As in, “If the SEC doesn’t pull up its socks and do a serious cost-benefit analysis, it may discover that Business Roundtable has become a verb. As in, the court Business Roundtabled yet another SEC rule.”

Here.

Filed under: business, disclosure regulation

Tomorrow morning at 10:30 I’ll be on a panel at AALS discussing behavioral economics and antitrust law and policy.

The panel includes: James Cooper, Bruce Kobayashi, William Kovacic, Steve Salop, Maurice Stucke, Avishalom Tor and myself.  Its a really good group and I’m looking forward to the discussion.  Here are the session details:

The program will focus on the influence of Behavioral Economics on Antitrust Law and Policy.  Behavioral economics, which examines how individual and market behavior are affected by deviations from the rationality assumptions underlying conventional economics, has generated significant attention from both academics and policy makers. The program will feature presentations by leading scholars who have addressed how behavioral economics impacts antitrust law and policy.

In my presentation I’ll be discussing my work on the topic (co-authored with Judd Stone) and some extensions of that work.

See you there.

Filed under: antitrust, behavioral economics

Iwas terribly saddened and, quite frankly, dumbfounded when I heard that Larry Ribstein had passed away. I had seen Larry approximately three weeks before when he gave a workshop at Yale and the last thought that would have crossed my mind would have been that I would be receiving such horrible news. At the time, Larry mentioned in his no-nonsense way numerous projects that he had in the works and how much he was looking forward to spending the Spring semester in New York. It is exceedingly difficult to accept that all of this will not happen.

Read the full piece here.

The American Antitrust Institute has announced plans to draft a comprehensive set of jury instructions for antitrust trials.  According to AAI president Bert Foer:

In Sherman Act Section 1 and Section 2 civil cases, judges tend to gravitate towards the ABA Model Instructions as the gold standard for impartial instructions. … The AAI believes the ABA model instructions are, in some situations, confusing, out of date, or do not adequately effectuate the goals of the antitrust laws. To provide an alternative, the AAI will develop a set of jury instructions that can be widely disseminated to lawyers and judges.

Foer is certainly right about existing jury instructions.  They’re often confusing and frequently provide so little guidance that jurors are effectively invited simply to “pick a winner.”  Crafting clearer, more concrete jury instructions would benefit the antitrust enterprise and further AAI’s stated mission “to increase the role of competition [and] assure that competition works in the interests of consumers.”

But clarity alone is not enough.  Any new jury instructions should set forth (in clear terms) liability standards whose substance enhances the effectiveness of the antitrust.  Here’s where I worry about the AAI project.

Throughout its history, AAI has shown little regard for the inherent limits of antitrust.  Those limits arise because the antitrust laws (1) embody somewhat vague standards that factfinders must flesh out ex post (e.g., they forbid “unreasonable” restraints of trade and “unreasonably” exclusionary conduct by monopolists) and (2) are privately enforceable in lawsuits giving rise to treble damages.  The former feature ensures that courts, regulators, and business planners face difficulty in evaluating the legality of business practices.  The latter guarantees that they’re regularly called upon to do so.  It also discourages borderline practices that might wrongly be deemed, after the fact, to be anticompetitive.  Antitrust therefore creates significant “decision costs” (in both adjudication and counseling) and “error costs” (in the form of either market power resulting from improper acquittals or foregone efficiencies resulting from improper convictions and the chilling of procompetitive conduct).  Those decision and error costs constitute the limits of antitrust and are inexorable:

• you can’t decrease decision costs (by simplifying a liability rule) without increasing error costs (incorrect judgments and enhanced chilling effect);
• you can’t decrease error costs (by making the rule more nuanced in order to better separate pro- from anticompetitive conduct) without increasing decision costs; 
• you can’t reduce false acquittals (by easing the plaintiff’s proof burden or cutting back on affirmative defenses) without increasing false convictions, and vice-versa.

In light of this unhappy situation, antitrust liability standards should be crafted so as to minimize the sum of decision and error costs.  As I have recently explained, the Roberts Court has taken this tack in its eight major antitrust decisions.

