Article 24 of 54
Cover Story/News: Analysis & Commentary: AFTER THE VERDICT
THE GREAT ANTITRUST DEBATE: Focus on innovation? Or stick to pricing issues? The outcome is critical
By Michael J. Mandel and Mike France in New York, and Dan Carney in Washington
 
06/26/2000
Business Week
Page 40
(Copyright 2000 McGraw-Hill, Inc.)

The war between Microsoft and the Justice Dept. is certainly far from over. But as the two meet again in court over the appeal of Judge Thomas Penfield Jackson's decision, there is a parallel intellectual struggle going on for the soul of antitrust policy. The key issue: Will antitrust continue to play a limited role in economic policy, as it has for twenty years? Or will it move to center stage as a key defender of innovation and innovative firms in the New Economy?

This debate has been simmering under the surface for the last few years, but only recently has it showed up clearly. For most of the postwar period, trustbusters worried mainly about companies charging excessive prices. It was generally accepted by both liberal and conservative economists that monopoly price increases, while they hurt customers, had relatively little effect on productivity or economic growth. This was the central tenet of the so-called Chicago School of antitrust, which dominated policy during the 1980s and held that there was rarely economic justification for aggressively pursuing antitrust actions. The result: Regulators were relegated to a peripheral role.

Increasingly, however, the Federal Trade Commission and the Justice Dept. have been focusing on innovation, not price, as the basis for antitrust action. Justice's proposal to break up Microsoft was based primarily on the argument that the company deterred ``innovations that would truly benefit consumers.'' A similar argument is being made in the antitrust case against Visa USA and MasterCard International Inc. that just went to trial. And the FTC and Justice recently issued guidelines for collaboration between rivals which paid special attention to the impact on innovation.

If the innovation-based approach to antitrust becomes widely accepted, it would greatly broaden the mandate of antitrust regulators. Unlike higher prices from monopoly, impediments to innovation in a market can have a direct impact on overall productivity and growth in the economy. ``Innovation becomes more and more the engine that drives consumer welfare,'' says FTC Chairman Robert Pitofsky. ``In many ways, innovation is the heart of the new economy.''

Nevertheless, there is real resistance to focusing on innovation as a key goal of antitrust policy. While antitrust economists generally agree that innovation is important, they worry that it may be hard to devise good remedies, or identify cases where innovation is hurt by market power. ``People don't even have an informed guess about what concentration does to innovation,'' says Stephen Calkins, antitrust professor at Wayne State University School of Law, who served as FTC general counsel.

The new approach also has to win the approval of skeptical judges who have been trained for years to think in terms of relatively narrow economic rationales for antitrust intervention. In particular, it is not clear whether the government's proposed breakup of Microsoft--primarily based on the claim that it will boost innovation--can survive the appeal (page 42). But whether or not the government ultimately wins the Microsoft case, there are powerful forces working in favor of the new approach--chief of which has to be the pivotal role innovation plays in the continued expansion of the New Economy. In a time of rapid technological change, notes Frederic M. Scherer, a leading antitrust economist at Harvard University, ``it's very important to maintain a level playing field [to] spark innovation.''

The new approach draws a direct link between antitrust policy and macroeconomic performance. ``It used to be thought that the industrial-policy economies, in Asia and in Europe, would be the powerhouses of the 21st century,'' says Assistant Attorney General Joel I. Klein. ``It is now clear that the most competitive economies will throw off the most innovation and the most dynamic growth.''

And antitrust regulators have been seeing more and more cases in which innovation plays a crucial role. That trend, rather than a Chicago School-style framework, shaped how Pitofsky and Klein began to evaluate cases, including Microsoft. At the same time, innovation has been receiving increasing attention within the economics profession, after years of being treated as a relatively unimportant sub-field. When Klein needed someone to write a brief supporting the Microsoft break-up, he chose Paul Romer, the Stanford economist widely credited with revitalizing the study of growth and innovation in the 1980s.

