This is part one of a two part series of posts in which I’ll address the problems associated with discerning an appropriate antitrust remedy to alleged search engine bias.  The first problem – and part – is, of course, how we should conceptualize Google’s allegedly anticompetitive conduct; in the next part, I will address how antitrust regulators should conceive of a potential remedy, assuming arguendo the existence of a problem at all.  Despite some commentators’ assumptions, I do not think the economics indicate any such problem exists.

The question of how to conceptualize Google’s business practices – even its business model! – remains the indispensible starting point for antitrust analysis, including potential remedies; doubly so in the wake of the FTC’s decision to formally investigate Google.  While the next part will focus more directly upon potential remedies that have been proposed by various Google critics, there is a fundamental link between how we conceptualize Google’s provision of search results for the purposes of antitrust analysis and the design of remedies.  Indeed, antitrust enforcers and scholars have taught that thinking hard about remedies upfront can and frequently should influence how we think about the competitive nature of the conduct at issue.  The question of how to conceptualize Google’s organic search results has sparked serious debate, as some have claimed that “Google’s behavior is harder to define” than traditional anticompetitive actions and represents “a new kind of competition.”  Some have also focused upon “search bias” itself as the relevant conduct for antitrust purposes.  Of course, as I’ve pointed out, these statements are not in line with modern antitrust economics and usually precede calls to deviate from traditional consumer-welfare-focused antitrust analysis.

I see two useful conceptual constructs in evaluating “search bias” within the antitrust framework.  Recall that “search bias” typically translates to allegations that Google favors its own affiliated content over that of rivals.  For example, a search query on Google for “map of Arlington, VA” might turn up a map of Arlington from Google Maps in the top link.  These allegations usually concede that we would expect Bing Maps if we ran the same search on Bing.  The complaints from vertical search engines and travel services like Expedia particularly center around the notion that Google’s “entry” into various spaces  –  such as travel services – supported by prominent search rankings disadvantages rivals and may lead to their exit.

Observant readers will note my use of scare quotes around “entry.”  This is not coincidental.  It is not obvious to me that Google necessarily enters a new sector (much less a well-defined antitrust product market) when it directs a user to content in a new format– such as a map, video, or place page.  Google’s primary function is search; users rely on search engines to reduce search and information costs.  I think it is at least as likely that Google’s attempts to provide this content by any chosen metric is simply an attempt to do their cardinal job better: answering user queries with relevant information at a minimum of cost.  Holding that threshold issue aside for a moment, in my mind, there are two ways to classify that conduct in the antitrust framework.

First, one might conceive of search bias allegations as “vertical integration” or vertical contractual activity.  I’ve explored this conception at significant length both in blog posts (see, e.g. here and here) as well as a longer article with Geoff.  The classic antitrust concern in this setting is that a monopolist might foreclose rivals from an input the rivals need to compete effectively.  For example, Google owns YouTube; Google could prominently place YouTube results when users enter queries seeking video content.  (Ignore for the moment that YouTube will necessarily rank highly on other search engines because it is the leading site for video content).  Within this vertical integration framework, there is a standard analysis for understanding when competitive concerns might arise, the conditions that must be satisfied for those concerns to warrant scrutiny, a deeply embedded understanding that harm to rivals must be distinguished from demonstrable harm to competition, and an equally deeply held understanding that these vertical arrangements and relationships are often, even typically, pro-competitive (e.g., in the YouTube example vertical integration likely leads to reduced latency and faster provision of video content).

Second, one might conceptualize organic search results as the product of Google’s algorithm and thus falling into the category of conduct analyzed as “product design” for antitrust purposes.  This algorithm faces competition from other search algorithms and vertical search engines to deliver relevant results to consumers.  It is the design of the algorithm that ranks Google-affiliated content, according to the complaints, preferentially and to the disadvantage of rivals. I explore both beneath the fold.

