doing so facilitates supracompetitive profit taking, a dominance of markets that is not necessary to help firms cover their costs. Antitrust policymakers today would treat every refusal to deal as if it were necessary for firms to cover research and development costs, a conceit that is necessary only because the reality of almost never condemning a refusal to deal is so unjustifiable.
The Surprisingly Apt Sports Metaphor
Ensuring that undesirable characteristics provide no advantage is just what we do when we level a playing field in sports. Take a soccer game played on a hillside, for example. The inclined field gives one side — the side with the higher goal — an advantage based on luck, or the ability to strong arm the other team when sides are chosen before play, instead of based on characteristics that we want to promote, such as training, endurance, and the ability to bend a football into a net from twenty yards out.
To avoid this sort of adulteration of play, we insist on level playing fields in sports. It’s the reason we recoiled from steroids in baseball, for example, because all those home runs created an advantage that made for boring, uni-dimensional, play. Indeed, we feel the same way about all doping, because it leads to selection based on chemistry, rather than on the endurance and coordination that we value in sports. Only the level playing field produces the fittest players, just as it produces the fittest firms.
Just as we expect opposing players to help each other up off the ground when they have fallen — because losing a player makes for less satisfying play — we should expect firms to help each other to enter markets, when that would make for tougher, and therefore more productive, competition.
Success and Excellence
The individual firm must therefore be governed by an ethic of excellence, rather than an ethic of success. For only the pursuit of excellence causes firms to affirmatively seek to bring competition upon themselves, whereas an ethic of success causes firms to seek only to win, rather than to win by being the best. We want the great athlete, who wants to run the hardest race against the toughest competitors, not the slouch or the crook, who celebrates when the going gets easiest.
This distinction, between the pursuit of success and the pursuit of excellence, may be loosely, and probably unfairly, associated with the divergent outlooks of the two great civilizations of European antiquity, the Romans and the Greeks. Ancient Greek culture focused on the struggle with the self, the desire to go beyond mortal limits through exposure to competition of the highest order, a desire reflected in the tradition of the Olympic Games.
The pursuit of success over excellence is a recipe for long-term failure of industry, and a threat to American national security in a world in which America is no longer clearly the most technologically advanced nationor the strongest economy, a world in which the failure to demand that our firms strive to be the best, even when they could succeed with less, could well mean the difference between victory and defeat in the next war. (True, Rome built a more enduring empire than did the Greeks, but that is only because internally, in their training and organization, the Romans were Greek.)
Which takes us back to what Facebook did to Vine. By killing Vine off via refusal to deal, Facebook prevented Vine, and Twitter, from morphing into genuine challenges to Facebook’s dominance as all-purpose social media platform.
That means that today Facebook doesn’t face the kind of competition it needs to continually improve, the competition on everything from likes to privacy that can come only from doing battle with other firms on an equal playing field, the competition that affects characteristics that matter. Instead, Facebook competed on one characteristic alone — the ability to build the largest network first — and used that high ground to defeat a more tech-savvy competitor.
That’s a recipe for the long-term decline of American social media, and of American tech savvy more generally.
The Antitrust Case against Facebook’s Treatment of Vine
Facebook’s killing of Vine should be the easiest of antitrust violations to prove, but instead the case can be made only through the luckiest of coincidences. Luck is needed because of the current ascendancy of the Colgate Doctrine: the right of any business to refuse to deal, even if that would create a monopoly.
Under the influence of economists and lawyers associated with the Chicago School, the courts have all but eliminated any liability for refusal to deal, allowing it only when the refusal represents the termination of a prior profitable course of dealing. The idea behind narrowing liability to this unusual set of facts is that only when the refusal to deal amounts to a choice to forego a current profitable relationship can enforcers be absolutely certain that the motivation for the refusal is to earn even greater profits from the destruction of competition. As Justice Scalia put it in that 2007 case,
The unilateral termination of a voluntary (and thus presumably profitable) course of dealing suggest[s] a willingness to forsake short-term profits to achieve an anticompetitive end.
