Happy Birthday to United States v. Arnold Schwinn & Co., 388 U.S. 365 (1967)!

     

Vox Clamantis in Deserto (circa 1966)

Fifty-three years ago today the Supreme Court released its opinion in United States v. Arnold Schwinn & Co., 388 U.S. 365 (1967).  The decision banned exclusive territories and other non-price intrabrand restraints as unlawful per se, unless the manufacturer that obtained the restrictions retained title to the products governed by the restraint.  Schwinn exemplified the inability of expert enforcement agencies to absorb recent insights from lower court decisions and evolving economic theory necessary to understand the actual economic impact of non-standard contracts.  This post describes the jurisprudential background of Schwinn as well as the role (or not) that evolving economic theory played in motivating and informing the decision.

1.   The Sherman Act prohibits contracts "in restraint of trade of trade or commerce among the several States."  In Standard Oil v. United States, 221 U.S. 1 (1911), the Supreme Court held that the Act prohibits only those agreements that restrain trade "unreasonably."  (For a detailed summary of the Standard Oil decision, go here.)  A restraint was unreasonable, in turn, if it produced monopoly or the consequences of monopoly.  The Court defined these negative consequences as higher prices, reduced output and/or reduced quality.  The Court also identified two categories of unreasonable agreements.  Those unreasonable because of their "nature or character," and those unreasonable because of the "surrounding circumstances."  Modern courts refer to restraints in the first category as "unlawful per se."  Courts assess restraints that are not unlawful per se under a fact-intensive Rule of Reason.

2.     Contracts are unlawful per se if they are part of a category of agreements that: (1) produce a "pernicious effect on competition" and, in addition, (2) "lack any redeeming virtues."  See Northern Pacific Railway Co. v. United States, 356 U.S. 1, 5-6 (1958).   When implementing this standard, the Court has effectively equated a pernicious effect on competition with any reduction in rivalry between the parties to the restraint.  As a result, the outcome of the application of this standard almost always turns on whether restraints in the given category could produce "redeeming virtues."  See Alan J. Meese, Price Theory, Competition and the Rule of Reason, 2003 Illinois L. Rev. 77, 96.   Both mergers and naked price fixing extinguish competitive rivalry.  But mergers survive per se condemnation because they may produce redeeming virtues.

3.   During the 1950s and 1960s, the nation's expert enforcement agencies condemned non-price intrabrand restraints, both horizontal and vertical, regardless of the market position of the parties.  For instance, the FTC challenged exclusive territories obtained by Sandura, a struggling manufacturer of vinal floor covering products.  See Sandura Co. v. FTC, 339 F.2d 847 (6th Cir. 1964).    The Department of Justice challenged exclusive territories and reservations of customers obtained by the White Motor Company.  See White Motor Co. v. United States, 372 U.S. 253 (1963).   Both agencies claimed that such restraints reduced rivalry (as they certainly did) and could not produce redeeming virtues, with the result that both deserved per se condemnation.

       Such restraints would later become known as non-standard contracts, because they did more than just mediate passage of title between buyer and seller.  See Oliver E. Williamson, Assessing Contract, 1 J. L., Econ. & Org. 177, 185-188 (1985) (distinguishing "classical market contracting" from "nonstandard contracts" such as tying, franchise restrictions, customer and territorial restrictions, minimum rpm and exclusive dealing).  The agencies' condemnation of these and other non-standard contracts flowed naturally from the dominant economic framework of the time, so-called Neoclassical Price Theory.  As the late Oliver Williamson explained, Price Theory only recognized technological efficiencies.  By their nature, these efficiencies, such as economies of scale, arose solely within the boundaries of a firm.  This incomplete and erroneous account of efficiencies precluded economists from recognizing that non-standard contracts that limited the discretion of trading partners after passage of title could produce cognizable benefits.   Such agreements all reduce competitive rivalry one way or the other.  Because economists and others could not imagine any beneficial consequences of such restraints, they naturally inferred that firms entered such agreements in an effort to obtain or exercise market power.  Put in legal terms, such agreements had a pernicious effect on competition and lacked any redeeming virtues.  See Northern Pacific Railway Co.  The result was the so-called "Inhospitality Tradition" of antitrust law, whereby courts and agencies presumed all non-standard agreements unlawful and very rarely allowed rebuttal of this presumption.  See Oliver E. Williamson, The Economics of Governance, 95 Amer. Econ. Rev. 1, 5 n. 8 (2005) (describing origins of this term) (citing Alan J. Meese, Intrabrand Restraints and the Theory of the Firm, 83 N.C. L. Rev. 5 (2004))

