Understanding Single-Firm Behavior: Empirical Perspectives Session

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2 and











20 9:00 A.M. TO 12:30 P.M.

24 Reported and transcribed by:

25 Susanne Bergling, RMR-CLR




3 Commissioner

4 Federal Trade Commission

5 and


7 Acting Deputy Assistant Attorney General

8 for Economic Analysis

9 Antitrust Division, U.S. Department of Justice


13 Jonathan B. Baker

14 Luke M. Froeb

15 Robert C. Marshall

16 Wallace Mullin

17 David Reitman

18 F. Michael Scherer

19 Clifford Winston



1 C O N T E N T S

3 Introduction

5 Presentations:

6      Jonathan B. Baker

7      Luke M. Froeb

8      Robert C. Marshall

9      Wallace Mullin

10      David Reitman

11      F. Michael Scherer

12      Clifford Winston

14 Moderated Discussion

16 Conclusion



1 P R O C E E D I N G S

2 - - - - -

3 DR. HEYER: Okay, first, it's a pleasure to be

4 here, and since you're probably less interested in what

5 I have to say than what these people have to say, I am

6 going to be brief before turning things over to Bill.

7 I wanted primarily to thank some people, not

8 only the panelists for giving us their time and soon

9 sharing their insights with us, but I wanted to thank

10 particular people at the Antitrust Division who have

11 helped prepare this and helped prepare me.

12 We have some people from the Legal Policy

13 Section in the Antitrust Division, Deputy Chief Gail

14 Kursh, who in an earlier life helped manage the Dentsply

15 case, which you will hear more about from Dr. Reitman

16 over there. One of the attorneys in her section, Joe

17 Matelis, crackerjack paralegal Brandon Greenland, and

18 most importantly, June Lee, one of the economists in the

19 Division, who, in addition to putting up with all the

20 administrative stuff, has actually contributed

21 substantively.

22 So, with nothing further, I am going to turn it

23 over to my distinguished colleague and co-moderator,

24 Bill Kovacic.

25 COMMISSIONER KOVACIC: Welcome to the New Jersey


1 Avenue Conference Facility on September 26th, the 92nd

2 Anniversary of the adoption of the Federal Trade

3 Commission Act. We're delighted to have you all here

4 today and to focus on what I think is one important

5 dimension of the assessment of what standards for

6 unilateral firm behavior ought to be. Many of the

7 presumptions that run throughout discussions of doctrine

8 and policy involving the enforcement of competition law

9 against dominant firms derive from empirical judgments

10 about the state of the world. To read judicial opinions

11 and see how often the opinions say "we know, it is

12 believed, it is thought, the world is," and then to look

13 futilely in the footnotes for what editors in journals

14 would note and say "Add cite," is a striking phenomenon.

15 More than that, when you take a look at the

16 papers of some of the Justices of the Supreme Court,

17 papers that have become available, you see how

18 frequently in their deliberations they're relying upon

19 hunches, judgments or assessments about the state of the

20 world and the way in which business behavior has been

21 used in the past, and about the significance of that

22 behavior. It's impossible, in short, in looking at the

23 full range of history and enforcement policy and

24 judicial decision-making, to escape the significant role

25 that assumptions about the state of the world play in


1 the formulation of doctrine.

2 Our aim today is to address three questions and

3 to try to link empirical work that's been done or might

4 be done in the future to the development of standards.

5 Three questions really animate our session today.

6 The first is to consider what past empirical

7 work tells us about how firms become and remain

8 dominant, to look back and, at least selectively, to

9 take a look at what work has been done by empirical

10 researchers, whether in the form of quantitative work,

11 whether in the form of case studies, whether simply in

12 the examination of the way in which judicial decisions

13 or enforcement decisions have affected the way firms

14 behave.

15 Second, and more forward-looking, is to ask what

16 we would like to learn if we could, what additional

17 facts would we like to have if we could get them in

18 principle.

19 And last, based upon what we offer as an answer

20 to the second question, how might we go about doing it?

21 What combination of effort within public enforcement

22 agencies, among think tanks, academic research centers

23 or other bodies, might provide the means by which

24 important empirical questions could be answered?

25 Later today, as Ken has, I will acknowledge the


1 many contributions of our professional staff that have

2 made the event possible. For now, to begin, I just want

3 to remind you of a couple of housekeeping details about

4 the session.

5 The first is to respect our speakers by turning

6 off all of your communication devices. I was at a

7 hearing a couple of years ago in the federal courthouse

8 where the bailiff stood up and said, "If your

9 Blackberries or cell phones go off, you will be

10 removed." We won't remove you, but please do honor this

11 convention.

12 Second, those of you who want to make your way

13 to the restrooms, they are through the lobby -- the

14 signs are marked -- between the elevators and off to the

15 right. Now and then, there are planned or unplanned

16 fire drills and alarms. If one goes off, we and our

17 staff will lead you out to the street, to the right,

18 back through the lobby, and we will simply gather out in

19 front of the building until it is possible to return.

20 To begin today, we have divided our session into

21 two parts. We are going to have a series of

22 presentations before we take a break, and then we will

23 have a larger discussion joined by two of our panelists

24 who have agreed to discuss what they have heard and then

25 to add comments of their own about the proceedings.


1 To get us started is Mike Scherer. Mike is as

2 renowned and significant a figure in the modern

3 development of economic research and analysis at the

4 Federal Trade Commission as there is. Going back to his

5 time as Bureau Director in this institution and through

6 his recurring assistance, research and analysis, I think

7 it is fair to say that, in the illustrious collection of

8 those who have served as Bureau Director of the Federal

9 Trade Commission, none has been more distinguished in

10 that very hall-of-fame like collection of individuals.

11 Mike is also well known for the extent to which

12 not simply has he done theory, but one of the reasons we

13 asked Mike to come here is Mike's particular affinity

14 and interest in empirical work and the extent to which

15 empirical work, as well as history and an examination of

16 the past, has figured into his own scholarship.

17 Mike, please, thank you.

18 (Applause.)

19 DR. SCHERER: Thank you for those kind words,

20 Bill.

21 Let me just briefly address the third of Bill's

22 questions, how to learn. In many ways, I have been a

23 disciple of Joseph Schumpeter, not the stuff he wrote

24 about monopoly and technological progress, but what he

25 wrote about how economics advances. Schumpeter argued


1 that economic analysis was all about three things. It

2 was about theory, it was about statistics, and it was

3 about history. To do economic analysis right, you need

4 all three, and I have tried hard to do all three of

5 those things. I think in the profession now there is a

6 bit of an imbalance; in particular, we do too little

7 history.

8 I am not sure whether it was distributed or

9 whether it is on the web or whatever, but I do have a

10 background paper for the meetings entitled

11 "Technological Innovation and Monopolization." It is a

12 case history of seven great high-tech monopolization

13 cases in the 20th Century, and the thrust of my remarks

14 will be based upon that paper.

15 Now, first of all, how do you monopolize? Well,

16 it is pretty well known. Mergers, here we have very

17 strong precedent, so I won't dwell longer. Natural

18 advantages, such as economies of scale, the control of

19 natural resources, network externalities and the like,

20 these are fairly rare except in the traditional

21 regulated industries or in those cases where you define

22 the market very narrowly, as in certain pharmaceutical

23 deals.

24 The most interesting one is surely superior

25 efficiency and especially technical innovation. These


1 pose the hardest cases for antitrust. When a firm

2 achieves a monopoly position through superior efficiency

3 or innovation, one faces very difficult trade-offs. We

4 should clearly, clearly be encouraging technological

5 superiority, but where is the line crossed? That is the

6 really tough question.

7 A subset of this is patent accumulations. In at

8 least two of the seven cases I analyzed, that is the key

9 to how firms monopolized, specifically, General Electric

10 in the lamp case and AT&T in the telephone case. We did

11 not do anything about it early in the century, and

12 therefore, we had a raft of problems to deal with

13 beginning in the 1940s and later.

14 There are some puzzles here. There is one that

15 I really think the FTC or someone ought to study very

16 carefully, and that's Cisco. Cisco reached its dominant

17 position in the network switch business on the strength

18 of about 100 acquisitions and a lot of patent

19 acquisitions. Was that necessary? Would we have had

20 the best market structure for the switch industry if

21 antitrust had intervened against these mergers?

22 I remember one time being at a cocktail party in

23 Cambridge and meeting a gentleman who told -- you know

24 what you do at these cocktail parties, "What do you do?

25 What do I do?" He said, "Well, what I have done, I have


1 developed a switch that is a thousand times faster than

2 anything Cisco has." He ran a high-tech startup,

3 needless to say. I said, "What are you going to do with

4 it?" "Oh, we are going to exploit it. We are going to

5 market it." The next thing I know, he is bought by

6 Cisco for a couple of billion dollars.

7 Now, what would have happened if this guy had

8 been encouraged to develop the switch technology on his

9 own? These are interesting counterfactual questions

10 that ought to be explored carefully.

11 I pass on very briefly to the pricing

12 consequences of monopoly. It has to be brief, because

13 the theory and the evidence are extraordinarily complex.

14 It depends critically on entry barriers, broadly

15 defined, or cost structures. In particular, if entry

16 barriers are low, you have the paradox of explaining how

17 a firm achieved dominance despite having low entry

18 barriers.

19 The United States Steel case, decided by the

20 Supreme Court in 1920, bears careful examination. The

21 evidence is very clear. The Bureau of Corporations did

22 a superb job studying that industry. U.S. Steel had no

23 cost advantage over its rivals after the Carnegie

24 properties had settled into normality. So, it had no

25 cost advantage. How could it preserve its dominant


1 position? Well, the answer is it could not, and so it

2 chose an umbrella pricing strategy. It set prices high

3 enough to provide nice profits for everybody in the

4 industry. That encouraged a flood of entry, and

5 gradually, U.S. Steel's market share declined, which the

6 Supreme Court saw as evidence of effective competition,

7 the declining market share.

8 In fact, what it was evidence of was setting

9 prices monopolistically high above the entry-deterring

10 level and behaving essentially sluggishly about entry,

11 and as a result, we have a steel industry that inherited

12 this tradition of sluggishness, of not responding to

13 price signals for 50 years until it got into big trouble

14 in the 1970s and 1980s.

15 Well, much more important than pricing is

16 technological innovation, much more important. There I

17 am clearly a "Schumpeterian." The question is, are

18 monopolists, are dominant firms, superior innovators?

19 The theory we have on this -- and we have got a lot of

20 it, and evidence, too -- the theory and evidence on this

21 say there's a duality. On the one hand there are

22 situations, situations mainly associated with

23 slow-moving technologies, where the science base is

24 changing slowly. There are situations where a

25 monopolist will, in fact, be a superior innovator, where


1 only a monopolist is able reasonably quickly to realize

2 sufficient quasi-rents to cover the R&D cost. Those

3 cases definitely do exist in small markets and markets

4 where the science base is moving slowly.

5 But there's an exception when the science and

6 technology base is moving rapidly, where you have

7 revolutions, the kind of revolution we have had in

8 information technology in the last few decades, where

9 that is happening, and/or when monopolists are reluctant

10 to cannibalize the rents that they are earning on the

11 products that they already have marketed. In those

12 cases, firms in dominant positions are almost surely

13 sluggish innovators. I say "almost surely" because

14 here, too, one can find exceptions.

15 The most interesting exception in recent years I

16 think has been Intel. Andy Grove's book Only the

17 Paranoid Survive is a really nice example. I

18 participated for the FTC in the case against Intel and

19 read all of Andy Grove's memoranda for several years.

20 Intel was really terribly alert to new technological

21 challenges and tried hard to stay abreast of them and

22 not be out-competed by upstart innovators. Even so, the

23 record is quite interesting. I do not have a slide

24 projector, and I did not bring a slide anyway -- I

25 forgot to bring it, it was the most important slide I


1 was going to bring with me, and I forgot to put it in my

2 portfolio --

3 COMMISSIONER KOVACIC: We have a sketch artist

4 in the back.

5 DR. SCHERER: No, I will wave my arms so you can

6 see. I did a graph, this was in the FTC's Intel case,

7 from public data. I had a graph on which time was the

8 horizontal axis, and on the vertical axis was the speed

9 of microprocessors, and what one sees is two things.

10 First of all, in the period when Intel had a

11 monopoly, at least in 32-bit chips, where Intel had a

12 monopoly, the trajectory introducting speed improvements

13 was like this, quite gradual, but then AMD and then

14 Cyrix caught up and got into the 32-bit technology and

15 began competing with Intel, and what you see, that slope

16 abruptly turns sharper. There was more rapid increase

17 in the key variable of competition, the speed of the

18 microprocessor, and one also found the individual new

19 product points more tightly clustered, showing that more

20 new products were being brought into the market as a

21 result of the competition from AMD and Cyrix.

22 Intel argued in the FTC's case that we are our

23 own best, sharpest competitors, because we have got all

24 this installed base out there, and we have to bring out

25 new products constantly or people will just stick with


1 their old microprocessors. I did a series of simulation

2 analyses, and what I found was that using reasonable

3 parameters, Intel would try to maintain a generation for

4 five or six years in the absence of competition. When

5 there was competition, however, it moved the speed of

6 the introduction process to two or three years.

7 Now, this blends into another aspect where you

8 really have serious problems for antitrust, and that is

9 the so-called fast second strategy. This is a concept

10 that was introduced in the late 1960s by Lee Baldwin

11 and -- I don't know his first name -- Childs, and there

12 has been a good deal of theoretical development on it

13 since. The basic idea is that the dominant firm holds

14 back until there is a real threat -- Andy Grove's Only

15 the Paranoid Survive -- and then when that threat

16 appears on the horizon, the dominant firm comes onto the

17 market with a new product, with all guns blazing, and

18 perhaps with a whole panoply of practices to make life

19 difficult for the new company. You can see them

20 described in the paper I submitted for the record, but

21 you clearly see this kind of conduct in Standard Oil, in

22 General Electric, in AT&T, in Xerox, in IBM, and in

23 Microsoft, you see at least delayed innovation, and for

24 IBM and Microsoft, a powerful fast second strategy.

25 How much time do I have?


1 MR. HEYER: You have got another ten minutes or

2 so.

3 DR. SCHERER: Oh, okay. Then I will read Judge

4 Jackson's -- I think it's the penultimate paragraph --

5 MR. HEYER: Five or ten minutes.

6 DR. SCHERER: -- in Judge Jackson's decision in

7 Microsoft.

8 "Most harmful of all is the message that

9 Microsoft's actions have conveyed to every enterprise

10 with the potential to innovate in the computer industry.

11 Through its conduct toward Netscape, IBM, Compaq, Intel

12 and others, Microsoft has demonstrated that it will use

13 its prodigious market power and immense profits to harm

14 any firm that insists on pursuing initiatives that could

15 intensify competition against one of Microsoft's core

16 products. Microsoft's past success in hurting such

17 companies and stifling innovation deters investment in

18 technologies and businesses that exhibit the potential

19 to threaten Microsoft. The ultimate result is that some

20 innovations that would truly benefit consumers never

21 occur for the sole reason that they do not coincide with

22 Microsoft's self-interest."

23 Well, Intel pursued similar policies. Actually,

24 the truth is more nuanced than what Judge Jackson said.

25 What he said was basically right, but recognizing this,


1 firms that had to compete with Microsoft or had to

2 compete with Intel pursued more sophisticated

3 strategies. Sometimes they simply tried to avoid areas

4 of dominant firm strategic interest, and therefore, we

5 may have missed significant innovations. We will never

6 know what we have missed.

7 But in other cases -- and I think this is the

8 larger majority of cases -- what they did was made their

9 appearance on the scene and then made it clear that they

10 really would like to be acquired by the dominant firm at

11 a very hefty price, and here we face a tough

12 counterfactual question. Would technological progress

13 be faster if they had seen their way clear to innovate

14 independently rather than having their operations taken

15 over by the dominant firm?

16 Now, my own view is that open competition is

17 clearly superior in inducing vigorous innovation as

18 compared to situations in which one has a relatively

19 secure dominant firm. The presumption of antitrust

20 should be to err on the side of maintaining competition

21 and especially, especially keeping both conduct

22 barriers, including fast second strategies, and

23 structural barriers at minimum feasible levels. This is

24 hard. There is no way to evaluate such situations

25 without a careful rule of reason analysis guided by


1 appropriate economic theory. But when monopoly

2 positions exist, the job can be done, and it should be

3 done.

4 At this, I will stop and will be happy to take

5 questions. Thank you.

6 (Applause.)

7 MR. HEYER: I think what we are going to do is

8 we are going to hold off on questions until we get into

9 the post-break round table discussion. We will let each

10 of the panelists go.

11 Let me say a few words about Luke, eager to get

12 up here. Luke has a very long title. He teaches at

13 Vanderbilt. He is particularly proud of his work

14 recently at the Federal Trade Commission, and I am happy

15 to say I know Luke back from when he was a staff

16 economist at the Antitrust Division. Despite his work

17 there, he became chief economist at the Federal Trade

18 Commission.

19 With no further adieu, we can --

20 DR. FROEB: Can we bring up the slides?

21 MR. HEYER: Actually, these aren't Luke's. All

22 right.

23 DR. FROEB: Thank you. It's a pleasure to be

24 here. Every time I go in and out of academia, I get

25 more discouraged about what we are doing in academia.


