Links to the Congressional testimony are available here (including from Luke Froeb), an informative article in the WSJ, and another at MSNBC quoting Boston University’s Keith Hylton on the possibility that the post-merger firm would force sellers to reduce fees and pass-on lower ticket prices to consumers.

As TOTM readers are likely to know, the Supreme Court denied certiorari in Rambus, a course of action I had argued was the appropriate response to the arguments set forth in the Commission petition.  I recently expanded the blog post into a short essay which I’ve posted on SSRN.  It will also be available in a few weeks at Global Competition Policy.  Here’s the abstract:

In November 2008, the Federal Trade Commission petitioned the Supreme Court to review the D.C. Circuit’s decision in FTC v. Rambus. That decision reversed the Commission’s finding that Rambus knowingly failed to disclose a patent to a standard setting organization and, in so doing, acquired monopoly power in violation of Section 2 of the Sherman Act. In February 2009, the Supreme Court denied the Commission’s petition. This article examines some deficiencies in the Commission’s arguments, concluding ultimately that the Supreme Court was correct to deny review. Moreover, the article suggests that the patent holdup problem, and ex post opportunism generally, is more effectively handled by contract and patent law. Because parties cannot contract around heavy mandatory antitrust remedies, contract and patent law offer superior substantive doctrine designed to distinguish good faith contractual modifications from bad faith holdup, thereby minimizing the social welfare reducing decision errors.

For a fuller elaboration on the arguments in the short essay, and in particular the case for contract and patent remedies as substitutes for antitrust, see Kobayashi and Wright.

One question I’ve been thinking about of late is where the Commission’s patent holdup agenda go from here?  There are a lot of competing forces and tensions to think about.  On the one hand, Rambus is an incredibly important decision in this area (especially now) militating toward perhaps a less aggressive patent holdup agenda at least with respect to Section 2.  However, the President’s promise of more active antitrust enforcement and Commissioner Leibowitz’s pending promotion to Chairman (who has advocated more aggressive enforcement of standard setting abuses under Section 5 where the Sherman Act may not apply, e.g. N-Data).  More on which way I think all of this (and other factors) cuts a bit later.

Here’s the press release. Congratulations to Chairman-to-be Leibowitz.

I also note that this marks the end of Chairman’s Kovacic’s reign at the Commission. On a personal note, I had the pleasure of working for the Chairman during my stint as the FTC Scholar in Residence and consider myself extremely fortunate to have had the opportunity. There is simply nobody that has given as much thought to the question of how competition policy enforcement institutions should be designed to achieve their objectives. Don’t believe me? Read this.  I hope one that I believe that the Chairman’s quest to make the Commission the “thinking man’s competition agency” will be viewed as amongst his most important contributions. The FTC at 100 program and self-study, the series of conferences on important competition policy issues ranging from RPM to the appropriate scope and application of Section 5, and the new FTC & Northwestern University Microeconomics Conference are among the projects that have Chairman Kovacic’s signature on them.

Congratulations to Chairman and soon to be Commissioner Kovacic for a job well done.

An anonymous reader reminds me of the FTC Statement from Commissioners Harbour, Leibowitz and Rosch (but not Chairman Kovacic, who was recused) making the case against certiorari in Linkline:

“The holding of the Ninth Circuit is unquestionably correct, and indeed merely echoes what other courts of appeals have held on the narrow issue presented to the court below: that claims of a predatory price squeeze in a partially regulated industry remain viable after Trinko.”

In all seriousness, I wonder why the use of the word unquestionably there? Its strong language for an issue where the Solicitor General disagrees and ultimately, so do all nine Supreme Court Justices.  This sort of strong language has become a hallmark of this trio of Commissions late in other debates.  For example, I’m reminded of the assertion that the DOJ Section 2 Report was a “blueprint for radically weakened enforcement of Section 2 of the Sherman Act”, that it “placed a thumb on the scale in favor of firms with monopoly power” and was “chiefly concerned with …  prescribing a legal regime that places these firms’ interests ahead of interests of consumers.”

Whatever one thinks about the merits of the arguments in Linkline, there were and have been serious doubts about the viability of price squeeze theories of liability for a long time.  Similarly, whatever one thinks about the merits of the Section 2 Report on specific issues, I’m not sure it advances the state of argument to contend that the drafters of that report (many career antitrust enforcers) are interested in harming consumers in order to help monopolists.  The working assumption ought to be that both sides are operating in good faith until there is evidence to the contrary.  The Section 2 Report deserves that presumption as well.  To be sure, it should be exposed to criticism where appropriate.  There are plenty of reasonable and vigorous debates that can be had over what types of conduct harm consumers and when, the evidence supporting competing theories of economic behavior, and how to design appropriate legal rules to protect consumers.  For example, there remain important wars to be waged on RPM, single firm conduct generally, the appropriate scope of Section 5, and more.  But these debates ought to be based on reasonable discourse about theory and empirical evidence, and a working assumption that both sides are interested in getting it right.