4.   Beginning in 1960, economists and law professors began to push back against Price Theory's account of non-standard contracts.  In 1960, Lester Telser famously argued that minimum resale price maintenance could prevent a manufacturer's dealers from free riding on each others' promotional expenditures and thus ensuring appropriate expenditures on advertising and promotion.  Six years later, Robert Bork (pictured above) contended that exclusive territories were properly understood as ancillary restraints.  See The Rule of Reason and the Per Se Concept: Price Fixing and Market Division II, 75 Yale L. J. 373 (1966).  This under-appreciated article rehabilitated William Howard Taft's doctrine of ancillary restraints, giving the doctrine economic content within a normative framework of wealth maximization.  See United States v. Addyston Pipe & Steel Co., 85 F. 271 (6th Cir. 1899).   Bork also invoked Ronald Coase's conclusion that business firm are simply a particular form of contractual integration and opined that partial contractual integration could perform the same function as complete integration.  See Bork, Price Fixing and Market Division, 75 Yale L. J. at 384, n. 29 (citing Ronald H. Coase, The Nature of the Firm, 4 Economica (n.s.) 318 (1937)).  See also Alan J. Meese, Robert Bork's Forgotten Role in the Transaction Cost Revolution, 79 Antitrust L. J. 953 (2014).  Fully-integrated manufacturers naturally engaged in profit-maximizing advertising and promotion without incurring antitrust liability.  However, some manufacturers might choose to rely upon independent dealers to distribute their products. Granting such dealers an exclusive territory, Bork said, would allow dealers to capture the benefits of their promotional investments, thereby inducing such dealers to engage in the same amount and type of promotion as a fully-integrated firm.  (For additional elaboration of Bork's contributions to Antitrust thinking, see here).

5.   Even before Bork's breakthrough lawyers were making similar arguments about the propensity of such restraints to produce redeeming virtues.  In White Motors, for instance, the defendants contended that exclusive territories would ensure that "dealers who have spent valuable time 'pre-selling' a customer --- i.e., softening him up for a White sale instead of a GM or Ford sale --- will not lose the legitimate reward of their labor to another White dealer who jumps territorial boundaries at a strategic moment and snatches away the pre-sold customer."  Sandura echoed these contentions in an amicus brief filed in White Motors.  The company described its efforts to recruit new distributors in an effort to reverse competitive failure.  Such distributors, it said, would have to do "an extensive job of promoting [the product]" and "pay for the bulk of advertising and other promotional expenditures." (p. 8)   Exclusive territories, the company said, would ensure that dealers could capture the benefits of such investments.  Id.

