Posted by Social Science Research Network
Antitrust and the Design of Production
By Herbert J. Hovenkamp (University of Pennsylvania)
Abstract: Both economics and antitrust policy have traditionally distinguished “production” from “distribution.” The former is concerned with how products are designed and built, the latter with how they are placed into the hands of consumers. Nothing in the language of the antitrust laws suggests much concern with production as such. Although courts do not view it that way, even per se unlawful naked price fixing among rivals is a restraint on distribution rather than production. Naked price fixing assumes a product that has already been designed and built, and the important cartel decision is what should be each firm’s output, or the price charged to buyers. At the same time, however, many price agreements among rivals are in fact a part of design or production rather than distribution.
Many of the difficulties that antitrust law has had with vertical restraints arose because antitrust courts mistakenly viewed a practice as part of distribution when it was really part of design or production. Agreements that seem nominally to be about distribution or price are in fact mechanisms by which firms share design and production activities. For example, tying arrangements are not simply ways of pricing finished goods. Rather, as the long history of tying-like practices in patent law illustrates, most tying is the consequence of a design or production choice or else a mechanism for sharing entrepreneurial risk.
Particularly misunderstood are variable proportion, or metering, ties. Ignoring incentive effects, when the seller has a monopoly in the tying product and the tied product is perfectly competitive, such ties may reduce short run consumer welfare from the single monopoly price, at least if they also reduce output of the durable good. However, that result is trivial across the range of litigated variable proportion tying cases. The sellers in these cases are virtually never monopolists or even close. When metering ties are imposed by non-monopolists the welfare effects are unambiguously positive.
An antitrust policy driven by concerns for consumer welfare should favor design and production initiatives but disfavor restraints on pricing. Indeed, it is more important for antitrust policy to get the innovation question right than to be right on price, because innovation has the potential to affect economic development much more dramatically, and in both directions. That is, just as innovation benefits the economy by a greater amount than price competition under constant technology, so too a restraint on innovation can do greater harm.
By focusing so much on price, antitrust policy has often missed the point of some arrangements, particularly those that involve new technologies or innovations in business organization. In the process, it has confused innovation with monopoly. For example, antitrust’s long war with tying arrangements occurred because litigants and courts were obsessed with pricing and either never queried or else did not appreciate how tying relates to innovation and production. By their nature, innovations upset a market’s equilibrium, producing temporarily higher returns. As a result, a common feature of innovation is short-run prices that are above cost and welfare reducing to the myopic eye. These are essential features of innovation-intensive markets, however, and in such cases the social cost of false condemnation is high.
