Tuesday, December 30, 2014

Robert Bork and Transaction Cost Economics

Lawyer and Scientist

Economic science and antitrust doctrine go hand in hand.  Over a century ago, in Standard Oil v. United States, 221 U.S. 1 (1911), the Supreme Court famously announced that the Sherman Act bans only those agreements and other conduct that results in monopoly or the consequences of monopoly. The Court identified three (and only three) such consequences: (1) output below the competitive level; (2) prices above the competitive level; and (3) quality below the competitive level. Thus, as Justice Stevens explained for the Court in National Society of Professional Engineers v. United States, 435 U.S. 679 (1978), Standard Oil is based upon "economic conceptions," and courts applying  the decision's "Rule of Reason" must focus solely on a challenged restraint's impact upon "competitive conditions."  It is thus no surprise that advances in economic science have influenced the content of antitrust doctrine over the past century or more.  As Herbert Hovenkamp put it over two decades ago:

"One of the great myths about American antitrust policy is that courts began to adopt an 'economic approach' to antitrust problems only in the 1970s.  At most this 'revolution' in antitrust policy represented a change in economic models.  Antitrust policy has been forged by economic ideology from its inception."

See Herbert Hovenkamp, Enterprise and American Law, 268 (1991).

Of course, judges are not economists, and they lack the leisure time and expertise necessary to keep abreast of the latest developments in economic science.  At the same time, economists are generally not lawyers, with the result that many will have difficulty "translating" developments in economic science into appropriate proposed changes in antitrust doctrine.  For decades, then, economically sophisticated legal scholars have played the role of translators, bridging the divide between economists and economic science, on the one hand, and generalist judges, on the other.   Successful translators have included Robert Bork, Philip Areeda, Donald Turner, Frank Easterbrook, Herbert Hovenkamp, and Richard Posner.  

This account of the relationship between economic science and antitrust doctrine treats economic science as exogenous and legal scholars and judges as passive recipients of developments in economics.  Indeed, some legal scholars have described their contributions in exactly this way.  For instance, Robert Bork claimed that his work simply assessed and critiqued antitrust doctrine in light of what he called "conventional price theory" and "basic price theory."  See e.g. Robert H. Bork, The Antitrust Paradox, 117 (1978) (invoking "conventional price theory"); Robert H. Bork, Resale Price Maintenance and Consumer Welfare, 77 Yale L. J. 950, 952 (1968) (invoking "basic price theory").   Richard Posner also claimed that the Chicago School of Antitrust Analysis was simply a manifestation of rigorous application of "price theory" to antitrust problem, an approach that Posner characterized as "novel."  See Richard A. Posner, The Chicago School of Antitrust Analysis, 127 U. Penn. L. Rev. 925 (1979).  By characterizing their contributions as mere applications of scientific principles determined elsewhere, these and other scholars could enhance the authority and persuasiveness of their proposals.

The assumption that economic science is exogenous to the legal academy is roughly true. There is, however, one counter-example suggesting that this assumption is not entirely accurate, namely, Robert Bork's contributions to the body of economic theory known as Transaction Cost Economics.  Contrary to his modest claim that he merely applied basic price theory to antitrust problems, Bork also made original contributions to economic science.  Ironically, these contributions actually undermined certain facets of price theory, particularly price theory's account of non-standard contracts. As previously explained on this blog, basic price theory identified two and only two rationales for complete or partial vertical integration: (1) the realization of technological efficiencies or (2) the acquisition or extension of market power.  By their nature, technological efficiencies arise "within" individual firms, during production and before sale.  However, non-standard contracts (minimum rpm, exclusive territories and the like) necessarily reach beyond the boundaries of the manufacturer to control the behavior of other firms, particularly wholesalers and retailers.  As a result, price theorists naturally assumed that such agreements cannot produce efficiencies and thus inferred that they were instead efforts to acquire or preserve market power.  The result was the so-called "inhospitality tradition" of antitrust, which was particularly hostile to various forms of partial contractual integration.