Motivation should have no place in the resolution of antitrust cases, because the antitrust laws are not about policing morality, but about guaranteeing the vigor of the economy. What matters in antitrust are outcomes, not whether businesspeople act with virtuous or heinous intent. But this perversion of the law is of no consequence in the case of Facebook’s treatment of Vine. Miraculously, the question of Facebook’s motivation is subject to no doubt here because the British have provided us with emails pregnant with anticompetitive intent:
Justin Osofsky — Twitter launched Vine today which lets you shoot multiple short video segments to make one single, 6-second video. As part of their NUX, you can find friends via FB. Unless anyone raises objections, we will shut down their friends API access today. We’ve prepared reactive PR, and I will let Jana know our decision.
MZ – “Yup, go for it.”
But even if there were no such evidence of intent, Facebook’s actions meet the prior profitable course of dealing standard imposed today by the courts.
Facebook’s sharing of friend lists with Vine allowed Facebook to collect valuable data about which Facebook users were using Vine. Facebook’s termination of that sharing therefore represented the termination of a prior profitable — in data-denominated terms — course of dealing, the unmistakable sign the court demands that the motivation was to earn even greater profits — here in the form of monopoly-level access to users’ social networking data — that come from squelching competition in the market.
So as luck would have it the case against Facebook fits squarely within the sliver of an exception to the Colgate Doctrine currently tolerated by the courts. But the fact that we need to fit the case into that sliver tells much about the extent to which antitrust has been failing in recent decades in its duty to ensure level competitive playing fields.
Integrating into Espionage
The situation is even worse when it comes to Facebook’s snooping on, and eventual gobbling up of, WhatsApp.
The story of global merger enforcers’ disastrous failure to block the WhatsApp acquisition due to a failure to appreciate that consumers pay for both Facebook and WhatsApp in data, making the two companies rivals, and the merger the brazen elimination of a nascent competitor, has already been told. But Onavo’s role in helping Facebook identify WhatsApp for acquisition points to another failure in contemporary antitrust: the death of vertical merger enforcement.
Onavo’s app is properly understood as a component of the social media product offered by Facebook , one that includes not just liking and photo sharing, but also privacy services. As such, Onavo and Facebook stood in what antitrust lawyers call a “vertical” or supply-chain relationship, producing components of a common end product — the social media experience — that is sold to consumers. And Facebook’s acquisition of Onavo was therefore a vertical merger.
But in the 1980s antitrust enforcers abandoned vertical merger enforcement entirely, on the assumption that innovation and efficiency always result when businesses in a vertical relationship work together to serve consumers. The district court’s stinging and misguided rebuke of the Justice Department’s recent attempt to revive vertical merger enforcement by challenging AT&T’s acquisition of TimeWarner shows how alien the old learning regarding the threat of vertical mergers has become to the courts in recent decades.
There might well have been some synergies between Onavo’s analytics services and Facebook’s social media platform, but the role the acquisition played in enabling anticompetitive snooping makes clear that the dogma that vertical mergers are always good for the economy must go.
In everyday life economics presents itself to us first and foremost as a problem of distribution, not of output, not of what economists would call “allocative efficiency.” This pizza place is ripping you off. That employer is lowballing you. In our intuitive economics, higher prices mean someone is taking money out of our pockets and putting it in theirs. And low prices mean we are taking money from someone else’s pockets and putting it in ours.
Only once we’ve considered these distributive consequences do we go on to consider the effect of pricing on output, and even then we usually do so only in the context of bargaining over distributive outcomes. Thus we might say: “If he doesn’t lower the price of a slice, I’m going elsewhere.” Now, that’s an effect on output: the high prices cause you to buy less. But even when we make threats like that, we think of them as a bargaining position: we threaten to go elsewhere, so that the price will go down, and we can therefore be richer.
Yes, maybe we go elsewhere because we can’t afford it, but then we rue the fact that we are not richer — that more wealth has not been distributed to us — so that we would be able to buy. We don’t think to ourselves: “this price tells me that I don’t care as much about this product as the person who produced it, and therefore it is right and proper that I not buy this product and buy something less expensive instead.” That would be a view focused on allocative efficiency. We think instead that we should be given more money, or should find a way to get it ourselves.
Our way of thinking about prices and markets is through and through about the distribution of wealth. But introductory economics takes almost no account of this. Instead, economists introduce their subject primary by reference to competition, not monopoly. (The wildly popular Varian Intermediate Microeconomics textbook, for example, teaches competition before monopoly.)
But theories of competition are not about distribution at all.