The two conceptions are not mutually exclusive.  The antitrust implications of the two different conceptions of Google’s organic search are significant.  Courts and agencies generally give wide latitude to product design decisions, through with some prominent exceptions (Microsoft, FTC v. Intel).  Courts are skeptical to intervene on the basis of complaints about product design by rivals because they concerned that such intervention will chill innovation.  Concern for false positives play a central part in the analysis, as do concerns that any remedy will involve judicial oversight of product innovation.  Plaintiffs can and do, from time to time, win these cases, but the product-design conception carries with it a heavy deference for design decisions.

The “vertical” (in the antitrust sense) conception of Google’s search results requires us to think about the economics of algorithmic search ranking, placement choices, and the economics of vertical relationships between a content provider and a search engine.  There are many economic reasons for vertical contractual relationships between such content or product providers and retailers.  Coca-Cola pays retailers for promotional shelf space, manufacturers compensate retailers by granting them exclusive territories, and product manufacturers and distributors often enter into exclusive relationships in which the distributor does not simply feature or promote the manufacturer’s product, but does so to the exclusion of all of the manufacturer’s rivals.

The anticompetitive narrative of Google’s conduct focuses heavily on that prominent placement within Google’s rankings, e.g. the first link or one towards the top of the page, results in a substantial amount of traffic.  This is no doubt true; it is not a sufficient condition for proving competitive harm.  It is equally true that eye-level and other premium level shelf space in the supermarket generates more sales than other placements within the store.  There is good economic reason for manufacturers to pay retailers for premium shelf space (see Klein and Wright, 2007); and evidence that these arrangements are good for consumers (Wright, 2008).  Retailers’ shelf space decisions, and decisions to promote one product over another, are often influenced by contractual incentives; and it is a good thing for consumers.   Now consider the case when the retailer shelf space decision is influenced not by contractual incentive and compensation, but by ownership.  This is really just a special case – as ownership aligns the incentives (like the contract would) of the manufacturer and retailer.  For example, a supermarket might promote its own private label brand in eye-level shelf space.  Alternatively, in a category management relationship, a retailer might delegate a specific manufacturer as “category captain” and allow it significant influence over product selection and shelf space placement decisions.  Note that in the case of exclusive relationships, the presumption that such arrangements are pro-competitive applies to shelf placement that would entirely exclude a rival from the shelf, not just demote it.

In economics, the theoretical and empirical verdict is in about these sorts of vertical contractual relationships: while they can be anticompetitive under some circumstances, the appropriate presumption is that they are generally pro-competitive and a part of the normal competitive process until proven otherwise.  How we conceptualize placement of search results, including those affiliated with the search engine (e.g. Google Maps on Google or Bing Maps on Bing), should influence how we think about the appropriate burden of production facing would-be antitrust plaintiffs, including the Federal Trade Commission.

Indeed, these two models offer important trade-offs for antitrust analysis.  To wit, in my view, the vertical integration model provides a still difficult, but relatively easier case for potential rivals to make under existing case law, but it also integrates efficiencies directly into the analysis.  For example, vertical integration and exclusive dealing cases accept as a starting point the notion that such arrangements are often efficient.  On the other hand, while potential plaintiffs have a tougher initial burden in a product design case, the focus often turns to how the design impacts interoperability and whether the defendant can defend its technical design choices.   Having explored the potential conceptual constructs for characterizing Google’s conduct for the purpose of antitrust analysis, my next post will link those concepts to a discussion of potential remedies, exploring the proposed remedies for Google’s conduct, a relevant historical parallel to today’s “search bias” debate raised by some as a model of regulatory success, and a discussion of the economic non sequiturs surrounding the case against Google as juxtaposed against these proposed remedies.

Filed under: antitrust, economics, federal trade commission, google, monopolization, technology

Others have linked to this, but its really a fantastic video of a discussion between Justin Wolfers and Robert Frank discussing happiness and economic growth.

Filed under: behavioral economics, economics

Of likely interest to many of our readers (HT: WSJ):

Christine Varney, the U.S. government’s chief antitrust regulator, is expected to join New York law firm Cravath, Swaine & Moore LLP as a partner later this year, people familiar with the matter said.  Ms. Varney was appointed assistant attorney general for the antitrust division in 2009, and had been at Hogan & Hartson LLP, focusing on the firm’s antitrust and Internet practices.  At Cravath, Ms. Varney will work on antitrust issues related to merger-and-acquisition transactions, the people said.

