How to Monitor Apple's Monitor

Suspicious of Monitors

 

Section 1 of the Sherman Act forbids "contracts in restraint of trade or commerce among the several states," while Section 2 forbids  "monopolization" and "attempts to monopolize."  The Act also requires the Department of Justice to enforce the Act, by seeking, where applicable, equitable and legal relief in U.S. District Courts against firms and individuals who have violated the Act's provisions.  It appears that the Department may have used this authority to impose, no doubt inadvertently, the very type of monopoly pricing the Sherman Act was designed to prevent.

This last July the United States prevailed in a civil suit that challenged Apple's alleged agreements with book publishers to maintain e-book prices above the levels that unbridled competition would produce.  Among other forms of relief, the United States sought and obtained from the U.S. District Court for the Southern District of New York the appointment of a so-called "External Compliance Monitor," in addition to a new "Internal Compliance Officer," both, of course, at Apple's expense.  The final judgment requiring these appointments did not provide for competitive bidding to set the fees of either monitor but instead simply provided that the monitors would charge a "reasonable" fee. 

In paper's filed the day before Thanksgiving, Apple informed the court that the External Monitor, charged with ensuring that Apple comply with the antitrust laws, is himself charging Apple $1,100 per hour, as well as an "administrative fee" of fifteen percent, for a total of $1265 per hour.  Apple claims that it has never paid such high legal fees.  (See here for a more detailed summary of Apple's objections.)

If Apple's assertions are correct, the government's insistence on such a monitor on the terms described above is supremely ironic.   After all, as explained in previous posts (see  here and here), the whole point of the Sherman Act and its Rule of Reason as articulated in Standard Oil v. United States, 221 U.S. 1 (1911) is to prevent contracts (Section 1) or other practices (Section 2) that produce or maintain monopoly or the consequences of monopoly, without any offsetting efficiency benefits.  These consequences, of course, include prices above those that a competitive market would produce.  By winning the appointment of an External Monitor, against Apple's will and without competitive bidding, the Department of Justice has created conditions conducive to the very sort of competitive harm the Sherman Act was designed to prevent.  To be sure, the monitor's fees cannot themselves violate the Sherman Act, which only regulates "trade or commerce among the several states."  Like the Commerce Clause itself, the Act assumes the existence of pre-existing commerce  that parties might restrain. (See also here and here).  The District Court's coercive (but apparently legal) requirement that Apple purchase legal services against its will does not seem to qualify as such commerce.  Moreover, the terms of the final judgment would authorize Apple to seek a judicial determination that the External Monitor's fee is unreasonable.    However, as William Howard Taft explained long ago in his most famous judicial decision, see Addyston Pipe and Steel Co. v. United States, 85 F. 271 (6th Cir. 1898) (Taft, J.),  judicial oversight of pricing decisions is a poor substitute for the determination of such prices by a competitive market, there competitive bidding by pipe producers.  Judges who take on this task, Taft said, "set sail on a sea of doubt," and rely upon their own "vague and varying opinions" regarding "how much, based on principles of political economy, men ought to be allowed to restrain competition."  See id. at 282-84.  See also National Society of Professional Engineers v. United States, 435 U.S. 679, 692-94 (1978) (describing competitive harm resulting from horizontal agreement not to engage in competitive bidding).

This Blogger has no doubt that the court-appointed External Monitor is a superb attorney who is highly-qualified to perform the duties described in the final judgment.  Moreover, there is no indication that, in setting his fee, the External Monitor has acted in anything other than complete good faith.   Nonetheless, as the Roman poet Juvenal (pictured above) asked, admittedly in a different context, "sed quis custodient ipsos custodes," viz. "who will monitor the monitors themselves?"  The best such monitor, as William Howard Taft explained, is competition.     

Don't "Plan" The Colorado River or Why Property Still Works

Bound For Los Angeles? 

Had a Better Idea

Yesterday's Los Angeles Times reported that "[w]ater demand in the Colorado River Basin will greatly outstrip supply in coming decades as a result of drought, climate change and population growth."  The story is based on a recent study by the U.S. Department of the Interior, which concludes that demand for the river's water will exceed supply by 3.2 million acre-feet per year in 2060.  According to the story, 3.2 million acre-feet is more than five times the current annual consumption of water by Los Angeles and its citizens.  The story concludes by discussing various possible responses to such a shortage.  Such responses include conservation, recycling, desalinization, building a pipeline from the Missouri River to Southern California, or towing icebergs from the Arctic Ocean to Southern California.  Interior Secretary Ken Salazar admonished all those who rely on water from the Colorado to "plan for this together."  