AAI, by contrast, has shown little concern for false positives and seems to equate an effective antitrust regime with one that produces more liability.  Time and again, the Institute has advocated “pro-plaintiff” liability rules that threaten high error costs in the form of false convictions (and the chilling effect that follows).  In all but one of the Roberts Court’s antitrust decisions (which, as noted, are consistent with a “decision-theoretic” framework that would help minimize the sum of decision and error costs), AAI has advocated a pro-plaintiff position that the Supreme Court ultimately rejected.  (See AAI’s positions in Twombly, Leegin, Credit Suisse, Dagher, Weyerhaeuser, LinkLine, and Independent Ink.)  This is a stunningly bad record. 

Moreover, AAI remains out of antitrust’s mainstream (which now acknowledges antitrust’s inherent limits and the need to constrain error costs) on practices involving somewhat unsettled liability rules.  Consider, for example, AAI’s views on: 

• Resale Price Maintenance (RPM).  Even after Leegin abrogated the per se rule against minimum RPM, AAI urged courts to adopt a rule of reason that would burden a defendant with “justifying” any instance of RPM that results in an increase in consumer prices.  Such an approach is likely to generate excessive liability because all instances of RPM — even those aimed at such procompetitive effects as the elimination of free-riding, the facilitation of new entry, or encouraging “non-free-rideable” demand-enhancing services — involve an increase in consumer prices.  AAI’s preferred rule essentially amounts to a presumption of illegality for RPM.  As I explained in this article, such an approach would involve huge error costs (and certainly wouldn’t minimize the sum of decision and error costs).
   
• Loyalty Rebates.  Efficiency-minded antitrust scholars have generally concluded that there should be a safe harbor for single-product loyalty rebates resulting in an above-cost discounted price for the product at issue.  The leading case on loyalty rebates, the Eight Circuit’s Concord Boat decision, agrees.  The thinking behind such a safe harbor is that any equally efficient rival could match a defendant’s loyalty rebate that resulted in an above-cost discounted price; permitting liability on the basis of such a rebate would chill discounting and create a price umbrella for relatively inefficient rivals.  AAI, however, has urged courts to reject the safe harbor approved in Concord Boat.
   
• Bundled Discounts.   Efficiency-minded antitrust scholars have also approved a safe harbor for some sorts of multi-product or “bundled”
   discounts: such a discount should be legal if each product in the bundle is priced above cost when the entire amount of the bundled discount is attributed to that single product.  The Ninth Circuit approved this safe harbor in its PeaceHealth decision.  Again, the rationale behind the safe harbor is that an equally efficient, single-product rival could meet any bundled discount resulting an above-cost pricing under this so-called “discount attribution” test.  And again, AAI has opposed this safe harbor.

These are but a few examples of AAI’s wildly pro-plaintiff view of antitrust—a view that ultimately injures consumers by ignoring the error costs (e.g., thwarted procompetitive business practices) associated with false convictions.  So in the end, I’m a bit worried about AAI’s jury instruction project.  If the Institute can simply provide clarity without pushing substantive liability standards in its preferred, pro-plaintiff (error cost-insensitive) direction, antitrust will be better off because of its efforts.  But I’m not optimistic.

Filed under: antitrust, bundled discounts, business, consumer protection, error costs, exclusionary conduct, regulation, resale price maintenance

In my series of three posts (here, here and here) drawn from my empirical study on search bias I have examined whether search bias exists, and, if so, how frequently it occurs.  This, the final post in the series, assesses the results of the study (as well as the Edelman & Lockwood (E&L) study to which it responds) to determine whether the own-content bias I’ve identified is in fact consistent with anticompetitive foreclosure or is otherwise sufficient to warrant antitrust intervention.