Former Cravath partner Katherine Forrest worked under Ms. Varney at the Justice Department beginning last October. Ms. Forrest is slated to become a federal judge in the Southern District of New York court.

Cravath is one of the top M&A law firms in New York, working on deals such as the $3 billion sale of retailer J. Crew to a group of private-equity firms including TPG Capital and last year’s merger between Continental Airlines and United Airlines.

 

Filed under: antitrust

FTC v. Staples is a seminal case in modern antitrust analysis of horizontal mergers.  Judge Posner has described it as the economic “coming of age” of merger analysis.   It is also a landmark decision in the development of unilateral effects theories.  Despite the fact that Judge Hogan did not explicitly rely upon the econometric evidence presented to demonstrate that a post-merger combination of Staples and Office Depot would be able to increase prices, it is also often discussed as having particular importance for the role of econometrics in antitrust analysis.  As Jonathan Baker observes:

Judge Hogan’s hidden opinion supports the government’s use of econometric evidence, though the court did not trumpet doing so. The opinion never uses the term, presumably in a conscious effort to downplay novelty in order to avoid creating an issue for appeal. Yet Judge Hogan demonstrably relied on econometric evidence in one instance,(14) when he stated that “in this case the defendants have projected a pass through rate of two-thirds of the savings while the evidence shows that, historically, Staples has passed through only 15-17%.”(15) The sole basis in the record for the 15-17% figure is the testimony of the FTC’s econometric expert as to the conclusions of his statistical analysis of the pass-through rate.

The district court was persuaded by the FTC’s pricing evidence, and evidence that entry would not timely, likely and sufficient to counter any price increase.  Part of that entry analysis was rejecting the defendant’s claim that firms like Walmart would discipline any attempt to increase prices.  In any interesting turn of events, nearly 15 years later, it looks like we are heading toward another significant merger between office superstores:

Office Depot Inc. (ODP) and OfficeMax Inc. (OMX) may need to merge after heightened competition for office-supply sales and a 26-year high in the U.S. unemployment rate helped wipe out almost $13 billion of shareholder value.

Office Depot, the second-largest U.S. office-supply chain, has plunged 90 percent to $1.16 billion in the last five years, more than any American retailer that still has a market value greater than $500 million, according to data compiled by Bloomberg. OfficeMax was valued at $664 million yesterday after plummeting 78 percent, the third-steepest drop. Both trade at 10 cents or less per dollar of sales — one-tenth of the industry average and ranking in the bottom five of 126 retailers.

Interestingly, competitive pressure from Wal-Mart and Target, among others, appears to have developed into a significant force in the market.

With businesses spending less on paper and printers as the U.S. jobless rate hovers at 9 percent, combining Office Depot with OfficeMax may reduce costs by almost $500 million, said KeyBanc Capital Markets Inc. Regulatory approval won’t be a hurdle because of more competition from Wal-Mart Stores Inc. (WMT) and Target Corp. (TGT) since Staples Inc. (SPLS) was blocked from buying Office Depot in 1997, said BB&T Capital Markets. Money-losing Office Depot of Boca Raton, Florida, hired interim Chief Executive Officer Neil Austrian in May after a seven-month search.

“Office Depot needs OfficeMax,” said Anthony Chukumba, an analyst with BB&T in New York. “They need to combine so they can scale up to better compete with Staples. For them to bring in a guy who’s been on the board forever and who has been CEO twice before on an interim basis, that just smacked of them saying, ‘We’re going to try to sell the company.’”

Of course, the ex post expansion of Wal-Mart and others into this territory does not mean that the FTC or Judge Hogan were wrong ex ante.  Indeed, the strength of the economic evidence in the case suggested that entry would be difficult — and indeed, perhaps it was.  Nonetheless, a merger of the the second and third largest office superstores is surely to attract some attention at the agencies.  Indeed, it may well be the case that the sale of consumable office supplies through office superstores in no longer a relevant antitrust product market.  However, the markets have changed in ways other than the emergence of significant pricing discipline from Wal-Mart and others.  The story notes that Office Depot’s market value has decreased by over $10,3 billion ($2.3 billion for OfficeMax since June 2006).