6.  These arguments thwarted the agencies' efforts to extend the per se rule to these restraints.  In White Motor the Court refused to the declare the challenged restraints unlawful per se.  Although the Court did not expressly mention the problem of free riding, it did opine that such restraints "may be allowable protections against aggressive competitors or the only practicable means a small company has for breaking into a staying in business."  Id. at 263.   The Court thus rejected the Department's claim that such restraints could never produce redeeming virtues, because it did "not know enough about the economic and business stuff out of which these arrangements emerge to be certain."  Id. at 263.  Instead, it remanded to the district court for additional findings on this question.  Shortly thereafter, in Sandura, the Sixth Circuit rejected the FTC's contentions.  The court observed that "distributors are unwilling to engage in extensive advertising and promotion of a product if the final sales may be made by another distributor."  As a result, it said, the "closed territories made for the vigor and health of Sandura, increasing the competitive good that flows from interbrand competition, without any showing of detriment to intrabrand competition."  Thus, the court said, the Commission's finding that the practice was "without justification or redeeming virtue," was "without support in the evidence."  In his 1966 article, Bork instanced Sandura as the lower court decision that "came nearer to the mark" at understanding the rationale of such restraints than other lower courts that had also rejected per se condemnation.  See Bork, Rule of Reason and the Per Se Concept, 75 Yale L. J. at  433.

7.   A neutral observer in 1967 may have reasonably predicted that the Supreme Court would soon expressly adopt the reasoning of Sandura and hold that non-price intrabrand restraints were subject to rule of reason scrutiny.  But then came Schwinn.  The government claimed that Schwinn had imposed exclusive territories on its wholesalers and also prevented retailers from reselling Schwinn's products to unapproved dealers.  The trial court found that exclusive territories at least were unlawful per se with respect to those products to which Schwinn no longer retained title.  By contrast, when Schwinn did retain title, as with a consignment agreement, such restraints survived per se condemnation and were instead analyzed under the Rule of Reason.  After conducting such an analysis, the court held that the United States had failed to prove that Schwinn's consignment agreements were unreasonable.

      The United States appealed, hoping to overturn the trial court's determination that the consignment restraints were not unreasonable.  Schwinn did not cross-appeal, thereby leaving in place the district court's per se condemnation of exclusive territories governing the disposition of products after title had passed.  Two antitrust all stars helped draft the government's brief: Donald Turner, a Yale-educated economist on leave from Harvard Law School and leading the Antitrust Division, and Richard Posner, a recent Harvard Law School graduate in the Solicitor General's office.  The brief claimed that the restrictions were unreasonable because they limited price competition between wholesalers and retailers without producing any offsetting benefits.  To bolster the claim that no benefits were present, the brief contended that: "integration into distribution may sometimes benefit the economy by leading to cost savings, agreements to retail prices or impose territorial restrictions of limited duration or outlet limitations of the type involved here have never been shown to produce comparable economies." (p. 50).

 8.  It should be noted that the opinion of the Antitrust Division of the Department of Justice was not unanimous.  Instead, Oliver Williamson, a young economist serving as a special assistant to Donald Turner, objected to the Turner/Posner position.  In 1999, Williamson conceded that, despite his objection, he did not have an alternative theory that explained such restraints.  See Oliver E. Williamson, Some Reflections, in Firms, Markets and Hierarchies, 32, 32  (Glenn R. Carrol and David E. Teece, Editors) (1999).  It thus does not seem that Williamson invoked the reasoning of Bork's very recent article on the subject. Unfortunately Turner and Posner persisted despite Williamson's objection.

9.  Schwinn's own brief asserted that it adopted its system so as to "encourage local sales effort by small retailers, including local advertising, salemanship and all forms of promotional advertising, as a competitive weapon against the heavy competitive advertising of large, well-financed mass merchandisers (i.e., Sears, Wards, etc.)."   (p. 94).   It did not, however, contend that dealers would refuse to promote Schwinn's products without exclusivity.    Schwinn mentioned Sandura once in its 114 page brief, and then only as part of a long string cite of decisions that had declined to condemn non-price restraints as unlawful per se.

