A number of opponents of Obamacare, such as Wall Street Journal columnist William McGurn, have criticized the President and his people for referring to pending proposals as “health insurance reform” rather than “health care reform.” I suppose these critics think the President is engaging in a sleight of hand in an effort to minimize the significance of the reform proposals — as in, “We’re not reforming the whole health care system, just health insurance. No biggie.” But Mr. Obama is right. This proposal is about insurance rather than the provision of health care itself. And that’s the main problem.

At the outset, the President claimed that a central goal of reform was to reduce the cost of health care itself. While Mr. Obama was always concerned with expanding health insurance coverage to the uninsured, he maintained that health care cost reduction is also key (and, in fact, necessary for expanding coverage without breaking the bank). For example, in a June 2009 radio address setting forth his goals for health care reform, the President insisted, “We must attack the root causes of skyrocketing health care costs,” and he reiterated his “belief that any health care reform must be built around fundamental reforms that lower costs, improve quality and coverage, and also protect consumer choice.” Similarly, his Council of Economic Advisers listed a reduction in actual health care costs as one of the two goals (along with insurance coverage expansion) of health care reform:

CEA’s findings on the state of the current system lead to a natural focus on two key components of successful health care reform: (1) a genuine containment of the growth rate of health care costs, and (2) the expansion of insurance coverage.

So I have a question for supporters of Obamacare (either the House bill, the Senate bill, or the President’s own proposal): What provisions of the proposed legislation will reduce the costs of health care itself? This is an honest question. I’m really trying figure out, if a reduction in health care costs is a primary goal of this legislation (and mustn’t it be?), what is the strongest possible case for the pending proposals?

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A common theme throughout the day has been the declining number of seed companies–increasing concentration–and its effect. Except no one has talked about the effect.  Other than pointing to the structural change itself, no one seems to have any evidence relating to the effect of the change.  One farmer at the open mic session (coincidentally one who had been sued by Monsanto) asserted that the move from 70 seed companies to 4 represented a relevant decline in competition.  But he didn’t talk about any relevant effect; he had nothing to offer on declining return on investment–no evidence that the change actually affected his bottom line.

Unfortunately, Diana Moss is the lone antitrust expert on the seed industry concentration panel (also known as the “is Monsanto an antitrust problem?” panel), and it falls to her to put meat on these bones.  But she fails in the effort, and really just repeats the same mantra as the farmer, with exactly the same amount of evidence (zero, in case I wasn’t clear on this point).  (Moss’s AAI paper on biotech seeds is available here; our ICLE paper partially addressing Moss’s is here).

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Bill Northey, IA Ag Sec’y, sounds a bit like an economist (ah, turns out he has a degree in ag business and an MBA . . . ).  Yes, price of seeds has gone up, but so has yield, and so has overall value.  The issue, he says, is how to divide the surplus, and he suggests that it’s dividing the pie that drives farmer concerns.  That’s not at all a surprise, but it’s also not much of an antitrust issue.  Unless the pie could be bigger absent, say, Monsanto’s huge investment in seeds and the resulting relatively-concentrated market structure (and basing enforcement on the theoretical possibility of that counter-factual is a perilous enterprise, as Josh and I have suggested many times), this is just a question of pecuniary transfers.  Sure, they matter a lot to the parties involved and there’s always an incentive to deputize the government to put a thumb on the scale of that dispute, but that’s not a matter of allocative efficiency, and not a matter for the antitrust laws.

Now we hear Iowa AG Miller pushing for the development of “the non-antitrust laws to deal with concentration.”  By which he means the Packers and Stockyards Act.  Maybe the DOJ has their Section 5 after all!

As if on cue, AG Miller trots out the pendulum story of antitrust enforcement–”how to bring the antitrust law back to the middle.”  This is not really an accurate description, unfortunately.  Even worse, it’s not an economically-sensible concept, and measuring the efficiency of antitrust enforcement by counting enforcement actions (or looking at rhetoric) is usually just flimsy cover for an essentially-political determination.  Combine that with Miller’s suggestion that the P&S Act’s “unfair practices” language should be enlisted in the service of dealing with concentration, and the risk of false positives is much magnified.  Which, of course, is a perfect lead-in for Christine Varney. (more…)

The WSJ implies that the answer is yes in an interesting article describing the Obama administration’s changing views on behavioral economics and regulation.  The theme of the article is that the Obama administration has eschewed the “soft paternalism” based “nudge” approach endorsed by the behavioral economics crowd and that received so much attention in the blogs — especially as it related to Cass Sunstein’s appointment to OIRA, the Consumer Financial Protection Agency and a few other issues — in favor of harder paternalism and “shoves” including recent proposals for “regulating health-insurance rate increases, separating commercial banking from investing on behalf of their own bottom lines, and prohibiting commercial banks from owning or investing in private-equity firms or hedge funds.”  The article also points to a proposal for new regulations (that I had not heard of prior), that “would require retirement counselors to base their advice on computer models that have been certified as independent” as a precondition that must be satisfied before advisers can push funds with which they are affiliated.

A few observations.

First, is anybody really shocked to see behavioral economics-based proposals give way to harder forms of paternalism?  Though I take Rizzo and Whitman to be focusing on a different slope towards old paternalism, the idea that the behavioral economics nudge approaches reveal policy preferences consistent with hard paternalism is one that has been discussed frequently in this context.  Perhaps the surprising thing is how quickly the shift has occurred?

Second, given the buzz around behavioral economics in antitrust, and especially the misguided notion that the financial crisis has taught us that the baseline assumption for antitrust analysis should that firms are irrational, I was pleased to see Peter Orszag recognizing that “Institutional decision-making is much closer to a rational economics than individual decision-making, no question.”

Third, and cutting to the chase a little bit, its unclear to me that the Administration was ever really interested in behavioral economics as an intellectual guiding force as a “new” approach to regulation.  For example, little attention has been paid to areas where behavioral economics implies less regulation.  Regulators of all sorts want intellectual support for what they are doing.  That is not a criticism.  But was there really ever anything there?  Has anybody seen anything that has come out of OIRA with the signature of behavioral economics?  On this score, TOTM readers may recall that, since early on, I have expressed skepticism about claims that the Obama administration had made any real commitments to behavioral economics:

The second issue is that I’m not convinced that Obama’s policies have much to do with a behavioral economics-based platform. Leonhardt raises Obama’s savings plan (opt-out 401(k)’s), broad based tax cuts for the middle class, and opposition to a health care “mandate” as examples of policies informed by behavioral economics. I understand the the connection between the 401k default policy and behavioral economics. But the second two examples don’t strike me as have much do with with the insights of behavioral economics per se. The link between tax cuts and the lessons of behavioral economics, in this context, is tenuous at best. And as Ezra Klein notes while taking the position that he doesn’t see much behavioral economics in Obama’s positions either, one might suspect that a health care mandate would be more in line with the teachings of behavioral economics rather than Obama’s plan.