As I’ve repeatedly emphasized, while I refer to differences among search engines’ rankings of their own or affiliated content as “bias,” without more these differences do not imply anticompetitive conduct.  It is wholly unsurprising and indeed consistent with vigorous competition among engines that differentiation emerges with respect to algorithms.  However, it is especially important to note that the theories of anticompetitive foreclosure raised by Google’s rivals involve very specific claims about these differences.  Properly articulated vertical foreclosure theories proffer both that bias is (1) sufficient in magnitude to exclude Google’s rivals from achieving efficient scale, and (2) actually directed at Google’s rivals.  Unfortunately for search engine critics, their theories fail on both counts.  The observed own-content bias appears neither to be extensive enough to prevent rivals from gaining access to distribution nor does it appear to target Google’s rivals; rather, it seems to be a natural result of intense competition between search engines and of significant benefit to consumers.

Vertical foreclosure arguments are premised upon the notion that rivals are excluded with sufficient frequency and intensity as to render their efforts to compete for distribution uneconomical.  Yet the empirical results simply do not indicate that market conditions are in fact conducive to the types of harmful exclusion contemplated by application of the antitrust laws.  Rather, the evidence indicates that (1) the absolute level of search engine “bias” is extremely low, and (2) “bias” is not a function of market power, but an effective strategy that has arisen as a result of serious competition and innovation between and by search engines.  The first finding undermines competitive foreclosure arguments on their own terms, that is, even if there were no pro-consumer justifications for the integration of Google content with Google search results.  The second finding, even more importantly, reveals that the evolution of consumer preferences for more sophisticated and useful search results has driven rival search engines to satisfy that demand.  Both Bing and Google have shifted toward these results, rendering the complained-of conduct equivalent to satisfying the standard of care in the industry–not restraining competition.

A significant lack of search bias emerges in the representative sample of queries.  This result is entirely unsurprising, given that bias is relatively infrequent even in E&L’s sample of queries specifically designed to identify maximum bias.  In the representative sample, the total percentage of queries for which Google references its own content when rivals do not is even lower—only about 8%—meaning that Google favors its own content far less often than critics have suggested.  This fact is crucial and highly problematic for search engine critics, as their burden in articulating a cognizable antitrust harm includes not only demonstrating that bias exists, but further that it is actually competitively harmful.  As I’ve discussed, bias alone is simply not sufficient to demonstrate any prima facie anticompetitive harm as it is far more often procompetitive or competitively neutral than actively harmful.  Moreover, given that bias occurs in less than 10% of queries run on Google, anticompetitive exclusion arguments appear unsustainable.

Indeed, theories of vertical foreclosure find virtually zero empirical support in the data.  Moreover, it appears that, rather than being a function of monopolistic abuse of power, search bias has emerged as an efficient competitive strategy, allowing search engines to differentiate their products in ways that benefit consumers.  I find that when search engines do reference their own content on their search results pages, it is generally unlikely that another engine will reference this same content.  However, the fact that both this percentage and the absolute level of own content inclusion is similar across engines indicates that this practice is not a function of market power (or its abuse), but is rather an industry standard.  In fact, despite conducting a much smaller percentage of total consumer searches, Bing is consistently more biased than Google, illustrating that the benefits search engines enjoy from integrating their own content into results is not necessarily a function of search engine size or volume of queries.  These results are consistent with a business practice that is efficient and at significant tension with arguments that such integration is designed to facilitate competitive foreclosure.

Inclusion of own content accordingly appears to be just one dimension upon which search engines have endeavored to satisfy and anticipate heterogeneous and dynamic consumer preferences.  Consumers today likely make strategic decisions as to which engine to run their searches on, and certainly expect engines to return far more complex results than were available just a few years ago. For example, over the last few years, search engines have begun “personalizing” search results, tailoring results pages to individual searchers, and allowing users’ preferences to be reflected over time.  While the traditional “10 blue links” results page is simply not an effective competitive strategy today, it appears that own-content inclusion is.  By developing and offering their own products in search results, engines are better able to directly satisfy consumer desires.

