Vienna Woods Law & Economics

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“Economics and Transparency in Antitrust Policy” By Theodore A. Gebhard — April 28, 2015

“Economics and Transparency in Antitrust Policy” By Theodore A. Gebhard

A significant turning point in antitrust thinking began in the mid-1970s with the formal integration of microeconomic analysis into both antitrust policy and antitrust litigation.  At that time, the Department of Justice and the Federal Trade Commission dramatically expanded their in-house economics staffs and ever since have increasingly relied on those staffs for strategic advice as well as technical analysis in policy and litigation.

For the most part, this integration of economics into antitrust thinking has been highly positive.  It has been instrumental to ensuring that the antitrust laws focus on what they are intended to do – promote consumer welfare.   Forty years later, however, economics has gone beyond its role as the intellectual undergirding of antitrust policy.  Today, no litigant tries an antitrust case without utilizing one or more economists as expert witnesses, as economic analysis has become the dominant evidence in antitrust enforcement.  In this regard, the pendulum may have swung too far.

Prior to the mid-1970s, economists, though creating a sizable academic literature, were largely absent in setting antitrust policy and rarely participated in litigation.  The result was that, for much of the history of antitrust, the enforcement agencies and the courts often condemned business practices that intuitively looked bad, but without much further consideration.  Good economics, however, is sometimes counter-intuitive.  Many of these older decisions did more to protect competitors from legitimate competition than protect competition itself.  Integrating sound economic thinking into enforcement policy was thus an important corrective.

Economic thinking has been most impactful on antitrust policy in two areas: unilateral business conduct and horizontal mergers.  Older antitrust thinking often conflated protecting competitors with protecting competition.  The most devastating critique of this confusion came from the so-called “Chicago School” of economics, and manifested itself to the larger antitrust legal community through Robert Bork’s seminal 1978 book, The Antitrust Paradox.  It is hard to exaggerate the impact that this book had on enforcement policy and on the courts.  Today, it is rare that unilateral conduct is challenged successfully, the courts having placed a de facto presumption of legality on such conduct and a heavy burden on plaintiffs to show otherwise.

Horizontal merger policy likewise had a checkered history prior to the mid-1970s.  Basically, any merger that increased market concentration, even if only slightly, was considered bad.  The courts by and large rubber-stamped this view.  This rigid thinking began to change, however, with the expanded roles of the economists at the DOJ and FTC.  The economists pointed out that, although change in market concentration is important, it is not dispositive in assessing whether a merger is anticompetitive.  Other factors must be considered such as the incentives for outside firms to divert existing capacity into the relevant market, the degree to which there are barriers to the entry of new capacity, the potential for the merger to create efficiencies, and the ability of post-merger firms to coordinate pricing.  Consideration of each of these economic factors was eventually formalized in merger guidelines issued in 1982 by the Reagan Administration’s DOJ.  These guidelines were joined by the FTC ten years later and amended to consider mergers that might be anticompetitive regardless of firms’ ability to coordinate prices.

Each of these developments led to far more sensible antitrust policy over the past four decades.  Today, however, economic thinking no longer merely provides broad policy guidance but, in the form of highly sophisticated statistical modeling, increasingly serves to be the principal evidence in specific cases.  Here, policy-making may now be exceeding the limits of economic science.  Friedrich Hayek famously described the difference between science and scientism, noting the pretentiousness of believing that economics can generate the kind of precision that the natural sciences can.  Yet, the enforcement agencies are approaching a point where their econometric analysis of market data in certain instances may be considered sufficiently “scientific” to determine enforcement decisions without needing to know much else about the businesses or products at issue.

Much of this is driven by advancements in cheap computing coincident with the widespread adoption of electronic data storage by businesses.  These developments have yielded a rich set of market data that can be readily obtained by subpoena, coupled with the ability to use that data as input into econometric estimation that can be done cheaply on a desktop.  So, for example, if it is possible to estimate the competitive effects of a merger directly, why bother with more traditional (and tedious) methodology that includes defining relevant markets and calculating concentration indexes?  In principle, even traditional documentary and testimonial evidence might be dispensed with, being unnecessary when there is hard “scientific” evidence available.

