Category Archives: Antitrust and Innovation

Democracy and prosperity: What can antitrust do to maintain or create an open economy?

“Why Nations Fail: The Origins of Power, Prosperity and Poverty” is quite an ambitious book. The authors, Daron Acemoglu and James A. Robinson, attempt to put forth a global theory that explains the cause of the differences in prosperity across countries. Granted, there is already substantial work on how many factors, such as low levels of education and corruption, affect income per capita levels and growth rates. The book in question goes, however, to a more fundamental level. Why have some nations been able to overcome these problems and others not? That is the trillion dollar question.

The differences that we see today in income levels across the globe were historically unprecedented before the industrial revolution started in Great Britain. Before that, the whole world was roughly equally poor. After this fateful development, some countries became substantially wealthier than others by adopting the latest production technologies and becoming themselves fertile ground for later frontier innovations. According to the book, at that time, the industrial revolution could only have happened in a country like Great Britain. Why? Because it had generated a virtuous circle of inclusive political and economic institutions. Here, inclusiveness means a regime that allows and encourages the participation of a broad cross-section of society as opposed to a small powerful elite (both in economic and political terms). The more inclusive the participation in political life became, the more inclusive the economic rules of the game, which in turn empowered more people who acquired a saying in what the government did. In the authors’ words, Great Britain broke the mold. Before then, the historical rule had been that of extractive regimes or relatively short-lived, imperfect attempts at inclusiveness (such as the Roman Republic and Venice between the 11th and 13th century). Was the benevolence of British rulers the cause of such a drastic departure from history? According to the book, no.

The explanation is of course somewhat complicated. It all starts with the Black Death, goes through the instauration of the Transatlantic trade, and ends up with the Glorious Revolution. I want to keep it short and also do not want to spoil more of the book so I will not go into much detail on this. The principle behind it all is that these shocks (or critical junctures, as the book calls them) provided an opportunity for some parts of the population who were historically neglected (peasants and merchants) to demand greater rights and representation from the crown. In all of these developments, there is one important element that the authors do not neglect: chance. Great Britain had some luck in coming out of these shocks as a more inclusive society than before.

I think this is enough explanation of the book to set the mood. The point that is worth highlighting in this blog is the part of the book that talks about antitrust. According to the authors, the US antitrust laws played an important role in the time of Standard Oil and the Robber Barons. The prosecution of anticompetitive behavior and monopolization of markets was key in maintaining the US economy open to the entrepreneurial efforts of a broader cross section of society. The book also talks about competition policy matters when it analyzes how the abolition of monopolies in many markets and trade routes in Great Britain in the years leading up to and after the Glorious Revolution allowed it to keep developing a more inclusive and prosperous society.

The point has important implications for what we consider competition law’s role in a society to be. The US antitrust laws were conceived as a tool to halt the rising tide of concentration in the American economy because such a trend was incompatible with democratic values. Later on, these views largely disappeared from antitrust scholarship and case law, though not from other fields of the economics profession. The predominant view now is that consumer welfare (or sometimes overall efficiency), both from a static and dynamic point of view, should guide enforcement activities.

Under the current paradigm, market concentration can be tolerable to the extent that it incentivizes creative destruction, or in other words, innovation efforts to become the next monopoly. To be sure, such a consideration does not always trump static concerns in many important cases. However, and here is where the theory developed in the book comes into play, the incentive of other firms to innovate in order to achieve a dominant position is not the only dynamic effect of market concentration. In addition, monopolies and oligopolies have an incentive to stop or delay innovation through their political influence. In other words, the dynamic effects of monopolies (at least the largest ones) are theoretically ambiguous. On one side we have eager firms who will spend considerable resources to innovate in order to achieve the same profitability of current dominant firms (or current dominant firms trying to maintain their lead); on the other, we have the obstacles that incumbent players could erect thanks to their political power.

The book is full of examples of how regimes in extractive societies explicitly opposed innovation and the adoption of the latest technologies based on the fear of social unrest and, therefore, their hold on power. Russian and Austrian monarchies were reluctant to allow the construction of railroads and the adoption of manufacturing technologies because these led to urban development, and cities made it easier for the people to organize and take action against social injustices.

In most countries with a competition law, it is hard to imagine that politicians can oppose innovation explicitly based on such considerations. The arguments have changed. However, organized interest groups are still able to exert their political influence to shield themselves from competitive pressures.  There is vast theoretical and empirical work that explores how policy is thus shaped.

The role of antitrust in developing countries could then be to support the development of inclusive social and economic institutions. In developed countries, antitrust can be a powerful tool to keep the economy open. How can antitrust authorities achieve this? Certainly not alone but they can do their part. Inclusive political and economic institutions depend on other important areas such as tax policy, social investments (e.g. education, public health, transport, and communications infrastructure), and IP rights.

Some highly complex questions that must be answered based on this are whether it should be anticompetitive that firms lobby to close markets and how much market concentration should be tolerated to keep dynamic incentives to innovate. The answer to neither of them has been uniform across jurisdictions.

The book’s theory is indeed compelling. It will go through a very important test in the medium to long term, namely, through the developments in China. Currently, this nation has been taking steps toward a more central and authoritarian rule. It is possible again for a president to hold power for his entire life. According to the Economist, Xi Jinping is the most powerful ruler since Mao Zedong. If the political situation does not change and China is still able to achieve the levels of prosperity in per capita terms as those experienced in Western Europe and the US, then the book’s hypothesis will suffer a fatal blow. If not, China might still be able to contest the technological supremacy of other nations in some fields (as it also happened in the times of the Soviet Union) but a wealthy society depends on a broader reach of innovative efforts.

I personally think it is highly unlikely that China will achieve, let alone sustain, a high level of prosperity under a ruler that faces little constraints. Even if we assume that Xi Jinping is an enlightened and benevolent statesman, the situation will still be fragile for three reasons (the first two taken from the book): first, there will be strong incentives to overthrow him since getting your hands on such a powerful economy will be incredibly attractive to his detractors, who may not show the same hypothetical restraint; second, even if the first does not happen, there is a high likelihood that an appointed successor, who will be subject to ever fewer restrictions regarding the exercise of power, will start to steer the economy to the benefit of its supporters, which normally has destructive consequences to economic welfare; and third, open dissent and public debate, which are necessary conditions of effective policy making, are utterly incompatible with authoritarian rule. On another level, I think it is still tricky to argue that it is good to live in a prosper society even if most civil liberties are abolished. Though I do not think it will come to that.

The purpose of this discussion is to open a fundamental debate regarding the role of antitrust. Should we go back to basics? i.e. should we apply the antitrust laws so that the functioning of the economy is not incompatible with democratic values (taking into account the positive feedback loop that may exist between both)? or should we leave it to other areas of public policy to guard the gates?

The way the two questions are formulated above implies that there should be some, at least academic, consensus on the need for limiting corporate influence on economic policy. If we assume this, then the question is which is the right policy approach to achieve this result. The book seems to lean toward interventions that aim at market structure. However, a legitimate question is whether other policy options could serve this purpose better. Direct regulation of campaign donations and lobbying activities are a choice. Whether these and structural measures should be substitutes or complements should also be explored. These could be some starting points. The matter is rather complex for one blog post but I leave you with the promise of future analysis.

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