Uncreative destruction: the misguided war on vertical integration in the information economy.

Author:Skorup, Brent
 
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TABLE OF CONTENTS I. INTRODUCTION II. THE SEPARATIONS PRINCIPLE A. The Proposal B. A New Spin on an Old Debate III. COMPETITION AND VERTICAL INTEGRATION A. Benefits of Complements and Tying B. Efficiency Benefits C. Competition in the Information Economy: Case Studies 1. AOL-Time Warner 2. News Corp.-DirecTV 3. Smartphone Sector D. Dynamic, Schumpeterian Change vs. Static Equilibrium Analysis E. Openness Concerns IV. REAL-WORLD APPLICATION OF THE SEPARATIONS PRINCIPLE ... A. Self-Regulation Norms B. Enforcement Challenges Associated with the Separations Principle C. Other Considerations Regarding the Wisdom of the Separations Principle 1. Regulatory Capture 2. Global Reach and International Competitiveness 3. Agency Conflicts and Administrative and Due Process Issues 4. Fifth Amendment Takings Issues 5. First Amendment Considerations V. CONCLUSION I. INTRODUCTION

Are information sectors sufficiently different from other sectors of the economy such that more stringent antitrust standards should be applied to them preemptively? Professor Tim Wu responds in the affirmative in his book, The Master Switch." The Rise and Fall of Information Empires. (1) Having successfully pushed net-neutrality regulation into the policy spotlight, (2) Wu turned his attention to what he regards as excessive market concentration and threats to free speech throughout the information economy. (3)

To support his call for increased antitrust intervention, Wu provides a unique view of competition in the information economy that substantially deviates from mainstream antitrust theory. (4) First, Wu contends that "information monopolies" are pervasive in the information economy. (5) Wu's "monopolists" include Facebook, Apple, Google, and even Twitter. (6) In The Master Switch and an article entitled In the Grip of the New Monopolists, Wu argues that these so-called monopolies are increasing their market power; requiring more aggressive oversight and regulation. (7)

Second, Wu argues that traditional antitrust analysis is not sufficient for information systems because they carry speech. (8) He claims "[i]nformation industries ... can never be properly understood as 'normal' industries," and traditional forms of regulation, including antitrust enforcement, "are alone inadequate for the regulation of information industries." (9) Wu believes that because information industries "traffic in forms of individual expression" they are "fundamental to democracy," and should, therefore, be subject to greater regulatory treatment. (10)

Third, in contrast to current competition law's focus on horizontal agreements, Wu desires reinvigorated regulatory enforcement addressing "the corrupting effects of vertically integrated power" in the information sectors. (11) He is particularly concerned about private threats to free speech arising from such vertical integration. (12) Wu's solution is to prevent vertical mergers in the information economy and mandate divestitures of vertically integrated companies. (13) To implement this, Wu proposes a "Separations Principle" for the information economy which would place information providers into three buckets, which this article has categorized as: information creators, information distributors, and hardware makers. (14)

This article outlines Wu's "Separations Principle," explains why Wu's fears regarding vertical relationships should be rejected by regulatory and antitrust policymakers, and illustrates the legal and practical problems Wu's proposed principle poses. This article also argues that there are widely accepted benefits of vertically integrated firms, and the antitrust harms Wu fears are not present. Further, this article shows that Wu's remedies are really policy preferences cloaked in the language of competition law. In fact, the information economy is largely competitive and does not warrant the interventionist enforcement approach Wu advocates. Since much of American economic vitality flows from the information economy and technology, (15) policymakers should reject a radical antitrust remedy like Wu's preemptive Separations Principle.

