Abstract

Ronald Coase famously exposed the limitations of economic analyses that rely upon assumptions of frictionless markets. He highlighted the importance of including transaction costs in economic analyses and issued a challenge to economists to think seriously about how transaction costs impact economic systems. Harold Demsetz, extended Coase’s analysis to show how these costs alter the way firms price and market their products. Demsetz’ analysis underscored that the costs of providing a market sometimes exceed the benefits of creating one in the first place and examined conditions where transaction costs imply that zero amounts of explicit market pricing will be efficient.

This article focuses upon extending Demsetz’s insights concerning non-linear pricing contracts that seem not to “price” key side effects of the economic exchange. In particular, we analyze the welfare and output effects of two examples of such contracts commonly used by firms that are frequently subject to antitrust scrutiny: metered pricing and loyalty discounts. The analysis demonstrates how a firm’s choice to set prices for its products are influenced by transaction and information costs and examines whether changes in output caused by the use of these non-linear pricing schemes are positively correlated with changes in total and consumer welfare. The article then discusses conditions under which measuring output effects can reliably differentiate between welfare-increasing and welfare-reducing uses of non-linear pricing.

Introduction

Since 1950, when Congress closed a loophole in Section 7 of the Clayton Act, the federal antitrust agencies have investigated actively, and prosecuted diligently, mergers the government believed could be anti-competitive. In 1976, the Clayton Act was amended to require notification of many mergers to the agencies before consummation, allowing the government to sue to stop these mergers before they occur. Throughout the decades, merger review has become an elaborate, expensive process consuming vast resources; involving the merging parties, their attorneys, various experts, and those in the government; and rarely ending in judicial proceedings. The large majority of mergers the government opposed were either abandoned or settled with agreements requiring asset divestitures before consummation.

Prospective merger screening at the federal antitrust agencies has evolved, using advances in theoretical and empirical economics, to deemphasize structural tests in favor of an effects-based analysis. The agencies’ merger guidelines have changed with this evolution in economic knowledge and agency practice. The goal of guideline changes has been to increase the predictability and accuracy of the agencies’ merger screening, thereby decreasing the social costs of merger enforcement.

Strident critics of modern antitrust law, including merger policy, hold each key competition job in the administration of Pres. Joseph R. Biden Jr., including heads of both the Federal Trade Commission (FTC) and the Antitrust Division of the U.S. Department of Justice. President Biden recently decried modern antitrust law and policy as a 40-year “experiment failed.”To correct these “mistakes,” the antitrust agencies plan to replace the 2010 Horizontal Merger Guidelines and the 2020 Vertical Merger Guidelines (already withdrawn by the FTC) with a new enforcement approach.

Periodic revisions to the merger guidelines ensure that they reflect current agency practice, recent legal developments, and sound antitrust policy. Given the current administration’s desire to alter significantly how the agencies analyze mergers, changes to the guidelines are necessary to ensure that they accurately describe the new agency practice. It is less clear, however, whether the planned changes to antitrust enforcement and guidelines will reflect current law or sound antitrust policy. Although the precise nature, including the operational details, of the new guidelines is unknown at this writing, the agencies not only have made their disdain for the guidelines of the past 40 years known, but also have expressed their affinity for the pre-1980 merger law that modern guidelines have repudiated. Both their request for comment on the guidelines, one year ago, and a recent speech from FTC Chair Lina Khan show this affinity. The request relied almost entirely on pre-1980 law; Chair Khan’s speech was even more explicit.

In September 2022 at Fordham Law School, FTC Chair Khan discussed her work on revising the merger guidelines and stressed “fidelity to the law” as a guiding principle. She claims that, starting in the 1980s, the antitrust agencies “began straying” by sidestepping “controlling precedent and the statutory text, including the 1950 amendments” through “administrative fiat.” The law to which Chair Khan refers relied on strict structural presumptions to proscribe mergers. As shown here, merger law then did much more, reflecting a populist animus against mergers. The result was an era when the only consistency in the cases, as Justice Potter Stewart famously remarked, was that “the Government always wins.” The case law was incoherent, illogical, and, most important, anti-consumer, condemning bigness for its own sake, even when the mergers were not especially large or in concentrated markets.

In her speech, Chair Khan also notes that a post–World War II FTC study showing growing industrial concentration was “cited extensively by Congress as evidence of the danger to the American economy in unchecked corporate expansions through mergers” and was a “major driver in the passage of the 1950 amendment.” David Cicilline, then Chairman of the House Judiciary Committee’s Antitrust, Commercial, and Administrative Law Subcommittee and a leading critic of recent antitrust enforcement, also cites the same historical evidence. Yet, the FTC study showing growing concentration as a result of merger activity was methodologically flawed and wrong on the facts. Scholars convincingly demonstrated the flaws in the study and its conclusions, and shortly thereafter the authors of this FTC study on concentration even conceded it was wrong. Concentration was in fact not growing, from mergers or otherwise, and may actually have been decreasing. The problems with this study were known shortly before Congress passed the 1950 amendments. The courts obviously were wrong to rely on this discredited study in the 1960s, and one is more puzzled still that the current administration finds it useful to approvingly cite a flawed and discredited study today.