Given the growth of Wal-Mart and others, I suspect that even a replay of the Staples-Office Depot transaction of the late 1990s would have a significantly better chance of approval today than it did then.  Those in the industry appear to be expecting a merger announcement, but describe government approval as “certainly not a given.”  In any event, a Office Depot – Office Max merger will provide a good opportunity to go back and look at the predictions of the agencies at the time, to evaluate those predictions against the development of the market, and perhaps to learn something useful about competitive dynamics and entry in the retail sector.

Filed under: antitrust, economics, federal trade commission, merger guidelines, mergers & acquisitions

From the WSJ:

The Department of Health and Human Services this month notified Howard Solomon of Forest Laboratories Inc. that it intends to exclude him from doing business with the federal government. This, in turn, could prevent Forest from selling its drugs to Medicare, Medicaid and the Veterans Administration. If the government implements its ban, Forest would have to dump Mr. Solomon, now 83 years old, in order to protect its corporate revenue. No drug company, large or small, can afford to lose out on sales to the federal government, a major customer.

….

The Health and Human Services department startled drug makers last year when the agency said it would start invoking a little-used administrative policy under the Social Security Act against pharmaceutical executives. This policy allows officials to bar corporate leaders from health-industry companies doing business with the government, if a drug company is guilty of criminal misconduct. The agency said a chief executive or other leader can be banned even if he or she had no knowledge of a company’s criminal actions. Retaining a banned executive can trigger a company’s exclusion from government business.

Debarment is obviously a very serious remedy.  The increased use of debarment in this context has been controversial, especially in cases in which the executive has not demonstrated that the debarred individual is actually complicit.  The WSJ story discusses the Forest Laboratories example along these lines in more detail:

According to Mr. Westling, “It would be a mistake to see this as solely a health-care industry issue. The use of sanctions such as exclusion and debarment to punish individuals where the government is unable to prove a direct legal or regulatory violation could have wide-ranging impact.” An exclusion penalty could be more costly than a Justice Department prosecution.

He said that the Defense Department and the Environmental Protection Agency, for example, have debarment powers similar to the HHS exclusion authority.

The Forest case has its origins in an investigation into the company’s marketing of its big-selling antidepressants Celexa and Lexapro. Last September, Forest made a plea agreement with the government, under which it is paying $313 million in criminal and civil penalties over sales-related misconduct.

A federal court made the deal final in March. Forest Labs representatives said they were shocked when the intent-to-ban notice was received a few weeks later, because Mr. Solomon wasn’t accused by the government of misconduct.

Forest is sticking by its chief. “No one has ever alleged that Mr. Solomon did anything wrong, and excluding him [from the industry] is unjustified,” said general counsel Herschel Weinstein. “It would also set an extremely troubling precedent that would create uncertainty throughout the industry and discourage regulatory settlements.”

The issue of debarment also arises in the antitrust context as a weapon in the toolkit of antitrust enforcement agencies prosecuting cartels.  Judge Ginsburg and I have argued, in Antitrust Sanctions, that the debarment remedy in that context, along with a shift toward individual responsibility and away from ever-increasing corporate fines, would result in a shift toward efficient deterrence.   In our case, we discuss debarment for the executive actually engaged in the price-fixing as well as officers and directors who negligently supervise the price-fixers (e.g., with failure to institute an antitrust compliance program).   Without safeguards to ensure that debarment is imposed in cases of actual wrongdoing or negligent supervision, and also in the cases of settlement, that there is a factual basis for debarment, imposition of these penalties runs the risk that enforcement agencies will have arbitrary power to banish executives that are disfavored for whatever reason.  If its application is properly constrained, however, debarment can be a more effective tool in prosecuting antitrust offenses and potentially other white-collar crime than ever-increasing corporate fines which are largely borne by shareholders.  I’ll refer interested readers to the Ginsburg & Wright link above for the more detailed case in favor of adding debarment to the cartel-enforcement toolkit, including a discussion of its application in the antitrust context in a variety of other countries as well as non-antitrust settings in the U.S.