10.  In a lengthy and sometimes confusing opinion, the Court abandoned White Motors and implicitly rejected the logic of Sandura.  Even though Schwinn had conceded the issue, the Court reached out to opine that exclusive territories are unlawful per se.  The Court did not mention the Northern Pacific Railway test for per se illegality or the concept of redeeming virtues.  Nor did it take issue or even allude to arguments made in White Motor and Sandura that such restraints could encourage dealers to expend sufficient resources on promotion.  Instead, the Court's brief analysis of the question invoked Dr. Miles v. John D. Park & Sons, 220 U.S. 373 (1911), which had banned minimum resale price maintenance.  Exclusive territories and other limits on resale, the Court said, were analogous to minimum rpm and should suffer the same fate.  See Schwinn, 388 U.S. at 378.

11.  It may be difficult to fault the Schwinn Court for failing to recognize and incorporate Bork's analysis.  At the same time, decisions such as Sandura pointed in the right direction.  Moreover, the Court would subsequently expressly ignore Bork's analysis in United States v. Topco, 405 U.S. 596 (1972).

12.  Nonetheless, Schwinn still prevailed.  After a lengthy exegesis, the Court finally turned to the question actually before it, viz., whether the intrabrand restrictions obtained via consignment agreements were unreasonable.  In three paragraphs, the Court affirmed the district court's holding rejecting the government's rule of reason case.  See Schwinn, 388 U.S. at 380-82.  Among other things, the Court noted that Schwinn's market share was declining in the face of stiff competition, including from mass merchandisers, the agreements allowed dealers to carry competing brands of bicycles, and consumers had access to bicycles sold to numerous competitors.  At the same time, the Court's analysis left the reader wondering how, exactly, the restraints themselves helped bolster Schwinn's competitive position vis a vis rivals.

13.  The Schwinn opinion sowed the seeds for future critiques.  For instance, the Court did not articulate the methodology it employed to determine whether restraints are unlawful per se.  Nor did the Court explain why that (unexplained) methodology treated the passage of title as dispositive.  Finally, the Court's rule of reason analysis rested in part on an assumption that furthering interbrand competition is a redeeming virtue, thus raising the possibility that other restraints that might produce such benefits would thereby avoid per se condemnation.

Stay tuned for "the rest of the story."

Contra Chemerinsky on "Original Intent:" Why the Constitution’s Original Meaning Does Not Preclude a Female President

Explained Why the Constitution is Binding

Rejected "Original Intent" in favor of "Original Public Meaning"

Qualified to Be President Under Article II, Sec. 1, cl. 5

In a recent Op-Ed in the Sacramento Bee, Erwin Chemerinsky, the Dean of Berkeley Law School, criticizes Judge Brett Kavanaugh, President Trump's nominee for the U.S. Supreme Court, for his adherence to originalism as a method of interpretation.   Invoking Chief Justice John Marshall's statement that "the Constitution must be adapted for ages to come," Chemerinsky claims that "orginalism is bad for justice."  He elaborates as follows:

"If constitutional interpretation must follow the specific intentions of the framers, the results often will be unacceptable. . . . For example, Article II refers to the President and the Vice President as 'he.'  The framers undoubtedly intended that those holding these offices would be men."

Chemerinsky is wrong in three different ways.  First, he badly misdescribes the methodology of originalism.  Second, election of a female president would in no way contradict the original meaning of the Constitution.  Third, originalism does not prevent adaption of the Constitution to new circumstances. 

First, proponents of originalism expressly and repeatedly reject the "specific intentions of the framers" as the goal of interpretation. Instead, originalism seeks to discern and enforce the "original public meaning" of statutory and constitutional texts.  More than two decades ago, Justice Antonin Scalia (pictured above), delivering the Tanner Lecture at Princeton University, rejected the claim that judges should "give effect to the 'intent of the legislature.'"  Instead, he said, Judges should seek the objective meaning of the text that the legislature actually enacted.  Thus, he quoted with approval the statement by Justice Holmes, subsequently approved by Justice Robert Jackson, that "[w]e do not inquire what the legislature meant; we ask only what the statute means."   See Antonin Scalia, A Matter of Interpretation, 16, 23 (Princeton 1997).  See also Oliver Wendell Holmes, Collected Legal Papers, 207 (1920), quoted in Schegman Bros. v. Calvert Distillers Corp., 341 U.S. 384, 397 (1951) (Jackson, J., concurring).  In the same lecture, Justice Scalia endorsed the very same approach to constitutional interpretation.  See Scalia, A Matter of Interpretation, at 38 ("What I look for in the Constitution is precisely what I look for in a statute: the original meaning of the text, not what the original draftsmen intended.") (emphasis supplied).

