Antitrust beyond competition: market failures, total welfare, and the challenge of intramarket second-best tradeoffs.

• Author: Hammer, Peter J.

INTRODUCTION

Should antitrust law ever sanction the accumulation of market power or permit other restraints of trade if such conduct would increase social welfare? This is the challenge raised by intramarket second-best tradeoffs.(1) The lesson of second-best analysis is that one market failure can sometimes counteract the effects of another market failure. In the presence of multiple market failures, it is conceivable that mergers or other restraints traditionally viewed as anticompetitive may be welfare-enhancing. A social planner, given the mandate of maximizing total welfare, would permit such restraints. Could an antitrust judge come to the same result under a defensible application (or extension) of existing legal doctrine? This question highlights the tensions between an antitrust policy dedicated to preserving "competition" and an antitrust policy dedicated to maximizing total welfare. In doing so, the question tests the theoretical and practical limits of antitrust law,(2) asking whether it is time for antitrust law to move beyond structural understandings of competition and into the realm of express welfare analysis.(3)

This Article argues (1) that antitrust law should recognize a defense for private acts that restrain "competition" under the traditional antitrust analysis but advance total welfare, (2) that courts are competent to administer this defense, and (3) that the framework of existing antitrust statutes permits courts to recognize this defense. Today, most judges and scholars would reject intramarket second-best arguments as a justification for otherwise impermissible acts that enhance or maintain private market power, regardless of the credibility of the underlying economic analysis. The reasons given for rejecting such claims, however, would vary with the commentator. Some would argue that intramarket second-best claims have no statutory basis. Others would argue that maximizing total welfare is not the goal of the antitrust laws. Still others, who might be sympathetic to an efficiency-oriented antitrust doctrine, would be skeptical of the ability of the courts to implement a total welfare standard.

This Article challenges such received wisdom. Part I examines the theory of intramarket second-best analysis and explores how it fits within contemporary antitrust scholarship. Analytically, a defense for second-best tradeoffs has much in common with Oliver Williamson's productive efficiency defense in merger cases and with various market failure defenses that have been advanced in the literature. These similarities are examined, and the parameters of an affirmative defense are outlined.

I suggest that to rebut a finding of illegality based upon a traditional presumption of anticompetitive effects, defendants should have to establish (1) that the challenged conduct is responsive to an identifiable market failure; (2) that the conduct produces a net increase in total welfare (static efficiency); (3) that the conduct will not substantially impair subsequent efforts to address the underlying market failure (dynamic efficiency); and (4) that there is not a less restrictive course of action consistent with the antitrust laws that could achieve the same static efficiency gain. This defense presupposes a total welfare standard of analysis.

Part II examines the technical viability of the affirmative defense. Section II.A outlines the theoretical basis of consumer surplus and explores the tools underlying economic welfare analysis. Section II.B advances two contentions. First, the economic tools underlying many intramarket second-best claims are sufficiently advanced to permit parties to explore such claims in the context of litigation. Second, the logic underlying a total welfare approach can be made intuitively accessible to judges, lawyers, and jurors. Indeed, a total welfare standard may actually provide better criteria for drafting jury instructions and counseling clients than an antitrust standard based on protecting "competition." Section II.C assesses the costs and benefits of implementing an intramarket second-best defense and examines how the doctrine can be defined to balance expected type one and type two errors.

Part III explores whether second-best tradeoffs and the total welfare standard underlying them can be reconciled with contemporary understandings of antitrust law and the institutional role of the courts. I argue that antitrust law is best understood in terms of an ongoing partnership between Congress and the courts. The reality of this partnership has important implications for statutory interpretation. While I disagree with scholars like Robert Bork, who claim that a total welfare standard is mandated by the antitrust statutes, I maintain that such an approach lies within the realm of acceptable evolutionary paths of judge-made antitrust doctrine. Consequently, the case for second-best analysis should be won or lost on the strength of its normative and policy justifications. I argue that a narrowly tailored affirmative defense restricted to intramarket tradeoffs creates an appropriate division of labor between Congress and the courts, and that a total welfare standard can be reconciled with the institutional role of the judiciary.

This Article presents only a skeletal outline of the second-best defense. Its purpose is to make it intellectually respectable to argue for the defense, not to demonstrate that in fact it should be allowed in any particular case. The examples that are provided suggest the kinds of seeming restraints that may deserve legitimation under this analysis, but to actually argue for these restraints in real cases would require more case-specific data and nuanced analysis. Only after courts and litigants have wrestled with second-best defenses in at least several real cases can the workability of the theoretical case I make here be fully evaluated. Broad abstract description, and an expression of faith in the combined capacities of courts and economists, only gets us started. Indeed, the best starting point may be to encourage enforcement officials to take second-best considerations into account in deciding whether to challenge particular restraints. This would permit the gradual accumulation of experience, which, if the decisions are incorporated in policy statements or made objects of study, may inform courts when they face intramarket second-best claims in litigation.

1. TOTAL WELFARE, MARKET FAILURES, AND INTRAMARKET SECOND-BEST CLAIMS: TOWARD DEFINING AN ANTITRUST DEFENSE

   1. Market Failures and the General Theory of Second Best

      According to the first theorem of welfare economics,(4) competitive equilibria are Pareto-efficient, meaning that there exists no reallocation of resources that could make someone better off without making someone else worse off.(5) This is a statement about the economy as a whole (general equilibrium), and envisions that when all industries and markets are competitive, the interaction between them will yield an efficient outcome. Economic proofs of the existence and efficiency of general competitive equilibria entail many restrictive assumptions. Some of these are: buyers and sellers act independently rather than collusively, resources are perfectly mobile and fungible, there are no production or consumption externalities, buyers know all relevant prices and qualities, and sellers know all production possibilities.(6) If any of these assumptions fail in any market, then the efficiency of the resulting general equilibrium (if one exists) can no longer be asserted.

      If one condition fails in one market, then the policy prescription is straightforward: remedy the isolated failure, and the result will be a "first-best" solution. If there are multiple failures in a single market, or multiple failures in multiple markets, the analysis becomes more complicated. As Lipsey and Lancaster demonstrated in their analysis of the "general theory of second best," the efficiency of competitive equilibria is an all-or-nothing proposition.(7) Unless all conditions can be satisfied in all markets, there is no guarantee that remedying separate market failures will improve efficiency. Indeed, the counterintuitive proposition that remedying isolated market failures could actually make outcomes worse becomes possible:

      From this theorem there follows the important negative corollary that there is no a priori way to judge as between various situations in which some of the Paretian optimum conditions are fulfilled while others are not. Specifically, it is not true that a situation in which more, but not all, of the optimum conditions are fulfilled is necessarily, or is even likely to be, superior to a situation in which fewer are fulfilled.(8) These insights can easily be leveraged into a full-scale attack on "piecemeal welfare economics."(9) Richard Markovits has explored many of the implications of second-best theory for law and economics.(10) In particular, Markovits has criticized courts and scholars for failing to appreciate the implications of second-best theory for contemporary antitrust doctrine.(11)

      Antitrust scholars have reacted to the general theory of second best either by dismissing its implications entirely, or by using its insights to invalidate economic approaches to antitrust altogether. Both responses are misguided. Many economically oriented scholars acknowledge second-best problems but nevertheless reject their implications. A range of justifications is provided: some contend that incorporating second-best concerns would be too complicated for courts to handle, others argue that a simple heuristic of promoting competition on a serial basis will lead to the most defensible results, and others maintain that second-best problems must be ignored because Congress has established a legislative policy favoring competition.(12) Scholars who are less sympathetic to an economically oriented antitrust law have employed second-best...