In competitive markets, there is no give whatsoever in price. Price is uniquely determined by supply and demand to be just high enough to cover the cost of production and just low enough so that everyone who is willing to pay the cost of production, but not a penny less, is able to buy. As a result, there is no distributive question in competitive markets. Sellers never make any profit, because they sell at cost. And buyers never get away with good deals, because they always pay the maximum that they would be willing to pay for the good.
Indeed, in a world of competitive markets, you cannot, must not, ever think of prices as being too high or too low. If the pizzeria raises prices, it must be because the costs of production have gone up. If your employer reduces your wages, it must be because the value of your labor to the employer has gone down. The pizzeria is not trying to redistribute wealth to itself, but only responding to changes in the value that society places on the ingredients of pizza — cheese, tomatoes, and labor. Society values some of these more than before, which is why their costs have gone up, and that in turn is why the price of your pizza must go up. If you can’t afford the new prices, then you must not care as much about pizza as society cares for the cheese, labor, and tomatoes, and so it is right and proper that you not buy. To complain about the higher prices is not just foolhardy — nothing you say or do can bring those prices down, unless you are able somehow to change the value that society places on those ingredients — complaining is also evil, because it amounts to demanding that you be given something that you don’t deserve. If the pizzeria were to listen to your blandishments and give you a discount, then someone who values the ingredients of pizza more than you, someone who is willing to pay more for them than you, will not be able to buy them, and society as a whole will be worse off, because it will have taken things from someone who values them more and given them to someone who values them less. To hold out for a better deal is to try to pervert a mechanism that, if left to its own devices, ensures the greatest good for the greatest number.
It is my sense that the main reason for which economics seems to turn off the students with the greatest interest in the field is that these students can find in theories of competitive markets no shred of the distributive intuition with which they are familiar. Moreover, the theory of competitive markets destroys the motivation to study economics of anyone who actually cares about economic outcomes. Because the theory of competition suggests that the economy is a machine, and not a social endeavor at all, which in turn suggests that non-interference is the proper way to interact with the economy. Do not complain about prices. Do not hold out. Do not bargain. Just accept the prices and wages that you are given, and make sure that everyone else does too, and you can be confident that the prices are just and the wages are just. But we do not become interested in, and study, things that we do not wish to interfere with. No. We become interested in, and study, things that we want to tweak, to improve, and so on.
So those who are most interested in economics come to economics (1) with a thirst to understand how economics drives distributive outcomes and (2) with a thirst to understand what can be done to improve those outcomes. Introductory economics courses tell these students: (1) economics poses no distributive questions at all and (2) to the extent that there are any problems with the economy, they can be solved only by doing nothing. No wonder that few economists seem really passionate about their subject. The way introductory economics is taught alienates all those students who are really passionate about the subject.
That is a shame, because the economic concept of monopoly speaks to all the frustrations of those who really care about economics. It’s a crime that the concept gets so little coverage in introductory economics courses, a crime all the more serious because not only do economists of all stripes agree — at least when pushed — that the monopoly concept is far more widely applicable to economic life than the competition concept (think product differentiation and monopolistic competition), but the monopoly concept is also the far older and more established of the two concepts in economics, stretching right back to Ricardo and beyond (Adam Smith talked about both competition and monopoly, but he didn’t have models for either). If there is one piece of good that might be done for the world in matters economic, it might well be to henceforth start all economics textbooks with monopoly, and leave competition for the last chapters, the way monopoly is left to the end today.
(This extends, as well, to the teaching of introductory game theory. The game theoretic counterpart of the monopoly concept is bargaining, also called cooperative game theory, because bargaining is all about the distribution of surplus, and not about immutable equilibrium results. Why, then, is it that Dixit only gets to bargaining in the final chapter of his seventeen-chapter introduction to the field, Games of Strategy? Do not tell me that it is because the mathematics of bargaining is harder. It’s only harder because distributive questions are underdetermined — any distribution is possible — which means mathematics isn’t all that useful for distributive questions to begin with. Distributive questions are political, not mathematical, questions. The responsibility of economics is to study the economy, and to emphasize the most important aspects of the economy, not to emphasize the aspects that are mathematically tractable. Economists ought to lose named chairs if they do otherwise.)