This view is worrisome for two reasons:  The first is the already stated Hayekian concern about the pretense of economic precision.  Any good statistician will tell you that econometrics is as much art as science.  Apart from this concern, however, an equally important worry is that antitrust enforcement policy is becoming too arcane in its attempt to be ever more economically sophisticated.  This means that it is increasingly difficult for businesspersons and their counsel to evaluate whether some specific conduct or transaction could be challenged, thus making even lawful business strategies riskier.  A basic principle of the rule of law is that the law must be understandable to those subject to it.

Regrettably, the Obama Administration has exacerbated this problem.  For example, some officials have indicated sympathy for so-called “Post-Chicago Economics,” whose proponents have set out highly stylized models that purport to show the possibility of anticompetitive harm from conduct that has not yet been reached by antitrust law.  Administration officials also rescinded a Bush Administration 2008 report that attempted to lay out clearer guidelines regarding when unilateral conduct might be challenged.  Although these developments have been mostly talk and not much action in the way of bringing novel cases, even mere talk increases legal uncertainty.

The Administration’s merger policy actions are more concrete.  The DOJ and FTC issued new guidelines in 2010 that, in an effort to be even more comprehensive, proliferated the number of variables that can be considered in merger analysis.  In some instances, these variables will be resistant to reliable measurement and relative weighting.  The consequence is that the new guidelines largely defeat the purpose of having guidelines – helping firms assess whether a prospective merger will be challenged.  Thus, firms considering a merger must often do so in the face of substantially more legal uncertainty and must also expend substantial funds on attorneys and consultants to navigate the maze of the guidelines. These factors likely deter at least some procompetitive mergers, thus forgoing potential social gains.

Antitrust policy certainly must remain grounded in good economics, and economic analysis is certainly probative evidence in individual cases.  But it is nonetheless appropriate to keep in mind that no legal regime can achieve perfection, and the marginal benefits from efforts to obtain ever greater economic sophistication must be weighed against the marginal costs of doing so.  When litigation devolves into simply a battle of expert witnesses whose testimony is based on arcane modeling that neither judges nor business litigants grasp well, something is wrong.

It is time to consider a modest return to simpler and more transparent enforcement policy that relies less on black box economics that pretends to be more scientific than it really is.  To be sure, clearer enforcement rules would not be without enforcement risk.  Some anticompetitive transactions could escape challenge.  But, procompetitive transactions that otherwise might have been deterred will be a social gain.  Moreover, substantial social cost savings can be expected when business decisions are made under greater legal clarity, when antitrust enforcement is administered more efficiently, and when litigation costs are substantially lower.  The goal of antitrust policy should not be perfection, but to maintain an acceptable level of workable competition within markets while minimizing the costs of doing so.  Simpler, clearer rules are the route to this end.

Theodore A. Gebhard is a law & economics consultant.  He advises attorneys on the effective use and rebuttal of economic and econometric evidence in advocacy proceedings.  He is a former Justice Department economist, Federal Trade Commission attorney, private practitioner, and economics professor.  He holds an economics Ph.D. as well as a J.D.  Nothing in this article is purported to be legal advice.  You can contact the author via email at theodore.gebhard@aol.com.

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“The FTC’s Supreme Court Victory in N.C. Dental: A Rare Win for Both Libertarians and Regulators” by Theodore A. Gebhard —

“The FTC’s Supreme Court Victory in N.C. Dental: A Rare Win for Both Libertarians and Regulators” by Theodore A. Gebhard

[Originally posted at Gayton Law Blog, April 1, 2015]

The Federal Trade Commission’s (FTC) recent Supreme Court victory in the North Carolina State Board of Dental Examiners (NCSB or Board) case brought together in common cause both economic libertarians and federal antitrust regulators — groups often at odds with each other respecting important philosophical and policy principles. The FTC’s win, however, gave both groups much reason to celebrate.