Of course, even before World War II, Ronald Coase undermined price theory's account of vertical integration, demonstrating that such integration could reduce transaction costs, regardless of any technological efficiencies.  See R.H. Coase, The Nature of the Firm, 4 Economica (n.s.) 381 (1937). However, this contribution went unnoticed at the time, exhibiting no influence on economic theory itself, let alone antitrust doctrine.  Indeed, according to conventional wisdom (including the work of Coase himself), no one understood or applied Coase's insight until various economists, particularly Oliver Williamson, rediscovered and expanded upon Coase's insight, particularly by expanding the definition of transaction costs to include the risk of opportunism that can arise due to relationship specific investments.

There is no doubt that Williamson played the preeminent role in bringing attention to Coase's insight and developing the transaction cost paradigm of industrial organization.  For this work he properly earned the Nobel Prize in Economic Science.   At the same time, this essay, prepared for a conference at Yale Law School and recently published by this blogger, contends that Robert Bork, although not an economist, played a hitherto unappreciated role in rediscovering Coase's transaction cost explanation for vertical integration.

As the essay shows, in a 1966 article, Bork critiqued the conventional wisdom regarding certain forms of contractual integration, particularly: (1) vertical contractual integration between a manufacturer and its dealers and (2) horizontal contractual integration between partners in an otherwise valid joint venture.  See Robert H. Bork, The Rule of Reason and the Per Se Concept: Price Fixing and Market Division II, 75 Yale L. J. 373 (1966).  (For more on Bork's revolutionary contributions to antitrust thought, go here.)  This critique cited Coase's 1937 work for the proposition that "contractual" integration and "ownership" integration can be alternative means of achieving the same economic objectives, an assertion at odds with price theory's technological conception of the firm.  (By contrast, Lester Telser's transaction cost interpretation of minimum resale price maintenance, on which Bork also drew, did not mention Coase.) Moreover, Bork also employed transaction cost reasoning to explain how exclusive territories (both vertical and horizontal), customer restrictions and ancillary horizontal minimum price fixing could overcome various costs of relying upon unfettered atomistic markets to conduct economic activity.  In so doing, he expressly assumed the existence of post-transaction opportunism, a condition unknown to price theory, albeit not in so many words.  That is, Bork assumed that a manufacturer's or joint venture's reliance upon an unfettered market to distribute goods could result in "parasitical" behavior by some distributors, behavior that would "take advantage" of and "victimize" fellow trading partners by "appropriating" to the parasite the contributions of others.  Parties would anticipate such opportunism, he said, and respond by adopting non-standard agreements that could prevent such behavior and, for instance, ensure an optimal quantity and type of promotional expenditure. 

Bork also explained how relegating manufacturers and joint ventures to the alternative of specifying the promotional obligations of distributors would entail prohibitive information and monitoring costs, costs that price theory simply assumed away, such as a manufacturer’s cost of ascertaining the appropriate type and amount of promotion for each dealer’s locality.  Thus, Bork conducted the sort of comparative analysis of alternative contractual mechanisms that today is a hallmark of transaction cost analysis.  Indeed, Bork even went so far as to characterize vertically-imposed exclusive territories as contractual property rights that aligned the interests of manufacturers and dealers, thereby departing from price theory's assumption of fixed property rights. (For additional elaboration on the "property rights" interpretation of intrabrand restraints, go here.)

In short, despite his repeated invocation of "price theory" as the only appropriate source of economic knowledge relevant to antitrust, Bork himself rejected various price-theoretic assumptions and developed tools of transaction cost economics to offer a novel interpretation of various non-standard agreements that price theory's "inhospitality tradition" had condemned.  Instead of functioning as a passive recipient of scientific change, Bork helped initiate such change himself.  Hopefully Bork's contributions to economic science will receive the notoriety they deserve.