Moreover, the purported bias does not involve attempts to prominently display Google’s own general or vertical search content over that of rivals.  Consider the few queries in Edelman & Lockwood’s small sample of terms for which Google returned Google content within the top three results but neither Bing nor Blekko referenced the same content anywhere on their first page of results.  For the query “voicemail,” for example, Google refers to both Google Voice and Google Talk; both instances appear unrelated to the grievances of general and vertical search rivals.  The query “movie” results in a OneBox with the next 3 organic results including movie.com, fandango.com, and yahoo.movies.com.  The single instance in Edelman & Lockwood’s sample for which Google ranks its own content in the Top 3 positions but this content is not referred to at all on Bing’s first page of results is a link to blogger.com in response to the query “blog.”  It is difficult to construct a story whereby this result impedes Bing’s competitive position.  In fact, none of these examples suggests that efforts to anticompetitively foreclose rivals are in play.  To the contrary, each seems to be a result of simple and expected procompetitive product differentiation.

Overall, the evidence reveals very little search engine bias, and no overwhelming or systematic biasing by Google against  search competitors.  Indeed, the data simply do not support claims that own-content bias is of the nature, quality, or magnitude to generate plausible antitrust concerns.  To the contrary, the results strongly suggest that own-content bias fosters natural and procompetitive product differentiation.  Accordingly, search bias is likely beneficial to consumers—and is clearly not indicative of harm to consumer welfare.

Antitrust regulators should proceed with caution when evaluating such claims given the overwhelmingly consistent economic learning concerning the competitive benefits generally of vertical integration for consumers.  Serious care must be taken in order not to deter vigorous competition between search engines and the natural competitive process between rivals constantly vying to best one another to serve consumers.

Filed under: advertising, antitrust, business, economics, exclusionary conduct, google, Internet search, law and economics, monopolization, technology Tagged: Bias, Bing, Blekko, Competition law, Edelman, google, microsoft, Web search engine

As everyone knows by now, AT&T’s proposed merger with T-Mobile has hit a bureaucratic snag at the FCC.  The remarkable decision to refer the merger to the Commission’s Administrative Law Judge (in an effort to derail the deal) and the public release of the FCC staff’s internal, draft report are problematic and poorly considered.  But far worse is the content of the report on which the decision to attempt to kill the deal was based.

With this report the FCC staff joins the exalted company of AT&T’s complaining competitors (surely the least reliable judges of the desirability of the proposed merger if ever there were any) and the antitrust policy scolds and consumer “advocates” who, quite literally, have never met a merger of which they approved.

In this post I’m going to hit a few of the most glaring problems in the staff’s report, and I hope to return again soon with further analysis.

As it happens, AT&T’s own response to the report is actually very good and it effectively highlights many of the key problems with the staff’s report.  While it might make sense to take AT&T’s own reply with a grain of salt, in this case the reply is, if anything, too tame.  No doubt the company wants to keep in the Commission’s good graces (it is the very definition of a repeat player at the agency, after all).  But I am not so constrained.  Using the company’s reply as a jumping off point, let me discuss a few of the problems with the staff report.

First, as the blog post (written by Jim Cicconi, Senior Vice President of External & Legislative Affairs) notes,

We expected that the AT&T-T-Mobile transaction would receive careful, considered, and fair analysis.   Unfortunately, the preliminary FCC Staff Analysis offers none of that.  The document is so obviously one-sided that any fair-minded person reading it is left with the clear impression that it is an advocacy piece, and not a considered analysis.

In our view, the report raises questions as to whether its authors were predisposed.  The report cherry-picks facts to support its views, and ignores facts that don’t.  Where facts were lacking, the report speculates, with no basis, and then treats its own speculations as if they were fact.  This is clearly not the fair and objective analysis to which any party is entitled, and which we have every right to expect.

OK, maybe they aren’t pulling punches.  The fact that this reply was written with such scathing language despite AT&T’s expectation to have to go right back to the FCC to get approval for this deal in some form or another itself speaks volumes about the undeniable shoddiness of the report.