The original meaning approach to Constitutional interpretation follows directly from the rationale for treating the Constitution as binding on future generations, a rationale that Chief Justice John Marshall (pictured above) articulated in Marbury v. Madison, 5 U.S. 137, 176-77 (1803).  According the Marshall:

"That the People have an original right to establish for their future government such principles as, in their opinion, shall most conduce to their own happiness, is the basis upon which the whole American fabric has been erected.  The exercise of this original right is a very great exertion; nor can it nor ought it be frequently repeated.  The principles, therefore, so established are deemed fundamental.  And, as the authority from which they proceed, is supreme, and can seldom act, they are designed to be permanent.

This original and supreme will organizes the government and assigns to different departments their respective powers.  It may either stop there or establish certain limits not to be transcended by those departments.

The government of the United States is of the latter description.  The powers of the legislature are defined and limited; and that those powers may not be mistaken or forgotten, the Constitution is written.  To what purpose are powers limited, and to what purposes are those powers committed to writing, if these limits may at any time be surpassed by those intended to be restrained?"

. . . . The Constitution is either a superior, paramount law, unchangeable by ordinary means, or it is on a level with ordinary legislative acts, and, like other acts, is alterable whenever the legislature shall choose to alter it.."

Thus, the Constitution is binding because the People, the ultimate repository of sovereignty, adopted it, enacting permanent, fundamental principles that both empower but also limit the Congress, the President, and Judges.  Judges who invoke the Constitution as the source of their authority must adhere to the document as written, thereby enforcing the instrument's fundamental and permanent principles.  To do so, of course, Judges must discern what the document meant to those who possessed and exercised the authority to bind others, namely, the People. Refusal to enforce such principles because a judge considers them "unacceptable" repudiates the only legitimate source of judicial authority and is thus lawless.

Second, there may well be instances in which enforcing the original meaning of the Constitution produces results with which most Americans might disagree.   Happily, the gender of the President is not such an instance, with the result that outstanding candidates such as Nikki Haley, pictured above, are eligible.

It may well be that the Framers and Ratifiers assumed or even intended that Presidents and Vice Presidents would be male, Protestant landowners.  But they did not enact these assumptions or intentions into law.  Article II, Section 1, Clause 5 of the Constitution, aptly known as the "Qualifications Clause," defines the qualifications for holding the office of President.  

"No person, except a natural born citizen, or a citizen of the United States, at the time of the adoption of this constitution, shall be eligible to the office of President; neither shall any person be eligible to that office who shall not have attained to the age of thirty five years, and have been fourteen years a resident of the United States."

Under the "plain meaning" of this provision, women, Catholics, and/or merchants, all of whom are "persons," are eligible to be President.  Had the Framers and Ratifiers wished to exclude women, they could have included a clause limiting the Presidency to men, in the same way they precisely limited the office to certain citizens of the United States and persons 35 or older.  They did not, however, include any such restriction.  

What, though, about the use of the pronoun "he" to describe the length of the President's term in office, for instance?  ("He shall hold his office during the term of four years[.])"   Does this use create an additional qualification, outside the qualifications clause?  Of course not. 

