Antitrust and Vertical Integration in “New Economy” Industries with Application to Broadband Access
Whether the firms that supply Internet hardware and software should face restrictions on the use of their property is an important and controversial policy issue. Advocates of “net neutrality”—including President Obama and the current FCC majority—believe that owners of broadband distribution systems (hardware used to distribute Internet and video services) and producers of certain “must-have” video content should be subject to prophylactic regulation that transcends present-day antitrust law enforcement. In the economic terms that are used in debates on competition policy, the concern is with vertical integration that may give firms both the opportunity (through denial of access or price discrimination) and incentive (increased profit) to restrict competition. This paper’s central point is that virtually every production process in the economy is vertically integrated, and economics predicts changes in the extent of vertical integration—that is, changes in the boundaries of the firm—in response to changes in relative prices, technology, or institutions. Both vertical integration and changes in the extent of vertical integration are benign characteristics of efficient, dynamic, competitive markets. While there is no shortage of theoretical models in which vertical integration may be harmful, most such models have restrictive assumptions and ambiguous welfare predictions—even when market power is assumed to be present. Empirical evidence that vertical integration or vertical restraints are harmful is weak, compared to evidence that vertical integration is beneficial—again, even in cases where market power appears to be present. Thus, it is reasonable to conclude that prophylactic regulation is not necessary, and may well reduce welfare. Sound policy is to wait for ex post evidence of harm to justify interventions in specific cases. Net neutrality, recently enacted by the FCC but subject to judicial review, is an unfortunate idea.
KeywordsAccess Antitrust Broadband Common carrier Contracting Essential facilities Ex ante regulation Firm boundaries Industrial organization Internet Net neutrality New economy Pin factory Schumpeter Vertical integration Vertical restraints
JEL ClassificationK20 K21 K23 L10 L11 L14 L22 L23 L24 L38 L40 L42 L50 L59 L82 L86 L96
- Acemoglu, D., & Cao, D. V. (2010). Innovation by entrants and incumbents. NBER working paper 16411. September.Google Scholar
- [Adelphia 2006] See FCC (2006).Google Scholar
- Arrow, K. J. (1962). Economic welfare and the allocation of resources for invention. In M. G. Harold (Ed.) Chairman, Universities-National Bureau Committee for economic research, 1962. The rate and direction of inventive activity: Economic and social factors, Cambridge MA: NBER books, National Bureau of economic research, Inc.Google Scholar
- Baker J. B. (2007) Beyond Schumpeter vs arrow: How antitrust fosters innovation. Antitrust Law Journal 74(3): 575–602Google Scholar
- Brown Shoe v. United States. (1962). 370 U.S. 294, 323–334.Google Scholar
- Burt D. L., Lemley M. A. (2009) The patent crisis and how the courts can solve it. University Chicago Press, ChicagoGoogle Scholar
- Bustos, A. E., & Galetovic, A. (2009). Vertical integration and sabotage with a regulated bottleneck monopoly. The B.E. Journal of Economic Analysis & Policy Issue 1 Article 35.Google Scholar
- Buttrick J. (1952) The inside contract system. The Journal of Economic History 12(3): 205–221Google Scholar
- Diamond, P., Vartiainen, H. (eds) (2007) Behavioral economics and its applications. Princeton University Press, PrincetonGoogle Scholar
- Eastman Kodak Co. v. (1992). Image technical services Inc., 504 U.S. 451.Google Scholar
- Evans D. S., Schmalensee R. (2002) Some economic aspects of antitrust analysis in dynamically competitive industries, In Innovation policy and the economy 2. National Bureau of Economic Research Inc, Cambridge, pp 1–50Google Scholar
- FCC. (2006). [Adelphia] In the matter of applications for consent to the assignment and/or transfer of control of licenses, MB Docket No. 05-192. Memorandum opinion and order, released July 21, 2006. FCC 06-105.Google Scholar
- FCC. (2010). Open internet order. FCC No. 10-201 (rel. Dec. 23, 2010).Google Scholar
- Feng, L., & Hendrikse, G. (2010). Cognition and governance structure. Working paper. University of Rotterdam. Presented at workshop on valuation methods in agro-food and environmental economics, Barcelona, July 1, 2010. http://www.creda.es/Web%20workshop%202010/full%20papers/Feng.pdf.
- Goldfine D. A. J., Vorrasi K. M. (2004) The fall of the Kodak aftermarket doctrine: Dying a slow death in the lower courts. Antitrust Law Journal 72(1): 209–231Google Scholar
- Hahn, R., & Passel, P. (2010). Greasy pole economics. regulation2point0 (August 19) http://regulation2point0.org/.