1 We work hard on problems no one cares about and publish

2 results in journals that nobody reads, and so it is a

3 delight to be back here working and thinking about

4 important problems that people care about.

5 This area is the source of the biggest policy

6 disagreement between the U.S. and the rest of the world.

7 The U.S. is relatively permissive towards single-firm

8 conduct, while the rest of the world is not. We have

9 reached agreement, by and large, on how to analyze

10 price-fixing and merger cases. And while we do have

11 differences about individual cases and evidence, we do

12 agree on the analytical framework.

13 There is no such agreement on single-firm

14 conduct, and why do we have this disagreement? What do

15 we really know about single-firm conduct? But more

16 importantly, do we know what we don't know about

17 single-firm conduct, and the message of this talk, there

18 is a lot of stuff we do not know, and I think we have

19 got to be really careful about policy in this area.

20 Before I start, I want to thank those who have

21 contributed to my thinking in this area. I thought I

22 would stop taking credit for other people's work once I

23 left the FTC, but apparently not for a couple more

24 years.

25 Okay, so why is horizontal merger analysis


1 easier than vertical? The biggest reason is we ignore

2 the long-run indirect and strategic effects of

3 horizontal mergers. We focus solely on the short-run

4 increases in market power, and we have relatively good

5 understanding of how that occurs. Most disagreements

6 focus on the magnitude of the effect and how to estimate

7 it. In other words, we disagree about the evidence, but

8 not on the analysis.

9 The second reason is that we have these distinct

10 mechanisms through which mergers affect consumer

11 welfare: unilateral effects, entry, product

12 repositioning, efficiencies, and coordinated effects.

13 I think we know less about coordinated effects than we

14 want to, but the other mechanisms are well understood.

15 To analyze cases, we gather evidence on each mechanism,

16 and estimate the net effect by estimating the magnitude

17 and likelihood of each individual mechanism.

18 So, why is analyzing single-firm conduct harder?

19 Well, we are concerned about long-run, indirect

20 strategic effects. We just cannot ignore them. If we

21 did, we would have a very simple analysis. And the

22 second reason is that mechanisms with opposing effects

23 usually appear in a single kind of behavior. Predation

24 is the simplest example. In the short run, firms reduce

25 price, but in the long run, we get fewer competitors.


1 Vertical integration has the same problem. In

2 the short run, we have the unilateral effect of vertical

3 integration where firms eliminate the double

4 marginalization. But in the long run, we might have a

5 raising-rivals'-costs or reducing-rivals'-revenue

6 mechanism.

7 Exclusive dealing, again, has two opposing

8 mechanisms. The immediate effect of exclusive dealing

9 is to reduce consumer choice, but indirectly, exclusive

10 dealing serves to align the incentives of the retailer

11 with the goals of the manufacturer. So, balancing these

12 effects is really, really difficult. They appear

13 together, and we do not really have good ways of

14 balancing them.

15 So, for these three reasons, single-firm conduct

16 is hard to analyze. There is a taxonomy that I borrowed

17 from Tim Brennan that says, let's consider the simplest

18 case where we have some kind of behavior that has only

19 two effects, two mechanisms at work. There is a

20 proximate, immediate, direct, short-run mechanism that

21 we may know something about, but the effects of the

22 distant mechanism are much less certain.

23 There are four possible outcomes, the distant

24 mechanisms and the proximate mechanisms can both be good

25 or bad. Those are the relatively easy cases. Where we


1 run into problems is when the mechanisms work in

2 opposing ways, where the distant mechanism can be bad or

3 good and the proximate mechanism has the opposite sign.

4 When you are doing single-firm analysis,

5 evidence determines which box you go in, and most of the

6 kind of behavior we are concerned about goes in either

7 the off-diagonal boxes. The good-bad box and the

8 bad-good box, those are the ones where we run into

9 problems. Most of the problem cases fall into the lower

10 left box where we have a distant bad and a proximate

11 good, and you can think about bundling, as an example.

12 Bundling offers consumers a better price for the

13 bundle. That is why they buy the bundle, and they are

14 better. But in the long run, the bundle may exclude

15 competitors, and that may have a negative long-run

16 effect. I have already talked about vertical

17 integration, but loyalty discounts and predation give

18 rise to the same kinds of problems.

19 So, how do we characterize the different

20 regimes? The big difference between the U.S. and the

21 rest of the world is that we disagree on the distant

22 effects of mechanisms, i.e., what is the magnitude of

23 these distant effects and how frequently do they occur?

24 The Europeans are much more concerned with the

25 long-run negative effects of things like bundling and


1 predation and loyalty discounts, and so they are

2 concerned with avoiding type II errors. If regulatory

3 agencies are uncertain about the effects of single-firm

4 behavior, they are going to make mistakes. They will

5 either deter behavior which is good, type I error, or

6 let bad behavior go through, type II error. And there

7 is an inevitable trade-off: The only way you can reduce

8 type I error is to increase type II error and vice

9 versa.

10 The U.S. regime is more concerned with type I

11 errors. We are more concerned with deterring good

12 behavior. So, we tend to regulate less aggressively.

13 Europeans are more concerned with type II errors, so

14 they regulate more aggressively. We cannot determine

15 who has the better regime, but we can say that relative

16 to the U.S., the Europeans commit more type I errors;

17 and relative to the Europeans, we commit more type II

18 errors.

19 The "makes no business sense" standard is really

20 about trying to find cases in that box so we do not

21 deter any good behavior. We miss more bad behavior than

22 the Europeans; but they deter more good behavior than

23 we.

24 So, the interesting question and the focus of

25 this hearing is, how do we determine the effects? Mike


1 correctly states that the effect question is a difficult

2 counterfactual. How do we know what would have happened

3 had a firm behaved differently?

4 This requires comparing two states of the world,

5 only one of which we observe. That is what Mike means

6 about the counterfactual. We have to figure out what

7 would have happened had the firm behaved differently.

8 There are two ways to do it. You can construct

9 a theory that describes competition, and use that theory

10 to tell me what would have happened had the firm behaved

11 differently.

12 The other way is to use what we call natural

13 experiments, and this is really a misnomer. Any

14 statistician in the audience will cringe when I use the

15 word "experiment," because there is nothing experimental

16 about economics data. We do not get to run experiments

17 with the economy, probably for good reason.

18 When I talk about natural experiments, I am

19 talking about comparing a market with the behavior to a

20 market without the behavior, and drawing inference about

21 the effect of the behavior by comparing those two

22 markets. The big questions here are how well does the

23 experiment mimic the effect of interest; and did we hold

24 everything else constant that could have accounted for

25 change. These are tough questions to answer.


1 We would particularly want to draw inference

2 about the distant, long-run, or strategic effects,

3 because we know less about them, and because uncertainty

4 about their effects is the source of conflict between

5 policy-makers, attorneys, and economists. I hate to be

6 so hackneyed, but we need more information; we need more

7 research. However, do we have natural experiments that

8 estimate the effects of these distant effects?

9 Here is my favorite study. It is from a paper

10 by Mike Vita of the FTC, and it estimates what happened

11 when the appeals court overturned the must-carry

12 regulations for cable TV. Local cable TV monopolists

13 must carry local over-the-air broadcast channels, and in

14 close areas like Baltimore/Washington, they must carry

15 both the Baltimore and the D.C. stations. When the

16 Court overturned those regulations, which stations did

17 the cable TV monopolist drop?

18 Would the Baltimore cable system drop the

19 Baltimore over-the-air broadcast stations which compete

20 for audience share and advertising revenue, or would

21 they drop the Washington over-the-air stations where

22 they do not compete and can get the same content? And

23 Mike found that they dropped the channels that had the

24 lower rating, and these tended to be the competitors.

25 Competitors were less likely to be dropped, and Mike


1 interprets this as evidence refuting the anticompetitive

2 hypothesis. He found that in the long run a firm will

3 not exclude its competitors, as long as they are

4 carrying a good product. I thought it was a very clever

5 kind of use of the decision to try to draw inference

6 about these long-run distant effects.

7 Another Whinston natural experiment is Indiana's

8 ban on exclusive territories for beer distributors.

9 After a state law banned exclusive territories, beer

10 consumption fell by 6 percent. Here again, the author

11 concludes exclusive territories were pro-competitive.

12 Other experiments show that gasoline prices are

13 3 cents higher in states where refiners are prohibited

14 from owning their own gas stations. For fast food,

15 prices at company-owned stores are 3 percent lower.

16 Another experiment which is pretty messy, and I have

17 given this talk over in the UK, and they fight me on

18 this one, on the banning of tied pubs -- so if you are a

19 beer manufacturer, you can't own your own pub to

20 exclusively promote your own -- you have to carry at

21 least two brands of beer. Small beer manufacturers

22 liked having their own pubs because they were using them

23 to promote their beer, and they thought it was an

24 effective way of competing against large brewers. And

25 once they got rid of tied pubs, price went up and


1 quantity went down. However, there were a lot of other

2 changes that were going on at the same time, so it is a

3 hard experiment to interpret. But more telling was that

4 the small beer manufacturers fought the change. They

5 liked being able to own their own tied pubs and to have

6 exclusives with a pub so they could promote their

7 brands, and sure enough, the small -- the small beer

8 manufacturers were hurt by the change.

9 At the same time that we were reviewing the

10 literature, Francine Lafontaine, who knows more about

11 franchise agreements than I, and Margaret Slade, who

12 used to be at the FTC and is now in the UK, were

13 reviewing the literature as well, and they used a

14 different taxonomy than we did. We were trying to

15 determine what can we learn about these distant effects,

16 but they were looking at government-imposed changes

17 versus voluntary changes, and they looked at a lot of

18 the same studies that we did. Here is their conclusion:

19 When manufacturers impose restraints, not only

20 do they make themselves better off, but they also

21 typically allow consumers to benefit from higher quality

22 products and better service provisions. In contrast,

23 when the Government prevents these kinds of contracts,

24 the effort is typically to reduce consumer welfare as

25 prices increase and service levels fall. And they


1 conclude that the interests of manufacturers and

2 consumer welfare are apt to be aligned, while

3 interference in the market is accomplished at the

4 expense of consumers, and, of course, manufacturers.

5 I would interpret this as evidence that these

6 kinds of arrangements are doing what we want them to do,

7 which is the U.S.'s relatively lenient attitude toward

8 single-firm behavior relative to the rest of the world.

9 I do realize there is a lot that we do not know, and I

10 think it is important to recognize that there is much we

11 do not know.

12 More importantly, how do we generalize these

13 studies to cases? I am not naive enough to think that

14 in a litigation context we are going to have a nice

15 natural experiment that we can interpret cleanly to tell

16 us what to do in a specific case. However, I am not

17 sure how frequently we have been looking for experiments

18 like these.

19 I am much less sanguine than Professor Scherer

20 that we know that much about innovation. So, you look

21 at the Intel innovation, who knows what the innovation

22 rates would have been had we had more people in there?

23 Maybe there was room for only one firm in the market?

24 It is a really tough counterfactual. I wish we knew

25 more.


1 And finally, how do we test for the effects of

2 antitrust intervention? Bill Kovacic has been a real

3 advocate for what he calls competition R&D. When we go

4 around the world and talk to new antitrust regimes, we

5 say, look, don't just adopt a regime and freeze it,

6 because what if you get it wrong? Instead, build in

7 some kind of feedback mechanism, and start with the kind

8 of follow-up studies that are done at the FTC and DOJ.

9 I think they are absolutely crucial to try to

10 characterize what are we doing, and to try to figure out

11 what would have happened had we done something

12 differently, in hope of improving.

13 So, characterizing what we do and determining

14 what its effects are really tough, but there are some

15 instances where we can figure out what is going on, and

16 I think we have to be on the lookout for good natural

17 experiments.

18 I guess that is all I want to say.

19 MR. HEYER: Thank you.

20 (Applause.)

21 MR. HEYER: Okay, our final panelist presenter

22 pre-break is Professor Wally Mullin. You have got his

23 bio. He is a professor at George Washington University,

24 and particularly of interest to us I think here is that

25 he has done a fair amount of empirical work on some of


1 the issues we are trying to grapple with. A lot of us

2 have a lot to say about theory, but he has gotten his

3 hands dirty a bit, and we look forward to his remarks.

4 DR. MULLIN: Thanks. I am delighted to have

5 this opportunity to appear in these public hearings, and

6 I thank the Department of Justice and the Federal Trade

7 Commission for jointly sponsoring these hearings and, of

8 course, in particular, the co-moderators today, Ken

9 Heyer and Bill Kovacic.

10 So, switching gears, today I want to talk about

11 what lessons we can draw from the history of antitrust

12 enforcement, okay? Now, these may very well be lessons

13 that are kind of in the DNA of current antitrust

14 enforcers, but in the interest of redundancy, I am going

15 to include some of those lessons as well.

16 So, the initial set of dominant firms arose out

17 of the trust movement in the sort of merger to monopoly

18 way. So, in saying that this should be an area of

19 contemporary interest, you know, I certainly acknowledge

20 that similar economic and legal conditions may never

21 return; however, the historical emphasis can still

22 provide a modern researcher with a relatively large

23 sample of dominant firms which faced antitrust scrutiny.

24 So, as an empirical economist, that is very attractive.

25 So, I am going to focus in the discussion today,


1 in part, as reflected in my own work, on an admittedly

2 non-random sample of these firms, okay, Standard Oil,

3 U.S. Steel, which Mike has already talked about a little

4 bit, and American Sugar Refining Corporation. So, this

5 choice arises out of a variety of factors. One is sort

6 of the economic importance of the firms, you know, at

7 that particular time, the legal significance of the

8 associated antitrust decisions, and to some extent the

9 similarity and differences in their business strategies.

10 In work with co-authors, I have studied two of

11 these firms. I haven't published any work on Standard

12 Oil, but other people here have, and obviously it's a

13 well-known case in terms of monopolization law.

14 So, since all three firms faced antitrust

15 prosecution, we can examine not only dominant firm

16 behavior, but also the effects of prosecution, and we

17 can also study the effects of remedy as implemented or,

18 admittedly, more speculatively, consider the effects of

19 remedies that were not ordered, because in some cases no

20 liability was found.

21 So, let's start with Standard Oil. My remarks

22 on this will be relatively brief, reflecting sort of

23 comparative advantage issues. So, Standard Oil, right,

24 if we want to have a poster child for different types of

25 dominant firms, Standard Oil was an aggressive


1 competitor, okay? So, while the claim that Standard Oil

2 engaged in predatory pricing has been debunked by McGee,

3 the company had other practices that still marked it as

4 an aggressive competitor. For example, Granitz and

5 Klein in 1996 published an article studying how Standard

6 Oil obtained differential rebates from the railroads on

7 petroleum transportation, and that is a source,

8 according to Granitz and Klein, of their sort of

9 supra-competitive rents, and those rebates, of course,

10 advantaged it relative to other refiners.

11 Of course, Standard Oil was found guilty and

12 dissolution was ordered, and it was kind of alluded to

13 by Mike, Bill Comanor and he have argued in a paper that

14 dissolution of Standard Oil raised long-term industry

15 performance, and also in that paper, this is

16 counterfactual, it would have been good had U.S. Steel

17 been dissolved.

18 In his academic work, Bill Kovacic has argued

19 that the effect of this dissolution rests in part on the

20 fact that the dissolution involved formerly independent

21 entities. So, one shouldn't necessarily take this as a

22 dissolution child's story in which everyone lives

23 happily ever after as an automatic indication that

24 structural remedies in all forms and in all

25 circumstances will work. You have to be sensitive to


1 the particular facts involved, but given the fact that

2 Standard Oil was organized as such that what was spun

3 off were things that were in some sense formerly

4 independent or had a certain amount of autonomy within

5 Standard Oil in terms of decision-making, in terms of

6 things like corporate culture, the enterprise was able

7 to grow and prosper going forward, and so my take-away

8 would be that, you know, a different remedy in another

9 industry or even with a firm with a different internal

10 organization and history might have unduly sacrificed

11 production costs, but that is merely a speculative

12 comment with a note of caution.

13 So, in terms of U.S. Steel, Mike has already

14 touched upon part of this. So, you know, John D.

15 Rockefeller and Standard Oil is the poster child for the

16 aggressive competitor. United States Steel is sort of a

17 poster child for a dominant firm that may be good for

18 competitors and bad for competition, which was something

19 that the Supreme Court didn't realize at the time.

20 So, in published work with co-author brothers,

21 and it's otherwise hard to find two other Mullins, we

22 have presented evidence that dissolution, which, of

23 course, was never ordered, would have lowered steel

24 prices in that case, in particular, and raised steel

25 output. So, in particular, the pattern of


1 contemporaneous stock market reactions to events from

2 the dissolution suit, okay, basically from 1911 to 1920,

3 not only judicial decisions but periods when it was

4 rumored U.S. Steel might dissolve itself to basically

5 avoid prosecution, and then a denial of that rumor the

6 next week, some subset of the events that I mentioned

7 ended up having big stock market reactions for U.S.

8 Steel, indicating that there was news sent to the

9 securities markets in those particular events, and in

10 those weeks, the stocks of customers, in particular, of

11 U.S. Steel, particularly the railroads, reacted in a way

12 that suggested that the stock market believed that

13 dissolution would have lowered steel prices.

