August 11, 2017 10:42AM

Antitrust for Fun and Profit: The Democrats’ Better Deal (Part 2)

The first installment of this blog was a preliminary look at a Washington Post article “Is Amazon Getting Too Big?” by Steven Pearlstein.  That article promoted strong opinions of Yale law school student Lina Khan based largely on (1) faulty market concentration estimates from President Obama’s Council of Economic Advisers and (2) a selective 40-year survey of mergers as evidence of some current problem linking concentrated markets to rising prices.    

There was another bit of indirect evidence in the Obama CEA memo which merits discussion.  A graph from former CEA Chair Jason Furman showed large recent gains in “returns on invested capital” among public nonfinancial firms, as measured by McKinsey & Co.  The CEA insinuated that this shows a recent surge in “rents” (receipts larger than needed to attract capital) which they wrongly defined as “greatly in excess of historical standards.”  There is a simpler explanation.

Return on invested capital is notoriously difficult to estimate and, as McKinsey explains, returns look relatively larger by this measure because invested capital has become smaller as the economy shifted from capital-intensive manufacturing to services and software:

“What if the invested-capital side of the equation approaches zero, as it increasingly does among companies that use outsourcing and alliances and thus reduce the capital intensity of parts of their businesses? Other businesses, such as software development and services, also have inherently low capital requirements or take advantage of atypical working-capital dynamics, including prepayment by customers for licenses and payment by suppliers for inventory. Even traditional businesses are shedding capital: the median level of invested capital for US industrial companies dropped from around 50 percent of revenues in the early 1970s to just above 30 percent in 2004.”

Like the CEA’s mention of a rising share of sales by Top 50 firms in 10 industries between two years, the CEA’s return on invested capital data also failed to uncover any new “market concentration” problem to be solved by the Democratic Party’s mysterious “Better Deal.”

Neither Khan, Pearlstein, nor their cited sources provide any evidence of (1) the alleged widespread increase in market share held by 3 or 4 firms, nor of (2) higher prices outside of federally-regulated and subsidized industries, nor of (3) any connection between concentration and monopoly pricing, nor of (4) any connection between return on invested capital and concentration or monopoly pricing.

Despite no evidence that market share (concentration) predicts higher pricing, Pearlstein and Khan talk about Amazon’s share of markets.  Pearlstein claims Amazon sells 40% of books in this country, but such estimates vary depending on how we handle Kindle’s share of e-Books, Amazon’s consumer-friendly discounting of new books, and Amazon’s utility as a market for used books. Many people, like me, sell very good used books on Amazon and eBay, making the market for new books more competitive than ever.  Stacy Mitchell’s “The Big Box Swindle” costs $14.32 on Amazon Prime, but very good used copies sell below $2.

Khan claims “Amazon now controls 46% of all e-commerce in the United States.” That inflated figure includes sales that Amazon processes for other retailers and producers. And retail alone is not “all e-commerce” even ignoring the biggest e-commerce market – China. In U.S. business-to-business sales, Amazon Business is ranked 37th in the B2B E-Commerce 300 by Digital Commerce.  Besides, e-commerce only  amounted to 11.7% of U.S. retail sales last year, according to the Commerce Department.

The source of Amazon's alleged 46% share of something or other is Stacy Mitchell (BA in History) a publicist for “local-self-reliance” (which was also the unwise goal [zi li geng sheng] of Mao Tse-tung’s 1958-59 “Great Leap Forward”).  As Ms. Mitchell and her co-author explain, “Amazon’s market share was calculated by the authors, drawing on information from Amazon and Channel Advisor.”

E-commerce is not a market, much less a U.S. market, and it’s not something that can be “controlled.”  But the Khan-Mitchell-Pearlstein complaint is not about a big market share causing higher prices for buyers but about lower prices for sellers.  Mitchell applauds the Democrats’ new tough talk on antitrust because, “With most industries now dominated by just a few firms, it is harder. . .  for small businesses to compete and for farmers and producers to get a fair price” [emphasis added].

“In considering whether a proposed merger or business practice would harm competition,” writes Mr. Pearlstein, “courts and regulators narrowed their analysis to ask whether it would hurt consumers by raising prices.” He and Kahn blame such a “narrow” emphasis on consumer welfare on what they call “The Chicago School.”  They want courts and regulators to instead ask whether businesses structure or practices would harm competitors by reducing prices. Khan thinks “antitrust enforcers” should take a “holistic” approach, taking account the interests of rival sellers or producers who might have a tough time competing with Amazon’s low prices, huge inventories, or fast delivery. 