Filed under: antitrust, corporate crime, corporate law, economics

I did not intend for this to become a series (Part I), but I underestimated the supply of analysis simultaneously invoking “search bias” as an antitrust concept while waving it about untethered from antitrust’s institutional commitment to protecting consumer welfare.  Harvard Business School Professor Ben Edelman offers the latest iteration in this genre.  We’ve criticized his claims regarding search bias and antitrust on precisely these grounds.

For those who have not been following the Google antitrust saga, Google’s critics allege Google’s algorithmic search results “favor” its own services and products over those of rivals in some indefinite, often unspecified, improper manner.  In particular, Professor Edelman and others — including Google’s business rivals — have argued that Google’s “bias” discriminates most harshly against vertical search engine rivals, i.e. rivals offering search specialized search services.   In framing the theory that “search bias” can be a form of anticompetitive exclusion, Edelman writes:

Search bias is a mechanism whereby Google can leverage its dominance in search, in order to achieve dominance in other sectors.  So for example, if Google wants to be dominant in restaurant reviews, Google can adjust search results, so whenever you search for restaurants, you get a Google reviews page, instead of a Chowhound or Yelp page. That’s good for Google, but it might not be in users’ best interests, particularly if the other services have better information, since they’ve specialized in exactly this area and have been doing it for years.

I’ve wondered what model of antitrust-relevant conduct Professor Edelman, an economist, has in mind.  It is certainly well known in both the theoretical and empirical antitrust economics literature that “bias” is neither necessary nor sufficient for a theory of consumer harm; further, it is fairly obvious as a matter of economics that vertical integration can be, and typically is, both efficient and pro-consumer.  Still further, the bulk of economic theory and evidence on these contracts suggest that they are generally efficient and a normal part of the competitive process generating consumer benefits.  Vertically integrated firms may “bias” their own content in ways that increase output; the relevant point is that self-promoting incentives in a vertical relationship can be either efficient or anticompetitive depending on the circumstances of the situation.  The empirical literature suggests that such relationships are mostly pro-competitive and that restrictions upon firms’ ability to enter them generally reduce consumer welfare.  Edelman is an economist, with a Ph.D. from Harvard no less, and so I find it a bit odd that he has framed the “bias” debate outside of this framework, without regard to consumer welfare, and without reference to any of this literature or perhaps even an awareness of it.  Edelman’s approach appears to be a declaration that a search engine’s placement of its own content, algorithmically or otherwise, constitutes an antitrust harm because it may harm rivals — regardless of the consequences for consumers.  Antitrust observers might parallel this view to the antiquated “harm to competitors is harm to competition” approach of antitrust dating back to the 1960s and prior.  These parallels would be accurate.  Edelman’s view is flatly inconsistent with conventional theories of anticompetitive exclusion presently enforced in modern competition agencies or antitrust courts.

But does Edelman present anything more than just a pre-New Learning-era bias against vertical integration?  I’m beginning to have my doubts.  In an interview in Politico (login required), Professor Edelman offers two quotes that illuminate the search-bias antitrust theory — unfavorably.  Professor Edelman begins with what he describes as a “simple” solution to the search bias problem:

I don’t think it’s out of the question given the complexity of what Google has built and its persistence in entering adjacent, ancillary markets. A much simpler approach, if you like things that are simple, would be to disallow Google from entering these adjacent markets. OK, you want to be dominant in search? Stay out of the vertical business, stay out of content.