14 So, interestingly -- and this is a bit in

15 contrast to maybe what Mike Scherer was talking about --

16 one of the things I also find of interest, and this is

17 part of the tension of monopolization law, is that there

18 are parts, going back to things that might have

19 potentially been sources of market power, that

20 contemporary scholarship would suggest maybe were, in

21 fact, efficiency-enhancing. So, in particular, U.S.

22 Steel was losing market share over time, and you might

23 think, well, wait a minute, is there some sort of scarce

24 factor upstream from steel production that they could

25 use and acquire in order to foreclose entry, you know,


1 or at least put a limit on that, right?

2 So, historically they were vertically integrated

3 into iron ore properties, as the Carnegie properties had

4 been, and during the period where they were undergoing

5 antitrust scrutiny at the start of the 20th Century,

6 they added to that a significant amount by long-term

7 leasing the iron ore properties of the Great Northern

8 Railway and James J. Hill. So, that is why they are

9 referred to as the Hill properties. And that was viewed

10 as anticompetitive by contemporary antitrust authorities

11 for some reason, as I will sort of talk about in the

12 next slide, but that is not only criticized by the

13 standing Congressional Committees -- the Federal Trade

14 Commission wasn't around at the time -- but the Bureau

15 of Corporation's report criticized it, and, in fact,

16 U.S. Steel ends up cancelling the lease in 1911 in part

17 to try to forestall prosecution because this was that

18 big of deal to the Department of Justice at the time.

19 Okay, so what might be some of the lessons we

20 take from there? So, as before, of course, the law

21 should protect competition, not competitors. You know,

22 it strikes me -- as I said, I recognize that this would

23 be known by the contemporary court, but it is a good

24 case to assign students, because you have them read the

25 case, and, of course, the Supreme Court is praising U.S.


1 Steel because its competitors had such nice things to

2 say about it at trial, and the contrast with Standard

3 Oil is pretty stark. U.S. Steel's anticompetitive

4 effect is not only due to single-firm conduct in a

5 narrow sense, but U.S. Steel's actions in organizing the

6 Gary dinners, which it later abandoned, clearly had a

7 collusive intent, and they were also bad for

8 competition, although good for competitors.

9 So, another tension of monopolization law is

10 that even a firm with market power may have

11 efficiency-enhancing innovations, right? So, the easy

12 case would be in which, you know, if you wanted to do

13 some variation of the diagram, the easy case would be,

14 oh, there are firms that have market power and there are

15 firms that have cost reductions, and they are completely

16 disjoint. I say empirically, that is not the case. In

17 fact, in terms of work that we have done, U.S. Steel was

18 a firm with both elements.

19 So, in a paper with one of my brother

20 co-authors, okay, we didn't have a falling out over the

21 difference in these papers, orthogonal to that issue,

22 the paper with Joe Mullin examines the Hill ore lease,

23 and says that, on balance, that it seems to be best

24 explained as being efficiency-enhancing rather than as

25 vertical foreclosure.


1 There are several reasons for this. So, if you

2 sort of back up, the underlying problem of developing an

3 iron ore mine is a problem of relationship-specific

4 investment, something that was studied later by

5 transaction cost economics, both for kind of developing

6 the mine or the investment in the mine, which, of

7 course, is not mobile once it is sunk, and also

8 development of transportation to get the ore or some

9 variation of the ore to market, and that transportation,

10 given where those mines were, was over the Great

11 Northern Railway, which otherwise would have owned the

12 mining rights.

13 So, the specific contractual terms that were in

14 the lease, which caused the Bureau of Corporations to

15 scratch its head circa 1906, has been studied by people

16 like Crocker and Masten. So, one example of this is

17 they had a take-or-pay provision which was quite large,

18 so U.S. Steel was basically committed to making these

19 large payments, and, in fact, during the initial period

20 of the execution of the lease before it fell under

21 antitrust scrutiny, they were, in fact, investing --

22 they were basically scaling up to exploit that property

23 at a very high level.

24 And it's striking, also, in the sense that you

25 might imagine some notion of vertical foreclosure or


1 barrier to entry would be, oh, well, they are going to

2 acquire this iron ore. They have other iron ores. They

3 don't need to exploit it to produce right now. They are

4 just going to sit on it and prevent anyone else from

5 gaining entry to it, but, in fact, they invested heavily

6 in trying to exploit the iron ore.

7 It is possible, of course, it had an

8 anticompetitive effect, so it is not so much a -- you

9 know, a complete nesting of the hypotheses, but rather,

10 sort of saying, our judgment, my judgment, the bulk of

11 the evidence would be that that particular aspect of

12 their innovation was something that was

13 efficiency-enhancing.

14 And, of course, the challenge for contemporary

15 antitrust enforcers is what sort of humility should they

16 exercise when faced with some sort of business practice

17 that they don't automatically have an obvious efficiency

18 explanation for? Now, obviously the staff and other

19 people are going to be aware of transaction cost work,

20 et cetera, right, but presumably, we will figure out 20

21 years from now other reasons why some firms might have

22 some sort of purpose. That doesn't necessarily mean

23 that the behavior is necessarily benign, but that's the

24 situation that requires the people to look at it.

25 So, finally, love of my life, American Sugar


1 Refining. So, David Genesove and I have written a

2 series of paper on this. This is one of those things

3 that you don't necessarily know what you're getting into

4 when you start. So, in a paper that recently appeared

5 in the Rand Journal, they profitably engaged in

6 predatory pricing, and that was one of their business

7 practices.

8 Now, these joint hearings have already included

9 a rich discussion of predatory pricing in an earlier

10 session, so I won't recapitulate that now. We might get

11 into some element of that in the discussion. David and

12 I noted in the paper that compelling evidence of

13 predation is rare. That is reflected not only in the

14 academic consensus, but obviously also in the case law,

15 but we think the evidence that we present in the paper

16 in this case is compelling.

17 So, in terms of a couple of things to point out,

18 American Sugar engaged in predation. They didn't prey

19 on all entrants. Every single entry episode didn't

20 trigger predation or didn't trigger immediate predation;

21 however, the nature of the market was such that after

22 they preyed, they acquired the entrants and other fringe

23 firms at lower buy-out prices. So, in a sense, if they

24 were making the dynamic calculation, they were sort of

25 saying, well, here's some small firm, it's entering, you


1 know, no big deal. As more firms enter, they are sort

2 of like, okay, well, now it's time to prey and buy

3 people out and raise up our market share.

4 In terms of trying to rationalize the

5 observations under different theories of business

6 behavior, that manipulation of rivals' beliefs played a

7 very big role as in some of the reputation models. So,

8 once again, it is not as if they sent out a clarion call

9 saying that, oh, they were going to prey and then they

10 were going to buy people out, so, in fact -- precisely

11 because there were multiple firms they were basically

12 preying on simultaneously, there are cases in which they

13 basically made an arrangement with one of the firms to

14 say, okay, well, fine, we are going to buy you out, here

15 are these terms, but let's keep this secret, and so --

16 and then continue the war, and then buy out the other

17 firms.

18 So, in some sense, part of the aspect of kind of

19 buying out firms and engaging in predation is that the

20 process is sort of the reverse of what we are calling

21 the free-rider problem when you form a trust, right? If

22 you form a trust, you are going to restrict output, and

23 so people will want to stay outside of it and just take

24 advantage of the output lowering entity.

25 Conversely, if there's predation going on, and


1 you know there will be a buy-out and the predatory

2 pricing is going to end, of course, people also want to

3 free-ride on that. So, the manipulation of rivals'

4 beliefs is I think part and parcel of being able to be

5 successful.

6 So, there was a monopolization suit, and it

7 stretched on over a period of time, that eventually

8 resulted in a consent decree. But there are some other

9 sort of, you know, maybe, you know, happy lessons here

10 that antitrust serves as a deterrent on a variety of

11 levels. Part of the rationale of the antitrust law is

12 to be punitive, but obviously you also want to think,

13 well, gee, you hope other firms get the message and we

14 don't have to go prosecute them, or this firm in the

15 future, once bitten, twice shy, and so will behave

16 better, and have some sort of implicit consent decree.

17 So, there are two examples of this, and one

18 deals with American Sugar and one deals with other

19 firms. So, during its monopolization case, American

20 Sugar underwent sort of partial "voluntary" dissolution,

21 so this was before the consent decree, because of the

22 government victories in the American Tobacco and

23 Standard Oil cases.

24 So, focusing on American Tobacco or Standard Oil

25 as cases, those basically had a spillover effect on the


1 behavior of another firm, in this case American Sugar,

2 and presumably other firms. The difficulty of the

3 non-random sample is, of course, it may be that the

4 whole universe of firms behaved differently, which is a

5 reason why people should do more work on it.

6 Later on, there is also an impact on American

7 Sugar itself. David Genesove and I also studied not a

8 single-firm conduct, but in terms of collusive conduct,

9 we studied The Sugar Institute of the twenties and

10 thirties, of which American Sugar was the largest and

11 most important member, but no longer as large as in 1911

12 or 1914.

13 So, this is noted in our AER paper, even though

14 it wasn't the focus of that paper, which was that the

15 legal representatives of American Sugar at these

16 basically collusive meetings within the industry were

17 very sensitive to things like discussion of price. That

18 was a part of the battle, in a sense, within The Sugar

19 Institute, one person complaining to his boss, oh, gee,

20 we are never allowed to do anything that's going to have

21 any real effect, and so that may just be the wise

22 counsel of American Sugar at the time, but one has to

23 think that the fact that they had had this antitrust

24 prosecution was something that empowered people within

25 the firm to say, okay, compliance is important. It is


1 certainly something you think that going forward would

2 be an important part of antitrust enforcement.

3 So, all I have for now.

4 (Applause.)


6 I would now like to invite Jon Baker to present

7 his comments. Jon, as you know, like Mike and Luke, is

8 part of the galaxy of superb economists who have headed

9 the Bureau of Economics at the FTC. In addition to

10 Jon's affiliation with the Commission, in many ways he's

11 been what I consider to be hitting for the scholarly

12 cycle. Not only has he done excellent quantitative

13 work, both at the Commission in matters such as Staples,

14 but also, in his own published work, he has contributed

15 wonderfully to theory. In studying the deliberations

16 that took place over the Verizon-Twombly matter, I many

17 times went back and referred to Jon's paper on two

18 Sherman Act dilemmas from the early 1990s. And quite

19 apropos for this panel as well, Jon, like so many of our

20 presenters, has a good aptitude for history, reflected

21 not only in his survey paper in the JEP on competition

22 enforcement, but also in his recent paper in the

23 Antitrust Law Journal on the development of widely

24 accepted norms and standards, and his political

25 bargaining paper. We are delighted to have Jon here


1 today.

2 DR. BAKER: Thank you. Thank you, Bill. That

3 was a very nice introduction. It is not what I would

4 expect from a case book co-author, but I appreciate it

5 anyway.

6 COMMISSIONER KOVACIC: I should have added, he

7 is the co-author of the most astonishing and --

8 MR. HEYER: Copies on sale in the lobby.

9 COMMISSIONER KOVACIC: During the break, there

10 will be the signing process --

11 DR. BAKER: And I am always delighted to be back

12 to see all my former FTC and Justice Department

13 colleagues. I worked with Ken and Luke back in the old

14 days at the Antitrust Division.

15 Well, so let me -- I have a -- sort of several

16 comments on what we have heard this morning. They are a

17 little bit disjointed, and I will just get into them and

18 see how far we get.

19 The first is on the question of what can we

20 learn from the old monopolization cases. On the one

21 hand, there are very few of them. They are often high

22 profile, but there aren't many, and a lot of them were

23 reviewed when antitrust standards were very different

24 than they are today and when ideas about remedies were

25 different than they are today. I don't think we would


1 remedy the Standard Oil monopoly were that to have

2 appeared today anything like the way it was remedied

3 then. We would have tried to get the parts that were

4 broken up to engage in head-to-head competition from the

5 beginning.

6 So, there's something funny about this exercise.

7 The -- you wouldn't -- it's a little like saying, well,

8 what can we learn about merger analysis from studying

9 Pabst and Von's, you know, some poster children of

10 merger cases that are no longer thought to be good

11 precedents, although they are technically controlling

12 Supreme Court precedents, as an aside.

13 Well, what we learn from Mike Scherer and Wally

14 Mullin, I think, is something that perhaps we have

15 always known, which is the value of careful

16 case-specific analysis. This is what the judicial

17 system at its best makes possible.

18 Now, that's not to say that the courts have

19 always undertaken this -- the adversarial system has

20 always forced the same level of analysis that later

21 scholars have been able to bring to these cases. I

22 mean, it took 50 years, but the Mullin Brothers finally

23 got to the bottom of the U.S. Steel case. One would

24 like that to have happened, in the case itself. But on

25 the other hand, it shows you the power of case-specific


1 analysis to hear Mike and Wally go through what they

2 have learned about these cases.

3 That's not to say that their conclusions are

4 undisputable, but the kind of analysis they do, they can

5 focus in on the issues, and it really does support the

6 kind of work that we do in the enforcement agencies and

7 the courts.

8 Now, let me move on to say something about the

9 issues Luke raised. It struck me, one interesting point

10 is the short-term focus, Luke says, of our antitrust

11 thinking. He didn't quite put it this way, but I mean I

12 guess I'm a little -- I read it in the light of also

13 thinking about a paper that John Lopatka and Bill Page

14 wrote where they argued that antitrust enforcement

15 courts are more congenial to -- or the decisions, I

16 suppose you would say, the decisions are more driven by

17 the short-term benefits and costs than the long-term

18 ones.

19 If you take that perspective and think about

20 Luke's charts, it seems to me that one message is we

21 shouldn't just give a free pass to all those kind of

22 practices in the lower left box of Luke's taxonomy:

23 Price predation, bundling, vertical integration and

24 loyalty discounts. These are things where I think Luke

25 says the proximate effect is good and the distant effect


1 is bad.

2 Now, I suppose that my characterization of the

3 implication of those boxes is a little different from

4 Luke's, but in order to go beyond the picture Luke drew

5 to an enforcement regime that gives a free pass -- well,

6 free pass is a little strong -- but that makes it tough

7 to bring cases in the lower left-hand box, you have to

8 take another step in the logic. You have to argue, as

9 some people do, things like the Government can't do a

10 good job analyzing these practices, separating out the

11 two kinds of effects, and remedying it, and you have to

12 conclude that the costs of one type of error are greater

13 than the other. There's a whole additional apparatus

14 that we have to apply before we can reach the conclusion

15 that antitrust should be hands off on all these

16 practices.

17 In thinking about Luke's taxonomy a little more,

18 I started thinking about most favored customer clause

19 cases or most favored nation clause cases. The Justice

20 Department for a while had an enforcement program

21 involving dominant firms that instituted these kinds of

22 practices. It was a dominant health insurer that had a

23 most favored customer clause in its contracts with

24 healthcare providers, and I'm thinking of -- was it

25 Delta Dental, there's a bunch of Delta Dental cases, and


1 I think there's some other ones.

2 So, the idea was the provider, the doctor or the

3 dentist or whatever it was, wouldn't lower rates to

4 rival health insurers without also lowering it to the

5 dominant provider, let's call it Blue Cross, and so that

6 makes it impractical for the rivals or the entrants to

7 make procompetitive deals; that is, rivals to Blue

8 Cross. Insurers want to come in and say if you give me

9 lower rates, I'll funnel more business to you, the

10 provider, and we will both do better, and then this

11 creates competition for Blue Cross.

12 Of course, these most favored customer clause

13 provisions can also result in collusion by making

14 discounting more costly, but we are in the dominant firm

15 context here, so we will put that aside.

16 The interesting thing about these most favored

17 customer clauses as a practice is that there are

18 efficiency justifications that are often offered, but in

19 a health care setting, they are not very plausible. The

20 best efficiency justifications are either preventing

21 opportunism when futures markets are unavailable, which

22 sometimes happens in long-term contracting where you see

23 these kinds of provisions, or perhaps signaling low

24 prices where buyer search is costly, and these are the

25 kind of -- here, we're thinking there about retail


1 businesses selling to customers.

2 Perhaps Luke will say to me I just moved these

3 provisions in the health care context from his lower

4 left box to his upper left box, where the efficiency

5 justification isn't very good, and so there isn't a

6 problem, but I think if you accept what I have gotten to

7 so far, that these provisions can be troublesome for

8 dominant firms to contract using them in many of these

9 health care contexts, you have to ask, well, when we

10 move outside the health care context, perhaps to one

11 where the efficiency justification is potentially more

12 plausible, don't we have to analyze? Don't we have to

13 think about whether the bad guy story and the good guy

14 story -- which is more powerful as between the two? So,

15 my take from Luke's taxonomy is we ought to think hard

16 about practices in the lower left-hand box and analyze

17 them as best we can.

18 On natural experiments, Luke, I think you missed

19 an opportunity when you were talking about experiments.

20 I have a new motto for the FTC, and this really would be

21 your motto, not mine, "We fool around with the economy

22 every day." Natural experiments are fine in

23 principle -- that was just a joke -- natural experiments

24 are fine in principle, and I basically am sympathetic to

25 what Luke was trying to do with them.