Fourth, and finally, I can’t help but note that some agreement on what counts as a behavioral economics-informed policy choice might be helpful in order to make progress.  I’ve been fairly critical of those, especially in the law review literature, who invoke the terms like irrationality and endowment effect willy-nilly, wave their hands around quickly while saying something about market failure (usually this section of the paper also has the term “orthodox neoclassical theory” in it somewhere), and move on to discuss regulatory proposals on the assumption that they will be costless.   But if we are going to be keeping a scorecard here, we should at least agree on what counts as a nudge.  The WSJ shares an example that it says is consistent with what is left of the Administration’s commitment to behavioral economics:

Landlords, for instance, have no incentive to replace a 40-year-old refrigerator if the tenants are paying the utility bills. So the Department of Housing and Urban Development, the Small Business Administration and the Energy Department are looking for ways to give property owners more incentives to save energy, possibly through loan discounts or guarantees offered through mortgage brokers. In October, Mr. Biden unveiled a pilot Property Assessed Clean Energy financing program to try it out.

Wait.  So, the landlord has less than optimal incentives to make investments in refrigerators when the tenant plays the bills because he doesn’t internalize the benefits of the investments.  I hate to be a stickler, but I’m pretty sure standard economics can do this one.   Transacting parties reach agreements to economize on agency costs and incentive conflicts.   The fact that the landlord’s private decision process is different when he owns the refrigerator than when he doesn’t imply irrationality!  Nor is any regulatory shove to get individuals to act closer to the what the regulators think is “optimal” decision-making based on behavioral economics simply by invoking the term.

But if the WSJ is right, maybe this debate about behavioral economics is old news anyway.  Shove is the new nudge and all that.

Today, the Commission announced a consent decree with Transitions Optical in an exclusionary conduct case.  Here’s the FTC description:

Transitions Optical, Inc., the nation’s leading manufacturer of photochromic treatments that darken corrective lenses used in eyeglasses, has agreed to stop using allegedly anticompetitive practices to maintain its monopoly and increase prices, under a settlement with the Federal Trade Commission announced today. Photochromic treatments are applied to eyeglass lenses to protect the eyes from harmful ultraviolet (UV) light. Treated lenses darken when exposed to UV light and fade back to clear when the UV light diminishes….

The FTC charges that the company illegally maintained its monopoly by engaging in exclusive dealing at nearly every level of the photochromic lens distribution chain. First, Transitions refused to deal with manufacturers of corrective lenses, known as “lens casters,” if they sold a competing photochromic lens. Further down the supply chain, Transitions used exclusive and other agreements with optical retail chains and wholesale optical labs that restricted their ability to sell competing lenses.  According to the FTC’s complaint, Transitions’ exclusionary tactics locked out rivals from approximately 85 percent of the lens caster market, and partially or completely locked out rivals from up to 40 percent or more of the retailer and wholesale lab market.

In settling the agency’s charges, Transitions has agreed to a range of restrictions, including an agreement to stop all exclusive dealing practices that pose a threat to competition. These provisions will end its allegedly anticompetitive conduct and make it easier for competitors to enter the market.

The Complaint is here.   And the analysis to aid public comment is available here.  A few quick observations and reactions, with the obvious caveat that these comments have only the benefit of the public information linked above and not more.

1. In light of a certain high-profile loyalty / market-share discount case that the Commission has on its plate, the analysis here is interesting not only on its own merits, but to the extent it might inform about how the Commission would pursue other cases involving similar conduct, i.e. exclusive dealing and discounts conditioned on full or partial exclusivity or threshold purchase requirements.   I note, for example, that the order prohibits Transitions from both exclusive dealing and partial exclusives/ loyalty discounts.  It will be interesting to see if the Commission adopts a similar approach of bearing the burden of demonstrating substantial foreclosure as a necessary but not sufficient condition in other cases involving allegedly exclusionary contracts aimed at depriving rivals of access to distribution sufficient to achieve minimum efficient scale.

2. The alleged foreclosure percentages are very high, over 85 percent with lens casters and “as much as 40 percent or more” with retailers and wholesale labs.  Under a straight Section 2 analysis, which the Commission discusses in the aid to public comment, and assuming the accuracy of these calculations, these foreclosure levels are likely to raise significant concerns where monopoly power is present and the contracts are difficult to terminate (both are alleged).

3. I found one passage in the aid to public comment troublesome, and in my view, incorrect.  With respect to pro-competitive efficiencies flowing from the arrangement, the Commission appears to be taking an overly narrow stance about cognizable justifications. Here’s what the FTC says about efficiencies from exclusives:

No procompetitive efficiencies justify Transitions’ exclusionary and anticompetitive conduct. Transitions cannot show that the exclusive arrangements were reasonably necessary to achieve a procompetitive benefit, such as protecting Transitions’ intellectual property or technical know-how, or preventing interbrand free-riding.5 Transitions does not transfer substantial intellectual property or technical know-how to its customers, and even if it did, any such transfer would likely be protected by existing confidentiality agreements. A concern about interbrand free-riding also does not justify the substantial anticompetitive effects found here. The vast majority of Transitions’ promotional efforts are brand specific, reducing the significance of any free-riding concern.6 While Transitions’ marketing efforts may generate some consumer interest in the product category as a whole – and not just in Transitions’ own products – this is a part of the natural competitive process. This type of consumer response does not raise a free-riding concern sufficient to justify the substantial anticompetitive effects found here.

As a conceptual matter, the Commission at least appears to reject the idea of distributional / promotional efficiencies in the absence of inter-retailer free-riding.  Footnote 6 of the analysis seems to support that conclusion.   As readers of this blog will know, I’ve done some work in this area arguing that this interbrand free-riding conception is too narrow and does not reflect the benefits of vertical restraints in resolving pervasive incentive conflicts between manufacturers and retailers even in the absence of free-riding.