Why does the concept of monopoly speak to our basic distributive intuition about economics? Because the monopoly concepts admits that people can and do choose their prices, that the supernatural forces of the market do not choose prices for them, and therefore that the distribution of wealth matters. The pizzeria can choose higher prices, and in so doing can extract more wealth from us. And our employers can pay us lower wages, and deny more wealth to us. And when the pizzeria or the employer acts this way, the monopoly concept tells us that the prices the pizzeria charges and the wages the employer pays are not necessarily an accurate reflection of the cost of making pizza or the value of our labor. If the pizzeria raises prices, it might be because costs have gone up, but it might also be — indeed, it is most likely to be, if we accept that in a world of differentiated products every firm has some amount of power over price — because the pizzeria has decided to try to extract more wealth from us in exchange for providing a good that hasn’t changed in value at all. And now, knowing that prices can rise even when value does not, it makes sense that our instinct is immediately to bargain, to walk away, to hold out, in order to drive that price down. Indeed, knowing that prices can rise even when value does not, it makes sense now that we intuitively view all of our economic interactions first and foremost in distributive terms, because economic interactions are first and foremost about distribution. Any creature foolish enough to just intuitively accept prices as dictated was long ago flushed from the gene pool, having failed to reproduce, because the creature spent all its money on pizza, or failed to bargain for a higher wage.
The monopoly concept tells us that to complain about prices is not to threaten to upset a well-oiled machine, not to try to take from others what they value more, but to insist on a share of the productive pie. The pizzeria creates value — surplus — over the cost of production when the pizzeria makes pies. Why? Because the pies are worth more to us than cheese, tomatoes, and labor separately. That surplus is expressed in the maximum prices that we are willing to pay for pizza, maximum prices that exceed the cost of cheese, tomatoes, and labor. What to do with this surplus of pleasure (our pleasure) over cost, of this surplus of our pleasure over the pleasures foregone by those who would otherwise use the cheese and tomatoes, or spend their labor time on other pursuits? If the pizzeria charges a high price — a price equal to our maximum willingness to pay — then we give that surplus to the pizzeria. If the pizzeria chooses to pay a higher wage than the minimum that its workers are willing to accept, then the pizzeria passes some of that surplus along to its workers. Otherwise, the surplus goes to the owners. And if the pizzeria charges a low price, a price equal just to its cost of cheese, labor, and tomatoes, then we, pizza eaters, get all of the surplus. This is real economics, the economics of the everyday. It’s also a fundamental part of virtually all economic research today, but you wouldn’t know it from taking an introductory economics class. Persevere.
In the world of the monopoly concept, economics is inexorably political, there is always something to be done to improve the system, and doing nothing means catastrophe. Distribution is politics. Should the workers take more of the surplus? Should consumers? Are prices too high? Too low? Something must be done. The monopoly concept takes you straightaway to action.
There is much that can be done. You can lower prices by promoting competition in markets. Is it hard to find another pizza place charging a lower price, which is why your local pizzeria feels comfortable raising prices? Why, then, is it hard to find competitors? Are they all owned by the same firm, despite different branding? Do they use WhatsApp to fix prices? Are there just too few of them? To solve these problems, you need to advocate for greater antitrust enforcement.
But you can also lower prices through “rate regulation” — government setting of prices. This is a lot more common than you might think. States regulate the prices charged by power, gas, and water companies, among others. And have regulated prices in many more industries over the past century or so. Indeed, regulatory economics and auction theory are devoted to little else than finding low-cost ways for government to set prices (albeit with less attention to distributive concerns than there should be).
There are yet other ways to deal with prices. Thee is the political harangue. Studies show that when presidents complain about high drug prices, prices fall. There is also the reallocation of property rights. Indeed, the problem of pricing strikes deeper than antitrust, with its focus on anticompetitive conduct, deeper even than rate regulation, with its focus on dictating prices, and instead goes to the heart of our legal system, and in particular the part of it dedicated to property. The home you own monopolizes a bit of space in the world, and that is why, when that space is in great demand, homeowners can become enormously wealthy, because they exploit that monopoly to charge the highest possible prices to buyers. Maybe that’s a good thing if the homeowner started out with modest means. But the point is that property is monopoly (a thing that was said long before Eric Posner and Glen Weyl called attention to it in a recent book). One way to drive prices down, or more generally to redistribute wealth, is to divide up or redistribute property. And that bring us to tax policy, which strives to deprive you of the fruit of your property-based monopolies, albeit without tying to deny you title to them. Property tax makes you pay some of that higher price you can claim back to the state. Income tax makes you pay some of the higher wages you can charge due to your monopoly over your talents back to the state. Sales tax does almost the same thing as rate regulation, making the pizzeria pay some of the monopoly profits it earns from you back to the state (don’t be fooled by the way stores fight the tax politically by adding the tax onto your bill — the bill would be higher without the tax). Trust getting busted, price being set, Presidents complaining, property being expropriated, and everything being taxed. You don’t get any more political and interventionist than that.
