Economic formalism in antitrust decisionmaking.

• Author: Shores, David F.

1. INTRODUCTION

   The Supreme Court's watershed decision in Continental T.V., Inc. v. GTE Sylvania Inc. (1) had a dramatic effect on the legality of vertical territorial and customer restraints. Prior to the decision, the legality of such restraints imposed by a manufacturer on a dealer limiting where or to whom the dealer could resell depended upon the context in which the restraints arose. (2) If imposed on a dealer who purchased the goods, the restraints were a per se violation of the Sherman Act. (3) If imposed on a dealer who took the goods on consignment and held them for resale as agent for the manufacturer, they were subject to rule-of-reason analysis and were generally upheld as reasonable restraints that were not prohibited by the Act. (4)

   The practical effect of the restraints on competition in the dealer's market did not depend upon whether title to the goods had passed from the manufacturer to the dealer. In Sylvania, the Court quite properly viewed the distinction between sales and consignments as irrelevant to antitrust analysis and therefore indefensible] Rational analysis required that "the per se rule ... be expanded to include" vertical restraints in the consignment context, or that it be withheld from such restraints in the context of a sale. (6) Recognizing that vertical territorial and customer restraints can serve legitimate business needs of the manufacturer, the Court overruled its earlier decision in Schwinn that had adopted the sale/consignment distinction, and held that all such restraints are subject to rule-of-reason analysis. (7)

   What has made Sylvania a watershed decision was not its impact on the analysis of nonprice vertical restraints under the Sherman Act, (8) or even its overruling of Schwinn. Rather, it was the language by which the Court announced its decision that gave Sylvania that status. "[W]e do make clear," the Court stated, "that departure from the rule-of-reason standard must be based upon demonstrable economic effect rather than--as in Schwinn--upon formalistic line drawing." (9) The distinction between sales and consignments was formalistic because it failed to address the core issue in every antitrust case: Does the challenged restraint adversely affect competition in the market?

   The broad teaching of Sylvania is that all antitrust analysis, not merely application of the per se rule in a particular context, must be based upon demonstrable economic effect. Factual distinctions that tell us little about economic effect, such as distinctions between sales and consignments, are to be cast aside. Presumably, general principles based on economic theory that tell us nothing about the actual economic effect of a particular restraint in a particular case should also be cast aside. In other words, antitrust decision-making should be based primarily on what the facts indicate concerning economic effect in a specific case. It should not be based on abstract economic principles that describe how markets generally function, but that tell us nothing about the effect of a particular practice in a particular case. Nor should it be based exclusively on economic principles that might be relevant to a determination of economic effect, since abstract principles never provide an infallible guide to economic effect. A core assumption of economic theory is that producers and consumers are rational maximizers. Producers seek to maximize profits, whereas consumers seek to maximize utility. And, each acts rationally in doing so. However, anyone passing through life with his eyes open knows that rational behavior is not universally practiced. (10) While relevant economic theory might be a useful tool in resolving factual issues, it should not displace fact analysis in the determination of economic effect. Economic effect is a slippery concept, not easily nailed down in an actual case. Thus, in determining the economic effect of a particular practice in a particular case, there is significant pressure to supplant analysis of facts with general economic principles.

   Yielding to that pressure is not necessarily a bad thing. It is desirable for one to be able to know what the law is--what is permitted and what is not. General principles, whether derived from economic theory or from other sources, facilitate that knowledge. They make the law more predictable. For example, when the Supreme Court adopted the general rule that above-cost price cuts never violate the antitrust laws, it made the law of predatory pricing more predictable than it had previously been. (11) In doing so, the Court clarified that a reduction in price cannot be challenged on antitrust grounds, provided it does not go below cost.