Thom has a great post on this summarizing Ben Klein’s work on RPM which is in a similar vein.  But the fundamental economic facts are that under a set of conditions frequently satisfied in conventional differentiated products markets (manufacturer margins > retailer margins; manufacturer-specific retailer promotional efforts lack significant inter-retailer effects), manufacturers will have to compensate retailers for promotional effort.  These payments can take a lot of different forms: discounts, RPM, slotting contracts, etc.  The promotional sales generated are output increasing and so, from an antitrust perspective, vertical restraints resolving these incentive conflicts provide an important efficiency justification for restraints such as RPM, as I note here, and as the majority in Leegin recognizes.  Or see Ben Klein’s latest on RPM for an excellent explanation of the economics at work here, extending the analysis in Klein and Murphy (1988).

The next key step, and the one relevant for exclusive dealing, is that the very fact that dealers are compensated by manufacturers for supplying promotion on the basis of all their sales also opens the door to a type of free-riding that might undermine these promotional efforts that does not involve switching sales to a rival.  The manufacturer and dealer can be thought of as having an implicit contact to supply the contracted-for level of promotional services, with the manufacturer paying a premium for this performance and monitoring its retailers, terminating for non-performance where necessary.   However, dealers can free-ride by taking the compensation but reducing costly promotional effort.  Even if inter-brand free-riding is not possible, the vertical chain faces this incentive conflict.  Exclusive dealing and reduce the incentive to free-ride and facilitate performance by increasing the incentives for the retailer to perform.

Klein and Lerner (2007) present this analysis is significant detail and readers are referred there.  The fundamental point is that, as the authors write:

In particular, the presence of free-rideable manufacturer investments and dealer switching, the conditions focused upon by the court in Dentsply, are not necessary conditions for determining whether a prevention of free-riding justification for exclusive dealing makes economic sense. All that is required for exclusive dealing to be used to prevent dealer free-riding is that dealers have a significant economic role in the promotion of the manufacturer’s product, that manufacturers are compensating dealers for the supply of additional promotion and that exclusive dealing encourages such extra dealer promotion by facilitating manufacturer enforcement of its implicit contract for dealer promotion.

Note that I am not arguing that these potential efficiencies were present in Transitions as a factual matter.  Rather, I am just saying that to the extent that the passage endorses the position that exclusive dealing cannot prevent free-riding in the absence of free-rideable investments by the manufacturer, it is overly restrictive.  I should also note that my view is not only consistent with much of the case law recognizing a “dealer loyalty” explanation for exclusive dealing, it is also the case that Commission itself has discussed this type of efficiency in the past!  See, for example, this advocacy filing (signed by BC, BE and OPP) concerning potential legislation restricting vertical restaints in the wine industry.  The filing (and there are others), signed ecognizes that in addition to preventing inter-brand free-riding (and citing Klein) “exclusive dealing can be used to assure that suppliers receive the sales-generating effort that they have bargained for from distributors (e.g., through direct payment or through increased revenue that comes with exclusive territories), rather than distributors focusing their efforts on competing brands.”

Because the Commission makes reference only to the inter-brand free-riding, and does not discuss other free-riding justifications, this seemed worth comment.  Of course, even if such a pro-competitive justification fit the facts, it also does not mean it would outweigh any potential anticompetitive effects, but I do find the omission at least mildly troublesome.

Professor Bainbridge has a provocative post up taking on empirical legal scholarship generally.  The While the Professor throws a little bit of a nod toward quantitative work, suggesting it might at least provide some “relevant gist for the analytical mill,” he concludes that “it’s always going to be suspect — and incomplete — in my book.”  Here’s a taste:

And then there’s a recent paper I had to read on executive compensation, whose author should remain nameless. The author found a statistically significant result that he didn’t like. So he threw it under the bus by claiming that his regressions were flawed. Accordingly, he turned to panel data analyses that gave him a result he liked. All the while, another paper on the same topic had found the same results as our author’s regressions. Who was it that said statistics don’t lie?

On top of which, of course, there’s the problem that the number crunchers can only tell you something when they’ve got numbers to crunch. Suppose there was a change in the law in 2000. A before and after comparison might be instructive. But companies weren’t required to disclose the relevant information until 2005. You don’t have anything to measure.

I’m tempted to ask how many legal theory debates have been resolved convincingly by a single paper?  But instead I’ll try to do something more constructive.  At least I hope so. Larry Ribstein chimes in to make the well taken starting point that theory itself is not useful without data.  That is obviously right.  And I think if one were too ask whether the legal literature was suffering from too many theories of too much empirical knowledge — I’d opt for the latter.  But, I’ve got a few different bones to pick.

The first is that even holding regressions and sophisticated quantitative analysis aside for the moment — we’ll come back to it — is that the data should constrain the theory.  In fields that I am familiar with, there is a great deal of legal scholarship that simply ignores the few stylized facts or empirical regularities established by the empirical literature but builds theories and rattles off policy implications.  Of course, the theory of legal theorists rejecting an empirical methodology that restricts their ability  to generate theory willy nilly is not one that can be casually rejected.  I mean, unconstrained theory does sound like more fun doesn’t it?

Second, I read Bainbridge’s post as revealing a common tendency in the legal academy to dismiss empirical evidence if it, alone, is not sufficient to resolve some policy debate.  Empirical evidence is hard to collect and a body of empirical knowledge builds over time.   My sense is that the intuitive gut instinct of law professors is that the role of empirical scholarship is to “prove” assertion X in the way that one might establish the proper interpretation of a contract or statute.  Fads in legal scholarship are another example of this high discount rate in the academy.  For example, I’ve complained before about what I think is the over-use of behavioral law and economics, lack of rigor in drawing out policy implications from the evidence and models, and insufficient attention to empirical data.   There is a premium in the legal literature on striking while the topic is hot, and on over-claiming (and of course, having a catchy paper title) as well, and without expert peer review of claims concerning the relevant empirical literature, perhaps the latter is to be expected.  In any event, the point is that to the extent that “law and social science” disciplines like law and economics want to be taken seriously, and claim the advantages of the ancillary discipline, they cannot simultaneously reject the methodological commitments that come with it — even if those come with the price of things moving a bit slower than the law review (or news) cycle.