Moreover, unlike in competition theory, in monopoly theory the alternative of doing nothing about prices is just not any option, unless you believe that owners should always enjoy all of the surplus generated by production. Why? Because all markets tend naturally toward monopoly. Firms acquire firms, and run others out of business. Over time the result is monopoly everywhere, and owners that charge consumers the highest possible prices, and redistribute nothing to their workers. Unless government does something, whether to promote competition through the antitrust laws or property reform, or to regulate prices directly as part of a rate regulatory regime, markets will tend naturally to allocate all wealth to business owners. We are very far now from the competitive world view in which any sort of intervention in the economy misallocates resources.Of course, the two models — competition and monopoly — do work together. If you drive prices too low, or wages too high, then the allocative effects that competition theory worries about start to kick in. The pizzeria does have costs, and if you drive price below costs, then you really will start taking cheese, tomatoes, and labor from those who value these things more highly than you do. But it’s a good rule of thumb to assume that the initial change in prices is a distributive change, not a competitive — or what economists would call an “efficiency”-driven change. Distribution comes first, which is why most of us intuitively think about it first when we consider economic issues, and why it ought to be taught first, too.
Indeed, I have come to believe that most of the differences I have with economists are attributable to the difference between the competitive and monopoly world views. Whether they admit it or not, all economists walk the earth with a default economic model in their heads, parsing and interpreting economic facts in the first instance through that model. And very often, precisely because they went through introductory economics courses that emphasized competition, economists’ default model is the competitive model, not the monopoly model. It’s fine to have a default model — all science has to start from priors — but for the reasons that I gave above, that economic reality is characterized in the first instance by pervasive monopoly, even if only of the differentiated product monopolistic competition variety, the default model that economists out to be carrying around with them is the monopoly model. But in fact economists don’t usually have the monopoly model in mind in the first instance, and sometimes they seem to have forgotten about it entirely when pressed on public policy matters, even though in their own advanced technical work they may use nothing but monopoly models themselves.
I struggled and struggled with his comments, trying to understand what I might be missing, until I realized that he was thinking in purely competitive terms. In his world, there simply was no surplus! Reduce the price of a pizza, and either someone gets something they don’t deserve, or — his point — the pizzeria will just produce less pizza, because any reduction in price must drive price below cost, making some production unprofitable. The notion that a price drop might have no effect on output was entirely alien to him. And yet at that very conference he had himself given a paper about monopoly in the finance sector! It wasn’t that he was somehow unaware of the monopoly concept, but that it wasn’t the default model that he useds when talking about policy issues.
Such are the wages of failing to emphasize the monopoly concept in economics education.
Baer kicked off his remarks by stating that antitrust’s consumer welfare standard — a target of OMI, and much discussed on panels earlier that day in Cambridge — should stay, because it’s the only administrable standard available to antitrust.
To see why the consumer welfare standard is hard to apply, consider the merger of AT&T and TimeWarner. Let us suppose that the merger would lead to reduced costs (because of the elimination of what economists call double marginalization), some improvements in program quality, because, for example, the combined firm can use viewing data to tailor content, and some increased market power, because TimeWarner can now raise prices to other content distributors safe in the knowledge that if negotiations fail and a blackout ensues, TimeWarner will still be able to continue to supply content to AT&T viewers.
The increase in market power suggests that consumers would be harmed by the deal, but whether that actually happens depends on whether either of two escape valves opens. First, cost reductions associated with the merger could make consumers better off, even after market power effects are taken into account, if some portion of those cost reductions are passed on to consumers in the form of lower, though still monopoly-power-inflated, prices. Second, even if any cost reductions are not passed on to consumers, the improvement in programming quality might itself ultimately make consumers better off, if the improvement is sufficiently large to offset any increase in prices. Given the existence of these two escape valves, determining whether consumers are harmed by the merger requires enforcers to predict the price effects of the merger, along with the dollar value of the improvements in programming quality brought about by the merger, and to compare the difference between the two, known as “consumer surplus”, with the original pre-merger difference between price and programming value to consumers.