The opinion is available here.  Yet another super-majority Roberts Court antitrust decision applying consensus economic theory.  No more price squeeze claims.  Alcoa is not overturned.  The Court declares that the price-squeeze claim in the absence of a duty to deal can be handled jointly by a straightforward application of Trinko and Brooke Group to the wholesale and retail prices at issue, respectively.  There is also an extended discussion of the common pitfalls of the application of antitrust as price regulation.

A few key excerpts for now:

“A straightforward application of our recent decision in Trinko forecloses any challenge to AT&T’s wholesale prices.”

“The nub of the complaint in both Trinko and this case is identical—the plaintiffs alleged that the defendants (upstream monopolists) abused their power in the wholesale market to prevent rival firms from competing effectively in the retail market. Trinko holds that such claims are not cognizable under the Sherman Act in the absence of an antitrust duty to deal”

“Plaintiffs’ price-squeeze claim, looking to the relation between retail and wholesale prices, is thus nothing more than an amalgamation of a meritless claim at the retaillevel and a meritless claim at the wholesale level. If there is no duty to deal at the wholesale level and no predatory pricing at the retail level, then a firm is certainly not required to price both of these services in a manner that preserves its rivals’ profit margins.3″

“It is difficult enough for courts to identify and remedy an alleged anticompetitive practice at one level, such aspredatory pricing in retail markets or a violation of the duty-to-deal doctrine at the wholesale level. See Brooke Group, supra, at 225 (predation claims “requir[e] an understanding of the extent and duration of the alleged predation, the relative financial strength of the predator and its intended victim, and their respective incentives and will”); Trinko, supra, at 408. Recognizing price squeeze claims would require courts simultaneously topolice both the wholesale and retail prices to ensure thatrival firms are not being squeezed. And courts would be aiming at a moving target, since it is the interaction between these two prices that may result in a squeeze”

And the wrap up in the last paragraph:

“Trinko holds that a defendant with no antitrust duty todeal with its rivals has no duty to deal under the terms and conditions preferred by those rivals. 540 U. S., at 409–410. Brooke Group holds that low prices are only actionable under the Sherman Act when the prices arebelow cost and there is a dangerous probability that thepredator will be able to recoup the profits it loses from the low prices. 509 U. S., at 222–224. In this case, plaintiffs have not stated a duty-to-deal claim under Trinko and have not stated a predatory pricing claim under Brooke Group. They have nonetheless tried to join a wholesale claim that cannot succeed with a retail claim that cannot succeed, and alchemize them into a new form of antitrust liability never before recognized by this Court. We decline the invitation to recognize such claims. Two wrong claims do not make one that is right.

The judgment of the Court of Appeals is reversed, andthe case is remanded for further proceedings consistent with this opinion.”

A draft of my new paper entitled The AIG Bailout is now up on SSRN. Here’s the abstract:

On February 28, 2008, American International Group, Inc. (AIG), the largest insurance company in the United States, announced 2007 earnings of $6.20 billion or $2.39 per share. Its stock closed that day at $50.15 per share. Less than seven months later, however, AIG was on the verge of bankruptcy and had to be rescued by the United States government through an $85 billion loan. AIG’s stock currently trades at less than $1.00 per share.

The Article explains why AIG, a company with $1 trillion in assets and $95.8 billion in shareholders’ equity, suddenly collapsed. It then details the terms of the government bailout, explores why it was undertaken, and questions its necessity. Considering a likely legacy of AIG is increased regulation of credit default swaps, the Article concludes by describing the current regulatory landscape for credit default swaps and offers some thoughts on regulatory reforms.

You can download the paper here. If you do read it and have comments, please email them to me at sjostromw [at] nku [dot] edu. Regardless, I will be revising the paper in light of the latest developments once the details come out.

I want to second Josh’s commendation of Ben Klein’s submission to the recent FTC Hearings on Resale Price Maintenance. Klein’s paper, which bears the same title as this post, is lucidly written (blissfully free of equations, Greek letters, etc.) and makes a point that, at this juncture in antitrust’s history, is absolutely crucial.

In the pre-Leegin era, commentators who were critical of Dr. Miles’s per se rule (including yours truly) usually emphasized the so-called free-rider rationale for minimum RPM. According to that rationale, manufacturers frequently set minimum resale prices for their products in order to encourage demand-enhancing point-of-sale services upon which retailers could free-ride. Golf club manufacturer Ping, for example, tried to control its dealers’ resale prices because it wanted dealers to expend great effort helping customers find the perfect set of highly customizable clubs. It worried that the ability to compete on resale price would lead some dealers to cut their own customizing services (and thus their costs), direct their customers to high-service dealers for the necessary customization, and then offer a discount to those customers on the clubs selected by the high service (and thus higher cost) dealers, who couldn’t afford to match the discount. If such free-riding were pervasive, Ping dealers would eventually stop providing the sort of customizing services that enhance demand for Ping clubs.

In the pre-Leegin era, it made sense for critics of Dr. Miles to emphasize the free-rider rationale because (1) it’s easy to explain, and (2) it applies often enough that we can say with confidence that RPM — often motivated by a desire to avoid free-riding on output-enhancing services — is not “always or almost always anticompetitive.” That, of course, is all we Dr. Miles critics needed to establish in order to undermine the per se rule against minimum RPM. (Per se illegality is appropriate only for practices that are always or almost always anticompetitive.)