Cicconi goes on to detail five areas where AT&T thinks the report went seriously awry:  “Expanding LTE to 97% of the U.S. Population,” “Job Gains Versus Losses,” “Deutsche Telekom, T-Mobile’s Parent, Has Serious Investment Constraints,” “Spectrum” and “Competition.”  I have dealt with a few of these issues at some length elsewhere, including most notably here (noting how the FCC’s own wireless competition report “supports what everyone already knows: falling prices, improved quality, dynamic competition and unflagging innovation have led to a golden age of mobile services”), and here (“It is troubling that critics–particularly those with little if any business experience–are so certain that even with no obvious source of additional spectrum suitable for LTE coming from the government any time soon, and even with exponential growth in broadband (including mobile) data use, AT&T’s current spectrum holdings are sufficient to satisfy its business plans”).

What is really galling about the staff report—and, frankly, the basic posture of the agency—is that its criticisms really boil down to one thing:  “We believe there is another way to accomplish (something like) what AT&T wants to do here, and we’d just prefer they do it that way.”  This is central planning at its most repugnant.  What is both assumed and what is lacking in this basic posture is beyond the pale for an allegedly independent government agency—and as Larry Downes notes in the linked article, the agency’s hubris and its politics may have real, costly consequences for all of us.

Competition

But procedure must be followed, and the staff thus musters a technical defense to support its basic position, starting with the claim that the merger will result in too much concentration.  Blinded by its new-found love for HHIs, the staff commits a few blunders.  First, it claims that concentration levels like those in this case “trigger a presumption of harm” to competition, citing the DOJ/FTC Merger Guidelines.  Alas, as even the report’s own footnotes reveal, the Merger Guidelines actually say that highly concentrated markets with HHI increases of 200 or more trigger a presumption that the merger will “enhance market power.”  This is not, in fact, the same thing as harm to competition.  Elsewhere the staff calls this—a merger that increases concentration and gives one firm an “undue” share of the market—“presumptively illegal.”  Perhaps the staff could use an antitrust refresher course.  I’d be happy to come teach it.

Not only is there no actual evidence of consumer harm resulting from the sort of increases in concentration that might result from the merger, but the staff seems to derive its negative conclusions despite the damning fact that the data shows that wireless markets have seen considerable increases in concentration along with considerable decreases in prices, rather than harm to competition, over the last decade.  While high and increasing HHIs might indicate a need for further investigation, when actual evidence refutes the connection between concentration and price, they simply lose their relevance.  Someone should tell the FCC staff.

This is a different Wireless Bureau than the one that wrote so much sensible material in the 15^th Annual Wireless Competition Report.  That Bureau described a complex, dynamic, robust mobile “ecosystem” driven not by carrier market power and industrial structure, but by rapid evolution and technological disruptors.  The analysis here wishes away every important factor that every consumer knows to be the real drivers of price and innovation in the mobile marketplace, including, among other things:

1. Local markets, where there are five, six, or more carriers to choose from;
2. Non-contract/pre-paid providers, whose strength is rapidly growing;
3. Technology that is making more bands of available spectrum useful for competitive offerings;
4. The reality that LTE will make inter-modal competition a reality; and
5. The reality that churn is rampant and consumer decision-making is driven today by devices, operating systems, applications and content – not networks.

The resulting analysis is stilted and stale, and describes a wireless industry that exists only in the agency’s collective imagination.

There is considerably more to say about the report’s tortured unilateral effects analysis, but it will have to wait for my next post.  Here I want to quickly touch on a two of the other issues called out by Cicconi’s blog post.

Jobs

First, although it’s not really in my bailiwick to comment on the job claims that have been such an important aspect of the public conversations surrounding this merger, some things are simple logic, and the staff’s contrary claims here are inscrutable.  As Cicconi suggests, it is hard to understand how the $8 billion investment and build-out required to capitalize on AT&T’s T-Mobile purchase will fail to produce a host of jobs, how the creation of a more-robust, faster broadband network will fail to ignite even further growth in this growing sector of the economy, and, finally, how all this can fail to happen while the FCC’s own (relatively) paltry $4.5 billion broadband fund will somehow nevertheless create approximately 500,000 (!!!) jobs.  Even Paul Krugman knows that private investment is better than government investment in generating stimulus – the claim is that there’s not enough of it, not that it doesn’t work as well.  Here, however, the fiscal experts on the FCC’s staff have determined that massive private funding won’t create even 96,000 jobs, although the same agency claims that government funding only one half as large will create five times that many jobs.  Um, really?

