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Antitrust Monopolization Regulation World

The Impractical Consumer Welfare Standard

As I mentioned in an earlier post, the CPI/CCIA conference at Harvard Law School last month brought together establishment scholars from the left and right to consider the calls for radical antitrust reform emanating from the Open Markets Institute (OMI), calls that have captured the imagination of some sections of the press and the political classes over the past few years. Former US and EU antitrust enforcers spoke at the last panel of the day, including Bill Baer, who headed the Antitrust Division of the Department of Justice for part of the Obama Administration.

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.

But is it?

Antitrust’s consumer welfare standard holds that enforcers should challenge only anticompetitive conduct that threatens to harm consumers. The standard is the product of brutal intellectual clashes in the 1960s and 1970s between antitrust’s old establishment, which favored condemnation of all antitcompetitive conduct, regardless of effects on consumers, and a group of law professors and economists associated with the University of Chicago. These Chicago Schoolers succeeded at convincing courts and enforcers in the 1970s and 1980s that all anticompetitive conduct should be subject to a test for harm to consumer welfare, and condemned only if there is in fact harm to consumers.

OMI has tended to condemn the consumer welfare standard because the standard privileges the interests of consumers over the interests of other groups that may be harmed by anticompetitive conduct, notably workers, who suffer when employment alternatives disappear. But the immediate difficulty created by the consumer welfare standard has been more mundane: consumer welfare is hard to measure. Which makes it strange that Baer should think the standard administrable.

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.

At least for the moment.

(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.)

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Antitrust Monopolization Regulation

Marginally Everywhere

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 scholarstop 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.

This conclusion has been supported by data showing an increase in market concentration over the past twenty years, the absence of expanded margins in Europe, which has not seen a decline in antitrust enforcement, and increased concentration in U.S. labor markets and a corresponding stagnancy in U.S. wages. Much of this evidence, and its implications for antitrust policy, was brilliantly summarized by leading antitrust economist Fiona Scott Morton in her keynote address at the 2018 Mannheim Centre for Competition and Innovation Annual Conference, signalling that the radical spirit of the times might be making its way into the antitrust establishment through the data-rich conduit of the margins work being done by finance economists.

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.

Categories
Civilization Deliberate acts against interest Regulation

The Importance of Education

Education, or perhaps the better word is training, is the most important method of good governance in the unitary state because there is no market or public to discipline administration. Control of the mind is not just about dissent but about performance. Free speech rights undermine the unitary state as an effective organ by making it impossible for the state to perform. By contrast, market economies function well on very little organizational education — training — because of the discipline of the market and the voting of feet.

What I mean by training is the altering of human preferences to ensure that the trainee makes the most efficient set of credible threats.

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Civilization Regulation

The Irrelevance of Manipulation

It is not freedom, but coherence, that we seek. I do not mind my role, if you can convince me that it matters.

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Meta Regulation World

Capitalisms

I’m an engineer by training. I’m a very systems, process, methodical decision maker. He’s an entrepreneur. Different mind-set.

Management runs publicly-traded companies like ExxonMobil. Owners run private firms. The former are bureaucracies, the latter, fiefs. The former are a progressive invention, the latter much older. There is managerial capitalism, and then there is finance capitalism. There are corporations, and then there are businesses. Their leaders may look similar; they will all be, after all, rich. But they belong to different worlds.  Ross, Mnuchin, and Trump belong to one world. Tillerson to another. The distinction is so lamentably obscure to the national consciousness that even the members of these groups sometimes fail to understand that they are different.

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Antitrust Monopolization Regulation

Whole Food for Thought

An important point that didn’t make it into my opinion article arguing that the FTC should unwind Amazon’s acquisition of Whole Foods is this: Most people don’t buy groceries online today, but eventually they will.