As I noted in the first blog, antitrust law is a large and lucrative industry, which has long been famously generous to politicians and think tanks who try to enlarge the volume and value of antitrust activities.  “Amazon is reported to be in the market for an antitrust economist,” notes Pearlstein, and “has engaged the services of two former heads of the Justice Department antitrust division, one Democrat and one Republican.” Indeed. That’s the way the antitrust extortion racket is played.  Skilled antitrust lawyers are equally eager to prosecute or defend, since they win either way.

Antitrust works very much like any other regulatory bureaucracy. Business lobbyists recruit antitrust agencies to get them to damage or constrain their more-successful rivals. Key members of congressional committees use antitrust threats to shake down corporate executives for campaign contributions and discourage them from supporting a rival Party’s policies or candidates.  Redundant federal agencies, the DOJ and FTC, drag companies into costly litigation battles for years, with the usual result being multi-billion-dollar fines rather than noticeable change in business practices.  Ambitious prosecutors use the publicity from high-profile cases as a red-carpet invitation into the revolving door of high-paying positions as antitrust defense attorneys or as executives in the effected industries.

Pearlstein suggests antitrust should be more about “fair play” and a “level field” to protect competitors who would much prefer to charge higher prices for less selection and slower service. “Some observers point to the E.U.’s Google case as an example of the difference between the American and European approach: They protect competitors; we protect consumers. ... To me, this view betrays a naïve belief that in our open market system, every person and every company has the same opportunity to succeed. ... Leveling the playing field is a legitimate policy goal.”  

To me, Pearlstein’s view betrays naïve optimism that ambitious politicians and prosecutors are omniscient and incorruptible. He thinks future antitrust cops should have great discretionary authority to “block Amazon” from competing too effectively with UPS, Oracle or Comcast.  If that threat ever materialized, it would surely attract generous donations from UPS, Oracle, or Comcast to sympathetic politicians and think tanks.  Antitrust law is not supposed to be about dividing the spoils but frequently is.

August 7, 2017 3:56PM

Antitrust for Fun and Profit: The Democrats’ Better Deal (Part 1)

“Is Amazon getting too big?” asks Washington Post columnist Steven Pearlstein, in a 4000-word column seeking justification for the Democrat Party’s quixotic pledge to “break up big companies" in its recent “Better Deal." “Just this week,” notes Pearlstein, “Democrats cited stepped-up antitrust enforcement as a centerpiece of their plan to deliver ‘a better deal’ for Americans should they regain control of Congress and the White House.” He concludes by saying “it sometimes takes a little public power to keep private power in check.” But maybe it takes a lot of public power to write antitrust lawyers some big checks.

Politics aside, the question “Is Amazon getting too Big?” should have nothing to do with antitrust, which is supposedly about preventing monopolies from charging high prices. Surely no sane person would dare accuse Amazon of monopoly or high prices. 

Even Mr. Pearlstein has doubts: “Is Amazon so successful, is it getting so big, that it poses a threat to consumers or competition? By current antitrust standards, certainly not. . . Here is a company, after all, known for disrupting and turbocharging competition in every market it enters, lowering prices and forcing rivals to match the relentless efficiency of its operations and the quality of its service. That is, after all, usually how firms come to dominate an industry. . .”

That should have ended this story “by current antitrust standards.” But if we simply lower those standards, then “Better Way” antitrust shakedown threats could become far more numerous, unpredictable, and lucrative for politically-generous antitrust law firms

Among the 19 largest law firm contributions to political parties in 2015/2016, according to Open Secrets, all but one, Jones Day, contributed overwhelmingly to Democrats. More to the point, all of these law firms contributing most generously to the Democratic Party are specialists in antitrust and mergers: They appear on U.S. News list of top Antitrust attorneys. And the Trial Lawyers Association (now disguised as “American Association for Justice”) contributed over $2.1 million to Democrats, over $1 million to liberal organizations and $67,500 to Republicans.

Antitrust law is a very big, profitable and concentrated industry. Antitrust lawyers’ have a special interest in greatly expanding the reach and grip of antitrust law. They were surely delighted by Pearlstein’s prominent endorsement of law journal paper by Lina Khan, a 28-year old student and fellow at the “liberal-leaning” think tank New America.

Ms. Kahn believes it self-evident that low operating profits must prove Amazon is “choosing to price below-cost.” That’s uninformed accounting. What low profits actually show is that Amazon has been plowing-back rapidly expanding cash flow into capital expenditures, such cloud computing, a movie studio, and unique consumer electronics (Kindle and Echo).