The problems here should be obvious.  Yes, a per se prohibition on vertical integration by Google into other economic activities would be quite simple; simple and thoroughly destructive.  The mildly more interesting inquiry is what Edelman proposes Google ought provide.  May, under Edelman’s view of a proper regulatory regime, Google answer address search queries by providing a map?  May Google answer product queries with shopping results?  Is the answer to those questions “yes” if and only if Google serves up some one else’s shopping results or map?  What if consumers prefer Google’s shopping result or map because it is more responsive to the query.  Note once again that Edelman’s answers do not turn on consumer welfare.  His answers are a function of the anticipated impact of Google’s choices to engage in those activities upon rival vertical search engines.  Consumer welfare is not the center of Edelman’s analysis; indeed, it is unclear what role consumer welfare plays in Edelman’s analysis at all.  Edelman simply applies his prior presumption that Google’s conduct, even if it produces real gains for consumers, is or should be actionable as an antitrust claim upon a demonstration that Google’s own services are ranked highly on its own search engine — even if Google-affiliated content is ranked highly by other search engines!  (See Danny Sullivan making that point nicely in this post).  Edelman’s proscription ignores the efficiencies of vertical integration and the benefits to consumers entirely.  It may be possible to articulate a coherent anticompetitive theory involving so-called search bias that could then be tested against the real world evidence.  Edelman has not.

Professor Edelman’s other quotation from the profile of the “academic wunderkind” that drew my attention was the following answer in response to the question “which search engine do you use?”  After explaining that he probably uses Google and Bing in proportion to their market shares, Professor Edelman is quoted as saying:

If your house is on fire and you forgot the number for the fire department, I’d encourage you to use Google. When it counts, if Google is one percent better for one percent of searches and both options are free, you’d be crazy not to use it. But if everyone makes that decision, we head towards a monopoly and all the problems experience reveals when a company controls too much.

By my lights, there is no clearer example of the sacrifice of consumer welfare in Edelman’s approach to analyzing whether and how search engines and their results should be regulated.  Note the core of Professor Edelman’s position: if Google offers a superior product favored by all consumers, and if Google gains substantial market share because of this success as determined by consumers, we are collectively headed for serious problems redressable by regulation.  In these circumstances, given the (1) lack of consumer lock-in for search engine use, (2) the overwhelming evidence that vertical integration is generally pro-competitive, and (3) the fact that consumers are generally enjoying the use of free services — one might think that any consumer-minded regulatory approach would carefully attempt to identify and distinguish potentially anticompetitive conduct so as to minimize the burden to consumers from inevitable false positives.  With credit to antitrust and its hard-earned economic discipline, this is the approach suggested by modern antitrust doctrine.  U.S. antitrust law requires a demonstration that consumers will be harmed by a challenged practice — not merely rivals.  It is odd and troubling when an economist abandons the consumer welfare approach; it is yet more peculiar that an economist not only abandons the consumer welfare lodestar but also argues for (or at least presents an unequivocal willingness to accept) an ex ante prohibition on vertical integration altogether in this space.

I’ve no doubt that there are more sophisticated theories of which creative antitrust economists can conceive that come closer to satisfying the requirements of modern antitrust economics by focusing upon consumer welfare.  Certainly, the economists who identify those theories will have their shot at convincing the FTC.  Indeed, Section 5 might even open the door to theories ever-so slightly more creative and more open-ended that those that would be taken seriously in a Sherman Act inquiry.  However, antitrust economists can and should remain intensely focused upon the impact of the conduct at issue — in this case, prominent algorithmic placement of Google’s own affiliated content its rankings — on consumer welfare.  Because Professor Edelman’s views harken to the infamous days of antitrust that cast a pall over any business practice unpleasant for rivals — even if the practice delivered what consumers wanted.  Edelman’s theory is an offer to jeopardize consumers and protect rivals, and to brush the dust off antiquated antitrust theories and standards and apply them to today’s innovative online markets.  Modern antitrust has come a long way in its thinking over the past 50 years — too far to accept these competitor-centric theories of harm.

Filed under: antitrust, economics, federal trade commission, google, technology

In the Huffington Post, Marcus Baram warns against those who claim to be concerned about over-regulation on Wall Street and in the consumer protection sphere.  Baram writes:

Today, Wall Street is again on the attack against a regulatory overhaul that includes more stringent investor and consumer protections. Though the financial landscape is far different and the details of the proposals have changed since 1912, the industry is using much of the same alarmist rhetoric to oppose new regulations and rules.