Meanwhile the agency simply dismisses AT&T’s job preservation commitments.  Now, I would also normally disregard such unenforceable pronouncements as cheap talk – except given the frequency and the volume with which AT&T has made them, they would suffer pretty mightily for failing to follow through on them now.  Even more important perhaps, I have to believe (again, given the vehemence with which they have made the statements and the reality of de facto, reputational enforcement) they are willing to agree to whatever is in their control in a consent decree, thus making them, in fact, legally enforceable.  For the staff to so blithely disregard AT&T’s claims on jobs is unintelligible except as farce—or venality.

Spectrum

Although the report rarely misses an opportunity to fail to mention the spectrum crisis that has been at the center of the Administration’s telecom agenda and the focus of the National Broadband Plan, coincidentally authored by the FCC’s staff, the crux of the report seems to come down to a stark denial that such a spectrum crunch even exists.  As I noted, much of the staff report amounts to an extended meditation on why the parties can and should run their businesses as the staff say they can and should.  The report’s section assessing the parties’ claims regarding the transition to LTE (para 210, ff.) is remarkable.  It begins thus:

One of the Applicants’ primary justifications for the necessity of this transaction is that, as standalone firms, AT&T and T-Mobile are, and will continue to be, spectrum and capacity constrained. Due to these constraints, we find it more plausible that a spectrum constrained firm would maximize deployment of more spectrally efficient LTE, rather than limit it. Transitioning to LTE is primarily a function of only two factors: (1) the extent of LTE capable equipment deployed on the network and (2) the penetration of LTE compatible devices in the subscriber base. Although it may make it more economical, the transition does not require “spectrum headroom” as the Applicants claim. Increased deployment could be achieved by both of the Applicants on a standalone basis by adding the more spectrally efficient LTE-capable radios and equipment to the network and then providing customers with dual mode HSPAILTE devices. . . .

Forget the spectrum crunch!  It is the very absence of spectrum that will give firms the incentive and the ability to transition to more-efficient technology.  And all they have to do is run duplicate equipment on their networks and give all their customers new devices overnight.  And, well, the whole business model fits in a few paragraphs, entails no new spectrum, actually creates spectrum, and meets all foreseeable demand (as long as demand never increases which, of course, the report conveniently fails to assess).

Moreover, claims the report, AT&T’s transition to LTE flows inevitably from its competition with Verizon.  But, as Cicconi points out, the staff is unprincipled in its disparate treatment of the industry’s competitive conditions.  Somehow, without T-Mobile in the mix, prices will skyrocket and quality will be degraded—let’s say, just for example, by not upgrading to LTE (my interpretation, not the staff’s).  But 100 pages later, it turns out that AT&T doesn’t need to merge with T-Mobile to expand its LTE network because it will have to do so in response to competition from Verizon anyway.  It would appear, however, that Verizon’s power over AT&T operates only if T-Mobile exists separately and AT&T has a harder time competing.  Remove T-Mobile and expand AT&T’s ability to compete and, apparently, the market collapses.  Such is the logic of the report.

There is much more to criticize in the report, and I hope to have a chance to do so in the next few days.

Filed under: antitrust, business, law and economics, merger guidelines, regulation, technology, telecommunications Tagged: at&t, FCC, merger, t-mobile

TOTM alumnus Todd Henderson recently pointed me to a short, ten-question interview Time Magazine conducted with Nobel prize-winning economist Daniel Kahneman.  Prof. Kahneman is a founding father of behavioral economics, which rejects the rational choice model of human behavior (i.e., humans are rational self-interest maximizers) in favor of a more complicated model that incorporates a number of systematic irrationalities (e.g., the so-called endowment effect, under which people value items they own more than they’d be willing to pay to acquire those same items if they didn’t own them). 