It’s now a new day in antitrust. Dr. Miles is dead, and the key question for courts, commentators, and the regulatory agencies is how particular instances of RPM should be evaluated to determine their legality. Answering that question requires more than a simple showing that RPM can, under a fairly common set of circumstances, lead to higher output. Indeed, if our rule of reason focuses exclusively on the free-rider rationale for RPM, it may well lead to condemnation of procompetitive instances of RPM in circumstances in which the free-rider rationale does not apply. For example, the highly influential Areeda-Hovenkamp treatise proposes a rule of reason that would automatically condemn RPM arrangements on “homogeneous products,” for which there are unlikely to be any point-of-sale services that are susceptible to free-riding. (See par. 1633c of the Second Edition.) The assumption here is that RPM’s only significant procompetitive effect is the elimination of free-riding.

Fortunately, the Supreme Court’s Leegin decision recognized that RPM may be output enhancing even in the absence of free-riding. The Court explained (page 12):

Resale price maintenance can also increase interbrand competition by encouraging retailer services that would not be provided even absent free riding. It may be difficult and inefficient for a manufacturer to make and enforce a contract with a retailer specifying the different services the retailer must perform. Offering the retailer a guaranteed margin and threatening termination if it does not live up to expectations may be the most efficient way to expand the manufacturer’s market share by inducing the retailer’s performance and allowing it to use its own initiative and experience in providing valuable services.

The idea here — developed fully in Klein & Murphy (1988) — is that RPM, which guarantees retailers a healthy margin on sales of the product at issue, can be used to generate retailer services that are hard to secure contractually. Exhaustively specifying ex ante all the services a retailer should provide would be quite difficult for a manufacturer. In addition, monitoring and enforcing a dealer’s performance obligations along multiple service dimensions would require substantial effort. RPM coupled with a liberal right of termination can provide an alternative means of securing the retailer services(attractive product placement, etc.) that enhance demand for the manufacturer’s products. If the manufacturer generally observes its retailers’ performance, retains an unfettered right to terminate underperformers, and provides an attractive retail margin as an incentive to avoid termination, then the manufacturer can motivate its retailers to provide demand-enhancing point of sale services without specifying them exhauastively.

While the Leegin majority nicely explained how RPM can be used to enhance demand-enhancing retailer services even when those services are not subject to free-riding, it failed to address one crucial question: Why would a manufacturer need to use RPM to encourage these services, since retailers themselves would also benefit from increasing the sales of their manufacturers’ products?

Justice Breyer pounced on this omission in his Leegin dissent. Referring to the majority’s contention that RPM “may be the most efficient way to expand the manufacturer’s market share by inducing the retailer’s performance and allowing it to use its own initiative and experience in providing valuable services,” Justice Breyer stated (pages 14-15):

…I do not understand how, in the absence of free-riding (and assuming competitiveness), an established producer would need resale price maintenance. Why, on these assumptions, would a dealer not “expand” its “market share” as best that dealer sees fit, obtaining appropriate payment from consumers in the process? There may be an answer to this question. But I have not seen it.

Klein’s submission to the FTC’s RPM hearings provides a straightforward answer to Justice Breyer’s question. RPM may be necessary, Klein contends, because a manufacturer and its dealers often have divergent incentives when it comes to services that expand demand for the manufacturer’s products. Frequently, a manufacturer will stand to gain much more from its dealers’ promotional efforts than the dealers themselves. Thus, “RPM plus a liberal right of termination” may be needed to incentivize dealers to provide the services that will maximize sales of the manufacturer’s products. Klein points to three commonly present economic factors that create the sort of incentive divergence that warrants RPM:

(1) Manufacturers often enjoy a larger per-unit profit margin than do their retailers. Because manufacturers’ products tend to be more highly differentiated than the services retailers provide, and because the ability to charge prices in excess of one’s costs is a function of the uniqueness of whatever one is providing, manufacturers will generally earn higher per-unit profits on their products than will the retailers who resell those products. Accordingly, manufacturers stand to gain more from incremental sales of their products than do their retailers, and they may therefore need a way to give their retailers an extra incentive to promote their products.

(2) Many manufacturer-specific retailer promotional efforts lack significant inter-retailer demand effects. While some retailer promotional efforts, such convenient free parking or extended store hours, would provide competitive benefits for both the manufacturers whose products are carried by the retailer and the retailer itself, other retailer promotional efforts, such as prominent placement of the manufacturer’s product within the “impulse buy” section of the retailer’s store, would really benefit only the manufacturer without enhancing demand for the retailer’s services over those of its competitors. Absent some nudge from the manufacturer, retailers won’t be adequately incentivized to perform these sorts of services. RPM can provide the needed nudge.