The question before the Court was whether unilateral anticompetitive actions of the NCSB, a state-created body, were immune from antitrust law under the “state action” doctrine. The state action doctrine arises from Parker v. Brown, a 1943 Supreme Court decision that sought to reconcile the Sherman Antitrust Act with the constitutional principle of federalism. Federalism is the idea that the U.S. Constitution recognizes both national and state government sovereignty by giving certain limited powers to the national government but reserving other powers to the individual states.

Because the Constitution is the highest law and therefore always trumps statutes, the Court carved out immunity from the Sherman Act for anticompetitive actions of states acting in their sovereign capacity, which includes regulating private actors in a way that restricts competition. In 1980 the Court extended this carve out to include the anticompetitive actions of non-sovereign bodies upon a showing that the actions were the result of clearly articulated state policy and were actively supervised by the state. (See, Cal. Liquor Dealers v. Midcal Aluminum, Inc.) The active supervision requirement ensures that the anticompetitive consequences are only those that the state has deliberately chosen to tolerate in exchange for other public policy goals.

The NCSB was established by the North Carolina Dental Act to be “the agency of the State for the regulation of the practice of dentistry.” In that capacity, the NCSB has authority to administer the licensing of dentists and to file suit to enjoin the unlawful practice of dentistry. Starting in 2006, the NCSB began to send strongly worded cease and desist letters to non-dentist providers of teeth whitening services. People in this occupation grew in numbers in North Carolina – as well as other states — as the popularity of these services increased over a period of years. Often the non-dentist providers are simply individual entrepreneurs operating out of kiosks in shopping malls and similar venues. Licensed dentists also provide teeth whitening services, but typically at substantially higher fees.

Significantly, the N.C. Dental Act is silent with respect to whether teeth whitening constitutes the practice of dentistry. Nonetheless, the NCSB determined that it was, though without hearing or comment and without any independent confirmation by any other state official. In so doing, the Board found that the non-dentists were unlawfully practicing dentistry. Instead of obtaining a judicial order to enjoin the non-dentists as prescribed by statute, however, the NCSB sent out cease and desist letters, which contained strong language including a warning that the non-dentist teeth whiteners were engaging in a criminal act. The letters effectively stopped the provision of teeth whitening services by non-dentists.

In 2010 the FTC sued the Board on antitrust grounds. In response, the NCSB asserted that it was entitled to immunity under the state action doctrine. The FTC rejected that claim and in an administrative hearing ruled that the cease and desist letters constituted unlawful concerted action to exclude non-dentist teeth whiteners from the North Carolina market for such services. The FTC further found that that this exclusion resulted in actual anticompetitive effects in the form of less consumer choice and higher prices. The Commission then ordered the NCSB to stop issuing cease and desist letters to non-dentist providers of teeth whitening services without first obtaining a judicial order.

Key to the FTC’s antitrust finding was that, under the N.C. Dental Act, the majority of NCSB members must be practicing dentists elected to the Board by the community of N.C. licensed dentists. Moreover, throughout the relevant period, most, if not all, of the dentist members of the NCSB performed teeth whitening in their respective practices. In addition, the Board’s actions came after it received several complaints from licensed dentists about the competition from non-dentists teeth whiteners and the lower fees that these providers charged. Only a few dentists suggested that teeth whitening by non-dentists might be harmful to customers. The FTC found the validity of such public health claims tenuous.

The NCSB appealed the FTC’s rejection of its state action defense. The appeal reached the Supreme Court in 2014, and in an opinion handed down last February, the Court held that, under the record facts, the NCSB does not have antitrust immunity. In reaching this conclusion, the Court found that, although the NCSB is a creature of the state and could properly be labeled a state agency, it is nonetheless a non-sovereign body and thus subject to the active supervision requirement for antitrust immunity to obtain. This requirement was not satisfied. (Not at issue was whether the state had a clearly articulated policy to regulate the practice of dentistry. All parties stipulated to this factor.)

