Freedom to Trade and the Competitive Process

4 March 2011 at 4:46 pm 3 comments

| Dick Langlois |

That’s the promising-sounding title of a new NBER Working Paper by Aaron Edlin and Joseph Farrell. Unfortunately, the argument turns out, in my opinion, to be extraordinarily wrongheaded. Here is the abstract.

Although antitrust courts sometimes stress the competitive process, they have not deeply explored what that process is. Inspired by the theory of the core, we explore the idea that the competitive process is the process of sellers and buyers forming improving coalitions. Much of antitrust can be seen as prohibiting firms’ attempts to restrain improving trade between their rivals and customers. In this way, antitrust protects firms’ and customers’ freedom to trade to their mutual betterment.

The promising part is that they talk explicitly about the competitive process.

The freedom-to-trade perspective . . . stresses the freedom of buyers and sellers to change their trading partners whenever that is mutually beneficial. The aspect of the competitive process that we study here is buyers and sellers exercising this freedom and forming improving coalitions (i.e., new configurations of trading partners). In a highly competitive market a seller who does not give its customers good deals will find that rivals offer better deals to attract these customers. The process of firms fighting over customers and offering them better and better deals raises consumers’ utility skyward. This competitive process is closely aligned with what Schumpeter called creative destruction.

As anyone who has read Schumpeter knows, of course, this is not even close to what he actually meant by creative destruction. I’ll leave it to the reader to decide if it’s close to Kirzner’s view of the market process. But the real problem here is the bit about freedom to trade. The classical liberal meaning of “freedom to trade” is the absence of legal restrictions like patents or price controls. In the formulation of Edlin and Farrell, by contrast, private agents can also violate other people’s freedom to trade by engaging in various post-Chicago strategic behaviors (like raising rivals’ costs) to impede movement toward the core. The idea is that well-informed, well-intentioned, and lightning-quick courts and antitrust authorities can restore that freedom by judicious intervention. (In my classes I like to compare this view of antitrust with the old arcade game in which little gophers (or moles or prairie dogs or something) constantly pop their heads out of holes and one has to bang them back in before they disappear. In the Edlin and Farrell view, courts and antitrust authorities should wield the mallet against those who would strategically impede the movement of others toward the core. But in antitrust as in the arcade, the gophers have most often disappeared of their own accord before the hammer comes down.) The Edlin and Farrell conception not only debases the idea of freedom of contract but actually invites courts to interfere with freedom to trade as it is classically understood. To borrow from Schumpeter: in view of the great good will that the classical conception of freedom has earned over the years from its economic benefits, we shouldn’t be surprised that even those who intend its opposite should wish to (mis)appropriate its name. If you want to argue for legal interference with freedom of contract in the name of greater economic efficiency, say what you mean and don’t call it an extension of freedom.

Edlin and Farrell are smart guys, and they realize that endogenous restrictions on contracting can actually be efficiency enhancing. “[C]onsider an art dealer D who agrees to sell a painting to buyer A in a week for $500, but leaves it hanging in his gallery. Buyer B arrives mid-week and offers $750 for the painting. The forward contract between D and A prevents D from selling to B at the higher price. Does it ‘restrain’ the freedom of B and D to trade to their mutual benefit and thwart an improving coalition {D, B}?” One way to answer, they say, is “that the forward sale did limit {D, B}’s freedom to trade, but might yet not violate Section 1. First, the forward sale may well have helped D and A to trade in the first place, so it might on balance increase freedom to trade. This approach would try to balance pro and anticompetitive effects in terms of the competitive process, not directly balance efficiencies.” What they don’t realize is how general this point is. One could argue that it is the very underpinning of the rule-utilitarian argument for freedom of contract as classically understood. But it is certainly Schumpeter’s (actual) argument about how “restrictive practices” actually enable real competition:

[P]ractices of this kind, as far as they are effective, acquire a new significance in the perennial gale of creative destruction, a significance which they would not have in a stationary state or in a state of slow and balanced growth. […] Practically any investment entails, as a necessary complement of entrepreneurial action, certain safeguarding activities such as insuring or hedging. Long-range investing under rapidly changing conditions, especially under conditions that change or may change at any moment under the impact of new commodities and technologies, is like shooting at a target that is not only indistinct but moving-and moving jerkily at that. Hence it becomes necessary to resort to such protecting devices as patents or temporary secrecy of processes or, in some cases, long-period contracts secured in advance. But these protecting devices which most economists accept as normal elements of rational management are only special cases of a larger class comprising many others which most economists condemn although they do not differ fundamentally from the recognized ones (pp. 87-88).

Entry filed under: - Langlois -, Austrian Economics, Classical Liberalism, Entrepreneurship, Law and Economics, Public Policy / Political Economy. Tags: .

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3 Comments Add your own

  • 1. srp  |  4 March 2011 at 10:58 pm

    Applying this argument to marriage contracts would convert fault divorce into per se restraint of trade. And jealousy would be subject to a rule of reason test.

  • 2. Peter Klein  |  5 March 2011 at 11:02 am

    The old Aghion and Bolton paper on “Contracts as a Barrier to Entry” (http://www.jstor.org/stable/1804102) focuses on contract length, not the welfare effects of entry barriers, but could easily be interpreted in the spirit of Edlin and Farrell — which would radically undermine the case for freedom of contract. I always thought their approach made the concept of entry barrier so general as to be meaningless.

    I was once Aaron Edlin’s RA, and he is a sharp guy, but has some unusual ideas about policy. One paper argues not only that price-matching guarantees are anticompetitive, but that consumers who ask a merchant to match a competitor’s price could be prosecuted as Sherman Act violators! (http://works.bepress.com/cgi/viewcontent.cgi?article=1013&context=aaron_edlin)

  • 3. Michael E. Marotta  |  5 March 2011 at 5:51 pm

    The evils of anti-trust are well-known. Just as every fact supports every other truth, so, too, does any falsehood fail from every perspective, aspect, context, investigation, or inspection. It is wrong, no matter how you interpret it.

    Allow me to take just one instance. Anti-trust laws assume that there is a fixed inventory of extant goods and services, that all the widgets and gadgets are like mountains and rivers: they always existed and always will be here. In fact, these are in constant flux, coming into and going out of favor with changing perceptions of utility: 78 RPM records and 5.25-inch floppy disks, just for two. As Larry the Liquidator said, the surest way to go broke is to win an ever larger share of a dying market.

    The other expression of that instance is the goods and services that come into existence from invention and entrepreneurship. What did not exist at all suddenly must be regulated, controlled, distributed, monitored and mandated.

    The recent prosecutions of LCD display makers is a case in point. A hundred years ago, this was cholesterol from carrot juice. A generation ago, it was a fancy, an applied lab experiment. A decade ago, it was an emerging market. Now, for people to agree among themselves on production and distribution is a crime.
    “TAIWAN HANNSTAR EXECUTIVE INDICTED FOR ROLE IN LCD PRICE-FIXING CONSPIRACY” at

    http://www.justice.gov/atr/public/press_releases/2011/266070.htm

    Goto the site and browse all the press releases back to June 2010.

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