(3) Manufacturer-specific retailer promotional efforts may cannibalize a multi-brand retailer’s sales of other brands. Many retailer services that would promote a manufacturer’s brand of a product would merely reduce the retailer’s sales of competing brands of the same product and would thus provide little, if any, net benefit to the retailer. Granting favored shelf space to one brand, for example, may require moving a competing brand to less favorable shelf space, thus reducing the sales of that brand. A manufacturer can induce its retailers to provide it with “cannibalizing” promotional services by employing RPM to guarantee the retailer a higher markup on sales of the manufacturer’s brand.

These sources of divergence between manufacturers’ and retailers’ incentives are discussed in more detail in Josh’s 2007 collaboration with Klein, The Economics of Slotting Contracts, 50 J. L. & Econ. 421 (2007). Taken together, the various sources of divergence make it in the interest of many manufacturers to adopt some sort of RPM policy, even when the product at issue is not one that is sold along with services that are susceptible to free-riding. The RPM policies manufacturers adopt to address incentive divergence enhance the manufacturers’ overall output and should thus be assumed to be procompetitive. Accordingly, liability rules such as that proposed in the Areeda-Hovenkamp treatise, which maintains that “[p]roduct homogeneity is an easily observable fact that is inconsistent with known legitimate uses of RPM” (Par. 1633c, at 334 (2d ed.)), are unsound and should be rejected.

Hot off the press (HT: Antitrust Review).

As TOTM readers will know, I think this is the correct result as I’ve argued here that the Supreme Court should indeed reject the Commission’s petition. I also believe the rejection is consistent with the Supreme Court’s antitrust case selection under Chief Justice Roberts in the sense that, on top of the fact that Broadcom and Qualcomm do not create a circuit split and seem relatively reasonable decisions given their factual and procedure contexts, there is no economic consensus that antitrust as an additional solution to those offered by contract and patent law makes sense. As Judge Douglas Ginsburg and Leah Brannon have pointed out, the consensus support of both economists and the Solicitor General have been fairly good predictors of Supreme Court outcomes.

Predicting what antitrust enforcement regimes in the current economic environment is a tricky business.  I’ve done my best here.  One probably cannot think of a better source for such predictions than those from the soon-to-be AAG Christine Varney, who recently spoke at an American Antitrust Institute panel on Section 2 enforcement (you can hear the panel audio at the link).  I had an RA transcribe Varney’s remarks so please note that all remarks attributed as quotations here may not be exact.

Generally, Varney applauded the AAI report, noting that is “a great framework that starts it and I do endorse the conclusions.” The AAI recommendations relating to monopolization, for those who have not read the report, includes at least the following proposals:

• Embracing a generally “Post-Chicago” vision of Section 2, including Kodak-style aftermarket claims and “other consumer protection market imperfections”
• Trimming the scope of Trinko in favor of the unilateral refusal to deal jurisprudence in Aspen and Kodak 
• Revitalizing the essential facilities doctrine as an independent theory of liability
• Reject cost-based safe harbors for loyalty and bundled discounts
• Make predatory pricing law more friendly to plaintiffs
• More aggressive remedies

Here are a three comments I found the most interesting:

1.  Varney on Google as An Emerging Antitrust Threat.

For me, Microsoft is so last century.  They are not the problem.  I think we’re going to continually see a problem potentially with Google, who I think so far has acquired a monopoly in internet, online advertising lawfully.  I do not think that they have done anything other than be a spectacular and innovative company.  I am deeply troubled by their acquisition of uh, Doubleclick and I am deeply troubled by their deal with Yahoo.  I submit to you that this administration, although they may open a investigation or a review of the Google-Yahoo deal, will do nothing.  I think that this is a classic area to explore how do you apply section 2 in a highly innovative, highly networked not terribly competitive environment. …

I find this a difficult area also by the way when it comes to Google, because Google has done so much terrific work and so much of it is IP-based, but as you can see they are quickly gathering market power in what I would call an online computing environment in the clouds and as we move into that environment I think you’re going to see Google has enormous market power there, again, I’m not saying it was anything other than lawfully achieved, but I wonder what’s going to happen when all of our enterprises move to computing in the clouds and there is a single firm that is offering the comprehensive solution that’s not interoperable with other potential solutions.  Now I think you’re going to see the same repeat of Microsoft, there will be companies that will begin to allege, and Ed can tell me why I’m wrong, they will be companies that begin to allege that Google is discriminating, that it is not allowing their products to interoperate with the Google products, and I think that we ought to have learned from the Microsoft experience, what the right standards are, and the problem that we had with Microsoft, I think, as a government we went in too late.

2.  On The Non-Existence of False Positives.

“My view and, you stole my thunder, I was prepared to say there is no such thing as a false positive, you know, let’s get real. I have counseled numerous incumbents who are dominant as well as numerous new entrants. I can tell you, at least in my own experience, there is not a dominant incumbent who hasn’t done something that is lawful because they were afraid that it might be reviewed by the DOJ or a state attorney general or an FTC. I just don’t see it. Ten years back in the private sector I have never once seen it, so I think that this ruse of, you know, we have to be restrained in our enforcement because false positives will chill innovation, take an economic toll on society and overall result in negative economic consequence, slowing output, increasing cost, I just think is false. I think the more people in the bars start rejecting this idea of false positives the better off we’re going to be.”