- Hazlett, T. W. (2010). Shooting blanks on wireless policy. Financial times FT.com. October 5.Google Scholar
- Holmstrom B., Roberts J. (1998) The boundaries of the firm revisited. Journal of Economic Perspectives 2: 73–94Google Scholar
- Jackson, C. K., & Schneider, H. S. (2010). Do social connections reduce moral hazard? Evidence from the New York City taxi industry. NBER working paper 16279.Google Scholar
- Joskow, P. L. (2005). Vertical integration. In Handbook of new institutional economics, Ch. 13 (pp. 319–348). Kluwer handbook of new institutional economics 2005, Section 4.Google Scholar
- Kahn A. E. (1988) The economics of regulation: Principles and institutions. MIT Press, CambridgeGoogle Scholar
- Kodak. (1992). See Eastman Kodak Co. v. Image Technical Services Inc.Google Scholar
- Lafontaine, F., & Slade, M. (2008a). Inter-Firm contracts: Evidence. Forthcoming in Gibbons & Roberts (eds) Working Paper. Handbook of organizational economics, Princeton University Press 2012.Google Scholar
- Lafontaine F., Slade M. E. (2008b) Exclusive contracts and vertical restraints: Empirical evidence and public policy. In: Paolo B. (eds) Handbook of antitrust economics. MIT Press, Cambridge, pp 391–414Google Scholar
- Lee, R. S. (2010b). Vertical integration and exclusivity in platform and two-sided markets. Working paper. Stern School of Business, New York University. http://pages.stern.nyu.edu/~rslee/papers/VIExclusivity.pdf.
- Lemley, M. A. (2010). Industry-specific antitrust policy for innovation. Working paper. Stanford Law School. http://ssrn.com/abstract=1670197
- Microsoft. (2002). See United States v. Microsoft Corp.Google Scholar
- Nocera, J. (2010). The struggle for what we already have. New York Times. September 3. http://www.nytimes.com/2010/09/04/business/04nocera.html?_r=1&pagewanted=print.
- Noll, R. G., & Owen, B. M. (1994). United States v. AT&T: The Economic Issues. In J. Kwoka & L. White (Eds.) The antitrust revolution 2nd edn. Scott Foresman 1988.Google Scholar
- Ordover J. A., Saloner G., Salop S. (1990) Equilibrium vertical foreclosure. American Economic Review 80: 127–142Google Scholar
- Organization for economic co-operation and development (OECD). (1993). Technology diffusion: Tracing the flows of embodied R&D in eight OECD countries. DSTI/EAS (93):5 Rev.1. Paris.Google Scholar
- Owen, B. M. (2007). Antecedents to net neutrality. Regulation Fall 14.Google Scholar
- Posner R. A. (2000) Antitrust in the new economy. Antitrust Law Journal 68: 925–943Google Scholar
- Pratten C. F. (1980) The manufacture of pins. Journal of Economic Literature XVIII: 93–96Google Scholar
- Riordan M., Salop S. (1995) Evaluating vertical mergers: A post-Chicago approach. Antitrust Law Journal 63: 513–568Google Scholar
- Riordan M. H. (2008) Competitive effects of vertical integration. In: Paolo B. (eds) Handbook of antitrust economics. MIT Press, CambridgeGoogle Scholar
- Schmalensee, R. (2000). Antitrust issues in Schumpeterian industries. The American Economic Review. 90(2):192–196. In Papers and proceedings of the 112th annual meeting of the American Economic Association (May, 2000).Google Scholar
- Schmalensee, R., Willig, R. D. (eds) (1989) The handbook of industrial organization. Elsevier , North HollandGoogle Scholar
- Schuett, F. (2010). Network neutrality: A survey of the economic literature. Review of Network Economics. 9(2):1 http://www.bepress.com/rne/vol9/iss2/1.
- Schumpeter J. (1950) Capitalism, socialism and democracy (3rd ed.). Harper, New YorkGoogle Scholar
- Smith, A. (1776). An inquiry into the nature and causes of the wealth of nations, 2 Vols., Everyman’s library. London: Dent & Sons 1904.Google Scholar
- Stewart P. (1966) Dissent in United States v. Von’s Grocery. 384 U.S. 270: 281Google Scholar
- Sutton J. (1991) Sunk costs and market structure. MIT Press, CambridgeGoogle Scholar
- Trinko. (2004). see Verizon Communications Inc. v. Law Offices of Curtis V. Trinko.Google Scholar
- United States Antitrust Modernization Commission. (2007). Report and Recommendations. http://govinfo.library.unt.edu/amc/report_recommendation/amc_final_report.pdf.
- U.S. Department of Justice—Federal Trade Commission Horizontal Merger Guidelines (rev. 2010) http://www.ftc.gov/os/2010/08/100819hmg.pdf
- United States v. Microsoft Corp. (2002). 253 F.3d 34 (D.C. Cir. 2001) (en banc); Final Judgment No. 98-1232, 2002 WL 31654530 (D.D.C. Nov. 12, 2002)).Google Scholar
- United States v. Von’s Grocery. (1966). 384 U. S. 270, 281.Google Scholar
- Varian, H. R. (2001). High technology industries and market structure. Working paper, University of California at Berkeley. http://people.ischool.berkeley.edu/~hal/Papers/structure
- Verizon Communications Inc. v. Law Offices of Curtis V. Trinko, 540 U. S. 398 (2004). [Trinko 2004].Google Scholar
- Williamson O. E. (1975) Markets and hierarchies: Analysis and antitrust implications. Free Press, New YorkGoogle Scholar
- Williamson O. E. (1985) The economic institutions of capitalism. Free Press, New YorkGoogle Scholar
- Williamson O. E. (1996) The mechanisms of governance. Oxford University Press, Oxford, UKGoogle Scholar
- Yoo C. S. (2002) Vertical integration and media regulation in the new economy. Yale Journal on Regulation 19: 171Google Scholar