Third, paragraphs like Bainbridge’s first make me wonder whether this attitude (not his specifically) about empirical work are informed judgments or just reflexive tendencies to question sophisticated models that are outside our own strike zone?  Knowing nothing about the paper that the Professor is talking about in his example, one can in the abstract think of lots of reasons an empiricist might run a plain vanilla OLS specification as a baseline, report the results, go on to suggest that OLS in this setting as various problems, and move on to some more sophisticated panel approach, and compare the more robust results to contrasting ones in the literature.  Of course, the sort of specification search that Steve hints at could also be going on too.  I’ve got no horse in that race.  But the more general point is that often the critiques of various econometric models by non-econometricians sometimes betray a thinly veiled anti-empirical bias that I think is often dressed up in the language of “omitted variable” bias.  I can vouch for having given dozens of workshops at law schools where no discussion of panel data techniques and description of what exactly fixed effects control for is sufficient to respond to the “but did you control for X, Y and Z” question.

In sum, there is a lot of empirical work out there that is worthy of suspicion.  There is work that it methodologically unsound, suffers from poor and unreliable data or from authors that overclaim.  But there is a lot of really good stuff out there too!  Data is getting cheaper and methods more sophisticated.  Of course, the reduced cost can lead to the types of problems that Steve raises.  But quality problems can and do also occur in doctrinal scholarship pplying other, non-quantitative methodologies to interpret statutes, synthesize cases, make historical claims, or construct theoretical models.  The devil in these arguments is typically in the details no matter what the methodological toolkit.  And rigorous academic discourse is often about identifying and exposing those details to evaluate claims and hopefully, answer questions that can move the literature forward.   I understand that lawyers are going to be suspicious of foreign toolkits, like econometric analysis.  But in my view, the reflexive rejection of empirical work because “its hard to control for everything” is about as persuasive as reflexive rejection of claims that there is some coherent theory of statutory interpretation because “the judge just makes it up anyway, doesn’t he?”  Both might be true on a case by case basis, but I think the bar that legal scholars face in each case is to take seriously the work of others and describe exactly what the problems are and what implications they have for the results.  Let me be absolutely clear that I do not view Professor Bainbridge’s post as committing that error — it IS a blog post after all  — but it did get me thinking about this issue of empirical work and its reception in the broader legal community more generally.

Richard Thaler’s NYT Economic View column features Tom Hazlett (my colleague, and former chief economist as the FCC) proposal for auctioning off TV spectrum.   Thaler points out:

These frequencies are very attractive on technological grounds. People in the industry refer to them as “beachfront property” because these low-frequency radio waves have desirable properties: they travel long distances and permeate walls. We have already allocated parts of this spectrum for mobile wireless, and the F.C.C. recently auctioned other parts for $19 billion. That has left 49 channels for over-the-air television.

Why is the current use of this spectrum so inefficient? First, because of the need to prevent interference among stations, only 17 percent of it is actually allocated by the F.C.C. for full-power television stations. (The so-called white space among stations is used for some limited short-range applications like wireless microphones.)

Second, over-the-air broadcasts are becoming a nearly obsolete technology. Already, 91 percent of American households get their television via cable or satellite. So we are using all of this beachfront property to serve a small and shrinking segment of the population.

Here’s how Professor Hazlett describes the problem in the introduction to his proposal:

The Federal Communications Commission’s digital television (DTV) transition is not nearly complete. The total bandwidth set aside for terrestrial digital video broadcasting — 49 channels allotted some 294 MHz — is worth over $100 billion in license value and at least ten times that amount in Consumer Surplus.2 But it contributes virtually nothing to society in its current configuration, a verdict that will not change if the FCC continues on its present path. The existing policy, which freezes TV stations in their current positions and then attempts to sprinkle in unlicensed devices in the “white spaces” surrounding them, blocks the flow of spectrum inputs to the wireless services consumers most desire to use.

The opportunities squandered are highly valued by consumers: more competition
among mobile voice and data carriers; innovative, spectrum-intensive applications for emerging platforms such as those supporting Blackberries, iPhones, and gPhones; broad expansion of machine-to-machine services as launched by OnStar, Kindle, health telemetrics vendors, and product monitoring devices. While the under-allocation of radio spectrum to mobile networks has been visible for some years,3 the crisis now looming is widely seen. The explosion in bandwidth usage by smart phone subscribers, a salubrious product of competitive rivalry between mobile carriers, is challenging network capacities even now – when high-bandwidth applications, such as audio and video streaming, are just beginning to take-off.

The solution? Thaler discusses Hazlett’s auction proposal:

Suppose we put this spectrum up for sale. (The local stations do not “own” this spectrum. They have licenses granted by the Federal Communications Commission.) Although the details of how to conduct this auction are important, they don’t make compelling reading on a Sunday morning. Interested readers should examine a detailed proposal made to the F.C.C. by Thomas W. Hazlett, a professor at the George Mason University School of Law who was formerly the F.C.C.’s chief economist.

Professor Hazlett estimates that selling off this spectrum could raise at least $100 billion for the government and, more important, create roughly $1 trillion worth of value to users of the resulting services. Those services would include ultrahigh-speed wireless Internet access (including access for schools, of course) much improved cellphone coverage and fewer ugly cell towers. And they would include other new things we can’t imagine any more than we could have imagined an iPhone just 10 years ago.  But some compelling technology that could use these frequencies already exists, like wireless health monitoring — to check diabetics’ blood sugar regularly, for example — and remote robotic surgery that can give a patient in Idaho a treatment like that available in New York or Chicago….

Professor Hazlett estimates that $300 per household should do it: that amounts to $3 billion at most. Compared with the gains from selling off the spectrum, it’s a drop in the bucket. Or, as an interim step, we could reduce the number of channels available in a community from 49 to, say, 5.

Who would oppose this plan? Local broadcasters are likely to contend that they are providing a vital community service in return for free use of the spectrum that was put in their hands decades ago. Whether the local news or other programs are vital services is up for debate, but their value isn’t the issue, because they can be made available via cable, satellite and other technologies, including improved broadband. …

I KNOW that this proposal sounds too good to be true, but I think the opportunity is real. And unlike some gimmicks from state and local governments, like selling off proceeds from the state lottery to a private company, this doesn’t solve current problems simply by borrowing from future generations. Instead, by allowing scarce resources to be devoted to more productive uses, we can create real value for the economy.

Economists are fond of saying that there is no such thing as a free lunch. Here we have an idea that is even better than a free lunch: being paid to eat lunch. More paid-lunch ideas will be coming in future columns.