3. On Convergence with the Europeans and Global Antitrust Leadership.

“Europeans are setting rules, companies that are doing business globally cannot generally distribute two products, cannot generally compete in one manner in Europe and a different manner in the United States. So we may see ourselves, and this is a bad thing, if we don’t have influence on the development of dominant firm behavior, I think the Europeans are much more extreme than even I would be. So unless we have some credibility and can sit at the table and jointly continue to pursue the evolution of what we would call section 2, I think we’re going to cede this territory to the Europeans entirely and we’re not gonna have a whole lot to say about what abusive dominance looks like for a global firm.”

I highlight this third comment because it was an interesting contrast to the rest of the remarks favoring much more interventionist-minded application of Section 2.  Perhaps current Article 82 enforcement places an upper bound on what we can will see in the United States with respect to Section 2?  But it is difficult to know what to make of this comment when placed in the context of the assertion that false positives do not exist, which  I find quite troublesome for a number of reasons.

First, what does it mean to assert that “there is no such thing as a false positive”?  Varney’s evidence in support of the proposition is that from her vast and impressive counseling experience she is not aware of a firm that has refrained from lawful activity because they were afraid of antitrust liability.  That is comforting.  But not responsive to the concern about false positives raised by commentators in the literature.  As one who often argues that errors and their social costs not only exist but should play a central role in how we think about antitrust analysis, let me offer a basic point: false positives are not just when a firm chooses not to engage in lawful activity for fear that it will be mistakenly found to be illegal.  No.  It is not fear that a court will fail to understand the distinction between legal and illegal behavior if given clear rules.  The error need not come from courts merely misapplying clear law and concluding that activity that should be “lawful” violates the Sherman Act.  The concept is broader.  Rather, the false positives commentators are talking about involve when a firm refrains from efficient, pro-competitive behavior because it fears antitrust liability.

The reasons these errors come about is because the task of distinguishing pro-competitive conduct from that which is anticompetitive and harms consumers is incredibly difficult.  For example, does anybody really believe that LePage’s did not result in some chilling on the margin of pro-competitive bundled discount schemes?   What about the FTC’s enforcement action in N-Data?  Varney’s assertion that false positives simply do not exist is either a mistake or wrong.  Antitrust’s history is strewn with false positives, i.e. conduct that antitrust condemned before we learned far later that it was actually typically a normal part of the competitive process.  To be sure, we’ve learned something since then.  But I’ve never heard anybody argue that we’ve learned so much (especially in the single firm conduct arena) that the fear of antitrust liability does not influence business decisions. Consider a thought experiment designing an antitrust policy which takes seriously the belief that there is no such thing as error costs.  Many of my more interventionist minded Post-Chicago friends, who might disagree with me about the relative frequency of false positives, would shudder at the thought.

In either case, the view that we ought to not think about error costs when we think about designing appropriate antitrust enforcement policy (especially in the monopolization context, but also in cartels and mergers) strikes me as one of the most provocative, interventionist, and mistaken statements on this issue that I’ve read.   Error cost analysis is now a mainstream part of antitrust analysis.  It is not a tool that belongs to the Chicago School, Post-Chicagoans, or anybody else.  To be sure, an important debate can be had on the empirical question of the relative frequency and magnitude of type 1 and type 2 errors and their social costs.   Sometimes this debate has taken an oversimplistic approach by merely counting cases.  But there has at least been debate over the relevant theoretical and empirical questions.  This debate should continue.  It is my hope that Varney’s statement was an off the cuff remark in a panel setting (though it doesn’t appear it was) and not a conceptual belief that will drive policy decisions at the Antitrust Division.

Victor Fleischer and Phil Weiser are putting on a Law and New Institutional Economics workshop for law professors in June.  The conference announcement is here. I believe Thom attended last year’s installment, and I will be on the program this year. Here are more details:

New Institutional Economics (NIE) is an interdisciplinary methodology that draws on economics, law, organization theory, political science, history, and sociology. It focuses on the study of political, legal, and social institutions and how those institutions shape the behavior of organizations, firms, or individuals. These institutions establish the “rules of the game” – the set of formal and informal laws, rules, and norms of social behavior that shape economic development and growth, innovation, social organizations, and political stability. NIE’s most often-cited proponents are Ronald Coase, Oliver Williamson, and Douglass North.

Workshop topics. The workshop is primarily intended for law professors, and it will include scholarly presentations both by workshop faculty and by several workshop participants. The primary focus is on (1) research that helps us understand the effects of laws and legal institutions on economic development, innovation, and social and political institutions, and (2) legal scholarship that draws on analysis of institutional context and institutional design (rather than, say, legal doctrinal analysis, or economic or social theory standing alone). Substantive legal areas may range widely, but may include such topics as business law and capital markets, trade and antitrust regulation, intellectual property, telecommunications, higher education policy, the legal profession, and tax policy.