Critics of antitrust enforcement since 1980 also cite newer studies that show increasing industry concentration and claim that this increase is associated with increases in aggregate markups and decreased competition. This evidence has the same flaws as the discredited evidence used to support the structural approach to merger control from the 1960s that the Biden administration admires. Industrial organization economists have repeatedly shown that reliable inferences about the competitive dynamics in antitrust markets cannot be derived from measures of concentration or correlations between concentration and aggregate markups. These advances in theoretical and empirical economics undermined the economic core of the structural approach and eventually caused the agencies under both political parties to abandon that approach to merger control. Surely, new evidence with the same flaws cannot support a return to structural antitrust.

To provide background on the issues and show the fallacy in returning to reliance on strong and simple structural presumptions, section II begins with a brief description of the economic evolution of the effects-based approach contained in the 2010 U.S. Horizontal Merger Guidelines and 2020 U.S. Vertical Merger Guidelines. Section III then examines the flawed economic evidence cited to support returning to strong structural presumptions. Section IV next analyzes why the statutory text of the 1950 amendment and the post-1950 merger law do not support turning the clock back to structural presumptions. Section V concludes.

My first post discussed one primary impediment to deregulating all the lawyers – which is the current system of legal regulation of lawyers.   Even if one agrees that deregulating all the lawyers may be the ultimate goal, this still leaves the question of how best to achieve this result.  Deregulating all the lawyers may not be the first thing we do.  One plausible candidate is fixing intellectual property protection for law.

This view is based upon the assumption that the best way to achieve the goal of deregulating all the lawyers is to create incentives for entrepreneurs to produce new and innovative legal information products.  As noted in my earlier post, innovation and entry by entrepreneurs into the legal information market can be a powerful force that weakens of the economic and political power of those whose interests are aligned with maintaining the current regulatory regime.  One result of this process is that deregulation becomes more likely.   This dynamic is why I love Virginia wine, even though I never drink it.

Creating incentives for entrepreneurs to innovate and enter requires a mechanism that allows them to appropriate a return to their investments.  Intellectual property rights can be an essential mechanism through which this occurs. Indeed, intellectual property rights can effectively protect many innovative legal information products.  However, in several important cases, legal information is subject to what can be described as a form of legal exceptionalism that results in weakened intellectual property rights.  In general, the availability and scope of intellectual property rights are limited so that the costs of restricting the use of already produced information do not exceed the benefits associated with the marginal incentives to create the information.   Intellectual property rights for law and related works seem to be further limited because of heightened concerns regarding use costs that are specific to legal information.

Perhaps the best example of legal exceptionalism is the legal treatment of the privately produced model building codes in Veeck v. SBCCI, 293 F.3d 791 (5th Cir. 2002, en banc).  In this case, Veeck posted SBCCI’s copyrighted model building codes on a website in violation of a license agreement that prohibited copying or distributing the work. The court held that the copyrighted code text entered the public domain when adopted as law by several local jurisdictions.  Through SBCCI retained copyrights to its model codes, they could not enforce them against Veeck, who identified the posted SBCCI model codes as the building codes of two municipalities.

Current copyright law precludes copyright protection for any work “prepared by an officer or employee of the United States Government as part of that person’s official duties”.  Under this definition, court opinions written by federal judges, congressional bills and statutes, and federal regulations are ineligible for copyright protection.  Courts have applied similar rules to state legal materials, including state judicial opinions, statutes, and regulations.   These rules assume that the use costs of intellectual property protection outweigh gains from improved private incentives to produce model laws.   Copyright law does not explicitly preclude copyright for model codes and other privately produced laws.  However, the court’s holding, by elevating due process concerns with public access to the law over providing economic incentives to produce model codes, effectively extends this prohibition to privately produced model codes and laws that have been adopted as law.

Protecting due process concerns does not require precluding copyright protection for privately produced works adopted as law.  Broad fair use privileges for those bound by the laws or codes could address these concerns while simultaneously protecting model codes from appropriation by competing commercial interests and other jurisdictions.   Restrictive licenses can also serve to appropriately balance the use-creation tradeoff by clarifying parties’ expectations regarding permitted uses and pricing of the copyrighted model law.   As part of these licenses, jurisdictions that adopt privately produced and copyrighted model codes could alleviate due process concerns by authorizing use by citizens bound by the law while preventing reproduction for other purposes.  Courts could require similar licenses to be granted by those wishing to file briefs and other potentially copyrightable documents.