That’s hard, because quantifying the value of programming to consumers requires enforcers to deduce the maximum prices that consumers would be willing to pay for the programming, rather than the real prices that consumers actually are paying.
Indeed, measuring consumer welfare is so hard that in practice enforcers don’t even try to measure it, the law be damned. Instead, they just test to see whether the merger will raise prices, pretending that price increases are a good proxy for consumer harm, which of course they are not. If the value of the product to consumers rises by more than prices, for example, then consumers benefit from the merger. By the same token, a merger could drive down quality — perhaps the union of AT&T and TimeWarner would unleash targeted advertising that actually reduces program quality, for example — to such an extent that consumers would end up worse off from the merger even if the merging firms were to share some of their cost savings with consumers by lowering prices.
Enforcers don’t try to measure consumer welfare because they can’t. And that tells us something important about whether the consumer welfare standard is as administrable as Baer says that it is: namely, that it isn’t administrable at all. Precisely because it is not clear in any case whether consumers are harmed, antitrust enforcers look to see whether prices would rise instead, since prices, thank goodness, are actually observable. Ostriches can relate.
In fact, enforcers don’t even proxy consumer welfare effects by looking exclusively at prices. Instead, they try to distinguish price effects unrelated to anticompetitive conduct, such as price hikes driven by higher energy prices, or other “exogenous” factors, and price effects that are attributable to the vigor of competition in the market. As I indicated in my earlier post on the CPI/CCIA conference, such an inquiry into what might be called “abnormal price effects” is really an inquiry into profit margins — increases in prices that are not driven by increases in costs.
And here is where the irony, and not just the falsity, of the claim that the consumer welfare standard is the only administrable antitrust standard shines forth. For the rule that antitrust should condemn anticompetitive conduct that increases profit margins is actually the old standard that the consumer welfare standard was fashioned to replace, the very standard in comparison to which the consumer welfare standard is supposed to be an improvement in administrability, practicality, clarity. The covert inquiry into profit margins that enforcers understand when they are supposed to be testing for consumer harm is nothing but the standard of the mid-20th-century golden age of antitrust. That standard prohibited all anticompetitive conduct, regardless whether the conduct harmed consumers or not, so long as that conduct could be expected to lead to, or protect, market power, defined as the power to earn abnormally high profit margins. The supreme inadministrability of the consumer welfare standard is actually expressed in the fact that enforcers don’t even follow that standard as a technical matter, but still follow the old standard that it was supposed to replace.
But if antitrust is still doing what it has always done in testing for abnormal profits, what explains the remarkable declines in antitrust enforcement since the Chicago School shifted antitrust to the consumer welfare standard in the late 1970s? The answer is that Chicago did not just change the standard on paper from harm to competition to harm to consumers, but also changed the burden of proof required to meet any standard. Thus while enforcers have continued covertly to apply the old standard — which looks at profit margins, not consumer welfare — they have done so with a level of skepticism about their own ability to identify increases in margins that did not exist before the triumph of the Chicago School in the 1970s.
To the extent that this skepticism is warranted, the consumer welfare standard is perhaps no more administrable than the margins alternative. But to the extent that the skepticism is not warranted, the consumer welfare standard is less administrable than the margins alternative. The fact that enforcers have sought in the measurement of profit margins a refuge from the challenge of measuring consumer welfare certainly suggests that margins are easier to measure, and that the consumer welfare standard is the less administrable standard. Either way, the consumer welfare standard is not more administrable than the profit margins alternative that came before it.
Another way to see this is to consider the role of the consumer welfare standard in basic antitrust doctrine. Before 1975, antitrust had two kinds of legal tests. The first, called the per se rule, condemned certain kinds of anticompetitive conduct full stop. The second, called the rule of reason, prohibited anticompetitive conduct by firms possessing, or acquiring through anticompetitive conduct, market power, understood to mean the ability to earn abnormal profits. The focus of the rule of reason on actually proving margins did not imply the unimportance of margins to the per se rule, only the willingness of enforcers to invest more time in proving margins in some cases (rule of reason cases) than in others (per se cases), for which latter it was hoped that proof of anticompetitive conduct alone would be sufficient to signal the existence of abnormal profit margins, at least on average.