Check out Thaler’s column, and Hazlett’s proposal.

Dick Langlois’ post on Carl Kaysen’s role in the United Machinery antitrust case reminded me of a question I’ve been meaning to blog about.  Langlois writes:

Obituaries praise Kaysen for his role as a policy intellectual of great scope, especially in the area of nuclear non-proliferation. But they either fail to mention, or mention with considerable approval, Kaysen’s pivotal role in the famous 1954 United Shoe Machinery case. Kaysen’s view of the case, and of the role of economic analysis in antitrust, is a key example of what Williamson calls the “inhospitality tradition” — that any kind of contract we don’t understand must therefore be anticompetitive. In the eyes of many present-day economists, Kaysen is implicated in having destroyed the American shoe machinery industry and with it the American shoe industry. (The post-mortem is by Masten and Snyder.) Not exactly McNamara in Vietnam, but worth mentioning amid the hagiography of Kaysen, not to mention the reawakened culture of elitist decision-making in Washington.

Kaysen was retained by Judge Wyzanski in United Machinery.  Kaysen sat in court with the judge, examined the evidence, and briefed the court — though the brief was apparently not available to either side.  In another famous example, economist Alfred Kahn was appointed in New York v. Kraft General Foods pursuant to Federal Rule of Evidence 706.  Judge Posner has long urged that district courts make greater use of court-appointed experts.  We recently discussed Judge Sarin’s reliance on economist Orley Ashenfelter to help resolve a Daubert dispute.  Michael Baye and I discuss judicial training in basic economics as one method of mitigating problems arising out of economic complexity in antitrust cases, and provide some empirical evidence suggesting positive returns to this approach in less complex cases.

The reason the Kaysen and Kahn cases are so frequently discussed, of course, is because the examples in antitrust are few and far between.  As I understand it, judicial use of court-appointed “neutral” experts or special masters is very rare in antitrust.  Casual empiricism and a little bit of digging suggest that it is much more common procedure in, for example, appointment of experts with specialized knowledge in science in patent cases involving claim construction.  Turns out, the lack of court appointed experts appears to be a real phenomenon, and one that doesn’t get much attention in part because it happens so infrequently. But the problem is at least perceived to be a big one in antitrust.  24 percent of economists in the ABA Task Force survey opined that judges don’t understand the general economic issues in modern antitrust litigation.

So, why is it that federal judges don’t use court appointed economists more often?  Is it that judges are more comfortable relying on experts in hard sciences but there is some stigma in admitting one needs “help” to understand economic testimony?  Are the outcomes in areas where courts do use court appointed experts more frequently positive?  Do they reduce appeal and reversal rates for district court judges?  If the stylized fact that court appointed experts are used much more frequently in some areas of the law than others, this seems like a neat puzzle to try to both document and explain.  Any thoughts?

Over at the International Center for Law and Economics website we’ve posted a link to a pdf e-book version of the collected content (including both posts and comments) from our recent “Interchange Fees and the Law and Economics of Credit Cards” symposium.  Head on over and download a copy if you’re interested in a dead tree version of the symposium.

Antitrust & Competition Policy Blog is hosting a symposium on Competition in Agriculture.  Mike’s post from yesterday is available here.   So far in the symposium there are also posts by Ron Cass (BU Law), Jeff Harrison (Florida Law), Peter Carstensen (Wisconsin Law), and Kyle Stiegert (Wisconsin Applied Econ).  Additional posts should be forthcoming from Christina Bohannan (Iowa Law), Andrew Novakovic (Cornell Applied Economics), and the great George Priest (Yale Law), who I hope gets the blogging bug.

Josh, Scott Kieff and I have posted a short comment based on our submission to the DOJ/USDA Workshops on Agricultural Competition, co-authored by us and Mike. The comment should be available for download from the DOJ webpage when the public comments are posted (someday . . . ).  A copy is also available here (www.laweconcenter.org), and comments are most welcome at gmanne@laweconcenter.org Please leave comments on this post over at the A&CP Blog.

Regarding firm size and integration, it must be kept in mind that the agriculture industry in the U.S. has, for good reasons, moved beyond the historic, pastoral image of small family farms operating in quiet isolation, devoid of big business and modern technologies. The genetic traits that give modern seeds their value—traits that confer resistance to herbicide and high yields, for example—are often developed through processes that are technologically-advanced, time- and money-intensive, risky investments, and subject to various layers of regulation. It doesn’t take expertise in industrial organization to imagine why at least for some participants in this market these processes are likely to be more efficiently and effectively conducted within large agribusiness companies having enormous research and development budgets and significant expertise in managing complex business and legal operations, than they are by the somber couple depicted in the famous 1930 Grant Wood painting, “American Gothic.” Nor is such expertise required to imagine why complex contracting across firms, of any size, is likely to be of significant help in supporting the specialization and division of labor that is useful in allowing some businesses (even a small family farm is a business) to be good at planting and harvesting while others are good at inventing, investing, managing, developing, testing, manufacturing, marketing, and distributing the next wave of innovative crop technologies. This requires on the one hand that the government give reliable enforcement to contracts and property rights whether tangible or intangible (extremely important in this industry are patents, trade secrets, and even trademarks), while on the other hand it allows firms wide flexibility to decide for themselves which of these contracts and property rights they would like to enter into or obtain pursuant to the applicable bodies of contract and property law.

When courts and regulatory agencies like the DOJ Antitrust Division adopt special approaches to the body of antitrust law to address concerns that may arise from these property rights and contracts, they run the risk of crafting doctrines that inappropriately override well-established bodies of law that are informed by longstanding judicial and scholarly thought and consideration of each area, and creating the potential to reduce innovation and economic growth. A central countervailing concern is that the putative antitrust injuries that might arise are rooted in stylized economic models that are heavily dependent on a narrow set of assumptions, leaving significant room for erroneous antitrust enforcement. A modest but fundamental safeguard to protect against this concern of “false positives,” is an approach to antitrust that requires a strong demonstration of actual anticompetitive effect as a precondition for a monopolization violation.

Not only are patents not presumptive proof of market power in any static sense, but patents can also meaningfully improve both competition and access to patented technologies over time, in the dynamic sense. From the public record it appears that the driver of much of today’s antitrust enforcement in the agricultural industry boils down to intervention into business disputes between large and sophisticated parties. The inherent uncertainty regarding the economic consequences of specific conduct, coupled with competitors’ poor incentives and the huge costs of error, counsel strongly against antitrust intervention without strong empirical evidence that the conduct has reduced competition and harmed consumers in the form of higher prices, lower quality, or reduced innovation.