  1. THE SEPARATIONS PRINCIPLE

    1. The Proposal

      In the final chapter of The Master Switch, Wu outlines his Separations Principle for the information economy, (16) a framework of industrial organization that, if adopted, would radically expand antitrust enforcement in information technology markets and grant vast new powers to federal regulators. (17) He writes,

      A Separations Principle would mean the creation of a salutary distance between each of the major functions or layers in the information economy. It would mean that those who develop information, those who own the network infrastructure on which it travels, and those who control the tools or venues of access must be kept apart from one another. (18) Wu concedes that it is radical to contemplate placing these "constitutional" restrictions on private actors, but says his idea is inspired by a long line of policy reformers, like Justice Brandeis and President Andrew Jackson, who had similar ideas regarding the dangers of market concentration and power. (19) Wu insists that this structural remedy "is not a regulatory approach but rather a constitutional approach to the information economy" because he models it on the constitutional principle of separation of powers. (20) This is an especially inapt comparison, however, because the Constitution focuses on constraining the powers of government, not businesses. As media historian Paul Starr noted in a review of The Master Switch, Wu "doesn't really mean constitutional in a 'formal' sense. Actually, what he means is regulation--he just can't bring himself to admit it." (21) It makes little difference how Wu describes his proposal. The practical result of his Separations Principle would be welfare-reducing regulation of the information economy.

    2. A New Spin on an Old Debate

      Concerns about the benefits and harms of vertical integration were largely resolved decades ago in the economics and antitrust literature. Wu is dissatisfied with the state of competition in the information economy and does not believe that the antitrust agencies--with their focus on social welfare calculations, efficiencies, and horizontal relationships--can prevent the sort of societal and competitive harms about which he is concerned. (22) Wu disapproves of the economic orthodoxy today that tolerates what he regards as "industrial dominations" and "imperial growth and overreach" (23)--no doubt referring to the general acceptance in antitrust theory of Chicago School economics, (24) the school of thought that displaced the interventionist Harvard School approach in the 1970s. In the end, marketplace evidence supported Chicago School's economic analysis relative to the Harvard School's structural focus. (25) He is troubled by Americans' "relative indifference to the danger of private power," the "sanctification of private property," (26) and the current interpretation and enforcement of antitrust statutes. (27) In Wu's estimation, Chicago School-style "economic vitality" depends "on the freedom of the economic system to rise and fall, crash and burn." (28) The problem, Wu says, is that respected economic thought accepts the booms and busts "as intrinsic to the free-market system...." (29) In light of the current state of antitrust enforcement, he says, a radical overhaul of competition law is needed.

      Whether intentional or not, Wu's call for renewed focus on vertical relationships resembles the so-called inhospitality tradition in antitrust, which was characterized by a deep suspicion of vertically integrated firms because they, allegedly, can foreclose entry of competitors and otherwise harm competition. (30) During that era, decades ago, antitrust policy was designed, in the words of a federal court of appeals, to "perpetuate and preserve, for its own sake and in spite of possible cost, an organization of industry in small units which can effectively compete with each other." (31) The Chicago School and the rise of transaction cost economics, however, revolutionized economists' interpretation of non-standard contracts and ultimately replaced the inhospitality tradition in the late 1970s. (32)

      Consequently, current economic thinking has a greater appreciation for the benefits of vertical integration in promoting inter-brand competition and innovation in distribution, and courts applying the antitrust laws have generally been persuaded by this approach. With surprising frankness, Wu rejects the modern approach and argues that "what was understood in the 1970s, and what needs to be understood again, is the role of ... restrictions in preserving both the free market of goods and services and the free market of ideas." (33)

      Wu's central contention in the book is that U.S. industrial structure determines the limits of free speech. (34) The information economy comprises the "speech industry," he says, and since speech is carried on privately owned platforms he worries that private actors will limit free speech. (35) Like his mentor, Harvard University law professor Lawrence Lessig, (36) Wu seems to accept that he cannot displace the dominant role of Chicago School doctrine in modern antitrust law and its acceptance in the federal courts, so he attempts to highlight a compelling reason for intervention into the information economy. (37) That compelling reason is the unique role of speech in an effective democracy.

      Antitrust practice today, Wu says, is unsuitable for the information economy since speech is so intertwined. (38) He says information industries, which carry speech, are just different from "normal" commodity industries. (39) These industries are fundamental to democracy and the efficiencies and utility with which antitrust concerns itself misses the bigger picture. (40) Behind every political revolution or genocide is not

      "orange juice, heating oil, [or] running shoes," but a partnership...

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