1 Tim Bresnahan and I have a recent paper where we

2 talk about something similar. We say that a key

3 challenge for antitrust analysis and empirical

4 industrial organization economics going forward, which

5 is not recognized in antitrust to the same extent that

6 it's recognized in economics, is to exploit similarities

7 among related industries that focus an inquiry involving

8 the industry and the firms under study. We have some

9 examples different from Luke's, but I think the spirit

10 of the exercise is similar. An important question, even

11 assuming it's a good natural experiment, is what

12 generalization you can make from it.

13 Tim and I think that the right generalization is

14 the level of the industry. In other words, I would look

15 at some of the examples that Luke has about -- oh, I

16 don't know, gasoline divorcement or something like that,

17 but not -- and perhaps that would create a presumption

18 about gasoline retailing, but I wouldn't connect the

19 dots and generalize to all vertical restraints. All of

20 Luke's examples, for example, in his representative

21 studies are about manufacturer- distributor

22 relationships in consumer products. They do not tell us

23 much about most favored customer clauses, for example,

24 in health insurer contracts with providers.

25 Finally -- I am not sure how much time I have


1 left. Do I have time left? Okay.

2 MR. HEYER: Is it good?

3 DR. BAKER: It's not as good as what's happened

4 already, Ken. I don't get better.

5 No, I think I'll just stop right there, and I

6 will -- it's not that good, Ken.

7 MR. HEYER: Save it for the discussion, all

8 right.

9 DR. BAKER: We will save it for the discussion.

10 Thank you.

11 (Applause.)

12 MR. HEYER: The final person we are going to

13 hear from before the break is Cliff Winston, who you'll

14 see is a long-time economist at The Brookings

15 Institution and has done just an incredible amount of

16 empirical work, largely having to do with regulated

17 industries but not exclusively, and partly because he's

18 really taken on some tough challenges empirically, he

19 seems like a perfect person to invite to talk here, and

20 let's just hear from Cliff.

21 DR. WINSTON: Thanks a lot for inviting me to

22 this conference.

23 Let me, since I'm a little bit on the fringe in

24 this enterprise, sort of tell you my context and how I

25 was thinking about this and eventually how I synthesized


1 what we have heard.

2 When Jim Taronji called me about this, my sort

3 of immediate perception was you were planning a series

4 of conferences that were basically assessing the

5 antitrust activity at the federal level of DOJ and FTC,

6 and I naturally thought this, and it turns out that -- I

7 had just finished a book called Government Failure verse

8 Market Failure that looks at all areas where the

9 government intervenes in trying to correct market

10 failures, including but certainly not limited to market

11 power, but information problems, externalities, public

12 good, public production and the like, and figured, well,

13 this is right along the lines of what I have just

14 written up, and so I can sort of look at what you're

15 doing from this perspective.

16 But I also pointed out that I was going to be

17 away a couple of weeks before the conference and

18 literally just got back late the night before, so it

19 would be good if I got the presentations beforehand.

20 Otherwise, you know, I would have to be on the fly, but

21 I thought there obviously might be difficulties in

22 getting things to me, and I was checking my web when I

23 was in Europe, but late last night, I realized a couple

24 had come in, but unfortunately one was in WordPerfect,

25 and Brookings doesn't use WordPerfect. I assume Mike


1 does this as a protest against Microsoft. I like

2 WordPerfect better. So, I didn't have them, but I did

3 have a fall-back position.

4 What I was going to do was sort of outline a

5 template, in general, about how I would assess the

6 performance of a federal agency and what recommendations

7 that I might make in terms of improving performance, set

8 that up, say, okay, and I'll just plug in everything I

9 hear in these areas.

10 So, let me outline the template and then just

11 make a few comments on what we've heard. So, the first

12 thing in general that I would ask and think about for

13 any federal agency is, is there compelling evidence of a

14 problem to begin with? That is, you know, are there

15 some stylized facts, summary measures of welfare, you

16 know, that something is going on, you know, information

17 problems are costing consumers hundreds of millions of

18 dollars a year, monopoly is causing similar kinds of

19 costs?

20 Okay, the first thing, just get a big picture

21 overview, when I do these things with transportation, it

22 is very easy, because I can just point to graphs of the

23 lake, there is a problem, congestion going on, airline

24 delay, going up, there's a problem, not too much

25 controversy about that.


1 The second question one would ask, you know,

2 what is the scholarly evidence -- when I mean the

3 scholarly evidence, I mean quantitative, welfare type

4 calculations, and certainly counterfactuals isolating

5 the effects of other factors, on first market failure,

6 what do we know about how markets are performing or not

7 performing, since they may be the source of the problem,

8 and government failure, that is, how are governments

9 doing in all of this, and third, government success.

10 So, you know, here are the things you want to look at

11 from the bottom up, the little pieces of evidence that

12 we look at to assess the agency.

13 Then the third thing, since this really is a

14 scholarly enterprise, when I ask the big picture

15 question, where is the field going? You know, since

16 we're getting a lot of the intellectual infrastructure

17 from the scholars who work in the area, how does the

18 field look at this problem? What kind of research are

19 they doing? Where are they likely to help in the

20 future, if at all? Are there incentives the agency

21 could give to researchers to sort of get them focused on

22 problems that they are interested in, so on and so

23 forth?

24 And then finally, you know, given one, two and

25 three, where do we go from here? How do we put all this


1 together and say, okay, here is how I think you can

2 improve your performance and your interventions, or here

3 is what I think we, you know, we need to know before we

4 can give confident recommendations.

5 So, let me go through these now with an eye

6 toward what has been said and what has not been said

7 about them. Okay, first, the big picture question, I

8 didn't really hear exactly what I was looking for there,

9 but there's a reason. It's really hard. They are

10 trying -- and I think it is one of the big problems --

11 maybe the biggest problem with industrial organization,

12 is unlike other fields in economics, there isn't this

13 stylized fact that you're constantly facing that reminds

14 you of what's going on out there.

15 It's not like in labor economics where you hear

16 about what the unemployment rate is, okay, or the

17 percent of people below the poverty line. You hear

18 these numbers, you know, these are the kinds of things

19 that researchers get to work on in dealing with this.

20 It is not like trade where we hear what's going on with

21 the dollar, the trade balance. Recently, it just came

22 out about we now have sort of have negative net capital

23 funds, I assure you now a lot of paper is going to come

24 out about this, trying to explain it to us, what is

25 going on, so on and so forth. You can think of a whole


1 bunch of things, but when you talk about IO, yes, your

2 instincts are well, we want some measure of economic

3 welfare, but that's not presented by the Commerce

4 Department. It's hard to construct that kind of thing.

5 Now, that said, there was an effort to do that.

6 In the sixties, there was a lot of effort to think of

7 things in terms of concentration ratios, and that was

8 sort of our stylized fact, and there was even a

9 Commission, the Neal Commission, you know, that met and

10 made recommendations about, you know, deconcentration of

11 industries that exceeded a 70 percent level of

12 concentration, and that may not be something that people

13 take seriously today, but there was a time when that was

14 sort of an orientation towards thinking about IO and

15 even antitrust policy, okay?

16 But there really isn't that, which is a bit of a

17 concern, because you never sort of know, well, are you

18 working on a problem that's really important? And the

19 only one who talked about that was Luke in terms of

20 motivating -- while we care about this, and he said this

21 in terms of, you know, apparent disagreement or I would

22 say just different approaches toward antitrust policy

23 between the U.S. and the EU, and I just simply say,

24 well, does that signify different concerns with the same

25 problem?


1 To the extent the U.S. is less aggressive and

2 more permissible and allows certain things to go on,

3 does it basically feel that competition is pretty

4 intense, and maybe this is just signifying we really

5 don't have that much of a problem, whereas in Europe,

6 they might feel that there is more, but this is

7 certainly something to think about.

8 Okay, secondly, the scholarly evidence on the

9 various issues, you know, first, looking at market

10 failure -- and I agree completely with Mike, it's an

11 excellent point, a point that is not made enough, that

12 too much of economists' orientation on market failure is

13 static inefficiencies, so price distortions and the

14 like, where so much of the big gains from policy

15 improvements are the dynamic ones, because that's the

16 counterfactual that you don't see.

17 So, if you look at what we've learned about

18 deregulation in terms of what regulation we're doing,

19 the big ticket effects were suppressing innovation,

20 right? So, there you get, you know, more than first

21 order effects. You get really big effects, you know,

22 shifts of cost curves as you completely change what

23 you're doing, shifts of demand curves where you provide

24 new products, okay? So, to the extent that a dominant

25 firm is working like a constrained regulatory policy,


1 you know, the effects can be big.

2 Now, that said, you know, measuring these things

3 are very difficult, and, you know, it's not clear to me

4 that we really have hard evidence on this kind of thing.

5 I think the anecdotes are informative, but it would be

6 nice if there was a really strong body of literature on

7 the dynamic effects of delayed innovation, so on and so

8 forth.

9 I would also add, though, just for balance, more

10 emphasis on the self-correcting nature of markets. All

11 the time you are listening to these firms, they are all

12 dinosaurs, right? Look what's happened to them all.

13 Mike mentioned U.S. Steel. Look what happened to them,

14 right? And it was foreign competition, the mini-mills,

15 right? I mean, look at the auto companies, you know,

16 look at Ford, GM, and it's amazing. You know, go on

17 down the line. Now, this does take time, but I think,

18 you know, it's important to keep in mind the

19 self-correcting nature of markets in all of this.

20 Along with that, then, is the parallel of

21 government failure. Now, there are parallels of all the

22 policies we're talking about. Antitrust is not made in

23 a vacuum. Everything that you're talking about

24 intersects a lot of major policies. Trade protection,

25 for example, right? You know, more often than not we


1 hear about, well, we need more competition in the

2 airline industry. Yes, let's allow cabin -- oh, no, we

3 are not going to do that. So, here you have trade

4 policy effectively working against what antitrust policy

5 is trying to do.

6 We talk about technology policy with no mention

7 of what happened in the early 1980s with the change in

8 the patent law, right? Patents are going up now,

9 lawsuits are going up now, you know, talk about, you

10 know, impact on innovation and technical changes, look

11 what's done in technology policy. That's not antitrust

12 policy, but it's the crazy patent system that we've got

13 now with, you know, the change in the '82 Act.

14 Regulatory policy, Luke's point was fair enough

15 about cable behavior, but again, it's a regulatory

16 policy that's facilitating that, you know, the whole

17 communications regulatory policy is screwed up. Again,

18 this is not antitrust's, you know, cross to bear, but to

19 some extent, it is. So, where you have a policy that is

20 constantly at cross-purposes with other areas of what

21 the Government is trying to do, it is going to make it

22 very difficult for you to figure out to do, but I might

23 add, the first best thing to do would be to have a

24 technology policy, regulatory policy and trade policy

25 that makes some sense, okay?


1 Government successes, you know, I think the key

2 thing on the government successes is almost more of the

3 learning rather than the status assessments. You know,

4 Standard Oil was interpreted as a success, and let me

5 just suggest that there is some controversy about that,

6 Bob Crandall and I head our exploration on antitrust

7 policy, and you know, our look at what the

8 counterfactual evidence was that, you know, there was

9 very little that we could see from changes in prices, if

10 one wanted to use that as a measure of welfare, and it

11 is certainly not a reasonable starting point for what

12 Standard Oil did.

13 I think the more attractive thing that I would

14 point to about antitrust is the learning just how one

15 thinks about problems in terms of anticompetitive --

16 what was initially thought of as sort of knee-jerk

17 anticompetitive reaction as to whether these things were

18 really efficiency-enhancing types of behavior and also

19 just the nature of dynamics, how things are changed, and

20 I think that's where antitrust policy has gone and is

21 certainly a lot better.

22 Now, the big thing about all of this and my

23 concern about this whole area is the effectiveness of

24 this evidence accumulated, because that's what you

25 really want. In certain areas, just to go to a


1 completely different area, you know, one's seen study

2 after study about congestion policy in this country,

3 every one of them, huge welfare losses, the Government

4 ought to have efficient pricing, and no one is really

5 disagreeing with that. There are obviously variations

6 from here to there, but the evidence really builds

7 beautifully, and you can just sort of drop it on

8 somebody's lap and say, okay, look, deal with this, and

9 it's easy to do that.

10 Here, it is quite hard. I mean, yes, there are

11 fragments of evidence, cases here and there, and as I

12 said, what Crandall and I attempted to do was actually

13 get a base case for a starting point of saying that

14 this -- and if you disagree with that, fair enough, but

15 at least build on that, reshape it, and then start

16 adding more, and frankly, the disappointment has been,

17 at least in the reaction to that paper, is, you know, I

18 could -- is predictable either pro or critical antitrust

19 people reacting to it, but in terms of actually new

20 evidence being added to the enterprise, that just

21 doesn't seem to be what idle people care about these

22 days, which leads to my third concern, where is the

23 empirical IO field going? And there was very little

24 mention of that here, and with good reason.

25 I mean, it is not clear where it is going in


1 relationship to your interest in what is going on here.

2 I mean, my sense, as I would say more of an observer

3 than a participant, that empirical IO is sort of trying

4 to get "uber" dynamic model of industry behavior, you

5 know, that's what we're looking for, for the -- what's

6 the word -- the Holy Grail, I guess that's because I saw

7 The Da Vinci Code on the plane. That's what we are

8 trying to do, and to the extent there's empirical work,

9 it's pretty much demonstration papers, right?

10 I mean, a lot of them are really pretty trivial,

11 you know, you can get data on it -- and I won't go into

12 examples, but you know what I'm talking about, and you

13 know, who cares? And they don't care. They just want

14 to show, yeah, I can get something estimated with some

15 generalized method of moments estimator and add some

16 structural stuff and something is going to get there,

17 and yeah, I'll talk about an industry, about some hotel

18 off a Nebraska highway, no one cares, but you know, the

19 results actually made sense.

20 The question is, where is this research going?

21 Now, I don't want to rule this out, because this is a

22 big ticket item. If people can succeed -- and this is I

23 think really the positive spin on it -- in really

24 building, you know, a structural dynamic model of an

25 evolution -- structural dynamic model of the evolution


1 of industry, to hell with these case studies. You have

2 got your tool, right? You just use this, run through

3 any policy scenario, and you could figure out, you know,

4 where things are going, what you ought to be doing, and

5 that is your guidance.

6 Well, you know, we've tried that with Keynesian

7 models (ph), we have tried that with rational

8 expectations, we have tried that with real business

9 cycles, you know, in a sense it's a parallel to macro

10 that we are really going to figure out in a big picture

11 way analytically how markets behave, industries behave,

12 and that will be your guidance for policy.

13 So, you know, that's where it's going. It's not

14 intersecting I think small case studies will build up,

15 it is not doing thing in terms of big picture facts,

16 even motivating what's going on, what people view to

17 within industry seems to be more the availability of

18 data and possible consistency with the analytics they

19 want to pursue.

20 All right, so, you know, where does that leave

21 us? Well, you know, there are three ways to go, and to

22 some extent you can pursue them simultaneously, you

23 know, you can think about first looking more what the IO

24 field is doing, the general model, that kind of work, or

25 I would say more constructively try to focus that kind


1 of work on the types of problems that you are interested

2 in.

3 The case evidence, I guess, you know, my concern

4 there is just whether it's accumulating, is it likely to

5 accumulate, because otherwise it won't be all that

6 helpful. You will continue to just have patches of

7 evidence that just don't seem to bind together to tell

8 you anything in general.

9 My interest is really going back to the first

10 one, which was abandoned, and probably for good reason,

11 is getting broad summary measures -- welfare measures of

12 industries, conservation measures is obviously one, and

13 work on quantifying the welfare loss from monopoly --

14 and that line of research obviously had its problems --

15 but there was a start of work I remember by Bobby

16 Willig, Dansby and Willig on trying to come up with

17 industry performance measures that I thought was

18 promising, but I think it went out very quickly as

19 people turned over to conduct, and so that work never

20 went anywhere.

21 But I think that it might be useful to think, at

22 least in some way, along those lines for this agency.

23 There are broad ways of gauging industry performance,

24 you know, is there really something systematically wrong

25 with what is going on with U.S. industry? Are we seeing


1 anything that is now, you know, sort of really

2 threatening a $13 trillion economy, or, okay, there are

3 some bad guys, we know that, every once in a while

4 certain things are going to go on, but the truth is

5 markets are self-correcting, the world is getting more

6 competitive all the time, you know, what do we have to

7 do?

8 I would not say at this point we're ready to say

9 where to go. I would just sort of step back and reflect

10 on various approaches and see what makes the most sense.

11 (Applause.)

12 MR. HEYER: Okay, we are about to take our

13 break. We are going to be joined afterwards, there will

14 be some remarks and discussion involving two of the

15 other panelists, Dave Reitman and Bob Marshall. I would

16 encourage people to think during the break about maybe

17 picking up a little bit on what Cliff ended with some

18 and other comments that were made about, say, the issue

19 of empirical anecdotes and what can be generalized from

20 them or not, should we be focusing more on case-by-case

21 analyses, or is there some kind of broader policy

22 guidance we can learn from the empirical work?

23 Anyway, let's take our break, and we will come

24 back -- what, 15 minutes?

25 COMMISSIONER KOVACIC: About 15 minutes.


1 MR. HEYER: Fifteen minutes, all right.

2 (A brief recess was taken.)