Antitrust & Competition Policy Blog is hosting a symposium on Competition in Agriculture. So far today, there are posts by Ron Cass (BU Law), Jeff Harrison (U of Florida Law), and me.  Additional posts should be forthcoming from Christina Bohannan (U. Iowa Law), Scott Kieff (GW Law), Andrew Novakovic (Cornell Applied Economics), George Priest (Yale Law), Kyle Stiegert (U. Wisconsin Agricultural and Applied Economics), and Josh Wright (George Mason Law). My contribution is reproduced below.  Please leave comments over at the A&CP Blog.

Learn from history, don’t repeat it.

Antitrust laws originated in Midwest states like Missouri in the late 1880s when small farmers banded together in the face of falling agricultural commodity prices to stand against the competitive pressures of larger, more efficient farming operations. Over a century later, it is, as Yogi Berra said, “déjà vu all over again.”

Of the almost 2.2 million farms in the USDA’s 2008 Agricultural Resource Management Survey, the 1.8 million smallest farms lost money on their farming operations (on average) even after accounting for government program payments. These farms represent only 10% of the value of agricultural production in the US, yet received roughly 28% of government payments.

In addition, these small-scale farmers are less likely than their larger competitors to shop beyond the nearest town for key inputs, to shop for the best price from suppliers, to negotiate price discounts, or to lock in prices for inputs. Small-scale farmers are also much less likely to market their products using contracts or to use market-based risk management tools. In short, small-scale farmers fail to (or are simply unable to) take advantage of market opportunities that larger, more efficient farms do. That large farms do engage in these activities suggest a very competitive agricultural economy.

Although antitrust has long been used as an anticompetitive club by economically inefficient competitors, such applications do more harm than good. The agriculture sector would be better served by eliminating the subsidies that sustain marginal producers than by using antitrust to penalize more efficient, better managed farming operations and other firms along the rest of the food value chain. DOJ’s antitrust inquiry will, at best, simply perpetuate the inefficient industry fringe or, more likely, inhibit the kinds of technological and market innovations that have provided US consumers and the world with a safe, reliable food supply.

The subject of antitrust exemptions has been an oft-discussed topic here at TOTM (see, e.g. here and here).  In the latter of those two links I was somewhat critical of the DOJ for taking a neutral stance on the insurance industry exemption, which has now become rather wrapped up in the health care reform debate. I wrote:

Look, when Harry Reid says that he knows insurance companies are anti-competitive “Because they make more money than any other business in America today,” its pretty hard to refrain from criticizing a political ploy that doesn’t have anything to do with the antitrust merits.  Not to mention that Congress is simultaneously considering passing other antitrust exemptions while its striking down others.  I’m sympathetic.  But just to be clear.  Whatever one thinks about the difficulties of application of the antitrust laws to single firm conduct (I’ve certainly been a critic of much of the modern approach to monopolization), it is worth repeating:  cartels are bad.  They raise price.  They reduce output.  That is not what the economy needs.  There is a substantial economic literature on this.  And I don’t think that any economist who has looked at the literature has or would ever support an industry wide antitrust exemption.  If I’m wrong, I’d love to see some citations.  Maybe there is some evidence out there that I’ve not seen that indicates that exemptions improve consumer welfare in practice.  I doubt it.  But that’s what the comments are for.

As the Antitrust Modernization Committee Report and Recommendation says:

Statutory immunities from the antitrust laws should be disfavored. They should be granted rarely, and only where, and for so long as, a clear case has been made that the conduct in question would subject the actors to antitrust liability and is necessary to satisfy a specific societal goal that trumps the benefit of a free market to consumers and the U.S. economy in general.

And:

to extent that insurance companies engage in anticompetitive collusion, however, then they appropriately would be subject to antitrust liability.

To be absolutely clear, I am NOT saying that I believe that repeal of the federal exemption will do much to lower prices or that I believe there is a high incidence of collusive behavior by the insurance firms.   But that’s not the point.  The point is that we should not be defending the merits of exemptions for prohibitions on cartel activity.  Personally, I believe that state imposed barriers to entry, regulatory constraints and rate regulation are more likely a much bigger problem for consumers than anticompetitive behavior and efforts aimed at increasing competition between the states will have a much bigger bang for the buck for consumers.  But the fact that state regulation is also a problem is not a good argument in favor of an antitrust exemption that allows collusion.

The Competitive Enterprise Institute’s Gregory Conko and Kevin Hiferty offer a defense of the exemption (HT: Washington Times):

There is no evidence that McCarran-Ferguson has resulted in higher premiums or profits, however. So, not only is federal intervention unnecessary for ensuring fair competition, it could actually hurt consumers by eliminating practices that help small insurers compete and drive down costs.  The law gives states the primary role in regulating “the business of insurance,” and exempts insurers from most federal regulation, including antitrust laws, as long as the states have laws governing the same conduct.  But where critics see only dominant market power and higher premiums, a closer look reveals a careful balancing by the states that helps promote competition and keep costs in check. As the Congressional Budget Office concluded in October, repealing the exemption would have little or no effect on insurance premiums because “state laws already bar the activities that would be prohibited under federal law if this bill was enacted.”

It is true that a handful of states have highly concentrated markets. In Hawaii, Rhode Island and Alaska, 95 percent or more of the small-group health insurance market is served by just two insurers. But the McCarran-Ferguson Act only shields activities that are integrally related to providing insurance and unique to the insurance industry, and consolidation isn’t one of them.  Practices that are not inherent to underwriting insurance, such as firm mergers, bundling and tying arrangements, agreements to allocate geographic market shares, and many other allegedly anti-competitive activities are, even under current law, subject to federal antitrust enforcement and actively policed by the Federal Trade Commission. So, additional federal intervention would have no effect on insurance industry consolidation.

What would be newly subject to federal enforcement is a variety of ongoing collaborative practices among health and medical-malpractice insurers that are now permitted by the states because they have pro-competitive effects.  At the state level, insurers actively share loss-experience data and related information through rating bureaus, so that each firm has a large enough pool of information to accurately price risks and set aside reserves. In some states, industry-run rating bureaus aggregate this underwriting data and calculate “target” or “advisory” rates under the supervision of state regulatory authorities. Many states also permit insurers to create joint underwriting associations that help insurers pool difficult-to-manage risks and share in the associated profits or losses.