JPMorgan chairman Jamie Dimon recently complained that proposed rules on derivatives, capital buffers and too-big-to-fail banks are bad for America. Wall Street could lose customers to European banks, he said.

Baram includes economist, and my co-author, David S. Evans in his list of those “crying wolf” over over-regulation:

At a congressional hearing on the Consumer Financial Protection Bureau, banking consultant David S. Evans attacked the “hard paternalism” of its interim director Elizabeth Warren. He cautioned that the bureau “could make it harder and more expensive for consumers to borrow money.”

Such Cassandra-like warnings are common in the history of financial regulation.

I think Baram might want to have this one back if given the chance.  His point is that the Dimon and David Evans and others are concerned about imposing an enormous regulatory burden are wrong.  Of course, I am no scholar of Greek mythology, but I seem to recall that Cassandra was right!  Her curse was that nobody believed her accurate predictions about the future.  Baram may have stumbled upon something here.

But more seriously, at a time when the unemployment rate is over 9%, when the intellectual architects of the CFPB were quite frank about favoring a regulatory approach that would restrict access to consumer credit (see here), and when the flow of credit is critical to economic growth and recovery, one has to be pretty deeply committed to the cause to so brazenly ignore predictions that massive regulatory structure just might hold the economy back.

Evans’ testimony at the House Hearing on the CFPB is available here.

Filed under: consumer financial protection bureau, consumer protection, economics, regulation

Daniel Kahnemann and co-authors discuss, in the most recent issue of the Harvard Business Review (HT: Brian McCann), various strategies for debiasing individual decisions that impact firm performance.  Much of the advice boils down to more conscious deliberation about decisions, incorporating awareness that individuals can be biased into firm-level decisions, and subjecting decisions to more rigorous cost-benefit analysis.  The authors discuss a handful of examples with executives contemplating this or that decision (a pricing change, a large capital outlay, and a major acquisition) and walk through how thinking harder about recognizing biases of individuals responsible for these decisions or recommendations might be identified and nipped in the bud before a costly error occurs.

Luckily for our HBS heroes they are able to catch these potential decision-making errors in time and correct them:

But in the end, Bob, Lisa, and Devesh all did, and averted serious problems as a result. Bob resisted the temptation to implement the price cut his team was clamoring for at the risk of destroying profitability and triggering a price war. Instead, he challenged the team to propose an alternative, and eventually successful, marketing plan. Lisa refused to approve an investment that, as she discovered, aimed to justify and prop up earlier sunk-cost investments in the same business. Her team later proposed an investment in a new technology that would leapfrog the competition. Finally, Devesh signed off on the deal his team was proposing, but not before additional due diligence had uncovered issues that led to a significant reduction in the acquisition price.

The real challenge for executives who want to implement decision quality control is not time or cost. It is the need to build awareness that even highly experienced, superbly competent, and well intentioned managers are fallible. Organizations need to realize that a disciplined decision-making process, not individual genius, is the key to a sound strategy. And they will have to create a culture of open debate in which such processes can flourish.

But what if they didn’t?  Of course, the result would be a costly mistake.  The sanction from the marketplace would provide a significant incentive for firms to act “as-if” rational over time.  As Judd Stone and I have written (forthcoming in the Cardozo Law Review), the firm itself can be expected to play a critical role in this debiasing:

Economic theory provides another reason for skepticism concerning predictable firm irrationality. As Armen Alchian, Ronald Coase, Harold Demsetz, Benjamin Klein, and Oliver Williamson (amongst others) have reiterated for decades, the firm is not merely a heterogeneous hodgepodge of individuals, but an institution constructed to lower transaction costs relative to making use of the price system (the make or buy decision). Firms thereby facilitate specialization, production, and exchange. Firms must react to the full panoply of economic forces and pressures, responding through innovation and competition. To the extent that cognitive biases operate to deprive individuals of the ability to choose rationally, the firm and the market provide effective mechanisms to at least mitigate these biases when they reduce profits.