Last summer, the University of Colorado Law School hosted a one-day workshop designed to introduce legal scholars from around the country to the basic foundations of New Institutional Economics. This year, we hope to build on last year’s program by revisiting some of the key ideas and enjoying the opportunity to hear from some leading scholars who study institutions.  In addition, this year’s program will include several presentations of recent scholarship and works-in-progress from conference participants, with our expert “workshop faculty” serving as discussants. If you are interested in presenting recently published work or a work-in-progress, please notify Victor Fleischer at victor.fleischer@gmail.com.

The workshop will be held at the University of Colorado Law School, in Boulder. We will provide meals, but participants will be expected to cover their own transportation and lodging expenses. The workshop will begin at 9:00 am on Thursday, June 4, 2009, and will conclude after lunch on Friday, June 5, 2009.

George Bittlingmayer (University of Kansas) and my colleague Tom Hazlett look at the market response to the stimulus and find it none too enthusiastic:

President Barack Obama’s “stimulus” plan invokes the 1930s fiscal strategy put forward by British economist John Maynard Keynes, who saw capitalism as pretty much spent. Having exhausted their store of innovative ideas, investors curled up. Workers lost jobs, spent less, and sent still other workers walking. Budget deficits – government spending without taxes to “pay as you go” – would pull unemployed workers off the street and arrest the downward spiral. Investors’ “animal spirits” would be calmed, new capital risked, and economic vitality restored.  So the Obama theory – government spending is stimulus. If so, financial markets should feel the love. The U.S. budget is awash in red ink, and $800 billion more of it should easily move the needle on our economic prospects. Indeed it has – in the wrong direction. Financial markets don’t want more government debt or a scramble for “shovel-ready” spending projects. They want the skeletons in the banking sector’s closet exposed and expunged…

Yet, from Nov. 4, 2008 through Feb. 12, 2009, the DJI overall fell 18% — a larger drop than during the Sept-Oct plunge. In January, when the Obama plan, promising far greater deficits than the two much smaller “emergency stimulus” plans signed by Pres. George W. Bush in 2008, was unveiled, the market tanked – the worst January performance in 113 years.  More pointedly, key political victories for the Team Obama spending plan have not been viewed as buying opportunities on Wall Street. A string of negative market reactions began with the December 18 announcement of a stimulus bill of $700 billion (Dow down 2.5%), continued with the January 7 announcement that the actual plan would be “on the high side” (-2.7%) and continued with last week’s 61-36 Senate vote supporting the Administration’s fiscal plan. The White House victory and the new bank bail-out plan announced the following day by Treasury Secretary Geithner were met with a 5% wipe-out in the DJI, and a decline in Treasury bond yields, indicating a “flight to quality.”

First, Peter Klein:

I am bewildered. But, more than that, I am angry. I can’t count how many news accounts I’ve seen about the poor, struggling homeowners who can’t make the monthly mortgage payment, are about to be foreclosed, and risk losing the family home, yard, white picket fence, and piece of the American Dream. But I haven’t heard one word about the poor, struggling renters, the ones who scrimped and saved and put money away each month towards a down payment, who kept the credit cards paid off, stayed out of trouble, and lived modestly, and thought that maybe, just maybe, the fall in housing prices meant that they, finally, could afford a house — maybe one of those foreclosed units down the street. These people are Bastiat’s unseen. For them, Obama’s housing plan is a giant slap in the face. To hell with the prudent. Party on, profligate! Now that’s what I call moral hazard.

Here’s Tyler Cowen (with lots of other links to other economists’ reactions — some much more favorable):

We should not be helping people stay in their homes if their mortgage payments are at 43 percent of their income.  (The bill requires banks, in such cases, to lower interest rates until monthly payments are at 38 percent of income.  The government then steps in to lower payments to 31 percent of income.)  I don’t feel moral outrage (although it is morally outrageous), I just don’t think it is a good use of money.  I also wonder how it works when your income is quite variable year to year.  Are they sure there is no way to game this?  It will in the short run prevent some (enough to matter?) foreclosures.  But it won’t keep up the long-term price of homes or prevent eventual foreclosures when the home has negative equity.  It adjusts interest rates on the payments, not principal on the loans (thank goodness).  Most of all it is a bad precedent which we will live to regret.  It is a significant move away from the idea of commercial decisions based on contract.

Anybody want to share a copy of the complaint?  (Email: jwrightg at gmu dot edu).

UPDATE: Here’s a copy of the TradeComet Complaint.

Thanks to an anonymous reader.

Some brief comments on the highlights of the Complaint.  Per Thom’s comment below, it looks like the thrust of the complaint is not the price hike which would be ruled out by Trinko, but exclusive search syndication arrangements allegedly entered into by Google with highly trafficked websites like AOL which deprive rivals of the opportunity to compete for minimum efficient scale.  There is other allegedly exclusionary conduct specified in the complaint, e.g. the use of “default defenders” which restrict the ability of users to switch their default search engine using Google’s toolbar (sound familiar?).   Some allegations involve the use of Google’s Landing Page Quality metric to give preferential (or disfavored) treatment to friends (or foes).  In paragraph 110, the Complaint hints at a unilateral refusal to deal theory built upon the termination of a previously profitable course of business involving TradeComet.