The Court’s finding that the NCSB is a non-sovereign body is the key to the decision, and rightly focuses on substance over form. In particular, the Court focused on the fact that the NCSB is majority-controlled by active market participants and that its decisions in this case were unsupervised by any state government officials. Given these circumstances, the Court found there to be a high risk that Board decisions were and are influenced by self-interest instead of public welfare. When this risk is present, it trumps any formal label given by a state to a regulatory body. The Court specifically held that a “state board on which a controlling number of decision makers are active market participants in the occupation the board regulates must satisfy [the] active supervision requirement in order to invoke state action antitrust immunity.”

The practical result of this holding is that the FTC’s finding of illegal anticompetitive conduct stands. This outcome will no doubt yield important benefits to North Carolina citizens. Teeth whitening entrepreneurs can seek to re-enter the market, and consumers of those services will enjoy lower fees resulting from the increased competition. These will be tangible, observable benefits.

Critically, however, the Court’s holding also has important legal and policy implications beyond North Carolina. States will have to re-evaluate their regulatory boards and account for the fact that giving unsupervised control over who is qualified to compete to boards comprised of members whose incomes depend on those decisions may not produce good outcomes. Going forward, states must give greater care not only to establishing such boards, but also to overseeing their decisions. Decisions made behind merely the facade of a state-created agency will be insufficient for a board to obtain state action immunity.

Additionally, the Court’s holding recognizes that license requirements that do not rest on firm evidence of a risk to public health absent licensure serve not only to protect incumbents from healthy competition, but unnecessarily infringe on basic economic liberty and the right to earn a living. As such, the holding implicitly elevates economic liberty to a position as prominent as the antitrust concern. In so doing, the holding is an important victory for economic libertarians, just as it is for antitrust enforcers. It is a rare example of an instance when groups with economic philosophies that often diverge can come together in common celebration. A great win for both.

Theodore A. Gebhard advises attorneys on the effective use and rebuttal of economic and econometric evidence in advocacy proceedings.  He is a former Justice Department antitrust economist, Federal Trade Commission attorney, private practitioner, and economics professor.  Mr. Gebhard holds an economics Ph.D. as well as a J.D.  Nothing in this article is purported to be legal advice.  Facts or circumstances described in the article may have changed by the time of posting. You can contact the author via email at theodore.gebhard@aol.com.

“Amazon: Bully or Not?” by Theodore A. Gebhard —

“Amazon: Bully or Not?” by Theodore A. Gebhard

[Originally posted at Gayton Law Blog, August 26, 2014]

Several articles in the business press during recent months have reported on a dispute between book publisher, Hachette, and book distributor, Amazon.  The dispute centers on the pricing of e-books.  Amazon wants a larger slice of the profits on e-book sales, and to obtain that larger slice, it wants Hachette to lower its wholesale prices.  Hachette, which publishes James Patterson among other best-selling authors, is resisting.  In turn, Amazon has removed Hachette titles from its pre-order list.  That list is important to publishers because pre-order sales go into the initial sales figures for a new title, better enabling the title to achieve best seller status and the marketing boost that this status brings about.

In the reporting on this dispute, Amazon’s tactics have been described, among other pejoratives, as “bullying” and “strong-arming.”  Hachette after all is a relatively small publisher, and Amazon is the world’s largest book seller.  The European press has gone even further.  The Financial Times, for example, asks whether Amazon might be “using its dominance in one market – ereaders – to boost its dominance in another – ebooks.”

Before jumping on the band wagon condemning Amazon, however, some understanding of relevant facts and relevant law is in order.  To begin with, we might ask why Hachette and Amazon are negotiating an agreement at this time?  The answer is because Hachette, along with Apple and four other publishers (Simon & Schuster, Macmillan, Penguin, and HarperCollins) were accused by the Justice Department in 2012 of conspiring with each other to raise e-book prices in violation of Section 1 of the Sherman Antitrust Act, which outlaws anticompetitive agreements.  According to Justice Department documents, the alleged unlawful conspiracy consisted of creating a collective plan to force Amazon to increase its $9.99 price point for trade e-books.