3 MR. HEYER: Okay, so let's resume.

4 The way we thought we would do it is Dave

5 Reitman and Bob Marshall are going to give short

6 presentations before we get into what hopefully will

7 begin with a round table discussion where maybe some of

8 the panelists and the discussants will comment on what

9 went on this morning and respond to one another,

10 elaborate on one another's comments, and then if we run

11 out of things to talk about, Bill and I will have a lot

12 of important questions as well.

13 So, we will begin with Dave Reitman. Usually

14 when people introduce others they say, "It's a pleasure

15 to introduce so and so," even if they don't know them

16 from a bar of soap. Dave is a pleasure for me to

17 introduce because I know him very well, and he is

18 relatively soft-spoken but incredibly talented

19 economist, and he has one other thing that makes him a

20 particularly valuable addition to this panel, I think,

21 is that unlike most of us who have done a lot of maybe

22 talking and thinking about some of the issues that are

23 raised by the topic, Dave has worked in the trenches on

24 them.

25 He was the Government's expert witness in U.S.


1 v. Dentsply and did an extraordinary amount of both

2 theoretical and empirical work on that case in the

3 course of testifying, and he also did a great deal of

4 empirical work in support of our experts in the American

5 Airlines case, which, sadly, never actually got to

6 trial, but I'd be interested in Dave's comments both

7 general and specific on these issues.

8 Dave?

9 DR. REITMAN: Thanks, Ken.

10 As Ken suggested, I just want to give a few

11 comments today as an antitrust practitioner about the

12 value of empirical tools, empirical work, in presenting

13 an antitrust case. It's really become clear listening

14 to the panel this morning that in doing a case, often we

15 are really talking about exceptions, that even if you're

16 convinced that exclusive dealing 90 percent of the time

17 or 99 percent of the time is beneficial, leads to lower

18 prices and some of the things Luke had in his slides,

19 still we're looking for the exceptions at the time when

20 it's used as a deterrent device or an exclusionary

21 device, and so the question is, what kinds of tools can

22 you bring to bear when you are looking at a specific

23 firm in a specific industry and a specific practice?

24 Again, as Ken said, my background, my tenure at

25 the DOJ, I was involved in two extremely lengthy


1 litigated Section 2 cases, and both of them involved a

2 fair bit of empirical work. American Airlines, I really

3 think there was a tremendous amount of empirical support

4 for a variety of elements of the case, and then

5 Dentsply, the Government ended up commissioning a survey

6 to try to measure some of the effects that were going on

7 in that market.

8 Now, if you look just at those two cases, you

9 have to say that neither of those was a great

10 testimonial as to the value of empirical work actually

11 going forward and presenting the case. In American, as

12 I said, there was all this empirical evidence brought to

13 bear, and yet the case never made it past the summary

14 judgment phase. In Dentsply, the survey was presented

15 and the analysis based on it was presented at the

16 District Court level. The District Court Judge threw

17 out the survey as being unreliable and decided against

18 the Government. Then the case was appealed to the Third

19 Circuit, which without the benefit of the empirical

20 evidence, was nevertheless able to reverse the decision

21 and decide in favor of the Government.

22 So, you might look at that and say, it doesn't

23 seem like the empirical evidence contributed much.

24 There are other cases along those lines that you could

25 point to in recent years where you would say it's not


1 clear that you really need to have the empirical pieces

2 in there. So, just to give one more example, if you

3 look at the LePage's case, where a lot of the

4 commentators looking at that have said, it really would

5 be nice if we had more evidence here, more data, so we

6 could decide between these competing theories on whether

7 this is procompetitive or anticompetitive. The

8 Solicitor General on the cert petition before the

9 Supreme Court really echoed the same things, we really

10 would just like more information, and yet the plaintiff

11 was able to present that case and win it without having

12 done the kinds of empirical things that the commentators

13 would have liked.

14 So, I'd like to just spend a few minutes looking

15 at the American case and the Dentsply case and talk

16 about what really is the value of going through and

17 doing the empirical exercise, and it may be just by the

18 magic of self-selection that in this room we're kind of

19 preaching to the choir, but nevertheless...

20 Let's start with the American Airlines case.

21 The airline industry is one where companies involved

22 collect a lot of data themselves and the Government

23 collects a lot of data. So, there's a tremendous amount

24 of data that's been a mainstay of the empirical IO

25 literature, and so it's only natural that a


1 monopolization case involving the airline industry would

2 have a lot of empirical work in it.

3 The Government's main expert in this case, Steve

4 Berry, is a preeminent empirical IO economist, and he

5 brought, as I said, empirical evidence on virtually

6 every point made, and a lot of that is not in the public

7 record, as there was no trial, but just to give a sense

8 of the scope of the empirical effort, you may recall

9 that what turned out to be the Government's main test

10 for predation when the case went up for appeal was what

11 was called Test 4, which suggests that there are at

12 least three and maybe a lot of other tests that

13 economists turn to to try to find the right way to take

14 the data and to sort it out and to say this is the right

15 way to classify what is predatory and what is not.

16 So, what, again, is the value of having that

17 empirical test for predation? And to answer that, let

18 me just go back a little bit farther in time. Not long

19 after I started at the Justice Department, Joel Klein

20 came aboard as Deputy Assistant Attorney General, and he

21 was making the rounds to the different sections to

22 introduce himself, and when he came to EAG, one thing I

23 remember from his presentation was he quoted from "The

24 Four Quartets" by T.S. Eliot, and he quoted, "We shall

25 not cease from exploration, and the end of all of our


1 exploring will be to arrive where we started and know

2 the place for the first time."

3 I actually have no idea at this point what

4 Joel's point was for quoting that, but it does seem to

5 apply nicely to the American case. The theory of what

6 happened, the basic story never changed from the very

7 beginning, before the complaint was filed, which was

8 American added a bunch of flights and routes where it

9 competed against low cost carriers and drove them out of

10 the market, but the understanding of the way that

11 mechanism worked, really why it worked and what it was,

12 really only evolved by really years of wrestling with

13 the data and trying to get a handle on what was going

14 on, and so the end, when we looked at sort of the final

15 presentations and the appellate memos, we said that the

16 Justice Department really seemed to know what they were

17 talking about and what they thought had happened, which

18 was that American Airlines was able to, by adding

19 flights, was able to take demand away from its competing

20 low-cost carriers in a way that it simply couldn't do by

21 lowering prices or by removing fare restrictions, but

22 the cost of that was to reduce load factors and push

23 American up to that increasing part of the marginal cost

24 curve to the point where the incremental cost of adding

25 these additional flights was above both the average cost


1 of serving the route as a whole and also the incremental

2 revenues received from the passengers.

3 So, there's a test that, you know, when you

4 arrive back at the place you started, you understand it,

5 and I certainly don't want this panel to start to brew

6 up a fight about whether that was a right theory or

7 whether there really was harm there. The only point is

8 that we really didn't understand what we were saying,

9 what we had, until that process of wrestling with the

10 data, really getting into it and being able to say, this

11 is the test, which at least for this company in this

12 industry in these markets is able to distinguish what

13 looks like predatory behavior from all the other routes

14 they had, which, you know, generated essentially no

15 false positives.

16 So, anyway, whether that's a legal analysis is

17 for the courts to decide, but that was the value of the

18 test there.

19 If we could turn to the Dentsply case, which is

20 sort of toward the other extreme in terms of the amount

21 of data available, this is a market where exclusive

22 dealing had been used for at least 15 years. Following

23 the kinds of things Luke was saying earlier, we looked

24 around for what we could use as a natural experiment,

25 and one thing that may be a potential was to compare the


1 policy in this country with other countries, but that

2 was ruled out fairly early on by the Court. So, we were

3 left with not a whole lot of empirical evidence to go

4 on.

5 To fill in the gap, what the Government

6 commissioned was a survey of dental labs, which are the

7 consumers of the dental teeth that were subject to

8 exclusive dealing, and among other things, the survey

9 asked respondents how they would choose among brands of

10 teeth given various prices and distribution

11 combinations, and so from those responses, you can then

12 map out demand, service, and estimate or quantify what

13 the anticompetitive effects were from the exclusive

14 dealing policy both in terms of pricing and in terms of

15 market shares, and that quantification was important.

16 Dentsply has been characterized by some as, you

17 know, as an easy case, or as in Luke's slide this

18 morning, it's one where the aggressive behavior was bad

19 in the proximate term and bad in the distant term,

20 right? But the only reason we're able to say it was bad

21 all around is because the District Court ruled that the

22 procompetitive explanation and justification that

23 Dentsply put forward was pretextual.

24 If you look at the case before the decision,

25 before the trial, before even the decision to bring the


1 case, it's not at all implausible that exclusive dealing

2 would have some advantages in aligning the incentives of

3 Dentsply with its dealers and that that would generate

4 some benefits. You may recall the particular mechanism

5 that Dentsply eventually put forward seemed to be

6 inconsistent with the facts, and so given how long

7 exclusive dealing had been in the market, it was tough

8 to be able to say how much competition would benefit by

9 removing the restrictions on dealers, or to say that the

10 benefit from eliminating competition or eliminating the

11 restriction would be larger than these amorphous

12 benefits from aligned incentives without some sort of

13 systematic study of customer preferences.

14 As it turned out in the case, of course, the

15 weighing -- it turned out -- it proved to be easy,

16 because we could sort of rule out procompetitive

17 benefits, but more generally, looking forward, there's

18 almost always going to be this kind of possible

19 trade-offs between the procompetitive and

20 anticompetitive story, and some quantification is vital

21 in determining that effect.

22 So, that leads to a third benefit of empirical

23 analysis in looking at these kinds of monopolist

24 practices, which is just in terms of lending conviction

25 about understanding what really happened or what we


1 think is happening in that particular market. We could

2 talk about this both in the context of American and

3 Dentsply, but I am going to stick to Dentsply, because

4 as Ken said, I was a testifying expert in this case, and

5 I suppose as a testifier, there is not a huge difference

6 between saying what could have been happening in a

7 market and what did happen. In both cases, the

8 disparate evidence you gather from different sources and

9 try to piece it together in unified whole, which gives

10 you the best plausible explanation of what was going on

11 in the market, but at least for me, it made a great deal

12 of difference in crossing over from could have happened

13 to it did happen to be able to actually see that effect

14 quantified in the survey data.

15 That is to say, my conviction that Dentsply's

16 dealer criterion had actually harmed competition was

17 crystallized just by being able to see it in the numbers

18 after analyzing the consumer preferences that came out

19 of the survey that had been commissioned, and it

20 crystallized it in a way that I wouldn't have been able

21 to achieve just by looking at documents and depositions

22 and all the other evidence, even though all of that

23 other stuff was consistent with the same conclusion.

24 Now, of course, the lessons we drew from the

25 survey were not uncontested and will never be


1 uncontested in this manner of case, and the level of

2 conviction didn't seem to make much difference to the

3 District Court, since they concluded that the survey

4 itself was unreliable, but I do have to believe that the

5 whole testimony was made stronger by having conviction

6 about key parts of it that were reinforced by the survey

7 and that empirical evidence contributed a great deal to

8 that sense of conviction.

9 So, that's really all I wanted to say as sort of

10 a little ode to the value of empirical research in these

11 cases. Hopefully, not a eulogy, I don't think it's a

12 eulogy, but there's value in knowing what you have,

13 value in having confidence in that, and then just being

14 able to quantify how much difference it makes in

15 competition, and those things are not always going to

16 carry the day, like they didn't in these two cases, but

17 they are nevertheless important to preserve for future

18 cases.

19 Thanks.

20 (Applause.)

21 COMMISSIONER KOVACIC: Thank you, David.

22 Our last presenter before we turn to a

23 discussion is Bob Marshall, who heads the economics

24 department at Penn State and co-directs ITS Center For

25 the Study of Auctions, Procurements and Competition


1 Policy. Bob's on leave this year. He's serving during

2 that time as a partner at Bates White.

3 Our interest in asking Bob to come today, again,

4 is related to a major strain of his own research. He

5 frequently has married both empirical work and theory, a

6 great deal of it dealing with auctions, procurement and

7 collusion. Bob's going to tell us a bit about lessons

8 that might be derived from that body of work for

9 dominant firm behavior.

10 Bob.

11 DR. MARSHALL: Thank you, Bill. If you got too

12 flowery, I knew that means you would be late with some

13 of the things you owe me as a co-author, so it's good to

14 hear that it didn't get out of hand. I am going to give

15 a brief overview and then I will get into some of the

16 slides.

17 So, I do a lot of thinking about cartels and

18 cartel behavior, so I understand Section 2 is not about

19 cartels, but a cartel is like, I would argue in many

20 cases, a single dominant firm, and cartels often go

21 beyond just the suppression of interfirm rivalry in

22 their actions. In fact, I am going to show you a number

23 of things where they go into behaviors that we would

24 think about as Section 2 violations. So, what we are

25 going to try to do here is tell a compelling story that


1 we can get some window into understanding Section 2

2 through the behavior of cartels, and hopefully there's

3 some additional tractability in terms of empirical

4 analysis that comes from that. So, that's the gist.

5 So, there's some fundamental difficulties of

6 Section 2 analysis. So, benchmarks are real important

7 in terms of doing analyses particularly of cartel

8 behavior. We like to think we have got a period of

9 time, for example, when firms are acting in a

10 noncollusive manner, and then we can look at this other

11 time period of alleged conduct to see what's going on.

12 With ongoing dominant firm behavior, that's often not

13 there, and that creates some difficulties with doing

14 Section 2 type analyses.

15 Then there's an issue of what is legal and what

16 is not for a dominant firm, and that usually doesn't

17 arise in the analysis of cartels. When a cartel

18 suppresses interfirm rivalry and then it goes off and

19 predates and then it goes off and engages in exclusive

20 dealing, no one calls us to say, "Well, I wonder if that

21 predation was really predation or if the exclusive

22 dealing was really exclusive dealing of an

23 anticompetitive nature." The fundamental premise that

24 cartels function under when they get together to

25 suppress interfirm rivalry is to suppress competition.


1 So, when they engage in these behaviors, it's somewhat

2 doubtful to think that they're thinking about some

3 social good that is not about suppressing competition.

4 So, I have already explained that we can think

5 of a cartel as being something like a single dominant

6 firm, and they can be highly heterogenous. Some are

7 struggling to maintain internal cohesion and stability.

8 Defections might be occurring; finding a mechanism that

9 works may be difficult. For others, those things might

10 be easy to attain and settle in very quickly. The

11 central goal is the elevation of prices and profits, but

12 then we see these other behaviors that start to merge,

13 and I will go through examples, predation, blocking of

14 entry, exclusive dealing, bundling, tying. Again, part

15 of cartel behavior.

16 So, there's some interesting empirical questions

17 that are immediately posing themselves here. Why do

18 some cartels engage in these Section 2 like violations

19 but others don't? And what's the advantage of looking

20 at this through the lens of cartels? Well, there is a

21 rich discovery record typically in place for some

22 cartels because they got busted, and because a lot of

23 them got busted, it means that we're able to look at

24 starting dates, ending dates, and we're able to say, Oh,

25 okay, so this is when the behavior began; this is when


1 it ended. This is when the antirivalry behavior began;

2 this is when it ended. This is when the monopolization

3 behavior began; this is when it ended.

4 Now, you may say, well, perhaps those things are

5 coincident and difficult to separate, the antirivalry

6 behavior and the Section 2 behavior. A lot of times

7 what we will see as we look through some of these cases

8 that I'll pose here is that the anti-rivalry behavior is

9 the first thing that happens. You have got to get that

10 set up first when there's running of a cartel. It's

11 then later, as the cartel reaches some maturity, that it

12 starts to investigate other sources of profit, and

13 that's where we get to the Section 2 violations.

14 I do this when I teach my "Economics and

15 Collusion" course at Penn State. These are Porter's

16 Five Forces. Now, in business school, this is basically

17 Business School 101, so let me explain why I put this

18 diagram up and what it is. These are the five forces of

19 competition that affect a firm's profits. So, this is

20 from Michael Porter's competitive strategy book.

21 In the middle of this diagram is interfirm

22 rivalry. For some reason I have been told not to refer

23 to that as the green zone, but in the green is the

24 interfirm rivalry, okay? So, this is whatever it may

25 be, differentiated product/price competition, whatever


1 this may be that's limiting profitability among the

2 competitors in the industry.

3 Now, what are these other four forces on the

4 perimeter? Well, at the top we have threat of new

5 entry; on the right, bargaining power of buyers; down

6 below, whether the goods produced by the firms in the

7 industry have substitutes or compliments; and on the

8 left, the bargaining power of suppliers. So, if we have

9 a lot of substitutability, we have a lot of entry

10 possibility, et cetera, well, profits are going to get

11 hurt by that, and if we don't have those things, profits

12 will be helped.

13 So, I would argue the following: Cartels at

14 their initiation work on the green zone, they are

15 limiting interfirm rivalry. That's the Section 1

16 violation. Once they get that nailed down, they then

17 often venture out into the blue zone. So, blue is

18 Section 2; green is Section 1. That's the way I view

19 that diagram.

20 So, I want to talk about some examples here, and

21 this is all based, by the way, on a co-authored paper

22 with my co-author Randy Heeb and Leslie Marks (ph),

23 who's at Duke University, and Randy is at the Bates

24 White office here. So, what are the examples of

25 monopolization behavior from recent cartel cases? So, I


1 am going to give you five cases, four listed here and I

2 will read another one, and that's not a recent one. I

3 had to go back to Stocking and Watkins and pick up

4 another example from there.