   Along with enhancing predictability, such a general rule constrains judicial discretion and makes it more likely that similar circumstances will be treated similarly. In short, general rules sometimes advance values that are important to any just law. But, that is not invariably true. As Justice Scalia has recognized, "[t]he trick is to carry general principle as far as it can go in substantial furtherance of the precise statutory or constitutional prescription." (12) And, one might add, the trick is to carry it no further. Once a general principle has surpassed that point, it loses its legitimacy as a tool of statutory construction. For example, if the general principle that above-cost price cuts never violate the antitrust laws conflicts with legislative history and congressional purpose, it cannot plausibly be viewed as advancing the prescription of the antitrust statutes. General principle then becomes a tool of statutory revision rather than a tool of statutory construction. The revised prescription fails to reflect the will of Congress. Since Congress is the branch of government most responsive to the people, the revised prescription fails to reflect the will of the people.

   The main theme of this article is that in a number of post-Sylvania decisions, the Court has gone too far in determining economic effect by relying on abstract economic principles. While those decisions claim to emphasize economic effect, and are therefore purportedly faithful to the teaching of Sylvania, their reliance on abstract economic theory to resolve the issue of economic effect is, in fact, highly formalistic. Thus, rejection in Sylvania of formalistic line drawing in favor of demonstrable economic effect has been subverted. Like the distinction between sales and consignments rejected in Sylvania, these post-Sylvania decisions tell us little or nothing about the actual economic effect of a particular restraint in a particular case. Under the decisions, actual economic effect need not be determined on a case-by-case basis because generally applicable economic principles tell us what the effect of a particular practice is. Just as was true with the discredited sale/consignment distinction adopted in Schwinn, antitrust analysis turns on bright line rules that tell us little or nothing about the demonstrable economic effect of the challenged practice.

   The concept of legal formalism, as it is generally understood, is also evident in the reasoning of the cases discussed below. Although legal formalism may take many forms, (13) Lochner v. New York (14) is frequently cited as a classic example of formalism. (15) In Lochner, the Court struck down a New York statute that limited employment hours. (16) "The general right to make a contract in relation to his business," the Court held, "is part of the liberty of the individual protected by the Fourteenth Amendment of the Federal Constitution." (17) Justice Holmes famously dissented, stating that "[g]eneral propositions do not decide concrete cases. The decision will depend on a judgment or intuition more subtle than any articulate major premise." (18)

   As Justice Holmes' comments suggest, the Court's reasoning was syllogistic. Its major premise was that one's liberty is protected by the Federal Constitution and may not be infringed by a state statute. (19) Its minor premise was that New York's statute infringed upon the liberty of employers and employees. (20) Its conclusion was that the statute was therefore in violation of the Constitution and could not stand. (21) Justice Holmes' point was that the term "liberty" does not inexorably include entering into an employment contract of one's choice. (22) He continued:

   I think that the word liberty in the Fourteenth Amendment is perverted when it is held to prevent the natural outcome of a dominant opinion, unless it can be said that a rational and fair man necessarily would admit that the statute proposed would infringe fundamental principles as they have been understood by the traditions of our people and our law. (23) As is always true with deductive reasoning, the validity of the Court's conclusion depended upon the validity of its premises. The validity of its minor premise depended upon the scope of its major premise. The minor premise was valid if, and only if, liberty necessarily included the freedom to choose the terms of one's employment. In Justice Holmes' judgment, the Court's minor premise was false because, as defined "by the traditions of our people and our law," liberty did not automatically include the right to contract for employment for more than ten hours a day. (24) The Court's reasoning was formalistic in that it viewed the term "liberty" as self-defining. (25) Justice Holmes, on the other hand, believed that its definition should have depended upon the persuasiveness of reasons for and against allowing states to legislate as New York had, in light of "the traditions of our people and our law." (26)

   The antitrust opinions discussed below involve much the same kind of formalistic reasoning as was involved in Lochner. It is referred to here as economic formalism, rather than legal formalism, because its major premise is supplied by economic theory, rather than--as in Lochner--by a legal rule such...