This kind of collaborative activity tends to lower costs, promote insurance industry solvency, and help small insurers compete with bigger firms. Although the Leahy-Whitehouse bill would permit a limited amount of data sharing, the other practices would be subjected to federal antitrust enforcement. That would, ironically, further strengthen the power of the biggest insurers and disadvantage smaller competitors.  Even aside from these important collaborative practices, federal antitrust law would still be a bad fit for the insurance industry. When faced with a market containing two or three dominant firms, a typical antitrust enforcer’s response is to break up the firms into smaller pieces – think of the dissolution of AT&T’s local service monopoly into seven Baby Bells.

But as Boston University health economist Austin Frakt has noted, limiting the size of insurers would also limit their ability to negotiate down prices with health care providers. On the whole, economics research “supports the notion that recent increased market power of insurers does not lead toward monopolistic pricing, but rather it provides a counterbalance to the power held by hospitals and provider groups.”  There are, however, other ways to promote competition in the health insurance market. One change Congress should consider is to permit individuals and business purchasers of health insurance to buy their policies from any willing provider in any U.S. state.  Under current law, an insurance firm registered in one state may not cover individuals in another without registering in the second state and being subject to all of its taxes and laws. This raises the cost of doing business across state lines and prevents many smaller and midsize companies from entering new markets to compete.

Allowing consumers in Alabama, for example, to escape Blue Cross-Blue Shield’s 83 percent market share in that state by shopping for an insurance policy in neighboring Florida’s highly competitive market would increase competition significantly. And it would do so without jeopardizing important pro-competitive business practices that help keep costs in check.  If congressional Democrats genuinely wanted to help consumers, they would seek ways to reduce burdensome regulations on the insurance industry that raise health premiums. Instead, if their effort to “get tough” on the insurance industry succeeds, they would do more harm to consumers than good.

What do readers think?  The economist cited invokes the countervailing power defense argument raised by Steve Salop.  I’m a strong supporter of the idea of opening sales of insurance across state lines as a measure that could help and would not harm.  But that’s not the issue here.   Is there any evidence that lifting antitrust exemptions helps consumers?  I read this article as largely offering the defense that lifting the exemption just won’t matter much.  Are you convinced?

The Amazon vs. Macmillan controversy has been beaten to a pulp in the blogosphere.  See Megan McArdle, John Scalzi, Joshua Gans, Virginia Postrel, Lynne Kiesling, Lynne Kielsing and Lynne Kiesling, among others.  Pulp or no (get it? It’s a book/e-book pun), I haven’t seen anyone hit squarely on what I think is the crux of the issue: control rights.

Amazon is an interesting hybrid, sometimes acting as a platform, sometimes acting as a direct merchant.  In its capacity as a platform, Amazon facilitates sales of goods from other merchants to Amazon’s customers through its website.  Amazon itself doesn’t actually sell these goods (because it never actually owns them), although it operates the system that enables these sales and takes a cut.  In its capacity as a merchant, Amazon purchases goods from suppliers and sells them directly to its customers.

The Kindle makes the merchant/platform distinction even more muddled for Amazon, and the distinction is at the core of the issue.

Basically, the difference between a merchant and a platform, as suggested above, is in the degree of control an intermediary exerts over pricing and other terms of sale, and the extent to which it bears risk.  The more control, the more merchant-like; the less control, the more platform-like (Thus the Gap is a merchant; eBay is a platform).  Background economic conditions determine which model (or where on the continuum between them) is more efficient for a given intermediary or market.  As these conditions change, the optimal degree of control may change, as well.  At the same time, suppliers or intermediaries may choose to assert or deny control in response to changing economic conditions–and this choice may not be optimal.  To my thinking, this is what is going on in the book/e-book market.

Steven Pearlstein in the WaPo hints at the issue:

While markets have their flaws, over the long run they are good at executing these technological transformations. My guess is that in the not-so-distant future, best-selling authors such as John Grisham and Malcolm Gladwell — along with unknown authors peddling their first books — will publish their own works, contracting with independent editors and marketers and selling directly to consumers as much as possible. Other authors will turn to smaller, more specialized publishing houses that will offer smaller advances but bigger royalties and will be built, as they once were, around great editors. Publishers will sell their books through competing online distributors and traditional hard-copy bookstores, the latter of which will continue to exist not only as places to browse and socialize, but also as places to have printed on demand. Backlists will be infinite, pricing will be dynamic, and more copies of more books will be read and sold.

From Amazon’s point of view, this possible future is probably a quite likely one (in part because it can help to hasten its arrival), and one which does not necessarily bode well for its merchant-like business model (on which see, e.g., Charlie Martin).  But this future is a goldmine for its platform model, particularly to the extent that Amazon’s Kindle offers a widespread and attractive platform to readers and authors alike.

When it comes to selling physical books directly, Amazon has, and is used to, full control over the terms of sale.  When it comes to selling e-books, however, Amazon is not really a merchant–but it’s not (yet) exactly a platform, either.  Most obviously, there is no physical inventory for Amazon to purchase with e-books, and whether it actually purchases e-books at the time of sale to resell in each transaction (even at a predetermined price) or simply facilitates a transaction between publisher and purchaser at the time of sale, Amazon bears the same extent of inventory risk: zero. Very platform-like.  But the terms of contracts with publishers complicate matters.  Under the Amazon-negotiated pricing scheme, Amazon does, indeed, buy the e-book and re-sell it.  Although this entails no inventory risk, it does mean that Amazon bears “pricing risk” (if that’s a term) just as a merchant does, and it is stuck with the price it negotiated with publishers, no matter the price at which it actually sells its e-books.

There are other nuances.  Important among these, use of e-books purchased through Amazon requires that buyers own a Kindle (just as use of Xbox video games generally requires owners to have purchased an Xbox).  If not enough buyers own Kindles, there is little value (and some cost) to publishers in participating in the e-book market through Amazon; likewise, if not enough publishers sell e-books through Amazon, there is little value to consumers in buying a Kindle.  Again, very platform-like.  But books will be written, published and marketed regardless (or maybe almost regardless) of the number of Kindle owners, and book buyers will buy the same books (or maybe almost the same books) whether they own Kindles or not–and some Kindle owners will buy physical books even though they own Kindles.  The point is that the indirect network effects (or economies of scale–a debate for another day) that one expects in platform markets and that one sees in, say, the video game market (the more Xbox owners, the more Xbox game developers there will be and thus the more Xbox owners there will be) are severely attenuated in the e-book market currently because of the overwhelming demand for physical versions of the same books.