5 But let's start with citric acid. So, this is

6 vitamins in training is a way you could view citric

7 acid. The guy who ran citric acid was promoted to run

8 the vitamins cartel. So, this is an important cartel in

9 the history of Section 1 violations. And, of course,

10 what they're trying to do, these firms, is suppress

11 interfirm rivalry. This is a section from the European

12 Commission decision regarding what part of the action,

13 part of the conduct of the citric acid cartel. So, they

14 were very bothered by entry by Chinese manufacturers,

15 particularly into the European community, so those

16 customers who were buying from the Chinese were

17 targeted, and there were specific predation against the

18 Chinese targeted at those customers. They were going to

19 undercut those customers, and this list of customers was

20 referred to as the Serbian list, and then there was

21 frequent discussions that went on about how that

22 predation activity was progressing.

23 Now, when you read stuff like this in European

24 Commission decisions, it becomes very clear very quickly

25 it's not just about the suppression of rivalry amongst


1 themselves. Once they have got that nailed down, as

2 members of the cartel, they start to reach out into

3 other mechanisms that they could use to increase

4 profitability.

5 Carbon brushes, this is also a story about

6 predation, and I'll just go to the next slide quickly

7 and show you a particular example on German

8 reunification. There was an East German company, EKL,

9 and there was a pesky little noncartel firm, and so two

10 strategies were agreed. None of the members of the

11 cartel would supply any graphite to EKL, that's the

12 basic raw material in making a carbon brush, the block,

13 carbon block, and EKL would be denied any market share

14 by systematically undercutting it with all customers, so

15 that it would not be able to sell anywhere. EKL was

16 taken over by one of the cartel members in 1997. Again,

17 targeted predation at a noncartel firm.

18 Now, keep in mind, again, this is a cartel that

19 begins and ends. This predation begins in '92, well

20 predating the beginning of the cartel behavior. So, we

21 have got the antirivalry behavior, that gets

22 established, that gets set in place, then the

23 monopolization behavior begins, okay?

24 Then there is also things like standardization.

25 The cartel implements a ban on advertising, not to


1 advertise or participate in sales exhibitions.

2 In vitamins, agreed-upon elimination of

3 competitors, and in this case, we're buying out

4 competitors, Coors, that's the folks who make beer, and

5 we're -- the two major cartel members here, Roche and

6 BASF, are racking up the purchase price in proportion to

7 their market shares.

8 The European Commission goes on to talk about

9 the use of the bundling of the basic vitamins into

10 premixes as another mechanism by which the cartel

11 predated against downstream blenders, so you have to

12 look -- you have to understand a little bit of what

13 happens here.

14 Hogs and chickens and cattle get fed a premix of

15 vitamins, and there were groups in the marketplace who

16 would actually mix the vitamins together and sell the

17 premixes to be added to the feed, and so to eliminate

18 those pesky competitors in the downstream market, strong

19 actions were taken by Roche and BASF to drive them out.

20 The European Commission notes in particular, if

21 you go to the second bullet here, it says, "In

22 addition," referring to Roche and BASF, "they enjoyed

23 greater flexibility to structure prices, promotions and

24 discounts and had a much greater potential for tying."

25 Again, we are not talking about just the suppression of


1 interfirm rivalry here. We are well into Section 2

2 violations now.

3 Sorbates, we're talking here about -- this is

4 another European Commission decision -- the blocking of

5 entry to the marketplace. And then I went back and just

6 pulled something from Stocking and Watkins regarding

7 General Electric and the incandescent electric lamp

8 cartel. Together with other lamp manufacturers, it made

9 exclusive contracts with the manufacturers of

10 lamp-making machinery and in bulbs and tubing, binding

11 them to sell goods exclusively to General Electric and

12 the companies associated with it or to sell to competing

13 companies only at discriminatory prices. So, this is

14 part of the action of the cartel.

15 So, let me just as an aside say, standing issues

16 about cartels are confusion to me at this point.

17 Noncartel firms don't have standing because they are

18 always the beneficiaries of cartel behavior. That seems

19 a bit odd to me just an aside here given the fact that

20 these Section 2 violations are existing, well documented

21 in the record, with regard to the noncartel firms, but

22 that's just an aside.

23 I would just like to say that I think that this

24 is a rich avenue for potential empirical investigation,

25 again, because we have got clear benchmarks in place.


1 We can also get a clear look at the discovery record

2 associated with cartel behavior and start to see when

3 these kind of behaviors, the Section 2 violations, are

4 implemented by the cartels, look across industries,

5 cartels in different industries, and see who was doing

6 these kind of activities, which industries are not

7 engaged in those kind of activities.

8 I'm hopeful that this illuminates as a potential

9 or at least gets investigated as a potential some of

10 these ambiguities that have existed in the past with

11 just looking at single dominant firms as being the

12 source of data and empirical inference.


14 (Applause.)

15 COMMISSIONER KOVACIC: Before we have the more

16 open-ended discussion among all the panelists, I'd like

17 to give our first four presenters an opportunity simply

18 to comment on what took place or to add additional

19 thoughts that came to mind. Could I simply go through

20 the order again, go with Mike, Luke, Jon and Cliff?

21 Mike?

22 DR. SCHERER: Well, lots of things I found

23 stimulating, so I'll have to be very, very selective.

24 I think the thing that struck me most was

25 Cliff's distinction between the European Union and the


1 United States. There are two points I'd like to make

2 there. One is a puzzlement; one I think I understand.

3 It's been said by several of the panelists that

4 the European Union has been more aggressive in some

5 sense towards dominant firms. They have tended to

6 pursue an abuse of dominance standard, whereas our

7 approach has been mainly structural combined with some

8 elements of conduct.

9 On the other hand, the Europeans have been

10 severely limited because when they tried to go against

11 abuse, as in, for example, the Hoffmann-La Roche Valium

12 case and the Volkswagen case, they ran into big troubles

13 ascertaining what an abusively high price was or an

14 abusively high level of profits was, and in this sense,

15 they are going back to the caveats that Judge Taft

16 expressed in the Addyston Pipe case more than a century

17 ago, but I think there's something else going on.

18 I think the ghost of Friedrich Hayek haunts the

19 Europeans in the sense that Hayek argues that you simply

20 cannot tell what an abusive price is. The European

21 community ran into this squarely in Microsoft. They

22 were unwilling -- at least initially, they realized in

23 the end they had to -- but they were unwilling initially

24 to state the fees that Microsoft could command for

25 licenses to its intraoperability information. And even


1 more seriously, when they required the provision by

2 Microsoft of an unbundled version of Windows without the

3 media player, they allowed Microsoft to sell both

4 products at an identical price. The obvious thing to do

5 would have been to set a price differential, but they

6 refrained and have continued to refrain from doing this,

7 and therefore, virtually no one has taken the unbundled

8 version when you could get a more complete version.

9 The Europeans have a serious problem. When you

10 look at our past compulsory licensing cases, you see we

11 were much more willing to intervene and said, "Here's

12 the reasonable royalty that you can command."

13 Now, the other thing about the Europeans is

14 this: Beginning with a conference at Fontainebleau in

15 1965 and then the book by Jean-Jacques Servan-Schreiber

16 and then another conference in Germany in 1976, and God

17 knows what else, the Europeans have adopted the policy

18 of encouraging large dominant national champion

19 enterprises with the express purpose of competing with

20 the United States technologically. In most respects,

21 they have failed.

22 In most areas of modern technology, they have

23 lagged the United States, and partly I think because we,

24 on the one hand, following the sage advice of Chairman

25 Mao, have encouraged 100 flowers to bloom. The


1 Europeans have tried to cultivate their national

2 champions, and they just didn't have the diversity

3 required to achieve technological innovations. The big

4 exception was in a couple of high-scale economy

5 industries. One is the provision of nuclear power

6 plants, and the other is the provision of aircraft,

7 although they are having trouble there now, too, but for

8 a while, Airbus was doing very, very well.

9 I think there really are important lessons to be

10 learned here, and they need to be studied much more

11 carefully than they have been thus far.

12 A point that Luke made, and I think Bill Kovacic

13 made it, too, and it is very, very important, that we

14 should be doing follow-up studies on areas in which we

15 have intervened. We did this, among others, in Xerox.

16 The FTC specifically commissioned a study by Tim

17 Bresnahan of the results of the Xerox case, which found

18 that it had been quite beneficial. Xerox did its own

19 study by David Kearns in a book entitled Prophets in the

20 Dark. It found that the entry of Japanese competition,

21 which was facilitated by the FTC intervention, had a

22 remarkably salutary effect on prices, reliability and

23 technical change in the copying machine industry.

24 Let me end with one footnote on the marginal

25 paper, vitamins. I happened to be a consultant for


1 Eisai in the vitamin E case. One should not look into

2 these things without taking into account international

3 trade rules and how they shape the framework within

4 which international agreements appear. Specifically, in

5 the case of Eisai, Eisai was a newcomer to the vitamin E

6 market. They began entering the U.S. and European

7 markets, and the chairman of Eisai was called into a

8 meeting by the head of Hoffmann-La Roche's vitamins

9 operation and was told, I quote exactly, "If you yellow

10 bastards don't join our cartel, we will drive you out of

11 both the U.S. market and the European market with

12 antidumping suits."

13 What happened after then is very complex, but

14 there remains in my mind at least a puzzle. I couldn't

15 find any change in Eisai's pricing behavior after they

16 allegedly joined the cartel. The one thing observable

17 that changed is that they began shipping more of their

18 output to China and they began dumping their excess

19 output in China. Why, I don't know, whether it was

20 because China was growing rapidly or that was a cartel

21 facilitating device, I do not know. There are

22 interesting stories here to be explored.

23 Thank you.


25 Luke?


1 DR. FROEB: Thanks. I just want to say a couple

2 of things.

3 First of all, to talk about Jon Baker comments

4 about how to balance the good proximate effects against

5 the bad distant ones, and there's two ways to do that,

6 you know, empirically or use some kind of model,

7 theoretical model that helps you do that, and if you

8 kind of contrast the way we balance horizontal, you

9 know, efficiencies against unilateral effects, we have

10 well-developed models that allow us to make the

11 trade-off. I just don't know of any well-developed

12 models that would allow us to make those kinds of

13 trade-offs, and furthermore, if we held our prosecutions

14 of these Section 2 cases to the same levels or same

15 standards that we did our merger cases, I mean, I think

16 it would be very difficult to bring good cases in those

17 instances.

18 I want to talk a little bit about what Cliff

19 Winston said about where is the empirical literature

20 going. In economics, young IO economists demonstrate

21 their technological expertise by building structural

22 models and, you know, trying to estimate them, and they

23 ignore, you know, trying to figure out, well, what's the

24 effect of things like Wal-Mart entry, you know, what is

25 Wal-Mart doing or what -- doing follow-up studies,


1 because they seem so pedestrian, yeah, anybody can do

2 that, you know, you just have to gather the evidence

3 and, you know, control for competing factors, and so

4 there's a natural bias in the economics literature

5 favoring, you know, structural technical modeling, even

6 when it's not appropriate, and we see that a lot. I

7 think that is one reason for the dearth of good

8 empirical evidence in industrial organization, because

9 we have this fetish almost with structural modeling.

10 I want to agree with what Cliff Winston said

11 also about the real problem is, you know, empirically,

12 you know, antitrust cleaning up trade, regulatory or

13 lousy patent policy. I mean, when you look at the

14 recent acts at the FTC bringing a lot of cases that

15 wouldn't exist but for the people abusing the patent

16 system, or I remember when I was back at the DOJ, we

17 challenged a merger between Westinghouse and GE in

18 electrical generators because Toshiba was out of the

19 market because they had been selling machine equipment

20 to the Russians to make submarines, so the Commerce

21 Department said, "Hey, you can't bid on electrical

22 generators in the United States," and that, you know,

23 would have made the merger okay, but, you know, we

24 blocked the merger because they were out of the market.

25 I want to note that Dave Reitman's Dentsply


1 case, he was able to estimate the proximate effect. He

2 wasn't able to estimate the distant effect, which wasn't

3 an issue in the trial because the judge said, "Hey,

4 there's no possible, you know, beneficial effect of

5 these exclusionary practices," but he was able to

6 estimate the proximate effect, not the distant one, and

7 I think the real challenge empirically is on these

8 distant effects, these indirect strategic effects.

9 I think that's all I want to say, and -- well, I

10 guess I would say to Bob, when you see these vertical

11 restraints in these cartels, I mean, suppose I form a

12 cartel upstream and I buy some downstream or put the

13 downstream guys out of business or refuse to deal with

14 them, I mean, there are certainly procompetitive

15 justifications for that given that you have a cartel.


17 DR. MULLIN: I would like to pick up on this

18 interplay between economic research, whether done at the

19 university or a think tank, and antitrust practice. So,

20 I've neither done any antitrust cases nor have I

21 estimated a discrete choice demand system. However, I

22 guess you can imagine talking about developing clinical

23 facts, which a judge or even an antitrust enforcement

24 agency might think are too bound up in the particular

25 circumstances to really be admissible.


1 I mean, if you said, okay, here are three or

2 four or five not tools but three or four or five, you

3 know, examples favors saying there's predation, is that

4 going to mean that the American case doesn't survive a

5 summary judgment? I don't know. I would be doubtful.

6 The argument I guess in favor of some sort of

7 methodology, right, is that, yeah, if the tool works,

8 then you can use it in lots of arenas. Operating very

9 quickly, so it's not a Section 2 example, but my sense

10 is that a lot of mergers involve firms that produce

11 differentiated products. The state of the art circa

12 1975 on estimating those models was not great. Berry

13 Levinsohn Pakes (BLP) offered a big methodological

14 improvement. Previously, the profession knew there were

15 problems with the standard approach. We just kicked it

16 under the rug and BLP took on a very difficult problem.

17 So, from their papers you can say, okay, well, I don't

18 just know something more about the automobile industry,

19 I can use this in other settings.

20 I guess the question that I have heard others

21 raise in other contexts in terms of the way the

22 industrial organization field has gone in certain

23 universities is whether -- maybe we did need to make

24 progress on the demand side and now have a better sense

25 of how to estimate demand, but we're industrial


1 organization economists. We study also the supply side,

2 at least at this point in the development of the

3 literature, it cannot yet say okay, here are some tools

4 in terms of supply that would allow you to make these

5 sort of counterfactual predictions. For example, if

6 this particular exclusive dealing isn't available, this

7 is how the market will change and this is how firms will

8 operate differently, which is a real cost of pursuing

9 models on motels in Nebraska or something like that.


11 Jon?

12 DR. BAKER: Thanks, Bill, a couple quick things.

13 First of all, I need to be a law professor for a

14 moment. When Bob Marshall talked about Section 1 and

15 Section 2, what he really is saying is a distinction

16 between conduct that's collusive and exclusionary.

17 Probably you would attack all of that conduct in the

18 context of the cartel cases that Bob was referring to.

19 The exclusionary conduct, you would probably attack it

20 under Section 1 of the Sherman Act, not Section 2. But

21 when we're talking about monopolization under Sherman

22 Act Section 2, typically the conduct is exclusionary,

23 and so that's why Bob thinks it's instructive to look at

24 the exclusionary conduct for the cartels.

25 I actually think there's a close connection


1 between exclusionary conduct and collusive conduct,

2 because you can think of exclusionary conduct as

3 creating an involuntary cartel or a coerced cartel.

4 Think about it this way: The dominant firm would like

5 to collude with a fringe rival, a prospective entrant or

6 whatever, but the rival doesn't go along, so the

7 dominant firm has to force the fringe rival or

8 prospective entrant to compete less aggressively, cut

9 back on output, not expand, whatever it would require,

10 and it does that with a panoply of exclusionary

11 techniques, raising rivals' costs, reducing their access

12 to the market or whatever, and the result is that

13 industry output falls below the competitive level, not

14 by voluntary agreement among the firms the way a cartel

15 would, but essentially by coercing the maverick. It's

16 an involuntary cartel; that is how I like to think of

17 it. So, they are closely connected.

18 My other comment on the conversation we have had

19 here, have had today, is about the problems of assessing

20 the "but-for" world. That was brought up I think by

21 several people here, Bob and Wally and Mike I think all

22 alluded to it, and probably everyone else did, too. To

23 make this concrete, I started to think about the Intel

24 case that the FTC brought in 1998, which was when I was

25 bureau director. It was settled in 1999 I think after I


1 had left, and it's the case that Mike was referring to

2 where he was going to be the witness for the Federal

3 Trade Commission.

4 The basic idea was that Intel refused to deal

5 with certain customers, cutting off their access to

6 technical information about upcoming new microprocessor

7 products that the customers needed if they were going to

8 be able to design complimentary products like personal

9 computers, and they did all this as a way of coercing

10 the licensees -- or, I'm sorry -- yes, getting the

11 rivals to license their microprocessor technology to

12 Intel. That was the story that the Commission told, and

13 the rivals included Digital Equipment Corporation or

14 DEC, Intergraph and Compaq.

15 So, Intel was trying to get leverage in

16 unrelated commercial disputes involving the scope of

17 competing intellectual property rights. The theory of

18 the case was that what Intel did to cut off these

19 customers from the technical information diminished the

20 incentives of those three Intel customers, as well as

21 all sorts of other firms that are similarly situated,

22 whether they are Intel customers or they are otherwise

23 dependent on Intel, to develop new innovations relating

24 to microprocessor technology.

