FRAMING THE CHICAGO SCHOOL OF ANTITRUST ANALYSIS.

• Date: 01 June 2020
• Author: Hovenkamp, Herbert

INTRODUCTION 1844 I. MARKETS AND STRUCTURE 1853 A. Market Diversity and Regulation 1853 B. Oligopoly, Monopolistic Competition, and Appropriate Antitrust Responses 1855 C. Barriers to Entry 1861 D. Market Structure and Mergers 1863 E. Leverage, Foreclosure, and Exclusion 1864 F. Error Cost Analysis 1870 II. INFLUENCE ON ANTITRUST JURISPRUDENCE 1871 A. The Chicago and Harvard JURISPRUDENCE 1871 B. Other Supreme Court Departures from Chicago Antitrust 1872 C. The Chicago and Harvard Schools and Antitrust Welfare Tests 1876 CONCLUSION 1878 INTRODUCTION

The Chicago School has had an important place in antitrust analysis since the 1960s. While its influence has waned considerably among scholars, it continues to find support among conservatives in business, politics, and the federal judiciary. This Article attempts to put some historical perspective on the Chicago School, focusing on its ideology as well as its microeconomic and legal antitrust analysis.

One well-known account of the Chicago School's development is a panel discussion edited by Ed Kitch of the University of Virginia in a program honoring Aaron Director and Ronald Coase. (1) His article bore the revivalistic title "The Fire of Truth," and it spoke of a religious movement, of people who "gathered to bear witness" to a remarkable event. (2)

Kitch attempted to locate the roots of the Chicago School in the rise of Legal Realism in the 1920s, with its efforts to examine how the law actually operates, rather than focusing purely on legal doctrine. (3) It was an unpromising comparison, as Kitch himself apparently realized. (4) Alternative accounts have found more plausible origins for the Chicago School of analysis in the thought of Friedrich Hayek or Frank Knight. (5) Kitch did properly fault the Legal Realists for compiling a great deal of observation with very little unifying theory or methodology. (6) Kitch's account is also notable for what it omitted. There was no mention of Robert L. Hale, the pioneering Columbia law and economics scholar who wrote about the relationship between economics and the legal system. (7) Nor did he mention Walton Hamilton's influential 1929 article in the American Economic Review, entitled Law and Economics, which first gave that discipline a name and attempted to set it on a more institutional path. (8) Another commentator made a single but uninformative mention of Thurman Arnold, (9) the Legal Realist who in 1938 became head of the Antitrust Division and became that Agency's most aggressive antitrust enforcer. (10) Chicago, if anything, became the anti-Thurman Arnold.

Also missing from Kitch's discussion was the single most important question that divided the Chicago School from most of its alternatives, the Legal Realists in particular: are markets similar, or do they differ from one another in fundamental ways? That issue sharply separated the Chicago ("similar") and Harvard ("differ") School approaches to industrial organization economics and antitrust policy. The residue of that division, which remains to this day, showed up in numerous ways. One was Chicago economists' and later lawyers' hostility toward the antitrust enforcement implications of both oligopoly theory and monopolistic competition theory. (11) Another was Chicago's narrow view of market failure and thus of the appropriate scope of public intervention, such as Pigouvian taxes (12) or price regulation. (13) Yet another was its continued efforts to de-emphasize the significance of market structure in both regulatory and antitrust decisionmaking. Chicago economist George Stigler devoted considerable intellectual capital to both criticizing the theory of monopolistic competition (14) and weakening the theory of oligopoly so as to make it no more than a special case of collusion. (15) This came through loudly in the popularizing scholarship of Robert Bork, who viewed oligopoly as something that existed only in economics textbooks (16) and who completely ignored the theory of monopolistic competition. (17)

Imperfect competition theories threatened the core commitment to nonintervention in Chicago School work. Joseph Schumpeter was prescient in his 1934 review of Joan Robinson's The Economics of Imperfect Competition. (18) If her work were to be taken seriously, he wrote, it would completely undermine the strong presumption against intervention. (19) Rather, the circumstances under which governmental action could increase welfare "becomes so extended as to make these cases the rule rather than more or less curious exceptions." (20) Built into Chicago School doctrine was a strong presumption that markets work themselves pure without any assistance from government. By contrast, imperfect competition models gave more equal weight to competitive and noncompetitive explanations for economic behavior.

