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

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Thursday, June 30, 2011

Reframing Antitrust in Light of Scientific Revolution: Accounting for Transaction Costs in Rule of Reason Analysis

Posted by D. Daniel Sokol

Alan Meese (William & Mary Law) has a new article titled Reframing Antitrust in Light of Scientific Revolution: Accounting for Transaction Costs in Rule of Reason Analysis.

ABSTRACT: This Article examines antitrust law’s failure to incorporate fully the lessons of transaction cost economics (“TCE”) when conducting rule of reason analysis under Section 1 of the Sherman Act. In particular, the article contends that modern rule of reason analysis, informed by workable competition’s partial equilibrium trade-off paradigm, is suitable for evaluating only a subset of agreements that may reduce transaction costs. To this end, the Article distinguishes between "technological" and "non-technological" transaction costs. Technological transaction costs entail the bargaining and information costs first emphasized by Ronald Coase, whose work sparked the transaction cost revolution. By contrast, non-technological transaction costs result from more fundamental departures from perfect competition of the sort stressed by Oliver Williamson, departures that create a risk of opportunism that accompanies relationship-specific investments.

The article demonstrates that modern rule of reason analysis, heavily influenced by the Harvard School of Antitrust, employs the partial equilibrium trade-off model to evaluate restraints challenged under Section 1. Modern law does accurately assess restraints that may reduce technological transaction costs - costs analogous to the sort of production costs recognized by the partial equilibrium trade-off model. However, this same methodology is poorly suited for analyzing restraints that may reduce non-technological transaction costs. To be precise, the model treats non-restraint price and output as a "competitive" baseline against which to measure a restraint’s impact, even when the restraint avoids per se condemnation because it may overcome market failure. As a result, tribunals applying the trade-off model may misinterpret benefits of such restraints, such as increased investment and resulting higher prices, as exercises of market power. Given the baselines that courts use, a test focused on price or output will mistakenly condemn many restraints that enhance welfare.

Several considerations explain courts’ failure to incorporate the lessons of TCE when analyzing contracts that may reduce non-technological transaction costs. For one thing, the trade-off paradigm has shed light on important antitrust problems, and practitioners of a successful paradigm do not readily abandon it. Moreover, Coase’s seminal work on TCE focused exclusively on technological transaction costs analogous to ordinary production costs easily recognized within the trade-off paradigm and thus did not cast doubt on that model. Furthermore, proponents of TCE actually embraced and refined the trade-off model for analyzing mergers producing technological efficiencies, thereby bolstering the model’s apparent usefulness. Finally, lower courts have modified aspects of the modern rule of reason test, saving beneficial restraints from condemnation and staving off anomalies that can undermine a paradigm’s support.

Given the trade-off paradigm’s shortcomings, courts should "reframe" their analysis, selecting a different baseline against which to measure the impact of restraints that may reduce non-technological transaction costs. That is, tribunals should ask whether the restraint produces higher prices (or lower output) compared to the prices or output that would obtain if the defendants made specific investments without a safeguard against opportunism. Such an approach would hold constant the other variables that influence price and output, thereby isolating the impact of the restraint simpliciter on market power and/or transaction costs.

http://lawprofessors.typepad.com/antitrustprof_blog/2011/06/reframing-antitrust-in-light-of-scientific-revolution-accounting-for-transaction-costs-in-rule-of-re.html

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