25 Just to give Intel's side of the story, they


1 defended by saying that the conduct alleged in the

2 complaint didn't diminish the incentive of any firm to

3 develop new innovations of any kind. So, that was the

4 dispute.

5 The case was settled with an agreement that

6 prohibited Intel from -- I wrote it down here --

7 impeding, altering, suspending, withdrawing, withholding

8 or refusing to provide access by any microprocessor

9 customer to -- oh, dear, I don't know what I wrote down

10 here -- some sort of information for reasons related to

11 intellectual property dispute with such customer -- et

12 cetera -- or basing any supply decisions for

13 general-purpose microprocessors upon the existence of an

14 intellectual property dispute.

15 So, the question is, all right, this case

16 against a big firm, it was technically a Section 5 case,

17 but it was basically a monopolization case, how do you

18 tell whether the consent made any difference? That's

19 the question I am trying to set up. The theory would

20 have to be that this consent encouraged rivals to

21 innovate in ways to take on Intel, and before they

22 didn't have the incentive to do that, and maybe that

23 makes sense.

24 I think that the kind of markets you're talking

25 about are winner-takes-most generally, and it's hard to


1 believe that Intel wouldn't keep innovating in those

2 markets even if you did something to make it easier for

3 the rivals to innovate, too.

4 But how do you prove or disprove that theory?

5 We know that AMD, a key rival, has been successful in

6 the last couple of years, but that doesn't settle the

7 issue. What we have to do is somehow construct a "but-

8 for" world and figure out how AMD would have done there.

9 We don't know whether AMD's success has anything to do

10 with this consent or not just from what I've recited as

11 the facts.

12 I guess what I am driven to, I'm not sure what

13 we would do. I think the best we could practically do

14 is probably use Section 6(b) of the Federal Trade

15 Commission Act to review the R&D plans and the marketing

16 plans of Intel and AMD and the other firms before and

17 after the case, assuming all the documents are still

18 available, and depose key executives and see if Intel

19 and its rivals changed their strategies -- we could

20 probably find that out -- changed how they thought about

21 innovation, the kind of innovation they went after, what

22 they would do with them and the like.

23 The point of this exercise is that it shows how

24 hard it is to construct the "but-for" world in any

25 actual case in order to either figure out the violation


1 in the first place, which was the point of some of my

2 colleagues here, or to evaluate how well we did in

3 bringing the case and remedying it.

4 I don't view this as a reason not to bring

5 cases, by the way, but I know that some people do.

6 That's my comment.

7 Go ahead, Cliff.

8 DR. WINSTON: Just two brief things, and let me

9 sort of shape them more toward ultimately, what advice

10 do we give Bill and Ken? Presumably at the end, they

11 will say, what should we do to make sense of all of

12 this?

13 You know, my comment on -- really about the

14 method -- the IO methodology is just more of a caution

15 about the difficulty of just focusing on, you know, can

16 we pull studies together and amass, you know, a core of

17 useful knowledge that way, and my caution was really

18 historical.

19 If we turn the pages back to the sixties, the

20 leading empirical enterprise of the day was basically

21 concentration and profit progression. I mean, there are

22 scores of those, and along with that was the policy

23 issue of, you know, should we have a deconcentration

24 policy in America as the focus for antitrust? And, you

25 know, these studies evolved certainly from, you know,


1 noneconometric approaches, contingency tables and the

2 like, to more sophisticated econometric approaches, but

3 ultimately the enterprise basically collapsed, obviously

4 concerns of heterogeneity and concerns that, in the end,

5 the concentrated industry is the good one, this is a

6 good thing we should be having, and there's just none of

7 that around at all, and no one even sort of looks at

8 that for much guidance.

9 Dick Schmalensee I remember in The Handbook of

10 IO tried to summarize that and offered, you know, 20

11 stylized facts that sort of stretches what you get out

12 of it, and I'm concerned that, you know, in the sense

13 the empirical IO we have got today may go in the same

14 way for a somewhat different reason, but ultimately,

15 there is a somewhat destructive nature of the

16 enterprise. It's extremely competitive, and it's

17 extremely easy to raise the stakes at every -- you'd be

18 surprised.

19 I mean, you know, at this point I would say BLP

20 has done a brilliant job of market share capturing,

21 nothing short of brilliant, among the best I have ever

22 seen of intellectual importers, and people think

23 naturally of, well, they have a nice demand system and

24 so on and so forth, but I think you will see, as certain

25 other papers come out, there are real cracks in even


1 what they've got, you know, for every model for which

2 you want to try to capture heterogeneity, you can point

3 out why there are problems in the way they are doing it,

4 and so almost every study can be replied with that as

5 the methodology pushes harder and harder and harder and

6 excludes more and more people and almost makes it

7 virtually impossible to understand for a lot of people

8 in practice.

9 I'm just wondering where all of this ultimately

10 is going to go and thinking, well, we can use this

11 still, you know, the simplest thing is in courts, but we

12 can't, because obviously the other side is going to come

13 back and use more technical things and just smash what

14 you do, and so I am concerned about ultimately where all

15 this stuff is going to converge in a constructive way.

16 You know, that said, then, you know, what then

17 would I say to emphasize? And I think this has been

18 touched on, but maybe not enough, and that is the

19 deterrence aspects of antitrust policy. I mean,

20 sometimes, you know, I am interpreted or at least my

21 paper with Crandall was interpreted saying we ought to

22 abolish antitrust intervention, and that's ridiculous,

23 we never said it, and I certainly don't believe it, but

24 the importance really of antitrust is in deterrence,

25 and, of course, that's your success story, but it's also


1 the most important and difficult thing to quantify.

2 So, the challenge, I would suggest, at this

3 point, where you could get help but certainly it's a

4 challenge at this point, is trying to find the areas

5 where there is evidence that we are clearly deterring

6 other areas, but what for going after Microsoft, who

7 would have known, all right, regardless of what people

8 think on that case, you know, other things that may be

9 done, and that may ultimately be the strength that a lot

10 of people think of antitrust and certainly the thing

11 that also needs to be emphasized and systematized, but

12 at this point, obviously, that's eluded our ability to

13 do that kind of thing.

14 MR. HEYER: Well, I want to give at least -- if

15 Dave and Bob want to say a couple of words. Otherwise,

16 we can throw out some very insightful, stimulating

17 questions.

18 DR. REITMAN: Well, we could end up looping

19 quite a bit here if we go round and round, but --

20 DR. MARSHALL: Fire away.

21 DR. REITMAN: Yeah.

22 MR. HEYER: Well, you guys can respond first

23 maybe.

24 I had one question I alluded to at the end of

25 the morning session that I wondered if everyone could


1 comment on, sort of a general question about the value

2 of individual anecdotes and studies, a number of which

3 have already been discussed, as compared with or maybe

4 related to what Cliff had referred to as the Holy Grail

5 and what I know Luke, some of his work has suggested is

6 broad policy guidance.

7 I mean, to what extent do folks think we are

8 able to learn enough from individual studies to base

9 policy and priors on versus doing what, say, serious

10 case-by-case analyses in determining the effects on an

11 "as it comes in the door" kind of basis?

12 Anyone? Professor Scherer? Luke?

13 DR. FROEB: I think that the broad aggregate

14 studies suffer from, you know, aggregation bias, and

15 it's very difficult to draw inference from the large

16 down to the small. I think it's much easier to go from

17 the small to the large. And the studies that we've been

18 doing at the FTC have shown that, say, for example, when

19 you're using census data and industry-level studies,

20 you're missing a whole lot that's going on at the

21 individual level, and I think you ultimately learn a lot

22 more by going as narrow and as case-specific as

23 possible.


25 DR. SCHERER: I somewhat disagree. What's the


1 value of anecdotes? As Zui Griliches used to say, "The

2 plural of anecdote is data." The humor of that escaped

3 you.

4 DR. WINSTON: Wasn't it Stigler who said it?

5 DR. SCHERER: Maybe he learned it from Stigler,

6 I don't know.

7 In any event, you have got to do all this stuff.

8 You have got to do case studies. You have got to do

9 data. You have got to integrate all the case studies.

10 All of these things need to be done in order to get

11 something like generalized knowledge.

12 Well, I guess that's all I'll say on that.

13 MR. HEYER: Jon?

14 DR. BAKER: Well, my reaction to this and to

15 some of the other comments here is that I think the

16 economics literature has been a little bit -- I have a

17 different perspective, shall I say, on the development

18 of empirical IO, which is that one of the big movements

19 has been away from cross-industry studies, which have

20 all sorts of problems that people here have described,

21 to individual industry studies, where you can learn

22 about -- which effectively control for lots of the

23 differences across the industries. There's been a lot

24 of learning about individual industries.

25 I'm just thinking of all the studies in Tim


1 Bresnahan's IO Handbook chapter, Peter Reiss and Frank

2 Wolak have a recent chapter that surveys a bunch of

3 studies, too, and there is just a wealth of knowledge

4 that -- the unit of observation in empirical IO has

5 shifted from the economy as a whole, across all

6 industries, to individual industries, and we've learned

7 a lot. Even when those structure-conduct-performance

8 studies are still done, they are all done largely on

9 related industries, as with the Leonard Weiss book I'm

10 thinking of from a while back.

11 You can use what you learn about individual

12 industries too, as I was saying before, to create

13 presumptions about related industries that you can argue

14 about what you know about retailing from retailing

15 industries and how it works. I'm thinking of Dean

16 Schmalensee's testimony in Microsoft. He was talking

17 about how software markets have certain kinds of

18 competition generally and that that observation probably

19 applies to operating systems. Then the Government comes

20 back and says, well, maybe that's an exception. The

21 presumption frames the analysis appropriately.

22 So, there's a lot you can do with individual

23 industry studies to learn about related industries that

24 I think we're undervaluing here.



1 DR. REITMAN: I just want to add that I think

2 you have to recognize that Section 2 cases are just

3 distinct from other kinds of antitrust cases in how

4 unique the behaviors are from case to case. So, it's

5 hard to generalize from, for example, our merger

6 analysis, which has benefited greatly from being able to

7 go back and forth between cases and theory and getting a

8 body of theory, which can then identify the cases and

9 the time.

10 There is so much individuality to any particular

11 set of bundled discounts, where a particular mechanism

12 that a firm predates, it's hard to see that even

13 generalizing from case studies or whatever is going to

14 add a whole lot to the analysis of a particular case,

15 even if it's necessary to some extent for the law. As

16 far as the analysis goes of what's going on in a

17 particular industry, I'm not sure how you can use that

18 very well.

19 COMMISSIONER KOVACIC: David, if I could follow

20 up on that, as you reflect on your experience with the

21 two cases you discussed, and if you were looking ahead

22 to try to extract more general observations from those,

23 is there something about an investigative methodology or

24 an analytical approach that you might derive from those

25 experiences?


1 Suppose you were thinking at the time you left

2 the Division about how to leave behind or to make more

3 concrete know-how that you had extracted from your

4 experience analyzing the cases and as a potential

5 testifying expert. Are there specific lessons that you

6 would have derived from those that you think would have

7 informed the analysis that you would use in future

8 cases?

9 DR. REITMAN: Well, the clear one I think is

10 from the Dentsply case, that the survey that we did

11 there seems to be fairly rare, at least on this side of

12 the Atlantic, although if you go across to England and

13 Europe, it seems like it's fairly routine as part of a

14 gathering of consumer information to do it

15 systematically through a survey, and the survey really

16 is just that, it's -- instead of interviewing a bunch of

17 customers, it's a way of systematically getting a

18 representative sample and asking the same sorts of

19 questions in a way which could be quantitatively

20 analyzed, and so I think that technique was helpful in

21 Dentsply. It could be helpful in a lot of

22 monopolization cases.

23 COMMISSIONER KOVACIC: Do you have an impression

24 about the arena in which, in many ways, so much of the

25 information we're talking about ultimately has to be


1 applied? Was the decision of the trial court simply to

2 reject the empirical study that had been done? Is that

3 just an outlier that we're going to encounter when we

4 bring cases? Or is there something to be learned there

5 about how to present evidence in a way that ensures that

6 it doesn't simply die at the doorstep of a preliminary

7 motion but makes its way into the resolution of the

8 case?

9 MR. HEYER: Objection, calls for a legal

10 conclusion.

11 DR. REITMAN: There are certainly things to be

12 learned there about how to actually conduct the survey

13 in order to be able to get through the hurdles of

14 reliability that the Court needs and rightly should

15 require. I don't think the analysis in the Court, at

16 least in Dentsply, really went beyond that, and so I'm

17 not sure what further lessons, but I do think you can

18 get over that hurdle. There may be additional hurdles

19 in terms of different sides looking at the same evidence

20 and, you know, making different conclusions from it and

21 the Court trying to figure out what to do with it and

22 such that we will have to wrestle with later, but the

23 first hurdle in terms of getting things admissible I

24 think you can overcome.

25 DR. WINSTON: I would just -- one thing, and you


1 can probably enlighten me on it, the whole discussion is

2 sort of taking place in a political vacuum, you know,

3 it's like antitrust policy proceeds, you know, that we

4 do the analysis right, find out what's going on and

5 bring the case. I mean, obviously all this proceeds

6 with a lot of political constraints and, you know,

7 within your department, you know, how you want to frame

8 the case, the kind of people you want to bring in, the

9 cases you want to go after.

10 I mean, I think all the things that Mike was

11 saying I agree with completely, that you want to draw on

12 as much evidence as possible, different sources,

13 different people, but all of this is constrained by just

14 political forces within and outside your agencies, and,

15 you know, how you grapple with that ultimately may be as

16 important as any of the analytical things that you

17 solve.

18 MR. HEYER: Do you want to take this one?

19 COMMISSIONER KOVACIC: What forces would those

20 be?

21 One reason that the FTC's anniversaries are

22 interesting to me is that my own appointment is tied to

23 the 26th of September. As the sands go through the

24 glass, I have five years before the appointment comes to

25 an end. So, one question for me, given that I have


1 perhaps a bit more influence in how decisions get made,

2 is how the agency should invest its resources. One

3 possibility that Mike referred to before, and it's

4 implicit in the comments that all of you have made, is

5 that one way to begin to use empirical methods to assess

6 the appropriate course in future policy making is to

7 examine past decisions to enforce or not to enforce.

8 As Mike said before, my first assignment at the

9 FTC in 1979 was to work with a young Assistant

10 Professor, Tim Bresnahan, in the formulation of the

11 Xerox study. I think in principle that any institution

12 ought to go back and look at completed matters, and for

13 purposes of some public discussion and revelation,

14 should make the results of that process available.

15 That's clearly a sensitive matter and I suppose

16 political in this sense: How do you develop a norm or a

17 standard that encourages ex post review in a way that

18 does not raise suspicions that you're picking topics for

19 study or examination simply to show up your predecessors

20 or in some way to reinforce a predilection or set of

21 preferences that you brought to the process?

22 I think we could agree generally that there are

23 tremendous methodological challenges in doing such

24 studies well. I don't put those aside as being

25 insignificant by any means. There would be a difficulty


1 in implementation.

2 My own preference would be that you would try to

3 develop an internal norm that puts money in the budget

4 every year to do that kind of work -- that is, that some

5 of it be done every year, that there be an expectation

6 such that outside observers would ask every year. "What

7 matters are you going to look at this year? Which

8 projects are you going to launch this year?"

9 Second -- you can't model this in a formal way,

10 this is simply a matter of leadership and choice --

11 incumbent leadership would be willing to pick matters

12 that could be sensitive to them. For myself, if I were

13 to pick mergers, I would be quite happy to see in the

14 relatively near future (that is, during my time here),

15 an examination of the cruise lines decision. I was

16 general counsel here when that transaction took place.

17 The FTC and three other jurisdictions studied the cruise

18 lines merger. I'd like to see if we got the answer

19 right. I'd also be interested in taking other matters

20 where we intervened and failed, Arch Coal being one.

21 I'd also like to take up the possibility that Jon

22 mentioned, that is at least with respect to the case

23 study component of matters, that there always be an FTC

24 6(b) matter in progress; that is, that it always be part

25 of the research agenda, perhaps with the possibility,


1 again, of using it to examine somewhat more

2 microscopically matters in which the agency intervened

3 and did not intervene.

4 To do that in a way that creates confidence that

5 it is being done in a technically acceptable and

6 even-handed manner requires a great deal of political

7 skill and judgment. One needs to make sure that the

8 evaluation process is perceived internally and

9 externally as being a neutral, truth-seeking exercise

10 rather than in some sense as a political exercise.

11 That's one thing an agency can commit itself to do.

12 The further question would be, what's the right

13 forum? Should something be done intramurally? Should

14 these be partnerships with academic institutions, or

15 think tanks, such as the AEI-Brookings Joint Center on

16 Regulation? Should it be done with specific centers of

17 research within the university community? What are, in

18 the language of international relationships, the

19 modalities for doing this kind of work? How it should

20 be conducted is another issue. To do it well and in a

21 way that would be regarded as a neutral, truth-seeking

22 exercise, as opposed to simply an effort to vindicate

23 one's own judgments or to discredit the judgments of

24 one's predecessors is politically a very delicate

25 matter. It would also be a politically delicate matter


1 to take one other matter we have mentioned here that's

2 of keen interest to me -- to look at the question of how

3 the antidumping system serves as the punishment

4 mechanism for cartel coordination. To even begin to put

5 a toe in the water in that kind of research work would

6 require a great deal of care to see how warm the water

7 was and to decide in what part of the pool you are going

8 to step in first. As a general matter, I can't help but

9 think that it's impossible to look at the question of

10 cartel coordination at home and abroad without

11 accounting for that.