It is standard English convention to employ purportedly "masculine" pronouns to refer to a category of persons that includes both men and women.  In these circumstances the apparently masculine pronoun in fact functions as a generic pronoun, akin to "they." See e.g. R.W. Burchfield, The New Fowler's Modern English Usage (3d ed. Oxford) ("From the earliest times until about the 1960s it was unquestionably acceptable to use the pronoun he (and him, himself, his) with indefinite reference to mean anyone, a person (of either sex)."); Oliver Strunk and E.B. White, The Elements of Style,  60 (1979) ("The use of he as pronoun for nouns embracing both genders is a simple, practical convention rooted in the beginnings of the English language. He has lost all suggestions of maleness in these circumstances.") (emphasis in original).  None of this is to say that "he" always functions as a generic pronoun.  The actual meaning will always depend upon context.  The most relevant context, of course, is the actual definition of the President's qualifications, which employs the generic term "person," instead of "man."  In short, use of the potentially and commonly generic pronoun "he" did not alter the plain meaning of "person" in the Qualifications Clause.

Indeed, Justice Scalia and Brian Garner addressed the original meaning of the pronoun "he" in Article II, in their leading text on legal interpretation:

"In the Constitution the President is referred to many times with the pronouns he, him, and his.  These references, by common grammatical understanding, refer to a President of either sex."

See Antonin Scalia and Brian Garner, Reading Law: The Interpretation of Legal Texts, 129 (2012).  They cite, for instance, Peter Bullions, The Principles of English Grammar (13th Ed. 1845) ("[T]he masculine term has also a general meaning, expressing both male and female, and is always to be used when the office, occupation, profession, etc., and not the sex of the individual, is chiefly to be expressed.").

In the same way, Latin employs masculine nouns or pronouns to refer to groups that include both men and women.  Indeed, the front page of Berkeley Law School's own website repeatedly refers to the school's "Alumni," the plural form of a Latin second declension masculine noun.  In so doing, the school presumably does not mean to exclude its female graduates!

Third, the original meaning approach to interpretation in no way prevents adaptation of the Constitution "for ages to come."   As previously explained on this blog, the Constitution does not necessarily enshrine particular results.  Instead, as Marshall explained in Marbury, the document often articulates fundamental and permanent principles. Thus, as the Supreme Court explained more than eight decades ago, changes external to the Constitution can compel courts to sustain legislation once deemed unconstitutional or invalidate legislation once thought perfectly constitutional.  

"While the meaning of constitutional guarantees never varies, the scope of their application must expand or contract to meet the new and different conditions which are constantly coming within their field of operation.   In a changing world, it is impossible that it should be otherwise.  But although a degree of elasticity is thus imparted not to the meaning, but to the application of constitutional principles, statutes and ordinances which, after giving due weight to the new conditions, are found clearly not to conform to the Constitution of course must fail."

See Village of Euclid v. Amber Realty, 272 U.S. 365 (1926).

More recently Justice Scalia explained that changes in technology, external to the Court, can require changed application of the Fourth Amendment's ban on unreasonable searches.  The common law principles that animate the Amendment remain constant and unchanged, e.g., police can only hold a suspect so long as reasonably necessary to bring the individual before a magistrate for a probable cause determination.  While that period may have been 72 hours in 1791, the reasonable period today, the Justice said "is obviously a function of helicopters and telephones" and thus, he said, 24 hours.  See County of Riverside v. McGlaughlin, 500 U.S. 44, 62 n. 1 (1991) (Scalia, J. dissenting). 

In short, Originalism survives Dean Chemerinsky's critique entirely unscathed. 

Kansas Gets it Right on Minimum RPM

 

Embracing Economic Science

 

Kansas Governor Sam Brownback  recently signed legislation reforming the state's approach to minimum resale price maintenance ("minimum rpm"), thereby conforming the law to the dictates of modern economic science.  (The legislation appears here. An official summary appears here.)  The legislation in question amended the state's Restraint of Trade Act to make it clear that the Act only forbids unreasonable restraints of trade, thereby incorporating into Kansas law the sort of "Rule of Reason" that the U.S. Supreme Court read into Section 1 of the federal Sherman Act in Standard Oil v. United States, 221 U.S. 1 (1911). In so doing, the new statute nullfied the Kansas Supreme Court's recent decision in O'brien v. Leegin Creative Leather Products, 277 P.3d 1062 (Kansas 2012), which had held that the state's Restraint of Trade Act bans any and all minimum rpm agreements, regardless whether the contract is reasonable in a particular case.     