 I’ve been interested in behavioral economics since I took Cass Sunstein’s “Elements of the Law” course as a first-year law student.  Prof. Sunstein is a leading figure in the “behavioral law and economics” movement, which advocates structuring laws and regulations to account for the various irrationalities purportedly revealed by behavioral economics.  Most famously, behavioral L&E calls for the imposition of default rules that “nudge” humans toward outcomes they’d likely choose but for the irrationalities and myopia with which they are beset.

 I’ve long been somewhat suspicious of the behavioral L&E project.  As I once explained in a short response essay entitled Two Mistakes Behavioralists Make,  I suspect that behavioral L&E types are too quick to reject rational explanations for observed human behavior and that they too hastily advocate a governmental fix for irrational behavior.  Time’s interview with Prof. Kahneman did little to allay those two concerns.

Asked to identify his “favorite experiment that demonstrates our blindness to our own blindness,” Prof. Kahneman responded:

It’s one someone else did.  During [the ’90s] when there was terrorist activity in Thailand, people were asked how much they’d pay for a travel-insurance policy that pays $100,000 in case of death for any reason.  Others were asked how much they’d pay for a policy that pays $100,000 for death in a terrorist act.  And people will pay more for the second, even though it’s less likely.

 This answer pattern is admittedly strange.  Since death from a terrorist attack is, a fortiori, less likely than death from any cause, it makes no sense to pay the same amount for the two insurance policies; the “regardless of cause” life insurance policy should command a far higher price.  So maybe people are wildly irrational in comparing risks and the value of risk mitigation measures.

 Or maybe, as boundedly rational (but not systematically irrational) beings, they just don’t want to waste effort answering silly, hypothetical questions about the maximum amount they’d pay for stuff.  I remember exercises in Prof. Sunstein’s class in which we were split into groups and asked to state either how much we’d pay to obtain a certain object or, assuming we owned the object, how much we’d demand as a sales price.  I distinctly recall thinking how artificial the question was.  Given the low stakes of the exercise, I quickly wrote down some number and returned to thinking about what I would have for lunch, what was going to be on Sunstein’s exam, and whether I had adequately prepared for my next class.  I suspect my classmates did as well.  Was it not fully rational for us to conserve our limited mental resources by giving quick, thoughtless answers to wholly hypothetical, zero-stakes questions?

If so, then there are two possible reasons for subjects’ strange answers to the terrorism insurance questions Kahneman cites:  Subjects could be wildly irrational with respect to risk assessment and the value of protective measures, or they might rationally choose to give hasty answers to silly questions that don’t matter.  What we need is some way to choose between these irrational and rational accounts of the answer pattern.

Perhaps the best thing to do would be to examine people’s revealed preferences by looking at what they actually do when they’re spending money to protect against risk.  If Kahneman’s explanation for subjects’ strange answers were sound, we’d see people paying hefty premiums for terrorism insurance.  Profit-seeking insurance companies, in turn, would scramble to create and market such risk protection, realizing that they could charge irrational consumers far more than their expected liabilities.  But we don’t see this sort of thing.

That suggests that the alternative, “rational” (or at least not systematically irrational) account is the more compelling story:  Subjects pestered with questions about how much hypothetical money they’d spend on hypothetical insurance products decide not to invest too much in the decision and just spit out an answer.  As we all learn as kids, you a ask a silly question, you get a silly answer.

So again we see the behavioralist tendency to discount the rational account too quickly.  But what about the second common behavioralist mistake (i.e., hastily jumping from an observation about human irrationality to the conclusion that a governmental fix is warranted)?  On that issue, consider this portion of the interview:

Time:  You endorse a kind of libertarian paternalism that gives people freedom of choice but frames the choice so they are nudged toward the option that’s better for them.  Are you worried that experts will misuse that?