That’s why I wrote that Amazon’s website, along with its voice search service, Alexa, constitute an essential marketing platform, required for future survival in grocery retail. Whole Foods now has a huge advantage over all other grocery retailers in attracting the coming wave of online grocery shoppers, because most people already use Amazon as their default search engine for finding goods to buy online. When these people start embracing online grocery shopping, they’ll log into Amazon to find a way to do that. And all they will find is Whole Foods. Even giant Walmart is unlikely to solve this problem, because its own website attracts far fewer online shoppers.

The central role of online product search to the future of the grocery market explains why Walmart responded to the Whole Foods deal by partnering with Google to offer Walmart items on Google’s Alexa competitor — Google Assistant. Google isn’t dominant in product search, or in voice search, so while that partnership may help Walmart, it won’t eliminate Amazon’s promotional advantage.

If the FTC were to unwind this deal, Amazon could still get into groceries, but only as a search platform, allowing grocery retailers to offer delivery services through Amazon, much as Amazon already opens its fulfillment centers to third party sellers. That would give existing retailers a more equal shot at search visibility on Amazon’s website. If the FTC won’t unwind the deal, it should at least order Amazon to give all grocers visibility, by including their offerings on its website, alongside those of Whole Foods.

True, the Whole Foods deal should lead to more competition in grocery retail for the time being. In order for Amazon to leverage its product search dominance to win market share, it must charge prices low enough to avoid encouraging consumers to give up using Amazon as their search default. That explains why Amazon cut Whole Foods prices immediately after the acquisition. As long as those prices stay low, consumers will stick with Amazon, and as online ordering takes off, Whole Foods will expand its share of grocery retail.

That in itself is a problem, and enough for the FTC to intervene, because it means that Whole Foods will win not by charging better prices or offering a better product, but because it can match the prices and product quality offered by others, and then tip the scale in its favor through its dominance of online product search. Competition realizes its potential only when firms win by charging lower prices or offering products of better quality.

Consumers will end up choosing Whole Foods not because it is better, but because it’s not worse, with visibility on consumers’ favorite product search platform becoming the deciding factor in the decision which grocer to use. The FTC won another case in the 1980s on precisely this ground, arguing that the maker of the ReaLemon brand of lemon juice used its promotional advantage to win market share while charging competitive prices.

A second consequence is that if Whole Foods manages to run the competition into the ground, then it will be able to raise prices eventually. Entering the grocery retail market, even an online market, is expensive, requiring a huge distribution network connecting, among other things, large numbers of suppliers of perishables to the grocer. If Walmart and other grocery retailers disappear, their distribution systems will disappear with them. And any competitor wishing to enter the market in response to eventual price hikes by Whole Foods will have to rebuild distribution from scratch.

Of course, Amazon might fail to capitalize on its advantage. Brand loyalty, or the promotional advantage bricks-and-mortar retailers have in promoting their own online delivery services to consumers shopping in their stores, might cause consumers to gravitate to the retailers they use today when they start shopping more online.

But the promotional advantage created by access to online product search platforms is real, and is likely to play a role in all consumer product markets in the future, if it does not already. The EU was concerned about precisely that when it fined Google $13.7 billion in June for privileging its own product search engine over others in its search results. Until government starts to treat product search as an essential facility or a public utility, an essential playing field that must be level if competition is to take place on the characteristics we care about, like price and quality, this problem will persist.

Categories
Regulation

An Unreliable Interest

The trouble with governance by markets is that self-interest is highly unreliable. The theory is that a firm’s owner will optimize management of the firm because it is in the financial self-interest of the owner to do so. But here we have Eddie Lampert, owner of Sears, phoning it in to Indiana from his home in Miami, and predictably driving the firm into the ground, losing himself billions.

If Sears were a government agency, and Lampert an appointee, he would have been fired, or reassigned, long ago, not least for failing to come to work. But because in the free market we bet everything on self-interest, when that fails we must watch paralyzed as an immense organization collapses, shedding jobs and undermaintained infrastructure as it goes down.

Yes, the market is disciplining Lampert in a sense, but at extraordinary cost in waste of assets, and disruption to workers’ lives, when the problem could be solved in a heartbeat for the price of a pink slip.