As set out in Justice Department documents, Apple, in conjunction with its launch of the I-Pad in January 2010, desired simultaneously to enter the e-book retailing business, but was concerned about its ability to compete with Amazon on price.  In a plan largely designed by Apple but implemented by the five publishers, pressure was put on Amazon to agree to new distribution agreements by which the publishers would set the retail prices of trade e-books instead of Amazon.  Rather than buy the books at wholesale from the publishers, Amazon would act as a selling agent and simply receive a fixed commission on each sale.  Later, a sixth publisher, Random House, adopted this business model as well for many of its e-books, resulting in nearly 50% of all trade e-books distributed and sold under this agency system.  The almost immediate consequence was a significant increase in the price of trade e-books.

Hachette and each of the other four publishers subsequently reached a settlement with the Justice Department.  Apple went to trial and lost in an opinion filed in July 2013 finding Apple’s conduct illegal.  Although not admitting guilt, the settling defendants, including Hachette, agreed to abandon any control of retail pricing of e-books with any retailer, and to arrive independently at new distribution agreements with Amazon.  This then is the basis for the current negotiations between Hachette and Amazon. As is apparent, Hachette put itself into this position by dint of its prior concerted actions with its competitors.

If anything, to date Amazon’s presence in the retail e-book market, by resisting efforts on the part of publishers to raise prices, has been a boon to consumers. Implicit in the Justice Department’s litigation is a recognition of this fact. Further, as Apple, Google, and others, such as the publishers themselves, enter and expand into retail e-book sales, price competition will only increase.  The key is the ability to compete on price and not have price uniformly set by upstream anticompetitive agreements.

As for Amazon’s alleged dominance in e-book readers (the Kindle) and the alleged potential to leverage that dominance anticompetitively into e-book sales, few, if any, real world facts suggest that this presents a serious antitrust concern at this time, at least under U.S. law.  Section 2 of the Sherman Act goes after conduct that is both something other than “competition on the merits” and results in actual monopolization or a dangerous probability of that result. Simply having a large market share — even a very large one — is not a violation of Section 2.  Section 2 is concerned only with obtaining or maintaining a monopoly by anticompetitive means, i.e., a means that harms consumer welfare.

Although the Kindle device links to Amazon’s Kindle Store, it is possible to download many e-books obtained elsewhere. Some may first have to be converted to the Kindle format (Mobi), however. Calibre is a free download conversion program that will do this in a few minutes or less. Thus, there generally are no significant obstacles to using the Kindle to read e-books obtained elsewhere. Furthermore, tablets such as the I-Pad are e-readers as well. In fact, some might argue that they are superior to the Kindle insofar as they can display content in color such as illustrations or exhibits in art books. Hence, if anything, we are likely to see considerable erosion of Amazon’s share of e-reader sales in the future, eliminating any potential to use those sales as leverage in the retail e-book market.

Notwithstanding the above, given the global marketplace, it is useful to note that there are differences between U.S. antitrust law and competition law in other jurisdictions.  Firms operating globally must be cognizant of these differences.  As noted, the Sherman Act does not outlaw conduct by dominant firms unless that conduct is detrimental to competition itself, i.e., it results in harm to consumer welfare. Indeed, the U.S. Supreme Court has often stated that it is axiomatic that the U.S. antitrust laws are intended for the “protection of competition, not competitors.” By contrast, competition law within the European Union is more suspect of firms with dominant market shares, and may be more protective of competitors and suppliers. Conduct and practices that may not be unlawful under U.S. law may be unlawful under EU law.  Not only Amazon, but any global enterprise, should take care to be informed about and in compliance with all relevant law.

Theodore A. Gebhard advises attorneys on the effective use and rebuttal of economic and econometric evidence in advocacy proceedings.  He is a former Justice Department antitrust economist, Federal Trade Commission attorney, private practitioner, and economics professor.  Mr. Gebhard holds an economics Ph.D. as well as a J.D.  Nothing in this article is purported to be legal advice.  Facts or circumstances described in the article may have changed by the time of posting. You can contact the author via email at theodore.gebhard@aol.com.