Kahneman:  What psychology and behavioral economics have shown is that people don’t think very carefully.  They’re influenced by all sorts of superficial things in their decisionmaking, and they procrastinate and don’t read the small print.  You’ve got to create situations so they’ll make better decisions for themselves.

Could Prof. Kahneman have been more evasive?  The question was about an obvious downside of governmental intervention to correct for systematic irrationalities, but Prof. Kahneman, channeling Herman “9-9-9” Cain, just ignored it and repeated his affirmative case.  This is a serious problem for the behavioral L&E crowd:  They think they’re done once they convince you that humans exhibit some irrationalities.  But they’re not.  Just as one may believe in anthropogenic global warming and still oppose efforts to combat it on cost-benefit grounds, one may be skeptical of a nudge strategy even if one believes that humans may, in fact, exhibit some systematic irrationalities.  Individual free choice may have its limits, but governmental decisionmaking (executed by self-serving humans whose own rationality is limited) may amount to a cure that’s worse than the disease.

Readers interested in the promise and limitations of behavioral law and economics should check out TOTM’s all-star Free to Choose Symposium.

 

Filed under: behavioral economics, behavioral economics, economics, free to choose symposium, law and economics, nobel prize, regulation

Economists are all quite familiar with the “holdup problem,” i.e. one contracting partner exploiting the other after asset specific investments have been made.  One classic law school textbook example is Alaska Packers v. Domenico in which the Alaska Packers’ Association hired Domenico for the salmon season for $50 plus 2 cents per salmon caught, but after leaving the dock and arriving in Alaskan waters for the short salmon season, the workers demanded an increase in their pay.  The defendant agreed, but upon return to San Francisco, refused to pay.  The seaman sued and lost on the theory that the exchange did not involve fresh consideration.  This, Judge Posner has argued, was the right economic result on the grounds that it discourages holdup.  Many of our readers will also be familiar with the famous Fisher Body / GM example of vertical integration solving the holdup problem, and the subsequent debate between Benjamin Klein and Ronald Coase over that particular example.

Now comes another example of the holdup problem at work.  In fact, it is difficult to imagine a better example.  Apparently, half way through a flight from India to Birmingham, England, an airline took advantage of the asset specific investments made by its passengers to alter the terms of the deal:

Passengers aboard two chartered jetliners from India to Britain were hit up for about $200 each, in cash, to continue their trip this week in what one flier compared to a hostage situation.  The charter company, Austria-based Comtel Air, and the Spanish company that owns the planes pointed fingers at each other over the situation Thursday. But Lal Dadrah, a passenger on one of the flights who recorded the crew passing the hat, called the situation “a complete, utter sham.”

Comtel Air passengers on a Tuesday flight to Birmingham, England, from the Indian city of Amritsar were hit up for 130 pounds — about $200 each — during a layover in Vienna. They were allowed off the aircraft to take the money from teller machines, a process that took about seven hours. There were varying accounts of what the money was to pay for, ranging from fuel to fees.

The NY Times story provides a few more details:

Britain’s Channel 4 news broadcast video showing a Comtel cabin crew member telling passengers: “We need some money to pay the fuel, to pay the airport, to pay everything we need. If you want to go to Birmingham, you have to pay.”

Some passengers said they were sent off the plane to cash machines in Vienna to raise the money.

“We all got together, took our money out of purses — 130 pounds ($205),” said Reena Rindi, who was aboard with her daughter. “Children under two went free, my little one went free because she’s under two. If we didn’t have the money, they were making us go one by one outside, in Vienna, to get the cash out.”

The economics don’t stop there.  There is potential for an agency problem as well:

Bhupinder Kandra, the airline’s majority shareholder, told the Associated Press from Vienna that travel agents had taken the passengers’ money before the planes left but had not passed it on to the airline.  “This is not my problem,” he said. “The problem is with the agents.”

A great example for the classroom.

 

Filed under: contracts

Source.

Filed under: behavioral economics