The court’s holding in Veeck unnecessarily limits the ability to use these mechanisms by effectively eliminating copyright protection rather than retaining the protection and using the mechanisms discussed above that would permit limited public use and mitigate any due process concerns.  In doing so, the courts holding, along with other similar forms of legal exceptionalism unnecessarily weakens incentives for legal innovation and can result in less pressure to deregulate all the lawyers.

Innovation and entry by entrepreneurs is a powerful force for change. Joseph Schumpetersaw these forces as the primary engine for long-term growth, even as the process of creative destruction destroyed existing wealth, including monopoly rents associated with established regulatory regimes.  The forces of creative destruction seemingly have their sights squarely on the legal profession, promising greater access to legal services while simultaneously threatening licensed lawyers’ monopoly over legal services.

The traditional market for legal services is breaking down in the face of increased competition from numerous sources.  One of the biggest threats comes from new technologies that enable clients to perform many tasks formerly performed by lawyers.  For example, large clients now use of sophisticated search algorithms to substitute for hours of manual document search and selection formerly performed in large law firms.  As technology improves, it is not hard to imagine the expansion of tasks performed by computers rather than lawyers.  At the low end, legal software products allow unsophisticated consumers competently to perform a wide variety of legal tasks with little or no additional input from legal professionals.  These and other legal information products allow the seller of such information and services to take advantage of technology as well as economies of scale and scope that were not captured by the traditional market.

The speed and extent to which such legal information products transform the supply of law legal services depends upon the extent to which innovation and entry by entrepreneurs, especially by those outside the traditional legal sector, occurs.  In our forthcoming article, Larry Ribstein and I discuss two important impediments to such entry.  The first is the current system of legal regulations, especially those that forbid non-lawyers from practicing law, which directly suppresses legal innovation.

The current system of legal regulation is based upon the assumption that legal advice is conveyed through one-to-one agency relationships in which an uninformed client depends on her lawyer’s judgment and independence.  This assumption supports the system of attorney ethical rules designed to reduce the agency costs of this one-to one relationship by promoting lawyers’ loyalty to clients.  It also supports licensing laws to ensure lawyer quality.

However, these regulations are costly.  They constrain the supply of legal services by suppressing the use of legal information products and services that would directly compete with traditional legal services.  These rules further inhibit innovation by preventing use of private contractual arrangements that limit organizational flexibility and increase the cost of collaboration between lawyers and non-lawyers.  Moreover, it is far from clear that such rules would serve much of a beneficial purpose outside of the traditional model of legal advice.  For example, if consumers of legal services instead could use legal information products traded in a broad and transparent market, the underlying rationale for ethical rules and licensing would be greatly diminished.  Market competition would reduce consumers’ reliance on the traditional agency relationship and market-based mechanisms could help ensure quality.   Thus, one effect of the current system of legal regulations is to suppress the development of a robust market for legal information products that, left unimpeded, would likely threaten both the viability and underlying rationale of the current regulatory system.

How this struggle comes out in equilibrium will depend upon how much pressure is placed on the existing system by the amount of innovation and entrepreneurial entry that occurs.   This in turn will depend upon the returns to such investments, which will in turn depend upon the ability of the entrepreneur to capture the returns from his investment.   This brings us to the second impediment we identify, a system of relatively weak intellectual property right protection for legal information that reduces the incentives for legal innovation.   I will take up this issue in my second post.

Dimming the Court’s Brooke Group Bright Line Administrable Rule?

As noted in my earlier post, the Supreme Court’s Brooke Group rule is held out as the primary example of an administrable bright line rule aimed at controlling the costs of type I error. In practice, the Brooke Group above cost rule is not as bright as one might wish. The Achilles heel of the Brooke Group cost based rule is the failure to clarify what the relevant cost is.

Read the full piece here.

One of the most important changes in the antitrust laws over the past 40 years has been the diminished reliance of rules of per se illegality in favor of a rule of reason analysis. With the Court’s recent rulings in Leegin (eliminating per se rule for minimum RPM) and Independent Ink (eliminating the per se rule against intellectual property tying), the evolution of the antitrust laws has left only tying (under a “modified” per se rule) and horizontal price fixing under per se rules of illegality. This movement reflects advances in law and economics that recognize that vertical restraints, once condemned as per se illegal when used by firms with antitrust market power, can be procompetitive. It also reflects the judgment that declaring such practices pre se illegal produced high type I error costs (the false condemnation and deterrence of pro competitive practices).

Read the full piece here.