Comes now the consumer welfare standard in the 1970s, which appears in the doctrine as an additional element required to meet the rule of reason test. Under that new rule of reason, three things were now required: (1) anticompetitive conduct, (2) market power, and now (3) consumer harm. Thus the consumer welfare standard created a compound test, one that requires both proof of abnormal margins and proof of harm to consumers.
But doing two things is not easier than doing just one of those things. The consumer welfare standard does not make it easier to do antitrust, but harder.
I put this point to the panel in Cambridge, but received only affirmations of faith in reply from several panelists, including former FTC chairs Jon Leibovitz and Bill Kovacic. Why does the consumer welfare standard seem to so many — and not just Baer — to be a practical standard? Why, because it’s an empyrean, an ideal, a beautiful but unobtainable thing. And we mistake the clarity of the vision for clarity of practice.
(Don’t the consumer welfare and market power (profit margins) elements in the new rule of reason test collapse into the same thing? No, for the same reason that consumer welfare can’t be proxied by price effects. Suppose that market power does allow AT&T and TimeWarner to raise prices after the merger, but also increases the value of programming to consumers by a greater amount. Consumer welfare increases, but margins also rise. Under the old rule of reason, which only looked at market power (profit margins), there is antitrust liability, but not under the new rule of reason, with its requirement of harm to consumers.)
The Challenges to Antitrust in a Changing Economy conference, put on by CPI and CCIA at Harvard Law School two weeks ago, was an opportunity for today’s antitrust establishment, on both the (center) left and right, to react to recent calls from activists and journalists loosely associated with the Open Markets Institute for a radical increase in antitrust enforcement. In particular, the conference provided a view of how establishment scholars have been processing OMI’s extraordinary influence on progressive thinking, not to mention the national press, over the past couple of years. (I don’t mean “establishment” pejoratively here, but only to signal that these are leading scholars in antitrust law and economics teaching at leading schools.)
The most serious challenge to the antitrust status quo as an intellectual matter has interestingly come not from OMI, but from finance economists, who have shown in recent years that firm margins, which are the difference between revenues and costs, have experienced an abnormal expansion over the past two decades or so, a period that corresponds uncannily to the period over which antitrust enforcement has been in decline. Margins are the profits of common parlance, and the implication of this work is that firms are generating greater profits than they ever could before, and have been doing it both in periods of recession — such as the Great Recession of 2007 — and in periods of economic expansion, such as that taking place right now.
These scholars — top flight economists all — have shown that none of the variables you might think would account for increased profitability, such as increased investment in new technologies, explain this trend. The explanation that leaps out, one that these scholars have not been able to explain away with their data, is that firms have been leveraging the greater market power permitted to them by declines in antitrust enforcement to extract more profits from markets.
Speakers at the CPI/CCIA conference two weeks ago pushed back against the evidence both of rising margins and of rising concentration. NYU’s Larry White kicked off the day with an attack on the margins evidence. He argued that the finance economists are missing something important that the industrial organization (IO) economists who traditionally have taken the lead in antitrust policy debates learned in the 1970s: namely, that margins can’t be measured.
The trouble, argued White, is that costs are difficult to define. Subtract away the costs of all physical inputs, compensation to workers, and the like, and you still might not end up with an accurate measure of margins, because some of the remaining amount may be necessary — necessary in the way that all costs are necessary to production — to serve as a cushion against an unexpected shock to revenues. Or to compensate innovators, or managers with special skills, and so on.
Invoking noted mid-20th-century IO economist Leonard Weiss, who was long an advocate of greater antitrust enforcement, White pointed out that it was Weiss who in the 1970s finally came to recognize that margin data were unreliable, and concluded that going forward antitrust policy would need to be based on observation of price effects, rather that margin effects. White’s point was that absent an accurate way to measure margins, antitrust policy must make do with looking to see whether prices, rather than margins, are rising abnormally in the economy. And prices, notably, have not been going up abnormally, creating no basis for increased antitrust enforcement. Finance economists, argued White, weren’t around for the bruising quarter-century-long quest to measure margins and relate them to concentration levels that took place in industrial organization economics during antitrust’s Postwar golden age, and therefore are making the same mistakes today that IO economists once made.