Still, the new approach faces many criticisms, chief among them its speculative and somewhat ad hoc nature. Research into antitrust and innovation remains inconclusive. Indeed, there is little clear-cut evidence on whether small companies or large companies have a better track record with innovation. Small companies can generate new ideas without worrying about corporate bureaucracies or existing products. Big companies have the advantage of sufficient resources for research and product development.

But it may very well be that in an era of relatively free-flowing venture capital, the resource advantage of big companies is less important. For the first time, it is possible for young, innovative companies to raise large sums and immediately challenge existing rivals. Thus, the New Economy model of innovation is the continual birth of startups that either grow big themselves or get snapped up by bigger fish.

As economists focus on innovation, they may uncover principles to guide antitrust policy. ``Even on relatively easy stuff like price, there is still a lot of debate,'' says Harvey J. Goldschmid, professor of antitrust law at Columbia University. ``But you can get research, and over time reach a consensus. You may get the same consensus over time on innovation.'' INSTANT ISSUE. One possibility, advanced by economists such as Romer, is that innovation will be squashed if big companies can choke off entry by new rivals. Consider instant messaging, for example. Much of the Internet's success has been the product of its openness to new applications. But America Online Inc., with the largest number of instant-message users by far, has consistently tried to keep other companies from tapping into its network, citing security concerns. The latest example: AOL recently blocked users of Odigo, a new type of instant-messaging software, from communicating with users of America Online instant-messaging software. AOL notes that it has royalty-free licensing agreements with more than a dozen companies that have agreed to abide by AOL's consumer privacy and security protections. Still, the FTC has asked AOL for more info on the blockage as part of its review of the AOL-Time Warner merger.

The innovation-based approach to antitrust also means focusing especially on industries where possible collusion between competitors may be holding up innovation. For example, in the case against Visa and MasterCard, the government alleges MasterCard shelved plans to develop a ``smart card''--a credit card with a microprocessor--because Visa decided not to go ahead with a similar product.

When it comes to mergers in research-intensive industries such as pharmaceuticals, it may be appropriate to intensify the already close scrutiny of overlaps in R&D. Indeed, one recent study by CenterWatch, a newsletter that monitors the clinical trials industry, found clinical-research spending and the number of development projects declined sharply in the three years following a merger.

Tough as it is to know how and when to apply innovation criteria, a bigger problem may be crafting workable remedies. Success in high-tech industries often depends on network effects in which consumers get most value from joining the network with the largest market share. The problem: Even if the company got its commanding position through anti-competitive acts, consumers might not benefit from a breakup of the monopoly. ``Winner-take-most-markets is a natural phenomenon,'' says Nicholas S. Economides , an economist at New York University's Stern School of Business. ``This has not really been recognized by the lawyers.''

The ongoing American Airlines predatory-pricing case, while not based on innovation, also highlights the obstacles to real remedies. The government alleges the airline cut fares to drive out small competitors from its Dallas-Fort Worth hub, then jacked prices up again. Is the government ``going to prevent American from adding capacity or lowering fares?'' asks George Washington University antitrust Professor William E. Kovacic. Any such rules, Kovacic says, would hurt consumers. In this case, remedies would almost certainly have to be merely punitive, coming after the elimination of rivals.

In addition, it's still unclear if courts or future administrations will accept the government's new theories. The Supreme Court's last major antitrust opinion, in '97, was decided 9-0 based on Chicago-school antitrust reasoning. And the appeals court that will likely hear Microsoft's case has shown no sign of being open to the broader innovation arguments.

The political environment is not necessarily conducive to an innovation-based antitrust policy either. George W. Bush, who earlier this year noted that the main legitimate role for antitrust is in preventing price-fixing, has been getting advice that current antitrust policy is too expansive, says former FTC Chairman James C. Miller III. Even more frustrating for Klein and Pitofsky, no one even in the Clinton Administration has made a more activist antitrust policy part of a broader political agenda. Without political consensus, survival of the new theories becomes less likely. Still, the New Antitrust has a powerful ally in the New Economy and its dependence on innovation. And as long as regulators continue to detect efforts to cut off ideas or their access to markets, the new antitrust will continue to take shape.

(See related article: "WILL THE APPEAL HOLD WATER?" -- BusinessWeek June 26, 2000)