Now, both of these points are discussed in different ways by many of the commentators I pointed to on this issue.  Obviously the nature of the contracts between Amazon and publishers is central to the story (in fact, it is the story), and everyone has discussed the issue.  Several folks have also pointed out that e-books compete with physical books, usually to mention that publishers are interested in price discrimination (on which Kiesling and Postrel are particularly good).

But I think viewed in the light of the choice of business model it is clear that the issue is control.  The question is the extent to which Amazon should act more like a platform or more like a merchant, and this distinction is determined by the amount of control it has.  As a merchant, Amazon expects–and everyone benefits from it having–a lot of control, with both its attendant costs and benefits, over the terms of sale of its products.  As a platform, Amazon is willing to cede control over the terms of sale and just manage the platform.

When publishers assert that they want more control over e-book prices they are pushing Amazon toward a platform model for e-books.  The problem is that because book publishers do not internalize the benefits conferred on other publishers from a wider use of Amazon’s platform, their pricing incentives may be inefficient.  As others have noted, publishers probably want to engage in pricing and price discrimination that will maximize their revenue.  But this control may not be optimal for the platform at this nascent stage.

And that’s really the twist.  Amazon is not ready to be a platform in this business.  The economic conditions are not yet right and it is clearly making a lot of money selling physical books directly to its users.  The Kindle is not ubiquitous and demand for electronic versions of books is not very significant–and thus Amazon does not want to take on the full platform development and distribution risk.  Where seller control over price usually entails a distribution of inventory risk away from suppliers and toward sellers, supplier control over price correspondingly distributes platform development risk toward sellers.  Under the old system Amazon was able to encourage the distribution of the platform (the Kindle) through loss-leader pricing on e-books, ensuring that publishers shared somewhat in the costs of platform distribution (from selling correspondingly fewer physical books) and allowing Amazon to subsidize Kindle sales in a way that helped to encourage consumer familiarity with e-books.  Under the new system it does not have that ability and can only subsidize Kindle use by reducing the price of Kindles–which impedes Amazon from engaging in effective price discrimination for the Kindle, does not tie the subsidy to increased use, and will make widespread distribution of the device more expensive and more risky for Amazon.

Many of the commentators (see especially Scalzi and Kiesling) are angered by Amazon’s conduct in the affair, and see in it reason to shift their loyalty from Amazon to its competitors (or at least they did before Amazon capitulated).  I see it quite differently.  To me the affair was a dispute over control rights allocated by contract.  Amazon is willing to pay more for control–to act, in other words, like a merchant re-selling publishers’ books.  It wants this control because it wants to sell e-books at a lower price than publishers want in an effort to sell more Kindles and encourage e-book use (and, incidentally, sell fewer physical books).  At this stage in this market what is needed is not more incentive for publishers to develop more inventory, but more incentive for Amazon to develop its platform.  To the extent that Amazon must now bear more of the risk and cost associated with the transition to e-books, the transition will likely occur more slowly.  Amazon’s effort to maintain pricing control by playing hardball with Macmillan in the physical book market was appropriate and gutsy.  And we would have been better off if it had succeeded.

I don’t think there’s anything to be “done” about the state of affairs other than for Amazon and publishers including Macmillan to continue negotiating.  But I will note one thing (seconding Joshua Gans):  It is almost certainly the case that Amazon capitulated in its dispute with Macmillan because of fear of drawing antitrust litigation.  If so, I think this would be most unfortunate, and it would represent antitrust enforcement placing an inefficient thumb on the bargaining power scale.  Perhaps we shouldn’t be so quick to reject the idea of false positives . . . .

Important Hat Tip.  When I started writing this post I hadn’t yet seen this article by Andrei Hagiu (Hagiu, Andrei (2007) “Merchant or Two-Sided Platform?,” Review of Network Economics: Vol. 6: Iss. 2, Article 3) (embarrassingly enough, as it was published in 2007).  But my thinking here maps significantly onto Andrei’s and I re-wrote some of the post, particularly reflecting some of his terminology, once I did read it in the middle of drafting the post.  It strikes me as an extremely important article in the two-sided markets literature, and I highly recommend it to everyone interested in the topic.  To the extent that I say what he says, he says it better; and to the extent that we diverge, he is probably correct and I am probably wrong.

Steve Horwitz writes a short, lay piece on crowding out and job creation.

Brad “smacks down” Steve Horowitz.

Russ Roberts amplifies Horwitz with a nice point about the dangers of aggregation.

David Henderson notes that Brad misses what Horwitz is really saying.

Brad DeLong “smacks down” Steve Horwitz again, not acknowledging any of the criticisms.  Brad writes:

Me: I don’t think so. Take

Government can only spend what it takes from the private sector one way or another, either through taxation, borrowing, or the redistribution effects of inflation. For every dollar that government spends, there is one less dollar being spent somewhere else in the economy…

and replace “government” by “Larry and Sergei’s internet company.” It then reads:

Larry and Sergei’s internet company can only spend what it gets from other businesses and consumers one way or another, either through sales or borrowing. For every dollar that Larry and Sergei’s internet company spends, there is one less dollar being spent somewhere else in the economy…

Brad’s claim is that Horwitz wouldn’t make the second claim and thus, he doesn’t really mean to make the first claim because they are equivalent.  So Horwitz is a partisan hack.

Brad, Brad, Brad, Brad.  This is so revealing.  Brad really believes, I guess, that the government randomly spending money digging ditches or the equivalent (without regard to Russ’s well-highlighted concerns about where money is being spent, among many other things) is as productive as Google spending money inventing, making and improving its products for sale in the market.  Brad really believes, I guess, that when Google engages in voluntary exchange with customers that it is offering value exactly equivalent to the value the government offers in exchange for an equivalent amount of involuntary taxation or inflation.  Apparently Brad believes that the two cases are equivalent, so anyone who disagrees with the second must disagree with the first (and is thus being disingenuous in supporting the first claim).  But anyone who would claim that these two cases should be treated equivalently and who would disregard the obvious and essential differences between government action and private exchange is an ethics-free partisan ass and shouldn’t be taken seriously.