 

The O'brien decision would have made perfect sense as a matter of antitrust policy in, say, 1950.  At that time economists and others were hostile to so-called "non-standard contracts," that is, agreements that limited the autonomy of dealers and others who purchased and took title to a manufacturer's product.  This hostility followed naturally from the state of economic learning at the time. For, as previously explained on this blog, during this era economists and others believed that complete or partial vertical integration could serve only two purposes: first, the realization of technological efficiencies and second, the creation or exercise of market power, by depriving rivals of sources of inputs or otherwise stifling competition.  Because minimum rpm and other non-standard agreements reached across the boundaries of one firm to dictate decisions by other firms, sometimes in other states, such agreements could not produce technological efficiencies.  As a result, economists and others inferred that such agreements, which reduced rivalry, necessarily fortified or exercised market power to the detriment of society's consumers.  The result was the so-called "inhospitality tradition" of antitrust law.  (See pp. 68-80  of this article for a more detailed explanation of the origins of the inhospitality tradition.) 

In 1960, however, everything changed.  In a path-breaking article, Professor Lester Telser explained how minimum rpm could prevent a manufacturer's dealers from free-riding on each others' promotional expenditures, thereby overcoming the market failure that would result if each dealer was left to his or her own discretion when determining promotional tactics. See Lester G. Telser, Why Should Manufacturers Want Fair Trade?, 3 J. L. & Econ. 86 (1960).  Six years later, and as previously recounted on this blog, Robert Bork reiterated Telser's argument and extended Telser's reasoning to non-price vertical restraints such as market division as well as horizontal price and non-price restraints that are ancillary to otherwise legitimate joint ventures. See Robert H. Bork, The Rule of Reason and the Per Se Concept: Price Fixing and Market Division, part II, 75 Yale L. J. 373 (1966).  (See also here,  here, and here for this blogger's views on the appropriate characterization and treatment of such restraints)   

The Supreme Court eventually took these lessons to heart.  Thus, in 1977, the Court, citing Bork and others, overruled a prior decision that had banned non-price vertical restraints such as exclusive territories.   See Continental T.V. v. GTE Sylvania, 433 U.S. 36 (1977).  Two decades later, the Court, again citing Bork and others, overruled a previous decision condemning maximum rpm as unlawful per se. See State Oil v. Khan, 522 U.S. 3 (1997).  Finally, in Leegin Creative Leather Products v. PSKS, 551 U.S. (2007), the Court overruled Dr. Miles v. John D. Park & Sons, 220 U.S.373 (1911), which had banned minimum rpm outright.  Writing for the Court, Justice Kennedy persuasively explained that Dr. Miles was based upon an economic misconception, namely, that manufacturer-imposed minimum rpm is economically indistinguishable from a horizontal cartel among the dealers of a manufacturer's product.  Relying upon the work of Bork, Telser and others, Justice Kennedy explained that, instead, manufacturer-imposed minimum rpm often produces significant efficiencies, by, among other things, preventing free-riding and thus ensuring an optimal amount of promotional expenditures, with the result that per se condemnation of the practice is not justified.  In so doing, the Court followed Standard Oil's requirement that courts employ "reason" to adjust antitrust doctrine in light of "more accurate economic conceptions," that is, advances in economic science.

Of course, the Supreme Court's Leegin decision only governed the federal Sherman Act, which generally does not preempt more interventionist state antitrust regulation, no matter how ill-advised.  Thus, Leegin left states perfectly free to ban minimum rpm as unlawful per se under their own antitrust laws, as some have, thereby reducing the welfare of a state's consumers.  Perhaps Kansas law left the O'brien court with little choice but to reaffirm such a per se ban in 2012.  Be that as it may, the people of Kansas are fortunate to have a legislature apparently committed to conforming the state's antitrust law to the dictates of economic science.