With due respect to Secretary Salazar, little or no planning is necessary.   Such a "shortage" is the natural and predictable result of the failure to establish property rights in a resource, a failure that results in below-market prices and thus artificially high demand and overuse by those, including agribusinesses, who do not internalize the full social cost of using the resource.  As one leading scholar has explained: "[w]ell-defined and defended property rights encourage greater resources stewardship and sustainable utilization."  See Jonathan Adler, Water Rights, Markets and Changing Ecological Conditions, 42 Environmental Law Review 93 (2012).  Thus, a well-functioning market for water from the Colorado River and elsewhere would result in prices that reflect the actual social cost of that water and thus a more efficient allocation of this precious resource.

At first glance it seems more difficult to establish property rights in water than in other items such as automobiles, I-Phones or candy bars.  After all, it's one thing to own a pickup truck; quite another to own a river.  And yet, auctioning off the Colorado River might be just the solution to this purported "shortage."  Such an auction would create a single owner of all the water in the river, and this owner would then charge a market price for the water in question, a price that would bring demand and supply into equilibrium and thus eliminate any artificial shortage.  In such a market, consumers would only purchase water when their personal value for the water equaled its true social cost.  Moreover, such consumers would have incentives to conserve water in any number of ways.  For instance, farmers might choose to plant crops that are less water-intensive, even if such crops are slightly less valuable.  Fewer citizens would purchase swimming pools, and some would forgo grass lawns for the sort of faux desert landscapes, complete with rocks, cacti and palm trees, already popular in the Southwest.

Without any planning whatsoever, then, the creation of property rights in the Colorado's water would encourage conservation and result in a more efficient allocation of this scarce resource.  As F.A. Hayek explained more than six decades ago, the price system is a "marvel" that transmits information about the value of competing uses of particular resources to various market participants.  Thus, different possible purchasers of water need know nothing about how or why other purchasers might use water, as the market price will reflect values that other market participants place on that use.  See F.A. Hayek, The Use of Knowledge in Society, 35 American Econ. Rev. 519 (1945).   Moreover, as Hayek explained in subsequent work, the creation and enforcement of well-defined property rights is a necessary condition for a well-functioning price system.   See F.A. Hayek, Free Enterprise and Competitive Order in Individualism and Economic Order, 110-16 (1948) (explaining that well-functioning competitive order depends upon properly-designed “legal framework” of contract, property, tort, and business law).  Thus, granting the Colorado's water to a single owner would facilitate the operation of a well-functioning price system and thus help optimize the allocation of water resources. 

 
Some might object that this hypothetical single owner of the Colorado River would reduce output below the socially optimal level and charge monopoly prices for the river's water.  There are, however, there distinct reasons that this possibility is less problematic than it might first seem.

First, even if such a single owner did reduce water output below the socially optimal level, such a (negative) deviation from the optimal output of water may do less social harm than the current regime, under which firms and individuals consume too much water, thereby resulting in artificial shortages.  All institutions are imperfect; as Ronald Coase explained over two decades ago, society must choose between various imperfect institutional arrangements.  Perhaps granting a monopoly over the Colorado's water would be the least imperfect means of allocating this resource.

Second, any claim that a monopolist will produce well below the optimal level of output assumes that the river's single owner will change the same price per gallon to all purchasers, that is, will not engage in price discrimination.  If, however, the firm does engage in price discrimination, albeit imperfect discrimination, it will be able to set output closer to the socially optimal level.  While such a firm would earn excessive profits, a properly-run and competitive auction would force the firm to pay the expected value of such profits to the national government, which could use these proceeds to reduce taxes or take other steps that would mitigate the distributional consequences of such monopoly pricing.

Third and finally, any claim of monopoly is likely overstated.  After all, the Colorado river is not the only source of water for many of the firms and individuals that currently draw water from it.  Indeed, one suspects that the current and artificially low price for the Colorado's water has discouraged firms and individuals from seeking out alternate sources.  Thus, creation of a single owner of the Colorado's water, by increasing prices closer to market levels, may actually spur users to identify competing sources of water.  If a single owner really did end up with meaningful monopoly power, the national government could consider allocating particular shares of the river's output to several sellers, who could then compete to sell the water to purchasers.

Don't look for the national government to sell off the Colorado River any time soon.  The proposal may have additional downsides not discussed here.  Moreover, the national government may have to pay just compensation to individuals who currently possess property rights to particular amounts of water under state law, for instance.  Finally, political pressure from those who benefit from the current system would prevent the sort of major reform suggested here.  Still, imagining such a radical, property-based solution could be the first step toward meaningful reform that would eliminate artificial shortages and thus obviate the need for schemes like towing icebergs to Los Angeles.