12 DR. FROEB: Based on the kind of studies we did,

13 you can't learn something from every follow-up study,

14 and I think it's really important to be opportunistic,

15 and I think Mike made a study of the Appellate Court

16 decision overturning the must carry laws provided a

17 really nice natural experiment where we could learn

18 something, and being opportunistic on something like

19 that, it takes a lot of judgment about are we going to

20 be able to learn anything from this? We've talked about

21 the difficulties of counterfactuals, and I think you

22 have got to be very careful about that.

23 MR. HEYER: Let me raise another question for

24 folks to talk about that was touched on earlier,

25 particularly Professor Scherer got into it when talking


1 about innovation and dominant firms.

2 In trying empirically to get at some of this

3 stuff, the effects of remedies, the performance of

4 dominant firms, I was wondering if there's anything we

5 can usefully do empirically having to do with more

6 long-run issues, incentive issues for firms to become

7 dominant or for firms to be acquired by dominant firms,

8 perhaps? I think Professor Scherer had suggested

9 that -- seemed to suggest, at least, and maybe I'm

10 reading it wrong -- that maybe the harms from

11 constraining some of the larger firms, at least in the

12 innovation arena, might not be too great, might be worth

13 it, you could get short-run benefits, long-run maybe as

14 well, but we can't tell.

15 I'm wondering if we know anything about long-run

16 effects, whether anything empirically can be done in

17 that area.

18 DR. WINSTON: Well, there, whatever you do, you

19 are going to have to interface the patent system just in

20 general with technology policy in this country. In

21 other words, you know, what you first want to start with

22 is, you know, just positive economics, you know, how is

23 it -- we understand innovation, which is obviously very

24 important and a very difficult thing to do, and layered

25 on top of that is going to be, you know, technology


1 policy, and just it does have an influence on that.

2 So, you know, whatever you are going ahead with,

3 you just want to caution yourself that your answers are

4 going to be shaped to a large extent by the

5 institutional environment that exists in this country.

6 DR. SCHERER: It should be done. It is really

7 hard. Obviously the longer time frame you deal with,

8 the more historical artifacts you have to factor in. I

9 think the way you get around that is to look at a broad

10 array of cases and try to see how did it work in one

11 case and not work in another case.

12 A really interesting one to study, I do not

13 think it has been studied, is the United Shoe Machinery

14 case. United was dominant in inventing and developing

15 shoe machinery, but Judge Wyzanski found them guilty of

16 monopolization around about 1955 or so. I happened to

17 interview them in a quite unrelated context in 1958, and

18 they said this was a case where we really had the wrong

19 policy. Wyzanski said I'm not going to break them up

20 now, and there were good reasons for not breaking them

21 up, but I am going to leave the Sword of Damocles

22 hanging over their heads. We will come back five years

23 from now and see whether they ought to be divested.

24 And so here's USM sitting there with this

25 possible divestment if they don't get their market


1 shares down in the future. So what did I find in 1958?

2 They were saying, we're not putting our R&D into shoe

3 machinery. We're putting it into diversification

4 activities. And what then happened -- and again, it's a

5 big fast-forward -- what happened eventually was that

6 they became noncompetitive in the shoe machinery

7 business. Italian firms, maybe they would have done so

8 anyway, Italian firms became the leading suppliers of

9 shoe machinery in the world, and United Shoe Machinery

10 gradually just declined to nothingness.

11 We ought to be studying cases where we clearly

12 failed as well as cases where we think we might have

13 succeeded.

14 DR. MULLIN: And this doesn't give a specific

15 methodology, but some insight might actually come from

16 the kind of, you know, cross-industry comparison or at

17 least looking at the experience of other industries,

18 even ones in which we don't think there's some problems

19 with competition. So, for example, you know, Scott

20 Stern and Josh Gans have a series of papers about

21 basically licensing in biotech, as they say, licensing

22 the gale of creative destruction. Before you look at

23 the data, you might think, oh, they are these small

24 people, they are going to come up with something that's

25 going to leapfrog Lilly or something like that, a Lilly


1 product, but in actuality, what they will end up doing

2 is end up being acquired through some sort of licensing.

3 Effectively their competitive advantage is innovation

4 and not dealing with regulatory hurdles, et cetera, and

5 it makes more sense for it to be joined with incumbent

6 pharmaceuticals.

7 Now, once again, you might imagine that a

8 different world where Lilly would shrink because it's

9 been leapfrogged by competitors, but by the same token,

10 you know, presumably the current system leads to

11 innovation at the biotech level because they basically

12 know they have got this opt-out in terms of an external

13 capital market. They know if they get a hit, they are

14 going to be acquired and they don't have to go through

15 the whole costs of taking the drug to market themselves.

16 DR. SCHERER: Absolutely right. My daughter is

17 research director of a small biotech startup, and she

18 knows she can't -- if they go into Phase II testing that

19 her firm can't do it. So, they expect either to license

20 out or be acquired.

21 COMMISSIONER KOVACIC: To what extent is the set

22 of institutional arrangements by which agencies actually

23 bring and prosecute cases something that has to be

24 examined as well? I think that many of you, if not all

25 of you, have been involved in litigation episodes,


1 either inside the agencies or outside the agencies. I

2 was struck at David's comment about how in the course of

3 American Airlines the basic intuition that led to the

4 decision to prosecute remained the same over time, but

5 perhaps the understanding of why it was a good case may

6 have changed in significant respects over time.

7 I suppose in any one instance, in deciding to

8 prosecute any one case, the agency not only makes

9 decisions in general terms about whether there's a

10 sustainable theory, but has to make decisions about

11 whether to gather information, what information to

12 present, what is ultimately going to be persuasive to a

13 reviewing tribunal.

14 One element of the equation that we have to

15 consider not simply the functionings of specific firms,

16 industries, and economy as a whole, but the means by

17 which agencies themselves formulate and present cases

18 basically the mechanism by which theories and ideas are

19 ultimately transmitted into specific cases and how those

20 cases are pursued.

21 DR. WINSTON: I mean --

22 COMMISSIONER KOVACIC: There are larger

23 questions of institutional capability.

24 DR. WINSTON: And/or institutional constraints.

25 I mean, there has been some political economy literature


1 about the role of Congress or, you know, funding sources

2 and how they affect what the agency does. There was

3 a -- I can't remember, but a while ago, wasn't there a

4 study on -- saying how FTC cases were influenced by

5 Congressional funding in terms of, you know, you weren't

6 going after cases or areas where somebody was high up on

7 a committee in Congress because that could affect your

8 funding? That kind of stuff has been around for a

9 number of years.


11 DR. WINSTON: I haven't seen recent work on

12 that, but, you know, there's that kind of political

13 economy reality in terms of your dealings with Congress

14 and the President, of course.

15 COMMISSIONER KOVACIC: But I'm saying that, even

16 in the instances where you've decided to go ahead, one

17 key variable is the skill, the shrewdness, with which

18 the institution actually pursues a given matter.

19 DR. SCHERER: Let me say, my greatest failure.

20 Because I had a long connection with Detroit, when I was

21 director of the Bureau of Economics in the seventies, I

22 put very high priority on beginning an investigation of

23 the automobile industry. It was clear they were headed

24 for trouble. Who was it? I think it was Cliff who

25 talked about how -- yeah, Cliff talked about the


1 dynamics that got GM and Ford into their present pickle.

2 Well, it was clear already in the seventies that

3 they were heading for trouble, and the objective of that

4 investigation was not primarily to bring an antitrust

5 case; it was to illuminate to the public and to the

6 Congress what was going on, and the whole thing failed.

7 If we had succeeded, I think we might have avoided some

8 very serious mistakes. The industry might have learned

9 some things, the public would have learned some things,

10 the Congress would have learned some things.

11 I didn't see that case going into litigation. I

12 saw it as performing the FTC's historical role of

13 telling the public what the hell's going on in American

14 industry.


16 DR. BAKER: I was going to add that in the paper

17 I alluded to before with Tim Bresnahan, we talk about

18 two ideas for increasing the institutional capacity of

19 the traditional system to use economic learning, one of

20 which is to think about limited rules for neutral

21 experts, and another is for the enforcement agencies,

22 particularly the economists, to identify and codify

23 relevant generalizations about industries from the

24 empirical economic literature and make that available to

25 courts.


1 You all do try to do something sort of like that

2 in Schering, essentially in that whole line of cases

3 where the FTC is effectively relying on the idea that

4 generic drugs, when they enter, the price goes down for

5 the brandeds, and you're thinking "what can we learn

6 from that about the importance of generic entry to

7 create a presumption about why practices that might

8 discourage generic entry would be a problem?" Well,

9 taking generalizations like that and writing reports and

10 having that available for courts is a way to increase

11 everyone's institutional capacity.

12 DR. SCHERER: The fact is that the FTC's report

13 on generic drug entry and patent extension strategies by

14 branded drug firms was superb.

15 COMMISSIONER KOVACIC: I guess the humbling

16 thing for me is Schering. The investment in the

17 generic drug study was a major decision of Bob

18 Pitofsky's in 2000 to start the project, handing the

19 baton to Tim Muris, who made a major decision to

20 continue to devote resources and make it a high

21 priority. I think the study was enormously illuminating

22 and an excellent example of how 6(b), which we have

23 talked about before, ought to be part of the

24 Commission's portfolio.

25 I am not asking everyone to accept the wisdom of


1 the Schering case on the merits (though I think you

2 should), but you had decades worth of FTC activity in

3 this area, you had the FTC's investment in the empirical

4 study in question, and you had related work that the

5 Commission had done. All of this was presented to the

6 Court of Appeals, and the FTC received exactly the

7 amount of deference that a wayward child would receive

8 from a parent, which was none at all. The decision of

9 the administrative law judge was accorded great

10 deference.

11 On the other hand, the decision of the

12 Commission, with this affiliated research, received

13 none. What is humbling when one walks into difficult

14 areas of analysis of this type, internally we have to

15 ask, I think, are we bringing to bear the assembled

16 knowledge in an effective way for a reviewing tribunal?

17 You don't get something very far saying, well, that was

18 an error by the Court; there's another erroneous court.

19 Yet another court has failed to get it right. They

20 ultimately are the gatekeepers we have to work with.

21 But in this instance, that was unsuccessful in a fairly

22 traumatic way.

23 MR. HEYER: One process point that I think might

24 be worth considering, although I'm not quite sure how to

25 get this in front of whoever makes the determination, in


1 talking to some international folks, they have a process

2 in some jurisdictions where they actually have the

3 testifying economists, maybe even the consulting

4 economists, the Court essentially has them discuss,

5 debate, reach consensus with one another on things that

6 they can agree on and things that they still disagree

7 on, and to some extent it helps cut through a lot of the

8 confusion that any layperson or court is going to face,

9 and, you know, there are going to be some remaining

10 differences, but that seems like it might be an

11 efficient thing to do, perhaps within the Division or

12 the FTC and perhaps within courts as well, to have that

13 sort of process.

14 DR. BAKER: Let me make a comment. I want to

15 advertise something else now, which I was the --

16 MR. HEYER: It's not another article, is it?

17 DR. BAKER: No, no Tim Bresnahan on this one.

18 I was co-chair of a task force of the Antitrust

19 Section of the American Bar Association on which Luke

20 participated last year the Economic Evidence Task Force.

21 We did a long analysis of various options like these and

22 laid out some pros and cons. We didn't reach a

23 consensus as a task force on it, but I think you would

24 find it very interesting and instructive, and I believe

25 if it is not now it will soon be available on the


1 Antitrust Section web site for everyone to take a look

2 at.

3 DR. SCHERER: Actually, I had an experience, I

4 was hired as an expert by Judge Will in Chicago on the

5 glass bottles case. Part of my task was to do what you

6 suggested. Individually I met with the experts from

7 each side, posed questions that essentially went to

8 their differences, and tried to see what areas of

9 agreement could be found and what new research or what

10 new analyses could be found that might illuminate the

11 differences. We got pretty close to getting a rational

12 settlement of the case, except that one economist on the

13 final day of testimony strayed from the chosen --

14 MR. HEYER: The script?

15 DR. SCHERER: -- chosen path, and then so turned

16 off the jury, the jury so disbelieved him, that although

17 he was right on the merits, they disbelieved him and

18 rendered a verdict that was totally nonsensical.

19 COMMISSIONER KOVACIC: I know we are close to

20 the end of our time for today. I had a couple of

21 closing remarks for the session, but I wanted to give

22 our panelists another minute or so, if you have other

23 thoughts you would like to bring up.

24 DR. MARSHALL: Well, I just had one comment

25 about the implied -- well, the suggestion that you had


1 implied, Bill, regarding the funding of research

2 programs coming out of either the FTC or the DOJ. I'm

3 not savvy about the political nature of all of that. I

4 am generally quite happy with what I see coming out of

5 the academic literature since I am not one to look down

6 at the shoulders I am standing on and speak pejoratively

7 about where I'm resting, but I think that if the DOJ and

8 FTC were to somehow jointly put forward data that was of

9 remarkable quality, you can move research programs that

10 way.

11 The academics will latch into rich sets of

12 quantifiable information and coordinate on that if it is

13 good enough. If they see that there is lots of economic

14 content in there that they could never get their hands

15 on otherwise, you will move research programs that way,

16 and that doesn't require creating some kind of, you

17 know, NSF-like program within the FTC/DOJ.

18 COMMISSIONER KOVACIC: Other closing thoughts?

19 (No response.)


21 MR. HEYER: No, I just wanted to thank everyone

22 again. I learned a good deal, and I know it's not an

23 easy matter to come to something like this, and on

24 behalf of the others as well, I wanted to thank

25 everyone.


1 COMMISSIONER KOVACIC: As Ken did earlier in

2 thanking June, Joe and the team at the Department, I

3 want to thank the folks at the FTC who put this session

4 together. Those of you who have ever organized

5 anything, even a discussion around a lunch table, know

6 that this doesn't happen automatically. This takes an

7 incredible amount of work by the organizers. Jim

8 Taronji, Pat Schultheiss, Doug Hilleboe, Elizabeth

9 Argeris, and David Balan at the Commission were the

10 folks who along with June and Joe, Ken, put this session

11 together.

12 I also want to thank the speakers again. In

13 some ways, to ask what we've learned, what we would like

14 to know, and how we go about learning what we like to

15 know are impossibly difficult questions to address in a

16 short period of time. To do this, we could only ask

17 people whose skills were equal to doing the impossibly

18 difficult. That's why this group is here. I want to

19 thank them for taking their very precious time to share

20 their ideas with us today.

21 I'm grateful for everyone's willingness to have

22 this session today. I think that it is truly the

23 marriage of theory and practice that is so important to

24 formulating good policy. I think that the empirical

25 dimension, both the broader scale inquiries using the


1 taxonomy that Cliff laid out for us, from the broader

2 economy-wide perspective down to the industry-wide

3 level, to the firm-wide level, down to cases, is a mix

4 that's very important to what we have to do.

5 Perceptions of the past deeply influence current

6 views about what policy should be. In many ways, they

7 set the presumptions about what policy is today, not

8 just at home but also abroad. There are interesting

9 opportunities to embed within agencies, and I speak of

10 my own institution, a norm that makes this a routine and

11 significant part of our agenda, every bit as important

12 as bringing the cases; doing the research on which cases

13 rest, looking at past enforcement events or

14 nonenforcement events as a way of considering the way

15 ahead, collaborations with researchers on the outside,

16 maybe the idea, on a limited basis, of regularly

17 convening a workshop at which promising empirical work

18 or promising paths of work are done, something that can

19 be done inexpensively in an illuminating way, and the

20 possibilities that we haven't talked a great deal about,

21 though we have touched upon some, for cross-border

22 comparisons.

23 It's also striking to see the number of academic

24 centers like Bob's, like the joint project that Cliff is

25 so deeply involved in, that have counterparts in Europe


1 where, week-in and week-out, at different centers,

2 interesting research along these lines are being done,

3 so that what work was done might have a truly

4 cross-border dimension to it.

5 I'm fond of the title that Earl Weaver chose for

6 his autobiography: It's What You Learn After You Know

7 It All That Really Counts, and that's why continuing

8 attention to doing good empirical work strikes me as a

9 day well spent.

10 Thank you all.

11 (Applause.)

12 (Whereupon, at 12:33 p.m., the hearing was

13 concluded.)



1 C E R T I F I C A T I O N O F R E P O R T E R



4 DATE: SEPTEMBER 26, 2006

6 I HEREBY CERTIFY that the transcript contained

7 herein is a full and accurate transcript of the notes

8 taken by me at the hearing on the above cause before the

9 FEDERAL TRADE COMMISSION to the best of my knowledge and

10 belief.

12 DATED: 10/9/06


18 C E R T I F I C A T I O N O F P R O O F R E A D E R

20 I HEREBY CERTIFY that I proofread the transcript

21 for accuracy in spelling, hyphenation, punctuation and

22 format.


Updated June 25, 2015