Yves here. This post provides a history of the rise of the current mainstream antitrust theory, the so-called Consumer Welfare Standard, and why it is deeply flawed, and in a pro-corporate direction, naturally. While it acknowledges that the contemporary intellectual campaign against, the New Brandesian movement, is an improvement, the authors describe its shortcomings and suggest a better approach: that of focusing on social welfare effects, particularly inequality.
By Mark Glick, Professor, University of Utah, Gabriel Lozada, Associate Professor of Economics, University of Utah, and Darren Bush, Professor, The University of Houston Law Center Faculty. Originally published at the Institute for New Economic Thinking website
Industrial organization economists play multiple roles in antitrust law enforcement, from economic consultants and providers of expert testimony to policy advocates. In each instance, economists rely on both positive and normative economic theory. Economists in these roles might believe their theories are exclusively positive. But positive economic models implicitly incorporate normative theory. For example, an economist might study the impact of vertical integration on output. Implicit is the assumption that output is the variable that best captures welfare. The latter is an assumption based on normative economics. In this INET Working Paper paper, we detail the flaws of antitrust’s current normative theory, which is known as the Consumer Welfare Standard (“CWS”). We explain how welfare economics has long ago abandoned such measurement of welfare for good reasons: the theory is flawed, inconsistent, and ethically unsustainable. It is regrettable that this old normative theory survives in some sub-fields of economics such as industrial organization. New Brandeisians, seeking a replacement for CWS, have advanced an alternative, the competitive process standard, which is an improvement but is not flawless. We argue the way forward for antitrust is to follow the way of modern welfare economics, which in telling coincidence, adopts matters of import consistent with Congressional goals behind the antitrust laws.
Is it Normative or Positive?
That which Industrial Organization Economists tout as positive economics is motivated by normative theory. For example, a large literature in antitrust economics addresses whether and when vertical mergers, or price discrimination, or tying, or other strategies, expand or reduce output. But why focus only on output? Why not ask under what conditions a vertical merger reduces income inequality? The assumption is that output, not inequality, is a better instrument by which antitrust policy can advance well-being or welfare. Thus, normative theory identifies the instrument—whether it be maximized output or reduced income inequality—and the model to determine the impact of corporate conduct on the instrument comes from positive theory.
The study of normative theories in economics is called “welfare economics.” When economists refer to the “welfare effects” of policy, they necessarily are referencing welfare economic theories. In economics, “welfare” refers to human well-being, either at the individual or social level; the latter is also called “social welfare.” In economics, policy positions can only be justified if they increase social welfare.
The antitrust polestar is a surplus theory of welfare known as the Consumer Welfare Standard (CWS). The CWS only recognizes part of the total economic surplus. Strangely, the CWS, despite its name, is often times considered by Industrial Organization economists and law professors to be a “Total Surplus” standard. “Post-Chicago” economists endorse the position that the polestar should be total surplus. “New Brandeisians” have attacked the CWS standard for its pro-business ramifications, but even they retain elements of the surplus approach.
But both CWS and the total surplus standards are fatally flawed. Even the originator of surplus theory, Alfred Marshall, recognized that it had several shortcomings. One shortcoming is that it endorses policies which hurt some people. Historically, this caused a retreat from the surplus approach in the early twentieth century, to the ideas of Vilfredo Pareto in welfare economics. This was followed by a return to a modified version of the surplus approach a few decades later based on work by Nicholas Kaldor and John Hicks.
Flaws and Paradoxes in CWS
Troublesome inconsistencies in this modified surplus approach emerged as early as Scitovsky’s work in 1941. Should the prices of two or more commodities change, the order of analyzing the resulting surplus changes affects the total surplus change calculated (Order of Analysis Paradox). It is recognized that there is not one neoclassical measure of value but two, equivalent variation (EV) and compensating variation (CV), and they are not the same. The two measures can result in contradictory policy conclusions.
In Industrial Organization, economists have ignored these problems, based on the work of Robert Willig who contended that the two measures (EV and CV) are generally “close.” But CV and EV are not necessarily close and can diverge greatly. The Kaldor and Hicks tests, typically described in law schools wrongly as a singular test, can also create divergent results. Moreover, as the Boadway Paradox shows, some Potential Pareto improvements cannot in actuality be achieved.
Moral Failings and Rationality Failures of CWS
Beyond these theoretical flaws, there are moral considerations that render CWS indefensible. Whether under “wealth maximization,” CWS, or any other surplus maximization approach, the rich are able and willing to pay more, so changes to their surplus matter more for total surplus than do changes to the surpluses of the poor. Therefore, policies benefitting the rich win.
All of these flaws are well understood. Yet, industrial organization economists continue to tout CWS as “science” as opposed to biased assumptions. Advances in welfare economics since the 1940s have been ignored by antitrust and industrial organization economists. Modern welfare economics widely rejects the surplus approach. For example, Economics Nobel laureate Angus Deaton says, “There is no valid theoretical or practical reason for ever integrating under a Marshallian demand curve,” meaning, there is no reason to calculate consumer surplus. Science has moved on.
Next, we show that the connection between consumer choice (which underlies the surplus approaches), on the one hand, and consumer welfare, on the other hand, relies on unreliable assumptions about human nature. Economics, biology, psychology, and other social sciences demonstrate such challenges to CWS. For one, humans are not self-interested in the way assumed in economics. The assumption of universal narrow self-interest is deeply flawed. Moreover, human preferences are not exogenous, as human beings are interdependent creatures who care about what other people are doing. Finally, human preferences are imperfect. People are notoriously bad at predicting the degree of adaptation to post-choice situations: buyer’s remorse is a thing.
How to Reboot
To move forward, antitrust’s normative theory needs a reboot. Does the New Brandeis School offer an acceptable alternative normative approach to antitrust policy? Our answer is not an unqualified yes. We suggest modifications to get closer to that goal using the tradition of modern welfare economics. Modern welfare economics follows either the Bergson-Samuelson Social Welfare Function approach or the Capabilities Approach, attributable to Amartya Sen. This has resulted in welfare economists developing a “dashboard” of important factors that influence social well-being. Some of those factors directly or indirectly reflect the traditional Congressional values revealed in the legislative intent when the antitrust statutes were promulgated. These were the very values that were replaced by the CWS, based on the outdated normative theory that we criticize in our paper.
Sen has remarked that one major problem with the dashboard is identifying the decision maker. Remarkably, this is not a problem for antitrust. Congress provided goals that are generally consistent with modern welfare economics. Those stated Congressional goals consisted of preserving political democracy through the dispersion of the economic and political power of big business, protecting small businesses, limiting income inequality, and protecting workers. These goals are among the characteristics whose importance to social welfare has been confirmed by the modern welfare economists and other social scientists.
In contrast, the New Brandeisian “competitive process” standard is not necessarily compatible with these goals. “Competition” is not a uniform ideal and whether or not competition improves welfare depends on what is encompassed in that ambiguous term. Economists do not have a consistent definition of competition, except perfect competition (which is inapplicable to antitrust policy). The New Brandeisian fallback position is to use the dictionary definition of “competition” as rivalry, but more rivalry is not necessarily better according to economic theory.
Thus, we argue that Congress has given us the welfare “dashboard,” that is, the components of welfare: protection of democracy and protection (probably partial) of small businesses, labor, consumers, and farmers. With mergers, taking these components of welfare into account leads to a rather simple suggestion: tighten merger thresholds. However, with firms that have become large due to internal growth, Congress has not given us an easy way to aggregate the dashboard elements, and more work will have to be done to plot a clear way forward.