Are Public Universities Like UVA Charging Monopoly Prices?

Actual Monopolist.  See United States v. Standard Oil, 221 U.S. 1 (1911).

Not a Monopolist

Earlier this week Peter Morici, an economist at the University of Maryland, opined that public universities like the University of Virginia are exercising monopoly power to drive up prices, thereby depriving numerous students of access to a high quality education.   As he puts it:

"High-quality universities have become too expensive and increasingly inaccessible because their presidents and other top leaders have failed to recognize and address the challenges and opportunities posed to their institutions by new technologies. . . . Too many well qualified applicants [for admission] are turned away, because the US population has grown much more rapidly that the residential model of higher education can accommodate. Monopoly power permits these institutions to unnecessarily run up costs, charge unconscionable tuition and afford faculty cosseted lives, whose teaching and research is becoming increasingly less relevant and responsive to our society’s needs."

Morici goes on to argue that schools should make better use of new technology to reduce the cost of providing a college education.

As a result, he said, the Board of Visitors at the University of Virginia got it right when it demanded that Teresa Sullivan, pictured above, resign.

While Morici's argument is directed to the situation at UVA, it has implications for many other public institutions of higher education as well.  Moreover, Morici's claim that UVA and similar public institutions are exercising monopoly power and gouging their citizens or, for that matter, out-of-state students, does not withstand cursory analysis.  On the contrary, every indication is that the University of Virginia, like some other Virginia universities, is providing a high quality education at a reasonable price (or lower).

1.  Schools like UVA seem to be doing something right.  As previously reported on this blog, the school received over 28,000 applications for admission to the undergraduate program, with an entering class of about 3,500, last year, a record.  Thousands of these applications came from out-of-state and around the world, despite the fact that UVA's out-ot-state tuition is over $38,000 per year.  Each of these applications is voluntary; no one compells anyone to apply to or attend UVA.  UVA is not the only public university experiencing record applications.  For instance, for the seventh year in a row, William and Mary received a record number of applications --- 13,600 applications for an entering undergraduate class of just under 1500.

2.   To be sure, the mere fact that consumers are purchasing a product voluntarily does not thereby exclude the possibility that they are purchasing from a monopolist.  There is, however, no indication that UVA is exercising monopoly power, unlike John D. Rockefeller, founder of the Standard Oil Company, pictured above.  As the Supreme Court explained in Standard Oil v. United States, 221 U.S. 1 (1911), the hallmark of monopoly and the exercise of monopoly power is output reduction and pricing above the cost of production.  However, in the past four decades, UVA has quadrupled its output, from just over 5,000 students in 1960 to over 20,000 students in 2010.  Recently, the school announced that it is increasing its enrollment further, adding 1,500 students over the next five years.   Moreover, the school's "sticker price" is $12,224 in tuition and fees per Virginia resident., far less than the actual cost of educating a UVA student.    (The state of Virginia provides a subsidy of over $8,000 per in-state student at UVA, and UVA's endowment and annual giving provide further support as well, thereby allowing UVA to charge prices that are below cost.)   A firm  that is increasing output and charging consumers less than its costs of production is not exercising monopoly power.

3.  Indeed, the "sticker price" at UVA overstates the actual cost of attendance for many students.  For instance, under the school's "Access UVA" program, students from families earning $75,000 or less pay a price of zero to attend UVA, that is, receive a UVA education (including room and board) for free.  Morici does not mention Access UVA and similar programs in place at other public universities when he claims that high tuition is depriving students access to college.

4.  Of course, out-of-state students pay much higher tuition and fees than in-state students, as noted above.  But here again, it is difficult to attribute this higher price to market power.   Like other nationally-prominent universities, UVA participates in a highly competitive market for out of state students.  An out-of-state student who can gain admittance to UVA can likely gain admittance to many other top quality schools, such as Notre Dame, Boston College, Emory, Georgetown, William and Mary, Cornell or the University of Pennsylvania, just to name a few.  An institution with so many competitors is hardly a "monopolist." 

5.   If UVA really is exercising monopoly power, then that exercise creates a market opportunity for other institutions, including for-profit online universities.  Such institutions could enter the market and attract customers who might otherwise attend UVA by charging lower tuition for a high quality product.  Indeed, such institutions, such as the University of Phoenix, already exist.  If more reliance on online education is the answer, then applications to UVA, William and Mary and other Virginia schools will begin to fall, as students forsake these schools for the likes of the University of Phoenix.  So far, the opposite seems to be occuring, thereby further contradicting Morici's argument.