The rejection of inconvenient advances in economics became a hallmark of Chicago School analysis. Its followers were libertarians who were committed on ideological grounds to less intervention by the state. The classical liberal Mont Pelerin Society claimed not only Friedrich Hayek and Frank Knight among its founding members, but also George Stigler, Aaron Director, Fritz Machlup, Milton Friedman, James M. Buchanan, and Gary Becker. (21) Many of them were also economists, however, and they liked competitive markets. Of course, an ideological commitment to nonenforcement and a desire for competitive markets can come into tension whenever firms use the profits from market power to obtain and keep that market power.

Because a firm has a financial incentive to use the profit from market power in order to maintain it, economic theory predicts that this would occur often. The Chicagoans thus needed an additional critical assumption: markets are inherently self-correcting and if left alone, they will work themselves pure. For example, cartels are naturally unstable, there are few entry barriers, monopoly attracts disruptive entry, mergers almost never produce anything except reduced costs, and vertical integration and contracting are unmitigated goods. With these assumptions in hand, government intervention in the form of antitrust enforcement is not needed to deliver competitive markets. (22)

This combination of beliefs found fertile ground in U.S. antitrust policy at mid-twentieth century. Enforcement at that time was excessively interventionist. Courts often either used no economics or poor economics to make decisions. (23) For example, the Court famously applied the per se rule to a competitively harmless joint venture because the rule of reason would "leave courts free to ramble through the wilds of economic theory in order to maintain a flexible approach." (24)

Here was a place where the Chicago School call to use economics in antitrust analysis would generate less enforcement--and have the handy side effect of being correct. For example, its first proposed reductions in enforcement attacked decisions condemning very small horizontal mergers (25) or competitively harmless vertical contracting. (26) The changes that resulted very likely increased consumer welfare and efficiency.

This side effect of being correct was critical to bringing the bulk of academic economists on board the Chicago movement. (27) The attractive feature of the movement was not the ideology of less enforcement regardless of the facts, but rather the idea of using economics to analyze business conduct in an effort to maximize social welfare. The economics angle was the marketing genius of the Chicago School, but it was a means to an end, not the end itself, as would later become clear when the School began to disavow later developments in economics. In the late 1970s, economically weak antitrust decisions from the 1960s and earlier provided plenty of low hanging fruit.

This movement sowed the seeds of its own intellectual decline, although its influence continued for decades. As economic reasoning was incorporated into court decisions, the marginal antitrust case became less offensive to good economics. Conduct that fell right on the (moving) line became more anticompetitive over time. Arguing that this more anticompetitive conduct was still benign became more difficult. Thus, as litigated cases trended, defendants' conduct became more difficult to justify economically. The practical success of the intellectual movement weakened its argument for reducing enforcement any further. Indeed, more up-to-date economic analysis revealed anticompetitive conduct and called for greater enforcement. (28) Making the problem worse, about this time (1980s) the economics profession developed applied game theory and there was a spate of sophisticated models of imperfect competition. (29) Now many more patterns of anticompetitive conduct could be explained and understood, particularly those in oligopoly markets.

While Bork's influential book The Antitrust Paradox was based largely on work he published in the 1960s, (30) it came out in 1978, (31) well after the game theory revolution and advances in modeling monopolistic competition and imperfect information were underway. (32) Bork did not consider these new economic tools. His book was also quaint and old fashioned in other ways. By 1980 the role of intellectual property, networks, and information technologies was becoming well established in antitrust policy. (33) Bork's book barely mentioned them, and almost completely ignored patents. His view of technology was entirely backward-looking. The Antitrust Paradox is peopled largely by the conventional manufacturers and dealers that dominated antitrust policy prior to 1970, and where much of the excessive intervention had occurred.

Combined with this old economics was an important legal default: when the conduct at issue admitted of any doubt, government should not intervene. By placing the burden of proof onto the government or plaintiff to show that a course of conduct was anticompetitive, any conduct...