A critical battleground for behaviorally-based regulatory intervention, including antitrust but not limited to it, is the question of whether agencies and courts on the one hand, or firms on the other, are the least cost avoiders of social costs associated with cognitive bias.  Stone & Wright argue in the antitrust context — contrary to the claims of Commissioner Rosch and other proponents of the behavioral approach — that the claim that individuals are behaviorally biased, and that because firms are made up of individuals, they too must be biased, simply does not provide intellectual support for behavioral regulation.  The most obvious failure is that it lacks the comparative institutional perspective described above.  Most accounts favoring greater implementation of behavioral regulation at the agency level glide over this question.  Not all, of course.

For example, Commissioner Rosch has offered the following response to the “regulators are irrational-too” critique:

My problem with this criticism is that it ignores the fact that, unlike human beings who make decisions in a vacuum, government regulators have the ability to study over time how individuals behave in certain settings (i.e., whether certain default rules provide adequate disclosure to help them make the most informed decision). Thus, if and to the extent that government regulators are mindful of the human failings discussed above, and their rules are preceded by rigorous and objective tests, it is arguable that they are less likely to get things wrong than one would predict. Of course, it may be the case that the concern with behavioral economics is less that regulators are imperfect and more than they are subject to political biases and that behavioral economics is simply liberalism masquerading as economic thinking.24 My response to that is that political capture is everywhere in Washington and that to the extent behavioral economics supports “hands on” regulation it is no more political than neoclassical economics which generally supports “hands off” regulation. On a more serious note, perhaps the best way behavioral economics could counter this critique over the long run would be to identify ways in which the insights from behavioral economics suggest regulation that one would not expect from a “left-wing” legal theory.

For my money, I find this reply altogether unconvincing.  It amounts to the claim that government agencies can be expected to have a comparative advantage over firms in ameliorating the social costs of errors.  The fact that government regulators might “get things wrong” less often than one might predict is besides the point.  The question is, again, comparing the two relevant institutions: firms in the marketplace and government agencies.  “We’re the government and we’re here to help” isn’t much of an answer to the appropriate question here.  There are further problems with this answer.  As I’ve written in response to the Commissioner’s claims:

But seriously, human beings making decisions “in a vacuum?”  It is individuals and firms who are making decisions insulated from market forces that create profit-motive and other incentives to learn about irrationality and get decisions right — not regulators?   The response to the argument that behavioral economics is simply liberalism masquerading as economic thinking (by the way, the argument is not that, it is that antitrust policy based on behavioral economics has not yet proven to be any more than simply interventionism masquerading as economic thinking — but I quibble) is weak.

As calls for behavioral regulation become more common, administrative agencies are built upon its teachings, or even more aggressive claims that behavioral law and economics can claim intellectual victory over rational choice approaches, it is critical to keep the right question in mind so that we do not fall victim to the Nirvana Fallacy.  The right comparative institutional question is whether courts and agencies or the market is better suited to mitigate the social costs of errors.   The external discipline imposed by the market in mitigating decision-making errors is well documented in the economic literature.  The claim that such discipline can replicated, or exceeded, in agencies is an assertion that remains, thus far, in search of empirical support.

Filed under: antitrust, behavioral economics, behavioral economics, consumer financial protection bureau, consumer protection, doj, economics, federal trade commission

The conventional predation claim involves a monopolist reducing price and increasing output.  Here’s a creative theory involving a claim that a decision to close down factories injures competition:

A federal judge in Texas is hearing testimony from farmers who contend that poultry producer Pilgrim’s Pride closed plants and ran them out of business to manipulate commodity chicken prices.

Their lawsuit alleges violations of a Depression-era antitrust law enacted to limit big meatpackers’ power over farmers and ranchers.

Bob Depper is one of the attorneys for the 275 farmers from several states. He says the trial in East Texas could last weeks or months. Friday was the second day of testimony.

The lawsuit is being tried before a judge rather than a jury in Marshall, about 175 miles east of Fort Worth.

Pilgrim’s Pride declined to comment on the lawsuit. It has said it closed some plants to save costs before emerging from Chapter 11 bankruptcy protection in 2009.

HT: Businessweek.  More background on the plant closings here.

Filed under: antitrust