The trouble with White’s argument is that it proves too much, because antitrust is through and through dedicated to the measurement and prohibition of anticompetitively-generated margins, whether antitrust is willing to admit it or not. So giving up on the measurement of margins means giving up on antitrust. White himself seemed inadvertently to advertise this point at the end of his presentation. In the final portion of his remarks, White observed that the margins problem rears its head in antitrust today whenever the courts require proof of market power, because market power is the power profitably to raise price above competitive levels, and profits are margins. But precisely because the requirement of proof of market power is ubiquitous in antitrust law — a staple of the “rule of reason” standard applied to both collusion claims under Section 1 of the Sherman Act and monopolization claims under Section 2 — White’s skepticism about the possibility of measuring margins translates into skepticism about the entire antitrust project. Take White’s position seriously, and there should not only be no radical increase in antitrust enforcement, but no antitrust at all.
White likely didn’t see that implication because he believes, as much of the antitrust establishment seems to believe today, that it is possible somehow to use price effects as a substitute for margin effects in deciding whether firms have power over markets. The argument for using price effects goes like this. Instead of trying to identify markets in which price increases are profitable, and then to scrutinize the behavior of firms in those markets to make sure that they are not profiting by actively squelching competition, antitrust enforcers need only look to see whether suspect firms could increase prices over competitive levels in any of the goods they sell. If prices could go up, and statistical analysis shows that the increase would not be due to irrelevant factors such as an increase in input costs, then it is safe to assume that the increase in prices would be due to the anticompetitive conduct. The apparent beauty of this approach is that there is no need to measure margins.
Or is there? What antitrust economists all ought to know, but perhaps don’t want to admit to themselves, is that when they consider price effects they are always also implicitly measuring margins. How? When they control for changes in input prices, of course. Price effects can have many causes, and antitrust is not a price stability regime. Antitrust wants to condemn conduct — like horizontal mergers — that leads to higher prices only when those higher prices are a result of anticompetitive conduct, and not the result of increases in costs. But that just puts any student of price effects in the position of having to distinguish between price effects that are driven by higher margins — the channel through which all anticompetitive conduct affects prices — and price effects that are driven by costs or other extraneous factors. When an econometrician controls for input cost increases, the econometrician is really just measuring margins, implicitly using a metric that expresses margins as revenues less input costs. (The funny thing is that this simple approach to margins is precisely the one that White, and the Chicago School in the 1970s, so roundly criticized the earlier Postwar establishment for employing.)
In other words, margins in antitrust are everywhere, and unavoidable. Indeed, you cannot have antitrust without the measurement of margins, because anticompetitive conduct is uniquely identifiable through the abnormal margins that the conduct makes possible. Anticompetitive conduct that does not increase margins simply is not anticompetitive. Conduct must somehow fail to squelch competition, and therefore fail to enable the firm to extract more value from consumers, in order to be anticompetitive.
Of course, the reverse is not true, higher margins can be caused by factors other than anticompetitive conduct, but that does not permit antitrust to ignore margin effects; the subject of antitrust is precisely margins caused by certain types of conduct. To give up on the ability of economics to measure margins is to give up on antitrust. Despite declines in enforcement since the late 1970s, today’s antitrust establishment has been unwilling to give up on antitrust, and it has dealt with the immense cognitive dissonance associated with practicing a discipline that it believes impossible to practice by using the classic cognitive strategies of denial and avoidance. The establishment today acts as if the show can go on without the measurement of margins, which of course it cannot.
I put this problem to the panel, and the responses were highly instructive. Bruce Kobayashi, current head of the FTC’s Bureau of Economics, stated that “everything” the Bureau does involves the measurement of margins. Antitrust cannot function without it. And White, to his credit, threw up his hands, seemingly agreeing that if the measurement of margins really is impossible, then there can be no antitrust enterprise.
In a way, this debate cuts right to the heart of antitrust’s agony of the past forty years. Until the mid-1970s, antitrust enforcement in the U.S. was vigorous. The Chicago School attack that lowered enforcement was based primarily on radical skepticism about the ability of economic science to identify truly anticompetitive conduct, and that skepticism was in turn expressed in a skepticism about the ability of economics to measure margins. Perhaps finance economists will drive renewed faith in the power of economics to engage in such measurement, but even if they don’t, we need to come to terms with the fact that the actions of IO economists have already spoken louder than their words. In continuing to muddle along measuring margins while professing not to be able to measure them, IO economists have been telling us for the last thirty years that yes, you can measure margins, and run an entire policy sector based on them.
Recognizing that fact may be all we need to cure antitrust of its present timidity.