Happy Birthday, Ronald Coase

102 Years Young

This Blogger wishes Ronald Coase, Professor Emeritus at the University of Chicago Law School, a happy birthday.  Born in 1910, Coase is 102 years old today.  As many readers know, Coase received the Nobel Prize in Economic Sciences in 1991.  Here is an excerpt from the Royal Swedish Academy's Press Release announcing the award:

"Coase showed that traditional basic microeconomic theory was incomplete because it only included production and transport costs, whereas it neglected the costs of entering into and executing contracts and managing organizations.  Such costs are commonly known as transaction costs and they account for a considerable share of the total use of resources in the economy.  Thus, traditional theory had not embodied all of the restrictions which bind the allocations of economic agents.  When transaction costs are taken into account, it turns out that the existence of firms, different corporate forms, variations in contract arrangements, the structure of the financial system and even fundamental features of the legal system can be given relatively simple explanations.  By incorporating different types of transaction costs, Coase paved the way for a systematic analysis of institutions in the economic system and their significance."

Coase’s work is the foundation of what modern scholars call “Transaction Cost Economics “ (“TCE” for short).  Coase began that work in 1937, with his now famous article “The Nature of the Firm.” As explained in a previous post, TCE eventually revolutionized antitrust law and policy, by altering how economists viewed both complete vertical integration and partial contractual integration via non-standard contracts such as exclusive dealing, minimum resale price maintenance, exclusive territories,  location clauses and tying agreements.  When Coase published "The Nature of the Firm," economists identified two, and only two, possible reasons for complete vertical integration.  First, such integration could create technological efficiencies and thus reduce production costs.  Second, integration could foreclose rivals from important  sources of inputs, thereby creating or fortifying the integrating party's market power.  Thus, when economists, or, for that matter, antitrust courts or enforcement agencies, could not identify any efficiency purposes for such integration, they naturally inferred that the conduct was anticompetitive.  The result was the so-called "inhospitality tradition" of antitrust law.

Coase's work and the resulting transaction cost revolution completely undermined these accounts of complete and partial integration.  According to Coase, reliance upon an unfettered market to conduct economic activity entailed various costs, what he dubbed "transaction costs."  By integrating vertically, then, a firm could avoid such transaction costs.  As Coase noted at the time, this explanation had nothing to do with market power or monopoly considerations.  Nor did this explanation depend upon any reduction in technological production costs.

Unfortunately Coase's work lay dormant for three decades, during which time antitrust courts and the enforcement agencies became increasingly hostile to complete and partial vertical integration.  During the mid-1960s, economists and others began to rediscover Coase's 1937 work, perhaps inspired to do so by Coase's "Problem of Social Cost," published in 1960.  Most famously, Oliver Williamson began to rearticulate and expand upon Coase's transaction cost thesis.  In particular, Williamson identified specific investments and the resulting threat of opportunism as an important source of transaction costs.  Moreover, during the same decade, Robert Bork cited Coase's Nature of the Firm in his 1966 work on the Sherman Act's treatment of non-standard contracts.  In particular, Bork explained why various forms of partial integration could align the interests and incentives of the contracting parties, thereby accomplishing the same economic objectives through partial integration that economic actors might otherwise achieve via complete vertical integration.  Most famously, building on the work of Lester Telser (who had not cited Coase), Bork argued that minimum resale price maintenance and non-price restraints such as exclusive territories and location clauses could ensure that independent dealers made optimal investments in promotional effort, thereby facilitating a manufacturer's strategy of relying upon a system of independent dealers to distribute the manufacturer's product.  As previously explained on this blog, this work, along with additional work by Bork and others, convinced the Supreme Court to repudiate numerous decisions from the inhospitality era.