Antitrust & Competition Policy Blog

Editor: D. Daniel Sokol
University of Florida
Levin College of Law

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Tuesday, April 27, 2010

Innovation and the Limits of Antitrust

Posted by D. Daniel Sokol

Geoffrey A. Manne, International Center for Law & Economics (ICLE), Lecturer in Law, Lewis & Clark Law School and Joshua D. Wright, George Mason University School of Law explore the important topic of Innovation and the Limits of Antitrust.

ABSTRACT: This paper offers an opportunity to reflect on Frank Easterbrook’s seminal work on the Limits of Antitrust and to discuss its particular relevance to the problem of antitrust enforcement in the face of innovation. The error-cost framework in antitrust originates with Easterbrook’s analysis, itself built on twin premises: first, that false positives are more costly than false negatives because self-correction mechanisms mitigate the latter but not the former, and second, that errors of both types are inevitable because distinguishing pro-competitive conduct from anti-competitive conduct is an inherently difficult task in a single-firm context.

While economists have applied this framework fruitfully to several business practices that have attracted antitrust scrutiny, our goal in this paper is to harness the power of this framework to take an Easterbrookian, error-cost minimizing approach to antitrust intervention in markets where innovation is a critical part of the competitive landscape. While much has been said about the relationship between innovation and antitrust, often in the way of broad pronouncements that innovation either renders antitrust essential to economic growth or entirely unnecessary, the error-cost framework allows for greater precision in policy prescriptions and a more nuanced approach. Some of the implications are well understood in the current body of literature and others have been frequently ignored or remain entirely unrecognized.

Both product and business innovations involve novel practices, and such practices generally result in monopoly explanations from the economics profession followed by hostility from the courts (though sometimes in reverse order) and then a subsequent, more nuanced economic understanding of the business practice usually recognizing its pro-competitive virtues. This sequence and outcome is exactly what one might expect in a world where economists’ career incentives skew in favor of generating models that demonstrate inefficiencies and debunk the Chicago School status quo, while defendants engaged in business practices that have evolved over time through trial and error have a difficult time articulating a justification that fits one of a court’s checklist of acceptable answers. From an error-cost perspective, the critical point is that antitrust scrutiny of innovation and innovative business practices is likely to be biased in the direction of assigning higher likelihood that a given practice is anticompetitive than the subsequent literature and evidence will ultimately suggest is reasonable or accurate.

Given recent activities in the antitrust enforcement landscape - identifying innovating firms in high-tech markets as likely antitrust targets combined with recent discussions of error costs from leading enforcers, at the Section 2 Hearings and elsewhere - we hope to begin a more rigorous discussion of the relationships between innovation, antitrust error, and optimal liability rules that goes beyond merely selecting economic models that fit regulator’s prior beliefs.

We begin by discussing some principles for application of the error cost framework in the innovation context in Part II before discussing the historical relationship between antitrust error and innovation in Part III. Part IV concludes by challenging the conventional wisdom that the error cost approach implies that the rule of reason should apply to most forms of business conduct rather than per se rules. While we agree that per se rules should not apply to cases involving product or business innovation, broadly defined, we argue that the error cost approach should not require generalist judges to evaluate state of the art economic theory and evidence on a case by case basis. Instead, we favor an approach that is consistent with the spirit of Easterbrook’s original analysis, identifying simple filters aiming to harness the best existing economic knowledge to design simple rules that minimize error costs. We conclude with five such proposals for simple rules based on existing economic theory, empirical evidence, and acknowledgment of the institutional biases toward false positives discussed above.

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