Here’s the press release:

TradeComet.com LLC filed in the United States District Court for the Southern District of New York, a complaint asserting Google violates antitrust laws by eliminating competition and choice. TradeComet was forced to file the lawsuit when Google refused to stop engaging in predatory conduct to block search traffic by imposing massive, unjustified price increases. Google’s anticompetitive conduct eliminated TradeComet as a competitor. Cadwalader, Wickersham & Taft, LLP, one of the world’s leading international law firms, will represent TradeComet.com.

SourceTool.com, a subsidiary of TradeComet.com, operated a thriving global business-to-business (B2B) search engine enabling buyers of industrial products to easily connect with suppliers. SourceTool.com focused on a specialized type of industrial search, which it positioned as a competitor to Google’s general purpose search engine. Due to SourceTool’s utility for buyers, sellers and advertisers, the site took off—within months reaching 650,000 visits per day. SourceTool.com also was named a ‘2006 Rising Star of Specialized Search’ by InfoCommerce and the ‘Second Fastest Growing Internet Site in the World’ by Comscore.

Google initially embraced its relationship with SourceTool.com, naming them Google’s ‘Site of the Week’; SourceTool.com was reinvesting approximately 80 percent of its revenue by purchasing $500,000 per month or more in Google keywords.

In its complaint, TradeComet.com provides details of how Google subsequently identified SourceTool.com as a competitive threat and then engaged in illegal conduct to diminish and ultimately extinguish SourceTool.com’s platform.

“SourceTool.com offered a valuable service and TradeComet.com had a thriving business before Google decided to eliminate them as a competitor,” said Rick Rule, Chair of Antitrust for Cadwalader, Wickersham & Taft, LLP, and former head of the United States Justice Department Antitrust Division. “We believe this complaint has strong merit and represents a serious antitrust violation.”

“With no notice, Google changed from cheerleader to tyrant when it realized we were a competitive threat,” said Dan Savage, founder and CEO of SourceTool.com and TradeComet.com. “For example, Google raised my prices by 10,000 percent, which strangled our business, virtually overnight. Citing an ambiguous quality score determined by a secretive algorithm to justify the price increase, Google refused to consider reductions even after SourceTool.com invested the company’s savings to make the changes that Google said would rectify the supposed problems. As a result of Google flexing its monopolistic muscle, SourceTool.com currently averages about one percent of the traffic it previously had and is no longer a competitively viable business.”

TradeComet.com aims to recover damages caused when Google’s anticompetitive conduct eliminated SourceTool.com’s primary source of search traffic.

I’ve been reading the papers for the FTC RPM Workshops, though I cannot attend.  On the procompetitive side, I especially recommend Ben Klein’s explanation of how RPM facilitates the supply of promotional services in the absence of dealer free-riding.  Critics of RPM, in my view, generally do not understand the fundamental economic point that retailer competition alone is not sufficient to guarantee the supply of promotional services because of incentive conflicts between manufacturers and retailers.  Klein and Wright (JLE, 2007) explains this incentive conflict in great detail, and how fixed per unit time payments (slotting contracts) can be used to solve this common incentive problem and are part of the normal competitive process.  Klein’s newest RPM explains how RPM contracts can be used to achieve the same effect, that is, solving the incentive conflict between manufacturers and retailers to facilitate the supply of efficient promotional services.

The most common argument raised by defenders of the Dr. Miles rule, including Justice Breyer in Leegin, is that Telser’s (1960) classic discount dealer free-riding story for RPM (RPM solves the problem of consumption of promotional services at the full service retailer before buying the product at the discounter — and thus unraveling the supply of services in equilibrium) does not apply to a number of products where we observe RPM used.  This is where Klein & Murphy’s (1988) seminal explanation comes into play, documenting how the incentive conflict is a real economic problem solved by these vertical restraints, and part of the normal competitive process.  The Klein’s RPM Workshop piece builds on and updates that analysis.

One of the other issues that I’ve been keeping my eye on during the hearings is the evaluation of the current empirical evidence.  I’ve written before that in my own evaluation of the evidence, “the evidence overwhelmingly shows (see also here) [that RPM agreements] are highly likely to make consumers better off in practice.”  I also wrote that I hoped the RPM Workshops would take a hands on and rigorous approach to evaluating the state of evidence in order to design appropriate antitrust enforcement approaches to RPM and vertical restraints generally:

In my view, while there is still a lot to learn about precisely how RPM works, when and by whom it is adopted, and to what effect, there is simply no empirical evidence that its effects warrant per se illegality…. Its my sincere hope that the policy debate to be had on RPM with the pending legislation and FTC Workshops upcoming will be fought on this margin rather than on marketing.