 “If Amazon is not a monopolist, Khan asks, why are financial markets pricing its stock as if it is going to be?” That’s uninformed finance theory. Investors rightly see Amazon’s current and future growth of cash flow (the result of expensive investments) as the source of future dividends and/or capital gains (more net assets per share).

Kahn believes antitrust has been unduly constrained by “The Chicago School approach to antitrust, which gained mainstream prominence and credibility in the 1970s and 1980s.” She thinks Chicago’s “undue focus on consumer welfare is misguided. It betrays legislative history, which reveals that Congress passed antitrust laws to promote a host of political economic ends.”

The trouble with grounding policy on legal precedent is that Congress passed many laws to promote the special interest of producers at the expense of consumers—including the Interstate Commerce Commission (1887), the National Economic Recovery Act (1933), the Civil Aeronautics Board (1938), and numerous tariffs and regulations designed to benefit interest groups and the politicians who represent them.

The well-named chapter “Antitrust Pork Barrel” in The Causes and Consequences of Antitrust quotes Judge Richard Posner noting that antitrust investigations are usually initiated “at the behest of corporations, trade associations, and trade unions whose motivation is at best to shift the cost of their private litigation to the taxpayer and at worse to harass competitors.”

To grasp how and why anti-trust is easily abused as a rent-seeking device, it helps to relearn the wisdom of Frederic Bastiat: “The seller wants the goods on the market to be scarce, in short supply, and expensive. The [buyer] wants them abundant, in plentiful supply, and cheap. Our laws should at least be neutral, not take the side of the seller against the buyer, of the producer against the consumer, of high prices against low prices, of scarcity against abundance [emphasis added].” 

Contrary to Bastiat, however, Ms. Kahn claims to have found “growing evidence shows that the consumer welfare frame has led to higher prices and few efficiencies.” 

Growing evidence turns out to mean three papers, one of which seems to say what she says it does (but only about mergers, not concentration): “Research by John Kwoka of Northeastern University,” Pearlstein writes, “has found that three-quarters of mergers have resulted in [were followed by?] price increases without any offsetting benefits. Kwoka cited industries such as airlines, hotels, car rentals, cable television and eyeglasses.” 

If you believe that, mergers left consumers overcharged by the Marriott hotel and Enterprise Rent-A-Car ‘monopolies.’ Even if that sounds plausible, Kwoka’s evidence does not. Two-thirds of his sample covers just three industries (petroleum, airlines, and professional journal publishing), the price estimates are unweighted without standard error data, and several mergers date back to 1976-82. As Federal Trade Commission economists Vita and Osinksi charitably noted, “Kwoka has drawn inferences and reached conclusions . . . that are unjustified by his data and his methods.”

Pearlstein turns to another paper in Kahn’s trio: “There is little debate that this cramped [Chicago] view of antitrust law has resulted in an economy where two-thirds of all industries are more concentrated than they were 20 years ago, according to a study by President Barack Obama’s Council of Economic Advisers, and many are dominated by three or four firms.” 

Nothing in Pearlstein’s statement is even approximately correct. The Obama CEA looked at shares revenue earned by two different lists of Top 50 firms (not “three or four”) in just 13 industries (not “all industries”) in 1997 and 2012. Pearlstein’s “two-thirds of all” really means 10 out of 13, though the U.S. has considerably more than 13 industries. In transportation, retailing, finance, real estate, utilities, and education, for example, the Top 50 had a slightly larger share of sales in 2012 than in 1997. So what?

Should we fear monopoly price gouging simply because 50 firms account for a larger share of the nation’s very large number of retail stores, real estate brokers, or finance companies? Of course not. “An increase in revenue concentration at the national level,” the Obama CEA concedes, “is neither a necessary nor sufficient condition in market power.”

The Obama CEA did add that “in a few industries. . . there is some evidence of increasing market concentration.” How few? Just three: Hospitals, railroads, and wireless providers. Those industries are heavily regulated, as is banking. 

The CEA notes the 10 largest banks had a larger share of bank loans in 2010 than in 1980, which is hardly a surprise. Hundreds of banks that existed before the 1981-82 stagflation and 2008-09 Great Recession had closed by 2010. More lending now flows through nonbanks and securities. And the Internet (e.g., lending tree) makes shopping for loans or credit cards more competitive than ever.

Did the Obama CEA present any evidence that its extraneous data about industry-level or market concentration “has led to higher prices and few efficiencies”? Certainly not. They made no such claim because so many previous efforts have failed. “The Market Concentration Doctrine” could not explain higher prices when Harold Demsetz examined it in 1973, and it still can’t.