In this light, it caught my eye that Patrick Rey’s slides and paper, which offers yet another possibility theorem of how RPM “could” result in anticompetitive outcomes.   The possibility theorem paper is nothing new in the sense that there are a ton of these around.  But the claim of empirical support is.  Indeed, my views on this matter are well known that there is not much empirical support at all for the anticompetitive theories of vertical restraints including RPM (see also the Lafontaine & Slade and Cooper et al literatuer surveys).  So I did some digging.  Here’s the claim from Rey’s paper with Thibaud Verge:

Our analysis supports this claim and shows that RPM can actually eliminate competition, not only among competing fascias, but also among competing brands. This possibility has been validated by recent empirical studies. Using data about retail prices of food products in French retail chains during the period 1994-1999, Biscourp, Boutin and Vergé (2008) find that the correlation between retail prices and the concentration of local retail markets was important before 1997 and no longer significant after that date. This suggests that the price increases that occurred after 1997 were indeed due to the impact of the new legislation on intrabrand competition.

So what does the Biscourp et al. study actually analyze?  You might think from the context that BBV (2008) studies Minimum RPM contracts.  But you would be wrong.  What did they actually study?  Get this: a set of French laws that make it illegal for retailers to sell “below cost.”  The Loi Galland came into force in 1997 and clarified a pre-existing ban on below-cost sales.  In other words, the Loi Galland set mandatory government enforced minimum price floors that apply to all retailers.  Boutin & Guerrero provide some details on the 1996 Loi Galland:

The Loi Galland gave a simple, precise definition of the actual purchase price and hence of the below-cost retail price floor: `The actual purchase price is the unit price stated on the invoice plus taxes on sales, specific taxes applied to the resale, and transportation costs.’  Since 1997, the definition of purchase price has thus been restricted to the price stated on the invoice, with no deductions such as year-end discounts. The Act also tightened official verification and raised fines. Only the margins formally applied at the invoice date and shown on the invoice the “upfront margins” can be passed on to final consumers through reductions in the final selling price. By contrast, all other discounts are described as “hidden margins” and therefore excluded from the below-cost retail price floor. Examples include margins linked to an annual sales volume, to the retailer’s display of the product on a minimum shelf length, to business cooperation, or simply to the respect of mutual commitments over a certain period. Consequently, hidden margins can in no way be passed on to consumers.

The law in other words, is similar to sales below costs laws i the US that are designed to anticompetitive raise prices, are binding on all sellers, and enforced by the government with significant fines.  Unsurprisingly, a law designed to prevent price-cutting achieves its intended effect and is found to have an anticompetitive effect.  But I’m frankly lost as to how Rey & Verge claim from this study of government imposed sales below cost laws that there is empirical support for the proposition that voluntary, privately negotiated RPM contracts are likely to be anticompetitive.  Note that Lafontaine & Slade’s leading survey of the literature argues that this distinction is quite important — concluding that mandatory restraints are far more likely to generate anticompetitive outcomes.

There is more.

Rey and Verge also claim that another paper from Bonnet and Dubois (2008) “supports his analysis of RPM.”  Curious, I took a closer look at this paper.  Does this second paper actually study RPM agreements?  Again, the answer is no.  B&D (2008) do something different: (1) they get retail prices and quantities for branded and unbranded bottles of water, (2) estimate a random coefficients logit model for the demand for bottled water (no data on costs or markups except for general input price indices), (3) infer wholesale and retail markups under a variety of assumptions about the nature of wholesale and retail competition which amount to 12 different models, and (4) from these estimated markups, estimate marginal costs (e.g. 12 different cost equations).  From these cost equations, they conduct a series of non-nested hypothesis tests, comparing the 12 different models against each other (table7, p. 34 at link above).  The authors conclude that “the results finally show that the best model appears to be model 10, that is the case where manufacturers use two part tariffs with resale price maintenance.”  From this series of assumptions and steps, the authors conclude that the branded water sellers are actually using RPM and two-part tariffs (”Our empirical analysis allows it to be concluded that manufacturers and retailers use nonlinear pricing
contracts and in particular two part tariff contracts with resale price maintenance.”)!  Further, the authors simulate the effect of moving from model 10 to other models of pricing and find that pricing is lower in other models and therefore conclude that RPM has anticompetitive effects.

There are some problems with this analysis.  First, suffice it to say that it is difficult to make confident policy statements about the effects of RPM contracts without studying actual RPM contracts.  There is no actual evidence that the water sellers are using RPM.  Indeed, RPM is illegal in France.  The inference is generated because the non-nested hypothesis test (which is notoriously weak) implies the model best fits the data.   Second, my understanding of merger simulations at the FTC is that when marginal costs are inferred from equilibrium conditions, attempts are made to verify the validity of the inference by comparing the inferred level to some actual measure (so that the model can be tossed if they don’t correspond to one another).

Evaluating the empirical evidence in favor of the various pro- and anti-competitive theories is an incredibly important step in the process of identifying the appropriate legal test to apply to resale price maintenance (and other vertical restraints). While the Rey & Verge piece offers an interesting theoretical effect of RPM, the key issue identified by Justice Breyer’s Leegin dissent is understanding how RPM contracts work in practice. In my view, Rey & Verge’s claim that there is empirical support for their model is unfounded. To the contrary, neither the BBV or BD papers add any empirical contribution to the debate over the appropriate antitrust treatment of privately and voluntarily adopted RPM contracts.